Business Economics Questions and Answers

Answer: B

Normally the demand curve slopes downwards from left to right.

The law of demand says that, other things being equal, the quantity demanded rises as price falls and falls as price rises. Plotted with price on the Y-axis and quantity on the X-axis, this inverse relationship gives a curve sloping down to the right. It reflects the substitution effect, the income effect and diminishing marginal utility.

An upward-sloping curve occurs only in exceptional cases such as Giffen goods. A horizontal curve shows perfectly elastic demand and a vertical curve perfectly inelastic demand, both theoretical extremes rather than normal conditions.

Answer: D

It is highly elastic demand.

Price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. When quantity responds more than proportionately, the elasticity is greater than 1, which is described as relatively or highly elastic demand. A 10 per cent cut in price raising sales by 25 per cent is an example.

Unitary elastic demand responds exactly in proportion (elasticity equal to 1). Perfectly elastic demand (infinite elasticity) and perfectly inelastic demand (zero elasticity) are the two theoretical extremes, not a response 'more than proportionate'.

Answer: C

The law of variable proportions applies in the short period.

The law describes what happens to output when one factor, such as labour, is increased while at least one other factor, such as land or machinery, is held fixed. Total product first rises at an increasing rate, then at a diminishing rate, and finally falls. Holding some factors fixed is possible only in the short run.

In the long and very long period all factors can be varied, and the relevant law is returns to scale. In the market period supply is fixed and production cannot be changed at all.

Answer: A

Average variable cost initially falls, then continues to rise.

AVC is total variable cost divided by output. As output first expands, the variable factors are used more efficiently with the fixed plant, so AVC falls. Beyond a point diminishing returns set in and AVC rises, giving the familiar U-shaped curve, whose minimum the marginal cost curve cuts from below.

AVC does not remain unchanged. It does not go on continuously falling; that describes average fixed cost, which falls as the fixed total is spread over more units. Nor does it rise from the start, which would ignore the early efficiency gains.

Answer: A

Goods with a negative cross elasticity of demand are complements.

Cross elasticity measures how the quantity demanded of good X responds to a change in the price of good Y:

\[ e_{xy} = \frac{\%\ \Delta Q_{x}}{\%\ \Delta P_{y}} \]

For complements such as cars and petrol, a rise in the price of one reduces the demand for both, so the sign is negative. For substitutes such as tea and coffee, a rise in the price of one raises the demand for the other, so the sign is positive. Luxuries are defined by a high income elasticity, and consumer goods is a broad class, so neither is identified by the sign of cross elasticity.

Answer: C

The budget line shifts upwards to the right.

The budget line shows all the combinations of two goods a consumer can buy with a given income at given prices. Its slope is the ratio of the two prices. If income rises while prices stay the same, the consumer can buy more of both goods, so the line moves outward parallel to itself, away from the origin, and the intercepts on both axes increase.

A shift backwards to the left would follow a fall in income. The line would stay unchanged only if income and prices were unchanged. It would become vertical only if the price of the good on the vertical axis became infinitely high, which has nothing to do with income.

Answer: D

Marginal utility is calculated as \(TU_{n} - TU_{n-1}\).

Marginal utility is the addition to total utility from consuming one more unit of a good. It is therefore the total utility after n units minus the total utility after n - 1 units. If total utility is 30 after three cups of tea and 36 after four, the marginal utility of the fourth cup is 36 - 30 = 6.

The other formulas give different quantities. TU/N is average utility, the total divided by the number of units. AU × N multiplies average utility back up to total utility. TU - AU has no economic meaning and does not give the utility of the extra unit.

Answer: A

The key's answer is that a rising MC will pull the average cost (AC) up.

This rests on the relation between marginal and average values: when the marginal cost of an extra unit is above the average cost, adding that unit raises the average; when it is below, it lowers the average. As output expands, MC eventually rises and crosses AC at the minimum point of AC, after which the rising MC lies above AC and pulls it upwards, which is the textbook reading the key adopts.

Strictly, MC can be rising while still below AC, just before the minimum of AC, and there AC still falls; the question takes the stretch beyond the crossing point. The other options are wrong in any case: a rising MC never pushes AC down once it is above AC, it does not 'split' AC, and AC is never unaffected by MC.

Answer: C

The one that is not a basic economic problem is What to consume ?

Every economy faces scarcity and must answer three central questions: what to produce (which goods and in what quantities), how to produce (which technique and combination of resources), and for whom to produce (how output is distributed).

What to consume is a choice for individual households once output exists. It is not one of the three basic problems of an economy, which is why it is the answer.

Answer: B

The key gives the income effect.

A change in the price of a good works through two channels. The substitution effect is the change in the quantity bought because the good has become relatively cheaper or dearer than others; it always moves against the price, so it is negative for every good. The income effect is the change because the price change alters the buyer's real income. For a superior (normal) good a price rise lowers real income and the quantity demanded falls, so the income effect moves against the price and is called negative.

For an inferior good the income effect has the opposite sign, and for a Giffen good it outweighs the substitution effect. That is why the sentence "is negative for superior goods" is a statement about the income effect: its sign depends on the kind of good, while the substitution effect is negative whatever the good. The substitution effect, option C, is also negative for superior goods, but the phrase singles out the effect whose sign depends on the type of good, and that is the reason the key chooses the income effect. The price effect is the total of the two, and inflation is not an effect of this kind.