Business Economics Questions and Answers

Answer: C

Moving down a straight-line demand curve, price elasticity Decreases.

On a linear demand curve the slope \(\Delta Q/\Delta P\) is the same everywhere, but elasticity is

\[ e = \frac{\Delta Q}{\Delta P} \times \frac{P}{Q} \]

Moving down the curve, price falls and quantity rises, so the ratio P/Q falls and elasticity falls with it. It is infinite where the line meets the price axis, unity at the midpoint and zero where it meets the quantity axis.

'Remains constant' confuses constant slope with constant elasticity; only a rectangular hyperbola has constant elasticity. 'Increases' gets the direction wrong, and 'multiplies' is not a description of elasticity at all.

Answer: D

When elasticity of demand is one, MR = 0 and AR \(\gt\) 0.

Marginal revenue is linked to average revenue (price) by the formula

\[ MR = AR \left(1 - \frac{1}{e}\right) \]

With e = 1 the bracket is zero, so MR = 0, while price (AR) is still positive. This is the point of maximum total revenue, at the midpoint of a straight-line demand curve.

MR \(\gt\) 0 holds only when demand is elastic (e \(\gt\) 1), and MR \(\lt\) 0 when demand is inelastic; AR = 0 would mean a zero price. MR = AR happens only when demand is perfectly elastic, as for a firm in perfect competition.

Answer: D

The item that is not an assumption of the law of diminishing marginal utility is Constant production function.

The law, as stated by Marshall, assumes that the consumer is rational, that utility is cardinal (measurable in units or in money), and that the units consumed are homogeneous (identical in size and quality) and taken continuously, with the consumer's tastes, income and the price of the good unchanged.

A production function relates inputs to output in a firm; it belongs to the theory of production, not of consumer utility. So it is the one option that is not an assumption of this law.

Answer: D

The statement that is not true of the law of variable proportions is Constant returns to scale in all three stages of production.

The law describes the short run: technology is unchanged, some inputs are fixed, and one input is varied, so the proportion between the factors changes. As more of the variable input is added, marginal product first rises, then falls, and finally turns negative, giving the three stages of increasing, diminishing and negative returns to the variable factor.

Returns to scale are a different, long-run idea, where all inputs change in the same proportion. Since in this law some inputs are fixed, scale is not being changed at all, and the returns differ across the three stages rather than being constant.

Answer: D

The curve that shows all combinations of inputs producing a given level of output is the Isoquant.

An isoquant (equal-product curve) joins every combination of two inputs, such as labour and capital, that yields the same output. It slopes downward and is convex to the origin because of the diminishing marginal rate of technical substitution.

An isocost line shows the input combinations that cost the same total amount. The expansion path joins the tangency points of isoquants and isocost lines as output grows, so it shows the least-cost combinations rather than all combinations for one output. An isobar is a line of equal atmospheric pressure on a weather map.

Answer: A

A competitive firm maximises short-run profit at the output where price is Equal to marginal cost.

Under perfect competition the firm is a price taker, so price equals marginal revenue. Profit is maximised where MR = MC, and therefore where P = MC, on the rising part of the MC curve. If price were above MC, producing one more unit would add to profit; if below, cutting output would.

So 'greater than' and 'less than marginal cost' are positions where profit can still be increased. A price below average variable cost is the shutdown condition: the firm would lose less by producing nothing.

Answer: B

It is called a Discriminating monopoly.

Price discrimination means selling the same commodity at different prices to different buyers or in different markets, for reasons not related to differences in cost. A monopolist can do this when the markets can be kept apart so that the good cannot be resold, and when the elasticities of demand differ; the higher price is charged where demand is less elastic.

A simple monopoly charges one price to all buyers. A natural monopoly arises from economies of scale so large that one firm can supply the market most cheaply, and a legal monopoly is created by a patent, licence or statute. None of these names refers to charging different prices.

Answer: C

The answer is Both 'A' and 'B' are correct.

Statement A is true: A.C. Pigou classified price discrimination into first, second and third degree in The Economics of Welfare (1920).

Statement B is also true. Under first-degree (perfect) discrimination the monopolist charges each buyer the maximum he is willing to pay for each unit, so the whole of the consumer surplus is captured by the seller and the buyer's surplus is zero. Second-degree discrimination (block pricing) and third-degree discrimination (separate markets) leave some surplus with the buyers.

Since neither statement is false, the options accepting only one of them, or rejecting both, are wrong.

Answer: A

Business economics is concerned with normative economics.

Positive economics describes what is, while normative economics prescribes what ought to be done. Business (managerial) economics applies economic theory to decisions: what price to charge, how much to produce, which project to choose. Because its purpose is to recommend a course of action that meets the firm's goals, textbooks describe it as mainly normative or prescriptive.

It uses positive analysis as an input, but its character is prescriptive, so 'positive' and 'descriptive' miss its purpose; 'alternative economics' is not a recognised branch.

Answer: B

Petrol and automobiles are complementary goods.

Complements are used together, so a fall in the price of one raises the demand for the other: cheaper petrol makes owning a car cheaper, and more cars are demanded. Their cross elasticity of demand is negative.

With substitutes the effect is the reverse: a fall in the price of tea reduces the demand for coffee. Inferior and normal goods are defined by how demand responds to income, not to the price of another good.