Microeconomics Questions and Answers

Answer: C

The theorem assumes all consumers and producers are price takers.

The second fundamental theorem of welfare economics says that any Pareto-efficient allocation can be achieved as a competitive equilibrium, given a suitable redistribution of initial endowments (and conditions such as convex preferences and technology). A competitive equilibrium is one in which every consumer and firm takes prices as given and cannot influence them.

Price makers and price leaders are features of monopoly and oligopoly, where market power undermines efficiency. 'Price followers' describes firms in a price-leadership oligopoly, not competitive agents.

Answer: D

Firms exist to economize on transaction costs.

In 'The Nature of the Firm' (1937), Ronald Coase asked why, if markets allocate resources efficiently, so much activity is organised inside firms. His answer: using the market has costs, such as finding prices, negotiating and enforcing contracts. A firm replaces many market contracts with direction by a manager, and it grows until the cost of organising one more transaction internally equals the cost of using the market.

Specialisation, division of labour and diversification can all happen through markets, so they do not explain the existence of firms in Coase's account.

Answer: D

It is concave because resources are not completely adaptable to alternative uses because of the specificity of the resources.

Some resources are better suited to one good than another. As production shifts towards one good, resources less and less suited to it have to be transferred, so ever more of the other good must be given up for each extra unit. Rising opportunity cost makes the PPC bowed out (concave to the origin).

Prices and consumers' incomes do not determine the shape of the PPC, which is a supply-side frontier. A simple difference in the cost of producing two goods gives a straight line if the cost is constant.

Answer: C

The reasons are (i), (ii) and (iv).

The MRS of X for Y falls as a consumer takes more X because (i) wants for a particular good are satiable, so the intensity of desire for X declines; (ii) the goods are imperfect substitutes, so X cannot fully replace Y; and (iv) in the cardinal account, marginal utility of X falls while that of Y rises as Y is given up.

(iii), fixed income, defines the budget line, not the shape of the indifference curve, so the options that include (iii) are wrong.

Answer: B

For a Giffen good, the negative income effect is greater than the substitution effect.

A Giffen good is a strongly inferior good taking a large share of the budget. When its price falls, the substitution effect raises demand, but the rise in real income cuts demand for the inferior good. If this negative income effect outweighs the substitution effect, quantity demanded falls with price, and the demand curve slopes upward.

If the income effect were equal to or smaller than the substitution effect, demand would not fall when the price falls, so the good would not be Giffen.

Answer: C

It is called a Pareto improvement.

A Pareto improvement is a change that makes at least one person better off and nobody worse off. Pareto efficiency (optimality) is the state where no such improvement remains: nobody can be made better off without making someone worse off.

So the described move is an improvement, not efficiency itself. Maximum social welfare needs a social welfare function, and interpersonal comparison of utility is exactly what the Pareto criterion avoids.

Answer: B

Economic cost is accounting cost + opportunity cost of the self-owned factors.

Accounting (explicit) cost covers payments to outsiders, such as wages, rent and materials. Economic cost adds the implicit cost of the owner's own resources: the salary the owner could earn elsewhere, the rent on their own building, the interest on their own capital.

Explicit cost alone and the opportunity cost of own factors alone are each only one part of economic cost. 'Minimization of cost' is a goal, not a definition.

Answer: C

Both (i) and (ii) are true.

Kaldor's compensation test asks whether the gainers from a change could compensate the losers and still be better off: it looks at the change from the gainers' side. Hicks's version asks whether the losers could not profitably bribe the gainers to forgo the change: it looks from the losers' side. Together they form the Kaldor-Hicks criterion of potential Pareto improvement.

Since both statements describe the two tests correctly, the options keeping only one, or neither, are wrong.

Answer: D

There are 30 payoffs.

In a two-firm game, each combination of one strategy from Firm I and one from Firm II gives one cell of the payoff matrix. With 5 strategies for Firm I and 6 for Firm II:

\[ 5 \times 6 = 30 \]

11 adds the strategies (\(5 + 6\)) instead of multiplying, and 22 doubles that. 6 counts only Firm II's strategies.

Answer: A

Profit is maximised when the difference between total revenue and total cost is highest.

Profit is \(\pi = TR - TC\), so it is greatest where the vertical gap between the TR and TC curves (with TR above) is widest. At that output the slopes of the two curves are equal, which is the condition MR = MC.

The smallest gap does not maximise profit. TR below TC means a loss, and where the curves meet, profit is zero (break-even).