Microeconomics, Miscellaneous, Final Exam Practice Problems
(The attached PDF file has better formatting.)
*Question 1.1: Fair Odds
When an individual is offered fair odds in a gamble, all but which of the following are true?
Both choices in the gamble have the same level of riskiness.
Both choices in the gamble have the same expected value.
A risk-loving individual may prefer to gamble.
A risk-neutral individual is indifferent between the two choices (all else being equal).
A risk-averse individual prefers not to gamble.
Answer 1.1: A
With fair odds, all choices have equal expected value, so the risk-loving person gambles, the risk averse person does not gamble, and the risk neutral person is indifferent. The choices have different levels of risk, so Statement A is the correct answer.
~Question 1.2: Fair Odds
If a person is offered a bet with fair odds, both outcomes
Have the same level of risk.
Have the same expected value.
Are equally desirable.
Offer the same level of diversification.
Have the same utility.
Answer 1.2: B
The budget line shows what the consumer can afford. If the consumer is offered fair odds, all baskets at the same price have the same expected value. They have the same utility (they are equally desirable) only if the consumer is risk-neutral.
Jacob: When is the answer "E: Have the same utility" if the person is not risk-neutral?
Rachel: If the person is indifferent between the two outcomes, they have the same utility for that person.
~ For a risk averse person, the outcome with the greater expected value must have higher risk.
~ For a risk loving person, the outcome with the greater expected value must have lower risk.
*Question 1.3: Favorable Odds and Risk Aversion
Suppose an individual is given an opportunity to place a bet at favorable odds. How will be respond if he is risk-averse?
He will decline the bet.
He will accept the bet.
He will accept the bet if it is sufficiently small, but he will decline the bet if it is too large.
He will accept the bet if it is sufficiently large, but he will decline the bet if it is too small.
He will accept the bet if it is sufficiently large, but he will be indifferent about the bet if it is too small.
Answer 1.3: C
If the bet is small, the favorable odds out-weigh the risk; if the bet is large, the risk out-weighs the favorable odds.
Know the theoretical relation to insurance. The risk averse consumer buys insurance if it is offered at the actuarial pure premium, but may not buy if it has a high expense loading. Since insurance is sold in a competitive market, the price of insurance does not depend on the consumers’ risk aversion; it depends on the insurers’ cost curves.
*Question 1.4: Dental Insurance
Because people needing dental work are more likely to seek dental insurance, insurers may have 12 month waiting periods before coverage begins or pre-existing conditions exclusions that exclude coverage for dental work in the first 12 months of the policy period. (Actual policy provisions vary; the policy may exclude new employees from coverage under a group dental policy for the first 12 months of employment.) The need for these policy provisions reflects which of the following?
Adverse selection
Cartel pricing
Morale hazard
Monopolistic pricing
Anti-trust violation.
Answer 1.4: A
Jacob: Putting off dental work for a year lets the teeth rot and raises ultimate costs. Why would insurers do this?
Rachel: Some insurers pay for fillings and cleanings the first year as well; they don’t pay for elective work, like bridges and caps. Some insurers say that the increased cost of employees who take a job to have dental work done and then quit after six months more than offsets the higher cost of employees who put off dental work for a year.
Jacob: Which lines of business have or don’t have adverse selection?
Rachel: The lines with have, in order from greatest to less: dental insurance, health insurance, life insurance, products liability, general liability, employers’ liability.
The lines which don’t have adverse selection, in order from least to more: auto insurance, Homeowners, workers’ compensation.
*Question 1.5: Ex Ante Preferences
When are an individual’s ex ante preferences under uncertainty illustrated using convex indifference curves?
They are always convex.
When the individual is risk-preferring.
When the individual is risk-neutral.
When the individual is risk-averse.
They are never convex.
Answer 1.5: D
*Question 1.6: Morale Hazard
Which of the following is an example of morale hazard?
Persons with dental insurance are more likely to see dentists.
Persons with dental insurance get dental cleanings more frequently.
Persons without dental insurance are more likely to have rotting teeth.
Persons with dental insurance are less likely to brush their teeth.
Persons with bad teeth are more likely to seek jobs with dental insurance.
Answer 1.6: D
*Question 1.7: Factor Shares
Suppose an industry is in long run competitive equilibrium and production has constant returns to scale. The factor shares paid to labor, capital, land, or entrepreneurs add up to
The firm’s marginal cost
The firm’s variable cost
The firm’s revenues
Producers’ surplus
Net after-tax profits
Answer 1.7: C
All the firm’s revenues are paid to some factor: labor, capital, land, or entrepreneurs.
*Question 1.8: Vertical Merger
A vertical merger takes place between two monopolists: a computer manufacturer and a memory chip supplier. The merger may increase social welfare because the new firm
Gets both consumers’ surplus from buying memory chips and producers’ surplus from selling memory chips.
Earns monopoly profits in both the memory chip market and the computer market.
Can force the memory chip supplier to sell at below cost to the computer manufacturer.
Will behave competitively in the market for computers.
Has the resources to spend more on research and development.
Answer 1.8: A
Jacob: What does statement A mean?
Rachel: Before the merger, the memory chip supplier set quantity to maximize producers’ surplus. After the merger, the firm sets quantity to maximize the sum of producers’ surplus and consumers’ surplus.
*Question 1.9: Competitive Strategy
Borrowing, "lying low," and future re-entry are strategies that a firm can use to counter
The effects of regulation
A supplier’s imposition of resale price maintenance
Predatory pricing
A proposed buy-out
Arbitrage opportunities
Answer 1.9: C
*Question 1.10: Resale Price Maintenance
Firms may practice resale price maintenance to enforce a cartel among retailers. Why else might a firm practice resale price maintenance?
To guarantee high monopoly prices.
To guarantee that retailers will supply customer service.
To prevent retailers from appropriating part of the firm’s monopoly profit.
To force retailers to absorb the cost of selling the good.
To prevent retailers from forming a cartel.
Answer 1.10: B
This is Landsburg’s alternative explanation. See the discussion forum postings for the standard explanation.
*Question 1.11: Resale Price Maintenance
Who gains from resale price maintenance?
The manufacturer, but not the retailers or consumers.
The retailers, but not the manufacturer or consumers.
The manufacturer and the retailers, but not the consumers.
The retailers and the consumers, but not the manufacturer.
The retailers gain, and the manufacturer and consumers may also gain.
Answer 1.11: E
Landsburg shows a scenario where all three parties gain in his alternative explanation.
*Cournot Oligopoly and Number of Firms
In a Cournot oligopoly with two firms, a linear demand curve, and constant marginal costs, a total of 2,400 units are produced. If there were three firms in this Cournot oligopoly, how many units would be produced?
1,800 units
2,400 units
2,700 units
3,000 units
3,600 units
Answer 1.11: C
In a two Cournot oligopoly, each firm produces a the competitive quantity; in a three firm Cournot oligopoly, each firm produces ¼ the competitive quantity.
The competitive quantity is 2,400 × ½ × 3 = 3,600.
In the three firm Cournot oligopoly, each firm produces 3,600 × ¼ = 900.
The total units are 3 × 900 = 2,700.
*Question 1.12: Entry and Exit
Which model highlights the effect that costless entry and exit have on firms’ behavior?
The Prisoner’s Dilemma model of cartels
The contestable market model of oligopoly
The Cournot oligopoly model
The Bertrant oligopoly model
The monopolistic competition model
Answer 1.12: B
*Question 1.13: Monopolistic Competition
Which of the following is the defining characteristic of monopolistic competition?
Tit-for-tat strategies
High levels of vertical integration
Price-taking behavior
High levels of horizontal integration
Product differentiation
Answer 1.13: E
*Question 1.14: Oligopoly Models
What may be inferred from comparing the Cournot and Bertrand oligopoly models?
An oligopolistic equilibrium is always less efficient than a competitive equilibrium.
Free entry and exit causes oligopolies to have excess capacity in the long run.
The outcome depends on the assumptions about firms’ reactions to rivals’ behavior.
Tit-for-tat is a superior strategy to predatory pricing, buy-outs, or collusion.
Successful oligopolies produce the monopolistic quantity at the monopoly price.
Answer 1.14: C
*Question 1.15: Cournot Oligopoly
Let QC be the competitive quantity, QM be the monopolistic quantity, QB be the Bertrand oligopolistic quantity, and QR be the Cournot oligopolistic quantity. Rank these quantities in order of size.
QM < QB < QR < QC
QM < QR < QB < QC
QM < QB < QR = QC
QM < QR < QB = QC
QM < QB = QR < QC
Answer 1.15: D
*Question 1.16: Bertrand Model
In the Bertrand model of oligopoly, firms produce
The competitive quantity.
The monopoly quantity.
More than the monopoly quantity, but less than the competitive quantity (but not necessarily the average).
Less than the monopoly quantity.
The average of the competitive quantity and the monopoly quantity.
Answer 1.16: A
*Question 1.17: Monopolistic Competition and Social Welfare
What are the welfare consequences of monopolistic competition?
The Invisible Hand Theorem shows that monopolistic competition, like competition, makes social gain as large as possible.
Social welfare would be improved if a monopolistically competitive industry were replaced by a competitive industry.
The welfare consequences of monopolistic competition, like those of monopoly, depend on the firms’ source of market power.
The welfare consequences of monopolistic competition are ambiguous, because its inefficiencies must be weighed against the benefits of having differentiated products.
The dead weight loss is reduced by a reduction in prices.
Answer 1.17: D
*Question 1.18: Free-Rider Problem
Which of the following situations is the best example of a free-rider problem?
Positive externalities cause beekeepers and orchard growers to establish elaborate contracts.
Property rights to a smoke free workplace are given nonsmokers in general instead of to a specific group of nonsmokers.
Mine owners are unable to observe if their workers follow safety guidelines.
Only about 10% of the viewers of public television contribute money to pay for its costs.
Property owners may higher taxes to compensate for their rent.
Answer 1.18: D
*Question 1.19: Principal-Agent Problem
A principal-agent problem occurs when
Transaction costs are too high to permit private bargaining among agents.
An employer is unable to effectively monitor an employee’s behavior.
An agent attempts to avoid paying for benefits received from the principal.
Property rights are assigned to vague groups instead of to specific agents.
Exclusive agents are less efficient than career agents.
Answer 1.19: B