cpa review

economics
Economics is a social science that
studies how individuals,
governments, firms and nations
make choices on allocating scarce
resources to satisfy their
unlimited wants. Economics can
generally be broken down into:
Macroeconomics, which
concentrates on the behavior of
the aggregate economy; and
Microeconomics, which focuses on
individual consumers.
Examples of Microeconomic and Macroeconomic Concerns

Divisions
of Economics Production Prices Income Employment

Microeconomics Production/output in Price of individual Distribution of Employment by

individual industries and goods and services income and individual
businesses wealth businesses
and industries
How much steel Price of medical care Wages in the auto
How much office Price of gasoline industry Jobs in the steel
space Food prices Minimum wage industry
How many cars Apartment rents Executive salaries Number of employees
Poverty in a firm
Number of
accountants

Macroeconomics National Aggregate price level National income Employment and

production/output unemployment in
the economy

Total industrial output Consumer prices Total wages and Total number of jobs
Gross domestic Producer prices salaries Unemployment rate
product Rate of inflation Total corporate
Growth of output profits

3 of 34
Coverage of the Discussion
Microeconomics
A. Focus
B. Demand
C. Supply
D. Market Equilibrium
E. Costs of Production
F. Production
G. Market Structure
Macroeconomics
A. Focus
B. Aggregate Demand and Supply
C. Business Cycles
D. Economic Measures
E. Monetary Policy
F. Fiscal Policy
G. Economic Theories
H. The Global Economy and International Trade
I. Foreign Exchange Rates
J. Foreign Investment
The Effects of the Global Economic Environment on Strategy
A. General Environment
B. Industry Environment
C. Industry Analysis
D. Strategic Planning
E. Estimating the Effects of Economic Change
Microeconomics
A. Focus
B. Demand
C. Supply
D. Market Equilibrium
E. Costs of Production
F. Production
G. Market Structure
Macroeconomics
A. Focus
B. Aggregate Demand and Supply
C. Business Cycles
D. Economic Measures
E. Monetary Policy
F. Fiscal Policy
G. Economic Theories
H. The Global Economy and
International Trade
I. Foreign Exchange Rates
J. Foreign Investment
The Effects of the Global
Economic Environment on
Strategy
A. General Environment
B. Industry Environment
C. Industry Analysis
D. Strategic Planning
E. Estimating the Effects
of Economic Change
Microeconomics
A. Focus
B. Demand
C. Supply
D. Market Equilibrium
E. Costs of Production
F. Production
G. Market Structure
Microeconomics focuses on the
behavior and purchasing
decisions of individuals and firms.
In a market economy goods and
services are distributed through a
system of prices. Goods and
services are sold to those willing
and able to pay the market price.
The market price is determined
based on demand and supply.
Microeconomics
A. Focus
B. Demand
C. Supply
D. Market Equilibrium
E. Costs of Production
F. Production
G. Market Structure
Demand is the quantity of a good or service
that consumers are willing and able to
purchase at a range of prices at a particular
time. Market demand for a product can be
recorded in a schedule or a graph.

The Law on Demand states that an inverse

relationship exists between the price and
quantity demanded That is, fewer products
are demanded at higher prices this is based
on the behavior of a consumer.

Graphically a demand curve shows a

downward sloping curve. The illustration
that follows is the demand schedule and
demand curve for Product X.
When price for X is $60 QUANTITY
DEMANDED is 2,500 . When price
increases to $70 QUANTITY
DEMANDED DECREASE to 2,000 , on
the other hand when price decrease to
$50 QUANTITY DEMANDED INCREASE
to 3,000

THEREFORE, FOR QUANTITY

DEMANDED INCREASING OR
DECREASING ONLY PRICE IS THE
CAUSE THE MOVEMENT IN THE GRAPH
IS ISOLATED TO A SINGLE DEMAND
CURVE
Demand Curve Shift.A demand
curve shifts when demand
variables other than price
change. For example, if the
price of substitute products for
Product X increase in price, the
demand for Product X would
shift upward and to the right.
A demand curve shift is
illustrated in the next slide
Demand Shifts
Substitute Goods
Complementary Goods
Normal and Inferior Goods
Shift of Demand versus Movement Along a Demand Curve

Shifts versus Movement Along a Demand Curve

21 of 49
Items 4 and 5are based on the following
information:Assume that demand for a
particular product changed as shown below
from D1 to D2.
4. Which of the following could
cause the change shown in the
graph?
a. A decrease in the price of the
product.
b. An increase in supply of the
product.
c. A change in consumer tastes.
d. A decrease in the price of a
substitute for the product.
4. (c) because a shift in demand
could result from a change in
consumer tastes. Answer (a) is
incorrect because this would
result in movement along the
existing demand curve. Answer
(b) is incorrect because change in
supply would not affect the
demand function. Answer (d) is
incorrect because a decrease in
price of a substitute would result
in a shift of the curve to the left.
5. What will be the result
on the equilibrium price
for the product?
a. Increase.
b. Decrease.
c. Remain the same.
d. Cannot be determined.
5. (a) because the shift (increase)
in demand will increase the price
of the product. Answer (b) is
incorrect because a shift of the
demand curve to the left would
have to occur to decrease price.
Answers (c) and (d) are incorrect
because the effect on price will
not be to remain the same and it
can be determined.
6.Which one of the
following has an inverse
relationship with the
demand for money?
a. Aggregate income.
b. Price levels.
c. Interest rates.
d. Flow of funds.
6. (c) because as interest rates
increase the demand for
money decreases because the
opportunity cost of holding on
to money becomes higher it
becomes costly to hold on to
money. Answers (a), (b), and
(d) are incorrect because they
do not have an inverse
relationship with the demand
9.A decrease in the price of a
complementary good will
a. Shift the demand curve of
the joint commodity to the left.
b. Increase the price paid for a
substitute good.
c. Shift the supply curve of the
joint commodity to the left.
d. Shift the demand curve of
the joint commodity to the
9. (d) If the price of a
complementary good
decreases, demand for the
joint commodity will increase.
This is due to the fact that the
total cost of using the two
products decreases. If demand
for a product increases the
demand curve will shift to the
right.
12.The local video store’s
business increased by 12%
after the movie theater raised
its prices from $6.50 to $7.00.
Thus, relative to movie theater
admissions, videos are
a. Substitute goods.
b. Superior goods.
c. Complementary goods.
d. Public goods.
12. (a) Substitute goods are selected by a
consumer based on price. When the price of
one goes up, demand for the other
increases. Answer (b) is incorrect because
superior goods are those whose demand is
directly influenced by income. Answer (c) is
incorrect because complementary goods are
used together and when the price of one
goes up, demand for the other goes down.
Answer (d) is incorrect because a public
good is one for which it is difficult to restrict
use, such as a national park.
19.In a competitive market for
labor in which demand is stable, if
workers try to increase their wage
a. Employment must fall.
b. Government must set a
maximum wage below the
equilibrium wage.
c. Firms in the industry must
become smaller.
d. Product supply must decrease.
19. (a) like any other good or
service, if price is increased for
labor, the demand will fall and
employment will fall. Answer (b) is
incorrect because setting a
maximum wage will not allow
workers to increase wages. Answer
(c) is incorrect because firms may
or may not change in size. Answer
(d) is incorrect because supply will
only decrease if the price of the
product decreases.
Price elasticity of demand.The elasticity of demand
measures the sensitivity of demand to a change in
price. It is calculated as follows:
To make results the same regardless of whether
there is an increase or decrease in price, the
amount is usually calculated using the arc method
as shown below.
Interpretation of the demand elasticity
coefficient.

1. ED is greater than 1, demand is elastic

(sensitive to price changes).
2. ED is equal to 1, demand is unitary (not
sensitive or insensitive to price changes).
3. If ED is less than 1, demand is inelastic
(not sensitive to price changes).
4. If ED is 0, demand is pfectly inelastic (not
sensitive to price changes).

The price elasticity of demand coefficient

allows management to calculate the effect
of a price change on demand for the
product.
 Hypothetical Demand Elasticities for Four Products
% Change
% In Quantity
Change Demanded Elasticity
Product In Price (% DQD) (% DQD ÷ %DP)
(% DP)
Insulin +10% 0% .0 Perfectly
inelastic
Basic +10% -1% -.1 Inelastic
telephone
service
Beef +10% -10% -1.0 Unitarily
elastic
Bananas +10% -30% -3.0 Elastic
perfectly inelastic demand Demand in which quantity
38 of 31
demanded does not respond at all to a change in price.
The elasticity of demand is
greater for a product when
there are
1. more substitutes for the good,
2. a larger proportion of income is
spent on the good, or
3. a longer period of time is
considered.

NOTE:The demand for luxury

goods tends to be more elastic
than for necessities.
29. As the price for a particular product changes,
the quantity of the product demanded changes
according to the following schedule:
Total quantity demanded Price per unit
100 $50
150 45
200 40
225 35
230 30
232 25
Using the arc method, the price elasticity of
demand for this product when the price decreases
from $50 to $45 is
a. 0.20
b. 10.00
c. 0.10
d. 3.80
29. (d) Using the arc method is calculated
by dividing the percentage change in
quantity demanded by the percentage
change in price, using the average
changes.
(150 – 100) ÷ [(150 + 100) ÷ 2]
___________________________ = 3.8
($50 – $45) ÷ [($50 + $45) ÷ 2]

Elastic
29. (d) Using the traditional method is
calculated by dividing the percentage
change in quantity demanded by the
percentage change in price, not using the
average
changes.
(150 – 100) ÷ 100) x 100% 50%
_______________________=____ = -5
($45 – $50) ÷ $50) x 100% - 10%

Elastic
30.As the price for a particular product changes, the
quantity of the product demanded changes according to
the following schedule:
Total quantity demanded Price per unit
100 $50
150 45
200 40
225 35
230 30
232 25
Using the arc method, the price elasticity of demand for
this product when the price decreases from $40 to $35 is
a. 0.20
b. 0.88
c. 10.00
d. 5.00
30. (b) formula for price elasticity is
equal to the percentage change in
quantity demanded divided by the
percentage change in price.

(225 – 200) ÷ [(225 + 200) ÷ 2]

___________________________= .088
($40 – $35) ÷ [($40 + $35) ÷ 2]

Inelastic
Relationship between price elasticity
and total revenue.
Total revenue from the sale of a good
is equal to the price times the
quantity. Price elasticity is an
important concept because if demand
is elastic an increase in sales price
results in a decrease in total revenue
for all producers. It reveals whether
the firm is likely to be able to pass on
cost increases to its customers.
Obviously, when demand is inelastic
the firm can increase its price with
less of a negative impact.
QUANTITY
DEMANDED PRICE REVENUE ΔD
1,000 100.00 100,000 ORIGINAL DATA ΔP

1,000 +/-0% 110.00 +10% 110,000 PERFECTLY INELASTIC -

990 -1% 110.00 +10% 108,900 INELASTIC -0.1

900 -10% 110.00 +10% 99,000 UNITARILY -1

700 -30% 110.00 +10% 77,000 ELASTIC -3

1,000 +/-0% 90.00 -10% 90,000 PERFECTLY INELASTIC -

1,010 +1% 90.00 -10% 90,900 INELASTIC -0.1

1,100 +10% 90.00 -10% 99,000 UNITARILY -1

1,300 +30% 90.00 -10% 117,000 ELASTIC -3

3. As a business owner you have
determined that the demand for your
product is inelastic. Based upon this
assessment you understand that
a. Increasing the price of your product
will increase total revenue.
b. Decreasing the price of your product
will increase total revenue.
c. Increasing the price of your product
will have no effect on total revenue.
d. Increasing the price of your product
will increase competition.
3. (a) If demand is inelastic an
increase in price will increase total
revenue. Answer (b) is incorrect
because if demand is inelastic the
quantity demanded will not be
affected significantly by a change in
price. Answer (c) is incorrect because
if the quantity demanded is not
significantly affected by an increase in
price, total revenue will increase.
Answer (d) is incorrect because an
increase in price may, or may not,
increase competition.
Income elasticity of demand.Income
elasticity of demand measures the
change in the quantity demanded of a
product given a change in income.
Income elasticity is calculated as
follows:
The demand for normal products
increases as consumer income
increases. For example, the demand
for normal goods,such as
beefsteaks,increases as consumer
income increases. Therefore, EI for
beefsteaks is positive. The demand for
inferior goods, such as burgers,
decreases as income increases; EI is
negative. The demand for inferior
goods increases as income declines,
because when individuals have less
money they substitute these less
expensive goods for normal goods.
Shift of Demand Curve

a. When income increases, the demand for

inferior goods shifts to the left
and the demand for normal goods shifts to the
right.
53 of 49
23. If the income elasticity
of demand coefficient for a
particular product is 3.00,
the good is likely
a. A luxury good.
b. A complementary good.
c. An inferior good.
d. A necessity.
23. (a) an income elasticity coefficient
of 3.00 indicates that demand for the
good is very sensitive to income
levels. This is a characteristic of a
luxury good.Answer (b) is incorrect
because while the good may be
complementary, it would have to be
complementary to a luxury good.
Answer (c) is incorrect because an
inferior good’s coefficient will be
negative. Answer (d) is incorrect
because demand for a necessity is not
sensitive to income levels.
Cross-elasticity of demand.Cross-elasticity of demand
measures the change in demand for a good when the price of
a related or competing product is changed. For example, Coca
Cola Company would be interested in knowing how an
increase in the price of Pepsi would affect the sales of Coca
Cola. The coefficient of cross-elasticity is calculated as
follows:
In our case Pepsi would be
Product Y, the competing product
with the price change, and Coca
Cola would be Product X. The
coefficient describes the
relationship between the two
products. If the coefficient is
positive, the products are
substitutes (like Pepsi and Coca
Cola). If the coefficient is
negative, the products are
complements
Pepsi would be Product Y, the
competing or substitute product
with the price change, and Coca
Cola would be Product X.

150 – 100 / 100 x100% 50%

----------------------------- = ---------- = 2.99
35 – 30 / 30 / 100 X 100% 16.67%
Gasoline would be Product Y,
the complementary
product with the price change,
and Cars would be Product X.

100 – 150 / 150 x100% -50%

----------------------------- = ---------- = -5.0
55 – 50 / 50 X 100% 10%
27.X and Y are substitute
products. If the price of product Y
increases, the immediate impact
on product X is
a. Price will increase.
b. Quantity demanded will
increase.
c. Quantity supplied will increase.
d. Price, quantity demanded, and
supply will increase.
27. (b) The demand and price of substitute
products are directly related. If the price of
a good increases, the demand for its
substitute will also increase. Answer (a) is
incorrect because the price of a product will
not increase due to an increase in a
substitute product’s price. Answer (c) is
incorrect because the quantity supplied will
not be impacted by an increase in price of a
substitute product. Answer (d) is incorrect
because even though the quantity
demanded will increase with an increase in
price of a substitute product, the price and
supply will not be directly affected.
36.In the pharmaceutical industry
where a diabetic must have insulin
no matter the cost and where there is
no other substitute, the diabetic’s
demand curve is bestdescribed as
a. Perfectly elastic.
b. Perfectly inelastic.
c. Elastic.
d. Inelastic.
36. (b) The requirement is to
identify the price elasticity of an
essential product with no
substitutes. The correct answer is
(b). Demand for the product is
perfectly inelastic because the
diabetic will purchase the product
regardless of the price.
Consumer demand and utility
a. The demand curve for a particular good is
downward sloping. Because as the price of
the good declines, consumers will purchase
more because of

The substitution effect refers to the fact

that as the price of a good falls, consumers
will use it to replace similar goods. Example,
as the price of pork falls, consumers will
purchase more pork than other types of
meat.

The income effectrefers to the fact that as

the price of a good falls, consumers can
purchase more with a given level of income.
Consumer demand and utility
b. An individual demands a particular good
because of the utility (satisfaction) he or
she receives from consuming it. The more
goods an individual consumes the more
total utility the individual receives.
However, the marginal (additional) utility
from consuming each additional unit
decreases. This is referred to as the law of
diminishing marginal utility.
c. A consumer maximizes utility from
spending his or her income when the
marginal utility of the last dollar spent on
each commodity is the same.
35.The law of diminishing marginal
utility states that
a. Marginal utility will decline as a
consumer acquires additional units of
a specific product.
b. Total utility will decline as a
consumer acquires
additional units of a specific product.
c. Declining utilities causes the
demand curve to slope upward.
d. Consumers’ wants will diminish
with the passage of time.
35. (a) The law states that
marginal utility declines as
consumers acquire more of a
good. Therefore, answer (a)
is correct. Answer (b) is
incorrect because total utility
will not decline as more of a
good is acquired. Answer (c) is
incorrect because the demand
curve slopes downward
d. The concept of marginal utility can be
illustrated with two types of goods (e.g.,
chocolate bars and cans of soda). They
construct a series of indifference
curveswhich illustrate the combinations of
chocolate bars and soda that provide equal
utility. The optimal level of consumption of
the two goods is then found where the
individual’s budget constraintline intersects
the highest possible utility curve. At this
point the individual receives the greatest
amount of utility for the amount of money
available. This relationship is
illustratedasfollows.
As illustrated, the individual gets the greatest
satisfaction for the funds available at point A.
Total and Marginal Utility
e. Consumption decisions depend
on many factors but the main one
is personal disposable income.
This is the amount
of income consumers have after
receiving transfer payments from
the government (e.g., welfare
payments) and paying
their taxes. When their personal
disposable income goes up,
consumers buy more. They buy
less when it goes down.
f. The relationship between changes in
personal disposable income and
consumption is described by a
consumption function. The function is
typically described as follows:
C=C0+C1YD
Where
C =Consumption for a period
YD=Disposable income for the period
CC00=The constant
CC11=The slope of the consumption function
g. The marginal propensity to save (MPS)is
the percentage of additional income that is
saved. Since a consumer can either spend or
save money, the marginal propensity to
consume plus the marginal propensity to
save is equal to one as shown
MPC+MPS =1
h. Certain nonincome factors may also affect
consumption, including
(1) Expectations about future prices of
goods
(2) Quantity of consumer liquid assets
(3) Amount of consumer debt
(4) Stock of consumer durable goods
(5) Attitudes about saving money
(6) Interest rates
13.An individual receives an
income of $3,000 per month, and
spends $2,500. An increase in
income of $500 per month
occurs, and the individual spends
$2,800. The individual’s marginal
propensity to save is
a. 0.2
b. 0.4
c. 0.6
d. 0.8
13. (b)marginal propensity to save is
the change in savings divided by the
change in income
[($500-$2,800-$2,500= 200)/($3,500
– $3,000 = $500) = .4].
$200/$500 = .4
(c) is incorrect this is the marginal
propensity to consume is the change
in spending divided by the change in
income [($2,800 – $2,500)/($3,500
– $3,000) = .6].
$300/$500 = .6
Note : .4 + .6 = 1
MPS + MPC = MARGINAL INCOME
15.Given the following data, what
is the marginal pronspensity to
consume
Level of
Disposable income Consumption
$40,000 $38,000
48,000 44,000
a. 1.33
b. 1.16
c. 0.95
d. 0.75
15. (d) marginal propensity to
consume.
=the change in consumption
________________________
the change in disposable income.
=[($44,000 – $38,000)/ = .75
___________________
($48,000 – $40,000)]
Disposable Income = Income –
Tax
Disposable Income Increase =
Conumption Increase
15. Average propensity to
consume
consumption
disposable income.
= $38,000 = .95
$40,000
Average propensity to save
savings
disposable income.
= $40,000 - $38,000 = .05
$40,000
APC + APS = 1 .95 + .05 = 1
Microeconomics
A. Focus
B. Demand
C. Supply
D. Market Equilibrium
E. Costs of Production
F. Production
G. Market Structure
Supply
A supply curve shows the amount
of a product that would be
supplied at various prices.
Graphically a supply curve
shows a direct relationship
between price and quantity sold.
The higher the price the more
products that would be
supplied. A supply schedule and
supply curve for Product X are
presented below.
Supply curve shift.A supply curve
shift occurs when supply variables
other than price change. As an
example, if the costs to produce
the product increase, the supply
curve would shift upward and to
the left. A shift in the supply
curve is illustrated below.
Supply Shifts
Substitutes and Complements in Production
Change in Supply vs Change in Quantity Supplied
2.A supply curve illustrates the
relationship between
a. Price and quantity supplied.
b. Price and consumer tastes.
c. Price and quantity demanded.
d. Supply and demand.
2. (a) The requirement is to
describe the relationship
shown by a supply curve. A supply
curve illustrates the
quantity supplied at varying prices
at a point in time.
Therefore, the correct answer is
(a). Answers (b) and (c)
are incorrect because they deal
with demand. Answer (d) is
incorrect because it deals with
demand-supply equilibrium
7.An improvement in technology that
in turn leads to improved worker
productivity would mostlikely result in
a. A shift to the right in the supply
curve and a lowering of the price of
the output.
b. A shift to the left in the supply curve
and a lowering of the price of the
output.
c. An increase in the price of the
output if demand is unchanged.
d. Wage increases.
7. (a) The requirement is to describe
the effect of an improvement in
technology that leads to increased
worker productivity. If the cost of
producing a good declines, more
will be supplied at a given price.
Therefore, the supply curve will shift
to the right and answer (a) is correct.
Answer (b) is incorrect because a shift
to the left would result in decreased
supplies. Answer (c) is incorrect
because price would not increase, and
answer (d) is incorrect because wages
would not necessarily increase.
16.Which of the following will
cause a shift in the supply
curve of a product?
a. Changes in the price of the
product.
b. Changes in production
taxes.
c. Changes in consumer tastes.
d. Changes in the number of
buyers in the market.
16. (b) A shift in the supply curve may
result from (1) changes in production
technology,
(2) changes or expected changes in
resource prices,
(3) changes in the prices of other goods, (4)
changes in taxes or subsidies,
(5) changes in the number of sellers in the
market,
(6) expectations about the future price of
the product.
(a) is incorrect because a change in the
price of the product involves movement
along the existing supply curve, not a shift
in the supply curve. Answers (c) and (d) are
result in a shift in the demand curve.
Elasticity of supply.The elasticity of supply
measures the percentage change in the
quantity supplied of a product resulting from
a change in the product price calculated as
Microeconomics
A. Focus
B. Demand
C. Supply
D. Market Equilibrium
E. Costs of Production
F. Production
G. Market Structure
Market Equilibrium
A product’s equilibrium price is determined
by demand and supply; it is the price at
which quantity demanded =quantity supplied
Market Equilibrium

Excess Demand

At a price of $1.75 per

bushel, quantity demanded
exceeds quantity supplied.
When excess demand
exists, there is a tendency
for price to rise.
When quantity demanded
equals quantity supplied,
excess demand is
eliminated and the market is
in equilibrium. Here the
equilibrium price is $2.50
and the equilibrium quantity
is 35,000 bushels.

When quantity demanded exceeds quantity supplied, price tends

to rise. When the price in a market rises, quantity demanded falls
and quantity supplied rises until an equilibrium is reached at
which quantity demanded and quantity supplied are equal.
99 of 49
Market Equilibrium

Excess Supply

At a price of $3.00, quantity

supplied exceeds quantity
demanded by 20,000
bushels.
This excess supply will
cause the price to fall.

When quantity supplied exceeds quantity demanded at the

current price, the price tends to fall. When price falls, quantity
supplied is likely to decrease and quantity demanded is likely to
increase until an equilibrium price is reached where quantity
supplied and quantity demanded are equal.
100 of 49
Market Equilibrium

Changes In Equilibrium

When supply and demand curves shift, the equilibrium price

and quantity change.

Before the freeze, the coffee

market was in equilibrium at
a price of $1.20 per pound.
At that price, quantity
demanded equaled quantity
supplied.
The freeze shifted the
supply curve to the left (from
S0 to S1), increasing the
equilibrium price to $2.40.

101 of 49
Government intervention.Government
actions may change market
equilibrium through taxes, subsidies,
and rationing. For example,
Subsidy paid to farmers will reduce
the cost of producing a particular farm
product and, therefore, cause the
equilibrium price to be lower than it
would be without the subsidy. Import
taxes, on the other hand, would
increase the cost of an imported
product causing the equilibrium price
to be higher.
a. Price ceiling. is a specified
maximum price that may be charged
for a good. If the price ceiling is set
for a good below the equilibrium price,
it will cause good shortages because
suppliers will devote their production
facilities to producing other goods.
b. Price floor. is a minimum specified
price that may be charged for a good.
If the price floor is set for a good
above the equilibrium price, it will
cause overproduction and surpluses
will develop.
Government intervention in
terms of taxes, subsidies, or
price controls interfere with
the free market and can
result in an inefficient
allocation of resources. Too
many resources are devoted
to certain sectors of the
economy at the expense of
other sectors.
Externalities. Another factor that causes
inefficiencies in the pricing of goods in the
market its the term used to describe
damage to common areas that is caused by
the production of certain goods. A
prominent example of an externality is
pollution. Because these externalities are
not included in the production costs of the
goods, the supply is higher and the price is
lower than is appropriate. Government laws
and regulations attempt to force firms to
change their production methods to make
externalities part of the cost of production.
This causes the market price of these
products to be a more accurate reflection of
the cost of the goods to society.
1.If both the supply and the
demand for a good increase,
the market price will
a. Rise only in the case of an
inelastic supply function.
b. Fall only in the case of an
inelastic supply function.
c. Not be predictable with only
these facts.
d. Rise only in the case of an
inelastic demand function.
1. (c) The requirement is to predict the
market price based on an increase in
both supply and demand. The correct
answer is (c) because without
additional information about the
extent of the change, the effect on
price is not determinable.
Answers (a), (b), and (d) are incorrect
because the price elasticity of the
demand or supply function does not
provide enough information to
determine the effect.
14.In any competitive market,
an equal increase in both
demand and supply can be
expected to always
a. Increase both price and
market-clearing quantity.
b. Decrease both price and
market-clearing quantity.
c. Increase market-clearing
quantity.
d. Increase price.
14. (c) If there is an equal
increase in both demand and
supply, the equilibrium price may
increase, decrease, or remain the
same. However, there will be
more units sold and, therefore,
answer (c) is correct. Answers
(a), (b), and (d) are incorrect
because the equilibrium price may
increase, decrease, or remain the
same.
8. Which of the following
market features is likely to
cause a surplus for a particular
product
a. A monopoly.
b. A price floor.
c. A price ceiling.
d. A perfect market.
8. (b) is correct because a price floor,
if it is above the equilibrium price, will
cause excess production and a
surplus. Answer (a) is incorrect
because a monopoly market is likely to
be characterized by underproduction
of the product. Answer (c) is incorrect
because a price ceiling, if it is below
the equilibrium price, will cause
underproduction and shortages.
Answer (d) is incorrect because in a
perfect market with no intervention
demand and supply will be equal.
21.If the federal government
regulates a product or service
in a competitive market by
setting a maximum price
below the equilibrium price
what is the long run effect
a. A surplus.
b. A shortage.
c. A decrease in demand.
d. No effect on the market.
21. (b) If the government
mandates a maximum price below
the equilibrium price, the product
will be selling at an artificially low
price resulting in shortages. (a) is
incorrect because price floors
result in surpluses. Answer (c) is
incorrect because price ceilings
would probably result in more
demand. Answer (d) is incorrect
because the market would be
affected.
22.A valid reason for the government
to intervene in the wholesale electrical
power market would include which
one of The following
a. A price increase that is more than
expected.
b. Electricity is an essential resource
and the wholesale market is not
competitive.
c. The electricity distribution
companies are losing money.
d. Foreign power generators have
contracts with the local government at
very high prices.
22. (b) is correct because a
valid reason for government
intervention is the lack of a
competitive market. Answers
(a), (c), and (d) are incorrect
because they provide no
indication that the market is
not competitive.
20. A polluting
manufacturing firm tends,
from the societal viewpoint,
to
a. Price its products too low.
b. Produce too little output.
c. Report too little
profitability.
d. Employ too little equity
financing.
20. (a) a polluting firm calculates its
profits without considering the costs
of environmental damage and, as a
result, prices its products too low.
Answer (b) is incorrect because the
polluting manufacturer is producing
too much, not too little output. (c) is
incorrect because the manufacturer
reports too much, not too little
profitability. (d) is incorrect because
there is no direct relationship between
the use of equity versus debt financing
and the externalities involved in the
production activities of the firm
Microeconomics
A. Focus
B. Demand
C. Supply
D. Market Equilibrium
E. Costs of Production
F. Production
G. Market Structure
1.Short-run total costs
a. In the short run, firms have both fixed
and variable costs. Total fixed costs are
those that are committed and
will not change with different levels of
production. An example of a fixed cost is the
rent paid on a long-term
lease for a factory. Variable costs are the
costs of variable inputs, such as raw
materials, variable labor costs,
and variable overhead. These costs are
directly related to the level of production for
the period. In the short run,
costs behave as follows:
Average fixed cost (AFC)—Fixed cost per
unit of production. It goes down
consistently as more units are produced.
Average variable cost (AVC)—Total variable
costs divided by the number of units
produced. It initially stays constant until the
inefficiencies of producing in a fixed-size
facility cause variable costs to begin to rise.
Marginal cost (MC)—The added cost of
producing one extra unit. It initially
decreases but then begins to increase due
to inefficiencies.
Average total cost (ATC)—Total costs
divided by the number of units produced. Its
behavior depends on the makeup of fixed
and variable costs.
The cause of the inefficiencies
described above is referred to
as the law of diminishing
returns. This law states
that as we try to produce more
and more output with a fixed
productive capacity, marginal
productivity will decline. The
graph below illustrates the
relationships between various
short-run costs.
b. In many industries, especially those
that are capital intensive, increasing
returns to scale occur up to a point,
generally as a result of division of labor
and specialization in production.
However, beyond a certain size,
management has problems controlling
production and decreasing returns to
scale arise. The following graph
illustrates a long-run average total cost
(ATC) curve which begins with increasing
returns to scale (A), and proceeds to
constant returns to scale (B), and
eventually decreasing returns to scale
(C) as the firm grows.
.
3. Profits.Economists refer to two
different types of profit.
a. Normal profit—The amount of profit
necessary to compensate the owners
for their capital and/or managerial
skills. It is just enough profit to keep
the firm in business in the long run.
b. Economic profit—The amount of
profit in excess of normal profit. In a
perfectly competitive market,
economic profit cannot be experienced
in the long run.
Production
1. Management makes production
decisions based on the relationship
between marginal revenue and
marginal cost. Marginal revenueis the
additional revenue received from the
sale of one additional unit of product.
A good should be produced and sold as
long as the marginal cost (MC) of
producing the good is less than or
equal to the marginal revenue (MR)
from sale of that good. This
relationship is shown in the graph .
2. The price of input resources (e.g., labor,
raw materials, etc.) is determined by
demand and supply. If the price of an input
increases, demand will decline. On the other
hand, demand will increase if the price
declines. In making decisions about the
employment of resources, management
considers the marginal product for each
input resource. The marginal productis the
additional output obtained from employing
one additional unit of a resource. The
change in total revenue from employing one
additional unit of a resource is referred to
as the marginal revenue product.
Microeconomics
A. Focus
B. Demand
C. Supply
D. Market Equilibrium
E. Costs of Production
F. Production
G. Market Structure
Market Structure
1. Industries are classified by
their market structure as
a. perfect competition,
b. pure monopoly,
c. monopolistic competition,
and
d. oligopoly.
Characteristics of Different Market Organizations
134 of 18
a. Perfect (pure) competition
(1) An industry is perfectly
competitive if
(a) It is composed of a large number
of sellers, each of which is too small to
affect the price of the product or
service
(b) The firms sell a virtually identical
product
(c) Firms can enter or leave the
market easily (i.e., no barriers to
entry) Common examples include the
commodity markets, such as markets
for wheat, soybeans, and corn.
(2) In this market, the firm’s
demand curveis perfectly elastic
(horizontal). The firm can sell as
many goods as it can produce at
the equilibrium price but no goods
at a higher price. The firm is a
price taker. Themarket demand
curveis downwards sloping.
Therefore, demand will increase if
all suppliers lower prices and will
decrease if all suppliers raise their
prices.
(3) Firms will continue to produce and
sell products until the margin cost is
greater than marginal revenue.
(4) Theoretically, no economic profits
can be generated in the long run. The
price will reflect the costs plus the
normal profit of the most efficient
producers.
(5) There is no product differentiation
and the key to being successful is
being the lowest cost producer .
Innovation is restricted to making
production, distribution, and sales
processes more efficient.
Market and Individual Firm Demand Curves
in a Perfectly Competitive Market
b. Pure monopoly
(1) A pure monopoly is a market in
which there is a single seller of a
product or service for which there are
no close substitutes. A monopoly may
exist for one or more of the following
reasons:
(a) Increasing returns to scale
(b) Control over the supply of raw
materials
(c) Patents (e.g., a drug
manufacturer)
(d) Government franchise (e.g., a
public utility)
(2) Monopolies that exist when economic or
technical conditions permit only one
efficient supplier are callednatural
monopolies.
(3) The monopolist sets the price for the
product (unless it is set by regulation). The
demand curve for the firm is negatively
sloping; the company must reduce price to
sell more output. The firm will continue to
produce and sell products as long as the
marginal revenue is greater than average
variable cost.
(4) Entry barriers make it possible for the
firm to make economic profit in the long
run.
(5) In a pure monopoly, the company has
little market incentive to innovate or control
costs. The company has no market control
on the price it charges. As a result pure
monopolies are generally subject to
government regulation. Price boards
generally review the company’s prices and
costs. From a strategic standpoint
monopolistic firms want to create a positive
image with the public to forestall additional
regulation it spend a lot in advertising to
influence laws. They can increase total
revenue if they can engage in price
discrimination by market segment (e.g.,
charging business customers more than
individual customers).
Comparing Demand Curves: Perfect Competition Versus Monopoly
Monopolistic competition
(1) Monopolistic competition is
characterized by many firms selling a
differentiated product or service. The
differentiation may be real or only
created by advertising, and there is
relatively easy entry to the market but
not as easy as in a perfectly
competitive market. This type of
market is prevalent in retailing,
including the markets for groceries,
detergents, and breakfast cereals.
(2) The demand curve in a monopolistic
competitive market is negatively sloped and
firms tend to produce and sell products until
the marginal revenue is less than average
variable cost. Goods tend to be priced
somewhat higher than in a perfectly
competitive market but less than in a
monopoly. There tends to be
underproduction as compared to a perfectly
competitive market.
(3) The strategies of firms in monopolistic
competitive markets tend to focus on
product or service innovation. Companies
may spend heavily on product development.
Customer relations and advertising
necessarily are important to firm strategies.
The Demand Curve and Marginal Revenue Curve for a
Monopolistically Competitive Firm
d. Oligopoly
(1) Oligopoly is a form of market
characterized by significant barriers to
entry. As a result there are few
(generally large) sellers of a product.
Because there are few sellers the
actions of one affect the others. Game
theory is often used to analyze the
behavior of the firms. An example of
an oligopoly is the automobile
industry. Other examples are found in
the production of steel, aluminum,
cigarettes, personal computers, and
many electrical appliances.
(2) Oligopolists often attempt to
engage in nonprice competition (e.g.,
by product differentiation or providing
high levels of service). However,
during economic downturns and
periods of overcapacity, price
competition in an oligopolistic market
can turn fierce.
(3) If left unregulated, ologopolists
tend to establish cartels that engage
in price fixing. Regulations in the US
prohibit collusion by firms to set
prices.
(4) The kinked-demand-curve
model seeks to explain the price
rigidity in oligopolistic markets.
This model holds that the demand
curve is kinked down at the
market price because other
oligopolists will not match price
increases but will match price
decreases. In the oligopolistic
market there is a price leader that
determines the pricing policy for
the other producers.
The Kinked Demand Curve
The Profit Payoff Matrix
52.Economic markets that are
characterized by monopolistic
competition have all of the
following characteristics except
a. One seller of the product.
b. Economies or diseconomies of
scale.
c. Advertising.
d. Heterogeneous products.
52. (a) because monopolistic
competition is a market
that has numerous sellers of
similar but differentiated
products.
Answers (b), (c), and (d) are
incorrect because they are all
characteristic of monopolistic
competition.
53. Which type of economic
market structure is
characterized by a few large
sellers of a product or service,
engaging primarily in nonprice
competition
a. Monopoly.
b. Oligopoly.
c. Perfect competition.
d. Monopolistic competition.
53. (b) is the definition of an
oligopoly. A(a) is incorrect because a
monopoly has a single seller of a
product or service for which there are
no close substitutes. (c) is incorrect
because perfect competition is
characterized by many firms selling an
identical product or service. Answer
(d) is incorrect because monopolistic
competition is characterized by many
firms selling a differentiated product
or service.
.
54. Which type of economic
market structure is composed of
a large number of sellers, each
producing an identical product,
and with no significant barriers to
entry or exit
a. Monopoly.
b. Oligopoly.
c. Perfect competition
d. Monopolistic competition.
54. (c) it is the definition of perfect
competition. Answer (a) is
incorrect because a monopoly has
a single seller of a product or
service for which there are no close
substitutes. (b) is incorrect
because an oligopoly is a form of
market in which there are few
large sellers of the product. (d) is
incorrect because monopolistic
competition is characterized by
many firms selling a differentiated
55.A natural monopoly exists
because
a. The firm owns natural
resources.
b. The firms holds patents.
c. Economic and technical
conditions permit only one
efficient supplier.
d. The government is the only
supplier
55. (c) because a natural
monopoly exists when, because of
economic or technical conditions,
only one firm can efficiently
supply the product.
(a) is incorrect because while owning
natural resources may contribute to the
establishment of a natural monopoly, the
firm would still have to be the best possible
producer of the product. (b) is incorrect
because a patent establishes a government-
created monopoly. (d) is incorrect because
if the govt is the only provider, the market
is a govt created monopoly.
58.An oligopolist faces a “kinked” demand curve.
This terminology indicates that
a. When an oligopolist lowers its price, the other
firms in the oligopoly will match the price reduction,
but if the oligopolist raises its price, the other firms
will ignore the price change.
b. An oligopolist faces a nonlinear demand for its
product, and price changes will have little effect on
demand for that product.
c. An oligopolist can sell its product at any price, but
after the “saturation point” another oligopolist will
lower its price and, therefore, shift the demand
curve to the left.
d. Consumers have no effect on the demand curve,
and an oligopolist can shape the curve to optimize
its own efficiency.
58. (a) The requirement is to describe the
reason for the kinked demand curve in an
oligopolist market. An oligopolist faces a
kinked demand curve because competitors
will often match price decreases but are
hesitant to match price increases.
Therefore, answer (a) is correct. Answer (b)
is incorrect because an oligopolist does not
face a nonlinear demand for its product.
Answer (c) is incorrect because an
oligopolist cannot sell its product for any
price. Answer (d) is incorrect because
consumer demand determines the demand
curve in all markets.