AA Economics Theories 5 — Questions and Answers
Question 1: Which economic concept explains why individuals contribute less to public goods when they expect others to pay?
- Adverse selection
- Free-rider problem (Correct answer)
- Tragedy of the commons
- Moral hazard
Correct answer: Free-rider problem
The free-rider problem occurs because non-excludable public goods allow people to benefit without contributing to their cost.
Question 2: According to the theory of the firm, a profit-maximizing firm should produce where:
- Average cost equals average revenue
- Marginal cost equals marginal revenue (Correct answer)
- Total cost is minimized
- Price equals average variable cost
Correct answer: Marginal cost equals marginal revenue
Setting MC = MR ensures that each additional unit adds at least as much to revenue as to cost, maximizing profit.
Question 3: The concept of 'adverse selection' in economics most commonly arises because of:
- Externalities in production
- Asymmetric information between buyers and sellers (Correct answer)
- Monopoly pricing power
- Government price controls
Correct answer: Asymmetric information between buyers and sellers
Adverse selection occurs before a transaction when one party has private information that leads to unfavorable market outcomes, as in Akerlof's 'market for lemons.'
Question 4: The multiplier effect in Keynesian economics predicts that an initial increase in government spending leads to:
- An equal increase in GDP
- A larger total increase in GDP due to successive rounds of spending (Correct answer)
- An immediate reduction in private investment
- No change in GDP if taxes are raised simultaneously
Correct answer: A larger total increase in GDP due to successive rounds of spending
Each round of spending becomes income for others who spend a fraction of it, amplifying the initial fiscal injection.
Question 5: Mercantilism, an early economic theory, held that national wealth was best accumulated by:
- Promoting free trade and specialization
- Maximizing exports and accumulating gold reserves (Correct answer)
- Reducing tariffs on imported goods
- Encouraging domestic consumption
Correct answer: Maximizing exports and accumulating gold reserves
Mercantilist policy favored trade surpluses and protectionism to build national gold stocks, which Adam Smith later criticized.
Question 6: The concept of 'consumer surplus' represents:
- Extra goods left unsold after demand is met
- The difference between what consumers are willing to pay and what they actually pay (Correct answer)
- Revenue earned above a firm's costs
- Government subsidies passed on to buyers
Correct answer: The difference between what consumers are willing to pay and what they actually pay
Consumer surplus measures the net benefit buyers receive when the market price is below their maximum willingness to pay.
Question 7: In institutional economics, Thorstein Veblen introduced the concept of 'conspicuous consumption' to describe:
- Efficient use of resources by wealthy firms
- Purchasing goods to signal social status rather than for utility (Correct answer)
- Overconsumption caused by government subsidies
- Wasteful production by monopolies
Correct answer: Purchasing goods to signal social status rather than for utility
Veblen argued that the wealthy buy expensive goods not for their intrinsic value but to display their social standing.
AA Economics Theories 5
Which economic concept explains why individuals contribute less to public goods when they expect others to pay?