CBE Microeconomics 3 — Questions and Answers
Question 1: Which of the following correctly describes a Giffen good?
- A luxury good with high income elasticity
- An inferior good whose demand curve slopes upward (Correct answer)
- A good for which the substitution effect exceeds the income effect
- A good that rises in price when supply decreases
Correct answer: An inferior good whose demand curve slopes upward
Giffen goods are inferior goods where the negative income effect of a price increase outweighs the substitution effect, causing quantity demanded to rise with price.
Question 2: Economic profit equals zero in the long run for a perfectly competitive firm because:
- Government regulations cap profits
- Free entry and exit drive price to minimum average total cost (Correct answer)
- Firms collude to set price equal to marginal cost
- Fixed costs disappear in the long run
Correct answer: Free entry and exit drive price to minimum average total cost
Positive profits attract new entrants who increase supply and drive price down to the minimum ATC, eliminating economic profit.
Question 3: The marginal rate of technical substitution (MRTS) measures:
- The rate at which output changes as one input increases
- The slope of the isocost line
- The rate at which capital can replace labor while holding output constant (Correct answer)
- The ratio of output price to input price
Correct answer: The rate at which capital can replace labor while holding output constant
MRTS = −ΔK/ΔL along an isoquant, representing how much capital is needed to replace one unit of labor without changing output.
Question 4: Consumer surplus is maximized under which market structure?
- Monopoly
- Oligopoly with collusion
- Perfect competition (Correct answer)
- Monopolistic competition
Correct answer: Perfect competition
Perfect competition sets P = MC at minimum ATC, producing the highest output and lowest price, thereby maximizing consumer surplus.
Question 5: An increase in the wage rate will shift a firm's isocost line by:
- Rotating it inward along the labor axis, keeping the capital intercept fixed (Correct answer)
- Shifting it outward parallel to the original line
- Rotating it outward along the capital axis
- Keeping it unchanged if total cost rises proportionally
Correct answer: Rotating it inward along the labor axis, keeping the capital intercept fixed
A higher wage raises the cost of labor, reducing the maximum labor affordable for a given budget while leaving the capital intercept unchanged.
Question 6: Which condition defines the profit-maximizing input choice for a competitive firm?
- Value of marginal product equals the input price (Correct answer)
- Average product equals the input price
- Total product is maximized
- Marginal product equals average product
Correct answer: Value of marginal product equals the input price
A firm maximizes profit by hiring inputs until VMP = w, where VMP = P × MP; this equates the revenue generated by the last unit of input to its cost.
Question 7: In a Stackelberg duopoly, the leader firm benefits from:
- Moving simultaneously with the follower
- Having lower marginal costs than the follower
- Committing to an output level first, forcing the follower to react (Correct answer)
- Setting price rather than quantity
Correct answer: Committing to an output level first, forcing the follower to react
The Stackelberg leader gains a first-mover advantage by credibly committing to output, which constrains the follower's best response and increases leader profits.
CBE Microeconomics 3
Which of the following correctly describes a Giffen good?