Microeconomic Principles Flashcards

A firm in a perfectly competitive market observes that the market price for its product is $20. The firm's marginal cost is $25, and its average total cost is $22. To maximize profits in the short run, what should this firm do?

Answer: Decrease its output because marginal cost is greater than price.

In a perfectly competitive market, a firm maximizes profit by producing at the quantity where price equals marginal cost (P=MC). Since the market price ($20) is less than the firm's marginal cost ($25), the firm is losing money on the last unit produced. Therefore, it should decrease its output to a level where P=MC to maximize its profits (or minimize its losses).

A local government imposes a tax on the production of a good that generates a negative externality. Which of the following is the most likely outcome of this policy?

Answer: The supply curve for the good will shift to the left, leading to a higher price and lower quantity.

A tax on production increases the cost for producers, which is represented by a leftward (or upward) shift of the supply curve. This shift leads to a new market equilibrium with a higher price for consumers and a lower quantity of the good being produced and consumed. This is a common method to address negative externalities by internalizing the external cost.

A consumer is allocating their budget between two goods, X and Y. The marginal utility of the last unit of good X consumed is 40 utils, and its price is $8. The marginal utility of the last unit of good Y consumed is 30 utils, and its price is $5. To maximize total utility, what should this consumer do?

Answer: Purchase more of good Y and less of good X.

The utility maximization rule states that a consumer should allocate their budget so that the marginal utility per dollar spent is equal for all goods (MUx/Px = MUy/Py). In this scenario, the marginal utility per dollar for good X is 40/8 = 5 utils per dollar, while for good Y it is 30/5 = 6 utils per dollar. Since the consumer gets more utility per dollar from good Y, they should increase their consumption of good Y and decrease their consumption of good X until the ratios are equal.

A manufacturing company can produce either 100 units of product A or 80 units of product B with its current resources. If the company chooses to produce 60 units of product A, what is the opportunity cost in terms of units of product B?

Answer: 32 units of B

The opportunity cost of producing 100 units of A is 80 units of B. This means the opportunity cost of 1 unit of A is 0.8 units of B (80B/100A). If the company produces 100 units of A, it forgoes 80 units of B. If it produces 60 units of A, it has used 60% of its resources on A, leaving 40% for B. Therefore, the opportunity cost of producing 60 units of A is the 40 units of A it did not produce, which is equivalent to 32 units of B (40A * 0.8B/A). Alternatively, the resources to produce the remaining 40 units of A could have produced 32 units of B (40 * (80/100)).

If the price of a product increases by 10%, and the quantity demanded decreases by 15%, the price elasticity of demand for this product is:

Answer: Elastic

Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. In this case, it is 15% / 10% = 1.5. Since the absolute value of the elasticity (1.5) is greater than 1, the demand is considered elastic, meaning the quantity demanded is relatively responsive to changes in price.

Which of the following is a key characteristic that distinguishes a monopoly from a perfectly competitive market?

Answer: Significant barriers to entry.

While both market structures aim for profit maximization and have many buyers, a key difference is the ease of entry. In perfect competition, there are no barriers to entry or exit. In a monopoly, there are significant barriers (e.g., patents, control of a resource, economies of scale) that prevent other firms from entering the market and competing.