CEA Economic Theory & Principles 2 — Questions and Answers
Question 1: Which concept explains why a firm will continue producing as long as marginal revenue exceeds marginal cost?
- Profit maximization principle (Correct answer)
- Law of diminishing returns
- Consumer surplus theory
- Price elasticity rule
Correct answer: Profit maximization principle
Firms maximize profit by producing up to the point where MR = MC, stopping if MR would fall below MC.
Question 2: In a perfectly competitive market, long-run equilibrium results in firms earning:
- Supernormal profits
- Normal (zero economic) profits (Correct answer)
- Negative profits
- Maximum accounting profits
Correct answer: Normal (zero economic) profits
Free entry and exit drive economic profits to zero in the long run under perfect competition.
Question 3: The concept of 'consumer sovereignty' in market economies refers to:
- Government control over consumer prices
- Consumers' power to direct resource allocation through purchasing decisions (Correct answer)
- Central planning of consumer goods production
- The dominance of large consumers in price negotiations
Correct answer: Consumers' power to direct resource allocation through purchasing decisions
Consumer sovereignty means that consumer preferences, expressed through market demand, guide what goods are produced.
Question 4: If the cross-price elasticity of demand between two goods is negative, the goods are:
- Substitutes
- Inferior goods
- Complements (Correct answer)
- Giffen goods
Correct answer: Complements
Negative cross-price elasticity indicates complements — a rise in one good's price reduces demand for the other.
Question 5: The 'invisible hand' metaphor introduced by Adam Smith describes:
- Government intervention guiding markets
- How self-interested behavior leads to socially beneficial outcomes in free markets (Correct answer)
- The hidden costs of monopoly power
- Central bank control over interest rates
Correct answer: How self-interested behavior leads to socially beneficial outcomes in free markets
Smith argued that individuals pursuing self-interest in competitive markets unintentionally promote the public good.
Question 6: Which of the following best defines 'economic rent'?
- Payment for the use of land only
- Payment to any factor of production above its opportunity cost (Correct answer)
- The cost of renting commercial property
- Revenue minus explicit costs
Correct answer: Payment to any factor of production above its opportunity cost
Economic rent is the surplus a factor earns above the minimum necessary to keep it in its current use.
Question 7: The Laffer Curve illustrates the relationship between:
- Inflation and unemployment
- Tax rates and tax revenue (Correct answer)
- Money supply and interest rates
- Trade deficits and GDP growth
Correct answer: Tax rates and tax revenue
The Laffer Curve shows that both a 0% and 100% tax rate yield zero revenue, with a revenue-maximizing rate in between.
CEA Economic Theory & Principles 2
Which concept explains why a firm will continue producing as long as marginal revenue exceeds marginal cost?