CEA Economic Theory & Principles 3 — Questions and Answers
Question 1: When a good has many close substitutes, its price elasticity of demand tends to be:
- Inelastic
- Perfectly inelastic
- Elastic (Correct answer)
- Unit elastic
Correct answer: Elastic
Availability of substitutes makes consumers highly responsive to price changes, resulting in elastic demand.
Question 2: Which market structure is characterized by a few large firms, mutual interdependence, and significant barriers to entry?
- Monopolistic competition
- Perfect competition
- Oligopoly (Correct answer)
- Monopsony
Correct answer: Oligopoly
Oligopoly features a small number of dominant firms whose strategic decisions are interdependent.
Question 3: The income effect of a price decrease suggests that consumers will:
- Buy less of the good because it is now cheaper
- Feel relatively richer and increase consumption of normal goods (Correct answer)
- Substitute away from the now-cheaper good
- Reduce savings to maintain consumption
Correct answer: Feel relatively richer and increase consumption of normal goods
A price decrease increases real purchasing power, allowing consumers to buy more of normal goods via the income effect.
Question 4: In game theory, a Nash Equilibrium occurs when:
- Both players cooperate to maximize joint payoffs
- Each player's strategy is optimal given the strategies of all other players (Correct answer)
- The dominant strategy leads to the best global outcome
- Players repeatedly interact until one wins
Correct answer: Each player's strategy is optimal given the strategies of all other players
At Nash Equilibrium, no player can unilaterally improve their outcome by changing their own strategy.
Question 5: Which of the following is an example of a positive externality?
- A factory polluting a nearby river
- A beekeeper's bees pollinating neighboring farms (Correct answer)
- Traffic congestion from commuters
- Noise from a construction site
Correct answer: A beekeeper's bees pollinating neighboring farms
Bees pollinating neighboring farms creates benefits for third parties not compensated by the market — a positive externality.
Question 6: The concept of 'price discrimination' requires which key condition?
- A perfectly competitive market
- The ability to prevent resale between market segments (Correct answer)
- Identical elasticities across buyer groups
- Government price controls
Correct answer: The ability to prevent resale between market segments
Price discrimination only works if the seller can segment markets and prevent arbitrage (resale between segments).
Question 7: Stagflation, a challenge for policymakers, is defined as a period of:
- High growth combined with low inflation
- Simultaneous high inflation and high unemployment (Correct answer)
- Deflation combined with economic expansion
- Rapid GDP growth with falling wages
Correct answer: Simultaneous high inflation and high unemployment
Stagflation combines stagnant economic growth (high unemployment) with rising inflation, which traditional policy tools struggle to address.
CEA Economic Theory & Principles 3
When a good has many close substitutes, its price elasticity of demand tends to be: