CEA Microeconomic Principles 4 — Questions and Answers
Question 1: The deadweight loss from a monopoly arises because the monopolist:
- Earns positive economic profits
- Sets price equal to marginal cost
- Produces less than the socially optimal output level (Correct answer)
- Engages in price discrimination
Correct answer: Produces less than the socially optimal output level
A monopolist restricts output below the competitive level to charge a higher price, creating deadweight loss from foregone mutually beneficial trades.
Question 2: According to the theory of consumer choice, a consumer maximizes utility when:
- Total expenditure on all goods is minimized
- The marginal utility of the last dollar spent is equal across all goods (Correct answer)
- Marginal utility of each good is equal
- The budget constraint is not binding
Correct answer: The marginal utility of the last dollar spent is equal across all goods
Utility maximization requires that MU/P be equal for all goods purchased, so no reallocation of spending can increase total utility.
Question 3: In the long run under perfect competition, economic profit tends toward zero because:
- Government regulations limit firm profits
- New firms enter the market when profits exist, driving down price (Correct answer)
- Firms collude to share the market equitably
- Demand for the product decreases as supply rises
Correct answer: New firms enter the market when profits exist, driving down price
Free entry allows new firms to enter profitable markets, increasing supply and reducing price until economic profit equals zero.
Question 4: Which of the following is a characteristic of a public good?
- Rival in consumption and excludable
- Non-rival in consumption and excludable
- Rival in consumption and non-excludable
- Non-rival in consumption and non-excludable (Correct answer)
Correct answer: Non-rival in consumption and non-excludable
Public goods are simultaneously non-rival (one person's use doesn't reduce availability to others) and non-excludable (no one can be prevented from using them).
Question 5: A firm is producing at a point where marginal cost exceeds marginal revenue. To maximize profit, the firm should:
- Increase output to drive down marginal cost
- Decrease output to increase marginal revenue (Correct answer)
- Maintain current output as this is optimal
- Increase price to raise marginal revenue
Correct answer: Decrease output to increase marginal revenue
When MC > MR, reducing output lowers costs more than it reduces revenue, increasing profit until MC = MR.
Question 6: The substitution effect of a price change always leads consumers to:
- Buy more of the good regardless of whether it is normal or inferior
- Buy less of a good whose relative price has risen (Correct answer)
- Buy more of inferior goods and less of normal goods
- Maintain the same consumption bundle to preserve utility
Correct answer: Buy less of a good whose relative price has risen
The substitution effect causes consumers to replace relatively more expensive goods with relatively cheaper alternatives, regardless of income effects.
Question 7: Which pricing strategy allows a monopolist to charge each consumer their maximum willingness to pay?
- Second-degree price discrimination
- Block pricing
- First-degree (perfect) price discrimination (Correct answer)
- Third-degree price discrimination
Correct answer: First-degree (perfect) price discrimination
First-degree price discrimination involves charging each consumer their reservation price, capturing the entire consumer surplus as producer surplus.
CEA Microeconomic Principles 4
The deadweight loss from a monopoly arises because the monopolist: