CEA Microeconomic Principles 5 — Questions and Answers
Question 1: When a tax is imposed on a good with perfectly inelastic demand, the tax burden falls:
- Entirely on producers
- Entirely on consumers (Correct answer)
- Equally between producers and consumers
- On neither party due to market adjustment
Correct answer: Entirely on consumers
With perfectly inelastic demand, consumers cannot reduce quantity demanded, so they bear the full burden of any per-unit tax.
Question 2: The 'prisoners' dilemma' illustrates that individually rational behavior can lead to:
- Pareto optimal outcomes for all players
- A collectively suboptimal outcome (Correct answer)
- Dominant strategies that maximize joint payoffs
- Cooperative equilibria without communication
Correct answer: A collectively suboptimal outcome
Each prisoner's dominant strategy is to confess, but both confessing produces a worse collective outcome than mutual silence.
Question 3: Which of the following best describes the concept of opportunity cost in microeconomics?
- The total monetary expenditure required to produce a good
- The explicit accounting costs recorded on financial statements
- The value of the next-best alternative forgone when making a choice (Correct answer)
- The sunk costs that cannot be recovered from a prior investment
Correct answer: The value of the next-best alternative forgone when making a choice
Opportunity cost captures the true economic cost of a decision by including the value of the best alternative that must be sacrificed.
Question 4: Adverse selection in insurance markets occurs when:
- Insurers deny coverage to high-risk individuals
- High-risk individuals are more likely to purchase insurance than low-risk individuals (Correct answer)
- Insured individuals take more risks after obtaining coverage
- Insurance premiums exceed the expected value of claims
Correct answer: High-risk individuals are more likely to purchase insurance than low-risk individuals
Adverse selection results from asymmetric information where high-risk types disproportionately seek insurance, making it unsustainable at average-risk premiums.
Question 5: A firm's economic profit differs from accounting profit because economic profit:
- Excludes all variable costs from the calculation
- Subtracts implicit (opportunity) costs in addition to explicit costs (Correct answer)
- Adds depreciation back to net income
- Only counts revenues from primary business operations
Correct answer: Subtracts implicit (opportunity) costs in addition to explicit costs
Economic profit deducts both explicit costs (paid to others) and implicit costs (opportunity costs of owner-supplied resources) from total revenue.
Question 6: Which of the following is an example of third-degree price discrimination?
- An airline charging more for last-minute tickets regardless of buyer identity
- A utility company charging lower rates for higher usage blocks
- A museum charging lower admission for students than for adults (Correct answer)
- A grocery store offering bulk discounts on the same product
Correct answer: A museum charging lower admission for students than for adults
Third-degree price discrimination charges different prices to identifiable groups (e.g., students vs. adults) based on differing demand elasticities.
Question 7: When a Pigouvian tax is correctly implemented on a negative externality, it causes the market to produce:
- More than the socially optimal quantity
- Less than the socially optimal quantity
- Exactly the socially optimal quantity (Correct answer)
- The same quantity as before the tax
Correct answer: Exactly the socially optimal quantity
A Pigouvian tax equal to the marginal external cost internalizes the externality, aligning private and social incentives at the efficient output level.
CEA Microeconomic Principles 5
When a tax is imposed on a good with perfectly inelastic demand, the tax burden falls: