Economics Model Answers Twelve - 2013

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1. Which concept in Economics do you think is the best self-motivator, which you might use to achieve more?

Answers vary, but could include a discussion of opportunity costs, maximizing marginal utility, economic costs, advantages of long run planning, how time is equivalent to money, etc.

2. Which is true about the average fixed costs (AFC) of a firm?

(a) A firm can eliminate these costs by shutting down in the short run.
(b) As output increases, AFC decreases.
(c) As output increases, AFC increases.
(d) AFC is part of average variable costs.

Briefly explain your answer.

B is the correct answer, because AFC is fixed costs divided by total output: FC/Q. As Q increases, the outcome decreases.

3. What is one of the primary responsibilities of the Federal Reserve Bank?

Control the interest rates of banks (which controls the flow of money), and keep banks from failing.

4. Review: Suppose that after completing this course, you start a new company. In your first year, you "broke even" (had zero profits), and in your second year you want to increase your revenue and profits. After careful study of your market, you decide that you can increase your revenue by increasing your price. Therefore your good must be price elastic/inelastic (choose one).

The price must be inelastic.

5. A monopolistic competitive firm has the following characteristic that is lacking for a perfectly competitive firm:

(a) There are low barriers to entry.
(b) MR = MC in the long run.
(c) P > MC
(d) There are many competitors.

Choose one of the above and explain your answer.

The correct answer is "C". A monopolistic competitive firm has the characteristic "P > MC", which is not true for a perfectly competitive firm. A monopolistic competitive firm does not have to repeatedly lower its prices to keep up wih the competition.

6. If you were to loan someone money, why would you want him to pay you something extra (interest) when he pays back the loan? Give at least one reason.

7. Review: is the cost of the bus for the March for Life trip to D.C. a "fixed cost" or a "variable cost"? Explain, assuming for the purpose of this question that one and only one bus can be used (in reality, we used several buses).

8. Suppose I will pay you $1000 in two years, and the interest rate is 10% per year, compounded annually. How much should you pay me today to receive $1000 in two years? Show your work.


9. Explain why in long-run equilibrium the price charged in monopolistic competition is greater than marginal cost but equal to average total cost.

In monopolistic competition there are almost no barriers of entry. A new firm can easily enter the market if products were selling above average total cost. If they charged more than ATC they would be undersold by the competition, and if they charged less then they would loss money overall.

10. Economics is sometimes called the “dismal science” because economists predicted population to grow faster than the food supply, marginal returns to diminish, and profits to vanish. But, in fact, there is an abundance of food and profits have not vanished. Why is economics not so dismal after all?

Because new inventions and hard work by people create wealth, charity, ingenuity, and so on.

11. What is "Keynesian economics" and what is your view of it?

Keynesian economics claims that government interference, and especially government spending, is good for the economy.

12. An agreement by different firms with each other to reduce output is illegal. Why should that be illegal?

13. Nash equilibrium, revisited: What is the Nash equilibrium for two gas stations (an oligopoly) that are situated immediately across the street from each other? In other words, what price do they sell at, expressed in terms of one of their cost measures? Explain the process that reaches that "equilibrium".