CEA - Certified Economic Analyst Microeconomic Principles Questions and Answers — Questions and Answers
Question 1: A firm in a perfectly competitive market observes that the market price for its product is $20. The firm's marginal cost is $25, and its average total cost is $22. To maximize profits in the short run, what should this firm do?
- Increase its output to lower its average total cost.
- Shut down its operations immediately.
- Decrease its output because marginal cost is greater than price. (Correct answer)
- Continue to produce at the current level since it is covering its average variable costs.
Correct answer: Decrease its output because marginal cost is greater than price.
In a perfectly competitive market, a firm maximizes profit by producing at the quantity where price equals marginal cost (P=MC). Since the market price ($20) is less than the firm's marginal cost ($25), the firm is losing money on the last unit produced. Therefore, it should decrease its output to a level where P=MC to maximize its profits (or minimize its losses).
Question 2: A local government imposes a tax on the production of a good that generates a negative externality. Which of the following is the most likely outcome of this policy?
- The market price of the good will decrease, and the quantity produced will increase.
- The supply curve for the good will shift to the left, leading to a higher price and lower quantity. (Correct answer)
- The demand curve for the good will shift to the left, leading to a lower price and lower quantity.
- Both the supply and demand curves will shift, resulting in an ambiguous change in price and quantity.
Correct answer: The supply curve for the good will shift to the left, leading to a higher price and lower quantity.
A tax on production increases the cost for producers, which is represented by a leftward (or upward) shift of the supply curve. This shift leads to a new market equilibrium with a higher price for consumers and a lower quantity of the good being produced and consumed. This is a common method to address negative externalities by internalizing the external cost.
Question 3: A consumer is allocating their budget between two goods, X and Y. The marginal utility of the last unit of good X consumed is 40 utils, and its price is $8. The marginal utility of the last unit of good Y consumed is 30 utils, and its price is $5. To maximize total utility, what should this consumer do?
- Purchase more of good X and less of good Y.
- Purchase more of good Y and less of good X. (Correct answer)
- Continue to consume the current amounts of both goods.
- Purchase less of both goods.
Correct answer: Purchase more of good Y and less of good X.
The utility maximization rule states that a consumer should allocate their budget so that the marginal utility per dollar spent is equal for all goods (MUx/Px = MUy/Py). In this scenario, the marginal utility per dollar for good X is 40/8 = 5 utils per dollar, while for good Y it is 30/5 = 6 utils per dollar. Since the consumer gets more utility per dollar from good Y, they should increase their consumption of good Y and decrease their consumption of good X until the ratios are equal.
Question 4: A manufacturing company can produce either 100 units of product A or 80 units of product B with its current resources. If the company chooses to produce 60 units of product A, what is the opportunity cost in terms of units of product B?
- 32 units of B (Correct answer)
- 48 units of B
- 80 units of B
- 50 units of B
Correct answer: 32 units of B
The opportunity cost of producing 100 units of A is 80 units of B. This means the opportunity cost of 1 unit of A is 0.8 units of B (80B/100A). If the company produces 100 units of A, it forgoes 80 units of B. If it produces 60 units of A, it has used 60% of its resources on A, leaving 40% for B. Therefore, the opportunity cost of producing 60 units of A is the 40 units of A it did not produce, which is equivalent to 32 units of B (40A * 0.8B/A). Alternatively, the resources to produce the remaining 40 units of A could have produced 32 units of B (40 * (80/100)).
Question 5: If the price of a product increases by 10%, and the quantity demanded decreases by 15%, the price elasticity of demand for this product is:
- Unit elastic
- Perfectly inelastic
- Elastic (Correct answer)
- Inelastic
Correct answer: Elastic
Price elasticity of demand is calculated as the percentage change in quantity demanded divided by the percentage change in price. In this case, it is 15% / 10% = 1.5. Since the absolute value of the elasticity (1.5) is greater than 1, the demand is considered elastic, meaning the quantity demanded is relatively responsive to changes in price.
Question 6: Which of the following is a key characteristic that distinguishes a monopoly from a perfectly competitive market?
- The presence of many buyers.
- The goal of profit maximization.
- Significant barriers to entry. (Correct answer)
- Production of a homogeneous product.
Correct answer: Significant barriers to entry.
While both market structures aim for profit maximization and have many buyers, a key difference is the ease of entry. In perfect competition, there are no barriers to entry or exit. In a monopoly, there are significant barriers (e.g., patents, control of a resource, economies of scale) that prevent other firms from entering the market and competing.
CEA - Certified Economic Analyst Microeconomic Principles Questions and Answers
A firm in a perfectly competitive market observes that the market price for its product is $20.
The firm's marginal cost is $25, and its average total cost is $22.
To maximize profits in the short run, what should this firm do?