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Question 1Microeconomics (consumer theory, producer theory, market structures)

A consumer has a fixed money income and faces fixed prices for two goods. The budget line's vertical intercept equals:

  1. The ratio of the two goods' prices
  2. The price of the good on the vertical axis divided by income
  3. Income multiplied by the price of the good on the vertical axis
  4. Income divided by the price of the good on the vertical axis Correct answer.

Explanation

Setting spending on the horizontal good to zero, all income goes to the vertical good, so the maximum affordable quantity is income divided by that good's price. This is the vertical intercept of the budget constraint.

Question 2Microeconomics (consumer theory, producer theory, market structures)

Along a single indifference curve, which quantity is held constant?

  1. The consumer's total expenditure
  2. The marginal rate of substitution of the goods
  3. The price ratio of the two goods
  4. The consumer's total utility Correct answer.

Explanation

An indifference curve is a level set of the utility function: every bundle on it yields the same total utility. The marginal rate of substitution generally changes as one moves along the curve.

Question 3Microeconomics (consumer theory, producer theory, market structures)

A firm's total product curve shows output rising at a decreasing rate as more labor is added with capital fixed. This pattern reflects:

  1. Increasing returns to scale
  2. Diminishing marginal product of labor Correct answer.
  3. Economies of scope
  4. Constant returns to scale

Explanation

When the total product rises but at a falling rate, each additional worker adds less output than the previous one. That is the definition of diminishing marginal product of a variable input in the short run.

Question 4Microeconomics (consumer theory, producer theory, market structures)

In a perfectly competitive market, an individual firm's demand curve is:

  1. Upward sloping because of increasing marginal cost
  2. Vertical at the firm's chosen quantity
  3. Horizontal at the prevailing market price Correct answer.
  4. Downward sloping and steeper than the market demand curve

Explanation

A price-taking firm can sell any quantity at the market price but nothing above it, so its perceived demand is perfectly elastic. The market demand curve remains downward sloping because buyers collectively respond to price.

Question 5Microeconomics (consumer theory, producer theory, market structures)

A monopolist maximizes profit at the output where marginal revenue equals marginal cost. At that output, price is:

  1. Equal to marginal cost
  2. Below marginal revenue
  3. Equal to average fixed cost
  4. Above marginal revenue Correct answer.

Explanation

For a downward-sloping demand curve, marginal revenue lies below price, so price exceeds marginal revenue at the profit-maximizing quantity. This gap is the source of the monopoly markup over marginal cost.

Question 6Microeconomics (consumer theory, producer theory, market structures)

Which statement describes a Giffen good?

  1. Its demand rises when its price rises because the substitution effect dominates the income effect
  2. It is a luxury good whose demand is independent of income
  3. It is a normal good with a very elastic demand curve
  4. Its demand rises when its price rises because the income effect dominates the substitution effect Correct answer.

Explanation

For a Giffen good the negative income effect of a price increase outweighs the substitution effect, so quantity demanded moves in the same direction as price. This requires the good to be strongly inferior and to absorb a large share of the budget.

Question 7Microeconomics (consumer theory, producer theory, market structures)

A firm produces where marginal cost is below average total cost. As output increases slightly, average total cost will:

  1. Stay unchanged
  2. Fall only if fixed costs are zero
  3. Fall Correct answer.
  4. Rise

Explanation

Average total cost falls whenever the marginal cost of the next unit is below the current average, since the new unit pulls the average down. Average cost rises only when marginal cost exceeds it.

Question 8Microeconomics (consumer theory, producer theory, market structures)

In a Cournot duopoly with identical firms and constant marginal cost, each firm's profit-maximizing output is best described as:

  1. The output that maximizes its profit given the other firm's output Correct answer.
  2. The competitive output divided equally between the firms
  3. The output at which price equals marginal cost for the firm
  4. The output that maximizes joint industry profit

Explanation

Cournot competition has each firm choose quantity to maximize its own profit taking the rival's quantity as given. The Nash equilibrium occurs where these best responses are mutually consistent.

Question 9Microeconomics (consumer theory, producer theory, market structures)

A consumer's marginal rate of substitution of good X for good Y equals 3, and the price ratio Px/Py equals 2. To increase utility while spending the same income, the consumer should:

  1. Buy more X and less Y Correct answer.
  2. Buy more of both goods
  3. Buy more Y and less X
  4. Keep the current bundle unchanged

Explanation

The consumer values the last unit of X at 3 units of Y but only has to give up 2 units of Y to buy it. Shifting spending toward X raises utility until the marginal rate of substitution falls to equal the price ratio.

Question 10Microeconomics (consumer theory, producer theory, market structures)

A firm has fixed costs of 100 and a constant marginal cost of 10 per unit. At an output of 20 units, average total cost equals:

  1. 10
  2. 30
  3. 15 Correct answer.
  4. 20

Explanation

Total cost is fixed cost plus variable cost: 100 + 10×20 = 300. Dividing by 20 units gives an average total cost of 15.

Question 11Microeconomics (consumer theory, producer theory, market structures)

A price ceiling set below the equilibrium price of a competitive market typically produces:

  1. An upward shift in the supply curve
  2. No effect because the market clears at the ceiling
  3. A shortage because quantity demanded exceeds quantity supplied Correct answer.
  4. A surplus because quantity supplied exceeds quantity demanded

Explanation

A binding ceiling holds price below equilibrium, so the quantity demanded exceeds the quantity supplied, creating excess demand. The resulting shortage is the gap between those two quantities at the ceiling price.

Question 12Microeconomics (consumer theory, producer theory, market structures)

A consumer's utility function is U = X·Y. With income 120, Px = 4, and Py = 2, the utility-maximizing quantity of X is:

  1. 20
  2. 10
  3. 30
  4. 15 Correct answer.

Explanation

For Cobb-Douglas utility with equal exponents, the consumer spends half of income on each good. Half of 120 is 60, and 60 divided by 4 gives 15 units of X.

Question 13Microeconomics (consumer theory, producer theory, market structures)

A firm in a perfectly competitive market faces a price of 25 and has marginal cost equal to 25 at an output of 40 units, where average total cost is 30. In the short run the firm should:

  1. Shut down immediately because price is below average total cost
  2. Produce 40 units because price exceeds average variable cost Correct answer.
  3. Expand output until price equals average total cost
  4. Reduce output to lower average fixed cost

Explanation

The short-run shutdown rule compares price with average variable cost, not average total cost. With price equal to marginal cost and above average variable cost, producing 40 units minimizes losses even though the firm makes negative economic profit.

Question 14Microeconomics (consumer theory, producer theory, market structures)

The long-run equilibrium of a perfectly competitive industry with free entry is characterized by:

  1. Price equal to minimum average total cost Correct answer.
  2. Price above marginal cost for each firm
  3. Firms producing below minimum efficient scale
  4. Positive economic profit for all firms

Explanation

Free entry and exit drive economic profit to zero, which occurs where price equals minimum average total cost. At that point each firm produces at the efficient scale and price also equals marginal cost.

Question 15Microeconomics (consumer theory, producer theory, market structures)

Compared with a single-price monopolist, a monopolist that can practice perfect first-degree price discrimination will:

  1. Charge every buyer the same price above marginal cost
  2. Set price below marginal cost to deter entry
  3. Produce less output and earn lower profit
  4. Produce the efficient quantity and capture all consumer surplus Correct answer.

Explanation

Perfect price discrimination charges each buyer their reservation price, so marginal revenue equals price and the monopolist expands output to where price equals marginal cost. All surplus becomes producer surplus, and the allocative distortion disappears.

Question 16Microeconomics (consumer theory, producer theory, market structures)

Two firms face a prisoners' dilemma payoff structure in a one-shot game. The Nash equilibrium is best described as:

  1. A mixed strategy in which each randomizes equally
  2. Both firms choosing the action that is individually dominant, yielding a Pareto-inferior outcome Correct answer.
  3. Both firms choosing the cooperative action
  4. One firm cooperating while the other defects

Explanation

In a prisoners' dilemma each player has a dominant strategy to defect, so the unique Nash equilibrium has both defecting. The outcome is worse for both than mutual cooperation, which is why it is Pareto inferior.

Question 17Microeconomics (consumer theory, producer theory, market structures)

A consumer's demand for a good has a price elasticity of demand of −0.4 in absolute value. If the price rises by 10 percent, quantity demanded will:

  1. Rise by 4 percent
  2. Remain unchanged
  3. Fall by 40 percent
  4. Fall by 4 percent Correct answer.

Explanation

Elasticity equals the percentage change in quantity divided by the percentage change in price. With an elasticity of 0.4 in absolute value and a 10 percent price increase, quantity falls by about 4 percent.

Question 18Microeconomics (consumer theory, producer theory, market structures)

When a firm's production function exhibits increasing returns to scale, its long-run average cost curve is:

  1. Upward sloping over the relevant range
  2. Vertical at the minimum efficient scale
  3. Downward sloping over the relevant range Correct answer.
  4. Horizontal over the relevant range

Explanation

Increasing returns to scale mean output rises more than proportionally when all inputs are scaled up, so cost per unit falls. That corresponds to the downward-sloping portion of the long-run average cost curve.

Question 19Microeconomics (consumer theory, producer theory, market structures)

In a Stackelberg duopoly, the leader's first-mover advantage arises because the leader:

  1. Can commit to an output that the follower then treats as given Correct answer.
  2. Sets a price that the follower must match exactly
  3. Colludes with the follower to split the market equally
  4. Faces lower marginal cost than the follower

Explanation

The Stackelberg leader chooses output first and anticipates the follower's best response. By committing to a larger quantity, the leader secures a larger share of the market and higher profit than in the simultaneous Cournot game.

Question 20Microeconomics (consumer theory, producer theory, market structures)

A consumer initially buys 10 units when income is 1,000 and 13 units when income is 1,200. The income elasticity of demand, computed with the midpoint formula, is approximately:

  1. 1.50 Correct answer.
  2. 2.00
  3. 3.00
  4. 0.50

Explanation

The percentage change in quantity using midpoints is 3/11.5 ≈ 26.1 percent, and the percentage change in income is 200/1,100 ≈ 18.2 percent. Dividing gives an income elasticity of about 1.44, closest to 1.50.

Question 21Microeconomics (consumer theory, producer theory, market structures)

A firm's production function is Q = min(2L, 3K). At the input combination L = 6 and K = 3, the firm's output is:

  1. 18
  2. 6 Correct answer.
  3. 9
  4. 12

Explanation

A Leontief production function is limited by the smaller of the two input-based quantities. Here 2L = 12 and 3K = 9, so the minimum and thus output is 9... wait, the smaller value is 9.

Question 22Microeconomics (consumer theory, producer theory, market structures)

Which market structure is characterized by many sellers, differentiated products, and free entry in the long run?

  1. Oligopoly
  2. Monopolistic competition Correct answer.
  3. Monopoly
  4. Perfect competition

Explanation

Monopolistic competition combines many firms and free entry with product differentiation, giving each firm a downward-sloping demand curve. Long-run entry drives economic profit to zero even though price exceeds marginal cost.

Question 23Microeconomics (consumer theory, producer theory, market structures)

A firm's marginal cost curve intersects its average variable cost curve at the point where average variable cost is:

  1. At its maximum
  2. Equal to average fixed cost
  3. At its minimum Correct answer.
  4. Equal to zero

Explanation

Marginal cost pulls average variable cost in the direction of the marginal value. When marginal cost crosses average variable cost from below, the average reaches its minimum, which also marks the shutdown point.

Question 24Microeconomics (consumer theory, producer theory, market structures)

For a consumer with strictly convex preferences facing a linear budget constraint, an interior optimum is characterized by:

  1. A corner solution at the intercept
  2. The marginal rate of substitution equaling the price ratio Correct answer.
  3. The marginal rate of substitution equal to zero
  4. The marginal rate of substitution exceeding the price ratio

Explanation

Tangency of the indifference curve with the budget line requires the slopes to match, so the marginal rate of substitution equals the price ratio. Strict convexity ensures this tangency identifies a unique utility maximum.

Question 25Microeconomics (consumer theory, producer theory, market structures)

A monopolist faces demand P = 100 − 2Q and has constant marginal cost of 20 with no fixed cost. The profit-maximizing quantity is:

  1. 25
  2. 20 Correct answer.
  3. 10
  4. 40

Explanation

Total revenue is 100Q − 2Q², so marginal revenue is 100 − 4Q. Setting marginal revenue equal to marginal cost of 20 gives 4Q = 80, hence Q = 20 and price of 60.

Question 26Microeconomics (consumer theory, producer theory, market structures)

A consumer's indifference curves are straight, downward-sloping lines. Which description of the consumer's preferences is consistent with this shape?

  1. The two goods are perfect substitutes, so the marginal rate of substitution is constant. Correct answer.
  2. The goods are inferior goods, so demand falls when income rises.
  3. The goods are normal goods, so demand rises when income rises.
  4. The two goods are perfect complements, so the consumer always consumes them in fixed proportions.

Explanation

Linear indifference curves have a constant slope, which means the consumer is always willing to trade the two goods at the same fixed rate regardless of how much of each is held. That constant marginal rate of substitution is the defining property of perfect substitutes. Perfect complements instead produce L-shaped indifference curves.

Question 27Microeconomics (consumer theory, producer theory, market structures)

A firm operates in a market where its product is identical to rivals' products, many firms sell, and firms can enter or exit freely. In long-run equilibrium, which outcome is expected?

  1. Price exceeds minimum average total cost and firms earn positive economic profit.
  2. Price equals marginal cost but firms earn positive economic profit because of product differentiation.
  3. Price equals minimum long-run average cost and each firm earns zero economic profit. Correct answer.
  4. Price is set above marginal cost because each firm has some market power.

Explanation

Free entry and exit drive price to the minimum of long-run average cost, where no firm has an incentive to enter or leave and economic profit is zero. This is the long-run competitive outcome: production at minimum efficient scale and price equal to marginal cost as well. Positive profit would attract entrants until it is competed away.

Question 28Microeconomics (consumer theory, producer theory, market structures)

In a market with a negative externality in production, the competitive equilibrium output exceeds the socially efficient output. Which policy instrument moves output toward the efficient level?

  1. A per-unit subsidy to producers equal to the marginal external cost.
  2. A lump-sum tax on producers independent of output.
  3. A per-unit tax on producers equal to the marginal external cost. Correct answer.
  4. A price floor set above the equilibrium price.

Explanation

A Pigouvian tax equal to the marginal external cost at the efficient quantity makes producers internalize the external damage and shifts the supply curve up to the social marginal cost curve. Output then falls to the socially efficient level. A lump-sum tax changes fixed cost only and does not affect marginal production decisions.

Question 29Microeconomics (consumer theory, producer theory, market structures)

A firm sells in a market with many sellers, differentiated products, and free entry. In long-run equilibrium, which condition holds?

  1. Price equals marginal cost, and price exceeds average total cost.
  2. Price exceeds both marginal cost and average total cost.
  3. Price exceeds marginal cost, and price equals average total cost. Correct answer.
  4. Price equals marginal cost and equals minimum average total cost.

Explanation

Monopolistic competition combines downward-sloping demand from product differentiation with free entry. Profit maximization sets marginal revenue equal to marginal cost, so price exceeds marginal cost, while free entry drives price down to average total cost so economic profit is zero. The tangency of demand and average cost occurs to the left of minimum average cost, reflecting excess capacity.

Question 30Microeconomics (consumer theory, producer theory, market structures)

A consumer spends a fixed budget on two goods. The price of good X falls while the price of good Y and income are unchanged. Which statement about the budget constraint is correct?

  1. The budget line pivots inward around the Y intercept, becoming steeper.
  2. The budget line shifts outward parallel to itself.
  3. The budget line pivots outward around the Y intercept, becoming flatter. Correct answer.
  4. The budget line is unaffected because income has not changed.

Explanation

The maximum affordable quantity of Y is income divided by the price of Y, which is unchanged, so the vertical intercept stays fixed. The maximum affordable quantity of X rises, so the horizontal intercept moves right and the slope, equal to the negative price ratio, becomes smaller in absolute value. The result is an outward pivot that is flatter.

Question 31Microeconomics (consumer theory, producer theory, market structures)

A firm's total cost function is TC = 50 + 4Q + Q². At Q = 10, what is the firm's marginal cost?

  1. 14
  2. 24 Correct answer.
  3. 10
  4. 19

Explanation

Marginal cost is the derivative of total cost with respect to output: MC = 4 + 2Q. Substituting Q = 10 gives MC = 4 + 20 = 24. The fixed cost of 50 does not enter marginal cost because it does not vary with output.

Question 32Microeconomics (consumer theory, producer theory, market structures)

A monopolist faces inverse demand P = 60 − Q and has constant marginal cost of 12 with no fixed costs. What quantity maximizes profit?

  1. 30
  2. 48
  3. 24 Correct answer.
  4. 12

Explanation

Total revenue is 60Q − Q², so marginal revenue is 60 − 2Q. Setting marginal revenue equal to marginal cost gives 60 − 2Q = 12, hence Q = 24. At that quantity price is 36 and the markup over marginal cost reflects the monopolist's market power.

Question 33Microeconomics (consumer theory, producer theory, market structures)

A consumer has utility U = X^0.5 · Y^0.5, income of 200, and faces prices Px = 5 and Py = 10. What is the utility-maximizing quantity of X?

  1. 25
  2. 10
  3. 20 Correct answer.
  4. 40

Explanation

With Cobb-Douglas exponents that sum to one, the consumer spends the share equal to the exponent on each good. Half of income, 100, goes to X, so X = 100/5 = 20. The same logic gives Y = 100/10 = 10, and the marginal rate of substitution equals the price ratio at this bundle.

Question 34Microeconomics (consumer theory, producer theory, market structures)

Two firms choose prices simultaneously for an identical product, each has constant marginal cost of 10, and each can serve the whole market at its posted price. What is the Nash equilibrium of this one-shot game?

  1. Both firms charge a price equal to marginal cost, 10. Correct answer.
  2. One firm charges a high price and the other undercuts slightly.
  3. Both firms charge the monopoly price and split the profit.
  4. Both firms charge a price above marginal cost and share the market equally.

Explanation

In Bertrand competition with homogeneous products, any price above marginal cost can be profitably undercut to capture the entire market. That undercutting continues until price equals marginal cost, where neither firm can gain by deviating. Hence the unique Nash equilibrium is price equal to 10 with zero economic profit.

Question 35Microeconomics (consumer theory, producer theory, market structures)

A firm's short-run production function is Q = 10L − 0.5L². At what level of labor does marginal product of labor become zero?

  1. 20
  2. 2
  3. 5
  4. 10 Correct answer.

Explanation

Marginal product of labor is the derivative of output with respect to labor: MPL = 10 − L. Setting this equal to zero gives L = 10, the point where total product peaks in the short run. Beyond that point additional labor reduces output because of congestion of the fixed input.

Question 36Microeconomics (consumer theory, producer theory, market structures)

A consumer's preferences exhibit a diminishing marginal rate of substitution. Along a downward-sloping linear budget line, what does this imply about the optimal interior bundle?

  1. The optimum occurs where the indifference curve crosses the budget line twice.
  2. The optimum cannot be identified without knowing the consumer's income.
  3. The optimum occurs at a corner where all income is spent on one good.
  4. The optimum occurs where the indifference curve is tangent to the budget line. Correct answer.

Explanation

Diminishing marginal rate of substitution makes indifference curves strictly convex to the origin, so the highest attainable curve touches the budget line at a single tangency point. At that point the marginal rate of substitution equals the price ratio. A corner solution arises only with linear or concave preferences.

Question 37Microeconomics (consumer theory, producer theory, market structures)

In a market with a positive externality in consumption, the competitive equilibrium quantity is below the socially efficient quantity. Which statement explains why?

  1. Social marginal benefit exceeds private marginal benefit, so the market underprovides the good. Correct answer.
  2. Private marginal benefit exceeds social marginal benefit, so consumers overconsume.
  3. Producers have market power that restricts output below the efficient level.
  4. The good is a public good, so it is impossible to charge any price for it.

Explanation

With a positive consumption externality, each additional unit consumed benefits others as well as the buyer, so the social marginal benefit curve lies above the private demand curve. The competitive market responds only to private benefit and therefore produces less than the efficient quantity. A Pigouvian subsidy equal to the marginal external benefit can close the gap.

Question 38Microeconomics (consumer theory, producer theory, market structures)

A firm uses inputs labor and capital and faces a wage of 20 and a rental rate of capital of 40. At its current input bundle, the marginal product of labor is 10 and the marginal product of capital is 30. What should the firm do to reduce cost while keeping output constant?

  1. Keep the current bundle because output is already maximized.
  2. Use more capital and less labor. Correct answer.
  3. Reduce both inputs proportionally.
  4. Use more labor and less capital.

Explanation

Cost minimization requires the marginal product per unit of expenditure to be equal across inputs. Here MPL/w = 10/20 = 0.5 while MPK/r = 30/40 = 0.75, so capital delivers more output per currency unit at the margin. Shifting spending from labor toward capital lowers cost for the same output.

Question 39Microeconomics (consumer theory, producer theory, market structures)

A monopolist faces a linear demand curve. At the quantity where marginal revenue is zero, what is true of the price elasticity of demand?

  1. Demand is elastic, and total revenue is rising with quantity.
  2. Demand is inelastic, and total revenue is falling with quantity.
  3. Demand is perfectly elastic, and price equals marginal revenue.
  4. Demand is unit elastic, and total revenue is at its maximum. Correct answer.

Explanation

Marginal revenue equals price times one minus the reciprocal of the elasticity magnitude, so marginal revenue is zero exactly when the elasticity magnitude equals one. At that point total revenue reaches its peak. A profit-maximizing monopolist never operates on the inelastic portion of demand because marginal revenue would be negative there.

Question 40Microeconomics (consumer theory, producer theory, market structures)

In a repeated prisoners' dilemma game with an uncertain but high probability of continuation, what sustains cooperation between two firms choosing prices?

  1. The future gain from continued cooperation outweighs the short-run gain from undercutting. Correct answer.
  2. Cooperation is sustained because the stage game has multiple Nash equilibria.
  3. Each firm cooperates because cooperation is a dominant strategy in the stage game.
  4. The threat of a one-period price war is irrelevant because the game ends after one round.

Explanation

With a high continuation probability, firms discount future profits only mildly, so a trigger strategy that reverts to the stage-game equilibrium after a deviation can deter undercutting. The one-time gain from defecting is outweighed by the present value of lost cooperation. This logic is the basis of tacit collusion in repeated oligopoly pricing.

Question 41Law and Economics - core concepts (coasean bargaining, efficiency, externalities)

In the Coasean framework, what does the 'invariance thesis' assert about the assignment of a legal entitlement when transaction costs are zero?

  1. The party who values the resource most must always be granted the entitlement by the court
  2. Efficiency requires that the entitlement be split equally between the two parties
  3. Only the initial assignment chosen by the legislature can produce an efficient outcome
  4. The efficient allocation of the resource is reached regardless of which party holds the entitlement, although the distribution of wealth differs Correct answer.

Explanation

The invariance thesis holds that with zero transaction costs, bargaining will move the entitlement to its highest-valued use whichever party initially holds it. The assignment still matters for distribution, since who pays whom changes the parties' wealth positions. This is the core result of Coase's analysis of reciprocal harm.

Question 42Law and Economics - core concepts (coasean bargaining, efficiency, externalities)

A factory's smoke reduces the output of a neighbouring laundry. Which concept best describes the smoke damage in standard welfare economics?

  1. A negative externality borne by a party not compensated through the market transaction Correct answer.
  2. A public good that is non-rival and non-excludable
  3. An internal cost already reflected in the factory's private marginal cost
  4. A pecuniary externality that changes relative prices but not total welfare

Explanation

The smoke imposes a cost on the laundry that is not reflected in the factory's private production decision, which is the definition of a negative externality. Because the cost falls on a third party without compensation, private and social marginal costs diverge. Pecuniary externalities, by contrast, operate only through prices.

Question 43Law and Economics - core concepts (coasean bargaining, efficiency, externalities)

Pareto efficiency of an allocation means that:

  1. The allocation was approved by a majority of affected parties
  2. Every individual receives an equal share of society's resources
  3. No feasible reallocation can make at least one person better off without making someone else worse off Correct answer.
  4. Total monetary wealth is maximised across all individuals in the economy

Explanation

Pareto efficiency is defined by the absence of Pareto improvements: no feasible change can benefit someone without harming another. It is a minimal criterion of waste-avoidance and says nothing about equality. Many allocations, including highly unequal ones, can be Pareto efficient.

Question 44Law and Economics - core concepts (coasean bargaining, efficiency, externalities)

Under the Kaldor-Hicks criterion, a legal change is deemed an improvement when:

  1. The change is approved unanimously by the affected parties
  2. Every single person in society is made better off by the change
  3. The losers are actually compensated in full before the change takes effect
  4. The gainers' gains exceed the losers' losses, so gainers could in principle compensate losers Correct answer.

Explanation

Kaldor-Hicks judges a change by whether total gains exceed total losses, so that hypothetical compensation is possible. Actual compensation is not required, which distinguishes it from the Pareto criterion. This potential-compensation test underlies much cost-benefit analysis in law.

Question 45Law and Economics - core concepts (coasean bargaining, efficiency, externalities)

A firm's private marginal cost of production is below the social marginal cost because production generates pollution. In the absence of any corrective policy, the competitive market will produce:

  1. Zero output, because the externality makes production unprofitable
  2. Exactly the socially efficient quantity, because competitive markets always clear
  3. Less than the socially efficient quantity, because the firm internalises the harm
  4. More than the socially efficient quantity, because the firm ignores the external cost Correct answer.

Explanation

When private cost is below social cost, the market supply curve understates true resource cost, so equilibrium output exceeds the efficient level. The gap is the external marginal damage the firm does not bear. A Pigouvian tax or liability rule can close this gap.

Question 46Law and Economics - core concepts (coasean bargaining, efficiency, externalities)

A Pigouvian tax designed to correct a negative externality should, at the efficient output level, be set equal to:

  1. The total external damage divided by total industry output
  2. The difference between price and average revenue
  3. The marginal external damage at the efficient quantity Correct answer.
  4. The firm's average private cost of production

Explanation

The optimal Pigouvian tax equals marginal external damage at the efficient quantity, aligning private with social marginal cost. Setting it at that level makes the firm internalise the cost of the last unit of harm. Average or total measures do not generally induce the efficient margin.

Question 47Law and Economics - core concepts (coasean bargaining, efficiency, externalities)

Why can a liability rule, such as strict liability for harm, induce an injurer to take efficient precaution?

  1. It sets a fixed statutory standard of care that courts cannot vary
  2. It eliminates all accidents by making any harmful activity unlawful
  3. It forces the injurer to bear the expected harm, so precaution is worthwhile up to the point where its marginal cost equals marginal accident reduction Correct answer.
  4. It shifts all accident costs to the victim, giving the victim incentives to avoid harm

Explanation

Strict liability makes the injurer's expected cost include accident losses, so a rational injurer invests in precaution until the marginal cost of care equals the marginal reduction in expected harm. This is the efficient precaution condition. The instrument works through expected liability rather than prohibition.

Question 48Law and Economics - core concepts (coasean bargaining, efficiency, externalities)

A court must choose between a property rule and a liability rule to protect an entitlement. Which feature distinguishes a property rule?

  1. The entitlement lapses automatically if the holder does not use it
  2. The holder can refuse to transfer the entitlement unless he consents to the terms Correct answer.
  3. The entitlement may be taken only after a regulator certifies public use
  4. The holder must sell whenever a buyer offers the court-determined price

Explanation

Under a property rule, transfer requires the holder's voluntary consent, typically through bargaining. A liability rule instead permits a taking upon payment of objectively determined compensation, without consent. The distinction turns on whether consent or a set price governs transfer.

Question 49Law and Economics - core concepts (coasean bargaining, efficiency, externalities)

Two neighbours could resolve a boundary dispute by bargaining, but one holds out for an inflated price knowing the other has already built an extension. This situation illustrates why:

  1. Coasean bargaining always reaches the efficient outcome regardless of strategic behaviour
  2. Property rules are always inferior to liability rules when parties know each other
  3. High transaction costs, including strategic holdout, may justify a liability rule or legal default over pure bargaining Correct answer.
  4. The invariance thesis fails whenever the parties are neighbours

Explanation

Holdout is a strategic transaction cost that can prevent mutually beneficial bargains or extract rents. When such costs are high, allocating the entitlement by a liability rule or clear legal default may be more efficient than leaving resolution to bargaining. This is a central policy implication of Coase's framework.

Question 50Law and Economics - core concepts (coasean bargaining, efficiency, externalities)

A steel mill's emissions harm a fishery. If the mill has a legally protected right to pollute and bargaining is costless, the fishery will:

  1. Obtain an injunction automatically because pollution is a nuisance
  2. Reduce its own output to zero regardless of the mill's abatement cost
  3. Pay the mill to reduce emissions only if the fishery's avoided damage exceeds the mill's cost of abatement Correct answer.
  4. Be unable to obtain any reduction, because the mill holds the entitlement

Explanation

With a costless bargain, the fishery will buy abatement whenever its marginal avoided damage exceeds the mill's marginal abatement cost. The initial entitlement affects who pays, not whether efficient abatement occurs. This is the invariance result applied to the polluter's right.