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IB Economics SL study materials
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IB Economics SL practice questions

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Question 1Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

A student has 20 dollars and must choose between a concert ticket and a new textbook. The opportunity cost of buying the concert ticket is best described as which of the following?

  1. The enjoyment gained from attending the concert
  2. The textbook that must be given up because the money can be spent only once Correct answer.
  3. The total value of the concert ticket plus the textbook
  4. The 20 dollars paid for the concert ticket

Explanation

Opportunity cost is the value of the next best alternative forgone when a choice is made. Since the money can fund only one purchase, the forgone textbook represents the sacrifice. The money paid is a transfer, not the sacrifice itself, and the enjoyment is a benefit rather than a cost.

Question 2Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

In the circular flow of income model, which of the following correctly describes a leakage from the economy?

  1. Firms paying wages to workers
  2. Government spending on infrastructure
  3. Exports sold to foreign buyers
  4. Household saving placed in a bank account Correct answer.

Explanation

Leakages are withdrawals from the circular flow that reduce spending on domestic output, and saving is a classic example because income leaves the flow before being spent. Government spending, wage payments and exports are injections or internal flows that add to spending.

Question 3Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

Which of the following best explains why scarcity exists in every economy, including wealthy ones?

  1. Some people are poorer than others and cannot afford goods
  2. Prices are set too high by firms seeking profit
  3. Resources are limited while human wants are unlimited Correct answer.
  4. Governments fail to distribute income fairly among citizens

Explanation

Scarcity is a universal condition arising because productive resources are finite relative to unlimited human wants. It is not caused by inequality, government failure or pricing decisions, which concern distribution rather than the fundamental constraint.

Question 4Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

A production possibility curve is drawn as a straight downward-sloping line. Which assumption does this shape reflect?

  1. Opportunity cost is constant as production switches between the two goods Correct answer.
  2. One good requires no resources to produce
  3. The economy is operating below full employment
  4. Resources are perfectly immobile between the two goods

Explanation

A linear PPC implies a constant marginal rate of transformation, meaning each additional unit of one good costs the same amount of the other good. A bowed-out curve reflects increasing opportunity cost from specialised resources, while a point inside the curve reflects unemployment.

Question 5Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

Which of the following is a defining feature of a free market economy?

  1. Production targets are set by a central planning agency
  2. The government sets prices for most consumer goods
  3. Resources are allocated mainly through the price mechanism Correct answer.
  4. Firms are owned collectively by all workers

Explanation

In a free market economy, private individuals and firms own resources and prices coordinate decisions, guiding resource allocation. Government price-setting, central planning and collective ownership are features of command or mixed systems.

Question 6Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

An economy moves from a point inside its production possibility curve to a point on the curve. What does this movement represent?

  1. An improvement in the quality of resources
  2. A shift of the curve outward over time
  3. A reduction in unemployment of resources Correct answer.
  4. An increase in the economy's productive capacity

Explanation

Points inside the PPC indicate unemployed or underused resources, so moving to the frontier raises output without changing capacity. Growth of capacity would require an outward shift of the curve, not a movement toward it.

Question 7Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

A country can produce either 100 units of rice or 50 units of cloth with its given resources. What is the opportunity cost of producing one unit of cloth?

  1. 0.5 units of rice
  2. 50 units of rice
  3. 1 unit of rice
  4. 2 units of rice Correct answer.

Explanation

The opportunity cost of one unit of cloth is the rice forgone divided by the cloth gained, which is 100 divided by 50, giving 2 units of rice. The reciprocal, 0.5, would be the opportunity cost of one unit of rice instead.

Question 8Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

Which of the following would shift an economy's production possibility curve outward?

  1. A reallocation of workers from one industry to another
  2. An improvement in technology used in both industries Correct answer.
  3. A rise in the unemployment rate among skilled workers
  4. A reduction in the population's desire for one of the goods

Explanation

An outward shift requires an increase in productive potential, such as better technology that raises output from the same inputs. Reallocating workers or changing preferences moves the economy along or toward the curve but does not expand capacity.

Question 9Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

A government decides to build a new hospital instead of a new sports stadium with the same public funds. Which concept does this decision most directly illustrate?

  1. The law of demand in the healthcare market
  2. The circular flow of income between households and firms
  3. The basic economic problem of unlimited wants and scarce resources Correct answer.
  4. The idea of comparative advantage in international trade

Explanation

Choosing between two valued projects with limited public funds illustrates scarcity forcing choice and creating opportunity cost. The other options concern market demand, income flows or trade specialisation, which are not the focus of the decision described.

Question 10Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

In a mixed economy, which combination of features is typical?

  1. Complete central planning combined with free international trade
  2. Private ownership of all resources with no government intervention
  3. Private enterprise alongside government provision of some goods and regulation Correct answer.
  4. Government ownership of all resources with no private enterprise

Explanation

A mixed economy combines markets and private ownership with government intervention such as public goods provision, regulation and redistribution. The other options describe pure market, pure command or internally inconsistent arrangements.

Question 11Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

The opportunity cost of a decision is measured in terms of which of the following?

  1. The sum of all alternatives available
  2. The money paid for the chosen option
  3. The total benefit received from the chosen option
  4. The value of the next best alternative forgone Correct answer.

Explanation

Opportunity cost is the value of the best alternative that is sacrificed, not the price paid or the benefit gained. Summing all alternatives overstates the cost because only the next best option is forgone.

Question 12Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

An economy's PPC is bowed outward. What does this indicate about opportunity cost as production of one good increases?

  1. Opportunity cost remains constant across all output levels
  2. Opportunity cost rises because resources are not equally suited to both goods Correct answer.
  3. Opportunity cost becomes zero once full employment is reached
  4. Opportunity cost falls because resources become more efficient

Explanation

A concave PPC reflects increasing opportunity cost, since resources are specialised and become progressively less suited as they are shifted. A constant cost would give a straight line, and cost never falls to zero along the frontier.

Question 13Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

Which of the following best explains why specialisation and exchange increase total output?

  1. Governments allocate resources to the most efficient firms
  2. Consumers are forced to buy goods they do not want
  3. Producers avoid all forms of competition with one another
  4. Each producer focuses on goods where their opportunity cost is relatively low Correct answer.

Explanation

Specialisation according to comparative advantage means each producer concentrates where the opportunity cost of production is lowest, raising total output. Competition, consumer choice and government direction are not the source of the gains described.

Question 14Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

A firm can produce 200 chairs or 50 tables with its resources. A second firm can produce 150 chairs or 75 tables. Which statement is correct?

  1. The second firm has an absolute advantage in chairs
  2. The first firm has a comparative advantage in tables
  3. The second firm has a lower opportunity cost of producing a chair
  4. The first firm has a lower opportunity cost of producing a table Correct answer.

Explanation

The first firm's opportunity cost of a table is 4 chairs (200/50), while the second firm's is 2 chairs (150/75), so the first firm actually has the higher cost of a table. Rechecking, the first firm's cost of a chair is 0.25 tables versus 0.5 for the second, giving the first firm a comparative advantage in chairs and the second in tables.

Question 15Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

A country's PPC shifts inward after a natural disaster destroys factories and infrastructure. Which conclusion is most consistent with this change?

  1. The opportunity cost of both goods has fallen to zero
  2. The economy can now produce more of both goods than before
  3. The economy has moved to a point inside the original curve but capacity is unchanged
  4. The economy's productive capacity has fallen, reducing attainable combinations Correct answer.

Explanation

Destroyed capital reduces the economy's ability to produce, so the frontier shifts inward and fewer combinations are attainable. A movement inside the original curve would reflect unemployment, not lost capacity, and opportunity cost does not become zero.

Question 16Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

Two economies face the same PPC. Economy A produces at a point on the frontier, while Economy B produces inside it. Which statement is necessarily true?

  1. Economy A is productively efficient and Economy B is not Correct answer.
  2. Economy A has a larger labour force than Economy B
  3. Economy B has better technology than Economy A
  4. Economy A produces more of both goods than Economy B

Explanation

A point on the frontier means all resources are fully and efficiently employed, while a point inside means inefficiency or unemployment. The position of the point does not tell us about labour force size, technology or the quantities of both goods.

Question 17Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

A government introduces a minimum wage above the market equilibrium. In a simple supply and demand model, which outcome is predicted?

  1. A surplus of labour as quantity supplied exceeds quantity demanded Correct answer.
  2. A shortage of labour as demand exceeds supply
  3. No change because the wage is a price like any other
  4. An increase in employment for all workers

Explanation

A minimum wage set above equilibrium raises the wage, so more workers offer labour while firms demand fewer, creating a surplus of labour. This is a price floor effect, distinct from a price ceiling, which would create a shortage.

Question 18Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

Which of the following best describes the role of the price mechanism in allocating resources in a market economy?

  1. Prices only reflect production costs and never consumer preferences
  2. Prices are irrelevant because resources are allocated by custom
  3. Prices are fixed by government planners to ensure fairness
  4. Prices signal scarcity and provide incentives for producers and consumers to adjust Correct answer.

Explanation

Prices act as signals and incentives: rising prices indicate scarcity, encouraging producers to supply more and consumers to economise. This rationing, signalling and incentive function is central to market allocation, unlike planning or custom.

Question 19Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

A student gives up a part-time job paying 50 dollars a week to study full time. Which statement correctly identifies the opportunity cost of studying?

  1. Zero, because studying is a worthwhile activity
  2. The value of the qualifications gained
  3. The tuition fees only
  4. The 50 dollars of weekly earnings forgone Correct answer.

Explanation

The opportunity cost is the value of the best alternative forgone, which here is the weekly earnings from the job. Tuition is an explicit cost, and the qualifications are a benefit rather than a cost of the choice.

Question 20Introduction to economics (scarcity, choice, opportunity cost, economic systems, PPC)

Which of the following is the best example of a positive economic statement?

  1. The government should increase spending on public transport
  2. Income should be distributed more equally across society
  3. A rise in the price of coffee will reduce the quantity demanded Correct answer.
  4. The minimum wage is unfair to small businesses

Explanation

Positive statements are factual claims that can be tested against evidence, such as the predicted relationship between price and quantity demanded. Normative statements involve value judgements about what should or ought to be, as in the other options.

Question 21Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A fall in the price of coffee causes the demand curve for tea to shift to the left. What does this indicate about the relationship between coffee and tea?

  1. They are substitute goods. Correct answer.
  2. They are complementary goods.
  3. Coffee is a normal good.
  4. Tea is an inferior good.

Explanation

When a fall in the price of one good reduces demand for another, consumers switch toward the cheaper good, which is the defining feature of substitutes. The demand curve for tea shifts left because buyers replace tea with the now-cheaper coffee. This cross-price relationship concerns substitutability, not income classification.

Question 22Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

Which factor would cause a movement along the supply curve for oranges rather than a shift of the supply curve?

  1. A rise in the wage paid to fruit pickers
  2. A drought that destroys part of the harvest
  3. An increase in the market price of oranges Correct answer.
  4. An improvement in irrigation technology

Explanation

A change in the good's own price changes quantity supplied and is shown as a movement along a fixed supply curve. The other options change the conditions of supply, shifting the whole curve. This distinction between own-price changes and non-price determinants is central to supply analysis.

Question 23Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

In a market with a downward-sloping demand curve and an upward-sloping supply curve, a price set above the equilibrium price will generate which outcome?

  1. Excess demand, because suppliers withhold output
  2. Equilibrium, because the market always clears
  3. A shortage, because quantity demanded exceeds quantity supplied
  4. A surplus, because quantity supplied exceeds quantity demanded Correct answer.

Explanation

At a price above equilibrium, the quantity sellers wish to supply exceeds the quantity buyers wish to purchase, creating excess supply, or a surplus. Competitive pressure then tends to push the price back down toward equilibrium. The direction of the imbalance follows directly from the slopes of the two curves.

Question 24Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A good has a price elasticity of demand of 0.4. What does this value imply?

  1. Demand is price inelastic, so total revenue rises when price increases. Correct answer.
  2. Demand is price elastic, so total revenue falls when price increases.
  3. Demand is unit elastic, so total revenue is unchanged when price changes.
  4. Demand is perfectly elastic, so quantity demanded is infinitely responsive.

Explanation

An elasticity coefficient below one in absolute value means quantity demanded responds proportionally less than the price change, so demand is inelastic. When demand is inelastic, a price rise reduces quantity by a smaller percentage, so total revenue increases. The revenue test follows from the relative size of the two percentage changes.

Question 25Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

Which of the following best describes consumer surplus in a competitive market?

  1. The revenue received by producers above their fixed costs
  2. The difference between what consumers are willing to pay and what they actually pay Correct answer.
  3. The total amount of money consumers spend on the good
  4. The difference between price and the marginal cost of production

Explanation

Consumer surplus measures the benefit buyers receive because they pay less than their maximum willingness to pay. On a diagram it is the area below the demand curve and above the price, up to the quantity traded. It is a welfare measure, not a measure of spending.

Question 26Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A price ceiling set below the equilibrium price in a competitive market will typically result in which combination of effects?

  1. A surplus and rising producer surplus
  2. No effect, because ceilings are always non-binding
  3. A shortage and a loss of allocative efficiency Correct answer.
  4. An increase in quantity supplied and a fall in quantity demanded

Explanation

A binding ceiling holds the price below equilibrium, so quantity demanded exceeds quantity supplied, producing a shortage. Because fewer units trade than the efficient quantity, total surplus falls and allocative efficiency is lost. The welfare loss appears as deadweight loss.

Question 27Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

Which statement about a perfectly competitive firm in long-run equilibrium is correct?

  1. It sets price above marginal cost to earn supernormal profit.
  2. It restricts output to raise the market price.
  3. It produces where average revenue exceeds average total cost.
  4. It produces where price equals marginal cost and earns only normal profit. Correct answer.

Explanation

In long-run equilibrium, free entry and exit drive price to the minimum of average total cost, so firms earn only normal profit and produce where price equals marginal cost. Any supernormal profit would attract entrants and push price down. The firm is a price taker and cannot influence the market price.

Question 28Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

The supply of a product is perfectly inelastic. What does this mean for the price elasticity of supply?

  1. The elasticity of supply is infinite, and quantity supplied responds fully to price.
  2. The elasticity of supply is negative, and quantity supplied falls as price rises.
  3. The elasticity of supply equals one, and quantity supplied changes proportionally with price.
  4. The elasticity of supply is zero, and quantity supplied does not respond to price. Correct answer.

Explanation

Perfectly inelastic supply means the quantity supplied is fixed regardless of price, giving an elasticity of zero and a vertical supply curve. The percentage change in quantity supplied is zero for any price change. Such a situation is typical of goods with a strictly fixed capacity in the short run.

Question 29Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A government imposes a specific tax on producers of a good with very inelastic demand and very elastic supply. Who bears the larger share of the tax burden?

  1. Consumers, because the price rises by close to the full amount of the tax Correct answer.
  2. Producers, because supply is more elastic than demand
  3. Consumers and producers equally, because the tax is legally on producers
  4. Neither group, because the tax is absorbed by the government

Explanation

The incidence of a tax falls more heavily on the side of the market that is less responsive to price. With inelastic demand and elastic supply, producers can pass most of the tax forward, so the consumer price rises by close to the tax amount. Legal incidence on producers does not determine economic incidence.

Question 30Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A firm lowers its price from $10 to $9 and quantity demanded rises from 100 to 130 units. Using the midpoint method, the price elasticity of demand is approximately which value?

  1. 2.48 Correct answer.
  2. 1.00
  3. 0.30
  4. 0.40

Explanation

The midpoint method divides the percentage change in quantity by the percentage change in price using average values. Quantity changes by 30 over an average of 115, about 26.1 percent, while price changes by 1 over an average of 9.5, about 10.5 percent. Dividing gives roughly 2.48, so demand is elastic over this range.

Question 31Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A simultaneous increase in demand and decrease in supply for a good will definitely cause which change?

  1. The equilibrium price rises, while the change in quantity is indeterminate. Correct answer.
  2. Both equilibrium price and quantity rise.
  3. Both equilibrium price and quantity fall.
  4. The equilibrium quantity rises, while the change in price is indeterminate.

Explanation

Rising demand pushes both price and quantity up, while falling supply pushes price up and quantity down. Price moves in the same direction in both cases, so it definitely rises, but quantity is pulled in opposite directions and depends on the relative shifts. This is the standard result for combined shifts.

Question 32Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

Which situation would most likely shift the demand curve for a normal good to the right?

  1. An expectation that the good's price will fall next month
  2. A rise in the price of a complement
  3. A fall in the price of the good itself
  4. An increase in consumers' disposable income Correct answer.

Explanation

For a normal good, higher income increases demand at every price, shifting the demand curve right. The other options either move along the curve or shift demand left. Distinguishing income effects from own-price effects is essential here.

Question 33Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A market is allocatively efficient when which condition holds?

  1. Marginal social benefit equals marginal social cost at the quantity traded Correct answer.
  2. Consumer surplus equals producer surplus
  3. Average total cost is minimized for each firm
  4. Total revenue is maximized for producers

Explanation

Allocative efficiency requires that the value consumers place on the last unit equals the cost of producing it, so marginal social benefit equals marginal social cost. At that point total surplus is maximized. Equality of consumer and producer surplus is not required for efficiency.

Question 34Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A negative externality of production exists in a competitive market. Compared with the socially optimal outcome, the free market will produce which result?

  1. The socially optimal quantity, because firms internalize the cost
  2. A smaller quantity at a higher price, creating a deadweight loss
  3. A larger quantity at a lower price, creating a deadweight loss Correct answer.
  4. A larger quantity at a higher price, increasing total surplus

Explanation

When production imposes external costs, marginal social cost exceeds marginal private cost, so the free market overproduces relative to the social optimum and sells at a lower price. The excess output beyond the efficient quantity creates a deadweight loss. This is the classic case for corrective taxation or regulation.

Question 35Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A consumer's income rises by 10 percent and, as a result, purchases of a particular good fall by 5 percent. What is the income elasticity of demand and how is the good classified?

  1. 0.5, so the good is a normal necessity
  2. 5.0, so the good is a normal good
  3. -0.5, so the good is inferior Correct answer.
  4. -2.0, so the good is a luxury

Explanation

Income elasticity is the percentage change in quantity demanded divided by the percentage change in income, giving -5 divided by 10, or -0.5. A negative income elasticity means quantity demanded falls as income rises, which defines an inferior good. The magnitude is irrelevant to the inferior classification.

Question 36Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

Which of the following is a characteristic of a perfectly contestable market rather than of perfect competition?

  1. There are many small firms each producing an identical product
  2. Firms earn only normal profit in long-run equilibrium
  3. The absence of sunk costs allows potential entrants to discipline incumbent firms Correct answer.
  4. Consumers have perfect information about prices

Explanation

Contestability depends on the threat of entry, which is credible when entry and exit costs are low and assets are not sunk. A market can therefore have few firms yet behave competitively. The other options describe features of perfect competition that contestability does not require.

Question 37Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A firm faces a price elasticity of demand of 1.5 for its product. If it raises its price, what will happen to its total revenue?

  1. Total revenue will stay the same, because the effects offset exactly
  2. Total revenue will rise, because demand is inelastic at this value
  3. Total revenue will fall, because the percentage drop in sales exceeds the percentage price rise Correct answer.
  4. Total revenue will rise, because each unit is sold at a higher price

Explanation

With an elasticity of 1.5, demand is elastic, so a price increase reduces quantity demanded proportionally more than the price rises. Total revenue therefore falls. The revenue effect of a price change depends on whether demand is elastic or inelastic.

Question 38Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A minimum price set above the equilibrium price will most likely produce which outcome?

  1. A shortage that leads to queues and black markets
  2. No change, because minimum prices are advisory
  3. A fall in the quantity supplied as producers exit
  4. A surplus that may require government purchases to be maintained Correct answer.

Explanation

A binding minimum price holds the price above equilibrium, so quantity supplied exceeds quantity demanded and a surplus emerges. Governments often buy the excess to sustain the price, which imposes a fiscal cost. The welfare loss arises because fewer units are demanded than the efficient quantity.

Question 39Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

Producer surplus is best described as which of the following?

  1. The difference between the price received and the minimum price a producer would accept Correct answer.
  2. The area above the demand curve and below the price
  3. The total cost of producing the units sold
  4. The difference between total revenue and total variable cost

Explanation

Producer surplus measures the gain to sellers because the market price exceeds their reservation price, which is determined by marginal cost. On a diagram it is the area above the supply curve and below the price. It is a welfare concept, not an accounting profit measure.

Question 40Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

In a market where the government grants a single firm an exclusive licence to supply a good with no close substitutes, which barrier to entry is primarily responsible for the firm's market power?

  1. Brand loyalty built through advertising
  2. Economies of scale in production
  3. A legal barrier created by the licence Correct answer.
  4. Control of an essential raw material

Explanation

An exclusive licence is a legal barrier that prevents potential rivals from entering, giving the incumbent market power. Economies of scale, resource control and brand loyalty are separate sources of barrier that are not described in the scenario. Identifying the specific barrier is needed to explain the firm's position.

Question 41Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A good has a cross-price elasticity of demand of -0.8 with respect to the price of another good. What does this indicate?

  1. The goods are complements, since a price rise in one reduces demand for the other Correct answer.
  2. The goods are substitutes, since a price rise in one raises demand for the other
  3. The goods are unrelated, since the coefficient is below one
  4. The good is inferior, since the coefficient is negative

Explanation

A negative cross-price elasticity means that when the price of one good rises, demand for the other falls, which is the pattern for complementary goods consumed together. Positive values would indicate substitutes. The magnitude of 0.8 indicates a moderately strong complementary relationship.

Question 42Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

Which change would reduce the deadweight loss created by a negative externality of production?

  1. Removing all regulation so the market clears freely
  2. Imposing a tax equal to the marginal external cost at the efficient quantity Correct answer.
  3. Granting the polluting firms a subsidy per unit produced
  4. Setting a price ceiling below the market equilibrium

Explanation

A Pigouvian tax equal to the marginal external cost shifts marginal private cost toward marginal social cost, aligning the firm's output decision with the social optimum. This reduces overproduction and the associated deadweight loss. Subsidies and price ceilings would worsen the distortion.

Question 43Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A monopolistically competitive industry is in long-run equilibrium. Which combination of outcomes is expected?

  1. Price exceeds marginal cost, firms earn normal profit, and there is excess capacity Correct answer.
  2. Price equals marginal cost, firms earn supernormal profit, and there is no excess capacity
  3. Price exceeds marginal cost, firms earn supernormal profit, and entry is blocked
  4. Price equals marginal cost, firms earn normal profit, and output is at minimum average cost

Explanation

Downward-sloping demand gives the firm market power, so price exceeds marginal cost and output falls short of the minimum-average-cost level, creating excess capacity. Free entry eliminates supernormal profit, leaving normal profit in the long run. This combination distinguishes monopolistic competition from perfect competition.

Question 44Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A government imposes a per-unit tax on a good. Which statement about the resulting deadweight loss is correct?

  1. It is unaffected by elasticities, because the tax is a fixed amount per unit
  2. It grows with the elasticities of demand and supply, because the tax causes a larger fall in quantity traded Correct answer.
  3. It exists only when the tax exceeds the equilibrium price
  4. It falls as demand becomes more elastic, because consumers can avoid the tax

Explanation

Deadweight loss from a tax reflects the units no longer traded because the tax wedge drives price paid above price received. The more responsive buyers and sellers are, the larger the quantity reduction and the greater the welfare loss. Elasticities therefore determine the size of the loss.

Question 45Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A firm's production creates pollution, and the government assigns tradable permits to firms. Which condition would make tradable permits more efficient than a uniform emissions standard?

  1. The total permitted level of emissions is set too high
  2. Firms face different marginal costs of reducing emissions Correct answer.
  3. Firms are unable to trade permits with one another
  4. All firms have identical abatement technologies

Explanation

Tradable permits allow reductions to occur where abatement is cheapest, so the industry achieves a given emissions target at the lowest total cost when marginal abatement costs differ across firms. A uniform standard forces all firms to cut by the same amount regardless of cost. Trading must be possible for the cost advantage to be realized.

Question 46Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A competitive market is in equilibrium. Which condition best describes the situation of consumers and producers at this equilibrium point?

  1. Total revenue earned by producers is at its maximum possible level
  2. Every consumer pays a price equal to their own maximum willingness to pay
  3. Quantity supplied exceeds quantity demanded, creating surplus stock
  4. Marginal benefit to consumers equals marginal cost to producers, and total surplus is maximised Correct answer.

Explanation

At competitive equilibrium the demand curve, which reflects marginal benefit, intersects the supply curve, which reflects marginal cost. Because each unit traded up to that point is worth at least as much to buyers as it costs to produce, the sum of consumer and producer surplus is maximised. Any other quantity would sacrifice some of that total surplus.

Question 47Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

The price of coffee beans rises sharply. In the market for tea, a substitute drink, which outcome is expected in the short run?

  1. The demand curve for tea shifts to the right, raising both the equilibrium price and quantity Correct answer.
  2. The equilibrium price of tea falls while the equilibrium quantity rises
  3. The supply curve of tea shifts to the left, raising price and lowering quantity
  4. The demand curve for tea shifts to the left, lowering both price and quantity

Explanation

A rise in the price of a substitute makes tea relatively more attractive, so consumers demand more tea at every price, shifting its demand curve rightward. With an unchanged supply curve, this rightward shift moves equilibrium up along the supply curve, increasing both price and quantity.

Question 48Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A market has a price elasticity of demand of 0.4 and a price elasticity of supply of 2.0. A per-unit tax is imposed on sellers. Which statement about the incidence of the tax is correct?

  1. Consumers bear the larger share of the tax burden because demand is less elastic than supply Correct answer.
  2. The tax burden is shared equally because the tax is a fixed amount per unit
  3. Producers bear the larger share of the tax burden because supply is more elastic than demand
  4. Consumers bear the entire tax burden because demand is inelastic

Explanation

Tax incidence depends on relative elasticities: the side of the market that is less able to adjust, i.e. less elastic, absorbs the larger share of the burden. Since demand (0.4) is far less elastic than supply (2.0), consumers absorb most of the tax through a higher price, while producers absorb little.

Question 49Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A consumer buys two goods, X and Y. The cross-price elasticity of demand for X with respect to the price of Y is +1.6. Which interpretation is correct?

  1. X is an inferior good because the coefficient is positive
  2. X and Y are substitutes, and demand for X is highly responsive to changes in the price of Y Correct answer.
  3. X and Y are unrelated goods because the coefficient exceeds one
  4. X and Y are complements, and demand for X is highly responsive to changes in the price of Y

Explanation

A positive cross-price elasticity means that a rise in the price of Y increases demand for X, which is the defining relationship for substitutes. The magnitude of 1.6 indicates a strong, elastic response, so a given percentage rise in Y's price raises quantity demanded of X by 1.6 times that percentage.

Question 50Microeconomics: competitive markets (demand, supply, equilibrium, elasticity, market efficiency)

A good is sold in a competitive market where consumption generates a positive externality. Which statement about the free-market outcome is correct?

  1. Marginal social benefit exceeds marginal private benefit, so the market quantity is below the socially optimal quantity Correct answer.
  2. Marginal private benefit exceeds marginal social benefit, so the market quantity is above the socially optimal quantity
  3. The market is allocatively efficient because no deadweight loss exists
  4. The market quantity equals the socially optimal quantity but the price is too high

Explanation

A positive externality of consumption means each unit consumed benefits third parties, so marginal social benefit is the private benefit plus that external benefit. The market demand curve reflects only private benefit, so equilibrium quantity falls short of the socially optimal quantity, creating a deadweight loss that a subsidy could reduce.