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LC Economics practice questions

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Question 1Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

A student has $20 and must choose between a concert ticket and a new book. The concert ticket is chosen. What is the opportunity cost of this decision?

  1. The total enjoyment gained from the concert
  2. The $20 paid for the concert ticket
  3. The new book that could have been bought with the $20 Correct answer.
  4. The time spent travelling to the concert only

Explanation

Opportunity cost is the value of the next best alternative forgone when a choice is made. Since the book was the alternative given up, it represents the opportunity cost, not the money itself, which is simply the means of payment.

Question 2Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

Which statement best describes the fundamental economic problem of scarcity?

  1. Some individuals in an economy have lower incomes than others
  2. Human wants are unlimited while resources are finite Correct answer.
  3. Resources are unlimited but human wants are limited
  4. Governments must always balance their budgets each year

Explanation

Scarcity arises because wants are unlimited but the resources available to satisfy them are limited. This forces choices about what, how and for whom to produce.

Question 3Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

A firm uses land, labour, capital and enterprise. Which factor of production earns profit as its reward?

  1. Land
  2. Enterprise Correct answer.
  3. Capital
  4. Labour

Explanation

Each factor of production earns a distinct reward: land earns rent, labour earns wages, capital earns interest and enterprise earns profit. The entrepreneur bears risk and organises the other factors, so profit is the residual reward.

Question 4Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

A production possibility frontier is drawn as a straight downward-sloping line. What does this shape imply about opportunity cost?

  1. Opportunity cost is zero because the line is straight
  2. Opportunity cost is constant as production shifts between the two goods Correct answer.
  3. Opportunity cost rises as more of either good is produced
  4. Opportunity cost falls as more of either good is produced

Explanation

A straight-line PPF means resources are equally suited to producing both goods, so each unit switched costs the same amount of the other good. The slope is constant, hence constant opportunity cost.

Question 5Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

Which of the following is best classified as capital in economics?

  1. A deposit of money held in a savings account
  2. A delivery van used by a bakery Correct answer.
  3. A plot of farmland
  4. A worker's physical strength

Explanation

In economics, capital refers to man-made goods used to produce other goods and services, such as machinery and vehicles. Money itself is not capital because it does not directly produce output.

Question 6Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

Why does the economic problem exist in every society, including wealthy ones?

  1. Because governments always allocate resources inefficiently
  2. Because wants are unlimited relative to scarce resources Correct answer.
  3. Because technology cannot improve over time
  4. Because rich countries still have unlimited resources

Explanation

The economic problem is universal because resources are limited while wants are effectively unlimited. Even wealthy societies must choose how to allocate scarce resources among competing uses.

Question 7Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

An economy operating on its production possibility frontier decides to produce more consumer goods. What happens to its production of capital goods?

  1. It stays the same because the frontier is fixed
  2. It falls because resources must be reallocated Correct answer.
  3. It falls only if the frontier shifts inward
  4. It increases because productivity rises automatically

Explanation

Points on the PPF represent full and efficient use of resources, so producing more of one good requires moving resources away from the other. Capital goods output therefore falls as resources shift to consumer goods.

Question 8Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

A point lying inside a production possibility frontier indicates which situation?

  1. Production is efficient and fully using resources
  2. The economy has experienced technological improvement
  3. Production is unattainable with current resources
  4. Production is inefficient, with unemployed or misused resources Correct answer.

Explanation

Any point inside the frontier means the economy could produce more of at least one good without sacrificing the other, so resources are not fully or efficiently employed. Points on the frontier are efficient and points beyond it are unattainable.

Question 9Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

Which change would shift an economy's production possibility frontier outward?

  1. A discovery of new natural resources combined with better technology Correct answer.
  2. A rise in the price of consumer goods
  3. An increase in the number of workers choosing leisure over employment
  4. A decision to produce more of one good and less of another

Explanation

The PPF shifts outward when the productive capacity of the economy grows, for example through more or better resources or improved technology. New resources plus better technology increase potential output of both goods.

Question 10Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

A government decides to build a new hospital on land that was previously a public park. What is the opportunity cost of this decision?

  1. The taxes collected from local residents
  2. The loss of the public park and its recreational benefits Correct answer.
  3. The construction costs of the hospital only
  4. The wages paid to hospital staff after opening

Explanation

Opportunity cost includes the next best alternative use of the resources involved. Using the land for a hospital means forgoing the park and the benefits it provided, which is the relevant sacrifice.

Question 11Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

Which best explains why the production possibility frontier is usually drawn concave to the origin?

  1. Resources are equally productive in all uses
  2. Resources are not perfectly transferable between uses Correct answer.
  3. Consumers always prefer one good to another
  4. The economy always operates at full employment

Explanation

A concave PPF reflects increasing opportunity cost: as more of one good is produced, resources less suited to it must be used, so increasingly more of the other good is sacrificed. This occurs because resources are not equally productive in every use.

Question 12Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

A worker can produce either 10 units of cloth or 5 units of wine in a day. What is the opportunity cost of producing one unit of wine?

  1. 0.5 units of cloth
  2. 2 units of cloth Correct answer.
  3. 1 unit of cloth
  4. 5 units of cloth

Explanation

To produce 5 units of wine the worker gives up 10 units of cloth, so each unit of wine costs 10 divided by 5, which equals 2 units of cloth. Opportunity cost is calculated per unit of the good chosen.

Question 13Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

Which statement about free goods and economic goods is correct?

  1. Free goods always command a positive market price
  2. Economic goods require no resources to produce
  3. Free goods have no opportunity cost because they are not scarce Correct answer.
  4. Economic goods are unlimited in supply

Explanation

Free goods, such as air in most circumstances, are not scarce relative to wants and so have no opportunity cost. Economic goods are scarce, require resources and therefore involve a cost.

Question 14Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

A firm switches from producing 100 units of good X and 0 units of good Y to producing 80 units of X and 20 units of Y. What is the opportunity cost of the first 20 units of Y?

  1. 80 units of good X
  2. 100 units of good X
  3. 20 units of good X Correct answer.
  4. 0 units of good X

Explanation

Moving to 20 units of Y reduces X output from 100 to 80, a sacrifice of 20 units of X. The opportunity cost of the 20 units of Y is therefore 20 units of X.

Question 15Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

Which combination of events would most clearly move an economy from a point inside its PPF to a point on the frontier?

  1. An increase in the population's desire for leisure
  2. A fall in the market price of consumer goods
  3. Reducing unemployment and improving the allocation of resources Correct answer.
  4. A shift in consumer preferences toward capital goods

Explanation

A point inside the frontier indicates inefficiency or unemployment, so using idle resources and improving allocation moves the economy onto the frontier without changing productive capacity. This is a movement toward efficiency rather than a shift of the frontier.

Question 16Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

In a market economy, the three basic questions of what, how and for whom to produce are mainly resolved by which mechanism?

  1. Trade unions negotiating output targets
  2. Tradition passed down through generations
  3. The price mechanism reflecting supply and demand Correct answer.
  4. Central government planning directives

Explanation

In a market economy, prices act as signals and incentives that guide resources to where demand exists, answering the three allocation questions. Government planning and tradition characterise command and traditional economies respectively.

Question 17Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

An economy's PPF shows increasing opportunity cost between food and machinery. As it produces successive additional units of machinery, what happens to the amount of food sacrificed?

  1. It decreases for each additional unit
  2. It increases for each additional unit Correct answer.
  3. It becomes zero once machinery output is large
  4. It remains constant for each additional unit

Explanation

With increasing opportunity cost, resources become progressively less suited to machinery production, so each extra unit of machinery requires giving up ever larger amounts of food. This is why the PPF is concave to the origin.

Question 18Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

A country can produce either 60 units of rice or 30 units of tea with its resources. A second country can produce either 40 units of rice or 40 units of tea. Which statement is correct?

  1. The first country has a comparative advantage in rice Correct answer.
  2. The second country has a comparative advantage in rice
  3. Neither country has a comparative advantage in either good
  4. The first country has a comparative advantage in tea

Explanation

The first country's opportunity cost of one rice unit is 0.5 tea, while the second country's is 1 tea. The first country therefore sacrifices less tea per unit of rice and has a comparative advantage in rice.

Question 19Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

A PPF is bowed outward. A government wishes to increase output of both goods simultaneously without any change in resources or technology. Which outcome is possible?

  1. It is impossible because such a combination lies outside the frontier
  2. It is possible only if opportunity cost becomes constant
  3. It is possible only if the frontier shifts inward
  4. It is possible if the economy moves from an inefficient point to the frontier Correct answer.

Explanation

If the economy is initially inside the frontier, better use of existing resources allows more of both goods without any change in capacity. Once on the frontier, however, increasing both goods is impossible without growth.

Question 20Scarcity, choice and the economic problem; factors of production; opportunity cost; production possibility frontier

Which situation best illustrates the concept of opportunity cost at the level of a whole economy?

  1. A household saving part of its monthly income in a bank
  2. A firm paying wages to its employees each month
  3. A government using tax revenue to fund a rail link instead of a new school Correct answer.
  4. A consumer comparing prices of two brands of the same product

Explanation

At the economy-wide level, opportunity cost is the value of the next best use of scarce public funds. Funding a rail link instead of a school means the school and its benefits are forgone.

Question 21Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A market has a downward-sloping demand curve and an upward-sloping supply curve. What happens to the equilibrium price and quantity if consumer incomes rise and the good is a normal good?

  1. Price falls and quantity falls
  2. Price falls and quantity rises
  3. Price rises and quantity rises Correct answer.
  4. Price rises and quantity falls

Explanation

Higher income for a normal good shifts demand to the right. A rightward demand shift along an upward-sloping supply curve raises both the equilibrium price and the equilibrium quantity.

Question 22Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

Which factor causes a movement along the supply curve rather than a shift of the supply curve?

  1. A new subsidy paid to producers
  2. An improvement in production technology
  3. A change in the cost of raw materials
  4. A change in the price of the good itself Correct answer.

Explanation

A change in the good's own price changes quantity supplied and is shown as a movement along a given supply curve. Cost changes, subsidies and technology change supply at every price and shift the curve itself.

Question 23Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

The price elasticity of demand for a good is 0.4. What does this value indicate?

  1. Demand is unit elastic, so total revenue is unchanged
  2. Demand is inelastic, so a price rise increases total revenue Correct answer.
  3. Demand is elastic, so a price rise increases total revenue
  4. Demand is perfectly elastic, so quantity is unchanged

Explanation

When the absolute value of price elasticity is below 1, demand is inelastic: quantity falls proportionately less than price rises. Because the percentage drop in quantity is smaller than the percentage rise in price, total revenue increases.

Question 24Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A government sets a price ceiling below the free-market equilibrium price. What is the predicted effect?

  1. A surplus, because demand falls at the lower price
  2. A shortage, because quantity demanded exceeds quantity supplied Correct answer.
  3. A surplus, because quantity supplied exceeds quantity demanded
  4. No effect, because the ceiling is above equilibrium

Explanation

A binding price ceiling sits below equilibrium, so the price is held down and quantity demanded rises while quantity supplied falls. The gap between them is a shortage.

Question 25Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

Which pair of goods is most likely to have a positive cross-price elasticity of demand?

  1. Petrol and cars
  2. Tea and coffee Correct answer.
  3. Bread and butter
  4. Printers and ink cartridges

Explanation

Positive cross-price elasticity means a rise in the price of one good increases demand for the other, which is the definition of substitutes. Tea and coffee are close substitutes.

Question 26Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

Why does a demand curve typically slope downward?

  1. At lower prices, consumers substitute toward the good and can afford more of it Correct answer.
  2. Producers supply less at lower prices
  3. Consumers buy more as the good becomes more expensive
  4. Higher prices reduce production costs

Explanation

A downward-sloping demand curve reflects the law of demand: as price falls, the good becomes cheaper relative to substitutes and purchasing power rises, so quantity demanded increases.

Question 27Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A price floor set above the equilibrium price is imposed in a labour market. What outcome is expected?

  1. A fall in the wage to the equilibrium level
  2. A surplus of labour, meaning unemployment Correct answer.
  3. No change, because the floor is non-binding
  4. A shortage of labour, meaning vacancies

Explanation

A binding price floor holds the wage above equilibrium, so quantity of labour supplied exceeds quantity demanded. The excess supply of labour is unemployment.

Question 28Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

Which statement best describes a shortage in a market?

  1. The market is in equilibrium at the ruling price
  2. Quantity demanded exceeds quantity supplied at the ruling price Correct answer.
  3. Quantity supplied exceeds quantity demanded at the ruling price
  4. Demand has shifted leftward at every price

Explanation

A shortage exists when, at the current price, buyers want to purchase more than sellers offer. The price is below equilibrium, and the excess demand pressures the price upward.

Question 29Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A firm faces a price elasticity of supply of 1.8. Which statement is consistent with this value?

  1. Supply is perfectly inelastic, so quantity supplied does not change
  2. Supply is unit elastic, so quantity supplied changes by the same percentage as price
  3. Supply is elastic, so quantity supplied responds proportionately more than price changes Correct answer.
  4. Supply is inelastic, so quantity supplied responds less than price changes

Explanation

An elasticity of supply above 1 means supply is elastic: a given percentage change in price produces a larger percentage change in quantity supplied. Producers respond strongly to price signals.

Question 30Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A government imposes a price ceiling on a good. Which factor most increases the size of the resulting shortage?

  1. The ceiling being set far above equilibrium
  2. The ceiling being set exactly at equilibrium
  3. Demand and supply both being highly price inelastic
  4. Demand and supply both being highly price elastic Correct answer.

Explanation

When both curves are elastic, a given gap between the ceiling and equilibrium price generates large changes in quantities demanded and supplied. The larger the quantity responses, the larger the excess demand.

Question 31Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

Two goods have a cross-price elasticity of demand of minus 0.9. What relationship does this indicate?

  1. They are substitutes, since a price rise in one reduces demand for the other
  2. They are complements, since a price rise in one reduces demand for the other Correct answer.
  3. They are unrelated, since the value is close to zero
  4. They are complements, since a price rise in one raises demand for the other

Explanation

A negative cross-price elasticity means a rise in the price of one good reduces demand for the other, which is the pattern of complements. The two goods are typically consumed together.

Question 32Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

The supply of a good is perfectly inelastic and demand increases. What is the predicted market result?

  1. Both price and quantity rise proportionally
  2. Quantity rises with no change in price
  3. Price falls and quantity rises
  4. Price rises with no change in quantity traded Correct answer.

Explanation

With a vertical supply curve, quantity supplied cannot change in response to price. A rightward demand shift therefore raises the price only, with quantity fixed.

Question 33Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A government removes a binding price ceiling on a good. What change is expected in the market?

  1. Price rises toward equilibrium and the shortage is eliminated Correct answer.
  2. Price remains unchanged and the shortage persists
  3. Price falls and a surplus develops
  4. Quantity supplied falls below quantity demanded

Explanation

Removing a binding ceiling allows the price to rise to its equilibrium level. As price rises, quantity demanded falls and quantity supplied rises until the shortage disappears.

Question 34Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

Which situation most likely produces a high price elasticity of demand for a good?

  1. The good is consumed habitually and accounts for a tiny share of income
  2. The good must be purchased immediately with no time to adjust
  3. The good is a necessity with no substitutes
  4. Many close substitutes are available and the good takes a large share of spending Correct answer.

Explanation

Elasticity rises when consumers can switch to close substitutes and when the good absorbs a large share of the budget. Both conditions make buyers sensitive to price changes.

Question 35Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A per-unit tax is placed on producers in a market where demand is highly inelastic and supply is elastic. Who bears the larger share of the tax burden?

  1. Consumers, because quantity demanded responds little to the price rise Correct answer.
  2. Neither, because the tax is fully absorbed by government
  3. Producers, because supply is elastic and they can cut output
  4. Consumers and producers equally, regardless of elasticities

Explanation

The tax burden falls more heavily on the side of the market that is less price elastic. With inelastic demand, buyers cannot reduce purchases much, so producers pass most of the tax forward in higher prices.

Question 36Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A market is in equilibrium. Simultaneously, a new production technology lowers costs and a successful advertising campaign raises demand. What can be concluded about the new equilibrium?

  1. Quantity rises, but the price change is ambiguous Correct answer.
  2. Both price and quantity rise unambiguously
  3. Price rises, but the quantity change is ambiguous
  4. Both price and quantity fall unambiguously

Explanation

Lower costs shift supply right and advertising shifts demand right. Both shifts increase quantity, but supply pushes price down while demand pushes price up, so the net price effect depends on the relative size of the shifts.

Question 37Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

Which good is most likely to have an income elasticity of demand that is negative?

  1. Restaurant meals
  2. Instant noodles purchased by low-income households Correct answer.
  3. Private education
  4. Domestic air travel

Explanation

Negative income elasticity identifies an inferior good, for which demand falls as income rises. Low-cost staple foods are commonly cited examples as households switch to better alternatives.

Question 38Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A government wants to reduce consumption of a harmful good and is choosing between a tax and a price floor. Which feature makes a tax more suitable than a floor?

  1. A tax works through the price mechanism and can raise revenue while reducing quantity Correct answer.
  2. A tax guarantees quantity demanded equals quantity supplied
  3. A tax removes the need to consider elasticity of demand
  4. A tax sets a legal minimum price that eliminates surplus

Explanation

A tax raises the price consumers pay and lowers the price producers receive, reducing equilibrium quantity and generating government revenue. A price floor above equilibrium creates a surplus that the government may have to buy up.

Question 39Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A subsidy is paid to producers of a good. What is the predicted effect on the market?

  1. Demand shifts left, price falls and quantity traded falls
  2. Demand shifts right, price rises and quantity traded rises
  3. Supply shifts left, price rises and quantity traded falls
  4. Supply shifts right, price falls and quantity traded rises Correct answer.

Explanation

A production subsidy lowers effective costs, shifting supply to the right. The new equilibrium has a lower price paid by consumers and a larger quantity traded.

Question 40Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

Demand for a good is perfectly inelastic. If supply decreases, what happens?

  1. Price rises and quantity traded is unchanged Correct answer.
  2. Both price and quantity rise
  3. Both price and quantity fall
  4. Quantity falls and price is unchanged

Explanation

With a vertical demand curve, consumers buy the same quantity at any price. A leftward supply shift therefore raises the price only, leaving quantity unchanged.

Question 41Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A firm lowers its price and finds total revenue falls. What does this imply about demand over that price range?

  1. Demand is unit elastic, since revenue is unchanged
  2. Demand is perfectly elastic, since revenue falls to zero
  3. Demand is inelastic, since quantity rises proportionately less than price falls Correct answer.
  4. Demand is elastic, since quantity rises proportionately more than price falls

Explanation

When price falls and revenue falls, the percentage increase in quantity is smaller than the percentage decrease in price. This is the definition of inelastic demand over that range.

Question 42Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A binding price floor is set in a competitive market. Which statement about the resulting outcome is correct?

  1. Quantity traded equals quantity demanded, which is below the equilibrium quantity Correct answer.
  2. Quantity traded rises above the equilibrium quantity
  3. The market clears at the floor price with no excess
  4. Quantity traded equals quantity supplied, which exceeds equilibrium quantity

Explanation

At a binding floor, sellers want to supply more than buyers will purchase. Trade is limited by the short side of the market, so quantity traded equals quantity demanded and is lower than at equilibrium.

Question 43Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A good has a price elasticity of demand of 2.0. If its price rises by 10 percent, what is the predicted change in quantity demanded?

  1. A fall of 5 percent
  2. A fall of 20 percent Correct answer.
  3. A rise of 20 percent
  4. A rise of 5 percent

Explanation

Elasticity equals the percentage change in quantity divided by the percentage change in price. With elasticity 2.0 and a 10 percent price rise, quantity falls by 20 percent, and the direction is negative because demand slopes downward.

Question 44Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A market has a horizontal supply curve and a downward-sloping demand curve. A per-unit tax is imposed on producers. What is the predicted incidence?

  1. Producers bear the entire tax with no change in price
  2. Consumers bear the entire tax through a price rise equal to the tax Correct answer.
  3. The burden is split equally between consumers and producers
  4. The tax has no effect on price or quantity

Explanation

A horizontal supply curve is perfectly elastic, so producers will not accept a lower net price and will supply nothing below the market price. The full tax is therefore passed on to consumers as a price rise equal to the tax.

Question 45Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

Demand increases in a market where supply is upward-sloping. Which statement about the resulting price and quantity changes is correct?

  1. The quantity rise is larger when supply is less elastic
  2. Price and quantity both change by the same percentage
  3. The price rise is larger when supply is less elastic Correct answer.
  4. The price rise is larger when supply is more elastic

Explanation

A steeper, less elastic supply curve means quantity supplied responds only weakly to price. A demand increase then produces a larger price increase and a smaller quantity increase than with a flatter supply curve.

Question 46Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A consumer's demand for a good is described as unit elastic over the current price range. If the price of the good falls by 8 percent, what happens to the quantity demanded and to total expenditure on the good?

  1. Quantity demanded is unchanged and total expenditure falls
  2. Quantity demanded rises by more than 8 percent and total expenditure falls
  3. Quantity demanded rises by less than 8 percent and total expenditure rises
  4. Quantity demanded rises by 8 percent and total expenditure is unchanged Correct answer.

Explanation

Unit elastic demand means the percentage change in quantity demanded exactly offsets the percentage change in price, so the elasticity coefficient equals one. A price cut therefore raises quantity by the same percentage, and because price times quantity is unchanged, total expenditure stays constant.

Question 47Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

In a competitive market the government sets a maximum legal price below the equilibrium price. Which combination of effects is predicted?

  1. The market clears at the legal price with no excess demand or supply
  2. Both quantity demanded and quantity supplied rise to the new legal price
  3. Quantity supplied exceeds quantity demanded and a surplus develops
  4. Quantity demanded exceeds quantity supplied and a shortage develops Correct answer.

Explanation

A maximum price below equilibrium is a binding price ceiling: at that price suppliers offer less than the equilibrium quantity while buyers want more. The gap between quantity demanded and quantity supplied is a shortage, which persists because the price is not allowed to rise to clear the market.

Question 48Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A market is initially in equilibrium. Simultaneously, consumers' incomes rise and the good is a normal good, while an increase in the price of a key input raises producers' costs. Which outcome for the equilibrium price and quantity is certain?

  1. Equilibrium price falls and equilibrium quantity falls
  2. Equilibrium price is unchanged and equilibrium quantity rises
  3. Equilibrium quantity rises; the change in equilibrium price is indeterminate
  4. Equilibrium price rises; the change in equilibrium quantity is indeterminate Correct answer.

Explanation

Higher income shifts demand rightward, pushing price and quantity up, while higher input costs shift supply leftward, pushing price up and quantity down. Both shifts raise price, so the price effect is unambiguous, but they pull quantity in opposite directions, leaving the quantity change dependent on the relative sizes of the shifts.

Question 49Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A per-unit tax is levied on producers in a market. Which feature of the market would cause consumers to bear the larger share of the tax burden?

  1. Demand is highly elastic relative to supply
  2. Both demand and supply have identical elasticities
  3. Demand is highly inelastic relative to supply Correct answer.
  4. Supply is highly elastic relative to demand

Explanation

The incidence of a per-unit tax falls more heavily on the side of the market that is less able to adjust, that is, the more inelastic side. When demand is highly inelastic relative to supply, firms pass most of the tax forward into a higher consumer price, so consumers absorb the larger share.

Question 50Demand, supply and market equilibrium; elasticity of demand and supply; price controls and market intervention

A government introduces a subsidy paid to producers for each unit sold. In a market with downward-sloping demand and upward-sloping supply, which statement best describes the welfare outcome?

  1. The subsidy raises the price paid by consumers and lowers the price received by producers
  2. Consumer and producer surplus both rise by the full amount of the subsidy payment
  3. Consumer surplus rises, producer surplus falls, and deadweight loss is eliminated
  4. Consumer and producer surplus rise, but part of the gain is offset by a deadweight loss from extra units whose marginal cost exceeds marginal value Correct answer.

Explanation

A per-unit subsidy shifts supply rightward, lowering the consumer price and raising the producer price, so both surpluses increase. However, output expands beyond the efficient level, and for the extra units the marginal cost of production exceeds the marginal benefit to consumers, creating a deadweight loss that reduces the net welfare gain.