In natural monopoly, AC continuously declines due to economies in distribution or in production, which tends to found in industries which face increasing returns to scale. If price were set equal to marginal cost, then:

ECO 550 Final Exam 36 Questions with Correct Answers

Question 1

The short-run cost function is:


where all inputs to the production process are variable

relevant to decisions in which one or more inputs to the production process are fixed

not relevant to optimal pricing and production output decisions

crucial in making optimal investment decisions in new production facilities

In a study of banking by asset size over time, we can find which asset sizes are tending to become more prominent. The size that is becoming more predominant is presumed to be least cost. This is called:


regression to the mean analysis.

breakeven analysis.

survivorship analysis.

engineering cost analysis.

a Willie Sutton analysis.

Which of the following is not
an assumption of the linear breakeven model:


constant selling price per unit

decreasing variable cost per unit

fixed costs are independent of the output level

a single product (or a constant mix of products) is being produced and sold

all costs can be classified as fixed or variable

Question 4

A ____ total cost function implies that marginal costs ____ as output is increased.


linear; increase linearly

quadratic; are constant

cubic; increase linearly

linear; are constant

Long distance telephone service has become a competitive market. The average cost per call is $0.05 a minute, and it’s declining. The likely reason for the declining price for long distance service is:


Governmental pressure to lower the price

Reduced demand for long distance service

Entry into this industry pushes prices down

Lower price for a barrel of crude oil

Increased cost of providing long distance service

What is the profit maximization point for a firm in a purely competitive environment?


The output where

The output where P < MC

The output where P > MC

The output where

The output where AVC < P

Question 7

The problems of asymmetric information exchange arise ultimately because


one party to the exchange possesses different information than another

one party has more information than another

one party knows nothing

one party cannot independently verify the information of another

information is scarce

Question 8

An “experience good” is one that:


Only an expert can use

Has undetectable quality when purchased

Can be readily experienced simply by touching or tasting

Improves with age, like a fine wine

Question 9

Of the following, which is not
an economic rationale for public utility regulation?


production process exhibiting increasing returns to scale

constant cost industry

avoidance of duplication of facilities

protection of consumers from price discrimination

Question 10

____ as practiced by public utilities is designed to encourage greater usage and therefore spread the fixed costs of the utility’s plant over a larger number of units of output.


Peak load pricing

Inverted block pricing

Block pricing

First degree price discrimination

Question 11

In natural monopoly, AC continuously declines due to economies in distribution or in production, which tends to found in industries which face increasing returns to scale. If price were set equal to marginal cost, then:


price would equal average cost.

price would exceed average cost.

price would be below average cost.

price would be at the profit maximizing level for natural monopoly

Question 12

Regulatory agencies engage in all of the following activities except _______.


controlling entry into the regulated industries

overseeing the quality of service provided by the firms

setting federal and state income tax rates on regulated firms

setting prices that consumers will pay

Question 13

5 points

In the Cournot duopoly model, each of the two firms, in determining its profit-maximizing price-output level, assumes that the other firm’s ____ will not change.




marketing strategy


Question 14

Barometric price leadership exists when


one firm in the industry initiates a price change and the others follow it as a signal of changes in cost or demand in the industry.

one firm imposes its best price on the rest of the industry.

all firms agree to change prices simultaneously.

one company forms a price umbrella for all others.

the firms are all colluding.

Question 15

A(n) ____ is characterized by a relatively small number of firms producing a product.






Question 16

Even ideal cartels tend to be unstable because


firms typically prefer competition to collusion as competition, because it leads to more profits.

collusion leads to lowest possible overall profits in the industry.

oligopolistic managers are extremely risk loving.

firms can benefit by secretly selling more than they promised the other firms

Question 17

The starting point of many methods for predicting equilibrium strategy in sequential games is


designing proactive reactions to rival actions

information sets

uncertain outcomes

backwards induction based on an explicit order of play

endgame analysis

Question 18

Cooperation in repeated prisoner’s dilemma situations seems to be enhanced by all of the following except


limited punishment schemes

clarity of conditional rewards

grim trigger strategy

provocability–i.e., credible threats of punishment

tit for tat strategy

Question 19

When there is no Equilibrium (or no Nash Equilibrium), we expect that:


the firms end up in the cooperative strategy.

a firm will follow a randomized strategy.

a firm will not care what it does.

a firm will very likely have a dominant strategy.

Question 20

In making promises that are not guaranteed by third parties and in imposing penalties that are not enforced by third parties, all of the following are credibility-enhancing mechanisms except


establishing a bond forfeited by violating the commitment

investing in a non-redeployable reputational asset tied to the promise or threat

interrupting the communication of negotiated compromises

offering a warranty

delivering a hostage (e.g., a patent license triggered by violating the promise)

Question 21

____ is a new product pricing strategy which results in a high initial product price. This price is reduced over time as demand at the higher price is satisfied.


Prestige pricing

Price lining


Incremental pricing

Third-degree price discrimination exists whenever:


the seller knows exactly how much each potential customer is willing to pay and will charge accordingly.

different prices are charged by blocks of services.

the seller can separate markets by geography, income, age, etc., and charge different prices to these different groups.

the seller will bargain with buyers in each of the markets to obtain the best possible price.

Which of the statements about price discrimination is (are) false?


It must be possible to segment the market.

It must be difficult to transfer the seller’s product from one market segment to another.

Public utilities practice first-degree price discrimination.

There must be differences in the elasticity of demand from one segment to another.

The following are possible examples of price discrimination, EXCEPT:


prices in export markets are lower than for identical products in the domestic market.

senior citizens pay lower fares on public transportation than younger people at the same time.

a product sells at a higher price at location A than at location B, because transportation costs are higher from the factory to A.

subscription prices for a professional journal are higher when bought by a library than when bought by an individual

Which of the following is not among the functions of contract?


to provide incentives for efficient reliance

to reduce transaction costs

to discourage the development of asymmetric information

to provide risk allocation mechanisms

Question 26

When borrowers who do not intend to repay are able to hide their bad credit histories, a lender’s well-intentioned borrowers should


complain to regulatory authorities

withdraw their loan applications

offer more collateral in exchange for lower interest charges

divulge still more information on their loan applications

hope for a pooling equilibrium

Question 27

When someone contracts to do a task but fails to put full effort into the performance of an agreement, yet the lack of effort is not independently verifiable, this lack of effort constitutes a


breach of contractual obligations

denial of good guarantee

loss of reputation

moral hazard

Question 28

Which of the following are not approaches to resolving the principal-agent problem?


ex ante incentive alignment

deferred stock options

ex post governance mechanism

straight salary contracts

monitoring by independent outside directors

Question 29

The lower the barriers to entry and exit, the more nearly a market structure fits the ____ market model.


monopolistic competition

perfectly contestable



Question 30

Industry A has market shares of 50, 30, and 20. Industry B has market shares of 45, 40, and 15. Hint: HHI = Σ (si2), where si is the market shares of the i-th firm in the industry.


The Herfindahl index for A is 100.

The Herfindahl index for A is 3,800.

The Herfindahl index for B is 3,600

The Herfindahl index for A is greater than for B.

The Herfindahl index is for B is 4,000.

Question 31

____ occurs whenever a third party receives or bears costs arising from an economic transaction in which the individual (or group) is not a direct participant.


Pecuniary benefits and costs



Monopoly costs and benefits

Question 32

____ yields the same results as the theory of perfect competition, but requires substantially fewer assumptions than the perfectly competitive model.


Baumol’s sales maximization hypothesis

The Pareto optimality condition

The Cournot model

The theory of contestable markets

Question 33

Which of the following would not be classified as a capital expenditure for decision-making purposes?


purchase of a building

investment in a new milling machine

purchase of 90-day Treasury Bills

investment in a management training program

Question 34

Capital expenditures:


are easily reversible

are forms of operating expenditures

Affect long-run future profitability

Involve only money, not machinery

Question 35

The ____ method assumes that the cash flows over the life of the project are reinvested at the ____.


net present value; computed internal rate of return

internal rate of return; firm’s cost of capital

net present value; firm’s cost of capital

net present value; risk-free rate of return

Question 36

The weights used in calculating the firm’s weighted-average cost of capital are equal to the proportion of debt and equity ____.


used to finance the project

used to finance the projects undertaken last year

in the industry average capital structure

in the firm’s target capital structure