Question 1

Which of the following statements is correct?
A)The markup pricing rule that is derived from the rule for profit maximization can be used as a substitute for determining the profit-maximizing level of output by equating marginal revenue and marginal cost.
B)It is reasonable to assume that a profit-maximizing firm will never operate in the inelastic portion of its demand curve.
C)The ability of a profit-maximizing firm to mark up price above average cost is unaffected by the price elasticity of demand for the firm's output.
D)The markup factor and the price elasticity of demand are positively related, i.e., as the price elasticity of demand increases, the markup factor that the profit-maximizing firm can apply to its marginal cost in setting price increases as well.

Accepted Answer

B) It is generally accepted in economic theory that a profit-maximizing firm will avoid operating in the inelastic portion of its demand curve because doing so would mean that the firm could increase its total revenue (and potentially its profits) by reducing its output and increasing its price. This is because, in the inelastic portion of the demand curve, the percentage decrease in quantity demanded is less than the percentage increase in price, leading to an increase in total revenue.

Question 2

Which of the following statements is correct?
A)To maximize profit, a firm should apply a uniform markup to each product it sells.
B)The profit-maximizing firm's ability to mark up price over average cost is limited by the price elasticity of demand for the product in question.
C)It is not possible to maximize profits by using a markup pricing strategy.
D)Using markup pricing is more complicated than simply setting price equal to marginal cost.

Accepted Answer

The profit-maximizing firm's ability to mark up price over average cost is limited by the price elasticity of demand for the product in question. A higher price markup may lead to fewer sales and ultimately lower profits. Therefore, the firm needs to consider the price elasticity of demand when determining the optimal markup. Choice A is incorrect because applying a uniform markup to each product does not consider differences in cost and demand elasticity across products. Choice C is incorrect because it is possible to maximize profits using markup pricing, but it requires considering the price elasticity of demand. Choice D is incorrect because while markup pricing may be more complicated than setting price equal to marginal cost, it still provides a way to account for differences in cost and demand when determining optimal pricing.

Question 3

When the marginal revenue resulting from a decrease in price is negative, demand for the product is:
A)elastic.
B)unit elastic.
C)inelastic.
D)cannot be determined without more information.

Accepted Answer

When the marginal revenue resulting from a decrease in price is negative, it means that the decrease in price is not leading to a significant increase in the quantity demanded, which indicates inelastic demand.

Question 4

Third-degree price discrimination refers to situation in which:
A)a firm charges different prices for different blocks of output.
B)a firm separates markets according to the price elasticity of demand.
C)a firm is able to charge the maximum price consumers are willing to pay for each unit of output.
D)a firm divides a market into thirds and charges each segment a different price.

Accepted Answer

Third-degree price discrimination involves dividing a market into different segments based on the price elasticity of demand and charging each segment a different price. This allows a firm to capture more consumer surplus and increase profits. Option A refers to quantity discounts, Option C refers to first-degree price discrimination, and Option D refers to arbitrary division of the market into thirds, which is not necessarily efficient.

Question 5

Assume the price elasticity of demand for a product is -4.In this case, the firm's optimal markup is (approximately):
A)400 percent.
B)100 percent.
C)33 percent.
D)25 percent.

Accepted Answer

The formula for optimal markup is:
Optimal Markup = (1/Elasticity of Demand) - 1

Substituting -4 for the price elasticity of demand into the formula:
Optimal Markup = (1/-4) - 1
Optimal Markup = -0.25 - 1
Optimal Markup = -1.25

However, we cannot have a negative markup, so we take the absolute value:
Optimal Markup = 1.25

To convert this to a percentage, we multiply by 100:
Optimal Markup = 125%

Therefore, the firm's optimal markup is approximately 33%, or choice C.

Question 6

Assuming the demand curve is downward sloping, as price increases, the price elasticity of demand for a good (in absolute value)and marginal revenue:
A)increase.
B)stay the same.
C)decrease.
D)cannot be determined.

Accepted Answer

The answer of Assuming the demand curve is downward sloping,...

Question 7

When demand is elastic, the marginal revenue resulting from a decrease in price is:
A)positive.
B)zero.
C)negative.
D)cannot be determined without more information.

Accepted Answer

When demand is elastic, a decrease in price leads to a proportionally larger increase in quantity demanded, which increases total revenue. Therefore, the marginal revenue, which is the additional revenue from selling one more unit, is positive.

Question 8

The situation in which a firm charges different prices for different blocks of output is referred to as:
A)first-degree price discrimination.
B)second-degree price discrimination.
C)third-degree price discrimination.
D)fourth-degree price discrimination.

Accepted Answer

Second-degree price discrimination is also known as block pricing, where the firm charges different prices for different quantities or blocks of output. This strategy allows the firm to capture more consumer surplus by offering discounts for larger purchases. First-degree price discrimination involves charging each customer their maximum willingness to pay, third-degree price discrimination involves charging different prices to different market segments, and fourth-degree price discrimination involves offering discounts to certain groups (such as students or seniors).

Question 9

The practice of setting price by increasing the average costs of production by some percentage is referred to as:
A)average cost pricing.
B)percentage pricing.
C)rate-of-return pricing.
D)markup pricing.

Accepted Answer

The answer of The practice of setting price by increasing...

Question 10

The difference between the total willingness to pay for a good and the amount actually spent measures:
A)the total benefits from consuming the good.
B)the net gain from the production and consumption of the good.
C)the amount by which producers are better off, i.e., producers' surplus.
D)the amount by which consumers are better off, i.e., consumers' surplus.

Accepted Answer

The difference between the total willingness to pay (the maximum amount a consumer would be willing to pay for a good) and the amount actually spent measures the amount by which consumers are better off, i.e., consumers' surplus. This is because consumers are able to obtain the good for less than they were willing to pay, resulting in a net gain in their well-being. This differs from producers' surplus (choice C), which measures the amount by which producers are better off due to the production and sale of the good.

Question 11

Which of the following is considered a necessary condition for successful price discrimination?
A)A firm's customers must all have the same price elasticity of demand.
B)Firms are able to prevent resale among different groups of customers.
C)Firms must be able to determine each customer's maximum willingness to pay for the product in question.
D)Firms must operate in a perfectly competitive market.

Accepted Answer

For successful price discrimination, firms must be able to prevent resale among different groups of customers. This ensures that higher-priced goods sold to one group cannot be resold to another group at a lower price, undermining the price discrimination strategy.

Question 12

Assume there is a decrease in the number of substitutes for a good produced by a profit-maximizing price-setting firm.All else constant, this would cause the firm's ability to markup price above average cost to:
A)decrease.
B)stay the same.
C)increase.
D)cannot be determined with the information given.

Accepted Answer

With fewer substitutes available, the demand for the firm's product becomes less elastic because consumers have fewer alternatives. This increases the firm's market power, allowing it to raise prices above average cost more than before.

Question 13

By and large, the price of each item on a restaurant menu is:
A)an accurate reflection of the item's marginal cost.
B)based strictly on consumer demand.
C)a function of cost and the price elasticity of demand for the item.
D)a fixed multiple of the item's total cost.

Accepted Answer

The price of each item on a restaurant menu is determined by a function of its cost and the price elasticity of demand for that item. This means that the price is influenced by how much it costs to produce the item, as well as how much customers are willing to pay for it. A restaurant will seek to set a price that maximizes its profits, taking into account both of these factors. Therefore, it is not strictly based on consumer demand or a fixed multiple of the item's cost. While the price may reflect the item's marginal cost to some extent, it is not necessarily an accurate reflection of that cost.

Question 14

Assume the inverse demand function for a good can be written as: P = 30 - 2Q.Assuming P = $10, the resulting consumer surplus would be equal to:
A)$50.
B)$100.
C)$200.
D)$225.

Accepted Answer

When P = $10, we can substitute this into the demand function to find the corresponding quantity:

$10 = 30 - 2Q

Solving for Q, we get Q = 10.

To find the consumer surplus at this price, we need to calculate the area under the demand curve above the price ($10) and up to the quantity (10):

Consumer Surplus = 0.5 * ($30 - $10) * 10

Consumer Surplus = $100

Therefore, the consumer surplus at a price of $10 is $100. The correct answer is option B.

Question 15

The practice of charging different prices to various groups of customers that are not based on differences in the costs of production is referred to as:
A)predatory pricing.
B)markup pricing.
C)discretionary pricing.
D)price discrimination.

Accepted Answer

Price discrimination refers to the practice of charging different prices to different groups of customers, often based on factors such as their willingness to pay or their ability to pay. This is different from markup pricing, which involves adding a profit margin to the cost of production, or discretionary pricing, which involves setting prices based on the seller's preferences or judgment. Predatory pricing, on the other hand, involves setting prices intentionally low in order to drive competitors out of the market.

Question 16

At the profit-maximizing level of output, the amount by which the firm can mark up price is:
A)inversely related to the price elasticity of demand for item in question.
B)directly related to the price elasticity of demand for item in question.
C)totally unrelated to the price elasticity of demand for item in question.
D)equal to the ratio of the marginal and average costs of production.

Accepted Answer

The amount by which a firm can mark up price is inversely related to the price elasticity of demand for the item in question. In other words, the more elastic the demand for the item, the less the firm can mark up the price without losing a significant amount of customers. At the profit-maximizing level of output, the firm will set the price where marginal revenue equals marginal cost, and the amount by which they can mark up the price will depend on the elasticity of demand.

Question 17

The situation in which a firm is able to charge the maximum price consumers are willing to pay for each unit of output the firm sells is referred to as:
A)first-degree price discrimination.
B)second-degree price discrimination.
C)third-degree price discrimination.
D)fourth-degree price discrimination.

Accepted Answer

First-degree price discrimination, also known as perfect price discrimination, occurs when a firm is able to charge each customer the exact maximum price they are willing to pay for each unit of output sold. This is only possible if the firm has perfect knowledge of each customer's willingness to pay and is able to charge different prices to different customers based on this information.

Question 18

It is frequently observed that when a city is located next to a major highway, gas stations located close to the highway charge higher prices than gas stations located farther away.This is an example of:
A)first-degree price discrimination.
B)second-degree price discrimination.
C)third-degree price discrimination.
D)illegal price discrimination.

Accepted Answer

This is an example of third-degree price discrimination, where prices are set based on the characteristics of the market, such as location. Gas stations located closer to the highway have a different customer base than those located further away and can therefore charge higher prices to profit from the convenience and location of their business.

Question 19

Assume a change in price causes the price elasticity of demand for a good (in absolute value)and marginal revenue to decrease.In this case we can conclude that the price of the good was:
A)increased.
B)held constant.
C)decreased.
D)cannot be determined.

Accepted Answer

The answer of Assume a change in price causes the...

Question 20

The suggestion that a seller will try to set price based on "what the market will bear" is explicit recognition of the constraint imposed by:
A)the firm's marginal cost of production.
B)the price elasticity of demand for that item.
C)the firm's competitors.
D)the need for most firms to earn positive economic profits over time if they are to remain in business.

Accepted Answer

The concept of "what the market will bear" suggests that the seller is taking into account the price elasticity of demand for the item, which refers to how much the quantity demanded will change in response to a change in price. If the demand for the item is elastic, meaning that a small change in price leads to a large change in quantity demanded, the seller will need to set a lower price in order to sell the item. If the demand is inelastic, meaning that a change in price has a smaller effect on quantity demanded, the seller can set a higher price. Thus, the constraint on the seller's pricing decision is the price elasticity of demand for the item.  The other options (marginal cost of production, competitors, and need for economic profits) may also influence the seller's pricing decision, but are not explicitly recognized by the concept of "what the market will bear."

Quiz 10: Pricing Strategies for the Firm

Which of the following statements is correct?

Which of the following statements is correct?

When the marginal revenue resulting from a decrease in price is negative, demand for the product is:

Third-degree price discrimination refers to situation in which:

Assume the price elasticity of demand for a product is -4.In this case, the firm's optimal markup is (approximately) :

Assuming the demand curve is downward sloping, as price increases, the price elasticity of demand for a good (in absolute value) and marginal revenue:

When demand is elastic, the marginal revenue resulting from a decrease in price is:

The situation in which a firm charges different prices for different blocks of output is referred to as:

The practice of setting price by increasing the average costs of production by some percentage is referred to as:

The difference between the total willingness to pay for a good and the amount actually spent measures:

Which of the following is considered a necessary condition for successful price discrimination?

Assume there is a decrease in the number of substitutes for a good produced by a profit-maximizing price-setting firm.All else constant, this would cause the firm's ability to markup price above average cost to:

By and large, the price of each item on a restaurant menu is:

Assume the inverse demand function for a good can be written as: P = 30 - 2Q.Assuming P = $10, the resulting consumer surplus would be equal to:

The practice of charging different prices to various groups of customers that are not based on differences in the costs of production is referred to as:

At the profit-maximizing level of output, the amount by which the firm can mark up price is:

The situation in which a firm is able to charge the maximum price consumers are willing to pay for each unit of output the firm sells is referred to as:

It is frequently observed that when a city is located next to a major highway, gas stations located close to the highway charge higher prices than gas stations located farther away.This is an example of:

Assume a change in price causes the price elasticity of demand for a good (in absolute value) and marginal revenue to decrease.In this case we can conclude that the price of the good was:

The suggestion that a seller will try to set price based on "what the market will bear" is explicit recognition of the constraint imposed by: