Question

1. If the Price Elasticity of Demand (PED) = 1 then…

1. Price should be decreased to maximize revenue.
2. Price should be increased to maximize revenue.
3. Revenue is at its maximum.
4. Profit is at its maximum.

2. If the demand for good X shifts to the right as the price of good Y rises, then goods X and Y are:

1. Inferior goods.
2. Complementary goods.
3. Normal goods.
4. Substitute goods.

3. Which of the following is not a determinant of Price Elasticity of Demand (PED)?
   1. The availability of close substitutes.
   2. Time horizon: the passage of time.
   3. The proportion of income spent on the good.
   4. The preferences of sellers.

4. The concepts of Utility and Marginal Utility are only applicable for:

1. Markets for two goods.
2. All the consumers of one good or service
3. An individual consumer or household.
4. None of the above.

5. An explicit cost is …

1. A variable cost that increases with quantity.
2. A fixed cost that does not increase with quantity.
3. A cost that involves spending money.
4. The same as an opportunity cost.

Answer 1

(1) PED = 1 implies that Revenue is maximum. PED=1 occurs at the middle of demand curve where MR=0 and beyond that level MR becomes negative. This eats into the Total Revenue. And at a point before that, PED>1, that is customers react positively to price reduction and sales increase the revenue. Thus, TR maximises where PED=1.

Hence, (c) is the correct answer.

(2) If the demand for good X shifts to the right when price of Y increases, then the goods are "Substitute Goods". This means that when X has become more expensive, it's customers are not willing to pay for it and they flock to consuming good Y which is a close substitute and its price is lower. Therefore, they obtain same utility at lower prices.

Hence, (d) is correct answer.

(3) Preferences of sellers aren't a determinant for Price Elasticity of Demand. Availability of substitutes makes demand more elastic as customers have an alternative option and will react immediately to price rise. Time horizon also raises elasticity, as in long term customers can find substitutes more easily than in short run. The proportion of income also has a bearing on elasticity. If consumer is spending a large chunk of his income on a good and its price rises, then he'll react more to it by reducing his consumption than to some other good on which he might be spending less income. And, preferences of seller have no effect on elasticity of demand as they are on the supply side of the equation.

Hence, (d) is the correct option.

(4) The concepts of utility and marginal utility are applicable to a market for 2 goods. This allows the consumer to compare and contrast between the utility he derives from consuming the goods or keeping his money with himself. If he derives greater utility from good 1 than good 2, and this utility is greater than his utility derived from keeping his money, then he'll spend on that good. On subsequent consumption of that good, his utility will decrease (law of diminishing MU) and then again he'll have a choice to analyse his utilities from both good.

Thus, (a) is the correct option.

(5) An explicit cost is a cost that involves spending of money. On the contrary, implicit cost may be something that has an economic value but is not paid for. For eg: If I hire a worker to work in my company, I'll pay him for his service. This is explicit cost. And otherwise, if I myself chose to work in his place, then I don't pay myself any salary but I am adding value. This is implicit cost.

Hence, (c) is the correct option.