CIMA BA1 · Chapter 7
Costs, revenue and market structures MCQs with Answers
11 multiple-choice questions on Costs, revenue and market structures for CIMA BA1 Fundamentals of Business Economics. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
In economics, the short run is defined as a period in which:
- A) All factors of production are variable
- B) The firm must earn normal profit
- C) At least one factor of production is fixed in quantity
- D) Prices cannot change
Show answer & explanation
Answer: C) At least one factor of production is fixed in quantity
The short run is not a fixed calendar period. It is the period in which at least one input (usually capital) cannot be changed. In the long run all factors are variable.
Question 2
The law of diminishing returns states that:
- A) As a firm increases the scale of all its inputs, long-run average cost always rises
- B) As more units of a variable factor are added to a fixed factor, the marginal product of the variable factor will eventually fall
- C) Total output will fall as soon as any additional worker is employed
- D) Average cost falls continuously as output rises in the short run
Show answer & explanation
Answer: B) As more units of a variable factor are added to a fixed factor, the marginal product of the variable factor will eventually fall
Diminishing marginal returns is a short-run concept: with at least one factor fixed, each additional unit of the variable factor eventually adds less to output than the previous one. This causes short-run marginal and average variable costs to rise. Diseconomies of scale are a separate long-run concept.
Question 3
A firm's total costs are $2,000 when output is zero, $5,000 when output is 100 units and $5,040 when output is 101 units. What is the average variable cost at an output of 100 units?
- A) $30
- B) $50
- C) $20
- D) $40
Show answer & explanation
Answer: A) $30
Fixed cost is the cost at zero output, $2,000. Variable cost at 100 units = 5,000 - 2,000 = $3,000. AVC = 3,000 / 100 = $30. Average total cost is $50, average fixed cost $20 and marginal cost of the 101st unit $40.
Question 4
Which of the following is an EXTERNAL economy of scale?
- A) Discounts obtained by a large firm for buying materials in bulk
- B) Cheaper borrowing available to a large firm because it is seen as less risky
- C) The ability of a large firm to employ specialist managers
- D) A pool of skilled labour developing in a region where the industry is concentrated
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Answer: D) A pool of skilled labour developing in a region where the industry is concentrated
External economies arise from the growth of the industry as a whole, benefiting all firms in it, such as specialised local labour, suppliers and infrastructure. The other options are internal economies arising from the size of the individual firm.
Question 5
Which of the following is NOT a characteristic of a perfectly competitive market?
- A) There are many buyers and sellers
- B) Firms sell an identical (homogeneous) product
- C) Firms can earn supernormal profits in the long run
- D) There is freedom of entry to and exit from the industry
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Answer: C) Firms can earn supernormal profits in the long run
In perfect competition, free entry means that any supernormal profits attract new firms, increasing supply and reducing price until only normal profit is earned in the long run.
Question 6
A profit-maximising firm will produce at the output where:
- A) Average cost is at its minimum
- B) Marginal cost equals marginal revenue
- C) Total revenue is at its maximum
- D) Average revenue equals average cost
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Answer: B) Marginal cost equals marginal revenue
Profit increases as long as each extra unit adds more to revenue than to cost (MR > MC). Profit is maximised where MR = MC, with MC rising through MR. Minimum average cost and maximum revenue are generally different output levels.
Question 7
In the short run, a perfectly competitive firm making a loss should continue to produce as long as:
- A) Price covers average variable cost
- B) Price covers average total cost
- C) Price covers average fixed cost
- D) Marginal revenue exceeds average total cost
Show answer & explanation
Answer: A) Price covers average variable cost
Fixed costs must be paid whether or not the firm produces. If price covers average variable cost, producing makes a contribution towards fixed costs and reduces the loss. If price falls below AVC, the firm should shut down in the short run.
Question 8
Compared with a perfectly competitive industry with the same cost conditions, a profit-maximising monopolist will normally:
- A) Charge a lower price and produce a higher output
- B) Charge the same price but produce a lower output
- C) Produce where price equals marginal cost
- D) Charge a higher price and produce a lower output, causing a deadweight welfare loss
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Answer: D) Charge a higher price and produce a lower output, causing a deadweight welfare loss
A monopolist faces the downward-sloping market demand curve, so MR is below price. Producing where MR = MC means price exceeds marginal cost, output is restricted and price is higher than under perfect competition. The lost consumer and producer surplus is the deadweight loss.
Question 9
The kinked demand curve model of oligopoly is used to explain:
- A) Why oligopolists always form cartels
- B) Why oligopolists earn only normal profits in the long run
- C) Why prices in oligopolistic markets tend to be stable
- D) Why there are many small firms in an oligopoly
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Answer: C) Why prices in oligopolistic markets tend to be stable
The model assumes rivals will match a price cut but not a price rise. Demand is elastic above the current price and inelastic below it, creating a gap in the MR curve. Changes in MC within the gap leave the profit-maximising price unchanged, explaining price rigidity.
Question 10
In long-run equilibrium under monopolistic competition, a typical firm:
- A) Earns supernormal profit protected by barriers to entry
- B) Earns normal profit and operates with excess capacity
- C) Produces at the minimum point of its average cost curve
- D) Faces a perfectly elastic demand curve
Show answer & explanation
Answer: B) Earns normal profit and operates with excess capacity
Free entry removes supernormal profit, so in the long run the demand curve is tangential to the average cost curve. Because the demand curve slopes downwards (differentiated products), the tangency is to the left of minimum average cost, so firms have excess capacity.
Question 11
A monopolist faces the demand curve P = 100 - 2Q, giving marginal revenue MR = 100 - 4Q. Its total cost is TC = 500 + 20Q. What is the maximum profit the firm can earn?
- A) $300
- B) $800
- C) $250
- D) $1,200
Show answer & explanation
Answer: A) $300
Marginal cost = 20. Set MR = MC: 100 - 4Q = 20, so Q = 20. Price = 100 - 2 x 20 = $60. Total revenue = 60 x 20 = $1,200. Total cost = 500 + 20 x 20 = $900. Profit = 1,200 - 900 = $300.