Big Drug's private demand for R&D funds at an 8 percent interest rate is $30 million, while the social demand at that rate is $52 million. By how much does the firm's investment fall short of the socially optimal amount?
$22 million
✓
$52 million
$30 million
$82 million
Correct Answer
$22 million
The shortfall is the social amount minus the private amount: $52 million - $30 million = $22 million. $52 million is the socially optimal investment itself, not the gap. $30 million is what the firm actually invests. $82 million comes from adding the two amounts instead of subtracting.
Category: Private vs Social Benefits
Question 2
How do economists define the social benefits of a good or an investment?
Private benefits minus external benefits
Private benefits plus external benefits
✓
Private benefits plus private costs
External benefits minus external costs
Correct Answer
Private benefits plus external benefits
Social benefits are the total gains to everyone: the private benefits kept by the buyer or investor plus the external benefits that spill over to third parties. Private benefits minus external benefits wrongly subtracts the spillover gains. Private benefits plus private costs mixes a benefit with a cost. External benefits minus external costs leaves out the private gains entirely.
Category: Private vs Social Benefits
Question 3
Why do private firms tend to invest less in research and development than would be best for society?
Research projects almost always lose money for the firms that fund them
Government rules prohibit most research by private companies
Rivals can copy new ideas, so innovators keep only part of the gains
✓
Consumers are generally unwilling to buy newly invented products
Correct Answer
Rivals can copy new ideas, so innovators keep only part of the gains
When competitors can imitate an innovation without paying for the research, the innovator captures only part of the total benefit, so its private incentive to invest is smaller than society's gain. Research projects almost always lose money is false; many succeed and earn high returns. Government rules prohibit most research by private companies is false; private industry funds a large share of research. Consumers are generally unwilling to buy newly invented products is false; successful new products often sell well.
Category: Private vs Social Benefits
Question 4
In a market for flu shots, getting vaccinated also lowers other people's chance of infection, and the government takes no action. How does the market quantity of flu shots compare with the socially optimal quantity?
It is larger than the socially optimal quantity
It is equal to the socially optimal quantity
It is zero because no one will pay for a shot
It is smaller than the socially optimal quantity
✓
Correct Answer
It is smaller than the socially optimal quantity
Buyers weigh only their own private benefit, so the market demand curve lies below the marginal social benefit curve and the market settles at a quantity below the social optimum. It is larger than the socially optimal quantity describes a good with spillover costs, not spillover benefits. It is equal to the socially optimal quantity ignores the benefit to third parties. It is zero because no one will pay for a shot is wrong because people do buy shots for their own protection.
Category: Positive Externalities
Question 5
A government subsidy moves the flu shot market to the socially optimal quantity. According to the model, how does the price consumers pay out of pocket compare with the price suppliers receive?
Consumers pay less than suppliers receive
✓
Consumers pay more than suppliers receive
Consumers pay exactly what suppliers receive
Consumers pay nothing and suppliers receive nothing
Correct Answer
Consumers pay less than suppliers receive
The subsidy fills the gap between the two prices: suppliers receive the full price per shot, while consumers pay that price minus the subsidy. Consumers pay more than suppliers receive describes a tax, not a subsidy. Consumers pay exactly what suppliers receive is the outcome with no subsidy. Consumers pay nothing and suppliers receive nothing would mean no shots are sold at all.
Category: Positive Externalities
Question 6
At the socially optimal quantity of flu shots, each shot gives the person vaccinated a benefit of $20 and gives other people an additional benefit of $12. According to the model, what per-shot subsidy moves the market to the socially optimal quantity?
$20
$12
✓
$32
$8
Correct Answer
$12
The efficient subsidy equals the per-unit spillover benefit, the gap between marginal social benefit ($20 + $12 = $32) and marginal private benefit ($20), which is $32 - $20 = $12. $20 is the private benefit the buyer already counts. $32 is the full marginal social benefit, which would overshoot. $8 comes from subtracting $12 from $20, which has no meaning here.
Category: Positive Externalities
Question 7
Why do economists argue that exclusive rights to an invention should last a limited number of years rather than forever?
Because inventions physically wear out after a few years
Because courts cannot enforce such rights for long periods
To reward inventors without allowing permanent monopoly pricing
✓
Because inventors usually prefer to give up their rights early
Correct Answer
To reward inventors without allowing permanent monopoly pricing
A limited term lets inventors earn enough to justify their research, while ensuring that competition and lower prices eventually return. Because inventions physically wear out confuses an idea with a machine; ideas do not wear out. Because courts cannot enforce such rights for long periods is false; courts enforce them for the full term. Because inventors usually prefer to give up their rights early is false; inventors generally want protection as long as possible.
Category: Intellectual Property
Question 8
Which creation would be protected by a copyright?
A new chemical process
A company's brand logo
A new machine design
A novel written by an author
✓
Correct Answer
A novel written by an author
Copyrights protect original creative works such as books, music, films and pictures, so a novel qualifies. A new chemical process is the kind of invention protected by a patent. A company's brand logo is protected by a trademark. A new machine design is also an invention, which falls under patent law.
Category: Intellectual Property
Question 9
How does granting a patent encourage firms to spend money on research?
It lets the inventor earn above-normal profits for a time
✓
It requires the government to buy every new invention
It forces competitors to share the research costs
It guarantees that the new product will succeed
Correct Answer
It lets the inventor earn above-normal profits for a time
A patent blocks imitators for its term, so a successful innovator can earn temporary monopoly profits that repay the cost and risk of research. It requires the government to buy every new invention is false; the inventor sells in the market. It forces competitors to share the research costs is false; competitors pay nothing. It guarantees that the new product will succeed is false; a patented product can still fail if buyers do not want it.
Category: Intellectual Property
Question 10
What is one advantage of giving firms tax breaks for research instead of having the government fund specific projects?
The government gives up no tax revenue at all
Firms rather than officials decide which projects to pursue
✓
Every project funded this way is certain to succeed
The research creates no spillover benefits for others
Correct Answer
Firms rather than officials decide which projects to pursue
With a research tax credit, a firm's taxes fall based on how much research it does, so the government does not have to review and choose individual projects. The government gives up no tax revenue at all is false; a tax break reduces revenue. Every project funded this way is certain to succeed is false; research is always risky. The research creates no spillover benefits for others is false, and creating spillovers is the reason to encourage the research in the first place.
Category: Government Support for R&D
Question 11
What concern do economists raise about direct government spending on research and development?
The results cannot be shared with private firms
It cannot be used to fund university research
Funding choices may be driven by politics
✓
It requires firms to pay higher tax rates on profits
Correct Answer
Funding choices may be driven by politics
When officials pick projects, decisions can reflect political factors, such as where a lawmaker's district is located, rather than scientific or economic merit. The results cannot be shared with private firms is false; publicly funded research can be made broadly available. It cannot be used to fund university research is false; universities receive much federal research money. It requires firms to pay higher tax rates on profits is not a feature of direct funding.
Category: Government Support for R&D
Question 12
Which pair of characteristics defines a public good?
Excludable and rivalrous
Excludable and nonrivalrous
Nonexcludable and rivalrous
Nonexcludable and nonrivalrous
✓
Correct Answer
Nonexcludable and nonrivalrous
A public good is one that people cannot easily be kept from using and whose use by one person does not reduce what is left for others. Excludable and rivalrous describes an ordinary private good such as a sandwich. Excludable and nonrivalrous describes a good like a subscription streaming service. Nonexcludable and rivalrous describes a common resource such as fish in the open ocean.
Category: Public Goods
Question 13
Which of the following is the best example of a public good?
National defense
✓
A slice of pizza
A cable television subscription
Fish in the open ocean
Correct Answer
National defense
National defense protects everyone in the country at once, and protecting one person does not reduce the protection of others, so it is both nonexcludable and nonrivalrous. A slice of pizza is rivalrous and easy to charge for. A cable television subscription is excludable because nonpayers can be cut off. Fish in the open ocean are rivalrous, which makes them a common resource rather than a public good.
Category: Public Goods
Question 14
A resident enjoys a town fireworks show paid for by neighbors' donations but contributes nothing. Which term describes this resident?
A patent holder
A free rider
✓
A price taker
A monopolist
Correct Answer
A free rider
A free rider benefits from a good without paying for it, counting on others to cover the cost. A patent holder owns exclusive rights to an invention. A price taker is a buyer or seller too small to affect the market price. A monopolist is the only seller in a market.
Category: Free Rider Problem
Question 15
Fish in open international waters can be caught by anyone with a boat, and each fish caught is one fewer for others. Which type of good are these fish?
Public good
Private good
Common resource
✓
Club good
Correct Answer
Common resource
A common resource is nonexcludable, because no one can easily be kept from fishing, but rivalrous, because each catch leaves less for others. Public good is wrong because a public good is nonrivalrous. Private good is wrong because private goods are excludable. Club good is wrong because a club good is excludable but nonrivalrous.
Category: Common Resources
Question 16
What outcome does the tragedy of the commons describe?
Underproduction of goods that create spillover benefits
High prices charged by the only seller in a market
Loss of profits after an invention's legal protection ends
Overuse of a shared resource that no one owns
✓
Correct Answer
Overuse of a shared resource that no one owns
When a resource is rivalrous but no one owns it, each user gains from taking more while the cost of depletion is shared by all, so the resource is overused. Underproduction of goods that create spillover benefits describes a positive externality. High prices charged by the only seller describes monopoly. Loss of profits after legal protection ends describes what happens when a patent expires.
Category: Common Resources
Question 17
Over-the-air radio is hard to charge listeners for directly. How do commercial broadcasters typically pay for it?
By selling advertising time to businesses
✓
By charging listeners a fee for each song
By collecting a property tax from listeners
By requiring a patent license from every radio owner
Correct Answer
By selling advertising time to businesses
Because anyone with a receiver can listen, stations sell advertising, and listeners pay indirectly through their time and through product prices that cover ad costs. By charging listeners a fee for each song is not possible with an open broadcast signal. By collecting a property tax from listeners is something only governments can do. By requiring a patent license from every radio owner is not how broadcasting is financed.
Category: Free Rider Problem
Question 18
Which situation is an example of a positive externality?
A factory's smoke irritates nearby residents
A neighbor's flower garden pleases people walking by
✓
A shopper pays more after a price increase
A worker earns more after finishing training
Correct Answer
A neighbor's flower garden pleases people walking by
A positive externality is a benefit that reaches third parties outside the transaction, like passersby enjoying a garden they did not pay for. A factory's smoke irritates nearby residents is a negative externality, a spillover cost. A shopper pays more after a price increase involves only the buyer and seller. A worker earns more after finishing training is a private benefit kept by the worker.
Category: Positive Externalities
Question 19
Which term describes the total return an investment brings to society, including spillover gains such as the lower crime that comes with a more educated population?
Private rate of return
Nominal interest rate
Social rate of return
✓
Accounting profit
Correct Answer
Social rate of return
A social rate of return counts all the gains an investment brings to society, including spillovers to third parties, which is why many nations fund education with tax money. Private rate of return refers to gains kept mainly by the individual, such as higher earnings for a graduate. Nominal interest rate is the stated rate on a loan or deposit. Accounting profit is a firm's revenue minus its explicit costs.
Category: Positive Externalities
Question 20
A neighborhood association relies on residents' sense of obligation to fund street patrols. Which approach to limiting free riding is it using?
Patent protection
Price discrimination
Market competition
Social pressure
✓
Correct Answer
Social pressure
Social pressure encourages people to contribute to shared goods because neighbors, friends or community members expect it, as with charity drives and neighborhood projects. Patent protection grants exclusive rights to inventions and does not fund shared services. Price discrimination is charging different buyers different prices. Market competition among sellers does not make people pay for a good they can enjoy for free.
Category: Free Rider Problem