Chapter 2 - Trade-offs, Comparative Advantage, and the Market System

Question 1

Why does scarcity require trade-offs?

Answer 1

Goods and services and the economic resources used to make them, or factors of production—workers, capital, natural resources, and entrepreneurial ability—are scarce.

Question 2

Production possibilities frontier (PPF)

Answer 2

A curve showing the maximum attainable combinations of two products that may be produced with available resources and current technology.

Question 3

Opportunity cost

Answer 3

The highest-valued alternative that must be given up to engage in an activity.

Question 4

What are PPF assumptions?

Answer 4

• Full employment:
  All available resources are in use
• Fixed resources:
  The total amount of resources are fixed
• Fixed technology:
  The technology of production is fixed

Question 5

Capital goods

Answer 5

Produced to produce something else

Question 6

Specialization

Answer 6

Resources are specialized to some extent because resources are better suited to produce one good than another

Question 7

Economic growth

Answer 7

The ability of the economy to increase the production of goods and services

Question 8

Trade

Answer 8

The act of buying and selling

Question 9

Absolute advantage

Answer 9

The ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources

Question 10

Comparative advantage

Answer 10

The ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors

Question 11

What is the basis for trade, absolute advantage or comparative advantage?

Answer 11

The basis for trade is comparative advantage, not absolute advantage.

This is because individuals, firms and countries are better off if they specialize in producing goods and services for which they have a comparative advantage and obtain other goods and services they need by trading

Question 12

Market

Answer 12

A group of buyers and sellers of a good or service and the institution or arrangement by which they come together to trade

Question 13

Product market

Answer 13

A market for goods—such as computers—or services—such as medical treatment

Question 14

Factor market

Answer 14

A market for the factors of production, such as labour, capital, natural resources, and entrepreneurial ability

Question 15

Factors of production

Answer 15

The inputs used to make goods and services

Question 16

What are the four factors of production?

Answer 16

1) Labour

Includes all types of work, from the part-time labour of teens working at McDonald’s to the work of CEOs of large corporations..

2) Capital

Refers to physical capital, such as computers, machines, and buildings that are used to make other goods.

3) Natural resources

Include land, water, oil, iron ore, and other raw materials (or “gifts of nature”) that are used in producing goods.

4) Entrepreneur

Someone who operates a business.

Question 17

Entrepreneurial ability

Answer 17

The ability to bring together the other factors of production to successfully produce and sell goods and services

Question 18

Circular-flow diagram

Answer 18

A model that illustrates how participants in markets are linked

Question 19

What are the two key groups that participate in markets?

Answer 19

1) Household

Consists of all the individuals in a home

2) Firms

Consists of suppliers of a good or service

Question 20

What do the different colours of arrows in a circular-flow diagram represent?

Answer 20

Blue arrows show the flow of the factors of production

Red arrows show the flow of goods and services from firms to households

Green arrows show the flow of funds

Question 21

Free market

Answer 21

A market with few government restrictions on how a good or service can be produced or sold or on how a factor of production can be employed

Question 22

The Market Mechanism

Answer 22

Individuals usually act in a rational, self-interested way.

For the market mechanism to work in responding to changes in consumers’ wants, prices must be flexible.

Firms respond individually to changes in relative prices by making decisions that collectively end up satisfying the wants of consumers.

Question 23

Property rights

Answer 23

The rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it

Question 24

Patents and copyrights

Answer 24

They protect intellectual property rights for inventors of ideas for new products or production methods and for creators of books, films,
and software

Question 25

Enforcement of Contracts and Property Rights

Answer 25

If property rights are not well enforced, fewer goods and services will be produced. This reduces economic efficiency, leaving the economy inside its production possibilities frontier.