Economics 1 - Chapter 1

Question 1

INTRODUCTION

what is the cause of all economic questions?

Answer 1

All economic questions arise because we want more than we can get.

Question 2

INTRODUCTION

Briefly explain Scarcity?

Answer 2

Our inability to satisfy all our wants is called scarcity (the basic economic problem that arises because people have unlimited wants but resources are limited).

Question 3

INTRODUCTION

Why must we make choices to allocate resources efficiently?

Answer 3

Because we face scarcity, we must make choices to allocate resources efficiently.

Question 4

INTRODUCTION

What does choices depend on?

Answer 4

Choices depend on incentives.

Question 5

INTRODUCTION

Briefly explain incentive?

Answer 5

An incentive is a reward that encourages or a penalty that discourages an action.

Question 6

INTRODUCTION

What is economics?

Answer 6

Economics is a social science that studies the choices that individuals, businesses, governments, and entire societies make as they cope with scarcity and the incentives that influence and reconcile those choices.

Question 7

INTRODUCTION

Economics can be divided into two parts, name those two parts?

Answer 7

• Microeconomics

- Macroeconomics

Question 8

INTRODUCTION

Briefly explain Microeconomics?

Answer 8

Microeconomics is the study of choices that individuals and businesses make, the way these choices interact in markets and the influence of government on those choices.

Question 9

INTRODUCTION

Briefly explain Macroeconomics?

Answer 9

Macroeconomics is the study of the effects on the national economy and the global economy of the choices that individuals, businesses and governments make.

Question 10

INTRODUCTION

List the factors of production?

Answer 10

Land
Labour
Capital
Entrepreneurship

Question 11

INTRODUCTION

Briefly explain Self interest?

Answer 11

You make choices that are in your self-interest—choices that you think are best for you.

Question 12

INTRODUCTION

Briefly explain Social interest?

Answer 12

Choices that are best for society as a whole are said to be in the social interest.

Question 13

INTRODUCTION
THE FUNDAMENTAL ECONOMIC CHALLENGE
CHOICES AND TRADE OFFS
true or false - You can think about every choice as a trade-off

Answer 13

True - You can think about every choice as a trade-off—giving up one thing to get something else. Whatever choice you make, you could have chosen something else instead.

Question 14

INTRODUCTION
THE FUNDAMENTAL ECONOMIC CHALLENGE
CHOICES AND TRADE OFFS
When making choices what do we have to consider?

Answer 14

In making choices, we have to make decisions about the best possible choices in terms of allocating resources efficiently and effectively. This includes incurring opportunity costs. Thus for every decision we take, we incur opportunity costs.

Question 15

INTRODUCTION
THE FUNDAMENTAL ECONOMIC CHALLENGE
CHOICES AND TRADE OFFS
Briefly explain Opportunity costs?

Answer 15

The highest-valued alternative that we give up to get something is the opportunity cost of the activity chosen. The concept of opportunity costs refers to the best option forgone. It is simply, giving up something to gain something else. Thinking about a choice as a trade-off emphasizes cost as an opportunity forgone

Question 16

INTRODUCTION
THE FUNDAMENTAL ECONOMIC CHALLENGE
CHOOSING AT MARGIN
What does it mean to make choices at margin?

Answer 16

People make choices at the margin, which means that they evaluate the consequences of making incremental changes in the use of their resources.

Question 17

INTRODUCTION
THE FUNDAMENTAL ECONOMIC CHALLENGE
CHOOSING AT MARGIN
What is the benefit of pursuing an incremental increase in an activity?

Answer 17

The benefit from pursuing an incremental increase in an activity is its marginal benefit.

Question 18

INTRODUCTION
THE FUNDAMENTAL ECONOMIC CHALLENGE
CHOOSING AT MARGIN
What is the opportunity cost of pursuing an incremental increase in an activity?

Answer 18

The opportunity cost of pursuing an incremental increase in an activity is its marginal cost.

Question 19

INTRODUCTION
THE FUNDAMENTAL ECONOMIC CHALLENGE
CHOOSING AT MARGIN
How do we use our scarce resource in the way that makes us as well off as possible?

Answer 19

By evaluating marginal benefits and marginal costs and choosing only those actions that bring greater benefit than cost, we use our scarce resource in the way that makes us as well off as possible.

Question 20

INTRODUCTION
THE FUNDAMENTAL ECONOMIC CHALLENGE
HUMAN NATURE, INCENTIVES AND INSTITUTIONS
True or False - Economists take human nature as given and view people as acting in their self-interest. Self-interested actions are not necessarily selfish actions.

Answer 20

True

Question 21

INTRODUCTION
CETERIS PARIBUS
What is the meaning of Ceteris Paribus?

Answer 21

This is a Latin term that means ―other things being equal or ―if all other relevant things remain the same

Question 22

INTRODUCTION
PRODUCTION POSSIBILITIES FRONTIER
What limits the quantities of goods and services that we can produce?

Answer 22

The quantities of goods and services that we can produce are limited by both our available resources and by technology.

Question 23

INTRODUCTION
PRODUCTION POSSIBILITIES FRONTIER
What needs to happen if we want to increase our production of one good?

Answer 23

If we want to increase our production of one good, we must decrease our production of something else – we face trade-offs.

Question 24

INTRODUCTION
PRODUCTION POSSIBILITIES FRONTIER
What is the production possibilities frontier (PPF)?

Answer 24

The production possibilities frontier (PPF) is the boundary between those combinations of goods and services that can be produced and those that cannot, that is, it is the limit to what we can produce.

Question 25

INTRODUCTION
PRODUCTION POSSIBILITIES FRONTIER
Draw a diagram depicting the PPF of CDs and Pizza and explain what can be determined?

Answer 25

Figure 1.1 page 9
Points on the frontier, such as points A, B, C, D, E and F and points inside the frontier, such as Z, are attainable. Points outside the frontier are unattainable. If we move along the PPF from C to D, the opportunity cost of the increase in pizza is the decrease in CDs. Note that the opportunity cost of a CD is the inverse of the opportunity cost of a pizza.
One pizza costs 3 CDs.
One CD costs 1/3 of a pizza.

Question 26

INTRODUCTION
PRODUCTION POSSIBILITIES FRONTIER
True or false - The PPF makes the concept of opportunity cost precise.

Answer 26

True

Question 27

INTRODUCTION
PRODUCTION POSSIBILITIES FRONTIER
True or False - All the points along the PPF are inefficient

Answer 27

False - All the points along the PPF are efficient.

Question 28

INTRODUCTION
PRODUCTION POSSIBILITIES FRONTIER
How do we determine which of the alternative efficient quantities to produce on the PPF?

Answer 28

To determine which of the alternative efficient quantities to produce, we compare costs and benefits.

Question 29

INTRODUCTION
THE PPF AND MARGINAL COST
What does the PPF determine?

Answer 29

The PPF determines opportunity cost.

Question 30

INTRODUCTION
THE PPF AND MARGINAL COST
What is the marginal cost of a good or service?

Answer 30

The marginal cost of a good or service is the opportunity cost of producing one more unit of it.

Question 31

INTRODUCTION
THE PPF AND MARGINAL COST
Draw a Diagram that illustrates the marginal cost of pizza and explain what can be determined?

Answer 31

Figure 1.2 page 10 illustrates the marginal cost of pizza.

As we move along the PPF , the opportunity cost and the marginal cost of pizza increases.

Question 32

INTRODUCTION

THE PPF AND MARGINAL COST

Answer 32

In Figure 1.3 the blocks illustrate the increasing opportunity cost of pizza.
Figure 1.3
Source: Parkin, Powell and Mathews (2017)
The black dots and the line labelled MC shows the marginal cost of pizza.
Preferences and Marginal Benefit
Preferences are a description of a person‘s likes and dislikes. Economists use marginal benefit
and the marginal benefit curve to describe them.
The marginal benefit of a good is the benefit received from consuming one more unit of it.
We measure marginal benefit by the amount that a person is willing to pay for an additional unit of a good or service.
It is a general principle that the more we have of any good or service, the smaller is its marginal benefit and the less we are willing to pay for an additional unit of it.
We call this general principle the principle of decreasing marginal benefit.
Figure 1.4 illustrates the marginal benefit curve which shows the relationship between the marginal benefit of a good and the quantity of that good consumed.
The marginal benefit curve slopes downward to reflect the principle of decreasing marginal benefit. At point A, with pizza production at 0.5 million, people are willing to pay 5 CDs per
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pizza. At point E, with pizza production at 4.5 million, people are willing to pay 1 CD per pizza.
Figure 1.4
Source: Parkin, Powell and Mathews (2017)
Efficient Use of Resources
When we cannot produce more of any one good without giving up some other good, we have achieved production efficiency, and we are producing at a point on the PPF.
When we cannot produce more of any one good without giving up some other good that we value more highly, we have achieved allocative efficiency, and we are producing at the point on the PPF that we prefer above all other points. The following figure illustrates allocative efficiency.
Figure 1.5
Source: Parkin, Powell and Mathews (2017)
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The point of allocative efficiency is the point on the PPF at which marginal benefit equals marginal cost. This point is determined by the quantity at which the marginal benefit curve intersects the marginal cost curve which is shown in Figure 1.6 below.
Figure 1.6
Source: Parkin, Powell and Mathews (2017)
If we produce less than 2.5 million pizza, marginal benefit exceeds marginal cost. We get more value from our resources by producing more pizza. Looking at Figure 1.7, on the PPF at point A, we are producing too many CDs, and we are better off moving along the PPF to produce more pizza.
Figure 1.7
Source: Parkin, Powell and Mathews (2017)
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ECONOMICS 1
From Figure 1.5, if we produce more than 2.5 million pizzas, marginal cost exceeds marginal benefit. We get more value from our resources by producing less pizza. On the PPF at point C, we are producing too much pizza, and we are better off moving along the PPF to produce less pizza.
Economic growth
The expansion of production possibilities—and increase in the standard of living—is called
economic growth.
The Cost of Economic Growth
Two key factors influence economic growth:
Technological change
Capital accumulation
Technological change is the development of new goods and of better ways of producing goods and services.
Capital accumulation is the growth of capital resources, which includes human capital.
To use resources in research and development and to produce new capital, we must decrease our production of consumption goods and services.
Figure 1.8 illustrates the trade-off we face.
Figure 1.8
Source: Parkin, Powell and Mathews (2017)
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ECONOMICS 1
We can produce pizza or pizza ovens along PPF0. By using some resources to produce pizza ovens, the PPF shifts outward in the future.
Gains from Trade
Comparative Advantage
A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost than anyone else. In other words, it refers to the ability of a party (an individual, a firm, or a country) to produce a product with the highest relative efficiency given all the other products that could be produced. It can be contrasted with absolute advantage which refers to the ability of a party to produce a particular good at a lower absolute cost than another. Comparative advantage explains how trade can create value for both parties even when one
can produce all goods with fewer resources than the other. The net benefits of such an outcome are called gains from trade. It is the main concept of the pure theory of international trade.
Production Without Trade
Suppose that Ace and Galaxy produce two components: case and discs. Each firm produces its own cases and discs. Total production at each factory is 3,000 CDs an hour. Table 1.1 shows their production possibilities.
Table 1.1: Production Possibilities
Possibility
Discs
(thousands per hour)
Cases
(thousands per hour)
A
0
4
B
3
3
C
6
2
D
9
1
E
12
0
Source: Parkin, Powell and Mathews (2017)
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The table shows Ace‘s production possibilities.
Ace produces 3,000 discs and 3,000 cases at possibility B. If Ace increases production of discs by 3,000 an hour, it must decrease production of cases by 1,000.
Table 1.2: Galaxy‘s Production Possibilities
Possibility
Discs
(thousands per hour)
Cases
(thousands per hour)
E’
0
12
D’
1
9
C’
2
6
B’
3
3
A’
4
0
Source: Parkin, Powell and Mathews (2017)
Galaxy produces 3,000 discs and 3,000 cases at possibility B’. If Galaxy increases production of discs by 1,000 an hour, it must decrease production of cases by 3,000.
Differences in Opportunity Cost
Figure 1.9
Source: Parkin, Powell and Mathews (2017)
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ECONOMICS 1
Ace can produce 3,000 discs and 3,000 cases at point B. Along its PPF, Ace‘s opportunity cost of a disc is 1/3 case and its opportunity cost of a case is 3 discs.
Galaxy can produce 3,000 discs and 3,000 cases at point B’.
Along its PPF, Galaxy‘s opportunity cost of a disc is 3 cases and its opportunity cost of a case is
1/3 of a disc.
If Ace and Galaxy exchange cases and discs at one case per disc (one disc per case), they exchange along the Trade line, figure 1.10.
Ace ends up at point F with 6,000 CDs—twice what it can achieve without specialization and trade.
Galaxy ends up at point at point at point F’ with 6,000 CDs—twice what it can achieve without specialization and trade
Figure 1.10
Source: Parkin, Powell and Mathews (2017)
Absolute Advantage
A person (or nation) has an absolute advantage if that person (or nation) can produce more goods with a given amount of resources than another person (or nation) can.
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Because the gains from trade arise from comparative advantage, people can gain from trade in they also have an absolute advantage.
Dynamic Comparative Advantage
Learning-by-doing occurs when a person (or nation) specializes and by repeatedly producing a particular good or service becomes more productive in that activity and lowers its opportunity cost of producing that good over time.
Dynamic comparative advantage occurs when a person (or nation) gains a comparative advantage from learning-by-doing.