Handout 1

Question 1

Scarcity means that there is less of a good or resource available than people wish to have.

Answer 1

TRUE

Question 2

Economics is the study of how evenly goods and services are distributed within society.

Answer 2

FALSE

Question 3

Economics is the study of how society allocates its unlimited resources.

Answer 3

FALSE

Question 4

Choosing not to attend a concert so that you can study for your exam is an example of a tradeoff.

Answer 4

TRUE

Question 5

The classic tradeoff between “guns and butter” states that when a society spends more on national defense, it has less to spend on consumer goods to raise the standard of living.

Answer 5

TRUE

Question 6

Efficiency means everyone in the economy should receive an equal share of the goods and services produced.

Answer 6

FALSE

Question 7

The cost of an action is measured in terms of foregone opportunities.

Answer 7

TRUE

Question 8

An increase in the marginal cost of an activity necessarily means that people will no longer engage in any of that activity.

Answer 8

FALSE

Question 9

A rational decision-maker takes an action if and only if the marginal cost exceeds the marginal benefit.

Answer 9

FALSE

Question 10

A tax on gasoline is an incentive that encourages people to drive smaller more fuel-efficient cars.

Answer 10

TRUE

Question 11

Trade allows each person to specialize in the activities he or she does best, thus increasing each individual’s productivity.

Answer 11

TRUE

Question 12

One way that governments can improve market outcomes is to ensure that individuals are able to own and exercise control over their scarce resources.

Answer 12

TRUE

Question 13

Economists devise theories, collect data, and then analyze these data in an attempt to verify or refute their theories.

Answer 13

TRUE

Question 14

Assumptions can simplify the complex world and make it easier to understand.

Answer 14

TRUE

Question 15

Economic models can help us understand reality only when they include all details of the economy.

Answer 15

FALSE

Question 16

The production possibilities frontier is a graph that shows the various combinations of outputs that the economy can possibly produce given the available factors of production and the available production technology.

Answer 16

TRUE

Question 17

Refer to Figure 1. If this economy uses all its resources in the dishwasher industry, it produces 35 dishwashers and no doghouses.

Answer 17

TRUE

Question 18

Refer to Figure 1. It is possible for this economy to produce 75 doghouses.

Answer 18

FALSE

Question 19

Refer to Figure 1. It is possible for this economy to produce 30 doghouses and 20 dishwashers.

Answer 19

TRUE

Question 20

Refer to Figure 1. It is possible for this economy to produce 45 doghouses and 30 dishwashers.

Answer 20

FALSE

Question 21

Under what conditions might government intervention in a market economy improve the economy’s performance?

Answer 21

If there is a market failure, such as a monopoly, government regulation might improve the well-being of society by promoting efficiency. If the distribution of income or wealth is considered to be unfair by society, government intervention might achieve a more equal distribution of economic well-being.

Question 22

Give three examples of important trade-offs that you face in your life

Answer 22

Examples of trade-offs include time trade-offs (such as studying one subject over another or studying at all compared to engaging in social activities) and spending trade-offs (such as whether to use your last 15 dollars to purchase a pizza or to buy a study guide for that tough economics course).

Question 23

What is the opportunity cost of seeings a movie?

Answer 23

The opportunity cost of seeing a movie includes the monetary cost of admission plus the time cost of going to the theater and attending the show. The time cost depends on your next best use of that time; if it is staying home and watching TV, the time cost may be small, but if it is working an extra three hours at your job, the time cost is the money you could have earned.

Question 24

Water is necessary for life. Is the marginal benefit of a glass of water large or small?

Answer 24

The marginal benefit of a glass of water depends on your circumstances. If you have just run a marathon or you have been walking in the desert sun for three hours, the marginal benefit is very high. But if you have been drinking a lot of liquids recently, the marginal benefit is quite low. The point is that even the necessities of life, like water, do not always have large marginal benefits.

Question 25

Why should policymakers think about incentives?

Answer 25

Policymakers need to think about incentives so they can understand how people will respond to the policies they put in place. The text’s example of seat belt laws shows that policy actions can have unintended consequences. If incentives matter a lot, they may lead to a very different type of policy; for example, some economists have suggested putting knives in steering columns so that people will drive much more carefully! While this suggestion is silly, it highlights the importance of incentives.

Question 26

Why isn’t trade among countries like a game with some winners and some losers?

Answer 26

Trade among countries is not a game with some losers and some winners because trade can make everyone better off. By allowing specialization, trade between people and trade between countries can improve everyone’s welfare.

Question 27

Explain the two main causes of market failure and give an example of each.

Answer 27

The two main causes of market failure are externalities and market power. An externality is the impact of one person’s actions on the well-being of a bystander, such as from pollution or the creation of knowledge. Market power refers to the ability of a single person (or small group of people) to unduly influence market prices, such as in a town with only one well or only one cable television company. In addition, a market economy also leads to an unequal distribution of income.

Question 28

Describe the trade off: A family deciding whether to buy a new car

Answer 28

A family deciding whether to buy a new car faces a trade-off between the cost of the car and other things they might want to buy. For example, buying the car might mean they must give up going on vacation for the next two years. So the real cost of the car is the family’s opportunity cost in terms of what they must give up.

Question 29

Describe the trade off: A member of Congress deciding how much to spend on national parks

Answer 29

For a member of Congress deciding whether to increase spending on national parks, the trade-off is between parks and other spending items or tax cuts. If more money goes into the park system, that may mean less spending on national defense or on the police force. Or instead of spending more money on the park system, taxes could be reduced.

Question 30

Describe the trade off: A company president deciding whether to open a new factory

Answer 30

When a company president decides whether to open a new factory, the decision is based on whether the new factory will increase the firm’s profits compared to other alternatives. For example, the company could upgrade existing equipment or expand existing factories. The bottom line is: Which method of expanding production will increase profit the most?

Question 31

Describe the trade off: A professor deciding how much to prepare for class

Answer 31

In deciding how much to prepare for class, a professor faces a trade-off between the value of improving the quality of the lecture compared to other things she could do with her time, such as working on additional research or enjoying some leisure time.

Question 32

Describe the trade off: A recent college graduate deciding whether to go to graduate school

Answer 32

In deciding whether to go to graduate school, the student faces a trade-off between his possible earnings with a bachelor’s degree and the benefits of an increased education (such as higher future earnings and greater knowledge).

Question 33

You are trying to decide whether to take a vacation. Most of the costs of the vacation (airfare, hotel, and forgone wages) are measured in dollars, but the benefits of the vacation are psychological. How can you compare the benefits to the costs?

Answer 33

When the benefits of something are psychological, such as going on a vacation, it is not easy to compare benefits to costs to determine if it is worth doing. But there are two ways to think about the benefits. One is to compare the vacation with what you would do in its place. If you did not go on vacation, would you buy something like a new set of golf clubs? Then you can decide if you would rather have the new clubs or the vacation. A second way is to think about how hard you had to work to earn the money to pay for the vacation. You can then decide if the psychological benefits of the vacation were worth the psychological cost of working.

Question 34

You were planning to spend Saturday working at your part-time job, but a friend asks you to go skiing. What is the true cost of going skiing? Now suppose you had been planning to spend the day studying at the library. What is the cost of going skiing in this case?

Answer 34

If you are thinking of going skiing instead of working at your part-time job, the cost of skiing includes its monetary and time costs, which includes the opportunity cost of the wages you are giving up by not working. If the choice is between skiing and going to the library to study, then the cost of skiing is its monetary and time costs including the cost of possibly earning lower grades in your courses.

Question 35

You win $100 in a basketball pool. You have a choice between spending the money now or putting it away for a year in a bank account that pays 5 percent interest. What is the opportunity cost of spending the $100 now?

Answer 35

If you spend $100 now instead of saving it for a year and earning 5 percent interest, you are giving up the opportunity to spend $105 one year from now.

Question 36

The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction on competing products has reduced the expected sales of your new product to $3 million. If it would cost $1 million to finish development and make the product, should you go ahead and do so? What is the most that you should pay to complete development?

Answer 36

The fact that you have already sunk $5 million is not relevant to your decision anymore, because that money is gone. What matters now is the chance to earn profits at the margin. If you spend another $1 million and can generate sales of $3 million, you’ll earn $2 million in marginal profit, so you should do so. You are right to think that the project has lost a total of $3 million ($6 million in costs and only $3 million in revenue) and you should not have started it. However, if you do not spend the additional $1 million, you will not have any sales and your losses will be $5 million. So what matters here is trying to minimize your loss. In fact, you would pay up to $3 million to complete development; any more than that, and you will not be increasing profit at the margin.

Question 37

A 1996 Bill reforming the federal government’s antipoverty programs limited many welfare recipients to only two years of benefits. How does this change the affect the incentives for working?

Answer 37

When welfare recipients have their benefits cut off after two years, they have a greater incentive to find jobs than if their benefits were to last forever.

Question 38

A 1996 Bill reforming the federal government’s antipoverty programs limited many welfare recipients to only two years of benefits. How might this change represent a trade-off between equality and efficiency?

Answer 38

The loss of benefits means that someone who cannot find a job will get no income at all, so the distribution of income will become less equal. But the economy will be more efficient, because welfare recipients have a greater incentive to find jobs. Thus, the change in the law is one that increases efficiency but reduces equality.

Question 39

Your roommate is a better cook than you are, but you can clean more quickly than your roommate can. If your roommate did all the cooking and you did all the cleaning, would your chores take you more or less time than if you divided each task evenly? Give an example of how specialization and trade can make two countries both better off.

Answer 39

By specializing in each task, you and your roommate can finish the chores more quickly. If you divided each task equally, it would take you more time to cook than it would take your roommate, and it would take him more time to clean than it would take you. By specializing, you reduce the total time spent on chores. Similarly, countries can specialize and trade, making both better off. For example, suppose it takes Spanish workers less time to make clothes than it takes French workers, and French workers can make wine more efficiently than Spanish workers can. Then Spain and France can both benefit if Spanish workers produce all the clothes and French workers produce all the wine, and they engage in trade between the two goods.

Question 40

How is economics a science?

Answer 40

Economics is like a science because economists use the scientific method. They devise theories, collect data, and then analyze these data in an attempt to verify or refute their theories about how the world works. Economists use theory and observation like other scientists, but they are limited in their ability to run controlled experiments. Instead, they must rely on natural experiments.

Question 41

Why do economists make assumptions?

Answer 41

Economists make assumptions to simplify problems without substantially affecting the answer. Assumptions can make the world easier to understand.

Question 42

Should an economic model describe reality exactly?

Answer 42

An economic model cannot describe reality exactly because it would be too complicated to understand. A model is a simplification that allows the economist to see what is truly important.

Question 43

Use a production possibilities frontier to describe the idea of efficiency.

Answer 43

An outcome is efficient if the economy is getting all it can from the scarce resources it has available. In terms of the production possibilities frontier, an efficient point is a point on the frontier, such as point A in Figure 4. When the economy is using its resources efficiently, it cannot increase the production of one good without reducing the production of the other. A point inside the frontier, such as point B, is inefficient since more of one good could be produced without reducing the production of another good.

Question 44

Imagine a society that produces military goods and consumer goods, which we’ll call “guns” and “butter”. Draw a production possibilities frontier for guns and butter. Using the concept of opportunity cost, explain why it most likely has a bowed shape.

Answer 44

Figure 6 shows a production possibilities frontier between guns and butter. It is bowed out because the opportunity cost of butter depends on how much butter and how many guns the economy is producing. When the economy is producing a lot of butter, workers and machines best suited to making guns are being used to make butter, so each unit of guns given up yields a small increase in the production of butter. Thus, the frontier is steep and the opportunity cost of producing butter is high. When the economy is producing a lot of guns, workers and machines best suited to making butter are being used to make guns, so each unit of guns given up yields a large increase in the production of butter. Thus, the frontier is very flat and the opportunity cost of producing butter is low.

Question 45

Imagine a society that produces military goods and consumer goods, which we’ll call “guns” and “butter”. Show a point that is impossible for the economy to achive. Show a point that is feasible but inefficient.

Answer 45

Point A is impossible for the economy to achieve; it is outside the production possibilities frontier. Point B is feasible but inefficient because it is inside the production possibilities frontier.

Question 46

Imagine a society that produces military goods and consumer goods, which we’ll call “guns” and “butter”. Imagine that the society has two political parties, called the Hawks (who want a strong military) and the Doves (who want a smaller military). Show a point on your production possibliities frontier that the Hawks might choose and a point that the Doves might choose.

Answer 46

The Hawks might choose a point like H, with many guns and not much butter. The Doves might choose a point like D, with a lot of butter and few guns.

Question 47

Imagine a society that produces military goods and consumer goods, which we’ll call “guns” and “butter”. Imagine that an aggressive neighboring country reduces the size of its military. As a result, both the Hawks and the Doves reduce their desired production of guns by the same amount. Which party would get the bigger peace dividend, measured by the increase in butter production.

Answer 47

If both Hawks and Doves reduced their desired quantity of guns by the same amount, the Hawks would get a bigger peace dividend because the production possibilities frontier is much flatter at point H than at point D. As a result, the reduction of a given number of guns, starting at point H, leads to a much larger increase in the quantity of butter produced than when starting at point D.

Question 48

An economy consists of three workers: Larry, Moe, and Curly. Each works ten hours a day and can produce two services: mowing lawns and washing cars. In an hour, Larry can either mow one lawn or wash one car; Moe can eiher mow one lawn or wash one car; Moe can either mow one lawn or wash two cars; and Curly can either mow two lawns or wash one car. Calculate how much of each service is produced under the following circumstances which we label A, B, C, and D. All three spend all their time mowing laws (A)

Answer 48

A: 40 lawns mowed; 0 washed cars

Question 49

An economy consists of three workers: Larry, Moe, and Curly. Each works ten hours a day and can produce two services: mowing lawns and washing cars. In an hour, Larry can either mow one lawn or wash one car; Moe can eiher mow one lawn or wash one car; Moe can either mow one lawn or wash two cars; and Curly can either mow two lawns or wash one car. Calculate how much of each service is produced under the following circumstances which we label A, B, C, and D.All three spend all their time washing cars (B)

Answer 49

B: 0 lawns mowed, 40 washed cars

Question 50

An economy consists of three workers: Larry, Moe, and Curly. Each works ten hours a day and can produce two services: mowing lawns and washing cars. In an hour, Larry can either mow one lawn or wash one car; Moe can eiher mow one lawn or wash one car; Moe can either mow one lawn or wash two cars; and Curly can either mow two lawns or wash one car. Calculate how much of each service is produced under the following circumstances which we label A, B, C, and D.All three spend half their time on each activity

Answer 50

C: 20 lawns mowed; 20 washed cars

Question 51

An economy consists of three workers: Larry, Moe, and Curly. Each works ten hours a day and can produce two services: mowing lawns and washing cars. In an hour, Larry can either mow one lawn or wash one car; Moe can eiher mow one lawn or wash one car; Moe can either mow one lawn or wash two cars; and Curly can either mow two lawns or wash one car. Calculate how much of each service is produced under the following circumstances which we label A, B, C, and D. Larry spends half his time on each activity while Moe only washes cars and Curly only mows lawns (D)

Answer 51

D: 25 lawns mowed; 25 washed cars

Question 52

An economy consists of three workers: Larry, Moe, and Curly. Each works ten hours a day and can produce two services: mowing lawns and washing cars. In an hour, Larry can either mow one lawn or wash one car; Moe can eiher mow one lawn or wash one car; Moe can either mow one lawn or wash two cars; and Curly can either mow two lawns or wash one car. Calculate how much of each service is produced under the following circumstances which we label A, B, C, and D.Graph the production possiblilites frontier for this economy. Using your answers to part (a), identify points A, B, C, and D on your graph.

Answer 52

The production possibilities frontier is shown in Figure 8. Points A, B, and D are on the frontier, while point C is inside the frontier.

Question 53

An economy consists of three workers: Larry, Moe, and Curly. Each works ten hours a day and can produce two services: mowing lawns and washing cars. In an hour, Larry can either mow one lawn or wash one car; Moe can eiher mow one lawn or wash one car; Moe can either mow one lawn or wash two cars; and Curly can either mow two lawns or wash one car. Explain why the production possibilities frontier has the shape it does.

Answer 53

Larry is equally productive at both tasks. Moe is more productive at washing cars, while Curly is more productive at mowing lawns.

Question 54

An economy consists of three workers: Larry, Moe, and Curly. Each works ten hours a day and can produce two services: mowing lawns and washing cars. In an hour, Larry can either mow one lawn or wash one car; Moe can eiher mow one lawn or wash one car; Moe can either mow one lawn or wash two cars; and Curly can either mow two lawns or wash one car. Are any of the allocations calculated inefficient?

Answer 54

Allocation C is inefficient. More washed cars and mowed lawns can be produced by simply reallocating the time of the three individuals.