PE Chapter 1+2+3 Review Flashcards
Problem set 1
The opportunity cost of going to college is
a. The total spent on food, clothing, books, transportation, tution, lodging and other expenses
b. The value of the best opportunity a student gives up to attend college
c. Zero for students who are fortunate enough to have all of their college expenses paid by someone else
d. Zero, since a college education will allow a student to earn a larger income after graduation
b. The value of the best opportunity a student gives up to attend college
Opportunity cost refers to the value of the next best alternative that is forgone when making a decision. In the case of going to college, a student gives up the opportunity to work full-time or pursue other career paths that might generate income or experience
A person’s willingness to pay for a good is based on
a. The availability of the good
b. The marginal benefit that an extra unit of the good would provide for that person
c. The marginal cost of producing an extra unit of the good
d. Esoteric factors, the study of which lies beyond the boundaries of economics
b. The marginal benefit that an extra unit of the good would provide for that person
A person’s willingness to pay for a good is determined by the marginal benefit they receive from consuming an additional unit of that good. This concept is central to demand theory in economics.
a. Availability affects supply but not directly a person’s willingness to pay
c. The marginal cost of production influences the seller’s pricing but not the buyer’s willingness to pay
d. Esoteric factors (abstract or non economic considerations) are not a primary focus of economic decision making
The average cost per seat on the 50-passenger Floating On Air Bus company’s trip from Kansas City to St. Louis, on which no refreshments are served, is $45. In advance of a particular trip, three seats remained unsold. The bus company could increase its profit only if it
a. Charged any ticket price above $0 for the three remaining seats
b. Charged at least $15 for each of the three remaining seats
c. Charged at least $45 for each of the three remaining seats
d. Paid three people to occupy the three remaining seats
a. Charged any ticket price above $0 for the three remaining seats
This question is about sunk costs and marginal revenue. Since the bus company has already incurred the costs of running the trip, any additional revenue from selling the remaining seats -even at a price lower than the average cost per seat ($45) - would contribute to increasing total profit
b. Charging at least $15 is an arbitrary threshold. Even a price lower than $15 (but above $0) would still generate additional revenue
c. Requiring at least $45 per seat ignores the fact that filling empty seats at any price above zero still increases total revenue
d. Paying people to occupy seats would reduce profit instead of increasing it
An arbitrary threshold is a limit or requirement that is set without a strong or logical justification.
A construction company has built 50 houses so far this year at a total cost to the company of $8 million. If the company builds a 51st house as total cost will increase to $8.18 million. Which of the following statements is correct?
a. For the first 50 houses, the average cost per house was $160,000
b. The marginal cost of the 51st house, if it is built, will be $180,000
c. If the company can experience a marginal benefit of $190,000 building 51st house, then the company should build it
d. All of the above are correct
d. All of the above are correct
c. The company should build the 51st house if the marginal benefit (MB) exceeds the marginal cost (MC). Given that MB = $190,000 and MC = $180,000, then company gians $10,000 in profit, so it should build the house
In an economy in which decisions are guided by prices and individual self-interest, there is
a. The potential to achieve efficiency in production
b. A strong need for government intervention in the market
c. Less efficiency than would be observed in a centrally-planned economy
d. More need for a strong legal system to control individual greed than would be needed in a centrally-planned economy
a. The potential to achieve efficiency in production
An economy where decisions are guided by prices and individual self-interest is a market economy (or free market system). In such an economy:
- Efficiency is achieved because firms and individuals respond to prices, supply and demand, which allocate resources optimally
Market economies promote efficiency in production by allowing prices and competition to drive resource allocation
A company that formely produced software went out of business because too many potential consumers bought illegally-produced copies of the software instead of buying the product directly from the company. This instance serves as an example of?
a. Market power
b. Market failure
c. Inadequate enforcement of property rights
d. The invisible hand at work
c. Inadequate enforcement of property rights
Property rights refer to the legal ownership and protection of resources, including intellectual property like software. In this case:
* The company went out of business because many people bought illegal copies instead of buying for the original software
* This means that property rights (intellectual property laws) were not enforced effectively, leading to piracy and loss of revenue
a. Market power refers to a firm’s ability to control prices, but this situation is about piracy, not monopoly power
b. While piracy is an issue, market failure usually refers to situations like externalities or public goods, not just illegal activity
d. The invisible hand (Adam Smith’s concept) describes how free markets lead to efficient outcomes, but piracy disturbing a company is not an example of that
Market failure can be caused by
a. Low consumer demand
b. Government intervention and price controls
c. Externalities and market power
d. High prices and foreign competition
c. Externalities and market power
Market failure happens when the free market does not allocate resources efficiently, leading to wasted resources, inefficiency, or unfair outcomes. Two keys causes are:
1. Externalities- When a third party is affected by a transaction they are not directly involved in (pollution from a factory harms nearby residents, but the cost isn’t factored into the product price)
2. Market Power - When a firm has too much control over pricing and supply (monopolies charging excessively high prices, restricting competition)
a. This affects specific businesses but is not a fundamental cause of market failure. Markets naturally adjust through supply and demand
b. While excessive intervention can cause inefficiencies, some regulations is necessary to correct market failures (like pollution control or antitrust laws)
Suppose that the average income of a Kenyan is higher than the average income of a South African. You might conclude that
a. South African firms are faced with stricter government regulations than Kenyan firms
b. Total income is divided among fewer workers in Kenya since it has a smaller labor force than South Africa
c. Kenya’s climate allows for longer growing seasons and therefore Kenya can produce large quantities of grain and other crops
d. Productivity in Kenya is higher than in South Africa
d. Productivity in Kenya is higher than in South Africa
- Average income (GDP per capita) is closely linked to productivity. If the average Kenyan earns more than the average South African, it suggests that Kenyan workers are producing more value per worker than South African workers
- Higher productivity leads to higher wages and income levels because workers generatae more output per unit of input (labot, capital, resources)
a. Regulations might impact businesses, but they do not directly explain the difference in average income
b. Even if Kenya has a smaller labor force, that doesn’t necessarily mean higher average income per worker. Productivity matters more
c. Climate affects agriculture, but it doesn’t explain overall national income differences across industries
Which of the following is the most correct statement about the relationship between inflation and unemployment?
a. In the short run, falling inflation is associated with falling unemployment
b. In the short run, falling inflation is associated with rising unemployment
c. In the long run, falling inflation is associated with falling unemployment
d. In the long run, falling inflation is associated with rising unemployment
b. In the short run, falling inflation is associated with rising unemployment
This relationship is best explained by the Phillips Curve, which shows an inverse relationship between inflation and unemployment in the short run
- When inflation decreases (falling prices), businesses tend to slow down production, leading to higher unemployment
- When inflation increases, businesses may hire more workers to meet rising demand, reducing unemployment
However, in the long run, the Phillips Curve becomes vertical, meaning there is no trade-off between inflation and unemployment. This is why the other options are incorrect
A circular-flow diagram is a model that
a. Helps to explain how participants in the economy interact with one another
b. Helps to explain how the economy is organized
c. Incorporates the markets for the factors of production
d. All of the above are correct
d. All of the above are correct
The circular-flow diagram is a fundamental economic model that illustrates how money, goods, and services move through the economy. It includes:
- How participants (households, firms, and the government) interact in the economy
- The overall structure of the economy and the flow of resources, goods and income
- The markets for factors of production (land, labor, and capital) and how they connect households and firms
In a circular-flow diagram
a. Taxes flow from households to firms, and transfer payments flow from firms to households
b. Income payments flow from firms to households, and sales revenue flows from households to firms
c. Resources flow from firms to households, and goods and services flow from households to firms
d. Inputs and outputs flow in the same direction as the flow of dollars, from firms to households
b. Income payments flow from firms to households, and sales revenue flows from households to firms
The circular-flow diagram represents the flow of money and goods/services in an economy:
- Households provide labor and resources to firms
- Firms pay income (wages, rent, profits, etc.) to households in return
- Households then use this income to buy goods and services from firms, generating sales revenue for businesses
Production possibilities frontiers are usually bowed outward. This is because:
a. The more resources a society uses to produce one good, the fewer resources it has available to produce another good
b. It reflects the fact that the opportunity cost of producing a good decreases as more and more of that good is produced
c. Of the effects of technological change
d. Resources are specialized, that is, some are better at producing particicular goods rather than other goods
d. Resources are specialized, that is, some are better at producing particicular goods rather than other goods
The Production Possibilities Frontier (PPF) is usually bowed outward because:
- Resources are not equally efficient in producing all goods
- Some resources are better suited for producing one good than another
- As production shifts from one good to another, the opportunity cost increases because less efficient resources must be used
Without trade,
a. A country is better off because it will have to learn to be sell-sufficient without trade
b. A country’s production possibilities frontier is also its consumption possibilities frontier
c. A country can still benefit from international specilization
d. Interdependence is more extensive than it would be with trade
b. A country’s production possibilities frontier is also its consumption possibilities frontier
Without trade, a country can only consume what it produces. This means that its production possibilities frontier (PPF) - which shows the maximum goods it can produce - is also its consumption possibilities frontier (CPF) because it has no access to goods produced by other countries
a. A country is not necessarily better off without trade. Trade allows countries to specalize and consume beyond their PPF, leading to overall economic growth
c. International specialization requires trade. Without trade, a country cannot specialize and must produce everything it needs by itself
d. Interdependence decreases without trade. Countries become more self-reliant, meaning they do not depend on each other as much. With trade, interdependence increases
Which of the following statements is not correct?
a. Trade allows for specialization
b. Trade has the potential to benefit all nations
c. Trade allows nations to consume outside of their production possibilities curves
d. Absolute advantage is the driving force of specialization
d. Absolute advantage is the driving force of specialzation
Comparative advantage, not absolute advantage, drives specialization
* Comparative advantage occurs when a country can produce a good at a lower opportunity cost than another country. This encourages trade and specialization
* Absolute advantage means a country can produce a good more efficiently (using fewer resources), but that does not necessarily mean it should specialize in that good
a. Trade enables specialization, allowing countries to focus on producing goods where they have a comparative advantage
b. Trade benefits nations by allowing them to access goods more efficiently than if they produced everything themselves
c. Trade expands consumption possibilities beyond a country’s PPF by allowing it to import goods it would struggle to produce domestically
The difference between production possibilities frontiers that are bowed out and those that are straight is that
a. Bowed-out production possibilities frontiers apply to economies that face trade-offs, whereas straight-line production possibilities frontiers apply to economies that do not face tradeoffs
b. Bowed-out production possibilities frontiers apply to economies in which resources are not specialized, whereas straight-line production possibilities frontiers apply to economies in which resources are specialized
c. Bowed-out production possibilities frontiers illustrate increasing opportunity cost, whereas straight-line production possibilities frontiers illustrate constant opportunity cost
d. Straight-line production possibilities frontiers illustrate real-world conditions, whereas bowed-out production possibilities illustrate more simplistic assumptions.
c. Bowed-out production possibilities frontiers illustrate increasing opportunity cost, whereas straight-line production possibilities frontiers illustrate constant opportunity cost
- A bowed-out PPF occurs when resources are not easily adaptable between the two goods, leading to an increasing opportunity cost. This reflects the real-world scenario where some inputs (like labor and machinery) are better suited for one type of production than another.
- A straight-line PPF occurs when resources are perfectly adaptable between the two goods, meaning the opportunity cost remains constant. This is a simplified case, often used for theoretical purposed
A production possibilities frontier can shift outward if
a. Government increases the amount of money in the economy
b. There is a technological improvement
c. Resources are shifted from the production of one good to the production of the other good
d. The economy abandons inefficient production methods in favor of efficient production methods
b. There is a technological improvement
A production possibilities frontier (PPF) shifts outward when an economy’s ability to produce goods and services increases. This can happen due to:
- Technological advancements (better machinery, innovation, automation)
- Increased resources (more labor, capital, or natural resources)
- Improved productivity (better skills, education, or training)
a. Does not necessariy expand production. More money can lead to inflation but won’t directly shift the PPF
c. Only moves production along the PPF, it doesn’t shift outward
d. Can improve output but doesn’t necessarily expand the economy’s total production capacity
