Principles of Economics Chapter 2

Question 1

The Three Basic Questions

Answer 1

Every society has some system or process that transforms its scarce resources into useful goods and services. In doing so, it must decide what gets produced, how it is produced, and to whom it is distributed.

Question 2

primary resources

Answer 2

land, labor, and capital

Question 3

capital

Answer 3

Things that are produced and then used in the production of other goods and services.

Question 4

factors of production (or factors)

Answer 4

The inputs into the process of production. Another term for resources.

Question 5

production

Answer 5

The process that transforms scarce resources into useful goods and services.

Question 6

inputs or resources

Answer 6

Anything provided by nature or previous generations that can be used directly or indirectly to satisfy human wants.

Question 7

outputs

Answer 7

Goods and services of value to households.

Question 8

Scarcity and Choice in a One-Person Economy

Answer 8

Nearly all the same basic decisions that characterize complex economies must also be made in a simple economy.

Question 9

opportunity cost

Answer 9

The best alternative that we give up, or forgo, when we
make a choice or decision.

Question 10

theory of comparative advantage

Answer 10

Ricardo’s theory that specialization and free trade will benefit all trading parties, even those that may be “absolutely” more efficient producers.

Question 11

absolute advantage

Answer 11

A producer has an absolute advantage over another in the production of a good or service if he or she can produce that product using fewer resources (a lower absolute cost per unit).

Question 12

comparative advantage

Answer 12

A producer has a comparative advantage over another in the production of a good or service if he or she can produce that product at a lower opportunity cost.

Question 13

consumer goods

Answer 13

Goods produced for present consumption.

Question 14

investment

Answer 14

The process of using resources to produce new capital.

Question 15

production possibility frontier (ppf)

Answer 15

A graph that shows all the combinations of goods and services that can be produced if all of society’s resources are used efficiently.

Question 16

marginal rate of transformation (MRT)

Answer 16

The slope of the production possibility frontier (ppf).

Question 17

Unemployment

Answer 17

During economic downturns or recessions, industrial plants run at less than their total capacity. When there is unemployment of labor and capital, we are not producing all that we can.

Question 18

Inefficiency

Answer 18

Waste and mismanagement are the results of a firm operating below its potential.
Sometimes inefficiency results from mismanagement of the economy instead of mismanagement of individual private firms.

Question 19

To be efficient,

Answer 19

an economy must produce what people want.

Question 20

economic growth

Answer 20

An increase in the total output of an economy. Growth occurs when a society acquires new resources or when it learns to produce more using existing resources.

Question 21

command economy

Answer 21

An economy in which a central government either directly or indirectly sets output targets, incomes, and prices.

Question 22

laissez-faire economy

Answer 22

Literally from the French: “allow [them] to do.” An economy in which individual people and firms pursue their own self-interest without any central direction or regulation.
The behavior of buyers and sellers in a laissez-faire economy determines what gets produced, how it is produced, and who gets it.

Question 23

market

Answer 23

The institution through which buyers and sellers interact and engage in exchange.
Some markets are simple and others are complex, but they all involve buyers and sellers engaging in exchange.

Question 24

consumer sovereignty

Answer 24

The idea that consumers ultimately dictate what will be produced (or not produced) by choosing what to purchase (and what not to purchase).

Question 25

free enterprise

Answer 25

The freedom of individuals to start and operate private businesses in search of profits.

Question 26

Income

Answer 26

is the amount that a household earns each year. It comes in a number of forms: wages, salaries, interest, and the like.

Question 27

Wealth

Answer 27

is the amount that households have accumulated out of past income through saving or inheritance.

Question 28

Price Theory

Answer 28

In a free market system, the basic economic questions are answered without the help of a central government plan or directives. This is what the “free” in free market means—the system is left to operate on its own with no outside interference. Individuals pursuing their own self-interest will go into business and produce the products and services that people want. Other individuals will decide whether to acquire skills; whether to work; and whether to buy, sell, invest, or save the income that they earn. The basic coordinating mechanism is price.

Question 29

Mixed Systems, Markets, and Governments

Answer 29

The differences between command economies and laissez-faire economies in their pure forms are enormous. In fact, these pure forms do not exist in the world; all real systems are in some sense “mixed.”