Economics Chapter 2
It is possible for the outcomes in a market system to be different from what firms and consumers intended them to be because
neither firms nor consumers are directly interested in increasing economic efficiency or the standard of living of the average person.
Firms are likely to produce more of a good or service when its price _________ and less of a good or service when its price __________
rises; falls
A production possibilities frontier:
shows the maximum attainable combinations of two goods that may be produced with available resources.
The principle of increasing marginal opportunity cost states that the more resources devoted to any activity, the __________ the payoff to devoting additional resources to that activity.
smaller
An entrepreneur is
someone who operates, bringing together the factors of production—labor, capital, and natural resources—to produce goods and services.
The production possibilities frontier will shift outward
If resources are used to produce capital goods
With respect to consumption, individuals and countries
can, through trade, consume beyond their production possibilities frontiers.
A psychic reward is best defined as
a nonmonetary form of remuneration that lifts one's spirit.
In what ways does a free market economy differ from a centrally planned economy? Unlike a free market economy,
centrally planned economies have extensive government controls.
What is the basis for trade?
comparative advantage
What role do private property rights play in the working of a market system? Private property rights:
encourage a significant number of people to be willing to risk funds by investing them in business. & encourage firms to spend money on research and development.
what is the outcome of enforcing contracts and property rights in a market system?
increased economic activity
On the diagram to the right, movement along the curve from points A to B to C illustrates
increasing marginal opportunity cost
Whether carried out by an individual or a country, production beyond the production possibilities frontier
is not physically possible.
Using the same amount of resources, suppose that Nicaragua can produce twice as much wheat as Colombia. Nevertheless, Colombia could still have the comparative advantage in producing wheat if
it is even less efficient than Nicaragua in the production of goods other than wheat
Refer to the graph. What is the opportunity cost of moving from point B to point C?
20 sedans
Which participants are of greatest importance in determining what goods and services are produced?
Households
How can a country gain from specialization and trade?
A country can specialize in producing that for which it has a comparative advantage and then trade for other needed goods and services.
What is a free market?
A free market is one where the government does not control the production of goods and services.
Which of the following events would create economic growth, that is, shift the production possibilities frontier outward?
An increase in technology that affects the production of both goods. & An increase in the available labor. & An increase in the available natural resources.
Who has comparative advantage in producing lumberjack boots ?
Canada
What do economists mean by scarcity?
Economists mean that unlimited wants exceed limited resources.
What is an entrepreneur?
Entrepreneurs operate businesses that produce goods and services.
In the 1950s, the economist Bela Balassa compared 28 manufacturing industries in the United States and Britain. In every one of the 28 industries, Balassa found that the United States had an absolute advantage In these circumstances, would there have been any gain to the United States from importing any of these products from Britain?
Even with an absolute advantage, the United States would have benefited from importing those products for which Britain had a comparative advantage.
If you and your neighbor both grow oranges and grapefruits and you are better than your neighbor at picking both oranges and grapefruits, there can be no advantage to you in specializing in growing only one type of fruit and trading with your neighbor for the other.
False
Writing in the New York Times, Michael Lewis argued that "...a market economy is premised on a system of incentives designed to encourage an ignoble human trait: self-interest." What incentives does a market system provide to encourage self-interest?
Financial reward.
What are the two main categories of participants in markets?
Firms and households.
According to Adam Smith, which of the following is necessary for the proper functioning of the market system?
For markets to work, people must be free to pursue their self-interest.
What does increasing marginal opportunity costs mean?
Increasing the production of a good requires larger and larger decreases in the production of another good.
At which point is the country's future growth rate likely to be the highest? Briefly explain why.
Point A because it is where the most resources are used to produce capital goods
Which point(s) are inefficient? Briefly explain why.
Point D because production there is not using all its available resources
Which point(s) are unattainable? Briefly explain why.
Point E because it is outside the production possibilities frontier
Which point(s) are efficient? Briefly explain why.
Points A, B, and C because this is where maximum output is produced with available resources.
Who has comparative advantage in producing lumberjack shirts ?
The United States
What is comparative advantage?
The ability to produce a good at a lower opportunity cost than another producer
What is absolute advantage?
The ability to produce more of a good or service than competitors using the same amount of resources.
What happens if a country produces a combination of goods that efficiently uses all of the resources available in the economy?
The country is operating on its production possibilities frontier.
What are the implications of this idea for the shape of the production possibilities frontier?
The production possibilities frontier will be bowed outward.
Suppose we can divide all the goods produced by an economy into two types: consumption goods and capital goods. Capital goods, such as machinery, equipment, and computers, are goods used to produce other goods. Is it likely that the ppf would be a straight line or a bowed out line
The production possibilities frontier would likely be bowed out because not all resources are equally well suited to produce both consumption and capital goods.
Suppose the president is attempting to decide whether the federal government should spend more on research to find a cure for heart disease. What is the opportunity cost of spending more money to find a cure for heart disease?
The reduction in funding for research to cure other diseases.
Why do entrepreneurs play a key role in a market system?
They bring together factors of production.
What is the circular-flow diagram and what does it illustrate?
The circular-flow diagram shows how households and firms are linked through product and factor markets.
During the 1928 presidential election campaign, Herbert Hoover, the Republican candidate, argued that the United States should only import those products that could not be produced here. Do you believe that this would be a good policy? Explain.
This is not a good policy because it does not necessarily result in countries producing those goods for which they have a comparative advantage.
Evaluate the following argument: "Adam Smith's analysis is based on a fundamental flaw: He assumes that people are motivated by self-interest. But this isn't true. I'm not selfish, and most people I know aren't selfish."
This statement is based on the misconception that following your self-interest and being selfish are the same thing.
The basis for trade is comparative advantage, not absolute advantage.
True
The primary difference between absolute and comparative advantage is
absolute advantage refers to the ability to produce more of a good or service using the same amount of resources and comparative advantage refers to the ability to produce a good or service at a lower opportunity cost.
If a market system functions well, which of the following is necessary for the enforcement of contracts and property rights?
an independent court system
intellectual property includes:
anything created by the mind of a person
In a simple circular-flow model, there are flows of _________ and flows of _________.
factors of production; goods and services & funds received from the sale of factors of production; spending on final goods and services
A free market is a market with ________ government restrictions on how a good or service can be produced or sold and with ________ government restrictions on how a factor of production can be employed.
few; few
If a country has a comparative advantage in the production of a good, then that country
has a lower opportunity cost in the production of that good.
Which of the following are the two key groups of participants in the circular flow of income
households and firms
According to Adam Smith, which of the following is the instrument the invisible hand uses to direct economic activity?
prices
Absolute advantage is 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.
In colonial America, the population was spread thinly over a large area, and transportation costs were very high because it was difficult to ship products by road for more than short distances. As a result, most of the free population lived on small farms where they not only grew their own food but also usually made their own clothes and very rarely bought or sold anything for money. Why were the incomes of these farmers likely to rise as transportation costs fell? As transportation costs fell
the farmers gained access to new markets and customers. Using comparative advantage, the farmers specialized, producing those goods for which they had lower opportunity cost. As they traded for other goods, their incomes and living standards increased.
This idea is an important intellectual contribution because
the interaction of firms and consumers in markets produces outcomes that are economically efficient and that promote the economic growth that results in rising living standards.
What are private property rights? Private property rights are:
the rights individuals and firms have to the exclusive use of tangible, physical property and intellectual property.
Property rights are
the rights individuals or firms have to the exclusive use of their property, including the right to buy or sell it.
Why are independent courts important for a well-functioning economy? Independence is necessary for courts:
to make their decisions based on the law. & to make their decisions free of influence from other parts of the government. & to make their decisions free of intimidation by criminal gangs. & to make their decisions free of influence from people with powerful political connections.
What is the role of an entrepreneur?
to operate a business that produces a good or service, take risks, and bring together factors of production
In addition to making cars, Tesla planned to open a new factory in Nevada in 2016 to make batteries, including home storage battery packs. The opportunity cost of Tesla's investment in a new battery factory in Nevada is
what the company considered to be the best foregone option to the factory.
How should policymakers determine the amount of money that should be allocated for research curing heart disease? They should base their decision on
whether the last dollar devoted to research on heart disease results in more benefit than the last dollar spent on research for curing other diseases.
Is it possible for a country to have a comparative advantage in producing a good without also having an absolute advantage? A country without an absolute advantage in producing a good
will have a comparative advantage if it has a lower opportunity cost of producing that good.
We can show economic inefficiency:
with points inside the production possibilities frontier
We can show economic efficiency:
with points on the production possibilities frontier.