ECON 2302: CH. 1 Study Guide

How does money make the circular flow model more efficient?

Having a common medium of exchange, like money, eliminates the need to barter. Since buyers and sellers both want money, they are happy to use it as a medium of exchange in transactions.

Because resources are scarce, all choices involve trade-offs, which means nothing is free.

True Because time, energy, and other resources are scarce, no matter what choices people make, they are always giving up one thing to obtain another. Because all options have opportunity costs, nothing is free.

Which description best captures the idea of marginal thinking?

evaluating the cost and benefit of one more unit of something Considering "one more unit" means choosing between two outcomes that differ by only one unit's worth of production or consumption.

In a _____-based economy, transactions require that each party have something the other desires. _____ increases market _____ by serving as a common commodity everyone wants. Now a transaction requires only that the _____ have something the _____ desires and that the buyer have enough money to pay the seller's asking price.

trade, money, efficiency, seller, buyer

Which of the following statements best captures the core economic concept of "incentives"?

"If you don't clean your room, you can't go out to the movies on Friday night." This threat, presumably by a parent to their child, provides a negative incentive for the child to clean his or her room.

Label each incentive as positive or negative. I. An electronics store employee earns a commission on each smartphone she sells. II. A boy faces a time out if he does not clean his room. III. In a class, everyone's starting grade is a 0, and students earn points for answering questions correctly. IV. A city will fine a homeowner if the lawn around the house is overgrown.

I. positive For each smartphone the employee sells, she is given a percentage of the sale. II. negative In order to avoid punishment, the boy must complete the task. III. positive Students are rewarded for correct answers rather than penalized for wrong answers. IV. negative To avoid the fine, the homeowner must mow the lawn regularly. Many economic relationships involve a mix of positive and negative incentives.

Which of the items listed fit the definition of a market?

Market: ~ eBay ~ a shopping mall ~ a swap meet Not a Market: ~ a hair salon A hair salon is run by a single seller who is competing with other sellers of the same service. ~ a restaurant A restaurant is a single seller who participates in a much broader service that provides options when eating out. A market is a venue where multiple sellers and multiple buyers meet to exchange goods or services.

Another word for _____ incentives is "rewards." Generally, these become more effective when coupled with _____ incentives. For example, a _____ grade in a class means more when it is possible to get a _____ grade.

positive, negative, passing, failing It is probably also true, of course, that negative incentives are more effective when coupled with positive ones.

The slogan "Information wants to be free" is sometimes used to justify unrestricted _____ of copyrighted materials, such as music. The _____ this practice is that depriving musicians of revenue from the sale of their work _____ an incentive for them to record new music, which may result in _____ recorded music being created.

sharing, problem with, removes, less

Vicky Torres and Juanita Alva were the first in line at Best Buy during a Black Friday sale so that they could secure a large-screen TV, which was normally $499 and was advertised on sale at $199. Because they arrived three weeks early, they ended up waiting in line for a total of 500 hours! The authors of your textbook found their choice puzzling because of the high opportunity cost in this scenario. The authors say: "Saving $300 by spending 500 hours makes Vicky and Juanita's time worth 60 cents an hour. They could have spent 30 hours working an extra job at $10 an hour and each earned enough money to purchase the TV at full price—and still had 470 hours to do other things. In short, they don't seem to have been aware of the opportunity cost of waiting in line." But this is not the only conclusion one can draw from Vicky and Juanita's behavior. Select the conclusion below that would be consistent with the idea that Vicky and Juanita were aware of the opportunity costs yet still found the three-week-wait to be worthwhile.

"However, they might have enjoyed the experience of camping out in line, meeting other customers, and gaining a degree of fame for their commitment to 'getting a good deal.'" Opportunity costs are nonmonetary costs that must be considered when analyzing a consumer's economic choices. But nonmonetary benefits must also be considered.

Calvin and Hobbes run a company that sells only two items: T-shirts and car decals. Calvin is fast at making decals and very slow at making T-shirts, whereas Hobbes is fast at making T-shirts and very slow at making decals. Which statements accurately describe the situation?

Accurately Describes the Situation: ~ Company output will be maximized if Calvin makes all the decals and Hobbes makes all the T-shirts. Each partner should focus on the task where he has a comparative advantage. ~ Calvin has a comparative advantage for making decals. If someone has a comparative advantage in producing something, that means he also has a lower opportunity cost in producing that object. ~ Hobbes has a higher opportunity cost for making decals than Calvin. If Hobbes has a higher opportunity cost for making decals, then Calvin has a lower opportunity cost for making decals. Does Not Accurately Describe the Situation: ~ Company output will be maximized if Calvin and Hobbes divide their time equally between making decals and making T-shirts. This is not true. In general, people should specialize in the activity where they have a competitive advantage. Production tends to be increased when people specialize in the tasks where they have a comparative advantage.

Alicia and Christine are doctors at a hospital and can each perform two tasks: open-heart surgery and liver transplants. Alicia is more efficient than Christine at both of these two tasks, but Alicia has a lower opportunity cost in performing liver transplants. Identify the actions that lead to the hospital seeing more patients.

Action That Leads to Seeing More Patients: ~ Alicia spends most of her time doing liver transplants. Because Alicia has a lower opportunity cost for performing liver transplants, she will be able to see more patients than if her time were allocated to heart surgeries. ~ Christine spends most of her time doing heart surgeries. Performing heart surgery is Christine's comparative advantage, so she can see more patients by focusing on heart surgery. Not an Action That Leads to Seeing More Patients: ~ Christine and Alicia get equal time doing heart surgery and equal time doing liver transplants. If each doctor focused on her comparative advantage, the total number of patients would increase. ~ Christine spends most of her time doing liver transplants. Alicia has a lower opportunity cost in performing liver transplants. ~ Because Alicia is more efficient at both types of surgery, the hospital has Christine do administrative tasks. Just because Alicia can do each task more efficiently does not mean that the hospital would see more patients if Alicia were the only doctor. This question illustrates the point that even if someone is better at everything, production can be increased through specialization.

Arshad is trying to choose his college major. His options are business administration, economics, English, and mathematics. He is leaning towards choosing mathematics because he enjoys those classes, but is also concerned about what his lifetime income would be after graduating. Of the majors he is considering, click on the bar on the graph that represents Arshad's opportunity cost of choosing to major in mathematics.

Click on bars labeled "Economics" Economics represents the highest valued alternative that Arshad would be forgoing if he chooses mathematics. Economics represents the highest valued alternative Arshad would be forgoing if he chooses mathematics.

Which items are consequences of globalized trade for a developed nation that begins to import more goods and services from less-developed countries?

Consequence of Globalized Trade: ~ lower labor costs Globalization makes it easier for firms to use labor in countries where workers' wages are low. ~ lower prices for consumers By lowering production costs, globalization lowers the costs that are passed on to consumers. Not a Consequence of Globalized Trade: ~ lower unemployment Although international trade creates jobs in countries where labor is cheap, it tends to eliminate jobs in countries where labor is more expensive. ~ lower economic growth Globalized trade is generally an engine of economic growth for all countries involved.

Direct incentives are designed to induce changes in behavior. Indirect incentives change behavior in ways that were not intended. Identify each item as an example of a direct or an indirect incentive.

Direct Incentive: ~ car alarms to discourage break-ins An alarm gives a would-be car burglar a strong reason to flee the scene immediately. ~ frequent-flier points to increase customer loyalty Points programs are intended to explicitly encourage people to fly more with a particular airline. Indirect Incentive: ~ government-funded debt relief for college graduates leads to more student-loan debt The intent of the programs is to make struggling graduates' lives easier, but an unintended consequence is to encourage students to take on more debt with an expectation of later debt relief. ~ raising corporate income tax rates leads to fewer new businesses The intent of high corporate income tax rates is to increase government revenue, but an unintended consequence is to make the prospect of starting or growing a business less attractive.

Increasing trade between two countries makes everyone in those countries better off.

False Individual firms and workers in some places may find themselves worse off due to increased competition. However, the overall world economy is better off when trade between countries increases because specialization and the gains from voluntary trade make the parties engaged in the exchange better off.

Which items are among the five foundations of economics?

Foundation of Economics: ~ marginal thinking Marginal thinking is about small increases and decreases in benefits and costs. ~ opportunity cost The opportunity cost of an action is the alternative action one is choosing to forgo. ~ the principle that trade creates value In a voluntary transaction, both sides profit or are made no worse off. Not a Foundation of Economics: ~ conditions of scarcity Conditions of scarcity set up the problems that the five foundations provide solutions for. ~ the universal desire for money Money, though important, is not one of the five foundations of economics.

Place the events in order to describe the unintended consequences of a government-created incentive.

I. A certain area has a problem with cobras, which are poisonous. II. The government announces a rewards for every captured cobra turned in. III. People begin breeding cobras to turn in, which is easier than hunting them. IV. Some bred cobras escape. V. The area has more free cobras on the loose than before. There are real-world cases like this, where government attempts at incentive-based pest control have made the pest problem worse.

Pharmaceutical companies are perceived as profiting unfairly from drugs they sell. A new law shortens the time during which the manufacturer has exclusive use of the drug formula. Place the events in sequence to illustrate how restricting profits by pharmaceutical companies affects innovation.

I. Pharmaceutical companies reduce their estimate of the profitability of new drug research. II. Pharmaceutical companies are less willing to invest in drug development. III. Fewer new drugs are brought to market. The slowed pace in the development of new drugs would be an unintended, but not surprising, consequence of limiting the incentive for drug companies to bring new drugs to market.

Label each statement as either a direct or an indirect incentive. A label may be used more than once. I. A college administration decides students who do not wear a face mask on campus will be expelled and will not receive a refund of their college tuition. II. A college administration decides to award all students with A's during the COVID lockdown. III. During the Great Recession, Congress authorized the extension of unemployment benefits beyond 26 weeks, which led to an increase in the average length of time a person remained unemployed. IV. Students who prefer not to wear a face mask do not sign up for face-to face-classes, and those classes are canceled.

I. direct This is an example of a direct negative incentive, or a disincentive. II. indirect This situation creates a disincentive to study course material, and students will not be motivated to learn. III. indirect Policymakers have a tough decision trying to determine how to balance conflicting incentives when faced with an economic downturn. In the 2020 COVID-induced recession, extended unemployment benefits were correlated with approximately a 7% increase in average unemployment duration. IV. indirect Indirect incentives may create unintended consequences. All these incentives share a commonality: they give people reasons to act or not to act. Policymakers must carefully balance these competing effects.

Match each term to its correct definition. I. the study of how individuals and societies allocate their limited resources to satisfy their practically unlimited wants II. the study of the individual units that make up the economy III. the study of dollars and cents IV. the study of individual cases that illustrate general economic laws V. the study of the overall aspects and workings of an economy

I. economics Individuals and countries must both deal with scarcity when making decisions. II. microeconomics Remember: "micro" deals with individual firms and individual consumers, whereas "macro" deals with geographic areas like cities, states, regions, or countries. III. LEAVE BLANK IV. microeconomics Economists often look at individual cases, and this is a defining feature of the field. V. macroeconomics Remember: "micro" deals with individual firms and individual consumers, whereas "macro" deals with geographic areas like cities, states, regions, or countries.

Place the appropriate label to classify each scenario as either microeconomic or macroeconomic. I. A laid-off worker enrolls in job retraining. II. Nationwide, new housing construction declines for the third month in a row. III. The inflation rate rises. IV. A team of three partners starts a new ad agency.

I. microeconomic Even if the job-retraining program is sponsored by the federal government, the circumstances of a single worker are a microeconomic situation. II. macroeconomic Statistics tracking home-building activity at a national level are macroeconomic statistics. III. macroeconomic Inflation is a national (macro) phenomenon. IV. microeconomic Even though more than one person is involved, this is a localized situation, and a single ad agency is in many ways a single economic unit. This is microeconomic activity. Microeconomics is about what happens on a small scale. Macroeconomics is about what happens on a large scale.

Adam prefers activities and goods in the following descending order: I. hanging out with friends II. having milkshakes with his mom III. playing video games IV. eating fried chicken Adam's mom has several chores she wants him to finish. Place the incentives in order, from most effective to least effective, that will encourage Adam to finish his chores.

I. not letting Adam leave home or have visitors until he finishes his chores This is a negative incentive. It's the strongest incentive Adam faces, because he enjoys hanging out with friends the most. II. promising to go with Adam to get milkshakes when he finishes the chores This is a positive incentive. Having milkshakes with his mom is Adam's second-most preferred activity. III. taking away Adam's video games until he finishes his chores This is a negative incentive. This is Adam's third-favorite activity, and therefore the third-most effective incentive. IV. promising Adam a fried chicken dinner after he gets done with his chores This is a positive incentive. Note that the effectiveness of an incentive is not determined by whether it is positive or negative.

Looking to invest in his first pair of dress shoes, Sean is deciding between a pair of slip-on shoes and a pair of traditional lace-up wingtips. In this case, the slip-ons cost $50 more than the wingtips. Which of the following should be included in the opportunity cost of buying the slip-ons?

Included in the Opportunity Cost: ~ the classic look of traditional wingtips Buying the slip-ons means forgoing the more traditional wingtip look. ~ the savings that would come from buying the wingtips Buying the slip-ons would mean not having an extra $50. Not Included in the Opportunity Cost: ~ the no-lace convenience of slip-ons Because Sean would have that convenience, it is not part of the cost he would pay. ~ the money that would be spent to buy the wingtips Because that money will be spent either way, it is not part of the opportunity cost. ~ the pride that comes with wearing the more expensive shoes Because buying the slip-ons would allow Sean to enjoy that pride, it is not part of the cost he would pay.

Place each label in its correct location in the diagram of the circular flow model, where the arrows represent the movement of goods and services.

Left peach circle: households Middle light blue rectangle: resource market Right peach circle: firms

In a 1953 speech, President Dwight Eisenhower listed some things that cost about as much as "one modern heavy-duty bomber": a modern urban school, a couple of power plants or hospitals, or 50 miles of highway. What points was he trying to make?

Point Made by Eisenhower: ~ The U.S. government has only so much money. Eisenhower's point would not have applied if the government always had unlimited funding. ~Using scarce resources involves trade-offs. The choice to build more bombers, Eisenhower was saying, was also a choice to build less infrastructure. Not a Point Made by Eisenhower: ~ Military spending is a poor use of money. As a former general, Eisenhower understood the need for a strong military. ~ A bomber is worth more than a power plant or hospital. Eisenhower's central point was not about what is more valuable or less valuable.

Which of the following explanations accurately describes why there are so many more dashboard cameras in Russia than in the United States?

Traffic fatalities are far more prevalent in Russia, and the cameras are a way for drivers to prove when they are not at fault for an accident. An example of the relative riskiness of driving in Russia can be seen in the starkly different number of traffic fatalities. There are 53.4 annual deaths per 100,000 vehicles in Russia and 12.9 annual deaths per 100,000 vehicles in the United States. This gives drivers a strong incentive to install dashboard cameras.

Which of the following is true of economically beneficial specialization?

True of Economically Beneficial Specialization: ~ Each worker does whatever involves the lowest opportunity cost, compared with other tasks. Specialization is based on comparative advantage. ~ Workers engage in the task which they are best at, compared to the other tasks they could do. This relates to comparative advantage, which is the basis of specialization. Not True of Economically Beneficial Specialization: ~ Workers do whatever gives them more comparative advantages. Comparative advantage is not a matter of having more or less. For a given task, a worker either has, or does not have, a comparative advantage over another worker. ~ Workers who are better than everyone else at a particular task engage in that task. This relates to absolute advantage, which is not the key to specialization. When specialization is combined with voluntary trade, one or more of the parties engaging in the exchange is made better off, and no one is made worse off. Usually, everyone engaging in voluntary exchange is made better off.

Which of the following items describe ways of classifying incentives according to their different types, from an economist's point of view?

Way of Classifying Incentives: ~ direct Direct incentives have an immediate, easily predicted connection to an action. ~ indirect Indirect incentives may create unintended consequences not originally intended. However, even unintended consequences function as incentives. ~ positive A positive incentive is in effect a reward for doing something. ~ negative A negative incentive is, in one form or another, a punishment for doing something and thereby a motive not to do it. Not a Way of Classifying Incentives: ~ irrational An incentive is by definition something that is reasonable or rational to take into account. There is no such thing as an irrational incentive. ~ secret A secret incentive would not induce a change in behavior, so such incentives would not make sense.

Eleanor works at a department store and is paid by the hour. She can work as many hours as she wants each week. When not at work, Eleanor likes to spend her time reading. The store recently increased her hourly wage. The increased hourly wage acts as _____ to work _____ hours. The wage increase causes the opportunity cost of reading to _____.

a direct incentive, more, increase By raising the value of Eleanor's work (giving her a raise), the employer indirectly changes her cost of reading.

Iowa has a _____ in producing corn. We would expect Texas to produce _____ and trade it for _____. If these states do not trade, cotton and corn production will be _____ than if the states did trade.

comparative advantage, cotton, corn, lower Specialization plus trade will maximize production of both corn and cotton.

The coach is weighing a(n) _____ risk of losing the game against a decreased risk of injury to the star quarterback. Weighing the _____ of such a decision is an example of _____.

increased, opportunity cost, trade-offs Economics can be found everywhere, even in the decision-making of football coaches.

Caroline has several options for how to spend her Saturday night, listed in order of descending preference: I. Go to a folk music concert with a friend. II. Get dinner with several of her sorority sisters. III. Go shopping with her mom. Caroline can do only one activity. Match each activity (on the left) with its opportunity cost (on the right).

miss sorority dinner: folk music concert Dinner is the second-best option, which means that it is the best available alternative to the concert. miss concert: dinner with sorority sisters, shopping with mom Dinner is the second-most-preferred option, which means that the opportunity cost of performing this activity is the preferred option—that is, the concert. The opportunity cost is the value of the best alternative. So even though Caroline is always choosing not to do two of the three activities, the opportunity cost is represented by only one of those two alternatives, namely the highest-valued one.

Even though _____ are almost always limited, whereas on the other hand, _____ are practically unlimited. We describe this situation by saying that a condition of _____ exists, which forces us to _____.

resources, our wants and/or needs, scarcity, make choices Some resources can seem unlimited, but even water and clean air can be in short supply in a crowded urban area. Even those who have more than almost everyone else usually want "just a little more" of something. In the economic sense, almost all resources are "scarce" because consumers collectively want to consume more than is readily available. To allocate something means to decide who gets it.