Economics Test, Chapter 2

In a free market system, which of the following groups brings together the factors of production— labor, capital, and natural resources—in order to produce goods and services? a. the government b. entrepreneurs c. lobbyists d. politicians

B

Could a production possibilities frontier ever slope upward?

No, production possibilities frontiers will always slope downward. Resources used in production are scarce, and increasing production of one good will always require a decrease in the production of another good along a production possibilities frontier. This means that the production possibilities frontiers always have a negative slope, or they are downward sloping.

Comment briefly on the following statement: "The circular-flow diagram implies that households' spending on goods and services in product markets equals the income they earn from providing factors of production in factor markets."

This is true. In the circular-flow diagram, households' spending for the goods and services they purchase is linked to the income they earn from providing factors of production. For household members to earn income to buy the goods and services they want, they must first sell their resource services to firms who purchase these services in factor markets. The market value of factor services determines the income resource owners receive.

. 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. a. smaller b. greater c. proportional d. more instant

A

Absolute advantage is the ability of an individual, firm, or country to a. produce more of a good or service than competitors using the same amount of resources. b. produce a good or service at a lower opportunity cost than other producers. c. consume more goods or services than others at lower costs. d. reach a higher production possibilities frontier by lowering opportunity costs.

A

According to Adam Smith, which of the following is the instrument the invisible hand uses to direct economic activity? a. price b. government regulation c. financial markets d. cost

A

What happens if a country produces a combination of goods that uses all of the resources available in the economy? a. The country is operating on its production possibilities frontier. b. The country is maximizing its opportunity cost. c. The country has eliminated scarcity. d. All of the above occur if a country uses all available resources.

A

Generally speaking, for a market system to work, individuals must a. be very cautious in their approach to saving and investment. b. take risks and act in rational, self-interested ways. c. be able to evaluate and understand all available options. d. consult people who have experience

B

If a market system functions well, which of the following is necessary for the enforcement of contracts and property rights? a. powerful political connections b. an independent court system c. action by government to prevent the exercise of certain property rights d. all of the above

B

Provide an example showing that absolute advantage in an activity does not necessarily imply comparative advantage in an activity.

Consider the following example: Student One can read 10 pages of psychology per day or 8 pages of economics per day, while Student Two can read 5 pages of psychology per day or 5 pages of economics per day. Student One has an absolute advantage in reading both psychology and economics; however, Student One's cost of reading 1 page of economics is 1.25 pages of psychology, and Student Two's cost of reading 1 page of economics is only 1 page of psychology.

Does the story about Apple's production of the iPad on page 53 in the textbook imply that people must cooperate with one another in order for specialization in production and trade to occur? Explain.

Cooperation is essential for specialization and trade, but it is an impersonal cooperation. It is not necessary for business owners, workers, suppliers and consumers to know or see one another. In fact, many of these individuals can be located thousands of miles away from each other, live in different countries, and speak different languages. Their cooperation is due to their self-interest, not their regard for one another's welfare.

What is the role of an entrepreneur? a. to operate a business that produces a good or service b. to bring together the factors of production—labor, capital, and natural resources c. to take risks d. all of the above

D

Which of the following would create economic growth, that is, shift the production possibilities frontier outward? a. an increase in the available labor b. an increase in technology that affects the production of both goods c. an increase in the available natural resources d. all of the above

D

The circular-flow diagram is used to explain why the opportunity cost of increasing the production of one good is the decrease in production of another good.

False A production possibilities frontier, not the circular flow diagram, illustrates opportunity cost in production.

Without regulations to protect property rights, there will be more incentives for entrepreneurs to introduce new products.

False Property rights give entrepreneurs incentives to introduce new products.

In the explanation of Adam Smith's argument in favor of replacing the guild system with a market system, the textbook states that "a key to understanding Smith's argument is the assumption that individuals usually act in a rational, self-interested way." Did Smith believe that the success of a market system requires that people act selfishly?

Smith did not believe that self-interest was the sole motive, nor did he believe that self-interest was synonymous with selfishness. People are motivated by a broad range of factors, but when they buy and sell in markets, monetary rewards usually provide the most important motivation.

A nation with an absolute advantage in the production of two goods will usually have a comparative advantage in only one of the goods.

True A nation can have the comparative advantage in the production of only one of the two goods.

It is possible to have an absolute advantage in producing a good without having a comparative advantage.

True Absolute advantage is about who produces more, while comparative advantage is about who produces the good at a lower opportunity cost.

In the United States, property rights a. are guaranteed by two amendments to the U.S. Constitution. b. are guaranteed by some state governments but not other state governments. c. are prohibited by the federal government. d. exist in markets but are not enforced by the government.

A

What is the outcome of enforcing contracts and property rights in a market system? a. increased economic activity b. decreased economic activity c. no effect on economic activity d. an unpredictable but definite effect on economic activity

A

Which of the following is critical to the success of a market system? a. to allow individuals or firms to have exclusive use of their property b. to prevent individuals from buying or selling their property depending on the circumstances c. Both a. and b. are critical to the success of a market system. d. to allow the government to determine the optimal use of private property

A

Which of the following refers to markets where goods such as computers or services such as medical treatment are offered? a. product markets b. essential markets c. factor markets d. competitive markets

A

If the opportunity cost of producing one good increases as more of that good is produced, then a. the production possibility frontier is linear. b. the production possibility frontier is bowed out. c. the production possibility frontier does not exist. d. the production possibility frontier has a positive slope.

B

Which of the following statements is most consistent with the principle about the basis for international trade? a. The United States would be better off being self-sufficient because it has an absolute advantage in producing most goods. b. The United States would be better off if it specialized in the production of some goods, and then traded some of them to other countries. c. The United States would be better off by producing at home the goods that it now imports—that way the nation can generate additional jobs here at home. d. The United States can never have an absolute advantage in producing every good it consumes, so it would be better off if it imported goods that it does not have an absolute advantage.

B

According to Adam Smith, which of the following is necessary for the proper functioning of the market system? a. For markets to work, people should take into account how their decisions affect society as a whole. b. For markets to work, government should help citizens make the right decisions. c. For markets to work, people must be free to pursue their self-interest. d. For markets to work, people and government need to coordinate their decisions.

C

According to Adam Smith, which of the following is true? a. Markets work because producers, aided by government, ensure that neither too many nor too few goods are produced. b. Market prices can come to reflect the prices desired by all consumers. c. Individuals usually act in a rational, self-interested way. d. A guild system is the best way for coordinating the activities of buyers and sellers.

C

Fill in the blanks. In a simple circular-flow model, there are flows of _________ and flows of _________. a. factors of production; goods and services b. funds received from the sale of factors of production; spending on final goods and services c. Both (a) and (b) are correct. d. None of the above. Actually, there are no flows in the circular flow of income.

C

If a country has a comparative advantage in the production of a good, then that country a. also has an absolute advantage in producing that good. b. should allow another country to specialize in the production of that good. c. has a lower opportunity cost in the production of that good. d. All of the above are true.

C

In which markets are factors of production, such as labor, capital, natural resources, and entrepreneurial ability traded? a. product markets b. essential markets c. factor markets d. competitive markets

C

What are copyrights designed to do? a. prevent entrepreneurs from earning excessive profits b. eliminate unnecessary duplication whenever it arises c. protect intellectual property rights d. all of the above

C

What is the term for the highest-valued alternative that must be given up to engage in any activity? a. scarcity b. the production possibilities frontier c. opportunity cost d. a trade-off

C

Which of the following comprises the two key groups of participants in the circular flow of income? a. domestic residents and foreign residents b. government and financial institutions c. households and firms d. savers and borrowers

C

In his book An Inquiry into the Nature and Causes of the Wealth of Nations, Adam Smith argued that a guild system was the most efficient way for a nation to coordinate the decisions of buyers and sellers.

False Adam Smith explained the inefficiencies of the guild system and how markets were more efficient.

An individual who has comparative advantage in producing a good must also have absolute advantage in producing that good.

False Comparative advantage involves production at the lowest cost, not necessarily the highest level of production overall.

If property rights are not enforced by the government, then more goods and services will be produced in free markets.

False For the market system to work properly, property rights must be enforced. Refer to page 56 in the textbook for a discussion of the importance of property rights.

People can increase their production and consumption by specializing in producing goods and services in which they have an absolute advantage.

False Gains from specialization and trade occur when people specialize in producing what they have a comparative advantage, not an absolute advantage.

Opportunity cost refers to the all of the alternatives that must be given up to engage in an activity.

False See the definition of opportunity cost on page 39 of the textbook.

Technological advances always increase the production of all goods and services equally.

False Technological advances often affect the production of some goods (those that use the advances most) more than others.

A production possibilities frontier that is bowed outward illustrates increasing marginal opportunity costs.

True As the slope of the frontier becomes steeper, the opportunity cost of obtaining one more unit of one good increases.

The story about Apple's production of the iPad shows how production requires the coordinated activities of many people, spread around the world.

True See Making the Connection "A Story of the Market System in Action: How Do You Make an iPad?" on page 53 in the textbook.

Because the governments of the United States, Canada, and Western European countries impose few restrictions on economic activity, the economies of these countries approximate free market economies.

True See page 52 in the book

Households are suppliers of the factors of production that are used by firms to produce goods and services.

True See the section titled "The Circular Flow of Income" starting on page 50 in the textbook.

The marginal opportunity cost along a linear (straight-line) production possibilities frontier is constant.

True The change in the opportunity cost per each additional unit of the good being produced—the marginal opportunity cost—is constant along a linear PPF.