ECON 2301 Exam #1
The next-best thing that must be forgone in order to produce one more unit of a given product:
Opportunity cost
Some large hardware stores, such as Home Depot, boast of carrying as many as 20,000 different products in each store. This volume of goods is the result of
the choice of consumers regarding what to purchase to satisfy their wants and the choice of producers regarding what to produce to maximize profits.
Marginal Cost
the cost of producing one more unit of a good
Explain the typical shapes of the marginal-benefit and marginal-cost curves.
The marginal-benefit curve is downward sloping: MB falls as more of a product is consumed because additional units of a good yield less satisfaction than previous units. The marginal-cost curve is upward sloping: MC increases as more of a product is produced since additional units require the use of increasingly unsuitable resources.
In market economies, firms rarely worry about the availability of inputs to produce their products, whereas in command economies input availability is a constant concern. This is because
in command economies, no market-pricing mechanism exists to incentive resource suppliers to increase resource availability when a shortage occurs.
An advantage of using capital in the production process is that it
improves efficiency, increases output, and provides for growth
The market system depends on private property and the protection of property rights to
provide an incentive to maintain the property and allow for the orderly transfer of property ownership.
The use of money
provides a common value that makes buying and selling transactions simpler than would be the case with barter.
In the goods and services portion of the circular flow model, there is a flow of
real goods and services and a flow of money.
In the circular flow model,
resource markets provide for the exchange of labor and product markets provide for the exchange of goods and services.
The term "division of labor" means that workers
specialize in tasks that take advantage of their individual abilities and skills.
Marginal Benefit
the additional benefit to a consumer from consuming one more unit of a good or service
The meaning of the phrase "invisible hand" is that
market prices coordinate the economy by rationing resources and output and by providing incentives to produce the goods and services most desired by society.
Consider the statement: "We want money only to part with it." When people express a desire to have money, they really want
the goods and services that money can buy.
Suppose that businesses buy a total of $100 billion of the four resources (labor, land, capital, and entrepreneurial ability) from households. If households receive $60 billion in wages, $10 billion in rent, and $20 billion in interest, how much are households paid for providing entrepreneurial ability?
$10 billion for entrepreneurial ability: $100 billion in total factor payments - $60 billion in wages - $10 billion in rent - $20 billion in interest.
If households spend $55 billion on goods and $45 billion on services, how much in revenues do businesses receive in the product market?
$100 billion: $55 billion + $45 billion, because household expenditures equal business revenues.
Why does the supply curve slope upward? To answer this question, use the choices below to identify the characteristics of an upward-sloping supply curve.
- Increasing opportunity costs - Increasing Marginal Costs
A woman who wants to start a flower shop finds she cannot do so unless the central government has already decided to allow a flower shop in her area.
Command system: There is central government planning of even minor things like how many flower shops can be in operation.
Why is entrepreneurial ability distinct from labor even though both are considered a category of economic resource
Because entrepreneurial ability is not directly engaged in production.
A Venezuelan-style economic collapse would be less likely in a mixed economy like the United States because
An economic collapse would be less likely in the United States because businesses have a large degree of autonomy over what to produce. Also government has less power to control industry, which reduces the likelihood of government officials harming production by engaging in corruption or by making large-scale poor decisions. In addition, producers have incentives to produce efficiently because that boosts their profits.
Which statement is consistent with the law of supply?
An increase in market price will lead to an increase in quantity supplied.
What is an opportunity cost? How does the idea relate to the definition of economics? Which of the following decisions would entail the greater opportunity cost: Allocating a square block in the heart of New York City for a surface parking lot or allocating a square block at the edge of a typical suburb for such a lot? Explain.
An opportunity cost is what was sacrificed to do or acquire something else. The condition of scarcity creates opportunity cost. If there was no scarcity, there would be no need to sacrifice one thing to acquire another. The opportunity cost would be much higher in New York City, as the alternative uses for that square block are much more valuable than for a typical suburban city block.
How is the market supply curve derived from the supply curves of individual producers?
By adding up the quantities supplied by all individual producers for each price
Explain the law of demand. Why does a demand curve slope downward? How is a market demand curve derived from individual demand curves?
As prices change, buyers will change the quantity they demand of that item. If the price drops, a larger quantity will be demanded. If the price rises, a lesser quantity will be demanded. Its downward slope reflects the law of demand—people buy more of a product, service, or resource as its price falls. The relationship between price and quantity demanded is inverse (or negative). An inverse relationship between two variables will always provide a negative slope. By adding the quantities demanded by all consumers at each of the various possible prices, we can get from individual demand to market demand.
Explain the law of supply. Why does the supply curve slope upward? How is the market supply curve derived from the supply curves of individual producers?
As prices rise because of increased demand for a commodity, producers find it more and more profitable to increase the quantity they offer for sale; that is, the supply curve will slope upward from left to right. Clearly, firms would rather sell at a higher price than at a lower price. Moreover, it is necessary for firms to demand a higher price as they increase production. This comes about because as they produce more and more, they start to run up against capacity constraints, and costs rise. At any given time, a plant has a given size. As production increases, the firm will need to add an extra shift and then a third shift, both perhaps at higher wages. It may run out of warehouse space and have to rent at higher cost from another firm. It may have to pay extra to get increasingly urgent raw materials, and so on.The market supply curve is derived by horizontally adding the individual supply curves.
"If you compare a list of today's most powerful and profitable companies with a similar list from 30 years ago, you will see lots of new entries."
Creative destruction: This quote is a reflection of how fast new technologies and new products destroy the market positions of even very powerful, older firms.
Which of the following is not a key element of the scientific method?
Designing data
The social science concerned with how individuals, institutions, and society make optimal (best) choices under conditions of scarcity
Economics
If current output is such that marginal cost exceeds marginal benefit, should more or fewer resources be allocated to this product?
If MC exceeds MB, fewer resources should be allocated to this use. The resources are more valuable in some alternative use (as reflected in the higher MC) than in this use (as reflected in the lower MB).
Suppose that you initially have $100 to spend on books or movie tickets. The books start off costing $25 each and the movie tickets start off costing $10 each. For each of the following situations, would the attainable set of combinations that you can afford increase or decrease? Your budget increases from $100 to $150 while the prices stay the same: Your budget remains $100, and the price of books remains $25, but the price of movie tickets rises to $20: Your budget remains $100, and the price of movie tickets remains $10, but the price of a book falls to $15:
Increase, because a larger budget allows you to purchase not only the combinations that you could afford before but also new combinations that you could not afford before (for example, you can now afford to purchase 4 books and 5 movie tickets). Decrease, because certain combinations are no longer affordable (for example, you can no longer purchase 10 movie tickets with your $100 budget). Increase, because the lower price allows you to purchase combinations that you could not afford before (for example, you can now purchase 6 books and 1 movie ticket).
What are the two major ways in which an economy can grow and push out its production possibilities curve?
Increases in resource supplies and advances in technology
"It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest."
Invisible hand: This quote (from Adam Smith's book The Wealth of Nations) reflects the idea that producers end up doing things that their customers want not out of a sense of charity but rather in an attempt to further their own interests. The butcher, the brewer, and the baker do a good job at their respective tasks because they want their customers' money.
"Managers in the old Soviet Union often sacrificed product quality and variety because they were being awarded bonuses for quantitative, not qualitative, targets."
Invisible hand: This quote is an example of what happens when the invisible hand is not allowed to work. It reflects how the poorly designed financial incentives of the old Soviet Union often led to managers making decisions that were personally beneficial but socially destructive.
"Each day, central planners in the old Soviet Union were tasked with setting 27 million prices—correctly."
Invisible hand: This quote is an example of what happens when the invisible hand is not allowed to work. It reflects the impossible complexity of centrally coordinating a large economy.
The only taxes levied by the government are to pay for national defense, law enforcement, and a legal system designed to enforce contracts between private citizens.
Laissez-faire system: The government restricts itself to only engaging in activities that protect private property and the operation of the market system.
A price ceiling will result in a shortage only if the ceiling price is less than the equilibrium price.
Less than: If the ceiling price is set at a value below the equilibrium price, then a shortage will result because quantity demanded will exceed quantity supplied. By contrast, if the ceiling price is set higher than the equilibrium price, it will not affect anything because the equilibrium price will not be in violation of the legal ceiling price and all the market participants can proceed as they normally would. Finally, if the ceiling price happens to be just equal to the market equilibrium price, then the market will behave as normal and reach the market equilibrium price because with the equilibrium price just equal to the ceiling price, nobody is violating the law and nobody has to change his or her behavior.
The consumer price index rose by 2.2 percent from November 2017 to November 2018:
Macroeconomics
The unemployment rate in the United States was 3.7 percent in December 2018:
Macroeconomics
U.S. output, adjusted for inflation, increased by 2.3 percent in 2017
Macroeconomics
Making choices based on comparing marginal benefits with marginal costs
Marginal analysis
Shops stock and sell the goods their customers want, but the government levies a sales tax on each transaction in order to fund elementary schools, public libraries, and welfare programs for the poor.
Market system: While the government is using its power to tax to promote public schools and welfare for the poor, it is mostly leaving markets alone so that they can be the dominant force in deciding what to produce, how to produce it, and who will get it.
A U.S. software firm laid off 15 workers last month and transferred the work to India:
Microeconomics
An unexpected freeze in central Florida reduced the citrus crop and caused the price of oranges to rise:
Microeconomics
Last week Wells Fargo Bank lowered its interest rate on business loans by one-half of 1 percentage point:
Microeconomics
For each stock in the stock market, the number of shares sold daily equals the number of shares purchased. That is, the quantity of each firm's shares demanded equals the quantity supplied. Why, then, do the prices of stock shares change?
Prices change in reaction to a mismatch between quantity demanded and quantity supplied.
Which of the following best describes the concept of "utility" and purposeful behavior?
Satisfaction from consuming goods or services
Because investment and capital goods are paid for with savings, higher savings rates reflect a decision to consume fewer goods in the present and more goods in the future. Households in China save 40 percent of their annual incomes each year, whereas U.S. households save less than 5 percent. At the same time, production possibilities are growing at roughly 7 percent per year in China but only about 3.0 percent in the United States. Use the graphical analysis of "present goods" versus "future goods" to explain the difference between China's growth rate and the U.S. growth rate.
Since the United States is consuming more today rather than saving, its production possibilities curve will shift out slower (less) over time because households are accumulating less capital. China's production possibilities curve will shift out faster (more) over time because households are accumulating more capital.
Suppose that, on the basis of a nation's production possibilities curve, an economy must sacrifice 10,000 pizzas domestically to get the 1 additional industrial robot it desires but that it can get the robot from another country in exchange for 9,000 pizzas. Now consider the following statement: "Through international specialization and trade, a nation can reduce its opportunity cost of obtaining goods and thus move outside its production possibilities curve." Which of the following explains the relationship between the situation described and the statement?
Specialization and trade have the same effect as having more and better resources or discovering improved production techniques.
Ted and Fred are the owners of a gas station. They invested $150,000 each and pay an employee named Lawrence $35,000 per year. This year's revenues are $900,000, while costs are $940,000. Who is legally responsible for bearing the $40,000 loss?
Ted and Fred: A firm's owners bear the firm's business risk, including the risk of running a loss (rather than breaking even or generating a profit). So, in this case, the loss will be born by Ted and Fred, since they are the owners. Lawrence, by contrast, is an employee and not legally bound to bear any business risk. So he must be paid his salary on time and in full whether or not the firm is running a profit, a loss, or just breaking even.
Which budget line features a larger set of attainable combinations of coconuts and fish?
The budget line from trading with Kwame features a larger set of attainable combinations of coconuts and fish. Because Kwame is willing to give up more fish per coconut, you can consume more of both (assuming you make a trade). This implies that you would prefer to trade with Kwame.
What happens to the supply curve when any of the following determinants change? Indicate whether each of these determinants causes a shift of the supply curve or a movement along the curve
The following will cause an increase in supply: a decrease in resource (input) prices; improved (lower cost) technology; a decrease in business taxes; an increase in subsidies to businesses; a decrease in the price of another commodity that this firm was making, provided that commodity is a substitute in production (the firm can switch from the now lower-priced one to our commodity); an expectation of lower prices in the future; and an increase in the number of sellers. The increase in supply caused by the noted change in one or more of the above will cause the entire supply curve to shift to the right. More will now be supplied at any given price. Alternatively expressed, any given amount will now be supplied at a lower price.
What are the determinants of supply?
The fundamental determinant of supply is the price of the commodity. As price increases, the quantity supplied increases. An increase in price causes a movement up a given supply curve. A decrease in price causes a movement down a given supply curve. The non-price determinants of supply are: resource (input) prices, technology, taxes and subsidies, changes in prices of other related goods, expectations, and the number of sellers. If one or more of these change, there will be a change in supply and the whole supply curve will shift to the right or to the left.
Which of the following represents a normative economic statement?
The government ought to lower taxes so people have more money. describe "what should be."
With these curves, the optimal allocation of resources to a particular product will occur when
The optimal amount of a particular product occurs where MB equals MC.
Given the following diagram, indicate whether the specified changes below represent a change in supply or a change in the quantity supplied.
The reverse of any or all of the above changes in the determinants of supply will cause a decrease in supply and will be shown as a shift of the supply curve to the left. Less will now be supplied at any given price. Alternatively expressed, any given amount will now be supplied at a higher price.
In 2001 an outbreak of hoof-and-mouth disease in Europe led to the burning of millions of cattle carcasses. What impact would you expect this event to have on the following?
The supply of cattle hides was reduced, raising the price of hides. Because hides were more expensive, it became more costly to produce leather, reducing the supply and raising the price of leather goods.
Which of the following represents a positive economic statement?
The unemployment rate is 4.8 percent. describe "what is."
What are the determinants of demand? What happens to the demand curve when any of these determinants change? Distinguish between a change in demand and a movement along a fixed demand curve, noting the cause(s) of each.
There are determinants of demand, which are factors that may shift the demand curve, or cause a "change in demand." These are the number of buyers, the tastes (or desires) of the buyers, the income of the buyers, the changes in price of related commodities (substitutes and complements), and expectations of the buyers regarding the future price of the commodity under discussion. The determinants of demand will cause a shift in the demand curve. If it is something that increases the demand, the curve will shift to the right. A decrease in demand will be shown by a shift to the left. This is representative of quantity demanded changing at every price, either increasing or decreasing. A change in price causes movement along the commodity's demand curve. This movement is called a change in quantity demanded. A decrease in price leads to movement down the demand curve, or an increase in quantity demanded. Increased price leads to movement up the demand curve, or a decrease in quantity demanded.
What roles do entrepreneurs play in the economy?
They coordinate the activities of the other three inputs for profit—or loss, which is why they are called risk-takers. Entrepreneurs sometimes manage companies that they own, but a manager who is not an owner is not necessarily an entrepreneur but may be performing some of the entrepreneurial functions for the company. Entrepreneurs are also innovators, or perhaps inventors, and profits help to motivate such activities.
Assume that a business firm finds that its profit is greatest when it produces $40 worth of product A. Suppose also that each of the three techniques shown in the table below will produce the desired output.
To calculate the cost of each technique, multiply the price per unit of each resource by the amount of the resource employed by the technique and add these together. For example, the cost of technique 1 equals $3 × 5 (labor cost) + $4 × 2 (land cost) + $2 × 2 (capital cost) + $2 × 4 (entrepreneurial cost) = $15 + $8 + $4 + $8 = $35. The same process is applied to techniques 2 and 3. The firm will choose technique 2, because it produces the output at the least cost ($34 compared to $35 for techniques 1 and 3). Economic profit will be $6 (= $40 - $34), causing the industry to expand. Expansion in this industry will continue until prices decline to where total revenue equals total cost of $34 and no additional firms will want to enter the industry because the incentive of economic profits is gone at this point.
The pleasure, happiness, or satisfaction obtained from consuming a good or service:
Utility
What do economists mean when they say "Price floors and ceilings stifle the rationing function of prices and distort resource allocation"?
When unrestrained, prices rise and fall to correct imbalances between the quantity supplied and quantity demanded in a market. If sellers find themselves at a given price with more output than consumers are willing to purchase, they will lower the price. Likewise, if the market is not offering enough of a good to satisfy consumer demand, the price will rise. Price floors and ceilings prevent price movements to correct these imbalances. When a price is set above equilibrium (i.e., a price floor), sellers will produce more than the market can support, diverting resources away from more highly valued uses. Price ceilings result in an underallocation of resources toward a particular good, where the excess demand (shortage) reveals that consumers value the good (and therefore the resources used to produce it) more than what the market currently offers.
In a command economy, scarce goods are allocated by
a government-appointed planning board based on the board's long-term priorities. The command economy is characterized by public ownership of nearly all property resources, and economic decisions are made through central planning. The planning board, appointed by the government, determines production goals for each enterprise. The division of output between capital and consumer goods is centrally decided based on the board's long-term priorities.
For each of the following situations involving marginal cost (MC) and marginal benefit (MB), indicate whether it would be best to produce more, fewer, or the current number of units.
a. 3,000 units at which MC = $10 and MB = $13: More b. 11 units at which MC = $4 and MB = $3: Fewer c. 43,277 units at which MC = $99 and MB = $99: Current number d. 82 units at which MC < MB: More e. 5 units at which MB < MC: Fewer Correct.
Critically evaluate: "In comparing the two equilibrium positions in the figure below, I note that a smaller amount is actually demanded at a lower price. This observation refutes the law of demand."
a. A decrease in demand from D1 to D2 results in a surplus b. This causes the price to fall c. This change in price results in an increase in quantity demanded along demand curve D2. d. This change in price results in a decrease in quantity supplied. e. The new equilibrium has a lower price and lower quantity when compared to the original equilibrium.f. Does this refute the law of demand: No Correct. g. Why: Because there was a change in demand
What effect will each of the following have on the supply of auto tires?
a. A technological advance in the methods of producing tires: Supply increases b. A decline in the number of firms in the tire industry: Supply decreases c. An increase in the price of rubber used in the production of tires: Supply decreases d. The expectation that the equilibrium price of auto tires will be lower in the future than it is now: Supply increases e. A decline in the price of large tires used for semi trucks and earth-hauling rigs (with no change in the price of auto tires): Supply increases Correct.f. The levying of a per-unit tax on each auto tire sold: Supply decreases g. The granting of a 50-cent-per-unit subsidy for each auto tire produced: Supply increases
Using the following circular flow diagram, where the red lines represent real flows and the blue lines represent monetary flows, match the correct letter in the diagram to the description provided.
a. Land, labor, capital, and entrepreneurial activity: H b. Households: B c. Consumer expenditures: E d. Costs: C e. Money income: D f. Resources: G g. Businesses: A h. Revenue: F i. Goods and services: I and J
What effect will each of the following have on the demand for small cars such as the Mini Cooper and Fiat 500?
a. Small cars become more fashionable: Demand increases b. The price of large cars rises (with the price of small cars remaining the same): Demand increases . c. Income declines and small cars are an inferior good: Demand increases d. Consumers anticipate that the price of small cars will decrease substantially in the near future: Demand decreases e. The price of gasoline substantially drops: Cannot be determined
Explain how (if at all) each of the following events affects the location of a country's production possibilities curve:
a. The quality of education increases: Curve shifts outward b. The number of unemployed workers increases: No change c. A new technique improves the efficiency of extracting copper from ore: Curve shifts outward d. A devastating earthquake destroys numerous production facilities: Curve shifts inward
Refer to the figure below. Suppose that the cost of cheese falls, so that the marginal cost of producing pizza decreases.
a. To think about cost schedules, we must think about input costs. If the cost of cheese falls, then the cost of making pizza is cheaper for all pizzas. This implies that the marginal cost schedule will shift down, reflecting the lower input cost. b. For a given marginal benefit, the optimal amount of pizza produced and sold will increase. Thus, the equilibrium price will fall. The opposite story would apply if the cost of cheese were to increase.
Self-interest helps achieve society's economic goals because
as consumers and producers exercise their freedom to act in their own self-interest, markets will produce the desired goods at the lowest possible cost.
In the circular flow model,
businesses sell goods and buy labor; households buy goods and sell labor.
What is produced is ultimately determined by
consumers, because if the goods offered are not what consumers want, consumers will not buy them.
The scientific method is the technique used by economists to determine
economic laws or principles. These laws or principles are formulated to explain and/or predict behavior of individuals or institutions.
Because economic resources are used to produce goods and services, they are called
factors of production or inputs
Barter requires that you
find a person who has what you want and a person who needs what you have to offer.
There is such a wide variety of desired goods and services in a market system because
individual wants are diverse.
Economists classify resources as
labor, land, real capital, and entrepreneurs.
Price ceilings during a hyperinflation are problematic because
many producers will go out of business because the costs of production will soon exceed the legal selling price.
In a market system, scarce goods are allocated by
market prices that are determined by consumers and producers acting in their own self-interest. A market system allows for the private ownership of resources and coordinates economic activity through market prices. Participants act in their own self-interest and seek to maximize satisfaction or profit through their own decisions regarding consumption or production. Goods and services are produced and resources are supplied by whomever is willing to do so. The result is competition and widely dispersed economic power.
Economic resources are the
natural, human, and manufactured inputs used to produce goods and services.
Money is not considered a capital resource in economics because money is
not productive
When an economy relies on specialization,
trade enables individuals to obtain the goods in which they do not have a specialization. On a regional basis, each region will produce those products for which it is best suited. By specializing in their comparative advantage, each region or set of human and material resources will be used to maximize efficiency. When resources are specialized, exchange is necessary to obtain the goods and services one needs. Markets facilitate the exchange of goods within a country or region and across countries and regions.
Consider the following statement: "The market system is a profit-and-loss system." This statement is
true, because producer decisions are motivated by the attempt to earn profits.
Consider the following statement: "Competition is the disciplinarian of the market economy." This statement is
true, because when producers face competition, they are driven to provide goods and services at the lowest possible cost.
