Macro econ chapter 2
What are the two main categories of participants in markets? Which participants are of greatest importance in determining what goods and services are produced?
Firms and households. Households.
What is absolute advantage? What is comparative advantage? 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
The ability to produce more of a good or service than competitors using the same amount of resources. The ability to produce a good or service at a lower opportunity cost than other producers. will have a comparative advantage if it has a lower opportunity cost of producing that good.
Whether carried out by an individual or a country, production beyond the production possibilities frontier With respect to consumption, individuals and countries
is not physically possible. can, through trade, consume beyond their production possibilities frontiers.
Using the same amount of resources, suppose that Nicaragua can produce twice as much sugarsugar as Columbia. Nevertheless, Columbia could still have the comparative advantage in producing sugarsugar if
it is even less efficient than Nicaragua in the production of goods other than
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.
What is the basis for trade? How can a country gain from specialization and trade?
Comparative advantage. A country can specialize in producing that for which it has a comparative advantage and then trade for other needed goods and services.
What does increasing marginal opportunity costs mean? What are the implications of this idea for the shape of the production possibilities frontier?
Increasing the production of a good requires larger and larger decreases in the production of another good. The production possibilities frontier will be bowed outward.
Suppose that Lichtenstein and Luxembourg currently have identical production possibilities frontiers but that Lichtenstein devotes only 5 percent of its resources to producing capital goods over each of the next 10 years, whereas Luxembourg devotes 30 percent. Which country is likely to experience more rapid economic growth LOADING... in the future?
Luxembourg
Uwe Reinhardt, an economist at Princeton University, wrote the following in a column in the New York Times: [Cost-effectiveness analysis] seeks to establish which of several alternative strategies capable of achieving a given therapeutic goal is the least-cost strategy. It seems a sensible form of inquiry in a nation that is dismayed over the rising cost of health care. . . . Opponents of cost-effectiveness analysis includes individuals who sincerely believe that health and life are "priceless." . . . Source: Uwe E. Reinhardt, "'Cost-Effectiveness Analysis' and U.S. Health Care," New York Times, March 13, 2009. If health and life were priceless,
people would spend all of their time preventing illness and protecting their life.
Suppose you win free tickets to a movie plus all you can eat at the snack bar for free. Would there be a cost to you to attend this movie?
Yes, because the movie's opportunity cost is equal to the highest-valued alternative that must be given up to attend the movie.
In The Wealth of Nations, Adam Smith wrote the following (Book I, Chapter II): "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." What did Smith mean by this?
Pursuing their own self-interest, entrepreneurs produce the goods and services most desired by their customers for financial reward.
What is a free market? In what ways does a free market economy differ from a centrally planned economy? Unlike a free market economy,
A free market is one where the government does not control the production of goods and services. centrally planned economies have extensive government controls.
In many parts of Europe during the mid-1770s, governments gave guilds, or organizations of producers, the authority to control who was allowed to produce a good, the amount of the good produced, and the price charged for the good. Would you expect more competition among producers in a guild system or in a market system? Regarding the entity occupying the center (of attention) in the two systems, it appears that
A market system is clearly more competitive because it allows for the free entry and exit of producers. the consumer is at the center of the market system while the guild system centered on the producer. With regard to the innovation of new products and technologies, the fact that it limited the entry oflimited the entry of new producers suggests that the guildguild system waswas LESS conducive to such innovation.
Imagine that the next time the Indianapolis Colts play the New England Patriots at Lucas Oil Stadium in Indianapolis, Colts star quarterback Andrew Luck has a temporary lack of judgment and plans to sell Colts memorabilia during the game because he realizes that he can sell five times more Colts products than any other player. Likewise, imagine that you are a creative and effective manager at work and that you tell your employees that during the next six months, you plan to clean the offices because you can clean five times better than the cleaning staff. You shouldn't necessarily do what you are better than anyone else at doing
Both you and Andrew are making an error in judgment by assuming that specialization should be based upon absolute advantage . unless your advantage in that activity is greater than advantages you possess in other activities.
What do economists mean by scarcity? Which of the following is not scarce according to the economic definition?
Economists mean that unlimited wants exceed limited resources. None of the above A. CoalCoal. B. FoodFood. C. Time. D. WorkersWorkers.
What is an entrepreneur? Why do entrepreneurs play a key role in a market system?
Entrepreneurs operate businesses that produce goods and services. They bring together factors of production.
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 LOADING... . In these circumstances, would there have been any gain to the United States from importing any of these products from Britain? Explain
Even with an absolute advantage, the United States would have benefited from importing those products for which Britain had a comparative advantage.
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." Source: Michael Lewis, "In Defense of the Boom." New York Times, October 27, 2002. What incentives does a market system provide to encourage self-interest?
Financial reward.
In a speech at the New York University Law School, Federal Reserve Chairman Ben Bernanke stated: Writing in the eighteenth century, Adam Smith conceived of the free-market system as an "invisible hand" that harnesses the pursuit of private interest to promote the public good. Smith's conception remains relevant today, notwithstanding the enormous increase in economic complexity since the Industrial Revolution. Source: Ben S. Bernanke, "Financial Regulation and the Invisible Hand," speech made at the New York University Law School, New York, New York, April 11, 2007. What is so important about the idea of the invisible hand?
Firms will provide consumers what they want without the government.
Suppose that France and Germany both produce wine and schnitzel. The table below shows combinations of the goods that each country can produce in a day.
France has a comparative advantage producing wine and Germany has a comparative advantage producing schnitzel.
Identify whether each of the following transactions will take place in the factor market LOADING... or in the product market LOADING... and whether households or firms are supplying the good or service or demanding the good or service.
George buys a Tesla Model S. This takes place in the PRODUCT market. The household DEMANDS the good and the firm SUPPLIES the good. Tesla increases employment at its Fremont plant. This takes place in the FACTOR market. The households SUPPLY the labor and the firm DEMANDS the labor. George works 20 hours per week at McDonald's. This takes place in the FACTOR market. The household SUPPLIES the labor and the firm DEMANDS the labor. George sells land he owns to McDonald's so it can build a new restaurant. This takes place in the FACTOR market. The household SUPPLIES the factor of production and the firm DEMANDS the factor of production.
Suppose Iran and Iraq both produce oil and olive oil. The following table shows combinations of both goods that each country can produce in a day, measured in thousands of barrels. Can these two countries gain from trading oil and olive oil?
Neither country has a comparative advantage producing oil because their opportunity costs of producing oil are equal. These countries cannot gain from trade because neither has a comparative advantage producing either good.
According to an article in the Wall Street Journal, the parts contained in the BlackBerry Torch smartphone include a power management chip made by Texas Instruments (United States), a memory chip made by Samsung (South Korea), a GPS receiver made by CSR (United Kingdom), a radio frequency (RF) transceiver made by Dialog Semiconductor (Germany), an RF transceiver made by Renesas (Japan), an application and communications processor made by Marvell (United States), a video image processor made by STMicroelectronics (Switzerland), and plastic and stamped metal parts made by several firms in China. A firm in Mexico carries out final assembly of the Torch before it is shipped to BlackBerry for sale in the United States and other countries. Source: Jennifer Valention-DeVries and Phred Dvorak, "Piece by Piece: The Suppliers behind the New BlackBerry Torch Smartphone," Wall Street Journal, August 16, 2010. Is it necessary for all of the managers in all of these firms to know how all of the components of the Torch are manufactured and how the components are assembled into a smartphone? Is it necessary for the chief executive officer (CEO) of BlackBerry to know this information?
Of course not. Any given manager need only command the knowledge necessary to produce the component for which s/he has responsibility. Generic knowledge about the product is certainly to be expected. But a CEO is more of a strategist and, ideally, a visionary, who orchestrates the conception, design, production, and marketing of an innovative product.
The 2012 International Property Rights Index study states: [T]hose developing countries that respect property rights grow on average faster than those that fail to provide sound legal and political environments and protection for physical property rights. Source: Guarev Tiwari, "Report: Property Rights Linked to Economic Security," International Property Rights Index 2012 Report. How would this creation of property rights LOADING... be likely to affect the economic opportunities available to citizens of those countries ranking lowest in property rights protections?
Owners could use their property as COLLATERAL FOR A LOAN , which, by affecting their ability to start a business, would INCREASE personal income and national wealth.
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 production possibilities frontier LOADING... in this situation would be a straight line: LOADING... click on the icon for an example or bowed out: LOADING... click on the icon for an example?
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? How should policymakers determine the amount of money that should be allocated for research curing heart disease? They should base their decision on
The reduction in funding for research to cure other diseases. 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.
Suppose that the federal government is deciding which of two cancer treatment therapies it will allow Medicare funds to be used to pay for (assume that only one treatment therapy will be funded): Therapy A, which will prolong the average lifespan of patients receiving the treatment by 3636 months and will cost $300 comma 000300,000 per patient treated; and Therapy B, which will prolong the average lifespan of patients receiving the treatment by 3030 months and will cost $200 comma 000200,000 per patient treated. What factors should the federal government take into account in making its decision of which therapy it will allow Medicare funds to be used to pay for? Which therapy would you recommend?
The relative cost of each therapy. Therapy B
In The Wonderful Wizard of Oz and his other books about the Land of Oz, L. Frank Baum observed that if people's wants were modest enough, most goods would not be scarce LOADING... . According to Baum, this was the case in Oz: "There were no poor people in the Land of Oz, because there was no such thing as money... Each person was given freely by his neighbors whatever he required for his use, which is as much as anyone may reasonably desire. Some tilled the lands and raised great crops of grain, which was divided equally among the whole population, so that all had enough. There were many tailors and dressmakers and shoemakers and the like, who made things that any who desired them might wear. Likewise there were jewelers who made ornaments for the person, which pleased and beautified the people, and these ornaments also were free to those who asked for them. Each man and woman, no matter what he or she produced for the good of the community, was supplied by the neighbors with food and clothing and a house and furniture and ornaments and games. If by chance the supply ever ran short, more was taken from the great storehouses of the Ruler, which were afterward filled up again when there was more of any article than people needed... You will know, by what I have told you here, that the Land of Oz was a remarkable country. I do not suppose such an arrangement would be practical with us. " Source: L. Frank Baum, The Emerald City of Oz, pp. 30-31, First edition published in 1910. Do you agree with Baum that the economic system in Oz wouldn't work in the contemporary United States?
The system in Oz wouldn't work. The wants of people in the United States exceed the resources available to fulfill those wants.
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.
Is specialization and trade between individuals and countries more about having a job or more about obtaining a higher standard of living? Individually, if you go from a situation of not trading with others (you produce everything yourself) to a situation of trading with others, do you still have a job? Does your standard of living increase? Likewise, if a country goes from not trading with other countries to trading with other countries, does it still have jobs? Does its standard of living increase?
While specialization and trade facilitate the attainment of higher living standards, the immediate or proximate motive behind it is most likely jobs. Yes you do, for even if you are less efficient than others in the production of everything, there will be something at which you are least disadvantaged; it is in this activity that you have a comparative advantage and, hence, a job. Economic theory says yes: specialization and trade produce mutually beneficial results. Certainly, because trade expands total production and therefore creates more jobs than it destroys. Economic theory says yes: specialization and trade produce mutually beneficial results.
Some economists have been puzzled that although entrepreneurs take on the risk of losing time and money by starting new businesses, on average their incomes are lower than those of people with similar characteristics who go to work at large firms. William Baumol believes part of the explanation for this puzzle may be that entrepreneurs are like people who buy lottery tickets. On average, people who don't buy lottery tickets are left with more money than people who buy tickets because lotteries take in more money than they give out. Baumol argues that "the masses of purchasers who grab up the [lottery] tickets are not irrational if they receive an adequate payment in another currency: psychic rewards." Source: William J. Baumol, The Microtheory of Innovative Entrepreneurship, Princeton, NJ: Princeton University Press, 2011. The term "psychic rewards" refers to Psychic rewards that an entrepreneur might receive include (check all that apply):
nonmonetary forms of remuneration that are psychologically uplifting. A.status within the community. Your answer is correct. B.the pride of self-accomplishment. Your answer is correct. C. stock options. Your answer is not correct. D. being one's own boss.
A production possibilities frontier: We can show economic efficiency: We can show economic inefficiency: The production possibilities frontier will shift outward
shows the maximum attainable combinations of two goods that may be produced with available resources. with points on the production possibilities frontier. with points inside the production possibilities frontier. If technological advances occur.
Lawrence Summers served as secretary of the treasury in the Clinton administration and as director of National Economic Council in the Obama administration. He has been quoted as giving the following moral defense of the economic approach. "There is nothing morally unattractive about saying: We need to analyze which way of spending money on health care will produce more benefit and which less, and using our money as efficiently as we can. I don't think there is anything immoral about seeking to achieve environmental benefits at the lowest possible costs." Source: David Wessel, "Precepts from Professor Summers," Wall Street Journal, October 17, 2002. It would be more moral to reduce pollution,
taking the cost into account because money spent on pollution reduction is not available for other worthy activities.
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.
What are private property rights? Private property rights are: What role do they play in the working of a market system? Private property rights: Why are independent courts important for a well-functioning economy? Independence is necessary for courts:
the rights individuals and firms have to the exclusive use of tangible, physical property and intellectual property. both a and b. A. encourage a significant number of people to be willing to risk funds by investing them in business. B. encourage firms to spend money on research and development. all of the above. A. to make their decisions free of influence from other parts of the government. B. to make their decisions free of intimidation by criminal gangs. C. to make their decisions based on the law. D. to make their decisions free of influence from people with powerful political connections.
