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UTK Notes


HW1: Homework - Ch. 1: Foundation of Economics

Quesiton 1

An economy is

A. the group of individuals who lead a society.
B. the political organization of a nation.
C. the system society uses to coordinate productive activities.
D. the geographical boundaries of a nation.

Hint How does an economy differ from a government or a nation?
Answer C. the system society uses to coordinate productive activities. An economy is the system by which society coordinates productive activities. It can be a market economy where buyers and sellers trade to determine what is produced. An economy can also be a command economy where a central authority decides what is produced.

An economy is often contained within the geographical boundaries of a nation, but it is not the boundaries themselves. Also, communication and transportation costs have decreased dramatically over recent decades, leading to a more global economy.

The group of individuals who lead a society, in whatever form, may have great influence over the economy. However, the economy is not these individuals.

The political organization of a nation is called its government. A government can hold great control over the economy, as in command economies, but the institution of government and the economy are not synonymous.

Question 2

All of the concepts are integral to the definition of economics as a social science EXCEPT

A. money
B. incentives
C. scarcity
D. choices

Hint Which of the listed concepts have influenced individuals, business, governments and societies across the world throughout history?
Answer A. money. Of the concepts listed, "money" is the only one that is not ubiquitous to the human experience. Even though in modern societies money often plays a central role in encouraging, facilitating, and rewarding economic activity, it is important to remember that economic activity such as production and trade existed well before the advent and common usage of money, and there are motivations other than money itself which are critical to explaining the economic outcomes we observe today. Further, the scope of economics is broader than just the study of finance.

Question 3

Which of the following is the best definition of the opportunity cost of a decision?

A. The difference between the benefits of the first and second best choices.
B. The sum of all benefits from all foregone alternatives.
C. Actual financial cost of a decision.
D. Benefits from the best foregone alternative.

Hint Opportunity costs are economic costs (in contrast with accounting costs) that look at all that is truly lost due to a decision.
Answer D. Benefits from the best foregone alternative. As the name suggests, opportunity costs is what you must give up when you make a decision. It is an economic concept that focuses attention on the fact that lost opportunities are part of the cost of any decision.

The money you spent − the actual financial cost of the decision –is money that could have been spent on something else, so it factors into the opportunity cost, but is not a complete accounting of opportunity cost. The enjoyment you could have derived from the next best choice − benefits from the best foregone alternative − is also part of what you give up.

Note, if you had not made that choice, you would not have had the opportunity to try every single one of the other choices, so it's only the best foregone alternative that factors in, not the sum of all benefits from all foregone alternatives. Also, the difference between benefits is more along the lines of marginal benefit, not opportunity cost.

Question 4

Thinking about scarcity in terms of the economic way of thinking, why does scarcity exist? Select the most complete explanation.

Scarcity

A. exists because people virtually have unlimited wants and because the earth has a limited supply of land, labor, capital, and entrepreneurial ability.
B. exists because there are limited productive resources in the world.
C. and poverty are the same thing; they are both unavoidable because poverty is relative.
D. exists because people have unlimited wants.
E. exists because people have limited incomes.

Hint Think about scarcity in terms of yourself. If you eat an apple today, does that mean you will never eat another apple again in your life?
Answer A. exists because people virtually have unlimited wants and because the earth has a limited supply of land, labor, capital, and entrepreneurial ability. The combination of unlimited wants and limited productive resources, including land, labor, capital, and entrepreneurial ability, creates scarcity and forces the individual to make choices.

Scarcity would not be an issue if a person had all the resources they needed in terms of their wants, and this is true vice versa. However, this is not always the case. People always need an additional thing, whether it is a warmer jacket or another piece of fruit. They will always be hungry, they will always need to sleep, and they will always need a method to get these things.

Question 5

Which phrase do we use to indicate that we are trying to study the relationship between two variables while the values of all other variables are held unchanged?

A. et cetera
B. e pluribus unum
C. et alii
D. ceteris paribus

Why is this restriction so useful in economic analysis?

A. If other variables that do not interact with these two variables are not held fixed, the true relationship between the two variables would be hidden.
B. If every variable is allowed to change, it would be impossible to isolate the impact of one variable on another.
C. To fully understand the relationship between two variables, it is necessary to change each of the variables sequentially while holding the others constant.
D. Because one of the two variables might have a larger impact on a third variable than the other one being examined.

Hint Think about scarcity in terms of yourself. If you eat an apple today, does that mean you will never eat another apple again in your life?
Answer D. ceteris paribus and B. If every variable is allowed to change, it would be impossible to isolate the impact of one variable on another. While all of the other phrases are used often in English, ceteris paribus has a special place in economics. Meaning "all else being equal," it is an observation that, when investigating the relationship between any two variables, it is essential to hold other variables constant.

Note that many things may affect the quantity sold. Note that a consumer's ability to buy chicken will vary with their income levels. However, different chicken prices will similarly impact its affordability. If we wanted to determine the impact of changes in consumer income upon quantities sold, allowing the price to change would mean the consumer's ability to pay would depend on the combination of income and price, not income alone. Therefore, in order to isolate the impact of consumer income on quantities of chicken sold, the price must be held constant. Similarly, to examine the relationship between price and quantity, consumer income must be held constant.

Note, it's not necessary to change every single variable sequentially. There are many variables that do not interact with the ones being examined in any meaningful way. For example, for the above analysis of chicken, we probably don't have to worry about the price of flashlights. One of the challenges in economic analysis is in determining which variables are relevant or not.

Question 6

In the figure is the production possibility frontier (PPF) for a society, Rubberland. On a given day, the society can produce according to the PPF shown and only makes rubber band balls and rubber hoses.

Suppose the economy is currently producing at point A. A large earthquake destroys many of the factories in the region where hoses and rubber band balls are produced. Shift the PPF by moving the endpoints in the desired directions to show the impact of this event.

Question06.jpg

Hint When the earthquake destroys factories, does that change the amount of resources Rubberland has available to use, or does it change the manner in which resources are used?

The PPF is often referred to as a production possibility curve (PPC).
Answer Answer06.jpg Remember that changes in resources, technology, or the productivity of resources will shift the PPF. In this case, there is an event that leads to the destruction of factories, a capital resource. As a result, Rubberland will be able to produce fewer rubber band balls and fewer hoses. The end points on both axes should shift in towards the origin. The entire PPF shifts in towards the origin, indicating economic decline. This economy is able to produce fewer goods and services than it did prior to the earthquake.

Question 7

The graph presents a production possibility frontier for the nation of New Carnitas. Each point on the curve represents a combination of steak and potatoes that this country can produce, given its resources and technology. Based on this information, determine whether the statements are true or false.

Question07.jpg

Hint The production possibility frontier tells us the maximum amounts of the two goods New Carnitas can produce, given available resources and technology.

A. Point B is an attainable combination of steak and potatoes.

A. True
B. False

Answer B. False

B. Between points C and D, the opportunity cost of 1 pound of steak is 20 pounds of potatoes.

A. True
B. False

Answer B. False

C. Between points D and E, the opportunity cost of 1 pound of steak is 10 pounds of potatoes.

A. True
B. False

Answer A. True

D. Between points E and H, the opportunity cost of 1 pound of steak is 30 pounds of potatoes.

A. True
B. False

Answer A. True

E. New Carnitas’s production possibility frontier is consistent with the law of increasing cost.

A. True
B. False

Answer A. True

F. Point F is consistent with the full employment of available resources.

A. True
B. False

Answer B. False

G. Point E is consistent with the full employment of available resources.

A. True
B. False

Answer A. True
Explanation If New Carnitas is fully employing its resources, then to produce more steak it will have to shift resources away from the production of potatoes to the production of steak. Under these circumstances, New Carnitas must give up some potatoes to enable it to produce more steak. All points on the production possibility frontier satisfy this condition for the full employment of available resources.

The opportunity cost of producing one more pound of steak is the quantity of potatoes that must be given up to produce one additional pound of steak. In moving from point D to point E, 4 more pounds of steak are produced while potato production falls by 40 pounds. The opportunity cost of each pound of steak is 10 pounds of potatoes. Moving from point E to point H, 2 additional pounds of steak cost a total of 60 pounds of potatoes, or 30 pounds of potatoes per pound of steak. Since the amount of potatoes given up per pound of steak rises as the economy increasingly specializes in steak, the opportunity cost of steak production rises as more steak is produced. Thus, the economy exhibits the law of increasing cost, the principle that the opportunity cost of producing an item increases as more of it is produced.

Given available resources and technology, it is not possible for New Carnitas to produce combinations of steak and potatoes located outside the production possibility frontier, such as at points B and G. Only points on or inside the production possibility curve are attainable.

Question 8

Consider the graph.

Question08.jpg

According to the graph of the production possibilities frontier, what is the opportunity cost of the first widget?

A. about 1 widget
B. less than 0.5 gizmos
C. about 8 widgets
D. about 4 gizmos

What best explains the shape of the production possibility frontier in the graph?

A. Some resources used to produce one of the goods are not as productive when they are used to produce the other good.
B. Producers can move from one point to another on the production possibilities frontier in response to consumers’ demands.
C. The production of widgets and gizmos require the same resources to produce.
D. This economy has the capacity to produce different combinations of widgets and gizmos.

Hint The opportunity cost is whatever must be given up when a choice is made. In this case, it is the number of gizmos foregone when another widget is produced.
Answer B. less than 0.5 gizmos and A. Some resources used to produce one of the goods are not as productive when they are used to produce the other good. The oportunity cost of the first widget is the number of gizmos that must be forgone when the first gizmo is produced. To calculate this, compare the number of widgets produced after the first gizmo has been produced with the number of widgets produced when one fewer gizmo is produced.

Resources may not be equally productive in all applications. Factors of production specifically designed to produce widgets, for example, will probably not be as good at gizmo production as factors designed for that purpose. As the economy specializes, however, it will be forced to shift factors into the "wrong" sector. This means the opportunity cost will rise as either intercept of the production possibilities frontier is approached.

Question 9

The three fundamental questions are NOT concerned with:

A. how well the goods are made.
B. how resources are used to produce goods.
C. what goods should be produced.
D. who gets what is produced.

Hint The three fundemental questions all deal with production.
Answer A. how well the goods are made. The three fundemantal questions in economics are
  • What should be produce?
  • How should it be produced?
  • For whom should it be produced?

Question 10

Indicate whether each event described falls mainly in the field of microeconomics or that of macroeconomics.

Hint Microeconomics concerns decision-making by individuals operating within particular markets or segments of the economy.

Macroeconomics concerns the economy as a whole or aggregated sectors of the economy.

A. A tax on tires increases the price of tires paid by car owners.

A. Microeconomics
B. Macroeconomics

Answer A. Microeconomics

B. As a result of a severe recession, the total output, or gross domestic product, of a nation falls by 4 percent.

A. Microeconomics
B. Macroeconomics

Answer B. Macroeconomics

C. Increased consumer spending causes the national unemployment rate to fall.

A. Microeconomics
B. Macroeconomics

Answer B. Macroeconomics

D. Increased consumer spending causes the rate of inflation to rise.

A. Microeconomics
B. Macroeconomics

Answer B. Macroeconomics

E. Optimism about future car sales leads General Motors to hire more auto workers.

A. Microeconomics
B. Macroeconomics

Answer A. Microeconomics

F. Robotic technology reduces the demand for auto workers.

A. Microeconomics
B. Macroeconomics

Answer A. Microeconomics
Explanation Microeconomics is the field of study that deals with decision-making by individuals operating within particular markets or segments of the economy. This would include issues confined to the tire market and the market for auto workers.

Macroeconomics is the field of study that deals with the economy as a whole or with aggregated sectors of the economy. This would include issues related to total output, or gross domestic output, the national unemployment rate, and an increase in the general price level, or inflation.

Question 11

Select the best choice that completes each sentence.

________ statements say something about how the world ought to be.

A. Positive
B. Microeconomics
C. Normative
D. Macroeconomics

________ statements say something that describes how the world currently is.

A. Positive
B. Microeconomics
C. Normative
D. Macroeconomics

Hint Think of the different kinds of statements we can make and how they are based on the economic effect of decisions.
Answer C. Normative and A. Positive Economics looks at the function and use of decisions made in the economy using a mix of positive and normative statements. For example, economists may look at the way a change in the amount of welfare has affected the economy (positive statement). They may also look at the way the policy should be affecting the economy (normative statement).