Chapter 1 Limited Resources & Lower Production – Macroeconomics
This chapter is about Limited Resources and Lower Production – Principles of Macroeconomics.
A friend of yours has an interview with an economics consulting firm and has been asked to discuss a microeconomics topic. Which of the following topics would you recommend that your friend discuss?
what the Federal Reserve will do with interest rates
the study of how prices are determined in the baseball card industry – correct
how unemployment is falling in the national economy
what the next President will do to stimulate the national economy
Explanation: Microeconomics is the study of the individual units that make up the economy, such as households and businesses. The baseball card industry is a specific industry, so this is microeconomics. The other three topics involve the broader workings of the economy, and are macroeconomics.
A physician who hires a plumber to fix a broken toilet is an example of
comparative advantage. – correct
Explanation: Comparative advantage refers to a situation in which an individual can produce a good or service at a lower opportunity cost than another individual. The physician is specialized in dispensing medical advice. He or she would have to give up more time spent dispensing medical advice in order to fix a broken toilet than the plumber, who specializes in fixing toilets and has a lower opportunity cost (in terms of medical advice dispensed) for this task.
Alison goes to an all-you-can-eat restaurant. She has eaten three slices of pizza and is considering having another, but she is quite full from the first three slices. Alison’s consideration is an example of
marginal thinking. – correct
Explanation: Marginal thinking requires a decision-maker to weigh the benefits and costs of an additional unit of action, rather than the action as a whole. Workers employing marginal thinking make the decision to work another hour, for example. Using marginal thinking, Alison weighs the benefit of the extra slice of pizza (how much enjoyment she gets) against its cost (feeling bloated and sick).
Judy spent 8 hours studying for an exam. Normally, she would have spent that time watching TV instead of studying. She figures she could have made a “B” after only studying 4 hours, but she really wanted an “A.” What is Judy’s marginal cost in terms of TV viewing to improve her grade from a “B” to an “A”?
4 hours – correct
Explanation: If Judy feels that 4 hours of study would allow her to receive a B, and she studies 8 hours to get an A, then the marginal cost of the A is (8 hours – 4 hours) or 4 hours of additional study time. Marginal cost is the additional cost of consuming one more unit. In this case, one more unit refers to increasing a grade by one letter.
Suppose a student has 3 hours of time to spend at her apartment before afternoon classes. She has the option of doing laundry, studying for a test, or watching television. If she decides to do laundry, then her opportunity cost is
either watching television or studying for the test, whichever would have been her second choice to doing laundry. – correct
studying for the test.
watching television and studying for the test.
Explanation: Opportunity cost is the highest-valued alternative that must be sacrificed in order to get something else. In this case, we can't say which activity will be her opportunity cost since we don't know which activity the student prefers between watching television and studying for the test.
Suppose that Tegan is good at cooking but not very good at cleaning up the kitchen afterward and that Sara is good at cleaning kitchens but not very good at cooking. Which of the following statements is true with regard to Tegan and Sara?
Sara should cook and clean up the kitchen.
Sara should cook and Tegan should clean up the kitchen.
Tegan should cook and Sara should clean up the kitchen. – correct
Tegan should cook and clean up the kitchen.
Explanation: If Tegan decided to specialize in cooking, she could trade meals to Sara in exchange for having the kitchen nice and clean. This shows gains from specialization and trade. Both people have a comparative advantage in doing one particular task. Since both people can specialize in what they do best, they are able to produce more value than if they tried to do both things themselves.
The concept of scarcity in economics refers to
limited resources and limited wants.
unlimited resources and limited wants.
the fact that resources can sometimes be limited.
limited resources and unlimited wants. – correct
Explanation: Even the most abundant physical resources, like the water we drink and the air we breathe, are limited in their use. A particular cup of water, for example, can only be used for one purpose at a time. Scarcity refers to the limited nature of society's resources, given society's unlimited wants and needs.
The difference between the study of microeconomics and the study of macroeconomics is a difference between
the study of individual economic units and the study of aspects of the economy as a whole. – correct
the study of government policy and the study of the private sector.
individuals and families.
single individuals and large companies.
Explanation: Microeconomics is the study of the individual units that make up the economy, whereas macroeconomics is the study of the overall aspects and workings of an economy.
What is the term for the voluntary exchange of goods and services between two or more parties?
trade – correct
Explanation: Trade is the voluntary exchange of goods and services between two or more parties.
What role does money play in the circular flow model?
It increases the efficiency of a market. – correct
It increases the need for a barter economy.
It allows the households to bribe the firms into giving them what they want.
It increases the chances of having a double coincidence of wants other than money.
Explanation: Instead of bartering for goods and services, people use money to make transactions more likely since goods can be exchanged for money rather than only other goods. Money acts as a medium of exchange, enabling the economy to avoid the double-coincidence-of-wants problem.
You order a $20 sweatshirt online for a Father’s Day gift. The shipping charge is $10. You can get free shipping if your order totals $25 or more. Consequently, you order a $5 bobble head doll, even though neither you nor your father really likes bobble head dolls. This is an example of
incentives. – correct
Explanation: Spending $25 gets you free shipping. If shipping on the $20 item is greater than $5, you may find something else to buy for $5, even if it is something you may not want. This is an example of incentives, because the web site offers you an incentive to spend more in order to save on shipping costs.
Austin, Jensen, Matthew, and Walker can all produce matches, brushes, cans, and shirts. The table below identifies how many of each good they can make in a day if they devote themselves to producing only that good.
Who has the absolute advantage in producing brushes?
Walker – correct
Explanation: The person with the absolute advantage is the one who can produce the most output. In this case, Walker can produce more brushes than anyone else, so he has the absolute advantage.
Examine the two figures below. Which of these figures will experience a higher long-run growth rate, assuming their ratio of consumer goods to capital goods produced is constant over time?
Economy A, because it produces more consumer goods relative to capital goods.
Economy B, because it produces more capital goods relative to consumer goods. – correct
Economy B, because its ratio of consumer goods to capital goods produced is higher than Economy A’s ratio of consumer goods to capital goods produced.
It is not possible to tell from the information in the figures.
Explanation: Societies that invest a relatively larger percentage of their production into capital goods, which are a type of investment in future production, experience higher growth rates. The economy in Figure A produces more consumer goods than capital goods while the economy in Figure B produces an equal proportion of consumer goods and capital goods. So, the ratio of capital to consumer goods produced is higher in economy B, and consequently economy B's growth rate will be higher.
Click to view larger image.
Which of the following would lead to the situation shown in the figure above?
a reduction in the retirement age
a reduction in skills for workers who produce pizza and workers who produce wings
an improvement in technology for production of both pizza and wings – correct
an earthquake in the country
Explanation: With improvement in technology it is possible to produce more of both goods while using the same amount of labor. This will allow the PPF to expand outward. An earthquake would destroy resources and cause the PPF to shrink inward. A reduction in retirement age would lower the size of the labor force, lower production, and cause the PPF to shrink inward. A reduction in worker skills would decrease the human capital available, decreasing production for workers and causing the PPF to shrink inward.
Mike has a linear production possibilities frontier that shows maximum production of trucks or computers of 10 million each. Debra also has a linear production possibilities curve that shows maximum production of 9 million trucks or 3 million computers.
Mike has a comparative advantage in the production of computers. – correct
Debra has an absolute advantage in the production of trucks.
Debra has an absolute advantage in the production of computers.
Debra has an absolute advantage in the production of computers.
Explanation: Mike has an absolute advantage in both goods. That means he can produce more than Debra using the same quantity of resources. From the graph, you can see that Mike has a lower opportunity cost in producing trucks; he gives up one truck for each computer he produces, while Debra gives up three trucks for each computer she produces. Mike has a comparative advantage in producing computers but not in producing trucks.
Suppose that a politician wants to build more production facilities for solar power and wind power. At the same time, the politician is unwilling to cut any other programs. If the resources that would be used to produce the solar and wind power facilities are already being efficiently used in other programs, where is the point the politician is trying to reach located on the production possibilities frontier?
this point does not exist
a point inside the frontier
a point on the original frontier
a point outside the frontier – correct
Explanation: If the resources are already being efficiently used in other programs (and the politician cannot raise the funds from another source), then it will be impossible to build additional facilities given the existing technology and resources available. The politician could build more wind and solar power facilities, but not without decreasing production of one or more of the goods currently in production. Producing more wind and solar power facilities without decreasing current production requires more resources or technology, represented by a point outside of the current PPF.
Suppose workers attend several skill-building workshops, increasing their labor productivity. How is this represented by a production possibilities frontier?
The entire PPF shifts out. – correct
The economy moves from a point below the PPF to a point on the PPF.
The entire PPF shifts in.
The economy moves from a point on the PPF to a point beyond the PPF.
Explanation: If workers become more skilled they can produce more goods. An increase in skills is an increase in human capital, a resource and input in the production of goods. When resources increase, the entire PPF shifts out.
When a student is making a decision about the college she will attend, which of the following would be an endogenous factor?
location of the school – correct
the national unemployment rate when she graduates
the school being wiped out by a natural disaster
death of a family member requiring the student to return home for a semester
Explanation: Endogenous factors are things you can plan for and take into consideration before going to a college, such as the location and price of tuition. Exogenous factors cannot be accounted for before you begin your education at a particular college because they are not related to the college you choose.
Where is unemployment such that employment is below the full-employment level plotted on a production possibilities frontier?
a point beyond the PPF
a point inside the PPF – correct
a point on the PPF
It will depend on how much unemployment exists, because the point could be on or inside the PPF.
Explanation: Unemployment is represented by points inside the frontier where resources are not being used efficiently. All points on the PPF are points at which the economy is at the full-employment level of employment.
Where would you plot full employment on a production possibilities frontier if all other resources are being used efficiently?
a point on the PPF – correct
a point below the PPF
It will depend on how much full employment exists; the point could be on or inside the PPF.
a point beyond the PPF
Explanation: Full employment is a characteristic of all points on the production possibilities frontier. For all points on the PPF, all resources available are being used efficiently.
Which of the following is an example of a positive economic statement?
The poor should pay more taxes and the rich should pay lower taxes toward social security.
The Kardashians should not be allowed to be on television.
The average rainfall in August 2016 was 5 inches nationwide. – correct
Congress should devote more resources to the environment.
Explanation: In economics it is important to avoid letting personal beliefs and values influence the outcome of analysis. To be as objective as possible, scientists will use positive statements, which can be tested and validated. The statement about average rainfall is something that can be validated. All other statements are normative, which have embedded value judgements.
Which of the following statements is consistent with Jonathan having a comparative advantage in producing apples?
Jonathan can sell apples at a lower price than anyone else and still make a profit.
Jonathan’s opportunity cost for producing apples is lower than anyone else’s. – correct
Jonathan can produce more apples (by weight) than anyone else.
Jonathan can produce more apples (by volume) than anyone else.
Explanation: The person with the comparative advantage is always the one with the lowest opportunity cost. This means Jonathan has a comparative advantage in producing apples if he gives up less production of other goods when he produces apples.
Which of the following would be consistent with taking the short-run approach to decision-making?
Studying for an economics test instead of going to a party
Going to the gym instead of watching TV
Eating a salad for dinner when it is your goal to eat healthily
Buying a new leather jacket instead of saving for retirement – correct
Explanation: In the short run, the individual is valuing the present over the future. Purchasing a leather jacket instead of saving for retirement is valuing future consumption over the value of the initial savings and the return on that savings in the long run
A recent study shows the benefits of using public transportation. Government officials have hired your consulting firm to increase the demand for public transportation. They come to you with three of their suggestions.
Suggestion 1. Reduce the price of public transportation.
Suggestion 2. Increase the price of private transportation by increasing tolls.
Suggestion 3. Offer monthly and yearly passes that reduce the price paid per ride of public transportation.
Which suggestion(s) does your firm recommend?
1 and 3
2 – correct
Explanation: Increasing the price of private transportation, a substitute good, will increase demand for public transportation. Your recommendations should be made on the basis of demand increasing, not quantity demanded increasing. Ask yourself, which variable(s) changes quantity demanded and which variable(s) changes demand?
According to the Food and Drug Administration, “…the ultraviolet (UV) radiation from these devices [sunlamps and tanning beds] poses serious health risks.” As a result of reading this, the local mayor decides to introduce legislation that will put a 10% excise tax on tanning consumers. From an economic point of view, this will
shift the demand curve leftward for tanning. – correct
shift the demand curve rightward for tanning.
shift the supply curve rightward for tanning.
move down along the demand curve for tanning.
Explanation: The excise tax lowers demand because consumers must now pay a higher tax in addition to the price they pay for the good. People will tan less because they now have to factor in the extra cost. This will be shown as a leftward shift of the demand curve.
As the owner of a hotel, you have decided to lower the price for all rooms in the month of October. What should you expect to happen?
As the price is lowered, demand for rooms will increase.
As the price is lowered, the demand for rooms will decrease.
As the price is lowered, the quantity demanded of rooms will decrease.
As the price is lowered, the quantity demanded of rooms will increase. – correct
Explanation: The law of demand states that quantity demanded will increase when price is lowered, all things being equal. In this case, more rooms will be sold. If only the price changes, apply the law of demand.
Businesses across the country are starting to install extra insulation in their buildings and warehouses. Households are now deciding to install more insulation as well. Which of the following outcomes would you predict will happen to the market for oil?
Equilibrium price will decrease and quantity will increase.
Equilibrium price will increase and quantity will decrease.
Equilibrium price and quantity of oil will increase.
Equilibrium price and quantity of oil will decrease. – correct
Explanation: Increased insulation will decrease the demand for heating oil. The demand curve for oil will shift leftward, leading to a decrease in the equilibrium price and quantity of oil.
Candy makers face high prices for cocoa butter, the special ingredient that gives chocolate its melt-in-the-mouth texture. This event will be shown in
Graph D. – correct
Explanation: Since the cocoa butter is an ingredient in the production of chocolate, the change in the cost of this ingredient will affect the supply curve. Since the cocoa butter is more expensive, it will lower profit margins for firms, and the supply curve will shift. The demand curve does not shift, because ingredient cost does not shift the demand curve.
In order to ensure that as many individuals as possible install a smoke detector, the government recently decided to subsidize the production of smoke detectors.
Click to view larger image.
Which of the graphs above demonstrates the change in the market for smoke detectors?
Graph B – correct
Explanation: The government wants households to be able to afford smoke detectors and to encourage the production of smoke detectors. As a result, subsidizing the industry and shifting the supply curve rightward will have the effect of lowering the equilibrium price and increasing the equilibrium quantity.
The market for breakfast cereal is currently in equilibrium. Suddenly there is a storm that destroys the wheat that farmers had been growing for the cereal manufacturer. What will happen to the cereal market after the storm?
Supply will increase.
Supply will decrease. – correct
Demand will increase.
Demand will decrease.
Explanation: A storm that destroyed the wheat crops would cause the price of that grain to rise. Given that grains are an important input in the manufacture of cereal, the rise in the price of grain represents an increase in input prices for cereal. This is represented in the cereal market as a leftward shift of the supply curve and no change in the demand curve.
There are a number goods that over time, for a variety of reasons, transition from being a normal good to an inferior good or from being an inferior good to a normal good. One such example of a good is the Toyota Camry. In the 1980s,more income for a household usually resulted in more Camrys being purchased. However, today more Toyota Camrys are purchased by households that have experienced a reduction in income.
How could this happen?
The Camry becomes a normal good because the good is now perceived as lower in quality than a Lexus.
Households have already purchased enough Camrys so income has little impact.
The Camry becomes an inferior good because the good is now perceived as lower in quality than a Lexus. – correct
The Camry becomes an inferior good because as consumers receive more purchasing power, they purchase more of the product.
Explanation: A normal good like a Camry can become an inferior good if it is perceived to be a lower quality good. What causes a person with more income to buy less of a product?
Which of the following will cause an increase in the supply of yogurt?
An increase in the costs of producing yogurt
An increase in tax on the sale of yogurt
An increase in the price of yogurt
An increase in the number of sellers in the market for yogurt – correct
Explanation: An increase in the supply is shown as a rightward shift of the supply curve. An increase in the number of sellers will lead to an increase in market production, and as a result, will shift the supply curve to the right.
You advise the owner of a local restaurant to lower the prices of his burgers. Which of the following is a consequence of this price change?
More people will cook burgers at home.
There is a decrease in demand for the restaurant burgers.
There is an increase in the demand for burgers.
There is an increase in demand for fries. – correct
Explanation: Since fries are a complement for burgers, lowering the price of the burger will increase demand for fries. Fewer people will cook burgers at home, because cooking burgers at home is a substitute good for getting burgers at a restaurant. Reducing the price of a burger will increase the quantity demanded, but will not shift the demand curve.
You are a producer of tortillas. In the market for tortillas, two events happen simultaneously: there is a decrease in the price of corn used to make your tortillas, and there are headlines that promote the link between eating tortillas and reducing heart attacks.
Which of the following is a consequence?
There is a decrease in the price of tortillas and an increase in the quantity of tortillas.
There is a decrease in the price of tortillas and a decrease in the quantity of tortillas.
We know the quantity will increase, but we don’t know what will happen to the price unless we know the size of the shifts. – correct
There is an increase in the price of tortillas and a decrease in the quantity of tortillas.
Explanation: The cost of making tortillas has decreased due to a cheaper ingredient, so the supply of tortillas will increase. The headlines linking lower rates of heart attacks with consumption of tortillas will increase the demand for tortillas. Both of these changes increase the equilibrium quantity of tortillas. To determine whether price will increase or decrease, we need to know whether the shift in supply or the shift in demand is greater.
You find out that the local Walmart is having a huge sale on Mountain Dew. You rush down with the intent of buying as much Mountain Dew as you can. This would be shown as
a shift rightward of the demand curve for Mountain Dew.
a shift rightward of the supply curve for Mountain Dew.
a shift leftward of the demand curve for Mountain Dew.
a movement along the demand curve for Mountain Dew. – corrrect
Explanation: Since the sale involves a reduction of the price, you are going to be staying on your original demand curve, and moving to a lower point. This is a change in quantity demanded and a movement along the curve. If your purchase behavior were changing due to health concerns, for example, this would be shown as a shift of the demand curve.
You’re an entrepreneur and had a great idea to sell shoes that have springs installed in them to make walking easier. However, the development costs were so high that the shoes are priced 15 times higher than shoes without springs. As a result, many of the shoes have gone unsold.
What possible event could eliminate the disequilibrium in the market for shoes?
There is an increase in income and “spring shoes” are an inferior good.
There is an increase in income and “spring shoes” are a normal good. – correct
There is a decrease in the price of rubber, which is an input in the production of shoes.
A study reveals that shoes with a spring can increase the chance of a broken leg.
Explanation: When there are too many spring shoes available, what is revealed is a surplus, where quantity supplied is greater than quantity demanded. On a graph, a surplus is illustrated with a horizontal line above the equilibrium point. The surplus can be removed as quantity demanded increases or when quantity supplied falls. In this case, an increase in income increases the demand for normal goods like spring shoes, thus removing the surplus.