Chapter One The Central Idea Economics is

Chapter One The Central Idea

Economics is the study of how people deal with scarcity – Scarcity: Situation in which the quantity of resources is insufficient to meet all wants (not enough stuff for our wants) – Leads to CHOICES: Must give up one thing in favor for another Economic interaction is the exchanges of goods and services between people These interactions can occur in a MARKET – an arrangement where economic exchanges between people take place

Consumer Decisions Opportunity Cost: Value of the next-best alternative that was not chosen Gains from Trade: Improvements in income, production, or satisfaction owing to the exchange of goods or services – Important: Voluntary trade only happens if BOTH parties gain. – Does not change total amount of goods, just redistributes or reallocates

Figure 1. 1: Gains from Trade Through a Better Allocation of Goods

Consumer Decisions Emily Poet Johann Printer Write Full Time Write and Print Cards 0 1 10 1 Poems 10 1 When acting alone, Emily and Johann can only produce 1 card each (2 total) If they sell their services to each other, they can produce 10 total cards They BOTH gain from trade

Consumer Decisions Specialization: People concentrating on what they are good at Creates a DIVISION OF LABOR: workers concentrate on different tasks Comparative Advantage: A situation where a person can produce a good for a lower opportunity cost than another person. – When people specialize where they have a comparative advantage, overall production is increased International Trade: Exchange of goods or services between people in different countries

Scarcity and Choice for the Economy as a Whole Consumption vs. Movies Computers 0 25, 000 100 24, 000 22, 000 300 18, 000 400 13, 000 500 0 Investment Opportunity cost of producing 200 movies instead of 100 movies is 2, 000 computers OC of making 300 movies instead of 200 movies is 4, 000 computers OC of making 400 movies instead of 300 is 5, 000 computers OC of making 500 movies instead of 400 is 13, 000 computers

Production Possibilities Movies Computers 0 25, 000 100 24, 000 22, 000 300 18, 000 400 13, 000 500 0 Because OC continues to go up as we make more movies, it is called INCREASING opportunity cost

Figure 1. 2: The Production Possibilities Curve

Production Possibilities Curve Bows out because of increasing opportunity cost of producing movies – each move causes a more dramatic fall in graph Points of line: EFFICIENT Points under or to the left of line: INEFFICIENT Points over or to the right of line: IMPOSSIBLE

Figure 1. 3: Shifts in the Production Possibilities Curve

Shifts in the PP Curve Shift out, up, right means increase in production, due to things like more workers or developing technology Doesn’t need to be a uniform shift Impossible points are not “forever” impossible

Figure 1. 4: Shifts in the Production Possibilities Curve Depend on Choices

Market Economies and Price Systems Market Economy: An economy where prices are freely determined and goods and services can be traded freely in markets – Examples: United States, Mexico, Australia Command Economy (Centrally Planned Economy): An economy where the government determines prices and production – Examples: Soviet Union, China Market Economies are more productive, so most of the world is trying to convert

Key Elements of a Market Economy Freely Determined Prices – Leads to inefficiencies. Example – feeding bread to cows in the Soviet Union Property Rights and Incentives – Property rights give people control over their assets – Incentives are devices used to motivate people to take action, usually increasing productivity Freedom to Trade both home and abroad

Key Elements of a Market Economy, continued A Role For Government – How much involvement should government have? Police? Education? Welfare? – Market Failure: Market is inefficient, potential for government involvement – Government Failure: Government made things worse Role of Private Organizations – Organizations exist to reduce transaction costs (costs of buying and selling)

The Price System Signals – As demand increases, prices increase therefore “signaling” that there needs to be more workers, more production, etc. Incentives – If more money is entering an industry, more firms will enter. In contrast, it will hurt competing industries. Distribution – Workers in “hot” industries earn more, while competing industries’ employees will earn less.

Answers to Text Problems 1. The limited budget for guest speakers means that you can either bring in Spike Lee for one lecture or have ten lectures by former economic advisers. As a resource, Spike Lee is scarcer than former economic advisers are, and therefore his price for a lecture is much higher. The scarcity represented by the limited budget means that either Spike Lee or former economic advisers can be invited to speak, and therefore a choice must be made. It is necessary to consider how many people will attend the lecture and what those people will prefer. To determine whether the money is better spent on Spike Lee or former economic advisers, you have to compare the additional satisfaction per dollar spent on Spike Lee versus the former economic advisers.

Answers to Text Problems 2. The opportunity cost of attending one more year of school is the income given up by not working over that year. So, in a sense, the cost of any additional year of school for each graduate is the same: lost income. However, the income one can earn increases with the attainment of higher levels of education. Therefore, the opportunity cost (income given up) of one year of school for the medical school graduate will be larger than the opportunity cost of the college graduate. Of the three graduates, the high school graduate has the smallest opportunity cost of an additional year of education.

Answers to Text Problems 3. The opportunity cost of any choice is the next-best or second-best alternative given up. Allison's opportunity cost of ranking the consulting job first is not being able to attend a local community college. The third alternative involving world travel has nothing to do with the opportunity cost of consulting. An opportunity cost is the nextbest alternative given up.

Answers to Text Problems 4. Assuming that people like salt and pepper to season food, both of us are better off if we trade one salt shaker for one pepper shaker. We both gain from a better allocation. There is no production going on in the question. We both lose if trade is prevented, not just the one person in the country that does not allow trade.

Answers to Text Problems 5. A. Tina is producing 30 units of salsa and Julia is producing 15 units of salsa. Total production is 45 units of salsa and 4 advertisements. B. Gains from trade are possible because they have different comparative advantages. This is to say, they have different relative efficiencies in the production of salsa and advertisements. C. Total production will be 5 ads and 50 units of salsa per week.

6. Answers to Text Problems B. The opportunity cost of increasing the time spent on math from 80 to 100 percent is 50 points on the English paper, a decrease in the English grade from 50 points to 0 points. The opportunity cost of increasing the time spent on math from 60 to 80 percent is 20 points on the English paper, a decrease in the paper's grade from 70 points to 50 points. C. There are increasing opportunity costs from spending more time studying math. This is because additional time spent on one subject takes away from the time available for the other subject, and time taken away from that subject becomes increasingly valuable when less time is available for that subject. D. Given the figures in the chart, there is no distribution of time between English and math that will create a grade of 92 on both. Therefore, the tradeoff curve needs to shift to the right. This might occur due to learning new study techniques.

Answers to Text Problems 7. A. B. PPF shifts out mainly in the production of cars. This is seen in the dashed line in the figure.

Answers to Text Problems 8. Japan had a high rate of saving relative to the United States, emphasizing investment more than Americans. As you can see in Figure 1. 3 in Chapter 1, higher investment results in a more rapid growth of the country's production possibilities curve. The consumption and investment decisions of past Japanese generations allow the current generation to enjoy a higher quantity and diversity of goods.

Answers to Text Problems 9. First, if Huey is not very efficient (inside his PPF) at either studying or having fun, Tracy may help with both by helping Huey be more efficient at having fun and studying. Huey would move toward his PPF. Second, if Huey is efficient (on his PPF), Tracy may know something new about how to study and how to have fun. Here, Huey's PPF shifts outward. In either case, Huey is not being efficient. Figure 1 -3 shows how Huey's economics grade could be increased without affecting his grade in mathematics starting from an inefficient situation.

Answers to Text Problems 10. Neither the country that sets prices nor the country that tries to adjust prices daily is a market economy. A market economy has prices determined in a free market through the interaction of self-interested buyers and sellers.

Answers to Text Problems 11. Oil is bought and sold on a world market. A higher price tells U. S. producers that their oil is more valuable and encourages them to increase production. The higher price redistributes income away from consumers of oil toward producers of oil.

Answers to Text Problems 12. Nearly any good and service can be put into the sentence to produce a true statement. The statement will not work, however, in the case of some public goods (for example, national defense); goods that involve externalities (such as clean air); services in which the transport costs are prohibitive (haircuts); goods and services that are explicitly illegal (illicit drugs); or human beings themselves (that is, slavery is illegal).

Chapter Review 1. The _______ of a choice is the value of the foregone alternative that was not chosen. A. Comparative advantage B. Production possibility C. Opportunity cost D. Gain from trade

Chapter Review 2. Specialization in production results in _______. A. B. C. D. gains from trade division of labor increasing opportunity costs comparative advantage

Chapter Review 3. The ________ is the price of money in terms of another. A. trade rate B. exchange rate C. medium of exchange D. comparative rate

Chapter Review 4. The two major types of economies are _______ and ______ economies. A. multilateral, command B. central, planned C. market, government D. market, command

Chapter Review 5. In a market economy, prices serve as ________, provide _______, and affect the ________. A. B. C. D. signals, incentive, distribution of income, signals, incentive signals, distribution of income, incentive, signals, distribution of income

Chapter Review 6. Scarcity is a characteristic of a command economy, but not of a market economy. A. True B. False

Chapter Review 7. If Canada produces two goods with less resources than the United States, there can be no comparative advantage in those two goods. A. True B. False

Chapter Review 8. The production possibilities curve slopes downward. A. True B. False

Chapter Review 9. A market economy is also called a centrally planned economy. A. True B. False

Chapter Review 10. Freely determined prices and property rights are characteristics of centrally planned economies. A. True B. False

Chapter Review 11. When one person or group of people can produce one good relative to another good with comparatively less time, effort, or resources than another person can produce that good, this is called A. B. C. D. comparative advantage. specialization. opportunity cost. division of labor.

Chapter Review 12. When more than two people engage in trade, it is called A. international trade. B. multilateral trade. C. gains from trade. D. comparative advantage.

Chapter Review 13. The production possibilities curve A. slopes downward and is bowed out from the B. C. D. origin. slopes upward and is bowed out from the origin. slopes downward and is bowed in toward the origin. slopes upward and is bowed in toward the origin

Chapter Review 14. Points outside the production possibilities curve are A. efficient. B. inefficient. C. impossible. D. possible.

Chapter Review 15. Economic growth causes A. an inward shift in the production possibilities B. C. D. curve. an outward shift in the production possibilities curve. an upward movement on the production possibilities curve. a downward movement on the production possibilities curve.

Chapter Review 16. The price that one department of an organization must pay to receive goods and services from another department in the same organization is called a(n) A. B. C. D. transfer price. transaction cost. opportunity cost. transaction price.

Chapter Review 17. Which of the following is NOT one of the important roles of prices in a market economy? A. B. C. D. They serve as signals. They provide incentives. They form preferences. They affect the distribution of income.

Chapter Review 18. If the economy devotes all of its resources to steel production, it will be producing at point a. A b. B c. H d. G

Chapter Review 19. Point F in the diagram represents a. b. c. d. an efficient production level. an inefficient production level. an impossible production level. a possible production level.

Chapter Review 20. If the economy is currently producing at point E, then A. B. C. D. it is utilizing its resources efficiently. it is utilizing its resources inefficiently. it is on its production possibilities curve. it is beyond its production possibilities curve.

Problems 1. Sharon has only thirty dollars to spend for her weekend entertainment. She can go to a college football game for thirty dollars, or she can go to the movies for ten dollars. Explain the problem of scarcity and choice in this context. What will Sharon consider as she decides whether to go to the football game or the movie?

Answer The scarcity represented by the limited budget means that Sharon can either go to the football game, or the movies three times, and therefore a choice between them must be made. Sharon will consider how intense her preferences are to see the football game and compare this to the ticket price. She will compare the additional satisfaction per dollar spent on the football game versus going to the movies.

Problems 2. Compare the opportunity cost of one more year of college versus for one year for (1) a factory worker earning $15, 000 a year, (2) an engineer earning $60, 000 a year, and (3) a computer programmer earning $100, 000 a year.

Answer One of the opportunity costs of one more year of college is the yearly earning one has to give up in order to attend college. Therefore, the opportunity cost is higher for the computer programmer than that for the engineer, which in turn is higher than that for the factory worker.

Problems 3. John is a high school student. He has ranked his 3 options of what he can do during the Christmas school break in the following order: (1) work in a fast-food restaurant full time and earn $2, 000, (2) work in a department store for the first two weeks of the break and earn $1, 000 and spend the rest of the break traveling, (3) work in his father’s shoe factory full time and earn $1, 500. What is the opportunity cost of his choice?

Answer John’s first choice is to work full time in a fast-food restaurant. His next best opportunity is working for part of the Christmas break and traveling for the remainder of the break. Therefore, the opportunity cost of his first choice is the $1, 000 he would have received from working in a department store as well as the time he could have used for traveling.

Problems 4. Suppose you have two hotdog sausages and a friend of yours has two hotdog buns. Explain how you can both gain from trade. Is this gain from trade through better allocation or greater production? Suppose now that your friend lives in another country, whose government does not allow trade between countries. Who would lose as a result of this trade barrier?

Answer You can trade one of your hotdog sausages for one of your friend’s hotdog buns. As a result, both you and your friend can gain from the exchange. This gain is through better allocation rather than greater production. If trade between you and your friends is prohibited, then both you and your friend would lose.

Problems 5. Suppose Ashley and Allison can produce the following combinations of pizza and cakes in a day: A. If Ashley and Allison are both currently producing 2 pizza pies per day, how many cakes are they producing? What is the total production of pizza and cakes between them? B. Is there a possibility for increasing production? Why or why not? C. Suppose that Ashley completely specializes in producing pizza and Allison completely specializes in producing cakes. What will be the total production of pizza and cakes?

Answer A. Ashley is producing 3 cakes and Allison is producing 6 cakes. Total production— 4 pizza pies and 9 cakes. B. Gains from trade are possible because they have different comparative advantage—different relative efficiencies in the production of pizzas and cakes. C. Total production will be 5 pizza pies and 10 cakes per day.

Problems 6. Suppose one country is relatively efficient at producing software and another country is relatively efficient at producing TV sets. Will specialization and trade between these two countries increase the total production of the two countries?

Answers Specialization and trade between two countries will increase the total production of the two countries because shifting production toward the good in which they are relatively efficient will increase the total world production of both goods.

Problems 7. Suppose you must divide your time between studying for your biology final and writing a final paper for your economics class. The time and the grades in the two classes are as follows: A. B. C. Draw a tradeoff curve for the biology grade versus the economics grade. What is the opportunity cost of increasing the time spent on biology from 60 to 80 percent? What is the opportunity cost of increasing the time spent on economics from 80 to 100 percent? Are there increasing opportunity costs from spending more time on biology? Explain.

Answer A. A tradeoff curve for the biology grade versus the economic grade is as follows: B. 20 points on the biology grade; 45 points on the economics grade. C. There are increasing opportunity costs from spending more time on biology because as more time is spent on biology, an increasing number of economics points must be given up.

Problems 8. A small country produces only two goods, CDs and T-shirts. Given its limited resources, this country has the following production possibilities: A. Draw the production possibilities curve. B. Suppose this country improves its technology for producing CDs, but technology remains the same for the production of T -shirts. What happens to the production possibility curve? How does this change affect the opportunity cost of increasing T-short production?

Answer A. B. The production possibilities curve shifts out in the direction of CDs, but the total quantity of T-shirts that can be produced remains the same. This change causes the production possibilities curve to be flatter when CD production is on the horizontal axis, and therefore decreases the opportunity cost of increasing CD production.

Problems 9. Look at the diagram below. What is the opportunity cost of moving from point B to point A? What are some ways in which the economy can move out of the inefficient area inside the production possibilities curve?

Answer There is no opportunity cost of moving from B to A because it is a move from inside the production possibility curve to a point on the production possibility curve. The economy can do this by increasing its use of resources and employing more of its capital and labor.

Problems 10. Suppose two countries initially have the same endowment of resources and are both able to produce computers and clothing. Computers represent investment and clothing represent consumption. Suppose one country chooses a combination that has more computers than the other. How do you think the production possibilities curves will differ in the future?

Answer The country that chooses more of the investment good will have its production possibilities curve shift out further than the other country’s production possibilities curve.

Problems 11. Susan the professor can spend her time doing research or preparing lectures. What is the opportunity cost of her spending time doing research? As Susan spends more and more time doing research, there are increasing opportunity costs. Why?

Answer 11. The opportunity cost is the value of the next best forgone alternative that was not chosen because Susan decided to do research. If this next best alternative is preparing lectures, the opportunity cost of research is the amount of lecture preparation she could have done with time allocated to research. The more time devoted to research, the less time that is allocated to teaching, the higher the value of the time allocated to teaching.

Problems 12. Suppose the government in a hypothetical economy is responsible for setting prices. Explain why, regardless of how the government sets prices, this cannot be a market economy.

Answer In a market economy prices are freely determined by many buyers and sellers. For this to work, prices cannot be set by a single entity such as the government.

Problems 13. Suppose increased production of VCRs in Asia causes the price of VCRs to decline all over the world. Explain how this change in the price signals information to U. S. producers, provides incentives to U. S. producers, and affects the distribution of income.

Answer A decrease in the price of VCRs signals U. S. producers that VCRs are now less scarce. A lower price decreases profits, thereby providing incentives for U. S. producers to produce fewer VCRs. It also redistributes income away from U. S. producers and toward consumers.

Problems 14. Explain how a market economy works to enable the production and allocation of surfboards.

Answer Prices in the surfboard market are free to vary; people have property rights to the surfboards they buy; many people sell surfboards; the government does not regulate the use of surfboards; and surfboard production takes place within firms with many workers. A higher price, for instance, will allocate surfboards to the serious surfers and away from the casual surfers.

Activities 1 2 3 4 5 6 7 8 Multiple Choice Questions, Short Free-Response Questions, Long Free-Response Questions

Activity 1 1. False – Sunshine isn’t scarce because it isn’t limited; it is a free good. 2. False – Polio isn’t scarce because it is desirable. 3. False – Scarcity is a relative, not an absolute, concept. Because resources are scarce and wants are unlimited, almost everything is scarce. If you pay an opportunity cost to use a good or service, it is scarce. If you pay a positive price for a good or service, it is scarce. Water may cover three-fourths of the earth, but we pay an opportunity cost and a positive price for clean water everywhere. Of course, water may be scarcer in the deserts than in the wetlands. Only a government can actually make water cheaper in a desert.

Activity 1 4. False – An important opportunity cost of going to college is lost earning. If you could earn $20, 000 a year by working, you will sacrifice $80, 000 during four years of college. 5. False – If all other things are equal, less mass transportation will be purchased if the price is higher. The price could be increased in terms of dollars, inconvenient schedules, crime and filthy cars. The demand curve for transportation would have to be perfectly inelastic, or vertical, for the answer to this question to be True.

Activity 1 6. False – The price of something depends on supply and demand, not on usefulness or on some criterion of quality. Water is more useful than diamonds, but it has a lower price. What you pay for a good or service depends on the market price determined by supply and demand.

Activity 1 7 & 8: False – When people trade voluntarily, both parties expect to gain, or they wouldn’t trade. One reason for this gain is the law of comparative advantage. If one person does legal work better than another and if a second person word-processes documents better than the first, they would gain by trade. But would a lawyer who is the fastest word processor in town hire a secretary? Yes, because of comparative advantage: Each person would specialize in what he or she does comparatively better. An hour spent word processing is an hour not spent in legal work, and the opportunity cost for the lawyer would be very high. The lawyer will specialize in legal work and the secretary in word processing. The total output of goods and services will increase. This concept can also be applied to countries.

Activity 1 9. False – A monopoly charges a higher price than a competitive market price, but the monopolist cannot repeal the law of demand. If the price is too high, the monopolist might sell nothing. A monopolist will try to establish a price at a point that will make the greatest profit. This price is higher than a competitive price and will result in less production.

Activity 1 10. False – Profits are an incentive for business to succeed. A business that doesn’t care about its customers will not make high profits. As Adam Smith said, “It is not from the benevolence of the butcher, the brewer or the baker that we expect our dinner, but from their regard for their own interest. We address ourselves not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages. ”

Activity 2 1. a. b. c. d. 2. a. b. c. d. Two Two Constant Two Four Six Increasing

Activity 2 Figure 2. 3: Bowed out Production Possibilities Curve Figure 2. 4: Vertical Production Possibilities Curve Figure 2. 5: Downward sloping, straight Production Possibilities Curve

Activity 2 3. BD’ 4. AA’ 5. CC’ 6. It is impossible for a country by itself to attain with existing resources and technology. 7. The economy is not fully using existing resources and technology. An example of point Y is the Great Depression of the 1930 s.

Activity 2 8. New resources are discovered. New technologies are developed. 9. Resources are not being fully employed. 10. The government might want to emphasize the production of capital goods so the economy would grow more in the future. This would shift the PPC outward in the future.

Activity 3 A. You decide to go to college 1. Explicit Costs: Tuition, Books, Travel 2. Implicit Costs: Income not earned, Less job experience B. You take a job after school – Explicit Costs: Work clothes, Meals, Transportation – Implicit Costs: Less Studying, Less Social Time

Activity 3 C. You study for and take an AP Economics Examination – Explicit Costs: Cost of AP Economics Books, Cost of AP Economics Exam – Implicit Costs: Money earned from part-time job, Less social time, Less study time for other courses

Activity 3 D. A stay-at-home dad returns to work 1. Explicit Costs: Work clothes, Taxes, Child-Care Expenses 2. Implicit Costs: Less time with family, Less time for recreation

Activity 3 E. Family members work in their parents’ restaurant A. Child’s (employee) viewpoint: 1. Explicit Costs: Taxes, Work Clothes 2. Implicit Costs: Lower pay than elsewhere, Less time for study, Less time for recreation B. Parents’ (employer) viewpoint: 1. Explicit Costs: Payroll Taxes, Wages for Child 2. Implicit Costs: Less flexibility in hiring and firing, More complex relationship with child

Activity 3 A. You decide to go to college: Consider the benefits of a college education to be your expected extra future income, growth in knowledge and social development. A decision to attend college occurs when the expected explicit and implicit costs are less than expected benefits. If income were the only criterion, individuals who drop out of college to become star professional athletes may have concluded that the costs of missing a professional sports career exceeded the anticipated future income from becoming a better educated, but nonstarring, individual in a career outside of sports.

Activity 3 B. You take a job after school: Working after school may supplement family income, but it normally increases the disposable income of the high school student. More disposable income benefits the income earner. Choice of hours, however, can make the benefits exceed the costs. Total benefits may exceed total costs, even when the cost of an additional hour of work per week exceeds the benefit of the additional hour of work. But the economic way of thinking causes the person to adjust work so the extra benefit from the extra hour just matches the extra cost. If this extra hour of work causes the worker to earn a lower grade in a class, total benefits of work may exceed total costs of work; but the marginal costs of that extra hour of work greatly exceed the marginal benefits of the extra income.

Activity 3 C. You study for an take an AP Economics Examination: While the benefits of studying for an AP Economics exam are self-evident, there are costs that most students can list in a minute. AP Economics students may take other AP tests, so the management of study time becomes a crucial factor in mastery of all the tests. Marginal decisions determine time allocation among the subject areas: When an extra hour spent on economic adds more expected score points than an hour spent on chemistry, the student spends the hour studying economics.

Activity 3 D. A stay-at-home dad returns to work: Stay-athome parents sacrifice money income. This stay -at-home dad concluded that the benefits of working for a living exceeded the lost benefits of staying at home. Lost benefits could be explicit in the form of lower or no public-assistance payments. Implicit lost benefits involve control over use of time, ability to bond with and teach children, and the ability to have household chores done without paying someone else. Explicit new costs will include payroll taxes, possibly income taxes, commuting costs, childcare expenses and costs of work clothes.

Activity 3 E. Family members work in their parents’ restaurant: This is the toughest scenario of all. Family decision making frequently follows tradition rather than market criteria. A student may work in a family business that is not the best fit for either the family or the student “just because” other generations worked there. At the other extreme, knowing the business and feeling a sense of ownership in it may bring out the finest service possible from a young worker. Either scenario carries costs and benefits. The student works to earn family approval, and this approval is worth more than the perceived costs. Adult members of the family business may want their high school children to sharpen their work ethic. The business may absolutely need the family members to assist as part of family tradition or because a family member has higher productivity than a stranger. Some family restaurants hold secret recipes that are not entrusted to anyone beyond the family. Both parties – the employee and the employer – must conclude that the benefits of working exceed the costs, or family labor services will not be purchased.

Activity 4 1. Because the supply of parking spaces is limited, the scare goods must be allocated among people who want parking spaces. 2. Tradition, Command, and the Market

Activity 4 Leave things as they have been: Tradition First-come, first-served: Tradition and Command Markets and a Price System: The Market Democracy: A political solution, which is Command Random Choice: Command with some market because of reselling

Activity 4 Leave things as they have been: Faculty are rewarded; Student parking is discouraged First-come, First-served: People with low opportunity costs for time are rewarded; Those who have high opportunity costs for time and many productive activities are penalized. Markets and a price system: People with higher incomes and more important time alternatives are rewarded; those with low opportunity costs for time or with lower incomes are penalized. Democracy: People with political clout are rewarded Random Choice: People with luck, regardless of cost, are rewarded; The unlucky are penalized.

Activity 4 5. It is impossible to say because equality or fairness depends on each individual’s perspective. Many students will choose firstcome, first-served or random choice because everyone has an “equal chance”. 6. The market system leads to the greatest efficiency because every choice has an opportunity cost. There is an incentive to make choices that minimize opportunity cost. Each person makes choices based on his or her costs and benefits. 7. Must base answers on equity or efficiency.

Activity 5 1. Resource owners are anyone who has land, labor, capital or entrepreneurship to sell in the factor market. 2. A business firm buys resources and in turn, sells goods and service to resource owners. 3. A market where finished goods and services are bought and sold. 4. Answers vary

Activity 5 5. A market where the factors of 6. 7. 8. 9. production (land, labor, capital, entrepreneurship) are bought and sold Wages for labor, for example They buy in the factor markets and sell in the product markets. Supply and demand From selling their resources in the factor markets.

Activity 5 10. From selling the goods and services they produce with the factors of production 11. Interdependence is important because people specialize and trade their production in markets for other products they need. The circular flow of income shows the interdependence of the economy.

Activity 6 1. Absolute advantage states that a particular individual or country can produce more of a specific commodity than another individual or country using the same amount of resources. Comparative advantage states that a particular country or individual can produce a specific commodity at a lower opportunity cost (in terms of forgone production in an alternative commodity) than another country or individual.

Activity 6 A. B. C. D. E. F. G. H. I. Washing two loads of dishes Vacuuming ½ of a room Washing one load of dishes Vacuuming one room Debbie Mike should wash dishes and Debbie should vacuum. They will finish their chores sooner by specializing according to their comparative advantage. The person with the lower opportunity cost should perform the chore.

Activity 6 A. B. C. D. E. F. G. H. I. Cleaning two jail cells Cleaning 4/3 of a jail cell Cleaning ½ of an office Cleaning ¾ of an office Hannah Andy Hannah should clean offices and Andy should clean jail cells, and they will finish sooner. The person with the lower opportunity cost should perform the chore.

Activity 6 A. B. C. D. E. F. G. H. I. J. For every car, it must give up 1/3 of a computer For every car, it must give up 3/5 of a computer For every computer, it must give up three cars For every computer it must give up 5/3 of a car United States Japan The U. S. should produce cars, and Japan should produce computers because cars and computers would then be produced by the lower-cost country. The total output of cars and computers will be higher. If people and national do not trade on the basis of comparative advantage, there will be fewer goods and services for people to enjoy. People will be poorer. Less trade or self-sufficiency means a lower standard of living.

Activity 7 Yes, Yes Master’s Degree Marginal Benefits = $100, 000 Marginal Costs = $100, 000 D. The person’s earning power is greater as he or she gets older. The higher degree also increases earning power. Going to school longer means these potential earnings are sacrificed, which increases the opportunity cost. A. B. C.

Activity 7 A. Answers vary – Ironing blue jeans and B. 3. 4. cleaning up every speck of dust are examples. Depends on the example People frequently don’t purchase the highestpriced goods because the marginal benefit of the highest quality is not worth the additional cost. You could make college acceptance conditional on work during the entire senior year. This would raise the cost of senioritis and provide an incentive for seniors to study harder.

Activity 8 1. False. The best things in life are not free. Even things such as love and friendship (not economic goods though) have opportunity costs. 2. No. If life were priceless, we would not use life as an opportunity cost for any other benefit. Yet we fight wars. The “benefits” of smoking, drinking, hang gliding, using illegal drugs, driving without a seat belt and driving at excessive speeds confront people with the risk of an increased probability of death, yet people engage in these activities. If life were priceless, we would use whatever resources were necessary to cure cancer, heart disease and other terminal illnesses.

Activity 8 3. Only C involves opportunity costs for the student who is cheating. For some people, the opportunity cost of cheating is their conscience. Students compare benefits and costs when contemplating cheating. For those with weak consciences, other costs must be substituted to discourage them. If the costs of cheating are greater than the benefits, cheating will not occur.

Activity 8 4. False. Scarcity is a relative concept, not an absolute one. Resources are scarce compared with wants. Unsold stocks of goods do not proved that scarcity does not exist because these goods still have a price. If there were no scarcity, we could produce everything we wanted at a price of zero. 5. False. Money is not a resource. If the government prints more money, it does not affect the number of goods and services used to satisfy our wants.

Activity 8 6. Her behavior does make sense economically. The benefits of finding a cheaper gas station were not as high as the opportunity cost. It was not until the tenth apartment that the additional benefits and additional opportunity costs of searching for apartments were equal. This makes sense. After all, a good place to live at a reasonable cost is more important than saving a few cents on a gallon of gas.

Activity 8 7. Tina should hire Tom. The key is the law of comparative advantage. Tina sacrifices an hour of legal fees if she does her own word processing. She can probably pay several Toms to word process for less than she can earn in an hour as a lawyer. Therefore, she specializes in law, and Tom specializes in word processing.

Multiple Choice Questions 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. D B E B D C E B B B A C C C D 16. C 17. B 18. C 19. D 20. E 21. C 22. C 23. A 24. C 25. C 26. B 27. B 28. C 29. C 30. E

Short Free-Response Questions 1. Graph I assumes increasing opportunity cost. The shape of the curve is concave to the origin or bowed out. If you move from Point A to Point E, you must give up increasing amounts of planes to get more butter. This is what a production possibilities curve should look like. Graph II assumes constant opportunity cost. As you go from Point A to Point E, the tradeoffs do not change. Graph III, a curve convex to the origin, assumes decreasing opportunity cost.

Short Free-Response Questions 2. False. People with $1 million cannot spend more than $1 million. Even if people had all the money they could use, time to use it would be scarce.

Long Free-Response Questions A. Scarcity exists because there are limited resources to fulfill unlimited wants. B. What to produce and how much of each good or service to produce, how to produce, and for whom to produce. C. Tradition, Command, and Market D. Varying Answers

Long Free-Response Questions A. Movie production indicates increasing per-unit opportunity costs. As more movies are produced, increasingly more computers must be sacrificed. B. Graph C. With a move from Point C to Point D, the per-unit opportunity cost of producing one additional computer is 5/3 movies.

Long Free-Response Questions D. The per-unit opportunity cost of producing E. F. G. one more movie as we alter the production from Point C to Point B is one computer. The point on the axis will shift inward for the movie production, but the point on the axis corresponding to computer production will not change. Shift the PPF inward. Shift the PPF outward.

Long Free-Response Questions A. More education increases human capital, a B. C. D. E. resource, and moves the curve outward Better medicine improves human capital, a resource, and moves the curve outward International trade increases output because of the law of comparative advantage and moves the curve outward. The increase in the unemployment rate results in underemployed resources, which is illustrated by a point inside the curve. The resources (workers) are still available but are not being employed. The computer viruses take computers out of commission, which shifts the curve inward.