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What are some key assumptions of economics?
- People are self interested
- People are rational
- People have limited resources to acquire their wants
What do economists mean by "self-interested behavior?
It means undertaking activities that maximize one's own welfare
Studies have shown that olive oil, which is high in antioxidants, may help prevent breast cancer and colon cancer. How would this effect the supply and demand curves?
The demand curve shifts to the right and the supply curve stays the same.
Suppose the price of a carton of yogurt rises to $1.50 from $1.00 while the price of apples remains unchanged at $.50. What happens to the opportunity cost of an apple?
The opportunity cost of an apple falls
Gayatri refuses to patronize ShopMart, a large grocery chain store, because she finds its labor policies distasteful even though the store offers lower prices for most of the items she routinely buys. An economics student would conclude that:
Gayatri is not responding to economic incentives
Liz Kooy loves sharp cheddar cheese and is willing to pay almost any price for it. She said, "ten dollars a brick, I'd still buy it and cut back on other purchases." Which of the following does this statement demonstrate?
People face tradeoffs
Warren Buffett, one of the world's wealthiest individuals, donated more than $30 billion to humanitarian causes such as AIDS and tuberculosis initiatives. Is there a tradeoff involved in his decision to donate these funds?
Yes, by choosing to give to humanitarian causes, those funds are not available to other causes such as the promotion of performing arts
- shows the number of goods firms want to produce at various prices over some specified time period
- generally, they have a positive slope
- price and quantity supplied are not held constant
Owners and buyers of resources respond to incentives created by the prices of the resources. A high price of a resource encourages:
Buyers to purchase less of that resource
Specialization does all of the following except:
Allow individuals to become more self-sufficient
Price elasticity of demand measures:
The responsiveness of quantity demanded to changes in price
The greater the absolute value of the price elasticity of demand,
The more responsive quantity demanded us to price changes
If the percentage change in quantity demanded is less than the percentage change in price, demand is:
A seller who continues to earn the same gross revenue from sales whether she raised or lowers her prices faces a demand curve that:
Is unit elastic
- Income elasticities of demand are positive for normal goods and negative for inferior goods
- Cross elasticities of demand are positive for substitutes and negative for compliments
- Price elasticities of supply are always positive
What results in higher price elasticity of demand?
More substitutes for a good
If a government wants to raise revenue by taxing a product, it will achieve greater success by taxing products that have:
Price inelastic demands
Price controls make it necessary to:
Develop a way of rationing the product through some means other than price
A persistent shortage will result when the government imposes a:
Price ceiling below the free market equilibrium price
What is likely to happen when legal ceilings are imposed on residential rents in a city?
- Landlords are less attentive to property maintenance
- people moving into the city will have difficulty locating residential space to rent
- Tenants have no incentives to reduce their use of dwelling space
The U.S. government has declared a war on drugs. How does criminalization affect the drug market?
The demand and supply of illegal drugs both decrease, resulting in a lower quantity traded and an indeterminate effect on price
A water shortage caused by a drought can be reduced by:
Allowing price of water to rise until quantity supplied equals quantity demanded
How do economists define an individual's wealth?
It is defined as the value of everything that individual owns
The difference between the value the consumer places on a good and the amount the consumer actually paid for the good is called:
Suppose that equilibrium price of new accounting textbooks is $110. Then suppose that, in an effort to make textbooks more affordable, the government places a price ceiling of $60 on accounting textbooks. What must be true?
The greatest wealth for society as a whole will be created at the price of $110
The value of a car:
Can increase when the car changes ownership
Heather bought a painting at an estate sale for $1,000 and then sold it a week later for $2,000 to an art collector. What can we conclude from this information?
The estate, Heather and the art collector all expected to be made better off by the exchange
Farmers would produce the most crops if:
A system in which each farmers retains ownership over all the crops he grows
In a market economy, innovation:
Is enhanced because resources are rationed to the potential innovators that seem most likely to produce commercially appealing innovations
What would increase the wealth of society?
Policies that allow for free trade between individuals
A nation has an absolute advantage in producing a good:
If it can make the good using fewer resources than its trading partner
If Sarawak can produce pineapples at a lower opportunity cost than Ducane, then:
Sarawak has a comparative advantage in pineapple production
Suppose in a given period, a worker in China can produce either 100 pairs of shoes or 150 pairs of shoes or hats and a worker in India can produce wither 200 pairs of shoes or 100 hats. What is the opportunity cost of producing 1 hat in India?
2 pairs of shoes
Trade and comparative advantage:
- The theory of comparative advantage state countries benefit from trade when they export goods in which they have a comparative advantage and import goods that other nations have a comparative advantage in producing
- Trade based on comparative advantage increases the wealth of a nation
- Trade tends to benefit both of the parties to the transaction
Sources of comparative advantage:
- Natural resource endowments. For example, the soil and climate of Malaysia are well suited for palm oil cultivation
- Literacy and education standards. For example, Kerala, India has one of the highest literacy rates in the world and a significant number of its citizens are well educated in the sciences
- Past work experience. For example, Rajesh graduated from college with a college degree and began substitute teaching. To supplement her income, she also started working part-time selling insurance, a job that helped her develop sales and interpersonal communications skills. In her second year, she was nominated "Top saleswoman of the Year." Later, she quit her teaching job to concentrate on insurance sales.
Could increase the unemployment rate in a country in the short run but over time, new jobs will be created that benefit the nation as a whole
If we add together all the economic gains from specialization and trade and then subtract all the losses, the net result would be:
Positive; a net gain for the world and each country
The infant industry argument advocates:
Temporary protection while firms gain experience needed to compete with foreign rivals
A country will not trade unless:
The terms of trade are superior to its own domestic opportunities (how much they can get by trading)
Tariffs and quotas differ in that:
Tariffs generate revenue for the domestic government while quotas generate additional revenue for exporters, but not for the domestic government
Costs that must be paid before even one unit of output is produced are called:
The marginal cost of production is:
The extra cost of producing one more unit of the good
Suppose the total cost of producing 100 units of a good is $1,500 and the variable cost is $600. Calculate the average fixed cost of production.
- Total cost= Fixed Cost + Variable cost
- $1,500 = X + $600
- X = $900
- Average Fixed Cost: $900/100 = $9
Economies (ATC > those produced) and diseconomies (upward sloping) of scale account for the shape of the:
Long-run average total cost curve
A telemarketer is interested in expanding her business. To double the number of customers solicited, she doubled the number of salespersons, telephone and computers. The telemarketer's average total cost exhibits:
Constant returns to scale
Average variable costs:
Can never be greater than average total costs
Economists study the perfectly competitive market model because:
Firms in numerous industries act similarly to how textbook models of perfect competition predict they should act
Which of the characteristics of perfect competition assures that long run economic profit will be zero?
There are no barriers to entry into the industry
In the long run, why would a firm in perfect competition exit the market?
Because its sales revenue does not cover total cost
A perfectly competitive market is in long run equilibrium. Assume that each firm faces increasing marginal cost. Now suppose there is a sudden increase in demand for the industry's product which causes the price of the good to rise to $60. In the short run will firms in this market produce more than, fewer than or exactly 300 units of output?
Each of the 1,000 firms will produce more than 300 units
Which of the following defines a pure monopoly?
A firm that has no competition
Which firm is not likely to exhibit monopoly power?
A wheat farmer
Utility companies that sell water mist build a network of water pipes to every home in the community. Once the network has been built, the marginal cost of providing water is relatively low and constant. What is the source of monopoly power here?
Enormous fixed/sunk costs
A natural monopoly arises when a firm has:
Decreasing average cost over the range of market demand
Is perfect price discrimination beneficial to any consumers?
Yes, because it allows some consumers who would not otherwise have purchased the product to buy the product
Examples of a business using self-selection to induce different groups of customers to take different visible actions?
- Aviva, an Italian restaurant, offers early-bird specials every Thursday evening where customers can purchase a set meal at $10.95
- A magazine offers an initial one-year subscription for $10; at the end of the year, renewing the subscription for another year costs $18
- Clean Whiz, a laundry detergent manufacturer, offers buyers a variety of options consisting of different price-quantity bundles such as super size, large, medium and small boxes of detergent
What could explain why a monopolist may have less incentive to innovate compared to a perfectly competitive firm?
Unlike a perfect competitive firm, a monopoly is insulated from competition and as a result, failure to innovate will not result in a loss of customers. Therefore, it is not costly to those running the firms not to innovate.
What would be a good candidate for price discrimination because of the threat of customers reselling the good?
- Meals at restaurants
- Airline tickets
- Museum visitor admission tickets
Airlines price discriminate by:
Assuming that travelers staying over a weekend are not flying for business and charging them lower fares
An effective method of price discrimination because they get the most price-sensitive customers to reveal themselves by taking the time to clip coupons, which price-incentive customers would not do
An oligopolistic firm differs from a perfectly competitive firm in that:
There are entry barriers in an oligopolistic market but virtually none in a perfectly competitive market
Firms in an oligopoly can increase their market power by:
Cooperating to set prices
The prisoners' dilemma helps explain:
Why cooperation is difficult is difficult to maintain in strategic situations
In an oligopoly where firms compete, often they can solve the Prisoners' Dilemma game and reach the most profitable outcome. One reason for this is that:
Firms play the game not once but repeatedly
Cooperation among firms:
In general, the lack of cooperation among firms in an oligopoly can be desirable from society's standpoint
- Is difficult to distinguish from fierce price competition in the marketplace
- (ex- Walmart v mom n' pop stores
Gillette's Mach 3, currently the most successful razor in the razor blade market, can only be used with its Mach 3 blades. Suppose rivals, Schick and Bic, announced new razors and replacements blades that are designed to work with Gillette's razor. What would happen to the razors' cross price elasticity of demand?
The cross price elasticity of demand will increase
A firm that charges a price that is higher than politicians deem "fair" is said to be engaged in the practice of:
In the brewery industry in the U.S., the largest four breweries have 90.5% of the market. Each company tries to differentiate its beer from other competing beers with advertising, packaging, and differences in ingredients and production processes. This industry would be classified as:
Suppose that a country has two groups of people: those who rarely participate in the political process and those who always vote and contribute to campaigns. A rational politician seeking office will benefit by:
Transferring resources from the first group (those who rarely participate in the political process) to the second group.
What is the simple three-step process formula that dictators can follow to maintain power?
Appropriate wealth from some disfavored group, redistribute to some favored group to garner support, suppress the disfavored group so they cannot harm the dictator.
The mayor picked firm before other firms had a chance. Then the firm donated $20,000 to the mayor's re-election campaign. What was his motivation?
The mayor was acting in a way that maximized his self-interest
What is the best explanation for the fact that democratic governments often pass pro-producer, anti-consumer laws?
Producers typically form concentrated interest groups, but consumers typically form diffuse interest groups
What proposed law is most likely to be supported by one powerful concentrated interest group and opposed by a different powerful concentrated interest group?
A law putting a cap on medical malpractice awards
A strong dictatorship may have less corruption than a weak dictatorship because:
Strong dictatorships can prevent corruption by lesser public officials in order to increase stealing by the dictator.
I which type of economy is rent seeking likely to be more prevalent, a socialist economy or a market economy and why?
Socialist economy because decision-making is centralized and thus increases the power of government officials
In a democracy,
Those policies which generate votes or contributions for politicians will be favored by the legislature, even if they are not efficient
In what situation will an economy tend to grow the fastest?
A democracy that has been in place for 150 years is run by politicians who compete against one another for the right to engage in wealth transfers from one group to another, but most of the economy is organized by the market
An externality is:
A cost or a benefit incurred by someone other than the seller or use of the good
If there are negative externalities in the production of a good and firms do
not have to account for these external costs, then firms will produce an
Is above society's wealth maximizing quantity
When does an externality occur?
- Hydro power plants built on rivers flood vast areas of primary rain forests, causing trees under water to decompose and forcing people living in the lowland forests to move further up the slopes
- The U.S. environmental protection agency estimates that fine particle pollution from power plant soot and gases that form particles contributes to more than 20,000 premature deaths a year in the U.S.
- Homes built on the mountainsides reduce the quality if the mountain view for people living below who like to see a natural mountainside
When negative externalities are present, why is there a difference between the private optimal quantity that a firm would choose to produce and the socially optimal quantity?
- Because private producers do not factor in the
- cost of the externality they impose on others
In a market where externalities are present:
- The market mechanism gives incorrect price and quantity signals and as a result, resources are misallocated
- The market mechanism understates the opportunity cost of producing a good which creates negative externalities
- The market mechanism overstates the opportunity cost of producing a good which creates positive externalities
For most types of pollutants zero pollution is inefficient because:
Many valuable economic activities create pollution and if the government banned all types of pollution it would drastically reduce economic production
What is meant by a command and control approach to public policy?
It is a policy in which to foster socially desirable behavior, the government simply mandates behavior in law and imposes a penalty for violation of that law
Suppose the production of a good generates a negative externality. What is the imposition of a Pigouvian tax as a method of internalizing the external costs?
The tax is unfair because it imposes a bigger burden on consumers than on producers
What are problems associated with command and control policies?
- It is difficult to meet the informational requirements necessary to assess the harm imposed by the pollution
- Command and control policies do not take into account information about the individual firm's costs of reducing pollution or the benefit the firm receives from polluting
- Politicians will sometimes use the command and control rules to transfer wealth to their supporters
Suppose the government issues permits for emitting 20 million tons of sulfur dioxide and an environmental group purchases the 2 million tons, which it subsequently destroys. Does this action maximize society's wealth?
Yes, because wealth is created when goods go to those who are willing to pay a higher price than others for those goods
A major problem with collective ownership is that:
No one person has a direct interest in maintaining or improving the conditions of the property
The tragedy of the commons refers to the:
Phenomenon that an un-owned or shared resource tends to be over-utilized because no single person has any incentive to do otherwise
An effective system of property rights would not be possible without:
A legal system to settle disagreements by supporting and enforcing those rights
What are the distinguishing characteristics of public goods?
They are non-rival and non-excludable
What is an example of a public good?
Services provided by the North Miami Police Department
Economists use the term "free-riding" to describe:
The tendency to wait for others to produce a good and then enjoy its consumption without paying for it
One difference between a common resource and a public good is that:
When an individual consumes a common resource, the quantity available to others diminishes, but consumption of a public good does not diminish the quantity available to others
The text argues that a prime reason for widespread poverty in the world is that:
The majority of the world's poor live in countries that lack adequate property rights
Why is it that private producers have only a small incentive to provide public goods?
Because a private producer will not be able to capture the entire benefits engendered by the goods since its benefits cannot be excluded to those who do not pay their fair share
What is a collateralized property loan?
A loan backed by the value of the property so that id the borrower defaults the lender can seize the property to reclaim the value of the loan
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