ANSWERS TO END-OF-CHAPTER QUESTIONS
2-1 Explain this statement: "If resources were unlimited and freely available, there would be no subject called economics."
If resources were unlimited and freely available, making choices would not be necessary. Every person could have as much as they wanted of any good or service. Economics, the science of choice, would be unnecessary.
2-2 Comment on the following statement from a newspaper article: "Our junior high school serves a splendid hot meal for $1 without costing the taxpayers anything, thanks in part to a government subsidy."
Obviously the writer is confused. Government subsidies come from government revenues and taxpayers are the source of tax revenues. It may be true that local property taxes that fund the junior high school are not being used for the lunches, but the federal government’s funds do come from taxpayers across the country, including those in the town with the junior high. This example helps support the saying, "There ain’t no such thing as a free lunch!"
2-3 Critically analyze: "Wants aren’t insatiable. I can prove it. I get all the coffee I want to drink every morning at breakfast." Explain: "Goods and services are scarce because resources are scarce." Analyze: "It is the nature of all economic problems that absolute solutions are denied us."
It may be that you get all the coffee you want on a particular morning, but will that satisfy your wants forever? Not if you want coffee in the future. Therefore, even your desire for coffee is insatiable over time.
Goods and services are the product of resources. If resources were abundant without limit, then we would not have a scarcity of the products they produce.
Economic problems are problems of relative scarcity—wants exceed resources in the relative sense. We cannot absolutely solve all of our economic problems; that is, satisfy all of everyone’s wants and needs. If all our wants were completely fulfilled, nothing would have a price—why pay for anything if you’ve got everything already? And if there were no unfulfilled wants there would be no economic resources—why pay for an input when you’ve got all the outputs you could ever need? The fact that totally free goods and services do not exist provides support for the notion that total fulfillment of our wants is impossible.
2-4 What are economic resources? What are the major functions of the entrepreneur?
Economic resources are of four main types: labor, land (natural resources), real capital (machines, factories, buildings, etc.,) and entrepreneurs. Economic resources are also called factors of production or inputs in the productive process. As these names imply, economic resources are required to produce the outputs desired by society. Since certain outputs are desired, they command a price and so, therefore, do economic resources. This can lead to some things being economic resources in some circumstances but not in others. Water in the middle of a lake, for example, is not an economic resource: Anyone can have it free. But the same water piped to a factory site is no longer free: Its movement must be paid for by taxes or by a specific charge. It is now an economic resource because the factory owner would not pay for its delivery unless the water was to be used in the factory’s production. These four types of resources are highlighted in the circular flow diagram where the type of income accruing to each type of resource is shown.
Entrepreneurs are risk-takers: They coordinate the activities of the other three inputs for profit—or loss, which is why they are called risk-takers. Entrepreneurs sometimes manage companies that they own, but a manager who is not an owner is not necessarily an entrepreneur but may be performing some of the entrepreneurial functions for the company. Entrepreneurs are also innovators, or perhaps inventors, and profits help to motivate such activities.
2-5 (Key Question) Why is the problem of unemployment a part of the subject matter of economics? Distinguish between allocative efficiency and productive efficiency. Give an illustration of achieving productive, but not allocative, efficiency.
Economics deals with the "limited resources—unlimited wants" problem. Unemployment represents valuable resources that could have been used to produce more goods and services—to meet more wants and ease the economizing problem.
Allocative efficiency means that resources are being used to produce the goods and services most wanted by society. The economy is then located at the optimal point on its production possibilities curve where marginal benefit equals marginal cost for each good. Productive efficiency means the least costly production techniques are being used to produce wanted goods and services. Example: manual typewriters produced using the least-cost techniques but for which there is no demand.
2-6 (Key Question) Here is a production possibilities table for war goods and civilian goods:
Type of Production
a. Show these data graphically. Upon what specific assumptions is this production possibilities curve based?
b. If the economy is at point C, what is the cost of one more automobile? One more rocket? Explain how this curve reflects increasing opportunity costs.
c. What must the economy do to operate at some point on the production possibilities curve?
(b) 4.5 rockets; .33 automobiles, as determined from the table. Increasing opportunity costs are
reflected in the concave-from-the-origin shape of the curve. This means the economy must give up larger and larger amounts of rockets to get constant added amounts of automobiles—and vice versa.
(c) It must obtain full employment and productive efficiency.
2-7 What is the opportunity cost of attending college? In 2000, nearly 80% of college-educated Americans held jobs, whereas only about 40% of those who did not finish high school held jobs. How might this difference relate to opportunity costs?
The opportunity cost of attending college (and of doing anything else) consists of the income forgone while attending college (and of doing anything else such as enjoying leisure) and the value of the goods that the student or the student’s parents sacrifice in order to pay tuition and buy books, and other items necessary for college but not necessary otherwise.
Those who are college-educated have the potential of earning more income than those who did not finish high school. The opportunity cost (sacrifice of goods and services) of not working is much greater for those with the higher earning potential.
2-8 Suppose you arrive at a store expecting to pay $100 for an item, but learn that a store two miles away is charging $50 for it. Would you drive there and buy it? How does your decision benefit you? What is the opportunity cost of your decision? Now suppose you arrive at a store expecting to pay $6000 for an item, but learn that it costs $5950 at the other store. Do you make the same decision as before? Perhaps surprisingly, you should! Explain why.
Driving to the other store to save $50 does involve some cost in terms of time and inconvenience. However, for most of us the time it takes to drive two miles would be worth $50. For example, if it takes about ten minutes extra time and a negligible amount of gasoline (unless your time is worth $300 an hour, or $50 per each ten-minute period), it would benefit you to drive to the other store. While in the second case, $50 may seem like less compared to the $6000 total price, for you the $50 is still a $50 savings, exactly the same as in the first case. Therefore, you should apply the same reasoning. Is the $50 benefit from driving the extra two miles worth the cost? The conclusion should be the same in both cases.
2-9 (Key Question) Specify and explain the shapes of the marginal-benefit and marginal-cost curves and use these curves to determine the optimal allocation of resources to a particular product. If current output is such that marginal cost exceeds marginal benefit, should more or less resources be allocated to this product? Explain.
The marginal benefit curve is downward sloping, MB falls as more of a product is consumed because additional units of a good yield less satisfaction than previous units. The marginal cost curve is upward sloping, MC increases as more of a product is produced since additional units require the use of increasingly unsuitable resource. The optimal amount of a particular product occurs where MB equals MC. If MC exceeds MB, fewer resources should be allocated to this use. The resources are more valuable in some alternative use (as reflected in the higher MC) than in this use (as reflected in the lower MB).
2-10 (Key Question) Label point G inside the production possibilities curve you have drawn for question 6. What does it indicate? Label point H outside the curve. What does this point indicate? What must occur before the economy can attain the level of production indicated by point H?
G indicated unemployment, productive inefficiency, or both. H is at present unattainable. Economic growth—through more inputs, better inputs, improved technology—must be achieved to attain H.
2-11 (Key Question) Referring again to question 6, suppose improvement occurs in the technology of producing rockets but not in the production of automobiles. Draw the new production possibilities curve. Now assume that a technological advance occurs in producing automobiles but not in producing rockets. Draw the new production possibilities curve. Now draw a production possibilities curve that reflects technological improvement in the production of both products.
See the graph for question 2-6. PPC1 shows improved rocket technology. PPC2 shows improved auto technology. PPC3 shows improved technology in producing both products.
2-12 Explain how, if at all, each of the following affects the location of the production possibilities curve.
a. Standardized examination scores of high school and college students decline.
b. The unemployment rate falls from 9 to 6 percent of the labor force.
c. Defense spending is reduced to allow government to spend more on health care.
d. A new technique improves the efficiency of extracting copper from ore.
(a) Assuming scores indicate lower skills, then productivity should fall and this would move the curve inward.
(b) Should not affect location of curve. Production moves from inside the curve toward frontier.
(c) Should not affect location of curve. Resources are allocated away from one type of government spending toward another (health care).
(d) The curve should shift outward as more production is possible with existing resources.
2-13 Explain: "Affluence tomorrow requires sacrifice today."
This quote refers to the fact that economic growth and a rising standard of living in the future require investment today. Society can choose to consume all of its income today, or it can set aside some of it for investment purposes. Productive resources that go for investment goods today, e.g., new factories, machines, equipment, are obviously not being used for producing consumer goods. Therefore, consumption is being sacrificed today so that investment goods can be produced with some of today’s resources.
2-14 Suppose that, based on a nation’s production possibilities curve, an economy must sacrifice 10,000 pizzas domestically to get the one additional industrial robot it desires, but can get that robot from another country in exchange for 9,000 pizzas. Relate this information to the following statement: "Through international specialization and trade, a nation can reduce its opportunity cost of obtaining goods and thus ‘get outside its production possibilities curve.’"
The message of the production possibilities curve is that an individual nation is limited to the combinations of output indicated by its production possibilities curve. International specialization means directing domestic resources to output which a nation is highly efficient at producing. International trade involves the exchange of these goods for goods produced abroad. Specialization and trade have the same effect as having more and better resources or discovering improved production techniques. The output gains from greater international specialization and trade are the equivalent of economic growth.
2-15 Contrast how a market system and a command economy try to cope with economic scarcity.
A market system allows for the private ownership of resources and coordinates economic activity through market prices. Participants act in their own self-interest and seek to maximize satisfaction or profit through their own decisions regarding consumption or production. Goods and services are produced and resources are supplied by whoever is willing to do so. The result is competition and widely dispersed economic power.
The command economy is characterized by public ownership of nearly all property resources and economic decisions are made through central planning. The planning board, appointed by the government determines production goals for each enterprise. The division of output between capital and consumer goods is centrally decided based on the board’s long-term priorities.
2-16 Distinguish between the resource market and product market in the circular flow model. In what way are businesses and households both sellers and buyers in this model? What are the flows in the circular flow model?
The resource markets are where the owners of the resources (the households) sell their resources to the buyers of the resources (businesses). In the product markets, businesses sell the goods and services they have produced to the buyers of the goods and services, the households.
Households (individuals) either own all economic resources directly or own them indirectly through their ownership of business corporations. These households are willing to sell their resources to businesses because attractive prices draw them into specific resource markets. Businesses buy resources because they are necessary for producing goods and services. The interaction of the buyers and sellers establishes the price of each resource.
In the product market, businesses are the sellers and householders are the buyers; their role in the market has been reversed. Each group of economic units both buys and sells.
One flow is the flow of real goods and services (including resource services) and the other flow is the flow of money (money income, consumption expenditures, revenue, production costs).
2-17 (Last Word) Which two of the six reasons listed in the Last Word do you think are the most important in explaining the rise in participation of women in the workplace? Explain your reasoning.
A poll taken in a class of 60 college freshman gave the first three reasons (women's rising wage rates, expanded job accessibility, and changing preferences and attitudes) nearly all the votes. Each of these explanations received about one third of the votes. Surprisingly, not a single student voted for "declining birth rates" as a reason for the rise in the number of women in the workforce. The consensus of the class was that the last three explanations (declining birth rates, rising divorce rates, and stagnating male earnings) were the effects, rather than the cause of more women joining the workforce. Because wage rates are higher the opportunity cost of raising children has risen. Women have chosen to bear fewer children, because they are now relatively more expensive. Similarly, women who have a higher earning capacity find the opportunity cost of getting a divorce reduced. Finally, male earnings may have stagnated partially because of the entrance of large numbers of well-educated women into the workforce, increasing the competition for the available jobs.