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Chapter 2 Thinking Like an Economists

TRUE OR FALSE

1. Economists devise theories, collect data, and then analyze these data in an attempt to verify or refute their theories. (T)

2. While the scientific method is applicable to studying natural sciences, it is not applicable to studying a nation’s economy. (F)

3. It is difficult for economists to make observations and develop theories, but it is easy for economists to run experiments to generate data to test their theories. (F)

4. Good assumptions simplify a problem without substantially affecting the answer. (T) 5. Assumptions can simplify the complex world and make it easier to understand. (T) 6. Economic models omit many details to allow us to see what is truly important. (T)

7. The circular-flow diagram explains, in general terms, how the economy is organized and how participants in the economy interact with one another. (T)

8. In the circular-flow diagram, households and firms are the decision makers. (T)

9. In the circular-flow diagram, factors of production are the goods and services produced by firms. (F)

10. In the circular-flow diagram, firms own the factors of production and use them to produce goods and services. (F)

11. In the circular-flow diagram, one loop represents the flow of goods and services, and the other loop represents the flow of factors of production. (F)

12. The production possibilities frontier is a graph that shows the various combinations of outputs that the economy can possibly produce given the available factors of production and the available production technology. (T)

13. Refer to Figure 2-1, if this economy uses all its resources in the dishwasher industry, it produces 35 dishwashers and no doghouses. (T) Figure 2-1

14. Refer to Figure 2-1, it is possible for this economy to produce 75 doghouses. (F) 15. Refer to Figure 2-1, it is possible for this economy to produce 30 doghouses and 20 dishwashers. (T)

16. Refer to Figure 2-1, it is possible for this economy to produce 45 doghouses and 30 dishwashers. (F)

17. Refer to Figure 2-1, unemployment could cause this economy to produce at point B. (T)

18. Refer to Figure 2-1, the opportunity cost of moving from point A to point D is 10 dishwashers. (T)

19. Refer to Figure 2-1, the opportunity cost of moving from point B to point D is 15 doghouses. (F)

20. Refer to Figure 2-1, the opportunity cost of an additional doghouse increases as more doghouses are produced. (T)

21. If an economy can produce more of one good without giving up any of another good, then the economy’s current production point is inefficient. (T)

22. When a production possibilities frontier is bowed outward, the opportunity cost of the first good in terms of the second good increases as more of the second good is produced. (F)

23. A production possibilities frontier will be bowed outward if some of the economy’s resources are better suited to producing one good than another. (T)

24. While the production possibilities frontier is a useful model, it cannot be used to illustrate economic growth. (F)

25. Microeconomics is the study of how households and firms make decisions and how they interact in specific markets. (T)

26. Macroeconomics is the study of economy-wide phenomena. (T)

27. Economists acting as scientists make positive statements, while economists acting as policy advisers make normative statements. (T)

28. Normative statements describe how the world is, while positive statements prescribe how the world should be. (F)

29. \statement, not a positive statement. (F)

30. There is only one explanation for why economists give conflicting advice on policy issues, and it is that they have different values about what policy should try to accomplish. (F)

31. The slope of a line is equal to the change in the x-variable divided by the change in the y-variable. (F)

Chapter 3 Interdependence And The Gains From Trade

TRUE OR FALSE

1. Interdependence among individuals and interdependence among nations are both based on the gains from trade. (T)

2. If a person chooses self-sufficiency, then she can only consume what she produces. (T)

3. If Wrex can produce more math problems per hour and more book reports per hour than Maxine can, then Wrex cannot gain from trading math problems and book reports with Maxine. (F) 4. Trade allows a country to consume outside its production possibilities frontier. (T) 5. Opportunity cost refers to how many inputs a producer requires to produce a good. (F) 6. Opportunity cost measures the trade-off between two goods that each producer faces. (T)

7. For a country producing two goods, the opportunity cost of one good will be the inverse of the opportunity cost of the other good. (T)

8. If one producer has the absolute advantage in the production of all goods, then that same producer will have the comparative advantage in the production of all goods as well. (F)

9. If a country has the comparative advantage in producing a product, then that country must also have the absolute advantage in producing that product. (F)

10. If one producer is able to produce a good at a lower opportunity cost than some other producer, then the producer with the lower opportunity cost is said to have an absolute advantage in the production of that good. (F)

11. Unless two people who are producing two goods have exactly the same opportunity costs, then

one person will have a comparative advantage in one good, and the other person will have a comparative advantage in the other good. (T)

12. The principle of comparative advantage states that, regardless of the price at which trade takes place, everyone will benefit from trade if they specialize in the production of the good for which they have a comparative advantage. (F)

13. Trade can benefit everyone in society because it allows people to specialize in activities in which they have a comparative advantage. (T)

14. Two countries can achieve gains from trade even if one country has an absolute advantage in the production of both goods. (T)

15. As long as two people have different opportunity costs, each can gain from trade with the other, since trade allows each person to obtain a good at a price lower than his or her opportunity cost. (T) 16. When each person specializes in producing the good in which he or she has a comparative advantage, each person can gain from trade but total production in the economy is unchanged. (F) 17. For both parties to gain from trade, the price at which they trade must lie exactly in the middle of the two opportunity costs. (F)

18. David Ricardo was the author of the 1817 book Principles of Political Economy and Taxation. (T) 19. International trade may make some individuals in a nation better off, while other individuals are made worse off. (T)

20. Trade can make some individuals worse off, even as it makes the country as a whole better off. (T) SHORT ANSWER

1. Explain the difference between absolute advantage and comparative advantage. Which is more important in determining trade patterns, absolute advantage or comparative advantage? Why?

Absolute advantage refers to productivity, as in the producer who can produce a product at a lower cost in terms of the resources used in production. Comparative advantage refers to the producer who can produce a product at a lower opportunity cost. Comparative advantage is the principle upon which trade patterns are based. Comparative advantage is based on opportunity cost, and opportunity cost measures the real cost to an individual or country of producing a particular product. Opportunity cost is therefore the information necessary for an individual or nation to determine whether to produce a good or buy it from someone else.

2. The only two countries in the world, Alpha and Omega, face the following production possibilities frontiers.

Alpha’s Production Possibilities Frontier Omega’s Production Possibilities Frontier

a. b. c. d.

Assume that each country decides to use half of its resources in the production of each good. Show these points on the graphs for each country as point A.

If these countries choose not to trade, what would be the total world production of popcorn and peanuts?

Now suppose that each country decides to specialize in the good in which each has a comparative advantage. By specializing, what is the total world production of each product now?

If each country decides to trade 100 units of popcorn for 100 units of peanuts, show on the graphs the gain each country would receive from trade. Label these points B.

Alpha’s Production Possibilities Frontier

Omega’s Production Possibilities Frontier

a. Alpha would be producing 125 units of peanuts and 75 units of popcorn (point A on its

production possibilities frontier) and Omega would be producing 50 units of peanuts and 150 units of popcorn (point A on its production possibilities frontier).

b. The total world production of peanuts would be 175 units and the total world production

of popcorn would be 225 units.

c. The total world production of peanuts would now be 250 units and the total world

production of popcorn would now be 300 units.

d. Alpha would be producing 250 units of peanuts and would trade 100 of them to Omega,

leaving Alpha with 150 units of peanuts. Alpha would then receive 100 units of popcorn from Omega. Omega would be producing 300 units of popcorn and would trade 100 of them to Alpha, leaving Omega with 200 units of popcorn. Omega would then receive 100 units of peanuts from Alpha.

Choice

1. People who provide you with goods and services (b)

a. are acting out of generosity.

b. do so because they get something in return. c. have chosen not to become interdependent. d. are required to do so by the government.

2. When an economist points out that you and millions of other people are interdependent, he or she is referring to the fact that we all (b)

a. rely upon the government to provide us with the basic necessities of life. b. rely upon one another for the goods and services we consume. c. have similar tastes and abilities.

d. are concerned about one another’s well-being. 3. When can two countries gain from trading two goods? (d)

a. when the first country can only produce the first good and the second country can only

produce the second good

b. when the first country can produce both goods, but can only produce the second good at

great cost, and the second country can produce both goods, but can only produce the first good at great cost

c. when the first country is better at producing both goods and the second country is worse

at producing both goods

d. Two countries could gain from trading two goods under all of the above conditions.

4. Shannon bakes cookies and Justin grows vegetables. In which of the following cases is it impossible for both Shannon and Justin to benefit from trade? (a)

a. Shannon does not like vegetables and Justin does not like cookies.

b. Shannon is better than Justin at baking cookies and Justin is better than Shannon at

growing vegetables.

c. Justin is better than Shannon at baking cookies and at growing vegetables. d. Both Shannon and Justin can benefit from trade in all of the above cases. 5. A production possibilities frontier is bowed outward when (d)

a. the more resources the economy uses to produce one good, the fewer resources it has

available to produce the other good.

b. an economy is self-sufficient instead of interdependent and engaged in trade. c. the rate of tradeoff between the two goods being produced is constant.

d. the rate of tradeoff between the two goods being produced depends on how much of

each good is being produced.

6. The following table contains some production possibilities for an economy for a given month. (d) Sweaters Gloves 4 300 6 ? 8 100 If the production possibilities frontier is bowed outward, then “?” could be