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Quiz 2 :

Thinking Like an Economist

Quiz 2 :

Thinking Like an Economist

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OPPORTUNITY COST Determine whether each of the following statements is true, false, or uncertain. Explain your answers: a. The opportunity cost of an activity is the total value of all the alternatives passed up. b. Opportunity cost is an objective measure of cost. c. When making choices, people carefully gather all available information about the costs and benefits of alternative choices. d. A decision maker seldom knows the actual value of a forgone alternative and therefore must make decisions based on expected values.
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a.Opportunity cost is the cost of the best alternative that an individual gave up; hence, the statement opportunity cost of an activity is the total value of all the alternatives passed up is FALSe.
b.Since the opportunity cost is a subjective measure of cost, only the individual can estimate the expected benefits and costs to him/her for choosing an option, therefore, the statement is FALSe.
c.Collecting information regarding all available alternatives is not feasible, in terms of time and cost. People take decisions based on the limited information that is available to them, and hence, the statement is FALSe.
d.Since the decision is made based on the expected value of the alternatives, the statement of A decision-maker seldom knows the actual value of a forgone alternative and therefore must make decisions based on expected values is TRUe.

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PRODUCTION POSSIBILITIES Under what conditions is it possible to increase production of one good without decreasing production of another good?
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Production possibilities frontier:
Production possibilities frontier (PPF) refers to the curve that shows all maximum output possibilities for two or more goods with available resources, such as labor, capital, and technology. The production possibilities frontier also shows that inputs should be efficiently used to produce two or more outputs.
Efficient production under production possibilities frontier:
An economy will operate on production possibility frontier if all the available resources are used efficiently to produce more of one good without giving up production of another good. Inside the production possibility frontier means the available resources are not efficiently used or allocated to produce goods. Thereby the idle resources should be allocated efficiently for the production of another good. It implies that there should be no idle or unused resources. Hence, it is feasible to produce more of one goods efficiently without compromising the production of another good.Operating an economy outside the production possibility frontier is not feasible.

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SHAPE OF THE PPF Suppose a production possibilities frontier includes the following combinations: img a. Graph the PPF, assuming that it has no curved segments. b. What is the cost of producing an additional car when 50 cars are being produced? c. What is the cost of producing an additional car when 150 cars are being produced? d. What is the cost of producing an additional washing machine when 50 cars are being produced? When 150 cars are being produced? e. What do your answers tell you about opportunity costs?
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a.Production possibility frontier (PPF):
The following production possibility frontier shows that a producer can either produce 200 cars or 1,000 washing machines with the available resources.
img Figure: Production possibility frontier
b.Production of additional cars:
In the above production possibility frontier, the available resources can produce 100 cars and 600 washing machines. A producer moves from 0 to 100 cars, he/she has sacrificed 400 washing machines (1,000 - 600).
Hence, cost of a car is equal to cost of four washing machines
img . Therefore, to produce 50 cars, a producer has to sacrifice
img washing machines
img . It implies that a producer can produce a combination of 50 cars and 800 (1,000 - 200) washing machines with the available resources.
c.Production of additional car:
In the above production possibility frontier, a producer can produce
img more cars by sacrificing 600 washing machines. Hence, the cost of a car is equal to cost of six washing machines
img .
Therefore, the cost of 150 cars is
img washing machines
img . It implies that a producer can produce a combination of 150 cars and
img washing machines with the available resources.
d.Production of additional washing machines:
Based on the calculations in answers of part (b) and (c), it is found that the cost of producing an additional unit of washing machine is
img cars, when 50 cars are being produced. On the other hand, the cost of producing an additional washing machine is
img cars, when 150 cars are being produced.
e.Opportunity cost:
Based on the answers of part (b) and (c), it is observed that to produce more number of cars, more number of washing machines need to be sacrificed. Hence, the opportunity cost of producing a car would increase.

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SPECIALIZATION Provide some examples of specialized markets or retail outlets. What makes the Web so conducive to specialization?
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ECONOMIC SYSTEMS What are the major differences between a pure capitalist system and a pure command system? Is the United States closer to a pure capitalist system or to a pure command system?
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PRODUCTION POSSIBILITIES Suppose an economy uses two resources (labor and capital) to produce two goods (wheat and cloth). Capital is relatively more useful in producing cloth, and labor is relatively more useful in producing wheat. If the supply of capital falls by 10 percent and the supply of labor increases by 10 percent, how will the PPF for wheat and cloth change?
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Case Study: The Opportunity Cost of College During the Vietnam War, colleges and universities were overflowing with students. Was this bumper crop of students caused by a greater expected return on a college education or by a change in the opportunity cost of attending college? Explain.
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Opportunity Cost You can either spend spring break working at home for $80 per day for five days or go to Florida for the week. If you stay home, your expenses will total about $100. If you go to Florida, the airfare, hotel, food, and miscellaneous expenses will total about $700. What's your opportunity cost of going to Florida?
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COMPARATIVE ADVANTAGE "You should never buy precooked frozen foods because the price you pay includes the labor costs of preparing food." Is this conclusion always valid, or can it be invalidated by the law of comparative advantage?
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SPECIALIZATION AND EXCHANGE Explain how the specialization of labor can lead to increased productivity.
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SUNK COST AND CHOICE Suppose you go to a restaurant and buy an expensive meal. Halfway through, despite feeling quite full, you decide to clean your plate. After all, you think, you paid for the meal, so you are going to eat all of it. What's wrong with this thinking?
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PRODUCTION POSSIBILITIES Under what conditions would an economy be operating inside its PPF? On its PPF? Outside its PPF?
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ABSOLUTE AND COMPARATIVE ADVANTAGE You have the following information concerning the production of wheat and cloth in the United States and the United Kingdom: Labor Hours Required to Produce One Unit img a. What is the opportunity cost of producing a unit of wheat in the United Kingdom? In the United States? b. Which country has an absolute advantage in producing wheat? In producing cloth? c. Which country has a comparative advantage in producing wheat? In producing cloth? d. Which country should specialize in producing wheat? In producing cloth?
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ECONOMIC QUESTIONS What basic economic questions must be answered in a barter economy? In a primitive economy? In a capitalist economy? In a command economy?
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PRODUCTION POSSIBILITIES "If society decides to use its resources efficiently (that is, to produce on its production possibilities frontier), then future generations will be worse off because they will not be able to use these resources." If this assertion is true, full employment of resources may not be a good thing. Comment on the validity of this assertion.
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PRODUCTION POSSIBILITIES There's no reason why a production possibilities frontier could not be used to represent the situation facing an individual. Imagine your own PPF. Right now-today-you have certain resources-your time, your skills, perhaps some capital. And you can produce various outputs. Suppose you can produce combinations of two outputs, call them studying and partying. a. Draw your PPF for studying and partying. Be sure to label the axes of the diagram appropriately. Label the points where the PPF intersects the axes, as well as several other points along the frontier. b. Explain what it would mean for you to move upward and to the left along your personal PPF. What kinds of adjustments would you have to make in your life to make such a movement along the frontier? c. Under what circumstances would your personal PPF shift outward? Do you think the shift would be a "parallel" one? Why, or why not?
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OPPORTUNITY COST Discuss the ways in which the following conditions might affect the opportunity cost of going to a movie tonight: a. You have a final exam tomorrow. b. School will be out for one month starting tomorrow. c. The same movie will be on TV next week. d. The Super Bowl is on TV.
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SHIFTING PRODUCTION POSSIBILITIES In response to an influx of undocumented workers, Congress made it a federal offense to hire them. How do you think this measure affected the U.S. production possibilities frontier? Do you think all industries were affected equally?
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Case Study: Rules of the Game and Economic Development ? Why is the standard of living higher in countries where doing business is easier? Why do governments collect any taxes or impose any regulations at all? Reference: Case Study Public Policy Rules of the Game and Economic Development ? Rules of the game can affect the PPF by either nurturing or discouraging economic development. Businesses supply jobs, tax revenue, and consumer products, but owning and operating a business is risky even in the best of times. How hard is it for an entrepreneur to start a business, import products for sale, comply with tax laws, and settle business disputes? The World Bank, a nonprofit international organization, has developed a composite measure that rolls answers to all these questions into a single measure and ranks 183 countries from best to worst based on their ease of doing business. Exhibit 3 lists the best 10 and the worst 10 countries in terms of the ease of doing business. The countries with the friendliest business climate all have a high standard of living and a sophisticated economy. The United States ranks fourth best, behind Singapore, New Zealand, and Hong Kong. The 10 most difficult countries all have a low standard of living, a poor economy, and nine are in Africa. Consider, for example, the burden facing a business that wants to sell an imported product. No business in the African country of Burundi makes bicycles, so a shop selling bicycles there must import them. Bicycles are shipped to Burundi via a port in Tanzania. In all, it takes the shop owner at least 10 documents and at least 71 days to get the bicycles from the port in Tanzania to the bicycle shop. Contrast this with 3 documents, and 5 days needed to import products in Denmark. Burundi is one of the poorest countries on earth, based on per capita income. Denmark is among the richest, with a per capita income about 120 times that of Burundi. How does the burden imposed by business taxes differ across countries? In Burundi, businesses are subject to a tax rate totalling 279 percent of profit. So all business profits and much more are eaten up by taxes, in the process destroying the primary reason to even open a business. Meanwhile, a business in Hong Kong pays a tax rate amounting to only 24 percent of profit. Of course, some level of business regulation and taxation is necessary to ensure public health and safety and to nurture market competition. Few would argue, however, that the world's most prosperous economies have allowed businesses to go wild. But why would a country impose taxes and regulations so severe as to kill business development, thereby choking off the jobs, taxes, and consumer products that go with it? One possible explanation is that many countries with the worst business climate were once under colonial rule and have not yet developed the ability to operate government efficiently. Another possibility is that governments in poor countries usually offer the most attractive jobs around. Politicians create government jobs for friends, relatives, and supporters. Overseeing bureaucratic regulations gives all these people something to do, and high tax rates are needed to pay the salaries of all these political cronies. Perhaps the darkest explanation for the bad business climate in some countries is that business regulations and tax laws provide government bureaucrats with more opportunities for graft and corruption. For example, the more government documents needed to execute a business transaction, the more opportunities to seek bribes. In other words, obstacles are put in the way of business so that government bureaucrats can demand bribes to circumvent those obstacles. Even Irish rocker Bono, a long-time supporter of aid to Africa, has called for "advances in fighting the evils of corruption in Africa." Regardless of the explanation, poor countries are poor in part because they have not yet developed the rules of the game that nurture a prosperous economy. img
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SHIFTING PRODUCTION POSSIBILITIES Determine whether each of the following would cause the economy's PPF to shift inward, outward, or not at all: a. An increase in average length of annual vacations b. An increase in immigration c. A decrease in the average retirement age d. The migration of skilled workers to other countries
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