Mid Term Macro Vocab Review

Chapter 1

Limits, Alternatives, & Choices

Budget lines alway slope_________blank because there is a(n)_________blank relationship between the two goods represented by the budget line.

The area beyond the budget line represents combinations of goods that (given your current income) are_________blank.

downward; inverse

unattainable

Explanation

Budget lines are always sloped downward. This downward slope shows an inverse relationship between the two goods, meaning that as you increase one, the other must decrease. This decrease is what you are giving up, or the opportunity cost, of the good you are getting more of.

Budget lines illustrate scarcity in that they show you that you are limited by your income. Since they slope downward, they show you cannot keep getting more and more of both goods. There is always a trade-off. The area beyond the budget line represents combinations of the goods that are beyond your income (and thus, unattainable).

When economists refer to scarcity, they are referring to

a situation where what we want of something exceeds what we have of that thing.

Which of the following is most accurate about economists' view of purposeful behavior?

Pursuing self-interest sometimes includes making personal sacrifices for others.

Explanation

Purposeful behavior means that people pursue their self-interest, but not without regard for others, especially to those with whom they might have a connection (family, friends, charitable causes). It involves a weighing of both costs and benefits but doesn't guarantee desirable outcomes nor does it make one immune to faulty thinking.

Economics involves marginal analysis because

most decisions involve changes from the present situation.

Rebecca likes to read in her spare time. If not reading, Rebecca also likes to do yoga, take walks on the beach, go wine tasting, and text with friends. Suppose that today she only has time for one of those activities, and suppose that if she reads, Rebecca will get 50 units of satisfaction ("utils"). She will get 30 utils from doing yoga, 40 utils walking on the beach, 25 utils wine tasting, and 35 utils texting with friends. Based on this information, today we expect that Rebecca will

read.

In constructing models, economists

make simplifying assumptions.

Kelly works at an ice cream shop and observes that the number of people buying ice cream varies greatly from day to day. For a couple of weeks, she has recorded the number of people at the shop each day, as well as the daily temperature. If Kelly is using the scientific method to better understand ice cream buying habits, her next step is to

use the observed data to form a hypothesis about ice cream buying behavior.

The issues of inflation, unemployment, and business cycles are

major topics of macroeconomics.

A positive statement is one that

focuses on facts, descriptions, and theoretical relationships.

The fact that the slope of the production possibilities curve becomes steeper as we move down along the curve indicates that

the principle of increasing opportunity costs is relevant.

A nation can increase its production possibilities by

improving labor productivity.

In a relationship between two variables, the "independent variable" refers to the

cause or source variable

Chapter 2

The Market System and Circular Flow

In a market system, scarce goods are allocated by

In a command economy, scarce goods are allocated by

market prices that are determined by consumers and producers acting in their own self-interest.

a government-appointed planning board based on the board's long-term priorities.

Explanation

1. 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.

2. 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.

An advantage of using capital in the production process is that it

The term "division of labor" means that workers

When an economy relies on specialization,

improves efficiency, increases output, and provides growth.

specialize in tasks that take advantage of their individual abilities and skills.

trade enables individuals to obtain the goods in which they do not have a specialization.

Explanation

1. Capital goods enable producers to operate more efficiently and to produce more output. Typically when capital is combined with labor, labor becomes more productive and more valuable.

2. "Division of labor" means that workers perform those tasks that are best suited to their individual abilities and skills.

3. On a regional basis, each region will produce those products for which it is best suited. By specializing in its comparative advantage, each region or set of human and material resources is being used to maximize efficiency. When resources are specialized, they are no longer self-sufficient. To obtain the goods and services one needs, exchange is necessary. Also, specialization will result in a surplus of a specific good being produced. The surplus of one good will be exchanged for the surplus production of other goods.

Consider the following statement: "The market system is a profit-and-loss system." This statement is

Consider the following statement: "Competition is the disciplinarian of the market economy." This statement is

true, because producer decisions are motivated by the attempt to earn profits.

true, because when producers face competition, they are driven to provide goods and services at the lowest possible cost.

Explanation

1. The quotation is accurate. In a market system, producer decisions are motivated by the attempt to earn profits. Those products that enable a firm to earn at least a normal profit (minimum compensation for the entrepreneur for his or her time and talents) will be produced. If the product cannot be produced for a profit—in other words, if losses are involved in production—the capitalist firm will respond by seeking lower-cost production methods and may halt the production of goods completely. Because profits and/or losses are the motivation behind the fundamental decisions made in a market system, it could be called a "profit-and-loss economy."

2. Competition provides discipline in two ways. First, it forces firms to seek the least-cost production methods or face being driven out of business by their rivals. Second, it prevents successful producers from charging whatever the market will bear. Competition keeps prices at a level where total revenue will just cover the total cost of production including a normal profit, but no more in the long run. If sellers try to charge a price that will earn them economic profits, new firms will enter the industry, increasing supply and lowering prices until the economic profits are eliminated.  Competition is indispensable in this role, because otherwise some other method would have to be found to direct firms to use the least-cost production technique and to charge a price that provides only a normal return. Where competition does not exist, such as in natural monopolies like public utility companies, regulators or publicly-owned companies must assume the role of disciplinarian. Experience has shown that this is a difficult process and does not achieve the same results as easily as a competitive market situation.

The emergence of self-driving cars is an example of "creative destruction" because

self-driving cars will likely replace most cars that require drivers.

Explanation

Creative destruction refers to the process by which the creation of new products and production methods destroys the market positions of firms committed to existing products and outdated ways of doing business. Once developed to the point where the public has full confidence in their safety, self-driving cars will likely cause a large decline in the production of conventional automobiles, just as cars once replaced horse and buggies. In addition, self-driving cars will likely reduce or eliminate the need for professional drivers such as taxi drivers and delivery drivers.

In market economies, firms rarely worry about the availability of inputs to produce their products, whereas in command economies input availability is a constant concern. This is because

in command economies, no market-pricing mechanism exists to incentivize resource suppliers to increase resource availability when a shortage occurs.

Explanation

In market economies, buyers of inputs know that sellers want to make resources available for sale because that is how they earn their profits. If there aren't enough resources available, prices will rise until input suppliers come forth with the desired amounts. In command economies, the availability of inputs depends on what was specified in the plan and how well the plan was executed because there is no opportunity (at least not legally) to offer greater payments to increase the amount of resources provided, an input shortage could occur.

Which of the following is a characteristic of a market system?

Private ownership of property resources

Explanation

Laissez-faire capitalism is a hypothetical economic system in which government's role would be restricted to protecting private property and enforcing contracts.

Governments in command systems own nearly all property and resources and make nearly all decisions about what to produce, how to produce it, and who gets the output.

Most countries today, including the United States, have market systems in which the government does play a large role, but in which most property and resources are privately owned and markets are the major force in determining what to produce, how to produce it, and who gets the output.

How does the market system answer the following fundamental question: How will the system accommodate change?

Through changes in prices and profit. Correct

Explanation

Every economy faces five fundamental questions:

1. What goods and services will be produced?

2. How will the goods and services be produced?

3. Who will get the goods and services?

4. How will the system accommodate change?

5. How will the system promote progress?

The market system produces products whose production and sale yield total revenue sufficient to cover total cost. It does not produce products for which total revenue continuously falls short of total cost. Competition forces firms to use the lowest-cost production techniques. Economic profit (total revenue minus total cost) indicates that an industry is prosperous and promotes its expansion. Losses signify that an industry is not prosperous and hasten its contraction.

Which of the following is a distinguishing feature of laissez-faire capitalism?

minimal government intervention

Explanation

In laissez-faire systems, the government's role is limited to protecting private property and establishing a legal environment in which contracts are enforced and people interact in markets to buy and sell goods, services, and resources. Entrepreneurs and businesspeople make their own decisions about what to produce and how to produce it.

Examples of command economies are

Cuba and North Korea.

Which of the following statements about market economies is correct?

All of these choices are correct.

Explanation

The market system is characterized by a mixture of centralized government economic initiatives and decentralized actions taken by individuals and firms. The precise mixture varies by country, but in each case the system features the private ownership of resources and the use of markets and prices to coordinate and direct economic activity. In the market system, individuals and businesses seek to achieve their economic goals through their own decisions regarding work, consumption, or production.

In a competitive market system

producers have the freedom to choose to enter or leave an industry based on their own self-interest.

Explanation

In a competitive system, producers can enter or leave an industry; no insurmountable barriers prevent an industry from expanding or contracting. This freedom to expand or contract provides the economy with the flexibility needed to remain efficient over time. Freedom of entry and exit enables the economy to adjust to changes in consumer tastes, technology, and resource availability.

Human specialization—the division of labor—enhances productivity and efficiency by

all of the means identified in the other answers.

Specialization in production is economically beneficial primarily because it

permits the production of a larger output with fixed amounts of resources.

—> Michigan Has Surplus Autos Wants Lettuce → Washington Has Surplus Apples Wants Autos —> Texas Has Surplus Lettuce Wants Apples (IDEK)

Given the information, and assuming trade occurs between the three states, we can expect

money to flow counter clockwise from Michigan to Texas to Washington.

The market system's answer to the fundamental question Who will get the goods and services? is essentially

Those most willing and able to pay for them.

Explanation

The answer to the question “What will be produced?” is “Goods and services that consumers want to buy.” The answer to the question “How will the goods and services be produced?” is “In ways that minimize the cost of output.” The answer to the question "Who will get the goods and services?" is "Those most willing and able to pay for them." and the answer to the question "How will the system accommodate change?" is “Through the guiding function of prices and the incentive function of profits."

A required element for specialization to lead to an increase in the satisfaction of society's wants is

exchange and trade.

An economic system in which money is not used as a medium of exchange is a

barter economy.

In a market system, production will be organized

in combinations and ways that minimize the cost per unit of output.

Explanation

Inefficiency drives up costs and lowers profits. As a result, any firm wishing to maximize its profits will make great efforts to minimize production costs. These efforts include using the right mix of labor and capital. They also mean locating production facilities optimally to hold down production and transportation expenses.

In a command economy like the old Soviet Union, one is able to improve one's lot and get ahead in society largely through

participating in the political hierarchy.

In the circular flow model, households earn their incomes in the

resource markets.

Chapter 3

Demand, Supply, & Market Equilibrium

Which statement is consistent with the law of demand?

Which of the following characteristics lead to a downward-sloping demand curve?

How is a market demand curve derived from individual demand curves?

A reduction in market price will lead to an increase in quantity demanded.

Diminishing marginal utility and An Increase in purchasing power as market price decreases

Add up quantities demanded by all individual consumers for each price.

Explanation

As prices change because of a change in supply for a commodity, buyers will change the quantity they demand of that item. If the price drops, a larger quantity will be demanded. If the price rises, a lesser quantity will be demanded.

The demand curve slopes downward because of diminishing marginal utility and the substitution and income effects. Because successive units of a good provide less additional utility than the previous units, buyers will only pay for these smaller amounts of utility if the price is lowered. When the price of a commodity decreases relative to that of substitutes, a buyer will substitute the now cheaper commodity for those whose prices have not changed. At the same time, the decreased price of the commodity under discussion will make the buyer wealthier in real terms. More can be bought of this commodity (as well as of others whose prices have not changed). Thus, the substitution and income effects reinforce each other: more will be bought of a normal (or superior) commodity as its price decreases. On a graph with price on the vertical axis and quantity on the horizontal axis, this is shown as a demand curve sloping downward from left to right.

To determine the market demand schedule, add up the individual quantities (demanded) at each price. This is referred to as horizontal summation for a private good. In other words, fix the price and add up the quantity demanded for each individual in the market.

Suppose that Rhonda has a TikTok account. If all of her TikTok friends switch to SnapChat, Rhonda’s demand for TikTok will likely_________blank.

Rhonda’s demand for SnapChat will likely_________blank.

decrease

increase

Explanation

Rhonda's demand for TikTok will shift to the left because her friends' departure means that there will be a much less strong network effect for her. With them gone, the value of interacting on TikTok will be much reduced.

Because all of her TikTok friends moved to SnapChat, SnapChat will have increased network effects for Rhonda, thereby increasing the attractiveness of that social app for Rhonda and thereby increasing her demand for SnapChat.

What are the determinants of supply?

What happens to the supply curve when any of the following determinants change? Indicate whether each of these determinants causes a shift of the supply curve or a movement along the curve.

Given the following diagram, indicate whether the specified changes below represent a change in supply or a change in the quantity supplied.

A change from point A to point B:

A change from point A to point C:

Prices of other goods, Technology, Resource prices, Number of Producers

1. Change in market price: Movement along the supply curve

2. Change in factor productivity: A shift of the supply curve

3. Change in producer expectations: A shift of the supply curve

4. Change in the price of other goods: A shift of the supply curve

5. Change in technology: A shift of the supply curve

6. Change in resource prices: A shift of the supply curve

7. Change in taxes: A shift of the supply curve'

A change in the quantity supplied

A change in supply

Explanation

1. The fundamental determinant of supply is the price of the commodity. As price increases, the quantity supplied increases. An increase in price causes a movement up a given supply curve. A decrease in price causes a movement down a given supply curve. The non-price determinants of supply are: resource (input) prices, technology, taxes and subsidies, changes in prices of other related goods, expectations, and the number of sellers. If one or more of these change, there will be a change in supply and the whole supply curve will shift to the right or to the left.

2. The following will cause an increase in supply: a decrease in resource (input) prices; improved (lower cost) technology; a decrease in business taxes; an increase in subsidies to businesses; a decrease in the price of another commodity that this firm was making, provided that commodity is a substitute in production (the firm can switch from the now lower-priced one to our commodity); an expectation of lower prices in the future; and an increase in the number of sellers. The increase in supply caused by the noted change in one or more of the above will cause the entire supply curve to shift to the right. More will now be supplied at any given price. Alternatively expressed, any given amount will now be supplied at a lower price.

3. The reverse of any or all of the above changes in the determinants of supply will cause a decrease in supply and will be shown as a shift of the supply curve to the left. Less will now be supplied at any given price. Alternatively expressed, any given amount will now be supplied at a higher price.

For each stock in the stock market, the number of shares sold daily equals the number of shares purchased. That is, the quantity of each firm's shares demanded equals the quantity supplied. Why, then, do the prices of stock shares change?

Prices change in reaction to a mismatch between quantity demanded and quantity supplied.

Explanation

During any given stock trading session, there will be both prospective buyers and sellers, each willing to buy or sell a certain number of shares depending on the price. If, at the current price (e.g., the day's opening price), the quantity of shares demanded exceeds the quantity of shares supplied, buyers must increase their price offers to induce sellers to offer enough shares. This will cause share prices to rise until the quantity demanded equals the quantity supplied. Suppose that during the trading session there is a report of bad economic news. Sellers may respond by trying to sell more shares than buyers are wanting at the current price. In order to find enough willing buyers, sellers will have to offer their shares at lower prices. On any given trading day, there will be multiple equilibrium prices, many of them not lasting for more than a few minutes (or even seconds).

True or False: A "change in quantity demanded" is a shift of the entire demand curve to the right or to the left.

False

Explanation

False: Be sure to distinguish properly between a change in quantity demanded and a change in demand. A change in quantity demanded is a movement from one point to another point along a fixed demand curve. A change in demand is a shift of the entire demand curve to the right or to the left. Note that these two types of changes have different causes. A change in quantity demanded (which is a movement along a fixed demand curve) is caused by a change in a good's own price. By contrast, a change in demand occurs because there has been a change in one or more of the determinants of demand (for example, a change in consumer tastes or a change in income).

What effect will each of the following have on the supply of auto tires?

A technological advance in the methods of producing tires:

A decline in the number of firms in the tire industry:

An increase in the price of rubber used in the production of tires:

The expectation that the equilibrium price of auto tires will be lower in the future than it is now:

A decline in the price of large tires used for semi trucks and earth-hauling rigs (with no change in the price of auto tires):

The levying of a per-unit tax on each auto tire sold:

The granting of a 50-cent-per-unit subsidy for each auto tire produced:

Supply increases

Supply decreases

Supply decreases

Supply increases

Supply increases

Supply decreases

Supply increases

Explanation

1. Increase: The technological advance allows the tire manufacturers to produce more tires using the same amount of inputs.

2. Decrease: There are less firms in the industry.

3. Decrease: The increase in the price of rubber results in an increase in production costs. Thus, each firm will need to charge a higher price at each level of output (or supply less at each price).

4. Increase: The expectation that the equilibrium price of auto tires will be lower in the future causes firms to sell their inventories today while the price is still high.

5. Increase: The decline in the price of large tires used for semi trucks and earth-hauling rigs (with no change in the price of auto tires) will cause firms to reduce production of large tires (now commanding a lower price) and produce more auto tires. These two goods are substitutes in production.

6. Decrease: The per-unit tax on each auto tire sold increases the cost of production because the tire manufacturers must now pay for input costs plus the per-unit tax.

7. Increase: The 50-cent-per-unit subsidy decreases the cost of production. The tire manufacturers receive the subsidy, which they can subtract from their input costs.

Suppose that in the market for computer memory chips, the equilibrium price is $50 per chip. If the current price is $55 per chip, then there will be _____ of memory chips.

a surplus

Explanation

A surplus: At the equilibrium price of $50 per chip, the quantity demanded exactly equals the quantity supplied. At higher prices, the quantity supplied increases while the quantity demanded decreases. Thus, at the $55 price, the quantity supplied exceeds the quantity demanded. The result is a surplus of unsold chips because not all of the chips that producers are willing to supply at the $55 price will find buyers at that price. In fact, the equilibrium price of $50 is the only price at which the desires of suppliers with regard to how much they wish to sell are consistent with the desires of buyers with regard to how much they wish to purchase.

If the equilibrium price in a market is $15, and the government imposes a price ceiling of $18, what will be the resulting market condition?

Equilibrium

Explanation

An effective price control is one that forces the market away from equilibrium. For a price ceiling to be effective, it needs to be set below market equilibrium so that the equilibrium price is prohibited by the price control. If this is the case, the price will be forced below the equilibrium price, causing the quantity demanded to be greater than the quantity supplied, thereby creating a shortage. If a price ceiling is set above equilibrium, the price control does not force the market away from equilibrium, so the market can stay there.

For a price floor to be effective, it needs to be set above equilibrium. If this is the case, the price will be forced above the equilibrium, thus causing a surplus. If a price floor is set below equilibrium, the price control does not force the market away from equilibrium, so the market can stay there.

If the income of buyers decreases, and good A is a normal good, the ____ will ____

This will cause the equilibrium price to _____ and the equilibrium quantity to _____

demand for good A

decrease

decrease

decrease

Explanation

A change in the income of buyers is a change in a non-price determinant of demand. This determinant has a direct relationship with the demand for the good when the good is a normal good, and an inverse relationship when the good is an inferior good. An increase in demand is shown by a shift to the right, and a decrease in demand is shown by a shift to the left. In this case, because demand is the only thing changing here, we can see a shift in demand has a direct relationship with both the equilibrium quantity and price.

A decrease in the demand for recreational fishing boats might be caused by an increase in the

price of outboard motors.

A increase in the excise tax on gasoline

raises the price of gasoline by shifting the supply curve left.

Explanation

Businesses treat most taxes as costs. An increase in taxes will increase production costs and reduce supply causing the price of the product to increase.

Assuming competitive markets with typical supply and demand curves, which of the following statements is correct?

An increase in demand with no change in supply will result in an increase in revenue.

In the following question you are asked to determine, other things equal, the effects of a given change in a determinant of demand or supply for product X upon (1) the demand (D) for, or supply (S) of, X; (2) the equilibrium price (P) of X; and (3) the equilibrium quantity (Q) of X.

If X is a normal good, an increase in income will

increase D, increase P, and increase Q.

A price ceiling is a

maximum price set by government and designed to help consumers

Explanation

A price ceiling is a maximum price set by government and is designed to help consumers. A price floor is a minimum price set by government and is designed to aid producers.

If a legal price ceiling is set above the equilibrium price,

neither the equilibrium price nor the equilibrium quantity will be affected.

Which would cause an increase in the supply curve of cell-phone services?

a decrease in the wages of cell-phone company workers

There is a shortage of tomatoes in the market. This implies that

the price of tomatoes will rise, as a result.

Explanation

If there is a shortage of tomatoes, that means that quantity demanded is greater than quantity supplied, and the price will rise.

Refer to the above graph showing the market for a product. Which of the following could not explain the indicated increase in equilibrium price from P₁ to P₂?

an increase in production costs

Explanation

An increase in demand could be due to a favorable change in consumer tastes; an increase in the number of buyers; rising incomes if the product is a normal good; falling incomes if the product is an inferior good; an increase in the price of a substitute good; a decrease in the price of a complementary good; a new consumer expectation that either prices or income will be higher in the future.

Chapter 4

Market Failures; Public Goods and Externalities

Economists say competitive markets are efficient because by producing at the output level where

Which of the following statements is true?

MB = MC, the maximum potential consumer surplus and producer surplus are generated.

Producing less than equilibrium leaves unrealized producer and consumer surplus, while producing more than equilibrium reduces total surplus.

Explanation

1. When consumers' utility exceeds the price paid, consumer surplus is generated. Likewise, when producers receive a price greater than marginal cost, producer surplus is created. By producing up to the point where MB = MC, the maximum potential consumer surplus and producer surplus are generated.

2. Producing less than the equilibrium level means that potential surplus is left unrealized. Overproduction subtracts from the surplus because society values the use of the additional resources in other pursuits more than it values them in the consumption of that good.

An apple grower's orchard provides nectar to a neighbor’s bees, while the beekeeper's bees help the apple grower by pollinating his apple blossoms. Consider the figure below to answer the questions that follow.

This situation of dual positive externalities might lead to an underallocation of resources to both apple growing and beekeeping because

This underallocation can get resolved via the means suggested by the Coase theorem because

there are spillover benefits for both the apple growers and the beekeepers.

apple growers and beekeepers can benefit from the other, so they will negotiate an optimal solution.

Explanation

1. Using the figure, the following can be said: The market demand curves for apples and honey would not include the spillover benefits accruing to the production of the other good. The output of both products, including the spillover benefits, would be greater than equilibrium outputs, leading to an underallocation of resources to both apple growing and beekeeping.

2. Using the Coase theorem, we note that it will be to the advantage of individual apple growers and beekeepers to negotiate so that beekeepers (whose hives can be moved) locate their production in or near apple orchards. This negotiation will occur as long as property ownership is well defined, only a few people are involved, and bargaining costs are low. For example, an apple grower who owns an orchard could allow a beekeeper to use a portion of his or her land, charging below market rents so that both parties gain from the agreement. This negotiation will occur as long as property ownership is well defined, only a few people are involved, and bargaining costs are low.

A negative externality or spillover cost occurs when

the total cost of producing a good exceeds the costs borne by the producer.

The marginal benefit to society of reducing pollution declines with increases in pollution abatement because of the law of

diminishing marginal utility.

(Last Word) A cap-and-trade program

hands out tradable emissions permits to firms that emit pollution.

Where there is asymmetric information between buyers and sellers,

markets can produce inefficient outcomes.

The market supply curve indicates the

minimum acceptable prices that sellers are willing to accept for the product.

When a competitive market achieves allocative efficiency, it implies that

the combined consumer and producer surplus is maximized.

When the marginal benefit of an output equals the marginal cost,

economic efficiency is achieved.

Explanation

Efficiency occurs at MB = MC, because maximum willingness to pay equals minimum acceptable price. All units where MB > MC generate net benefits because maximum willingness to pay exceeds minimum acceptable price for each of those units. The demand curve reflects buyers’ full willingness to pay and the supply curve reflects all of the costs facing sellers, the equilibrium quantity reflects economic efficiency, which consists of productive efficiency (lowest-cost production) and allocative efficiency (directing scarce resources toward their highest-valued use). The correct amount of society's scarce resources is efficiently allocated to a particular good or service when that product is produced at the output level at which MB = MC.

Refer to the provided graph. Suppose consumers do not fully appreciate the benefits of the product whose market is shown in the graph. If an external agency is able to provide full information to consumers about the benefits of the product, then

the demand curve will shift to the right.

Refer to the provided graph. Suppose that it shows the market for an insurance product. If something happens to worsen the adverse selection problem faced by sellers in this market, then

the supply curve will shift to the left.

The franchising of fast-food restaurants would be an example of how a private business

overcomes private information problems.

A public good is

Public goods are not privately provided because

The free-rider problem occurs when

Is U.S. border patrol a public good or a private good? What type of good is satellite TV?

nonrival and nonexcludable.

when goods are nonexcludable, those purchasing the good could allow others the use without requiring compensation.

people benefit from the public good without contributing to the cost.

U.S. border patrol is a public good, but satellite TV is a private good.

Explanation

1. Public goods are nonrival (one person's consumption does not prevent consumption by another) and nonexcludable (once the goods are produced, nobody—including free riders—can be excluded from the goods' benefits).

2. If goods are nonrival, there is less incentive for private firms to produce them—those purchasing the good could simply allow others the use without compensation. Similarly, if goods are nonexcludable, private firms are unlikely to produce them as the potential for profit is low.

3. The free-rider problem occurs when people benefit from the public good without contributing to the cost (tax revenue proportionate to the benefit received).

4. U.S. border patrol is a public good—my use and benefit does not prevent yours, and no one can be excluded from consuming it. Satellite TV is a private good—if the dish, receiver, and service go to my residence, it can't go to my neighbors. Therefore, those that don't pay can be excluded. The fact that I could invite my neighbors over to watch does not change its status from being a private good.

Jean-Baptiste Colbert was the Minister of Finance under King Louis XIV of France. He famously observed, "The art of taxation consists in so plucking the goose as to obtain the largest possible amount of feathers with the smallest possible amount of hissing." How does his comment relate to the special-interest effect?

A smaller group will be more active in seeking significant group gains than a larger group who faces small losses at the individual level.

Explanation

The logic in the above statement applies to the special-interest effect as well. In the case of special interests, the large gains to the smaller group motivate these individuals to be more active politically and financially than the larger group who faces small losses at the individual level. That is, the smaller group will extract resources from the larger group until it is no longer politically feasible.

Refer to the provided graph. Suppose consumers do not fully appreciate the benefits of the product whose market is shown in the graph. If an external agency is able to provide full information to consumers about the benefits of the product, then

the demand curve will shift to the right.

Refer to the provided graph. Suppose that it shows the market for an insurance product. If something happens to worsen the adverse selection problem faced by sellers in this market, then

the supply curve will shift to the left.

The franchising of fast-food restaurants would be an example of how a private business

overcomes private information problems.

Chapter 5

Government’s Role & Government Failure

The problem of limited and bundled choice in the political process tends to

Public bureaucracies are possibly less efficient than business firms because

reduce economic efficiency, because politicians choose programs with positive and negative net benefits.

the private market is driven by profit, but this competitive force does not operate in public bureaucracies.

Explanation

1. The problem of limited and bundled choice in the political process tends to reduce economic efficiency because blocks of public goods and social programs are provided. That is, instead of evaluating each public good and social program on its respective costs and benefits, the politician chooses all programs together. Some of these goods and programs may benefit society (positive net benefits), but others may hurt society (negative net benefits).

2. The private market is driven by profit. If a company continues to lose money or produces a good that society does not want, it goes out of business. If the public sector, a bureaucracy, fails to use its resources efficiently, then the market is not there to discipline it. In this case, the bureaucracy continues to operate inefficiently and may actually grow in size in an attempt to "fix" the inefficiency. However, we need to look carefully at the logic underlying this argument. Most bureaucratic operations do not provide private goods. They provide public goods and social services that correct potential market failures through regulation and direct provision. Thus, the market analogy may not apply.

The optimal quantity of a public good occurs where marginal benefit equals marginal cost

and efficiently allocates society’s scarce resources.

Explanation

The government must try to estimate the demand for the public good through surveys or public votes and then it can compare the marginal benefit (MB) of an added unit of the public good against the government's marginal cost (MC) of providing it.

Suppose the U.S. House of Representatives is debating a bill to fund construction and maintenance for the nation's highway system. Representative Sandy Shady adds a provision to the bill that would fund a new public art museum in her district. The authorization of expenditure for the museum would be an example of

an earmark.

Which of the following is the best example of rent-seeking behavior?

Students at a university lobby the administration to improve dorms and reduce class sizes without increasing tuition.

"Earmarks" refer to

authorized expenditures benefiting a narrow, specifically designated group that are included in more comprehensive spending legislation.

The trading of votes by elected officials to secure favorable outcomes is called

logrolling.

Government in a market system can increase economic efficiency by collecting taxes in order to subsidize the production of

public and quasi-public goods.

The so-called pork-barrel politics refers to congressional members

inserting provisions for local narrow projects into comprehensive legislation.

Continued regulation might be the better option if the deregulated industry

tends toward monopoly.

Explanation

Deregulation works well in terms of economic efficiency only if the deregulated industry becomes competitive and is automatically guided toward allocative and productive efficiency by competitive forces and the invisible hand. If the deregulated industry instead tends toward monopoly or ends up generating substantial negative externalities, continued regulation might be the better option.

Which would be an avenue for resolving the inefficiencies associated with majority voting?

interest groups

When voters have different opinions about an issue, the position that is most likely to be adopted is that of the

median voter.

The median-voter model indicates that political parties will

try to appeal to the sentiments of the voter holding the middle position.

Chapter 7

Measuring Domestic Output and National Income

Statistics derived from national income accounting

are useful to assess the health of an economy and formulate policies to maintain and improve that health.

Explanation

National income accounting does for the economy as a whole what private accounting does for businesses. Firms measure income and expenditures to assess their economic health. The national income accounting system measures the level of production in the economy at some particular time and helps explain that level. By comparing national accounts over a number of years, we can track the long-run course of the economy. Information supplied by national accounts provides a basis for designing and applying public policies to improve the performance of the economy. Without national accounts, economic policy would be guesswork. National income accounting allows us to assess the health of an economy and formulate policies to maintain and improve that health.

Which of the following goods are usually intermediate goods and which are usually final goods?

Running shoes:

Cotton fibers:

Watches:

Textbooks:

Coal:

Sunscreen lotion:

Lumber:

Final good

Intermediate good

Final good

Final good

Intermediate good

Final good

Intermediate good

Explanation

1. Running shoes are usually a final good. The person purchasing the running shoes is typically the individual who will use the shoes.

2. Cotton fibers are usually an intermediate good. The cotton fibers are used to produce other goods that will be sold on the market.

3. Watches are usually a final good. The person purchasing the watch is typically the individual who will use the watch.

4. Textbooks are usually a final good. The person purchasing the textbook is typically the individual who will use the textbook.

5. Coal is usually an intermediate good. The coal is used to produce other goods, primarily electricity, that will be sold on the market.

6. Sunscreen lotion is usually a final good. The person purchasing the sunscreen lotion is typically the individual who will use the sunscreen lotion.

7. Lumber is an intermediate good. Lumber is used to build houses, furniture, and the like.

An economy's output, in essence, is also equal to its income because

the value of everything that is produced is also the value of everything sold.

Explanation

Everything that is produced is sold, even if the "selling" in the case of inventory is to the producing firm itself. Since the same amount of money paid out by buyers of the economy's output is received by sellers as income (looking only at a private-sector economy at this point), an economy’s output is also its income.

Use the concepts of gross investment and net investment to distinguish between an economy that has a rising capital stock and one that has a falling capital stock. Answer the questions below by evaluating each of the following statements:

Evaluate: "In 1933 net private domestic investment was negative $6 billion. This means that in that particular year the economy produced no capital goods at all."

This statement is

Evaluate: "Though net investment can be positive, negative, or zero, it is impossible for gross investment to be less than zero."

This statement is

incorrect, because negative net investment does not mean the economy produced no new capital goods in that year.

correct, because it is not possible to invest less than nothing.

Explanation

1. When gross investment exceeds depreciation, net investment is positive and production capacity expands; the economy ends the year with more physical capital than it started with. When gross investment equals depreciation, net investment is zero and production capacity is said to be static; the economy ends the year with the same amount of physical capital. When depreciation exceeds gross investment, net investment is negative and production capacity declines; the economy ends the year with less physical capital. An economy cannot invest less than nothing in its production capacity, thus, it is impossible for gross investment to be less than zero regardless of the amount of depreciation.

   The statement is incorrect. Just because net investment was negative $6 billion in 1933 does not mean the economy produced no new capital goods in that year. It simply means depreciation exceeded gross investment by $6 billion. So the economy ended the year with $6 billion less capital.

2. The statement is correct because net investment equals gross investment minus depreciation. In typical years, gross investment exceeds depreciation. Thus, net investment is positive and the nation’s stock of capital rises by the amount of net investment. Gross investment need not always exceed depreciation, however. When gross investment and depreciation are equal, net investment is zero and there is no change in the size of the capital stock. When gross investment is less than depreciation, net investment is negative. The economy then is disinvesting—using up more capital than it is producing—and the nation’s stock of capital shrinks. That happened in the Great Depression of the 1930s. However, depreciation can never be less than zero. Otherwise, net investment could be greater than gross investment, which is not logical. Therefore, it is mathematically impossible for gross investment to be less than zero. It is simply not possible to invest less than nothing, so gross investment can never go below zero regardless of how large the amount of depreciation.

Nominal GDP is

The more reliable measure for comparing changes in the standard of living over a series of years is

The GDP price index is

Which of the following statements is true?

the market or money value of all final goods and services produced by the economy in a given year, whereas real GDP is adjusted for inflation.

real GDP.

a measure of the price of a specified collection of goods and services compared to the price of a highly similar collection of goods and services in a reference year. Correct

Real GDP is nominal GDP divided by the price index.

Explanation

1. Nominal GDP is a measure of the market or money value of all final goods and services produced by the economy in a given year. We use money or nominal values as a common denominator in order to sum that heterogeneous output into a meaningful total. Suppose the value of money itself changes in response to inflation (rising prices) or deflation (falling prices). We can compare the market values of GDP from year to year by adjusting nominal GDP to take into account potential changes in prices. This adjustment results in real GDP, where nominal GDP has been deflated or inflated to reflect changes in the price level (also called adjusted GDP).

2. We use real GDP to compare standards of living over time. Individuals are concerned about the amount of actual goods consumed rather than the nominal value of the goods. Would you prefer to have two candy bars priced at $1.00 each or one candy bar priced at $2.00? Both have the same nominal value of consumption!

3. A price index is a measure of the price of a specified collection of goods and services called a “market basket” in a given year as compared to the price of an identical (or highly similar) collection of goods and services in a reference year.

4. To find real GDP we divide the nominal GDP by this price index.

LAST WORD Refer to the Last Word to answer the following questions:

“Free” products make the calculation of GDP ____ difficult because

Hedonic adjustments are used to

Inflation tends to be __________ if quality improvements are not accounted for.

more

statisticians must indirectly estimate the value that free products provide to their users.

account for improvements in product quality when estimating GDP and inflation.

overstated

Explanation

1. "Free" products provide some value to consumers. However, since the consumers do not directly pay for the products, estimating the value that these products contribute to the economy is difficult. If the value of the "free" products is not included in GDP calculations, GDP will likely be understated. Government economists and statisticians who are responsible for calculating GDP have come up with various ways to estimate the value of these "free" products (and thus, their contribution to GDP). However, the methods are much less straightforward than when a consumer pays for a product directly.

2. Hedonic adjustments are an attempt to account for improvements in product quality when estimating GDP and inflation. For example, if the new iPhone model is priced the same as last years' model but contains better features, the amount of entertainment or utility per dollar will increase. Hedonic adjustment involves looking at a product as a collection of separate characteristics or services for which people are willing to pay money. Viewed this way, an iPhone is not a single item but a collection of, among other things, a camera, a Web browser, a video game platform, a telephone, a compass, a map, a flashlight, and a way of accessing social media platforms. Once an iPhone is thought of as a collection of attributes or services, inflation in the economy will depend not on the price of iPhones themselves, but on how the prices of the underlying attributes or services vary over time. Adjustments are made to account for quality improvements to get a more accurate picture of inflation in the economy.

3. If the same expenditure on a similar item gives a consumer more entertainment than it did in a previous year, the impact of the improvement will cause inflation to be overstated if these improvements are not accounted for. For example, if this year’s most popular video game delivered twice as much entertainment as last year’s top-selling video game but their prices were both $60, how much of a contribution did those games make toward the economy’s overall level of inflation? Viewed from a perspective of “the price of a top video game remained constant at $60,” the contribution was zero. Viewed from a perspective of “how much money does it cost to purchase one unit of entertainment?” the contribution was negative 50 percent since the same dollar expenditure delivers twice as much enjoyment today as it did last year. Hedonic adjustments are used to try to adjust inflation to account for these types of quality improvements.

Identify which of the following measures are used to calculate national income.

Personal consumption expenditures:

Net foreign factor income:

Transfer payments:

Rents:

Consumption of fixed capital (depreciation):

Statistical discrepancy:

Social Security contributions:

Interest:

Proprietors’ income:

Net exports:

Dividends:

Compensation of employees:

Taxes on production and imports:

Undistributed corporate profits:

Personal taxes:

Corporate income taxes:

Corporate profits:

Government purchases:

Net private domestic investment:

Personal saving:

Gross private domestic investment:

No

No

No

Yes

No

No

No

Yes

Yes

No

No

Yes

Yes

No

No

No

Yes

No

No

No

No

Explanation

National income = compensation of employees + rents + interest + proprietors' income + corporate profits + taxes on production and imports.

Which of the following is a final good or service?

a haircut purchased by a father for his 12-year-old son

Which of the following will be included in U.S. GDP?

the value of the cars produced at a Japanese-owned Toyota factory in Ohio

Explanation

The value of the cars produced at a Japanese-owned Toyota factory in Ohio would count as part of U.S. GDP (because the factory is located in the United States), but the other items would not (because those factories lie outside the borders of the United States). What matters for GDP is where the final output is produced, not who makes it or who consumes it.

Gross output (GO) for an economy in a given year

will always exceed GDP for that economy in the same year.

The sale of a used automobile would not be included in GDP of the current year because it is a

nonproduction transaction.

Money spent on the purchase of a new house is included in the GDP as a part of

gross domestic private investment.

The consumption of fixed capital in each year's production is called

depreciation.

(Last Word) The strategy for measuring the value of an economy's output has become more challenging over the past 20 years because

it is increasingly difficult to properly account for quality improvements.

of the rapid change in Digital Age products like electronics, software, and video games.

many Internet products like Google maps and driving directions are provided free of charge.

All of the answers are correct.