Module 1 (Week 1) - Chapter 1: Economic Issues and Concepts

Define economics.

The study of how humans allocate scarce resources to satisfy unlimited needs and wants

Define scarcity.

The condition in which existing supply of resources are sufficient to produce only a small fraction of desired goods and resources

Explain the relationship between scarcity and choice.

• Due to scarcity (limited resources), if individuals are society want more of one thing, they will have to give up some amount of something else

• Ex: increasing spending on public healthcare may result in raising taxes or spending less on public education

What are the 3 types of resources?

• Land

• Labour

• Capital

The 3 general categories of an economy’s resources are ______, ______, and ______. Economists refer to these resources as the ______ of production.

The 3 general categories of an economy’s resources are land, labour, and capital. Economists refer to these resources as the factors of production.

Define land.

Natural endowments

• Ex: arable land, forests, lakes, crude oil, minerals

Define labour.

Mental and physical human resources

• Ex: management skills

Define capital.

Manufactured aids to production

• Ex: tools, machinery, buildings

Define factors of production.

Resources used to produce desired goods and services

Define goods.

Tangible

• Ex: cars, clothing

Define services.

Intangible

• Ex: legal advice, internet access

Define production.

The act of making goods and services

Define consumption.

The act of using goods and services

Define opportunity cost.

Measuring the cost of one product in terms of the cost of other products that could have been obtained instead

What is the name given to the highest-valued alternative that must be given up to engage in any activity?

A) Opportunity cost

B) Tradeoff

C) Production possibilities frontier

D) Scarce alternative

A) Opportunity cost

Adam Smith observed that people pursuing their own self-interest in a free market will actually result in the best interest of society as if these actions were guided by a(n) ______.

A) Invisible hand

B) Government official

C) Central bank

D) Central authority

A) Invisible hand

Adam Smith notes that specialization increases productivity. Which of the following was the cause of this phenomenon?

A) Combining production steps

B) Increasing factor size

C) Division of labour

D) The invisible hand

C) Division of labour

Which of the following is critical to the success of the market system?

A) To allow the government to determine optimal use of property

B) To allow individuals or firms to have exclusive use of their property

C) To prevent individuals from buying or selling their property depending on circumstances

D) To prevent certain individuals from participating in the market

B) To allow individuals or firms to have exclusive use of their property

Ted has a marginal cost of $90 per hour. How many hours should Ted stay open?

A) 21 hours

B) 23 hours

C) 22 hours

D) 24 hours

C) 22 hours

When nations specialize in their comparative advantage and engage in trade, ______.

A) Overall standards of living increase

B) 100 percent of the population will benefit

C) Overall poverty levels increase

D) The variety of goods for sale declines

A) Overall standards of living increase

Which of the following combinations of pies and cakes is unattainable given the existing resources?

A) One cake and seven pies

B) Zero cakes and ten pies

C) Two cakes and six pies

D) Four cakes and seven pies

D) Four cakes and seven pies

What is country A’s opportunity cost of producing 1 unit of clothing?

A) 2 units of clothing

B) Half a unit of food

C) 2 units of food

D) Half a unit of clothing

C) 2 units of food

The outward shift of the production possibilities boundary from point A to point B in the above graph would most likely be caused by:

A) Depletion of iron ore used to manufacture the steel consumed in both industries

B) A change in technology that only impacts the automobile industry

C) A technological advance that affects both the production of automobiles and aircraft carriers

D) Higher levels of unemployment in both industries

C) A technological advance that affects both the production of automobiles and aircraft carriers

Which of the following is not an opportunity cost of attending college?

A) Money spent on tuition

B) The cost of housing

C) Wages you could have made instead of attending class and studying

D) The cost of textbooks

B) The cost of housing

• A person would have to live somewhere regardless of their choice to attend college

In the circular flow model of the economy, ______ are the suppliers of goods and services.

A) Producers

B) Financial intermediaries

C) Households

D) Workers

A) Producers

Which of the following best represents the situation in which BMW must face a tradeoff between producing SUVs and producing hybrids?

A) Moving from point F to point G

B) Moving from point C to point G

C) Moving from point F to point B

D) Moving from point B to point C

D) Moving from point B to point C

The principle of opportunity cost evolves from the concept of ______.

A) Wealth

B) Scarcity

C) Poverty

D) Consumer spending

B) Scarcity

In this circular flow diagram, which arrow shows the flow of goods and services?

A) A

B) B

C) C

D) D

B) B

What does the budget line represent?

Shows all combinations of the two alternatives (kilometres of road repair vs. kilometres of new bicycle paths)

What does the slope of the budget line represent?

Reflects opportunity cost

• 2 kilometres of bicycle path is the opportunity cost of 1 kilometre of road repair

True or False: Opportunity cost is a ratio, where two alternatives are inverses of one another.

True

Define production possibilities boundary (or curve/frontier).

Negatively sloped curve showing which alternative combinations of output can be attained if all available resources are used efficiently

• Boundary between attainable and unattainable output combinations

Explain the relationship between production possibilities boundary and scarcity.

Scarcity is indicated by the unattainable combinations outside of the production possibilities boundary.

Explain the relationship between production possibilities boundary and choice.

Choice is reflected in the need to choose between alternative attainable points along the production possibilities boundary.

Explain the relationship between production possibilities boundary and opportunity cost.

Opportunity cost is represented by the negative slope of the production possibilities boundary.

• Movement from one point to another requires the reallocation of resources

Define straight-line production possibilities boundary.

Opportunity cost of one good stays constant, no matter how much of it is produced

What are the 3 types of decision makers?

• Consumers

• Producers

• Governments

Define consumers.

Individuals, families, households

• Consumers typically earn income by selling their labour to employers

• Consumers purchase goods and services with their income

Define producers.

For-profit firms and non-profit or charitable organizations

• Producers hire workers, purchase or rent material inputs and supplies, and produce and sell products

  • Charitable organizations often distribute products for free

Define governments.

A type of decision maker

• Usually provide goods and services at no direct cost

• Operations are financed by taxes collected from consumers and producers (not by revenue from the sale of products)

• Governments create and enforce laws and regulations that must be followed by consumers and producers

Explain how sellers and buyers respond to incentives.

• Sellers want to sell more when prices are high (higher earnings)

• Buyers want to buy more when prices are low

Explain why the production possibilities boundary is concave to the origin.

The shape occurs because each factor of production is not equally useful in producing all goods.

• It indicates that opportunity cost of either good increases when increasing the amount produced

True or False: countries must choose between producing goods for final consumption (food, clothing) and goods for investment to increase future production (machines, factories).

True

What do points a, b, and c represent?

Points a, b, and c represent full and efficient use of society’s resources (along the production possibilities boundary).

• Attainable combinations of goods

What does point d represent?

Point d represents either inefficient use of resources or failure to use all available resources.

Explain what happens when production changes from point a to point b.

Opportunity cost is involved.

• Opportunity cost of producing Δx more consumption goods is the necessary reduction in production of investment goods equal to Δy.

Interpret point c.

At point c, most resources are devoted to the production of consumption goods.

Explain what happens when production moves from point c to point a.

• As we shift more and more resources towards production of investment goods, resources become less well suited to the production of consumption goods (such as arable land)

• Opportunity cost of producing investment goods rises as more of them are produced

  • Amount of consumption goods that must be given up to produce one extra unit of investment goods rises

The 3 economic concepts illustrated by the production possibilities boundary are ______, ______, and ______.

The 3 economic concepts illustrated by the production possibilities boundary are scarcity, choice, and opportunity cost.

What are the 4 key economic problems/questions?

• What is produced and how?

• What is consumed and by whom?

• Why are resources sometimes idle?

• Is productive capacity growing?

Define resource allocation.

The allocation of scarce resources among alternative uses

• Determines the quantities of goods that are produced

Define distribution of consumption.

The distribution of a nation’s total output among its people

Explain what happens when resources are idle.

• Unemployment of workers

• Economy operates inside its production possibilities boundary

True or False: The capacity to produce goods and services (productive capacity) may grow rapidly, grow slowly, or decline in different countries.

True

Explain how the production possibilities boundary is affected by growth in productive capacity (economic growth).

Growth in productive capacity is represented by the outward shift of the production possibilities boundary.

• Unattainable combinations become attainable

• Capacity to produce more of all products

Define microeconomics.

The study of the determination of prices and quantities of products and factors of production (decisions of individual households and firms)

• “Bottom-up” view of the circular flow of income and expenditure

• Ex: what is produced and how, what is consumed and by whom

Define macroeconomics.

The study of the determination of economic aggregates

• “Top-down” view of the circular flow of income and expenditure

• Ex: total output, total employment, rate of economic growth

Explain the conditions of market failures.

Market failures occur when free markets lead to too much of some goods being produced (such as pollution) and too little of others (such as basic research).

How are market failures often corrected?

Market failures are often corrected through government policy, designed to alter the allocation of the economy’s resources.

True or False: Government policy could be why a nation’s resources are sometimes idle.

True

• Ex: during the COVID-19 pandemic, increase in unemployed labour was encouraged by the government to slow the spread of the virus

Define economy.

A system in which scarce resources (land, labour, capital) are allocated among competing uses

Define market economy (or free-market economy).

Economy based on free-market transactions

• A society in which people specialize in productive activities and meet most of their material wants through voluntary market transactions with others

• Individual economic agents (consumers and producers) make most economic decisions independently

  • Decisions about resource allocation and income distribution are made without any central direction

Explain how a market economy is self-organizing through self-interest.

Collective outcome is coordinated when consumers and producers act independently to pursue their own self-interests (spontaneous economic order).

• Self-interest is the foundation of economic order

  • When individuals pursue their self-interests, they typically promote what is best for society

Explain how a market economy is efficient.

Prices are determined in markets to respond to overall conditions of scarcity or abundance.

• All decision makers respond to the same set of prices

• Billions of decisions and transactions are made daily

Define efficiency.

Available resources are organized to produce goods and services that consumers want to purchase and to produce them with the least possible amount of resources

What are the 4 types of economic systems?

• Traditional economy

• Command economy

• Free-market economy

• Mixed economy

Define traditional economy.

Economic behaviour is based primarily on tradition, custom, and habit

• Techniques of production follow traditional patterns (little change in the pattern of goods produced from year to year)

• Ex: feudal system in medieval Europe

  • Young men inherited their fathers’ occupations

True or False: Traditional economies work best in an unchanging environment (static conditions).

True

• Under static conditions, traditional economies do not continually require people to make choices

  • Effective in meeting economic and social needs

Define command economy.

Economic behaviour is determined by central authority (government or dictator), who makes most of the necessary economic decisions

What is the main characteristic of a command economy?

The main characteristic of a command economy is the centralization of decision making.

• Centrally planned economy

What is the main characteristic of a free-market economy?

The main characteristic of a free-market economy is the decentralization of decision making.

Explain the role of governments in a pure free-market economy.

In a pure free-market economy, governments are responsible for defining property rights and protecting citizens against foreign and domestic enemies.

What is the main coordinating device in a free-market economy?

The main coordinating device is the set of market-determined prices (price systems).

Define mixed economy.

Mixture of central control, market determination and traditional behaviour

• In practice, all economies are mixed economies

Explain the role of governments in a mixed economy.

• Governments create and enforce institutions (such as private property and freedom of contract)

  • Governments provide institutions to enforce laws (such as police and courts)

• Governments intervene to correct market failures

• Governments redistribute income in the interests of equity

Define externalities.

Private producers or consumers imposing costs on those who have no say in the transaction

• Ex: factories polluting air and rivers

  • The public is harmed but plays no part in the transaction

Who was Adam Smith?

Father of modern economics

• Analyzed the operation of markets

• Stressed the relative efficiency of free-market economies

What was Karl Marx’s ideology?

• Although free-market economies are successful in producing high levels of output, they do not ensure fair distribution of output and income among citizens

• Centrally planned economy allows governments to ensure more equitable distribution of output

What are the 2 major causes of globalization?

• Rapid Reduction in Transportation Costs:

  • Reduced costs due to containerization and increasing size of ships

• Revolution in Information Technology:

  • Increased ability to transmit and analyze data

  • Ability to coordinate international economic transactions

What are the 2 ways in which economic decisions are made?

• Maximizing decisions

• Marginal decisions

Define maximizing decisions.

Consumers and producers make the best decisions for themselves (self-interest)

• Individuals make choices designed to maximize their well-being (or utility)

  • Ex: producers make choices designed to maximize profits

Define marginal decisions.

To maximize decisions, consumers weigh the costs and benefits of their decisions at the margin

• Comparing marginal cost to marginal benefit

• Ex: a producer interested in maximizing profit will hire an extra worker if the marginal benefit (increase in sales revenue) exceeds marginal cost (extra wages)

Define marginal benefit.

Additional satisfaction

• When making marginal decisions, marginal benefit is compared to marginal cost

Define circular flow of income and expenditure.

Basic illustration of how income and expenditure pass through economic markets (goods markets and factor markets), involving interactions between consumers (individuals) and producers (firms)

Define factor markets.

Markets in which consumers sell factor services (factors of production) to producers

• Ex: participating in the factor market by getting a part-time job

Define goods markets.

Markets in which producers sell their outputs of goods to services to consumers

• Ex: participating as a consumer in the goods market by purchasing a haircut

Explain how consumers earn income.

Consumers earn income by selling factor services to producers (through factor markets) and receiving payments in return.

• Individual consumers own factors of production

Define factors of production.

Inputs or resources (land, labour, capital) flowing through factor markets from individuals (consumers) to firms (producers) that use them to make goods and services

• Factors of production are owned by individual consumers

Explain how producers earn income.

Producers earn income by using the factor services they purchased to make goods and services.

• Goods and services are sold to individuals (consumers) through goods markets, and producers receive payments in return

  • Consumers spend their income on buying goods and services

Define distribution of income.

The distribution of a nation’s total income among its citizens

• Largely determined by the price that each type of factor service receives in factor markets

  • Ex: high prices for certain types of factor services lead to higher incomes

True or False: Overall market prices and quantities are determined by the collective interactions of self-interested buyers and sellers, both of whom respond to incentives determining what they want to buy and sell.

True

True or False: Market prices and quantities fluctuate as buyers change their preferences and sellers change their abilities to produce.

True

According to Adam Smith, what are the 2 characteristics of complex production?

• Specialization

• Division of labour

Define specialization of labour.

The allocation of different jobs to different people

• Specialization requires trade

  • Shift away from self-sufficiency (hunter-gatherer and subsistence economies)

Give 2 reasons why specialization is more efficient than universal self-sufficiency.

• Accounting for Differences in Individual Abilities:

  • Specialization allows individuals to specialize in what they do best

  • Leads to comparative advantage

    • Specialization leads to greater total economic production (compared to self-sufficiency)

• Improvements in Individual Abilities:

  • By concentrating on one activity, a person gains experience through their own successes and failures

Define division of labour.

Specialization within the production process of a particular product

• Work is divided into highly specialized tasks

• Each worker repeatedly performs one or few small tasks

Define market.

Institutions that allow buyers and sellers to transact with each other (both physical and online)

True or False: Due to specialization, individuals must satisfy most of their wants by consuming things produced by other people.

True

Define barter.

The trading of goods directly for other goods

• Early form of trading

Define double coincidence of wants.

A successful barter transaction requires both traders to possess goods that the other person wants

• Ex: if a farmer owns wheat but wants a hammer, they must find someone who is willing to trade a hammer and wants wheat