d089 practice questions

1. What are the three fundamental questions every economy must answer?

Give an example of a "What" question. 1. What to produce? Ex: One business wants to drill for oil, the other want to raise cattle. 2. How to produce it? Ex: Company needs to decide to use a current factory or find a new location. 3. From who to produce?

10 Principles of economics?

1. People face trade-offs

2. The cost of something is what you give up to get it

3. Rational people think at the margin

4. People respond to incentives

5. Trade can make everyone better off

6. Markets are usually a good way to organize economic activity

7. Governments can sometimes improve market outcomes

8. A country's standard of living depends on its ability to produce goods and services

9. Prices rise when the government prints too much money

10. Society faces a short-run trade-off between inflation and unemployment

11. Identify the payment that goes to each of the four factors of production?

1. Natural resources: rent for land and buildings. 2. Labor: wages 3.Capital: interest and dividends 4. Entrepreneur: profit

12. What does the circular flow diagram depict?

The circular flow model demonstrates how money moves through society. Money flows from producers to workers as wages and flows back to producers as payment for products. In short, an economy is an endless circular flow of money.

1. Why is the concept of scarcity so important in economics?

Because the number of goods and services that can be produced with them can be limited and there will never be enough resources to meet everyone's needs.

2. What does an individual's budget constraint identify?

all the possible combinations that you can afford within their given income.

3. Identify two ways in which the budget constraint and the PPF are similar and two ways in which they are different.

They are similar because they both assume resource and technology are fixed and they both use two goods to simplify assumptions. They are different because the budget constraint is used by individuals and PPF is used by firms.

7. What does the PPF look like when resources are homogeneous?

It is a straight line.

8. How does an increase in labor productivity change the PPF?

It moves to the right.

9. Define the term Opportunity Cost.

It is what is given up when making a decision.

10. What causes increasing opportunity costs?

Opportunity cost increases as production increases.

1. Explain the "Law of Demand" using a demand curve to illustrate the concept.

IF all else is constant, as price falls, the quantity demanded rises and as price increases the quantity demanded falls. Ex: $6 price per pound the quantity demanded of coffee is 30 million pounds in a month. If the price of coffee decreases from $6 to $4 per pound, US consumers increase their buying, their quantity demanded, from 30 million pounds per month to 40 million pounds per month.

3. As income increases, the demand for used cars decreases. Is a used car a normal good or an inferior good? Explain.

It is a inferior good. Since the income rises, demand declines as consumers switch to a new car because it becomes more affordable.

4. Does a change in the price of a good cause a change in demand or a change in quantity demand? Explain.

A change in demand.

5. Explain the "Law of Supply" using a supply curve to illustrate the concept.

If the price of a good rises, the quantity supplied of that good increases. If the price falls, the quantity supplied of that good decreases.When the price of coffee is $6 per pound, the quantity supplied of coffee is 30 million pounds in a month. If the price of coffee increases from $6 to $8 per pound, the quantity that companies are willing to sell increase from 30 to 40 pounds of coffee. The quantity supplied increases because companies are able to profit more at higher prices.

6. Describe and illustrate a case where there is a decrease in supply. Be sure to identify the market being analyzed and the event leading to the decrease is supply.

If Peru has a freeze and most coffee bean plants are damaged, the supply of coffee beans will decrease.

7. Does a change in the price of a good cause a change in supply or a change in quantity supplied? Explain.

Quantity supplied

10. Assume the market for orange juice is in equilibrium. What will happen to the equilibrium price and quantity if a new orange picking technology is implemented?

The price will decrease and the quantity will increase causing a supply shift to the right. Use a graph to illustrate your answer.

11. When a local grocery store increased the price of marshmallows by 8%, the quantity of marshmallows demanded decreased by 16%. What is the price elasticity of marshmallows?

16/8 = 8

12. Demand for eggs is inelastic. If the price of eggs increases by 10% does the quantity of eggs decrease by less than 10%, more than 10% or exactly 10%? Explain.

It would be exactly or equal to 10% because it is a unit elastic, which is when the percentage change of the price of a good and the percentage change of the demand of the good is the same.

1. What is a price floor? Based on the information in the table below, what happens when a price floor is set at $4?

Price floor is keeps a price from falling below a certain level . At $4 consumers want to purchase 50 units per month. Suppliers are willing to bring 100 units per month to the market. This creates a surplus of 50 units per month. Prices are not able to fall, so this surplus will persist.

2. What is a price ceiling? Based on the information in the table above, what happens when a price ceiling is set at $2?

Price ceiling keeps a price from rising above a certain level. Price control that limits the maximum price that can be charged for a product or service. At the price of $2, consumers want to purchase 100 units per month. Suppliers are only willing to bring 50 units per month to the market, this creates a shortage of 50 units per month. Prices are not able to rise, so this shortage will persist.

3. Why are price controls inefficient?

The imposition of a price floor ceiling will prevent a market from adjusting to its equilibrium price and quantity, thus creating an inefficient outcome.

4. What is a "thin market" and how is this related to the problem of imperfect information?

A market with few buyers and few sellers. Because a relatively small number of buyers and sellers attempt to communicate enough information to agree on a price. They have greater price volatility. The balance between buyers and sellers can change quickly, altering prices substantially.

5. What is "moral hazard" and how can it lead to market inefficiency?

A situation in which a person or firm is willing to take more risks because they are protected against the potential cost of risky decisions. Result of asymmetric information.

6. What is "adverse selection"?

the market deteriorates when buyers and sellers have access to imperfect information, also known as asymmetric information. Provide an example where adverse selection impacts the market. It's a process by which uneven knowledge causes a decrease in the quality of either the goods provided or the type of buyer. EX: Health insurance market sets a single price for a insurance plan and makes it available to a pool of interested buyers. Because there is imperfect information on the seller's side about the health of any particular buyer, the plan is priced based on the average medical expenses of people in the pool.

7. What techniques do firms use to reduce the problem of imperfect information in the market?

Money back guarantees, warranties, service contracts.

8. What is the difference between a warranty and a service contract?

A warranty is a promise to fix or replace the good for a certain period of time. In a service contract, the buyer pays an extra amount and the seller agrees to fix anything that goes wrong for a set time period.

9. Give an example of a positive externality.

A person who keeps bees for his or her own enjoyment, and gardeners in the area benefit because their flowers are pollinated.

When there are positive externalities present in a market, how does the market output differ from the socially optimal level of output?

Homeowners have experienced a positive externality because they received a benefit for a decision that they were not involved in making. (increase in home values).

10. Give an example of a negative externality.

Home values declining due to a decision homeowners were not involved in.

When there are negative externalities present in a market, how does the market output differ from the socially optimal level of output?

The landfill decision was made for private benefit without regard to the homeowners investments which generates high levels of pollution that affect the economic environment and increase social costs in the local community.

11. What policies can governments use to correct negative externalities?

By instituting policies such as pollution penalites, permitting civil lawsuits by private parties to recover damages, and levying environmental taxes. These regulations can help recover funds to help fix the damage caused by negative externalities.

1. Give examples of an implicit cost and an explicit cost. Explain.

Explicit Costs- payments made to cover the firm's expenses and are sometimes called out of pocket payments. (Firms bills, salaries for employees, rent for its office. Implicit cost-resources already owned by the firm. (expanding factory onto land already owned, forgone wages, interest, depreciation).

2. Why do economists calculate profits in a different way from accountants?

Economists want to know if the firms owners are making enough money and accountants wants to determine how much money the firm is making.

3. The following equation describes costs in the short run.

TC = TFC +TVC Total Cost=total variable cost + total fixed cost

Identify and describe the components of this equation. How do you know that this equation describes short run costs?

Fixed costs only occur in the short run and are expenditures that do not change with the level of production. (Ex: rent on a factory)

4. Create an example to explain the concept of diminishing marginal returns.

A worker may produce 100 units per hour for 40 hours. In the 41st hour, the output of the worker may drop to 90 units per hour. The output has started to decrease.

5. What is the relationship between diminishing marginal returns and total costs in the short run?

The marginal product of labor will eventually decline when additional units of labor are added to a fixed amount of capital. If marginal product of labor is positive, total product will increase.

6. Gus' cookie business produces 3,000 cookies in a month. His total variable costs are $700 and his total fixed costs are $500. What is his average total cost?

700+500=1200/3000=$0.40 per cookie

7. When Gus makes 4,000 cookies in a month his total cost is $1,500. Using the information provided in questions 6, calculate the marginal cost of the 4,000th cookie.

Change in total cost is $1400-$1200=$300 and divide it by the change in quantity which is 4,000-3,000 which is 1,000 so you divide the change in total cost by the change in quantinty. $300/1000=$0.30

9. Explain why the long run cost of producing a specific quantity of output will always be equal to the lowest short run cost of producing that same quantity.

Because the variable cost rise equally with production increases.

10. When a firm has economies of scale, what happens to its average total costs as it increases output?

The average cost decrease as output increases

2. What is the profit maximizing rule?

The firm maximizes profit by

producing that quantity of output where marginal revenue equals marginal cost. MR=MC

3. At its current level of production a firm's marginal revenue is less than its marginal cost. What change can the firm make to increase profits? Explain.

Reduce the amount of output.

4. Explain why perfectly competitive firms choose the quantity of output to maximize profits while firms in other markets choose both price and quantity.

Perfectly competitive firms can't choose price, so they choose quantity to maximize profits.

5. What type of market structure is most likely to have collusion?

Oligopolies

6. How does collusion change market outcomes? Who benefits and who loses?

It can lead to high prices for consumers.

7. Suppose a firm is making positive economic profits in the short run. What would happen in the long run if the firm operates in a perfectly competitive market structure?

It will have economic profits of zero.

b. If a firm is making positive economic profits in the short run. What would happen in the long run if the firm operates in an oligopoly market structure?

It will have positive economic profits.

8. Why is advertising more valuable for firms in monopolistic competition than for firms in other market structures?

Monopolistic involves many firms competing against each other so they advertise more so it helps minimize the cost of choosing between different products and will differentiate itself from its competitors.

9. Why are concentration ratios used?

Because we don't want the market concentration to get to high.

10. What is the difference between the HHI and the 4-firm concentration ratio?

The 4 firm concentration ratio is the total of the market shares for the first 4 firms and the HHI is the squares of every market share. The higher the concentration ratio, the less likely 2 firms will join with each other

1. Using the expanded circular flow model, describe the transactions that take place in the a. Goods and services market?

The exchange of products between buyers and sellers.

b. Transactions in the Factor market?

wages, profit, interest, and rent

c. Transactions in the Financial market?

borrowing, lending, and saving

2. What is the GDP and how is it calculated?

The market value of all final goods and services produced in a country in a year. GDP= consumption+ investment + Government + net exports

3. What is the largest component of GDP?

Consumers spending money

4. Identify and explain two of the challenges to calculating the GDP.

Making sure to only count the final good and not double counting the intermediate goods. Only count the final goods that were made within the year specified.

5. Why do economists use real GDP instead of nominal GDP when they want to compare one year's output to another year's output?

Real GDP is a more accurate reflection of the output of an economy and it is not affected by changes in prices. It also accounts for inflation while nominal does not.

6. Why is the population of a country not the same as its labor force? Explain.

Population counts everyone. Labor force only counts who are working or want to work. Labor force does not count those who are retired or disabled and not actively looking for work.

7. What is the unemployment rate in a country with 14 million people unemployed and a labor force of 350 million people?

14/350=0.04=4%

8. What is the labor force participation rate in a country with a labor force of 350 million and a population of 500 million people?

350/500= 0.7= 70%

9. What are the three types of unemployment?

Frictional, structural, and cyclical

10. What is the natural rate of unemployment?

Rate that would result from the combination of structural unemployment + frictional unemployment

11. How is inflation measured in the U.S.?

tracking how a basket of goods and services price changes over time.

12. Identify and explain two problems with the way inflation is measured.

Change in quality of goods- price rises may not reflect inflation, but just the fact it is an improved good. Substitution bias- consumers find less expensive goods to purchase.

13. What are menu costs?

Costs incurred from constantly reworking prices, advertisements, and other costs from adjusting prices due to inflation.

14. Explain how inflation can lead to a loss of purchasing power for individuals.

When wages do not increase every year at the same rate as inflation, every dollar earned will be less valuable. Will not be able to purchase the same amount as before.

15. Which groups benefit from inflation? Explain.

Borrowers benefit because the value of money they pay back is less.

2. How does the quantity of GDP demanded change as the price level in the economy increases?

It leads to a lower quantity of spending on domestic goods and services declines.

3. List and explain the components of aggregate demand.

Consumption spending, investment spending, government spending, and spending on net exports or exports minus imports. C+I+G+x-M

4. Identify the factors that shift AD.

Wealth effect, interest rate effect, foreign price effect

6. Why is the short-run AS curve (SRAS) upward sloping?

As price increases, AS increases

7. Why is the long-run AS curve (LRAS) vertical?

The level of real GDP supplied does not change with price.

8. What is the relationship between the LRAS, potential GDP, and full- employment GDP?

LRAS is also known as potential GDP-when an economy is utilizing all labor and assets to their fullest then unemployment is low.

9. Identify the factors that shift the LRAS curve.

Productivity growth. (how much output can be produced with a given quantity of labor or capital).

10. Identify the factors that shift the SRAS curve.

Anything that affects the LRAS to shift, will cause the SRAS to shift in the same direction. Improvement in technology, reduction in wages, increase in wages, loss of productivity, or increase in fuel prices.

5. Identify and describe the four policy actions the FED can take to increase the money supply.

the reserve requirement, open market operations, the discount rate, and interest on reserves.

7. Identify two factors that can shift the demand for money.

the level of income, interest rates, and inflation as well as uncertainty about the future.

8. How would an increase in the demand for money change the interest rate?

Money supply and interest rates have an inverse relationship. A larger money supply lowers market interest rates, making it less expensive for consumers to borrow. Conversely, smaller money supplies tend to raise market interest rates, making it pricier for consumers to take out a loan.

9. Explain how the FED could use its policy tools to address the problem of Inflation and recession?

The Fed has several monetary policy tools it can use to fight off a recession. It can lower interest rates to spark demand and increase the amount of money in circulation via open market operations (OMO), including quantitative easing (QE), through which additional types of assets may be purchased by the Fed.

10. What are the tools of fiscal policy?

Government expenditure and taxation. Taxes influence the economy by determining how much money the government has to spend in certain areas and how much money individuals should spend.

11. How can the government use fiscal policy to address a recession?

During a recession, the government may lower tax rates or increase spending to encourage demand and spur economic activity.

12. What is the difference between a debt and a deficit?

The budget deficit is the amount by which expenditures exceed revenues in a particular year, while the national debt is the cumulative effect of all past budget deficits and surpluses.

13. Under what economic conditions would you expect a budget deficit to increase?

National budget deficits can be caused by a number of factors: Tax cuts that decrease revenue, such as those intended to boost large companies' ability to hire employees. Low GDP (gross domestic product — the money being made in the country) resulting in low overall revenue, and so low tax revenue.

14. What is the relationship between inflation and unemployment shown by the Phillip's curve?

Inflation is higher when unemployment is low and lower when unemployment is high.

15. When unemployment is below its natural rate, what changes occur to bring the economy back to the long run Phillips curve?

if there is an increase in structural unemployment because workers' job skills become obsolete, then the long-run Phillips curve will shift to the right (because the natural rate of unemployment increases).

1. Explain the difference between absolute and comparative advantage.

Comparative advantage is producing a good at the lowest opportunity cost. Absolute advantage is able to make more.

3. What are three benefits of specialization?

More stuff is produced than working independently. Greater efficiency, consumer benefits.

4. What are three problems with specialization?

Threats to uncompetitive sectors, risk of overspecialization, there can be no comparative advantage, cannot find work at the same pay as before. Strategic vulnerability.

5. How does trade benefit the nation?

Political benefits, efficiency gains, benefits of increased competition (leads to lower prices for consumers and a wider variety of products.

6. Which group within the country is harmed by trade and why?

If it does not have comparative advantage.

7. Identify and describe three different types of tariffs.

Ad Valorem is a %. Specific tariffs is a flat amount on each item that is imported. Compound is a combination of specific and ad valorem tariffs. Can be a flat rate and %.

8. How does imposing a tariff impact price, quantity and efficiency in the protected market?

Will hurt the consumers but the supply will decrease for the producers for more money. Raise price in market and raise overall quantity.

9. Identify and describe three arguments for implementing trade restrictions.

Job protection, cheap foreign labor and outsourcing, differences in environmental standards.