CHAPTER 1



Chapter One

Limits, Alternatives, and Choices

ANSWERS TO END-OF-CHAPTER QUESTIONS

1-1 Ralph Waldo Emerson once wrote: “Want is a growing giant whom the coat of have was never large enough to cover.” How does this statement relate to the definition of economics?

Emerson’s statement reflects the fundamental economic problem of attempting to satisfy unlimited wants with finite (scarce) economic resources.

1-2 “Buy 2, get 1 free.” Explain why the “1 free” is free to the buyer but not to society.

Because an expenditure is not required for the buyer to obtain the “1 free” once she has already purchased the first two, it is free to the buyer. It is not free to society, however, because resources were used in producing the third unit that could have been directed to alternate uses.

1-3 Which of the following decisions would entail the largest opportunity cost: Devoting a square block in the heart of New York City to build a surface parking lot or devoting a square block at the edge of a typical suburb to build such a lot? Explain.

Building the lot in the heart of New York City would have the greatest opportunity cost, given the many commercial possibilities and potentially high rents to be earned.

1-4 What is meant by the term “utility” and how does it relate to purposeful behavior?

“Utility” refers to the pleasure, happiness, or satisfaction gained from engaging in an activity (eating a meal, attending a ball game, etc.). It is an important component of the economic perspective because people will allocate their scarce time, energy, and money in an attempt to gain the most utility possible.

1-5 Cite three examples of recent decisions that you made in which you, at least implicitly, weighed marginal cost and marginal benefit.

Student answers will vary, but may include the decision to come to class, to skip breakfast to get a few extra minutes of sleep, to attend college, or to make a purchase. Marginal benefits of attending class may include the acquisition of knowledge, participation in discussion, and better preparation for an upcoming examination. Marginal costs may include lost opportunities for sleep, meals, or studying for other classes. In evaluating the discussion of marginal benefits and marginal costs, be careful to watch for sunk costs offered as a rationale for marginal decisions.

1-6 Indicate whether each of the following statements applies to microeconomics or macroeconomics:

(a), (d), and (f) are macroeconomics; (b), (c), and (e) are microeconomics.

1-7 Suppose you won $15 on a lotto ticket at the local Seven-Eleven and decided to spend all of the winnings on candy bars and bags of peanuts. The price of candy bars is $.75 and the price of peanuts is $1.50.

a. Construct a table showing the alternative combinations of the two products that are available.

|Number of Candy Bars |Bags of Peanuts |Total Expenditure |

|0 |10 |$15 = $0 + $15 |

|4 |8 |$15 = $3 + $12 |

|8 |6 |$15 = $6 + $9 |

|12 |4 |$15 = $9 + $6 |

|16 |2 |$15 = $12 + $3 |

|20 |0 |$15 = $15 + $0 |

b. Plot the data in your table as a budget line in a graph. What is the slope of the budget line? What is the opportunity cost of one more candy bar? Of one more bag of peanuts? Do these opportunity costs rise, fall, or remain constant as each additional unit of the product is purchased?

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The slope is -2 [loss of two bags of peanuts for every candy bar obtained]

The opportunity cost of one more candy bar is two bags of peanuts. The opportunity cost of one more bag of peanuts is ½ a candy bar. The opportunity costs are constant.

c. How, in general, would you decide which of the available combinations of candy bars and bags of peanuts to buy?

You would choose the combination where MB=MC.

d. Suppose that you had won $30 on your ticket, not $15. Show the $30 budget line in your diagram. Why would this budget line be preferable to the old one?

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This new budget line is preferable because it allows you to purchase more of both goods than when the budget constraint was $15.

1-8 What are economic resources? What categories do economists use to classify them? Why are resources also called factors of production? Why are they called inputs?

Economic resources are the human, manufactured, and natural elements used to produce goods and services.

Economists identify four categories of resources: land, labor, capital, and entrepreneurial ability.

Resources are called factors of production because they are used to create (produce) goods and services. “Production” and “goods and services” are typically synonyms in economics.

Resources are also called “inputs” because they go into a production process that generates “output,” another term for “production” or “goods and services.”

1-9 Why isn’t money considered a capital resource in economics? Why is entrepreneurial ability considered a category of economic resource, distinct from labor? What are the major functions of the entrepreneur?

Money isn’t a capital resource because it is not productive. While it is a means to acquire factors of production, money itself doesn’t produce goods or services.

Entrepreneurial ability is treated differently from labor because its function is different. The entrepreneurial function is to organize resources, assume risk, innovate, and make strategic business decisions. Labor, on the other hand, directly produces goods and services. The entrepreneurial role in the production process is more indirect.

1-10 Below is a production possibilities table for consumer goods (automobiles) and capital goods (forklifts):

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a. Show these data graphically. Upon what specific assumptions is this production possibilities curve based?

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The curve is based on the assumptions of full employment, fixed resources, fixed technology, and two goods.

b. If the economy is at point C, what is the cost of one more automobile? Of one more forklift? Explain how the production possibilities curve reflects the law of increasing opportunity costs.

One more automobile would cost 4.5 forklifts (2 automobiles = 9 forklifts).

One more forklift would cost 1/3 automobiles (6 forklifts = 2 automobiles.

The law of increasing opportunity costs could be reflected as follows: Producing the first two automobiles only costs three forklifts; the next two cost six forklifts; and so forth. Producing the last two automobiles would cost twelve forklifts; demonstrating that each additional automobile costs more than the previous one.

c. If the economy characterized by this production possibilities table and curve were producing 3 automobiles and 20 fork lifts, what could you conclude about its use of its available resources?

The economy’s resources are not fully employed.

d. What would production at a point outside the production possibilities curve indicate? What must occur before the economy can attain such a level of production?

Producing outside the curve is not possible. To reach a level of production beyond an existing curve would require expansion of the curve by increasing the quantity or quality of resources, or by advancing technology.

e. Suppose improvement occurs in the technology of producing forklifts but not in the technology of producing automobiles. Draw the new production possibilities curve. Now assume that a technological advance occurs in producing automobiles but not in producing forklifts. Draw the new production possibilities curve. Now draw a production possibilities curve that reflects technological improvement in the production of both goods.

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1-11 Specify and explain the typical shapes of marginal-benefit and marginal-cost curves. How are these curves used to determine the optimal allocation of resources to a particular product? If current output is such that marginal cost exceeds marginal benefit, should more or fewer resources be allocated to this product? Explain.

The marginal benefit curve is down-sloping, reflecting that each additional unit of a good provides less benefit than the previous unit. The marginal cost curve slopes upward, indicating that each additional unit of a good costs more to produce than the previous one. The intersection of the two curves (MB=MC) reveals the optimal allocation.

If marginal cost exceeds marginal benefit, fewer resources should be allocated to this product. At the current output, what is being sacrificed to obtain the last unit (MC) is greater than what is gained by having the last unit (MB).

1-12 Explain how (if at all) each of the following events affects the location of a country’s production possibilities curve.

a. The quality of education increases.

b. The number of unemployed workers increases.

c. A new technique improves the efficiency of extracting copper from ore.

d. A devastating earthquake destroys numerous production facilities.

(a) The curve will shift out as the labor resource improves.

(b) The curve will not shift, but the economy will produce further inside the curve.

(c) The curve will shift out as a result of the technological improvement.

(d) The curve will shift in as resources are destroyed.

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