ECONOMICS WORKBOOK PAGE 2 OF 158 DEMIDEC © 2008

[Pages:158]ECONOMICS WORKBOOK

PAGE 2 OF 158

DEMIDEC ? 2008

Economics Workbook

2008-2009: Latin America

Table of Contents

I. Fundamentals of Economics......................................................................................................................................... 3 II. Microeconomics .......................................................................................................................................................... 36 III. Macroeconomics ........................................................................................................................................................ 87 IV. International Trade & Economic Development.................................................................................................131 About the Author ........................................................................................................................................................... 144 About the Editors ........................................................................................................................................................... 144 Answer Key......................................................................................................................................................................145

Jessica Raasch

Arizona State University `07

edited by

Dean Schaffer and Daniel Berdichevsky

William Howard Taft High School Stanford University

reviewed and updated by

Lawrence Lan

Palos Verdes Peninsula High School Cornell University

DemiDec and The World Scholar's Cup are registered trademarks of the DemiDec Corporation. Academic Decathlon and USAD are registered trademarks of the United States Academic Decathlon Association.

DemiDec is not affiliated with the United States Academic Decathlon.

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I. Basics of Economics

This section covers everything in Section I of the curriculum outline except for topics related to trade, which are found in Section IV. Material on the Mexican Economy is contained in

its own workbook.

Microeconomics and Macroeconomics....................................................................

Economics is a study of decision-making. It can be divided into two broad areas of study. In microeconomics, we study the economic decision-making of the individual and the consequences of those decisions. We isolate individual markets and we try to explain how they function and what will cause their behavior to change. In macroeconomics, we study the behavior of an economy as an aggregate, or as a whole. We might try to measure the size of the economy or we might try to assess its health. We might also try to predict how a policy change could affect the economy.

1.01 THINK FAST

Spit it out. In five or fewer words, what is economics?

____________________________________________________________________________

1.02 CATEGORIZATION

The big picture. Below is a list of topics in the study of economics. Determine whether each topic is in the area of microeconomics ("Micro") or macroeconomics ("Macro"). Circle your answer choices.

Ex. Micro

1.

Micro

2.

Micro

3.

Micro

4.

Micro

5.

Micro

Macro Macro Macro Macro Macro Macro

How an individual decides which brand of cereal to buy

How the Federal Reserve influences consumer spending in the U.S. How a household decides which brand of laundry detergent to buy How a firm decides when to go out of business How debt affects the income gap among Americans How new parents decide whether to work or stay home with their children

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The Basic Economic Problem...............................................................................

We begin our study of economics with the problem of scarcity. We experience scarcity when there is less of something available to us than we'd like. It might be food, time, or just about anything. Even if a resource is given away for free, it is scarce if people want more of it than what is available to them.

Scarcity and Choice

Scarcity is the basic problem of economics. We can't have everything we want, so we're forced to choose among alternatives. In other words, scarcity forces us to make choices. Economics is the study of how we make those choices. When we study economics, we presume people are dealing with scarcity; we presume they are constantly struggling to balance unlimited wants with limited resources.

Some resources seem to be abundantly available to everyone, so we have trouble seeing them as "limited." These are termed free goods. Air is the most common example of a free good, because we all breathe as much air as we need. However, an economist will tell you nothing is free, not even air (and certainly not oxygen, which is now sold in small, presumably invigorating quantities at oxygen bars.) If we give it enough thought, we see that everything has a cost. As the saying goes, "There Ain't No Such Thing As A Free Lunch" (TANSTAAFL). Even the air we breathe has a price tag. After all, we pay taxes to support the environmental regulations that help keep our air breathable.

1.03 FILL-IN

Fill `er up, Phillip . Complete these statements by writing in the missing words. The first statement has been completed for you.

1. There ain't no such thing as a free

lunch

(TANSTAAFL).

2. Economics is based on the assumption that people have unlimited

______________________________ and limited ______________________________.

3. The basic problem of economics is ______________________________.

4. If less of a resource is available to us than we like, then the resource is said to be _______________.

5. The most common example of a free good is ______________________________.

Opportunity Cost and Trade-offs...........................................................................

In order to make use of our scarce resources, we have to choose to have some things and to do without others. A trade-off is a decision to have something and to do without something else.

Suppose you choose to go on a cruise, rather than take a backpacking trip to Machu Picchu. Your decision is a trade-off. By opting for the cruise, you decide to have the luxury of sleeping in late, eating extravagant meals, and breathing the salty sea air. You also decide to do without the opportunity to walk among ancient Incan ruins and to breathe the crisp mountain air of the Andes.

The opportunity cost of a decision is the value of the best alternative not chosen--the value of the thing you could have had, but didn't. If backpacking to Machu Picchu is the best alternative to a cruise, then the opportunity cost of the cruise is the value to you of the backpacking trip. It's the cost of the lost opportunity.

When evaluating alternative solutions to a problem, economists want to consider all the relevant costs involved. Some costs are obvious because they require an outlay of cash. Others are less obvious. You're probably familiar with what an economist would call an "accounting cost." It's the amount that is actually paid in exchange for a good or service; it's also known as explicit cost. However, an economist is most concerned with the economic cost of a decision. The economic cost of a decision is the complete cost, which is a measure of its net economic impact. This includes the accounting cost and the opportunity cost, as well as other less-obvious costs, like the value of lost product quality or the value of a change in employee morale. All costs that are not accounting costs are also known as implicit costs. Of course, the value of a

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change in quality can be difficult to quantify, so the economic cost of a decision is not something we can easily express in dollars.

1.04 IN BRIEF

Short answer. Write a brief response to each question below.

1. What is the basic problem of economics? ______________________________________________________________________

2. According to economists, why do people have to make choices? ______________________________________________________________________

3. Why do economists say "There ain't no such thing as a free lunch"? ______________________________________________________________________

4. What is a free good? ______________________________________________________________________

5. What is a trade-off? ______________________________________________________________________

6. What is the opportunity cost of a decision? ______________________________________________________________________

7. What is the difference between accounting cost and economic cost? ______________________________________________________________________

8. Why is it difficult to quantify the economic cost of a decision? ______________________________________________________________________ ______________________________________________________________________

TEST-TAKING TIP

In your mind, you should link the terms "trade-off" and "opportunity cost." Also, link "opportunity cost" with the phrases "did not choose" and "chose not to." On an exam, if you see one term from a linked pair in a question stem, the other one could be lurking in the correct answer choice. Here is an example:

Bob made a trade-off when he chose a job located close to his home over a job he loved. The value of working a job he loved was his

a. alternative cost b. economic cost c. opportunity cost d. marginal benefit

e. marginal cost

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1.05 EXAM PRACTICE

"Is this gonna be on the test?" The questions below are similar to those that have appeared on Decathlon exams in the past. In this exercise, you'll practice outsmarting them. First, in each question, underline the phrases you know to link together. Then, circle the letter of the correct answer choice.

1. The cost of a trade-off is known as its

a. opportunity cost b. trade-off cost c. explicit price d. real value e. future cost

2. A firm can produce T-shirts or sweatshirts. The opportunity cost of the firm's decision to produce T-shirts is BEST measured by the

a. fixed costs of T-shirt production b. variable costs of T-shirt production c. price of the T-shirts produced d. number of sweatshirts the firm chose not to produce e. total costs of T-shirt production

1.06 MATCHING

It's better than clashing. Match the letter of each term in the column on the left to the BEST description in the column on the right. Write your answers in the blanks provided. An example has been completed for you.

a. opportunity cost b. scarcity c. economic cost d. increase in insanity e. free good f. trade-off g. individual h. aggregate

1. _____ a decision to have more of one thing and less of another

2. _____ the scale of the study of microeconomics

3. d a negative externality of working for DemiDec for seven years

4. _____ equal to the value of the best alternative not taken

5. _____ a measure of the net economic impact of an action

6. _____ the scale of the focus of macroeconomics

7. _____ available in a sufficient quantity to anyone who wants it

8. _____ the reason we study economics

The Production of Goods and Services....................................................................

A trade-off decision is not usually as simple as choosing which vacation to take. Sometimes we have to decide whether to have more of something and less of something else, or vice versa. A firm might wish to decide whether to produce more of one product or another. A nation might have to decide whether to produce more tanks or more medical supplies.

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The Production Possibilities Frontier

We use the Production Possibilities Frontier (PPF) to help us make trade-off decisions. The PPF graphically represents all possible combinations in which two given goods or services can be produced. Typically, the frontier is curved, bowed outward from the origin. For any point along the frontier, the xcoordinate represents a quantity of one good that can be produced, and the y-coordinate represents the corresponding quantity of the other good, assuming all resources are fully utilized. By moving from one point on the curve to another, we make a trade-off: we sacrifice some of one good in order to produce more of the other.

Production at any point along the PPF is attainable and efficient, because all available resources are being used. Production at a point inside the frontier is attainable but inefficient, because more of either good could be produced. Production at a point beyond the frontier is impossible to attain. After all, the frontier represents production possibilities. Later in this workbook, we'll discuss how a nation can trade to reach a point of consumption outside the frontier.

As production approaches a point closer to either end of the frontier, the trade-offs become increasingly costly. A small increase in the production of one type of good will result in a substantial decrease in the production of the alternative type of good. This law of increasing opportunity costs is what causes the PPF to curve. Theoretically, if the frontier is a straight line with a slope exactly equal to -1, then there are no increasing opportunity costs. In other words, an increase in the production of one of good will result in an equal decrease in the production of the other good. This can happen when the two goods in consideration are very similar.

When the PPF represents a nation's production possibilities, one axis represents the production of capital goods and the other represents the production of consumer goods. In most modern economics texts, you'll see this trade-off represented as "guns and butter." At DemiDec, we prefer to call it "missiles and milk." In either case, the two goods are very different, so the opportunity cost of a trade-off is very high. The resources used to make one type of good may not be very useful for the production of the other good. As we say in the DemiDec Economics Resource, "It is easy to make milk out of cows; it is more difficult to make nuclear missiles out of cows."

Production Possibilities Frontier

Quantity of Milk

unattainable efficient

inefficient

Costs increase as production approaches a point closer to either axis.

Quantity of Missiles

The PPF is only a graphical representation of the possibilities of production. We don't use the PPF alone to make a decision. After all, we use goods and services to satisfy wants, but everyone has different wants. The decision-makers in one nation might want a strong military, but the decision-makers in another nation might want an effective healthcare system. Even if both countries have the same PPF, each might choose to produce at a different point. Each will choose a different combination of capital and consumer goods to satisfy its different wants.

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1.07 TRUE OR FALSE

The truth is out there. Below are statements about the PPF. Determine whether each statement is true or false, then add any necessary corrections to make the false statements true.

1.

T F Every point along the PPF is efficient.

2.

T F On the PPF, as production approaches a point closer to either axis, the

opportunity cost of a trade-off decreases.

3.

T F Without trade, a point above or to the right of the PPF is unattainable.

4.

T F If the PPF is a straight line with a slope of -1, the two goods concerned are very

different.

5.

T F The PPF is often used to graphically represent the trade-off between the

production of capital goods and the production of missiles.

6.

T F A movement along the PPF represents a trade-off.

7.

T F The law of increasing opportunity costs explains why the PPF is usually curved.

1.08 GRAPHING

Conquer a new frontier. On the left, I've given you production possibilities data for Milk and Missiles in the country of Decalon. Plot the data from the table into the graph on the right, using the y-axis for the consumer good and the x-axis for the capital good. Connect the dots to form a frontier. Also, be sure to label the axes.

Production Possibilities in

Decalon

Milk

Missiles

(thousands

of gallons)

60

0

58

15

50

30

35

45

20

52

15

53

0

55

Y 60

55

50

45

40

35

30

25

20

15

10

5

0

5 10 15 20 25 30 35 40 45 50 55 60 X

1.09 THINK FAST!

No, faster! What law is demonstrated by the expression, "It is easy to make milk out of cows; it is more difficult to make nuclear missiles out of cows"?

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