Economics 104 Chapter 2 Review Questions Answers ANSWERS TO QUESTIONS FOR REVIEW 1 Opportunity Costs Discuss the ways in which the following conditions might affect the opportunity cost of going to a movie tonight a You have a final exam tomorrow b School will be out for one month starting tomorrow c The same movie will be on TV next week d The Superbowl is on TV tonight a This greatly increases the opportunity cost Your opportunity cost includes the ticket price plus the value of the loss of study time and loss of sleep that may have a negative effect on your final exam grade tomorrow b This significantly lowers the opportunity cost Your opportunity cost includes the ticket price plus the value of any other activity you might have engaged in tonight instead such as staying home and watching TV c This leaves the opportunity cost unchanged but the movie becomes a less attractive alternative d This may increase or decrease the opportunity cost depending on whether or not you are a football fan 2 Opportunity Costs Determine whether each of the following statements is true or false or uncertain Explain your answers a The opportunity cost of an activity is the total value of all the alternatives passed up b Opportunity cost is an objective measure of cost c When making choices people carefully gather all available information about the costs and benefits of d A decision maker seldom knows the actual value of a forgone alternative and therefore must make alternative choices decisions based on expected values a FALSE The opportunity cost is the value of only the single best alternative forgone b FALSE Opportunity cost is a subjective measure of cost Only the individual can estimate the expected benefits and costs to himself or herself c FALSE Information is gathered only as long as the expected benefits from information gathering exceed the expected costs Acquiring information about alternatives is costly and time consuming Individuals usually make their choices based on limited and incorrect information because that was what was available given their time and cost constraints d TRUE For example you can guess that you will enjoy a movie and then find it too violent for your tastes 3 Comparative Advantage You should never buy precooked frozen foods because the price you pay includes the labor costs of preparing the food Is this conclusion always valid or can it be invalidated by the law of comparative advantage This statement conflicts with the idea of comparative advantage If your opportunity cost of preparing food is higher than the cost of buying prepared food the law of comparative advantage would direct you to buy the product with the lowest opportunity cost There will be some people with very high time costs e g surgeons who will make the decision not to cook The fact that prepared foods have become popular indicates that they are fulfilling a need This need arises from the increasing opportunity cost of preparing one s own food The increasing opportunity cost is caused by the fact that the value of time to the professional person is rising faster than the cost of precooked frozen food 4 Specialization and Exchange Explain how the specialization of labor can lead to increased productivity People are assigned various tasks according to their individual skills that is their comparative advantages Also people become better at a task the more they practice it no time is lost in moving from one task to another Specialization allows a more efficient organization of the production process and the introduction of more efficient production methods With specialization it is possible for a group of people to produce much more than the group could if each person produced the entire product herself or himself 5 Production Possibilities Under what conditions is it possible to increase production of one good without decreasing production of another good An economy can produce more of one good without sacrificing production of another good if it is operating inside its PPF The economy is inside the PPF when some resources are idle or when they are allocated inefficiently Therefore production can increase by using more of the idle resources or by allocating resources more efficiently 6 Production Possibilities Under what conditions would an economy be operating inside its PPF On its PPF Outside its PPF The economy is inside its PPF if some resources are idle unemployed or if resources are allocated inefficiently An economy is producing on its PPF if all resources are employed efficiently An economy cannot operate outside of its PPF Points outside the PPF represent unattainable combinations given the resources rules of the game and the technology available 7 Shifting Production Possibilities In response to an influx of undocumented workers Congress made it a federal offense to hire them How do you think this measure affected the U S production possibilities frontier Do you think all industries were affected equally Such a law should cause the PPF to shift inward because fewer resources would be available to the United States economy The more labor intensive industries such as agriculture and services would be hurt the most especially those requiring unskilled labor 8 Production Possibilities If society decides to use its resources efficiently that is to produce on its production possibilities frontier then future generations will be worse off because they will not be able to use these resources If this assertion is true full employment of resources may not be a good thing Comment on the validity of this assertion The answer to this question depends on how the resources are used If resources are used to produce consumer non durables and if little capital is produced then future generations will be worse off If society s resources are used to produce capital goods and research then economic growth in the future will be faster making future generations better off The key to this question is the realization that most of society s productive resources are reproducible and that full employment can promote growth 9 Economic Questions What basic economic questions must be answered in a barter economy In a primitive economy In a capitalist economy In a command economy All of the listed types of economies face the same three basic questions what goods and services to produce how to produce those goods and services and for whom the goods and services should be produced 10 Economic Systems What are the major