Chapter 1INTRODUCTION

1. The source of an economy’s scarcity problem is that people have limited resources to satisfy their unlimited material wants.

2. Resources, or factors of production are inputs used in the production of goods and services. They include land, labor, capital, and entrepreneurship.

3. The reality of scarcity forces us to make choices that involve giving up another opportunity to do or use something else. Economists use the term opportunity cost to denote the value of the best alternative sacrificed.

4. A production possibilities curve illustrates graphically the maximum combinations of two goods that an economy can produce, given its available resources and technology. An economy located along its production possibilities curve operates at maximum efficiency.

5. As we move along an outward-bowed production possibilities curve, opportunity costs increase as more of a good is produced. Increasing opportunity costs occur because resources are not completely adaptable to alternative uses.

6. Economic growth entails an outward shift in an economy's production possibilities curve so that more of all goods can be produced. It is made possible by an increase in an economy's resource base or technological advance.

7. Economic sanctions are government imposed limitations placed on trade and financial relations among nations. The nation initiating the sanctions, the imposing nation, hopes that economic hardship caused by caused by sanctions will inspire the target nation to alter its political or military policies. Economic sanctions can force a target nation to locate beneath its production possibilities curve and can even cause the target nation's production possibilities curve to shift inward.

Chapter Objectives

After reading this chapter, you should be able to:

1. Discuss the nature of economics and the economic way of thinking.

2. Explain how the concept of scarcity relates to the concept of opportunity cost.

3. Develop a production possibilities curve that shows the combinations of goods which an economy can produce.

4. Discuss what it means for an economy to operate at maximum efficiency.

5. Identify the causes of economic growth and decline.

6. Describe the purpose and effects of economic sanctions.

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The Chapter in a Nutshell

2 Chapter 1: Introduction

Key Concept Quiz

1. economics

2. positive economics

3. normative economics

4. opportunity cost

5. efficiency

6. law of increasing opportunity cost

7. economic sanctions

8. capacity utilization rate

9. models

10. circular flow model

_____ a. involves value judgments

_____ b. value of the best alternative sacrificed

_____ c. study of choice under conditions of scarcity

_____ d. is the ratio of an industry’s production to its capacity

_____ e. describes the facts of the economy

_____ f. shows the interaction of households and businesses

_____ g. bowed out production possibilities curve

_____ h. points along the production possibilities curve

_____ i. complete bans on trade

_____ j. simplified presentations of the real world

Multiple Choice Questions

1. Opportunity cost is the

a. price of a good or serviceb. all out-of-pocket costsc. value of the best alternative sacrificed. price that exceeds market price.

2. A movement along the production possibilities curve is a movement from

a. one efficient point to anotherb. an inefficient point to an efficient onec. an efficient point to an inefficient oned. one inefficient point to another

3. The best point on the production possibilities curve is

a. the one in the middleb. the extreme point on the horizontal axisc. the extreme point on the vertical axisd. impossible to determine without knowledge of society’s preferences.

4. Along a production possibilities curve, an increase in the production of one good is always associated with

a. a decrease in the production of the other good

Knowledge Check

Chapter 1: Introduction 3

b. an increase in the production of the other goodc. no change in the production of the other goodd. all of the above

5. When the production possibility curve has a constant slope, the opportunity cost of producing one good is

a. constantb. increasingc. decreasingd. increasing at a constant rate

6. Positive economics

a. describes the facts of the economyb. does not allow for empirical testingc. involves value judgementsd. is identical to normative economics

7. The law of increasing costs implies that

a. resources are scarceb. resources are not used efficientlyc. resources are not completely adaptable to alternative usesd. resources are costly

8. Economic growth occurs when

a. resources increaseb. resources are not used efficientlyc. resources are not completely adaptable to alternative usesd. resources decrease

9. Economic sanctions may be

a. government-imposed regulationsb. complete bans on tradec. used to combat international terrorismd. all of the above

10. Economics is a study of

a. choice under conditions of scarcityb. decisions made by households and firmsc. the overall performance of an economyd. all of the above

11. A nation that emphasizes production of capital goods

a. grows more rapidly than another that emphasizes production of consumer goodsb. sacrifices future consumptionc. does not necessarily face a tradeoff between present and future consumptiond. must always import consumer goods

4 Chapter 1: Introduction

The figure below shows hypothetical production possibilities curves for U.S. computer and automobile production. Answer the next three questions on the basis of this information.

Production Possibilities Curves

12. Suppose that PPC0 is the initial production possibilities curve. If the U.S. economy is at point H, then:

a. it is operating at maximum capacity and cannot produce more of both goodsb. it realizes unemployment or underproduction, and thus is capable of producing more of

both goodsc. the opportunity cost of computers is increasing and the opportunity cost of autos is

decreasingd. the opportunity cost of computers is decreasing and the opportunity cost of autos is

increasing

13. If we slide downward along curve PPC0, from E to F to G, then:

a. there is a technological improvement in auto production but not in computer productionb. the opportunity cost of computers increases in terms of autos sacrificedc. we are sure that resources are fully substitutable from auto production to computer

productiond. there is unemployment of computer workers, but not auto workers

14. If the production possibilities curve shifts outward from PPC0 to PPC1, then:

a. the economy moves from unemployment to full employmentb. the opportunity cost of producing both autos and computers decreasesc. there is an increases in resources which permits more autos and computers to be

produced

PPC0

PPC1

H

E

F

Automobil

es

G

Computers0

Chapter 1: Introduction 5

d. there is a technological improvement which permits the production of more computers, but not more autos

15. When resources are not fully substitutable from one industry to another, the production possibilities schedule appears as a (an)

a. downward sloping straight lineb. upward sloping straight linec. curve that is bowed inwardd. curve that is bowed outward

16. The cornerstones of economics include all of the following except

a. every choice has a costb. people make better choices by thinking at the marginc . people are characterized by rational self interestd. people have unlimited resources to satisfy their limited wants

17. The opportunity cost of a new baseball stadium for the New York Yankees isa. the wages paid to construction workers who build the stadiumb. the increased property taxes for owners of the stadiumc. other goods that must be sacrificed to construct the stadiumd. interest that must be paid on money borrowed by the stadium’s owners

18. The production possibilities curve would shift outward for all of the following reasons except

a. an improvement in technologyb. an increase in resourcesc. a rise in labor productivity d. a reduction in the unemployment rate

19. Which question best concerns normative economics?

a. Why do major league baseball players earn more than high school teachers?b. Do tariffs on steel imports protect the jobs of American steelworkers?c. Should the minimum wage be increased to help teenage workers?d. Will falling business taxes result in more investment spending?

20. Points inside the production possibilities curve are

a. attainable, but not efficientb. attainable, and efficientc. unattainable, but not efficientd. unattainable, and efficient

True-False Questions

1. T F The opportunity cost of a good or service is the cost of the other alternative.

2. T F Models and theories are used to explain and predict.

3. T F Positive economics involves value judgements.

6 Chapter 1: Introduction

4. T F Normative economics allows for empirical testing.

5. T F Scarcity of resources forces economists to recognize opportunity costs of production.

6. T F The production possibilities curve is always downward-sloping.

7. T F An upward-sloping production possibilities curve would indicate that there are no opportunity costs.

8. T F When the technology improves, the production possibilities curve shifts inward.

9. T F All points along the production possibilities curve are efficient.

10. T F The capacity utilization rate measures the ratio of an industry’s production to its capacity.

11. T F A production possibilities curve that is bowed outward reflects the law of increasing opportunity cost.

12. T F Future and present consumption involves tradeoffs.

13. T F All economic sanctions are consistently effective.

14. T F The law of increasing opportunity costs suggests that resources are completely adaptable to alternative uses.

15. T F Economics is founded on the assumption of rational self-interest by people.

16. T F If Mary states that unemployment benefits should be increased, she is making a normative statement.

17. T F The source of the scarcity problem is that resources are unlimited and people have limited material wants.

18. T F The factors of production include money, land, labor, and entrepreneurship.

19. T F Economic growth results in the production possibilities curve becoming flatter.

20. T F Successful economic sanctions levied against Iraq tend to force Iraq to operate inside of its production possibilities curve in the short run, while its entire curve shifts inward in the long run.

Application Questions

1. The following table and diagram describes the production possibilities curve for a society.

Wheat Lentils

PPC

H

D

C

BA

Lentils

400

600

800

1000

Chapter 1: Introduction 7

A 0 900

B 200 850

C 400 700

D 600 500

E 800 0

a. If society is at point B, what is the opportunity cost of producing 200 additional units of wheat?

b. What is the opportunity cost of changing from exclusive production of lentils (A) to producing 400 units of wheat (C)?

c. Why should society not produce at point G? Is there a possibility of society ever producing this combination?

d. Can society produce at point H? Will it ever be possible to produce this combination?

e. As society moves from point A to E, what is happening to the opportunity costs of production? Calculate the changing opportunity costs as you move from one combination to the next, beginning with A?

15. The following production schedule describes a new range of combinations for the products described in question 1 above: wheat and lentils.

Wheat Lentils

A 0 800

B 200 600

C 400 400

8 Chapter 1: Introduction

D 600 200

E 800 0

a. What is the most important difference between the production schedule described in question 1 and this one?

b. What is the shape of the production possibility schedule that describes the information in the above table?

Key Concept Answers

1. c 6. g2. e 7. i3. a 8. j4. b 9. k5. h 10. d

Multiple Choice Answers

1. c 5. a 9. d 13. b 17. c2. a 6. a 10. a 14. d 18. d3. d 7. c 11. a 15. d 19. c4. a 8. a 12. b 16. d 20. a

True-False Answers

1. T 6. T 11. T 16. T2. T 7. T 12. T 17. F3. F 8. F 13. F 18. F4. F 9. T 14. F 19. F5. T 10. T 15. T 20. T

Answers to Knowledge Check Questions

Chapter 1: Introduction 9

Application Question Answers

1. a. 150 units of lentils

b. 200 units of lentils

c. Producing at point G is inefficient. Yes, society could produce this combination if resources are lost or technology is downgraded. This may occur when economic sanctions are imposed.

d. Producing at point H is infeasible. Yes, if society’s resource base expands or if there are advances in technology.

e. Opportunity costs keep increasing.

A to B.............50 units of lentilsB to C............150 units of lentilsC to D...........200 units of lentilsD to E............500 units of lentils

2. a. The opportunity costs remain constant.

b. The production possibility schedule is a straight line.