Principles Of Economics-important Questions 5a5p65

CHAPTER #

1 REVIEW QUESTION # 1 & 4

1. What is the distinction between a positive statement and a normative statement? Provide an example (different from those in the chapter) of each type of statement. A positive statement is a description of how the world is. It is testable. A normative statement is a description of how the world ought to be. It is, by its very nature, not testable because there is no universally approved criterion by which the statement can be judged. ―I will receive an A in this course,‖ is a positive statement made by an economics student—it might not be true, but it is testable. ―I will receive a good grade for this course,‖ is a normative statement. Whether someone agrees with it depends on his or her interpretation of what makes for a ―good‖ grade. 1. What is a ceteris paribus assumption and how is it used? CETERIS PARIBUS: A Latin term meaning that all other factors are held unchanged. The ceteris paribus assumption is used to isolate the effect one economic factor has on another. Without this assumption, it would be difficult to determine cause and effect in the economy. Relaxing the ceteris paribus assumption is the primary analytical technique used in the study of economics, especially when analyzing the market. Much like a chemist adds one chemical at a time to a mixture to determine the resulting reaction, an economist relaxes one ceteris paribus assumption at a time to observe the results CHAPTER # 2 REVIEW QUESTION # 2 & 6 1. How does the production possibilities frontier show that every choice involves a tradeoff? The production possibility frontier illustrates the fact that every choice involves a tradeoff because every movement along the frontier means that while more of one good is produced, less of something else can be produced. Hence every choice to produce more of one thing necessitates the tradeoff of producing less of something else. 2. Why does the PPF for most goods bow out-ward so that opportunity cost increase as the quantity produce of a good increases? The production possibility frontier bows outward because different resources are better suited for production of one good than for another. Thus the opportunity cost of producing another unit of a good rises as more of the item is produced. Take, for instance, the case in which an economy is producing two goods: compact discs and video games, as illustrated in Figure 3.6. As more compact discs are produced, eventually resources that are ill suited for manufacturing compact discs but good for producing video games must be switched from producing video games to producing compact discs. As this change happens, the opportunity cost of additional compact discs -- that is, the video games that are foregone -- increases. Each movement, from point a to b to c to d to e to f and finally to g on the PPF, gains 1,000 additional compact discs, as illustrated by the horizontal line labeled "1 CD. " The opportunity cost of gaining each 1,000 compact discs is the video games that must be foregone. The vertical line extending from the horizontal line to the PPF gives this cost. Because the additional compact discs come at higher and higher opportunity costs, each subsequent vertical line is longer than the previous one, which s for the outward bow of the production possibility curve.

CHAPTER # 3 REVIEW QUESTION # 1 & 2 1. What is the effect on the price of an audiotape and the quantity of audio tape sold if

a. The price of a CD rises? The price of an audiotape will rise, and the quantity of audiotapes sold will increase. CDs and audiotapes are substitutes. If the price of a CD rises, people will buy more audiotapes and fewer CDs. The demand for audiotapes will increase. The price of an audiotape will rise, and more audiotapes will be sold. b. The price of a walkman rises The price of an audiotape will fall, and fewer audiotapes will be sold. Walkmans and audiotapes are complements. If the price of a Walkman rises, fewer Walkmans will be bought. The demand for audiotapes will decrease. The price of an audiotape will fall, and people will buy fewer audiotapes. c. The supply of a CD player increases? The price of an audiotape will fall and fewer audiotapes will be sold. The increase in the supply of CD players will lower the price of a CD player. With CD players cheaper than they were, some people will buy CD players. The demand for CDs will increase, and the demand for audiotapes will decrease. The price of an audiotape will fall, and people will buy fewer audiotapes. d. Consumer income increases? The price of an audiotape will rise, and the quantity sold will increase. An increase in consumers' incomes will increase the demand for audiotapes. As a result, the price of an audiotape will rise and the quantity bought will increase. e. Workers who make audiotape get a pay raises? The price of an audiotape will rise, and the quantity sold will decrease If the workers who make audiotapes get a pay raise, the cost of making an audiotape increases and the supply of audiotapes decreases. The price will rise, and people will buy fewer audiotapes. f.

The price of a Walkman rises at the same time as the workers who make audio tapes get a pay raise?

The quantity sold will decrease, but the price might rise, fall, or stay the same. Walkmans and audiotapes are complements. If the price of a Walkman rises, fewer Walkmans will be bought and so the demand for audiotapes will decrease. The price of an audiotape will fall, and people will buy fewer audiotapes. If the wages paid to workers who make audiotapes rise, the supply of audiotapes decreases.

The quantity of audiotapes sold will decrease, and the price of an audiotape will rise. Taking the two events together, the quantity sold will decrease, but the price might rise, fall, or stay the same 2. What is the effect on the price of an DVD players and the quantity of DVD sold if a. The price of a DVD rises? The price of a DVD player will fall, and the quantity of DVD players sold will decrease DVDs and DVD players are complements. If the price of a DVD rises, people will buy fewer DVDs and fewer DVD players. The demand for DVD players will decrease. The price of a DVD player will fall, and fewer DVD players will be sold. b. The price of a DVD falls? The price of a DVD player will rise, and the quantity of DVD players sold will increase. DVDs and DVD players are complements. If the price of a DVD falls, people will buy more DVDs and more DVD players. The demand for DVD players will increase. The price of a DVD player will rise, and more DVD players will be sold. c. The supply of a DVD player increases? The price of a DVD player will fall and more DVD players will be sold. With the increase in the supply of DVD players, the supply curve of DVD players shifts rightward. The price of a DVD player falls and the quantity sold increases. d. Consumer income decrease? The price of a DVD player will fall, and the quantity sold will decrease. A decrease in consumers' incomes will decrease the demand for DVD players. As a result, the price of a DVD player will fall and the quantity sold will decrease e. The wages rate of workers who produce DVD player increases? The price of a DVD player will rise, and the quantity sold will decrease. If the workers who make DVD players get a pay raise, the cost of making a DVD player increases and the supply of DVD players decreases. The price will rise, and people will buy fewer DVD players. f.

The wages rate of workers who produce DVD player raise at the same time the price of DVD falls?

The price will rise but the quantity sold might increase, decrease, or remain the same. DVDs and DVD players are complements. If the price of a DVD falls, more DVD players will be bought and so the demand for DVD players will increase. The price of a DVD player will rise, and people will buy more DVD players. If the wages paid to workers who make DVD players rise, the supply of DVD players decreases. The quantity of DVD players sold will decrease, and the price of a DVD player will rise. Taking the two events together, the quantity sold might increase, decrease, or remain the same, but the price will rise.

CHAPTER # 4 REVIEW QUESTION # 1 & 2 1. Rain spoils the strawberry crop. As a result, the price raise from $4 to $6 a box and the quantity demanded decrease from 1,000 to 600 boxes a week. Over this price change. a. What is the price elasticity of demand? The price elasticity of demand is 1.25. The price elasticity of demand equals the percentage change in the quantity demanded divided by the percentage change in the price. The price rises from $4 to $6 a box, a rise of $2 a box. The average price is $5 a box. So the percentage change in the price is $2 divided by $5 and then multiplied by 100, which equals 40 percent. The quantity decreases from 1,000 to 600 boxes, a decrease of 400 boxes. The average quantity is 800 boxes. So the percentage change in quantity is 400 divided by 800, which equals 50 percent. The price elasticity of demand for strawberries is 50 percent divided by 40 percent, which equals 1.25. ($2÷$5) × 100 b. Describe the demand for strawberries? The price elasticity of demand exceeds 1, so the demand for strawberries is elastic. 2. Good weather brings a bumper tomato crop. The price falls $7 to $5 a basket, and the quantity demanded increase from 300 to 500 baskets a day. Over this price range, a. What is the price elasticity of demand? The price elasticity of demand is 1.67. The price elasticity of demand equals the percentage change in the quantity demanded divided by the percentage change in the price. The price falls from $6 to $4 a basket, a fall of $2 a basket. The average price is $5 a basket. So the percentage change in the price equals $2 divided by $5, which equals 40 percent. The quantity increases from 200 to 400 baskets, an increase of 200 baskets. The average quantity is 300 baskets. So the percentage change in quantity equals 200 divided by 300, which equals 66.7 percent. The price elasticity of demand for tomatoes equals 66.7 divided by 40, which is 1.67. b. Describe the demand for tomatoes. The price elasticity of demand exceeds 1, so the demand for tomatoes is elastic.

CHAPTER # 7 REVIEW QUESTION # 2 & 3 1. What is utility and how do we use the concept of utility to describe a consumer’s preferences? Utility is a measure of satisfaction, referring to the total satisfaction received by a consumer from consuming a good or service. Economists use the concept of utility t describe preference Total utility is the total benefit that a person gets from the consumption of goods and services total utility depends on the level of consumption more consumption gives more total utility The units of utility are arbitrary the marginal utility of a good or service is the utility gained (or lost) from an increase (or decrease) in the consumption of that good or service. Economists sometimes speak of a law of diminishing marginal utility, meaning that the first unit of consumption of a good or service yields more utility than the second and subsequent units

  

Economists assume the higher the satisfaction a good or service provides, the more a consumer will pay. Utility - The pleasure or satisfaction obtained from a good or service. There is an important distinction between total utility and marginal utility: o Total Utility - The amount of satisfaction obtained from entire consumption of a product. o Marginal Utility – The change in total utility obtained by consuming one additional (marginal) unit of a good or service.

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change in total utility marginal utility = ------------------------change in quantity

2. What is the distinction between total utility and marginal utility?

Difference Between Total Utility and Marginal Utility: People buy goods because they get satisfaction from them. This satisfaction which the consumer experiences when he consumes a good, when measured as number of utils is called utility. It is here to necessary to make a distinction between total utility and marginal utility.

Total Utility (TU): Definition and Explanation: "Total utility is the total satisfaction obtained from all units of a particular commodity consumed over a period of time". For example, a person consumes eggs and gains 50 utils of total utility. This total utility is the sum of utilities from the successive units (30 utils from the first egg, 15 utils from the second and 5 utils from the third egg). Summing up total utility is the amount of satisfaction (utility) obtained from consuming a particular quantity of a good or service within a given time period. It is the sum of marginal utilities of each successive unit of consumption.

Formula: TUx = ∑MUx

Marginal Utility (MU): Definition and Explanation: "Marginal utility means an additional or incremental utility. Marginal utility is the change in the total utility that results from unit one unit change in consumption of the commodity within a given period of time". For example, when a person increases the consumption of eggs from one egg to two eggs, the total utility increases from 30 utils to 45 utils. The marginal utility here would be the15 utils of the 2nd egg consumed. Marginal utility, thus, can also be described as difference between total utility derived from one level of consumption and total utility derived from another level of consumption.

Formula: 3. MU = ∆TU ∆Q It may here be noted that as a person consumes more and more units of a commodity, the marginal utility of the additional units begins to diminish but the total utility goes on increasing at a diminishing rate. When the marginal utility comes to zero or we say the point of satiety is reached, the total utility is the maximum. If consumption is increased further from this point of satiety, the marginal utility becomes negative and total utility begins to diminish. The relationship between total utility and marginal utility is now explained with the help of following schedule and a graph. Schedule: Units of Apples Consumed Daily 1 2 3 4 5 6

Total Utility in Utils Per Day 7 11 13 14 14 13

Marginal Utility in Utils Per Day 7 4 (11-7) 2 (13-11) 1 (14-13) 0 (14-14) -1 (13-14)

The above table shows that when a person consumes no apples, he gets no satisfaction. His total utility is zero. In case he consumes one apple a day, he gains seven units of satisfaction. His total utility is 7 and his marginal utility is also 7. In case he consumes second apple, he gains extra 4 utils (MU). Thus given him a total utility of 11 utils from two apples. His marginal utility has gone down from 7 utils to 4 utils because he has a less craving for the second apple. Same is the case with the consumption of third apple. The marginal utility has now fallen to 2 utils while the total utility of three apples has increased to 13 utils (7 + 4 + 2). In case the consumer takes fifth apple, his marginal utility falls to zero utils and if he consumes sixth apple also, the total showing total utility and marginal utility is plotted in figure below:

Diagram/Curve:

4.

(i) The total utility curves starts at the origin as zero consumption of apples yield zero utility. (ii) The TU curve reaches at its maximum or a peak of M when MU is zero. (iii) The MU curve falls through the graph. A special point occurs when the consumer consumes fifth apple. He gains no marginal utility from it. After this point, marginal utility becomes negative. (iv) The MU curve can be derived from the total utility curve. It is the slope of the line ing two adjacent quantities on the curve. For example, the marginal utility of the third apple is the slope of line ing points a and b. The slope of such given by the formula: MU = ∆TU ∆Q Here MU = 2.

CHAPTER # 10 REVIEW QUESTION # 2 & 3 1. What is the Law of diminishing returns? Why does marginal product eventually diminish? Answer The law of diminishing returns states that as a firm uses more of a variable input without changing the quantity of fixed inputs, the marginal product of the variable input eventually diminishes. In other words, as more labor is combined with a fixed amount of capital, eventually the marginal product of labor falls. The law of diminishing returns affects the shape of the total product, average product, and marginal product curves. When the firm is experiencing diminishing returns, the MP curve falls, as the marginal product of an additional worker falls short of the marginal product of the previous worker. As long as the marginal product of the worker is positive, the total product curve rises, but at a declining rate. Immediately after the firm experiences diminishing returns, the average product curve continues to rise, but at a declining rate. Eventually, as the marginal product curve continues to decline, the marginal product curve cuts the average product curve (when the average product is at its maximum). After that point, diminishing returns implies that the average product curve declines.

2. Explain the relationship between marginal product and average product: The average product and marginal product are related via the standard average/marginal relationship: The average product increases when the marginal product exceeds the average product; the average product falls when the marginal product is smaller than the average product; and the average product is at its maximum and does not change when the marginal product equals the average product. The relation between average product and marginal product is one of several that reflect the general relation between a marginal and the corresponding average. The general relation is this:   

If the marginal is less than the average, then the average declines. If the marginal is greater than the average, then the average rises. If the marginal is equal to the average, then the average does not change.

This general relation surfaces throughout the study of economics. It also applies to average and marginal cost, average and marginal revenue, average and marginal propensity to consume, and well, any other average and marginal encountered in economics.

How does average product change when marginal product exceeds average product?

Making Tacos

Average and Marginal Product

The graph at the right for the hourly production of Super Deluxe TexMex Gargantuan Tacos (with sour cream and jalapeno peppers) illustrates the relation between average product and marginal product. 

Marginal Greater Than Average : For the first few quantities of variable input (workers), marginal product is rising and lies above average product. This is consistent with an increasing average product. If Waldo (proprietor of Waldo's TexMex Taco World) hires an additional worker in this early stage of production, then the marginal product (that is the extra contribution) of this worker is greater than that of the existing workers. This, as such, increases the average for all workers.

Even after the law of diminishing marginal returns kicks in, and marginal product declines, average product continues to increase because the marginal exceeds the average. 



Marginal Equal To Average: The point of intersection between the marginal product and average product curves is also the peak of the average product curve. If the productivity of the marginal worker is equal to the average productivity of the existing workers, then the average does not change. Marginal Less Than Average: Once the marginal product curve moves below the average product curve, then the average product curve declines. As Waldo hires an additional worker in the middle of this range, the marginal product of this worker is less than that of the existing workers, which pulls down the overall average.

The Law of Diminishing Marginal Returns This average-marginal relation for production is closely tied to the law of diminishing marginal returns. Marginal product declines with the onset of diminishing marginal returns. The "hump shape" of the marginal product curve reflects first increasing marginal returns then decreasing marginal returns.

For this reason, the "hump shape" of the average product curve is attributable, indirectly, to the law of diminishing marginal returns and the "hump shape" of the marginal product curve. Increasing marginal returns means marginal product is rising and because average product necessarily starts at zero (zero production means zero average product), marginal product lies above average product and causes it to rise, as well. With the onset of decreasing marginal returns, marginal product declines. However, for this initial part of the marginal product decline, average product continues rising because marginal product is still greater. After marginal product falls enough to meet up and intersect average product, average product peaks. As marginal product, again guided by the law of diminishing marginal returns, continues to decline and falls below average product. This causes the decline of average product. In essence, the average product curve plays catch-up to the marginal product curve, sort of follow the leader. At first, marginal product rises, so average product tags along like an annoying younger sibling. Then marginal product decides to fall, so average product chases after it. Because marginal product is guided by the law of diminishing marginal returns, so too is average product.

How does average product change when average product exceeds marginal product?

CHAPTER # 12 REVIEW QUESTION # 1 1. What is the relationship between marginal cost and marginal revenue when a single – price monopoly maximizes profit?

CHAPTER #

20

REVIEW QUESTION # 2, 3 & 4 1. What is the distinction between real GDP and potential GDP?

Gross domestic product (GDP) has many different measurements, including real GDP and potential GDP, but those numbers are often so similar that it can be difficult to know the differences. Real GDP and potential GDP treat inflation differently, because potential GDP is based on a constant inflation while real GDP can change. Potential GDP is an estimate that is often reset each quarter by real GDP, while real GDP describes the actual financial status of a country or region. It is based on a constant inflation rate, so potential GDP cannot rise any higher, but real GDP can go up. As with the inflation rate, these GDP measurements treat unemployment either as a constant or as a variable. Inflation, whether positive or negative, is a factor that constantly affects a country or region. While this is true, real GDP and potential GDP treat inflation differently, which often results in differences ranging from slight to major. With potential GDP, inflation is treated as a constant, so the rate never changes. When calculating real GDP, the actual inflation rate — which is prone to changing — is used. Potential GDP’s inflation rate is usually reset each quarter to the inflation rate that occurred with the real GDP.

Real GDP is the more accurate of the real GDP and potential GDP measurements, because it describes how a country or region is actually doing financially. Potential GDP is used as an estimate that describes how well a country or region might do during a quarter, but the real measurement may be completely different. This means real GDP is often used to see how a country or region did last quarter, while potential GDP is used as a measuring tool for the next quarter. It is based on an estimated inflation rate, so potential GDP cannot rise any higher than its estimated value. Real GDP can drastically alter during the quarter, based on production amounts and inflation. While potential GDP is often thought of as a tool to show a country’s or region’s highest GDP value, real GDP can sometimes be higher than potential GDP. Unemployment is a factor that can affect production, inflation rates and the general worth of a country or region. Much like with inflation rates, potential GDP treats unemployment as a constant while real GDP measures the actual unemployment rate. The unemployment rate typically does not alter as much as inflation rates, so this tends to have less of an affect on the GDP value. 2. What is a business cycle and what are its phases? A business cycle is periodic but irregular up and down movement in production. It is measures by fluctuations in real GDP. CHAPTER #

21 REVIEW QUESTION # 1 &2

1. What is the distinction between nominal GDP and real GDP? A distinction between Nominal GDP and Real GDP allows us to measure the actual changes in production, separate and apart from any price changes that may have occurred in the economy during the year Nominal GDP: The total market value of all the final goods and services produced within an economy in a given year. The value of GDP in current dollar. Real GDP: A measure of GDP that adjusts for changes in prices. The value of GDP in constant dollar 2. What is the traditional method of calculating real GDP?

CHAPTER # 23 REVIEW QUESTION # 3 1. Describe three types of short run macro-economic equilibrium? The Macroeconomic Short Run The macroeconomic short run a period during which some money prices are sticky so that 

Real GDP might be below, above, or at potential GDP.

The unemployment rate might be above, below, or at the natural unemployment rate Short-Run Macroeconomic Equilibrium Short-run macroeconomic equilibrium occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied at the point of intersection of the AD curve and the SAS curve.

CHAPTER # 28 REVIEW QUESTION # 1 How does demand-pull inflation begin? What are the initial effects of demand-pull inflation on real GDP Demand-pull inflation is caused by increases in aggregate demand. In theory, any factor that increases aggregate demand, such as an increase in government purchases, decrease in taxes, increase in the money supply, increase in exports, or increase in investment, can start a demand-pull inflation. As a practical matter, most economists suggest that most demand-pull inflations are started by increased growth in the money supply. To start, suppose an increase in the money supply causes the AD curve to shift rightward. This shift increases the price level, thereby creating inflation. It also increases real GDP so that the economy is above potential real GDP; that is, it is at an above full-employment equilibrium. As a result, money wages increase, which shifts the SAS curve leftward. This shift decreases real GDP back to potential GDP and raises the price level, thus creating another round of inflation. If the Fed again increases the money supply to expand (again) the level of production, the process resumes: The price level moves higher and then money wages move higher, resulting in demand-pull inflation