ECO Final Exam | Complete Solution

Chapter 2 Question 1: What do economists mean by scarcity?

a.       Economists mean that unlimited wants exceed limited resources.

b.       Economists mean that trade is not possible.

c.       Economists mean that people are not employed.

d.       Economists mean that production is inefficient.

e.       Economists mean that economy is unable to produce increasing quantities of goods and services

What of the following is not scarce according to the economic definition?

a.       Coal

b.       Time

c.       Food

d.       Capital

e.       None of the above

Chapter 2 Question 2: A production possibilities frontier:

a.       Shows the market for a good or service

b.       Shows how unlimited wants exceed the limited resources available to fulfill those wants

c.       Shows how participants in the market are linked

d.       Shows the maximum attainable combinations of two goods that may be produced with available resources.

We can show economic efficiency:

a.       With points inside the production possibilities frontier

b.       With points on the production possibilities frontier

c.       With points inside and on the production possibilities frontier

d.       With points on and outside the production possibilities frontier

e.       With points outside the production possibilities frontier

We can show economic inefficiency:

a.       With points inside the production possibilities frontier

b.       With points on the production possibilities frontier

c.       With points inside and on the production possibilities frontier

d.       With points on and outside the production possibilities frontier

e.       With points outside the production possibilities frontier

The production possibilities frontier will shirt outward:

a.       If technological advances occur.

Chapter 2 Question 3: What does increasing marginal opportunity costs mean?

a.       The economy is unable to produce increasing quantities of good and services.

b.       Increasing the production of a good requires decreases in the production of another good

c.       Production is not occurring on the production possibilities frontier

d.       Increasing the production of a good requires smaller and smaller decreases in the production of another good

e.       Increasing the production of a good requires larger and larger decreases in the production of another good

What are the implications of this idea for the shape of the production possibilities frontier?

a.       The production possibilities frontier will be bowed inward

b.       The production possibilities frontier will have a negative slope

c.       The production possibilities frontier will be a straight line

d.       The production possibilities frontier will have a positive slope.

e.       The production possibilities frontier will be bowed outward.

Chapter 2 Question 4: GRAPH Consider the production possibilities frontier (PPF) that shows the trade-off between the production of cotton and the production of soybeans depicted in the figure to the right. Use the three-point curved line drawing tool to show the effect that improved fertilizers/prolonged drought would have on the initial production possibilities frontier by drawing a new production possibilities frontier. Properly label this curve.

Chapter 2 Question 5: GRAPH Consider the production possibilities frontier (PPF) that shows the trade-off between the production of cotton and the production of soybeans depicted in the figure to the right. Suppose that genetic modifications make soybeans resistant to insects, allowing yields to increase. Use the three-point curved line drawing tool to show the effect of this technological change by drawing a new production possibilities frontier. Properly label this curve.

Chapter 2 Question 6: GRAPH One of the trade-offs BMW faces is between safety and gas mileage. For example, adding steel to a car makes it safer but also heavier, which results in lower gas mileage.

Use the three-point curved line drawing tool to draw a hypothetical production possibilities frontier that BMW engineers face that shows this trade-off. Assume that this trade-off is consistent with increasing costs of added safety. Properly label this curve.

Chapter 2 Question 7: Suppose you win free tickets to a movie plus all you can eat at the snack bar for free. Would there be a cost to you to attend this movie?

a.       No because the movie ticket and snacks at the bar are free.

b.       No because the movies are not scarce

c.       No because the movie ticket is free

d.       Yes because attending movies is not on the production possibilities frontier

e.       Yes because the movie’s opportunity cost is equal to the highest-valued alternative that must be given up to attend the movie.

Chapter 2 Question 8: Suppose we can divide all the goods produced by an economy into two types: consumption goods and capital goods. Capital goods, such as machinery, equipment, and computers, are goods used to produce other goods. Is it likely that the production possibilities frontier in this situation would be a straight line: or bowed out?

a.       The production possibilities frontier would likely be bowed out because not all resources are equally well suited to produce both consumption and capital goods.

Chapter 2 Question 9: GRAPH Suppose we can divide all the goods produced by an economy into two types: consumption goods and capital goods. Capital goods, such as machinery, equipment, and computers, are goods used to produce other goods. Suppose a technological advance occurs that affects the production of capital goods but not consumption goods. Use the three-point curved drawing tool to show the effect of this technological change by drawing a new production possibilities frontier. Properly label this curve.

Chapter 2 Question 10: GRAPH Suppose we can divide all the goods produced by an economy into two types: consumption goods and capital goods. Capital goods, such as machinery, equipment, and computers, are goods used to produce other goods. Suppose that country A and country B currently have identical production possibilities frontiers but that country A devotes only 5 percent of its resources to producing capital goods over each of the next 10 years, whereas country B devotes 30 percent. Which country is likely to experience more rapid economic growth in the future?

a.       Country B

Use the three-point curved drawing tool to illustrate this by drawing two production possibilities frontiers. Specifically, your graph should include production possibilities frontiers for country A in 10 years (the future) and production possibilities frontiers for country B in 10 years (the future). Properly label the curves.

Chapter 2 Question 11: What is absolute advantage?

a.       The ability to produce more of a good or service than competitors using the same amount of resources.

What is comparative advantage?

a.       The ability to produce a good or service at a lower opportunity cost than other producers.

Is it possible for a country to have a comparative advantage in producing a good without also having an absolute advantage? A country without an absolute advantage in producing a good:

a.       Will have a comparative advantage if it has a lower opportunity cost of producing that good.

Chapter 2 Question 12: What is the basis for trade?

a.       Comparative advantage

How can a country gain from specialization and trade?

a.       A country can specialize in producing that for which it has a comparative advantage and then trade for other needed goods and services.

Chapter 2 Question 13: GRAPH The graph to the right shows how many pounds of apples and pounds of cherries you and your neighbor can each pick in one week. For example, if you devote all of your time to picking apples and none of your time to picking cherries, you can pick 12 pounds of apples. If you devote all of your time to picking cherries, you can pick 72 pounds. At the same time, if your neighbor devotes all of her time to picking apples, she can pick 32 pounds of apples. If she devotes all of her time to picking cherries, she can pick 32 pounds. Suppose initially that you (Y) are consuming 8 pounds of apples and 24 pounds of cherries and that your neighbor (N) is consuming 4 pounds of apples and 28 pounds of cherries, as indicated in the graph. Then, suppose you and your neighbor specialize by each only picking the good for which you have a comparative advantage and trade. In particular, suppose you trade your neighbor half of your production for half of what your neighbor produces. In the table below, first fill in production when specializing. Next fill in consumption with trade. Recall that you trade your neighbor half of what you pick for half of what your neighbor picks. Finally, fill in gains from trade.

Chapter 2 Question 14: GRAPH Using the same amount of resources, the United States and Canada can both produce lumberjack shirts and lumberjack boots, as shown in the production possibilities frontiers in the figure to the right.

The United States has a comparative advantage in producing lumberjack boots.

Canada has a comparative advantage in producing lumberjack boots.

Does either country have an absolute advantage in producing both goods?

a.       Neither country has an absolute advantage in both goods because the United States can produce more boots but Canada can produce more shirts.

Suppose initially that the United States is consuming 18 boots and 2 shirts and Canada is consuming 4 boots and 8 shirts, as indicated in the figure. Then, suppose the United States and Canada specialize by each only producing the good for which they have a comparative advantage and then trade. In particular, suppose the United States trades Canada half of its production for half of what Canada produces.

The United States will have 10 additional shirt(s) after the trade and 0 additional boot(s).

At the same time, Canada will be able to consume 4 additional shirt(s) as a result of the trade and 14 additional boot(s).

Chapter 2 Question 15: In the 1950’s, the economist Bela Balassa compared 28 manufacturing industries in the United States and Britain. In every one of the 28 industries, Balassa found that the United States had an absolute advantage. In these circumstances, would there have been any gain to the United States from importing any of these products from Britain? Explain.

a.       Even with an absolute advantage, the United States would have benefited from importing those products for which Britain had a comparative advantage.

Chapter 2 Question 16: CHART Suppose Iran and Iraq both produce oil and olive oil. The following table shows combinations of both goods that each country can produce in a day, measured in thousands of barrels.

Who has the comparative advantage in producing oil?

a.       Neither country has a comparative advantage producing oil because their opportunity costs of producing oil are equal.

Can these two countries gain from trading oil and olive oil?

a.       These countries cannot gain from trade because neither has a comparative advantage producing either good.

Chapter 2 Question 17: CHART Suppose that France and Germany both produce wine and schnitzel. The table below shows combinations of the goods that each country can produce in a day. Who has the comparative advantage in producing wine and who has the comparative advantage in producing schnitzel?

a.       France has a comparative advantage producing wine and Germany has a comparative advantage producing schnitzel.

Suppose that France is currently producing 1 bottle of wine and 12 pounds of schnitzel and Germany is currently producing 3 bottles of wine and 10 pounds of schnitzel. Then, assume instead that France and Germany specialize by producing only the good for which they have a comparative advantage and then trade 3 bottles of wine for 13 pounds of schnitzel. After specialization and trade, France gains by consuming the same amount of wine and 1 additional pound(s) of schnitzel and Germany gains by consuming the same amount of wine and 2 additional pound(s) of schnitzel.

Chapter 2 Question 18: What is the circular-flow diagram and what does it illustrate?

a.       The circular-flow diagram shows how households and firms are linked through product and factor markets.

Chapter 2 Question 19: What are the two main categories of participants in markets?

a.       Firms and households

Which participants are of greatest importance in determining what goods and services are produced?

a.       Households.

Chapter 2 Question 20: What is a free market?

a.       A free market is one where the government does not control the production of goods and services.

In what ways does a free market economy differ from a centrally planned economy? Unlike a free market economy,

a.       Centrally planned economies have extensive government controls.

Chapter 2 Question 21: What is an entrepreneur?

a.       Entrepreneurs operate businesses that produce goods and services.

Why do entrepreneurs play a key role in a market system?

a.       They bring together factors of production.

Chapter 2 Question 22: Firms are likely to produce more of a good or service when its price rises and less of a good or service when its price falls.

Chapter 2 Question 23: What are private property rights? Private property rights are:

a.       The rights individuals and firms have to the exclusive use of tangible, physical property and intellectual property.

What role do they play in the working of a market system? Private property rights:

a.       Both a and b – encourage a significant number of people to be willing to risk funds by investing them in business. Encourage firms to spend money on research and development.

Why are independent courts important for a well-functioning economy? Independence is necessary for courts:

a.       All of the above – to make their decisions from of influence from people with powerful political connections, free of intimidation by criminal gangs, based on the law, free of influence from other parts of government.

Chapter 2 Question 24: Identify whether each of the following transactions will take place in the factor market or in the production market and whether households or firms are supplying the good or service or demanding the good or service. George buys a BMW X5 SUV. This takes place in the product market. The household demands the good the firm supplies the good. BMW increases employment at its Spartanburg plant. This takes place in the factor market. The households supply the labor and the firm demands the labor. George works 20 hours per week at McDonald’s. This takes place in the factor market. The household supplies the labor and the firm demands the labor. George sells land he owns to McDonald’s so it can build a new restaurant. This takes place in the factor market. The household supplies the factor of production and the firm demands the factor of production.

Chapter 2 Question 25: In The Wealth of Nations, Adam Smith wrote the following: “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.” What did Smith mean by this?

a.       Pursuing their own self-interest, entrepreneurs produce the goods and services most desired by their customers for financial reward.

Chapter 3 Question 1: GRAPH Below are both a demand schedule and a demand curve. Which one is best suited to find the quantity demanded at a price of $4.00? The demand schedule.

Chapter 3 Question 2: What do economists mean when they use the Latin expression ceteris paribus?

a.       All else equal

Chapter 3 Question 3: GRAPH Use the point drawing tool to show a change in demand given the combinations of price and quantity-demanded shown at point A.

Chapter 3 Question 4: The law of demand is the assertion that

a.       The quantity demanded of a product is inversely related to its price.

An increase in the price of a product causes a decrease in quantity demanded because of the income and substitution effects. More specifically,

a.       The substitution effect is the decrease in quantity demanded because the product is more expensive relative to other goods and the income effect is the decrease in quantity demanded owning to the decline in consumers’ purchasing power.

Chapter 3 Question 5: GRAPH A grilled cheese sandwich is considered to be a normal good. Use the line drawing tool to show how a decrease in consumer income affects the demand for grilled cheese sandwiches. Label this new line ‘D2’.

Chapter 3 Question 6: GRAPH Jiffy peanut butter and Smucker’s Strawberry jam are considered to be complementary goods. Use the line drawing tool to show how an increase in the price of Jiffy peanut butter affects the demand for Smucker’s Strawberry jam. Label this new line ‘D2’.

Chapter 3 Question 7: GRAPH Below are both a supply schedule and a supply curve. Which one is best suited to find the quantity supplied at a price of $4.50? The supply curve.

Chapter 3 Question 8: The difference between a change in supply and a change in the quantity supplied is that the latter is

a.       Displayed graphically as a movement along a supply curve while the former is shown as a shift in the supply curve.

Chapter 3 Question 9: From the list below, select the variable that will cause the supply curve to shift:

a.       The cost of raw materials

Chapter 3 Question 10: Identify whether each of the following statements describes a change in supply or a change in the quantity supplied.

a.       To take advantage of high prices for snow shovels during a very snowy winter, Alexander Shovels, Inc., decides to increase output. A change in quantity supplied.

b.       The success of Apple’s iPod leads more firms to begin producing digital music players. A change in supply.

c.       In the six months following Hurricane Katrina, production of oil in the Gulf of Mexico declined by 25 percent. A change in supply.

Chapter 3 Question 11: GRAPH On the diagram to the right, a movement from A to B represents a

a.       Change in quantity supplied.

Chapter 3 Question 12: GRAPH According to the law of supply,

a.       A and C only – there is a positive relationship between price and quantity supplied. As the price of a product increases, firms will supply more of it to the market.

Chapter 3 Question 13: Consider the supply of crude oil on the world market. In August 2011, the price of oil was roughly $80 per barrel. Which of the following changes would increase the supply of oil? The oil supply curve would shift to the right if

a.       Future oil prices were expected to be lower.

Chapter 3 Question 14: When economists speak of a shortage, they mean a situation in which

a.       All of the above – the market price is below the equilibrium price, some consumers are unable to make a purchase at the current price, the quantity demanded exceeds quantity supplied.

Chapter 3 Question 15: Complete the following statement: “When there is a shortage of a good

a.       Consumers complete against one another by bidding the price upward. The process continues until the market is finally in equilibrium.”

Chapter 3 Question 16: GRAPH An article discusses the market for autographs by Mickey Mantle, the superstar centerfielder for the New York Yankees during the 1950s and the 1960s: “At card shows, gold outings, charity dinners, Mr. Mantle signed his name over and over.” One expert on sport autographs is quoted as saying: blah blah blah. Show how the price of baseballs signed by Mantle could be higher than the price of baseballs signed by Ford.

1)     Use the line drawing tool to draw the supply curve (SFord) and the demand curve (DFord) for baseballs autographed by Whitey Ford. Properly label the lines.

2)     Use the line drawing tool to draw the supply curve (SMantle) and the demand curve (DMantle) for baseballs autographed by Mickey Mantle. Properly label the lines.

3)      Use the point drawing tool to indicate the equilibrium price and quantity of autographed baseballs by Ford and the equilibrium price and quantity of autographed baseballs by Matle. Properly label the lines.

Chapter 3 Question 17: During the summer of 2011, General Motors (GM) had trouble selling pickup trucks. According to an article in USA Today: “General Motors dealers had a 122-day supply of Chevrolet Silverado and GMC Sierra pickups in June, more than 50% above what’s considered optimum … Behind the glut: The year started strong and makes pumped up production. Then the economy slowed faster than they cut back.” The term glut implies that relative to the quantity supplied of GM pickup trucks, the quantity demanded was smaller. Given the situation in the market for GM pickup trucks in the summer of 2011, their prices would be expected to fall. A slowing economy helped cause the glut of pickup trucks because

a.       Income growth was sluggish and GM pickup trucks are a normal good.

Chapter 3 Question 18: GRAPH Assume the figure to the right illustrates the market for houses for sale in a small city. Suppose the market price of houses is $250,000. How large will the resulting surplus be? At a price of $250,000, there will be 800 surplus houses. What is the equilibrium price is $150,000.

Chapter 3 Question 19: GRAPH In the diagram to the right, when the price is $71 per player, the amount of the surplus is 56 million players per month.

Chapter 3 Question 20: The market for corn in country A is highly competitive. At the current market price of $5/bushel there is a shortage of 100,000 bushels of corn in this country. Media reports claim that the price of corn will rise drastically in the near future. According to these reports, the neighboring country B had witnessed a similar situation recently. At the same price, the shortage in country B was also 100,000 bushels and eventually the equilibrium price in B went up to $10/bushel. Both countries are known to have equal number of corn producers and the market supply of corn is identical at all prices. This, combined with the fact that consumers in the two countries also have similar tastes and preferences, let the media to conclude that the price of corn in country A would soon be as high as $10/bushel. Which of the following is being assumed by the media while concluding that the price in country A will also rise to $10/bushel?

a.       Demand conditions in both countries are identical.

Chapter 3 Question 21: The market for corn in country A is highly competitive. At the current market price of $5/bushel there is a shortage of 100,000 bushels of corn in this country. Media reports claim that the price of corn will rise drastically in the near future. According to these reports, the neighboring country B had witnessed a similar situation recently. At the same price, the shortage in country B was also 100,000 bushels and eventually the equilibrium price in B went up to $10/bushel. Both countries are known to have equal number of corn producers and the market supply of corn is identical at all prices. This, combined with the fact that consumers in the two countries also have similar tastes and preferences, let the media to conclude that the price of corn in country A would soon be as high as $10/bushel. This reasoning is flawed because it assumes that:

a.       Similar tastes and preferences translate into similar willingness and ability to pay.

Chapter 3 Question 22: The market for corn in country A is highly competitive. At the current market price of $5/bushel there is a shortage of 100,000 bushels of corn in this country. Media reports claim that the price of corn will rise drastically in the near future. According to these reports, the neighboring country B had witnessed a similar situation recently. At the same price, the shortage in country B was also 100,000 bushels and eventually the equilibrium price in B went up to $10/bushel. Both countries are known to have equal number of corn producers and the market supply of corn is identical at all prices. This, combined with the fact that consumers in the two countries also have similar tastes and preferences, let the media to conclude that the price of corn in country A would soon be as high as $10/bushel. If the new equilibrium price turns out to be below $10/bushel, which of the following inferences can be drawn?

a.       The demand curve for corn must be flatter in country A than in country B.

Chapter 4 Question 1: GRAPH Dissolvable tobacco products contain less nicotine than cigarettes and can help people quit smoking. Suppose that figure to the right illustrates five consumers’ willingness to pay for tobacco lozenges. If the price of a pack of tobacco lozenges is $5.50, what is the consumer surplus for these consumers? Consumer surplus is $5.50

Chapter 4 Question 2: Firm A is a new producer in the market for good X, which is characterized by linear demand and supply curves. Initially, to attract customers, the firm prices its product low at $8 per unit. While the firm sells 1,000 units of the product at this price, there is a shortage in the market. This shortage can be cleared if price is increased to $10 per unit. The quantity demanded and supplied at this higher price will be 1,500 units. Which of the following is most strongly supported by this information?

a.       Producer surplus will increase if the price rises from $8 per unit to $10

Chapter 4 Question 3: Firm A is a new producer in the market for good X, which is characterized by linear demand and supply curves. Initially, to attract customers, the firm prices its product low at $8 per unit. While the firm sells 1,000 units of the product at this price, there is a shortage in the market. This shortage can be cleared if price is increased to $10 per unit. The quantity demanded and supplied at this higher price will be 1,500 units. Rajiv Bose, a market analyst with firm A, claims that an increase in producer surplus would necessarily increase average profit for the firm. Which of the following, if true, would weaken Rajiv’s claim?

a.       Cost increase significantly as production expands.

Chapter 4 Question 4: Briefly explain whether you agree with the following statement: “If consumer surplus in a market increases, producer surplus must decrease.”

a.       The statement is incorrect. Consumer surplus (and producer surplus) could increase by decreasing deadweight loss.

Chapter 4 Question 5: Does an increase in economic surplus in a market always mean that economic efficiency in the market has increased? Briefly explain.

a.       If the marginal cost of production decreases but market output remains unchanged, then economic surplus and deadweight loss would both increase, decreasing economic efficiency.

Chapter 4 Question 6: Country Talmar produces 100,000 cars during a particular year. The market price of cars in Talmar is $5,000. In a recent meeting of the Economic Council, an economist, Carl Anderson claimed the nation’s production of cars was inefficiently high because the industry seemed to have positive inventory every year. Another economist, Tara Henderson, felt that the production was inefficiently low because there is a huge segment of the population that does not own cars. Which of the following statements are Tara and Carl likely to agree with?

a.       There is a deadweight loss at the given production level.

Chapter 4 Question 7: Country Talmar produces 100,000 cars during a particular year. The market price of cars in Talmar is $5,000. In a recent meeting of the Economic Council, an economist, Carl Anderson claimed the nation’s production of cars was inefficiently high because the industry seemed to have positive inventory every year. Another economist, Tara Henderson, felt that the production was inefficiently low because there is a huge segment of the population that does not own cars. Which of the following if true, would support Carl’s view?

a.       The market segment that does not own cars has excellent access to the mass transit system.

Chapter 4 Question 8: Country Talmar produces 100,000 cars during a particular year. The market price of cars in Talmar is $5,000. In a recent meeting of the Economic Council, an economist, Carl Anderson claimed the nation’s production of cars was inefficiently high because the industry seemed to have positive inventory every year. Another economist, Tara Henderson, felt that the production was inefficiently low because there is a huge segment of the population that does not own cars. Which of the following, if true, would support Tara’s view?

a.       A rapid increase in two-earner households had increased the demand for personal modes of transport.

Chapter 4 Question 9: GRAPH Use the information on the kumquat market in the following table to answer the questions. The equilibrium price is $15 and the equilibrium quantity is 100 million crates.

Suppose the federal government imposes a price floor of $25 per crate and purchases any surplus kumquats from producers. Now how much revenue will kumquat producers receive? Kumquat producers will receive $4.5 billion in revenue.

1)     Use the rectangular drawing tool to shade in the revenue received by kumquat producers before the price floor. Properly label the shaded area.

2)     Use the rectangular drawing tool to shade in the revenue received by kumquat producers after the price floor. Properly label the shaded area.

3)     Use the rectangular drawing tool to shade in the area representing the amount the government spends to purchase surplus kumquats. Properly label the shaded area.

Chapter 4 Question 10: GRAPH Suppose the figure to the right represents a local cattle market. What would be the effect on this market of the local government regulating a price ceiling of $1.00 per pound? The market would have a shortage of 20 thousand pounds.

Chapter 4 Question 11: The carpet industry in a developing country, A was going through difficult times. While this industry was once a major foreign exchange earner, there was a steady fall in production levels for the past three to four years. Workers, who had the requisite abilities to weave carpets, were finding it difficult to sustain themselves in this industry and began looking for opportunities elsewhere. Since the carpet industry was one of country A’s oldest industries, many people lobbied the government to take some action. Widespread support from various groups induced the government to invest heavily in the carpet industry last year. This was expected to boost the industry’s production level considerably. However, the increase in carpet production was much lower than expected. Which of the following, if true, could explain this outcome?

a.       A new minimum wage law came into effect this year, increasing wage rates substantially.

Chapter 4 Question 12: A deadly hurricane caused substantial damage to corn produced in the eastern region of a small country, which is its main corn-producing belt. This resulted in acute shortage of corn in this country and the price increased. The government decided to introduce a price ceiling for corn in an attempt to prevent an abnormal price hike. Kyra, a student of economics, believed that this was not a good idea as it was likely to increase the shortage and create a huge deadweight loss. Her friend, Dona, however felt that the resultant deadweight loss may not be too high. Which of the following, if true, would support Kyra’s claim.

a.       Recent easing of immigration laws has resulted in more and more people migrating to this country.

Chapter 4 Question 13: GRAPH Consider the market illustrated in the figure to the right. Supply curve S1 represents the private cost of production and demand curve D1 represents the private benefit from consumption. Suppose the consumption of this good creates a negative externality. In turn, the social benefit from consumption is represented by demand curve D2. Show how the externality affects market efficiency. Use the triangle drawing tool to share in the new economic surplus (new surplus) or the deadweight loss (deadweight loss) created by the negative externality. Properly label this shaded area.

Chapter 4 Question 14: Which of the following is not an example of an externality? An externality is not created by

a.       Consuming a pair of Gap jeans.        

Chapter 4 Question 15: How do externalities affect markets? If a negative externality in production is present in a market, then

a.       The private cost of production will be different than the social cost of production.

Chapter 4 Question 16: How do externalities in the production of college educations result in market failure? Because of externalities, the market for college educations will

a.       Provide insufficient college educations.

Chapter 4 Question 17: A coal-fired electric utility has a capacity of producing 500MW of electricity every month. To maximize its profit, the firm produces 400MW of electricity in a month. Kevin Peters, the president of an environmental advocacy group, claims that the production at this utility is inefficient and should be reduced by 200MW. The Environmental Protection Agency (EPA), however, has a different opinion. Although the EPA agrees that production needs to be reduced, it claims that the electric utility need not reduce production by as much as 200 MW. Which of the following, if true, would support Kevin’s claim?

a.       The social marginal cost of generating the last 200MW of electricity is higher than the marginal benefit to consumers.

Chapter 4 Question 18: A coal-fired electric utility has a capacity of producing 500MW of electricity every month. To maximize its profit, the firm produces 400MW of electricity in a month. Kevin Peters, the president of an environmental advocacy group, claims that the production at this utility is inefficient and should be reduced by 200MW. The Environmental Protection Agency (EPA), however, has a different opinion. Although the EPA agrees that production needs to be reduced, it claims that the electric utility need not reduce production by as much as 200 MW. Which of the following, if true, would support the EPA’s view?

a.       The analysis of the environmental advocacy group overstated he damage caused by the coal-fired plants.

Chapter 4 Question 19: The gross annual production of petrochemical plants situated in Jamnagar district of the Indian state of Gujarat is around 130 million tons. Each plant follows the profit-maximization principle and supplies petrochemicals up to the point where price equals the price marginal cost of production. Industry experts claim that the aggregate production of this industry is socially efficient because at this output level the supply of petrochemicals is equal to its demand. Which of the following, if true, would strengthen the claim of the industry experts that production is socially efficient?

a.       The operation of petrochemical plants does not damage the local tourism industry.

Chapter 4 Question 20: In a paper written for the Harvard Project on International Climate Agreements, the authors state that while a majority of developed nations are enacting significant regulations to mitigate climate change, “developing countries typically place greater priority on economic development than on environment protection, despite being vulnerable to the potential adverse effects of continued warming.” Recall the definition of normal goods. Is environmental protection a normal good? If so, is there any connection between this fact and the observation of the authors of the above statement? Briefly explain. How do the marginal cost and marginal benefit of environmental protection change with economic development? Environmental protection is

a.       A normal good because demand for it likely decreases as income decreases.

The authors’ statement

a.       Suggests that environmental protection is a normal good.

Since developed countries have enacted more significant regulations to mitigate climate change than developing countries, it must be the case that for a given level of environmental protection,

a.       The difference in the marginal benefit and the marginal cost is higher in developed countries.

Chapter 4 Question 21: GRAPH Suppose the figure to the right represents the production of a manufactured good. Production of this good generates volatile organic compounds, which are a type of air pollution. As a result, the cost of production to society is greater than the private cost of production is represented by MC1 and the marginal social cost is represented by MC2. Suppose the government decides to impose a Pigovian tax to bring about an efficient level of output. What size should the tax be? The government should levy a tax of $225 per ton produced.

Chapter 4 Question 22: Suppose the United States has two utilities, Commonwealth Utilities and Consolidated Electric. Both produce 20 million tons of sulfur dioxide pollution per year. However, the marginal cost of reducing a ton of pollution for Consolidated Electric is $200 per ton and the marginal cost of reducing a ton of pollution for Commonwealth Utilities is $250 per ton. The government’s goal is to cut sulfur dioxide pollution in half (by 20 million tons per year). If the government issues 10 million tradable pollution permits to each utility, what will be the cost of eliminating half of the pollution to society? Using a cap-and-trade system of tradable emission allowances will eliminate half of the sulfur dioxide pollution at a cost of $4,000 million per year. If the permits are not tradable, what will be the cost of eliminating half of the pollution? If permits cannot be traded, then the cost of the pollution reduction will be $4500 million per year.

Chapter 4 Question 23: The advanced machinery used for limestone quarrying in a particular region leads to noise pollution and affects the hearing ability of people residing in the neighborhood. The quarrying activity also results in soil erosion. Blah blah blah. Which of the following, if true, would support the taxation policy proposed by the research group?

a.       Recent environmental research reveals that the dust from the limestone quarrying site has severely contaminated the water at a nearby lake.

Chapter 4 Question 24: The advanced machinery used for limestone quarrying in a particular region leads to noise pollution and affects the hearing ability of people residing in the neighborhood. The quarrying activity also results in soil erosion. Blah blah blah. Suppose the government responds by imposing a tax on the production of limestone. After the tax is imposed, total production of limestone declines by the amount the environmental research group had estimated. This convinces them that limestone production is now socially efficient. Which of the following conclusions can most reasonably be drawn from the given information?

a.       The marginal private cost of producing limestone at this quarry is now equal to the marginal social cost as estimated by the research group.

Chapter 4 Question 25: The government of Country X follows a cap-and-trade system of tradable emissions allowances. Each steel manufacturing firm in this country is permitted to release a maximum of 30 million pounds of pollutants annually, but the firms can freely trade their emission allowances with each other. Clemington Inc., an iron and steel manufacturer in this country, releases 1.2 million pounds of airborne pollutants into the atmosphere every year and had been asked by the pollution control department to reduce pollution. Stella Morris, a director at Clemington Inc., strongly recommends that the board buy the allowances from other steel plants instead of curbing production. Which of the following, if true, would strengthen Stella’s view?

a.       The cost of installing air scrubbers that would limit the release of pollutants is higher than the market price of the emission allowance.

Chapter 7 Question 1: What is the definition of marginal utility?

a.       The change in utility from consuming an additional unit of a good or service.

The law of diminishing utility suggests that:

a.       Consumers experience diminishing additional satisfaction as they consume more of a good or service.

Marginal utility is more useful than total utility in consumer decision making because:

a.       Optimal decisions are made at the margin.

Chapter 7 Question 2: TABLE The table below shows the relationship between the number of movies seen per month and the total utility received. Fill in marginal utility in the table below. In this example, consuming additional movies illustrates the law of diminishing marginal utility.

Chapter 7 Question 3: Consider the demand for Ramen noodles. Suppose the price of Ramen noodles decreases. If Ramen noodles are a normal good, this will produce a positive substitution effect and a positive income effect.

Chapter 7 Question 4: Explain how a downward-sloping demand curve results from consumers adjusting their consumption choices to changes in price.

a.       When the price of a good rises, the ration of the marginal utility to price falls, leading consumers to buy less of that good.

Chapter 7 Question 5: GRAPH The demand for lemonade for Luci (DL) and Kyle (DK) is illustrated in the figure to the right. Derive the market demand curve for lemonade if the market is comprised of only these two consumers.  Use the line drawing tool, draw the market demand curve for lemonade in the figure to the right. Attach the provided label.

Chapter 7 Question 6: GRAPH The table below shows the demand for tickets to professional basketball games for you, Gina, and Chad. Use the line drawing tool to draw the market demand curve for basketball tickets (assuming the market consists of you, Gina, and Chad). Label this line ‘Market Demand’.

Chapter 7 Question 7: Suppose that Lady Gaga can sell out a concert at Madison Square Garden with tickets priced at $80 each. Lady Gaga’s manager estimates that the singer could still sell out the Garden at $130 per ticket. Why might Lady Gaga and her manager want to keep ticket prices at $80?

a.       All of the above – they do not want to raise prices out of fear that they will lose customers who believe the price increases were unfair. When a ticket to a concert is hard to get, the product is more popular. So raising the price of tickets until just enough are sold to fill the Garden might reduce Lady Gaga’s popularity. They are giving up some profits in the short run to keep their customers happy and increase their profits in the long run.

Chapter 7 Question 8: Suppose that the Amazing Spider-man comes out, and hundreds of people arrive at a theater and discover that the movie is already sold out. Meanwhile, the theater is also showing a boring movie in its third week of release in a mostly empty theater. Why would this firm charge the same $8.00 for a ticket to either movie, when the quantity of tickets demanded is much greater than the quantity supplied for one movie, and the quantity of tickets demanded is much less than the quantity supplied for the other?

a.       All of the above – the firm may do this because the excess demanders from The Amazing Spider-man may also decide to stay and watch their second-favorite movie, while planning to return to see The Amazing Spider-Man later. The firm may do this because customers think this is fair, The firm may do this because a sell-out creates even more interest in the movie, bringing in more customers later in the week.

Chapter 7 Question 9: What effect does a network externality have on the market for a product? If a network externality is present for a product, then

a.       Consumers may be more likely to buy the product because it is more useful.

Chapter 7 Question 10: Consider a form of public consumption such as wearing clothes. An individual’s demand for clothes depends on:

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