Chapter 1 - The Fundamentals of

Economics

3.
Define each of the following terms carefully and give examples:
PPF:
or production-possibility frontier shows the maximum amounts of production thatcan be obtained by an
economy, given its technical knowledge and quantity of inputsavailable. The PPF represents the menu of
goods and services available to society.
e.g. if the two outputs are guns and butter, then for a given technical knowledge andquantity of inputs:

The line shows the total amount of guns and/or butter a society can make given itstechnical knowledge
and quantity of inputs available. It can make 5 million pounds of butter, and no guns. Or it can make 15
thousand guns, and no butter. Or it can makevarying amounts of each as described by the line, where the
society is operating on itsPPF. It makes explicit the opportunity costs of making more butter, or more
guns, whenwe move along the PPF. For example, we can see that increasing gun production fromzero to
five thousand means reducing our butter production by one million pounds.It cannot work outside the
PPF. It may work inside its PPF, where it is leaving inputs idle,or not producing outputs efficiently.

Scarcity:
A situation in which goods and services are limited relative to desires. Scarcityis the distinguishing
characteristic of an economic good. That an economic good is scarce
means not that it is rare but only that it is not freely available for the taking. To obtainsuch a good, one
must either produce it or offer other economic goods in exchange.e.g cars are scarce. There are not
enough cars in the world for everyone to have as manyas they desire. We cannot get them for free.
Productive efficiency:
occurs when an economy cannot produce more of onegood without producing less of another good; this
implies that the economy is onits production-possibility frontier.e.g. if we are operating on the
production-possibility frontier, we cannot producemore butter without first withdrawing resources
from making guns and divertingthem to making butter.
Inputs:
are commodities and services that are used to produce goods andservices. They are sometimes called
factors of production
: which can be classifiedinto three broad categories

land, labour and capital.

Land
are those natural resources given by nature to aid our productive processes

such as land to build on, materials to build with and air to breathe.
Labour
is human time spent in production.
Capital
resources are durable goods that are used to aid production to produceyet further goods, such as
machines, roads, computers, cars and buildings.e.g. flour, eggs, a hot oven, the skills of a chef are the
inputs used to make pizza.
Outputs:
are the goods and services produced when existing technology has beenused to combine inputs. They can
be consumed or used for further production.e.g. a pizza is the output from combining our inputs in
the previous example.

Chapter 2 - Markets and Government in a Modern

Economy
2.
When a good is limited, some means must be found to ration the scarce commodity.Some
examples of rationing devices are auctions, ration coupons, and first-come, first-served
systems. What are the strengths and weaknesses of each? Explain carefully in
what sense a market mechanism rations scarce goods and services.
Auctions:
are similar to a market mechanism, in that the dollar votes of people determinethe price at which
goods are sold. If an item is desired by many people, then each bidderwill have to increase their
bidding price to outbid their rivals. The good is eventually soldto the highest bidder, that person
who shows they value the good most by paying thehighest price. The goods should be allocated

efficiently to those who most want them.The disadvantage is similar to the market mechanism in
that those will high incomes willbe able to outbid those with low incomes, which might
seem inequitable.
Ration coupons:
may have the advantage that they could be distributed more equitablythan market incomes.Their
disadvantage is that, unlike market mechanisms, they take no
account of peoples
dollar votes. They will be allocated by some non-market mechanism, and so may notmatch
supply and demand, and so allocate the goods or service efficiently. For instance,
the coupons may not be sufficiently scarce to reflect the goods
scarcity, so consumersmay not use the good efficiently and producers will not be given the
signal and incentiveto produce more.
First-come, first-served:
has the advantage of simplicity.Its disadvantage is that goods may not go to those who value it
most.
The market mechanism rations scarce goods and services as follows. If a good is scar
ce,that is if the demand is higher than the supply of the good, then its price will be high. Ifthe
price is high, then consumers will buy less of the good, and substitute cheaper (lessscarce) goods
for it. Those who most value the good (represented by those willing to paythe high price) will
buy it.

Chapter 3 - Basic Elements of Supply and Demand

1.
a. Define carefully what is meant by a demand schedule or curve. State the law
of downward-sloping demand. Illustrate the law of downward-sloping demand with
two cases from your own experience.

The law of downward-sloping demand is: When the price of a commodity is raised
(another things are held constant), buyers tend to buy less of the commodity. Similarly,
when the price is lowered, other things being constant, quantity demanded increases. Two
examples from my personal experience: When a store drastically reduces prices of food
(such as pastries or chocolate) just before its

best before
date, I will buy more of these than I normally would.Another example was when the
Financial Times

offered a cheap years subscript

ion online, I decided to buy it, whereas I would not have subscribed at full price

b. Define the concept of a supply schedule or curve. Show that an increase in

supply means a rightward and downward shift of the supply curve. Contrast
this with the rightward and upward shift of the demand curve implied by an
increase in demand.
The Supply schedule shows the relationship between the market price of a
commodity and the quantity of that commodity that producers are willing to
produce and sell, other things held constant.
For example, the supply schedule for a box of cornflakes could look like this

If there is an increase in supply, then the quantity supplied at each price will
increase. Anew schedule, with quantity supplied increased by 5 million boxes per
year at each price, is

At the time the market equilibrium

quantity demanded equals the quantity supplied. There isno tendency for prices to rise or fall at
the equilibrium. Looking at the above table, wesee that at $3 a box, 12 million boxes
of cornflakes are supplied and 12 million boxes aredemanded. Al
l supply and demand orders are filled, the books are cleared of orders,
and demanders and suppliers are satisfied.The same thing can be seen by looking at the supply
and demand curves. Where thedemand curveDDand supply curveSSintersect

at pointE- the quantity demandedequals the quantity supplied. AtE, we can see the equilibrium
price is $3 (see where ahorizontal line fromEintersects the vertical axis) and the equilibrium
quantity is 12million boxes per year (see where a vertical line fromEintersects the horizontal
axis).Now, imagine the market price starts out too high at $5. This can be seen towards thetop of
the curves diagram. Here we see that the quantity supplied (18 million boxes) isgreater than the
quantity demanded (9 million boxes). There is a surplus of cornflakes.Cornflakes will pile up
on the supermarket shelves. In order to sell these, the supermarketwill start cutting prices. As
prices decrease, the quantity demanded will increase (we willmove along the demand curveDDas
shown by the arrows) but the quantity supplied willbe reduced (we will move along the supply
curveSS as shown by the arrows). Eventuallythe price will reduce to the equilibrium price
atE.Now, imagine the market price starts out too low, at $2. This can be seen towards thebottom
of the curves diagram. Here we see that the quantity demanded (15 millionboxes) is greater than
the quantity supplied (7 million boxes). There is a shortage of cornflakes. Long queues will form
at the supermarket for cornflakes. Buyers will bid uptheir prices in order to get the scarce
cornflakes. As prices increase, the quantitydemanded will decrease (we will move along the
demand curveDDas shown by thearrows) but the quantity supplied will increase (we will move

along the supply curveSS as shown by the arrows). Eventually the price will increase to the
equilibrium price atE.
4.
Explain why each of the following is
false
:a.
A freeze in Brazils coffee
-growing region will lower the price of coffee.
A freeze in Brazils
coffee-growing region will reduce the supply of coffee. The supplycurve will shift to the left, as
less coffee is supplied at each price. Assuming that thedemand for coffee remains the same, the
equilibrium price will be higher, not lower, thanbefore, as shown below.
(N.B. Price on the vertical axis is denoted by P. Quantity on the horizontal axis is denoted by Q.
Demand curves are denoted DD. Supply curves are denoted by SS.E represents theintersection of
the two curves, which gives the equilibrium price and quantity. An
apostrophe, , is suffixed to the
D ,S , or E to indicate a shifted curve or equilibrium. The
bold red arrows
indicate the change in price and quantity due to a shifted curve)