Topic 1 – Basic Economic Concepts

1. Economics is primarily the study of:

a. how scarcity can be eliminated
b. how firms manipulate prices
c. how government influences resource allocation decisions
d. the problem of scarce resources relative to human wants

Answer: d
Feedback: The fundamental economic problem is one of scarce resources relative to human
wants. Such scarcity can never be eliminated; it implies we must make choices.

2. Suppose you have a $20 iTunes gift card with which you can buy (download) songs or videos.
Songs cost $1.00 each and videos cost $2.00 each. The opportunity cost of one video:
a. increases as more videos are purchased
b. is $1.00
c. is constant and equal to ½ song
d. is constant and equal to 2 songs

Answer: d
Feedback: The purchase of an additional video requires $2.00. At a price of $1.00 each, two
songs would have to be given up to obtain the required amount for one video.

3. You should decide to study an extra hour tonight

a. if the marginal cost of studying an extra hour exceeds its marginal benefit
b. if the marginal benefit of studying an extra hour exceeds its marginal cost
c. if you got a lower than expected grade on your last exam
d. because studying harder will improve your test scores

Answer: b
Feedback: Purposeful behavior in the face of scarcity entails comparing marginal benefit to
marginal cost. Any activity whose marginal benefit exceeds its marginal cost should be
expanded.

4. Answer the next question on the basis of the data given in the following production
possibilities table:

Production possibilities (alternatives)

A B C D E F
Capital goods 5 4 3 2 1 0
Consumer goods 0 5 9 12 14 15
The data in the table indicate that increasing production of capital goods requires:
a. increasing sacrifices of consumer goods
b. decreasing sacrifices of consumer goods
c. constant sacrifices of consumer goods
d. no sacrifices of consumer goods

Answer: a
Feedback: As capital goods production increases by one unit, production of consumer goods
initially decreases by one unit (moving from combination F to combination E), then 2 units (E to
D), and so on. This illustrates the law of increasing opportunity costs.

5. Consider the problem Marsha faces of how to allocate her weekly allowance between books
and videos. An increase in Marsha’s allowance will:
a. shift her budget line to the right
b. shift her budget line to the left
c. rotate her budget line, allowing her to buy more books but not more videos
d. rotate her budget line, allowing her to buy more videos but not more books

Answer: a
Feedback: Increased income allows Marsha to purchase additional books, additional videos, or
both but does not change the opportunity cost of one in terms of the other. Her budget line shifts
out parallel to itself.

6. The negative slope of the production possibilities curve illustrates that:

a. some resources are always unemployed
b. when resources are fully employed, an economy can produce more of one thing only by
producing less of something else
c. opportunity costs are constant
d. businesses can sell more goods when their prices are low

Answer: b
Feedback: Each point on the production possibilities curve represents some maximum
combination of the output of the two goods—the economy has achieved maximum production of
one good for a given amount of the other. Increased production of any good requires sacrificing
some of the other; the production possibilities curve will exhibit an inverse relationship between
the two goods.

7. A microeconomist would most likely study:

a. how consumers respond to a change in gasoline prices
b. the effects of an income tax reduction on the size of the national budget deficit
c. the effects of aggregate consumer debt on overall consumption spending
d. the relationship between the size of the money supply and the rate of inflation

Answer: a
Feedback: Microeconomics is concerned with specific economic units and the operation of
individual markets. Macroeconomics, on the other hand, is concerned with the economy as a
whole or with basic aggregates such as the money supply or consumer spending.

8. Refer to the following production possibilities diagram:

Production of which of the points in the diagram is currently unattainable given the economy’s
resources?
a. Point A
b. Point B
c. Point C
d. Point D

Answer: d
Feedback: The production possibilities curve shows the greatest attainable combinations of goods
and services given available resources. Point D lies outside this boundary and is therefore
unattainable.

9. The fundamental problem of economics implies that:

a. governments must be relied upon to supply essential goods and services
b. inflation and unemployment are unavoidable
c. growing populations will deplete natural resources
d. individuals and communities must make choices among competing alternatives

Answer: d
Feedback: The fundamental economic problem is one of scarce resources relative to human
wants. Such scarcity can never be eliminated; it implies we must make choices.

10. Margaret decides to stay home and study for her exam rather than going out to a movie with
her friends. Her dilemma is an example of:
a. the economic perspective
b. marginal analysis
c. opportunity cost
d. allocative efficiency

Answer: c
Feedback: Opportunity cost is defined as the value of the best foregone alternative. In this case,
Margaret has foregone the movie in order to study.

Use the following information to work Problems 1 to 3. Brazil produces ethanol from sugar, and
the land used to grow sugar can be used to grow food crops. Suppose that Brazil’s production
possibilities for ethanol and food crops are as in the table.

Ethanol Food crops

(barrels per day) (tons per day)
70 and 0
64 and 1
54 and 2
40 and 3
22 and 4
0 and 5

1. a. Draw a graph of Brazil’s PPF and explain how your graph illustrates scarcity.
Figure 2.1 shows Brazil’s PPF. The production possibilities frontier indicates scarcity because it
shows the limits to what can be produced. In particular, production combinations of ethanol and
food crops that lie outside the production possibilities frontier are not attainable.

b. If Brazil produces 40 barrels of ethanol a day, how much food must it produce to achieve
production efficiency?
If Brazil produces 40 barrels of ethanol per day, it achieves production efficiency if it also
produces 3 tons of food per day.
 c. Why does Brazil face a tradeoff on its PPF?
Brazil faces a tradeoff on its PPF because Brazil’s resources and technology are limited. For
Brazil to produce more of one good, it must shift factors of production away from the other
good. Therefore to increase production of one good requires decreasing production of the other,
which reflects a tradeoff.

2. a. If Brazil increases its production of ethanol from 40 barrels per day to 54 barrels per day,
what is the opportunity cost of the additional ethanol?
When Brazil is production efficient and increases its production of ethanol from 40 barrels per
day to 54 barrels per day, it must decrease its production of food crops from 3 tons per day to 2
tons per day. The opportunity cost of the additional ethanol is 1 ton of food per day for the
entire 14 barrels of ethanol or 1/14 of a ton of food per barrel of ethanol.
b. If Brazil increases its production of food crops from 2 tons per day to 3 tons per day,
what is the opportunity cost of the additional food?
When Brazil is production efficient and increases its production of food crops from 2 tons per
day to 3 tons per day, it must decrease its production of ethanol from 54 barrels per day to 40
barrels per day. The opportunity cost of the additional 1 ton of food crops is 14 barrels of
ethanol.
c. What is the relationship between your answers to parts (a) and (b)?
The opportunity costs of an additional barrel of ethanol and the opportunity cost of an additional
ton of food crop are reciprocals of each other. That is, the opportunity cost of 1 ton of food
crops is 14 barrels of ethanol and the opportunity cost of 1 barrel of ethanol is 1/14 of a ton of
food crops.
3. Does Brazil face an increasing opportunity cost of ethanol? What feature of Brazil’s PPF
illustrates increasing opportunity cost?
Brazil faces an increasing opportunity cost of ethanol production. For instance, when increasing
ethanol production from 0 barrels per day to 22 barrels the opportunity cost of a barrel of
ethanol is 1/22 of a ton of food while increasing ethanol production another 18 barrels per day
(to a total of 40 barrels per day) has an opportunity cost of 1/18 of a ton of food per barrel of
ethanol. The PPF’s bowed outward shape reflects the increasing opportunity cost.