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2
The Key Principles
of Economics
Chapter Summary
Chapter 2 introduces the key principles that are central to all economic theory:
The principle of opportunity cost states that the opportunity cost of something is what you
sacrifice to get it. Opportunity costs in production are generally increasing, and thus, the
production possibilities curve is bowed outward.
The marginal principle states that any activity should be increased as long as the marginal
benefits of the additional activity exceed the marginal costs.
The principle of voluntary exchange states that a voluntary exchange between two people makes
both people better off.
The principle of diminishing returns states that, in the short run, if use of one input is increased
while all others are held constant, production will eventually increase at a decreasing rate.
The real-nominal principle states that what matters to people is the real value or purchasing
power of money or income, not its face or nominal value.
Learning Objectives:
1. The Principle of Opportunity Cost: Apply the principle of opportunity cost.
2. The Marginal Principle: Apply the marginal principle.
3. The Principle of Voluntary Exchange: Apply the principle of voluntary exchange.
4. The Principle of Diminishing Returns: Apply the principle of diminishing returns.
5. The Real-Nominal Principle: Apply the real-nominal principle.
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©2018 Pearson Education Ltd.
Chapter Outline
2.1 The Principle of Opportunity Cost
A. Definition
1. The opportunity cost of something is what you sacrifice to get it.
2. What you sacrifice is the next best alternative.
3. For example, if you choose to buy a cup of coffee, you are giving up the money it costs to
buy it. What else would you have used the $2.00 for? The opportunity cost of the coffee is the
one thing (or next best alternative) that you would buy if not the coffee.
Teaching Tip
Ask the students what they would be doing if they weren’t in class. Answers will range
from sleeping, working, watching TV, studying, etc. You can make the point that the
alternatives are infinite and computing the cost of them all is impossible. However, since
they could only be doing one thing (not all of them) if they were not in class, determining
the opportunity cost requires only knowing the one thing they would be doing.
Teaching Tip
It’s also helpful to have a discussion about whether room and board should be considered a
cost of college. If the person has to pay the same amount for room and board whether
he/she goes to college or works, it should not be considered a cost of college.
Teaching Tip
Use something students are familiar with to construct their first production possibilities
curve. Pick two classes, such as Economics and Marketing. Tell them they are going to
allocate study time to produce grades in the classes. The choice involves how much study
time to allocate for each class. You can start with an all-or-nothing scenario producing an
A|F outcome and make adjustments from there. Once they are comfortable, remind them
that everything else was held constant. Ask them what would happen to the curve if the
professors were better teachers, if students had better study skills, smaller classes, better
textbooks, upgraded computers, or more time to study.
This Application gives an example of a business to explain how we can use the principle of opportunity
cost to compute a business’s costs. In a business, the total costs are affected by the costs of raw materials,
the opportunity costs of funds invested, and the opportunity costs of time. This Application shows that we
must include not just the costs of materials but also the opportunity cost of funds invested, as well as the
opportunity costs of time in computing the true cost of running a business.
Teaching Tip
There are several easy-to-understand examples of the Marginal Principle in the world of
college students. An easy way to start is with examples where the marginal cost is zero:
The amount of food consumed at a particular meal in the cafeteria; Internet minutes in the
computer lab; cell phone weekend minutes with some plans. Given that the marginal costs
are zero, the student’s decision to consume is based on positive marginal benefits. You can
then introduce situations where there are positive marginal costs, such as fast food that
needs to be paid for.
VI
His first action on awakening was always to stretch out his hand
for the letters that his silent man would have placed by his side, and
to glance at the clock on his dressing table to see how many hours
he had slept. And, indeed, next morning his first sensation was one
of bodily well-being and of satisfaction because the clock appeared
to inform him that he had slept for three hours longer than was his
habit. But with a slight feeling of uneasiness he remembered how
late he had been the night before, and stretching out his hand for the
letters, he heard a voice say:
“Are you 4,259 Mayfair?”
He had answered “What?” before he realized that this question
was nothing more than a very vivid recollection. But even when he
had assured himself that it was only a very vivid recollection, he lay
still and discovered that his heart was beating very quickly. And so
afraid was he that the motion of stretching out his arm would bring
again the voice to his ears, that he lay still, his hand stretched along
the counterpane. And suddenly he got up.
He opened one white-painted cupboard, then the other. Finally,
he went to the door of the room and peered out. His man,
expressionless, carrying over his arm a pair of trousers, and in one
hand a white letter crossed with blue, was slowly ascending the
staircase at the end of the corridor.
“You didn’t ask me a question,” Dudley Leicester said, “about
two minutes ago?”
Saunders said: “No, sir, I was answering the door to the
postman. This, sir.” And he held out the registered letter.
It was as if Dudley Leicester recoiled from it. It bore Pauline’s
handwriting, a large, round, negligent scrawl.
“Did he ask our number?” Dudley inquired eagerly; and
Saunders, with as much of surprise as could come into his impassive
face, answered:
“Why, no, sir; he’s the regular man.”
“Our telephone number, I mean,” Dudley Leicester said.
Saunders was by this time in the room, passing through it to the
door of the bath-cabinet.
“As a matter of fact, sir,” he said, “the only thing he asked was
whether Mrs. Leicester’s mother was any better.”
“It’s very odd,” Dudley Leicester answered. And with Saunders
splashing the water in the white bath-cabinet, with a touch of sun
lighting up the two white rooms—in the midst of these homely and
familiar sounds and reflections, fear suddenly seized Dudley
Leicester. His wife’s letter frightened him; when there fell from it a
bracelet, he started as he had never in his life started at a stumble of
his horse. He imagined that it was a sort of symbol, a sending back
of his gifts. And even when he had read her large, sparse words, and
discovered that the curb chain of the bracelet was broken, and
Pauline desired him to take it to the jeweller’s to be repaired—even
then the momentary relief gave way to a host of other fears. For
Dudley Leicester had entered into a world of dread.
II
III
“No,” she commenced, “do not put down this form of obstinacy
to mental aberration. It is rather to be considered as a manifestation
of passion. You say that Kitty is not of a passionate disposition. I
imagine it may prove that she is actually of a disposition passionate
in the extreme. But all her passion is centred in that one desire—the
desire to excite concern. The cure for this is not medical; it is merely
practical. Nerve treatment will not cure it, nor solicitude, but feigned
indifference. You will not touch the spot with dieting; perhaps by ...
But there, I will not explain my methods to you, old Ellida. I
discussed Kitty’s case, as you set it forth, very fully with the chief in
Philadelphia, and between us we arrived at certain conclusions. I
won’t tell you what they were, not because I want to observe a
professional reticence, but simply so that, in case one treatment
fails, you may not be in agonies of disappointment and fear. I haven’t
myself much fear of non-success if things are as you and Dr.
Tressider say. After all, weren’t we both of us as kiddies celebrated
for fits of irrational obstinacy? Don’t you remember how one day you
refused to eat if Calton, the cat, was in the dining-room? And didn’t
you keep that up for days and days and days? Yet you were awfully
fond of Calton.... Yes; I think I can change Kitty for you, but upon one
condition—that you never plead for Robert Grimshaw, that you never
mention his name to me. Quite apart from any other motive of mine
—and you know that I consider mother’s example before anything
else in the world—if he will not make this sacrifice for me he does
not love me. I do not mean to say that you are to forbid him your
house, for I understand he dines with you every other day. His
pleadings I am prepared to deal with, but not yours, for in you they
savour of disrespect for mother. Indeed, disrespect or no disrespect,
I will not have it. If you agree to this, come to our hotel as soon as
you have read it. If you disagree—if you won’t, dear, make me a
solemn promise—leave me three days in which to make a choice out
of the five patients who wish to have me in London, and then come
and see me, bringing Kitty.
“Not a word, you understand—not one single word!
“On that dreadful day when Robert told us that father had died
intestate and that other—I was going to add ‘horror,’ but, since it was
mother’s doing, she did it, and so it must have been right—when he
told us that we were penniless and illegitimate, I saw in a flash my
duty to mother’s memory. I have stuck to it, and I will stick to it.
Robert must give in, or I will never play the part of wife to him.”
She folded her letter into the stamped envelope, and, having
dropped it deliberately into the ship’s letter-box, she rejoined Mrs.