Dr.

Louis Jaeck
Visiting assistant professor

ECON 201
Chapter 1: Practice

Cases study:

Make sure you fully understand trade-offs in terms of the context of the case study. The big
picture is about the trade-off between extracting natural resources against the other factors of
labor and capital. You should consider whether Arab world countries are too dependent on oil
given the increased global growth in renewable energy and electric cars as substitutes for oil.
• In this example the opportunity cost is what an economy must give up in order to increase
R&D. That could be reducing the amount of resources going into extracting oil, or foregoing
Dr. Louis Jaeck
Visiting assistant professor

some current consumption by increasing taxes with the tax revenue being used to support
R&D. Less consumption now leads to greater consumption in the future.
• Foreign investors want better security of return for their risk. Unstable economies are less
attractive than stable ones.
• Discuss a range of incentives such as government grants for R&D You should also think
about how to increase the ease of business investment that might arise from having a better
educated workforce, improving access to reliable energy and providing a good infrastructure
system.
Dr. Louis Jaeck
Visiting assistant professor

First of all, understand that your economics instructor will be pleased if you would never
cheat under any circumstances.
But the benefit of cheating is greater when:
(a) the positive consequences of receiving a high grade are great (for example, a high grade is
necessary to maintain a scholarship, gain admittance to graduate school, or get a good job
offer), and/or

(b) the probability of getting caught is low (the instructor gives the same multiple-choice
exam to all students in a large classroom with no supervision). Reducing the benefit and
increasing the cost of getting caught will reduce the incidence of cheating. If appeals to
personal integrity are not enough to convince students not to cheat, then a more effective
deterrent may be for potential employers to let students know that they don’t hire students
with a record of cheating.
Dr. Louis Jaeck
Visiting assistant professor

Problems:

1/ Describe some of the trade-offs faced by each of the following:

a. A family deciding whether to buy a new car.

A family deciding whether to buy a new car faces a trade-off between the cost of
the car and other things they might want to buy. For example, buying the car
might mean they must give up going on vacation for the next two years. So the
real cost of the car is the family’s opportunity cost in terms of what they must give
up

b. A member of Congress deciding how much to spend on national defense.

For a member of the government deciding how much to spend on defense, the
trade-off is between defense and other spending items or tax cuts. If more money
is spent on defense, that may mean less spending on other areas such as the police
force. Or instead of spending money on defense, taxes could be reduced.

c. A company president deciding whether to open a new factory.

When a company president decides whether to open a new factory, the decision is
based on whether the new factory will increase the firm’s profits compared to
other alternatives. For example, the company could upgrade existing equipment or
expand existing factories. The bottom line is: Which method of expanding
production will increase profit the most?

d. A professor deciding how much to prepare for class.

In deciding how much to prepare for class, a professor faces a trade-off between
the value of improving the quality of the lecture compared to other things she
could do with her time, such as working on additional research or enjoying some
leisure time.

e. A recent college graduate deciding whether to go to graduate school.

In deciding whether to go to graduate school, the student faces a trade-off between
his possible earnings with a bachelor’s degree and the benefits of an increased
education (such as higher future earnings and greater knowledge).

2/ You are trying to decide whether to take a vacation. Most of the costs of the vacation
(airfare, hotel, and forgone wages) are measured in dollars, but the benefits of the vacation
are psychological. How can you compare the benefits to the costs?
When the benefits of something are psychological, such as going on a vacation, it is not easy
to compare benefits to costs to determine if it is worth doing. But there are two ways to think
Dr. Louis Jaeck
Visiting assistant professor
about the benefits. One is to compare the vacation with what you would do in its place. If you
did not go on vacation, would you buy something like a new set of golf clubs? Then you can

decide if you would rather have the new clubs or the vacation. A second way is to think about
how hard you had to work to earn the money to pay for the vacation. You can then decide if
the psychological benefits of the vacation were worth the psychological cost of working.
3/ You were planning to spend Saturday working at your part-time job, but a friend asks you
to go to the beach. What is the true cost of going to the beach? Now suppose you had been
planning to spend the day studying at the library. What is the cost of going to the beach in this
case? Explain.
If you are thinking of going to the beach instead of working at your part-time job, the cost of
going to the beach includes its monetary and time costs, which includes the opportunity cost
of the wages you are giving up by not working. If the choice is between going to the beach
and going to the library to study, then the cost going to the beach is its time costs including
the cost of possibly earning lower grades in your courses.

4/ A 1996 bill reforming the federal government’s antipoverty programs limited many welfare
recipients to only 2 years of benefits.
a. How does this change affect the incentives for working?
When welfare recipients have their benefits cut off after two years, they have a
greater incentive to find jobs than if their benefits were to last forever.
b. How might this change represent a trade-off between equality and efficiency?
The loss of benefits means that someone who cannot find a job will get no income
at all, so the distribution of income will become less equal. But the economy will
be more efficient because welfare recipients have a greater incentive to find jobs.
Thus, the change in the law is one that increases efficiency but reduces equality.

5/ Explain whether each of the following government activities is motivated by a concern

about equality or a concern about efficiency. In the case of efficiency, discuss the type of
market failure involved.
a. Regulating cable TV prices.
Efficiency: The market failure comes from the market power of the satellite TV firm.

b. Providing some poor people with vouchers that can be used to buy food.
Equity

c. Prohibiting smoking in public places.

Dr. Louis Jaeck
Visiting assistant professor
Efficiency: An externality arises because secondhand smoke harms nonsmokers.

6/ Water is necessary for life. Is the marginal benefit of a glass of water large or small?
The marginal benefit of a glass of water depends on your circumstances. If you have just run
a marathon or you have been walking in the desert sun for three hours, the marginal benefit is
very high. But if you have been drinking a lot of liquids recently, the marginal benefit is quite
low. The point is that even the necessities of life, like water, do not always have large
marginal benefits.

7/ Thinking at the Margin

Hours of advertising Total number of customers
0 300
1 350
2 380
3 400
4 410
5 415

a/ If a firm finds that advertising increases the total number of customers, for how many hours should
it advertise? Assume that each extra customer spends an average of $10 at the store, and an extra hour
of advertising costs the firm $200.
Hours of advertising Marginal cost Marginal benefit
0 200
1 200 50 × $10 = $500
2 200 30 × $10 = $300
3 200 20 × $10 = $200
4 200 10 × $10 = $100
5 200 5 × $10 = $50

The firm should advertise for 3 hours because at 3 hours, marginal benefit will equal
marginal cost ($200 = $200). If the firm advertises for one more hour (it will go from 3 to 4
hours of advertising in total), it will lose $200 and gain $100. That’s why 3 hours of
advertising is optimal.
Dr. Louis Jaeck
Visiting assistant professor

MCQs:
1. The word “economy” comes from the Greek word oikonomos, which means
a. “environment.”
b. “production.”
c. “one who manages a household.”
d. “one who makes decisions.”
ANS: C

2. Resources are
a. scarce for households but plentiful for economies.
b. plentiful for households but scarce for economies.
c. scarce for households and scarce for economies.
d. plentiful for households and plentiful for economies.
ANS: C

3. Economics deals primarily with the concept of

a. scarcity.
b. money.
c. poverty.
d. banking.
ANS: A

4. The overriding reason why households and societies face many decisions is that
a. resources are scarce.
b. goods and services are not scarce.
c. incomes fluctuate with business cycles.
d. people, by nature, tend to disagree.
ANS: A

5. The phenomenon of scarcity stems from the fact that

a. most economies’ production methods are not very good.
b. in most economies, wealthy people consume disproportionate quantities of goods and
services.
c. governments restrict production of too many goods and services.
d. resources are limited.
ANS: D
Dr. Louis Jaeck
Visiting assistant professor

6. Approximately what percentage of the world's economies experience scarcity?

a. 10 percent
b. 40 percent
c. 85 percent
d. 100 percent
ANS: D

7. The principle that "people face trade-offs" applies to

a. individuals.
b. families.
c. societies.
d. All of the above are correct.
ANS: D

8. Guns and butter are used to represent the classic societal trade-off between spending on
a. durable and nondurable goods.
b. imports and exports.
c. national defense and consumer goods.
d. law enforcement and agriculture.
ANS: C
Dr. Louis Jaeck
Visiting assistant professor

9. When society requires that firms reduce pollution, there is

a. a trade-off because of reduced incomes to the firms' owners and workers.
b. a trade-off only if some firms are forced to close.
c. no trade-off, since the cost of reducing pollution falls only on the firms affected by the
requirements.
d. no trade-off, since everyone benefits from reduced pollution.
ANS: A

10. Economists use the word equality to describe a situation in which

a. each member of society has the same income.
b. each member of society has access to abundant quantities of goods and services,
regardless of their income.
c. society is getting the maximum benefits from its scarce resources.
d. society's resources are used efficiently.
ANS: A

11. Efficiency means that

a. society is conserving resources in order to save them for the future.
b. society's goods and services are distributed equally among society's members.
c. society's goods and services are distributed fairly, though not necessarily equally, among
society's members.
d. society is getting the maximum benefits from its scarce resources.
ANS: D

12. When the government attempts to improve equality in an economy the result is often
a. an increase in overall output in the economy.
b. additional government revenue since overall income will increase.
c. a reduction in equality.
d. a reduction in efficiency.
ANS: D

13. A likely effect of government policies that redistribute income and wealth from the wealthy to
those on low incomes is that those policies
a. enhance equality.
b. reduce efficiency.
c. reduce the reward for working hard.
d. All of the above are correct.
ANS: D
Dr. Louis Jaeck
Visiting assistant professor

14. The opportunity cost of an item is

a. the number of hours needed to earn money to buy the item.
b. what you give up to get that item.
c. usually less than the dollar value of the item.
d. the dollar value of the item.
ANS: B

15. A student spends an hour studying instead of watching TV with their friends. The opportunity cost
to them of studying is
a. the improvement in their grades from studying for the hour.
b. the improvement in their grades from studying minus the enjoyment of watching TV.
c. the enjoyment they would have received if they had watched TV with their friends.
d. zero. Since they chose to study rather than to watch TV, the value of studying must have
been greater than the value of watching TV.
ANS: C

16. A rational decision maker

a. ignores marginal changes and focuses instead on “the big picture.”
b. ignores the likely effects of government policies when making choices.
c. takes an action only if the marginal benefit of that action exceeds the marginal cost of that
action.
d. takes an action only if the combined benefits of that action and previous actions exceed
the combined costs of that action and previous actions.
ANS: C

17. Suppose the cost of operating a 100-room hotel for a night is $10,000 and there are five empty
rooms for tonight. If the marginal cost of operating one room for one night is $30 and a customer is
willing to pay $60 for the night, the hotel manager should
a. rent the room because the marginal benefit exceeds the marginal cost.
b. rent the room because the marginal benefit exceeds the average cost.
c. not rent the room because the marginal benefit is less than the marginal cost.
d. not rent the room because the marginal benefit is less than the average cost.
ANS: A
Dr. Louis Jaeck
Visiting assistant professor

18. Economists are particularly good at understanding that people respond to

a. laws.
b. incentives.
c. punishments more than rewards.
d. rewards more than punishments.
ANS: B

19. In economics, the term ________ means "additional" or "extra."

a. allocative
b. marginal
c. equity
d. optimal
Answer: B

20. A grocery store sells a bag of potatoes at a fixed price of $2.30. Which of the following is a term
used by economists to describe the money received from the sale of an additional bag of potatoes?
a. marginal revenue
b. gross earnings
c. pure profit
d. marginal costs
e. net benefit
Answer: A

21. Allison's Auto Art is a company that applies pinstripes to vehicles. Allison's cost for a basic 1-
color pinstriping job is $35, and she charges $95 for this service. For a total price of $175, Allison
will apply a fancier 3-color pinstripe application to an automobile, a service that adds an additional
$40 to the total cost of the package. What is Allison's marginal benefit if she sells a basic 1-color job?
a. $35
b. $60
c. $95
d. The marginal benefit cannot be determined.
Answer: C
Dr. Louis Jaeck
Visiting assistant professor

Table 1-1

Extra Hours
Total Revenue (dollars)
Open
1 $50
2 75
3 95
4 110
5 120
6 125

Lydia runs a small nail salon in the town of New Hope. She is debating whether she should extend her
hours of operation. Lydia figures that her sales revenue will depend on the number of extra hours the
nail salon is open as shown in the table above. She would have to hire a worker for those extra hours
at a wage rate of $10 per hour.

22. Refer to Table 1-1. Using marginal analysis, by how many hours should Lydia extend her nail
salon's hours of operations?
a. 2 hours
b. 3 hours
c. 4 hours
d. 5 hours
e. 6 hours
Answer: D

23. Refer to Table 1-1. What is Lydia's marginal benefit if she decides to stay open for an extra two
hours instead of one hour?
a. $25
b. $50
c. $75
d. $125
Answer: A

24. Refer to Table 1-1. What is Lydia's marginal cost if she decides to stay open for an extra two
hours instead of one hour?
a. $10
b. $20
c. $25
d. $40
Answer: A
Dr. Louis Jaeck
Visiting assistant professor

25. Trina's Tropical Fish Store sells goldfish for $2 each and angelfish for $10 each. What is the
opportunity cost of buying a goldfish?
a. 5 angelfish
b. 1/5 of an angelfish
c. $10
d. $2
Answer: B

26. Trinh quits his $80,000-a-year job to become a full-time volunteer at a museum. What is the
opportunity cost of his decision?
a. 0 since he will no longer be earning a salary
b. depends on the "going rate" of museum employees
c. at least $80,000
d. the value he attributes to the joy of working at a museum
Answer: C

27. Which of the following is a problem inherent in centrally planned economies?

a. There are no problems and everyone, including consumers, is satisfied.
b. There is too much production of low-cost, high-quality goods and services.
c. Production managers are more concerned with satisfying government's orders than with
satisfying consumer wants.
d. Unemployment is too high.
Answer: C

28. Which is the most accurate statement about trade?

a. Trade can make every nation better off.
b. Trade makes some nations better off and others worse off.
c. Trading for a good can make a nation better off only if the nation cannot produce that
good itself.
d. Trade helps rich nations and hurts poor nations.
ANS: A

29. Suppose that a country with a high level of output per person agrees to trade with a country with a
low level of output per person. Which country can benefit?
a. Only the one with a low level of output per person.
b. Only the one with a high level of output per person.
c. Both
d. Neither
ANS: C
Dr. Louis Jaeck
Visiting assistant professor

30. Trade
a. allows specialization, which increases costs.
b. allows specialization, which reduces costs.
c. reduces specialization, which increases costs.
d. reduces specialization, which reduces costs.
ANS: B

31. Central planning refers to

a. markets guiding economic activity. Today many countries that had this system have
abandoned it.
b. markets guiding economic activity. Today many countries that did not have this system
have implemented it.
c. government guiding economic activity. Today many countries that had this system have
abandoned it.
d. government guiding economic activity. Today many countries that did not have this
system have implemented it.
ANS: C

32. One advantage market economies have over centrally-planned economies is that market
economies
a. provide an equal distribution of goods and services to households.
b. establish a significant role for government in the allocation of resources.
c. solve the problem of scarcity.
d. are more efficient.
ANS: D

33. For markets to work well, there must be

a. market power.
b. a central planner.
c. property rights.
d. abundant, not scarce, resources.
ANS: C
Dr. Louis Jaeck
Visiting assistant professor

34. A company that formerly produced software went out of business because too many potential
customers bought illegally produced copies of the software instead of buying the product directly
from the company. This instance serves as an example of
a. market power.
b. inefficient trade.
c. inadequate enforcement of property rights.
d. the invisible hand at work.
ANS: C

35. Public policies

a. may be able to improve either economic efficiency or equality.
b. may be able to improve economic efficiency but cannot improve equality.
c. may be able to improve equality but cannot improve economic efficiency.
d. cannot improve either equality or economic efficiency.
ANS: A

36. Who, in a market economy, decides what goods and services will be produced with the scarce
resources available in that economy?
a. the government
b. producers
c. consumers
d. consumers and producers
e. the government, consumers, and producers
Answer: D

37. Voluntary exchange ________ economic efficiency because neither the buyer nor the seller would
agree to a trade unless ________.
a. increases; they both benefit
b. increases; only one party benefits
c. decreases; neither benefit
d. decreases; they both benefit
Answer: A
Dr. Louis Jaeck
Visiting assistant professor
Dr. Louis Jaeck
Visiting assistant professor
Dr. Louis Jaeck
Visiting assistant professor