Practice Test 1 (Cha1, Ch2, Ch3, Ch4) Multiple Choice Questions 1.

Economists, like mathematicians, physicists, and psychologists, a. b. c. d. make use of the scientific method. make use of their own language. devise theories, and collect and analyze data. All of the above are correct.

2. Which of the following statements about economic models is valid? a. b. Economic models are built to mirror reality exactly. Economic models are useful, but they should not be used for the purpose of improving public policies. Because economic models omit many details, they allow us to see what is truly important. Economic models seldom incorporate equations or diagrams.

c.

d.

3. a. b. c. d.

In the simple circular-flow diagram, the participants in the economy are firms and government. households and firms. households and government. elected officials and ordinary citizens. 4. In the circular-flow diagram,

a. b. c. d.

factors of production flow from government to firms. goods and services flow from households to firms. income paid to the factors of production flows from firms to households. spending on goods and services flows from firms to households.

5. In the figure above, which arrow represents the flow of goods and services? a. b. c. d. A B C D

6. The bowed-out shape of the production possibilities frontier can be explained by the fact that a. b. c. scarcity is a fact of life. economic growth is always occurring. the opportunity cost of one good in terms of the other depends on how much of each good the economy is producing. an assumption that is made in constructing a production possibilities frontier is that tradeoffs are unimportant.

d.

7. In the figure above, the economy has the ability to produce at which point or points? a. b. c. d. B, D, E A, B, D, E D, C D

8. When an economy is operating at a point on (rather than inside) its production possibilities frontier, then a. b. c. d. consumers are content with the mix of goods and services that is being produced. there is no way to produce more of one good without producing less of the other. equal amounts of the two goods (measured along the two axes) are being produced. All of the above are correct.

9. Microeconomics is best described as the study of a. b. c. d. economy-wide phenomena. how households and firms make decisions and how they interact in specific markets. the flows of dollars between households and firms. markets for land, labor, and capital.

10. Which of the following is not a positive statement? a. b. c. Higher gasoline prices will reduce gasoline consumption. Equity is more important than efficiency. Trade restrictions lower our standard of living.

d. If a nation wants to avoid inflation, it will restrict the growth rate of the quantity of money.

11. A country's consumption possibilities frontier can be outside its production possibilities frontier if a. the countrys technology is superior to the technologies of other countries.

b. the citizens of the country have a greater desire to consume goods and services than do the citizens of other countries. c. d. the country engages in trade. All of the above are correct.

12. Which of the following statements is not correct? a. b. c. d. Trade allows for specialization. Trade has the potential to benefit all nations. Trade allows nations to consume outside of their production possibilities curves. Absolute advantage is the driving force of specialization.

Table 1 Labor Hours Needed to Make 1 Pound of: Meat Farmer Rancher 8 4 Potatoes 2 5 Pounds produced in 40 hours:

Meat 5 10

Potatoes 20 8

13. Refer to Table 1. The rancher has a comparative advantage in a. b. c. d. neither good, and the farmer has a comparative advantage in both goods. both goods, and the farmer has a comparative advantage in neither good. potatoes, and the farmer has a comparative advantage in meat. meat, and the farmer has a comparative advantage in potatoes.

14. Which of the following would not result from all countries specializing according to the principle of comparative advantage? a. b. c. d. Each countrys production possibilities frontier will shift outward. Worldwide production of goods and services will increase. The well-being of citizens in each country will be enhanced. The size of the economic pie will increase.

Table 2 Hours needed to make one: Car Japan U.S. 30 50 Airplane 150 200 Amount produced in 2400 hours: Cars 80 48 Airplanes 16 12

15. Refer to Table 2. The United States and Japan could benefit by the United States specializing in a. b. c. d. airplanes and Japan specializing in airplanes. cars and Japan specializing in airplanes. airplanes and Japan specializing in cars. neither good and Japan specializing in cars.

16. In a competitive market, each seller has limited control over the price of his product because a. b. c. d. other sellers are offering similar products. buyers exert more control over the price than do sellers. these markets are highly regulated by government. sellers usually agree to set a common price that will allow each seller to earn a comfortable profit.

17. A higher price for batteries would result in a(n) a. b. c. d. increase in the demand for flashlights. decrease in the demand for flashlights. increase in the demand for batteries. decrease in the demand for batteries.

18. Suppose Spencer and Kate are the only two demanders of lemonade. Each month, Spencer buys six glasses of lemonade when the price is $1.00 per glass, and he buys four glasses when the price is $1.50 per glass. Each month, Kate buys four glasses of lemonade when the price is $1.00 per glass, and she buys two glasses when the price is $1.50 per glass. Which of the following points is on the market demand curve? a. b. c. d. (quantity demanded = 4, price = $2.50) (quantity demanded = 16, price = $2.50) (quantity demanded = 3, price = $1.50) (quantity demanded = 10, price = $1.00)

19. Which of these statements best represents the law of demand? a. b. c. d. When buyers tastes for a good increase, they purchase more of the good. When income levels increase, buyers respond by purchasing more of most goods. When the price of a good falls, buyers respond by purchasing more of the good. When buyers demands for a good increase, the price of the good will increase.

20. Which of the following events would cause a movement upward and to the right along the supply curve for tomatoes? a. b. c. d. The number of sellers of tomatoes increases. There is an advance in technology that reduces the cost of producing tomatoes. The price of fertilizer decreases, and fertilizer is an input in the production of tomatoes. The price of tomatoes rises.

21. Workers at a bicycle assembly plant currently earn the mandatory minimum wage. If the federal government increases the minimum wage by $1.00 an hour it is likely that the a. b. c. d. demand for bicycle assembly workers will increase. supply of bicycles will shift to the right. supply of bicycles will shift to the left. firm must increase output to maintain profit levels.

22. When there is a shortage of 100 units of a particular good, a. b. the law of supply predicts upward pressure on the price of the good from its current level. the law of demand predicts downward pressure on the price of the good from its current level. we say that there is a scarcity of 100 units of the good. None of the above is correct.

c. d.

23. Suppose there is an earthquake that destroys several corn canneries. Which of the following would not be a direct result of this event? a. Sellers would decrease their ability to produce and sell as much as before at each relevant price. The supply would decrease. Buyers would not be willing to buy as much as before at each relevant price. The equilibrium price would rise.

b. c. d.

24. Suppose that demand decreases and supply decreases. What would you expect to occur in the market for the good? a. Equilibrium price would increase, but the impact on equilibrium quantity would be ambiguous. Equilibrium price would decrease, but the impact on equilibrium quantity would be ambiguous. Equilibrium quantity would decrease, but the impact on equilibrium price would be ambiguous. Both equilibrium price and equilibrium quantity would increase.

b.

c.

d.

25. During the last few decades in the United States, health officials have argued that eating too much beef might be harmful to human health. As a result, there has been a significant decrease in the amount of beef produced. Which of the following best explains the decrease in production? a. Beef producers, concerned about the health of their customers, decided to produce relatively less beef. Government officials, concerned about consumer health, ordered beef producers to produce relatively less beef. Individual consumers, concerned about their own health, decreased their demand for beef, which lowered the relative price of beef, making it less attractive to produce. Anti-beef protesters have made it difficult for both buyers and sellers of beef to meet in the marketplace.

b.

c.

d.

26. What will happen to the equilibrium price of new textbooks if more students attend college, paper becomes cheaper, textbook authors accept lower royalties and fewer used textbooks are sold? a. b. c. d. Price will rise. Price will fall. Price will stay exactly the same. The price change will be ambiguous

Answers:
1. D 2. C 3. B 4. C 5. B 6. C 7. A 8. B 9. B 10. B 11. C 12. D 13. D 14. A 15. C 16. A 17. B 18. D 19. C 20. D 21. C 22. D 23. C 24. C 25. C 26. D

Short Answer Questions Question 1: Mention two principles of how people make decisions. Mention two principles of how people interact Mention two principles of how the economy as a whole works.

Question 2: Using this outline, draw a circular-flow diagram representing the interactions between households and firms in a simple economy. Explain briefly the various parts of the diagram.

Answer:

Question 3: Draw a production possibilities frontier showing increasing opportunity cost for hammers in terms of horseshoes. a. On the graph, identify the area of feasible outcomes and the area of infeasible outcomes. b. On the graph, label a point that is efficient as point "E" and a point that is inefficient as point "I". c. On the graph, illustrate the effect of the discovery of a new vein of iron ore, a resource needed to make both horseshoes and hammers, on this economy. d. On a second graph, illustrate the effect of a new computerized assembly line in the production of hammers on this economy. Answer:

Question 4: The figure below shows the PPF for two goods, Y and X. Use this figure to answer the following questions.

a. Use the PPF to explain the idea of the trade-off. b. Why the PPF is downward sloping? c. What is the opportunity cost of the 6th unit of good X (increasing X from 5 to 6 units)? Show your work. Answer: a. The principle of trade off states that because resources are limited, we cannot have more of one good thing without having less of another. Using the PPF, if the economy is to produce more of X, it has to produce less of Y and vice versa. If the economy is to move from point A to point B, for example, it can produce more of X (from 3 to 4) but that must mean producing less of Y (from 1100 to 900). b. Because resources are limited. If the economy needs to produce more of X, it has to shift more resources to produce the good X which means it will have less resources left for producing good Y. c. The opportunity cost is 400.

Question 5

Explain the difference between absolute advantage and comparative advantage. Which is more important in determining trade patterns, absolute advantage or comparative advantage? Why? Answer: Absolute advantage refers to productivity, as in the producer who can produce a product at a lower cost in terms of the resources used in production. Comparative advantage refers to the producer who can produce a product at a lower opportunity cost. Comparative advantage is the principle upon which trade patterns are based. Comparative advantage is based on opportunity cost, and opportunity cost measures the real cost to an individual or country of producing a particular product. Opportunity cost is therefore the information necessary for an individual or nation to determine whether to produce a good or buy it from someone else. Question 6 The only two countries in the world, Alpha and Omega, face the following production possibilities frontiers.

a. Assume that each country decides to use half of its resources in the production of each good. Show these points on the graphs for each country as point A. b. If these countries choose not to trade, what would be the total world production of popcorn and peanuts? c. Now suppose that each country decides to specialize in the good in which each has a comparative advantage. By specializing, what is the total world production of each product now? d. If each country decides to trade 100 units of popcorn for 100 units of peanuts, show on the graphs the gain each country would receive from trade. Label these points B.

Answer:

a. Alpha would be producing 125 units of peanuts and 75 units of popcorn (point A on its production possibilities frontier) and Omega would be producing 50 units of peanuts and 150 units of popcorn (point A on its production possibilities frontier). b. The total world production of peanuts would be 175 units and the total world production of popcorn would be 225 units. c. The total world production of peanuts would now be 250 units and the total world production of popcorn would now be 300 units. d. Alpha would be producing 250 units of peanuts and would trade 100 of them to Omega, leaving Alpha with 150 units of peanuts. Alpha would then receive 100 units of popcorn from Omega. Omega would be producing 300 units of popcorn and would trade 100 of them to Alpha, leaving Omega with 200 units of popcorn. Omega would then receive 100 units of peanuts from Alpha.

Question 7: Consider the following table Hours Needed to Make One: Car 30 50

Japan US

Airplane 150 200

a. Which country has absolute advantage in producing cars and which country has absolute advantage in producing airplanes? Explain in details b. Which country has comparative advantage in producing cars and which country has comparative advantage in producing airplanes? Explain in details c. Which country should specialize in cars and which country should specialize in airplanes? Explain Why? Answer: a. Japan has absolute advantage in producing both cars and airplanes. It costs japan less resources (less time) to produce both cars and airplanes. b. Japan has comparative advantage in cars and the US has comparative advantage in airplanes. The opportunity cost of cars is (1/5) for Japan while it is (1/4) for the US. That is, when Japan produces one car, it loses 1/5 of a plane while when the US produces one car it loses of a plane. Since Japan has lower opportunity cost of cars than the US, Japan has comparative advantage in cars while the U.S has comparative advantage in airplanes. c. The U.S specializes in airplanes and Japan specializes in cars. Each country specializes in the good that has comparative advantage at. Question 8 Classify the following topics as relating to microeconomics or macroeconomics. a. Susans decision about how much income to save (Microeconomics) b. The impact of a decrease in national saving on a countrys economic growth (Macroeconomics) c. The impact of an increase in the price of computer chips on the market for personal computers (Microeconomics) d. The impact of an increase in government purchases on the unemployment rate (Macroeconomics) e. The decision by McDonalds to hire fewer workers because of an increase in the minimum wage (Microeconomics) Question 9 Classify each of the following statements as positive or normative. Explain a. An increase in inflation temporarily reduces unemployment (positive) b. The government should increase the rate of inflation in order to reduce the unemployment rate. (Normative)

Question 10 Suppose we are analyzing the market for hot chocolate. Explain and graphically illustrate the impact each of the following would have on demand or supply. Also show how equilibrium price and quantity have changed. a. Protesting farmers dump millions of gallons of milk, causing the price of milk to rise. b. Consumer income falls because of a recession and hot chocolate is considered a normal good. Answer: a. Milk is used to make hot chocolate. When protesting farmers dump milk, supply of milk falls and its price would rise. If the price of milk goes up, cost of producing hot chocolate would go up causing supply of hot chocolate to fall. Supply of hot chocolate will shift left which increases the equilibrium price and reduces the equilibrium quantity of hot chocolate as shown in panel (g) below. b. If consumers income fall and hot chocolate is considered to be a normal good, then demand for hot chocolate will fall causing demand curve to shift left. This causes a decrease in both equilibrium price and equilibrium quantity of hot chocolate as shown in panel (h) below.

Question 11 Consider the market for X. X is a normal good. Suppose the incomes of the consumers of X increase and about the same time the cost to produce X decreases. Given these two events, what would happen in the market for X? Show your answer using graphs. (Get the answer on your own)