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Chapter 2
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1. Explain and apply the Principle of Comparative
Advantage
2. Explain and apply the Principle of Increasing
Opportunity Cost (also called the Low-Hanging-Fruit
Principle)
3. Identify factors that shift the menu of production
possibilities
4. Explain and apply the role of comparative advantage
in international trade and describe why some jobs
are more vulnerable to outsourcing than others
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2-2
Joe Jamail, a highly successful trial attorney,
employs another attorney to write his will
Writing your own will: 2 hours
Opportunity cost of 2 hours: $10,000+
Hiring someone to spend 4 hours
on your will: $3,200
Making the right economic choice: priceless
Do It Yourself only when
Opportunity cost < hired cost
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2-3
A person has an absolute advantage at a particular
task if he or she can perform the task in fewer hours
than the other person
A person has a comparative advantage at a
particular task if his or her opportunity cost of
performing the task is lower than the other persons
opportunity cost
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2-4
The Principle of Comparative Advantage
Everyone does best when each person (or each country)
concentrates on the activities for which his or her opportunity
cost is the lowest.
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2-5
Two parties have different opportunity costs
for two activities
Concentrate on the activities for which you have
the lowest opportunity cost
Total value of output increases with
specialization and trade
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2-6
Production
Times
Mary
Paula
Web Update
Bike Repair
20 minutes
30 minutes
10 minutes
30 minutes
Paula and Mary can each update web pages and repair
bikes
Mary has an absolute advantage in both
Comparative advantage drives specialization
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2-7
Production
Times
Mary
Paula
Opportunity
Cost
Mary
Paula
Web Update
Bike Repair
20 minutes
30 minutes
10 minutes
30 minutes
Web Update
Bike Repair
2 repairs
1 repair
0.5 update
1 update
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2-8
Production
Times
Mary
Paula
Hourly Output
Mary
Paula
Web Update
Bike Repair
20 minutes
30 minutes
10 minutes
30 minutes
Web Update
3 updates
2 updates
Bike Repair
6 repairs
2 repairs
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2-9
Hourly Output
Mary
Paula
Web Update
3 updates
Bike Repair
6 repairs
2 updates
2 repairs
16 web updates are ordered
Mary spends half her time at each activity: 12 updates
and 24 repairs
Paula produces 4 updates and 12 repairs
Total output 16 updates and 36 repairs
Specialization produces 16 updates and 48
repairs
12 more repairs for the same inputs!
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2-10
Hourly Output
Pat
Meg
Web Update
Bike Repair
2 updates
3 updates
1 repair
3 repairs
This table shows output per hour
Apply the Principle of Comparative Advantage
Look at opportunity cost per unit
Pat repairs bikes and Meg updates web pages
Opportunity
Cost
Pat
Meg
Web Update
Bike Repair
½ repair
1 repair
2 updates
1 update
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2-11
None since 1941
Not a decline in athletic ability
Specialization keeps averages lower
Pitching and fielding skills have improved
Pitchers specialize in starters, middle relievers, and
closers; right- or left-handed
batters; strike outs
Fielders play one position
Specialized coaches
Detailed analysis of hitters'
weaknesses
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2-12
Talent
Natural resources
Cultures or societal norms
Languages
Institutions
Value placed on craftsmanship
Support for entrepreneurship
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2-13
Unattainable point
Attainable point
Inefficient point
Efficient point
Coffee (lb/day)
A production possibilities curve illustrates the
combinations of two goods that can be produced
with given resources
24 A
Unattainable
Definitions:
Combination
16
8
Scarcity Principle
Give up one good to get
another
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B
Inefficient
Combination
C
D
4
8
12
Nuts (lb/day)
2-14
Two goods: coffee and nuts
Work 6 hours per day
1 hour of labor
Coffee (lb/day)
= 4 pounds of coffee OR
= 2 pounds of nuts
Graph shows options
Negative slope
24
16
8
A
B
C
D
4
8
12
Nuts (lb/day)
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2-15
Marginal cost: 8 coffee
Marginal benefit: 4 nuts
Marginal cost: 8 nut
Marginal benefit: 16 coffee
24
Coffee (lb/day)
Loss in coffee
Gain in nuts
Opportunity cost of 1 nut is
2 coffee
A
B
16
C
8
Loss in nuts
Gain in coffee
Opportunity cost of 1 coffee is
½ nut
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4
8
D
12
Nuts (lb/day)
2-16
Work 6 hours per day
Productivity determines the slope of the
PPC
Opportunity cost
Marginal cost: 4 coffee
Marginal benefit: 8 nuts
Tom's opportunity cost of
1 coffee is 2 nuts
His opportunity cost of
1 nut is ½ coffee
12
Coffee (lb/day)
1 hour of labor
= 4 pounds of nuts OR
= 2 pounds of coffee
A
B
8
C
4
D
8
16
24
Nuts (lb/day)
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2-17
24
Coffee (lb/day)
PPCs show comparative
advantage
Sue's curve is steeper,
better for coffee
Tom's curve is flatter,
better for nuts
Comparative advantage
is a comparison
To get 1 coffee
Sue gives up ½ nuts
Tom gives up 2 nuts
Susans PPC
12
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Toms PPC
12
Nuts (lb/day)
24
2-18
Without trade, each person can consume
along his production possibilities curve
What you produce determines what you consume
With trade, each person's consumption can
be greater than production
Produce according to comparative advantage
Trade to get what you want
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2-19
Coffee (lb/day)
24
Susan and Tom
exchange
12 nuts, 12 coffee
12
8
Preferred diet is half
nuts, half coffee
No trade: 8 pounds of coffee
and 8 pounds of nuts
Total output is 32 pounds
Specialization gives each
person 12 pounds of each
good
48 total pounds
8 12
Nuts (lb/day)
24
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2-20
Sue's PPC
Coffee (lb/day)
24
Trade
benefits
With trade
12
Tom's PPC
4
No trade
4
12
Nuts (lb/day)
24
Benefits increase when
differences in opportunity
cost increase
Sue's opportunity cost of
one pound of nuts
increases to 6 coffee
Tom's opportunity cost of
one pound of coffee
increases to 6 nuts
No trade: 3.4 nuts and
3.4 coffee each
With trade: 12 nuts and
12 coffee each
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2-21
Coffee (1000s of lb/day)
Two goods: coffee and nuts
Multiple people
Different opportunity costs
100
95
9
0
A
B
Intercepts show maximum
production of one good
Some resources better at
coffee, some better at nuts
C
D
E
20
1
5
20
3
0
Nuts (1000s of lb/day)
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75
80
77
2-22
Maximum coffee: 100,000 lb / day
Coffee (1000s of lb/day)
Give up 5,000 pounds coffee, get 20,000 pounds of nuts
Give up another 5,000 pounds of coffee, get 10,000
additional pounds of nuts
100
95
90
A
B
C
D
E
20
15
20
30
Nuts (1000s of lb/day)
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75
80
77
2-23
Then move to next
highest opportunity
cost
And still higher
opportunity cost
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Decreasing productivity
Start with resources
with lowest
opportunity cost
2-24
A PPC represents current choices
Changes in choices occur over time due to
More resources
Investment in capital
Population growth
Improvements in technology
More specialization: start-up and switching costs
Increases in knowledge
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2-25
Neutral Technical
Change
Coffee
Technical Change
in Coffee
Coffee
Nuts
Nuts
Coffee
Technical Change
in Nuts
Nuts
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2-26
Specialization is easier when
Population density passes a threshold
Markets are connected
Transportation for goods
Communications for services
Legal framework supports business
Financial markets enable start-ups
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2-27
Imagine this:
Your hair stylist only cuts blonde hair
An expert in tropical diseases opens a practice in
a town of 500 people in Wisconsin
Seven bookstores, each open a different day of
the week
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2-28
Principle of Comparative Advantage and gains from
trade apply worldwide
Potentially large gains from trading with different and distant
countries
Trade can be controversial
Trade benefits society broadly
Costs are concentrated
Some industries suffer
People lose their jobs
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2-29
Service work performed overseas by low wage
workers has been termed outsourcing
Medical transcription
Customer call centers
?
?
Medical tourism
Technical writing
Limits to outsourcing
Quality control
Physical presence (haircuts)
Complex communications
Understand nuance
Greatest security for workers is the ability to adapt
quickly to changing circumstances
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2-30
Comparative
Advantage
Specialization and
Gains
from Trade
Outsourcing
Increasing
Opportunity Cost
Production
Possibilities Curve
Individual
Shift
PPC
Economy
2-31
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Chapter 1
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1. Explain and apply the Scarcity
Principle
2. Explain and apply the Cost-Benefit
Principle
3. Discuss three important pitfalls that
occur when applying the Cost-Benefit
Principle inconsistently
4. Explain and apply the Incentive
Principle
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1-2
Economics: The study of how people
make choices under scarcity and the
results of these choices for society.
The Scarcity Principle: People have
unlimited wants and limited resources.
Having more of one good means
having less of another.
Also called No Free-Lunch Principle
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1-3
Scarcity is involved in
Global
warming
Political
elections
Career
choices
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Buying
bottled
water
1-4
Take an action if and only if the extra benefits
are at least as great as the extra costs
Costs and benefits are not just money
Marginal
Benefits
Marginal
Costs
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1-5
Assume people are rational
A rational person has well defined goals and tries to
fulfill those goals as best they can
Would you walk to town to save $10 on
an item?
Benefits are clear
Costs are harder to define
Hypothetical auction
Would you walk to town if someone paid you $9?
If you would walk to town for less than $10, you gain
from buying the item in town
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1-6
You clip grocery
coupons but Bill
and Melinda
Gates do not
You speed on
the way to work
but not on the
way to school
At the ball park,
you pay extra to
buy a soda from
the hawkers in
the stands
You skip your
regular dental
check-up
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1-7
The economic surplus of an action is equal
to its benefit minus its costs
Total
Costs
Total Benefits
Economic
Surplus
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1-8
Opportunity cost is the value of what must be
foregone in order to undertake an activity
Consider explicit and implicit costs
Examples:
Give up an hour of babysitting to go to the movies
Give up watching TV to walk to town
Caution: NOT the combined value of all
possible activities
Opportunity cost considers only your best
alternative
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1-9
Simplifying assumptions
Which aspects of the decision are absolutely
essential?
Which aspects are irrelevant?
Abstract representation of key
relationships
The Cost-Benefit Principle is a model
If costs of an action increase, the action is less
likely
If benefits of an action increase, the action is more
likely
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1-10
Economic analysis predicts likely
behavior
Three general cases of mistakes
1. Measuring costs and benefits as
proportions instead of absolute amounts
2. Ignoring implicit costs
3. Failure to think at the margin
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1-11
Measuring costs
and benefits as
proportions
instead of
absolute amount
Would you walk to
town to save $10
on a $25 item?
Would you walk to
town to save $10
on a $2,500 item?
Marginal
Benefits
Marginal
Costs
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Action
1-12
#2
Ignoring implicit costs
Consider your
alternatives
The value of a Frequent
Flyer coupon depends on
its next best use
Expiration date
Do you have time for
another trip?
Cost of the next best
trip
Explicit
Costs
Opportunity
Cost
Implicit
Costs
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1-13
Failure to think at the
margin
Sunk costs cannot be
recovered
Marginal
Benefits
Examples:
Eating at an all-you-caneat restaurant
Attend a second year of
law school
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Marginal
Costs
1-14
Marginal cost is the increase in total cost
from one additional unit of an activity
Average cost is total cost divided by the
number of units
Marginal benefit is the increase in total
benefit from one additional unit of an
activity
Average benefit is total benefit divided by the
number of units
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1-15
# of Launches
Total Cost
($B)
Marginal
Average Cost
Cost
($B/launch)
($B)
0
$0
$0
1
$3
$3
$3
$4
2
$7
$3.5
3
$12
$4
4
$20
5
$32
$5
$8
$5
$12
$6.4
If the marginal benefit is $6 billion per launch, how many launches
should NASA make?
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1-16
Normative
economic principle
says how people
should behave
Gas prices are too
high
Building a space base
on the moon will cost
too much
Positive economic
principle predicts
how people will
behave
The average price of
gasoline in May 2010
was higher than in
May 2009
Building a space base
on the moon will cost
more than the shuttle
program
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1-17
Incentives are central to people's choices
Benefits
Costs
Actions are more likely
to be taken if their
benefits rise
Actions are less likely to
be taken if their costs
rise
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1-18
? Microeconomics studies
choice and its implications for
price and quantity in individual
markets
? Sugar
? Carpets
? House cleaning services
? Microeconomics considers
topics such as
? Costs of production
? Demand for a product
? Exchange rates
? Macroeconomics studies
the performance of national
economies and the policies
that governments use to try
to improve that performance
? Inflation
? Unemployment
? Growth
? Macroeconomics considers
? Monetary policy
? Deficits
? Tax policy
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1-19
Focus in this course is on a short list of
powerful ideas
Explain many economic issues
Predict decisions made in a variety of
circumstances
Core Principles are the foundation for
solving economic problems
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1-20
There are many things that economics
can help to explain
Economic Naturalist topics
Why is expensive software bundled with
PCs?
Why can't you buy a car without heaters
Drive-up ATMs with Braille
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1-21
Chapter 1 Appendix
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Equation
Variable
Dependent variable
Independent variable
Parameter (constant)
Slope
Intercept
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1-23
Identify the variables
Calculate the parameters
Slope
Intercept
Write the equation
Example: Phone bill is $5 per month
plus 10 cents per minute
B = 5 + 0.10 T
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1-24
B = 5 + 0.10 T
Draw and label axes
Horizontal is
independent variable
Vertical is dependent
variable
To graph,
Plot the intercept
Plot one other
point
Connect the
points
B
D
12
C
8
6
5
A
10
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30
70
T
1-25
Identify variables
Independent
Dependent
Identify parameters
Intercept
Slope
Write the equation
B = 4 + 0.2 T
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1-26
An increase in the
intercept shifts the
curve up
Slope is unchanged
Caused by an
increase in the
monthly fee
A decrease in
the intercept
shifts the curve
down
Slope is
unchanged
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1-27
An increase in the slope makes the curve
steeper
Intercept is unchanged
Caused by an increase in the per minute fee
A decrease in the
slope makes the
curve flatter
Intercept is
unchanged
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1-28
Time
(minutes/month)
10
20
30
40
Bill
($/month)
$10.50
$11.00
$11.50
$12.00
Identify variables
Independent
Dependent
Label axes
Plot points
Connect points
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1-29
Time
(minutes/month)
10
20
30
40
Bill
($/month)
$10.50
$11.00
$11.50
$12.00
Identify independent and dependent variables
Calculate slope
Slope = (11.5 10.5) / (30 10) = 1/20 = 0.05
Solve for intercept, f, using any point
B = f + 0.05 T
12 = f + 0.05 (40) = f + 2
f = 12 2 = 10
B = 10 + 0.05 T
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1-30
Two equations, two unknowns
Solving the equations gives the values of
the variables where the two equations
intersect
Value of the independent and dependent
variables are the same in each equation
Example
Two billing plans for phone service
How many minutes make the two plans cost the
same?
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1-31
Plan 1
B=
10 + 0.04 T
Plan 2
B=
20 + 0.02 T
Plan 1 has higher
per minute price
while Plan 2 has a
higher monthly
fee
Find B and T
for point A
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1-32
Plan 1
B = 10 + 0.04 T
Plan 2
B = 20 + 0.02 T
Subtract Plan 2 equation from
Plan 1 and solve for T
B = 10 + 0.04 T
B = 20 0.02 T
0 = 10 + 0.02 T
T = 500
Find B when T = 500
B = 10 + 0.04 T
B = 10 + 0.04 (500)
B = $30
OR
B = 20 + 0.02 T
B = 20 + 0.02 (500)
B = $30
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1-33
Question 4 (1 point)
Refer to the table below. According to the table, Corey has the absolute
advantage in:
Pizzas
Made
Per Hour
12
Pizzas
Delivered
Per Hour
6
15
Corey
Pat
10
A) making and delivering pizza.
B) delivering pizza.
C) neither making nor delivering pizza.
D) making pizza.
Question 5 (1 point)
On a graph of a production possibilities curve, an inefficient point is:
A) necessarily an attainable point.
B) necessarily an unattainable point.
C) not necessarily an attainable point.
D) possibly an unattainable point.
Question 1 (1 point)
The field of economics that would be most concerned with a recent fall in interest
rates is:
A) macroeconomics.
B) microeconomics.
C) economic naturalism.
D) marginal economics.
Question 2 (1 point)
All else equal, relative to a person who earns minimum wage, a person who earns
$30 hour has:
A)
a higher opportunity cost of working an additional hour.
B) a higher opportunity cost of taking the day off work.
C)
a lower opportunity cost of driving farther to work.
D) the same opportunity cost of spending time on leisure activities.
Question 3 (1 point)
You are the Minister of Trade for a small island country with the following annual
PPC:
500
Annual PPC on
Your Island
Coconuts Per Year
1,500
Fish Per Year
You are negotiating a trade agreement with a neighboring island with the
following annual PPC:
500
Annual PPC on
Neighboring Island
Coconuts Per Year
2,500
Fish Per Year
If you offer to give the other island 1 coconut for every 4 fish they give you, then
they will:
A) accept your offer because their opportunity cost of a coconut is greater than
4 fish.
B) refuse your offer because they have a comparative advantage in fish.
C) refuse your offer because they can produce as many coconuts as you can.
D) accept your offer because your opportunity cost of a coconuts is less than 4
fish.
Question 6 (1 point)
You have two options for how to spend the afternoon. You can either go see a
movie with your roommate or work as a tutor for the Math Department. From
experience, you know that going to see a movie gives you $20 worth of
enjoyment, and with your student discount, a movie ticket only costs $12. If you
spend the afternoon working as a math tutor, you will get paid $45. On a typical
day, you wouldn't be willing to spend the afternoon working as a math tutor for
less than $35. Should you go see a movie or work as a math tutor?
A) You should go to the movies.
B) Both options are equally good.
C) You should work as a math tutor.
D) You should do neither.
Question 7 (1 point)
Suppose it takes Dan 5 minutes to make a sandwich and 15 minutes to make a
smoothie, and it takes Tracy 6 minutes to make a sandwich and 12 minutes to
make a smoothie. Which of the following statements is correct?
A) Tracy should specialize in sandwiches and smoothies.
B) Dan should specialize in sandwiches, and Tracy should specialize in
smoothies.
C) Dan should specialize in both sandwiches and smoothies.
D)
Dan should specialize in smoothies, and Tracy should specialize in
sandwiches.
Question 8 (1 point)
The Incentive Principle is an example of:
A) an economic decision-making pitfall.
0
B)
a positive economic principle.
C) over-estimating the benefits of an action.
D) a normative economic principle.
Question 9 (1 point)
You paid $35 for a ticket (which is non-refundable) to see SPAM, a local rock
band, in concert on Saturday. Assume that $35 is the most you would have been
willing to pay for a ticket. Your boss called, and she is looking for someone to
cover a shift on Saturday at the same time as the concert. You would have to work
4 hours and she would pay you $11/hr. The psychic cost to you of working is
$2/hr. Your economic surplus from going to work instead of seeing SPAM on
Saturday is:
A) $35
B) $36
C) $1
D) $0
Question 10 (1 point)
The production possibilities curve shows:
A) how increasing the resources used to produce one good increases the
production of the other good.
B) the maximum production of one good for every possible production level of
the other good.
the minimum production of one good for every possible production level of
the other good.
D) how increasing the production of one good allows production of the other
good to also rise.
Question 17 (1 point)
A firm pays Pam $40 per hour to assemble personal computers. Each day, Pam
can assemble 4 computers if she works 1 hour, 7 computers if she works 2 hours,
9 computers if she works 3 hours, and 10 computers if she works 4 hours. Pam
cannot work more than 4 hours day. Each computer consists of a motherboard, a
hard drive, a case, a monitor, a keyboard, and a mouse. The total cost of these
parts is $600 per computer. If the firm sells each computer for $625, then how
many hours a day should the firm employ Pam to maximize its net benefit from
her employment?
A) 2 hours
B) 1 hour
C) 3 hours
D) 4 hours
Question 18 (1 point)
Moe has a big exam tomorrow. He considered studying this evening, but decided
to hang out with Curly instead. If neither activity involves any explicit costs, and
Moe always chooses rationally, it must be true that:
A) Moe gets more benefit from spending time with Curly than from studying.
B)
the opportunity cost of studying is less than the value Moe gets from
spending time with Curly.
C) Moe gets less benefit from spending time with Curly than from studying.
D)
the opportunity cost of studying is greater than the value Moe gets from
spending time with Curly.
Question 19 (1 point)
Refer to the figure below. As the production of pizza increases, the opportunity
cost of producing pizza:
125
100
75
Salads Per Hour
50
25
0
0
10
20
30
35 38 40
Pizzas Per Hour
A) become negative.
B) decreases.
C) increases.
D) doesn't change.
Question 20 (1 point)
A country is most likely to have a comparative advantage in the production of cars
if:
A) it has a relative abundance in the natural resources needed to produce cars.
B) its citizens prefer driving cars to other forms of transportation.
C) it has strict environmental protection laws governing automobile emissions.
D) it imports most of the raw materials necessary to produce cars.
Question 13 (1 point)
The following table shows the relationship between the speed of a computer's
CPU and its benefits and costs. Assume that all other features of the computer are
the same (that is, CPU speed is the only source of variation), and only the CPU
speeds listed below are available for purchase.
Marginal
Benefit
Total
Cost
$900
Marginal
Cost
CPU
GHz
2.0
2.5
3.0
3.5
4.0
Total
BO efit
$1.000
$1,400
$100
$300
$1.200
$1.500
$1,900
$2.000
$400
The marginal cost of upgrading from a 2.5GHz to 3.0GHz computer is:
A) $300.
B) $200.
C) $100.
D) $400.
Question 14 (1 point)
Refer to the table below. The average cost of 4 units of this activity is:
Units of
Activity
0
1
2
3
Total
Cost
SO
$30
$40
$60
$100
$150
$210
Total
Benefit
$0
$100
$160
$190
$210
$220
$225
+
5
6
A) $25
O
B) $40
C) $30
D) $20
Question 15 (1 point)
An individual has an absolute advantage in producing pizzas if that individual:
A) has a higher opportunity cost of producing pizzas than anyone else.
B) charges the lowest price for pizzas.
C) has a lower opportunity cost of producing pizzas than anyone else.
D)
can produce more pizzas in a given amount of time than anyone else.
Question 16 (1 point)
The table below shows the relationship between the number of times you get
your car washed each month and your total monthly benefit from car washes.
Each car wash costs $15.
Number of
Car Washes
Per Month
0
1
2
3
4
5
Total Monthly
Benefit from
Car Washes
$0
$20
$36
$48
$56
$60
+
What is the marginal benefit of the 3rd car wash each month?
A) $48
B) $16
C) $4
D) $12
Question 19 (1 point)
Refer to the figure below. As the production of pizza increases, the opportunity
cost of producing pizza:
125
100
75
Salads Per Hour
50
25
0
0
10
20
30
35 38 40
Pizzas Per Hour
A) become negative.
B) decreases.
C) increases.
D) doesn't change.
Question 20 (1 point)
A country is most likely to have a comparative advantage in the production of cars
if:
A) it has a relative abundance in the natural resources needed to produce cars.
B) its citizens prefer driving cars to other forms of transportation.
C) it has strict environmental protection laws governing automobile emissions.
D) it imports most of the raw materials necessary to produce cars.
Question 16 (1 point)
The table below shows the relationship between the number of times you get
your car washed each month and your total monthly benefit from car washes.
Each car wash costs $15.
Number of
Car Washes
Per Month
0
Total Monthly
Benefit from
Car Washes
$0
$20
$36
1
$48
2
3
4
5
$56
$60
What
the marginal benefit of the 3rd car wash each month?
A) $48
B) $16
C) $4
D) $12
Question 11 (1 point) Saved
Refer to the figure below. Moving from point C to point B, the opportunity cost of
25 more salads is:
125
100
75
Salads Per Hour
50
25
0
10
20
30 35 38 40
Pizzas Per Hour
O
A) 10 pizzas.
B) 30 pizzas.
C) 15 pizzas.
D 5 pizzas.
Question 12 (1 point)
If Jane can produce 3 pairs of shoes per hour, while Bob can produce 2, then
has an) advantage in producing shoes.
A) Jane; comparative
B) Jane; absolute
C) Bob; absolute
D) Bob; comparative
Question 4 (1 point)
Refer to the table below. According to the table, Corey has the absolute
advantage in:
Pizzas
Made
Per Hour
12
10
Pizzas
Delivered
Per Hour
6
15
Corey
Pat
A) making and delivering pizza.
O
o
B) delivering pizza.
C) neither making nor delivering pizza.
O
D) making pizza.
Question 5 (1 point)
On a graph of a production possibilities curve, an inefficient point is:
A) necessarily an attainable point.
B) necessarily an unattainable point.
C) not necessarily an attainable point.
D)
possibly an unattainable point.
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