1

TutorialChapter 2Decisions

2

1. A perfectly free market can provide society with everything it needs.

FalseThe market fails in many aspects of meeting

our needs and therefore has to be modified.

3

2. If the federal government interferes with the price mechanism too much, communication among its parts will begin to break down as price signals blur.

TrueA free market system can only function

smoothly if there is ample communication among its various parts.

4

3. Rent seeking occurs when big business financially supports politicians to influence legislation.

TrueWhen a business decides support a lobby

effort in Washington D.C instead of spending the money on better production, we can this practice rent seeking.

5

4. Moral hazard occurs when a business is insulated from risk and therefore behaves differently than it would if it were fully exposed to risk.

TrueMoral hazard is a consequence of rent seeking.

Caution is thrown to the wind when people are not held responsible for their actions.

6

5. If we developed a fertility drug doubling the number of cows, economists would say that the supply of cows has increased.

FalseEconomists only consider events if there is a

market transaction. Economists are less concerned about how many cows we have standing on four feet as they are about how many cows are brought to market.

7

6. Strictly speaking, money is considered capital.

FalseCapital is defined as the machines, buildings, or tools

used in the productive process. Money does not fit this definition of capital. Money that is used to purchase capital is called financial capital.

8

7. It is folly for a society to always want more goods and services. When society has plenty of everything, people should be satisfied with what they have and not always want more.

FalseThe problem of being satisfied with what we

already have is that everything wears out over time. If we do not consistently replace what we have, tomorrow we will have less.

9

8. Some economic goals are conflicting.

TrueSociety is always faced with conflicting goals

because of opportunity costs. If we spend more on a clean environment we will have fewer resources devoted to the military, and vice versa.

10

9. Pollution is a negative externality.

TrueNegative externalities are the negative by-product

of the industrial process.

11

10. America is rich enough in natural resources and capital that we would not be harmed if we did not trade with other nations.

FalseDespite are wealth the standard of living for

the average person would diminish if we did not trade with other nations.

12

11. The old adage of “the rich get richer and the poor get poorer” is an accurate assessment of how the economy works.

TrueThere is a natural law whereby those people

who have the most receive more than people who have less. The more you have, the more you will be given. The less you have, the less you will be given.

13

12. Crony capitalism can lead to moral hazard.

TrueCrony capitalism is a system whereby the government

and the means of production are controlled by a handful of private individuals who arrange the economy to benefit only themselves. This presents a moral hazard situation because even in failure these people gain financially and therefore are risk adverse.

14

13. The law of comparative advantage states that the person who should produce a good is the person whoa. has the lowest opportunity cost of producing that good.b. can produce that good using the fewest resources.c. will produce that good using the most expensive resources.

A. If you make $7 an hour and have to pay someone $8 an hour to paint your house, you have a comparative advantage of painting the house yourself. However, if you make $20 an hour, you do not have a comparative advantage in painting the house yourself.

15

14 Comparative advantagea. leads to all of the following.b. leads to the most efficient allocation of resources and the

greatest combined output.c. eliminates specialization, so that each person produces for

all of his own needs independently.

B. Should a country produce those goods that it is best at producing? Not necessarily. For example, let’s suppose Americans were better than any anyone else at producing hand made wicker baskets, should we spend our time and energy producing baskets? No, because that time and energy would be better spent in the technology area, like computers.

16

15. What is crony capitalism? a. Occurs when cronies participate in the free enterprise

system.b. A system where success in business depends on close

relationships between business and government.c. An economic system that is totally free of government

interference.d. An economic system which is highly regulated.

B. Instead of the government regulating and overseeing the business sector the government becomes a partner of big business.

17

16. Because of specialization and comparative advantage, most people

a. consume only what they produce themselves.b. consume the products produced by their family and

friends.c. consume the products of many other specialists.

C. Because of specialization and the fact that people pursue activities that they have a comparative advantage in, means that we do not have to be self sufficient. By specializing and then buying from one another, our standard of living increases.

18

17. The “division of labor” refers to a. discrimination in labor markets.

b. separating a job into smaller tasks completed by different people.

c. one worker who divides his time among different jobs and duties.

d. defining a job according to the appropriate sex.

B. One of the characteristics of a modern industrial society is a greater specialization of labor. This is one reason why productivity and a resultant higher standard of living is possible than in less developed economies.

19

18. Specialization of labor a. increases productivity without creating any

problems.b. reduces productivity, and is usually eliminated

by business firms.c. can create problems of boredom and repetitive

motion injuries.d. prevents the introduction of more sophisticated

and efficient production techniques.

C. On an individual basis, the division of labor has the downside of boredom and physical and emotional type problems.

20

19. When business are bailed out of losing situations, where does the government get the money?a. Taxes. b. Debtc. The money is createdd. all of the above

D. These are the three places the government gets money.

21

20. If the government borrows to increase spending, we do not pay for it now, only later. a. Trueb. Falsec. Can’t telld. Depends on who lends the money

B. A dollar spent today is paid for today regardless of where it comes from. We either pay for it in terms of higher taxes, higher interest rates, or inflation.

22

21. “Efficiency” refers to a. producing output using the least amount of labor.

b. producing output using the least amount of capital.

c. producing as far inside the production possibilities frontier as possible.

d. getting the maximum possible output from available resources.

D. A country is being most efficient when it uses its resources the best way possible.

23

22. If all resources are used efficiently to produce goods and services, the nation will find itself producinga. inside its production possibilities frontier.b. somewhere on its production possibilities frontier.c. outside of its production possibilities frontier.d. at one extreme of its production possibilities frontier.

B. If a country uses its resources inefficiently it will operate inside its production possibilities curve.

24

23. Opportunity cost is constant if a. resources are equally adaptable to the

production of all goods.b. each resource is specialized in the

production of one particular good.c. larger and larger sacrifices must be made

to gain equal successive amounts of a good.d. all resources are used fully and efficiently.

A. This is an unrealistic assumption but is sometimes made. For example, if you were a farmer, this would mean that an acre of land will yield the same amount no matter what crop you plant in the acreage. The land is equally suited for both crops being considered.

25

24. The set of mechanism and institutions that resolve the basic economic questions is called the

a. economic system.b. production possibilities dilemma.c. business resolution device.d. absolute advantage determination.

A. All countries have to have some mechanism to decide what to produce, how to produce, and who gets what and how much. The economic system, whether it be a free market system or a command system, is the mechanism countries use to answer these questions.

26

25. If newspaper and magazine publishers switch from human typesetting to computerized typesetting, they are changing their answer to which economic question?

a. What to produce?b. How to produce?c. For whom will commodities be produced?d. Why will commodities be produces?

B. The typesetting chosen is a matter of preference, they are alternatives in how to produce.

27

26. Pure capitalism and command economies represent a. two extremely different ways of answering the

basic economic questions.b. two names describing exactly the same way of

answering the basic economic questions.c. the only two ways of answering the basic

economic questions.d. the most efficient ways to answer the basic

economic questions.

A. A command economy is one where the central government makes all of the economic decisions. Capitalism is a system where the decisions are made by private individuals that have as their motive, profit.

28

27. Which of the following does not distinguish between different types of economic systems?

a. Laws about resource ownership.b. The extent of government involvement in

the economy.c. Whether or not the basic economic

questions must be answered.d. What process is used to allocate resources

and products.

C. No matter the economic system, the basic economic questions must be answered.

29

28. Which of the following is a characteristic of a planned economy?a. All resources are privately owned.b. Economic activity is coordinated by the

price system.c. Competitive markets guide resources to

their highest-valued uses.d. Centralized economic planning is used to

answer basic economic questions.

D. Friedrich Hayek’s book The Road to Serfdom he explains how centralized planning can lead to a loss of personal freedoms and economic stagnation.

30

29. Which of the following is a characteristic of pure capitalism?a. All resources are owned communally.b. Economic activity is coordinated by

government decision makers.c. The price system is used to guide resources to

their highest-valued uses.

C. Because individuals are making decisions to maximize their welfare and profit, consumers will purchase at the lowest price possible and suppliers will sell at the highest price possible. The market is at equilibrium where the two parties reach an agreement.

31

30. Problems with pure capitalism include which of the following?

a. People have no incentive to direct resources to their highest-valued use.b. The active government involvement in controlling

the economy may not be in the best interest of the individuals involved.

c. Public goods, while desirable, may not be produced.

C. This is why we have modified capitalistic system; we have modified it in an attempt to rectify some of its weaknesses. We support a government that taxes us and then uses the tax money to support things that would not exist in a purely free enterprise system.

32

31. Problems with a pure command economy include which of the following?

a. Property rights cannot be enforced.b. Public goods, while desirable, may not be produced.c. The lack of a legal system makes it impossible to

create contracts.d. Large, diverse economies may be extremely difficult

for central authorities to analyze and control.

D. Command economies may have some advantages, but one of the big disadvantages is the fact that large complex and diversified economies are difficult to analyze and control by any one central authority.

33

32. With regard to pure capitalistic economies and pure command economies,

a. all real-world societies are purely capitalistic.b. all real-world societies are pure command.c. all real-world societies are purely capitalistic

or purely command.d. real-world societies are usually a mixture of

command and capitalism.

D. Even our own American system, even though it is primarily a free market system, has some aspects of a command system in it.

34

33. A mixed capitalist economy occurs whena. decisions are based primarily on religion or custom.b. all resources are publicly owned and economic

planning is centralized.c. all resources are privately owned and prices are

used to coordinate economic activity.d. resources are both publicly and privately owned

and some markets are regulated.

D. Some economists call our type of economic system a mixed economic system because we have aspects of both systems.

35

END