Solutions for End of Chapter Questions
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Solutions for End of Chapter Questions
Chapter 1
Easy
1Suppose society abolishes higher education and so, students have to find jobs immediately. If there are no jobs available, how do wages and prices adjust so those who want jobs can find them?
1This would represent an increase in the supply of labour. Wages will fall for those jobs for which students wish to offer themselves.
A-head: 1.3 Scarcity and the competing use of resources
Learning Objective:Ways in which society decides what, how and for whom to produce
Type: Application
2Communist Russia used prices to allocate production among different consumers. Central planners set production targets but then put output in shops, fixed prices and gave workers money to spend. Why not plan the allocation of particular goods to particular people as well?
2This would be too bureaucratic, even by command economy standards. Even in a dictatorship this could be politically unacceptable as well as impractical. Even with modern information technology it would probably betoo costly to plan for, deliver to and monitor individuals.
A-head:1.4 The role of the market
Learning Objective:Ways in which society decides what, how and for whom to produce
Type: Application
3Which of the following statements are positive, and which are normative? (a) Annual inflation is below 2 per cent. (b) Because inflation is low, the government should cut taxes. (c) Income is higher in the UK than in Poland. (d) Brits are happier than Poles.
3(a) Positive (b) Normative (c) Positive (d) Normative at present, though social scientists are trying to develop objective measurements of well-being and happiness.
A-head: 1.5Positive and normative
Learning Objective:Positive and normative economics
Type: Application
4Common fallacies Why are these statements wrong? (a) Since some economists are Tory but others Labour, economics can justify anything. (b) Efficiency gains cannot increase the production of some commodities without sacrificing others, and therefore there is no such thing as a “free lunch.” (c) Economics is about people, and thus cannot be a science.
4(a) Economics cannot necessarily justify anything. Positive economicstatements can be tested against evidence while normative statements, even if they are made by economists, cannot. (b) Beginning from an inefficient point to the left of the production possibility frontier, efficiency gains can increase the production of some commodities without sacrificing others and thus yield a “free lunch.” (c) Economics is a social science with all the limitations which that classification implies.Scientific method can be used to study human behaviour, but it is often more useful to refer to economic tendencies rather than economic laws.
A-head: Introduction, 1.3Scarcity and the competing use of resources, 1.5Positive and normative
Learning Objective:Ways in which society decides what, how and for whom to produce, Positiveand normative economics, Economics is the study of how society resolves the problem of scarcity
Type: Conceptual understanding
5Which of the following statements refer to microeconomics, which to macroeconomics? (a) Inflation is lower than in the 1980s. (b) The price of a can of beans fell this month. (c) Good weather means a good harvest. (d) Unemployment in London is below the UK average.
5(a) Macroeconomics (b) Microeconomics (c) Microeconomics (d) Macroeconomics
A-head: 1.6Micro and macro
Learning Objective: Microeconomics and macroeconomics
Type: Application
Medium
6OPEC made a fortune for its members by organizing production cutbacks and forcing up prices. (a) Why have coffee producers not managed to do the same? (b) Could UK textile firms force up textile prices by cutting back UK textile production?
6(a) There was an attempt to organise a “coffee quota” during the 1970s but it was not very effective. There are many more producers of coffee than of oil, so it is much more difficult to co-ordinate them. Also the demand for coffee is more elastic than the demand for oil, so a reduction in supply does not have quite so much impact on the price. High prices are also an incentive for cartel members to cheat on the collective agreement to restrict output – an individual producer that raises its output gets much higher income. Chapter 10 explains how Saudi Arabia disciplined other OPEC members to keep them in line, which was possible only because of the large oil reserves and cheap production costs of Saudi Arabia compared with other OPEC members. (b) It would fail because the UK would simply be swamped by cheap textile imports.
A-head: 1.2Economic issues
Learning Objective:Ways in which society decides what, how and for whom to produce
Type: Application
7Suppose it becomes possible in 5 years’ time to make as much energy as we want from biofuels provided the price is the equivalent of at least $50/barrel for oil. (a) What does this imply about the eventual price of oil in, say, 10 years’ time? (b) Is it possible for oil prices to be substantially above $50/barrel for the next few years? (c) Do higher oil prices in the short run increase or reduce the incentive to look for alternative energy technologies?
7(a) The price of oil will be around $50 a barrel.
(b) Yes, until the biofuel process is on stream.
(c)Higher oil prices in the short run increase the incentive to look for alternative energy technologies.
A-head: 1.2Economic issues
Learning Objective: ways in which society decides what, how and for whom to produce
Type: Application
8An economy has 5 workers. Each worker can make 4 cakes or 3 shirts.(a) Draw the production possibility frontier. (b) How many cakes can society get if it does without shirts? (c) What points in your diagram are inefficient? (d) Can the economy produce an output combination which lies above the production possibility frontier? (e) What is the opportunity cost of making a shirt and making a cake? (f) Does the law of diminishing returns hold in this economy?
8(a) As shown in the figure, the production possibilities frontier will be a downsloping line joining 15 shirts and 20 cakes. (b) 20 cakes (5 workers x 4cakes) (c) All points below the frontier. (d) No, such combinations are unattainable. Given the inputs available, such output combinations cannot be made. Scarce resources limit society to a choice of points inside or on the production possibility frontier. Society must choose how to allocate these scarce resources between competing uses.(e) The opportunity cost of making a shirt = 1.33 cakes;the opportunity cost of making a cake =0.75 shirts(f) No, because the production possibility frontier is a straight line.
A-head: 1.3Scarcity and the competing use of resources
Learning Objective:Economics is the study of how society resolves the problem of scarcity
Type: Calculation, Graphing
9Suppose that a country can produce two goods, food and clothing. To produce one unit of food, it requires one worker. To produce one unit of clothing, it requires two workers. The total amount of workers available in the economy is fixed and equal to 100. Denoting with L the total amount of workers, with F the units of food produced, and with C the units of clothing produced, the resource constraint for this economy can be written as: ,where aF is the amount of workers needed to produce one unit of food and aC the amount of workers needed to produce one unit of clothing. Show how to construct the production possibility frontier from that resource constraint. In a graph with C on the vertical axis and F on the horizontal axis, plot the PPF of this economy. What is the slope of the PPF?
9With 100 workers, that economy can produce 50 units of clothing and no food, or 100 units of food and no clothing.Therefore with Clothing on the y (vertical) axis and Food on the x (horizontal) axis, mark points at 50 on the y axis and 100 on the x axis.Join these with a straight line.This is the production possibility frontier.The gradient of the line is ∆y/∆x =-1/2(The gradient is negative because the line is downward sloping).
A-head: 1.3Scarcity and the competing use of resources
Learning Objective:Economics is the study of how society resolves the problem of scarcity
Type: Calculation, Graphing
Hard
10. Suppose a farmer is planning to grow cabbages on his land. The cost of growing cabbages is £50 per acre and he earns £100 from the produce in the market. There is another option for him, to grow pumpkins, which could yield him £110 if he spent £70 on it. (a) What is the opportunity cost of growing cabbages? (b) Is it rational for the farmer to grow cabbages instead of pumpkins? (c) Suppose the only other option for him to earn from his farmland is to rent it to another farmer. How will the farmer arrive at a rational decision?
10(a) The opportunity cost of an activity is the value of the best alternative you must sacrifice. The opportunity cost of growing cabbages accounts for the explicit cost of growing cabbages plus the value of growing pumpkins. The value of growing pumpkins is equal to £40 i.e. £110 minus £70. Therefore, the opportunity cost of growing cabbages is £40.
(b) As a rational individual, the farmer should weigh the costs and benefits of growing cabbages and pumpkins. The cost of growing cabbages is £50, plus £40, the opportunity cost of growing pumpkins. The benefit from growing cabbages is £100. The benefit is greater than the cost. Therefore, it is rational for the farmer to grow cabbages.
(c) The farmer should consider renting out his farmland only if the rent exceeds the benefits he gets from growing cabbages.
A-head: 1.1 How economists think about choices
Learning Objective:The concept of opportunity costs
Type: Application
11Essay question Two similar countries take the decision to try to increase the health of their poorest people. One country raises taxes on the rich and gives more money to the poor. The other country raises taxes on the rich and provides more health care, free to patients, through its National Health Service. Which country do you think is more likely to meet its objective? Why?
11The answer to this question involves more than economic reasoning.Most people approaching this debate will have value judgment baggage; even economists geared to a positive analysis. There is no such thing as a value-free social science and in a question of this kind political persuasions are also important.
The Liberal reforms of 1906 – 1914, (which many historians have argued paved the way for the post 1945 welfare reforms, collectively called the “Welfare State” with the NHS at its heart), were born out of the scandalous state of theBoer War recruits and to head off the threat of organised labour. In addition, employers benefit from a healthy workforce through increased levels of productivity, hence the reforms associated with public health in the nineteenth century.
For most of the period 1945 – 1979, the major tenets of Social Democracy held sway in the UK, whereby the progressive income tax system levied higher levels of taxation on the richer sections of society than on the poorer sections, and the government then used the receipts to fund the NHS and some benefits for the poor, the unemployed and those of pensionable age.
The policy of raising taxes on the rich and giving money to the poor in the hope of improving the health-care of their poorest peopleis more market-orientated than the policy that prefers to adopt a similar taxation policybut is keen to provide health care free to participants.The latter fits the social democratic paradigm.This perspective is not in favour of empowering the poorest with cash in the hope that some of it will be spent on health care.Supporters of this perspective do not trust the poorest sections of society, or indeed other sections, to spend their money “wisely”. Proponents of the philosophy that “the government knows best” would refer to feckless sections of society spending any extra money received on “undesirable” goods and services such as alcohol, gambling and drugs.Food, housing and health care would be low on the agenda.It would be argued that people do not always act to benefit themselves in the long term.
A positive economist would draw on economic theory to point out that cash transfers allow consumers choice and freedom to purchase what they need and want, and that transfers in kind limit consumer options.Consumer utility is also reckoned to be less with transfers in kind than with cash of the same monetary value. However, transfers in kind do have widespread appeal amongst all the mainstream political parties.Despite major changes in political philosophy since 1979, with all three major parties in Britain accepting the market as the main arbiter in the allocation of resources, there is no appetite as yet to privatise completely the NHS, and provide for cash transfersso that people can take responsibility for their own health care.
Vouchers have been suggested for use in the purchase of educational services and there will be supporters of this system with regard to health care. Creeping privatisation and marketization within the NHS could foreshadow a major shift in the provision in the near future as the struggle to reduce the government budget deficit will result in the slaying of some “sacred cows”. Economic arguments could yet transcend social and political philosophies.
Free market economists would argue that, to the extent that consumers are rational enough to exercise self-interest in all its aspects, they are better off, or at least no worse off, if transfers are received in cash rather than in kind. It is doubtful whether or not the “national interest”, a dubious concept difficult to define but used here to mean “the greatest happiness of the greatest number” is best served by this approach.
A-head: 1.3 The role of the market, 1.4 Positive and normative
Learning Objective:Positive and normative economics, Ways in which society decides what, how and for whom to produce
Type: Conceptual understanding
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