CHAPTER 1. THE CHALLENGE OF ECONOMICS

 

 


ANSWERS TO QUESTIONS FOR DISCUSSION AND PROBLEMS

 

QUESTIONS FOR DISCUSSION

 

1.                What is the opportunity cost you incurred in reading this chapter?

 

There are many other things you could have done with your time instead of reading this chapter.  The most desired activity you gave up is the opportunity cost.

 

 

2.               In Figure 1.7, government failure causes output to fall below its full potential.  How might this happen? If government intervention moved the mix of output to a point between M and X, would this be government failure?

 

The government policies might result in inefficiencies that cause production to fall short of its potential. Moving the mix of output to some point between M and X is not considered government failure because the government intervention improved on the market outcome and moved the economy closer to the optimal mix.

 

 

3.               In 2008, President George W. Bush proposed to increase military spending by $30 billion.  What would that added spending cost us?  Is this too much or too little?  How can we decide?

 

The cost of the added spending is the opportunity cost.  What will we have to give up to increase the military spending?  Examples might include more education spending, more health care spending, etc.  Whether this is too much or too little is a normative economic question.  Economic theory generally tries not to decide if this is too little or too much.  The question could be looked at from the perspective of comparative opportunity costs to get some ideas about the effectiveness of military output versus nonmilitary output.

 

 

4.               What public- or private-sector output would you cut back in order to make resources available for post-hurricane reconstruction?

 

Again, this is a normative question.  Economics can identify different potential cuts -- different opportunity costs that can be compared for information about alternatives and loss of output in other fields -- but it does not tell us which cuts are the best

 

 

5.               Why might it be necessary to reduce consumer spending in order to attain faster economic growth?  Would it be worth the sacrifice?

 

One choice any society must make is whether to use its resources to produce consumer goods or whether to produce capital with those same resources.  To increase economic growth it may be necessary to produce more capital.  As a result, it may be necessary to reduce output of consumer goods so resources are available to produce more capital goods.  Whether it is worth the sacrifice depends on which one society values more, current consumption or future consumption.

 

 

6.               If auto-emissions controls weren't required, would people willingly buy and install them?  Explain.

 

Some would, but most probably would not.  People prefer to spend money on things that give them direct pleasure.  The person who buys controls gets little direct benefit. Without government intervention, most people would ignore the air pollution externality.

 

 

7.                Why doesn’t North Korea reduce its military and put more resources into food production (Headline, p. 11)? What is the optimal mix of “guns” and “butter” for a nation?

 

North Korea doesn’t reduce its military and put more resources into food production because North Koreans apparently believe that a large military establishment is essential to their well-being and security. The optimal mix of “guns” and “butter” depends on values and, therefore, the answer to this question will depend on the values of the individual answering it.

 

 

8.               Which government income transfers do rich people receive?  Who pays for them?

 

Pensions, agricultural subsidies, student loans, health care, social security.  Everyone who pays taxes pays for these transfers.

 

 

9.    If taxes on the rich were raised to provide more housing for the poor, how would the willingness to work be affected?  What would happen to total output?

 

Given the standard assumptions about market participant reactions, we would expect that those being taxed more would reconsider their choices between work and leisure.  Since their reward for working would now be less (after taxes) they could be expected to work less.  Poor people, too, might work less if they get free or subsidized housing.  Changes in the work incentives facing both the rich and the poor would lead to less total output.

 

 

10.  Why is public confidence in government so low (see Headline, p. 20)?  How can government failure be avoided?

 

                              Low public confidence in government is probably due to increased media exposure of government failure.  This exposure has become increasingly possible with modern telecommunications.  It is impossible to avoid government failure because it is impossible to fully anticipate future economic events.  All that can be hoped for is to minimize government failure using sound economic principles when developing policy.

 

 

PROBLEMS

 

1.                According to Figure 1.1, what is the opportunity cost of increasing consumer output from OF to OD?

 

In figure 1.1, the move from OF to OD along the consumer goods axis moves the economy from point X to point C on the production possibilities curve.  As a result, the economy must give up G minus E military goods.

 

 

2.               Draw a production possibilities curve based on Table 1.1, labeling combinations A-F.  What is the opportunity cost of increasing missile production (a) From 50 to 100?

(b)  From 200 to 250?

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The opportunity cost of changing production from 50 to 100 missiles is a reduction in the production of houses from 90 to 75, or a loss of 15 houses.  From 200 to 250 results in a loss of 30 houses.

 

 

3.    Assume that it takes 4 hours of labor time to paint a room and 3 hours to sand a floor.  If all 24 hours were spent painting, how many rooms could be painted by one worker?  If a decision were made to sand two floors, how many painted rooms would have to be given up?  Illustrate with a production-possibilities curve.

 

                      

If all 24 hours were spent painting, it would be possible to paint a total of six rooms (24/4 = 6).  If you wanted to sand two floors, it would take a total of six hours (3 hours per floor x two floors).  In these six hours, you could have painted 1-1/2 rooms, thus the opportunity cost of sanding two floors is not paining 1-1/2 rooms.

 

 

4.     Suppose in problem 3 that a second worker became available.  Illustrate the resulting change in production possibilities.  Now what would be the opportunity cost of sanding two floors?

 

 

 

 

Assuming the second worker is as productive as the first, a doubling of the labor input allows you, in 24 hours, to paint and sand twice as many rooms and floors.  The opportunity cost of sanding two floors, however, has remained unchanged.  Opportunity cost is the value of what you must give up in order to do the next best thing.  Even though you now have two workers, the opportunity cost of sanding two floors for either worker is still 1˝ floors.

 

 

5.           According to Figure 1.3, what is the cost of a war that increases military output from M2 to M1? What is the opportunity cost of maintaining military output to M1?

 

If military output increases from M2 to M1, then the decrease in output of consumer goods is reduced from C2 to C1.

 

The opportunity cost of maintaining military output at M1 is the amount of consumer goods forgone.  At point S, there are many millions of men and women on active military duty and additional millions of civilians employed by the Department of Defense or military contractors.  All of this labor and other resources could be used to produce consumer goods or public works.

 

 

6.           On a single graph, draw production possibilities curves for 1945 and 2007 with consumer goods and military goods as the output choices.  Label points A and B to approximate the choices made in each year (see Figure 1.2 for data).

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 


                                             

 

 

 

 

 

 

                                                             

 

 

 

 

 

Figure 1.2 suggests that, as a percentage of GDP, total military output was higher in 1945 than in 2000.    Thus, as suggested by point A, in 1945 the U.S. made a choice to produce a relatively high level of military goods (nearly 40 percent).  Since 1945 the U.S. economy has grown, as demonstrated by an outward shift of the PPC, and military output as a percentage of GDP has declined, to around 4 percent, as illustrated by point B.

 

 

7.            Assume that the table on the next page describes the production possibilities confronting an economy.  Using that information:

a.            Draw the production-possibilities curve.  Be sure to label each alternative output combination (A through E).

b.           Calculate and illustrate on your graph the opportunity cost of building one convenience store per week.

c.            What is the cost of producing a second convenience store?  What might account for the difference?

d.           Why can’t more of both outputs be produced?

e.            Which point on the curves is the most desired one?  How will we find out?

 

 

Potential Weekly

Output Combinations

Homeless

Shelters

Convenience

Stores

A

10

0

B

9

1

C

7

2

D

4

3

E

0

4

 

              

               a.

                             

              

 

              

b.           The opportunity cost of producing the first convenience store is reducing the production of homeless shelters from 10 to 9, or 1 homeless shelter.

 

c.            The opportunity cost of producing the second convenience store is to reduce the production of homeless shelters from 9 to 7, or 2 homeless shelters.

 

d.           It is not possible to produce more of both outputs because resources are scarce. Thus, assuming that all resources are efficiently used, i.e., we are on the production- possibilities curve, to produce more convenience stores requires taking resources from the production of homeless shelters, and vice versa.  To produce more of both would require either finding more resources or developing new technology that allows for existing resources to be used more efficiently, i.e., the production-possibilities curve would shift outward.

 

e.            With the available information, it is not possible to tell which point is the most desired.  This point depends on the tastes and preferences of the society that is producing the items.  In general, the combination that is most desired is that combination which offers the most amount of satisfaction for consumers while maximizing profits for producers.  This point will be discovered through the interaction of market forces.

 

 

8.           In 2005, the dollar value of total output was roughly $35 billion in North Korea and $800 billion in South Korea.  Use the data in Figure 1.4 to compute the amount of defense spending in each country.

 

In North Korea, military spending accounts for 14.8 percent of total GDP.  With a GDP of $35 billion, North Korean military spending is roughly $5.2 billion.  In South Korea, total military spending by the South Korean government is approximately $22.4 billion, which is 2.8% of that economy’s GDP.