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2.E: Choice in a World of Scarcity (Exercises)

2.1: How Individuals Make Choices Based on Their Budget Constraint

Self-Check Questions

Q1

Suppose Alphonso’s town raised the price of bus tickets to \(\$1\) per trip (while the price of burgers stayed at \(\$2\) and his budget remained \(\$10\) per week.) Draw Alphonso’s new budget constraint. What happens to the opportunity cost of bus tickets?

Review Questions

Q2

Explain why scarcity leads to tradeoffs.

Q3

Explain why individuals make choices that are directly on the budget constraint, rather than inside the budget constraint or outside it.

Critical Thinking Questions

Q4

Suppose Alphonso’s town raises the price of bus tickets from \(\$0.50\) to \(\$1\) and the price of burgers rises from \(\$2\) to \(\$4\). Why is the opportunity cost of bus tickets unchanged? Suppose Alphonso’s weekly spending money increases from \(\$10\) to \(\$20\). How is his budget constraint affected from all three changes? Explain.

Problems

Q5

Use this information to answer the following \(4\) questions: Marie has a weekly budget of \(\$24\), which she likes to spend on magazines and pies.

  1. If the price of a magazine is \(\$4\) each, what is the maximum number of magazines she could buy in a week?
  2. If the price of a pie is $12, what is the maximum number of pies she could buy in a week?
  3. Draw Marie’s budget constraint with pies on the horizontal axis and magazines on the vertical axis. What is the slope of the budget constraint?
  4. What is Marie’s opportunity cost of purchasing a pie?

Solution

S1

The opportunity cost of bus tickets is the number of burgers that must be given up to obtain one more bus ticket. Originally, when the price of bus tickets was \(50\) cents per trip, this opportunity cost was \(0.50/2 = 0.25\) burgers. The reason for this is that at the original prices, one burger (\(\$2\)) costs the same as four bus tickets (\(\$0.50\)), so the opportunity cost of a burger is four bus tickets, and the opportunity cost of a bus ticket is \(0.25\) (the inverse of the opportunity cost of a burger). With the new, higher price of bus tickets, the opportunity cost rises to \(\$1/\$2\) or \(0.50\). You can see this graphically since the slope of the new budget constraint is flatter than the original one. If Alphonso spends all of his budget on burgers, the higher price of bus tickets has no impact so the horizontal intercept of the budget constraint is the same. If he spends all of his budget on bus tickets, he can now afford only half as many, so the vertical intercept is half as much. In short, the budget constraint rotates clockwise around the horizontal intercept, flattening as it goes and the opportunity cost of bus tickets increases.

fig 2.1.2.png

Figure 2.E.1: Alphonso's budget

2.2: The Production Possibilities Frontier and Social Choices

Self-Check Questions

Q1

Return to the example in Figure 2.2.2. Suppose there is an improvement in medical technology that enables more healthcare to be provided with the same amount of resources. How would this affect the production possibilities curve and, in particular, how would it affect the opportunity cost of education?

Q2

Could a nation be producing in a way that is allocatively efficient, but productively inefficient?

Q3

What are the similarities between a consumer’s budget constraint and society’s production possibilities frontier, not just graphically but analytically?

Review Questions

Q4

What is comparative advantage?

Q5

What does a production possibilities frontier illustrate?

Q6

Why is a production possibilities frontier typically drawn as a curve, rather than a straight line?

Q7

Explain why societies cannot make a choice above their production possibilities frontier and should not make a choice below it.

Q8

What are diminishing marginal returns?

Q9

What is productive efficiency? Allocative efficiency?

Critical Thinking Questions

Q10

During the Second World War, Germany’s factories were decimated. It also suffered many human casualties, both soldiers and civilians. How did the war affect Germany’s production possibilities curve?

Q11

It is clear that productive inefficiency is a waste since resources are being used in a way that produces less goods and services than a nation is capable of. Why is allocative inefficiency also wasteful?

Solution

S1

Because of the improvement in technology, the vertical intercept of the PPF would be at a higher level of healthcare. In other words, the PPF would rotate clockwise around the horizontal intercept. This would make the PPF steeper, corresponding to an increase in the opportunity cost of education, since resources devoted to education would now mean forgoing a greater quantity of healthcare.

S2

No. Allocative efficiency requires productive efficiency, because it pertains to choices along the production possibilities frontier.

S3

Both the budget constraint and the PPF show the constraint that each operates under. Both show a tradeoff between having more of one good but less of the other. Both show the opportunity cost graphically as the slope of the constraint (budget or PPF).

2.3: Confronting Objections to the Economic Approach

Self-Check Questions

Q1

Individuals may not act in the rational, calculating way described by the economic model of decision making, measuring utility and costs at the margin, but can you make a case that they behave approximately that way?

Q2

Would an op-ed piece in a newspaper urging the adoption of a particular economic policy be considered a positive or normative statement?

Q3

Would a research study on the effects of soft drink consumption on children’s cognitive development be considered a positive or normative statement?

Review Questions

Q4

What is the difference between a positive and a normative statement?

Q5

Is the economic model of decision-making intended as a literal description of how individuals, firms, and the governments actually make decisions?

Q6

What are four responses to the claim that people should not behave in the way described in this chapter?

Critical Thinking Questions

Q7

What assumptions about the economy must be true for the invisible hand to work? To what extent are those assumptions valid in the real world?

Q8

Do economists have any particular expertise at making normative arguments? In other words, they have expertise at making positive statements (i.e., what will happen) about some economic policy, for example, but do they have special expertise to judge whether or not the policy should be undertaken?

Solution

S1

When individuals compare cost per unit in the grocery store, or characteristics of one product versus another, they are behaving approximately like the model describes.

S2

Since an op-ed makes a case for what should be, it is considered normative.

S3

Assuming that the study is not taking an explicit position about whether soft drink consumption is good or bad, but just reporting the science, it would be considered positive.