ESCOBAL, AL ANULAO

BA01
BASIC MICROECONOMICS
11-BBA-02

CHAPTER 2 THINKING LIKE AN ECONOMIST

CHAPTER QUICK QUIZ

1.C
2.A
3.B
4.C
5.D
6.A

Questions for Review

1. Economics is a science because economists use the scientific method. They devise theories,
collect data, and then analyze these data in an attempt to verify or refute their theories about
how the world works. Economists use theory and observation like other scientists, but they are
limited in their ability to run controlled experiments. Instead, they must rely on natural
experiments.
2. Economists make assumptions to simplify problems without substantially affecting the
answer. Assumptions can make the world easier to understand.

3. An economic model cannot describe reality exactly because it would be too

complicated to understand. A model is a simplification that allows the economist to see
what is truly important.

4. There are many possible answers.

5. There are many possible answers, including interactions involving government or international
trade.
6. Figure 3 shows a production possibilities frontier between milk and cookies (PPF1). If a
disease kills half of the economy's cow population, less milk production is possible, so the
PPF shifts inward (PPF2). Note that if the economy produces all cookies, it does not need any
cows and production is unaffected. But if the economy produces any milk at all, then there will
be less production possible after the disease hits.
7. An outcome is efficient if the economy is getting all it can from the scarce resources it has
available. In terms of the production possibilities frontier, an efficient point is a point on the
frontier, such as point A in Figure 4. When the economy is using its resources efficiently, it
cannot increase the production of one good without reducing the production of the other. A
point inside the frontier, such as point B, is inefficient since more of one good could be
produced without reducing the production of another good.

8. The two subfields in economics are microeconomics and macroeconomics.

Microeconomics is the study of how households and firms make decisions and how they
interact in specific markets. Macroeconomics is the study of economy-wide phenomena,
including inflation, unemployment, and economic growth.

9. Positive statements are descriptive and make a claim about how the world is, while
normative statements are prescriptive and make a claim about how the world ought to be.
Here is an example. Positive: A rapid growth rate of money is the cause of inflation.
Normative: The government should keep the growth rate of money low.

10. Economists sometimes offer conflicting advice to policymakers for two reasons: (1)
economists may disagree about the validity of alternative positive theories about how the
world works; and
(2) economists may have different values and, therefore, different normative views about
what public policy should try to accomplish.

Problems and Applications

1. a. Figure 6 shows a production possibilities frontier between guns and butter. It is bowed
out because of the law of increasing opportunity costs. As the economy moves from
producing many guns and a little butter (point H) to producing fewer guns and more
butter (point D), the opportunity cost of each additional unit of butter increases because
the resources best suited to producing guns are shifting toward the production of butter.
Thus, the number of guns given up to produce one more unit of butter is increasing.

b. Point A is impossible for the economy to achieve; it is outside the production possibilities
frontier. Point B is feasible but inefficient because it is inside the production possibilities
frontier.

c. The Hawks might choose a point like H, with many guns and not much butter. The
Doves might choose a point like D, with a lot of butter and few guns.

d. If both Hawks and Doves reduced their desired quantity of guns by the same amount,
the Hawks would get a bigger peace dividend because the production possibilities
frontier is much flatter at point H than at point D. As a result, the reduction of a given
number of guns, starting at point H, leads to a much larger increase in the quantity of
butter produced than when starting at point D.

2. See Figure 7. The shape and position of the frontier depend on how costly it is to maintain
a clean environmentthe productivity of the environmental industry. Gains in environmental
productivity, such as the development of new way to produce electricity that emits fewer
pollutants, lead to shifts of the production-possibilities frontier, like the shift from PPF1 to
PPF2 shown in the figure.
 Figure 7 Figure 8

3. a. A: 40 lawns mowed; 0 washed

cars B: 0 lawns mowed, 40
washed cars C: 20 lawns
mowed; 20 washed cars D: 25
lawns mowed; 25 washed cars

b. The production possibilities frontier is shown in Figure 8. Points A, B, and D are on the
frontier, while point C is inside the frontier.

c. Larry is equally productive at both tasks. Moe is more productive at washing cars,
while Curly is more productive at mowing lawns.

d. Allocation C is inefficient. More washed cars and mowed lawns can be produced
by simply reallocating the time of the three individuals.
 4. a. A: 40 lawns mowed; 0
washed cars B: 0 lawns
mowed, 40 washed cars C:
20 lawns mowed; 20
washed cars D: 25 lawns
mowed; 25 washed cars

e. The production possibilities frontier is shown in Figure 8. Points A, B, and D are

on the frontier, while point C is inside the frontier.

f. Larry is equally productive at both tasks. Moe is more productive at washing cars,
while Curly is more productive at mowing lawns.

g. Allocation C is inefficient. More washed cars and mowed lawns can be

produced by simply reallocating the time of the three individuals.

5. a. A family's decision about how much income to save is related to microeconomics.

b. The effect of government regulations on auto emissions is related to microeconomics.

c. The impact of higher saving on economic growth is related to macroeconomics.

d. A firm's decision about how many workers to hire is related to microeconomics.

e. The relationship between the inflation rate and changes in the quantity of money
is related to macroeconomics.

6. a. The statement that society faces a short-run trade-off between inflation and
unemployment is a positive statement. It deals with how the economy is, not how
it should be. Since economists have examined data and found that there is a
short-run negative relationship between inflation and unemployment, the
statement is a fact.

b. The statement that a reduction in the rate of money growth will reduce the rate of
inflation is a positive statement. Economists have found that money growth and
inflation are very closely related. The statement thus tells how the world is, and so
it is a positive statement.

c. The statement that the Federal Reserve should reduce the rate of money growth
is a normative statement. It states an opinion about something that should be
done, not how the world is.

d. The statement that society ought to require welfare recipients to look for jobs is a
normative statement. It does not state a fact about how the world is. Instead, it is a
statement of how the world should be and is thus a normative statement.

The statement that lower tax rates encourage more work and more saving is a positive
statement. Economists have studied the relationship between tax rates and work, as well as the
relationship between tax rates and saving. They have found a negative relationship in both
cases. So the statement reflects how the world is and is thus a positive statement.