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Common Sense Economics
Part II. Seven Major Sources of Economic Progress
1. Under a system of private property, could a 60-year-old owner of a tree
farm benefit by planting and caring for a crop of Douglas firs, most of which
will not be ready to harvest for 50 years?
a. No, the farmer will be dead before the crop will be ready for harvest.
b. Yes, the farmer will benefit from increased valuation of the land as the
trees grow and the harvest moves closer.
c. No, the value of the land will decline since the farmer is taking it out of
production for the next 50 years.
d. Yes, but only if the project is subsidized by the government or private
conservation groups.
Answer: b
2. Which of the following is most important if a country is going to achieve and
sustain rapid economic growth?
a. High tariffs and imposition of other trade restrictions.
b. High marginal tax rates.
c. An open and competitive capital market.
d. High rates of inflation.
Answer: c
3. Even-handed enforcement of contracts fuels economic prosperity because
it:
a. permits individuals to invade or infringe on the property rights of others.
b. increases transaction costs.
c. increases market uncertainty and the probability of contract violations.
d. promotes gains from trade by minimizing the costs of entry and
enforcement of contracts.
Answer: d
4. What role do losses play in a competitive market?
a. They penalize a firm for producing a good that consumers value highly
relative to its cost.
b. They signal that more resources are needed in this market.
c. They show firms that barriers to entry are high.
d. They send a message that more value would be created if the
resources were used to produce other goods.
Answer: d
5. Which of the following best summarizes the importance of business failure
and the central idea of “creative destruction in a market economy”?
a. When a business fails, the assets and resources from that business
become unemployed, resulting in higher government subsidies.
b. Business failure allows the assets and resources from that business to
move into other areas where those resources will be more productive and
highly valued.
c. Only through frequent business failure will it be possible to avoid
income being concentrated into the hands of a few rich entrepreneurs.
d. The new, rival businesses that drive out old competitors tend to be less
efficient and less creative than the older established businesses.
Answer: b
6. If a nation is going to achieve and sustain a high rate of economic growth, it
must
a. prohibit low-wage foreign producers from supplying goods to the
domestic market.
b. have an abundant domestic supply of low cost energy resources.
c. have a mechanism capable of attracting savings and channeling them
into wealth-creating projects.
d. impose regulations that will limit the intensity of competition among
domestic firms.
Answer: c
7. “Wal-Mart is a low-wage firm and this indicates that it exploits its workers.”
Which of the following should cause one to question the validity of this
statement?
a. The high profits of Wal-Mart.
b. The large sales revenue of Wal-Mart.
c. No one is required to work for Wal-Mart and, therefore, it must attract
workers by paying them more attractive wages than they could earn
elsewhere.
d. This is a trick question. Wal-Mart does exploit its workers and the below
average wage of Wal-Mart employees illustrates this point.
Answer: c
8. If the government levies $20 billion in taxes to finance additional spending
on military weapons, the net impact on total employment will be
a. a substantial increase in employment because the additional spending
will create lots of jobs.
b. a substantial decrease in employment because the higher taxes will
destroy lots of jobs.
c. small because the higher taxes will reduce spending in the private
sector, which will tend to offset any jobs created by the government
spending.
d. a substantial expansion in employment, but only if the additional
spending leads to an increase in the general level of prices.
Answer: c
9. Monetary and price instability will
a. make it easier for both individuals and businesses to plan wisely for the
future.
b. generate uncertainty, and encourage investors and businesses to move
their activities to countries with a more stable monetary environment.
c. encourage businesses to invest and expand their future output.
d. encourage domestic citizens to increase their rate of saving.
Answer: b
10. Trade restrictions like tariffs and quotas will
a. protect American jobs and increase employment.
b. ensure that more dollars stay in the United States.
c. reduce the value of goods and services that we will be able to produce
and consume.
d. make all Americans better off.
Answer: c
11. In order to achieve a high economic freedom rating, a country must
a. elect political officials democratically.
b. protect property rights, enforce contracts even-handedly, and rely
extensively on markets to allocate goods and services.
c. provide citizens with housing, health care, and other basic goods free of
charge.
d. use the taxing power of the state to redistribute income from the rich to
the poor and thereby promote income equality.
Answer: b
12. Legal entitlement to scientific discoveries, inventions, innovations and
intellectual property:
a. encourages technological advancements.
b. reduces the incentive to invest in research and development.
c. protects production on the basis of tradition, social customs and habits.
d. results in an equal distribution of income and profits.
Answer: a
13. Which of the following will most likely occur under a system of clearly
defined and enforced private property rights?
a. Resource owners will fail to conserve vital resources, even if they
expect their scarcity to increase.
b. Resource owners will ignore the wishes of others, including others who
would like to use the resource that is privately owned.
c. Resource owners will fail to consider the wishes of potential future
buyers when they decide how to employ privately owned resources.
d. Resource owners will gain by discovering and employing their
resources in ways that are highly valued by others.
Answer: d
14. Which of the following is a private owner prohibited from doing?
a. Selling the property to another person.
b. Erecting a fence designed to keep others from using the property.
c. Maintaining the property.
d. Using the property in a manner that invades or infringes on the property
of another.
Answer: d
15. If a business is realizing economic losses in a competitive market, it is:
a. price gouging its customers.
b. exploiting its workers.
c. producing goods and services in a market that is characterized by high
entry barriers.
d. producing goods and services that are valued less than the resources
required to produce them.
Answer: d
16. Joseph Schumpeter introduced the term “creative destruction” to
describe
a. how the discovery of new products and the replacement of old ones will
lead to improvements in living standards through time.
b. why the discovery of new products and the replacement of old ones will
reduce living standards through time.
c. how tried and true methods of production will be the norm and
innovation will be discouraged.
d. why the gains of producers will be made primarily at the expense of
consumers and workers.
Answer: a
17. “Competition is the great regulator.” This statement reflects that
a. when competition is present, businesses have a strong incentive to
serve the general public and therefore there is little need for regulation of
competitive markets.
b. government regulation is the key ingredient of competitive markets and
therefore markets cannot be competitive without regulation.
c. extensive regulation is needed to assure that businesses will treat
consumers properly and serve the interests of the general public.
d. when markets are regulated by the government, there is no need for
competition among business firms.
Answer: a
18. When a price control pushes the price of a good or resource below the
market equilibrium, then
a. the quantity supplied will be greater than the quantity demanded of the
good.
b. the scarcity of the good will be eliminated.
c. a shortage of the good will develop.
d. a surplus of the good will develop.
Answer: c
19. Which of the following is true in markets where price controls are
applied?
a. Price controls are enacted solely with consumers’ interests in mind.
b. Price controls increase the number of exchanges which will occur.
c. Price controls distort the incentives faced by both buyers and sellers.
d. Price controls clarify the incentives faced by both buyers and sellers.
Answer: c
20. Government-owned housing, as opposed to privately-owned housing, is
generally
a. better maintained and more attractive.
b. run down and poorly maintained.
c. easier to purchase or rent.
d. more durable and constructed to last longer.
Answer: b
21. A competitive capital market is important to society because it directs
resources toward projects that
a. can be completed quickly.
b. are valued more highly than their cost.
c. have an outcome that is known with certainty.
d. reduce the value of the resources employed.
Answer: b
22. In a market economy, persons undertaking an investment project must
a. obtain approval from political authorities before the project can be
undertaken.
b. either personally supply the required funds or convince other investors
to do so.
c. use a corporation as a form of business organization.
d. get the approval of several banks before the project can be undertaken.
Answer: b
23. Other things constant, countries with higher investment rates will
a. tend to have higher incomes in the future.
b. have to impose high taxes in order to finance the investment.
c. have to use central government planning to allocate investment.
d. have lower standards of living.
Answer: a
24. If money were not used as a medium of exchange,
a. the gains from trade would be severely limited.
b. our standard of living would probably improve.
c. the transactions costs of exchange would be lower.
d. economic efficiency would increase.
Answer: a
25. Compared to a barter economy, money of stable and predictable value
will
a. reduce transactions costs and increase the volume of trade.
b. increase transactions costs and reduce the volume of trade.
c. reduce both transactions costs and the volume of trade.
d. increase both transactions costs and the volume of trade.
Answer: a
26. Which of the following is the best definition of money?
a. Anything that widely serves as a medium of exchange, unit of account,
and store of value.
b. Various types of paper notes and coinage backed by precious metals.
c. The outstanding credit debt of households and businesses.
d. Currency plus outstanding credit card balances.
Answer: a
27. Inflation
a. is an increase in the price of a single good or service.
b. is a continuing decline in the general level of prices of goods and
services.
c. reduces the purchasing power of the dollar.
d. implies the number of people unemployed has risen.
Answer: c
28. When the inflation rate is high and volatile,
a. investment is more risky and gains from trade are reduced.
b. investment is less risky and gains from trade are reduced.
c. real output and real wages will grow rapidly.
d. employment will expand and the unemployment rate will decline.
Answer: a
29. Over the long haul, rapid increases in the supply of money lead to
a. inflation.
b. higher levels of production and real output.
c. lower unemployment rates.
d. rapid growth of real wages.
Answer: a
30. High marginal tax rates will
a. increase the incentive of people to earn.
b. make it expensive for taxpayers to purchase tax deductible items.
c. cause some people to work and earn less than would be the case if
marginal tax rates were lower.
d. attract workers from other countries where tax rates are lower.
Answer: c
31. Economic analysis indicates that high tax rates will
a. reduce productive activity.
b. retard capital formation.
c. promote wasteful use of resources.
d. all of the above.
Answer: d
32. The principles of international trade
a. are different than the principles underlying trade between individuals
and businesses.
b. explain why trade across national boundaries will reduce the production
possibilities of people in both countries.
c. explain why consumption will be reduced even if trade is able to expand
production.
d. explain why trade will expand the consumption opportunities available
to people in countries involved in the trade.
Answer: d
33. When the residents of a nation are free to trade with foreigners,
domestic producers will be able to
a. export more of those goods for which they are a high-cost supplier.
b. supply a larger quantity of those goods which they can produce at a
relatively low cost.
c. charge higher prices than would otherwise be the case.
d. survive in the marketplace even if they do not produce efficiently.
Answer: b
34. How do high tariffs and other restraints on international trade affect a
nation's prosperity?
a. They increase employment and thereby promote the growth of real
GDP.
b. They prevent the nation from fully realizing the potential gains from
specialization, exchange, and competition.
c. They protect domestic producers and thereby promote economic
growth.
d. Both a and c are correct.
Answer: b
35. If import restrictions prohibit foreigners from selling various goods and
services in the U.S. market,
a. the U.S. will be able to export more goods abroad.
b. foreigners will have fewer U.S. dollars with which to buy U.S. goods and
services.
c. the U.S. will be able to produce more output than would otherwise be
the case.
d. the domestic producers in the protected industries will supply goods to
U.S. consumers at lower prices than would otherwise be the case.
Answer: b
36. The political attractiveness of tariffs, quotas, and other trade restrictions
is primarily the result of the
a. political clout of foreigners.
b. political clout of domestic consumers.
c. special interest nature of trade restrictions.
d. attractiveness of sound economic policies to elected political officials.
Answer: c
37. Politicians will often be able to gain from support of trade restrictions
because
a. organized interest groups benefiting from the restrictions will make large
contributions to political campaigns while most others will not feel
strongly about the restrictions.
b. the restrictions will lead to lower prices and substantial benefits for
consumer groups.
c. foreigners benefiting from the restrictions will be a major source of
political contributions.
d. trade restrictions will generate substantial benefits for consumer groups
at the expense of well-organized labor and industrial interests.
Answer: a
38. Are jobs the key to economic progress and the achievement of high
income levels?
a. Yes, as long as people are working, income levels will be high.
b. Yes, when full employment is present, the income levels of the
residents will be at their maximum.
c. No, the people must be employed in jobs where they are producing
goods and services that others value highly relative to their cost.
d. Uncertain, jobs are the key for a market economy, but they are less
important for a centrally planned economy.
Answer: c
39. If higher tariffs and more restrictive quotas reduced the imports of the
United States,
a. U.S. employment would increase.
b. unemployment in the United States would decline.
c. U.S. exports would also increase because foreigners would want to buy
more from U.S. producers.
d. U.S. exports would decline because foreigners would be earning fewer
of the dollars needed to purchase goods and services from Americans.
Answer: d
40. “Capital flight” occurs when
a. domestic investors seek higher returns internationally and only foreign
investors are willing to supply capital in a country.
b. foreign investors seek higher returns internationally while only domestic
investors are willing to supply capital in a country.
c. both domestic and foreign investors are attracted to the country.
d. both domestic and foreign investors reduce their investments in the
country due to political, economic and social uncertainties.
Answer: d
41. The argument that import restrictions save jobs and promote prosperity
fails to recognize that
a. there are no secondary effects of import restrictions.
b. import restrictions will lower prices in the protected industries.
c. import restrictions cannot create jobs in any industry.
d. U.S. imports provide people in other countries with the purchasing
power required for the purchase of U.S. exports.
Answer: d
42. A country’s level of economic freedom is influenced by
a. the relative size of government expenditures, taxes and enterprises.
b. the even-handedness of the court system and security of property
rights.
c. freedom to trade internationally.
d. all of the above .
Answer: d
43. Which of the following would result in a low rating on the Economic
Freedom of the World Index?
a. Free trade and low taxes.
b. Monetary instability and trade restrictions.
c. A legal system that secures private property rights and provides evenhanded enforcement of contracts.
d. Competitive markets and minimal government regulation.
Answer: b
44. Which of the following best describes the relationship between
economic freedom and real per capita Gross Domestic Product (GDP)?
a. There are too many extraneous factors involved to discern a direct
relationship.
b. As economic freedom decreases, real per capita GDP increases.
c. As economic freedom increases, real per capita GDP increases.
d. As economic freedom increases, real per capita GDP decreases.
Answer: c
Short Essay (12 pts.)
1. Will regulations that require employers to get permission from government officials
before dismissing workers reduce the rate of unemployment? Why or why not (make sure
that your argument is based on basic economic concepts like incentives)?