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Chapter 8: Suggested Answers and Solutions
CHAPTER 8
Suggested Answers and Solutions
CHAPTER 2: INTRODUCTION TO ECONOMICS
Answers to the Multiple Choice Questions
1.
B
The payments for the factors of production are wages, rent, interest and profit.
2.
C
The opportunity cost of increasing clothing output from 120 to 150 is the 40 units of food
output foregone.
3.
D
The four factors of production in economics are land, labour, capital and enterprise.
4.
B
Relative scarcity is the existence of limited resources and unlimited needs and wants.
5.
A
Consumer sovereignty does not influence 'how to produce?' which is determined by firms.
6.
B
Between points A and B the trend is falling output and inflation and rising unemployment.
7.
D
The opportunity cost is the other goods which could be produced with the same resources.
8.
C
9.
B
A n example of investment in the economic sense would be a business buying new machinery
to expand production.
The equilibrium condition in the five sector circular flow of income model is where total
leakages equal total injections i.e. S + T + M = I + G + X .
10. B
The opportunity cost of increasing the production of mobile phones from 40 to 200 would be
200 iPods.
11. A
The two main classifications of economic systems are market and planned economies.
12. B
What to produce and how to produce are determined by consumer demand and the level of
resources in a market economy.
The economic problem is where resources are limited in relation to the unlimited wants of
13. D
consumers.
14. C
Since injections of I + G + X = 700, and exceed the leakages of S + T + M = 600, the economy's
equilibrium income will rise and there will be an expansion in the circular flow of income.
15. A
For capital accumulation to take place in an economy there must be saving.
16. D
Macroeconomics involves the study of aggregate economic behaviour.
17. B
Higher productivity of existing resource could cause an outward shift in the production
possibility frontier.
18. C
Technical efficiency is where resources are used at minimum cost.
19. A
A person who consumes more of their income than another person will have a higher standard
of living in the present.
Consumer sovereignty is where consumer spending determines the types of goods and services
produced.
20. D
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Year 11 Economics Workbook 2nd Editio.
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Suggested Solutions to the Short Answer Questions
21. Production Possibility Curves
(a) Construct a production possibility curve from the information in the table.
A production possibility curve can be constructed by using the data in the table as shown below. To
receive two marks for this answer the production possibility curve must be constructed and labelled
correcdy. A n alternative and acceptable way of constructing the production possibility curve is to
plot rice on the horizontal axis and wheat on the vertical axis.
(b) State the opportunity cost of producing the first 100 kgs of wheat and the first 100 kgs
of rice.
From the data in the table the opportunity cost of producing the first 100 kgs of wheat
is 100 kgs of rice.
From the data in the table the opportunity cost of producing the first 100 kgs of rice
is 100 kgs of wheat.
(c) Explain how the discovery of new resources and improvements in technology could affect
wheat and rice production in this economy.
The discovery of new resources such as more land and water supplies suitable for wheat and rice
production would lead to an outward shift in the production possibility curve or frontier for both
wheat and rice production as greater combinations of wheat and rice could be produced with
more resources. Improvements in technology will have the same effect in moving the production
possibility curve outwards as improved technology may lead to higher productivity of existing
resource use for wheat and rice production. Improved technology could include better farm
machinery or scientific methods of growing wheat and rice.
New resources and improvements in technology affecting only wheat production would lead to an
outward shift in the production possibility curve along the wheat output axis only. Similarly new
resources and improvements in technology affecting only rice production would lead to an outward
shift in the production possibility curve along the rice output axis only.
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Chapter 8: Suggested Answers and Solutions
(d) Explain T W O ways that an economy operating within its production possibility frontier
could achieve fiill employment of its resources.
A n economy operating within its production possibility frontier has some unemployed resources.
Such an economy would not be realising its production potential and would need to discover new
additional resources or improve the productivity of existing resource use to increase its production
potential to achieve full employment.
One way of increasing resource use would be to increase the employment of land, labour, capital
or entrepreneurial resources to increase production. This would lead to an outward shift in the
economy's production possibility frontier and the economy would be operating at a point of full
employment i f it was producing at a point on the production possibility frontier.
Another way of achieving full employment of resource use would be to increase the productivity
of existing resource use through the use of more efficient capital or new technology which may
raise the productivity of land and labour resources used in production. This would raise overall
productivity and shift the production possibility frontier outwards. I f the economy is operating
•on its production possibility frontier it is realising its production potential and achieving the fiill
employment of its resources.
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Chapter 8: Suggested Answers and Solutions
© Tim Riley Publications Pty Ltd
22. The Circular Flow of Income Model
(a) What is meant by the circidar flow of income?
The circular flow of income is a simple model depicting the relationship between output, income
and expenditure in the economy. The model represents the expenditure and income flows that link
the different sectors of the economy. I n its extended form the circular flow is usually comprised of
five interconnected sectors: households, firms, finance, government and the overseas sector.
(b) Oudine the relationship between the household sector and the firms sector in the simple two
sector circular flow of income model.
In the simplest sense, the flow of income from firms to households and of consumption expenditure
from households to firms is what is termed the circular flow of income and expenditure. The simple
circular flow of income model is comprised of only two sectors: households and firms.
Households are the people who buy the nation's output of goods and services and are the owners of
the economy's factors of production. Agents in this sector obtain income from selling factor inputs
or resources such as land, labour, capital and enterprise to firms. The income received from firms
(i.e. rent, wages, interest and profit) is then spent on consumption goods and services, paid in taxes
to the government and saved as an increase in wealth.
Firms hire the factors of production from households and use these factors to produce the nation's
output of goods and services. Agents in the firms sector purchase inputs (e.g. labour, raw materials,
machinery and equipment) to make goods and services which are sold to customers (i.e. households,
other firms, the government and foreigners). Firms' income which is received in the form of profits,
is distributed as dividends to the owners, paid as taxes to the government, or saved and used to
buy assets. Firms also have access to the savings of households by borrowing money from financial
institutions such as banks and life insurance companies and superannuation funds.
(c) Explain the role of leakages and injections in the five sector circular flow of income model.
Investment (I), government purchases of goods and services (G) and exports (X) are called injections
into the circular flow of income and expenditure. Savings (S), taxation ( T ) , and imports (M) are
called leakages from the circular flow of income and expenditure. Leakages are flows that reduce
planned spending on domestic output, while injections are flows, additional to consumption, that
increase planned spending on domestic output.
Savings (S) is the main leakage from the circular flow and is income received but not used to finance
expenditure on goods and services. Taxation ( T ) is another leakage and is comprised of payments
that households and firms have to make to the government. Imports (M) are also known as a
leakage because they represent expenditure of income which is spent on goods produced overseas
as opposed to the domestic economy. Leakages cause the amount of income circulating in the
economy to fall. They represent income which is earned by households in the economy but not
spent on final goods and services.
Injections represent spending on final goods and services in addition to consumption. Investment
(I) is the most important injection into the circular flow and is where firms increase their stock of
capital and expand their output. They gain access to the savings of households by borrowing fiinds
from financial institutions. Government expenditure (G) on goods and services represents another
important injection. Government spending is directed to a diverse range of areas of the economy
including health, education and social welfare. When foreigners purchase domestic goods and
services the firms sector receives payments for exports (X). Exports are also classified as an injection
into the circular flow as they represent a source of income not coming directly from households.
Overall, injections increase the level of aggregate demand in the economy.
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© Tim Riley Publications Pty Ltd
© Tim Riley Publicafions Pty Ltd
Chapter 8: Suggested Answers and Solutions
CHAPTER 4: MARKETS
Answers to the Multiple Choice Questions
1.
A Monopolistic competition is a market structure characterised by many sellers of slightly
differentiated products and low barriers to entry to the market.
2.
B To find the price elasticity of demand the percentage change method can be used i.e.
%AQ
%AP
10%
=
20%
= 0.5
Since the price elasticity of demand co-efficient is less than one, demand is price inelastic.
3.
C Since the supply of milk has shifted to the left (SS to S^S^) this is a decrease in supply which may
have been caused by the impact of a drought on milk production.
4.
D A contraction in the demand for new cars could be caused by an increase in the price of new
cars.
5.
C Total ouday is $800,000 when price is $800 and $600,000 when price rises to $1000. Hierefore
demand is price elastic over this price range since total outlay has fallen after a price rise.
6.
D A likely impact of an increase in the supply of fish on market equilibrium is that there will be a
fall in the equilibrium price and a rise in the equilibrium quantity of fish.
7.
A
A government could impose a price ceiling to ration the supply of a scarce commodity.
8.
B The price elasticity of supply is influenced by the ability of producers to hold inventories.
9.
C At the price floor of Pj there is a surplus of sugar in the market equal to QiQ^-
Production
quotas could be imposed on sugar growers to limit the extent of this sugar surplus.
10. B The incidence of pollution in production is an example of market failure.
1 1 . D Perfect and monopolistic competition are examples of market structures where firms have litde
to no influence over price and are said to be price takers.
12. A Changes in the prices of the factors of production coidd cause a shift in an existing market
supply curve.
13. D The demand curve for beef could shift from D D to D , D j (an increase in demand) as a result of
an increase in consumer incomes.
14. B An example of a factor market in Australia is the capital market.
15. A The role of prices in markets is to reflect the scarcity of goods and services.
16. C I f demand was price inelastic the producer would raise price to increase revenue.
17. C At the price ceiling of P^ in the market for petrol, there is a shortage of petrol of Q^Q^ •
18. B Examples of substitute goods in a market are meat and fish.
19. D I f there is a surplus in a market, supply will contract, demand will expand and price will fall.
20. A I f the demand for a good is perfectly price elastic consumers will buy an infinite quantity of
the good at the market price.
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Year I / Economics.
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Chapter 8: Suggested Answers and Solutions
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Answers to the Short Answer Questions
21. Demand and Supply
(a) State the initial equilibrium price and quantity for Queensland prawns.
Market equilibrium occurs where demand equals supply. In the diagram the initial equilibrium
price for Queensland prawns is $20 per kilogram.
The initial equilibrium quantity of Queensland prawns at a price of $20 per kilogram is 300
kilograms.
(b) Using the total ouday method, calculate the change in total outlay between a price of $20 per
kilogram and $30 per kilogram.
Total outlay or total revenue is equal to the price multiplied by the quantity sold. At a price of $20
producers sell 300 kilograms of Queensland prawns. Therefore total outlay is $6,000. As a residt
of the shift in the demand curve from D D to D^Dj the equilibrium price rises to $30 and 400
kilograms of Queensland prawns are sold. The total ouday is therefore $12,000.
The change in total outlay is therefore $6,000.
(c) State whether the demand for Queensland prawns is price elastic, inelastic or unit elastic over
the price range $20 to $30 per kilogram.
Since total ouday rises from $6,000 to $12,000 over the price range of $20 to $30, demand is price
inelastic. Demand is price inelastic if price rises and total outlay rises, meaning that demand is
relatively unresponsive to a change in price.
(d) Explain T W O factors which could cause an increase in demand for Queensland prawns firom
D D to D j D , .
Students should explain two factors that could cause an increase in the demand for Queensland
prawns. This could include any two of the following seven factors.
• A rise in the price of a substitute good such as meat or imported prawns could cause an increase in
the demand for Queensland prawns. A fall in the price of a complementary good such as oysters
or other seafood could cause an increase in demand for Queensland prawns.
• I f tastes, preferences or fashion change in favoiu- of the demand for Queensland prawns then
consumers may increase their demand for the product.
• A n increase in consumer incomes could lead to an increase in the demand for Queensland prawns
and cause a shift to the right of the existing demand curve.
^
• A n increase in the size of the population may increase the demand for Queensland prawns because
there are more consumers in the market.
• Changes in the distribution of income may affect the demand for Queensland prawns. A more
even distribution of income may increase the demand for luxury foods like Queensland prawns
by low, middle and high income groups.
• Consumer expectations of a future rise in the price of Queensland prawns could lead to an
increase in the demand for Queensland prawns in the present.
• Technological progress such as prawn farming could lead to improved quality of prawns and cause
an increase in the demand for Queensland prawns.
Year 11 Economics Workbook 2nd Edition
© Tim Riley Publications Pty Ltd
(e) With reference to the diagram, explain the difference between an extension in demand and an
increase in demand for Queensland prawns.
An extension in demand is caused by a fall in the price of a good or service and results in a
movement along an existing demand curve. O n the otherhand an increase in demand is caused by
a factor affecting demand conditions such as changes in consumer incomes or preferences.
In the diagram the initial demand curve is D D and market equilibrium is at price $20 and quantity
of300 kilograms of Queensland prawns. If the price of Queensland prawns fell to $10 per kilogram
consumers would extend their demand from 300 kilograms to 400 kilograms. The extension in
demand for Queensland prawns is only a result of the price falling from $20 to $10 per kilogram.
In the diagram, the demand for Queensland prawns shifts from D D to D^Dj causing the equilibrium
price to rise from $20 to $30 and the equilibrium quantity increases from 300 kilograms to 400
kilograms. An increase in the demand for Queensland prawns could be caused by any of the seven
factors affecting demand conditions such as:
• A fall in the relative prices of substitute and complementary goods and services;
• A shift in tastes towards Queensland prawns;
• A rise in consumer incomes;
• A increase in the size of the popidation;
• A more even distribution of income;
• Consumer expectations of a price rise in the future; or
• An improvement in technological progress which raises the quality of Queensland prawns.
The increase in demand for Queensland prawns means that more prawns will be demanded
over the whole range of prices, and a higher price will also be paid for existing quantities of
Queensland prawns.
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Year 11 Economics Workbook 2nd Edition