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Review: Chapter 2 – Economic Tools and Economic Systems
This review is worth 20 points. Your correct answers to the true/false and multiple choice
questions, combined with your accurate explanation of how you reached your answer to each
question are worth one point each.
1) Suppose an imaginary economy has constant resources and constant technology. If that
economy is sliding along its Production Possibilities Frontier (PPF) for two different outputs,
then that economy is changing its mixture of final goods produced while avoiding maximum use
of its production resources. When the sliding movement is completed, the economy will have
produced more of one product, but conserved some of its production capacity for other purposes
while accepting an opportunity cost of reduced production of a second product.
a) True
b) False
Explain your answer: The PPF is a graphed curve showing combinations of the maximum
Outputs an economy can produce of two types of goods with existing Technology, using
available resources with Efficiency. Efficiency means the economy is getting the most value
from its limited production resources. An economy producing any combination of these goods
on the PPF is using all its production capacity. The question proposes that this economy was
operating on the PPF, but not making maximum use of its production resources. This is not
possible, given what a PPF represents.
2) Suppose someone asks these questions, “How will I know if an economy is a pure command
system when I see it? What characteristic (or characteristics) is (are) fundamental to any
command economy?” Which of the following best answers these questions?
a) A command economy is based on private property owned by individual households and
businesses, and relies upon market competition to diffuse market power.
b) A command economy is characterized by government ownership and control of most
scarce resources.
c) A command economy requires that government planning boards make most
decisions about how resources are used.
d) A command economy depends on self interest, market-determined prices and
specialization to organize how resources are used.
e) Both answers "b" and "c".
Explain your answer: The key attributes (Rules of the Game) of a Command Economic System
include Public Ownership of Resources and Centralized Planning. B and C describe this system,
while A and D describes attributes of a Capitalist, Market-Based Economic System.
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3) An economy experiences a technological discovery that increases the efficiency of its
production plants by an average of 15%. Using a standard analysis of the impact of
technological change on the resource base, we would expect the Production Possibilities
Frontier for this economy to:
a)
b)
c)
d)
e)
show the slope of the PPF becomes a straight line, and positive in slope.
show the slope of the PPF remains negative, but it is converted from a convex
shape to a straight-line shape.
shift to the right.
shift to the left.
remains fixed in its current position
Explain your answer: The PPF is a graphed curve showing combinations of the maximum
Outputs an economy can produce of two types of goods with existing Technology, using
available resources with Efficiency. Any increase in resources, favorable technology changes,
or improvements in the Rules of the Game will increase production possibilities and shift the
PPF to the right. The technology advance in the question that increases production efficiency
results in a right shift in the PPF, representing the economy’s increased productive capacity. A
change in productive capacity – whether an increase or a decrease – does not change the slope or
shape of the PPF.
Civilian
Goods
Point B
Point C
Production
Possibilities Curve
Point A
Military
Goods
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4) In the graph of a production possibilities curve (PPC) above, if resources and technology are
constant, then
a) Point C is inefficient, Point B illustrates an economy operating at full
employment, and Point A is unobtainable.
b) Point B is inefficient, Point A illustrates an economy operating at full
employment, and Point C is an economy experiencing unemployment or
underemployment.
c) Point A is inefficient, Point B illustrates an economy operating at full
employment, and Point C is an economy experiencing unemployment or
underemployment.
d) Point A is inefficient, Point C illustrates an economy operating at full
employment, and Point B is unobtainable.
e) None of the above.
Explain your answer: The PPF is a graphed curve showing combinations of the maximum
Outputs an economy can produce of two types of goods with existing Technology, using
available resources with Efficiency. Thus, any point on the PPF represents a production point
where the economy is fully utilizing its productive resources. This means Point C represents an
economy operating at full employment (Labor), as well as using is land, capital, and
entrepreneurial resources to their max. Answer D is the only answer that correctly identifies the
nature of Point C. Any point inside the PPF represents an Inefficient use of one or more
resources. Any point outside the PPF is Unobtainable, given the economy’s resources and
technology.
5) The economic concept of “scarcity” underlies which of the following other economic
concepts:
a)
b)
c)
d)
e)
the economic concept of choice
the economic concept of opportunity cost
the economic concept of efficiency
the economic concept of the Law of Comparative Advantage
all the above
Explain your answer: Scarcity forces us to make Choices between alternatives – whenever we
make a choice, we pass up the alternatives we don’t choose. Economists call these rejected
alternatives our Opportunity Cost. Efficiency means getting the most value from the limited
(Scarce) resources available. The Law of CA means the person, firm, or country with the
lowest Opportunity Cost of producing a particular good or service should specialize in
producing that good or service. Thus, each of these economic concepts relate back to scarcity.
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6) Suppose there is a production possibilities frontier that represents the potential output and
resources of an imaginary economy. If the graph of this PPF shows production at a point to the
left of the production possibilities frontier, it is assumed that
a) resources and technology are constant and fully-employed.
b) resources and technology are underutilized.
c) resources and technology do not permit the economy to obtain that level of production.
c) resources and technology are deteriorating and depreciating in value.
d) the economy no longer faces the problem of scarcity.
Explain your answer: The PPF is a graphed curve showing combinations of the maximum
Outputs an economy can produce of two types of goods with existing Technology, using
available resources with Efficiency. Any point inside the PPF represents an Inefficient use of
one or more resources. This means one or more production resources is being underutilized.
Given our understanding of what a PPF represents, B is the only possible answer.
7) A production possibilities frontier (PPF) is always concave. The law of increasing
opportunity costs dictates this concave shape of any PPF.
a) True
b) False
Explain your answer: The PPF is a graphed curve showing combinations of the maximum
Outputs an economy can produce of two types of goods with existing Technology, using
available resources with Efficiency. The PPF is always bowed outward (convex) because of the
Law of Increasing Opportunity Cost. The LIOC dictates this convex shape of the PPF
because to produce more of one good, the economy must sacrifice successively larger amounts
of the other good. The question states the PPF is concave, but we know it is convex.
8) Identify which of the following are good examples of economic efficiency.
a. A farmer “resting” pasture land for a month during the summer by not letting livestock
graze it during that time.
b. A farmer performing her own repair work on cultivator blades.
c. A farmer permitting her children to choose a market lamb to raise and keep as a pet.
d. A farmer putting in a field of oats for feed despite the higher market for corn.
e. All the above
f. Answers “a” and “b”
g. Answers “c” and “d”
Explain your answer: Efficiency means getting the most value from the limited (Scarce)
resources available. The scarce resources in this question include a pasture, which must be
rested periodically to ensure the grass regenerates; the farmer’s money for repairs, which she
conserves by doing her own repairs; the market lamb, which should be fed out and sold at market
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to provide a valuable return on the inputs the farmer used to raise the lamb; and the farmers time,
seed, production land, and capital usage which, according to the Law of Comparative
Advantage, should be devoted to raising corn. The Law of Comparative Advantage says the
person, firm, or country with the lowest Opportunity Cost of producing a particular good or
service should specialize in producing that good or service. The market is higher for corn than
oats, so the Opportunity Cost of raising oats is the higher value of a corn crop raised on the
same land. Since the Opportunity Cost of raising corn is the lower value of an oat crop on the
same land, the famer should raise corn.
9) When we examine a nation’s economy, we can identify its underlying economic system by
examining how it organizes its productive capacity and distributes the benefits of its production
output. For example, if we see that nation’s consumers own their property and purchase goods
and services in a product market from private producers who, in turn, own their businesses and
obtain their production resources (land, labor, capital, and entrepreneurial ability) by buying
them in a factor market, we know that the underlying economic system is a command economy.
a) True
b) False
Explain your answer: The key attributes (Rules of the Game) of a Command Economic System
include Public Ownership of Resources and Centralized Planning. The question is describing a
Capitalist, Market-Based Economic System, whose key attributes (Rules of the Game) include
Private Property Rights and Market-Based Production and Distribution of goods and services.
10) Choose the production outcome dictated by the Law of Comparative Advantage under the
following scenario:
A copper/nickel mining company exploring in northern Minnesota has determined that it can
produce copper at a cost of $6,250/ton. It can produce nickel at a cost of $8,950/ton. These
metals are currently trading on the commodities market at $17,950/ton for nickel and at $8,250
for copper.
a) The company would elect to produce nickel.
b) The company would elect to produce copper.
c) The company would elect to produce both metals.
d) The company would elect not to produce either metal until commodity prices go up.
Explain your answer: The Law of Comparative Advantage means the person, firm, or country
with the lowest opportunity cost of producing a particular good or service should specialize in
producing that good or service. An Opportunity Cost is the value of the next best alternative
that we forgo (give up) when we make a choice. The opportunity cost to firm of producing
copper is the $9,000/ton profit it can make producing nickel. The opportunity cost to firm of
producing nickel is the $2,000/ton profit it can make producing copper. The company would
choose to produce nickel.
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