Chapter 2: The Market System and the Circular Flow
Multiple-Choice Questions
1. Economic planning by central government agencies is primarily associated with
(A) command economies
(B) market economies
(C) laissez faire economies
(D) mixed economies
(E) traditional economies
(A) Government planning is the hallmark of a command economy. In other economies,
individuals and firms play the central role in decision-making.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: Economic Systems
2. In market economies, the incentive that draws entrepreneurs into industry is
(A) government bonuses for meeting production quotas
(B) the opportunity to gain profit
(C) government assumption of the risk of failure
(D) government assistance with making output and pricing decisions
(E) a guaranteed minimum income level
(B) The profit motive draws new firms into industry in market economies, because private
property rights allow firms to keep those profits.
Difficulty: Easy
Style: Conceptual
AP Economics Curricular Requirement Microeconomics: Property Rights and the Role of
Incentives
Book Section: Characteristics of the Market System
3. In a mixed economy, the economic decisions of what to produce, how to produce, and who will
receive products are made by
(A) the government
(B) consumers and firms
(C) banks and stock markets
(D) firms, consumers, and the government
(E) banks and the government
(D) Mixed economies provide for some government intervention, such as regulation and the
provision of public goods, but primarily rely on the decision-making of firms and consumers in
markets.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: Economic Systems
4. Fundamental economic questions that every society must answer include
I. What will be produced?
II. How will goods be produced?
III. How will goods be distributed to consumers?
(A) I only
(B) III only
(C) I and II only
(D) II and III only
(E) I, II, and III
(E) Scarcity forces societies to answer these and other questions about economic growth and
security.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: Five Fundamental Questions
5. What did economist Adam Smith identify as the "invisible hand" that directs the decisionmaking of firms and households in a market economy?
(A) Government
(B) Product demand
(C) Self-interest
(D) International trade
(E) Entrepreneurial ability
(C) In The Wealth of Nations, Adam Smith recognized that in market economies, market
participants make decisions to benefit themselves, but at the same time their decisions will also
indirectly benefit society.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: The “Invisible Hand”
6. In the product market of the circular flow model
(A) firms buy finished products from households
(B) consumers buy factors of production from firms
(C) firms sell factors of production to the government
(D) consumers buy finished products from firms
(E) firms buy factors of production from consumers
(D) In the product market, firms sell products to consumers.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Macroeconomics: Circular Flow
Book Section: Product Market
7. Which of the following activities would occur in the resource (factor) market?
(A) A teacher buys a new truck from a car dealership.
(B) The Department of Defense buys a tank from a weapons manufacturer.
(C) A farmer buys farmland from a retiring farmer.
(D) A retirement fund buys stock in a major corporation.
(E) A welder buys a personal home computer from an electronics store.
(C) In the resource (factor) market, firms buy factors of production (land, labor, capital, and
entrepreneurial ability) from resource providers.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Macroeconomics: Circular Flow
Book Section: Resource Market
8. While resources and products flow in one direction of the circular flow model, what flows the
other direction?
(A) Money
(B) Services
(C) Public goods
(D) Imported goods
(E) Information
(A) Money, in the form of paychecks, profit, and other payments, serves as an incentive for
households to provide resources, and for firms to produce products in a market economy.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Macroeconomics: Circular Flow
Book Section: The Circular Flow Model
9. The use of money facilitates specialization because money
I. facilitates trade
II. forces a coincidence of wants
III. establishes a medium of exchange
(A) I only
(B) III only
(C) I and III only
(D) I and II only
(E) I, II, and III
(C) Money, unlike barter, facilitates specialization because it does not require buyers and sellers
to have exactly the same (coincidence of) wants. As a medium of exchange that is universally
accepted, money allows buyers and sellers to engage in mutually beneficial trade.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Macroeconomics: Definition of Financial Assets: Money,
Stocks, Bonds
Book Section: Use of Money
10. Unlike the command economic system, the merits of the market system are
I. economic efficiency
II. effective central planning
III. individual freedom of choice
IV. incentives generate innovation
(A) I and IV only
(B) I and III only
(C) I, II, and IV only
(D) I, III, and IV only
(E) III and IV only
(D) Unlike the command economic system that depends on government central planning, the free
market system achieves economic efficiency through emphasis on competition, incentives, and
the freedom of choice.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: Characteristics of the Market System
11. The major problems faced by a pure command economy include all of the following EXCEPT
(A) limited consumer choice
(B) lack of entrepreneurial incentives
(C) a lack of central planning
(D) inefficient use of resources
(E) a lack of fluctuation in prices
(C) The pure command economy functions through central planning by the government. Under
the pure command system, the government rather than the market system determines what to
produce, how to produce, where to produce, who will produce, how much to produce, and at what
price to produce each good and service.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: The Demise of the Command Systems
12. The resource market determines all of the following EXCEPT
(A) a worker’s wages
(B) the incentives for entrepreneurs
(C) the price of a worker’s clothing
(D) the capital costs of a new factory
(E) the per-acre price of farmland
(C) The price of a worker’s clothing is determined in the product market, where the final goods
and services produced by the economy are bought and sold. In this case, it is the interaction of
supply and demand in the product market that determines the price and quantity of a worker’s
clothing.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Macroeconomics: Circular Flow
Book Section: The Circular Flow Model
13. In the free market system, consumer sovereignty occurs for which of the following reasons?
I. Consumers, through their dollar votes, determine how resources are distributed and
what goods and services are produced to meet their wants.
II. Consumers are free to determine how they earn their income and spend their wages.
III. Consumers must buy goods and services that business decides to provide.
(A) I only
(B) II only
(C) III only
(D) I and II only
(E) I, II, and III
(A) Through their choices about what to buy (their dollar votes), consumers make decisions in the
product market and determine the answers to the five fundamental questions that establish the
basis for the free market system.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: Five Fundamental Questions
14. All of the following are key features of the market system EXCEPT
(A) the interaction of supply and demand
(B) change will be accommodated
(C) economic growth and progress
(D) the need for central economic planning
(E) the trade-off between limited incomes and unlimited wants
(D) Central economic planning is not a feature of a market system, but the central feature of a
command economic system.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: Characteristics of the Market System
15. In a command economic system, the answers to the fundamental economic questions are
determined by
(A) government, businesses, and consumers
(B) consumers through their dollar votes and government through its economic mandates
(C) consumers, businesses, and government through their trade-offs
(D) government alone
(E) government and businesses
(D) In a command economic system, the government through central planning determines all the
answers to the key economic questions of what is to be produced, how to produce, what quantity
to produce, what price will be charged, and for whom goods and services will produced. There is
no consumer sovereignty.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: Economic Systems
16. In the circular flow model
(A) households buy and businesses sell land, labor, and capital in the resource market
(B) households sell and businesses buy land, labor, and capital in the product market
(C) households sell and businesses buy land, labor, and capital in the resource market
(D) households buy and businesses sell land, labor, and capital in the product market
(E) both households and businesses buy land, labor, and capital in the resource market
(C) In the resource market, households sell their resources or services to businesses and receive
money income in return for their resources and services. Businesses buy the resources and
services of households and pays for these with the revenues gained from the final sale of goods
and services that those resources and services create.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Macroeconomics: Circular Flow
Book Section: The Circular Flow Model
17. In the circular flow model, the factor market determines all of the following EXCEPT
(A) employee weekly wages
(B) price of used student textbooks in the bookstore
(C) price of printing presses for commercial use
(D) office rents for lawyers and doctors
(E) the price of fertilizer used in the production of cotton
(B) Businesses provide used textbooks in the bookstore to be bought and sold by students in the
product market.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Macroeconomics: Circular Flow
Book Section: The Circular Flow Model
18. Which of the following illustrate the use of economic incentives to create the potential for
real, long-run economic growth?
I. Government grants to students to pay for higher education
II. Government tax credits to stimulate research into alternative energy production
III. Tariffs and quotas to limit foreign imports
(A) I only
(B) II only
(C) III only
(D) I and II only
(E) I, II, and III
(D) Encouraging students to pursue higher education increases not only their skill as workers, but
also their capacity to create new technology for the future output. Research into alternative
energy production has the potential to provide the technology critical in the future. Neither tariffs
nor quotas create incentives for increasing the potential for real, long-run economic growth.
Difficulty: Medium
Style: Conceptual
AP Economics Curricular Requirement Microeconomics: Property Rights and the Role of
Incentives
Book Section: Characteristics of the Market System
19. Specialization of labor contributes to increased economic output by
I. creating optimal use of human resources by taking advantage of the different skills of
each individual in the workforce
II. encouraging each individual to perform as many different tasks as possible
III. taking advantage of skill development as each worker becomes more efficient in
performing the same task
(A) I only
(B) II only
(C) III only
(D) I and III only
(E) I, II, and III
(D) Specialization takes advantage of human differences and builds on the efficiency created by
skill development as workers focus on particular tasks. Because of potential for inefficiency,
specialization does not encourage workers to perform as many tasks as possible.
Difficulty: Medium
Style: Conceptual
AP Economics Curricular Requirement Microeconomics: Comparative Advantage, Absolute
Advantage, Specialization, and Trade
AP Economics Curricular Requirement Macroeconomics: Comparative Advantage,
Specialization, and Exchange
Book Section: Specialization
20. A country achieves an optimal point of production outside of its domestic production
possibility curve by taking advantage of
I. human and geographic specialization
II. human and geographic specialization combined with tariffs and quotas
III. international trade
(A) I only
(B) II only
(C) III only
(D) I and II only
(E) I and III only
(E) To achieve an optimal point outside of a country’s production possibilities curve, a nation
must maximize the benefits and efficiencies of human and geographic specialization combined
with efficiencies gained through unhindered international trade.
Difficulty: Medium
Style: Conceptual
AP Economics Curricular Requirement Microeconomics: Comparative Advantage, Absolute
Advantage, Specialization, and Trade
AP Economics Curricular Requirement Macroeconomics: Comparative Advantage,
Specialization, and Exchange
Book Section: Specialization
21. In a laissez-faire economy, the primary role of government in the economy is to
(A) establish price ceilings and floors
(B) regulate industry to ensure worker safety
(C) protect private property rights
(D) promote international trade
(E) stabilize the economy through fiscal and monetary policy
(C) In a laissez-faire economy, the government is prevented from intervening in the economy,
other than to protect property rights and create a legal environment for the enforcement of
contracts.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: Laissez-Faire Capitalism
22. Private property rights are critically important for the development of
I. entrepreneurship
II. investment
III. intellectual property
(A) I only
(B) III only
(C) I and II only
(D) II and III only
(E) I, III, and III
(E) Private property rights allow producers to keep the profits from their work, giving them the
incentive to develop intellectual property, start businesses, and invest in future development.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Property Rights and the Role of
Incentives
Book Section: Private Property
23. Market systems promote economic growth and higher standards of living by
(A) supporting the development of new technology
(B) creating new firms to compete with private industry
(C) increasing taxes on businesses that increase investment
(D) imposing anti-pollution regulations on corporations
(E) rationing capital to ensure all businesses have an opportunity to earn profit
(A) Technological advance allows businesses to create more output with the same amount of
resources or fewer resources. Production possibilities increase and standards of living increase.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: Five Fundamental Questions
24. In the resource market, income flows to households in each of the following forms EXCEPT
(A) Wages
(B) Rents
(C) Interest
(D) Taxes
(E) Profits
(D) In the resource market, income flows to households to pay for land, labor, capital, and
entrepreneurial ability. Taxes are an income flow to the government, not to households.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Macroeconomics: Circular Flow
Book Section: Resource Market
25. Which type of economic system communicates changes in consumer tastes through price and
profit signals?
(A) A command economy
(B) A market economy
(C) A traditional economy
(D) A communist economy
(E) A directed economy
(B) In a market economy, changes in demand cause changes in prices and profit, giving firms an
incentive to respond to the change in demand.
Difficulty: Easy
Style: Factual
AP Economics Curricular Requirement Microeconomics: Economic Systems
Book Section: Five Fundamental Questions
Free-Response Question
Assume a closed economic system in which there is neither foreign trade nor government.
Construct and correctly label a circular flow diagram that illustrates the money flow and
exchange of goods and services between households and businesses.
Free-Response Explanation
7 points:
 1 point is earned for a correctly labeled circular flow diagram.
 1 point is earned for correctly identifying that households buy products (goods and
services) and sell resources.
 1 point is earned for correctly identifying that businesses buy resources and sell products.
 1 point is earned for correctly identifying the resource market, noting that households sell
and businesses buy resources (land, labor, capital, and entrepreneurial ability).
 1 point is earned for correctly identifying the product market, noting that households buy
and businesses sell final goods and services.
 1 point is earned for correctly identifying that resources (land, labor, capital, and
entrepreneurial ability) and products (goods and services) flow in one direction.
 1 point is earned for correctly identifying that money flows in the opposite direction. In
the resource market, money is exchanged between households and businesses (rent for
land, wages for labor, interest and profits for entrepreneurial ability). In the product
market, money is exchanged between households and businesses for products (goods and
services).
Difficulty: Easy
Style: Applied
AP Economics Curricular Requirement Macroeconomics: Circular Flow
Book Section: The Circular Flow Model