Review Questions - Chapter 2
Question 1:
Q) The police research department wants to study whether the level of crime is affected by the unemployment
rate. (a) How would you test this idea? What data would you want? (b) What ‘other things equal’ problems
would you bear in mind?
(a) Data needed: Crime rates and unemployment rates in different regions or cities over a period.
How would test it: calculate the change in crime rates over the unemployment. (change in y/ change in x) or
linear regression (y=a+bx)
Dependent variable is the crime rate (y-axis)
Independent variable: unemployment rate (x-axis)
(b)
• Other factors affecting crime rate (poverty, lack of education, government policies)
• The data sample might not be enough (limited data)
• It could be other way around which is unemployment is affected by crime rate….
Question 2:
Consumption (y-axis)
Q) Suppose the relationship between income and consumption is such that higher incomes are associated with
higher consumption of a similar amount. How can the relationship be represented on a graph?
Linear graph (straight line) with a positive gradient going upwards, and the income will be on the x-axis and the
consumption y-axis.
Income (x-axis)
Question 3:
Q) Which of the following graphs shows a negative linear relationship?
Graph (A) is showing a negative linear relationship which means as one variable decreases the other decreases
and the gradient is negative.
Question 4:
Q) Suppose the relationship between the price of a car and its quantity demanded, other things equal, is graphed
as a downward-sloping straight line. Suppose the income of consumers increases and the demand for cars
increases. What happens to the downward-sloping straight line when demand for cars increases owing to an
increase in consumers’ income?
The downward-sloping straight line will shift rightward because if consumers income increases that will results
in the increase of purchasing power which means consumers can buy more of the product at the same price
level given their currency, so when the purchasing power increases the demand increases and that’s why it will
shift to the right. But the graph or the slope itself doesn’t change.
The fact that, as the price of a good or
service increases, the quantity demanded
of that good or service decreases (other
things equal) holds for almost every
good or service and is known as the law
of demand
Question 5:
Q) Common fallacies Why are these statements wrong? (a) The purpose of a theory is to let you ignore the
facts. (b) Economics cannot be used to analyse social aspects of the world such as criminal activity or whether
to start a family. (c) People have feelings and act haphazardly. It is misguided to reduce their actions to
scientific laws.
(a) The theories are meant to give you an idea about the fact that can help you understand it.
(b) Economics is a social science, so it does analyse how individuals, firms make decisions according to scare
resources
(c) There are patterns and rules that can be used to understand and predict their behaviour by using economy
and other social sciences which means human behaviour is not random and can be predicted.
Question 6:
Q) Suppose you earn £1,200. You purchase only shirts, which are £10 each, with your income every month. (a)
What is the purchasing power of your income? (b) Now, suppose your income increases to £1,500 a month but
the price of shirts remains the same. Does the purchasing power of your income change? (c) Suppose your
income remains £1,200 but the price of shirts increases to £12 each. Does the purchasing power of your income
change?
The purchasing power of money is an index of the quantity of goods that can be bought for £1.
(a) 1200/10=120 shirts
(b) Yes, 1500/10=150 shirts (it will increase which means you
Purchasing power= Income/Price of
can buy more than before due to higher income)
product
(c) Yes, 1200/12=100 shorts (decrease because you can buy
less than before due to higher prices of shirts)
Question 7:
Q) The table below shows car prices and the consumer price index (CPI) for the years 2000, 2014, 2018.
Calculate the real prices of cars by expressing them at the 2014 prices.
Car prices
CPI (2014 = 100)
2000
12,780
73
2014
17,120
100
2018
23,125
105
The consumer price index (CPI) measures changes in the cost of living by looking at the cost of a standard
‘shopping basket’ of goods.
Real price= Price of car/CPI of the year x the year that you want to express them
•
12780/73=175
Real price: 175x100=17500
•
23125/105=220
Real price: 220x100= 22000
Question 8:
Q) The table below shows car prices and house prices for the years 2017 and 2018. Calculate the absolute
change and the percentage change in the prices of cars and houses between the years 2017 and 2018.
2017
Car prices (£)
21,456
House prices (£)
215,700
Absolute change in car prices: 23000-21456= 1544£
Absolute change in house prices: 214400-215700= -1300£
Percentage change in car price : 1544/21456x100=7.19%
Percentage change in house prices: -1300/215700x100= -0.6%
Question 9:
2018
23,000
214,400
The percentage change is the absolute
change divided by the original
number, then multiplied by 100.
Q) Calculate the slope of the straight line in the graph provided below. Also, write down the equation of the
straight line.
Point 1: (1,200)
Point 2: (2,300)
Method 1:
Slope= Rise/Run
Slope= 300-200/2-1=100/1= 100
Q=100P+c
100=100(0)+c
C=100
Equation of straight line:
Q=100P+100
Method 2:
(y-y1)=m(x-x1)
(Q-Q1)=m(P-P1)
(Q-200)=100(P-1)
Q-200=100P-100
Q=100P-100=200
Q=100P+100
Question 10:
Q) When we use economic data to test an economic theory, we must choose how high to set the bar in our test.
If we say that whenever the data depart at all from the prediction of the theory, we will reject most of our
theories, which were only approximations in the first place. Conversely, if we only reject a theory when the data
are a long way away from the prediction of the theory, we will hardly ever reject any theory. Which of these
two possible mistakes is more dangerous?
In my opinion both are dangerous in making economic decisions, because if we predict and accept theory based
on small sample data the theory might be incorrect and we might misunderstand some theories. While on the
other hand if we set the bars high and don’t accept many theories then we will limit our knowledge in economy
and might miss some important insights (Reject valid theories that makes sense).
Question 11:
Q) The table below shows unemployment rates in the capital (London) and the rest of England. One-third of the
national population lives in the capital. Construct an index of national unemployment, treating 2015 as 100.
What weights did you use for the two unemployment rates? Why?
Unemployment 2012
(%)
London
9.1
Rest of
7.9
Country
2013
2014
2015
2016
2017
2018
8.5
7.7
6.5
6.2
6.0
5.3
5.2
4.9
5.0
4.4
4.6
4.1
Data we have:
1/3=0.33 lives in the capital (London)
2/3=0.67 in the rest of the world
In year 2015:
(0.33x6)+(0.67x5.3)= 5.51
The weights have been used based on the population size, treating 2015 as 100 means one-third of it is like
33.3% and 100-33.3= 66.7% (for the rest of the world)
Index number for a variable= Value at a time/ Value at a base year x100
Year
2012
2013
2014
2015
2016
2017
2018
Calculations
(0.33x9.1) + (0.67x7.9)=8.296
8.296/5.51 x 100=148%
(0.33x8.5) + (0.67x7.7)=7.964
7.965/5.51x100=145.5%
(0.33x6.5) + (0.67x6.2)=6.4
6.3/5.51x100=116.6%
5.51/5.51x100=100%
(0.33 × 5.2) + (0.67 × 4.9) = 5.03
5.03/5.51x100=91.2%
(0.33x5) + (0.67x4.4)=4.7
4.7/5.51x100=85.7%
(0.33x4.6) + (0.67x4.1)= 4.3
4.3/5.51x100=77.4
The index of national
unemployment Compared to
2015
148
145
116
100
91
86
77
Question 12:
Q) Revenues at Tom’s Pizza Place have been falling in the past few years. The owner, Tom Booker, wants to
change his pricing policies to increase revenue. Considering the factors you think would affect Tom’s Pizza
Place’s revenue, construct a revenue model and explain your model.
Factors affect Tom’s revenue:
•
•
•
•
•
Lack of marketing and promotion
Inefficient pricing strategies
Higher competition
Inconsistent high quality or customer service
Economic instability
Revenue model:
Revenue= (Price x Sales or volume) – Costs
This model shows the main factor that affects the revenue and how they are related.
Revenue Model for Tom’s Pizza
How to price (pricing strategies):
1. Maybe use volume pricing and lower the prices so that the demand increases (the law of
demand)
2. Use loss leaders pricing strategy which use a very cheap product to attract customers (example is
the McDonald ice cream)
3. Use competitor pricing which means that setting prices based on other firms so that Tom’s pizza
can compete against them
Setting up cost: One of the main factors that will affect the revenue of the pizza place and its cashflow is
the cost and all expenses included in the production process, Tom should try to reduce these and use the
resources in an optimal way.
Marketing or promotion: The marketing segment is very important to Tom’s pizza place, the better the
marketing the more customers will come. So, Tom should try and advertise in man ways possible, and
promote the product and many special offers like very well know pizza places do (Dominos, Papa Johns)