Limits, Alternatives, and Choices
CHAPTER ONE
LIMITS, ALTERNATIVES, AND CHOICES
ANSWERS TO END-OF-CHAPTER QUESTIONS
1-1
Ralph Waldo Emerson once wrote: “Want is a growing giant whom the coat of have was never
large enough to cover.” How does this statement relate to the definition of economics?
Emerson’s statement reflects the fundamental economic problem of attempting to satisfy
unlimited wants with finite (scarce) economic resources.
1-2
“Buy 2, get 1 free.” Explain why the “1 free” is free to the buyer but not to society.
Because an expenditure is not required for the buyer to obtain the “1 free” once she has already
purchased the first two, it is free to the buyer. It is not free to society, however, because
resources were used in producing the third unit that could have been directed to alternate uses.
1-3
Which of the following decisions would entail the largest opportunity cost: Devoting a square
block in the heart of New York City to build a surface parking lot or devoting a square block at
the edge of a typical suburb to build such a lot? Explain.
Building the lot in the heart of New York City would have the greatest opportunity cost, given
the many commercial possibilities and potentially high rents to be earned.
1-4
What is meant by the term “utility” and how does it relate to purposeful behavior?
“Utility” refers to the pleasure, happiness, or satisfaction gained from engaging in an activity
(eating a meal, attending a ball game, etc.). It is an important component of the economic
perspective because people will allocate their scarce time, energy, and money in an attempt to
gain the most utility possible.
1-5
Cite three examples of recent decisions that you made in which you, at least implicitly, weighed
marginal cost and marginal benefit.
Student answers will vary, but may include the decision to come to class, to skip breakfast to get
a few extra minutes of sleep, to attend college, or to make a purchase. Marginal benefits of
attending class may include the acquisition of knowledge, participation in discussion, and better
preparation for an upcoming examination. Marginal costs may include lost opportunities for
sleep, meals, or studying for other classes. In evaluating the discussion of marginal benefits and
marginal costs, be careful to watch for sunk costs offered as a rationale for marginal decisions.
1-6
Indicate whether each of the following statements applies to microeconomics or
macroeconomics:
(a), (d), and (f) are macroeconomics; (b), (c), and (e) are microeconomics.
1-7
Suppose you won $15 on a lotto ticket at the local Seven-Eleven and decided to spend all of the
winnings on candy bars and bags of peanuts. The price of candy bars is $.75 and the price of
peanuts is $1.50.
a. Construct a table showing the alternative combinations of the two products that are available.
1
Limits, Alternatives, and Choices
Number of Candy Bars
Bags of Peanuts
Total Expenditure
0
10
$15 = $0 + $15
4
8
$15 = $3 + $12
8
6
$15 = $6 + $9
12
4
$15 = $9 + $6
16
2
$15 = $12 + $3
20
0
$15 = $15 + $0
b. Plot the data in your table as a budget line in a graph. What is the slope of the budget line?
What is the opportunity cost of one more candy bar? Of one more bag of peanuts? Do these
opportunity costs rise, fall, or remain constant as each additional unit of the product is
purchased?
20
Quantity of Candy
16
12
8
4
2
4
6
8 10 12 14 16
Quantity of Peanuts
18 20
The slope is -2 [loss of two bags of peanuts for every candy bar obtained]
The opportunity cost of one more candy bar is two bags of peanuts. The opportunity cost of
one more bag of peanuts is ½ a candy bar. The opportunity costs are constant.
c. How, in general, would you decide which of the available combinations of candy bars and
bags of peanuts to buy?
You would choose the combination where MB=MC.
d. Suppose that you had won $30 on your ticket, not $15. Show the $30 budget line in your
diagram. Why would this budget line be preferable to the old one?
2
Limits, Alternatives, and Choices
Quantity of Candy
40
Income = $30
20
Income = $15
10
20
40
Quantity of Peanuts
This new budget line is preferable because it allows you to purchase more of both goods than
when the budget constraint was $15.
1-8
What are economic resources? What categories do economists use to classify them? Why are
resources also called factors of production? Why are they called inputs?
Economic resources are the human, manufactured, and natural elements used to produce goods
and services.
Economists identify four categories of resources: land, labor, capital, and entrepreneurial ability.
Resources are called factors of production because they are used to create (produce) goods and
services. “Production” and “goods and services” are typically synonyms in economics.
Resources are also called “inputs” because they go into a production process that generates
“output,” another term for “production” or “goods and services.”
1-9
Why isn’t money considered a capital resource in economics? Why is entrepreneurial ability
considered a category of economic resource, distinct from labor? What are the major functions
of the entrepreneur?
Money isn’t a capital resource because it is not productive. While it is a means to acquire factors
of production, money itself doesn’t produce goods or services.
Entrepreneurial ability is treated differently from labor because its function is different. The
entrepreneurial function is to organize resources, assume risk, innovate, and make strategic
business decisions. Labor, on the other hand, directly produces goods and services. The
entrepreneurial role in the production process is more indirect.
1-10
Below is a production possibilities table for consumer goods (automobiles) and capital goods
(forklifts):
3
Limits, Alternatives, and Choices
a. Show these data graphically. Upon what specific assumptions is this production possibilities
curve based?
30
Forklifts
27
21
12
2 4 6 8 10
20
Automobiles
30
The curve is based on the assumptions of full employment, fixed resources, fixed technology,
and two goods.
b. If the economy is at point C, what is the cost of one more automobile? Of one more forklift?
Explain how the production possibilities curve reflects the law of increasing opportunity
costs.
One more automobile would cost 4.5 forklifts (2 automobiles = 9 forklifts).
One more forklift would cost 1/3 automobiles (6 forklifts = 2 automobiles.
The law of increasing opportunity costs could be reflected as follows: Producing the first
two automobiles only costs three forklifts; the next two cost six forklifts; and so forth.
Producing the last two automobiles would cost twelve forklifts; demonstrating that each
additional automobile costs more than the previous one.
c. If the economy characterized by this production possibilities table and curve were producing
3 automobiles and 20 fork lifts, what could you conclude about its use of its available
resources?
The economy’s resources are not fully employed.
d. What would production at a point outside the production possibilities curve indicate? What
must occur before the economy can attain such a level of production?
4
Limits, Alternatives, and Choices
Producing outside the curve is not possible. To reach a level of production beyond an
existing curve would require expansion of the curve by increasing the quantity or quality of
resources, or by advancing technology.
e. Suppose improvement occurs in the technology of producing forklifts but not in the
technology of producing automobiles. Draw the new production possibilities curve. Now
assume that a technological advance occurs in producing automobiles but not in producing
forklifts. Draw the new production possibilities curve. Now draw a production possibilities
curve that reflects technological improvement in the production of both goods.
Improved technology
for forklifts only
Forklifts
30
8
Automobiles
5
Limits, Alternatives, and Choices
Improved technology
for automobiles only
Forklifts
30
8
Automobiles
Improved technology for both
forklifts and automobiles
Forklifts
30
8
1-11
Automobiles
Specify and explain the typical shapes of marginal-benefit and marginal-cost curves. How are
these curves used to determine the optimal allocation of resources to a particular product? If
current output is such that marginal cost exceeds marginal benefit, should more or fewer
resources be allocated to this product? Explain.
6
Limits, Alternatives, and Choices
The marginal benefit curve is down-sloping, reflecting that each additional unit of a good
provides less benefit than the previous unit. The marginal cost curve slopes upward, indicating
that each additional unit of a good costs more to produce than the previous one. The intersection
of the two curves (MB=MC) reveals the optimal allocation.
If marginal cost exceeds marginal benefit, fewer resources should be allocated to this product.
At the current output, what is being sacrificed to obtain the last unit (MC) is greater than what is
gained by having the last unit (MB).
1-12
Explain how (if at all) each of the following events affects the location of a country’s production
possibilities curve.
a. The quality of education increases.
b. The number of unemployed workers increases.
c. A new technique improves the efficiency of extracting copper from ore.
d. A devastating earthquake destroys numerous production facilities.
(a) The curve will shift out as the labor resource improves.
(b) The curve will not shift, but the economy will produce further inside the curve.
(c) The curve will shift out as a result of the technological improvement.
(d) The curve will shift in as resources are destroyed.
7