Solutions for End of Chapter Questions

Chapter 1
Easy
1

Suppose society abolishes higher education and so, students have to find jobs
immediately. If there are no jobs available, how do wages and prices adjust so
those who want jobs can find them?
This would represent an increase in the supply of labour. Wages will fall for
those jobs for which students wish to offer themselves.

A-head: 1.3 Scarcity and the competing use of resources

Learning Objective: Ways in which society decides what, how and for
whom to produce
Type: Application
2

Communist Russia used prices to allocate production among different

consumers. Central planners set production targets but then put output in
shops, fixed prices and gave workers money to spend. Why not plan the
allocation of particular goods to particular people as well?
This would be too bureaucratic, even by command economy standards. Even
in a dictatorship this could be politically unacceptable as well as impractical.
Even with modern information technology it would probably be too costly to
plan for, deliver to and monitor individuals.

A-head: 1.4 The role of the market

Learning Objective: Ways in which society decides what, how and for
whom to produce
Type: Application
3 Which of the following statements are positive, and which are normative? (a)
Annual inflation is below 2 per cent. (b) Because inflation is low, the
government should cut taxes. (c) Income is higher in the UK than in Poland. (d)
Brits are happier than Poles.
3 (a) Positive (b) Normative (c) Positive (d) Normative at present, though social
scientists are trying to develop objective measurements of well-being and
happiness.
A-head: 1.5 Positive and normative
Learning Objective: Positive and normative economics
Type: Application
4 Common fallacies Why are these statements wrong? (a) Since some
economists are Tory but others Labour, economics can justify anything. (b)
Efficiency gains cannot increase the production of some commodities without
sacrificing others, and therefore there is no such thing as a free lunch. (c)
Economics is about people, and thus cannot be a science.
4 (a) Economics cannot necessarily justify anything. Positive economic
statements can be tested against evidence while normative statements, even
if they are made by economists, cannot. (b) Beginning from an inefficient
point to the left of the production possibility frontier, efficiency gains can
increase the production of some commodities without sacrificing others and

thus yield a free lunch. (c) Economics is a social science with all the
limitations which that classification implies. Scientific method can be used to
study human behaviour, but it is often more useful to refer to economic
tendencies rather than economic laws.
A-head: Introduction, 1.3 Scarcity and the competing use of resources,
1.5 Positive and normative
Learning Objective: Ways in which society decides what, how and for
whom to produce, Positive and normative economics, Economics is
the study of how society resolves the problem of scarcity
Type: Conceptual understanding
5 Which of the following statements refer to microeconomics, which to
macroeconomics? (a) Inflation is lower than in the 1980s. (b) The price of a
can of beans fell this month. (c) Good weather means a good harvest. (d)
Unemployment in London is below the UK average.
5 (a)
Macroeconomics
(b)
Microeconomics
(c)
Microeconomics
(d)
Macroeconomics
A-head: 1.6 Micro and macro
Learning Objective: Microeconomics and macroeconomics
Type: Application
Medium
6 OPEC made a fortune for its members by organizing production cutbacks and
forcing up prices. (a) Why have coffee producers not managed to do the
same? (b) Could UK textile firms force up textile prices by cutting back UK
textile production?
6 (a) There was an attempt to organise a coffee quota during the 1970s but it
was not very effective. There are many more producers of coffee than of oil, so
it is much more difficult to co-ordinate them. Also the demand for coffee is
more elastic than the demand for oil, so a reduction in supply does not have
quite so much impact on the price. High prices are also an incentive for cartel
members to cheat on the collective agreement to restrict output an
individual producer that raises its output gets much higher income. Chapter
10 explains how Saudi Arabia disciplined other OPEC members to keep them
in line, which was possible only because of the large oil reserves and cheap
production costs of Saudi Arabia compared with other OPEC members. (b) It
would fail because the UK would simply be swamped by cheap textile imports.
A-head: 1.2 Economic issues
Learning Objective: Ways in which society decides what, how and for
whom to produce
Type: Application
7 Suppose it becomes possible in 5 years time to make as much energy as we
want from biofuels provided the price is the equivalent of at least $50/barrel
for oil. (a) What does this imply about the eventual price of oil in, say, 10
years time? (b) Is it possible for oil prices to be substantially above $50/barrel
for the next few years? (c) Do higher oil prices in the short run increase or
reduce the incentive to look for alternative energy technologies?

(a) The price of oil will be around $50 a barrel.

(b) Yes, until the biofuel process is on stream.
(c) Higher oil prices in the short run increase the incentive to look for
alternative energy technologies.

A-head: 1.2 Economic issues

Learning Objective: ways in which society decides what, how and for
whom to produce
Type: Application
8

An economy has 5 workers. Each worker can make 4 cakes or 3 shirts. (a)
Draw the production possibility frontier. (b) How many cakes can society get if
it does without shirts? (c) What points in your diagram are inefficient? (d) Can
the economy produce an output combination which lies above the production
possibility frontier? (e) What is the opportunity cost of making a shirt and
making a cake? (f) Does the law of diminishing returns hold in this economy?
8 (a) As shown in the figure, the production possibilities frontier will be a
downsloping line joining 15 shirts and 20 cakes. (b) 20 cakes (5 workers x 4
cakes) (c) All points below the frontier. (d) No, such combinations are
unattainable. Given the inputs available, such output combinations cannot be
made. Scarce resources limit society to a choice of points inside or on the
production possibility frontier. Society must choose how to allocate these
scarce resources between competing uses. (e) The opportunity cost of making
a shirt = 1.33 cakes; the opportunity cost of making a cake = 0.75 shirts (f)
No, because the production possibility frontier is a straight line.

A-head: 1.3 Scarcity and the competing use of resources

Learning Objective: Economics is the study of how society resolves the
problem of scarcity
Type: Calculation, Graphing
9 Suppose that a country can produce two goods, food and clothing. To produce
one unit of food, it requires one worker. To produce one unit of clothing, it
requires two workers. The total amount of workers available in the economy is
fixed and equal to 100. Denoting with L the total amount of workers, with F the
units of food produced, and with C the units of clothing produced, the resource
constraint for this economy can be written as: L a F F aC C ,where aF is the
amount of workers needed to produce one unit of food and a C the amount of
workers needed to produce one unit of clothing. Show how to construct the
production possibility frontier from that resource constraint. In a graph with C
on the vertical axis and F on the horizontal axis, plot the PPF of this economy.

What is the slope of the PPF?

9 With 100 workers, that economy can produce 50 units of clothing and no
food, or 100 units of food and no clothing. Therefore with Clothing on the y
(vertical) axis and Food on the x (horizontal) axis, mark points at 50 on the y
axis and 100 on the x axis. Join these with a straight line. This is the
production possibility frontier. The gradient of the line is y/x = -1/2 (The
gradient is negative because the line is downward sloping).

A-head: 1.3 Scarcity and the competing use of resources

Learning Objective: Economics is the study of how society resolves the
problem of scarcity
Type: Calculation, Graphing
Hard
10. Suppose a farmer is planning to grow cabbages on his land. The cost of
growing cabbages is 50 per acre and he earns 100 from the produce in the
market. There is another option for him, to grow pumpkins, which could yield
him 110 if he spent 70 on it. (a) What is the opportunity cost of growing
cabbages? (b) Is it rational for the farmer to grow cabbages instead of
pumpkins? (c) Suppose the only other option for him to earn from his
farmland is to rent it to another farmer. How will the farmer arrive at a
rational decision?
10 (a) The opportunity cost of an activity is the value of the best alternative you
must sacrifice. The opportunity cost of growing cabbages accounts for the
explicit cost of growing cabbages plus the value of growing pumpkins. The
value of growing pumpkins is equal to 40 i.e. 110 minus 70. Therefore, the
opportunity cost of growing cabbages is 40.
(b) As a rational individual, the farmer should weigh the costs and benefits of
growing cabbages and pumpkins. The cost of growing cabbages is 50, plus
40, the opportunity cost of growing pumpkins. The benefit from growing
cabbages is 100. The benefit is greater than the cost. Therefore, it is rational
for the farmer to grow cabbages.
(c) The farmer should consider renting out his farmland only if the rent
exceeds the benefits he gets from growing cabbages.
A-head: 1.1 How economists think about choices
Learning Objective: The concept of opportunity costs
Type: Application

11Essay question Two similar countries take the decision to try to increase the
health of their poorest people. One country raises taxes on the rich and gives
more money to the poor. The other country raises taxes on the rich and
provides more health care, free to patients, through its National Health
Service. Which country do you think is more likely to meet its objective? Why?
11 The answer to this question involves more than economic reasoning. Most
people approaching this debate will have value judgment baggage; even
economists geared to a positive analysis. There is no such thing as a valuefree social science and in a question of this kind political persuasions are also
important.
The Liberal reforms of 1906 1914, (which many historians have argued
paved the way for the post 1945 welfare reforms, collectively called the
Welfare State with the NHS at its heart), were born out of the scandalous
state of the Boer War recruits and to head off the threat of organised labour. In
addition, employers benefit from a healthy workforce through increased levels
of productivity, hence the reforms associated with public health in the
nineteenth century.
For most of the period 1945 1979, the major tenets of Social Democracy held
sway in the UK, whereby the progressive income tax system levied higher
levels of taxation on the richer sections of society than on the poorer sections,
and the government then used the receipts to fund the NHS and some
benefits for the poor, the unemployed and those of pensionable age.
The policy of raising taxes on the rich and giving money to the poor in the
hope of improving the health-care of their poorest people is more marketorientated than the policy that prefers to adopt a similar taxation policy but is
keen to provide health care free to participants. The latter fits the social
democratic paradigm. This perspective is not in favour of empowering the
poorest with cash in the hope that some of it will be spent on health care.
Supporters of this perspective do not trust the poorest sections of society, or
indeed other sections, to spend their money wisely. Proponents of the
philosophy that the government knows best would refer to feckless sections
of society spending any extra money received on undesirable goods and
services such as alcohol, gambling and drugs. Food, housing and health care
would be low on the agenda. It would be argued that people do not always act
to benefit themselves in the long term.
A positive economist would draw on economic theory to point out that cash
transfers allow consumers choice and freedom to purchase what they need
and want, and that transfers in kind limit consumer options. Consumer utility
is also reckoned to be less with transfers in kind than with cash of the same
monetary value. However, transfers in kind do have widespread appeal
amongst all the mainstream political parties. Despite major changes in
political philosophy since 1979, with all three major parties in Britain accepting
the market as the main arbiter in the allocation of resources, there is no
appetite as yet to privatise completely the NHS, and provide for cash transfers
so that people can take responsibility for their own health care.

Vouchers have been suggested for use in the purchase of educational services
and there will be supporters of this system with regard to health care.
Creeping privatisation and marketization within the NHS could foreshadow a
major shift in the provision in the near future as the struggle to reduce the
government budget deficit will result in the slaying of some sacred cows.
Economic arguments could yet transcend social and political philosophies.
Free market economists would argue that, to the extent that consumers are
rational enough to exercise self-interest in all its aspects, they are better off,
or at least no worse off, if transfers are received in cash rather than in kind. It
is doubtful whether or not the national interest, a dubious concept difficult to
define but used here to mean the greatest happiness of the greatest
number is best served by this approach.
A-head: 1.3 The role of the market, 1.4 Positive and normative
Learning Objective: Positive and normative economics, Ways in which
society decides what, how and for whom to produce
Type: Conceptual understanding