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Chapter 2

Thinking Like an Economist


Problem 1

Draw a circular-flow diagram. Identify the parts of the model that correspond to the flow of goods and services and the flow of dollars for each of the following activities.
a. Selena pays a storekeeper \$1 for a quart of milk.
b. Stuart earns \$8 per hour working at a fast-food restaurant.
c. Shanna spends \$40 to get a haircut.
d. Salma earns \$20,000 from her 10 percent ownership of Acme Industrial.

Yi Chun L.
Washington University in St Louis

Problem 2

Imagine a society that produces military goods and consumer goods, which we'll call "guns" and "butter."
a. Draw a production possibilities frontier for guns and butter. Using the concept of opportunity
cost, explain why it most likely has a bowed-out shape.
b. Show a point that is impossible for the economy to achieve. Show a point that is feasible but
c. Imagine that the society has two political parties, called the Hawks (who want a strong military)
and the Doves (who want a smaller military). Show a point on your production possibilities
frontier that the Hawks might choose and a point that the Doves might choose.
d. Imagine that an aggressive neighboring country reduces the size of its military. As a result, both
the Hawks and the Doves reduce their desired production of guns by the same amount. Which
party would get the bigger "peace dividend," measured by the increase in butter production?

Yi Chun L.
Washington University in St Louis

Problem 3

The first principle of economics discussed in Chapter 1 is that people face trade-offs. Use a production possibilities frontier to illustrate society's trade-off between two "goods"$-$a clean environment
and the quantity of industrial output. What do you suppose determines the shape and position of the
frontier? Show what happens to the frontier if engineers develop a new way of producing electricity
that emits fewer pollutants.

Yi Chun L.
Washington University in St Louis

Problem 4

An economy consists of three workers: Larry, Moe, and Curly. Each works 10 hours a day and can produce two services: mowing lawns and washing cars. In an hour, Larry can either mow one lawn or wash one car; Moe can either mow one lawn or wash two cars; and Curly can either mow two lawns or wash one car.
a. Calculate how much of each service is produced under the following circumstances, which we
label A, B, C, and D:
$\bullet$ All three spend all their time mowing lawns. (A)
$\bullet$ All three spend all their time washing cars. (B)
$\bullet$ All three spend half their time on each activity. (C)
$\bullet$ Larry spends half his time on each activity, while Moe only washes cars and Curly only mows lawns. (D)
b. Graph the production possibilities frontier for this economy. Using your answers to part a, identify
points A, B, C, and D on your graph.
c. Explain why the production possibilities frontier has the shape it does.
d. Are any of the allocations calculated in part a inefficient? Explain.

Yi Chun L.
Washington University in St Louis

Problem 5

Classify the following topics as relating to microeconomics or macroeconomics.
a. a family's decision about how much income to save
b. the effect of government regulations on auto emissions
c. the impact of higher national saving on economic growth
d. a firm's decision about how many workers to hire
e. the relationship between the inflation rate and changes in the quantity of money

Yi Chun L.
Washington University in St Louis

Problem 6

Classify each of the following statements as positive or normative. Explain.
a. Society faces a short-run trade-off between inflation and unemployment.
b. A reduction in the rate of money growth will reduce the rate of inflation.
c. The Federal Reserve should reduce the rate of money growth.
d. Society ought to require welfare recipients to look for jobs.
e. Lower tax rates encourage more work and more saving.

Kaylee M.
Numerade Educator