Answers to in-text Questions in Economics (6th edition)

Chapter 1
Page 4 Could production and consumption take place without money? If you think they could, give examples. Yes. People could produce things for their own consumption. For example, people could grow vegetables in their garden or allotment; they could do their own painting and decorating. Alternatively people could engage in barter: they could produce things and then swap them for goods that other people had produced.

Before reading on, how would you define scarcity? Must goods be at least temporarily unattainable to be scarce? See page 2 of text for a definition of scarcity. Goods need not be unattainable to be scarce. Because peoples incomes are limited, they cannot have everything they want from shops, even though the shops are stocked full. If all items in shops were free, the shelves would soon be emptied! If we would all like more money, why does the government not print a lot more? Could it not thereby solve the problem of scarcity at a stroke? The problem of scarcity is one of a lack of production. Simply printing more money without producing more goods and services will merely lead to inflation. To the extent that firms cannot meet the extra demand (i.e. the extra consumer expenditure) by extra production, they will respond by putting up their prices. Without extra production, consumers will end up unable to buy any more than previously. (Box 1.1) What is it that makes each one of the above news items an economics item? Each one of the items has something to do with production, consumption or exchange, and/or the money incomes and expenditures involved. Which of the following are macroeconomic issues, which are microeconomic ones and which could be either depending on the context? (a) Inflation. (b) Low wages in certain service industries. (c) The rate of exchange between the pound and the euro. (d) Why the price of cabbages fluctuates more than that of cars. (e) The rate of economic growth this year compared with last year. (f) The decline of traditional manufacturing industries. (a) Macro. It refers to a general rise in prices across the whole economy. (b) Micro. It refers to specific industries (c) Either. In a world context, it is a micro issue, since it refers to the price of one currency in terms of one other. In a national context it is more of a macro issue, since it refers to the euro exchange rate at which all UK goods are traded internationally. (This is certainly a less clearcut division that in (a) and (b) above.) (d) Micro. It refers to specific products. (e) Macro. It refers to the general growth in output of the economy as a whole. (f) Micro (macro in certain contexts). It is micro because it refers to specific industries. It could, however, also help to explain the macroeconomic phenomena of high unemployment or balance of payments problems.

Answers to questions in Economics (6th edition) by John Sloman Page 7 (Box 1.2) 1. Has the UK generally fared better or worse than the other three countries? Generally worse until recent years. Unemployment was higher than in Germany and Japan, and also than in the USA from 1981 to 2000. In the last period, however, UK unemployment has been lower than in Germany. Inflation has generally been higher than in the other countries, although in the last period it has been lower than the US rate. In the 1960s and 70s, UK growth was lower than in the other three countries. In the last two periods, economic growth in the UK has been higher than that in Germany and Japan and only slightly lower than that in the USA. If current account deficits are regarded as undesirable, then both the USA and the UK have fared significantly worse than Japan and somewhat worse than Germany for most of the time since 1961. The UKs deficit, however, has generally been less severe than the USAs, especially in the latest period.

(Box 1.2) 2. Was there a common pattern in the macroeconomic performance of each of the four countries over these 45 years? With inflation yes, but not with the other indicators. Unemployment has been rising throughout in Germany and Japan, whereas in the UK it has fallen in the last two periods. The USA has not followed a similar pattern to any of the other three countries, with unemployment lowest in the middle period (the period in the UK when unemployment was at its highest). Inflation was highest for all four countries in the second period. Since then each subsequent period has recorded lower inflation than the previous one. Growth rates in Germany and Japan have slowed, whereas rates in the UK and the USA have generally been maintained. UK and US current account deficits have deteriorated, with a dramatic worsening in the USA in the last period. German and Japanese current account surpluses have increased, with the exception of Germany in the penultimate period. Note that the figures given are merely the averages for each period. They do not indicate, therefore, the fluctuations that took place within the periods. For example the early 1980s and early 1990s were periods of low growth and high unemployment, whereas the late 1970s and late 1980s were periods of relatively high growth and high inflation and the late 1990s was also a period of relatively high growth. (Threshold Concept 1) 1. Think of three things you did yesterday. What are the opportunity costs of each one? Obviously, this depends on the three things you choose. In the case of things you purchased, the opportunity cost is the next best thing you could have purchased with the money. In the case of other activities, the opportunity cost is the next best thing you could have done with the time. (Threshold Concept 1) 2. Assume that a supermarket has some fish that has reached its sell-by date. It was originally priced at 10, but yesterday was marked down to 5 for quick sale. It is now the end of the day and it still has not been sold. The supermarket is about to close and there is no-one in the store that wants fish. What is the opportunity cost for the store of throwing the fish away. It is simply the cost of disposing of it which may be zero, if its waste disposal is not charged per unit. The price it paid for the fish is irrelevant since it cannot recoup this cost.

Assume that you are looking for a job and are offered two. One is more unpleasant to do, but pays more. How would you make a rational choice between the two jobs? You should weigh up whether the extra pay (benefit) from the better paid job is worth the extra hardship (cost) involved in doing it. How would the principle of weighing up marginal costs and benefits apply to a worker deciding how much overtime to work in a given week? The worker would consider whether the extra pay (the marginal benefit) is worth the extra effort and loss of leisure (the marginal cost).

Page 10 (Threshold Concept 2) 1. Assume that a firm is selling 1000 units of a product at 20 each and that each unit on average costs 15 to produce. Assume also that to produce additional units will cost the 2

Chapter 1 firm 19 each and that the price will remain at 20. To produce additional products will therefore reduce the average profit per unit. Should the firm expand production? Explain? Yes. Additional units still earn extra profit of 1 each (i.e. 20 19). If the firm wants to increase profits, therefore, it should increase production, even though additional units earn only an extra 1 and not the average of 5 earned on previous units. We consider the concepts of marginal cost and marginal revenue in Chapter 5. (Threshold Concept 2) 2. Assume that a ferry has capacity for 500 passengers. Its operator predicts that it will typically have only 200 passengers on each of its mid-week sailings over the winter. Assume also that each sailing costs the company 10,000. This means that mid-week winter sailings cost the company an average of 10,000/200 = 50 per passenger. Currently tickets cost 60. Should the company consider selling stand-by tickets during the winter for (a) less than 60; (b) less than 50? (Clue: think about the marginal cost of taking additional passengers.) It should consider the additional cost of taking the extra passengers. This is likely to be close to zero, given that there is room for extra passengers and the ferry is sailing anyway. In considering how much to reduce the stand-by price below the current price of 60, the company must weigh up the extra passengers attracted by the lower price against the lower amount earned per stand-by passenger. If a 20 per cent cut in price, say, resulted in an increase in passengers of more than 20 per cent, then the ferry company would earn more as a result of that price cut. We will consider these calculations when we look at the concept of elasticity in section 2.4. These calculations assume that selling stand-by tickets does not affect the number of passengers on regular tickets. However, if cheap stand-by tickets reduce the number of people buying regular tickets, then the net gain in revenue will be less. 11

(Box 1.3) What might prevent you from making the best decision? Lack of knowledge. You will not know just how much benefit you will gain from the textbook until you have read it, taken your exams or had your assignments marked! Another cause of making poor decisions is the lack of care taken in making them. (Box 1.3) 1. If there are several other things you could have done, is the opportunity cost the sum of all of them? No. It is the sacrifice of the next best alternative. (Box 1.3) 2. What is the opportunity cost of spending an evening revising for an economics exam? What would you need to know in order to make a sensible decision about what to do that evening? The next best alternative might be revising for another exam, or it might be taking time off to relax or to go out. To make a sensible decision, you need to consider these alternatives and whether they are better or worse for you than studying for the economics exam. One major problem here is the lack of information. You do not know just how much the extra study will improve your performance in the exam, because you do not know in advance just how much you will learn and you do not know what is going to be on the exam paper. Similarly you do not know this information for studying for other exams. (Box 1.3) 1. Why is the cost of food not included? Because you would buy food anyway. If, however, food were being provided free of charge by your parents if you lived at home, but you had to pay for it if you went to university or college, then food would be an opportunity cost to you. (Box 1.3) 2. Make a list of the benefits of higher education. The benefits to the individual include: increased future earnings; the direct benefits of being more educated; the pleasure of the social contacts at university or college.

Answers to questions in Economics (6th edition) by John Sloman Page 11 (Box 1.3) 3. Is the opportunity cost to the individual of attending higher education different from the opportunity costs to society as a whole? Yes. The opportunity cost to society as a whole would include the costs of providing tuition (staffing costs, materials, capital costs, etc.), which could be greater than any fees the student may have to pay. On the other hand, the benefits to society would include benefits beyond those received by the individual. For example, they would include the extra profits employers would make by employing the individual with those qualifications.

Would it ever be desirable to have total equality in an economy? The objective of total equality may regarded as desirable in itself by many people. There are two problems with this objective, however. The first is in defining equality. If there were total equality of incomes then households with dependants would have a lower income per head than households where everyone was working. In other words, equality of incomes would not mean equality in terms of standards of living. If on the other hand, equality were to be defined in terms of standards of living, then should the different needs of different people be taken into account? Should people with special health or other needs have a higher income? Also, if equality were to be defined in terms of standards of living, many people would regard it as unfair that people should receive different incomes (according to the nature of their household) for doing the same amount of work. The second major problem concerns incentives. If all jobs were to be paid the same (or people were to be paid according to the composition of their household), irrespective of peoples efforts or skills, then what would be the incentive to train or to work harder? (Box 1.4) 1. There is a saying in economics, There is no such thing as a free lunch (hence the sub-title for this box). What does this mean? That there is always (or virtually always) an opportunity cost of anything we consume. Even if we do not incur the cost ourselves (the lunch is free to us), someone will incur the cost (e.g. the institution providing the lunch). (Box 1.4) 2. Are any other (desirable) goods or services truly abundant? Very few! Possibly various social interactions between people, but even here, the time to enjoy them is not abundant. 1. What is the opportunity cost of the seventh million units of clothing? 3 million units of food. (Food production falls from 3 million units to zero.) 2. If the country moves upward along the curve and produces more food, does this also involve increasing opportunity costs? Yes. Ever increasing amounts of clothing have to be sacrificed for each extra unit of food produced. 3. Under what circumstances would the production possibility curve be (a) a straight line; (b) bowed in toward the origin? Are these circumstances ever likely? (a) When there are constant opportunity costs. This will occur when resources are equally suited to producing either good. This might possibly occur in our highly simplified world of just two goods. In the real world it is unlikely. (b) When there are decreasing opportunity costs. This will occur when increased specialisation in one good allows the country to become more efficient in its production. It gains economies of scale sufficient to offset having to use less suitable resources. We shall look at economies of scale in Chapter 5, sections 5.3 and 5.4. Economies of scale are common in the real world.

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Chapter 1 Page 14 Will economic growth necessarily involve a parallel outward shift of the production possibility curve? No. Technical progress, the discovery of raw materials, improved education and training, etc., may favour one good rather than the other. In such cases the gap between the old and new curves would be widest where they meet the axis of the good whose potential output had grown more. 17

Do you agree with the positions that the eight countries have been given in the spectrum diagram? Explain why or why not. Given that there is no clearly defined scale by which government intervention is measured, the precise position of the countries along the spectrum is open to question. Can you think of any examples where prices and wages do not adjust very rapidly to a shortage or surplus? For what reasons might they not do so? Many prices set by companies are adjusted relatively infrequently: it would be administratively too costly to change them every time there was a change in demand. For example a mail order company, where all the items in its catalogue have a printed price, would find it costly to adjust prices very frequently, since that would involve printing a new catalogue, or at least a new price list. Many wages are set annually by a process of collective bargaining. They are not adjusted in the interim. (Threshold Concept 3) 1. Give two other examples of perverse incentives. How could the incentives be improved? If the government caps the amount of money that local authorities can raise in council tax in order to encourage them to cut waste and reduce their bureaucracy, it might have the perverse effect of reducing the quality of services the local authority provides. If house prices rise in response to the excess of demand over supply, this may have the perverse effect of increasing demand, not choking it off. The reason is that people may see prices rising and rush to buy now before they rise any further. We examine this destabilising speculation in section 2.5. If the government, or firm or anyone else is offering incentives for people to do things, they need to think closely about the unintended consequences of these incentives and, if necessary, change the incentives so as to avoid them. In general it is best to tackle a problem as close to source as possible if these unintended consequences or side effects are to be minimised. (Threshold Concept 3) 2. Find out just what the learning objectives are of the economics course or module that you are studying. What positive incentives are there for you to meet these learning objectives? Identify any perverse incentives and how you would change them. Perverse incentives are likely to arise from assessment capturing only some of the learning objectives, with the result that others will be ignored by some students. Lecturers are encouraged to consider constructively aligning their courses. What this means is that teaching and study methods, class activities, reading and assessment should all match the learning objectives of the course or module.

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(Threshold Concept 4) 1. If there is a shortage of certain skilled workers in the economy, how will market forces lead to an elimination of the skills shortage? The shortage of skilled workers will drive up their wages relative to other workers, thereby choking off the excess demand firms will try to economise on these skilled workers, perhaps by using alternative techniques of production. The higher wages will encourage more people to train. It will also encourage skilled workers to move to the country from abroad. Over time, then, this will lead to increased supply. This will have a dampening effect on the wage rate, making the net rise smaller.

Answers to questions in Economics (6th edition) by John Sloman Page 22 (Threshold Concept 4) 2. If consumers want more of a product, it is always desirable that market forces result in more being produced? No. People may be unaware of the harmful consequences to themselves from the increased consumption of certain products. Also the consumption of certain products may have adverse consequences on other people (e.g. the effects of passive smoking, or the nuisance of litter). Similarly the production of certain goods may result in pollution.

1. Why do the prices of fresh vegetables fall when they are in season? Could an individual farmer prevent the price falling? Because supply is at a high level. The increased supply creates a surplus which pushes down the price. Individual farmers could not prevent the price falling. If they continued to charge the higher price, consumers would simply buy from those farmers charging the lower price. 2. If you were the owner of a clothes shop, how would you set about deciding what prices to charge for each garment at the end of season sale? You would try to reduce the price of each item as little as was necessary to get rid of the remaining stock. The problem for shop owners is that they do not have enough information about consumer demand to make precise calculations here. Many shops try a fairly cautious approach first, and then, if that is not enough to sell all the stock, they make further end of sale reductions later. 3. The number of owners of compact disc players has grown rapidly and hence the demand for compact discs has also grown rapidly. Yet the prices of discs have fallen. Why? The costs of manufacture have fallen with improvements in technology and mass-production economies. Competition from increased numbers of manufacturers has increased supply and driven prices down. Budget-priced CDs of original analogue recordings cost less to produce (there are no new studio costs). In the early 2000s, the advent of copying CD tracks from the Internet has reduced the demand for CDs. This change in demand has further compounded the fall in price. Summarise this last paragraph using symbols like those in Figure 1.7.
T e p e m c a is : th e c o th d c v ry o ra m te ls h ric e h n m e ffe t f e is o e f w a ria

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F c r M rk t a to a e Si s rp s u lu (Si > Di) Pi

Si u til n Di Di = S i

G o s M rk t od a e Sg Pi Sg s rp s u lu (Sg > D
g)

Pg Dg

u til n

Dg = Sg

Are different factor markets similarly interdependent? Give examples. Yes. A rise in the price of one factor (e.g. oil) will encourage producers to switch to alternatives (e.g. coal). This will create a shortage of coal and drive up its price. This will encourage increased production of coal.

Chapter 1 Page 24 (Threshold Concept 5) 1. Would you ever swap things with friends if both of you did not gain? Explain your answer. In most cases you would not do so. The exceptions would be: where you thought you would gain at the time you made the swap, but afterwards find that the item you have obtained does not give you the benefit you thought it would. The problem here is one of imperfect knowledge at the time of the swap. where you were thinking more about the other person than yourself, and swapped something you know they really wanted from you for something you did not really want from them. The question here, however, is whether you can still be said to have gained because you made a sacrifice yourself for someone else. A similar question is whether you gain from giving to charity or giving someone a gift.

(Threshold Concept 5) 2. Give one or two examples of involuntary (i.e. compulsory) economic interaction where one side gains but the other loses. Paying taxes; robbery; parking fines. (Threshold Concept 6) 1. If global warming affects all of us adversely, why in a purely market economy would individuals and firms continue with activities that contribute towards global warming? Partly out of ignorance of the effects, but mainly because people individually gain more from such activities than they lose. Although each time you use your car, or use electricity generated by fossil fuels, you are contributing to global warming, your individual contribution is minuscule. What is more, the amount you suffer personally from global warming is again minuscule compared with the total amount the whole population of the world suffers. Thus many people selfishly ignore the environmental costs of their actions. But when the majority of people do this, then the costs to all of us may be considerable, let alone the costs to wildlife and the planet generally. (Threshold Concept 6) 2. In what ways do your own consumption patterns adversely affect other people? You may what to take a while to reflect on the costs to others of what you do yourself. Are you ever inconsiderate, and if so, in what ways? Do you ever chuck litter away? Do you ever drive without giving due care and attention to other road users, pedestrians or residents, or do you ever park inconsiderately? Do you ever play music in public places that others can hear?

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(Threshold Concept 7) 1. How may welfare benefits be seen as a means of correcting market failures? Does the payment of such benefits create any problems for society? A market economy may lead to a very unequal society. To the extent that this is seen as a market failure, then benefits can help to correct it by redistributing income from richer to poorer people. The main problems from benefits are: They may discourage people from looking for work if this will result in them losing their benefits. They may be set at too low a level to make a significant difference to inequality. The higher taxes that must be paid to fund the benefits may act as a disincentive to taxpayers generally to work so much. This will reduce the level of the countrys production and income. These issues are examined in section 10.2.

(Threshold Concept 7) 2. Assume that the government sees litter as a market failure that requires government action. Give some examples of policies it could adopt to reduce litter. Having litter wardens who could fine people for dropping litter; increasing fines for dropping litter; having an anti-litter campaign on television or on posters; requiring schools to include litter awareness as part of citizenship education; requiring fast food outlets to provide adequate wastebins and encourage their use; putting a tax on plastic bags and packaging to encourage manufacturers, shops and consumers to find alternatives.

Answers to questions in Economics (6th edition) by John Sloman Page 29 Which of the following are positive statements, which are normative statements and which could be either depending on the context? (a) Cutting the higher rates of income tax will redistribute incomes from the poor to the rich. (b) It is wrong that inflation should be reduced if this means that there will be higher unemployment. (c) It is wrong to state that putting up interest rates will reduce inflation. (d) The government should raise interest rates in order to prevent the exchange rate falling. (e) Current government policies should reduce unemployment. (a) Positive. This is merely a statement about what would happen. (b) Normative. The statement is making the value judgement that reducing inflation is a less desirable goal than the avoidance of higher unemployment. (c) Positive. Here the word wrong means incorrect not morally wrong. The statement is making a claim that can be tested by looking at the facts. Do higher interest rates reduce inflation, or dont they? (d) Both. The positive element is the claim that higher interest rates prevent the exchange rate falling. This can be tested by an appeal to the facts. The normative element is the value judgement that the government ought to prevent the exchange rate falling. (e) Either. It depends what is meant. If the statement means that current government policies are likely to reduce unemployment, the statement is positive. If, however, it means that the government ought to direct its policies towards reducing unemployment, the statement is normative.