Basics of Economics

Economics is the study of how people react and allocate resources that are limited in supply.
Under most circumstances, the answer to this question is determined by assessing what a self
serving person will do because self interest is assumed to drive most human behavior. With the
basic tools of economics in hand, one can predict behavior not only in business and finance but
also in basic human behavior. Economics can be a very useful discipline to understand.

History of Economics
1. Economics as a formal discipline began with Adam Smith and the 1776 publication of
"An Inquiry into the Nature and Causes of the Wealth of Nations." The book, which
eventually became known as "The Wealth of Nations" contended that economies
gravitate to efficient allocations through the influence of "the invisible hand." The
invisible hand of which Smith speaks is the human desire to get the most for himself that
he can; one might describe it as greed. In the early years, economics was a subset of
philosophy and many early economists were also famous philosophers, such as John
Stuart Mill.

Supply Curve
2. The supply curve represents the quantity of goods that will be produced at various prices.
As one would expect, the higher the price that can be received, the more that will be
produced. The pitch of the curve describes the impact of changes of price on the quantity
of the goods that will be produced.

Demand Curve
3. The demand curve is the major counterpart to the supply curve. It represents the
relationship between the price of goods and the quantity that will be demanded.
Logically, the quantity demanded drops as price increases and vice versa. As wtth the
supply curve, the pitch of the demand curve represents the degree to which price will
effect the quantity demanded.

Equilibrium in a Simple Macroeconomic Model

4. Graphically, supply and demand almost always intersect because supply curves slope
upward and demand curves slope downward. The Y axis is cost and the X axis is
quantity. The result looks something like an X. The point where the lines cross is
equilibrium--the quantity supplied matches to that demanded. This is the most efficient
production point.

Assumptions in Basic Economic Models

 5. The basic economic model assumes competition by many potential suppliers and many
potential buyers. Using this assumption, an efficient allocation of resources will occur.
However, markets do not always have many participants. Some industries only have a
few suppliers; these are called oligopolies. Some only have one; these are monopolies.
Likewise, there may be limited numbers of buyers, creating oligopsonies or monopsonies.
In any of these instances, the allocation of resources will not be as efficient as with
competitive markets.

Objective-Type Economics Questions

With objective test questions, there is only one correct answer. True-false and multiple choice
items are popular formats for objective questions. Objective tests are popular in economics
courses, especially in the introductory principles classes, such as principles of microeconomics
and principles of macroeconomics. Objective questions in economics may seem easy to design,
but require solid economics knowledge, as well as an understanding of how to write good test
questions.

Question Components
1. Objective questions in economics or in any subject consist of four parts: the stem, or the
text of the question itself; the options the set of answer choices (two in the case of a true-
false question, or three to five with a multiple choice question); the key, or the correct
option; and the distracters, the incorrect options.

Before writing an economics test, it is important to consider the question format. Many
examiners and instructors recommend multiple choice questions, with four or five answer
choices. With the true-false format, a student has a 50-percent probability of choosing a
correct answer, making it possible to get at least some questions correct through blind
guesses.

Economic Terms and Concepts

2. Most objective economics questions focus on key terms and concepts in the discipline.
The following question illustrates this:

"In a free market economy, production and allocation decisions are made by: a) the
government; b) voters; c) the private sector; d) consumers." The correct answer in this
example is c, the private sector. Questions such as this help to gauge student knowledge
of basic economic concepts, which will inform their understanding of more advanced
principles.
 Tools of Analysis
3. Other objective questions can test students' understanding of some of the basic tools of
economic analysis. For example, a question could measure a students' understanding of
supply and demand curves, which they will see on many economic diagrams. One such
question might be the following:

"A supply curve can shift because of changes in: a) prices of inputs; b) increased demand;
c) government regulation; d) all of the above." The correct answer here is d. This
question tests students' knowledge of one of the basic characteristics of supply curves.

Cautionary Notes
4. When writing objective questions for economics tests, it is important to write the
questions in clear, straightforward language that is free of extraneous material. To use an
earlier example, the question "In a free market economy, such as that advocated by Adam
Smith in The Wealth of Nations, production and allocation decisions are made by..."
contains unnecessary information because of the phrase about Adam Smith.

Other important considerations when designing questions include ensuring that there is
only one correct answer for each question and that distracters are plausible.

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