Answers to Questions in Chapter 1

Review Questions

Thinking Exercises

4. Change the numbers in the example of gains from trade in the following way: Assume that Lisa takes 6 hours (rather than 4 hours) to complete an inventory count. Then Table 1 changes to:
 

Without trade, Lisa would work 9 hours and Mitch would work 11 hours. With the specified trade, Lisa works 6 hours and Mitch works 10 hours, so Lisa gains 3 hours of time from the trade, and Mitch gains 1 hour of time.

(b) How would your answer to Exercise 4a change if Lisa took 10 hours to count inventory in one section of the store?

Without trade, Lisa would work 16 hours and Mitch would work 11 hours. With the specified trade, Lisa would work 6 hours and Mitch would work 10 hours, so Lisa would gain 10 hours of time from the trade, and Mitch would gain 1 hour of time.
 

5. Change the numbers in the example of gains from trade in the following way: Assume that Mitch takes 2 hours (rather than 5 hours) to count inventory in one section of the store. Then Table 1 changes to:
 

Without trade, Lisa would work 7 hours and Mitch would work 8 hours. With the specified trade, Lisa would work 6 hours and Mitch would work 4 hours, so Lisa would gain 1 hour of time from the trade, and Mitch would gain 4 hours of time.

(b) How would your answer to part (a) change if Mitch took 1 hour to count inventory in one section of the store?

Without trade, Lisa would work 7 hours and Mitch would work 7 hours. With the specified trade, Lisa would work 6 hours and Mitch would work 2 hours, so Lisa would gain 1 hour of time from the trade, and Mitch would gain 5 hours of time.
 

6. Review your list of questions from Exercise 3, and explain how the answers to these questions could affect your life.

What makes our material standard of living rise over time? Conditions in the world could change so that standards of living start falling, making me poorer in the future; or conditions could change so that standards of living start rising even more rapidly, raising my future standard of living.

Why do countries like the United States, Japan, and Germany produce so many more goods and services per person than countries like Bangladesh and Ethiopia? Understanding the answer to this question might allow poor countries to improve their standards of living, which may lead to richer cultural influences on my life and perhaps even decreased chances of war in the future.

What are the causes of poverty? What can governments do about poverty?

Reducing poverty would clearly help the poor. Because the consequences of poverty include social problems of many sorts, it would also have indirect effects on other people.

What leads our economy to produce enough food and housing for us? It is important to my future that the economy produce the goods and services that I will want to buy.

Why do about 130 million Americans hold paid jobs outside the home? Why are 6 million unemployed? A better understanding of the causes of unemployment might help us reduce it, raising my future economic security.

Who gets which of the goods and services worth $36,000 per person that are produced each year in the United States? The distribution of income matters -- do the rich get most of the goods and services produced in our economy?

How do government economic policies—taxes, regulations, and spending—affect your life? Taxes will affect me because I will pay them. Government regulations may affect the type of job I get and the types of goods and services available for me to buy; Government spending will affect the quality of the roads I drive on, the schools my children attend, and my future safety from criminals and terrorists.
 
 

Review Questions

7. What is an opportunity cost? Give an example.

Your opportunity cost of doing something is the value of whatever you must sacrifice to do it. For example, your opportunity cost of spending 10 dollars for a T-shirt equals the value to you of the other things you could have bought for those 10 dollars. Your opportunity cost of reading this book may be watching television, if that is what you would do if you didn’t have to read this. The opportunity cost of spending an hour watching television might equal the value of one hour sleep. The opportunity cost to a community of spending additional resources for a sports center might equal the value of improved schools that the community could have had for those same resources.
 

8. Who wrote The Wealth of Nations and what important point did it make?

Adam Smith wrote the Wealth of Nations. In it, he explained that when people trade voluntarily, all parties expect to benefit. He also explained that because people trade, each person's actions affect other people. Even selfish actions often help other people. He explained that the butcher and the baker provide food for our dinner not because of their own altruism, but because of their own self-interests. Smith explained that even in acting selfishly, people are often "led by an invisible hand to promote an end which was no part" of their intentions.
 

9. What was the point of the pencil story?

The point of the pencil story was to show how the market process coordinates people's actions by providing them with incentives to do things that help others. The market process leads the actions of people to fit together even when people do not know each other or come from distant lands with different cultures and languages. It leads people to cooperate to make pencils, even though no one person plans or directs the whole operation. The pencil story illustrates Adam Smith's invisible hand in action.
 

10. What was the point of the cookie-jar example?

The point of the cookie jar example was to illustrate how property rights affect incentives. Property rights provide incentives to conserve resources, and to create more goods. When a person owns a resource, she has an incentive to conserve it and use it wisely. When a resource is not owned by anyone in particular, people have incentives to overuse that resource. Also, people have incentives to work to create additional goods and services if they will own the results of their labor.

Thinking Exercises

11. (a) What is your opportunity cost of attending this economics course?

I might take a history course instead. The opportunity cost of attending a particular lecture might be the sleep I could have instead.

(b) What is your opportunity cost of attending college?

The opportunity cost of attending college includes the tuition and fees that I have to pay, plus the money that I could be earning if I were working in a job full-time.

(c) What was your opportunity cost of the last meal you ate?

I had a hamburger at the last meal ate. The opportunity cost of that was a taco.

I had already paid for a college food plan, so my last meal didn't cost any extra money. However, I could have spent the time sleeping instead, and I could have saved calories for the party tonight.

(d) What is society’s opportunity cost of producing pizzas?

The people who make the pizzas could work in other jobs -- washing cars, painting houses, writing poetry, performing surgery, etc. The tomatoes that went into the pizza sauce could have gone into ketchup instead, or the farmers who grew the tomatoes could have produced soybeans instead, or stopped farming and worked as plumbers or rock musicians instead. The electricity used to heat the ovens to bake the pizzas could have been used for additional lighting or air conditioning. Similar comments apply to all the other inputs used to produce the pizzas. Basically, the economy could have produced other goods and services instead of pizzas.

12. The beginning of this chapter discussed a trade between Lisa and Mitch.

Table 1

Lisa and Mitch Gain from Trade
 

	Hours of Work Required for
	Lisa	Mitch
Task
Taking inventory in one section of the store	4 hours	5 hours
Setting up a new display in one section of the store	3 hours	6 hours
total time spent
Without a trade	7 hours	11 hours
With the trade	6 hours	10 hours
the trade
Mitch trades 5 hours of his time (taking inventory in the women’s section) for 3 hours of Lisa’s time (setting up the display in the men’s section). Mitch pays 5 hours of his time for 3 hours of Lisa’s time; Lisa pays 3 hours of her time for 5 hours of Mitch’s time.  Lisa and Mitch both gain 1 hour of leisure time from the trade.

 
Look back at Table 1 and identify:

(a) Lisa’s opportunity cost of taking inventory in one section of the store

Lisa’s opportunity cost of taking inventory in one section of the store is setting up 1-1/3 displays. In other words, in the four hours that she needs to take inventory in one section, she could have set up one new display (which takes her three hours) and spent the remaining hour setting up one-third of another display.

(b) Lisa’s opportunity cost of setting up a new display in one section of the store

Lisa's opportunity cost of setting up in new display in one section of the store equals three-fourths of a completed inventory. In other words in the three hours it takes her to set up a display, she could have the inventory 3/4 done.

(c) Mitch’s opportunity cost of taking inventory in one section of the store

Mitch’s opportunity cost of taking inventory in one section of the store is setting up 5/6 of a display.

(d) Mitch’s opportunity cost of setting up a new display in one section of the store

Mitch’s opportunity cost of setting up a new display in one section of the store is getting 1-1/5 of an inventory completed.

13. List five trades you have recently made. Explain your gains from the trades and the gains to the other parties to the trades.

(1) I did the dishes, and my sister did the wash. I gained, because I hate doing the wash. She gained, because she hates doing the dishes.

(2) I got free CD in the mail for joining a music club. I hate the CD, but my roommate likes it, so I traded it to my roommate in return for CD that I like better. We both gained from trade because we both ended up with CDs that we like better than the ones we had before.

(3) I visited home for my mother's birthday. I didn't really want to go, but I never would've heard the end of it if I hadn't gone. In essence, I traded my presence at home that weekend for freedom from complaints from my family. I gained from this trade because it was better to go home than to put up with those complaints. They gained because they wanted me home, and I went.

(4) I bought a paperback book for six dollars; I probably would been willing to pay up to about nine or 10 dollars for that book. Therefore, my gain from trade was about three or four dollars. In fact, the book was even better than I expected, so my gain from trade turned out to be even higher than that. At the time I bought the book, however, I expected a gain equal to about three or four dollars. The store that sold the book got my six dollars, and they probably had to pay less than six dollars to buy the book from the publisher, so they gained the trade also.

(5) As usual, I went to work for ten hours last week. They pay me seven dollars per hour, so I'm trading each hour of my leisure time for seven dollars. I gain from this trade because 70 dollars per week is more valuable to me then the 10 hours of leisure time I could have otherwise had.

(6) I bought lunch for $3.15. I gained from the trade because I wanted that lunch more than I wanted my $3.15. The lunch was worth about $4.25 to me -- if the prices had been higher, I would have been willing to pay up to about $4.25 (but not more than that) for the lunch. So I gained about $1.10 because -- to me -- the lunch was worth about $1.10 more than I had to pay for it. I presume the restaurant gained some profit from selling me the lunch, but I don't know how much profit. After all, they had to buy and cook the food, and pay the people who cooked it and operated the cash register.

Problems

14. Read the news article, "Clashing Priorities: Cancer Drug May Save Many Human Lives—At Cost of Rare Trees," and explain how its topic relates to scarcity and opportunity costs.

The yew trees are scarce, and Northern spotted owls are scarce and they need the trees, but the medication that people can get from the trees is also scarce. The opportunity cost of getting the medicine to save human lives is killing some of the trees and therefore some of the owls. The opportunity cost of saving the trees and owls is losing some human lives.
 

15. Comment on this statement: "The opportunity cost of AIDS research is cancer research."

The more time and resources that medical researchers spend on one disease, the less time and resources available for other diseases, unless more people become medical researchers and society provides them with more resources for research (in which case the opportunity cost is whatever other goods and services those people and resources would have otherwise produced).
 

16. What is the opportunity cost of:

(a) Getting married

An opportunity cost of getting married includes the freedom to live alone, differently than one might live when married, and to continue looking for another partner.

(b) Freedom of speech

The opportunity cost of freedom of speech includes the harm that people sometimes feel from speech that they consider offensive.

(c) A law prohibiting college-age students from drinking alcohol

The opportunity cost of a law prohibiting college-age students from drinking alcohol may include whatever benefits those students might perceive from drinking alcohol, or disrespect for a law that people view as unfair and choose to violate.

(d) A policy to reduce global warming

The opportunity cost of a policy to reduce global warming includes the loss of benefits from products that the policy may restrict.

(e) The war on illegal drugs

The opportunity cost of war on illegal drugs includes the human time and other resources devoted to that effort, which could be used for other purposes (such as other types of law enforcement, or production of other goods and services).

(f) Protecting children from pornography on the Internet

The opportunity cost of protecting children from pornography on the Internet may include loss of freedom for adults who wish to view pornography, as well as inadvertent restrictions on access to other, non-pornographic, material.

(g) Preventing terrorists from acquiring chemical, biological, or nuclear weapons

The opportunity cost of preventing terrorists from acquiring such weapons includes resources that could produce other goods and services, and may also include losses of freedom and privacy.

17. Explain how the market process can lead people who act out of selfish interests to do things that help others.

Most people work out of selfish interests -- they want the money they can earn by working. Generally, their work helps other people; so they act out of selfish interests to do things help others. People work to produce better products in order to attract more customers and keep them. The market process gives people incentives to produce parts for products that they will never see, such as graphite for pencils or iron oxide for videotapes, by providing markets for these products.
 

18. What is the "invisible hand" in economics?

The invisible hand is a metaphor, first used by Adam Smith, for the market process.
 

19. Explain how limitations on property rights can lead people to waste scarce resources.

Limitations on property rights can lead people to waste scarce resources by reducing incentives to conserve those resources. For example, if people share the cookies in a cookie jar, they have incentives to eat them faster than if each person has his own cookies. When no one owns the fish in a lake, people lack incentives to conserve those fish -- as a result, people tend to over fish the lake and deplete the waters. When no one owns a forest, people lack incentives to conserve the forest -- as a result, people chop down the trees and clear the forest more rapidly than they would if an owner had the incentive to conserve that forest. Typically, people of greater incentives to take care of things that they own then to take care of things that are owned by no one in particular.

20. Explain how a tax can interfere with people’s incentives to gain from a trade.

A tax can interfere with people's incentives to trade, reducing gains from trade. For example, suppose Lisa and Mitch must pay a 10 dollar tax on the trade. They may decide that it is better not to trade -- and sacrifice the leisure time that they would have gains from a trade -- than to trade, gain leisure time, but pay the 10-dollar tax.

21. A baker is willing to bake a cake if he can sell it for at least $6 (to cover the costs of ingredients, the use of his oven, and his time and effort). A customer is willing to pay $10 for a cake.

(a) Would some trade help both the baker and the customer? What trade?

Yes. Suppose the customer pays $8 for the cake. Then both the customer and the baker gain. (The same is true for any price between $6 and $10.)

(b) How much do the baker and the customer gain from the trade you proposed in part (a)?

The customer would be willing to pay up to $10 for the cake, so the customer gains $2 from buying the cake for only $8. The baker would be willing to sell the cake for any price above $6, so the baker also gains $2 from selling the cake for $8.

(c) How would your answer to part (a) change if the government imposed a $2 tax on every cake sold?

The baker and the customer can still gain from trade. The customer could pay $7 for the cake, plus $2 tax, for a total of $9. The customer gains from trade because the price is below $10. The baker gains from the trade, by selling the cake for $7.

(d) How would your answer to part (a) change if the government imposed a $5 tax on every cake sold?

Now there is no trade in which the baker and the customer can each gain. The customer is not willing to pay more than $10, but if the price including the $5 tax is $10, then the baker only collects $5. The baker is not willing to sell a cake for a price that low, so there is no possible trade in which both people gain.

22. How can someone own a song? How can someone own an idea?

A person can own a song if that person has the right to determine the use of that song, or receives payment for its use. For example, the owner of the song may collect money whenever someone performs it for profit, either live on a recording. A person can own an idea if that person has the right to determine who uses that idea in certain ways, and to collect payment for its use.

23. Comment on this claim: "People who say that the Gulf War [between the United Nations and Iraq in 1991] cost the United States billions of dollars are wrong. Most of those billions of dollars were spent on military equipment sold by American businesses. The arms manufacturers got money that would otherwise have gone to beer manufacturers, but the United States as a whole did not pay a big cost for the war." What was the United States’ opportunity cost of the war?

The opportunity cost of the war included all of the goods and services that the United States could have produced -- including beer -- if people had produced these other goods instead of military equipment. If the nation produced billions of dollars worth of military equipment, it could probably have produced billions of dollars of other goods and services instead, so the United States did pay a big cost for the war.

Inquiries for Further Thought

24. Reread the news article from Exercise 14. How do you think our society should make decisions on matters like this? Can you think of any general principles that would apply to all similar kinds of decisions?

25. Do people always benefit from voluntary trades? Why might voluntary trades leave them worse off rather than better off?

26. Should the government prohibit people from trading some goods or services? Why or why not? Defend your answer.