Practice Test 1

Multiple Choice
Identify the choice that best completes the statement or answers the question.
____

1. What do economists mean when they state that a good is scarce?

a. There is a shortage or insufficient supply of the good at the existing price.
b. It is impossible to expand the availability of the good beyond the current amount.
c. People will want to buy more of the good regardless of the price of the good.
d. The amount of the good that people would like exceeds the supply freely available from
nature.

____

2. According to Adam Smith, individual self-interest

a. is a powerful force for economic progress when it is directed by competitive markets.
b. is a powerful force for economic progress when individuals are wisely directed by a strong
central government.
c. is a major factor in retarding the economic progress of humankind.
d. could be either a positive or negative force for economic progress, depending on the moral
influences of political leaders.

____

3. People are more likely to purchase a consumer ratings magazine that reviews new automobiles before buying
a new car than they are to purchase a consumer ratings magazine that reviews pens and pencils before buying
a new pen or pencil. Which of the following best explains this behavior?
a. Because the consumer ratings magazine must have a higher price for the issue reviewing
pens and pencils.
b. Because the value of the information, in terms of avoiding a mistake on the purchase, is
much higher for an automobile than for a pen or pencil, it is more worthwhile to gather
this information.
c. Because people generally do not know which products are reviewed by these consumer
magazines.
d. None of the above explain this behavior.

____

4. Which of the following best illustrates the fallacy of composition?

a. If the price of a product rises, the quantity produced will decline.
b. The average wage rate tends to increase at approximately the same rate as inflation; hence,
wage increases must cause inflation.
c. Resources are scarce; therefore, there is no such thing as a free lunch.
d. If Susan had more money she could buy more. If everyone had more money they could
buy more.

____

5. The expression "There's no such thing as a free lunch" means

a. in an exchange, if one person gains, someone else must lose.
b. each person must pay for exactly what he or she receives.
c. the use of resources to meet one need means that those resources can no longer be used to
meet another need.
d. in an exchange, if one person gains, someone else must lose and equal amount.

____

6. If an economy is operating at a point inside the production possibilities curve,

a. its resources are not being used efficiently.
b. the curve will begin to shift inward.
c. the curve will begin to shift outward.
d. This is a trick question because an economy cannot produce at a point inside the curve.
Figure 2-1

____

7. In Figure 2-1, point A is

a. unattainable.
b. inefficient.
c. efficient.
d. preferable to point B.
Figure 2-2

____

8. Which of the following would most likely cause the production possibilities curve for breadfruit and fish to
shift outward from AA to BB in Figure 2-2?
a. a decrease in the labor force of the country
b. a sudden change in consumer preferences for more fish and less breadfruit
c. a major technological advance
d. a decrease in the capital stock

Figure 2-10

____

9. Refer to Figure 2-10. If this economy put all available resources into the production of bananas, it could
produce
a. 200 bananas and also 150 baseballs.
b. 300 bananas and also 100 baseballs.
c. 400 bananas and no baseballs.
d. It is impossible to know unless we know the quantity of resources available.

____ 10. Refer to Figure 2-10. If the economy moves from point C to point B, then which of the following statements
is correct?
a. The economy benefited from a technological advance in the production of baseballs.
b. The opportunity cost of each additional baseball is 2 bananas.
c. The opportunity cost of each additional banana is 2 baseballs.
d. The move involves no opportunity cost; it simply reflects the desires of the economy's
citizens.
____ 11. Middlemen, such as grocers, stockbrokers, and realtors
a. specialize in reducing transactions costs.
b. provide nothing of value to either the buyer or the seller.
c. have no effect on economic output in society.
d. do not exist in capitalist economies.
____ 12. When the nation of Duxembourg allows trade and as a result becomes an importer of software,
a. residents who produce software become worse off; residents who buy software become
better off; and the economic well-being of Duxembourg rises.
b. residents who produce software become worse off; residents who buy software become
better off; and the economic well-being of Duxembourg falls.
c. residents who produce software become better off; residents who buy software become
worse off; and the economic well-being of Duxembourg rises.
d. residents who produce software become better off; residents who buy software become
worse off; and the economic well-being of Duxembourg falls.

____ 13. Suppose the United States exports cars to France and imports cheese from Switzerland. This situation
suggests that
a. the United States has a comparative advantage relative to Switzerland in producing
cheese, and France has a comparative advantage relative to the United States in producing
cars.
b. the United States has a comparative advantage relative to France in producing cars, and
Switzerland has a comparative advantage relative to the United States in producing
cheese.
c. the United States has an absolute advantage relative to Switzerland in producing cheese,
and France has an absolute advantage relative to the United States in producing cars.
d. the United States has an absolute advantage relative to France in producing cars, and
Switzerland has an absolute advantage relative to the United States in producing cheese.
____ 14. In 2002, President Bush enacted a 30 percent tariff on imported steel. The primary beneficiaries of this tariff
were
a. U.S. steel companies and employees.
b. U.S. automobile companies and employees.
c. foreign steel companies.
d. foreign steel workers.
e. both a and b above.
____ 15. Public choice theory indicates that tariffs, quotas, and other trade restrictions are primarily the result of the
a. political clout of foreigners.
b. political clout of domestic consumers.
c. political power of the special interest groups.
d. attractiveness of sound economic policies to elected political officials.
____ 16. Nevada is the low opportunity cost producer of computer software, and California is low opportunity cost
producer of wine. Which of the following is true?
a. Nevada has no comparative advantage over California in the production of wine or
computer software.
b. Nevada has a comparative advantage in producing wine
c. Nevada has a comparative advantage in producing software.
d. Nevada has a comparative advantage in producing both wine and software.

Exhibit 18-6

____ 17. Refer to Exhibit 18-6. Which of the following is true?

a. A has a comparative advantage in both cheese and wine.
b. B has a comparative advantage in both cheese and wine.
c. A has a comparative advantage in cheese, and B has a comparative advantage in wine.
d. B has a comparative advantage in cheese, and A has a comparative advantage in wine.
e. none of the above
____ 18. The national-defense argument for trade protectionism holds that
a. what is good for business is good for the country.
b. what is good for consumers is good for the country.
c. consumers' surplus rises by more than producers' surplus falls.
d. producers' surplus rises by more than consumers' surplus falls.
e. none of the above
____ 19. The infant-industry argument for trade protectionism holds that
a. new industries sometimes need a protective environment in which to grow so that they can
compete with older, more established foreign competitors.
b. foreign competitors are often viewed as "infants" by large U.S. firms.
c. tariffs are often preferred to quotas.
d. quotas raise prices more than tariffs raise prices.
e. a and c

____ 20. The following table indicates the production possibilities of food and clothing per worker day in the United
States and South Korea.

Food
Clothing

Units of Output per Worker Day

United States
South Korea
6
2
2
1

Which of the following is true?

a. Mutual gains could be realized if the United States specialized in producing food and
South Korea in producing clothing.
b. Mutual gains could be realized if the United States specialized in clothing production and
South Korea in food production.
c. South Korean workers are the high-cost producers of clothing.
d. None of the above are true.
Essay
21. If economics is correct in its assumption that people are rational, why then would anyone choose to smoke
cigarettes?
22. A radio station gives "free money" to those listeners whose names are drawn and announced over the
airwaves from postcards the listeners sent into the radio station. Is the money really free for the listener?
23. Why would a radio station give money to listeners? Does this violate the economic way of thinking?
24. Joe observes that a car in 1925 sold for an average of $500 versus $20,000 for a 2005 model. He concludes
that 2005 cars must be 40 times better than 1925 cars. What's wrong with this way of thinking?
25. Evaluate this statement: "People engaged in economizing behavior will always buy the lowest priced item
they can find."
26. Homeowners can deduct interest payments on their mortgages from their federal income tax. If this deduction
were removed, how would the housing market be affected?
27. If people are self-interested, why does anyone give money to public radio?
28. When Mother Theresa won the Nobel Peace Prize, the monetary award was well in excess of $100,000. Did
she accept the money? If so, what did she do with it?
29. Who is more likely to drive carelessly, Sue in her 1980 Ford with bad brakes or Sally, who has a 2005 BMW
with all the most recent safety options?
30. A popular video program, used to teach primary school children about economics, defines scarcity as "when
you don't have enough of something." Evaluate this definition based on your understanding of the scarcity
concept.

31. A popular video program used to teach economics to primary school children defines opportunity cost as
"what you give up to get something." In light of your understanding of opportunity cost, how would you
modify this definition?
32. After the terrorist attacks on September 11, 2001, the United States began devoting substantial resources
toward the War on Terrorism, homeland security, and relief efforts. Use the production possibilities curve to
demonstrate how this might affect the production of other goods in the United States.
33. An economics professor points to a student in the front row and announces that "sitting in class is the thing
you value most during this time period." Is the professor correct? Why or why not?
34. Explain the idea of capital investment by using the story of Robinson Crusoe. What is sacrificed, and what is
gained?
35. The president of a large public university proclaims, "If we can get the state government to fund our new
football stadium, it will not cost us anything." Evaluate this view from an economic perspective.
36. Mark and John are 10-year-old twins who do not get along. They have opened separate lemonade stands and
are competing with each other, selling lemonade on their block. Their mother observes that Mark is very good
at making lemonade and John is an excellent young salesman. She suggests they both could make more
money if they worked together. John counters that two stands will always make more money than one. Who is
right? Why?
37. A department store buys a wool coat for $120 and sets its retail price at $300. The coat costs $85 to produce.
When the coat doesn't sell, the store marks the price down to $200, then $100, and finally $70. At $70, Amy
buys the coat. What was the coat's true value? Why?
38. Jim values his car at $2,000, and Kelly values it at $5,000. Can value be created in this situation? How?
Suppose Jim refuses to sell for less than $6,000. Is value destroyed? Why or why not?
39. Market economies are often criticized for how they answer the basic question, "For whom are goods
produced?" This criticism usually comes from people who believe that the distribution of income is not "fair."
Is there some way to separate production from distribution so that we can leave production just as it is but
make the distribution of income "fairer"?
40. It can be said that, ultimately, consumers are the driving force in answering the three basic economic
questions. Explain the consumer's role in providing these answers.
41. What benefits are to be gained from countries producing according to the law of comparative advantage?
What if a country is absolutely more productive in all goods?
42. What is the law of comparative advantage, and why is it important in international trade?
43. At one time, it was believed that the way for a nation to prosper was to export as much as possible while
importing as little as possible. More money would flow into a country than out of a country. Is this really a
sound economic strategy? What is the relationship between exports and imports?

44. Suppose that in the absence of trade, the U.S. price for peas was lower than the world price for peas. Would
allowing international trade mean that the United States would import or export peas? Who in the United
States would benefit and who would lose with a free trade policy, and would the gains be greater than the
losses?
45. Suppose that in the absence of trade, the U.S. price for bicycles was higher than the world price for bicycles.
Would allowing international trade mean that the United States would import or export bicycles? Who in the
United States would benefit and who would lose with a free trade policy, and would the gains be greater than
the losses?
46. "Economists have demonstrated that imports benefit consumers while causing losses to producers, and
exports benefit producers while causing losses to consumers. In the balance then, international trade neither
benefits nor hurts a nation as a whole." Evaluate this statement.
47. What is the difference between a tariff and a quota?
48. What are the effects of a tariff, and who benefits and who loses when tariffs are imposed? What are the effects
of a quota, and who benefits and who loses when quotas are imposed?
49. "Trade restrictions will stop foreign imports, which will increase American employment and protect American
jobs." Most economists realize this argument is wrong. Can you explain why?
50. In 1993 the negotiations over the North American Free Trade Agreement and the General Agreement on
Tariffs and Trade were frequently characterized by comments such as, "Free trade with low-wage countries
will cause the wages of U.S. workers to fall." Identify the errors in statements such as this.

Practice Test: Econ 1/2

Answer Section
MULTIPLE CHOICE
1. ANS: D
PTS: 1
OBJ: Suggested Quiz
2. ANS: A
PTS: 1
TOP: Outstanding Economist: The Importance of Adam Smith, the Father of Economic Science
3. ANS: B
PTS: 1
TOP: The Economic Way of Thinking
4. ANS: D
PTS: 1
TOP: Pitfalls to Avoid in Economic Thinking
5. ANS: C
PTS: 1
OBJ: On-line Practice
6. ANS: A
PTS: 1
OBJ: Suggested Quiz
7. ANS: B
PTS: 1
OBJ: Graphics Questions
8. ANS: C
PTS: 1
OBJ: Graphics Questions
9. ANS: C
PTS: 1
OBJ: Graphics Questions
10. ANS: B
PTS: 1
OBJ: Graphics Questions
11. ANS: A
PTS: 1
OBJ: On-line Practice
12. ANS: A
PTS: 1
TOP: Gains from Specialization and Trade
13. ANS: B
PTS: 1
TOP: Gains from Specialization and Trade
14. ANS: A
PTS: 1
TOP: Trade Barriers and Popular Trade Fallacies

15. ANS: C
PTS: 1
16. ANS: C
PTS: 1
17. ANS: C
PTS: 1
LOC: International trade and finance
18. ANS: E
PTS: 1
LOC: International trade and finance
19. ANS: A
PTS: 1
LOC: International trade and finance
20. ANS: A
PTS: 1

TOP: Trade Barriers and Popular Trade Fallacies

OBJ: On-line Practice
DIF: Moderate
NAT: Analytic
DIF: Moderate

NAT: Analytic

DIF: Moderate

NAT: Analytic

TOP: Gains from Specialization and Trade

ESSAY
21. ANS:
Even though the harmful effects of cigarette smoking are documented, more than 20 percent of the U.S. adult
population continues to smoke. The economic model of rational choice suggests that individuals weigh the
marginal benefit of smoking an additional cigarette (the pleasure obtained) against the marginal costs (the
pecuniary cost, the price of the cigarette, and the risk of being afflicted by smoking-related diseases,
discounted by the probability). Since the likelihood of getting a smoking-related disease increases with age, it
is not surprising that more people elect to give up the habit as they get older.
PTS: 1
OBJ: Critical Thinking
22. ANS:
While most students can identify the monetary cost of the postcard and stamp, we also must consider the
opportunity cost of listening to the radio. It is true that we can do other activities while the radio is on and
listen attentively when a name is drawn and announced over the airwaves. But there's also the opportunity
cost of not being able to listen to another station, one that might offer more preferred programming.
PTS: 1
OBJ: Critical Thinking
23. ANS:
Radio stations do surveys to see what types of prizes listeners want (for example, cars, boats, vacations, etc.).
Overwhelmingly, people say they want cash. A radio station that gives away money attracts listeners, and the
more listeners a station has, the more it can charge advertisers. The owners of the radio station clearly believe
the revenue this activity generates, in terms of advertising dollars, exceeds the money given away.
PTS: 1
OBJ: Critical Thinking
24. ANS:
Poor Joe has made several errors. First, a 1925 car differs substantially from a 2005 car. As the saying goes,
Joe is comparing apples and oranges. Second, the value of the dollar has declined; Joe, therefore, is using as
his measure a unit that has changed sizes. This is like measuring one room with a 50-inch stick and another
room with a 20-inch stick. We can give both measures in terms of sticks, but they are not very comparable.
PTS: 1
OBJ: Critical Thinking
25. ANS:
As long as price is the only factor, we would expect people to buy the lowest priced product. However, once
we consider quality, ease of operation, performance, durability, looks, etc., we can see why people would not
necessarily buy the lowest priced item. While people generally seek products that yield the most benefits
relative to costs, a product that can provide additional benefits would lead to a willingness to pay a higher
price.

PTS: 1
OBJ: Critical Thinking
26. ANS:
The deductibility of these interest payments is an attractive feature of home ownership. If this deduction were
removed, we would expect fewer people choosing to own their own homes. Additionally, we would expect to
see more families in rental housing.
PTS: 1
OBJ: Critical Thinking
27. ANS:
Since people can listen to public radio without having to contribute, we know this can create a funding
problem. However, since the economic concept of enlightened self-interest is broader than a narrow, selfish
view, we would see people making this choice as contributing to their own interests. These people consider
public radio good for their community. They value their community's well-being and, therefore, support
public radio.
PTS: 1
OBJ: Critical Thinking
28. ANS:
Mother Theresa used the money to help the poor, whom she spent a lifetime assisting. While we consider
Mother Theresa to have been one of the most unselfish of people, it is clear that she could have gained more
of what she valued if she had more money.
PTS: 1
OBJ: Critical Thinking
29. ANS:
On the surface, we might conclude that Sally will be more careful since she appears to have more to lose (a
higher priced car), but insurance likely will cover any monetary loss. Most people value their life and health
more than material possessions; because of this, we expect Sue to be more careful due to her unsafe car. Sally
can afford to take more risks since her car is in better condition and has the latest safety features.
PTS: 1
OBJ: Critical Thinking
30. ANS:
This definition is a bit simplistic for college understanding. The video uses the example of three hats and four
children to assert a scarcity of hats. We would more properly view this as a shortage of hats created because
the hats, as presented, have no price. The shortage can be eliminated but scarcity cannot. Scarcity is the
fundamental concept from which economics derives. Besides resources, virtually all other things, including
your time, are scarce. Your textbook's definition will serve you better than the one from the video.
PTS: 1
OBJ: Critical Thinking
31. ANS:
The video program always gives the children two choices; the choice forgone, therefore, is the opportunity
cost. For children of this age and reasoning ability, this is probably a good approach. We know, however, that
more than one option is relinquished once a decision has been made. A choice to take a 9 a.m. economics
class will mean that you cannot take English, French, math, biology, or philosophy at that time. Our
understanding of opportunity cost reveals that it is only the highest valued alternative forgone.
PTS: 1
OBJ: Critical Thinking
32. ANS:
Increased resources devoted toward these efforts must come away from the production of other goods,
reducing the production of these other goods.
PTS: 1

OBJ: Critical Thinking

33. ANS:
If the student is rational (and this is an assumption made in economics), he allocates time to its highest valued
use. By attending class, the student has revealed that this activity was valued most during that time period. If
this were not true, the student wouldn't be there.
PTS: 1
OBJ: Critical Thinking
34. ANS:
For Robinson Crusoe, engaging in capital investment involves producing tools now that would increase his
consumption possibilities in the future. Examples might include making a net for fishing or constructing a
tool that enables him to pick fruit faster. By engaging in these activities, he will not be able to use the time to
fish and pick fruit for immediate consumption. He sacrifices consumption and gains the ability to consume
more fish and more fruit in the future.
PTS: 1
OBJ: Critical Thinking
35. ANS:
While it may not directly affect the university's budget, the cost will be borne by taxpayers. Also, there will be
opportunity costs brought about by diverting stadium funding from roads, hospitals, or primary schools. We
also should not ignore the fact that the state may reduce its funding of the university in other areas, such as
student financial aid, to compensate for the cost of the football stadium.
PTS: 1
OBJ: Critical Thinking
36. ANS:
The mother makes the point that gains from trade are possible and that the law of comparative advantage
should apply. If the two stands operate separately, Mark might make quite a bit of lemonade but be unable to
sell it. John might sell all he makes, but this is probably not very much. By working together, the two should
be able to sell more lemonade than is possible if they operate two stands independently.
PTS: 1
OBJ: Critical Thinking
37. ANS:
Since the coat sold for $70, we would have to say that this is its value. In economics, the value of a product is
assigned when a trade is made. Retail prices, costs of production, etc. are not relevant when assigning value.
Goods are valued based on what individuals will give for them.
PTS: 1
OBJ: Critical Thinking
38. ANS:
Value can be created in this situation. Jim can sell the car at more than $2,000, and Kelly can buy it at $5,000
or less. For example, suppose the car sells for $3,000. Jim has given up a good worth $2,000 to him in
exchange for $3,000. He is better off by $1,000, a value created by the exchange. Similarly, Kelly is $2,000
better off because she has something that is worth $5,000 to her, and she only had to relinquish $3,000 to
acquire it. If Jim refuses to sell the car, no value will be created, but none will be destroyed either. While a
possible gain is forgone, no one is made any worse off by a transaction not taking place.
PTS: 1
OBJ: Critical Thinking
39. ANS:
Unfortunately, there is no way to totally separate the act of production from the way income is distributed. We
know that incentives matter, and tying income to production gives people the incentive to produce. Fairness is
a normative concept, and reasonable people will disagree over what distribution of income is more fair. Since
incentives matter, any attempt to change the distribution of income is likely to destroy some of the incentives
for production.

PTS: 1
OBJ: Critical Thinking
40. ANS:
What will be produced is determined by businesses, but they know that the only way to succeed is to offer
products consumers find desirable. What they produce is determined by what consumers want. How the goods
will be produced is determined by firms that continually seek lower costs of production. Since consumers are
price conscious, they will buy the product that carries the lowest price, ceteris paribus. Firms that lower
production costs can lower prices and attract more consumers. The goods are consumed by people who desire
them and have the ability to pay. Since income is derived from production, those who produce more of what
consumers value will have higher incomes. The consumer is at the heart of all three basic economic questions.
PTS: 1
OBJ: Critical Thinking
41. ANS:
When countries produce according to the law of comparative advantage and then trade, the consumption
possibilities expand for all countries involved. This is because producing goods for which a country has a
comparative advantage means that goods are produced at the lowest relative opportunity cost, thus freeing
resources for the production of more goods. Even if a country has an absolute advantage, it will still gain from
trade because it is comparative, not absolute, advantage that determines which countries should produce
which goods.
PTS: 1
OBJ: Critical Thinking
42. ANS:
The law of comparative advantage states that aggregate output is maximized when countries specialize in the
production of goods for which they are the lowest opportunity cost producer and then trade for other goods. It
explains how countries can improve their situation through trade, rather than producing all goods themselves.
PTS: 1
OBJ: Critical Thinking
43. ANS:
This is a bad strategy. When few goods are imported, foreign countries will not have the currency necessary
to buy a country's exports, and the volume of trade must therefore decline. For international trade to take
place at all, a country must both import and export. There cannot be one without the other.
PTS: 1
OBJ: Critical Thinking
44. ANS:
The United States would export peas as producers increased output to take advantage of the higher world
price. The U.S. price would rise to meet the world price, and U.S. producers would gain, while U.S.
consumers would lose. The gains to producers would, however, outweigh the losses to consumers.
PTS: 1
OBJ: Critical Thinking
45. ANS:
The United States would import bicycles as consumers demanded more bicycles at the lower world price. The
U.S. price would fall to meet the world price, and U.S. consumers would gain, while U.S. producers would
lose. The gains to consumers would, however, outweigh the losses to producers.
PTS: 1
OBJ: Critical Thinking
46. ANS:
The first part is true, but the conclusion is incorrect. With both imports and exports, the gains to one party
outweigh the losses to the other party. International trade, therefore, leads to net gains for a country as output
and consumption are expanded beyond what could be achieved in the absence of trade.

PTS: 1
OBJ: Critical Thinking
47. ANS:
A tariff is a tax imposed by a government on foreign imports. A quota is a ceiling placed on the quantity of
foreign imports during a given period.
PTS: 1
OBJ: Critical Thinking
48. ANS:
A tariff raises the domestic price of the good the tariff is placed on. The higher price benefits domestic
producers, and the tariff revenue benefits the government, both at the expense of domestic consumers. A quota
raises the domestic price of the good with the quota imposed on it. The higher price benefits domestic
producers and the foreign producers who are allowed to sell the good, both at the expense of the domestic
consumer.
PTS: 1
OBJ: Critical Thinking
49. ANS:
Trade restrictions will stop foreign imports, but this means that foreigners will no longer have the dollars that
those imports used to generate. With fewer dollars, foreigners will buy fewer American goods (since this is
virtually the only thing that dollars are good for). Employment in American export industries will suffer.
Trade restrictions only protect jobs in industries that compete with imports; they destroy jobs in export
industries.
PTS: 1
OBJ: Critical Thinking
50. ANS:
One error is that higher wages do not mean higher per-unit labor costs. The costs of producing a good depend
on both labor costs and labor productivity, an area where the United States frequently has a tremendous
advantage. A second error stems from the difference between absolute and comparative advantage. High
productivity will not allow the United States to produce everything more cheaply, and neither will low wages
allow other countries to produce everything more cheaply. Beneficial trade will be based on comparative
advantage, not wage rates.
PTS: 1

OBJ: Critical Thinking