Questions for Review with Answers
Chapter 1. The Paradigm of Economics
I. The Nature of Man
Chapter 1– Question 1
What are the major characteristics of homo economicus?
* Homo economicus is a selfish, rational maximiser of utility whose needs are unlimited.
Chapter 1– Question 2
Define utility.
* Joan Robinson's definition on this chapter's front page is quite good: "Utility is the quality which makes commodities desirable to buyers." It is, however, confined to purchases. Homo economicus is a very comprehensive concept covering all human decisions. The definition given in the book is therefore better: Utility stands for everything that an individual deems positive. Another definition is: Utility is the quality which makes individuals choose an option.
II. Decisions of Individuals and Firms
Chapter 1 – Question 3
Define incentives.
* Incentives are the real or expected rewards of a choice.
Chapter 1 – Question 4
Why do incentives matter?
* Because many activities are not rewarding in themselves, for instance, without pay very few people would be willing to work as charladies or factory workers.
Chapter 1 – Question 5
Define trade-offs.
* Trade-offs are alternatives.
Chapter 1 – Question 6
Why are all choices trade-offs?
* Because everybody's budget and everybody's time are limited.
Chapter 1 – Question 7
Compare absolute and relative scarcity.
* Absolute scarcity is an excess of demand over supply. Demand stands for ability and willingness to buy. Relative scarcity is an excess of willingness to have over ability to buy.
Chapter 1– Question 8
What are the consequences of relative scarcity?
* Prices. The whole of price theory rests on the assumption of relative scarcity. Economists assume that, without absolute or relative scarcity, all goods would be free.
Chapter 1– Question 9
Can you give an example of a free lunch?
* Economists acknowledge two examples: (1) A free ride, for instance, the benefits you derive from your neighbour's beautiful house paint or the good education of his child. (2) Transfer payments, which are, by definition, payments for which the recipient gives nothing in exchange. Examples are subsidies, scholarships, welfare benefits. But they often come with expectations and pressure to enforce them.
Chapter 1 – Question 10
Distinguish opportunity costs and normal costs.
* Opportunity costs are the rewards of your next best alternative. Costs are incurred by the alternative you have chosen. Both sorts of costs can be monetary or non-monetary.
Chapter 1– Question 11
Define marginal utility.
* It is the utility derived from an additional unit, the last one for the time being.
Chapter 1– Question 12
Explain the law of diminishing marginal utility and describe how it determines buying decisions.
* The more units you have of a commodity, the lower is the value that you ascribe to additional units. For the last unit you buy, utility equals price.
Chapter 1– Question 13
The law of diminishing utility is the economic value and price theory. Can you explain why?
* Value is equated with marginal utility, which diminishes. Price is normally equal for all units you buy; the third banana costs the same as the first one. Value and price are identical for the last unit you buy. For previous units, value was higher than price. For further units, value would be below price.
Chapter 1– Question 14
Define marginal cost and explain the law of diminishing returns.
* Marginal cost is the cost incurred by producing one additional unit. To put the same otherwise, it is the increase in total cost incurred by producing one additional unit. The law of diminishing returns states that costs rise as output is expanded. More precisely, it states that increases in some but not all factors of production generate increases in output, but these increases diminish as output is expanded.
III. The Individual and the Public
Chapter 1– Question 15
Define efficiency.
* Efficiency means that, given a country's resources, the maximum of goods and services is produced. You will encounter more complex definitions of efficiency in later chapters, but for the time being this one may suffice.
Chapter 1– Question 16
Explain the relationship between individual interest and the public interest.
* Individual interest is equated with maximum utility, which is ultimately equated with the maximum quantity of money and wealth. The public interest is equated with maximum GDP, which is the sum of all individual incomes.
IV. The Economy
Chapter 1– Question 17
Which magnitudes does the self-regulating market determine?
* Supply, demand and prices.
Chapter 1– Question 18
Define equilibrium.
* It is a state where quantity demanded equals quantity supplied. Graphically, it is the point where the demand curve and the supply curve intersect. More generally, it is a state that cannot be improved.
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