Answers to Questions in Chapter 1

Note: No. before indicates a page number

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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 5 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.

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 Australian dollar and the yen.
(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 yen exchange rate at which all Australian goods are traded
internationally. (This is certainly a less clear-cut 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.

Answers to questions in Economics by Sloman and Norris

(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.
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(Box 1.1) 1. Has Australia generally fared better or worse than the other three
countries?
Unemployment was around the same as in the UK but higher than in Japan and the
USA. Australias relative inflation performance improved significantly in the 1990s.
Notice the improvement in Australias relative growth performance. Since 1990 the
growth rate has been higher than in the other three countries. Australia has the largest
current account deficit.

(Box 1.1) 2. Was there a common pattern in the macroeconomic performance of each
of the four countries over these seventeen years?
Yes. Unemployment was higher in the early to mid-1980s and the early to mid-1990s.
Inflation was higher in the first half of the period.

(Box 1.2) 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 1.2) 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 1.2) 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, 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.

(Box 1.2) 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). 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.

10 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.
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Chapter 1
10 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).
11 (Box 1.3) 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).
11 (Box 1.3) 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.
13 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.)
13 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.
13 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 5.2
and 5.4. Economies of scale are common in the real world.
14 (Box 1.4) Should all polluting activities be banned? Could pollution ever be justified?
Explain your answer.
Most economists would argue that many polluting activities ought to be allowed to
continue. It might be wise to ban certain very seriously polluting activities, or those
where the effects of pollution are not known. In other cases, however, economists argue
that governments should attempt to weigh up whether the full marginal benefit to
society from the polluting activity (i.e. the extra production of desirable goods and
services) is greater or less than the full marginal cost to society, where that marginal
cost includes the environmental damage done by the pollution. Of course, this will
require measuring the pollution damage: something that is not always easy to do.
Economists generally argue that if the marginal cost to society from production
(including the pollution damage) exceeds the marginal benefit, then production should
be cut back; but if the marginal benefit exceeds the marginal cost, production should be
increased.
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Answers to questions in Economics by Sloman and Norris

15 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.
18 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.

20 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.
20 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.
20 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 massproduction 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).

22 Summarise this last paragraph using symbols like those in Figure 1.7.
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Chapter 1
Factor Market
Si

surplus
(Si > Di)

Pi

Si until Di = Si
Di

Goods Market
Pi
Sg

Sg

surplus Pi

Sg until Dg =

(Sg > Dd)

Dg

22 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.
26 (Box 1.7) There is the probability that all but the largest countries will lose some control
over their own economies. Globalisation will also probably lead to a greater inequality
of incomes within developed countries as unskilled workers compete with workers in low
income countries.
There is the probability that all but the largest countries will lose some control over their
own economies. Globalisation will also probably lead to a greater inequality of incomes
within developed countries as unskilled workers compete with workers in low income
countries.
28 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
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Answers to questions in Economics by Sloman and Norris

unemployment, the statement is normative.
29 What else is the diagram telling us?

That below a certain level of income the person spends nothing at all on
entertainment.

That even if the persons income dropped to zero, some food would still be
purchased (presumably by borrowing or begging the money).

That as income rises the proportion spent on food falls.

That as income rises the proportion spent on entertainment rises.

That although as income rises, a smaller amount is spent out of each pound on
food, the rate at which this amount falls gradually gets less (the curve changes
slope less rapidly).

That although as income rises, a larger amount is spent out of each pound on
entertainment, the rate at which this amount rises gradually gets less (the curve
changes slope less rapidly).

30 The table in Box 1.1 shows time-series data for four different variables for four different
countries. Would there have been any advantage in giving the figures for each separate
year? Would there have been any disadvantage?
Advantages: more detailed information; peaks and troughs can be more precisely
identified - in terms of both timing and magnitude; might identify trends within the three
year periods.
Disadvantages: more information to take in; may make long-term trends harder to
identify; may give undue weight to short-term aberrations.
31 Would it be possible to show three different lines on the same diagram?
You could simply use three different vertical scales - one for each line. You could
actually show the units of two (or even all three) up the left-hand (vertical) axis. If you
glance forward to page 621 of the text, you will see an example of this.
33 Could bar charts or pie charts be used for representing time-series data?
Bar charts are frequently used for this purpose. Pie charts are not so suitable for this
purpose, unless we want to see how something has been divided up over a period of
time. For example, we may want to represent how a persons annual income is spent
over the course of the year and divide the pie into twelve segments, each one
representing the proportion of annual income spent in that month. The twelve segments
could be represented in chronological order going clockwise round the pie.
33 1. If the vertical scale for Figure A1.2 ran from 0 to 2 million, how would this alter your
impression of the degree to which unemployment had changed?
Unemployment would seem to have been more stable over the period. The rise between
1990/91 and 1992/93 would seem to be smaller, as would the fall in unemployment
from 1993/94 to 1999/2000. (Of course, there would be no real difference at all.)
33 2. What are the advantages and disadvantages of presenting data graphically with the
axes starting from zero?

Chapter 1
You can get a clearer impression of the percentage rate of change of a variable. On the
other hand, if the values of the variable in question start from a high level (e.g.
unemployment fluctuating between 0.5 and 1.0 million), then to have the axis running
from, say, 0.4 to 1.0 million, will show up the fluctuations more dramatically. It is like
putting a magnifying glass on the information.
35 1. If a bank paid its depositors 5% interest and inflation was 3%, what would be the real
rate of interest?
-2%. The real value of your deposits would be falling by 2% per year.
35 2. Has your real income gone up or down this last year?
Look at the percentage increase in your nominal income, and then deduct the rate of
inflation. (Note that not all goods and services go up in price at the same rate, and thus
the headline rate of inflation, based on the retail price index (see page 34 of the text),
may not fairly reflect the increases in costs you personally have faced.)
35 Does this mean that the value of manufacturing output in 1998/1999 was 2.6% higher
than in 1997/1998?
No. If prices have risen (as they invariably do), the value of output in money terms will
rise more than the volume of output.
36 What was the growth rate in manufacturing output from (a) 1990/1991 to 1991/1992;
(b) 1995/1996 to 1996/1997?
Using the formula (It It-1)/ It-1 100 gives
(a) (87.4 90.1)/90.1 100 = minus 3.0%
(b) (99.6 97.3)/97.3 100 = 2.4%
36 If the CPI went up from 150 to 162 over 12 months, what would be the rate of inflation?
Using the formula (CPIt - CPIt-1)/CPIt-1 100, gives:
(162 150)/150 100 = 8%
38 On a diagram like Figure A1.8 draw the graphs for the following equations:
y = 3 + 4x
y = 15 3x
In the first case, the graph would cross the vertical (y) axis at -3. It would be upward
sloping and have a slope of 4: i.e. as you move up the line, for every one unit you move
along the horizontal axis you would move 4 units up the vertical.
In the second case, the graph would cross the vertical axis at 15. It would be downward
sloping and have a slope of -3: i.e. as you move down the line, for every one unit you
move along the horizontal axis you would move 3 units down the vertical.
Note that both graphs are a straight line. This is because there is no x squared term (or
any other x term to a power greater than 1).
39 What shaped graph would you get from the equations:
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Answers to questions in Economics by Sloman and Norris

y = 6 + 3x + 2x2
y = 10 4x + x2
(If you cannot work out the answer, construct a table like Table 1.9 and then plot the
figures on a graph.)
In the first case, the graph will be a curve crossing the vertical axis at 6. As the value
of x increases above 0 and the x2 term grows more and more rapidly, the curve will
slope upwards more and more steeply.
In the second case, the graph will be a curve crossing the vertical axis at 10. As the
value of x increases above 0, initially the curve will slope downwards because the 4x
term will be dominant; but then the curve will slope upwards again as the x2 term begins
to dominate.
40 Draw a hill-shaped curve. Explain how the slope of the curve changes as we move
along it from left to right.
As we move towards the top of the hill the curve has a positive slope which gets smaller
and smaller until at the summit the gradient is zero. Beyond the summit the gradient is
negative and, in absolute terms, gets larger as we descend.