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ECO 401-Z Micro and Macro Economics

Assignment # 1
1.

Date of Submission: 25-09-2016

Describe the three economic systems. Explain the features, advantages and disadvantages of each
of the systems. On the basis of the features, advantages and disadvantages you have just
discussed, give a conclusion about which economic system did you like the most.

Ans: Most countries in the world can be identified with three major kinds of economic systemstraditional, command, and market.
Traditional Economic System:
A traditional economic system is based on every person's career being determined by birth. Children
will probably do what their parents did to earn a living. Individuals are not free to make decisions
based on what they want or would like to have. The allocation of scarce resources, and nearly all other
economic activity, stems from ritual, habit, or custom.
Examples: Middle East, Asia, Africa and Latin America.
Advantages:
1. Everyone knows which role to play.
2. Little uncertainty exists over WHAT to produce, HOW to produce and FOR WHOM to produce.
Disadvantages:
1. Tends to discourage new ideas and new ways of doing things.
2. The strict roles have the effect of punishing people who act differently.
3. The lack of progress leads to a lower standard of living than in other types of economic societies.
Command Economic System:
A command economic system is one in which a central authority makes most of the WHAT, HOW, and
FOR WHOM decisions. Economic decisions are made by the government: the people have little, if any,
influence over how the basic economic questions are answered.
Examples: China, Russia and Uganda.
Advantages
1. It can change direction drastically in a relatively short time.
2. Many health and public services are available to everyone at little or no cost.
Disadvantages
1. It is not designed to meet the wants of consumers, even though many basic needs are provided
2. The system does not give people the incentive to work hard. As a result, many people work just
hard enough to fill the production quotas
3. Requires a large decision-making bureaucracy. Many people are needed to operate the system
which makes slow decision making and raise the costs of production.
4. It does not have the flexibility to deal with minor, day-to-day problems.
5. Rewards for individual initiative are rare. People with new or unique ideas find it difficult to get
ahead in a command economy
Market Economic System:
In a market economy people and firms act in their own best interests to answer the WHAT, HOW, and
FOR WHOM questions. In economic terms, a market is an arrangement that allows buyers and sellers
to come together in order to exchange goods and services.
Examples: United States, Canada, Japan, South Korea, Singapore, Germany, France.

Advantages:
1.
2.
3.
4.
5.

Economy can adjust over time. Companies shift to produce other goods and services if a particular
good or service is not being sold.
It has high degree of individual freedom. Producers may make whatever they think will sell. They
also decide the HOW question. Consumers spend their money on the goods and services they
prefer. Individuals are free to choose where and when they want to work.
Relatively small degree of government interference.
Decision making is decentralized, or not concentrated in the hands of a few.
Variety of goods and services are available to consumers and high degree of consumer satisfaction

Disadvantages:
1.
2.

Does not provide for the basic needs of everyone in the society
Relatively high degree of uncertainty that workers and businesses face as a result of change.

Conclusion:
Each of the economic system has its own pros and cons. In a command economy, many basic needs
are provided. It is good for some members of the society who find difficulty surviving in a pure market
economy without assistance from government or private groups. But on the other hand, it is not
designed to meet the wants of people. In Market economy there is a high degree of freedom but so
does there is also high degree of uncertainty. For this reason, a mix of command and free market
economy is the best course of action for the satisfaction of majority of the people.
2.

How is economics a science?

Ans: Economics is like a science because economist use the scientific method. They devise theories,
collect data, and then analyze these data in an attempt to verify or refute their theories about how the
world works. Economist use theory and observation like other scientist, but they are limited in their
ability to run controlled experiments, Instead, they must rely on natural experiments.
3.

Why do economists make assumptions?

Ans: Economists make assumptions to simplify problems without substantially affecting the answer.
Assumptions can make the world easier to understand.
4.

Should an economic model describe reality exactly?

Ans: An economic model cannot describe reality exactly because it would be too complicated to
understand. A model is a simplification that allows the economist to see what is truly important.
5.

Name a way that your family interacts in the factor market and a way that it interacts in the
product market.

Ans: A way my family interacts in the factor market is by working. Their time is bought by the firms,
and they provide their hard work to the firm. My family interacts with the product market by buying
goods and services. An example of this could be insurance as it is sold by a firm and bought by a
household.
6. Imagine a society that produces military goods and consumer goods, which well call guns and
butter.
a. Draw a production possibilities frontier for guns and butter. Using the concept of opportunity cost,
explain why it most likely has a bowed-out shape.
Ans: The graph shows a production possibilities frontier between guns and butter. It is bowed out
because the opportunity cost of butter depends on how much butter and how many guns the economy
is producing. When the economy is producing a lot of butter, workers and machines best suited to
making guns are being used to make butter, so each unit of guns given up yields a small increase in
the production of butter. Thus, the frontier is steep and the opportunity cost of producing butter is

high. When the economy is producing a lot of guns,


workers and machines best suited to making butter are
being used to make guns, so each unit of guns given up
yields a large increase in the production of butter. Thus,
the frontier is very flat and the opportunity cost of
producing butter is low.
b. Show a point that is impossible for the economy to
achieve. Show a point that is feasible but inefficient.
Ans: Point A is impossible for the economy to achieve; it
is outside the production possibilities frontier. Point B is feasible but inefficient because it is inside the
production possibilities frontier.
c. Imagine that the society has two political parties, called the Hawks (who want a strong military) and
the Doves (who want a smaller military). Show a point on your production possibilities frontier that
the Hawks might choose and a point that the Doves might choose.
Ans: The Hawks might choose a point like H, with many guns and not much butter. The Doves might
choose a point like D, with a lot of butter and few guns.
d. Imagine that an aggressive neighboring country reduces the size of its military. As a result, both the
Hawks and the Doves reduce their desired production of guns by the same amount. Which party
would get the bigger peace dividend, measured by the increase in butter production? Explain.
Ans: The Hawks would get the bigger peace dividend. Since opportunity cost of butter in terms of
guns increases as butter production increases and the Doves has bigger butter production than the
Hawks, an additional unit of butter costs more reduction of guns production for the Doves than the
Hawks. When both parties reduce guns production by the same amount, the Hawks will get a bigger
increase in butter production.
7. An economy consists of three workers: Larry, Moe, and Curly. Each works 10 hours a day and can
produce two services: mowing lawns and washing cars. In an hour, Larry can either mow one lawn or
wash one car; Moe can either mow one lawn or wash two cars; and Curly can either mow two lawns
or wash one car.
a. Calculate how much of each service is produced under the following circumstances, which we
label A, B, C, and D:
All three spend all their time mowing lawns. (A)
All three spend all their time washing cars. (B)
All three spend half their time on each activity. (C)
Larry spends half his time on each activity, while Moe only washes cars and Curly only mows
lawns. (D)
Ans: The result can be tabulated as

b. Graph the production possibilities frontier for this economy. Using your answers to part (a), identify
points A, B, C, and D on your graph.

c. Explain why the production possibilities frontier has the shape it does.
Ans: At first, all three spend all their time on mowing lawns. If we want to increase quantity of cars
washed and make the loss of lawn mowed as low as possible, we shouldn't make Curly give up lawn
mowing because opportunity cost of it is the highest. The marginal costs of assigning Larry and Moe to
give up lawn mowing are equal, but since Moe is skillful in car washing, the marginal benefit of
assigning him to wash car is higher. Therefore, the best choice in order to increase quantity of cars
washed is to make Moe give up lawn mowing and turn to car washing.
Now we get to the second point which is Curly and Larry spend all their time on mowing lawn while
Moe spends all his time on washing cars, getting the output of 30 lawns and 20 cars. It is obvious that
the lowest opportunity cost of 20 cars is 10 lawns which is the quantity of lawns that Moe can mow in a
day. This is why point C is in efficient.
Notice here the opportunity cost per car is 1/2 lawn.
If we go on increasing the quantity of cars washed, according to the deduction above, we should make
Larry give up mowing lawn and turn to washing cars because while the marginal benefit (10 cars/d) are
the same, Larry's opportunity cost (10 lawns/d) is lower than Curly's (20 lawns/d). Notice here the
opportunity cost per car is 1 lawn.

Now we get to the third point which is Curly spends all her time on mowing lawns while Moe and Larry
spend all their time on washing cars. If we still want to increase the quantity of cars washed, we have
to make Curly to give up mowing lawns, making the opportunity cost per car 2 lawns. In the most
efficient way, the opportunity cost per car changes from 1/2 lawn to 1 lawn, and at last, to 2 lawns.
Since the opportunity cost per car increases, the frontier grows deeper and deeper.
d. Are any of the allocations calculated in part (a) inefficient? Explain.

Ans: At the second point which is Curly and Larry spend all their time on mowing lawn while Moe
spends all his time on washing cars, getting the output of 30 lawns and 20 cars. It is obvious that the
lowest opportunity cost of 20 cars is 10 lawns which is the quantity of lawns that Moe can mow in a
day. This is why point C is in efficient.

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