obtain a good or service. For example, the cost of doing these exercises and reading this answer

Chapter 1

Questions

• Explain the concept of opportunity cost.

Opportunity cost is the value of the next best alternative which must be forgone in order to obtain a good or service. For example, the cost of doing these exercises and reading this answer might be the TV you could have watched.

• List goods, or services, that compete for your income. Similarly, list activities that compete

for your time. In deciding what you will spend your income on and how you will allocate your time, do you minimize your opportunity costs?

Goods or services competing for your income might include rent, food, heating and travel.Activities competing for your time might include studying, work, sleep and leisure activities, such as the cinema, drinking and sport.In assessing whether you minimize your opportunity costs you need to examine what you decided to do, or consume, and compare these with what you decided not to do, or consume. If you minimized your opportunity costs, then you have chosen all the things that provide you with the maximum amount of benefit.

• Consider whether it is ever possible to solve the problem of scarcity.

The problem of scarcity cannot ever be resolved. Resources are finite and wants are unlimited.For example, if we discover new oil fields in the world, this does not mean that the oil supply is no longer finite. At some point we will stop finding oil. Nor does the new discovery stop the world’s demand for oil increasing.

• An economy produces two goods, Ferraris and Ray-Ban sunglasses. Using a production

possibility frontier assess what must happen to the production of Ferraris, if the production of Ray-Ban sunglasses decreases.

If the production of Ray-Ban sunglasses reduces, then resource such as labour will become available. This under utilised resource can be hired by Ferrari and so the production of Ferraris could increase.

• The same Ferrari and Ray-Ban economy receives an influx of migrant workers. What do you

think will happen to the production possibility frontier for this economy?

An influx of migrant workers is an addition to the labour resource in an economy. With more resource, more output can be produced. So the production possibility frontier will move outwards to the right.

• How does the production possibility frontier illustrate the concept of opportunity cost?

(Economics for Business, 5e David Begg, Damian Ward) (Solution Manual, For Complete File, Download link at the end of this File) 1 / 4

It depicts the trade-off between goods and/or services produced. As resources are used for the production of one commodity those resources cannot be used for the production of another good or service.

• Why does the law of diminishing returns require the production possibility frontier to be

curved, rather than a straight line?

The slope of the production possibility frontier shows the opportunity cost of increasing the production of one type of good or service. For example, as more capital goods are produced the opportunity cost in terms of consumer goods foregone increases. This could result from the fact that some resources are more efficient in the production of one type of good, or that changing the proportion of factors employed in one form of production causes the output to increase at a decreasing rate. This is explained by the law of diminishing returns and gives the P.P.F a circular appearance.

• Explain the resource allocation mechanism within a market economy and also a planned

economy.

The recourse allocation mechanism within a market economy is the price mechanism/system. It is based on the idea of a competitive market in which no individual can influence the price of factors of production and no single firm can influence the market price of its product. A market exists when buyers and sellers of a particular commodity are in communication for the purpose of exchange. Market forces operate to satisfy the desire of one person to sell something and the desire of another to buy it. A price is agreed which is acceptable to both the buyer and the seller.Price acts as the mechanism which equalises the demand for and supply of a commodity.

A planned economy is a system in which all economic decisions are made by the central authorities; unlike the price/market system which assumes in its purest state no government interference in economic activity. In a command or planned economy a central planning body makes all the basic economic decisions, the state owns or controls all the factors of production and determines what to produce by assessment of consumer needs and the requirements of the state. Priorities are drawn up and production quotas set accordingly.

• Using examples, highlight why your own economy is probably best described as a mixed

economy.

A mixed economy is an economy in which decisions are made partly by the state and partly by individuals and firms. In Britain the production and sale of groceries is a market solution with private firms supplying consumers via supermarkets and similar outlets. Health care for most British people is provided by the state. Hence Britain is a mixed economy.

• Which of the following statements relate to macro or microeconomics? (a) During the last

12 months average car prices have fallen; (b) inflation for the past 12 months has been 3.5 per cent; (c) strong sales in the housing market have prevented the Bank of England from reducing interest rates. 2 / 4

(a) The price of cars is a microeconomic issue. It is an issue associated with one market, or sector.(b) Inflation is the rise in prices across the entire economy and, therefore, represents a macroeconomic problem. (c) Strong sales in the housing market are a micro issue as they relate to a single market. However, the housing market is linked to the macroeconomy and, in this example, has led to the Bank of England holding interest rates constant. As interest rates are set for the whole economy, this is a macroeconomic issue.

• Is the labour market a micro or macroeconomic topic?

Factors affecting the labour market as a whole, e.g. the national level of unemployment, wage inflation, are macroeconomic. Factors affecting individual labour markets, e.g. the supply of carpenters, the wages of doctors, are microeconomic.

• Why does business need to understand the functioning of markets?

Firms operate within markets. If product markets are a collection of firms supplying products and consumers buying products, then it is important for business to understand how consumers and firms interact in markets. Furthermore, firms will also be interested in understanding how competing firms interact in markets. Business also buys its inputs, such as labour, from markets, so the costs of firms are, in part, determined within markets. Therefore, understanding markets can lead to an understanding of profitability.

• Why does business need to understand the functioning of the economy?

Firms also operate within economies. Governments seek to control economies. Understanding how government economic policy will influence consumers’ ability to spend, firms’ ability to invest and the level of international trade and competition are all important issues for business to comprehend.

Questions 14 and 15 relate to material within the appendix

• Which of the following is positive and which is normative? (a) It is in the long-term

interest of the UK to be a member of the Euro; (b) Will entry into the Euro reduce UK inflation?

(a) Asserts an opinion without any supporting theory. It is, therefore, a normative statement. (b) In contrast, this asks a question that can be answered using economic theory. It is, therefore, a positive statement.

• Using the data listed below, plot house prices on the Y axis and time on the X axis. Is there

a positive or negative relationship between time and house prices? Convert the data series on house prices into an index using 2005 as the base year.Calculate the percentage increase in house prices for each year. 3 / 4

Year Average price of a house

2005 £100 000

2006 £120 000

2007 £155 000

2008 £190000

2009 £170 000

2010 £150 000

The plot of house prices against year shows a positive relationship until 2008, and a negative relationship from 2008 to 2010.

Year Index % increase

2005 100

2006 120 20

2007 155 29.2

2008 190 22.6

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