1. 1
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First Principles
Krugman/Wells
CHECK YOUR UNDERSTANDING

2. Check Your Understanding 1-1 Question 1
Explain how each of the following
situations illustrates one of the four
principles of individual choice.

3. trade-off in marginal analysis
1a) You are on your third trip to a restaurant’s all-you-can-eat dessert buffet and are feeling very full. Although it would cost you no additional money, you forgo another slice of coconut cream pie but have a slice of chocolate cake.
resources are scarce
opportunity cost
trade-off in marginal analysis
people exploit opportunities to make themselves better off
The opportunity cost of the chocolate cake is the coconut pie that is given up. This also illustrates a trade-off because in choosing the chocolate cake you give up the pie.

4. trade-off in marginal analysis
1b) Even if there were more resources in the world there would still be scarcity.
resources are scarce
opportunity cost
trade-off in marginal analysis
people exploit opportunities to make themselves better off
Unless the additional resources are unlimited, they are still scarce.

5. trade-off in marginal analysis
1c) Different teaching assistants teach several Economics 101 tutorials. Those taught by the teaching assistants with the best reputations fill up quickly, with spaces left unfilled in the ones taught by assistants with poor reputations.
resources are scarce
opportunity cost
trade-off in marginal analysis
people exploit opportunities to make themselves better off
By choosing the best teachers, the students are exploiting opportunities to make themselves better off. The fact that their classes fill up illustrates scarcity.

6. trade-off in marginal analysis
1d) To decide how many hours per week to exercise, you compare the health benefits of one more hour of exercise to the effect on your grades of one less hour spent studying.
resources are scarce
opportunity cost
trade-off in marginal analysis
people exploit opportunities to make themselves better off
To make the decision, you are comparing the benefit of one more hour of exercise (the marginal benefit) with the cost of one hour less spent studying the marginal cost).

7. Check Your Understanding 1-1 Question 2
You make $45,000 per year at your current job with Whiz Kids Consultants. You are considering a job offer from Brainiacs, Inc., which will pay you $50,000 per year.

8. 2a) The increased time spent commuting to your new job is an opportunity cost of accepting the new job.
True
False
The opportunity cost of the increased commuting time is the lost benefit that you would get from using that time for something else, maybe studying or sleeping longer.

9. 2b) The $45,000 salary from your old job is an opportunity cost of accepting the new job.
True
False
You give up the salary at the old job, so your opportunity cost is $45,000.

10. 2c) The more spacious office at your new job is an opportunity cost of accepting the new job.
True
False
The spacious office is a benefit, not a cost, of the new job.

11. Check Your Understanding 1-2 Question 1
Directions: Which of the five principles of interaction is illustrated in the situations described?

12. Markets move toward equilibrium.
1a) Using the college Web site, any student who wants to sell a used textbook for at least $30 is able to sell it to another who is willing to pay $30.
gains from trade
Markets move toward equilibrium.
Resources should be used as efficiently as possible to achieve society’s goal.
Markets usually lead to efficiency.
When markets don’t achieve efficiency, government intervention can improve society’s welfare.
If everyone who wants to buy or sell a book for $30, then the market is efficient because no one can be made better off without someone being made worse off.

13. Markets move toward equilibrium.
1b) At a college tutoring co-op, students can arrange to provide tutoring in subjects they are good in (like economics) in return for receiving tutoring in subjects they are poor in (like philosophy).
gains from trade
Markets move toward equilibrium.
Resources should be used as efficiently as possible to achieve society’s goal.
Markets usually lead to efficiency
When markets don’t achieve efficiency, government intervention can improve society’s welfare.
Students benefit by trading tutoring in their strong subjects for tutoring in their weak subjects.

14. Markets move toward equilibrium.
1c) The local municipality imposes a law that requires bars and nightclubs near residential areas to keep their noise levels below a certain threshold.
gains from trade
Markets move toward equilibrium.
Resources should be used as efficiently as possible to achieve society’s goal.
Markets usually lead to efficiency.
When markets don’t achieve efficiency, government intervention can improve society’s welfare.
The noise is a side effect that the market doesn’t recognize, so this is a situation where government intervention improves society’s welfare.

15. Markets move toward equilibrium.
1d) To provide better care for low-income patients, the local municipality has decided to close some underutilized neighborhood clinics and shift funds to the main hospital.
gains from trade
Markets move toward equilibrium.
Resources should be used as efficiently as possible to achieve society’s goals.
Markets usually lead to efficiency.
When markets don’t achieve efficiency, government intervention can improve society’s welfare.
By closing the clinics and shifting funds to the main hospital efficiency is increased because better health care can be provided to low-income patients.

16. Markets move toward equilibrium.
1e) On the college Web site, books of a given title with approximately the same level of wear and tear sell for about the same price.
gains from trade
Markets move toward equilibrium.
Resources should be used as efficiently as possible to achieve society’s goals.
Markets usually lead to efficiency.
When markets don’t achieve efficiency, government intervention can improve society’s welfare.
The market is in equilibrium because books of the same quality sell for the same price.

17. Check Your Understanding 1-2 Question 2
Which of the following describes an equilibrium situation? Which does not?

18. 2a) The restaurants across the street from the university dining hall serve better-tasting and cheaper meals than those served at the university dining hall. The vast majority of students continue to eat at the dining hall.
True
False
This is not an equilibrium because the students could switch to eating at the restaurants and be better off, at least until prices at the restaurant increased or the meals at the dining hall improved.

19. 2b) You currently take the subway to work
2b) You currently take the subway to work. Although taking the bus is cheaper, the ride takes longer. So you are willing to pay the higher subway fare in order to save time.
True
False
This is an equilibrium, because if you start riding the bus, you would not be better off because you are willing to pay more for the subway to save time.

20. Check Your Understanding 1-3 Question 1
Explain how each of the following
examples illustrates one of the three
principles of economy-wide interactions.

21. One person’s spending is another person’s income.
1a) The White House urged Congress to pass major tax cuts in the spring of 2001, when it became clear that the U.S. economy was experiencing a slump.
One person’s spending is another person’s income.
Overall spending doesn’t match the economy’s productive capacity.
Government policies can change spending.
Tax cuts will change income and change spending.

22. One person’s spending is another person’s income.
1b) Oil companies are investing heavily in projects that will extract oil from the “oil sands” of Canada. In Edmonton, Alberta, near the projects, restaurants and other consumer businesses are booming.
One person’s spending is another person’s income.
Overall spending doesn’t match the economy’s productive capacity.
Government policies can change spending.
As the oil companies pay workers on the projects, the workers spend in local businesses, generating income for the business owners who will spend and generate income for others.

23. One person’s spending is another person’s income.
1c) In the mid-2000s, Spain, which was experiencing a big housing boom, also had the highest inflation rate in Europe.
One person’s spending is another person’s income.
Overall spending doesn’t match the economy’s productive capacity.
Government policies can change spending.
Spending on housing was exceeding the economy’s capacity to produce more houses, causing an increase in house prices and, as a result of higher housing prices, increases in overall prices, which is inflation.