Tutorial 1 answers

Econ 111

Autumn 2015

Tutorial 1 answers

1. What would happen to the study of economics if scarcity disappeared? Explain your answer.

ANS: Since economics is the study of how society allocates its scarce resources, if there was no scarcity, there would be no need for economics. Everyone could have all the goods and services they wanted. No one would have to make decisions based on trade-offs, because there would be no opportunity cost. (It is difficult to conceive of a situation where time is not scarce, however.)

2. Suppose you got out to lunch with your wealthy but boring uncle. He pays for your meal. Does this violate the economic concept that ‘There is no such thing as a free lunch’?

ANS: The issue is that everything has an opportunity cost. While there is no monetary cost to you, there is still an opportunity cost. You have to give up some of your time.

3. New Zealand used to use a bounty system to control possums. Trappers got paid a fixed amount for each possum they caught. Given that people respond to incentives, explain why this system failed to halt the spread of possums in New Zealand.

ANS: Trappers did not have an incentive to trap all the possums in their area because this would result in the loss of the income from bounties. Rather they would have an incentive to increase possum numbers so that more could be trapped for bounties.

4. Adam Smith used the term ‘invisible hand’ in his 1776 book The Wealth of Nations. Prices are the instrument with which the ‘invisible hand’ directs economic activity in a market economy. Consider the following sequence of events: (1) hurricane damages banana plantations in QLD;

(2) consumption of bananas in NSW falls, while consumption of oranges and apples increases. Show how one can employ the metaphor of ‘invisible hand” to establish the causal link between (1) and (2).

ANS: Hurricane damage => decrease supply of bananas in NSW => increase price of bananas in NSW => consumers start to substitute to cheaper alternatives, oranges and apples => demand for oranges and apples in NSW increases => prices of oranges and apples increase which lead to the increase in supply.

Notice how price acts as a signal about the relative scarcity of given commodity and induces some of the consumers substitute to the alternatives which are relatively less scarce at that point in time.

5. Suppose that the government enforces a law which prohibits the creation of any pollution. What effect do you think the enforcement of this law will have on the wellbeing of society? Hint: consider both benefits and cost of this policy.

ANS: While pollution creates an external cost to society, there is also a cost to society of eliminating pollution. A law that prohibits pollution considers the marginal benefit to society of eliminating pollution but not the marginal cost. Hence the enforcement of the law could actually harm society, if the cost of eliminating the pollution were greater than the benefit.

6. Draw a production possibilities frontier representing the economy’s possible production of milk and eggs. Now show what will happen to the frontier or the production point under each of the following circumstances. Use a separate graph to illustrate each situation.

a. the outcome for the economy is efficient, with society choosing approximately equal amounts of milk and eggs

b. a recession causes a significant percentage of the labour force to become unemployed

c. some cows are found to be infected with mad cow disease and many of the cows must be destroyed

d. chickens are infected with a rare disease and egg-laying is reduced

e. improvements in animal nutrition raise the general productivity of cows and chickens

f. the cow and chicken populations increase

g. the Surgeon General announces that drinking milk prolongs life

ANS:

7. Which of the following statements are positive, and which are normative? Explain your answers.

a. The minimum wage creates unemployment among young and unskilled workers.

b. The minimum wage ought to be increased.

c. If there is a reduction in competition in a market, then other things being equal, prices will increase.

d. A little bit of unemployment is worse for society than a little bit of inflation.

e. There is a trade-off between inflation and unemployment in the short run.

f. Endangered species would be better off if the trade in wildlife was stopped.

g. If interest rates increase, forestry plantings will decrease.

h. If welfare benefits were reduced, the country would be better off.

ANS: a, c, e, f, and g are positive statements. b and d are normative statements, while h can be interpreted as normative or positive, depending on what is meant by “the country would be better off”. If this part refers to a personal opinion of a speaker then the statement is normative. If this refers to the well-defined measure of economic welfare then the statement is positive.