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Price Level Real GDP

Price Level Real GDP SRAS2 SRAS 1 Appendix: Why Increasing SRAS Has Not Led to a Lower Price Level Labor productivity in the U.S. economy has generally been increasing. (For instance, see Example 5C on page 6-5.) As labor productivity increases, the overall costs of production decrease and the SRAS curve shifts to the right. This should lead to an increase in Real GDP and to a decrease in the price level. Real GDP has been increasing. The table on page 5-8 indicates that Real GDP increased by almost 3-fold between 1974 and 2013. But the price level has not been decreasing. Between 1974 and 2013, the Consumer Price Index increased by over 5-fold. (See the table on page 4-2.) Why hasn’t increasing SRAS led to a lower price level? The price level depends on both SRAS and AD. While the SRAS curve has been shifting to the right, the AD curve has been shifting to the right even faster, causing the price level to rise. The AD curve has been shifting rapidly to the right because the money supply has been increasing. Example 7: According to the Federal Reserve Board, the money supply (M1) increased by over 9-fold from 1974 to 2013. Increasing SRAS may not have led to a lower price level, but it has caused goods to become more affordable to the average American household. The percentage of American households that own automobiles, color televisions, air conditioners, microwave ovens, washing machines, etc. is much higher than it was decades ago. Goods that were not available decades ago and which were very expensive when first introduced (e.g. personal computers, DVD players, cell phones, MP3 players, etc.), have become much more affordable over time. And even though the nominal price of food and shelter may be much higher than it was decades ago, food and shelter have grown increasingly more affordable for the average American household. Example 8: The percentage of disposable income the average American household spends on food fell from about 25% at the end of World War II to less than 10% today. The percentage of Americans who own their own homes is higher today than it was fifty years ago. And the average home today is significantly larger and better equipped than the average home of fifty years ago. FOR REVIEW ONLY - NOT FOR DISTRIBUTION AD The Aggregate Market 6 - 8

Appendix: Why the Aggregate Demand Curve Slopes Downward The aggregate demand curve indicates an inverse relationship between the price level and the quantity demanded of Real GDP. Economists have identified three causes of this inverse relationship: 1. The wealth (real balance) effect. This is similar to the income effect discussed in Chapter 3. When the price level decreases, consumers are wealthier (their money holdings have more buying power). This means that consumers can afford to buy a greater quantity of goods and services as the price level decreases. This increase in consumption as the price level decreases will cause the aggregate demand curve to be downward sloping. 2. The interest rate effect. When the price level decreases, the demand for money will decrease (as households need less money to make their normal purchases). The decrease in the demand for money will cause interest rates to decrease. As discussed earlier in this chapter, lower interest rates will cause increased consumption (particularly of durable goods) and will cause increased investment. The increases in consumption and investment as the price level decreases will cause the aggregate demand curve to be downward sloping. 3. The exchange rate effect. As discussed above, when the price level decreases, interest rates will decrease. Lower interest rates in the U.S. will cause depreciation in the exchange rate for the dollar (see Chapter 16). As discussed earlier in this chapter, if the exchange rate for the dollar depreciates, net exports will increase. The increase in net exports as the price level decreases will cause the aggregate demand curve to be downward sloping. Appendix: Why the Short-Run Aggregate Supply Curve Slopes Upward The short-run aggregate supply curve indicates a direct relationship between the price level and the quantity supplied of Real GDP. Economists have identified three causes of this direct relationship. 1. Sticky-wage effect. Wages in a market economy can be slow to adjust (especially downward). This stickiness is due to such factors as long-term labor contracts, labor unions, and general employee resistance to wage cuts. If the price level decreases and nominal wages do not decrease, real wage rates will be higher. The increase in real wage rates will cause employers to employ less labor and produce less output. The decrease in output due to sticky wages as the price level decreases will cause the short-run aggregate supply curve to be upward sloping. 2. Sticky-price effect. Prices in a market economy can be slow to adjust (especially downward). This stickiness is due to such factors as menu costs (the costs to producers of changing the prices on their menus, catalogs, etc.) and producer concern about consumer reaction to rising prices in the future. If the price level decreases and nominal prices do not decrease, real prices will be higher. The increase in real prices will cause a decrease in sales. As sales decline, producers will produce less output. The decrease in output as the price level decreases will cause the short-run aggregate supply curve to be upward sloping. 3. Misperception effect. If the price level changes, both workers and producers may misperceive the effect of the change in the price level. If the price level decreases, workers may perceive a decrease in their nominal wages as a decrease in real wages. Thus, workers may decrease the amount of labor supplied. If the price level decreases, producers may perceive a decrease in their nominal prices as a decrease in real prices and thus reduce the amount of output produced. The decrease in output as the price level decreases due to the misperceptions of workers and producers will cause the short-run aggregate supply curve to be upward sloping. FOR REVIEW ONLY - NOT FOR DISTRIBUTION 6 - 9 The Aggregate Market

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    PRINCIPLES OF ECONOMICS JEFF HOLT S

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    Principles of Economics, 6th Editio

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    16. Study Guide for Chapter 7 17. C

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    11. Appendix: Book Review - “The

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    20. Appendix: The NCAA Cartel 21. S

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    Introduction: A Brief History of U.

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    In the twentieth century, per capit

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    Appendix: The 35 Largest National E

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    Multiple Choice: ___ 1. The Jamesto

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    2. Describe the economic cost of th

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    Chapter 1 Scarcity and Choices The

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    Example 5B: At the end of 1982, the

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    Example 11: When Cindy quits her jo

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    consequences may result in failure

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    An upward sloping curve (as in Exam

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    In making decisions, humans tend to

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    5. ______________________ _________

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    ___ 13. If the value of one variabl

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    Y Point X Y A 0 1 B 3 3 C 6 5 D 9 7

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    Chapter 2 Trade and Economic System

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    Example 4B: The following quantitie

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    1. An increase in the quantity of r

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    3. For whom to produce? This is det

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    The graph below illustrates the shi

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    The two primary economic systems ar

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    ___ 12. The capitalist vision sees

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    ___ 25. According to the book “Ca

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    Chapter 3 Demand, Supply, and Equil

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    . For inferior goods, income and de

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    Chapter 10 Money, Money Creation, a

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    Example 4B: The castaways on Gillig

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    Looking at the balance sheet below,

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    Demand-side One-shot Inflation Exam

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    4. Inflation increases uncertainty

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    life; it came into existence not by

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    calculated by using the potential d

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    ___ 12. If the required-reserve rat

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    4. Referring to the balance sheet f

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    Chapter 11 The Federal Reserve Syst

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    5. After Bank X sells the $300,000

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    Low Mortgage Interest Rates Mortgag

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    Relaxed Standards for Mortgage Loan

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    The Bursting of the Housing Bubble

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    On February 17, 2009, the federal g

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    Fed policies caused short-term inte

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    ___ 10. The Fed’s most important

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    ___ 25. In response to the recessio

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    Chapter 12 Monetary Policy The basi

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    2. A change in aggregate demand (AD

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    Monetarist Transmission Mechanism C

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    3. Borrowers do not have to seek ou

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    Appendix: Book Review - “The Age

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    Questions for Chapter 12 Fill-in-th

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    ___ 16. The primary source of incom

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    7. According to Alan Greenspan, wha

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    Chapter 13 Taxes, Deficits, and the

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    Example 5: In 2015, Taxpayer A had

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    of $5 and a quantity of 10 units. T

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    The complexity of the tax law also

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    the current government spending and

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    cut of 1964. The top rate was lower

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    ___ 6. Federal excise taxes: a. are

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    3. How would eliminating the loopho

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    Chapter 14 Economic Growth The basi

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    2. Labor. Labor can contribute to e

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    estricting international trade (e.g

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    An improvement in technology (e.g.

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    The table below shows the economic

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    will increase both Real GDP and per

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    ___ 8. Which of the following is co

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    ___ 26. The opinion that economic g

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    Chapter 15 Less Developed Countries

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    Example 8: Countries A, B, C, and D

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    Obstacles to Economic Development f

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    c. Restrictions on international tr

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    Appendix: Book Review - “The Powe

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    Example 25: In Brazil, about half t

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    Study Guide for Chapter 15 Chapter

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    ___ 13. Among the counterproductive

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    4. List four ways that governments

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    Chapter 16 International Trade The

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    Other Benefits of Free Internationa

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    Example 6: The graph below illustra

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    competitive disadvantage. But dumpi

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    is only 25% as productive as before

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    Smith was skeptical of government a

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    ___ 4. For Country X, what is the o

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    ___ 18. Frédéric Bastiat’s “P

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    4. On the graph below: (1) What is

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    Chapter 17 Elasticity We are often

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    Example 4A: What is price elasticit

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    Example 5A: Gertie’s Gas and Go i

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    Example 10A: When the price of Good

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    Example 13B: On the graph below, su

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    $7 - 6 - 5 - Price 4 - 3 - 2 - 1 -

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    In the long run, would the deadweig

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    ___ 7. The factors that determine w

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    3. a. Which price (or prices) from

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    Chapter 18 Utility The basic econom

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    Nonetheless, society generally assu

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    Example 9: Capital City operates a

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    Marginal rate of substitution - the

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    The diamond-water paradox is the ob

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    Complete the table below to answer

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    4. The graph below shows indifferen

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    Chapter 19 The Firm The basic econo

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    than contributing to team productio

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    1. Difficulty in raising large amou

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    Corporations also use self-financin

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    Example 24: A blacksmith who produc

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    For financing needs, proprietorship

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    ___ 13. Corporations: a. are comple

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    5. List two things that the absence

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    Chapter 20 Production and Costs The

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    In Example 5B, Birdwell finds that

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    variable cost initially decreases,

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    Quantity TC MC AFC AVC ATC 0 240 X

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    If the scale of operation is increa

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    average total cost. Average fixed c

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    ___ 11. Concerning the cost curves:

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    5. Complete the following cost tabl

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    Chapter 21 Perfect Competition The

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    Even though a perfect competitor ca

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    Example 6C: This example builds on

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    At what price will there be neither

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    Appendix: Perfect Competition in th

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    Multiple Choice: ___ 1. A perfect c

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    ___ 17. Perfect competition: a. req

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    Answers for Chapter 21 Fill-in-the-

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    Chapter 22 Monopoly Of the four mar

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    3. Exclusive ownership of an essent

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    maximizing quantity (4 units) creat

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    $22 - 20 - 18 - 16 - 14 - Deadweigh

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    2. Negotiating, beginning at a high

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    Legal barriers are created by gover

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    ___ 8. The slope of the demand curv

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    Price Quantity 3. List some of the

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    Chapter 23 Monopolistic Competition

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    For Percomp (the perfect competitor

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    Example 7A: The graph below represe

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    Example 9: The Organization of the

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    Example 12 illustrates the dilemma

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    its current price and quantity. The

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    ___ 14. Game theory: a. is a method

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    Answers for Chapter 23 Fill-in-the-

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    Chapter 24 Factor Markets The basic

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    $ $240 - 200 - 160 - 120 - 80 - 40

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    Since producers will attempt to equ

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    2. Differences in nonmoney aspects

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    were his strikeouts, walks, and hom

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    ___ 3. To maximize profits, a produ

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    ___ 19. According to the book, “M

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    Multiple Choice: 1. a. 8. c. 15. d.

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    Chapter 25 Labor Unions The primary

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    The elasticity of demand for union

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    Example 4A: Assume that the graph b

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    Notice from the graph in Example 6

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    Wage Factory A Quantity of Labor S

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    As a cartel, a labor union faces a

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    ___ 10. For a monopsony: a. there i

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    3. The graph below represents a lab

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    Chapter 26 Interest, Present Value,

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    An increase in expected rates of re

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    An asset is valuable because we exp

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    Example 13B: General Ordnance prove

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    Appendix: Present Value Table One f

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    ___ 4. An increase in expected rate

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    Problems: 1. List and explain the t

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    Chapter 27 Market Failure The basic

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    External Benefit If a market genera

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    Example 2: To encourage the consump

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    $100 - 90 - 80 - MSC 70 - $ 60 - 50

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    A common good is nonexcludable. Non

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    Study Guide for Chapter 27 Chapter

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    ___ 5. What government policy would

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    4. Based on the information on the

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    Chapter 28 Public Choice and Govern

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    Candidates and the Median Voter Mod

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    Example 8: According to State and F

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    Example 10: When Elvis Presley was

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    4. Pessimistic bias. This is the te

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    ___ 5. An elected official will: a.

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    2. If a certain policy will yield s

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    Chapter 29 Government Regulation of

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    underproduction is the amount that

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    micromanagement results in business

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    market. They may agree with their c

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    Questions for Chapter 29 Fill-in-th

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    ___ 10. The public interest theory

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    4. List the four types of costs imp

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    Chapter 30 Agriculture and Health C

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    weather may cause bumper crops. Bad

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    Security and Rural Investment Act o

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    Example 12: From 1960 to 2013, the

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    1. NHI would provide universal heal

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    d. Insurance providers are not allo

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    Study Guide for Chapter 30 Chapter

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    Answer questions 7. through 10. by

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    ___ 21. If there were no individual

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    Chapter 31 Income Distribution and

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    Income is more equally distributed

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    over a typical career is the accumu

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    Ideal Income Redistribution The ide

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    Poverty - a family whose income fal

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    Appendix: Income Inequality around

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    How is this story an analogy for th

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    ___ 2. In 2013, the Lowest Income 6

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    Problems: 1. Explain the two primar

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    Absolute advantage - when one natio

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    Fiat money - money by government de

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    Nonrivalrous good - a good for whic

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    Absolute advantage, 16-9 Absolute e

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    “Company town”, 25-6 Comparativ

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    Eli Lilly and Company, 22-1 Emergen

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    Houston, Texas, 15-10 Human capital

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    Market, 3-1, 3-8-9 Market basket, 4

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    Political bias, 9-4, 12-7 Political

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    Short run production, 20-2-3 Short-

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    Upturns, 9-4 USDA, 27-9, 30-1-2, 30

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