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With money as the medium

With money as the medium of exchange, a double coincidence of wants is not required. You find someone who wants what you have and sell it to him or her for money. Then you take the money and buy what you want from someone who has what you want. Using money to make the exchange eliminates the need for a double coincidence of wants. Thus, money reduces the transaction costs of making exchanges. This allows for a greater degree of specialization and trade, which leads to a higher standard of living. The primary function of money is to serve as a medium of exchange. Functions of Money 1. Medium of exchange. As discussed above, money serves as a medium of exchange, a way to make trades more easily. Using money as a medium of exchange reduces the transaction costs of making exchanges. This enables people to make more exchanges and to specialize in producing according to comparative advantage. This is the most important function of money. 2. Measure of value. Money is used to measure value. The value of goods, services, and resources is expressed in terms of the monetary unit. When we compare the prices of different goods, services, or resources, we are using money as a measure of value. Having a measure of value makes it easier to discover mutually beneficial exchanges. 3. Store of value. When we receive money, we don’t have to spend it immediately. We can store up the buying power for later use by holding onto the money. This allows us to use our buying power when it is most valuable to us. Money is not a perfect store of value. Money can be lost or stolen. Another problem with using money as a store of value is that inflation can reduce money’s value (buying power). Example 3: Cathey goes to the dress store. She compares the prices of the dresses available. The red dress is $180. The blue dress is $120. Cathey likes the red dress better, but the blue dress is cheaper. Cathey is using money as a measure of value. Cathey decides to buy the blue dress. She hands the clerk the necessary money ($120 plus tax) to pay for the dress. Cathey is using money as a medium of exchange. Then Cathey changes her mind. She decides to keep her money and wait for the red dress to go on sale. She is using money as a store of value. Why Money Is Valuable Money is valuable. Practically everyone would agree with that statement. But why is money valuable? Is money valuable because it is backed by gold? No. The U.S. went off the gold standard years ago. And even when our currency was backed by gold, the gold was not the source of the money’s value. Money has value because it is generally accepted as a medium of exchange. Money is not valuable in itself. We do not want money to keep. We want money to trade for what we really want. Since we use money as a measure of value, we tend to think that money makes goods valuable. But it’s the other way around. The goods and services we produce make our money valuable, because we can trade the money for the goods and services. Example 4A: The castaways on Gilligan’s Island decide to use Monopoly money as their medium of exchange. When they first land on the island, they are only able to produce a small amount of output compared to the relatively large amount of money that each person has to spend. Since the quantity of money spent is high compared to the quantity of products purchased, prices are quite high; one coconut costs 20 Monopoly dollars. (Refer back to Chapter 4 for the explanation of how the price level is determined.) Five years later, they are producing over ten times as much output. With an increase in the quantity of products purchased relative to the quantity of money spent, prices have fallen. Now one coconut costs 2 Monopoly dollars. Their money has become more valuable, not because of any change in the money, but rather because of the increase in production. The goods and services we produce make our money valuable. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Money, Money Creation, and Inflation 10 - 2

Example 4B: The castaways on Gilligan’s Island are using Monopoly money as their medium of exchange. One day a crate floats up to the island. When Gilligan opens the crate, he discovers that it contains a dozen Monopoly games. Gilligan is ecstatic. “We’re rich!” he shouts. But the castaways are no better off than before. Their level of production has not increased. With the increase in the money supply, the price of goods and services will increase. But the money does not make the goods and services valuable. The goods and services make the money valuable. Measuring the Money Supply Money is whatever is generally accepted as a medium of exchange. There are different measures of the money supply: 1. Currency. Currency is the most basic measure of the money supply. Currency consists of the coins and paper money issued by the federal government. 2. M1. M1 consists of currency in circulation (held outside banks) plus checkable deposits. Checkable deposits are deposits in banks or other financial institutions on which checks can be written. M1 is sometimes called “transactions money”. 3. M2. M2 consists of M1 plus small-denomination time deposits, savings deposits, and money market accounts. The measure of the money supply we will use is M1. As of November, 2014, the money supply (M1) was approximately $2,850 billion. This was an increase of over 100% since August, 2008, when the money supply was about $1,400 billion. Checks and Credit Cards A large percentage of transactions are made through the use of checks and credit cards. Are checks and credit cards money? Checks are not money. Checks are a way to transfer the money held in a checkable deposit. The checkable deposit is money, but the check is not. Example 5: Professor D. Imwit writes a check for $1500 to purchase a new LED television. Has Professor Imwit spent money? If the balance in Professor Imwit’s checking account is sufficient to cover the amount of the check, Professor Imwit has spent money. The check allows Professor Imwit to use some of his money (checkable deposit) to pay for the TV. If the balance of Professor Imwit’s checking account is not sufficient to cover the check, Professor has not spent money. He has committed fraud. Are credit cards money? Credit cards are not money. When a purchase is made through the use of a credit card, the purchaser is not spending money to make the purchase, he or she is taking out a loan. Example 6: Professor Imwit purchases a new LED television for $1500 using his credit card. Professor Imwit has not spent money to buy the television. He has taken out a loan. When he writes a check to make a payment on his credit card balance, he is spending money (assuming that the balance in his checking account is sufficient to cover the amount of the check). Money Creation Our banking system is a fractional reserve system. In a fractional reserve system, banks are able to create money. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Money creation – increases in checkable deposits made possible by fractional reserve banking. In a fractional reserve system, banks hold reserves equal to only a fraction of their deposits. Fractional reserve banking makes it possible for banks to serve as financial intermediaries. 10 - 3 Money, Money Creation, and Inflation

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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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    The same information can be placed

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    Not only does a free market elimina

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    $7 - 6 - 5 - S 3 S1 S 2 Price 4 - 3

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    Example 17: The graph below illustr

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    Questions for Chapter 3 Fill-in-the

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    ___ 12. Assuming a market originall

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    $8 - 7 - 6 - 5 - Price 4 - 3 - 2 -

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    Chapter 4 Inflation and Unemploymen

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    Computing the Rate of Inflation The

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    Full Employment Though unemployment

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    3. Cyclical unemployment - due to d

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    During the Great Depression, the ec

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    Appendix: Think Like an Economist -

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    Answer questions 8. and 9. based on

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    ___ 25. The extension of unemployme

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    Chapter 5 Measuring Total Output: G

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    5. Leisure. Leisure time is by defi

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    The U.S. is a high per capita GDP c

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    Example 17: In “An International

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    The simple circular flow diagram be

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    ___ 3. Which of the following would

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    2. Explain what nonproduction trans

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    Chapter 6 The Aggregate Market The

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    Example 2C: Assume the same facts a

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    Example 5B: The price of crude oil

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    Price Level Real GDP SRAS AD 2 AD 1

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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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