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Example 3: To illustrate

Example 3: To illustrate marginal utility, let’s say that Jan eats one slice of pizza and receives 50 utils of satisfaction. Then Jan eats additional slices, and experiences the following results: Slices of Pizza Total Utility Marginal Utility 0 0 utils X 1 50 utils 50 utils 2 90 utils 40 utils 3 115 utils 25 utils 4 120 utils 5 utils As Jan eats additional slices of pizza, each additional slice adds less to her total utility. Thus the marginal utility of each additional slice decreases (diminishes). Jan is experiencing the law of diminishing marginal utility. Law of diminishing marginal utility – the marginal utility from consuming additional units of a good eventually declines. This law assumes that consumption takes place over a relatively short period of time. If the second slice of pizza is eaten a week after the first slice, the second slice may be just as satisfying as the first slice. The law of diminishing marginal utility is important for understanding consumer behavior. If there were no law of diminishing marginal utility, consumer behavior would be very different than it actually is. Example 4: If your favorite food is apples and you have $50 to spend on groceries, you would spend the entire $50 on apples, if there were no law of diminishing marginal utility. The fiftieth dollar spent on apples would yield just as much marginal utility as the first dollar spent on apples, and more marginal utility than a dollar spent on any other grocery item. But there is a law of diminishing marginal utility. Once you have consumed a few apples, you will receive more marginal utility from buying something else with your next dollar rather than more apples. So you purchase a variety of groceries, apples, oranges, bread, milk, eggs, etc. Diminishing Marginal Utility and Income Distribution Because of scarcity, it is not possible to satisfy all human wants. The basic goal in dealing with scarcity is to produce as much consumer satisfaction as possible with the limited resources available. Or, the basic goal is to produce as much total utility for society as possible. A market economy contributes toward achieving this goal by giving resource owners the incentive to produce the output that generates the most satisfaction for the consumers. The output that generates the most satisfaction for the consumers will also generate the most income for the resource owners. However, a market economy also results in an unequal distribution of income. The distribution of income in the U.S. economy is unequal. Those with much income can afford goods that give them a great deal of marginal utility and also goods that give them little marginal utility. Those with little income may be unable to afford goods that would give them a great deal of marginal utility. Does the unequal distribution of income mean less total utility for society? Would redistributing income from those with more income to those with less income increase total utility for society? The law of diminishing marginal utility seems to indicate that it would. Example 5: Max has annual income of $200,000. Minnie has annual income of $10,000. Which person would gain more marginal utility from an extra $100 of income? The law of diminishing marginal utility seems to indicate that Minnie would. But the law of diminishing marginal utility does not actually indicate which person would receive greater marginal utility from additional income. Utility cannot be measured objectively. There is no objective way to measure or to compare the marginal utility that Max and Minnie would receive from an extra $100 of income. Thus, marginal utility cannot be scientifically compared for different persons. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Utility 18 - 2

Nonetheless, society generally assumes that extra income would yield more utility to a lowincome person than to a high-income person. And hundreds of billions of dollars in income are redistributed each year, generally from persons with more income to persons with less income, with the goal of increasing total utility for society. (We will look more closely at income distribution and redistribution in Chapter 31.) Diamond-Water Paradox Is the price of a good related to the utility received from consuming the good? Logically, we would expect the price of a good to be related to the good’s utility. If Bertram is willing to pay $6 for a chili dog, Bertram must be anticipating at least $6 worth of utility from consuming the chili dog. But what about the diamond-water paradox? Diamond-water paradox – the observation that essential goods are often lower priced than nonessential goods. Some goods that are essential to life (like water) have a very low price. Other goods that are nonessential (like diamonds) have a very high price. This seems paradoxical. Shouldn’t a good’s price be related to its utility? Actually, it is. The price of a good is equal to the marginal utility of the last unit of the good consumed. This is the explanation of the diamond-water paradox. Water has a very high total utility. A person would be willing to pay a very high price to have sufficient water for drinking purposes. Example 6: If the only source of drinking water had a price of $20 per gallon, a person would willingly pay the high price rather than perish from thirst. But a person consumes many units of water, for a variety of uses. The first units of water purchased have very valuable uses, such as drinking. As more units of water are consumed less valuable uses are made of water, such as bathing, washing clothes, washing cars, watering flowers, etc. The last units of water consumed have a very low marginal utility, and are consumed only because of the very low price of water. If water had a price of $20 per gallon, a person would not buy water for its less valuable uses. (Good luck, flowers, you are on your own.) A person consumes few diamonds. The last diamond consumed has a very high price, and is consumed only because the buyer expects a very high marginal utility. If diamonds were more abundant and had a lower price, they would be consumed for less valuable purposes. If diamonds were as abundant as gravel, they would be used to pave driveways. So which is more valuable, water or diamonds? Water is more valuable than diamonds in terms of total utility, but diamonds have a higher marginal utility, and thus a higher price. Example 7: Pat buys a diamond engagement ring in March, paying $2500. Pat’s water bill in March is $30 for 1,500 gallons of water, or an average price of 2¢ per gallon. The diamond ring provides Pat with more marginal utility than the fifteen hundredth gallon of water (which dripped out of a leaky faucet). But the water that Pat consumed in March provided Pat with more total utility than the diamond ring. Utility Maximization Consumers will attempt to maximize the utility (satisfaction) that they receive from their limited incomes. To determine the utility-maximizing combination of goods to consume requires consumers to consider how much marginal utility different goods yield, and also the prices of the different goods. To illustrate this, assume that Consumer A is trying to choose the combination of Good X and Good Y that will maximize Consumer A’s utility. Good X and Good Y yield the amounts of total and marginal utility to Consumer A indicated on the table on the next page: FOR REVIEW ONLY - NOT FOR DISTRIBUTION 18 - 3 Utility

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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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    Appendix: Why the Aggregate Demand

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    ___ 3. DEF Company can invest in ne

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    2. List and explain the two factors

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    Chapter 7 Classical Economic Theory

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    Notice that the investment demand c

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    Long-Run Equilibrium If Real GDP is

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    Example 6B: When the economy is in

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    Laissez-faire If the economy is sel

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    ___ 5. According to Say’s Law: a.

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    3. On the graph below, draw an aggr

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    Chapter 8 Keynesian Economic Theory

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    Example 2B: The graph below illustr

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    Example 5: Assume that the table be

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    Notice on the graph on the previous

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    According to Keynesian theory, a ch

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    “The General Theory” also inclu

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    ___ 8. If the consumption function

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    3. If the MPC is .667, and investme

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    Chapter 9 Fiscal Policy The basic e

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    Keynesian Fiscal Policy Theory and

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    Example 5A: The federal government

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    The Laffer Curve What will happen t

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    Appendix: The Importance of Incenti

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    ___ 4. A decrease in government exp

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    2. Explain what automatic stabilize

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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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    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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