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## In making decisions,

In making decisions, humans tend to make comparisons to determine relative values. Let’s say you are shopping for an inexpensive book (Roget’s Thesaurus) which you have found in your college bookstore priced at \$12. A fellow student informs you that an off-campus bookstore has the same book priced at \$2. Would you make the trip to the off-campus bookstore to save \$10? You probably would, since \$10 seems like a huge savings relative to the price of the book. Now let’s say you are shopping for an expensive textbook (chemistry) which you have found in your college bookstore priced at \$275. A fellow student informs you that an off-campus bookstore has the same book priced at \$265. Would you make the trip to the off-campus bookstore to save \$10? You probably would not, since \$10 seems like a trivial savings relative to the price of the book. In making decisions, humans tend to get “anchored” to the first information that they receive. Let’s say that 100 college students are shown a new app for their smart phones. They are asked, “Would you be willing to pay \$50 for this new app?” Then they are instructed to “write down the highest price that you would be willing to pay.” A different group of 100 college students are shown the same new app. They are asked, “Would you be willing to pay \$1 for this new app?” Then they are instructed to “write down the highest price that you would be willing to pay.” The first group of students would almost certainly indicate a higher price than the second group of students. There is no rational reason that a suggested price should influence how highly the students value the app. But “anchoring” leads to irrational behavior. In making decisions, humans are influenced by the irrational power of the zero price effect. If you were offered a choice between buying a \$20 iTunes gift card for \$12 or buying a \$10 iTunes gift card for \$4, you would probably choose the \$20 gift card, since the savings is greater, \$8 versus \$6. But if you were offered a choice between buying a \$20 iTunes gift card for \$8 or receiving a \$10 iTunes gift card for free, you would probably choose the \$10 gift card. In making decisions, humans are influenced by social norms versus market norms. Your friend asks you (as a favor) to help him move to his new apartment. This will take a few hours on Saturday, and you are happy to do it. Alternatively, your friend offers to pay you \$10 to help him move to his new apartment. The offer of pay moves this from social norm to market norm, and the pay seems inadequate. You decline. Other examples of predictably irrational behavior discussed in the book include: (1) The powerful effect of emotional arousal on decision-making. (2) The tendency to procrastinate and to fail to exercise self-control. (3) The “endowment effect”; the tendency to overvalue items that we own. (4) The difficulty of choosing between similar options. (5) The effect of expectations, e.g. food served on fancy china will taste better to us than the same food served on paper plates. (6) The effect of price on the placebo effect, e.g. an antihistamine that costs you 10 dollars will relieve your allergies better than an antihistamine that costs you 10 cents, even if the drugs are chemically identical. (7) The tendency to consider ourselves as basically honest, while also tending to cheat when the the opportunity arises. (8) The tendency to cheat less when money is involved, e.g. we may take a pencil worth 10 cents from work, but we won’t take 10 cents out of the petty cash drawer to buy a pencil. Appendix: Think Like an Economist – Rational Robbers If the government responds to an increase in the incidence of liquor store hold-ups by passing a law that makes the punishment for armed robbery the same as the punishment for murder, there will be fewer liquor store hold-ups. If you work at a liquor store, will you be happy about this change in the law? Thinking like an economist (remembering that rational people respond to incentives), how would you expect the behavior of armed robbers who continue to rob liquor stores to change in response to the new law? FOR REVIEW ONLY - NOT FOR DISTRIBUTION 1 - 11 Scarcity and Choices

Study Guide for Chapter 1 Chapter Summary for Chapter 1 The basic economic problem is scarcity. Human wants are unlimited. Resources are limited. Scarcity is the problem that human wants exceed the production possible with the limited resources available. Economics is the study of how individuals and societies use their limited resources to try to satisfy their unlimited wants. The basic goal in dealing with the problem of scarcity is to produce as much consumer satisfaction as possible with the limited resources available. Resources are the inputs that make production possible. The four categories of resources are labor, land, capital, and entrepreneurship. Most resources are owned by private persons. In economics, people are assumed to behave rationally, which means that they will respond to incentives in the pursuit of their own self-interest. As resource owners pursue self-interest in the use of their resources, the best interest of society will also generally be served. In a competitive market, resource owners will direct their resources to the use that is most highly valued by consumers and will use their resources as efficiently as possible. This serves society’s interest in producing as much consumer satisfaction as possible with the limited resources available. Opportunity cost is the value of the best alternative surrendered when a choice is made. Scarcity creates the necessity to ration the limited resources to production and to ration the limited goods to consumers. The primary rationing device is dollar price. Economic decisions are made by comparing marginal benefits with marginal costs. The optimal level of an activity occurs where marginal benefit and marginal cost are equal. To make sound economic decisions, a person needs to think like an economist. This includes; (1) realizing that association does not necessarily indicate causation, (2) avoiding the fallacy of composition, (3) avoiding the zero-sum fallacy (4) avoiding the free lunch fallacy, (5) distinguishing between positive statements and normative statements, (6) assuming ceteris paribus when examining the relationship between variables, (7) realizing that people respond to incentives, and (8) trying to anticipate unintended consequences. Macroeconomics is the branch of economics that focuses on overall economic behavior. Microeconomics is the branch of economics that focuses on components of the economy. Graphs illustrate the relationship between two variables. An upward sloping curve indicates a direct relationship between the variables. A downward sloping curve indicates an inverse relationship between the variables. The slope of a curve is the ratio of the vertical change to the horizontal change between two points on the curve. Questions for Chapter 1 Fill-in-the-blanks: 1. ______________________ is the problem that human wants exceed the production possible with the limited resources available. 2. ______________________ is the study of how individuals and societies use their limited resources to try to satisfy their unlimited wants. FOR REVIEW ONLY - NOT FOR DISTRIBUTION 3. ______________________ are the inputs that make production possible. 4. ______________________ refers to the physical and mental efforts that people contribute to production. Scarcity and Choices 1 - 12

• Page 2 and 3: PRINCIPLES OF ECONOMICS JEFF HOLT S
• Page 4 and 5: Principles of Economics, 6th Editio
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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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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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