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Example 9: The

Example 9: The Organization of the Petroleum Exporting Countries (OPEC) acted as a cartel to increase oil prices from about $3 per barrel in 1973 to about $35 per barrel in 1981. This led to increased production by non-OPEC countries. OPEC’s share of the world oil market fell from about 60% in 1973 to under 40% in 1985. The cartel will need some type of barrier to entry to keep noncartel competition out of the industry. Economies of scale may make it extremely difficult for small firms to enter the industry. Sometimes, the government will create legal barriers that block the entry of new firms. This may be justified as preventing “cutthroat competition”. (2) The tendency of cartel members to “cheat” on the agreement. As mentioned before, the cartel can increase the price in the industry by reducing industry production. The members of the cartel must agree to cut production for this to work. But each member of the cartel can increase its own profits by “cheating” on the cartel agreement and producing more. The cartel will need to come up with some method to identify and punish cheaters, or the cartel agreement is likely to fall apart. Example 10: OPEC has had trouble maintaining its production agreements. OPEC members have often cheated on the cartel agreement by producing in excess of their production quotas. The tendency of cartel members to “cheat” on a cartel agreement is an example of a “prisoners’ dilemma”. The concept of prisoners’ dilemma is explained in the appendix on game theory. The Economic Inefficiency of Oligopoly In each of the theories of oligopoly behavior, an oligopoly faces a downward sloping demand curve. As a result, oligopoly will be economically inefficient. Oligopoly is inefficient for the same reason that monopoly and monopolistic competition are inefficient. Oligopoly results in a quantity of output where price exceeds marginal cost, and thus where marginal social benefit exceeds marginal social cost. The deadweight loss of oligopoly will be less than that of monopoly, unless the oligopoly firms form a successful cartel. Appendix: Game Theory There is not a consensus among economists as to how oligopoly firms behave. We looked at three different theories of oligopoly behavior in this chapter. Oligopoly behavior can also be analyzed through the use of game theory. Game theory – a method for analyzing strategic behavior. Game theory was developed by mathematician John von Neumann. The groundbreaking book, “Theory of Games and Economic Behavior” was published by von Neumann and economist Oskar Morgenstern in 1944. Game theory is a method for analyzing strategic behavior. The mutual interdependence of oligopoly firms forces them to use strategic behavior in their decision making process. Example 11: Nguyen’s Widgets is one of four firms in the widget market. If Nguyen’s tries to increase its market share by lowering its price by 10%, Nguyen’s action will affect the three other firms in the widget market. If the other firms respond by lowering their prices by 20%, Nguyen’s may lose market share. Nguyen’s is affected by the actions of the other firms, so Nguyen’s will have to think strategically in deciding whether to lower the price of its widgets. FOR REVIEW ONLY - NOT FOR DISTRIBUTION A famous “game” that illustrates the power of game theory in analyzing strategic behavior is called “prisoners’ dilemma”. Example 12 on the next page is an example of the prisoners’ dilemma game. 23 - 7 Monopolistic Competition and Oligopoly

Example 12: Bo and Luke are caught red-handed committing a crime (breaking and entering). The district attorney of Hazzard County suspects that they are also guilty of committing a more serious crime (the manufacture, transportation, and sale of illegal beverages). The D.A. has sufficient evidence to convict Bo and Luke of breaking and entering, but does not have sufficient evidence to convict them of the more serious crime. If Bo and Luke do not confess that they have committed the more serious crime, they will be convicted of the lesser crime, and each will be sentenced to two years in prison. However, the D.A. believes that Bo and Luke can be persuaded to confess to the more serious crime. The D.A. places Bo and Luke in separate cells so that they cannot communicate with each other. Then the D.A. speaks to Bo: “If you confess to the more serious crime and Luke does not confess, you will be given probation and Luke will be convicted of the more serious crime (based on your confession) and will be sentenced to ten years in prison. If Luke confesses to the more serious crime and you do not confess, Luke will be given probation and you will be convicted of the more serious crime and will be sentenced to ten years in prison. If you both confess, you will each be sentenced to five years in prison.” The D.A. then presents the same alternatives to Luke. Will Bo and Luke confess that they have committed the more serious crime or will they not confess? The payoff matrix below illustrates the strategies available to Bo and Luke and the payoff (results) of each pair of strategies: Luke’s Strategies Confess Not Confess Confess Bo-5years Luke - 5 years Bo - probation Luke - 10 years Bo’s Strategies Not Confess Bo - 10 years Luke - probation Bo-2years Luke - 2 years Bo will reason as follows: “If Luke confesses, then the best strategy for me is to confess. That way, I will only be sentenced to five years in prison instead of ten years. And if Luke does not confess, then the best strategy for me is to confess. That way, I will receive probation instead of being sentenced to two years in prison.” Thus, Bo’s dominant strategy is to confess. Dominant strategy – a strategy that always yields the best result regardless of the strategies of the other players. Luke will reason the same way as Bo. Luke’s dominant strategy is also to confess. Thus, the Nash equilibrium will be for Bo and Luke to both confess, and to both receive a five year prison sentence. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Nash equilibrium – the outcome when each game player has chosen their best strategy, assuming that all other players have also chosen their best strategies. Monopolistic Competition and Oligopoly 23 - 8

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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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    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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    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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