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A common good is

A common good is nonexcludable. Nonpayers cannot easily be excluded from consuming the good. Example 15: Fishing in Lake Springfield has never been subject to restrictions. The lake has never been popular for fishing. People complain that the fish taste funny. So there has never been a reason to incur the cost of placing limitations on how many fish any one person can catch from the lake. There were never so many fish removed from the lake to significantly affect the fish population. Because a common good is nonexcludable, consumers will tend to overconsume the good. Example 16: Due to the publicity it receives from a popular television show, the Monty has become a valuable fish. Aquariums will pay hundreds of dollars for each one. Unfortunately, Montys are unable to reproduce in any environment other than Lake Springfield. Something in the water. Ideally, the Monty would be fished out of Lake Springfield no faster than it can reproduce and sustain its population. If Lake Springfield were privately owned, its owner would be motivated to avoid overfishing. But since the lake is a common good, each person who fishes the lake will be motivated to catch all the Montys that they can before someone else catches them all. The Monty will be fished to extinction. The tendency to overconsume common goods is called the “tragedy of the commons”. Historical examples include the hunting to extinction of the passenger pigeon (which was once the most common bird in North America) and the hunting to near-extinction of the American Bison. Other examples include traffic congestion, overfishing the oceans, overcrowded National Parks, and environmental degradation. The tragedy of the commons can be analyzed as an externality problem. Each person who consumes a common good is receiving a private benefit and generating both a private cost and an external cost (the reduction of the amount of the common good available for others to consume). As long as the marginal private benefit exceeds the marginal private cost, the person will continue to consume. Example 17: As long as the benefit to Homer of catching one more Monty from Lake Springfield exceeds the cost to Homer, he will continue to catch more Montys. He will ignore the external cost that he is imposing on others. The tragedy of the commons can also be analyzed as a type of prisoners’ dilemma. Example 18: All of the people fishing for Montys in Lake Springfield would benefit if they could agree to limit their catch in order to sustain the Montys in the lake. However, each person’s dominant strategy is to catch as many Montys as possible, whether other people stick to the agreement or break it. One way to solve the tragedy of the commons is to turn the common good into a privately owned good. Example 19: If Lake Springfield were privately owned, its owner would be motivated to avoid overfishing in order to sustain the population of Montys. Example 20: According to the USDA, about 35 million cattle are slaughtered in the U.S. each year. Yet there is no concern that cows will become extinct. Another way to solve the tragedy of the commons is by government regulation or taxation to prevent overconsumption. FOR REVIEW ONLY - NOT FOR DISTRIBUTION 27 - 9 Market Failure

Example 21: The city of Springfield can place a limitation on the number of Montys that can be fished out of Lake Springfield each year. The most economically efficient approach would be to auction off Monty fishing licenses to the high bidder. That would ensure that the limited supply of Montys would go to the user with the most valuable use. Asymmetric Information Another source of market failure is asymmetric information. One party to an exchange may have information that the other party doesn’t have. Asymmetric information may result in a market producing more or less than the optimal quantity. Example 22: Fifty years ago, tobacco companies knew a lot more about the dangers of cigarette smoking than the average cigarette smoker knew. Asymmetric information may result in adverse selection. When adverse selection occurs, the party lacking information will be confronted by a different selection than expected. Example 23A: If an auto insurance company charges “one rate” for all drivers, the company may expect a normal selection of drivers to apply for a policy. But the actual selection will consist mainly of “high risk” drivers. Example 23B: Under the Affordable Care Act, insurance providers may not deny coverage or charge higher premiums based on pre-existing conditions. If there were no individual mandate requiring most individuals to purchase health insurance, a person could wait until they developed a health problem before purchasing health insurance. A person could not be denied coverage or charged higher premiums based on this pre-existing condition. Individuals in good health would have no incentive to purchase health insurance, since they could always purchase the health insurance that they need after they develop a health problem. Thus, only those with health problems would purchase health insurance. This adverse selection of purchasers would mean that health insurance premiums would have to be very high. Asymmetric information may result in moral hazard. Moral hazard occurs when one party to an exchange changes his or her behavior after the exchange in a way unexpected by and detrimental to the other party. Example 24: After drivers acquire an auto insurance policy, their driving habits may deteriorate since their personal risk of loss from an auto accident is reduced. Economists disagree on how severe a problem is created by asymmetric information. Some economists see asymmetric information as a major flaw in the market system and believe that the less informed party (usually the consumer) suffers large losses as a result. Other economists argue that information is usually available, though at a cost. They assert that the decision as to how much information to acquire is best left to the consumer. Example 25: Barney is in the market for a used car. Barney is a big guy and often suffers from alcohol-induced clumsiness, so he is looking for a car that is roomy and easy to climb into and out of. Moe owns a used car that is roomy and easy to climb into and out of. Moe knows a lot about the car’s history for reliability. Barney does not. This asymmetric information may cause Barney to buy a car that he would not want or to agree to pay a price that is more than he would be willing to pay if he were better informed. However, Barney has the option of acquiring more information. He can take the car to a trusted mechanic to have it checked out. He can research the reliability of cars of the same make and model. He can pay for a service that will give him a history of the car. Barney will decide how much cost he is willing to incur to increase the information he has about the car. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Market Failure 27 - 10

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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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    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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    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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