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Chapter 5 Measuring

Chapter 5 Measuring Total Output: GDP The three macroeconomic goals are price level stability, full employment, and economic growth. We looked at inflation and unemployment in the last chapter. Economic growth refers to an increase in total output for the economy. Measuring total output is the topic of this chapter. Gross Domestic Product To determine whether total output is increasing from year to year, and by how much, we need a measurement of total output. The basic measurement of total output is called gross domestic product (GDP). Gross domestic product – the market value of all final goods and services produced annually. The market value of goods and services means the price that purchasers actually paid for the goods and services. The price actually paid would include any sales or excise tax paid. Example 1: Cindy’s Cinnamon Rolls produced and sold 100,000 cinnamon rolls in 2013 and had sales revenue (including sales tax) of $250,000. Cindy’s production had a market value of $250,000 and thus added $250,000 to GDP in 2013. In 2014, Cindy’s produced and sold 110,000 cinnamon rolls and had sales revenue (including sales tax) of 302,500. Thus, Cindy’s production added $302,500 to GDP in 2014. Notice in Example 1 that Cindy’s produced 10 percent more cinnamon rolls in 2014 than in 2013 (110,000 rolls versus 100,000 rolls). However, Cindy’s contribution to GDP increased by 21% percent ($302,500 versus $250,000). Some of the increase in Cindy’s contribution to GDP from 2013 to 2014 is due to higher prices for the cinnamon rolls rather than to increased production. Nominal GDP numbers will change from year to year for two different reasons. Nominal GDP numbers change due to changes in production. An increase in production will contribute towards an increase in nominal GDP. Nominal GDP numbers will also change if there is a change in the price level. This complicates the comparison of GDP numbers from different years. If GDP numbers from different years are to be fairly compared, an adjustment must be made for the change in the price level in the different years. We will look at the calculations to adjust nominal GDP to Real GDP later in the chapter. What is Excluded in Computing Gross Domestic Product The primary purpose of computing GDP is to compare total output from year to year. Thus, GDP needs to be calculated as objectively and as consistently as possible. For this reason, certain types of production that are difficult to measure objectively are excluded in calculating GDP. Also, factors that affect the quality of life, but that do not affect production are excluded from GDP. And financial transactions that do not result directly in production are excluded from GDP. GDP excludes: 1. Intermediate goods. An intermediate good has not yet reached its final user, but rather is an input in the production of another good or has been purchased for resale. Example 2A: Cindy buys 5 pounds of flour at the store for $2.80 for use at her home. This flour is a final good and its market value ($2.80) is included in GDP. Cindy buys 500 pounds of flour from a wholesaler for $240 for use in her cinnamon roll shop. This flour is an intermediate good. It will be an input in the production of a final good (cinnamon rolls). Since this flour is an intermediate good, the value of the flour is excluded from GDP. Cindy’s cinnamon rolls (which include the flour as an ingredient) are final goods and their market value is included in GDP. If intermediate goods were included in GDP, this would overstate GDP by double counting. The flour purchased by the shop would be included once as flour and a second time as an ingredient in the cinnamon rolls. FOR REVIEW ONLY - NOT FOR DISTRIBUTION 5 - 1 Measuring Total Output: GDP

Example 2B: If Milton buys a candy bar at QuikTrip for $1.07, the candy bar is a final good and its market value is included in GDP. If Milton buys 10 boxes of candy bars from Sam’s Club for $165 to re-stock his vending machines, the candy bars are intermediate goods and their value is excluded from GDP. When the candy bars are purchased by consumers from the vending machines, their market value will be included in GDP. 2. Nonproduction transactions. The market value of goods and services produced is measured by the price paid in market transactions. But some transactions do not directly result in production, and are thus excluded from GDP. Nonproduction transactions include; a. Used goods. Used goods were included in GDP when they were first produced. They are not included in GDP when they are exchanged as used goods, because no new production takes place. Example 3: Marshall buys a new Cadillac Escalade for $80,000. The $80,000 will be included in GDP. Two years later, Marshall sells the Escalade to his bodyguard for $50,000. The $50,000 will be excluded from GDP. No new production results from the exchange of the used good. b. Financial transactions. Purchases of stocks and bonds, loans, and gifts of money are examples of financial transactions where money changes hands but no new production takes place. Since no new production takes place, the transactions are excluded from GDP. Example 4: Darla borrows $20,000 from 1 st Bank. She spends $10,000 on Krispy Kreme common stock, spends $8,000 on a used delivery van for her donut shop, spends $1,800 on a new sign for her donut shop, and sends $200 to her sister Carla as a birthday gift. Of these transactions, only the $1,800 spent on the new sign is included in GDP. The loan, the purchase of common stock, and the birthday gift are all financial transactions where no new production takes place. The delivery van is excluded from GDP because it is a used good. c. Transfer payments. Transfer payments are transfers of income from the government to households or businesses, not in exchange for goods, services, or resources. Since no new production takes place, transfer payments are excluded from GDP. Example 5: Transfer payments include social security benefits, Temporary Assistance for Needy Families, unemployment compensation, etc. 3. Nonmarket production. In nonmarket production, new production is taking place. But there is no market transaction to reveal an objective market value for the production. So the value of nonmarket production is excluded from GDP. Do-it-yourself production is an example of nonmarket production. Example 6: Dewey’s house needs to be painted. Dewey contacts Jasper, a professional housepainter. Jasper quotes Dewey a price of $2,300. Dewey decides to paint the house himself. Dewey spends $350 on paint and brushes. Then he spends four weekends painting his house. Only the $350 worth of paint and brushes will be included in GDP. Dewey’s labor is nonmarket production and is excluded from GDP. 4. Underground production. This is unreported production. Production may be unreported because it is illegal (e.g. the output of a meth lab) or because the producer is evading taxation (e.g. unreported cash income). Example 7: Dewey’s house needs to be painted. Dewey contacts Jasper, a professional housepainter. Jasper quotes Dewey a price of $2,300, or $1,800 if Dewey pays in cash. Dewey hires Jasper, who paints the house and collects $1,800 in cash from Dewey. Jasper does not report this cash income. So this underground production is excluded from GDP. FOR REVIEW ONLY - NOT FOR DISTRIBUTION Measuring Total Output: GDP 5 - 2

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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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    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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