Economics

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define scarcity.
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   The condition in which wants exceed the resources available to satisfy them

2. Name the four factors of production.
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   Land, labor, capital and entrepreneurship

3. State the three questions every economy must answer.
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   What to produce, how to produce it, and who receives what is produced

4. Define a free good.
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   One available in greater quantity than anyone wants at a price of zero

5. Distinguish scarcity from shortage in one sentence.
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   A shortage is a temporary gap at a particular price and can be eliminated; scarcity is permanent and cannot

6. Show from the council's figures that choice is forced rather than chosen.
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   The five proposals total 8,800,000 against a budget of 4,000,000, so requests exceed resources by 4,800,000 and at least one project cannot proceed. That gap does not depend on how competently or honestly the council operates, and it does not depend on how badly each project is needed. Even adjourning without deciding is a choice, since it funds none of them. The necessity comes from scarcity itself. Requests exceed the budget by 4,800,000, so something must be refused whatever the council does

7. Why would a larger budget not eliminate the problem?
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   Because wants expand to meet whatever resources exist. If the budget rose to 8,800,000 and every current proposal were funded, the council would immediately face requests it had not previously bothered to submit: a second clinic, a bus service, a park, higher salaries. The gap reappears at the new level. That is precisely the difference between scarcity, which is a permanent relationship, and a shortage, which is a temporary gap that can be closed. Wants expand to meet resources, so the gap reappears at any budget

8. Explain why a wealthy person still faces scarcity.
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   Because scarcity is a relationship between wants and resources rather than a property of any particular resource, and some resources cannot be bought. A wealthy person has the same twenty-four hours as everyone else and the same finite attention, so accepting one invitation still means declining another and reading one book still means not reading a different one. Money relieves scarcity of goods without touching scarcity of time. Time and attention remain limited however much money someone has

9. Identify the scarce factors in the council's situation besides money.
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   There are a limited number of qualified teachers available to hire in that area, so funding twelve posts does not guarantee twelve teachers. There is a limited construction season, so two large building projects may not both fit into one year. And there is a limited amount of council attention for supervising work, which is why organizations that attempt everything at once execute badly. None of those constraints is relieved by more money. Available qualified labor, construction time, and administrative attention

10. State the causal relationship between scarcity and choice precisely.
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    Resources are insufficient to satisfy all desired uses, so committing a resource to one use necessarily means forgoing every other use of it, and someone must therefore decide which use it serves. Choice is not a preference for deciding things; it is an unavoidable consequence of the resource being unable to do two jobs at once. Remove scarcity and choice becomes unnecessary, which is why scarcity is the starting point of the subject. Insufficient resources mean one use excludes another, so someone must decide

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define opportunity cost.
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   The value of the next best alternative forgone when a choice is made

2. Define marginal cost and marginal benefit.
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   The cost of producing one more unit and the value of consuming one more unit

3. State the marginal decision rule.
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   Continue while marginal benefit exceeds marginal cost; stop when marginal cost overtakes it

4. Define a sunk cost.
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   A cost already spent that cannot be recovered

5. What does the slope of a production possibilities frontier represent?
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   The opportunity cost of one good in terms of the other

6. Work through the bakery decision and justify the stopping point.
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   Cake one gains 25 minus 9, which is 16; cake two gains 15; cake three 13; cake four 9; cake five 2. Cake six costs 34 against a benefit of 25, losing 9. So the baker stops at five. Total gain is 16 plus 15 plus 13 plus 9 plus 2, which is 55, against 46 for six cakes and 21 for seven. The rule maximizes, and the arithmetic confirms it. Five cakes, giving 55 against 46 for six and 21 for seven

7. Why does marginal cost rise with each additional unit?
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   Because a producer uses the best available resources first and progressively worse ones afterward. The baker fills the most convenient oven space before the awkward space, works normal hours before paying overtime, and buys ingredients on the regular schedule before paying short-notice prices. Each extra unit therefore draws on a less favorable alternative than the one before, so the cost of producing it is higher. Best resources are used first, so later units draw on worse alternatives

8. Explain why the 400 mixer does not change the answer.
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   Because it is spent identically under every option. Baking zero cakes, five cakes or seven cakes all leave the 400 equally gone and unrecoverable, so it cannot make any option better or worse than another. A figure that appears the same on both sides of a comparison cancels out of it. The best decision remains five cakes, and the day's result is 55 minus 400, a loss of 345. It is identical under every option, so it cannot distinguish between them

9. Why does baking more to justify the mixer make things worse?
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   Because the sixth and seventh cakes lose money on their own terms, costing 34 and 50 against a benefit of 25 each. Baking seven yields 21 rather than 55, so the day's loss deepens from 345 to 379. The mixer is not recovered by any of this, since it was never recoverable. Trying to justify a past expenditure by adding further loss-making activity is the classic sunk cost error. The extra cakes lose money, deepening the loss from 345 to 379

10. Set the decision up as an opportunity cost comparison.
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    If the baker's next best use of the day is teaching a class for 40, then 40 is the opportunity cost of baking. The comparison is the 55 that optimal baking yields against the 40 from teaching, so baking is better by 15. Notice that the 400 mixer appears on neither side, since it is gone whichever the baker does, and that the relevant alternative is the single next best one rather than every option that existed. 55 from baking against 40 from teaching, with the mixer on neither side

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define an incentive.
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   Anything that alters the expected cost or benefit of an action and therefore how likely it is to be taken

2. Give three examples of monetary incentives.
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   Wages, prices, taxes, subsidies, fines and bonuses

3. Give three examples of nonmonetary incentives.
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   Time, convenience, status, safety, reputation, guilt and approval

4. Distinguish positive from negative incentives.
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   Positive incentives reward an action; negative incentives penalize one

5. Why does an unnoticed incentive have no effect?
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   Because people respond to incentives as they perceive them, not as they are written

6. Why does a ten cent bag charge change behavior so much?
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   Because it operates on two margins at once. The monetary cost of a bag rises from zero to ten cents, which is genuinely a change from free to not free even though the amount is trivial. More importantly, the charge makes the decision visible: the shopper must actively ask for a bag and be seen paying for it, which attaches a small nonmonetary cost of awkwardness. The nonmonetary component does much of the work. It adds a small money cost and a larger visibility cost at the same time

7. Explain how the nursery late fee could increase lateness.
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   Because before the fee, collecting a child late carried guilt and the visible disapproval of staff, and many parents treated that nonmonetary cost as substantial. Posting a price of 3 converts lateness from a transgression into a purchasable service, so a parent who values twenty extra minutes at more than 3 can now buy them with a clear conscience. The monetary cost added is smaller than the moral cost removed. The posted price removed a moral cost larger than the price it added

8. What should a policy designer check before adding a monetary incentive?
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   What nonmonetary incentive is already operating, and how large it is. If duty, reputation, guilt or professional pride is already restraining the behavior, attaching a price may displace that restraint and make things worse rather than better. The relevant question is not whether the new incentive points the right way but whether it is larger than whatever it replaces, and that requires knowing what is already there. Whether an existing nonmonetary incentive is larger than the price being added

9. Why is a bonus tied to test scores difficult to design well?
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   Because it attaches the reward to the measure rather than to the goal, and every behavior that raises the measure is thereby encouraged. Scores can be raised by teaching better, which is intended, but also by narrowing teaching to only what is tested, by concentrating effort on students just below the passing mark where a small gain moves the number most, or by misreporting. Designing an incentive means listing the cheapest ways to move the measure. It rewards the measure, so every cheap way of moving that measure is encouraged

10. How would you evaluate the insulation subsidy?
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    By estimating what share of recipients changed their behavior because of it. Households that would have insulated anyway collect 2,000 for doing what they had already decided to do, which costs the budget and changes nothing. Households that were just short of acting are moved to act, which is the entire point. The policy is worth its cost only if the second group is large relative to the first, which is an empirical question requiring data rather than argument. Estimate how many recipients changed behavior against how many were paid for decisions already made

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define a property right.
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   An enforceable claim to use a resource, exclude others from it, and transfer it

2. Define the tragedy of the commons.
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   Overuse of an open access resource because each user takes the full benefit and bears only a fraction of the cost

3. Why does transferability matter?
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   Because an owner who can sell has a reason to maintain value even when intending to leave

4. Name three resources for which exclusion is impractical.
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   Migrating fish, groundwater, air, and ocean fisheries

5. Distinguish a renewable from a nonrenewable resource.
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   A renewable resource can be harvested indefinitely below its replacement rate; a nonrenewable one can only be used at a chosen speed

6. Work through one skipper's calculation under open access.
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   Taking 120 tonnes at 1,200 per tonne earns 144,000, all of which goes to that skipper. The cost of the resulting depletion is spread across all 100 boats, so if the future loss caused by this boat is worth 50,000 across the fleet the skipper bears only one hundredth of it, which is 500. Comparing 144,000 of private gain with 500 of private cost, fishing hard is overwhelmingly rational. 144,000 in private gain against 500 in private cost

7. Why is the resulting collapse not caused by irrationality?
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   Because every individual skipper is making the decision that is correct for them given what everyone else will do. Restraint by one boat leaves 99 others taking the fish anyway, so the restrained skipper bears the whole cost of abstaining and captures almost none of the benefit. The outcome is collectively disastrous and individually rational, which is exactly why it cannot be fixed by persuasion or by appealing to better judgment. Each skipper's choice is individually correct, so the collapse needs no irrationality

8. Work through the single owner's calculation.
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   Harvesting sustainably at 8,000 tonnes yields 9,600,000 a year indefinitely. Harvesting 12,000 tonnes yields 14,400,000 this year and then perhaps 6,000,000 a year afterward as the depleted stock recovers slowly. The owner gains 4,800,000 now and loses 3,600,000 every following year, so is behind within about two years. Because the whole future loss falls on the owner, restraint becomes profitable rather than merely admirable. 4,800,000 gained once against 3,600,000 lost annually, so restraint pays within two years

9. How does the ability to sell change a retiring owner's behavior?
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   Without transferability, an owner intending to retire next year has no reason to preserve a stock they will never harvest again, so they strip it. Because the right can be sold, and any buyer will pay far more for a healthy fishery than a depleted one, overfishing now reduces the sale price directly. Transferability converts a distant future loss into an immediate one, which is why it matters as much as ownership itself. A buyer pays less for a depleted stock, so future loss becomes a present one

10. Under what conditions does private property fail to conserve?
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    When exclusion is impractical and when title is insecure. If the fish migrate through waters the owner cannot police, the exclusive right cannot be enforced and the open access arithmetic returns in full. If the owner expects the right to be revoked or seized within two years, they have every reason to strip the stock immediately rather than preserve value they will not capture. The mechanism requires both enforceable exclusion and secure tenure. When exclusion cannot be enforced, or when the owner expects to lose the title

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. State Smith's central claim in one sentence.
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   That people pursuing their own interest in a competitive market frequently benefit others without intending to

2. Why does a voluntary exchange benefit both parties?
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   Because neither would agree to it unless they expected to gain

3. What did Smith say about people of the same trade meeting together?
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   That the conversation tends to end in a conspiracy against the public or a contrivance to raise prices

4. Name three duties Smith assigned to government.
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   Defense, justice, public works no individual would fund, and education

5. What is exit, and why does it matter politically?
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   The ability to take custom or labor elsewhere, which makes a person harder to coerce

6. What condition is hidden in the butcher and baker passage?
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   That the customer has an alternative. The baker's self-interest produces good bread only because losing your custom costs the baker something, which requires that you could buy bread somewhere else. If the baker is the only supplier and you cannot go elsewhere, that same self-interest points toward charging more and caring less. Competition, not self-interest alone, is doing the work in the argument, and Smith understood this. That the buyer has an alternative, so competition is what makes self-interest serve others

7. How do the two passages fit together?
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   Without contradiction, once you see that Smith supported competitive markets rather than businesses. Firms would prefer not to face competition, so they lobby for restrictions, licenses, tariffs and agreements that raise prices. The interest of a market and the interest of the firms currently in it therefore diverge, and policy that pleases established businesses frequently damages the competitive process Smith was defending. He defended competitive markets, not businesses, whose interests diverge

8. Work through the invented town to show how dispersed economic power supports liberty.
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   In a town with one employer, one landlord and one shop, all under a single authority, a resident who criticizes that authority can lose their job, their housing and their supply of goods simultaneously, so criticism is prohibitively expensive. Give the same town twenty employers, many landlords and several shops, and the same criticism costs far less, because each of those relationships can be replaced. The cost of dissent falls as alternatives multiply. Many independent employers, landlords and sellers make dissent affordable

9. What counterexample shows the argument depends on competition rather than private ownership?
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   A single dominant private employer in a remote town. Residents depend on it for wages, and there is nowhere else to work, so it can impose terms and punish complaint in exactly the way a state monopoly could. Private ownership has not supplied liberty here because exit is unavailable. What protects the resident is the existence of alternatives, and alternatives require competition regardless of who owns what. A single dominant private employer produces the same dependence as a state monopoly

10. State the argument with its condition attached.
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    Competitive markets tend to support political and personal liberty by dispersing economic decisions among many independent parties, which gives individuals somewhere else to go and therefore makes coercing them expensive. The condition is that competition must be genuine. Concentrated economic power removes the exit that produced the benefit, and it does so whether the concentration is public or private, which is why Smith attacked monopoly in both forms. Markets support liberty by providing exit, but only where competition is real

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. State the law of demand.
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   As price rises, quantity demanded falls, other things equal

2. State the law of supply.
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   As price rises, quantity supplied rises, other things equal

3. Define a substitute and a complement.
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   A substitute serves a similar purpose; a complement is used together with the good

4. How is price elasticity of demand calculated?
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   Percentage change in quantity divided by percentage change in price

5. What does an elasticity above 1 mean?
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   Demand is elastic: quantity responds proportionally more than price changes

6. Compute and compare the two elasticities.
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   Both towns face a price rise from 2.00 to 2.40, which is 20 per cent. In town A quantity falls from 10,000 to 9,400, a fall of 6 per cent, giving an elasticity of 6 divided by 20, or 0.3, which is inelastic. In town B quantity falls from 10,000 to 7,000, a fall of 30 per cent, giving 30 divided by 20, or 1.5, which is elastic. The same price change produces very different responses. Town A gives 0.3 and town B gives 1.5

7. Explain the difference in terms of substitutes.
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   Town B has a train on the same route, a bike path and dense housing near the center, so a rider who objects to the higher fare has three realistic alternatives and takes one. Town A is spread out with no train and little parking, so the choice is the bus or not traveling at all. The number and closeness of substitutes is what determines how far buyers can move when a price rises, and therefore determines elasticity. B has close substitutes so riders switch; A has none so they stay

8. Work out what the price rise does to each operator's revenue.
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   In town A, revenue moves from 2.00 times 10,000, which is 20,000, to 2.40 times 9,400, which is 22,560, so it rises by 2,560. In town B, revenue moves from 20,000 to 2.40 times 7,000, which is 16,800, so it falls by 3,200. The identical price increase helps one operator and harms the other, because quantity fell proportionally less than price rose in A and more in B. A's revenue rises to 22,560; B's falls to 16,800

9. State the general relationship between elasticity and revenue, and show it follows from the arithmetic.
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   Raising price raises revenue when demand is inelastic and lowers it when demand is elastic, with the boundary at an elasticity of exactly 1. This follows directly: revenue is price times quantity, so a 20 per cent price rise combined with a 6 per cent quantity fall must raise the product, while the same rise combined with a 30 per cent fall must lower it. It is arithmetic rather than a separate fact to memorize. Price rises help revenue below elasticity 1 and hurt it above, arithmetically

10. Explain the incentive behind the law of supply using the figures.
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    A higher price makes production worth doing for sellers whose costs previously made it unprofitable. An operator whose cost per journey is 3.00 cannot run a route at a fare of 2.80 without losing money, so it does not run. At a fare of 3.20 that same route becomes profitable and the operator enters. A price rise therefore brings in every supplier whose cost sits between the old price and the new one, which is why quantity supplied rises. A higher price brings in suppliers whose costs lie between the old and new price

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. What causes a movement along a demand curve?
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   A change in the good's own price

2. Name four things that shift demand.
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   Income, tastes, prices of substitutes and complements, number of buyers, and expectations

3. Name four things that shift supply.
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   Input costs, technology, number of sellers, taxes and subsidies, and expectations

4. What happens to price and quantity when supply falls?
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   Price rises and quantity falls

5. What happens to price and quantity when demand rises?
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   Both rise

6. Find the original equilibrium and explain why no other price works.
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   Equilibrium is 220, where quantity demanded and quantity supplied are both 700. At 200, buyers want 800 while sellers offer 600, so 200 units of demand go unsatisfied and disappointed buyers bid the price up. At 240, sellers offer 800 while buyers want 600, so 200 units sit unsold and sellers cut prices to move them. Only at 220 does nobody have a reason to change. 220 and 700, because at every other price someone has an unmet reason to move

7. Work through the poor harvest and state the result.
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   Supply falls by 200 at every price, so it becomes 300 at 180, 400 at 200, 500 at 220, 600 at 240 and 700 at 260. Demand is unchanged. At 260 there is a surplus of 200, while at 240 demand is 600 and supply is 600, so the new equilibrium is a price of 240 and a quantity of 600. Price rose by 20 and quantity fell by 100, matching the supply-falls rule. New equilibrium at 240 and 600: price up, quantity down

8. Why can price alone not tell you which event occurred?
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   Because a fall in supply and a rise in demand both raise price, and in these figures both raised it to exactly 240. What distinguishes them is quantity: the supply fall cut quantity from 700 to 600, while the demand rise pushed it from 700 to 800. An observer who sees only that wheat got dearer cannot say whether the harvest failed or buyers got richer, and those call for completely different responses. Both events raise price to 240; only quantity distinguishes them

9. Work through the simultaneous shift.
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   Supply falls 200 and demand rises 200 at every price. At 260, demand becomes 500 plus 200, which is 700, and supply becomes 900 minus 200, which is also 700. They are equal, so equilibrium price is 260 and quantity is 700. Price rose by 40, which is more than either shift produced alone, and quantity did not move at all from its original level. Price 260 and quantity 700: price rises sharply, quantity is unchanged

10. State the general rule for simultaneous shifts and test it.
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    When supply falls and demand rises, both changes push price upward, so price definitely rises. They push quantity in opposite directions, so the quantity outcome depends on which shift is larger and cannot be determined from the directions alone. Here the two shifts were equal at 200 each and quantity stayed at 700; make the demand increase 300 while supply falls 200 and quantity would rise, which confirms the rule. Price is determinate and quantity depends on which shift is larger

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Why are property rights necessary for exchange?
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   Because you cannot sell what you do not own, and nobody buys what a seller cannot transfer

2. Name two things competition does.
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   Forces price toward cost and quality toward what buyers want, and discovers which methods work

3. Define profit.
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   Revenue minus cost

4. What does a loss signal?
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   That the resources are worth more in another use and should be moved

5. What competes profit away?
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   Entry by other firms attracted by the margin

6. Explain what a margin of 36 on a cost of 14 communicates.
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   That buyers value this particular use of labor, plastic and engineering far more than those inputs cost in their other uses. The gap is a measure of how underused the opportunity is, and because prices are public the information reaches every firm in the economy at once without anyone compiling or publishing it. That is the informational function of profit, and it is distinct from its function as a reward to the firm. That these inputs are worth far more here than elsewhere, visible to everyone

7. Trace what entry did to price, output and buyers.
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   Three competitors entering pushed price from 50 to 34 and raised combined output from 40,000 to 110,000 units, so buyers gained 16 per unit and far more units were available. By year four, seven firms had pushed price to 12.50. The original firm's margin fell from 36 to 20 and then further, which it neither chose nor could prevent. Entry is how the profit signal causes the reallocation it announces. Price fell from 50 to 12.50 and output more than doubled as firms entered

8. How did competition spread the cheaper production method?
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   The firm that found an 11 cost method earned 8 per unit against its rivals' 5, so it could cut price further and still profit while they could not. It expanded, and the others faced a choice between adopting the method and losing share until they exited. A discovery made privately by one firm therefore became general practice across the industry, which is competition performing its informational function rather than merely its disciplinary one. The low-cost firm could undercut rivals, so they had to copy the method or exit

9. What happens to the whole process if the first firm holds a monopoly?
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   It stops after year one. Price stays near 50 and output near 40,000, so buyers never receive the 37.50 per unit they eventually gained. The cheaper production method is never found, because nobody has a reason to look for it when the existing margin is secure. Profit persists instead of being competed away, which means the signal is broadcast but never acted on, and the reallocation it called for never happens. Price and output stay where they were, and the signal is never acted on

10. Why does removing property rights stop the process before it starts?
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    Because the firm develops the filter in the expectation of capturing the return, and if the design can be seized or the factory taken then that return cannot be captured. The rational response is not to develop it, so the product never exists and none of the four years of falling prices and rising output occurs. Property rights are therefore not merely a fairness matter; they are a precondition for the investment that begins the whole sequence. Without a capturable return, the firm never develops the product at all

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. What does a price reflect?
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   Relative scarcity: how scarce a good is compared with how much people want it

2. State the allocative function of price.
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   It directs a good to the uses that value it most, since only those will pay the price

3. How does a price ration on the demand side?
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   By discouraging the least valuable uses first

4. Why does a price economize on information?
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   Because a buyer needs only the number, not the reason it moved

5. What does a price allocate by?
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   Willingness and ability to pay

6. Work through which uses stop and why that outcome is notable.
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   Decorative fittings value copper at 10,200 and novelty souvenirs at 8,900, both below the new price of 11,600, so both stop buying rather than pay more than the copper is worth to them. Medical imaging at 40,000, wiring at 19,000 and motors at 13,500 continue. What is notable is that the two uses eliminated are precisely the two lowest valued ones, and nobody ranked them or instructed anyone. The two lowest valued uses stop, without anyone ranking them

7. What would a committee need to know to reproduce that result?
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   The value of copper in every single use throughout the economy, including uses in small firms nobody thought to survey and uses that would exist if circumstances changed, and it would have to update all of it continuously as those values moved. No committee can assemble that, and the participants themselves could not report it honestly since understating rivals' needs would serve them. The price achieved it without any participant holding the information. Every use's value across the whole economy, updated continuously and reported honestly

8. Name the three responses the price triggered at once.
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   It pushed low-value uses out of the market, since paying 11,600 for something worth 10,200 is a loss. It pulled in new supply, because mines with extraction costs between 8,000 and 11,600 became profitable and recycling became worth doing at scale. And it triggered substitution, because aluminum and fiber alternatives not worth their disadvantages at 8,000 became worth them at 11,600. One number did all three. Rationing of low-value uses, new supply entering, and substitution away from copper

9. What happens if the price is held at 8,000 by law?
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   The shortage remains, because supply is still 12 per cent lower and the law changed no physical fact. Souvenir makers keep buying, since 8,000 is below the 8,900 the copper is worth to them, and high-value users may go short. No additional mines reopen and no substitution occurs, since neither is profitable at 8,000. Allocation then depends on who ordered first, who has connections or who queues, rather than on value. The shortage persists and allocation shifts from value to queuing and connections

10. State the honest limitation of allocation by price.
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    Willingness to pay tracks value only where buyers have the means to pay, so a household priced out of heating is not thereby signaling that warmth matters little to it. The mechanism measures value weighted by purchasing power. That is a real limitation, and it argues for transferring income to those who lack it rather than for suppressing the price, since suppression destroys the allocation without creating any additional supply. It weights value by purchasing power, which argues for income transfers not price controls

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define equilibrium.
   Show the full solution

   The price at which quantity demanded equals quantity supplied

2. What exists above the equilibrium price?
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   A surplus of unsold goods

3. What exists below the equilibrium price?
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   A shortage of unsatisfied buyers

4. Which way does competition among buyers push price?
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   Up

5. Which way does competition among sellers push price?
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   Down

6. Work through what happens at a price of 80.
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   Only B1 at 95 and B2 at 82 are willing to pay 80, so two units are demanded, while S1, S2, S3, S4 and S5 are all willing to accept 80 or less, so five are supplied. That is a surplus of three. Three sellers therefore have no buyer, and each would rather sell at a lower price than not sell at all, so one offers less and the others must match or lose the sale. Price falls. Two demanded against five supplied, so three sellers must cut their price

7. Work through what happens at 45.
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   B1 through B5 are all willing to pay 45, so five units are demanded, while only S1 at 30 and S2 at 41 will accept it, so two are supplied. That is a shortage of three. Three buyers get nothing, and B3, who values a unit at 70, would far rather pay 55 than go without, so B3 offers more. Buyers competing against one another push price upward. Five demanded against two supplied, so disappointed buyers bid the price up

8. Find the equilibrium and identify the marginal participants.
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   At 60, buyers B1, B2 and B3 are willing, since B4's limit of 58 is below it, so three are demanded. Sellers S1, S2 and S3 are willing, since S4's minimum of 61 is above it, so three are supplied. Any price from 59 to 61 clears with three units trading. The marginal participants are B3, who values a unit at 70, and S3, who would accept 50; they are the last buyer and seller to trade. Equilibrium near 60 with three units, B3 and S3 being marginal

9. Why does nobody need to know the equilibrium price in advance?
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   Because each participant acts only on their own reservation price and on what they observe happening around them, and those local actions have a consistent direction. A surplus means some seller is holding unsold stock they would rather sell cheaper, so price is pushed down; a shortage means some buyer is going without something they value more than the asking price, so price is pushed up. The process converges without any participant computing anything. Surpluses and shortages each give someone a reason to move price the right way

10. Why do some markets converge faster than others?
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    Because convergence depends on how quickly participants can observe prices and how easily they can change what they do. A share market where every transaction is posted instantly and orders can be changed in a second converges almost immediately. A housing market where each sale is private, comparable properties differ, and moving takes months converges slowly, which is why house prices can sit above the clearing level for a long time with few sales. It depends on how fast prices are observed and how quickly participants can adjust

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define a price ceiling and a price floor.
   Show the full solution

   A legal maximum price and a legal minimum price

2. When does a ceiling bind?
   Show the full solution

   Only when it is set below the equilibrium price

3. What does a binding ceiling produce?
   Show the full solution

   A persistent shortage

4. Name three forms of non-price rationing.
   Show the full solution

   Queues and waiting lists, favoritism, quality reduction, and illegal side payments

5. Why does quality fall under a ceiling?
   Show the full solution

   Because a seller who cannot raise price can instead reduce what is delivered for it

6. Work through the ceiling and quantify the shortage.
   Show the full solution

   Equilibrium is 1,000 with 26,000 apartments. A ceiling of 600 raises quantity demanded to 34,000 and cuts quantity supplied to 18,000, so the shortage is 16,000 apartments. It is permanent rather than temporary, because the mechanism that would normally close a shortage is a rising price and that has been prohibited. The gap therefore persists for as long as the control does. A permanent shortage of 16,000 apartments

7. Identify the winners and losers precisely.
   Show the full solution

   The 18,000 households that obtain an apartment save 400 a month each, which is 7,200,000 a month collectively, so they gain substantially. The 16,000 that do not get one lose, and 8,000 of those would have been housed at the market price of 1,000, so the control actively displaced them. Landlords lose 400 a month on every unit let plus the return on the units withdrawn. The policy redistributes rather than simply helping. 18,000 tenants gain 400 a month each; 16,000 households and all landlords lose

8. Why does supply fall rather than staying constant?
   Show the full solution

   Because owners whose maintenance, tax and financing costs fall between 600 and 1,000 cannot cover them at the controlled rent. Their rational responses are to convert units to other uses, sell them to owner occupiers, or leave them vacant, and no developer starts a new building that cannot cover its costs. The control therefore does not merely fail to create housing; it removes 8,000 units that existed at the market price. Owners whose costs exceed 600 withdraw units, and no new ones are built

9. Explain how allocation changes and who it favors.
   Show the full solution

   With 34,000 households chasing 18,000 units, landlords must choose among applicants by something other than price, so waiting lists, demands for references, preference for tenants seen as low risk, and key money paid informally all appear. Existing tenants also stop moving, which reduces turnover further. Allocation shifts to those best placed to wait, to those with connections, and to those able to pay outside the rules, rather than to those who value housing most. It favors incumbents, the well-connected and those who can pay informally

10. Work through the wage floor and state the honest qualification.
    Show the full solution

    At an equilibrium wage of 13, employment is 40,000. A floor of 17 cuts employer demand to 34,000 while 47,000 people want the work, so 6,000 lose their jobs and 13,000 want work they cannot get. The 34,000 remaining gain 4 an hour. Whether this helps on balance depends on how responsive employment actually is to the wage, which economists genuinely dispute, so a strong answer reports the disagreement rather than asserting one side. 34,000 gain 4 an hour and 6,000 lose their jobs, with the true responsiveness disputed

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Name three things competition does to a product.
   Show the full solution

   Lowers its price, raises its quality, and raises the quantity available

2. Why does competition raise quality?
   Show the full solution

   Because buyers with alternatives will leave, so quality becomes a way of competing

3. How does international competition differ mechanically from domestic competition?
   Show the full solution

   It does not; the foreign firm is simply another rival

4. Where do the gains from international competition fall?
   Show the full solution

   Diffusely, across all consumers

5. Where do the losses fall?
   Show the full solution

   Concentrated in particular industries and towns

6. Quantify the consumer gain from the price fall.
   Show the full solution

   The 900,000 households that would have bought a machine anyway each save 700 minus 460, which is 240, giving a total saving of 216,000,000 a year. A further 400,000 households now buy who previously could not afford to, and each gains the difference between what they valued the machine at and the 460 they paid. The second group's gain is harder to measure but is real, since they previously went without entirely. 216,000,000 a year to existing buyers, plus real gains to 400,000 new ones

7. Work out the quality gain and explain why it exceeds the price fall.
   Show the full solution

   Owning a machine costing 700 and lasting six years costs about 117 a year. Owning one costing 460 and lasting nine years costs about 51 a year. The annual cost has more than halved, whereas the price alone fell by about a third. The quality improvement multiplies the price effect, because a buyer purchases years of service rather than an object, and reliability is a margin firms compete on once price competition begins. Annual ownership cost falls from 117 to 51, more than halving

8. Quantify the loss and compare it honestly with the gain.
   Show the full solution

   Employment falls from 11,000 to 6,500, so 4,500 jobs are lost, and at 42,000 each that removes 189,000,000 of annual income from a small number of towns. The measurable consumer gain of 216,000,000 exceeds that, and the quality and new-buyer gains are additional, so the net is positive. The comparison is honest only if it states that 4,500 identifiable people bear the whole cost while the gain is spread across 1,300,000. 189,000,000 in lost wages against 216,000,000 in savings, so positive net with real losers

9. Explain the political asymmetry.
   Show the full solution

   A household saving 240 a year will not organize, contact a legislator or attend a hearing about it, because the saving is too small to justify the effort and most households will not even notice it. A household losing 42,000 a year will do all three, and so will its neighbors, its union and its town's representatives. Concentrated losses therefore generate political pressure that diffuse gains never generate, so protection is demanded far more often than the arithmetic supports. Small diffuse gains never organize while large concentrated losses always do

10. What policy follows from the arithmetic, and why not a tariff?
    Show the full solution

    Since the gain of 216,000,000 exceeds the loss of 189,000,000, the gainers could in principle compensate the losers and everyone would end up better off, which is the case for adjustment assistance, retraining and transitional income support. A tariff does the opposite: it prevents the loss by canceling the gain, restoring the higher price for all 1,300,000 households in order to protect 4,500 jobs, which destroys more value than it preserves. Compensate the losers from the gains; a tariff cancels the gain to prevent the loss

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. What does an entrepreneur do?
   Show the full solution

   Organizes the other factors of production and bears the risk of the venture

2. Distinguish accounting profit from economic profit.
   Show the full solution

   Accounting profit subtracts explicit costs; economic profit also subtracts opportunity costs

3. Define normal profit.
   Show the full solution

   The return just sufficient to keep the entrepreneur in this activity rather than the next best one

4. Name two things profit compensates for.
   Show the full solution

   Risk of failure and the delay between committing resources and receiving revenue

5. What useful function does a business closing perform?
   Show the full solution

   It frees labor, premises and capital for uses buyers value more

6. Compute both profit measures for the bakery.
   Show the full solution

   Explicit costs are 90,000 for ingredients, 48,000 rent, 96,000 wages and 22,000 utilities and insurance, totaling 256,000, so accounting profit is 310,000 minus 256,000, which is 54,000. The implicit costs are the 47,000 the owner could earn elsewhere and the 6,000 the 120,000 of savings could earn at 5 per cent. Economic profit is therefore 54,000 minus 53,000, which is 1,000. 54,000 accounting profit against 1,000 economic profit

7. Why does an economic profit near zero not mean failure?
   Show the full solution

   Because zero economic profit means the owner is earning exactly as much as the next best alternative would pay, including a normal return on their capital and a normal wage for their time. They are fully compensated and have no reason to move. This is the usual long-run condition of a competitive industry, since any surplus above it attracts entry that competes the surplus away, as lesson 2.3 showed. Zero economic profit means earning exactly the next best alternative, which is viable

8. Explain why risk requires the successful case to pay much more than normal profit.
   Show the full solution

   Because the entrepreneur does not know in advance which case they are in, so the return they can expect is the average across all outcomes weighted by probability. If only 40 per cent of new bakeries survive five years, then the successful 40 per cent must generate enough to cover the losses of the other 60 per cent as well as their own normal return, or nobody would rationally start one. An upside of 1,000 a year plainly cannot do that. The successful cases must cover the failed ones, since the outcome is unknown in advance

9. What does this imply about observing a highly profitable surviving firm?
   Show the full solution

   That the observation is close to meaningless on its own, because survivors are selected precisely for having succeeded. A 30 per cent return in a business where two thirds of entrants fail may represent a poor expected return once the failures are counted, while a 6 per cent return in a safe business may be excellent. Judging any industry's profitability requires knowing the failure rate, and failed firms are invisible by construction. Survivors are selected for success, so their returns say nothing without the failure rate

10. Trace what happens when revenue is only 240,000.
    Show the full solution

    Accounting loss is 240,000 minus 256,000, which is 16,000, and economic loss is that plus the 53,000 of forgone alternatives, which is 69,000. The owner closes. The premises then become available to a business that buyers value enough to pay the rent, the four employees move to employers who can afford their wages, and the owner takes the 47,000 job. Every resource is released to a use valued more highly. A 69,000 economic loss closes it, releasing premises, workers and the owner to better uses

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. State the primary function of a financial market.
   Show the full solution

   Channeling savings to investment, so resources reach those who can use them most productively

2. Distinguish a stock from a bond.
   Show the full solution

   A stock is a share of ownership with a claim on profits; a bond is a loan with a fixed repayment schedule

3. Define liquidity.
   Show the full solution

   The ability to convert an asset into cash quickly without a large loss of value

4. Name two ways financial markets handle risk.
   Show the full solution

   They price it, so riskier borrowers pay more, and they spread it across many holders

5. Name two ways financial markets fail.
   Show the full solution

   Bubbles when prices detach from value, panics when liquidity vanishes, and incentives rewarding risk taken with others' money

6. Why is waiting to fund the factory internally so costly?
   Show the full solution

   Because at 1,400,000 of annual earnings it takes nearly six years to accumulate 8,000,000, and during those six years competitors who can raise capital will build their own factories and take the market. The opportunity cost of waiting is not six years of delayed profit but potentially the entire project, since the opportunity may not still exist. That is exactly the problem financial intermediation solves. Nearly six years of accumulation during which rivals take the opportunity

7. Compare the risk profile of debt and equity for this firm.
   Show the full solution

   The bond costs 560,000 a year regardless of outcome, including the two construction years when the factory earns nothing, and if the factory delivers only 400,000 the firm still owes the full amount and must find it elsewhere or default. Equity costs nothing if the project fails, since there is no repayment obligation, but gives new shareholders a permanent share of the upside if it succeeds. Debt is cheap and unforgiving; equity is expensive and forgiving. Debt owes 560,000 whatever happens; equity costs nothing on failure and much on success

8. What does a firm's financing choice reveal to outsiders?
   Show the full solution

   How confident its managers are in the project. Choosing debt commits to fixed payments regardless of outcome, which a firm does only when it expects cash flow to be reliable. Choosing equity, and accepting permanent dilution, suggests the returns are uncertain enough that fixed obligations would be dangerous, or that management thinks the shares are currently well priced. The choice is therefore itself a signal, readable without any inside information. Debt signals confidence in reliable cash flow; equity signals uncertainty

9. Explain what the gap between 7 and 12 per cent represents.
   Show the full solution

   The market's estimate of the extra probability that the weaker firm defaults. Lenders competing to make the loan bid the rate down to the lowest level that still compensates them for expected losses, so the 5 point gap is a continuously updated, publicly readable assessment of relative risk. No regulator or agency computed it, and anyone considering dealing with either firm can read it for free, which is the informational function of a financial market. Five points of extra default risk, priced continuously by competing lenders

10. Work through how risk spreading makes the project financeable.
    Show the full solution

    If a single investor lends the whole 8,000,000 and the firm fails, that investor is ruined, so almost nobody would take the position and the factory is never built. If 4,000 investors each buy 2,000 of the bond, a total failure costs each of them 2,000, which is survivable, and each of them also holds forty other bonds so the loss is a small part of their position. The same aggregate risk is borne with far less damage to anyone. Dividing the loan means failure costs each holder 2,000 rather than ruining one

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. State the rent gradient principle.
   Show the full solution

   Land near a market commands higher rent, so it is used more intensively and low-value uses move outward

2. Where does a weight-losing industry locate, and why?
   Show the full solution

   Near its materials, because moving the discarded weight would be pointless

3. Name three agglomeration benefits.
   Show the full solution

   A shared labor pool, specialist suppliers, and the exchange of knowledge

4. Define threshold and range.
   Show the full solution

   The minimum customers a service needs, and the maximum distance people will travel to it

5. Why do break of bulk points attract activity?
   Show the full solution

   Because goods must be handled there anyway, so processing adds no extra transfer cost

6. Work through the two crops at the two distances.
   Show the full solution

   Salad greens at 12 km earn 3,200 minus 850 of rent, which is 2,350, while barley there earns 600 minus 850, a loss of 250. At 90 km barley earns 600 minus 140, which is 460, and greens cannot be grown at all since they spoil before reaching market. Greens therefore take the close land and barley the far land. Neither farmer consulted the other; the rent gradient made the allocation. Greens earn 2,350 close in where barley loses 250; barley earns 460 far out

7. Work through the refinery calculation.
   Show the full solution

   Eight tonnes of beet yield one tonne of sugar, and transport costs 3 per tonne per 100 km over 400 km, which is 12 per tonne. Refining at the fields means moving one tonne of sugar, costing 12. Refining at the market means moving eight tonnes of beet, costing 96. Locating at the fields saves 84 per tonne of sugar, because the seven tonnes of waste never travel at all. 12 to ship the sugar against 96 to ship the beet, saving 84 a tonne

8. Why do software firms pay the highest rents in the country?
   Show the full solution

   Because the agglomeration benefit exceeds the rent premium by a wide margin. A firm in a cluster of 200 similar firms hires a specialist in three weeks where an isolated firm needs nine months or must relocate someone, and if a delayed project costs 40,000 a month that difference is worth roughly 240,000 per hire. Add specialist suppliers and circulating knowledge, and the cluster advantage dwarfs any conceivable saving on office space. Faster specialist hiring alone is worth about 240,000, far more than any rent saving

9. Test the showroom's viability and explain the clustering it implies.
   Show the full solution

   A 15 km range encloses about 707 square kilometers, which at 900 households per square kilometer holds roughly 636,000 households against a threshold of 45,000. The showroom is comfortably viable, and so are a dozen competitors on the same site, since the catchment supports many times the threshold. That is why furniture retailers cluster on ring roads rather than spreading evenly: each one's customers are willing to travel, so proximity to rivals costs little and shared traffic helps. 636,000 households against a 45,000 threshold, so many competitors can cluster

10. What do all four decisions have in common methodologically?
    Show the full solution

    Each compared the cost of one location against the cost of a specific alternative rather than asserting where the activity belongs. The greens were compared with barley on the same land, the refinery at the fields with the refinery at the market, the clustered firm with the isolated one, and the showroom's catchment with its threshold. No principle in this lesson is a rule about location; each is a method for working out which alternative costs less. Every one is a comparison between named alternatives, not a rule about belonging

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define a public good.
   Show the full solution

   A good that is non-rival and non-excludable

2. What is the free rider problem?
   Show the full solution

   That someone who does not pay benefits anyway, so voluntary funding collapses

3. Define a negative externality.
   Show the full solution

   A cost imposed on third parties who are not part of the transaction

4. Define information asymmetry.
   Show the full solution

   When one party knows something material that the other cannot verify before the transaction

5. Name the five roles the standard lists.
   Show the full solution

   National defense, environmental concerns, property rights, making markets competitive, and consumer protection

6. Work through why the lighthouse is not privately built.
   Show the full solution

   It costs 400,000 and delivers 1,200,000 of benefit, so it is worth three times its cost. But the light shines on every passing ship whether or not its owner paid, so each owner reasons that the others will fund it and the light will be there regardless. Every owner reasons identically, voluntary contributions fall far short, and a good worth building is not built. Non-excludability alone produces this. Each ship benefits without paying, so every owner declines and nothing is funded

7. Explain why the factory pollutes too much, and what the right remedy does.
   Show the full solution

   Because its cost calculation includes the 900,000 it would spend on treatment and excludes the 2,000,000 it imposes on 4,000 downstream households. Private cost is below social cost, so more discharge occurs than is efficient. A charge of 2,000,000 on the discharge makes the factory face the full cost, after which it will treat the waste whenever treatment costs less than that. The aim is a correct price, not a ban. Private cost omits the 2,000,000 imposed on others; a charge corrects the price

8. Trace what information asymmetry does to the used car market.
   Show the full solution

   If a sound car is worth 9,000 and a failing one 3,000 and buyers cannot tell them apart, buyers who believe half are faulty will offer about 6,000. Owners of sound cars refuse that price and withdraw, which raises the proportion of bad cars remaining, so buyers rationally lower their offers again, driving out more good cars. The quality of what is traded collapses even though good cars exist and buyers want them. Buyers discount for hidden risk, good sellers withdraw, and quality spirals down

9. How is the bus agreement different from the other three cases?
   Show the full solution

   The other three are failures of the market mechanism: a good it cannot fund, a cost it does not price, and information it cannot verify. The bus agreement is a suppression of a mechanism that was working. Competition is what delivers the falling prices and rising quality of lesson 2.3, and the two firms have agreed to abandon it. This is precisely what Smith predicted about people of the same trade meeting. The others are market failures; this is competition being deliberately suppressed

10. State the general test to apply before proposing intervention.
    Show the full solution

    Name the specific failure. Is the good non-excludable, so that free riding prevents voluntary funding? Is a real cost falling on third parties outside the transaction? Is material information held by one side and unverifiable by the other? Has competition been suppressed by agreement or barrier? If none of those four applies, the case for intervention has not yet been made, and lesson 3.2 explains why proceeding anyway is costly. Identify which of the four failures is present, or the case is not made

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. What is the correct comparison when evaluating intervention?
   Show the full solution

   An imperfect market against an imperfect government, not a real market against an ideal policy

2. Define deadweight loss.
   Show the full solution

   Value destroyed when a tax prevents transactions that would have benefited both parties

3. Define regulatory capture.
   Show the full solution

   When the regulated industry comes to influence its own regulator

4. Define rent seeking.
   Show the full solution

   Spending on obtaining favorable treatment rather than on producing anything

5. Why do programs persist past their justification?
   Show the full solution

   Because beneficiaries defend them and nobody's job depends on ending them

6. Explain the information problem using the tax example.
   Show the full solution

   A perfectly set tax of 30 per tonne would make producers face the true social cost and deliver an efficient outcome. But nobody knows the external cost is 30: estimates range from 8 to 62 depending on assumptions about health effects and how those effects are valued. The regulator must choose a number from that range without being able to verify it, so the policy's success depends on a quantity that cannot be observed. The correct tax depends on a figure nobody can actually determine

7. Quantify the cost of setting the tax too high.
   Show the full solution

   A tax of 62 rather than 30 cuts output from about 380,000 tonnes to perhaps 210,000. The 170,000 tonnes prevented were worth more than their full social cost, so the prevention destroys value; if each carried 20 of net social benefit, the loss is 3,400,000. Overcorrecting an externality is not merely cautious, it imposes its own deadweight loss, which is why the direction of error matters as much as its existence. About 3,400,000 of value destroyed by preventing worthwhile production

8. Why is setting the tax too low worse than doing nothing in some respects?
   Show the full solution

   Because a tax of 8 barely changes output, so most of the 15,000,000 in external harm remains, while the monitoring, inspection, laboratory and compliance apparatus is fully built and paid for. The economy bears roughly 3,500,000 a year in administration and compliance and buys almost no reduction in harm with it. A policy can therefore be worse than inaction by being too weak rather than too strong. Nearly all the harm remains while the full administrative cost is still paid

9. Why is rent seeking a pure loss rather than a transfer?
   Show the full solution

   Because the 1,800,000 spent on lobbying for exemptions employs lawyers, analysts and advocates whose work produces no goods, no services and no output of any kind; it only shifts who bears an obligation. The obligation shifted is a transfer, but the resources consumed in shifting it are gone. Those people and that money could have produced something, and the existence of a valuable exemption to seek is what drew them away. It consumes real resources to move an obligation, producing nothing at all

10. State what this lesson does and does not establish.
    Show the full solution

    It establishes that correcting a market failure is itself an activity with costs: information that cannot be obtained, deadweight loss, administration and compliance, rent seeking, capture and persistence past the justification. It does not establish that the externality was imaginary or that intervention is always wrong. The conclusion is that both options are imperfect and must be compared as they actually are, which cuts in both directions. Correcting failure has real costs, which argues for comparison rather than against action

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define fiscal policy.
   Show the full solution

   The use of government spending and taxation to influence economic activity

2. What does expansionary fiscal policy do and aim at?
   Show the full solution

   Raises spending or cuts taxes, aiming to raise production and employment

3. Give two examples of automatic stabilizers.
   Show the full solution

   Tax receipts falling in a downturn and unemployment payments rising

4. Define crowding out.
   Show the full solution

   Government borrowing raising interest rates and displacing private investment

5. Name the three lags affecting fiscal policy.
   Show the full solution

   Recognition, legislation and implementation

6. Work through the multiplier round by round.
   Show the full solution

   The 2,000,000,000 becomes income for construction firms and workers. They spend 70 per cent, which is 1,400,000,000, at shops and restaurants. Those recipients spend 70 per cent of that, which is 980,000,000, then 686,000,000, then 480,200,000, each round smaller. The multiplier is 1 divided by the 0.30 not spent, which is about 3.33, so the total effect is roughly 6,670,000,000. Rounds of 2bn, 1.4bn, 980m and so on, totaling about 6,670,000,000

7. Why does the multiplier converge rather than grow without limit?
   Show the full solution

   Because each round leaks 30 per cent of the money to saving, taxation and imports, none of which becomes domestic income in the next round. The rounds therefore shrink geometrically, and a geometric series with a ratio below one has a finite sum. A multiplier is arithmetic rather than perpetual motion, and the size of the leakage is exactly what determines how large it is: a higher propensity to save gives a smaller multiplier. Each round leaks 30 per cent, so the series shrinks geometrically to a finite sum

8. Work through the crowding out objection.
   Show the full solution

   The 2,000,000,000 is borrowed, so the government competes with private borrowers for the available pool of savings, pushing interest rates up. If rates rise half a point and private investment consequently falls by 700,000,000, the net addition to demand is only 1,300,000,000, and the multiplied effect falls in the same proportion, from about 6,670,000,000 to roughly 4,330,000,000. The policy still works, but its size has been overstated. 700,000,000 of displaced private investment cuts the net stimulus by 35 per cent

9. Work through the lag objection and state why it can reverse the policy's effect.
   Show the full solution

   Six months to recognize the downturn, seven to legislate and five to let the first contracts gives eighteen months. If the recovery actually began at month twelve, the money arrives into an economy that is already expanding. Adding demand to a recovering economy raises prices rather than employment, so a policy intended to stabilize ends up amplifying the cycle. The lag does not merely weaken the policy; it can invert it. Eighteen months of lag means stimulus can land on a recovery and raise prices instead

10. Why do automatic stabilizers avoid that problem?
    Show the full solution

    Because they require no decision at any stage. When incomes fall, tax receipts fall in the same month and unemployment payments rise in the same month, so there is no recognition lag, no legislative debate and no implementation delay. They are weaker per unit of budget than a deliberate stimulus, and they are correctly timed by construction, which is why they do much of the cushioning in a real downturn. They require no decision, so all three lags disappear

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define monetary policy.
   Show the full solution

   Management of the money supply and interest rates to influence economic activity

2. State the Federal Reserve's three statutory goals.
   Show the full solution

   Maximum employment, stable prices, and moderate long-term interest rates

3. What are open market operations?
   Show the full solution

   Purchases and sales of government securities that add or drain bank reserves

4. What does the reserve requirement do?
   Show the full solution

   Sets the fraction of deposits a bank must hold rather than lend, capping the money multiplier

5. What does expansionary monetary policy do to interest rates?
   Show the full solution

   Lowers them, to encourage borrowing, investment and spending

6. Work through the money creation chain.
   Show the full solution

   A deposit of 100,000 with a 10 per cent reserve requirement means the bank holds 10,000 and lends 90,000. That 90,000 is spent and deposited elsewhere, so the second bank holds 9,000 and lends 81,000, the third holds 8,100 and lends 72,900, and so on. The money multiplier is 1 divided by 0.10, which is 10, so 100,000 of reserves supports up to 1,000,000 of deposits. Banks created 900,000 by lending. 100,000 of reserves supports 1,000,000 of deposits at a multiplier of 10

7. Trace an open market purchase through to lending.
   Show the full solution

   The central bank buys 50,000,000 of government securities from banks and pays by crediting their reserve accounts, so system reserves rise by 50,000,000. At a multiplier of 10 that supports up to 500,000,000 in additional deposits and lending. With more reserves available than banks need, they compete to lend them out and the overnight rate falls, which pulls down rates on business loans, mortgages and car finance. 50,000,000 of reserves supports up to 500,000,000 of lending and pushes rates down

8. Why is it wrong to say the central bank prints money?
   Show the full solution

   Because its principal instrument is buying and selling securities, which changes the reserves banks hold, which changes how much they are able to lend, which changes the money supply indirectly through the multiplier. Most of the money in the economy was created by commercial banks making loans, not by any printing press. The central bank sets the conditions under which that creation happens rather than performing it itself. It changes bank reserves; commercial bank lending creates most of the money

9. Explain the tension inside the statutory mandate.
   Show the full solution

   Maximum employment and stable prices can pull in opposite directions. Policy that lowers rates to encourage hiring adds demand, and if the economy is near capacity that demand raises prices rather than output. The statute directs the Board to pursue both goals and gives no instruction about what to do when they conflict, so every decision in that situation involves a judgment the law does not supply, which is why the decisions are publicly argued about. The two goals conflict near capacity and the statute does not say which wins

10. Why is monetary policy more reliable at slowing an economy than starting one?
    Show the full solution

    Because raising rates directly makes borrowing more expensive and nobody can avoid that, so investment and durable purchases fall. Lowering rates only makes borrowing cheaper; it cannot compel anyone to borrow. In a severe downturn, firms facing empty order books will not invest at any interest rate and banks fearing default will not lend, so the transmission from cheap credit to actual spending breaks down. Cheap credit cannot force borrowing, while dear credit genuinely prevents it

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Where does labor demand come from, and what raises it?
   Show the full solution

   From employers; it rises when the value of what a worker produces rises

2. Name two ways labor differs from other goods.
   Show the full solution

   The seller must be physically present, it cannot be stored, and the seller has limited ability to wait

3. What did the Wagner Act establish?
   Show the full solution

   The right to organize, bargain collectively and strike, with a board to enforce it

4. Name three procedures unions use to gain benefits.
   Show the full solution

   Collective bargaining, the credible threat of a strike, grievance procedures, and political action

5. What does unemployment insurance do?
   Show the full solution

   Pays a portion of lost wages temporarily to a worker who loses a job

6. Explain and quantify the bargaining asymmetry the Act describes.
   Show the full solution

   A firm with 4,000 employees loses perhaps 6,000 in recruitment and training if one worker leaves, while that worker loses an entire income of 44,000 a year. The cost of failing to agree is therefore about seven times larger for the worker, so the worker must accept terms the employer can simply decline. Bargaining outcomes depend on who can afford to walk away, and individually the worker cannot. 6,000 of replacement cost against 44,000 of lost income, so the employer can wait

7. How does combination change that arithmetic?
   Show the full solution

   If all 4,000 workers bargain as one, the employer's cost of failing to agree is no longer replacing a single worker but losing all production, perhaps 900,000 a week. Both sides now face heavy losses from disagreement, so neither can simply decline and wait. That symmetry is what the Act means by freedom of association, and it is why combination changes the terms reached rather than merely the volume of complaint. The employer now risks 900,000 a week, so both sides lose from disagreement

8. Work out the wage and employment effects of the negotiated wage.
   Show the full solution

   Moving from a nonunion wage of 21 to a negotiated 27 gives each member 6 an hour, which over 2,000 hours is 12,000 a year. At the higher wage the employer finds some tasks worth automating or contracting out, and if employment falls from 4,000 to 3,650 then 350 jobs disappear while 3,650 workers gain 12,000 each. The union both raised pay and redistributed from those who lost jobs to those who kept them. 3,650 workers gain 12,000 each while 350 jobs are lost

9. Why is the employment effect of a minimum wage genuinely disputed?
   Show the full solution

   Because cutting jobs is only one of several ways an employer can respond. They can also cut hours, reduce other benefits, raise prices, accept lower profit, or save on the recruitment and training costs that high turnover imposes, and which response dominates varies by industry, by local labor market and by the size of the increase. Studies of different settings therefore reach different answers, which makes this an open empirical question rather than an ideological one. Employers have several possible responses, so the effect varies by setting and size

10. Give the two-sided analysis of unemployment insurance.
    Show the full solution

    It keeps consumption up during a downturn, which supports the businesses the unemployed buy from and cushions the wider economy, and it lets a laid-off engineer search for engineering work rather than taking the first available job, which produces a better match and higher productivity afterward. It also slightly lengthens average search time, since the cost of one more week of looking is lower. Both effects are real and neither cancels the other. It stabilizes consumption and improves job matching, while slightly lengthening search

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Name the four sectors.
   Show the full solution

   Primary, secondary, tertiary and quaternary

2. Define a routine task.
   Show the full solution

   One that can be specified as a complete sequence of rules

3. What kinds of task does technology complement?
   Show the full solution

   Non-routine ones: judgment, coordination, persuasion, caregiving, and physical work in unpredictable settings

4. Define polarization.
   Show the full solution

   Growth at the high-skill and low-skill ends of the wage distribution with weakness in the routine middle

5. What kind of work does international competition affect most?
   Show the full solution

   Tradable work, since a service delivered in person cannot be performed abroad

6. Why does rising productivity reduce employment in a sector?
   Show the full solution

   Because if each worker produces far more and demand for the output does not rise proportionally, fewer workers are needed to satisfy it. People do not eat ten times more food when farm productivity rises tenfold, so agricultural employment collapses while agricultural output grows. The same applies to manufacturing. Employment in a sector depends on output demanded divided by output per worker, and the denominator has grown faster. Output per worker rose faster than demand for the output, so fewer workers are needed

7. Compare the payroll clerk and the plumber, and explain what that shows.
   Show the full solution

   The payroll clerk's work is 85 per cent routine and requires no presence, so software takes the calculation and compliance checks and the remainder can be done anywhere: the occupation shrinks sharply. The plumber's work is 25 per cent routine and must be done on site in unpredictable conditions, so neither automation nor offshoring reaches it. The clerk usually has more formal education, which shows vulnerability tracks task routineness rather than qualification. The less-credentialed plumber is far safer, because routineness not prestige determines exposure

8. Why is the task the right unit of analysis rather than the job?
   Show the full solution

   Because almost every occupation is a bundle of different tasks, and technology takes some while leaving others. The radiologist is 45 per cent routine, so image analysis software takes a substantial share of the work without eliminating the occupation, since judgment on ambiguous cases and discussion with other clinicians remain. Predicting at the level of whole jobs produces false binaries; predicting at the level of tasks explains how jobs change composition. Jobs are bundles of tasks, so technology changes their composition rather than removing them

9. Explain how polarization follows from the task analysis.
   Show the full solution

   Routine tasks concentrate in the middle of the wage distribution, in clerical work and in production work, and those are exactly what technology substitutes for. The high end is non-routine analytical and managerial work, which technology complements and therefore makes more valuable. The low end is in-person service work, which is non-routine and must be delivered physically, so it is also protected. Both ends grow and the middle hollows out. Routine work sits in the middle, and that is precisely what technology replaces

10. State the two questions to ask about any occupation.
    Show the full solution

    What share of its tasks could be written down as a complete set of rules, and whether it must be performed in the physical presence of the customer. High routineness combined with no need for presence is the most exposed position, since both automation and offshoring apply. Low routineness combined with required presence is the most protected, since neither does. Those two questions predict better than any judgment about skill level or prestige. How routine are the tasks, and must the work be done in person

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define marginal revenue product.
   Show the full solution

   The extra revenue one more worker generates, which is the maximum an employer will pay

2. What does labor demand derive from?
   Show the full solution

   Demand for the output the worker produces

3. Name three things that restrict labor supply.
   Show the full solution

   Rare talent, long or costly training, and licensing or other barriers

4. Define a compensating differential.
   Show the full solution

   Extra pay for work that is dangerous, unpleasant, isolated or badly timed

5. Name three factors beyond supply and demand that affect wages.
   Show the full solution

   Discrimination, incomplete information about pay, and differences in bargaining power

6. Explain why childcare pays little despite being essential.
   Show the full solution

   Because employers' need being very high sets only one side of the market. The supply of people able to do the work is also very large, since the required training is modest and a great many people are capable of it, so employers can fill posts without raising pay. A large supply meeting a high demand produces a low price, exactly as it would for any good. Importance affects demand and has no effect on supply. High demand meets very large supply, and supply sets the price down

7. What does the childcare case prove about merit-based explanations of pay?
   Show the full solution

   That they fail. If wages tracked importance to society, childcare would be among the best paid work there is, since almost nothing matters more and the demand is universal. It is among the worst paid. No account based on social value, moral desert or effort can explain that outcome, whereas the supply and demand account explains it in one sentence. This is why economists use the framework despite its coldness. An essential occupation is poorly paid, which no merit account can explain

8. Distinguish the two causes of restricted supply for the anesthesiologist.
   Show the full solution

   Part is genuine: the training really does take about thirteen years, it really is difficult, and relatively few people can complete it, so supply would be limited under any arrangement. Part is institutional: the number of training places is set by decision rather than by demand, and increasing it would raise supply and lower the wage. Both restrict supply and produce a high wage, but only the second could be changed by policy. Genuine difficulty of training, and a deliberately limited number of training places

9. Why does the violinist disprove a demand-only account of wages?
   Show the full solution

   Because demand is low, since very few employers anywhere want a top-tier concert soloist, and yet the wage is 240,000. If wages were set by how much employers wanted the work, this occupation should pay very little. Supply is almost nonexistent, and that alone produces the high price. A small demand meeting an even smaller supply yields a high wage, which demonstrates that both blades of the scissors are needed. Low demand still yields a high wage because supply is nearly nonexistent

10. Work through how productivity raises a wage without changing effort.
    Show the full solution

    If a driver moves from a vehicle carrying 18 tonnes to one carrying 30, each hour of driving now delivers two thirds more freight, so the revenue that driver generates rises by two thirds. Marginal revenue product is the ceiling on what an employer will pay, so the ceiling rises, and competing employers who also have larger vehicles must bid up to keep drivers. The effort is identical; what the effort produces has changed. Marginal revenue product rises by two thirds, raising what employers will bid

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define capital mobility and labor mobility.
   Show the full solution

   The movement of investment funds and productive assets, and of workers, across borders toward higher returns

2. Why does capital move more easily than labor?
   Show the full solution

   Money crosses borders instantly and legally, while people face visas, language, licensing and family ties

3. How does inward capital raise wages?
   Show the full solution

   By giving workers more and better equipment, which raises their productivity

4. Define remittances.
   Show the full solution

   Earnings sent home by workers employed abroad

5. What determines immigration's effect on a particular worker's wage?
   Show the full solution

   Whether the arrivals substitute for that worker or complement them

6. Work through both gains from the inward investment.
   Show the full solution

   Directly, 2,400 workers gain 7,000 each as pay rises from 34,000 to 41,000, which is 16,800,000 a year, and the gain comes from the plant's equipment raising their marginal revenue product rather than from generosity. Indirectly, other local employers must now compete against a 41,000 wage or lose staff, so they raise pay too. Workers who never enter the new plant therefore benefit, which is how inward capital lifts wages beyond its own payroll. 16,800,000 directly, plus raised pay at every competing local employer

7. Who loses from inward investment?
   Show the full solution

   Existing local employers, who now face higher wage costs because they must match or approach the new plant's pay, and some of whom become unprofitable and close. Firms producing goods that compete with the new plant's output also lose market share. The net effect on the region is positive, but stating it as a universal gain is inaccurate, and the firms that close are as real as the workers who gain 7,000 each. Existing employers facing higher wage costs and competing firms losing share

8. Why is the outward move so contested when both countries gain something?
   Show the full solution

   Because of the mobility asymmetry. The capital relocated in a week, while the 900 workers who lost 41,000 jobs cannot follow it, being held by visas, language, licensing, housing and family. The gains are spread across consumers everywhere and across workers in the receiving country, while the losses are concentrated on 900 identifiable people who are geographically stuck. One factor moves freely and the other does not. Capital moves in a week and the displaced workers cannot follow it

9. Work out the two opposing effects on construction wages from the arrivals.
   Show the full solution

   The 20,000 arriving construction workers substitute directly for the existing 60,000, raising supply in that occupation by a third, which pushes wages down or slows their growth. At the same time the 10,000 arriving engineers complement construction labor: more engineers means more projects designed and specified, which raises demand for construction workers. The two effects run in opposite directions and the net outcome depends on their relative size. Substitution by 20,000 pushes wages down while complementary engineers pull demand up

10. State the correct form of an answer about immigration's economic effects.
    Show the full solution

    Total output rises because more people are producing, and consumers gain from lower costs in the affected industries. Beyond that the answer must be disaggregated: workers whose jobs the arrivals can do face wage pressure, while workers in occupations that complement the arrivals gain. A single number for the whole economy averages two opposite effects together and therefore conceals precisely the question being asked. Output and consumers gain; individual workers gain or lose by substitution against complementarity

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Distinguish a nominal from a real figure.
   Show the full solution

   Nominal is measured in the prices of its own year; real is adjusted for price changes

2. What is a price index?
   Show the full solution

   A measure of the cost of a fixed basket of goods over time, with a base year set at 100

3. How do you convert nominal to real?
   Show the full solution

   Divide by the price index and multiply by 100

4. How is the real interest rate approximated?
   Show the full solution

   The nominal interest rate minus the inflation rate

5. Who gains from unexpected inflation?
   Show the full solution

   Borrowers, who repay in money worth less than they borrowed

6. Convert the year 6 wage and state what it shows.
   Show the full solution

   The year 6 nominal wage of 48,100 divided by the price index of 129 and multiplied by 100 gives 37,287 in year 1 prices, which is below the year 1 wage of 38,000. So a nominal increase of 26.6 per cent over five years is actually a real fall of about 1.9 per cent. Workers ended the period worse off despite every year's pay packet being larger than the one before it. 37,287 in year 1 prices: a 26.6 per cent nominal rise is a 1.9 per cent real fall

7. Trace the real wage across the six years.
   Show the full solution

   Year 1 is 38,000. Year 3 is 41,000 divided by 111 times 100, which is 36,937. Year 4 is 43,400 divided by 120 times 100, which is 36,167, the lowest point. Year 5 is 46,300 divided by 126 times 100, which is 36,746, and year 6 is 37,287. Real pay therefore fell steadily to a trough in year 4 and then partially recovered without regaining the year 1 level. A fall to a trough of 36,167 in year 4, then partial recovery to 37,287

8. Compare nominal and real GDP growth and state the significance.
   Show the full solution

   Nominal GDP rose from 820 to 1,102, an increase of 34.4 per cent. Real GDP in year 6 is 1,102 divided by 129 times 100, which is 854, so real growth was 4.1 per cent over five years, under 1 per cent a year. Almost all the reported growth was price increases rather than additional output, so the economy produced barely more at the end than at the beginning. 34.4 per cent nominal against 4.1 per cent real, so most growth was prices

9. Work out the real return to a lender charging 9 per cent in year 3.
   Show the full solution

   Prices rose from 104 to 111 between years 2 and 3, which is an increase of 6.7 per cent. The real return is approximately the nominal 9 per cent minus that 6.7 per cent, which is 2.3 per cent. The lender's money grew by 9 per cent and bought only 2.3 per cent more goods than before, so nearly three quarters of the apparent return was simply keeping pace with prices. About 2.3 per cent real, since 6.7 of the 9 points was inflation

10. Quantify the redistribution from a five year loan.
    Show the full solution

    Someone who borrowed 200,000 in year 1 and repays 200,000 in year 6 is repaying money worth, in year 1 purchasing power, 200,000 divided by 129 times 100, which is 155,039. The borrower has handed back about 45,000 less real value than they received, and the lender has lost exactly that. Neither party did anything; inflation alone transferred the wealth, which is why unexpected inflation favors borrowers. The borrower repays only 155,039 of real value, gaining about 45,000 from the lender

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define the labor force.
   Show the full solution

   Employed people plus people without work who are available and actively looking

2. How is the unemployment rate calculated?
   Show the full solution

   Unemployed divided by the labor force, times 100

3. Define a discouraged worker.
   Show the full solution

   Someone who has stopped looking because they believe no work is available

4. How is the inflation rate calculated?
   Show the full solution

   The percentage change in a price index from one period to the next

5. Why is deflation dangerous?
   Show the full solution

   It raises the real value of debts and encourages buyers to wait

6. Compute both years' unemployment rates and then explain the fall.
   Show the full solution

   Year 1's labor force is 5,800,000 plus 520,000, which is 6,320,000, giving a rate of 8.2 per cent. Year 2's is 5,860,000 plus 430,000, which is 6,290,000, giving 6.8 per cent. But employment rose by only 60,000 while those outside the labor force rose by 180,000, so of the 90,000 fewer unemployed only 60,000 found work. The labor force shrank even though the population grew by 150,000. 8.2 falling to 6.8 per cent, mostly because people stopped looking

7. Recompute the rate on a broader definition and state the implication.
   Show the full solution

   Adding the 180,000 extra non-participants back as unemployed gives a labor force of 6,470,000 and 610,000 unemployed, which is 9.4 per cent. Adding the 395,000 part time workers who want full time work gives 1,005,000 out of 6,470,000, which is 15.5 per cent. The same economy in the same year measures 6.8, 9.4 or 15.5 per cent, so the definition has to be stated alongside any figure quoted. 6.8, 9.4 or 15.5 per cent for one economy, depending on the definition

8. Why is a positive net jobs figure not automatically good news?
   Show the full solution

   Because the population is growing at the same time. Here 60,000 net new jobs were created while the working age population grew by 150,000, so 90,000 more people entered the population of potential workers than the new jobs could absorb. Employment rose in absolute terms and fell as a share of the working age population, which is why the jobs number must always be read against population growth rather than on its own. 60,000 new jobs against 150,000 more working age people is a relative fall

9. Compute the inflation rate and explain the denominator.
   Show the full solution

   The index rose from 138.0 to 142.8, an increase of 4.8 points, so the rate is 4.8 divided by 138.0 times 100, which is 3.5 per cent. The denominator is the previous period's level rather than the base year of 100, because inflation measures the proportional change from where prices actually were. Dividing by 100 would give 4.8 per cent, which overstates it by more than a third. 3.5 per cent, dividing by the previous level of 138 rather than the base 100

10. Compute growth and per capita growth, and say which matters.
    Show the full solution

    Real GDP rose from 945 to 963, which is 18 divided by 945 times 100, or 1.9 per cent. Population grew by 150,000 on 10,000,000, which is 1.5 per cent, so per capita real growth is about 0.4 per cent. The per capita figure is the one corresponding to living standards, because total output rising only as fast as the number of people sharing it leaves each person no better off. 1.9 per cent total and 0.4 per cent per head, with the second reflecting living standards

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Distinguish short-term from long-term interest rates.
   Show the full solution

   Short rates apply to lending for days to a year; long rates apply to lending for many years

2. What mainly sets short rates?
   Show the full solution

   Central bank policy, through its control of bank reserves

3. What mainly sets long rates?
   Show the full solution

   Market expectations of average short rates and inflation over the term

4. What is the yield curve, and what is its normal shape?
   Show the full solution

   A plot of interest rate against term, normally sloping upward

5. What is an inverted yield curve taken to indicate?
   Show the full solution

   That markets expect rates and activity to fall, which has historically preceded downturns

6. Why do long rates normally exceed short rates?
   Show the full solution

   Because a lender committing money for thirty years bears risks that a three month lender does not: inflation may erode the real value of the repayment over that period, the borrower's circumstances may deteriorate, and the lender gives up the option to redirect the money if better opportunities appear. Compensation for those risks and for the lost flexibility is what produces the upward slope from 2.1 per cent to 4.4 in curve A. Longer commitment means more inflation risk, more default risk and lost flexibility

7. Why would anyone accept 4.2 per cent for ten years when three month money pays 5.4?
   Show the full solution

   Because a ten year rate is roughly the average of the short rates expected over those ten years. Locking in 4.2 per cent is rational if you expect short rates to fall well below 4.2 for much of the decade, since rolling three month deposits would then earn less on average. The inversion is therefore a statement about expected future rates rather than an irrational preference for less return. Because they expect short rates to fall far below 4.2 during the decade

8. Explain the chain from inversion to a recession warning.
   Show the full solution

   Inversion implies markets expect short rates to fall sharply. Central banks cut short rates when they want to stimulate a weak economy, so expecting sharp cuts amounts to expecting weakness serious enough to require them. The curve is therefore an aggregation of many participants' forecasts, priced with real money, and that is why it is watched as a signal despite being an inference rather than a direct measurement. Expected rate cuts imply expected weakness, since cuts are the response to it

9. Explain how the same curve can be restrictive and accommodating at once.
   Show the full solution

   Under curve B, a business financing inventory or working capital at short rates pays 5.4 per cent, which is expensive and discourages it, while a household taking a thirty year mortgage pays 4.1 per cent, which is cheap and encourages it. Borrowers at different terms face opposite conditions from a single curve, so describing monetary conditions as simply tight or loose conceals which part of the economy is being squeezed. Short borrowers pay 5.4 while long borrowers pay 4.1 on the same curve

10. Why is it wrong to say the central bank sets interest rates?
    Show the full solution

    Because it sets only the shortest rate directly, by draining or adding reserves, and influences long rates solely through what it leads markets to expect. A thirty year rate reflects thirty years of expected short rates and inflation, which no central bank controls. Raising short rates today can even lower long rates, by persuading markets that a slowdown is coming, so the two ends of the curve can move in opposite directions. It controls only the short end; long rates follow expectations and can move against it

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define absolute advantage.
   Show the full solution

   Producing more of a good with the same resources than another producer can

2. Define comparative advantage.
   Show the full solution

   Producing a good at a lower opportunity cost than another producer

3. Which one drives trade?
   Show the full solution

   Comparative advantage

4. Define the terms of trade.
   Show the full solution

   The rate at which the two goods exchange between the countries

5. How did Western Hemisphere trade change over the twentieth century?
   Show the full solution

   From primary commodities exchanged for manufactures toward manufactured goods and components moving both ways

6. Compute both countries' opportunity costs and identify each comparative advantage.
   Show the full solution

   In Norland one worker-year yields 20 tonnes of grain or 10 machines, so a machine costs 2 tonnes of grain and a tonne of grain costs 0.5 machines. In Sudland one worker-year yields 8 tonnes or 6 machines, so a machine costs 1.33 tonnes and a tonne costs 0.75 machines. Sudland gives up less grain per machine, so it has the comparative advantage in machines; Norland gives up fewer machines per tonne, so it has it in grain. Machines cost 2 tonnes in Norland and 1.33 in Sudland, so Sudland specializes in machines

7. Why does Norland gain from trade despite being better at both goods?
   Show the full solution

   Because absolute advantage says nothing about what Norland must give up. Every worker-year Norland spends making machines is a worker-year not producing 20 tonnes of grain, so machines are expensive for it in the only sense that matters. Buying machines from Sudland at 1.7 tonnes each, rather than producing them at a cost of 2 tonnes each, saves Norland 0.3 tonnes per machine. Being better at something does not make doing it worthwhile. Its own machines cost 2 tonnes of forgone grain, and importing costs 1.7

8. Show that specialization raises world output.
   Show the full solution

   Splitting resources evenly, Norland makes 10,000 tonnes and 5,000 machines and Sudland makes 4,000 tonnes and 3,000 machines, giving world totals of 14,000 tonnes and 8,000 machines. If Sudland moves entirely into machines, producing 6,000, and Norland puts 850 worker-years into grain for 17,000 tonnes and 150 into machines for 1,500, world totals become 21,000 tonnes and 7,500 machines. Grain rises by 7,000 at a cost of 500 machines. World grain rises from 14,000 to 21,000 tonnes for a loss of 500 machines

9. Verify that terms of trade of 1.7 benefit both.
   Show the full solution

   Sudland gives up 1.33 tonnes of grain to produce a machine and receives 1.7 tonnes for it, gaining 0.37 tonnes on every machine traded. Norland gives up 1.7 tonnes to obtain a machine that would have cost it 2 tonnes to make itself, gaining 0.3 tonnes per machine. Both gain because 1.7 lies strictly between the two opportunity costs of 1.33 and 2, which is the condition for mutual benefit. Sudland gains 0.37 tonnes and Norland 0.3 per machine, since 1.7 lies between 1.33 and 2

10. Why are the gains aggregate rather than universal?
    Show the full solution

    Because specialization means some industries contract. Norland's machine industry shrinks from 500 worker-years to 150, so 350 worker-years of machine-building labor must find other work, and the skills, plant and towns built around that industry lose value. The country as a whole consumes more, and specific identifiable people bear real costs, which is why trade is politically contested despite the arithmetic being favorable. Contracting industries impose real losses on identifiable workers even as the country gains

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define a tariff and a quota.
   Show the full solution

   A tax on imports, and a quantity limit on imports

2. Give two examples of non-tariff barriers.
   Show the full solution

   Standards, licensing requirements, and burdensome customs procedures

3. What did the Tariff Act of 1930 do?
   Show the full solution

   Raised United States duties across a very wide range of imports during the early Depression

4. What followed it?
   Show the full solution

   Retaliation by trading partners and a sharp contraction in world trade

5. Name three present-day arguments for trade restriction.
   Show the full solution

   Job protection, labor and environmental standards abroad, national security in strategic industries, and responses to dumping

6. Work out the cost per job saved by the tariff.
   Show the full solution

   A 25 per cent tariff raises the imported price from 100 to 125, so buyers pay either 125 for the import or 118 for the domestic equivalent instead of 100. Across 2,000,000 units that is at least 36,000,000 a year in extra cost. If roughly 900 jobs are preserved, consumers are paying about 40,000 per job saved annually, which is a real transfer from many people to a few and usually exceeds the wage itself. About 40,000 a year per job, paid by consumers

7. Explain how retaliation can reverse the policy's employment effect.
   Show the full solution

   The exporting country responds by raising its own duties on goods it buys from you, so your exporters lose sales. If that costs 1,400 jobs while the tariff protected 900, net employment has fallen, and buyers are still paying the higher prices. The policy has produced a loss on both counts. This general pattern is what followed the 1930 Act as partners raised duties in response across the schedules. 1,400 export jobs lost against 900 protected, with the consumer cost remaining

8. Why is trade restriction especially damaging during a general downturn?
   Show the full solution

   Because when demand is collapsing everywhere, every country faces the same pressure to protect its own producers, so retaliation is near certain rather than merely possible. Each round of restriction reduces someone else's exports, which deepens their downturn and increases their own pressure to restrict. Trade barriers therefore transmit and compound a contraction across borders rather than containing it within one economy. Every country faces the same incentive at once, so restriction compounds the contraction

9. Explain the structural difference between 1930 and now.
   Show the full solution

   Most imports today are inputs to domestic production rather than finished goods competing with it. A 25 per cent steel tariff helps 80,000 steelworkers and raises costs for the 2,000,000 people employed making vehicles, appliances and machinery from steel, so it assists one worker for roughly every twenty-five it harms. Supply chains mean a tariff now taxes the domestic manufacturers it was supposed to protect. Imports are now mostly inputs, so tariffs raise domestic manufacturers' costs

10. Which arguments for restriction survive scrutiny, and why?
    Show the full solution

    Narrow ones that make a specific checkable claim. A national security argument about a particular strategic input identifies a good, a risk and a quantity, all of which can be examined on evidence. A response to demonstrated dumping below production cost is similarly specific. A general argument that imports cost jobs does not survive, because it counts the protected jobs while ignoring the consumer cost and the export jobs lost to retaliation. Specific security or dumping claims are checkable; general job arguments omit both costs

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define territorial sovereignty.
   Show the full solution

   A state's exclusive authority to make and enforce law within its own borders

2. What have borders become more permeable to, and less permeable to?
   Show the full solution

   More permeable to goods, capital and information; in many places less permeable to people

3. Why do states accept shared rules in trade agreements?
   Show the full solution

   Because membership gains them market access they could not otherwise have

4. Name two problems that cross borders inherently.
   Show the full solution

   Emissions, financial contagion, and disease

5. Name three things borders remain decisive for.
   Show the full solution

   Labor movement, legal jurisdiction, taxation, and currency

6. Compare what the border does to files, goods, money and people.
   Show the full solution

   Engineering files move between countries instantly at no cost and no official inspects them, so the border stops nothing. Physical components are counted, may be tariffed and must meet the importing country's standards, so the border is real though often cheap to cross. Payments settle in seconds with essentially no friction. An engineer needs a visa, recognition of qualifications and permission to work, so for people the border is substantial. Open for information and capital, managed for goods, firmly closed for people

7. Explain how profit moves between countries without any good crossing a border.
   Show the full solution

   The subsidiary holding the intellectual property in country D charges the operating companies in A, B and C a licensing fee for using it. Setting that fee high makes costs rise and profits fall in A, B and C while profits rise in D. Nothing physical has moved and no border has been crossed by any object, yet taxable income has relocated between jurisdictions by contract alone. An intra-group licensing fee shifts taxable income without moving anything

8. Has country A lost sovereignty in that example?
   Show the full solution

   No. Country A retains full legal authority to tax profits arising within A, and nobody has taken that authority away. What has happened is that the firm has arranged for fewer profits to arise there. The authority is undiminished while the base it applies to has moved, which is a different problem and one that requires cooperation between states rather than more forceful assertion by any one of them. The authority is intact; the tax base moved, which needs cooperation not assertion

9. Why can sovereignty not solve the cross-border pollution case?
   Show the full solution

   Because country C has complete authority over its own territory and none whatever over a factory inside country B, and the pollution originates in B. No law C passes, however vigorously enforced, reaches the source. Sovereignty is territorial by definition, so a problem whose cause lies outside the territory is outside its reach, and a treaty in which B agrees to act is the only instrument available. The source lies outside C's territory, so territorial authority cannot reach it

10. State the standard's answer about the changing role of borders.
    Show the full solution

    Borders have become selectively permeable rather than irrelevant: nearly open to information and capital, managed and often cheap for goods, and firmly closed for labor. Legal sovereignty over territory is undiminished, while its practical reach is constrained by the mobility of what it applies to. States have responded by exchanging specific authorities for specific benefits through agreements, which is an exchange rather than a surrender. Selectively permeable borders, undiminished legal authority, and sovereignty exchanged for benefits

Questions 1 to 5 are recall. Questions 6 to 10 ask for reasoning.

1. Define an exchange rate.
   Show the full solution

   The price of one currency expressed in terms of another

2. Where does demand for a currency come from?
   Show the full solution

   Foreigners wanting that country's goods, services, assets or currency itself

3. Distinguish appreciation from depreciation.
   Show the full solution

   Appreciation is a gain in value against other currencies; depreciation is a loss

4. What does a stronger dollar do to imports and exports?
   Show the full solution

   Makes imports cheaper and exports more expensive abroad

5. How do higher interest rates affect a currency?
   Show the full solution

   They attract foreign funds seeking the return, raising demand for the currency and its value

6. Work through what appreciation to 5 marks does to both goods.
   Show the full solution

   The 30,000 dollar machine costs a foreign buyer 30,000 times 5, which is 150,000 marks, up from 120,000, a rise of 25 per cent although the producer changed nothing. The 60,000 mark car costs a domestic buyer 60,000 divided by 5, which is 12,000 dollars, down from 15,000, a fall of 20 per cent. Exporters are harmed and importers and consumers gain, purely from the currency move. Exports rise 25 per cent abroad while imports fall 20 per cent at home

7. Explain how inflation depreciates a currency.
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   Higher domestic inflation makes the country's goods dearer, so foreigners buy fewer of them and demand less of its currency to pay for them. At the same time its own residents find imports relatively cheaper and buy more, which increases the supply of its currency on the market. Demand falls and supply rises simultaneously, so the price of the currency falls, here from 4 marks to 3.2. Falling foreign demand and rising domestic supply of the currency push its price down

8. Why is the depreciation partly self-correcting?
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   Because it offsets the inflation for trade purposes. Domestic goods became dearer in domestic currency, but foreigners are now buying that currency more cheaply, so the price they actually face rises less than the inflation rate or may even fall. The 30,000 dollar machine costs 96,000 marks after depreciation against 120,000 before. Exchange rates therefore tend over long periods toward equalizing purchasing power, while deviating for years at a time. A cheaper currency offsets dearer goods, pushing toward purchasing power parity

9. What does the third cause show about what moves exchange rates?
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   That capital flows matter as much as trade flows and are far larger and faster. Investors moving funds into dollars because the mark country's economy has weakened raises dollar demand for reasons unconnected with any good being bought or sold. This is why a currency can appreciate while its country runs a trade deficit, an outcome that would be impossible if only trade in goods and services set the rate. Capital flows can move a rate independently of trade, even against a deficit

10. State the trade-off between fixed and floating rates.
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    A fixed rate gives traders and investors certainty about future prices, which encourages long-term contracts and investment, and it costs the country its independent monetary policy, since interest rates must be set to defend the peg rather than to suit domestic conditions. It can also break, when reserves run down faster than pressure eases. A floating rate preserves monetary independence and imposes exchange risk on everyone who trades. Certainty at the cost of monetary independence, against independence at the cost of risk