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Praxis Economics practice questions

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Question 1Fundamental Economic Concepts

A student claims that a free concert ticket has no opportunity cost because no money changed hands. Which statement best evaluates this claim?

  1. The claim is correct because opportunity cost requires a market transaction.
  2. The claim is correct because the ticket's marginal cost is zero once it has been issued.
  3. The claim is incorrect because opportunity cost always equals the ticket's face value.
  4. The claim is incorrect because the ticket still has a positive opportunity cost: the value of the next best alternative use of the time spent attending. Correct answer.

Explanation

Opportunity cost is the value of the best forgone alternative, whether or not money is exchanged. Even a free ticket consumes time that could be used for work or leisure, so a cost exists. The concept is about trade-offs, not cash flows.

Question 2Fundamental Economic Concepts

In a production possibilities frontier with two goods and constant opportunity costs, the frontier appears as which shape?

  1. A bowed-out curve concave to the origin
  2. A right angle at the maximum of one good
  3. A downward-sloping straight line Correct answer.
  4. An upward-sloping straight line

Explanation

Constant opportunity cost means each additional unit of one good always requires giving up the same quantity of the other good. That constant trade-off rate produces a straight-line frontier. A bowed-out curve instead reflects increasing opportunity costs.

Question 3Fundamental Economic Concepts

A point located inside a production possibilities frontier represents which situation?

  1. Production that uses resources inefficiently or leaves some unemployed Correct answer.
  2. Production that is unattainable with current resources
  3. Production that reflects a technological advance beyond the frontier
  4. Production that is efficient but unattainable

Explanation

Points inside the frontier are attainable but inefficient because more of one good could be produced without sacrificing the other. The frontier itself shows efficient combinations, while points beyond it are unattainable. Unemployment or misallocation explains an interior point.

Question 4Fundamental Economic Concepts

Which change shifts the demand curve for coffee to the right?

  1. A fall in the price of coffee
  2. A rise in the price of coffee
  3. An increase in consumer income, if coffee is a normal good Correct answer.
  4. A fall in the price of coffee beans

Explanation

A change in income shifts demand for a normal good: higher income increases quantity demanded at every price, moving the curve right. Price changes for the good itself cause movements along the demand curve, not shifts. Input prices affect supply rather than demand.

Question 5Fundamental Economic Concepts

A price ceiling set below the equilibrium price will most likely produce which outcome?

  1. An increase in supply as producers respond to higher prices
  2. A shortage because quantity demanded exceeds quantity supplied Correct answer.
  3. No effect because the market clears at the ceiling
  4. A surplus because quantity supplied exceeds quantity demanded

Explanation

A binding price ceiling below equilibrium prevents the price from rising to clear the market. At that lower price, quantity demanded exceeds quantity supplied, creating a shortage. Nonbinding ceilings set above equilibrium have no effect.

Question 6Fundamental Economic Concepts

Which pair of goods is most likely to be classified as complements?

  1. Bus travel and airline travel
  2. Butter and margarine
  3. Coffee and tea
  4. Printers and ink cartridges Correct answer.

Explanation

Complements are consumed together, so a fall in the price of one raises demand for the other. Printers and ink cartridges fit this pattern because printers require cartridges. The other pairs are substitutes that can replace one another.

Question 7Fundamental Economic Concepts

The law of demand states that, all else equal, as the price of a good rises:

  1. Quantity demanded rises
  2. Demand increases
  3. Supply decreases
  4. Quantity demanded falls Correct answer.

Explanation

The law of demand describes an inverse relationship between price and quantity demanded, holding other factors constant. A higher price reduces the quantity buyers are willing and able to purchase. This is a movement along the demand curve, not a shift of demand.

Question 8Fundamental Economic Concepts

Which of the following is a normative economic statement?

  1. The government should raise the minimum wage to reduce poverty. Correct answer.
  2. The unemployment rate rose to 4.2 percent last quarter.
  3. A price ceiling below equilibrium creates a shortage.
  4. An increase in the minimum wage raises the quantity of labor supplied.

Explanation

Normative statements express value judgments about what ought to be and cannot be tested solely with data. The word "should" signals a policy recommendation. Positive statements describe what is and can be evaluated with evidence.

Question 9Fundamental Economic Concepts

A firm can produce either 100 units of good X or 50 units of good Y with its fixed resources. What is the opportunity cost of one unit of good X?

  1. 0.5 units of good Y Correct answer.
  2. 2 units of good Y
  3. 100 units of good Y
  4. 50 units of good Y

Explanation

The trade-off is 100 units of X for 50 units of Y, so each unit of X costs 50/100 = 0.5 units of Y. Opportunity cost is expressed in terms of the forgone good. Dividing in the correct direction is essential.

Question 10Fundamental Economic Concepts

A production possibilities frontier bows outward from the origin primarily because:

  1. Resources are not perfectly adaptable, so opportunity costs rise as production shifts Correct answer.
  2. Technology improves continuously over time
  3. Consumers prefer variety in consumption
  4. Resources are equally suited to producing both goods

Explanation

A bowed-out frontier reflects increasing opportunity cost, which arises when resources are specialized. As more of one good is produced, increasingly less suitable resources must be transferred, raising the forgone output. Perfectly adaptable resources would yield a straight line.

Question 11Fundamental Economic Concepts

The price of a good falls by 10 percent and quantity demanded rises by 25 percent. Demand for this good is:

  1. Relatively inelastic
  2. Unit elastic
  3. Perfectly inelastic
  4. Relatively elastic Correct answer.

Explanation

Price elasticity of demand is the percentage change in quantity demanded divided by the percentage change in price. Here 25/10 = 2.5, which exceeds 1, so demand is elastic. Elastic demand means quantity responds proportionally more than price.

Question 12Fundamental Economic Concepts

A technological improvement lowers the cost of producing solar panels. In the market for solar panels, what happens to equilibrium price and quantity?

  1. Price falls and quantity rises Correct answer.
  2. Price rises and quantity falls
  3. Price rises and quantity rises
  4. Price falls and quantity falls

Explanation

Lower production costs shift the supply curve to the right. Along a downward-sloping demand curve, greater supply lowers equilibrium price and raises equilibrium quantity. The demand curve itself does not shift in this scenario.

Question 13Fundamental Economic Concepts

Which event would shift the supply curve for wheat to the left?

  1. A decrease in the price of fertilizer
  2. A decrease in consumer income
  3. An increase in the wages paid to farm workers Correct answer.
  4. A new study reporting that wheat is healthy

Explanation

Higher wages for farm workers raise input costs, reducing the quantity supplied at every price and shifting supply left. Input prices are a determinant of supply. Consumer income and health studies affect demand instead.

Question 14Fundamental Economic Concepts

A government sets a price floor above the equilibrium price in the market for milk. Which outcome is expected?

  1. The market clears at the equilibrium price
  2. A shortage of milk
  3. Quantity demanded rises above the equilibrium level
  4. A surplus of milk Correct answer.

Explanation

A binding price floor holds the price above equilibrium, so quantity supplied exceeds quantity demanded. The result is a surplus that the market cannot clear through price adjustment. A shortage would require a binding price ceiling instead.

Question 15Fundamental Economic Concepts

Two goods have a positive cross-price elasticity of demand. These goods are best described as:

  1. Inferior goods
  2. Complements
  3. Normal goods
  4. Substitutes Correct answer.

Explanation

Positive cross-price elasticity means a rise in the price of one good increases demand for the other, which is the pattern for substitutes. Complements have negative cross-price elasticity because higher prices for one reduce demand for the other. Income elasticity, not cross-price elasticity, classifies inferior and normal goods.

Question 16Fundamental Economic Concepts

If demand for a product is perfectly inelastic, a per-unit tax imposed on sellers will be borne:

  1. Entirely by buyers Correct answer.
  2. Equally by buyers and sellers
  3. Entirely by sellers
  4. By neither party because quantity is unchanged

Explanation

Tax incidence depends on the relative elasticities of supply and demand. With perfectly inelastic demand, buyers cannot reduce quantity in response, so the full tax is passed through in the price. Sellers bear none of the burden in this extreme case.

Question 17Fundamental Economic Concepts

The marginal benefit of consuming a good is best interpreted as:

  1. The additional satisfaction from consuming one more unit Correct answer.
  2. The total satisfaction from all units consumed
  3. The average satisfaction per unit consumed
  4. The price paid for the first unit

Explanation

Marginal analysis focuses on the change resulting from one additional unit. Marginal benefit is the extra satisfaction or value gained from consuming one more unit. Rational consumers compare this with marginal cost when deciding quantities.

Question 18Fundamental Economic Concepts

A country can produce 200 units of cloth or 100 units of wine, while its trading partner can produce 150 units of cloth or 150 units of wine. Which statement is correct?

  1. The second country has an absolute advantage in cloth
  2. Neither country has a comparative advantage in either good
  3. The first country has a comparative advantage in cloth Correct answer.
  4. The first country has a comparative advantage in wine

Explanation

The first country's opportunity cost of cloth is 0.5 wine, versus 1 wine for the partner, so the first country has the comparative advantage in cloth. Comparative advantage depends on relative opportunity costs, not absolute output. The partner therefore has the comparative advantage in wine.

Question 19Fundamental Economic Concepts

Which situation describes a movement along a demand curve rather than a shift of the curve?

  1. A new substitute good enters the market
  2. Consumer income rises and buyers purchase more of a normal good
  3. Advertising makes the product more popular
  4. The price of the good falls and buyers purchase more of it Correct answer.

Explanation

A change in the good's own price changes quantity demanded and is shown as a movement along a fixed demand curve. Shifts occur when a non-price determinant such as income, prices of related goods, or preferences changes. Distinguishing the two is a core demand concept.

Question 20Fundamental Economic Concepts

A firm's production possibilities frontier shifts outward. Which change could explain this?

  1. A reduction in the labor force
  2. An increase in consumer demand for both goods
  3. A decision to produce more of one good
  4. An improvement in production technology Correct answer.

Explanation

An outward shift of the frontier reflects an increase in productive capacity, such as better technology or more resources. Technological improvement allows more of both goods to be produced. Demand changes and output choices do not move the frontier itself.

Question 21Fundamental Economic Concepts

In a market with a negative externality such as pollution, the unregulated competitive equilibrium typically results in:

  1. Too little output relative to the socially efficient level
  2. The socially efficient level of output
  3. Zero output
  4. Too much output relative to the socially efficient level Correct answer.

Explanation

With a negative externality, private marginal cost is below social marginal cost, so firms produce more than the socially efficient quantity. The market price fails to reflect the external damage. A corrective tax or regulation can reduce output toward the efficient level.

Question 22Fundamental Economic Concepts

A consumer's budget constraint rotates outward along the horizontal axis when:

  1. Income falls and both goods are normal
  2. The price of the vertical-axis good rises while income stays constant
  3. The price of the horizontal-axis good falls while income and the other price stay constant Correct answer.
  4. Both prices and income double

Explanation

A lower price for the horizontal-axis good raises the maximum quantity affordable on that axis, rotating the intercept outward while the vertical intercept stays fixed. Income changes shift the constraint parallel. Proportional changes in prices and income leave the real budget set unchanged.

Question 23Fundamental Economic Concepts

The income effect of a price increase for a normal good reinforces the substitution effect because:

  1. The substitution effect is zero for normal goods
  2. Consumers always substitute toward the more expensive good
  3. Higher prices reduce real purchasing power, decreasing quantity demanded Correct answer.
  4. Higher prices raise real purchasing power, increasing quantity demanded

Explanation

A price increase lowers real income, and for a normal good the income effect reduces quantity demanded. The substitution effect also reduces quantity demanded as consumers switch to relatively cheaper goods. Both effects therefore work in the same direction.

Question 24Fundamental Economic Concepts

A price-discriminating monopolist facing two markets with different demand elasticities maximizes profit by:

  1. Charging a higher price in the market with less elastic demand Correct answer.
  2. Charging a higher price in the market with more elastic demand
  3. Selling only in the market with more elastic demand
  4. Charging the same price in both markets

Explanation

Profit maximization equates marginal revenue across markets, and marginal revenue is higher where demand is less elastic at a given price. The firm therefore charges more to buyers who are less responsive to price. Charging a higher price to more elastic buyers would drive away too many sales.

Question 25Fundamental Economic Concepts

A good is classified as inferior if its income elasticity of demand is:

  1. Negative Correct answer.
  2. Exactly zero
  3. Between zero and one
  4. Greater than one

Explanation

Inferior goods are those for which quantity demanded falls as income rises, producing negative income elasticity. Normal goods have positive income elasticity, with luxury goods above one. A zero elasticity describes a good unrelated to income changes.

Question 26Fundamental Economic Concepts

Which statement best describes the central problem of scarcity in economics?

  1. Firms produce more output than consumers are willing to purchase during recessions.
  2. Human wants are unlimited while productive resources are limited, so choices must be made. Correct answer.
  3. Some households are poor while others are wealthy, which creates social conflict.
  4. Governments must ration goods whenever prices rise above their historical averages.

Explanation

Scarcity arises because resources such as labor, land, and capital are finite while wants are effectively unlimited. This forces individuals and societies to choose among competing uses, which is why opportunity cost exists. Poverty and surplus production are separate issues from the definition of scarcity.

Question 27Fundamental Economic Concepts

Which of the following is an example of a capital resource in economics?

  1. A worker's years of formal education
  2. A delivery van owned by a bakery Correct answer.
  3. Money held in a checking account
  4. A natural forest used for hiking

Explanation

Capital refers to produced goods used to produce other goods and services, such as machinery, tools, and vehicles. The delivery van was manufactured and is used in the bakery's production process. Education is human capital, money is a medium of exchange, and a natural forest is a land resource.

Question 28Fundamental Economic Concepts

A bakery can use its ovens to bake either 300 loaves of bread or 200 cakes per day. What is the opportunity cost of one cake?

  1. 200 loaves of bread
  2. Two-thirds of a loaf of bread
  3. One and one-half loaves of bread Correct answer.
  4. 300 loaves of bread

Explanation

The opportunity cost of one cake equals the number of loaves given up divided by the number of cakes gained, or 300 divided by 200, which is 1.5 loaves. This constant ratio reflects the trade-off along a straight-line production possibilities frontier.

Question 29Fundamental Economic Concepts

Which question is addressed by positive economics rather than normative economics?

  1. How much of the federal budget ought to be spent on housing aid
  2. What effect a minimum wage increase has on teenage employment Correct answer.
  3. Whether reducing inequality is more important than promoting growth
  4. Whether the minimum wage should be raised to reduce poverty

Explanation

Positive economics concerns testable statements about what is, such as the employment effects of a policy. Normative economics involves value judgments about what ought to be. Questions of should, ought, or importance rest on ethical judgments rather than empirical evidence.

Question 30Fundamental Economic Concepts

In a circular-flow model, which of the following flows from households to firms?

  1. Factors of production such as labor Correct answer.
  2. Payments for goods and services
  3. Wages, rent, and profit
  4. Goods and services produced

Explanation

Households supply factors of production, including labor and capital, to firms in the resource market. In return, firms pay wages, rent, interest, and profit. Households also buy goods, so they send spending to firms and receive output from them.

Question 31Fundamental Economic Concepts

Which of the following best illustrates the concept of marginal analysis?

  1. A firm compares the extra revenue from one more unit with the extra cost of producing it. Correct answer.
  2. A firm calculates its total revenue for the entire year.
  3. A consumer buys the same basket of goods every week out of habit.
  4. A government reports the average income of all households.

Explanation

Marginal analysis compares the additional benefit of a small change with its additional cost. Decisions such as whether to produce or consume one more unit rest on this incremental comparison. Totals and averages describe levels of activity rather than the effect of a one-unit change.

Question 32Fundamental Economic Concepts

Which of the following is a microeconomic topic rather than a macroeconomic topic?

  1. The relationship between government spending and aggregate output
  2. The effect of an increase in the money supply on the national inflation rate
  3. How a single firm sets output to maximize profit Correct answer.
  4. The determinants of the unemployment rate during a recession

Explanation

Microeconomics studies individual decision-making units such as households, firms, and specific markets. A single firm's output decision is a standard microeconomic question. Inflation, unemployment, and aggregate output are economy-wide variables studied in macroeconomics.

Question 33Fundamental Economic Concepts

The demand for a good increases sharply when consumers expect its price to rise next month. Which shifter of demand does this illustrate?

  1. A change in the number of sellers
  2. A change in consumer income
  3. A change in expectations about future prices Correct answer.
  4. A change in the price of a substitute

Explanation

Expectations of a higher future price raise current demand because buyers prefer to purchase before the price rises. This shifts the demand curve to the right at every current price. Changes in income, substitute prices, and the number of sellers are separate demand shifters, and the number of sellers affects supply.

Question 34Fundamental Economic Concepts

The supply curve for a product is upward sloping. Which explanation is most consistent with this shape?

  1. Consumers value additional units less as they consume more.
  2. Producers must accept lower prices to sell additional units.
  3. Firms always earn positive economic profit in competitive markets.
  4. Higher prices make additional production profitable because marginal costs rise with output. Correct answer.

Explanation

An upward-sloping supply curve reflects increasing marginal cost: producing more requires resources that become progressively more expensive, so sellers require higher prices to expand output. The curve also reflects profit opportunities at higher prices. Declining marginal value belongs to demand, not supply.

Question 35Fundamental Economic Concepts

In the market for coffee, the price of tea (a substitute) rises and simultaneously a new harvesting technology lowers coffee production costs. What happens to the equilibrium price and quantity of coffee?

  1. Price falls and quantity falls
  2. Price is indeterminate and quantity rises Correct answer.
  3. Price falls and quantity is indeterminate
  4. Price rises and quantity rises

Explanation

A higher tea price raises coffee demand, pushing price and quantity up, while cheaper harvesting raises coffee supply, pushing price down and quantity up. Quantity unambiguously rises because both shifts increase it. Price moves in opposite directions, so its net change cannot be determined without knowing the relative magnitudes.

Question 36Fundamental Economic Concepts

A price ceiling is set below the equilibrium price in a competitive market. Which result should be expected?

  1. An immediate shift of the supply curve to the right
  2. A shortage of the good and a loss of gains from trade Correct answer.
  3. An increase in quantity supplied above the equilibrium level
  4. A surplus of the good and upward pressure on price

Explanation

A binding price ceiling below equilibrium means quantity demanded exceeds quantity supplied, creating a shortage. Some mutually beneficial trades do not occur, producing deadweight loss. The ceiling does not shift either curve; it creates a movement along both curves.

Question 37Fundamental Economic Concepts

The price elasticity of supply for a product is 0.4. This value indicates that supply is:

  1. Unit elastic, because the value is a fraction
  2. Perfectly elastic, because suppliers respond at any price
  3. Inelastic, because the value is less than one Correct answer.
  4. Elastic, because the value is positive

Explanation

Elasticity of supply measures the percentage change in quantity supplied divided by the percentage change in price. A value below one in absolute terms means a proportional price change produces a smaller proportional quantity change, so supply is inelastic. Perfectly elastic supply corresponds to an elasticity of infinity.

Question 38Fundamental Economic Concepts

A consumer's total utility rises as more units of a good are consumed, but each additional unit adds less satisfaction than the previous one. This pattern describes:

  1. Negative marginal utility
  2. Constant total utility
  3. Diminishing marginal utility Correct answer.
  4. Increasing marginal utility

Explanation

Diminishing marginal utility means each successive unit adds less to total satisfaction even though total utility keeps rising. This principle helps explain the downward slope of demand. Negative marginal utility would mean additional units reduce total satisfaction.

Question 39Fundamental Economic Concepts

A firm's total fixed cost is $200 and its total variable cost at 10 units of output is $300. What is average total cost at 10 units?

  1. $30
  2. $500
  3. $50 Correct answer.
  4. $20

Explanation

Total cost equals fixed cost plus variable cost, or $500 at 10 units. Average total cost divides total cost by output, giving $50 per unit. Fixed cost alone divided by output would give average fixed cost of $20.

Question 40Fundamental Economic Concepts

A perfectly competitive firm maximizes profit in the short run by producing where:

  1. Total revenue is maximized regardless of cost
  2. Price equals average total cost at the minimum point of the average total cost curve
  3. Price equals marginal cost, provided price exceeds average variable cost Correct answer.
  4. Marginal revenue exceeds marginal cost by the largest possible amount

Explanation

For a price-taking firm, marginal revenue equals the market price, so profit is maximized where price equals marginal cost. The firm should shut down if price falls below minimum average variable cost. Producing where marginal revenue exceeds marginal cost leaves profitable units unproduced.

Question 41Fundamental Economic Concepts

Which characteristic is a source of market power for a monopoly?

  1. Barriers to entry that protect the firm from new competitors Correct answer.
  2. Many sellers offering identical products
  3. Perfect information available to all buyers
  4. Free exit and entry in the long run

Explanation

A monopoly persists only when barriers such as patents, control of a key resource, or economies of scale prevent entry. Without such barriers, competition would erode market power. Many sellers, perfect information, and free entry describe competitive markets instead.

Question 42Fundamental Economic Concepts

A firm's production function exhibits diminishing marginal returns to labor in the short run. This implies that:

  1. Workers are paid less than their marginal product
  2. Each additional worker adds less output than the previous worker, holding capital fixed Correct answer.
  3. Total output falls as more workers are hired
  4. The firm's long-run average cost curve must slope upward

Explanation

Diminishing marginal returns occur when adding successive units of a variable input to fixed inputs yields smaller increments of output. Total output can still rise, but at a decreasing rate. This short-run phenomenon is distinct from long-run economies or diseconomies of scale.

Question 43Fundamental Economic Concepts

A tax is placed on the sellers of a good with relatively inelastic demand and elastic supply. Who bears the larger share of the tax burden?

  1. Buyers, because their quantity demanded responds little to price changes Correct answer.
  2. Sellers, because the tax is legally collected from them
  3. Neither group, because the tax is fully absorbed by the government
  4. Sellers and buyers equally, because the tax is split by law

Explanation

Tax incidence depends on relative elasticities, not on who legally remits the tax. The group with the less elastic response bears more of the burden because it cannot easily avoid the price change. Inelastic demand therefore places most of the burden on buyers.

Question 44Fundamental Economic Concepts

A public good such as national defense is characterized by:

  1. Rivalry in consumption but no exclusion costs
  2. Nonrivalry in consumption and difficulty excluding nonpayers Correct answer.
  3. Rivalry in consumption and easy exclusion of nonpayers
  4. Excludability with no free-rider problem

Explanation

Public goods are nonrival, meaning one person's use does not reduce another's, and nonexcludable, meaning nonpayers cannot easily be kept from benefiting. These features create the free-rider problem and justify public provision. Private goods are both rival and excludable.

Question 45Fundamental Economic Concepts

In a market with a positive externality from vaccination, the socially optimal quantity is:

  1. Greater than the private market quantity because marginal social benefit exceeds marginal private benefit Correct answer.
  2. Less than the private market quantity because external costs exceed private costs
  3. Equal to the private market quantity because externalities do not affect efficiency
  4. Zero because the good is provided only by government

Explanation

A positive externality means the marginal social benefit of consumption exceeds the marginal private benefit. The unregulated market equates marginal private benefit with marginal cost, so it underproduces relative to the social optimum. A subsidy can move output toward the efficient level.

Question 46Fundamental Economic Concepts

A firm's long-run average total cost curve declines over a wide range of output. This pattern indicates:

  1. Economies of scale Correct answer.
  2. Diseconomies of scale
  3. Diminishing marginal returns
  4. Constant returns to scale

Explanation

Economies of scale exist when long-run average total cost falls as output expands, often because of specialization and spreading fixed costs. Constant returns to scale leave average cost unchanged, while diseconomies of scale raise it. Diminishing marginal returns is a short-run concept involving a fixed input.

Question 47Fundamental Economic Concepts

Two countries both produce only bread and steel. Country A has an absolute advantage in both goods, while Country B has a lower opportunity cost of producing steel. According to comparative advantage theory:

  1. Country B should specialize in bread because it is less efficient overall
  2. Country B should specialize in steel and Country A in bread, and both can gain from trade Correct answer.
  3. No gains from trade are possible because Country A is more productive in both goods
  4. Country A should produce both goods and not trade because it is more productive

Explanation

Comparative advantage rests on opportunity cost, not absolute productivity. Country B should specialize in steel because it sacrifices less bread per unit of steel, and Country A should specialize in bread. Trade then allows both countries to consume beyond their individual production possibilities.

Question 48Fundamental Economic Concepts

An economy is operating on its production possibilities frontier. A government decides to shift resources into producing more capital goods and fewer consumer goods. The most likely long-run consequence is:

  1. Current consumption rises immediately with no effect on future output
  2. The frontier shifts outward more rapidly because capital goods expand future productive capacity Correct answer.
  3. The economy moves inside the frontier because resources are reallocated
  4. The frontier shifts inward because consumer goods are no longer produced

Explanation

Capital goods are used to produce other goods, so devoting more resources to them raises future production capacity and shifts the frontier outward over time. The trade-off is reduced current consumption. The economy remains on the frontier because resources are still fully employed.

Question 49Fundamental Economic Concepts

A country's economy can be described by the data in this table: working-age population = 200 million; employed = 120 million; unemployed = 10 million; discouraged workers who have stopped searching = 5 million. Using the standard definition of the unemployment rate, what is the value?

  1. 5.0 percent
  2. 4.8 percent
  3. 7.7 percent Correct answer.
  4. 8.3 percent

Explanation

The unemployment rate equals the number of unemployed divided by the labor force, where the labor force is employed plus unemployed persons actively seeking work. Here the labor force is 120 + 10 = 130 million, so the rate is 10/130, which is about 7.7 percent. Discouraged workers are not counted in the labor force because they are not actively searching.

Question 50Fundamental Economic Concepts

An economy's consumer price index rises from 150 to 162 over one year. A worker's nominal wage rises by 4 percent during the same period. Which statement best describes the change in the worker's real wage?

  1. The real wage rises by about 8 percent because the index rose by 12 points.
  2. The real wage falls by about 4 percent because inflation of 8 percent outpaces the nominal increase. Correct answer.
  3. The real wage rises by about 4 percent because the nominal wage increase exceeds zero.
  4. The real wage falls by about 8 percent because the price level itself increased by 8 percent.

Explanation

Inflation is measured as the percentage change in the price index: (162 − 150)/150 = 8 percent. The real wage change is approximately the nominal wage change minus the inflation rate, so 4 percent minus 8 percent equals roughly a 4 percent decline in purchasing power.