Short-Answer Quiz: Answer Key

1. The basic economic problem is scarcity, which is caused by unlimited wants and limited resources. To address this, societies must decide how to use the three factors of production: land (natural resources), labor (human resources), and capital (anything that helps produce resources, like machines or education).
2. Absolute advantage exists when a country can produce a good using fewer resources per unit of output than another country. In contrast, comparative advantage exists when a country can produce a good at a lower opportunity cost, meaning it gives up less of another good to produce it.
3. Three determinants of demand are income, consumer expectations, and the price of complementary goods. An increase in income for a normal good shifts demand right, while an expectation of a future price drop shifts current demand left. If the price of a complementary good (like hot dog buns) rises, the demand for the primary good (hot dogs) will shift to the left.
4. A perfectly competitive market is characterized by many small firms, a homogeneous or identical product, and easy entry and exit from the market. Firms in this structure have no price control and are considered “price takers,” accepting the market price. There is no non-price competition.
5. A price floor is a government-mandated minimum price, such as the minimum wage, which is effective only when set above the equilibrium price, causing a surplus. A price ceiling is a maximum price, such as rent control, and is effective only when set below the equilibrium price, causing a shortage.
6. Gross Domestic Product (GDP) is the total value of all final goods and services produced on a nation’s soil in a year. Excluded from GDP calculations are purely financial transactions like buying stocks, public and private transfer payments like welfare or monetary gifts, and secondhand sales.
7. Expansionary fiscal policy is used during a recession to increase aggregate demand and involves decreasing taxes and/or increasing government spending. Contractionary fiscal policy is used to combat inflation by decreasing aggregate demand through increased taxes and/or decreased government spending.
8. The three tools are the reserve requirement, the discount rate, and open market operations. The reserve requirement is the fraction of deposits banks must hold, the discount rate is the interest rate the Fed charges banks for loans, and open market operations involve the Fed buying and selling government bonds to alter bank reserves.
9. A negative externality occurs when a firm’s production shifts some of its costs onto the community, such as through pollution. This is a market failure because the firm’s private costs are lower than the total social costs, leading to an overproduction of the good beyond the socially efficient level.
10. M1 is the most liquid measure of the money supply, consisting of all currency in public hands, all checkable deposits, and traveler’s checks. M2 is a broader measure that includes all of M1 plus less liquid assets like savings deposits, certificates of deposit (under $100,000), and money market mutual funds.