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Sloman WBK fnl AW2 08/11/2005 11:13 Page 1

sixth
John Sloman • Peter Smith edition

ECONOMICS sixth

ECO N O M I CS WORKBOOK
edition

STUDENT WORKBOOK John Sloman • Peter Smith

This comprehensive Economics Student Workbook is specifically designed to be used

alongside the sixth edition of John Sloman’s Economics and contains over 1500
questions of various types, carefully matched to the content of the main text. It is an
invaluable guide for any student of economics, as well as a useful teaching aid for tutors.

Features:
Each chapter corresponds to a chapter in the main book, Economics, and includes
the following:

ECONOMICS
• A review of key concepts
• Review questions
• Longer problems and exercises
• Student projects

STUDENT
• Data response questions
• Discussion topics and essay questions
STUDENT WORKBOOK
This workbook is suitable for use on principles of economics courses as a part of single or
sixth edition
joint honours economics degree programmes, or on introductory economics courses as
part of a business, social science or other degree programme. It is also ideal for self-study
in the principles of economics.

John Sloman • Peter Smith

About the authors:
John Sloman is Principal Lecturer in the School of Economics at the University of the West of
England. He is also Director of the Economics Network: the economics subject centre of the
Higher Education Academy. Economics Network is based at the University of Bristol.

Peter Smith is Senior Lecturer in the Economics Division at the University of Southampton.
He is also Editor of Economic Review.

Additional student support at Additional student support at

www.pearson-books.com
an imprint of www.pearsoned.co.uk/sloman www.pearsoned.co.uk/sloman
EW6_A01.qxd 11/1/05 1:23 PM Page i

Economics
Student Workbook
EW6_A01.qxd 11/1/05 1:23 PM Page ii

We work with leading authors to develop the

strongest educational materials in economics,
bringing cutting-edge thinking and best
learning practice to a global market.

Under a range of well-known imprints, including

Financial Times Prentice Hall, we craft high quality
print and electronic publications which help readers
to understand and apply their content, whether
studying or at work.

To find out more about the complete range of our

publishing, please visit us on the World Wide Web at:
www.pearsoned.co.uk
EW6_A01.qxd 11/1/05 1:23 PM Page iii

Economics
Student Workbook

SIXTH EDITION

John Sloman
University of the West of England and the Economics Network

Peter Smith
University of Southampton
EW6_A01.qxd 11/1/05 1:23 PM Page iv

Pearson Education Limited

Edinburgh Gate
Harlow
Essex CM20 2JE
England

and Associated Companies throughout the World.

Visit us on the World Wide Web at:

www.pearsoned.co.uk

First edition published 1991

Second edition published 1994
Third edition published 1997
Fourth edition published 2000
Fifth edition published 2003
Sixth edition published 2006

© John Sloman and Mark Sutcliffe 1991, 2003

© John Sloman, Mark Sutcliffe and Peter Smith 2006

The rights of John Sloman, Peter Smith and Mark Sutcliffe to be identified as authors of
this work have been asserted by them in accordance with the Copyright, Designs and
Patents Act 1988.

All rights reserved. No part of this publication may be reproduced, stored in a

retrieval system, or transmitted in any form or by any means, electronic, mechanical,
photocopying, recording or otherwise, without either the prior written permission of the
publisher or a licence permitting restricted copying in the United Kingdom issued by the
Copyright Licensing Agency Ltd, 90 Tottenham Court Road, London W1T 4LP.

ISBN-13: 978-0-273-70517-8
ISBN-10: 0-273-70517-2

British Library Cataloguing-in-Publication Data

A catalogue record for this book can be obtained from the British Library

10 9 8 7 6 5 4 3 2 1
10 09 08 07 06

Typeset by 35 in 8/12 pt Stone Serif

Printed and bound in Great Britain by Henry Ling Ltd., at the
Dorset Press, Dorchester, Dorset
EW6_A01.qxd 11/1/05 1:23 PM Page v

Contents

Preface vi

1 Introducing Economics 1

2 Supply and Demand 10

3 Government Intervention in the Market 25

4 Background to Demand 34

5 Background to Supply 46

6 Profit Maximising under Perfect Competition and Monopoly 61

7 Profit Maximising under Imperfect Competition 73

8 Alternative Theories of the Firm 83

9 The Theory of Distribution of Income 92

10 Inequality, Poverty and Policies to Redistribute Incomes 105

11 Markets, Efficiency and the Public Interest 116

12 Applied Microeconomics 130

13 The National Economy 143

14 Macroeconomic Issues and Analysis: An Overview 151

15 The Roots of Modern Macroeconomics 165

16 Short-run Macroeconomic Equilibrium 173

17 Money and Interest Rates 185

18 The Relationship between the Money and Goods Markets 193

19 Fiscal and Monetary Policy 204

20 Aggregate Supply, Unemployment and Inflation 216

21 Long-term Economic Growth 228

22 Supply-side Policies 233

23 International Trade 241

24 The Balance of Payments and Exchange Rates 253

25 Global and Regional Interdependence 265

26 Economic Problems of Developing Countries 272

EW6_A01.qxd 11/1/05 1:23 PM Page vi

Preface

TO THE STUDENT

Welcome to this Economics Workbook. We hope that the book will help to make your study of
the fascinating subject of economics both enjoyable and thought provoking and that it will
improve your ability to analyse the economic problems faced by individuals and nations: prob-
lems that we hear about daily in the news or come across in our own lives.

Studying economics can be much more rewarding if it is not just seen as a body of knowledge
to absorb. Applying the theories, working through problems, analysing data, gathering informa-
tion, scouring newspapers, reports and official publications and debating with other students can
all help to bring the subject alive. This Workbook will give you the opportunity to do all these
things.

The book may be used with any introductory text, although it is specifically designed to be
used with John Sloman, Economics (6th edition). Each chapter in the Workbook corresponds to a
chapter in the main text.

Each chapter is divided into four sections: (A) Review, (B) Problems, exercises and projects,
(C) Discussion topics and essays, (D) Answers. Between them, these sections will help you pre-
pare for all types of examination and assessment currently used at first-year degree level and
A level, and on BTEC and professional courses.

Review Delete wrong word

This section takes you step-by-step through the material These are sometimes true/false questions, sometimes yes/no
covered in the respective chapter of Economics (6th edition), questions, or sometimes deleting one of two or more alter-
using a mixture of narrative and short questions. native answers.
The questions are of seven different types, six of which
are signified by symbols. Diagram/table manipulation
These involve you completing a diagram or table, or read-
Multiple choice ing things off a diagram or table.
These are set out in the standard multiple-choice format.
Calculation
In virtually all cases there are five alternative answers and
These involve short mathematical calculations, usually
you are required to circle the correct one. The questions are
just simple arithmetic, but in some of the optional, starred
typical of those used at first-year degree level and at A level.
questions (see below) they involve simple differentiation.

Written answer Matching/ordering

These require you to give one or two words or sentences. These are of two types. The first involves matching a set of
Sometimes there will be a list of points for you to give. definitions to a set of descriptions, or a set of answers to a
EW6_A01.qxd 11/1/05 1:23 PM Page vii

PREFACE vii

set of questions. The second involves putting a set of points more stimulating than the more purely descriptive, theoreti-
or events into the correct order. cal or analytical questions sometimes used for essays. The
last question in this section is usually a motion for a debate.
The final type of question is embedded in the narrative,
and involves you deleting the wrong word, phrase or sen-
Additional resources
tence from two or more alternatives given.
Another way in which you can practise applying economic
Some questions are starred. These are on additional top-
ideas to practical situations is to think about how eco-
ics and may be omitted if desired.
nomics helps us to interpret events that occur in the world
around us. To help you in this, the Sloman website at
Problems, exercises and projects
www.pearsoned.co.uk/sloman contains hot links to a wide
This section consists of longer, multi-part questions, often
range of articles that will be useful to extend your ability to
involving simple calculations or the manipulation of
apply economics. All you need to do is go to the website and
graphs. There are also questions involving the gathering
follow the link to ‘Economics News Articles’. In addition,
and analysis of data. These ‘mini-project’ questions can be
you should make use of the case studies that are on the web-
set by your tutor as an assigned piece of work, to be done
site: these are referenced at the end of each chapter in the
either individually or in groups. The information gathered
main text.
can then be used for in-class discussions.

Discussion topics and essays Answers

These questions, as the name suggests, can be used for prac- Full answers plus, where appropriate, full explanations are
tice in writing essays or making essay plans (which will given to all section A questions. These will help you check
help you prepare for exams), or for discussion with fellow on your understanding as you work your way through the
students. Most of the questions in this section are designed relevant chapter of the main text. They allow section A to
to raise issues of policy or controversy, and thus should be be used as a comprehensive revision tool.

TEACHING AND LEARNING: A NOTE TO TUTORS

In devising this Workbook, we intended that it should be both an independent study tool for the
student and also a useful teaching aid for tutors. Sections A to C can all be used in a classroom
context, adding variety and spice to the delivery of economic principles and policy. Outlined
below are some suggestions for ways in which you might use the various sections.

Review give you feedback on the success of your lesson in meeting

The main purpose of this section is to help reinforce stu- its objective(s). With the answers provided to all section A
dents’ learning and understanding of key principles by questions at the end of each chapter, students could mark
putting them to use in answering simple questions. The each other’s work.
questions are built up in a sequence that mirrors that in the
main text. Problems, exercises and projects
In addition to being used as a learning tool by students As the title of this section suggests, there are three types of
and as a useful revision and practice aid for exams, these question to be found here.
questions could also be used in class. Students might be
asked, either prior to the class meeting, or in the first part • Multi-part problems. These longer questions provide
of the class, to complete a set number of questions from ideal material for use in very large workshops (of up to
this section. Then, preferably in small groups, they would 200 students). We have been running workshops simi-
attempt to identify the definitive answer. Groups would be lar to these for a number of years and find them very
expected to explain the reasoning behind the answers they popular with students and a good medium for learn-
had chosen. ing and applying basic economic concepts. Students
Alternatively, at the end of a lesson (lecture, seminar or can work through these multi-part questions (or a por-
class), a short test based on questions in this section could tion of them), discussing them with their neighbours
be set. This would be quick to administer and mark, and as they do so, and then the lecturer can go through the
EW6_A01.qxd 11/1/05 1:23 PM Page viii

viii PREFACE

answers from the front. If you leave one row free in Discussion topics and essays
every three in the lecture theatre, tutors can go round These questions can be set as essays, or they can be used as
giving help to students if they are stuck. This is a good the basis of class discussion. Why not, mid-way through a
way of using postgraduate teaching assistants. Answers lecture, or class, following a particular point of theory, pose
to these questions are given on the CD. one of the questions for students to discuss and to ascertain
• Exercises. Many of these questions require students its relevance to what they have just been taught? For exam-
to look up data or other information from books ple, you have introduced your students to the idea of profit
or electronic media. They are best set in advance maximisation. You now want them to consider its rele-
of the lesson, unless information collection is one vance to real-world business decision making. Ask them
of its main purposes. Once the information has the following discussion question:
been collected, however, students could work in
small groups to devise answers to the questions. This Imagine you were the managing director of a fashion house
is a very effective way of stimulating debate and producing expensive designer clothing. What achievements of
discussion. you and your company would give you special satisfaction?
• Mini projects. These involve students gathering infor-
After a short period of time ask the supplementary question:
mation, sometimes by field work, and then writing a
small report or considering a question relating to the Are the achievements consistent with profit maximisation?
information obtained. Again, this work could be done
in small groups. You can then proceed to discuss alternative theories of the
firm and students can debate whether managerial utility
These last two types of question also lend themselves maximisation might be more relevant as a goal of business
well to group presentations, which help to develop useful rather than the maximisation of profit.
communication skills. As part of their presentation, stu- The last question in section C is usually a debate. We sug-
dents could be required to consider the method(s) by gest that the debate is conducted as formally as possible,
which they solve problems and construct answers. Telling with two student proposing the motion and two opposing
others how they approached such issues also helps to it. After the formal speeches we suggest that the debate is
develop useful skills for themselves and their audience. opened to question and/or contributions from the floor.
The questions in this section also lend themselves very Finally the proposer and opposer could give a concluding
well to being used as assigned pieces of work. They gener- speech. By conducting the proceedings formally, you can
ally require of the student a greater depth of understanding develop an atmosphere of theatre, with students acting
than section A questions. parts. This can make the learning environment fun.

ACKNOWLEDGEMENTS

The whole team at Pearson Education has been very helpful and we have really appreciated everyone’s hard work. A particu-
lar thanks to Justinia Seaman and Linda Dhondy for their encouragement, and to Sarah Wild for meticulously guiding the
book through production. Most of all, we owe the book to the unfailing support of Alison and Maureen and the rest of our
families.
John Sloman and Peter Smith
UWE Bristol and University of Southampton, September 2005
EW6_C01.qxd 11/1/05 10:42 AM Page 1

Chapter 1
Introducing Economics

A REVIEW

In this first chapter we start by looking at the subject matter of economics. What is it that
economists study? How is the subject divided up? What makes a problem an economic one?

Although all countries face economic problems, they nevertheless tackle them in different
ways. In some countries the government plays a major role in economic decision making. In
others decisions are left much more to individuals. Section 1.2 examines how these different
types of economy operate.

We then turn to examine types of reasoning employed by economists. Do economists proceed

like natural scientists, or does being a social science make economics different from subjects like
physics and chemistry? We also examine the extent to which economists can contribute to policy
making. Can economists tell governments what they ought to do?

1.1 What do economists study? production involves using various resources or factors of
(Page 4) Economists study many issues, but all of them stem production.
from the central economic problem of scarcity. Scarcity
occurs because there are not enough resources (labour, land Q3. It is normal to group factors of production into
and capital) to produce everything that people would like. three broad categories. These are:

Q1 . The problem of scarcity is directly relevant: 1. .......................................................................................

A. only to those times when rationing has been enforced.
B. only to developing countries low in resources. 2. .......................................................................................
C. only to those on low incomes.
D. only to those periods of history before mass production. 3. .......................................................................................
E. to all countries and all individuals.
Q4. Which one of the following would not be
Q2. The problem of scarcity will eventually disappear classified as a factor of production?
with the development of new technology and resulting A. Jim Bodget, a bricklayer for a local construction firm.
higher levels of production. True/False B. The cement mixer Jim uses.
C. The cement Jim puts in the mixer.
(Page 4) In order to tackle the problem of scarcity, societies D. The building site Jim works on.
produce goods and services for people to consume. This E. The wage Jim gets paid at the end of the week.

Multiple choice Written answer Delete wrong word Diagram/table manipulation Calculation Matching/ordering
EW6_C01.qxd 11/1/05 10:42 AM Page 2

2 CHAPTER 1 INTRODUCING ECONOMICS

(Page 5) One way of understanding the problem of scarcity (a) That consumers will not buy goods which increase
is in terms of potential demand and supply. Potential demand their satisfaction by just a small amount. True/False
relates to the Q5. wants/needs of individuals, whereas (b) That consumers will attempt to maximise their indi-
potential supply is determined by Q6. the level of resources vidual satisfaction for the income they earn.
available/the amount that consumers demand. True/False
(c) That consumers buy the sorts of goods that the aver-
(Pages 5–9) Because of scarcity, people are concerned that age person buys. True/False
society should produce more goods and that the resources (d) That consumers seek to get the best value for money
should be used as fully as possible. This is the subject of from the goods they buy. True/False
Q7. microeconomics/macroeconomics. But given that enough (e) That consumers compare (maybe very casually) the
can never be produced to satisfy potential demands, choices cost of an item they are purchasing with the benefit
have to be made: what items to produce and in what quant- they expect to gain from it. True/False
ities, how to produce them and for whom. These choices
between alternatives are the subject of Q8. microeconomics/ (Pages 9–10) When we make rational choices, what we are
macroeconomics. in fact doing is weighing up the marginal benefit of each
activity against its marginal (opportunity) cost. If the
Q9. Which of the following are macroeconomic issues marginal benefit (i.e. the extra benefit of doing a bit more of
and which are microeconomic ones? the activity) exceeds its marginal cost (i.e. the extra cost of
(a) The level of government spending. micro/macro doing a bit more), it is rational to choose to do that bit
(b) A grant given by the government to the UK film more.
industry. micro/macro Even though we may not be conscious of doing so,
(c) The level of investment in the UK by overseas firms. we apply this marginal analysis on a regular basis in our
micro/macro day-to-day decision making. This is such an important and
(d) The price of cotton cloth. micro/macro widely applicable concept that it is the second of our
(e) The rate of inflation. micro/macro Threshold Concepts, to help you to think like an economist.
(f ) The average wage rate paid to textile workers.
micro/macro Q13. Which one of the following statements is not an
(g) The total amount spent by UK consumers on clothing example of marginal analysis?
and footwear. micro/macro A. If I eat another chocolate bar, I might be sick.
(h) The amount saved last year by households. B. If mortgage rates rise by another 1 per cent, some
micro/macro people will no longer be able to afford the repayments.
C. If a firm earns more from selling its products than they
(Pages 7–9) Choices involve sacrifices or costs. If as a society
cost to produce, it will make a profit.
we consume more of one good or service then, unless there
D. If J. Bloggs (Warehousing) Ltd buys a new forklift truck
are idle resources, we will be able to consume less of other
of the latest design, it should be able to stack another
goods and services.
500 pallets per day.
E. Fitting flue gas desulphurisation equipment to a coal-
Q10. The cost of one good measured in terms of what
fired power station in Britain producing x kilowatts
we must sacrifice is called the:
will reduce the costs of acid rain pollution in
A. real cost.
Scandinavia by £y.
B. opportunity cost.
C. average cost.
(Pages 12–14) One way in which scarcity, choice and oppor-
D. potential cost.
tunity cost can all be illustrated is via a production possibility
E. social cost.
curve. This depicts a simplified world in which a country
produces just two goods. The curve shows all the possible
(Page 8) The notion of opportunity cost is the first of fifteen
combinations of the two goods that the country can pro-
Threshold Concepts. Once you have come to grips with
duce in a given period of time.
these, and appreciate their significance, you will begin to
Figure 1.1 shows the production possibility curve for a
think like an economist.
country that can produce various combinations of two
Q11. Your opportunity cost of tackling this question is goods X and Y.

............................................................................................... Q14. Which point or points illustrate a situation:

Q12. Economists assume that economic decisions are (a) Which is efficient? .........................................................
made rationally. In the case of consumers, rational decision
making means: (b) Which is inefficient?......................................................
EW6_C01.qxd 11/1/05 10:42 AM Page 3

CHAPTER 1 INTRODUCING ECONOMICS 3

Figure 1.1 A production possibility curve Figure 1.3 Production possibility curves for two years

(c) Of complete specialisation? ........................................... Q17. Figure 1.3 shows a country’s production possibil-
ity curves for two years, 2005 and 2008. The production
(d) Which is unobtainable?................................................. point shifts outward from point A in 2005 to point B in
2008. The following are possible things that might have
Moving from one point to another round a production pos- happened:
sibility curve illustrates the concept of opportunity cost. (i) Potential output has increased.
(ii) Actual output has increased.
Q15. Figure 1.2 shows a production possibility curve. (iii) A fuller use has been made of resources.
Production is currently at point A. The opportunity cost of Which is correct?
producing one more unit of good X is: A. (i), (ii) and (iii).
A. 10 units of X. B. (i) and (ii), but not (iii).
B. 1 unit of X. C. (ii) and (iii), but not (i).
C. 8 units of Y. D. (ii), but not (i) or (iii).
D. 6 units of Y. E. It is impossible to say from the information given.
E. 2 units of Y.
Q18. Which one of the following would directly lead
Q16. A production possibility curve is typically drawn
to an outward shift of a country’s production possibility
bowed outward from the origin. This illustrates
curve?
A. An increase in the population of working age.
...............................................................................................
B. A reduction in the level of unemployment in the
economy.
Figure 1.2 Production possibility curve C. A reduction in value added tax and duties on petrol
and alcohol.
D. An increase in the general level of prices.
E. A reduction in government expenditure on education.

A production possibility diagram can illustrate the distinc-

tion between microeconomics and macroeconomics.

Q19. Which of the following are microeconomic and

which are macroeconomic issues?
(a) Whether the production possibility curve shifts out-
wards over time. micro/macro
(b) Whether the economy is operating on the production
possibility curve or inside it. micro/macro
(c) The choice whether to produce more X and less Y, or
more Y and less X (i.e. where to produce on the pro-
duction possibility curve). micro/macro
EW6_C01.qxd 11/1/05 10:42 AM Page 4

4 CHAPTER 1 INTRODUCING ECONOMICS

C. The system of planning can ensure that producers

Figure 1.4 The circular flow of incomes and of goods
respond automatically to consumer wishes.
and services
D. Resources can be diverted from consumption to invest-
ment if it is desired to increase the rate of economic
growth.
E. Unemployment can be avoided.

Q24. Name two potential disadvantages of a pure com-

mand economy.

1. .......................................................................................

2. .......................................................................................

(Pages 20–5) In a totally free-market economy the questions

of what, how and for whom to produce are determined by
(Pages 15–16) Another diagram that can be used to illustrate the decisions of individual households and firms through
the distinction between micro- and macroeconomics and the interaction of demand and supply. In goods markets
the process of satisfying consumer wants is the circular flow households are Q25. suppliers/demanders/price setters, whereas
of income diagram. It shows the inter-relationships between in factor markets households are Q26. suppliers/demanders/
firms and households in a money economy. A simplified neither suppliers nor demanders of factor services. The third
circular flow diagram is illustrated in Figure 1.4. Threshold Concept highlights the way in which people
respond to incentives. Price is one key incentive in a free
Q20. Which flow (I, II, III or IV) illustrates each of the market: if the price of a good rises, firms have an incentive
following? to produce Q27. more/less, and households have an incen-
(a) Goods and services. I/II/III/IV tive to consume Q28. more/less.
(b) Wages, rent, profit and interest. I/II/III/IV Demand and supply are brought into balance by the
(c) Factor services. I/II/III/IV effects of changes in price. If supply exceeds demand in
(d) Consumer expenditure. I/II/III/IV any market (a surplus), the price will Q29. rise/fall/stay
the same. This will lead to Q30. a rise in the quantity both
1.2 Different economic systems demanded and supplied/a fall in the quantity demanded and
(Pages 16–17) Different countries tackle the problem of supplied/a rise in the quantity demanded but a fall in the quan-
scarcity in different ways. One major way in which the eco- tity supplied/a rise in the quantity supplied but a fall in the
nomic systems of countries differ is in the extent to which quantity demanded. If, however, demand exceeds supply in
they rely on the market or the government to allocate any market (a shortage), the price will Q31. fall/rise/stay
resources. the same. This will lead to a Q32. fall/rise in the quantity
demanded and a Q33. fall/rise in the quantity supplied. In
Q21. At the one extreme is the full command economy. either case the adjustment of price will ensure that demand
Here all decisions concerning what should be produced, and supply are brought into equilibrium, with any shortage
how it should be produced, and for whom are made by or surplus being eliminated. This idea of how markets reach
equilibrium is the fourth Threshold Concept (Page 22).
...............................................................................................
Goods and factor markets are linked. A change in
demand or supply in one market will stimulate changes in
Q22. At the other extreme is the completely free-
other markets.
market economy. Here all economic decisions are made by

Q34. What incentives could be set to encourage

...............................................................................................
(a) firms to produce more?

(Pages 17–20) There are a number of potential advantages

...............................................................................................
of a command economy.

(b) consumers to buy more?

Q23. Which one of the following is not a potential
advantage of a command economy? ...............................................................................................
A. The planning authority can obtain an overall view of
the whole economy and ensure a balanced expansion (c) motorists to avoid causing congestion?
of its various parts.
B. Resources can be distributed according to need. ...............................................................................................
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CHAPTER 1 INTRODUCING ECONOMICS 5

(d) people to smoke fewer cigarettes?

1. .......................................................................................
...............................................................................................
2. .......................................................................................
(e) you to work harder on your economics course?
3. .......................................................................................
...............................................................................................
1.3 The nature of economic reasoning
Q35. If the demand for houses rises, how will this (Pages 27–9) The methodology used by economists has
affect the wages of bricklayers? much in common with that used by natural scientists. Like
natural scientists, economists construct models.
...............................................................................................
Q39. Which one of the following is not true of eco-
Provided there are many firms competing in each market, nomic models?
the free-market economy can be claimed to lead to a num- A. They simplify reality.
ber of advantages. B. They provide an explanation of the cause of certain
economic phenomena.
Q36. These include: C. They enable predictions of the ‘if . . . then . . .’ variety
(a) A lack of bureaucracy in economic decision making. to be made.
True/False D. They are constructed by conducting experiments
(b) Producers respond to changes in demand and con- under controlled conditions.
sumers respond to changes in supply. True/False E. They can be tested by appealing to the facts.
(c) The competition provides an incentive for producers
to be efficient. True/False Building models involves a process known as Q40. deduction/
(d) The interaction of demand and supply ensures that induction, whereas using a model to make a prediction
resources are equally distributed. True/False involves a process known as Q41. deduction/induction.
(e) Firms will produce goods that are desirable for society, Let us assume that an economist was attempting to
since only such goods can be sold profitably. establish the relationship between the rate of growth in the
True/False supply of money in the economy and the rate of inflation
(i.e. the annual percentage increase in retail prices) the fol-
(Pages 25–7) In reality no economy is a completely planned lowing year. In the process a number of steps are followed.
or completely free market. All economies are mixed. The
mixture of government and the market varies, however, Q42. Rearrange the following steps in the correct order:
from one economy to another. It is thus the degree and (a) Predict the rate of inflation next year.
form of government intervention that distinguishes one (b) Collect data on the current rate of growth in the
type of economy from another. money supply.
Threshold Concept 5 highlights the way in which people (c) Collect data on the rate of growth in the money sup-
gain from voluntary economic interaction, but Threshold ply and the rate of inflation over a number of past years.
Concept 6 sounds a warning note that market failure may (d) If the prediction is wrong, amend the theory or aban-
sometimes prevent society from reaching the best possible don it.
market outcomes. Fortunately, we learn from Threshold (e) Establish a hypothesis about the relationship between
Concept 7 that government may be able to intervene to the two variables.
improve market outcomes. (f ) Continue collecting more evidence.
(g) Conduct observations to establish whether the predic-
Q37. Which of the following might be a source of mar- tion is correct.
ket failure?
A. A giant firm dominates the market for a good, and Correct order: ........................................................................
charges a high price in order to make large profits.
B. A firm becomes complacent from lack of competition (Pages 28–9) Economics concerns human behaviour, which
and ceases to look for maximum efficiency. is inherently unpredictable at the individual level. How-
C. A factory producing leather goods causes pollution. ever, on average, people are likely to behave predictably.
D. Private enterprise is unable to provide street lighting. Economists have an important role in helping govern-
E. All of the above. ments to formulate and assess economic policy. In doing
this it is important to separate positive questions about
Q38. List three different ways in which the govern- what the effects of the policies are, from normative ones as
ment can intervene. to what the goals of policy should be. Economists in their
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6 CHAPTER 1 INTRODUCING ECONOMICS

role as economists have no superior right to make norma- E. Rail privatisation has attracted private investment into
tive judgements on the ideological/moral/political basis the industry.
of the policy. They can and do, however, play a major role
in assessing whether a policy meets the political objec- Q44. Which of the following statements are positive
tives of government (or opposition). and which are normative?
(a) The best policy is one that will maximise the rate
Q43. Which one of the following is a normative of economic growth for the country.
statement? Positive/Normative
A. The privatisation of the railways has reduced the level (b) Government policies give a higher priority to curing
of traffic congestion. inflation than to curing unemployment.
B. The privatisation of the railways has led to an increase Positive/Normative
in fares. (c) The government ought to give higher priority to cur-
C. Many on the political left believe that the privatisa- ing unemployment than to curing inflation.
tion of the railways is wrong. Positive/Normative
D. It is fairer that rail commuters should pay the full costs (d) If the government gave a higher priority to curing
of the journeys rather than having them subsidised by unemployment, that would be popular with the
the government. electorate. Positive/Normative

B PROBLEMS, EXERCISES AND PROJECTS

Q45. Make a list of 5 things you did yesterday and any

Figure 1.5 Production possibility curve
items you purchased. What was the opportunity cost of
each? If your fellow students are doing this question, have
a look at some of their lists and see if you agree with their
estimates of their opportunity costs.

Q46. Imagine that country X could produce just two

goods: food and clothing. Assume that over a given time
period it could produce any of the following combinations:

Units of clothing 0 1 2 3 4 5 6
Units of food 24 23 21 18 14 8 0

(a) Draw the production possibility curve for country X

on Figure 1.5.
(b) What is the opportunity cost of producing one more
unit of clothing if the current level of production is
(i) 2 units, (ii) 3 units, (iii) 4 units?
(c) Assume that technical innovation in agriculture Q48. Choose two current economics news items reported
allows a greater food output per unit of resources in the newspapers. Choose two newspapers of opposing
devoted to agriculture. What effect will this have on political views which report this item. Give examples from
the opportunity cost of producing clothes? these reports of positive statements and normative state-
(d) Now assume that there is a drought that halves the ments. Are there any statements that are not clearly one or
amount of food that can be produced per unit of the other?
resources. Draw the new production possibility curve.
Q49. East European economies have undergone consider-
Q47. Conduct a survey to establish what your fellow able changes since 1989. Using data from the Internet or
non-economics students believe economics to be about. from your institution’s library:
To what extent is their perception of the contents of eco- (a) Plot annual economic growth, unemployment and
nomics the same as yours (a) was before you started your inflation figures since 1989 for three ‘transitional’
current course, (b) is now? economies.
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CHAPTER 1 INTRODUCING ECONOMICS 7

(b) Describe the patterns. (d) Using the data and other relevant articles, discuss the
(c) How might greater reliance on market forces have adverse consequences caused by shifting from a com-
(i) improved and (ii) worsened the performance of mand economy to a market economy.
your chosen three economies?

C DISCUSSION TOPICS AND ESSAYS

Q50. Make a list of some current problems that are the (a) Why has this occurred?
concern of economists. Are they microeconomic or macro- (b) What are the economic implications of an increase in
economic problems, or a bit of both? How do they relate to the proportions of health care and education that are
the problem of scarcity? provided by the private sector?

Q51. Virtually every good is scarce in the sense we have Q55. ‘Economists can advise on economic policy and
defined it. There are, however, a few exceptions. Under cer- still avoid value judgements.’ Explain how this could be
tain circumstances water and air are not scarce. When and so. Is it desirable that economists should avoid value
where might this be true for (a) water and (b) air? Why is it judgements?
important to define water and air very carefully before
deciding whether they are scarce or abundant? Under cir- Q56. Debate
cumstances where they are not scarce, would it be possible Each side should prepare a case in support of one of the
to charge for them? following two statements (you may wish to use current
economics news items).
Q52. How can scarcity be a problem when the shops are
1. The distinction between positive and normative
well stocked, there are well over one million people unem-
economics is a very important distinction, since it
ployed (a surplus of labour), and there are butter and grain
clearly delineates the boundary between the legiti-
‘mountains’ in many countries?
mate areas of enquiry, analysis and pronouncements
Q53. Using relevant examples, explain what is meant by by economists and those areas where the econo-
‘technological progress’. What would cause the rate of tech- mist has no superior right of pronouncement to the
nological progress to increase? Will technological progress layperson.
eventually overcome the economic problem? 2. The distinction between positive and normative eco-
nomics is a dangerous and often bogus one. It tends to
Q54. In the past 15 years, many countries have experi- confer a legitimacy on economists’ pronouncements
enced an increase in the proportion of goods and services which, while seeming to be ‘positive’, are in reality
provided by the private sector. highly normative in their implications.

D ANSWERS

Q1. E. We define scarcity as the excess of human wants Q5. wants. Potential demand refers to what people would
over the means of fulfilling those wants. Virtually like to have and not merely to those items that are
everyone would like more than they have. Even very thought of as being necessities.
rich people would normally like a higher income, Q6. the level of resources available. What society can pro-
and even if money was no object at all for them, they duce depends on what labour, land and capital are
would still have a shortage of time to do everything available.
they would like to do. Q7. macroeconomics.
Q2. False. Human desires are virtually boundless. For Q8. microeconomics.
example, in 100 years people will want things that Q9. (a) macro.
have not been invented yet. (b) micro.
Q3. Labour, land (and raw materials), and capital. (c) macro. (It would be micro if we were looking at
Q4. E. All the others contribute towards production. The overseas investment in a specific industry.)
wages are the reward for Jim’s labour: they do not (d) micro.
add to production. (e) macro.
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8 CHAPTER 1 INTRODUCING ECONOMICS

(f ) micro. (We are only referring to wages in a Q18. A. An increase in the population of working age rep-
specific industry.) resents an increase in (human) resources and hence
(g) micro. an increase in production potential. Note: B repres-
(h) macro. (We are referring to total household sav- ents a movement outward of the production point
ing in the economy, not to the saving of specific towards the production possibility curve; C may
households or to saving in specific financial encourage increased consumption and may as a result
institutions.) stimulate a greater level of production (a movement
Q10. B. The opportunity cost is the cost measured in terms outward of the production point) but does not
of the next best alternative forgone. directly increase production potential; D means that
Q11. Your answer to this will depend on what you would the money value of output potential has risen, but
most like to be doing instead of tackling this ques- there is no change in physical output potential; E is
tion, perhaps watching TV, or going out with your likely to lead to an inward shift of the curve as the
friends. quality of the labour force declines.
Q12. (b), (d), (e) true; (a) and (c) false. Rational behaviour Q19. (a) and (b) macro, (c) micro. In the case of (a) and (b)
involves weighing up the costs and benefits of any the whole economy is being considered: whether it
activity. For consumers this involves comparing the is growing (a), or whether there is a full use of
price of a good with the benefit the consumer resources (b). In the case of (c), however, the ques-
expects to receive. The consumer will think (how- tion is one of the composition of production: how
ever briefly), ‘Is this item worth purchasing?’ The much of each good is being produced.
answer will vary from person to person according Q20. (a) IV.
to their tastes (i.e. not (c)). (b) II.
Q13. C. All the other statements consider the effects of a (c) I.
bit more of something (eating another chocolate bar, (d) III.
mortgage rates rising by another 1 per cent, purchas- Q21. The state or some central or local planning agency.
ing another forklift truck, installing anti-pollution Q22. Individuals: households and firms.
equipment on one more power station). In the case Q23. C. In a pure command economy, firms do not have
of C, however, we are considering the effect of total the discretion to respond to changes in consumer
revenues for the firm exceeding its total production demand.
costs. Q24. Costly in terms of administration; difficulty in
Q14. (a) A, D, F and G. All these points lie on the produc- devising incentives to ensure that the plan is carried
tion possibility curve and thus show that the out as the planners would like; loss of individual
country is fully utilising its potential. liberty; planners may not act in the interests of the
(b) B and C. These points lie inside the curve and people.
thus illustrate that not as many goods are being Q25. demanders.
produced as could be. Q26. suppliers.
(c) A and G. Point A shows complete specialisation Q27. more.
in good Y and point G shows complete speciali- Q28. less.
sation in good X. Q29. fall.
(d) E. Point E lies outside the production possibility Q30. a rise in the quantity demanded but a fall in the quantity
curve and is thus unobtainable. supplied.
Q15. E. When production is initially at point A, producing Q31. rise.
one more unit of good X (i.e. the eleventh unit) will Q32. fall.
involve reducing production of good Y by 2 units Q33. rise.
(from 8 to 6 units). Q34. (a) Firms may be encouraged to produce more if
Q16. The phenomenon of increasing opportunity costs. As the price of the good rises – or perhaps if the
more and more of one good is produced, increas- firm’s costs fall.
ingly larger and larger amounts of the other have to (b) Consumers may buy more in response to a
be sacrificed. decrease in price – or in response to changes in
Q17. B. The outward shift of the curve illustrates an preferences, perhaps as a result of advertising by
increase in potential output (i). The movement out- firms.
ward of the production point from A to B illustrates (c) One way of discouraging motorists from using
an increase in actual output (ii). But the fact that congested roads is through road pricing – for
point A is on the earlier curve whereas point B is instance, as in the London Congestion Charge.
inside the later curve means that resources are being (d) Past experience has suggested that taxing
used less fully (or efficiently) than previously. cigarettes has limited effect on smoking
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CHAPTER 1 INTRODUCING ECONOMICS 9

behaviour, but that campaigns spreading infor- and policing); price controls and controls over inter-
mation about the harmful effects of smoking est rates and exchange rates.
tobacco can have some effect. Q39. D. It is usually not possible to conduct controlled
(e) We guess you have some ideas about this! experiments in economics since, unlike certain of
Perhaps your lecturers could make the course the natural sciences, it is not a laboratory science. It is
even more interesting than it is already – or per- not possible to hold other things constant. Instead,
haps they could set you more tests! we simply have to assume that other things are
Q35. The rise in demand for houses will cause a shortage constant (ceteris paribus). Note: although economic
of houses. This will cause the price of houses to rise. models can usually be tested by appealing to the
This will increase the profitability of house construc- facts (answer E), there will be a delay if a prediction
tion. This in turn will increase the demand for brick- of the future is being tested.
layers. The resulting shortage of bricklayers will lead Q40. induction.
to a rise in their wages (the ‘price’ of bricklayers). Q41. deduction.
Q36. (a) True. Q42. (c), (e), (b), (a), (g), (d), (f ).
(b) True. Q43. D. This statement is a question of value. Some people
(c) True. Competition will help to keep prices down may regard it as fair, some may not: it depends on
and thus encourage firms to reduce their costs what they believe to be right or wrong. The other
in order to make a satisfactory level of profit. statements in principle can all be tested by an appeal
(d) False. While competition between firms may to facts. They may be correct or incorrect, but they
prevent very high profits in any industry and are statements about what is or is not the case. Note
the competition between workers may prevent that statement C is positive because it is not a state-
very high wages in any type of job, the owner- ment about whether privatisation is desirable or not,
ship of resources is not equal. Some people own but about what those on the left believe.
a lot of property; others own none; some work- Q44. (b) and (d) are positive. The person making the state-
ers are skilled and can command high wages; ments is not saying whether government policies are
others are unskilled. good or bad, or what the government ought to do. In
(e) False. Goods that are profitable for a firm both cases the statements can be assessed by an appeal
may not necessarily be socially desirable. For to the facts (albeit in the case of (d) you would have
example, the production of certain industrial to wait to see how the electorate responded). (a) and
goods may damage the environment. On the (c), on the other hand are normative. The person mak-
other hand, some things that are socially desir- ing the statements is saying what the government
able (such as pavements) may not be profitable ought to do or what the goals of government policy
for private enterprise to supply. should be. Note: in the case of (d), there is the impli-
Q37. E. All of the statements describe a possible source of cation that if the government wants to be popular
market failure. These – and other – forms of market with the electorate, it would be wise to give a higher
failure will be discussed later in the book. priority to curing unemployment, but that does not
Q38. Examples include: state ownership of various indus- make it a normative statement. The statement as it
tries (nationalisation); legislation to affect produc- stands is only about means to ends, not whether
tion or consumption (e.g. to control pollution); those ends are desirable. Only if the person making
taxation (e.g. high rates on tobacco and spirits); sub- the statement is implying that the government ought
sidies and benefits (e.g. pensions and other benefits to do what is popular with the electorate does the
to help the poor); direct provision (e.g. of education statement have normative overtones.
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Chapter 2
Supply and Demand

A REVIEW

In this chapter we examine the workings of the free market. The market simply refers to the
coming together of buyers (demanders) and sellers (suppliers).

We look first at demand, then at supply and then put the two together to show how price
is determined. We then turn to examine just how responsive demand and supply are to their
various determinants and particularly to changes in price; in doing this we will examine the
important concept of elasticity.

The response of demand, supply and price to changing market conditions is unlikely to be
instantaneous. In the final section, therefore, we examine the time dimension of markets. We
look at the process of adjustment after the elapse of different periods of time.

2.1 Demand Q2. The income effect refers to the effect on price and
(Page 34) There are several determinants of consumer quantity demanded of a change in consumer income.
demand for a product. The relationship between demand and True/False
one of these determinants is expressed in the law of demand.
Q3. The substitution effect refers to the effect on the
Q1. The law of demand states that: quantity demanded of a change in the price of a substitute
A. quantity demanded increases as price decreases. good. True/False
B. demand rises as income rises.
C. producers respond to an increase in demand by (Pages 35–6) The relationship between price and the
producing more. quantity demanded can be shown graphically on a demand
D. an increase in demand causes an increase in price. curve. A demand curve can be an individual’s demand
E. the amount purchased depends on the amount curve, or that of a group of individuals (a section of the
demanded. market) or that of the whole market.

(Page 34) The effect of a change in price on the quantity Q4. Consider the (imaginary) data in Table 2.1. This
demanded can be divided into an income effect and a sub- shows the annual demand for tennis shoes in three sec-
stitution effect. tions of the market.

Multiple choice Written answer Delete wrong word Diagram/table manipulation Calculation Matching/ordering
EW6_C02.qxd 11/1/05 10:43 AM Page 11

CHAPTER 2 SUPPLY AND DEMAND 11

Table 2.1 The demand for tennis shoes (b) The amount shops charge for tennis shoes.

Price Tennis club Players but not Non-tennis Total

.......................................................................................
members club members players market
(annual) (annual) (annual) (annual)
(000s) (000s) (000s) (000s) (c) The earnings of people who might possibly buy tennis
shoes.
£100 6 1 0 …
£80 7 3 0 …
.......................................................................................
£60 8 6 2 …
£40 9 10 8 …
(d) The price of running shoes.
£20 10 18 20 …

.......................................................................................

Figure 2.1 The demand for tennis shoes (annual) (e) The likelihood that the government will impose a
tax on imported sportswear in order to protect the
domestic sportswear industry.

.......................................................................................

(f ) The amount of coverage to tennis given on the

television.

.......................................................................................

(Pages 37–8) When the price of a good changes, we say that

this causes the Q6. demand/quantity demanded to change.
This is shown by Q7. a shift in the demand curve/a movement
along the demand curve. When one of the other determinants
changes, however, we say that this causes the Q8. demand/
quantity demanded to change. This is shown by Q9. a shift in
the demand curve/a movement along the demand curve.

Q10. Consider the demand curve for petrol. What

effect will the following have?
(a) Fill in the column for annual market demand. (a) An increase in the price of cars. Rightward shift/leftward
(b) Draw the annual demand curve for each of the three shift/movement up along/movement down along/need more
groups and the annual market demand on Figure 2.1. information to say.
(b) An increase in the proportion of the population own-
(Page 36) But price is not the only factor that determines ing cars. Rightward shift/leftward shift/movement up along/
how much of a good people will demand. Let us take the movement down along/need more information to say.
case of a particular product: (c) A rise in transport costs of shipping oil. Rightward
shift/leftward shift/movement up along/movement down
Q5. It is normal to group the various determinants of along/need more information to say.
demand into categories. The categories include: (d) A growing concern for environmental issues by the
(i) The price of the good. general public. Rightward shift/leftward shift/movement
(ii) The price of substitute goods. up along/movement down along/need more information
(iii) The price of complementary goods. to say.
(iv) Tastes. (e) An increase in duty on diesel. Rightward shift/leftward
(v) Income. shift/movement up along/movement down along/need more
(vi) Expectations of future price changes. information to say.
(f ) A reduction in duty on petrol. Rightward shift/leftward
Into which of the above categories would you put the shift/movement up along/movement down along/need
following determinants of the demand for tennis shoes? more information to say.
(a) The price of tennis rackets.
One of the most important determinants of demand is the
....................................................................................... level of consumer income. When considering the effect of
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12 CHAPTER 2 SUPPLY AND DEMAND

a change in income on demand, we distinguish between Q20. Consider the case of the supply curve of organ-
normal goods and inferior goods. ically grown wheat. What effect would the following have?
(a) A reduction in the cost of organic fertilisers. Rightward
Q11. We define a normal good as one shift/leftward shift/movement up along/movement down
along.
............................................................................................... (b) An increase in the demand for organic bread. Rightward
shift/leftward shift/movement up along/movement down
Q12. On the other hand, we define an inferior good as along.
one (c) An increase in the price of organic oats and barley.
Rightward shift/leftward shift/movement up along/move-
............................................................................................... ment down along.
(d) The belief that the price of organic wheat will rise
2.2 Supply substantially in the future. Rightward shift/leftward
(Page 39) The relationship between supply and price is Q13. shift/movement up along/movement down along.
a direct/an inverse relationship. (e) A drought. Rightward shift/leftward shift/movement up
along/movement down along.
Q14. Which of the following are explanations of this (f ) A government subsidy granted to farmers using organic
relationship between price and market supply (there are methods. Rightward shift/leftward shift/movement up
more than one)? along/movement down along.
(a) Costs tend to rise over time. Yes/No
(b) As price rises, producers find that it is worth incurring
2.3 Price and output determination
the higher costs per unit associated with producing
(Page 43) If the demand for a good exceeds the supply,
more. Yes/No
there will be a Q21. shortage/surplus. This will lead to a
(c) At higher prices it is worth using additional, less
Q22. fall/rise in the price of the good. If the supply of a
productive factors of production. Yes/No
good exceeds the demand, there will be a Q23. shortage/
(d) The lower the price, the more firms will switch to pro-
surplus. This will lead to a Q24. fall/rise in the price.
ducing other products which are thus now relatively
Price will settle at the equilibrium. The equilibrium price
more profitable. Yes/No
is the one that clears the market.
(e) Technological improvements mean that more can be
produced and this in turn will affect prices. Yes/No
Q25. This is the price where

(Pages 40–1) Given that the quantity supplied is likely to

...............................................................................................
rise as price rises, the supply curve is likely to be upward
sloping.
(Pages 43–4) If the demand or the supply curve shifts, this will
lead either to a shortage or to a surplus. Price will therefore
(Page 41) As with demand, price is not the only thing that
either rise or fall, Q26. causing a shift in/movement along the
affects supply.
other curve, until a new equilibrium is reached at the posi-
tion where the supply and demand curves now intersect.
Q15. Other determinants of supply include:

1. ....................................................................................... Q27. The demand and supply schedules for organic-

ally grown wheat in a free market are shown in Table 2.2.
2. ....................................................................................... (a) Draw the demand and supply curves on Figure 2.2.
(b) What would be the size of the shortage or surplus at a
3. ....................................................................................... price of a180 per tonne?

4. ....................................................................................... Shortage/surplus of ..........................................................

5. ....................................................................................... (c) What would be the size of the shortage or surplus at a

price of a340 per tonne?
(Pages 41–2) If price changes, the effect is shown by Q16.
a shift in/a movement along the supply curve. We call this Shortage/surplus of ..........................................................
effect a change in Q17. supply/the quantity supplied. If any
other determinant of supply changes, the effect is shown (d) What is the equilibrium price and quantity?
by Q18. a shift in/a movement along the supply curve. We
call this effect a change in Q19. supply/the quantity supplied. P = ...............................; Q = ..........................................
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CHAPTER 2 SUPPLY AND DEMAND 13

Table 2.2 The market for organically grown wheat (k) Is there any shift in the supply curve that could restore
(imaginary figures) both the original equilibrium price and the original
quantity? Yes/No
Price per tonne
(A) 100 140 180 220 260 300 340 380
Explain...........................................................................
Tonnes supplied
per week 220 260 320 400 500 640 880 1400
.......................................................................................
Tonnes demanded
per week 770 680 610 550 500 460 400 320
Q28. If income increases, then for an inferior good,
the quantity sold will decrease and the price will increase.
True/False
Figure 2.2 The market for organically grown wheat
(weekly figures) Q29. Figure 2.3 shows the demand for and supply of
new purpose-built flats.
The supply and demand curves are initially given by S0
and D0. The market is in equilibrium at point x. Various fac-
tors then change which have the effect of shifting the
demand curve to D1 or D2 and/or the supply curve to S1 or
S2. What is the new equilibrium point in each of the follow-
ing cases? (Remember that in each case the market is ini-
tially in equilibrium at point x.)
(a) A rise in the price of building materials.
Point .....................
(b) Flat living becomes more fashionable.
Point .....................
(c) A fall in the price of new houses.
Point .....................
(d) A rise in the price of old houses and flats.
Point .....................
(e) The imposition of a new construction tax on houses
(but not flats).
Point .....................
(e) Now assume that the demand for organic wheat (f ) The belief that the price of flats will soon rise
increases by 180 tonnes per week at all prices. Draw substantially.
the new demand curve. Point .....................
(f ) What is the size of the shortage or surplus at the
original equilibrium price?
Figure 2.3 The market for new flats
Shortage/surplus of ..........................................................

(g) What is the new equilibrium price?...............................

(h) Has the equilibrium quantity increased by more or less

than the 180 tonnes per week increase in demand?
More/Less
Assume that supply now changes by an equal amount at all
prices.
(i) What would this change have to be to restore the
original equilibrium price?

Increase/Decrease of ........................................................

(j) What would this change have to be to restore the

original equilibrium quantity?

Increase/Decrease of ........................................................
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