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4 CHAPTER The Market System Topic 1. Characteristics of the market system; capital accumulation 2. Specialization 3. Exchange; use of money 4. Market system; profits and costs 5. Least-cost combination of resources 6. Consumer sovereignty; invisible hand Last Word True-False Question numbers ___________________________________________________________________________________________________ 1-14 15-18 19-24 25-49 50-57 58-72 73-74 75-85 ___________________________________________________________________________________________________ Multiple Choice Questions Characteristics of the market system; capital accumulation 1. Which of the following is not a characteristic of the market system? A) private property B) freedom of enterprise C) government ownership of the major industries D) competition in product and resource markets 2. Which of the following is a fundamental characteristic of the market system? A) property rights B) central planning by government C) altruistic behavior D) government-set wages and prices 3. Copyrights and trademarks are examples of: A) capital goods. B) human capital. C) property rights. D) public goods. 4. The pursuit of self-interest: A) is highly detrimental to the market system. Page 1 B) means the same as "selfishness." C) is reflected in the behavior of firms, but not in the behavior of consumers. D) gives direction to the market system. 5. The regulatory mechanism of the market system is: A) self-interest. B) private property. C) competition. D) specialization. 6. Broadly defined, competition involves: A) private property and freedom of expression. B) independently acting buyers and sellers and freedom to enter or leave markets. C) increasing opportunity costs and diminishing marginal utility. D) capital goods and division of labor. 7. Competition means that: A) sellers can manipulate market price by causing product scarcities. B) there are independently-acting buyers and sellers in each market. C) a product can be purchased at a number of different prices. D) there is more than one seller in a market. 8. Well-defined property rights: A) discourage investment and growth. B) discourage hard work. C) impede exchange. D) encourage owners to maintain or improve their property. 9. To increase the amount of capital goods in a full employment-full production economy, society must: A) decrease consumption. B) increase consumption. C) inflate the general price level. D) deflate the general price level. 10. "Roundabout production" ordinarily leads to: A) the use of fewer capital goods. B) smaller markets. C) greater production. D) simultaneous increases in consumer goods production. 11. Which of the following is an example of a capital good. A) a Federal government bond. B) a share of General Motors stock C) a bag of potatoe chips D) a Boeing 757 airplane Page 2 12. If an economy is operating on its production possibilities curve, an increase in the production of capital goods: A) necessarily involves an increase in the division of labor. B) is in conflict with the concept of "consumer sovereignty." C) necessitates production of fewer consumer goods. D) will impair future productive efficiency. 13. The basic reason for the production of capital goods is to: A) promote the concentration of economic power in the business sector. B) facilitate exchange where a coincidence of wants does not exist. C) better synchronize the operation of resource and product markets. D) enhance future productive efficiency. 14. The term "roundabout production" refers to the: A) use of capital goods in the production process. B) double exchange of money for goods and goods for money. C) use of money as a medium of exchange. D) fact that barter impedes specialization. Specialization 15. The division of labor means that: A) labor markets are geographically segmented. B) unskilled workers outnumber skilled workers. C) workers specialize in various production tasks. D) each worker performs a large number of tasks. 16. Specialization in production is important primarily because it: A) results in greater total output. B) allows society to avoid the coincidence-of-wants problem. C) allows society to trade by barter. D) allows society to have fewer capital goods. 17. Specialization--the division of labor--enhances productivity and efficiency by: A) allowing workers to take advantage of existing differences in their abilities and skills. B) avoiding the time loss involved in shifting from one production task to another. C) allowing workers to develop skills by working on one, or a limited number, of tasks. D) all of the above means. 18. Specialization in production is economically beneficial primarily because it: A) allows everyone to have a job which they like. B) permits the production of a larger output with fixed amounts of resources. C) facilitates trade by bartering. D) guarantees full employment. Exchange; use of money Page 3 Use the following to answer questions 19-21: 19. On the basis of the above information it can be said that: A) no coincidence of wants exists between any two states. B) a coincidence of wants exists between Michigan and Washington. C) a coincidence of wants exists between Texas and Washington. D) a coincidence of wants exists between Michigan and Texas. 20. On the basis of the above information and assuming trade occurs between the three states we can expect: A) Washington to exchange apples with Texas and receive money in return. B) Washington to exchange apples with Michigan and receive money in return. C) Texas to exchange lettuce with Michigan and receive autos in return. D) Texas to trade lettuce directly for Washington apples. 21. Given the above information and assuming trade does occur between the three states we can expect: A) that there is no means by which Michigan can obtain lettuce while specializing in the production of autos. B) that money will not be needed to accomplish the desired exchanges. C) money to flow counterclockwise from Michigan to Texas to Washington. D) money to flow clockwise from Michigan to Washington to Texas. 22. Barter: A) is the major means of exchange in centrally planned economies. B) accounts for over 30 percent of the dollar volume of all exchange in the U.S. economy. C) entails the exchange of goods for goods. D) is used to circumvent the problem of a lack of coincidence of wants among potential buyers and sellers. 23. The "coincidence of wants" problem associated with barter refers to the fact that: A) for exchange to occur each transactor must have a product that the other transactor wants. B) money must be used as a medium of exchange or trade will never occur. C) specialization is restricted by the size or scope of a market. D) buyers in resource markets and sellers in product markets can never engage in exchange. 24. The use of money contributes to economic efficiency because: A) governmental direction of the production and distribution of output can be avoided by using money. B) "roundabout production" could not occur without the availability of money. C) it is necessary for the creation of capital goods. D) it promotes specialization by overcoming the problems with barter. Page 4 Market system; profits and costs 25. Which of the following is one of the Four Fundamental Questions? A) Which products will be in scarce supply and which in excess supply? B) Who should appoint the head of the central bank? C) How much should the society save? D) What goods and services will be produced? 26. Normal profit is: A) a cost because any excess of total receipts over total costs will go to the businessperson. B) a cost because they represent payments made for the resources which the businessperson owns and supplies in his or her own enterprise. C) not a cost because a firm can avoid this payment by temporarily closing down. D) not a cost of production because it need not be realized for a firm to retain entrepreneurial ability. 27. Economic profit is: A) a cost because it is really a part of wage costs. B) a cost because it accrues to the entrepreneur. C) not a cost because it cannot be calculated. D) not an economic cost because it need not be realized for a business to acquire and retain entrepreneurial ability. 28. A firm's economic profit is: A) usually lower than its normal profit. B) profit over and above that which it needs to compensate for the time and other resources the owner supplies to the business. C) a cost of production. D) a signal to the firm that it is producing too much output. 29. Which of the following is not an economic cost? A) wages B) rents C) economic profits D) normal profits 30. If competitive industry Z is making substantial economic profit, output will: A) fall, product price will fall, and economic profit will disappear. B) fall, product price will rise, and economic profit will disappear. C) expand, product price will fall, and economic profit will disappear. D) expand, product price will fall, and economic profit will rise. 31. When a competitive industry is in equilibrium: A) economic profit will be zero. B) product demand and derived demand are equal. C) the economizing problem will have been solved for that industry. Page 5 D) normal profit will not be realized. 32. From society's point of view the economic function of profits and losses is to: A) promote the equal distribution of real assets and wealth. B) achieve full employment and price level stability. C) contribute to a more equal distribution of income. D) reallocate resources from less desired to more desired uses. 33. In a market economy a significant change in the demand for product X will: A) alter the profits or losses received by certain firms. B) cause a reallocation of scarce resources. C) cause some industries to expand and others to contract. D) do all of the above. 34. Economic profits in an industry suggests the industry: A) can earn more profits by increasing product price. B) should be larger to better satisfy consumer demand. C) has excess production capacity. D) is the size that consumers want it to be. 35. Economic profits and losses: A) are both considered by economists to be a part of production costs. B) are essential to the reallocation of resources from less desired goods to more desired goods. C) have no influence on the composition of the domestic output. D) equalize the distribution of income in the long run. 36. If an increase occurs in the demand for product X, all of the following will occur except: A) an increase in the profits of industry X. B) an increase in the demand for resources employed by industry X. C) an increase in the output of industry X. D) a decrease in the prices of resources employed in industry X. 37. An increase in demand for strawberries is most likely to: A) increase the demand for strawberry pickers. B) reduce the supply of strawberry pickers. C) reduce the supply of strawberries. D) reduce the demand for strawberry pickers. 38. If competitive industry Y is incurring substantial losses, output will: A) expand, product price will rise, and losses will disappear. B) contract, product price will fall, and losses will increase. C) contract, product price will rise, and losses will disappear. D) expand, product price will fall, and losses will disappear. 39. The economic function of profits and losses is to: A) bring about a more equal distribution of income. Page 6 B) signal that resources should be reallocated. C) eliminate small firms and reduce competition. D) tell government which industries need to be subsidized. 40. In a competitive economy prices: A) influence consumers in their purchases of goods and services. B) influence businesses in their purchases of economic resources. C) influence workers in making occupational choices. D) do all of the above. 41. Suppose a firm's total economic cost in producing 1,000 aluminum baseball bats is $10,000. These bats are then sold by the firm for $12,000. Thus: A) the firm is necessarily using the least-cost production technique because it is realizing an economic profit. B) the firm's normal profit is $2000. C) the firm's economic profit is $2000. D) there is no economic reason for the aluminum bat industry to expand or contract. 42. If a competitive industry is neither expanding nor contracting, we would expect: A) normal profits to be zero. B) economic profits to be zero. C) consumer demand and derived demand to be equal. D) external costs or benefits to be large. 43. Suppose industry A is realizing substantial economic profit. Which of the following best describes the adjustment process that would bring about a new equilibrium? A) Firms will leave the industry, output will fall, and product price will rise. B) Firms will enter the industry, output will rise, and product price will rise. C) Firms will leave the industry, output will rise, and product price will fall. D) Firms will enter the industry, output will rise, and product price will fall. 44. An industry is in equilibrium when: A) normal profits are zero. B) total revenue exceeds total economic costs. C) total economic costs exceed total revenue. D) economic profits are zero. 45. When economists say that the demand for a resource is "derived a demand," they mean that: A) producers substitute low-priced for high-priced resources. B) the demand for resources depends on the demand for the product that those resources produce. C) government demand complements private demand for most goods and services. D) resource demand curves are often upsloping. 46. Which of the following best reflects the idea of "derived demand"? A) Product demand is determined by the demand for resources. B) The demand for automobiles will decline if the price of gasoline goes up. C) Economic resources are demanded because there is a demand for the goods they produce. Page 7 D) The "dollar votes" of consumers determine the composition of output. 47. The competitive market system: A) encourages innovation because government provides tax breaks and subsidies to those who develop new products or new productive techniques. B) discourages innovation because it is difficult to acquire additional capital in the form of new machinery and equipment. C) discourages innovation because firms want to get all the profits possible from existing machinery and equipment. D) encourages innovation because successful innovators are rewarded with economic profits. 48. An increase in consumer demand for product X increases the demand for resources used in producing X. This indicates that: A) consumer sovereignty is not functioning in this economy. B) the idea of derived demand is relevant. C) production must be taking place at a loss. D) firms are failing to use the least-cost production technique. 49. In a market economy the distribution of income will be determined primarily by: A) consumer needs and preferences. B) the quantities and prices of the resources that households supply. C) government regulations that provide a minimum income for all. D) a social consensus as to what distribution of income is most equitable. Least-cost combination of resources 50. The most efficient combination of resources in producing any output is the combination that: A) comes closest to using the same quantities of land, labor, capital, and entrepreneurial ability. B) can be obtained for the smallest money outlay. C) uses the smallest total quantity of all resources. D) conserves most on the use of labor. Use the following to answer questions 51-54: Answer the next question(s) using the following data which show all available techniques for producing 20 units of a particular commodity: Resource Land Labor Capital Entrepreneurial ability Resource prices $4 3 3 2 Possible production techniques #1 #2 #3 #4 4 4 2 2 2 1 1 4 2 1 5 3 1 4 3 1 #5 4 3 2 1 51. Refer to the above data. In view of the indicated resource prices, the economically most efficient production technique(s) is (are) technique(s): A) #1. B) #2 and #4. Page 8 C) #3. D) #1 and #3. 52. Refer to the above data. Assuming that the firm is motivated by self-interest and that the 20 units which can be produced with each technique can be sold for $2 per unit, the firm will: A) realize an economic profit of $10. B) realize an economic profit of $4. C) only make a normal profit. D) close down rather than incur a loss by producing. 53. Refer to the above data. Which of the following statements concerning this industry is correct? A) Firms in this industry will find that firms in other industries are able to outbid them for resources. B) The industry will contract as firms are forced out of business. C) The industry will expand as new firms enter. D) The industry is in equilibrium in that there is no reason for it to expand or contract. 54. Refer to the above data. If a new production technique is developed that enables a firm to produce 20 units of output with 3 units of land, 3 of labor, 1 of capital, and 2 of entrepreneurial ability, this technique would: A) not be adopted because, although it reduces production costs, it does not increase profit. B) be adopted because it would lower production costs and increase economic profit. C) not be adopted because it entails higher production costs than other available techniques. D) be adopted, even though economic profits would be reduced slightly. Use the following to answer questions 55-56: Answer the next question(s) on the basis of the following information: Suppose 30 units of product A can be produced by employing just labor and capital in the four ways shown below. Assume the prices of labor and capital are $2 and $3 respectively. I 4 2 Production techniques: II III IV 3 2 5 3 5 1 Labor Capital 55. Refer to the above information. Which technique is economically most efficient in producing A? A) I B) II C) III D) IV 56. Refer to the above information. If the price of product A is $.50, the firm will realize: A) an economic profit of $4. B) an economic profit of $2. C) an economic profit of $6. D) a loss of $3. 57. In a competitive market economy firms will select the least-cost production technique because: Page 9 A) B) C) D) such choices will result in the full employment of available resources. to do so will maximize the firms' profits. this will prevent new firms from entering the industry. "dollar voting" by consumers mandates such a choice. Consumer sovereignty; invisible hand 58. The market system's answer to the fundamental question "What will be produced?" is essentially: A) "Goods and services that are profitable." B) "Low cost goods and services." C) "Goods and service that can be produced using round-about production." D) "Goods and services that possess lasting value." 59. The market system's answer to the fundamental question "How will the goods and services be produced?" is essentially: A) "With as much machinery as possible." B) "Using the latest technology." C) "By exploiting labor." D) "At least-cost production." 60. The market system's answer to the fundamental question "Who will get the goods and services?" is essentially: A) "Those willing and able to pay for them." B) "Those who physically produced them." C) "Those who most need them." D) "Those who get utility from them." 61. The market system's answer to the fundamental question "How will the system accommodate change?" is essentially: A) "Through government leadership and direction." B) "Through the guiding function of prices and the incentive function of profits." C) "Through training and retraining programs." D) "Through random trial and error." 62. The advent of the digital video disk (DVDs) threatens to eventually demolish the market for videocassettes. This is an example of: A) creative destruction. B) derived demand. C) capital accumulation. D) the difference between normal and economic profits. 63. "Consumer sovereignty" refers to the: A) fact that resource prices are higher than product prices in capitalistic economies. B) idea that the pursuit of self-interest is in the public interest. C) idea that the decisions of producers and resource suppliers with respect to the kinds and amounts of goods produced must be appropriate to consumer demands. D) fact that a Federal agency exists to protect consumers from harmful and defective products. Page 10 64. "The 'dollar votes' of consumers ultimately determine the composition of output and the allocation of resources in a market economy." This statement best describes the concept of: A) derived demand. B) consumer sovereignty. C) the invisible hand. D) market failure. 65. Assume the demand for product Y increases and the market system responds by producing more Y. This illustrates: A) that the concept of derived demand is inapplicable. B) that consumer sovereignty is inoperative in this economy. C) the scarcity function of prices. D) the directing or guiding function of prices. 66. Which of the following best describes the "guiding function" of competitive prices? A) Profitable industries contract and unprofitable industries expand. B) The market system will always generate economic profits for firms that use the least costly production technology. C) The market system can negotiate reallocations of resources that are appropriate to changes in consumer tastes, technology, and resource supplies. D) When prices are in equilibrium, product shortages or surpluses cannot occur. 67. Which of the following best describes the "invisible hand" concept? A) The desires of resource suppliers and producers to further their own self-interest will automatically further the public interest. B) The nonsubstitutability of resources creates a conflict between private and public interests and calls for government intervention. C) The market system is the best system for overcoming the scarce resources-unlimited wants problem. D) Central direction by the government will improve resource allocation in a capitalistic economy. 68. The "invisible hand" refers to the: A) fact that the U.S. tax system redistributes income from rich to poor. B) notion that, under competition, decisions motivated by self-interest promote the social interest. C) tendency of monopolistic sellers to raise prices above competitive levels. D) fact that government controls the functioning of the market system. 69. The "invisible hand" concept suggests that: A) market failures imply the need for a national economic plan. B) big businesses are inherently more efficient than small businesses. C) the competitiveness of a capitalistic market economy invariably diminishes over time. D) assuming competition, private and public interests will coincide. 70. The "invisible hand" concept suggests that: A) changes in product demands are only randomly reflected in changes in the demands for resources. B) profit maximization is inconsistent with an efficient allocation of resources. C) government action is necessary to correct for market failures. Page 11 D) when firms maximize their profits, society's output will also be maximized. 71. Two major virtues of the market system are that it: A) allocates resources efficiently and allows economic freedom. B) results in an equitable personal distribution of income and always maintains full employment. C) results in price level stability and a fair personal distribution of income. D) eliminates discrimination and minimizes environmental pollution. 72. The market system: A) produces considerable inefficiency in the use of scarce resources. B) effectively harnesses the incentives of workers and entrepreneurs. C) is inconsistent with freedom of choice in the long run. D) has slowly lost ground to emerging command systems. Last Word Questions 73. (Last Word) According to economist Donald Boudreaux, the world's tens of billions of individual resources get arranged productively: A) because government has become highly effective at central planning. B) because private property encourages people to consider the alternative uses of their resources and select those that provide the most rewards. C) because people tend to be creative and orderly. D) through random trial and error. 74. (Last Word) According to economist Donald Boudreaux: A) private property eliminates the possibility that resource arrangements will be random. B) the market system threatens to do irreparable harm to the world's ecosystem. C) arranging resources under the market system is much like shuffling a deck of cards. D) the market system works wondrously for advanced industrial nations but not for developing nations. True/False Questions 75. Market economies use capital goods because they improve productive efficiency. 76. Differences in opportunity costs are the basis for specialized production and trade. 77. Money functions as a medium of exchange in permitting the ready comparison of the relative worth of heterogeneous products. 78. Consumer sovereignty means that legislation now protects the rights of consumers to dispose of their incomes as they see fit. 79. Programs by state governments to keep milk prices higher than market-determined prices to protect family Page 12 dairy farms from bankruptcy promote the efficient allocation of resources. 80. Specialization may expand total output even though the individuals involved may have identical abilities. 81. The wants of consumers are expressed on the demand side of the product market. 82. Costs can be defined as total payments made to workers, land owners, and capital suppliers less normal profits. 83. If firms in any industry fail to earn normal profits, firms will leave the industry. 84. The guiding function of prices indicates that, at equilibrium prices, neither product surpluses nor shortages can occur. 85. The "invisible hand" refers to the many indirect controls that the Federal government imposes in a the market system. Page 13 Answer Key -- ch. 4 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. 13. 14. 15. 16. 17. 18. 19. 20. 21. 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 35. 36. 37. 38. 39. 40. 41. 42. 43. 44. 45. 46. 47. 48. 49. 50. 51. 52. 53. 54. C A C D C B B D A C D C D A C A D B A A C C A D D B D B C C A D D B B D A C B D C B D D B C D B B B B A C B Page 14 55. 56. 57. 58. 59. 60. 61. 62. 63. 64. 65. 66. 67. 68. 69. 70. 71. 72. 73. 74. 75. 76. 77. 78. 79. 80. 81. 82. 83. 84. 85. D B B A D A B A C B D C A B D D A B B A True True False False False True True False True False False Page 15

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