WRITTEN BY:

JOSEPH CALHOUN

Florida State University

JOHN MORTON

former President, Arizona

Council on Economic

Education

MARK SCHUG

Professor Emeritus

University of Wisconsin–

Milwaukee

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Table of Contents

PART 1 QUESTIONS: The Role of Markets.............................................................3

PART 2 QUESTIONS: Entrepreneurship and Creative Destruction .........................5

PART 3 QUESTIONS: Interfering with Markets.......................................................7

PART 4 QUESTIONS: Costs of Regulation and Fraud .............................................9

PART 5 QUESTIONS: Effects of Government Programs .......................................11

ANSWER KEY (for All Parts) ..................................................................................13

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Part 1: The Role of Markets

1) An increase in per capita income will generally lead to which of the following?

a. More material goods, but a decline in the quality of the environment.

b. A reduction in life expectancy because working conditions are less desirable.

c. An increase in the number of hours worked by residents.

d. An increase in the living standards of most people.

2) Compared to countries with less economic freedom, countries that have a larger

degree of economic freedom tend to have, on average:

a. higher per capita income levels, but slower rates of economic growth.

b. lower per capita income levels, but more rapid rates of economic growth.

c. both higher per capita income levels and more rapid growth rates.

d. both lower income levels and slower growth rates.

3) According to Adam Smith in his book, An Inquiry into the Nature and Causes of the

Wealth of Nations, individual self-interest:

a. is a powerful force for economic progress when it is directed by competitive

markets.

b. is a powerful force for economic progress when individuals are wisely

directed by a strong central government.

c. is a major factor in retarding the economic progress of humankind.

d. could be either a positive or negative force for economic progress,

depending on the moral influences of political leaders.

4) Which of the following is true in an informed and voluntary exchange?

a. Both parties receive something they value more than what they gave up.

b. Both parties place an equal value on what they received and what they gave

up.

c. Neither party can gain more than the other.

d. One trader can gain only at the expense of the other.

5) According to the law of comparative advantage:

a. individuals and nations gain when they specialize in producing those

products and services they consume.

b. individuals and nations gain when they specialize in producing products and

services they can produce at a high opportunity cost and can exchange for

other desired products and services they can produce cheaply.

c. individuals and nations gain when they specialize in producing those

products and services they can produce at a low opportunity cost and can

exchange for other desired products and services they can't produce as

cheaply.

d. all of the above are true.

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6) Which of the following scenarios applies the law of comparative advantage?

a. Countries with small amounts of labor relative to capital should specialize in

producing labor-intensive commodities.

b. Since Malaysian labor is cheaper than American labor, trade between the

countries results in exploitation of American workers.

c. Since workers in countries such as the United States utilize larger amounts

of capital than workers in less developed nations, trade between capital-

rich and capital-poor nations results in the exploitation of labor in the less

developed countries.

d. Countries that are low cost producers of agricultural products should trade

those products for goods they can produce only at a high opportunity cost.

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Part 2: Entrepreneurship and Creative Destruction

1) When an entrepreneur introduces a new good or service that is highly valued relative

to cost:

a. consumers will be worse off.

b. the demand for the products that are good substitutes for the new product

will increase.

c. some of the existing products will become obsolete and businesses

producing those products will fail.

d. total employment will decline if there are business failures.

2) Which of the following is true of entrepreneurship?

a. Entrepreneurial discovery is an important source of economic growth and

higher living standards.

b. The role of the entrepreneur is not very important, and that is why it is

generally not included in economic models.

c. The role of entrepreneurial discovery could be easily integrated into

economic models, but economists choose to ignore it.

d. Economic models are able to capture fully the important role of the

entrepreneur in the market process.

3) Which of the following will private owners do when property rights are clearly

defined and enforced?

a. They will use their property for selfish ends because they have little or no

incentive to consider the desires of others.

b. They will develop and direct their property toward uses that others value

highly because the market will generally reward them for doing so.

c. They have little or no incentive to take care of their property or to conserve

it for the future.

d. They will be unable to derive personal gain if they are sensitive to the

desires of others when deciding how to use their property.

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4) The student government associations at several universities have experimented with

purchasing bicycles to leave around campus for everyone's use. Anyone who needs

the bike can use it. They are not allowed to lock the bike or take it home, but must

leave it on campus for someone else to use. Which of the following does economic

theory predict will happen?

a. Students will take better care of these commonly owned bicycles than they

do their own bicycles.

b. Students will take equally as good care of these commonly owned bicycles

as they do their own bicycles.

c. Students will not take as good of care of these commonly owned bicycles as

they do their own bicycles.

d. Because universities have a lot of money, these bikes will be better

maintained than the ones owned privately by college students, who tend to

have little money.

5) Which of the following is the best example of “creative destruction”?

a. A family declaring bankruptcy because of a high level of debt.

b. The virtual elimination of the film camera by the digital camera.

c. The failure of a business because of poor management.

d. The failure of a business because of higher cost resulting from government

regulation.

6) Which of the following is a positive side effect of business start-ups and the business

failures that often follow?

a. The process makes it possible to try out numerous new ideas, and some of

them will substantially improve our lives.

b. The process increases total employment, and leads to a lower rate of

unemployment.

c. The process generates additional revenue for the government, which will

then be used to produce goods and services that people value.

d. There are no positive side effects of business failures.

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Part 3: Interfering with Markets

1) Which of the following is true if the prices of essential goods are not permitted to rise

after a natural disaster?

a. People will wait in line and those at the front often buy more than they need,

leaving nothing for those at the back of the line.

b. People’s love for one another will motivate enough people to bring

desperately needed goods to those suffering from the effects of the

disaster.

c. There will be plenty of goods to go around so that everyone can have them.

d. All of the above.

2) How do prices direct economic activity in a market economy?

a. They influence the actions of buyers and sellers.

b. They reduce scarcity of the goods and services produced.

c. They eliminate the need for government intervention.

d. They allocate goods and services in the most equitable way.

3) At the most basic level, the distinguishing characteristic of government that makes it

different from private firms is its ability to:

a. use coercive force against citizens to modify their behavior or force them to

pay for a good or service.

b. direct resources in a manner that serves the public interest rather than the

private interest of individuals.

c. produce goods and services that people value.

d. escape the constraints imposed by scarcity.

4) Which one of the following is a major difference between collective action through

government and market decisions?

a. Individuals are motivated by personal interests when making market choices,

but they will be motivated primarily by the public interest when making

collective choices.

b. Competitive behavior is present when decisions are made in the

marketplace, but competition is absent when choices are made

collectively.

c. Scarcity constrains output when decisions are made in the market sector, but

scarcity is absent when goods are provided by the government.

d. In the market sector, there is generally a one-to-one link between payment

and consumption; this link is often absent in the government sector.

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5) Which of the following is the best definition of the opportunity cost of an action?

a. The monetary payment the action required.

b. The total time spent by all parties in carrying out the action.

c. The value of the best opportunity that must be sacrificed in order to take the

action.

d. The cost of all alternative actions that could have been taken, added together.

6) In economics, what are secondary effects?

a. The best alternative that must be forgone as the result of a choice.

b. The unintended consequences of a change that are not immediately

identifiable but are recognized only with time.

c. The immediate and visible intended consequences of a change.

d. The impact of the scarcity of resources on the scarcity of the goods that are

produced with those resources.

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Part 4: Costs of Regulation and Fraud

1) Markets fail when externalities are present:

a. because all of the costs and benefits of producing a good are reflected in the

market price.

b. because some of the costs and benefits of producing a good are not reflected

in the market price.

c. only if they are negative; positive externalities are not market failures.

d. because profits are not maximized.

e. if the negative externalities are greater than the positive externalities.

2) Which of the following is an obstacle for the government that makes price regulation

less than an ideal solution?

a. There is no effective way to enforce price regulation.

b. The government cannot tell what price a firm is charging.

c. Regulators frequently will not have the information they need to set prices.

d. Regulation often will lead to lower costs.

3) When government imposes price controls in a market:

a. non-price factors become more important in the distribution of the good.

b. efficiency in the market is enhanced.

c. shortages and surpluses are eliminated.

d. buyers and sellers both become better off.

4) A price ceiling that sets the price of a good below equilibrium price will cause:

a. an increase in quantity demanded of the good.

b. a decrease in quantity supplied of the good.

c. a shortage of the good.

d. all of the above.

5) A minimum wage that is set above a market's equilibrium wage will result in which

of the following?

a. An excess demand for labor, that is, unemployment.

b. An excess demand for labor, that is, a shortage of workers.

c. An excess supply of labor, that is, unemployment.

d. An excess supply of labor, that is, a shortage of workers.

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6) Which of the following is the most likely outcome of minimum wage laws?

a. An increase in both the quantity of labor supplied by workers and the

quantity of labor demanded by firms.

b. An increase in the quantity of labor supplied by workers and a decrease in

the quantity of labor demanded by firms.

c. A decrease in the quantity of labor supplied by workers and an increase in

the quantity of labor demanded by firms.

d. A decrease in both the quantity of labor supplied by workers and the

quantity of labor demanded by firms.

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Part 5: Effects of Government Programs

1) When the Social Security system begins running a deficit, the bonds in the trust fund

will be drawn down. The funds to redeem these bonds will have to come from:

a. higher taxes, spending reductions in other programs, or additional

government borrowing.

b. the surplus funds deposited in governmental banking accounts.

c. equity capital being liquidated.

d. the sale of private equities and securities that the government has been

purchasing with the funds.

2) Which of the following best explains why the Social Security system will face

financial difficulties in the future?

a. Too much Social Security revenue was invested in the private sector rather

than in government bonds.

b. In the next two decades, the number of workers paying into the system will

decline sharply relative to the number of retirees collecting benefits.

c. The federal government does not pay interest on the money it borrows from

the Social Security system.

d. The funds in the Social Security trust fund were invested in high-risk assets

that failed to pay off.

3) A special-interest issue is one that:

a. allocates the cost of the activity in accordance with the benefits received.

b. benefits a small, well-organized interest group at the expense of taxpayers or

consumers.

c. benefits everyone while imposing a cost on everyone.

d. benefits a small, well-organized interest group but makes that group pay for

the cost of the program.

4) Which of the following describes why private production tends to be more efficient

than government production?

a. Politicians have a strong incentive to support projects that have immediate

and easily recognized benefits and distant and unidentifiable costs, even if

the total costs outweigh the total benefits.

b. Politicians have a strong incentive to support programs where the benefits

are highly concentrated on special interest groups and the costs are widely

dispersed among voters, even if the total costs outweigh the benefits.

c. Private companies face a profit motive that keeps them operating efficiently,

while government bureaucracies use taxpayer money and, therefore, do

not face this profit motive.

d. All of the above are reasons why private production tends to be more

efficient then government production.

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5) Pork-barrel legislation typically bundles the pet projects of several special interest

groups. Such legislation:

a. is frequently enacted, even though the overall costs to society are greater

than the overall benefits to society.

b. seldom benefits special interest groups.

c. usually, if successful, helps the majority of taxpayers.

d. seldom passes, because social benefits are far smaller than social costs.

6) Which of the following best explains why pork-barrel spending is often approved,

even when the spending is inefficient?

a. Each representative has little incentive to oppose pork-barrel spending, since

the tax savings would accrue to taxpayers throughout the nation.

b. General opposition to pork-barrel spending by a legislator would make it

more difficult for the legislator to arrange for pork-barrel projects that

provide concentrated benefits for his district.

c. Logrolling increases the likelihood that pork-barrel projects will be

approved.

d. All of the above are correct.

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Answer Key

Answers for Part 1 Questions:

Question 1: d

Question 2: c

Question 3: a

Question 4: a

Question 5: c

Question 6: d

Answers for Part 2 Questions:

Question 1: c

Question 2: a

Question 3: b

Question 4: c

Question 5: b

Question 6: a

Answers for Part 3 Questions:

Question 1: a

Question 2: a

Question 3: a

Question 4: d

Question 5: c

Question 6: b

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Answers for Part 4 Questions:

Question 1: b

Question 2: c

Question 3: a

Question 4: d

Question 5: c

Question 6: b

Answers for Part 5 Questions:

Question 1: a

Question 2: b

Question 3: b

Question 4: d

Question 5: a

Question 6: d