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ECO 1104 Study Guide - Midterm Guide: Invisible Hand, Opportunity Cost, Comparative Advantage

Course Code
ECO 1104
Lawrence Harris
Study Guide

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PART A: INTRODUCTORY MATERIAL (12 points) These 4 questions were worth 3
points each.
a) Define the term opportunity cost and explain the relationship between scarcity, choices, and
opportunity costs.
It is the cost of the highest foregone alternative. Due to the presence of scarcity,
economic decision makers (households, consumers, firms, governments, NGOs,
workers, investors, and other input factor suppliers) are forced to make choices, and
every choice incurs an opportunity cost. You did not have to write this, but it is true
that if there is no opportunity cost, then we are talking about a “free good”, but “there
ain’t no such thing as a free good” in economics.
b) What are some the reasons why the so-called ‘right-wing, free-market’ types like the market
based, capitalist system? Two reasons will suffice.
Highly dynamic and flexible, as it adjusts quickly to changes in the economic
Efficient, in the surpluses and shortages that do emerge are quickly alleviated.
Given the challenge of scarcity, output is maximized given the available inputs. It
provides the appropriate incentives.
It promotes economic freedom in that most (but perhaps not all) economic decision
makers (listed above) can make economic choices on their own.
Some but not all adherents of this view also admire the inegalitarian distribution of
the product, claiming that it is virtuous that those who contribute the most (least) to
the production process tend to receive the highest (lowest) remuneration (You did
not have to write that point.)
One might mention the decentralized nature of the coordination process. That is indeed an
attribute of the system, but that is not really why believers in the system like it so much.
c) What is the essence of Adam Smith’s invisible hand notion?
The idea that greedy consumers and greedy producers can consumer, produce, and
interact in such a fashion that economic well-being is promoted rather than
undermined. The invisible hand essentially harnesses the greedy urges and re-directs
them so that the economic outcomes benefit most people. My greed offsets your greed
when we make a deal.
d) Any economy, from the most primitive to the most developed, has to face three central
coordination tasks. Name them and provide a little bit of description.
What goods and services should be produced, and in what quantities? In other
words, how should the scarce inputs be allocated?
How should this output be produced from the available inputs (i.e the technology

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of production)
For whom are the goods and services produced? Given the final production
bundle, how should it be distributed among the consumers in the economy?
2. These questions concern the production possibilities frontier, also known as the
transformation curve.
These questions were worth two points each.
a) Explain how a country might be able to expand its production possibilities frontier in the
By shifting the composition of output away from consumption goods towards capital goods.
By so doing, the productive capacity of the economy will be increased. This can also occur
as a result of a technological advance that raises productivity levels. Recall that
productivity = output / input.
b) Assuming that the country is successful in expanding it, what would be the economic
significance of that event?
Production Combinations that were once unattainable given the available land, labour, and
capital inputs are not feasible. It implies an improvement in living standards.
3. This problem is quite similar to one that is in the study guide (only the numbers have been
changed). The following table shows the units of output a worker can produce per month in
Australia and Korea.
Food Electronics
Australia 40 10
Korea 4 2
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