Test on Ten Principles of Economics

Question 1: When faced with a decision, rational people primarily base their choices on the average cost of an action rather than the marginal cost.

A. Ano

B. Ne

Explanation: Rational people make decisions by comparing marginal benefits and marginal costs. The study materials illustrate this by explaining that comparing the marginal benefit to the marginal cost (not the average cost) leads to the correct decision, such as making a cell phone call or selling an airline ticket below average cost but above marginal cost.

Question 2: According to the provided materials, what is the typical outcome when government policies are designed to achieve greater equality within society?

A. These policies simultaneously lead to a larger economic pie.

B. These policies tend to reduce efficiency by diminishing the reward for hard work and lowering overall production.

C. These policies guarantee that society maximizes the benefits from its scarce resources.

D. These policies have no impact on the overall size of the economic pie, only on its distribution.

Explanation: The study materials state that 'When the government redistributes income from the rich to the poor, it reduces the reward for working hard; as a result, people work less and produce fewer goods and services. In other words, when the government tries to cut the economic pie into more equal slices, the pie gets smaller.' This directly indicates that policies aimed at greater equality often reduce efficiency.

Question 3: Prices are the instrument with which the invisible hand directs economic activity.

A. Ano

B. Ne

Explanation: The study materials explain that "prices are the instrument with which the invisible hand directs economic activity." As a result of the decisions buyers and sellers make, market prices reflect both the value and cost to society, guiding them to outcomes that maximize overall well-being.

Question 4: According to the provided text, how do externalities impact economic efficiency?

A. Externalities always lead to an efficient allocation of resources, as the invisible hand accounts for all costs.

B. Externalities cause market failure, meaning the market on its own fails to produce an efficient allocation of resources.

C. Externalities enhance economic efficiency by ensuring all social costs are reflected in market prices.

D. Externalities have no significant impact on economic efficiency; they primarily affect market power.

Explanation: The study materials state that 'one possible cause of market failure is an externality' and define market failure as 'a situation in which the market on its own fails to produce an efficient allocation of resources.' This directly indicates that externalities lead to a failure in achieving efficient resource allocation. The text further explains that 'when the production of a good pollutes the air... the market left to its own devices may fail to take this cost into account,' which demonstrates how efficiency is compromised.

Question 5: In communist countries, central planners effectively ran the economy by setting prices that accurately reflected consumers' tastes and producers' costs.

A. Ano

B. Ne

Explanation: The study materials state that in communist countries, central planners failed because prices were dictated and they lacked the necessary information about consumers' tastes and producers' costs, which in a market economy is reflected in prices.