CEA Economic Theory & Principles — Questions and Answers

Question 1: What does the law of demand state?

Demand increases as price increases
Demand decreases as price increases (Correct answer)
Demand is unaffected by price
Demand increases with supply

Correct answer: Demand decreases as price increases

The law of demand is a fundamental principle in economics that describes the inverse relationship between price and quantity demanded. As the price of a good or service rises, consumers typically demand less of it, assuming all other factors remain constant. Conversely, when prices fall, the quantity demanded tends to increase.

Question 2: What is opportunity cost?

The total cost of a choice
Value of the foregone alternative (Correct answer)
Sunk cost
Fixed cost

Correct answer: Value of the foregone alternative

Opportunity cost is the value of the next best alternative that must be given up when a choice is made. It highlights that every decision involves a trade-off, as resources are scarce. For example, the opportunity cost of studying for an exam might be the income lost from not working during that time.

Question 3: What does the law of supply state?

Supply decreases as price increases
Supply increases as price increases (Correct answer)
Supply is unrelated to price
Supply decreases with demand

Correct answer: Supply increases as price increases

The law of supply states that, all else being equal, as the price of a good or service increases, the quantity supplied by producers also increases. This is because higher prices make production more profitable, incentivizing firms to produce and offer more of the good to the market. Conversely, lower prices lead to a decrease in the quantity supplied.

Question 4: What is market equilibrium?

Price is highest
Supply exceeds demand
Demand exceeds supply
Demand equals supply (Correct answer)

Correct answer: Demand equals supply

Market equilibrium is the state in a market where the quantity of a good or service demanded by consumers precisely matches the quantity supplied by producers. At this point, there is no pressure for the price to change, as both buyers and sellers are satisfied. The equilibrium price and quantity are determined by the intersection of the supply and demand curves.

Question 5: What is elasticity of demand?

Sensitivity of demand to price (Correct answer)
Total demand at any price
Fixed demand level
Demand at equilibrium

Correct answer: Sensitivity of demand to price

Elasticity of demand measures how responsive the quantity demanded of a good or service is to a change in its price. If demand is elastic, a small price change leads to a large change in quantity demanded, while inelastic demand means quantity demanded changes little with price fluctuations. This concept is crucial for businesses in setting prices and understanding consumer behavior.

Question 6: What is a public good?

A good only some can use
Non-excludable and non-rivalrous good (Correct answer)
Private product
Exclusive good

Correct answer: Non-excludable and non-rivalrous good

A public good is characterized by two main properties: non-excludability and non-rivalry. Non-excludable means it's difficult or impossible to prevent individuals from consuming the good even if they don't pay for it, while non-rivalrous means one person's consumption does not diminish another's ability to consume it. Examples include national defense or street lighting, which often lead to the "free-rider problem."

Question 7: What is the role of government in a market economy?

Control all businesses
Regulate and correct failures (Correct answer)
Ignore markets
Eliminate competition

Correct answer: Regulate and correct failures

In a market economy, the government's role is typically to establish and enforce rules, protect property rights, and intervene to correct market failures. Market failures occur when the free market fails to allocate resources efficiently, such as in the case of externalities, public goods, or monopolies. Government regulation aims to promote efficiency, equity, and stability.

Question 8: What is comparative advantage?

Producing more goods overall
Producing at lower opportunity cost (Correct answer)
Selling goods cheaply
Producing goods with highest cost

Correct answer: Producing at lower opportunity cost

Comparative advantage refers to an economy's ability to produce a particular good or service at a lower opportunity cost than its trading partners. This means it gives up less to produce that good compared to another entity. Specializing in goods where one has a comparative advantage and trading allows for greater overall production and consumption for all parties involved.

Question 9: What is the difference between microeconomics and macroeconomics?

Micro is bigger than macro
Micro studies individuals, macro studies economy (Correct answer)
They are the same
Macro studies firms only

Correct answer: Micro studies individuals, macro studies economy

Microeconomics focuses on the behavior of individual economic agents, such as households, firms, and specific markets, and how they make decisions and interact. Macroeconomics, on the other hand, examines the economy as a whole, looking at aggregate phenomena like inflation, unemployment, economic growth, and national income. Both branches are essential for a complete understanding of economic activity.

CEA Economic Theory & Principles

What does the law of demand state?