Naked Economics Questions

Topics: Economics, Purchasing power parity, Market failure Pages: 4 (918 words) Published: February 18, 2014

Summer Reading: Naked Economics

Chapter 1: The Power of Markets
1. What are the two basic assumptions that economists make about individuals and firms?
The two basic assumptions that economists make is that individuals do what they can to make themselves as well off and prosperous as possible and that firms attempt to maximize profits.

2. What is the role and significance of prices in the market economy? With demand rising, the price of a particular item will usually go up. This means the provider of the product will earn more capital and there will be more competition within the market for the product. With demand lowering, the price of the item will usually go down as well. Basically, the perfect price is the price that leads to the quantity of sales that earn the company the most money. This is true efficiency!

3. What’s so great about a market economy anyway?
A market economy is a good choice among many other alternatives. A market economy allows us to have a constantly rising higher standard of living due to the competition between firms to create the “next best thing”. Within every transaction, all parties are better off. We are able to enjoy individual liberty and the many different choices offered to us.

Chapter 2: Incentives Matter
4. Explain how each of the following relates to efficient outcomes in a market economy: adverse selection, “perverse incentives”, principal agent problem, and the prisoner’s dilemma.

-Adverse Selection:

-Perverse Incentives:

-Principal Agent Problem:

-Prisoner’s Dilemma:

Chapter 3: Government and the Economy
5. In your own words, explain what an externality is.
An externality is when someone/something has the incentive to do/make something, but it comes at the expense of something else. Take your bottle of water, for example, when producing the bottle the company produced pollution. However, the cost of the cleanup of pollution is not a factor in price, and it is not a variable in demand...
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