Chapter 1
1. a) It is unlikely that seat selection in a classroom helps determine exam grades. More
likely, well-prepared students choose to sit in the front, while less-prepared students opt
for the back of the classroom (perhaps hoping to avoid being asked questions by the
instructor during class.)
b) The Super Bowl did not determine the fate of the stock market. The stock market
rose consistently for many years while National Football Conference teams happened to
dominate the Super Bowl. The two occurrences were surely coincidental, with no causal
relationship whatsoever.
3. Answers will vary.
5. a) Self-interest is the desire to improve one's life. It includes the desire to advance any
goal one cares about, including many "altruistic" goals, such as helping the poor.
Selfishness is the "excessive" concern for oneself and one's own advantage without
regard for others.
b) Inactions are choices not do do something. Inactions, like actions, have
consequences. For example, if you choose not to study, you may fail an exam.
c) Observation and prediction are more difficult in economics than in chemistry
because, unlike chemists, economists generally cannot observe behavior in a laboratory
setting where all relevant environmental variables can be carefully controlled.
Economists study economic behavior in the real world, where many variables influence
behavior simultaneously. It is difficult in a complex global economy to observe and
predict relationships between variables, isolated from other effects.
d) Economics is concerned with reaching generalizations about human behavior. If one
generalizes on the basis of observed individual behavior, one risks committing the fallacy
of composition. Generalizations based upon observed group behavior are likely to be
both more realistic and useful (reliable).
7. Positive economic statements: a), c), d), and f).
Normative economic statements: b) and e).
9. The statement illustrates the fallacy of composition because it assumes that what is
true for an individual is true for everyone.
11. Answers will vary. Positive economic statements are descriptive in nature and are
testable. Normative economic statements involve making value judgements and often
use words such as "should" or "ought".
Chapter 2
1.
Scarce goods are those which we would like to have more of, but given
limited resources, we must make choices. The following goods are all scarce:
c)
clothes
d)
clean air in a big city
f)
a public library
3.
The opportunity cost of an activity is always the value of the best foregone
alternative.
a)
The opportunity cost of going to college includes not just expenses such
as tuition and books, but also the lost income which could have been earned
while attending college. Room and board expenses should not be included in the
calculation of opportunity cost, if those expenses are equivalent to that which
would be incurred in the best foregone alternative to attending college.
b)
The opportunity cost of missing a lecture includes the potential damage to
one's grade in a course from not being present while important subject material is
covered, as well as the knowledge's foregone value in the "real world." The
magnitude of the opportunity cost depends partly on how much essential
information the instructor provides during the missed class session.
c)
The opportunity cost of withdrawing and spending $100 from your savings
account is the 5% interest which could have been earned annually if the funds
remained in the savings account.
d)
The opportunity cost of going snowboarding on the weekend before final
examinations is likely to include the value of lost study time and possibly a lower
course grade, as well as the explicit costs of the snowboarding trip.
5.
Positive incentives are those that either increase benefits or reduce costs
and thus tend to increase the level of an activity. Both of the following are
examples of positive incentives:
b)
a trip to Hawaii paid for by your parents or significant other for earning an
“A” in your economics course
d)
a subsidy for installing solar panels on your house
Negative incentives either reduce benefits or increase costs, and tend to
decrease the level of the related activity or behavior. Both of the following are
examples of negative incentives:
a)
a fine for not cleaning up after your dog defecates in the park
c)
a higher tax on cigarettes and alcohol
7.
It is important that a country or region specialize in the production of a
good for which it has the lower opportunity cost in order to make the best use of
available resources. By specializing in the production of a good for which a
country has a comparative advantage and then trading for other desirable goods,
a country is able to gain the greatest benefit from its available resources. Trade
restrictions force countries to specialize less, and thereby raises the opportunity
cost of production.
9. There is an opportunity cost even for the use of "free" online services. The
time spent chatting with people online or playing games at Games.com could be
used for some other purpose. The opportunity cost of using these services is the
best foregone use of your time.
Chapter 3
1.
The three basic economic questions are:
What is to be produced?
How are these goods to be produced?
For whom are the goods produced?
Scarcity requires that these questions be addressed in some way by every
economy. Market economies answer these questions in a decentralized way
through the interaction of millions of buyers and sellers. In command economies,
decisions are made largely through planning boards. The manner in which an
economic system answers these questions helps determine the allocation of
limited resources.
3.
a)
A production possibilities curve, which applies to a specific period
of time, is drawn assuming that resources and the level of technology are held
constant.
b)
The opportunity cost of another gun, when moving from point B to point C,
is 4 units of butter. The opportunity cost of another gun, when moving from point
D to point E, is 8 units of butter.
5.
People acquire human capital though education, which adds to the
nation's ability to produce, just as is the case with additions to the physical capital
stock.
7.
The politician would be able to keep his promise if the economy is
currently operating inside the production possibilities curve. It is then possible to
have more of both schools and space stations by better utilizing available
resources. Alternatively, an advance in technology or an increase in available
resources (perhaps due to immigration) would also make it possible to have
more of both goods by shifting the production possibilities curve in an outward
direction.
9.
North Korea, at this time, more closely fits the description of a command
economy because production decisions are largely made through central
planning. Nearly all manufactured goods are produced by state-owned
enterprises.
Chapter 4
1. a) Assuming that beef is a normal good, demand for beef increases with
consumer income, causing the equilibrium price and quantity exchanged to
increase.
b)
An increase in the price of beef, ceteris paribus, decreases the quantity of
beef demanded.
c)
Ceteris paribus, an outbreak of mad cow disease is likely to decrease the
demand for beef, leading to both a decrease in the equilibrium price and the
quantity of beef exchanged.
d)
An increase in the price of a substitute increases the demand for beef.
The equilibrium price and quantity of beef traded both increase.
e)
If the price of a complement, barbecue grills, increases, the demand for
beef will likely decrease. Both the equilibrium price and quantity of beef
exchanged will decrease as a result.
3.
a)
The supply of wheat will decrease due to the flood in the Midwest,
increasing the price of wheat and decreasing the equilibrium quantity of wheat
traded.
b)
If the price of corn decreases, corn farmers are likely to plant less corn
and more wheat. As a result, the supply of wheat to the marketplace will
increase, decreasing the equilibrium price of wheat and increasing the
equilibrium quantity of wheat exchanged.
c)
If the Midwest has exceptionally favorable weather, crop yields are likely
to increase. The supply curve for wheat will shift to the right, decreasing the
equilibrium price and increasing the equilibrium quantity of wheat traded.
d)
Fertilizer is an input to the production of wheat. As a result of a decrease
in the price of fertilizer, more will be used, raising crop yields, and the supply of
wheat will increase. The equilibrium price of wheat will decrease and the
equilibrium quantity will increase.
e)
If more individuals begin growing wheat, the market supply curve for
wheat will increase. The equilibrium price of wheat will decrease and the
equilibrium quantity will increase.
5.
a)
The equilibrium price equals $4, where the quantity of baseball tickets
demanded equals the quantity of tickets supplied.
b)
The supply curve is unusual in that it is vertical at a level of 2,000 tickets.
c)
A shortage will exist if the market price is less than the $4 equilibrium
price. For example, at a price of $2, there would be a shortage of 2,000 tickets.
d)
A surplus will exist if the market price of baseball tickets exceeds $4. For
example, at a price of $6, a 1,000 ticket surplus will occur. At a price of $8, a
1,500 ticket surplus will occur.
e)
Next year's demand curve will shift to the right. The new equilibrium price
of baseball tickets increases to $6, where the new quantity demanded (1,000 +
1,000) equals the 2,000 seat stadium capacity.
7.
a) If the price of cell phones falls, it will increase the quantity of cell
phones demanded, ceteris paribus.
b) Assuming that cell phones are normal goods, an increase in income will
increase the demand for cell phones (and therefore the equilibrium price and
quantity exchanged.)
c) An increase in the price of cell phone service (a complement) will decrease
the demand for cell phones, reducing both their price and the quantity
exchanged.
d) An increase in the price of pagers (a substitute) will also increase the demand
for cell phones, increasing both the price and the quantity exchanged.
9.
A price floor set above the equilibrium price for dairy products would result
in a surplus. A price floor set below the equilibrium price would have no impact
on the price or quantity of dairy products traded. (A price floor is a minimum
allowed price, not a mandated market price.)
11.
Even though the tuition "price" is the same in both cases, student demand for 10
a.m. classes is typically greater than for 8 a.m. classes. College students often
prefer to sleep in later than punctual attendance at an 8 a.m. class would allow.
A shortage of 10 a.m. class space relative to demand is the likely result. There
may exist a surplus of class space in 8 a.m. courses if the demand for early
morning classes is sufficiently low.
Chapter 5
1.
If the elasticity of demand is estimated to equal -1.6, then demand is
relatively elastic. A decrease in ticket prices would increase the quantity of
tickets demanded sufficiently to increase the overall revenue from ticket sales. If
the elasticity of demand is estimated to equal -0.4, then demand is relatively
inelastic. In this case, an increase in ticket prices would boost the revenue from
ticket sales.
3.
a)
substitutes
b)
complements
5.
If the price increases by 10%, quantity demanded will fall by 15% when
the elasticity of demand for hamburgers equals -1.5. Hamburger sales will
decline by approximately 6,000. If the price of hamburgers decreases by 5%,
then quantity demanded will increase by 7.5%, or by 3,000 hamburgers.
7.
If a price is chosen along the elastic portion of a downward-sloping linear
demand curve, reductions in price will increase total revenue. If a price is chosen
along the inelastic portion of a downward-sloping linear demand curve, increases
in price will boost total revenue. A firm seeking to maximize total revenue should
reduce price until it is no longer operating on the elastic portion of the demand
curve and increase price until it is out of the inelastic range. That leaves the unit
elastic point along a linear demand curve. The price that corresponds to the unit
elastic point is the price at which total revenue is maximized.
9.
If the goal is to increase tax revenue, good markets to tax are those for
which demand is relatively inelastic, such as the markets for alcohol and
gasoline.
11.
If gasoline prices are projected to temporarily increase or decrease in the
near future, your short-term consumption is unlikely to change a great deal. You
may try to fill your gas tank shortly before prices increase or delay filling your
tank until prices decrease. Once a gasoline price increase does take effect, you
might combine errands so as to reduce driving time or consider taking the bus to
work. Over the long term, people have more time to adjust their consumption of
gasoline--by organizing car pools or purchasing more fuel-efficient cars, for
example, or even moving where they work or live.
Chapter 6
1.
According to the rule of rational choice, a diner should continue eating as
long as the marginal benefit of an additional helping exceeds the marginal cost of
that helping. The marginal cost of the first helping of food is $9.95. Once $9.95
is paid for the “All-You-Can-Eat” meal, the marginal dollar cost of an additional
helping equals zero. (The marginal cost to one's health from eating additional
portions may exceed zero, however.) Food consumption should continue until
the marginal benefit of an additional helping just equals zero (or until the
marginal benefit just equals the expected marginal cost to one's health). The
optimal level of food consumption is likely to yield more than $9.95 worth of total
satisfaction. It is expected that the marginal utility of successive helpings will
diminish as consumption increases.
3.
The marginal utility per dollar derived from soda equals 6 utils per dollar,
while the marginal utility derived from pizza consumption equals 2 utils per dollar
(4 utils/$2). Since the satisfaction per dollar derived from the last can of soda
consumed exceeds the satisfaction per dollar derived from the last slice of pizza,
Brandy should purchase more soda and less pizza. As Brandy consumes more
soda, the marginal utility per dollar spent on soda will fall (since marginal utility
will diminish). As less pizza is consumed, the marginal utility per dollar spent on
pizza will increase (since the marginal utility derived from pizza will increase).
5.
When a price ceiling is imposed below equilibrium price in the natural gas
market, producer surplus declines. Consumers may either gain or lose surplus
overall. Consumers who are able to buy output benefit from paying a lower price,
increasing consumer surplus. However, the quantity of output supplied to the
market will decline, . Some buyers will not be able to purchase output, despite
their willingness-to-pay. A deadweight loss (illustrated above) results from the
imposition of a price ceiling below equilibrium price, since units are not produced
which consumers value in excess of what it costs to produce them.
7.
If the demand for apples increased from D1 to D2 in the diagram above as a
result of a news story that highlighted the health benefits of two apples a day,
producer surplus would increase as indicated.
9.
A deadweight loss occurs due to a subsidy (as indicated above) because
producers have a private incentive to produce more than the socially efficient
level of output at Q*. As a result, units are manufactured (between Q* and Q 1)
which consumers value less than what it costs to produce them, leading to a
deadweight loss from over-expanding output.
Chapter 7
1.
Property rights give individuals the power to use, sell, rent, dispose of, or enhance
the value of their resources. If those rights are not respected and enforced with regard to
bicycle ownership, then people would be less willing to purchase bicycles. Not only
would bicycle theft result in a redistribution of income from victims to thieves, but a less
than socially efficient quantity of bicycles would be produce and exchanged. A welfare
loss for society would result.
3.
Positive externalities:
b)
you are given a flu shot.
d)
a college fraternity and sorority clean up trash along a two mile stretch on the
highway.
Negative externalities:
a)
during a live theater performance, an audience member’s cell phone loudly rings.
e)
a firm dumps chemical waste into a local water reservoir.
f)
the person down the hall in your dorm plays a Brittany Spears CD loudly while
you are trying to sleep
No externalities:
c)
you purchase and drink a soda during a break from class.
5.
The government must assess the benefits and costs to the public of such projects.
However, it is difficult in practice to ascertain the true benefits and costs to interested
parties. Interested parties have an incentive to exaggerate the true benefit or harm
involved in order to sway the government's decision. Ultimately, the government must
make an educated guess as to the appropriate level of a public good to provide.
7.
An individual might have to hire chemists to analyze food content and ascertain
its nutritional value. If many individuals did likewise, it would result in an inefficient
duplication of research. Consumers could band together and jointly finance research
about the content of food products. However, it would be difficult in practice to prevent
free-riders from benefiting from such research efforts. A less than socially efficient level
of information gathering is the likely result. The government can overcome many of
these difficulties by compelling the disclosure of such information by manufacturers
directly.
9.
If insurance companies cannot identify smokers from non-smokers, then a single
rate must be charged to individuals in both groups. Smokers are likely to take out more
insurance coverage than non-smokers since they face greater health risks from smokingrelated diseases but no higher insurance rates. An adverse selection problem results.
11.
In many nations, the majority vote of legislators or citizens determines how tax
revenues are spent. As a taxpayer, you may be forced to pay for goods and services you
would prefer not to contribute towards. The government's power to compel payment can
be beneficial, as it helps to overcome the free-rider problem associated with public goods.
13.
Answers will vary. The external costs imposed on third parties due to air
pollution in Washington state (or Montana and Wyoming) are generally less than the
external costs imposed on others in California, where the air is more polluted and poses
greater health risks. More restrictive smog requirements may be necessary in California
in order to better internalize the more extensive negative externalities.
Chapter 8
1.
Since the opportunity cost (foregone alternative) of using your land triples,
the cost of using your land to grow strawberries will increase.
3.
a)
The marginal product of the seventh worker equals 6 units of output.
b)
The law of diminishing product begins with the fifth worker is hired.
c)
A firm would never choose to hire 9 workers, since the marginal product of
the ninth worker is negative.
5.
Marginal costs will increase by as much as 50% when workers must be
paid time-and-a-half beyond an eight-hour day. (If labor is the only variable
input, marginal cost will increase by exactly 50%.) If workers are less productive
after 8 hours of work, marginal costs will be even higher beyond 8 hours of work.
7.
Your choice will affect your fixed and variable costs. If you choose to pay
the flat fee, your fixed costs for the film will equal $5,000 for the week. Your
variable costs associated with the leasing of the film would then equal zero. If
you choose to pay $2 per customer, then the costs associated with leasing the
film will be all variable.
9.
In the long run, a food service company can vary the size of the kitchen
and its food preparation equipment. When cooking for a large number of
students, food preparers can utilize mass production techniques to cook large
quantities of food at each meal. Food preparers can specialize at particular
culinary tasks and thereby become more proficient at them. As a result, the
average total cost of producing meals is likely to decrease in the long run as the
number of students served increases.
Chapter 10
1. a) Although many actresses compete for acting roles, in some sense an
actress like Kate Hudson has a monopoly over her own special talents.
b) The diamond market is not a pure monopoly. However, the DeBeers
company does possess significant monopoly power since it controls 75% of the
world's output of diamonds.
c) The only doctor in a small town has a local monopoly over physician services.
Such a doctor's monopoly power is likely to be limited, however, if physicians are
available in nearby towns.
d) Ford Motor Company would not be considered a monopoly.
3. It is not optimal for a monopolist to operate on the inelastic portion of the
demand curve. When demand is inelastic, quantity demanded changes by a
smaller percentage than does the price. As a result, a monopolist could increase
total revenue simply by reducing output and raising price. At the same time,
reducing output reduces total production costs. If revenue rises and costs fall
when output is reduced, profit increases. Therefore, a profit-maximizing
monopolist should increase price until it is no longer operating in the inelastic
portion of the demand curve.
5. There is a welfare loss associated with monopoly because the monopolist
produces at a level of output such that price is greater than marginal cost. The
marginal value to society of the last unit produced is greater than its marginal
cost. The monopolist is not producing enough of the good from society's
perspective. There would be no welfare loss if a price discriminating monopolist
were able to perfectly price discriminate, because the monopolist would sell units
until price just equals the marginal cost, charging each customer the maximum
price he is willing to pay.
7. A profit-maximizing simple monopolist will continue to produce output as long
as marginal revenue exceeds marginal cost, provided that price exceeds average
variable cost. To find marginal revenue, first obtain total revenue by multiplying
price times quantity at each level of output. Marginal revenue is the change in
total revenue from selling one more unit of output. To find marginal cost, first
obtain the total cost by summing fixed cost and variable cost at each output level.
Marginal cost is the change in total cost from selling one more unit of output. The
firm's marginal revenue and marginal cost at each level of output are as follows:
Output
1
Marginal Revenue Marginal Cost
$90
$25
2
$70
$15
3
$50
$10
4
$30
$20
5
$10
$30
6
-$10
$40
7
-$30
$50
8
-$50
$60
The firm should produce four units of output. It would not be profit-maximizing to
produce a fifth unit of output, since marginal cost exceeds marginal revenue for
the fifth unit of output.
9. If the differences in prices to people with different hair lengths reflects
differences in the cost of providing a permanent, then it is not price
discrimination.
11. a) Students demand for movie tickets tends to be more elastic than for the
average individual. To entice students to the movie theater more frequently,
theaters offer discounts to students who can show a student ID.
b) The long distance service is practicing price discrimination by offering lower
rates to those who make longer calls than to those who make very short calls.
This type of quantity discount is a form of price discrimination.
c) The psychic attempts to perfectly price discriminate by charging individuals
the maximum price each is willing to pay for a reading.
d) Seniors, who often live on fixed incomes and have more "free time" to search
for good deals, tend to have more elastic demands for many goods and services.
Local restaurants offer discounts to seniors to attract them to their restaurants
(often restricting them to "early bird" times, so seniors don't crowd out regular
price dinner customers at the peak demand period).
e) Coupon discounts are only offered to those individuals who are willing to take
the time and effort to locate, clip, and bring the laundry detergent coupon to the
store. People whose demand for laundry detergent is relatively elastic are more
likely to clip and organize coupons than are those with relatively inelastic
demand. The use of coupons separates customers into groups with different
elasticities of demand charging different groups different effective prices.
13. There is no welfare loss when a firm is able to perfectly price discriminate. A
perfect price discriminator sells units until price just equals the marginal cost,
charging each customer the maximum price he is willing to pay. Since for the
last unit sold price equals marginal cost, there is no welfare loss. In the case of
simple monopoly, however, the monopolist restricts output below the socially
efficient level and charges a price in excess of marginal cost for the last unit sold.
Chapter 11
1. a) A highly organized agricultural market such as for soybeans, where there
are a large number of sellers producing homogeneous products, most closely
resembles perfect competition.
b) The retail clothing market tends to be monopolistically competitive, where a
large number of sellers produce differentiated products.
c) & d) The U.S. postal service and local cable service are monopolistic markets,
where a single seller operates and is able to influence the market price.
e) Restaurants, such as the famous Spago Beverly Hills, compete in
monopolistically competitive markets. Restaurants differentiate their services by
location, décor, cuisine, etc.
3. Answers will vary. One's choice of gas stations may be based upon the price
of gasoline, location, services and amenities offered, the quality of gas, brand
identity, etc.
5. Some restaurants are more successful at differentiating their establishments
and appealing to customers than are others. Restaurants which are particularly
successful in promoting customer goodwill may continue to earn economic profits
even while other restaurants in the area fail.
7. The corner barber shop services clients in a limited area. Many people are
aware of the barbershop because it is local and they patronize local barbershops
for the sake of convenience. Advertising is unlikely to attract a significant
number of people from a different part of town to a particular barber shop. Toys R
Us and Office Depot, on the other hand, which offer a large variety of products,
are national chain stores which stand to benefit much more from advertising.
Advertising may significantly increase the customer base of Toys R Us and
Office Depot by attracting people who do not live in the vicinity of their stores.
9. Answers will vary. Certainly not all individuals will respond to each and every
advertisement. By advertising, a firm hopes it can both increase demand and
make it more inelastic, thereby enhancing profits. Critics of advertising argue that
advertisers attempt to manipulate preferences and engender brand loyalty to
reduce competition. Defenders of advertising argue that production costs can be
reduced if substantial economies of scale exist. Also, by raising consumer
awareness of substitute products, advertising can help increase the
competitiveness within markets and lead to lower prices. Advertising may be
considered a "waste" by someone who always knows which good he wants, but
advertising would not be employed by sellers who do not think it would increase
demand sufficiently to make it profitable.
Chapter 12
1. The following markets are oligopolistic: b) funeral services, c) airline travel, e)
oil, and f) breakfast cereals.
3. Since the market for wheat is highly competitive, it is unlikely that the SmithJones cartel will be at all successful or have any impact on the price of wheat.
There are too many good substitutes available for the wheat produced by
Farmers Smith and Jones. If Smith and Jones choose to restrict their combined
output, their profits will in all likelihood fall, with virtually no effect on the market
price.
5. Unlike perfectly competitive firms, oligopolists can earn economic profits in the
long run if barriers to entry are sufficiently high to deter new firms from entering
the market.
7. Each of the following are barriers to entry: b) copyrights, c) a monopoly over
crucial inputs, d) economies of scale, and f) an exclusive government license. If
an existing firm had any of these advantages, there would be barriers to entry.
9. It is possible for students to collude and all write down the same answers on
the take-home final, "earning" each an A in the course. It is possible for students
to each earn an A even with little effort put forth in answering the exam
questions, as long as all of the students write down the exact same answers and
if the answers are consistently graded. However, if it is believed that even one
person will choose not to abide by such an agreement or the answers will not be
consistently graded, then the collusive agreement is likely to fail. If even one
person were to put in genuine effort in answering the exam questions, while the
rest of the class did not, then it is possible that most of the class would receive a
poor exam grade. Faced with this prospect, students may find it difficult to
collude successfully.
Chapter 13
1. Characteristics of sole proprietorships: c) Unlimited liability.
Characteristics of partnerships: c) Unlimited liability and d) shared ownership
among multiple individuals.
Characteristics of corporations: a) Double taxation, b) relative ease of
transferring ownership, d) limited liability, and e) shared ownership among
multiple individuals.
3. The pay of managers could be structured so that it depends on the profitability
of the firm. By awarding managers shares of stock and/or options to buy stock,
or bonuses which depend on the firm's profitability, a board of directors can
ensure that the interests of managers are more closely tied to the interests of
shareholders.
5. Answers will vary by date.
7. No answer.
9. Answers will vary. First steps may including choosing a legal structure,
identifying the competition, obtaining insurance coverage, choosing a location,
naming the business, obtaining necessary supplies and equipment, etc.
Chapter 14
1. Quantity of LaborTotal OutputMarginal Product of Labor Value of Marginal
Product of Labor
@TB: 0
1
2
3
4
5
6
250
$1,000
350
$1400
300
$1200
225
$900
175
$700
150
$600
250
600
900
1125
1300
1450
110
7
$440
1560
3. The demand curve for labor shifts to the right when the equilibrium price of
output increases.
5. The equilibrium wage would tend to decrease if a company provided on-thejob training and health benefits to its workers (since part of the compensation to
employees would come in the form of these benefits.) If the government
mandated a minimum wage of $9 per hour, employers would likely reduce
benefits such as health insurance and on-the-job training in response.
7. The demand for unskilled labor, used to produce hamburgers and fries, would
increase as well.
9. One reason is that there is a great demand for the services of professional
athletes. Lots of people are willing to pay high prices to see their favorite sports
stars perform. The second reason that professional athletes, and not teachers,
command such a large amount of compensation, is that extremely talented
athletes are in highly limited supply.
11. The best engineering professors will likely consider leaving Middle State in
order to earn higher salaries elsewhere. At the same time, more poetry
professors are likely to apply for positions at Middle State than would be true of
other universities. As a result, the quality of the engineering department is likely
to decline, and the quality of the poetry department is likely to increase.
13. Answers will vary. Factors contributing to the difference in earnings include
the availability of labor with particular skills and expertise, the demand for labor
with particular skills and expertise, and the productivity of labor.
Chapter 15
1. a) A massive influx of low-skilled immigrants would increase the proportion of
the overall population earning low-incomes.
b) In the event of a baby boom, some individuals would opt to become full-time
parents, transforming two-income families into single-income families. This
would tend to reduce the proportion of the population in high income quintiles
and increase the proportion in the low-income quintiles.
c) When the babies in b) enter their twenties and begin working, the proportion
of the population in low-income quintiles will likely increase (since young workers
earn lower incomes on average then middle-aged workers).
d) When the babies in b) reach age 65 or older, again the proportion of the
population in low-income quintiles will increase (since retirees earn lower
incomes on average than middle-aged workers).
3. A significant reduction in the divorce rate would increase the proportion of
families in higher income brackets, as fewer households would become single
parent and single-income households.
5. Answers will vary. The highest ten percent of income earners in Denmark
receives a significantly less share of total income than does the highest ten
percent of income earners in Guatemala. Middle income groups in Denmark also
seem to fare better than middle-income groups in Guatemala. The lowest ten
percent of the population in Denmark receives a larger share of total income
than does the lowest ten percent of the population in Guatemala..
7. If the selling of kidneys were legalized, more kidneys would be supplied to the
market. As a result, it would be easier to obtain a kidney transplant. The supply
of kidneys would increase because people only need one kidney to survive. For
a sufficiently high price, some individuals would likely be willing to sell a kidney.
9. Answers will vary. These queries fall into the realm of normative analysis
because they involve making value judgments.
Chapter 16
1. If the steel company is not held liable for dumping crud into the air, it will only
consider the $25 labor costs and the $10 equipment costs.
3. The firm should reduce its emissions at a cost of $30 per ton and sell its
permits for $40 per ton. It would profit $10 per ton of emissions which are
reduced as a result.
5. A change in the law is not necessary to achieve an efficient outcome in this
situation. If the resort owner and chemical factory could reach an agreement
whereby the resort owner compensates the chemical factory for hauling the
pollution to the toxic waste dump, the socially efficient outcome could be
achieved. Since the damage to the resort owner exceeds the cost of hauling the
pollution to the toxic waste dump site, this is a possibility, as long as the property
rights are clearly defined and the cost of negotiating and transacting is low
enough.
7. A pollution reduction program which relies on emissions standards would
force firms to limit pollution levels, regardless of the cost of doing so. With an
emissions permit program, firms which can reduce pollution levels at relatively
low marginal cost can sell their permits to firms which can reduce pollution levels
only at higher marginal costs. The same level of pollution reduction can be
achieved with either program, however, the latter program would achieve the
reduction in pollution at lower cost to society.
9.
As indicated above, a subsidy of $s to firms using recycled materials, would shift
the demand curve for recycled materials vertically by the amount of the subsidy.
As a result of this increase in demand, the equilibrium price of recycled materials
would increase, although by less than the amount of the subsidy. The
equilibrium quantity of recycled materials would increase as well. The total cost
of the government subsidy program, $s x Q2 units, is the shaded region.
11. From the perspective of social efficiency, water pollution should be reduced
as long as the marginal benefit of pollution reduction exceeds the marginal cost
of achieving that reduction. The socially efficient level of water pollution will
exceed a level of zero contaminants, as long as achieving zero pollution is too
costly on the margin to be worthwhile.
13. Answers will vary. If rules are too stringent, then the marginal cost of
achieving cleaner air may exceed the marginal benefit of doing so.
Chapter 17
1. a) Sam is a discouraged worker who is not actively seeking work, and
therefore not considered unemployed.
b) The fourteen year old is under 16 years of age and not considered part of the
labor force.
d) The receptionist is considered employed, even though she would like to work
more hours each week.
e) The high school graduate is not actively seeking work, and therefore not
considered unemployed.
An economist would consider the following individuals unemployed:
c) A factory worker is temporarily laid off but expects to be called back to work
soon.
3. The civilian labor force equals the number of persons employed plus the
number of persons unemployed, which equals 95 million persons. The
unemployment rate equals the number of people unemployed, divided by the
civilian labor force, which equals 15 million/95 million, or approximately 15.8
percent.
5. If union bargaining raises the union wage above the equilibrium level, the
quantity of unionized labor demanded will decrease and the quantity of unionized
labor supplied will increase. Some union workers will be unemployed as a result
and will either seek nonunion work or wait to be rehired in the union sector.
Union workers that are still employed are better off due to their higher earnings.
7. If the slowing of the rate of inflation is unexpected, then there is a
redistribution of income from borrowers to lenders (assuming the borrowers do
not default on their loans as a result). If the slowing of the rate of inflation is fully
anticipated at the time the loan is taken out, then there is no redistribution of
income associated with the student loan.
9. It is likely that such legislation would result in greater unemployment in that
particular district's hotel and shopping industry. An increase in the minimum
wage both increases the quantity of labor supplied and decreases the quantity of
labor demanded. The unemployment rate in neighboring areas is likely to fall, as
fewer workers move to and seek employment in those regions.
Chapter 18
1. The following are including in GDP calculations:
a) cleaning services performed by Molly Maid corporation
d) prescription drugs manufactured in the U.S. and sold at a local pharmacy
g) toxic waste cleanup performed by a local company
h) car parts manufactured in the United States for assembly of a car in Mexico
3. When Ford Motor Company buys tires to put on a vehicle that it manufactures,
the tires are considered to be intermediate goods. Only final goods, goods which
are ready for their designated ultimate use, are included in GDP statistics. Tires
purchased by consumers to replace worn ones represent final goods and are
therefore included in GDP.
5. One cannot say that production has increased in Nowhereland from 1999 to
2000 by just looking at nominal GDP. Production may have increased.
However, nominal GDP could increase due to inflation while production were to
remain unchanged (as would be the case with a 20 percent inflation rate) or even
decrease (with a greater than 20 percent inflation rate).
7.
Year
Nominal GDP
1996
($7,200 billion/100)x100 = $7,200 billion
1997
($7,500 billion/102)x100 = approximately $7,353 billion
1998
($8,000 billion/110)x100 = approximately $7,273 billion
1999
($9,000 billion/114)x100 = approximately $7,895 billion
2000
($9,600 billion/120)x100 = $8,000 billion
9.
Year
Real GDP per capita
1980
$4,000 million/1.25 million = $3,200
1990
$6,750 million/1.6 million = approximately $4,219
2000
$9,000 million/1.8 million = $5,000
Real GDP per capita is increasing over time.
Chapter 19
1. e) The annual percentage change in real GDP per capita best measures
economic growth.
3. When capital goods are manufactured in the current period, the ability to
produce and consume in future periods is enhanced. So when a choice is made
in the current period between producing consumer goods and capital goods, it
represents a tradeoff between present and future consumption.
5. Using the rule of 70:
a) 7 years
b) 14 years
c) 35 years
d) 140 years
7. Labor is the physical and/or mental effort used to produce goods and services.
Human capital is the investment in education or on-the-job training or experience.
9. An increase in the population will increase the size of the labor force, in
addition to increasing the number of mouths in an economy to feed. With a
larger labor force, more output, including food, can be produced. Also, additions
to human and physical capital, as well as technological progress, increase the
standard of living and the ability of a nation to feed its people over time.
11. Answers will vary by year.
Information available as of 2001:
United States
GDP - per capita: purchasing power parity - $33,900 (1999 est.)
GDP - real growth rate: 4.1% (1999 est.)
Life expectancy at birth:
total population: 77.12 years
male: 74.24 years
female: 79.9 years (2000 est.)
Birth rate: 14.2 births/1,000 population (2000 est.)
Death rate: 8.7 deaths/1,000 population (2000 est.)
Literacy:
definition: age 15 and over can read and write
total population: 97%
male: 97%
female: 97% (1979 est.)
Thailand
GDP - per capita: purchasing power parity - $6,400 (1999 est.)
GDP - real growth rate: 4% (1999 est.)
Life expectancy at birth:
total population: 68.55 years
male: 65.29 years
female: 71.97 years (2000 est.)
Birth rate: 16.86 births/1,000 population (2000 est.)
Death rate: 7.53 deaths/1,000 population (2000 est.)
Literacy:
definition: age 15 and over can read and write
total population: 93.8%
male: 96%
female: 91.6% (1995 est.)
Haiti
GDP - per capita: purchasing power parity - $1,340 (1999 est.)
GDP - real growth rate: 2.4% (1999 est.)
Life expectancy at birth:
total population: 49.21 years
male: 47.46 years
female: 51.06 years (2000 est.)
Birth rate: 31.97 births/1,000 population (2000 est.)
Death rate: 15.13 deaths/1,000 population (2000 est.)
Literacy:
definition: age 15 and over can read and write
total population: 45%
male: 48%
female: 42.2% (1995 est.)
Economic growth tends to decrease both birth and death rates and increase the
literacy rate.
Chapter 20
1. This behavior illustrates the permanent income hypothesis, which asserts that
people consume on the basis of lifetime income expectations, which are only
partly determined by current income.
3. The statement is correct. A higher price level reduces the quantity of goods
and services which can be purchased with a U.S. dollar. Exports will decrease,
since a higher U.S. price level makes it relatively more expensive for foreign
consumers to purchase U.S. goods. At the same time, imports will increase,
since, faced with higher prices at home, more U.S. residents will buy imported
goods. Net exports, and therefore real GDP demanded, decrease.
5. Of the choices available, only b), an increase in taxes, both decreases
consumption and shifts the aggregate demand curve to the left.
7. a) Exports; aggregate demand will shift to the right.
b) Investment and consumption; aggregate demand will shift to the right.
c) Consumption and investment; aggregate demand will shift to the right.
d) Investment; aggregate demand will shift to the right.
e) Consumption; aggregate demand will shift to the left.
9. Answers will vary by date. When capacity utilization rates trend upward
(downward), investment and aggregate demand are likely to increase (decrease).
Chapter 21
1. This is an example of the misperception effect. The misperception effect
implies an upward sloping supply curve.
3. a) shift LRAS to the right
b) shift LRAS to the right
c) no effect on LRAS unless it reflects permanent changes in the supply of labor
d) shift LRAS to the left
5. Output increases; unemployment decreases; the price level increases.
7. Cost-push inflation occurs when the short-run aggregate supply curve shifts to
the left, pushing up prices. Demand-pull inflation occurs when the aggregate
demand curve shifts to the right, pulling up prices. Examples will vary. Costpush inflation may be caused by an increase in input prices, such as the price of
crude oil or wages. Demand-pull inflation may be caused by an increase in
consumer confidence or a decrease in taxes.
9. Yes, an economy may operate above full employment in the short-run by using
its resources more intensively. Firms encourage workers to work overtime,
extend the hours of part-time workers, hire recently retired employees, or reduce
frictional unemployment through more extensive searches for employees.
However, this level of output and employment cannot be sustained in the long
run.
Chapter 22
1. a) 4
b) 5
c) 2.5
3. An increase in spending by $100 billion; an increase in spending by $133.3 billion.
5.
When the economy is operating above full employment, as depicted above, a tax cut
increases disposable income, shifting aggregate demand to the right, from AD1 to AD2.
As a result,, the existing expansionary gap and the price level both increase. Such a
policy may be imprudent, because it creates inflation. However, supply-sider economists
argue that tax cuts can also foster long-term economic growth by stimulating personal
income, savings, and capital formation. According to this view, a tax cut also increases
the level of full employment output, shifting the long-run and short-run aggregate supply
curves to the right. Conceivably, if the supply-side effect is large enough, it may reduce
or completely offset any inflation caused by the demand-side stimulus.
7. a) Unemployment compensation payments decrease.
b) Welfare payments decrease.
c) Income tax receipts increase.
d) The government budget deficit (surplus) decreases (increases).
9. If a new tax system eliminated all deductions and tax shelters, there would be fewer
opportunities to engage in tax avoidance, reducing the incentive to engage in such
behavior. The incentive to work by a particular individual could either increase or
decrease, depending on whether one's marginal tax rates were higher or lower after the
change in the tax code.
Chapter 23
1. An economics professor may find it difficult to locate a trading partner willing to
listen to economics lectures or receive economic advice in exchange for a new car.
There may be significant search costs involved in locating such a trading partner. The
professor might have to provide lectures in exchange for goods which are not desired,
hoping ultimately, after perhaps a series of trades, to be able to obtain a new car.
3. a) a traveler's check
b) a six-month Treasury bill
c) a demand deposit
d) a savings account
5. a) 10
b) 50
c) 5
d) 12.5
7. The value of the money multiplier would equal one. Banks would not be able to
create money in such a case, because they would be unable to issue loans using customer
deposits, and thereby generate new demand deposit accounts.
9. Yes, accounts at two different FDIC-insured banks are each insured up to $100,000.
Multiple accounts at the same institution (including branch offices) are only insured for
$100,000.
Chapter 24
1. The following are functions of the Federal Reserve Bank:
b) supervise member banking institutions
d) provide a system for check clearing
e) regulate the money supply
f) loan money to member banks
g) act as the bank for the U.S. government
3. $200 million ($10 million x 1/.05); $40 million ($10 million x 1/.25).
5. Required reserves decrease to $50,000 and excess reserves temporarily increase from
$0 to $50,000. If the Bank of Arizona loans out the $50,000 in excess reserves, the
money supply can change by as much as $1,000,000 ($50,000 x 1/.05).
7. a) asset motive
b) precautionary motive
c) transaction motive
d) precautionary motive
9. Answers may vary. An appropriate use of the Federal Reserve Bank's tools during the
Great Depression may have included a decrease in the required reserve ratio, a decrease
in the discount rate, and a purchase of bonds by the Federal Reserve Bank. All of these
policies would stimulate the economy and encourage spending, shifting the aggregate
demand curve to the right.
Chapter 25
1. A central bank can fool people by conducting monetary policy that is inflationary, for
example, when people are expecting no inflation. Employees may sign wage contracts
which fix the nominal wages paid over the duration of the contracts. If output prices rise
as a result of expansionary monetary policy, but money wages remain fixed, real wages
fall. At the lower real wage, fewer people will be unemployed, because the lower real
wage rate makes it profitable to hire more, now cheaper, employees than before. If people
begin to anticipate future monetary policy correctly, then nominal wages wmill adjust
accordingly. For example, employees will demand higher nominal wages to compensate
for the increased cost-of-living due to inflation. If nominal wages rise at the same rate as
do output prices, then real wages remain constant and the unemployment rate will be
unaffected by the monetary policy changes.
3.
a. decrease as a result of an increase in the money supply
b. increase as a result of a decrease in the money supply
c. increase as a result of a decrease in the money supply
5. Cost-of-living adjustments increase nominal wages when the economy experiences
inflation. Consequently, real wages and the unemployment rate do not change as much
as would otherwise be expected as a result of the conduct of monetary policy.
7. How would each of the following likely affect aggregate supply and employment in
the macroeconomy?
a. increase aggregate supply in the short-run and in the long-run, for a given level of
employment
b. decrease aggregate supply and employment in the short-run; little or no effect in the
long-run
c. increase aggregate supply for a given level of employment (by increasing the
productivity of labor) in the short-run and the long-run
9. Economists who believe that people form rational expectations are more likely to favor
discretionary monetary policy over fixed monetary policy rules. Rational expectations
theorists believe that when policy targets become public, that people alter their behavior
from what it otherwise would have been in order to maximize their own utility. As a
result, the intended impact of policy changes is negated. In this view, discretionary
monetary policy would be fully anticipated by consumers and workers and therefore fail
to achieve the intended goals. Rational expectations theorists believe that in order to have
the desired effect, the public must be caught by surprise by policy changes. Discretionary
monetary policy has the potential to impact the economy in the desired fashion, but only
if the public is unable to fully anticipate such monetary policy actions.
11. In years where worker productivity growth declined, such as in the early 1970s, the
U.S. economy experienced adverse supply shocks.
Chapter 26
1. Country B has a comparative advantage over the production of good X because its
opportunity cost of producing 1 unit of good X is only 1.5 units of good Y versus 2 units
of good Y in country A. Country A has a comparative advantage in the production of
good Y.
3. The statement is false. Even small developing countries which do not possess an
absolute advantage in the production of any goods or services can benefit from
specialization and international trade. All that a country needs to benefit from
specialization and trade is to possess a comparative advantage in the production of at
least one good or service. There is no reason to produce all goods domestically in an
attempt to be self-sufficient if goods can be obtained at lower opportunity cost through
trade.
5. The imposition of a tariff results in a loss of consumer surplus which is greater than the
gain to domestic producers (in the form of producer surplus) and to the government (in
the form of tax revenue.).
7. Many labor groups were opposed to NAFTA because the trade agreement will
gradually eliminate protectionist policies which protect jobs in certain sectors of the
economy. Mexico, with its large pool of low-skilled and semi-skilled labor, has a
comparative advantage in the production of many manufactured goods. It was expected
that jobs would be lost in those manufacturing industries in the U.S. as a result of the
agreement. NAFTA will encourage greater specialization and trade within North
American, leading to a decline in industries where a country has a "comparative
disadvantage" and an expansion in industries where there is a comparative advantage.
9. The U.S. Import-Export Bank helps promote U.S. exports by helping importers find
financing with which to buy U.S. exports, guaranteeing loans for U.S. exporters, and
protecting domestic firms against nonpayment by foreign buyers.
11. Answers will vary by date.
Chapter 27
1. a) debit
b) credit
c) debit
d) credit
3. a) U.S. exports will increase, imports decrease, and the trade deficit (surplus) will
decrease (increase)
b) U.S. exports will decrease, imports increase, and the trade deficit (surplus) will
increase (decrease)
c) U.S. exports will increase and the trade deficit (surplus) will decrease (increase)
d) U.S. imports will decrease the the trade deficit (surplus) will decrease (increase)
e) U.S. exports will decrease, imports increase, and the trade deficit (surplus) will
increase (decrease)
5. ***Q: If the demand for a domestic currency decreases in a country using a fixed
exchange rate system, what must the central bank do to keep the currency value steady?
***
The central bank must purchase the currency using foreign reserve assets to prevent its
currency from falling in value relative to foreign currencies.
7. The balance of payments must balance so that credits and debits are equal. If the
balance of payments equals -$200 million, the statistical discrepancy must equal +$200
million, not zero.