To the Instructor:
Having created homework assignments from the discussion questions, review questions, and
exercises printed in Microeconomics in Context (Goodwin et al, 2nd edition) in the Fall of 2007,
in the Spring of 2009 I wanted to give my students a different set of exercises. What follows are
the new homework assignments I created on material from chapters 1-12. In a few cases, the
questions are taken from the (on-line) Instructors Resource Manual for the textbook, but most are
newly written.
A note on the appropriateness of these materials: The University of Massachusetts Boston, where
I teach, draws a population of mostly non-elite and often under-prepared students from a wide
range of ages and backgrounds. Many are recent immigrants. While some bring fascinating life
experiences to class, many of them need simple explanations and lots of review to master
concepts, and many start the class intellectually disengaged from all but the most personallyrelated economic issues. If you teach a more elite or engaged group, you may find these
exercises too simple or repetitive.
A note on teaching strategy: In order to give students immediate feedback on how they were
doing—and ease my grading load!—I instructed students to always complete the assignments in
blue or black ink, or pencil. Then I passed out pens with green ink in class, projected the answers
and point (or "circle") values (as annotated in some of the answer notes) onto a screen, and had
students "pre-grade" their work in green before passing in their papers and the pens. This
seemed to work pretty well.
I actually taught Chapters 4 and 5 immediately after Chapter 1, but I present the homeworks in
sequential chapter order here.
Feel free to use any these ideas in your classrooms, but please don't electronically post the
answer sheets where they may become publically available to any student, anywhere.
Julie A. Nelson
Department of Economics
University of Massachusetts, Boston
julie.nelson@umb.edu
Econ 101
Prof. Nelson
Chapter 1
1. Web
Answer sheets to homeworks and exams, as well as important class announcements, will be
posted on the course website (at http://boston.umassonline.net/.) As part of this Problem Set,
familiarize yourself with the website by going to the “Got a Question” section and following the
(simple) instructions in the “Read Me” message.
Answer the following questions based on Chapter 1 of the textbook, in the order given, on a new
sheet of paper. Remember to use blue or black ink, or pencil!
2. Short Answer
Answer the following questions in short paragraphs. (You do not need to copy out everything
the book says on a topic, but you do need to say enough to make it clear that you have correctly
understood the terms used.)
a. Briefly describe the four essential economic activities.
b. [For this problem, ignore the statement on p. 4 of the text about "the final goal of getting a
good job." Jobs are generally valued as intermediate goals, that move you towards final goals
such as those mentioned in the table on the top of p. 9.] What would you say are some of the
"final goals" you have for your own life? How is your attendance at an introductory economics
class related to your own "final" and "intermediate" goals?
c. "Economics is all about businesses and profit." Is this statement true or false? Explain,
including in your explanation a correct definition of economics, and an identification of the three
spheres of economic activity.
d. A radio station broadcasts a program giving people information about how to make their
homes more energy-efficient. Is this program a "public good"? Why or why not?
Go to next page 
3. Problem
The figure below shows a society's Production Possibilities Frontier for production of corn and
wheat. Answer the questions below, referring to this figure.
A
B
C
PPF
D
E
F
Quantity of Wheat
a. What is the maximum quantity of corn that can be produced, if the society produces no wheat?
b. If the society produces 15 units of wheat, what is the maximum quantity of corn it can
produce?
c. Does point A represent an efficient use of resources? Explain.
d. Which point on the graph represents a combination of outputs that is unattainable? Explain,
referring to specific quantities of corn and wheat in your explanation.
e. Find a point on the graph that illustrates an inefficient use of resources. Explain why there is
inefficiency, referring to specific quantities of corn and wheat in your explanation.
f. Suppose the society moves from (efficiently) producing only wheat to producing both wheat
and 40 units of corn. What is the opportunity cost of producing these first 40 units of corn?
g. Suppose the society moves from (efficiently) producing 40 units of corn to producing 80 units
of corn. What is the opportunity cost of producing these last 40 units of corn?
h. Comparing your answer to part (g) to your answer in part (f), what point about the use of
resources for different kinds of production is illustrated? That is, why does the opportunity cost
change?
i. Would producing at point D be the best choice for this society? Explain your answer.
Econ 101
Prof. Nelson
Chapter 1 ANSWER NOTES
1. Web (3 circles)
2. Short Answer (8 circles total)
a. 'Briefly describe the four essential economic activities." (2 circles)
The four essential economic activities are:
1. resource maintenance, which is the management of natural, manufactured, human,
and social resources
2. production, which is the conversion of resources into goods and services
3. distribution, which shares products and resources among people,
and
4. consumption, which is the final use of a good or service.
b. "What would you say are some of the "final goals" you have for your own life? How is your
attendance at an introductory economics class related to your own "final" and "intermediate"
goals?" (2 circles--for an answer that correctly distinguishes final from intermediate goals,
whatever the examples given!)
Final goals: probably include goals such as survival, happiness, having a sense of
meaning to one's life, "being all you can be," or spiritual goals (see suggestions in the
table on the top of p. 9).
Attendance in this class could relate directly to your final goals if it makes you happy or
develops your potential. If you hope it will increase your earning power, then it is
directed towards the intermediate goal of gaining wealth (which you hope will satisfy
needs and make you happy).
c. "'Economics is all about businesses and profit.' Is this statement true or false? Explain,
including in your explanation a correct definition of economics, and an identification of the three
spheres of economic activity." (2 circles)
False. Economics is much broader--it is about the way that people organize
themselves to sustain life and enhance its quality. In addition to the business sphere,
the core sphere (of families and communities) and the public purpose sphere (of
governments and non-profits) are also important locations of economic activity.
d. A radio station broadcasts a program giving people information about how to make their
homes more energy-efficient. Is this program a "public good"? Why or why not? (2 circles)
Yes--it fits the definition of a public good on p. 22. One person listening to a radio
program doesn't make it any harder for another person to listen, too ("nondiminishable"),
and anyone with a radio can listen in ("nonexcludable").
3. Problem (9 circles total)
a. 80 units of corn (1 circle)
b. 60 units of corn (1 circle)
c. Yes, point A is efficient. All points that lie on the PPF represent efficient production. (1 circle)
d. Point B is unattainable. Point B represents production of 15 units of wheat and 80 units of
corn. But if the society produces 15 units of wheat they only actually have enough resources left
to produce, at the most, 60 units of corn. (Alternatively, if it produces 80 units of corn, it can
produce zero units of wheat.) (1 circle)
e. Point E illustrates inefficiency. At point E only 15 units of wheat and 10 units of corn are
produced, when more of each output—for example, 20 units of wheat and 40 units of corn at
point D—are possible. (1 circle)
f. The opportunity cost of the first 40 units of corn is only five units of wheat. (Point F to point
D) (1 circle)
g. The opportunity cost of the last 40 units of corn is 20 units of wheat. (Point D to Point A) (1
circle)
h. The first units of corn use the resources best suited for corn production, and least suited for
wheat, and so are relatively "cheap." As more corn is produced, it competes more for resources
that could also be used for producing wheat, so the opportunity cost rises. (1 circle)
i. Not necessarily. We cannot know which point is best for the society unless we know its needs
and preferences for corn versus wheat. (1 circle)
TOTAL POSSIBLE: 17 circles for questions 2 and 3; I will add the 3 circles for #1 when I check
the website. 20 CIRCLES TOTAL.
Econ 101
Prof. Nelson
Chapter 2 and Chapter 3
1. Matching
Match each concept in Column A with a definition or example in Column B.
Column A
a. low time discount rate
b. market value
c. perfect rationality
d. posted prices
e. wholesale market
f. consent
g. institution
h. futures market
i. resale market
j. administration
k. physical infrastructure
l. choice behavior
Column B
1. the market for used furniture on Craig's
list
2. the price determined by a (perhaps
hypothetical) interaction of many buyers
and sellers on an auction-type market
3. the price tag on a shirt says "$14.99"
4. the type of market that connects food
producers with supermarkets
5. roads and communications equipment
6. when one person or agency is given
decision-making authority
7. buying fuel oil now, that will be
delivered two months from now
8. when people discuss and negotiate to
come to an agreement
9. selecting from among alternatives
10. a way of structuring social interactions
11. putting a lot of importance on the
future
12. thoughtfully coming to the optimal
decision
2. Mini-Research and Analysis
Locate a article from a mainstream newspaper (for example, the Boston Globe or New York
Times, either on-line or in print) concerning the current economic crisis and its causes or possible
solutions. It should be from sometime in the last three months. Some good keywords to search on
to find such an article, this week, include:
financial (or banking) crisis
financial regulation
financial deregulation
mortgage crisis
recession
nationalization
Citigroup
government bailout
Glass-Steagall Act
Print and attach this article to the homework you hand in. Also write a short paragraph (5-10
sentences):
1. Describing how this article relates to debates about whether the United States should have a
"laissez-faire" economy.
2. Describing questions you have in your mind after reading the article. (These could be, for
example, about unfamiliar terms, about whether certain facts are correct, or about the
quality of arguments made.)
Econ 101
Prof. Nelson
Chapter 2 and Chapter 3 ANSWER NOTES
Matching:
a-11
b-2
c-12
d-3
e-4
f-8
g-10
h-7
i-1
j-6
k-5
l-9
(12 circles)
2. Mini-Research and Analysis
Graded by the instructor (15 circles)
Econ 101
Prof. Nelson
Chapter 4
1. Short Answer
Answer the following questions in short paragraphs. Pay special attention to the words and
phrases underlined!
a. Name the five "nonprice determinants" of supply.
b. Name the five "nonprice determinants" of demand.
c.. State whether the following statements are true or false, in the model of supply and demand,
and explain why (using words and/or graphs). Pay special attention to the words and phrases that
are underlined!
i. "In the market for gasoline, if the price of gasoline goes up, the supply of gasoline will
increase."
ii. "In the market for shoes, if the price of shoes goes down, the quantity demanded of
shoes will rise."
iii. "Complementary goods are goods that make the person buying them look good."
iv. "A rise in demand for IPods will drive up their price, which will increase the supply
of IPods."
v. "A price ceiling in the market for haircuts will create a surplus of haircuts."
2. Problem: The Market for Tea
Suppose the following schedules describe supply and demand for tea, where prices are per pound
and quantities are in tons.
Price
Quantity of Tea
Supplied
Quantity of Tea
Demanded
$ 1.00
$1.50
$2.00
$2.50
$3.00
15
20
25
30
35
25
20
15
10
5
a. Using graph paper and a ruler, or a computer spreadsheet or presentation program, carefully
graph and label the supply and demand curves for tea.
b. At a price of $2.50 per pound, is there a surplus, shortage, or equilibrium? Illustrate in the
graph.
c. At a price of $1.50 per pound, is there a surplus, shortage, or equilibrium? Illustrate in the
graph.
d. Now suppose that a drought hits tea-growing areas. At each price, the quantity suppliers are
willing to provide to the market is reduced by 10 tons. (For example, at a price of $1.00, only 5
tons are now supplied, and at a price of $1.50, only 10 tons.) Demand is unchanged. On a new
supply and demand graph, show both the original and the new (drought) situation.
e. Has the drought caused a change in the supply of tea?
f. Has the drought resulted in a change in the quantity of tea demanded? Why or why not?
3. Problem: The consequences of Shifts in Supply, Demand, or Both
Answer the questions below by drawing a graph. Also state which "nonprice determinant" is
being effected, on which side of the market, and what happens to equilibrium price and
equilibrium quantity. Think about only the strongest and most direct effect(s) and remember the
ceteris paribus assumption.
Example: Market for gasoline: A hurricane hits the Gulf of Mexico, destroying refineries that
produce gasoline from crude oil.
Supply Side: "the number of producers"
P  (or "equilibrium price increases")
Q  (or "equilibrium quantity falls")
a. Market for solar water heaters: There is a large increase in the number of firms making solar
water heaters.
b. Market for solar water heaters: The price of gas and electricity, which are used to power (nonsolar) hot water heaters in many homes, rises.
c. Market for solar water heaters: Due to the invention of a new technology, the price of solar
cells used to make solar water heaters falls.
d. Market for solar water heaters: Due to a recession, the incomes of homeowners fall.
e. Market for oranges: A movie star appears in television advertisements, promoting the health
and beauty benefits that come from eating oranges.
f. Market for oranges: An insect infestation reduces the size of the orange crop.
g. Market for oranges: The prices of grapes, apples, and tangerines all fall.
h. Market for oranges: Consumers hear a rumor that an insect infestation is going to raise the
price of oranges.
i. Market for oranges: An insect infestation reduces the size of the orange crop and a movie star
appears in television advertisements promoting the benefits of eating oranges.
Econ 101
Prof. Nelson
Chapter 4 ANSWER NOTES
1. Short Answer (9 circles total)
a. Name the five "nonprice determinants" of supply. (2 circles)
1. The available technology of production
2. Resource prices
3. The number of producers
4. Producer expectations about future prices and technology
5. The prices of related goods and services
b. Name the five "nonprice determinants" of demand. (2 circles)
1. Tastes and preferences
2. Incomes and/or available assets
3. Availability and prices of related goods and services
4. Consumer expectations about future prices and incomes
5. The number of consumers
c. State whether the following statements are true or false, in the model of supply and demand,
and explain why (using words and/or graphs).
i. "In the market for gasoline, if the price of gasoline goes up, the supply of gasoline will
increase."
False. This should read, "the quantity supplied of gasoline will go up," since
it refers to a movement along a supply curve. (1 circle)
ii. "In the market for shoes, if the price of shoes goes down, the quantity demanded of
shoes will rise."
True. When a good's own price changes, the "quantity demanded" changes.
This is a movement along a curve. (1 circle)
iii. "'Complementary' goods are goods that make the person buying them look good."
False. complementary goods are goods that are used together (such as pens
and paper. (1 circle)
iv. "A rise in demand for IPods will drive up their price, which will increase the supply
of IPods."
False. The increase in price (that results from the rise in demand) will cause
a movement along the supply curve for IPods, as illustrated below. The
supply curve doesn't shift. (1 circle)
Price
of
Ipods
P2
S
P1
D2
D1
Q1
Q2 Quantity
of Ipods
v. "A price ceiling in the market for haircuts will create a surplus of haircuts."
False. If it is below the equilibrium price, the ceiling will create a shortage of
haircuts, as shown in the graph below (where QD > QS). (1 circle)
Price of
Haircuts
S
Price
ceiling
D
QS
QD
Quantity of
Haircuts
2. (8 circles total)
a. Using graph paper and a ruler, or a computer spreadsheet or presentation program,
carefully graph and label the supply and demand curves for tea. (3 circles)
$3.50
Supply
$3.00
$2.50
$2.00
E
$1.50
$1.00
Demand
$0.50
$0.00
0
5
10
15
20
25
30
35
Quantity of Tea (tons)
b. At a price of $2.50 per pound, is there a surplus, shortage, or equilibrium? Illustrate in the
graph.
Surplus (as shown by the dashed line in the graph). (1 circle)
c. At a price of $1.50 per pound, is there a surplus, shortage, or equilibrium? Illustrate in the
graph.
Equilibrium (see point E). (1 circle)
d. On a new supply and demand graph, show both the original and the new (drought) situation.
(1 circle)
$3.50
Supply (Drought)
$3.00
$2.50
E2
$2.00
Supply
(Original)
E1
$1.50
$1.00
Demand
$0.50
$0.00
0
5
10
15
20
25
30
35
Quantity of Tea (tons)
e. Has the drought caused a change in the supply of tea?
Yes. The supply curve shifted back (or "to the left"). (1 circle)
f. Has the drought resulted in a change in the quantity of tea demanded? Why or why not?
Yes. We can see that from E1 to E2 the equilibrium price of tea rises. This rise in price is
what causes consumers to want to now buy only 15 tons, instead of the earlier quantity
demanded of 20 tons. It is a movement along the demand curve. (1 circle)
3. Problem (18 circles total: In each part, 1 circle for correct graph and 1 for correct
explanation.)
S1
Price
S2
a. Market for solar water heaters: There is a
large increase in the number of firms
making solar water heaters.
P1
P2
Supply side: "the number of producers"
D
Q1 Q2
Price
P
Q
Quantity
b. Market for solar water heaters: The price
of gas and electricity, which are used to
power (non-solar) hot water heaters in many
homes, rises.
S
P2
P1
D2
D1
Q1
Q2 Quantity
Demand side: "Availability and prices of
related goods and services." (Gas and
electricity are substitute goods for solar
water heating.)
P
Q
S1
Price
S2
c. Market for solar water heaters: Due to the
invention of a new technology, the price of
solar cells used to make solar water heaters
falls.
P1
P2
D
Q1 Q2
Quantity
Supply side: The available technology of
production
P
Q
Price
d. Market for solar water heaters: Due to a
recession, the incomes of homeowners fall.
S
P1
Demand side: "Incomes and/or available
assets"
P2
D1
D2
P
Q
Q2 Q1 Quantity
Price
S
e. Market for oranges: A movie star appears
in television advertisements, promoting the
health and beauty benefits that come from
eating oranges.
P2
P1
Demand side: "Tastes and preferences"
D2
D1
Q1
P 
Q2 Quantity
Q
S2
Price
f. Market for oranges: An insect infestation
reduces the size of the orange crop.
S1
P2
P1
Supply side: "The number of producers"
D
Q2 Q1
Quantity
P
Q 
Price
g. Market for oranges: The prices of grapes,
apples, and tangerines all fall.
S
P1
P2
D1
D2
P
Q2 Q1 Quantity
Price
Demand side: "Availability and prices of
related goods and services." (These other
fruits are substitutes for oranges.)
Q 
S
h. Market for oranges: Consumers hear a
rumor that an insect infestation is going to
raise the price of oranges.
P2
P1
D2
D1
Q1
Q2 Quantity
Demand side: "Consumer expectations
about future prices and incomes"
(Consumers are likely to "stock up" in
anticipation of the price rise.)
P
Q
S2
Price
i. Market for oranges: An insect infestation
reduces the size of the orange crop and a
movie star appears in television
advertisements promoting the benefits of
eating oranges.
S1
P2
P1
D2
D1
or
Supply side: "The number of producers"
and
Demand side: "Tastes and preferences"
Quantity
P
Q could go either  or 
35 CIRCLES TOTAL
Econ 101
Prof. Nelson
Chapter 5
1. Short Answer (Price Elasticity of Demand)
a. What are three reasons why demand for a good might be price inelastic?
b. When the price of lipstick rises 10%, the quantity of lipstick demanded falls 5%.
(i) What is the price elasticity of demand?
(ii) Is revenue to the sellers of lipstick raised or lowered by the change?
c. The price elasticity of demand for gadgets is 1.3. When the price of gadgets goes down by
10%, what happens to the quantity demanded of gadgets? That is, by how much does the
quantity change, and in which direction?
d. Given that university students usually must have them in order to pass their courses, the price
elasticity of demand for many assigned textbooks is essentially zero.
(i) Sketch a demand curve that represents this case.
(ii) Is the seller of textbooks a "price taker"?
e. One proposal for improving the diets of Americans is to put a large sales tax on junk foods,
thus making unhealthy food more expensive. Would this policy be relatively more effective in
changing peoples' eating habits if the demand for junk foods is price inelastic or price elastic?
Explain.
2. Problem
Jamal has a side business selling custom ringtones from his website. His daily sales before he
decided to raise the price he charges is given by Point A in the graph below. His daily sales after
the price increase are given by Point B.
$4
B
$3
Demand
$2
A
$1
$0
0
1
2
3
4
5
6
7
Quantity of Ringtones
8
a. Calculate the price elasticity of demand for Jamal's ringtones (using the "midpoint formula").
b. Is the demand Jamal faces "price elastic" or "price inelastic"?
c. What was his daily revenue from sales before he raised the price? After he raised the price?
d. Do you think it's likely that potential buyers feel that there are a number of good, close
substitutes for Jamal's ringtones, or very few good, close substitutes? Why?
e. Assuming Jamal wants to keep his revenues high, was raising his price a good idea?
3. Short Answer (Other Concepts)
a. A consumer can buy all the milk he or she wants at the supermarket, at a constant price. How
would you describe the supply curve faced by this consumer? Use words and sketch a graph.
b. Is it possible for the income elasticity of demand for a good to be negative? If so, give an
example of a specific good for which this might be true.
c. Fill in the blanks:
(i) Spending on PCs usually is directly related to consumers' incomes: That is, they are
________ goods.
(ii) An increase in the price of PCs makes people who buy PCs essentially "poorer," so
they may buy fewer PCs. This is called the ____________ effect of a price change.
(iii) If the price of PCs rise, people may buy fewer of them, because they can switch to
buying Macs instead. This is called the ____________ effect of a price change.
Econ 101
Prof. Nelson
Chapter 5 ANSWERS
1. Short Answer (Price Elasticity of Demand) (10 circles total)
a. What are three reasons why demand for a good might be price inelastic? (2 circles)
1. there are very few good, close substitutes for the good
2. the good is considered necessary to buyers
3. the good is a very small part of a buyer’s budget.
b. When the price of lipstick rises 10%, the quantity of lipstick demanded falls 5%. (2 circles)
(i) What is the price elasticity of demand?
|(% change in quantity demanded)/(% change in price)| = |-5/10| = .5
(ii) Is revenue to the sellers of lipstick increased or decreased by the change?
Increased, since demand for the good is inelastic.
(Also: % change in revenue % change in quantity demanded + % change in price
- 5 + 10 = + 5 %, a positive number.)
c. The price elasticity of demand for gadgets is 1.3. When the price of gadgets goes down by
10%, what happens to the quantity demanded of gadgets? That is, by how much does the
quantity change, and in which direction? (2 circles)
It increases by 13%.
Explanation: Using the formula for the price elasticity of demand:
1.3 = |(% change in quantity demanded)/(-10)|
Mathematically, setting the "change in quantity demanded" to either +13% or
-13% solves this equation. But we know that in general, price and quantity are
inversely related along a demand curve, so that if the price goes down, the quantity
demanded will rise.
d. Given that university students usually must have them in order to pass their courses, the price
elasticity of demand for many assigned textbooks is essentially zero. (2 circles)
(i) Sketch a demand curve that represents this case.
D
Price
Quantity
(ii) Is the seller of textbooks a "price taker"? No.
e. One proposal for improving the diets of Americans is to put a large sales tax on junk foods,
thus making unhealthy food more expensive. Would this policy be relatively more effective in
changing peoples' eating habits if the demand for junk foods is price inelastic or price elastic?
Explain. (2 circles)
It would be more effective if demand for junk food is price elastic. When demand is
price elastic, this means that the quantity demanded changes relatively more in
response to price, than when demand is inelastic. So if demand is elastic and the
price increases, the tax would cause people to eat substantially less unhealthy food.
2. Problem (8 circles total)
Jamal has a side business selling custom ringtones from his website…
$4
B
$3
Demand
$2
A
$1
$0
0
1
2
3
4
5
6
7
8
Quantity of Ringtones
a. Calculate the price elasticity of demand for Jamal's ringtones (using the "midpoint formula"),
for this price change. (4 circles)
We can see from the graph that Q0 = 7 and P0= 2, while Q1 = 3 and P1=$3.
% change in quantity demanded = [(3  7)/((3+7)/2)] × 100 = (-4/5) × 100 =  80%
% change in price = [(3  2)/((3+2)/2)] × 100 = (1/2.5) × 100 = 40%
price elasticity of demand
= |(% change in quantity demanded)/(% change in price)| = |-80%/40%| = 2
b. Is the demand Jamal faces "price elastic" or "price inelastic"? (1 circle)
Price elastic (that is, it is greater than 1).
c. What was his daily revenue from sales before he raised the price? After he raised the price? (1
circle)
Revenue = P × Q
Before: Revenue = $2 × 7 = $14
After: Revenue = $3 × 3 = $9
d. Do you think it's likely that potential buyers feel that there are a number of good, close
substitutes for Jamal's ringtones, or very few good, close substitutes? Why? (1 circle)
They probably feel there are a number of good, close substitutes--this is one of the
things that can make demand elastic.
e. Assuming Jamal wants to keep his revenues high, was raising his price a good idea? (1 circle)
No.
3. Short Answer (Other Concepts) (7 circles total)
a. A consumer can buy all the milk he or she wants at the supermarket, at a constant price. How
would you describe the supply curve faced by this consumer? Use words and sketch a graph. (2
circles)
The supply is perfectly elastic.
Price
S
Quantity
b. Is it possible for the income elasticity of demand for a good to be negative? If so, give an
example of a specific good for which this might be true. (2 circles)
Yes--this is true for inferior goods. An example might be poor quality bread, or
really cheap beer.
c. Fill in the blanks: (3 circles)
(i) Spending on PCs usually is directly related to consumers' incomes: That is, they are
__normal_ goods.
(ii) An increase in the price of PCs makes people who buy PCs essentially "poorer," so
they may buy fewer PCs. This is called the __income___ effect of a price change.
(iii) If the price of PCs rise, people may buy fewer of them, because they can switch to
buying Macs instead. This is called the __substitution___ effect of a price change.
TOTAL POSSIBLE: 25 CIRCLES
Econ 101
Prof. Nelson
Chapter 6 and Beginning of Chapter 7
1. For each of following, state whether it represents a stock or a flow, and which of the
five major kinds of capital it either is (if a stock) or changes the level of (if a flow).
Example: Trees in a forest: Stock, natural capital.
a. The Wheatley Building on the UMB Campus.
b. You learn from a coworker how to do a new task.
c. Your bank savings account.
d. A grocery store gets a shipment of canned goods, which it adds to its shelves.
e. A sewing machine.
f. A highway bridge deteriorates with age.
g. People lose trust in their investment advisors because of all the recent investment
scandals.
h. Coal in the ground.
i. A sewing machine.
j. Laws that make people avoid violence when they deal with each other.
k. A bank issues a new loan.
l. Carbon dioxide continues to build up in the earth's atmosphere.
OVER 
2. Soundly Run is a music recording business. Jonelle, the owner, provides services in
the form of studio space and equipment that musicians can use to record their own music.
She has entered into a long-term lease for the space she rents for the studio, and invested
in thousands of dollars of recording equipment that is always on hand. In order to buy
the equipment, she took out a loan from the bank. As well as giving up working as a
musician in order to devote herself full-time to this business, she keeps one
administrative assistant and one recording engineer on the staff full-time. She has three
other people she calls on to help out, part-time, when the studio is especially busy.
She would like to expand her business by buying more equipment, but hasn't been able to
get a bank loan that would allow her to get purchase more. She would also like to find a
new location, since the neighboring businesses are complaining about the loud noises
coming from the studio. But she can't seem to find the time to search for a new location,
nor does she have the money to hire an agent to search for her.
Name the best example of each of the following, mentioned in the story about Soundly
Run:
Example: output:
a. a fixed input
b. a limiting factor
c. an external cost
d. an opportunity cost
e. an input
f. an accounting cost
g. a transactions cost
h. a variable cost
recording services
Econ 101
Prof. Nelson
Chapter 6 and Beginning of Chapter 7—ANSWERS
1. For each of following, state whether it represents a stock or a flow, and which of the
five major kinds of capital it either is (if a stock) or changes the level of (if a flow). (11
circles total)
Example: Trees in a forest: Stock, natural capital. (1 circle each. Write "1/2" if only half
correct)
m. The Wheatley Building on the UMB Campus.
Stock, manufactured capital.
n. You learn from a coworker how to do a new task.
Flow, human capital.
o. Your bank savings account.
Stock, financial capital.
p. A grocery store gets a shipment of canned goods, which it adds to its shelves.
Flow, manufactured capital (note: addition to inventory)
q. A sewing machine.
Stock, manufactured capital.
r. A highway bridge deteriorates with age.
Flow, manufactured capital. (note: depreciation)
s. People lose trust in their investment advisors because of all the recent investment
scandals.
Flow, social capital.
t. Coal in the ground.
Stock, natural capital.
u. Laws that make people avoid violence when they deal with each other.
Stock, social capital.
v. A bank issues a new loan.
Flow, financial capital.
w. Carbon dioxide continues to build up in the earth's atmosphere.
Flow, natural capital.
2. Soundly Run is a music recording business. Jonelle, the owner, provides services in
the form of studio space and equipment that musicians can use to record their own music.
She has entered into a long-term lease for the space she rents for the studio, and invested
in thousands of dollars of recording equipment that is always on hand. In order to buy
the equipment, she took out a loan from the bank. As well as giving up working as a
musician in order to devote herself full-time to this business, she keeps one
administrative assistant and one recording engineer on the staff full-time. She has three
other people she calls on to help out, part-time, when the studio is especially busy.
She would like to expand her business by buying more equipment, but hasn't been able to
get a bank loan that would allow her to get purchase more. She would also like to find a
new location, since the neighboring businesses are complaining about the loud noises
coming from the studio. But she can't seem to find the time to search for a new location,
nor does she have the money to hire an agent to search for her.
Name the best example of each of the following, that is explicitly mentioned in the story
about Soundly Run: (1 circle each; 8 circles total)
Example: output:
recording services
i. a fixed input
space (or recording equipment)
j. a limiting factor
the amount of recording equipment (or the loan
she can't get)
k. an external cost
the noise suffered by the neighbors
l. an opportunity cost
Jonelle's foregone earnings in another job (as a
musician)
m. an input
space, recording equipment, labor
n. an accounting cost
space, equipment, labor (also—but not
mentioned in the story—interest, depreciation)
o. a transactions cost
the time or money to search for a new location
p. a variable cost
labor (the staff)
TOTAL POSSIBLE: 19 CIRCLES
Econ 101
Prof. Nelson
The Rest of Chapter 7
1. TRX Marketing is a firm that sells service contracts to owners of home appliances, by phone.
(That is, if you have, say, recently bought a dishwasher, they will call and tell you that you can
get all the repairs you need if you buy a contract with a repair company for a "only a low annual
fee!") TRX buys lists of phone numbers of households who have recently purchased appliances
from retailers, and hires telemarketing workers to make the phone calls.
TRX knows that households in certain area codes are more likely to buy service contracts than
people in other area codes, so on any given day they always have the first worker hired call the
most likely-to-buy households. Because later-hired workers get phone numbers with
progressively less promising area codes, the Total Product Curve for the number of service
contracts sold per day, as TRX varies the number of workers they hire, looks like this:
a. Fill out columns (2) and (3) of the Table below, referring to the graph above.
(1)
(2)
Quantity Quantity
of the
of Output
Variable (Contracts)
Input
(Labor)
0
1
2
3
(3)
Marginal
Return
(Contracts)
--
(4)
Fixed
Cost ($)
(5)
Variable
Cost ($)
(6)
Total
Cost ($)
(7)
Cost of an
Additional
Worker ($)
(8)
Marginal
Cost of
Production
($ per
Contract)
--
--
b. The workers are paid $15 per day. All the other costs of running this business total $30 per
day, and have to be paid whether any workers are hired or not. Fill in columns (4), (5), (6) and
(7) of the Table above.
c. Using graph paper or a spreadsheet presentation program, graph the Total Cost Curve. (What
is measured on the horizontal axis? The vertical axis?)
d. Using information from the Table above, calculate the marginal cost per contract sold in
Column (8) above. (Hint: It is equal to Column (7)  Column (3)).
e. Circle the terms among the following which can be used to describe TRX's production and
cost structure, over at least some levels of production:
diminishing (marginal) returns
constant (marginal) returns
increasing (marginal) returns
decreasing marginal costs
constant marginal costs
increasing marginal costs
f. Can you tell from the information given above what the most profitable level of production is,
for TRX Marketing?
g. Suppose, instead, that all the phone numbers that TRX buys are equally likely to result in a
sale. How would the Total Product Curve of this firm likely be different? Explain briefly in
words or a graph.
Econ 101
Prof. Nelson
The Rest of Chapter 7—ANSWERS
1. TRX Marketing is a firm that sells service contracts to owners of home appliances….
the Total Product Curve for the number of service contracts sold per day, as TRX varies the
number of workers they hire, looks like this:
a, b and d: 2 circles for each of columns (2) through (8)—making a total of 14 circles possible
for the complete table
(1)
(2)
Quantity Quantity
of the
of Output
Variable (Contracts)
Input
(Labor)
0
1
2
3
0
4
6
7
(3)
Marginal
Return
(Contracts)
(4)
Fixed
Cost ($)
(5)
Variable
Cost ($)
(6)
Total
Cost ($)
(7)
Cost of an
Additional
Worker ($)
(8)
Marginal
Cost of
Production
($ per
Contract)
-4
2
1
30
30
30
30
0
15
30
45
30
45
60
75
-15
15
15
-3.75
7.50
15.00
The workers are paid $15 per day. All the other costs of running this business total $30 per day,
and have to be paid whether any workers are hired or not.
c. Using graph paper or a spreadsheet presentation program, graph the Total Cost Curve. (What
is measured on the horizontal axis? The vertical axis?) 3 circles
e. 3 circles (1 circle for each of the two correct answers, plus one for NOT circling any incorrect
answers. Subtract a circle for each incorrect answer.)
diminishing (marginal) returns
constant (marginal) returns
increasing (marginal) returns
decreasing marginal costs
constant marginal costs
increasing marginal costs
f. Can you tell from the information given above what the most profitable level of production is,
for TRX Marketing?
NO. (1 circle)
f. Suppose, instead, that all the phone numbers that TRX buys are equally likely to result in a
sale. How would the Total Product Curve of this firm likely be different? Explain briefly in
words or a graph. (2 circles)
The Total Product Curve would be closer to a straight line--perhaps perfectly straight.
(There would be less reason for additional workers to have lower returns.)
TOTAL POSSIBLE: 23 CIRCLES
Econ 101
Prof. Nelson
Chapter 8
1. ABC Gourmet Cola bottles a premium cola—flavored soft drink. The cost structure for the
firm, per day, is given in columns (1) and (3) below.
(1)
Quantity of
Output
(thousands
of bottles)
(2)
Marginal
Cost
(thousands
of $)
0
1
2
3
4
5
--
(3)
Total Cost
(thousands
of $)
(4)
Marginal
Revenue (=
Price) ($ per
bottle)
2
3
4
6
10
17
(5)
Total
Revenue
(thousands
of $)
(6)
Total Profit
(thousands
of $)
--
a. Compute the marginal costs of bottling cola, at each output level. Fill in Column (2)
above.
b. How much does this firm have in fixed costs?
c. Using graph paper or a computer spreadsheet (do not try to just sketch this), graph the
total cost curve for the production of bottled premium cola.
d. Suppose that the premium cola sells for $4 per bottle. Fill in Columns (4)-(6) above.
e. Add a total revenue curve to the graph you created earlier (see the top part of Figure 8.4
in the textbook for an example).
f. Using graph paper or a computer spreadsheet, graph the marginal cost and marginal
revenue curves for this firm (see the lower part of Figure 8.4 in the textbook for an
example).
g. Graph the total profit curve (see Figure 8.6 in the textbook for an example).
h. What is the profit maximizing level of output for the firm?
2. Continuing on from the previous problem:
a. Create a new table showing how the firms situation would change if premium cola sells
for only $2 per bottle.
b. What is the profit-maximizing level of output for the firm, now?
Econ 101
Prof. Nelson
Chapter 8—ANSWERS
1. (17 circles total) ABC Gourmet Cola bottles a premium cola—flavored soft drink. The cost
structure for the firm, per day, is given in columns (1) and (3) below.
a and d: 2 circles each for columns (2),(4),(5) and (6), for a total of 8 circles for the table
(1)
Quantity of
Output
(thousands
of bottles)
(2)
Marginal
Cost
(thousands
of $)
0
1
2
3
4
5
-1
1
2
4
7
(3)
Total Cost
(thousands
of $)
2
3
4
6
10
17
(4)
Marginal
Revenue (=
Price) ($)
-4
4
4
4
4
(5)
Total
Revenue
(thousands
of $)
0
4
8
12
16
20
(6)
Total Profit
(thousands
of $)
-2
1
4
6
6
3
b. How much does this firm have in fixed costs? $2,000 (This is the amount that needs to
be paid, whether they produce or not.) 1 circle
c and e.: 2 circles
f. 2 circles
g. 2 circles
h. Profit is maximized at (3 or) 4 units—that is, (3,000 or) 4,000 bottles per day. 2 circles
2. (6 circles total) Continuing on from the previous problem:
a. Create a new table showing how the firms situation would change if premium cola sells
for only $2 per bottle.
3 circles (notice that only columns (4)-(6) change)
(1)
Quantity of
Output
(thousands
of bottles)
0
1
2
3
4
5
(2)
Marginal
Cost
(thousands
of $)
-1
1
2
4
7
(3)
Total Cost
(thousands
of $)
(4)
Marginal
Revenue (=
Price) ($)
2 -3
4
6
10
17
2
2
2
2
2
(5)
Total
Revenue
(thousands
of $)
0
2
4
6
8
10
(6)
Total Profit
(thousands
of $)
-2
-1
0
0
-2
-7
b. What is the profit-maximizing level of output for the firm, now? 3 circles
Profit is maximized at (2 or) 3 units—that is, (2,000 or) 3,000 bottles per day. Note
that even though the firm makes no profit, it should NOT shut down in the short
run. If it produces zero units, it will be even worse off, making negative profits (that
is, losses).
TOTAL POSSIBLE: 23 CIRCLES
Econ 101
Prof. Nelson
Chapter 9
1. The table below shows the maximum of two items that two countries (N and E) could
produce, if they each specialized entirely in one good or the other. (For example, Nebay could
produce 10 tons of wheat if it specializes in producing only wheat, or 2 tons of lumber if it
produces only lumber.) They each have straight-line Production Possibilities Frontiers for
production of the two goods.
Product
Country
Nebay (N)
Eland (E)
Wheat
Lumber
10 tons
3 tons
2 tons
2 tons
a. Sketch the PPFs for each country, carefully labeling the axes.
b. What is the opportunity cost of producing each product in each country?
One cell has been filled in, below, as an example. From the chart above and the PPF, we know
that in Nebay, the opportunity cost of 10 tons of wheat is 2 tons of lumber. Because the PPF is
linear, producing 1/10th of the total possible amount of wheat will cost 1/10th of the total possible
amount of lumber. So producing 1 ton of wheat "costs" (1/10) 2 tons = 1/5 ton of lumber.
Country
Nebay (N)
Product
Opportunity Cost of
Opportunity Cost of
1 ton of Wheat
1 ton of Lumber
1/5 ton of lumber
Eland (E)
c. Suppose that people in Nebay would like to consume 7 tons of wheat and 1 ton of lumber.
Mark this point on their PPF. Suppose that people in Eland would like to consume 3 tons of
wheat and 1 ton of lumber. Market this point on their PPF. Can the two countries achieve these
desired consumption bundles separately, each producing only for itself?
d. Describe a process by which each country could attain its desired consumption bundle. Give
numbers.
e. Suppose you are the Commissioner of Foreign Trade for Eland. Eland is weaker in military
strength than Nebay, and you haven't been able to find any countries other than Nebay interested
in buying the good your country sells. Suppose that you meet with a representative from Nebay
meet to discuss the terms of exchange.
(1) With the consumption desires of your country's people in mind, what is the minimum
offer you would accept for selling 1 ton of the good you have been selling, before you
would stop trading with Nebay? Explain how you arrived at your answer.
(2) If Nebay uses its superior strength in bargaining with you over trade, which country
will benefit more from trade?
f. Which of the following concepts are illustrated somewhere in this story? (List or circle only
those that apply).
the principle of comparative advantage
a disadvantage of transfer
gains from specialization and exchange
the fact that voluntary exchange isn't always fair
in-kind transfers
infant industry
Gini ratio
Econ 101
Prof. Nelson
Chapter 9 ANSWERS
1. The table below shows the maximum of two items that two countries (N and E) could
produce, if they each specialized entirely in one good or the other. …They each have straightline Production Possibilities Frontiers for production of the two goods.
Product
Country
Nebay (N)
Eland (E)
Wheat
Lumber
10 tons
3 tons
2 tons
2 tons
a. Sketch the PPFs for each country, carefully labeling the axes. (2 circles. Note: it’s OK if you
reverse the axes.)
b. What is the opportunity cost of producing each product in each country?
Country
Product
Opportunity Cost of
Opportunity Cost of
1 ton of Wheat
1 ton of Lumber
Nebay (N)
1/5 of a ton of lumber
5 tons of wheat
(1 circle)
Eland (E)
2/3 of a ton of lumber
(1 circle)
3/2 tons of wheat
(1 circle)
c. Suppose that people in Nebay would like to consume 7 tons of wheat and 1 ton of lumber.
Mark this point on their PPF. Suppose that people in Eland would like to consume 3 tons of
wheat and 1 ton of lumber. Market this point on their PPF. Can the two countries achieve these
desired consumption bundles separately, each producing only for itself? NO. (3 circles)
d. Describe a process by which each country could attain its desired consumption bundle. Give
numbers. (4 circles. Either the table or words is OK, or both.)
Production
N
E
total
Wheat
10
0
10
Lumber
0
2
2
Exchange
N
E
sell 3
buy 3
buy 1
sell 1
Consumption
N
E
7
3
10
total
1
1
2
That is, Nebay specializes in wheat (in which it has a comparative advantage—its
opportunity costs are relatively low) and Eland specializes in lumber (where it has the
comparative advantage). Nebay sells 3 tons of wheat to Eland in exchange for 1 ton of
lumber. Both countries consume their preferred bundles.
e. Suppose you are the Commissioner of Foreign Trade for Eland. Eland is weaker in military
strength than Nebay, and you haven't been able to find any countries other than Nebay interested
in buying the good your country sells. Suppose that you meet with a representatives from Nebay
meet to discuss the terms of exchange.
(1) With the consumption desires of your country's people in mind, what is the minimum
offer you would accept for selling 1 ton of the good you have been selling, before you
would stop trading with Nebay? Explain how you arrived at your answer.
Eland would accept no less than 1.5 tons of wheat in return for 1 ton of lumber.
Anything less than this, it could produce itself, while still domestically producing
and consuming one ton of lumber. (See the PPF.) (At exactly 1.5 tons of wheat per
ton of lumber, it would be indifferent between trading and not trading.) 1 circle
(2) If Nebay uses its superior strength in bargaining with you over trade, which country
will benefit more from trade?
Obviously, Nebay will. They can get more than their "desired consumption," while
Eland may not get much out of the deal at all. 1 circle
f. Which of the following concepts are illustrated somewhere in this story? (List or circle only
those that apply). 1 circle for each correctly included answer, and -1 for each one incorrectly
included.
the principle of comparative advantage
a disadvantage of transfer
gains from specialization and exchange
the fact that voluntary exchange isn't always fair
in-kind transfers
infant industry
Gini ratio
TOTAL POSSIBLE: 17 CIRCLES
Econ 101
Prof. Nelson
Chapter 10
1. Ka's utilities from playing Star Force (SF) and Return of Ishtar (RI) at her local arcade are in
the graphs below. The arcade charges $1 per game (for any game), and she has enough money to
play four games. If she plays 3 games of SF and 1 of RI (as shown by large points on the graphs
below), has she acted rationally to "maximize utility"? Complete the steps below to prove why or
why not.
a. What is her total utility from playing 3 games of SF and 1 of RI?
b. What is the marginal utility she gets from playing the 3rd game of SF? From playing the 1st
game of RI?
c. Now, what combination of games (that she can afford) would give her the most utility?
d. Explain in a sentence or two how your answer to part (c) illustrates the "rule" for utility
maximization in the neoclassical model of consumption.
2. Jose has $4 to spend on a quick breakfast. Energy bars cost $1 each and beverages (juice or
coffee cost) cost $2 per serving.
a. Sketch Jose's budget line.
b. Can Jose afford coffee, juice, and an energy bar? Show this point on your graph, as well as
stating "yes" or "no."
c. If the price of beverages falls to $1 per serving, how would his budget line change? Show in
the same graph.
d. After the fall in prices, can Jose afford coffee, juice, and an energy bar? Could he get more?
3. Suppose you are in charge of a marketing campaign to increase sales of sweatshirts
emblazoned with "University of Massachusetts Boston" and the university's logo. Describe how
your marketing campaign--that is, the characteristics of the sweatshirts you might emphasize, the
sort of people you might try to sell it to, and/or the slogans you might use--would differ,
depending on whether you target people's:
a. physiological needs
b. social needs
c. interest in membership groups
d. interest in aspirational groups
e. self-actualization needs
(The best slogans will be read out in class!)
Econ 101
Prof. Nelson
Chapter 10—ANSWERS
1. Ka's utilities from playing Star Force (SF) and Return of Ishtar (RI) at her local arcade are in
the graphs below. The arcade charges $1 per game (for any game), and she has enough money to
play four games. If she plays 3 games of SF and 1 of RI (as shown by large points on the
graphs), has she acted rationally to "maximize utility"? Complete the steps below to prove why
or why not.
a. What is her total utility from playing 3 games of SF and 1 of RI?
20 utils from SF + 12 utils from RI = 32 utils
b. What is the marginal utility she gets from playing the 3rd game of SF?
+2 utils (= 20 for three games – 18 for two games)
From playing the 1st game of RI?
+ 12 utils
c. Now, what combination of games (that she can afford) would give her the most utility?
2 SF games and 2 RI games: this gives 18 + 20 = 38 utils.
You can find this by comparing 3 SF and 1 RI (32 utils), 2 of each (38 utils) and 1 SF and 3 RI
(34 utils), OR by applying the "rule."
d. Explain in a sentence or two how your answer to part (c) illustrates the "rule" for utility
maximization in the neoclassical model of consumption.
The rule says that the marginal utilities per dollar should be made equal across goods. The
marginal utilities of the games (per dollar) are equated if Ka plays two games of each. (In
each case, the marginal utility of the 2nd game is +8.)
2. Jose has $4 to spend on a quick breakfast. Energy bars cost $1 each and beverages (juice or
coffee cost) cost $2 per serving.
a. Sketch Jose's budget line.
b. Can Jose afford coffee, juice, and an energy bar? Show this point on your graph, as well as
stating "yes" or "no." NO.
c. If the price of beverages falls to $1 per serving, how would his budget line change? Show in
the same graph.
d. After the fall in prices, can Jose afford coffee, juice, and an energy bar? Could he get more?
Yes. Has a dollar left over—he could get another energy bar.
3. Suppose you are in charge of a marketing campaign to increase sales of sweatshirts
emblazoned with "University of Massachusetts Boston" and the university's logo. Describe how
your marketing campaign--that is, the characteristics of the sweatshirts you might emphasize, the
sort of people you might try to sell it to, and/or the slogans you might use--would differ,
depending on whether you target people's:
a. physiological needs: Emphasize warmth, or sell to cold people.
b. social needs: Imply that wearing this will get you friends.
c. interest in membership groups: Sell to UMB students, to advertize being a part of the
student community.
d. interest in aspirational groups. Sell to high school students, to advertize that they are
college- bound.
e. self-actualization needs: Emphasize how education can make you "be all you can be"—
and imply that dressing right is part of the process. (Think yoga clothing…)
(The best slogans will be read out in class!)
Econ 101
Prof. Nelson
Chapter 11
1. The neoclassical model of "perfect competition" is central to the argument, made by some
economists, that a system of market exchange leads to the highest levels of allocative efficiency
and well-being (while government action, on the other hand, is said to lead to inefficiency and
loss of well-being). But this conclusion only follows to the extent that real-world markets behave
like idealized neoclassical "perfectly competitive" markets.
For each of the following cases, answer "YES" if the model would apply to a situation
characterized by the situation described. Answer "NO" if it would not, and, in this case, also
explain why.
Example: The distribution of income is very unjust.
Answer: NO: the model assumes that society finds the current distribution of income to be
acceptable.
a) There are numerous small buyers and sellers.
b) People aren't really sure about the true quality of the goods being sold in the market.
c) Various kinds of goods are sold in the market.
d) Producers can freely enter or exit the industry.
e) The good being sold is one that contributes to environmental pollution.
f) All goods are private. (That is, there are no public goods.)
g) Production is characterized by economies of scale.
2. Suppose the market for apples is in competitive equilibrium, with 10,000 apples (per day)
selling for $.50 each.
a) Sketch a supply and demand graph of this market, clearly labeling your curves and the
equilibrium price and quantity.
b) One of the apple producers sells 50 apples (a day). Sketch a supply and demand graph
showing this individual firm's situation.
c) Suppose some firms leave this market—that is, they stop producing apples. Show the
effect of this on the market and individual firm graphs.
d) How much profit will a firm in this market make, after every firm that might want to
enter or exit has done so? Explain why.
Go to next page 
3. Suppose the market for apples starts out in competitive equilibrium, with 10,000 apples (per
day) being sold. Then an excise tax is put on apples, of $.05 per apple. After the tax, only 9,000
apples (per day) are sold on this market.
a) Sketch a supply and demand graph illustrating the imposition of this tax on the apple
market. Use numbers in labeling your horizontal axis.
b) Label the area of consumer surplus (after the imposition of the tax) on your graph "CS,"
the area of producer surplus "PS", and the area of deadweight loss "DWL."
c) A government official considering imposing this tax says, "Well, a $.05 tax per apple on
10,000 apples should bring in $500. So that's how much revenue we can expect to raise
from this tax." Is the official right or wrong? (How much revenue is actually raised?)
Explain.
Econ 101
Prof. Nelson
Chapter 11—ANSWERS
1. Answer "YES" if the neoclassical model of "perfect competition" leading to the highest level
of well-being would apply to a situation characterized by the situation described. Answer "NO"
if it would not, and, in this case, also explain why.
h) There are numerous small buyers and sellers.
YES.
i) People aren't really sure about the true quality of the goods being sold in the market.
NO. The model assumes perfect information.
j) Various kinds of goods are sold in the market.
NO. Only one kind of good is sold, and all units are identical.
k) Producers can freely enter or exit the industry.
YES
l) The good being sold is one that contributes to environmental pollution.
NO. For the well-being result, there can be no externalities. (See text, p. 293).
m) All goods are private. (That is, there are no public goods.)
YES.
n) Production is characterized by economies of scale.
NO. In the model, production must be characterized by constant returns to scale.
(See text, bottom of p. 289).
2. Suppose the market for apples is in competitive equilibrium, with 10,000 apples (per day)
selling for $.50 each.
e) Sketch a supply and demand graph of this market, clearly labeling your curves and the
equilibrium price and quantity.
f) One of the apple producers sells 50 apples (a day). Sketch a supply and demand graph
showing this individual firm's situation.
g) Suppose some firms leave this market—that is, they stop producing apples. Show the
effect of this on the market and individual firm graphs.
Market
Individual Firm
h) How much profit will a firm in this market make, after every firm that might want to
enter or exit has done so? Explain why.
Zero economic profit (or normal profit). If they made more than this, more firms
would be attracted to this market, entering and driving down prices and profits. If they
made less than this, firms would give up and leave the market, driving up prices and
profit.
3. Suppose the market for apples starts out in competitive equilibrium, with 10,000 apples (per
day) being sold. Then an excise tax is put on apples, of $.05 per apple. After the tax, only 9,000
apples (per day) are sold on this market.
d) Sketch a supply and demand graph illustrating the imposition of this tax on the apple
market. Use numbers in labeling your horizontal axis.
e) Label the area of consumer surplus (after the imposition of the tax) on your graph "CS,"
the area of producer surplus "PS", and the area of deadweight loss "DWL."
f) A government official considering imposing this tax says, "Well, a $.05 tax per apple on
10,000 apples should bring in $500. So that's how much revenue we can expect to raise
from this tax." Is the official right or wrong? (How much revenue is actually raised?)
Explain.
The official forgot that consumers would respond to the higher plus-tax price by buying
fewer apples. The tax will raise $.05  9,000 = $450.
Econ 101
Prof. Nelson
Chapter 12 (and pp. 440-442)
1. Fill in the blanks in the following, using terms from your textbook's discussion of
market structures with market power, and their regulation.
a) You notice that when the biggest airline company raises its fares from Boston to
New York, all the other airlines firms in that market do, too. You wonder if this
could be a case of ________________________.
b) You observe a market in which a fairly large number of firms all make similar
products, and advertize their brands heavily. An economist would say that the
market is characterized by the structure of _______________________________.
c) A large cable company in Boston, seeing a small new company trying to break
into the Boston market for cable services, begins to offer its services at a new and
very, very low price. An alert economist (or lawyer) may suspect that this could
be a case of _______________________.
d) Lots of companies offer cable services nationwide, but only one offers services in
the town of East Podunk, Maine. An economist would say that this company is
(or has) a _____________________.
e) You observe that a health insurance company has been making very high profits,
over a long period of time. You also notice that the service it sells is not unique.
You conclude that the market is probably structured as a(n)
__________________________.
f) You own a business located in Boston, and believe that one of your fellow
Boston-based competitors is using an illegal and unfair business practice to try to
drive you out. You will complain to the _____________________ or the
______________________.
2. Only one firm in the world produces Gizmorex, a new, patented drug. The demand
curve for Gizmorex is described in the demand schedule below. (The unit of quantity is
hundreds of doses.)
Quantity of
Gizmorex
(units)
0
1
2
3
Selling Price
($ per unit)
—
150
110
70
Total
Revenue
($)
0
Marginal
Revenue
($)
—
a. Calculate the total and marginal revenue corresponding to each level of production.
b. Add the Demand and Marginal Revenue curves to the following figure.
c. What quantity will the Gizmorex producer make and sell, if it's goal is to maximize
profits? Explain how you got your answer.
d. How much will the profit-maximizing Gizmorex producer charge the buyer, for each
unit?
3. Suppose that two shopping mall firms located in a hot climate each are deciding how
much to spend on air conditioning. The electricity needed to keep a mall air conditioned
to 74 F is very expensive. But if either keeps its mall warmer than 74 F, most of the
customers will go to the other mall, and the firm will make losses. Taking a look at the
profit situation, we can see that keeping the mall too warm reduces profits by drastically
reducing revenues, while spending a lot on air conditioning reduces profits somewhat by
raising costs. The payoff matrix for these firms' decisions is thus as follows:
Firm 1’s Options
Firm 2’s Options
Spend a lot
Spend a little
low profit
Spend a
lot
Spend a
little
low profit
high profit
high profit
loss
loss
moderate profit
moderate profit
a. If Firm 1 decides to spend a lot on air conditioning, and Firm 2 spends only a little,
how much profit will each firm make? (Answer in words.)
b. If Firm 1 decides to spend a lot, what is the worst that can happen to it? If it decides to
spend only a little, what is the worst that can happen to it? What, then, would Firm 1
choose to do, if it wants to be reasonably well off no matter what the other firm does?
c. If the firms are noncooperative, and each firm makes the choice that leaves it best off
no matter what the other firm does, what will the outcome be?
d. Suppose that, due to concerns about carbon emissions and climate change, the
government passes a law that says that shopping malls may not set their air conditioning
below 80 F. How would this rule change the profit situation of these two firms?
e. Some people claim that "Environmental regulations are bad for business!" Does your
analysis in part (d) support this claim? Explain.
Econ 101
Prof. Nelson
Chapter 12 (and pp. 440-442)—ANSWERS
1. Fill in the blanks in the following, using terms from your textbook's discussion of
market structures with market power, and their regulation.
a) You notice that when the biggest airline company raises its fares from Boston to
New York, all the other airlines firms in that market do, too. You wonder if this
could be a case of price leadership.
b) You observe a market in which a fairly large number of firms all make similar
products, and advertize their brands heavily. An economist would say that the
market is characterized by the structure of monopolistic competition.
c) A large cable company in Boston, seeing a small new company trying to break
into the Boston market for cable services, begins to offer its services at a new and
very, very low price. An alert economist (or lawyer) may suspect that this could
be a case of predatory pricing.
d) Lots of companies offer cable services nationwide, but only one offers services in
the town of East Podunk, Maine. An economist would say that this company is
(or has) a local monopoly.
e) You observe that a health insurance company has been making very high profits,
over a long period of time. You also notice that the service it sells is not unique.
You conclude that the market is probably structured as a(n) oligopoly.
f) You own a business located in Boston, and believe that one of your fellow
Boston-based competitors is using an illegal and unfair business practice to try to
drive you out. You will complain to the Federal Trade Commission or the
Department of Justice.
2. Only one firm in the world produces Gizmorex, a new, patented drug. The demand
curve for Gizmorex is described in the demand schedule below. (The unit of quantity is
hundreds of doses.)
Quantity of
Gizmorex
(units)
0
1
2
3
Selling Price
($ per unit)
—
150
110
70
Total
Revenue
($)
0
150
220
210
Marginal
Revenue
($)
—
150
70
-10
a. Calculate the total and marginal revenue corresponding to each level of production.
(see table)
b. Add the Demand and Marginal Revenue curves to the following figure.
c. What quantity will the Gizmorex producer make and sell, if it's goal is to maximize
profits? Explain how you got your answer.
2 units, because this is where MR=MC.
d. How much will the profit-maximizing Gizmorex producer charge the buyer, for each
unit?
$110
3. Suppose that two shopping mall firms located in a hot climate each are deciding how
much to spend on air conditioning. The electricity needed to keep a mall air conditioned
to 74 F is very expensive. But if either keeps its mall warmer than 74 F, most of the
customers will go to the other mall, and the firm will make losses. Taking a look at the
profit situation, we can see that keeping the mall too warm reduces profits by drastically
reducing revenues, while spending a lot on air conditioning reduces profits somewhat by
raising costs. The payoff matrix for these firms' decisions is thus as follows:
Firm 1’s Options
Firm 2’s Options
Spend a lot
Spend a little
low profit
Spend a
lot
Spend a
little
low profit
high profit
high profit
loss
loss
moderate profit
moderate profit
a. If Firm 1 decides to spend a lot on air conditioning, and Firm 2 spends only a little,
how much profit will each firm make? (Answer in words.)
Firm 1: high profit
Firm 2: loss
b. If Firm 1 decides to spend a lot, what is the worst that can happen to it? If it decides to
spend only a little, what is the worst that can happen to it? What, then, would Firm 1
choose to do, if it wants to be reasonably well off no matter what the other firm does?
If it spends a lot, the worst possibility is making low profit.
If it spends a little, the worst possibility is making a loss.
So it will choose to spend a lot.
c. If the firms are noncooperative, and each firm makes the choice that leaves it best off
no matter what the other firm does, what will the outcome be?
Both firms will choose to spend a lot (that is, keep their malls cool and pay high
electricity bills). Both will make low profits.
d. Suppose that, due to concerns about carbon emissions and climate change, the
government passes a law that says that shopping malls may not set their air conditioning
below 80 F. How would this rule change the profit situation of these two firms?
Now both firms are forced to spend less on electricity. This will raise profits for
each of them. (Each can keep its mall warmer, without losing customers, since the
other mall is now warmer, too.)
e. Some people claim that "Environmental regulations are bad for business!" Does your
analysis in part (d) support this claim? Explain.
No. In this case, the regulation forces them to do something that is actually good for
profits, that they couldn't do on their own.