Download Answers to the Problems Charpter 1 1. a. Tunes remain scarce

Answers to the Problems
Charpter 1
1.
a.
Tunes remain scarce because even with iTunes making tunes feely available,
many people do not own iPods and so cannot enjoy music away from their
computers. In addition, tunes remain scarce even for people with Ipods because
they might want to listen to music at times they cannot, such as when they are in
class listening to the instructor.
b.
Apple’s decision changes people’s incentives. For example, it increases people’s
incentives to buy an iPod in order to take advantage of the newly “free” music
available on iTunes.
c.
Apple’s decision is a microeconomic decision because it affects a single company
and a single market.
d.
Apple’s decision decreases the opportunity cost of a tune by removing the
previous monetary cost of 99¢ per tune.
2.
3.
a.
Labor is paid wages, so this pair matches.
b.
Land is paid rent, so this pair matches.
c.
Entrepreneurship is paid profit, so this pair matches.
d.
Capital is paid interest, so this pair does not match.
a.
Wal-Mart’s expansion is a decision made by Wal-Mart in order to further
Wal-Mart’s interest. Thus the decision is directly in Wal-Mart’s self interest. The
question of whether this sort of choice also furthers the social interest is one that is
studied in microeconomics.
b.
Taco bell’s expansion is a decision made by Taco Bell in order to further Taco
Bell’s interest. Thus the decision is directly in Taco bell’s self interest. The
question of whether this sort of choice also furthers the social interest is one that is
studied in microeconomics.
c.
McDonald’s decision to serve salads is a decision made by McDonald’s in order
to further McDonald’s interest. Thus the decision is directly in McDonald’s self
interest. The question of whether this sort of choice also furthers the social interest
is one that is studied in microeconomics.
d.
The decision to require that food must be labeled with nutrition information is
made in the social interest. This decision is not made by any one single firm and
so does not (necessarily) reflect anyone’s self interest.
4.
a.
Yes, you faced a tradeoff. The tradeoff was between a higher test score and an
evening you’re your friends at the movies.
b.
The opportunity cost of going to the movies is the fall in your grade. That is the 20
points forgone from choosing to see the movie rather than study.
5.
6.
a.
The statement is normative and cannot be tested.
b.
The statement is positive and can be tested.
c.
The statement is positive and can be tested.
a.
The statement reflects the fallacy of composition.
b.
c.
The statement reflects the fallacy of composition.
The statement reflects the post hoc fallacy.
Charpter 2
1.
a.
Wendell’s opportunity cost of an hour of tennis is 2.5 percentage points.
When Wendell increases the time he plays tennis from 4 hours to 6 hours, his
grade in economics falls from 75 percent to 70 percent. His opportunity cost of 2
hours of tennis is 5 percentage points. So his opportunity cost of 1 hour of tennis
is 2.5 percentage points.
b.
Wendell’s opportunity cost of an hour of tennis is 5 percentage points.
When Wendell increases the time he plays tennis from 6 hours to 8 hours, his
grade in economics falls from 70 percent to 60 percent. His opportunity cost of 2
hours of tennis is 10 percentage points. So his opportunity cost of 1 hour of tennis
is 5 percentage points.
2.
a.
Wendell’s grade in economics is 66 percent.
When Wendell increases the time he plays tennis from 4 hours to 6 hours, his
opportunity cost of the additional 2 hours of tennis is 5 percentage points. So his
opportunity cost of an additional 1 hour is 2.5 percentage points. Plot this
opportunity cost at 5 hours on the graph (the midpoint between 4 and 6 hours).
When he increases the time he plays tennis from 6 hours to 8 hours, his
opportunity cost of the additional 2 hours of tennis is 10 percentage points. So his
opportunity cost of the additional 1hour of tennis is 5 percentage points. Plot this
opportunity cost at 7 hours on the graph (the midpoint between 6 and 8 hours).
When he increases the time he plays tennis from 8 hours to 10 hours, his
opportunity cost of the additional 2 hours of tennis is 20 percentage points. So his
opportunity cost of the additional 1hour of tennis is 10 percentage points. Plot this
opportunity cost at 9 hours on the graph (the midpoint between 8 and 10 hours).
Wendell’s opportunity cost of playing tennis increases as he spends more time on
tennis. Join the points plotted. This curve is Wendell’s marginal cost of a
additional hour of tennis.
Wendell uses his time efficiently if he plays tennis for 7 hours a week because
when he plays 7 hours a week his marginal benefit from tennis equals its marginal
cost. Wendell’s marginal benefit is 5 percentage points and his marginal cost is 5
percentage points. When Wendell plays 7 hours of tennis, his grade in economics
(from his PPF) is 66 percent.
b.
If Wendell studied for enough hours to get a higher grade, he would have fewer
hours to play tennis. Wendell’s marginal benefit from tennis would be greater than
his marginal cost, so he would be more efficient (better off) if he played more
hours of tennis and took a lower grade.
3.
a.
Sunland’s PPF is a straight line.
To make a graph of Sunland’s PPF, measure the quantity of one good on the
x-axis and the quantity of the other good on the y-axis. Then plot the quantities in
each row of the table and join the points.
b.
The opportunity cost of 1 pound of food is 1/2 gallon of sunscreen.
The opportunity cost of the first 150 pounds of food is 75 gallons of sunscreen. To
find the opportunity cost of the first 150 pounds of food, increase the quantity of
food from 0 pounds to 150 pounds. In doing so, Sunland’s production of
sunscreen decreases from 150 gallons to 75 gallons. The opportunity cost of the
first 150 pounds of food is 75 gallons of sunscreen. Similarly, the opportunity
costs of producing the second 150 pounds of food is 75 gallons of sunscreen. So
the opportunity cost of 1 pound of food is 75 gallons of sunscreen/150 pounds of
food, or 1/2 gallon of sunscreen per pound of food.
c.
The opportunity cost of 1 gallon of sunscreen is 2 pounds of food.
The opportunity cost of producing the first 75 gallons of sunscreen is 150 pounds
of food. To calculate this opportunity cost, increase the quantity of sunscreen from
0 gallons to 75 gallons. Sunland’s production of food decreases from 300 pounds
to 150 pounds. Similarly, the opportunity cost of producing the second 75 gallons
of sunscreen is 150 pounds of food. So the opportunity cost of 1 gallon of
sunscreen is 150 pounds of food/75 gallons of sunscreen, or 2 pounds of food per
gallon of sunscreen.
4.
a.
The marginal benefit curve slopes downward.
To draw the marginal benefit from sunscreen, plot the quantity of sunscreen on the
x-axis and the willingness to pay for sunscreen (that is, the number of pounds of
food that they are willing to give up to get a gallon of sunscreen) on the y-axis.
b.
The efficient quantity is 75 gallons a month.
The efficient quantity to produce is such that the marginal benefit from the last
gallon equals the opportunity cost of producing it. The marginal cost of a gallon of
sunscreen is 2 pounds of food. The marginal benefit of the 75th gallon of
sunscreen is 2 pounds of food. So the marginal benefit equals marginal cost when
Sunland produces 75 gallons of sunscreen per month.
5.
a.
The PPF will have the quantity of wheat on one axis and the quantity of pork on
the other axis. The PPF will be bowed outward from the origin.
b.
The PPF will shift outward so that the maximum quantity of pork increases but
the maximum quantity of wheat does not change. The PPF will remain bowed
outward from the origin.
c.
The opportunity cost of a ton of wheat has increased because the new technology
means that more pork must be forgone for each ton of wheat. In the PPF diagram,
if the quantity of wheat is measured along the horizontal axis, the opportunity cost
of a ton of wheat equals the slope of the PPF. With the new technology, the PPF
has shifted so that the magnitude of the slope is larger, which means that the
opportunity cost of a ton of wheat is larger. If the quantity of wheat is measured
along the horizontal axis, the opportunity cost of a ton of wheat equals the
reciprocal of the slope. With the new technology, the PPF has shifted so that the
magnitude of the slope is smaller, which means that the opportunity cost of a ton
of wheat is larger.
d.
As long as the farm produces on its PPF, it is production efficient both before and
after the change in technology. If the farm produces at a point within its PPF, then
it is production inefficient both before and after the change in technology.
6.
a.
Tom’s opportunity cost of producing a ball is 4 bats/40 balls, or 0.10 bats per ball.
b.
Tessa’s opportunity cost of producing a ball is 4 bats/80 balls, or 0.05 bats per
ball.
c.
Tessa has the comparative advantage in producing balls because her opportunity
cost of a ball is lower than Tom’s opportunity cost.
d.
Both Tom and Tessa gain from the specialization and trade.
Tom specializes in producing bats and Tessa specializes in producing balls. Tom
produces 4 bats per hour and Tessa produces 80 balls, for total production of 4
bats and 80 balls. If neither specialized and both spent half their time producing
balls and the other half producing bats, Tom would produce 2 bats and 20 balls
and Tessa would produce 2 bats and 40 balls. The total production would be 4 bats
(2 from Tom and 2 from Tessa) and 60 balls (20 from Tom and 40 from Tessa).
Specialization means that Tom can trade 2 bats for 30 balls and so have 2 bats and
30 balls, 10 more balls than the case without specialization and trade. Tessa would
have 2 bats and 50 balls, (also) 10 more balls than the case without specialization
and trade.
e.
Tessa has the comparative advantage in producing bats.
Tom’s opportunity cost of a bat is 40 balls/4 bats, or 10 balls per bat. Tessa’s
opportunity cost of a bat is 80 balls/20 bats or 4 balls per bat. Tessa has the
comparative advantage in producing bats because her opportunity cost of
producing a bat is lower than Tom’s opportunity cost of producing a bat.
f.
Tom and Tessa can still gain from trade if each specializes in his or her
comparative advantage (Tom in balls, Tessa in bats) and then trades.
g.
Tessa specializes in bats and is definitely willing to trade 1 bat for 15 balls
because her opportunity cost of producing a bat is only 4 balls. Tom, however, is
not willing to pay Tessa 15 balls for a bat because his cost of producing a bat is
only 10 balls. Tom can produce bats at a lower cost than 15 balls per bat. The
price of a bat will settle so that it is less than Tom’s opportunity cost of producing
a bat and more than Tessa’s opportunity cost of producing a bat.
Charpter 3
1.
a.
½ pound of wool trades for 1 pound of butter trades.
b.
Butter is 40¢ a pound.
c.
Yes, many people would accept Mr. Gregg’s offer. People could use $1.60 to buy
8 pounds of bacon. They could then trade this bacon with Mr. Gregg for 8 yards of
cloth. Then they could trade the 8 yards of cloth for 1 bushel of salt. The salt
could be sold for $2.00, which would leave a profit of $0.40.
2.
a.
Bottled water and health club memberships are complements in consumption
because people in health clubs drink a lot of bottled water.
3.
b.
French fries and baked potatoes are substitutes in consumption.
c.
Leather purses and leather shows are substitutes in production.
d.
SUVs and pickup trucks are substitutes in consumption.
e.
Diet coke and regular coke are substitutes in consumption and in production.
f.
Low-fat milk and cream are complements in production.
The statement is false for several reasons. First, if the demand for Internet services
increases and nothing else changes, the price of Internet service will rise not fall.
Second, if the price of Internet services falls, the supply of Internet services does not
change. Rather, there is a decrease in the quantity supplied, that is, a movement along
the supply curve rather than a shift of the supply curve.
4.
a.
The price of a recordable CD will rise, and the quantity of recordable CDs sold
will increase.
Recordable CDs and MP3 downloads are substitutes. If the price of an MP3
download rises, people will buy more recordable CDs and fewer MP3 downloads.
The demand for recordable CDs will increase. The price of a recordable CD will
rise, and more recordable CDs will be sold.
b.
The price of a recordable CD will fall, and fewer recordable CDs will be sold.
Recordable CDs and iPods are substitutes. If the price of an iPod falls, more iPods
will be bought. The demand for recordable CDs will decrease. The price of a
recordable CD will fall, and people will buy fewer recordable CDs.
c.
The price of a recordable CD will rises and more recordable CDs will be sold.
CD players and recordable CDs are complements. The increase in the supply of
CD players will lower the price of a CD player. With CD players cheaper than
they were, some people will buy CD players. The demand for recordable CDs will
increase. The price of a recordable CD will rise, and people will buy more
recordable CDs.
d.
The price of a recordable CD will rise, and the quantity sold will increase.
A recordable CD is a normal good. An increase in consumers’ income will
increase the demand for recordable CDs. As a result, the price of a recordable CD
will rise and the quantity sold will increase.
e.
The price of a recordable CD will rise, and the quantity sold will decrease.
If the workers who make recordable CDs get a pay raise, the cost of making a
recordable CD increases and the supply of recordable CDs decreases. The price
will rise, and people will buy fewer recordable CDs.
f.
The price will rise but the quantity sold might decrease, increase, or stay the same.
Recordable CDs and MP3 downloads are substitutes. If the price of an MP3
download rises, fewer MP3 downloads will be bought and so the demand for
recordable CDs will increase. The price of a recordable CD will rise and people
will buy more recordable CDs. If the wages paid to workers who make recordable
CDs rise, the supply of recordable CDs decreases. The quantity of recordable CDs
sold will decrease and the price of a recordable CD will rise. Taking the two
events together, the price definitely rises, but the quantity sold might increase,
decrease, or stay the same.
5.
a.
(ii) and (iii) and (iv)
The demand for gasoline will change if the price of a car changes, all speed limits
on highways are abolished, or robot production cuts the cost of producing a car. If
the price of a car rises, the quantity of cars bought decrease. So the demand for
gasoline decreases. If all speed limits on highways are abolished, people will drive
faster and use more gasoline. The demand for gasoline increases. If robot
production plants lower the cost of producing a car, the supply of cars will
increase. With no change in the demand for cars, the price of a car will fall and
more cars will be bought. The demand for gasoline increases.
b.
(i)
The supply of gasoline will change if the price of crude oil changes. If the price of
crude oil rises, the cost of producing gasoline will rise. So the supply of gasoline
decreases.
c.
(i)
If the price of crude oil (a resource used to make gasoline) rises, the cost of
producing gasoline will rise. So the supply of gasoline decreases. The demand for
gasoline does not change, so the price of gasoline will rise and there is a
movement up the demand curve for gasoline. The quantity demanded of gasoline
decreases.
d.
(ii) and (iii) and (iv)
If the price of a car rises, the quantity of cars bought decrease, so the demand for
gasoline decreases. The supply of gasoline does not change. The price of gasoline
falls and there is a movement down the supply curve of gasoline. The quantity
supplied of gasoline decreases.
If all speed limits on highways are abolished, people will drive faster and use
more gasoline. The demand for gasoline increases. The supply of gasoline does
not change, so the price of gasoline rises and there is a movement up along the
supply curve. The quantity supplied of gasoline increases.
If robot production plants lower the cost of producing a car, the supply of cars will
increase. With no change in the demand for cars, the price of a car will fall and
more cars will be bought. The demand for gasoline increases. The supply of
gasoline does not change, so the price of gasoline rises and the quantity of
gasoline supplied increases.
4.
a.
(i)
The demand for leather bags will increase when airfares halve. More people will
plan on buying an air ticket and will also plan on buying a travel bag. Then
demand for leather bags will increase.
b.
(ii), (iii), and (iv)
The supply of leather will decrease when the price of beef falls. Cowhide (from
which leather is made) is a complement in production of beef. If the price of beef
falls, fewer cows will be slaughtered and less cowhide will be produced. The
supply of leather decreases. The price of leather will rise and the supply of leather
bags will decrease.
The producers of leather bags will switch to using the cheaper cloth. The supply
of leather bags will decrease.
A new technology for cutting leather will lower the cost of making a leather bag
and the increase the supply of leather bags.
c.
(ii), (iii), and (iv)
When the supply of leather bags changes, there is a shift of the supply curve of
leather bags and a movement along the demand curve of leather bags. The
quantity demanded of leather bags will increase if the supply of leather bags
increases and the quantity demanded of leather bags will decrease if the supply of
leather bags decreases. So a fall in the price of beef and a new cheaper cloth for
making bags will lead to a decrease in the quantity demanded of leather bags. A
new technology increases the supply of leather bags and increases the quantity
demanded of leather bags.
d.
(i)
When the demand for leather bags changes, there is a shift of the demand curve
and a movement along the supply curve. The quantity supplied of leather bags will
increase when the demand for leather bags increases.
6.
The demand curve is the curve that slopes down toward to the right. The supply curve
is the curve that slopes up toward to the right. The equilibrium price is $14 a pizza, and
the equilibrium quantity is 200 pizzas a day.
a.
If the price of a pizza is $16, there is a surplus of pizza; the quantity supplied of
pizzas exceeds the quantity demanded. The surplus forces the price lower and the
price falls to its equilibrium of $14 a pizza.
b.
If the price of a pizza is $12, there is a shortage of pizza; the quantity demanded of
pizzas exceeds the quantity supplied. The shortage forces the price higher and the
price rises to its equilibrium of $14 a pizza.
7.
a.
The equilibrium price is 50 cents a pack, and the equilibrium quantity is 120
million packs a week.
The price of a pack adjusts until the quantity demanded equals the quantity
supplied. At 50 cents a pack, the quantity demanded is 120 million packs a week
and the quantity supplied is 120 million packs a week.
b.
At 70 cents a pack, there will be a surplus of gum and the price will fall.
At 70 cents a pack, the quantity demanded is 80 million packs a week and the
quantity supplied is 160 million packs a week. There is a surplus of 80 million
packs a week. The price will fall until market equilibrium is restored at a price of
50 cents a pack.
c.
At 30 cents a pack, there will be a shortage of gum and the price will rise.
At 30 cents a pack, the quantity demanded is 160 million packs a week and the
quantity supplied is 80 million packs a week. There is a shortage of 80 million
packs a week. The price will rise until market equilibrium is restored at a price of
50 cents a pack.
d.
The supply curve has shifted leftward and there has been a movement along the
demand curve. The new equilibrium price is 60 cents, and the equilibrium quantity
is 100 million packs a week.
As the number of gum-producing factories decreases, the supply of gum
decreases. There is a new supply schedule, and the supply curve shifts leftward.
Supply decreases by 40 millions packs a week. That is, the quantity supplied at
each price decreases by 40 million packs. The quantity supplied at 50 cents is now
80 million packs, and there is a shortage of gum. The price rises to 60 cents a
pack, at which the quantity supplied equals the quantity demanded (100 million
packs a week).
e.
The new price is 70 cents a pack, and the quantity is 120 million packs a week.
The demand for gum increases, and the demand curve shifts rightward. The
quantity demanded at each price increases by 40 million packs. Supply decreases
by 40 millions packs a week. That is, the quantity supplied at each price decreases
by 40 million packs. At any price below 70 cents a pack there is a shortage of
gum. The price of gum will rise until the shortage is eliminated.
8.
a.
The equilibrium price is 65 cents a bag, and the equilibrium quantity is 145
million bags a week.
The price of a bag adjusts until the quantity demanded equals the quantity
supplied. At 65 cents a bag, the quantity demanded is 145 million bags a week and
the quantity supplied is 145 million bags a week.
b.
At 60 cents a bag, there will be a shortage of potato chips and the price will rise.
At 60 cents a bag, the quantity demanded is 150 million bags a week and the
quantity supplied is 140 million bags a week. There is a shortage of 10 million
bags a week. The price will rise until market equilibrium is restored—65 cents a
bag.
c.
The demand curve has shifted rightward and there has been a movement along the
supply curve. The new equilibrium price is 80 cents, and the equilibrium quantity
is 160 million bags a week.
As the new dip comes onto the market, the demand for potato chips increases and
the demand curve shifts rightward. Supply does not change, so the price rises
along the supply curve. Demand increases by 30 millions bags a week. That is, the
quantity demanded at each price increases by 30 million bags. The quantity
demanded at 65 cents is now 170 million bags a week of potato chips. The price
rises to 80 cents a bag, at which the quantity supplied equals the quantity
demanded (160 million bags a week).
d.
The new price is 100 cents a bag, and the quantity is 140 million bags a week.
The supply of potato chips decreases, and the supply curve shifts leftward. The
quantity supplied at each price decreases by 40 million bags. The result of the new
dip entering the market is a price of 80 cents a bag. At this price, there is now a
shortage of potato chips. The price of potato chips will rise until the shortage is
eliminated.
Charpter 4
1.
a.
The price elasticity of demand is 1.25.
The price elasticity of demand equals the percentage change in the quantity
demanded divided by the percentage change in the price. The price rises from $4
to $6 a box, a rise of $2 a box. The average price is $5 a box. So the percentage
change in the price equals $2 divided by $5, which equals 40 percent.
The quantity decreases from 1,000 to 600 boxes, a decrease of 400 boxes. The
average quantity is 800 boxes. So the percentage change in quantity equals 400
divided by 800, which equals 50 percent.
The price elasticity of demand for strawberries equals 50 divided by 40, which is
1.25.
2.
b.
The price elasticity of demand exceeds 1, so the demand for strawberries is elastic.
a.
The price elasticity of demand is 2.
When the price of a DVD rental rises from $3 to $5, the quantity demanded of
DVDs decreases from 75 to 25 a day. The price elasticity of demand equals the
percentage change in the quantity demanded divided by the percentage change in
the price.
The price increases from $3 to $5, an increase of $2 a DVD. The average price is
$4 a DVD. So the percentage change in the price equals $2 divided by $4, which
equals 50 percent.
The quantity decreases from 75 to 25 DVDs, a decrease of 50 DVDs. The average
quantity is 50 DVDs. So the percentage change in quantity equals 50 divided by
50, which equals 100 percent.
The price elasticity of demand for DVD rentals equals 100 divided by 50, which is
2.
b.
The price elasticity of demand equals 1 at $3 a DVD.
The price elasticity of demand equals 1 at the price halfway between the origin
and the price at which the demand curve hits the y-axis. That price is $3 a DVD.
3.
The demand for dental services is unit elastic.
The price elasticity of demand for dental services equals the percentage change in the
quantity of dental services demanded divided by the percentage change in the price of
dental services. The price elasticity of demand equals 10 divided by 10, which is 1.
The demand is unit elastic.
4.
a.
Total revenue increases.
When the price of a chip is $400, 30 million chips are sold and total revenue
equals $12,000 million. When the price of a chip falls to $350, 35 million chips
are sold and total revenue is $12,250 million. Total revenue increases when the
price falls.
b.
Total revenue decreases.
When the price is $350 a chip, 35 million chips are sold and total revenue is
$12,250 million. When the price of a chip is $300, 40 million chips are sold and
total revenue decreases to $12,000 million. Total revenue decreases as the price
falls.
c.
Total revenue is maximized at $350 a chip.
When the price of a chip is $300, 40 million chips are sold and total revenue
equals $12,000 million. When the price is $350 a chip, 35 million chips are sold
and total revenue equals $12,250 million. Total revenue increases as the price
rises from $300 to $350 a chip. When the price is $400 a chip, 30 million chips
are sold and total revenue equals $12,000 million. Total revenue decreases as the
price rises from $350 to $400 a chip. Total revenue is maximized when the price
is $350 a chip.
d.
The demand for chips is unit elastic.
The total revenue test says that if the price changes and total revenue remains the
same, the demand is unit elastic at the average price. For an average price of $350
a chip, cut the price from $400 to $300 a chip. When the price of a chip falls from
$400 to $300, total revenue remains at $12,000 million. So at the average price of
$350 a chip, demand is unit elastic.
5.
The demand for chips is inelastic.
The total revenue test says that if the price falls and total revenue falls, the demand is
inelastic. When the price falls from $300 to $200 a chip, total revenue decreases from
$12,000 million to $10,000 million. So at an average price of $250 a chip, demand is
inelastic.
6.
a.
Your total expenditure decreases because your demand is elastic. The fall in
expenditure is approximately 15 percent, the 5 percent rise in price offset by the
20 percent decrease in the quantity purchased.
b.
The quantity of bananas you buy decreases by 20 percent.
The price elasticity of demand equals the percentage change in the quantity
demanded divided by the percentage change in the price. Rearranging this formula
gives the percentage change in the quantity demanded equals the price elasticity of
demand multiplied by the percentage change in the price. In the case at hand, the
percentage change in the quantity demanded equals 4  5 percent, which is 20
percent.
7.
a.
The price elasticity of demand for orange juice is 1.83.
The price elasticity of demand is the percentage change in the quantity demanded
of the good divided by the percentage change in the price of the good. So the price
elasticity of demand equals 22 percent divided by 12 percent, which is 1.83.
b.
The cross elasticity of demand between orange juice and apple juice is 1.17.
The cross elasticity of demand is the percentage change in the quantity demanded
of one good divided by the percentage change in the price of another good. The
rise in the price of orange juice resulted in an increase in the quantity demanded of
apple juice. So the cross elasticity of demand is the percentage change in the
quantity demanded of apple juice divided by the percentage change in the price of
orange juice. The cross elasticity equals 14 divided by 12, which is 1.17.
8.
The income elasticity of demand equals the percentage change in the quantity
demanded divided by the percentage change in income. The change in income is
$2,000 and the average income is $4,000, so the percentage change in income equals
50 percent.
a.
The change in the quantity demanded is 4 bagels and the average quantity
demanded is 6 bagels, so the percentage change in the quantity demanded equals
66.67 percent. The income elasticity of demand for bagels equals 66.67/50, which
is 1.33.
b.
The change in the quantity demanded is 6 donuts and the average quantity
demanded is 9 donuts, so the percentage change in the quantity demanded is
66.67. The income elasticity of demand for donuts equals 66.67/50, which is
1.33.
9.
a.
Using the data in the question, the price elasticity of demand is 0.90.
The change in the price is $6 and the average of the two prices is $18, so the
percentage change in the price is ($6/$18)  100, which is 33.3 percent. The
increase in the quantity demanded was estimated to be 30 percent. The price
elasticity of demand equals 30.0/33.3, or 0.90.
b.
The demand is inelastic, so if nothing else changes the price cut leads to a
decrease in Universal Music’s total revenue. However, downloaded music and
CDs are substitutes for each other and the quantity of downloaded music was
forecast to rise substantially. Effectively, the price of downloading music fell as
more people gained access to the Internet and download sites proliferated. The fall
in the price of the substitute, downloaded music, decreases the demand for
Universal Music’s CDs, so the price cut most likely was the result of the
(forecasted) decrease in demand for CDs.
10. a.
The elasticity of supply is 1.
The elasticity of supply is the percentage change in the quantity supplied divided
by the percentage change in the price. When the price falls from 40 cents to 30
cents, the change in the price is 10 cents and the average price is 35 cents. The
percentage change in the price is 28.57.
When the price falls from 40 cents to 30 cents, the quantity supplied decreases
from 800 to 600 calls. The change in the quantity supplied is 200 calls, and the
average quantity is 700 calls, so the percentage change in the quantity supplied is
28.57.
The elasticity of supply equals 28.57/28.57, which equals 1.
b.
The elasticity of supply is 1.
The formula for the elasticity of supply calculates the elasticity at the average
price. So to find the elasticity at an average price of 20 cents a minute, change the
price such that 20 cents is the average price—for example, a fall in the price from
30 cents to 10 cents a minute.
When the price falls from 30 cents to 10 cents, the change in the price is 20 cents
and the average price is 20 cents. The percentage change in the price is 100. When
the price falls from 30 cents to 10 cents, the quantity supplied decreases from 600
to 200 calls. The change in the quantity supplied is 400 calls and the average
quantity is 400 calls. The percentage change in the quantity supplied is 100.
The elasticity of supply is the percentage change in the quantity supplied divided
by the percentage change in the price. The elasticity of supply is 1.
Charpter 5
1.
a.
The market demand schedule equals the sum of the quantity demanded by Ben,
Beth, and Bo at each price. So, when the price is $3 per mile, the market quantity
demanded is 85; when the price is $4 per mile, the market quantity demanded is
65; when the price is $5 per mile, the marker quantity demanded is 45; when the
price is $6 per mile, the market quantity demanded is 25; when the price is $7 per
mile, the market quantity demanded is 15; when the price is $8 per mile, the
market quantity demanded is 5; and when the price is $9 per mile, the market
quantity demanded is 0.
b.
The marginal social benefit when the quantity is 50 miles is $4.75 per mile.
The marginal social benefit can be determined from the demand (and marginal
social benefit) curve as the maximum price that consumers will pay for the
quantity. Using the demand schedule shows that the maximum price consumers
will pay for 50 miles is $4.75 per mile.
c.
Ben’s consumer surplus is $62.50; Beth’s consumer surplus is $40.00; and, Bo’s
consumer surplus is $20.00.
When the price is $4 per mile, Ben buys 25 miles. Ben’s consumer surplus is the
triangular area under his demand curve and above the price. The demand curve is
linear, so Ben’s consumer surplus is 1/2  ($9  $4)  25, which equals $62.50.
When the price is $4 per mile, Beth buys 20 miles. Beth’s consumer surplus is the
triangular area under her demand curve and above the price. The demand curve is
linear, so Beth’s consumer surplus is 1/2  ($8  $4)  20, which equals $40.00
When the price is $4 per mile, Bo buys 20 miles. Bo’s consumer surplus is the
triangular area under his demand curve and above the price. The demand curve is
linear, so Bo’s consumer surplus is 1/2  ($6  $4)  20, which equals $20.00.
d.
The economy’s consumer surplus is the sum of Ben’s consumer surplus plus
Beth’s consumer surplus plus Bo’s consumer surplus, or $122.50.
2.
a.
The minimum supply-price equals the lowest price at which a producer is willing
to produce the given quantity. Ann’s minimum supply-price for 10 rides is
$15.00; Arthur’s minimum supply-price is $17.50; and, Abby’s minimum
supply-price is $20.00.
b.
Ann has the largest producer surplus. When the price is $17.50, Ann produces the
largest quantity. And, at any quantity for which Ann produces rides, her supply
schedule shows that her minimum supply-price (which is equal to her marginal
cost) is lower than Arthur’s and Abby’s minimum supply-price.
c.
The marginal social cost of producing 45 rides a day is the minimum supply-price
from the market supply schedule. From the table, the minimum supply-price is
$20.00 because at this is the lowest price for which 45 rides will be supplied.
d.
The market supply schedule equals the sum of the quantity supplied by Ann,
Arthur, and Abby at each price. So, when the price is $10.00 per ride, the market
quantity supplied is 0 rides; when the price is $12.50 per ride, the market quantity
supplied is 5 rides; when the price is $15.00 per ride, the marker quantity supplied
is 15 rides; when the price is $17.50 per ride, the market quantity supplied is 30
rides; and when the price is $20.00 per ride, the market quantity supplied is 45
rides.
3.
a.
The equilibrium price is $10.00 a CD, and the equilibrium quantity is 100 CDs a
month.
b.
The consumer surplus is the area of the triangle under the demand curve above the
market price.
c.
The producer surplus is the area of the triangle above the supply curve below the
market price.
d.
The total surplus is $750.
The total surplus is the sum of consumer surplus plus producer surplus. Consumer
surplus is $500. The consumer surplus is the area of the triangle under the demand
curve above the market price. The market price is $10.00 a CD. The area of the
triangle equals ($20  $10)/2 multiplied by100, which is $500. Producer surplus is
$250. The producer surplus is the area of the triangle above the supply curve
below the market price. The market price is $10.00 a CD. The area of the triangle
equals ($10  $5)/2 multiplied by 100, which is $250. So the total surplus is $500
+ $250, which is $750.
e.
The efficient quantity is 100 CDs a month.
The efficient quantity is the quantity that makes the marginal benefit from CDs
equal to the marginal cost of producing CDs. The demand curve shows the
marginal benefit and the supply curve shows the marginal cost. Only if 100 CDs
are produced is the quantity produced efficient.
4.
a.
The maximum price that consumers will pay for the 200th sandwich is $2.
The demand schedule shows the maximum price that consumers will pay for each
sandwich. The maximum price that consumers will pay for the 200th sandwich is
$2.
b.
The minimum price that producers will accept for the 200th sandwich is $4.
The supply schedule shows the minimum price that producers will accept for each
sandwich. The minimum price for which produces will produce the 200th
sandwich is $4.
c.
200 sandwiches a day are more than the efficient quantity because the marginal
social benefit (the maximum price consumers will pay) is less than the marginal
social cost (the minimum price suppliers will accept).
d.
Consumer surplus is $225.
150 sandwiches is the efficient quantity. The equilibrium price is $3. The
consumer surplus is the area of the triangle under the demand curve above the
price. The area of the consumer surplus triangle is ($6  $3)/2 multiplied by 150,
which is $225.
e.
Producer surplus is $225.
The producer surplus is the area of the triangle above the supply curve below the
price. The price is $3 and the quantity is 150. The area of the triangle is ($3 
$0)/2 multiplied by 150, which is $225.
f.
The deadweight loss is $50.
Deadweight loss is the sum of the consumer surplus and producer surplus that is
lost because the quantity produced is not the efficient quantity. The deadweight
loss equals the quantity (200  150) multiplied by ($4  $2)/2, which is $50.
g.
If the demand for sandwiches increases and the market continues to produce 200
sandwiches, the consumer surplus increases, the producer surplus increases, and
the total surplus increases. The deadweight los decreases. Indeed, if the demand
increases enough so that 200 sandwiches becomes the equilibrium quantity, there
is no deadweight loss at all.
5.
a.
The maximum price that consumers will pay is $25.
The demand schedule shows the maximum price that consumers will pay for each
bottle of sunscreen. The maximum price that consumers will pay for the 300th
bottle is $25.
b.
The minimum price that producers will accept is $15.
The supply schedule shows the minimum price that producers will accept for each
bottle of sunscreen. The minimum price that produces will accept for the 300th
bottle is $15.
c.
There is less than the efficient quantity being produced. The efficient quantity is
the equilibrium quantity, 400 bottles a shortage. The equilibrium price is $20. If
the supply decreases to only 300 bottles and the price remains $20, there is a
shortage of 100 bottles per day.
d.
The bottles can be allocated using a contest (a raffle for the bottles, perhaps),
first-come, first-served (a line until all 300 bottles are distributed), personal
characteristics (perhaps all fair-haired people are allocated the sun screen), or
force (a fight).
Using the “fair results” criteria, none of the allocation schemes are necessarily fair
because there is no guarantee that poorer people will receive the sun screen. Using
the “fair rules” criteria, the force method is definitely unfair and the others are
fair.
Charpter 6
1.
a.
The equilibrium rent is $450 a month and the equilibrium quantity is 20,000
housing units.
b.
The quantity rented is 10,000 housing units.
The quantity of housing rented is equal to the quantity supplied at the rent ceiling.
c.
The shortage of housing is 20,000 housing units.
At the rent ceiling, the quantity of housing demanded is 30,000, but the quantity
supplied is 10,000, so there is a shortage of 20,000 housing units.
d.
The maximum price that someone is willing to pay for the 10,000th unit available
is $600 a month.
The demand curve tells us the maximum price that someone is willing to pay for
the 10,000th unit.
e.
The quantity of housing rented is equal to 20,000 units.
If the rent ceiling is set at $600 per month, it is above the equilibrium rent and so
is ineffective. The rent stays at $450 per month and the quantity rented remains at
20,000 housing units
f.
There is no shortage of housing units.
Because the rent ceiling is ineffective, the market remains at its equilibrium so
there is no shortage of housing units.
g.
The maximum price that someone is willing to pay for the 20,000th unit available
is $450 a month.
The demand curve tells us the maximum price that someone is willing to pay for
the 20,000th unit.
2.
a.
The equilibrium wage rate is $6 an hour, and employment is 2,000 hours a month.
b.
Unemployment is zero. Everyone who wants to work for $6 an hour is employed.
c.
They work 2,000 hours a month.
A minimum wage rate is the lowest wage rate that a person can be paid for an
hour of work. Because the equilibrium wage rate exceeds the minimum wage rate,
the minimum wage is ineffective. The wage rate will be $6 an hour and
employment is 2,000 hours.
d.
There is no unemployment
The wage rate rises to the equilibrium wage—the quantity of labor demanded
equals the quantity of labor supplied. So there is no unemployment.
e.
At $7 an hour, 1,500 hours a month are employed and 1,000 hours a month are
unemployed.
The quantity of labor employed equals the quantity demanded at $7 an hour.
Unemployment is equal to the quantity of labor supplied at $7 an hour minus the
quantity of labor demanded at $7 an hour. The quantity supplied is 2,500 hours a
month, and the quantity demanded is 1,500 hours a month. So 1,000 hours a
month are unemployed.
f.
The wage rate is $7 an hour, and unemployment is 500 hours a month.
At the minimum wage of $7 an hour, the quantity demanded is 2,000 hours a
month and the quantity supplied is 2,500 hours a month. So 500 hours a month are
unemployed.
3.
a.
With no tax on brownies, the price is 60 cents a brownie and 4 million a day are
consumed.
b.
The price, including the tax, is 70 cents a brownie, and 3 million brownies a day
are consumed. The price, excluding the tax, is 50 cents a brownie. Consumers and
producers each pay 10 cents of the tax on a brownie.
The tax decreases the supply of brownies and raises the price of a brownie. With
no tax, producers are willing to sell 3 million brownies a day at 50 cents a
brownie. But with a 20 cent tax, they are willing to sell 3 million brownies a day
only if the price is 20 cents higher at 70 cents a brownie.
c.
The price, excluding the tax, is 50 cents a brownie, and 3 million brownies a day
are consumed. The price, including the tax, is 70 cents a brownie. Consumers and
producers each pay 10 cents of the tax on a brownie.
The tax decreases the demand for brownies and lowers the price of a brownie.
With no tax, consumers are willing to buy 3 million brownies a day at 70 cents a
brownie. But with a 20 cent tax, they are willing to buy 3 million brownies a day
only if the price, excluding the tax, is 20 cents lower at 50 cents a brownie.
5.
a.
With a subsidy on rice, the price is $1.20 a box, the marginal cost $1.50 a box, and
the quantity produced is 3,000 boxes a week.
The subsidy of $0.30 lowers the price at which each quantity in the table is
supplied. For example, rice farmers will supply 3,000 boxes a week if the price is
$1.50 minus $0.30, which is $1.20. With a subsidy, the market equilibrium occurs
at $1.20 a box. At this price, the quantity demanded is 3,000 boxes and the
quantity supplied is 3,000 boxes. The marginal cost of producing rice is given by
the supply schedule. The marginal cost of supplying 3,000 boxes a week is $1.50
a box.
b.
With a quota of 2,000 boxes a week, the price is $1.60 a box, the marginal cost
$1.30 a box, and the quantity produced is 2,000 boxes a week.
The quota decreases the quantity supplied to 2,000 boxes a week. The price
willingly paid for 2,000 boxes a week is $1.60 (given by the demand schedule).
The marginal cost of producing 2,000 boxes of rice is given by the supply
schedule. The marginal cost of supplying 2,000 boxes a week is $1.30 a box.
6.
a.
With a penalty of $20 a unit on sellers, the price is $70 a unit and the quantity is
100 units.
The $20 penalty on sellers decreases the supply. The supply curve shifts leftward
so that the vertical distance between the initial supply curve and the new supply
curve is $20. With this new supply curve, the equilibrium price is $70 a unit and
the equilibrium quantity is 100 units.
b.
With a penalty of $20 a unit on buyers, the price is $50 a unit and the quantity is
100 units.
The $20 penalty on buyers decreases the demand. The demand curve shifts
leftward so that the vertical distance between the initial demand curve and the new
demand curve is $20. With this new demand curve, the equilibrium price is $50 a
unit and the equilibrium quantity is 100 units.
c.
With a penalty of $20 a unit on sellers and on buyers, the price is $60 a unit and
the quantity is 90 units.
The $20 penalty on sellers decreases the supply. The supply curve shifts leftward
so that the vertical distance between the initial supply curve and the new supply
curve is $20. The $20 penalty on buyers decreases the demand. The demand curve
shifts leftward so that the vertical distance between the initial demand curve and
the new demand curve is $20. With these new supply and demands curve, the
equilibrium price is $60 a unit and the equilibrium quantity is 90 units.
Charpter 7
1.
a.
To draw a graph of Jason’s budget line, plot the number of DVDs on the x-axis
and the number of spy novels on the y-axis. The budget line will go through the
vertical intercept of 6 spy novels, 0 DVDs and the horizontal intercept of 3 DVDs
and 0 spy novels. Combinations of spy novels and DVDs within and on the budget
line are affordable; combinations that lie beyond the budget line are not
affordable. The figure will look similar to Fig. 7.1.
b.
Jason’s real income in terms of spy novels is 6 spy novels.
c.
The relative price of a DVD is $20 per DVD  $10 per spy novel, which is 2 spy
novels per DVD.
2.
a.
To draw a graph of Jason’s budget line, plot the number of DVDs on the x-axis
and the number of spy novels on the y-axis. The new budget line will go through
the vertical intercept of 9 spy novels, 0 DVDs and the horizontal intercept of 4.5
DVDs and 0 spy novels. It will have the same slope as the budget line in problem
1 but will lie farther from the origin. The figure will look similar to Fig. 7.1.
b.
Jason’s real income in terms of spy novels is 9 spy novels.
c.
The relative price of a DVD has not changed; it remains
$20 per DVD  $10 per
spy novel, which is 2 spy novels per DVD.
3.
a.
To draw a graph of Jason’s budget line, plot the number of DVDs on the x-axis
and the number of spy novels on the y-axis. The new budget line will go through
the vertical intercept of 9 spy novels, 0 DVDs and the horizontal intercept of 6
DVDs and 0 spy novels. The figure will look similar to Fig. 7.1. Compared to the
budget line in problem 2, the vertical intercept is the same and the horizontal
intercept has moved further out along the x-axis.
b.
Jason’s real income in terms of DVDs is 6 DVDs.
c.
Jason’s real income in terms of spy novels has not changed from problem 2; it
remains 9 spy novels.
d.
The relative price of a DVD is $15 per DVD  $10 per spy novel, which is 1.5 spy
novels per DVD.
4.
a.
To draw a graph of Jason’s total utility from DVDs, plot the number of DVDs on
the x-axis and Jason’s utility from DVDs on the y-axis. The curve will look
similar to Fig. 7.3(a). To draw a graph of Jason's total utility from spy novels,
repeat the above procedure but use the spy novel data.
b.
Jason gets more utility from any number of DVDs than he does from the same
number of spy novels.
c.
To draw a graph of Jason’s marginal utility from DVDs plot the number of DVDs
on the x-axis and Jason’s marginal utility from DVDs on the y-axis. The curve
will look similar to Fig. 7.3(b). To draw a graph of Jason’s marginal utility from
spy novels, repeat the above procedure but use the spy novel data.
Jason’s marginal utility from DVDs is the increase in total utility he gets from one
additional DVD. Similarly, Jason’s marginal utility from spy novels is the
increase in total utility he gets from one additional spy novel.
d.
Jason gets more marginal utility from an additional DVD than he gets from an
additional spy novel when he has the same number of each.
e.
Jason buys 2 DVDs and 2 spy novels.
When Jason buys 2 DVDs and 2 spy novels he spends $60. Jason maximizes his
utility when he spends all of his money and the marginal utility per dollar spent on
DVDs and spy novels is the same. When Jason buys 2 DVDs his marginal utility
per dollar spent is 2.5 units per dollar and when Jason buys 2 spy novels his
marginal utility per dollar spent is 2.5 units per dollar.
5.
To maximize his utility, Max windsurfs for 3 hours and snorkels for 1 hour.
Max will spend his $35 such that all of the $35 is spent and that the marginal utility per
dollar spent on each activity is the same. When Max windsurfs for 3 hours and
snorkels for 1 hour, he spends $30 renting the windsurfing equipment and $5 renting
the snorkeling equipment—a total of $35.
The marginal utility from the third hour of windsurfing is 80 and the rent of the
windsurfing equipment is $10 an hour, so the marginal utility per dollar spent on
windsurfing is 8. The marginal utility from the first hour of snorkeling is 40 and the
rent of the snorkeling equipment is $5 an hour, so the marginal utility per dollar spent
on snorkeling is 8. The marginal utility per dollar spent on windsurfing equals the
marginal utility per dollar spent on snorkeling.
6.
a.
Max’s consumption possibilities line is a straight line that runs from 5.5 hours
windsurfing and 0 hours snorkeling to 11 hours snorkeling and 0 hours
windsurfing.
Max’s possibilities line shows the various combinations of hours spent snorkeling
and hours spent windsurfing that has a total expenditure of $55. Windsurfing is
$10 an hour, so if Max spends all his money on windsurfing, he can windsurf for
5.5 hours.
Snorkeling is $5 an hour, so if Max spends all his money on snorkeling, he can
snorkel for 5.5 hours.
b.
To maximize his utility, Max windsurfs for 4 hours and snorkels for 3 hours.
Max will spend his $55 such that all of the $55 is spent and that the marginal
utility per dollar spent on each activity is the same. When Max windsurfs for 4
hours and snorkels for 3 hours, he spends $40 renting the windsurfing equipment
and $15 renting the snorkeling equipment—a total of $55.
The marginal utility from the fourth hour of windsurfing is 60 and the rent of the
windsurfing equipment is $10 an hour, so the marginal utility per dollar spent on
windsurfing is 6. The marginal utility from the third hour of snorkeling is 30 and
the rent of the snorkeling equipment is $5 an hour, so the marginal utility per
dollar spent on snorkeling is 6. The marginal utility per dollar spent on
windsurfing equals the marginal utility per dollar spent on snorkeling.
7.
To maximize his utility, Max windsurfs for 6 hours and snorkels for 5 hours. Max will
use his $55 such that all of the $55 is spent and that the marginal utility per dollar
spent on each activity is the same. When Max windsurfs for 6 hours and snorkels for 5
hours, he spends $30 renting the windsurfing equipment and $25 renting the snorkeling
equipment—a total of $55.
The marginal utility from the sixth hour of windsurfing is 12 and the rent of the
windsurfing equipment is $5 an hour, so the marginal utility per dollar spent on
windsurfing is 2.4. The marginal utility from the fifth hour of snorkeling is 12 and the
rent of the snorkeling equipment is $5 an hour, so the marginal utility per dollar spent
on snorkeling is 2.4. The marginal utility per dollar spent on windsurfing equals the
marginal utility per dollar spent on snorkeling.
8.
To maximize his utility, Max windsurfs for 5 hours and snorkels for 1 hour.
Because the equipment is free, Max does not have to allocate his income between the
two activities; instead, he allocates his time between the two activities. Max spends 6
hours on these activities. Max allocates the 6 hours such that the marginal utility from
each activity is the same. When Max windsurfs for 5 hours and snorkels for 1 hour, he
spends 6 hours. His marginal utility from the fifth hour of windsurfing is 40 and his
marginal utility from the first hour of snorkeling is 40—so the marginal utilities are
equal.
9.
a.
Two points on Max’s demand curve for renting windsurfing equipment are a price
of $10 per hour and a quantity of 4 hours windsurfing (from problem 6), and a
price of $5 per hour and a quantity of 6 hours of windsurfing (from problem 7).
b.
Max’s demand curve is drawn in figure with the rental price of windsurfing
equipment on the vertical axis and the quantity of hours he windsurfs on the
horizontal axis. The demand curve is a downward sloping line going through the
points $10 per hour/4 hours and $5 per hour/6 hours.
c.
Between the two points on the demand curve in part b, Max’s elasticity of demand
for windsurfing is equal to 0.60. Max’s demand is inelastic between these two
points. The total expenditure test gives the same result: The fall in price decreases
Max’s total expenditure on windsurfing.
10. a.
Max’s demand for snorkeling increases. The quantity demanded at a price of $5
per hour for snorkeling equipment increases from 3 hours (problem 6) to 5 hours
(problem 7).
b.
Max’s demand curve is drawn in figure with the rental price of snorkeling
equipment on the vertical axis and the quantity of hours he snorkels on the
horizontal axis. The initial demand curve is a downward sloping line that goes
through the point $5 per hour/3 hours. The second demand curve is a downward
sloping line lying rightward of the original demand curve that goes through the
point $5 per hour/5 hours.
c.
Max’s cross elasticity of demand for snorkeling with respect to the price of
windsurfing equipment is equal to –0.75.
d.
11. a.
Max’s cross elasticity of demand is negative, so the two goods are complements.
Max’s demand for windsurfing equipment increases and his demand curve for
windsurfing equipment shifts rightward. The quantity demanded at a price of $10
per hour for windsurfing equipment increases from 3 hours (problem 5) to 4 hours
(problem 6).
b.
Max’s demand for snorkeling equipment increases and his demand curve for
snorkeling equipment shifts rightward. The quantity demanded at a price of $5 per
hour for snorkeling equipment increases from 1 hour (problem 5) to 3 hours
(problem 6).
c.
Renting windsurfing equipment is a normal good for Max because his demand
increased when his income increased.
d.
Renting snorkeling equipment is a normal good for Max because his demand
increased when his income increased.
12. a.
In total, water is move valuable to Ben because water has a (much!) higher total
utility. On the marginal, an additional bunch of flowers has larger marginal utility
than does an additional 1,000 gallon of water.
b.
Flowers are more expensive than water even though water is essential to life. The
reason flowers are more expensive is because People, such as Ben, consume fewer
flowers than they do water. Because people consume so much water, its marginal
utility is quite low even though its total utility is tremendous. Because so few
flowers are consumed, their marginal utility is relatively high even though their
total utility is small. Prices, though, reflect the marginal utility of the good and so
flowers are more expensive than water.
Charpter 8
1.
a.
Sara’s real income is 4 cans of cola.
Sara’s real income in terms of cans of cola is equal to her money income divided
by the price of a can of cola. Sara’s money income is $12, and the price of cola is
$3 a can. Sara’s real income is $12 divided by $3 a can of cola, which is 4 cans of
cola.
b.
Sara’s real income is 4 bags of popcorn.
Sara’s real income in terms of popcorn is equal to her money income divided by
the price of a bag of popcorn, which is $12 divided by $3 a bag or 4 bags of
popcorn.
c.
The relative price of cola is 1 bag per can.
The relative price of cola is the price of cola divided by the price of popcorn. The
price of cola is $3 a can and the price of popcorn is $3 a bag, so the relative price
of cola is $3 a can divided by $3 a bag, which equals 1 bag per can.
d.
The opportunity cost of a can of cola is 1 bag of popcorn.
The opportunity cost of a can of cola is the quantity of popcorn that must be
forgone to get a can of cola. The price of cola is $3 a can and the price of popcorn
is $3 a bag, so to buy one can of cola Sara must forgo 1 bag of popcorn.
e.
The equation that describes Sara’s budget line is QP = 4 – QC.
Call the price of popcorn PP and the quantity of popcorn QP, the price of cola PC
and the quantity of cola QC, and income y. Sara’s budget equation is PPQP +
PCQC = y.
If we substitute $3 for the price of popcorn, $3 for the price of cola, and $12 for
the income, the budget equation becomes $3QP + $3QC = $12.
Dividing both sides by $3 and subtracting QC from both sides gives QP = 4 – QC
f.
To draw a graph of the budget line, plot the quantity of cola on the x-axis and the
quantity of popcorn on the y-axis. The budget line is a straight line running from 4
bags on the y-axis to 4 cans on the x-axis.
g.
The slope of the budget line, when cola is plotted on the x-axis is minus 1. The
magnitude of the slope is equal to the relative price of cola.
The slope of the budget line is “rise over run.” If the quantity of cola decreases
from 4 to 0, the quantity of popcorn increases from 0 to 4. The rise is 4 and the
run is 4. Therefore the slope equals 4/4, which is 1.
2.
a.
Sara’s real income falls from 4 cans of cola to 3 cans of cola.
Sara’s real income in terms of cola is equal to her money income divided by the
price of a can of cola. Sara’s money income is now $9 and the price of can of cola
is $3. Sara’s real income is now $9 divided by $3 a cola, which is 3 cans of cola.
b.
Sara’s real income falls from 4 bags of popcorn to 3 bags of popcorn.
Sara’s real income in terms of popcorn is equal to her money income divided by
the price of a bag of popcorn. Sara’s money income is now $9 and the price of bag
of popcorn is $3. Sara’s real income is now $9 divided by $3 a bag, which is 3
bags of popcorn.
c.
The relative price of cola is 1 bag per can, the same relative as before her income
fell.
The relative price does not depend on Sara’s income. Instead the relative price of
cola is the price of cola divided by the price of popcorn. The price of cola is $3 a
can and the price of popcorn is $3 a bag, so the relative price of cola is $3 a can
divided by $3 a bag, which equals 1 bag per can.
d.
The slope of the budget line, when cola is plotted on the x-axis is minus 1, the
same slope as before her fall in income. The magnitude of the slope is equal to the
relative price of cola. The relative price does not change when Sara’s income
decreases so the slope of the budget line does not change.
3.
a.
The rise in the price of a bag of popcorn has no effect on Sara’s real income in
terms of cola. Sara’s real income in terms of cola is 4 cans of cola, the same real
income she had in Problem 1.
b.
Sara’s real income in terms of popcorn is 2 bags of popcorn. Compared to
Problem 1, Sara’s real income in terms of popcorn falls.
Sara’s real income in terms of popcorn is equal to her money income divided by
the price of a bag of popcorn. Sara’s money income is $12 and the price of bag of
popcorn is now $6. Sara’s real income is now $12 divided by $6 a bag, which is 2
bags of popcorn.
c.
The relative price of cola is 1/2 bag per can. Compared to Problem 1, the rise in
the price of a bag of popcorn lowered the relative price of cola in terms of
popcorn.
The relative price of cola is the price of cola divided by the price of popcorn. The
price of cola is $3 a can and the price of popcorn is $6 a bag, so the relative price
of cola is $3 a can divided by $6 a bag, which equals 1/2 bag per can.
d.
The slope of the budget line, when cola is plotted on the x-axis is minus 1/2. The
magnitude of the slope is equal to the relative price of cola. Compared to problem
1, the relative price has fallen so the magnitude of the slope of the budget line has
fallen.
4.
a.
Rashid’s marginal rate of substitution is 1 book per CD.
Rashid’s marginal rate of substitution equals the slope of his indifference curve at
his best affordable point. If Rashid buys 3 books and 2 CDs, the slope of his
indifference curve at this point is minus 1 book per CD.
b.
Rashid’s marginal rate of substitution is 1/2.
Rashid’s marginal rate of substitution equals the slope of his indifference curve at
his best affordable point. If Rashid buys 3 books and 2 CDs, the slope of his
indifference curve at this point is minus 1/2 book per CD.
5.
Although the students’ indifference curves will generally differ for the different goods,
there still should be some points in common, discussed below.
a.
Right and left gloves are perfect complements, so the indifference curves should
be right angles, such as those in Figure 8.5c. The marginal rate of substitution
does not change moving down along the indifference curve except when moving
around the 90 degree point where it goes from infinity to zero.
b.
Coca-Cola and Pepsi are, for most students, almost perfect substitutes. The
indifference curves should either be linear (for perfect substitutes, as shown in
Figure 8.5b) or nearly linear. If the indifference curves are linear, then the
marginal rate of substitution does not change moving along the indifference curve;
if the indifference curves are nearly linear, then the marginal rate of substitution
falls slightly moving along an indifference curve.
c.
Baseball balls and bats are complements but probably not perfect complements.
The indifference curves should be significantly bowed in. (If a student says these
goods are perfect complements, the indifference curves should be right angles,
such as those in Figure 8.5c.) If the indifference curves are not right angles, then
the marginal rate of substitution falls rapidly moving down along an indifference
curve. (If the goods are perfect complements, the marginal rate of substitution
does not change moving down along the indifference curve except when moving
around the 90 degree point where it goes from infinity to zero.)
d.
Tylenol and acetaminophen are, for most people, very close substitutes. For some
consumers, they might be perfect substitutes. The indifference curves should
either be linear (for perfect substitutes, as shown in Figure 8.5b) or nearly linear.
If the indifference curves are linear, then the marginal rate of substitution does not
change moving along the indifference curve; if the indifference curves are nearly
linear, then the marginal rate of substitution falls slightly moving down along an
indifference curve.
e.
Eye glasses and contact lenses are substitutes, though probably not perfect
substitutes. The indifference curve will be slightly bowed in toward the origin.
The marginal rate of substitution falls slightly moving down along an indifference
curve.
f.
Desktop computers and laptop computers are substitutes, though not perfect
substitutes. The indifference curve will be bowed in toward the origin. The
marginal rate of substitution falls moving down along an indifference curve.
g.
Skis and ski poles are complements, indeed, potentially perfect complements. If
the student answers that they a complements, then the indifference curves should
be significantly bowed in. The marginal rate of substitution falls rapidly moving
down along an indifference curve. If the student answers that they are perfect
complements, then the indifference curves should be right angles, such as those in
Figure 8.5c. The marginal rate of substitution does not change moving down along
the indifference curve except when moving around the 90 degree point where it
goes from infinity to zero.
6.
a.
Sara buys 2 cans of cola and 2 bags of popcorn.
Sara buys the quantities of cola and popcorn that gets her onto the highest
indifference curve, given her income and the prices of cola and popcorn. The
graph shows Sara’s indifference curves. So draw Sara’s budget line on the graph.
The budget line is tangential to indifference curve I0 at 2 cans of cola and 2 bags
of popcorn. The indifference curve I0 is the highest indifference curve that Sara
can get onto.
b.
Sara’s marginal rate of substitution is 1.
The marginal rate of substitution is the magnitude of the slope of the indifference
curve at Sara’s consumption point, which equals the magnitude of the slope of the
budget line. The slope of Sara’s budget line is 1, so the marginal rate of
substitution is 1.
7.
a.
Sara buys 6 cans of cola and 1 bag of popcorn.
Draw the new budget line on the graph with Sara’s indifference curves. The
budget line now runs from 8 cans of cola on the x-axis to 4 bags of popcorn on the
y-axis. The new budget line is tangential to indifference curve I1 at 6 cans of cola
and 1 bag of popcorn. The indifference curve I1 is the highest indifference curve
that Sara can now get onto.
b.
Two points on Sara’s demand for cola are the following: At $3 a can of cola, Sara
buys 2 cans of cola. At $1.50 a can of cola, Sara buys 6 cans. Her demand curve is
downward sloping and goes through these two points.
c.
The substitution effect is 2 cans of cola.
To divide the price effect into a substitution effect and an income effect, take
enough income away from Sara and gradually move her new budget line back
toward the origin until it just touches Sara’s indifference curve I0. The point at
which this budget line just touches indifference curve I0 is 4 cans of cola and 0.5
bag of popcorn. The substitution effect is the increase in the quantity of cola from
2 cans to 4 cans along the indifference curve I0. The substitution effect is 2 cans of
cola.
d.
The income effect is 2 cans of cola.
The income effect is the change in the quantity of cola from the price effect minus
the change from the substitution effect. The price effect is 4 cans of cola (6 cans
minus the initial 2 cans). The substitution effect is an increase in the quantity of
cola from 2 cans to 4 cans. So the income effect is 2 cans of cola.
e.
Cola is a normal good for Sara because the income effect is positive. An increase
in income increases the quantity of cola she buys from 4 to 6 cans.
8.
a.
Pam can still buy 30 cookies and 5 comic books. When Pam buys 30 cookies at $1
each and 5 comic books at $2 each, she spends $40 a month. Now that the price of
a cookie is 50 cents and the price of a comic book is $5, 30 cookies and 5 comic
books will cost $40. So Pam can still buy 30 cookies and 5 comic books.
But Pam will not want to buy 30 cookies and 5 comic books because the marginal
rate of substitution does not equal the relative price of the goods. Pam will move
to a point on the highest indifference curve possible where the marginal rate of
substitution equals the relative price.
b.
Pam prefers cookies at 50 cents each and comic books at $5 each because she can
get onto a higher indifference curve than when cookies are $1 each and comic
books are $2 each.
To see why Pam can get to a higher indifference curve, note that the new budget
line and the old budget line both pass through the point 30 cookies and 5 comic
books. If comic books are plotted on the x-axis, the marginal rate of substitution at
this point on Pam’s indifference curve is equal to the relative price of a comic
book at the original prices, which is 2. The new relative price of a comic book is
$5/50 cents, which is 10. That is, the budget line is steeper than the indifference
curve at 30 cookies and 5 comic books. So Pam’s new equilibrium combination of
cookies and comic books must be on an indifference curve at a point steeper than
the initial indifference. Because the new budget line is steeper and passes through
the initial equilibrium combination, the new equilibrium must lie above the initial
equilibrium point so it must be on a higher indifference curve.
c.
Pam will buy more cookies and fewer comic books.
The new budget line and the old budget line pass through the point at 30 cookies
and 5 comic books. If comic books are plotted on the x-axis, the marginal rate of
substitution at this point on Pam’s indifference curve is equal to the relative price
of a comic book at the original prices, which is 2. The new relative price of a
comic book is $5/50 cents, which is 10. That is, the budget line is steeper than the
indifference curve at 30 cookies and 5 comic books. Pam will buy more cookies
and fewer comic books.
d.
There will be a substitution effect and an income effect.
A substitution effect arises when the relative price changes and the consumer
moves along the same indifference curve to a new point where the marginal rate
of substitution equals the new relative price. An income effect arises when the
consumer moves from one indifference curve to another, keeping the relative price
constant.
Charpter 9
1.
Explicit costs are $30,000. Explicit costs are all the costs for which there is a payment.
Explicit costs are the sum the wages paid ($20,000) and the goods and services bought
from other firms ($10,000).
Implicit costs are the sum of the costs that do not involve a payment. Implicit costs are
the sum of the interest forgone on the $50,000 put into the firm, which presumably
could have been used to pay part of the mortgage, in which case the interest forgone is
$3,000; the $30,000 income forgone by Jack not working at his previous job; $15,000,
which is the value of 500 hours of Jill’s leisure (10 hours a week for 50 weeks); and
the economic depreciation of $2,000 ($30,000 minus $28,000).
2.
a.
All methods other than “pocket calculator with paper and pencil” are
technologically efficient.
To use a pocket calculator with paper and pencil to complete the tax return is not a
technologically efficient method because it takes the same number of hours as it
would with a pocket calculator but it uses more capital.
b.
The economically efficient method is to use (i) a pocket calculator, (ii) a pocket
calculator, (iii) a PC.
The economically efficient method is the technologically efficient method that
allows the task to be done at least cost.
When the wage rate is $5 an hour: Total cost with a PC is $1,005, total cost with a
pocket calculator is $70, and total cost with paper and pencil is $81. Total cost is
least with a pocket calculator.
When the wage rate is $50 an hour: Total cost with a PC is $1,050, total cost with
a pocket calculator is $610, and the total cost with paper and pencil is $801. Total
cost is least with a pocket calculator.
When the wage rate is $500 an hour: Total cost with a PC is $1,500, total cost
with a pocket calculator is $6,010, and total cost with pencil and paper is $8,001.
Total cost is least with a PC.
3.
a.
Methods A, B, C, and D are technologically efficient. Compare the amount of
labor and capital used by the four methods. Start with method A. Moving from A
to B to C to D, the amount of labor increases and the amount of capital decreases
in each case.
b.
The economically efficient method in (i) is method D, in (ii) is methods C and D,
and in (iii) is method A.
The economically efficient method is the technologically efficient method that
allows the 100 shirts to be washed at least cost.
(i) Total cost with method A is $1,001, total cost with method B is $805, total cost
with method C is $420, and total cost with method D is $150. Method D has the
lowest total cost.
(ii) Total cost with method A is $505, total cost with method B is $425, total cost with
method C is $300, and total cost with method D is $300. Methods C and D have
the lowest total cost.
(iii) Total cost with method A is $100, total cost with method B is $290, total cost with
method C is $1,020, and total cost with method D is $2,505. Method A has the
lowest total cost.
4.
a.
Wal-Mart is a huge organization. As such, it uses both command and incentive
systems. At the lower, store level, command is the system that is most commonly
used. (For instance, an associate is old that he or she will help unload a delivery
and stack the packages against the South wall.) At the higher, corporate level,
incentive is the system most commonly used. (For instance, regional directors
have part of their income tied to their region’s performance.) However, even at the
store level some incentive systems are used (associates can enroll in a profit
sharing plan) and even at the corporate level some command systems are used
(regional directors are told that they must report to their supervisors on a weekly
basis).
b.
Ms. Frey-Talley probably uses a command system significantly more than an
incentive system. Her farm has few employees and so it is easy to tell each
employee what to do, when to do it, and where to do it. Possibly the only use of an
incentive system might be if Ms. Frey-Talley has some higher-ranking family
members on a profit-sharing program.
c.
Wal-Mart faces many more principal-agent problems than does Ms. Frey-Talley.
For Ms. Frey-Talley’s farm, it is relatively straightforward to monitor each
employee so employees will find it difficult to shirk. Plus Ms. Frey-Talley owns
the farm herself, and so there is no principal-agent problem associated with a
difference between the owners and the managers. Wal-Mart, however, has more
than one million employees. Each of these employees realizes that if he she shirks,
it will make little difference to Wal-Mart’s overall performance. So Wal-Mart’s
managers must be constantly alert to this problem. Wal-Mart also faces the
principal-agent problem that results because its owners are not its managers. As a
result, the owners must try to create incentives for the managers to behave in the
best interests of the owners.
Wal-Mart has a number of ways that it can try to overcome the principal-agent
problems it faces. Its top management is given stock options. Regional managers,
store managers, and top level store management are given profit sharing packages
that depend on the performance of the region or a particular store. Buyers are
often given profit-sharing packages that increase the buyer’s income depending on
well the products the buy purchased perform in the stores. All of these are
designed to give the recipient the incentive to make decisions that boost
Wal-Mart’s profit and thereby its stock price, which benefit the owners.
5.
a.
The four-firm concentration ratio is 60.49.
The four-firm concentration ratio equals the ratio of the total sales of the largest
four firms to the total industry sales expressed as a percentage. The total sales of
the largest four firms is $450 + $325 + $250 + $200, which equals $1,225. Total
industry sales equal $1,225 + $800, which equals $2,025. The four-firm
concentration ratio equals ($1,225/$2,025)  100, which is 60.49 percent.
b.
This industry is highly concentrated because the four-firm concentration ratio
exceeds 60 percent.
6.
a.
The Herfindahl-Hirschman Index is 1,800.
The Herfindahl-Hirschman Index equals the sum of the squares of the market
shares of the 50 largest firms or of all firms if there are less than 50 firms. The
2
2
2
2
2
2
Herfindahl-Hirschman Index equals 15 + 10 + 20 + 15 + 25 + 15 , which
equals 1,800.
b.
This industry is moderately competitive because the Herfindahl-Hirschman Index
lies in the range 1,000 to 1,800.
7.
a.
Lego faced all of the three types of constraints: Technology, information, and
market.
The technology constraint that Lego faced was how it produced its Legos. Before
it made any changes, Lego used a relatively large number of high-paid,
presumably high-skilled workers in the United States and Switzerland. After its
changes, Lego switched to using apparently fewer workers, who are lower-paid
and so likely lower-skilled in Eastern Europe and Mexico.
Lego also faced information constraints. In particular, if Lego had had full
information about its market and its competitors’ plans, it is unlikely Lego would
have suffered economic losses in 2003 and 2004. And, of course, if Lego had had
better information, even after it started to suffer economic losses, Lego would
have more rapidly made changes in order to limit its losses. In addition, Lego
apparently faced information problems about which managers were not working
as hard as they should.
Finally, Lego faced significant market constraints. Other firms were making very
similar but lower-priced blocks. This competition lead Lego’s customers to switch
(some of) their purchases from Lego to Lego’s competitors, thereby leaving Lego
to suffer an economic loss.
b.
When Lego was suffering an economic loss, Lego was manufacturing its blocks in
Switzerland and the United States. These workers were generally high-skilled and
therefore high-paid. In an effort to restore its profit, Lego changed is production
method by firing 3,500 workers and moving its factories where to Eastern Europe
and Mexico, where it could use lower-skilled, and therefore lower-paid workers.
Apparently before the changes Lego was using an economically inefficient
production method, with too many workers in general and too many high-skilled
workers in particular.
c.
Lego faced an information and organization problem because Lego apparently did
not know which managers were shirking. In order to overcome this important
principal-agent problem, Lego changed its compensation methods by introducing
performance-based pay for its managers. By basing its managers’ pay on their
performance, Lego gave its managers the incentive to work diligently in their
efforts to boost Lego’s profits.
8.
d.
Lego operates in a monopolistically competitive market.
a.
Microsoft entered the market to hire various firms, Astro Studios and Hers
Experimental Design Laboratory to design the Xbox 360 and then entered the
market again to hire IBM, ATI, and SiS to design the hardware of the Xbox 360.
Finally, Microsoft once again entered the market to hire Flextronics and Wistron,
and Celestica to produce the Xbox 360. Once Microsoft had contracted with these
firms, the design, manufacture, etc. takes place within the firm.
b.
Microsoft works with a large number of firms rather than doing everything
in-house because it is less expensive for Microsoft to work with other firms. These
other firms have specialized in various tasks and so have gained economies of
scale that Microsoft does not possess. Therefore it is cheaper for Microsoft to
enter the market and hire the expertise it needs than to do it all itself.
c.
Microsoft needed to determine what part of designing, building, and marketing the
Xbox would take place inside of Microsoft and what would take place in other
companies that Microsoft hired. Hiring other companies means that Microsoft
would incur the transactions costs of using markets. However, other companies
that specialized in different tasks could have economies of scale, economies of
scope, and/or economies of team production that lower the cost to Microsoft of
hiring them. So Microsoft had to determine which parts of the Xbox 360 would be
cheaper to undertake inside of Microsoft and which parts would be cheaper to
enter the market to contract with other firms.
d. The Xbox is designed in America and Japan because America and Japan has a
large number of highly-skilled workers who can successfully design the Xbox.
With a large number of technically adept workers, it is less expensive to design the
Xbox in these countries. Manufacturing the Xbox, however, takes place in China
because China has a large number of lower-skilled workers and so it is less
expensive to build the Xbox in China.
Charpter 10
1.
a.
To draw the total product curve measure labor on the x-axis and output on the
y-axis. The total product curve is upward sloping.
b.
The average product of labor is equal to total product divided by the quantity of
labor employed. For example, when 3 workers are employed, they produce 120
surfboards a week, so average product is 40 surfboards per worker.
The average product curve is upward sloping when up to 3 workers are hired and
the average product curve is downward sloping when more than 4 workers are
hired.
c.
The marginal product of labor is equal to the increase in total product when an
additional worker is employed. For example, when 3 workers are employed, total
product is 120 surfboards a week. When a fourth worker is employed, total
product increases to 160 surfboards a day. The marginal product of going from 3
to 4 workers is 40 surfboards.
The marginal product curve is upward sloping when up to 2.5 workers a week and
it is downward sloping when more than 2.5 workers a week are employed.
d.
The firm has the benefits of increased specialization and division of labor over the
range of output for which the marginal cost decreases. This range of output is the
same range over which the marginal product of labor rises. For Sue’s Surfboards,
the benefits of increased specialization and division of labor occur until 2.5
workers are employed.
e.
The marginal product of labor decreases after 2.5 workers are employed.
f.
The marginal product of labor decreases and the average product of labor rises
between 2.5 and 3.5 workers.
g.
As long as the marginal product of labor exceeds the average product of labor, the
average product of labor rises. So for a range of output, the marginal product of
labor, while decreasing, remains greater than the average product of labor so the
average product of labor rises.
2.
a.
Total cost is the sum of the costs of all the factors of production that Sue’s
Surfboards uses in production. Total variable cost is the total cost of the variable
factors. Total fixed cost is the total cost of the fixed factors.
For example, the total variable cost of producing 160 surfboards a week is the
total cost of the workers employed, which is 4 workers at $500 a week, which
equals $2,000. Total fixed cost is $1,000, so the total cost of producing 160
surfboards a week is $3,000.
To draw the short-run total cost curves, plot output on the x-axis and the total cost
on the y-axis. The total fixed cost curve is a horizontal line at $1,000. The total
variable cost curve and the total cost curve have shapes similar to those in Fig.
10.4, but the vertical distance between the total variable cost curve and the total
cost curve is $1,000.
b.
Average fixed cost is total fixed cost per unit of output. Average variable cost is
total variable cost per unit of output. Average total cost is the total cost per unit of
output.
For example, when the firm makes 160 surfboards a week: Total fixed cost is
$1,000, so average fixed cost is $6.25 per surfboard; total variable cost is $2,000,
so average variable cost is $12.50 per surfboard; and total cost is $3,000, so
average total cost is $18.75 per surfboard.
Marginal cost is the increase in total cost divided by the increase in output. For
example, when output increases from 120 to 160 surfboards a week, total cost
increases from $2,500 to $3,000, an increase of $500. That is, the increase in
output of 40 surfboards increases total cost by $500. Marginal cost is equal to
$500 divided by 40 surfboards, which is $12.50 a surfboard.
The short-run average and marginal cost curves are similar to those in Fig. 10.5.
c. The table sets out the data to use to draw the curves.
Labor
(worker
s)
1
Output
(surfboard
s)
30
AP
(surfboar
ds per
worker)
MP
(surfboar
ds per
worker)
30.0
TC
(dollar
s)
70
35.0
120
2,000
40.0
160
2,500
40.0
190
3,000
38.0
210
3,500
35.0
3.
220
13.16
25.00
4,000
10.0
7
12.50
16.67
20.0
6
12.50
12.50
30.0
5
14.29
10.00
40.0
4
16.67
12.50
50.0
3
AVC
(dollars
per
surfboar
d)
1,500
40.0
2
MC
(dollars
per
surfboar
d)
31.4
14.29
50.00
4,500
15.91
The rent is a fixed cost, so the total fixed costs increase. The increase in total fixed cost
increases total cost but does not change total variable cost. Average fixed cost is total
fixed cost per unit of output. The average fixed cost curve shifts upward. Average total
cost is total cost per unit of output. The average total cost curve shifts upward. The
marginal cost and average variable cost do not change.
4.
The increase in the wage rate is a variable cost, so the total variable costs increase. The
increase in total variable costs increases total cost but total fixed cost does not change.
Average variable cost is total variable cost per unit of output. The average variable cost
curve shifts upward. Average total cost is total cost per unit of output. The average
total cost curve shifts upward. The marginal cost curve shifts upward. The average
fixed cost curve does not change.
5.
A is the average fixed cost, AFC, when the output is 20. Average fixed cost equals total
fixed cost divided by output, or AFC = FC ÷ Q. Rearranging gives FC = AFC × Q. So
the total fixed cost for the problem equals $120 × 10, which is $1,200. A equals
$1,2000, FC, divided by 20, Q, which is $60.
B is the average variable cost, AVC, when output is 20. Use the result that AFC + AVC
= ATC by rearranging to give AVC = ATC  AFC, so average variable cost for the
problem equals $150  $60, which is $90.
D is the average total cost, ATC, when output, Q, equals 40. Average total cost equals
total cost divided by output, or ATC = TC ÷ Q. Rearranging gives TC = ATC × Q. So
the total cost when 30 are produced is $130 × 30, which is $3,900. Marginal cost, MC,
equals the change in total cost divided by the change in quantity, or MC = TC ÷ Q.
Rearranging gives TC = MC × Q, so the change in total cost between Q = 30 and Q
= 40 is $130 × 10, or $1,300. Therefore the total cost when Q equals 40 is $3,900 +
$1,300, or $5,200. The average total cost when Q is 40 is $5,200 ÷ 40, or $130.
C is the average variable cost, AVC, when output, Q, equals 40. Use the result that
AFC + AVC = ATC by rearranging to give AVC = ATC  AFC. As a result, average
variable cost for the problem equals $130  $30, which is $100.
E is the marginal cost, MC, between outputs of 40 and 50. Marginal cost, MC, equals
the change in total cost divided by the change in quantity, or MC = TC ÷ Q. To
calculate marginal cost, the total cost when output is 40 and the total cost when output
is 50 are needed. Average total cost equals total cost divided by output, or ATC = TC ÷
Q. Rearranging gives TC = ATC × Q. So the total cost when 40 are produced is $130 ×
40, which is $5,200 and total cost when 50 are produced is $132 × 50, which is $6,600.
So the marginal cost equals ($6,600  $5,200) ÷ 10, which equals $140.
6.
a.
Total cost is the cost of all the factors of production. For example, when 4 workers
are employed they now produce 240 surfboards a week. With 4 workers, the total
variable cost is $2,000 a week and the total fixed cost is (coincidentally also)
$2,000 a week. The total cost is $4,000 a week. The average total cost of
producing 24 surfboards is $16.67 a surfboard. The remainder of the ATCs are
calculated similarly.
b.
The long-run average cost curve is made up of the lowest parts of the firm's
short-run average total cost curves when the firm operates one plant and two
plants. The long-run average cost curve is similar to Fig. 10.8.
c.
It is efficient to operate the number of plants that has the lower average total cost
of a surfboard. It is efficient to operate one plant when output is less than
(approximately) 200 surfboards a week, and it is efficient to operate two plants
when the output is more than 200 surfboards a week.
Over the output range 1 to 200 surfboards a week, average total cost is less with
one plant than with two, but if output exceeds 200 surfboards a week, average
total cost is less with two plants than with one.
7.
a.
For example, the average total cost of producing a balloon ride when Bonnie rents
2 balloons and employs 40 workers equals the total cost ($1,000 rent for the
balloons plus $1,000 for the workers) divided by the 20 balloon rides produced.
The average total cost equals $2,000/20, which is $100 a ride.
The average total cost curve is U-shaped, as in Fig. 10.5.
b.
The long-run average cost curve is similar to that in Fig. 10.8.
c.
Bonnie’s minimum efficient scale is 13 balloon rides when Bonnie rents 1
balloon.
The minimum efficient scale is the smallest output at which the long-run average
cost is a minimum. To find the minimum efficient scale, plot the average total cost
curve for each plant and then check which plant has the lowest minimum average
total cost.
d.
Bonnie will choose the plant (number of balloons to rent) that gives her minimum
average total cost for the normal or average number of balloon rides that people
buy.
8.
a.
If the firm is producing where it experiences economies of scale, then by
increasing its plant size the firm moves along its long-run average cost to a lower
long-run average cost. As a result, the firm’s minimum average total cost falls
with its new, larger plant size.
b.
If the firm is producing where it experiences diseconomies of scale, then by
decreasing its plant size the firm moves along its long-run average cost to a lower
long-run average cost. As a result, the firm’s minimum average total cost falls
with its new, smaller plant size.
c.
If the firm is producing where it has constant returns to scale, then if the firm
increases or decreases its plant size its long-run average cost does not change. As
a result, the firm’s average total cost curve is the same whether or not the firm
increases or decreases its plant size.
9.
a.
The curves have their standard shapes, illustrated in Figure 10.5. The AFC curve
for the gas turbine plant lies below the AFC curves for the other types of plants.
Lying above the gas AFC curve and below the other curves is the AFC curve for
hydroelectric plants. The minimum point of the AVC curve for the gas turbine
plant lies above the minimum points of the AVC curves for the other types of
plants. The minimum point of the AVC curve for the hydroelectric plant lies below
the minimum points of the AVC curves for the other plants. The ATC curve for the
hydroelectric plant has the lowest minimum point and the ATC curve of the gas
turbine plant has the highest minimum point.
b.
The MC curves for all the plants go through the minimum points of the plants’
ATC curves. The MC curve for hydroelectric power has the lowest minimum point
and the MC curve for the gas turbine plant has the highest minimum point.
c.
We use more than one type of plant for at least three reasons. First, hydroelectric
plants might be the least expensive to operate, but they must be near rapidly
flowing rivers. Second, the scale of the electricity that is demanded needs to be
examined. For instance, at some locations so much electricity is demanded that
hydroelectric plants (or other type of plants) are operating where there are
diseconomies of scale that raise their long-run average cost. In these locations,
some other plant, perhaps gas or nuclear, might have lower average costs for the
quantity of electricity demanded. Third, the price of natural gas, coal, oil, and
nuclear fuel can vary tremendously. By having different types of plants some
protection is gained against having a concentration in a type of plant whose costs
happened to soar.
Charpter 11
1.
a.
Lin is operating in a perfectly competitive market.
b.
The equilibrium price is determined by the equilibrium between the market
demand and the market supply.
c.
Lin’s marginal revenue equals the market price for a box of cookies.
d.
Lin will sell no boxes of fortune cookies.
e.
All buyers will want to buy Lin’s cookies. so the demand for Lin’s cookies is
essentially infinite. More realistically, Lin would probably sell the quantity that
maximizes his profit but that profit will be less than if he sells at the going market
price of $10 a box.
f.
The elasticity of demand for Lin’s cookies is infinite. The elasticity of demand in
the market for cookies is not infinite.
2.
a.
Quick Copy’s marginal revenue equals the market price so it is 10 cents per page.
b.
Quick Copy’s profit-maximizing quantity is 80 pages an hour.
Quick Copy maximizes its profit by producing the quantity at which marginal
revenue equals marginal cost. In perfect competition, marginal revenue equals
price, which is 10 cents a page. Marginal cost is 10 cents when Quick Copy
produces 80 pages an hour.
c.
Quick Copy’s economic profit is $2.40 an hour.
Economic profit equals total revenue minus total cost. Total revenue equals $8.00
an hour (10 cents a page multiplied by 80 pages). The average total cost of
producing 80 pages is 7 cents a page, so total cost equals $5.60 an hour (7 cents
multiplied by 80 pages). So economic profit equals $8.00 minus $5.60, which is
$2.40 an hour.
3.
a.
(i) At $14 a pizza, Pat’s profit-maximizing output is 4 pizzas an hour and
economic profit is $10 an hour.
Pat’s maximizes its profit by producing the quantity at which marginal revenue
equals marginal cost. In perfect competition, marginal revenue equals price, which
is $14 a pizza. Marginal cost is the change in total cost when output is increased
by 1 pizza an hour. The marginal cost of increasing output from 3 to 4 pizzas an
hour is $13 ($54 minus $41). The marginal cost of increasing output from 4 to 5
pizzas an hour is $15 ($69 minus $54). So the marginal cost of the fourth pizza is
half-way between $13 and $15, which is $14. Marginal cost equals marginal
revenue when Pat produces 4 pizzas an hour..
Economic profit equals total revenue minus total cost. Total revenue equals $64 (
$14 multiplied by 4). Total cost is $54, so economic profit is $10.
(ii) At $12 a pizza, Pat’s profit-maximizing output is 3 pizzas an hour and
economic profit is $5.
Pat’s maximizes its profit by producing the quantity at which marginal revenue
equals marginal cost. Marginal revenue equals price, which is $12 a pizza.
Marginal cost of increasing output from 2 to 3 pizzas an hour is $11 ($41 minus
$30). The marginal cost of increasing output from 3 to 4 pizzas an hour is $13. So
the marginal cost of the third pizza is half-way between $11 and $13, which is
$12. Marginal cost equals marginal revenue when Pat produces 3 pizzas an hour.
Economic profit equals total revenue minus total cost. Total revenue equals $36
($12 multiplied by 3). Total cost is $41, so economic profit is $5.
(iii) At $10 a pizza, Pat’s profit-maximizing output is 2 pizzas an hour and
economic profit is $10.
Pat’s maximizes its profit by producing the quantity at which marginal revenue
equals marginal cost. Marginal revenue equals price, which is $10 a pizza.
Marginal cost of increasing output from 1 to 2 pizzas an hour is $9 ($30 minus
$21). The marginal cost of increasing output from 2 to 3 pizzas an hour is $11. So
the marginal cost of the second pizza is half-way between $9 and $11, which is
$10. Marginal cost equals marginal revenue when Pat produces 2 pizzas an hour.
Economic profit equals total revenue minus total cost. Total revenue equals $20
($10 multiplied by 2). Total cost is $30, so economic profit is $10.
b.
Pat’s shutdown point is at a price of $10 a pizza.
The shutdown point is the price that equals minimum average variable cost. To
calculate total variable cost, subtract total fixed cost ($10, which is total cost at
zero output) from total cost. Average variable cost equals total variable cost
divided by the quantity produced. For example, the average variable cost of
producing 2 pizzas is $10 a pizza. Average variable cost is a minimum when
marginal cost equals average variable cost. The marginal cost of producing 2
pizzas is $10. So the shutdown point is a price of $10 a pizza.
c.
Pat’s supply curve is the same as the marginal cost curve at prices equal to or
above $10 a pizza and the y-axis at prices below $10 a pizza.
d.
Pat and firms with the same cost as Pat will exit the pizza industry if in the long
run the price is less than $13 a pizza.
Pat’s Pizza Kitchen and other firms with the same costs will leave the industry if
they incur an economic loss in the long run. To incur an economic loss, the price
will have to be below minimum average total cost. Average total cost equals total
cost divided by the quantity produced. For example, the average total cost of
producing 2 pizzas is $15 a pizza. Average total cost is a minimum when it equals
marginal cost. The average total cost of 3 pizzas is $13.67, and the average total
cost of 4 pizzas is $13.50. Marginal cost when Pat’s produces 3 pizzas is $12 and
marginal cost when Pat’s produces 4 pizzas is $14. At 3 pizzas, marginal cost is
less than average total cost; at 4 pizzas, marginal cost exceeds average total cost.
So minimum average total cost occurs between 3 and 4 pizzas—$13 at 3.5 pizzas
an hour.
e.
Pat and firms with the same cost as Pat will enter the pizza industry if in the long
run the price is greater than $13 a pizza.
The reasoning is essentially the reverse of the reasoning behind the answer to part
(d). Pat’s Pizza Kitchen and other firms with the same costs will enter the industry
if they can earn an economic profit. To earn an economic profit, the price will
have to be above minimum average total cost. Average total cost equals total cost
divided by the quantity produced. For example, the average total cost of producing
2 pizzas is $15 a pizza. Average total cost is a minimum when it equals marginal
cost. The average total cost of 3 pizzas is $13.67, and the average total cost of 4
pizzas is $13.50. Marginal cost when Pat’s produces 3 pizzas is $12 and marginal
cost when Pat’s produces 4 pizzas is $14. At 3 pizzas, marginal cost is less than
average total cost; at 4 pizzas, marginal cost exceeds average total cost. So
minimum average total cost occurs between 3 and 4 pizzas—$13 at 3.5 pizzas an
hour.
5.
a.
The market price is $8.40 per box of paper.
The market price is the price at which the quantity demanded equals the quantity
supplied. The firm’s supply curve is the same as its marginal cost curve at prices
above minimum average variable cost. Average variable cost is a minimum when
marginal cost equals average variable cost. Marginal cost equals average variable
cost at the quantity 250 boxes a week. So the firm’s supply curve is the same as
the marginal cost curve for the outputs equal to 250 boxes or more. When the
price is $8.40 a box, each firm produces 350 boxes and the quantity supplied by
the 1,000 firms is 350,000 boxes a week. The quantity demanded at $8.40 is
350,000 a week.
b.
The industry output is 350,000 boxes a week.
c.
Each firm produces 350 boxes a week.
d.
Each firm incurs an economic loss of $581 a week.
Each firm produces 350 boxes at an average total cost of $10.06 a box. The firm
can sell the 350 boxes for $8.40 a box. The firm incurs a loss on each box of $1.66
and incurs an economic loss of $581a week.
e.
In the long run, some firms exit the industry because they are incurring economic
losses.
f.
The number of firms in the long run is 750.
In the long run, as firms exit the industry, the price rises. In long-run equilibrium,
the price will equal the minimum average total cost. When output is 400 boxes a
week, marginal cost equals average total cost and average total cost is a minimum
at $10 a box. In the long run, the price is $10 a box. Each firm remaining in the
industry produces 400 boxes a week. The quantity demanded at $10 a box is
300,000 a week. So the number of firms is 300,000 boxes divided by 400 boxes
per firm, which is 750 firms.
g.
In the long run, the price equals the minimum average total cost, $10 a box.
h.
In the long run, the 750 firms together produce the equilibrium quantity of
300,000 boxes.
5.
a.
The market price is $7.65 a box, the equilibrium industry quantity is 300,000
boxes a week, and each firm incurs an economic loss of $834 a week.
When the price is $7.65 a box, each firm produces 300 box and the quantity
supplied by the 1,000 firms is 300,000 boxes a week. The quantity demanded at
$7.65 is 300,000 a week. Each firm produces 300 boxes at an average total cost of
$10.43 a box. The firm can sell the 300 boxes for $7.65 a box. The firm incurs a
loss on each box of $2.78 and incurs an economic loss of $834 a week.
b.
In the long run, the market price is $10.00 a box, the equilibrium industry quantity
is 200,000 boxes a week, and each firm makes zero economic profit, that is, earns
a normal profit.
In the long run, the price equals the minimum average total cost, which is $10.00 a
box. The quantity demanded at $10 a box is 200,000 a week.
c.
This industry has constant costs because the cost schedule does not change as the
number of firms changes. The long-run supply curve will be horizontal at a price
of $10 per box.
6.
a.
Once at the competitive equilibrium quantity, which is the same as the efficient
quantity, the sum of consumer surplus plus producer surplus is as large as
possible. So the consumer surplus can be increased but only at the expense of a
larger decrease in producer surplus. For instance, a price ceiling set below the
equilibrium price forces the price downward and might increase consumer surplus
depending on the extent of the decrease in the quantity produced. However, the
decrease in producer surplus would be larger than the increase in consumer
surplus. In addition, in the long run the price ceiling will lead to exit from the
industry so that the quantity supplied decreases even more and the consumer
surplus shrinks.
b.
Once at the competitive equilibrium quantity, which is the same as the efficient
quantity, the sum of consumer surplus plus producer surplus is as large as
possible. So the producer surplus can be increased but only at the expense of a
larger decrease in consumer surplus. For instance, a price floor set above the
equilibrium price forces the price upward and might increase producer surplus
depending on the extent of the decrease in the quantity demanded. However, the
decrease in consumer surplus would be larger than the increase in producer
surplus.
c.
The consumer is on his or her demand curve and so is making the best possible
use of his or her income. Substituting away from this good cannot make the
consumer better off.
d.
In the long-run equilibrium, the perfectly competitive firms are producing the
good at the lowest possible average total cost, so it is not possible to produce the
good fro a lower average total cost.
Charpter 12
1.
a.
Substitutes for the U.S. Postal Service include email, fax, and private delivery
services, such as FedEx or UPS. Substitutes for Lipitor are other statin drugs, such
as Zocor, non-statin drugs that also lower cholesterol, and also exercise.
Substitutes for Cox Communications include satellite television services.
b.
The U.S. Postal Service and Pfizer are protected by legal barriers to entry. The
Postal Service has the legal right given to it by the Private Express Statutes to be
the only first class non-urgent mail service and Pfizer has a patent on Lipitor. Cox
Communications definitely has a natural barrier to entry because it is a natural
monopoly.
c.
Cox Communications is the only natural monopoly. Its cost curve will look
similar to Figure 12.1. Cox communications has a large fixed cost of creating a
massive infrastructure and then a small marginal cost when it increases the
quantity of its customers. As a result, its economies of scale means that its average
cost curve is downward sloping when it crosses the demand curve.
d.
Both the U.S. Postal Service and Pfizer are legal monopolies. The Postal Service
has the legal right given to it by the Private Express Statutes to be the only first
class non-urgent mail service and Pfizer has a patent on Lipitor
e.
All three of the firms practice price discrimination. The second ounce in a first
class letter is less expensive to mail than the first ounce. Lipitor’s price varies
according to the insurance policy a customer has. Cox Communications bundles
packages of services that have a lower price than each item taken separately so
that additional units of service are less expensive than the initial units.
2.
a.
Minnie’s total revenue schedule lists the total revenue at each quantity sold. For
example, Minnie’s can sell 1 bottle for $8 a bottle, which is $8 of total revenue at
the quantity 1 bottle.
b.
Minnie’s marginal revenue schedule lists the marginal revenue that results from
increasing the quantity sold by 1 bottle. For example, Minnie’s can sell 1 bottle
for a total revenue of $8. Minnie’s can sell 2 bottles for $6 each, which is $12 of
total revenue at the quantity 2 bottles. So by increasing the quantity sold from 1
bottle to 2 bottles, marginal revenue is $4 a bottle ($12 minus $8).
c.
Minnie’s demand curve and marginal revenue curve will be similar to those in
Figure 12.2 The demand curve will intersect the vertical axis at a price of $10 and
will intersect the horizontal axis at a quantity of 5. The marginal revenue curve
will intersect the vertical axis at a price of $10 and will intersect the horizontal
axis at a quantity of 2.5.
d.
Minnie’s marginal revenue is less than her price because to sell an additional unit
of output, Minnie must lower her price on all units sold. So when Minnie sells an
additional unit of output, her revenue consists of the price she receives for this
extra unit minus what she loses on all previous units she sells because of the new,
lower price.
e.
Interpolating along the demand curve, Minnie’s total revenue is maximized at a
price of $5. At this price she sells 2.5 bottles an hour for a total revenue of $12.50.
f.
The demand for Minnie’s Mineral Springs water is elastic between $5 per bottle
and $10 per bottle.
g.
Minnie will not produce a quantity at which the demand for her water is inelastic
because producing at such a price does not maximize her profit. If Minnie is
producing where her demand is inelastic, she can decrease the quantity she
produces and thereby: 1) increase her total revenue, and 2) decrease her total cost.
Because her total revenue increases and her total cost decreases, Minnie’s total
profit unambiguously increases. Anytime Minnie’s production is at an inelastic
point on her demand curve, she can always increase her total profit by decreasing
her production.
3.
a.
Marginal cost is the increase in total cost that results from increasing output by 1
unit. When Minnie’s increases output from 1 bottle to 2 bottles, total cost
increases by $4, so the marginal cost is $4 a bottle.
b.
Minnie’s profit-maximizing output is 1.5 bottles and her profit-maximizing price
is $7a bottle..
The marginal cost of increasing the quantity from 1 bottle to 2 bottles is $4 a
bottle ($7 minus $3). That is, the marginal cost of the 1.5 bottles is $4 a bottle.
The marginal revenue of increasing the quantity sold from 1 bottle to 2 bottles is
$4 ($12 minus $8). So the marginal revenue from 1.5 bottles is $4 a bottle. Profit
is maximized when the quantity produced makes the marginal cost equal to
marginal revenue. The profit-maximizing output is 1.5 bottles. The
profit-maximizing price is the highest price that Minnie’s can sell the
profit-maximizing output of 1.5 bottles. Minnie’s can sell 1 bottle for $8 and 2
bottles for $6, so it can sell 1.5 bottles for $7 a bottle.
c.
Minnie’s economic profit is $5.50.
Economic profit equals total revenue minus total cost. Total revenue equals price
($7 a bottle) multiplied by quantity (1.5 bottles), which is $10.50. Total cost of
producing 1 bottle is $3 and the total cost of producing 2 bottles is $7, so the total
cost of producing 1.5 bottles is $5. Profit equals $10.50 minus $5, which is $5.50.
4.
a.
The profit-maximizing quantity is 267 newspapers a day and price is 73 cents a
paper.
Profit is maximized when the firm produces the output at which marginal cost
equals marginal revenue. Draw in the marginal revenue curve. It runs from 100 on
the y-axis to 500 on the x-axis. The marginal revenue curve cuts the marginal cost
curve at the quantity 267 newspapers a day. The highest price that the publisher
can sell 267 newspapers a day is read from the demand curve.
b.
The daily total revenue is $194.91 (267 papers at 73 cents each).
c.
Demand is elastic.
Along a straight-line demand curve, demand is elastic at all prices above the
midpoint of the demand curve. The price at the midpoint is 50 cents. So at 73
cents a paper, demand is elastic.
d.
The consumer surplus is $36.05 a day and the deadweight loss is $8.65 a day.
Consumer surplus is the area under the demand curve above the price. The price is
73 cents, so consumer surplus equals (100 cents minus 73 cents) multiplied by
267/2 papers a day, which is $36.05 a day.
Deadweight loss arises because the publisher does not produce the efficient
quantity. Output is restricted to 267 rather than 400, and the price is increased to
73 cents rather than 60 cents. The deadweight loss equals (73 cents minus 60
cents) multiplied by 133/2.
e.
This market would encourage rent seeking because the producer is earning an
economic profit. Other entrepreneurs would like to transfer the economic profit to
their pockets and will rent seek in an attempt to do so.
f.
The quantity would be 400 newspapers per day, the price would be 60 cents per
newspaper. The consumer surplus is the triangular area under the demand curve
and above the price. The price is 60 cents, so consumer surplus equals (100 cents
minus 60 cents) multiplied by 400/2 papers a day, which is $80 a day. The
producer surplus is the triangular area under the price and above the supply curve.
The price is 60 cents, so producer surplus equals (60 cents minus 20 cents)
multiplied by 400/2 papers a day, which is $80 a day.
5.
a.
La Belle Pizza is price discriminating, which increases the firm’s profit. It is price
discriminating along two dimensions. First, it is charging consumers a second
price on the second pizza they buy. This sort of price discrimination essentially is
moving downward along a consumer’s demand curve and increasing the quantity
the consumer purchases. Second, it is giving away coupons that lower the price on
a stand-priced pizza. La Bella must have consumers with different willingness to
pay and the coupon enables La Bella to increase its sales to the coupon users who
have a lower willingness to pay for the pizza. On both counts, La Belle is
increasing its sales and, because its marginal revenues from these additional sales
exceed its marginal cost of $2, the additional sales increase La Belle’s profit.
b.
The figure will look like Figure 12.9, where some consumers buy pizzas at a price
of $14.99, others buy pizzas at a price of $9.99 (the $14.99 regular price minus the
$5 coupon), and still other pizzas are sold for a price of $4.99.
c.
La Belle could increase its price discrimination even more. For instance, it might
sell a third pizza for $3.99, which, given the marginal cost of $2, would still be
profitable for La Belle.
d.
A firm that can price discriminate increases its production relative to what it
would produce if it could not price discriminate. So the quantity of pizza La Bella
produces is closer to the efficient quantity with the price discrimination that it
would be if La Bella did not price discriminate.
6.
a.
Calypso will produce 2 cubic feet a day and sell it for 6 cents a cubic foot.
Draw in the marginal revenue curve. It runs from 10 on the y-axis to 2.5 on the
x-axis. The profit-maximizing output is 2 cubic feet at which marginal revenue
equals marginal cost. The price charged is the highest that people will pay for 2
cubic feet a day, which is 6 cents a cubic foot.
b.
Calypso will produce 3 cubic feet a day and charge 4 cents a cubic foot.
If Calypso is regulated to earn only normal profit, it produces the output at which
price equals average total cost—at the intersection of the demand curve and the
ATC curve.
c.
The firm will produce 4 cubic feet a day and charge 2 cents a cubic foot.
If the firm is regulated to be efficient, it will produce the quantity at which price
(marginal social benefit) equals marginal social cost—at the intersection of the
demand curve and the marginal social cost curve.
7.
a.
If Calypso is unregulated, it produces 2 cubic feet a day and sells it for 6 cents a
cubic foot. The consumer surplus is 4 cents, the producer surplus is 8 cents, and
the deadweight loss is 4 cents.
The consumer surplus is the triangular area under the demand curve and above the
price. The price is 6 cents, so consumer surplus equals (10 cents minus 6 cents)
multiplied by 2/2 cubic feet a day, which is 4 cents. The producer surplus is the
rectangular area under the price and above the MC curve. The price is 6 cents, so
producer surplus equals (6 cents minus 2 cents) multiplied by 2 cubic feet a day,
which is 8 cents. The efficient output is 4 cubic feet, at which marginal cost equals
price (marginal benefit). The deadweight loss is the triangular area between the
demand (or marginal benefit curve) and the marginal cost curve from the
equilibrium quantity to the efficient quantity. So the deadweight loss equals (4
minus 2 cubic feet) multiplied by (6 minus 2 cents)/2, which is 4 cents a day.
b.
If Calypso is regulated to make zero economic profit, it produces 3 cubic feet a
day and sells it for 4 cents a cubic foot. The consumer surplus is 9 cents, the
producer surplus is 6 cents, and the deadweight loss is 1 cent.
The consumer surplus is the triangular area under the demand curve and above the
price. The price is 4 cents, so consumer surplus equals (10 cents minus 4 cents)
multiplied by 3/2 cubic feet a day, which is 9 cents. The producer surplus is the
rectangular area under the price and above the MC curve. The price is 4 cents, so
producer surplus equals (4 cents minus 2 cents) multiplied by 3 cubic feet a day,
which is 6 cents. The efficient output is 4 cubic feet, at which marginal cost equals
price (marginal benefit). The deadweight loss is the triangular area between the
demand (or marginal benefit curve) and the marginal cost curve from the
equilibrium quantity to the efficient quantity. So the deadweight loss equals (4
minus 3 cubic feet) multiplied by (4 minus 2 cents)/2, which is 1 cent a day.
c.
If Calypso is regulated to be efficient, it produces 4 cubic feet a day and sells it for
2 cents a cubic foot. The consumer surplus is 16 cents, the producer surplus is 0
cents, and the deadweight loss is 0 cents.
The consumer surplus is the triangular area under the demand curve and above the
price. The price is 2 cents, so consumer surplus equals (10 cents minus 2 cents)
multiplied by 4/2 cubic feet a day, which is 16 cents. There is no producer surplus
because the price equals the marginal cost. And there is no deadweight loss
because the quantity produced is the efficient quantity.
Charpter 13
1.
a.
Lite and Kool produces 100 pairs a week.
To maximize profit, Lite and Kool produces the quantity at which marginal
revenue equals marginal cost.
b.
Lite and Kool charges $80 a pair.
To maximize profit, Lite and Kool charges the highest price for the 100 pairs of
shoes, as read from the demand curve.
c.
Lite and Kool makes a profit of $2,000 a week.
Economic profit equals total revenue minus total cost. The price is $80 a pair and
the quantity sold is 100 pairs, so total revenue is $8,000. Average total cost is $60
a pair, so total cost equals $6,000. Economic profit equals $8,000 minus $6,000,
which is $2,000 a week.
2.
a.
The price of a pair of running shoes falls in the long run.
Lite and Kool is earning an economic profit. This profit attracts entry into the
market. As new firms enter, the demand for Lite and Kools’ shoes decreases. The
decrease in demand leads to the price of running shoes falling.
b.
The quantity of running shoes produced by Lite and Kool decreases in the long
run.
Lite and Kool is earning an economic profit. This profit attracts entry into the
market. As new firms enter, the demand for Lite and Kools’ shoes decreases. The
decrease in demand leads to the quantity of running shoes produced by Lite and
Kool decreasing.
c.
The quantity of running shoes in the market as a whole increases in the long run.
Lite and Kool is earning an economic profit. This profit attracts entry into the
market. As new firms enter, each initial firm decreases its output a bit. But the
new firms produce more shoes and, on net, the quantity of shoes in the entire
market increases.
d.
Lite and Kool does not produce at the minimum of the average total cost in the
long run.
Lite and Kool is a monopolistically competitive firm. In the long run,
monopolistically competitive firms produce less output than the amount which
minimizes the average total cost.
3.
a.
The average total cost of a jacket is $200.
The average total cost equals the total cost divided by the quantity. The fixed cost
is $2,000. Because the marginal cost is $100 per jacket, the total variable cost is
$2,000. So the total cost is the $2,000 fixed cost plus the $2,000 variable cost, or
$4,000. So the average total cost is $4,000/20, which is $200.
b.
The average total cost of a jacket is $180.
The average total cost equals the total cost divided by the quantity. The fixed cost
is $4,000. Because the marginal cost is $100 per jacket, the total variable cost is
$5,000. So the total cost is the $4,000 fixed cost plus the $5,000 variable cost, or
$9,000. The average total cost is $9,000/50, which is $180.
c.
If the advertising has increased the demand and made it more elastic, which is
likely the case if all firms advertise, then the price will fall. However, if the
advertising has increased the demand and made the price less elastic, then the
price will rise.
d.
If the price falls, then the makeup falls; if the price rises, then the markup rises.
e.
It is not possible to determine the effect on the profit in the short run. In the long
run, however, the economic profit will equal zero as it does for all
monopolistically competitive firms in the long run.
4.
The market for CPUs is natural oligopoly, most likely a natural duopoly. There are
only two firms in the market, Intel and AMD, and there are no legal barriers to entry
which limit the number of firms to two. Because other firms could enter the market but
do not do so supports the idea that this industry is a natural duopoly. The cost curves
and demand curve for this market would be similar to Figure 13.9, which shows the
situation for a market in which two firms can satisfy the market demand.
5.
a. The situation being described is that of a firm facing a kinked demand curve. The
figure will be similar to Figure 13.11 in which the demand curve has a kink at the
current price of flat panel TVs.
b.
Walmart’s marginal cost of a flat panel TV has fallen, so Walmart’s marginal cost
curve has shifted downward. Figure 13.11 shows the issue: As long as the
marginal curve “intersects” the marginal revenue curve in the break, Walmart will
not change the price or the quantity of flat panel TVs it buys and sells. If the fall
in the marginal cost is large enough so that the marginal cost curve intersects the
marginal revenue below the vertical break portion, Walmart will lower the price
(and increase the number) of the flat panel TVs it sells.
6.
a.
The price rises, output increases, and economic profit increases.
The dominant firm, Big Joe’s Trucking, produces the quantity and sets the price
such that it maximizes its profit. When demand increases, marginal revenue
increases, so the firm produces a larger output. The highest price at which the
dominant firm can sell its output increases. Economic profit increases.
b.
The price rises, output increases, and economic profit increases.
The small firms are price takers, so the price they charge rises. Because these
firms are price takers, the price is also marginal revenue. Because marginal
revenue increases, the small firms move up along their marginal cost curves
(supply curves) and increase the quantity they produce. Because price exceeds
marginal cost, economic profit increases.
7.
a.
The game has 2 players (A and B), and each player has 2 strategies: to answer
honestly or to lie. There are 4 payoffs: Both answer honestly; both lie; A lies, and
B answers honestly; and B lies, and A answers honestly.
b.
The payoff matrix has the following cells: Both answer honestly: A gets $100, and
B gets $100; both lie: A gets $50, and B gets $50; A lies and B answers honestly: A
gets $500, and B gets $0; B lies and A answers honestly: A gets $0, and B gets
$500.
c.
The equilibrium is that each player lies and gets $50.
If B answers honestly, the best strategy for A is to lie because he would get $500
rather than $100. If B lies, the best strategy for A is to lie because he would get
$50 rather than $0. So A’s best strategy is to lie, no matter what B does. Repeat the
exercise for B. B’s best strategy is to lie, no matter what A does.
d.
The game is a the same as a prisoners’ dilemma. In this game, as in the prisoners’
dilemma game, both players get the jointly worse equilibrium outcome because
they cannot trust the other player to cooperate. If the players could cooperate, they
would achieve a better result.
8.
a.
Each firm has two strategies: to abide with the agreement or to cheat on the
agreement.
b.
The payoff matrix has the following cells: Both abide by the agreement: Soapy
makes $1 million profit, and Suddies makes $1 million profit; both cheat: Soapy
makes $0 profit, and Suddies makes $0 profit; Soapy cheats and Suddies abides
by the agreement: Soapy makes $1.5 million profit, and Suddies incurs a $0.5
million loss; Suddies cheats and Soapy abides by the agreement: Suddies makes
$1.5 million profit, and Soapy incurs $0.5 million loss.
c.
The equilibrium is that both firms cheat and each makes normal profit.
d.
The equilibrium is a dominant strategy because for each firm, regardless of the
opponent’s choice, the best strategy for the firm is to cheat. If Suddies abides by
the agreement, the best strategy for Soapy is to cheat because it would make a
profit of $1.5 million rather than $1 million. If Suddies cheats, the best strategy
for Soapy is to cheat because it would make a profit of $0 (the competitive
outcome) rather than incur a loss of $0.5 million. So Soapy’s best strategy is to
cheat, no matter what Suddies does. Repeating the exercise for Suddies shows that
Suddies’s best strategy also is to cheat, no matter what Soapy does.
9.
a.
Each firm can adopt a tit-for-tat strategy or a trigger strategy, strategies that were
not possible in a one-time game.
b.
The game has a cooperative equilibrium. If the firms employ a trigger strategy or a
tit-for-tat strategy, they can reach the cooperative abide/abide outcome. Take the
case of the tit-for-tat strategy. If both firms comply for, say, three periods, both
firms make $3 million profit. If a firm cheats in the first period while its opponent
complies, the cheater makes a $1.5 million profit. In the second period, the
opponent cheats, so if the first firm complies, it losses $0.5 million. In the third
period the opponent will comply so the first firm can again cheat and make $1.5
million. However, in these three periods the total profit is only $2.5 million, so the
cooperative equilibrium is possible.
c.
The game has a cooperative equilibrium. If the firms employ a trigger strategy or a
tit-for-tat strategy, they can reach the cooperative abide/abide outcome. In these
cases, the profit from complying with the agreement exceeds that from cheating
and so the cooperative equilibrium is likely.
Charpter 14
1.
a.
The price is 30 cents a bottle.
Elixir Springs is a natural monopoly. It produces the quantity that makes marginal
revenue equal to marginal cost, and it charges the highest price it can for the
quantity produced. The marginal revenue curve is twice as steep as the demand
curve, so it runs from 50 on the y-axis to 1.25 on the x-axis. Marginal revenue
equals marginal cost at 1 million bottles a year. The highest price at which Elixir
can sell 1 million bottles a year is 30 cents a bottle, read from the demand curve.
b.
Elixir Springs sells 1 million bottles a year.
c.
Elixir maximizes producer surplus.
If Elixir maximizes total surplus, it would produce the quantity that makes price
equal to marginal cost. That is, it would produce 2 million bottles a year and sell
them for 10 cents a bottles. Elixir is a natural monopoly, and it maximizes its
producer surplus.
2.
a.
The price is 10 cents a bottle.
Marginal cost pricing regulation sets the price equal to marginal cost, 10 cents a
bottle.
b.
Elixir sells 2 million bottles.
With the price set at 10 cents, Elixir maximizes profit by producing 2 million
bottles—at the intersection of the demand curve (which shows price) and the
marginal cost curve.
c.
Elixir incurs an economic loss of $150,000 a year.
Economic profit equals total revenue minus total cost. Total revenue is $200,000
(2 million bottles at 10 cents a bottle). Total cost is $350,000 (total variable cost
of $200,000 plus total fixed cost of $150,000). So Elixir incurs an economic loss
of $150,000 (a revenue of $200,000 minus $350,000).
d.
Consumer surplus is $400,000 a year.
Consumer surplus is the area under the demand curve above the price. Consumer
surplus equals 40 cents a bottle (50 cents minus 10 cents) multiplied by 2 million
bottles divided by 2, which is $400,000.
e.
The regulation is in the social interest because total surplus is maximized. The
outcome is efficient.
The outcome is efficient because marginal benefit (or price) equals marginal cost.
When the outcome is efficient, total surplus is maximized.
3.
a.
The price is 20 cents a bottle.
Average cost pricing regulation sets the price equal to average total cost. Average
total cost equals average fixed cost plus average variable cost. Because marginal
cost is constant at 10 cents, average variable cost equals marginal cost. Average
fixed cost is total fixed cost ($150,000) divided by the quantity produced. For
example, when Elixir produces 1.5 million bottles, average fixed cost is 10 cents,
so average total cost is 20 cents. The price at which Elixir can sell 1.5 million
bottles a year is 20 cents a bottle.
b.
Elixir sells 1.5 million bottles.
c.
Elixir makes zero economic profit.
Economic profit equals total revenue minus total cost. Total revenue is $300,000
(1.5 million bottles at 20 cents a bottle). Total cost is $300,000 (1.5 million bottles
at an average total cost of 20 cents). So Elixir makes zero economic profit.
d.
Consumer surplus is $225,000 a year.
Consumer surplus is the area under the demand curve above the price. Consumer
surplus equals 30 cents a bottle (50 cents minus 20 cents) multiplied by 1.5
million bottles divided by 2, which is $225,000.
e.
The regulation creates a deadweight loss, so the outcome is inefficient. The
regulation is not in the social interest.
4.
a.
The price is 30 cents a bottle.
If Elixir Springs captures the regulator, it will be able to inflate its cost up to the
profit-maximizing price and quantity. Problem 1a showed that the
profit-maximizing price is 30 cents a bottle.
b.
Elixir Springs sells 1 million bottles a year.
If Elixir Springs captures the regulator, it will be able to inflate its cost up to the
profit-maximizing price and quantity. Problem 1b showed that the
profit-maximizing quantity is 1 million bottles a year.
e.
The inflated average total cost is 30 cents a bottle.
Even after it captures the regulator and inflates its costs, Elixir Springs still earns a
normal profit, which requires that its price equal its average total cost. Because the
price is 30 cents a bottle, the average total cost must also be 30 cents a bottle.
5.
a.
The price is $500 a trip, and the quantity is 2 trips a day.
Regulation in the social interest is marginal cost pricing. Each airline charges
$500 a trip and produces the quantity at which price equals marginal cost. Each
airline makes 1 trip a day.
b.
The price is $750 a trip, and the number of trips is 1 trip a day (one by each airline
on alternate days).
If the airlines capture the regulator, the price will be the same as the price that an
unregulated monopoly would charge. An unregulated monopoly produces the
quantity and charges the price that maximizes profit—that is, the quantity that
makes marginal revenue equal to marginal cost. This quantity is 1 trip a day, and
the highest price that the airlines can charge for that trip (read from the demand
curve) is $750.
c.
Deadweight loss is $125 a day.
Deadweight loss arises because the number of trips is cut from 2 to 1 a day and
the price is increased from $500 to $750. Deadweight loss equals (2 minus 1) trip
multiplied by ($750 minus $500) divided by 2. Deadweight loss is $125 a day.
d.
If there are only a few large producers and many consumers, public choice theory
predicts that regulation will protect the producer’s interest and politicians will be
rewarded with campaign contributions. But if there is a significant number of
small producers with large costs or if the cost of organizing consumers is low,
regulation will be in the social interest.
6.
If the airlines can form an effective cartel, they will set the price and quantity at the
monopoly price and quantity. If this market was a monopoly, the marginal revenue
curve would intersect the marginal cost curve at a quantity of 1 trip per day, so an
effective cartel would produce the same quantity, 1 trip per day. The demand curve
shows that the monopoly price for 1 trip per day is $750 per trip, so an effective cartel
would set the same price, $750 per trip.
7.
The airline that is predatorily pricing might be successful in driving the other airline
out of business, but to do so it would suffer an economic loss during the entire period
of predatory pricing. In the long run, it is unlikely it would succeed because, as long as
it is earning an economic profit, other airlines have the incentive to enter the market.
And there are no barriers to entry, then other airlines will enter the market if there is a
potential for economic profit.
8.
a.
The owners are engaged in price fixing. If discovered, they will be charged under
Section 1 of the Sherman Act.
b.
These mergers will be challenged by the FTC because they almost surely exceed
the FTC’s HHI guidelines. Likely the mergers will be challenged under Section 2
of the Sherman Act as well as the Clayton Act’s prohibition about acquiring a
competitor’s shares or assets if the acquisition substantially lessens competition or
creates monopoly.
c.
This event is likely legal under the nation’s antitrust laws.
d.
This action is likely legal under the nation’s antitrust laws. If the government
wants to challenge it, the government will use the Clayton Act’s prohibition of
tying contacts and assert that the contract substantially lessens competition or
creates monopoly.
e.
This action is likely legal under the nation’s antitrust laws. If the government
wants to challenge it, the government will use the Clayton Act’s prohibition of
tying contacts and assert that the contract substantially lessens competition or
creates monopoly.
9.
Regulation consists of rules administered by government agency to influence economic
activity by determining prices, product standards and types, and the conditions under
which new firms may enter an industry. Antitrust law regulates or prohibits price
fixing and the attempt to monopolize. Regulation applies mainly to natural monopoly
and antitrust law to oligopoly. Regulation of electric utilities is an example of
regulation. The ruling against Microsoft is an example of the application of the
antitrust law.
10. The first part of the Sherman Act, which outlaws all forms of price-fixing, has been
applied consistently and firmly. The second part of the Sherman Act, which outlaws
attempts to monopolize, has been applied with varying degrees of firmness. Price
fixing is clear, easy to define, and once discovered, clearly violates the Act. Attempts
to monopolize are vague and varied, hard to define, and ambiguous even when
detected. This difference in the clarity of the violation probably accounts for the
difference in the way the law has treated the two parts of the Act.
11. a.
The merger would not be in the social interest because it would create a fast food
firm with substantial market power. This firm could operate almost as would a
monopoly and so would restrict its output, boost its prices, and create a
deadweight loss.
b.
The price of a burger would rise because the firm could act as a monopoly.
c.
Because the giant firm would operate almost as would a monopoly, the firm
would boost the price of its burgers and decrease the quantity. As a result of this
market power, the consumer surplus decreases, the producer surplus increases,
and the deadweight loss increases.
d.
The government almost surely would move to block the merger because it would
violate their merger guidelines.
Charpter 15
1.
a.
The planes create a negative production externality from their noise.
b.
The sunset creates no externality.
c.
The increase in the number of people studying for graduate degrees creates a
positive consumption externality.
d.
The perfume creates a negative consumption externality.
e.
The homeowner creates a positive consumption externality.
f.
The drunk creates a negative consumption externality.
g.
Presuming people like the smell of baking bread, the bakery creates a positive
production externality.
2.
a.
5 tons per week are produced and the marginal cost falling on the trout farmer is
$167 a ton.
When 5 tons a week are produced, the pesticide producer’s marginal cost is $75 a
ton and the marginal benefit of pesticide is $75 a ton. At this quantity, the trout
farmer’s MC from pesticide production is $167 a ton.
b.
3 tons per week are produced and the pesticide producer pays the farmer $100 a
ton = $300 a week.
The efficient quantity is 3 tons at which marginal social cost equals marginal
social benefit. If the trout farmer owns the lake, the cost of pollution can be forced
back onto the pesticide producer, who when has the incentive to produce the
efficient quantity.
c.
3 tons per week; the rent is $1,000 minus $300 = $700 a week.
The efficient quantity is 3 tons at which marginal social cost equals marginal
social benefit. If the pesticide producer owns the lake, the cost of pollution is
borne by the pesticide producer in the form of a decreased rent from the trout
farmer.
3.
4.
d.
The quantities in 1b and 1c are equal because the Coase theorem applies.
a.
$100 a ton.
b.
The pollution tax equals the marginal external cost—it is a Pigovian tax.
a.
3 tons a week.
b.
$300 a permit. The pesticide producer buys the permit from the trout farmer for
$300.
c.
The same as amount paid by the producer to the farmer with property
rights—Pigovian tax.
5.
a.
If Betty drives her car, Betty has the property right to the air in her car. Anna can
offer to pay Betty some amount more than $36 and less than $50 to not smoke.
Betty will accept and will not smoke on the trip. Betty’s net benefit from smoking
is $36 (equals the marginal benefit, $40, minus the price of the pack, $6) and so
for any amount greater than $36 she is willing to not smoke. Anna values a
smoke-free environment at $50, so Anna is willing to pay any amount less than
$50 for a smoke-free environment.
b.
If Anna drives her car, Anna has the property right to the air in her car. Betty will
not smoke because she will not offer Anna a high enough price to allow Betty to
smoke.
6.
a.
Educating nurses at community colleges is significantly more expensive than
educating other students because the class size of nursing classes is smaller than
the class size for other students. But the funding for community colleges pays
them the same amount for educating a nurse as it does for other students.
Community colleges have the incentive to offer fewer nursing classes because the
subsidy per nursing class is smaller than the subsidy per other class. As a result,
there will be an inefficiently small number of nurses trained.
b.
The budget for a community college could differ according to the students’
majors, with more costly majors contributing more to the community college’s
budget.
7.
a.
If schools are competitive, 30,000 students enroll and tuition is $4,000 a year.
In a competitive market, schools maximize profit. They produce the quantity at
which the marginal benefit of the last student enrolled equals the marginal cost of
educating the last student enrolled. Tuition is $4,000 a student.
b.
The efficient number of places is 50,000 and the tuition is $4,000 a student.
The efficient number of places is such that the marginal social benefit of
education equals the marginal social cost of education. The marginal social benefit
equals the marginal private benefit plus the external benefit. For example, the
marginal social benefit of 50,000 places equals the marginal private benefit of
$2,000 plus the external benefit of $2,000, which is $4,000.
Charpter 16
1.
a.
Gettysburg National Military Park is nonexcludable and nonrival. It is a public
good.
b.
A Big Mac is excludable and rival. It is a private good.
c.
The Brooklyn Bridge is nonexcludable (because there is no toll for using it) and
rival (especially when it is crowded). It is a common resource.
d.
The Grand Canyon is nonexcludable and nonrival. It is a public good.
e.
Air is nonexcludable and rival. (If someone uses air, for instance, pollutes it, then
no one else can use the same air.) It is a common resource.
f.
Police protection is nonexcludable and rival. It is a common resource.
g.
Sidewalks are nonexcludable and rival (when they are crowded). They are a
common resource.
h.
U.S. Postal system is rival (a carrier cannot deliver mail to my house and your
house simultaneously) and excludable (a user must buy a stamp). It is a private
good.
i.
FedEx is rival (a carrier cannot deliver a package to my house and your house
simultaneously) and excludable (a user must pay). It is a private good.
2.
j.
The MyEconLab web site is excludable and nonrival. It is a natural monopoly.
a.
There is a free rider problem because everyone can watch the display regardless of
whether or not the person paid for it.
b.
Interstate 81 potentially has a free rider problem. However if the state of Virginia
uses the gas tax revenue it receives from the sale of gasoline near the interstate to
pay to maintain the freeway, then users of the Interstate pay for the road. In this
case there is no free rider problem.
c.
Wireless Internet access in hotels can avoid the free rider problem is the hotel
limits use of the access to guests staying at the hotel.
d.
Sharing downloaded music has a free rider problem. Once someone pays to
download music, assuming that the music producer has not placed limits on its
use, then sharing the music is nonexcludable (amongst friends) and nonrival.
e.
The public library has a free rider problem because people can use the library even
if they pay no taxes to support it.
3.
a.
The capacity that achieves maximum net benefit is 2.5 million gallons a day.
Net benefit is maximized at the capacity where marginal social benefit equals
marginal social cost, which is 2.5 million gallons a day.
b.
$62.50 per person.
The efficient capacity is the one that maximizes net benefit. Total cost of the
sewerage system is the sum of the marginal cost of each additional gallon of
capacity. That is, total cost is the area under the marginal cost curve up to 2.5
million gallons, which equals $62.5 million. The population is 1 million, so each
person will have to pay $62.50.
c.
The political equilibrium will be a sewerage system that has a capacity of 2.5
million gallons.
If voters are well informed, the political equilibrium will be the efficient capacity.
d.
Bureaucrats will provide a capacity of 5 million gallons.
With voters rationally ignorant, bureaucrats will maximize the budget. That is,
they will increase the capacity until net benefit is zero. The total benefit from a
capacity of 5 million gallons is $250 million. The total cost of a capacity of 5
million gallons is $250 million. So the net benefit from a capacity of 5 million
gallons is zero.
4.
a.
The marginal private benefit of each fishing boat is the average catch per boat.
The table shows the marginal private benefit (MPB) of each boat.
Value of cod
MPB
MSB
Number
catch
(thousands of
(thousands
of boats
(thousands of
dollars)
of dollars)
dollars)
0
b.
0
0
10
2,000
200
200
20
3,400
170
140
30
4,200
140
80
40
4,400
110
20
50
4,000
80
40
60
3,000
50
100
70
1,400
20
160
The marginal social benefit of each fishing boat is the change in the value of the
catch divided by the change in the number of boats. The table above shows the
marginal social benefit (MSB) of each boat.
c.
With no regulation, the number of boats will be 50 and the catch will be
$4,000,000.
The number of boats will increase until the marginal private benefit of a boat
equals the marginal cost of a boat. The marginal cost is $80,000 a boat and with
50 boats the marginal private benefit is $80,000 per boat. The 50 boats will catch
that is valued at $4,000,000.
d.
The equilibrium is an overfishing equilibrium because fewer boats can take a
larger catch—the maximum catch occurs with 40 boats.
e.
The efficient number of boats is 30.
The number of boats is efficient if marginal social benefit from operating boats
equals the marginal cost of operating that number of boats. The marginal social
cost is $80,000. The marginal social benefit is $80,000 when 30 boats are used.
f.
The efficient value of the catch is $4,200,000 a month—the catch of 30 boats.
g.
The fishing industry definitely wants to overfish because the marginal private
benefit of catching more fish exceeds the marginal (private) cost. The consumers
of cod have a slightly different perspective. If the industry overfishes, then the
price of cod will be lower than if the industry remains at the sustainable level. But
this situation means that the cod will be depleted. So there is a reason that
consumers might prefer that the catch remain at the sustainable level.
h.
The quota would be at the efficient amount, $4,200,000 of cod.
i.
The price of an ITQ would be $60,000.
The price of the ITQ that would deliver the efficient number of boats equals the
marginal private benefit per boat when 30 boats operate (the efficient quantity)
minus the cost of operating a boat. That is the price of the ITQ would be $140,000
minus $80,000, which equals $60,000.
Charpter 17
1.
a.
The wage rate is $6 an hour. The wage rate adjusts to make the quantity of labor
demanded equal to the quantity supplied.
b.
The number of pickers hired is 400 a day. At a wage rate of $6 an hour, 400
pickers a day are hired.
c.
The income received by blueberry pickers is $2,400 an hour. Income equals the
wage rate ($6 an hour) multiplied by the number of pickers (400).
d.
The wage rate is $5 an hour. The demand curve shifts leftward by 100 pickers at
each wage rate. The wage rate adjusts to make the quantity of labor demanded
equal to the quantity supplied.
e.
The number of pickers hired is 350 a day. At a wage rate of $5 an hour, 50 pickers
are laid off.
f.
The income received is $1,750 an hour. Income equals the wage rate ($5 an hour)
multiplied by the number of pickers (350).
2.
a.
The marginal product of labor is the increase in total product that results from
hiring one additional student. For example, if Wanda increases the number of
students hired from 4 to 5, total product (the quantity of fish packed) increases
from 120 to 145 pounds. The marginal product of increasing the number of
students from 4 to 5 is 25 pounds of fish.
To plot the marginal product curve, the marginal product is plotted at the
mid-point. For example, when the number of students increases from 4 to 5 a day,
marginal product is 25 pounds of fish. The 25 pounds of fish is plotted at 4.5
students a day.
b.
The marginal revenue product of labor is the increase in total revenue that results
from hiring one additional student. For example, if Wanda hires 4 students, they
produce 120 pounds of fish. Wanda sells the fish for 50 cents a pound, so total
revenue is $60. If Wanda increases the number of students hired from 4 to 5, total
product increases to 145 pounds. Total revenue from the sale of this fish is $72.50.
Marginal revenue product resulting from hiring the fifth student is $12.50 ($72.50
minus $60). Alternatively, marginal revenue product equals marginal product
multiplied by marginal revenue (price). Marginal revenue product of hiring the
fifth student is $12.50, which is 25 pounds of fish she sells at 50 cents a pound.
c.
One point on Wanda’s demand for labor curve: At a wage rate of $12.50 an hour,
Wanda will hire 4.5 students. The demand for labor curve is the same as the
marginal revenue product curve.
d.
Wanda hires 6.5 students a day.
Wanda hires the number of students that makes the marginal revenue product
equals to the wage rate of $7.50 an hour. When Wanda increases the number of
students from 6 to 7, marginal product is 15 pounds of fish an hour, which Wanda
sells for 50 cents a pound. Marginal revenue product is $7.50—the same as the
wage rate. Remember the marginal revenue product is plotted at the mid-point
between 6 and 7 students a day—6.5 students a day.
3.
a.
The marginal product does not change. If Wanda hires 5.5 students a day, the
marginal product is still 25 pounds of fish.
b.
Marginal revenue product decreases.
If Wanda hires 5.5 students a day, marginal product is 25 pounds of fish. Now
Wanda sells the fish for 33.33 cents, so marginal revenue product is now $8.33,
down from $12.50.
c.
Wanda’s demand for labor decreases, and her demand for labor curve shifts
leftward. Wanda is willing to pay the students their marginal revenue product, and
the fall in the price of fish has lowered their marginal revenue product.
d.
Wanda will hire fewer students. At the wage rate of $7.50, the number of students
Wanda hires decreases as the demand for labor curve shifts leftward.
4.
a.
The marginal revenue product does not change. If Wand hires 5.5 students an
hour, the marginal product is 25 pounds of fish, which she sells at 50 cents a
pound. So marginal revenue product remains at $12.50.
b.
Wanda’s demand for labor remains the same because marginal revenue product
has not changed.
c.
Wanda will hire fewer students. At the wage rate of $10 an hour, Wanda hires the
number of students that makes marginal revenue product equal to $10 an hour.
Wanda now hires 5.5 students an hour—down from 6.5 students an hour. The
marginal product of 5.5 students is 20 pounds of fish an hour, and Wanda sells
this fish for 50 cents a pound. Marginal revenue product is $10 an hour.
5.
Wanda maximizes her profit when marginal revenue product equals the wage rate and
when marginal revenue equals marginal cost.
When the wage rate is $7.50 an hour, Wanda hires 6.5 students an hour. Marginal
revenue product is marginal product (15 pounds of fish an hour) multiplied by the
price of fish (50 cents a pound), which equals $7.50 an hour.
Marginal revenue resulting from selling an additional pound of fish is 50 cents. The
cost of a student is $7.50 an hour and the marginal product of 15 pounds of fish, so the
marginal cost of an additional pound of fish is $7.50 an hour divided by 15 pounds of
fish, which is 50 cents. So when Wanda hires 6.5 students an hour, marginal revenue
equals marginal cost and profit is maximized.
6.
a.
The labor union is an industrial union because all the workers work in the same
industry, sneaker stores.
b.
Labor unions probably are scarce because unions find these workers difficult to
organize. In particular, most of them are low-skilled workers and the supply of
low-skilled workers is probably elastic and difficult for unions to control or
influence. In this situation, unions are unlikely to have much success in raising the
wage rate.
c.
The workers who signed the contract (and keep their jobs) win form the new
union contract. The owners of the companies lose. Customers lose because the
supply will decrease. In addition, any workers who are fired due to the higher
wage rate (or are unable to be hired because of the higher wage rate) lose.
d.
This union can try to change the demand for its members’ labor by creating
training programs to boost their productivity. In addition, it can support
“buy-American” policies, such as advertising and/or restrictions of foreign
imported sneakers.
7.
a.
Trump Tower is not a natural resource because it is made by people. It is a piece
of capital.
b.
Lake Michigan is a renewable natural resource. It is renewable because Lake
Michigan can continue to be used day after day.
c.
Coal is a nonrenewable natural resource. It is nonrenewable because once the
lump of coal is used, it can no longer be used again.
d.
The Internet is not a natural resource because it is made by people. It is a piece of
capital
e.
Yosemite National Park is a renewable natural resource. It is renewable because
the park can continue to be used day after day.
f.
The wind generating the power is a renewable natural resource because it recurs
day after day. The turbine generating the power is a piece of capital equipment,
not a natural resource, because it is made by people.
8.
a.
The demand for this land has increased. The supply is perfectly inelastic, so price
changes reflect (only) changes in the demand.
9.
b.
The Trump Group is earning economic rent because the supply is perfectly elastic.
c.
The supply of land is perfectly inelastic.
a.
When the interest rate is 2 percent, the present value of the first laptop is equal to:
$700 $700
$700


$2,019 . The present values of the other laptops are
1.02 (1.02 )2 (1.02 )3
calculated similarly and are $1,802 for the second laptop, $1,657 for the third
laptop, and $1,441 for the fourth laptop. Keshia will purchase 3 laptops because
the present value of the marginal revenue products of these laptops exceeds the
cost of buying the laptop.
b.
When the interest rate is 4 percent, the present value of the first laptop is equal to:
$700 $700
$700


$1,942 . The present values of the other laptops are
1.04 (1.04 )2 (1.04 )3
calculated similarly and are $1,735 for the second laptop, $1,596 for the third
laptop, and $1,388 for the fourth laptop. Keshia will purchase 2 laptops because
the present value of the marginal revenue products of these laptops exceeds the
cost of buying the laptop.
c.
When the interest rate is 6 percent, the present value of the first laptop is equal to:
$700 $700
$700


$1,871 . The present values of the other laptops are
2
1.06 (1.06 )
(1.06 )3
calculated similarly and are $1,671 for the second laptop, $1,536 for the third
laptop, and $1,337 for the fourth laptop. Keshia will purchase 2 laptops because
the present value of the marginal revenue products of these laptops exceeds the
cost of buying the laptop.
Charpter 18
1.
a.
Money income equals market income (wages, interest, and rent) plus cash
payments from the government.
b.
To draw the Lorenz curve, plot the cumulative percentage of households on the
x-axis and the cumulative percentage of income on the y-axis. Make the scale on
the two axes the same. The Lorenz curve will pass through the following points:
20 percent on the x-axis and 4 percent on the y-axis; 40 percent on the x-axis and
14.8 percent on the y-axis; 60 percent on the x-axis and 32.1 percent on the y-axis;
80 percent on the x-axis and 56.3 percent on the y-axis; and 100 percent on the
x-axis and 100 percent on the y-axis.
c.
U.S. money income was distributed more equally in 1967 than in 2005.
The line of equality shows an equal distribution of income. The closer the Lorenz
curve is to the line of equality, the more equal is the income distribution. The
Lorenz curve for the U.S. economy in 1967 lies closer to the Line of equality than
does the Lorenz curve in 2005.
d.
The biggest difference in the distribution of income in the United States in 1967
and 2005 is the share of income received by the highest 20 percent. This share
increased from 43.7 percent to 50.4 percent. Smaller differences are the shares
received by the four other groups, each of which decreased. The most likely
explanation for these differences (and the one provided in the chapter) is that the
information technologies and globalization of the 1990s are substitutes for
low-skilled labor and complements of high-skilled labor. The demand for
low-skilled labor has decreased relative to the supply of low-skilled labor and the
wage rate of low-skilled labor has increased more slowly than the average. The
demand for high-skilled labor has increased relative to the supply of high-skilled
labor and the wage rate of high-skilled labor has increased faster than the average.
2.
a.
The wage rate of low-skilled workers is $6 an hour.
The wage rate adjusts to make the quantity of labor demanded equal to the
quantity supplied.
b.
Firms employ 2,000 hours of low-skilled workers a day. At a wage rate of $6 an
hour, 2,000 hours are employed each day.
c.
The wage rate of high-skilled workers is $12 an hour.
Because the marginal product of high-skilled workers at each employment level is
$8 greater than the marginal product of low-skilled workers, firms are willing to
pay high-skilled workers a higher wage rate than they are willing to pay
low-skilled workers. For example, the demand curve for low-skilled workers tells
us that firms are willing to hire 4,000 hours of low-skilled workers at a wage rate
of $4 an hour. So firms are willing to hire 4,000 hours of high-skilled workers at
$12 an hour. That is, the demand curve for high-skilled labor lies above the
demand curve for low-skilled workers such that at each quantity of workers the
wage rate for high-skilled workers is $8 greater than that for low-skilled workers.
(You can check this answer by drawing a new and larger figure than the one at the
bottom of page 433.)
The supply curve of high-skilled workers lies above the supply curve of
low-skilled workers such that the vertical distance between the two supply curves
equals the cost of acquiring the high skill—$6 an hour. That is, high-skilled
workers will supply any amount of labor a day if the wage rate is $12 an hour.
Equilibrium in the labor market for high-skilled workers occurs at a wage rate of
$12 an hour.
d.
Firms employ 4,000 hours of high-skilled workers a day.
e.
The wage rate increases by exactly the cost of acquiring the skill because the
supply of labor is perfectly elastic.
High-skilled workers are willing to supply any amount of labor at a wage rate of
$12 an hour. They will supply no labor at wage rates below $12 an hour.
3.
a.
The wage rate of workers who are discriminated against is $5 an hour.
The wage rate adjusts to make the quantity of labor demanded equal to the
quantity supplied.
b.
The wage rate of workers who do not face discrimination is $8 an hour.
Because the marginal product of workers not facing discrimination is perceived to
be twice the marginal product of the other workers, firms are willing to pay the
workers not facing discrimination twice the wage rate that they are willing to pay
the workers who face discrimination. For example, the demand curve for the
workers being discriminated against tells us that firms are willing to hire 6,000
hours of these workers at a wage rate of $4 an hour. So with workers not facing
discrimination perceived to be twice as productive as the other workers, firms are
willing to hire 6,000 hours of non-discriminated workers at $8 an hour. That is,
the demand curve for labor for the workers not facing discrimination lies above
the demand curve for workers facing discrimination such that at each quantity of
workers the wage rate for workers not facing discrimination is double that for
workers facing discrimination.
The supply of workers not facing discrimination lies to the left of the supply of
workers facing discrimination by 2,000 hours of labor. The vertical distance
between the two supply curves is $2 an hour. That is, workers not facing
discrimination will supply 6,000 hours a day if the wage rate is $8 an hour.
Equilibrium in the labor market for workers not facing discrimination occurs at a
wage rate of $8 an hour.
c.
Firms employ 5,000 hours of workers facing discrimination a day. At a wage rate
of $5 an hour, 5,000 hours are employed each day.
4.
d.
Firms employ 6,000 hours of workers not facing discrimination a day.
a.
Tax Plan A is a proportional tax. At each level of income, 10 percent of income is
paid in taxes.
b.
Tax Plan C is regressive. When income is $10,000, 20 percent of income is paid in
taxes; when income is $20,000, 10 percent of income is paid in taxes; and, when
income is $30,000, 6.67 percent of income is paid in taxes.
c.
Tax Plan B is progressive. When income is $10,000, 10 percent of income is paid
in taxes; when income is $20,000, 20 percent of income is paid in taxes; and,
when income is $30,000, 30 percent of income is paid in taxes.
5.
d.
Tax Plan C increases inequality.
e.
Tax Plan B decreases inequality.
f.
Tax Plan A has no effect on inequality.
a.
Market income is the income earned by factors of production in the marketplace.
Labor earns wages, capital earns interest, land earns rent and entrepreneurship
earns profit.
b.
To draw the Lorenz curve, plot the cumulative percentage of households on the
x-axis and the cumulative percentage of market income on the y-axis. Make the
scale on the two axes the same. The Lorenz curve will pass through the following
points: 20 percent on the x-axis and 1.1 percent on the y-axis; 40 percent on the
x-axis and 8.2 percent on the y-axis; 60 percent on the x-axis and 22.1 percent on
the y-axis; 80 percent on the x-axis and 44.9 percent on the y-axis; and 100 percent
on the x-axis and 100 percent on the y-axis.
c.
U.S. money income is distributed more equally in than market income in 2005.
The Lorenz curve for the U.S. money income in 2005 lies closer to the line of
equality than does the Lorenz curve for U.S. market income in 2005. Money
income is distributed more equally than market income because money income
includes cash payments to poor household, which increases their income.
6.
a.
Redistribution lowers the highest income group’s share by 5.0 percent of total
income.
The highest income group earns 55.1 percent of total market income and 50.1
percent of total money income. So redistribution lowers the highest income
group’s share by 5.0 percent of total income.
b.
Redistribution raises the lowest income group’s share by 2.4 percent of total
income.
The lowest income group earns 1.1 percent of market income and has 3.5 percent
of total money income. So redistribution raises the lowest income group’s share
by 2.4 percent of total income.
c.
If the highest income group’s share fall from 55.1 to 30 percent of total income,
redistribution takes 25.1 percent of income from this group. If the lowest income
group’s share rises from 1.1 to 15 percent, redistribution raises this group’s share
to 13.9 percent of total income. The other 11.2 percent (25.1 minus 13.9 percent)
would be distributed to other groups.
This redistribution scheme would require a tax on the highest groups of 45.5
percent— (25.1/55.1)  100 percent. Such a large increase in the tax rate and
redistribution might create the big tradeoff effect. The highly taxed people might
choose to do less work and if they do, total income might decrease.
7.
a.
Inequality between people in China and India and people in the United States is
lessening. Income for the, on the average, poorer people in China and India is
increasing more rapidly than income for the, on the average richer people in the
United States, so the fraction of income going to the people in China and India is
growing.
b.
The world Lorenz is moving closer to the line of equality and the Gini ratio is
falling in value.