Download Microeconomics Extra Credit For only those who scored less than a

Microeconomics Extra Credit
For only those who scored less than a 70 on the test.
Due: 5/18
Ch 1: 1.3, 1.8
Ch 2: 2.6, 2.7, 2.8
Ch 3: 3.5, 3.6, 3.10
Ch 4: 4.6, 4.7, 4.10, 4.12
Ch 5: 5.3, 5.6, 5.8
Ch 6: 6.2, 6.9
Ch 1: 1.3, 1.8
1.3
Anytime an individual makes any decision, he or she is trying to reach some goal—most often
happiness. To choose A over B implies that the happiness that results from choosing A (its
benefits minus the cost of choosing it) must exceed the happiness that results from choosing B. If
choice B created more net happiness, then the individual would have chosen it. It is easily seen,
therefore, that any human decision can be described in terms of costs and benefits. Sometimes,
however, the costs and benefits are of a type that would be difficult to capture in a scientific way.
For example, many costs and benefits are emotional in nature. Costs of some decisions may
involve things like stress, anxiety, guilt, or anger; benefits may involve things like involve relief,
comfort, relaxation, or love. So while all human decisions can be discussed in economic terms,
many would, due to the nature of the costs and benefits involved, be difficult to analyze
empirically.
1.8
Student responses will vary, but the most common answers will involve the following costs of
attending college: being in class takes up time, so one gives up the opportunities to earn money,
relax, spend time with friends and family, etc.; books and tuition cost money, so one gives up the
opportunity to consume more goods right now; living in a dorm can be uncomfortable and
frustrating, so one gives up the comfort of living on one’s own (or at one’s parents’ house). These
costs are endured in order to enjoy the benefits of a college education, which include things like
increased future income, better ability to take care of one’s health, better parenting skills, and a
feeling of accomplishment.
Ch 2: 2.6, 2.7, 2.8
2.6
A ban on Canadian beef would lower the supply of beef available to US consumers, which would
cause an increase in the price of beef.
Initially, before the price changes, there will not be
enough beef to satisfy demand. This will cause upward pressure on prices, driving some
consumers out of the market, and leading some suppliers into the market. Depending on how
much of the beef being sold in the US was Canadian beef, the increase could be great. Americans
will reduce their beef consumption (though more Americans are producing beef than before).
In Canada, beef producers would be supplying too much beef to the market, with no one to buy
it. This will cause downward pressure on prices. Because of the decrease in price, some Canadian
consumers will enter the market and some producers will leave the market. Canadians will
consume more beef (and produce less).
Unless US consumers believed that the health risk associated with Canadian beef also implied
health risks associated with US-produced beef, the analysis for the US would not be any different.
If US consumers did believe that all beef was unsafe, this would cause a decrease in the demand
for beef, which would reverse the price-increasing trend of the ban (making the final effect on
price ambiguous) while further reducing beef consumption.
If Canadian consumers believed that their beef was unsafe, there would also be a decrease in
demand. This would counter the trend toward consuming more beef (so that the final effect on
beef consumption would be ambiguous, but it would further reduce the price.
2.7
Recalling the formula for elasticity of demand (when working with a linear demand curve) is Ed =
–B(P/Q) or Ed = –B(P/(A – BP)), we can just substitute our numbers into the formula. Based on the
demand function, A = 6000 and B = 30.
 P 
E d   B

 A  BP 


75

E d  30
 6000  30  75 


75

E d  30
 6000  30  75 
Ed = –0.6
2.8
The largest total expenditure occurs when price elasticity of demand equals –1.
 P 
E d   B

 A  BP 
P


 1  30

 6000  30 P 
Multiplying both sides by 6000 – 30P yields:
30P – 6000 = –30P
60P = 6000
P = 100
Ch 3: 3.5, 3.6, 3.10
3.5
In the absence of any other changes (specifically changes to benefits), this statement is correct. In
the language of economists, it would be more correct to say “ ceteris paribus, if the cost of
repairing your car goes up you should do less of it.” The only way that a higher cost could inspire
a higher best choice would be if the benefits also increase, and if the benefits increased by more
than the costs. (Note that if benefits and costs both increase by the same amount, the best
choice should remain unchanged.)
3.6
Since we can hire the mechanic for anywhere from 0 to 6 hours, the best choice is one of the
following three choices: hire the mechanic for 0 hours, hire the mechanic for 6 hours, or hire the
mechanic for the number of hours at which MB = MC. To decide which is best, we should
compare the total benefits of these three choices. First we need to find out where MB = MC:
MB(H) = MC(H)
654 – 80H = 110 + 240H
544 = 320H
H = 1.7
So the correct answer is 0, 1.7 or 6. To figure out which, we calculate the net benefit (benefit
minus cost) of each. The highest net benefit occurs at 1.7 hours of repair time.
Total benefit, B(H)
Total cost, C(H)
Repair time, H
654H – 40H2
110H + 24H2
Net benefit, B(H) – C(H)
0
0
0
0
1.7
996.2
533.8
462.4
6
2,484
4,980
–2,496
3.10
Once the investors had incurred expenses of ₤2.5 million, this cost became sunk and was no
longer relevant to the decision about whether or not to complete the project. At this point, they
compare the cost of an action to its benefit. Suppose the cost of quitting is ₤0, which would only
be the case if they can just leave everything where it is and do not have contracts, which is not
likely. For the sake of argument, however, let’s suppose this cost is zero. The benefit of
abandoning the project is also ₤0, since there would be no revenue earned. Therefore, the net
benefit of abandoning the project is ₤0. They compare this to the benefit of completing the
project (clearly, they would not choose to do more work, incurring more expenses, but still not
complete the project). The benefit of completing the project is ₤4 million in revenue that they
expect to earn. If the cost of completing the project is ₤ X million, then the net benefit is ₤(4 – X)
million. So long as X < 4, this net benefit would be positive, making it greater than the net
benefit of quitting. In other words, given that the initial ₤2.5 million is a sunk cost, investors will
complete the project as long as they can break even starting from the present.
Ch 4: 4.6, 4.7, 4.10, 4.12
4.6
Student answers will vary considerably, but some acceptable answers include illness/heath, clear
cutting/forests,
war/peace,
water
pollution/clean
water,
inefficiency/efficiency,
deceptive
advertising/honest advertising, time spent studying/time spent partying (or vice versa, depending
on the student’s outlook).
4.7
Ryan’s indifference curves look like the indifference curves below, where indifference curve I2
represents a higher level of utility than indifference curve I1. Since Ryan feels the same way about
the two goods, the indifference curves should be downward-sloping, to indicate trades he is
willing
to
make
to
leave
his
happiness
unchanged: more of one makes him unhappy,
but less of the other makes him more happy.
To
understand
the
bowed-outward
shape,
consider the points plotted on indifference curve
I2. When water pollution is at a level of 8, a 1unit increase causes Ryan so much additional
unhappiness that he must be compensated (in
order for his happiness to remain unchanged)
with a 2-unit reduction in air pollution (from 5 to 3). However, when water pollution is at a lower
level, like 4, a 1-unit increase in water pollution can be compensated for by just a ½-unit decrease
in air pollution (from 8 to 7½). The bowed outward shape of the indifference curves shows that
water (air) pollution has a worse marginal impact the higher the level of water (air) pollution; it
shows that Ryan needs to be compensated more for such increases at higher levels.
4.10
A person who prefers a sports car considers horsepower a more important feature than fuel
economy. Consistent with Figure 4.10 on page 109, a person who considers the good on the
vertical axis more important will have flatter indifference curves. Therefore, in Figure 4.5, a person
who prefers a sports car will have flatter indifference curves. He or she will be willing to give up
more fuel economy for additional horsepower than an individual who does not prefer a sports car.
Or, stated differently, a reduction in horsepower needs to be compensated with a greater increase
in fuel economy, since the reduction in horsepower has a greater negative effect on this person’s
utility. A person who prefers a compact car probably considers fuel economy more important than
horsepower, and therefore will have steeper indifference curves (because fuel economy is on the
horizontal axis). Again, Figure 4.10 on page 109 is helpful here. This person will give up more
horsepower for smaller increases in fuel economy.
4.12
Answers will vary. Most obvious answers are given first, with descriptions of some other possible
interpretations where likely or appropriate. The key is that students understand the differences
between complements and substitutes, and further that they recognize that these characteristics
are not contained within the goods themselves, but rather are revealed by the particular
consumer’s preferences.
(1) Complements. Low. There are lots of different goods that can be paired with either bread or
butter. Context matters here: at a table in a restaurant, bread and butter are used together more
often than they are at home.
(2) Substitutes. High. Context matters here as well: substitutability is high for many uses like
writing down information, marking appointments on a calendar, performing mathematical
operations. In some situations, they could even be complements; what if a customer needs a pen
to fill out an order form that is then processed by a person who enters the information into a
computer?
(3) Substitutes. High. Like in (2), only in very specific situations might these be complements. A
student might point out that fax machines (needed for facsimile service) ordered over the phone
or internet might be shipped via mail service, making them complements.
(4) Substitutes. Low. While both movies and video games provide entertainment, they do so in
very different ways. Video games are active and possibly competitive, making them also
substitutes for card games or sports. Movies are passive and sometimes involve going out,
making them substitutes also with the ballet or opera. When video games are made based on
movies or vice versa (yes, it has happened!) then the two goods are complements.
(5) Most students will probably say Substitutes with Low substitutability, because they are both
fuels but fuels are not easily interchangeable. A better answer might be that they are
Complements, however, since most or all gasoline sold now has some ethanol in it.
(6) Substitutes, High.
(7) This will depend on the student. The student will say Substitutes (High) if the goal of owning
CDs is simply to listen to music by that artist. The student will say Complements (probably Low) if
owning more of an artists’ catalogue makes that artists’ music more enjoyable, or if the goal is to
have as complete a collection as possible.
(8) Complements. Low. Though they are both foods, in most situations lettuce and beef are not
interchangeable. More likely they are used together in applications like burgers or tacos.
Ch 5: 5.3, 5.6, 5.8
5.3
Example 5.2 on page 131 provides an example of how students are to do this problem.
Below is the table of Madeline’s preferences (Table 4.2, page 96) with the affordable bundles
shaded in (as in In-Text Exercise 5.1). As in Table 4.2, the numbers represent rankings, not
Bread (loaves)
expenditures.
3
11
7
3
1
2
13
8
4
2
1
15
9
6
5
0
16
14
12
10
0
1
2
3
Soup (bowls)
Of the five affordable bundles, the one ranked highest (9 th) is one loaf of bread and one bowl of
soup. This is the bundle Madeline will choose. Students may also notice that the bundles in which
the numbers are italicized are all the bundles that Madeline prefers to this (1,1) bundle, but that
she cannot afford.
5.6
From Worked-Out Problem 5.2 on page 142, we find that U =
C  F , with MUC = F and MUF =
C. Natasha’s income, M, is $300. In this problem, PC = $30 and PF = $15. Just like in Worked-Out
Problem 5.2, we start with the tangency condition as given in formula (6) from page 141:
MU C MU F

PC
PF
F
C

$30 $15
15F = 30C
F = 2C
This result can be plugged into the budget constraint.
M = PCC + PFF
$300 = $30C + $15F
$300 = $30C + $15(2C)
$300 = $30C + $30C
$300 = $60C
C=5
Since F = 2C, it must be that F = 10. Natasha purchases five concert tickets and ten film tickets
per month.
5.8
Since Alejandro believes films and concerts to be
perfect 1:1 complements, he will always buy film
tickets and concert tickets in equal numbers, or in
“pairs.” According to this problem, film tickets have
a price, PF, of $8 each, and concert tickets have a
price, PC of $5 each. This means that a pair of one
film ticket and one concert ticket costs $13.
Therefore, the number of film and concert tickets
he buys will always be equal to M/$13, which
makes finding the utility maximizing choices easy
to find.
To the right is an example of an income-consumption curve, constructed using the possible
incomes $200, $160 and $120. The income used by your students will vary, but the incomeconsumption curve should be the line C = F.
Because Alejandro always buys the same number of concert and film tickets, his Engel curves for
concert and film tickets will be identical. Also, as discussed above, the number of tickets he wants
will always be equal to M/$13. Suppose we
were to construct his Engel curve for
concert tickets; we know the relationship
between the number of concert tickets he
will buy is C = M/$13. To draw this as an
Engel curve, it might be easier to solve
this for M, which is on the vertical axis of
an Engel curve. When we solve for M, we
get M = $13C. So the Engel curve for
concert (and film) tickets is just a straight
line with a slope of 13, like the one
depicted to the right.
Because both Engel curves are always upward-sloping, both goods are normal goods.
Ch 6: 6.2, 6.9
6.2
If two regular-strength tablets are equivalent to one extra-strength tablet, then the consumer will
always spend his or her entire pain killer
budget on regular-strength tablets if they
are less than half the price of extra-strength
tablets. If regular-strength tablets are more
than half of the price of extra-strength
tablets, the consumer would purchase only
extra strength tablets. The increases in the
price
of
regular
strength
tablets
are
discussed below.
(a) If the final price of extra-strength
tablets is more than twice the price
of regular-strength tablets after the
price of regular-strength tablets has
increased, then this means that two regular-strength tablets were and are cheaper than
extra-strength tablets. Therefore, the consumer would always have purchased zero extra-
strength tablets and spent his or her entire pain killer budget on regular strength tablets.
In this case, compensating for the price increase means giving the consumer enough
additional income to purchase the same number of regular-strength tablets as before,
since this consumer never purchases extra-strength tablets. In this case, there is no
substitution effect; there is only an income effect.
(b) In this scenario, two regularstrength pain tablets were cheaper
than one extra-strength pain tablet
before the price change (so the
consumer purchased only regularstrength), but this is no longer true
after the price change. Now, one
extra-strength tablet is cheaper
than two regular-strength tablets,
so this consumer purchases only
extra-strength tablets. Since after
the price change the consumer
purchases only extra strength
tablets, the compensation involves giving the consumer extra income to buy more extrastrength tablets, but does not have an impact on the demand for regular strength tablets.
At the higher price for regular-strength tablets, compensated and uncompensated
demand for regular-strength tablets
would be the same: zero. With respect
to regular-strength tablets, there is no
income effect, only a pure substitution
effect.
(c) In this case, the consumer always
purchases only extra-strength tablets,
so that the demand, whether
compensated or uncompensated, for
regular-strength tablets is always zero.
When compensated, this change does
not affect the consumer’s choice,
because the new budget constraint is also the compensated budget constraint. There is
no substitution or income effect here for regular-strength tablets.
With perfect substitutes, the size of the substitution effect depends on the current price level and
whether the price change actually causes a substitution. In parts (a) and (c) there was no
substitution effect because the consumer did not substitute away from one good in favor of the
other good. In part (b) there was only a substitution effect for regular-strength tablets (the
uncompensated change was from some regular-strength tablets to none and the compensated
change was the same) because the consumer made a substitution.
6.9
If Albert’s demand curve for music downloads is M = 150 – 60PM, then the choke price (the
lowest price at which he will demand zero downloads) is $2.50. (This will be needed to calculate
the height of the CS triangle.) At a price of $1.00 per download, Albert demands 90 downloads; at
a price of $2.00, he demands 30. Using this information, we can calculate his increase in consumer
surplus as the price falls from $2.00 to $1.00:
Original CS: ½($2.50 - $2.00)(30) = $7.50
New CS: ½($2.50 - $1.00)(90) = $67.50
The increase in consumer surplus is $60.