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McConnell 10E Microeconomics
Chapter One
1.
Is rational self-interest the same thing as selfishness? Explain.
No, they are not the same. Selfishness means that a person is only concerned
with himself or herself to the exclusion of others. Rational self-interest simply
means that people strive to achieve personal satisfaction. This personal
satisfaction can be achieved in many ways, from both selfish and unselfish acts.
For example, a person may be unselfish and volunteer time to help other people
or make donations to charities because the person derives personal satisfaction
from doing so. In this case the person is not being selfish, but is acting to
maximize the person’s well-being by helping others.
2.
Why are economic theories and principles imprecise? Shouldn’t they apply to
everyone?
The main reason is that they are generalizations relating to economic behaviour
or the economy. The economic facts used to develop the theories and principles
differ from person to person or economic institution to institution. They reflect
tendencies or averages across large groups that may not apply to a particular
individual. For example, if the price of a product drops significantly, the
quantity demanded among consumers as a group is expected to increase, but
some consumers may not increase their purchases.
3.
Explain the economic fallacy in the statement: “If the Jones family would just
cut up their credit cards and live within their means, they’d be better off. And if
consumers in this nation cut up their credit cards and lived within their means,
the nation would be better off.”
This is an example of the fallacy of composition. Cutting up credit cards may be
good for the Jones family depending on their circumstances. If they have taken
on too much debt and are in financial trouble, then cutting up credit cards would
reduce their impulses to spend money. But if all consumers cut up their credit
cards this action would reduce consumer spending in the economy because there
would be fewer transactions and it would make the economy less efficient.
Economic growth would decline because of the reduced consumer spending.
Chapter Two
1
“The two cornerstones of economics are the scarcity of resources and the
multiplicity of wants. True economy consists of deriving maximum want
satisfaction from available resources.” Explain.
The first statement refers to the basic economic problem: that society’s wants are
unlimited relative to the limited supply of productive resources. The second part
of the statement refers to the concept of efficiency, both allocative and
productive. Since resources are scarce, it is desirable to achieve the most output
from those available. Otherwise we waste resources and will not satisfy as many
wants as we could from the resources that we have available, which would mean
not achieving productive efficiency. Allocative efficiency means the maximum
satisfaction of wants with these resources.
2
How are tradeoffs illustrated by the production possibilities curve? Consider the
case of federal government spending on national defence and spending on social
programs.
In the production possibilities model, an increase in government spending on
national defence will come at the expense of government spending on social
programs. If the nation wants to be more secure then it will have to give up the
opportunities to use its scarce budget resources for social programs. Conversely,
if there is more spending on social programs, there will have to be cuts to
national defence, assuming that there is a fixed budget constraint. Moving in
either direction on the production possibilities curve will involve trading off one
desirable public good for another.
3.
Explain the relationship between the increase in women in the labour force over
the last forty years in Canada and the production possibilities for the economy.
The increase in women in the labour force represents a shift outward in the
production possibilities curve. The reason for the shift is that there are now
greater labour resources available for production than there were in past decades.
Chapter Three
1.
What effect should each of the following have on the demand for gasoline in a
competitive market? State what happens to demand. Explain your reasoning in
each case and relate it to a demand determinant.
(a)
(b)
(c)
an increase in the number of cars
the economy moves into a recession
an increase in the price of car insurance, taxes, maintenance
(d)
consumer expectations of substantial price increases in gasoline
(a)
Demand would increase because there would be more buyers of gasoline.
The additional buyers would come from the additional cars and trucks.
(b) Demand would decrease because consumer and business incomes would
fall. Consumer and businesses would have less money to spend on gasoline.
(c)Demand would decrease because of increase in the price of complementary
goods. Car insurance, car taxes, and car maintenance expenses are complements
to gasoline.
(d) Current demand for gasoline would increase because expectations about
the future have changed and may prompt consumers to “buy now” to beat the
future price increases.
2.
What effect will each of the following most likely have on the supply of corn in a
competitive market? State what happens to supply. Explain your reasoning in
each case and relate it to a supply determinant.
(a) the development of an improved corn seed that resists drought conditions
(b) an increase in the price of soybeans which can also be planted on land used
for growing corn
(c) an increase in government payments for growing corn
(d) an increase in the price of fertilizer
(a)The supply of corn will increase because of an improvement in the technology
of corn production. More bushels of corn will be produced at each and every
price.
(b) The supply of corn will decrease because of a change in the price of another
good that can be produced. Some farmers will no longer use their land to grow
corn, but instead will grow soybeans.
(c) The supply of corn will increase because of a government subsidy. The
government payment reduces the costs of corn production at each and every
price.
(d) The supply curve for corn will decrease because of a change in the price of a
resource. Fertilizer is used to grow corn and it is now more costly to grow corn
at each and every price.
3.
(Consider This) Is demand more important than supply in determining
equilibrium price and quantity in a competitive market? Explain.
Demand and supply are equally important. It is the intersection of the demand
and supply curve that determines equilibrium price and quantity. Without
demand or without supply there would be no intersection and no price
determination. Alfred Marshall likened supply and demand to a pair of scissors.
Each blade is needed for the scissors to operate properly and make a cut.
Chapter Four
1.
Describe the three major virtues of a market system.
First, the market system promotes efficient use of scarce resources. Products are
produced in the least costly way and the products most desired by society get
produced. Second, the market system provides incentives for continual
improvement and innovation. Rewards are given to entrepreneurs, workers, and
consumers who attempt to make the best use of scarce resources. Third, the
market system gives great support to individual freedom for producers,
consumers, and workers. Each group is able to pursue their own self-interest and
thus promote the social interest.
2.
Why is there a free-rider problem with public goods?
Most private goods and services are subject to the exclusion principle which is
the idea that those who pay for the product are the ones who get it, but those who
don’t pay for it are excluded from the benefits provided by that product.
The free-rider problem exists when it is not possible to exclude a person from the
benefit of a good even if the person did not pay for its costs. Such is the case
with a public good. Once a public good is provided, it is available to all people
regardless of whether or not they pay for its cost.
Chapter Five
1.
What is the main difference between the law of demand and the price elasticity of
demand?
The law of demand tells you that quantity demanded will increase as price falls, or
conversely, that quantity demanded will decrease as price rises. So, the law of
demand says there is an inverse relationship between price and quantity demanded.
By contrast, the price elasticity of demand tells you “how much” quantity
demanded changes when price changes. It shows the responsiveness of a change
in quantity demanded to a change in price.
2.
Why do economists use percentages rather than absolute amounts in measuring
the responsiveness of consumers to changes in price?
There are two basic reasons. First, the choice of units when absolute changes are
used will have an arbitrary effect on the interpretation of responsiveness. For
example, if price is calculated in dollars, then a one-unit drop in price (from $5 to
$4) might be associated with a 10-unit increase in quantity. If, however, the
price was calculated in cents, then a 100-unit drop in price would be associated
with a 10-unit increase in quantity. In the first case, it would appear the demand
is inelastic and in the second case it would appear to be elastic. Second, the use
of percentages allows comparisons to be made across products. You can
compare the percentage change in quantity demanded to a percentage change in
price across all products for which you have data on changes in price and
quantity demanded.
3.
How do you interpret the coefficient of the price elasticity of demand? Explain
when Ed is 1.5, 0.7, and 1.0.
The interpretation is based on the elasticity formula. The formula has the
percentage change in quantity demanded in the numerator and the percentage
change in price in the denominator. A coefficient of 1.5 indicates that demand is
elastic because the percentage change in quantity demanded (the numerator) is
greater than the percentage change in price (the denominator). A coefficient of
0.7 indicates that demand is inelastic because the percentage change in quantity
demanded (the numerator) is less than the percentage change in price (the
denominator). A coefficient of 1.0 indicates that demand is unit elastic because
the percentage change in quantity demanded (the numerator) is the same as the
percentage change in price (the denominator).
Chapter Six
1.
(Consider This) Why does a newspaper dispenser open to a stack of newspapers
and essentially “trusts” a consumer to take just one copy whereas a soft drink
vending machine does not “trust” consumers and dispenses one can for each
purchase?
The difference is explained by the diminishing marginal utility of the two
products. The marginal utility of a second newspaper taken from a newspaper
dispenser is essentially zero for the consumer, so they have little incentive to take
more than one copy. The marginal utility of the second can of soft drink,
however, is not close to zero. The consumer can take that second can and save it
for consumption the next day. In fact, the consumer has a great incentive to take
all the cans because they can be stored or used in the future or resold whereas
multiple newspapers are only good for one day and have little resale value.
2.
Use marginal-utility analysis to explain why the growing popularity of digital
versatile disks (DVDs) over videocassettes (VCs).
DVDs and DVD players are complementary goods. The price of DVD players
has decreased, thus increasing the demand for DVDs. DVDs and VCs are
substitute goods. The audio and visual quality of DVDs is better and these
features have increased consumer preference for DVDs over VCs. DVDs have
gained popularity among consumers relative to VCs because many consumers
have concluded that DVDs have higher ratios of marginal utility to price than the
ratios for VCs.
Chapter Seven
1.
(Consider This) How can total course learning and studying be related to the law
of diminishing returns?
Total course learning can be considered an output in the educational production
process. The inputs include intelligence or ability, quality of the course materials,
instructor effectiveness, class time, and study time. If you hold constant the other
inputs, and just change study time, then you can use this change to explain the law
of diminishing returns. As study time is added to these other fixed resources, the
contribution made by each additional hour of study time to total course learning
eventually starts to fall.
2.
Explain how the production of a newspaper reflects economies of scale.
The production of the daily newspaper is an example of economies of scale
because as output increases the average total costs falls. There are high fixed
costs to producing a newspaper (writing it, including photos and ads, checking
copy, and laying out articles). But once the newspaper is written and ready to be
printed, these high fixed costs can be spread over a large number of units of
output. The average total cost falls as print production increases. As a
consequence the cost of a newspaper can be kept at a modest price. Those
newspapers, however, that cannot spread their high fixed costs over a large
number of units of output because the newspaper has few sales, will find that
they experience diseconomies of scale.
Chapter Eight
1.
Why does pure competition provide consumers with the largest utility surplus?
In pure competition, product price is determined by the intersection of the
demand and supply curves. Product price times quantity is the amount of
expenditures made by consumers for the product. In most cases, however, some
consumers would have been willing to pay more for the product because
consumers collectively would obtain more utility (total satisfaction) from their
purchases than the amount of their expenditures. This difference in utility value
and the equilibrium price is the consumer surplus. Pure competition is
economically efficient (P = MC = minimum ATC) and thus establishes the
lowest price consistent with continued production. This lowest price means that
the consumers collectively obtain the largest sustainable amount of utility
surpluses.
Chapter Nine
1.
(Consider This) Why does price discrimination work in the sale of seats to
children and adults at baseball games, but not to the sale of food at concession
stands to children and adults at baseball games?
There are three conditions that need to be met for price discrimination to work:
(a) the business has monopoly power; (b) it offers different prices to groups of
consumers (adults or children) based on the price elasticity of demand for baseball
games among children and adults; and (c) there is no resale or transfer of the
product from children who buy it at the lower price to adults who must buy it at the
higher price. In the case of seats to baseball games all three conditions hold. In
the case of food concessions, the third condition does not hold. If a child bought
food at a lower price than an adult, they could just give the food to the adults who
took them to the game. This transfer would undercut the price discrimination
power.
2.
(Last Word) How was the original DeBeers diamond company an example of
classic monopoly behaviour? How did it manipulate demand and supply?
De Beers produces about 50 percent of all rough-cut diamonds in the world and
buys for resale many of the diamonds produced elsewhere. It markets about 65
percent of the world’s diamonds. The price and output decisions of this original
firm fit the monopoly model. It controlled the supply of a large portion of the
diamond market. Thus it was able to sell a limited quantity of diamonds to yield
an “appropriate” monopoly price that was well over production costs. The firm
earned monopoly profit.
On the demand side, when demand decreased, it reduced diamond sales to
maintain the most profitable price. It also tried to increase demand through
advertising. On the supply side, it attempted to control the production from
mines that it did not own. It made deals with other producers to market their
diamonds through DeBeers and share the profits. It undercut the prices of rogue
producers who sold diamonds outside the DeBeers control by selling its
stockpiles of such diamonds and driving down the price. It also purchased
diamonds from other producers.
3.
(Last Word) What market forces made DeBeers change its monopoly behaviour
and end its attempts to control the diamond market?
Several supply factors undercut the monopoly power of DeBeers. New diamond
discoveries in Africa and Canada increased the supply of diamonds on the market
that were not under the firm’s control. The production of Russian diamonds is
only partly under DeBeers control. Other firms, such as Argyle in Australia,
withdrew from an arrangement in which they sold their diamonds to DeBeers and
these firms now market their diamonds on their own. DeBeers was also
concerned about possible boycotts from their buying diamonds in war-torn
regions of Africa, and thus they would be accused of indirectly financing the
conflicts. These diamond-producing areas were no longer under DeBeers
control. The company has responded to the problem of no longer being able to
control diamond supply as a monopolist by putting more emphasis on the
demand for its diamonds through advertising, which in effect creates an
increased demand for DeBeers diamonds over other diamonds. DeBeers can also
still manipulate supply to a certain extent because it still has control over a large
share of diamonds produced and marketed.
Chapter Ten
1.
(Consider This) How is strategic behaviour illustrated by the competition among
three sellers of native arts and crafts near a national park?
Each seller must consider the reaction of the rivals to any changes in prices or nonprice competition. If one seller changes prices, the other sellers are likely to
change their prices to match. There will be a great deal of copycat behaviour.
2.
Compare pure competition, pure monopoly, monopolistic competition, and
oligopoly on each of the following points:
(a)
(b)
(c)
(d)
Ability to manipulate price.
Flexibility of prices.
Expenditures on advertising and sales promotion.
Efficiency in allocation of resources.
(a)Firms have least ability to manipulate price in pure competition, some ability
in oligopoly depending on conditions, a slight ability under monopolistic
competition, and total ability in a monopoly.
(b) Prices would be most flexible under monopolistic competition and pure
competition. Under pure competition, prices would change only if market
demand or supply conditions changed, but the firm would not have control over
this flexibility. Prices under oligopoly would not be flexible; rather output
adjustments would tend to be made to changing demand conditions. Monopoly
prices could be flexible in response to changing demand or cost conditions.
(c)Purely competitive firms would spend virtually nothing on advertising.
Monopolistic competitors and oligopolies with differentiated products would
spend the most. Monopolies would probably spend a slight amount on
informational or goodwill advertising.
(d) Productive and allocative efficiency are achieved only under conditions of
pure competition, with the qualification that in some industries, economies of
scale dictate some other market model to achieve efficiency. Among the other
three models, it would depend on the circumstances. In a regulated, natural
monopoly, efficiency may nearly be achieved. In monopolistic competition
without excessive advertising, and in oligopolies realizing economies of scale,
efficiency may be attained.
Chapter Eleven
1.
Compare pure competition, pure monopoly, monopolistic competition, and
oligopoly for technological advance in the form of new product development.
In the strict model of pure competition, firms have little ability to achieve
technological advance in product development because they do not earn
economic profits. One might argue that the highest degree of product
development would come under oligopoly because of the investment potential
and rivalry but an oligopoly can also be complacent if it has a stable market share
and is earning economic profits without developing new products. Monopoly
has only the threat of potential competition to motivate its product development,
but this competition is very limited, so it has little incentive to innovate.
Monopolistic competition would be strongly motivated to innovate by
competition, but may not have the resources for extensive product development.
Chapter Twelve
1.
How is price fixing treated under anti-combines policy? Give two examples of
legal actions against price fixing.
Price fixing is treated strictly. Evidence of price fixing, by large or small firms,
will be cause for anti-combines violations. Just the attempt to fix prices or to rig
market outcomes are considered illegal even if they are not successful in
increasing monopoly dominance. Such violations are called per se violations
because they are illegal in and of themselves and are not subject to the rule of
reason.
2.
How is price discrimination treated under anti-combines laws?
Price discrimination involves charging different prices to different groups based
on certain characteristics such as age. This practice is not illegal because it often
promotes competition and contributes to consumer welfare. It is illegal in those
cases when it is used as a means of blocking the entry of a new business or to
drive out competitors.
3.
What do critics of social regulation need to remember about government?
The major point to remember is that less government is not always better
government. Social regulation if applied carefully has the potential to improve
economic efficiency and overall societal welfare. Such regulation can reduce the
hard edges of a market economy by making the workplace safer, drugs safer,
eliminating discriminatory work practices, and other action. This regulation can
help maintain political support for a market economy without undermining the
benefits of competition.
Chapter Thirteen
1.
(Consider This) How is marginal revenue product reflected in “winner-take-all”
markets such as in the music industry?
In the music industry, there is stiff competition to become a superstar. The
superstars attract a large following that are willing to pay high prices for concert
tickets and purchase many of the CDs produced by the artists. As a consequence,
the artists’ work generates a great deal of revenue for the company. These
superstars also have high earnings that reflect their high marginal revenue product.
2.
What are examples of the fastest growing occupations expected to in the next 5
years. What economic principle of factor pricing best explains these trends?
In percentage terms, the fastest growing occupations are in the computer field:
computer engineers, computer support specialists, systems analysts, and database
administrators. These increases in these occupations are largely explained by the
relatively large increases in labour demand for these types of workers. The
increase in the demand for computer products and information technology has
increased the demand for workers in these areas. Several factors underlying the
demand for these workers explain this increase in demand. First, the price or value
of the product produced by these types of workers has increased. Second, this new
technology improves the productivity of other workers, which increases the
demand for this type of equipment and its associated workers. Third, there has
been a significant decline in the price of computers and technological resources,
which has lowered the cost of producing products and increased the demand for
this equipment and its workers because of output effects.
Chapter Fourteen
1.
What explains wage differentials in labour markets? Evaluate from a demand
and supply perspective.
Consider a labour market with an upsloping but stable supply curve. In this
market, shifts in demand will determine the equilibrium wage. Those markets
with a high demand will have a high equilibrium wage and those markets with a
low demand will have a low equilibrium wage. Now consider a labour market
with a downsloping but stable demand curve. In this market, shifts in supply will
determine the equilibrium wage. Those markets with a highly restrictive supply
of labour will have a high equilibrium wage and those markets with an abundant
supply of labour will have a low equilibrium wage.
2.
Why is there a difference in the strength of demand for labour?
The main explanation is the marginal revenue product of workers. Those
workers with a high MRP will be greatly sought by employers and thus there will
be a strong demand for the labour services of these workers. As a consequence
they will be paid high wages. Those workers with a low MRP will not be often
sought by employers, and thus there will be a weak demand for the labour
services of these workers. As a consequence, they will not be highly paid.
Chapter Fifteen
1.
(Consider This) How did economist Irving Fischer explain interest to a masseur?
After receiving a massage, Fischer told the masseur that he would pay the $30 he
owed as a note payable a hundred years from then without interest. He asked the
masseur if that would be acceptable. The masseur replied that he could not afford
to wait that long to be paid. Fischer then asked what price he would require to
wait a period of time, say ten years. The masseur stated that he would have to be
paid more than the thirty dollars. Fischer then explained that the amount that he
would pay above the thirty dollars for the use of the money for a period of time
was interest.
2.
What is the relationship between uninsurable risk and profit? What three general
sources contribute to uninsurable risk?
Uninsurable risks are a potential source of profit. Uninsurable risks are mainly
due to uncontrollable and unpredictable changes in the demand and supply
conditions for a business. There are three general sources: (a) changes in the
economic environment due to such factors as recession; (b) changes in the
structure of the economy such as a decline in a particular industry; and (c)
changes in government policy that affects a business. The changes can be
positive for a business, in which case profits should rise, or they can be negative
for a business, in which case profits will fall.
Chapter Sixteen
1.
What is the basic difference between a public good and a private good?
A private good is characterized by rivalry and excludability. Rivalry means that
when one person obtains the product it is not available for purchase or
consumption by another person. Excludability means that a person can not
receive the benefits of the good if the person does not pay for it. Public goods
are characterized by non-rivalry and non-excludability. Once a public good is
provided to one person it is available for benefit by everyone. Also, people
cannot be excluded from receiving the benefits of public good.
2.
Describe the rationale behind supply and demand analysis for public goods.
With a private good you add together the quantities demanded people are willing
to pay at each possible price, whereas with a public good you add together the
prices people are willing to pay for the last unit of the public good at each
possible quantity demanded. The demand curve for a public good slopes
downward because of the law of diminishing marginal utility. The supply curve
for a public good is upsloping because of the law of diminishing returns. The
demand curve for a public good is, in essence, a marginal benefit curve; the
supply curve for a public good reflects rising marginal costs. The optimal
quantity of a public good will be shown by the intersection of the collective
demand and supply curves, which means that the marginal benefit of the last unit
equals that unit’s marginal cost.
3.
(Consider This) Why does a new car lose substantial market value when it is
purchased, but a new car left on the car dealer lot still retains its market value?
The answer is related to asymmetric information and the adverse selection problem
that arises. Owners of used cars have better information about the condition of
their cars than do potential buyers (asymmetric information). Owners of defective
used cars have an incentive to get rid of their cars in the used-car market, thus
creating an adverse selection problem. The higher proportion of such low-quality
used cars that are sold reduces the average quality of cars in the used car market.
A potential buyer anticipates that he or she will have repair costs for a used car, so
he or she is only willing to pay the going price for an average-quality used car, and
not pay the price for a higher-quality car. So, when a new car is purchased, the
value of the new car quickly drops to the average price of used cars in the market.
Chapter Seventeen
1.
What is the meaning of the incidence of a tax? Give an example using a landlord
and tenants.
The incidence of a tax refers to who bears the actual burden or cost of the tax. If
it is not the taxpayer who pays the tax to the government, then the burden of the
tax is said to be “shifted” onto another individual. For example, the landlord is
the taxpayer who sends in the property tax money to the state or local
government, but the incidence is probably shifted onto the tenant who finds that
the rent has been raised to cover the cost of the property tax.
2.
What is the probable incidence of the personal income tax?
The personal income tax is borne by the taxpayer, unless the taxpayer has the
ability to raise fees or salary to cover the cost of the tax. This might be the case
with a few professions where the demand for their services is somewhat inelastic
and the consumer would be willing to pay a higher fee that would cover the cost
of any increase in income taxes. However, for most income earners, the ability
to shift the income tax is very limited.