Ch16solution Manual

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual
Chapter 16
General Equilibrium Theory
Solutions to Review Questions
1. What is the difference between a partial equilibrium analysis and a general equilibrium
analysis? When analyzing the determination of prices in a market, under what
circumstances would a general equilibrium analysis be more appropriate than a partial
equilibrium analysis?
A partial equilibrium analysis studies the determination of price and output in a single market,
taking as given the prices in all other markets. In general equilibrium analysis, we study the
determination of price and output in more than one market at the same time.
One would employ a partial equilibrium analysis in situations where the concerns focused on a
single market; for example, how does an increase in rainfall affect the price of corn? One would
use general equilibrium analysis when one was concerned with how changes in price and output
in one market affect the price and output in another market; for example, how does an increase in
the price of natural gas affect the price and output for electric furnaces?
2. In a general equilibrium analysis with two substitute goods, X and Y, explain what would
happen to the price in market X if the supply of good Y increased (i.e., if the supply curve
for good Y shifted to the right). How would your answer differ if X and Y were
complements?
If the supply of good Y increased, the equilibrium price of good Y would fall. Since X and Y
are assumed to be substitutes, when the price of good Y falls relative to good X , the demand for
good X will fall, lowering the equilibrium price and quantity for good X .
If X and Y are complements, when the price of good Y falls, the demand for good X will
increase, increasing the equilibrium price and quantity for good X .
3. What role does consumer utility maximization play in a general equilibrium analysis?
What is the role played by firm cost minimization in a general equilibrium analysis?
In a general equilibrium, demand for finished products comes from utility maximization by
households, while demand for inputs comes from cost minimization by firms. The supply of
finished products comes from profit maximization by firms, while the supply of inputs comes
from profit maximization by households.
4. What is Walras Law? What is its significance?
Walras Law implies that a general equilibrium analysis will only be able to determine prices in
N 1 of the markets being studied. This implies that a general equilibrium determines the prices
of all goods and inputs relative to the price of another good or input, rather than determining the
absolute levels of all prices.
Copyright 2014 John Wiley & Sons, Inc.
Chapter 16 - 1
5. What is an economically efficient allocation? How does an economically efficient

allocation differ from an inefficient allocation?
An allocation of goods and inputs is economically efficient if there is no other feasible allocation
of goods and inputs that would make some consumers better off without hurting other
consumers. In contrast, an allocation of goods and inputs is economically inefficient if there is
an alternative feasible allocation of goods and inputs that would make all consumers better off as
compared with the initial allocation.
6. What is exchange efficiency? In an Edgeworth box diagram, how do efficient allocations
and inefficient allocations differ?
Exchange efficiency occurs when a fixed amount of consumption goods cannot be reallocated
among consumers in an economy without making at least some consumers worse off. Efficient
allocations in an Edgeworth Box occur at points where the indifference curves for different
consumers are tangent. Inefficient allocations occur at points where the indifference curves for
different consumers intersect.
7. How does exchange efficiency differ from input efficiency? Could an economy satisfy the
conditions for exchange efficiency but not the conditions for input efficiency?
Input efficiency occurs when a fixed stock of inputs cannot be reallocated among firms in an
economy without reducing the output of at least one of the goods that is produced in the
economy. It is quite possible that an economy could enjoy exchange efficiency, where the
amount of goods available in the economy is allocated so that no consumer can be made better
off without making some other consumer worse off, and not enjoy input efficiency, where the
amount of inputs could be reallocated to produce more of all goods.
8. Suppose an economy has just two goods, X and Y. True or False: If the condition of input
efficiency prevails, we can increase the production of X without decreasing the production
of Y. Explain your answer.
False. If an economy has input efficiency, then the inputs cannot be reallocated among firms in
an economy without reducing the output of at least one of the goods that is produced in the
economy. That is, input efficiency implies that an expansion of output in one industry
necessitates a reduction in output in another industry.
9. What is the production possibilities frontier? What is the marginal rate of
transformation? How does the marginal rate of transformation relate to the production
possibilities frontier?
The production possibilities frontier describes the combinations of consumption goods that can
be produced in an economy given the economys available supply of inputs. The points on the
frontier satisfy input efficiency, while the points inside the frontier have input inefficiency.
Chapter 16 - 2
The marginal rate of transformation is the absolute value of the slope of the production
possibilities frontier at some point. This measures the amount of one good the economy must
give up in order to gain one additional unit of output for some other good.
10. Explain how consumers in an economy can be made better off if the marginal rate of
transformation does not equal consumers marginal rates of substitution.
If the marginal rate of transformation is not equal to consumers marginal rate of substitution,
then consumers in the economy can be made better off. As an example, suppose the marginal
rate of substitution was 3 and the marginal rate of transformation was 1 for goods x and y . By
producing one more unit of x , the economy would need to sacrifice one unit of y . Consumers
are willing to sacrifice 3 units of y , however, to get one additional unit of x . Therefore, if the
economy produces one more unit of x and one fewer unit of y , consumers would be better off.
11. Explain how the conditions of utility maximization, cost minimization, and profit
maximization in competitive markets imply that the allocation arising in a general
competitive equilibrium is economically efficient.
In a general competitive equilibrium, the economy will satisfy exchange, input, and substitution
efficiency. This implies that all consumers are maximizing utility given the prices of goods in
the economy and producers are maximizing profit at the point where prices equal marginal costs.
P
That is, MRS x , y x Py , px MCx , and Py MC y . Together these imply that
P MCx
MRS x , y x
MRTx , y
Py MC y
That is, utility maximization by consumers and profit maximization by producers implies the
marginal rate of substitution will equal the marginal rate of transformation. This guarantees
substitution efficiency is satisfied at the general competitive equilibrium. In other words, the
allocation that arises in a general competitive equilibrium is economically efficient.
12. What is comparative advantage? What is absolute advantage? Which of these two
concepts is more important in determining the benefits from free trade?
Comparative advantage implies that one country has a lower opportunity cost in the production
of some good, expressed in units of some other good forgone, than another country.
Absolute advantage implies that one country can produce a product at a lower cost in terms of
units of some input, labor for example, than another country.
In determining the benefits from free trade, one must compare the opportunity costs to identify
the benefits. For example, in a two-good world, while one country may have an absolute
advantage in the production of both goods, it is still likely that each country has a comparative
advantage in the production of different goods, and through specialization and trade, each
country can be made better off.
Chapter 16 - 3
Solutions to Problems
16.1. Consider the markets for butter (B) and margarine (M), where the demand curves are
Q = 20 2PM + PB and Q = 60 6PB + 4 PM and the supply curves are QM = 2PM and QB =
3PB.
a) Find the equilibrium prices and quantities for butter and margarine.
b) Suppose that an increase in the price of vegetable oil shifts the supply curve of
margarine to QM = PM. How does this change affect the equilibrium prices and quantities
for butter and margarine? Using words and graphs, explain why a shift in the supply curve
for margarine would change the price of butter.
a)
In equilibrium we must have quantity supplied equal to quantity demanded in both the
butter and margarine markets. This implies in equilibrium we will have
QMd QMs
QBd QBs
Substituting in the given curves implies
20 2 PM PB 2 PM
60 6 PB 4 PM 3PB
Solving for PB in the first equation and substituting into the second equation implies
60 4 PM 9(4 PM 20)
60 4 PM 36 PM 180
PM 7.5
When PM 7.5 , PB 10 . At these prices, QM 15 and QB 30 .
b)
When the supply curve for margarine shifts to QMs PM , we have

20 2 PM PB PM
60 6 PB 4 PM 3PB
Solving the first equation for PB and substituting into the second equation implies
60 4 PM 9(3PM 20)
60 4 PM 27 PM 180
PM 10.43
When PM 10.43 , PB 11.30 . At these prices, QM 10.43 and QB 33.91 . The increase in the
price of vegetable oil increases the price of margarine and decreases the quantity of margarine
Chapter 16 - 4
consumed. As consumers switch to butter, the price of butter rises and the quantity of butter
consumed goes up.
The price of butter rises when the price of vegetable oil rises because butter and margarine are
substitutes. The effects can be seen in the following graphs.
Market for Margarine
Price
40
S'
30
20
10
0
0
10
15
20
25
30
35
Quantity
Price
Market for Butter

25
20
15
10
5
0
S
D'
D
0
10
20
30
40
50
60
70
Quantity
Because the goods are substitutes, when the supply of margarine shifts inward from S to S,
raising the price of margarine, consumers substitute butter for margarine, shifting demand for
butter outward from D to D. This raises both the equilibrium price and quantity of butter.
16.2. Suppose that the demand curve for new automobiles is given by QA = 20 0.7PA PG
where QA and PA are the quantity (millions of vehicles) and average price (thousands of
dollars per vehicle), respectively, of automobiles in the United States, and PG is the price of
gasoline (dollars per gallon). The supply of automobiles is given by Q5A = 0.3PA. Suppose
that the demand and supply curves for gasoline are QdG = 3 PG and QSG = PG.
a) Find the equilibrium prices of gasoline and automobiles.
Chapter 16 - 5
b) Sketch a graph that shows how an exogenous increase in the supply of gasoline affects
the prices of new cars in the United States.
a)
In equilibrium, the quantity supplied and the quantity demanded for both goods will be
equal. This implies
QAd QAs
QGd QGs
20 0.7 PA PG 0.3PA
3 PG PG
Here we have two equations and two unknowns. Solving the second equation for PG yields
PG 1.5 . Substituting into the first equation results in
20 0.7 PA 1.5 0.3PA
PA 18.5
At these prices, QA 5.55 and QG 1.5 .
b)
If the supply of gasoline increases, the supply curve for gasoline will shift to the right
lowering the equilibrium price of gasoline as seen in the graph below.
Market for Gasoline

4
S
Price
3
2
S'
0
0
Quantity
Because gasoline is a complement good for autos, the reduction in the price of gasoline will
increase the demand for autos. This will shift the demand curve to the right, increasing the
equilibrium price and quantity for autos as seen in the following graph.
Chapter 16 - 6
Market for Autos

80
S
Price
60
40
20
D'
0
0
10
15
D
20
Quantity
16.3. Studies indicate that the supply and demand schedules for ties (t) and jackets (j) in a
market are as follows:
The estimates of the schedules are valid only for prices at which quantities are positive.
a) Find the equilibrium prices and quantities for ties and jackets.
b) Do the demand schedules indicate that jackets and ties are substitute goods,
complementary goods, or independent goods in consumption? How do you know?
a)
In equilibrium (1) the supply and demand for ties will be equal
410 5Pt 2Pj = 60 + 3PK , and

(2) the supply and demand for jackets will be equal
295 Pt 3Pj = 120 + 2Pj
Solving these two simultaneous equations, we find that Pj = 75 and Pt = 40. Also, using either
the demands or supply schedules, we calculate that the equilibrium quantity of jackets is 30, and
the equilibrium quantity of ties is 60.
b)
The demand function for ties shows that a higher price of jackets decreases the demand
for ties. Similarly the demand function for jackets shows that a higher price of ties decreases the
demand for jackets. Ties and jackets are therefore complements in consumption.
16.4. Suppose that the demand for steel in Japan is given by the equation QdS = 1200 4PS +
PA + PT, where QS is the quantity of steel purchased (millions of tons per year), PS is the
price of steel (yen per ton), PA is the price of aluminum (yen per ton), and PT is the price of
Chapter 16 - 7
titanium (yen per ton). The supply curve for steel is given by QSS = 4PS. Similarly, the
demand and supply curves for aluminum and for titanium are given by QdA = 1200 4PA +
PS + PT (demand curve for aluminum), QSA = 4PA (supply curve for aluminum), QdT = 1200
4PT + PS + PA (demand curve for titanium), and QST = 4PT (supply curve for aluminum).
a) Find the equilibrium prices of steel, aluminum, and titanium in Japan.
b) Suppose that a strike in the Japanese steel industry shifts the supply curve for steel to
QSS = PS. What does this do to the prices of steel, aluminum, and titanium?
c) Suppose that growth in the Japanese beer industry, a big buyer of aluminum cans, fuels
an increase in the demand for aluminum so that the demand curve for aluminum becomes
QdA = 1500 4PA + PS + PT. How does this affect the prices of steel, aluminum, and
titanium?
a)
In equilibrium the quantity supplied will equal the quantity demanded in all three
markets. Algebraically this implies
QSd QSs
QAd QAs
QTd QTs
1200 4 PS PA PT 4 PS
1200 4 PA PS PT 4 PA
1200 4 PT PS PA 4 PT
Solving the first equation for PT and substituting into the second equation implies
1200 4 PA PS (8 PS PA 1200) 4 PA
9 PS 9 PA
PS PA
Substituting these results into the third equation implies
1200 4(8 PA PA 1200) PA PA 4(8 PA PA 1200)
10,800 54 PA
PA 200
At PA 200 , PS 200 and PT 200 . The equilibrium quantities are QA 800 , QS 800 , and
QT 800 .
b)
Substituting the new supply curve for steel into the equilibrium condition implies
Chapter 16 - 8
1200 4 PS PA PT PS
Again solving for PT in the first equation and substituting into the second equation implies
1200 4 PA PS (5PS PA 1200) 4 PA
6 PS 9 PA
PS 1.5 PA
1200 4(5(1.5 PA ) PA 1200) 1.5 PA PA 4(5(1.5 PA ) PA 1200)
10,800 49.5PA
PA 218.18
At PA 218.18 , PS 327.27 and PT 218.18 . At these prices, the equilibrium quantities are
QA 872.72 , QS 327.27 , and QT 872.72 .
The shift in the supply of steel raises the equilibrium price for all three goods, lowering the
equilibrium quantity of steel and raising the equilibrium quantities of aluminum and titanium.
This last effect comes as a result of the demand curves for aluminum and titanium increasing in
response to the shift in the steel supply curve.
c)
Returning to the original equilibrium, this shift in the demand for aluminum implies
1200 4 PS PA PT 4 PS
Solving the first equation for PT and substituting into the second equation implies
1500 4 PA PS (8 PS PA 1200) 4 PA
9 PS 300 9 PA
PS PA 33.33
1200 4(8( PA 33.33) PA 1200) ( PA 33.33) PA 4(8( PA 33.33) PA 1200)
12,900 54 PA
PA 238.89
Chapter 16 - 9
At PA 238.89 , PS 205.56 and PT 205.56 . At these prices, the equilibrium quantities are
QA 955.56 , QS 822.24 , and QT 822.24 .
An increase in the demand for aluminum will raise the equilibrium prices and quantities in all
three markets. The price and quantity in the steel and aluminum industries increase because as
the price of aluminum rises, the demand for steel and titanium increases.
16.5. Consider a simple economy that produces two goods, beer (denoted by x) and quiche
(denoted by y), using labor and capital (denoted by L and K, respectively) that are supplied
by two types of households, those consisting of wimps (denoted by W) and those consisting
of hunks (denoted by H). Each household of hunks supplies 100 units of labor and no units
of capital. Each household of wimps supplies 10 units of capital and no units of labor. There
are 100 households of each type. Both beer and quiche are produced with technologies
exhibiting constant returns to scale. The market supply curves for beer and quiche are
where w denotes the price of labor and r denotes the price of capital. The market demand
curves for beer and quiche are given by
where X and Y denote the aggregate quantities of beer and quiche demanded in this
economy and IW and IH are the household incomes of wimps and hunks, respectively.
Finally, the market demand curves for labor and capital are given by
There are four unknowns in our simple economy: the prices of beer and quiche, Px and Py,
and the prices of labor and capital, w and r. Write the four equations that determine the
equilibrium values of these unknowns.
First, in equilibrium, the quantity supplied of beer and quiche must equal the quantity demanded
of beer and quiche. This implies
20 IW 90 I H
w1/ 6 r 5/ 6
X
80 IW 10 I H
w3/ 4 r1/ 4
Y
Now, since each hunk supplies 100 units of labor and no units of capital and each wimp supplies
10 units of capital and no units of labor,
Chapter 16 - 10
IW ( w, r ) 10r
I H ( w, r ) 100 w
Substituting these into the conditions above yields our first two equations:
200r 9000 w
X
800r 1000 w
w1/ 6 r 5/ 6
w3/ 4 r1/ 4
Second, in equilibrium, the quantity supplied of labor and capital must equal the quantity
demanded of labor and capital. Since there are 100 households of each type, we will have
L 100(100) 10, 000 and K 100(10) 1, 000 . Setting these equal to demand yields the third
and fourth equations:
X
10, 000
6
r

w
5 X w
1, 000

6 r
5/ 6
1/ 4
Y w

4 r
3/ 4
3Y

4
1/ 6
16.6. In an economy, there are 40 white-collar households, each producing 10 units of

capital (and no labor); the income from each unit of capital is r. There are also 50 bluecollar households, each producing 20 units of labor (and no capital); the income from each
unit of labor is w.
Each white-collar households demand for energy is XW = 0.8MW/PX, where MW is income
in the household. Each white-collar households demand for food is YW = 0.2MW/PY. Each
blue-collar households demand for energy is XB = 0.5MB/PX, where MB is income in the
household. Each blue-collar households demand for food is YB = 0.5MB/PY. Energy is
produced using only capital. Each unit of capital produces one unit of energy, so r is the
marginal cost of energy. The supply curve for energy is described by PX = r, where PX is
the price of a unit of energy. Food is produced using only labor. Each unit of labor produces
one unit of food, so w is the marginal cost of food. The supply curve for labor is described
by PY = w, where PY is the price of a unit of food. a) In this economy, show that the amount
of labor demanded and supplied will be 1,000 units. Show also that the amount of capital
demanded and supplied will be 400 units.
b) Write down the supply-equals-demand conditions for the energy and food markets.
c) In equilibrium how will the price of a unit of energy compare with the price of a unit of
food?
d) In equilibrium how will the income of each white-collar family compare with the income
of each blue-collar family?
Chapter 16 - 11
a)
The total amount of capital produced (all by white collar households together) is
(40 households)(10 units/household) = 400 units.
The total amount of labor produced (all by blue collar households together) is
(50 households)(20 units/household) = 1000 units.
b)
The income in each white collar household is MW = 10r.
The income in each blue collar household is MB = 20w.
The aggregate demand for energy will be X = [50(0.5MB) + 40(0.8MW)]/PX = [500w + 320r]/PX
The aggregate demand for food will be Y =[50(0.5MB) + 40(0.2MW)]/PY = [500w + 80r]/PY.
The supply-equals demand condition in the energy market is
r = [500w + 320r]/X = [500w + 320r]/400, or r = 6.25w
The supply-equals demand condition in the food market is
w = [500w + 80r]/Y= [500w + 80r]/1000, or, as before r = 6.25w (same as above by Walras Law)
c)
PX = r and PY = w. Since r = 6.25w, the price of a unit of energy is 6.25 times as large as
the price of a unit of food.
d)
The income of a blue collar family is MB = 20w. The income of a white collar family is MW
= 10r = 10(6.25w) = 62.5w. So a white collar family has an income 3.125 (= 62.5/20) times larger
than that of a blue collar family.
16.7. One of the implications of Walras Law is that the ratios of prices (rather than the
absolute levels of prices) are determined in general equilibrium. In Learning-By-Doing
Exercise 16.2, show that price labor will be 25/52 0.48 of the price of capital, as illustrated
in Figure 16.9.
When we equated the supply and demand for energy, we eliminated the price of energy to derive
Equation 16.4:
w1/3r2/3
, we find that
. Call this equation A.
Similarly, when we equated the supply and demand for food, we eliminated the price of food to
derive Equation 16.5:
w1/2r1/2
Chapter 16 - 12
, we find that
. Call this equation B.
When we substitute Equations A and B into the supply-equals-demand in the labor market
(Equation 16.6), we find that
7000 =
=
0.48.
Thus: 42000w =
Exercise 16.2, show that the ratio of the price of energy to the price of capital is about 0.79,
as illustrated in Figure 16.9.
Equation 16.4:
w1/3r2/3
, we find that
w1/2r1/2
, we find that
Chapter 16 - 13
7000 =
=
0.48.
Thus: 42000w =
Finally, from the relationship describing the supply of energy we know that
Px = w1/3r2/3 =
r=
r 0.79 r
Exercise 16.2, show that the ratio of the price of food to the price of capital is about 0.7, as
illustrated in Figure 16.9.
Equation 16.4:
w1/3r2/3
, we find that
w1/2r1/2
, we find that
Chapter 16 - 14
7000 =
=
0.48.
Thus: 42000w =
Finally, from the relationship describing the supply of food we know that
PY = w1/2r1/2 =
r=
r 0.7 r
16.10. Two consumers, Josh and Mary, together have 10 apples and 4 oranges.
a) Draw the Edgeworth box that shows the set of feasible allocations that are available in
this simple economy.
b) Suppose Josh has 5 apples and 1 orange, while Mary has 5 apples and 3 oranges.
Identify this allocation in the Edgeworth box.
c) Suppose Josh and Mary have identical utility functions, and assume that this utility
function exhibits positive marginal utilities for both apples and oranges and a diminishing
marginal rate of substitution of apples for oranges. Could the allocation in part (b)5
apples and 1 orange for Josh; 5 apples and 3 oranges for Marybe economically efficient?
a & b)
Mary
Oranges
3
2
1
0
Josh 0
10
Apples
Chapter 16 - 15
c)
To be economically efficient, the two consumers must have identical marginal rates of
substitution at the allocation. While we are not given the MRS for each consumer, we are told
that each has an identical utility function. This implies that at an efficient allocation where the
MRS for each consumer is the same, the ratio of apples to oranges must be the same. Since at
the current allocation Josh has a ratio of apples to oranges equal to 5 and Mary has a ratio of
1.67, this allocation cannot be efficient. The contract curve in this case will be a straight line
between the origins for each consumer.
16.11. Ted and Joe each consume peaches, x, and plums, y. The consumers have identical
utility functions, with
Together, they have 10 peaches
and 10 plums. Verify whether each of the following allocations is on the contract curve:
a) Ted: 8 plums and 9 peaches; Joe: 2 plums and 1 peach.
b) Ted: 1 plum and 1 peach; Joe: 9 plums and 9 peaches.
c) Ted: 4 plums and 3 peaches; Joe: 6 plums and 7 peaches.
d) Ted: 8 plums and 2 peaches; Joe: 2 plums and 8 peaches.
To be on the contract curve, an allocation must yield identical marginal rates of substitution for
each consumer.
a)
MRSTed = 80/9 < MRSJoe = 20/1. Not on the contract curve.
b)
MRSTed = 10/1 = MRSJoe = 90/9. On the contract curve.
c)
MRSTed = 40/3 > MRSJoe = 60/7. Not on the contract curve.
d)
MRSTed = 80/2 > MRSJoe = 20/8. Not on the contract curve.
16.12. Two consumers, Ron and David, together own 1,000 baseball cards and 5,000
Pokmon cards. Let xR denote the quantity of baseball cards owned by Ron and yR denote
the quantity of Pokmon cards owned by Ron. Similarly, let xD denote the quantity of
baseball cards owned by David and yD denote the quantity of Pokmon cards owned by
David. Suppose, further, that for Ron, MRSRx,y = yR/xR, while for David, MRSDx,y = yD/2xD.
Finally, suppose xR = 800, yR = 800, xD = 200, and yD = 4,200.
a) Draw an Edgeworth box that shows the set of feasible allocations in this simple economy.
b) Show that the current allocation of cards is not economically efficient.
c) Identify a trade of cards between David and Ron that makes both better off. (Note:
There are many possible answers to this problem.)
a)
Chapter 16 - 16
David
Pokemon Cards
5000
4000
3000
2000
1000
0
Ron
200
400
600
800
1000
Baseball Cards
b)
To be economically efficient, the MRS for the two consumers must be equal. At this
allocation we have
y
800
MRS xR, y R
1
xR 800
y
4200
MRS xD, y D
10.5
2 xD 2(200)
Since MRSD > MRSR, the current allocation is not economically efficient.
c)
At the current allocation Ron is willing to trade one baseball card for one Pokemon card,
and David is willing to trade one baseball card for 10.5 Pokemon cards. If David gives Ron 9
Pokemon cards in exchange for one baseball card, both consumers will be better off.
Or, in other words, Ron thinks a baseball card is worth just one Pokemon card while David
thinks it is worth 10.5 Pokemon cards. So both will be better off if Ron sells David a baseball
card for anything more than one Pokemon card and less than 10.5 Pokemon cards.
16.13. There are two individuals in an economy, Joe and Mary. Each of them is currently
consuming positive amounts of two goods, food and clothing. Their preferences are
characterized by diminishing marginal rate of substitution of food for clothing. At the
current consumption baskets, Joes marginal rate of substitution of food for clothing is 2,
while Marys marginal rate of substitution of food for clothing is 0.5. Do the currently
consumed baskets satisfy the condition of exchange efficiency? If not, describe an exchange
that would make both of them better off.
Since the marginal rates of substitution are not equal for both people, the current consumption
baskets do not satisfy exchange efficiency. Joe would be willing to give up 2 units of food to get
1 additional unit of clothing. Mary would be willing to give up 0.5 units of food to get 1
additional unit of clothing; put another way, Mary would be willing to give up 2 units of clothing
to get 1 additional unit of food.
Chapter 16 - 17
One exchange that would make both better off would be for Joe to give 1 unit of food to Mary in
exchange for 1 unit of clothing. Joe is better off (he would have been willing to give up 2 units of
food to get 1 additional unit of clothing). But what about Mary? To get the 1 additional unit of
clothing, she would have been willing to give up 2 units of clothing; but with the proposed
exchange, she only had to give up 1 unit of clothing. So the proposed exchange also makes her
better off.
16.14. Consider an economy that consists of three individuals: Maureen (M), David (D),
and Suvarna (S). Two goods are available in the economy, x and y. The marginal rates of
substitution for the three consumers are given by MRSMaureenx,y = 2yM/xM, MRSDavidx,y = 2yD/xD
and MRSSuvarnax,y = yS/xS. Maureen and David are both consuming twice as much of good x
as good y, while Suvarna is consuming equal amounts of goods x and y. Are these
consumption patterns economically efficient?
To be economically efficient, the marginal rates of substitution for all consumers must be equal.
From the given information we know xM 2 yM , xD 2 yD , and xS yS . Substituting into the
marginal rates of substitution we have
2y
MRS xMaureen
M 1
,y
2 yM
2 yD
MRS xDavid
1
,y
2 yD
y
MRS xSu, yvarna S 1
yS
Thus, each consumer has an identical marginal rate of substitution. This consumption pattern is
therefore economically efficient.
16.15. Two firms together employ 100 units of labor and 100 units of capital. Firm 1
employs 20 units of labor and 80 units of capital. Firm 2 employs 80 units of labor and 20
units of capital. The marginal products of the firms are as follows: Firm 1: MP1l = 50,
MP1k = 50; Firm 2: MP2l = 10, MP2k= 20. Is this allocation of inputs economically
efficient?
To satisfy input efficiency, the marginal rates of technical substitution must be equal across
firms. Here we have
MRTS
1
l ,k
MPl1 50
1
MPk1 50
MRTS l2,k
MPl 2 10
0.5
MPk2 20
Thus, the allocation of inputs is not economically efficient.
Chapter 16 - 18
16.16. There are two firms in an economy. Each of them currently employs positive
amounts of two inputs, capital and labor. Their technologies are characterized by
diminishing marginal rate of technical substitution of labor for capital. At the current
operating basket, Firm As marginal rate of technical substitution of labor for capital is 3,
while Firm Bs marginal rate of technical substitution of labor for capital is 1. Do the
current production baskets satisfy the condition of input efficiency? If not, describe an
exchange of inputs that would improve efficiency.
Since the marginal rates of technical substitution are not equal for both firms, the current
production baskets do not satisfy input efficiency. Firm A would be willing to give up 3 units of
capital to get one additional unit of labor. Firm B would be willing to give up 1 unit of capital to
get 1 additional unit of labor; put another way, Firm B would be willing to give up 1 unit of
labor to get 1 additional unit of capital.
One exchange that would make both firms better off would be for Firm A to give 2 units of
capital to Firm B in exchange for 1 unit of labor. Firm A is better off (it would have been willing
to give up 3 units of capital to get 1 additional unit of labor). But what about Firm B? To get the
2 additional units of capital, it would have been willing to give up 2 units of labor; but with the
proposed exchange, Firm B only had to give up 1 unit of labor. So the proposed exchange also
makes Firm B better off.
16.17. Two firms together employ 10 units of labor (l) and 10 units of capital (k). The
marginal rate of technical substitution of each firm is given by: MRTS1lk = k1/l1 and
MRTS2lk = 4k2/l2. Which of the following input allocations satisfy the condition of input
efficiency?
a) Firm 1 uses 5 units of labor, 5 units of capital; Firm 2 uses 5 units of labor, 5 units of
capital.
b) Firm 1 uses 5 unit of labor, 8 units of capital; Firm 2 uses 5 units of labor; 2 units of
capital.
c) Firm 1 uses 9 units of labor, 9 units of capital; Firm 2 uses 1 unit of labor; 1 unit of
capital.
d) Firm 1 uses 2 units of labor; 5 units of capital; Firm 2 uses 8 units of labor; 5 units of
capital.
To satisfy input efficiency, the marginal rates of technical substitution must be equal across
firms.
a)
MRTS1 = 5/5 = 1 < MRTS2 = 4(5)/5 = 4. The allocation does not satisfy input efficiency.
b)
MRTS1 = 8/5 = 1.6 = MRTS2 = 4(2)/5 = 1.6. The allocation satisfies input efficiency.
c)
MRTS1 = 9/9 = 1 < MRTS2 = 4(1)/1 = 4. The allocation does not satisfy input efficiency.
d)
MRTS1 = 5/2 = 2.5 = MRTS2 = 4(5)/8 = 2.5. The allocation satisfies input efficiency.
Chapter 16 - 19
16.18. Two firms together employ 20 units of labor and 12 units of capital. For Firm 1,
which uses 5 units of labor and 8 units of capital, the marginal products of labor and
capital are MP1l = 20 and MP1k = 40. For Firm 2, which uses 15 units of labor and 4 units
of capital, the marginal products are MP2l = 60 and MP2k = 30.
a) Draw an Edgeworth box for inputs that shows the allocation of inputs across these two
firms.
b) Is this allocation of inputs economically efficient? Why or why not? If it is not, identify a
reallocation of inputs that would allow both firms to increase their outputs.
a)
Firm 2
12
Capital
10
8
6
4
2
0
Firm 1 0
10
15
20
Labor
b)
To satisfy input efficiency we must have

MRTS L1 , K MRTS L2, K
MPL1 MPL2
MPK1 MPK2
Substituting in the given information implies

20 60
40 30
0.5 2
Since the MRTS are not equal, the current allocation of inputs is not economically efficient.
At the current allocation, Firm 1 can trade 2 units of labor for 1 unit of capital without changing
output. By giving up one unit of labor to receive one unit of capital the firm can increase its
output. At the current allocation Firm 2 can trade 2 units of capital for one unit of labor without
affecting output. By giving up only one unit of capital in exchange for one unit of labor Firm 2
Chapter 16 - 20
can increase its output. Therefore, by reallocating one unit of capital from Firm 2 to Firm 1 and
one unit of labor from Firm 1 to Firm 2, both firms can produce more output.
16.19. Consider an economy that produces two goods: food, x, and clothing, y. Production
of both goods is characterized by constant returns to scale. Given current input prices, the
marginal cost of producing clothing is $10 per unit, while the marginal cost of producing
food is $20 per unit. What is the marginal rate of transformation of x for y? How much
clothing must the economy give up in order to get one additional unit of food?
In general equilibrium, MRTx,y = MCx / MCy = 20/10 = 2. To get one additional unit of food (x),
the economy must sacrifice 2 units of clothing (y).
16.20. An economy consists of two consumers (Julie and Carina), each consuming positive
amounts of two goods, food and clothing. Food and clothing are both produced with two
inputs, capital and labor, using technologies exhibiting constant returns to scale. The
following information is known about the current consumption and production baskets:
The marginal cost of producing food is $2, and the price of clothing is $4. The wage rate is
2/3 the rental price of capital, and the marginal product of capital in producing clothing is
3. In a general competitive equilibrium, what must be
a) The price of food?
b) The marginal rate of transformation of food for clothing?
c) The shape of the production possibilities frontier for the economy?
d) The marginal product of labor in producing clothing?
a)
In a competitive equilibrium, price must equal marginal cost for each good. Thus, the
price of food must be $2.
b)
By the same reasoning as in (a) the marginal cost of clothing must be $4.
MRTfood,clothing = MCfood / MCclothing = $2/$4 = 0.5
c)
Because all production occurs with constant returns to scale, the marginal costs will be
constant, and thus the MRTfood,clothing is always 0.5. On a graph with food on the horizontal axis
and clothing on the vertical axis, the Production Possibilities Frontier will be a straight line with
a slope of -0.5.
d)
With input efficiency, w/r = MPL/MPK ; thus, 2/3 = MPL/3. So MPL = 2.
16.21. Consider an economy that uses labor and capital to produce two goods, beer (x) and
peanuts ( y), subject to technologies that exhibit constant returns to scale. The marginal
cost of a 12-ounce can of beer is $0.50. The marginal cost of a 12-ounce tin of peanuts is
$1.00. Currently, the economy is producing 1 million 12-ounce cans of beer and 2 million
12-ounce tins of peanuts. The marginal rates of technical substitution of labor for capital in
the beer and peanut industries are the same. Moreover, there are 1 million identical
Chapter 16 - 21
consumers in the economy, each with a marginal rate of substitution of beer for peanuts
given by MRSx,y = 3y/x.
a) Sketch a graph of the economys production possibilities frontier. Identify the economys
current output on this graph.
b) Does the existing allocation satisfy substitution efficiency? Why or why not?
a)
Because the technologies exhibit constant returns to scale, the production possibilities
frontier will be a straight line with slope
MC x 0.50
MRTx , y
0.50
MC y 1.00
Here is a graph of the production possibilities frontier for this economy.
3
Current Production
Peanuts
2.5
2
1.5
1
0.5
0
0
Beer
b)
To achieve substitution efficiency we must have MRTx , y MRS x, y . At the current
allocation this implies
MCx
x
MC y 3 y
At the current allocation we have
0.50
1
1.00 3(2)
0.50 0.17
Since MRT < MRS, consumer utility would go up if more resources were devoted to beer
production (x) and less resources were devoted to peanut production (y).
16.22. The United States and Switzerland both produce automobiles and watches. The
labor required to produce a unit of each product is shown in the following table:
Chapter 16 - 22
a) Which country has an absolute advantage in the production of watches? In the

production of automobiles?
b) Which country has a comparative advantage in the production of watches? In the
production of automobiles?
a)
From the information given in the table, the U.S. has an absolute advantage in the
production of watches because the production of one watch takes only 50 hours per watch in the
U.S. compared with 60 hours per watch in Switzerland.
The U.S. also has an absolute advantage in the production of automobiles since the U.S. spends
only 5 hours per auto produced compared with 20 hours per auto in Switzerland.
b)
In the U.S. the opportunity cost of producing one watch is 10 autos. In Switzerland the
opportunity cost of producing one watch is 3 autos. Because the opportunity cost is lower for
Switzerland than the U.S., Switzerland has a comparative advantage in the production of
watches.
In the U.S. the opportunity cost of producing one auto is 1/10 of a watch. In Switzerland, the
opportunity cost of producing one auto is 1/3 of a watch. Because the opportunity cost is lower
for the U.S., the U.S. has a comparative advantage in the production of autos.
16.23. Brazil and China can produce cotton and soybeans. The labor required to produce a
unit of each product is shown in the following table:
a) Which country has an absolute advantage in the production of cotton? In the production
of soybeans?
b) Which country has a comparative advantage in the production of cotton? In the
production of soybeans?
a)
From the information given in the table, Brazil has an absolute advantage in the
production of cotton because it takes only 10 hours of labor per unit of cotton in Brazil compared
with 20 hours per unit cotton in China.
Brazil also has an absolute advantage in the production of soybeans since it spends only 80 hours
of labor per unit of soybeans compared with 100 hours per unit of soybeans in China.
Chapter 16 - 23
b)
In Brazil the opportunity cost of producing one unit of cotton is 8 soybeans. In China the
opportunity cost of producing one unit of cotton is 5 soybeans. Because the opportunity cost is
lower for China than Brazil, China has a comparative advantage in the production of cotton.
In Brazil the opportunity cost of producing one unit soybeans is 1/3 of a unit of cotton. In China,
the opportunity cost of producing one unit of soybeans is 1/5 of a unit of cotton. Because the
opportunity cost is lower for Brazil than China, Brazil has a comparative advantage in the
production of soybeans.
Chapter 16 - 24

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Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

5. What is an economically efficient allocation? How does an economically efficient

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

When the supply curve for margarine shifts to QMs PM , we have

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Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Market for Margarine

Market for Butter

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Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Market for Gasoline

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Market for Autos

410 5Pt 2Pj = 60 + 3PK , and

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

16.6. In an economy, there are 40 white-collar households, each producing 10 units of

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Thus, the allocation of inputs is not economically efficient.

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

To satisfy input efficiency we must have

Substituting in the given information implies

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

With input efficiency, w/r = MPL/MPK ; thus, 2/3 = MPL/3. So MPL = 2.

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

a) Which country has an absolute advantage in the production of watches? In the

Copyright 2014 John Wiley & Sons, Inc.

Besanko & Braeutigam Microeconomics, 5th editionSolutions Manual

Copyright 2014 John Wiley & Sons, Inc.

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