Chapter1

1.a)Itisunlikelythatseatselectioninaclassroomhelpsdetermineexamgrades.More
likely,wellpreparedstudentschoosetositinthefront,whilelesspreparedstudentsopt
forthebackoftheclassroom(perhapshopingtoavoidbeingaskedquestionsbythe
instructorduringclass.)
b)TheSuperBowldidnotdeterminethefateofthestockmarket.Thestockmarket
roseconsistentlyformanyyearswhileNationalFootballConferenceteamshappenedto
dominatetheSuperBowl.Thetwooccurrencesweresurelycoincidental,withnocausal
relationshipwhatsoever.

3.Answerswillvary.

5.a)Selfinterestisthedesiretoimproveone'slife.Itincludesthedesiretoadvanceany
goalonecaresabout,includingmany"altruistic"goals,suchashelpingthepoor.
Selfishnessisthe"excessive"concernforoneselfandone'sownadvantagewithout
regardforothers.
b)Inactionsarechoicesnotdodosomething.Inactions,likeactions,have
consequences.Forexample,ifyouchoosenottostudy,youmayfailanexam.
c)Observationandpredictionaremoredifficultineconomicsthaninchemistry
because,unlikechemists,economistsgenerallycannotobservebehaviorinalaboratory
settingwhereallrelevantenvironmentalvariablescanbecarefullycontrolled.

Economistsstudyeconomicbehaviorintherealworld,wheremanyvariablesinfluence
behaviorsimultaneously.Itisdifficultinacomplexglobaleconomytoobserveand
predictrelationshipsbetweenvariables,isolatedfromothereffects.
d)Economicsisconcernedwithreachinggeneralizationsabouthumanbehavior.Ifone
generalizesonthebasisofobservedindividualbehavior,oneriskscommittingthefallacy
ofcomposition.Generalizationsbaseduponobservedgroupbehaviorarelikelytobe
bothmorerealisticanduseful(reliable).

7.Positiveeconomicstatements:a),c),d),andf).
Normativeeconomicstatements:b)ande).

9.Thestatementillustratesthefallacyofcompositionbecauseitassumesthatwhatis
trueforanindividualistrueforeveryone.

11. Answerswillvary.Positiveeconomicstatementsaredescriptiveinnatureandare
testable.Normativeeconomicstatementsinvolvemakingvaluejudgementsandoften
usewordssuchas"should"or"ought".

Chapter2

1.

Scarce goods are those which we would like to have more of, but

given limited resources, we must make choices. The following goods

are all scarce:
c)

clothes

d)

clean air in a big city

f)

a public library

3.

The opportunity cost of an activity is always the value of the best

foregone alternative.
a)

The opportunity cost of going to college includes not just

expenses such as tuition and books, but also the lost income which
could have been earned while attending college. Room and board
expenses should not be included in the calculation of opportunity cost,
if those expenses are equivalent to that which would be incurred in the
best foregone alternative to attending college.
b)

The opportunity cost of missing a lecture includes the potential

damage to one's grade in a course from not being present while

important subject material is covered, as well as the knowledge's
foregone value in the "real world." The magnitude of the opportunity
cost depends partly on how much essential information the instructor
provides during the missed class session.

c)

The opportunity cost of withdrawing and spending $100 from

your savings account is the 5% interest which could have been earned
annually if the funds remained in the savings account.
d)

The opportunity cost of going snowboarding on the weekend

before final examinations is likely to include the value of lost study

time and possibly a lower course grade, as well as the explicit costs of
the snowboarding trip.

5.

Positive incentives are those that either increase benefits or

reduce costs and thus tend to increase the level of an activity. Both of
the following are examples of positive incentives:
b)

a trip to Hawaii paid for by your parents or significant other for

earning an A in your economics course

d)

a subsidy for installing solar panels on your house

Negative incentives either reduce benefits or increase costs, and tend

to decrease the level of the related activity or behavior. Both of the
following are examples of negative incentives:
a)

a fine for not cleaning up after your dog defecates in the park

c)

a higher tax on cigarettes and alcohol

7.

It is important that a country or region specialize in the

production of a good for which it has the lower opportunity cost in

order to make the best use of available resources. By specializing in

the production of a good for which a country has a comparative

advantage and then trading for other desirable goods, a country is able
to gain the greatest benefit from its available resources. Trade
restrictions force countries to specialize less, and thereby raises the
opportunity cost of production.

9. There is an opportunity cost even for the use of "free" online

services. The time spent chatting with people online or playing games
at Games.com could be used for some other purpose. The opportunity
cost of using these services is the best foregone use of your time.

Chapter3

1.

The three basic economic questions are:

What is to be produced?
How are these goods to be produced?
For whom are the goods produced?
Scarcity requires that these questions be addressed in some way by
every economy. Market economies answer these questions in a
decentralized way through the interaction of millions of buyers and
sellers. In command economies, decisions are made largely through
planning boards. The manner in which an economic system answers
these questions helps determine the allocation of limited resources.

3.

a)

A production possibilities curve, which applies to a specific

period of time, is drawn assuming that resources and the level of

technology are held constant.
b)

The opportunity cost of another gun, when moving from point B

to point C, is 4 units of butter. The opportunity cost of another gun,

when moving from point D to point E, is 8 units of butter.

5.

People acquire human capital though education, which adds to

the nation's ability to produce, just as is the case with additions to the
physical capital stock.

7.

The politician would be able to keep his promise if the economy

is currently operating inside the production possibilities curve. It is

then possible to have more of both schools and space stations by
better utilizing available resources. Alternatively, an advance in
technology or an increase in available resources (perhaps due to
immigration) would also make it possible to have more of both goods
by shifting the production possibilities curve in an outward direction.

9.

North Korea, at this time, more closely fits the description of a

command economy because production decisions are largely made

through central planning. Nearly all manufactured goods are produced

by state-owned enterprises.

Chapter4

1. a) Assuming that beef is a normal good, demand for beef increases

with consumer income, causing the equilibrium price and quantity
exchanged to increase.
b)

An increase in the price of beef, ceteris paribus, decreases the

quantity of beef demanded.

c)

Ceteris paribus, an outbreak of mad cow disease is likely to

decrease the demand for beef, leading to both a decrease in the

equilibrium price and the quantity of beef exchanged.
d)

An increase in the price of a substitute increases the demand for

beef. The equilibrium price and quantity of beef traded both increase.
e)

If the price of a complement, barbecue grills, increases, the

demand for beef will likely decrease. Both the equilibrium price and
quantity of beef exchanged will decrease as a result.

3.

a)

The supply of wheat will decrease due to the flood in the

Midwest, increasing the price of wheat and decreasing the equilibrium

quantity of wheat traded.
b)

If the price of corn decreases, corn farmers are likely to plant less

corn and more wheat. As a result, the supply of wheat to the

marketplace will increase, decreasing the equilibrium price of wheat
and increasing the equilibrium quantity of wheat exchanged.
c)

If the Midwest has exceptionally favorable weather, crop yields

are likely to increase. The supply curve for wheat will shift to the right,
decreasing the equilibrium price and increasing the equilibrium
quantity of wheat traded.
d)

Fertilizer is an input to the production of wheat. As a result of a

decrease in the price of fertilizer, more will be used, raising crop yields,
and the supply of wheat will increase. The equilibrium price of wheat
will decrease and the equilibrium quantity will increase.
e)

If more individuals begin growing wheat, the market supply curve

for wheat will increase. The equilibrium price of wheat will decrease
and the equilibrium quantity will increase.

5.
a)

The equilibrium price equals $4, where the quantity of baseball

tickets demanded equals the quantity of tickets supplied.

b)

The supply curve is unusual in that it is vertical at a level of

2,000 tickets.
c)

A shortage will exist if the market price is less than the $4

equilibrium price. For example, at a price of $2, there would be a

shortage of 2,000 tickets.
d)

A surplus will exist if the market price of baseball tickets exceeds

$4. For example, at a price of $6, a 1,000 ticket surplus will occur. At
a price of $8, a 1,500 ticket surplus will occur.
e)

Next year's demand curve will shift to the right. The new

equilibrium price of baseball tickets increases to $6, where the new

quantity demanded (1,000 + 1,000) equals the 2,000 seat stadium
capacity.

7.

a) If the price of cell phones falls, it will increase the quantity of

cell phones demanded, ceteris paribus.

b) Assuming that cell phones are normal goods, an increase in income
will increase the demand for cell phones (and therefore the equilibrium
price and quantity exchanged.)
c) An increase in the price of cell phone service (a complement) will
decrease the demand for cell phones, reducing both their price and the
quantity exchanged.

d) An increase in the price of pagers (a substitute) will also increase

the demand for cell phones, increasing both the price and the quantity
exchanged.

9.

A price floor set above the equilibrium price for dairy products

would result in a surplus. A price floor set below the equilibrium price
would have no impact on the price or quantity of dairy products traded.
(A price floor is a minimum allowed price, not a mandated market
price.)

11.
Even though the tuition "price" is the same in both cases, student
demand for 10 a.m. classes is typically greater than for 8 a.m. classes.
College students often prefer to sleep in later than punctual
attendance at an 8 a.m. class would allow. A shortage of 10 a.m. class
space relative to demand is the likely result. There may exist a surplus
of class space in 8 a.m. courses if the demand for early morning
classes is sufficiently low.

Chapter5

1.

If the elasticity of demand is estimated to equal -1.6, then

demand is relatively elastic. A decrease in ticket prices would increase

the quantity of tickets demanded sufficiently to increase the overall
revenue from ticket sales. If the elasticity of demand is estimated to
equal -0.4, then demand is relatively inelastic. In this case, an increase
in ticket prices would boost the revenue from ticket sales.

3.
a)

substitutes

b)

complements

5.

If the price increases by 10%, quantity demanded will fall by 15%

when the elasticity of demand for hamburgers equals -1.5. Hamburger

sales will decline by approximately 6,000. If the price of hamburgers
decreases by 5%, then quantity demanded will increase by 7.5%, or by
3,000 hamburgers.

7.

If a price is chosen along the elastic portion of a downward-

sloping linear demand curve, reductions in price will increase total

revenue. If a price is chosen along the inelastic portion of a downwardsloping linear demand curve, increases in price will boost total
revenue. A firm seeking to maximize total revenue should reduce price
until it is no longer operating on the elastic portion of the demand

curve and increase price until it is out of the inelastic range. That
leaves the unit elastic point along a linear demand curve. The price
that corresponds to the unit elastic point is the price at which total
revenue is maximized.

9.

If the goal is to increase tax revenue, good markets to tax are

those for which demand is relatively inelastic, such as the markets for
alcohol and gasoline.

11.

If gasoline prices are projected to temporarily increase or

decrease in the near future, your short-term consumption is unlikely to

change a great deal. You may try to fill your gas tank shortly before
prices increase or delay filling your tank until prices decrease. Once a
gasoline price increase does take effect, you might combine errands so
as to reduce driving time or consider taking the bus to work. Over the
long term, people have more time to adjust their consumption of
gasoline--by organizing car pools or purchasing more fuel-efficient cars,
for example, or even moving where they work or live.

Chapter6

1.

According to the rule of rational choice, a diner should continue

eating as long as the marginal benefit of an additional helping exceeds

the marginal cost of that helping. The marginal cost of the first helping
of food is $9.95. Once $9.95 is paid for the All-You-Can-Eat meal, the
marginal dollar cost of an additional helping equals zero. (The
marginal cost to one's health from eating additional portions may
exceed zero, however.) Food consumption should continue until the
marginal benefit of an additional helping just equals zero (or until the
marginal benefit just equals the expected marginal cost to one's
health). The optimal level of food consumption is likely to yield more
than $9.95 worth of total satisfaction. It is expected that the marginal
utility of successive helpings will diminish as consumption increases.

3.

The marginal utility per dollar derived from soda equals 6 utils

per dollar, while the marginal utility derived from pizza consumption
equals 2 utils per dollar (4 utils/$2). Since the satisfaction per dollar
derived from the last can of soda consumed exceeds the satisfaction
per dollar derived from the last slice of pizza, Brandy should purchase
more soda and less pizza. As Brandy consumes more soda, the
marginal utility per dollar spent on soda will fall (since marginal utility
will diminish). As less pizza is consumed, the marginal utility per dollar
spent on pizza will increase (since the marginal utility derived from
pizza will increase).

5.
When a price ceiling is imposed below equilibrium price in the natural
gas market, producer surplus declines. Consumers may either gain or
lose surplus overall. Consumers who are able to buy output benefit
from paying a lower price, increasing consumer surplus. However, the
quantity of output supplied to the market will decline, . Some buyers
will not be able to purchase output, despite their willingness-to-pay. A
deadweight loss (illustrated above) results from the imposition of a
price ceiling below equilibrium price, since units are not produced
which consumers value in excess of what it costs to produce them.

7.
If the demand for apples increased from D1 to D2 in the diagram above
as a result of a news story that highlighted the health benefits of two
apples a day, producer surplus would increase as indicated.

9.
A deadweight loss occurs due to a subsidy (as indicated above)
because producers have a private incentive to produce more than the
socially efficient level of output at Q*. As a result, units are
manufactured (between Q* and Q1) which consumers value less than

what it costs to produce them, leading to a deadweight loss from overexpanding output.

Chapter7

1.

Propertyrightsgiveindividualsthepowertouse,sell,rent,disposeof,orenhance

thevalueoftheirresources.Ifthoserightsarenotrespectedandenforcedwithregardto
bicycleownership,thenpeoplewouldbelesswillingtopurchasebicycles.Notonly
wouldbicycletheftresultinaredistributionofincomefromvictimstothieves,butaless
thansociallyefficientquantityofbicycleswouldbeproduceandexchanged.Awelfare
lossforsocietywouldresult.

3.

Positiveexternalities:

b)

youaregivenaflushot.

d)

acollegefraternityandsororitycleanuptrashalongatwomilestretchonthe

highway.
Negativeexternalities:
a)

duringalivetheaterperformance,anaudiencememberscellphoneloudlyrings.

e)

afirmdumpschemicalwasteintoalocalwaterreservoir.

f)

thepersondownthehallinyourdormplaysaBrittanySpearsCDloudlywhile

youaretryingtosleep
Noexternalities:

c)

youpurchaseanddrinkasodaduringabreakfromclass.

5.

Thegovernmentmustassessthebenefitsandcoststothepublicofsuchprojects.

However,itisdifficultinpracticetoascertainthetruebenefitsandcoststointerested
parties.Interestedpartieshaveanincentivetoexaggeratethetruebenefitorharm
involvedinordertoswaythegovernment'sdecision.Ultimately,thegovernmentmust
makeaneducatedguessastotheappropriatelevelofapublicgoodtoprovide.

7.

Anindividualmighthavetohirechemiststoanalyzefoodcontentandascertain

itsnutritionalvalue.Ifmanyindividualsdidlikewise,itwouldresultinaninefficient
duplicationofresearch.Consumerscouldbandtogetherandjointlyfinanceresearch
aboutthecontentoffoodproducts.However,itwouldbedifficultinpracticetoprevent
freeridersfrombenefitingfromsuchresearchefforts.Alessthansociallyefficientlevel
ofinformationgatheringisthelikelyresult.Thegovernmentcanovercomemanyof
thesedifficultiesbycompellingthedisclosureofsuchinformationbymanufacturers
directly.

9.

Ifinsurancecompaniescannotidentifysmokersfromnonsmokers,thenasingle

ratemustbechargedtoindividualsinbothgroups.Smokersarelikelytotakeoutmore
insurancecoveragethannonsmokerssincetheyfacegreaterhealthrisksfromsmoking
relateddiseasesbutnohigherinsurancerates.Anadverseselectionproblemresults.

11.

Inmanynations,themajorityvoteoflegislatorsorcitizensdetermineshowtax

revenuesarespent.Asataxpayer,youmaybeforcedtopayforgoodsandservicesyou
wouldprefernottocontributetowards.Thegovernment'spowertocompelpaymentcan
bebeneficial,asithelpstoovercomethefreeriderproblemassociatedwithpublicgoods.

13.

Answerswillvary.Theexternalcostsimposedonthirdpartiesduetoair

pollutioninWashingtonstate(orMontanaandWyoming)aregenerallylessthanthe
externalcostsimposedonothersinCalifornia,wheretheairismorepollutedandposes
greaterhealthrisks.MorerestrictivesmogrequirementsmaybenecessaryinCalifornia
inordertobetterinternalizethemoreextensivenegativeexternalities.
Chapter8

1.

Since the opportunity cost (foregone alternative) of using your

land triples, the cost of using your land to grow strawberries will
increase.

3.
a)

The marginal product of the seventh worker equals 6 units of

output.
b)
hired.

The law of diminishing product begins with the fifth worker is

c)

A firm would never choose to hire 9 workers, since the marginal

product of the ninth worker is negative.

5.

Marginal costs will increase by as much as 50% when workers

must be paid time-and-a-half beyond an eight-hour day. (If labor is the

only variable input, marginal cost will increase by exactly 50%.) If
workers are less productive after 8 hours of work, marginal costs will
be even higher beyond 8 hours of work.

7.

Your choice will affect your fixed and variable costs. If you

choose to pay the flat fee, your fixed costs for the film will equal
$5,000 for the week. Your variable costs associated with the leasing of
the film would then equal zero. If you choose to pay $2 per customer,
then the costs associated with leasing the film will be all variable.

9.

In the long run, a food service company can vary the size of the

kitchen and its food preparation equipment. When cooking for a large
number of students, food preparers can utilize mass production
techniques to cook large quantities of food at each meal. Food
preparers can specialize at particular culinary tasks and thereby
become more proficient at them. As a result, the average total cost of
producing meals is likely to decrease in the long run as the number of
students served increases.

Chapter 10
1. a) Although many actresses compete for acting roles, in some
sense an actress like Kate Hudson has a monopoly over her own
special talents.
b) The diamond market is not a pure monopoly. However, the
DeBeers company does possess significant monopoly power since it
controls 75% of the world's output of diamonds.
c) The only doctor in a small town has a local monopoly over physician
services. Such a doctor's monopoly power is likely to be limited,
however, if physicians are available in nearby towns.
d) Ford Motor Company would not be considered a monopoly.

3. It is not optimal for a monopolist to operate on the inelastic portion

of the demand curve. When demand is inelastic, quantity demanded
changes by a smaller percentage than does the price. As a result, a
monopolist could increase total revenue simply by reducing output and
raising price. At the same time, reducing output reduces total
production costs. If revenue rises and costs fall when output is
reduced, profit increases. Therefore, a profit-maximizing monopolist
should increase price until it is no longer operating in the inelastic
portion of the demand curve.

5. There is a welfare loss associated with monopoly because the

monopolist produces at a level of output such that price is greater than
marginal cost. The marginal value to society of the last unit produced
is greater than its marginal cost. The monopolist is not producing
enough of the good from society's perspective. There would be no
welfare loss if a price discriminating monopolist were able to perfectly
price discriminate, because the monopolist would sell units until price
just equals the marginal cost, charging each customer the maximum
price he is willing to pay.

7. A profit-maximizing simple monopolist will continue to produce

output as long as marginal revenue exceeds marginal cost, provided
that price exceeds average variable cost. To find marginal revenue,
first obtain total revenue by multiplying price times quantity at each
level of output. Marginal revenue is the change in total revenue from
selling one more unit of output. To find marginal cost, first obtain the
total cost by summing fixed cost and variable cost at each output level.
Marginal cost is the change in total cost from selling one more unit of
output. The firm's marginal revenue and marginal cost at each level of
output are as follows:

Output
1

Marginal RevenueMarginal Cost

$90

$25

$70

$15

$50

$10

$30

$20

$10

$30

-$10

$40

-$30

$50

-$50

$60

The firm should produce four units of output. It would not be profitmaximizing to produce a fifth unit of output, since marginal cost
exceeds marginal revenue for the fifth unit of output.

9. If the differences in prices to people with different hair lengths

reflects differences in the cost of providing a permanent, then it is not
price discrimination.

11. a) Students demand for movie tickets tends to be more elastic

than for the average individual. To entice students to the movie
theater more frequently, theaters offer discounts to students who can
show a student ID.
b) The long distance service is practicing price discrimination by
offering lower rates to those who make longer calls than to those who

make very short calls. This type of quantity discount is a form of price
discrimination.
c) The psychic attempts to perfectly price discriminate by charging
individuals the maximum price each is willing to pay for a reading.
d) Seniors, who often live on fixed incomes and have more "free time"
to search for good deals, tend to have more elastic demands for many
goods and services. Local restaurants offer discounts to seniors to
attract them to their restaurants (often restricting them to "early bird"
times, so seniors don't crowd out regular price dinner customers at the
peak demand period).
e) Coupon discounts are only offered to those individuals who are
willing to take the time and effort to locate, clip, and bring the laundry
detergent coupon to the store. People whose demand for laundry
detergent is relatively elastic are more likely to clip and organize
coupons than are those with relatively inelastic demand. The use of
coupons separates customers into groups with different elasticities of
demand charging different groups different effective prices.

13. There is no welfare loss when a firm is able to perfectly price

discriminate. A perfect price discriminator sells units until price just
equals the marginal cost, charging each customer the maximum price
he is willing to pay. Since for the last unit sold price equals marginal
cost, there is no welfare loss. In the case of simple monopoly,

however, the monopolist restricts output below the socially efficient

level and charges a price in excess of marginal cost for the last unit
sold.

Chapter 11
1. a) A highly organized agricultural market such as for soybeans,
where there are a large number of sellers producing homogeneous
products, most closely resembles perfect competition.
b) The retail clothing market tends to be monopolistically competitive,
where a large number of sellers produce differentiated products.
c) & d) The U.S. postal service and local cable service are monopolistic
markets, where a single seller operates and is able to influence the
market price.
e) Restaurants, such as the famous Spago Beverly Hills, compete in
monopolistically competitive markets. Restaurants differentiate their
services by location, dcor, cuisine, etc.

3. Answers will vary. One's choice of gas stations may be based upon
the price of gasoline, location, services and amenities offered, the
quality of gas, brand identity, etc.

5. Some restaurants are more successful at differentiating their

establishments and appealing to customers than are others.

Restaurants which are particularly successful in promoting customer

goodwill may continue to earn economic profits even while other
restaurants in the area fail.

7. The corner barber shop services clients in a limited area. Many

people are aware of the barbershop because it is local and they
patronize local barbershops for the sake of convenience. Advertising is
unlikely to attract a significant number of people from a different part
of town to a particular barber shop. Toys R Us and Office Depot, on the
other hand, which offer a large variety of products, are national chain
stores which stand to benefit much more from advertising. Advertising
may significantly increase the customer base of Toys R Us and Office
Depot by attracting people who do not live in the vicinity of their
stores.

9. Answers will vary. Certainly not all individuals will respond to each
and every advertisement. By advertising, a firm hopes it can both
increase demand and make it more inelastic, thereby enhancing
profits. Critics of advertising argue that advertisers attempt to
manipulate preferences and engender brand loyalty to reduce
competition. Defenders of advertising argue that production costs can
be reduced if substantial economies of scale exist. Also, by raising
consumer awareness of substitute products, advertising can help

increase the competitiveness within markets and lead to lower prices.

Advertising may be considered a "waste" by someone who always
knows which good he wants, but advertising would not be employed by
sellers who do not think it would increase demand sufficiently to make
it profitable.

Chapter 12

1. The following markets are oligopolistic: b) funeral services, c)

airline travel, e) oil, and f) breakfast cereals.

3. Since the market for wheat is highly competitive, it is unlikely that

the Smith-Jones cartel will be at all successful or have any impact on
the price of wheat. There are too many good substitutes available for
the wheat produced by Farmers Smith and Jones. If Smith and Jones
choose to restrict their combined output, their profits will in all
likelihood fall, with virtually no effect on the market price.

5. Unlike perfectly competitive firms, oligopolists can earn economic

profits in the long run if barriers to entry are sufficiently high to deter
new firms from entering the market.

7. Each of the following are barriers to entry: b) copyrights, c) a

monopoly over crucial inputs, d) economies of scale, and f) an
exclusive government license. If an existing firm had any of these
advantages, there would be barriers to entry.

9. It is possible for students to collude and all write down the same
answers on the take-home final, "earning" each an A in the course. It
is possible for students to each earn an A even with little effort put
forth in answering the exam questions, as long as all of the students
write down the exact same answers and if the answers are consistently
graded. However, if it is believed that even one person will choose not
to abide by such an agreement or the answers will not be consistently
graded, then the collusive agreement is likely to fail. If even one
person were to put in genuine effort in answering the exam questions,
while the rest of the class did not, then it is possible that most of the
class would receive a poor exam grade. Faced with this prospect,
students may find it difficult to collude successfully.

Chapter 13
1. Characteristics of sole proprietorships: c) Unlimited liability.
Characteristics of partnerships: c) Unlimited liability and d) shared
ownership among multiple individuals.

Characteristics of corporations: a) Double taxation, b) relative ease of

transferring ownership, d) limited liability, and e) shared ownership
among multiple individuals.

3. The pay of managers could be structured so that it depends on the

profitability of the firm. By awarding managers shares of stock and/or
options to buy stock, or bonuses which depend on the firm's
profitability, a board of directors can ensure that the interests of
managers are more closely tied to the interests of shareholders.

5. Answers will vary by date.

7. No answer.

9. Answers will vary. First steps may including choosing a legal

structure, identifying the competition, obtaining insurance coverage,
choosing a location, naming the business, obtaining necessary supplies
and equipment, etc.

Chapter 14

1. Quantity of Labor

Total Output Marginal Product of Labor

Value of Marginal Product of Labor

@TB: 0

250

$1,000

350

$1400

300

$1200

225

$900

175

$700

150

$600

110

$440

250

600

900

1125

1300

1450

1560

3. The demand curve for labor shifts to the right when the equilibrium
price of output increases.

5. The equilibrium wage would tend to decrease if a company provided

on-the-job training and health benefits to its workers (since part of the

compensation to employees would come in the form of these benefits.)

If the government mandated a minimum wage of $9 per hour,
employers would likely reduce benefits such as health insurance and
on-the-job training in response.

7. The demand for unskilled labor, used to produce hamburgers and

fries, would increase as well.

9. One reason is that there is a great demand for the services of

professional athletes. Lots of people are willing to pay high prices to
see their favorite sports stars perform. The second reason that
professional athletes, and not teachers, command such a large amount
of compensation, is that extremely talented athletes are in highly
limited supply.

11. The best engineering professors will likely consider leaving Middle
State in order to earn higher salaries elsewhere. At the same time,
more poetry professors are likely to apply for positions at Middle State
than would be true of other universities. As a result, the quality of the
engineering department is likely to decline, and the quality of the
poetry department is likely to increase.

13. Answers will vary. Factors contributing to the difference in

earnings include the availability of labor with particular skills and
expertise, the demand for labor with particular skills and expertise, and
the productivity of labor.

Chapter 15
1. a) A massive influx of low-skilled immigrants would increase the
proportion of the overall population earning low-incomes.
b) In the event of a baby boom, some individuals would opt to become
full-time parents, transforming two-income families into single-income
families. This would tend to reduce the proportion of the population in
high income quintiles and increase the proportion in the low-income
quintiles.
c) When the babies in b) enter their twenties and begin working, the
proportion of the population in low-income quintiles will likely increase
(since young workers earn lower incomes on average then middle-aged
workers).
d) When the babies in b) reach age 65 or older, again the proportion
of the population in low-income quintiles will increase (since retirees
earn lower incomes on average than middle-aged workers).

3. A significant reduction in the divorce rate would increase the

proportion of families in higher income brackets, as fewer households
would become single parent and single-income households.

5. Answers will vary. The highest ten percent of income earners in

Denmark receives a significantly less share of total income than does
the highest ten percent of income earners in Guatemala. Middle
income groups in Denmark also seem to fare better than middleincome groups in Guatemala. The lowest ten percent of the population
in Denmark receives a larger share of total income than does the
lowest ten percent of the population in Guatemala..

7. If the selling of kidneys were legalized, more kidneys would be

supplied to the market. As a result, it would be easier to obtain a
kidney transplant. The supply of kidneys would increase because
people only need one kidney to survive. For a sufficiently high price,
some individuals would likely be willing to sell a kidney.

9. Answers will vary. These queries fall into the realm of normative
analysis because they involve making value judgments.

Chapter 16

1. If the steel company is not held liable for dumping crud into the air,
it will only consider the $25 labor costs and the $10 equipment costs.

3. The firm should reduce its emissions at a cost of $30 per ton and
sell its permits for $40 per ton. It would profit $10 per ton of emissions
which are reduced as a result.

5. A change in the law is not necessary to achieve an efficient

outcome in this situation. If the resort owner and chemical factory
could reach an agreement whereby the resort owner compensates the
chemical factory for hauling the pollution to the toxic waste dump, the
socially efficient outcome could be achieved. Since the damage to the
resort owner exceeds the cost of hauling the pollution to the toxic
waste dump site, this is a possibility, as long as the property rights are
clearly defined and the cost of negotiating and transacting is low
enough.

7. A pollution reduction program which relies on emissions standards

would force firms to limit pollution levels, regardless of the cost of
doing so. With an emissions permit program, firms which can reduce
pollution levels at relatively low marginal cost can sell their permits to
firms which can reduce pollution levels only at higher marginal costs.

The same level of pollution reduction can be achieved with either

program, however, the latter program would achieve the reduction in
pollution at lower cost to society.

9.
As indicated above, a subsidy of $s to firms using recycled materials,
would shift the demand curve for recycled materials vertically by the
amount of the subsidy. As a result of this increase in demand, the
equilibrium price of recycled materials would increase, although by less
than the amount of the subsidy. The equilibrium quantity of recycled
materials would increase as well. The total cost of the government
subsidy program, $s x Q2 units, is the shaded region.

11. From the perspective of social efficiency, water pollution should be

reduced as long as the marginal benefit of pollution reduction exceeds
the marginal cost of achieving that reduction. The socially efficient
level of water pollution will exceed a level of zero contaminants, as
long as achieving zero pollution is too costly on the margin to be
worthwhile.

13. Answers will vary. If rules are too stringent, then the marginal
cost of achieving cleaner air may exceed the marginal benefit of doing
so.

Chapter 17
1. a) Sam is a discouraged worker who is not actively seeking work,
and therefore not considered unemployed.
b) The fourteen year old is under 16 years of age and not considered
part of the labor force.
d) The receptionist is considered employed, even though she would
like to work more hours each week.
e) The high school graduate is not actively seeking work, and
therefore not considered unemployed.
An economist would consider the following individuals unemployed:
c) A factory worker is temporarily laid off but expects to be called back
to work soon.

3. The civilian labor force equals the number of persons employed

plus the number of persons unemployed, which equals 95 million
persons. The unemployment rate equals the number of people
unemployed, divided by the civilian labor force, which equals 15
million/95 million, or approximately 15.8 percent.

5. If union bargaining raises the union wage above the equilibrium

level, the quantity of unionized labor demanded will decrease and the
quantity of unionized labor supplied will increase. Some union workers

will be unemployed as a result and will either seek nonunion work or

wait to be rehired in the union sector. Union workers that are still
employed are better off due to their higher earnings.

7. If the slowing of the rate of inflation is unexpected, then there is a

redistribution of income from borrowers to lenders (assuming the
borrowers do not default on their loans as a result). If the slowing of
the rate of inflation is fully anticipated at the time the loan is taken out,
then there is no redistribution of income associated with the student
loan.

9. It is likely that such legislation would result in greater

unemployment in that particular district's hotel and shopping industry.
An increase in the minimum wage both increases the quantity of labor
supplied and decreases the quantity of labor demanded. The
unemployment rate in neighboring areas is likely to fall, as fewer
workers move to and seek employment in those regions.

Chapter 18

1. The following are including in GDP calculations:

a) cleaning services performed by Molly Maid corporation

d) prescription drugs manufactured in the U.S. and sold at a local

pharmacy
g) toxic waste cleanup performed by a local company
h) car parts manufactured in the United States for assembly of a car in
Mexico

3. When Ford Motor Company buys tires to put on a vehicle that it

manufactures, the tires are considered to be intermediate goods. Only
final goods, goods which are ready for their designated ultimate use,
are included in GDP statistics. Tires purchased by consumers to
replace worn ones represent final goods and are therefore included in
GDP.

5. One cannot say that production has increased in Nowhereland from

1999 to 2000 by just looking at nominal GDP. Production may have
increased. However, nominal GDP could increase due to inflation while
production were to remain unchanged (as would be the case with a 20
percent inflation rate) or even decrease (with a greater than 20
percent inflation rate).

7.
Year

Nominal GDP

1996

($7,200 billion/100)x100 = $7,200 billion

1997

($7,500 billion/102)x100 = approximately $7,353 billion

1998

($8,000 billion/110)x100 = approximately $7,273 billion

1999

($9,000 billion/114)x100 = approximately $7,895 billion

2000

($9,600 billion/120)x100 = $8,000 billion

9.
Year

Real GDP per capita

1980

$4,000 million/1.25 million = $3,200

1990

$6,750 million/1.6 million = approximately $4,219

2000

$9,000 million/1.8 million = $5,000

Real GDP per capita is increasing over time.

Chapter 19

1. e) The annual percentage change in real GDP per capita best

measures economic growth.

3. When capital goods are manufactured in the current period, the

ability to produce and consume in future periods is enhanced. So
when a choice is made in the current period between producing
consumer goods and capital goods, it represents a tradeoff between
present and future consumption.

5. Using the rule of 70:

a) 7 years
b) 14 years
c) 35 years
d) 140 years

7. Labor is the physical and/or mental effort used to produce goods

and services. Human capital is the investment in education or on-thejob training or experience.

9. An increase in the population will increase the size of the labor

force, in addition to increasing the number of mouths in an economy to
feed. With a larger labor force, more output, including food, can be
produced. Also, additions to human and physical capital, as well as
technological progress, increase the standard of living and the ability of
a nation to feed its people over time.

11. Answers will vary by year.

Information available as of 2001:
United States
GDP - per capita: purchasing power parity - $33,900 (1999 est.)
GDP - real growth rate: 4.1% (1999 est.)

Life expectancy at birth:

total population: 77.12 years
male: 74.24 years
female: 79.9 years (2000 est.)
Birth rate: 14.2 births/1,000 population (2000 est.)

Death rate: 8.7 deaths/1,000 population (2000 est.)

Literacy:
definition: age 15 and over can read and write
total population: 97%
male: 97%
female: 97% (1979 est.)
Thailand
GDP - per capita: purchasing power parity - $6,400 (1999 est.)
GDP - real growth rate: 4% (1999 est.)

Life expectancy at birth:

total population: 68.55 years
male: 65.29 years
female: 71.97 years (2000 est.)
Birth rate: 16.86 births/1,000 population (2000 est.)

Death rate: 7.53 deaths/1,000 population (2000 est.)

Literacy:
definition: age 15 and over can read and write
total population: 93.8%
male: 96%
female: 91.6% (1995 est.)
Haiti
GDP - per capita: purchasing power parity - $1,340 (1999 est.)
GDP - real growth rate: 2.4% (1999 est.)
Life expectancy at birth:
total population: 49.21 years
male: 47.46 years
female: 51.06 years (2000 est.)

Birth rate: 31.97 births/1,000 population (2000 est.)

Death rate: 15.13 deaths/1,000 population (2000 est.)

Literacy:
definition: age 15 and over can read and write
total population: 45%
male: 48%
female: 42.2% (1995 est.)
Economic growth tends to decrease both birth and death rates and
increase the literacy rate.

Chapter 20

1. This behavior illustrates the permanent income hypothesis, which

asserts that people consume on the basis of lifetime income
expectations, which are only partly determined by current income.

3. The statement is correct. A higher price level reduces the quantity

of goods and services which can be purchased with a U.S. dollar.
Exports will decrease, since a higher U.S. price level makes it relatively
more expensive for foreign consumers to purchase U.S. goods. At the
same time, imports will increase, since, faced with higher prices at
home, more U.S. residents will buy imported goods. Net exports, and
therefore real GDP demanded, decrease.

5. Of the choices available, only b), an increase in taxes, both

decreases consumption and shifts the aggregate demand curve to the
left.

7. a) Exports; aggregate demand will shift to the right.

b) Investment and consumption; aggregate demand will shift to the
right.

c) Consumption and investment; aggregate demand will shift to the

right.
d) Investment; aggregate demand will shift to the right.
e) Consumption; aggregate demand will shift to the left.

9. Answers will vary by date. When capacity utilization rates trend

upward (downward), investment and aggregate demand are likely to
increase (decrease).

Chapter 21

1. This is an example of the misperception effect. The misperception

effect implies an upward sloping supply curve.

3. a) shift LRAS to the right

b) shift LRAS to the right
c) no effect on LRAS unless it reflects permanent changes in the supply
of labor
d) shift LRAS to the left

5. Output increases; unemployment decreases; the price level

increases.

7. Cost-push inflation occurs when the short-run aggregate supply

curve shifts to the left, pushing up prices. Demand-pull inflation occurs
when the aggregate demand curve shifts to the right, pulling up prices.
Examples will vary. Cost-push inflation may be caused by an increase
in input prices, such as the price of crude oil or wages. Demand-pull
inflation may be caused by an increase in consumer confidence or a
decrease in taxes.

9. Yes, an economy may operate above full employment in the shortrun by using its resources more intensively. Firms encourage workers
to work overtime, extend the hours of part-time workers, hire recently
retired employees, or reduce frictional unemployment through more
extensive searches for employees. However, this level of output and
employment cannot be sustained in the long run.

Chapter 22

1.a)4
b)5
c)2.5

3.Anincreaseinspendingby$100billion;anincreaseinspendingby$133.3billion.

5.
Whentheeconomyisoperatingabovefullemployment,asdepictedabove,ataxcut
increasesdisposableincome,shiftingaggregatedemandtotheright,fromAD1toAD2.
Asaresult,,theexistingexpansionarygapandthepricelevelbothincrease.Sucha
policymaybeimprudent,becauseitcreatesinflation.However,supplysidereconomists
arguethattaxcutscanalsofosterlongtermeconomicgrowthbystimulatingpersonal
income,savings,andcapitalformation.Accordingtothisview,ataxcutalsoincreases
theleveloffullemploymentoutput,shiftingthelongrunandshortrunaggregatesupply
curvestotheright.Conceivably,ifthesupplysideeffectislargeenough,itmayreduce
orcompletelyoffsetanyinflationcausedbythedemandsidestimulus.

7.a)Unemploymentcompensationpaymentsdecrease.
b)Welfarepaymentsdecrease.
c)Incometaxreceiptsincrease.
d)Thegovernmentbudgetdeficit(surplus)decreases(increases).

9.Ifanewtaxsystemeliminatedalldeductionsandtaxshelters,therewouldbefewer
opportunitiestoengageintaxavoidance,reducingtheincentivetoengageinsuch
behavior.Theincentivetoworkbyaparticularindividualcouldeitherincreaseor

decrease,dependingonwhetherone'smarginaltaxrateswerehigherorlowerafterthe
changeinthetaxcode.

Chapter23

1.Aneconomicsprofessormayfinditdifficulttolocateatradingpartnerwillingto
listentoeconomicslecturesorreceiveeconomicadviceinexchangeforanewcar.
Theremaybesignificantsearchcostsinvolvedinlocatingsuchatradingpartner.The
professormighthavetoprovidelecturesinexchangeforgoodswhicharenotdesired,
hopingultimately,afterperhapsaseriesoftrades,tobeabletoobtainanewcar.

3.a)atraveler'scheck
b)asixmonthTreasurybill
c)ademanddeposit
d)asavingsaccount

5.a)10
b)50
c)5
d)12.5

7.Thevalueofthemoneymultiplierwouldequalone.Bankswouldnotbeableto
createmoneyinsuchacase,becausetheywouldbeunabletoissueloansusingcustomer
deposits,andtherebygeneratenewdemanddepositaccounts.

9.Yes,accountsattwodifferentFDICinsuredbanksareeachinsuredupto$100,000.
Multipleaccountsatthesameinstitution(includingbranchoffices)areonlyinsuredfor
$100,000.

Chapter24

1.ThefollowingarefunctionsoftheFederalReserveBank:
b)supervisememberbankinginstitutions
d)provideasystemforcheckclearing
e)regulatethemoneysupply
f)loanmoneytomemberbanks
g)actasthebankfortheU.S.government

3.$200million($10millionx1/.05);$40million($10millionx1/.25).

5.Requiredreservesdecreaseto$50,000andexcessreservestemporarilyincreasefrom
$0to$50,000.IftheBankofArizonaloansoutthe$50,000inexcessreserves,the
moneysupplycanchangebyasmuchas$1,000,000($50,000x1/.05).

7.a)assetmotive
b)precautionarymotive
c)transactionmotive
d)precautionarymotive

9.Answersmayvary.AnappropriateuseoftheFederalReserveBank'stoolsduringthe
GreatDepressionmayhaveincludedadecreaseintherequiredreserveratio,adecrease
inthediscountrate,andapurchaseofbondsbytheFederalReserveBank.Allofthese
policieswouldstimulatetheeconomyandencouragespending,shiftingtheaggregate
demandcurvetotheright.

Chapter25

1.Acentralbankcanfoolpeoplebyconductingmonetarypolicythatisinflationary,for
example,whenpeopleareexpectingnoinflation.Employeesmaysignwagecontracts
whichfixthenominalwagespaidoverthedurationofthecontracts.Ifoutputpricesrise

asaresultofexpansionarymonetarypolicy,butmoneywagesremainfixed,realwages
fall.Atthelowerrealwage,fewerpeoplewillbeunemployed,becausethelowerreal
wageratemakesitprofitabletohiremore,nowcheaper,employeesthanbefore.Ifpeople
begintoanticipatefuturemonetarypolicycorrectly,thennominalwageswmilladjust
accordingly.Forexample,employeeswilldemandhighernominalwagestocompensate
fortheincreasedcostoflivingduetoinflation.Ifnominalwagesriseatthesamerateas
dooutputprices,thenrealwagesremainconstantandtheunemploymentratewillbe
unaffectedbythemonetarypolicychanges.

3.
a.decreaseasaresultofanincreaseinthemoneysupply
b.increaseasaresultofadecreaseinthemoneysupply
c.increaseasaresultofadecreaseinthemoneysupply

5.Costoflivingadjustmentsincreasenominalwageswhentheeconomyexperiences
inflation.Consequently,realwagesandtheunemploymentratedonotchangeasmuch
aswouldotherwisebeexpectedasaresultoftheconductofmonetarypolicy.

7.Howwouldeachofthefollowinglikelyaffectaggregatesupplyandemploymentin
themacroeconomy?
a.increaseaggregatesupplyintheshortrunandinthelongrun,foragivenlevelof
employment

b.decreaseaggregatesupplyandemploymentintheshortrun;littleornoeffectinthe
longrun
c.increaseaggregatesupplyforagivenlevelofemployment(byincreasingthe
productivityoflabor)intheshortrunandthelongrun

9.Economistswhobelievethatpeopleformrationalexpectationsaremorelikelytofavor
discretionarymonetarypolicyoverfixedmonetarypolicyrules.Rationalexpectations
theoristsbelievethatwhenpolicytargetsbecomepublic,thatpeoplealtertheirbehavior
fromwhatitotherwisewouldhavebeeninordertomaximizetheirownutility.Asa
result,theintendedimpactofpolicychangesisnegated.Inthisview,discretionary
monetarypolicywouldbefullyanticipatedbyconsumersandworkersandthereforefail
toachievetheintendedgoals.Rationalexpectationstheoristsbelievethatinordertohave
thedesiredeffect,thepublicmustbecaughtbysurprisebypolicychanges.Discretionary
monetarypolicyhasthepotentialtoimpacttheeconomyinthedesiredfashion,butonly
ifthepublicisunabletofullyanticipatesuchmonetarypolicyactions.

11.Inyearswhereworkerproductivitygrowthdeclined,suchasintheearly1970s,the
U.S.economyexperiencedadversesupplyshocks.

Chapter26

1.CountryBhasacomparativeadvantageovertheproductionofgoodXbecauseits
opportunitycostofproducing1unitofgoodXisonly1.5unitsofgoodYversus2units
ofgoodYincountryA.CountryAhasacomparativeadvantageintheproductionof
goodY.

3.Thestatementisfalse.Evensmalldevelopingcountrieswhichdonotpossessan
absoluteadvantageintheproductionofanygoodsorservicescanbenefitfrom
specializationandinternationaltrade.Allthatacountryneedstobenefitfrom
specializationandtradeistopossessacomparativeadvantageintheproductionofat
leastonegoodorservice.Thereisnoreasontoproduceallgoodsdomesticallyinan
attempttobeselfsufficientifgoodscanbeobtainedatloweropportunitycostthrough
trade.

5.Theimpositionofatariffresultsinalossofconsumersurpluswhichisgreaterthanthe
gaintodomesticproducers(intheformofproducersurplus)andtothegovernment(in
theformoftaxrevenue.).

7.ManylaborgroupswereopposedtoNAFTAbecausethetradeagreementwill
graduallyeliminateprotectionistpolicieswhichprotectjobsincertainsectorsofthe
economy.Mexico,withitslargepooloflowskilledandsemiskilledlabor,hasa
comparativeadvantageintheproductionofmanymanufacturedgoods.Itwasexpected
thatjobswouldbelostinthosemanufacturingindustriesintheU.S.asaresultofthe

agreement.NAFTAwillencouragegreaterspecializationandtradewithinNorth
American,leadingtoadeclineinindustrieswhereacountryhasa"comparative
disadvantage"andanexpansioninindustrieswherethereisacomparativeadvantage.

9.TheU.S.ImportExportBankhelpspromoteU.S.exportsbyhelpingimportersfind
financingwithwhichtobuyU.S.exports,guaranteeingloansforU.S.exporters,and
protectingdomesticfirmsagainstnonpaymentbyforeignbuyers.

11.Answerswillvarybydate.

Chapter27

1.a)debit
b)credit
c)debit
d)credit

3.a)U.S.exportswillincrease,importsdecrease,andthetradedeficit(surplus)will
decrease(increase)
b)U.S.exportswilldecrease,importsincrease,andthetradedeficit(surplus)will
increase(decrease)

c)U.S.exportswillincreaseandthetradedeficit(surplus)willdecrease(increase)
d)U.S.importswilldecreasethethetradedeficit(surplus)willdecrease(increase)
e)U.S.exportswilldecrease,importsincrease,andthetradedeficit(surplus)will
increase(decrease)

5.***Q:Ifthedemandforadomesticcurrencydecreasesinacountryusingafixed
exchangeratesystem,whatmustthecentralbankdotokeepthecurrencyvaluesteady?
***
Thecentralbankmustpurchasethecurrencyusingforeignreserveassetstopreventits
currencyfromfallinginvaluerelativetoforeigncurrencies.

7.Thebalanceofpaymentsmustbalancesothatcreditsanddebitsareequal.Ifthe
balanceofpaymentsequals$200million,thestatisticaldiscrepancymustequal+$200
million,notzero.