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Economics, 9th Edition Solution Manual

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    C hapter 0 1 - Economics and Economic Reasoning 1 - 1 Chapter 1: Economics and Economic Reasoning Questions and Exercises 1. Coordination refers to how the three central problems facing any economy are solved. Those three problems are what and how much to produce, how to produce, and for whom to produce. Inevitably , individuals desire more than is available in light of how much they’re willing to work, causing a problem of scarcity. The concept of scarcity has two elements : our wants and our means of fulfilling those wants. Those two elements are interrelated since wants are changeable and are partially determined by society and the means of fulfilling those wants. In addition, the degree of scarcity is constantly changing , depending on the available means of production and the development of new wants. Therefore, the author of the textbook focused on coordination instead of scarcity to emphasize the subsidiary nature of scarcity to the overall concept of coordination. Economics is not merely about our wants or the means of fulfilling those wants; it is also about reconciling our wants with reality, where reality consists of decision - making mechanisms, social customs, and political realities. 2. a. Macro . b. Micro . c. Macro . d. Micro. e. Micro . f. Micro . 3. Answers will differ. Two microeconomic problems are the pricing policies of firms (price - fixing in particular) and the way wages are determined in labor markets. (Why do athletes and celebrities make so much money , anyway?) Two macroeconomic problems are unemployment and inflation (business cycles and growth are also macroeconomic problems). 4. a. The opportunity cost of attending college is the sacrifice one must make to attend college. It can be estimated by figuring out the benefit of the next - best alternative. If that alternative is working, one would guess the likely wage that could be earned at a job that does not require a college degree and then multiply by 40 hours for each week in college. The opportunity cost is also what could be done with the money used for tuition and other costs related to attending college. b. The opportunity cost of taking a course could be estimated by using the same technique as in part a if you otherwise would be working during these hours. If you had taken another course instead, the opportunity cost would be the benefit you would have received from taking the other course. c. The opportunity cost of attending yesterday’s lecture would depend on what you otherwise could have done with the time (sleep? eat lunch with an interesting person?). Although this is no longer a choice to you, past activities do have opportunity costs.

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    C hapter 0 1 - Economics and Economic Reasoning 1 - 2 5. Answers will vary. A correct answer will indicate that the student compared the marginal costs and benefits and chose the activity because the marginal benefit exceeded the marginal cost. 6. The marginal costs are the additional costs. They are $0. 15 per mile for miles above 150 plus the cost of gas. Therefore , the marginal cost is $7.50 plus the cost of gas. The initial payment can be forgotten because it is a sunk cost; it is not part of marginal costs. 7. No, since the marginal cost of drug control exceeds the marginal benefit; government should not spend $4,170 to deter one person from using drugs. 8. The opportunity cost of buying a $20,000 car is the benefit we would have gained by using that $20,000 for the next - best alternative, which could be spending it on other goods and services or saving it. 9. Only the marginal costs and benefits of taking the job are relevant. That means that the sunk cost of the bachelor’s degree is irrelevant. Therefore, the relevant costs are the opportunity cost of taking the job (forgone earnings from your current job) and other things you could have done with the money you need to pay business school tuition. The relevant benefit is the increased lifetime earnings of $300,000. 10. I would spend the $5 million on those projects which provide the highest marginal benefit per dollar spent. The opportunity cost of spending the money on one project is the lost benefit that the college would have received by spending it on a different project. Thus, another way to restate the decision rule is to spend the money on the project that minimizes opportunity cost per dollar. 11. Answers will differ. Two examples of social forces are our unwillingness to charge friends interest and our unwillingness to “buy” dates with other people. These issues are still subject to economic forces; however, there is no market in dates or in loans to friends, and so the economic force does not become a market force. 12. Answers will differ. Two examples of political or legal forces are rent control laws and restrictions on immigration. Both prevent the invisible hand from working. Rent control laws place a price ceiling on rent, causing shortages of apartments, and immigration restrictions cause the number of immigrants seeking entry to exceed the number allowed to enter, which tends to cause wage rates to differ among countries. 13. a. Both parties benefit. The person who gains the kidney benefits if it works when transplanted into his or her body and will no longer have the emotional and

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    C hapter 0 1 - Economics and Economic Reasoning 1 - 3 financial burden of dialysis. The person selling the kidney gains the $30,000. Their gains will also have impacts on others (their families, for example). b. Both parties must undergo surgery and face all the attendant risks and costs. The seller also faces the potential cost of a future illness or injury harming his or her only remaining kidney , causing the seller to need dialysis. c. Whether a society should allow this transaction is a question of value judgments and cultural norms. Our society has chosen not to allow such transactions because (among other reasons) those with more money would have increased access to organs and therefore would have advantages over those of limited means, and thus the poor could be exploited in such transactions. 14. An economic model is a framework that places the generalized insights of a theory in a more specific contextual setting. Policy makers need to understand the empirical evidence supporting the theory as well as real - world economic institutions to make policy recommendations. 15. No . Economic theory proves nothing about what system is best. It simply provides ways to look at systems and indicates what the advantages and disadvantages of various systems probably will be. Normative decisions about what is best can only follow from one’s value judgments. 16. A theorem is a proposition that is logically true based on the assumptions of the model , whereas a precept is a policy rule that a particular course of action is preferable. Economists can agree about theorems but disagree about precepts if they have different value judgments about appropriate goals. 17. A normative statement reflects ethical judgments about what should be. It reflects values. A positive statement refers to a fact or a logical relationship. It is in principle testable or is the result of logic analysis. Positive statements of fact are not subject to debate among educated individuals. The art of economics refers to issues of judgment on how to achieve the goals determined in normative economics , giving the facts and logical relationships one finds in positive economics. Art of economic s statements are subject to debate. 18. a. Positive statement since it is a statement of fact. b. Normative. c. Since this is relating a normative goal to a decision, this could be a statement in the art of economics. It also could be seen as a normative statement if one interprets it as a normative imperative. d. Positive statement since it is a statement of fact.

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    C hapter 0 1 - Economics and Economic Reasoning 1 - 4 Questions from Alternative Perspectives 1. Austrian Most economists would answer yes because they see economic variables such as unemployment as objective measures, which makes them available as measures for planning. Most economists see only individual preferences, not social preferences, as subjective. Austrians believe in a radical subjectivity, uncertainty with respect to time, knowledge, and matters beyond preferences. This eliminates the possibility of using objective economic analysis as the basis for government planning. For an Austrian study on the nature of time and uncertainty for economics , see the work of Mario Rizzo and Gerald O’Driscoll, Jr. 2. Religious a. The rational choice model assumes that individuals are one - dimensional, that they know what they want, and that they will do what is in their best interest. Addictive behavior undermines that assumption, leading to a conflict between passion and reason. b. The conflict suggests that we have to be careful not to apply the economic model in cases in which that conflict is important, such as with behaviors that have addictive elements. Whe n there is a conflict between passion and reason , there may be greater reason for government to limit access to the addictive good or behavior. 3. Feminist a. Patriarchy is a social institution in which men exercise a disproportionate amount of social power and are in a position to define the roles of women and children as well as make most decisions. Because patriarchy affects the ways people behave and interact, it is an institution. It definitely affects the labor market because those who are in power will make hiring decisions that perpetuate their position of power. For example, husbands and fathers may make, or heavily influence, the decisions of whether a woman will look for work. b. Some economists might argue that men and women are merely expressing their preferences in job choices, whereas feminist economists might argue that these choices are culturally determined by institutions, or patterns of behavior, such as patriarchy. It is impossible to separate the free market from the institutions within which it is embedded. The free market may not determine the institutions or mores of a society ; it operates within those institutions.

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    C hapter 0 1 - Economics and Economic Reasoning 1 - 5 4. Institutionalist a. A free market outcome would provide flu vaccine to those willing and able to pay the most for it, which will not include all of those given priority under the rationing scheme. b. The determination of which option is “just” requires delving into theories of justice. The free market solution best mirrors commutative justice — one based on efficiency of exchange — and the rationing scheme best mirrors distributive justice — one based on some notion of fairness that favors those with a greater predisposition to illness. 5. Post - Keynesian a. This answer will differ among students. b. Most students probably will answer this question no. The standard theory presented in the book is based on the assumption that decision makers have full information about all factors that might influence their decisions: They have substantive knowledge of all possible outcomes of their decision making and the consequences of each decision. Most likely you had limited knowledge of the pros and cons of all schools when deciding which college to attend and turned to the advice and norms of a small group of friends, family members, or teachers to help you make a decision. c. Recognizing that you have limited time, knowledge, and ability to compute all the possible outcomes of each economic decision, you probably rely on social norms and rules of thumb to help you make many of your economic decisions (e.g. , when you go to a grocery store , you continue to buy Diet Coke even though other diet sodas might provide you with a higher level of satisfaction at a lower price because you are in the habit of buying Diet Coke and uncertain of the exact benefit the other diet drinks will give you). d. The implication of this behavior is that individuals do not follow the economic decision rule of gaining complete information to optimize their choices but rely on rules of thumb or habit to come up with a satisfactory outcome even though it might not be the most optimizing. This means that economic analysis which assumes that humans are one - dimensional rational beings who calculate all relevant marginal costs and benefits is limited. 6. Radical a. It implies that there is no clear - cut distinction between positive and normative economics and that seemingly positive economics has implicit value judgments hidden within it.

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    C hapter 0 1 - Economics and Economic Reasoning 1 - 6 b. Economics is value - laden. The relevant question about whether the distinction is tenable is whether it is relatively less value - laden than the alternatives. That is an open question. Issues to Ponder 1. Regretting a decision doesn’t necessarily mean that we did not use the economic decision rule when making that decision. At the time the decision was made, we weighed the marginal costs and marginal benefits, undertaking the activity if the marginal benefits exceeded the marginal costs and not undertaking the activity if the marginal costs exceeded the marginal benefits. Many decisions are made without knowledge of the full marginal costs and marginal benefits. Sometimes these marginal costs and marginal benefits are revealed at a later date , making us regret the initial decision. An example is going out to a restaurant. From recommendations, we assume that the marginal benefit is one thing. If that recommendation overstates our actual experience, we will have overestimated the marginal benefit of eating out. We may regret having spent the money to eat out. 2. a. It depends on the perspectives used to answer the question. From a pure ly economic perspective, we would conclude that it is reasonable to execute hackers based on cost / benefit analysis. However, since this decision by no means can be simplified to pure economics, we need to take into consideration social, political, and religious factors. Therefore, Landsburg’s argument should be evaluated in a more complete context. b. Cost / benefit analysis can be extended to many areas, such as social welfare programs and almost all policy discussions. (Source: “Feed the Worms Who Write the Worms to the Worms,” http://slate.com/id/2101297/ ), Slate Magazine , May 26, 2004.) 3. The Theory of Moral Sentiments emphasizes the importance of morality. The invisible hand directs people’s selfish desires (tempered by the social and political forces) to the common good but is based on certain presuppositions about the morality of individuals which constrains individuals’ selfish actions. What Smith is suggesting is that the way individuals calculate marginal cost and marginal benefit must be interpreted within a social context. 4. a, b. Parts a and b have no “right” answers. Most people would say no to a and yes to b . If one were answering this question from the perspective of the economic decision rule alone, one would measure the marginal benefits against the marginal costs of the choice. c. People tend to believe that children should be afforded greater protection than is afforded to adults and are therefore rep el led by the idea of sacrificing a child even though it would save the lives of other children. Sick people are closer to death , and therefore their lives tend to be valued less. d. Brain imaging suggests that the moral sense behind one’s answers does not come from rational though, but instead from emotion — gut responses. This suggests that

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    C hapter 0 1 - Economics and Economic Reasoning 1 - 7 a kind of moral intuition exists that is quite separate from reason. If that is the case, opportunity costs were not central to the decision. It was a moral, not an economic , decision. Opinions among philosophers and economists differ on this issue. 5. a. It depends. On the basis of cost/benefit analysis, one could figure out cases in which most people would say that they should be dishonest, but cost/benefit analysis is not the final arbiter if you believe that dishonesty is wrong. Additionally, you should consider the effects of dishonesty on your reputation and future interactions. b. You can make yourself more believable by developing a reputation for honesty. Developing such a reputation usually has a cost because it requires one to be honest even when others might be dishonest. To encourage the other person to tell the truth, you could use economic incentives. 6. a. Answers will vary. b. Economic theory says that prices are determined by supply and demand, but businesses often use rules of thumb such as cost - plus - markup rules to set their prices. If two firms have different costs of supplying the same item, they probably will set a different price for that item. People might be willing to pay the higher price if the store is closer to where they live or simply to support a smaller, local store. c. Again, answer s will vary, but the reasoning is the same as in part b . 7. It depends on the perspective one takes. It is economically reasonable to legalize organ sales. But from a moral perspective, organ sales may be unethical, and poorer people might feel compelled to sell their organs to support their family, a result that many people would find morally reprehensible. Economics has nothing definitive to say on normative moral issues such as this. 8. Answers will vary. Here is an example: Banks are economic institutions. They take a cost / benefit approach to deciding to whom to give loans, and they influence decision making by allowing individuals to spend more money than they earn or have as wealth. 9. a. This is a matter of personal views; there are arguments for and against it. An argument against the practice is that wealthy songwriters would have too much power in promoting their songs. The songs of the songwriters who can afford to share profits will get more play time and become even more famous to the detriment to new entrants into the industry. Arguments for this practice are that it could be used to offset racism as in the example given and , to the extent that new songwriters have the capability of offering such royalty share, promote new kinds of music. b. The royalty payment gave Freed a strong incentive to choose what he considered the best song and to promote that song heavily. The flat payment would have just

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    C hapter 0 1 - Economics and Economic Reasoning 1 - 8 given him an incentive to play any song and no long - term interest in whether the song succeeded or failed. c. Product placement in movies is legal, as are free newspapers to professors for getting a class to use the newspaper. Direct payment to doctors for prescribing a particular type of drug are illegal, although taking doctors to lunch is not. 10. Three ways (among many) that dormitory rooms could be rationed are administrative decree, lottery, and a market system. In the first, individual behavior would be forced to fit the will of the administrator. Individuals probably would complain and try to influence the administrator's decision. Because administrative decree is not necessarily an efficient system, some people probably would attempt to trade rooms after the allocation. In the second, individual behavior would be forced to fit the luck of the draw; individuals probably would attempt to trade rooms after the draw. In the final example, individual behavior would have already been subject to economic forces, and thus, there will be no tendency to trade after one has "bought" the room one can afford. 11. It suggests that policy should be willing to give up more in possible gains to avoid losses than otherwise would be the case. Economic policies should be risk - averse — more committed to maintaining the current standard of living than to risking economic losses by trying to improve it. Another possible policy response would be to offset this tendency by making gains more salient than losses. 12. A good economist always tries to be objective. However, no one can ever be completely objective. Sometimes the best we can hope for is an awareness of the cultural norms and value judgments that influence our views and decisions. Additionally, many policy issues (such as organ markets and minimum wage laws) probably should not be approved in a purely objective way, since they are also moral and social issues.

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    Chapter 0 2 - The Production Possibility Model, Trade, and Globalization 2 - 1 Chapter 2: The Production Possibility Model, Trade, and Globalization Questions and Exercises 1 . I n the accompanying figure, wadget production is measured on the vertical axis and widget production is measured on the horizontal axis. If the society becomes more productive in its output of widgets, it can produce more of them, and the endpoint of the curve on the horizontal axis will move to the right, as shown in the graph . If the society is also less productive in its production of wadgets, the endpoint on the vertical axis will move down, as shown in the graph . The result is a new production possibility curve. 2 . If a society became equally more productive in the production of both widgets and wadgets, the production possibility curve would shift out to the right , as shown in the accompanying graph. 3 . Any production possibility curve that shows the principle of a rising trade - off must be bowed out. The accompanying grade production possibility curve embodies the principle of rising trade - off . The table is also presented here . Notice that for each 20 - point gain in the History grade , the amount of points lost on the Economics grade steadily increases.

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    Chapter 0 2 - The Production Possibility Model, Trade, and Globalization 2 - 2 4. a. To produce one more Peep, JustBorn must give up 3 Mike and Ikes. Hence, the trade - off for 1 Peep is 3 Mike and Ikes. The trade - off for 1 Mike and Ike is 1/3 of a Peep . b. See the accompanying graph. c. Point A is efficient. Point B is inefficient. Point C is impossible . d. See the accompanying graph. 5 . The theory of comparative advantage underlies the shape of the production possibility curve. If each person's comparative advantage is taken advantage of , higher total output can be reached than would be the case if each produced all goods on his or her own or if each produced goods for which he or she did not have a comparative advantage. As more and more of a good is produced, resources that have less of a comparative advantage are brought into the production of a good, causing the production possibility curve to be bowed outward. History Economics 40 100 60 80 80 50

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    Chapter 0 2 - The Production Possibility Model, Trade, and Globalization 2 - 3 6 . a. See the accompanying graph. b. As the output of food increases, the trade - off between food and clothing is increasing. To illustrate, giving up 4 of clothing (from 20 to 16) results in a gain of 5 food (from 0 to 5), but giving up another 4 clothing (from 16 to 12) results in a gain of 4 food (from 5 to 9), and this pattern continues. c. If the country gets better at producing food, the place where the production possibility curve intersects the horizontal axis will move to the right. d. If the country gets equally better at producing food and producing clothing, the production possibility curve will shift out along both axes by the same proportion. 7 . There are no gains from trade when neither of two countries has a comparative advantage in either of two goods. 8 . The fact that the production possibilit y model tells us that trade is good does not mean that in the real world free trade is the best policy. The production possibilit y model does not take into account the importance of institutions and government in trade. For example, the model does not take into account externalities associated with some trades, the provision of public goods, or the need for a stable set of institutions or rules. The production possibility model shows maximum total output, but that is not the only societal goal to take into account in formulating policy. 9. a. See the accompanying graph.

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    Chapter 0 2 - The Production Possibility Model, Trade, and Globalization 2 - 4 b. The United States has a comparative advantage in the production of wheat because it can produce 2 additional tons of wheat for every 1 fewer bolt of cloth , whereas Japan can produce 1 additional ton of wheat for every 2 fewer bolts of cloth. Japan has a comparative advantage in producing cloth. c. The United States should trade wheat to Japan in return for bolts of cloth. One possibility is that the United States produces 1 , 000 tons of wheat and Japan produces 1 , 000 bolts of fabric and they divide total production equally . Both get 500 tons of wheat and 500 yards of fabric. Both end up with more of each good. (Note: Other combinations are possible. ) d. See the accompanying graph. 10. Globalization increases competition by allowing greater specialization and division of labor. Because companies can move operations to countries with a comparative advantage, they can lower production costs and increase competitive pressures. The decreased importance of geographical location increases the size of potential markets, increasing the number of suppliers in each market and thus increasing competition. 11. The law of one price rules, meaning that U.S. wages can exceed foreign wages only to the degree that U.S. workers are more productive than foreign workers. Therefore, the adjustments that will need to occur will equalize wage rates. Thus , either Western nominal wages will grow slowly and foreign nominal wages will grow rapidly and catch up or U.S. exchange rates will decline to equalize wages. Some combination of the two is most likely. It is possible that there will develop areas of production/services that will allow U.S. wages to remain high. 1 2 . The law of one prices states that the wages of workers in one country will not differ significantly from the wages of (equal) workers in another institutionally similar country. As the world is globalizing, the law of one price causes firms to hire workers in other countries. Because wages adjusted for productivity differences are lower in other countries, firms choose to use workers in foreign countries. As they do so, wage s will be bid up until wages, adjusted for productivity differences, are equal between the two countries.

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    Chapter 0 2 - The Production Possibility Model, Trade, and Globalization 2 - 5 Questions from Alternative Perspectives 1. Austrian In a market economy competition , the market process translates individual actions into actions that are good for society. There is no such mechanism for government; government has a monopoly on power, which allows individuals in government to use that monopoly to achieve their ends, which may not be “good” ends. This monopoly on power makes government less reli able than the market for do ing good, since the government is not subject to entry and exit as firms are in the market. Also, whether every individual voice is taken into account depends on the government system, whereas the market will always include any individual’s voice by that individual’s entry or exit. 2. Religious a. Most people would say that although it might be a component of the goals of society, it is not “the” goal of society. Other goals might include virtues such as kindness and generosity. b. If a country is Christian, maximizing should not be "the" goal of society. c. In a Christian society , the paramount goal would be to discern and fulfill the will of God. 3. Feminist a. Companies definitely think that sex sells products. Just look at the cover of any number of magazines. b. Sex is used in the advertising of numerous products. c. All people are subject to abuse by advertising, but women are more likely to be portrayed as objects instead of people and are therefore at greater risk of exploitation. d. Although men and women may both be used in advertising, typically men are shown to be in a dominant position of power and women are shown in subordinate positions. 4. Institutionalist a. Back in the 1950s President Eisenhower warned of the military/industrial complex, which maintains all types of military spending on projects so that they continue to generate jobs in those areas. Senators with power on the appropriations committee inevitably have larger defense expenditures in their districts than do senators not on the appropriations committee. This

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    Chapter 0 2 - The Production Possibility Model, Trade, and Globalization 2 - 6 high spending on military production results in a trade - off. It means that there is less money to spend on consumer goods, leading to lower production of consumer goods. b. The short - term consequence is a loss in consumer goods. The long - term consequences are potentially much more serious, because for the military to justify the expenditures, wars are necessary; thus , the production of military goods over consumer goods can increase the probability of wars. Some might argue that the latest Iraq war is an example, with Halliburton benefiting from it and the former head of Halliburton, Vice President Cheney, leading the group pushing for the U.S. entrance into the war. 5. Radical a. Yes, for many low - wage jobs it does, although technology is changing that to some degree. b. When making policy decisions, society must take into account not only what is produced but the methods and means of production. Issues to Ponder 1. This statement can be true or false depending on the implicit assumptions made in the analysis. It is true in light of the fact that individuals will eliminate all inefficiencies they see through trading. It might be false if not everyone knows all the benefits and the inefficiencies or does not have the opportunity to correct the inefficiencies or if the costs of eliminating the inefficiency are too high. 2. If a particular distribution of income is one of society’s goals, a particular production technique that leads to greater output but also an undesirable distribution of income might be considered an inefficient method of production. Remember, efficiency is achieving a goal as cheaply as possible. Maximizing output is not the only goal of a society. 3. a. From the numbers alone, one would choose not to work because the opportunity cost of working is giving up an $80,000 increase in lifetime income whereas the benefit is $32,000 of income now. Although there is a correlation between working time and GPA, we cannot conclude that working an after - school job causes the decrease in GPA. Therefore , one might be able to maintain a decent GPA while working. Moreover, earning money might be the priority for a particular student to reach a goal, such as saving for college that will lead to even greater lifetime earnings. b. It depends on the particular student. Working takes time from study and thus might be a reason for the decrease in GPA. But the situation varies from student to student.

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    Chapter 0 2 - The Production Possibility Model, Trade, and Globalization 2 - 7 4 . The fact that lawns occupy more land in the United States than does any single crop does not mean that the United States is operating inefficiently. Although the cost of enjoying lawns is not included in GDP, lawns are nevertheless produced consumption goods and are included in the production possibility curve for the United States. The high proportion of land devoted to lawns implies that the United States has enough food that it can devote a fair amount of land to the production of goods for enjoyment such as lawns. 5 . Following the hint that society’s production possibility curve reflects more than just technical relationships, we realize that trust is an input to production to the extent that it is necessary for transactions. If everyone could fake honesty, the production possibility curve would shift inward since no one could trust anyone else , leading to the disintegration of markets. If some could fake honesty, those few would gain at the expense of others. This is an example of the tragedy of the commons. 6 . a. Firms may produce in Germany because (1) transportation costs to and from the other countries may be very high, so that if these costs are included, it would not be efficient to produce there , (2) there might be tariffs or quotas for imports into Germany that will prevent producing elsewhere , (3) the productivity of German labor may be so much higher that unit labor costs in Germany are the lowest , and (4) historical circumstances may have led to production in Germany , and the cost of moving production may exceed potential gains. b. There would probably not be a significant movement of workers right away. One would expect some movement from Greece and Italy into Germany, but this would be limited by social restrictions such as language, culture , and the economic climate in Germany, which currently has high unemployment. Movement in the long run, however, might be substantial. c. I would want to know about the rule of law in Thailand that will govern business practices, the stability of the government, and the infrastructure. All of these will affect the cost of production.

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    Chapter 0 2 - The Production Possibility Model, Trade, and Globalization 2 - 8 Chapter 2: Appendix A 1. See the accompanying graph. 2. 3. See the accompanying graph. 4. a. The relationship is nonlinear because it is curved, not straight. b. From 0 to 5, cost declines as quantity rises (inverse relationship). From 5 to 10, cost rises as quantity rises (direct relationship). c. From 0 to 5, the slope is negative (slopes down). From 5 to 10, the slope is positive (slopes up). d. The slope between 1 and 2 units is the change in cost (30 – 20) divided by the change in quantity (1 – 2), or – 10. 3. See the accompanying graph. b 1 2 3 4 5 6 7 8 9 10 1 2 3 4 5 6 7 9 10 a 8 c d

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    Chapter 0 2 - The Production Possibility Model, Trade, and Globalization 2 - 9 4. a. 1 . b. – 3 . c. 1/3 . d. – 3/4 . e. 0 . 5. a. C . b. A and E . c. B and D . d. B is a local maximum; D is a local minimum. 6. a. See line a in the accompanying graph. b. See line b in the accompanying graph. c. See line c in the accompanying graph. 7. a. y = 5 x + 1,000 . b. y = 3 x + 1,500. 8. a. Line graph . b. Bar graph . c. Pie chart . d. Line graph .

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    Chapter 03 - Economic Institutions 3 - 1 Chapter 3: Economic Institutions Questions and Exercises 1. The central coordinating mechanism in a market economy is price. 2. The central coordinating mechanism in a centrally planned economy is the central planners. 3. Market economies solve the three problems through markets and the system of rewards and payments. What gets produced is what businesses believe can be sold. How it gets produced is determined by businesses; generally , they choose the method that produces the largest profit. Those who are willing to pay for the goods at the market - determined prices will get them. Thus, supply and demand determine what, how, and for whom to produce. 4. Centrally planned socialist economies solve the three problems by using administrative control. Central planners decide what to produce according to what they believe is socially beneficial. In deciding how to produce, central planners are guided by what they believe is good for the country. Central planners decide about distribution on the basis of their perception of individuals’ needs. 5. The answer to this question requires determining what is meant by better. Economics can explain how each system functions and explain how efficient each is, but economics does not provide an answer to normative questions without imposing normative judgments. 6. An economy depends on coordination, and the mechanisms of coordination depend on the people who choose which goods to supply and what to demand. People supply the labor that makes the economy run. Economic growth and what is considered a resource depend on technology, and people develop new technologies. Even the institutions that oversee the economy are governed by that economy’s people. It follows that the economy’s ultimate strength resides in its people. 7. Business is dynamic; it involves meeting new problems constantly, recognizing needs, and meeting those needs in a timely fashion. These are precisely the skills of entrepreneurship. 8. The three forms of businesses are corporations, partnerships , and sole proprietorships. a. In the United States, sole proprietorships are the most common. b. The largest proportion of sales are made by corporations. 9. You most likely would choose a sole proprietorship because it’s easy to start, requires minimal bureaucratic hassle, and is controlled by you, the owner. If you

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    Chapter 03 - Economic Institutions 3 - 2 need more money than you have to start this business, you might consider taking on a partner. This would also allow you to share the work and the risk, but you also would have to share the profits and figure out a way to maintain a friendship while working together. 10. The two largest categories of federal expenditures are income security and health and education. 11. The six roles of government in a market economy are (1) providing a stable set of institutions and rules, (2) promoting effective and workable competition, (3) correcting for externalities, (4) ensuring economic stability and growth, (5) providing public goods, and (6) adjusting for undesired market results. 12. Pollution permits require firms to pay the cost of pollution they create. When these permits are tradable, firms that face the lowest cost of reducing pollution will reduce pollution emissions the most and sell their extra rights to firms that face a higher cost of reducing pollution. Permits assign rights, thus correcting for the externality. 13. A merit good is a good that government believes is good for you even if you choose not to buy it. An example might be operas. A demerit good is a good that government believes is bad for you even if you choose to buy it. An example is alcohol or drugs. A public good is a good that if supplied to one person must be supplied to all and whose consumption by one does not preclude consumption by another. An example is national defense. An externality is the effect of a trade on a person not involved in the trade. An example is cigarette smoke. 14. Economic actions are coordinated by a wide variety of international organizations such as the United Nations, the World Trade Organization (WTO), and the World Bank. (The student needs to mention only two of these three organizations.) 15. Countries have developed global and regional organization to coordinate trade barriers and reduce trade barriers. The World Trade Organization, the European Union , and NAFTA are examples of these types of organizations 1 6 . International organizations are limited in their effectiveness because membership is voluntary , as are any agreements among members. There is no world government to enforce international laws or agreements.

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    Chapter 03 - Economic Institutions 3 - 3 Questions from Alternative Perspectives 1. Austrian a. The dangers of government intervention and support of activities is that once intervention begins, it is hard to limit. For example, if the state supports children , the state will want control of those children, which will impinge on individual s ’ freedoms. b. If governments financially support families , that might induce them to attempt to limit the number of children families can have, as the People’s Republic of China did. Alternatively, the government may want more children for an increase in the size of the military and, to achieve its ends, limit birth control, as Romania did in its socialist period, and force individuals to have more children. 2. Religious He meant that strongly held religious beliefs can lead people to violate the law, because they hold the law of God above the law of the state. There is debate about whether he is correct, but as can be seen with some religious fundamentalists who incorporate violence into their belief system s , the state may face serious problems when people rely on religion as their primary guide for action. 3. Feminist a. Economists know relatively little about intrahousehold decision making and have generally assumed that households have a single joint utility function. In one popular theory, those with power (parents) are assumed to be benevolent and those without power (children) are assumed to be selfish. Widespread wife and child abuse as well as evidence for unequal food distribution within the family which harms women and children clearly undermines this simple notion of household decision making. b. Absolutely. Bargaining is likely to take place among individuals in a household. A child might agree to eat certain foods in exchange for getting a toy, for example. c. The ability to walk away from the bargain is what gives someone power. Paying the bill also gives a person power. In families with separate checking accounts, the individual with a higher income is likely to have greater bargaining power. d. Individuals are more likely to act cooperatively within a household because there are mechanisms besides money to maintain accountability. However, there may be unspoken competition within a family, such as when children compete for their parents' attention. There is also cooperation elsewhere, such as when employees work together to accomplish a task.

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    Chapter 03 - Economic Institutions 3 - 4 e. It makes sense within the theory of the social behavior of groups of various sizes and strength of relations. 4. Institutionalist The dilemma is obvious and represents an inherent conflict in a society whose values are greatly influenced by the Judeo - Christian ethic of charity toward all and the free market ethic which emphasizes the unbridled pursuit of self - interest. Here discussion can be used to delineate concepts of justice and the difficulty of universal application. 5. Radical a. To some degree consumer s ’ desires influence what is produced, but with so much advertising, it is difficult to determine people’s true desires and whether those desires are being created by businesses. b. Again, views can differ on this issue, and it is difficult to say which view is correct. c. The other group that has some sovereignty is business. If business sovereignty holds, the analysis based on consumer sovereignty is misleading and should not necessarily be followed. Issues to Ponder 1. Markets have a small role in most families. In most families , decisions about who gets what usually are made by benevolent parents. Because families are small and social bonds are strong, this benevolence can work. Thus, a socialist organization seems more appropriate to a family and a market - based organization to a large economy in which social bonds don’t hold the social unit together. The propensity to look after the common good is much stronger in a family than in an entire economy. The benefits of a market - based economy in a family would be to provide incentives to all the members of the family to contribute to family production, although this may undermine the social bonds of families. 2. a. The fact that more money is spent on adults than on children in the family does not imply that the children are deprived or that the distribution is unfair. Children and adults have different needs. b. Yes . These percentages probably change with income. The lower the income, the larger the percent of total expenditures spent on children. The reason is that most families want to provide a basic level of needs for their children. Many families feel that luxuries should not be given to children until the children have learned how to work for themselves. c. Our suspicion is that the allocation would not be significantly different in command economies compared with capitalist economies. If, however, the

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    Chapter 03 - Economic Institutions 3 - 5 average income in command economies were lower, the percentage of total expenditure spent on children might be higher, as described in part b . 3. a. Innovation requires a certain level of freedom of thought and a possibility of profit making from the innovation. Neither existed in centrally planned economies. Government planners directed production with income based on need, and so workers had neither the freedom nor the incentive to innovate. b. Both freedom and the possibility of making profits provide the means and incentives for innovation in capitalist countries. c. Schumpeter’s argument was based on the idea that profit making by innovators was necessary for innovation to occur. As firms become larger, however, the individual ceases to become the direct beneficiary of his or her innovations. d. Since his predictions did not materialize, one must believe that firms have been able to create incentive structures to foster innovation or that some other venue for innovation has arisen. Firms have large research and development departments designed to promote innovation. In addition, individual innovators have been able to raise enough capital to start their own companies to profit directly from their innovations. In the United States , there has been enormous growth in the number of such firms. The U.S. government has been a large motivator of innovation through its strong patent and copyright system as well as by providing subsidies for research at universities and support ing military innovations, both of which have large spillovers into private industry. 4. a. Such an idea could be expanded to include college courses, but that is unlikely to happen because the quantity of in - person college courses demanded would decline as people substitute d toward recorded lectures. Substitution, however, is not perfect since neither DVDs nor CDs can provide the interaction between student and instructor or among students that exists in the classroom. Social forces would act against the movement away from college classroom instruction even if the invisible hand pressed action toward it. b. Technical problems are virtually nonexistent. Socially, the problems are substantial. A diminishing role of the university would significantly change its role of providing a focal point for intellectual discussion and discovery, thus changing the nature of education. There would be great social pressures to maintain this role of American colleges. The economic issues are substantial as well. A course could be taught once and used over a period of years. This would reduce the demand for professors and create revenues for certifying agencies that would regulate the distribution and quality of the tapes. If these college - at - home courses became an accepted educational credential, the demand for a traditional college education would fall, putting major competitive pressure on traditional colleges. c. Even though the program is technically possible and cost - efficient, it will not necessarily be a success because social forces will play a major role in limiting the market. Social forces are often strong enough to overcome economic forces.

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    Chapter 03 - Economic Institutions 3 - 6 5. Answers will vary. This exercise asks students to gather information about the limitations on businesses of different types in their communities. They are then asked to make judgments about whether the limitations were necessary (are they clear about the goals involved?) and whether the number of limitations is correct. The information is linked to the text’s material in part d . Part e asks students to learn about business taxes in their communities, and part f has them gather a sense of business satisfaction. 6. Consumers decide what goods they want and demonstrate their decisions in their willingness to pay for th os e goods. Businesses decide what to produce, but their decisions reflect consumer desires. Thus, there is no contradiction. However, advertising, in which businesses attempt to influence behavior, can limit consumer sovereignty. 7. Individuals might disagree as to the categorization of a good as a merit, demerit , or public good or a good that involves an externality. In the case of an externality, they may believe that with sufficient property rights, the externality will be solved most efficiently by the market, not by government. 8. There is market failure only if people do not value operas as much as they should. This normative statement is valid only if the “should” can be measured against some absolute truth about the value of operas ; otherwise , how would one decide who decides the value of operas? Because it is only through the market that value is revealed, we’d argue that government intervention in this case will probably lead to government failure — the failure of government to value operas accurately . With government intervention, the value probably will reflect the preferences of those with political power, not necessarily the preferences of the general population. 9. People have based decisions on the rules that were set up, and so changing them after the game has been started may be more unfair than continuing to play by the original rules. Such decisions must be made based on the marginal cost and the benefit of changing the rules. 10. In making such trade agreements, it is important for countries to realize that trade includes not only economic issues but cultural and social ones as well. Although free and unregulated trade is generally the most economically beneficial (maximizes consumption possibilities), these economic benefits can be overpowered by the loss of cultural identity as a result of globalization. Taking into consideration such losses is a government’s responsibility when it negotiates trade agreements. These losses must be weighed against the benefits of free trade.

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    Chapter 0 4 - Supply and Demand 4 - 1 Chapter 4: Supply and Demand Questions and Exercises 1. The law of demand states that quantity demanded falls as price increases or that quantity demanded rises as price falls. Price is inversely related to quantity demanded because as price rises, consumers substitute other goods whose price has not risen. 2. a. Price Market Demand 2 64 4 56 6 44 8 36 10 28 12 20 14 12 16 8 b. See the accompanying graph of the table. c. At the market price of $4, the total market demand is 56. If the price rises to $8, the total market demand will fall to 36. d. All the curves will shift to the right by 50 percent. [ (Note: The top part of John's demand curve will not shift to the right (an additional 50 percent of zero is still zero) .] 3. Four shift factors of demand are income, price of other goods, tastes, and expectations. A fifth shift factor is taxes and subsidies to consumers. As income

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    Chapter 0 4 - Supply and Demand 4 - 2 rises, demand increases. As the prices of other substitute goods rise, demand increases. As tastes change to favor a particular good, the demand for that good increases. If people expect the price of a good to fall in the future, demand will fall now. Taxes reduce demand, whereas subsidies increase it. 4. A change in the price causes a movement along the demand curve to a new point on the same curve. A shift in the demand curve means that the quantities will be different at all prices; the entire curve shifts. 5. The law of supply states that quantity supplied rises as price increases or, alternatively, that quantity supplied falls as price decreases. Price is directly related to quantity supplied because as price rises, people and firms rearrange their activities to supply more of that good to take advantage of the higher price. 6. Saying that supply increases means that the curve has shifted to the right, which is not the result of a price change. The correct statement is that normally, as price rises, the quantity supplied increases, other things constant. 7. Shift factors of supply include the price of inputs, technological advances, changes in expectations, and taxes and subsidies. As the price s of inputs increase, the supply curve shifts to the left. As technological advances are made that reduce the cost of production, the supply curve shifts to the right. If a supplier expects the price of her good to rise, she may decrease supply now to save and sell later. Other expectational effects are also possible. Taxes paid by suppliers shift the supply curve to the left. Subsidies given to producers shift the supply curve to the right. 8. When adding two supply curves, sum horizontally the two individual supply curves, as in the accompanying diagram. S 3 is the market supply curve. 9. a. The market demand and market supply curves are shown in the accompanying graph.

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    Chapter 0 4 - Supply and Demand 4 - 3 b. At a price of $30, quantity demanded is 35 and quantity supplied is 15. Excess demand is 20. At a price of $60, quantity demanded is 5 and quantity supplied is 45. Excess supply is 40. c. Equilibrium price is $40. Equilibrium quantity is 25. 10. In the accompanying graph, the demand curve has shifted to the left, causing a decrease in the market price and the market quantity. 11. The price of airline tickets rises during the summer months because demand for airline travel increases as more people take vacations. This is shown in the accompanying graph.

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    Chapter 0 4 - Supply and Demand 4 - 4 12. Sales volume increases (equilibrium quantity rises) when the government suspends the tax on sales by retailers because the price to demanders falls and hence equilibrium quantity demanded rises. This occurs because the supply curve shifts to the right because suppliers do not have to pay taxes on their sales (cost of production declines). 13. Increased security measures imposed by government will increase the cost of providing air travel. This will shift the supply curve to the left, increase equilibrium price to P 1 , and decrease equilibrium quantity to Q 1 as shown in the accompanying graph. They also might reduce demand (the hassles of the increased security and the additional time it takes to travel), further decreasing equilibrium quantity and offsetting the rise in price, in this case to P 2 .

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    Chapter 0 4 - Supply and Demand 4 - 5 Some students might argue that increased security will increase demand because consumers will feel more comfortable flying (they don't have to worry about terrorists as much). If demand increased, the price would go up even higher and the equilibrium quantity would also increase. 14. Customers will flock to stores demanding that funky “economics professor” look, creating excess demand (the demand curve shifts right). This excess demand will soon catch the attention of suppliers, and prices will be pushed upward. 15. As substitutes for bottled water — clean tap water — decrease, demand for bottled water increases enormously, and there will be upward pressure on prices. Social and political forces will, however, probably work in the opposite direction — against “profiteering” from people’s misery. 1 6 . Increasing oil production (not as a result of a price change) will shift the supply of oil out to the right. The price of oil will decline , as shown in the accompanying graph.

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    Chapter 0 4 - Supply and Demand 4 - 6 1 7 . a. The bad weather causes a decrease in supply. This is shown by a shift in supply from S 0 to S 1 . Equilibrium price rises from P 0 to P 1 , and equilibrium quantity falls from Q 0 to Q 1 . See the accompanying graph. b. The medical report causes a decrease in demand. This is shown by a shift in demand from D 0 to D 1 . Equilibrium price falls from P 0 to P 1 , and equilibrium quantity falls from Q 0 to Q 1 . See the accompanying graph c. The innovation causes an increase in supply. This is shown as a shift in supply from S 0 to S 1 . Equilibrium price falls from P 0 to P 1 , and equilibrium quantity rises from Q 0 to Q 1 . See the accompanying graph

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    Chapter 0 4 - Supply and Demand 4 - 7 d. The drop in income causes a decrease in demand. This is shown by a shift in demand from D 0 to D 1 . Equilibrium price falls from P 0 to P 1 , and equilibrium quantity falls from Q 0 to Q 1 . See the accompanying graph 1 8 . a. I would expect wheat prices to decline since the supply of wheat is greater than expected. Wheat commodity markets are very competitive, and so the initial 3 0 percent increase in output was already reflected in the current price of wheat. It is only the additional 10 percent increase that will push down the price of wheat. b. This is graphically represented by a shift to the right in the supply of wheat, as shown in the accompanying graph. Equilibrium price falls from P 0 to P 1 , and equilibrium quantity rises from Q 0 to Q 1 .

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