Microeconomics: Fourth Edition Solution Manual

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DGraphics Worth: Krugman Economics 3e in ModsPrinciple 7: Resources should be used efficiently toachieve society’s goals. Priceline.com exploited an oppor-tunity to use resources more efficiently. It is inefficientto have empty hotel rooms and airline seats if someone iswilling to pay some price to use them on short notice.Principle 8: Because people usually exploit gains fromtrade, markets usually lead to efficiency. It is inefficientto have planes flying with empty seats and hotels withunoccupied beds. Thus, introducing a market for thoseitems—which is what Priceline.com did—improvesefficiency.Principle 9: When markets don’t achieve efficiency, gov-ernment intervention can improve society’s welfare. Itwould have been inefficient to have major airlines failbecause of the public’s temporary fear of flying. Vastresources would have been wasted as pilots and supportstaff lost their jobs, planes were mothballed, necessarytrips cancelled, and so on. It improved efficiency for thegovernment to step in and temporarily aid the airlineindustry so that it could survive the temporary downturn.Principle 10: One person’s spending is another person’sincome. In the aftermath of the attacks of September2001, as people stopped spending on items like travel theincome of airline workers was severely reduced.Principle 11: Overall spending sometimes gets out of linewith the economy’s productive capacity. The overall econo-my went into a slump after the attacks of September 2001as the economy’s productive capacity exceeded its spending.Principle 12: Government policies can change spending.The $15 billion aid appropriation by Congress was spenton stabilizing the airline industry and prevented majorairline failures.Chapter 21.What is the opportunity cost associated with having aworker wander across the factory floor from task to taskor in search of tools and parts?Suggested Solution1.The opportunity cost of a worker wandering across thefactory floor is forgone output—the output that workercould have produced in the time spent wandering around.2.Explain how lean manufacturing improves the economy’sefficiency in allocation.Suggested Solution2.Lean production (also known as lean manufacturing)improves the economy’s efficiency in allocation because,for example, an automaker can more quickly switch toproducing more of the types of cars that more consum-ers want and fewer of the types of cars that fewer con-sumers want.SUGGESTED SOLUTIONS FOR BUSINESSCASEQUESTIONS FOR THOUGHTThis section offers suggested answers to the “Questions for Thought” that conclude eachbusiness case at the end of chapters.Chapter 11.Explain how each of the twelve principles of economicsis illustrated in this case study.Suggested Solution1.Principle 1: People must make choices because resourcesare scarce. Neither money nor time is unlimited; they areboth scarce resources. Priceline.com caters to customerswho have chosen to sacrifice some of their preferencesabout convenience or quality in order to get a lowerprice.Principle 2: The opportunity cost of an item—what youmust give up in order to get it—is its true cost. The truecost of an empty airplane seat or an empty hotel bed isthe revenue the airline or hotel could have earned fromthe next best use of that seat or bed—namely, the rev-enue earned from a paying customer.Principle 3: “How much” is a decision at the margin.How much more a customer is willing to pay for aticket to a destination depends upon how much timeand inconvenience is saved by purchasing the higherpriced ticket.Likewise, how much more a customer is willing topay for a ticket purchased well in advance of his traveldate depends upon how much more security he gains byadvance planning rather than waiting to purchase. Thesame principle applies to decisions about the quality andlocation of hotels, and so on.Principle 4: People usually respond to incentives,exploiting opportunities to make themselves better off.Priceline.com was successful because its customers—travelers, airlines, and hotels—were exploiting opportu-nities to make themselves better off by using its services.Priceline.com also responded to incentives to make itselfbetter off by expanding into new profitable marketssuch as Europe.Principle 5: There are gains from trade. Travelers gainfrom using Priceline.com’s networks of hotels to find ahotel rather than doing the research themselves. Theygain from using Priceline.com’s services to book a flightrather than contacting each airline individually. Also,travelers gain by using the services of airlines and hotels,rather than transporting themselves or pitching a tentovernight to sleep in. Hotels, particularly in Europe, gainfrom using Priceline.com’s network rather than trying tocontact potential customers directly.Principle 6: Because people respond to incentives, marketsmove towards equilibrium. Expedia and Orbitz movedinto the online travel service industry in order to exploitopportunities that had been pioneered by Priceline.com.In this way, the market for online travel services will movetowards equilibrium until there are no more opportuni-ties for new travel service companies to exploit.BCS-1KrugWellsEC4e_Micro_BCS.indd11/13/151:09 PM

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BCS-2A n s w e r st oB u s i n e s sCAs eQ u e s t i o n sf o rth o u g h tDGraphics Worth: Krugman Economics 3e in Modsmarket equilibrium is achieved. Kalanick’s claim is true.At any price lower than the equilibrium price, there isa shortage of taxis and fewer people actually get rides;at any price higher than the equilibrium price there arefewer customers, so fewer rides are transacted.Chapter 41.Use the concepts of consumer surplus and producer sur-plus to analyze the exchange between The Boss and hisfans. Draw a diagram to illustrate.Suggested Solution1.By pricing tickets below the market equilibrium price,fans that get tickets receive greater consumer surplusthan they would have received at the market equilibriumprice: the increased consumer surplus is a way for aband to reward fans’ loyalty. Correspondingly, producersurplus is lower than it would have been: the reducedproducer surplus is the money that bands forfeit whenthey price tickets below the market equilibrium price.In the accompanying diagram, the supply curve fortickets is drawn as a vertical line: the supply of ticketsfor any particular concert is fixed at the number of seatsavailable at the venue, hereQE. The demand curve isdownward-sloping as lower ticket prices encourage morefans to buy tickets. The market equilibrium is at pointE,with a market price ofPEand a quantity bought and soldofQE. Pricing tickets at a pricePCthat is below the mar-ket equilibrium price acts like a price ceiling: it creates ashortage of tickets. Consumer surplus is the area belowthe demand curve but above the price; in the diagram itis given by the sum of areasXandY.Producer surplus isthe area above the supply curve but below the price; it isshown by areaZin the diagram.Price ofticketsQuantity of ticketsEXYZDSBAPriceceilingQEPEPCShortageIf tickets were priced at the market equilibrium pricePE,consumer surplus would be lower (areaX), and pro-ducer surplus would be higher (the sum of areasYandZ). In other words, the amount of consumer surplusgiven by areaYis Bruce Springsteen’s reward for hisfans’ loyalty; but it is also the money that he forfeits bypricing tickets below the market equilibrium price.2.Explain how the rise of the internet has disrupted thisexchange.3.Before lean manufacturing innovations, Japan mostlysold consumer electronics to the United States. How didlean manufacturing innovations alter Japan’s compara-tive advantage vis-à-vis the United States?Suggested Solution3.Before the innovations in lean production, Japan had acomparative advantage vis-à-vis the United States in con-sumer electronics. After the innovations, Japan’s com-parative advantage vis-à-vis the United States shifted toauto production.4.Predict how the shift in the location of Toyota’s produc-tion from Japan to the United States is likely to alterthe pattern of comparative advantage in automakingbetween the two countries.Suggested Solution4.The shift in the location of Toyota’s production fromJapan to the United States means that it is likely thatJapan will no longer have a clear comparative advantagein automaking vis-à-vis the United States.Chapter 31.Before Uber, how were prices set in the market for ridesin New York City? Was it a competitive market?Suggested Solution1.Before Uber, prices for rides were set by city regulators.This was not a competitive market because the price wasnot set by supply and demand but by city regulators.2.What accounts for the fact that during good weatherthere are typically enough taxis for everyone whowants one, but during snowstorms there typically aren’tenough?Suggested Solution2.If everyone who wants to get a taxi during good weathercan typically get one, then this implies that the priceset by regulators is approximately equal to the market-clearing price on good weather days.But a snowstormis likely to produce two changes to supply and demand:an increase in demand (rightward shift of the demandcurve) because more people want to ride in a taxi ratherthan walk or wait for a bus at any given price; and adecrease in supply as more taxi drivers want to staywarm and dry at home at any given price. As a resultof these two shifts, the market-clearing price rises. Butbecause the actual price is set by regulators and cannotincrease, a shortage of taxis arises.3.How does Uber’s surge pricing solve the problemdescribed in the previous question? Assess Kalanick’sclaim that the price is set to leave as few people possiblewithout a ride.Suggested Solution3.Uber’s surge pricing solves this problem because itallows drivers to charge higher prices until supply equalsdemand. This increases the quantity of rides suppliedwhile reducing the quantity of rides demanded untilKrugWellsEC4e_Micro_BCS.indd21/13/151:09 PM

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A n s w e r st oB u s i n e s sCAs eQ u e s t i o n sf o rth o u g h tBCS-3DGraphics Worth: Krugman Economics 3e in Modsin effect getting around the restriction on the numberof taxis in the city by creating their own, company-specific taxi fleets.3.Predict the effect on Medallion Financial’s business if NewYork City eliminates restrictions on the number of taxis.That is, if the quota is removed.Suggested Solution3.Eliminating restrictions on the number of taxis woulddestroy Medallion Financial’s business. The quota rentsthat accrue to the owners of medallions would fall tozero, leading the value of a medallion to fall to zero.There would be no need to take out a loan to buy one.In addition, the value of Medallion Financial’s existingloans would fall significantly.Chapter 61.How would you describe the price elasticity of demand forairline flights given the information in this case? Explain.Suggested Solution1.The price elasticity of demand for airline flights is inelas-tic. We know this because airlines were able to increasetheir revenues and profit by reducing supply and increas-ing price.2.Using the concept of elasticity, explain why airlineswould create such great variations in the price of a ticketdepending on when it is purchased and the day and timethe flight departs. Assume that some people are willingto spend time shopping for deals as well as fly at incon-venient times, but others are not.Suggested Solution2.By creating such variations in prices, the airline industryis trying to appeal to customers who have a high priceelasticity of demand as well as charge higher prices tothose with a low price elasticity of demand. Customerswith a high price elasticity of demand will shop for deals,buy their tickets midweek, and fly on cheaper early-morning flights. So by offering lower fares for ticketspurchased midweek or for flights that depart in the earlymorning, airlines attract those customers with a highprice elasticity of demand. Customers with a low priceelasticity of demand aren’t willing to do those things, sothe airlines can and do charge them higher prices.3.Using the concept of elasticity, explain why airlines haveimposed fees on things such as checked bags. Why mightthey try to hide or disguise fees?Suggested Solution3.Because airlines know that travelers have a low priceelasticity of demand for services like having their suit-cases fly with them or being served drinks onboard,they know they can raise revenue by imposing fees onthese services. Airlines often try to hide or disguisethese fees to prevent travelers from making substitu-tions, like choosing a different airline that doesn’tcharge for such services.Suggested Solution2.The rise of internet resellers like StubHub andTicketsNow allows the ticket price paid by consumersto rise; if we assume that all tickets are scooped up andresold, then price rises to the market equilibrium pricePE. In this case, the resellers captureY,the consumersurplus that had formerly gone to fans.3.Draw a diagram to show the effect of resellers on theallocation of consumer surplus and producer surplus inthe market for concert tickets. What are the implicationsof the internet for all such exchanges?Suggested Solution3.If all fans bought tickets from internet resellers, theprice of tickets would rise to the market equilibriumprice,PE. Look again at the diagram accompanyingsolution 1. As the price rises fromPCtoPE, consumersnow receive consumer surplus equal to areaX. However,producer surplus rises to the sum of areasYandZ,thearea above the supply curve but below the price. Of thisproducer surplus, areaZgoes to the band and areaYiscaptured by the internet reseller. The result for BruceSpringsteen is described by one of his lyrics: “Yourown worst enemy has come to town.” His fans are notrewarded for their loyalty (they obtain tickets only at themarket equilibrium price, not the lower box office price),and the resulting increase in producer surplus goes tothe internet reseller, not to The Boss.Chapter 51.How does Medallion Financial benefit from the restric-tion on the number of New York taxi medallions?Suggested Solution1.Medallion Financial benefits from the restrictionon the number of taxi medallions because demandfor its loans and the amount of interest it earns onthem increase as the price of medallions goes up.In addition, its loans are secured by the medallionspurchased by its borrowers; as a result, those loansare worth more when medallion prices are high. Andsince the fewer the medallions, the higher their price,Medallion Finance benefits from the restriction on thenumber of medallions.2.What will be the effect on Medallion Financial if NewYork companies resume widespread use of limousineservices for their employees? What is the economic moti-vation that prompts companies to offer this perk to theiremployees? (Note that it is very difficult and expensive toown a personal car in New York City.)Suggested Solution2.If more New Yorkers are using limousine servicesinstead of taking taxis, the demand for taxis falls,leading to a fall in income for taxi drivers and a fallin the value of a medallion. This will reduce both thedemand for Medallion Financial’s loans and the valueof its existing loans. So greater use of limousine ser-vices hurts Medallion Financial. By offering limousineservices to their employees as a perk, companies areKrugWellsEC4e_Micro_BCS.indd31/13/151:09 PM

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BCS-4A n s w e r st oB u s i n e s sCAs eQ u e s t i o n sf o rth o u g h tDGraphics Worth: Krugman Economics 3e in Mods2.What principle do you think underlies Li & Fung’s deci-sions on how to allocate production of a good’s inputsand its final assembly among various countries?Suggested Solution2.Comparative advantage is the principle that underlies Li& Fung’s decisions. Inputs that require more skill or aremore capital-intensive can be produced in countries thathave relatively higher-skilled workers or are relativelymore abundant in capital, such as Hong Kong and Japan.Similarly, inputs that are more labor-intensive can beproduced in countries that are relatively more abundantin labor, like mainland China and Thailand.3.Why do you think a retailer prefers to have Li & Fungarrange international production of its jeans rather thanpurchase them directly from a jeans manufacturer inmainland China?Suggested Solution3.A retailer that purchased jeans directly from a manu-facturer in mainland China would not benefit from thegains from trade that arise from sourcing inputs fromdifferent countries according to those countries’ com-parative advantage.4.What is the source of Li & Fung’s success? Is it based onhuman capital, on ownership of a natural resource, or onownership of capital?Suggested Solution4.The source of Li & Fung’s success is human capital.The company understands how to use the principle ofcomparative advantage to exploit gains from trade in theproduction process. In addition, it is skilled in providingquality control and logistics.Chapter 91.Give an example of a type of rational decision making illus-trated by this case and explain your choice.Suggested Solution1.J. C. Penney customers were using the anchoring behav-ioral strategy, which is a form of bounded rationality. Theylooked to the pre-sale price as a benchmark to estimate thevalue of the good and, therefore, the real savings they weregetting once the discount was applied.2.Give an example of a type of irrational decision makingillustrated by this case and explain your choice.Suggested Solution2.J. C. Penney customers who followed the sales-and-couponstrategy were underestimating their opportunity costs.They weren’t actually paying less under the sales-and-coupon pricing strategy, yet they were expending a lot oftime and effort to keep track of sales and clip couponswithout any payoff.3.What purpose does Walmart’s price-match guaranteeserve? What do you predict would happen if it dropped thispolicy? Would you predict its competitors—say, the localsupermarket or K-Mart—would adopt the same policy?4.Use an elasticity concept to explain under what condi-tions the airline industry will be able to maintain itshigh profitability in the future. Explain.Suggested Solution4.The airline industry will be able to maintain its profitsif price elasticity of supply is low—that is, if airlinesdo not respond to an increase in travel demand bygreatly increasing quantity supplied. If price elasticityof supply is high, airlines will increase quantity sup-plied dramatically when demand increases, prices willfall, and their profits will fall as well.Chapter 71.What effect do you think the difference in state sales taxcollection has on Amazon’s sales versus BarnesandNoble.com’s sales?Suggested Solution1.It is easy to compare the price of books among the variousonline retailers and choose the one with the lowest price.As a result, consumers are more likely to buy from Amazonthan from BarnesandNoble.com because they will seek topay a lower final price by avoiding paying the sales tax.2.Suppose sales tax is collected on all online books sales.From the evidence in this case, what do you think is the inci-dence of the tax between seller and buyer? What does thisimply about the elasticity of supply of books by book retail-ers? (Hint:Compare the pre-tax prices of the book.)Suggested Solution2.The fact that the pre-tax price is the same at Amazonand BarnesandNoble.com means that all of the tax isbeing borne by the consumer. In other words, the priceelasticity of books is perfectly elastic.3.How did Amazon’s tax strategy distort its businessbehavior? What measures would eliminate thesedistortions?Suggested Solution3.To avoid collecting sales tax, Amazon refused to expandits physical operations such as warehouses, distributioncenters, and even partnerships with affiliates in much ofthe United States. This increased the time it took for cus-tomers to receive their merchandise and made Amazon’soperations more costly. These distortions would be elimi-nated by making Amazon collect sales tax, regardless ofwhere the customer is located or where Amazon’s opera-tions are.Chapter 81.Why do you think it was profitable for Li & Fung to gobeyond brokering exports to becoming a supply chain man-ager, breaking down the production process and sourcingthe inputs from various suppliers across many countries?Suggested Solution1.By sourcing inputs from various suppliers across manycountries, Li & Fung was able to allocate production towhere it is most cost effective.KrugWellsEC4e_Micro_BCS.indd41/13/151:09 PM

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A n s w e r st oB u s i n e s sCAs eQ u e s t i o n sf o rth o u g h tBCS-5DGraphics Worth: Krugman Economics 3e in ModsChapter 111.Assume that a firm can sell a robot, but that the saletakes time and the firm is likely to get less than what itpaid. Other things equal, which system, human-based orrobotic, will have a higher fixed cost? Which will have ahigher variable cost? Explain.Suggested Solution1.Other things equal, a robotic system will have a higherfixed cost because unlike humans, robots cannot behired and fired—in other words, purchased and sold—quickly and cheaply. Since a robotic system reduces theneed for humans, a human-based system will have moreworkers than a robotic system. So a human-based sys-tem will have a higher variable cost.2.Predict the pattern of off-holiday sales versus holidaysales that would induce a retailer to keep a human-basedsystem. Predict the pattern that would induce a retailerto move to a robotic system.Suggested Solution2.A retailer that has a huge surge in holiday sales is likelyto maintain a human-based system. That’s because itwould have to install a large number of robots to handleits holiday sales that would then sit idle during the restof the year. In contrast, a retailer that has only a moder-ate increase in holiday sales is likely to move to a roboticsystem because it will have a relatively small number ofrobots left idle during the off-season.3.How would a “robot-for-hire” program affect youranswer to Question 2? Explain.Suggested Solution3.A “robot-for-hire” program would make retailers witha large ratio of holiday sales to off-holidays sales morelikely to switch to a robotic system. These retailers couldacquire a robotic system at a much lower cost by rent-ing robots when they need them, rather than purchasingthem and having them sit idle during much of the year.Chapter 121.From the evidence in the case, what can you infer aboutwhether or not the retail market for electronics satisfiedthe conditions for perfect competition before the adventof mobile-device comparison shopping? What was themost important impediment to competition?Suggested Solution1.The retail market for electronics did not satisfy theconditions for perfect competition because stores likeBest Buy were able to charge higher prices than otherretailers. In perfect competition every transaction atthe market equilibrium takes place at the same price.The major impediment to competition was customers’inability to compare prices across various retailers,which would have required them to go to or call sev-eral stores.Suggested Solution3.Walmart’s price-match guarantee means that its customerscan be assured that Walmart’s prices are indeed low andtherefore they do not need to search for an anchor to verifythis. As a result, the local supermarket or K-Mart wouldlose their customers to Walmart if they didn’t offer thesame guarantee. If Walmart dropped the price guarantee,however, they would become like J. C. Penney and losecustomers.Chapter 101.Give an example of a normal good and an inferior goodmentioned in this case. Cite examples of substitutioneffects and income effects from the case.Suggested Solution1.A normal good is a good for which demand rises as incomerises; full-service restaurant meals are normal goods. Aninferior good is a good for which demand rises as incomefalls; fast-food meals are inferior goods. Price discountsand promotions at fast-food outlets have given rise to sub-stitution effects: the substitution of cheaper fast-food mealsfor more expensive full-service restaurant meals and thesubstitution of discounted items on the menu for moreexpensive items. Examples of negative income effects inresponse to reduced consumer income are fewer purchasesof full-service restaurant and fast-food meals and the prep-aration of more meals at home. One can also argue thatthere is a positive income effect on consumers’ purchas-ing power: the discounted price menus at fast-food outletsallow consumers to purchase more meals than they wouldhave been able to, other things equal.2.To induce fast-food customers to eat more healthfulmeals, what alternatives are there to bans? Do you thinkthese alternatives would work? Why or why not?Suggested Solution2.One could tax less healthful items more heavily and alsotry to educate consumers to choose the more healthfulitems. The tax is likely to work because it would inducea substitution effect away from the now more expensiveunhealthful items to the now less expensive healthful ones.Advertising is less likely to work because people appearto have strong preferences for unhealthful foods. In otherwords, consumers are often not rational in their choices.3.What do you think accounts for McDonald’s success?Relate this to concepts discussed in the chapter.Suggested Solution3.It is likely that McDonald’s is more successful than its rivalsbecause it has aggressively expanded both its menu and itsadvertising. By giving customers more choice, the companycan appeal to a wider range of customers, especially thosewho formerly ate in full-service restaurants. It understandsthat different people have different preferences. McDonald’shas also exploited the income effect: spending-constrainedconsumers can purchase their espresso drinks for less atMcDonald’s than at coffeehouses like Starbucks.KrugWellsEC4e_Micro_BCS.indd51/13/151:09 PM

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BCS-6A n s w e r st oB u s i n e s sCAs eQ u e s t i o n sf o rth o u g h tDGraphics Worth: Krugman Economics 3e in Modshere than in the fictional world in which all the booksare the same because readers derive more enjoymentfrom the higher quality of books that successfulwriters produce, as shown by their willingness to payhigher prices.The share of the surplus captured from readers is thensplit between the author, the publisher (if there is one),and the retailer.2.What are the various sources of market power here?What is at risk for the various parties?Suggested Solution2.Successful authors produce a unique product that isprotected by copyright laws. Hence they hold somemarket power that allows them to command higherprices for their books compared to lower quality, morecommodity-like books. Amazon has some market powerderiving from their control of a significant share of theretail capacity in the book market. This has allowedit to capture an increasing share of the surplus thataccrues to authors and their publishers. Amazon hasacquired this capacity through its immensely costlyinvestments in its website and its delivery system. Theultimate source of Amazon’s market power is its inves-tors who have bankrolled these investments on thepromise of future profits.As Amazon attempts to capture a larger share of themarket surplus, successful authors and their publish-ers are at risk of losing surplus to Amazon. Moreover,if publishers are at risk of being forced out of business,successful authors fear that a source of their successwill disappear.Amazon is at risk of losing the backing of these inves-tors who are growing impatient with the many years oflosses. If investors desert it and Amazon loses its abilityto subsidize its expensive investments, then it could loseits dominance in the retail industry.Chapter 141.Explain why Virgin Atlantic and British Airlines mightcollude in response to increased oil prices. Was the mar-ket conducive to collusion or not?Suggested Solution1.They may have wanted to collude because it was reason-able to fear that if one of them raised its price, the otherwould not and so cause a price war. The market was con-ducive to collusion because so much of it was dominatedby British Airways, making it a natural price leader.2.How would you determine whether illegal behavior actu-ally occurred? What might explain these events otherthan illegal behavior?Suggested Solution2.For the airlines’ actions to have been illegal, it wouldhave been necessary for the two companies to make anagreement to coordinate price increases. If one imposedthe surcharge and the other merely followed suit, theiractions would not have been illegal.2.What effect is the introduction of mobile shopping appshaving on competition in the retail market for electronics?On the profitability of brick-and-mortar retailers like BestBuy? What, on average, will be the effect on the consumersurplus of purchasers of these items?Suggested Solution2.The introduction of these apps will make the retail mar-ket for electronics much more competitive, which willreduce the profitability of brick-and-mortar retailerslike Best Buy. The consumer surplus of purchasers willincrease because, on average, they now pay a lower price.3.Why are some retailers responding by having manufac-turers make exclusive versions of products for them? Isthis trend likely to increase or diminish?Suggested Solution3.By carrying products exclusive to their shelves, retail-ers can foil mobile-device comparison shoppers becauseno other store will have the same product. This trend islikely to increase for two reasons: (1) It is a way to avoidthe “commodification” of the items that retailers sell.Because these items differ across retailers, there is noway to do a direct price comparison. (2) More and morepeople are likely to join the ranks of mobile-device com-parison shoppers.Chapter 131.What is the source of surplus in this industry? Whogenerates it? How is it divided among the various agents(author, publisher, and retailer)?Suggested Solution1.To understand the source of the surplus in this indus-try, note that the production is the writing of books byauthors. Surplus is created by trade between authorswho write books and readers who enjoy reading them.Publishers may improve the product by providing edit-ing, marketing, etc., but the ultimate source of produc-tion is in the hands and minds of authors.Now imagine a world in which every author’s style ofwriting is the same. In such a world, nothing would dif-ferentiate a thriller written by Ms. Dagger versus onewritten by Mr. Cloak. Books would be like commodi-ties, making the book industry perfectly competitive.The equilibrium price of books would settle at a levelthat leaves authors indifferent between writing a bookor not. In this world, all of the surplus accrues to read-ers. Note that readers, who value variety, education,and quality in their books, may not enjoy this worldvery much.But the real world does not operate this way. Authorsdo indeed write in different ways. Successful authorswrite well enough that their books command a pricethat allows them to capture some of the market sur-plus (and like Douglas Preston, to live a comfortablelifestyle). Moreover, efforts by publishers in the form ofediting, advertising, etc., can increase the share of thesurplus going to the author by raising readers’ willing-ness to pay for a given book. Total surplus is higherKrugWellsEC4e_Micro_BCS.indd61/13/151:09 PM

Microeconomics: Fourth Edition Solution Manual - Page 8 preview image

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3.Explain the dilemma facing the two airlines as well astheir individual executives.Suggested Solution3.Both the airlines and their individual executives faceda prisoners’ dilemma because the first to confess wouldgain immunity. As the defense lawyer said, it was best toconfess even if there had been no illegal activity in orderto protect oneself. Moreover, it was in the interest ofBritish Airways, once accused, to cut a deal for leniencyand to sacrifice its accused executives.Chapter 151.What explains the complexity of today’s razors and thepace of innovation in their features?Suggested Solution1.The complexity of razors and pace of innovation in theirfeatures are a reflection of the intense non-price compe-tition between Schick and Gillette.2.Why is the razor business so profitable? What explainsthe size of the advertising budgets of Schick and Gillette?Suggested Solution2.The business is so profitable because Schick and Gillettehave been able to convince customers to pay higherprices for more complex razors. Schick and Gillette havelarge advertising budgets to accomplish this.3.What explains the popularity of the Dollar Shave Club?What dilemma do Schick and Gillette face in their deci-sions about whether to maintain their older, simplerrazor models? What does this indicate about the welfarevalue of the innovation in razors?Suggested Solution3.The popularity of the Dollar Shave Club can be explainedby its lower prices. For customers who find that upgrad-ed features are not worth the cost (those who are wel-fare reducing), DSC offers an appealing alternative. Thedilemma that Schick and Gillette face in maintainingtheir older, simpler models is that these cheaper modelscan cannibalize sales of the newer, more complex ones.But if Schick and Gillette don’t maintain these models, acompetitor could, and very well might, undercut them.Chapter 161.Describe the nature of the externality in social mediawebsites.Suggested Solution1.Social media sites work as a network externality becausethey are channels for communication among their users.2.Assume that there are two competing social mediawebsites. Explain why it is likely that one will come todominate. Explain why the decline of a site is likely to beswift, with a cascade of departures.Suggested Solution2.Whenever there is a network externality there is a posi-tive feedback effect: the more other people join the site,the more I will want to join the site. If two sites are ofequal size, then over time it is very likely that events willtip in favor of one site over another—events such as tech-nical problems or too much advertising. Once the declineof a site begins, it will be rapid as the positive feedbackworks in reverse: the more other people leave a site, themore I will want to leave the site.3.Explain the nature of the problem that underminedMySpace relative to Facebook. Is it unique to MySpaceor common to all social media sites?Suggested Solution3.MySpace was undermined by its imperative to makemoney at a time when Facebook was not focused onprofit. Recall that in network externalities the attrac-tiveness of a network is increased the lower the cost ofusing it. So irritating ads, along with a slow and buggyplatform, increased the cost to MySpace users of using itcompared to using Facebook. However, this phenomenonis not unique to MySpace. Facebook has been trying touse its site to make money and, as could be predicted,has alienated many of its users.Chapter 171.Using the concepts you learned in this chapter, explainthe economic incentives behind the huge losses inKenyan wildlife.Suggested Solution1.Unprotected African wildlife and their grazing areas area common resource. It is difficult to stop people fromexploiting them by poaching the animals or turning theland to agricultural use, but any one person’s exploita-tion means fewer animals and less grazing area forthem. Without some economic incentive to conserve thewildlife and their grazing lands, Kenyans will overusethem, leading to huge losses.2.Compare the economic incentives facing John Humewith those facing a Kenyan rancher.Suggested Solution2.Hume’s ownership of a large ranch and the animals onit means that he now has property rights on the com-mon resource, leading him to efficiently maintain thatresource. A Kenyan rancher, who cannot own the wild-life found on his or her land, cannot earn income fromthe animals and so has an incentive to overuse the com-mon resource: killing the wildlife and turning grazingareas into income-producing farmland.3.What regulations should be imposed on a rancher whosells opportunities to trophy hunt? Relate these to theconcepts in the chapter.A n s w e r st oB u s i n e s sCAs eQ u e s t i o n sf o rth o u g h tBCS-7DGraphics Worth: Krugman Economics 3e in ModsKrugWellsEC4e_Micro_BCS.indd71/13/151:09 PM

Microeconomics: Fourth Edition Solution Manual - Page 9 preview image

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2.How does the Costco story fit into our discussion of thereasons similar workers may end up being paid differentwages?Suggested Solution2.Costco and Walmart compete for workers. By paying anabove market wage, an efficiency wage, Costco is induc-ing its workers to be more productive and it is aiming toreduce turnover. Because Costco workers stay in theirjobs longer, they can acquire job skills and experienceand, as a result, have a higher value of marginal product.Therefore, a Costco employee will be paid more than aWalmart employee.3.President Obama, as his speech indicated, would like toencourage more companies to adopt a high-wage strate-gy. Other politicians would like to do the same. What arethe possible positive and negative effects if this becomesofficial government policy?Suggested Solution3.If government policy encourages more companies to actlike Costco, paying higher wages to induce workers tobe more productive, the gains would be direct: higherearnings for many workers, with many of the benefi-ciaries being workers who would otherwise have beenpoorly paid. Also, to the extent that the strategy works,the economy as a whole would become more productiveand richer. There are two possible downsides. First, whatapparently works for Costco might not work for every-one, so costs would rise—and this cost increase wouldbe passed on in the form of higher prices. Second, com-panies could end up hiring fewer workers in total, rais-ing the natural rate of unemployment and hurting thoseworkers who are shut out.Chapter 201.Did AIG accurately assess the default risk that itinsured? Why or why not?Suggested Solution1.AIG did not accurately assess the default risk it insuredbecause its losses far exceeded the premium income ithad earned.2.What did AIG assume about the probabilities of defaultsby different homeowners in the U.S. housing market?Were they wrong or right?Suggested Solution2.AIG assumed that defaults by different homeowners inthe U.S. housing market were independent events. It wasvery clearly wrong since the collapse of the U.S. housingmarket showed that defaults were positively correlated.3.What are the examples of moral hazard in the case? Foreach example, explain who committed the moral hazardand against whom and identify the source of the privateinformation.Suggested Solution3.Regulations should ensure that the rancher, like JohnHume, is committed to the long-term care of theranch and its animals. Regulations should establisheconomic incentives so that the rancher regards thecommon resource as an asset and protects its valueover time.Chapter 181.Why does Norway have to have higher taxes overallthan the United States?Suggested Solution1.Norway provides health care to everyone, generous sup-port for the unemployed, financial assistance to the poor,and so on; all this costs money, so the large welfare staterequires correspondingly high taxes.2.This case suggests that government-paid health carehelps entrepreneurs. How does this relate to the argu-ments for social insurance in the text?Suggested Solution2.As we suggested, guaranteeing health care in the eventof illness can improve everyone’s expected welfare, sinceeveryone knows that he or she might have significantmedical expenses at some point. Similarly, potentialentrepreneurs know that their venture might fail; theirexpected welfare when starting a business is higher ifthey know they won’t lose health coverage even if theirenterprise fails.3.How would the incentives of people like Wiggo Dalmobe affected if Norwegian health care was means-testedinstead of available to all?Suggested Solution3.If Norwegian health coverage was means-tested, itwould act as an effective tax on success: Wiggo Dalmowould have lost his coverage once his business expandedand he began making a lot of money.Chapter 191.Use the marginal productivity theory of income distri-bution to explain how companies like Walmart can payworkers so little that they fall below the poverty line.Suggested Solution1.The marginal productivity theory of income distributionis consistent with a low wage—one that falls below thepoverty rate—if workers have a low value of marginalproduct. This can happen if the job requires very littleskill, education, or job experience. Walmart has designedits business so that this is the case. For example,Walmart touts its low prices but not its customer service.As a consequence of paying low wages, Walmart hashigh worker turnover. And high worker turnover meansthat the average Walmart worker has a low value of mar-ginal product because she has not acquired job skills orexperience.BCS-8A n s w e r st oB u s i n e s sCAs eQ u e s t i o n sf o rth o u g h tDGraphics Worth: Krugman Economics 3e in ModsKrugWellsEC4e_Micro_BCS.indd81/13/151:09 PM

Microeconomics: Fourth Edition Solution Manual - Page 10 preview image

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Suggested Solution3.There are several examples of moral hazard in the case:a.By preventing AIG’s auditors from inspecting thedivision’s books, Cassano committed moral hazardagainst AIG. He had private information about theextent of the risk to which he had exposed AIG.b.Goldman Sachs and other investment banks thatinsured bonds they knew were likely to default com-mitted moral hazard against AIG. They had privateinformation about the quality of the bonds for whichthey purchased CDS insurance.c.AIG committed moral hazard against its insurees byplacing its Financial Products Division in London,outside the reach of U.S. regulations. It (or, moreaccurately, Cassano) had private information aboutAIG’s insufficient capital for the risks it was under-taking. This was moral hazard against its insureesbecause in the event of loss, AIG would not haveenough capital to pay their claims.4.Cite an example of adverse selection from the case. Whatwas the source of the private information?Suggested Solution4.AIG faced adverse selection in insuring mortgage-backedsecurities because some investors, like Goldman Sachs,had private information about the likelihood of thedefault of their bonds.A n s w e r st oB u s i n e s sCAs eQ u e s t i o n sf o rth o u g h tBCS-9DGraphics Worth: Krugman Economics 3e in ModsKrugWellsEC4e_Micro_BCS.indd91/13/151:09 PM

Microeconomics: Fourth Edition Solution Manual - Page 11 preview image

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Solution1.In each of the following situations, identify which of the twelve principles is at work.a.You choose to shop at the local discount store rather than paying a higher pricefor the same merchandise at the local department store.b.On your spring break trip, your budget is limited to $35 a day.c.The student union provides a website on which departing students can sell itemssuch as used books, appliances, and furniture rather than giving them away totheir roommates as they formerly did.d.After a hurricane did extensive damage to homes on the island of St. Crispin,homeowners wanted to purchase many more building materials and hire manymore workers than were available on the island. As a result, prices for goods andservices rose dramatically across the board.e.You buy a used textbook from your roommate. Your roommate uses the money tobuy songs from iTunes.f.You decide how many cups of coffee to have when studying the night before anexam by considering how much more work you can do by having another cup ver-sus how jittery it will make you feel.g.There is limited lab space available to do the project required in Chemistry 101.The lab supervisor assigns lab time to each student based on when that student isable to come.h.You realize that you can graduate a semester early by forgoing a semester of studyabroad.i.At the student union, there is a bulletin board on which people advertise useditems for sale, such as bicycles. Once you have adjusted for differences in quality,all the bikes sell for about the same price.j.You are better at performing lab experiments, and your lab partner is better atwriting lab reports. So the two of you agree that you will do all the experiments,and she will write up all the reports.k.State governments mandate that it is illegal to drive without passing a driving exam.l.Your parents’ after- tax income has increased because of a tax cut passed byCongress. They therefore increase your allowance, which you spend on a springbreak vacation.1.a.People usually exploit opportunities to make themselves better off. In this case,you make yourself better off by buying merchandise at a lower price.b.Resources are scarce. Since you have only $35 a day, your resources are limited(scarce).c.Markets usually lead to efficiency. The market here is represented by the buyersand sellers who use the student union website to trade goods, in contrast to the“nonmarket” of simply giving items away to one’s roommate. The market is effi-cient because it enables people who want to sell items to find those who want tobuy those items. This is in contrast to a system in which items are simply left witha roommate, who may have little or no desire to have them.S-11CHAPTERFirst PrinciplesKrugWellsECPS4e_Micro_CH01.inddS-1KrugWellsECPS4e_Micro_CH01.inddS-19/23/149:35 AM9/23/149:35 AM

Microeconomics: Fourth Edition Solution Manual - Page 12 preview image

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Solutiond.Overall spending sometimes gets out of line with the economy’s productive capac-ity. The spending by St. Crispin homeowners on building materials and workersfell short of the economy’s ability to produce those goods and services. As a result,prices on the island rose across the board (inflation).e.One person’s spending is another person’s income. Your spending on the usedtextbook is your roommate’s income.f.“How much” is a decision at the margin. Your decision is one of “how much”coffee to consume, and you evaluate the trade- off between keeping yourself awakeand becoming more jittery from one more cup of coffee.g.Resources should be used as efficiently as possible to achieve society’s goals.Allocating scarce lab space according to when each student can use that space isefficient.h.The real cost of something is what you must give up to get it. The real cost of asemester abroad is giving up the opportunity to graduate early.i.Markets move toward equilibrium. Any bicycle a buyer chooses will leave him orher equally well off. That is, a buyer who chooses a particular bicycle cannot changeactions and find another bicycle that makes him or her better off. Also, no sellercan take a different action that makes him or her better off: no seller can charge ahigher price for a bicycle of similar quality, since no one would buy that bicycle.j.There are gains from trade. If each person specializes in what he or she is good at(that is, in comparison with others that person has an advantage in producingthat good), then there will be gains from specialization and trade.k.When markets don’t achieve efficiency, government intervention can improvesociety’s welfare. Unsafe drivers don’t take into account the dangers they pose toothers and often to themselves. So when unsafe drivers are allowed to drive, every-one is made worse off. Government intervention improves society’s welfare byassuring a minimum level of competence in driving.l.Government policies can change spending. In this case, a tax cut has increasedspending.2.Describe some of the opportunity costs when you decide to do the following.a.Attend college instead of taking a jobb.Watch a movie instead of studying for an examc.Ride the bus instead of driving your car2.a.One of the opportunity costs of going to college is not being able to take a job.By choosing to go to college, you give up the income you would have earned onthe job and the valuable on- the - job experience you would have acquired. Anotheropportunity cost of going to college is the cost of tuition, books, supplies, and soon. Alternatively, the benefit of going to college is being able to find a better, morehighly paid job after graduation in addition to the joy of learning.b.Watching the movie gives you a certain benefit, but allocating your time (a scarceresource) to watching the movie also involves the opportunity cost of not beingable to study for the exam. As a result, you will likely get a lower grade on theexam—and all that that implies.c.Riding the bus gets you where you need to go more cheaply than, but probably notas conveniently as, driving your car. That is, some of the opportunity costs oftaking the bus involve waiting for the bus, having to walk from the bus stop towhere you need to go rather than parking right outside the building, and probablya slower journey. If the opportunity cost of your time is high (your time isvaluable), these costs may be prohibitive.S-2C H A P T E R1F I R S TP R I N C I P L E SKrugWellsECPS4e_Micro_CH01.inddS-2KrugWellsECPS4e_Micro_CH01.inddS-29/23/149:35 AM9/23/149:35 AM

Microeconomics: Fourth Edition Solution Manual - Page 13 preview image

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C H A P T E R1F I R S TP R I N C I P L E SS-3Solution3.Liza needs to buy a textbook for the next economics class. The price at the collegebookstore is $65. One online site offers it for $55 and another site, for $57. Allprices include sales tax. The accompanying table indicates the typical shipping andhandling charges for the textbook ordered online.a.What is the opportunity cost of buying online instead of at the bookstore? Notethat if you buy the book online, you must wait to get it.b. Show the relevant choices for this student. What determines which of theseoptions the student will choose?3.a.The opportunity cost of buying online is whatever you must give up to get thebook online. So the opportunity cost of buying online is the sum of the shippingcharges plus the opportunity cost of your time spent waiting for the book to arrive(at the bookstore the book is available immediately) minus the cost saving youreceive by buying online versus buying at the bookstore.b.Below is a list of all of Liza’s options and their purely monetary costs:Buy from bookstore$65Buy from first site (price $55), 1-day delivery$55 + $13.98=$68.98Buy from first site (price $55), 2-day delivery$55 + $08.98=$63.98Buy from first site (price $55), 3- to 7-day delivery$55 + $03.99=$58.99Buy from second site (price $57), 1-day delivery$57 + $13.98=$70.98Buy from second site (price $57), 2-day delivery$57 + $08.98=$65.98Buy from second site (price $57), 3- to 7-day delivery$57 + $03.99 = $60.99It is clear that Liza would never buy from the second site, where the book costs$57: for each delivery time, she is better off buying the book from the first site,where the book costs $55. It is also clear that she would never buy the book fromthe first site and have it delivered the next business day: it costs more that way($68.98) than getting it from the bookstore (assuming that it is costless to get toand from the bookstore). But it is not clear whether she will buy the book fromthe bookstore or the first site with delivery times of 2 or 3–7 days: this depends onher opportunity cost of time. The higher the cost of waiting, the more likely she isto buy the book from the bookstore, where she does not need to wait.4.Use the concept of opportunity cost to explain the following.a.More people choose to get graduate degrees when the job market is poor.b.More people choose to do their own home repairs when the economy is slow andhourly wages are down.c.There are more parks in suburban than in urban areas.d.Convenience stores, which have higher prices than supermarkets, cater to busypeople.e.Fewer students enroll in classes that meet before 10:00A.M.ShippingDeliverymethodtimeChargeStandard shipping3–7 days$3.99Second-day air2 business days8.98Next-day air1 business day13.98KrugWellsECPS4e_Micro_CH01.inddS-3KrugWellsECPS4e_Micro_CH01.inddS-39/23/149:35 AM9/23/149:35 AM

Microeconomics: Fourth Edition Solution Manual - Page 14 preview image

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SolutionSolution4.a.The worse the job market, the lower the opportunity cost of getting a graduatedegree. One of the opportunity costs of going to graduate school is not being ableto work. But if the job market is bad, the salary you can expect to earn is low oryou might be unemployed—so the opportunity cost of going to school is also low.b.When the economy is slow, the opportunity cost of people’s time is also lower: thewages they could earn by working longer hours are lower than when the economyis booming. As a result, the opportunity cost of spending time doing your ownrepairs is lower—so more people will decide to do their own repairs.c.The opportunity cost of parkland is lower in suburban areas. The price per squarefoot of land is much higher in urban than in suburban areas. By creating park-land, you therefore give up the opportunity to make much more money in citiesthan in the suburbs.d.The opportunity cost of time is higher for busy people. Driving long distances tosupermarkets takes time that could be spent doing other things. Therefore, busypeople are more likely to use a nearby convenience store.e.Before 10:00A.M. the opportunity cost of time for many students is very high—itmeans giving up an extra hour’s sleep. That extra hour is much more valuablebefore 10:00A.M. than later in the day.5.In the following examples, state how you would use the principle of marginal analy-sis to make a decision.a.Deciding how many days to wait before doing your laundryb.Deciding how much library research to do before writing your term paperc.Deciding how many bags of chips to eatd.Deciding how many lectures of a class to skip5.a.Each day that you wait to do your laundry imposes a cost: you have fewer cleanclothes to choose from. But each day that you wait also confers a benefit: you canspend your time doing other things. You will wait another day to do your laundryif the benefit of waiting to do the laundry that day is greater than the cost.b.The more research you do, the better your paper will be. But there is also anopportunity cost: every additional hour you spend doing research means you can-not do other things. You will weigh the opportunity cost of doing one more hourof research against the benefit gained (in terms of an improved paper) from doingresearch. You will do one more hour of research if the benefit of that hour out-weighs the cost.c.Each bag of chips you eat gives you a benefit: it satisfies your hunger. But it alsohas a cost: the money spent for each bag (and, if you are weight- conscious, theadditional calories). You will weigh the cost against the benefit of eating one morebag. If the cost is less than the benefit, you will eat that one more bag of chips.d.Each lecture that you skip implies a cost: getting further behind with the materialand having to teach it to yourself just before the exam. But each skipped lecturealso means you can spend the time doing other things. You will continue to skiplectures if the cost of skipping is lower than the benefit of spending that timedoing other things.6.This morning you made the following individual choices: you bought a bagel andcoffee at the local café, you drove to school in your car during rush hour, and youtyped your roommate’s term paper because you are a fast typist—in return for whichshe will do your laundry for a month. For each of these actions, describe how yourindividual choices interacted with the individual choices made by others. Were otherpeople left better off or worse off by your choices in each case?S-4C H A P T E R1F I R S TP R I N C I P L E SKrugWellsECPS4e_Micro_CH01.inddS-4KrugWellsECPS4e_Micro_CH01.inddS-49/23/149:35 AM9/23/149:35 AM

Microeconomics: Fourth Edition Solution Manual - Page 15 preview image

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C H A P T E R1F I R S TP R I N C I P L E SS-5SolutionSolutionSolution6.When you bought the bagel and coffee, you paid a price for them. You would nothave bought that breakfast if your enjoyment of it (your welfare) had not been great-er than the price you paid. Similarly, the café owner would not have sold you thebagel and coffee if the price he received from you were less than the cost to him ofmaking them. This is an example of how everybody gains from trade: both you andthe café owner are better off.When you chose to drive your car during the rush hour, you added to the congestionon the road. Your choice had a side effect for other motorists: your driving slowedeverybody else down just a little bit more. Your choice made other motorists worse off.Typing your roommate’s term paper in exchange for her doing your laundry is anoth-er example of the gains that come from trade. Both of you voluntarily agreed tospecialize in a task that each is comparatively better at because you expected to gainfrom this interaction. Your choice made both you and your roommate better off.7.The Hatfield family lives on the east side of the Hatatoochie River, and the McCoyfamily lives on the west side. Each family’s diet consists of fried chicken and corn-on- the - cob, and each is self- sufficient, raising their own chickens and growing theirown corn. Explain the conditions under which each of the following would be true.a.The two families are made better off when the Hatfields specialize in raising chick-ens, the McCoys specialize in growing corn, and the two families trade.b.The two families are made better off when the McCoys specialize in raising chick-ens, the Hatfields specialize in growing corn, and the two families trade.7.a.Gains from trade usually arise from specialization. If the Hatfields (comparedto the McCoys) are better at raising chickens and the McCoys (compared to theHatfields) are better at growing corn, then there will be gains from specializationand trade.b.Similar to the answer to part a, if the McCoys (compared to the Hatfields) arebetter at raising chickens and the Hatfields (compared to the McCoys) are betterat growing corn, then there will be gains from specialization and trade.8.Which of the following situations describes an equilibrium? Which does not? If thesituation does not describe an equilibrium, what would an equilibrium look like?a.Many people regularly commute from the suburbs to downtown Pleasantville. Dueto traffic congestion, the trip takes 30 minutes when you travel by highway butonly 15 minutes when you go by side streets.b.At the intersection of Main and Broadway are two gas stations. One stationcharges $3.00 per gallon for regular gas and the other charges $2.85 per gallon.Customers can get service immediately at the first station but must wait in a longline at the second.c.Every student enrolled in Economics 101 must also attend a weekly tutorial. This yearthere are two sections offered: section A and section B, which meet at the same timein adjoining classrooms and are taught by equally competent instructors. Section A isovercrowded, with people sitting on the floor and often unable to see what is writtenon the board at the front of the room. Section B has many empty seats.8.a.This is not an equilibrium. Assume that all people care about is the travel time towork (not, for instance, how many turns they need to make or what the sceneryis like). Some people could be better off using the side streets, which would cutdown their travel time. Eventually, as the situation moves to equilibrium (that is,as more people use the side streets), travel times on the highway and along theside streets will equalize.KrugWellsECPS4e_Micro_CH01.inddS-5KrugWellsECPS4e_Micro_CH01.inddS-59/23/149:35 AM9/23/149:35 AM

Microeconomics: Fourth Edition Solution Manual - Page 16 preview image

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Solutionb.This might be an equilibrium. Those who buy gas at the first station would beworse off by buying gas at the second if the value of their time spent waitingexceeded the savings at the pump: they would save 15 cents per gallon but wouldincur the opportunity cost of waiting in a long line. You should expect very busypeople (a high opportunity cost of time) to buy gas at the first station. Thosewho buy gas at the second station might be worse off by buying gas at the first:they would not have to wait in line but would pay 15 cents more per gallon. Youshould expect people with a lot of free time (a low opportunity cost of time) tobuy gas at the second station.c.This is not an equilibrium. If students from section A attended section B instead,they would be better off: they could get seats and see the board without incurringany cost (since the section meets at the same time and is taught by an equallycompetent instructor). Over time, you should expect students to switch fromsection A to section B until equilibrium is established.9.In each of the following cases, explain whether you think the situation is efficient ornot. If it is not efficient, why not? What actions would make the situation efficient?a.Electricity is included in the rent at your dorm. Some residents in your dorm leavelights, computers, and appliances on when they are not in their rooms.b.Although they cost the same amount to prepare, the cafeteria in your dorm con-sistently provides too many dishes that diners don’t like, such as tofu casserole,and too few dishes that diners do like, such as roast turkey with dressing.c.The enrollment for a particular course exceeds the spaces available. Some studentswho need to take this course to complete their major are unable to get a spaceeven though others who are taking it as an elective do get a space.9.a.This is not efficient. If the lights were turned off, some students could be madebetter off without making other students worse off because the college would savemoney on electricity that it could spend on student programs. By leaving lightsand appliances on when leaving their rooms, residents do not take into accountthe negative side effect they impose on their college—the higher cost of electricity.If students were forced to pay their own individual electricity costs (that is, if theyfully took into account the cost of their actions), then they would turn the lightsand appliances off when leaving their rooms. This situation would be efficient.b.This is not efficient. Instead of serving dishes that many diners do not like, the caf-eteria should serve more of the equal-cost dishes that diners do like. That way, somestudents could be made better off without other students being made worse off.c.This is not efficient. In an efficient scheme, spaces would be allocated to thosestudents who value them most. In this case, however, some spaces are allocatedto students who value them less (those who take the course as an elective) thanother students (those who need the course to graduate). Efficiency could beimproved as follows: if a student who is not currently enrolled in the course val-ues it more than a student who is enrolled, then the unenrolled student should bewilling to pay the enrolled student to give up his or her space. At some price, thistrade would make both students better off and the outcome would be efficient.10.Discuss the efficiency and equity implications of each of the following policies. Howwould you go about balancing the concerns of equity and efficiency in these areas?a.The government pays the full tuition for every college student to study whateversubject he or she wishes.b.When people lose their jobs, the government provides unemployment benefitsuntil they find new ones.S-6C H A P T E R1F I R S TP R I N C I P L E SKrugWellsECPS4e_Micro_CH01.inddS-6KrugWellsECPS4e_Micro_CH01.inddS-69/23/149:35 AM9/23/149:35 AM

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