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Solution Manual for Macroeconomics: Principles, Applications, and Tools, 10th Edition

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    Microeconomics: Principles, Applications and Tools Tenth Edition Arthur O’Sullivan Steven M. Sheffrin Stephen J. Perez Resource Manual (Download Only) for Microeconomics: Principles, Applications and Tools Jeffrey Phillips

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    Contents Chapter 1 Introduction: What Is Economics?  1 Chapter 2 The Key Principles of Economics  12 Chapter 3 Exchange and Markets  25 Chapter 4 Demand, Supply, and Market Equilibrium  35 Chapter 5 Elasticity: A Measure of Responsiveness  53 Chapter 6 Market Efficiency and Government Intervention  66 Chapter 7 Consumer Choice: Utility Theory and Insights from Neuroscience  82 Chapter 8 Production Technology and Cost  91 Chapter 9 Perfect Competition  102 Chapter 10 Monopoly and Price Discrimination  116 Chapter 11 Market Entry and Monopolistic Competition  127 Chapter 12 Oligopoly and Strategic Behavior  136 Chapter 13 Controlling Market Power: Antitrust and Regulation  150 Chapter 14 Imperfect Information: Adverse Selection and Moral Hazard  159 Chapter 15 Public Goods and Public Choice  171 Chapter 16 External Costs and Environmental Policy  179 Chapter 17 The Labor Market and the Distribution of Income  193 Chapter 18 International Trade and Public Policy  206

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    1 1 Introduction: What Is Economics? Chapter Summary Chapter 1 provides a basic illustration of what economics is and why it is useful. Economics is the study of the choices people, firms, and governments make when resources are scarce. Economic analysis helps us understand the consequences of these choices. Here are the main points of the chapter:  Most of modern economics is based on positive analysis, which answers the question “Wha t is ?” or “What will be ?”  Economies must answer three questions: What products do we produce? How do we produce the products? Who consumes the products?  Normative analysis answers the question “What ought to be ?”  To think like an economist, we (a) use assumptions, (b) use the notion of ceteris paribus , (c) think in marginal terms, and (d) assume that rational people respond to incentives.  Macroeconomics helps us understand why economies grow and understand economic fluctuations. Microeconomics helps us understand how markets work. Learning Objectives: 1.1 What is Economics? List the three key economic questions. 1.2 Economic Analysis and Modern Problems: Discuss the insights from economics for a real-world problem such as congestion. 1.3 The Economic Way of Thinking: List the four elements of the economic way of thinking. 1.4 Employability —Economic Logic on the Job: Explain how studying economics improves a person’s employment prospects. 1.5 Preview of Coming Attractions — Macroeconomics: List three ways to use macroeconomics. 1.6 Preview of Coming Attractions — Microeconomics: List three ways to use microeconomics. Approaching the Material The first classes are very important in determining your students’ attitudes toward economics. You have to find out their attitude and use real-world examples that help them understand that economics relates to their lives. Stating to the class that economics is “The study of how scarce resources are allocated to satisfy unlimited wants” is accurate but is also one of the reasons why some people still refer to economics as “the dismal science.” Try the following definition of economics instead: “Economics is the study of how you, your friends, the stores where you shop, and your mayor make choices.” Ever y student in front of you makes choices everyday — what to wear, what to have for breakfast, or whether to sleep in, whether to study or play video games. Students allocate resources all day long. Time is one resource that everyone can relate to and everyone has the same amount of. Use what students know to teach them what you want them to know.

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    2 O'Sullivan/Sheffrin/Perez, Microeconomics, 10e Chapter Outline 1.1 What Is Economics? A. Scarcity: the resources we use to produce goods and services are limited. Economics is the study of choices when there is scarcity.  Teaching Tip Students have scarce resources they have to allocate. Ask the class who had breakfast this morning. You should have a room full of both breakfasters and those who did not eat. Ask those who did not eat breakfast why not. Someone is sure to say they did not have the time. Explain that we all have the same amount of time (a scarce resource), but we choose to allocate it differently. (i.e., sleep in, workout, study, eat breakfast). B. Factors of Production Factors of production: the resources used to produce goods and services, also known as production inputs. Natural resources: the resources provided by nature and used to produce goods and services. Labor: the physical and mental effort people use to produce goods and services. Physical capital: the stock of equipment, machines, structures, and infrastructure that is used to produce goods and services. Human capital: the knowledge and skills acquired by a worker through education and experience. Entrepreneurship: the effort used to coordinate the factors of production — natural resources, labor, physical capital, and human capital — to produce and sell products. C. Positive versus Normative Analysis 1. Positive analysis answers the questions “ What is?” or “ What will be?” a. For example: What is the effect on poverty of a living wage ordinance? Or, What is the effect on a city’s costs of a living wage ordinance? 2. Normative analysis answers questions of “ W hat ought to be?” a. For example: Should a city implement a living wage ordinance?  Teaching Tip Tell the students that Mr. Alumni Bigbucks has donated 50 million dollars to the university. The following question is an example of positive analysis: Should the donation be used to build a new stadium or a state-of-the art library/technology center? The following question is an example of normative analysis: What do they think should be built and why? D. The Three Key Economic Questions The choices made by individuals, firms, or governments answer three fundamental questions: 1. What goods and services do we produce? 2. How do we produce these goods and services? 3. Who consumes the goods and services that are produced?

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    Chapter 1: Introduction: What Is Economics? 3  Teaching Tip Now is a good time to introduce the concept of markets indirectly. Consumers decide what is produced and for whom; businesses decide how the products are produced. E. Economic Models An economic model is a simplified representation of an economic environment, often employing a graph. For example, economists use the model of a market to analyze the effects of public policy on economic outcomes. 1.2 Economic Analysis and Modern Problems Economic analysis can provide insights into real-world problems such as: A. Economic View of Traffic Congestion: problem is solved by paying tolls. B. Trade-offs from International Trade: there are winners and losers (or trade-offs) associated with specialization and trade. C. Economic View of Managing the U.S. Economy: governments throughout the world intervene to try and help their economies. 1.3 The Economic Way of Thinking A. Use of Assumptions to Simplify and Facilitate Learning B. Isolate Variables — Ceteris Paribus A variable is a measure of something that can take on different values. The ceteris paribus is a Latin expression meaning other variables being held fixed. The assumption is that when we consider changes in one variable, we hold all other variables constant.  Teaching Tip Ask the students to recall doing experiments in high school science (chemistry) classes. Remind them that in order to obtain reliable results, they had to change only one component while holding other components constant. C. Thinking at the Margin Economists consider small, incremental changes to determine whether or not it is desirable to change the level of economic activity. A small, one-unit change in value is known as a marginal change . For example, should you eat the fourth piece of pizza if you aren’t hungry? D. Rational People Respond to Incentives  Teaching Tip Self-interest is not the same as selfishness. Ask the students to think about all of the things their parents have done for them over the years. Not selfish but certainly in the parent’s self - interest.

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    4 O'Sullivan/Sheffrin/Perez, Microeconomics, 10e E. Example: Southern California Addresses Its Congestion Problem The Southern California Council of Governments (SCAG) advocates a congestion tax (or “decongestion fee”) that would be paid by drivers who use roads during peak periods. A similar plan was implemented in Stockholm, which experienced a 20 percent decrease in traffic as a result.  Teaching Tip Ask the students what other pricing schemes London could have used to reduce congestion — free public transportation, alternative work hours, higher parking rates.  Teaching Tip Almost every college campus in America lacks enough spaces for those who want to park. Discuss the current parking policy at your university. Ask the students to use economic analysis to come up with alternative policies to solve the parking problem (small groups should work well here). The possible solutions should include raising parking fees, restricting parking by types of parkers (no freshman, faculty/staff only), remote parking with free shuttles, altering class schedules, rewards for car pooling, and expanding parking spaces. Review these key questions and their related Applications: Question 1: How do people respond to incentives? APPLICATION 1: INCENTIVES TO INSTALL ROOFTOP SOLAR PANELS The federal government is offering a tax credit for homeowners to install rooftop solar panels to generate electricity. Studies have shown that consumers are very responsive to tax incentives for solar power, especially if they pay a relatively high price for electricity. Question 2: What is the role of prices in allocating resources? APPLICATION 2: HOUSING PRICES IN CUBA The Cuban government confiscated most housing in 1960 and did not allow homeowners to sell their property. As a result, the housing stock deteriorated because there was little incentive to repair it. Housing reforms allowed the sale and purchase of homes in Cuba in 2011. These reforms increase incentives and are expected to increase construction of houses. 1.4 Employability: Economic Logic on the Job Economics involves making choices. There are many examples of jobs in the real world where economic analysis can be applied in making decisions.

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    Chapter 1: Introduction: What Is Economics? 5 1.5 Preview of Coming Attractions: Macroeconomics Macroeconomics is the study of the nation’s economy as a whole; it focuses on the issues of inflation, unemployment, and economic growth. A. Why Study Macroeconomics? 1. To understand why economies grow 2. To understand economic fluctuations 3. To make informed business decisions 1.6 Preview of Coming Attractions: Microeconomics Microeconomics is the study of the choices made by households, firms, and the government, and how these choices affect the markets for goods and services. A. Why Study Microeconomics? 1. To understand markets and predict changes 2. To make personal or managerial decisions 3. To evaluate public policies Additional Applications to Use in Class Question: Does a real estate agent have an incentive to get you the highest price? ADDITIONAL APPLICATION: FREAKONOMICS Source: Motley Fool audio interview with economist Steven Levitt Interviewed by David Gardner “Freakonomics” Summary: Key Points in the Article This audio clip features an interview with one of the authors of the best-selling book Freakonomics . Economist Steven Levitt answers a host of questions typically not tackled by most economists. One of the questions is related to realtors and agency relationships. In other words, do realtors really work for real estate sellers? According to Levitt, it is in the best interest of the realtor to convince sellers to take an offer lower than they would receive if the property remained on the market. Since the percentage of the sales price that real estate salespersons receive from selling a house is a very small fraction, a $10,000 increase in sales price might net a real estate professional another $150 commission for a tremendous amount of additional work. Therefore, it is in the real estate salesperson’s best interest to convince the seller to make the quick sale and take the first reasonable offer. Levitt points toward evidence that real estate professionals tend to leave their own properties on the market longer and receive 2 percent to 3 percent more in sales price. Levitt addresses many other issues including market efficiency, horse racing, and drug dealing in this interview. Listen to the clip for Levitt’s economic explanation of numerous topics. Analyzing the News Levitt’s primary contribution is his application of economic thought to a number of topics typically not addressed by economics. As you will hear, economics is truly a social science that can be used to explain quite a bit of human behavior.

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    6 O'Sullivan/Sheffrin/Perez, Microeconomics, 10e Thinking Critically Questions 1. What is “freakonomics?” 2. Why would the illustration of “realtors” and not maximizing sales price for sellers be an economic topic? 3. Are the stock markets efficient according to Levitt?  Teaching Tip This is a great example of how people’s incentives are often not the same. Although the real estate agent works for the seller, their interests regarding holding out for a higher price are not the same. Question: How does a tightening of discretionary income affect luxury industries? ADDITIONAL APPLICATION: SPORTSBIZ: GOLF INDUSTRY GETS HIT HARD Sweet, David “SportsBiz: Golf Industry Gets Hit Hard” Posted 12/3/2008 on MSNBC.com Summary: Key Points in the Article Golf courses are not only on hold in the United States, but also many are being converted to other uses. The 1990s saw tremendous expansion in the sport, which is now being reversed as many people forgo the game due to tight budgets. More courses are closing this year than are opening, and openings are the lowest in 20 years. In addition, many new courses are tied to housing projects that are currently mothballed due to the flagging housing market. Equipment sales are down as well as rounds played. The one bright spot appears to be China. One course designer formerly in high demand in the United States is now focusing on China’s growing appetite for the game. Analyzing the News Golf is a game that consumes discretionary income. As more people look for ways to reduce spending either due to job loss or conservation of cash, golf may be one of the first luxuries to go. It appears that the recession may be impacting all levels of income. You may begin to see a reduction in price as shown in the graph as golf courses attempt to draw customers back to the green. Of course, if the number of golf courses in the United States falls even further, you would see a leftward shift in supply that might help the surviving courses. Thinking Critically Questions 1. What is causing the leftward shift in demand for golf? 2. How do expectations cause demand shifts? 3. Why is China experiencing a golf boom?

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    Chapter 1: Introduction: What Is Economics? 7 Question: Should people invest in low-cost health insurance? ADDITIONAL APPLICATION: IS LOW-COST HEALTH INSURANCE WORTH IT? McCormack, Karyn “Is Low- Cost Health Insurance Worth It?” Posted 8/04/2008 on MSNBC.com Businessweek Summary: Key Points in the Article Some of the low-cost health insurance plans currently being pitched on television may not be worth the price. A couple of options limit coverage so that any surgery or hospitalization is capped at less than $1,200. The primary coverage is minor medical instead of major medical. Critics maintain that policies of this nature do little for the insured since any major medical event would result in thousands of dollars of expenses not paid by the plans. However, representatives at one of the companies said that company representatives will negotiate large bills on behalf of their clients. The company, iCan, maintains that their network pricing clout and negotiation will reduce a typical $50,000 bill to around $10,000 to $12,000. There are currently 47 million uninsured Americans that may opt for these low-cost mini-medical plans. However, even at the low end price of $160 a month for individuals and $260 a month for families these plans may stress a lot of budgets. Analyzing the News Access to medical care is a critical issue in the United States. Does everyone have access to treatment? Probably not equally and many people are forced into bankruptcy every year due to high medical bills. Expect to see continued debate over this issue after the presidential election. Thinking Critically Questions 1. Why is this issue important? 2. What are some options for the government to debate? 3. What forms of nationalized health care currently exist? Appendix A Using Graphs and Percentages 1A.1 Using Graphs A. Graphing Single Variables 1. Pie charts 2. Bar graphs 3. Line graphs Students who are not familiar with graphs will need lots of time here. Give them simple data, and let them create their own pie charts and bar graphs. B. Graphing Two Variables 1. Two variable graphs use both the horizontal and vertical axis. 2. Play “connect the dots” to determine points on the line.

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    8 O'Sullivan/Sheffrin/Perez, Microeconomics, 10e  Teaching Tip Have the students create graphs without numbers. Using concepts they are familiar with (Hours of study, G.P.A.), have them draw the line that shows the general shape of the relationship. Positive relationship: a relationship in which two variables move in the same direction. Negative relationship : a relationship in which two variables move in opposite directions. C. Computing the Slope Slope of the curve is the vertical difference between two points (the rise ) divided by the horizontal difference (the run ).  Teaching Tip Most students should be familiar with the concept of slope, but it is worth your time to go step by step for at least a few problems. D. Moving along the Curve versus Shifting the Curve 1. Variables in the graph versus variables not in the graph 2. Changing variables in the graph — movement along the curve 3. Changing variables not in the graph — movement of the curve Emphasize that the Y-intercept represents variables not in the graph. E. Graphing Negative Relationships Illustrate the negative relationship between downloads and CDs purchased. Most students should not have a problem with the concept of a negative relationship.  Teaching Tip Ask students to come up with three pairs of variables that have a negative relationship. F. Graphing Nonlinear Relationships Show students what a nonlinear relationship looks like. Unless you have an unusual class, you should avoid using calculus to explain nonlinear relationships. An explanation of how there may not be a constant relationship between variables would be useful. 1A.2 Computing Percentage Changes and Using Equations A. Computing Percentage Changes Use the formulas to show students how to compute percentage change. Several examples may be necessary.  Teaching Tip Most students are shoppers. Use concepts like “20 percent off” sales to help them understand this concept .

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    Chapter 1: Introduction: What Is Economics? 9 Review this key question and the related application: Question 3: How do we compute percentage changes? APPLICATION 3: THE PERILS OF PERCENTAGES This Application explains how in the 1970s the government of Mexico City repainted highway lines to make a four-lane highway into a six-lane highway and then turned it back into a four-lane highway. When reporting on the results of those changes in lanes on the highway, the government incorrectly reported the percentage changes of the effects of redoing the highway because they used the simple approach to computing percentage changes. Thi s shows that percentage calculations can be inaccurate, if you’re not careful. It’s important to remember that the midpoint formula accurately records percentage changes. B. Using Equations to Compute Missing Values Follow the formulas in the book. As this is basic algebra, students should be well-versed, but a few in-class problems should be helpful.

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    Chapter 1: Introduction: What Is Economics? 9 Solutions to End-of-Chapter Exercises Chapter 1 SECTION 1.1: WHAT IS ECONOMICS? 1.1 what, how, Who 1.2 natural resources, labor, physical capital, human capital, entrepreneurship 1.3 statement “a.” is TRUE 1.4 a. normative b. positive c. normative d. normative e. positive SECTION 1.2: ECONOMIC ANALYSIS AND MODERN PROBLEMS 2.1 b. 2.2 benefits, prices. 2.3 workers displaced by international trade. 2.4 inflation. SECTION 1.3: THE ECONOMIC WAY OF THINKING 3.1 the earth is flat, the roads are flat 3.2 assumptions, use of ceteris paribus to isolate variables, margin, incentives 3.3 b. 3.4 8 3.5 housing repair and maintenance 3.6 false Critical Thinking 1. Hillyland specializes in coffee, and Flatland specializes in rice. Consumers benefit because the price of rice decreases in Hillyland and the price of coffee decreases in Flatland. Rice workers in Hillyland lose their jobs, and so do coffee workers in Flatland. The negative job effects will persist until displaced workers make the transition to the other job.

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    10 O'Sullivan/Sheffrin/Perez, Microeconomics, 10e 2. The decrease in price decreases the incentive for maintenance and repair, so the quality of housing will decrease over time as the owner spends less on maintenance and repair. Chapter 1 Appendix 1. a. b. $5.00, hours/month c. $15.00 d. 6 additional hours

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    Chapter 1: Introduction: What Is Economics? 11 2. $20, $4.00, 10, $60, $80 3. a. b. -2.0 movies, CD 4. a. Number of Deliveries Total Costs 0 50 5 90 10 130 15 170 20 210 b. $8.00, delivery c. Drivers’ wages and the rental cost of the truck. In addition, the other costs of delivery, such as the price of fuel, insurance, and taxes. d. deliveries e. drivers’ wages, the rental cost of the truck, or the price of fuel 5. along, shifts 6. 10.0%, -2.0%, 6.0% 7. 112, 54, 23 8. 40% = 20/50, 33% = 20/60

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    12 2 The Key Principles of Economics Chapter Summary Chapter 2 introduces the key principles that are central to all economic theory:  The principle of opportunity cost states that the opportunity cost of something is what you sacrifice to get it. Opportunity costs in production are generally increasing, and thus, the production possibilities curve is bowed outward.  The marginal principle states that any activity should be increased as long as the marginal benefits of the additional activity exceed the marginal costs.  The principle of voluntary exchange states that a voluntary exchange between two people makes both people better off.  The principle of diminishing returns states that, in the short run, if use of one input is increased while all others are held constant, production will eventually increase at a decreasing rate.  The real-nominal principle states that what matters to people is the real value or purchasing power of money or income, not its face or nominal value. Learning Objectives: 2.1 The Principle of Opportunity Cost: Apply the principle of opportunity cost. 2.2 The Marginal Principle: Apply the marginal principle. 2.3 The Principle of Voluntary Exchange: Apply the principle of voluntary exchange. 2.4 The Principle of Diminishing Returns: Apply the principle of diminishing returns. 2.5 The Real-Nominal Principle: Apply the real-nominal principle. Approaching the Material Continue the approach you developed in the first chapter, reaching students where they are. The decision to go to college is a great illustration of opportunity costs because students forgo earnings that they would have received from a full-time job. Apply the concept of diminishing returns to hours studying: If a student studies for five hours, will studying one additional hour really benefit him or her? Most of the students will have had jobs, so use the price of a gallon of gas or a burger per hour worked to explain real wages. Most students will have trouble with the marginal principle, so have plenty of examples ready. A seat on a bus or train that is not full is a good example. An extra passenger in a car for a road trip or another person watching a movie will also work.

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