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Solution Manual for Microeconomics, 8th Edition

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    Online Instructor’s Resource Manual By Leonie Stone State University of New York College at Geneseo For Microe conomics Eighth Edition Jeffrey M. Perloff University of California, Berkeley

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    Contents Chapter 1 Introduction ................................ ................................ ................................ ................ 1 Chapter 2 Supply and Demand ................................ ................................ ................................ ... 5 Chapter 3 Applying the Supply - and - Demand Model ................................ ................................ .. 27 Chapter 4 Consumer Choice ................................ ................................ ................................ ....... 45 Chapter 5 Applying Consumer Theory ................................ ................................ ....................... 66 Chapter 6 Firms and Production ................................ ................................ ................................ . 94 Chapter 7 Costs ................................ ................................ ................................ ........................... 109 Chapter 8 Competitive Firms and Markets ................................ ................................ ................. 129 Chapter 9 Applying the Competitive Model ................................ ................................ ............... 151 Chapter 10 General Equilibrium and Economic Welfare ................................ ............................. 173 Chapter 11 Monopoly ................................ ................................ ................................ ................... 186 Chapter 12 Pricing and Advertising ................................ ................................ .............................. 207 Chapter 13 Oligopoly and Monopolistic Competition ................................ ................................ .. 228 Chapter 14 Game Theory ................................ ................................ ................................ .............. 247 Chapter 15 Factor Markets ................................ ................................ ................................ ............ 272 Chapter 16 Interest Rates, Investments, and Capital Markets ................................ ....................... 283 Chapter 17 Uncertainty ................................ ................................ ................................ ................. 295 Chapter 18 Externalities, Open - Access, and Public Goods ................................ .......................... 311 Chapter 19 Asymmetric Information ................................ ................................ ............................ 326 Chapter 20 Contracts and Moral Hazards ................................ ................................ ..................... 339

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    Chapter 1 Introduction „ Chapter Outline 1.1 Microeconomics: The Allocation of Scarce Resources Trade-Offs Which goods and services to produce. How to produce. Who gets the goods and services. Who Makes the Decisions Prices Determine Allocations Application: Twinkie Tax 1.2 Models Application: Income Threshold Model and China Simplifications by Assumption Testing Theories Maximizing Subject to Constraints Positive Versus Normative 1.3 Uses of Microeconomic Models

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    2 Perloff • Microeconomics, Eighth Edition „ Teaching Tips You might begin the first class by discussing with the students the role of the intermediate microeconomics class in the larger curriculum. Encourage the students to be interactive by asking questions, bringing in examples from the newspaper, and questioning concepts that seem untrue or unrealistic. For many professors, a primary goal of the course is to get them to think like economists. The material in Chapter 1 should help the students to understand what is required to do so. You might want to ask your students the policy questions listed below as a kind of pre-test. Simply ask them to write down the best answer they can for now, and then put their answers away. You can then return to these answers later in the semester. Some suggested policy questions (be sure to ask only questions that you will address later in the course): 1. How do minimum wages affect wages, employment, and unemployment? 2. Is the CPI a good measure of inflation? 3. Why do stores offer coupons instead of simply reducing the price by the value of the coupon? 4. Why is the price of electricity regulated in most areas? 5. Why do some workers prefer set wages rather than commissions, even if they might make more working on commission? 6. Agree or disagree: We should strive to be a zero-pollution society. On a more pragmatic level, I stress to the students that success in the class is heavily dependent on their approach to the material. Specifically, I emphasize that memorization is an extremely ineffective tool for studying economics, and that students who memorize material are very prone to confusion and “drawing a blank” on exams. I try to persuade them that a much better approach is to press for understanding. I also stress that understanding usually comes only through active engagement with the material, both in class and out. The problems in the text, as well as the additional problems available in this manual and the Study Guide, will benefit the students in this regard. The conceptual and technical questions throughout these problem sets are designed to facilitate student understanding. I also emphasize the importance of coming to class regularly. Paul Romer’s article, “Do Students Go to Class? Should They?” in the Journal of Economic Perspectives (vol. 7, no. 3, Summer 1993:167–74) shows that perfect class attendance is worth between one and two grade points, and attendance at all rather than half of classes is worth between 0.67 and 1.24 grade points. Referring to this evidence might add some weight to your argument. Finally, I recommend that all students bring a protractor and a few colored pencils to class to aid their note taking. One of the most frequent problems of students who are struggling is sloppy lecture notes. A protractor is great for drawing lines and curves and has the added benefit of being transparent. Colored pencils are a big help when students are taking notes on graphs with many different lines, such as income and substitution effects and long- and short-run cost. Chapter 1 serves as an introduction to the text as well as a refresher on some basic economic concepts and definitions. This is a good chapter to get started on during the first day, as most students will not have read it before class. It will give you the opportunity to get a feeling for the students’ recall of these basic concepts. I usually start by asking the class for a definition of economics. If you get several suggestions that do not include the concept of scarcity, consider writing them on the board. Ask the class if they can think of

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    Chapter 1 Introduction 3 what central idea is missing from the definitions given. The discussion of scarcity and the questions of what, how, and for whom to produce should lead you directly into a discussion of the role of prices as an allocation mechanism. In the discussion of prices and markets, I try to get the students to offer examples from recent events where prices have risen or fallen sharply. Another possibility is to ask the students why some prices are so high (e.g., professional athletes’ salaries), and others are so low (computer disks). Ideally, you will end up in a discussion of the demand-driven nature of a market economy and the ways in which supply and demand interact to allocate resources. I also like to talk briefly about market failure and why the United States is a mixed economy rather than a pure market economy. A discussion on the benefit of intervention might encourage the students to consider when a mixed economy might be beneficial. You could use an example, such as primary education, to discuss what would happen in the absence of intervention, and why the government might intervene. When discussing allocation of goods and services, an effective counterpoint to the market system is consideration of the centrally planned economy and the changes in Eastern Europe. Many students have very little knowledge of how centrally planned economies operate, the difficulties they face in meeting the demands of their citizens, and how these difficulties relate to the current political changes. The discussion of economic models is very important. Most students do not have a sound understanding of the construction and purpose of an economic model. Stress the point that economic models are allegories used to describe behaviors and outcomes that would otherwise be unnecessarily complicated. Rather than try to duplicate the actual phenomenon, economists use models to make predictions about the behavior of firms and individuals. Perhaps the most important point to make regarding models is that they are simplified through the use of assumptions. You might choose a typical market and describe the wide variety of complex interactions that would have to be quantified in order to produce a complete model. Then describe the circumstances under which a very simple economic model can make satisfactory predictions (where “satisfactory” can be defined a number of ways, such as the coefficient of determination in a regression model). You may also want to discuss interactions that are too difficult to model, and why. For example, modeling behavior in unstable political climates is difficult because of the large influence of events that cannot be forecast. Finally, you might discuss the use of models to test theories and make predictions. Often students have a somewhat jaded view of economists and their predictions. I like to point out that while predictions often turn out to be incorrect, the error can often be traced to incorrect assumptions made at the time of the prediction. For example, suppose a forecasting model is constructed to predict baseball game attendance. Assuming a bright sunny day, attendance at a baseball game is predicted to be 40,000. If only 10,000 fans show up on game day, it could be that the model is bad, but it could also be that the weather is cool with a steady rain. In this case the assumption, not the model, was flawed. The application in the text considers the income threshold model in China. Students are often facing large increases in income upon graduation. I would ask them what large purchases they plan to make following graduation and apply that back to the China example. If a large portion of the economy had a large income shock, either positive or negative, what would happen to the demand for consumer durables? I would discuss how this change in demand might be disproportionate to the change in income due to the income threshold model. Chapter 1 also introduces the difference between positive and normative economics. It does not take long to cover, and a brief discussion of this point is worth the time. You might begin by asking students the distinction between positive and normative problems. I often find that students either do not know at all or are very unsure about their responses. To get the class thinking, use current societal problems as discussion points. Ask the class what would be a fair price for an AIDS vaccine. The variety of responses shows the normative nature of the question, but there is no disagreement that the vaccine should be produced in the least costly way possible regardless of how the gains are shared. Note that most problems have both

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    4 Perloff • Microeconomics, Eighth Edition positive and normative aspects and that by separating objective issues from subjective ones, we can more easily understand and approach the problems and find effective solutions. The text example of the wisdom of food price controls in Africa during droughts makes this point well. When covering Section 1.3 (Uses of Microeconomic Models), you might draw on examples from your own experience or current events that require the use of models. I like to draw the distinction between structural models that may be used, for example, to determine an elasticity and forecasting models that emphasize predictive power over theoretical correctness. If students have a weak background in statistics, you may have to keep this discussion at a broad conceptual level. This section provides a great opportunity to make the subject matter come alive for the students. „ Discussion Questions 1. If water is needed to survive and diamonds are simply for jewelry, then why are diamonds so expensive and water so inexpensive? 2. Discuss the positive and normative aspects of the economics of the Food Stamp program. 3. Are prices the best way to allocate pharmaceutical products? 4. Suppose you wanted to build a model to predict hurricanes. Which would be better, a model that resulted in more false positive predictions (storm is predicted but does not occur) or more false negatives (storm occurs but is not predicted)? Why? 5. What assumptions might you make to simplify the task of building an economic model of the grape market? 6. Think of a market the government currently intervenes in. What is an economic rationale for the intervention? 7. Economists often have differing opinions on what house prices will do over the next five years. What feature of economic models might explain these differing opinions?

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    Chapter 2 Supply and Demand „ Chapter Outline Challenge: Quantities and Prices of Genetically Modified Foods 2.1 Demand The Demand Curve Effect of Prices on the Quantity Demanded Effect of Other Factors on Demand Application : Calorie Counting The Demand Function Solved Problem 2.1 Summing Demand Curves Application : Aggregating Corn Demand Curves 2.2 Supply The Supply Curve Effect of Price on Supply Effect of Other Variables on Supply The Supply Function Summing Supply Curves How Government Import Policies Affect Supply Curves Solved Problem 2.2 2.3 Market Equilibrium Using a Graph to Determine the Equilibrium Using Math to Determine the Equilibrium Forces That Drive a Market to Equilibrium 2.4 Shocking the Equilibrium Effects of a Shock to the Supply Curve Solved Problem 2.3 Effects of a Shock to the Demand Curve

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    6 Perloff • Microeconomics, Eighth Edition 2.5 Effects of Government Interventions Policies That Shift Supply Curves Licensing Laws Application : Occupational Licensing Quotas Solved Problem 2.4 Policies That Cause the Quantity Demanded to Differ from the Quantity Supplied Price Ceilings Application: Venezuelan Price Ceilings and Shortages Price Floors Solved Problem 2.5 Why the Quantity Supplied Need Not Equal the Quantity Demanded 2.6 When to Use the Supply-and-Demand Model „ Teaching Tips This chapter reviews basic supply-and-demand concepts from the principles level. Your interactions with the class from the first session or two should give you a good indication of how much class time to spend on it. If it has been some time since their principles course, students may need fairly consistent prompting to recall the basic supply-and-demand model. For example, many will remember that there is a Law of Demand but will not remember the law itself. Encourage students in the strongest terms to read the chapter carefully. It is well worth the time spent at this stage to make sure everyone has solid recognition of these basic tools and concepts. A good way to motivate the chapter is by beginning with the genetically modified food example found in the Challenge. Try to keep the conversation focused on possible effects of entry or of the ban. Let students brainstorm about which parties might be in favor of a ban and who would be opposed and why. When reviewing demand, be sure students are clear on the difference between movement along the curve and a shift of the entire curve. Two points should be helpful. First, note to them that both in Equation 2.1 and on the graph in Figure 2.1, price is the only independent variable present. Thus, only price can cause a movement along the curve. Second, underscore the role of other variables. After compiling a list of the factors that can shift the demand curve (once they get started, the class as a group should be able to provide you with this list), I ask what factors are held constant along a single demand curve. Surprisingly, this question is often greeted by a protracted silence. By realizing that it is the same factors that shift the curve when they change, students develop a more solid understanding. The text makes this point well in Equations 2.2 and 2.3. The introduction of demand curves and equations is a good opportunity to review the basic geometric concepts of slope and intercept. This does not take much time, as most students can recognize slope and intercept of a written equation, but there is sometimes a surprising lack of connection between what appears in an equation and the resulting graph. Draw a demand curve and tell the class that the slope of this curve is –2. Then ask the students what will happen in the graph if the slope changes to − 4. Although it is likely that several, perhaps most students will know immediately, some will not. Rather than referring to the slope increasing or decreasing, I tend to refer to it as becoming steeper or flatter, and thus this way I can talk about the shift in supply and demand curve slopes the same way (an increase in slope would cause the demand curve to become flatter and the supply curve to become steeper,

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    Chapter 2 Supply and Demand 7 which can be confusing for students). I try to use the simple algebra and geometry in these early chapters to help me to gauge what portion of the class is likely to struggle when the material gets tougher. Assigning some of the quantitative problems at the end of the chapter and collecting them (even if you do not intend to collect homework throughout the term) is another good diagnostic. Alternatively use five minutes of lecture time to ask students to answer two or three basic quantitative questions and collect their responses. Assure the students that their answers will not be graded and will simply be used to gauge comprehension. This will allow you to adjust your next lecture if necessary, and by walking around while students are working, you can answer any basic questions they might have. It is also valuable to discuss the inverse demand curve and the process of inversion. I usually motivate this review by noting that this process will be needed later when formulating a total revenue equation from a demand equation. I combine this with the discussion of the problem of the reversed axes. At this point, you can refer back to the graph and show how to find the intercept and slope from Equation 2.3 I try to keep the discussion of supply parallel to that of demand. For factors that can shift the entire supply curve, note that they can all be lumped together under the broader heading of costs, government rules and regulations, and other variables (as is done in the text). The text notes that there is no “Law of Supply,” and most students have learned this in their principles course. Be aware, however, that some principles instructors refer to the upward slope of supply curves in the short run as the “Law of Supply.” Adopting a uniform taxonomy and vocabulary reduces confusion. This includes uniformity with the text with respect to symbols and upper- versus lower-case labeling. When combining supply and demand in the discussion of equilibrium, press the students for a usable definition of the term. You will likely receive the suggestion of “where supply equals demand.” Though incorrect, this definition is useful in the introduction of price floors and ceilings where the quantity supplied does not equal demanded at the equilibrium quantity. An important point regarding equilibrium solutions of supply-and-demand problems is that they are typically stable and self-correcting. To illustrate this point, use examples of commonly purchased items such as discounted clothing where reduced prices reflect excess supply. Now that students have an idea of what a market looks like in equilibrium, I might ask for examples of markets that are not in equilibrium. This leads in to the discussion of government interventions and how they distort the market. This is also a good place to use a news article to show students how to use graphs to explain effects mentioned in the article. When discussing floors and ceilings, I stress the definitions using simple graphs as illustrations. Although it seems counterintuitive to some students that an effective floor must be above the equilibrium price and an effective ceiling must be below, suggest that they use this as a mnemonic device. In this section, I try to engage the class in a discussion of unintended or secondary effects of government intervention. This issue deserves significant class discussion time. Most students have not thought much about the consequences of ceilings and floors beyond the simple price effects. The text has a good description of the unintended effects of price controls in Zimbabwe. A discussion on the initial reaction to the price controls, and then the actual effect of the controls, would lead students to realize the importance of looking beyond the initial effect and using economic models to predict outcomes. Another good example for discussing secondary effects is rent control. On the supply side, landlords’ incentives to provide efficient levels of upkeep and safety measures in rent-controlled buildings are distorted. On the demand side, time spent searching and undesired doubling-up reduce consumer satisfaction. Secondary effects of floors are also worth noting. I recommend that you discuss the text’s example of the possible negative effects of minimum wages. Again, students are likely to view minimum wages as strictly a benefit to workers because they have not considered that job loss will mean that some workers are harmed rather than helped by the establishment of minimums or increases in their level.

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    8 Perloff • Microeconomics, Eighth Edition These policy issues provide an opportunity to use current affairs in class. Using an article from a newspaper or online source, I often break down the predictions in the article and use the theory learned in class to determine their veracity. In the section on when to use the supply-and-demand model, be sure to define and discuss transaction costs. Most students will not be familiar with this term from principles, and it has important implications on the functioning of thin markets and markets where there is substantial uncertainty. At the end of the chapter, you can return to the discussion of genetically modified foods (or another appropriate example) and use the supply and demand model to analyze the effects of entry. „ Discussion Questions 1. Can you think of any reasons why the Law of Demand might not hold? 2. Would you expect most supply curves to have an upward slope? Why or why not? 3. What are some examples of markets that are competitive? 4. In which markets that would otherwise be competitive would you expect transaction costs to be very high? 5. Can you think of situations where the government would want to take actions that cause shortages? 6. In what markets and situations would you expect that the quantity demanded would not equal the quantity supplied? 7. Can you think of an example where a good is sold below equilibrium price without government intervention causing excess demand? Which property of perfect competition is violated? „ Additional Questions and Problems 1. Suppose you are planning to conduct a study of the running shoe market. List the factors that you believe would cause changes in the demand for running shoes. In each case, note whether the relationship would be positive (direct) or negative (inverse). Also list the factors that you believe would affect the supply, again noting the nature of the relationship. 2. In each case below, identify the effect on the demand curve for steak (a normal good). a. An increase in the price of lamb b. A decrease in the population c. An increase in consumer income d. A decrease in the price of steak sauce e. An increase in advertising by chicken producers 3. In each case below, identify the effect on the supply curve for coal. a. The development of a new, lower cost mining technique b. An increase in wages paid to coal miners c. The imposition of a $2 per ton tax on coal d. A government ban on all imports of coal e. A new government regulation requiring air purifiers in all work areas

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    Chapter 2 Supply and Demand 9 4. In a competitive labor market, demand for workers is Q D = 10,000 – 100 W , and supply is Q S = 2,000 + 1,900 W , where Q is the quantity of workers employed and W is the hourly wage. What is the initial equilibrium wage and employment level? Suppose that the government decides that $5 per hour is the minimum allowable wage in any market. How would this new minimum wage alter this market? What would the new employment level be? What would happen to total payments to labor? Would there be any excess supply of labor? If so, how much? 5. For each of the following sentences describing changes in the tangerine market, note whether the statement is true, false, or uncertain, and explain your answer. You will find it helpful to draw a graph for each case. a. If consumer income increases and worker wages fall, quantity will rise, and prices will fall. b. If orange prices decrease and taxes on citrus fruits decrease, quantity will fall, and prices will rise. c. If the price of canning machinery (a complement) increases and the growing season is unusually cold, quantity and price will both fall. 6. If demand for show tickets is described by the equation Q D = 100 – p , and supply is Q S = 20 + p , find the equilibrium price and quantity. How would your answer change if the supply curve shifted to 10 S Q p ′ = + due to increases in actor salaries? What would the supply curve look like if the capacity of the theatre was 50 people? 7. Suppose the demand for onion ice cream was described by the equation Q D = 20 – p and the supply was described by Q S = –40 + p . What are the equilibrium price and quantity? Show your answer using a graph. 8. If demand for toy drums is described by the equation Q D = 300 – 5 p and supply is Q S = 60 + 3 p , find the equilibrium price and quantity. How would your answer change if a decrease in consumer income shifted the demand curve to 220 5 ? D Q p ′ = − 9. Suppose the United States does not produce any baseball hats domestically but imports them from foreign producers. Initially, demand is 1000 2 , D Q p = − and supply (from foreign producers) is 100 S Q p = + . Determine the equilibrium price and quantity. The government then decides that no more than 300 baseball hats should be imported per period and imposes a quota at that level. How does this quota affect the equilibrium price and quantity? Show the solution using a graph and calculate the numerical answer. How might this quota affect the market for cowboy hats (a substitute good)? 10. Demand for park visits is * 0 10,000 100 . Q P = − If park visits are free, how many visitors will attend? How will your answer change if the park adds a $20.00 admission fee? Show using a graph. 11. A firm introduces a new model of MP3 player that can play both audio and video files. The price is the same as that of a previous model that can only play audio files. What would happen to the market of the previous model? What if the new model is more expensive than the previous one? 12. In a competitive labor market, demand for workers is Q D = 9,900 − 100 W , and supply is Q S = 2,000 + 1,900 W , where Q is the quantity of workers employed and W is the hourly wage. Suppose the government decides to impose a wage ceiling of $3 per hour. What would the equilibrium be in this labor market?

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    10 Perloff • Microeconomics, Eighth Edition 13. New York requires all taxis to be licensed and limits the number of licenses available. Suppose the market is currently in equilibrium. If the city no longer requires licenses, what will happen to the equilibrium price and quantity supplied? Why? „ Answers to Additional Questions and Problems 1. Possible responses include: Demand: The price of running shoes (–) Sock prices (–) Prices of other sneaker types ( + ) Number of people who are regular runners ( + ) Income ( + ) Supply: Worker wages (–) Increases in leather prices (–) Removal of import tariffs ( + ) A unit tax on running shoes (–) 2. a. The demand curve shifts to the right. b. The demand curve shifts to the left. c. The demand curve shifts to the right. d. The demand curve shifts to the right. e. The demand curve shifts to the left. 3. a. The supply curve shifts to the right. b. The supply curve shifts to the left. c. The supply curve shifts to the left. d. The supply curve shifts to the left. e. The supply curve shifts to the left. 4. Without minimum wages, the equilibrium is * * 10,000 100 2,000 1,900 4 9,600. W W W Q − = + = = With the new minimum wage of $5, employment will equal the amount of labor demanded at the minimum wage. 10,000 100(5) 9,500. d Q = − = Total payments to labor would increase from $38,400 to $47,500. Excess supply of labor would equal 2,000 = 2,000 + 1,900(5) − 9,500. Thus, in addition to the 100 people who would lose jobs that they had before the minimum, an additional 1,900 would now want jobs that would be unobtainable at the higher wage rate. 5. In each case, you must draw a graph that shows the original supply and demand curves, plus the new curves after the changes. You must then consider whether it matters or not how far the curve shifts in response to the change in the parameter indicated.

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    a b a. Uncertain definitely of the sup than the s F igure 2. b . False. Th due to the the magn supply co F igure 2. n . In this case y increase, bu pply and dem shift in supply 1 h e supply curv e decrease in itude of the sh ompared to th 2 © 20 e, both the sup t whether pric mand shifts. Se y, prices incre ve shifts right orange prices hifts. See Fig he relatively sm 018 Pearson Educ pply and the d ces rise, fall, ee Figure 2.1; ease. t due to the de s. Prices will b gure 2.2. In th mall shift of t cation, Inc. demand curve or remain con ; because the ecrease in tax be lower, and he case of Figu the demand c Chapter 2 es shift to the nstant depend demand shift xes, and the de d the change i ure 2.2, the la curve causes q Supply and De right. Quanti ds on the relat t is relatively emand curve in quantity de arge rightward quantity to inc emand 11 ity will tive sizes larger shifts left epends on d shift in crease.

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    12 6 2 Perloff • M c. Unce but pr See F F igur 6 . Set D Q = For For $ 30 M icroeconomics, rtain. In this c rice may rise, Figure 2.3. In r e 2.3 S Q and solve 20 50 Eighth Edition case, the dem , fall, or rema this case, pric . Q 0 S © 2018 Pearson mand and supp ain unchanged ce remains un * * 100 S Q p p Q = − = = = * * 100 Q p p Q ′ = − = = = When th tickets, t will hav supply. n Education, Inc. ply curves bot d depending o nchanged. 20 20 40 60 p p = + = + = = 10 10 45 55 p p = + = + = = he capacity of the supply cu e no effect on th shift to the on the relative f the theater h urve becomes n the number e left. Quantity e magnitude o has been reach vertical; incr of tickets the y decreases, of the shifts. hed at 50 reases in price e theater will e

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    7. E o F 8. S F F 9. T W T p ( Set S Q Q = E quilibrium q output is posi F igure 2.4 S et D S Q Q = a For For The equilibriu When the quo Thus, the supp price is determ (see Figure 2. D Q and solve. quantity is zer tive. See Figu and solve. um solution w ota is imposed ply curve bec mined by whe .5). To solve f © 20 ro because the ure 2.4. with no govern 1 d at 300 units comes vertica ere the supply for the price, 018 Pearson Educ * * 30 10 P Q = = − e demand cur * * 30 300 5 60 30 15 D Q p p Q = − = = = * * 22 220 5 60 20 12 D Q p p Q ′ = − = = = n ment interve * * 000 2 10 30 40 p p Q − = = = , supply cann al at 300 units y curve with t plug the quot * 1000 2 p p − = = cation, Inc. 0 rve lies below 00 5 0 3 0 50 units p p − + 20 5 0 3 0 20 p p − + ention is 00 00 00. p + not exceed tha s. The new eq the quota ( S qu ta value (300) 300 350 Chapter 2 w the supply c at level, regar quilibrium qua uota ) intersects ) into the dem Supply and De curve at all pr rdless of price antity is 300, the demand c mand equation emand 13 ices where e. and curve n.

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    14 4 Perloff • M F igure A quot cowbo equilib 10. When entran F igure 11. The de the dem 12. Withou where With t employ M icroeconomics, e 2.5 t a on baseball oy hats. As a brium price fo park visits ar ce fee quantit e 2.6 e mand curve o mand curve fo ut the wage c he wage ceili yed will be 7 Eighth Edition l hats would i result, deman or cowboy ha re free, the eq ty falls to 8,00 of the previou for the previou ceiling, the eq 10 ing of $3 per h ,700. © 2018 Pearson increase the p nd for cowboy ts would incr quilibrium qua 00. See Figur us model shif us model still quilibrium is g 0,000 100 W − W = 4 and hour, the mar n Education, Inc. price of baseb y hats would rease. antity is 10,00 re 2.6. fts to the right l shifts to the given by 2,000 1,9 = + d Q = 9,600. rket wage rate ball hats, whic increase (shif 00 = 10,000 – t. If the new m right, but wit 900 , W e will be W = c h are a subst ft upwards), a – 100(o). With model is more th a smaller m 3, and the am titute for and the h a $20.00 e expensive, magnitude. mount of labo or

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    13. I t s m b S F „ Cha Supp 1.1 1.2 1.3 I f the governm the price incre supply curve market. When becomes flatt See Figure 2.7 F igure 2.7 Answers a pter 2 ply and D Q = 17 1 − 2 The demand increase in The demand unaware of ment limits th eases. As a re becomes stee n the governm er, and the eq 7. s to Textb emand 2 0 p + 20 p b + 3 d curve for po income cause d for Starbuck f the calorie co © 20 he number of esult, once the eper, as any ad ment eliminate quilibrium pri b ook Que 3 p c + 2 Y = 17 ork is Q = 17 1 es the quantity ks’ coffee wil ontent prior to 018 Pearson Educ licenses avail e number of ta dditional taxi es the restrict ice decreases, e stions 7 1 – 20 p + 20 1 – 20 p + 20 p y demanded t ll shift to the o the signage cation, Inc. lable, new tax axis equals th i rides must b tion, the supp , while the eq 0(3) + 3(3 1 3 ) p b + 3 p c + 2 Y . to increase by left (decrease and view hig Chapter 2 xis can no lon he number of e supplied by ly curve no lo quilibrium qua + 2(12.5) = 2 As a result, Δ y 0.2 million k e), assuming t gh calorie drin Supply and De nger enter the licenses avai y taxis current onger has a ki antity increas 266 – 20 p. Δ Q / Δ Y = 2. A kg per year. that consume nks negatively emand 15 e market if ilable, the tly in the ink and es. A $100 ers were y.

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    16 Perloff • Microeconomics, Eighth Edition 1.4 Substituting in the price of tomatoes and the original level of income gives Q = 160 – 40 p or p = 4 – 0.025 Q . With the new level of income, Q = 170 – 40 p or p = 4.25 – 0.025 Q . The demand curve shifts to the right. 1.5 We know that Δ p = –0.05 Δ Q. If Δ Q = –2 (a reduction of 2 million kg of pork per year), Δ p = –0.05 × –2 = 0.10. Thus, a 10 cent per kg increase in price will result in a 2 million kg drop in demand. 1.6 The total demand curve is the horizontal sum of the individual demand curves for food and feed: Q = Q food + Q feed . Since Q feed = 0 at prices above $27.56, for p > 27.56; Q = 1,487 – 22.1 p and for p < 27.56 Q = 7,735 – 248.8 p . 1, 487 22.1 , 27.56 7,734.5 – 248.8 , 27.56 p p Q p p − ≥ ⎧ = ⎨ < ⎩ 1.7 Q = Q 1 + Q 2 = (120 – p ) + (60 – 1/2 p ) = 180 – 1.5 p. 1.8 The total demand function is Q = Q s + Q l = 15.6 p –0.563 + 16 p –0.296 . 1.9 The total demand function is Q = 2 3.7 1.4 1.4 . p p − − + At a price of $1.00, Apple Store customers demand 2 1.4 *1 1.4 apps A Q − = = , and Google Play customers demand 3.7 1.4 *1 1.4 apps A Q − = = , for a total of 2.8 million apps. 2.1 Supply: Q = 178 + 40 p − 60 p h . Replacing p h with $3 per kg gives us a supply function Q = 178 + 40 p − 60 × $3 = 40 p − 2. That is, the slope of the supply curve does not change from Equation 2.7, but the whole supply curve shifts to the left. 2.2 The change in avocadoes supplied with respect to a change in the price of fertilizer is 20 f Q p Δ = − Δ . Thus a $1.10 increase in income results a 22 unit decrease in avocadoes supplied. Graphically, this would be a leftward shift of the supply curve. 2.3 The world supply is: Q = Q a + Q r = (a + b p ) + (a + c p ) = 2a + (b+c) p .

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    2.4 2.2 In the follow U.S. domes foreign supp curve under . p At price foreign supp with the quo equals the q foreign supp shifted Q u prices less t the same as than S , indi than withou The effect o Thus, an inc wing figure, t stic supply cu pliers want to r the quota, S es above , p f ply curve wit ota, , S is the quota plus the ply is , f Q so units to the rig than or equal s S . At prices cating that a g ut one. of a change in crease in the p © 20 the no-quota t rve, S d , and th o supply quan , f S is the sam foreign suppli th a quota, f S e horizontal su e domestic sup o the total sup ght. As a resu to , p the sam above , p les given increas n p f on Q is price of fertil 018 Pearson Educ total supply c he no-quota f ntities less tha me as the no-q iers want to su , f is vertical um of S d and pply. For exa pply is * d Q Q + u lt, the portion me quantity is ss is supplied e in price rais f Q p Δ Δ = –20 f Q p Δ Δ = –20( f Q p Δ Δ = –22 u izer will shift cation, Inc. curve, S in pan foreign supply an the quota, quota foreign upply more b at Q for pric . f S At any p ample, at p *, t . f Q Above p n of S above s supplied wit with the quot ses the quanti 0 p f 1.10) units. ft the avocado Chapter 2 nel c, is the h y curve, S f . At . Q As a resul supply curve but are limited ces above . p price above p the domestic , p S is the dom e p has the s th and withou ta than withou ity supplied b o supply curve Supply and De horizontal sum t prices less th lt, the foreign e, S f , for price d to . Q Thus The total sup , p the total su supply is * d Q m estic supply ame slope as ut the quota, s ut one, so S b y less with a e to the left. emand 17 m of the han , p n supply s less than the pply curve upply , and the y curve S d . At so S is is steeper quota

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    18 Perloff • Microeconomics, Eighth Edition 3.1 The statement “Talk is cheap because supply exceeds demand” makes sense if we interpret it to mean that the quantity supplied of talk exceeds the quantity demanded at a price of zero. Imagine a downward-sloping demand curve that hits the horizontal, quantity axis to the left of where the upward-sloping supply curve hits the axis. (The correct aphorism is “Talk is cheap until you hire a lawyer.”) 3.2 a. We know that the town consumes 9000 gallons per day at no cost; thus, there is a point on the demand curve at p = 0, q = 9,000. Thus (becauase we assume there is no negative demand), a linear demand curve would be along the horizontal axis, where p = 0. b. The supply curve is drawn along the horizontal axis from the point where q = 0 until q = 10,000. To the right of where q = 10,000, the supply curve is upward sloping. c. Quantity supplied and demanded reach an equilibrium at any point under q = 10,000, where p = 0. 3.3 The supply curve is upward sloping and intersects the vertical price axis at $6. The demand curve is downward sloping and intersects the vertical price axis at $4. When all market participants are able to buy or sell as much as they want, we say that the market is in equilibrium: a situation in which no participant wants to change its behavior. Graphically, a market equilibrium occurs where supply equals demand. An equilibrium does not occur at a positive quantity because supply does not equal demand at any price. 3.4 Set quantity demanded equal to quantity supplied: 171 − 20 p + 20 p b + 3 p c + 2 Y = 178 + 40 p – 60 p h Solving for p yields: 7 1 1 1 60 3 20 30 b c h p p p Y p = − + + + + Solving for q yields: 520 40 4 2 20 3 3 3 b c h q p p Y p = + + + − Inserting prices of other goods yields P = $3.30 and Q = 220.

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    Chapter 2 Supply and Demand 19 3.5 In equilibrium, the quantity demanded, Q = a – bp , equals the quantity supplied, Q = c + ep , so a – bp = c + ep . By solving this equation for p , we find that the equilibrium price is p = ( a – c )/( b + e ). By substituting this expression for p into either the demand curve or the supply curve, we find that the equilibrium quantity is Q = ( ae - bc )/( b + e ). 3.6 The demand for processed tomatoes is 0.2 0.15 ln( ) 2.6 0.2ln( ) 0.15ln( ) or 13.46 . D t t Q p p Q P P − = − + = When P t = 110, 0.2 0.15 0.2 13.46 (110) 27.24 D Q P P − − = = . To find the equilibrium, we equate the right sides of the original logarithmic supply and demand functions and using algebra, we find 3.2 0.2 0.2 0.75ln( ) 2.4 0.15ln( ) ln( ) 3.2 0.2ln( ) * 24.53 . t t t t p p p p p e p p = + = + = = We then set p t = 110, solve for p = $62.80/ton. Or, we can find the supply function: 0.55 ln( ) 0.2 0.55ln( ) or 1.22 S Q p Q P = + = . Equating the right side of the supply and demand functions, we find 0.55 0.2 0.75 1.22 27.24 22.33 $62.80. P P P P − = = ⇒ = Substituting the price in either the supply or the demand function yields a quantity at equilibrium of about 11.9 million tons. 4.1 The supply shock is unusually good luck or an unexpected increase in the number of lobsters in the ocean. The supply curve shifts to the rights, and thus the price falls. 4.2 Because it is now more attractive to rent an apartment (because you can more easily sublet for short periods of time), demand for apartments increases, which, all other things equal, increase the equilibrium rental price and quantity of apartments rented. (Note that an alternative answer might be that it reduces the supply of apartments on the market because if owners of apartments can make more money through Airbnb than through renting conventionally, they may withhold apartments from the market. In this case, supply decreases as well, reinforcing the rental price increase but making the effect on the quantity indeterminate.

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    20 Perloff • Microeconomics, Eighth Edition 4.3 The demand curve shifts to the left from D 1 to D 2 by 30 percent, which is the distance between Q 0 and Q 4 . For supply curve S 1 , the price drops from p 0 to p 1 , a change of less than 30 percent. For a steeper supply curve S 2 , the price decreases to p 2 , a larger decrease, yet still smaller than 30 percent. Accordingly, the equilibrium quantity changes less than 30 percent as well. (See figure below.) 4.4 A decrease in the supply of eggs increases the equilibrium price of eggs and reduces the equilibrium quantity. 4.5 Health benefits from eating avocados shift the demand curve for avocados to the right because more avocados are now demanded at each price. The new market equilibrium is where the original supply curve intersects the new avocado demand curve, at a higher price and larger quantity. Imports shift the supply curve for avocados to the right because more avocados are now supplied at each price. The new market equilibrium is where the original demand curve intersects the new avocado supply curve, at a lower price and higher quantity.

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    Chapter 2 Supply and Demand 21 A recession shifts the demand curve for avocados to the left because fewer avocados are now demanded at each price. The new market equilibrium is where the original supply curve intersects the new avocado demand curve, at a lower price and lower quantity. New technologies increasing yields shift the supply curve for avocados to the right because more avocados are now supplied at each price. The new market equilibrium is where the original demand curve intersects the new avocado supply curve, at a lower price and higher quantity. 4.6 The Internet shifts the demand curve for newspaper advertising to the left because fewer companies demand newspaper advertising with online advertising available. The Internet may force some newspapers out of business, so the supply curve for newspaper advertising will shift to the left some. The new market equilibrium is where the new demand curve intersects the new supply curve. At the new equilibrium, there is less newspaper advertising. 4.7 The increased use of corn for producing ethanol will shift the demand curve for corn to the right. This increases the price of corn overall, reducing the consumption of corn as food.

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    22 Perloff • Microeconomics, Eighth Edition 4.8 Setting quantity supplied equal to quantity demanded gives p = 40 + 4 r . As the price of capital increases, the equilibrium price rises. Likewise, inverting the demand and supply curves and solving now for quantity, Q = 140 – 8 r . The equilibrium quantity falls as the price of capital increases. (The increase in the price of capital reduces supply.) 4.8 The supply for processed tomatoes is ln( Q ) = 0.2 + 0.55ln( p ) or Q S = 1.22 P 0.55 . The demand for processed tomatoes is ln( Q ) = 2.6 – 0.2 ln( p ) + 0.15 ln( p t ) or Q D = 13.46 –0.2 0.15 . t P Given our equilibrium condition, Q S = Q D and solving for P : 1.22 P 0.55 = 13.46 P –0.2 0.15 t P P 0.75 = 11.033 0.15 t P P * = 24.56 0.2 t P and Q * = 7.095 0.11 . t P If the price of tomato paste falls by 10%, the new price will be P t = 99. Therefore, P * = 24.56(99) 0.2 and Q * = 7.095(99) 0.11 or P * = 61.59 and Q * = 11.76. (Answers will vary slightly with rounding) 5.1 An increase in demand due to higher quality professionals will shift the demand curve to the right, further raising prices. The equilibrium quantity could be more, less, or the same as before the licensing restriction, depending on whether the supply or the demand effect is greatest. However, it will be more than the quantity would be with only the licensing change in place. 5.2 A ban has no effect if foreigners supply nothing at the pre-ban equilibrium price. Thus, if imports occur only at prices above those actually observed, a ban has no practical effect. 5.3 When the ban on legal imports went into effect, the demand for imports in the United States fell to zero. Given that the United States represents 60% of the market, it would have caused a dramatic drop in prices. If the drop in prices made caviar harvesting unprofitable and fishermen turned to other activities, it would help the fish population. If a black market developed, price and quantity sold would not drop as much as with a totally effective ban. If exporters simply shipped the caviar to other countries, but at lower prices, it could make problems with the sturgeon population even worse as exporters increase output to maintain income levels. 5.4 The quota causes the supply curve to become steeper at the price where foreign imports are impacted by the quota, above which foreign imports cannot be increased and the foreign supply

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    Chapter 2 Supply and Demand 23 curve becomes vertical. Below that price, the supply curve is unaffected. If the demand curve intersects the supply curve at a price below the kink, the equilibrium is unaffected, and the quota does not bind. If the quota is binding (the demand curve intersects supply above the kink), the equilibrium price will be higher and the quantity will be lower than without the quota. 5.5 The quota on foreign-trained physicians would alter the supply curve. In the following figure, the unregulated supply curve, S , becomes more inelastic once the quota on foreign doctors is reached. The new supply curve, S 1 , results in higher prices for medical services due to higher salaries for physicians if the demand curve intersects the supply curve above the “kink.” In that case, American physicians are better off with the quota because of the increase in wages. Consumers are harmed because of the increase in price and decrease in quantity. If demand intersects supply below the kink, a quota will have no effect on equilibrium supply and demand. 5.6 With a binding price ceiling, such as a ceiling on the rate that can be charged on loans, some consumers who demand loans at the rate ceiling will be unable to obtain them. This is because the demand for bank loans is greater than the supply of bank loans to low-income households with the usury law. 5.7 a. The minimum wage raises the wage above the equilibrium level. This reduces the quantity of labor demanded (where the Bt300 minimum wage intersects the labor demand curve) and increases the quantity of labor supplied (where the Bt300 minimum wage intersects the labor supply curve). Unemployment equals excess labor. That is, unemployment equals the quantity of labor supplied minus the quantity of labor demanded: L s – L d .

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    24 Perloff • Microeconomics, Eighth Edition b. The minimum wage shifts the supply curve up, as production costs increase, until the point where the demand curve intersects the new supply curve is at a price of Bt40 for ready-to-eat meals. c. The price controls lower the price of meals below the equilibrium level. This increases the quantity demanded (where the maximum price with the price controls intersects the demand curve) and decreases the quantity supplied (where the maximum price intersects the supply curve). d. As the price of meals demanded decreases, owners of restaurants will demand fewer workers, shifting the labor demand curve to the left. 5.8 With the binding rent ceiling, the quantity of rental dwellings demanded is that quantity where the rent ceiling intersects the demand curve ( Q D ). The quantity of rental dwellings supplied is that quantity where the rent ceiling intersects the supply curve ( Q S ). With the rent control laws, the quantity supplied is less than the quantity demanded, so there is a shortage of rental dwellings. 5.9 The law would create a price ceiling (at the pre-emergency price). Because the supply curve shifts substantially to the left during the emergency, the price control will create a shortage: A smaller quantity will be supplied at the ceiling price than will be demanded.

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    Chapter 2 Supply and Demand 25 5.10 At $65 per ton, calculate the firm’s supply curve: ln( Q ) = 0.2 + (0.55) ln(65) = 2.5, Q = 12.18 million tons. The demand for tomatoes is ln( Q ) = 2.6 – (0.2) ln(65) = (0.15) ln(110) = 2.47. Q = exp(2.47) = 11.82 million tons. Therefore, the government buys 12.18 – 11.82 = 0.36 million tons. 5.11 In the Venezuelan corn flour market, there is a price ceiling, and thus there is a shortage (graph is the same as the rent ceiling graph in Question 5.8). If corn flour is smuggled to Columbia, the supply of corn flour increases there, resulting in a lower price and higher quantity sold. 6.1 The supply-and-demand model is useful for making predictions in perfectly competitive markets. That is, the supply-and-demand model is applicable in markets in which everyone is a price taker, firms sell identical products, everyone has full information about the price and quantity of goods, and the costs of trading are low. Markets in which the supply-and-demand model has proven useful include agriculture, finance, labor, construction, services, wholesale, and retail—markets with many firms and consumers and where firms sell identical products. a. The market for apples is a competitive, agricultural market. b. The market with convenience stores is a competitive, retail market. c & d. The supply-and-demand model is not appropriate in markets in which there are only one or a few sellers (such as electricity), firms produce differentiated products (such as music CDs), consumers know less than sellers about quality or price (such as used cars), or there are high transaction costs (such as nuclear turbine engines). Electronic games are differentiated products supplied by three dominant firms. 7.1 When Japan banned U.S. imports, the supply curve of beef in Japan shifted to the left from S 1 to S 2 in panel (a) of the figure. (The figure shows a parallel shift, for the sake of simplicity.) Presumably, the Japanese demand curve, D, was unaffected as Japanese consumers had no increased risk of consuming tainted meat. Thus, the shift of the supply curve caused the equilibrium to move along the demand curve from e 1 to e 2 . The equilibrium price rose from p 1 to p 2 , and the equilibrium quantity fell from Q 1 to Q 2 . U.S. beef consumers’ fear of mad cow disease caused their demand curve in panel (b) of the figure to shift slightly to the left from D 1 to D 2 . In the short run, total U.S. production was essentially unchanged. Because of the ban on exports, beef that would have been sold in Japan and elsewhere was sold in the United States, causing the U.S. supply curve to shift to the right from S 1 to S 2 . As a result, the U.S. equilibrium changed from e 1 (where S 1 intersects D 1 ) to e 2 (where S 2 intersects D 2 ). The U.S. price fell 15% from p 1 to p 2 = 0.85 p 1 , while the quantity rose 43% from Q 1 to Q 2 = 1.43 Q 1 . Note : Depending on exactly how the U.S. supply and demand curves had shifted, it would have been possible for the U.S. price and quantity to have both fallen. For example, if D 2 had shifted far enough left, it could have intersected S 2 to the left of Q 1 , so that the equilibrium quantity would have fallen.

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    26 7. 7. 6 Perloff • M .2 If the de equilibr increase in suppl .3 Both th supply greater M icroeconomics, e mand curve rium quantity e, given the di ly work toget he demand and shifted down than the incre Eighth Edition had shifted to y would have irection of the ther to lower t d supply of gu to the right. H ease in supply © 2018 Pearson o the left mor fallen. Under e shifts, becau the equilibriu uns have incr However, the y and this led n Education, Inc. re than the sup r no circumsta use the leftwar um price. reased; that is e results sugge to an increas pply curve sh ances could th rd shift in dem s, demand shif est that the in se in both equ hifted to the ri he equilibrium mand and the fted up to the ncrease in dem uilibrium pric ight, then the m price rightward shi e right and mand was e and quantity ft y.

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    Chapter 3 Applying the Supply-and-Demand Model „ Chapter Outline Challenge: Who Pays the Gas Tax? 3.1 How Shapes of Supply and Demand Curves Matter 3.2 Sensitivity of the Quantity Demanded to Price Price Elasticity of Demand Solved Problem 3.1 Application: The Demand Elasticities for Google Play and Apple Apps Elasticity Along the Demand Curve Downward-Sloping Linear Demand Curve Horizontal Demand Curve Vertical Demand Curve Demand Elasticity and Revenue Solved Problem 3.2 Application: Amazon Prime Demand Elasticities over Time Other Demand Elasticities Income Elasticity Cross-Price Elasticity Application: Anti-Smoking Policies May Reduce Drunk Driving 3.3 Sensitivity of the Quantity Supplied to Price Elasticity of Supply Elasticity Along the Supply Curve Supply Elasticities over Time Application: Oil Drilling in the Arctic National Wildlife Refuge Solved Problem 3.3 3.4 Effects of a Sales Tax Effects of a Specific Tax on the Equilibrium The Equilibrium Is the Same No Matter Whom the Government Taxes Solved Problem 3.4 Firms and Customers Share the Burden of the Tax Tax Incidence Tax Effects Depend on Elasticities Application: Taxes to Prevent Obesity Solved Problem 3.5

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    28 Perloff • Microeconomics, Eighth Edition Ad Valorem and Specific Taxes Have Similar Effects Solved Problem 3.6 Subsidies Application: Subsidizing Ethanol „ Teaching Tips Chapter 3 continues work with the supply-and-demand model from Chapter 2. Some of this material, however, may be new to students rather than review. Two main topics are in the chapter: elasticities and tax effects. Although own-price elasticities are covered in principles, income and cross-price elasticities generally are not. Thus, you should budget significant class time to discuss them. The presentation on tax incidence may also require significant class time, as students are sometimes confused as to why, for example, the resulting equilibrium is independent of whether the demand curve or the supply curve shifts to show the tax. It may be difficult for students to understand why elasticities are important (at least to economists). A discussion of the gas tax outlined in the Challenge may be a good place to start. By discussing who would benefit from a gas tax holiday and by how much, you can introduce the need for elasticities in order to measure policy implications. You might also explain that an entire demand curve can be difficult to estimate empirically, but elasticities are easier to measure. Estimating elasticities at a given point allow economists to predict the implications of a given policy without having to estimate the entire demand curve. When discussing own-price elasticities, students need to understand that several formulas yield an elasticity, and the choice of formula is driven mostly by the information that is given. When talking about the formula as simply a ratio of percentage changes, you might try to find a current newspaper piece that has a percentage change in prices and the percentage change in quantity that results. If you are using calculus, you may want to demonstrate that when demand curves are linear, their answers using the derivative formula in Footnote 1 will be the same as those derived using Equation 3.2, but there will be differences when demand relationships are nonlinear. Be sure to point out Footnote 2 regarding signs. It may be the case that your students learned the elasticity formula with a (–) sign imbedded in it, making elasticities appear as positive numbers. Note that even when the sign is not imbedded in the formula, economists often do not say, “the elasticity is –2”, but rather, “the elasticity is 2” with the minus sign implicit. When discussing elasticities, two points require significant attention. The first is to get the students to make the connection between a verbal description of an elasticity, the slope of the demand curve, the elasticity formulas, and the graph of a demand curve. You can give the students information in different forms and ask them to compute an elasticity in each case. Some students are good at computing elasticities only if they are given certain information to work with, such as two prices and their associated quantities. The second area of confusion is that linear demand curves are not of constant elasticity (except when perfectly elastic or inelastic). I demonstrate using an equation and a graph that although the slope is constant, the price-to-quantity ratio is changing, which changes the elasticity as price falls. I also show what the resulting curve is if elasticity is constant. When covering income and cross-price elasticities, if your students have had a statistics course or if you covered the Appendix 2A on regressions, consider using the following approach. Choose a product and ask the students what factors might influence demand (choose something that has clear substitutes and complements, such as a computer or a food item). Once you get a list, put a hypothetical demand equation on the board. If you have a computerized classroom, you can bring in data and estimate a demand equation for the class, which seems to take some of the abstraction out of demand analysis. Either way, once you have an equation, review how an own-price elasticity can be determined from this equation, and use that as a springboard into the cross-price and income elasticities. It is useful to change the units of one of the

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