Solution Manual For Modern Principles: Microeconomics, 4th Edition

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CHAPTER1Modern Principles of Economics:TheBig IdeasFacts and Tools1.A headline in theNew York Timesread: “Study Finds Enrollment Is Up at Colleges DespiteRecession.”How would you rewrite this headline now that you understand the idea of opportunity cost?Solution1.The easiest change is to switch “despite” to “because of.” Ordinary people focus on the fact thatwhen times are tough, people can’tafford college.Economists, on the other hand,see that there is anopposing effect:when times are tough the price (or opportunity cost) of attending college is low.There’s some truth to both viewpoints. It’s tough for you or your parents to pay for tuition when jobsare hard to come by and income is low,but,as you learned, in the real world it’s actually quite commonfor students to flood colleges during recessions. That means that the price effect usually dominates.2.When bad weather in India destroys the crop, does this sound like a fall in the total “supply” of cropsor a fall in people’s “demand” for crops? Keep your answer in mind as you learn about economic boomsand busts later on.Solution2.It sounds like a fall in supply.3.How much did national output fall during the Great Depression? According to the chapter, whichgovernment agency might have helped to avoid much of the Great Depression had it acted more quicklyand appropriately?Solution3.Output fell by about 30 percent and much of the blame belongs to the Federal Reserve for failing toact.4.The chapter lists four things that entrepreneurs save and invest in. Which of the four are actualobjects, and which are more intangible, like concepts or ideas or plans? Feel free to use Wikipedia orsome other reference source to get definitions of unfamiliar terms.Solution4.Physical capital is the object, while human capital (education), innovation, and efficient organizationare more like concepts, ideas, or plans.5.Who has a better incentive to work long hours in a laboratory researching new cures for diseases: ascientist who earns a percentage of the profits from any new medicine she might invent, or a scientistwho will get a handshake and a thank you note from her boss if she invents a new medicine?

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Solution5. The scientist who gets a share of the profits will have a stronger incentive to invent more new drugs.6.In the discussion of Big Idea Five, the chapter says that “self-sufficiency is death” because most of uswould not be able to produce for ourselves the food and shelter that we need to survive. In addition todeath, however, one could also say that self-sufficiency isboredomorignorance. How doesspecialization and trade help you to avoid boredom and ignorance?Solution6.Justaseach of us could not produce enough food and shelter to survive, we also could not produceenough entertainment or educational/informational services to keep us from boredom or ignorance.Under total self-sufficiency, one would have to produce any TV show one watched, and gather any newsone is interested in,and so on.Clearly, this is not possible, especially because everyone would be toobusy just trying to survive.Thinking and Problem Solving7.In recent years, Zimbabwe has had hyperinflation, with prices tripling (or more!) every month.According to what you learned in this chapter, what do you think the government can do to end thishyperinflation?Solution7.It can stop printing so much money.8.Some people worry that machines will take jobs away from people, making people permanentlyunemployed. Only 150 years ago in the United States, most people were farmers. Now, machines doalmost all of the farm work and fewer than 2% of Americans are farmers, yet that 2% produces enoughfood to feed the entire country while still exporting food overseas.a. What happened to all of those people who used to work on farms? Do you think most adult males inthe U.S. are unemployed nowadays, now that the farm work is gone?b. Some people say that it’s okay for machines to take jobs, because we’ll get jobs fixing the machines.Just from looking around, do you think that most working Americans are earning a living by fixing farmequipment? If not, what do you think most working people are doing instead? (We’ll give a full answerlater in this book.)Solution8. a.They are mostly employed in other industries. Farm states don’thave tens of millions of peoplesearching for jobs.b.Very few people fix farm equipment for a living. Instead, they work in offices, warehouses, andfactories. The demand for more goods and services is almost limitless so when innovations make itpossible to produce a good with fewer resources,otherresources (including labor)are freed uptoproduce other goods.

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9.Let’s connect Big Ideas Six and Nine: Do you think that people in poor countries are poor because theydon’t have enough money? In other words, could a country get richer by printing more pieces of papercalled “money” and handing those out to its citizens?Solution9.No. If a country printed more money, prices would rise, butthe countrywould not get richer.10.NobelPrize winner Milton Friedman said that a bad central banker is like a “fool in the shower.” In ashower, of course, when you turn the faucet right now, it won’t show up in the showerhead for a fewseconds. So if a “fool in the shower” is always making big changes in the temperature based on how thewater feelsright now, the water is likely to swing back and forth between too hot and too cold. Howdoes this apply to central banking?Solution10.It takes a few months for the central banker’s actions to affect theeconomy. So if he or she is alwaysmaking today’s decisions based on how the economy looks right now, he or she might make theeconomy swing back and forth between too “hot” and too “cold.”11.According to the United Nations, there were roughly 300 million humans on the planet a thousandyears ago. Essentially all of them were poor by modern standards: They lacked antibiotics, almost alllacked indoor plumbing, and none traveled faster than a horse or a river could carry them. Today,between 1 and 3 billion humans are poor out of about 7 billion total humans. So, over the last thousandyears, what has happened to thefractionof humans who are poor: Did it rise, fall, or stay about thesame? What happened to the totalnumberof people living in deep poverty: Rise, fall, or no change?Solution11.The fraction of poor people has fallen: almost 100 percent were poor in 1000 AD,whilemuch lessthan 50 percent are poor now. The number of poor has risen: We went from about 300 million poorpeople to 1 to 3 billion today, depending on your definitionof poverty. The number of poor people hasincreased, partly because fewer poor people starve to death today than in the past;in this sense today’spoor are marginally better off than the poor of the past.Challenges12.We claim that part of the reason the Great Depression was so destructive is because economistsdidn’t understand how to use government policy very well in the 1930s. In your opinion, do you thinkthat economists during the Great Depression would have agreed? In other words, if you had asked themwhy the Depression was so bad, would they have said, “Because the government ignored our wiseadvice,” or would they have said, “Because we don’t have any good ideas about how to fix this?” Whatdoes your answer tell you about the confidence of economists and other experts?Solution12.They probably would have been very confident. That’s what experts tend to do: Project confidenceeven when theyaren’t entirely sure. Today, most economists think that the Great Depression couldhave been avoided. Even if they are right,that doesn’t mean that economists today know enough toavoid future depressions, since many things have changed since the 1930s. Economic knowledge andthe economy both continue to grow.

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13.Some problems that economists try to solve are easy aseconomic problemsbut hard aspoliticalproblems. Medical doctors face similar kinds of situations: Preventing most deaths from obesity or lungcancer is easy as amedical problem(eat less, exercise more, don’t smoke), but hard as aself-controlproblem. With this in mind, how is ending hyperinflation like losing 100 pounds?Solution13.Losing 100 pounds requires a lot of self-control. Similarly, ending hyperinflation requires a lot of self-control: The government must stop using the printing press to pay for things.14.As Nobel prize winner andNew York Timescolumnist Paul Krugman has noted, the field ofeconomics is a lot like the field of medicine: They are fields where knowledge is limited (both are new asreal scientific disciplines), and where many cures are quite painful (opportunity cost), but where regularpeople care deeply about the issues. What are some other ways that economics and medicine are alike?Solution14.There are many possible answers, but onepossible oneis that it’s hardin both fieldsto run goodexperiments:When people are sick or economies are in trouble, you want to help them,butyou can’tjust say, “No, we’re going to help half of the economies the best we can and leave the others alone.”Both fields have a lot of phonies, snake-oil salespeople, and amateurs who offer their very-confidentopinions about how to fix things.And,the person-on-the-street often has strong opinions about bothfields—They are often more confident than the experts.On the other hand,hopefully, they are bothfieldsthatwe will know a lot moreaboutin the future!15.Economics is sometimes called “the dismal science.” Of the Big Ideas in this chapter, which sounddismal—like bad news?Solution15.These are often a matter of judgment (as are many of the Challenge questions). Here are the mostobvious examples:1. Big Idea Three, that trade-offs are everywhere.2. Big Idea Eight, that you have to live with the boom–bust cycle.3. Big Idea Ten, that central banking is hard, so even the best might fail.

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CHAPTER2Modern Principles of Economics:The Power of Trade and Comparative AdvantageFacts and Tools1.Use the idea of the “division of knowledge” to answer the following questions.a.Which country has more knowledge: Utopia, where in the words of Karl Marx, each person knows justenough about hunting, fishing, and cattle raising to “hunt in the morning, fish in the afternoon, [and]rear cattle in the evening,” or Drudgia, where one-third of the population learns only about hunting,one-third only about fishing, and one-third only about cattle raising?b.Which planet has more knowledge: Xeroxia, each of whose one million inhabitants knows the samelist of one million facts, or Differentia, whose one million inhabitants each know a different set of onemillion facts? How many facts are known in Xeroxia? How many facts are known in Differentia?Solution1. a.There is more knowledge in Drudgia.b.In Xeroxia, people know one million facts. In Differentia, people know one trillion facts, a million timesmore. We would expect Differentia to have a higher standard of living.2.In theWealth of Nations, Adam Smith said that one reason specialization makes someone moreproductive is because “a man commonly saunters a little in turning his hand from one sort ofemployment to another.” How can you use this observation to improve your pattern of studying foryour four or five college courses this semester?Solution2.You should set aside long blocks of time (perhaps 1 to 2 hours) for each individual course, rather thanswitching every 15 minutes from reading biology to reading economics and back again. Every time youswitch jobs, you waste some time getting used to the new task.3.“Opportunity cost” is one of the tougher ideas in economics. Let’s make it easier by starting withsome simple examples. In thefollowingexamples,find the opportunity cost: Your answer should be arate, as in “1.5 widgets per year” or “6 lectures per month.” Ignoring Adam Smith’s insight from theprevious question, assume that these relationships are simple linear ones, so that if you put in twice thetime you get twice the output, and half the time yields half the output.a.Erin has a choice between two activities: She can repair one transmission per hour or she can repairtwo fuel injectors per hour. What is the opportunity cost of repairing one transmission?b.Katie works at a customer service center and every hour she has a choice between two activities:answering 200 telephone calls per hour or responding to 400 emails per hour. What is the opportunitycost of responding to 400 phone calls?

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c.Deirdre has a choice between writing one more book this year or five more articles this year. What isthe opportunity cost of writing half a book this year, in terms of articles?Solution3. a.2 fuel injectors.b.800 emails.c.2.5 articles.4. a.American workers are commonly paid much more than Chinese workers.True or false: This islargely because American workers are typically more productive than Chinese workers.b.Julia Child, an American chef (and World War II spy) who reintroduced French cooking to Americans inthe 1960s, was paid much more than most American chefs.True or false: This was largely because JuliaChild was much more productive than most American chefs.Solution4. a.True. Productivity differences are the biggest reason for wage differences.b.True. Although Julia Child could not cook a 3-minute egg any faster than any other chef, her valuableoutput included her television show and many cookbooks. Thus, as a celebrity chef and cookbookauthor, Julia Child produced much more GDP than the typical restaurant chef and was more productive.5.According to theWall Street Journal(August 30, 2007, “In the Balance”), it takes about 30 hours toassemble a vehicle in the United States. Let’s use that fact plus a few invented numbers to sum up theglobal division of labor in auto manufacturing. In international economics, “North” is shorthand for thehigh-tech developed countries of East Asia, North America, and Western Europe, while “South” is short-hand for the rest of the world. Let’s use that shorthand here.a.Consider the following productivity table: Which region has an absolute advantage at making high-quality cars? And low-quality cars?b.Using the information in the productivity table, estimate the opportunity cost of making high-or low-quality cars in the North and in the South. Which region has a comparative advantage (i.e., lowestopportunity cost) for manufacturing high-quality cars? For low-quality cars?c.One million hours of labor are available formaking cars in the North, and another 1 million hours oflabor are available for making cars in the SouthIn a no-trade world, let’s assume that two-thirds of the auto industry labor in each region is used tomake high-quality cars and one-third is used to make low-quality cars. Solve for how many of each kind

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of car will be produced in North and South, and add up to determine total global output of each type ofcar. (Why will both kinds of cars be made? Because the low-quality cars will be less expensive.)d.Now allow specialization. If each region completely specializes in the type of car in which it holds thecomparative advantage, what will global output of high-quality cars be? Of low-quality cars? In thefollowing table, report your answers. Is global output in each kind of car higher than before? (We’ll solvea problem with the final step of trade in the Thinking and Problem Solving section.)Solution5. a. North has an absolute advantage at both high-quality and low-quality cars.b.Aftercalculating opportunity costs horizontally within countries, compare them vertically acrosscountries to determine who has a comparative advantage. North’s comparative advantage is high-quality cars (lower opportunity cost of making high-quality cars). South’s comparative advantage is low-quality cars (lower opportunity cost of making low-quality cars).c. Output with no trade.d.Given this setup, the number of high-quality cars is identical with specialization and the number oflow-quality cars increases:

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6.It has been reported that John Lennon was once asked whether Ringo was the best drummer in theworld, and he quipped, “He’s not even the best drummer in the Beatles!” (Paul also drummed on someof the White Album.) Assuming that this story is true and that Lennon was correct, explain, usingeconomics, why it could still make sense to have Ringo on drums.Solution6.Even if Paul were a better drummer than Ringo, Ringo could have a comparative advantage indrumming. If Paul was a little bit better than Ringo on drums and much better than Ringo at playing bassand singing (surely true), then the total output of The Beatles could be increased by not having the bestdrummer on drums.Thinking and Problem Solving7. Fit each of the following examples into one of these reasons for trade:I. Division of knowledgeII. Comparative advantagea. Two recently abandoned cats, Bingo and Tuppy, need to quickly learn how to catch mice in order tosurvive. If they also remain well groomed, they stand a better chance of surviving: Good groomingreduces the risk of disease and parasites. Each cat could go it alone, focusing almost exclusively onlearning to catch mice.The alternative would be for Bingo to specialize in learning how to groom welland for Tuppy to specialize in learning how to catch mice well.b.Supreme Court Chief Justice John Robertshires attorneys who are less skilled than himself to doroutine legal work.Solution7. a. Division of knowledgeb. Comparative advantage8. NobelLaureate Paul Samuelson said that comparative advantage is one of the few ideas in economicsthat is both “true and not obvious.” Since it’s not obvious, we should practice with it a bit. In each of thecases, who has the absolute advantage at each task, and who has the comparative advantage?a. In 30 minutes, Kana can either make miso soup or she can clean the kitchen. In 15 minutes, Mitchellcan make miso soup; it takes Mitchell an hour to clean the kitchen.b. In one hour, Ethan can bake 20 cookies or lay the drywall for two rooms. In one hour, Sienna can bake100 cookies or lay the drywall for three rooms.c. Kara can build two glass sculptures per day or she can design two full-page newspaper advertisementsper day. Sara can build one glass sculpture per day or design four full-page newspaper ads per day.d. Data can write 12 excellent poems per day or solve 100 difficult physics problems per day. Riker canwrite one excellent poem per day or solve 0.5 difficult physics problems per day.Solution8. a. Mitchell’s absolute and comparative advantages are at miso; Kana’s absolute and comparativeadvantages are at cleaning.

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b. Sienna has an absolute advantage at both, but her comparative advantage is at baking cookies.Ethan’s comparative advantage is at laying drywall.c. Kara’s absolute and comparative advantages are at sculpture, while Sara’s absolute and comparativeadvantages are at newspaper ad design.d. Data has an absolute advantage at both, but Riker has a comparative advantage at writing poetry.9. The federal education reform law known as No Child Left Behind requires every state to createstandardized tests that measure whether students have mastered key subjects. Since the same test isgiven to all students in the same grade in the state, this encourages all schools within a state to coverthe same material. According to the division of knowledge model, what are the costs of this approach?Solution9. The cost is that with everyone knowing the same thing, our “hive mind,” our social knowledge, is lesspowerful than it could be. For instance, some parts of a state might emphasize statistics courses in highschool while other parts might emphasize geometry and other parts might emphasize number theory.Each could be useful at a particular place and time, but few students would have the time to master allthree fields. But it’s not necessary for everyone to master all three: It’s enough to have a few (thousand)people who master each field, just in case a need arises. Undergraduate university education is morespecialized than high school, graduate university education is more specialized yet. Indeed, the ideal of agraduate education is that at some point the PhD candidate knows something that no one else in theworld knows!10. In this chapter, we’ve often emphasized how specialization and exchange can create moreoutput.But sometimes the output from voluntary exchange is difficult to measure and doesn’t show up in GDPstatistics. In each of the following cases, explain how the two parties involved might be able to makethemselvesbothbetter off just by making a voluntary exchange.a. Alan received two copies ofGears of Waras birthday gifts. Burton received two copies ofHaloasbirthday gifts.b. Jeb has a free subscription toField and Streambut isn’t interested in hunting. George has a freesubscription to theMiami Heraldbut isn’t all that interested in Florida news.c. Pat has a lot of love to give, but it is worthless unless received by another. Terry is in the same sadsituation.Solution10. a. Alan could give one of his copies ofGearsto Burton, who could offer one of his copies ofHalotoAlan.b. They could swap free subscriptions and both be better off, especially if both men have the last nameBush. At the very least, both parties are no worse off after the exchange.c. If they offer love to each other, both will be better off at no cost—aclassic positive-sum game.11. Many people talk about manufacturing jobs leaving the United States and going to other places, likeChina. Why isn’t it possible for all jobs to leave the United States and go overseas (as some people fear)?

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Solution11. This is notpossible because every nation has to have a comparative advantage in something. Thegreater China’s comparative advantage in manufacturing, for example, the greater the United States’comparative advantage must be in some other type of production. (This can be seen in Table 2.1: Thenumbers in each row are just reciprocals, so the lower the opportunity cost of a shirt in Mexico, thegreater the opportunity cost of a computer in Mexico.) The more that firms want to locatemanufacturing processes in countries like China, the more that those countries would give up (thehigher the opportunity cost) if they pursued other,nonmanufacturing activities. Even if it were cheaperto produce everything in China—thus giving China something like an absolute advantage in allproduction—trade is based on comparative advantage, not absolute advantage.12. Suppose the following table shows the number of labor hours needed to produce airplanes andautomobiles in the United States and South Korea, but one of the numbers is unknown.a. Without knowing the number of labor hours required to produce an auto in South Korea, you can’tfigure out which country has the comparative advantage in which good. Can you give an example of anumber for the empty cell of the table that would give the United States the comparative advantage inthe production of airplanes? What about South Korea?b. Who has the absolute advantage in the production of airplanes? What about autos?c. What exact number would you have to place in the empty cell of the table for it to be impossible thattrade between the United States and South Korea could benefit both nations?Solution12. a. Any number less than 12.5 will give the United States the comparative advantage in airplanes. Anynumber higher than 12.5 will give South Korea the comparative advantage in airplanes.b. The United States clearly has the absolute advantage in the production of airplanes. We do not knowwho has the absolute advantage in the production of autos. If the missing number is greater than 5, theUnited States has the absolute advantage in autos; if the missing number is less than 5, South Korea hasthe absolute advantage.c. If the missing number was exactly equal to 12.5, then the opportunity cost of one airplane would be160 autos in both countries. In this case, no possible benefits exist from trade, because neither countrycan produce either good at a lower cost than can the other country.13. In the chapter, you saw how to create a production possibilities frontier for the United States andMexico. Let’s take a look at how to combine these PPFs to make one PPF for the U.S.–Mexico tradealliance. You’ll use the same set of axes that wasused in the chapter: computers on the vertical axis andshirts on the horizontal axis. Refer to Figure 2.1 and Table 2.1 as needed.

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a. First, you need to plot the endpoints of the PPF by figuring out the maximum numbers of computersand shirts. If both the United States and Mexico produced only computers, how many would theyproduce? What if they only produced shirts? Plot these two points and label them asA(all computers)andZ(all shirts). The PPF for the U.S.–Mexico trade alliance is going to look a little different from thePPFs for the individual countries, so we don’t want to simply connect the two points with a straight line.We need to figure out the rate at which the U.S.–Mexico trade alliance gives up computers to get shirts(or vice versa).b. Starting at pointA, if citizens of the United States or Mexico decided they wanted more shirts, wherewould those shirts be produced?Why? What do you think the PPF should look like as the U.S.–Mexicotrade alliance initially moves away from pointA?c. Starting at pointZ, if citizens of the United States or Mexico decided they wanted more computers,where would those computers be produced? Why? What do you think the PPF should look like as theU.S.–Mexico trade alliance initially moves away from pointZ?d. Plot the point at which each country is completely specializing in the good for which it has thecomparative advantage. Label this point B. Connect pointsA, B,andZ. This is the PPF for the U.S.–Mexico trade alliance. Can you describe how this PPF is a combination of the two nations’ separatePPFs?e. Suppose now that a third nation, Haiti, enters the trade alliance. In Haiti, the opportunity cost of acomputer is 12 shirts, and Haiti has the labor necessary to produce 1 computer (or 12 shirts). Can youdraw a new PPF for the U.S.–Mexico–Haiti trade alliance?f. Okay, what willhappen to the PPF as more and more countries join the trade alliance?What would itlook like with an infinite number of countries?Solution13.The United States could produce 24 computers or 24 shirts. Mexico could produce two computers or12 shirts.a. If both countries devote all of their resources to producing computers, they could produce 26computers (24 + 2). PointAshould be placed at the point (0, 26). If both countries devote all of theirresources to producing shirts, they could produce 36 shirts (24 + 12). PointZshould be placed at thepoint (36, 0).

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b. The United States has an opportunity cost of one computer per shirt. In Mexico, one shirt carries anopportunity cost of (2/12) = (1/6) computer. Mexico has the lower opportunity cost of producing shirts,so it should be the first to reduce computer production in order to produce shirts.c. The United States has an opportunity cost of one shirt per computer and Mexico has the opportunitycost of 6 shirts per computer. The United States has the lower opportunity cost of producing computers,and so would be the first to reduce shirt production in order to produce computers.d. If Mexico produces only shirts and the United States produces only computers, their combined outputwould be 12 shirts and 24 computers. PointBshould be placed at (12, 24).e. and f. See the PPF for the U.S.–Mexico–Haiti trade alliance in the figure above. When we add acountry to the World PPF, the frontier shifts out but it also tends to become more concave, or boundedout. Mexico was a lower-cost producer of shirts than the United States, which is why the first part of theWorld PPF starting from 0 shirts has a lower, or flatter, slope. Haiti has an even lower cost of producingshirts than Mexico, so when we add Haiti, the initial slope starting from 0 shirts is even flatter—whichmeansthatwe can have more shirts and give up fewer computers. In the same way, when we addcountries that are even more productive at producing computers (i.e., a high cost of producing shirts)than the United States, the PPF gets steeper (starting from zero computers on the horizontal axis).Therefore, we can get lots of computers just by giving up a few shirts.In other words, by allocating production first to where it can be done at the lowest cost, countries canincrease the total amount produced beyond the sum of each country’s individual production, which isanother way of expressing comparative advantage and the gains from trade.Challenges14.In the computers and shirts example from the chapter, the United States traded one computer toMexico in exchange for three shirts. This is not just an arbitrary ratio of shirts to computers, however.Let’s explore theterms of tradea little bit more.a. Why is trading away a computer for three shirts a good trade for the United States? Why is it also agood deal for Mexico?b. What if, instead, the agreed-upon terms of trade were one computer for eight shirts? Would thistrade still benefit both the United States and Mexico?c. What is the maximum (and minimum) number of shirts that a computer can trade for if the UnitedStates and Mexico are both to benefit from the trade?Solution14. a. This is a good deal for the United States, because it onlygave up one shirt to produce thecomputer, so receiving three shirts benefits the United States. It is a good deal for Mexico becauseMexico would have to give up six shirts toproduce one computer on its own, so if Mexico can gain onecomputer by giving up only three shirts, this deal makes that country better off.b. This trade would benefit the United States,since itwill still be receiving more shirts (eight) than itgave up in order to produce the computer (one). However, this would not benefit Mexico becauseMexico could have produced its own computer at an opportunity cost of just eight shirts, which wouldbe a better deal than trading at this rate.

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c. The number of shirts traded for each computer must be higher than one so that it benefits the UnitedStates but less than six so that it benefits Mexico.15. Go to www.Ted.com and watch Thomas Thwaites’s talk, “How I built a toaster—from scratch.” Howmuch money and time do you think Thwaites spent building his toaster? How long do you think it wouldhave taken Thwaites to earn enough money in, say, a minimumwage job to buy a toaster? Comment onthe division of labor and the importance of specialization in increasing productivity.Solution15. Thwaites seems to have spent several thousand dollars and about a year to “build” his toaster, whichprobably would have killed him had he tried to plug it in. If he had gone to Walmart, Thwaites couldhave bought a toaster for about $15 or two hours of work at the minimum wage. In other words, thedivision of labor and specialization meant that Thwaites’ productivity was multiplied by a factor of atleast one thousand.Due to the power of specialization and comparative advantage,Thwaitesand youand I are ablepurchasegoods that wecould not have produced onourown without much, muchgreater effort and expense if at all.

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CHAPTER3Modern Principles of Economics:Supply and DemandFacts and Tools1.When the price of a good increases,the quantity demanded ____. When the price of a gooddecreases,the quantity demanded ____.Solution1.When the price of a goodincreases,the quantity demandedfalls. When the price of a gooddecreases,the quantity demandedrises.2.When will people search harder for substitutes for oil: When the price of oil is high or when the priceof oil is low?Solution2.When the price of oil is high, people will search harder for substitutes.3.Your roommate just bought a Nike+ Sportwatch for $160. She would have been willing to pay $250 fora device that could improve her morning runs by measuring the speed, distance, and duration of theruns, andcalculating the calories she burns. How much consumer surplus does your roommate enjoyfrom the Nike+ Sportwatch?Solution3.Yourroommate enjoys $90 of consumer surplus from the Nike+ Sportwatch (willingness to pay minusprice you actually paid equals consumer surplus: $250 − $160 = $90).4.What are three things that you’ll buy less of once you graduate from college and get a good job?What kinds of goods are these called?Solution4.There are many possible answers, including ramen noodles, macaroni and cheese, clothes fromdiscount stores, low-quality used cars, and bus tickets. These are called “inferior goods.”5.When the price ofAppleMacBooks goes down, what probably happens to the computers?Solution5.The demand for laptops featuring Microsoft Windows probably falls—remember that this means theentire demand curve shifts downandto the left. The demand for laptops featuring Microsoft Windowsfalls when the price of MacBooks goes down because laptops featuring Microsoft Windows andMacBooks are substitutes. Thus, when the price of MacBooks goes down, people switch to buying moreMacBooks and fewer laptopsthat featureMicrosoft Windows at any particular price.

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6. a.When the price of olive oil goes up, what probably happens to the demand for corn oil?b.When the price of petroleum goes up, what probably happens to the demand for natural gas? To thedemand for coal? To the demand for solar power?Solution6.a.The demand for corn oilprobably goes up—remember that thisprice increasemeans the entiredemand curve shifts upandto the right,and thatthe demand for corn oil rises when the price of oliveoil goes up because olive oil and corn oil are substitutes.b.When the price of petroleum goes up, the demand for these substitutes also goes up.7. a.If everyone thinks that the price of tomatoes will go up next week, what is likely to happen todemand for tomatoes today?b.If everyone thinks that the price of gasoline will go up next week, what is likely to happen to thedemand for gasoline today? (Note:Is this change in demand caused by consumers or by gas stationowners?)Solution7. a.Today’s demand for tomatoes will probably rise, since people see “tomatoes today” and “tomatoesnext week” as substitutes.b.It’s the same question as 7a: So gas demand probably rises. This rise in demand is caused byconsumers, since consumers create demand, not the gas station owners.8.Along a supply curve, if the price of oil falls, what will happen to the quantity of oil supplied? Why?Solution8.As the price of oil falls, it will drop below the cost of production of the highest-cost producers, such asthose developing Canada’s tar sands. Thus, as the price falls,the high-cost producers will stopproducing,thereby reducing the quantity supplied.9.If the price of cars falls, are carmakers likely to make more or fewer cars, according to the supplycurve? (Notice that the “person on the street” often thinks the opposite is true!)Solution9.If the price of cars falls but the technology for making cars stays the same, carmakers are likely toproduce fewer cars. This is because at a lower price, the only factories that will stay open are the onesthat are most efficient at producing cars. The person on the street often thinks that if the price falls,businesses will have to make more cars in order to earn the same amount of total revenue, but this logicis wrong in most cases. Rational business owners care about profits (total revenue minus costs) not totalrevenue.10.When is a pharmaceutical business more likely to hire highly educated, cutting-edge workers anduse new, experimental research methods: When the business expects the price of its new drug to be lowor when it expects the price to be high?

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