Economics, 9th Edition Solution Manual

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Chapter 01-Economics and Economic Reasoning1-1Chapter 1:Economics and Economic ReasoningQuestions and Exercises1.Coordination refers to how the three central problems facing any economy aresolved. Those three problems are what and how much to produce, how toproduce, and for whom to produce. Inevitably,individuals desire more than isavailablein light ofhow much they’re willing to work, causing a problem ofscarcity. The concept of scarcity has two elements:our wants and our means offulfilling those wants. Those two elements are interrelated since wants arechangeable andarepartially determined by society and the means of fulfillingthose wants. In addition, the degree of scarcity is constantly changing,dependingon the available means of production and the development of new wants.Therefore, the author of the textbook focused on coordination instead of scarcityto emphasize the subsidiary nature of scarcity to the overall concept ofcoordination. Economics is not merely about our wants or the means of fulfillingthose wants; it is also about reconciling our wants with reality, where realityconsists of decision-making mechanisms, social customs, and political realities.2.a.Macro.b.Micro.c.Macro.d.Micro.e.Micro.f.Micro.3.Answers will differ.Two microeconomic problems are the pricing policies offirms (price-fixing in particular) andthe waywages are determined in labormarkets. (Why do athletes and celebrities make so much money,anyway?) Twomacroeconomic problems are unemployment and inflation (business cycles andgrowth are also macroeconomic problems).4.a.The opportunity cost of attending college is the sacrifice one must maketoattendcollege. It can be estimated by figuring out the benefit of the next-best alternative.If that alternative is working, one would guess the likely wage that could beearned at a job that does not require a college degree and then multiply by 40hours for each week in college. The opportunity cost is also what could be donewith the money used for tuition and other costs related to attending college.b.The opportunity cost of taking a course could be estimatedbyusing the sametechnique as in partaif you otherwise would be workingduringthese hours. Ifyou had taken another course instead, the opportunity cost would be the benefityou would have received from takingthe othercourse.c.The opportunity cost of attending yesterday’s lecture would depend on what youotherwise could have done with the time (sleep? eat lunch with an interestingperson?). Although this is no longer a choice to you, past activities do haveopportunity costs.

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Chapter 01-Economics and Economic Reasoning1-25.Answers will vary.A correct answer will indicate that the student compared themarginal costs and benefits and chose the activity because the marginal benefitexceeded the marginal cost.6.The marginal costs are theadditionalcosts. They are$0.15 per mile for milesabove 150 plus the cost of gas. Therefore,the marginal cost is $7.50 plus the costof gas. The initial payment can be forgotten because it is a sunk cost; it is not partof marginal costs.7.No, since the marginal cost of drug control exceeds the marginal benefit;government should not spend $4,170 to deter one person from using drugs.8.The opportunity cost of buying a $20,000 car is the benefit we would have gainedby using that $20,000 for the next-best alternative, which could be spending it onother goods and services or saving it.9.Only the marginal costs and benefits of taking the job are relevant. That meansthatthe sunk cost of the bachelor’s degree is irrelevant. Therefore, the relevantcosts are the opportunity cost of taking the job (forgone earnings from yourcurrent job) and other things you could have done with the money you need topay business school tuition. The relevant benefit is the increased lifetime earningsof $300,000.10.I would spend the $5 million on those projectswhichprovide the highest marginalbenefit per dollar spent. The opportunity cost of spending the money on oneproject is the lost benefit that the college would have received by spending it onadifferentproject. Thus, another way to restate the decision rule is to spend themoney on the project that minimizes opportunity cost per dollar.11.Answers will differ. Two examples of social forces are our unwillingness tocharge friends interest and our unwillingness to “buy” dates with other people.These issues are still subject to economic forces; however, there is no market indates or in loans to friends, andsothe economic force does not become a marketforce.12.Answers will differ.Two examples of political or legal forces are rent controllaws and restrictions on immigration. Both prevent the invisible hand fromworking.Rentcontrol laws place a price ceiling on rent, causing shortages ofapartments, and immigration restrictions cause the number of immigrants seekingentry to exceedthe numberallowed to enter, which tends to cause wage rates todiffer among countries.13.a.Both parties benefit.The person who gains the kidney benefits if it works whentransplanted into his or her body and will no longer have the emotional and

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Chapter 01-Economics and Economic Reasoning1-3financial burden of dialysis. The person selling the kidney gains the $30,000.Their gains will also have impacts on others (their families, for example).b.Both parties must undergo surgery and face all the attendant risks and costs. Theseller also faces the potential cost of a future illness or injury harming his or heronly remaining kidney,causing the seller to need dialysis.c.Whether a society should allow this transaction is a question of value judgmentsand cultural norms. Our society has chosen not to allow such transactions because(among other reasons) those with more money would have increased access toorgans and thereforewouldhave advantages over those of limited means, andthusthe poor could be exploited in such transactions.14.An economic model is a framework that places the generalized insights of atheory in a more specific contextual setting. Policymakers need to understand theempirical evidence supporting the theory as well as real-world economicinstitutions to make policy recommendations.15.No.Economictheory proves nothing about what system is best. It simplyprovidesways to look at systems andindicateswhat the advantages anddisadvantages of various systemsprobablywill be. Normative decisions aboutwhat is best can only follow from one’s value judgments.16.A theorem is a proposition that is logically true based on the assumptions of themodel,whereasa precept is a policy rule that a particular course of action ispreferable. Economists can agree about theorems but disagree about precepts ifthey have different value judgments about appropriate goals.17.A normative statement reflects ethical judgments about what should be. It reflectsvalues. A positive statement refers to a fact or a logical relationship. It is inprinciple testable oristhe result of logic analysis. Positive statements of fact arenot subject to debate among educated individuals. The art of economics refers toissues of judgmentonhow to achieve the goals determined in normativeeconomics,giving the facts and logical relationships one finds in positiveeconomics. Art of economicsstatements are subject to debate.18.a.Positive statement since it is a statement of fact.b.Normative.c.Since this is relating a normative goaltoa decision, this could be a statement inthe art of economics. Italsocould be seen as a normative statement if oneinterprets it as a normative imperative.d.Positive statement since it is a statement of fact.

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Chapter 01-Economics and Economic Reasoning1-4Questions from Alternative Perspectives1.AustrianMost economists would answer yes because they see economic variablessuch as unemployment as objective measures, which makes them availableas measures for planning. Most economists see only individual preferences,not social preferences, as subjective. Austrians believe in a radicalsubjectivity, uncertainty with respect to time, knowledge, and mattersbeyond preferences. This eliminates the possibility of using objectiveeconomic analysis as the basis for government planning. For an Austrianstudy on the nature of time and uncertainty for economics,see the work ofMario Rizzo and Gerald O’Driscoll, Jr.2.Religiousa.The rational choice model assumes that individuals are one-dimensional, thatthey know what they want, and that they will do what is in their best interest.Addictive behavior undermines that assumption, leading to a conflictbetween passion and reason.b.The conflict suggests that we have to be careful not to apply the economicmodel in casesin whichthat conflict is important, such aswithbehaviors thathave addictive elements. Whenthere is a conflict between passion andreason,there may be greater reason for government to limit access to theaddictive good or behavior.3.Feminista.Patriarchy is a social institution in which men exercise a disproportionateamount of social power and are inaposition to define the roles of womenand children as well as make most decisions. Because patriarchy affectsthewayspeople behave and interact, it is an institution. It definitely affects thelabor market because those who are in power will make hiring decisions thatperpetuate their position of power. For example, husbands and fathers maymake, or heavily influence, the decisions of whether a woman will look forwork.b.Some economists might argue that men and women are merely expressingtheir preferences in job choices,whereasfeminist economists might arguethat these choices are culturally determined by institutions, or patterns ofbehavior, such as patriarchy. It is impossible to separate the free marketfrom the institutions within which it is embedded. The free market may notdetermine the institutions or mores of a society;it operates within thoseinstitutions.

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Chapter 01-Economics and Economic Reasoning1-54.Institutionalista.A free market outcome would provide flu vaccine to those willing and able topay the most for it, which will not include all of those given priority under therationing scheme.b.The determination of which option is “just” requires delving into theories ofjustice. The free market solution best mirrors commutative justice—onebased on efficiency of exchange—andthe rationing scheme best mirrorsdistributive justice—one based on some notion of fairness that favors thosewith a greater predisposition to illness.5.Post-Keynesiana.This answer will differ among students.b.Most studentsprobablywill answer this question no. The standard theorypresented in the book is based on the assumption that decision makers havefull informationaboutall factors that might influence their decisions: Theyhave substantive knowledge of all possible outcomes of their decisionmaking and the consequences of each decision. Most likely you had limitedknowledge of the pros and cons of all schools when deciding which college toattend and turned to the advice and norms of a small group of friends, familymembers, or teachers to help you make a decision.c.Recognizing that you have limited time, knowledge, and ability to compute allthepossible outcomes of each economic decision, you probably rely on socialnorms and rules of thumb to help you make many of your economic decisions(e.g.,when you go to a grocery store,you continue to buyDiet Cokeeventhough other diet sodas might provide you with a higher level of satisfactionat a lower price because you are in the habit of buyingDiet Cokeanduncertain of the exact benefit the other diet drinks will give you).d.The implication of this behavior is that individuals do not follow theeconomic decision rule of gaining complete information to optimize theirchoices but rely on rules of thumb or habit to come up with a satisfactoryoutcome even though it might not be the most optimizing. This means thateconomic analysis which assumes that humans are one-dimensional rationalbeings who calculate all relevant marginal costs and benefits is limited.6.Radicala.It implies that there is no clear-cut distinction between positive andnormative economics and that seemingly positive economics has implicitvalue judgments hidden within it.

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Chapter 01-Economics and Economic Reasoning1-6b.Economics is value-laden. The relevant question about whether thedistinction is tenable is whether it is relatively less value-laden than thealternatives. That is an open question.Issues to Ponder1.Regretting a decision doesn’t necessarily mean that we did not use the economicdecision rule when makingthatdecision. At the time the decision was made, weweighed the marginal costs and marginal benefits, undertaking the activity if themarginal benefits exceeded the marginal costs and not undertaking the activity ifthe marginal costs exceeded the marginal benefits. Many decisions are madewithoutknowledge ofthe full marginal costs and marginal benefits. Sometimesthese marginal costs and marginal benefits are revealed at a later date,making usregrettheinitial decision. An example is going out to a restaurant. Fromrecommendations, we assume that the marginal benefit is one thing. If thatrecommendation overstates our actual experience, we will have overestimated themarginal benefit of eating out. We may regret having spent the money to eat out.2.a.It depends on the perspectives used to answer the question. From a purelyeconomic perspective, we would conclude that it is reasonable to execute hackersbased on cost/benefit analysis. However, since this decision by no means can besimplified to pure economics, we need to take into consideration social, political,and religious factors. Therefore, Landsburg’s argument should be evaluated in amore complete context.b.Cost/benefit analysis can be extended to many areas, such as social welfareprograms and almost all policy discussions. (Source: “Feed the Worms WhoWrite the Worms to the Worms,”http://slate.com/id/2101297/),Slate Magazine,May 26, 2004.)3.TheTheory of Moral Sentimentsemphasizes the importance of morality. Theinvisible hand directs people’s selfish desires (tempered by the social and politicalforces) to the common good but is based on certain presuppositions about themorality of individuals which constrains individuals’ selfish actions. What Smithis suggesting is that the way individuals calculate marginal cost and marginalbenefit must be interpreted within a social context.4.a, b. Partsaandbhave no “right” answers. Most people would say no toaand yes tob. Ifone wereanswering this question from the perspective of the economicdecision rule alone, one would measure the marginal benefits against the marginalcosts of the choice.c.People tend to believe that children should be afforded greater protection thanisafforded to adults and are therefore repelled by the idea of sacrificing a child eventhough it would save the lives of other children. Sick people are closer to death,and therefore theirlivestend to be valued less.d.Brain imaging suggests that the moral sense behind one’s answers does not comefrom rational though, but instead from emotion—gut responses. This suggests that

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Chapter 01-Economics and Economic Reasoning1-7a kind of moral intuition exists that is quite separate from reason. If that is thecase, opportunity costs were not central to the decision. It was a moral, not aneconomic,decision. Opinions among philosophers and economists differ on thisissue.5.a.It depends. On the basis of cost/benefit analysis, one could figure out casesinwhichmost people would say that they should be dishonest, but cost/benefitanalysis is not the final arbiter if you believe that dishonesty is wrong.Additionally, you should consider the effects of dishonesty on your reputation andfuture interactions.b.You can make yourself more believable by developing a reputation for honesty.Developing such a reputation usually has a cost because it requires one to behonest even when others might be dishonest. To encourage the other person to tellthe truth, you could use economic incentives.6.a. Answers will vary.b. Economic theory says that prices are determined by supply and demand, butbusinesses often use rules of thumb such as cost-plus-markup rules to set theirprices. If two firms have different costs of supplying the same item, theyprobablywill set a different price for that item. People might be willing to pay the higherprice if the store is closer to where they live or simply to support a smaller, localstore.c. Again, answerswill vary, but the reasoning is the same as in partb.7.It depends on the perspective one takes. It is economically reasonable to legalizeorgan sales. But from a moral perspective, organ sales may be unethical, andpoorer people might feel compelled to sell their organs to support their family, aresult that many people would find morally reprehensible. Economics has nothingdefinitive to say on normative moral issues such as this.8.Answers will vary. Here is an example:Banks are economic institutions. Theytake a cost/benefit approach to deciding to whom to give loans, and they influencedecision making by allowing individuals to spend more money than they earn orhave as wealth.9.a.This is a matter of personal views; there are arguments for and against it. Anargument against the practice is that wealthy songwriters would have too muchpower in promoting their songs. The songs of the songwriters who can afford toshare profits will get more playtime and become even more famoustothedetriment to new entrants into the industry. Arguments for this practicearethat itcould be used to offset racism as in the example givenand, to the extent that newsongwriters have the capability of offering such royalty share, promote new kindsof music.b.The royalty payment gave Freed a strong incentive to choose what he consideredthe best song and to promote that song heavily. The flat payment would have just

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Chapter 01-Economics and Economic Reasoning1-8given him an incentive to play any song and no long-term interest in whether thesong succeeded or failed.c.Product placement in movies is legal, as are free newspapers to professors forgettingaclass to use the newspaper. Direct payment to doctors for prescribing aparticular type of drugareillegal, although taking doctors to lunch is not.10.Three ways (among many) that dormitory rooms could be rationedareadministrative decree, lottery, and a market system. In the first, individualbehavior would be forced to fit the will of the administrator. Individualsprobablywould complain and try to influence the administrator's decision. Becauseadministrative decree is not necessarily an efficient system, some peopleprobablywould attempt to trade rooms after the allocation. In the second, individualbehavior would be forced to fit the luck of the draw; individualsprobablywouldattempt to trade rooms after the draw. In the final example, individual behaviorwould have already been subject to economic forces, and thus, there will be notendency to trade after one has "bought" the room one can afford.11.It suggests that policy should be willing to give up more in possible gains to avoidlosses than otherwise would be the case. Economic policies should be risk-averse—more committed to maintaining the current standard of living thantorisking economic losses by trying to improve it. Another possible policy responsewould be to offset this tendency by making gains more salient than losses.12.A good economist always tries to be objective. However, no one can ever becompletely objective. Sometimes the best we can hope for is an awareness of thecultural norms and value judgments that influence our views and decisions.Additionally, many policy issues (such as organ markets and minimum wagelaws) probablyshouldnot be approved in a purely objective way, since they arealso moral and social issues.

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Chapter02-The Production Possibility Model, Trade, and Globalization2-1Chapter 2: The Production Possibility Model, Trade, and GlobalizationQuestions and Exercises1.In theaccompanyingfigure, wadget production is measured on the vertical axisand widget production is measured on the horizontal axis. If the society becomesmore productive in its output of widgets, it can produce more of them, and theendpoint of the curve on the horizontal axis will move to the right, as showninthe graph. If the society is also less productive in its production of wadgets, theendpoint on the vertical axis will move down, as shownin the graph. The result isa new production possibility curve.2.If a society became equally more productive in the production of both widgetsand wadgets, the production possibility curve would shift out to the right,asshown in the accompanying graph.3.Any production possibility curve that shows the principle ofa rising trade-offmust be bowed out. The accompanying grade production possibility curveembodies the principle ofrising trade-off. The table isalsopresentedhere. Noticethat for each 20-point gain in the History grade,the amount of points lost on theEconomics grade steadily increases.

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Chapter02-The Production Possibility Model, Trade, and Globalization2-24.a.Toproduce one more Peep, JustBorn must give up 3 Mike and Ikes. Hence, thetrade-off for 1 Peep is 3 Mike and Ikes. The trade-off for1Mike and Ike is 1/3 ofaPeep.b.See the accompanying graph.c.Point A is efficient. Point B is inefficient. Point C is impossible.d.See the accompanying graph.5.The theory of comparative advantage underlies the shape of the productionpossibility curve.Ifeach person's comparative advantageis taken advantage of,higher total output can be reached thanwould be the caseifeach produced allgoods onhis or herown or if each produced goods for whichhe or shedid nothave a comparative advantage. As more and more of a good is produced,resources that have less of a comparative advantage are brought into theproduction of a good, causing the production possibility curve to be bowedoutward.HistoryEconomics4010060808050

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Chapter02-The Production Possibility Model, Trade, and Globalization2-36.a.See the accompanying graph.b.As the output of food increases, thetrade-offbetween food and clothingisincreasing. To illustrate, giving up 4 of clothing (from 20 to 16) results in a gainof 5 food (from 0 to 5), but giving up another 4 clothing (from 16 to 12) results ina gain of 4 food (from 5 to 9), and this pattern continues.c.If the country gets better at producing food, the placewhere the productionpossibilitycurve intersects the horizontal axis will move to the right.d.If the country gets equally better at producing food andproducingclothing, theproduction possibility curve will shift out along both axes by the same proportion.7.There are no gains from trade when neither of two countries has a comparativeadvantage in either of two goods.8.The fact that the production possibilitymodel tells us that trade is good does notmean that in the real world free trade is the best policy. The production possibilitymodel does not take into account the importance of institutions and government intrade. For example, the model does not take into account externalities associatedwith some trades, the provision of public goods, or the need for a stable set ofinstitutions or rules. The production possibility model shows maximum totaloutput, but that is not the only societal goal to take into accountinformulatingpolicy.9.a.See the accompanying graph.

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Chapter02-The Production Possibility Model, Trade, and Globalization2-4b.The United States has a comparative advantage in the production of wheatbecause it can produce 2 additional tons of wheat for every 1 fewer bolt of cloth,whereasJapan can produce 1 additional ton of wheat for every 2 fewer bolts ofcloth. Japan has a comparative advantage in producing cloth.c.The United States should trade wheat to Japan in return for bolts of cloth. Onepossibility is that the United States produces 1,000 tons of wheat and Japanproduces 1,000 bolts of fabricand they divide total production equally.Both get500tons of wheat and500yards of fabric. Both end up with more of each good.(Note: Other combinations are possible.)d.See the accompanying graph.10.Globalization increases competition by allowing greater specialization anddivision of labor. Because companies can move operations to countries with acomparative advantage, they can lower production costs and increase competitivepressures. The decreased importance of geographical location increases the size ofpotential markets, increasing the number of suppliers in each market and thusincreasing competition.11.The law of one price rules, meaning that U.S. wages can exceed foreign wagesonlyto the degree that U.S. workers are more productive than foreignworkers.Therefore,theadjustmentsthat will need to occur will equalizewage rates.Thus, either Western nominal wages will grow slowly andforeign nominal wages will grow rapidly and catch up or U.S. exchange rateswill decline to equalize wages. Some combination of the two is most likely. Itis possible that there will develop areas of production/services that willallow U.S. wages to remain high.12.The law of one prices states thatthewages of workers in one country will notdiffer significantly fromthewages of (equal) workers in another institutionallysimilar country. As the world is globalizing, the law of one price causes firms tohire workers in other countries.Because wages adjusted for productivitydifferences are lower in other countries, firms choose touse workersin foreigncountries. As they do so, wageswill be bid up until wages, adjusted forproductivity differences, are equal between the two countries.

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Chapter02-The Production Possibility Model, Trade, and Globalization2-5Questions from Alternative Perspectives1.AustrianIn a market economy competition,the market process translates individualactions into actions that are good for society. There is no such mechanism forgovernment; government has a monopoly on power, which allowsindividuals in government to use that monopoly to achieve their ends, whichmay not be “good” ends. This monopoly on power makes government lessreliable than the marketfordoinggood, since the government is not subjectto entry and exit as firms are in the market. Also, whether every individualvoice is taken into account depends on the government system,whereasthemarket will always include any individual’s voice bythat individual’sentry orexit.2.Religiousa.Most people would say thatalthoughit might be a component of the goals ofsociety, it is not “the” goal of society. Other goals might include virtues suchas kindness and generosity.b.If a country is Christian, maximizing should not be "the" goal of society.c.In a Christian society,the paramount goal would be to discern and fulfill thewill of God.3.Feminista.Companies definitely think that sex sells products. Just look at the cover of anynumber of magazines.b.Sex is used in the advertising of numerous products.c.All people are subject to abuse by advertising, but women are more likely to beportrayed as objects instead of people and are therefore at greater risk ofexploitation.d.Althoughmen and women may both be used in advertising, typically men areshown to be in a dominant position of powerandwomen are shown insubordinate positions.4.Institutionalista.Back in the 1950s President Eisenhower warned of the military/industrialcomplex, which maintains all types of military spending on projects so thatthey continue to generate jobsinthose areas. Senators with power on theappropriations committee inevitably have larger defense expenditures intheir districts thandosenators not on the appropriations committee. This

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Chapter02-The Production Possibility Model, Trade, and Globalization2-6high spending on military production results in a trade-off. It means thatthere is less money to spend on consumer goods, leading to lower productionof consumer goods.b.The short-term consequence is a loss in consumer goods. The long-termconsequences are potentially much more serious, because for the military tojustify the expenditures, wars are necessary; thus,the production of militarygoods over consumer goods can increase the probability of wars. Some mightargue that the latest Iraq war is an example, with Halliburton benefiting fromit and the former head of Halliburton, Vice President Cheney, leading thegroup pushing for the U.S. entrance into the war.5.Radicala.Yes, for many low-wage jobs it does, although technology is changing that tosome degree.b.When making policy decisions, society must take into account not only whatis produced but the methods and means of production.Issues to Ponder1.This statement can be true or false depending on the implicit assumptions made inthe analysis. It is truein light of the factthat individuals will eliminate allinefficiencies they see through trading. It might be false if not everyone knows allthe benefits and the inefficiencies or does not have the opportunity to correct theinefficiencies or if the costs of eliminating the inefficiency are too high.2.If a particular distribution of income is one of society’s goals, a particularproduction technique that leads to greater output but also an undesirabledistribution of income might be considered an inefficient method of production.Remember, efficiency is achieving a goal as cheaply as possible. Maximizingoutput is not the only goal of a society.3.a.From the numbers alone, one would choose not to work because theopportunity cost of working is giving up an $80,000 increase in lifetimeincomewhereasthe benefit is $32,000 of income now. Although there is acorrelation between working time and GPA, we cannot conclude thatworking an after-school job causes the decrease in GPA. Therefore,one mightbe able to maintain a decent GPA while working. Moreover, earning moneymight be the priority for a particular student to reach a goal, such as savingfor college that will lead to even greater lifetime earnings.b.It depends on the particular student. Working takes time from study and thusmight be a reason for the decrease in GPA. But the situation varies fromstudent to student.

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Chapter02-The Production Possibility Model, Trade, and Globalization2-74.The fact that lawns occupy more land in the United States thandoesany singlecrop does not mean that the United States is operating inefficiently. Although thecost of enjoying lawns is not included in GDP, lawns are nevertheless producedconsumption goods and are included in the production possibility curve for theUnited States. The high proportion of land devoted to lawns implies that theUnited States hasenoughfood that it can devote a fair amount of land to theproduction of goods for enjoyment such as lawns.5.Following the hint that society’s production possibility curve reflects more thanjust technical relationships, we realize that trust is an input to production to theextent that it is necessary for transactions. If everyone could fake honesty, theproduction possibility curve would shift inward since no one could trust anyoneelse,leading to the disintegration of markets. If some could fake honesty, thosefewwouldgain at the expense of others. This is an example of the tragedy of thecommons.6.a.Firms may produce in Germany because (1) transportation costs toandfromthe other countries may be very high, so that if these costs are included, itwould not be efficient to produce there,(2) there might be tariffs or quotasfor imports into Germany that will prevent producing elsewhere,(3) theproductivity of German labor may be so much higher that unit labor costs inGermany are the lowest,and (4) historical circumstances may have led toproduction in Germany,and the cost of moving production may exceedpotential gains.b.There would probably not be a significant movement of workers right away.One would expect some movement from Greece and Italy into Germany, butthiswould belimited by social restrictions such as language, culture,and theeconomic climate in Germany, which currently has high unemployment.Movement in the long run, however,mightbe substantial.c.I would want to know about the rule of law in Thailand that will governbusiness practices, the stability of the government, and the infrastructure. Allof these will affect the cost of production.

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Chapter02-The Production Possibility Model, Trade, and Globalization2-8Chapter 2: Appendix A1.See the accompanying graph.2.3.See the accompanying graph.4.a.The relationship is nonlinear because it is curved, not straight.b.From 0 to 5, cost declines as quantity rises (inverse relationship). From 5 to 10,cost rises as quantity rises (direct relationship).c.From 0 to 5, the slope is negative (slopes down). From 5 to 10, the slope ispositive (slopes up).d.The slope between 1 and 2 units is the change in cost (30–20) divided by thechange in quantity (1–2), or–10.3.See the accompanying graph.b123456789101234567910a8cd

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Chapter02-The Production Possibility Model, Trade, and Globalization2-94.a.1.b.–3.c.1/3.d.–3/4.e.0.5.a.C.b.AandE.c.BandD.d.Bis a local maximum;Dis a local minimum.6.a.See lineain the accompanying graph.b.See linebin the accompanying graph.c.See linecin the accompanying graph.7.a.y= 5x+ 1,000.b.y= 3x+ 1,500.8.a.Linegraph.b.Bargraph.c.Piechart.d.Linegraph.

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Chapter03-Economic Institutions3-1Chapter 3: Economic InstitutionsQuestions and Exercises1.The central coordinating mechanism in a market economy is price.2.The central coordinating mechanism in a centrally planned economy is the centralplanners.3.Market economies solve the three problems through markets and the system ofrewards and payments. What gets produced is what businesses believe can besold. How it gets produced is determined by businesses; generally,they choosethe method thatproducesthe largest profit. Those who are willing to pay for thegoods at the market-determined prices will get them. Thus, supply and demanddetermine what, how, and for whom to produce.4.Centrally planned socialist economies solve the three problems by usingadministrative control. Central planners decide what to produce according to whatthey believe is socially beneficial.In deciding how to produce,centralplannersareguided by what they believe is good for the country. Central planners decideaboutdistribution onthe basis oftheir perception of individuals’ needs.5.The answer to this question requires determining what is meant by better.Economics can explain how each system functions and explain how efficient eachis, but economics does not provide an answer to normative questions withoutimposing normative judgments.6.An economy depends on coordination, and the mechanisms of coordinationdepend on the people who choose which goods to supply and what to demand.People supply the labor that makes the economy run. Economic growth and whatis considered a resource depend on technology, and people develop newtechnologies. Even the institutions that oversee the economy are governed by thateconomy’s people. It follows that the economy’s ultimate strength resides in itspeople.7.Business is dynamic; it involves meeting new problems constantly, recognizingneeds, and meeting those needs in a timely fashion. These are precisely the skillsof entrepreneurship.8.The three forms of businesses are corporations, partnerships,and soleproprietorships.a.In the United States, sole proprietorships are the most common.b.The largest proportion of sales are made by corporations.9.You most likelywouldchoose a sole proprietorship because it’s easy to start,requires minimal bureaucratic hassle, and is controlled by you, the owner. If you

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Chapter03-Economic Institutions3-2need more money than you have to start this business, you might consider takingon a partner. This would also allow you to share the work and the risk, but youalsowouldhave to share the profits and figure out a way to maintain a friendshipwhile working together.10.The two largest categories of federal expenditures are income security and healthand education.11.The six roles of government in a market economy are (1) providing a stable set ofinstitutions and rules, (2) promoting effective and workable competition, (3)correcting for externalities, (4) ensuring economic stability and growth, (5)providing public goods, and (6) adjusting for undesired market results.12.Pollution permits require firms to pay the cost of pollution they create.Whenthese permitsaretradable, firms that face the lowest cost of reducing pollutionwill reduce pollution emissions the most and sell their extra rights to firmsthatface a higher cost of reducing pollution. Permits assign rights,thuscorrecting forthe externality.13.A merit good is a good that government believes is good for you even if youchoose not to buy it. An example might be operas. A demerit good is a good thatgovernment believes is bad for you even if you choose to buy it. An example isalcohol or drugs. A public good is a good that if supplied to one person must besupplied to all and whose consumption by one does not preclude consumption byanother. An example is national defense. An externality is the effect of a trade ona person not involved in the trade. An example is cigarette smoke.14.Economic actions are coordinated by a wide variety of international organizationssuch as the United Nations,theWorld Trade Organization (WTO), and the WorldBank. (Thestudentneeds to mention only two of these three organizations.)15.Countries have developed global and regional organization to coordinate tradebarriers and reduce trade barriers. The World Trade Organization,theEuropeanUnion,and NAFTA are examples of these types of organizations16.International organizations are limited in their effectiveness because membershipis voluntary,as are any agreements among members. There is no worldgovernment to enforce international laws or agreements.

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Chapter03-Economic Institutions3-3Questions from Alternative Perspectives1.Austriana.The dangers of government intervention and support of activities is that onceintervention begins, it is hard to limit. For example, if the state supports children,the state will want control of those children, which will impinge on individuals’freedoms.b.If governments financially support families, thatmight induce them to attempt tolimit the number of children families can have, as the People’s Republic of Chinadid. Alternatively, the government may want more children for an increase in thesize of the military and, to achieve its ends, limit birth control, as Romania did inits socialist period, and force individuals to have more children.2.ReligiousHe meant that strongly held religious beliefs can lead people to violate the law,because they hold the law of God above the law of the state. There is debate aboutwhether he is correct, but as can be seen with some religious fundamentalists whoincorporate violence into their belief systems, the state may face serious problemswhen people rely on religion as their primary guide for action.3.Feminista.Economists know relatively little about intrahousehold decisionmaking and havegenerally assumed that households have a single joint utility function. In onepopular theory, those with power (parents) are assumed to be benevolentandthose without power (children) are assumed to be selfish. Widespread wife andchild abuse as well as evidence for unequal food distribution within the familywhich harms women and children clearly undermines this simple notion ofhousehold decisionmaking.b.Absolutely. Bargaining is likely to take place among individuals in a household.A child might agree to eat certain foods in exchange for getting a toy, forexample.c.The ability to walk away from the bargain is what gives someone power. Payingthe bill also givesa personpower. In families with separate checking accounts,the individual withahigher income is likely to have greater bargaining power.d.Individuals are more likely to act cooperatively within a household because thereare mechanisms besides money to maintain accountability. However, there maybe unspoken competition within a family, such as when children compete for theirparents' attention. There is also cooperation elsewhere, such as when employeeswork together to accomplish a task.

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Chapter03-Economic Institutions3-4e.It makes sense within the theory ofthesocialbehaviorof groups of various sizesand strength of relations.4.InstitutionalistThe dilemma is obvious and represents an inherent conflict in a society whosevalues are greatly influenced by the Judeo-Christian ethic of charity toward alland the free market ethic which emphasizes the unbridled pursuit of self-interest.Here discussion can be used to delineate concepts of justice and the difficulty ofuniversal application.5.Radicala.To some degree consumers’ desires influence what is produced, but with so muchadvertising, it is difficult to determine people’s true desires and whether thosedesires are being created by businesses.b.Again, views can differ on this issue, and it is difficult to say which view iscorrect.c.The other group that has some sovereignty is business. If business sovereigntyholds, the analysis based on consumer sovereignty is misleading and should notnecessarily be followed.Issues to Ponder1.Markets havea smallrole in most families. In most families,decisions about whogets what usuallyaremade by benevolent parents. Because families are small andsocial bonds are strong, this benevolence can work. Thus, a socialist organizationseems more appropriate to a family and a market-based organization to a largeeconomyin whichsocial bonds don’t hold the social unit together. The propensityto look after the common good is much stronger in a family than in an entireeconomy. The benefits of a market-based economy in a family would be toprovide incentives to allthemembers of the family to contribute to familyproduction, although this may undermine the social bonds of families.2.a.The fact that more money is spent on adults than on children in the family doesnot imply that the children are deprived or that the distribution is unfair. Childrenand adults have different needs.b.Yes.Thesepercentages probably change with income. The lower the income, thelarger the percent of total expenditures spent on children. The reason is that mostfamilies want to provide a basic level of needs for their children. Many familiesfeel that luxuries should not be given to children until the children have learnedhow to work for themselves.c.Our suspicion is that the allocation would not be significantly different incommand economies comparedwithcapitalist economies. If, however, the

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Chapter03-Economic Institutions3-5average income in command economies were lower, the percentage of totalexpenditure spent on children might be higher, as described in partb.3.a.Innovation requires a certain level of freedom of thought and a possibility ofprofitmaking from the innovation. Neither existed in centrallyplannedeconomies. Government planners directed production with income based on need,andso workers had neither the freedom nor the incentive to innovate.b.Both freedom and the possibility of making profits provide the means andincentives for innovation in capitalist countries.c.Schumpeter’s argument was based on the idea that profitmaking by innovatorswas necessary for innovation to occur. As firms become larger, however, theindividual ceases to become the direct beneficiary of his or her innovations.d.Since his predictions did not materialize, one must believe that firms have beenable to create incentive structures to foster innovation or that some other venuefor innovation has arisen. Firms have large research and development departmentsdesigned to promote innovation. In addition, individual innovators have been ableto raise enough capital to start their own companies to profit directly from theirinnovations. In the United States,there has been enormous growth in the numberof such firms. The U.S. government has been a large motivator of innovationthrough its strong patent and copyright system as well asbyproviding subsidiesfor research at universities and supportingmilitary innovations, both of whichhave large spillovers into private industry.4.a.Such an idea could be expanded to include college courses, but that is unlikely tohappen because the quantity of in-person college courses demanded woulddecline as people substitutedtoward recorded lectures. Substitution, however, isnot perfect since neither DVDs nor CDs can provide the interaction betweenstudent and instructor or among students that exists in the classroom. Socialforces would act against the movement away from college classroom instructioneven if the invisible hand pressed action toward it.b.Technical problems are virtually nonexistent. Socially, the problems aresubstantial. A diminishing role of the university would significantly change itsrole of providing a focal point for intellectual discussion and discovery, thuschanging the nature of education. There would be great social pressures tomaintain this role of American colleges. The economic issues are substantial aswell. A course could be taught once and used over a period of years. This wouldreduce the demand for professors and create revenues for certifying agencies thatwould regulate the distribution and quality of the tapes. If these college-at-homecourses became an accepted educational credential, the demand foratraditionalcollege education would fall, putting major competitive pressure on traditionalcolleges.c.Even though the program is technically possible and cost-efficient, it will notnecessarily be a success because social forces will play a major role in limitingthe market. Social forces are often strong enough to overcome economic forces.

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Chapter03-Economic Institutions3-65.Answers will vary.This exercise asks students to gather information about thelimitations on businesses of different types in their communities. They are thenasked to make judgmentsaboutwhether the limitations were necessary (are theyclear about the goals involved?) and whether the number of limitations is correct.The information is linked to the text’s material in partd. Parteasks students tolearn about business taxes in their communities, and partfhas them gather a senseof business satisfaction.6.Consumers decide what goods they want and demonstrate their decisions in theirwillingness to pay for those goods. Businesses decide what to produce, but theirdecisions reflect consumer desires. Thus, there is no contradiction. However,advertising, in which businesses attempt to influence behavior, can limitconsumer sovereignty.7.Individuals might disagree as to the categorization of a good as a merit, demerit,or public good or a good that involves an externality. In the case of an externality,they may believe thatwithsufficient property rights, the externality will be solvedmost efficiently by the market, notbygovernment.8.There is market failure only if people do not value operas as much as they should.This normative statement is valid only if the “should” can be measured againstsome absolute truthaboutthe value of operas;otherwise,how would one decidewho decides the value of operas? Because it is only through the market that valueis revealed, we’d argue that government intervention in this case willprobablylead to government failure—the failure of government to value operasaccurately.With government intervention, the valueprobablywill reflect the preferences ofthose with political power, not necessarilythe preferencesof the generalpopulation.9.People havebaseddecisions on the rules that were set up,andso changing themafter the game has been started may be more unfair than continuing to play by theoriginal rules. Such decisions must be made based on the marginal cost andthebenefit of changing the rules.10.Inmaking such trade agreements, it is important for countries to realize that tradeincludes not only economic issues but cultural and social ones as well.Althoughfree and unregulated trade is generally the most economically beneficial(maximizes consumption possibilities), these economic benefits can beoverpowered by the loss of cultural identity as a result of globalization. Takinginto consideration such losses is a government’s responsibility whenit negotiatestrade agreements. These losses must be weighed against the benefits of free trade.

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Chapter04-Supply and Demand4-1Chapter 4: Supply and DemandQuestions and Exercises1.The law of demand states that quantity demanded falls as price increases or thatquantity demanded rises as price falls. Price is inversely related to quantitydemanded because as price rises, consumers substitute other goods whose pricehas not risen.2.a.PriceMarketDemand264456644836102812201412168b.See the accompanying graph of the table.c.At the market price of $4, the total market demand is 56. If the price rises to $8,the total market demand will fall to 36.d.All the curves will shift to the right by 50 percent.[(Note: The top part of John'sdemand curve will not shift to the right (an additional 50percentof zero is stillzero).]3.Four shift factors of demand are income, price of other goods, tastes, andexpectations.A fifth shift factor is taxes and subsidies to consumers.As income

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Chapter04-Supply and Demand4-2rises, demand increases. As the prices of other substitute goods rise, demandincreases. As tastes change to favor a particular good, the demand for that goodincreases. If people expect the price of a good to fall in the future, demand willfall now.Taxes reduce demand,whereassubsidies increase it.4.A change in the price causes a movement along the demand curve to a new pointon the same curve. A shift in the demand curve means that the quantities will bedifferent at all prices; the entire curve shifts.5.The law of supply states that quantity supplied rises as price increases or,alternatively, that quantity supplied falls as price decreases. Price is directlyrelated to quantity supplied because as price rises, people and firms rearrangetheir activities to supply more of that good to take advantage of the higher price.6.Saying that supply increases means that the curve has shifted to the right, which isnot the result of a price change. The correct statement is that normally, as pricerises, the quantity supplied increases, other things constant.7.Shift factors of supply include the price of inputs, technological advances,changes in expectations, and taxes and subsidies. As the pricesof inputs increase,the supply curve shifts to the left. As technological advances are made that reducethe cost of production, the supply curve shifts to the right. If a supplier expects theprice of her good to rise, she may decrease supply now to save and sell later.Other expectational effects are also possible. Taxes paid by suppliers shift thesupply curve to the left. Subsidies given to producers shift the supply curve to theright.8.When adding two supply curves, sum horizontally the two individual supplycurves, as in the accompanying diagram.S3is the market supply curve.9.a.The market demand and market supply curves are shown in the accompanyinggraph.

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Chapter04-Supply and Demand4-3b.At a price of $30, quantity demanded is 35 and quantity supplied is 15. Excessdemand is 20. At a price of $60, quantity demanded is 5 and quantity supplied is45. Excess supply is 40.c.Equilibrium price is $40. Equilibrium quantity is 25.10.In the accompanying graph, the demand curve has shifted to the left, causing adecrease in the market price and the market quantity.11.The price of airline tickets rises during the summer months because demand forairline travel increases as more people take vacations. This is shown in theaccompanying graph.

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Chapter04-Supply and Demand4-412.Sales volume increases (equilibrium quantity rises) when the governmentsuspends the tax on sales by retailers because the price to demanders falls andhence equilibrium quantity demanded rises. This occurs because the supply curveshifts to the right because suppliers do not have to pay taxes on their sales (cost ofproduction declines).13.Increased security measures imposed by government will increase the cost ofproviding air travel. This will shift the supply curve to the left, increaseequilibrium price toP1,and decrease equilibrium quantity toQ1as shown in theaccompanying graph. They also might reduce demand (the hassles of theincreased security and the additional time it takes to travel), further decreasingequilibrium quantity and offsetting the rise in price, in this case toP2.

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Chapter04-Supply and Demand4-5Some students might argue that increased security will increase demand becauseconsumers will feel more comfortable flying (they don't have to worry aboutterrorists as much). If demand increased, the price would go up even higher andthe equilibrium quantity would also increase.14.Customers will flock to stores demanding that funky “economics professor” look,creating excess demand (the demand curve shifts right). This excess demand willsoon catch the attention of suppliers, and prices will be pushed upward.15.As substitutes for bottled water—clean tap water—decrease, demand for bottledwater increases enormously, and there will be upward pressure on prices. Socialand political forces will, however,probablywork in the opposite direction—against “profiteering” from people’s misery.16.Increasing oil production (not as a result of a price change) will shift the supply ofoil out to the right. The price of oil will decline,as shown in the accompanyinggraph.

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Chapter04-Supply and Demand4-617.a.The bad weather causes a decrease in supply. This is shown by a shift in supplyfromS0toS1. Equilibrium price rises fromP0toP1, andequilibrium quantity fallsfromQ0toQ1.See the accompanying graph.b.The medical report causes a decrease in demand. This is shown by a shift indemand fromD0toD1. Equilibrium price falls fromP0toP1,and equilibriumquantity falls fromQ0toQ1.See the accompanying graphc.The innovation causes an increase in supply. This is shown as a shift in supplyfromS0toS1. Equilibrium price falls fromP0toP1, andequilibrium quantity risesfromQ0toQ1.See the accompanying graph

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Chapter04-Supply and Demand4-7d.The drop in income causes a decrease in demand. This is shown by a shift indemand fromD0toD1. Equilibrium price falls fromP0toP1,and equilibriumquantity falls fromQ0toQ1.See the accompanying graph18.a.I would expect wheat prices to decline since the supply of wheat is greater thanexpected. Wheat commodity markets are very competitive,andso the initial 30percent increase in output was already reflected in the current price of wheat. It isonly the additional10percent increase that will push down the price of wheat.b.This is graphically represented by a shift to the right in the supply of wheat, asshown in the accompanying graph. Equilibrium price falls fromP0toP1, andequilibrium quantity rises fromQ0toQ1.

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