Economics, 9th Edition Solution Manual
Struggling with problems? Economics, 9th Edition Solution Manual provides clear, detailed solutions for better learning.
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Chapter 01 - Economics and Economic Reasoning
1-1
Chapter 1: Economics and Economic Reasoning
Questions and Exercises
1. Coordination refers to how the three central problems facing any economy are
solved. Those three problems are what and how much to produce, how to
produce, and for whom to produce. Inevitably, individuals desire more than is
available in light of how much they’re willing to work, causing a problem of
scarcity. The concept of scarcity has two elements: our wants and our means of
fulfilling those wants. Those two elements are interrelated since wants are
changeable and are partially determined by society and the means of fulfilling
those wants. In addition, the degree of scarcity is constantly changing, depending
on the available means of production and the development of new wants.
Therefore, the author of the textbook focused on coordination instead of scarcity
to emphasize the subsidiary nature of scarcity to the overall concept of
coordination. Economics is not merely about our wants or the means of fulfilling
those wants; it is also about reconciling our wants with reality, where reality
consists 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 of
firms (price-fixing in particular) and the way wages are determined in labor
markets. (Why do athletes and celebrities make so much money, anyway?) Two
macroeconomic problems are unemployment and inflation (business cycles and
growth are also macroeconomic problems).
4. a. The opportunity cost of attending college is the sacrifice one must make to attend
college. 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 be
earned at a job that does not require a college degree and then multiply by 40
hours for each week in college. The opportunity cost is also what could be done
with the money used for tuition and other costs related to attending college.
b. The opportunity cost of taking a course could be estimated by using the same
technique as in part a if you otherwise would be working during these hours. If
you had taken another course instead, the opportunity cost would be the benefit
you would have received from taking the other course.
c. The opportunity cost of attending yesterday’s lecture would depend on what you
otherwise could have done with the time (sleep? eat lunch with an interesting
person?). Although this is no longer a choice to you, past activities do have
opportunity costs.
1-1
Chapter 1: Economics and Economic Reasoning
Questions and Exercises
1. Coordination refers to how the three central problems facing any economy are
solved. Those three problems are what and how much to produce, how to
produce, and for whom to produce. Inevitably, individuals desire more than is
available in light of how much they’re willing to work, causing a problem of
scarcity. The concept of scarcity has two elements: our wants and our means of
fulfilling those wants. Those two elements are interrelated since wants are
changeable and are partially determined by society and the means of fulfilling
those wants. In addition, the degree of scarcity is constantly changing, depending
on the available means of production and the development of new wants.
Therefore, the author of the textbook focused on coordination instead of scarcity
to emphasize the subsidiary nature of scarcity to the overall concept of
coordination. Economics is not merely about our wants or the means of fulfilling
those wants; it is also about reconciling our wants with reality, where reality
consists 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 of
firms (price-fixing in particular) and the way wages are determined in labor
markets. (Why do athletes and celebrities make so much money, anyway?) Two
macroeconomic problems are unemployment and inflation (business cycles and
growth are also macroeconomic problems).
4. a. The opportunity cost of attending college is the sacrifice one must make to attend
college. 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 be
earned at a job that does not require a college degree and then multiply by 40
hours for each week in college. The opportunity cost is also what could be done
with the money used for tuition and other costs related to attending college.
b. The opportunity cost of taking a course could be estimated by using the same
technique as in part a if you otherwise would be working during these hours. If
you had taken another course instead, the opportunity cost would be the benefit
you would have received from taking the other course.
c. The opportunity cost of attending yesterday’s lecture would depend on what you
otherwise could have done with the time (sleep? eat lunch with an interesting
person?). Although this is no longer a choice to you, past activities do have
opportunity costs.
Chapter 01 - Economics and Economic Reasoning
1-1
Chapter 1: Economics and Economic Reasoning
Questions and Exercises
1. Coordination refers to how the three central problems facing any economy are
solved. Those three problems are what and how much to produce, how to
produce, and for whom to produce. Inevitably, individuals desire more than is
available in light of how much they’re willing to work, causing a problem of
scarcity. The concept of scarcity has two elements: our wants and our means of
fulfilling those wants. Those two elements are interrelated since wants are
changeable and are partially determined by society and the means of fulfilling
those wants. In addition, the degree of scarcity is constantly changing, depending
on the available means of production and the development of new wants.
Therefore, the author of the textbook focused on coordination instead of scarcity
to emphasize the subsidiary nature of scarcity to the overall concept of
coordination. Economics is not merely about our wants or the means of fulfilling
those wants; it is also about reconciling our wants with reality, where reality
consists 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 of
firms (price-fixing in particular) and the way wages are determined in labor
markets. (Why do athletes and celebrities make so much money, anyway?) Two
macroeconomic problems are unemployment and inflation (business cycles and
growth are also macroeconomic problems).
4. a. The opportunity cost of attending college is the sacrifice one must make to attend
college. 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 be
earned at a job that does not require a college degree and then multiply by 40
hours for each week in college. The opportunity cost is also what could be done
with the money used for tuition and other costs related to attending college.
b. The opportunity cost of taking a course could be estimated by using the same
technique as in part a if you otherwise would be working during these hours. If
you had taken another course instead, the opportunity cost would be the benefit
you would have received from taking the other course.
c. The opportunity cost of attending yesterday’s lecture would depend on what you
otherwise could have done with the time (sleep? eat lunch with an interesting
person?). Although this is no longer a choice to you, past activities do have
opportunity costs.
1-1
Chapter 1: Economics and Economic Reasoning
Questions and Exercises
1. Coordination refers to how the three central problems facing any economy are
solved. Those three problems are what and how much to produce, how to
produce, and for whom to produce. Inevitably, individuals desire more than is
available in light of how much they’re willing to work, causing a problem of
scarcity. The concept of scarcity has two elements: our wants and our means of
fulfilling those wants. Those two elements are interrelated since wants are
changeable and are partially determined by society and the means of fulfilling
those wants. In addition, the degree of scarcity is constantly changing, depending
on the available means of production and the development of new wants.
Therefore, the author of the textbook focused on coordination instead of scarcity
to emphasize the subsidiary nature of scarcity to the overall concept of
coordination. Economics is not merely about our wants or the means of fulfilling
those wants; it is also about reconciling our wants with reality, where reality
consists 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 of
firms (price-fixing in particular) and the way wages are determined in labor
markets. (Why do athletes and celebrities make so much money, anyway?) Two
macroeconomic problems are unemployment and inflation (business cycles and
growth are also macroeconomic problems).
4. a. The opportunity cost of attending college is the sacrifice one must make to attend
college. 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 be
earned at a job that does not require a college degree and then multiply by 40
hours for each week in college. The opportunity cost is also what could be done
with the money used for tuition and other costs related to attending college.
b. The opportunity cost of taking a course could be estimated by using the same
technique as in part a if you otherwise would be working during these hours. If
you had taken another course instead, the opportunity cost would be the benefit
you would have received from taking the other course.
c. The opportunity cost of attending yesterday’s lecture would depend on what you
otherwise could have done with the time (sleep? eat lunch with an interesting
person?). Although this is no longer a choice to you, past activities do have
opportunity costs.
Chapter 01 - Economics and Economic Reasoning
1-2
5. Answers will vary. A correct answer will indicate that the student compared the
marginal costs and benefits and chose the activity because the marginal benefit
exceeded the marginal cost.
6. The marginal costs are the additional costs. They are $0.15 per mile for miles
above 150 plus the cost of gas. Therefore, the marginal cost is $7.50 plus the cost
of gas. The initial payment can be forgotten because it is a sunk cost; it is not part
of 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 gained
by using that $20,000 for the next-best alternative, which could be spending it on
other goods and services or saving it.
9. Only the marginal costs and benefits of taking the job are relevant. That means
that the sunk cost of the bachelor’s degree is irrelevant. Therefore, the relevant
costs are the opportunity cost of taking the job (forgone earnings from your
current job) and other things you could have done with the money you need to
pay business school tuition. The relevant benefit is the increased lifetime earnings
of $300,000.
10. I would spend the $5 million on those projects which provide the highest marginal
benefit per dollar spent. The opportunity cost of spending the money on one
project is the lost benefit that the college would have received by spending it on a
different project. Thus, another way to restate the decision rule is to spend the
money on the project that minimizes opportunity cost per dollar.
11. Answers will differ. Two examples of social forces are our unwillingness to
charge friends interest and our unwillingness to “buy” dates with other people.
These issues are still subject to economic forces; however, there is no market in
dates or in loans to friends, and so the economic force does not become a market
force.
12. Answers will differ. Two examples of political or legal forces are rent control
laws and restrictions on immigration. Both prevent the invisible hand from
working. Rent control laws place a price ceiling on rent, causing shortages of
apartments, and immigration restrictions cause the number of immigrants seeking
entry to exceed the number allowed to enter, which tends to cause wage rates to
differ among countries.
13. a. Both parties benefit. The person who gains the kidney benefits if it works when
transplanted into his or her body and will no longer have the emotional and
1-2
5. Answers will vary. A correct answer will indicate that the student compared the
marginal costs and benefits and chose the activity because the marginal benefit
exceeded the marginal cost.
6. The marginal costs are the additional costs. They are $0.15 per mile for miles
above 150 plus the cost of gas. Therefore, the marginal cost is $7.50 plus the cost
of gas. The initial payment can be forgotten because it is a sunk cost; it is not part
of 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 gained
by using that $20,000 for the next-best alternative, which could be spending it on
other goods and services or saving it.
9. Only the marginal costs and benefits of taking the job are relevant. That means
that the sunk cost of the bachelor’s degree is irrelevant. Therefore, the relevant
costs are the opportunity cost of taking the job (forgone earnings from your
current job) and other things you could have done with the money you need to
pay business school tuition. The relevant benefit is the increased lifetime earnings
of $300,000.
10. I would spend the $5 million on those projects which provide the highest marginal
benefit per dollar spent. The opportunity cost of spending the money on one
project is the lost benefit that the college would have received by spending it on a
different project. Thus, another way to restate the decision rule is to spend the
money on the project that minimizes opportunity cost per dollar.
11. Answers will differ. Two examples of social forces are our unwillingness to
charge friends interest and our unwillingness to “buy” dates with other people.
These issues are still subject to economic forces; however, there is no market in
dates or in loans to friends, and so the economic force does not become a market
force.
12. Answers will differ. Two examples of political or legal forces are rent control
laws and restrictions on immigration. Both prevent the invisible hand from
working. Rent control laws place a price ceiling on rent, causing shortages of
apartments, and immigration restrictions cause the number of immigrants seeking
entry to exceed the number allowed to enter, which tends to cause wage rates to
differ among countries.
13. a. Both parties benefit. The person who gains the kidney benefits if it works when
transplanted into his or her body and will no longer have the emotional and
Chapter 01 - Economics and Economic Reasoning
1-2
5. Answers will vary. A correct answer will indicate that the student compared the
marginal costs and benefits and chose the activity because the marginal benefit
exceeded the marginal cost.
6. The marginal costs are the additional costs. They are $0.15 per mile for miles
above 150 plus the cost of gas. Therefore, the marginal cost is $7.50 plus the cost
of gas. The initial payment can be forgotten because it is a sunk cost; it is not part
of 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 gained
by using that $20,000 for the next-best alternative, which could be spending it on
other goods and services or saving it.
9. Only the marginal costs and benefits of taking the job are relevant. That means
that the sunk cost of the bachelor’s degree is irrelevant. Therefore, the relevant
costs are the opportunity cost of taking the job (forgone earnings from your
current job) and other things you could have done with the money you need to
pay business school tuition. The relevant benefit is the increased lifetime earnings
of $300,000.
10. I would spend the $5 million on those projects which provide the highest marginal
benefit per dollar spent. The opportunity cost of spending the money on one
project is the lost benefit that the college would have received by spending it on a
different project. Thus, another way to restate the decision rule is to spend the
money on the project that minimizes opportunity cost per dollar.
11. Answers will differ. Two examples of social forces are our unwillingness to
charge friends interest and our unwillingness to “buy” dates with other people.
These issues are still subject to economic forces; however, there is no market in
dates or in loans to friends, and so the economic force does not become a market
force.
12. Answers will differ. Two examples of political or legal forces are rent control
laws and restrictions on immigration. Both prevent the invisible hand from
working. Rent control laws place a price ceiling on rent, causing shortages of
apartments, and immigration restrictions cause the number of immigrants seeking
entry to exceed the number allowed to enter, which tends to cause wage rates to
differ among countries.
13. a. Both parties benefit. The person who gains the kidney benefits if it works when
transplanted into his or her body and will no longer have the emotional and
1-2
5. Answers will vary. A correct answer will indicate that the student compared the
marginal costs and benefits and chose the activity because the marginal benefit
exceeded the marginal cost.
6. The marginal costs are the additional costs. They are $0.15 per mile for miles
above 150 plus the cost of gas. Therefore, the marginal cost is $7.50 plus the cost
of gas. The initial payment can be forgotten because it is a sunk cost; it is not part
of 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 gained
by using that $20,000 for the next-best alternative, which could be spending it on
other goods and services or saving it.
9. Only the marginal costs and benefits of taking the job are relevant. That means
that the sunk cost of the bachelor’s degree is irrelevant. Therefore, the relevant
costs are the opportunity cost of taking the job (forgone earnings from your
current job) and other things you could have done with the money you need to
pay business school tuition. The relevant benefit is the increased lifetime earnings
of $300,000.
10. I would spend the $5 million on those projects which provide the highest marginal
benefit per dollar spent. The opportunity cost of spending the money on one
project is the lost benefit that the college would have received by spending it on a
different project. Thus, another way to restate the decision rule is to spend the
money on the project that minimizes opportunity cost per dollar.
11. Answers will differ. Two examples of social forces are our unwillingness to
charge friends interest and our unwillingness to “buy” dates with other people.
These issues are still subject to economic forces; however, there is no market in
dates or in loans to friends, and so the economic force does not become a market
force.
12. Answers will differ. Two examples of political or legal forces are rent control
laws and restrictions on immigration. Both prevent the invisible hand from
working. Rent control laws place a price ceiling on rent, causing shortages of
apartments, and immigration restrictions cause the number of immigrants seeking
entry to exceed the number allowed to enter, which tends to cause wage rates to
differ among countries.
13. a. Both parties benefit. The person who gains the kidney benefits if it works when
transplanted into his or her body and will no longer have the emotional and
Chapter 01 - Economics and Economic Reasoning
1-3
financial 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. The
seller also faces the potential cost of a future illness or injury harming his or her
only remaining kidney, causing the seller to need dialysis.
c. Whether a society should allow this transaction is a question of value judgments
and cultural norms. Our society has chosen not to allow such transactions because
(among other reasons) those with more money would have increased access to
organs and therefore would have advantages over those of limited means, and
thus the poor could be exploited in such transactions.
14. An economic model is a framework that places the generalized insights of a
theory in a more specific contextual setting. Policy makers need to understand the
empirical evidence supporting the theory as well as real-world economic
institutions to make policy recommendations.
15. No. Economic theory proves nothing about what system is best. It simply
provides ways to look at systems and indicates what the advantages and
disadvantages of various systems probably will be. Normative decisions about
what 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 the
model, whereas a precept is a policy rule that a particular course of action is
preferable. Economists can agree about theorems but disagree about precepts if
they have different value judgments about appropriate goals.
17. A normative statement reflects ethical judgments about what should be. It reflects
values. A positive statement refers to a fact or a logical relationship. It is in
principle testable or is the result of logic analysis. Positive statements of fact are
not subject to debate among educated individuals. The art of economics refers to
issues of judgment on how to achieve the goals determined in normative
economics, giving the facts and logical relationships one finds in positive
economics. Art of economics statements are subject to debate.
18. a. Positive statement since it is a statement of fact.
b. Normative.
c. Since this is relating a normative goal to a decision, this could be a statement in
the art of economics. It also could be seen as a normative statement if one
interprets it as a normative imperative.
d. Positive statement since it is a statement of fact.
1-3
financial 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. The
seller also faces the potential cost of a future illness or injury harming his or her
only remaining kidney, causing the seller to need dialysis.
c. Whether a society should allow this transaction is a question of value judgments
and cultural norms. Our society has chosen not to allow such transactions because
(among other reasons) those with more money would have increased access to
organs and therefore would have advantages over those of limited means, and
thus the poor could be exploited in such transactions.
14. An economic model is a framework that places the generalized insights of a
theory in a more specific contextual setting. Policy makers need to understand the
empirical evidence supporting the theory as well as real-world economic
institutions to make policy recommendations.
15. No. Economic theory proves nothing about what system is best. It simply
provides ways to look at systems and indicates what the advantages and
disadvantages of various systems probably will be. Normative decisions about
what 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 the
model, whereas a precept is a policy rule that a particular course of action is
preferable. Economists can agree about theorems but disagree about precepts if
they have different value judgments about appropriate goals.
17. A normative statement reflects ethical judgments about what should be. It reflects
values. A positive statement refers to a fact or a logical relationship. It is in
principle testable or is the result of logic analysis. Positive statements of fact are
not subject to debate among educated individuals. The art of economics refers to
issues of judgment on how to achieve the goals determined in normative
economics, giving the facts and logical relationships one finds in positive
economics. Art of economics statements are subject to debate.
18. a. Positive statement since it is a statement of fact.
b. Normative.
c. Since this is relating a normative goal to a decision, this could be a statement in
the art of economics. It also could be seen as a normative statement if one
interprets it as a normative imperative.
d. Positive statement since it is a statement of fact.
Chapter 01 - Economics and Economic Reasoning
1-4
Questions from Alternative Perspectives
1. Austrian
Most economists would answer yes because they see economic variables
such as unemployment as objective measures, which makes them available
as measures for planning. Most economists see only individual preferences,
not social preferences, as subjective. Austrians believe in a radical
subjectivity, uncertainty with respect to time, knowledge, and matters
beyond preferences. This eliminates the possibility of using objective
economic analysis as the basis for government planning. For an Austrian
study on the nature of time and uncertainty for economics, see the work of
Mario Rizzo and Gerald O’Driscoll, Jr.
2. Religious
a. The rational choice model assumes that individuals are one-dimensional, that
they know what they want, and that they will do what is in their best interest.
Addictive behavior undermines that assumption, leading to a conflict
between passion and reason.
b. The conflict suggests that we have to be careful not to apply the economic
model in cases in which that conflict is important, such as with behaviors that
have addictive elements. When there is a conflict between passion and
reason, there may be greater reason for government to limit access to the
addictive good or behavior.
3. Feminist
a. Patriarchy is a social institution in which men exercise a disproportionate
amount of social power and are in a position to define the roles of women
and children as well as make most decisions. Because patriarchy affects the
ways people behave and interact, it is an institution. It definitely affects the
labor market because those who are in power will make hiring decisions that
perpetuate their position of power. For example, husbands and fathers may
make, or heavily influence, the decisions of whether a woman will look for
work.
b. Some economists might argue that men and women are merely expressing
their preferences in job choices, whereas feminist economists might argue
that these choices are culturally determined by institutions, or patterns of
behavior, such as patriarchy. It is impossible to separate the free market
from the institutions within which it is embedded. The free market may not
determine the institutions or mores of a society; it operates within those
institutions.
1-4
Questions from Alternative Perspectives
1. Austrian
Most economists would answer yes because they see economic variables
such as unemployment as objective measures, which makes them available
as measures for planning. Most economists see only individual preferences,
not social preferences, as subjective. Austrians believe in a radical
subjectivity, uncertainty with respect to time, knowledge, and matters
beyond preferences. This eliminates the possibility of using objective
economic analysis as the basis for government planning. For an Austrian
study on the nature of time and uncertainty for economics, see the work of
Mario Rizzo and Gerald O’Driscoll, Jr.
2. Religious
a. The rational choice model assumes that individuals are one-dimensional, that
they know what they want, and that they will do what is in their best interest.
Addictive behavior undermines that assumption, leading to a conflict
between passion and reason.
b. The conflict suggests that we have to be careful not to apply the economic
model in cases in which that conflict is important, such as with behaviors that
have addictive elements. When there is a conflict between passion and
reason, there may be greater reason for government to limit access to the
addictive good or behavior.
3. Feminist
a. Patriarchy is a social institution in which men exercise a disproportionate
amount of social power and are in a position to define the roles of women
and children as well as make most decisions. Because patriarchy affects the
ways people behave and interact, it is an institution. It definitely affects the
labor market because those who are in power will make hiring decisions that
perpetuate their position of power. For example, husbands and fathers may
make, or heavily influence, the decisions of whether a woman will look for
work.
b. Some economists might argue that men and women are merely expressing
their preferences in job choices, whereas feminist economists might argue
that these choices are culturally determined by institutions, or patterns of
behavior, such as patriarchy. It is impossible to separate the free market
from the institutions within which it is embedded. The free market may not
determine the institutions or mores of a society; it operates within those
institutions.
Chapter 01 - Economics and Economic Reasoning
1-5
4. Institutionalist
a. A free market outcome would provide flu vaccine to those willing and able to
pay the most for it, which will not include all of those given priority under the
rationing scheme.
b. The determination of which option is “just” requires delving into theories of
justice. The free market solution best mirrors commutative justice—one
based on efficiency of exchange— and the rationing scheme best mirrors
distributive justice—one based on some notion of fairness that favors those
with a greater predisposition to illness.
5. Post-Keynesian
a. This answer will differ among students.
b. Most students probably will answer this question no. The standard theory
presented in the book is based on the assumption that decision makers have
full information about all factors that might influence their decisions: They
have substantive knowledge of all possible outcomes of their decision
making and the consequences of each decision. Most likely you had limited
knowledge of the pros and cons of all schools when deciding which college to
attend and turned to the advice and norms of a small group of friends, family
members, or teachers to help you make a decision.
c. Recognizing that you have limited time, knowledge, and ability to compute all
the possible outcomes of each economic decision, you probably rely on social
norms 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 buy Diet Coke even
though other diet sodas might provide you with a higher level of satisfaction
at a lower price because you are in the habit of buying Diet Coke and
uncertain of the exact benefit the other diet drinks will give you).
d. The implication of this behavior is that individuals do not follow the
economic decision rule of gaining complete information to optimize their
choices but rely on rules of thumb or habit to come up with a satisfactory
outcome even though it might not be the most optimizing. This means that
economic analysis which assumes that humans are one-dimensional rational
beings who calculate all relevant marginal costs and benefits is limited.
6. Radical
a. It implies that there is no clear-cut distinction between positive and
normative economics and that seemingly positive economics has implicit
value judgments hidden within it.
1-5
4. Institutionalist
a. A free market outcome would provide flu vaccine to those willing and able to
pay the most for it, which will not include all of those given priority under the
rationing scheme.
b. The determination of which option is “just” requires delving into theories of
justice. The free market solution best mirrors commutative justice—one
based on efficiency of exchange— and the rationing scheme best mirrors
distributive justice—one based on some notion of fairness that favors those
with a greater predisposition to illness.
5. Post-Keynesian
a. This answer will differ among students.
b. Most students probably will answer this question no. The standard theory
presented in the book is based on the assumption that decision makers have
full information about all factors that might influence their decisions: They
have substantive knowledge of all possible outcomes of their decision
making and the consequences of each decision. Most likely you had limited
knowledge of the pros and cons of all schools when deciding which college to
attend and turned to the advice and norms of a small group of friends, family
members, or teachers to help you make a decision.
c. Recognizing that you have limited time, knowledge, and ability to compute all
the possible outcomes of each economic decision, you probably rely on social
norms 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 buy Diet Coke even
though other diet sodas might provide you with a higher level of satisfaction
at a lower price because you are in the habit of buying Diet Coke and
uncertain of the exact benefit the other diet drinks will give you).
d. The implication of this behavior is that individuals do not follow the
economic decision rule of gaining complete information to optimize their
choices but rely on rules of thumb or habit to come up with a satisfactory
outcome even though it might not be the most optimizing. This means that
economic analysis which assumes that humans are one-dimensional rational
beings who calculate all relevant marginal costs and benefits is limited.
6. Radical
a. It implies that there is no clear-cut distinction between positive and
normative economics and that seemingly positive economics has implicit
value judgments hidden within it.
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Chapter 01 - Economics and Economic Reasoning
1-6
b. Economics is value-laden. The relevant question about whether the
distinction is tenable is whether it is relatively less value-laden than the
alternatives. That is an open question.
Issues to Ponder
1. Regretting a decision doesn’t necessarily mean that we did not use the economic
decision rule when making that decision. At the time the decision was made, we
weighed the marginal costs and marginal benefits, undertaking the activity if the
marginal benefits exceeded the marginal costs and not undertaking the activity if
the marginal costs exceeded the marginal benefits. Many decisions are made
without knowledge of the full marginal costs and marginal benefits. Sometimes
these marginal costs and marginal benefits are revealed at a later date, making us
regret the initial decision. An example is going out to a restaurant. From
recommendations, we assume that the marginal benefit is one thing. If that
recommendation overstates our actual experience, we will have overestimated the
marginal 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 purely
economic perspective, we would conclude that it is reasonable to execute hackers
based on cost/benefit analysis. However, since this decision by no means can be
simplified to pure economics, we need to take into consideration social, political,
and religious factors. Therefore, Landsburg’s argument should be evaluated in a
more complete context.
b. Cost/benefit analysis can be extended to many areas, such as social welfare
programs and almost all policy discussions. (Source: “Feed the Worms Who
Write the Worms to the Worms,” http://slate.com/id/2101297/), Slate Magazine,
May 26, 2004.)
3. The Theory of Moral Sentiments emphasizes the importance of morality. The
invisible hand directs people’s selfish desires (tempered by the social and political
forces) to the common good but is based on certain presuppositions about the
morality of individuals which constrains individuals’ selfish actions. What Smith
is suggesting is that the way individuals calculate marginal cost and marginal
benefit must be interpreted within a social context.
4. a, b. Parts a and b have no “right” answers. Most people would say no to a and yes to
b. If one were answering this question from the perspective of the economic
decision rule alone, one would measure the marginal benefits against the marginal
costs of the choice.
c. People tend to believe that children should be afforded greater protection than is
afforded to adults and are therefore repelled by the idea of sacrificing a child even
though it would save the lives of other children. Sick people are closer to death,
and therefore their lives tend to be valued less.
d. Brain imaging suggests that the moral sense behind one’s answers does not come
from rational though, but instead from emotion—gut responses. This suggests that
1-6
b. Economics is value-laden. The relevant question about whether the
distinction is tenable is whether it is relatively less value-laden than the
alternatives. That is an open question.
Issues to Ponder
1. Regretting a decision doesn’t necessarily mean that we did not use the economic
decision rule when making that decision. At the time the decision was made, we
weighed the marginal costs and marginal benefits, undertaking the activity if the
marginal benefits exceeded the marginal costs and not undertaking the activity if
the marginal costs exceeded the marginal benefits. Many decisions are made
without knowledge of the full marginal costs and marginal benefits. Sometimes
these marginal costs and marginal benefits are revealed at a later date, making us
regret the initial decision. An example is going out to a restaurant. From
recommendations, we assume that the marginal benefit is one thing. If that
recommendation overstates our actual experience, we will have overestimated the
marginal 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 purely
economic perspective, we would conclude that it is reasonable to execute hackers
based on cost/benefit analysis. However, since this decision by no means can be
simplified to pure economics, we need to take into consideration social, political,
and religious factors. Therefore, Landsburg’s argument should be evaluated in a
more complete context.
b. Cost/benefit analysis can be extended to many areas, such as social welfare
programs and almost all policy discussions. (Source: “Feed the Worms Who
Write the Worms to the Worms,” http://slate.com/id/2101297/), Slate Magazine,
May 26, 2004.)
3. The Theory of Moral Sentiments emphasizes the importance of morality. The
invisible hand directs people’s selfish desires (tempered by the social and political
forces) to the common good but is based on certain presuppositions about the
morality of individuals which constrains individuals’ selfish actions. What Smith
is suggesting is that the way individuals calculate marginal cost and marginal
benefit must be interpreted within a social context.
4. a, b. Parts a and b have no “right” answers. Most people would say no to a and yes to
b. If one were answering this question from the perspective of the economic
decision rule alone, one would measure the marginal benefits against the marginal
costs of the choice.
c. People tend to believe that children should be afforded greater protection than is
afforded to adults and are therefore repelled by the idea of sacrificing a child even
though it would save the lives of other children. Sick people are closer to death,
and therefore their lives tend to be valued less.
d. Brain imaging suggests that the moral sense behind one’s answers does not come
from rational though, but instead from emotion—gut responses. This suggests that
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Chapter 01 - Economics and Economic Reasoning
1-7
a kind of moral intuition exists that is quite separate from reason. If that is the
case, opportunity costs were not central to the decision. It was a moral, not an
economic, decision. Opinions among philosophers and economists differ on this
issue.
5. a. It depends. On the basis of cost/benefit analysis, one could figure out cases in
which most people would say that they should be dishonest, but cost/benefit
analysis is not the final arbiter if you believe that dishonesty is wrong.
Additionally, you should consider the effects of dishonesty on your reputation and
future 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 be
honest even when others might be dishonest. To encourage the other person to tell
the truth, you could use economic incentives.
6. a. Answers will vary.
b. Economic theory says that prices are determined by supply and demand, but
businesses often use rules of thumb such as cost-plus-markup rules to set their
prices. If two firms have different costs of supplying the same item, they probably
will set a different price for that item. People might be willing to pay the higher
price if the store is closer to where they live or simply to support a smaller, local
store.
c. Again, answers will vary, but the reasoning is the same as in part b.
7. It depends on the perspective one takes. It is economically reasonable to legalize
organ sales. But from a moral perspective, organ sales may be unethical, and
poorer people might feel compelled to sell their organs to support their family, a
result that many people would find morally reprehensible. Economics has nothing
definitive to say on normative moral issues such as this.
8. Answers will vary. Here is an example: Banks are economic institutions. They
take a cost/benefit approach to deciding to whom to give loans, and they influence
decision making by allowing individuals to spend more money than they earn or
have as wealth.
9. a. This is a matter of personal views; there are arguments for and against it. An
argument against the practice is that wealthy songwriters would have too much
power in promoting their songs. The songs of the songwriters who can afford to
share profits will get more play time and become even more famous to the
detriment to new entrants into the industry. Arguments for this practice are that it
could be used to offset racism as in the example given and, to the extent that new
songwriters have the capability of offering such royalty share, promote new kinds
of music.
b. The royalty payment gave Freed a strong incentive to choose what he considered
the best song and to promote that song heavily. The flat payment would have just
1-7
a kind of moral intuition exists that is quite separate from reason. If that is the
case, opportunity costs were not central to the decision. It was a moral, not an
economic, decision. Opinions among philosophers and economists differ on this
issue.
5. a. It depends. On the basis of cost/benefit analysis, one could figure out cases in
which most people would say that they should be dishonest, but cost/benefit
analysis is not the final arbiter if you believe that dishonesty is wrong.
Additionally, you should consider the effects of dishonesty on your reputation and
future 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 be
honest even when others might be dishonest. To encourage the other person to tell
the truth, you could use economic incentives.
6. a. Answers will vary.
b. Economic theory says that prices are determined by supply and demand, but
businesses often use rules of thumb such as cost-plus-markup rules to set their
prices. If two firms have different costs of supplying the same item, they probably
will set a different price for that item. People might be willing to pay the higher
price if the store is closer to where they live or simply to support a smaller, local
store.
c. Again, answers will vary, but the reasoning is the same as in part b.
7. It depends on the perspective one takes. It is economically reasonable to legalize
organ sales. But from a moral perspective, organ sales may be unethical, and
poorer people might feel compelled to sell their organs to support their family, a
result that many people would find morally reprehensible. Economics has nothing
definitive to say on normative moral issues such as this.
8. Answers will vary. Here is an example: Banks are economic institutions. They
take a cost/benefit approach to deciding to whom to give loans, and they influence
decision making by allowing individuals to spend more money than they earn or
have as wealth.
9. a. This is a matter of personal views; there are arguments for and against it. An
argument against the practice is that wealthy songwriters would have too much
power in promoting their songs. The songs of the songwriters who can afford to
share profits will get more play time and become even more famous to the
detriment to new entrants into the industry. Arguments for this practice are that it
could be used to offset racism as in the example given and, to the extent that new
songwriters have the capability of offering such royalty share, promote new kinds
of music.
b. The royalty payment gave Freed a strong incentive to choose what he considered
the best song and to promote that song heavily. The flat payment would have just
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Chapter 01 - Economics and Economic Reasoning
1-8
given him an incentive to play any song and no long-term interest in whether the
song succeeded or failed.
c. Product placement in movies is legal, as are free newspapers to professors for
getting a class to use the newspaper. Direct payment to doctors for prescribing a
particular type of drug are illegal, although taking doctors to lunch is not.
10. Three ways (among many) that dormitory rooms could be rationed are
administrative decree, lottery, and a market system. In the first, individual
behavior would be forced to fit the will of the administrator. Individuals probably
would complain and try to influence the administrator's decision. Because
administrative decree is not necessarily an efficient system, some people probably
would attempt to trade rooms after the allocation. In the second, individual
behavior would be forced to fit the luck of the draw; individuals probably would
attempt to trade rooms after the draw. In the final example, individual behavior
would have already been subject to economic forces, and thus, there will be no
tendency 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 avoid
losses than otherwise would be the case. Economic policies should be risk-
averse—more committed to maintaining the current standard of living than to
risking economic losses by trying to improve it. Another possible policy response
would 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 be
completely objective. Sometimes the best we can hope for is an awareness of the
cultural norms and value judgments that influence our views and decisions.
Additionally, many policy issues (such as organ markets and minimum wage
laws) probably should not be approved in a purely objective way, since they are
also moral and social issues.
1-8
given him an incentive to play any song and no long-term interest in whether the
song succeeded or failed.
c. Product placement in movies is legal, as are free newspapers to professors for
getting a class to use the newspaper. Direct payment to doctors for prescribing a
particular type of drug are illegal, although taking doctors to lunch is not.
10. Three ways (among many) that dormitory rooms could be rationed are
administrative decree, lottery, and a market system. In the first, individual
behavior would be forced to fit the will of the administrator. Individuals probably
would complain and try to influence the administrator's decision. Because
administrative decree is not necessarily an efficient system, some people probably
would attempt to trade rooms after the allocation. In the second, individual
behavior would be forced to fit the luck of the draw; individuals probably would
attempt to trade rooms after the draw. In the final example, individual behavior
would have already been subject to economic forces, and thus, there will be no
tendency 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 avoid
losses than otherwise would be the case. Economic policies should be risk-
averse—more committed to maintaining the current standard of living than to
risking economic losses by trying to improve it. Another possible policy response
would 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 be
completely objective. Sometimes the best we can hope for is an awareness of the
cultural norms and value judgments that influence our views and decisions.
Additionally, many policy issues (such as organ markets and minimum wage
laws) probably should not be approved in a purely objective way, since they are
also moral and social issues.
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Chapter 02 - The Production Possibility Model, Trade, and Globalization
2-1
Chapter 2: The Production Possibility Model, Trade, and Globalization
Questions and Exercises
1. In the accompanying figure, wadget production is measured on the vertical axis
and widget production is measured on the horizontal axis. If the society becomes
more productive in its output of widgets, it can produce more of them, and the
endpoint of the curve on the horizontal axis will move to the right, as shown in
the graph. If the society is also less productive in its production of wadgets, the
endpoint on the vertical axis will move down, as shown in the graph. The result is
a new production possibility curve.
2. If a society became equally more productive in the production of both widgets
and wadgets, the production possibility curve would shift out to the right, as
shown in the accompanying graph.
3. Any production possibility curve that shows the principle of a rising trade-off
must be bowed out. The accompanying grade production possibility curve
embodies the principle of rising trade-off. The table is also presented here. Notice
that for each 20-point gain in the History grade, the amount of points lost on the
Economics grade steadily increases.
2-1
Chapter 2: The Production Possibility Model, Trade, and Globalization
Questions and Exercises
1. In the accompanying figure, wadget production is measured on the vertical axis
and widget production is measured on the horizontal axis. If the society becomes
more productive in its output of widgets, it can produce more of them, and the
endpoint of the curve on the horizontal axis will move to the right, as shown in
the graph. If the society is also less productive in its production of wadgets, the
endpoint on the vertical axis will move down, as shown in the graph. The result is
a new production possibility curve.
2. If a society became equally more productive in the production of both widgets
and wadgets, the production possibility curve would shift out to the right, as
shown in the accompanying graph.
3. Any production possibility curve that shows the principle of a rising trade-off
must be bowed out. The accompanying grade production possibility curve
embodies the principle of rising trade-off. The table is also presented here. Notice
that for each 20-point gain in the History grade, the amount of points lost on the
Economics grade steadily increases.
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Chapter 02 - The Production Possibility Model, Trade, and Globalization
2-2
4. a. To produce one more Peep, JustBorn must give up 3 Mike and Ikes. Hence, the
trade-off for 1 Peep is 3 Mike and Ikes. The trade-off for 1 Mike and Ike is 1/3 of
a Peep.
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 production
possibility curve. If each person's comparative advantage is taken advantage of,
higher total output can be reached than would be the case if each produced all
goods on his or her own or if each produced goods for which he or she did not
have a comparative advantage. As more and more of a good is produced,
resources that have less of a comparative advantage are brought into the
production of a good, causing the production possibility curve to be bowed
outward.
History Economics
40 100
60 80
80 50
2-2
4. a. To produce one more Peep, JustBorn must give up 3 Mike and Ikes. Hence, the
trade-off for 1 Peep is 3 Mike and Ikes. The trade-off for 1 Mike and Ike is 1/3 of
a Peep.
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 production
possibility curve. If each person's comparative advantage is taken advantage of,
higher total output can be reached than would be the case if each produced all
goods on his or her own or if each produced goods for which he or she did not
have a comparative advantage. As more and more of a good is produced,
resources that have less of a comparative advantage are brought into the
production of a good, causing the production possibility curve to be bowed
outward.
History Economics
40 100
60 80
80 50
Loading page 11...
Chapter 02 - The Production Possibility Model, Trade, and Globalization
2-3
6. a. See the accompanying graph.
b. As the output of food increases, the trade-off between food and clothing is
increasing. To illustrate, giving up 4 of clothing (from 20 to 16) results in a gain
of 5 food (from 0 to 5), but giving up another 4 clothing (from 16 to 12) results in
a gain of 4 food (from 5 to 9), and this pattern continues.
c. If the country gets better at producing food, the place where the production
possibility curve intersects the horizontal axis will move to the right.
d. If the country gets equally better at producing food and producing clothing, the
production 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 comparative
advantage in either of two goods.
8. The fact that the production possibility model tells us that trade is good does not
mean that in the real world free trade is the best policy. The production possibility
model does not take into account the importance of institutions and government in
trade. For example, the model does not take into account externalities associated
with some trades, the provision of public goods, or the need for a stable set of
institutions or rules. The production possibility model shows maximum total
output, but that is not the only societal goal to take into account in formulating
policy.
9. a. See the accompanying graph.
2-3
6. a. See the accompanying graph.
b. As the output of food increases, the trade-off between food and clothing is
increasing. To illustrate, giving up 4 of clothing (from 20 to 16) results in a gain
of 5 food (from 0 to 5), but giving up another 4 clothing (from 16 to 12) results in
a gain of 4 food (from 5 to 9), and this pattern continues.
c. If the country gets better at producing food, the place where the production
possibility curve intersects the horizontal axis will move to the right.
d. If the country gets equally better at producing food and producing clothing, the
production 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 comparative
advantage in either of two goods.
8. The fact that the production possibility model tells us that trade is good does not
mean that in the real world free trade is the best policy. The production possibility
model does not take into account the importance of institutions and government in
trade. For example, the model does not take into account externalities associated
with some trades, the provision of public goods, or the need for a stable set of
institutions or rules. The production possibility model shows maximum total
output, but that is not the only societal goal to take into account in formulating
policy.
9. a. See the accompanying graph.
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Chapter 02 - The Production Possibility Model, Trade, and Globalization
2-4
b. The United States has a comparative advantage in the production of wheat
because it can produce 2 additional tons of wheat for every 1 fewer bolt of cloth,
whereas Japan can produce 1 additional ton of wheat for every 2 fewer bolts of
cloth. Japan has a comparative advantage in producing cloth.
c. The United States should trade wheat to Japan in return for bolts of cloth. One
possibility is that the United States produces 1,000 tons of wheat and Japan
produces 1,000 bolts of fabric and they divide total production equally. Both get
500 tons of wheat and 500 yards 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 and
division of labor. Because companies can move operations to countries with a
comparative advantage, they can lower production costs and increase competitive
pressures. The decreased importance of geographical location increases the size of
potential markets, increasing the number of suppliers in each market and thus
increasing competition.
11. The law of one price rules, meaning that U.S. wages can exceed foreign wages
only to the degree that U.S. workers are more productive than foreign
workers. Therefore, the adjustments that will need to occur will equalize
wage rates. Thus, either Western nominal wages will grow slowly and
foreign nominal wages will grow rapidly and catch up or U.S. exchange rates
will decline to equalize wages. Some combination of the two is most likely. It
is possible that there will develop areas of production/services that will
allow U.S. wages to remain high.
12. The law of one prices states that the wages of workers in one country will not
differ significantly from the wages of (equal) workers in another institutionally
similar country. As the world is globalizing, the law of one price causes firms to
hire workers in other countries. Because wages adjusted for productivity
differences are lower in other countries, firms choose to use workers in foreign
countries. As they do so, wages will be bid up until wages, adjusted for
productivity differences, are equal between the two countries.
2-4
b. The United States has a comparative advantage in the production of wheat
because it can produce 2 additional tons of wheat for every 1 fewer bolt of cloth,
whereas Japan can produce 1 additional ton of wheat for every 2 fewer bolts of
cloth. Japan has a comparative advantage in producing cloth.
c. The United States should trade wheat to Japan in return for bolts of cloth. One
possibility is that the United States produces 1,000 tons of wheat and Japan
produces 1,000 bolts of fabric and they divide total production equally. Both get
500 tons of wheat and 500 yards 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 and
division of labor. Because companies can move operations to countries with a
comparative advantage, they can lower production costs and increase competitive
pressures. The decreased importance of geographical location increases the size of
potential markets, increasing the number of suppliers in each market and thus
increasing competition.
11. The law of one price rules, meaning that U.S. wages can exceed foreign wages
only to the degree that U.S. workers are more productive than foreign
workers. Therefore, the adjustments that will need to occur will equalize
wage rates. Thus, either Western nominal wages will grow slowly and
foreign nominal wages will grow rapidly and catch up or U.S. exchange rates
will decline to equalize wages. Some combination of the two is most likely. It
is possible that there will develop areas of production/services that will
allow U.S. wages to remain high.
12. The law of one prices states that the wages of workers in one country will not
differ significantly from the wages of (equal) workers in another institutionally
similar country. As the world is globalizing, the law of one price causes firms to
hire workers in other countries. Because wages adjusted for productivity
differences are lower in other countries, firms choose to use workers in foreign
countries. As they do so, wages will be bid up until wages, adjusted for
productivity differences, are equal between the two countries.
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Chapter 02 - The Production Possibility Model, Trade, and Globalization
2-5
Questions from Alternative Perspectives
1. Austrian
In a market economy competition, the market process translates individual
actions into actions that are good for society. There is no such mechanism for
government; government has a monopoly on power, which allows
individuals in government to use that monopoly to achieve their ends, which
may not be “good” ends. This monopoly on power makes government less
reliable than the market for doing good, since the government is not subject
to entry and exit as firms are in the market. Also, whether every individual
voice is taken into account depends on the government system, whereas the
market will always include any individual’s voice by that individual’s entry or
exit.
2. Religious
a. Most people would say that although it might be a component of the goals of
society, it is not “the” goal of society. Other goals might include virtues such
as 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 the
will of God.
3. Feminist
a. Companies definitely think that sex sells products. Just look at the cover of any
number 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 be
portrayed as objects instead of people and are therefore at greater risk of
exploitation.
d. Although men and women may both be used in advertising, typically men are
shown to be in a dominant position of power and women are shown in
subordinate positions.
4. Institutionalist
a. Back in the 1950s President Eisenhower warned of the military/industrial
complex, which maintains all types of military spending on projects so that
they continue to generate jobs in those areas. Senators with power on the
appropriations committee inevitably have larger defense expenditures in
their districts than do senators not on the appropriations committee. This
2-5
Questions from Alternative Perspectives
1. Austrian
In a market economy competition, the market process translates individual
actions into actions that are good for society. There is no such mechanism for
government; government has a monopoly on power, which allows
individuals in government to use that monopoly to achieve their ends, which
may not be “good” ends. This monopoly on power makes government less
reliable than the market for doing good, since the government is not subject
to entry and exit as firms are in the market. Also, whether every individual
voice is taken into account depends on the government system, whereas the
market will always include any individual’s voice by that individual’s entry or
exit.
2. Religious
a. Most people would say that although it might be a component of the goals of
society, it is not “the” goal of society. Other goals might include virtues such
as 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 the
will of God.
3. Feminist
a. Companies definitely think that sex sells products. Just look at the cover of any
number 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 be
portrayed as objects instead of people and are therefore at greater risk of
exploitation.
d. Although men and women may both be used in advertising, typically men are
shown to be in a dominant position of power and women are shown in
subordinate positions.
4. Institutionalist
a. Back in the 1950s President Eisenhower warned of the military/industrial
complex, which maintains all types of military spending on projects so that
they continue to generate jobs in those areas. Senators with power on the
appropriations committee inevitably have larger defense expenditures in
their districts than do senators not on the appropriations committee. This
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Chapter 02 - The Production Possibility Model, Trade, and Globalization
2-6
high spending on military production results in a trade-off. It means that
there is less money to spend on consumer goods, leading to lower production
of consumer goods.
b. The short-term consequence is a loss in consumer goods. The long-term
consequences are potentially much more serious, because for the military to
justify the expenditures, wars are necessary; thus, the production of military
goods over consumer goods can increase the probability of wars. Some might
argue that the latest Iraq war is an example, with Halliburton benefiting from
it and the former head of Halliburton, Vice President Cheney, leading the
group pushing for the U.S. entrance into the war.
5. Radical
a. Yes, for many low-wage jobs it does, although technology is changing that to
some degree.
b. When making policy decisions, society must take into account not only what
is produced but the methods and means of production.
Issues to Ponder
1. This statement can be true or false depending on the implicit assumptions made in
the analysis. It is true in light of the fact that individuals will eliminate all
inefficiencies they see through trading. It might be false if not everyone knows all
the benefits and the inefficiencies or does not have the opportunity to correct the
inefficiencies 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 particular
production technique that leads to greater output but also an undesirable
distribution of income might be considered an inefficient method of production.
Remember, efficiency is achieving a goal as cheaply as possible. Maximizing
output is not the only goal of a society.
3. a. From the numbers alone, one would choose not to work because the
opportunity cost of working is giving up an $80,000 increase in lifetime
income whereas the benefit is $32,000 of income now. Although there is a
correlation between working time and GPA, we cannot conclude that
working an after-school job causes the decrease in GPA. Therefore, one might
be able to maintain a decent GPA while working. Moreover, earning money
might be the priority for a particular student to reach a goal, such as saving
for college that will lead to even greater lifetime earnings.
b. It depends on the particular student. Working takes time from study and thus
might be a reason for the decrease in GPA. But the situation varies from
student to student.
2-6
high spending on military production results in a trade-off. It means that
there is less money to spend on consumer goods, leading to lower production
of consumer goods.
b. The short-term consequence is a loss in consumer goods. The long-term
consequences are potentially much more serious, because for the military to
justify the expenditures, wars are necessary; thus, the production of military
goods over consumer goods can increase the probability of wars. Some might
argue that the latest Iraq war is an example, with Halliburton benefiting from
it and the former head of Halliburton, Vice President Cheney, leading the
group pushing for the U.S. entrance into the war.
5. Radical
a. Yes, for many low-wage jobs it does, although technology is changing that to
some degree.
b. When making policy decisions, society must take into account not only what
is produced but the methods and means of production.
Issues to Ponder
1. This statement can be true or false depending on the implicit assumptions made in
the analysis. It is true in light of the fact that individuals will eliminate all
inefficiencies they see through trading. It might be false if not everyone knows all
the benefits and the inefficiencies or does not have the opportunity to correct the
inefficiencies 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 particular
production technique that leads to greater output but also an undesirable
distribution of income might be considered an inefficient method of production.
Remember, efficiency is achieving a goal as cheaply as possible. Maximizing
output is not the only goal of a society.
3. a. From the numbers alone, one would choose not to work because the
opportunity cost of working is giving up an $80,000 increase in lifetime
income whereas the benefit is $32,000 of income now. Although there is a
correlation between working time and GPA, we cannot conclude that
working an after-school job causes the decrease in GPA. Therefore, one might
be able to maintain a decent GPA while working. Moreover, earning money
might be the priority for a particular student to reach a goal, such as saving
for college that will lead to even greater lifetime earnings.
b. It depends on the particular student. Working takes time from study and thus
might be a reason for the decrease in GPA. But the situation varies from
student to student.
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Chapter 02 - The Production Possibility Model, Trade, and Globalization
2-7
4. The fact that lawns occupy more land in the United States than does any single
crop does not mean that the United States is operating inefficiently. Although the
cost of enjoying lawns is not included in GDP, lawns are nevertheless produced
consumption goods and are included in the production possibility curve for the
United States. The high proportion of land devoted to lawns implies that the
United States has enough food that it can devote a fair amount of land to the
production of goods for enjoyment such as lawns.
5. Following the hint that society’s production possibility curve reflects more than
just technical relationships, we realize that trust is an input to production to the
extent that it is necessary for transactions. If everyone could fake honesty, the
production possibility curve would shift inward since no one could trust anyone
else, leading to the disintegration of markets. If some could fake honesty, those
few would gain at the expense of others. This is an example of the tragedy of the
commons.
6. a. Firms may produce in Germany because (1) transportation costs to and from
the other countries may be very high, so that if these costs are included, it
would not be efficient to produce there, (2) there might be tariffs or quotas
for imports into Germany that will prevent producing elsewhere, (3) the
productivity of German labor may be so much higher that unit labor costs in
Germany are the lowest, and (4) historical circumstances may have led to
production in Germany, and the cost of moving production may exceed
potential 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, but
this would be limited by social restrictions such as language, culture, and the
economic climate in Germany, which currently has high unemployment.
Movement in the long run, however, might be substantial.
c. I would want to know about the rule of law in Thailand that will govern
business practices, the stability of the government, and the infrastructure. All
of these will affect the cost of production.
2-7
4. The fact that lawns occupy more land in the United States than does any single
crop does not mean that the United States is operating inefficiently. Although the
cost of enjoying lawns is not included in GDP, lawns are nevertheless produced
consumption goods and are included in the production possibility curve for the
United States. The high proportion of land devoted to lawns implies that the
United States has enough food that it can devote a fair amount of land to the
production of goods for enjoyment such as lawns.
5. Following the hint that society’s production possibility curve reflects more than
just technical relationships, we realize that trust is an input to production to the
extent that it is necessary for transactions. If everyone could fake honesty, the
production possibility curve would shift inward since no one could trust anyone
else, leading to the disintegration of markets. If some could fake honesty, those
few would gain at the expense of others. This is an example of the tragedy of the
commons.
6. a. Firms may produce in Germany because (1) transportation costs to and from
the other countries may be very high, so that if these costs are included, it
would not be efficient to produce there, (2) there might be tariffs or quotas
for imports into Germany that will prevent producing elsewhere, (3) the
productivity of German labor may be so much higher that unit labor costs in
Germany are the lowest, and (4) historical circumstances may have led to
production in Germany, and the cost of moving production may exceed
potential 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, but
this would be limited by social restrictions such as language, culture, and the
economic climate in Germany, which currently has high unemployment.
Movement in the long run, however, might be substantial.
c. I would want to know about the rule of law in Thailand that will govern
business practices, the stability of the government, and the infrastructure. All
of these will affect the cost of production.
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Chapter 02 - The Production Possibility Model, Trade, and Globalization
2-8
Chapter 2: Appendix A
1. 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 is
positive (slopes up).
d. The slope between 1 and 2 units is the change in cost (30 – 20) divided by the
change in quantity (1 – 2), or –10.
3. See the accompanying graph.
b
1 2 3 4 5 6 7 8 9 10
1
2
3
4
5
6
7
9
10
a
8
c
d
2-8
Chapter 2: Appendix A
1. 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 is
positive (slopes up).
d. The slope between 1 and 2 units is the change in cost (30 – 20) divided by the
change in quantity (1 – 2), or –10.
3. See the accompanying graph.
b
1 2 3 4 5 6 7 8 9 10
1
2
3
4
5
6
7
9
10
a
8
c
d
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Chapter 02 - The Production Possibility Model, Trade, and Globalization
2-9
4. a. 1.
b. –3.
c. 1/3.
d. –3/4.
e. 0.
5. a. C.
b. A and E.
c. B and D.
d. B is a local maximum; D is a local minimum.
6. a. See line a in the accompanying graph.
b. See line b in the accompanying graph.
c. See line c in the accompanying graph.
7. a. y = 5x + 1,000.
b. y = 3x + 1,500.
8. a. Line graph.
b. Bar graph.
c. Pie chart.
d. Line graph.
2-9
4. a. 1.
b. –3.
c. 1/3.
d. –3/4.
e. 0.
5. a. C.
b. A and E.
c. B and D.
d. B is a local maximum; D is a local minimum.
6. a. See line a in the accompanying graph.
b. See line b in the accompanying graph.
c. See line c in the accompanying graph.
7. a. y = 5x + 1,000.
b. y = 3x + 1,500.
8. a. Line graph.
b. Bar graph.
c. Pie chart.
d. Line graph.
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Chapter 03 - Economic Institutions
3-1
Chapter 3: Economic Institutions
Questions and Exercises
1. The central coordinating mechanism in a market economy is price.
2. The central coordinating mechanism in a centrally planned economy is the central
planners.
3. Market economies solve the three problems through markets and the system of
rewards and payments. What gets produced is what businesses believe can be
sold. How it gets produced is determined by businesses; generally, they choose
the method that produces the largest profit. Those who are willing to pay for the
goods at the market-determined prices will get them. Thus, supply and demand
determine what, how, and for whom to produce.
4. Centrally planned socialist economies solve the three problems by using
administrative control. Central planners decide what to produce according to what
they believe is socially beneficial. In deciding how to produce, central planners
are guided by what they believe is good for the country. Central planners decide
about distribution on the basis of their 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 each
is, but economics does not provide an answer to normative questions without
imposing normative judgments.
6. An economy depends on coordination, and the mechanisms of coordination
depend 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 what
is considered a resource depend on technology, and people develop new
technologies. Even the institutions that oversee the economy are governed by that
economy’s people. It follows that the economy’s ultimate strength resides in its
people.
7. Business is dynamic; it involves meeting new problems constantly, recognizing
needs, and meeting those needs in a timely fashion. These are precisely the skills
of entrepreneurship.
8. The three forms of businesses are corporations, partnerships, and sole
proprietorships.
a. In the United States, sole proprietorships are the most common.
b. The largest proportion of sales are made by corporations.
9. You most likely would choose a sole proprietorship because it’s easy to start,
requires minimal bureaucratic hassle, and is controlled by you, the owner. If you
3-1
Chapter 3: Economic Institutions
Questions and Exercises
1. The central coordinating mechanism in a market economy is price.
2. The central coordinating mechanism in a centrally planned economy is the central
planners.
3. Market economies solve the three problems through markets and the system of
rewards and payments. What gets produced is what businesses believe can be
sold. How it gets produced is determined by businesses; generally, they choose
the method that produces the largest profit. Those who are willing to pay for the
goods at the market-determined prices will get them. Thus, supply and demand
determine what, how, and for whom to produce.
4. Centrally planned socialist economies solve the three problems by using
administrative control. Central planners decide what to produce according to what
they believe is socially beneficial. In deciding how to produce, central planners
are guided by what they believe is good for the country. Central planners decide
about distribution on the basis of their 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 each
is, but economics does not provide an answer to normative questions without
imposing normative judgments.
6. An economy depends on coordination, and the mechanisms of coordination
depend 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 what
is considered a resource depend on technology, and people develop new
technologies. Even the institutions that oversee the economy are governed by that
economy’s people. It follows that the economy’s ultimate strength resides in its
people.
7. Business is dynamic; it involves meeting new problems constantly, recognizing
needs, and meeting those needs in a timely fashion. These are precisely the skills
of entrepreneurship.
8. The three forms of businesses are corporations, partnerships, and sole
proprietorships.
a. In the United States, sole proprietorships are the most common.
b. The largest proportion of sales are made by corporations.
9. You most likely would choose 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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Chapter 03 - Economic Institutions
3-2
need more money than you have to start this business, you might consider taking
on a partner. This would also allow you to share the work and the risk, but you
also would have to share the profits and figure out a way to maintain a friendship
while working together.
10. The two largest categories of federal expenditures are income security and health
and education.
11. The six roles of government in a market economy are (1) providing a stable set of
institutions 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. When
these permits are tradable, firms that face the lowest cost of reducing pollution
will reduce pollution emissions the most and sell their extra rights to firms that
face a higher cost of reducing pollution. Permits assign rights, thus correcting for
the externality.
13. A merit good is a good that government believes is good for you even if you
choose not to buy it. An example might be operas. A demerit good is a good that
government believes is bad for you even if you choose to buy it. An example is
alcohol or drugs. A public good is a good that if supplied to one person must be
supplied to all and whose consumption by one does not preclude consumption by
another. An example is national defense. An externality is the effect of a trade on
a person not involved in the trade. An example is cigarette smoke.
14. Economic actions are coordinated by a wide variety of international organizations
such as the United Nations, the World Trade Organization (WTO), and the World
Bank. (The student needs to mention only two of these three organizations.)
15. Countries have developed global and regional organization to coordinate trade
barriers and reduce trade barriers. The World Trade Organization, the European
Union, and NAFTA are examples of these types of organizations
16. International organizations are limited in their effectiveness because membership
is voluntary, as are any agreements among members. There is no world
government to enforce international laws or agreements.
3-2
need more money than you have to start this business, you might consider taking
on a partner. This would also allow you to share the work and the risk, but you
also would have to share the profits and figure out a way to maintain a friendship
while working together.
10. The two largest categories of federal expenditures are income security and health
and education.
11. The six roles of government in a market economy are (1) providing a stable set of
institutions 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. When
these permits are tradable, firms that face the lowest cost of reducing pollution
will reduce pollution emissions the most and sell their extra rights to firms that
face a higher cost of reducing pollution. Permits assign rights, thus correcting for
the externality.
13. A merit good is a good that government believes is good for you even if you
choose not to buy it. An example might be operas. A demerit good is a good that
government believes is bad for you even if you choose to buy it. An example is
alcohol or drugs. A public good is a good that if supplied to one person must be
supplied to all and whose consumption by one does not preclude consumption by
another. An example is national defense. An externality is the effect of a trade on
a person not involved in the trade. An example is cigarette smoke.
14. Economic actions are coordinated by a wide variety of international organizations
such as the United Nations, the World Trade Organization (WTO), and the World
Bank. (The student needs to mention only two of these three organizations.)
15. Countries have developed global and regional organization to coordinate trade
barriers and reduce trade barriers. The World Trade Organization, the European
Union, and NAFTA are examples of these types of organizations
16. International organizations are limited in their effectiveness because membership
is voluntary, as are any agreements among members. There is no world
government to enforce international laws or agreements.
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Chapter 03 - Economic Institutions
3-3
Questions from Alternative Perspectives
1. Austrian
a. The dangers of government intervention and support of activities is that once
intervention 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, that might induce them to attempt to
limit the number of children families can have, as the People’s Republic of China
did. Alternatively, the government may want more children for an increase in the
size of the military and, to achieve its ends, limit birth control, as Romania did in
its socialist period, and force individuals to have more children.
2. Religious
He 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 about
whether he is correct, but as can be seen with some religious fundamentalists who
incorporate violence into their belief systems, the state may face serious problems
when people rely on religion as their primary guide for action.
3. Feminist
a. Economists know relatively little about intrahousehold decision making and have
generally assumed that households have a single joint utility function. In one
popular theory, those with power (parents) are assumed to be benevolent and
those without power (children) are assumed to be selfish. Widespread wife and
child abuse as well as evidence for unequal food distribution within the family
which harms women and children clearly undermines this simple notion of
household decision making.
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, for
example.
c. The ability to walk away from the bargain is what gives someone power. Paying
the bill also gives a person power. In families with separate checking accounts,
the individual with a higher income is likely to have greater bargaining power.
d. Individuals are more likely to act cooperatively within a household because there
are mechanisms besides money to maintain accountability. However, there may
be unspoken competition within a family, such as when children compete for their
parents' attention. There is also cooperation elsewhere, such as when employees
work together to accomplish a task.
3-3
Questions from Alternative Perspectives
1. Austrian
a. The dangers of government intervention and support of activities is that once
intervention 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, that might induce them to attempt to
limit the number of children families can have, as the People’s Republic of China
did. Alternatively, the government may want more children for an increase in the
size of the military and, to achieve its ends, limit birth control, as Romania did in
its socialist period, and force individuals to have more children.
2. Religious
He 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 about
whether he is correct, but as can be seen with some religious fundamentalists who
incorporate violence into their belief systems, the state may face serious problems
when people rely on religion as their primary guide for action.
3. Feminist
a. Economists know relatively little about intrahousehold decision making and have
generally assumed that households have a single joint utility function. In one
popular theory, those with power (parents) are assumed to be benevolent and
those without power (children) are assumed to be selfish. Widespread wife and
child abuse as well as evidence for unequal food distribution within the family
which harms women and children clearly undermines this simple notion of
household decision making.
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, for
example.
c. The ability to walk away from the bargain is what gives someone power. Paying
the bill also gives a person power. In families with separate checking accounts,
the individual with a higher income is likely to have greater bargaining power.
d. Individuals are more likely to act cooperatively within a household because there
are mechanisms besides money to maintain accountability. However, there may
be unspoken competition within a family, such as when children compete for their
parents' attention. There is also cooperation elsewhere, such as when employees
work together to accomplish a task.
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Chapter 03 - Economic Institutions
3-4
e. It makes sense within the theory of the social behavior of groups of various sizes
and strength of relations.
4. Institutionalist
The dilemma is obvious and represents an inherent conflict in a society whose
values are greatly influenced by the Judeo-Christian ethic of charity toward all
and 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 of
universal application.
5. Radical
a. To some degree consumers’ desires influence what is produced, but with so much
advertising, it is difficult to determine people’s true desires and whether those
desires are being created by businesses.
b. Again, views can differ on this issue, and it is difficult to say which view is
correct.
c. The other group that has some sovereignty is business. If business sovereignty
holds, the analysis based on consumer sovereignty is misleading and should not
necessarily be followed.
Issues to Ponder
1. Markets have a small role in most families. In most families, decisions about who
gets what usually are made by benevolent parents. Because families are small and
social bonds are strong, this benevolence can work. Thus, a socialist organization
seems more appropriate to a family and a market-based organization to a large
economy in which social bonds don’t hold the social unit together. The propensity
to look after the common good is much stronger in a family than in an entire
economy. The benefits of a market-based economy in a family would be to
provide incentives to all the members of the family to contribute to family
production, 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 does
not imply that the children are deprived or that the distribution is unfair. Children
and adults have different needs.
b. Yes. These percentages probably change with income. The lower the income, the
larger the percent of total expenditures spent on children. The reason is that most
families want to provide a basic level of needs for their children. Many families
feel that luxuries should not be given to children until the children have learned
how to work for themselves.
c. Our suspicion is that the allocation would not be significantly different in
command economies compared with capitalist economies. If, however, the
3-4
e. It makes sense within the theory of the social behavior of groups of various sizes
and strength of relations.
4. Institutionalist
The dilemma is obvious and represents an inherent conflict in a society whose
values are greatly influenced by the Judeo-Christian ethic of charity toward all
and 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 of
universal application.
5. Radical
a. To some degree consumers’ desires influence what is produced, but with so much
advertising, it is difficult to determine people’s true desires and whether those
desires are being created by businesses.
b. Again, views can differ on this issue, and it is difficult to say which view is
correct.
c. The other group that has some sovereignty is business. If business sovereignty
holds, the analysis based on consumer sovereignty is misleading and should not
necessarily be followed.
Issues to Ponder
1. Markets have a small role in most families. In most families, decisions about who
gets what usually are made by benevolent parents. Because families are small and
social bonds are strong, this benevolence can work. Thus, a socialist organization
seems more appropriate to a family and a market-based organization to a large
economy in which social bonds don’t hold the social unit together. The propensity
to look after the common good is much stronger in a family than in an entire
economy. The benefits of a market-based economy in a family would be to
provide incentives to all the members of the family to contribute to family
production, 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 does
not imply that the children are deprived or that the distribution is unfair. Children
and adults have different needs.
b. Yes. These percentages probably change with income. The lower the income, the
larger the percent of total expenditures spent on children. The reason is that most
families want to provide a basic level of needs for their children. Many families
feel that luxuries should not be given to children until the children have learned
how to work for themselves.
c. Our suspicion is that the allocation would not be significantly different in
command economies compared with capitalist economies. If, however, the
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Chapter 03 - Economic Institutions
3-5
average income in command economies were lower, the percentage of total
expenditure spent on children might be higher, as described in part b.
3. a. Innovation requires a certain level of freedom of thought and a possibility of
profit making from the innovation. Neither existed in centrally planned
economies. Government planners directed production with income based on need,
and so workers had neither the freedom nor the incentive to innovate.
b. Both freedom and the possibility of making profits provide the means and
incentives for innovation in capitalist countries.
c. Schumpeter’s argument was based on the idea that profit making by innovators
was necessary for innovation to occur. As firms become larger, however, the
individual ceases to become the direct beneficiary of his or her innovations.
d. Since his predictions did not materialize, one must believe that firms have been
able to create incentive structures to foster innovation or that some other venue
for innovation has arisen. Firms have large research and development departments
designed to promote innovation. In addition, individual innovators have been able
to raise enough capital to start their own companies to profit directly from their
innovations. In the United States, there has been enormous growth in the number
of such firms. The U.S. government has been a large motivator of innovation
through its strong patent and copyright system as well as by providing subsidies
for research at universities and supporting military innovations, both of which
have large spillovers into private industry.
4. a. Such an idea could be expanded to include college courses, but that is unlikely to
happen because the quantity of in-person college courses demanded would
decline as people substituted toward recorded lectures. Substitution, however, is
not perfect since neither DVDs nor CDs can provide the interaction between
student and instructor or among students that exists in the classroom. Social
forces would act against the movement away from college classroom instruction
even if the invisible hand pressed action toward it.
b. Technical problems are virtually nonexistent. Socially, the problems are
substantial. A diminishing role of the university would significantly change its
role of providing a focal point for intellectual discussion and discovery, thus
changing the nature of education. There would be great social pressures to
maintain this role of American colleges. The economic issues are substantial as
well. A course could be taught once and used over a period of years. This would
reduce the demand for professors and create revenues for certifying agencies that
would regulate the distribution and quality of the tapes. If these college-at-home
courses became an accepted educational credential, the demand for a traditional
college education would fall, putting major competitive pressure on traditional
colleges.
c. Even though the program is technically possible and cost-efficient, it will not
necessarily be a success because social forces will play a major role in limiting
the market. Social forces are often strong enough to overcome economic forces.
3-5
average income in command economies were lower, the percentage of total
expenditure spent on children might be higher, as described in part b.
3. a. Innovation requires a certain level of freedom of thought and a possibility of
profit making from the innovation. Neither existed in centrally planned
economies. Government planners directed production with income based on need,
and so workers had neither the freedom nor the incentive to innovate.
b. Both freedom and the possibility of making profits provide the means and
incentives for innovation in capitalist countries.
c. Schumpeter’s argument was based on the idea that profit making by innovators
was necessary for innovation to occur. As firms become larger, however, the
individual ceases to become the direct beneficiary of his or her innovations.
d. Since his predictions did not materialize, one must believe that firms have been
able to create incentive structures to foster innovation or that some other venue
for innovation has arisen. Firms have large research and development departments
designed to promote innovation. In addition, individual innovators have been able
to raise enough capital to start their own companies to profit directly from their
innovations. In the United States, there has been enormous growth in the number
of such firms. The U.S. government has been a large motivator of innovation
through its strong patent and copyright system as well as by providing subsidies
for research at universities and supporting military innovations, both of which
have large spillovers into private industry.
4. a. Such an idea could be expanded to include college courses, but that is unlikely to
happen because the quantity of in-person college courses demanded would
decline as people substituted toward recorded lectures. Substitution, however, is
not perfect since neither DVDs nor CDs can provide the interaction between
student and instructor or among students that exists in the classroom. Social
forces would act against the movement away from college classroom instruction
even if the invisible hand pressed action toward it.
b. Technical problems are virtually nonexistent. Socially, the problems are
substantial. A diminishing role of the university would significantly change its
role of providing a focal point for intellectual discussion and discovery, thus
changing the nature of education. There would be great social pressures to
maintain this role of American colleges. The economic issues are substantial as
well. A course could be taught once and used over a period of years. This would
reduce the demand for professors and create revenues for certifying agencies that
would regulate the distribution and quality of the tapes. If these college-at-home
courses became an accepted educational credential, the demand for a traditional
college education would fall, putting major competitive pressure on traditional
colleges.
c. Even though the program is technically possible and cost-efficient, it will not
necessarily be a success because social forces will play a major role in limiting
the market. Social forces are often strong enough to overcome economic forces.
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Chapter 03 - Economic Institutions
3-6
5. Answers will vary. This exercise asks students to gather information about the
limitations on businesses of different types in their communities. They are then
asked to make judgments about whether the limitations were necessary (are they
clear about the goals involved?) and whether the number of limitations is correct.
The information is linked to the text’s material in part d. Part e asks students to
learn about business taxes in their communities, and part f has them gather a sense
of business satisfaction.
6. Consumers decide what goods they want and demonstrate their decisions in their
willingness to pay for those goods. Businesses decide what to produce, but their
decisions reflect consumer desires. Thus, there is no contradiction. However,
advertising, in which businesses attempt to influence behavior, can limit
consumer 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 that with sufficient property rights, the externality will be solved
most efficiently by the market, not by government.
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 against
some absolute truth about the value of operas; otherwise, how would one decide
who decides the value of operas? Because it is only through the market that value
is revealed, we’d argue that government intervention in this case will probably
lead to government failure—the failure of government to value operas accurately.
With government intervention, the value probably will reflect the preferences of
those with political power, not necessarily the preferences of the general
population.
9. People have based decisions on the rules that were set up, and so changing them
after the game has been started may be more unfair than continuing to play by the
original rules. Such decisions must be made based on the marginal cost and the
benefit of changing the rules.
10. In making such trade agreements, it is important for countries to realize that trade
includes not only economic issues but cultural and social ones as well. Although
free and unregulated trade is generally the most economically beneficial
(maximizes consumption possibilities), these economic benefits can be
overpowered by the loss of cultural identity as a result of globalization. Taking
into consideration such losses is a government’s responsibility when it negotiates
trade agreements. These losses must be weighed against the benefits of free trade.
3-6
5. Answers will vary. This exercise asks students to gather information about the
limitations on businesses of different types in their communities. They are then
asked to make judgments about whether the limitations were necessary (are they
clear about the goals involved?) and whether the number of limitations is correct.
The information is linked to the text’s material in part d. Part e asks students to
learn about business taxes in their communities, and part f has them gather a sense
of business satisfaction.
6. Consumers decide what goods they want and demonstrate their decisions in their
willingness to pay for those goods. Businesses decide what to produce, but their
decisions reflect consumer desires. Thus, there is no contradiction. However,
advertising, in which businesses attempt to influence behavior, can limit
consumer 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 that with sufficient property rights, the externality will be solved
most efficiently by the market, not by government.
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 against
some absolute truth about the value of operas; otherwise, how would one decide
who decides the value of operas? Because it is only through the market that value
is revealed, we’d argue that government intervention in this case will probably
lead to government failure—the failure of government to value operas accurately.
With government intervention, the value probably will reflect the preferences of
those with political power, not necessarily the preferences of the general
population.
9. People have based decisions on the rules that were set up, and so changing them
after the game has been started may be more unfair than continuing to play by the
original rules. Such decisions must be made based on the marginal cost and the
benefit of changing the rules.
10. In making such trade agreements, it is important for countries to realize that trade
includes not only economic issues but cultural and social ones as well. Although
free and unregulated trade is generally the most economically beneficial
(maximizes consumption possibilities), these economic benefits can be
overpowered by the loss of cultural identity as a result of globalization. Taking
into consideration such losses is a government’s responsibility when it negotiates
trade agreements. These losses must be weighed against the benefits of free trade.
Loading page 24...
Chapter 04 - Supply and Demand
4-1
Chapter 4: Supply and Demand
Questions and Exercises
1. The law of demand states that quantity demanded falls as price increases or that
quantity demanded rises as price falls. Price is inversely related to quantity
demanded because as price rises, consumers substitute other goods whose price
has not risen.
2. a.
Price Market
Demand
2 64
4 56
6 44
8 36
10 28
12 20
14 12
16 8
b. 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's
demand curve will not shift to the right (an additional 50 percent of zero is still
zero).]
3. Four shift factors of demand are income, price of other goods, tastes, and
expectations. A fifth shift factor is taxes and subsidies to consumers. As income
4-1
Chapter 4: Supply and Demand
Questions and Exercises
1. The law of demand states that quantity demanded falls as price increases or that
quantity demanded rises as price falls. Price is inversely related to quantity
demanded because as price rises, consumers substitute other goods whose price
has not risen.
2. a.
Price Market
Demand
2 64
4 56
6 44
8 36
10 28
12 20
14 12
16 8
b. 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's
demand curve will not shift to the right (an additional 50 percent of zero is still
zero).]
3. Four shift factors of demand are income, price of other goods, tastes, and
expectations. A fifth shift factor is taxes and subsidies to consumers. As income
Loading page 25...
Chapter 04 - Supply and Demand
4-2
rises, demand increases. As the prices of other substitute goods rise, demand
increases. As tastes change to favor a particular good, the demand for that good
increases. If people expect the price of a good to fall in the future, demand will
fall now. Taxes reduce demand, whereas subsidies increase it.
4. A change in the price causes a movement along the demand curve to a new point
on the same curve. A shift in the demand curve means that the quantities will be
different 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 directly
related to quantity supplied because as price rises, people and firms rearrange
their 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 is
not the result of a price change. The correct statement is that normally, as price
rises, 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 prices of inputs increase,
the supply curve shifts to the left. As technological advances are made that reduce
the cost of production, the supply curve shifts to the right. If a supplier expects the
price 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 the
supply curve to the left. Subsidies given to producers shift the supply curve to the
right.
8. When adding two supply curves, sum horizontally the two individual supply
curves, as in the accompanying diagram. S3 is the market supply curve.
9. a. The market demand and market supply curves are shown in the accompanying
graph.
4-2
rises, demand increases. As the prices of other substitute goods rise, demand
increases. As tastes change to favor a particular good, the demand for that good
increases. If people expect the price of a good to fall in the future, demand will
fall now. Taxes reduce demand, whereas subsidies increase it.
4. A change in the price causes a movement along the demand curve to a new point
on the same curve. A shift in the demand curve means that the quantities will be
different 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 directly
related to quantity supplied because as price rises, people and firms rearrange
their 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 is
not the result of a price change. The correct statement is that normally, as price
rises, 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 prices of inputs increase,
the supply curve shifts to the left. As technological advances are made that reduce
the cost of production, the supply curve shifts to the right. If a supplier expects the
price 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 the
supply curve to the left. Subsidies given to producers shift the supply curve to the
right.
8. When adding two supply curves, sum horizontally the two individual supply
curves, as in the accompanying diagram. S3 is the market supply curve.
9. a. The market demand and market supply curves are shown in the accompanying
graph.
Loading page 26...
Chapter 04 - Supply and Demand
4-3
b. At a price of $30, quantity demanded is 35 and quantity supplied is 15. Excess
demand is 20. At a price of $60, quantity demanded is 5 and quantity supplied is
45. 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 a
decrease in the market price and the market quantity.
11. The price of airline tickets rises during the summer months because demand for
airline travel increases as more people take vacations. This is shown in the
accompanying graph.
4-3
b. At a price of $30, quantity demanded is 35 and quantity supplied is 15. Excess
demand is 20. At a price of $60, quantity demanded is 5 and quantity supplied is
45. 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 a
decrease in the market price and the market quantity.
11. The price of airline tickets rises during the summer months because demand for
airline travel increases as more people take vacations. This is shown in the
accompanying graph.
Loading page 27...
Chapter 04 - Supply and Demand
4-4
12. Sales volume increases (equilibrium quantity rises) when the government
suspends the tax on sales by retailers because the price to demanders falls and
hence equilibrium quantity demanded rises. This occurs because the supply curve
shifts to the right because suppliers do not have to pay taxes on their sales (cost of
production declines).
13. Increased security measures imposed by government will increase the cost of
providing air travel. This will shift the supply curve to the left, increase
equilibrium price to P1, and decrease equilibrium quantity to Q1 as shown in the
accompanying graph. They also might reduce demand (the hassles of the
increased security and the additional time it takes to travel), further decreasing
equilibrium quantity and offsetting the rise in price, in this case to P2.
4-4
12. Sales volume increases (equilibrium quantity rises) when the government
suspends the tax on sales by retailers because the price to demanders falls and
hence equilibrium quantity demanded rises. This occurs because the supply curve
shifts to the right because suppliers do not have to pay taxes on their sales (cost of
production declines).
13. Increased security measures imposed by government will increase the cost of
providing air travel. This will shift the supply curve to the left, increase
equilibrium price to P1, and decrease equilibrium quantity to Q1 as shown in the
accompanying graph. They also might reduce demand (the hassles of the
increased security and the additional time it takes to travel), further decreasing
equilibrium quantity and offsetting the rise in price, in this case to P2.
Loading page 28...
Chapter 04 - Supply and Demand
4-5
Some students might argue that increased security will increase demand because
consumers will feel more comfortable flying (they don't have to worry about
terrorists as much). If demand increased, the price would go up even higher and
the 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 will
soon catch the attention of suppliers, and prices will be pushed upward.
15. As substitutes for bottled water—clean tap water—decrease, demand for bottled
water increases enormously, and there will be upward pressure on prices. Social
and political forces will, however, probably work 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 of
oil out to the right. The price of oil will decline, as shown in the accompanying
graph.
4-5
Some students might argue that increased security will increase demand because
consumers will feel more comfortable flying (they don't have to worry about
terrorists as much). If demand increased, the price would go up even higher and
the 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 will
soon catch the attention of suppliers, and prices will be pushed upward.
15. As substitutes for bottled water—clean tap water—decrease, demand for bottled
water increases enormously, and there will be upward pressure on prices. Social
and political forces will, however, probably work 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 of
oil out to the right. The price of oil will decline, as shown in the accompanying
graph.
Loading page 29...
Chapter 04 - Supply and Demand
4-6
17. a. The bad weather causes a decrease in supply. This is shown by a shift in supply
from S0 to S1. Equilibrium price rises from P0 to P1, and equilibrium quantity falls
from Q0 to Q1. See the accompanying graph.
b. The medical report causes a decrease in demand. This is shown by a shift in
demand from D0 to D1. Equilibrium price falls from P0 to P1, and equilibrium
quantity falls from Q0 to Q1. See the accompanying graph
c. The innovation causes an increase in supply. This is shown as a shift in supply
from S0 to S1. Equilibrium price falls from P0 to P1, and equilibrium quantity rises
from Q0 to Q1. See the accompanying graph
4-6
17. a. The bad weather causes a decrease in supply. This is shown by a shift in supply
from S0 to S1. Equilibrium price rises from P0 to P1, and equilibrium quantity falls
from Q0 to Q1. See the accompanying graph.
b. The medical report causes a decrease in demand. This is shown by a shift in
demand from D0 to D1. Equilibrium price falls from P0 to P1, and equilibrium
quantity falls from Q0 to Q1. See the accompanying graph
c. The innovation causes an increase in supply. This is shown as a shift in supply
from S0 to S1. Equilibrium price falls from P0 to P1, and equilibrium quantity rises
from Q0 to Q1. See the accompanying graph
Loading page 30...
Chapter 04 - Supply and Demand
4-7
d. The drop in income causes a decrease in demand. This is shown by a shift in
demand from D0 to D1. Equilibrium price falls from P0 to P1, and equilibrium
quantity falls from Q0 to Q1. See the accompanying graph
18. a. I would expect wheat prices to decline since the supply of wheat is greater than
expected. Wheat commodity markets are very competitive, and so the initial 30
percent increase in output was already reflected in the current price of wheat. It is
only the additional 10 percent 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, as
shown in the accompanying graph. Equilibrium price falls from P0 to P1, and
equilibrium quantity rises from Q0 to Q1.
4-7
d. The drop in income causes a decrease in demand. This is shown by a shift in
demand from D0 to D1. Equilibrium price falls from P0 to P1, and equilibrium
quantity falls from Q0 to Q1. See the accompanying graph
18. a. I would expect wheat prices to decline since the supply of wheat is greater than
expected. Wheat commodity markets are very competitive, and so the initial 30
percent increase in output was already reflected in the current price of wheat. It is
only the additional 10 percent 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, as
shown in the accompanying graph. Equilibrium price falls from P0 to P1, and
equilibrium quantity rises from Q0 to Q1.
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Subject
Economics