Economics: Principles, Problems, and Policies (McGraw-Hill Series in Economics) 20th Edition Solution Manual

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Chapter 01-Limits, Alternatives, Choices1-1Chapter 01-Limits, Alternatives, and ChoicesMcConnell Brue Flynn 20eDISCUSSION QUESTIONS1.What is an opportunity cost? How does the idea relate to the definition of economics? Whichof the following decisions would entail the greater opportunity cost: Allocating a square block inthe heart of New York City for a surface parking lot or allocating a square block at the edge of atypical suburb for such a lot? Explain.LO1Answer:An opportunity cost is what was sacrificed to do or acquire something else. Thecondition of scarcity creates opportunity cost. If there was no scarcity, there would be noneed to sacrifice one thing to acquire another.The opportunity cost would be much higher in New York City as the alternative uses forthat square block are much more valuable than for a typical suburban city block.2.Cite three examples of recent decisions that you made in which you, at least implicitly,weighed marginal cost and marginal benefit.LO1Answer:Student answers will vary, but may include the decision to come to class, toskip breakfast to get a few extra minutes of sleep, to attend college, or to make apurchase. Marginal benefits of attending class may include the acquisition of knowledge,participationindiscussion,andbetterpreparationforanupcomingexamination.Marginal costs may include lost opportunities for sleep, meals, or studying for otherclasses.In evaluating the discussion of marginal benefits and marginal costs, be carefulto watch for sunk costs offered as a rationale for marginal decisions.3.What is meant by the term “utility” and how does the idea relate to purposeful behavior?LO1Answer:“Utility” refers to the pleasure, happiness, or satisfaction gained from engagingin an activity (eating a meal, attending a ball game, etc.). It is an important component ofpurposeful behavior because people will allocate their scarce time, energy, and money inan attempt to gain the most utility possible.4.What are the key elements of the scientific method and how does this method relate toeconomic principles and laws?LO2Answer:The key elements include the gathering of data (observation), the formulation ofpossible explanations (hypothesis), testing the hypothesis, determining the validity of thehypothesis, and repeated testing of hypotheses that have appeared to be valid in priortests.The scientific method is the technique used by economists to determine economic laws orprinciples. These laws or principles are formulated to explain and/or predict behavior ofindividuals or institutions.

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Chapter 01-Limits, Alternatives, Choices1-25.State (a) a positive economic statement of your choice, and then (b) a normative economicstatement relating to your first statement.LO3Answer:Student answers will vary. Example: (a) The unemployment rate is 4.8 percent;(b) the unemployment rate is too high.In general we treat “what is” statements aspositive, “what should be” as normative, but keep an eye out for statements like “at fullemployment an increase in the production of pizzasshouldcome at the cost of lessrobots.” Some students may incorrectly identify the statement as normative because ofthe term “should.”6.How does the slope of a budget line illustrate opportunity cost and trade-offs?How does abudget line illustrate scarcity and the effect of limited incomes?LO4Answer:Budget lines are always sloped downward.This downward slope shows aninverse relationship between the two goods, meaning that as you increase one, the othermust decrease.This decrease is what you are giving up, or opportunity cost, of the goodyou are getting more of.Budget lines illustrate scarcity in that they show you are limited by your income. Sincethey slope downward, they show you cannot keep getting more and more of both goods.There is always a trade-off.The area beyond the budget line represents combinations ofthe goods that are beyond your income.7.What are economic resources? What categories do economists use to classify them? Why areresources also called factors of production? Why are they called inputs?LO5Answer:Economic resources are the natural, human, and manufactured inputs used toproduce goods and services.Economic resources fall into four main categories:labor,land(naturalresources),realcapital(machines,factories,buildings,etc.,)andentrepreneurs. Economic resources are also calledfactors of productionbecause they areused toproducegoods and services.They are calledinputsbecause they gointo aproduction process (like ingredients go into a bowl to make a cake), with the resultinggoods and services also being referred to asoutput.

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Chapter 01-Limits, Alternatives, Choices1-38.Why is money not considered to be a capital resource in economics? Why is entrepreneurialability considered a category of economic resource, distinct from labor? What are the majorfunctions of the entrepreneur?LO5Answer:Money is not considered a capital resource because money is not productive–itprovides access to resources but itself does not directly contribute to the production ofgoods and services. Additionally, the quantity of money in circulation does not determinean economy’s productive capacity, while the amount of capital and other resources does.Doubling the amount of money in circulation does not change the economy’s physicalcapacity to produce goods and services.Money is, however, referred as afinancialresourceandfinancial capital, reflecting its ability to acquire real economic resources.Entrepreneurial ability and labor are both human resources, but they perform differentfunctions in the productive process.Entrepreneurial ability does not directly producegoods and services; it organizes the resources that do.Labor refers to the human inputsthat directly engage in production.Entrepreneurs are risk-takers: They coordinate the activities of the other three inputs forprofit—or loss, which is why they are called risk-takers.Entrepreneurs sometimesmanage companies that they own, but a manager who is not an owner is not necessarilyan entrepreneur but may be performing some of the entrepreneurial functions for thecompany.Entrepreneurs are also innovators, or perhaps inventors, and profits help tomotivate such activities.9.Specify and explain the typical shapes of marginal-benefit and marginal-cost curves. How arethese curves used to determine the optimal allocation of resources to a particular product? Ifcurrent output is such that marginal cost exceeds marginal benefit, should more or fewerresources be allocated to this product? Explain.LO6Answer:The marginal benefit curve is downward sloping, MB falls as more of a productis consumed because additional units of a good yield less satisfaction than previous units.The marginal cost curve is upward sloping, MC increases as more of a product isproduced since additional units require the use of increasingly unsuitable resource.Theoptimal amount of a particular product occurs where MB equals MC.If MC exceedsMB, fewer resources should be allocated to this use, as the additional cost is more thanthe additional benefit.

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Chapter 01-Limits, Alternatives, Choices1-410.Suppose that, on the basis of a nation’s production possibilities curve, an economy mustsacrifice 10,000 pizzas domestically to get the 1 additional industrial robot it desires but that itcan get the robot from another country in exchange for 9,000 pizzas. Relate this information tothe following statement:“Through international specialization and trade, a nation can reduce its opportunity cost ofobtaining goods and thus ‘move outside its production possibilities curve.’”LO7Answer:The message of the production possibilities curve is that an individual nation islimited to the combinations of output indicated by its production possibilities curve.International specialization means directing domestic resources to output which a nationis highly efficient at producing. International trade involves the exchange of these goodsfor goods produced abroad. Specialization and trade have the same effect as having moreand better resources or discovering improved production techniques.The output gainsfrom greater international specialization and trade are the equivalent of economic growth.11.LAST WORDStudies indicate that married men on average earn more income thanunmarried men of the same age and education level. Why must we be cautious in concluding thatmarriage is the cause and higher income is the effect?Answer:Correlation does not necessarily mean that there is causation.The relationshipcould be purely coincidental or dependent on some other factor not included in theanalysis. It is also possible that higher income is the variable that “causes” marriage.REVIEW QUESTIONS1. Match each term with the correct definition.LO1economicsopportunity costmarginal analysisutilitya. The next-best thing that must be foregone in order to product one more unit of a given product.b. The pleasure, happiness, or satisfaction obtained from consuming a good or service.c. The social science concerned with how individuals, institutions, and society make optimal(best) choices under conditions of scarcity.d. Making choices based on comparing marginal benefits with marginal costs.Answer:a. opportunity cost; b. utility; c.economics; d. marginal analysis

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Chapter 01-Limits, Alternatives, Choices1-52. Indicate whether each of the following statements applies to microeconomics ormacroeconomics:LO3a.The unemployment rate in the United States was 8.1 percent in August 2012.b.A U.S. software firm discharged 15 workers last month and transferred the work to India.c.An unexpected freeze in central Florida reduced the citrus crop and caused the price of orangesto rise.d.U.S. output, adjusted for inflation, decreased by 2.4 percent in 2009.e.Last week Wells Fargo Bank lowered its interest rate on business loans by one-half of 1percentage point.f.The consumer price index rose by 3.8 percent from August 2011 to August 2012.Answer:a. macro; b. micro; c. micro; d. macro; e. micro; f. macro3.Suppose that you initially have $100 to spend on books or movie tickets. The books start offcosting $25 each and the movie tickets start off costing $10 each. For each of the followingsituations, would the attainable set of combinations that you can afford increase or decrease?LO4a. Your budget increases from $100 to $150 while the prices stay the same.b. Your budget remains $100, the price of books remains $25, but the price of movie tickets risesto $20.c. Your budget remains $100, the price of movie tickets remains $10, but the price of a book fallsto $15.Answer:a.increasebecause a larger budget allows you to purchase not only the combinations thatyou could afford before but also new combinations that you could not afford before (forexample, you can now afford to purchase 4 books and 5 movie tickets);b.decreasebecause certain combinations are no longer affordable (for example, you canno longer purchase 10 movie tickets with your $100 budget);c.increasebecause the lower price allows you to purchase combinations that you couldnot afford before (for example, you can now purchase 6 books and 1 movie ticket)].4.Suppose that you are given a $100 budget at work that can be spent only on two items: staplersand pens. If staplers cost $10 each and pens cost $2.50 each, then the opportunity cost ofpurchasing one stapler is:LO4a. 10 pens.b. 5 pens.c. zero pens.d. 4 pens.Answer:4 pens.You must forego purchasing 4 pens if you are to free up enough money(4 x $2.50 = $10) to purchase a stapler.

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Chapter 01-Limits, Alternatives, Choices1-65.For each of the following situations involving marginal cost (MC) and marginal benefit (MB),indicate whether it would be best to produce more, fewer, or the current number of units.LO4a. 3,000 units at which MC = $10 and MB = $13.b. 11 units at which MC = $4 and MB = $3.c. 43,277 units at which MC = $99 and MB = $99.d. 82 units at which MC < MB.e. 5 units at which MB < MC.Answer:a.morebecause MB > MC--the benefit of consuming one more unit exceed theopportunity costs (scarce resources used elsewhere) of producing that additional unit.b.fewerbecause MC > MB--the opportunity costs (scarce resources used elsewhere) ofproducing one more unit exceed the benefit of consuming that additional unit.c.current amountbecause MB = MC--there is no net gain in using scarce resources inproducing and consuming one more unit.d.morebecause MB > MC--see the explanation for part(a)e.fewerbecause MB < MC--see the explanation for part(b)6.Explain how (if at all) each of the following events affects the location of a country’sproduction possibilities curve:LO6a.The quality of education increases.b.The number of unemployed workers increases.c.A new technique improves the efficiency of extracting copper from ore.d.A devastating earthquake destroys numerous production facilities.Answer:a.Assuming better education translates into better work skills, then productivity shouldrise and this would shift the curve outward.b.Should not affect location of curve.Production moves inward, away from the curve.c.The curve should shift outward as more production is possible with existing resourcesd.The curve should shift inward with the destruction of resources (capital).7. What are the two major ways in which an economy can grow and push out its productionpossibilities curve?LO7a. Better weather and nicer cars.b. Higher taxes and lower spending.c. Increases in resource supplies and advances in technology.d. Decreases in scarcity and advances in auditing.Answer:The economy produces output from resource inputs like land, labor, and capital.So onemajor way for an economy to grow and push out its production possibilities curve is for ittoobtain more resources.The second major way is todevelop new and better technologiesso that the economy canproduce more from any given amount of resources

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Chapter 01-Limits, Alternatives, Choices1-7PROBLEMS1.Potatoes cost Janice $1 per pound, and she has $5.00 that she could possibly spend on potatoesor other items. If she feels that the first pound of potatoes is worth $1.50, the second pound isworth $1.14, the third pound is worth $1.05, and all subsequent pounds are worth $0.30, howmany pounds of potatoes will she purchase? What if she only had $2 to spend?LO1Answer: 3; 2Feedback:Janice will purchase potatoes until the value of potatoes is less than the costof potatoes or until her income has been exhausted. For example, assume Janice has$5.00 to spend on potatoes or other items and the cost of a pound of potatoes is $1. Nowassume the first pound of potatoes is worth $1.50 to Janice. She will purchase this poundof potatoes since the value of the pound of potatoes ($1.50) is greater than the cost ($1).If the second pound is worth $1.14 and the third pound is worth a $1.05 then Janice willpurchase these as well since the value exceeds the cost of $1. If all remaining pounds areworth $0.30 then Janice will not purchase these because the value is less than the cost.So, Janice will purchase 3 pounds of potatoes at total cost of $3.00.Now assume Janice only has $2.00 to spend on potatoes. She will purchase the firstpound because it is worth $1.50 to her and it only costs a $1. She will purchase thesecond pound because it is worth $1.14. She has now spent her entire income on potatoes.She would like to purchase the third pound because the value of this pound of potatoes is$1.05, but she does not have the income to make this purchase. So, Janice will purchase 2pounds of potatoes at a total cost of $2.00.2.Pham can work as many or as few hours as she wants at the college bookstore for $9 per hour.But due to her hectic schedule, she has just 15 hours per week that she can spend working ateither the bookstore or at other potential jobs. One potential job, at a café, will pay her $12 perhour for up to 6 hours per week. She has another job offer at a garage that will pay her $10 anhour for up to 5 hours per week. And she has a potential job at a daycare center that will pay her$8.50 per hour for as many hours as she can work. If her goal is to maximize the amount ofmoney she can make each week, how many hours will she work at the bookstore?LO1Answer: 4.Feedback:Pham will choose to work at the bookstore as long as the wage rate at thebookstore exceeds her other opportunities. However, if another job offers a higher wagerate she will choose employment there. She will work until her total time allotment (forwork) is exhausted.For example, assume Pham only has 15 hours per week that she can work and the wagerate at the bookstore is $9 per hour. She can also spend her time working at acafé thatwill pay her $12 per hour for up to 6 hours per week, at a garage that will pay her $10 anhour for up to 5 hours per week, and at a daycare center that will pay her $8.50 per hourfor as many hours as she can work.She will choose to work at the café for the full 6 hours because the wage rate at the caféis $12 per hour, which is greater than the wage rate at the bookstore of $9. This leaves herwith 9 hours of work time remaining. Next, she will choose to work at the garage for thefull 5 hours because the wage rate here is $10, which again is greater than the bookstorewage rate $9. After this decision she only has 4 hours of work time remaining. She will

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Chapter 01-Limits, Alternatives, Choices1-8choose to work these last 4 hours at the bookstore because the bookstore wage rate of $9exceeds the daycare center wage rate of $8.50.3.Suppose you won $15 on a lotto ticket at the local 7-Eleven and decided to spend all thewinnings on candy bars and bags of peanuts. Candy bars cost $0.75 each while bags of peanutscost $1.50 each.LO5a.Construct a table showing the alternative combinations of the two products that are available.b.Plot the data in your table as a budget line in a graph. What is the slope of the budget line?What is the opportunity cost of one more candy bar? Of one more bag of peanuts? Do theseopportunity costs rise, fall, or remain constant as additional units are purchased?c.Does the budget line tell you which of the available combinations of candy bars and bags ofpeanuts to buy?d.Suppose that you had won $30 on your ticket, not $15. Show the $30 budget line in yourdiagram. Has the number of available combinations increased or decreased?Answers:Part a:Consumption alternativesGoodsABCDEFCandy bars048121620Bags of peanuts1086420Part b:Candy Bars2010Bags ofPeanuts5.5.175.−=−=SlopeFeedback:The slope for the budget line above, with candy bars on the horizontal axis, is-0.5 (=-Pcb/Pbp). Note that the figure could also be drawn with bags of peanuts on thehorizontal axis. The slope of that budget line would be-2.

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Chapter 01-Limits, Alternatives, Choices1-9The opportunity cost of one more candy bar is ½ of a bag of peanuts. The opportunitycost of one more bag of peanuts is 2 candy bars. These opportunity costs are constant.They can be found by comparing any two of the consumption alternatives for the twogoods.Part c:No; it only tells you what is possible.Feedback:The budget line does not tell you which of the available combinations ofcandy bars and bags of peanuts to buy. You will need to use your preference relationshipfor candy bars and bags of peanuts to determine which combination to buy. The budgetline only tells you which combinations are feasible.Part d:Increased.Candy BarsB ags ofP eanuts10202040Income = $30Incom e= $15Feedback:The budget line at $30 would be preferable because it would allow greaterconsumption of both goods.4.Suppose that you are on a desert island and possess exactly 20 coconuts. Your neighbor,Friday, is a fisherman, and he is willing to trade 2 fish for every 1 coconut that you are willing togive him. Another neighbor, Kwame, is also a fisherman, and he is willing to trade 3 fish forevery 1 coconut.LO5a.On a single figure, draw budget lines for trading with Friday and for trading with Kwame. (Putcoconuts on the vertical axis.)b.What is the slope of the budget line from trading with Friday?c.What is the slope of the budget line from trading with Kwame?d.Which budget line features a larger set of attainable combinations of coconuts and fish?e.If you are going to trade coconuts for fish, would you rather trade with Friday or Kwame?

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Chapter 01-Limits, Alternatives, Choices1-10Answers:Part a:Part b:-1/2Feedback:The slope of the budget line from trading with Friday equals-(1/2). Thisimplies that for every coconut I give up, Friday must give up two fish. Or, for every fishthat Friday gives up, I must give up (1/2) a coconut.Part c:-1/3Feedback:The slope of the budget line from trading with Kwame equals-(1/3). Thisimplies that for every coconut I give up, Kwame must give up three fish. Or, for everyfish that Friday gives up, I must give up (1/3) a coconut.Part d: The budget line from trading with KwameFeedback:The budget line from trading with Kwame features a larger set of attainablecombinations of coconuts and fish. Because Kwame is willing to give up more fish percoconut, I can consume more of both (assuming I make a trade). This implies that youwould prefer to trade with Kwame.Part e: KwameFeedback:Because Kwame is willing to give up more fish per coconut, I can consumemore of both (assuming I make a trade). This implies that you would prefer to trade withKwame.CoconutsFish204060Trade withFridaySlope =-1/2Trade withKwameSlope =-1/3

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Chapter 01-Limits, Alternatives, Choices1-115.Below is a production possibilities table for consumer goods (automobiles) and capital goods(forklifts):LO6a.Show these data graphically. Upon what specific assumptions is this production possibilitiescurve based?b.If the economy is at point C, what is the cost of one more automobile? Of one more forklift?Which characteristic of the production possibilities curve reflects the law of increasingopportunity costs: its shape or its length?c.If the economy characterized by this production possibilities table and curve were producing 3automobiles and 20 fork lifts, what could you conclude about its use of its available resources?d.Is production at a point outside the production possibilities curve currently possible? Could afuture advance in technology allow production beyond the current production possibilities curve?Could international trade allow a country to consume beyond its current production possibilitiescurve?Answers:Part a:(See figure below.)The assumptions are full employment, fixed suppliesof resources, fixed technology and two goods.Part b: 4 automobiles and 21 forklifts; its shape.automobilesforklifts830D (12,6)C (21,4)B (27,2)

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Chapter 01-Limits, Alternatives, Choices1-12Feedback:Consider the following example:Assume the economy is producing at point C. Thus, the economy is producing 4automobiles and 21 forklifts.The cost of producing one more automobile can be found by moving to point D andcalculating the number of forklifts given up for the 2 additional automobiles. At point Dthe economy is producing 12 forklifts, which is a loss of 9 forklifts (moving from C to D)for the 2 additional automobiles. Thus the cost of 1 more automobile equals 9 (forklifts)divided by 2 (automobiles), or (9/2) = 4.5 forklifts.The cost of producing one more forklift can be found in an equivalent fashion. First, wewill move to point B (from point C). Here we must give up 2 automobiles to get 6forklifts. Thus, the cost of 1 more forklift equals 2 (automobiles) divided by 6 (forklifts),which is (2/6) = (1/3).In review, take the cost (loss) and divide by the gain. If we were at point D, the cost ofone more forklift equals 2 automobiles (loss) divided by 9 forklifts (gain). Thus, the costof 1 more forklift at point B is (2/9) automobiles.Increasing opportunity cost implies that we must give up more of a particular good to getan additional unit of a different good. This implies as we move along the productionpossibilities curve (from left to right) I must give up more automobiles to get anadditional forklift. Thus, the SHAPE of the schedule captures the increasing opportunitycost concept.Part c: Underutilizing.Feedback:The economy is underutilizing resources (inside the PPC).Part d:No; Yes; Yes.Feedback:No, the country cannot produce outside its PPC. Yes, a technological advancewould shift the PPC outward allowing the country produce more with a given amount ofinputs. Yes, by specializing in goods we have a comparative advantage producing we cantrade to gain access to goods beyond our own PPC.

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Chapter 01-Limits, Alternatives, Choices1-136.Look at Figure 1.3. Suppose that the cost of cheese falls, so that the marginal cost of producingpizza decreases. Will the MC curve shift up or down? Will the optimal amount of pizza increaseor decrease?LO6Answers: MC will shift down; the optimal amount of pizza will increase.Feedback:To think about cost schedules we must think about input costs. If the cost ofcheese falls, then the cost of making pizza is cheaper for all pizzas. This implies that themarginal cost schedule will shift down reflecting the lower input cost. For a givendemand schedule, the optimal amount pizza produced and sold will increase and theequilibrium price would fall. The opposite story would apply if the cost of cheese were toincrease.7.Referring to the table in problem 5, suppose improvement occurs in the technology ofproducing forklifts but not in the technology of producing automobiles. Draw the new productionpossibilities curve. Now assume that a technological advance occurs in producing automobilesbut not in producing forklifts. Draw the new production possibilities curve. Now draw aproduction possibilities curve that reflects technological improvement in the production of bothgoods.LO7Answers: See figures.Technological advance in producing forklifts and not automobiles.Feedback:This implies we can produce more forklifts with the given resources, so theschedule will shift out along the horizontal axis.Technological advance in producing automobiles and not forklifts.automobilesforklifts830

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Chapter 01-Limits, Alternatives, Choices1-14Feedback:This implies we can produce more automobiles with the given resources, sothe schedule will shift up along the vertical axis.Technological in advance in producing automobiles and forklifts.Feedback:This implies we can produce more forklifts and automobiles with the givenresources, so the schedule will shift up out along the vertical and horizontal axes.automobilesforklifts830automobilesforklifts830

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Chapter 01-Limits, Alternatives, Choices1-158.Because investment and capital goods are paid for with savings, higher savings rates reflect adecision to consume fewer goods for the present in order to be able to invest in more goods forthe future.On average, households in China save 40 percent of their annual income each year,whereas households in the United States save less than 5 percent. Production possibilities aregrowing at roughly 9 percent annually in China and 3.5 percent in the United States. Usegraphical analysis of “present goods” versus “future goods” to explain the differences in growthrates.LO7Answers: See figures belowAPresentGoodsFutureGoodsUnited StatesFutureGoodsPresentGoodsBChinaFeedback:Since the United States is consuming more today rather than saving, theirproduction possibilities curve will shift out slower (less) over time because they areaccumulating less capital. China's production possibilities curve will shift out faster(more) over time because they are accumulating more capital. See diagrams below.

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