Macroeconomics Fourth Edition Solution Manual

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Solution1.In each of the following situations, identify which of the twelve principles is at work.a.You choose to shop at the local discount store rather than paying a higher pricefor the same merchandise at the local department store.b.On your spring break trip, your budget is limited to $35 a day.c.The student union provides a website on which departing students can sell itemssuch as used books, appliances, and furniture rather than giving them away totheir roommates as they formerly did.d.After a hurricane did extensive damage to homes on the island of St. Crispin,homeowners wanted to purchase many more building materials and hire manymore workers than were available on the island. As a result, prices for goods andservices rose dramatically across the board.e.You buy a used textbook from your roommate. Your roommate uses the money tobuy songs from iTunes.f.You decide how many cups of coffee to have when studying the night before anexam by considering how much more work you can do by having another cup ver-sus how jittery it will make you feel.g.There is limited lab space available to do the project required in Chemistry 101.The lab supervisor assigns lab time to each student based on when that student isable to come.h.You realize that you can graduate a semester early by forgoing a semester of studyabroad.i.At the student union, there is a bulletin board on which people advertise useditems for sale, such as bicycles. Once you have adjusted for differences in quality,all the bikes sell for about the same price.j.You are better at performing lab experiments, and your lab partner is better atwriting lab reports. So the two of you agree that you will do all the experiments,and she will write up all the reports.k.State governments mandate that it is illegal to drive without passing a driving exam.l.Your parents’ after- tax income has increased because of a tax cut passed byCongress. They therefore increase your allowance, which you spend on a springbreak vacation.1.a.People usually exploit opportunities to make themselves better off. In this case,you make yourself better off by buying merchandise at a lower price.b.Resources are scarce. Since you have only $35 a day, your resources are limited(scarce).c.Markets usually lead to efficiency. The market here is represented by the buyersand sellers who use the student union website to trade goods, in contrast to the“nonmarket” of simply giving items away to one’s roommate. The market is effi-cient because it enables people who want to sell items to find those who want tobuy those items. This is in contrast to a system in which items are simply left witha roommate, who may have little or no desire to have them.S-11CHAPTERFirst PrinciplesKrugWellsECPS4e_Micro_CH01.inddS-1KrugWellsECPS4e_Micro_CH01.inddS-19/23/149:35 AM9/23/149:35 AM

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Solutiond.Overall spending sometimes gets out of line with the economy’s productive capac-ity. The spending by St. Crispin homeowners on building materials and workersfell short of the economy’s ability to produce those goods and services. As a result,prices on the island rose across the board (inflation).e.One person’s spending is another person’s income. Your spending on the usedtextbook is your roommate’s income.f.“How much” is a decision at the margin. Your decision is one of “how much”coffee to consume, and you evaluate the trade- off between keeping yourself awakeand becoming more jittery from one more cup of coffee.g.Resources should be used as efficiently as possible to achieve society’s goals.Allocating scarce lab space according to when each student can use that space isefficient.h.The real cost of something is what you must give up to get it. The real cost of asemester abroad is giving up the opportunity to graduate early.i.Markets move toward equilibrium. Any bicycle a buyer chooses will leave him orher equally well off. That is, a buyer who chooses a particular bicycle cannot changeactions and find another bicycle that makes him or her better off. Also, no sellercan take a different action that makes him or her better off: no seller can charge ahigher price for a bicycle of similar quality, since no one would buy that bicycle.j.There are gains from trade. If each person specializes in what he or she is good at(that is, in comparison with others that person has an advantage in producingthat good), then there will be gains from specialization and trade.k.When markets don’t achieve efficiency, government intervention can improvesociety’s welfare. Unsafe drivers don’t take into account the dangers they pose toothers and often to themselves. So when unsafe drivers are allowed to drive, every-one is made worse off. Government intervention improves society’s welfare byassuring a minimum level of competence in driving.l.Government policies can change spending. In this case, a tax cut has increasedspending.2.Describe some of the opportunity costs when you decide to do the following.a.Attend college instead of taking a jobb.Watch a movie instead of studying for an examc.Ride the bus instead of driving your car2.a.One of the opportunity costs of going to college is not being able to take a job.By choosing to go to college, you give up the income you would have earned onthe job and the valuable on- the - job experience you would have acquired. Anotheropportunity cost of going to college is the cost of tuition, books, supplies, and soon. Alternatively, the benefit of going to college is being able to find a better, morehighly paid job after graduation in addition to the joy of learning.b.Watching the movie gives you a certain benefit, but allocating your time (a scarceresource) to watching the movie also involves the opportunity cost of not beingable to study for the exam. As a result, you will likely get a lower grade on theexam—and all that that implies.c.Riding the bus gets you where you need to go more cheaply than, but probably notas conveniently as, driving your car. That is, some of the opportunity costs oftaking the bus involve waiting for the bus, having to walk from the bus stop towhere you need to go rather than parking right outside the building, and probablya slower journey. If the opportunity cost of your time is high (your time isvaluable), these costs may be prohibitive.S-2C H A P T E R1F I R S TP R I N C I P L E SKrugWellsECPS4e_Micro_CH01.inddS-2KrugWellsECPS4e_Micro_CH01.inddS-29/23/149:35 AM9/23/149:35 AM

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C H A P T E R1F I R S TP R I N C I P L E SS-3Solution3.Liza needs to buy a textbook for the next economics class. The price at the collegebookstore is $65. One online site offers it for $55 and another site, for $57. Allprices include sales tax. The accompanying table indicates the typical shipping andhandling charges for the textbook ordered online.a.What is the opportunity cost of buying online instead of at the bookstore? Notethat if you buy the book online, you must wait to get it.b. Show the relevant choices for this student. What determines which of theseoptions the student will choose?3.a.The opportunity cost of buying online is whatever you must give up to get thebook online. So the opportunity cost of buying online is the sum of the shippingcharges plus the opportunity cost of your time spent waiting for the book to arrive(at the bookstore the book is available immediately) minus the cost saving youreceive by buying online versus buying at the bookstore.b.Below is a list of all of Liza’s options and their purely monetary costs:Buy from bookstore$65Buy from first site (price $55), 1-day delivery$55 + $13.98=$68.98Buy from first site (price $55), 2-day delivery$55 + $08.98=$63.98Buy from first site (price $55), 3- to 7-day delivery$55 + $03.99=$58.99Buy from second site (price $57), 1-day delivery$57 + $13.98=$70.98Buy from second site (price $57), 2-day delivery$57 + $08.98=$65.98Buy from second site (price $57), 3- to 7-day delivery$57 + $03.99 = $60.99It is clear that Liza would never buy from the second site, where the book costs$57: for each delivery time, she is better off buying the book from the first site,where the book costs $55. It is also clear that she would never buy the book fromthe first site and have it delivered the next business day: it costs more that way($68.98) than getting it from the bookstore (assuming that it is costless to get toand from the bookstore). But it is not clear whether she will buy the book fromthe bookstore or the first site with delivery times of 2 or 3–7 days: this depends onher opportunity cost of time. The higher the cost of waiting, the more likely she isto buy the book from the bookstore, where she does not need to wait.4.Use the concept of opportunity cost to explain the following.a.More people choose to get graduate degrees when the job market is poor.b.More people choose to do their own home repairs when the economy is slow andhourly wages are down.c.There are more parks in suburban than in urban areas.d.Convenience stores, which have higher prices than supermarkets, cater to busypeople.e.Fewer students enroll in classes that meet before 10:00A.M.ShippingDeliverymethodtimeChargeStandard shipping3–7 days$3.99Second-day air2 business days8.98Next-day air1 business day13.98KrugWellsECPS4e_Micro_CH01.inddS-3KrugWellsECPS4e_Micro_CH01.inddS-39/23/149:35 AM9/23/149:35 AM

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SolutionSolution4.a.The worse the job market, the lower the opportunity cost of getting a graduatedegree. One of the opportunity costs of going to graduate school is not being ableto work. But if the job market is bad, the salary you can expect to earn is low oryou might be unemployed—so the opportunity cost of going to school is also low.b.When the economy is slow, the opportunity cost of people’s time is also lower: thewages they could earn by working longer hours are lower than when the economyis booming. As a result, the opportunity cost of spending time doing your ownrepairs is lower—so more people will decide to do their own repairs.c.The opportunity cost of parkland is lower in suburban areas. The price per squarefoot of land is much higher in urban than in suburban areas. By creating park-land, you therefore give up the opportunity to make much more money in citiesthan in the suburbs.d.The opportunity cost of time is higher for busy people. Driving long distances tosupermarkets takes time that could be spent doing other things. Therefore, busypeople are more likely to use a nearby convenience store.e.Before 10:00A.M. the opportunity cost of time for many students is very high—itmeans giving up an extra hour’s sleep. That extra hour is much more valuablebefore 10:00A.M. than later in the day.5.In the following examples, state how you would use the principle of marginal analy-sis to make a decision.a.Deciding how many days to wait before doing your laundryb.Deciding how much library research to do before writing your term paperc.Deciding how many bags of chips to eatd.Deciding how many lectures of a class to skip5.a.Each day that you wait to do your laundry imposes a cost: you have fewer cleanclothes to choose from. But each day that you wait also confers a benefit: you canspend your time doing other things. You will wait another day to do your laundryif the benefit of waiting to do the laundry that day is greater than the cost.b.The more research you do, the better your paper will be. But there is also anopportunity cost: every additional hour you spend doing research means you can-not do other things. You will weigh the opportunity cost of doing one more hourof research against the benefit gained (in terms of an improved paper) from doingresearch. You will do one more hour of research if the benefit of that hour out-weighs the cost.c.Each bag of chips you eat gives you a benefit: it satisfies your hunger. But it alsohas a cost: the money spent for each bag (and, if you are weight- conscious, theadditional calories). You will weigh the cost against the benefit of eating one morebag. If the cost is less than the benefit, you will eat that one more bag of chips.d.Each lecture that you skip implies a cost: getting further behind with the materialand having to teach it to yourself just before the exam. But each skipped lecturealso means you can spend the time doing other things. You will continue to skiplectures if the cost of skipping is lower than the benefit of spending that timedoing other things.6.This morning you made the following individual choices: you bought a bagel andcoffee at the local café, you drove to school in your car during rush hour, and youtyped your roommate’s term paper because you are a fast typist—in return for whichshe will do your laundry for a month. For each of these actions, describe how yourindividual choices interacted with the individual choices made by others. Were otherpeople left better off or worse off by your choices in each case?S-4C H A P T E R1F I R S TP R I N C I P L E SKrugWellsECPS4e_Micro_CH01.inddS-4KrugWellsECPS4e_Micro_CH01.inddS-49/23/149:35 AM9/23/149:35 AM

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C H A P T E R1F I R S TP R I N C I P L E SS-5SolutionSolutionSolution6.When you bought the bagel and coffee, you paid a price for them. You would nothave bought that breakfast if your enjoyment of it (your welfare) had not been great-er than the price you paid. Similarly, the café owner would not have sold you thebagel and coffee if the price he received from you were less than the cost to him ofmaking them. This is an example of how everybody gains from trade: both you andthe café owner are better off.When you chose to drive your car during the rush hour, you added to the congestionon the road. Your choice had a side effect for other motorists: your driving slowedeverybody else down just a little bit more. Your choice made other motorists worse off.Typing your roommate’s term paper in exchange for her doing your laundry is anoth-er example of the gains that come from trade. Both of you voluntarily agreed tospecialize in a task that each is comparatively better at because you expected to gainfrom this interaction. Your choice made both you and your roommate better off.7.The Hatfield family lives on the east side of the Hatatoochie River, and the McCoyfamily lives on the west side. Each family’s diet consists of fried chicken and corn-on- the - cob, and each is self- sufficient, raising their own chickens and growing theirown corn. Explain the conditions under which each of the following would be true.a.The two families are made better off when the Hatfields specialize in raising chick-ens, the McCoys specialize in growing corn, and the two families trade.b.The two families are made better off when the McCoys specialize in raising chick-ens, the Hatfields specialize in growing corn, and the two families trade.7.a.Gains from trade usually arise from specialization. If the Hatfields (comparedto the McCoys) are better at raising chickens and the McCoys (compared to theHatfields) are better at growing corn, then there will be gains from specializationand trade.b.Similar to the answer to part a, if the McCoys (compared to the Hatfields) arebetter at raising chickens and the Hatfields (compared to the McCoys) are betterat growing corn, then there will be gains from specialization and trade.8.Which of the following situations describes an equilibrium? Which does not? If thesituation does not describe an equilibrium, what would an equilibrium look like?a.Many people regularly commute from the suburbs to downtown Pleasantville. Dueto traffic congestion, the trip takes 30 minutes when you travel by highway butonly 15 minutes when you go by side streets.b.At the intersection of Main and Broadway are two gas stations. One stationcharges $3.00 per gallon for regular gas and the other charges $2.85 per gallon.Customers can get service immediately at the first station but must wait in a longline at the second.c.Every student enrolled in Economics 101 must also attend a weekly tutorial. This yearthere are two sections offered: section A and section B, which meet at the same timein adjoining classrooms and are taught by equally competent instructors. Section A isovercrowded, with people sitting on the floor and often unable to see what is writtenon the board at the front of the room. Section B has many empty seats.8.a.This is not an equilibrium. Assume that all people care about is the travel time towork (not, for instance, how many turns they need to make or what the sceneryis like). Some people could be better off using the side streets, which would cutdown their travel time. Eventually, as the situation moves to equilibrium (that is,as more people use the side streets), travel times on the highway and along theside streets will equalize.KrugWellsECPS4e_Micro_CH01.inddS-5KrugWellsECPS4e_Micro_CH01.inddS-59/23/149:35 AM9/23/149:35 AM

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Solutionb.This might be an equilibrium. Those who buy gas at the first station would beworse off by buying gas at the second if the value of their time spent waitingexceeded the savings at the pump: they would save 15 cents per gallon but wouldincur the opportunity cost of waiting in a long line. You should expect very busypeople (a high opportunity cost of time) to buy gas at the first station. Thosewho buy gas at the second station might be worse off by buying gas at the first:they would not have to wait in line but would pay 15 cents more per gallon. Youshould expect people with a lot of free time (a low opportunity cost of time) tobuy gas at the second station.c.This is not an equilibrium. If students from section A attended section B instead,they would be better off: they could get seats and see the board without incurringany cost (since the section meets at the same time and is taught by an equallycompetent instructor). Over time, you should expect students to switch fromsection A to section B until equilibrium is established.9.In each of the following cases, explain whether you think the situation is efficient ornot. If it is not efficient, why not? What actions would make the situation efficient?a.Electricity is included in the rent at your dorm. Some residents in your dorm leavelights, computers, and appliances on when they are not in their rooms.b.Although they cost the same amount to prepare, the cafeteria in your dorm con-sistently provides too many dishes that diners don’t like, such as tofu casserole,and too few dishes that diners do like, such as roast turkey with dressing.c.The enrollment for a particular course exceeds the spaces available. Some studentswho need to take this course to complete their major are unable to get a spaceeven though others who are taking it as an elective do get a space.9.a.This is not efficient. If the lights were turned off, some students could be madebetter off without making other students worse off because the college would savemoney on electricity that it could spend on student programs. By leaving lightsand appliances on when leaving their rooms, residents do not take into accountthe negative side effect they impose on their college—the higher cost of electricity.If students were forced to pay their own individual electricity costs (that is, if theyfully took into account the cost of their actions), then they would turn the lightsand appliances off when leaving their rooms. This situation would be efficient.b.This is not efficient. Instead of serving dishes that many diners do not like, the caf-eteria should serve more of the equal-cost dishes that diners do like. That way, somestudents could be made better off without other students being made worse off.c.This is not efficient. In an efficient scheme, spaces would be allocated to thosestudents who value them most. In this case, however, some spaces are allocatedto students who value them less (those who take the course as an elective) thanother students (those who need the course to graduate). Efficiency could beimproved as follows: if a student who is not currently enrolled in the course val-ues it more than a student who is enrolled, then the unenrolled student should bewilling to pay the enrolled student to give up his or her space. At some price, thistrade would make both students better off and the outcome would be efficient.10.Discuss the efficiency and equity implications of each of the following policies. Howwould you go about balancing the concerns of equity and efficiency in these areas?a.The government pays the full tuition for every college student to study whateversubject he or she wishes.b.When people lose their jobs, the government provides unemployment benefitsuntil they find new ones.S-6C H A P T E R1F I R S TP R I N C I P L E SKrugWellsECPS4e_Micro_CH01.inddS-6KrugWellsECPS4e_Micro_CH01.inddS-69/23/149:35 AM9/23/149:35 AM

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C H A P T E R1F I R S TP R I N C I P L E SS-7SolutionSolution10.a.Although this policy is equitable, it may not be efficient, depending on the benefi-cial side effects of education. It does allow everyone, regardless of ability to pay, toattend college. But it may not be efficient: subsidizing the full cost of tuition foreveryone lowers the opportunity cost of going to college, and this might lead somepeople to go to college when they could more productively follow a career thatdoes not require a college education. And since resources (including governmentmoney) are scarce, paying tuition for these people has an opportunity cost: someother (possibly more worthwhile) government projects cannot be undertaken.One way of getting around this problem is to award scholarships based on aca-demic ability.b.Although this policy may be equitable (it guarantees everyone a certain amount ofincome), it may not be efficient. People respond to incentives. If unemploymentbecomes more attractive because of the unemployment benefit, some unemployedpeople may no longer try to find a job or may not try to find one as quickly asthey would without the benefit. Ways to get around this problem are to provideunemployment benefits only for a limited time or to require recipients to provethat they are actively searching for a new job.11.Governments often adopt certain policies in order to promote desired behavioramong their citizens. For each of the following policies, determine what the incentiveis and what behavior the government wishes to promote. In each case, why do youthink that the government might wish to change people’s behavior, rather than allowtheir actions to be solely determined by individual choice?a.A tax of $5 per pack is imposed on cigarettes.b.The government pays parents $100 when their child is vaccinated for measles.c.The government pays college students to tutor children from low- income families.d.The government imposes a tax on the amount of air pollution that a companydischarges.11.a.This policy creates an incentive to smoke less by making a pack of cigarettes morecostly. This is exactly what policy makers wish to promote. Cigarettes have unde-sirable side effects on other people, which smokers do not (or only insufficiently)take into account. One is that other people have to breathe in second- handsmoke. Another is the cost of health care: when smokers who need treatmentfor lung cancer are covered by Medicare or Medicaid, the rest of society has tofoot the bill. Since individuals do not take these costs (costs that arise for otherpeople) into account in deciding whether or not (or how much) to smoke, theamount of cigarettes smoked will be inefficiently high. The tax is a way to makepeople take these costs into account in deciding whether or not to smoke.b.This policy creates an incentive to have children vaccinated: it increases the ben-efit to parents from vaccination of their children. Getting vaccinated means notonly that a child will not contract the measles but also that he or she cannot passthe measles on to other children. That is, there is a side effect for other people(their children get sick less often) that parents do not take into account in theirdecision of whether or not to have their own child vaccinated. The subsidy is away to make individuals take into account in their decisions the benefit they cancreate for other people.c.This policy creates incentives for low- income families to get college students totutor their children, since getting a tutor is now cheaper or free. This results inbetter performance in school by these children and higher levels of educationalattainment. This has positive side effects for the rest of society: the better childrendo in school, the more productive, happier, and healthier citizens they will be.KrugWellsECPS4e_Micro_CH01.inddS-7KrugWellsECPS4e_Micro_CH01.inddS-79/23/149:35 AM9/23/149:35 AM

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SolutionSolutiond.This tax creates the incentive to emit fewer air pollutants. Pollution has a nega-tive side effect for others: it decreases air quality (for instance, it contributes tothe formation of ozone smog) and results in a variety of health complications(for instance, asthma). In deciding how much pollution to discharge, a companydoes not take these negative side effects sufficiently into account. The tax is a wayto make pollution more expensive, that is, to make the company face the cost itimposes on others.12.In each of the following situations, explain how government intervention couldimprove society’s welfare by changing people’s incentives. In what sense is the mar-ket going wrong?a.Pollution from auto emissions has reached unhealthy levels.b.Everyone in Woodville would be better off if streetlights were installed in thetown. But no individual resident is willing to pay for installation of a streetlightin front of his or her house because it is impossible to recoup the cost by chargingother residents for the benefit they receive from it.12.a.In deciding how much to drive, each driver does not take into account the cost ofauto emissions he or she imposes on others. That is, the market will lead to therebeing too much pollution. One way for governments to intervene would be to taxfuel or to tax cars that get low gas mileage. Or governments could subsidize newand cleaner fuels or technologies, such as hybrid cars. This would create incentivesfor people to switch to cars that use less polluting gas or to drive less.b.The market in this situation leads to too few (or no) streetlights in Woodville.Governments could improve residents’ welfare by paying for streetlight installationfrom the taxes paid by residents.13.In 2010, Tim Geithner, Treasury secretary at the time, published an article defendingthe administration’s policies. “The recession that began in late 2007 was extraordi-narily severe,” he declared, “but the actions we took at its height to stimulate theeconomy helped arrest the freefall, preventing an even deeper collapse and puttingthe economy on the road to recovery. Which two of the three principles of economy-wide interaction are at work in this statement?13.The Obama stimulus is an example of government policy aimed at changing spend-ing: by cutting taxes and also by directly increasing government spending, the pack-age sought to boost overall spending in the economy. And as spending rises, firmsincrease production. This is an example of the principle that one person’s spending isanother person’s income.14.In August 2007, a sharp downturn in the U.S. housing market reduced the incomeof many who worked in the home construction industry. AWall Street Journalnewsarticle reported that Walmart’s wire-transfer business was likely to suffer becausemany construction workers are Hispanics who regularly send part of their wages backto relatives in their home countries via Walmart. With this information, use one ofthe principles of economy-wide interaction to trace a chain of links that explainshow reduced spending for U.S. home purchases is likely to affect the performance ofthe Mexican economy.S-8C H A P T E R1F I R S TP R I N C I P L E SKrugWellsECPS4e_Micro_CH01.inddS-8KrugWellsECPS4e_Micro_CH01.inddS-89/23/149:35 AM9/23/149:35 AM

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C H A P T E R1F I R S TP R I N C I P L E SS-9SolutionSolutionSolution14.The correct principle in this case is that one person’s spending is another person’sincome. Here, a reduction in spending for U.S. home purchases leads to a fall in theincome of workers in the home construction industry. This, in turn, leads to areduction in funds sent by workers to relatives in Mexico, which leads to a reductionin spending by Mexican households. This, in turn, leads to less business for Mexicanfirms and job losses in Mexico. Ultimately, the Mexican economy is likely to beadversely affected by the downturn in the U.S. housing market.15.In 2012, Hurricane Sandy caused massive destruction to the northeast United States.Tens of thousands of people lost their homes and possessions. Even those whoweren’t directly affected by the destruction were hurt because businesses and jobsdried up. Using one of the principles of economy-wide interaction, explain how gov-ernment intervention can help in this situation.15.The destruction caused by Hurricane Sandy caused a reduction in spending byresidents in the area. This, in turn, led to reduced income as businesses failedor contracted and employment suffered. The government can help remedy thesituation by spending more in the area—say, by employing people for cleanup andconstruction—to counterbalance the reduced spending by private residents. This isan example of the principle that government policies can change spending.16.During the Great Depression, food was left to rot in the fields or fields that had oncebeen actively cultivated were left fallow. Use one of the principles of economy-wideinteraction to explain how this could have occurred.16.During the Great Depression, spending fell far short of the country’s capacity to pro-duce. This reflects the principle that overall spending sometimes gets out of line withthe economy’s productive capacity. As a result of the plunge in spending during theGreat Depression, farmers could not find enough buyers for food that had alreadybeen produced, so it was left to rot. Likewise, some farmers left their fields fallow.KrugWellsECPS4e_Micro_CH01.inddS-9KrugWellsECPS4e_Micro_CH01.inddS-99/23/149:35 AM9/23/149:35 AM

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Solution1.Two important industries on the island of Bermuda are fishing and tourism.According to data from the Food and Agriculture Organization of the United Nationsand the Bermuda Department of Statistics, in 2009 the 306 registered fishermen inBermuda caught 387 metric tons of marine fish. And the 2,719 people employed byhotels produced 554,400 hotel stays (measured by the number of visitor arrivals).Suppose that this production point is efficient in production. Assume also that theopportunity cost of 1 additional metric ton of fish is 2,000 hotel stays and that thisopportunity cost is constant (the opportunity cost does not change).a.If all 306 registered fishermen were to be employed by hotels (in addition to the2,719 people already working in hotels), how many hotel stays could Bermudaproduce?b.If all 2,719 hotel employees were to become fishermen (in addition to the 306fishermen already working in the fishing industry), how many metric tons of fishcould Bermuda produce?c.Draw a production possibility frontier for Bermuda, with fish on the horizontalaxis and hotel stays on the vertical axis, and label Bermuda’s actual productionpoint for the year 2009.1.a.Forgoing the production of 1 metric ton of fish allows Bermuda to produce 2,000additional hotel stays. Therefore, forgoing the production of 387 metric tons offish allows Bermuda to produce 2,000×387=774,000 additional hotel stays. Ifall fishermen worked in the hotel industry, Bermuda could produce554,000+774,000=1,328,400 hotel stays.b.Forgoing the production of 2,000 hotel stays allows Bermuda to produce 1 addi-tional metric ton of fish, so giving up 554,400 hotel stays allows Bermuda to produce554,400/2,000=277.2 additional metric tons of fish. If all hotel employees worked inthe fishing industry, Bermuda could produce 387+277.2=664.2 metric tons of fish.c.The accompanying diagram shows the production possibility frontier for Bermuda.Note that it is a straight line because the opportunity cost is constant. PointAisBermuda’s actual production point.A0Quantity ofhotel stays(thousands)BermudaPPFQuantity of fish (metric tons)1,328.4554.4387664.2S-112CHAPTEREconomic Models:Trade-offs and TradeKrugWellsECPS4e_Micro_CH02.inddS-11KrugWellsECPS4e_Micro_CH02.inddS-119/30/1412:51 PM9/30/1412:51 PM

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Solution2.According to data from the U.S. Department of Agriculture’s National AgriculturalStatistics Service, 124 million acres of land in the United States were used for wheator corn farming in a recent year. Of those 124 million acres, farmers used 50 mil-lion acres to grow 2.158 billion bushels of wheat and 74 million acres to grow 11.807billion bushels of corn. Suppose that U.S. wheat and corn farming is efficient inproduction. At that production point, the opportunity cost of producing 1 addi-tional bushel of wheat is 1.7 fewer bushels of corn. However, because farmers haveincreasing opportunity costs, additional bushels of wheat have an opportunity costgreater than 1.7 bushels of corn. For each of the following production points, decidewhether that production point is (i) feasible and efficient in production, (ii) feasiblebut not efficient in production, (iii) not feasible, or (iv) unclear as to whether or notit is feasible.a.Farmers use 40 million acres of land to produce 1.8 billion bushels of wheat,and they use 60 million acres of land to produce 9 billion bushels of corn. Theremaining 24 million acres are left unused.b.From their original production point, farmers transfer 40 million acres of landfrom corn to wheat production. They now produce 3.158 billion bushels of wheatand 10.107 bushels of corn.c.Farmers reduce their production of wheat to 2 billion bushels and increase theirproduction of corn to 12.044 billion bushels. Along the production possibilityfrontier, the opportunity cost of going from 11.807 billion bushels of corn to12.044 billion bushels of corn is 0.666 bushel of wheat per bushel of corn.2.a.This point is feasible but not efficient in production. Producing 1.8 billion bushelsof wheat and 9 billion bushels of corn is less of both wheat and corn than is pos-sible. They could produce more if all the available farmland were cultivated.b.At this new production point, farmers would now produce 1 billion more bush-els of wheat and 1.7 billion fewer bushels of corn than at their original produc-tion point. This reflects an opportunity cost of 1.7 bushels of corn per additionalbushel of wheat. But, in fact, this new production point is not feasible because weknow that opportunity costs are increasing. Starting from the original productionpoint, the opportunity cost of producing 1 more bushel of wheat must be higherthan 1.7 bushels of corn.c.This new production point is feasible and efficient in production. Along the pro-duction possibility frontier, the economy must forgo 0.666 bushel of wheat peradditional bushel of corn. So the increase in corn production from 11.807 billionbushels to 12.044 billion bushels costs the economy (12.044−11.807) billionbushels of corn×0.666 bushel of wheat per bushel of corn=0.158 bushel ofwheat. This is exactly equal to the actual loss in wheat output: the fall from 2.158billion to 2 billion bushels of wheat.3.In the ancient country of Roma, only two goods, spaghetti and meatballs, are pro-duced. There are two tribes in Roma, the Tivoli and the Frivoli. By themselves, theTivoli each month can produce either 30 pounds of spaghetti and no meatballs,or 50 pounds of meatballs and no spaghetti, or any combination in between. TheFrivoli, by themselves, each month can produce 40 pounds of spaghetti and no meat-balls, or 30 pounds of meatballs and no spaghetti, or any combination in between.a.Assume that all production possibility frontiers are straight lines. Draw onediagram showing the monthly production possibility frontier for the Tivoli andanother showing the monthly production possibility frontier for the Frivoli. Showhow you calculated them.b.Which tribe has the comparative advantage in spaghetti production? In meatballproduction?S-12C H A P T E R2E C O N O M I CM O D E L S : T R A D E - O F F S A N D T R A D EKrugWellsECPS4e_Micro_CH02.inddS-12KrugWellsECPS4e_Micro_CH02.inddS-129/30/1412:51 PM9/30/1412:51 PM

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SolutionInA.D. 100 the Frivoli discover a new technique for making meatballs that doublesthe quantity of meatballs they can produce each month.c.Draw the new monthly production possibility frontier for the Frivoli.d.After the innovation, which tribe now has an absolute advantage in producingmeatballs? In producing spaghetti? Which has the comparative advantage in meat-ball production? In spaghetti production?3.a.The accompanying diagram shows the production possibility frontier for the Tivoli inpanel (a) and for the Frivoli as the line labeled “Original FrivoliPPF” in panel (b).50403020100Quantityof spaghetti(pounds)Quantity of meatballs (pounds)201050406030(a) Production possibility frontierfor the Tivoli50403020100Quantityof spaghetti(pounds)Quantity of meatballs (pounds)201050406030Original FrivoliPPFNew FrivoliPPF(b) Production possibility frontierfor the FrivoliThe production possibility frontier for the Tivoli was calculated as follows: theTivoli can produce either 30 pounds of spaghetti and no meatballs, or they canproduce no spaghetti but 50 pounds of meatballs. That is, the opportunity costof 1 pound of meatballs is3⁄5of a pound of spaghetti: in order to produce 1 morepound of meatballs, the Tivoli have to give up3⁄5of a pound of spaghetti. Thismeans that the slope of their production possibility frontier is−3⁄5. A similarargument for the Frivoli shows that their production possibility frontier has aslope of−4⁄3.b.For the Tivoli, the opportunity cost of 1 pound of meatballs is3⁄5of a poundof spaghetti. For the Frivoli, the opportunity cost of 1 pound of meatballs is4⁄3pounds of spaghetti. That is, the Tivoli have a comparative advantage in meatballproduction because their opportunity cost is lower. For the Tivoli, the opportunitycost of 1 pound of spaghetti is5⁄3pounds of meatballs. For the Frivoli, the oppor-tunity cost of 1 pound of spaghetti is3⁄4pound of meatballs. That is, the Frivolihave a comparative advantage in spaghetti production because their opportunitycost is lower.c.The Frivoli’s new production possibility frontier is the line labeled “New FrivoliPPF” in panel (b) of the diagram. Instead of producing 30 pounds of meatballs (ifthey produce no spaghetti), they can now produce 60 pounds.d.Now the Frivoli have the absolute advantage in both meatball production and spa-ghetti production. The Frivoli’s opportunity cost of meatballs has now fallen to4⁄6=2⁄3; that is, for each pound of meatballs that the Frivoli now produce, they haveto give up producing2⁄3of a pound of spaghetti. Since the Frivoli’s opportunitycost of meatballs (2⁄3) is still higher than the Tivoli’s (3⁄5), the Tivoli still have thecomparative advantage in meatball production. The Frivoli’s opportunity cost ofspaghetti is3⁄2pounds of meatballs and the Tivoli’s is5⁄3pounds of meatballs, sothe Frivoli have the comparative advantage in spaghetti production.C H A P T E R2E C O N O M I CM O D E L S : T R A D E - O F F S A N D T R A D ES-13KrugWellsECPS4e_Micro_CH02.inddS-13KrugWellsECPS4e_Micro_CH02.inddS-139/30/1412:51 PM9/30/1412:51 PM

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SolutionSolution4.One July, the United States exported aircraft worth $1 billion to China and importedaircraft worth only $19,000 from China. During the same month, however, theUnited States imported $83 million worth of men’s trousers, slacks, and jeans fromChina but exported only $8,000 worth of trousers, slacks, and jeans to China. Usingwhat you have learned about how trade is determined by comparative advantage,answer the following questions.a.Which country has the comparative advantage in aircraft production? In produc-tion of trousers, slacks, and jeans?b.Can you determine which country has the absolute advantage in aircraft produc-tion? In production of trousers, slacks, and jeans?4.a.Since countries gain from specializing in production of the goods and services inwhich they have a comparative advantage, the United States must have the com-parative advantage in aircraft production, and China must have the comparativeadvantage in production of trousers, slacks, and jeans.b.Since trade has nothing to do with absolute advantage, we cannot determine fromthese data which country has an absolute advantage in either of these goods.5.Peter Pundit, an economics reporter, states that the European Union (EU) is increas-ing its productivity very rapidly in all industries. He claims that this productivityadvance is so rapid that output from the EU in these industries will soon exceed thatof the United States and, as a result, the United States will no longer benefit fromtrade with the EU.a.Do you think Peter Pundit is correct or not? If not, what do you think is thesource of his mistake?b.If the EU and the United States continue to trade, what do you think will charac-terize the goods that the EU exports to the United States and the goods that theUnited States exports to the EU?5.a.Peter Pundit is not correct. He confuses absolute and comparative advantage. Evenif the EU had an absolute advantage over the United States in every product it pro-duced, the United States would still have a comparative advantage in some prod-ucts. And the United States should continue to produce those products: trade willmake both the EU and the United States better off.b.You should expect to see the EU export those goods in which it has the compara-tive advantage and the United States export those goods in which it has the com-parative advantage.6.You are in charge of allocating residents to your dormitory’s baseball and basketballteams. You are down to the last four people, two of whom must be allocated to base-ball and two to basketball. The accompanying table gives each person’s batting aver-age and free - throw average.a.Explain how you would use the concept of comparative advantage to allocate theplayers. Begin by establishing each player’s opportunity cost of free throws interms of batting average.S-14C H A P T E R2E C O N O M I CM O D E L S : T R A D E - O F F S A N D T R A D ENameBatting averageFree-throw averageKelley70%60%Jackie50%50%Curt10%30%Gerry80%70%KrugWellsECPS4e_Micro_CH02.inddS-14KrugWellsECPS4e_Micro_CH02.inddS-149/30/1412:51 PM9/30/1412:51 PM

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SolutionSolutionb.Why is it likely that the other basketball players will be unhappy about thisarrangement but the other baseball players will be satisfied? Nonetheless, whywould an economist say that this is an efficient way to allocate players for yourdormitory’s sports teams?6.a.Let’s begin by establishing the opportunity cost of free throws for each player. Ifyou allocate Kelley to the basketball team, the team gains a player with a 60%free- throw average and the baseball team loses a player with a 70% batting aver-age. That is, the opportunity cost of allocating Kelley to the basketball team is7⁄6.Similarly, Jackie’s opportunity cost of playing basketball is 1; Curt’s opportunitycost of playing basketball is1⁄3, and Gerry’s opportunity cost of playing basketballis8⁄7. Jackie and Curt have the lowest opportunity costs of playing basketball; thatis, they have the comparative advantage in basketball. Therefore, they should beallocated to the basketball team. Kelley and Gerry have the comparative advantagein baseball and should therefore play on the baseball team.b.It is likely that the basketball team will be unhappy with this arrangement. BothJackie and Curt have an absolute disadvantage at playing basketball, compared tothe other two players. (They also have an absolute disadvantage at playing base-ball, but they are comparatively less bad at basketball than at baseball.) The base-ball team is likely to be happy about this allocation because both Kelley and Gerryhave an absolute advantage at playing baseball. However, if you are concernedwith the total number of wins for the dormitory (as an economist would be con-cerned about efficiency), this allocation is the best one: it maximizes the overallchances of the dormitory winning at any sport.7.The inhabitants of the fictional economy of Atlantis use money in the form of cowryshells. Draw a circular-flow diagram showing households and firms. Firms producepotatoes and fish, and households buy potatoes and fish. Households also providethe land and labor to firms. Identify where in the flows of cowry shells or physicalthings (goods and services, or resources) each of the following impacts would occur.Describe how this impact spreads around the circle.a.A devastating hurricane floods many of the potato fields.b.A very productive fishing season yields a very large number of fish caught.c.The inhabitants of Atlantis discover Shakira and spend several days a month atdancing festivals.7.The accompanying diagram illustrates the circular flow for Atlantis.ShellsShellsShellsShellsLand andlaborPotatoesand fishPotatoesand fishLand andlaborHouseholdsFirmsMarkets forgoods andservicesFactormarketsC H A P T E R2E C O N O M I CM O D E L S : T R A D E - O F F S A N D T R A D ES-15KrugWellsECPS4e_Micro_CH02.inddS-15KrugWellsECPS4e_Micro_CH02.inddS-159/30/1412:51 PM9/30/1412:51 PM

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