Solution Manual for Introduction to Agricultural Economics, 7th Edition

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Online Instructor’s Manual with Testbank
for
Introduction to Agricultural
Economics
7th Edition
John B. Penson, Jr.
Texas A&M University
Oral Capps, Jr.
Texas A&M University
C. Parr Rosson III
Texas A&M University
Richard T. Woodward
Texas A&M University

Table of Contents
Part One Introduction
Chapter 1 What is Agricultural Economics? 1
Chapter 2 The U.S. Food and Fiber Industry 4
Part Two Understanding Consumer Behavior
Chapter 3 Theory of Consumer Behavior 8
Chapter 4 Consumer Equilibrium and Market Demand 13
Chapter 5 Measurement and Interpretation of Elasticities 17
Part Three Business Behavior and Market Equilibrium
Chapter 6 Introduction to Production and Resource Use 21
Chapter 7 Economics of Input and Product Substitution 26
Chapter 8 Market Equilibrium and Product Price: Perfect Competition 32
Chapter 9 Market Equilibrium and Product Price: Imperfect Competition 36
Part Four Government in the Food and Fiber Industry
Chapter 10 Natural Resources, the Environment, and Agriculture 41
Chapter 11 Government Intervention in Agriculture 46
Part Five Macroeconomics of Agriculture
Chapter 12 Product Markets and National Output 50
Chapter 13 Macroeconomic Policy Fundamentals 55
Chapter 14 Consequences of Business Fluctuations 61
Chapter 15 Macroeconomic Policy and Agriculture 64
Part Six International Agricultural Trade
Chapter 16 Agricultural Trade and Exchange Rates 68
Chapter 17 Why Nations Trade 73
Chapter 18 Agricultural Trade Policy and Preferential Trading Arrangements 76

To the instructor
This book is designed to capture the relationships between the consumer and the firm and how
the markets where they interact are affected by macroeconomic policies and global trade. An
attempt is made to foster greater understanding of how a broad set of events taking place in
markets and economies can bear on the decisions made by individual consumers and producers.
The book flows from micro to markets and to macro concepts. But we attempt once arriving at
macro concepts to relay how macro policies can affect markets and individual market
participants.
We initially define the field of economics and then develop a definition of agricultural
economics based upon the broad role that agricultural economists play at the micro and macro
levels. Emphasis throughout the book is place on applicability of economics to decisions made in
the nation’s food and fiber industry. Part 2 helps the student understand the decisions made by
individual consumers and the market demand curve. Particular emphasis is placed on the
measurement and interpretation of elasticities. Part 3 focuses on decisions made by producers
under conditions of perfect and imperfect competition and the market supply curve. Part 4
pertains to natural resources and the environment as well as the role of government in the
nation’s food and fiber industry. Part 5 focuses on the macroeconomics of agriculture by initially
addressing measuring and understanding macroeconomic activity and policy. The effects of
specific changes in macroeconomic policy are traced back to agriculture and their impact at the
individual producer level. Finally, Part 6 focuses on international agricultural trade, its
importance to U.S. agriculture, and the measurement and applicability of foreign exchange rates
as they affect trade flows and market shares in a global agricultural framework.
This book is accompanied by a set of chapter power point slide shows designed to emphasize key
points covered in each chapter. A set of questions presented in the “Testing Your Economic
Quotient” section at the end of each chapter helps underscore key concepts in the chapter. The
answers to all of these questions are available in this instructor’s manual.

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Syllabi
Our collective experience in teaching introductory courses in agricultural economics in a 16-
week semester setting suggests all six sections of the book can be addressed with the choice
being the level of emphasis placed on individual topics.
An introduction to the field of agricultural economics can be taught in either a single semester or
a two semester sequence where the first semester focuses on microeconomic topics ending with
welfare analysis and the second semester focuses on macroeconomics and trade.
Our experience has been in a single semester setting which forces the instructor to pick and
choose the topics deemed essential for the beginning student. For example, Chapters 1 through 9
dealing with the scope of the food and fiber industry through market equilibrium under
conditions of perfect and imperfect competition provide an important foundation for additional
courses in an agricultural economics curriculum. To allow for a complete treatment of the
macroeconomic of agriculture covered in Chapters 12 through 15, one can assume that natural
resource topics and sector-specific policy topics covered in Chapters 10 and 11 will be covered
in other courses in the curriculum. Finally, Chapter 16 dealing with agricultural trade and
exchange rates is essential in today’s global economy. Chapters 17 and 18 dealing with why
nations trade and trade agreements can be covered if time is available.
Use of this book in a 10-week course obviously requires a narrower focus. One option would be
to cover the essential microeconomic topics in Chapters 3 through 9, the measurement of
macroeconomic activity (Chapter 12), the macroeconomics of agriculture (Chapter 15) and
agricultural trade and exchange rates (Chapter 16).

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Chapter 1: What is Agricultural Economics?
CHAPTER OVERVIEW
The purpose of this chapter was to define the field of agricultural economics as a subset of the
general field of economics. The major points made in this chapter may be summarized as
follows:
1. Scarce resources are human and non-human resources that exist in a finite quantity. Scarce
resources can be subdivided into three groups: (1) natural and biological resources, (2)
human resources, and (3) manufactured resources.
2. Resource scarcity forces both consumers and farmers to make choices.
3. Most resources are best suited to be a particular use. Specialization of effort may lead to a
higher total output.
4. The field of economics can be divided into microeconomics and macroeconomics.
Microeconomics focuses on the actions of individuals -- specifically the economic behavior
of consumers and farmers. Microeconomic analysis largely deals with the notion of partial
equilibrium; events outside the market in question are assumed to be constant.
Macroeconomics focuses on broad aggregates, including the nation's aggregate performance
as measured by gross domestic product (GDP), unemployment, and inflation.
Macroeconomic analysis normally deals with the notion of general equilibrium; events in all
markets are allowed to vary.
5. Positive economic analysis focuses on what-is and what-would-happen-if questions and
policy issues. Normative economic analysis focuses on what-should-be or what-ought-to-be
policy issues.
6. Capitalism, or free market economics, socialism, and communism represent alternative
economic systems. The U.S. economy represents a mixed economic system. Some markets
are free to determine price, and other market prices are regulated.
CHAPTER OBJECTIVES
❑ Define economics and agricultural economics.
❑ Distinguish between the fields of macroeconomics and microeconomics.
❑ Discuss the difference between positive and normative economic policy analysis.
❑ Identify the three measures of economic performance in the economy.
❑ Discuss the economist's role at the microeconomic and macroeconomic level.
❑ Understand the concept of marginal analysis.

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LECTURE OUTLINE
❑ Scope of Economics
o Scarce Resources
o Making Choices
❑ Definition of Economics
o Microeconomic versus Macroeconomics
o Positive versus Normative Economics
o Alternative Economic Systems
❑ Definition of Agricultural Economics
❑ What Does an Agricultural Economist Do?
o Role at Microeconomic Level
o Role at Macroeconomic Level
❑ Summary
The coverage of the Chapter 1 power point slide show follows this lecture outline.
While no major changes were made from the 6th edition, a number of photos of pioneers in
economics and key leaders in agriculture today enhance the student’s interest.
ANSWERS TO TESTING YOUR ECONOMIC QUOTIENT EXERCISES
Exercises appearing on page 11-12:
1. a. Natural resources
b. Human resources
c. Manufactured resources
2. a. Alternative 2 because this alternative provides the maximum profit
b. $12 million, the profit associated with the next best alternative
3. a. Normative economics
b. Positive economics
c. Macroeconomics
d. Microeconomics
4. Change
5. Mixed (d).
6. Agricultural economics
7. Fallacy of composition (b).
8. The Belford family should grow cotton. In doing so, the net return per acre is $195 as
opposed to $152.50 per acre for growing wheat and $160 per acre for leasing. The next best
alternative to the Belford family is leasing, As such, the opportunity cost to this family is a
net return of $160 per acre. The total economic cost in arriving at this decision is the $285
per acre of production expenses in growing cotton plus the opportunity cost of $160 per
acre. Hence, the total economic cost is $445 per acre.
9. Specialization
10. 1
11. Adam Smith

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Chapter 2: The U.S. Food and Fiber Industry
CHAPTER OVERVIEW
The purpose of this chapter was to acquaint the student with the structure and performance of the
farm sector during the post-World War II period and its role in the nation's food and fiber
industry. The major points made in this chapter may be summarized as follows:
1. The U.S. food and fiber industry consists of different groups of business entities called
sectors, which are in one way or another associated with the supply of food and fiber
products to consumers. In addition to the farm sector, this industry consists of firms that
supply manufactured inputs to farms and ranches, firms that process raw food and fiber
products, and firms that distribute food and fiber products to consumers.
2. Among the physical structural changes taking place in the farm sector during the post-World
War II period is the trend toward fewer but larger farms. We have also seen a tremendous
expansion in the use of manufactured inputs, such as machinery and chemicals, and a decline
in labor use. Rising capital requirements in general during the period have increasingly
represented a potential barrier to entry for would-be farmers.
3. Although the total quantity of inputs used in producing raw agricultural products has
remained relatively stable during the post-World War II period, the total quantity of output
has increased substantially. These results, taken together, imply an increase in productivity,
or the ratio of output to inputs.
4. Gross farm income has increased, albeit somewhat erratically, during the post-World War II
period, while production expenses have behaved in similar fashion. The result is a highly
variable level of profits, or profitability, from one year to the next.
5. The financial structure of the farm sector during the post-World War II period shows that
financial assets represent a considerably smaller portion of total farm assets. Real estate
assets are the major component of farm asset..
6. The U.S. food marketing sector is the network of processors, wholesalers, retailers, and
restaurateurs that market food from farmers to consumers. Approximately 83% of the
personal consumption expenditures on food went to pay for activities taking place beyond the
farm gate.
7. Along the flow of products from farmers to processors and eventually on to consumers,
middlemen play a vital role. Classifications of middlemen firms include merchant
middlemen firms, agent middlemen firms, speculative middlemen firms, processing and
manufacturing firms, and facilitative organizations.

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8. In recent times, the number of mergers and acquisitions in food industries has increased
sharply relative to historical levels. Consequently, food industries have become more
concentrated. Concentration is particularly high in industries marketing products such as
breakfast cereals, beer, candy, and soft drinks.
9. The food processing industry and the wholesale and retail trade industries are characterized
by a relatively small number of firms that account for a substantial portion of total industry
sales. Although aggregate concentration has increased, the number of food marketing
companies has remained relatively constant.
10. Farmers and ranchers get approximately 17% of the dollar spent on food. This share varies
considerably by commodity. The remaining portion goes to food processors, wholesalers,
and retailers. The major categories of expenditures include labor, packaging, transportation,
and advertising.
11. The transportation of food and fiber products along the marketing chain is an extremely
important component. The storing and exporting of nonperishable commodities is also an
important dimension of the marketing of agricultural commodities.
CHAPTER OBJECTIVES
❑ Visualize the scope of the U.S. food and fiber industry.
❑ Understand the changing structure of farming.
❑ Define productivity and understand post-WW II trends.
❑ Discuss trends in real net farm income and equity of farmers.
❑ Understand the role played by other firms in the food and fiber system.
❑ Understand the notion of how economists report measures of economic activity.
❑ Understand how to calculate and interpret output and price indices
❑ Understand the difference between real and nominal measures of economic activity.
LECTURE OUTLINE
❑ Measuring and Interpreting Indices
❑ What is the Food and Fiber Industry
❑ Changing Complexion of Farming
o Physical Structure
o Specialization, Diversification, Organization and Contracting
o Productivity
o Profitability
o Financial Structure
❑ Other Sectors in the Food and Fiber Industry
o Farm Input Suppliers
o Food Processors, Wholesalers, and Retailers
o Value-Added Process
o Fiber Manufacturers

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o Shippers and Handlers
o Importance of Export Markets
❑ Summary
The coverage of the Chapter 2 power point slide show follows this lecture outline. While no
major changes were made from the 6th edition, selected charts and figures have been updated
where appropriate with information available at the time of publication. Minor changes were
made to the questions at the end of the chapter.
ANSWERS TO TESTING YOUR ECONOMIC QUOTIENT EXERCISES
Exercises appearing on page38-40:
1. c, between 10 and 15.
2. $14 million, net worth=assets-liabilities
3. marketing bill
4. b
5. d
6. (a) farm input suppliers; (b) farmers; (c) food processors and manufacturers; (d) food
wholesalers, retailers, and food service purveyors; (e) consumers
7. Labor
8. 20
9. $30,000
10. 0.9; 1.25; 1
11. a, b, c
12. 2
13. (a) $350,000; (b) $8 million
14. (a) 0.9333; (b) 0.9655; (c) 2010
15. $60,000
16. see Table 2-1
17. see Table 2-2
18. inflation
19. a
20. d
21. c

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Chapter 3: Theory of Consumer Behavior
CHAPTER OVERVIEW
The major points made in the chapter may be summarized as follows:
1. The budget constraint represents the amount of income the consumer has to commit to
consumption in the current period. A proportional change in all prices and income has no
effect on the budget constraint. For this reason, economists argue that only relative price
changes matter. When presented graphically, the budget constraint is frequently referred
to as the budget line, which tells us the rate of exchange between two goods as their
prices change, is given by the negative of the price ratio. A change in relative prices will
change the slope of the budget line. Finally, an increase (decrease) in income will shift
the budget line to the right (left). Changes in income do not affect the slope of the budget
line.
2. We assume that consumers are rational and maximize their satisfaction, or utility. Thus,
consumers are assumed to be able to rank all their choices.
3. Early researchers of consumer behavior argued that utility could be measured. The term
utils was used as a unit of measure. A hamburger might yield 10 utils, a soda 4 utils, and
so on. Marginal utility describes the change in utility or utils as more of a good is
consumed and is thought to diminish as consumption increases. This phenomenon is
known as the law of diminishing marginal utility.
4. Today no one really believes that utility can be measured in utils. Instead, utility is
thought of in the context of a personal index of satisfaction. The magnitude of this index
(or function) serves to order the consumption bundles, or combinations of goods the
consumer faces.
5. All consumption points that provide the same utility form an iso-utility, or indifference
curve. Increases (decreases) in utility are indicated by a shift in an indifference curve to
the right (left). The negative of the slope of this curve is known as the marginal rate of
substitution (MRS). This rate indicates the willingness of the consumer to substitute one
good for another. The decline in the willingness of the consumer to substitute one good
for another as one moves down an indifference curve indicates the existence of the
principle of diminishing marginal utility.
CHAPTER OBJECTIVES
❑ Understand the concept of total utility.
❑ Understand the concept of marginal utility.

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❑ Be able to apply the Law of Diminishing Marginal Utility.
❑ Define an indifference curve and apply the Law of Diminishing Marginal Utility to
Indifference curve analysis.
❑ Explain what an indifference curve map is and determine which indifference curves on a
map represent more or less total utility.
❑ Compare and contrast the assumptions regarding the analysis of total utility received by
the consumer.
❑ Address both the marginal utility and indifference curve approaches to consumer
behavior.
❑ Define the budget constraint and be able to discuss the two factors that determine its
position and slope.
❑ State and address Engel’s Law.
LECTURE OUTLINE
❑ Utility Theory
o Total Utility
o Marginal Utility
o Law of Diminishing Marginal Utility
❑ Indifference Curves
o Concept of Isoutility
o Marginal Rate of Substitution
❑ The Budget Constraint
❑ Summary
The coverage of the Chapter 3 power point slide show follows this lecture outline. While no
major changes were made from the 6th edition, selected charts and figures have been updated
where appropriate with information available at the time of publication. Minor changes were
made to the questions at the end of the chapter.
ANSWERS TO TESTING YOUR ECONOMIC QUOTIENT EXERCISES
Exercises appearing on pages 51-55:
1. # wings total utility marginal utility
a. 1 30 --
b. 2 58 28
c. 3 84 26
d. 6 150 22
e. 12 222 12
f. 24 306 7
The slope is negative because of the law of diminishing marginal utility.

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2. a. Choose 12 bottles of suds and 3 wings. Higher total utility
b. Choose 12 bottles of suds and 6 wings.
c. The marginal rate of substitution between A and E is –1. The marginal rate of
substitution between B and C is -0.5.
a. The budget line would be 24 wings and 8 bottles of Coca-Cola
b. The budget line would be 24 wings and 12 bottles of Coca-Cola
c. The budget line would be 4 wings and 8 bottles of Coca-Cola
d. The budget line would be 80 wings and almost 27 bottles of Coca-Cola
e. Cannot say without accounting for utility of consumption of wings and Coca-Cola
3. a. -1.25
b. Willing to give up 1.25 tacos to get one more hamburger
i = 7 tacos and 1 hamburger gives 100 utils
ii = 2 tacos and 5 hamburgers gives 100 utils
iii = 5 tacos and 7 hamburgers gives 300 utils
iv = 7 tacos and 5 hamburgers gives 300 uitls
4. 1st graph = price of hamburgers doubled
2nd graph = income fell in half or the price of both products doubled
3rd graph = price of tacos fell in half
5.
50
80 A
B
20 30 Environmental quality
Chea
p
food

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a. Indifference curve
b. MRS= -3.0. So, you are willing to give up 3 units of cheap food to get one more
unit of environmental quality
6.
7. (a) 5; (b) 3
8. a, The price of steak rose.
9. $2.50 per pound
10. Utility
11. law of diminishing marginal utility
12. (a) 2; (b) marginal rate of substitution
13. indifference curve or iso-utility curve
14. (a) budget line; (b) price of beef changed
15. a. Extreme points—buy only movies (10); buy only video games (25)
Place movies on the y-axis and video games on the x-axis. The coordinates are (0,10) and
(25,0). Draw a straight line through these points. The slope of the budget line is -0.4. Now
Biscuit
s
10
6
60
(b
)
(a
)
Tea

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Chapter 4: Consumer Equilibrium and Market Demand
CHAPTER OVERVIEW
The major points made in the chapter can be summarized as follows:
1. Factors affecting consumer demand are:
o price of the product
o price of other products
o disposable income of consumers and
o tastes and preferences
2. The consumer is at equilibrium when the marginal rate of substitution or slope of the
highest attainable indifference curve is equal to the slope of the budget line, or
alternatively, when an additional dollar spent on each good would return the same
marginal utility per dollar.
3. Each tangency point between the budget line and indifference curve when price changes
leads to a new consumer equilibrium. The locus of all such tangencies is called the price-
consumption curve.
4. A demand curve is a schedule that shows, ceteris paribus, how many units of a good the
consumer is willing and able to buy at different prices for that good during some
specified time in a specified market.
5. Movement along a demand curve when the price of the good changes is referred to as a
change in the quantity demanded; a shift in the demand curve resulting from a change in
prices of other goods, income, population and/or tastes and preferences is referred to as a
change in demand.
6. The market demand for a good is equal to the sum of all individual demands for the good.
Individual demand curves for a product are added horizontally at each price to obtain the
market demand curve for a product. As a general law, demand curves are presumed to
have a negative slope, reflecting the inverse relationship of prices and quantities
demanded.
7. Changes in tastes and preferences refer to changes in composition of the population,
attitudes toward nutrition and health, and attitudes toward food safety, lifestyles,
technological forces, and advertising.
CHAPTER OBJECTIVES

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❑ Explain the concept of consumer equilibrium.
❑ Demonstrate how changes in prices or income affect consumer equilibrium.
❑ Derive a consumer's demand curve.
❑ Know the difference between a change in demand and a change in quantity demanded.
❑ Demonstrate how a change in consumer disposable income, a change in the price of a
related good, or a change in tastes and preferences affects consumer demand.
❑ Identify the various components of consumer tastes and preferences that affect the
demand for goods and services produced in the food and fiber system.
❑ Derive a market demand curve.
❑ Define consumer surplus and explain its usefulness to economic policy makers.
LECTURE OUTLINE
❑ Conditions of Consumer Equilibrium
❑ Changes in Equilibrium
o Changes in Product Price
o Changes in Other Demand Determinants
❑ The Law of Demand
o Market Demand
o Interpretation of Market Demand
❑ Tastes and Preferences
o Composition of the Population
o Attitudes Toward Nutrition and Health
o Food Safety
o Lifestyles
o Technological Forces
o Advertising and Promotion
❑ Consumer Surplus
❑ Summary
The coverage of the Chapter 4 power point slide show follows this lecture outline. While no
major changes were made from the 6th edition, selected charts and figures have been updated
where appropriate with information available at the time of publication. Minor changes were
made to the questions at the end of the chapter.
ANSWERS TO TESTING YOUR ECONOMIC QUOTIENT EXERCISES
Exercises appearing on pages 69-73:
1. Betty at point A= 30 shirts, 5 pair, $15.00, $30.00
Betty at point B = 10 shirts, 10 pair, $30.00, $30.00
Wilma at point C = 60 shirts, 10 pair, $15 .00, $30.00
Wilma at point D = 20 shirts, 20 pair, $30.00, $30.00

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2. (a) $4 per pound; (b) $3 per pound; (c) 6 pounds of steak and 8 pounds of chicken were
bought; this combination of steak and chicken maximizes utility given the budget
constraint of $48. The consumer is in equilibrium at point A.
3. (a) Price on the y-axis and quantity on the x-axis. Draw a downward sloping line.
(b) a perfectly inelastic demand curve
(c) a perfectly elastic demand curve
4. The following table gives points on the Engel curve:
At point PS1, quantity A = 7.5, quantity B = 5 and income = $22.50
At point PS2, quantity A = 19.5, quantity B = 7 and income = $45.00
At point PS3, quantity A = 18.0, quantity B = 18.0 and income = $67.50
Product A is a normal good from point PS1 to point PS2, but an inferior good from point
PS2 to point PS3. Product B is a normal good from point PS1 to point PS2 and from point
PS2 to point PS3.
5. (a) Consumer surplus is area ABD
(b) Consumers are better off with area ACE over ABD, or by the change in area BDCE
(c) $3 million
(d) $9 million
6. (a) The demand curve shifts to the left
(b) Change in demand
7. (a) Engel curve; (b) normal good
8. equilibrium
9. a, b, d
Bett
y
Wilma Marke
t
30
15
10 30 20 60
30
90
Qt-shirts
Pt-shirts

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Chapter 5: Measurement and Interpretation of Elasticities
CHAPTER OVERVIEW
The major points made in the chapter may be summarized as follows:
1. The own price elasticity of demand measures the percentage change in the quantity
demanded for a good, given a 1% change in price. If this elasticity is greater than one,
demand is said to be elastic (i.e., the percentage change in quantity exceeds the
percentage change in price). If this elasticity is less than one, demand is said to be
inelastic (i.e., percentage changes in quantity are smaller than percentage changes in
price). If this elasticity is equal to one, demand is said to be unitary elastic (i.e.,
percentage changes in quantity are equal to percentage changes in price).
2. The income elasticity of demand measures the percentage change in the quantity
demanded for a good, given a 1% change in income. When the income elasticity of
demand is between zero and one, the good is classified as a necessity; when this elasticity
exceeds one, the good is classified as a luxury good. Both luxury goods and necessities
are normal goods. When the income elasticity of demand is negative, the good is
classified as an inferior good.
3. If demand is inelastic, a rise (reduction) in price will lead to increased (decreased)
consumer expenditures. If demand is elastic, a rise (reduction) in price will lead to a
reduction (increase) in consumer expenditures. Finally, if demand is unitary elastic,
expenditures are unchanged as price changes.
4. Cross-price elasticity measures the change in the demand for one good in light of a 1% change in the price
of another good. If this elasticity is positive (negative), the two goods are said to be substitutes
(complements). If this elasticity is equal to zero, the two goods are independent in demand.
5. Determinants of the elasticity of demand of a commodity include availability of
substitutes for the commodity, alternative uses for the commodity, type of market (e.g.
farm level versus retail level or domestic market versus export market), percentage of the
budget spent on the commodity, and time.
CHAPTER OBJECTIVES
❑ Define, derive, and interpret an own-price elasticity of demand coefficient.
❑ Define, derive, and interpret an income elasticity of demand coefficient.
❑ Define, derive, and interpret a cross-price elasticity of demand coefficient.
❑ Discuss the factors influencing these three types of elasticity.
❑ Understand the differences between these elasticities between the short run and the long
run.

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❑ Discuss the implications of an inelastic demand versus an elastic demand at all levels of
the food and fiber system.
LECTURE OUTLINE
❑ Own Price Elasticity of Demand
❑ Income Elasticity of Demand
❑ Cross Price Elasticity of Demand
❑ Other General Properties
o Real World Examples of Elasticities
❑ Applicability of Demand Elasticities
o Applicability to Policymakers
o Applicability to Farmers
o Applicability to Consumers
o Applicability to Input Manufacturers
o Applicability to Food Processors and Trade Firms
❑ Summary
The coverage of the Chapter 5 power point slide show follows this lecture outline. While no
major changes were made from the 6th edition, selected charts and figures have been updated
where appropriate with information available at the time of publication. Minor changes were
made to the questions at the end of the chapter.
ANSWERS TO TESTING YOUR ECONOMIC QUOTIENT EXERCISES
Exercises appearing on pages 87-89:
1. Demand curve shifts to the right as a result of successful advertising. Other determinants
include (1) the price of Big Macs, (2) the price of substitutes and complements such as
Burger King hamburgers and french fries, and (3) income.
2. a. Complements
b. Ppancakes
Qpancakes
B
A
Psyrup
Qsyrup

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c. The cross price elasticity is negative for pancakes and syrup.
3. Between A and B, the own price elasticity is elastic (-1.38). Between B and C, the own
price elasticity if inelastic (-0.46). Between A and B, recommend a price decrease.
Between B and C, recommend price increase to raise total revenue.
4. The elasticity is –1.3. The price of $7.70 represents a 20 percent increase from the initial
price of $7.00. Therefore, the percentage change in quantity must be –13%. If 3,000
burger platters currently are sold at $7.00, a 20 percent increase in price is associated with
2,610 platters sold.
5. The income elasticity between points A and B is 1.80. The income elasticity between
points B and C is –1.57. Therefore the good is a normal good (actually a luxury item since
its income elasticity exceeds one) between A and B, and the good is an inferior good
between B and C.
6. Hamburger consumption will fall by 3 percent. Hamburger and hamburger buns are
complements since the cross-price elasticity of demand is negative.
7. Sales of Pepsi will rise by 4 percent. Thus, this retailer will sell 1.040 six packs of Pepsi
per day as a result of the price of Coca-Cola increasing by 5 percent, assuming all other
factors are invariant. Pepsi and Coca-Cola are substitutes because of the positive cross-
price elasticity of demand of 0.4.
8. -2/3=-0.667
9. Alfred Marshall
10. b
11. d
12. b
13. c
14. b
15. b
16. -0.4
17. (a) substitutes; (b) necessity (also a normal good)

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18. c
19. The price of $3.00 represents a 20 percent increase from the initial price of $2.50.
Therefore, the percentage change in quantity must be 12%.
20. -1.25
21. Note that by definition, the own-price elasticity of demand is equal to the % change in
quantity demanded divided by the % change in price. So to determine the % change in
price, take the ratio of the % change in quantity demanded and divide by the own-price
elasticity of demand. In this case that ratio is equal to 1/-.34= -2.94. Hence a 1% increase in
quantity coming onto the market would depress farm prices by 2.94 % or almost 3%.
22. Note that by definition, the own-price elasticity of demand is equal to the % change in
quantity demanded divided by the % change in price. So to determine the % change in
price, take the ratio of the % change in quantity demanded and divide by the own-price
elasticity of demand. In this case that ratio is equal to -10/-.2015= 49.63. Hence a 10%
decrease in quantity of apples coming onto the market due to a freeze would increase the
price of apples by 49.63 % or nearly 50%.
23. b

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Chapter 6: Introduction to Production and Resource Use
CHAPTER OVERVIEW
The purpose of this chapter was to illustrate the various physical relationships that exist between
inputs and outputs and the economics of short run production decisions. The major points of this
chapter can be summarized as follows:
1. Farm inputs can be classified into land, labor, capital, and management. A production
function captures the causal physical relationship between these inputs and the level of
output.
3. The total physical product reflects the level of output of a given level of input use.
Marginal physical product represents the change in the level of output associated with a
change in the use of a particular input. Finally, average physical product reflects the
level of output per unit of input use. In each case, all other inputs are held fixed. The
value of the marginal physical product represents the slope of the total physical product
curve. No rational farmer would want to produce beyond the point at which the marginal
physical product equals zero, because further input use would cause the level of output to
fall.
4. There are three stages of production: stage I is the point at which the marginal physical
product curve for a particular input is rising but still lies above the average physical
product curve, stage II is the point at which the marginal physical product equals the
average physical product and continues until the marginal physical product for the input
in question reaches zero, and stage III is the point at which stage II left off, or where the
total physical product curve begins to decline and the marginal physical product curve
becomes negative.
5. The law of diminishing marginal returns states that as the use of an input increases, its
marginal physical product will eventually fall.
6. Marginal cost is the change in total cost with respect to a change in output. Average cost
is total cost divided by total output. Fixed costs are those costs that do not vary with
output.
7. The profit maximizing level of output occurs in the short run where marginal cost equals
marginal revenue. The perfectly competitive business takes the market price (MR) as
given by the market place and makes its production decisions by equating MC = MR.
8. The profit maximizing level of input use occurs in the short run at the input level at
which MVP = MIC. The competitive business takes the per unit price of the variable

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input (MIC) as given by the market place and makes it purchasing decisions by equating
MVP = MIC.
9. The business will break even in the short run at the output level if the price the business
receives for its product falls to the point at which average revenue (AR) equals average
total cost (ATC), or where average profit per unit of output is zero. The business may
continue to operate in the short run if AR < ATC, because it can minimize its losses (i.e.,
cover at least some of its fixed costs).
10. The business will cease operations, or shut down, in the short run if the price the business
receives for its product falls to the point at which average revenue is less than average
variable cost (AR < AVC). When this occurs, the business will no longer be able to
cover its variable costs (e.g., pay its fuel bill) and will be unable to acquire additional
inputs.
CHAPTER OBJECTIVES
❑ Understand the conditions necessary for perfect competition.
❑ Discuss the inputs necessary for the production of a product.
❑ Understand, graphically depict, and mathematically derive the main production
relationships between inputs and outputs including total physical product, average
physical product, marginal physical product, and the stages of production.
❑ Understand, graphically depict, and mathematically derive the short-run production costs
such as total cost, average total cost, average variable cost, marginal cost, and marginal
input cost.
❑ Understand the relationship between the short-run production cost curves and the short
run physical product curves.
❑ Understand, graphically depict, and mathematically derive the important revenue
relationships such as total revenue, average revenue, marginal revenue, and marginal
value product.
❑ Be able to determine the profit-maximizing level of output and the profit-maximizing
level of input use and their relationship to one another.
LECTURE OUTLINE
❑ Conditions of perfect competition
❑ Classification of inputs
o Land
o Labor
o Capital
o Management
❑ Important production relationships
o The Production Function

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Solution Manual for Introduction to Agricultural Economics, 7th Edition

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