Solution Manual for Microeconomics, 11th Edition

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1CHAPTER1:ECONOMICS AND ECONOMICREASONINGQuestions and Exercises1.Coordination refers to how the three central problems facing any economy aresolved. Those three problems are what and how much to produce, how toproduce, and for whom to produce. Inevitably,individuals desire more than isavailablein light ofhow much they’re willing to work, causing a problem ofscarcity.The concept of scarcity has two elements:our wants and our means of fulfillingthose wants. Those two elements are interrelated since wants are changeable andarepartially determined by society and the means of fulfilling those wants. Inaddition, the degree of scarcity is constantly changing,depending on the availablemeans of production and the development of new wants.Therefore, the author of the textbook focused on coordination instead of scarcityto emphasize the subsidiary nature of scarcity to the overall concept ofcoordination. Economics is not merely about our wants or the means of fulfillingthose wants; it is also about reconciling our wants with reality, where realityconsists of decision-making mechanisms, social customs, and political realities.2.a.Macroeconomicb.Microeconomicc.Macroeconomicd.Microeconomice.Microeconomicf.MicroeconomicMicroeconomics studies how economic forces influence individual choices suchas the pricing policies of firms, households’ decisions on what tobuy, and howmarkets allocate resources among alternative ends. Macroeconomics studiesaggregate relationships such as how household consumption is related to incomeand how government policies can affect growth.3.Answers will differ.Two microeconomic problems are the pricing policies offirms (price-fixing in particular) andthe waywages are determined in labormarkets. (Why do athletes and celebrities make so much money,anyway?) Twomacroeconomic problems are unemployment and inflation (business cycles andgrowth are also macroeconomic problems).

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24.a.The opportunity cost of attending college is the sacrifice one must makebyattendingcollege. It can be estimated by figuring out the benefit of the next-best alternative. If that alternative is working, one would guess the likely wagethat could be earned at a job that does not require a college degree and thenmultiply by 40 hours for each week in college. The opportunity cost is also whatcould be done with the money used for tuition and other costs related to attendingcollege.b.The opportunity cost of taking a course couldalsobe estimatedusing the sametechnique as in partaif you otherwise would be workingduringthese hours. Ifyou had taken another course instead, the opportunity cost would be the benefityou would have received from takingthatothercourse.c.The opportunity cost of attending yesterday’s lecture would depend on what youotherwise could have done withthattime (sleep,eat lunch with an interestingperson, etc.). Although this is no longer a choice to you, past activities do haveopportunity costs.5.Answers will vary.A correct answer will indicate that the student compared themarginal costs and benefits and chose the activity because the marginal benefitexceeded the marginal cost.6.The marginal costs are theadditionalcostsof the additional activity.In this case,the additional activity is driving (200–100) miles.Themarginal cost isthe 10centsper mile forallmilesover100plus theadditionalcost of gas. Therefore,themarginal cost is $10.00[0.10× (200–100)]plus the cost of gas. The initialpayment can be forgotten because it is a sunk cost; it is not part ofthemarginalcosts.7.No, since the marginal cost of drug control exceeds the marginal benefit;thegovernment should not spend $4,170 to deter one person from using drugs.8.The opportunity cost of buying a $20,000 car is the benefityouwould havegained by using that$20,000 for the next-best alternative, which could bespending it on other goods and services or saving it.9.Only the marginal costs and benefits of taking the job are relevant. That meansthatthe sunk cost of the bachelor’s degree is irrelevant. Therefore, the relevantcosts are the opportunity cost of taking the job (forgone earnings from yourcurrent job) and other things you could have done with the money you need to

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3ess school. The relevant benefit is the increased lifetime earnings of $600,000.10.You shouldspend the $5 million on projectsthatprovide the highest marginalbenefit per dollar spent. The opportunity cost of spending the money on oneproject is the lost benefit that the college would have received by spending it onadifferentproject. Thus, another way to restate the decision rule is to spend themoney on the project that minimizes opportunity cost per dollar.11.Answers will differ. Two examples of social forces are our unwillingness tocharge friends interest and our unwillingness to “buy”friends. These issues arestill subject to economic forces; however, there is no market in“friends”or inloans to friends, andsothe economic force does not become a market force.12.Answers will differ.Two examples of political or legal forces are rent controllaws and restrictions on immigration. Both prevent the invisible hand fromworking.Rentcontrol laws place a price ceiling on rent, causing shortages ofapartments, and immigration restrictions cause the number of immigrants seekingentry to exceedthe numberallowed to enter, which tends to cause wage rates todiffer among countries.13.a.Both parties benefit.The person who gains the kidney benefits ifitworks whentransplanted into his or her bodyas he or shewill no longer have the emotionaland financial burden of dialysis. The person selling the kidney gains the $30,000.Theirgains will also have impacts onothers (theirfamily, for example).b.Bothparties must undergo surgery and face all the attendant risks and costs. Theseller faces the potential cost of a future illness or injury harming his or her onlyremaining kidney,causing the seller to need dialysis.It raises moral issues thatcould be seen as hurting society because organs change from being inalienable tobeing a commodity and, hence,is another element that negatively affects theindividuals.c.Whether a society should allow this transaction is a question of value judgmentsand cultural norms. Our society has chosen not to allow such transactions because(among other reasons) those with more money would have increased access toorgans and thereforewouldhave advantages over those of limited means.Thus,the poor could be exploited in such transactions.14.An economic model is a framework that places the generalized insights of atheory in a more specific contextual setting. Policymakers need to understand the

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4l evidence supporting the theory as well as real-world economic institu-tions to make policy recommendations.15.No.Economictheory proves nothing about what system is best. It simplyprovidesa wayto look at systems andindicateswhat the advantages anddisadvantages of various systems willlikelybe. Normative decisions about whatis best can only follow from one’s value judgments, which are subjective.16.A theorem is a proposition that is logically true based on the assumptions of themodel,whereasa precept is a policy rule that a particular course of action ispreferable. Economists can agree about theorems but disagree about precepts ifthey have different value judgmentsregarding theintended goals.17.A normative statement reflects ethical judgments about what should be. It reflectsvaluesand is subjective. A positive statement refers to a fact or a logicalrelationship. It is in principle testable oristhe result of logic analysis. Positivestatements of factsare not subject to debate among individuals. The art ofeconomics refers to issues of judgmentonhow to achieve the goals determined innormative economics,giving the facts and logical relationships one finds inpositive economics. Art of economicsstatements are subject to debate.18.a.Positive statement,since it is a statement of fact.b.Normativeeconomics, since it deals with what the goals of the economy shouldbe and is subjective.c.Since this is relating a normative goaltoa decision, this could be a statement inthe art of economics. It couldalsobe seen as anormativestatement if oneinterprets it as a normative imperative.d.Positive statement,since it is a statement of fact.Questions from Alternative Perspectives1.AustrianMost economists would answer“yes”because they see economic variables suchas unemployment as objectivemeasures, which makethem available as measuresfor planning. Most economists see only individual preferences, not socialpreferences, as subjective. Austrians believe in a radical subjectivity, uncertaintywith respect to time, knowledge, and matters beyond preferences. This eliminates

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5the possibility of using objective economic analysis as the basis for governmentplanning. For an Austrian study on the nature of time and uncertainty foreconomics,see the work of Mario Rizzo and Gerald O’Driscoll, Jr.2.Religiousa.The rational choice model assumes that individuals are one-dimensional, that theyknow what they want, and that they will do what is in their best interest.Addictive behavior undermines that assumption, leading to a conflict betweenpassion and reason.b.The conflict suggests that we have to be careful not to apply the economic modelin casesin whichthat conflict is important, such aswithbehaviors that haveaddictive elements. Whenthere is a conflict between passion and reason,theremay be greater reason for government to limit access to the addictive good orbehavior.3.Feminista.Patriarchy is a social institution in which men exercise a disproportionate amountof social power and are inaposition to define the roles of women and children.Because patriarchy affectsthewaypeople behave and interact, it is an institution.Genderaffects the labor market because those who are in power will make hiringdecisions that perpetuate their position of power. For example, husbands andfathers may make, or heavily influence, the decisions of whether a woman willlook for work.b.Some economists might argue that men and women are merely expressing theirpreferences in job choices,whereasfeminist economists might argue that thesechoices are culturally determined by institutions, or patterns of behavior, such asthepatriarchy. It is impossible to separate the market from the institutions withinwhichthey areembedded. The free market may not determine the institutions ormores of a society, butitneverthelessoperates within those institutions.4.Institutionalista.A free market outcome would provide flu vaccine to those willing and able to paythe most for it, whichprobably wouldnot include all of those given priority underthe rationing scheme.b.The determination of which option is “just” requires delving into theories ofjustice. The free market solution best mirrors commutative justice—one based onefficiency of exchange—andthe rationing scheme best mirrors distributive

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6some notion of fairness that favors those with a greater predisposition to ill-ness.5.Post-Keynesiana.This answer will differ among students, but should include an assessment of themarginal benefits incurred between various institutions.b.Most studentsprobablywill answer this question“no.”The standard theorypresented in the book is based on the assumption that decision makers have fullinformationaboutall factors that might influence their decisions: They havesubstantive knowledge of all possible outcomes of their decisionmaking and theconsequences of each decision. Most likely you had limited knowledge of thepros and cons ofthe schools you were consideringwhen deciding which collegeto attend. As a result, you probablyturned to the advice and norms of a smallgroup of friends, family members, or teachers to help you make a decision.c.Recognizing that you have limited time, knowledge, and ability to compute allthepossible outcomes of each economic decision, you probably rely on social normsand rules of thumb to help you make many of your economic decisions. Forexample,when you go tothegrocery store,youmaycontinue to buyDiet Cokeeven though other diet sodas might provide you with a higher level of satisfactionat a lower price because you are in the habit of buyingDiet Cokeand uncertain ofthe exact benefityou’ll incur fromother dietbeverages.d.The implication of this behavior is that individuals do not follow the economicdecision rule of gaining complete information to optimize their choices but relyon rules of thumb or habit to come up with a satisfactory outcome even though itmight not be the most optimizing. This means that economic analysis,whichassumes that humans are one-dimensional rational beings who calculate allrelevant marginal costs and benefits,is limited.6.Radicala.It implies that there is no clear-cut distinction between positive and normativeeconomics and that seemingly positive economics has implicit value judgmentshidden withinit.b.Economics is value-laden. The relevant question about whether the distinction istenable is whether it is relatively less value-laden than the alternatives. That is anopen question.

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7Issues to Ponder1.Regretting a decision doesn’t necessarily mean that we did not use the economicdecision rule when makingthatdecision.The economic decision rule infers thatthe individual has perfect information, which is an idealization of the reality ofdecision-making.At the time the decision was made, we weighed the marginalcosts and marginal benefits, undertaking the activity if the marginal benefitexceeded the marginal cost and not undertaking the activity if the marginal costexceeded the marginal benefit. Many decisions are made withoutknowledge ofthe full marginal costs and marginal benefits. Sometimes these marginal costs andmarginal benefits are revealed at a later date,making us regrettheinitial decision.An example is going out to a restaurant. From recommendations, weform anexpectation aboutthe marginal benefit. If that recommendation overstates ouractual experience, we will have overestimated the marginal benefit of eating out.We may regret having spent the money to eat out.2.a.Itdepends on the perspectives used to answer the question. From a purelyeconomic perspective, we would conclude that it is reasonable to executehackers based on cost/benefit analysis. However, since this decisioncanby no meansbe simplified to pure economics, we need to take intoconsiderationsocial, political, and religious factors.Therefore,Landsburg’s argumentshould beevaluated in a moreholisticcontext.b.Cost/benefit analysis can be extended to many areas, such as social welfareprograms and almost allthepolicy discussions. (Source: “Feed the Worms WhoWrite the Worms to the Worms,”http://slate.com/id/2101297/),Slate Magazine,May 26, 2004.)3.TheTheory of Moral Sentimentsemphasizes the importance of morality. Theinvisible hand directs people’s selfish desires (tempered by the social and politicalforces) to thewelfare of society,but is based on certain presuppositions about themorality of individuals which constrains individuals’ selfish actions. What Smithis suggesting is that the way individuals calculate marginal cost and marginalbenefit must be interpreted within a social context.4.a. &b.Partsaandbhave no “right” answers. Most people would say“no”toaand“yes”tob. Ifone wereanswering this question from the perspective ofthe economic decision rule alone,one would measure the marginalbenefits against the marginal costs of the choice.c.People tend to believe that children should be afforded greater protection thanisafforded to adults and are therefore repelled by the idea of sacrificing a child even

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8though it would save the lives of other children. Sick people are closer to death,and therefore theirlivestend to be valued less.d.Brain imaging suggests that the moral sense behind one’s answers does not comefrom rational thought, but instead from emotional,gut responses. This suggeststhat a kind of moral intuition exists that is quite separate from reason. If that is thecase, opportunity costs were not central to the decision. It was a moral, not aneconomic,decision. Opinions among philosophers and economists differ on thisissue.5.a.It depends. On the basis of cost/benefit analysis, one could figure out casesinwhichmost people would say that they should be dishonest, butcost/benefitanalysis is not the final arbiter ifyou believe that dishonesty iswrong.Additionally, you should consider thesocial implicationsof dishonesty,asyourreputation and future interactions may be impacted.b.You can make yourself more believable by developing a reputation for honesty.Developing such a reputation usually has a cost because it requiresyouto behonest even when others might be dishonest. To encourage the other person to tellthe truth, you could use economic incentives.6.a.Answers will vary.b.Economic theory says that prices are determined by supply and demand, butbusinesses often usecost-plus-markup rules, orrules of thumb,to set their prices.If two firms have different costs of supplying the same item, theyprobablywillset different pricesfor that item. People might be willing to pay the higher price ifthe store is closer to where they live or simply to support a smaller, local store.c.Again, answerswill vary, but the reasoning is the same as in partb.7.It depends onthe perspective one takes. It is economically reasonable to legalizeorgan sales. But from a moral perspective, organ sales may be unethical, andpoorer people might feel compelled to sell their organs to support their family, aresult that many people would find morally reprehensible. Economics has nothingdefinitive to say on normative moral issues such as this.8.Answers will vary. Here is an example: Banks are economic institutions. Theytake a cost/benefit approach to deciding to whom to give loans, and they influencedecision making by allowing individuals to spend more money than they earn orhave as wealth.

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99.a.This is a matter of personal views; there are arguments for and against it. Anargument against the practice is that wealthy songwriters would have too muchpower in promoting their songs. The songs of the songwriters who can afford toshare profits will get more playtime and become even more famoustothedetrimentofnew entrants into the industry. Arguments for this practicearethat itcould be used to offset racism as in the example givenand, to the extent that newsongwriters have the capability of offering such royalty share, promote new kindsof music.b.The royalty payment gave Freed a strong incentive to choose what heconsideredthe best song and to promote that song heavily. The flat payment would have justgiven him an incentive to play any song and no long-term interest in whether thesong succeeded or failed.c.Answers will vary. Here are a few examples:Product placement in movies islegal, as are free newspapers to professors for gettingaclass to use thenewspaper. Direct paymentsto doctors for prescribing a particular type of drugareillegal, although taking doctors to lunch is not.10.Three ways (among many) that dormitory rooms could be rationedareadministrative decree, lottery, and a market system. In the first, individualbehavior would be forced to fit the will of the administrator. Individualsprobablywould complain and try to influence the administrator's decision. Becauseadministrative decree is not necessarily an efficient system, some peopleprobablywould attempt to trade rooms after the allocation. In the second, individualbehavior would be forced to fit the luck of the draw; individualsprobablywouldattempt to trade rooms after the draw. In the final example, individual behaviorwould have already been subject to economic forces, and thus, therewouldbe notendency to trade after one has "bought" the room one can afford.11.It suggests that policy should be willing to give up more in possible gains to avoidlosses than otherwise would be the case. Economic policies should be risk-averse—more committed to maintaining the current standard of living thantorisking economic losses by trying to improve it. Another possible policy responsewould be to offset this tendency by making gains more salient than losses.12.A good economist always tries to be objective. However, no one can ever becompletely objective. Sometimes the best we can hope for is an awareness of thecultural norms and value judgments that influence our views and decisions.Additionally, many policy issues (such as organ markets and minimum wagelaws) probablyshouldnot be approved in a purely objective way, since theyalsohave moral and social implications.

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1013.“Letting the data speak” means using computer power to finds patterns in data. Ascomputational methods have improved exponentially, the patterns that computersfind are more robust and useful in finding patterns. So the reason moderneconomists are more likely to let the data speak is due to technological change incomputational methods.

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1CHAPTER 2:THE PRODUCTION POSSIBILITY MODEL,TRADE, AND GLOBALIZATIONQuestions and Exercises1.In the figure to the right, wadget production is measuredon the vertical axis and widget production is measured onthehorizontal axis. If the society becomes moreproductive in its output of widgets, it can produce moreof them, and the end point of the curve on the horizontalaxis will move to the right, as shown. If the society is alsoless productive in its production of wadgets, the end pointon the vertical axis will move down, as shown. The resultis a new production possibility curve.2.If a society became equally more productive in theproduction of both widgets and wadgets, the productionpossibility curve would shift out to the right as shown inthe accompanying graph.3.Any production possibility curve that shows the principleofrising trade-offmust be bowed out. Theaccompanying grade production possibility curveembodies the principle ofrising trade off. The table ispresented below.Notice that for each 20-point gain in theHistory grade the amount of points lost on theEconomics grade steadily increases.HistoryEconomics40100608080504.a.In order to produce one more Peep, JustBorn must give up 3 Mike and Ikes.Hence, the trade-off for 1 Peep is 3 Mike and Ikes. The trade-off for one Mike andIke is 1/3 of a peep.b.See the accompanying graph.

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2c.Point A is efficient. Point B is inefficient. Point C isimpossible.d.See the accompanying graph5.The theory of comparative advantage underlies the shape of the productionpossibility curve. By taking advantage of each person's comparative advantage,higher total output can be reached than ifeach produced all goods onhis or herown, or if each produced goods for whichhe or shedid not have a comparativeadvantage. As more and more of a good is produced, resources that have less of acomparative advantage are brought into the production of a good, causing theproduction possibility curve to be bowed outward.6.a.See the accompanying graph.

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3b.As the output of food increases, thetrade-offbetween food and clothingincreases.To illustrate, giving up 4units of clothing (from 20 to 16) results in a gain of 5units offood (from 0 to 5), but giving up another 4units ofclothing (from 16 to12) results in a gain of 4units offood (from 5 to 9), and this pattern continues.c.If the country gets better at producing food, the placewhere the productionpossibilitycurve intersects the horizontal axis will move to the right.d.If the country gets equally better at producing food and clothing, the productionpossibility curve will shift out along both axes by the same proportion.7.There are no gains from trade when neither of two countries has a comparativeadvantage in either of two goods.8.The fact that the production possibilitymodel tells us that trade is good does notmean that in the real world, free trade is the best policy. The productionpossibilitymodel does not take into account the importance of institutions andgovernment in trade. For example, the model does not take into accountexternalities associated with some trades, the provision of public goods, or theneed for a stable set of institutions or rules. The production possibility modelshows maximum total output, but that is not the only societal goal to take intoaccount when formulating policy.9.a.See the accompanying graph.b.The United States has a comparative advantage in the production of wheatbecause it can produce 2 additional tons of wheat for every 1 fewer bolt of clothwhile Japan canproduce 1 additional ton of wheat for every 2 fewer bolts ofcloth. Japan has a comparative advantage in producing cloth.c.The United States should trade wheat to Japan in return for bolts of cloth. Onepossibility is that the United Statesproduces 1,000 tons of wheat and Japanproduces 1,000 bolts ofclothand they divide total production equally.Both get

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4500tons of wheat and500yards ofcloth. Both end up with more of each good.(Note: Other combinations are possible.)d.See the accompanying graph.Point A is the bundle of goods each country will beable to consume. Because point A is outside the production possibility curve foreach country, trade clearly benefits both countries.10.Globalization increasescompetition by allowing greater specialization anddivision of labor. Because companies can move operations to countries with acomparative advantage, they can lower production costs and increase competitivepressures. The decreased importance of geographical location increases the size ofpotential markets, increasing the number of suppliers in each market and thusincreasing competition.11.The law of one price rules, meaning that U.S. wages can only exceed foreignwages to the degree that U.S.workers are more productive than foreign workers.The adjustments, therefore, that will need to occur will equalize wage rates. So,either Western nominal wages will grow slowly and foreign nominal wages willgrow rapidly and catch up or U.S. exchange rates will decline to equalize wages.Some combination of the two is most likely. It is possible that there will developareas of production/services that will allow U.S. wages to remain high.12.The law of one price states that wages of workers in one country will not differsignificantly from wages of (equal) workers in another institutionally similarcountry. As the world is globalizing, the law of one price causes firms to hireworkers in other countries.Because wages adjusted for productivity differencesare lower in other countries, firms choose touse workersin foreign countries. Asthey do so, wageswill be bid up until wages, adjusted for productivitydifferences, are equal between the two countries.

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5s from Alternative Perspectives1.AustrianIn a market economy competition the market process translates individual actionsinto actions that are good for society. There is no such mechanism forgovernment; government has a monopoly on power, which allows individuals ingovernment to use that monopoly to achieve their ends, which may not be “good”ends. This monopoly on power makes government lessreliable than the market todo good, since the government is not subject to entry and exit as firms are in themarket. Also, whether or not every individual voice is taken into account dependson the government system, while the market will always include any individual’svoice by either their entry or exit.2.Religiousa.Most people would say that while it might be a component of the goals of society,it is not “the” goal of society. Other goals might include virtues such as kindnessand generosity.b.If a country is Christian, maximizingoutput probablyshould not be "the" goal ofsociety.c.In a Christian society the paramount goal would be to discern and fulfill the willof God.3.Feminista.Companies definitely think that sex sells products. Just look at the cover of anynumber of magazines.b.Sex is used in the advertising of numerous products.c.All people are subject to abuse by advertising, but women are more likely to beportrayed as objects instead of people, and are therefore at greater risk ofexploitation.d.While men and women may both be used in advertising,many timesmen areshown to be in a dominant position of power, while women are shown insubordinate positions.4.Institutionalista.Back in the 1950s President Eisenhower warned of the military/industrialcomplex, which maintains all types of military spending on projects so that they

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