Solution Manual for Microeconomics, 8th Edition

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Online Instructor’s Resource Manual
By
Leonie Stone
State University of New York College at Geneseo
For
Microeconomics
Eighth Edition
Jeffrey M. Perloff
University of California, Berkeley

Contents
Chapter 1 Introduction ................................................................................................................ 1
Chapter 2 Supply and Demand ................................................................................................... 5
Chapter 3 Applying the Supply-and-Demand Model.................................................................. 27
Chapter 4 Consumer Choice ....................................................................................................... 45
Chapter 5 Applying Consumer Theory ....................................................................................... 66
Chapter 6 Firms and Production ................................................................................................. 94
Chapter 7 Costs ........................................................................................................................... 109
Chapter 8 Competitive Firms and Markets ................................................................................. 129
Chapter 9 Applying the Competitive Model ............................................................................... 151
Chapter 10 General Equilibrium and Economic Welfare ............................................................. 173
Chapter 11 Monopoly ................................................................................................................... 186
Chapter 12 Pricing and Advertising .............................................................................................. 207
Chapter 13 Oligopoly and Monopolistic Competition .................................................................. 228
Chapter 14 Game Theory .............................................................................................................. 247
Chapter 15 Factor Markets ............................................................................................................ 272
Chapter 16 Interest Rates, Investments, and Capital Markets ....................................................... 283
Chapter 17 Uncertainty ................................................................................................................. 295
Chapter 18 Externalities, Open-Access, and Public Goods .......................................................... 311
Chapter 19 Asymmetric Information ............................................................................................ 326
Chapter 20 Contracts and Moral Hazards ..................................................................................... 339

Chapter 1
Introduction
Chapter Outline
1.1 Microeconomics: The Allocation of Scarce Resources
Trade-Offs
Which goods and services to produce.
How to produce.
Who gets the goods and services.
Who Makes the Decisions
Prices Determine Allocations
Application: Twinkie Tax
1.2 Models
Application: Income Threshold Model and China
Simplifications by Assumption
Testing Theories
Maximizing Subject to Constraints
Positive Versus Normative
1.3 Uses of Microeconomic Models

2 Perloff • Microeconomics, Eighth Edition
Teaching Tips
You might begin the first class by discussing with the students the role of the intermediate microeconomics
class in the larger curriculum. Encourage the students to be interactive by asking questions, bringing in
examples from the newspaper, and questioning concepts that seem untrue or unrealistic. For many
professors, a primary goal of the course is to get them to think like economists. The material in Chapter 1
should help the students to understand what is required to do so. You might want to ask your students the
policy questions listed below as a kind of pre-test. Simply ask them to write down the best answer they can
for now, and then put their answers away. You can then return to these answers later in the semester.
Some suggested policy questions (be sure to ask only questions that you will address later in the course):
1. How do minimum wages affect wages, employment, and unemployment?
2. Is the CPI a good measure of inflation?
3. Why do stores offer coupons instead of simply reducing the price by the value of the coupon?
4. Why is the price of electricity regulated in most areas?
5. Why do some workers prefer set wages rather than commissions, even if they might make more
working on commission?
6. Agree or disagree: We should strive to be a zero-pollution society.
On a more pragmatic level, I stress to the students that success in the class is heavily dependent on their
approach to the material. Specifically, I emphasize that memorization is an extremely ineffective tool for
studying economics, and that students who memorize material are very prone to confusion and “drawing a
blank” on exams. I try to persuade them that a much better approach is to press for understanding. I also
stress that understanding usually comes only through active engagement with the material, both in class
and out. The problems in the text, as well as the additional problems available in this manual and the Study
Guide, will benefit the students in this regard. The conceptual and technical questions throughout these
problem sets are designed to facilitate student understanding.
I also emphasize the importance of coming to class regularly. Paul Romer’s article, “Do Students Go to
Class? Should They?” in the Journal of Economic Perspectives (vol. 7, no. 3, Summer 1993:167–74)
shows that perfect class attendance is worth between one and two grade points, and attendance at all rather
than half of classes is worth between 0.67 and 1.24 grade points. Referring to this evidence might add
some weight to your argument.
Finally, I recommend that all students bring a protractor and a few colored pencils to class to aid their
note taking. One of the most frequent problems of students who are struggling is sloppy lecture notes. A
protractor is great for drawing lines and curves and has the added benefit of being transparent. Colored
pencils are a big help when students are taking notes on graphs with many different lines, such as income
and substitution effects and long- and short-run cost.
Chapter 1 serves as an introduction to the text as well as a refresher on some basic economic concepts and
definitions. This is a good chapter to get started on during the first day, as most students will not have
read it before class. It will give you the opportunity to get a feeling for the students’ recall of these basic
concepts.
I usually start by asking the class for a definition of economics. If you get several suggestions that do not
include the concept of scarcity, consider writing them on the board. Ask the class if they can think of

Chapter 1 Introduction 3
what central idea is missing from the definitions given. The discussion of scarcity and the questions of
what, how, and for whom to produce should lead you directly into a discussion of the role of prices as an
allocation mechanism.
In the discussion of prices and markets, I try to get the students to offer examples from recent events
where prices have risen or fallen sharply. Another possibility is to ask the students why some prices are so
high (e.g., professional athletes’ salaries), and others are so low (computer disks). Ideally, you will end up
in a discussion of the demand-driven nature of a market economy and the ways in which supply and
demand interact to allocate resources. I also like to talk briefly about market failure and why the United
States is a mixed economy rather than a pure market economy. A discussion on the benefit of intervention
might encourage the students to consider when a mixed economy might be beneficial. You could use an
example, such as primary education, to discuss what would happen in the absence of intervention, and why
the government might intervene.
When discussing allocation of goods and services, an effective counterpoint to the market system is
consideration of the centrally planned economy and the changes in Eastern Europe. Many students have
very little knowledge of how centrally planned economies operate, the difficulties they face in meeting
the demands of their citizens, and how these difficulties relate to the current political changes.
The discussion of economic models is very important. Most students do not have a sound understanding of
the construction and purpose of an economic model. Stress the point that economic models are allegories
used to describe behaviors and outcomes that would otherwise be unnecessarily complicated. Rather than
try to duplicate the actual phenomenon, economists use models to make predictions about the behavior of
firms and individuals. Perhaps the most important point to make regarding models is that they are simplified
through the use of assumptions. You might choose a typical market and describe the wide variety of
complex interactions that would have to be quantified in order to produce a complete model. Then describe
the circumstances under which a very simple economic model can make satisfactory predictions (where
“satisfactory” can be defined a number of ways, such as the coefficient of determination in a regression
model). You may also want to discuss interactions that are too difficult to model, and why. For example,
modeling behavior in unstable political climates is difficult because of the large influence of events that
cannot be forecast. Finally, you might discuss the use of models to test theories and make predictions.
Often students have a somewhat jaded view of economists and their predictions. I like to point out that
while predictions often turn out to be incorrect, the error can often be traced to incorrect assumptions made
at the time of the prediction. For example, suppose a forecasting model is constructed to predict baseball
game attendance. Assuming a bright sunny day, attendance at a baseball game is predicted to be 40,000.
If only 10,000 fans show up on game day, it could be that the model is bad, but it could also be that the
weather is cool with a steady rain. In this case the assumption, not the model, was flawed.
The application in the text considers the income threshold model in China. Students are often facing large
increases in income upon graduation. I would ask them what large purchases they plan to make following
graduation and apply that back to the China example. If a large portion of the economy had a large income
shock, either positive or negative, what would happen to the demand for consumer durables? I would
discuss how this change in demand might be disproportionate to the change in income due to the income
threshold model.
Chapter 1 also introduces the difference between positive and normative economics. It does not take long
to cover, and a brief discussion of this point is worth the time. You might begin by asking students the
distinction between positive and normative problems. I often find that students either do not know at all or
are very unsure about their responses. To get the class thinking, use current societal problems as discussion
points. Ask the class what would be a fair price for an AIDS vaccine. The variety of responses shows the
normative nature of the question, but there is no disagreement that the vaccine should be produced in
the least costly way possible regardless of how the gains are shared. Note that most problems have both

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4 Perloff • Microeconomics, Eighth Edition
positive and normative aspects and that by separating objective issues from subjective ones, we can more
easily understand and approach the problems and find effective solutions. The text example of the wisdom
of food price controls in Africa during droughts makes this point well.
When covering Section 1.3 (Uses of Microeconomic Models), you might draw on examples from your
own experience or current events that require the use of models. I like to draw the distinction between
structural models that may be used, for example, to determine an elasticity and forecasting models that
emphasize predictive power over theoretical correctness. If students have a weak background in statistics,
you may have to keep this discussion at a broad conceptual level. This section provides a great opportunity
to make the subject matter come alive for the students.
Discussion Questions
1. If water is needed to survive and diamonds are simply for jewelry, then why are diamonds so
expensive and water so inexpensive?
2. Discuss the positive and normative aspects of the economics of the Food Stamp program.
3. Are prices the best way to allocate pharmaceutical products?
4. Suppose you wanted to build a model to predict hurricanes. Which would be better, a model that
resulted in more false positive predictions (storm is predicted but does not occur) or more false
negatives (storm occurs but is not predicted)? Why?
5. What assumptions might you make to simplify the task of building an economic model of the grape
market?
6. Think of a market the government currently intervenes in. What is an economic rationale for the
intervention?
7. Economists often have differing opinions on what house prices will do over the next five years. What
feature of economic models might explain these differing opinions?

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Chapter 2
Supply and Demand
Chapter Outline
Challenge: Quantities and Prices of Genetically Modified Foods
2.1 Demand
The Demand Curve
Effect of Prices on the Quantity Demanded
Effect of Other Factors on Demand
Application: Calorie Counting
The Demand Function
Solved Problem 2.1
Summing Demand Curves
Application: Aggregating Corn Demand Curves
2.2 Supply
The Supply Curve
Effect of Price on Supply
Effect of Other Variables on Supply
The Supply Function
Summing Supply Curves
How Government Import Policies Affect Supply Curves
Solved Problem 2.2
2.3 Market Equilibrium
Using a Graph to Determine the Equilibrium
Using Math to Determine the Equilibrium
Forces That Drive a Market to Equilibrium
2.4 Shocking the Equilibrium
Effects of a Shock to the Supply Curve
Solved Problem 2.3
Effects of a Shock to the Demand Curve

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6 Perloff • Microeconomics, Eighth Edition
2.5 Effects of Government Interventions
Policies That Shift Supply Curves
Licensing Laws
Application: Occupational Licensing
Quotas
Solved Problem 2.4
Policies That Cause the Quantity Demanded to Differ from the Quantity Supplied
Price Ceilings
Application: Venezuelan Price Ceilings and Shortages
Price Floors
Solved Problem 2.5
Why the Quantity Supplied Need Not Equal the Quantity Demanded
2.6 When to Use the Supply-and-Demand Model
Teaching Tips
This chapter reviews basic supply-and-demand concepts from the principles level. Your interactions with
the class from the first session or two should give you a good indication of how much class time to spend
on it. If it has been some time since their principles course, students may need fairly consistent prompting
to recall the basic supply-and-demand model. For example, many will remember that there is a Law of
Demand but will not remember the law itself. Encourage students in the strongest terms to read the chapter
carefully. It is well worth the time spent at this stage to make sure everyone has solid recognition of these
basic tools and concepts.
A good way to motivate the chapter is by beginning with the genetically modified food example found in
the Challenge. Try to keep the conversation focused on possible effects of entry or of the ban. Let students
brainstorm about which parties might be in favor of a ban and who would be opposed and why.
When reviewing demand, be sure students are clear on the difference between movement along the curve
and a shift of the entire curve. Two points should be helpful. First, note to them that both in Equation 2.1
and on the graph in Figure 2.1, price is the only independent variable present. Thus, only price can cause a
movement along the curve. Second, underscore the role of other variables. After compiling a list of the
factors that can shift the demand curve (once they get started, the class as a group should be able to provide
you with this list), I ask what factors are held constant along a single demand curve. Surprisingly, this question
is often greeted by a protracted silence. By realizing that it is the same factors that shift the curve when
they change, students develop a more solid understanding. The text makes this point well in Equations 2.2
and 2.3.
The introduction of demand curves and equations is a good opportunity to review the basic geometric concepts
of slope and intercept. This does not take much time, as most students can recognize slope and intercept of
a written equation, but there is sometimes a surprising lack of connection between what appears in an equation
and the resulting graph. Draw a demand curve and tell the class that the slope of this curve is
–2. Then ask the students what will happen in the graph if the slope changes to −4. Although it is likely
that several, perhaps most students will know immediately, some will not.
Rather than referring to the slope increasing or decreasing, I tend to refer to it as becoming steeper or
flatter, and thus this way I can talk about the shift in supply and demand curve slopes the same way (an
increase in slope would cause the demand curve to become flatter and the supply curve to become steeper,

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Chapter 2 Supply and Demand 7
which can be confusing for students). I try to use the simple algebra and geometry in these early chapters
to help me to gauge what portion of the class is likely to struggle when the material gets tougher.
Assigning some of the quantitative problems at the end of the chapter and collecting them (even if you do
not intend to collect homework throughout the term) is another good diagnostic. Alternatively use five
minutes of lecture time to ask students to answer two or three basic quantitative questions and collect their
responses. Assure the students that their answers will not be graded and will simply be used to gauge
comprehension. This will allow you to adjust your next lecture if necessary, and by walking around while
students are working, you can answer any basic questions they might have.
It is also valuable to discuss the inverse demand curve and the process of inversion. I usually motivate this
review by noting that this process will be needed later when formulating a total revenue equation from a
demand equation. I combine this with the discussion of the problem of the reversed axes. At this point, you
can refer back to the graph and show how to find the intercept and slope from Equation 2.3
I try to keep the discussion of supply parallel to that of demand. For factors that can shift the entire supply
curve, note that they can all be lumped together under the broader heading of costs, government rules and
regulations, and other variables (as is done in the text). The text notes that there is no “Law of Supply,”
and most students have learned this in their principles course. Be aware, however, that some principles
instructors refer to the upward slope of supply curves in the short run as the “Law of Supply.” Adopting a
uniform taxonomy and vocabulary reduces confusion. This includes uniformity with the text with respect
to symbols and upper- versus lower-case labeling.
When combining supply and demand in the discussion of equilibrium, press the students for a usable
definition of the term. You will likely receive the suggestion of “where supply equals demand.” Though
incorrect, this definition is useful in the introduction of price floors and ceilings where the quantity supplied
does not equal demanded at the equilibrium quantity. An important point regarding equilibrium solutions
of supply-and-demand problems is that they are typically stable and self-correcting. To illustrate this point,
use examples of commonly purchased items such as discounted clothing where reduced prices reflect
excess supply.
Now that students have an idea of what a market looks like in equilibrium, I might ask for examples of
markets that are not in equilibrium. This leads in to the discussion of government interventions and how
they distort the market. This is also a good place to use a news article to show students how to use graphs
to explain effects mentioned in the article.
When discussing floors and ceilings, I stress the definitions using simple graphs as illustrations. Although
it seems counterintuitive to some students that an effective floor must be above the equilibrium price and
an effective ceiling must be below, suggest that they use this as a mnemonic device. In this section, I try to
engage the class in a discussion of unintended or secondary effects of government intervention. This issue
deserves significant class discussion time. Most students have not thought much about the consequences of
ceilings and floors beyond the simple price effects. The text has a good description of the unintended
effects of price controls in Zimbabwe. A discussion on the initial reaction to the price controls, and then
the actual effect of the controls, would lead students to realize the importance of looking beyond the initial
effect and using economic models to predict outcomes.
Another good example for discussing secondary effects is rent control. On the supply side, landlords’
incentives to provide efficient levels of upkeep and safety measures in rent-controlled buildings are
distorted. On the demand side, time spent searching and undesired doubling-up reduce consumer
satisfaction. Secondary effects of floors are also worth noting. I recommend that you discuss the text’s
example of the possible negative effects of minimum wages. Again, students are likely to view minimum
wages as strictly a benefit to workers because they have not considered that job loss will mean that some
workers are harmed rather than helped by the establishment of minimums or increases in their level.

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8 Perloff • Microeconomics, Eighth Edition
These policy issues provide an opportunity to use current affairs in class. Using an article from a
newspaper or online source, I often break down the predictions in the article and use the theory learned in
class to determine their veracity.
In the section on when to use the supply-and-demand model, be sure to define and discuss transaction
costs. Most students will not be familiar with this term from principles, and it has important implications
on the functioning of thin markets and markets where there is substantial uncertainty.
At the end of the chapter, you can return to the discussion of genetically modified foods (or another
appropriate example) and use the supply and demand model to analyze the effects of entry.
Discussion Questions
1. Can you think of any reasons why the Law of Demand might not hold?
2. Would you expect most supply curves to have an upward slope? Why or why not?
3. What are some examples of markets that are competitive?
4. In which markets that would otherwise be competitive would you expect transaction costs to be
very high?
5. Can you think of situations where the government would want to take actions that cause shortages?
6. In what markets and situations would you expect that the quantity demanded would not equal
the quantity supplied?
7. Can you think of an example where a good is sold below equilibrium price without government
intervention causing excess demand? Which property of perfect competition is violated?
Additional Questions and Problems
1. Suppose you are planning to conduct a study of the running shoe market. List the factors that you
believe would cause changes in the demand for running shoes. In each case, note whether the
relationship would be positive (direct) or negative (inverse). Also list the factors that you believe
would affect the supply, again noting the nature of the relationship.
2. In each case below, identify the effect on the demand curve for steak (a normal good).
a. An increase in the price of lamb
b. A decrease in the population
c. An increase in consumer income
d. A decrease in the price of steak sauce
e. An increase in advertising by chicken producers
3. In each case below, identify the effect on the supply curve for coal.
a. The development of a new, lower cost mining technique
b. An increase in wages paid to coal miners
c. The imposition of a $2 per ton tax on coal
d. A government ban on all imports of coal
e. A new government regulation requiring air purifiers in all work areas

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