Solution Manual for Microeconomics Principles, Applications and Tools, 10th Edition

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Microeconomics:Principles, Applicationsand ToolsTenth EditionArthur O’SullivanSteven M. SheffrinStephen J. PerezResource Manual(Download Only) forMicroeconomics: Principles,Applications and ToolsJeffrey Phillips

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ContentsChapter 1 Introduction: What Is Economics?1Chapter 2 The Key Principles of Economics12Chapter 3 Exchange and Markets25Chapter 4 Demand, Supply, and Market Equilibrium35Chapter 5 Elasticity: A Measure of Responsiveness53Chapter 6 Market Efficiency and Government Intervention66Chapter 7 Consumer Choice: Utility Theory and Insights from Neuroscience82Chapter 8 Production Technology and Cost91Chapter 9 Perfect Competition102Chapter 10 Monopoly and Price Discrimination116Chapter 11 Market Entry and Monopolistic Competition127Chapter 12 Oligopoly and Strategic Behavior136Chapter 13 Controlling Market Power: Antitrust and Regulation150Chapter 14 Imperfect Information: Adverse Selection and Moral Hazard159Chapter 15 Public Goods and Public Choice171Chapter 16 External Costs and Environmental Policy179Chapter 17 The Labor Market and the Distribution of Income193Chapter 18 International Trade and Public Policy206

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11Introduction:What Is Economics?Chapter SummaryChapter 1 provides a basic illustration of what economics is and why it is useful. Economics is the study ofthe choices people, firms, and governments make when resources are scarce. Economic analysis helps usunderstand the consequences of these choices. Here are the main points of the chapter:Most of modern economics is based on positive analysis, which answers the question “Whatis?”or “Whatwill be?”Economies must answer three questions: What products do we produce? How do we produce theproducts? Who consumes the products?Normative analysis answers the question “Whatought to be?”To think like an economist, we (a) use assumptions, (b) use the notion ofceteris paribus, (c) thinkin marginal terms, and (d) assume that rational people respond to incentives.Macroeconomics helps us understand why economies grow and understand economic fluctuations.Microeconomics helps us understand how markets work.Learning Objectives:1.1What is Economics? List the three key economic questions.1.2Economic Analysis and Modern Problems: Discuss the insights from economics for a real-worldproblem such as congestion.1.3The Economic Way of Thinking: List the four elements of the economic way of thinking.1.4Employability—Economic Logic on the Job: Explain how studying economics improves a person’semployment prospects.1.5Preview of Coming Attractions—Macroeconomics: List three ways to use macroeconomics.1.6Preview of Coming Attractions—Microeconomics: List three ways to use microeconomics.Approaching the MaterialThe first classes are very important in determining your students’ attitudes toward economics. Youhave tofind out their attitude and use real-world examples that help them understand that economics relates to theirlives.Stating to the class that economics is “The study of how scarce resources are allocated to satisfyunlimited wants” is accurate butis also one of the reasons why some people still refer to economics as “thedismal science.” Try the following definition of economics instead: “Economics is the study of how you,your friends, the stores where you shop, and your mayor make choices.” Every student in front of youmakes choices everyday—what to wear, what to have for breakfast, or whether to sleep in, whether to studyor play video games. Students allocate resources all day long. Time is one resource that everyone can relateto and everyone has the same amount of. Use what students know to teach them what you want them toknow.

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2O'Sullivan/Sheffrin/Perez,Microeconomics,10eChapter Outline1.1 What Is Economics?A.Scarcity:the resources we use to produce goods and services are limited.Economicsis the studyof choices when there is scarcity.Teaching TipStudents have scarce resources they have to allocate. Ask the class who had breakfast thismorning. You should have a room full of both breakfasters and those who did not eat. Askthose who did not eat breakfast why not. Someone is sure to say they did not have the time.Explain that we all have the same amount of time (a scarce resource), but we choose toallocate it differently. (i.e., sleep in, workout, study, eat breakfast).B.Factors of ProductionFactors of production:the resources used to produce goods and services, also known asproduction inputs.Natural resources:the resources provided by nature and used to produce goods and services.Labor:the physical and mental effort people use to produce goods and services.Physical capital:the stock of equipment, machines, structures, and infrastructure that is used toproduce goods and services.Human capital:the knowledge and skills acquired by a worker through education and experience.Entrepreneurship:the effort used to coordinate the factors of production—natural resources,labor, physical capital, and human capital—to produce and sell products.C.Positive versus Normative Analysis1.Positive analysisanswers the questions “Whatis?” or “Whatwill be?”a.For example: What is the effect on poverty of a living wage ordinance? Or, What is theeffect on a city’s costs of a living wage ordinance?2.Normative analysisanswers questions of “What ought to be?”a.For example: Should a city implement a living wage ordinance?Teaching TipTell the students that Mr. Alumni Bigbucks has donated 50 million dollars to the university.The following question is an example of positive analysis: Should the donation be used tobuild a new stadium or a state-of-the art library/technology center? The following questionis an example of normative analysis: What do they think should be built and why?D.The Three Key Economic QuestionsThe choices made by individuals, firms, or governments answer three fundamental questions:1.Whatgoods and services do we produce?2.Howdo we produce these goods and services?3.Whoconsumes the goods and services that are produced?

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Chapter 1: Introduction: What Is Economics?3Teaching TipNow is a good time to introduce the concept of markets indirectly. Consumers decide whatis produced and for whom; businesses decide how the products are produced.E.Economic ModelsAneconomic modelis a simplified representation of an economic environment, often employinga graph. For example, economists use the model of a market to analyze the effects of public policyon economic outcomes.1.2 Economic Analysis and Modern ProblemsEconomic analysis can provide insights into real-world problems such as:A.Economic View of Traffic Congestion: problem is solved by paying tolls.B.Trade-offs from International Trade: there are winners and losers (or trade-offs) associated withspecialization and trade.C.Economic View of Managing the U.S. Economy: governments throughout the world intervene totry and help their economies.1.3 The Economic Way of ThinkingA.Use of Assumptions to Simplify and Facilitate LearningB.Isolate Variables—Ceteris ParibusAvariableis a measure of something that can take on different values. Theceteris paribusis aLatin expression meaning other variables being held fixed. The assumption is that when weconsider changes in one variable, we hold all other variables constant.Teaching TipAsk the students to recall doing experiments in high school science (chemistry) classes.Remind them that in order to obtain reliable results, they had to change only one componentwhile holding other components constant.C.Thinking at the MarginEconomists consider small, incremental changes to determine whether or not it is desirable tochange the level of economic activity. A small, one-unit change in value is known as amarginalchange.For example, should you eat the fourth piece of pizza if you aren’t hungry?D.Rational People Respond to IncentivesTeaching TipSelf-interest is not the same as selfishness. Ask the students to think about all of the thingstheir parents have done for them over the years. Not selfish but certainly in the parent’s self-interest.

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4O'Sullivan/Sheffrin/Perez,Microeconomics,10eE.Example: Southern California Addresses Its Congestion ProblemThe Southern California Council of Governments (SCAG) advocates a congestion tax (or“decongestion fee”) that would be paid by drivers who use roads during peak periods. A similarplan was implemented in Stockholm, which experienced a 20 percent decrease in traffic as a result.Teaching TipAsk the students what other pricing schemes London could have used to reduce congestion—free public transportation, alternative work hours, higher parking rates.Teaching TipAlmost every college campus in America lacks enough spaces for those who want to park.Discuss the current parking policy at your university. Ask the students to use economic analysisto come up with alternative policies to solve the parking problem (small groups should workwell here). The possible solutions should include raising parking fees, restricting parking bytypes of parkers (no freshman, faculty/staff only), remote parking with free shuttles, alteringclass schedules, rewards for car pooling, and expanding parking spaces.Review these key questions and their related Applications:Question 1: How do people respond to incentives?APPLICATION 1: INCENTIVES TO INSTALL ROOFTOP SOLAR PANELSThe federal government is offering a tax credit for homeowners to install rooftop solar panels to generateelectricity.Studies have shown that consumers are very responsive to tax incentives for solar power,especially if they pay a relatively high price for electricity.Question 2: What is the role of prices in allocating resources?APPLICATION 2: HOUSING PRICES IN CUBAThe Cuban government confiscated most housing in 1960 and did not allow homeowners to sell theirproperty. As a result, the housing stock deteriorated because there was little incentive to repair it. Housingreforms allowed the sale and purchase of homes in Cuba in 2011. These reforms increase incentives andare expected to increase construction of houses.1.4 Employability: Economic Logic on the JobEconomics involves making choices. There are many examples of jobs inthe real world where economic analysis can be applied in making decisions.

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Chapter 1: Introduction: What Is Economics?51.5 Preview of Coming Attractions: MacroeconomicsMacroeconomicsis the study of the nation’s economy as a whole; it focuses on the issues of inflation,unemployment, and economic growth.A. Why Study Macroeconomics?1.To understand why economies grow2.To understand economic fluctuations3.To make informed business decisions1.6 Preview of Coming Attractions: MicroeconomicsMicroeconomicsis the study of the choices made by households, firms, and the government, and howthese choices affect the markets for goods and services.A. Why Study Microeconomics?1.To understand markets and predict changes2.To make personal or managerial decisions3.To evaluate public policiesAdditional Applications to Use in ClassQuestion: Does a real estate agent have an incentive to get you the highest price?ADDITIONAL APPLICATION: FREAKONOMICSSource: Motley Fool audio interview with economist Steven LevittInterviewed by David Gardner“Freakonomics”Summary: Key Points in the ArticleThis audio clip features an interview with one of the authors of the best-selling bookFreakonomics.Economist Steven Levitt answers a host of questions typically not tackled by most economists. One of thequestions is related to realtors and agency relationships. In other words, do realtors really work for realestate sellers?According to Levitt, it is in the best interest of the realtor to convince sellers to take an offer lower thanthey would receive if the property remained on the market. Since the percentage of the sales price that realestate salespersons receive from selling a house is a very small fraction, a $10,000 increase in sales pricemight net a real estate professional another $150 commission for a tremendous amount of additional work.Therefore, it is in the real estate salesperson’s best interest to convince the seller to make the quick sale andtake the first reasonable offer. Levitt points toward evidence that real estate professionals tend to leave theirown properties on the market longer and receive 2 percent to 3 percent more in sales price.Levitt addresses many other issues including market efficiency, horse racing, and drug dealing in thisinterview. Listen to the clip for Levitt’s economic explanation ofnumerous topics.Analyzing the NewsLevitt’s primary contribution is his application of economic thought to a number of topics typically notaddressed by economics. As you will hear, economics is truly a social science that can be used to explainquite a bit of human behavior.

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6O'Sullivan/Sheffrin/Perez,Microeconomics,10eThinking Critically Questions1.What is “freakonomics?”2.Why would the illustration of “realtors” and not maximizing sales price for sellers be an economictopic?3.Are the stock markets efficient according to Levitt?Teaching TipThis is a great example of how people’s incentives are often not the same.Although the realestate agent works for the seller, their interests regarding holding out for a higher price arenot the same.Question: How does a tightening of discretionary income affect luxury industries?ADDITIONAL APPLICATION: SPORTSBIZ: GOLF INDUSTRY GETS HIT HARDSweet, David“SportsBiz: Golf Industry Gets Hit Hard”Posted 12/3/2008 on MSNBC.comSummary: Key Points in the ArticleGolf courses are not only on hold in the United States, but also many are being converted to other uses.The 1990s saw tremendous expansion in the sport, which is now being reversed as many people forgo thegame due to tight budgets. More courses are closing this year than are opening, and openings are thelowest in 20 years.In addition, many new courses are tied to housing projects that are currently mothballed due to theflagging housing market. Equipment sales are down as well as rounds played. The one bright spot appearsto be China. One course designer formerly in high demand in the United States is now focusing onChina’s growing appetite for the game.Analyzing the NewsGolf is a game that consumes discretionary income. As more people look for ways to reduce spendingeither due to job loss or conservation of cash, golf may be one of the first luxuries to go. It appears thatthe recession may be impacting all levels of income. You may begin to see a reduction in price as shownin the graph as golf courses attempt to draw customers back to the green. Of course, if the number of golfcourses in the United States falls even further, you would see a leftward shift in supply that might help thesurviving courses.Thinking Critically Questions1.What is causing the leftward shift in demand for golf?2.How do expectations cause demand shifts?3.Why is China experiencing a golf boom?

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Chapter 1: Introduction: What Is Economics?7Question: Should people invest in low-cost health insurance?ADDITIONAL APPLICATION: IS LOW-COST HEALTH INSURANCE WORTH IT?McCormack, Karyn“IsLow-Cost Health Insurance Worth It?”Posted 8/04/2008 on MSNBC.comBusinessweekSummary: Key Points in the ArticleSome of the low-cost health insurance plans currently being pitched on television may not be worth theprice. A couple of options limit coverage so that any surgery or hospitalization is capped at less than$1,200. The primary coverage is minor medical instead of major medical.Critics maintain that policies of this nature do little for the insured since any major medical event wouldresult in thousands of dollars of expenses not paid by the plans. However, representatives at one of thecompanies said that company representatives will negotiate large bills on behalf of their clients. Thecompany, iCan, maintains that their network pricing clout and negotiation will reduce a typical $50,000bill to around $10,000 to $12,000.There are currently 47 million uninsured Americans that may opt for these low-cost mini-medical plans.However, even at the low end price of $160 a month for individuals and $260 a month for families theseplans may stress a lot of budgets.Analyzing the NewsAccess to medical care is a critical issue in the United States. Does everyone have access to treatment?Probably not equally and many people are forced into bankruptcy every year due to high medical bills.Expect to see continued debate over this issue after the presidential election.Thinking Critically Questions1.Why is this issue important?2.What are some options for the government to debate?3.What forms of nationalized health care currently exist?Appendix AUsing Graphs and Percentages1A.1 Using GraphsA.Graphing Single Variables1.Pie charts2.Bar graphs3.Line graphsStudents who are not familiar with graphs will need lots of time here. Give them simple data,and let them create their own pie charts and bar graphs.B.Graphing Two Variables1.Two variable graphs use both the horizontal and vertical axis.2.Play “connect the dots” to determine points on the line.

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8O'Sullivan/Sheffrin/Perez,Microeconomics,10eTeaching TipHave the students create graphs without numbers. Using concepts they are familiar with(Hours of study, G.P.A.), have them draw the line that shows the general shape of therelationship.Positive relationship:a relationship in which two variables move in the same direction.Negative relationship: a relationship in which two variables move in opposite directions.C.Computing the SlopeSlope of the curveis the vertical difference between two points (therise) divided by thehorizontal difference (therun).Teaching TipMost students should be familiar with the concept of slope, but it is worth your time to gostep by step for at least a few problems.D.Moving along the Curve versus Shifting the Curve1.Variables in the graph versus variables not in the graph2.Changing variables in the graph—movement along the curve3.Changing variables not in the graph—movement of the curveEmphasize that the Y-intercept represents variables not in the graph.E.Graphing Negative RelationshipsIllustrate the negative relationship between downloads and CDs purchased. Most studentsshould not have a problem with the concept of a negative relationship.Teaching TipAsk students to come up with three pairs of variables that have a negative relationship.F.Graphing Nonlinear RelationshipsShow students what a nonlinear relationship looks like. Unless you have an unusual class, youshould avoid using calculus to explain nonlinear relationships. An explanation of how theremay not be a constant relationship between variables would be useful.1A.2 Computing Percentage Changes and Using EquationsA.Computing Percentage ChangesUse the formulas to show students how to compute percentage change. Several examples maybe necessary.Teaching TipMost students are shoppers. Use concepts like “20percentoff” sales to help them understandthis concept.

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Chapter 1: Introduction: What Is Economics?9Review this key question and the related application:Question 3: How do we compute percentage changes?APPLICATION 3: THE PERILS OF PERCENTAGESThis Application explains how in the 1970s the government of Mexico City repainted highway lines tomake a four-lane highway into a six-lane highway and then turned it back into a four-lane highway. Whenreporting on the results of those changes in lanes on the highway, the government incorrectly reported thepercentage changes of the effects of redoing the highway because they used the simple approach tocomputing percentage changes. This shows that percentage calculations can be inaccurate, if you’re notcareful.It’s important to remember that the midpoint formula accurately records percentage changes.B.Using Equations to Compute Missing ValuesFollow the formulas in the book. As this is basic algebra, students should be well-versed, but afew in-class problems should be helpful.

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Chapter 1: Introduction: What Is Economics?9Solutions to End-of-Chapter ExercisesChapter 1SECTION 1.1: WHAT IS ECONOMICS?1.1what, how, Who1.2natural resources, labor, physical capital, human capital, entrepreneurship1.3statement “a.” is TRUE1.4a. normativeb. positivec. normatived. normativee. positiveSECTION 1.2: ECONOMIC ANALYSIS AND MODERN PROBLEMS2.1b.2.2benefits, prices.2.3workers displaced by international trade.2.4inflation.SECTION 1.3: THE ECONOMIC WAY OF THINKING3.1the earth is flat, the roads are flat3.2assumptions, use ofceteris paribusto isolate variables, margin, incentives3.3b.3.483.5housing repair and maintenance3.6falseCritical Thinking1.Hillyland specializes in coffee, and Flatland specializes in rice. Consumers benefit because the priceof rice decreases in Hillyland and the price of coffee decreases in Flatland. Rice workers in Hillylandlose their jobs, and so do coffee workers in Flatland.The negative job effects will persist untildisplaced workers make the transition to the other job.

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10O'Sullivan/Sheffrin/Perez,Microeconomics,10e2.The decrease in price decreases the incentive for maintenance and repair, so the quality of housingwill decrease over time as the owner spends less on maintenance and repair.Chapter 1 Appendix1.a.b.$5.00, hours/monthc.$15.00d.6 additional hours

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Chapter 1: Introduction: What Is Economics?112.$20, $4.00, 10, $60, $803.a.b.-2.0 movies, CD4.a.Number of DeliveriesTotal Costs050590101301517020210b.$8.00, deliveryc.Drivers’ wages and the rental cost of the truck.In addition, the other costs of delivery, such asthe price of fuel, insurance, and taxes.d.deliveriese.drivers’ wages, the rental cost of the truck, or theprice of fuel5.along, shifts6.10.0%, -2.0%, 6.0%7.112, 54, 238.40% = 20/50, 33% = 20/60

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122The Key Principlesof EconomicsChapter SummaryChapter 2 introduces the key principles that are central to all economic theory:Theprinciple of opportunity coststates that the opportunity cost of something is what you sacrificeto get it. Opportunity costs in production are generally increasing, and thus, the productionpossibilities curve is bowed outward.Themarginal principlestates that any activity should be increased as long as the marginal benefitsof the additional activity exceed the marginal costs.Theprinciple of voluntary exchangestates that a voluntary exchange between two people makesboth people better off.Theprinciple of diminishing returnsstates that, in the short run, if use of one input is increasedwhile all others are held constant, production will eventually increase at a decreasing rate.Thereal-nominal principlestates that what matters to people is the real value or purchasing powerof money or income, not its face or nominal value.Learning Objectives:2.1The Principle of Opportunity Cost: Apply the principle of opportunity cost.2.2The Marginal Principle: Apply the marginal principle.2.3The Principle of Voluntary Exchange: Apply the principle of voluntary exchange.2.4The Principle of Diminishing Returns: Apply the principle of diminishing returns.2.5The Real-Nominal Principle: Apply the real-nominal principle.Approaching the MaterialContinue the approach you developed in the first chapter, reaching students where they are. The decisionto go to college is a great illustration of opportunity costs because students forgo earnings that they wouldhave received from a full-time job. Apply the concept of diminishing returns to hours studying: If a studentstudies for five hours, will studying one additional hour really benefit him or her? Most of the students willhave had jobs, so use the price of a gallon of gas or a burger per hour worked to explain real wages. Moststudents will have trouble with the marginal principle, so have plenty of examples ready. A seat on a busor train that is not full is a good example. An extra passenger in a car for a road trip or another personwatching a movie will also work.

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