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Chapter 1
Answers to End-of-Chapter Problems and Applications
2. Yes, even Bill Gates faces scarcity because his wants exceed his resources. Gates has
established a foundation with billions of dollars to spend on worthy causes like eradicating
malaria and reducing homelessness. However, there are an unlimited number of worthy causes
that Gates desires to fund, so even he faces scarcity. Secondly, even Gates has only twenty-four
hours in a day, so he must make choices about how to spend his scarce time. Everyone I know
faces scarcity, because human desires are virtually unlimited. Because the world’s resources are
limited, the only way to not face scarcity is to reduce one’s wants to be less than one’s resources.
4. The manager is failing to think at the margin. Dell has lost $400,000 on the last 10,000
laptops, so their profits would have been higher if they had not produced them.
6. Your friend is failing to think at the margin. It doesn’t matter how much time has already been
spent studying psychology. What matters is the marginal benefit to be received from studying
psychology relative to the marginal cost, where cost is measured as the opportunity cost of lower
grades in other subjects. If the course is required, that may raise the marginal benefit.
8. The contractors had little incentive to deliver the Indians to Oklahoma alive. Instead, they
benefited when the Indians died along the way, because they had to spend even less money on
food and transportation. One way to change the incentives to lower the death rate would have
been to pay the contractors more if the Indians arrived safely in Oklahoma.
10. The problem with Dr. Strangelove’s theory is that it cannot be tested unless we can devise a
way to measure the emission of these subatomic particles, which seems to be impossible since
they don’t exist in our universe. Because we cannot test the model’s predictions, it is not very
useful to us – even though it might be true, we have no way of knowing.
12. a. It is doubtful that centrally planned economies have been less efficient purely by chance.
The underlying reason seems to be that centrally planned economies don’t give as great
incentives for hard work and innovation as market economies do. In addition, the people running
centrally planned economies cannot make the most productive decisions because they don’t have
the information that is in the minds of all the decentralized decision makers in a market economy.
b. You might still prefer having a centrally planned economy if you considered it to be more
equitable. (Also, you might prefer a centrally planned economy if you were in charge.)
14. a. The groups that are most likely to get the tickets will be those for whom the expected
marginal benefit of going to City Hall on Monday morning is greater than the expected marginal
costs. These might include people who have a very low opportunity cost of traveling to City Hall
and standing in line, such as people who don’t have a job in the morning and those who live or
work very close by. These might also include people who see a large benefit from going to get the
tickets, such as die-hard NASCAR fans or professional ticket scalpers.
b. The major opportunity cost of distributing the tickets this way is the cost to the people who
attempt to get the tickets – the cost of travel to City Hall, the activities that cannot be done (such
as earning money at work) when one is standing in line, and the costs to all those people who try
to get tickets but don’t get there soon enough. (There’s also the cost of people blocking traffic in
and around City Hall.)
c. This isn’t an efficient way to distribute the tickets, since it wastes so much time. Perhaps the
most efficient way to distribute the tickets is to hand them out unannounced to people walking by
– this would take only a few minutes. Alternatively, the city could sell them back to NASCAR
and have them distribute the tickets.
d. Equity is hard to define. Some people will see this as equitable, since only the deserving, true
fan will put up with the hassle of getting the tickets. Others will disagree, saying that no money
was raised for the taxpayers of the city, who deserve to get the benefits of selling the tickets since
they fund the police department.
16. a. and c. are positive statements; b. and d. are normative statements.
18. a. The proposal might protect consumers because lawyers are generally better trained and
more knowledgeable about these matters than non-lawyers.
b. The law will clearly protect lawyers by reducing the competition facing them and allowing
them to increase their prices. The gains to consumers may be very small since consumers are
often wise enough to know when going to a lawyer is their best decision and when relying on
someone with less training is acceptable.
c. Answers will vary, but people will tend to favor the law if they have financial ties to lawyers,
or they suspect that the advice from these non-lawyers will be incompetent. Also, people will
tend to oppose the law if they think that consumers are in a good position to decide for
themselves who is offering good advice at a good price.
Answers to Problems and Applications in the Appendix
2.
4. –1.9%. The percentage change in real GDP from one year to the next is the economy’s growth
rate.
6. The triangle’s area = 0.5 x 60,000 x $0.75 = $22,500.
Chapter 2
Answers to End-of-Chapter Problems and Applications
2. Increased safety will decrease gas mileage, as shown in the figure. Tradeoffs can be between
physical goods, such as cotton and soybeans in problem 1, or between less tangible things like
mileage and safety.
4a. The production possibility frontier will be concave like Figure 2-2 because some economic
inputs are likely to be more productive when making capital goods, and others are likely to be
more productive when making consumption goods.
b.
c. Because it will have more machinery and equipment, Country B is likely to experience more
rapid growth.
6a.
b. The opportunity cost of increasing your chemistry score by 4 points in moving from Choice C
to Choice D is the 4 point decline in your economics score.
c. Choice A might be sensible if the marginal benefits of doing well on the chemistry exam are
low relative to the marginal benefits from doing well on the economics exam – for example, the
chemistry exam is only a small portion of your grade, but the econ exam is a large portion of your
grade; or if your are majoring in economics and don’t care much about chemistry; or if you
already have an A sewn up in chemistry, but the econ professor will replace a low exam grade
with this exam grade.
8. Most economists would argue that unless the costs of complying with environmental
regulations are taken into account, society runs the risk of devoting too many resources to
improving the environment compared with other goals. By ordering the EPA to ignore costs,
Congress was forcing the EPA to approve regulations that it would not have approved if costs
were taken into account. The decision to tell the EPA to ignore costs may have been a foolish
mistake or a way of seeming very friendly to the environment to people who don’t think about the
opportunity cost of reducing air pollution.
10. Economic systems that do not allow people to keep most of the output they produce do not
provide much incentive for people to work hard. Unfortunately, experience has shown that
people are more self-interested and less altruistic than would be necessary for the system used in
Oz to work in the real world.
12. a. Neither country has a comparative advantage in either good. In both countries, the
opportunity cost of one barrel of oil is one barrel of olive oil. Comparative advantage only arises
if someone has a lower opportunity cost, but these two countries have the same opportunity cost.
b. No, the countries can’t gain from trade. Trading across the border gives the same tradeoffs that
can be made within each country.
14. Yes, the United States would have benefited from importing those products where Britain had
a comparative advantage.
16. Adam Smith was making the “invisible hand” argument that, in pursuing their self-interest,
business people end up producing the goods and services most desired by consumers.
18. Adam Smith realized – as economists today realize – that people’s motives can be complex.
But in analyzing people in the act of buying and selling, economists have concluded that in most
instances, the motivation of financial reward provides the best explanation for the actions people
take. Moreover, being self-interested – looking out for your own well-being and happiness – and
being selfish – caring only about yourself – are not exactly the same things. Many successful
business people are, in fact, generous: donating to charity, volunteering for activities, and
otherwise acting in a generous way. This is not inconsistent with making business decisions that
maximize profits for their companies.
20. Most economists would agree that this is a good basis to judge an economy. It’s hard to
disagree with respect to developing countries, where many people live in abject poverty and
standards of living are low. It’s easier to disagree if everyone in a society has a very high
standard of living, but has to give up a lot to get it, by, say, working long hours. Any debate
would probably center on what is meant by the “standard of living.”
22. Falling transportation costs allowed people to trade more easily and to specialize on the basis
of their comparative advantage.
Chapter 3
Answers to End-of-Chapter Problems and Applications
2. a. substitutes
b. complements
c. complements
d. probably unrelated
4. It is possible. For instance, someone who likes the taste of hamburger may consume a larger
quantity of hamburgers as his income rises. Another person may only be consuming hamburgers
because his income is low. As this person’s income rises, he may substitute steak for hamburger
in his diet.
6. The student’s reasoning is incorrect. He should have said: “Increased production leads to a
lower price, which increases the quantity demanded.”
8.
Quantity Supplied
(pizzas per week)
Price Mark Mike Bill Market
$5.00 25 30 20 75
5.50 30 40 25 95
5.75 35 50 30 115
6.00 40 60 35 135
6.25 45 70 40 155
10. Zero would be the equilibrium quantity if the supply curve is always above the demand curve
– that is, if the lowest price at which anyone is willing to supply the good is above the highest
price that anyone is willing to pay for the good. The quantity supplied and the quantity demanded
will be zero in such a market.
12a. Complements
12b. Answer to problem 12b consists of the following two graphs:
14a. The supply of corn must be falling if output is falling and prices are rising. The fall in the
corn supply may be due to farmers switching over to soybean production in response to higher
soybean prices. The demand for soybeans must be increasing if the price rises when supply is
increasing.
14b.
16. The graph shows that there was a surplus of commercial real estate in the San Francisco
market. The difference between Q2 and Q1 is four million square feet. Whenever there is a
surplus in a market, we expect that the price will fall.
18.
20. Refrigeration allowed for the storage of perishable products. This removed some of the
supply during the peak season, shifting the supply curve to the left from S1 to S2 and driving the
price up from P1 to P2. During the off-season, the refrigerated supply could be offered for sale,
shifting right the relatively small supply from S3 to S4 and causing the price to fall from P3 to P4.
22.
24. The shift to the left of the U.S. supply curve from SUS1 to SUS2 increases the price from P1 to
P2. In the non-U.S. market, the demand rises from D1 to D2 because the price of a substitute
(American-grown cotton) had risen. This causes the movement along the non-U.S. supply curve
shown by the arrow. (The price of both types of cotton probably rose by about the same amount,
if they were close substitutes.)
26. The graph with the vertical demand curve is more likely to represent the market for the life-
saving drug. If the price of this good rises, patients are unlikely to reduce the quantity they
demand, but if the price of the BMW rises, households will reduce the quantity they demand as
they switch to buying other luxury cars.
Chapter 4
Answers to End of Chapter Problems and Applications
2a. The equilibrium quantity is 100 million crates of kumquats per year and the equilibrium price
is $20 per crate. Kumquat producers receive revenue of $2 billion.
b. Consumers will purchase 80 million crates of kumquats. Kumquat producers receive revenue
of $2.4 billion.
c. Kumquat producers will receive the revenue in b. plus $30 x 100 million crates, for a total of
$5.4 billion. The government will spend $3 billion purchasing the 100 million crates of surplus
kumquats.
4a. As the supply curve shifts inward from S1 to S2, consumer surplus will decrease from A + B +
C + D to A.
b. Producer surplus will change from E + F + G to B + E. This may be an increase or a decrease,
depending on the size of B relative to F + G.
c. Total surplus will fall from A + B + C + D + E + F + G to A + B + E.
6. Under the current program, farmers receive subsidy payments whether they are rich or poor,
and rich farmers are likely to receive more payments. One alternative would be for the
government to give subsidies only to farmers whose incomes would otherwise be below a certain
level.
8a. In the absence of control, the equilibrium price is $800 and the equilibrium quantity is
300,000. In this case, every renter who is willing to pay the market price of $800 will find an
apartment and every landlord willing to accept the market price of $800 will find a renter. The
demand and supply curve are shown in the figure, along with the equilibrium price (PE) and
quantity (QE).
b. At a price ceiling of $600, the quantity demanded is 350,000 but the quantity supplied is only
250,000, so there is a shortage of 100,000 apartments.
c. If all landlords abide by the law, the quantity sold will fall to 250,000. As shown in the figure,
consumer surplus with the price ceiling enforced is A + C, producer surplus is E, and deadweight
loss is B + D.
d. If landlords supply only 250,000 apartments and ignore the price ceiling, they can charge
$1000. This is the amount that renters are willing to pay for the 250,000th apartment.
10. The statement is correct.
12. The advocate’s reasoning is incorrect. A fall in price will increase the quantity of kidney
transplants demanded, but not the demand for kidney transplants. Although the price ceiling will
increase the quantity demanded, the quantity supplied will fall, and fewer kidney transplants will
occur. In the graph, without a price ceiling, patients receive Q1 kidney transplants, and with a
price ceiling, patients receive only Q2.
14. The people who benefit from rent controls are politically powerful and have resisted seeing
them abolished.
16 a. With no price ceiling, the equilibrium price of gasoline would be $3.00 per gallon and the
quantity demanded and quantity supplied would both be 40 million gallons per month. With a
price ceiling and no black market, the price of gasoline is $2.00 per gallon, the quantity
demanded is 45 million gallons, the quantity supplied is 30 million gallons, and there is a
shortage of 15 million gallons.
b. Consumer surplus = A + B + C, producer surplus = D, and deadweight loss = E + F.
c. Consumer surplus = A, producer surplus = B + C + D, and deadweight loss = E + F.
d. They are, at least in the short run, as long as a black market does not develop, because their
consumer surplus with the price ceiling is A + B + C, but without the ceiling it would be only A +
B + E. (C is larger than E. E’s area is 0.5 x 10,000,000 x $2.00 = $10,000,000, while C = $1.00
x 30,000,000 = $30,000,000.)
18. For many years the family farm was considered the social and moral backbone of the country.
This may account for the special help family farmers receive from the government.
(Alternatively, it may be because states with a lot of family farms are disproportionately
represented in the U.S. Senate.)
20a. The tax equals $1.25. This is the vertical distance between the two supply curves.
b. Producers receive $2.50 from consumers but keep only $1.25 after paying the tax to the
government.
c. Tax revenue = $1.25 x 18 billion = $22.5 billion.
22. If the demand curve is correct, the consumer surplus is infinite, because the willingness to pay
is infinite – unlike the other markets we’ve studied. (It’s pretty much impossible for the demand
curve to be vertical forever, however, because no one has an infinite amount of money to spend.)
24. If you could accurately measure it (a difficult task), economic surplus (the sum of producer
and consumer surplus) would be a great indicator of the well-being generated from economic
activity, since it sums up all the value created from economic activity. The most economically
efficient country would have the highest amount of total surplus.
Answers to Appendix Problems and Applications
2. The minimum wage will have the larger impact in the top figure. Because its demand curve is
so flat (elastic), employers will reduce the quantity of labor demanded considerably more than in
the bottom figure.
4a. Deadweight loss = C + E. C = 0.5 x $1 x 10,000 = $5000. E = 0.5 x $1 x 10,000 = $5000.
b, c, and d. Consumer surplus without the price floor is A + B + C, and with the price floor
remaining, consumer surplus is A. Producer surplus without the price floor is D + E + F, and
with the price floor it is B + D + F. Thus area B of consumer surplus is transferred from
consumers to producers. B = $1 x 10,000 = $10,000. D = $1 x 10,000.
Chapter 5
Answers to End-of-Chapter Problems and Applications
2. Drinking excessive amounts of alcohol is an example of consumption generating a negative
externality. One example of production generating a positive externality is the production of
honey, as described in Making the Connection 5-2.
4. There is a positive externality in production. Because of the way premium cable channels are
marketed, a hit program on one channel will increase sales of other channels. It is possible to
think of a private agreement in which other cable channels assume some of the production costs
of hit shows, but negotiating such an agreement would be difficult.
6. Yes, assuming that the marginal benefit does not drop to zero before all of that type of
pollution is eliminated.
8. By market failures, she means that an unregulated market will result in more than the
economically efficient amount of wetlands and forests being developed. Habitat loss refers to the
conversion of wetlands and forests into developed land. Because the market fails to take into
account the external cost of lost forests and wetlands, an inefficiently large quantity of land (Q1)
is developed. The efficient level of land development is Q2, which is determined by the
intersection of demand and S2.
10. You will disagree because the marginal benefit of reducing sulfur dioxide emissions all the
way to zero will be very low, but the marginal cost will be very high.
12. The managers of firms in the Communist system were usually rewarded for fulfilling
production quotas. They were usually not penalized for any pollution they might generate. In
addition, because individuals had limited – if any – rights to private property, there were fewer
checks on polluting the land, water, and air than under a market system.
14a. The tax should be the amount necessary to shift up the supply curve from S1 to S2. That
amount is $7.50 – $7.15 = $0.35 per item dry-cleaned.
14b. The deadweight loss from excessive dry cleaning arises because the efficient amount of
items to dry clean is 600,000 per week, but the market outcome is 750,000 per week. The
deadweight loss equals the amount by which the marginal social cost (S2) of cleaning the last
150,000 items exceeds the marginal benefit (which equals the demand curve). This is shown by
area A of the figure: 0.5 x $0.35 x 150,000 = $26,250.
16a. The optimal level of a public good occurs at the quantity where the public’s marginal benefit
from the good – as represented by the demand curve – is equal to the marginal cost of providing
the good. To solve the problem, we need to know the demand curve for the city park and the
marginal cost of providing the park. To calculate their overall demand, we need to add the dollar
amounts that Jill and Joe are willing to pay at each quantity:
Demand
Price per acre Number of acres
$25 0
23 1
21 2
19 3
17 4
15 5
13 6
11 7
9 8
7 9
The graph shows that the optimal size park – where marginal cost equals marginal benefit – is 4
acres.
16b. The marginal cost of supplying the second acre is $13. But the demand curve tells us that
the marginal benefit Jill and Joe receive from the second acre is $21. Because the marginal
benefit to society is well above the additional cost, 2 acres cannot be the optimal size city park.
18. People who produce and distribute new ideas have trouble capturing all of the benefits from
the new ideas. As a result, they lack the incentive to produce the optimal quantity of new ideas.
20. The total amount of sulfur dioxide pollution would decline because some allowances would
no longer be available. Because the demand for allowances would increase, the price will rise.
22.
The efficient amount of alcohol consumption is Q2, but because the negative externality is
ignored actual consumption is Q1. The deadweight loss is area A.
24. Private goods include mail delivery (you’ll be excluded if you don’t use a stamp), education
in a private school, hiking in a park surrounded by a fence, and an apple. A TV broadcast and
hiking in a park without a fence are public goods. Education in a public school is a common
resource good – at least for people within the school district who won’t be excluded. It is rival
because as more students crowd into a classroom, the amount of attention the teacher gives to
each student declines. In cases where it isn’t rival, it would be a public good for those who are
eligible.
Chapter 6
Answers to End-of-Chapter Problems and Applications
2. Elasticity = (percentage change in quantity)/(percentage change in price) = –3%/4% = –0.75.
Because price rises and demand is price inelastic, revenue received by suppliers has increased.
4. (Percentage change in price) x (price elasticity of demand) = percentage change in quantity.
20% x –0.28 = –5.6%, so the reduction in quantity demanded will be 5.6%.
6a.
6b. Based on this information, we don’t know much at all about the price elasticity of demand for
roses. The demand curve has shifted, so the rise in the quantity of roses demanded is not caused
by the rise in their price – and we can’t calculate the demand elasticity. We have a movement
along the supply curve, so we can calculate the price elasticity of supply for roses.
The supply elasticity = (percentage change in quantity supplied)/(percentage change in price) =
5.112
000,19000,8000,30
−
−
= 667.0158.1
= 1.74.
The fact that the elasticity doesn’t have a negative sign is a reminder that this isn’t the price
elasticity of demand – which would be negative.
8a. Along D1 between points A and C, the price elasticity of demand is
75.200.350.2
250200300
−
−
= 1818.04.0
− = –2.2.
Along D2 between points A and B, the elasticity of demand is
75.200.350.2
5.212200225
−
−
= 1818.01176.0
− = –0.65.
Because the quantity response is much larger to the same price cut, demand curve D1 is much
more elastic.
8b. Along D1, revenue climbs from $3 x 200 = $600 to $2.50 x 300 = $750. Revenue rises as the
price is cut, because this demand curve is elastic. Along D2, revenue falls from $600 to $2.50 x
225 = $562.50. Revenue falls as the price is cut, because D2 is inelastic.
10. Percentage change in quantity = 1000/500,500 = .001998. Percentage change in price = –
1/439.5 = –0.002275. The price elasticity of demand = 0.001998/–0.002275 = –0.88. According
to this calculation, the demand for Model T’s was price inelastic.
12. If this happens, demand must be price elastic.
14. Milk and prescription medicine are likely to be price inelastic due to lack of substitutes, but
frozen cheese pizza and cola are likely to be price elastic because they have good substitutes.
16. The publisher’s analysis is only correct in the unlikely event that demand is perfectly
inelastic.
18. Using the midpoint formula, the percentage change in price was 000,21000,2000,40 −
x 100 =
181%. So, the price elasticity of demand = %95%181−
= –1.91.
20. His reasoning is correct: The revenue of kumquat producers will fall.
22 a. Lettuce – the percentage change in quantity demanded is much larger for lettuce.
b. Positive. As the price of lettuce rises, the quantity demanded for the other green veggies rises,
so they are substitutes.
24 a. and c. are substitutes, so the cross-price elasticities will be positive; b. and d. are
complements, so the cross-price elasticities will be negative.
26. Bread, Pepsi, personal computers, Mercedes Benz automobiles is the most likely order.
28a. For the Route 22 Bridge:
Percentage change in quantity demanded = 514,476337,519691,433 −
= –0.179 or -18%.
Percentage change in price =
75.0$50.0$00.1$ −
= .667 or 66.7%.
Therefore, the price elasticity of demand = %7.66%18−
= –0.27.
For the Interstate 78 Bridge:
Percentage change in quantity demanded = 5.139,692022,728257,656 −
= –0.1037 or -10.4%.
Percentage change in price = 66.7%.
Therefore, the price elasticity of demand = %7.66%4.10−
= –0.16.
b. Total revenue in November was (519,337 + 728,022) x $0.50 = $623,679.50. In December
total revenue increased to (433,691 + 656,257) x $1 = $1,089,948. The increase occurred because
the demand at both bridges is price inelastic.
Chapter 7
Answers to End-of-Chapter Problems and Applications
2. Limited liability is a major advantage of incorporation and some people fear that it gives the
corporation’s owners a license to skip out on their debts. Eliminating limited liability would
probably cripple an advanced economy like ours, however. Most investors would be very wary
of buying stock in corporations unless they were very, very sure about the personal integrity of
top management and the financial soundness of the firm. Investors will generally be less willing
to lend to (buy bonds from) a firm with limited liability – knowing that they are less likely to be
paid back. On the other hand, investors will generally be more willing to buy stock in a firm with
limited liability – knowing that their personal fortune isn’t at stake, that they cannot lose more
than what they’ve invested in the firm.
4. You would be better off if you had bought the stock, because it will have increased in value,
while the interest on the bonds will have remained the same.
6. The argument is correct, unless an independent board of directors is able to monitor closely the
top managers or has set up an effective incentive system.
8. If chief executives do not own much stock in a company, they may have goals other than
maximizing profits. Boards of directors attempt to design compensation packages that will
reward chief executives for maximizing profits – for example, paying bonuses based on profits.
An owner-manager will already have an incentive to maximize profits, so he or she may not need
bonuses or stock options as a further inducement..
10. Firms will weigh the costs and benefits of raising money in each way. If owners can borrow
money at a lower cost, they will do this – especially since they don’t need to give up control of
the firm. However, investors are wary of firms that borrow too much and in which the owners
don’t have much of a financial stake.
12. This bond had a smaller coupon than other bonds issued more recently.
14. The statement is false. These shares were traded in the secondary market (the NASDAQ), so
the money went from the new shareholder to the previous shareholder. The money didn’t go to
Microsoft.
16. Generally accepted accounting principles are the rules that corporations are required to follow
in preparing their financial statements. Top managers generally benefit from having earnings as
large as possible, which allow them to earn higher salaries and bonuses and which increase the
value of their stock options. Stockholders who relied on inflated earnings reports when they
decided to buy WorldCom stock would have been hurt. Stockholders who sold WorldCom stock
after its price had risen because of inflated earnings reports, but before the manipulation of the
earnings reports had been publicly revealed, would have benefited.
18. Investors reward a company by their willingness to buy its stock and bonds, and punish a
company by selling its stock and bonds. By doing this, investors can have an effect on the value
of a company, and, thereby, on the compensation of the members of its board of directors and top
managers.
20.
a. Google’s stock price will fall because its expected future revenues and profits have fallen.
b. Stock price will rise because Google’s after-tax profits will rise.
c. Stock price will fall because expected future profits will fall.
d. Stock price will rise because expected revenues and profits will rise.
e. Stock price will be unchanged.
Answers to Appendix Problems and Applications
2. Because the formula divides by the interest rate, a higher interest rate yields a lower present
value.
4a. 25 x $1,440,000 = $36,000,000.
b. $13,070,937.63
c. $20,295,280.18
d. 6.24% gives a present value of almost exactly $18 million.
6. Stock price = )( GrowthRatei
Dividend−
= )02.010.0(
00.2$−
= $2/0.08 = $25. If the interest rate is 5%,
the maximum price you would pay is $2/0.03 = $66.66. Following this pattern, a lower interest
rate means that stock prices should rise.
8. Figures are in millions.
Revenue $19,065
Revenue from company restaurants $14,224
Revenue from franchised restaurants $4,841
Operating expenses
Cost of operating company restaurants $12,100
Interest expense $338
General and administrative $1,980
Cost of restaurant leases $1,003
Other operating costs $441
Total operating expenses $15,862
Operating income $3,203
Income before income taxes $3,203
Income taxes $924
Net income (accounting profit) $2,279
10. Answer: Google’s current ratio = 340$693,2$ = 7.9 . Firms with a low current ratio may
have difficult raising cash quickly.
Chapter 8
Answers to End-of-Chapter Problems and Applications
2. Japan had a comparative advantage in producing these goods, even though it did not have an
absolute advantage.
4. The opportunity cost of producing one good is the amount of the other good that has to be
given up. To produce one cell phone, Japan has to give up 0.5 MP3 players. To produce one
MP3 player, Japan has to give up two cell phones. To produce one cell phone, the United States
has to give up two MP3 players. To produce one MP3 player, the United States has to give up
0.5 cell phones.
6. By trading this way with the Chinese, Americans aren’t “surrendering” the more efficient
industries. These industries aren’t more efficient; they produce their goods at a higher
opportunity cost than in China. By moving resources out of these industries, the U.S. can do even
better – freeing up these resources to produce the goods in which it has the comparative
advantage and using this output to trade for goods that can be produced at a lower opportunity
cost elsewhere. A country increases its income by specializing in products where it has a
comparative advantage, even if this means giving up production of products where it has an
absolute advantage, but not a comparative advantage.
8. “Protectionist demands” refers to the use of tariffs, quotas and non-tariff barriers to protect
domestic industries. Unilateral free trade would benefit American consumers because they could
buy some goods more cheaply than before. In fact, it would benefit all the countries involved by
allowing America’s overseas trading partners to specialize more in the goods and services in
which they have the lowest opportunity cost and to trade them for goods that the U.S. can
produce at a lower opportunity cost.
10. The commentator is confusing absolute advantage and comparative advantage. Every
country, no matter how poor, will have a comparative advantage is producing some good. (Often
countries are poor because they cannot or will not trade with others.)
12a.
12b.
Before the tariff, the quantity of beef sold by U.S. producers is Q1; after the tariff, the quantity of
beef sold by U.S. producers is Q3. Before the tariff, the quantity of beef imported = Q2 – Q1; after
the tariff, the quantity of beef imported = Q4 – Q3.
12c. The winners from the tariff are domestic producers of beef and the government, which
collects the tariff revenue. The losers are domestic consumers of beef.
14. Those industries that use sugar in their products will be hurt by the sugar quota. Producers of
artificial sweeteners and other substitutes for sugar (like corn syrup) will be helped by the sugar
quota because it raises the price of sugar.
16. These subsidies allow European farmers to sell sugar for a lower price than they otherwise
would. This pushes down the world price for sugar and allows European producers to retain part
of the sugar market they would otherwise lose to South African and other foreign producers of
sugar.
18. The student’s reasoning is flawed. The prices charged by U.S. producers will rise by as much
or more if foreign competition is entirely eliminated. With a tariff the price in the U.S. will be
PUS instead of the world price, PW. If imports are banned altogether the price in the U.S. will rise
to PNT, the no-trade price. Also, if the imported goods are a different style or quality than the U.S.
goods, U.S. consumers will face a reduced variety of goods.
20. Economists usually measure the standard of living by the goods and services that the typical
person in a country is able to purchase. In this case, the Chinese government will have reduced
the standard of living of its own people and raised the standard of living of people in the United
States. The standard of living in the U.S. is raised because U.S. consumers are able to purchase
Chinese goods at a price below their true cost of production. The standard of living in China is
reduced because the government has used some of the country’s resources to cover the cost of
goods that are sent to the United States. Subsidizing exports is almost like giving money to
foreign consumers.
22. Trade allows a country to specialize in producing the goods in which it has a comparative
advantage. After trading, the country can consume more. In this sense it can “produce more with
less” and consumers win. See Table 8-4 for a good example of trade leading to gains for
consumers.
24. While society as a whole benefits, not everyone wins from expanding international trade.
Some domestic suppliers and their workers lose if they are driven out of the market (and into new
markets) by lower-priced imports.
Answers to Appendix Problems and Applications
2. Both automobiles and farm machinery were assembled using unskilled labor. U.S. labor costs
were the highest in the world, so assembling these products overseas gave the firms access to
low-cost labor. In addition, both products are expensive to ship, so manufacturing overseas
would reduce these costs and operating overseas would avoid tariff barriers. Also, overseas
consumers probably would be more willing and able to purchase products manufactured in their
own countries.
4. A U.S. firm might produce at a higher cost in another country if this allowed the firm to avoid
tariffs or if it feared future tariffs or other trade restrictions. Also, foreign consumers probably
would be more willing and able to purchase the firm’s product if it is manufactured in their
country.
6. In some ways expanding internationally is similar to expanding into a new product market.
Expanding into a new product market requires learning about new technologies and the tastes and
preferences of consumers in a new area. International expansion also requires learning about the
tastes and preferencs of new consumers, but the existing technology can often be applied in the
new market. Among the key differences are that international expansion often brings added
complications due to language, cultural and legal differences, and potential trade restrictions,
while expanding a product line rarely brings these complications.
Chapter 9
Answers to End of Chapter Problems and Applications
2. The last dollar saved should give them the same additional utility as the last dollar spent on
goods and services.
4. To maximize utility, Joe needs to make sure that the marginal utility per dollar is the same for
both Twinkies and Ho-Hos, and that he has spent the $16. We can make the analysis easier by
constructing a table.
Twinkies Ho-Hos
Quantity MU MU/P MU MU/P
1 10 10 18 9
2 8 8 16 8
3 6 6 14 7
4 4 4 12 6
5 2 2 10 5
6 0 0 8 4
7 0 0 6 3
8 0 0 4 2
9 0 0 2 1
10 0 0 0 0
Joe will maximize utility by buying four packs of Twinkies and six packs of Ho-Hos.
6. The substitution effect is likely to be much larger than the income effect. The drop in price of
nearly 15 percent is fairly big and will make Fritos relatively cheaper in comparison to other
similar snacks, inducing much substitution. The income effect will be tiny because most people
don’t spend a large fraction of their incomes on Fritos, so their purchasing power will barely rise.
8. If pizza were an inferior good, the income effect would lead you to consume less pizza as its
price falls. It is possible that a lower price would lead you to buy less if the income effect were
larger than the substitution effect. In reality, the income effect is never larger than the
substitution effect.
10. Network externalities arise when the usefulness of a product increases with the number of
consumers who use it. This is very likely for fax machines, and perhaps for board games (the
game is more interesting if all your friends are playing it, too), and both types of television sets,
but not for dog food.
12. The endowment effect describes the tendency of people to be unwilling to sell something they
already own for a price that is greater than the price they would be willing to pay to buy the good
if they didn’t already own it. Your little brother is exhibiting the endowment effect. He is
unwilling to sell the card for $20, even though he would not spend $20 to buy it.
14. The restaurant will want to appear to be acting fairly to local customers because they are
likely to return often. Businesses will sometimes set their prices below the equilibrium level,
giving up some profits in the short run to keep their customers happy and increase their profits in
the long run. On the other hand, the visitors to the Olympics are unlikely to return to the area, so
the restaurant doesn’t lose their business if they think that it is behaving unfairly by raising its
prices to the temporarily-high equilibrium level.
16. The firm may do this because customers think this is fair. It may also do this because a sell-
out creates even more interest in the movie, bringing in more customers later in the week. The
excess demanders from Spider-Man 3 may also decide to stay and watch their second-favorite
movie, while planning to return to see Spider-Man 3 later.
18. What you paid for your ticket is a sunk cost and, if you are rational, it should not affect your
decision whether to attend.
20. You will want to compare the marginal benefit of spending $4,000 to have the car repaired
against the benefits you would receive from spending the $4,000 in other ways, such as by
making a down payment on another car. The price you paid for your car is irrelevant to the
decision of whether you should repair it.
22. The statement is probably correct. People often eat food like potato chips in the present
because they tell themselves – unrealistically – that they intend to eat better in the future. If they
were more realistic about their future actions, they would eat fewer potato chips today and the
demand curve would shift to the left.
24. The $3000 in recent refinancing fees is a sunk cost and should be ignored.
Answers to Appendix Problems and Applications
2a.
b. The income increase causes a parallel outward shift in the budget constraint. Because both
goods are normal, higher income leads to greater consumption of both goods, shown by the move
from the initial point of consumption (A) to a point like B.
c. If ice cream is inferior, consumption of it will fall as income rises, moving Jacob from point A
to a point like C. (Indifference curves I2 and I3 may cross because they represent two different
tastes.)
4a. The prices of the goods can be found by dividing Nikki’s budget by the maximum amount
that she can buy of each good. The price of blouses = $200/5 = $40. The price of skirts =
$200/10 = $20.
b. Four blouses and two skirts cannot be the optimal point because the indifference curve going
through this point isn’t tangent to Nikki’s budget constraint. She can reach higher indifference
curves at points between the two intersections of her budget constraint and the indifference curve
that is shown.
6. Because prices and incomes are unchanged for the typical consumer, the budget constraint
doesn’t change. Instead, tastes change so the indifference curves change. The initial point of
tangency was at a very low level of prune juice consumption, point A. But the new point of
tangency is at a much higher level of prune juice consumption, point B.
