Macroeconomics. Case. Fair. 10Th Ed. Solutions to Problems Chs.1-4

Solutions to Problems CHAPTER 1 1. Answers will vary, but should include the notion that each activity provides benefits in the form of satisfaction or additional income, but also takes time away from the pursuit of other activities (opportunity cost). Time spent on each activity is limited because the additional benefit of devoting an extra unit of time to any one activity falls as more time is devoted to the activity. Hence, as more and more time is spent on one activity, it will become increasingly attractive to devote the next unit of time to some other activity. 2. Answers will vary. 3. (a) normative (b) positive (c) normative 4. The average cost is $0.89 ($16.99 / 19). The marginal cost is $0. 5. (a) The state should allow the market to provide what people want. Since gambling is not mandatory, only those who want to gamble will do so. Tax revenues that arise from casino gambling are paid voluntarily. (b) Some argue that casino gambling is associated with criminal activity that has a cost to the community at large. In addition, gambling can be addictive, and sometimes entices those who can least afford it to participate. These concerns bear on the efficiency argument to the extent that there are costs from gambling not reflected in the price of gambling. These costs could potentially affect the community at large (e.g., more crime, the social cost of addiction) or the individual (to the extent that gambling creates unwanted addiction). (c) Legalized gambling has a number of fairness issues around it. First, a lot of people want the services that a gambling casinos provide. It is clearly entertainment that many people like. (If you don‘t like Texas Hold ‗em just watch it or go away.) But many consider gambling to be bad. They think it is fair to tax ―sins.‖ A big fairness issue is that people who gamble may be addicted to it. Like many other issues of it‘s kind there are positives and negatives from the fairness side. First, since gamblers tend to be in low and moderate income brackets, gambling taxes and receipts would likely be regressive. That is, higher income households would pay a smaller percent of their income in taxes. Equity arguments are always the subject of disagreement. 6. (a) Tuition (which could have been spent on other things), forgone wages, study time, and so on. (b) All the money (gas, depreciation of the car, and so on) could have been spent on other items; time spent en route could have been used for other activities. (c) A better grade, no headache, perhaps admission to a better grad school, a higher-paying job. He has traded off an investment in human capital (staying in to study) for present consumption (going to the party). (d) The other goods and services that Annie could buy with $200. (e) The $1 million could have been invested in other profit-making ventures or projects, or it could have been put in the bank or loaned to someone else with interest. (f) From the standpoint of the store, Alex is free. From Alex‘s standpoint, he gives up other uses of time and wages that could be earned elsewhere. 7. Answers will vary.

8. (a) This statement is an example of the post hoc fallacy. Just because Jeremy washed his car and the next day it rained, this does not mean that washing the car caused the rain to fall. (b) This statement is an example of the fallacy of composition, which is the erroneous belief that what is true for a part is necessarily true for the whole. Requiring all students to attend after-school tutoring would waste resources on those students who do not need tutoring, and would not be a good use of time for those students. (c) This statement confuses correlation and causation. There is most likely a correlation between people who drive hybrid automobiles and the amount of trash they recycle, since both are environmentally friendly actions, but the act of recycling trash is not the cause of people driving hybrid automobiles. 9. (a) This is an example of a microeconomic concern since it addresses output for a specific firm in a specific industry. (b) This is an example of a macroeconomic concern since it addresses a potential tax that would impact the entire nation. (c) This is an example of a macroeconomic concern since it addresses the inflation rate, which impacts the whole economy. (d) This is an example of a microeconomic concern since it addresses potential employment growth in a particular industry. 10. Carlos Slim Helu does face scarcity because resources are limited. A person‘s net worth does not change the fact that everyone faces scarcity. Consider one of our most important resources—time. There are only 24 hours in a day, and everyone, including Helu, must live their lives under this constraint, making decisions about how to spend this time. CHAPTER 1 APPENDIX 1. The slopes are as follows: line 1: 5; line 2: –5; line 3: 1; line 4: –1; line 5: slope is 1 as X goes from 0 to 20, and –1 as X goes from 20 to 40; line 6: –250.

2. Answers will vary.

(a) Negative slope. As price rises, quantity of apples purchased falls. (b) Positive (and declining) slope. As income rises, taxes rise; but the rise in taxes is less at higher incomes than at lower incomes. (c) Negative (and declining) slope. As mortgage rates fall, home sales increase, but the increase in home sales is more at lower mortgage rates than at higher mortgage rates. (d) Negative, then positive slope. As young children get older, they run faster, but as adults get older (beyond a certain age), they run slower. (e) Positive slope. Greater sunshine leads to greater corn yield. (f) Positive, then negative slope. Up to a point, more fertilizer increases corn yield, but beyond a certain point, adding more fertilizer actually decreases the yield. 3.

4. (a) The relationship between the price of roses and the quantity of roses sold by Fiona‘s Flowers is a positive relationship because as the price increases, the quantity sold increases.

(b) The slope of the line is equal to 0.5. Price per dozen 60 50 40 30 20 10 0 10 20 30 40 50 60 70 80 90 100

Quantity (dozens)

5. At point A, the tangent line runs through the points (p = 34, q = 20) and (p = 24, q = 45). The slope is therefore (34 – 24) / (20 – 45) = 10 / –25 = –0.4. At point B, the tangent line runs through the points (p = 12, q = 90) and (p = 5, q = 140). The slope is therefore (12 – 5) / (90 – 140) = 7 / –50 = –0.14. CHAPTER 2 1. Answers will vary, but should include: (a) the value of alternative uses of time (studying for other classes, leisure). (b) the value of alternative uses of time (studying, other forms of leisure). (c) the value of the other goods and services that could have been purchased with the money used to purchase the car. (d) the value of the goods and services that taxpayers could have purchased with the additional property tax revenue. (e) the value of other goods and services that the governments could have purchased with the money used to purchase the space station, or the value of the goods and services that taxpayers could have purchased with the tax revenue used to finance the space station. (f) the foregone salary that you would have earned and the value of the alternative uses of time. 2. Disagree. To be efficient, an economy must produce what people want. This means that in addition to operating on the ppf (resources are fully employed, best technology is being used), the economy must be operating at the right point on the ppf. 3. Opportunity costs of building the bridge include the value of other goods and services that the government of Mallsburg could have purchased with $25 million or the value of the goods and services that taxpayers could have purchased with the tax revenue used to finance the bridge, as well as any inefficiencies created by the income tax by reducing incentives to work. In addition, the construction itself may impose costs—delays, noise, and so on—and presumably shopkeepers located near the older bridge will lose as consumers shift their business toward the main mall. Benefits of the new bridge include reduced travel time for shoppers and commuting time for workers, increased sales tax revenues for Mallsburg, and gains for shopkeepers located in the main mall. There may be other quality of life costs and benefits that are difficult to sort out without more information. The bridge may have environmental effects that could be positive (less pollution from idling traffic) or negative (depending on where and how the bridge is

constructed). Also, there may be effects on the look and lifestyle of the town. A bridge through the center of the town is likely to affect daily living in any number of ways. Beyond the costs and benefits, there is always the question of distribution. Is the income tax system of Mallsburg equitable? Are the shopkeepers likely to lose more than those likely to gain? Economists would typically argue for governments to undertake projects whose costs exceed their benefits, and then address any concerns about income distribution separately. To the extent these concerns are not addressed, however, you might consider writing about the income distribution effects of the new bridge. 4. (a) For Kristen, the ―cost‖ of a pot holder is five wristbands; for Anna, the cost of a pot holder is six wristbands. Kristen has a comparative advantage in pot holders. (b) Anna has a comparative advantage in the production of wristbands because the opportunity cost (1/6 of a pot holder) is lower for Anna than it is for Kristen (1/5 of a pot holder). (c)

W

W

300 240

0

60 Kristen

P

0

P

40 Anna

(d) Kristen: 150 wristbands and 30 pot holders. Anna: 120 wristbands and 20 pot holders. Total wristbands = 270. Total pot holders = 50. (e) 285 wristbands and 51 pot holders. (f) Kristen should specialize in pot holder production and earn 60 x $5.50 = $330. Anna should specialize in wristband production and earn 240 x $1 = $240. Maximum combined revenue is $570. 5. (a) Sherice sacrifices the value of goods and services that could have been purchased with the income from work in order to obtain more leisure today. To the extent that this income will need to be replaced to finance her education, Sherice substitutes future work for present consumption (of leisure). On the other hand, if the time off improves Sherice‘s state of mind, she may be a more successful student, which may be pleasant in its own right, and may also provide monetary rewards (better job, better graduate school) in the future. (b) For Frank, the opportunity costs are the alternative uses of time spent working out and the forgone pleasure of consuming foods that are not part of the diet. Presumably, the present sacrifice yields a future benefit of better health and more enjoyment of leisure activities. (c) Time and money spent today on maintenance is an investment. By reducing resources available for consumption today, more resources will be available for Mei in the future (since repair costs will be lower and breakdowns less frequent). (d) Jim may get to work faster, but at the risk of an accident or ticket, which could be costly. Included in the potential cost of this behavior are the monetary, criminal, or psychological penalties (remorse or direct concern about the welfare of others) that Jim will pay if others are harmed.

6. (a) Blah Blah (b) Blah: fruit Figistan: timber (c)

(d) Figistan:

800 workers to timber 400 workers to fruit Produces 4,000 of each (800 x 5 = 4,000); (400 x 10 = 4,000) Blah: 900 workers to timber 300 workers to fruit Produces 9,000 of each (900 x 10 = 9,000); (300 x 30 = 9,000) These production points are shown on the graphs for part c. (e) Figistan moves all labor to timber and produces 6,000 board feet. Blah moves 450 out of timber into fruit. 450 in fruit produces 13,500 baskets (450 x 30 = 13,500). 750 in timber produces 7,500 ft (750 x 10 = 7,500). Blah trades 4,200 baskets to Figistan for 1,800 board feet. Blah ends up with 9,300 of each (13,500 – 4,200 = 9,300 baskets of fruit; 7,500 + 1,800 = 9,300 board feet of timber). Figistan ends up with 4,200 of each (4,200 baskets of fruit from Blah; 6,000 – 1,800 = 4,200 board feet of timber). Both countries move beyond their individual ppfs. 7. (a) The ppf curve is a straight line intersecting the Y-axis at 1,000 units of luxury goods and intersecting the X-axis at 500 units of the necessity goods. These are the limits of production if all resources are used to produce only one good.

(b) Society‘s production could be inside the ppf as a result of (i) unemployment or underemployment of labor or (ii) inefficient production with full employment. With only one factor, the possibility of inefficient production means that workers are not using the best available technology to produce one or both goods. To move from inside the ppf to a point on the ppf, the economy would need to move to full employment or to adopt the most efficient production technology. (c) Answers will vary, but the decision should be based on the relative value of necessities and luxuries, as well as the degree of concern that enough necessities are produced to meet the needs of the population. Although this part does not address distribution, if too few necessities are produced, some people will not have enough necessities under any distribution scheme. (d) If left to the free market, income distribution will depend on some combination of individual effort and chance, where chance includes the possession of valuable abilities, opportunity, and inheritance. Each individual would have to find a job to earn income to command some of the economy‘s production. 8. (a) c, d, e (b) a, b, d, e, f (c) d, e (since they prefer meat); could also be c (d) e (e) b, c, d, e, f (f) b 9. (a)

(b) Yes, increasing opportunity cost applies. The opportunity cost of the first 15 million loaves of bread is 4 ovens; of the next 15 million loaves, 6 ovens; and so on. (c) Over time, as the number of ovens increases, the capacity to produce bread with the same quantity of other resources will also increase. Thus, the production possibilities curve will shift out horizontally to the right. The vertical intercept (maximum possible

oven production) will remain unchanged, but the horizontal intercept (maximum possible bread production) will increase. (d) See graph in part (a) above. (e) Before the introduction of the new technology, production of 22 ovens left enough resources to produce 45 loaves of bread. After the introduction of the new technology, production of 30 ovens leaves enough resources to produce 60 loaves of bread. 10. As stated in the Economics in Practice feature, producing a meal takes two basic ingredients: food and time. For individuals who work, the opportunity cost of time for preparing meals is high. For retired individuals, the opportunity cost of time shopping and preparing meals is lower. More time spent shopping for bargains will mean that retired individuals are likely to pay less for the same bundle of goods as individuals who work. 11. The key here is the opportunity cost of Dr. Falk‘s time. Every time Falk fills two cavities, he gives up the chance to whiten someone‘s teeth (since the cavities take 15 minutes and the whitening 30 minutes). But Falk earns $150 for the whitening and only nets $100 for the two cavities. Clearly, when Falk takes on cavity-filling, he has not been paying attention to the opportunity cost of his time in whitening. Falk should either raise the price of filling cavities (we will talk more about price in a later chapter), or concentrate on whitening teeth.

12. Even with winning free tickets to the Cowboys‘ games, you would still experience an opportunity cost each time you went to a game. This opportunity cost would be the highestvalued alternative that you must give up to attend each game. 13. A command economy is one in which the basic economic questions are answered by a central government. Through a combination of government ownership of state enterprises and central planning, the government, either directly or indirectly, sets output targets, incomes, and prices. A laissez-faire economy is one in which individual people and firms pursue their own self-interest, without any central direction or regulation. A laissez-faire economy implies a complete lack of government involvement, and the central institution through which the basic economic questions are answered is the market, where buyers and sellers interact and engage in exchange. No pure forms of either system exist in the world. In economies where the government plays a major role, individual enterprise sill exists and independent choice is still exercised, and no market economies exist without some form of government involvement and government regulation. 14. Rougarou experiences increasing opportunity costs because for every bushel of potatoes it produces, it must give up increasing amounts of turnips. When Rougarou moves from production alternative A to production alternative B, it gives up 10,000 bushels of turnips to gain 10,000 bushels of potatoes. When it moves from alternative B to alternative C, it must give up 20,000 bushels of turnips to gain 10,000 bushels of potatoes. From alternative C to D, 30,000 bushels of turnips are given up for 10,000 bushels of potatoes, and from D to E, 40,0000 bushels of turnips are given up for 10,000 bushels of potatoes. For each additional 10,000 bushels of potatoes Rougarou gains, the amount of turnips that must be given up increases. The increasing opportunity costs are shown on the graph with the concave production possibilities curve.

Turnips (thousands of bushels) 100 90 70

40

A B C D

0

E 10 20 30 40

Potatoes (thousands of bushels)

15. (a) Technological innovation allows the nation to produce more with existing resources, so the production possibilities curve would shift up and to the right. (b) An increase in unemployed workers does not change the production possibilities curve, but rather shifts the economy to a point inside the production possibilities curve. (c) A hurricane that destroys productive capacity in the nation will reduce the amount of production possible in the nation, and therefore shift the production possibilities curve down and to the left. (d) As the quality of education improves, so does the productivity of workers. Education can also be thought of as adding ―human capital‖ as an added resource. This moves the production possibilities curve up and to the right. (e) If all employers are required to increase the amount of paid vacation they must give employees, they will not be able to utilize resources as efficiently. The production possibilities curve will not shift, but the nation‘s production will move to a point inside the production possibilities curve. CHAPTER 3 1.

(a)

(b)

(c)

(d)

(e)

2.

(a)

(b) It depends on whether demand responds to the lower price and by how much. The diagram in (a) suggests that if price was lowered a substantial amount, the stadium would be filled. If demand is ―elastic‖ enough, the quantity demanded will increase by more than the fall in ticket price and revenues will rise. If demand is not responsive enough, the quantity demanded may not increase enough to offset the fall in ticket prices and revenues will fall. The easiest example of the latter would occur if demand were ―perfectly inelastic,‖ which implies that no one else would come to the game despite the lower price. (c) The price system was not allowed to work to ration the New York tickets. Some other rationing device must have been used. Perhaps people stood in line or queued. Perhaps

there was a lottery. In all likelihood, there would be a secondary market for the tickets (scalpers). You could no doubt find the tickets for sale online at a high price. 3. If the supply of new homes kept pace with the expanding demand, prices would remain constant. The supply curve shifts to the right at the same rate as the demand curve shifts to the right:

4. (a) Disagree. They are complements. An increase in the price of a complement for product X causes demand for product X to fall.

(b) Agree An increase in supply causes price to fall.

(c) Disagree. A fall in income will cause the demand for inferior goods to rise, pushing prices up Price S P1 P0 D1 D0

0

Q0

Q1

Quantity

(d) Disagree. Sure they can. Both steak and lobster are normal goods. An increase in the price of steak (a normal good) increases the demand for lobster (also a normal good).

(e) Disagree. Price could go down if the shift of supply was larger than the shift of demand. An increase in demand and an increase in supply may cause price to decrease.

(f) Agree. A decrease in the price of product A increases the demand for a complement (product B), increasing the price of product B.

5. If the price of tobacco is supported by limiting land used to grow it, then the supply curve for tobacco shifts to the left. The anti-smoking publicity works to shift the demand curve to the left. Both of these policies work together to reduce consumption of tobacco.

6. (a) See diagram below. (b) Price would fall until the quantity demanded and the quantity supplied were equal at some price below $200,000. In the diagram shown here that would be at $170,000. (c) Quantity demanded would drop but the new units put up for sale would stay the same and the inventory of unsold property would grow. We would see more signs in front of houses. If prices did not fall below $200,000, what is often called the ―sticky price,‖ supply might begin to shift downward as fewer units are built as the inventory builds. This is often called a ―quantity clearing market‖ instead of a price clearing market. (d) The only way that the inventory of unsold new homes will shrink is if more new homes are sold than new homes are produced. Thus, either household formations, the number of new households entering the market, exceeds new housing starts. That can happen if new starts drop sharply or if demand picks up. By late 2010 prices in the U.S. were still sticky and production was at a 50 year low.

7. (a) This sequence confuses changes in demand (shifts of the demand curve) with changes in quantity demanded (movements along a demand curve). First, a demand shift does cause price to rise. As price rises, the quantity supplied increases along the supply curve, and the quantity demanded declines along the new demand curve as the market moves to reestablish equilibrium. Nothing here suggests that demand shifts back down, or that prices will fall back to their original levels. (b) This sequence confuses a change in price (per unit) with a change in total spending on meat. When price falls, the quantity demanded increases along the demand curve. Thus, the total amount spent (price  quantity demanded) depends on whether quantity demanded goes up by more than price per unit falls. Total spending could increase if demand responds strongly to the lower price.

8.

9. (a)

Price

Quantity Demanded Quantity Supplied (in Millions) (in Millions) $.50 90 30 $1.00 80 50 $1.50 70 70 $2.00 60 90 $2.50 50 110 (b) Quantity demanded equals quantity supplied at P = $1.50, with quantity = 70 million dozen eggs.

(c)

10. (a)

The demand-side strategy (vouchers) results in higher rents. (b) Critics believe that the supply curve for low-income housing looks like this:

11. (a)

(b) Qd = Qs  300 – 20 P = 20P – 100  P = $10. Substitute P = $10 into either the demand or supply equation to get Q = 100. (c) With P = $15, producers would want to supply 20  15 – 100 = 200 pizzas, but consumers would want to buy 300 – 20  15 = 0 pizzas. There would be an excess supply of pizzas, which would bring the price down. As the price decreased, quantity supplied would decrease while quantity demanded would increase until both were equal at a price of $10 and a quantity of 100. (d) The new market demand for pizzas would be Qd = 600 – 40 P. (e) Qd = Qs  600 – 40 P = 20 P – 100  700/60 = $11.67. Substitute P  $11.67 into either the demand or supply equation to get Q = 133. 12. The explanation in the case of the strawberries and the case of the coats comes from the interaction of supply and demand. Demand for winter coats is highest in the fall and winter; that is, the market will purchase more coats at a given price during those times than in the summer. The demand curve representing the fall and winter is thus to the right of the demand for winter coats in the summer. With an upward-sloping supply curve for coats, we would expect the price to be higher in winter than in summer. Note that there is no reason to think the costs of making coats would be different during different seasons. For strawberries, however, the most important seasonal shift is in the supply curve. Summer is when strawberries grown in the United States are ready for market. In the winter, strawberries must be shipped from abroad, which is expensive. Thus, the supply curve for strawberries that we see in the summer is to the right of the winter supply curve. This leads to a lower price in the peak sales period for strawberries. You could illustrate answers with the following two diagrams.

13. The demand curve for newspapers in Baltimore might shift to the right if income levels in the area are rising, since we expect newspapers to be a normal good. Fewer substitutes for newspapers would also shift the curve to the right; perhaps television broadcasting is shifting away from news programs and toward reality shows. Finally, if the population of Baltimore is growing, that would also shift the demand curve to the right. 14. (a) When the price of a product changes, the quantity demanded changes. A reduction in the price of shoes would increase the quantity of shoes demanded. (b) Clearly for Tabitha 3-D TV is a normal or luxury good. Her income rose and she bought one. But what about market demand? If everybody were like Tabitha, 3D TV‘s would be a normal or luxury good, but we do not know that from the data given in the problem. A normal good is one where a rise in income among potential demanders leads to an increase in market demand. (c) The increase in the price of peaches decreases the quantity of peaches demanded. Since many consumers are now choosing to purchase plums, the increase in the price of peaches has increased the demand for plums, which in this instance are considered a substitute for peaches. (d) A change in tastes and preferences changes demand. The potential problem with the breaking system of the Galactica has reduced consumers‘ preference for this automobile, decreasing its demand. (e) A change in consumer expectations changes demand. Antonio expects his income may be decreasing in the near future and has chosen to not go on his annual vacation to Hawaii. Therefore, the demand for Hawaiian vacations has decreased.

15. (a) Price of shoes A

p1

B

p2

Demand 0

q1

Quantity of shoes

q2

(b)

(c) Price of peaches

Price of plums B

p2

A

p1

D2 D1

Demand 0

q2

q1

Quantity of peaches

0

Quantity of plums

(d) Price of Asteroid Galacticas

D2

D1

0

Quantity of Asteroid Galacticas

(e) Price of Hawaiian vacations

D2 0

D1 Quantity of Hawaiian vacations

16. The decrease in demand for large trucks and SUVs produced by General Motors was the result of several factors, including falling incomes, lower net worth, and rising oil prices. Falling income levels resulting from the recession gave consumers less income to spend in general, and the relatively expensive large truck and SUV segment of the automobile market definitely fell victim to these income changes. The recession also brought with it a decrease in wealth, or net worth, to many American consumers, and as net worth fell, consumer spending also fell, which impacted the entire market for new automobiles, trucks and SUVs included. Rising oil prices resulted in higher gasoline prices. Gasoline is a complementary good for automobiles, and when gas prices rise, consumers tend to shift away from those vehicles which tend to get relatively low gas mileage, such as large trucks and SUVs, to vehicles that get higher gas mileage, such as small cars and hybrid vehicles. The combination of falling income, declining net worth, and rising gas prices greatly contributed to the large decline in demand for large trucks and SUVs, and this subsequently led to GM‘s decision to significantly reduce the production of these vehicles.

17. Price $10 20 30 40

Quantity supplied by: Firm A Firm B Firm C 3 2 0 4 4 2 5 6 3 6 8 5

Firm D 2 3 4 5

Firm E 4 5 7 8

Market 11 18 25 32

Price of manicures

50

Market Supply

40 30 20 10 0 11 18

Quantity of manicures

25 32

18. The equilibrium price is $20 and the equilibrium quantity is 9 cameras. If the market price is $30, a surplus of (15 – 5) = 10 cameras would occur. If the market price is $15, a shortage of (11 – 6) = 5 cameras would occur. Price of cameras 35

Supply

30 Surplus = 10

25 20

Shortage = 5

15 10 Demand

5 0 3

6 9 12 15 18 21 24

Quantity of cameras

CHAPTER 4 1. (a) Price ($ millions)

Supply

51.6

Demand 0

Portrait d'Angel Fernández de Soto

1

(b) Price per pound ($) S1 Supply, S0 0.81 0.58

Demand 0

Q1

Q0

Quantity

(c) s

2. Disagree. Every demand curve hits the quantity axis because of diminishing marginal utility—at a price of zero, there is a limit to how much one can or wants to consume. The

argument that at some price, demand goes to zero explains why all demand curves hit the price axis. 3.

The diagram shows that some people are willing to pay a very high price (even higher than P*) for the tickets. Some nonprice rationing system was used to allocate the tickets to people willing to pay as little as Px. What a scalper does is pay those near Px more than they paid for the tickets and then sells the tickets to someone nearer or even above P*. Since both the buyers and sellers engage in the trade voluntarily, both are better off and the exchange is efficient.

4. The subsidy does increase the ―cost‖ of planting—there is now an opportunity cost. (By planting, the farmers must give up the subsidy.) The subsidy will clearly lead to fewer acres of production and higher farm prices. In effect, it shifts the supply curve to the left.

5. Disagree; this is not hard to explain. The law of demand does say that higher prices should lead to lower demand, but that refers to a change in the quantity demanded, a movement along a demand curve. An increase in demand (a rightward shift of the demand curve) would result in a higher price. Therefore, a sharp increase in the demand for apartments in New York City is entirely consistent with a sharp increase in rent, which is the price of those apartments. 6.

7.

8. (a)

(b) With free trade in oil, Americans would pay $70 per barrel. At this price, the U.S. demand schedule shows that Americans would buy 15 million barrels per day. The U.S. supply schedule shows that U.S. producers would supply 6 million barrels per day, with the remainder—9 million barrels—imported from foreign sources. (c) With a tax of $4 per barrel, Americans would have to pay $74 for imported oil. Quantity demanded would decrease from 15 million to 13 million barrels. Of this, American producers would supply 10 million barrels, whereas imports would be cut back from 9 million to 3 million barrels. The U.S. government would collect a tax of $4  3 million = $12 million per day. (d) American oil consumers are harmed by the tax; they are paying a higher price for oil. American oil producers are helped by the tax; they receive a higher price for oil, and this induces them to produce more oil. Foreign oil producers are harmed because Americans buy less imported oil. Finally, the U.S. government (and the U.S. taxpayer generally) benefit from the tax revenue. 9. (a) Using demand and supply data for the United States only, the equilibrium price is $76 and the equilibrium quantity is 12 million barrels.

(b) With a price ceiling of $74, quantity demanded equals 13 million barrels, while quantity supplied equals 10 million barrels. There is an excess demand of 3 million barrels. (c) Quantity supplied will determine the quantity purchased. In a market system, no one can be forced to buy or sell more than he or she wants to. Under conditions of excess demand, suppliers will supply only as much as they want, and some consumer demand will go unsatisfied.

10. At $8 and 6 million meals: CS = $18 million; PS = $18 million; total = $36 million. At 3 million meals: CS = $13.5 million; PS = $13.5 million; total = $27 million. Deadweight loss = $9 million

11. Those who predicted $4 a gallon by the end of 2008 were right. By the summer it was over $4.00. The price of oil (the major input into gasoline production) had risen to $147 a barrel as world demand seemed to outpace supply. But by August, oil had dropped to $114 per barrel, and gasoline prices were back below $4. Markets can be volatile. Why did it go back down? Part of the answer seems to be that the high prices themselves led to a big drop in energy consumption world wide. People drove less, and they bought more fuel efficient cars. The demand for gasoline and oil in general appears to be more elastic than most economists thought. It is also true that the world economy slowed significantly in 2008. Another debate that is not well understood yet is that the rise in ―hedge funds‖ that speculate in futures and options in oil may have driven prices up or down (you may want to search ―hedge funds‖ and read about them). 12. The demand for 5-day trips is most likely highest for cruises that depart on a Thursday and return on a Monday. People booking these trips can take a ―long weekend‖ and schedule vacation time for only 3 of the 5 days, missing less work than they would by traveling Monday through Friday. Since the supply of cabins on an individual ship is fixed, the higher demand increases the equilibrium price a cruise line is able to charge for these trips, increasing the per-passenger revenue the cruise line receives. Also, since the demand is most likely higher for these 5-day cruises and the supply of cabins on each ship is fixed, the cruise lines can increase the supply of cabins by providing more ships that offer these trips. Increasing the supply to meet the higher demand increases the overall revenue received by the cruise lines and explains the disproportionate number of cruises offered over these 5 days of the week. 13. First of all, waiting in line is not a very productive use of time. There is an opportunity cost. If tickets are available at a price below equilibrium, there is a shortage or excess demand at the current price. Let‘s suppose that the tickets are put on sale at $15 to be ―fair‖ to theater goers. Suppose A who is willing to pay $50 per ticket has a high time value and, therefore, doesn‘t buy the ticket. Someone else, B, stands in line and buys the ticket for $15 which is the maximum he is willing to pay. If A and B could get together, A could pay B $30 for the ticket. Both would be better off, and no one is worse off. Conversely, A could hire someone to sit in line for him. Generally, waiting in line seems like a bad idea in terms of economic efficiency.

Playing music to make it less costly encourages people to stand or sit in line rather than doing something more useful. It is taking resources to subsidize an unproductive activity. 14.

Equilibrium price is calculated as (40 – 5P = 10P – 20); 60 = 15P; P = 4. Equilibrium quantity is calculated as Qd = 40 – 5(4) = 40 – 20 = 20; or Qs = 10(4) – 20 = 40 – 20 = 20, so Q = 20. Consumer surplus = ½ (8 – 4) x 20 = 40. Producer surplus = ½ (4 – 2) x 20 = 20. 15. The decrease in supply will cause the price to increase and the quantity to decrease. This will reduce consumer surplus. Before the oil spill, consumer surplus was equal to areas A + B + E + F. After the oil spill, consumer surplus is reduced to only area A. Because price increased and quantity decreased, the change in producer surplus is uncertain. Prior to the oil spill, producer surplus was equal to the areas C + D + G. After the oil spill, producer surplus is equal to the areas B + C. If areas D + G are greater than area B, producer surplus will increase. If areas D + G are less than area B, producer surplus will decrease. Price of fish

S2 A

S1

P2 B E

P1

F

C

G D

Demand

0 Q2

Q1

Quantity of fish

16. (a) Consumer surplus is represented by area A on the graph and is equal to ½ (6 – 4) x 18 = $18 million. Producer surplus is represented by area B on the graph and is equal to ½ (4 – 2) x 18 = $18 million. Price of DVDs

7 6 5

Supply A

4 3

B Demand

2 1 0 3 6 9 12 15 18 21 24 27 30

Quantity of DVDs (millions)

(b) With underproduction of 9 million DVDs, consumer surplus is represented by areas C + D, and is equal to ½(6 – 5) x 9 + (5 – 4) x 9 = $13.5 million. Producer surplus is now represented by areas E + F, and is equal to (4 – 3) x 9 + ½(3 – 2) x 9 = $13.5 million. The deadweight loss is equal to areas G + H, and is equal to ½(5 – 4) x (18 – 9) + ½(4 – 3) x (18 – 9) = $9 million.

Price of DVDs

7 6

Supply

C

5 D

4

G H

E

3

F

Demand

2 1 0 3 6 9 12 15 18 21 24 27 30

Quantity of DVDs (millions)

(c) With overproduction of 27 million units, the original amounts of consumer surplus and producer surplus do not change and are still represented by areas A and B, respectively, with values of $18 million each. The deadweight loss is now located to the right of equilibrium, and is represented by area J, with a value of ½(5 – 4) x (27 – 18) + ½(4 – 3) x (27 – 18) = $9 million. Price of DVDs 7 6 5

Supply A J

4 B 3

Deman d

2 1 0

3 6 9 12 15 18 21 24 27 30

Quantity of DVDs (millions)

17. (a) If a price ceiling is set at $10 per bushel, the market price would not be able to rise to its equilibrium price. Quantity demanded would rise to 20 million bushels and quantity supplied would fall to 4 million bushels, resulting in a shortage of (20 – 4) = 16 million bushels. If a price ceiling is set at $30 per bushel, the market would remain at its equilibrium price of $20 per bushel with an equilibrium quantity of 14 million bushels. A price ceiling set above the equilibrium price will therefore have no impact on the market. (b) If a price floor is set at $30 per bushel, the market price would not be able to fall to its equilibrium price. Quantity demanded would fall to 8 million bushels and quantity supplied would rise to 22 million bushels, resulting in a surplus of (22 – 8) = 14 million bushels. If a price floor is set at $10 per bushel, the market would remain at its equilibrium price of $20 per bushel with an equilibrium quantity of 14 million bushels. A price floor set below the equilibrium price will therefore have no impact on the market. 18. The total revenue is given for 2009: $221.7 million. According to the article, the total revenue fell by $23 million from 2008 to 2009, so the total revenue in 2008 was $221.7 million + $23 million = $244.7 million. The total catch is given for 2009: 75.6 million pounds. The total catch for 2009 increased by 8 percent from 2008, so the total catch in 2008 had to be 75.6 / 1.08 = 70.0 million pounds. The market price can be found by dividing total revenue by the output. For 2009, the market price is equal to $221.7 million divided by an output of 75.6 million. So, the 2009 market price was $2.93 / pound. For 2008, the market price was $244.7 million / 70.0 million = $3.50 / pound. From 2008 to 2009, output increased from 70.0 million pounds to 75.6 million pounds, and price decreased from $3.50 per pound to $2.93 per pound.