econ midterm 1 textbook problems

• Suppose a decrease in consumers' incomes causes a decrease in the demand for chicken and an increase in the demand for potatoes. Which good is inferior and which is normal? How will the equilibrium price and quantity change for each good?

Chicken is a normal good. Income and demand are positively related. Potatoes, however, are inferior due to the inverse relationship between income and the demand for potatoes. The equilibrium price and equilibrium quantity of chicken will fall while the equilibrium price and equilibrium quantity of potatoes will rise.

The rule of 72 gives the approximate doubling time of a variable if you know its rate of growth. For example, if the population of a country is 200 million and the rate of growth of its population is 2 percent per year, then it will take approximately 36 years for the country's population to reach 400 million. Assume that per capita income in 2006 is $40,000 in the United States and $5,000 in China. If the per capita growth rate in China is 9 percent a year, how long will it take for China to reach a per capita income level that is equivalent to the United States' 2006 per capita income level?

For China, about 24 years. The calculation is 72/9 = 8 years to double from $5,000 to $10,000, plus another 8 years to double from $10,000 to $20,000, plus another 8 years to double from $20,000 to $40,000.

A small country produces only two goods, cars and cakes. Given its limited resources, this country has the following production possibilities: picture Draw the production possibilities curve. • Suppose car production uses mainly machines and cake production uses mainly labor. Show what happens to the curve when the number of machines increases, but the amount of labor remains unchanged.

The outer line shows that with the addition of machines, but not labor, the production possibilities curve for car production increases much more than cake production. Adding machines to the economy primarily increases car production but it may also permit some labor in car production to shift to cake production, adding to the overall production of cakes.

• When you look at the economies of the United States, Europe, or Japan, you see most of the ingredients of a market economy. For example, consider bicycles. Prices in the bicycle market are free to vary; people have property rights to the bicycles they buy; many people sell bicycles; many bicycles sold in the United States, Europe, and Japan come from other countries; the government regulates bicycle use (no bicycles on the freeways, for example); and bicycle production takes place within firms with many workers. Replace bicycles with another good or service of your choosing and comment on whether the statement is still true.

"Bicycle" can be replaced here by any of thousands of items, such as food, clothing, appliances, and electronics. Decisions about what, how, and for whom to produce are largely made by individual consumers and firms, with the government providing 1) broad rules for activity and 2) some goods and services that may not result from market activity.

Suppose that Lesotho, an extremely poor African country, announces that it will ignore patents held by companies in the Western Hemisphere on HIV/AIDS-related pharmaceuticals and instead will buy copies of the drugs produced by Indian firms. • Would you support such a decision? Why? • Would your answer change if, instead of Lesotho, it was a richer country like Thailand or Brazil that was threatening to break the patent? Why?

Answers may vary. Those who write no should discuss how pirated copies create disincentives for research and development. Those who say yes should discus the value of human capital (health) in the creation of new technology. Answers will vary with similar logic as applied in part a.

• Suppose that an unanticipated bout of good weather results in almost ideal growing conditions, leading to a substantial increase in the supply of wheat in the United States. Refer to Figure 7.6 in the text • Draw a supply and demand diagram to show what will happen to the equilibrium price and quantity of wheat in the United States, assuming that the demand curve does not shift. Suppose the U.S. government observes that the price of wheat is likely to fall rapidly and imposes a price floor equal to the original equilibrium price. What effect does the price floor have on the quantity supplied and demanded of wheat? How are consumer and producer surplus affected by the price floor? Graphically show the deadweight loss created by the price floor.

Assume that the blue line is the supply curve after the good weather. The price falls from E to D (assuming the original supply crossed demand at point F) and the quantity rises from Qd to the quantity directly below point C. The price floor keeps the quantity demanded equal to Qd but quantity supplied is Qs. As shown in the figure, consumer surplus is reduced by CDEF while producer surplus is increased by DEFI and decreased by CGI, with the net effect depending on the size of the two areas. CFG is the deadweight loss.

Suppose Tina and Julia can produce brownies and romantic poems (which can be combined to make a lovely gift) in the following combinations in a given week: picture in phone If Tina and Julia are each currently producing two poems per week, how many brownies are they producing? What is the total production of brownies and poems between them? If Tina and Julia are each producing 2 poems, Tina will produce 30 brownies and Julia will produce 15 brownies. • Is there a possibility for increasing production? Why or why not? • Suppose Julia completely specializes in producing poems and Tina completely specializes in producing brownies. What will be their total production of brownies and poems?

If Tina and Julia are each producing 2 poems, Tina will produce 30 brownies and Julia will produce 15 brownies. If Tina writes no poems, she will make 50 brownies. Julia can increase the number of poems she writes to 4 poems per week, but her brownie productivity will only go down to 5. This will hold poems constant, but increase brownies Total production will be 5 poems and 50 brownies

• More than 20 states have laws outlawing price gouging during a state of emergency, which might be declared after a hurricane or an earthquake. These laws prohibit price increases on basic necessities, such as gasoline. Which of the arguments against price ceilings might not be significant during a state of emergency?

It might be the case that during an emergency, consumers have little concern over the quality of a good that is available.

Food items often have low elasticities of demand. Suppose excellent weather leads to bumper yields of agricultural crops. Why might farmers complain about market conditions?

Low price elasticity indicates that demand is inelastic. As the bumper crop increase the supply with a stable demand, the resulting fall in the price of a product will reduce total revenue across the whole market. Farmers as a group will have less revenue and this might be the reason for complaints.

If we estimate the share of capital in income incorrectly, it can affect our estimation of how large technological growth has been. Rework Problem 4 assuming that capital's share is one-fourth. Explain intuitively the difference in the importance of technology.

Of the 2 percentage point decline in productivity, .75 percentage points was due to the slowdown in the growth rate of capital and 1.25 percentage points was due to the slowdown in the growth rate of technology. With the capital growth rate having a lower impact, the growth rate of technology must have a larger influence.

• Given the following income elasticities of demand, would you classify the following goods as normal or inferior goods?

Potatoes: elasticity = 0.5 Normal good • Pinto beans: elasticity = -0.1 Inferior good • Bottled water: elasticity = 1.1 Normal good • Video cameras: elasticity = 1.4 Normal good

Analyze the distribution of income, using the household incomes in the following table. Rank the families by income. Compute the percentage of total income going to the poorest 20 percent of the families, the second 20 percent, and the richest 20 percent. Draw a Lorenz curve for the income distribution of these 10 families. Is their distribution more equal or less equal than that of the U.S. population as a whole?

The distribution appears to be almost the same, but the families in problem 10 have a smaller percentage of income in the top quintile than is the case for the United States. First 20 percent has 6 percent. Second 20 percent has 11 percent. Third 20 percent has 16 percent. Fourth 20 percent has 28 percent. Fifth 20 percent has 39 percent.

Using the answers you provided above for Problems 1 and 2, verify that the three efficiency conditions are satisfied for the ukulele market.

The first efficiency condition: MB = MC = 80 on the last item produced. The second efficiency condition: while not exactly obtained, MC is never above 80 on units produced and equals 80 on the last unit produced. The third efficiency condition: while not exactly obtained, MB is never below 80 on units consumed and equals 80 on the last united consumed.

Suppose the government decides to increase the payroll tax paid by employers. If the labor supply curve has a low elasticity, what will happen to the workers' wages? Who actually bears the burden of the tax, the workers or the firms? Would it be different if the labor supply had a high elasticity?

The labor demand curve would shift downward by the amount of the tax. The steeper the supply curve (and, thus, the relatively less elastic), the more wages fall. More of the burden is on workers. A flatter supply curve would shift more of the burden to employers.

Determine which of the following four sentences use the terminology of the supply and demand model correctly.

The price of bicycles rose, and therefore the demand for bicycles went down. • The demand for bicycles increased, and therefore the price went up. • The price of bicycles fell, decreasing the supply of bicycles. • The supply of bicycles increased, and therefore the price of bicycles fell. Sentences (b) and (d) use the correct terminology. In sentence a replace demand with quantity demanded, and in sentence c replace supply with quantity supplied to be correct.

A change in the relative price of a good matters more than the change in the price of a good in analyzing the change in spending on that good. Show that the relative price of a good can fall on occasions when the price of that good is rising, falling, or remaining unchanged, using numerical examples from the table in Problem 2.

The relative price was lower than the previous year six times in Problem 2. In those six cases, when viewed from the previous year the (absolute) price increased in 1999, 2000, 2003 and 2005, decreased in 2006, and was unchanged in 1998.

consider following table What is the tax due on a taxable income of $25,000? • What is the tax due on a taxable income of $50,000? • Why does the tax more than double when the income doubles? • Is this tax system progressive?

What is the tax due on a taxable income of $25,000? $3,372.50. The formula is $755 + 0.15($25,000 - $7,550). • What is the tax due on a taxable income of $50,000? $9,057.50. The formula is $4,220 + 0 .25($50,000 - $30,650). • Why does the tax more than double when the income doubles? The tax more than doubles because some of the additional income is taxed at a higher rate. • Is this tax system progressive? Yes, this tax system is progressive.

Which of the following types of government spending are likely to help economic growth? Why? • Military spending on advertising for recruits • Military spending on laser research • Funding for a nationwide computer network • Subsidies for a national opera company • Extra funding for education programs

Which of the following types of government spending are likely to help economic growth? Why? • Military spending on advertising for recruits Not likely to help, because neither capital nor technology is affected. • Military spending on laser research Yes, this will help, since research spills over, provided it is nonrivalrous and nonexclusive. • Funding for a nationwide computer network Same as part b, since it potentially affects rates of diffusion and innovation. Such a network could also change the way firms are organized and improve human capital. • Subsidies for a national opera company Same as part a. • Extra funding for education programs Yes, provided funding improves and increases the stock of human capital

Michelle Wie, a teenage golf prodigy who earned $16 million in endorsements and $4 million in prize money and appearance fees in 2006, announced that she would enroll as a student at Stanford University in the fall of 2007. What was her opportunity cost of a year of college? How does it compare to your opportunity cost of a year of college?

You and Michelle Wie are both giving up the money you would have earned by working for a year. For Ms. Wie, that is approximately 20 million dollars. For you, it is probably substantially less.

• Suppose you notice that the prices of fresh fish have been rising while the amounts sold have been falling in recent years. Which of the following is the best explanation for this?

• Consumer preferences have shifted in favor of fish because it is healthier than red meat. • Fishermen are prevented from using the most advanced equipment because of concerns about overfishing. • Consumers' incomes have risen faster than inflation. • Consumers have become worried about mercury levels in fish. Answer (b) is correct. This causes a decrease in supply. As the supply curve shifts left along a stable demand curve, price will rise while the equilibrium quantity will fall.

Identify each of the following as either a capital saving or a labor-saving technological change:

• A public library installs an electronic machine that can automatically scan books for library patrons. Labor saving, since fewer attendants are needed. • A university upgrades its email system to be accessible by users with smartphones. Capital saving, since fewer answering machines are needed. • A university reorganizes its departments to cut back on administrative costs. Labor saving, since fewer administrators are needed.

Suppose the prices of illegal drugs fall in your community at the same time that police drug seizures increase. Which is the best explanation for this?

• Fewer drugs are being supplied locally. • Police arrests are removing more drug dealers. • Police arrests are reducing drug consumption sharply. • More drugs are being supplied locally. Answer d is correct. There is an increase in supply. As the supply curve shifts right along a stable demand curve, price will fall while the equilibrium quantity will rise.

Consider a country in which capital per hour of work from 1950 to 1973 grew by 3 percent per year and output per hour of work grew by about 3 percent per year. Suppose that from 1973 to 1991, capital per hour of work did not grow at all and output per hour of work grew by about 1 percent per year. How much of the slowdown in productivity (output per hour of work) growth was due to technological change? Explain. (Assume that the coefficient on capital in the growth accounting formula is one-third.)

Half of the slowdown in productivity growth was due to the slowdown in technology growth. While the capital per hour of work went from growth of 3 percent to zero percent, only one-third of the capital growth rate impacts productivity. So, of the 2 percentage point decline in productivity, 1 percentage point was due to the slowdown in the growth rate of capital and 1 percentage point was due to the slowdown in the growth rate of technology.

Suppose you have two boxes of chocolate chip cookies and a friend of yours has 2 gallons of milk. Explain how you can both gain from trade. Is this a gain from trade through better allocation or greater production?

If my friend keeps both gallons of milk, he can probably only drink one before the other goes bad. If I keep both boxes of cookies, I can probably only eat one before the other goes stale. If I trade him a box of cookies for one of his gallons of milk, we can each enjoy many delicious cookies-and-milk experiences and not waste resources. This is an example of better allocation; neither I nor my friend are producing anything.

Donors of organs for transplantation or medical research are prohibited from charging a price for these organs (there is a price ceiling of zero). Will this result in a shortage? How will the market cope with the shortage?

Yes, at a zero price the quantity demanded will be larger than the quantity supplied. There will be a rise in nonprice forms of allocation. For example, there are waiting lists for some organs.

Firm A and firm B both produce the same product with the following total costs: Consider a situation in which the market price is $3 and four units are produced in total: Firm A produces two units, and firm B produces two units. • Explain why this situation is not Pareto efficient. Come up with two different production allocations for the two firms that allow the four items to be produced at a lower overall total cost. Which of these two allocations would be the outcome in a competitive market in which both firms maximized profits? • How would the actions of the two firms be coordinated in a competitive market to achieve this outcome?

If each firm produces 2 units, the marginal costs are not equal. At this production allocation each firm is losing money (firm A $2 and firm B $3). But, if firm A makes 3 units and firm B makes 1 unit, firm 8 is no worse off and firm B is better off (firm A still has loss of $2, while firm B only loses $2). Firm A could produce all 4 units at an overall cost of $15 compared to the cost of $17, or Firm A could produce 3 units and Firm B could produce 1 unit at an overall cost of $16. The second option. Marginal costs need to be equal across the two producers. All firms face the same price in a competitive market. Each firm, to maximize profit, will want to make the output where P = MC. So, in the free market, these activities will be coordinated by the independent action of each firm.

• Consider the following data for a supply curve: Use the midpoint formula to calculate the price elasticity of supply between a price of $7 and $8. • Use the midpoint formula to calculate the price elasticity of supply between a price of $3 and $4. • How does supply elasticity change as you move up the supply curve? • Why does the supply elasticity change even though the slope of the supply curve is unchanged as you move up the supply curve?

Use the midpoint formula to calculate the price elasticity of supply between a price of $7 and $8. Elasticity between $7 and $8: 1.1538. • Use the midpoint formula to calculate the price elasticity of supply between a price of $3 and $4. Elasticity between $3 and $4: 1.4. • How does supply elasticity change as you move up the supply curve? Elasticity falls. • Why does the supply elasticity change even though the slope of the supply curve is unchanged as you move up the supply curve? The elasticity changes along a linear supply curve because the base (what the changes in price and quantity are relative to) changes. Elasticity is not the same as slope; it is the relative change in quantity supplied divided by the relative change in price.

Calculate the cross-price elasticity for the following goods. Are they substitutes or complements? • The price of movie theater tickets goes up by 10 percent, causing the quantity demanded for video rentals to go up by 4 percent. • The price of computers falls by 20 percent, causing the quantity demanded of software to increase by 15 percent. The price of apples falls by 5 percent, causing the quantity demanded of pears to fall by 5 percent. The price of ice cream falls by 6 percent, causing the quantity demanded of frozen yogurt to fall by 1 percent.

0.4. Cross elasticity is positive. Movie tickets and video rentals are substitutes. • The price of computers falls by 20 percent, causing the quantity demanded of software to increase by 15 percent. -0.75. Cross elasticity is negative. Computers and software are complements. The price of apples falls by 5 percent, causing the quantity demanded of pears to fall by 5 percent. 1.0 Cross elasticity is positive. Apples and pears are substitutes. The price of ice cream falls by 6 percent, causing the quantity demanded of frozen yogurt to fall by 1 percent. 0.1667. Cross elasticity is positive. Ice cream and frozen yogurt are substitutes.

Determine whether each of the following is consumption, investment, or neither. Explain your answer.

A landscaping company buys a new four-wheel-drive vehicle to carry fertilizer and flowers. Investment, because it is business spending for the purchase of physical capital • A doctor buys a new four-wheel-drive vehicle to use on vacation. Consumption, because it occurs in a household • A family puts a new kitchen in their house. This is consumption, because the individuals purchase the new items for the kitchen. • The campus bookstore increases its inventory of textbooks. This is investment, because of the addition to business inventory. • Your parents purchase their dream home, newly built to their specification by a local contractor. This is investment because of the special category called new residential construction, • Your parents buy a vacation home from a friend who had owned that home for years. Neither, because it wasn't produced this year

A phenomenon of the twentieth-century U.S. economy was the replacement of home production by production purchased through markets. • Give an example of a food item that was widely produced by family members in 1915 and that was widely purchased from businesses by 2015. • Give an example of a clothing item that was widely produced by family members in 1915 and that was widely purchased from businesses by 2015. • Give an example of a service that was widely produced by family members in 1915 and that was widely purchased from businesses by 2015. • How does the replacement of home production with production purchased through markets affect real GDP? How does it affect the usefulness of comparisons of real GDP per capita today with the same measure a hundred years ago? • The economies of some countries in the twenty-first century are more similar to the U.S. economy in 1915 than they are to the U.S. economy in 2015. How useful are comparisons between real GDP in the United States and in these economies?

A phenomenon of the twentieth-century U.S. economy was the replacement of home production by production purchased through markets. • Give an example of a food item that was widely produced by family members in 1915 and that was widely purchased from businesses by 2015. Answers will vary. Breakfast foods such as bacon and eggs may be appropriate, along with fruits and vegtables. • Give an example of a clothing item that was widely produced by family members in 1915 and that was widely purchased from businesses by 2015. Answers will vary. Shirts, dresses, pants, socks, gloves, and scarves are appropriate. • Give an example of a service that was widely produced by family members in 1915 and that was widely purchased from businesses by 2015. Answers will vary. Plumbing repair, pest control, and day care are appropriate. • How does the replacement of home production with production purchased through markets affect real GDP? How does it affect the usefulness of comparisons of real GDP per capita today with the same measure a hundred years ago? Real GDP rises when there is a switch to market production from home production. Given all other factors, the resulting increase in real GDP hasn't increased the standard of living because no additional goods and services have been produced. • The economies of some countries in the twenty-first century are more similar to the U.S. economy in 1915 than they are to the U.S. economy in 2015. How useful are comparisons between real GDP in the United States and in these economies? The comparison is not very useful because the standard of living is vastly different between countries.

• Allison will graduate from high school next June. She has ranked her three possible post-graduation plans in the following order: (1) work for two years at a consulting job in her hometown paying $20,000 per year, (2) attend a local community college for two years, spending $5,000 per year on tuition and expenses, and (3) travel around the world tutoring a rock star's child for pay of $5,000 per year. What is the opportunity cost of her choice?

Allison's choice to take the consulting job at $20,000 a year for two years has an opportunity cost of -$5000 (the money she saves on a year of tuition) and the unquantified costs of delaying her education by two years (or more, if she continues to work at the consulting firm when two years have passed). Choice 3 is not an opportunity cost, as only the next most desirable option is given up.

Most developing countries have low saving rates and governments that run budget deficits. What will be required for such countries to have large increases in their capital stocks? What will happen if industrial countries' saving rates decline as well? How does this affect the developing countries' prospects for catching up?

Developing economies must increase investment and capital either through higher saving rates or through investment from abroad. If, at the same time, the industrialized nations have lower savings rates, investment from abroad is reduced for developing nations, making the prospect for catch-up remote.

Consider the market for automatic teller machine (ATM) services in a city. The price is the fee for a cash withdrawal. • Sketch the demand curve and the supply curve for ATM transactions. • How is the equilibrium price determined? • If the town council imposes a ban on ATM fees— equivalent to a price ceiling in this market—what happens to quantity supplied and quantity demanded? Economists frequently argue against price controls because of the shortages and associated problems that they create. What are some of the potentially negative side effects of interference in the ATM market?

Equilibrium is determined by competition between buyers and sellers. The presence of shortages or surpluses results in price adjustments until the market clears. A ban on fees increases the quantity demanded and decreases the quantity supplied. As a result, a shortage is created equal to Q1-Q0. Banks incur costs when they provide ATM services. When a ban on fees is used, banks earn no revenue from transactions but incur costs. Therefore, banks are discouraged from providing ATM services. This may mean machines, if maintained at all, will not be serviced as often and customers will not be able to get cash when desired.

In the same market, three sellers (John, George, and Ringo) have the marginal cost (MC) schedules shown below. If the equilibrium price is $80, calculate the following: • The quantity produced by each seller. • The producer surplus for each seller. • The producer surplus for the market as a whole.

If the equilibrium price is $80, calculate the following: • The quantity produced by each seller. John will sell 2, George will sell 3, and Ringo will sell 3. • The producer surplus for each seller. John's surplus is (80 - 30) + (80 - 60) = 70, George's surplus is (80 - 20) + (80 - 50) + (80-80) = 90, and Ringo's surplus is (80 - 10) + (80 - 40) + (80 - 70) = 120. • The producer surplus for the market as a whole.

High international prices for soybeans in recent years led many Argentinean farmers to switch land that had been used as pasture to raise cattle to soybean production. This resulted in a shortfall in the supply of beef. Refer to Figure 7-8 in the text. • Draw a supply and demand diagram to show what will happen to the equilibrium price and quantity of beef in Argentina, assuming that the demand curve does not shift.

On the basis of the information in the problem, the supply curve shifts to the left. Assume that the blue line is the supply curve after this shift has occurred. The price rises from H to D and the quantity falls from Qd to the value directly below point C.

Suppose that in a competitive market for ukuleles, three buyers (Peter, Paul, and Mary) have the marginal benefit (MB) schedules below. If the equilibrium price is $80, calculate the following: • The quantity purchased by each buyer. • The consumer surplus for each buyer. • The consumer surplus for the market as a whole.

If the equilibrium price is $80, calculate the following: • The quantity purchased by each buyer. Peter buys 3, Paul buys 3, and Mary buys 2. • The consumer surplus for each buyer. Peter's surplus is (150 - 80) + (120 - 80) + (90 - 80) = 120, Paul's surplus is (140 - 80) + (110 - 80) + (80 - 80) = 90, and Mary's surplus is (130 - 80) + (100 - 80) = 70. • The consumer surplus for the market as a whole. Total consumer surplus is 280.

In the United States, corn often is used as an ingredient in animal feed for livestock. Why does an increase in the use of corn to make ethanol, an additive that is used in gasoline, raise the price of meat? Use supply and demand curves for the corn market and the meat market to explain your answer.

In the corn market the demand curve shifts right along a stable supply curve, increasing the price of corn. In the meat market, the supply curve shifts left reflecting a decrease in supply due to higher input costs. With a stable demand curve for meat, the supply shifting left will result in a higher price of meat.

Consider the following table, which provides the price of chicken and the price of all foods from 1996 to 2006. picture on phone Calculate the relative price of chicken for each year using the formula below plot relative price of chicken What can you say about how the price of chicken has varied in comparison to the price of all foods in the decade from 1996 to 2006.

Over the long term of the whole data series the relative price has fallen, while in a few shorter-term periods the either did not change or actually increased. An economic model of the data should attempt to explain both the long-term trend and the short-term variability.

he table here shows how output (those cells not bolded) depends on capital and labor. • Using the table, draw the production function Y = F (L) when the capital stock (K) is 50. What do you observe about the shape of the production function? • Now draw three similar curves that correspond to a capital stock of 100, 150, and 200. What happens to the production function? • Using the diagrams you drew above, indicate the diminishing returns to labor and to capital.

See the left side of the below graph. The shape is such that the curve begins to flatten out as more labor is added. See the right side of Graph 21-1. As the capital stock increases the production function shifts up. If labor is plotted on the x-axis and output on the y-axis, diminishing returns to labor is seen as the flattening of any one curve and diminishing returns to capital is seen as smaller and smaller shift in the curve for equal increments to capital.

The following table gives the income distribution in Brazil and in Australia. Draw the Lorenz curve for each. Which country has the larger Gini coefficient?

The Gini coefficient is larger for Brazil because there is greater income inequality. The curve is farther from the line of complete equality than the line of Australia

The board of directors of an airline wishes to increase revenue. One group favors cutting airfares, and the other group favors raising airfares. What are the assumptions each group is making about the price elasticity of demand?

The group who wish to cut fares is assuming that the elasticity of demand for airline seats is elastic, so that many more seats are filled as the price is reduced. Because there is a relatively large increase in passengers as the fare is cut, revenues increase. Since the costs of servicing more passengers are relatively stable in an aircraft that is already scheduled to fly, profits will rise. If the demand is inelastic, revenues will decline as fares are cut. However, revenues will increase as the airfare is increased. Once again, because of the relative stability of costs for an aircraft that is already scheduled to fly, profits will rise.

Consider Problem 5. Suppose that there is a drought in Sri Lanka that reduces the supply of tea by 400 billion pounds at every price. Suppose demand does not change. • Write down in a table the new supply schedule for tea. Find the new equilibrium price and the new equilibrium quantity. Explain how the market adjusts to the new equilibrium. • Graph the new supply curve along with the old supply curve and the demand curve. • Show the change in the equilibrium price and the equilibrium quantity on the graph. Did the equilibrium quantity change by more or less than the change in supply? Show how you arrived at your answer using both the table and the supply and demand diagram that you drew.

The new equilibrium price is $0.37. The equilibrium quantity is 600. At the original price of $0.36 the quantity demanded is 700 and the new quantity supplied is 300. This shortage means the price will rise. The equilibrium quantity changed by less than the change in supply. Note at the price of $0.36 the supply fell by 400 units, but the resulting increase in price due to the shortage means the quantity supplied will rise by 300 on the new schedule and curve while the quantity demanded falls by 100 units.

Compare a market in which supply and demand are very (but not perfectly) inelastic to one in which supply and demand are very (but not perfectly) elastic. Suppose the government decides to impose a price floor $1 above the equilibrium price in each of these markets. Compare, diagrammatically, the surpluses that result. In which market is the surplus larger?

The surplus AB is much smaller than the surplus CD. The surplus CD is larger because the demand and supply curves are relatively more elastic (flatter in slope).

Suppose that the United States has 200 million units of labor and Mexico has 100 million units, and that the production of wheat and strawberries per unit of labor in the United States and Mexico is as follows: What is the shape of the production possibilities curve for each country? What does this shape imply about the nature of the trade-off between wheat and strawberries? Is this a realistic assumption? Explain. • Which country has a comparative advantage in wheat production? Why? • With free trade between the United States and Mexico, is it possible that 1 bushel of wheat will trade for 1 pint of strawberries? Why or why not? • Suppose the free trade price is 1 bushel of wheat for 2 pints of strawberries. Draw a diagram indicating the production possibilities curve with and without trade.

The slope of the curves reflects the opportunity cost of production. The opportunity cost of a pint of strawberries for Mexico is 1/3 a bushel of wheat; for the United States the opportunity cost of a pint of strawberries is 2/3 a bushel of wheat. This constant slope is not realistic because opportunity costs rise as a country moves toward specializing in the production of one good. • Which country has a comparative advantage in wheat production? Why? The United States should specialize in wheat because its opportunity cost for 1 bushel of wheat is 1.5 pints of strawberries. Mexico's opportunity cost for 1 bushel of wheat is 3 pints of strawberries. Since the United States sacrifices less to make wheat, it should specialize in wheat production. Mexico sacrifices less wheat to make strawberries (see part a), so Mexico should specialize in strawberry production. • With free trade between the United States and Mexico, is it possible that 1 bushel of wheat will trade for 1 pint of strawberries? Why or why not? Mexico would love a 1 to 1 trade. Internal to Mexico giving up 3 pints would return 1 bushel, but with trade the 3 pints would return 3 bushels. The United States will not like these terms. Internally 2 bushels of wheat yield 3 pints, but with trade the yield would only be 2 pints. Why trade and be worse off? The price for 1 bushel of wheat, with trade, will settle somewhere between 1.5 and 3 pints of strawberries. • Suppose the free trade price is 1 bushel of wheat for 2 pints of strawberries. Draw a diagram indicating the production possibilities curve with and without trade. •

The U.S. states have moved toward one another in real income per capita over the past 100 years, but the countries of the world have not. What differences between state borders and country borders might explain this problem?

There is a greater degree of variability in laws, geography, and governments between countries than between states. Capital is more mobile between states compared to countries because of differences in interest rates, exchange rates, and governments. The political structure is more homogeneous between states than countries.

• Plot on a scatter diagram the data for the Asian countries that appear below. Does a catch-up line appear in the scatter diagram?

This graph shows that there is a definite catch-up line, but it has a good deal of variability.

Suppose you wanted to modify the Bertrand and Mullainathan study to focus on gender discrimination. Describe the "experiment" that you would run. Also be sure to explain how the ceteris paribus assumption is involved in terms of the names you would choose for the men and for the women.

To test gender one could run an experiment where resumes were sent out in which the individual had similar sounding names (to hold race constant), similar experiences (holding resume quality constant), but different genders. This format would only allow gender to vary, hence testing for its effect.

• Consider the following data for a demand curve: Use the midpoint formula to calculate the elasticity between a price • Use the midpoint formula to calculate the elasticity between a price of $3 and $4. • Because this is a linear demand curve, why does the elasticity change? • At what point is price times quantity maximized? What is the elasticity at that point?

Use the midpoint formula to calculate the elasticity between a price of $10 and $11. The percentage change in quantity demanded is [20 - 10]/[(20 + 10)/2] = 10/15 and the percentage change in price is [10 - 11]/[(10 + 11)/2] = -1/10.5. The elasticity (ignoring the negative sign) is [10/15]/[1/10.5] = 7. • Use the midpoint formula to calculate the elasticity between a price of $3 and $4. Elasticity between $3 and $4 is 0.41. • Because this is a linear demand curve, why does the elasticity change? The slope of a linear function is constant. However, elasticity is not just the slope of the curve. So, elasticity can change even though the slope is constant. Note that each time the price changes by $1 the quantity changes by 10 units. This is why the slope is constant between each successive point. But, the change of 10 units from point to point represents smaller and smaller percentage changes. Moving down the table means the $1 change in price will be a larger percentage change the farther down the table one moves. Thus, the elasticity changes because of the changing base of each percentage change calculation • At what point is price times quantity maximized? What is the elasticity at that point? The point where total revenue is maximized is P = 6 and Q = 60. Starting from a price of $7 the elasticity is 1.2 and starting from a price of $5 the elasticity is 0.85. Perhaps the elasticity is unitary when we consider smaller than $1 changes in price.

• What is the tax due for a couple if each spouse has a taxable income of $25,000? • Use the results from the preceding question to compare the tax the couple would have paid if they were not married (and filed as single persons) to the amount of tax they pay as a married couple (filing jointly). • What is the tax due for a couple if one spouse has a taxable income of $50,000 and the other spouse has no taxable income? • Does the tax system treat households making the same amount of income in an identical manner? Can it do so while remaining a progressive system?

• What is the tax due for a couple if each spouse has a taxable income of $25,000? $6,745. The formula is $1,510 + 0.25($50,000 - $15,100). • Use the results from the preceding question to compare the tax the couple would have paid if they were not married (and filed as single persons) to the amount of tax they pay as a married couple (filing jointly). The tax is the same since $6,745 = 2($3,372.50). • What is the tax due for a couple if one spouse has a taxable income of $50,000 and the other spouse has no taxable income? The tax is the same, namely, $6,745. • Does the tax system treat households making the same amount of income in an identical manner? Can it do so while remaining a progressive system? Yes, the tax code does treat households making the same amount of income in an identical manner. This is not inconsistent with a progressive tax system.

Determine whether each of the following would be included in GDP, and explain why or why not.

• You buy a used CD from a friend. Not included; the CD is used and so already counted. • You purchase a song from an online music provider like iTunes. Included; this is a new sale • You cook a romantic dinner for two on Valentine's Day. Not included; the production of the meal did not occur in a market context. • You buy a nice bottle of French wine to serve with dinner. Not included; the bottle of French wine is an import and therefore not included. • You take your mom out to brunch on Mother's Day. Included; the production of the meal occurs in a market context. • The restaurant where you intend to go for brunch purchases strawberries, which it intends to serve at the brunch, from a local vendor. Not included, because the strawberries present an intermediate good

Suppose decreased production of oil in the Middle East causes the price of oil to rise around the world. Explain how this change in the price signals information to U.S. producers of various goods, provides incentives to U.S. producers of various goods, and affects the distribution of income.

A higher price of oil signals makers of products where oil is an input, such as in the production of gasoline, that the cost of production will increase. This increase lowers incentives to produce these types of goods. At the same time, there is more incentive to explore for and drill for oil in the United States. Income will shift from oil users to oil producers, and the cost of goods that require shipping will also increase.

• Consider an economic model of donut production. Show how to represent this model graphically, algebraically, and verbally, as in Figure 2.6.

An algebraic representation would be donuts produced = (√number of workers) x 100. A verbal representation could be the following. As the number of workers making donuts increases, so does the numbers of donuts produced. Moreover, to get equal increments of donuts, increasing amounts of workers must be added.

In March 2007, the Argentinean government, concerned about the rising price of beef, imposed a price ceiling on beef. Assuming that the price ceiling was equal to the original equilibrium price before the supply decreased, what effect does the price ceiling have on the quantity supplied and demanded of beef? • How are consumer and producer surplus affected by the price ceiling? • Graphically show the deadweight loss created by the price ceiling.

Assume that the price ceiling equals price H. The quantity demanded rises back to Qd and the quantity supplied falls to Qs. Producer surplus is reduced by CDHG while consumer surplus is increased by DHGI and decreased by CFI, with the net effect depending on the size of the two areas. The deadweight loss equals CFG

Consider the following supply and demand model of the world tea market (in billions of pounds): Is there a shortage or a surplus when the price is $0.38? What about $0.34? • What are the equilibrium price and the equilibrium quantity? graph supply/demand curves If there is a shortage or surplus at a price of $0.38, calculate its size in billions of pounds and show it on the graph.

At $0.38 the quantity supplied (1,500) exceeds the quantity demanded (525). There is a surplus. At $0.34 the quantity demanded (1,200) exceeds the quantity supplied (550). There is a shortage. Equilibrium price is $0.36 with an equilibrium quantity of 700 units. Surplus, 1,500 - 525 = 975

Use the following data for a South Dakota wheat farm. Calculate the value added by this farm. Value added is (profit + wages & salaries + rent) . • Profits are revenue minus costs. Capital income consists of profits, rents, and interest. Show that value added equals capital income plus labor income paid by the farm. • Suppose that, because of flooding in Kansas, wheat prices increase suddenly and revenues rise to $1,100, but the prices of intermediate inputs do not change. What happens to value added and profits in this case?

Calculate the value added by this farm. Value added is (profit + wages & salaries + rent) . • Profits are revenue minus costs. Capital income consists of profits, rents, and interest. Show that value added equals capital income plus labor income paid by the farm. Revenue - cost $0, while capital income + labor income. • Suppose that, because of flooding in Kansas, wheat prices increase suddenly and revenues rise to $1,100, but the prices of intermediate inputs do not change. What happens to value added and profits in this case? Profits increase by $100 and value added increases by $100, since profits are part of the value added.

Recognizing that both positive and negative effects may occur, how will GDP be affected by • The legalization of drugs • A law making the standard workweek 35 hours • The replacement of checks by online banking • A program granting legal status to previously undocumented immigrants working in the United States

Recognizing that both positive and negative effects may occur, how will GDP be affected by • The legalization of drugs GDP increases because part of what used to be part of the underground economy would now be recorded. • A law making the standard workweek 35 hours GDP decreases due to fewer hours being worked without a change in productivity. • The replacement of checks by online banking It will most likely increase because it will be easier (and cheaper) to process business transactions and to encourage more firms and consumers to undertake these transactions. • A program granting legal status to previously undocumented immigrants working in the United States GDP increases for the same reason in part a.

n 1991, the price of milk fell 30 percent. Senator Leahy of Vermont, a big milk-producing state, supported a law in the U.S. Congress to put a floor on the price. The floor was $13.09 per hundred pounds of milk. The market price was $11.47. Draw a supply and demand diagram for milk and show how the equilibrium price and quantity would be determined in the absence of the price floor. • Using the diagram you just drew, explain the effects of the legislation. The dairy farmers supported the legislation, while consumer groups opposed it. Why? Economists frequently argue against price floors because of the surpluses and associated problems that they create. What are some of the potentially negative side effects of interference in the milk market?

Sellers are better off because the floor price is above the free market price. However, consumers must pay more. Because sellers are better off from the price supports, it makes sense that they support the legislation; consumers will be paying more so they oppose it. The side effects may include the government having to buy the surplus and, perhaps, put it in storage. This costs taxpayers money. Maybe the government will pay to reduce the size of herds and not have as much milk produced.

Sketch the market supply and demand curves. Show the equilibrium quantity and price. • graphically show the producer surplus and consumer surplus in the market for candy bars. The above graph also shows both producer and consumer surplus. • What would happen to the price of this product if a tax of $0.75 per candy bar sold were enacted by the government? Show your answer graphically. • Show the deadweight loss due to the tax on your diagram.

Sketch the market supply and demand curves. Show the equilibrium quantity and price. • graphically show the producer surplus and consumer surplus in the market for candy bars. The above graph also shows both producer and consumer surplus. • What would happen to the price of this product if a tax of $0.75 per candy bar sold were enacted by the government? Show your answer graphically. The supply curve shifts upward by $.75 to S2. The equilibrium price rises to $1.25 and the equilibrium quantity falls to 6, as in the graph below. • Show the deadweight loss due to the tax on your diagram. The deadweight loss is the sum of areas a and b.

Indicate whether you expect positive or negative correlation for the following pairs of variables, labeled X and Y. For each pair, state whether X causes Y, Y causes X, or both.

Sunrise (X) and crowing roosters (Y) A positive correlation is expected. To show causation, it is necessary to argue that one of these causes the other. In this case, it would be useful to have both a theory explaining how roosters respond to sunrise and data supporting the positive relationship. • The use of umbrellas (X) and a thunderstorm (Y). A positive correlation is expected. Thunderstorms cause the use of umbrellas. • The price of theater tickets (X) and the number of theatergoers (Y). A negative correlation could be expected. To show causation, it is necessary to have a theory and supporting data showing that people go to the theater less when the price of tickets rises. But, if it can be argued and supported by data that the more theatergoers there are, the higher will be the price of tickets then the correlation is expected to be positive. • Weekly earnings of a worker (X) and the number of hours a week she works at her job (Y). As hours worked rise, then weekly earnings should rise. There is a positive correlation. • The number of children who were vaccinated against a disease (X) and the number of children who currently suffer from that disease (Y). A negative correlation is expected. The more children vaccinated, the fewer children with the disease.

Suppose that in the ukulele market described in Problem 2, the government imposes a $40 sales tax, which causes the equilibrium price to go up to $100. Calculate the following: • The quantity purchased by each buyer, the consumer surplus for each buyer, and the consumer surplus for the market as a whole. • The quantity produced by each seller, the producer surplus for each seller, and the producer surplus for the market as a whole. • The amount of revenue collected by the government. Six units are sold, so government revenue is 6 x $40 = $240. • The deadweight loss for the economy resulting from the tax.

Suppose that in the ukulele market described in Problem 2, the government imposes a $40 sales tax, which causes the equilibrium price to go up to $100. Calculate the following: • The quantity purchased by each buyer, the consumer surplus for each buyer, and the consumer surplus for the market as a whole. Peter's surplus is 70 and he buys 2, Paul's surplus is 50 and he buys 2, and Mary's surplus from buying 2 is 30. Total consumer surplus is 150. • The quantity produced by each seller, the producer surplus for each seller, and the producer surplus for the market as a whole. John's surplus is 30 after selling 2, George's surplus is 50 after selling 2, and Ringo's surplus is 70 after selling 2. Total producer surplus is 150. • The amount of revenue collected by the government. Six units are sold, so government revenue is 6 x $40 = $240. • The deadweight loss for the economy resulting from the tax. The deadweight loss from the tax is the difference between the total surplus before the tax (calculated in problems 1 and 2) and the sum of the total surplus after the tax plus the tax revenue (calculated in this problem). This value is (280 + 280) - (150 + 150 + 240) = 20.

Suppose that the labor demand curve is perfectly flat. What is the impact on a typical worker's hourly wage if the government increases the payroll tax paid by employers by 10 percent of the wage? Show what happens in a labor supply and labor demand graph. Why does the slope of the labor supply curve not affect your answer?

Suppose that the labor demand curve is perfectly flat. What is the impact on a typical worker's hourly wage if the government increases the payroll tax paid by employers by 10 percent of the wage? Show what happens in a labor supply and labor demand graph. Why does the slope of the labor supply curve not affect your answer? The payroll tax increase decreases labor demand. S1 and S2 show two different labor supply curves of differing slopes. Because labor demand is horizontal, the new market wage after the tax (w2) is equal to the old market wage (w1) minus the full tax. This is true regardless of the supply curves. Hours worked, however, are affected greatly.

The Family Leave Act is a federal law that requires employers to give employees unpaid leave to care for a newborn or a sick relative. Show how the Family Leave Act affects the supply and demand for labor. According to this model, what will happen to wages and employment compared with the situation before the law was passed?

The Family Leave Act is a federal law that requires employers to give employees unpaid leave to care for a newborn or a sick relative. Show how the Family Leave Act affects the supply and demand for labor. According to this model, what will happen to wages and employment compared with the situation before the law was passed? The leave bill will cause the demand for labor to decline from D1 to D2 and the supply of labor to increase from S1 to S2. The labor supply curve will probably not shift down as much as the labor demand curve does because the workers probably will not value the benefit quite as much as its cost to the firm. As shown in the diagram, both wages and hours will fall.

• Suppose you decide to build a model to explain why the average worker in a particular occupation works more hours during some weeks than during others. • What data would you collect to describe this phenomenon? What variable do you believe would supply the major part of the explanation of the variation in hours worked? If you graph the data with hours worked on the vertical axis and your explanatory variable on the horizontal axis, will the relationship be upward sloping or downward sloping? • What does your answer to part c imply for whether the data on hours worked and the data on your explanatory variable are positively or negatively correlated?

The data should be for many workers in the same occupation over time. The explanatory variable would be calendar time on a week-by-week basis. You would expect some oscillation about some average number of hours. You would expect one or the other depending on the month of a year.

• Suppose a developing country does not allow foreign investment to flow into the country and, at the same time, has a very low saving rate. Use the fact that saving equals investment plus net exports and the growth accounting formula to explain why this country will have difficulty catching up with the industrial countries. What can the country do to improve its productivity if it does not allow capital in from outside the country?

The growth accounting formula is gY/L = rgK/L + gT, where gY/L is the growth rate of output per hour of work, r is a coefficient (usually 1/3), gK/L is the growth rate of capita per hour of work, and gT is the growth rate of technology. If and the rate of saving is low, then investment will be low, which makes the growth rate of capital gK low. Moreover, since foreign investment is not allowed, trade surpluses in the rest of the world cannot be invested. Growth will be low unless gT is high, which would not be likely if foreign investment cannot occur. Import substitution for external technology by subsidizing domestic R&D, tax credits, and so on, is conceivable but not likely.

According to Chapter 19, The Spending Allocation Model, a decrease in government spending results in, among other things, an increase in investment in the long run. Suppose the capital stock is $1 trillion and a fall in government spending causes a $50 billion rise in investment. Determine the effect of the change in government purchases on long-run per capita output growth, using the growth accounting formula. (Assume that the coefficient on capital in the growth accounting formula is one-third.) Suppose that a country has no growth in technology, and that capital and labor hours are growing at the same rate. What is the growth rate of real GDP per hour of work? Explain. Suppose that capital in the country described in part (a) continues to grow at its previous rate and technology growth is still zero, but growth in labor hours falls to half its previous rate. What happens to growth in real GDP per hour of work?

The growth accounting formula shows that the growth rate of real GDP per hour of work will be zero. With zero technological growth, the growth rate of real GDP per hour of work is solely determined by the growth rate of capital per hour of work. But if capital and labor are growing at the same rate, then the growth rate of capital per hour of work is not growing. The growth in real GDP per hour of work is zero. Again, with zero technological growth, the growth rate of real GDP per hour of work is solely determined by the growth rate of capital per hour of work. If capital is growing twice as fast as labor, then the growth rate of capital per work hour is 2 percent. Multiplied by the 1/3 coefficient implies that the growth rate of real GDP per hour of work is 2/3 percent.

• Figure 28.6 identifies the countries with the highest GDP per capita in the world. What characteristics of the labor forces in these countries provide part of the explanation for their higher incomes?

The labor force in the highest-income countries have more education, training, and work experience than those workers in the lowest-income countries. Also, the labor force in the highest-income countries have civil liberties and well-functioning labor markets that ensure healthy working conditions and job mobility.

• Using the demand and supply diagrams (one for each market), show what short-run changes in price and quantity would be expected in the following markets if terrorism-related worries about air safety cause travelers to shy away from air travel. Each graph should contain the original and new demand and supply curves, and the original and new equilibrium prices and quantities. For each market, write one sentence explaining why each curve shifts or does not shift.

The market for air travel. The demand for air travel would decrease. Traveler fears would reduce demand. As a result, price and quantity would fall. • The market for rail travel. The demand for rail travel would increase. Rail travel is a substitute for air travel and may be seen as being safer. As a result, price and quantity would rise. • The market for hotel rooms in Hawaii. The demand for hotel rooms would fall due to fewer tourists. Price and quantity would fall. • The market for gasoline. The demand for gasoline would increase as people would drive more. Price and quantity would rise.

Two popular programs for helping workers with very low incomes are to raise the minimum wage and to raise the EITC. Why do economists tend to favor the EITC?

The minimum wage and earned income tax credit assist workers at the very bottom of the income distribution. Raising the minimum wage is a blunt instrument providing assistance to all workers below the new minimum regardless of their circumstances. Workers gain from the increase whether they are single or have children, for example. The earned income tax credit is more targeted. Because it is administered through the income tax system, it takes into account workers' circumstances. For example, it provides more assistance to workers with children (who have larger tax allowances) than to workers with the same wages who are single. A drawback of the minimum wage is that it leads to some unemployment although the amount may be small. A drawback of the earned income tax credit is that it is financed from taxation and taxation has deadweight losses.

Use the supply and demand model to explain what happens to the equilibrium price and the equilibrium quantity for frozen yogurt in the following cases:

The number of firms producing frozen yogurt expands significantly. An increase in the number of firms producing yogurt will cause an increase in supply. As a result, the equilibrium price will fall and the equilibrium quantity will rise. • It is widely publicized in the press that frozen yogurt is not healthier for you than ice cream. This will shift the demand curve to the left: a decrease in demand. The equilibrium price and quantity will fall. • It is widely publicized in the press that people who eat a cup of frozen yogurt a day live to be much happier in their retirement years. This will shift the demand curve to the right. Equilibrium price will rise and the equilibrium quantity will rise. • The price of milk used to produce frozen yogurt suddenly increases. This will shift the supply curve to the left resulting in a higher equilibrium price and lower equilibrium quantity. • Frozen yogurt suddenly becomes popular because a movie idol promotes it in television commercials. This will shift the demand curve to the right resulting in a higher equilibrium price and quantity.

Suppose you must divide your time between studying for your math final and writing a final paper for your English class. The fraction of time that you spend studying math and its relation to your grade in the two classes given in the table below. picture in phone • Draw a trade-off curve for the math grade versus the English grade. • What is the opportunity cost of increasing the time spent on math from 80 to 100 percent? What is the opportunity cost of increasing the time spent on math from 60 to 80 percent? • Are there increasing opportunity costs from spending more time on math? Explain. Suppose your parents want you to get a 92 percent in both subjects. What would you tell them?

The opportunity cost of increasing the time spent on math from 80 to 100 percent is 50 points on the English paper, a decrease in the English grade from 50 points to 0 points. The opportunity cost of increasing the time spent on math from 60 to 80 percent is 20 points on the English paper, a decrease from 70 to 50 points. Yes, the more time spent studying math, the greater the percentage decline in the English grade, which represents a substantial increase in the opportunity cost. The decrease for the first 20% reduction in time spent on the English paper (from 100% to 80%) is only 5 points; the decrease for the last 20% time reduction on the paper (from 20% to 0% time) is a full 50 points. You would tell your parents that you cannot divide your time between English and math in a way that will create a grade of 92 on both. Given the current state of your talent and resources, a 92% is never possible in math.

• Why is it typical for economists to make the ceteris paribus assumption when making predictions? Now consider the statement: "If the local McDonald's reduces the price of a Big Mac hamburger, it will sell a lot more hamburgers." What other variables are most likely being held fixed under the ceteris paribus assumption when this statement is being made?

The variable the economist would like to predict may be influenced by many explanatory variables. The ceteris paribus assumption is made to isolate the impact one explanatory variable has on the main variable. If the local McDonald's reduces the price of a Big Mac hamburger, it will sell a lot more Big Mac's assuming the prices of items at other local fast food restaurants stay the same and given that the income of local residents stays the same.

• In 1992, the federal government placed a tax of 10 percent on goods like luxury automobiles and yachts. The yacht-manufacturing industry had huge declines in orders for yachts and laid off many workers, whereas the reaction in the auto industry was much milder. (The tax on yachts was subsequently removed.) Explain this situation using two supply and demand diagrams. Compare the elasticity of demand for luxury autos with that for yachts based on the experience with the luxury tax.

This graph shows the market for luxury boats and luxury cars. Based on the 1992 events, the demand for yachts was more elastic relative to the demand for luxury cars. This is shown by the relative steepness of the two demand curves. A tax shifts supply from S1 to S2. In both cases, quantity (orders) falls. Orders for yachts fell by a relatively greater amount because demand is relatively more elastic.

Tracy tells Huey that he can improve his economics grade without sacrificing fun activities or his grades in other courses. Can you imagine ways in which this might be possible? What does that imply about the initial situation? If Huey is taking just two courses and he can improve his economics grade without hurting his math grade, how could you represent this situation graphically?

Tracey is telling Huey he is not using his time efficiently. Perhaps he is studying economics in his dorm room while his roommate is always watching television and playing music loudly. By moving to a more conducive study environment such as the library, Huey could get more out of his study time. Alternately, it's possible Huey has been doing other activities that are neither work for other courses nor fun, and that he could improve his economics grade by reducing time spent in one or more of those activities. The following graph shows Huey improving his economics course without hurting his math grade:

• Suppose General Motors buys $50 million worth of tires from Goodyear in November of 2014 for use in its Chevrolet line of cars. Of these tires, $20 million are put into cars that are sold to consumers in December of 2014, and $10 million are put into cars that are produced in December but will not be sold to consumers until February of 2015. The remaining $20 million will be put into cars manufactured and sold in 2015. Describe how each of these tire-related transactions enters into inventory investment calculations in 2014 and 2015.

When GM bought the tires in November, it increased its inventory investment by 50 million. When it put 30 million tires into cars that were produced (even if only 20 million were sold), its inventories fell by 30 million. So overall, inventory investment for 2006 was 20 million tires. In 2007, it put the remaining tires into cars so its inventories fell by 20 million. Inventory investment for 2007 would be -20 million tires.

Suppose that you are president of the student government, and you have to decide how to allocate a $20,000 fund for guest speakers for the year. Conan O'Brien and Will Ferrell each cost $10,000 per appearance, Stephen Colbert costs $20,000 per appearance, and former economic advisers to the government charge $1,000 per lecture. Explain the economic problem of choice and scarcity in this case. What issues would you consider in arriving at a decision?

With $20,000, you can invite 1) Steven Colbert one time, 2) Will Ferrell and Conan O'Brien each one time, 3) Either Will Ferrell or Conan O'Brien twice, 4) Either Will Ferrell or Conan O'Brien once plus up to ten former economic advisers, or 5) twenty former economic advisers. When making this decision, you have to weigh the excitement each speaker will generate in the student body and the effects on your popularity as the student body president. If you are attending a school of politics and economics, your choice may be very different than your choice if you are attending a clown college, UCLA, or Julliard.

• Name one way in which use of the following technologies has made you more productive: All of the following answers may vary; examples are given.

• ATM machine ATM machines permit 24 hour banking, so the individual has more options of when to bank • Cell phone Smart phones allow phone meetings to happen from anywhere • The Internet The internet means more time to spend researching and less travel time. • Laptop computer Allows remote work, reducing commuting time.

Many U.S. companies in the software, music, and movie industries have been asking the Chinese government to better enforce intellectual property rights. Discuss the impact of this enforcement on • Chinese firms • U.S. firms • Chinese consumers

• Chinese firms This enforcement would increase the operating costs of Chinese firms in the entertainment industries, making them less profitable. • U.S. firms This enforcement would provide more incentive for U.S. firms in the entertainment industries to engage in research and development and to export their products to China. • Chinese consumers As the operating costs for the Chinese firms increased, Chinese consumers would eventually bear the higher costs by paying higher prices for the entertainment products

Bill and Hillary are two very smart lawyers who also have an active interest in public policy. Bill can write a law paper in three months or a policy paper in one month. Hillary can write a law paper or a policy paper in one month. Bill and Hillary like each other a lot and would like to get married. However, because the marriage of two lawyers often is fraught with difficulty, they decide that one of them should write law papers and the other should write policy papers. • Draw a production possibilities curve for Bill and one for Hillary. • Who has an absolute advantage in writing law papers? In writing policy papers? • Who has a comparative advantage in writing law papers? In writing policy papers? • Explain how to reconcile your answers to (b) and (c).

• Draw a production possibilities curve for Bill and one for Hillary. Hillary has an absolute advantage in law papers, and both are equally good at producing policy papers. Hillary has a comparative advantage in law papers, and Bill has a comparative advantage in policy papers. Explain how to reconcile your answers to (b) and (c): Hillary is three times faster (productive) than Bill at writing law papers. Alternatively, the opportunity cost of writing a law paper for her is one policy paper. For Bill, the opportunity cost of writing a law paper is three policy papers. Since her opportunity cost is lower, she should specialize in law papers, and he in policy papers.

Suppose an economic study shows that increasing the tax rate on cigarettes will reduce the amount of smoking. Which of the following statements can be validly made on the basis of the study because they are positive statements, and which cannot be validly made because they are normative statements?

• Increasing the cigarette tax rate is a method of reducing smoking. • If the government wishes to reduce smoking, it should raise the cigarette tax. • If the government wishes to reduce smoking, it can raise the cigarette tax. • The government should reduce smoking by raising the cigarette tax. • The government should not raise the cigarette tax on low-income smokers. The statement in part (a) is clearly positive, while the statement in part (e) is clearly negative. The other three statements have the positive element made in the supposition, but enter the realm of normative economics with the recommendation of economic policy.

Which of the following will increase the likelihood of poor countries catching up to rich countries, and which will decrease the likelihood? Explain. • Industrial countries do not allow their technology to be ] • Worldwide saving rates shift up. • The legal system in developing countries is improved to protect property rights. • Governments in developing countries make use of their international aid to buy armaments from developed countries. • Investment in human capital increases in the developing countries.

• Industrial countries do not allow their technology to be bought or leased by firms in developing countries. Decrease. This will make it more difficult for developing countries to obtain capital goods. • Worldwide saving rates shift up. Increase. As worldwide saving rates increase, catch-up will increase as foreign investment increases in developing countries, increasing productivity growth. • The legal system in developing countries is improved to protect property rights. Increase. Catch-up will increase as the rights of entrepreneurs are protected because incentives are enhanced and risk reduced. • Governments in developing countries make use of their international aid to buy armaments from developed countries. Decrease. Catch-up should decrease as armament spending displaces spending on more productive investment, and this should increase instability. • Investment in human capital increases in the developing countries. Increase. An increase in human capital will promote an increase in catch-up because the capital used by an educated, skilled work force is more productive.

• Which of the following variables are studied as part of microeconomics, and which are studied as part of macroeconomics?

• The U.S. unemployment rate. Macroeconomic • The amount of tips earned by a waiter Microeconomic. • The national rate of inflation. Macroeconomic • The number of hours worked by a student. Microeconomic • The price paid to obtain this economics textbook. Microeconomic

For each of the following markets, indicate whether the stated change causes a shift in the supply curve, a shift in the demand curve, a movement along the supply curve, or a movement along the demand curve.

• The housing market: Consumers' incomes fall. A shift in demand. • The tea market: The price of sugar goes down. A shift in demand. • The coffee market: A freeze in Brazil severely damages the coffee crop. A shift in supply. • The fast-food market: The number of fast food restaurants in an area decreases. A shift in supply. • The peanut market in the U.S. Southeast: A drought lowers supply. A shift in supply

• Identify whether the following policy statements are positive or normative. Explain.

• The price of gasoline is too high. This is a normative statement. This is a statement of opinion. • The average price of gasoline rose to a record high of $4.02 in June 2008. This is a positive statement. This statement is a statement of fact. It is either true or false. • Forty-four million Americans lack access to health insurance. This is a positive statement. It can be tested by examining data. • The government needs to provide basic health care to the uninsured. This is a normative statement. It is an opinion. • A collapse in the stock market will affect many Americans. While the statement is somewhat vague, there is a suggestion of a testable hypothesis. Thus, this is a positive statement.