ECON 202 CHAPTERS 1-5

1. The equation for a demand curve is P = 2/Q. What is the elasticity of demand as price falls from 5 to 4? What is the elasticity of demand as the price falls from 9 to 8? Would you expect these answers to be the same?

(5) = 2/Q; Q = 0.4 (4) = 2/Q; Q = 0.5 E = %∆Q/%∆P = [0.5 - 0.4)/0.4]/[(4 - 5)/5] = -1.25 We would expect the elasticity to be lower at the higher prices: (9) = 2/Q; Q = 0.22 (8) = 2/Q; Q = 0.25 E = %∆Q/%∆P = [(0.25 - 0.22)/0.22]/[(8 - 9)/9] = -1.12

1. A computer systems engineer could paint his house, but it makes more sense for him to hire a painter to do it. Explain why.

. A computer systems engineer could paint his house, but it makes more sense for him to hire a painter to do it. Explain why.

1. Explain why the following statement is false: "In the goods market, no buyer would be willing to pay more than the equilibrium price."

1. Explain why the following statement is false: "In the goods market, no buyer would be willing to pay more than the equilibrium price."

1. In the labor market, what causes a movement along the demand curve? What causes a shift in the demand curve?

1. In the labor market, what causes a movement along the demand curve? What causes a shift in the demand curve?

1. Individuals may not act in the rational, calculating way described by the economic model of decision making, measuring utility and costs at the margin, but can you make a case that they behave approximately that way?

1. Individuals may not act in the rational, calculating way described by the economic model of decision making, measuring utility and costs at the margin, but can you make a case that they behave approximately that way?

1. Suppose there is an improvement in medical technology that enables more healthcare to be provided with the same amount of resources. How would this affect the production possibilities curve and, in particular, how would it affect the opportunity cost of education?

1. Suppose there is an improvement in medical technology that enables more healthcare to be provided with the same amount of resources. How would this affect the production possibilities curve and, in particular, how would it affect the opportunity cost of education?

1. What is the difference between microeconomics and macroeconomics?

1. What is the difference between microeconomics and macroeconomics?

1. Why do you think that most modern countries' economies are a mix of command and market types?

1. Why do you think that most modern countries' economies are a mix of command and market types?

Residents of the town of Smithfield like to consume hams, but each ham requires 10 people to produce it and takes a month. If the town has a total of 100 people, what is the maximum amount of ham the residents can consume in a month?

100 people / 10 people per ham = a maximum of 10 hams per month if all residents produce ham. Since consumption is limited by production, the maximum number of hams residents could consume per month is 10.

1. The equation for a supply curve is 4P = Q. What is the elasticity of supply as price rises from 3 to 4? What is the elasticity of supply as the price rises from 7 to 8? Would you expect these answers to be the same?

4(3) = Q = 12; 4(4) = Q = 16; E = %∆Q/%∆P = [(16 - 12)/12]/[(4 - 3)/3] = 1 At the higher price, the elasticity should be the same. 4(7) = Q = 28; 4(8) = Q = 32; E = %∆Q/%∆P = [(32 - 28)/28]/[(8 - 7)/7] = 1

1. The supply of paintings by Leonardo Da Vinci, who painted the Mona Lisa and The Last Supper and died in 1519, is highly inelastic. Sketch a supply and demand diagram, paying attention to the appropriate elasticities, to illustrate that demand for these paintings will determine the price.

: The supply of Da Vinci paintings will be represented by a vertical line, since no amount of price fluctuation can change them. Price is therefore wholly determined by the position of the demand curve.

Invisible Hand

Adam Smith's concept that individuals' self-interested behavior can lead to positive social outcomes

Suppose we extend the circular flow model to add imports and exports. Copy the circular flow diagram onto a sheet of paper and then add a foreign country as a third agent. Draw the flows of imports, exports, and the payments for each on your diagram.

Draw a box outside the original circular flow to represent the foreign country. Draw an arrow from the foreign country to firms, to represents imports. Draw an arrow in the reverse direction representing payments for imports. Draw an arrow from firms to the foreign country to represent exports. Draw an arrow in the reverse direction to represent payments for imports.

1. Use the four-step process to analyze the impact of a reduction in tariffs on imports of iPods on the equilibrium price and quantity of Sony Walkman-type products.

Draw the graph of the initial supply and demand curves. Does the change affect demand or supply? Since tariffs affect the price consumers pay, the effect will be on demand. The reduction in the price of iPods causes a leftward shift in demand for the substitute good, the Walkman. The leftward shift in demand for Walkmans would cause a reduction in price and quantity sold.

1. Use the four-step process to analyze the impact of the advent of the iPod (or other portable digital music players) on the equilibrium price and quantity of the Sony Walkman (or other portable audio cassette players).

Draw the graph of the initial supply and demand curves. Does the introduction of the iPod cause a shift in supply or demand for Walkmans? Since the iPod is a consumer good, the change will be in demand Since the iPod is a substitute for a Walkman, the demand curve will shift left. A leftward shift in the demand curve will cause the price and quantity to fall.

1. The equation for a demand curve is P = 48 - 3Q. What is the elasticity in moving from a quantity of 5 to a quantity of 6?

P = 48 - 3(5) = 33; P = 48 - 3(6) = 30; E = %∆Q/%∆P= [(6 - 5)/5]/[(30 - 33)/33] = -2.2

1. The average annual income rises from $25,000 to $38,000, and the quantity of bread consumed in a year by the average person falls from 30 loaves to 22 loaves. What is the income elasticity of bread consumption? Is bread a normal or an inferior good?

Percentage change in quantity demanded = [(change in quantity)/ (original quantity)] ×100 = [22 - 30]/ [(22 + 30) / 2] × 100 = -8/26 ×100 = -30.77 Percentage change in income = [(change in income)/ (original income)] ×100 = [38,000 - 25,000] / [(38,000 + 25,000) / 2] × 100 = 13/36.5 ×100 = 36

The chapter defines private enterprise as a characteristic of market-oriented economies. What would public enterprise be? Hint: It is a characteristic of command economies.

Public enterprise means the factors of production (resources and businesses) are owned and operated by the government.

1. What is scarcity? Can you think of two causes of scarcity?

Scarcity means human wants for goods and services exceed the available supply. Supply is limited because resources are limited. Demand, however, is virtually unlimited. Whatever the supply, it seems human nature to want more.

100 people / 10 people per ham = a maximum of 10 hams per month if all residents produce ham. Since consumption is limited by production, the maximum number of hams residents could consume per month is 10.

She is very productive at her consulting job, but not very productive growing vegetables. Time spent consulting would produce far more income than it what she could save growing her vegetables using the same amount of time. So on purely economic grounds, it makes more sense for her to maximize her income by applying her labor to what she does best (i.e. specialization of labor).

1. Identify the most accurate statement. A price floor will have the largest effect if it is set: a. substantially above the equilibrium price b. slightly above the equilibrium price c. slightly below the equilibrium price d. substantially below the equilibrium price

Sketch all four of these possibilities on a demand and supply diagram to illustrate your answer.

Use this information to answer the following 4 questions: Marie has a weekly budget of $24, which she likes to spend on magazines and pies. 1. If the price of a magazine is $4 each, what is the maximum number of magazines she could buy in a week?

Solution : $24/$4 = 6 magazines.

1. A balanced federal budget and a balance of trade are considered secondary goals of macroeconomics, while growth in the standard of living (for example) is considered a primary goal. Why do you think that is so?

Solution : A Balanced federal budget and the balance of trade do not have direct effects on the well-being of individuals. While we can argue about what their long term effects are, the standard of living (as measured by economic growth, for example) is directly responsible for how well off people are within an economy, so that is what economists care about.

1. What causes a movement along the demand curve? What causes a movement along the supply curve?

Solution : A change in the price received by sellers will cause a movement along the supply curve. A change in the price demanded by buyers will cause a movement along the demand curve.

1. Explain why societies cannot make a choice above their production possibilities frontier and should not make a choice below it.

Solution : A choice above the PPF is not possible because the PPF already illustrates the maximum amount of production. Producing at a point inside the PPF is inefficient because more production could be achieved at no additional cost.

1. Explain why individuals make choices that are directly on the budget constraint, rather than inside the budget constraint or outside it.

Solution : A point inside the budget constraint indicates that the individual could have more of one good without have to give up any of the other. This is inefficient. A point outside the budget constraint is one that the individual cannot afford, as much as he might like to. The budget constraint line represents the set of all allocations of resources that are both efficient and possible.

1. What is the difference between a positive and a normative statement?

Solution : A positive statement simply describes an actual result or situation. "If the government raises the minimum wage, some jobs will be lost" is a positive statement. A normative statement is a recommendation of a particular policy as either being a good or bad idea. "The government should raise the minimum wage" is a normative statement.

1. What is the effect of a price ceiling on the quantity demanded of the product? What is the effect of a price ceiling on the quantity supplied? Why exactly does a price ceiling cause a shortage?

Solution : A price ceiling (which is below the equilibrium price) will cause the quantity demanded to rise and the quantity supplied to fall. This is why a price ceiling creates a shortage.

1. Does a price ceiling change the equilibrium price?

Solution : A price ceiling is just a legal restriction. Equilibrium is an economic condition. People may or may not obey the price ceiling, so the actual price may be at or above the price ceiling, but the price ceiling doesn't change the equilibrium price.

1. How does a price ceiling set below the equilibrium level affect quantity demanded and quantity supplied?

Solution : A price ceiling set below the equilibrium price will result in a greater quantity demanded than the quantity supplied otherwise known as a shortage.

1. How does a price floor set above the equilibrium level affect quantity demanded and quantity supplied?

Solution : A price floor set above the equilibrium level results in a greater quantity supplied than the quantity demanded, otherwise known as a surplus.

1. Can you think of any examples of free goods, that is, goods or services that are not scarce?

Solution : Air for breathing is, in most cases, not scarce. Of course, for the scuba diver or the astronaut, this is far from the case. Even goods that are not scarce for most practical purposes can become scarce under certain circumstances.

1. It is clear that productive inefficiency is a waste since resources are being used in a way that produces less goods and services than a nation is capable of. Why is allocative inefficiency also wasteful?

Solution : Allocative inefficiency is wasteful because it means that a nation is producing goods that are not the most highly demanded. Not only does this result in goods piling up on store shelves, but it means that people have to pay higher prices for the relatively scarce goods they actually want.

1. We know that a change in the price of a product causes a movement along the demand curve. Suppose consumers believe that prices will be rising in the future. How will that affect demand for the product in the present? Can you show this graphically?

Solution : An anticipated price increase will cause the demand curve to shift to the right, an increase in demand, as consumers try to take advantage of what they believe to be temporarily low prices.

1. What are the three ways that societies can organize themselves economically?

Solution : As a command economy, a market economy, or a mixture of the two.

1. How did John Maynard Keynes define economics?

Solution : As a method of thinking that help people draw correct conclusions.

1. How do you suppose the demographics of an aging population of "Baby Boomers" in the United States will affect the demand for milk? Justify your answer.

Solution : Assuming that milk is primarily consumed by children, an aging population will probably see a reduction in demand as Baby Boomers stop having children.

1. Would a research study on the effects of soft drink consumption on children's cognitive development be considered a positive or normative statement?

Solution : Assuming that the study is not taking an explicit position about whether soft drink consumption is good or bad, but just reporting the science, it would be considered positive.

1. What is the relationship between quantity demanded and quantity supplied at equilibrium? What is the relationship when there is a shortage? What is the relationship when there is a surplus?

Solution : At equilibrium, quantity demanded and quantity supplied are equal to one another. In a shortage, quantity demanded exceeds quantity supplied. In a surplus, quantity supplied exceeds quantity demanded.

1. What are the similarities between a consumer's budget constraint and society's production possibilities frontier, not just graphically but analytically?

Solution : Both the budget constraint and the PPF show the constraint that each operates under. Both show a tradeoff between having more of one good but less of the other. Both show the opportunity cost graphically as the slope of the constraint (budget or PPF).

1. What is the difference between the demand and the quantity demanded of a product, say milk? Explain in words and show the difference on a graph with a demand curve for milk.

Solution : Demand describes consumers' willingness to buy a good at any price. Demand is shown by the position of a demand curve, in other words, how far away from the origin it is. Quantity demanded refers to how much will be purchased at a single, specific price, that is, at one point on the demand curve.

1. Why is it unfair or meaningless to criticize a theory as "unrealistic?"

Solution : Economic models and the accompanying theories typically employ simplifying assumptions that, by definition, make the models less than perfectly realistic. If the models are good ones, they are still useful for understanding how a system works, in the same way that a physicist might assume an absence of friction to simplify his understanding of how a ball rolls across a surface. By making models simple, we can understand the basic mechanisms of how things like supply and demand work without having to worry too much about all the real world complications

1. What are four responses to the claim that people should not behave in the way described in this chapter?

Solution : Economics describes behavior as it is, not as we would like it to be; Self-interest can be represented as personal choice and freedom; Self-interest results in economic efficiency, which ultimately leads to better standards of living; Self-interest does not imply that people are never charitable or selfless.

1. When analyzing a market, how do economists deal with the problem that many factors that affect the market are changing at the same time?

Solution : Economists try to isolate one variable to study at a time, holding all other factors constant. This can be challenging in the real world, but is useful in economic models.

1. Are firms primarily buyers or sellers in the goods and services market? In the labor market?

Solution : Firms are primarily sellers in the goods and services market, offering their wares to consumers. They are primarily buyers in the labor market, hiring employees to produce for them.

1. Give the three reasons that explain why the division of labor increases an economy's level of production.

Solution : First, division of labor allows for specialization, in which workers do what they do best, second, workers learn to be more efficient, and third, businesses can take advantage of economies of scale.

1. During the Second World War, Germany's factories were decimated and suffered many human casualties, both soldiers and civilians. How did the war affect Germany's production possibilities curve?

Solution : Germany's PPF would have shifted inward, because the country's decrease in labor, capital and other inputs would reduce their ability to produce output at every allocation of resources.

Solution : As a command economy, a market economy, or a mixture of the two.

Solution : Globalization is an increase in connections and economic activity across international lines. Globalization allows small economies to take fuller advantage of the division of labor.

1. What are the three main goals of macroeconomics?

Solution : Growth in the standard of living, low unemployment and low inflation.

1. Are households primarily buyers or sellers in the goods and services market? In the labor market?

Solution : Households are primarily buyers in the goods and services market, as they use their income to purchase food, housing, education, transportation and many other items. Households are typically sellers in the labor market, offering their labor for a salary or hourly wage in order to earn a living.

1. Agricultural price supports result in government holding large inventories of agricultural products. Why do you think the government can't simply give the products away to poor people?

Solution : If the government gave away these agricultural holdings, the recipients would then have no incentive to buy the goods from producers, demand would contract and prices would fall, exactly what the policy is trying to prevent. There would also be nothing stopping the poor from selling the products given to them by the government. This would be an increase of supply and be accompanied by a drop in prices.

1. If the price is above the equilibrium level, would you predict excess supply or excess demand? If the price is below the equilibrium level, would you predict a shortage or a surplus? Why?

Solution : If the price is above the equilibrium level, there will be excess supply known as a surplus. If the price is below the equilibrium level, there will be excess demand, known as a shortage. This happens because the number of people who want to buy the good is not equal to the number of people who want to sell it at the given price.

1. Do economists have any particular expertise at making normative arguments? In other words, they have expertise at making positive statements (i.e., what will happen) about some economic policy, for example, but do they have special expertise to judge whether or not the policy should be undertaken?

Solution : In order to make a normative statement, there must be an underlying assumption about what the goal of the policy is, or what is right. A normative statement of sort "If your only goal is for fewer people to smoke, you should raise cigarette taxes" may be within an economist's realm of expertise, but typically these sorts of statements contain a moral component that lies outside the domain of economics.

1. Suppose, as an economist, you are asked to analyze an issue unlike anything you have ever done before. Also, suppose you do not have a specific model for analyzing that issue. What should you do? Hint: What would a carpenter do in a similar situation?

Solution : In this situation, most economists would attempt to construct a model to describe the issue in question, using observation and reasonable assumptions. This model can then be applied to the problem to get a consistent answer.

1. What are examples of individual economic agents?

Solution : Individuals, households and businesses are all economic agents.

1. Could a nation be producing in a way that is allocatively efficient, but productively inefficient?

Solution : No. Allocative efficiency requires productive efficiency, because it pertains to choices along the production possibilities frontier.

1. Is the economic model of decision-making intended as a literal description of how individuals, firms, and the governments actually make decisions?

Solution : No. Economic models use simplifying assumptions to help us understand complex systems. These are useful, but are not intended as a literal representation of actual behavior.

1. What is productive efficiency? Allocative efficiency?

Solution : Productive efficiency means that it is impossible to produce more of one good without producing less of some other good. Allocative efficiency means that the combination of goods being produced represents the mix of goods most desired by society.

1. Would an op-ed piece in a newspaper urging the adoption of a particular economic policy be considered a positive or normative statement?

Solution : Since an op-ed makes a case for what should be, it is considered normative.

1. Explain why scarcity leads to tradeoffs.

Solution : Since the supplies of virtually all goods are limited, and since human wants are unlimited, there is competition between individuals. If you want a certain good, you have to give up something else to get it, whether that be time, money, labor or another good offered in trade.

1. Why is a production possibilities frontier typically drawn as a curve, rather than a straight line?

Solution : Some inputs are better suited to one area of production than another. As these are diverted towards less efficient uses, some amount of production is lost, causing the PPF to bend.

1. Can you think of ways that globalization has helped you economically? Can you think of ways that it has not?

Solution : Some people may have benefitted from the inexpensive and diverse goods made available through global trade, while others may feel that they have lost jobs or opportunities due to competition from producers in foreign countries.

1. Name some factors that can cause a shift in the supply curve in markets for goods and services.

Solution : Supply shocks such as natural disasters can shift the supply curve. Changes in technology or the price of inputs can also have an effect.

1. Suppose you have a team of two workers: one is a baker and one is a chef. Explain why the kitchen can produce more meals in a given period of time if each worker specializes in what they do best than if each worker tries to do everything from appetizer to dessert.

Solution : The baker and the chef have specialized skills that allow them to be more productive in certain areas than in others. The baker will be able to make a pie faster than the chef, and the chef will be better at cooking the main course. By each worker doing what he does best, productivity and efficiency are maximized and total output is greater.

1. Explain why the following statement is false: In the goods market, no seller would be willing to sell for less than the equilibrium price."

Solution : The equilibrium price merely equalizes the number of willing sellers and buyers. There would still be people willing to sell even if the price were to fall.

Solution : Allocative inefficiency is wasteful because it means that a nation is producing goods that are not the most highly demanded. Not only does this result in goods piling up on store shelves, but it means that people have to pay higher prices for the relatively scarce goods they actually want.

Solution : The main assumptions behind the invisible hand are that people are rational, meaning they act in their own best interests, and that they have perfect information about the goods and services they buy. The first assumption is generally true except in the case of the seriously mentally ill. The second is rarely true in the real world.

Solution : Economics describes behavior as it is, not as we would like it to be; Self-interest can be represented as personal choice and freedom; Self-interest results in economic efficiency, which ultimately leads to better standards of living; Self-interest does not imply that people are never charitable or selfless.

Solution : The opportunity cost is defined as the ratio of the prices of the two goods. Since the price of both goods doubles, the ratio stays the same and the opportunity cost for Alphonso remains 1/4 of a burger to buy one bus ticket. Once his income doubles as well, his budget constraint is unchanged because in both cases he can still choose 5 burgers, 20 bus tickets or any combination in between.

1. Suppose Alphonso's town raised the price of bus tickets to $1 per trip (while the price of burgers stayed at $2 and his budget remained $10 per week.) Draw Alphonso's new budget constraint. What happens to the opportunity cost of bus tickets?

Solution : The opportunity cost of bus tickets is the number of burgers that must be given up to obtain one more bus ticket. Originally, when the price of bus tickets was 50 cents per trip, this opportunity cost was .50/2 = .25 burgers. The reason for this is that at the original prices, one burger ($2) costs the same as four bus tickets ($.50), so the opportunity cost of a burger is four bus tickets, and the opportunity cost of a bus ticket is .25 (the inverse of the opportunity cost of a burger). With the new, higher price of bus tickets, the opportunity cost rises to $1/$2 or .50. You can see this graphically since the slope of the new budget constraint is steeper than the original one. If Alphonso spends his entire budget on burgers, the higher price of bus tickets has no impact so the vertical intercept of the budget constraint is the same. If he spends his entire budget on bus tickets, he can now afford only half as many, so the horizontal intercept is half as much. In short, the budget constraint rotates clockwise around the vertical intercept, steepening as it goes. Since the slope of the budget constraint reflects the opportunity cost of whatever good is on the vertical axis (in this case, bus tickets) the opportunity cost of bus tickets increases.

1. What does a production possibilities frontier illustrate?

Solution : The production possibilities frontier is the set of every combination of goods that is both possible and efficient to produce.

1. Will demand curves have the same exact shape in all markets? If not, how will they differ? What does an upward-sloping supply curve mean about how sellers in a market will react to a higher price?

Solution : The shape of a demand curve will be different depending o the market and the nature of the good being demanded. An upward sloping supply curve means that sellers are willing to supply more goods at higher prices.

1. Review the following figure. Suppose the government decided that, since gasoline is a necessity, its price should be legally capped at $1.30 per gallon. What do you anticipate would be the outcome in the gasoline market?

Solution : There would be a shortage of gasoline. At such a low price, consumers would be very eager to buy, but producers would see limited profit opportunities. The quantity demanded would therefore exceed the quantity supplied by the market.

1. Macroeconomics is an aggregate of what happens at the microeconomic level. Would it be possible for what happens at the macro level to differ from how economic agents would react to some stimulus at the micro level? Hint: Think about the behavior of crowds.

Solution : While the macroeconomy is ultimately the sum of individual actions, we can sometimes see a different result from collective action than we do for individual action. This can happen for a number of reasons, including crowd psychology, concentrated benefits and dispersed costs, and difficulties in coordination.

1. Why would division of labor without trade not work?

Solution : With no trade, each individual must produce all the goods and services he wants to consume. Therefore, by definition, he cannot specialize and so he can obtain the benefits of specialization. With trade, on the other hand, by specializing on what the individual does best, he can maximize product and income and trade for whatever else he wants to consume. In short, specialization results in a net gain rather than a loss.

Use this information to answer the following 4 questions: Marie has a weekly budget of $24, which she likes to spend on magazines and pies. 1. If the price of a pie is $12, what is the maximum number of pies she could buy in a week?

Solution: $24/$12 = 2 pies.

1. What does a downward-sloping demand curve mean about how buyers in a market will react to a higher price?

Solution: A downward sloping demand curve means that buyers will demand less of a good the higher the price becomes.

1. Describe the general appearance of a demand or a supply curve with infinite elasticity.

Solution: A horizontal line, since as much of the product as desired can be sold or bought at a single price.

1. What would be the impact of imposing a price floor below the equilibrium price?

Solution: A price ceiling is a legal maximum price, but the market will choose the equilibrium price as long as the latter is below the former. In other words, a price floor below equilibrium will have no effect.

1. Does a price ceiling attempt to make a price higher or lower?

Solution: A price ceiling prevents the price from rising above a certain level, keeping prices low.

1. Does a price floor attempt to make a price higher or lower?

Solution: A price floor prevents the price from rising below a certain level, keeping prices high.

1. Can you propose a policy that would induce the market to supply more rental housing units?

Solution: A reduction in property taxes would make it cheaper for landlords to own houses and rent them out, resulting in an increase in supply.

1. Suppose there is soda tax to curb obesity. What should a reduction in the soda tax do to the supply of sodas and to the equilibrium price and quantity? Can you show this graphically? (Hint: assume that the soda tax is collected from the sellers)

Solution: A reduction in the soda tax means that sellers receive a higher price for each soda sold. This will increase the supply of sodas.

1. Describe the general appearance of a demand or a supply curve with zero elasticity.

Solution: A vertical line, since quantity will not change at all in response to a change in price.

13. Whether the product market or the labor market, what happens to the equilibrium price and quantity for each of the four possibilities: increase in demand, decrease in demand, increase in supply, and decrease in supply.

Solution: An increase in demand leads to a higher price and a higher quantity; a decrease in demand leads to a lower price and lower quantity; an increase in supply leads to a lower price and a higher quantity; a decrease in supply leads to a higher price and a lower quantity.

22. If the government imposed a federal interest rate ceiling of 20% on all loans, who would gain and who would lose?

Solution: Borrowers would gain, as the amount of debt that could accrue was limited, and lenders would lose and their loans became less profitable.

1. Suppose both of these events took place at the same time. Combine your analyses of the impacts of the iPod and the tariff reduction to determine the likely impact on the equilibrium price and quantity of Sony Walkman-type products. Show your answer graphically.

Solution: Both effects shift demand for Walkmans in the same direction and both result in a lower price and lower quantity at equilibrium

1. The federal government decides to require that automobile manufacturers install new anti-pollution equipment that costs $2,000 per car. Under what conditions can carmakers pass almost all of this cost along to car buyers? Under what conditions can carmakers pass very little of this cost along to car buyers?

Solution: Carmakers can pass this cost along to consumers if the demand for these cars is inelastic. If the demand for these cars is elastic, then the manufacturer must pay for the equipment.

1. In the financial market, what causes a movement along the demand curve? What causes a shift in the demand curve?

Solution: Changes in the interest rate (i.e., the price of financial capital) cause a movement along the demand curve. A change in anything else (non-price variable) that affects demand for financial capital (e.g., changes in confidence about the future, changes in needs for borrowing) would shift the demand curve.

1. In the financial market, what causes a movement along the supply curve? What causes a shift in the supply curve?

Solution: Changes in the interest rate (i.e., the price of financial capital) cause a movement along the supply curve. A change in anything else that affects the supply of financial capital (a non-price variable) such as income or future needs would shift the supply curve.

1. In the labor market, what causes a movement along the supply curve? What causes a shift in the supply curve?

Solution: Changes in the wage rate (the price of labor) cause a movement along the supply curve. A change in anything else that affects supply of labor (e.g., changes in how desirable the job is perceived to be, government policy to promote training in the field) causes a shift in the supply curve.

1. Name some factors that can cause a shift in the demand curve in markets for goods and services.

Solution: Changes in the wealth of consumers, such as in a recession or economic boom, can shift the demand curve. Changes in prices of substitute and complement goods can also have an effect.

Solution : A point inside the budget constraint indicates that the individual could have more of one good without have to give up any of the other. This is inefficient. A point outside the budget constraint is one that the individual cannot afford, as much as he might like to. The budget constraint line represents the set of all allocations of resources that are both efficient and possible.

Solution: Comparative advantage is when a country can produce a good at a lower cost in terms of other goods or when a country has a lower opportunity cost of production.

1. What is deadweight loss?

Solution: Deadweight loss is the loss in social surplus that occurs when a market produces an inefficient quantity.

1. What is the relationship between price elasticity and position on the demand curve? For example, as you move up the demand curve to higher prices and lower quantities, what happens to the measured elasticity? How would you explain that?

Solution: Demand becomes less elastic as we move up the demand curve, because elasticities are calculated as percentages. A large increase of an already high price may be only a small percentage increase, whereas a small decrease of an already very low quantity may be quite a large percentage decrease.

21. Other than the demand for labor, what would be another example of a "derived demand?"

Solution: Demand for the raw materials involved in production, such as steel or lumber, can be examples of "derived demand."

1. What are diminishing marginal returns?

Solution: Diminishing marginal returns describe the decreased utility of additional units of a good or service. To take an extreme example, purchasing a haircut when you have not had one in a while is quite beneficial, but purchasing a second haircut on the same day is unlikely to yield very high utility.

1. Transatlantic air travel in first class has an estimated elasticity of demand of 0.62 while transatlantic air travel in economy class has an estimated price elasticity of 0.12. Why do you think this is the case?

Solution: Due to the length of time it takes to travel across the Atlantic and the discomfort of traveling economy class, we would expect the sorts of people who purchase first class tickets to be largely unwilling to downgrade their preference for comfort, which yields an inelastic demand. Additionally, many transatlantic tickets are paid for by large companies on behalf of their employees, where price is less of a concern than for individuals traveling economy class.

1. What is the relationship between total surplus and economic efficiency?

Solution: Economic efficiency of the market equilibrium is demonstrated when the total surplus is larger at equilibrium quantity and price than it would be at any other quantity. At the efficient level of output, it is impossible to produce greater consumer surplus without reducing producer surplus, and it is impossible to produce greater producer surplus without reducing consumer surplus, which would be evident of economic efficiency.

1. What are three reasons to study economics?

Solution: Economics factors into every major policy decision, economics encourages good citizenship, and economics makes for a well-rounded education.

Solution: A reduction in property taxes would make it cheaper for landlords to own houses and rent them out, resulting in an increase in supply.

Solution: Economists use the term consumer surplus to describe what happens when a shopper gets a "good deal" on a product because the consumer surplus is the amount that individuals are willing to pay, minus the amount they actually paid.

1. What is the formula for calculating elasticity?

Solution: Elasticity is calculated by dividing the percent change in quantity over the percent change in price. E = %∆Q/%∆P

22. Suppose that a 5% increase in the minimum wage causes a 5% reduction in employment. How would this affect employers and how would it affect workers? In your opinion, would this be a good policy?

Solution: Employers would have to make do with fewer workers, which they might do by reducing output or substituting towards more capital use. The employees would enjoy higher wages and therefore have more money to demand goods, but the resulting unemployed would experience the opposite effect.

13. How is equilibrium defined in financial markets?

Solution: Equilibrium is where the quantity of loanable funds demanded equals the quantity supplied.

22. What assumption is made for a minimum wage to be a nonbinding price floor? What assumption is made for a living wage price floor to be binding?

Solution: For a minimum wage to be nonbinding, it must be set below the equilibrium wage. For the living wage price floor to be binding, it must be set above the equilibrium wage.

1. Under which circumstances does the tax burden fall entirely on consumers?

Solution: For the tax burden to fall entirely on consumers, the supply curve must be perfectly elastic. Graphically, the supply curve must be horizontal.

1. When someone's kidneys fail, the person needs to have medical treatment with a dialysis machine (unless or until they receive a kidney transplant) or they will die. Sketch a supply and demand diagram, paying attention to the appropriate elasticities, to illustrate that the supply of such dialysis machines will primarily determine the price.

Solution: Given that the patient will die without the aid of a dialysis machine, their demand will be almost perfectly inelastic, as they will be willing to pay any amount of money to survive. The demand curve is therefore a near-vertical line, and price is determined by the position of the supply curve.

22. Why are the factors that shift the demand for a product different from the factors that shift the demand for labor? Why are the factors that shift the supply of a product different from those that shift the supply of labor?

Solution: Goods and labor are supplied and demanded by different economic agents, so the factors that affect them are different. Goods are typically demanded by households and supplied by firms, whereas labor is supplied by households and demanded by firms.

1. Normal goods are defined as having a positive income elasticity. We can divide normal goods into two types: Those whose income elasticity is less than one and those whose income elasticity is greater than one. Think about products that would fall into each category. Can you come up with a name for each category?

Solution: Goods with high income elasticity could be classified as luxuries. We buy more of them as our incomes rise, but are easily willing to give them up if our incomes fall. Goods with low income elasticities could be classified as necessities, where we don't vary our consumption much no matter how much money we make.

13. Are households demanders or suppliers in the goods market? Are firms demanders or suppliers in the goods market? What about the labor market and the financial market?

Solution: Households demand goods and supply labor, whereas firms supply goods and demand labor.

1. If a usury law limits interest rates to no more than 35%, what would the likely impact be on the amount of loans made and interest rates paid?

Solution: If market interest rates stay in their normal range, an interest rate limit of 35% would not be binding. If the equilibrium interest rate rose above 35%, the interest rate would be capped at that rate, and the quantity of loans would be lower than the equilibrium quantity, causing a shortage of loans.

1. Suppose you are in charge of sales at a pharmaceutical company, and your firm has a new drug that causes bald men to grow hair. Assume that the company wants to earn as much revenue as possible from this drug. If the elasticity of demand for your company's product at the current price is 1.4, would you advise the company to raise the price, lower the price, or to keep the price the same? What if the elasticity were 0.6? What if it were 1? Explain your answer.

Solution: If the elasticity is 1.4 at current prices, you would advise the company to lower its price on the product, since a decrease in price will be offset by the increase in the amount of the drug sold. If the elasticity were 0.6, then you would advise the company to increase its price. Increases in price will offset the decrease in number of units sold, but increase your total revenue. If elasticity is 1, the total revenue is already maximized, and you would advise that the company maintain its current price level.

1. In a market where the supply curve is perfectly inelastic, how does an excise tax affect the price paid by consumers and the quantity bought and sold?

Solution: If the supply curve is perfectly inelastic, it is represented by a vertical curve. Sellers bear the entire tax burden, and the quantity bought and sold remains unchanged with the tax. The price paid by consumers remains the same, and the price received by sellers is reduced by the amount of the tax.

13. What is the "price" commonly called in the labor market?

Solution: In labor markets, price is typically called a "wage."

1. Why would a free market never operate at a quantity greater than the equilibrium quantity? Hint: What would be required for a transaction to occur at that quantity?

Solution: In order for a market to operate at a quantity greater than the equilibrium quantity, the government would need to get involved by imposing either a price floor or a price ceiling in order to adjust equilibrium price and quantity. If this is the case, the market is no longer considered a free market.

1. Can you think of an industry (or product) with near infinite elasticity of supply in the short term? That is, what is an industry that could increase Qs almost without limit in response to an increase in the price?

Solution: Many internet companies fall into this model, where the addition of one more user to a website has almost zero cost. Any site that operates on a subscription service could potentially do this, at least in the short run.

1. If demand is inelastic, will shifts in supply have a larger effect on equilibrium price or on quantity?

Solution: On price.

1. If supply is elastic, will shifts in demand have a larger effect on equilibrium quantity or on price?

Solution: On quantity.

1. Does a price ceiling increase or decrease the number of transactions in a market? Why? What about a price floor?

Solution: Price ceilings and price floors prevent markets from adjusting to their equilibrium price and quantity. A price ceiling would decrease the number of transactions in a market when the price ceiling is set below the equilibrium price, which results in the quantity demanded exceeding the quantity supplied. If the supply can't keep up with demand, the number of transactions in a market decreases. Similarly, a price floor would also decrease the number of transactions in a market if the price floor is set above the equilibrium price because the quantity supplied would exceed quantity demanded. If demand can't keep up with supply, the number of transactions in a market decreases.

1. What determines the level of prices in a market?

Solution: Prices are determined by a combination of the level of demand for a good and how much of that good is being supplied.

13. Name some factors that can cause a shift in the demand curve in labor markets.

Solution: Recessions and expansions in the economy can cause a shift in the demand for labor, as can changes in the price of capital (a substitute) and new production technologies.

1. Review the following figure. Suppose the price of gasoline is $1.60 per gallon. Is the quantity demanded higher or lower than at the equilibrium price of $1.40 per gallon? What about the quantity supplied? Is there a shortage or a surplus in the market? If so, how much?

Solution: Since $1.60 per gallon is above the equilibrium price, the quantity demanded would fall and the quantity supplied would rise. (These results are due to the laws of demand and supply, respectively.) The outcome of lower Qd and higher Qs would be a surplus in the gasoline market.

1. Why is a living wage considered a price floor? Does imposing a living wage have the same outcome as a minimum wage?

Solution: Since a living wage is a suggested minimum wage, it acts like a price floor (assuming, of course, that it is followed). If the living wage is binding, it will cause an excess supply of labor at that wage rate.

1. If a price floor benefits producers, why does a price floor reduce social surplus?

Solution: Social surplus is the sum of consumer surplus and producer surplus. A price floor reduces social surplus because with a price floor, the losses to consumers are greater than the benefits to producers. For example, when a government purchases excess supply from farmers in effort to impact demand, the farmers benefit from the price floor while taxpayers and consumers of food end up paying the costs.

1. What is the difference between the supply and the quantity supplied of a product, say milk? Explain in words and show the difference on a graph with the supply curve for milk.

Solution: Supply describes producers' willingness to sell at any price. Supply is shown by the position of a supply curve, in other words, how far away from the origin it is. Quantity supplied refers to how much will be sold at a single, specific price, that is, at one point on the supply curve.

1. Would you expect supply to play a more significant role in determining the price of a basic necessity like food or a luxury like perfume? Explain. (Hint: Think about how the price elasticity of demand will differ between necessities and luxuries.)

Solution: Supply plays more of a role in determining the price of necessities, since demand for these items is inelastic and people cannot easily forego them. Prices for luxury goods are determined primarily by demand, as there are many easy substitutes for these items.

13. Name some factors that can cause a shift in the supply curve in labor markets.

Solution: Supply shocks such as wars and natural disasters which decrease population can shift supply, as can sudden population influxes, such as from immigration.

1. Why might Belgium, France, Italy, and Sweden have a higher export to GDP ratio than the United States?

Solution: The United States is a large country economically speaking, so it has less need to trade internationally than the other countries mentioned. (This is the same reason that France and Italy have lower ratios than Belgium or Sweden.) One additional reason is that each of the other countries is a member of the European Union, where trade between members occurs without barriers to trade, like tariffs and quotas.

1. A city has built a bridge over a river and it decides to charge a toll to everyone who crosses. For one year, the city charges a variety of different tolls and records information on how many drivers cross the bridge. The city thus gathers information about elasticity of demand. If the city wishes to raise as much revenue as possible from the tolls, where will the city decide to charge a toll: in the inelastic portion of the demand curve, the elastic portion of the demand curve, or the unit elastic portion? Explain.

Solution: The city should charge a toll at the unit elastic portion of the demand curve. Charging more than this will see a larger decrease in drivers that will reduce revenue, and charging less than this will not increase traffic enough to make up for the lost revenues.

1. Why is the supply curve with constant unit elasticity a straight line?

Solution: The constant unit elasticity is a straight line because the curve slopes upward and both price and quantity are increasing proportionally.

1. What is consumer surplus? How is it illustrated on a demand and supply diagram?

Solution: The consumer surplus is the extra benefit consumers receive from buying a good or service, measured by what the individuals would have been willing to pay minus the amount that they actually paid. The consumer surplus is illustrated on the demand and supply below in the area labeled F, which is the area above the market price and below the demand curve.

1. Suppose you could buy shoes one at a time, rather than in pairs. What do you predict the cross-price elasticity for left shoes and right shoes would be?

Solution: The cross price elasticity would be very nearly unitary, for few people would have a use for a left shoe without a right shoe and vice versa.

1. Why is the demand curve with constant unit elasticity concave?

Solution: The demand curve with constant unit elasticity is concave because the absolute value of declines in price are not identical. The left side of the curve starts with high prices, and then price falls by smaller amounts as it goes down toward the right side. This results in a slope of demand that is steeper on the left but flatter on the right, creating a curved, concave shape.

32. What happens to the price and the quantity bought and sold in the cocoa market if countries producing cocoa experience a drought and a new study is released demonstrating the health benefits of cocoa? Illustrate your answer with a demand and supply graph.

Solution: The drought is a supply shock that will reduce the supply of cocoa, whereas the health study will increase demand. Both of these shifts will result in higher prices, but they have opposite effects on the quantity produced and sold. Without knowing the magnitudes of the effects, we cannot say for sure what happens to the equilibrium quantity.

1. How can you locate the equilibrium point on a demand and supply graph?

Solution: The equilibrium is the point where the demand curve and the supply curve cross.

1. Most government policy decisions have winners and losers. What are the effects of raising the minimum wage? It is more complex than simply producers lose and workers gain. Who are the winners and who are the losers, and what exactly do they win and lose? To what extent does the policy change achieve its goals?

Solution: The minimum wage is a price floor that prevents the price of labor from falling below a certain level. Like all binding price floors, this creates a surplus of labor, also known as unemployment. Those who do not offer enough productive value to earn the minimum wage will lose out on job opportunities they might otherwise have had. On the other hand, those who do manage to keep their jobs will benefit from higher wages. In this way, minimum wages make some workers better off, but actually harm those with the least education or skills, who cannot compete for jobs at the higher wage level.

Use this information to answer the following 4 questions: Marie has a weekly budget of $24, which she likes to spend on magazines and pies. 1. What is Marie's opportunity cost of purchasing a pie?

Solution: The opportunity cost of a pie is the (absolute value of the) slope of the budget line is 6/2 or 3 magazines.

1. What is the formula for the income elasticity of demand?

Solution: The percent change in quantity demanded over the percent change in income. E = %∆Q/%∆I

1. What is the formula for the cross-price elasticity of demand?

Solution: The percent change in quantity demanded over the percent change in the price of the substitute or complement good. E = %∆Q/%∆Ps or %∆Q/%∆Pc

1. What is the formula for elasticity of savings with respect to interest rates?

Solution: The percent change in savings over the percent change in interest rates. E = %∆S/%∆Ir

1. What is the formula for the wage elasticity of labor supply?

Solution: The percent change in the quantity of labor supplied over the percent change i the wage rate. E = %∆Q/%∆W

1. What would the gasoline price elasticity of supply mean to UPS or FedEx?

Solution: The percentage change in quantity supplied as a result of a given percentage change in the price of gasoline.

1. What is the price elasticity of demand? Can you explain it in your own words?

Solution: The price elasticity of demand is the extent to which quantity demanded responds to a change in price.

1. What is the price elasticity of supply? Can you explain it in your own words?

Solution: The price elasticity of supply is the extent to which quantity supplied responds to a change in price.

1. What is producer surplus? How is it illustrated on a demand and supply diagram?

Solution: The producer surplus is the extra benefit producers receive from selling a good or service, measured by the price the producer actually received minus the price the producer would have been willing to accept. The producer surplus is illustrated in the demand and supply diagram below in the area labeled G, which is the area between the market price and the segment of the supply curve below the equilibrium.

1. Review the following figure. Suppose the price of gasoline is $1.00. Will the quantity demanded be lower or higher than at the equilibrium price of $1.40 per gallon? Will the quantity supplied lower or higher? Is there a shortage or a surplus in the market? If so, of how much?

Solution: The quantity demanded will be higher than at the equilibrium price and the quantity supplied will be lower, resulting in a shortage of 300 million gallons.

22. Suppose the U.S. economy began to grow more rapidly than other countries in the world. What would be the likely impact on U.S. financial markets as part of the global economy?

Solution: The quantity of loanable funds would increase, resulting in lower interest rates and more borrowing from other countries.

1. Will supply curves have the same shape in all markets? If not, how will they differ?

Solution: The shape of supply curves will differ based on how easy it is to vary the level of supply in response to a price change. For example, a natural resource of which there is a finite amount may have a very steep supply curve, because of the difficulty in increasing production.

Use this information to answer the following 4 questions: Marie has a weekly budget of $24, which she likes to spend on magazines and pies. 1. Draw Marie's budget constraint with pies on the horizontal axis and magazines on the vertical axis. What is the slope of the budget constraint?

Solution: The slope is -3.

1. Say that a certain stadium for professional football has 70,000 seats. What is the shape of the supply curve for tickets to football games at that stadium? Explain.

Solution: The supply curve is almost perfectly inelastic, since the quantity of seats is fixed, and will therefore be represented by a vertical line. In the short run, no increase in demand can result in more than 70,000 seats being supplied.

1. Assume that the supply of low-skilled workers is fairly elastic, but the employers' demand for such workers is fairly inelastic. If the policy goal is to expand employment for low-skilled workers, is it better to focus on policy tools to shift the supply of unskilled labor or on tools to shift the demand for unskilled labor? What if the policy goal is to raise wages for this group? Explain your answers with supply and demand diagrams.

Solution: To expand employment, the best option is to shift demand, since employers will not greatly respond to price changes. On the other hand, if the goal is to boost wages, shifting supply is a better option, since employers will not be able to easily reduce their workforce and will therefore have to pay a higher wage.

1. Why do economists use the ceteris paribus assumption?

Solution: To make it easier to analyze complex problems. Ceteris paribus allows you to look at the effect of one factor at a time on what it is you're trying to analyze. When you've analyzed all the factors individually, you add the results together to get the final answer. See the next two questions for examples of how this is done.

1. What is total surplus? How is it illustrated on a demand and supply diagram?

Solution: Total surplus is the sum of consumer surplus and producer surplus. It is also referred to as economic surplus or social surplus. The total surplus in the demand and supply diagram below would be shown as the area F +G because the total surplus is the sum of the consumer surplus (F) and the producer surplus (G).

13. Would usury laws help or hinder resolution of a shortage in financial markets?

Solution: Usury laws make lending less profitable, so they would hinder resolution of a shortage.

1. Explain why voluntary transactions improve social welfare.

Solution: Voluntary transactions improve social welfare because they allow both the buyers and sellers to willingly engage in the market.

1. Would you usually expect elasticity of demand or supply to be higher in the short run or in the long run? Why?

Solution: We should expect demand to be more elastic in the short run, since it takes time to vary production to supply more or less of a good. However, in the long run supply is likely to be more elastic, as producers have a potentially unlimited ability to vary supply with prices.

1. How does one analyze a market where both demand and supply shift?

Solution: When both demand and supply shift, they will generally have opposite effects on either quantity or price. In this case it is necessary to know the magnitude of the changes in order to analyze them.

Solution: Equilibrium is where the quantity of loanable funds demanded equals the quantity supplied.

Solution: When people want to borrow money, but are unable to find a willing lender.

1. When the price is above the equilibrium, explain how market forces move the market price to equilibrium. Do the same when the price is below the equilibrium.

Solution: When price is above the equilibrium, there will be more sellers than buyers and the surplus goods will start to pile up. The only way for sellers to get rid of their excess goods is to lower prices. Conversely, if the price is too low, there will be more buyers than sellers, and those who demand the good will be willing to offer higher prices for them.

1. Consider the demand for hamburgers. If the price of a substitute good (e.g., hot dogs) increases and the price of a complement good (e.g., hamburger buns) increases, can you tell for sure what will happen to the demand for hamburgers? Why or why not?

Solution: Without more information, we cannot say what will happen to the demand for hamburgers. The increase in the price of hot dogs will increase the demand for hamburgers, but the increase in the price of hamburger buns will have the opposite effect. Only by knowing the magnitude of each effect can we say for sure what will happen.

1. Which of the following changes in the financial market will lead to an increase in the quantity of loans made and received: a. a rise in demand b. a fall in demand c. a rise in supply d. a fall in supply

Solution: a) and c) will increase the quantity of loans. More people who want to borrow will result in more loans being given, as will more people who want to lend.

1. Which of the following changes in the financial market will lead to a decline in interest rates: a)a rise in demand b)a fall in demand c)a rise in supply d)a fall in supply

Solution: b) and c) will lead to a fall in interest rates. At a lower demand, lenders will not be able to charge as much, and with more available lenders, competition for borrowers will drive rates down.

12. Select the correct answer. A price ceiling will usually shift:

Solution: d) Neither. A shift in demand or supply means that at every price, either a greater or a lower quantity is demanded or supplied. A price ceiling does not shift a demand curve or a supply curve. However, if the price ceiling is set below the equilibrium, it will cause the quantity demanded on the demand curve to be greater than the quantity supplied on the supply curve, leading to excess demand.

1. Select the correct answer. A price floor will usually shift: a. demand b. supply c. both d. neither

Solution: d) Neither. A shift in demand or supply means that at every price, either a greater or a lower quantity is demanded or supplied. A price floor does not shift a demand curve or a supply curve. However, if the price floor is set above the equilibrium, it will cause the quantity supplied on the supply curve to be greater than the quantity demanded on the demand curve, leading to excess supply.

1. The equation for a supply curve is P = 3Q - 8. What is the elasticity in moving from a price of 4 to a price of 7?

Solve for Q: (4) = 3Q - 8; Q=4 (7) = 3Q - 8' Q=5 E = %∆Q/%∆P = [(5 - 4)/4]/[(7 - 4)/4] = 0.33

1. A tariff is a tax on imported goods. Suppose the U.S. government cuts the tariff on imported flat screen televisions. Using the four-step analysis, how do you think the tariff reduction will affect the equilibrium price and quantity of flat screen TVs?

Step 1: Draw the graph with the initial supply and demand curves. Label the initial equilibrium price and quantity. Step 2: Did the economic event affect supply or demand? A tariff is treated like a cost of production, so this affects supply. Step 3: A tariff reduction is equivalent to a decrease in the cost of production, which we can show as a rightward (or downward) shift in supply. Step 4: A rightward shift in supply causes a movement down the demand curve, lowering the equilibrium price and raising the equilibrium quantity.

1. Let's think about the market for air travel. From August 2014 to January to 2015, the price of jet fuel increased roughly 47%. Using the four-step analysis, how do you think this fuel price increase affected the equilibrium price and quantity of air travel?

Step 1: Draw the graph with the initial supply and demand curves. Label the initial equilibrium price and quantity. Step 2: Did the economic event affect supply or demand? Jet fuel is a cost of producing air travel, so an increase in price affects supply. Step 3: An increase in the price of jet fuel caused an increase in the cost of air travel. We show this as an upward or leftward shift in supply. Step 4: A leftward shift in supply causes a movement up the demand curve, raising the equilibrium price of air travel and lowering the equilibrium quantity

1. Suppose the cross-price elasticity of apples with respect to the price of oranges is 0.4, and the price of oranges falls by 3%. What will happen to the demand for apples?

The formula for cross-price elasticity is % change in Qd for apples / % change in P of oranges. Multiplying both sides by % change in P of oranges yields: % change in Qd for apples = cross-price elasticity X% change in P of oranges = 0.4 × (-3%) = -1.2%, or a 1.2 % decrease in demand for apples.

What would be another example of a "system" in the real world that could serve as a metaphor for micro and macroeconomics?

There are many physical systems that would work, for example, the study of planets (micro) in the solar system (macro), or solar systems (micro) in the galaxy (macro).

What is an example of a problem in the world today, not mentioned in the chapter, that has an economic dimension?

There are many such problems. Consider the AIDS epidemic. Why are so few AIDS patients in Africa and Southeast Asia treated with the same drugs that are effective in the United States and Europe? It is because neither those patients nor the countries in which they live have the resources to purchase the same drugs.

production possibilities frontier (PPF

a diagram that shows the productively efficient combinations of two products that an economy can produce given the resources it has available.

circular flow diagram

a diagram that views the economy as consisting of households and firms interacting in a goods and services market and a labor market

goods and services market

a market in which firms are sellers of what they produce and households are buyers

underground economy

a market where the buyers and sellers make transactions in violation of one or more

1. In an analysis of the market for paint, an economist discovers the facts listed below. State whether each of these changes will affect supply or demand, and in what direction. a. There have recently been some important cost-saving inventions in the technology for making paint. b. Paint is lasting longer, so that property owners need not repaint as often. c. Because of severe hailstorms, many people need to repaint now. d. The hailstorms damaged several factories that make paint, forcing them to close down for several months.

a. An improvement in technology that reduces the cost of production will cause an increase in supply at any price. Alternatively, you can think of this as a reduction in price necessary for firms to supply any quantity. Either way, this can be shown as a rightward (or downward) shift in the supply curve. b. An improvement in product quality is treated as an increase in tastes or preferences, meaning consumers will demand more paint at any price level, so demand in the present will increase or shift to the right. If this seems counterintuitive, note that demand in the future for the longer-lasting paint will fall, since consumers are essentially shifting demand from the future to the present. c. An increase in need causes an increase in demand or a rightward shift in the demand curve. d. Factory damage means that firms are unable to supply as much in the present. Technically, this is an increase in the cost of production. Either way you look at it, the supply curve shifts to the left.

1. Many changes are affecting the market for oil. Predict how each of the following events will affect the equilibrium price and quantity in the market for oil. In each case, sketch a supply and demand diagram to support your answer. a. Cars are becoming more fuel efficient, and therefore get more miles to the gallon. b. The winter is exceptionally cold. c. A major discovery of new oil is made off the coast of Norway. d. The economies of some major oil-using nations, like Japan, slow down. e. A war in the Middle East disrupts oil-pumping schedules. f. Landlords install additional insulation in buildings. g. The price of solar energy falls dramatically. h. Chemical companies invent a new, popular kind of plastic made from oil.

a. More fuel efficient cars means there is less need for gasoline. This causes a leftward shift in the demand for gasoline and thus oil. Since the demand curve is shifting down the supply curve, the equilibrium price and quantity both fall. b. Cold weather increases the need for heating oil. This causes a rightward shift in the demand for heating oil and thus oil. Since the demand curve is shifting up the supply curve, the equilibrium price and quantity both rise. c. A discovery of new oil will make oil more abundant. This can be shown as a rightward shift in the supply curve, which will cause a decrease in the equilibrium price along with an increase in the equilibrium quantity. (The supply curve shifts down the demand curve so price and quantity follow the law of demand. If price goes up, then the quantity goes down.) d. When an economy slows down, it produces less output and demands fewer inputs, including energy, which is used in the production of virtually everything. A decrease in demand for energy will be reflected as a decrease in the demand for oil, or a leftward shift in demand for oil. Since the demand curve is shifting down the supply curve, both the equilibrium price and quantity of oil will fall. e. Disruption of oil pumping will reduce the supply of oil. This leftward shift in the supply curve will show a movement up the demand curve, resulting in an increase in the equilibrium price of oil and a decrease in the equilibrium quantity. f. Increased insulation will decrease the demand for heating. This leftward shift in the demand for oil causes a movement down the supply curve resulting in a decrease in the equilibrium price and quantity of oil. g. Solar energy is a substitute for oil-based energy. So if solar energy becomes cheaper, the demand for oil will decrease as consumers switch from oil to solar. The decrease in demand for oil will be shown as a leftward shift in the demand curve. As the demand curve shifts down the supply curve, both equilibrium price and quantity for oil will fall. h. A new, popular kind of plastic will increase the demand for oil. The increase in demand will be shown as a rightward shift in demand, raising the equilibrium price and quantity of oil.

28. Predict how each of the following events will raise or lower the equilibrium wage and quantity of coal miners in West Virginia. In each case, sketch a demand and supply diagram to illustrate your answer. a. The price of oil rises. b. New coal-mining equipment is invented that is cheap and requires few workers to run. c. Several major companies that do not mine coal open factories in West Virginia, offering a lot of well-paid jobs. d. Government imposes costly new regulations to make coal-mining a safer job.

a. Since oil is a substitute for coal, and increase in the price of oil will shift the demand curve right, increasing wages and increasing the quantity of coal miners employed. a. Coal mining equipment is a substitute for labor, so the demand curve for coal miners shifts left, reducing wages and reducing employment. a. The availability of new factory jobs, should shifts the supply curve for coal miners left, increasing wages and reducing the quantity of jobs mining. a. Mandated expenditures on safety reduce the demand for labor, shifting the demand curve left, reducing wages and reducing quantity. However, since coal mining is safer, this may also cause an increase in the supply of miners as well, shifting supply to the right. The combination of both effects will reduce wages, but the effect on employment is indeterminate.

28. Identify each of the following as involving either demand or supply. Draw a circular flow diagram and label the flows A through F. (Some choices can be on both sides of the goods market.) a. Households in the labor market b. Firms in the goods market c. Firms in the financial market d. Households in the goods market a. Firms in the labor market b. Households in the financial market

a. Supply b. Supply c. Demand d. Demand e. Demand f. Supply (and sometimes demand too)

28. Predict how each of the following economic changes will affect the equilibrium price and quantity in the financial market for home loans. Sketch a demand and supply diagram to support your answers. a. The number of people at the most common ages for home-buying increases. b. People gain confidence that the economy is growing and that their jobs are secure. c. Banks that have made home loans find that a larger number of people than they expected are not repaying those loans. d. Because of a threat of a war, people become uncertain about their economic future. e. The overall level of saving in the economy diminishes. f. The federal government changes its bank regulations in a way that makes it cheaper and easier for banks to make home loans.

a. The demand curve shifts right, increasing interest rates and increasing quantity of loans b. The demand curve shifts right, increasing interest rates and increasing quantity of loans c. The supply curve shifts left, increasing interest rates and reducing quantity of loans d. The demand curve shifts left, reducing interest rates and reducing quantity of loans e. The supply curve shifts left, increasing interest rates and reducing quantity of loans a. The demand curve shifts right, increasing interest rates and increasing quantity of loans b. The demand curve shifts right, increasing interest rates and increasing quantity of loans c. The supply curve shifts left, increasing interest rates and reducing quantity of loans d. The demand curve shifts left, reducing interest rates and reducing quantity of loans e. The supply curve shifts left, increasing interest rates and reducing quantity of loans

22. During a discussion several years ago on building a pipeline to Alaska to carry natural gas, the U.S. Senate passed a bill stipulating that there should be a guaranteed minimum price for the natural gas that would be carried through the pipeline. The thinking behind the bill was that if private firms had a guaranteed price for their natural gas, they would be more willing to drill for gas and to pay to build the pipeline a. Using the demand and supply framework, predict the effects of this price floor on the price, quantity demanded, and quantity supplied. b. With the enactment of this price floor for natural gas, what are some of the likely unintended consequences in the market? c. Suggest some policies other than the price floor, working within the framework of demand and supply that the government can pursue if it wishes to encourage drilling for natural gas and for a new pipeline in Alaska.

a. The price floor would result in more natural gas being supplied than the quantity demanded. b. There would be a surplus of natural gas, with firms producing more than consumers would be willing to buy at the mandated price. c. Policies that directly affect supply and demand are more efficient than price floors. For example, the government could shift investment away from public transportation and ethanol towards technologies that rely more heavily on natural gas to stimulate demand, or the government could stimulate supply by offering subsidies to producers.

32. Imagine that to preserve the traditional way of life in small fishing villages, a government decides to impose a price floor that will guarantee all fishermen a certain price for their catch. a. Using the demand and supply framework, predict the effects on the price, quantity demanded, and quantity supplied. b. With the enactment of this price floor for fish, what are some of the likely unintended consequences in the market? c. Suggest some policies other than the price floor, working within the framework of demand and supply, to make it possible for small fishing villages to continue.

a. The price floor, if it is binding, will increase prices, which will result in a higher quantity supplied and a lower quantity demanded. b. We are likely to see a surplus of fish, as fishermen are more willing to supply them at the mandated price than consumers are willing to buy them. c. A better policy would be to stimulate demand for fish, which would result in higher prices without the inefficiencies of a surplus. This could be done through advertising, or by arranging exclusive contracts for the government to buy from the fishing villages. Alternatively, the fishermen could be offered wage subsidies to increase the effective price they receive for their fish without raising the price to consumers

opporunity set

all possible combinations of consumption that someone can afford given the prices of goods and the individual's income

budget contraint

all possible consumption combinations of goods that someone can afford, given the prices of goods, when all income is spent; the boundary of the opportunity set

market economy

an economy where economic decisions are decentralized, private individuals own resources, and businesses supply goods and services based on demand

command economy

an economy where economic decisions are passed down from government authority and where the government owns the resources

law of diminishing returns

as we add additional increments of resources to producing a good or service, the marginal benefit from those additional increments will decline

law of diminishing marginal utility

as we consume more of a good or service, the utility we get from additional units of the good or service tends to become smaller than what we received from earlier units

market interaction

between potential buyers and sellers; a combination of demand and supply

sunk costs

costs that we make in the past that we cannot recover

fiscal policy

economic policies that involve government spending and taxes

marginal analysis

examination of decisions on the margin, meaning a little more or a little less from the status quo

GDP

measure of the size of total production in an economy

opportunity cost

measures cost by what we give up/forfeit in exchange; opportunity cost measures the value of the forgone alternative

1. If demand is elastic, will shifts in supply have a larger effect on equilibrium quantity or on price?

on quantity

monetary policy

policy that involves altering the level of interest rates, the availability of credit in the economy, and the extent of borrowing

imports

products (goods and services) made abroad and then sold domestically

exports

products (goods and services) made domestically and sold abroad

theory

representation of an object or situation that is simplified while including enough of the key features to help us understand the object or situation

utility

satisfaction, usefulness, or value one obtains from consuming goods and services

normative statements

statement which describes how the world should be

positive statement

statement which describes the world as it is

microeconomics

the branch of economics that focuses on actions of particular agents within the economy, like households, workers, and business firms

Macroeconomics

the branch of economics that focuses on broad issues such as growth, unemployment, inflation, and trade balance

labor market

the market in which households sell their labor as workers to business firms or other employers

Economics

the study of how humans make choices under conditions of scarcity

Globalization

the trend in which buying and selling in markets have increasingly crossed national borders

division of labor

the way in which different workers divide required tasks to produce a good or service

traditional economy

typically an agricultural economy where things are done the same as they have always been done

comparative advantage

when a country can produce a good at a lower cost in terms of other goods; or, when a country has a lower opportunity cost of production

scarcity

when human wants for goods and services exceed the available supply

productive efficiency

when it is impossible to produce more of one good (or service) without decreasing the quantity produced of another good (or service)

economies of scale

when the average cost of producing each individual unit declines as total output increases

allocation efficiency

when the mix of goods produced represents the mix that society most desires

Specilization

when workers or firms focus on particular tasks for which they are well-suited within the overall production process

Private enterprise system

where private individuals or groups of private individuals own and operate the means of production (resources and businesses)