SOLUTION’S MANUAL Microeconomics 3rd Edition by Daron Acemoglu; David Laibson; John List
TABLE OF CONTENTS Chapter 1: The Principles and Practice of Economics Chapter 2: Economic Science: Using Data and Models to Understand the World Chapter 3: Optimization: Trying to Do the Best You Can Chapter 4: Demand, Supply, and Equilibrium Chapter 5: Consumers and Incentives Chapter 6: Sellers and Incentives Chapter 7: Perfect Competition and the Invisible Hand Chapter 8: Trade Chapter 9: Externalities and Public Goods Chapter 10: The Government in the Economy: Taxation and Regulation Chapter 11: Markets for Factors of Production Chapter 12: Monopoly Chapter 13: Game Theory and Strategic Play Chapter 14: Oligopoly and Monopolistic Competition Chapter 15: Trade-offs Involving Time and Risk Chapter 16: The Economics of Information Chapter 17: Auctions and Bargaining Chapter 18: Social Economics
Chapter 19: The Wealth of Nations: Defining and Measuring Macroeconomic Aggregates Chapter 20: Aggregate Incomes Chapter 21: Economic Growth Chapter 22: Why Isn't the Whole World Developed? Chapter 23: Employment and Unemployment Chapter 24: Credit Markets Chapter 25: The Monetary System Chapter 26: Economic Fluctuations Chapter 27: Macroeconomic Policy Chapter 28: Macroeconomics and International Trade Chapter 29: Open Economy Macroeconomics
Chapter 1: The Principles and Practice of Economics Questions 1. Give examples to explain how economic analysis can be positive and normative. Answer: Positive economics is objective and based on facts. However, normative economics is subjective and opinion-based. For example, Positive economics: The mismatch between students’ knowledge and market requirements is afactor that underlies low employability. Normative economics: The government should increase the minimum wage earned by each employee. 2.
Economists think of almost all human behavior as the outcome of choices. Do you agree with this statement? Based on your reading of the chapter, how would you define economics?
Answer: Scarcity of resources for individuals, firms, and nations in the situation of having unlimited wants pushes them to make choices by allocating scarce resources to their wants. Individuals have limited budgets (scarce resources) compared to the unlimited wants that they wish to satisfy. Firms have unlimited investment projects as compared to their limited budgets.Nations may have many areas—growth, human development, healthcare, legislature, and education—that require expenditure, but due to limited budgets, governments need to prioritizeareas for spending. Economics is a science that helps in performing this allocation. 3.
Examine the following statements and determine if they are examples of normative economics or positive economics. Explain your answer. a. According to the World Economic Outlook Update released by the International Monetary Fund in January 2021, the global economy is projected to grow 5.5 percent in 2021 and 4.2 percent in 2022. b. According to an article published in the European Central Bank (ECB) Economic Bulletin in January 2021, government spending on investment should be a priority duringthe interim phase in the run-up to the economic recovery in the euro area.
Answer: a. This is an objective prediction released by the IMF about growth in the global economy. Positive economics is analysis that generates objective descriptions or predictions about the world, which can be substantiated with data. Since data can be used to underline why the IMF believes that growth will be 5.5 percent in 2021 and 4.2 percent in 2022, this is an example of positive economic analysis. However, students should note that different organizations may have different growth predictions about the global economy and that the IMF itself will revise these calculations every quarter. b. The statement that government spending on investment should be a priority is normative since it states what governments ought to do. Normative economics prescribes what an
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individual or society should do. Source: Stephan Haroutunian, Steffen Osterloh, and Kamila Sławińska,“The Initial Fiscal Policy Responses of Euro Area Countries to the Covid-19 Crisis,” ECB Economic Bulletin, January 2021, https://www.ecb.europa.eu/pub/economicbulletin/articles/2021/html/ecb.ebart202101_03 ~c5595cd291.en.html. 4.
How does microeconomics differ from macroeconomics? Would the supply of iPhones in the United States be studied under microeconomics or macroeconomics? What about the growth rate of total economic output in the national economy?
Answer: Microeconomics is the study of how individuals, households, firms, and governments make choices, and how those choices affect prices, the allocation of resources, and the well-being of other agents. Macroeconomics is the study of the economy as a whole. Macroeconomists study factors that affect overall – in other words, aggregate – economic performance. The supply of iPhones refers to the supply of a good by an individual firm, Apple. The iPhone market will be studied under microeconomics. Microeconomics studies how individuals, households, firms and governments make choices, and how those choices affect prices and the allocation of resources. The growth rate of total economic output, on the other hand, refers to the aggregate American economy, and is therefore studied under macroeconomics. 5.
Why do economic agents have to make trade-offs on any given day of their lives? What kind of non-monetary budget constraints do agents face?
Answer: An economic agent faces the prospect of a trade-off when the agent needs to give up one thing to get something else. For instance, an agent faces a trade-off when organizing their daily schedule. Should they go to work, or stay at home and watch a TV series? Should they spend an extra hour at work or hang out with friends? Should they spend their free time focusing on getting an extra degree in legal studies or be happy with the current work position they are in? An example of a non-monetary budget constraint is that of time. All economic agents have 24 hours in their day. Therefore, based on their utilities, agents optimize by making trade-offs on the type of activity that they take part in. 6.
This chapter introduces the idea of opportunity cost. a. What is meant by opportunity cost? b. What is the opportunity cost of taking a year after graduating from high school and backpacking across Europe? Are people who do so being irrational?
Answer: a. Opportunity cost is the best alternative use of a resource. The opportunity cost of a particular choice is measured in terms of the benefit foregone from the next best alternative. To facilitate comparison, the benefits and costs of various choices are translated into monetary units like dollars. b. The opportunity cost of backpacking across Europe, for a particular person, is the cost of anything else that could have been done in that year. The backpacker could have attended college or started working. These costs are the opportunity costs of the gap year. This, however, does not mean that backpackers are irrational, because the benefits may exceed the cost. Every action has an opportunity cost. The choices that people make are optimal based on their perceived costs and benefits. 7.
Suppose you wish to take out a mortgage to buy a new house for your family. However, the houses you like exceed your budget. You are considering three options: choose a neighborhood that is less fashionable and, therefore, the prices are lower; take out a mortgage
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with a longer maturity period; or instead of buying a house, buy a larger apartment in your current neighborhood. How would you evaluate these options and choose the optimal one? Answer: You can use cost-benefit analysis to compare the various feasible alternatives and pick the best one. Cost-benefit analysis is a calculation that adds up costs and benefits using a common unit of measurement, such as euros. Buying a house in a less fashionable neighborhood would give you a larger space and your family a garden to enjoy; however, it might take longer to commute to work, or the schools in the locality might be of a lower quality. The mortgage with a longer maturity period allows you to buy your dream house, but you will be opening yourself up to a greater risk of default should you, or your partner, face job loss. Buying a larger apartment instead of a house gives you enough room for an expanding family, but not a garden. All these options need to be converted into values in euros. This will include monetary as well as opportunity costs. You can then choose the option that offers you the greatest net benefit. 8.
Suppose the market price of the latest model of iPhone is €759 in Germany. What are the three conditions that will need to be satisfied for the iPhone market to be in equilibrium at this price?
Answer: For the market to be in equilibrium, three conditions will need to be satisfied:
9.
•
At the price of €759 per unit, the number of iPhones supplied by Apple should be equal to the number of iPhones purchased by buyers in the market.
•
Apple has chosen the optimal quantity of iPhones to supply, given the price of €759 per unit.
•
Consumers have chosen the optimal quantity of iPhones to buy, given the price of €759 per unit.
Suppose you are living in a housing project that has 100 apartments. The housing project has its own garden, swimming pool, library, and community center. To be able to utilize the available amenities, residents must contribute €50 a month towards the upkeep while also taking turns keep it clean. In this context, answer the following questions. a. What is meant by free riding? b. How would you define a free-riding resident? Why would it be a problem for the housing project?
Answer: a. A free rider is a person who receives the benefit of a good but avoids paying for it. People tend to pursue their own private interests and usually don’t contribute voluntarily to the public interest. For example, watching a pirated copy of a movie is cheaper than buying one. Those who watch the pirated version are free riders because there are others who buy the movie or pay for movie tickets. If everyone watched pirated copies, making movies would not be profitable and the industry would not function. b. In the situation described in the question, a free-riding resident would be a person or family that does not contribute in terms of money and commitment to maintain the housing project and keep it clean. In a way, this person is using the services being offered by the housing project for free and is taking advantage of the other contributing residents. This is a problem for the housing project because it will compel the paying residents to either eventually pay more money for the upkeep of the garden, swimming pool, and other amenities, or they will have to work more in any given week to keep it clean.
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10. “Scarcity exists because people have unlimited wants in a world of limited resources.” Explain this statement using a real-life example. Answer: Since the world has limited resources, no one can have everything they want. Scarce resources are things that people want, where the quantity desired exceeds the quantity that is available. For example, emerging viral pandemics, such as the COVID-19 pandemic, may place unexpectedly high and sustained demands on public healthcare systems and on various essential services. However, certain regions with large outbreaks may have fewer hospital beds and ventilators, or smaller hospitals in rural areas may have less space and supplies to offer. Thus, the demand for such items in these regions, especially during a pandemic, may exceed the resources available, causing scarcity. These situations will create the need to ration supplies and interventions. 11. Identify the cause and the effect in the following phenomena in a hypothetical country: a. A surge in the price of goods and an increase in the workers’ income. b. A rise in GDP and an increase in the number of university graduates. Answer: a. The increase in income is likely to induce people to spend more, thus leading to a surge in prices. b. The increase in the number of university graduates in the country is likely to lead to higher productivity, resulting in a rise in GDP.
Problems 1.
You have purchased a non-refundable ticket to the Maldives with an early morning departure scheduled for Saturday. You receive a call notifying you about an interview for a job that may be scheduled around the same time. While you really wanted this job, you think that going on the trip is more important for your mental wellbeing as you have been planning this trip for a year now. a. The human resources department from the company you applied to informs you that there is only one slot available for the interview, which clashes with your flight. Should this affect your decision to go on the trip? Explain by using the term “opportunity cost. b. Suppose instead that you realize that the non-refundable travel ticket, which you already purchased, cost you €100; previously you had mistakenly believed the price was €250. Should learning this information affect your decision to go to the Maldives trip?
Answer: a. This should affect your decision, or at least make you reconsider. The explicit cost of the trip has not changed, nor has the benefit of the trip itself. However, the opportunity cost of not making it to the interview is now higher than you previously thought. b. This should not affect your decision. Whether you paid €100 or €250 in the past is irrelevant to the costs and benefits that you can affect by going (or not going) on the trip. 2.
You are thinking about buying a house in London. You find one you like that costs £1,000,000. You learn that, based on the value of the house and your wages, your bank will give you a mortgage for 20 years in the region of £600,000. This means that you must make a down payment of £400,000. What are some of the monetary and non-monetary opportunity costs of this purchase?
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Answer: By using your £400,000 to buy the house, you give up the opportunity to earn interest on that money. If you could earn 4% interest, then the opportunity cost is 0.04 × £400,000 = £16,000 per year. Also, if the value of the house increases (real increase) by 2% per annum, then the value of your property will have increased by £20,000 a year (£1,000,000 × 1.02 = £1,020,000). Subtracting the opportunity cost of £16,000, this indicates a gain of £4,000. However, you will also have to pay mortgage. At a 4% mortgage, you will be paying £24,000 per annum. Under these conditions, you will have to decide whether it makes sense for you to buy the house. Some of the non-monetary opportunity costs include the benefits associated with a better neighborhood, such as accessibility to public transport, shops, and schools. 3.
Your local coffee shop used to be the best in the neighborhood; however, due to a recent change in ownership the quality of the service and products offered has been steadily decreasing. Nevertheless, you have some fond memories of the place and it is also quite conveniently located—on the way to the train station that you use to get to work.
a. What is the opportunity cost of searching for a new coffee shop? b. You have found a new coffee shop, but to get there you have to take a longer route to the train station. How would you determine, every morning, which coffee shop to visit? The old one or the new one? Answer: a. You have to invest time and effort in finding a new coffee shop. You will also have to leave your apartment (flat) earlier or spend some extra time after work to find the optimal one. Instead, this time could be spent in relaxing or meeting with friends. b. You will have to factor in whether the longer walk to get to the train station is worthwhile to visit your new coffee shop. If you were able to leave your flat on time, or if there are trains every five minutes from your local station, then the opportunity cost of visiting your new coffee shop will be presumably low. However, if you are late, if it is raining, or if your old coffee shop holds some sentimental value for you, you might stick to the old one. 4.
You have decided that you are going to consume 600 calories of beer and snacks at a party Saturday night. A beer has 150 calories and a snack has 75 calories. a. Create a table that shows the various combinations of beer and snacks you can consume. To keep things simple, use only round numbers (e.g., you could choose 1 or 2 beers but not 1.5 beers). b. What is the opportunity cost of a beer?
Answer: a. Suppose you choose to consume 0 beers. Then you could use all 600 calories on snacks. Since snacks have 75 calories you could consume 600 / 75 = 8 snacks. Now suppose you choose 1 beer. A beer has 150 calories and so you would be left with 600 – 150 = 450 calories for snacks. You could therefore consume 450 / 75 = 6 snacks if you choose 1 beer. You can use the same logic to complete the table below.
Chapter 1 | The Principles and Practice of Economics
Beer
Snacks
0
8
1
6
2
4
3
2
4
0
6
b. If you consume 1 more beer you will have 150 fewer calories for snacks. Since a snack has 75 calories, consuming one more beer means that you will have to give up 150 / 75 = 2 snacks. The opportunity cost of a beer is therefore 2 snacks. 5.
Consider the following three statements : a. You are planning a conference in St. Petersburg, Russia, and your closing gala will be on a cruise boat in November. Do you think hosting the event on a boat is a rational choice? b. You have to reach the airport during rush hour to catch your flight to St. Petersburg. You have two options: take the underground or take a taxi. Although you have an hour to get there, traffic most of the time is heavy during rush hour. Which option would be the rational choice? c. Suppose you decided to take a taxi to the airport and made it to the airport in time. Once you landed in St. Petersburg, you noticed that the temperature was surprisingly mild, making the cruise boat experience comfortable. Do these outcomes mean that the decisions to host an event on a cruise boat in November and take a taxi to the airport were rational?
Answer: a. Considering the low average temperature in St. Petersburg in November, if the boat does not have heating or paneling, or is not made for the Russian winter, hosting the event on a cruise boat is likely to be an irrational decision. b. If the traffic is heavy during rush hour, the rational choice would be to take the underground to the airport and avoid traveling by road. c. It is possible to beat the odds despite making an irrational decision. The probable temperature in November in St. Petersburg and the time taken to get to the airport by taxi are estimated as averages; there can always be some deviation from the mean. 6.
Consider the following three statements: a. “Your friends are coming over for lunch and you realize you have forgotten to get groceries. You go to the local market, where there are about 50 stalls. You are in a hurry, so you decide to do all of your shopping at the first two stalls. b. You find a stall that sells good quality vegetables and fruit. However, you do not have enough money on you. You start to haggle and agree on a 15 percent discount for the products you are buying. c. “Despite being in a hurry, you now decide to go around the market to check the prices and quality at all stalls.
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Which of these statements deals with optimization, which deals with equilibrium, and which deals with empiricism? Explain. Answer: The first statement involves optimization. You believe that you will be better off by making all your purchases quickly to get home in time to do the cooking. The second statement involves equilibrium. The shopkeeper may have been in a hurry to make the sale, or the fruits and vegetables might have been nearing their expiry date. Therefore, you settled on a price that is acceptable to both parties. In other words, supply met demand at an agreed-on price. The third statement involves empiricism. You decided to obtain data on price and quality through observation in order to make an informed purchase. 7.
In 2014, California was in its third year of a major drought. With water supplies dwindling, Governor Brown issued a plea for a voluntary 20 percent reduction in water use. This target was not reached. In early 2015 Governor Brown issued an executive order requiring local water agencies to reduce water use by 25 percent, but no enforcement mechanism was specified. No taxes or fines were in the executive order. State officials hoped that they could achieve compliance without resorting to fines. a. From an individual homeowner’s perspective, what are the costs and benefits of using water during a drought? Why do you think that the voluntary reduction order in 2014 didn’t work? b. Using concepts from this chapter, explain how you might get individual homeowners to reduce water use during a drought. c. Eventually, many communities began levying fines on water use. However, while many middle income families dramatically cut water use, wealthy households cut back their water use relatively little. How can you explain this phenomenon from an economic perspective?
Answers: a. With no specific enforcement mechanism, there is low cost to using water. Water bills are not zero, but these prices were low enough in the past to create a water shortage, so clearly the financial cost is not high enough to prevent a shortage. There may be some social stigma attached to watering a lawn, though this cost varies for each person and depends on their sense of civic responsibility. On the flip side, the benefits of using water are quite clear: Green lawns, pleasant showers, and odorless toilets. The fact that the 2014 plea did not work is because the cost of violating a call for civic responsibility is not very high for most people. b. Charging a higher price for water than in 2014 would likely result in a reduction in water usage. When the price goes up, people would discover that some of their usage is actually not that important. c. Fines are equivalent to a higher price for water. In this case, lower income individuals were more price elastic; they responded more sharply to a price change. This implies that the willingness to pay for the last gallon of water in a low-income household is less than the willingness to pay in a high-income household. 8.
Use the concepts discussed in this chapter to answer the following problems: a. Oskar is about to join a new factory where he has the option of joining a trade union. Being a part of the trade union means that he will have to pay 5 percent of his wages to the union. Why do you think some workers decide not to join a trade union?
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b. You are living in a semi-detached house with a common garden. This means that both families living in the house can use it while being jointly responsible for its maintenance and upkeep. However, you decide that you cannot spare any time to maintain the garden. How can the other family get you to do your share of the maintenance? Answer: a. The free-rider problem explains why some workers decide not to join a trade union. On the one hand, they hope that they will not need the services provided by the trade union, such as legal assistance. On the other hand, they know that even if such a need arises, the services will be available to everyone, irrespective of whether they have paid a membership fee or not. b. The other family can insist on signing a joint usage-of-the-garden contract that states the responsibilities shared by the two families. It can also state the consequences of failing to share those responsibilities. Alternatively, they can decide to maintain only the half that is closer to them. 9. It is the night before your trip to Spain and you must decide how many hours to spend on expanding your vocabulary. The total benefits column shows how many more Spanish words you expect to learn. The cost column shows how many Spanish words you will mispronounce because of the increased fast learning. (The “marginal” columns show the effect of each additional hour spent studying. These marginal numbers are calculated by taking the difference within a column from one row to the next row.) Hours Spent Learning
Total Benefit
Marginal Benefit
Total Cost
Marginal Cost
0
0
--
0
--
1
8
8
0
0
2
13
5
2
2
3
16
3
6
4
4
16
0
12
6
a. If you study in an optimal way, how many more Spanish words will you learn? b. Explain how you can find the optimal number of hours by using the marginal benefits and marginal costs columns. Answer: a. Total benefit minus total cost is maximized at 13 − 2 = 11 when you study for two hours. This difference is lower in all other rows. b. You can arrive at the answer of two hours by noticing that the first hour is well worth it since the marginal benefit of 8 is greater than the marginal cost of 0. The second hour is also worth it since 5 > 2. However, the third hour is not worth it since 3 < 4; thus, you will gain fewer points than you will lose. (This sort of “marginal analysis” is a recurrent theme in economics.)
Chapter 2
Economic Science: Using Data and Models to Understand the World Questions 1.
Why do economists use the scientific method? Explain your answer by arguing for and against the use of this method.
Answer: The scientific method is the name for the process that economists and other scientists use to develop models of the world, test them with data, and evaluate how well they predict or describe behavior. Data are needed to know what is happening, and models are needed to know what the interaction is between different sets of data. When arguing for the usage of the scientific method, imagine a situation where you are responsible for the production of cars. Your task is to know, in advance, what colors customers will want their cars to have. Using empiricism, you can collect data on consumer preferences in advance and thus know what percentage of consumers prefer black, white, or blue cars. You can also create a model based on your collection of data in addition to other data such as previous purchases, social background, and wages to extrapolate which car color will be more popular with consumers. The difficulties of obtaining data, the expenses involved, and the challenges of statistical analysis may be put forth as arguments against the use of the scientific method. However, all these arguments are outweighed by arguments in favor of the use of scientific methods. We simply cannot make well-grounded, general observations about our world without having models that are backed by data. 2.
Explain how economists study the economic behavior of a society empirically. By using hypotheses, confirmed by empirical evidence, how do the economists and the empirical evidence contribute to the welfare of the society?
Answer: Economic behaviors and patterns help economists to study (a) the effects of psychological, cognitive, social, emotional, and other factors on economic decisions made by individuals and institutions; and (b) the consequences of market prices, returns, and resource allocation. These studies are mostly confirmed by empirical data collected by the economists themselves or by other individuals and organizations. Suppose economists study the amount of tax (10 percent) that will need to be paid by citizens of two states in order to construct a bridge that will connect the two states, which are divided by a river. For this purpose, they gather data on the income of the citizens (based on which the 10 percent tax will be calculated), how much the government should receive, how much tax will be evaded, and what is the estimated cost of building the bridge versus the actual cost. Such empirical data on constructing a bridge helps economists plan better when creating a good that contributes to public welfare. 3.
Are economic models detailed or simplified versions of reality? Could economists build perfect economic models? Why?
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Answer: Economists create simplified descriptions that enhance an individual’s understanding of how things work, based on which economic models are built. Such economic models are designed to yield hypotheses about economic behavior that can be tested. Because they are built on assumptions, they have no objective measure of economic outcomes and are mostly subjective in nature. Different economists will draw different conclusions to explain their interpretations of reality. Because economics models are based on real-world factors that are hard to control, condition, or simulate due to complex and dynamic variables, they cannot be perfect representations of reality. Consider macroeconomic models used by central banks. These are approximations and simplifications of the economy, but usually correct in their predictions. 4.
How is the mean calculated from a series of observations? Suppose a supermarket near you sells 4 types of fruit juice (apple, orange, lemon, and grape). The price of the apple juice is €3, the price of the orange juice is €5, the lemon juice is €6, and the grape juice is €4. What is the average price of juice in the supermarket?
Answer: The mean is the average value of a set of observations. It is calculated as the sum of all the different items divided by the number of items. The average value is the sum of the prices of all the types of fruit juice divided by, in this case, four. Therefore, (3 + 5 + 6 + 4) / 4 = €4.50. This means that the average price of fruit juice is €4.50. 5.
Why does the size of the sample matter in an empirical argument?
Answer: The size of the sample used to test the argument can affect the results. A small sample may bias the results of a study. Bias means that the sample will not accurately reflect the entire population for which you were trying to obtain information. For example, you wish to obtain information on the consumption habits of European Union (EU) citizens. If you are using a small sample of 50 people, it might be possible that all of them are only from Germany and France, and the other EU member countries are not represented. However, if a random sample of 1,000 people is used, you will get a representative result. For details on minimal acceptable sample sizes, you can check with your statistics tutor or use the following website: https://www.surveysystem.com/sscalc.htm 6.
Explain why correlation does not equal causation. Give examples where the cause and effect relationship between events is not necessarily clear.
Answer: Correlation means that there is a relationship between two variables; as one variable changes, another variable also changes. Causation occurs when one variable directly affects another through a cause-and-effect relationship. Correlation suggests that there is some connection but not necessarily one of cause and effect. You bought a very fast sports car, which you use for getting to work. You are always on time. Your neighbor has a slow car and works at the same place as you do. He is always late for work. Is it because your car is faster? Not necessarily. In most countries there are speed limits; thus, your sports car probably cannot go any faster than your neighbor’s car. Presumably, your neighbor is either taking a longer route to get to work, or getting bogged down in traffic. One of your classmates attended all the classes in the statistics module the previous semester and received an A. Does this mean that if you attend all the classes, you will also receive an A? Not necessarily. You will also have to study for the class; otherwise, it is unlikely that you will get good grades.
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The newest superhero movie has been released, and it is a major financial success. Does this mean that the film is actually good? Once again, not necessarily, as the cartoon characters featured in the movie may have such a large fandom that people would be eager to see them on the big screen. 7. Consider the following examples and state whether there is positive correlation, negative correlation, or zero correlation between the variables. a. A person’s gender and how well they drive a car. b. The number of sunglasses sold and the number of sunny days. c. The amount of gas (petrol) sold and its price. Answer: a. This is an instance of stereotyping. A person’s gender is unlikely to influence how well they can drive a car. The best drivers are typically the ones who practice a lot. Therefore, this is an example of zero correlation. b. The more the number of sunny days a region has, the more likely it is for people to wear sunglasses; therefore, there is positive correlation. c. If the price of gas drops, people will be more likely to use their cars frequently. As opposed to this, when the price of gas increases, fewer people will use cars. The frequency of usage will also drop. Therefore, this is an example of negative correlation. 8.
What is data? Is it always numerical? How is data used in empirical analysis? Give an example.
Answer: Data refers to facts that can be observed or measured. It is also referred to as empirical evidence. Data can be either numerical (quantitative) or qualitative in nature. For example, Mia paid €200 in taxes in the year 2017 is numerical data. On the other hand, Mia prefers to pay by credit card over check is qualitative data. Data can be collected and organized for empirical analysis in order to establish facts or truths about various phenomena. For example, if you survey your classmates about their incomes from part-time jobs, you can analyze those data to determine their average income. 9.
Why is it necessary to conduct experiments before releasing new drugs in a market? Why is randomization needed for experiments?
Answer: In order to know whether a drug works on people, it has to be tested. The best way to test it is to administer the drug to a treatment group (those who receive the drug) and to a control group (those who receive a placebo). If there is a significant improvement of health in the treatment group vis-à-vis the control group, the drug could be working. However, the drug may have side effects; therefore, a large pool of people should be tested. The best results are obtained when a large sample is selected randomly. 10. Suppose you had to find the effect of smoking on cancer. Would you choose to run a randomized experiment or would it make sense to use natural experiments here? Explain. Answer: It would be unethical to conduct a randomized experiment and ask people to smoke cigarettes, in order to test whether they might contract lung cancer or not. It makes more sense to conduct surveys or analyze medical records to find the linkage between smoking and cancer. Thus, the use of a natural experiment is the way forward.
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Problems 1.
Some studies have found that people who owned guns were more likely to be killed with a gun. Do you think this study is strong evidence in favor of stricter gun control laws? Explain.
Answer: Not necessarily. It is quite possible that people who thought they were at risk (perhaps because they live in dangerous neighborhoods) were more likely to buy a gun for self-protection. This is an example of a case where correlation may not imply causation. There has been a good deal of research on this question. See, for example, a Harvard School of Public Health 2011 interview with David Hemenway: http://www.hsph.harvard.edu/news/features/review-gunspolitics-hemenway 2.
The average score for a class of 30 students is 70. The score for the top 20 students in the class averaged at 75. What is the average score of the remaining 10 students in the class?
Answer: The total score of 30 students = 30 × 70 = 2,100. The total score of 20 students = 75 × 20 = 1,500. Thus, the total score for the remaining 10 students = 2,100 − 1,500 = 600. Therefore, the average score of the remaining 10 students is 600 / 10 = 60. 3.
This chapter stressed the importance of using appropriate samples for empirical studies. Consider the following two problems in that light. a. Imagine you are a sociologist and your task is to find out the average wage in a small town in rural Europe. Since you are short on time you travel to the city and ask 10 random people waiting at the train station about their wages, then travel back and report on the data. Are you going to get an accurate number? b. Your friend was visiting a European capital city for two days and comes home saying that this city has the best restaurants in the world. Do you think his/her conclusion is justified?
Answer:
4.
a.
Even though an attempt at randomization has been made, there are different types of bias in the sample. First, your sample is small; second, you are interviewing people at a special place and time, which may not provide accurate reflections about the whole small town. Let us consider that the interviews are conducted in the morning and perhaps the interviewed people are commuters to the capital city nearby where wages are higher. Thus, you will be reporting on the wages in the city and not those in your small town.
b.
No, as the sample that your friend was using was more than likely limited to a couple of experiments with restaurants. Again, they could have got lucky and tried only the good ones.
A study in 1991 have found that hormone replacement therapy (HRT), used to treat symptoms of menopause, reduces coronary heart disease risk. Do you think this study is strong evidence in favor of HRT? Explain.
Answer: Not necessarily. It is quite possible that women who resort to HRT are also financially better-off and, hence, lead healthier lives in terms of physical exercise and diet. This is an example of a case in which correlation may not imply causation. This question has been explored by several studies. Refer, for example, to the following 2004 article in the International Journal of Epidemiology: https://academic.oup.com/ije/article/33/3/464/716652. Source: https://science.howstuffworks.com/innovation/science-questions/10-correlations-that-arenot-causations4.htm (original sources within) (Retrieval Date: May 26, 2020).
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As the text explains, it can sometimes be very difficult to sort out the direction of causality. a. As opposed to the United States, which has serious speed limits, in Germany, many places have no speed limits on the motorway. This means that you can easily travel at 200 kilometers per hour. Does the lack of a speed limit on the motorway mean that there are likely to be more fatalities due to car accidents in Germany? b. In 2017, Europe experienced the hottest summer since 2003. The heatwave was aptly named Lucifer. Temperatures crossed 40°C. Do you think it is likely that more people would have bought an air-conditioning device for their home?
Answer: a. Essentially, it should. However, the better roads, the skill and training of the drivers, the better quality of the cars, and strict penalties for tailgating ensure that fatalities are lower in, Germany than in the United States. b. Probably yes. If they had experienced high temperatures and could not tolerate the heat, it is likely that they bought air-conditioners to mitigate the discomfort. For further reference, students may refer to the following: Leonard Evans, “Traffic Fatality Reductions: United States Compared With 25 Other Countries,” American Journal of Public Health, August 2014, 104(8): 1501–1507, https://www.ncbi.nlm.nih.gov/pmc/articles/PMC4103211/; Aaron Brown, “8 Reasons That Germany's Autobahn Is so Much Better than US Highways,” Business Insider, March 31, 2016; and Stan Cox, “Climate Risks Heat up as World Switches on to Air Conditioning,” The Guardian, July 10, 2012. 6.
During the summer of 2015, the European Union (EU) experienced a record number of applications from asylum seekers. Some said they are economic migrants who just want to take advantage of the relatively good social protection system of the EU, whereas others pointed out that most asylum applications come from countries experiencing civil war. Why do you think asylum seekers were trying to get into the EU? List at least 5 possible explanations.
Answer: Migration can be best analyzed by looking at push and pull factors. Push factors are the factors that push people from their home country. These can include intensity of civil war; political, sexual, or religious repression; climate change; and a lack of job opportunities. Pull factors are those that draw migrants to a new country, such as safety, tolerance, job prospects, higher wages, minorities from the same country of origin, and common spoken language. (For further reading, students may refer to the following article: Timothy Hatton, “Refugees, Asylum Seekers, and Policy in OECD Countries,” American Economic Review: Papers & Proceedings, 106(5): 441–445, 2016.). 7.
An independent variable is a variable whose value does not depend on another variable, whereas a dependent variable is a variable whose value depends on another variable. Assume that ACT scores obtained by the students is the dependent variable. a. What kind of independent variables might we use in order to predict how a student might perform in secondary school? b. Assuming that in order to pass their calculus module students on average have to spend 100 hours studying. If they study more, they will of course improve on their ACT score. If someone i) has a higher IQ ii) has better teachers iii) has more committed classmates iv) has to work part time, will they have to spend more or less hours on average to pass calculus?
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Answer: a. ACT scores are a measure of a student’s performance. In this case, the possible independent variables could be: IQ level, number of hours spent studying, family income, number of students in the classroom, qualification of teaching staff, etc. b. i) If someone has a higher IQ, they might have to study less. ii) Having better teachers means that students might understand the topic in class; thus, they might have to study less at home. iii) Peer pressure can be a highly influential factor in improving grades, although it does not mean that students will have to study less. iv) If someone has to work part-time, it means that they will have less time to spare for studies; however, they will have to spend, on average, at least 100 hours studying in order to pass the course. 8.
In 2016, most British voters decided that the United Kingdom should exit the European Union (EU). This withdrawal is popularly known as Brexit. How can we use this to demonstrate the effects of EU membership? Is this a natural experiment? What economic impact will this have on the United Kingdom?
Answer: Brexit, in a way, is a natural experiment. This is the first time that a country has decided to voluntarily exit the EU, and, so far, we have no experience in what happens to the economy of a country that does exit. We can analyze how the British economic growth will unfold in the future and compare it to that of the larger countries in the EU, such as France, Germany, or Italy. It is difficult to predict the economic impact of Brexit; however, growth is estimated to be less dynamic. Another consequence of Brexit was the illustration of how difficult it is to leave the EU to other member states. Source: Larry Elliott and Phillip Inman, “Gloomy Brexit Forecasts for UK are Coming True, Says IMF,” The Guardian, December 20, 2017, https://www.theguardian.com/. 9.
An economist believes that the consumption patterns of a household can be determined by using the equation C = a + bI, where I is the income, a denotes a positive number, and b a percentage. a. Is the economist using a model? b. would you test this it?
Answer: a. Yes, the economist is using a model. A model is a simplified version of the economic reality. This equation simplifies a household’s consumption behavior. So, we can consider it to be a model. b. The consumption is simplified by a model with two main variables. The first variable denotes the irreducible consumption: We consume even when we don’t have an income. The second set of variables denotes that a certain proportion (b) of the income (I) is devoted to consumption. A1. How would you represent the following graphically? a. Income inequality in the U.S. has increased over the past 10 years. b. All the workers in the manufacturing sector in a particular country fit into one (and only one) of the following categories: 31.5 percent are high school dropouts, 63.5 percent have a high school diploma, and the rest have vocational training certificates. c. The median income of a household in Alabama was $43,464 in 2012, and the median income of a household in Connecticut was $64,247 in 2012.
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Answer: a. Since the graph needs to show how income inequality increases over a period of time, a time-series graph needs to be used here. b. A pie chart is a circular chart split into segments to show the percentages of parts to the whole. Since the given data is in percentages, a pie-chart can be used to represent each category of workers. c. A bar chart would be a good way to compare income in Alabama and Connecticut. The height of each bar would represent the income in each one of the states. A2. Consider the following data that shows the quantity of coffee produced in Brazil from 20042012. Year
Production (in tons)
2004
2,465,710
2005
2,140,169
2006
2,573,368
2007
2,249,011
2008
2,796,927
2009
2,440,056
2010
2,907,265
2011
2,700,440
2012
3,037,534
a. Plot the data in a time series graph. b. What is the mean quantity of coffee that Brazil produced from 2009 to 2011? c. In percentage terms, how much has the 2012 crop increased over the 2009-2011 mean? Answer: a. A time-series graph can be used to represent the quantity of coffee produced from 2004 to 2012.
b. The average quantity of coffee that Brazil produced during the 2009-11 period is 2,682,589 587 tons. This is the sum of the total quantity produced divided by the number of years.
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c. The coffee crop in 2012 is 14.6% larger than the average coffee crop in 2009-2011. The increase in production is 3,073,534 – 2,682,589 = 390,945. In percentage terms, the change is 390,945 / 2,682,589 587 = 14.6%. Data taken from: http://faostat.fao.org/site/567/default.aspx#ancor A3. Suppose the following table shows the relationship between revenue that the Girl Scouts earn and the number of cookie boxes that they sell. Number of cookie boxes
Revenue ($)
50
200
150
600
250
1,000
350
1,400
450
1,800
550
2,200
a. Present the data in a scatter plot. b. Do the two variables have a positive relationship or do they have a negative relationship? Explain. c. What is the slope of the line that you get in the scatter plot? What does the slope imply about the price of a box of Girl Scout cookies? Answer: a. The following line chart shows the relationship between the Girl Scouts’ revenue and the number of cookie boxes that they sell:
b. Since the values of both variables increase together in the same direction, they have a positive relationship. This means that as more cookie boxes are sold, the revenue earned increases. c. The slope is constant in this problem and so we can choose any two points to calculate the slope. Suppose we use the first and last data points. The slope is calculated as
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. The slope implies that one extra box of cookies sold is associated with $4 more in revenue.
Chapter 3
Optimization: Trying to Do the Best You Can Questions 1.
Are people, households, businesses, and governments always exercising their optimal choice when making decisions?
Answer: Economists don’t assume that people are always successfully optimizing. However, they believe that economic agents try to optimize, given the available information. These economic agents are not perfect optimizers and their decisions are not always optimal, because optimization is usually not easy. For example, a student has one week to prepare for two exams. He decides to allocate 3 days to preparation for the first exam and 4 days to preparation for the second exam. According to the student, this is the best allocation of time, which may or may not be the optimal choice. 2.
How is optimization used to predict economic or business outcomes?
Answer: As stated in the chapter, “whatever choices people face, economists believe that they will choose optimally.” When presented with the same set of available information, optimization means that different economic agents will make the same (or a similar) choice. Hence, businesses can predict the optimal economic or business decisions of their rivals, customers, and suppliers. Through seeking and providing advice, economists and business leaders can attempt to make optimal decisions by quantifying the effect of future decisions to gauge possible outcomes before the decision is finalized. With the help of optimization, they can not only predict what might happen but also analyze why it will happen. Using input from various data sets, optimization, when implemented correctly, can have a large impact on how businesses make decisions. This is done by providing scope for analysis of several areas—production, schedules, and inventory— and ensuring that the right products and services are put out in the market at the right time, which in turn will help optimize the experience of the consumers. This is the reason behind the success of websites that are used to compare identical or similar products and their prices, since they help economic agents make informed decisions regarding what to consume. Economic and business decision makers certainly hope that consumers do use optimization when consuming; therefore, when a product (such as an iPhone) is more expensive, people can be convinced that it offers more or better services. Students should note that efficient optimization requires time—initially, people will struggle to choose the best products; however, with time, they will learn from their mistakes and optimize better. 3.
Suppose your workplace does not have a cafeteria and you have to go out during your lunch break to grab a bite to eat. You have two options: an expensive restaurant that is two minutes away or a cheaper one that is ten minutes away. Does picking the one that is ten minutes away necessarily imply that you are optimizing?
Answer: Not necessarily. You only have a 30-minute lunch break, and you are spending 20 minutes of this time in getting to the restaurant, almost devouring your food because of lack of