SOLUTIONS MANUAL for Economics, 14th Edition by Michael Parkin by welldoneassistant

Table of Contents

Preface  Part 1 Chapter 1 Appendix Chapter 2  Part 2 Chapter 3 Chapter 4 Chapter 5 Chapter 6 Chapter 7  Part 3 Chapter 8 Chapter 9  Part 4 Chapter 10 Chapter 11 Chapter 12 Chapter 13 Chapter 14 Chapter 15  Part 5 Chapter 16 Chapter 17  Part 6 Chapter 18 Chapter 19 Chapter 20  Part 7 Chapter 21 Chapter 22

v Introduction What is Economics? Graphs in Economics The Economic Problem

1 9 21

How Markets Work Demand and Supply Elasticity Efficiency and Equity Government Actions in Markets Global Markets in Action

39 53 65 79 93

Households’ Choices Utility and Demand Possibilities, Preferences, and Choices

107 121

Firms and Markets Organizing Production Output and Costs Perfect Competition Monopoly Monopolistic Competition Oligopoly

137 151 165 179 197 209

Market Failure and Government Public Choices, Public Goods, and Healthcare Externalities

223 235

Factor Markets, Inequality, and Uncertainty Markets for Factors of Production Economic Inequality Uncertainty and Information

247 261 275

Monitoring Macroeconomic Performance Measuring the Value of Production: GDP Monitoring Jobs and Inflation

285 299

 Part 8 Chapter 23 Chapter 24 Chapter 25 Chapter 26

Macroeconomic Trends Economic Growth Finance, Saving, and Investment Money, the Price Level, and Inflation The Exchange Rate and the Balance of Payments

313 325 337 351

 Part 910Macroeconomic Fluctuations Chapter 27 Chapter 28 Chapter 29  Part 5 Chapter 30 Chapter 31

Aggregate Supply and Aggregate Demand Expenditure Multipliers The Business Cycle, Inflation, and Deflation

363 379 393

Macroeconomic Policy Fiscal Policy Monetary Policy

409 423

C h a p t e r

WHAT IS ECONOMICS?

Answers to the Review Quiz Page 2 1.

List some examples of the scarcity that you face. Examples of scarcity common to students include not enough income to afford both tuition and a nice car, not enough learning capacity to study for both an economics exam and a chemistry exam in one night, and not enough time to allow extensive studying and extensive socializing.

Find examples of scarcity in today’s headlines. A headline in The New York Times on June 17, 2021 was “What is a Megadrought?” The story defined a megadrought as a “period of extreme dryness that lasts for decades.” It then pointed out that the Western United States has suffered from drought conditions since 2000 and because of climate change the drought may continue. The entire story points out the role of scarcity because it is concerned with the scarcity of water, which is a vital resource.

During the Covid-19 pandemic, what incentives did you face and how did you respond? In some locales students and others faced incentives to wear a facemask, because if they did not wear a mask they could not legally enter particular stores and if they did so anyway, they might be fined. Some students and others faced the incentive to work remotely because that was the type of job being offered. Many students faced the incentive to take classes remotely because this was how almost all classes were offered.

Find an example of the distinction between microeconomics and macroeconomics in today’s headlines. Microeconomics: On June 17, 2021 a headline in East Bay Times was “The Housing Market Is So Hot Buyers Are Paying $1 Million Over Asking Price.” This story covers a microeconomic topic because it discusses how the choices of individuals and the interactions of the choices in the housing market have forced prices higher. Macroeconomics: On June 17, 2021, a headline in The Wall Street Journal was “Fed Pencils In Earlier Interest-Rate Increase.” This story covers a macroeconomic topic because it concerns interest rates, which affects the national economy.

Page 7 1.

Describe the broad facts about what, how, and for whom goods and services are produced. What gets produced is significantly different today than in the past. Today the U.S. economy produces more services, such as medical operations, teaching, and hair styling, than goods, such as pizza, automobiles, and computers. How goods and services are produced is by businesses determining how the factors of production, land, labor, capital and entrepreneurship, are combined to make the goods and services we consume. Land includes all natural resources, both renewable natural resources such as wood, and nonrenewable natural resources such as natural gas. Labor’s quality depends on people’s human capital. In the U.S. economy, human capital obtained through schooling has increased over the years with far more people completing high school and attending college than in past years. Finally, for whom are goods and services to be produced depends on the way income is distributed to U.S. citizens. This distribution is not equal; the 20 percent of people with the lowest income earn about 5 percent of the nation’s total income while the 20 percent of people with the highest incomes earn about 50 percent of © 2023 Pearson Education, Inc.

CHAPTER 1

total income. On the average, men earn more than women, whites more than non-whites, and college graduates more than high school graduates.

Give some examples to illustrate the potential for conflict between self-interest and the social interest during the Covid-19 pandemic. The decision whether to wear a facemask shows the potential conflict between self-interest and social interest. It was in the self-interest of some people to not wear a mask, possibly because they felt the mask was too constraining, but it was in the social interest to do so because it helped limit the spread of the disease. Similarly, it was in the self-interest of owners and employees of bars and restaurants to remain open at 100 percent capacity, but it was in the social interest to close them and, when they were allowed to reopen, to do so at a reduced capacity. It was in the self-interest of some parents to have their child (or children) attend school, perhaps because attendance helped the child learn or because the parents lacked daycare, but it was in the social interest to have schools closed and use remote classes.

Page 10 1.

Explain the idea of a tradeoff and think of three tradeoffs that you have made today. A tradeoff reflects the point that when someone gets one thing, something else must be given up. What is given up is the opportunity cost of whatever is obtained. Three examples of tradeoffs that are common to students include: a) When a student sleeps in rather than going to his or her early morning economics class, the student trades off additional sleep for study time. The opportunity cost of the decision is a lower grade on the exam. b) When a student running late for class parks his or her car illegally, the student trades off saving time for the risk of a ticket. The potential opportunity cost of the decision is the goods and services that cannot be purchased if the student receives an expensive parking ticket. c) A student trades off higher income by spending time during the day working at a part-time job for less time spent at leisure time and study. The opportunity cost for the higher income is less leisure and lower grades in classes.

Explain what economists mean by rational choice and think of three choices that you’ve made today that are rational. A rational choice is one that compares the costs and benefits of the different actions and then chooses the action that has the greatest benefit over cost for the person making the choice. Three rational choices made by students include: a) The choice to skip breakfast to go to class. In this case the benefit is the higher grade in the class and the cost is the breakfast forgone. b) The choice to stop talking with a friend on the phone and start studying for an impending exam. In this case the benefit is the resulting higher grade in the class and the cost is the conversation forgone. c) The choice to do laundry today rather than watch television. In this case the benefit is the fact the student will have clean clothes to wear and the cost is the loss of the entertainment the television show would have provided.

Explain why opportunity cost is the best forgone alternative and provide examples of some opportunity costs that you have faced today. When a decision to undertake one activity is made, often many alternative activities are no longer possible. Often these activities are mutually exclusive so only the highest valued alternative is actually forgone. For instance, the decision to go to a student’s 8:30 AM class eliminates the possibility of sleeping in during the hour and of jogging during the hour. But in this case, it is impossible to both sleep in and to jog during the hour, so the opportunity cost cannot be both activities. What is lost is only the activity that otherwise would have been chosen—either sleeping in or jogging—which is whatever activity would have been chosen, that is, the most highly valued of the forgone alternatives. For students, attending class, doing homework, studying for a test are all activities with opportunity costs.

Explain what it means to choose at the margin and illustrate with three choices at the margin that you have made today. Choosing at the margin means choosing to do a little more or a little less of some activity. Three common examples students encounter are: a) When a student faces a chemistry and an economics final exam in one © 2023 Pearson Education, Inc.

WHAT IS ECONOMICS?

day, the student must determine whether spending the last hour studying a little more chemistry or a little more economics will yield a better contribution (marginal benefit) to his or her overall GPA. b) A college student buying a computer must decide whether the marginal benefit of adding 1 GB of additional memory is worth the marginal cost of the additional memory. c) A student football fan with a choice of a cheap seat in the student bleachers located at the far end of the playing field or a more expensive seat located on the 30 yard line must determine whether the marginal benefit of watching the game from a better seat is worth the marginal cost of the higher ticket price.

Explain why choices you made during the Covid-19 pandemic were in your self-interest. Why might your choices not have been in the social interest? People making rational decisions in their self-interest about actions compare the marginal benefits to themself to the marginal costs to themself. Therefore people’s choices are in their self-interest because they are looking at their marginal benefits and marginal costs. Some of these choices may not have been in the social interest because the social interest includes costs imposed on other people. For example, in many college towns students visited nightclubs and did not socially distance nor wear masks because to these students the marginal benefit of socializing exceeded the marginal cost they incurred, say the likelihood of catching coronavirus. But this was not in the social interest because if the student was infected, then he or she in turn might infect others, including some high-risk individuals. The cost to the other people from catching COVID-19 is ignored by students who visited nightclubs with socially distancing or masking.

Page 11 1.

Distinguish between a positive statement and a normative statement and provide examples associated with the Covid-19 vaccine rollout. A positive statement is a description of how the world is. It is testable. A normative statement is a description of how the world ought to be. It is, by its very nature, not testable because there is no universally approved criterion by which the statement can be judged. “I will be vaccinated as quickly as possible,” is a positive statement—it might not be true, but it is testable. “I will be vaccinated because I think it is a good idea,” is a normative statement. Whether someone agrees with it depends on his or her interpretation of what makes for a “good” idea. “The percentage of the population fully vaccinated in my state is over 60 percent” is a positive statement—again, it might not be true, but it is testable. “The percentage of the population fully vaccinated in my state is too low” is a normative statement because it depends on people’s personal interpretation of what is “too low.”

What is a model? Can you think of a model that you might use in your everyday life? A model is a description of some aspect of the economic world. It includes only those features that are necessary to understand the issue under study. An economic model is designed to reflect those aspects of the world that are relevant to the user of the model and ignore the aspects that are irrelevant. A typical model is a GPS map. It reflects only those aspects of the real world that are relevant in assisting the user in reaching his or her destination and avoids using information irrelevant to travel.

How do economists try to disentangle cause and effect? Economists use models to understand some aspect of the economic world. Testing the predictions of models makes it necessary to disentangle cause and effect. To overcome this problem, economists have three methods of testing their models: Using a natural experiment, using a statistical investigation, and using economic experiments. A natural experiment is a situation that arises in the ordinary course of life in which one factor being studied varies and the other factors are the same. This method allows the economist to focus on the effect from the factor that differs between the two situations. A statistical investigation looks for correlations between variables but then determining whether the correlation actually reflects causation can be difficult. An economic experiment puts people into decision making situations and then varies the relevant factors one at a time to determine each factor’s effect.

CHAPTER 1

How is economics used as a policy tool? Individuals, businesses, and governments use economics as a policy tool. Individuals use the economic ideas of marginal benefit and marginal cost when making decisions for such topics as attending college, paying cash or credit for a purchase, and working. Businesses also use the concepts of marginal benefit and marginal cost when making decisions about what to produce, how to produce, and even how many hours to stay open. Finally governments also use marginal benefit and marginal cost when deciding issues such as the level of property taxes, the amount to fund higher education, or the level of a tariff on Brazilian ethanol.

Page 14 1.

What types of jobs do economists do? Economists are found in a large variety of jobs. Many of these jobs are analysts of various sorts. Some economists are market research analysts—they work with data on sales and try to predict a product’s success and the price that should be set for it. Other economists are financial analysts—they work with data on interest rates, stock and bond prices to try to forecast the cost of borrowing and the returns that can be expected on investments. Still other economists work as budget analysts—they use data on an organization’s cash inflows (its receipts) and its outflows (its payments) in order to prepare plans forecasting future cash flows.

What are the skills needed for an economics job? Economists need five important skills:  Critical-thinking skills: Economists need the ability to use logical thinking to clarify and then solve realworld problems.  Analytical skills: Economists must be able to use economic ideas and tools to analyze data to determine important patterns and reach logical conclusions.  Math skills: Economists need to be able to use mathematical and statistical tools to explore and analyze data to reach valid conclusions.  Writing skills: Economists must be able to clearly write reports presenting ideas, conclusions from any analysis and reasons why the conclusions are valid.  Oral communication skills: Economists need the ability to orally explain ideas, conclusions, and the reasons why the conclusions are correct to a variety of people, including those with little knowledge of economics.

What is the range and median level of economists’ pay? How do they compare to other college majors? Economists’ pay ranges from $56,500 to $139,600 a year and has a median salary of $105,100 a year. Students who earn a PhD in economics typically earn about $150,000 a year by mid-career. Economists who work as analysts have incomes that range from an average of $55,000 a year for market research analysts to $82,000 a year for financial analysts. Midcareer, petroleum engineering and operations research majors earn more than applied economics majors but the salaries for economics majors are higher than most other majors, such as chemical engineering, nuclear engineering, and corporate accounting and finance.

Why is the underrepresentation of women and minorities in economics an economic problem? The underrepresentation of women and minorities in economics is an economic problem because the outcome is inefficient. The marginal benefit of women and minorities working as economists exceeds their marginal cost. Resources are not being allocated efficiently. With a more diverse group of economists, likely more diverse questions will be studied in more diverse ways. This exploration should increase the quality and accuracy of economists’ advice and predictions.

WHAT IS ECONOMICS?

Answers to the Study Plan Problems and Applications 1.

Apple Inc. decides to make iTunes freely available in unlimited quantities. a. Does Apple’s decision change the incentives that people face? Apple’s decision changes people’s incentives. For example, it increases people’s incentives to buy an iPhone to take advantage of the newly “free” music available on iTunes.

b. Is Apple’s decision an example of a microeconomic or a macroeconomic issue? Apple’s decision is a microeconomic decision because the decision deals with the choices of individuals and a business and how they interact.

Which of the following pairs does not match? a. Labor and wages Labor earns wages, so this pair matches.

b. Land and rent Land earns rent, so this pair matches.

c. Entrepreneurship and profit Entrepreneurship earns profit, so this pair matches.

d. Capital and profit Capital earns interest, so this pair does not match.

Explain how the following news headlines concern self-interest and the social interest. a. Starbucks Expands in China Starbucks’ expansion is a decision made by Starbucks to further Starbucks’ interest. Thus the decision is directly in Srarbucks’ self interest. The social interest is affected because Starbucks’ expansion will have an effect in China. For instance, more Chinese citizens might drink coffee rather than tea and fewer coffee shops run by Chinese firms might open.

b. McDonald’s Moves into Online Ordering McDonald’s decision to use online ordering is a decision made by McDonald’s to further McDonald’s interest. Thus the decision is directly in McDonald’s self interest. The social interest is affected because more people will order online rather than queuing up to order in person.

c. Food Must Be Labeled with Nutrition Data The decision to require that food must be labeled with nutrition information is made in the social interest. This decision is not made by any one single firm and so does not (necessarily) reflect anyone’s self interest.

The night before an economics test, you decide to go to the movies instead of studying for the test. Your grade on the test was 50 percent, lower than your usual 70 percent score. a. Did you face a tradeoff? Yes, you faced a tradeoff. The tradeoff was between a higher test score and an evening with your friends at the movies.

b. What was the opportunity cost of your evening at the movies? The opportunity cost of going to the movies is the fall in your grade. That is the 20 points forgone from choosing to see the movie rather than study.

CHAPTER 1

5. Olympics Could Cost More Than $26 Billion Japanese media estimate that overall spending on Japan’s new expensive national venues is between $26 billion and $28 billion. Source: Los Angeles Times, December 20, 2019 What is Japan’s opportunity cost of hosting the Olympic Games? Explain your answer. What could otherwise have been purchased with the $26 billion to $28 billion spent on the new Olympic facilities is an opportunity cost of the Olympics if the funds would not have spent building these otherwise. However, if there were already plans underway to build the facilities, then their cost is not an opportunity cost of the Olympics because the cost would have been paid even if Japan did not host the Olympics. If the facilities would not otherwise have been built, then the expenditures on them are an opportunity cost of the Olympics.

Which of these statements is positive, which is normative? Explain why. a. The United States should cut its imports. The statement is normative and cannot be tested.

b. China imports U.S. pork and soybean. The statement is positive and can be tested.

c. If the iPhone price rises, iPhone sales will fall. The statement is positive and can be tested.

What are the five basic skills needed for an economics job? The five basic skills are critical-thinking skills (the ability to use logical thinking to clarify and solve realworld problems), analytical skills (the ability to use economic ideas and tools to analyze data to reach accurate conclusions), mathematical skills (the ability to use mathematical and statistical tools to analyze data to reach correct conclusions), writing skills(the ability to clearly write reports presenting ideas and conclusions), and oral communication skills (the ability to orally explain ideas, conclusions, and the reasons why the conclusions are correct to a variety of people).

How is the AEA trying to encourage more women and minorities to study economics? The AEA has created an undergraduate essay prize, a travel grant, and other similar programs to help encourage women and minorities to study economics.

How does the BLS expect jobs for economists to grow in the next decade? Between 2019 and 2029, the BLS expects relatively rapid growth in jobs for economists. The BLS expects that overall, jobs will grow by 3 percent. For economists, the picture is rosier. The BLS predicts that jobs for economists with a Ph.D. will grow by 14 percent, jobs for budget analysts will grow by 3 percent, jobs for financial analysts will grow by 5 percent, and jobs for market research analysts will grow by 18 percent.

WHAT IS ECONOMICS?

Answers to Additional Problems and Applications 10.

Swifties, Rejoice! Taylor Swift Will Perform a Free JamFest Source: USA Today, November 8, 2019 When Taylor Swift performs at JamFest, what is free and what is scarce? Explain your answer. The seats at JamFest are scarce—there are only a limited number. You don't pay any money to attend Taylor Swift's concert but you give up time to go to the concert, and you probably pay for transit or to park your car. The publicity Ms. Swift receives is not free because she must perform at the concert. Additionally, the publicity uses reporters’ scarce time to report on the concert rather than reporting on other news worthy events.

11.

How does the creation of a successful movie influence what, how, and for whom goods and services are produced? The “what” question is affected in two ways. First, one good or service that is produced is the successful movie. Second, spinoffs (Iron Man II) and/or similar films likely will be created in the future. The “how” question is affected to the extent that movies use different production methods. Some movies, for instance, have a lot of special effects while other movies have few or none. The “for whom” question is influenced because those people who, as the result of the blockbuster movie, have higher incomes so that more goods and services are produced for them.

12.

How does a successful movie illustrate self-interested choices that are also in the social interest? The a successful movie increases the income of the people involved with the movie. Hence these people’s choices are driven largely by self interest. However the creation of a successful movie also increases the quantity of widely enjoyed entertainment. The amount of entertainment available in the economy increases which benefits society. So the choices the people made in their self interest also reflected choices made in the social interest.

13.

Before starring in Guardians of the Galaxy, Chris Pratt had appeared in 11 movies that grossed an average of $7 million on the opening weekend. Guardians of the Galaxy grossed $94 million. a. How will the success of Guardians of the Galaxy influence the opportunity cost of hiring Chris Pratt? The salary that must be paid to Chris Pratt to appear in future movies increased because some of the success of Guardians of the Galaxy was attributed to Mr. Pratt. As a result the opportunity cost to movie producers of hiring Mr. Pratt increased.

b. How have the incentives for a movie producer to hire Chris Pratt changed? There are two effects on the incentives of producers to hire Mr. Pratt. First, because the opportunity cost of hiring Mr. Pratt increased, the incentive to hire him decreased. However because part of the success of Guardians of the Galaxy was attributed to Mr. Pratt acting in the leading role, producers expect that his acting will lead to increased success for future movies. This belief increases producers’ incentives to hire Mr. Pratt.

14.

What might be an incentive for you to take a class in summer school? List some of the benefits and costs involved in your decision. Would your choice be rational? Early graduation, smaller class sizes, and/or retaining eligibility for a scholarship are examples of incentives that encourage taking summer classes. The benefits of taking summer classes might include early graduation, more personal attention from the instructor, retained eligibility for a scholarship, and increased knowledge about some aspect of the world. Costs potentially include forgone summer jobs or internships, less time to spend with friends, and additional tuition and other class-related expenses if the class I not one that would be taken otherwise. The choice is rational as long as the student determines that taking summer classes offers the highest benefit over cost for the use of his or time and efforts. © 2023 Pearson Education, Inc.

15.

CHAPTER 1

Look at today’s Wall Street Journal. What is the leading economic news story? Which big economic questions and tradeoffs does it discuss or imply? On June 17, 2021, the top economic news story discussed the Supreme Court’s upholding of the Affordable Care Act. Congress had eliminated the penalty for not possessing health insurance and several states had sued seeking to eliminate the law. The Supreme Court ruled that the plaintiffs had suffered no harm and therefore did not have standing to bring the suit. This story clearly discusses the “for whom” question: With the Affordable Care Act still in place, more poor and disabled people will receive certain types of healthcare. It also discusses the “what” question: If more Americans have health insurance, more goods and services related to health care will be produced. The story implicitly illustrates a tradeoff: If choices are taken to limit the amount of healthcare poor and disabled people receive, their health will generally be worse than otherwise.

16.

Provide two microeconomic statements and two macroeconomic statements. Classify your statements as positive or normative, and explain your classifications. Microeconomic statements are: Fewer deep water oil wells should be drilled in the Gulf of Mexico. If less oil is produced, the price of oil will rise. The first statement is normative because it relies on what the person thinks “should” be done. The second statement is positive because it is possible to test the effect of less oil being produced. Macroeconomic statements are: The currently unemployment rate is too high. The current unemployment rate is higher for blacks than for whites. The first statement is normative because it depends on what is deemed “too high.” The second statement is positive because it can be checked to determine its validity.

17.

What might be an incentive for economics students to do a Ph.D.? What would be the opportunity cost of doing a Ph.D.? One incentive for a student to earn a Ph.D. in economics is the chance to continue to learn more economics. Another incentive is that the student may be better able to follow a preferred career, for example, as a researcher, as a policy analysist, as an instructor, or whatever the student prefers. A final incentive is the pay, which is higher than many other salaries. An opportunity cost is the time that a Ph.D. requires. The time spent earning the Ph.D. would otherwise be used for another endeavor, and this endeavor is the opportunity cost of the time. There may also be tuition and/or book costs, so whatever else would have been purchased in place of the tuition and/or books are opportunity costs of the Ph.D.

Appendix

GRAPHS IN ECONOMICS

Answers to the Review Quiz Page 30 1.

Explain how we “read” the three graphs in Figs. A1.1 and A1.2. The points in the graphs relate the quantity of the variable measured on the one axis to the quantity of the variable measured on the other axis. The quantity of the variable measured on the horizontal axis (the xaxis) is measured by the horizontal distance from the origin to the point. Similarly, the quantity of the variable measured on the vertical axis (the y-axis) is measured by the vertical distance from the origin to the point. The point relates these two quantities. For instance, in Figure A1.2, point A shows that at a price of $8.43 per ticket, 1.3 billion tickets are sold.

Explain what scatter diagrams show and why we use them. Scatter diagrams plot the value of one economic variable against the value of another variable for a number of different values of each variable. We use scatter diagrams because they quickly reveal if a relationship exists between the two variables. Moreover, if a relationship exists, scatter diagrams show whether increases in one variable are associated with increases or decreases in the other variable.

Explain how we “read” the three scatter diagrams in Figs. A1.3 and A1.4. The scatter diagram in Figure A1.3 shows the relationship between a film’s worldwide box office ticket sales and the film’s production budget. The figure shows that higher box office sales are associated with a higher production budget. The scatter diagram in Figure A1.4a shows the relationship between income, in thousands of dollars per year, and expenditure, also in thousands of dollars per year, for the years 2000 to 2020. The scatter diagram shows that higher income leads to higher expenditure. The figure also shows that the relationship is relatively strong. The scatter diagram in Figure A1.4b shows the relationship between the inflation rate and the unemployment rate for the years 2001 to 2020. The figure shows that there is no relationship between the inflation rate and unemployment rate.

APPENDIX 1

Draw a graph to show the relationship between two variables that move in the same direction. A graph that shows the relationship between two variables that move in the same direction is shown by a line that slopes upward. Figure A1.1 illustrates such a relationship.

Draw a graph to show the relationship between two variables that move in opposite directions. A graph that shows the relationship between two variables that move in the opposite directions is shown by a line that slopes downward. Figure A1.2 illustrates such a relationship.

GRAPHS IN ECONOMICS

Draw a graph of two variables whose relationship shows (i) a maximum and (ii) a minimum. A graph that shows the relationship between two variables that have a maximum is shown by a line that starts out sloping upward, reaches a maximum, and then slopes downward. Figure A1.3 illustrates such a relationship with curve B. A graph that shows the relationship between two variables that have a minimum is shown by a line that starts out sloping downward, reaches a minimum, and then slopes upward. Figure A1.3 illustrates such a relationship with curve A.

Which of the relationships in Questions 4 and 5 is a positive relationship and which is a negative relationship? The relationship in Question 4 between the two variables that move in the same direction is a positive relationship. The relationship in Question 5 between the two variables that move in the opposite directions is a negative relationship.

What are the two ways of calculating the slope of a curved line? To calculate the slope of a curved line we can calculate the slope at a point or across an arc. The slope of a curved line at a point on the line is defined as the slope of the straight line tangent to the curved line at that point. The slope of a curved line across an arc—between two points on the curved line—equals the slope of the straight line between the two points.

How do we graph a relationship among more than two variables? To graph a relationship among more than two variables, hold constant the values of all the variables except two. Then plot the value of one of the variables against the other variable.

10.

Explain what change will bring a movement along a curve. A movement along a curve occurs when the value of a variable on one of the axes changes while all of the other relevant variables not graphed on the axes do not change. The movement along the curve shows the effect of the variable that changes, ceteris paribus (holding all of the other non-graphed variables constant).

11.

Explain what change will bring a shift of a curve. A curve shifts when there is a change in the value of a relevant variable that is not graphed on the axes. In this case the entire curve shifts.

12.

Netflix’s monthly fee for 1 screen is $8.99, for 2 screens $13.99, and for 4 screens is $17.99. Describe the relationship between the fee and the number of screens. The relationship is positive because a higher fee is associated with more streams.

APPENDIX 1

Answers to the Study Plan Problems and Applications Use the spreadsheet to work Problems 1 to 3. The spreadsheet provides data on the U.S. economy: Column A is the year, column B is the inflation rate, column C is the interest rate, column D is the growth rate, and column E is the unemployment rate.

1 2 3 4 5 6 7 8 9 10 11

A 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

B 1.6 3.1 2.1 1.5 1.6 0.1 1.3 2.1 2.4 1.8 1.2

C 0.1 0.1 0.1 0.1 0.0 0.1 0.3 1.0 2.0 2.1 0.4

D 2.6 1.6 2.2 1.8 2.5 3.1 1.7 2.3 3.0 2.2 ─3.5

E 9.6 8.9 8.1 7.4 6.2 5.3 4.9 4.4 3.9 3.7 8.1

Draw a scatter diagram of the inflation rate and the interest rate. Describe the relationship. To make a scatter diagram of the inflation rate and the interest rate, plot the inflation rate on the x-axis and the interest rate on the y-axis. The graph will be a set of dots and is shown in Figure A1.4. The pattern made by the dots tells us that as the inflation rate increases, the interest rate usually increases so there is a (weak) positive relationship.

Draw a scatter diagram of the growth rate and the unemployment rate. Describe the relationship. To make a scatter diagram of the growth rate and the unemployment rate, plot the growth rate on the xaxis and the unemployment rate on the y-axis. The graph will be a set of dots and is shown in Figure A1.5. The pattern made by the dots tells us that when the growth rate increases, the unemployment rate usually decreases so there is a weak negative relationship.

GRAPHS IN ECONOMICS

Draw a scatter diagram of the interet rate and the unemployment rate. Describe the relationship. To make a scatter diagram of the interest rate and the unemployment rate, plot the interest rate on the x-axis and the unemployment rate on the yaxis. The graph will be a set of dots and is shown in Figure A1.6. The pattern made by the dots tells us that when the interest rate increases, the unemployment rate usually decreases so there is a negative relationship.

Use the following news clip to work Problems 4 to 6.

Star Wars Tops the Box Office: Source: Boxofficemojo.com, Data for weekend of January 3-5, 2020 4. Draw a graph of the relationship between the revenue per theater on the y-axis and the number of theaters on the x-axis. Describe the relationship. Figure A1.7 shows the relationship. As the figure shows, there is positive relationship.

Movie Star Wars Episode IX: The Rise of Skywalker Jumanji: The Next Level Little Women Frozen II

Calculate the slope of the relationship in Problem 4 between 3,308 and 4,134 theaters. The slope equals the change in revenue per theater divided by the change in the number of theaters, or ($4,114  $6,344)/(3,308  4,134) which equals $2.70 per theater.

Calculate the slope of the relationship in Problem 4 between 3,175 and 4,406 theaters. The slope equals the change in revenue per theater divided by the change in the number of theaters, or ($3,733  $7,835)/(3,175  4,406) which equals $3.33 per theater.

Theaters (number) 4,406

Revenue (dollars per theater) $7,835

4,134

$6,344

3,308 3,175

$4,114 $3,733

APPENDIX 1

Calculate the slope of the relationship shown in Figure A1.8.

The slope is 5/4. The curve is a straight line, so its slope is the same at all points on the curve. Slope equals the change in the variable on the yaxis divided by the change in the variable on the x-axis. To calculate the slope, you must select two points on the line. One point is at 10 on the yaxis and 0 on the x-axis, and another is at 8 on the x-axis and 0 on the y-axis. The change in y from 10 to 0 is associated with the change in x from 0 to 8. Therefore the slope of the curve equals 10/8, which equals 5/4.

Use the relationship shown in Figure A1.9 to work Problems 8 and 9. 8. Calculate the slope of the relationship at point A and at point B.

The slope at point A is 2, and the slope at point B is 0.25. To calculate the slope at a point on a curved line, draw the tangent to the curved line at the point. Then find a second point on the tangent and calculate the slope of the tangent. The tangent at point A cuts the y-axis at 10. The slope of the tangent equals the change in y divided by the change in x. The change in y equals 4 (6 minus 10) and the change in x equals 2 (2 minus 0). The slope at point A is 4/2, which equals 2. Similarly, the slope at point B is 0.25. The tangent at point B goes through the point (4, 2). The change in y equals 0.5, and the change in x equals 2. The slope at point B is 0.25.

Calculate the slope across the arc AB.

The slope across the arc AB is 1.125. The slope across an arc AB equals the change in y, which is 4.5 (6.0 minus 1.5) divided by the change in x, which equals 4 (2 minus 6). The slope across the arc AB equals 4.5/4, which is 1.125.

GRAPHS IN ECONOMICS

Use the table to work Problems 10 and 11. The table gives the price of a balloon ride, the temperature, and the number of rides a day. 10. Draw a graph to show the relationship between the price and the number of rides, when temperature is 70°F. Describe this relationship.

Price (dollars per ride) 5 10 15

Figure A1.10 shows the relationship between the price and the number of balloon rides when the temperature is 70F. The relationship between the price and the number of rides is inverse; that is, when the price rises, the number of rides decreases.

11.

What happens in the graph in Problem 10 if the temperature rises to 90°F? If the temperature rises to 90F, the curve shifts rightward. This shift is illustrated in Figure A1.11. In that figure, both the initial curve, which applies when the temperature is 70F, and the new curve, which applies when the temperature is 90F, are illustrated. The curve when the temperature is 90F lies to the right of the curve when the temperature is 70F indicating that at every price, more balloon rides are taken when the temperature is 90F rather than 70F.

Balloon rides (number per day) 50F 70F 90F 32 40 50 27 32 40 18 27 32

APPENDIX 1

Answers to Additional Problems and Applications Use the spreadsheet to work Problems 12 to 14. The spreadsheet provides data on oil and gasoline: Column A is the year, column B is the price of oil (dollars per barrel), column C is the price of gasoline (cents per gallon), column D is U.S. oil production, and column E is the U.S. quantity of gasoline refined (both in millions of barrels per day).

12.

1 2 3 4 5 6 7 8 9 10 11

A 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

B 66 72 100 62 79 95 94 98 93 49 45

C 262 284 330 241 284 358 368 358 344 252 225

D 5.1 5.1 5.0 5.4 5.5 5.6 6.5 7.5 8.8 9.4 8.9

E 15.6 15.4 15.3 14.8 15.2 15.1 15.5 15.2 15.5 16.6 16.4

Draw a scatter diagram of the price of oil and the quantity of U.S. oil produced. Describe the relationship. Figure A1.12 shows the scatter diagram between the price of a barrel of oil and the quantity of U.S. oil produced. It shows a weak negative relationship.

13.

Draw a scatter diagram of the price of gasoline and the quantity of gasoline refined. Describe the relationship. Figure A1.13 shows the scatter diagram between the price of a gallon of gasoline and the quantity of gasoline refined. It shows a weak negative relationship.

GRAPHS IN ECONOMICS

14.

Draw a scatter diagram of the quantity of U.S. oil produced and the quantity of gasoline refined. Describe the relationship. Figure A1.14 shows the scatter diagram between the quantity of U.S. oil produced and the quantity of gasoline refined. It shows a positive relationship.

Use the following data to work Problems 15 to 17. Draw a graph that shows the relationship between the two variables x and y in the table to the right.

x y

0 25

1 24

2 22

3 18

4 12

5 0

To make a graph that shows the relationship between x and y, plot the x variable on the x-axis and the y variable on the y-axis. Figure A1.15 shows this graph.

15. a. Is the relationship positive or negative? The relationship is negative because x and y move in opposite directions: As x increases, y decreases.

b. Does the slope of the relationship become steeper or flatter as the value of x increases? The slope becomes steeper as x increases.

c. Think of some economic relationships that might be similar to this one. The less expensive a good, the greater is the number of people who buy it. The higher the interest rate, the smaller is the number of people who take out home mortgages. The less expensive gasoline, the greater the miles car owners drive.

16.

Calculate the slope of the relationship between x and y when x equals 3.

The slope equals 4.0. The slope of the curve at the point where x is 3 is equal to the slope of the tangent to the curve at that point. Plot the relationship and then draw the tangent line at the point where x is 3 and y is 18. Now calculate the slope of this tangent line by finding another point on the tangent. When x equals 5, y equals 10 on the tangent, so another point is x equals 5 and y equals 10. The slope equals the change in y, 8, divided by the change in x, 2, so the slope is 4.0.

17.

APPENDIX 1

Calculate the slope of the relationship across the arc as x increases from 4 to 5. The slope is –12. The slope of the relationship across the arc when x increases from 4 to 5 is equal to the slope of the straight line joining the points on the curve at x equals 4 and x equals 5. When x increases from 4 to 5, y falls from 12 to 0. The slope equals the change in y, 12 (12 minus 0), divided by the change in x, 1 (4 minus 5), so the slope across the arc is 12.0.

18.

Calculate the slope of the curve in Figure A1.16 at point A.

The slope is 2. The curve is a straight line, so its slope is the same at all points on the curve. Slope equals the change in the variable on the y-axis divided by the change in the variable on the x-axis. To calculate the slope, select two points on the line. One point is at 18 on the y-axis and 0 on the x-axis, and another is at 9 on the x-axis and 0 on the y-axis. The change in y from 18 to 0 is associated with the change in x from 0 to 9. Therefore the slope of the curve equals 18/9, which equals 2.

Use Figure A1.17to work Problems 19 and 20. 19. Calculate the slope at point A and at point B.

The slope at point A is 4, and the slope at point B is 1. To calculate the slope at a point on a curved line, draw the tangent to the line at the point. Then find a second point on the tangent and calculate the slope of the tangent. The tangent at point A cuts the x-axis at 2.5. The slope of the tangent equals the change in y divided by the change in x. The change in y equals 6 (6 minus 0) and the change in x equals 1.5 (1 minus 2.5). The slope at point A is 6/1.5, which equals 4. Similarly, the slope at point B is 1. The tangent at point B cuts the y-axis at 5. The change in y equals 3, and the change in x equals 3. The slope at point B is 1.

20.

Calculate the slope across the arc AB.

The slope across the arc AB is 2. The slope across the arc AB equals the change in y, which is 4 (6 minus 2) divided by the change in x, which equals 2 (1 minus 3). The slope across the arc AB equals 4/2, which equals 2.

GRAPHS IN ECONOMICS

Use the following table to work Problems 21 to 23. The table gives information about umbrellas: price, the number purchased, and rainfall in Price inches. (dollars per 21. Draw a graph to show the relationship umbrella) between the price and the number of umbrellas purchased, holding the 20 30 amount of rainfall constant at 1 inch. 40 Describe this relationship. Figure A1.18 shows the relationship. To draw a graph of the relationship between the price and the number of umbrellas when the rainfall equals 1 inch, keep the rainfall at 1 inch and plot the data in that column against the price. This curve is the relationship between price and number of umbrellas when the rainfall is 1 inches. The relationship between the price and the number of umbrellas is an inverse relationship; as the price rises, the number of umbrellas decreases.

22.

What happens in the graph in Problem 21 if the price rises and rainfall is constant? If the price rises, the number of umbrellas decreases. In Figure A1.18, there is a movement upward along the (unchanged) curve.

23.

What happens in the graph in Problem 21 if the rainfall increases from 1 inch to 2 inches? As shown in Figure A1.19, the curve shifts rightward. In that figure, both the initial curve, which applies when the rainfall is 1 inch, and the new curve, which applies when the rainfall is 2 inches, are illustrated. The curve when the rainfall is 2 inches lies to the right of the curve when the rainfall is 1 inch indicating that at every price, more umbrellas are purchased when the rainfall is 2 inches than when the rainfall is 1 inch.

Umbrellas (numbers purchased per day) 0 1 2 (inches of rainfall) 4 7 8 2 4 7 1 2 4

C h a p t e r

THE ECONOMIC PROBLEM

Answers to the Review Quizzes Page 36 1.

How does the production possibilities frontier illustrate scarcity? The unattainable combinations of production that lie beyond the PPF illustrate the concept of scarcity. There simply are not enough resources to produce any of these combinations of outputs. Additionally, while moving along the PPF to increase the production of one good requires that the production of another good be reduced, which also illustrates scarcity.

How does the production possibilities frontier illustrate production efficiency? The combinations of outputs that lie on the PPF illustrate the concept of production efficiency. These points are the maximum production points possible and are attained only by producing the goods and services at the lowest possible cost. Any point inside the frontier reflects production where one or both outputs may be increased without decreasing the other output level. Clearly, such points cannot be production efficient.

How does the production possibilities frontier show that every choice involves a tradeoff? Movements along the PPF frontier illustrate that producing more of one good requires producing less of other good. This observation reflects the result that a tradeoff must be made when producing output efficiently.

How does the production possibilities frontier illustrate opportunity cost? The negative slope of the production possibility curve illustrates the concept of opportunity cost. Moving along the production possibility frontier, producing additional units of a good requires that the output of another good must fall. This sacrifice is the opportunity cost of producing more of the first good.

Why is opportunity cost a ratio? The slope of the PPF is a ratio that expresses the quantity of lost production of the good on the y-axis to the increase in the production of the good on the x-axis moving downward along the PPF. The steeper the slope, the greater ratio, and the greater is the opportunity cost of increasing the output of the good measured on the horizontal axis.

Why does the PPF bow outward and what does that imply about the relationship between opportunity cost and the quantity produced? Some resources are better suited to produce one type of good or service, like pizza. Other resources are better suited to produce other goods or services, like DVDs. If society allocates resources wisely, it will use each resource to produce the kind of output for which it is best suited. Consider a PPF with pizza measured on the x-axis and DVDs measured on the y-axis. A small increase in pizza output when pizza production is relatively low requires only a small increase in the use of those resources still good at making pizza and not good at making DVDs. This yields a small decrease in DVD production for a large increase in pizza production, creating a relatively low opportunity cost reflected in the gentle slope of the PPF over this range of output. However, the same small increase in pizza output when pizza production is relatively large will require society to devote to pizza production those resources that are less suited to making pizza and more suited to making DVDs. This reallocation of resources yields a relatively small increase in pizza output for a large decrease in DVD output, creating a relatively high opportunity cost reflected in the steep © 2023 Pearson Education, Inc.

CHAPTER 2

slope of the PPF over this range of output. The opportunity cost of pizza production increases with the quantity of pizza produced as the slope of the PPF becomes ever steeper. This effect creates the bowed out effect (the concavity of the PPF function) and means that as more of a good is produced, the opportunity cost of producing additional units increases.

On the global PPF of healthcare supplies and other goods and services, how did the production point change as the Covid-19 pandemic spread across the globe? The production point moved along the global PPF so that more healthcare supplies were produced and fewer other goods and services were produced.

Page 39 1.

What is marginal cost? How is it measured? Marginal cost is the opportunity cost of producing one more unit of a good or service. Along a PPF marginal cost is reflected in the absolute value of the slope of the PPF. In particular, the magnitude of the slope of the PPF is the marginal cost of a unit of the good measured along the x-axis. As the magnitude of the slope changes moving along the PPF, the marginal cost changes.

What is marginal benefit? How is it measured? The marginal benefit of a good or service is the benefit received from consuming one more unit of it. It is measured by what an individual is willing to give up (or pay) for an additional that last unit.

How does the marginal benefit of a good change as the quantity produced of that good increases? As the more of a good is consumed, the marginal benefit received from each unit is smaller than the marginal benefit received from the unit consumed immediately before it, and is larger than the marginal benefit of the unit consumed immediately after it. This set of results is known as the principle of decreasing marginal benefit and is often assumed by economists to be a common characteristic of an individual’s preferences over most goods and services in the economy.

What is allocative efficiency and how does it relate to the production possibilities frontier? Production efficiency occurs when production takes place at a point on the PPF. This indicates that all available resources are being used for production and society cannot produce additional units of one good or service without reducing the output of another good or service. Allocative efficiency, however, requires that the goods and services produced are those that provide the greatest possible benefit. This definition means that the allocative efficient level of output is the point on the PPF (and hence is a production efficient point) for which the marginal benefit equals the marginal cost.

What conditions must be satisfied if resources are used efficiently? Resources are used efficiently when more of one good or service cannot be produced without producing less of some of another good or service that is valued more highly. This is known as allocative efficiency and it occurs when: 1) production efficiency is achieved, and 2) the marginal benefit received from the last unit produced is equal to the marginal cost of producing the last unit.

How do you think Covid-19 pandemic changed the marginal benefit of an effective vaccine? The Covid-19 pandemic drastically increased the marginal benefit of an effective vaccine. With the pandemic, people were willing to give up more for an effective vaccine.

Page 44 1.

What gives a person a comparative advantage? A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost than anyone else, If the person gives up the least amount of other goods and services to produce a particular good or service, the person has the lowest opportunity cost of producing that good or service.

THE ECONOMIC PROBLEM

Distinguish between comparative advantage and absolute advantage. A person has a comparative advantage in producing a good when he or she has the lowest opportunity cost of producing it. Comparative advantage is based on the output forgone. A person has an absolute advantage in production when he or she uses the least amount of time or resources to produce one unit of that particular good or service. Absolute advantage is a measure of productivity in using inputs.

Why do people specialize and trade? People can compare consumption possibilities from producing all goods and services through self-sufficiency against specializing in producing only those goods and services that reflect their comparative advantage and trading their output with others who do the same. People can then see that the consumption possibilities from specialization and trade are greater than under self-sufficiency. Therefore it is in people’s own selfinterest to specialize. It was Adam Smith who first pointed out in the Wealth of Nations how individuals voluntarily engage in this socially beneficial and cooperative activity through the pursuit of their own selfinterest, rather than for society’s best interests.

What are the gains from specialization and trade? From society’s standpoint, the total output of goods and services available for consumption is greater with specialization and trade. From an individual’s perspective, each person who specializes enjoys being able to consume a larger bundle of goods and services after trading with others who have also specialized, than would otherwise be possible under self-sufficiency. These increases are the gains from specialization and trade for society and for individuals.

What is the source of the gains from trade? As long as people have different opportunity costs of producing goods or services, total output is higher with specialization and trade than if each individual produced goods and services under self-sufficiency. This increase in output is the gains from trade.

Why does specialization and the gains from trade make the economy’s PPF outward bowed? Specialization and the gains from trade make the economy’s PPF bow outward because the resources that have the comparative advantage in producing a good or service are the first to be utilized to produce that good or service. Consequently when the good or service is first produced, its opportunity cost—the amount of the other good or service forgone—is small and so the PPF is relatively flat. Ultimately, when so much of the good or service is produced such that resources without a comparative advantage in it must be utilized, the opportunity cost becomes larger so that the PPF becomes steeper. When the PPF starts out flatter and becomes steeper, it bows outward.

Why is not specializing and reaping the gains from trade inefficient? By not specializing and trading, some suppliers are not producing the good in which they have a comparative advantage. Consequently production occurs inside the PPF at a production inefficient point. All of the economy’s resources might be employed but they are misallocated.

How do you think the Covid-19 pandemic influenced Liz’s and Joe’s gains from trade? Explain your answer. If Liz’s and Joe’s restaurants were closed due to the pandemic, their gains from trade would vanish. Presuming their stores were allowed to remain open, if there is a decrease in the resources necessary to produce one or both goods, then both their PPFs would have shifted inward which means the Liz-Joe Economy PPF also shifts inward. This change reduces the gains from trade because the total production of one or both of the goods decreases with the inward shift of the PPF.

Page 47 1.

What generates economic growth? The two key factors that generate economic growth are technological change and capital accumulation. Technological change allows an economy to produce more with the same amount of limited resources,

CHAPTER 2

Capital accumulation, the growth of capital resources including human capital, means that an economy has increased its available resources for production.

How does economic growth influence the production possibilities frontier? Economic growth shifts the PPF outward. Persistent outward shifts in the production possibility frontier— economic growth—are caused by the accumulation of resources, such as more capital equipment or by the development of new technology.

What is the opportunity cost of economic growth? When a society devotes more of its scarce resources to research and development of new technologies, or devotes additional resources to produce more capital equipment, both decisions lead to increased consumption opportunities in future periods at the cost of less consumption today. The loss of consumption today is the opportunity cost borne by society for creating economic growth.

Explain why Singapore has experienced faster economic growth than the United States. Singapore chose to devote a greater proportion of its available resources to the production of capital than the United States. This allowed Singapore to grow at a faster rate than the United States. By foregoing production of some consumption goods and producing a greater proportion of capital goods over the last few decades, Singapore was able to achieve output per person equal to 150 percent of that in the United States.

Does economic growth overcome scarcity? Scarcity reflects the inability to satisfy all our wants. Regardless of the amount of economic growth, scarcity will remain present because it will never be possible to satisfy all our wants. For instance, it will never be possible to satisfy all the wants of the several thousand people who all would like to ski the best slopes on Vail with only their family and a few best friends present. So economic growth allows more wants to be satisfied but it does not eliminate scarcity.

How does economic growth change the patterns of production? In low-income nations a large fraction of production is agriculture with distinctly less devoted to industry. For example, in Ethiopia agriculture accounts for 35 percent of production and industry for 22 percent. As the nation grows to middle income, investment in capital and new technology leads to an increase in the fraction of production that is industrial and a decrease in the fraction that is agricultural. For example, in China 8 percent of production is agriculture and 41 percent is industry. Finally, in high-income nations, services becomes an increasingly large proportion of production. In the United States, for example, services account for 80 percent of production while industry and agriculture together account for 20 percent of production.

Why does economic growth destroy some jobs and create new jobs? Economic growth leads to changes in the pattern of production—some sectors and products increase while others decrease. In the areas that increase in size, new jobs are created while in those that decrease, jobs are destroyed. Often workers who lose their jobs in the declining sectors need to acquire new skills for the new jobs and/or uproot their life to move to a new location. Some unemployed workers are unwilling to incur these costs and, as a result, remain unemployed, leading the economy to produce at a point inside its PPF.

Page 49 1.

Why are social institutions such as firms, markets, property rights, and money necessary? These social institutions factors necessary for a decentralized economy to coordinate production. Firms are necessary to allow people to specialize. Without firms, specialization would be limited because a person would need to specialize in the entire production of a good or service. With firms people are able to specialize in producing particular bits of a good or service. For a society to enjoy the fruits of specialization and trade, the individuals who comprise that society must voluntarily desire to specialize in the first place. Discovering trade opportunities after a person has specialized in his or her comparative advantage in production is what allows that person to gain from his or her own specialization efforts. Trading © 2023 Pearson Education, Inc.

THE ECONOMIC PROBLEM

opportunities can only take place if a market exists where people observe prices to discover available trade opportunities. Money is necessary to allow low-cost trading in markets. Without money, goods would need to be directly exchanged for other goods, a difficult and unwieldy situation. Finally people must enjoy social recognition of and government protection of property rights to have confidence that their commitments to trade arrangements will be respected by everyone in the market.

What are the main functions of markets? The main function of a market is to enable buyers and sellers to get information and to do business with each other. Markets have evolved because they facilitate trade, that is, they facilitate the ability of buyers and sellers to trade with each other.

What are the flows in the market economy that go from firms to households and the flows from households to firms? On the real side of the economy, goods and services flow from firms to households. On the monetary side of the economy, payments for factors of production, wages, rent, interest, and profits, flow from firms to households. Flowing from households to firms on the monetary side of the economy are the expenditures on goods and services and on the real side are the factors of production, labor, land, capital, and entrepreneurship.

CHAPTER 2

Answers to the Study Plan Problems and Applications Use the following data to work Problems 1 to 3. Brazil produces ethanol from sugar, and the land used to grow sugar can be used to grow food crops. The table to the right sets out Brazil’s production possibilities for ethanol and food crops. 1. a. Draw a graph of Brazil’s PPF and explain how your graph illustrates scarcity. Figure 2.1 shows Brazil’s PPF. The production possibilities frontier indicates scarcity because it shows the limits to what can be produced. In particular, production combinations of ethanol and food crops that lie outside the production possibilities frontier are not attainable.

Ethanol (barrels per day) 70 64 54 40 22 0

and and and and and and

Food crops (tons per day) 0 1 2 3 4 5

b. If Brazil produces 40 barrels of ethanol a day, how much food must it produce to achieve production efficiency? If Brazil produces 40 barrels of ethanol per day, it achieves production efficiency if it also produces 3 tons of food per day.

c. Why does Brazil face a tradeoff on its PPF? Brazil faces a tradeoff on its PPF because Brazil’s resources and technology are limited. For Brazil to produce more of one good, it must shift factors of production away from the other good. Therefore to increase production of one good requires decreasing production of the other, which reflects a tradeoff.

2. a. If Brazil increases ethanol production from 40 barrels per day to 54 barrels per day, what is the opportunity cost of the additional ethanol? When Brazil is production efficient and increases its production of ethanol from 40 barrels per day to 54 barrels per day, it must decrease its production of food crops from 3 tons per day to 2 tons per day. The opportunity cost of the additional ethanol is 1 ton of food per day for the entire 14 barrels of ethanol or 1/14 of a ton of food per barrel of ethanol.

b. If Brazil increases food production from 2 tons per day to 3 tons per day, what is the opportunity cost of the additional food? When Brazil is production efficient and increases its production of food crops from 2 tons per day to 3 tons per day, it must decrease its production of ethanol from 54 barrels per day to 40 barrels per day. The opportunity cost of the additional 1 ton of food crops is 14 barrels of ethanol.

c. What is the relationship between your answers to parts (a) and (b)? The opportunity costs of an additional barrel of ethanol and the opportunity cost of an additional ton of food crop are reciprocals of each other. That is, the opportunity cost of 1 ton of food crops is 14 barrels of ethanol and the opportunity cost of 1 barrel of ethanol is 1/14 of a ton of food crops.

Does Brazil face an increasing opportunity cost of ethanol? What feature of Brazil’s PPF illustrates increasing opportunity cost? Brazil faces an increasing opportunity cost of ethanol production. For instance, when increasing ethanol production from 0 barrels per day to 22 barrels the opportunity cost of a barrel of ethanol is 1/22 of a ton of food while increasing ethanol production another 18 barrels per day (to a total of 40 barrels per day) has © 2023 Pearson Education, Inc.

THE ECONOMIC PROBLEM

an opportunity cost of 1/18 of a ton of food per barrel of ethanol. The PPF’s bowed outward shape reflects the increasing opportunity cost.

Use the above table (for Problems 1 to 3) to work Problems 4 and 5. 4. Define marginal cost and calculate Brazil’s marginal cost of producing a ton of food when the quantity produced is 2.5 tons per day. The marginal cost of a good is the opportunity cost of producing one more unit of the good. When the quantity of food produced is 2.5 tons, the marginal cost of a ton of food is the opportunity cost of increasing the production of food from 2 tons per day to 3 tons per day. The production of ethanol falls from 54 barrels per day to 40 barrels per day, a decrease of 14 barrels per day. The opportunity cost of increasing food production is the decrease in ethanol product, so the opportunity cost of producing a ton of food when 2.5 tons of food per day are produced is 14 barrels of ethanol per day.

Define marginal benefit. Explain how it is measured and why the data in the table does not enable you to calculate Brazil’s marginal benefit of food. The marginal benefit of a good is the benefit received from consuming one more unit of the good. The marginal benefit of a good or service is measured by the most people are willing to pay for one more unit of it. The data in the table do not provide information on how much people are willing to pay for an additional unit of food. The table has no information on the marginal benefit of food.

Distinguish between production efficiency and allocative efficiency. Explain why many production possibilities achieve production efficiency but only one achieves allocative efficiency. Production efficiency occurs when goods and services are produced at the lowest cost. This definition means that production efficiency occurs at any point on the PPF. Therefore all of the production points on the PPF are production efficient. Allocative efficiency occurs when goods and services are produced at the lowest cost and in the quantities that provide the greatest possible benefit. The allocatively efficient production point is the single point on the PPF that has the greatest possible benefit.

Use the following data to answer questions 7 and 8. In an hour, Sue can produce 40 caps or 4 jackets and Tessa can produce 80 caps or 4 jackets. 7. a. Calculate Sue’s opportunity cost of producing a cap. Sue forgoes 4 jackets to produce 40 caps, so Sue’s opportunity cost of producing one cap is (4 jackets)/(40 caps) or 0.1 jacket per cap.

b. Calculate Tessa’s opportunity cost of producing a cap. Tessa forgoes 4 jackets to produce 80 caps, so Tessa’s opportunity cost of producing one cap is (4 jackets)/(80 caps) or 0.05 jacket per cap.

c. Who has a comparative advantage in producing caps? Tessa’s opportunity cost of a cap is lower than Sue’s opportunity cost, so Tessa has a comparative advantage in producing caps.

d. If Sue and Tessa specialize in producing the good in which they have a comparative advantage, and they trade 1 jacket for 15 caps, who gains from the specialization and trade? Tessa specializes in caps and Sue specializes in jackets. Both Sue and Tessa gain from trade. Sue gains because she can obtain caps from Tessa at a cost of (1 jacket)/(15 caps), which is 0.067 jacket per cap, a cost that is lower than what it would cost her to produce caps herself. Tessa also gains from trade because she trades caps for jackets for 0.067 jacket per cap, which is higher than her cost of producing a cap.

Suppose that Tessa buys a new machine that enables her to make 20 jackets an hour. (She can still make only 80 caps per hour.) a. Who now has a comparative advantage in producing jackets? Sue forgoes 40 caps to produce 4 jackets, so Sue’s opportunity cost of producing one jacket is (40 caps)/(4 jackets) or 10 caps per jacket. Tessa forgoes 80 caps to produce 20 jackets, so Tessa’s opportunity cost of © 2023 Pearson Education, Inc.

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producing one jacket is (80 caps)/(20 jackets) or 4 caps per jacket. Tessa has the comparative advantage in producing jackets because her opportunity cost of a jacket is lower than Sue’s opportunity cost.

b. Can Sue and Tessa still gain from trade? Tessa and Sue can still gain from trade because Tessa (now) has a comparative advantage in producing jackets and Sue (now) has a comparative advantage in producing caps. Tessa will produce jackets and Sue will produce caps.

c. Would Sue and Tessa still be willing to trade 1 jacket for 15 caps? Explain your answer. Sue and Tessa will not be willing to trade 1 jacket for 15 caps. In particular, Sue, whose comparative advantage lies in producing caps, can produce 1 jacket at an opportunity cost of only 10 caps. So Sue will be unwilling to pay any more than 10 caps per jacket.

A farm grows wheat and produces pork. The marginal cost of producing each of these products increases as more of it is produced. a. Make a graph that illustrates the farm’s PPF. The PPF is illustrated in Figure 2.2 as PPF0. Because the marginal cost of both wheat and pork increase as more of the good is produced, the PPF displays increasing opportunity cost so it has the “conventional” bowed-outward shape.

b. The farm adopts a new technology that allows it to use fewer resources to fatten pigs. On your graph sketch the impact of the new technology on the farm’s PPF. The new technology rotates the PPF outward from PPF0 to PPF1.

c. With the farm using the new technology in part (b), has the opportunity cost of producing a ton of wheat changed? Explain and illustrate your answer. The opportunity cost of producing wheat has increased. The opportunity cost of a bushel of wheat is equal to the magnitude of 1/(slope of the PPF). As illustrated in Figure 2.2, for each quantity of wheat the slope of PPF1 has a smaller magnitude than the slope of PPF0 so the opportunity cost of a bushel of wheat is higher along PPF1. For a specific example, the opportunity cost of increasing wheat product from 600 bushels per week to 800 bushels per week along PPF1 is 6,000 pounds of pork but is only 3,000 pounds of pork along PPF0.

d. Is the farm more efficient with the new technology than it was with the old one? Why? The farm is able to produce more with the new technology than with the old, but it is not necessarily more efficient. If the farm was producing on its PPF before the new technology and after, the farm was production efficient both before the new technology and after.

10.

For 50 years, Cuba has had a centrally planned economy in which the government makes the big decisions on how resources will be allocated. a. Why would you expect Cuba’s production possibilities (per person) to be smaller than those of the United States? Cuba’s economy is almost surely less efficient than the U.S. economy. The Cuban central planners do not know people’s production possibilities or their preferences. The plans that are created wind up wasting resources and/or producing goods and services that no one wants. Because firms in Cuba are owned by the government rather than individuals, no one in Cuba has the self-interested incentive to operate the firm © 2023 Pearson Education, Inc.

THE ECONOMIC PROBLEM

efficiently and produce goods and services that consumers desire. Additionally, Cuba does not actively trade so Cuba produces most of its consumption goods rather than buying them from nations with a comparative advantage. Because Cuba uses its resources to produce consumption goods, it cannot produce many capital goods, so its economic growth rate has been low.

b. What are the social institutions that Cuba might lack that help the United States to achieve allocative efficiency? Of the four social institutions, firms, money, markets, and property rights, Cuba’s economy has firms and money. Markets, however, are less free of government intervention in Cuba. But the major difference is the property rights in the Cuban economy. In Cuba the government owns most of the firms; that is, the government has the property right to run the producers. Because the firms are not motivated to make a profit, the managers of these firms have little incentive to operate the firm efficiently or to produce the goods and services that consumers desire. In the United States, firms are owned by individuals; that is, people have the property right that allows them to run firms. These owners have the self-interested incentive to operate the firm efficiently and to produce the goods and services people want, an incentive sorely lacking in the Cuban economy.

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Answers to Additional Problems and Applications Use the table to work Problems 11 and 12. Suppose that Yucatan’s production possibilities are given in the table. 11. a. Draw a graph of Yucatan’s PPF and explain how your graph illustrates a tradeoff. Yucatan’s PPF is illustrated in Figure 2.3. The figure illustrates a tradeoff because moving along Yucatan’s PPF producing more of one good requires producing less of the other good. Yucatan trades off more production of one good for less production of the other.

Food (pounds per month) 300 200 100 0

and and and and

Sunscreen (gallons per month) 0 50 100 150

b. If Yucatan produces 150 pounds of food per month, how much sunscreen must it produce if it achieves production efficiency? If Yucatan produces 150 pounds of food per month, then the point labeled A on the PPF in Figure 2.11 shows that Yucatan must produce 75 gallons of sunscreen per month to achieve production efficiency.

c. What is Yucatan’s opportunity cost of producing (i) 1 pound of food and (ii) 1 gallon of sunscreen? Yucatan’s PPF is linear so the opportunity cost of producing 1 pound of food is the same at all quantities. Calculate the opportunity cost of producing 1 pound of food when increasing the production of food from 0 to 100 pounds per month. Between these two ranges of production, the quantity of sunscreen produced falls from 150 gallons per month to 100 gallons per month, a decrease of 50 gallons. The opportunity cost is 50 gallons of sunscreen to gain 100 pounds of food. The opportunity cost per pound of food equals (50 gallons of sunscreen)/(100 pounds of food), or an opportunity cost of 0.5 gallon of sunscreen per pound of food. Yucatan’s PPF is linear so the opportunity cost of producing 1 gallon of sunscreen is the same at all quantities. Calculate the opportunity cost of producing 1 gallon of sunscreen when increasing the production of sunscreen from 0 to 50 gallons per month. Between these two ranges of production, the quantity of food produced falls from 300 pounds per month to 200 pounds per month, a decrease of 100 pounds. The opportunity cost is 100 pounds of food to gain 50 gallons of sunscreen, or (100 pounds of food)/(50 gallons of sunscreen) which yields an opportunity cost of 2.0 pounds of food per gallon of sunscreen.

e. What is the relationship between your answers to part (c)? Answers (c) and (d) reflect the fact that opportunity cost is a ratio. The opportunity cost of gaining a unit of a good moving along the PPF equals the quantity of the other good or service forgone divided by the quantity of the good or service gained. The opportunity cost of one good, food, is equal to the inverse of the opportunity cost of the other good, sunscreen.

12.

What feature of a PPF illustrates increasing opportunity cost? Explain why Yucatan’s opportunity cost does or does not increase. If opportunity costs increase, the PPF bows outward. Yucatan’s PPF is linear and along a linear PPF the opportunity cost is constant. Yucatan does not face an increasing opportunity cost of food because the © 2023 Pearson Education, Inc.

THE ECONOMIC PROBLEM

opportunity cost remains constant, equal to 0.5 gallons of sunscreen per pound of food. Yucatan’s resources must be equally productive in both activities.

13.

In problem 11, what is the marginal cost of 1 pound of food in Yucatan when the quantity produced is 150 pounds per day? What is special about the marginal cost of food in Yucatan? The marginal cost of a pound of food in Yucatan is constant at all points along Yucatan’s PPF and is equal to 0.5 gallons of sunscreen per pound of food. The special point about Yucatan’s marginal cost is the fact that the marginal cost is constant. This result reflects Yucatan’s linear PPF.

14.

The table describes the preferences in Yucatan. a. What is the marginal benefit of sunscreen and how is it measured?

Sunscreen (gallons per month) 25 75 125

Willingness to pay (pounds of food per gallon) 3 2 1

The marginal benefit of sunscreen is the benefit enjoyed by the person who consumes one more gallon of sunscreen. It is equal to the willingness to pay for an additional gallon. For example, in the table when 75 gallons of sunscreen are produced, the marginal benefit of a gallon is 2 pounds of food per gallon.

b. Using the table in Problem 11, what does Yucatan produce to achieve allocative efficiency? To achieve allocative efficiency, the marginal benefit of a gallon of sunscreen must equal the marginal cost of a gallon of sunscreen. Yucatan’s marginal cost of a gallon of sunscreen is 2 pounds of food per gallon. When Yucatan produces 75 gallons of sunscreen, the table shows that Yucatan’s marginal benefit is 2 pounds of food per gallon. Therefore, allocative efficiency is achieved when 75 gallons of sunscreen and, from the PPF, 150 pounds of food are produced.

15.

Up To 10,000 Retail Stores Could Close This Year Up to 10,000 U.S. storefronts could disappear by the end of 2021. Consumers prefer the safety of shopping online during the Covid-19 pandemic. Source: CBS News, January 28, 2021 a. Draw the PPF curves for storefront and online retailers before and after the Covid-19 pandemic. Before the Covid-19 pandemic, the production possibilities frontier was PPF0 in Figure 2.4. With thousands of storefronts closing, the PPF shifts inward along the horizontal axis to PPF1.

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b. Draw the marginal cost and marginal benefit curves for storefront retailers and online retailers before and after the Internet became available. The marginal benefit for the goods is the same regardless of whether they came from an online store or a storefront retailer. Therefore in Figure 2.5 the marginal benefit curve for retail goods is MB. The marginal cost of storefront retailing increases as the quantity increases, so both preand post-Internet, the storefront marginal cost curve is MCSTORE. Before the Internet, no online retailing could occur so the marginal cost curve is the vertical marginal cost curve MCPRE-INT running along the y-axis. After the Internet was developed online retailers have a lower marginal cost than do brick-and-mortar retailers, so the marginal cost curve of online retailers is MCPOST-INT.

c. Explain how changes in production possibilities, preferences, or both have changed the way in which goods are retailed. The change in production possibilities, which created lower-cost online retailers, have changed the way retail goods are produced. In addition, the Covid-19 pandemic changed people’s preferences in favor of online retailing. With the lower cost of online retailing and the increased preferences for online retailing, the quantity of online retailing increased.

Use the following news clip to work Problems 16 and 17. Defeat Malaria in a Generation—Here’s How The world could be free of malaria within a generation, a major report says. Malaria eradication within a generation is ambitious, achievable, and necessary. The report estimates around $4.3bn is spent on malaria every year. But it would need a further $2bn a year to rid the world of malaria by 2050. Source: BBC News, September 9, 2019 16. Does the report describe production efficiency or allocative efficiency or both? The report describes both allocative efficiency and production efficiency. The allocatively efficient quantity occurs when marginal cost equals marginal benefit. The assessment that malaria eradication is “necessary” indicates that it this is allocatively efficient quantity of malaria cases. It also discusses production efficiency when it suggests that spending an additional $2 billion a year is necessary to eliminate malaria. This increased spending represents a movement along the PPF.

THE ECONOMIC PROBLEM

17.

Make a graph with the percentage of malaria cases eliminated on the x-axis and the marginal cost and marginal benefit of driving down malaria cases on the y-axis. On your graph, (i) Draw curves to show the marginal cost and marginal benefit of malaria eradication. (ii) Identify the quantity of malaria eradicated that achieves allocative efficiency. Figure 2.6 shows a marginal cost curve and a marginal benefit curve that are consistent with the report. The allocatively efficient quantity is the percentage of malaria cases eliminated for which the marginal benefit equals the marginal cost. The figure shows this allocatively efficient quantity to be 100 percent of malaria cases eliminated but because the article did not present enough detail, it the allocatively efficient quantity might less than 100 percent.

Use the following data to work Problems 18 and 19. Kim can produce 40 pies or 400 cakes an hour. Liam can produce 100 pies or 200 cakes an hour. 18. a. Calculate Kim’s opportunity cost of a pie and Liam’s opportunity cost of a pie. If Kim spends an hour baking pies, she gains 40 pies but forgoes 400 cakes. Kim’s opportunity cost of 1 pie is (400 cakes)/(40 pies), or 10 cakes per pie. If Liam spends an hour baking pies, he gains 100 pies but forgoes 200 cakes. Liam’s opportunity cost of 1 pie is (200 cakes)/(100 pies), or 2 cakes per pie.

b. If each spends 30 minutes of each hour producing pies and 30 minutes producing cakes, how many pies and cakes does each produce? Kim produces 20 pies and 200 cakes. Liam produces 50 pies and 100 cakes. The total number produced is 70 pies and 300 cakes.

c. Who has a comparative advantage in producing (i) pies and (ii) cakes? Liam has the comparative advantage in producing pies because his opportunity cost of a pie is less than Kim’s opportunity cost. Kim has the comparative advantage in producing cakes because her opportunity cost of a cake is less than Liam’s opportunity cost.

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19. a

Draw a graph of Kim’s PPF and Liam’s PPF and show the point at which each produces when they spend 30 minutes of each hour producing pies and 30 minutes producing cakes.

Kim’s PPF is illustrated in Figure 2.7; Liam’s PPF is illustrated in Figure 2.8. Point A in both figures shows their production points when each spends 30 minutes making cakes and 30 minutes making pies.

b. On your graph, show what Kim produces and what Liam produces when they specialize. Kim will specialize in cakes and Liam will specialize in pies. Point B in both figures shows the production points when each specializes.

c. When they specialize and trade, what are the total gains from trade? Kim will specialize in cakes and Liam will specialize in pies. If they specialize and trade, the total production of both cakes and pies increase. When each spends 30 minutes making cakes and 30 minutes making pies, together they produce 300 cakes and 70 pies. When they specialize, together they produce 400 cakes and 100 pies. The 100 increase in cakes and the 30 increase pies is the gains from trade.

d. If Kim and Liam share the total gains equally, what trade takes place between them? Kim will trade 50 cakes (half of the gain in cake production) to Liam in exchange for 15 pies (half of the increase in pie production).

Tony’s Production Possibilities Snowboards Skis (units per week) (units per week) 25 and 0 20 and 10 15 and 20 10 and 30 5 And 40 0 And 50 20.

Patty’s Production Possibilities Snowboards Skis (units per week) (units per week) 20 and 0 10 and 5 0 and 10

Tony and Patty produce skis and snowboards. The tables show their production possibilities. Tony produces 5 snowboards and 40 skis a week; Patty produces 10 snowboards and 5 skis a © 2023 Pearson Education, Inc.

THE ECONOMIC PROBLEM

week. a. Who has a comparative advantage in producing (i) snowboards and (ii) skis? (i) Tony’s opportunity cost of a snowboard is (10 skis)/(5 snowboards), or 2 skis per snowboard. Patty’s opportunity cost of a snowboard is (5 skis)/(10 snowboards), or 0.5 skis per snowboard. Patty’s opportunity cost of a snowboard is lower than Tony’s opportunity cost, so Patty has the comparative advantage. (ii) Tony’s opportunity cost of a ski is (5 snowboards)/(10 skis), or 0.5 snowboards per ski. Patty’s opportunity cost of a ski is (10 snowboards)/(5 skis), or 2.0 snowboards per ski. Tony’s opportunity cost of a ski is lower than Patty’s opportunity cost, so Tony has the comparative advantage.

b. If Tony and Patty specialize and trade 1 snowboard for 1 ski, what are the gains from trade? Tony has a comparative advantage in producing skis, so he specializes in producing skis. Patty has a comparative advantage in producing snowboards, so she specializes in snowboards. Tony now produces 50 skis and Patty produces 20 snowboards. Before specializing they produced a total of 45 skis (Tony’s 40 plus Patty’s 5) and 15 snowboards (Tony’s 5 plus Patty’s 10). By specializing, the total production of skis increases by 5 and the total production of snowboards increases by 5. This increase in total production is the gains from trade. By trading 1 ski for 1 snowboard, they can share these gains. Tony obtains snowboards from Patty for less than it costs him to produce them and Patty obtains skis from Tony for less than it costs her to produce them.

21.

Capital accumulation and technological change bring economic growth: Production that was unattainable yesterday becomes attainable today; production that is unattainable today will become attainable tomorrow. Why doesn’t economic growth bring an end to scarcity one day? Scarcity is always being defeated yet will never suffer defeat. Scarcity reflects the existence of unmet wants. People’s wants are infinite—regardless of what a person already possesses, everyone can easily visualize something else he or she wants, if only more time in the day to enjoy their possessions. Because people’s wants are insatiable, scarcity will always exist regardless of economic growth.

22.

SpaceX Plans to Send Three Tourists to the International Space station Next Year SpaceX CEO Elon Musk announced that SpaceX has plans to send three tourists on a 10-day trip to the International Space station in 2021. Source: The Verge, March 5, 2020 a. What is the opportunity cost of creating the technology for trips to the International Space Station? The opportunity cost of creating the technology is the next best alternative forgone by the resources used to develop this technology. For example, the engineers who are working to develop SpaceX’s technology might otherwise be assisting in the production of technology used to more powerful batteries, so the opportunity cost is the decrease in production of the more powerful battery.

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b. Sketch SpaceX’s PPF for trips to the International Space Station and other goods and services and show Space X’s planned production in 2021. Figure 2.9 shows SpaceX’s PPF. In 2021, SpaceX planned a trip to send three tourists to the International Space Station. Its planned production point in 2021 is labeled A, where it sends one trip to the International Space Station.

23.

On a graph of the circular flows in the market economy, indicate the real and money flows in which the following items belong: a. You buy an iPad from the Apple Store. Figure 2.10 shows the circular flows in a market economy. Your purchase of an iPad from Apple is the purchase of a good from a firm. This flow is in the black arrow indicated by point a in the figure. When you pay for the iPad, the corresponding money flow is in the grey arrow in the opposite direction to the black arrow labeled a.

b. Apple Inc. pays the designers of the iPad. Apple’s payment to the designers of the iPad is the payment of a wage to a factor of production. This flow is in the grey arrow indicated by point b in the figure. The flow of design services from the designer to Apple is in the black arrow in the opposite direction to the grey arrow labeled b.

c. Apple Inc. decides to expand and rents an adjacent building. Apple’s decision to expand by renting a building means that Apple is increasing the capital it uses. This flow is in the black arrow indicated by point c in the figure. The flow of the payment for the rental services of the building is in the grey arrow in the opposite direction to the black arrow labeled c.

THE ECONOMIC PROBLEM

d. You buy a new e-book from Amazon. Your purchase of an e-book from Amazon is the purchase of a good from a firm. This flow is in the black arrow indicated by point d in the figure. When you pay for the e-book, the corresponding money flow is in the grey arrow in the opposite direction to the black arrow labeled d.

e. Apple Inc. hires a student to work as an intern. Apple’s decision to hire a student intern is Apple increasing the labor it uses. The flow of labor services is in the black arrow indicated by point e in the figure. The flow of the payment for the labor services is in the grey arrow in the opposite direction to the black arrow labeled c.

Economics in the News 24. After you have studied Reading Between the Lines on pp. 50–51, answer the following questions. a. How did Covid-19 change U.S. production possibilities in 2020? Covid-19 decreased the U.S. production possibilities and shifted the U.S PPF inward.

b. How did the rapid development and rollout of vaccines change the U.S. production possibilities in 2021? The rapid development and rollout of vaccines increased U.S. production possibilities and shifted the U.S. PPF outward.

c. How do productive resources get reallocated between private and government goods and services? Productive resources are reallocated so that the economy is producing at the allocatively efficient point.

d. How might the Biden spending packages change U.S. production possibilities after 2021? Some of the items in the $6 trillion Biden plan are productivity enhancing capital goods, such as transportation infrastructure, research and development, and education. The increase in the production of these items increases production possibilities, which would result in an increase in U.S. production possibilities after 2021.

25. Disney Hopes Wall Street Bets on New Global Streaming Service Walt Disney Co. unveiled details of a family-friendly streaming service on Thursday with TV shows and movies from some of the world’s most popular entertainment franchises. Disney says its new streaming service, Disney Plus, will cost $6.99 US per month. Source: Reuters, April 11, 2019 a. How has live streaming changed the production possibilities of video entertainment and other goods and services? b.

Live streaming has increased the production possibilities. For any quantity of other goods and services, now more video entertainment can be produced. The production possibilities frontier has changed so that the maximum quantity of video entertainment has increased but the maximum quantity of other goods and services has not changed.

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b. Sketch a PPF for video entertainment and other goods and services before live streaming. The PPF should have video entertainment on one axis and other goods and services on the other as illustrated in Figure 2.11. The PPF is bowed outward as a conventional PPF.

c. Show how the arrival of inexpensive live streaming has changed the PPF. The arrival of inexpensive live streaming shifts the PPF outward as shown by the change from PPF0 to PPF1 in Figure 2.11. The intersection of the new PPF along the axis measuring video entertainment increases and the intersection of the new PPF along the axis measuring other goods and services does not change.

d. Sketch a marginal benefit curve and marginal cost curve for video entertainment before and after live streaming. In Figure 2.12, the marginal benefit and marginal cost from video entertainment is measured along the vertical axis and the quantity of video entertainment is measured along the horizontal axis. As the figure shows, the marginal benefit curve is a conventional downward-sloping marginal benefit curve and the marginal cost curve is a conventional upward-sloping marginal cost curve. The introduction of low cost live streaming does not change the marginal benefit curve—it remains MB. But it lowers the marginal cost and shifts the marginal cost curve from MC0 to MC1.

e. Explain how the efficient quantity of video entertainment has changed. As Figure 2.12 shows, the allocatively efficient quantity of video entertainment increases. In Figure 2.12, the allocatively efficient quantity increases from 4 million units per year to 6 million units per year

C h a p t e r

DEMAND AND SUPPLY

Answers to the Review Quizzes Page 60 1.

What is the distinction between a money price and a relative price? The money price of a good is the dollar amount that must be paid for it. The relative price of a good is its money price expressed as a ratio to the money price of another good. Thus the relative price is the amount of the other good that must be foregone to purchase a unit of the first good.

Explain why a relative price is an opportunity cost. The relative price of a good is the opportunity cost of buying that good because it shows how much of the next best alternative good must be forgone to buy a unit of the first good.

Think of examples of goods whose relative price has risen or fallen by a large amount. Some examples of items where both the money price and the relative price have risen over time are gasoline, college tuition, and food. Some examples of items where both the money price and the relative price have fallen over time are personal computers, HD televisions, and calculators.

Describe a competitive market in which you buy or sell a good or service. Fruits and vegetables have highly competitive markets. Students who buy in these markets have no influence over the price because there are literally millions of buyers and any students whose families (or themselves) who sell in these markets also have no influence over the price because there are hundreds of thousands of sellers.

Page 65 1.

Define the quantity demanded of a good or service. The quantity demanded of a good or service is the amount that consumers plan to buy during a given time period at a particular price.

What is the law of demand and how do we illustrate it? The law of demand states: “Other things remaining the same, the higher the price of a good, the smaller is the quantity demanded; and the lower the price of a good, the greater is the quantity demanded.” The law of demand is illustrated by a downward-sloping demand curve drawn with the quantity demanded on the horizontal axis and the price on the vertical axis. The slope is negative to show that the higher the price of a good, the smaller is the quantity demanded and the lower the price of a good, the greater is the quantity demanded.

What does the demand curve tell us about the price that consumers are willing to pay? For any fixed quantity of a good available, the vertical distance of the demand curve from the x-axis shows the maximum price that consumers are willing to pay for that quantity of the good. The price on the demand curve at this quantity indicates the marginal benefit to consumers of the last unit consumed at that quantity.

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List all the influences on buying plans that change demand, and for each influence, say whether it increases or decreases demand. Influences that change the demand for a good include:  The prices of related goods. A rise (fall) in the price of a substitute increases (decreases) the demand for the first good. A rise (fall) in the price of a complement decreases (increases) the demand for the first good.



The expected future price of the good. A rise (fall) in the expected future price of a good increases (decreases) the demand in the current period.



Income. An increase (decrease) in income increases (decreases) the demand for a normal good. An increase in income decreases (increases) the demand for an inferior good.



Expected future income and credit. An increase (decrease) in expected future income or credit increases (decreases) the demand.



The population. An increase (decrease) in population increases (decreases) the demand.



People’s preferences. If people’s preferences for a good rise (fall), the demand increases (decreases).

Why does demand not change when the price of a good changes with no change in the other influences on buying plans? If the price of a good falls and nothing else changes, then the quantity of the good demanded increases and there is a movement down along the demand curve, but the demand for the good remains unchanged and the demand curve does not shift.

During the Covid-19 lockdown, yeast’s popularity increased as millennials and home chefs were willing and able to spend more time cooking. Did yeast’s increased popularity increase demand or the quantity of yeast demanded. Yeast’s popularity reflects an increase in demand due to a change in people’s preferences.

Page 69 1.

Define the quantity supplied of a good or service. The quantity supplied of a good or service is the amount of the good or service that firms plan to sell in a given period of time at a specified price.

What is the law of supply and how do we illustrate it? The law of supply states that “other things remaining the same, the higher the price of a good, the greater is the quantity supplied; and the lower the price of a good, the smaller is the quantity supplied.” The law of supply is illustrated by an upward-sloping supply curve drawn with the quantity supplied on the horizontal axis and the price on the vertical axis. The slope is positive to show that the higher the price of a good, the greater is the quantity supplied and the lower the price of a good, the smaller is the quantity supplied.

What does the supply curve tell us about the producer’s minimum supply price? For any quantity, the vertical distance between the supply curve and the x-axis shows the minimum price that suppliers must receive to produce that quantity of output. As a result, the price is the marginal cost of the last unit produced at this level of output.

List all the influences on selling plans, and for each influence, say whether it changes supply. Changes in the price of the good change the quantity supplied. They do not change the supply of the good. Influences that change the supply of a good include:  Prices of factor of production. A rise (fall) in the price of a factor of production increases firms’ costs of production and decreases (increases) the supply of the good.

DEMAND AND SUPPLY



Prices of related goods produced. If the price of a substitute in production rises (falls), firms decrease (increase) their sales of the original good and the supply for the original good decreases (increases). A rise (fall) in the price of a complement in production increases (decreases) production of the original good, causing the supply of the original good to increase (decrease).



The expected future price of the good. A rise (fall) in the expected future price of the good decreases (increases) the amount suppliers sell today. This change in expectations decreases (increases) the supply in the current period.



The number of sellers. An increase (decrease) in the number of sellers in a market increases the quantity of the good available at every price, and increases (decreases) the supply.



Technology. An advance in technology increases the supply.



The state of nature. A good (bad) state of nature, such as good (bad) weather for agricultural products, increases (decreases) the supply.

What happens to the quantity of smartphones supplied and the supply of smartphones if the price of a smartphone falls? If the price of a smartphones falls and nothing else changes, then the quantity of smartphones supplied will decrease and there is a movement down along the supply curve for smartphones. The supply of smartphones, however, remains unchanged and the supply curve does not shift.

The price of the cheese that goes on top of a burger rose 18 percent during 2020. Did this higher price change the quantity of burgers supplied or the supply of burgers? The higher price changed the supply of burgers because it reflects a change in the price of a factor of production.

Page 71 1.

What is the equilibrium price of a good or service? The equilibrium price is the price at which the quantity demanded by the buyers is equal to the quantity supplied by the sellers.

Over what range of prices does a shortage arise? What happens to the price when there is a shortage? A shortage arises at market prices below the equilibrium price. A shortage causes the price to rise, decreasing quantity demanded and increasing quantity supplied until the equilibrium price is attained.

Over what range of prices does a surplus arise? What happens to the price when there is a surplus? A surplus arises at market prices above the equilibrium price. A surplus causes the price to fall, decreasing quantity supplied and increasing quantity demanded until the equilibrium price is attained.

Why is the price at which the quantity demanded equals the quantity supplied the equilibrium price? At the equilibrium price, the quantity demanded by consumers equals the quantity supplied by producers. At this price, the plans of producers and consumers are coordinated and there is no influence on the price to move away from equilibrium.

Why is the equilibrium price the best deal available for both buyers and sellers? The equilibrium price reflects that the highest price consumers are willing to pay for that amount of the good or service and is just equal to the minimum price that suppliers require for delivering it. Demanders would prefer to pay a lower price, but suppliers are unwilling to supply that quantity at a lower price. Suppliers would prefer a higher price, but demanders are unwilling to pay a higher price for that quantity. Hence neither demanders not suppliers can do business at a better price.

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Page 77 What is the effect on the price and quantity of smartphones if 1. The price of a music-streaming subscription falls or the price of a wireless plan rises? (Draw the diagrams!) Because a large majority of smartphone owners listen to streaming music on their smartphones (68 percent according to a study published by Digital Music News), streaming music is a complement of a smartphone. A fall in the price of a music-streaming subscription increases the demand for smartphones. The demand curve for smartphones shifts rightward. Supply remains unchanged. The price of a smartphone rises and the quantity increases. Figure 3.8 on page 72 illustrates this sort of change. A rise in the price of a wireless plan decreases the demand for smartphones because a wireless plan is a complement of a smartphone. The demand curve for smartphones shifts leftward. Supply remains unchanged. The price of a smartphone falls and the quantity decreases.

More firms produce smartphones or electronics workers’ wages rise? (Draw the diagrams!) An increase in the number of firms that produce smartphones increases the supply of smartphones. The supply curve of smartphones shifts rightward. Demand remains unchanged. The price of a smartphone falls and the quantity of smartphones increases. You can illustrate this outcome by drawing a diagram like Figure 3.9 on page 74. A rise in the wages of electronic workers decreases the supply of smartphones because it increases the cost of producing smartphones. The supply curve of smartphones shifts leftward. Demand remains unchanged. The price of a smartphone rises and the quantity of smartphones decreases.

Any two of these events in questions 1 and 2 occur together? (Draw the diagrams!) There are six combinations: (1) If the price of a music streaming service falls and the price of a wireless plan rises, supply is unchanged and demand might increase, decrease, or not change so the outcome cannot be predicted. (2) If the price of a music streaming service falls and more firms produce smartphones, demand increases and supply increases so the quantity increases and the price might rise, fall, or not change. (3) If the price of a music-streaming service falls and the wages paid electronic workers rise, demand increases and supply decreases so the price rises and the quantity might increase, decrease, or not change. (4) If the price of a wireless plan rises and more firms produce smartphones, demand decreases and supply increases so the price falls and quantity might increase, decrease, or remain the same. (5) If the price of a wireless plan rises and the wages paid electronic workers rise, demand decreases and supply decreases so the quantity decreases and the price might rise, fall, or remain the same. (6) If more firms produce smartphones and the wages paid electronics workers rise, demand is unchanged and supply might increase or decrease or remain unchanged, so the outcome cannot be predicted.