SOLUTIONS MANUAL FOR Essential Foundations of Economics 8th Edition By Robin Bade Michael Parkin by welldoneassistant

Part 1 . INTRODUCTION

Draw a time-series graph of quantity of compact discs sold. Say in which year or years the quantity sold (a) was highest, (b) was lowest, (c) increased the most, and (d) decreased the most. If the data show a trend, describe it. Figure A1.2 illustrates the time series of the quantity of compact discs sold using the data from the spreadsheet. a. b. c. d.

The quantity sold was the highest in 2004. The quantity sold was the lowest in 2014. The quantity sold never increased. The quantity sold decreased the most between 2006 and 2008 when it decreased by 235 million. Over the entire time period covered in the figure, there is a downward trend in the quantity of compact discs sold.

The following data shows the relationship between two variables x and y. x

Is the relationship between x and y positive or negative? Calculate the slope of the relationship when x equals 2 and when x equals 4. How does the slope change as the value of x increases? The relationship is negative: When x increases, y decreases. The slope of the relationship equals the change in y divided by the change in x along the tangent line; that is, the slope of the relationship at a point equals the slope of the tangent line at that point. When x equals 2, the slope of the tangent line equals –4, so the slope of the relationship equals –4. When x equals 4, the slope of the tangent line equals –8, so the slope of the relationship equals –8. The slope of the relationship increases in magnitude (the line becomes steeper) as x increases.

Appendix 1 . Making and Using Graphs

The table provides data on the Price price of a balloon ride, the tem(dollars perature, and the number of per ride) rides a day. Draw graphs to 5 show the relationship between 10 • The price and the number of 15 rides, when the temperature 20 is 70°F. Figure A1.3 illustrates the relationship between the price and the number of rides when the temperature is 70°F.

Balloon rides (number per day) 50F

70F

90F

32 27 18 10

50 40 32 27

40 32 27 18

• The number of rides and the temperature, when the price is $15 a ride. Figure A1.4 illustrates the relationship between the number of rides and the temperature, when the price is $15 a ride.

Part 1 . INTRODUCTION

◼ Instructor Assignable Problems Use the information in the table to work Problems 1 and 2. Column A is the year; the other columns are quantities sold in millions per year of compact discs (column B), music videos (column C), and singles downloads (column D). 1.

2004

767

139

2006

620

586

2008

385

1,033

4 Draw a scatter diagram to show the relationship between quantities sold of music 5 videos and singles downloads. Describe the 6 relationship. Figure A1.5 illustrates the relationship of the data from the spreadsheet between the quantities sold of music videos and singles downloads. Over all the period, there appears to be a negative or indirect relationship; that is, when fewer music videos are sold, more singles are downloaded.

2010

226

1,162

2012

211

1,392

2014

144

1,200

Appendix 1 . Making and Using Graphs

Draw a time-series graph of the quantity of music videos sold. Say in which year or years the quantity sold (a) was highest, (b) was lowest, (c) decreased the most, and (d) decreased the least. If the data show a trend, describe it. Figure A1.6 illustrates the time series of music videos sold using the data from the spreadsheet. a. The quantity sold was the highest in 2006. b. The quantity sold was the lowest in 2014. c. The quantity sold decreased the most between 2004 and 2006 and between 2006 and 2008, when it decreased by 10 million per period. d. Setting aside the periods during which the quantity increased, the quantity sold decreased the least between 2008 and 2010. There is a downward trend in the quantity of music videos sold.

Use the following data on the relationship between two variables x and y to work Problems 3 and 4. x

Is the relationship between x and y positive or negative? Explain. The relationship is positive: When x increases, y also increases.

Calculate the slope of the relationship when x equals 2 and x equals 4. How does the slope change as the value of x increases? The slope of the relationship equals the change in y divided by the change in x along the tangent line; that is, the slope of the relationship at a point equals the slope of the tangent line at that point. When x equals 2, the slope of the tangent line equals 4, so the slope of the relationship equals 4. When x equals 4, the slope of the tangent line equals 8, so the slope of the relationship equals 8. The slope of the relationship increases as x increases.

Part 1 . INTRODUCTION

The table provides data on the price of hot chocolate, the Price (dollars temperature, and the cups of per cup) hot chocolate bought. Draw graphs to show the 2.00 relationship between 2.50 3.00 • The price and cups of hot 3.50 chocolate bought, when the temperature is constant. Figure A1.7 illustrates the relationship between the price and the number of cups bought holding constant the temperature. Note that there are three relationships, one for each temperature.

Hot chocolate (cups per week) 50F

70F

90F

40 30 20 10

30 20 10 0

20 10 0 0

• The temperature and cups of hot chocolate bought, when the price is constant. Figure A1.8 illustrates the relationship between the number of cups bought and the temperature, holding constant the price. Note that there are four relationships, one for each price.

The U.S. and Global Economies ANSWERS TO CHAPTER CHECKPOINT

◼ Study Plan Problems and Applications 1.

Which of the following items are not consumption goods and services? Explain why not. • A chocolate bar A chocolate bar is a consumption good. • A ski lift A ski lift is not a consumption good. It is capital that produces a service for skiers. • A golf ball A golf ball is a consumption good. 2. Which of the following items are not capital goods? Explain why not. • An auto assembly line An auto assembly line is a capital good. • A shopping mall A shopping mall is a capital good. • A golf ball A golf ball is not a capital good. It is a consumption good. 3. Which of the following items are not factors of production? Explain why not. • Vans used by a baker to deliver bread Vans used to deliver bread are capital, so they are factors of production. • 1,000 shares of Amazon.com stock 1,000 shares of Amazon.com stock are not a factor of production. The shares represent partial ownership of Amazon.com and therefore are financial capital. • Undiscovered oil in the Arctic Ocean Undiscovered oil is not a factor of production because it is not used to

Chapter

Part 1 . INTRODUCTION

produce goods or services. Once it is discovered, it will become a factor of production. Which factor of production earns the highest percentage of total U.S. income? Define that factor of production. What is the income earned by this factor of production called? Labor earns by far the largest percentage of total U.S. income, 63 percent of total income in 2014. Labor consists of the work time and the work effort that people devote to producing goods and services. The income earned by labor is a wage.

With more job training and more scholarships to poor American students, which special factor of production is likely to grow faster than in the past? As more people go to school and/or receive job training, the nation’s human capital will grow more rapidly. Human capital is the knowledge and skills people obtain from education, on-the-job training, and work experience. With more job training and more scholarships, human capital will grow more rapidly.

Define the factor of production called capital. Give three examples of capital, different from those in the chapter. Distinguish between the factor of production capital and financial capital. Capital is the tools, instruments, machines, buildings, and other items that have been produced in the past and that businesses now use to produce goods and services. Capital includes railroad engines and cars, servers, and ATMs. The factor of production “capital” is the actual good itself; “financial capital,” such as stocks and bonds, are the funds that provide businesses with their financial resources which can be used to acquire capital goods.

The pace at which new businesses are created in the U.S. economy and the percentage of U.S. jobs in young firms has fallen. Ryan Decker and others, “The Role of Entrepreneurship in U.S. Job Creation and Economic Dynamism.” Journal of Economic Perspectives, 2014. Explain how you would expect these facts to influence what, how, and for whom goods and services are produced in the United States The answer to the what question changes if, as is probably the case, new and young business produce different goods and services than more established business. For example, new and young firms are more likely to create apps than older and more established firms. If these groups of producers produced their goods and services using different technologies than the rest of the producers, then the question of how goods and services would change. For whom goods and services are produced would

Chapter 2 . The U.S. and Global Economies

change if some groups of consumers prefer the goods and services produced by the new and young firms while other groups do not. 8.

In the circular flow model, explain the real flow and/or the money flow in which each item below belongs. Illustrate your answers on a circular flow diagram. • You buy a coffee at Starbucks. In Figure 2.1 the dark arrows represent money flows and the grey arrows represent flows of goods and services and factors of production. If you buy a coffee at Starbucks, your expenditure is a money flow from households to the goods market, labeled a in the figure. • The government buys some Dell computers. The purchase of computers by the government represents a flow of computers from the goods market to the government, labeled b in the figure. • A student works at a FedEx office. The student working at FedEx is a factor of production, so the flow is a flow of the services of factor of production from households to the factor markets, labeled c in the figure. • Donald Trump rents a Manhattan building to a hotel. Donald Trump’s building in Manhattan is a factor of production, so the flow is the services from this factor of production from households to the factor markets, labeled d in the figure. • You pay your income tax. Your income tax payment is a money flow from households to the government and is labeled e in the figure.

Part 1 . INTRODUCTION

Why you can get a free college education in Germany but not in California Even American students can get a free college degree in Germany, where high taxes pay for colleges. Despite college being free, fewer students in Germany earn college degrees than in the United States and more enter vocational apprenticeships. Source: Los Angeles Times, October 29, 2015 If California adopted the German model of higher education, how would that change for whom goods and services are produced? The students in California who otherwise would not have gone to college but who take advantage of the “free” college education will have higher incomes than otherwise. Consequently, more goods and services will be produced for them. The taxpayers who must pay the taxes necessary to fund these college educations will have less income to spend on goods and services, so fewer goods and services will be produced for them. 10. Read Eye on the Dreamliner on p. 43 and then answer the following questions: • How many firms are involved in the production of the Dreamliner and how many are identified in the figure on p. 43? Over 400 firms are involved in the production of the Dreamliner. Only 15 of them are identified in the figure. • Is the Dreamliner a capital good or a consumption good? Explain why? The Dreamliner is a capital good because it will be used to produce services (airline travel) throughout many future years. • State the factors of production that make the Dreamliner and provide an example of each. All the factors of production—land, labor, capital, and entrepreneurship—are used to make the Dreamliner. The copper used for wiring is an example of the land used; the engineer who helped design the landing gear is an example of labor; the huge cranes that lift the various pieces of the Dreamliner to assemble them is an example of capital; and the creative and imaginative input of Boeing’s top managers who organize the resources used to produce the Dreamliner exemplify entrepreneurship. • Explain how the production of the Dreamliner influences what, how, and for whom, goods and services are produced. Dreamliner influences “what” goods and services are produced by creating a demand for components manufactured around the world. It influences “how: goods are produced because Boeing and the other 400 firms all determine the best way to produce each particular part

Chapter 2 . The U.S. and Global Economies

•

of the Dreamliner. It influences “for whom” because factors of production employed to make the Dreamliner receive income from this production, thereby increasing the quantity of goods and services they can purchase. Use a graph to show where in the circular flow model of the global economy the flows of the components listed on p. 43 appear and where the sales of Dreamliners appear. Except for the components built in the United States, spending on the other components appear in the flow of expenditure on U.S. imports. Sales of Dreamliners appear in the flow of expenditure on U.S. exports.

Part 1 . INTRODUCTION

◼ Instructor Assignable Problems and Applications 1.

Boeing’s Dreamliner has had a rocky start. • Why doesn’t Boeing manufacture all the components of the Dreamliner at its own factory in the United States? Boeing wants to manufacture the Dreamliner at the lowest possible cost. It would be more expensive for Boeing to manufacture Dreamliners at its own factory in the United States because Boeing does not have the expertise possessed by its subcontractors and because the wages Boeing pays U.S. workers exceed the wages its subcontractors pays their workers. • Describe some of the changes in what, how, and for whom, that would occur if Boeing manufactured all the components of the Dreamliner at its own factories in the United States. If Boeing manufactured all the components of the Dreamliner at its own factories in the United States, more components would be produced in the United States and more capital would have been used in their production. U.S. workers and investors would have received higher incomes but the Dreamliner would cost more to produce so Boeing would have earned a lower profit. • State some of the tradeoffs that Boeing faces in making the Dreamliner. Boeing faced a huge number of tradeoffs. For example, when designing the plane, Boeing’s engineers had to make decisions about fuel economy and passenger load. Increasing the passenger load decreased fuel economy, so the engineers traded passenger load for fuel economy. Another example revolves around the construction of the Dreamliner. Boeing could have constructed the plane using just a few companies but instead it used over 400. Boeing was trading off the simplicity of dealing with just a handful of companies for the increased specialization by dealing with many specialized companies. • Why might Boeing’s decisions in making the Dreamliner be in the social interest? Building the Dreamliner itself advances the social interest because it increases the quantity of comfortable, rapid transportation. The amount of high-quality transportation available in the economy increases, which benefits society. The decisions in making the Dreamliner advance the social interest because they were designed to make the Dreamliner at low cost and thereby avoid wasting resources. 2. The global economy has seen a fall in the number of landlines and rapid growth in the number of smartphones. In the United States, 41 percent of

Chapter 2 . The U.S. and Global Economies

households have no landline and 90 percent have a smartphone. In Africa, 33 percent have a smartphone. Describe the changes in what, how, and for whom telecommunication services are produced in the global economy. What: As the number of cell phone users increases, the global economy has been producing more cell phone telecommunication services. More cell phones are produced, fewer land phones are produced, and presumably more cell phone frequencies are used. How: More telecommunication services are being produced using cell phones rather than fixed-line phones. For whom: While the amount of telecommunication services has been rising throughout the world, it has been increasing most rapidly in Africa. So more telecommunication services are being produced for residents of Africa as well as for residents in the rest of the world. 3.

Which of the entries in the list are conList sumption goods and services? Explain your • An interstate highway choice. • An airplane A pack of bubble gum and a movie are • A school teacher consumption goods. They are purchased • A stealth bomber by consumers. • A garbage truck Which of the entries in the list are capital • A pack of bubble gum goods? Explain your choice. • President of the United States An airplane, a garbage truck, and an ATM • A strawberry field are capital goods. All provide services to • A movie produce other goods and services. The in• An ATM terstate highway and the stealth bomber also are capital goods. They also provide services (transportation and defense) that help produce other goods and services.

Which of the entries in the list are factors of production? Explain your choice. An interstate highway, an airplane, a school teacher, a stealth bomber, a garbage truck, the President of the United States, a strawberry field, and an ATM are factors of production. A school teacher and the President are labor; an interstate highway, an airplane, a stealth bomber, a garbage truck, and an ATM are capital; and, a strawberry field is land.

In the African nation of Senegal, to enroll in school a child needs a Birth Certificate that costs $25. This price is several weeks’ income for many families. Explain how this requirement is likely to affect the growth of human capital in Senegal. Human capital growth depends, in part, on the extent of schooling: More schooling means more human capital. Because of Senegal’s hefty fee for a

Part 1 . INTRODUCTION

required Birth Certificate, fewer children will enroll in school, thereby decreasing Senegal’s human capital growth. 7.

China’s income gap widens The income gap has widened in China. In 2014, the pay of workers in the coastal regions increased by 9.7 percent while that of workers in the inland regions grew by 9 percent. Source: South China Morning Post, May 28, 2015 Explain how the distribution of personal income in China can be getting more unequal even though the poorest are getting richer. The distribution of income in China can be getting more unequal even when the poorest are getting richer if the richest are getting richer even faster. If the rich are getting richer faster, the fraction of the nation’s total income received by the poorest 20 percent falls, which makes the personal distribution of income more unequal.

Compare the scale of agricultural production in the advanced and developing economies. In which is the percentage higher? In which is the total amount produced greater? Agricultural is a small part of total production in advanced economies. It is a much larger part in developing economies. Even though advanced economies devote only a small part of their total production to agriculture, they still produce about one third of the world’s total production of food. The remaining two thirds is produced in the developing nations.

Chapter 2 . The U.S. and Global Economies

On a diagram of the circular flow model, indicate in which real or money flow each entry in the list belongs. • General Motors’ pays its workers wages. General Motors wage payment is a money flow that is a payment for use of the services of a factor of production and so flows out of the factor market to households (it flowed into the factor market from General Motors, a firm). In Figure 2.3 the dark arrows represent money flows and the grey arrows represent flows of goods and services and factors. The flow of wage payments to households is labeled a in the figure in Figure 2.3. • IBM pays a dividend to its stockholders. IBM’s dividend payment is a money flow that is a payment for use of the services of a factor of production and so flows out of the factor market to households (it flowed into the factor market from IBM, a firm). The flow to households is labeled b in the figure. • You buy your groceries. Your purchase of groceries represents a money flow from households to the goods market, labeled c in the figure. • Southwest rents some aircraft. The aircraft are factors of production, so the flow is the services from these factors of production from the factor markets to firms, labeled d in the figure. • Nike pays Serena Williams for promoting its sports shoes. Serena Williams is a factor of production, so the flow is a money flow

Part 1 . INTRODUCTION

from the factor markets to households in exchange for Ms. Williams’ services of promoting the sports shoes. The flow is labeled e in the figure. Use the following information to work Problems 10 and 11. Poor India makes millionaires at fastest pace India, with the world’s largest population of poor people, also paradoxically created millionaires at the fastest pace in the world. Millionaires increased by 22.7 percent to 123,000. In contrast, the number of Indians living on less than a dollar a day is 350 million and those living on less than $2 a day is 700 million. In other words, there are 7,000 very poor Indians for every millionaire. Source: The Times of India, June 25, 2008 10. How is the personal distribution of income in India changing? If the number of millionaires is growing more rapidly than the number of other income groups, it will be the case that the personal distribution of income in India is becoming less equally distributed. 11. Why might incomes of $1 a day and $2 a day underestimate the value of the goods and services that these households actually consume? The people living on $1 and $2 a day probably grow a lot of their food and produce a lot of their clothing and shelter. If these goods and services are not taken into account, their share of goods and services is understated. Including them raises the value of the goods and services these households actually consume.

Chapter 2 . The U.S. and Global Economies

◼ Multiple Choice Quiz 1.

Which of the following classifications is correct? A. City streets are consumption goods because they wear out with use. B. Stocks are capital goods because when people buy and sell them they make a profit. C. The coffee maker in the coffee shop at an airport is a consumption good because people buy the coffee it produces. D. White House security is a government service because it is paid for by the government. Answer: D Answer D is correct. 2.

Which of the following statements about U.S. production is correct? A. Construction accounts for a larger percentage of total production than does manufacturing. B. Real estate services account for 14.5 percent of the value of total production, larger than any other item of services or goods. C. Consumption goods and services represent 78.5 percent of U.S. production by value and that percentage doesn’t fluctuate much. D. The manufacture of goods represents more than 50 percent of total production. Answer: C Answer C is correct as the data on page 34 show. 3.

Which of the following items is not a factor of production? A. An oil rig in the Gulf of Mexico B. A ski jump in Utah C. A bank loan to a farmer D. An orange grove in Florida Answer: C Answer C is not a factor of production because it is financial capital; see page 37. 4.

What is human capital? A. A fruit picker B. Unskilled labor C. Your professor’s knowledge of the economy D. An auto assembly line robot Answer: C Answer C uses the definition of human capital on page 37.

Part 1 . INTRODUCTION

Which of the following statements is correct? A. Labor earns wages and entrepreneurship earns bonuses. B. Land earns interest and capital earns rent. C. Entrepreneurship earns interest and capital earns profit. D. Capital earns interest and labor earns wages. Answer: D Page 39 shows that answer D is correct. 6.

How are goods and services produced in the global economy? A. Developing countries use less human capital but just as much physical capital as advanced economies. B. Emerging economies use more capital-intensive technology than do developing economies. C. Human capital in all economies is similar. D. Advanced economies use less capital than developing economies. Answer: B Developing countries have less capital than emerging economies. 7.

In the circular flow model, which of the following items is a real flow? A. The flow of government expenditures to firms for the goods bought B. The flow of income from firms to households for the services of the factors of production hired C. The flow of U.S. borrowing from the rest of the world D. The flow of labor services from households to firms Answer: D Answer D is a real flow because it is a labor service.

The Economic Problem ANSWERS TO CHAPTER CHECKPOINTS

Chapter

◼ Study Plan Problems and Applications 1.

The table shows the quantities of corn and beef that a farm Corn can produce in a year. Draw a graph of the farm’s PPF. Mark (bushels) on the graph: 250 200 • An inefficient combination of corn and beef—label this 100 point A. 0 • An unattainable combination of corn and beef—label this point B. • An efficient combination of corn and beef—label this point C. The production possibilities frontier is illustrated in Figure 3.1. Any production point in the interior of the PPF, such as the point marked A, is an inefficient combination of corn and beef. Any production point beyond the PPF, such as the point marked B, is an unattainable combination of corn and beef. Any production point on the PPF, such as the point marked C is a production efficient combination of corn and beef.

Beef (pounds) and and and and

0 300 500 600

Part 1 . INTRODUCTION

Use the following information to work Problems 2 and 3. The people of Leisure Island have 50 hours of Entertainment labor a day that can be used to produce enterLabor (units) tainment and good food. The table shows the 0 0 or maximum quantity of either entertainment or 10 20 or 20 40 or good food that Leisure Island can produce 30 60 or with different quantities of labor. 40 80 or 2. Is an output of 50 units of entertainment 50 100 or and 50 units of good food attainable and efficient? With a production of 50 units of entertainment and 50 units of good food, do the people of Leisure Island face a tradeoff? Producing 50 units of good food and 50 units of entertainment is attainable. However, at this production point, Leisure Island’s resources are not fully employed or are misallocated. They are producing within their PPF. As a result, the people of Leisure Island do not face a tradeoff—they can produce more entertainment or good food at no opportunity cost. 3.

What is the opportunity cost of producing an additional unit of entertainment? Explain how the opportunity cost of producing a unit of entertainment changes as more entertainment is produced. If production is initially within the PPF, the opportunity cost of an additional unit of entertainment is zero. If production is on the PPF there is an opportunity cost of producing a unit of entertainment because good food must be forgone. At that point, the opportunity cost while moving along the PPF equals the loss in good food produced divided by the gain in entertainment produced. Once on the PPF, as more entertainment is produced, the opportunity cost of an additional unit increases.

Use the following information to work Problems 4 and 5. Malaria can be controlled The World Health Organization’s malaria chief says that it is too costly to try to fully eradicate the disease. He says that by using nets, medicine, and DDT it is possible to eliminate 90 percent of malaria cases. But to eliminate 100 percent of cases would be extremely costly. Source: The New York Times, March 4, 2008 4. Make a graph of the production possibilities frontier with malaria control on the x-axis and other goods and services on the y-axis. Figure 3.2 (on the next page) shows the PPF. 5.

Describe how the opportunity cost of controlling malaria changes as more resources are used to reduce the number of malaria cases. As more resources are used to control malaria, the opportunity cost increases. Indeed, the malaria chief indicated that the opportunity cost of eliminating the last 10 percent of malaria would have an extremely high

Good food (units) 0 30 50 60 65 67

Chapter 3 . The Economic Problem

opportunity cost. This conclusion is shown in the PPF diagram by the very steep PPF between 90 percent elimination and 100 percent elimination.

Explain how the following events influence U.S. production possibilities: • Some retail workers are re-employed building dams and wind farms. When these former retail workers are re-employed at their new occupations, more dams and wind farms are produced and fewer retail services are produced. The opportunity cost of the increased numbers of dams and wind farms is the forgone production of retail services. There is a movement along the PPF. • More people take early retirement. As more people retire, the quantity of labor available in the economy shrinks. As a result, the nation’s PPF shifts inward. • Drought devastates California’s economy. The nation’s PPF shifts inward as a result of the drought. The drought decreases the amount of productive land, thereby decreasing production of agricultural products and shifting the PPF inward.

Part 1 . INTRODUCTION

Use the following information to work Problems 7 and 8. Figure 3.3 (on the next page) shows Tom’s production possibilities and Figure 3.4 (on the next page) shows Abby’s production possibilities. Tom uses all his resources and produces 2 rackets and 20 balls an hour. Abby uses all her resources and produces 2 rackets and 40 balls an hour. 7. What is Tom’s opportunity cost of producing a racket? What is Abby’s opportunity cost of a racket? Who has a comparative advantage in producing rackets? Who has a comparative advantage in producing balls? If Tom increases his production by 1 racket, he forgoes 10 balls. So his opportunity cost of 1 racket is 10 balls  1 racket, or 10 balls per racket.

If Abby increases her production by 1 racket, she forgoes 20 balls. So her opportunity cost of 1 racket is 20 balls  1 racket, or 20 balls per racket. Tom has the comparative advantage in producing rackets. Tom’s opportunity cost of a racket is 10 balls per racket and Abby’s opportunity cost of a racket is 20 balls per racket. Abby has the comparative advantage in producing balls. Tom’s opportunity cost of a ball is 0.10 rackets per ball and Abby’s opportunity cost of a ball is 0.05 rackets per ball. 8.

If Tom and Abby specialize and trade 15 balls for 1 racket, what are the gains from trade? Both Tom and Abby gain from their specialization and trade. Tom could produce 4 rackets and then trade 2 of the rackets for 30 balls. Tom would wind up with 2 rackets and 30 balls, 10 more balls than he had without the specialization and trade. Abby could produce 80 balls and then trade

Chapter 3 . The Economic Problem

30 of them for 2 rackets. Abby would wind up with 2 rackets and 50 balls, also 10 more balls than she had without the specialization and trade. 9.

Read Eye on the Environment on p. 68 and describe a tradeoff faced when deciding how to generate electricity and whether to use wind power. Using wind power to generate electricity requires that the wind turbines be located in areas with wind which often are not near population centers. Long transmission lines are required which means transmissions losses are large. If other sources are used to generate power, long transmission lines are not necessary and smaller generating facilities are required because transmissions losses are less. If wind power is used to generate power, more resources are used and fewer other goods can be produced.

Part 1 . INTRODUCTION

◼ Instructor Assignable Problems and Applications Use the following information to work Problems 1 to 4. Representatives Waxman of California and Markey of Massachusetts proposed a law to limit greenhouse gas emissions from electricity generation and require electricity producers to generate a minimum percentage of power using renewable fuels, with some emission rights to be auctioned. The Congressional Budget Office estimated that the government would receive $846 billion from auctions and would spend $821 billion on incentive programs and compensation for higher energy prices. Electricity producers would spend $208 million a year to comply with the new rules. (Think of these dollar amounts as dollars’ worth of other goods and services.) 1. Would the Waxman-Markey law achieve production efficiency? Production efficiency requires producing on the PPF. Use a PPF showing the tradeoff between electricity and clean air. Production efficiency requires producing on the PPF so that gaining more clean air means giving up some electricity. Before the new law, production might have been on the PPF if the producers had used the most efficient technologies and taken account of the pollution they created. After the law is in place, production might be within the PPF if the law requires more production of energy from renewable sources than is production efficient. 2.

Is the $846 billion that electricity producers would pay for the right to emit greenhouse gasses part of the opportunity cost of producing electricity? To the extent that the $846 billion pays for the cost that greenhouse gasses impose on society (by way of forgone production of other goods and services), the $846 billion is part of the opportunity cost of generating electricity.

Is the $821 billion that the government would spend on incentive programs and compensation for higher energy prices part of the opportunity cost of producing electricity? The incentive programs change what electricity providers buy in order to produce electricity with lower emissions. The goods and services forgone are the opportunity cost of these programs. Compensation for higher energy prices is a transfer payment from taxpayers to consumers. Nothing is forgone and so it is not an opportunity cost.

Is the $208 million that electricity producers will spend to comply with the new rules part of the opportunity cost of producing electricity? The $208 million is part of the opportunity cost of producing electricity because it represents the purchase of goods and services necessary to produce electricity.

Chapter 3 . The Economic Problem

The people of Foodland have 40 Bread hours of labor a day to bake pizza Labor Pizzas (loaves) and bread. The table shows the 0 0 or 0 10 30 or 10 maximum quantity of either pizza 20 50 or 20 or bread that Foodland can bake 30 60 or 30 with different quantities of labor. 40 65 or 40 Can Foodland produce 30 pizzas and 30 loaves of bread a day? If it can, is this output efficient, do the people of Foodland face a tradeoff, and what is the opportunity cost of producing an additional pizza? Producing 30 pizzas and 30 loaves of bread is attainable and efficient. There is a tradeoff because the nation is operating on its production possibilities frontier. As a result, if the production of pizza increases, less bread can be produced and if the production of bread increases, less pizza can be produced. For the nation to produce 20 more pizzas requires 10 more hours of labor devoted to making pizza, which means 10 fewer hours devoted to making bread. Foodland gives up 10 loaves of bread. The opportunity cost of another pizza equals the loaves of bread forgone, 10 loaves, divided by the pizzas obtained, 20 pizzas, or 10 loaves of bread  20 pizzas, or 1/2 of a loaf of bread per pizza. Use the table, which shows a farm’s production Soybean Chicken (bushels (pounds possibilities, to work Problems 6 and 7. per year) per year) 6. If the farm uses its resources efficiently, what 500 and 0 is the opportunity cost of an increase in chicken 400 and 300 production from 300 pounds to 500 pounds a 200 and 500 0 and 550 year? Explain your answer. If the farm expands chicken production from 300 pounds to 500 pounds, soybean production decreases from 400 to 200 bushels. The opportunity cost of the additional 200 pounds of chicken is 200 bushels of soybean, or 1 bushel of soybeans per pound of chicken. 7.

If the farm adopted a new technology, which allows it to use fewer resources to fatten chickens, explain how the farm’s production possibilities will change. Explain how the opportunity cost of producing a bushel of soybean will be affected. The farm’s PPF rotates outward; the maximum quantity of soybeans (500 bushels) does not change but the maximum quantity of chicken increases. The opportunity cost of a bushel of soybeans increases because more chicken must be given up to produce additional soybeans.

In an hour, Sue can produce 40 caps or 4 jackets and Tessa can produce 80 caps or 4 jackets. Who has a comparative advantage in producing caps? If Sue and Tessa specialize and trade, who will gain?

Part 1 . INTRODUCTION

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 jackets per 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 jackets per cap. Tessa’s opportunity cost of a cap is lower than Sue’s opportunity cost, so Tessa has a comparative advantage in producing caps. If Tessa specializes in caps and Sue specializes in jackets, both Sue and Tessa gain from trade. For instance, suppose they settle upon a price of 1 jacket for 15 caps. 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. Use the following opinion to work Problems 9 to 11. Free Internet? Everyone should have free Internet access to education, news, jobs, and more. Source: Internet.org by Facebook, May 4, 2015 9. Explain how Internet access has changed the production possibilities and the opportunity cost of producing education and news. Internet access is a technological advance that has increased the production possibilities of all goods and services. The opportunity cost of producing more education and news is the quantity of other goods and services that must be given up to get an additional unit of education and news. With more education and news placed on the Internet, Internet access means that for the same quantity of resources used before widespread Internet access, the production of these services has increased. The opportunity cost of education and news has decreased.

Chapter 3 . The Economic Problem

10. Sketch a PPF with education and news on the x-axis and other goods and services on the y-axis before and after the Internet. The PPFs in Figure 3.5 have the conventional outward bowed shape. The figure shows that the introduction of the Internet shifted the production possibilities frontier outward from the PPF labeled “Initial PPF,” to the PPF labelled “New PPF.” The illustrated PPF assumes that effect on education and news is larger than the effect on other goods and services. 11. Explain why it is not possible for everyone to have free Internet access to education, news, jobs, and more. Providing Internet access is not free because it takes resources. But the opportunity cost of Internet service increases as more people gain access, so the opportunity cost of giving everyone “free” access to the Internet would be extremely high, probably much higher than society is willing to pay.

Part 1 . INTRODUCTION

◼ Multiple Choice Quiz 1.

The table shows the PPF of an island communiFish Berries ty. Choose the best statement. Possibility (pounds) (pounds) A. This community has enough resources to A 0 and 40 produce 2 pounds of fish and 36 pounds of B 1 and 36 C 2 and 30 berries. D 3 and 22 B. This community cannot produce 2 pounds of E 4 and 12 fish and 36 pounds of berries because this F 5 and 0 combination is inefficient. C. This community will waste resources if it produces 2 pounds of fish and 22 pounds of berries. D. This community can produce 2 pounds of fish and 30 pounds of berries but this combination is inefficient. Answer: C The production point is inside the PPF and so is inefficient. 2.

The table above shows the PPF of an island community. Choose the best statement. A. Suppose that this community produces 3 pounds of fish and 20 pounds of berries. If it decides to gather more berries, it faces a tradeoff. B. When this community produces 4 pounds of fish and 12 pounds of berries it faces a tradeoff, but it is inefficient. C. Suppose that this community produces 5 pounds of fish and 0 pounds of berries. If it decides to gather some berries, it will get a free lunch. D. If this community produces 3 pounds of fish and 22 pounds of berries, production is efficient but to produce more fish it faces a tradeoff. Answer: D The production point is on the PPF so production is efficient and there is a tradeoff when more fish are produced. 3.

The table above shows the PPF of an island community. This community’s opportunity cost of producing 1 pound of fish ______. A. is the increase in the quantity of berries gathered as the quantity of fish increases by 1 pound B. increases as the quantity of berries gathered increases C. is 10 pounds of berries if the quantity of fish increases from 2 to 3 pounds D. increases as the quantity of fish caught increases Answer: D Page 68 discusses why opportunity increases as production of the good increases.

Chapter 3 . The Economic Problem

The table above shows the PPF of an island community. Choose the best statement. A. When a drought hits the island, its PPF shifts outward. B. When the islanders discover a better way of catching fish, the island’s PPF shifts outward. C. When islanders reduce the time they spend gathering berries, the PPF shifts inward. D. If the islanders decide to spend more time gathering berries but continue to spend the same amount of time fishing, they face a tradeoff. Answer: B Page 70 shows that technological progress, such as exemplified in answer B, shifts the PPF outward. 5.

Mary makes 10 pies and 20 cakes a day and her opportunity cost of producing a cake is 2 pies. Tim makes 20 pies and 10 cakes a day and his opportunity cost of producing a cake is 4 pies. If Mary and Tim specialize in the good in which they have a comparative advantage ______. A. Mary produces only pies B. Tim produces both pies and cakes C. Mary produces only cakes while Tim produces only pies D. Tim produces only cakes while Mary produces only pies Answer: C Answer C is correct because Mary has the lower opportunity cost of making a cake.

Chapter

Demand and Supply ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications 1.

Explain how each of the following events changes the demand for or supply of air travel. • Airfares tumble, while long-distance bus fares don’t change. A change in the price of airfares does not change either the demand for or the supply of air travel. (It changes the quantity demanded and the quantity supplied of air travel.) •

The price of jet fuel rises. The rise in the price of jet fuel decreases the supply of air travel because it raises the cost of producing air travel.

•

Airlines reduce the number of flights each day. The reduction in the number of flights decreases the supply of air travel.

•

People expect airfares to increase next summer. The current demand for air travel increases when people expect airfares to increase next summer because people fly now, when airfares are relatively cheaper, rather than next summer.

•

The price of train travel falls. Train travel is a substitute for air travel. So, a fall in the price of train travel decreases the demand for air travel.

•

The price of a pound of air cargo increases. Transporting cargo by air is a substitute in production for transporting people by air. So, the rise in the price of air cargo decreases the supply of air travel for people.

Use the laws of demand and supply to explain whether the statements in Problems 2 and 3 are true or false. In your explanation, distinguish between a change in demand and a change in the quantity demanded and between a change in supply and a change in the quantity supplied. 2. The United States does not allow oranges from Brazil (the world’s largest

Part 1 . INTRODUCTION

producer of oranges) to enter the United States. If Brazilian oranges were sold in the United States, oranges and orange juice would be cheaper. The statement is true. Allowing Brazilian oranges into the United States increases the supply of oranges and the supply curve shifts rightward. The equilibrium price of an orange falls and the equilibrium quantity increases. The quantity of oranges demanded increases and there is a movement down along the demand curve. Oranges are a resource used in the production of orange juice. When the price of an orange falls, it costs less to produce orange juice and the supply of orange juice increases. The quantity of orange juice demanded increases and there is a movement down along the demand curve. The equilibrium price of orange juice falls and the equilibrium quantity increases. 3.

If the price of frozen yogurt falls, the quantity of ice cream consumed will decrease and the price of ice cream will rise. The statement is false. Frozen yogurt and ice cream are substitutes for consumers. When the price of frozen yogurt falls, people substitute frozen yogurt for ice cream. The demand for ice cream decreases and the demand curve shifts leftward. The equilibrium quantity of ice cream decreases but the equilibrium price of ice cream falls. There is a change in the quantity of ice cream supplied and a movement down along the supply curve.

The table shows the demand and supPrice Quantity Quantity ply schedules for running shoes. What (dollars demanded supplied is the market equilibrium? If the price per pair) (pairs per day) is $70 a pair, describe the situation in 60 1,000 400 70 900 500 the market. Explain how market equi80 800 600 librium is restored. If a rise in income 90 700 700 increases the demand for running 100 600 800 shoes by 100 pairs a day at each price, 110 500 900 explain how the market adjusts to its new equilibrium. The market equilibrium occurs at a price of $90 a pair and 700 pairs of running shoes a day. At the price of $90 a pair, the quantity demanded equals the quantity supplied. If the price is $70 a pair, the quantity demanded is 900 pairs and the quantity supplied is 500 pairs. There is a shortage of 400 pairs a day and the price rises. As the price rises, the quantity demanded decreases, the quantity supplied increases, and the shortage decreases. The price rises until the shortage disappears.

Chapter 4 . Demand and Supply

The table shows the new demand Price New Quantity Quantity schedule after the increase in income (dollars demanded supplied has increased the quantity demanded by per pair) (pairs per day) 100 pairs of shoes at each price. At the 60 1,100 400 70 1,000 500 original equilibrium price of $90 a pair, 80 900 600 there is a shortage and the price rises. 90 800 700 As the price rises, the quantity demand100 700 800 ed decreases, the quantity supplied in110 600 900 creases, and the shortage decreases. The price rises until the shortage disappears. The price rises to $95 a pair and the quantity increases to 750 pairs of running shoes a day. 5.

“As more people buy fuel-efficient hybrid cars, the demand for gasoline will decrease and the price of gasoline will fall. The fall in the price of gasoline will decrease the supply of gasoline.” Is this statement true? Explain. The first statement is correct. As more people buy fuel-efficient cars, the demand for gasoline will decrease. The price of gasoline will fall. The second statement is false. The demand for gasoline decreases and the demand curve shifts leftward. There is a movement along the supply curve and a decrease in the quantity of gasoline supplied but no change in supply.

OPEC deadlocked on oil production hike Oil prices exceeded the $100-a-barrel mark Wednesday after OPEC said it could not reach an agreement about raising crude production. Source: CNN Money, June 8, 2011 Suppose that OPEC members had agreed to increase production. Use a graph of the oil market to show the effect of this decision on the market equilibrium. The market initially is in equilibrium in Figure 4.1 with demand curve D and supply curve S0. The initial equilibrium price is $105 per barrel of oil and the initial equilibrium quantity is 120 million barrels per day. If OPEC agreed to increase the supply, the supply curve shifts rightward, as illustrated in Figure 4.1 by the shift from S0 to S1. In the figure the price of a barrel of oil falls from $105 per barrel to $90 per barrel and the quantity increases from 120 million barrels per day to 150 million barrels per day.

Part 1 . INTRODUCTION

Use the following information to work Problems 7 and 8. Rain delays to U.S. planting lift corn and soybean prices Heavy rain has delayed the planting of corn and soybean and soggy conditions have slowed the winter wheat harvest. Source: Financial Times, June 25, 2015 7. Explain how heavy rain and soggy conditions will change the prices of corn, soybean, and wheat. The heavy rain and soggy conditions decrease the supply of corn and soybean because farmers may not plant some acreage. The soggy conditions have delayed the harvesting of wheat, which decreases the supply of wheat. Consequently, the prices of these crops rise. 8.

Use graphs to show how supply and demand will change in the markets for corn, soybean, and wheat. The effect in all three markets is similar, so Figure 4.2 uses corn as the example. The heavy rains decrease the supply of corn. In Figure 4.2, the supply curves shifts leftward from S0 to S1. The price of corn rises, in the figure from $5.90 per bushel to $6.10 per bushel, and the equilibrium quantity decreases, from 600 million bushels to 400 million bushels.

Read Eye on the Price of Coffee on p. 105 and explain how we know that the price increased in 2014 because the supply of coffee decreased and not because the demand for coffee increased. We know that the supply decreased because the quantity of coffee decreased. If the higher price was the result of an increase in demand, the quantity of coffee would have increased.

Chapter 4 . Demand and Supply

◼ Instructor Assignable Problems and Applications 1.

Why can we be confident that the market for coffee is competitive and that a decrease in supply rather than the greed of coffee growers is the reason for the 2014 rise in price? There are more than 55,000 coffee shops in the United States and probably more than 100,000 growers worldwide. Even if coffee growers were greedy, the fact that there are tens of thousands of other growers with whom they compete keeps their greed from affecting the price they charge. If one greedy grower raised his or her price, a large number of buyers would switch to other growers whose price had not changed.

What is the effect on the equilibrium price and equilibrium quantity of orange juice if the price of apple juice decreases and the wage rate paid to orange grove workers increases? Apple juice and orange juice are substitutes for consumers, so the fall in the price of apple juice decreases the demand for orange juice. The demand curve for orange juice shifts leftward. The increase in the wage rate paid to orange grove workers raises the cost of producing oranges and thereby boosts the cost of producing orange juice. The supply of orange juice decreases and the supply curve of orange juice shifts leftward. The net effect of these events decreases the equilibrium quantity but has an undetermined effect on equilibrium price. If supply decreases by more than the demand decreases, the equilibrium price rises. If demand decreases more than the supply decreases, the equilibrium price falls. And if they decrease by the same amount, the equilibrium price does not change.

What is the effect on the equilibrium in the orange juice market if orange juice becomes more popular and a cheaper robot is used to pick oranges? Because orange juice becomes more popular, demand increases and the demand curve for orange juice shifts rightward. The cheaper picking robot lowers the production costs of orange juice, so the supply of orange juice increases and the supply curve of orange juice shifts rightward. The equilibrium quantity increases. But the effect on the equilibrium price is ambiguous. If the increase in supply is greater than the increase in demand, the equilibrium price falls. If the increase in demand is greater than the increase in supply, the equilibrium price rises. And if the increase is the same size, then the equilibrium price does not change.

Concerns over winter wheat may boost price Concerns about the U.S. winter wheat crop and dry conditions in other wheat-producing nations have increased the price of wheat. Source: Agweb.com, July 6, 2015 Explain how an upcoming harvest influences today’s price of wheat. The upcoming harvest will help determine the future price of wheat. If

Part 1 . INTRODUCTION

the harvest is low, then the supply of wheat will decrease, thereby raising the price of wheat in the future. The higher expected future price of wheat affects the current demand and supply of wheat. In particular, the higher expected future price increases the current demand, so the demand curve shifts rightward, and decreases the current supply, so the supply curve shifts leftward. The current increase in demand and decrease in supply raise the current price of wheat. The table shows the demand and supply Price Quantity Quantity schedules for boxes of chocolates in an av(dollars demanded supplied erage week. Use this information to work per box) (boxes per week) Problems 5 and 6. 13.00 1,600 1,200 14.00 1,500 1,300 5. If the price of chocolates is $17.00 a 15.00 1,400 1,400 box, describe the situation in the mar16.00 1,300 1,500 ket. Explain how market equilibrium 17.00 1,200 1,600 is restored. 18.00 1,100 1,700 At the price of $15.00 a box, the quantity supplied equals the quantity demanded. At a price of $17.00 a box, the Price suppliedQuantity quantity demanded is 1,200 boxes and the quantity is 1,600 box- Quantity (dollars demanded supplied es. There is a surplus of 400 boxes a week and the price falls. As the price per pad) (mouse pads per week) falls, the quantity demanded increases, the quantity supplied decreases, 3 180 120 and the surplus decreases. The price falls until4 the surplus disappears. 170 130 The market equilibrium occurs at a price of $15.00 5 a box and 1,400 160boxes a 140 6 150 150 week so the price falls to $15.00 a box. 7 140 160 6. During Valentine’s week, more people buy 8 130 170 chocolates and chocolatiers offer their chocolates in special red boxes, which cost more to produce than the everyday box. Set out the three-step process of analysis and show on a graph the adjustment process to the new equilibrium. Describe the changes in the equilibrium price and the equilibrium quantity. Starting with the demand side, Valentine’s week increases people’s preferences for boxes of chocolate so the demand for boxes of chocolate increases. The demand curve for chocolates shifts rightward, from D0 to D1 in Figure 4.4. Moving to the supply side, the fancy red box raises the cost of producing boxes of chocolate, which decreases the supply. The rise in the cost of producing boxes of chocolates shifts the supply

Chapter 4 . Demand and Supply

curve leftward, from S0 to S1 in Figure 4.4. After these changes, at the initial price of a box of chocolate, $15.00, in Figure 4.4 there is a shortage of 600 boxes of chocolate per week. The shortage forces the price higher, so the equilibrium price of a box of chocolate rises, to $18.00 in the figure. The problem points out that people buy more boxes of chocolate during Valentine’s week. This result means that the change in demand exceeds the change in the supply, that is, the magnitude of the increase in demand exceeds that of the decrease in supply. Figure 4.4 illustrates this situation and in the figure the equilibrium quantity increases from 1,400 boxes per week to 1,500 boxes per week. 7.

After a severe bout of foreclosures and defaults on home loans, banks made it harder for people to borrow. How does this change influence: • The demand for new homes? The demand for homes decreases. •

The supply of new homes? The supply of new homes does not change.

•

The price of new homes? The price of new homes falls.

Illustrate your answer with a graphical analysis. Figure 4.5 shows the effect of making home loans more difficult to obtain. Before the change in difficulty, the demand curve is D0. In the figure the price of a new home is $350,000. After the increase in difficulty, the demand decreases and the demand curve shifts leftward, in the figure from D0 to D1. The supply curve does not shift. The price of a new home falls, in the figure from $350,000 to $275,000. 8.

Bacon is 25 percent cheaper Bacon is 25 percent cheaper now than a year ago and bacon sales are up 13 percent on the year. At the same time, the bird flu virus is killing millions of chickens, raising egg prices. Source: CNN Money, May 20, 2015 Explain how this news clip illustrates: (a) the law of demand and why the price of bacon fell, and (b) how the markets for bacon and eggs influence each other. Draw a graph to illustrate your explanation. The result that bacon is less expensive and the quantity sold is higher indicate that the supply of bacon increased. The increase in the supply of

Part 1 . INTRODUCTION

bacon lowers the price, creating a movement along the demand curve and thereby demonstrating the law of demand: A lower price increases the quantity demanded. Bacon and eggs are complements for consumers so changes in their price affect the demand for the other good. Consider the market for eggs. The fall in the price of bacon increases the demand for eggs, so, as Figure 4.6 illustrates, the demand curve for eggs shifts rightward. However, bird flu killed millions of chickens and decreased the supply of eggs, which shifts the supply curve leftward. As the figure shows, the price of eggs rises from $1.00 per dozen to $1.75. The effect on the quantity is ambiguous: If the change in demand dominates, the quantity increases; if the change in supply dominates, the quantity decreases; or, if as in the figure, the changes offset each other, the quantity does not change. 9.

“As more people buy smartphones, the demand for smartphone service increases and the price of smartphone service falls, which decreases the supply of smartphone service.” Is this statement true or false? Explain. The assertion that the demand for smartphone service increases as more people buy smartphones is true. However, the claim that the increase in demand reduces the price of smartphone service is false; the increase in demand raises the price of smartphone services. The second sentence is false. Regardless of whether the price of smartphone service rises or falls, the supply of smartphone service does not change. Rather the change in price changes the quantity of smartphone service supplied.

10. China slowdown could bring good news China’s economic slowdown could help reduce the cost of steel used by U.S. auto makers. Source: The Wall Street Journal, September 8, 2015 Explain how an economic slowdown in China influences the global steel market. What happens to the equilibrium price of steel? The economic slowdown in China reduces the demand for steel in China. The demand curve for steel shifts leftward. The slowdown does not change the supply of steel, so the supply curve of steel does not shift. As the demand curve shifts leftward, there is a movement down along the supply curve of steel and a decrease in the price of steel.

Chapter 4 . Demand and Supply

◼ Multiple Choice Quiz 1.

Which of the following events illustrates the law of demand: Other things remaining the same, a rise in the price of a good will ________ . A. decrease the quantity demanded of that good B. increase the demand for a substitute of that good C. decrease the demand for the good D. increase the demand for a complement of that good Answer: A The law of demand is the inverse relationship between the price of a good and the quantity demanded. 2.

In the market for jeans, which of the following events increases the demand for a pair of jeans? A. The wage rate paid to garment workers rises. B. The price of a denim skirt (a substitute for jeans) rises. C. The price of denim cloth falls. D. New technology reduces the time it takes to make a pair of jeans. Answer: B The other factors listed change the supply; only answer B increases the demand. 3.

Other things remaining the same, a fall in the price of peanuts will ________. A. increase the supply of peanuts B. decrease the supply of peanut butter C. decrease the quantity supplied of peanuts D. decrease the supply of peanuts Answer: C A fall in the price of the good creates a movement along the supply curve and decreases the quantity supplied. 4.

In the market for smartphones, which of the following events increases the supply of smartphones? A. New technology lowers the cost of making a smartphone B. Rise in the price of an e-book reader (a substitute in production) C. An increase in people’s incomes D. A rise in the wage rate paid to electronics workers Answer: A Answers B and D decrease the supply of smartphones; answer C affects the demand for smartphones.

Part 1 . INTRODUCTION

When floods wiped out the banana crop in Central America, the equilibrium price of bananas ________ and the equilibrium quantity of bananas ________. A. rose; increased B. rose; decreased C. fell; increased D. fell; decreased Answer: B Figure 4.12(b) on page 104 illustrates this case of a decrease in supply. 6.

A decrease in the demand for chocolate with no change in supply will create a ________ of chocolate at today’s price, but gradually the price will ________. A. surplus; fall B. shortage; fall C. surplus; rise D. shortage; rise Answer: A Figure 4.11(b) on page 102 illustrates this case of a decrease in demand. 7.

Many Americans are selling their used cars and buying new fuel-efficient hybrids. Other things remaining the same, in the market for used cars, ________ and in the market for hybrids ________. A. supply increases and the price falls; demand increases and the price rises B. demand decreases and the price rises; supply increases and the price falls C. both demand and supply decrease and the price might rise, fall, or not change; demand increases and the price rises D. demand decreases, supply increases, and the price falls; supply increases and the price falls Answer: A Selling their used cars increases the supply of used cars. Buying new hybrids increases the demand for hybrids.

Chapter

Elasticities of Demand and Supply ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications When the price of home heating oil increased by 20 percent, the quantity demanded decreased by 2 percent and the quantity of wool sweaters demanded increased by 10 percent. Use this information to work Problems 1 and 2. 1. Use the total revenue test to determine whether the demand for home heating oil is elastic or inelastic. When the price of home heating oil increased by 20 percent, the total revenue collected by sellers of home heating oil increased because the quantity demanded decreased by only 2 percent. Because the total revenue increased when the price rose, the total revenue test tells us that the demand for home heating oil is inelastic. (To check, the elasticity of demand is (2 percent)  (20 percent), which is 0.10. Recall that when calculating the price elasticity of demand, we use absolute values or magnitudes and ignore the minus sign.) 2.

If the price of a wool sweater did not change, calculate the cross elasticity of demand for wool sweaters with respect to the price of home heating oil. Are home heating oil and wool sweaters substitutes or complements? Why? The cross elasticity of demand for wool sweaters with respect to home heating oil is:

 Percentage change in quantity of sweaters demanded   10 percent   =     20 percent  = 0.50. Percentage change in price of heating oil     Home heating oil and sweaters are substitutes because as the price of home heating oil rises, you can stay warm by using less home heating oil and putting on a sweater. The cross elasticity of demand for a substitute is positive.

Part 2 . A CLOSER LOOK AT MARKETS

The figure shows the demand for movie tickets. Is the demand for movie tickets elastic or inelastic over the price range $7 to $9 a ticket? If the price falls from $9 to $7 a ticket, explain how the total revenue from the sale of movie tickets will change. Calculate the price elasticity of demand for movie tickets when the price is $8 a ticket. The percentage change in the quantity of movie tickets demanded equals

 300 tickets − 100 tickets     100 , or 100  (100 tickets + 300 tickets)  2 )  percent. The percentage change in the price of a movie ticket equals  $9 a ticket − $7 a ticket     100 , or 25  ($9 a ticket + $7 a ticket)  2 )  percent. So, the demand for movie tickets is elastic because the percentage change in the quantity demanded is larger than the percentage change in price. Because the demand is elastic, the fall in the price of a movie ticket increases the total revenue from the sale of movie tickets. When the price is $9 a ticket, the total revenue is $9 a ticket  100 tickets, which is $900. When the price is $7 a ticket, the total revenue is $7 a ticket  300 tickets, which is $2,100. So, the total revenue increases by $1,200. The price elasticity of demand for movie tickets is the percentage change in the quantity of movie tickets demanded divided by the percentage change in the price of a movie ticket. The percentage change in the quantity of movie tickets

 300 tickets − 100 tickets    100 , which is 100 perdemanded equals   (100 tickets + 300 tickets)  2 )  cent. The percentage change in the price of a movie ticket equals  $9 a ticket − $7 a ticket     100 , which is 25 percent. So, the price  ($9 a ticket + $7 a ticket)  2 )  elasticity of demand for movie tickets at the price of $8 is 100 percent  25 percent, or 4.00. 4.

The price elasticity of demand for Pete’s chocolate chip cookies is 1.5. Pete wants to increase his total revenue. Would you recommend that Pete raise or lower his price of cookies? Explain your answer. Because the price elasticity of demand for cookies is 1.5, Pete should lower the price of cookies to raise his total revenue. Because demand is elastic a decrease in the price of cookies will bring about a larger percentage increase in the quantity demanded than the percentage fall in price.

Chapter 5 . Elasticities of Demand and Supply

Use the following information to work Problems 5 and 6. The price of a plane ride rises by 10 percent. The price elasticity of demand for plane rides is 0.5 and the price elasticity of demand for train rides is 0.2. The cross elasticity of demand for train rides with respect to the price of a plane ride is 0.4. 5. Calculate the percentage changes in the quantity demanded of plane rides and train rides. The percentage change in the quantity demanded of plane rides equals the price elasticity of demand for plane rides multiplied by the percentage change in the price of a plane ride, which is (0.5)  (10 percent) = 5 percent. The percentage change in the quantity demanded of train rides equals the cross elasticity of demand for train rides with respect to the price of a plane ride multiplied by the percentage change in the price of a plane ride, which is (0.4)  (10 percent) = 4 percent increase. 6.

Given the rise in the price of a plane ride, what percentage change in the price of a train ride will leave the quantity demanded of train rides unchanged? From the previous answer, when the price of a plane ride rises 10 percent, the quantity of train rides demanded increases 4 percent. The price rise of a train ride necessary to decrease the quantity demanded by 4 percent is 20 percent because a 20 percent increase in the price of train ride decreases the quantity demanded by (0.2)  (20 percent) = 4 percent.

A survey found that when incomes increased by 10 percent, the following changes in the quantities demanded occurred: spring water up by 5 percent; sports drinks down by 2 percent; cruises up by 15 percent. For which good is demand income elastic? For which good is income inelastic? Which goods are normal goods? Because the percentage change in the quantity of cruises demanded increased by more than the percentage change in income, the demand for cruises is income elastic. Because the percentage change in the quantity of spring water demanded increased by less than the percentage change in income, the demand for spring water is income inelastic. The demand for cruises increases with income, so cruises are a normal good. The demand for spring water increases with income, so it is a normal good. The demand for sports drinks decreases with income, so it is an inferior good.

Use the following information to work Problems 8 and 9. Record U.S. corn crop, up 24%, is forecast The USDA reported that world corn production will be 9.9 percent greater than last year’s, while U.S. corn production will be 24 percent larger. The price of corn is expected to be 46 percent higher than last year’s price. Source: Bloomberg News, August 11, 2007

Part 2 . A CLOSER LOOK AT MARKETS

Did Starbucks start a pumpkin boom? Ever since Starbucks introduced its famed pumpkin spice latte about a Decade ago, pumpkin sales have skyrocketed. Source: CNNMoney, October 1, 2014 The price of pumpkin increased from $286 per ton in 2000 to $732 per ton in 2014 (both prices in 2014 dollars) and the quantity produced increased from 423,000 tons in 2000 to 657,150 in 2014. Calculate the U.S. price elasticity of supply of pumpkin: Is its supply elastic? The price elasticity of supply equals the percentage change in the quantity supplied divided by the percentage change in the price. The change in the quantity supplied is: [(657,150 tons – 423,000)/540,075] × 100 = 43.4 percent, where 540,075 is the midpoint between the two quantities. The percentage change in the price is: [($732 − $286)/$509] × 100 = 87.6 percent, where $509 is the midpoint between the two prices. So, the price elasticity of supply equals 43.4 percent  87.6 percent, which is 0.5. The supply of pumpkins corn is not elastic; it is inelastic.

Read Eye on Elasticity at the Coffee Shop on p. 123 and then explain why the demand for latte is inelastic while the demand for a Starbucks latte is elastic. Which demand is likely to be more inelastic: the demand for latte or the demand for coffee? The demand for latte is inelastic because there are not many substitutes for a latte. Most of the substitutes, such as tea or water, are poor substitutes, which also makes the demand for latte inelastic. The demand for Starbucks latte, however, is elastic because there are good substitutes for Starbucks latte. As the Eye on Elasticity at the Coffee Shop explained, Dunkin’ Donuts latte is a substitute. So, too, are lattes from independent coffee shops. With more good substitutes, the demand for Starbucks latte is elastic. The demand for a latte is probably more elastic than the demand for coffee because a latte is a more narrowly defined good than coffee, which is a more broadly defined good. Anything that substitutes for coffee also substitutes for a latte and all other coffee-based drinks are also substitutes for a latte. Because a latte has more substitutes than does coffee, its demand is more elastic than the demand for coffee.

Chapter 5 . Elasticities of Demand and Supply

◼ Instructor Assignable Problems and Applications Use the following information to work Problems 1 and 2. When Elle’s Espresso Bar increased its prices by 10 percent, the quantity of coffee that Elle sold decreased by 40 percent. When Elle and all her competitors cut their prices by 10 percent, the quantity of coffee sold by Elle increased by only 4 percent. 1. Calculate the price elasticity of demand for Elle’s Espresso Bar coffee and the price elasticity of demand for coffee. The price elasticity of demand equals the percentage change in the quantity demanded divided by the percentage change in price. When Elle alone increased the price by 10 percent, the quantity of coffee demanded decreased by 40 percent, so the price elasticity of demand for Ellie’s coffee is (40 percent)/(10 percent) = 4.0. When all the stores lowered their prices by 10 percent, the quantity demanded increased by 4 percent, so the price elasticity of demand for coffee equals (4 percent)/(10 percent) = 0.4. 2.

Explain the difference between the responses to Elle’s price hike and price cut. Why did the price increase bring a large response in the quantity sold while the price cut had only a small effect? The demand for Elle’s coffee is elastic (4.0) because there are many good substitutes for Elle’s coffee, such as the coffees sold by all of Elle’s competitors. So, in this case the quantity of Elle’s coffee demanded decreased quite substantially. When all stores lowered their prices, customers can buy at Ellie’s store and at all the competitors’ stores also. So, in this case, because the demand for coffee is inelastic (0.4), the (small) increase in the quantity demanded is spread over all Ellie’s store and all the other coffee stores.

When rain ruined the banana crop in Central America, the price of bananas rose from $1 to $2 a pound. Growers sold fewer bananas, but their total revenue was unchanged. By what percentage did the quantity demanded of bananas change? Is the demand for bananas elastic, unit elastic, or inelastic? Because the total revenue did not change, the percentage change in bananas demanded equals the percentage increase in price. Using the midpoint method, the percentage increase in the price equals ($1.00  $1.50) = 66.67 percent. So, the quantity of bananas demanded decreased by 66.67 percent. The demand for bananas is neither elastic nor inelastic; it is unit elastic because the percentage increase in the price equals the percentage decrease in the quantity of bananas demanded.

Part 2 . A CLOSER LOOK AT MARKETS

The income elasticity of demand for haircuts is 1.5, and the income elasticity of demand for food is 0.14. You take a weekend job, and the income you have to spend on food and haircuts doubles. If the prices of food and haircuts remain the same, will you double your expenditure on haircuts and double your expenditure on food? Explain why or why not. Your expenditure on haircuts will more than double because the income elasticity of demand exceeds 1.0. Your expenditure on food will not double because the income elasticity of demand is less than 1.0. Only if the income elasticity of demand equals 1.0 will the expenditure on a good or service change proportionally with income.

Drought cuts the quantity of wheat grown by 2 percent. If the price elasticity of demand for wheat is 0.5, by how much will the price of wheat rise? If pasta makers estimate that this change in the price of wheat will increase the price of pasta by 25 percent and decrease the quantity demanded of pasta by 8 percent, what is the pasta makers’ estimate of the price elasticity of demand for pasta? If pasta sauce makers estimate that, with the change in the price of pasta, the quantity of pasta sauce demanded will decrease by 5 percent, what is the pasta sauce makers’ estimate of the cross elasticity of demand for pasta sauce with respect to the price of pasta? Rearranging the price elasticity of demand formula shows that the percentage change in the price of wheat equals the percentage change in the quantity demanded divided by the price elasticity of demand. The percentage change in the price of wheat is (2 percent)  (0.5), or 4 percent. The estimated price elasticity of demand for pasta is equal to the percentage change in the quantity demanded of pasta divided by the estimated change in the price of pasta. So, the estimated price elasticity of demand for pasta is (8 percent)  (25 percent), which is 0.32. The estimated cross elasticity of demand for pasta sauce with respect to the price of pasta is equal to the percentage change in the quantity demanded of pasta sauce divided by the estimated change in the price of pasta. So, the estimated cross elasticity of demand for pasta sauce with respect to the price of pasta is −(5 percent)  (25 percent), which is −0.2.

“In a market in which demand is price inelastic, producers can gouge consumers and the government must set high standards of conduct for producers to ensure that consumers get a fair deal.” Do you agree or disagree with each part of this statement? Explain how you might go about testing the positive part. Most of this statement is normative in nature. The terms “gouge,” “high standards of conduct,” and “fair deal” are all normative. To the extent

Chapter 5 . Elasticities of Demand and Supply

that the statement can be interpreted as a positive statement, the first part might mean “in a market in which demand is price inelastic, producers can set a higher price than otherwise.” If this is the meaning of the first part, then it is testable by determining the extent to which the price elasticity of demand affects the equilibrium price in markets. Use the following information to work Problems 7 and 8. Valentine roses On Valentine’s Day 2015, 257 million roses were sold for about double the normal price. On a normal day, 3 million roses are sold. Source: aboutflowers.com, 2015 7. Does the information about the market for roses enable us to estimate an elasticity, and if so, which one: the price elasticity of demand, the price elasticity of supply, an income elasticity, or a cross elasticity? Explain your answer. The information does not allow us to estimate an income elasticity of demand nor a cross elasticity of demand because there is no data about a change in income nor a change in the price of a related good. The price elasticity of demand is measured along an unchanging demand curve but on Valentine ’s Day the demand for roses increases and the demand curve shifts to the right. Consequently, we cannot estimate the price elasticity of demand. If we assume that the supply of roses did not change, so that the supply curve did not shift, then we can sue the data to estimate the price elasticity of supply. 8.

What is the magnitude of the elasticity that you can estimate using the information provided? Explain your answer. Presuming the supply curve did not shift, the price elasticity of supply equals the percentage change in the quantity supplied divided by the percentage change in the price. The percentage change in the quantity supplied is given as 100 percent (“double the normal price”) and the percentage change in the quantity supplied is equal to: [(257 million – 3 million)/130 million] × 100 = 195 percent, where 130 million is the midpoint (the average) between 257 million and 3 million. So, the price elasticity of supply equals (195 percent)/(100 percent) = 1.95.

Part 2 . A CLOSER LOOK AT MARKETS

◼ Multiple Choice Quiz 1.

When the price of ice cream rises from $3 to $5 a scoop, the quantity of ice cream bought decreases by 10 percent. The price elasticity of demand for ice cream is _______. A. 5 B. 0.2 C. 50 D. 2.5 Answer: B The percentage change in the price is equal to ($2/$4) × 100, which is 50 percent. The price elasticity of demand is equal to (10 percent) ÷ (50 percent), which is 0.2. 2.

In Pioneer Ville, the price elasticity of demand for bus rides is 0.5. When the price of a bus ticket rises by 5 percent, _______. A. the demand for bus rides increases by 10 percent B. the quantity of bus rides demanded increases by 2.5 percent C. the demand for bus rides decreases by 2.5 percent D. the quantity of bus rides demanded decreases by 2.5 percent Answer: D The quantity of bus rides demanded decreases by (0.5) × (5 percent), which is 2.5 percent. 3.

The price elasticity of demand for a good is 0.2. A 10 percent rise in the price will _______ the total revenue from sales of the good. A. decrease B. increase C. decrease the quantity sold with no change in D. not change Answer: B The total revenue test on page 123 shows that a rise in the price increases the total revenue if demand is inelastic. 4.

If the price of a good falls and expenditure on the good rises, the demand for the good is _______. A. elastic B. perfectly elastic C. inelastic D. unit elastic Answer: A The total revenue test on page 123 shows that demand is elastic.

Chapter 5 . Elasticities of Demand and Supply

When the price of a good rises from $5 to $7 a unit, the quantity supplied increases from 110 to 130 units a day. The price elasticity of supply is _______. The supply of the good is _______. A. 60; elastic B. 10; elastic C. 0.5; inelastic D. 2; inelastic Answer: C The price elasticity of supply equals (20/120)÷($2/$6), which is 0.5; the price elasticity of supply is less than 1.0, so the supply is inelastic. 6.

The cross elasticity of demand for good A with respect to good B is 0.2. A 10 percent change in the price of good B will lead to a ____ percent change in the quantity of good A demanded. Goods A and B are _______. A. 2; substitutes B. 0.5; complements C. −2; complements D. −0.5; substitutes Answer: A The change in the quantity of good A demanded is computed as (0.2) × (10 percent), which is 2 percent; the cross price elasticity is positive, so the goods are substitutes. 7.

A 2 percent increase in income increases the quantity demanded of a good by 1 percent. The income elasticity of demand for this good is _______. The good is a _______ good. A. 2; normal B. –2; inferior C. 1/2; normal D. 2; inferior Answer: C The income elasticity of demand equals (1 percent) ÷ (2 percent); it is positive so the good is a normal good.

Chapter

Efficiency and Fairness of Markets ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications At McDonald’s, no reservations are accepted; at the St. Louis Art Museum Restaurant, reservations are accepted; at Le Bernardin in New York, reservations are essential. Use this information to work Problems 1 to 3. 1. Describe the method of allocating table resources in these three restaurants. All these restaurants use a first-come, first-serve system. McDonald’s uses this system directly. Le Bernardin uses a first-come, first-serve because the first person to call to make a reservation at a particular time is allocated the table at that time. The St. Louis Art Museum Restaurant uses a combination of the immediate first-come, first serve system and the reservation based first-come, first-serve system. 2.

Why do you think restaurants have different reservation policies, and why might each restaurant be using an efficient allocation method? The speed with which tables turn over at the different restaurants probably is quite different and the customers probably have quite different values of time. Le Bernardin has a low turnover rate—only 1 or 2 groups of customers can use a table each night—and its customers have a high value of time. If Le Bernardin refused to take reservations, its customers would need to wait an inefficiently long time and would go elsewhere so that Le Bernardin’s profits would be lower. At McDonald’s, the tables have a high turnover rate (indeed, many customers do not use the tables at all, buying their food to go) and the customers have a lower value of time. Allowing reservations would be costly for McDonald’s and would spare its customers only a slight wait at most so that allowing reservations would decrease McDonald’s profits. At the St. Louis Art Museum Restaurant, the turnover rate of the tables is between that at Le Bernardin and McDonald’s, so it uses a combination of phone reservation first-come, first-serve and appear in person first-come, first serve. Each restaurant is using a different allocation method because of the rela-

Part 2 . A CLOSER LOOK AT MARKETS

When the marginal benefit from a good exceeds its marginal cost, ______. A. there is overproduction of the good B. a deadweight loss, which is the excess of marginal benefit over marginal cost, arises C. producer surplus decreases and consumer surplus increases D. total production increases and efficiency increases Answer: B Figure 6.9(a) on page 157 shows the deadweight loss when the marginal benefit exceeds the marginal cost. 6.

Market failure arises if ______. A. there is overproduction of the good but not if there is underproduction B. the deadweight loss is zero C. producer surplus exceeds consumer surplus D. total surplus is not maximized Answer: D When the total surplus is maximized, resource allocation is efficient; if it is not maximized, then resource allocation is inefficient and market failure occurs. 7.

The allocation of resources is fair ______. A. in the fair-rules view if everyone has equal opportunity B. in the fair-results view if most resources are distributed to the poorest people C. in the fair-rules view if owners of the resources are protected by property rights and all transfers of resources are voluntary D. in the fair-results view if resources are transferred voluntarily so that everyone has the same quantity Answer: C Page 161 discusses the rules view of fairness.

Chapter

Government Actions in Markets

ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications 1.

In Florida, sunscreen and sunglasses are vital items. If the tax on sellers of these items is doubled from 5.5 percent to 11 percent, who will pay most of the tax increase: the buyer or the seller? Will the tax increase halve the quantity of sunscreen and sunglasses bought? Because sunscreen and sunglasses are necessities, the demand for them is inelastic. So, most of a tax imposed on them will be paid by the buyer. Even though the tax doubles, the quantity purchased is not halved because the demand is inelastic.

Suppose that the government imposes a $2 a cup tax on coffee. What determines by how much Starbucks will raise its price? How will the quantity of coffee bought in coffee shops change? Will this tax raise much revenue? The price elasticities of demand and supply determine how much more Starbucks charges for a coffee. The smaller the price elasticity of demand and the larger the price elasticity of supply, the more Starbucks will raise the price of a coffee. The quantity of coffee bought will decrease. The amount of revenue the government raises depends on the size of the tax and the size of the decrease in the quantity of coffee purchased. For a given tax, the government collects more revenue the smaller the price elasticities of demand and supply because the smaller these elasticities, the smaller the decrease in the quantity purchased.

3. The table illustrates the market for Internet service. What is the market price of Internet service? If the government taxes Internet service $15 a month, what is the price the buyer pays? What is the price the sell-

Price (dollars per month)

0 10 20 30 40

Quantity Quantity demanded supplied (units per month)

30 25 20 15 10

0 10 20 30 40

Global Markets in Action ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications Use Figures 8.1 and 8.2 to work Problems 1 to 4. Figure 8.1 and Figure 8.2 show the markets for shoes if there is no trade between the United States and Brazil.

Which country has a comparative advantage in producing shoes? With international trade, explain which country would export shoes and how the price of shoes in the importing country and the quantity produced by the importing country would change. Explain which country gains from this trade. Brazil has the comparative advantage in producing shoes because, with no international trade, the price in Brazil is less than the price in the Unit-

Chapter

Part 3 . A CLOSER LOOK AT MARKETS

ed States. With international trade, Brazil will export shoes to the United States. The price of a pair of shoes in the United States will fall and the quantity of shoes produced in the United States will decrease. Both countries will gain from this trade. In Brazil producers of shoes gain (consumers of shoes lose, but the gain to the producers exceeds the loss to consumers) and in the United States consumers of shoes gain (producers of shoes lose, but the gain to the consumers exceeds the loss to producers). 2.

The world price of a pair of shoes is $20. Explain how consumer surplus and producer surplus in the United States changes as a result of international trade. On the graph, show the change in U.S. consumer surplus (label it A) and the change in U.S. producer surplus (label it B). The consumer surplus of U.S. consumers increases because the price U.S. consumers pay for a pair of shoes falls. As a result of the fall in price, U.S. consumers increase the number of shoes they buy. Consumer surplus increases because the price falls and because the quantity of shoes purchased increases. The producer surplus of U.S. producers decreases because of the fall in the price of a pair of shoes. As a result of the fall in price, U.S. producers decrease the quantity of shoes they produce. Producer surplus decreases both because the price falls and because the quantity of shoes produced decreases. Figure 8.3 shows the change in consumer surplus and the change in producer surplus. The increase in consumer surplus equals the area A + B (the part of the light colored gain that lies beneath area B is not visible). The loss of producer surplus equals the dark gray area B.

The world price of shoes is $20. Explain how consumer surplus and producer surplus in Brazil change as a result of international trade. Show the change in Brazil’s consumer surplus (label it C) and the change in Brazil’s producer surplus (label it D). The consumer surplus of Brazilian consumers decreases because the price Brazilian consumers pay for a pair of shoes rises. As a result of the rise in price, Brazilian consumers decrease the number of shoes they buy. Consumer surplus decreases both because the price rises and because the quantity of shoes purchased decreases. The producer surplus of Brazilian producers increases because of the rise in the price of a pair of shoes. As a result of the rise in price, Brazilian producers increase the quantity of shoes they produce. Producer surplus increases both because the price

Externalities: Pollution, Education, and Healthcare ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications

Chapter

Price Quantity The first table shows the demand schedule for electricity (cents per demanded from a coal-burning utility. The second table shows the utilikilowatt) (kilowatts per day) ty’s cost of producing electricity and the external cost of the 4 500 pollution created. Use this information to work Problems 1 8 400 to 3. 12 300 1. With no pollution control, calculate the quantity of elec16 200 20 100 tricity produced, the price of electricity, and the margin24 0 al external cost of the pollution generated. With no pollution control, the quantity of elecQuantity Marginal Marginal tricity produced is the amount at which the (kilowatts cost external cost quantity demanded equals the quantity supper day) (cents per kilowatt) plied as determined by the marginal private cost 0 0 0 of producing electricity. In this case, the quanti100 2 2 200 4 4 ty is 400 kilowatts per day and the price is 8¢ per 300 6 6 kilowatt. At this quantity, the marginal external 400 8 8 cost is (also) 8¢ per kilowatt. 500 10 10 2. With no pollution control, calculate the quantity of electricity produced, the marginal social cost of the electricity generated, and the deadweight loss. With no pollution control, the quantity of electricity produced is the amount at which the quantity demanded equals the quantity supplied as determined by the marginal private cost of producing electricity. In this case, the quantity is 400 kilowatts per day. At this quantity, the marginal external cost is (also) 8¢ per kilowatt so the marginal social cost is 16¢ per kilowatt. The deadweight loss equal to the area of the triangle whose height is the marginal external cost at the equilibrium quantity and whose base is the difference between the efficient quantity and the privatemarket equilibrium quantity. The efficient quantity is 300 kilowatts and at

Part 2 . A CLOSER LOOK AT MARKETS

the equilibrium quantity the marginal external cost is 8¢ per kilowatt. The difference between the efficient quantity and the equilibrium quantity is 100 kilowatts. So, the deadweight loss equals 1/2  100 kilowatts  8¢ per kilowatt, or $4.00. 3.

If the government levies a pollution tax such that the utility generates the efficient quantity of electricity, calculate the quantity of electricity generated, the price of electricity, the size of the pollution tax, and the tax revenue. The efficient quantity of electricity is the amount at which the quantity demanded (which reflects the marginal social benefit) equals the marginal social cost. The marginal social cost is the sum of the marginal cost and the marginal external cost. The efficient quantity is 300 kilowatts because at this quantity the marginal social cost, 12¢ per kilowatt, equals the price, also 12¢ per kilowatt. The pollution tax must equal the marginal external cost, 6¢ per kilowatt. The tax revenue equals 6¢ per kilowatt  300 kilowatts, which is $18.00.

Use the following information to work Problems 4 and 5. Tom and Larry must spend a day working together. Tom likes to smoke cigars and the price of a cigar is $2. Larry likes a smoke-free environment. 4. If Tom’s marginal benefit from a cigar a day is $20 and Larry’s marginal benefit from a smoke-free environment is $25 a day, what is the outcome if they meet at Tom’s home? What is the outcome if they meet at Larry’s home? Larry is willing to pay Tom up to $25 to not smoke. Tom’s net benefit from smoking is $18 (the marginal benefit minus the price of the cigar). The Coase theorem says that in this case, with Tom and Larry meeting at Tom’s home, Larry pays Tom some amount between $18 to $25 not to smoke and Tom does not smoke. If Tom and Larry meet at Larry’s house, Tom is willing to pay up to $18 to be allowed to smoke. But Larry will accept nothing less than $25 to allow Tom to smoke. Tom cannot offer enough to Larry, so Tom does not smoke. In both questions, the efficient outcome, Tom not smoking, is attained regardless of who is given the property right, that is, regardless of who owns the house in which the meeting occurs. 5.

If Tom’s marginal benefit from a cigar a day is $25 and Larry’s marginal benefit from a smoke-free environment is $20 a day, what is the outcome if they meet at Tom’s home? What is the outcome if they meet at Larry’s home? Larry is willing to pay Tom up to $20 to not smoke. Tom’s net benefit from smoking is $23 (the marginal benefit minus the price of the cigar). When Tom and Larry meet at Tom’s house, Larry cannot offer enough to Tom to make Tom quit smoking, so Tom smokes. If Tom and Larry meet

Chapter

Production and Cost

ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications 1.

Joe runs a shoe shine stand at the airport. Joe has no skills, no job experience, and no alternative job. Entrepreneurs in the shoe shine business earn $10,000 a year. Joe pays the rent of $2,000 a year, and his total revenue is $15,000 a year. He borrowed $1,000 at 20 percent a year to buy equipment. At the end of one year, Joe was offered $500 for his business and all its equipment. Calculate Joe’s annual explicit costs, implicit costs, and economic profit. Joe’s explicit costs are the $2,000 rent and $200 in interest (the amount of interest equals the loan, $2,000, multiplied by the interest rate, 0.10), so the total explicit costs are $2,200. Joe’s implicit costs are $10,000 of normal profit and $500 depreciation for his capital equipment, the chair, polishes, and brushes. Joe’s total implicit costs are $10,500. Joe’s economic profit equals his total revenue minus his total opportunity costs. Joe’s total revenue is $15,000. His total opportunity costs are the sum of his explicit costs, $2,200, and his implicit costs, $10,500. Joe’s total opLabor Total product portunity costs are $12,700 so his economic profit is $15,000 (workers (body boards minus $12,700, or $2,300. per day) per day) Len’s body board factory rents equipment for shaping 0 0 boards and hires students. The table sets out Len’s total 1 20 product schedule. Construct Len’s marginal product and average product schedules. Over what range of workers do marginal returns increase? The table on the next page has Len’s total product, marginal product, and average product schedules. As the table there shows, marginal returns increase for the 1st and 2nd work

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Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE

ers. After the second worker is hired, marginal returns decrease.

Labor 0

Total product 0

Average product xx

Use the following information to work Problems 3 to 6. Len’s body board factory pays $60 a day for equipment and $200 a day to each student it hires. The table sets out Len’s total product schedule. 3. Construct Len’s total variable cost and total cost schedules. What does the difference between total cost and total variable cost at each output equal? The variable costs are the costs of labor; the fixed costs are the costs of the equipment. The total cost schedules per day are in the second table to right. Total cost equals the total variable cost plus the total fixed cost so the difference between total variable cost and total cost is total fixed cost. This difference, $60 for this problem, is the same at each level of output. 4.

Marginal product 20 24 16 12

Labor Total product (workers (body boards per day) per day) 0 0 1

Total Total Total Total product fixed cost variable cost cost Labor (body boards) (dollars) (dollars) (dollars) 0 0 60 0 60 1 20 60 200 260 2 44 60 400 460 3 60 60 600 660 4 72 60 800 860

Construct the average fixed cost, average variable cost, and average total cost schedules and the marginal cost schedule. Labor 0

Total Average Average varproduct fixed cost iable cost (body boards) (dollars) (dollars) 0 xx xx

Average total cost (dollars) xx

3.00

10.00

13.00

1.36

9.09

10.45

1.00

10.00

11.00

.83

11.11

11.94

Marginal cost (dollars) 10.00 8.33 12.50 16.67

Chapter 10 . Production and Cost

An increase in the rent that a firm pays for its factory does not increase ______. A. total cost B. fixed cost C. marginal cost D. average fixed cost Answer: C Rent is a fixed cost, so an increase in the rent increases fixed cost, total cost, and average fixed cost. But it does not change the marginal cost because fixed costs have no influence on the marginal cost. 6.

An increase in the wage rate ______. A. shifts the average total cost curve and the marginal cost curve upward B. shifts the average fixed cost and average variable cost curve upward C. increases average variable cost but does not change marginal cost D. does not change average variable cost but increases average total cost Answer: A Wages are a variable cost, so an increase in the wage rate increases the average total cost and the marginal cost. 7.

When average variable cost is at its minimum level, marginal product _________. A. equals average product B. exceeds average product C. is less than average product D. is at its maximum level Answer: D Figure 10.7 in the textbook shows that D is the correct answer. 8.

In the long run, with an increase in the plant size, _____ . A. the short-run average total cost curve shifts downward B. the long-run average cost curve slopes downward C. the short-run average total cost curve shifts downward if economies of scale exist D. the average total cost of production rises Answer: C The fall in the short-run average total cost means that the long-run average total cost decrease, which is the case when there are economies of scale.

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Chapter

Perfect Competition ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications 1.

In what type of market is each good or service in the following list sold? Explain your answers. • Wheat Wheat is sold in a perfectly competitive market because there are many producers, an identical product, and no barriers to entry or exit. • Jeans Jeans are sold in a monopolistically competitive market. There are many firms, no barriers to entry, and each firm produces a similar but slightly different type of jean. • Printer cartridges The printer cartridge market is likely an oligopoly. There are four major firms: Hewlett Packard, Cannon, Epson, and Lexmark. • Toothpaste The toothpaste market is monopolistically competitive with a large number of similar but not identical brands. • Gym membership in a town with one gym The membership is provided by a monopoly because there is only one firm in the market. 2. Explain why in a perfectly competitive market, the firm is a price taker. Why can’t the firm choose the price at which it sells its good? The firm cannot choose its price because it produces only a small portion of the entire market output and its good has perfect substitutes. If the firm increases its production, it has no impact on the market price. If the firm raises the price of its good above the market price, no one buys from it, switching instead to cheaper, perfect substitutes. And, if the firm lowers its price below the market price, the firm does not maximize its profit because it does not pick up any sales beyond what it could have gained

Chapter

Monopoly ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications Use the following information to work Problems 1 to 3. Elixir Spring produces a unique and highly prized mineral water. The firm’s total fixed cost is $5,000 a day, and its marginal cost is zero. The table shows the demand schedule for Elixir water. 1. On a graph, show the demand for Elixir water and Elixir Spring’s marginal revenue curve. What are Elixir’s profit-maximizing price, output, and economic profit? Elixir Spring’s marginal revenue curve and demand curve are illustrated in Figure 12.1. Also in the figure is Elixir’s marginal cost curve. The marginal cost curve runs along the horizontal axis because the marginal cost is zero. Elixir produces the quantity where the marginal cost curve intersects the marginal revenue curve, so Elixir produces 5,000 bottles a day. Elixir sets a price of $5 a bottle because that is the price at which 5,000 bottles a day is the quantity demanded. Elixir’s economic profit equals its revenue, which is $5 a bottle  5,000, = $25,000 a day, minus its cost, which is its fixed cost of $5,000 a day. Elixir’s economic profit is $25,000 − $5,000, which is $20,000 a day. 2.

Price (dollars per bottle) 10 8 6 4 2 0

Compare Elixir’s profit maximizing price with the marginal cost of producing the profit-maximizing output. At the profit-maximizing price, is the demand for Elixir water inelastic or elastic? Elixir’s profit-maximizing price is $5 per bottle and Elixir’s profit-

Quantity (bottles per day) 0 2,000 4,000 6,000 8,000 10,000

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Part 3 . PRICES, PROFITS, AND INDUSTRY PERFORMANCE

maximizing output is 5,000 bottles per day. The price, $5, is well above the marginal cost, $0. At this price and quantity, the demand for Elixir water is unit elastic because the marginal revenue equals zero. 3.

Suppose that there are 1,000 springs, all able to produce this water at zero marginal cost and with zero fixed costs. Compare the equilibrium price and quantity produced with the price and quantity produced by Elixir water. In this (extreme) situation, the competitive outcome has price equal to marginal cost, $0. The quantity demanded at this price is 10,000 bottles a day, so the equilibrium quantity will be 10,000 bottles a day.

Blue Rose Inc. is the only flower grower to have cracked the secret of making a blue rose. Figure 16.2 shows the demand for blue roses and the marginal cost of producing a blue rose. What is Blue Rose’s profit-maximizing output? What price does Blue Rose charge and is it efficient? To work the question, it is handy to use Figure 12.3 which shows Blue Rose’s marginal cost curve as well as its demand curve, and marginal revenue curve. To maximize profit, Blue Rose produces the quantity where the marginal cost curve intersects the marginal revenue curve. Figure 16.3 shows that Blue Rose produces 2 roses a day, determined by the intersection of its marginal revenue and marginal cost curves. The demand curve shows that the price is $40 a (blue) rose because that is the price at which 2 roses per day is the quantity demanded. Blue Rose is not using its resources efficiently because Blue Rose is creating a deadweight loss.

Chapter 12 . Monopoly

A single-price monopoly is ______. A. inefficient because it converts consumer surplus to producer surplus B. inefficient because it produces too small an output and creates a deadweight loss C. efficient because buyers are paying a price equal to their willingness to pay D. efficient because it is the only producer of the good Answer: B The monopoly creates inefficiency by producing less than a competitive market to raise its price. 6.

A monopoly that price discriminates ______. A. benefits buyers because it offers the good at a variety of prices B. gains because it converts consumer surplus to economic profit C. uses resources more efficiently than would a competitive market D. enables buyers to maximize their consumer surplus Answer: B Price discrimination converts consumer surplus to economic profit. 7.

Governments regulate natural monopoly by capping the price at _____. A. marginal revenue and allowing the monopoly to maximize profit B. marginal cost so that the monopoly is efficient and makes zero economic profit C. average total cost, which allows the monopoly to be inefficient but make zero economic profit D. the buyers’ willingness to pay, which makes the monopoly operate efficiently Answer: C Figure 12.12 illustrates the effects of using an average cost pricing rule to regulate the natural monopoly.

141

Monopolistic Competition and Oligopoly ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications 1.

Chapter

Which of the following items are sold by firms in monopolistic competition? Explain your selections. • Cable TV service The cable television market is not an example of monopolistic competition because at any locale, there are not a lot of firms competing. •

Wheat The wheat market is not an example of monopolistic competition because the many competing firms each produce an identical product.

•

Athletic shoes The athletic shoe market is an example of monopolistic competition. There are several producers of athletic shoes, with extensive product differentiation and competition on quality, price, and marketing.

•

Soda The soda market is not an example of monopolistic competition because there are only two producers who together have a very large market share.

•

Toothbrushes The toothbrush market is an example of monopolistic competition. There are many producers of toothbrushes, with extensive product differentiation and competition on quality, price, and marketing.

•

Ready-mix concrete The ready-mix concrete market is not an example of monopolistic competition.

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The oligopoly dilemma is whether to ________. A. act together to restrict output and raise the price B. raise the price to the monopoly profit-maximizing price C. cheat on others in the cartel to take advantage of profit opportunities D. lower the price to the perfectly competitive price Answer: C Cheating on the others in the cartel will boost the cheater’s profit as long as the other participants also do not cheat. 6.

In the prisoners’ dilemma game, each player ________. A. consults the other player to determine his best action B. chooses the best outcome for the other player C. chooses the best outcome for himself D. chooses the best outcome for both players together Answer: C Each player maximizes his or her own well-being. 7.

A Nash equilibrium ______. A. is the outcome that delivers maximum economic profit B. is the outcome in which each player takes the best action given the other player’s action C. changes each time the game is played D. is the best possible outcome for the two players Answer: B Answer B is the definition of a Nash equilibrium.

GDP: A Measure of Total Production and Income ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications 1.

Chapter

Figure 14.1 shows the flows of income and expenditure in an economy. In 2013, U was $2 trillion, V was $1.5 trillion, W was $7 trillion, X was $1.5 trillion, and Z was zero. Calculate total income, net taxes, and GDP. Total income (which is flow Q) equals total expenditure, the sum of consumption expenditure, investment, government expenditure on goods and services, and net exports of goods and services. Flow U is government expenditure on goods and services, G; flow W is consumption expenditure, C; flow X is investment, I; and flow Z is net exports of goods and services, NX. Total expenditure equals $7 trillion + $1.5 trillion + $2 trillion + $0, which is $10.5 trillion, so total income also equals $10.5 trillion. Net taxes equal total income minus consumption expenditure and saving. Total income is $10.5 trillion. Consumption expenditure is $7 trillion. Saving is the flow into the financial markets (flow V) and equals $1.5 trillion. So net taxes equal $10.5 trillion − $7 trillion − $1.5 trillion, which is $2 trillion. Total income equals total expenditure which equals GDP, so GDP equals $10.5 trillion.

Use the following data to work Problems 2 and 3. The national accounts of Parchment Paradise are kept on (you guessed it) parchment. A fire in the statistics office destroys some accounts, leaving only the following data: • GDP (income approach) $2,900

Chapter

Appendix: Measuring Real GDP ANSWERS TO APPENDIX CHECKPOINTS

◼ Study Plan Problems An island economy produces 2015 2016 only bananas and coconuts. The Item Quantity Price Quantity Price table gives the quantities produced and prices in 2015 and Bananas 100 $10 110 $15 in 2016. The base year is 2015. Coconuts 50 $12 60 $10 1. Calculate nominal GDP in 2015 and nominal GDP in 2016. Nominal GDP in 2015 = ($10  100) + ($12  50) = $1,000 + $600 = $1,600. Nominal GDP in 2016 = ($15  110) + ($10  60) = $1,650 + $600 = $2,250. 2.

Calculate the value of 2016 production in 2015 prices and the percentage increase in production when valued at 2015 prices. Using 2015 prices, the value of 2016 production is ($10  110) + ($12  60) = $1,100 + $720 = $1,820. In 2015 prices, GDP in 2015 is $1,600 so the value of production increased from $1,600 to $1,820, an increase of $220. The percentage increase is equal to ($220  $1,600)  100, which is 13.75 percent.

Calculate the value of 2015 production in 2016 prices and the percentage increase in production when valued at 2016 prices. Using 2016 prices, the value of 2015 production is ($15  100) + ($10  50) = $1,500 + $500 = $2,000. In 2016 prices, GDP in 2016 is $2,250 so the value of production increased from $2,000 to $2,250, an increase of $250. The percentage increase is equal to ($250  $2,000)  100, which is 12.5 percent.

Use the chained-dollar method to calculate real GDP in 2015 and 2016. In terms of what dollars is each of these two real GDPs measured? Real GDP in 2015 = $1,600. It is equal to nominal GDP because 2015 is the base year. To calculate real GDP in 2016 compute the growth rate of real GDP between 2015 and 2016. That growth rate is the average of the growth rates

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between 2015 and 2016 using prices from 2015 and using prices from 2016. Taking the average of the answers to Problems 2 and 3 gives an average percentage increase of 13.13 percent. This result means that real GDP in 2016 is 13.13 percent greater than real GDP in 2015. Real GDP in 2015 was $1,600, so real GDP in 2016 equals ($1,600)  (1.1313), which is $1,810.08. These real GDPs are in terms of 2015 dollars. 5.

Using the chained-dollar method, compare the growth rates of nominal GDP and real GDP in 2016. Between 2015 and 2016, nominal GDP increased from $1,600 to $2,250, an increase of $650. The growth rate of nominal GDP is ($650 ÷ $1,600)  100, which is 40.6 percent. The growth rate of real GDP is 13.13 percent, so nominal GDP grew much more rapidly than did real GDP.

If the base year is 2016, use the chained-dollar method to calculate real GDP in 2015 and 2016. In terms of what dollars is each of these two real GDPs measured? Real GDP in 2016 = $2,250. It is equal to nominal GDP because 2016 is the base year. To calculate real GDP in 2015 compute the growth rate of real GDP between 2015 and 2016. That growth rate is the average of the growth rates between 2015 and 2016 using prices from 2015 and using prices from 2016. Taking the average of the answers to Problems 2 and 3 gives an average percentage increase of 13.13 percent. This result means that real GDP in 2016 is 13.13 percent greater than real GDP in 2015 so real GDP in 2015 equals ($2,250) ÷ (1.1313), which is $1,988.86. These real GDPs are in terms of 2016 dollars.

If the base year is 2016, compare the growth rates of nominal GDP and real GDP in 2016. From Problem 5, the growth rate of nominal GDP is 40.6 percent. From Problem 6, the growth rate of real GDP in 2016 dollars is 13.13 percent.

Chapter

Jobs and Unemployment ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications

Use the following information gathered by a BLS labor market survey of four households to work Problems 1 and 2. • Household 1: Candy worked 20 hours last week setting up her Internet shopping business. The rest of the week, she completed application forms and attended two job interviews. Husband Jerry worked 40 hours at his job at GM. Daughter Meg, a student, worked 10 hours at her weekend job at Starbucks.

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Household 2: Joey, a full-time bank clerk, was on vacation. Wife, Serena, who wants a full-time job, worked 10 hours as a part-time checkout clerk.

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Household 3: Ari had no work last week but was going to be recalled to his regular job in two weeks. Partner Kosta, after months of searching for a job and not being able to find one, has stopped looking and will go back to school.

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Household 4: Mimi and Henry are retired. Son Hank is a professional artist, who painted for 12 hours last week and sold one picture. Classify each of the 10 people into the labor market category used by the BLS. Who are part-time workers and who are full-time workers? Of the part-time workers, who works part time for economic reasons? Candy is employed because she worked for more than 15 hours at her family business. Jerry is employed because he worked full time at General Motors. Their 17-year old daughter, Meg, is employed because she worked for more than 1 hour as a paid employee. All three are in the labor force and in the working-age population. Joey is employed because he is temporarily absent from his job. Serena is employed because she worked for more than 1 hour as a paid employee. Both are in the labor force and in the working-age population.

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Ari is unemployed because he is waiting to be recalled to his job. Ari is in the labor force and in the working-age population. Kosta is in the working age population but is not in the labor force so Kosta is a marginally attached worker. Mimi and Henry are in the working-age population but are not in the labor force. Hank is not in the labor force. He is not employed because he worked for less than 15 hours in the family business. And he is not unemployed because he made no effort to find employment and was not waiting to be recalled to a job. Hank is not in the labor force but he is in the working age population. Candy, Meg, and Serena are part-time workers. Jerry and Joey are fulltime workers. Candy and Serena are part time for economic reasons. 2.

Calculate the unemployment rate and the labor force participation rate, and compare these rates with those in the United States in 2016. The labor force is 6 people and 1 of the people is unemployed. The U-3 unemployment rate is (1  6)  100, which is 16.7 percent. The unemployment rate is higher than the U.S. unemployment rate, which was 4.7 percent in May, 2016. The labor force is 6 people and the working age population is 10 people. The labor force participation rate is (6  10)  10, which is 60 percent. The labor force participation rate is slightly less than the U.S. labor force participation rate, which was 62.6 percent in May, 2016.

Describe two examples of people who work part time for economic reasons and two examples of people who work part time for noneconomic reasons. Sam is an associate at JCPenney and would like to work 40 hours per week. However, sales at JCPenney are slow and so he is scheduled to work only 25 hours per week. Maria is a server at Olive Garden and would like to work at least 40 hours per week. But Maria is scheduled for only 20 hours per week because Olive Garden’s sales are down. Both Sam and Maria work part time for economic reasons. Mike is a student who wants to work 20 hours per week at Cost Cutters hair styling so that he can attend class and study. Cost Cutters schedules him for 20 hours per week. Lorri is partially retired and wants to work only 15 hours per week at Walgreens so that she may spend most of her time with her spouse. Walgreens schedules Lorri for 15 hours per week. Both Mike and Lorri work part time for noneconomic reasons.

Chapter

The CPI and the Cost of Living ANSWERS TO CHAPTER CHECKPOINTS

◼ Study Plan Problems and Applications 1.

In Canada, the reference base period for the CPI is 2002. By 2014, prices had risen by 25.2 percent since the base period. The inflation rate in Canada in 2015 was 1.1 percent. Calculate the CPI in Canada in 2015. Because 2002 is the reference base period in Canada, in 2002 the CPI equaled 100. Between 2002 and 2014 prices rose by 25.2 percent. The formula for the percentage rise in prices is [(CPI in 2014 − 100)  100]  100. So, [(CPI in 2014 − 100)] = 25.2 percent. Solving the formula for the CPI in 2014 shows that the CPI in 2014 is 125.2. Finally, with an inflation rate of 1.1 percent in 2015, the CPI in 2015 equals 125.2 × (1.011) = 126.6. In Brazil, the reference base period for the CPI is 2000. By 2005, prices had risen by 51 percent since the base period. The inflation rate in Brazil in 2006 was 10 percent, and in 2007, the inflation rate was 9 percent. Calculate the CPI in Brazil in 2006 and 2007. Brazil’s CPI in 2008 was 173. Did Brazil’s inflation rate increase or decrease 2008? Because 2000 is the reference base period for Brazil, the CPI in that year is 100. Between 2000 and 2005 prices rose by 51 percent. Over this period, the formula for the percentage rise in prices is [(CPI in 2005 − 100)  100]  100. So, [(CPI in 2005 − 100)] = 51 percent. Solving the formula for the CPI in 2005 shows that the CPI in 2005 is 151. The price level in 2006 equals the price level in 2005, 151, multiplied by 1.10. (The 1.10 comes from the observation that the price level in 2006 equals the price level in 2005, which accounts for the “1,” plus the inflationary increase of 10 percent, which accounts for the “0.10.”) So the price level in 2006 equals (151  1.10), which is 166.1. The price level in 2007 equals the price level in 2006, 166, multiplied by 1.09. So the price level in 2007 equals (166.1  1.09), which is 181. The inflation rate in Brazil in 2008 equals [(173 − 181)  181]  100, which is −4.4 percent. Brazil’s inflation rate decreased in 2008.

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The table shows the Week 1 Week 2 quantities of the goods Price Price that Suzie bought and the Item Quantity (per unit) Quantity (per unit) prices she paid during Coffee 11 cups $3.25 11 cups $3.25 two consecutive weeks. Suzie’s CPI market DVDs 1 $25.00 3 $12.50 basket contains the goods Gasoline 15 gallons $2.50 5 gallons $3.00 she bought in Week 1. 1 ticket $95.00 Calculate the cost of Concert Suzie’s CPI market basket in Week 1 and in Week 2. What percentage of the CPI market basket is gasoline? Calculate the value of Suzie’s CPI in Week 2 and her inflation rate in Week 2. Susie’s CPI market basket contains 11 cups of coffee, 1 DVD, and 15 gallons of gasoline. The cost of her market basket in Week 1 is (11 cups  $3.25 a cup) + (1 DVD  $25 each) + (15 gallons of gasoline  $2.50 a gallon), which is $35.75 + $25.00 + $37.50, or $98.25. The cost of her market basket in Week 2 is (11 cups  $3.25 a cup) + (1 DVD  $12.50 each) + (15 gallons of gasoline  $3.00 a gallon), which is $35.75 + $12.50 + $45.00, or $93.25. Her market basket in Week 2 does not include concert tickets because she purchased no tickets in the base week. Gasoline accounted for $37.50 of her $98.25 market basket, which is ($37.50 ÷ $98.25) × 100 or 38.2 percent. Her CPI in Week 2 is equal to [$93.25  $98.25]  100, which is equal to 94.9. The CPI in the base week is 100, so the inflation rate in week 2 equals ([94.9 − 100.0]  100)  100, which is −5.1 percent.

Use the following information to work Problems 4 and 5. The GDP price index in the United States in 2008 was about 99, and real GDP in 2008 was $14.8 trillion (2009 dollars). The GDP price index in 2013 was about 107, and real GDP in 2013 was $15.5 trillion (2009 dollars). 4. Calculate nominal GDP in 2008 and in 2013 and the percentage increase in nominal GDP between 2008 and 2013. Nominal GDP in 2008 equals $14.8 trillion  99  100, which is $14.65 trillion. Nominal GDP in 2013 equals $15.5 trillion  107  100, which is $16.59 trillion. The percentage increase in nominal GDP is equal to ([$16.59 trillion − $14.65 trillion]  $14.65 trillion)  100, which is 12.9 percent. 5.

What was the percentage increase in production between 2008 and 2013, and by what percentage did the price level rise between 2008 and 2013? The percentage increase in production is equal to the percentage increase in real GDP. That percentage is {[$15.5 trillion − $14.8 trillion]  $14.8 trillion}  100, or 4.7 percent. The percentage increase price level is equal to ([107 − 99]  99)  100, or 8.1 percent.