Instructor’s Solutions Manual to accompany Exploring Microeconomics, 6th Edition Robert L. Sexton Co by StudyGuide

Answer Key

FOR YOUR REVIEW ANSWER KEY CHAPTER 1 THE ROLE AND METHOD OF ECONOMICS Section 1.1 Economics: A Brief Introduction 1. The definition of economics must recognize the central parts of the economist’s point of view: Resources are scarce, scarcity forces us to make choices, and the cost of any choice is the cost of the lost opportunity with the highest value. 2. a. b. c. d. e.

Microeconomics Macroeconomics Microeconomics Macroeconomics Microeconomics

Section 1.2 Economic Theory 3. a. The first is positive and the other is normative. The first statement (a positive statement) expresses a fact or a testable theory that a higher income tax rate would generate increased tax revenues. The second statement (a normative statement) expresses an opinion regarding how any additional tax revenues should be used. b. Both are normative statements that express opinions. The first regards the relative value of studying physics as opposed to studying sociology, and the second regards the value of studying either physics or sociology. c. Both statements are positive. They are expressions of facts or testable theories regarding the relationship between the price of wheat and how much wheat will be purchased and produced. d. The first is positive and the other is normative. The first statement (positive) expresses a fact or testable theory regarding the relationship between the price of butter and how much will be purchased. The second statement (normative) is an expression of opinion about the social value of buying butter. e. Both statements are positive. They are expressions of fact or testable theory regarding demographic change. 4. a. Positive. The statement is a testable hypothesis. b. Normative. Asserting that funding for social assistance should be reduced contains a value judgment about the costs and benefits of doing so. c. Positive. The statement expresses a fact or a testable theory that tariffs will result in higher prices for domestic wine. d. Positive. The statement could be confirmed or refuted by empirical data. e. Normative. A benefit of charging a provincial sales tax on Internet sales is that it will level the playing field with non-Internet retailers. However, a cost of this same tax is that it will reduce

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f. 5. a. b. c. d. e.

total Internet sales and possibly have other negative effects. The statement implies a value judgment that the benefits outweigh the costs. Positive. The statement is subject to empirical testing. This involves confusing correlation with causation. This involves confusing correlation with causation. This involves the fallacy of composition. This is a violation of the ceteris paribus conditions.

There is no fallacy in this statement.

6. Observation and prediction are more difficult in economics than in chemistry because, unlike chemists, economists generally cannot observe behaviour in a laboratory setting where all relevant environmental variables can be carefully controlled. Economists study economic behaviour in the real world, where many variables influence behaviour simultaneously. It is difficult in a complex global economy to observe and predict relationships between variables, isolated from other effects. 7. Economics is concerned with reaching generalizations about human behaviour. If you generalize on the basis of observed individual behavior, you risk committing the fallacy of composition. Generalizations based on observed group behaviour are likely to be both more realistic and useful (reliable).

Section 1.3 Scarcity 8. Being poor means that you have access to few resources, which limits the goods and services you consume. Scarcity means you don’t have enough resources to do everything you want to do, so you have to make choices. Everyone experiences scarcity, because we can always think of more things that we want than we can produce with our resources. 9. The automobile freed Canadians to travel and helped to create the tourism business. New wants included motels, resorts, and theme parks. The increased importance of automobile and truck transportation also created the desire for more and better roads and highways. The automobile also allowed people to live farther from where they worked, so that people wanted more land and newer houses. 10. Scarce goods are those that people pay for in either time or money or, in other words, have an opportunity cost. Garbage and dirty air in the city are not scarce goods since we either pay to get rid of them or pay with the consequences of their presence. Similarly, salt water is not a scarce good. Although it is in limited supply, the current abundance of salt water makes it seem limitless. Clothes, clean air, and public libraries are scarce goods because their production requires the use of scarce resources that could be used for the production of other goods.

Section 1.4 Opportunity Cost 11. Since Sarah’s time is probably worth more during the school year (it would cost part of her salary), the opportunity cost of the trip is higher in February than in July. 12. The opportunity cost of this decision valued in dollars would be $33.50 ($30 forgone pay for not tutoring for two hours + $3.50 for the cup of coffee).

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13. a. The opportunity cost of going to college or university includes the income you could have earned by working instead; it also includes the money spent on school-specific expenses like tuition and textbooks. Room and board and transportation would not necessarily be included, since you would need those services even if you were not going to school. b. The opportunity cost of missing a lecture includes the potential damage to one’s grade in a course from not being present while important subject material is covered, as well as the knowledge’s forgone value in the ―real world.‖ The magnitude of the opportunity cost depends partly on how much essential information the instructor provides during the missed class session or if any activities were conducted. c. The opportunity cost of spending $100 today is the $105 you could have spent next year. If you are withdrawing the money just to have cash in your pocket, the opportunity cost of holding money is the 5 percent interest you could have been earning. d. The opportunity cost of snowboarding the weekend before final examinations is the expected reduction in grades that will result, in addition to the cost of a lift ticket. 14. Inactions are choices not to do something. Inactions, like actions, have consequences. For example, if you choose not to study, you may fail an exam. 15. One of the most important resources used raising children has historically been the mother's time. As opportunities for women to hold jobs, start businesses, and participate in political life increase, the cost of using women's time for raising children increases. As the cost of the mother's time rises, fewer children are born.

Section 1.5 Marginal Thinking 16. a. $50; $25 b. 3; 5; Mark would go as long as his marginal benefit was greater than the admission price. c. Yes; 6; Mark would buy the pass because his total benefits exceed his total cost. Once he has the pass, the marginal cost of attending one more day becomes zero, so he will go as long as his marginal benefits exceed zero. 17. a. $57; $88 b. 43; 44; he would produce widgets as long as the price (marginal benefit) exceeded the marginal cost. 18. The expected marginal benefits of jaywalking are the time saved and convenience of crossing the street where you want. The expected marginal costs are the additional risk of being hit by a car and the risk of being fined for jaywalking. a. Increases cost by increasing the risk of being hit by a car. b. Lowers cost by lowering the risk of being hit by a car and the risk of being fined. c. Increases the benefit because of the higher value of saved time. d. Increases cost because of a higher risk of receiving a fine. e. The time and convenience benefits are larger. f. The time and convenience benefits are smaller. 19. Marginal thinking involves incremental changes to a plan of action. All of the activities listed involve marginal thinking. When studying, one chooses whether or not to study for one more hour; when eating, one chooses whether or not to consume one more portion; when driving, one chooses whether or not to travel one more kilometre (or one more kilometre per hour); when shopping, one chooses whether or not to buy one more item or visit one more store; when getting ready for a night out, one chooses whether or not to spend another minute styling one's hair. Copyright © 2024 Cengage Learning Canada, Inc.

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20. As long as people follow the rule of rational choice, they will always make decisions from which they expect to gain more in benefits than they have to give up in costs; that is, they will make decisions from which their net marginal benefit (marginal benefit minus marginal cost) is positive. They will always be better off in this case. However, if people’s expectations about benefits or costs are wrong, their decisions may unexpectedly make them worse off.

Section 1.6 Incentives Matter 21. Positive incentives are those that either increase benefits or reduce costs and thus tend to increase the level of an activity. Both of the following are examples of positive incentives: (b) a trip to Hawaii paid for by your parents or significant other for earning an A in your economics course; (d) a subsidy for installing solar panels on your house. Negative incentives either reduce benefits or increase costs, and thus tend to decrease the level of the related activity or behaviour. Both of the following are examples of negative incentives: (a) a fine for not cleaning up after your dog defecates in the park; (c) a higher tax on cigarettes and alcohol. 22. Singapore’s tough drug-trafficking penalty would clearly impact the cost−benefit ratios of would-be smugglers. Lighter sentences would probably result in more drug smuggling because the overall cost of breaking the law would be reduced. 23. The Chinese government was attempting to promote population control. As the world’s most populated country, China has historically struggled with controlling population growth in it attempts to manage economic growth and national standards of living. The sanctions and penalties associated with not following the one-child policy would be considered negative incentives designed to discourage couples from having more than one child. The rewards and honours associated with following the policy would be considered positive incentives designed to promote adherence to the policy.

Section 1.7 Specialization and Trade 24. Denying trade possibilities also eliminates the possibility of specialization. In autarky, a country must produce everything it consumes. Scarce resources will be wasted producing goods with higher opportunity costs. Trading would allow the country to produce more with the same resources. 25. The opportunity cost to Fran of growing soybeans is the lost value because she can’t grow corn. This opportunity cost is equal to $1800 (3000 kg × $0.60/kg). The opportunity cost of growing corn is the lost opportunity to grow and sell soybeans, which is equal to $2250 (1500 kg × $1.50/kg). Fran should specialize in soybeans, which is the crop with the lower opportunity cost. For each hectare of corn that Fran converts to soybeans, she will gain $450. 26. a. b. c. d.

Canada has a comparative advantage in wheat. Colombia has a comparative advantage in coffee. British Columbia has a comparative advantage in lumber. Alberta has a comparative advantage in oil.

27. a. If the country or region with the lower opportunity cost produces the good, the opportunity cost of consuming that good is minimized. b. Trade allows people, regions, and countries to specialize in producing those goods in which they have the lowest opportunity cost, so reducing trade restrictions will encourage specialization,

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thereby increasing efficiency.

Section 1.8 The Three Economic Questions Every Society Faces 28. The three basic economic questions are: (1) What is to be produced? (2) How are these goods and services to be produced? (3) Who will get the goods and services? Scarcity requires that these questions be addressed in some way by every economy. Market economies answer these questions in a decentralized way through the interaction of millions of buyers and sellers. In command economies, decisions are made largely through planning boards. The manner in which an economic system answers these questions helps determine the allocation of limited resources. 29. No, Karl is wrong. Markets provide important signals, and the signal being sent in this situation is that Adam should look for some other way to support his ambitions, something that society values. Remember the function of consumer sovereignty in the marketplace. Clearly, consumers were not voting for Adam’s art. 30. Differences in economic decision making in pure command and pure market systems stem from differences in control over economic resources. In pure command systems, all economic resources are controlled by a central authority (usually represented by the government); this control gives this same central authority the ability to make all economic decisions for this economy. In a pure market system, economic resources are privately owned and therefore privately controlled. This decentralized control produces decentralized economic decision making. While economic inequality is possible in any type of economic system, the pure market system’s reliance on individual ability as the deciding factor in determining distribution (answering the ―how to we distribute what we have produced?‖ question) could generate a greater amount of economic inequality. In such a system, different levels of individual ability result in different levels of distribution (i.e., inequality) as opposed to a system where all individuals are treated equally and by association distribution is equal.

CHAPTER 1 APPENDIX WORKING WITH GRAPHS 1. b. c. d. e. f.

a. (−2, 2) (2, 1) (3, 2) (−1, −2) (2, –1) (−2, −1)

a. 8% b. 20% c. Two-door sedans d. All-electric

a. Semester 1 b. Semesters 3 and 4 c. Semester 2 d. Total number of boys: 372; total number of girls: 366

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Graph 1: Upward sloping

Graph 2: Downward sloping

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Graph 3: Unrelated

5. b. c. d. e. 6.

a. 2 −3 –0.5 Undefined 0

a. b. 5% c. 0.8% d. 5.5

50%

FOR YOUR REVIEW ANSWER KEY CHAPTER 2 SCARCITY, TRADE-OFFS, AND PRODUCTION POSSIBILITIES Section 2.1 The Production Possibilities Curve 1. a.

b. 1 side of beef; 6 kegs of beer; 9 kegs of beer c. 35 kegs of beer d. No; that combination is inside the production possibilities curve, which means more of one good could be produced without giving up any production of the other good.

e. No; that combination is beyond the production possibilities curve and therefore unattainable. 2. a. b. c.

A production possibilities curve, which applies to a specific period of time, is drawn assuming that resources and the level of technology are held constant. The opportunity cost of another pizza, when moving from point B to point C, is 4 units of robots. The opportunity cost of another pizza, when moving from point D to point E, is 8 units of robots. These combinations are exhibiting increasing opportunity cost―the more pizzas you have, the higher the opportunity cost of obtaining additional pizzas.

3. This is the law of increasing opportunity cost in action. As you planted more and more of your land in wheat, you would move into some of the less fertile land and, consequently, wheat yields on this additional land would fall. If you were to go so far as to plant the entire island with wheat, you would find that some of the less fertile land would yield virtually no extra wheat. It would, however, have been great for cattle grazing—a large loss. So, the opportunity cost of using that marginal land for wheat rather than cattle grazing would be very high.

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Section 2.1 The Production Possibilities Curve ―And― Section 2.2 Economic Growth and the Production Possibilities Curve 4. a.

Double-digit unemployment would not affect the production possibilities curve itself. An economy experiencing double-digit unemployment would be operating at a point inside the production possibilities curve. b. The production possibilities curve shifts outward whenever the economy experiences economic growth. c. Assuming resources are being used efficiently, the economy moves from one point along the production possibilities curve to another in the direction of more food production (requiring a sacrifice of shelter). d. Assuming resources are being used efficiently, the economy moves from one point along the production possibilities curve to another in the direction of more shelter (requiring a sacrifice of food).

5. a.

As indicated in the table above, if the province of Quebec is to continually increase tractor production by 10 tractors it must give up increasing amounts of cheese―thus illustrating the law of increasing opportunity cost.

Answer Key c.

The alteration in production from production alternative B to alternative E represents an increase in capital goods and a decrease in consumption goods. As a result, the prediction would be that the province of Quebec would experience greater economic growth in the future.

6. a.

Yes, the bowed-outward shape of the production possibilities curve indicates increasing opportunity costs. b. Zero; because point I is inside the production possibilities curve, moving from point I to point D means that the output of food can increase with no decrease in the output of shelter. c. 10 units of food d. All of the points on the production possibilities curve are efficient because at any of those points, more of one good could be produced only by sacrificing some output of the other good. However, the curve does not tell us which of those points is best from the perspective of society. e. Point N; additional resources or new technology (shifting the PPC outward). f. Point I; the economy must ensure that all resources are being utilized to their fullest extent―no wasted resources.

Section 2.2 Economic Growth and the Production Possibilities Curve 7. Investment in capital goods increases the future productive potential of an economy. Economy A will grow more rapidly, shifting the production possibilities curve outward to a greater extent over time, if it invests in a higher proportion of capital goods than does Economy B.

8. The politician would be able to keep her promise if the economy was operating inside the production possibilities curve. It would then be possible to have more of both schools and prisons by better utilizing

Answer Key available resources. Alternatively, an advance in technology or an increase in available resources (perhaps due to immigration) would also make it possible to have more of both goods by shifting the production possibilities curve in an outward direction.

9. a. A country will fail to grow if its sacrificed consumption is spent in other countries. b. A country will fail to grow if it chooses not to sacrifice because it cares so much about current consumption. c. Growth will be limited if a country does not invest in human capital. d. A country will fail to grow if its sacrificed consumption is spent on goods other than capital goods.

10. People acquire human capital though education, which adds to the nation's ability to produce, just as is the case with additions to the physical capital stock.

Section 2.3 Market Prices Coordinate Economic Activity 11. The definition of a market focuses on the process of exchange not on the physical location where the exchange takes place. Therefore, even though online buyers and sellers are never actually in the same place, their behaviour still constitutes a market transaction due to the fact that goods and services are being exchanged.

12. Buyers determine the demand side of the market. Consumers demand goods and services in product markets and producers demand resources in factor markets. Alternatively, resource owners supply factors of production in factor markets and producers supply goods and services in product markets.

13. Options (a), (b), and (c) would cause increases in the relative value and price of potatoes. In option (d), the reduction in the prices of potato substitutes would make alternatives more attractive and reduce the relative value and price of potatoes.

14. a. b. c. d. e.

Price of Jack Russell terriers rises Price of housing in Tampa rises Price of coffee rises Price of wheat rises Wages of Canadian doctors fall

15. The market is global. Manufacturers sell to dealers throughout the world. Transportation costs are low relative to the costs of a laptop computer. Middlepersons make information about prices and quality easily available.

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Section 2.4 The Circular Flow Model 16.

17. a. b. c. d.

Product market Factor market Product market Factor market. Furniture is a good purchased in the product market from firms. Labour is a resource that households sell to firms in the factor market. Restaurant food is a good purchased by consumers in the product market. Finally, Billy’s entrepreneurial resource is paid a profit, which is the amount left over after all his other costs have been paid. This takes place in the factor market.

18. a. The events of Claire getting paid $800 as a rental agent and Markus getting paid $70 to teach a b.

fitness class both occur in the factor market. The events of Claire spending $40 a week on her gym membership and Markus spending $200 on a rental car both occur in the product market.

FOR YOUR REVIEW ANSWER KEY CHAPTER 3 SUPPLY AND DEMAND Section 3.1 Demand 1. a. P $5 4 3 2 1

QD 4 8 12 16 20

P $5 4 3 2 1

QD 6 12 18 24 30

Answer Key c. P $5 4 3 2 1

QD 5 10 15 20 25

2. The market demand curve shows the total amounts of a good or service that all of the buyers as a group are willing to buy at various possible prices in a particular time interval, while the individual demand curve shows how much a single buyer is willing to purchase at various prices over a particular time period. The market quantity demanded at a given price is just the sum of the quantities demanded by each individual buyer at that price. 3.

Answer Key 4. Quantity Demanded (mL per week) Price ($ per mL) $15 12 9 6 3

Hillary 5 10 15 20 25

Marita 0 5 10 15 20

Jacquie 15 20 25 30 35

Market 20 35 50 65 80

Section 3.2 Shifts in the Demand Curve 5. a. b. c. d.

Demand decreases (Determinant: Price of substitute falls) Demand decreases (Determinant: Price of complement rises) Demand increases (Determinant variable: Taste and preference increase) Demand increases (Determinant: Number of consumers increases)

6. a. b. c. d.

Demand decreases (Determinant: Price of substitute decreases) Demand increases today (Determinant: Expected future price increases) Demand increases (Determinant: Income increases for a normal good) Demand increases (Determinant: Price of a complement decreases)

7. a. b. c. d.

Point B represents an increase in quantity demanded. Point E represents an increase in demand. Point F represents a decrease in demand. Point C represents a decrease in quantity demanded.

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8. a.

Assuming that beef is a normal good, demand for beef increases with consumer income, causing the demand curve to shift to the right.

b. An increase in the price of beef, ceteris paribus, decreases the quantity of beef demanded.

c. Ceteris paribus, an outbreak of mad cow disease is likely to decrease the demand for beef, shifting the demand curve to the left.

d. An increase in the price of a substitute increases the demand for beef, shifting the demand curve to the right.

e. If the price of a complement, barbecue grills, increases, the demand for beef will likely decrease, shifting

Answer Key the demand curve to the left.

9. a.

Hamburgers and ketchup are complements. An increase in the price of hamburger will decrease the demand for ketchup.

b. Coca-Cola and Pepsi are substitutes. An increase in the price of Coca-Cola will increase the demand for Pepsi.

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c. iPhones and iPhone cases are complements. An increase in the price of iPhones will decrease the demand for iPhone cases.

d. Golf clubs and golf balls are complements. An increase in the price of golf clubs will decrease the demand for golf balls, ceteris paribus.

e. Assuming that skateboards and razor scooters are substitutes, an increase in the price of skateboards will increase the demand for razor scooters.

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10. The demand for plane travel and all other normal goods will increase if incomes increase, while the demand for bus travel and all other inferior goods will decrease if incomes increase.

11. a. b. c. d.

The shift from D0 to D1 is called an increase in demand. The movement from B to A is called a decrease in the quantity demanded. The movement from A to B is called an increase in the quantity demanded. The shift from D1 to D0 is called a decrease in demand.

12. a.

The demand curve would shift rightward, indicating an increase in demand. b.

The demand curve would shift leftward, indicating a decrease in demand. c.

The demand curve would shift rightward, indicating an increase in demand.

Answer Key d.

The demand curve would shift leftward, indicating a decrease in demand. e.

The demand curve would shift leftward, indicating a decrease in demand.

Section 3.3 Supply 13. The market price of wheat would have to rise for Felix to have the incentive to produce from the second field. Because costs are higher in the second field, Felix must receive a higher price to compensate him for his higher costs.

14.

15.

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Price ($ per barrel) $5 10 15

Quantity Supplied (barrels per month) Rolling Rock Armadillo Oil Pecos Petroleum

Market

10 000 15 000 20 000

8 000 10 000 12 000

2 000 5 000 8 000

20 000 30 000 40 000

20 25

25 000 30 000

14 000 16 000

11 000 14 000

50 000 60 000

P $5 4 3 2 1

QS 25 20 15 10 5

16. a.

Answer Key b. P $5 4 3 2 1

QS 30 24 18 12 6

P $5 4 3 2 1

QS 20 16 12 8 4

Section 3.4 Shifts in The Supply Curve 17. a. b. c. d.

The shift from S0 to S1 is called an increase in supply. The movement from A to B is called an increase in the quantity supplied. The movement from B to A is called a decrease in the quantity supplied. The shift from S1 to S0 is called a decrease in supply.

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18. a.

The supply curve would shift rightward, indicating an increase in supply. b.

The supply curve would shift leftward, indicating a decrease in supply. c.

The supply curve would shift leftward, indicating a decrease in supply.

Answer Key d.

The supply curve would shift rightward, indicating an increase in supply.

19. a.

An increase in the price of corn would increase the quantity of corn supplied, but not the supply of corn. This is because a change in the price of corn causes the market for corn to experience a movement in supply (as opposed to a shift in supply). b. An increase in the price of corn would decrease the supply of wheat, which is a substitute in production to corn. This is because a change in the price of corn―a substitute in production with wheat―causes the market for wheat to experience a shift in supply (as opposed to a movement).

20. a. Supply decreases (Determinant: Input prices increase) b. Supply decreases (Determinant: Taxes increase) c. Supply increases (Determinant: Technology advances) 21. a. b. c. d. e.

Supply decreases (Determinant: Bad weather) Supply decreases (Determinant: Input prices rise) Supply increases (Determinant: Subsidies) Supply increases (Determinant: Technology advance) Supply decreases today (Determinant: Expected future price increases)

22. a. b. c. d.

Supply increases (Determinant: Input prices) Supply increases (Determinant: Number of suppliers) Supply decreases (Determinant: Taxes) Supply increases (Determinant: Technology)

23. a. b. c. d.

Point B represents an increase in quantity supplied Point C represents an increase in supply Point D represents a decrease in quantity supplied Point E represents a decrease in supply

24. a.

An increase in the price of sugar would increase the quantity of sugar supplied, but not the supply of sugar. This is because a change in the price of sugar causes the market for sugar to experience a movement in supply (as opposed to a shift in supply). An increase in the price of sugar would increase the supply of molasses, which is a complement in production to sugar. This is because a change in the price of sugar―a complement in production with molasses―causes the market for molasses to experience a shift in supply (as opposed to a movement).

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25. An increase in wages, or any other input price, would decrease the supply of guitars (the supply curve would shift to the left), making fewer guitars available for sale at any given price, by raising the opportunity cost of producing guitars.

Section 3.2 Shifts in The Demand Curve and Section 3.4 Shifts in The Supply Curve 26. a. b. c. d. e.

The supply of oil decreases, (supply curve for oil shifts left). The supply of oil increases, (supply curve for oil shifts right). The demand for heating oil increases, (demand curve for oil shifts right). The supply of oil increases (supply curve shifts right) Fewer people will drive gasoline-powered automobiles, decreasing the demand for oil (demand curve for oil shifts left).

FOR YOUR REVIEW ANSWER KEY CHAPTER 4 BRINGING SUPPLY AND DEMAND TOGETHER Section 4.1 Market Equilibrium Price and Quantity 1.

When a price is above the equilibrium price, the quantity of a good or service willingly supplied by sellers exceeds the quantity willingly demanded by buyers. If sellers want to sell a greater quantity of goods or services, it is necessary to reduce the price (or otherwise improve the terms of sale, such as with free delivery or lower interest rate financing) in order to induce buyers to make additional purchases. Market forces thus exert a downward pressure on price in the direction of equilibrium price. A surplus is eliminated once price falls to the equilibrium price. If a price is below the equilibrium price, then the quantity of a good or service willingly demanded by buyers exceeds the quantity willingly supplied by sellers. In order to induce sellers to provide a greater quantity to the marketplace, it is necessary for buyers to offer a higher price for the good or service. Market forces exert upward pressure on price in the direction of the equilibrium. A shortage is eliminated once price increases to the equilibrium price.

b. There is a shortage of 400 bottles. c. There is a surplus of 200 bottles. 3.

Equilibrium price = $400; Equilibrium quantity = 6.3 million units

b. A shortage exists at any price below $400; market forces would raise the price of a tablet computer up to $400 to self-regulate a solution to this shortage situation.

c. A surplus exists at any price above $400; market forces would lower the price of a tablet computer down to $400 to self-regulate a solution to this surplus situation.

Section 4.1 Market Equilibrium Price and Quantity and Section 4.2 Changes in Equilibrium Price and Quantity 4.

Pe = $4; Qe = 5000 kg

b. Surplus of 6000 kg c. Shortage of 3000 kg

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d. Surplus of 3000 kg e. Coffee market is in equilibrium at $2; therefore, no surplus or shortage. 5. a.

b. $7; 40 units traded. c. Surplus. At $9, above the equilibrium price, there will be a surplus of 30 units of Z [the quantity supplied at $9 (50) minus the quantity demanded at $9 (20)].

d. Shortage. At $3, below the equilibrium price, there will be a shortage of 60 units of Z [the quantity demanded at $3 (80) minus the quantity supplied at $3 (20)].

e. $8, with 45 units traded (at the new supply and demand intersection). f. $6, with 50 units traded (at the new supply and demand intersection). 6. a.

The equilibrium price equals $4, where the quantity of baseball tickets demanded equals the quantity of tickets supplied. b. The supply curve is unusual in that it is vertical at a level of 2000 tickets. c. A shortage would exist if the market price was less than the $4 equilibrium price. For example, at a price of $2, there would be a shortage of 2000 tickets. d. A surplus would exist if the market price of baseball tickets exceeded $4. For example, at a price of $6, a 1000 ticket surplus would occur. At a price of $8, a 1500 ticket surplus would occur. e. Next year's demand curve will shift to the right. The new equilibrium price of baseball tickets increases to $6, where the new quantity demanded (1000 + 1000) equals the 2000-seat stadium capacity.

7. An increase in supply increases the quantity supplied at the original equilibrium price, but it does not change the quantity demanded at that price, meaning that it would create a surplus at the original equilibrium price.

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8. a.

The price of wheat increases, and the equilibrium quantity of wheat traded decreases.

If the price of corn decreases, corn farmers are likely to plant less corn and more wheat. As a result, the supply of wheat to the marketplace will increase, decreasing the equilibrium price of wheat and increasing the equilibrium quantity of wheat exchanged.

If the Prairie provinces have exceptionally favourable weather, crop yields are likely to increase. The supply curve for wheat will shift to the right, decreasing the equilibrium price and increasing the equilibrium quantity of wheat traded.

Answer Key d.

Fertilizer is an input to the production of wheat. As a result of a decrease in the price of fertilizer, wheat is less expensive to produce, and the supply of wheat will increase. The equilibrium price of wheat will decrease, and the equilibrium quantity will increase.

If more individuals begin growing wheat, the market supply for wheat will increase. The equilibrium price of wheat will decrease, and the equilibrium quantity will increase.

9. a.

Effect on the hamburger market of an increase in the price of hot dogs:

Effect on cab trips of a decrease in the number of taxi companies:

Effect of El Niño rainstorm destruction of strawberry crops.

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10. Even though the tuition ―price‖ is the same in both cases, student demand for 10 a.m. classes is typically greater than for 8 a.m. classes. Students often prefer to sleep in later than punctual attendance at an 8 a.m. class would allow. A shortage of 10 a.m. class spaces relative to demand is the likely result. There may be a surplus of class spaces in 8 a.m. courses if the demand for early- morning classes is sufficiently low.

11.

Fresh fruit is less expensive in the summer because the supply curve for fresh fruit shifts rightward in the summer, thus lowering equilibrium price and increasing equilibrium quantity.

  

This event is supply-side, since it deals with how growers are making product available for sale. The event is a shift since the price of fresh fruit is not independently changing in the question. The event is expansionary, since Canadian producers are seen as being able to make more fresh fruit available in the summer, when it is in season, as opposed to in the winter.

Answer Key 12.

An increase in consumer income, when laptop computers are assumed to be a normal good, will

cause the demand curve to shift rightward (the supply curve remains unchanged). This rightward shift in demand will cause equilibrium price to increase and equilibrium quantity to increase. b.

Now that laptop computers are easier to use, there would be a greater preference (on behalf of consumers) to use them. This greater preference would shift the demand curve rightward (the supply curve remains unchanged). This rightward shift in demand will cause equilibrium price to increase and equilibrium quantity to increase. More expensive components would increase the cost of producing laptop computers. This increase in production cost will cause the supply curve to shift leftward (the demand curve remains unchanged). This leftward shift in supply will cause equilibrium price to increase and equilibrium quantity to decrease. The lower price of desk-top computers will increase the quantity demanded of desk-top computers. If desktop computers and considered a substitute to laptop computers, this increase in the quantity demanded of desk-top computers will result in a decrease in the demand for laptop computers (a leftward shift in demand). This decline in demand will cause equilibrium price to decrease and equilibrium quantity to decrease. Subsidizing the production of laptop computers will result in an increase in their production. This rightward shift in the supply curve will cause equilibrium price to decrease and equilibrium quantity to increase.

Section 4.3 Simultaneous Changes in Demand and Supply 13. a.

Price falls, quantity rises.

Price rises, quantity rises.

Answer Key c.

Price rises, quantity falls.

Price falls, quantity falls.

14.

a. An increase in income for a normal good will increase demand, shifting the demand curve to the right. A decrease in the price of an input will increase supply, shifting the supply curve to the right. Equilibrium quantity will increase, but equilibrium price is indeterminate. A technological advance increases supply, shifting the supply curve to the right. A decrease in the number of buyers reduces demand, shifting the demand curve to the left. Equilibrium price will fall but the effect on quantity is indeterminate. An increase in the price of a substitute good will increase demand, shifting the demand curve to the right. An increase in the number of suppliers will increase supply, shifting the supply curve to the right. Equilibrium quantity will increase, but equilibrium price is indeterminate. If producers expect that prices will soon fall, supply will be increased, shifting the supply curve to the right. A reduction in consumers’ taste for the good will reduce demand, shifting the demand curve to the left. Equilibrium price will fall but the effect on quantity is indeterminate.

15. If grape buyers expect grape prices to rise in the near future, it will increase their current demand to buy grapes, which would tend to increase current prices and increase the current quantity of grapes sold. If grape sellers expect grape prices to rise in the near future, they will decrease their current supply of grapes for sale, which would tend to increase current prices and decrease the current quantity of grapes sold. Because both of these effects tend to increase the current price of grapes, grape prices will rise. However, the supply and demand curve shifts tend to change current sales in opposing directions, so without knowing which of these shifts was of a greater magnitude, we do not know what will happen to current grape sales. They could go up, go down, or even stay the same.

Answer Key 16. a.

The first group of economists believes that an increase in demand is the cause of the increasing price of bathroom tissue. Panic buying results in a rightward shift in the demand curve which will cause equilibrium price to increase and equilibrium quantity to increase. The second group of economists believes that the increase in price is being caused by a decrease in supply. Supply-chain problems and resource shortages would both cause the supply curse for bathroom tissue to shift leftward, causing equilibrium price to increase and equilibrium quantity to decrease.

The simultaneous impact of both of these changes on equilibrium quantity can be used to determine which effect is greater. If the demand effect is greater than the supply effect, equilibrium quantity will increase. However, if the supply effect is greater than the demand effect, equilibrium quantity will decrease.

Section 4.4 Price Controls 17.

d. e.

a. To get to point A would require a decrease in supply; to get to point B would require a decrease in supply and an increase in demand; to get to point C would require an increase in demand; to get to point D would require a decrease in supply and a decrease in demand; point E is the current equilibrium; to get to point F would require an increase in supply and an increase in demand; to get to point G would require a decrease in demand; to get to point H would require an increase in supply and a decrease in demand; and to get to point I would require an increase in supply. The new equilibrium would be point F, because it is an increase in supply and an increase in demand. Equilibrium quantity would increase and if the magnitude of the demand and supply changes were equal, equilibrium price would remain constant. Indeterminate; because one of the changes decreases supply and the other increases supply, we don’t know what the net effect is on supply. If the effects were of the exact same magnitude, the result would be E; if the increase in supply was greater than the decrease in supply, the answer would be I; if the decrease in supply was greater than the increase in supply, the answer would be A. C; A; A. G; I; G.

18.

b. c.

If the price floor is raised, the quantity supplied increases, the quantity demanded decreases, and the surplus increases; if the price floor is lowered, the quantity supplied decreases, the quantity demanded increases, and the surplus decreases. The quantity supplied does not change, the quantity demanded increases, and the surplus decreases. The quantity supplied increases, the quantity demanded does not change, and the surplus increases.

19.

Answer Key

a. If the price ceiling is raised, the quantity supplied increases, the quantity demanded decreases, and the shortage is reduced; if the price ceiling is lowered, the quantity supplied decreases, the quantity demanded increases, and the shortage is increased. b. The quantity supplied does not change, the quantity demanded increases, and the shortage is increased. c. The quantity supplied increases, the quantity demanded does not change, and the shortage is decreased. 20. When a price floor is imposed above the equilibrium price, the quantity demanded by buyers falls. Sellers cannot sell what buyers are unwilling to purchase at this price. The quantity traded is therefore reduced relative to the market equilibrium. When a price ceiling is imposed below the equilibrium price, the quantity supplied falls. Buyers cannot purchase more units than sellers are willing to exchange. Therefore, the quantity traded decreases relative to the market equilibrium. 21. A price floor set above the equilibrium price for dairy products would result in a surplus. A price floor set below the equilibrium price would have no impact on the price or quantity of dairy products traded. (A price floor is a minimum allowed price, not a mandated market price.) 22. The $2 price ceiling will likely result in a shortage of movie tickets. At the new, lower price, quantity demanded will rise. People will want more tickets at $2 than they did at $10. Assuming that the equilibrium price is somewhere around $10, the ceiling will cause the quantity of tickets sold to decline. Some theatres may reduce their hours of operation, and some may even go out of business. Some theatres may stop showing first-run movies. Theatre owners will certainly suffer. While some movie-goers may benefit from lower prices, they may also have to stand in long lines to buy tickets. They may also see a reduction in the quality of movies offered by theatres.

FOR YOUR REVIEW ANSWER KEY CHAPTER 5 ELASTICITY Section 5.1 Price Elasticity of Demand 1. a.

Chevrolets (more substitutes). Chevrolets have more substitutes than cars in general since any other brand is a good substitute. b. Housing (greater share of budget). The price elasticity of demand for housing will be greater than for salt because of the large role housing plays in the household budget. c. Natural gas over the course of several years (more time to adjust). Natural gas has a more price- elastic demand in the long run since this gives consumers time to adjust their habits and complementary capital to any change. Also, the price elasticity of demand for a product will increase as more and better substitutes are available―the availability of more and better energy substitutes possibly increasing with time.

2. Demand would be relatively more inelastic if your work presentation is in two hours, as opposed to next week. If your presentation needs to be copied and bound within two hours, fewer alternatives are available to you. The quantity of copying and binding services that you demand will be less sensitive to changes in price if you have all week to search for better prices.

3. a.

Demand for Paul Mitchell Shampoo is likely more elastic than the demand for shampoo in general. There are more substitutes available for a particular brand of shampoo than there are substitutes for shampoo generally. b. The urgent need to travel quickly and on short notice to visit an ill family member makes demand relatively more inelastic than that for vacation air travel. c. Elasticity of demand is likely much greater for apartment rentals. The rent on an apartment comprises a much larger portion of one's annual budget than do paper clips. d. More substitutes are generally available for a generic headache remedy than for prescription heart medication. Therefore, the elasticity of demand for a generic headache remedy will be greater than that for heart medicine.

4. a. The elasticity of demand would equal 1. b. The elasticity of demand would equal 2. c. The elasticity of demand would equal 0.5. 5. The average of prices and quantities demanded does not change when the direction of movement is reversed, so the percentage changes in price and quantity demanded do not change. However, when the initial price and quantity demanded are used for calculating the percentage changes, a movement down along a demand curve starts with a higher initial price and lower initial quantity demanded than the same movement up along it, changing the percentage changes.

Answer Key

6. For many people, far fewer good substitutes are acceptable for turkey at Thanksgiving than at other times, so the demand for turkeys is more inelastic at Thanksgiving. But grocery stores looking to attract customers for their entire large Thanksgiving shopping trip also often offer and heavily advertise turkeys at far better prices than normally. This means shoppers have available more good substitutes and a more price elastic demand curve for buying a turkey at a particular store than usual.

7. If the price increases by 10 percent, quantity demanded will fall by 15 percent when the elasticity of demand for hamburgers equals 1.5. Hamburger sales will decline by approximately 6000 (15 percent of 40 000). If the price of hamburgers decreases by 5 percent, quantity demanded will increase by approximately 3000 hamburgers (7.5 percent of 40 000). 8.

9. If the price rises from $3 to $5, the change in price is $2. Using the midpoint technique, the midpoint price ($4) is used to calculate the percentage change in price. It will be (2/4 × 100) = 50 percent. Similarly, the percentage change in quantity is based on the change in quantity (−600) divided by the midpoint (1200) or −50 percent. The elasticity of demand is 1.

10. Demand is unit elastic if Isabella always spends the same dollar amount on roses, regardless of price.

Section 5.2 Total Revenue and Price Elasticity of Demand 11. If the elasticity of demand is estimated to equal 1.6, then demand is relatively elastic. A decrease in ticket prices would increase the quantity of tickets demanded sufficiently to increase the overall revenue from ticket sales. If the elasticity of demand is estimated to equal 0.4, then demand is relatively inelastic. In this case, an increase in ticket prices would boost the revenue from ticket sales.

12. The statement is only partially correct. Along a downward-sloping linear demand curve, the slope is indeed constant. However, elasticity of demand varies along a downward-sloping demand curve, decreasing as you move down to the right along the demand curve.

13. The demand is relatively elastic at prices above the midpoint of a straight-line demand curve and relatively inelastic below the midpoint, so it is relatively elastic for a price change from $12 to $10 but relatively inelastic for a price change from $6 to $4.

14. If the demand facing the Caesars Wexton is inelastic, then raising prices will increase total revenue, even if it reduces the number of guests. The advisors assumed that their demand was inelastic. There are three reasons for this assessment. First, since there are no other four-diamond hotels in Wexton, there are few good substitutes for the services provided by the hotel. The fewer the available substitutes, the more inelastic the demand elasticity. Second, hotel expenditures are probably a small part of the budgets of people who stay in four-diamond hotels; items that represent a smaller portion of a household’s budget generally exhibit a lower price elasticity of demand. Finally, it takes time for people to adjust their behaviour. In the short run, demand will be relatively inelastic.

Answer Key

15. a. b. c.

Total revenue increases from $200 ($4 × 50) to $300 ($3 × 100). Since total revenue increased with a decrease in price, demand must be relatively elastic. Since total revenue goes down from $300 ($2 × 150) to $200 ($1 × 200) as price falls from $2 to $1, demand must be relatively inelastic in that range of the demand curve.

16. If a price is chosen along the elastic portion of a downward-sloping linear demand curve, reductions in price will increase total revenue. If a price is chosen along the inelastic portion of a downwardsloping linear demand curve, increases in price will boost total revenue. A firm seeking to maximize total revenue should reduce price until it is no longer operating on the elastic portion of the demand curve and increase price until it is out of the inelastic range. That leaves the unit elastic point along a linear demand curve. The price that corresponds to the unit elastic point is the price at which total revenue is maximized.

Section 5.3 Other Demand Elasticities 17. The cross-price elasticity of demand coefficient equals (Percentage change in the quantity demanded of Brimm) / (Percentage change in the price of Fram). The percentage change in the quantity demanded of Brimm equals (900 – 1200)/[(900 + 1200)/2] = -0.286. The percentage change in the price of Fram equals (20 – 16)/[(20+16)/2] = 0.222. The cross-price elasticity of demand coefficient between Fram and Brimm equals (-0.286)/(0.222) = -1.288. Observing that this coefficient is negative allows you to determine that Fram and Brimm and complements. 18. 20 percent ÷ –10 percent = –2. 19. a. If the income elasticity of demand for a good is positive, it is a normal good. b.

If the income elasticity of demand for a good is negative, it is an inferior good.

20. The cross-elasticity of demand for this example is obtained by dividing the percentage change in quantity demanded for tea (25 percent) by the percentage change in the price of coffee (10 percent). The cross-elasticity is 2.5. 21. a. The income elasticity of demand equals (Percentage change in the quantity demanded)/(Percentage change in incomes). The percentage change in quantity demanded over the period equals (18 − 19)/([18 + 19]/2) = −0.054. The income elasticity of demand for rail travel equals (−0.054)/(0.13) = −0.415. b.

The cross-price elasticity equals (Percentage change in quantity demanded)/(Percentage change in the price of air travel). The percentage change in quantity demanded equals (19 − 17.5)/([19 + 17.5]/2) = 0.082. The cross-price elasticity of demand for rail travel equals (0.082)/(0.075) = 1.09. The positive cross-price elasticity shows us that air travel and rail travel are substitute goods. The negative income elasticity shows us that rail travel is an inferior good.

Answer Key

22. Calculation:

Interpretation: Designer jeans are considered a normal good because EI > 0. The jeans are also considered a luxury good because EI > 1.

Section 5.4 Price Elasticity of Supply 23. a. The elasticity of supply would equal 1. b. The elasticity of supply would equal 0.5. c. The elasticity of supply would equal 2. 24. The government-imposed price ceiling causes a 20 percent reduction in price (from $1000 to $800). However, using the midpoint formula, the change in price is 22 percent. If elasticity of demand equals 2.0, quantity demanded is likely to change by 44 percent to approximately 14 400 apartments. If elasticity of supply equals 0.5, a 22 percent change in price will lead to an 11 percent decrease in the quantity of apartments supplied. The new quantity supplied will equal approximately 8900 rental units. A shortage of 14 400 – 8900 = 5500 units is the predicted result. 25. If the price of tablet computers increases by 5 percent, quantity supplied will increase by 3 percent when price elasticity of supply is 0.6. Production volumes will increase by 1.5 million units (3 percent of 50 million). If the price of tablet computers decreases by 8 percent, then quantity supplied will decrease by 4.8 percent, or 2.4 million units (4.8 percent of 50 million).

Section 5.5 Elasticity and Taxes 26. When demand is less elastic than supply, the tax burden falls primarily on consumers. When demand is more elastic than supply, the tax burden falls primarily on producers. The tax burden of a tax on food would fall primarily on consumers, while the tax burden of a tax on basketball tickets would fall primarily on producers. 27. Relative elasticities of supply and demand determine the incidence of a tax. If the difference between the short-run and long-run elasticity was greater on one side of the market than the other, the longrun incidence could be dramatically different from the short-run incidence. For example, if supply was very inelastic in the short run but very elastic in the long run, suppliers could bear most of the short-run burden of a tax, but very little of the burden in the long run. As both demand and supply become more elastic in the long run, this will lead to larger reductions in the quantity exchanged; the revenue from a given tax would tend to decrease over time, other things being equal.

Answer Key

28. a.

The amount of the tax is the difference between the after-tax price paid by the consumer and the after-tax price received by producers. In this case, after the tax is imposed, consumers pay $2 and producers receive $1.40, so the tax amounts to $0.60 ($2 − $1.40).

FOR YOUR REVIEW ANSWER KEY CHAPTER 6 CONSUMER CHOICE AND MARKET EFFICIENCY Section 6.1 Consumer Behaviour 1. We know that the person’s marginal utility for the next bite is negative—that the person’s total utility will be reduced if she or he eats one more bite. 2. Escargot Marginal Utility Per Day 1

Total Utility 10

3. The ski resort knows that the utility you derive from an additional 4 hours of skiing will be less than the first 4 hours of skiing (law of diminishing marginal utility). As a result, in order to make the second 4 hours of skiing economically justifiable, the resort must sell the second 4 hours of skiing at a lower price ($10 instead of $23). 4. Since you would have to pay for additional units, you would be unwilling to do so unless you received a sufficient positive marginal benefit as well, and where total utility is diminishing, marginal utility is negative.

5. The highlighted numbers in the table below are the ones that were missing. Number of Smartphone Apps 0

Total Utility 0

Marginal Utility ―

−2

6. According to the rule of rational choice, a diner should continue eating as long as the marginal benefit of an additional helping exceeds the marginal cost of that helping. The marginal cost of the

Answer Key

first helping of food is $9.95. Once $9.95 is paid for the ―All-You-Can-Eat‖ meal, the marginal dollar cost of an additional helping equals zero. (The marginal cost to one's health from eating additional portions may exceed zero, however.) Food consumption should continue until the marginal benefit of an additional helping just equals zero (or until the marginal benefit just equals the expected marginal cost to one's health). The optimal level of food consumption is expected to yield more than $9.95 worth of total satisfaction. The marginal utility of successive helpings will diminish as consumption increases.

Section 6.2 Consumer Choice 7. The marginal utility per dollar derived from soft drinks equals 6 utils/$1, while the marginal utility derived from pizza consumption equals 2 utils per dollar (4 utils/$2). Since the satisfaction per dollar derived from the last soft drink consumed exceeds the satisfaction per dollar derived from the last slice of pizza, Brandy should purchase more soft drinks and less pizza. As Brandy consumes more soft drinks, the marginal utility per dollar spent on soft drinks will fall (since marginal utility will diminish). As less pizza is consumed, the marginal utility per dollar spent on pizza will increase (since the marginal utility derived from pizza will increase). 8. You are likely to receive more marginal utility from pizza after a late-night study session than after finishing a five-course holiday dinner. You are more likely to visit the Domino’s website and place an order after (or during) the night of studying. If you pay for pizza consumed at home but do not pay for the pizza at a party, you might tend to eat a greater quantity of pizza at the party (perhaps until the marginal utility of an additional slice equals zero). If, however, you are concerned about social etiquette and ensuring that pizza is available for others to enjoy, you might consume fewer slices of pizza at a party than you would at home. 9. In consumer equilibrium, the typical student will purchase 4 cups of coffee (49 utils) and 1 muffin (6 utils), for a total of 55 utils of satisfaction. Cups of Coffee Number of Cups 0

TU 0

MU ―

Muffins MU/P ―

Number of Muffins 0

6.5

TU 0

MU ―

MU/P ―

5.5

4.5

2.5

−2

Answer Key

10. In consumer equilibrium, the utility-maximizing student will purchase 4 cups of coffee (49 utils) and 2 muffins (10 utils), for a total of 59 utils of satisfaction. Cups of Coffee

Muffins

Number of Cups 0

MU/P ―

Number of Muffins 0

TU 0

MU ―

TU 0

MU ―

MU/P ―

6.5

5.5

4.5

2.5

−2

−4

11. The highlighted numbers in the table below are the ones that were missing. Hockey Games TU MU 0 ―

MU/P ―

Number 0

1.25

4 5 6

Number 0

Football Games TU MU 0 ―

MU/P ―

1.5

0.75

0.5

0.625

0.5

0.25

0.375

The sports fan will attend 2 football games (30 utils) and 4 hockey games (58 utils), generating a total of 88 utils of satisfaction.

Section 6.3 Consumer and Producer Surplus 12. a. b.

Consumer surplus equals area A. Consumer surplus increases by area B + C.

13. a. Steve is willing to pay $4.50 for one bag of potato chips. b. Steve is willing to pay $4.00 for a second bag of potato chips. c. Steve’s consumer surplus is $5.00 when he buys five bags. He gets a $2.00 surplus on the first bag, $1.50 on the second, $1.00 on the third, and $0.50 on the fourth. At $2.50 per bag, he gets no consumer surplus on the fifth bag. d. Steve’s total willingness to pay for 5 bags is $17.50. He is willing to pay $4.50 for the first bag, $4.00 for the second, $3.50 for the third, $3.00 for the fourth, and $2.50 for the fifth bag.

Answer Key

14. If a freeze ruined this year’s lettuce crop, the supply of lettuce decreases from S1 to S2 in the diagram below―as does consumer surplus.

15. If the demand for apples increased from D0 to D1 in the diagram below as a result of a news story that highlighted the health benefits of two apples a day, producer surplus would increase as indicated.

16. At the efficient level of output, the societal gains from trade, or total surplus, is maximized. When less than the efficient level of output is produced, a deadweight loss occurs. Some of the potential gains from trade are not realized when a less than efficient level of output is produced.

17. a. b.

$30 Producer surplus will increase from $30 to $60, an increase of $30

FOR YOUR REVIEW ANSWER KEY CHAPTER 7 PRODUCTION AND COSTS Section 7.1 Profits: Total Revenues Minus Total Costs 1. As urban development continues, placing increasing pressures on key scarce resources such as the Greenbelt, the opportunity cost (forgone alternative) of using the Greenbelt for farming and environmental protection will continue to increase. As the opportunity cost increases, so will the economic cost of using this land for farming and environmental protection.

2. Despite the fact that the explicit cost of growing strawberries remains unchanged, since the opportunity cost (forgone alternative) of using your land triples, the cost (Economic cost = Explicit costs + Implicit costs) of using your land to grow strawberries will increase.

3. Anglers may not have to pay their relatives to work as crew but that does not mean this strategy has no cost. Employing relatives reduces the anglers’ explicit cost because crew salaries are reduced. However, there are still opportunity costs. Implicit costs will increase as long as the relatives have alternative uses of their time. Employing relatives might increase accounting profits but it can decrease economic profits at the same time.

4. No, Emily’s mother will not agree with the accountant, because he forgot to include the implicit costs when calculating Emily’s profits. That is, he neglected to take into account what Emily could have been doing with her time if she had not been selling lemonade. For example, she could have been playing with her friends, cleaning her room, or perhaps helping her friends make money at their garage sale. These lost opportunities are implicit costs that should be included in the calculation of Emily’s economic profits.

Section 7.2 Production in the Short Run 5. a. Labour (workers)

Total Product (visits Marginal Product per hour)

―

−2

b. Beginning with the third worker. c. Beginning with the sixth worker. 6. a.

Answer Key

Labour 1 day 2 days 3 days 4 days 5 days 6 days 7 days

With Three Machines Total Product Marginal (hats) Product (hats) 8 8 18 10 30 12 45 15 57 12 67 10 72 5

Labour 1 day 2 days 3 days 4 days 5 days 6 days 7 days

With Four Machines Total Product Marginal Product (hats) (hats) 9 9 20 11 35 15 55 20 76 21 88 12 95 7

b. The point of diminishing marginal product is at five worker days with three machines and six worker days with four machines.

c. Crowding occurs later with more machines. 7. Labour (workers) 0 1 2 3 4 5 6

Total Product (kilograms) 0 20 44 62 74 80 78

Marginal Product (kilograms) ― 20 24 18 12 6 −2

a. Candy’s Candies begins to experience diminishing marginal product with the third worker, the first one for which marginal product begins to fall.

b. Candy’s Candies experiences a negative marginal product beginning with the sixth worker. 8. Diminishing marginal product means that as the amount of a variable input is increased—the amount of other inputs being held constant—a point will ultimately be reached beyond which marginal product will decline. It is caused by reductions in the amount of fixed inputs that can be combined with each unit of a variable input, as the amount of that variable input used increases. 9. a. The marginal product of the seventh worker equals 6 units of output. b. The law of diminishing product begins with the fifth worker hired. c. A firm would never choose to hire nine workers under these conditions, since the marginal product of the ninth worker is negative.

10. As a variable factor, such as labour, is added to a given amount of the fixed factor, such as capital or land, the marginal product of that factor will eventually diminish. Once the marginal product begins to diminish, an increasing amount of the variable factor must be added in order to boost the output of a good by a particular increment in the short run. An increasing amount of output from alternative productive activities must be sacrificed (an increasing opportunity cost).

Section 7.3 Costs in The Short Run 11.

Answer Key

Output 1 2 3 4 5 6 7 8

Total Fixed Total Variable Average Fixed Average Average Total Costs Costs Total Costs Costs Variable Costs Costs $100 100 100 100 100 100 100 100

$30 50 60 64 90 126 168 218

$130 150 160 164 190 226 268 318

$100 50 33.33 25 20 16.67 14.29 12.50

$30 25 20 16 18 21 24 27.25

Marginal Costs

$130 75 53.33 41 38 37.67 38.29 39.75

$30 20 10 4 26 36 42 50

12. The average cost per day equals $20 for the two-day pass. The marginal cost of the second day is $4. 13. Your choice will affect your fixed and variable costs. If you choose to pay the flat fee, your fixed costs for the film will equal $5000 for the week. Your variable costs associated with the leasing of the film would then equal zero. If you choose to pay $2 per customer, then the costs associated with leasing the film will all be variable.

14. Marginal costs will increase by as much as 50 percent when workers must be paid time-and-a-half beyond an eight-hour day. (If labour is the only variable input, marginal cost will increase by exactly 50 percent.) If workers are less productive after eight hours of work, marginal costs will be even higher beyond eight hours of work.

15. Not necessarily. It is marginal cost that is critical. The next barrel of oil might cost $30 to produce because the well might be drying up or the company might have to drill deeper to get additional oil, making it even more costly to retrieve. It is possible that the marginal cost of the additional barrels of oil might be greater than the market price; therefore, the situation is no longer profitable. 16.

Output

Total Fixed Costs

Total Variable Costs

Total Costs

Average Average Average Fixed Cost Variable Cost Total Cost

Marginal Cost

$200

$60

$260

$200

$60

$260

$60

200

100

300

100

150

200

120

320

66.67

106.67

200

128

328

200

180

380

200

252

452

33.33

75.33

200

366

566

28.57

52.29

80.86

114

200

536

736

67.00

92.00

170

17. The note-taker's wage is a fixed cost, which does not vary with the number of subscriptions sold. 18. a. The marginal product of the 51st worker is 200 vests per month. b. The marginal cost equals $8 ($1600/200). c. Average variable costs will rise because average variable cost is $6.67 when 12 000 vests are produced ($1600 × 50/12 000).

d. Marginal cost rises because marginal product is falling.

Answer Key

19. a. b. c. d. e.

Average fixed cost (AFC) Average variable cost (AVC) Average total cost (ATC) Marginal cost (MC) Where MC is less than AVC, AVC is falling; when MC equals AVC, AVC does not change; and when MC exceeds AVC, AVC is rising, so the intersection of MC and AVC is at the minimum point of AVC. When MC is less than ATC, ATC is falling, when MC equals ATC, ATC does not change, and when MC exceeds ATC, ATC is rising, so the intersection of MC and ATC is at the minimum point of ATC. The point where MC equals AFC has no economic significance.

20.

21. a.

AVC is at its minimum at the q1 level of output, where the AVC and MC curves intersect. This point marks the minimum of AVC because at levels of output below this (such as q0) MC is less than AVC, forcing AVC downward. For levels of output above this (such as q2) MC is greater than AVC, pulling AVC upward. ATC is at its minimum at the q2 level of output, where the ATC and MC curves intersect. This point marks the minimum of ATC because at levels of output below this (such as q1), MC is less than ATC, forcing ATC downward. For levels of output above this (such as q3), MC is greater than ATC, pulling ATC upward. MC is at its minimum at the q0 level of output. This level of output marks the minimum of MC since it coincides with the point where diminishing marginal productivity sets in.

Section 7.5 Cost Curves: Short Run and Long Run 22. a.

No, none of the firms experience constant returns to scale over their ranges of output. This is because as output increases, LRATC does not remain constant. b. Belle’s Bananas experiences diseconomies of scale over its entire range and Cam’s Cantaloupes experiences diseconomies of scale from the fourth unit of output. This is because as output increases, LRATC increases. c. Arnold’s Apples experiences economies of scale over its entire range and Cam’s Cantaloupes experiences economies of scale for the first three units of output. This is because, as output increases, LRATC decreases.

23. a.

Answer Key b. c.

B Diseconomies of scale

24. Output 0 1 2 3 4 5 6 7

TVC0 0 10 18 21 26 35 51 77

TVC1 0 15 27 31.5 39 52.5 76.5 115.5

AVC0 ― 10 9 7 6.5 7 8.5 11

AVC1 ― 15 13.5 10.5 9.75 10.5 12.75 16.5

MC0 ― 10 8 3 5 9 16 26

MC1 ― 15 12 4.5 7.5 13.5 24 39

Answer Key 25. Change a. The government imposes a tax that is applied to every unit produced. b. The price of rent increases.* c. New technology that improves productivity is introduced. d. The cost of labour increases. e. The cost of materials used in manufacturing decreases. f. Property taxes increase.*

AVC

ATC

↑ R/u ↓ ↑ ↓ R/u

↑ ↑ ↓ ↑ ↓ ↑

* These changes impact only ATC (and have no effect on AVC and MC) because they cause only FC to change. Note: ―R/u‖ stands for ―Remains unchanged.‖ 26. Mrs. Bill is assuming that Buffalo Bill is operating in the range of economies of scale. If this were the case, increasing his output would lower average total costs. This change may lower average total costs below the price Buffalo Bill receives for his chips.

FOR YOUR REVIEW ANSWER KEY CHAPTER 8 PERFECT COMPETITION Section 8.1 The Four Major Market Structures 1. If a perfectly competitive firm sells only a small amount relative to the total market supply, even sharply reducing its output will make virtually no difference in the market quantity supplied; therefore, it will make virtually no difference in the market price. In this case, a firm is able to sell all it wants at the market equilibrium price but is unable to appreciably affect that price; therefore, it takes the market equilibrium price as given—that is, it is a price taker. 2. Industry Montreal taxi business: City issues a limited number of permits.

Identical Products

Commercial aircraft company: The costs of starting such a business are significant. Window-washing business: Low cost of entry and limited specialized training. Fast-food business: Restaurant chains produce meals that are distinctive. Broccoli farming: There are many producers of broccoli, which requires no special growing conditions.

Ease of Entry and Exit

Perfectively Competitive Market

Many Firms and Buyers

Yes

3. Farms can be thought of as perfectly competitive businesses, which produce products that are very close to perfect substitutes. For example, one farmer’s eggs are very good substitutes for any other farmer’s eggs. Any advertising for eggs―such as that by an industry council―will increase the market demand for all farmers’ eggs. All farms will benefit since the market price will rise. In this situation, no single farm has an incentive to invest in advertising since it will benefit from the advertising of others and the price it can charge will increase.

Answer Key

Section 8.2 An Individual Price Taker’s Demand Curve 4. a.

5. A perfectly competitive firm is able to sell all it wants at the market equilibrium price. Therefore, it has no incentive to lower prices (sacrificing revenues and therefore profits) in an attempt to increase sales. Because other firms are willing to sell perfect substitutes for each other’s product (because goods are homogeneous) at the market equilibrium price, trying to raise the price would lead to the firm losing all of its sales. Therefore, it has no incentive to try to raise its price, either. 6.

The predominant feature is that it is perfectly elastic (horizontal).

Answer Key

Section 8.3 Profit Maximization 7. Average revenue equals total revenue divided by output, or $25 at all output levels. Marginal revenue is the addition to total revenue from selling one more unit of output, also equal to $25 at all levels of output. If marginal revenue is constant and equal to $25 at all levels of output, $25 must be the market price. The short-run profit-maximizing (loss-minimizing) level of output is found where marginal revenue equals marginal cost (provided that price exceeds average variable cost). Marginal revenue equals marginal cost for the third unit. 8. Total Revenue Quantity 6 7 8 9 10 11 12

Price $10 10 10 10 10 10 10

$60 70 80 90 100 110 120

Marginal Revenue $10 10 10 10 10 10 10

Marginal Cost Total Cost $30 35 42 51 62 75 90

$3 5 7 9 11 13 15

Total Profit $30 35 38 39 38 35 30

Its profit-maximizing output is 9 units.

9. When average total cost is $3, profit will be total revenue (1000 × $5 = $5000) minus total costs (1000 × $3 = $3000) or $2000. When average total cost is $6, profit will be total revenue (1000 × $5= $5000) minus total costs (1000 × $6 = $6000) or −$1000. A firm will make a profit if price exceeds average total cost for the quantity produced and sold, and a loss if price is less than average total cost for the quantity produced and sold. 10. a. At P0, zero units; at P1, q1 units; at P2, q2 units; at P3, q3 units b. c. d.

At any price above P2; P2; any price below P2 At any prices below P1 The firm’s supply curve would be its MC curve above the minimum point of the AVC curve.

11. a. Quantity 10 11 12 13 14

Price $12 12 12 12 12

Total Revenue $120 132 144 156 168

Marginal Revenue $12 12 12 12 12

Marginal Cost $8 9 11 12 14

Total Profit $25 28 29 29 27

The profit-maximizing level of output is 13 units. b. Marginal revenue equals marginal costs at 13 units of output, so 13 units is the profit-maximizing output level (to be precise, the entrepreneur could produce either 12 or 13 and earn the same profit, since MR and MC are equal on the 13th unit). Even though the firm does not increase profits on the 13th unit, it will still produce this quantity since it is covering its costs, so the entrepreneur is earning an amount equal to his opportunity costs. c. At a price of $9, the profit-maximizing output would be 11 units, where marginal revenue equals marginal cost. If the firm produced 12 units, profits would fall by $2 (marginal cost minus marginal revenue).

Answer Key

Section 8.4 Short-Run Profits and Losses 12. If price was greater than average variable cost but less than average total cost, a firm would be earning losses and would eventually go out of business if that situation continued. However, in the short run, as long as total revenues more than covered total variable costs, losses from operating would be less than the losses from shutting down (these losses equal total fixed cost), as at least part of fixed costs would be covered by revenues; so, a firm would continue to operate in the short run in this situation. 13. a. $35 per unit, 85 units b. c. c.

TR = $35 × 85 = $2975, TC = $31 × 85 = $2635, Economic profits = $2975 − $2635 = $340 TR = $25 × 65 = $1625, TC = $31 × 65 = $2015, Economic profits = $1625 − $2015 = −$390 (loss) The firm should continue to produce in the short run, since price (MR) is greater than its AVC. The firm should choose to shut down in the short run, since price (MR) is now less than its AVC.

14. a. Price must cover AVC, or firms will lose more by operating than by shutting down. Producing output when the price is less than average variable cost will cause firms to lose not only their fixed costs, but also a fraction of their variable costs. By shutting down when average variable cost exceeds price, firms can limit their losses to only fixed costs. b.

Loss-minimizing (profit-maximizing) firms will continue to operate in the short run if price exceeds average variable cost. By continuing to operate, firms can cover their variable costs, as well as a portion of their fixed costs. If they were to shut down, firms would suffer losses equal to the total dollar amount of their fixed costs. In the short run, when not all factors of production can be varied, a firm can receive a price in excess of average total cost and thereby earn economic profits. Price cannot exceed average total cost in a perfectly competitive market in the long run, however, when all factors of production can be varied. In the long run, new firms have sufficient time to enter the industry and established firms can more readily expand output. New entry will occur until the market price falls to the level of average total cost and economic profits are eliminated.

15. a. False. When economic profits are zero, firms are earning normal profits. Total revenue is sufficient to cover all costs of production, including a normal rate of return for business owners.

b. False. In the long run, a perfectly competitive firm maximizes profit at a level of output where average total

cost is minimized. In the short run, however, if a profit-maximizing firm is earning economic profits, it will not produce at an output level where average total cost (or any other cost) is minimized. Rather, the firm chooses output where marginal revenue equals marginal cost. False. The statement is ambiguous. For example, a firm could minimize overall costs by not producing any output at all. Such a strategy would certainly not result in positive economic profits. In the long run, if a firm is producing at the output level where average total cost is minimized, it is also maximizing its profits. However, in the short run, choosing an output level at which average total cost is minimized is unlikely to yield maximum profits for the firm. Instead, to maximize profits, the firm should choose to produce a quantity of output where marginal revenue equals marginal cost.

Answer Key

Section 8.5 Long-Run Equilibrium 16. a. Firms maximize profits (minimize losses) by choosing output where marginal revenue equals marginal cost. Profit is also therefore maximized where the price equals marginal cost, since the marginal revenue of a perfectly competitive firm equals the price. Profit-maximizing firms will choose output where P = MC, both in the short run and the long run. b.

In the long run, when all inputs can be varied and firms are able to freely enter and exit an industry, perfectly competitive firms will earn a normal profit. All short-run economic profits (losses) are dissipated as new firms enter (exit) the industry. Firms earn a normal profit when P = Minimum ATC.

17. If firms are currently earning economic profits, that will attract entry into the industry, shifting the industry supply to the right. That will lower the price and reduce economic profits. If firms are currently earning economic losses, firms will exit the industry, shifting the industry supply curve to the left. That will raise the price and reduce economic losses. 18. a. (1) Price ($) 2 4 6 8 10 b.

(2) (3) Market Supply (tonnes Market Demand (tonnes per per year) year) 4 000 19 000 8 000 18 000 12 000 17 000 16 000 16 000 20 000 15 000

Pat will produce where her MC is equal to the equilibrium price of $8. This is at a quantity of 16 tonnes per year. At this profit-maximizing level of output, Pat will be earning a profit, as her ATC curve is below the MR curve at this point. As for the market, it too will generate a profit while producing 16 000 tonnes per year. The profit indicated in part (b) will trigger entry into the corn market―increasing market supply. This entry will continue until existing short-run profits disappear. This will happen at an equilibrium price of $6 per tonne (at the minimum of the firm ATC curve).

Section 8.6 Long-Run Supply 19.

The short-run effect of an increase in demand on the perfectly competitive firm is illustrated by the movement from point a to point b in the firm diagram and from point A to point B in the market diagram. As a result of this increase in demand, the firm is now earning positive economic profits in the short run.

Answer Key b.

The long-run effect of an increase in demand for a constant-cost industry is illustrated by the movement from point b to point c (same as point a) in the firm diagram and from point B to point C in the market diagram. The entry triggered by the short-run profits will lower market price; this lower market price will result in lower economic profits for the individual perfectly competitive firm. Entry into the industry will continue and market price will continue to fall until economic profits are eliminated and all firms are once again earning a normal amount of economic profit.

20.

A decrease in market demand from D1 to D2, as illustrated above, causes the market price to fall from P1 to P2. Since a perfectly competitive firm is a price taker, the perfectly elastic demand curve faced by an individual firm shifts downward from d1 to d2. Firms initially earning zero economic profits will begin suffering losses (the shaded area) as price falls below the average total cost of production. Over time, firms will exit the industry, shifting the market supply curve leftward from S1 to S2. Exit from the industry continues until firms once again begin earning a normal profit, which in a constant-cost industry occurs when the market price returns to its original level 21. a. b. c.

Increasing-cost, since more teams will bid up the price of good pitchers and reduce the quality of the average pitcher. Constant-cost, since expansion of output will not significantly increase the price of these unspecialized inputs. Increasing-cost, since industry expansion will put upward pressure on the wages offered to these trained workers

FOR YOUR REVIEW ANSWER KEY CHAPTER 9 MONOPOLY Section 9.1 Monopoly: The Price Maker 1. a. Although many actors compete for acting roles, in some sense an actor like Simu Liu has a monopoly over his own special talents. b.

c. d.

While not the only means, electricity is the predominant way in which we power the various items we use on a daily basis. Electricity is therefore largely a product without alternative. Since BC Hydro is the sole provider of electricity for most if not all of the province of British Columbia, we could consider BC Hydro to be a monopoly. The only doctor in a small town has a local monopoly over physician services. Such a doctor's monopoly power is likely to be limited, however, if physicians are available in nearby towns. Ford Motor Company would not be considered to be a monopoly.

2. Question a. b. c. d.

Government Patent or Licence

Ownership of an Essential Resource

High Entry Costs

X X X X

3. Being a price maker does give the monopolist the ability to set price at a desired level. However, in doing so, the monopolist must accept whatever quantity consumers are willing to buy at that price. A monopolist can determine either price or quantity sold, but not both. 4. It is not optimal for a monopolist to operate on the inelastic portion of the demand curve. When demand is inelastic, quantity demanded changes by a smaller percentage than does the price. As a result, a monopolist could increase total revenue simply by reducing output and raising price. At the same time, reducing output reduces total production costs. If revenue rises and costs fall when output is reduced, profit increases. Therefore, a profit-maximizing monopolist should increase price until it is no longer operating in the inelastic portion of the demand curve.

Answer Key

Section 9.2 Demand and Marginal Revenue in Monopoly 5. Demand Elastic or Inelastic

Quantity

Price

Total Revenue

Marginal Revenue

$11

Elastic

−1

Inelastic

−3

Inelastic

−5

Inelastic

−7

Inelastic

−9

Inelastic

Quantity

Price

Total Revenue

Marginal Revenue

Demand Elastic or Inelastic

Total Cost

Marginal Cost

Profit

$11

Elastic

−3

Elastic

−1

Inelastic

−3

Inelastic

−10

−5

Inelastic

−19

−7

Inelastic

−30

−9

Inelastic

−43

The monopolist’s profit-maximizing price is $8 and profit-maximizing output is 4 units.

Answer Key 7.

a. Marginal Revenue Elastic or Inelastic

c. d.

Quantity 30

Price $3.65

Total Revenue $109.50

3.58

110.98

$1.48

Elastic

3.51

112.32

1.34

Elastic

3.44

113.52

1.20

Elastic

3.37

114.58

1.06

Elastic

3.30

115.50

0.92

Elastic

3.22

115.92

0.42

Elastic

3.14

116.18

0.26

Elastic

3.06

116.28

0.10

Elastic

2.98

116.22

(0.06)

Inelastic

2.90

116.00

(0.22)

Inelastic

2.82

115.62

(0.38)

Inelastic

2.74

115.08

(0.54)

Inelastic

2.66

114.38

(0.70)

Inelastic

2.58

113.52

(0.86)

Inelastic

2.50

112.50

(1.02)

Inelastic

2.42

111.32

(1.18)

Inelastic

2.34

109.98

(1.34)

Inelastic

2.25

108.00

(1.98)

Inelastic

2.15

105.35

(2.65)

Inelastic

2.04

102.00

(3.35)

Inelastic

At first, marginal revenue is positive as the price declines. After the price falls below $3.06, marginal revenue becomes negative as the price declines. Marginal revenue is always less than price beyond the first unit of output. Marginal revenue is negative as the price declines when the demand curve is inelastic, so the demand becomes inelastic below a price of $3.06. NorOnt Phones will increase the number of substitutes for northern Ontario long-distance phone service. An increase in the number of substitutes will increase the elasticity of the demand facing Star Phone. a.

Quantity (litres)

Price (per litre)

Total Revenue

100

$1.28

$128.00

101

$1.27

128.27

102

$1.26

103 104 b. c.

Marginal Revenue

Marginal Costs

Average Total Costs

Profit

$0.15

$1.252

$2.80

$0.27

$0.18

$1.241

2.93

128.52

0.25

$0.21

$1.231

2.96

$1.25

128.75

0.23

$0.23

$1.221

2.99

$1.24

128.96

0.21

$0.26

$1.212

2.91

Profits are greatest at 103 litres, where marginal revenue equals marginal costs. The firm would lose $100.01 by producing ($2.99 – $103). The firm would keep producing in the short run because it would lose less than the $103 it would lose by shutting down production in the short run.

Answer Key

To sell two units, the monopolist would have to lower the price on both units to $8. That is, the seller would not receive $10 from unit one and $8 for unit two, but rather, would receive $8 for each of the units. So, what happens to marginal revenue? There are two parts to this answer. One, there is a loss in revenue, $2, from selling the first unit at $8 instead of $10. Two, there is a gain in revenue from selling the additional output—the second unit―at $8. So, the marginal revenue is $6 ($8 – $2), which is less than the price of the good, $8.

Section 9.3 The Monopolist’s Equilibrium 10.

The profit-maximizing quantity would be Q* and the profit-maximizing price would be P*. b.

Answer Key c.

11. If economic profits are zero, the firm is earning a normal profit, so there is no incentive to leave the industry. It is possible for a monopolist earning positive economic profits to maintain them in the long run, because barriers prevent new firms from entering and reducing economic profits through competition. 12. A profit-maximizing simple monopolist will continue to produce output as long as marginal revenue exceeds marginal cost, provided that price exceeds average variable cost. To find marginal revenue, first obtain total revenue by multiplying price times quantity at each level of output. Marginal revenue is the change in total revenue from selling one more unit of output. To find marginal cost, first obtain the total cost by summing fixed cost and variable cost at each output level. Marginal cost is the change in total cost from selling one more unit of output. The firm's marginal revenue and marginal cost at each level of output are as follows: Marginal Revenue Output 1 2 3 4 5 6 7 8

$90 $70 $50 $30 $10 −$10 −$30 −$50

Marginal Cost $25 $15 $10 $20 $30 $40 $50 $60

The firm should produce four units of output. It would not be profit-maximizing to produce a fifth unit of output, since marginal cost exceeds marginal revenue for the fifth unit of output. 13. The short-run profit-maximizing level of output is found where marginal revenue equals marginal cost at five units of output (MR = $10 = MC). Price equals $30 at that level of output and the firm earns an economic profit (positive profit) of $120 (TR – TC = $150 - $30 = $120).

Answer Key

Section 9.4 Monopoly and Welfare Loss 14. The welfare cost of monopoly represents the net gains from trade (the difference between the marginal values of those goods indicated by the demand curve and the marginal costs of producing them) from those units of a good that would have been traded, but are no longer traded because of the output restriction of monopoly. It is measured by the area between the demand curve and the marginal cost curve for those units that are no longer traded because of the monopoly output restriction. 15. b. c.

a. At profit maximization: P* = $18, Q* = 60 units, ATCQ* = $13. TR = $18 × 60 = $1080, TC = $13 × 60 = $780; therefore, Total profit = $300. No, the monopolist is not achieving productive efficiency at Q*. This is because the monopolist is not producing at the minimum of ATC when operating at Q* (minimum of ATC is $12). No, the monopolist is not achieving allocative efficiency at Q*. This is because, at Q*, the monopolist experiences P > MC (allocative efficiency is achieved where P = MC).

16. One reason for the change might be changes in technology that reduce or eliminate the advantages of scale. One firm might no longer be able to produce the product at lower per-unit costs than two or more firms can. The inefficiencies of a regulated monopoly might also result in competition being a more efficient organization. Regulated monopolies suffer three types of inefficiencies. First, they produce less than the output at which allocative efficiency is reached. Second, there is no incentive for the firm to produce in the least-cost way. Finally, if special interests dominate decision making, efficiency is only an accidental outcome. Since a competitive environment would not suffer these inefficiencies, competition might be more efficient even with the loss of scale if these other losses are significant.

Section 9.5 Monopoly Policy 17. b. c.

a. The efficient result is determined by the marginal cost pricing alternative―point C. Since price is below average total cost at point C, the monopolist is incurring a loss (indicated by the shaded area). The average cost-pricing alternative is detailed in the graph at point B. A normal rate of return is earned.

Answer Key 18. If a natural monopolist is required to price where demand equals marginal cost and service all customers, then the socially efficient level of output where price equals marginal cost will result. However, since price is less than average total cost at this output level, it is necessary to subsidize the monopolist for all losses incurred, creating a burden on taxpayers. If a firm is required to set a price where the demand curve intersects the average total cost curve, a subsidy is unnecessary in order for the firm to earn a normal profit. However, a less-thanefficient level of output results, because price exceeds marginal cost. In practice, regulators may have little information about demand and cost curves, making it very difficult for regulators to estimate costs and other values. Additionally, regulated firms have little or no incentive to reduce costs, since the regulated price would be reduced in such a case. Special-interest groups complicate regulation further, as consumer groups and industry representatives lobby regulators for rates most favourable to themselves.

Section 9.6 Price Discrimination Students’ demand for movie tickets tends to be more elastic than for the average individual. To entice students to the movie theatre more frequently, theatres offer discounts to students who can show a student ID. b. The long-distance service is practising price discrimination by offering lower rates to those who make longer calls than to those who make very short calls. This type of quantity discount is a form of price discrimination. c. Seniors, who often live on fixed incomes and perhaps have more time to search for good deals, tend to have more elastic demands for many goods and services. Local restaurants offer discounts to seniors to attract them to their restaurants (but often restrict them to "early bird" times, so seniors don't crowd out regularprice dinner customers at the peak demand period). d. Coupon discounts are offered only to those individuals who are willing to take the time and effort to locate, clip, and bring the laundry detergent coupon to the store. People whose demand for laundry detergent is relatively elastic are more likely to clip and organize coupons than are those with relatively inelastic demand. The use of coupons separates customers into groups with different elasticities of demand, charging different groups different effective prices.

19. a.

20. This is a form of price discrimination because on hot days when demand for a cold drink is relatively more inelastic, the vending machines automatically increase the price of drinks. If Coca-Cola's vending machines sell the only drinks available in a particular area, then it constitutes a monopoly over cold drinks in that local area. If other vending machines not owned by Coca-Cola are in the same vicinity, however, then the market for drinks will be much more competitive. 21. If the differences in prices of haircuts for people with different hair lengths reflect differences in the costs of providing a haircut, then it is not price discrimination. 22. If students are offered a significant discount, then such an agreement helps to prevent resale across groups (with students buying for others). 23. The airline industry has found that business travellers have a more inelastic demand for air travel than vacationers do. The airlines know that business travellers are generally unwilling to stay over for the weekend (away from home, family, or their favourite golf course), spend only a day or two at their destination, and often do not make their reservations far in advance. All of which means the business traveller has a more inelastic demand curve for flights (fewer substitutes). If the airlines cut prices for business travellers, airline revenues would fall. Personal travellers (perhaps vacationers) are operating on a much more elastic demand curve— they are much more flexible.

Answer Key For these travellers, many substitutes are available, such as other modes of transportation and different travel times (non-peak times). Clearly the airlines can make more money by separating the market according to each group’s elasticity of demand rather than by charging all users the same price. 24. Often, the key to price discrimination is observing the difference in demand curves for different customers. For example, Tara, who spends time looking through the Saturday paper for coupons, will probably have a relatively more elastic demand curve than, say, a busy executive. 25. A welfare loss is associated with monopoly because the monopolist produces at a level of output such that price is greater than marginal cost. The marginal value to society of the last unit produced is greater than its marginal cost. The monopolist is not producing enough of the good from society's perspective. There would be no welfare loss if a price-discriminating monopolist was able to perfectly price-discriminate, because the monopolist would sell units until price just equalled the marginal cost, charging each customer the maximum price that customer would be willing to pay.

FOR YOUR REVIEW ANSWER KEY CHAPTER 10 MONOPOLISTIC COMPETITION AND OLIGOPOLY Section 10.1 Monopolistic Competition 1. The market for soybeans is perfectly competitive, as large numbers of buyers and sellers trade standardized products on a world market. Retail clothing stores and restaurants offer differentiated products and services and are therefore monopolistically competitive.

2. A grocery store can differentiate itself from its competitors in many ways, including by location, service, the quality of products and services offered, credit terms, and image.

3. Monopolistic competition is like monopoly in that sellers’ actions can change the price. It is like competition in that it is characterized by competition from substitute products, many sellers, and relatively free entry.

4. If Frank earns significant profits when he first opens, he can expect to face competition in the future. Barriers to entry in the hot dog vending business are likely insignificant. New competitors are likely to enter the industry until economic profits are dissipated in the long run.

5. Some restaurants are more successful at differentiating their establishments and appealing to customers than are others. Restaurants that are particularly successful in promoting customer goodwill may continue to earn economic profits even while other restaurants in the area fail.

6. The "cost" that restaurant patrons might incur is a loss of product differentiation. Fewer restaurant choices will be available to patrons. In addition, longer waiting times may increase costs during peak demand periods as going out to dinner has a greater opportunity cost associated with it.

7. Starbucks differentiates its product by location, hours of operation, service, and product choice and quality. Starbucks operates thousands of stores worldwide, offering its patrons a large variety of sandwiches, salads, speciality deserts, and speciality beverages, as opposed to just doughnuts, bagels, and coffee. Starbucks is also open very early, when many people want to drink coffee because of its caffeine stimulant. Another differentiating feature found at Starbucks is its cup sizes. In place of the standard small, medium, and large sizes, Starbucks sells its beverages in trenta, short, tall, grande, and venti cup sizes

8. a. b.

Physical differences are probably most important. Big Macs, Whoppers, tacos, and various types of pizza all have physical differences that attract customers. Location of restaurants is important as well. A convenient location is very important, although service is considered an important aspect by many espresso drinkers.

Answer Key c. d.

Service is number one, but location is important as well. How far are you willing to drive to get a great cut or highlight? Physical qualities, including taste and the look of the container, are most important, although location is important, too. Coca-Cola gained market leadership years ago by making Coke available everywhere—at movie theatres, at lunch counters, and in ubiquitous vending machines. Physical difference is probably the most important, but prestige is important as well.

Section 10.2 Price and Output Determination in Monopolistic Competition 9.

In the above diagram, the firm is making economic profits because the price the firm is able to charge (P*) at output q* is greater than the firm’s average total costs at output q*. These positive economic profits will attract the entry of new firms into the industry, cutting into the market demand of existing firms. The demand curves for each of these existing firms will therefore shift downward. This decline will continue until the average total cost (ATC) curve becomes tangent to the demand curve and economic profits are reduced to zero.

In the above diagram, the firm is suffering economic losses because the price the firm is able to charge (P*) at output q* is less than the firm’s average total costs at output q*. These economic losses will result in the exit of firms from the industry, increasing the market demand of existing firms. The demand curves for each of these existing firms will therefore shift upward. This increase will continue until the average total cost (ATC) curve becomes tangent to the demand curve and economic losses are reduced to zero.

Answer Key

10. In long-run equilibrium (where economic profits are zero), because the monopolistically competitive firm faces a downward-sloping demand curve, the point where demand is just tangent to the average cost curve results in costs greater than the minimum possible average cost. While this same tangency to long-run cost curves characterizes the long-run zero economic profit equilibrium in perfect competition, because the firms’ demand curves are horizontal, that tangency comes at the minimum point of the firms’ average cost curves.

11. a. b. c.

12. a. b.

13. a.

When price is greater than average total cost at q* (the intersection of marginal revenue and marginal cost), the firm will earn positive economic profits. When price is less than average total cost at q* (the intersection of marginal revenue and marginal cost), the firm will earn economic losses. and d. When price is equal to average total cost at q* (the intersection of marginal revenue and marginal cost), the firm will earn zero economic profits. This is also the long-run condition as a result of entry and exit. Profit maximization is achieved at QA output (where MR = MC)―the monopolistically competitive firm will charge PA. Point A―profit maximization―is considered to be the long-run equilibrium position for this firm because the ATC curve is tangent to the demand curve at this point. This tangency indicates that the monopolistically competitive firm is earning zero economic profits at QA output and PA price. Therefore, long-run equilibrium is achieved. In reading the brief opening description of this firm, we would consider it to be monopolistically competitive because (1) it is one of several firms in the industry, (2) it has differentiated its service from its competition, and (3) firms have been able to enter the industry with relative ease.

Quantity (number of oil changes)

Price ($)

TR ($)

50.00

0.00

45.00

MR ($)

MC ($)

ATC ($)

45.00

13.00

30.50

40.00

80.00

35.00

18.00

26.75

35.00

105.00

25.00

23.00

24.75

30.00

120.00

15.00

28.00

26.25

25.00

125.00

5.00

33.00

28.75

20.00

120.00

−5.00

38.00

32.50

According to the above table, MR = MC at a quantity of 3 oil changes (q* = 3). If we assume that the firm cannot provide a partial oil change, the profit-maximizing number of oil changes is 3, since the 4th oil change delivers more marginal cost than marginal revenue. Our monopolistically competitive business will charge a price of $35 per oil change as a result. At the q* of 3 oil changes, P* is greater than ATCq*; as a result, this firm is generating positive economic profits at profit maximization. TR (at q*) = $105; TC (at q*) = $74.25 ($24.75 × 3). Therefore, total profits = $30.75.

Answer Key

Section 10.3 Monopolistic Competition vs. Perfect Competition 14. At point A, long-run equilibrium, productive efficiency is not met because this point is not at the minimum of the ATC curve (which is at point B). Allocative efficiency is not met because, at point A, P > MC. This is because the monopolistically competitive firm is charging a price (PA) that is above its marginal cost of production (point D).

15. Both types of firms operate in industries with many other sellers and with no real barriers to entry or exit. They follow similar rules when choosing the level of output. Both types of firms also will experience zero economic profits in the long run. In the short run, monopolistic competitors and perfectly competitive firms follow similar rules for choosing the profit-maximizing output. They produce where marginal revenue equals marginal cost. Monopolistic competitors will produce less than perfectly competitive firms because the relationship between price and marginal revenue differs between those types of firms. Since firms that are monopolistic competitors face a negatively sloped demand curve, they produce less output than the output where price equals marginal cost for perfectly competitive firms. In the long run, entry will force both types of firms to the output where economic profits are equal to zero, which occurs where the demand curves are tangent to the average total cost curve. Because the monopolistic competitor faces a negatively sloped demand curve, this point will be at a level of output less than that of the perfect competitor. 16.

The price of variety is the higher cost due to the excess capacity that results in monopolistically competitive markets. Firms do not produce at minimum long-run average total cost. Price exceeds marginal cost at the profit-maximizing level of output. Society places a higher value on the last unit of output than it costs to produce. Less output is produced than is considered to be allocatively efficient. 17. Perfect Competition Standardized product

Monopolistic Competition Differentiated product

Allocative efficiency

Downward-sloping demand curve

Productive efficiency

Excess capacity

Horizontal demand curve No control over price

Answer Key

Section 10.4 Advertising 18. The corner barbershop services clients in a limited area. Many people are aware of the barbershop because it is local, and they patronize local barbershops for the sake of convenience. Advertising is unlikely to attract a significant number of people from a different part of town to a particular barbershop. On the other hand, Canadian Tire and Office Depot, which offer a large variety of products, are national chain stores that stand to benefit much more from advertising. Advertising may significantly increase the customer base of Canadian Tire and Office Depot by attracting people who do not live in the vicinity of their stores.

19. Answers will vary. Certainly not all individuals will respond to each and every advertisement. By advertising, a firm hopes it can both increase demand and make it more inelastic, thereby enhancing profits. Critics of advertising argue that advertisers attempt to manipulate preferences and engender brand loyalty to reduce competition. Defenders of advertising argue that production costs can be reduced if substantial economies of scale exist. Also, by raising consumer awareness of substitute products, advertising can help increase the competitiveness within markets and lead to lower prices. Advertising may be considered a waste by someone who always knows which good he or she wants, but advertising would not be used by sellers who do not think it would increase demand sufficiently to make it profitable.

20. Producers use advertising to increase the demand for their products and reduce the elasticity of the demand facing their firms. They do this to increase their profits. If all firms advertise, the results are often not those anticipated by a firm. Advertising by firms makes consumers more aware of the prices charged by other firms and the availability of substitutes for the goods and services they buy. This type of information will increase the elasticity of demand facing firms as well as making the industry more competitive. Advertising may result in lower prices and more output and lower profits.

21. By advertising, firms hope to increase demand and create a less elastic demand curve for their products, thus enhancing revenues and profits.

22. Monopolistically competitive firms must compete with many other firms, so they often must advertise to try to convince potential customers that their products and services are better than others’. This then may influence the shape and position of the demand curve for a monopolistically competitive firm and potentially increase profits. Remember, monopolistically competitive firms are different from competitive firms because of their ability, to some extent, to set prices.

Section 10.5 Oligopoly 23. The following markets are oligopolistic: (b) funeral services, (c) airline travel, (e) oil, and (f) breakfast cereals. 24. Oligopolistic industries are characterized by (b) a few firms that are (f) mutually interdependent. In addition, (d) the barriers to entry are often quite high.

25. Unlike perfectly competitive firms, oligopolists can earn economic profits in the long run if barriers to entry are sufficiently high to deter new firms from entering the market.

Answer Key 26. Perfect Competition Many small firms Allocative efficiency Productive efficiency Horizontal demand curve No control over price

Oligopoly Mutual interdependence Downward-sloping demand curve High barriers to entry Few large firms Large economies of scale

Section 10.6 Collusion and Cartels 27. Since the market for wheat is highly competitive, it is unlikely that the Smith−Jones cartel will be at all successful or have any impact on the price of wheat. There are too many good substitutes available for the wheat produced by Farmers Smith and Jones. If Smith and Jones choose to restrict their combined output, their profits will in all likelihood fall, with virtually no effect on the market price.

28. When firms collude and jointly maximize profits, output is chosen where the marginal revenue and the combined marginal cost are equal. The marginal revenue is derived from the market demand schedule, and the combined marginal cost is the horizontal sum of the individual short-run marginal cost curves for the oligopolists. Firms set the price from the market demand curve at this level of output.

29. a. b.

If the Canadian and Russian mines provide a significant share of the world’s supply, increasing the supply will result in the price of diamonds falling. This could result in the breakdown of the cartel. CSO will no longer be willing to advertise to increase the demand for all diamonds in general. This type of advertising might instead sell more Canadian or Russian diamonds and generate no profit for CSO. If CSO continues to advertise diamonds, it will try to distinguish the diamonds it is selling. CSO might try to establish a brand to differentiate its product from the others.

30. Collusive agreements are typically unstable and short-lived because they are strictly illegal under anti-combine laws in Canada and many other countries. Also, firms experience a great temptation to cheat on collusive agreements by increasing their output and decreasing prices, which undermines any collusive agreement.

Section 10.7 Game Theory and Strategic Behaviour 31. If both firms employ small advertising budgets, then they both earn modest profits of $50 million. If one firm opts for a large ad budget, but the other does not, then the firm with the large ad budget enjoys significantly greater profits than the firm that does not. If both firms spend large sums of money on advertising, then each earns the greatest amount of profit possible, equal to $150 million. This is a Nash equilibrium.

32. The dominant strategy—the optimal strategy regardless of the rival’s actions—for Pepsi and Coca- Cola is to advertise.

33. a.

There is a dominant strategy, which is for both prisoners to confess. Whichever strategy the other prisoner adopts, the prisoner in question gets less time by confessing. b. Since each does as well as possible given the actions of the other, this same strategy (both prisoners confessing) is a Nash equilibrium. 34. The self-interests of players often prevent cooperative behaviour in a one-shot game. However, repeated games allow cooperation to be rewarded and noncooperation to be punished in the future (as in a tit-for-tat strategy), making cooperative results more likely.

35. Shirking at school may be a one-shot game with no future consequences. At work, however, it is a repeated game with adverse future consequences.

FOR YOUR REVIEW ANSWER KEY CHAPTER 11 LABOUR MARKETS AND THE DISTRIBUTION OF INCOME Section 11.1 Labour Markets 1. The demand for unskilled labour used to produce hamburgers and fries would increase as well. 2. a. b. c.

The equilibrium wage rate is $6 an hour. 200 apple pickers a day have been hired. The new equilibrium wage rate would be $10 an hour.

Section 11.2 Supply and Demand in the Labour Market 3.

Quantity of Labour

Total Output/Week

0 1 2 3 4 5 6 7

― 250 600 900 1125 1300 1450 1560

Marginal Product of Labour

Marginal Revenue Product of Labour

250 350 300 225 175 150 110

$1000 1400 1200 900 700 600 440

Six workers will be hired if the equilibrium wage rate equals $550 per week. Five workers will be hired if the wage rate equals $650.

5. Total Corn Output Workers 1 2 3 4 5 6 6.

4 000 10 000 15 000 18 000 19 000 18 000

Marginal Product of Labour 4000 6000 5000 3000 1000 −1000

A backward-bending individual supply curve for labour would result when the income effect of a higher wage (since leisure is a normal good, a higher income leads to a reduction in labour supplied as a result) dominates

Answer Key the substitution effect of a higher wage (at a higher wage, the cost of forgoing labour time for leisure becomes greater, leading to an increase in labour supplied). 7.

Workers

Total Output

Marginal Product

Price

Marginal Revenue Product

1 2 3 4 5 6 7 8

200 380 540 680 800 900 980 1040

200 180 160 140 120 100 80 60

20 20 20 20 20 20 20 20

4000 3600 3200 2800 2400 2000 1600 1200

8. The marginal revenue product from hiring another worker equals 40 × $2 = $80 per day. The marginal resource cost is only $60 per day. The University Pizza Parlour would add to its profits if it hired another worker, assuming the other costs of making the 40 pizzas (ingredients, etc.) were less than $20.

Section 11.3 Labour Market Equilibrium 9. The equilibrium wage would tend to decrease if a competitive firm provided on-the-job training and dental benefits to its workers (since part of the compensation to employees would come in the form of these benefits). If the government mandated a minimum wage of $12 per hour, employers would likely respond by reducing benefits such as dental insurance and on-the-job training.

10. One reason is that there is a great demand for the services of professional athletes. Many people are willing to pay high prices to see their favourite sports stars perform. The second reason that professional athletes, and not teachers, command such a large amount of compensation is that extremely talented athletes are in highly limited supply.

11. An influx of immigrants into a country will increase the supply of labour and decrease real wages. On the other hand, the home countries of the departing immigrants will experience a decrease in the supply of available labour, which puts upward pressure on real wages.

12. The best engineering professors will likely consider leaving Anara University in order to earn higher salaries elsewhere. At the same time, more poetry professors are likely to apply for positions at Anara than would be true of other universities. As a result, the quality of the engineering department is likely to decline, and the quality of the poetry department is likely to improve.

13. a. E; b. C; c. G; d. I; e. A; f. B; g. D; h. F; i. H 14. a.

An increase in immigration shifts the supply of workers to the right, decreasing wages and increasing the number of workers employed.

Answer Key

b. Decreasing the demand for Canadian-made goods shifts the demand for workers to the left, decreasing wages and decreasing the number of workers employed.

c. Increasing Canadian workers’ productivity shifts the demand for workers to the right, increasing wages and increasing the number of workers employed.

d. Increasing job amenities shifts the supply of workers to the right, decreasing wages and increasing the number of workers employed.

e. If people become less willing to work at a given wage, it shifts the supply of workers to the left, increasing wages and decreasing the number of workers employed.

Section 11.4 Labour Unions 15. a. and b.

Union wages go up and the number of union workers hired goes down; nonunion wages go down, and the number of nonunion workers hired goes up.

16. Labour unions can be seen as partly responsible for increased workplace productivity in that they provide workers with a ―voice‖ to communicate their grievances and discontent. This voice diminishes the need for action in the form of quitting or other disruptive behaviour. In addition to this, the fact that the union−employer relationship provides a grievance process for workers can also be seen as motivational.

Section 11.5 Income Distribution 17. The official data may overstate the actual degree of income inequality because it fails to take into consideration differences in age, demographic factors such as the increasing number of both divorced couples and doubleincome families, and government redistributive activities (by ignoring the effects of taxes and in-kind subsidies).

18. Males may possess education/skills/training/human capital that affords them higher earnings; males may choose higher pay over other workplace amenities; males may prefer occupations that, due to their unpleasant/dangerous characteristics, are higher paying. Another consideration is the existence of employment and/or workplace discrimination.

19. a.

A massive influx of low-skilled immigrants would increase the proportion of the overall population earning low incomes.

Answer Key

b. In the event of a baby boom, some individuals would opt to become full-time parents, transforming twoincome families into single-income families. This would tend to reduce the proportion of the population in high-income quintiles and increase the proportion in the lowincome quintiles. c. When the babies in (b) enter their twenties and begin working, the proportion of the population in lowincome quintiles will likely increase (since young workers earn lower incomes on average then middleaged workers). d. When the babies in (b) reach age 65 or older, again the proportion of the population in lowincome quintiles will increase (as retirees earn lower incomes on average than middle-aged workers do).

20. A nation with a Gini coefficient of 25.0 would be considered as having a very low degree of income inequality, whereas one with a Gini coefficient of 75.0 would be considered as having a very high degree of income inequality.

21. Countries ranked in order of Gini coefficient (lowest to highest): Norway, Sweden, Germany, Venezuela, Columbia, Brazil. High Gini coefficient countries (Venezuela, Columbia, Brazil) seem to have lower levels of economic development—they would all be considered developing economics. The countries with relatively low Gini coefficients (Norway, Sweden, Germany) would all be considered developed/industrialized economies. 22. Even with the same lifetime incomes, some would be in their peak earning years and others would be in low earning years (e.g., young or retired people) at a given point in time, resulting in current income inequality. 23. A significant reduction in the divorce rate would increase the proportion of families in higher income brackets, as fewer households would become single-parent and single-income households.

Section 11.6 Poverty 24. Economic growth could potentially reduce absolute measures of poverty by increasing real incomes. However, economic growth by itself cannot eliminate relative measures of poverty because there will always be some with lower real incomes than others. 25.

a. Yes, Ryan’s income (alone) of $37 000 is less than the Official Poverty Line for a family living in a community in Alberta with a population between 30 000 and 99 000. This Official Poverty Line is $45 919. No, the relevant Official Poverty Line for a rural community in New Brunswick is $41 716. Ryan and Trisha’s projected income of $45 000 is more than that.

26. These programs include progressive income taxes; cash transfers such as Employment Insurance and in-kind transfers such as school lunch programs; social assistance programs such as the Guaranteed Income Supplement; government subsidies in the form of public housing; and minimum-wage laws.

Answer Key

FOR YOUR REVIEW ANSWER KEY CHAPTER 12 MARKET FAILURE AND THE ENVIRONMENT Section 12.1 Externalities 1. Positive externalities: b. d.

You are given a flu shot. A local youth group cleans up trash along a two-kilometre stretch of highway.

Negative externalities: a. During a live-theatre performance, an audience member’s cellphone rings loudly. e. A firm dumps chemical waste into a local stream. f. The person down the hall in your residence plays a hip-hop playlist loudly while you are trying to sleep. No externalities: c. You purchase and drink a soft drink during a break from class. 2.

Section 12.2 Negative Externalities and Pollution

Answer Key

3. If the steel company is not held liable for dumping crud into the air, it will consider only the $25 labour costs and the $10 equipment costs.

4. If the airport was already there when the homeowner moved in, then the negative impact of living near an airport would have been reflected in a lower purchase price of the home. If, however, the airport was built after the homeowner moved in, then the homeowner will suffer a loss in property value due to the presence of negative externalities. It would matter whether or not the homeowner knew the airport would be built. If the homeowner had such knowledge, then a lower home purchase price would reflect the anticipation of the expected future noise pollution.

5. If diesel engines were banned, there would be fewer future incidences of the sorts of cancer it causes. However, the advantages of transportation and other production processes using diesel engines would be lost. The cost of shipping freight would likely increase, raising the prices of many goods. 6.

7. a.

When taxes are imposed to address external costs, the costs of production to producers will rise, shifting supply curves up (left). The market result of such decreases in supply is higher prices for the goods whose production imposes external costs. When subsidies are given to address external benefits, the net of subsidy costs of production to producers will fall, shifting supply curves down (right). The market result of such increases in supply is lower prices for the goods whose production creates external benefits. b. Workers would benefit from subsidies to an industry that address external benefits―more output will increase the demand for workers and other inputs―but they would be hurt by taxes that address external costs. 8. A subsidy to firms using recycled materials would shift the demand curve for recycled materials vertically by the amount of the subsidy per unit. As a result of this increase in demand, the equilibrium price of recycled materials would increase. The equilibrium quantity of recycled materials would increase as well. The total cost of the government subsidy program would be the subsidy per unit times the number of units subsidized.

Answer Key

Section 12.3 Public Policy and the Environment 9. a. b. c.

A higher tax on gasoline encourages people to drive less and therefore reduces air pollution. An annual tax on automobiles based on average emissions might discourage some people from buying a car, but is unlikely to alter the driving habits of individual car owners in any significant way. An annual tax on total emissions from a particular model of car would encourage both less driving and more switching to more environmentally friendly cars.

10. The firm should reduce its emissions at a cost of $30 per tonne and sell its permits for $40 per tonne. As a result, the firm would profit $10 per tonne of emissions that it is able to reduce.

11. A pollution reduction program that relies on emissions standards would force firms to limit pollution levels, regardless of the cost of doing so. With an emissions permit program, firms that can reduce pollution levels at relatively low marginal cost can sell their permits to firms that can reduce pollution levels only at higher marginal costs. The same level of pollution reduction can be achieved with either program. However, the latter program would achieve the reduction in pollution at lower cost to society.

12. From the perspective of social efficiency, water pollution should be reduced as long as the marginal benefit of pollution reduction exceeds the marginal cost of achieving that reduction. The socially efficient level of water pollution will exceed a level of zero contaminants, as long as achieving zero pollution is too costly on the margin to be worthwhile.

13. Transferable pollution rights would create a market for pollution reduction. Every polluter would then find it profitable to reduce pollution as long as they could do it more cheaply than the price of a pollution right. Therefore, producers would employ the lowest-cost pollution control methods for a given amount of pollution reduction.

Answer Key

14. The answer depends on the relative magnitudes of the marginal external costs and benefits. If the marginal external costs were greater, there would be net costs and a tax could move the result closer to the efficient solution. However, it would also reduce the external benefits received by some, harming them. If the marginal external benefits were greater, there would be net benefits and a subsidy could move the result closer to the efficient solution. However, it would also increase the external costs borne by some, harming them.

Section 12.4 Property Rights 15. A change in the law is not necessary to achieve an efficient outcome in this situation. If the resort owner and chemical factory could reach an agreement whereby the resort owner compensates the chemical factory for hauling the pollution to the toxic waste dump, the socially efficient outcome could be achieved. Since the damage to the resort owner exceeds the cost of hauling the pollution to the toxic waste dump site, this is a possibility, as long as the property rights are clearly defined and the cost of negotiating and transacting is low enough.

16. How the property rights to the air are assigned would make a difference in the quantity of pollution generated. If the property rights were assigned to the factory, conceivably the neighbours could collectively pay the factory to reduce its emissions to the socially efficient level. However, such negotiations would be difficult when 2000 households are involved. There would undoubtedly be disagreements about how much each household should pay and households that attempt to act like free riders. It is doubtful that the factory would adjust its pollution levels in such a case. If the property rights were assigned to the households in the neighbourhood, conceivably the factory could compensate the neighbours for the right to pollute. However, negotiating with 2000 households for the right to pollute would also be extremely difficult. Pollution levels are likely to be much less if the rights to the air are assigned to the neighbourhood households than if they are assigned to the factory.

Section 12.5 Public Goods 17. a. b. c. d. e. f. g. h. i.

Hot dogs: Private good Cable TV: Nonrival; private good Broadcast TV: Nonrival; nonexclusive; public good Automobiles: Private good National defence: Nonrival; nonexclusive; public good Pollution-control policy: Nonrival; nonexclusive; public good Parking spot in a parking structure: Private good A sunset: Nonrival; nonexclusive; public good Admission to a theme park: Private good

18. If many ships benefit from a lighthouse, whether contributing to its upkeep or not, then a lighthouse is indeed a public good. If, however, a lighthouse primarily benefits ships going to a local port where they can be charged docking fees, then the lighthouse resembles more closely a private good from which nonpayers can be excluded and no significant free-rider problem exists.

19. Buffalo almost became extinct because people did not have clear property rights for buffalo, unlike cattle. You can buy a buffalo burger today because people now have clear property rights to buffalo.

Answer Key

20. Consumption of an unscrambled TV broadcast is both nonexcludable and nonrivalrous. Anyone with a television set can receive an unscrambled signal, whether a paying customer or not. Also, when one person tunes in a broadcast signal, it doesn’t diminish the ability of other viewers to tune in. Specialty cable services like the Discovery Channel are typically blocked so that nonpaying customers can be excluded. 21. The free-rider problem arises in the case of public goods because people cannot be prevented from enjoying the benefits of public goods once they are provided. Therefore, people have an incentive not to voluntarily pay for those benefits, making it difficult or even impossible to finance the efficient quantity of public goods through voluntary market arrangements. The government can overcome the free-rider problem by forcing people to pay for the provision of a public good through taxes.