Solutions to Quick Quizzes for 5th ed

1 Solutions to Quick Quizzes Chapter 1 1. There are many possible answers. 2. There are many possible answers. 3. The three principles that describe how the economy as a whole works are: (1) a country’s standard of living depends on its ability to produce goods and services; (2) prices rise when the govern- ment prints too much money; and (3) society faces a short-run trade- off between inflation and unem- ployment. A country’s standard of living depends largely on the productivity of its workers, which in turn depends on the education of its workers and the access its workers have to the necessary tools and technology. Prices rise when the government prints too much money because more money in circulation reduces the value of money, causing inflation. Society faces a short-run trade-off between inflation and unemployment that is only temporary. Policymakers have some short-term ability to exploit this relationship using vari- ous policy instruments. Chapter 2 1. Economics is like a science because economists devise theories, collect data, and analyze the data in an attempt to verify or refute their theories. In other words, eco- nomics is based on the scientific method. Figure 1 shows the production possibilities frontier for a society that produces food and clothing. Point A is an efficient point (on the frontier), point B is an inef- ficient point (inside the frontier), and point C is an infeasible point (outside the frontier). B A Quantity of Food Produced Q ua nt it y of C lo th in g P ro du ce d C Figure 1 The effects of a drought are shown in Figure 2. The drought reduces the amount of food that can be produced, shifting the production possibilities frontier inward. Quantity of Food Produced Q ua nt it y of C lo th in g P ro du ce d PPF2 PPF1 Figure 2 Microeconomics is the study of how households and firms make decisions and how they interact in markets. Macroeconomics is the study of economy-wide phenom- ena, including inflation, unem- ployment, and economic growth. 2. An example of a positive state- ment is “a higher price of coffee causes me to buy more tea.” It is a positive statement because it is a claim that describes the world as it is. An example of a norma- tive statement is “the government should restrain coffee prices.” It is a normative statement because it is a claim that prescribes how the world should be. Many other examples are possible. Parts of the government that regularly rely on advice from economists are the Department of the Treasury in designing tax policy, the Department of Labor in analyzing data on the employ- ment situation, the Department of Justice in enforcing the nation’s antitrust laws, the Congressional Budget Office in evaluating policy proposals, and the Federal Reserve in analyzing economic develop- ments. Many other answers are possible. 3. Economic advisers to the president might disagree about a question of policy because of differences in scientific judgments or differences in values. Chapter 3 1. Figure 1 shows Robinson Crusoe’s production possibilities frontier 89972_solutions v2.indd 189972_solutions v2.indd 1 10/13/08 2:27:11 PM10/13/08 2:27:11 PM 2 SOLUTIONS TO QUICK QUIZZES for gathering coconuts and catch- ing fish. If Crusoe lives by himself, this frontier limits his consump- tion of coconuts and fish, but if he can trade with natives on the island, he will possibly be able to consume at a point outside his production possibilities frontier. Coconuts Gathered Fi sh C au gh t Figure 1 2. Crusoe’s opportunity cost of catching one fish is 10 coconuts, since he can gather 10 coconuts in the same amount of time it takes to catch one fish. Friday’s oppor- tunity cost of catching one fish is 15 coconuts, since he can gather 30 coconuts in the same amount of time it takes to catch two fish. Friday has an absolute advantage in catching fish, since he can catch two per hour, while Crusoe can catch only one per hour. But Cru- soe has a comparative advantage in catching fish, since his opportu- nity cost of catching a fish is less than Friday’s. 3. If the world’s fastest typist hap- pens to be trained in brain sur- gery, she should hire a secretary because the secretary will give up less for each hour spent typing. Although the brain surgeon has an absolute advantage in typing, the secretary has a comparative advantage in typing because of the lower opportunity cost of typing. Chapter 4 1. A market is a group of buyers (who determine demand) and a group of sellers (who determine supply) of a particular good or service. A perfectly competitive market is one in which there are many buyers and many sellers of an identical product so that each has a negligible impact on the market price. 2. Here is an example of a monthly demand schedule for pizza: Price of Number of Pizza Pizza Slice Slices Demanded $0.00 10 0.25 9 0.50 8 0.75 7 1.00 6 1.25 5 1.50 4 1.75 3 2.00 2 2.25 1 2.50 0 The demand curve is graphed in Figure 1. P ri ce o f P iz za S lic e 0 $2.50 2.00 1.50 1.00 0.50 2 4 6 8 10 Demand Number of Pizza Slices Demanded Figure 1 Examples of things that would shift the demand curve include changes in income, prices of related goods like soda or hot dogs, tastes, expectations about future income or prices, and the number of buyers. A change in the price of pizza would not shift this demand curve; it would only lead to a movement from one point to another along the same demand curve. 3. Here is an example of a monthly supply schedule for pizza: Price of Number of Pizza Pizza Slice Slices Supplied $0.00 0 0.25 100 0.50 200 0.75 300 1.00 400 1.25 500 1.50 600 1.75 700 2.00 800 2.25 900 2.50 1000 The supply curve is graphed in Figure 2. P ri ce o f P iz za S lic e 0 $2.50 2.00 1.50 1.00 0.50 200 400 600 800 1000 Supply Number of Pizza Slices Supplied Figure 2 Examples of things that would shift the supply curve include changes in prices of inputs like tomato sauce and cheese, changes in technology like more efficient pizza ovens or automatic dough makers, changes in expectations about the future price of pizza, or a change in the number of sellers. A change in the price of pizza would not shift this supply curve; it would only lead to a movement from one point to another along the same supply curve. 4. If the price of tomatoes rises, the supply curve for pizza shifts to the left because there has been an increase in the price of an input 89972_solutions v2.indd 289972_solutions v2.indd 2 10/13/08 2:27:12 PM10/13/08 2:27:12 PM 3SOLUTIONS TO QUICK QUIZZES into pizza production, but there is no shift in demand. The shift to the left of the supply curve causes the equilibrium price to rise and the equilibrium quantity to decline, as Figure 3 shows. If the price of hamburgers falls, the demand curve for pizza shifts to the left because the lower price of hamburgers will lead consum- ers to buy more hamburgers and fewer pizzas, but there is no shift in supply. The shift to the left of the demand curve causes the equilibrium price to fall and the equilibrium quantity to decline, as Figure 4 shows. P ri ce o f P iz za Quantity of Pizza D S1 S2 Figure 3 P ri ce o f P iz za Quantity of Pizza S D1 D2 Figure 4 Chapter 5 1. The price elasticity of demand is a measure of how much the quantity demanded of a good responds to a change in the price of that good, computed as the percent- age change in quantity demanded divided by the percentage change in price. When demand is inelastic (a price elasticity less than 1), a price increase raises total revenue, and a price decrease reduces total revenue. When demand is elastic (a price elasticity greater than 1), a price increase reduces total reve- nue, and a price decrease increases total revenue. When demand is unit elastic (a price elasticity equal to 1), a change in price does not affect total revenue. 2. The price elasticity of supply is a measure of how much the quan- tity supplied of a good responds to a change in the price of that good, computed as the percent- age change in quantity supplied divided by the percentage change in price. The price elasticity of supply might be different in the long run than in the short run because over short periods of time, firms cannot easily change the sizes of their factories to make more or less of a good. Thus, in the short run, the quantity supplied is not very responsive to the price. However, over longer periods, firms can build new factories, expand exist- ing factories, close old factories, or they can enter or exit a market. So, in the long run, the quantity sup- plied can respond substantially to a change in price. 3. A drought that destroys half of all farm crops could be good for farmers (at least those unaffected by the drought) if the demand for the crops is inelastic. The shift to the left of the supply curve leads to a price increase that will raise total revenue if the price elasticity of demand is less than 1. No one farmer would have an incentive to destroy his crops in the absence of a drought because he takes the market price as given. Only if all farmers destroyed a portion of their crops together, for example through a government program, would this plan work to make farmers better off. Chapter 6 1. A price ceiling is a legal maximum on the price at which a good can be sold. Examples of price ceil- ings include rent controls, price controls on gasoline in the 1970s, and price ceilings on water during a drought. A price floor is a legal minimum on the price at which a good can be sold. Examples of price floors include the minimum wage and farm price supports. A price ceiling leads to a shortage, if the ceiling is binding, because suppliers will not produce enough goods to meet demand. A price floor leads to a surplus, if the floor is binding, because suppli- ers produce more goods than are demanded. 2. With no tax, as shown in Figure 1, the demand curve is D1 and the supply curve is S. The equilibrium price is P1 and the equilibrium quantity is Q1. If the tax is imposed on car buyers, the demand curve shifts downward by the amount of the tax ($1,000) to D2. The downward shift in the demand curve leads to a decline in the price received by sellers to P2 and a decline in the equilibrium quan- tity to Q2. The price received by sellers declines by P1 – P2, shown in the figure as ΔPS. Buyers pay a total of P2 + $1,000, an increase in what they pay of (P2 + $1,000) – P1, shown in the figure as ΔPB. P2 � $1,000 P1 P2 Quantity of Cars P ri ce of C ar s Q1Q2 �PB �PS D1 D2 S Figure 1 89972_solutions v2.indd 389972_solutions v2.indd 3 10/13/08 2:27:13 PM10/13/08 2:27:13 PM 4 SOLUTIONS TO QUICK QUIZZES If the tax is imposed on car sellers, as shown in Figure 2, the sup- ply curve shifts upward by the amount of the tax ($1,000) to S2. The upward shift in the supply curve leads to a rise in the price paid by buyers to P2 and a decline in the equilibrium quantity to Q2. The price paid by buyers increases by P2 – P1, shown in the figure as ΔPB. Sellers receive P2 – 1,000, a decrease in what they receive by P1 – (P2 – $1,000), shown in the figure as ΔPS. P2 � $1,000 P1 P2 Quantity of Cars P ri ce of C ar s Q1Q2 �PB �PS S2 S1 D Figure 2 Chapter 7 1. Figure 1 (on the next page) shows the demand curve for turkey. The price of turkey is P1 and the consumer surplus that results from that price is denoted CS. Consumer surplus is the amount a buyer is willing to pay for a good minus the amount the buyer actually pays for it. It measures the benefit to buyers of participating in a market. Quantity of Turkey P ri ce o f Tu rk ey Demand P1 CS Figure 1 Quantity of Turkey P ri ce o f Tu rk ey Supply PS P1 Figure 2 2. Figure 2 shows the supply curve for turkey. The price of turkey is P1 and the producer surplus that results from that price is denoted PS. Producer surplus is the amount sellers are paid for a good minus the sellers’ cost of provid- ing it (measured by the supply curve). It measures the benefit to sellers of participating in a market. P ri ce o f Tu rk ey P1 Quantity of Turkey Supply Demand PS CS Figure 3 3. Figure 3 shows the supply and demand for turkey. The price of turkey is P1, consumer surplus is CS, and producer surplus is PS. Producing more turkeys than the equilibrium quantity would lower total surplus because the value to the marginal buyer would be lower than the cost to the marginal seller on those additional units. Chapter 8 1. Figure 1 shows the supply and demand curves for cookies, with equilibrium quantity Q1 and equi- librium price P1. When the govern- ment imposes a tax on cookies, the price to buyers rises to PB, the price received by sellers declines to PS, and the equilibrium quantity falls to Q2. The deadweight loss is the triangular area below the demand curve and above the supply curve between quantities Q1 and Q2. The deadweight loss shows the fall in total surplus that results from the tax. PB DWL DWL P1 Quantity of Cookies Q2 P ri ce o f C oo ki es PS Q1 Demand Supply Figure 1 2. The deadweight loss of a tax is greater the greater is the elasticity of demand. Therefore, a tax on beer would have a larger deadweight loss than a tax on milk because the demand for beer is more elastic than the demand for milk. 3. If the government doubles the tax on gasoline, the revenue from the gasoline tax could rise or fall depending on whether the size of the tax is on the upward or down- ward sloping portion of the Laffer curve. However, if the government doubles the tax on gasoline, you can be sure that the deadweight loss of the tax rises because dead- weight loss always rises as the tax rate rises. 89972_solutions v2.indd 489972_solutions v2.indd 4 10/13/08 2:27:13 PM10/13/08 2:27:13 PM 5SOLUTIONS TO QUICK QUIZZES Chapter 9 1. Since wool suits are cheaper in neighboring countries, Autarka would import suits if it were to allow free trade. 2. Figure 1 shows the supply and demand for wool suits in Autarka. With no trade, the price of suits is 3 ounces of gold, consumer sur- plus is area A, producer surplus is area B + C, and total surplus is area A + B + C. When trade is allowed, the price falls to 2 ounces of gold, consumer surplus rises to A + B + D (an increase of B + D), producer surplus falls to C (a decline of B), so total surplus rises to A + B + C + D (an increase of D). A tariff on suit imports would reduce the increase in consumer surplus, reduce the decline in producer surplus, and reduce the gain in total surplus. C B D A P ri ce o f W oo l S ui ts 3 Quantity of Wool Suits Domestic supply Domestic demand 2 World price Imports Figure 1 3. Lobbyists for the textile industry might make five arguments in favor of a ban on the import of wool suits: (1) imports of wool suits destroy domestic jobs; (2) the wool-suit industry is vital for national security; (3) the wool-suit industry is just starting up and needs protection from foreign competition until it gets stronger; (4) other countries are unfairly subsidizing their wool-suit indus- tries; and (5) the ban on the impor- tation of wool suits can be used as a bargaining chip in international negotiations. In defending free trade in wool suits, you could argue that: (1) free trade creates jobs in some industries even as it destroys jobs in the wool-suit industry and allows Autarka to enjoy a higher standard of living; (2) the role of wool suits for the military may be exaggerated; (3) government protection is not needed for an industry to grow on its own; (4) it would be good for the citizens of Autarka to be able to buy wool suits at a subsidized price; and (5) threats against free trade may backfire, leading to lower levels of trade and lower economic welfare for everyone. Chapter 10 1. Examples of negative externalities include pollution, barking dogs, and consumption of alcoholic beverages. Examples of positive externalities include restoring historic buildings, research into new technologies, and education. (Many other examples of nega- tive and positive externalities are possible.) Market outcomes are inefficient in the presence of exter- nalities because markets produce a larger quantity than is socially desirable when there is a negative externality and a smaller quantity than is socially desirable when there is a positive externality. 2. The town government might respond to the externality from the smoke in three ways: (1) regula- tion; (2) corrective taxes; or (3) tradable pollution permits. Regulation prohibiting pollu- tion beyond some level is good because it is often effective at reducing pollution. But doing so successfully requires the govern- ment to have a lot of informa- tion about the industries and the alternative technologies that those industries could adopt. Corrective taxes are a useful way to reduce pollution because the tax can be increased to get pollution to a lower level and because the taxes raise revenue for the government. The tax is more efficient than regulation because it gives factories economic incentives to reduce pollution and to adopt new technologies that pollute less. The disadvantage of corrective taxes is that the government needs to know a lot of information to pick the right tax rate. Tradable pollution permits are similar to corrective taxes but allow the firms to trade the right to pollute with each other. As a result, the government does not need as much information about the firms’ technologies. The gov- ernment can simply set a limit on the total amount of pollution, issue permits for that amount, and allow the firms to trade the permits. This reduces pollution while allow- ing economic efficiency. Those opposed to pollution permits argue that it is wrong to put a price on pollution and wrong to allow even low levels of pollution, but economists have little sympa- thy with these arguments. 3. Examples of private solutions to externalities include moral codes and social sanctions, charities, and relying on the interested par- ties entering into contracts with one other. The Coase theorem is the proposition that if private parties can bargain without cost over the allocation of resources, they can solve the problem of externalities on their own. Private economic participants are sometimes unable to solve the problems caused by an externality because of transactions costs or because bargaining breaks down. This is most likely when the num- ber of interested parties is large. Chapter 11 1. Public goods are goods that are neither excludable nor rival in consumption. Examples include 89972_solutions v2.indd 589972_solutions v2.indd 5 10/13/08 2:27:13 PM10/13/08 2:27:13 PM 6 SOLUTIONS TO QUICK QUIZZES national defense, knowledge, and uncongested nontoll roads. Common resources are goods that are rival in consumption but not excludable. Examples include fish in the ocean, the environment, and congested nontoll roads. 2. The free-rider problem occurs when people receive the benefits of a good but avoid paying for it. The free-rider problem induces the government to provide public goods because the private mar- ket will not produce an efficient quantity on its own. The govern- ment uses tax revenue to provide the good, everyone pays for it, and everyone enjoys its benefits. The governm