Supply and Demand and Key Question

McConnell, Brue, Barbiero 11th Canadian edition Microeconomics ANSWERS TO END-OF-CHAPTER AND APPENDIX QUESTIONS Chapter 1 1-3(Key Question) Cite three examples of recent decisions that you made in which you, at least implicitly, weighed marginal costs and marginal benefits. Student answers will vary, but may include the decision to come to class, to skip breakfast to get a few extra minutes of sleep, to attend college or university, or to make a purchase. Marginal benefits of attending class may include the acquisition of knowledge, participation in discussion, and better preparation for an upcoming examination.

Marginal costs may include lost opportunities for sleep, meals, or studying for other classes. In evaluating the discussion of marginal benefits and marginal costs, be careful to watch for sunk costs offered as a rationale for marginal decisions. . 1-5(Key Question) Indicate whether each of the following statements applies to microeconomics or macroeconomics: a. The unemployment rate in Canada was 7. 0 percent in January 2005. b. A Canadian software firm discharged 15 workers last month and transferred the work to India. c.

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An unexpected freeze in central Florida reduced the citrus crop and caused the price of oranges to rise. d. Canadian output, adjusted for inflation, grew by 3. 0 percent in 2004. e. Last week the Scotia Bank lowered its interest rate on business loans by one-half of 1 percentage point. f. The consumer price index rose by 2. 2 percent in 2005. Macroeconomics: (a), (d), and (f) Microeconomics: (b), (c), and (e) 1-7(Key Question)Suppose you won $15 on a Lotto Canada ticket at the local 7-Eleven and decided to spend all the winnings on candy bars and bags of peanuts.

The price of candy bars is $. 75 and the price of peanuts is $1. 50. a. Construct a table showing the alternative combinations of the two products that are available. b. Plot the data in your table as a budget line in a graph. What is the slope of the budget line? What is the opportunity cost of one more candy bar? Of one more bag of peanuts? Do these opportunity costs rise, fall, or remain constant as each additional unit of the product is purchased. c. How, in general, would you decide which of the available combinations of candy bars and bags of peanuts to buy? . Suppose that you had won $30 on your ticket, not $15. Show the $30 budget line in your diagram. Why would this budget line be preferable to the old one? (a)Consumption alternatives |Goods |A |B |C |D |E |F | |Candy bars |0 |4 |8 |12 |16 |20 | |Bags of peanuts |10 |8 |6 |4 |2 |0 | (b) [pic] The slope for the budget line above, with candy bars on the horizontal axis, is -0. 5 (= -Pcb/Pbp).

Note that the figure could also be drawn with bags of peanuts on the horizontal axis. The slope of that budget line would be -2. The opportunity cost of one more candy bar is ? of a bag of peanuts. The opportunity cost of one more bag of peanuts is 2 candy bars. These opportunity costs are constant. They can be found by comparing any two of the consumption alternatives for the two goods. (c)The decision of how much of each to buy would involve weighing the marginal benefits and marginal costs of the various alternatives.

If, for example, the marginal benefits of moving from alternative C to alternative D are greater than the marginal costs, then this consumer should move to D (and then compare again with E, and so forth, until MB=MC is attained). (d) [pic] The budget line at $30 would be preferable because it would allow greater consumption of both goods. 1-10(Key Question)Below is a production possibilities table for consumer goods (automobiles) and capital goods (forklifts): Type of Production |Production Alternatives | | | | | | | | | |A |B |C |D |E | | | | | | | | |Automobiles |0 |2 |4 |6 |8 | |Forklifts |30 |27 |21 |12 |0 | | | | | | | | a. Show these data graphically. Upon what specific assumptions is this production possibilities curve based? b. If the economy is at point C, what is the cost of one more automobile?

Of one more forklift? Explain how the production possibilities curve reflects the law of increasing opportunity costs. c. If the economy characterized by this production possibilities table and curve were producing 3 automobiles and 20 fork lifts, what could you conclude about its use of available resources? d. What would production at a point outside the production possibilities curve indicate? What must occur before the economy can attain such a level of production? a) See curve EDCBA. The assumptions are full employment, fixed supplies of resources, fixed technology and two goods. [pic] (b)4. 5 forklifts; . 33 automobiles, as determined from the table.

Increasing opportunity costs are reflected in the concave-from-the-origin shape of the curve. This means the economy must give up larger and larger amounts of rockets to get constant added amounts of automobiles—and vice versa. (c)The economy is underutilizing its available resources. The assumption of full employment has been violated. (d)Production outside the curve cannot occur (consumption outside the curve could occur through foreign trade). To produce beyond the current production possibilities curve this economy must realize an increase in its available resources and/or technology. . 1-11(Key Question)Specify and explain the typical shapes of the marginal-benefit and marginal-cost curves.

How are these curves used to determine the optimal allocation of resources to a particular product? If current output is such that marginal cost exceeds marginal benefit, should more or fewer resources be allocated to this product? Explain. The marginal benefit curve is downward sloping, MB falls as more of a product is consumed because additional units of a good yield less satisfaction than previous units. The marginal cost curve is upward sloping, MC increases as more of a product is produced since additional units require the use of increasingly unsuitable resource. The optimal amount of a particular product occurs where MB equals MC. If MC exceeds MB, fewer resources should be allocated to this use.

The resources are more valuable in some alternative use (as reflected in the higher MC) than in this use (as reflected in the lower MB). 1-13(Key Question) Suppose improvement occurs in the technology of producing forklifts but not in the technology of producing automobiles. Draw the new production possibilities curve. Now assume that a technological advance occurs in producing automobiles but not in producing forklifts. Draw the new production possibilities curve. Now draw a production possibilities curve that reflects technological improvement in the production of both products. See the graph for question 1-10. PPC1 shows improved forklift technology. PPC2 shows improved auto technology. PPC3 shows improved technology in producing both products. -14(Key Question) On average, households in China save 40 percent of their annual income each year, whereas households in the Canada save less than 5 percent. Production possibilities are growing at roughly 9 percent annually in China and 3. 5 percent in Canada. Use graphical analysis of “present goods” versus “future goods” to explain the differences in growth rates. Figure 1. 6 on page 20 depicts this situation. Canada would be represented by Figure 1. 6a (“Presentville”), producing primarily goods for the present. China’s situation is depicted by Figure 1. 6b (“Futureville”), where emphasis on goods for the future leads to a greater expansion of production possibilities.

Chapter 1 – Appendix 1A-2(Key Appendix Question) Indicate how each of the following might affect the data shown in the table and graph in Figure 2 of this appendix: a. IU’s athletic director schedules higher-quality opponents. b. An NBA team locates in the city where IU plays. c. IU contracts to have all its home games televised. (a)More tickets are bought at each price; the line shifts to the right. (b)Fewer tickets are bought at each price, the line shifts to the left. (c)Fewer tickets are bought at each price, the line shifts to the left. 1A-3(Key Appendix Question) The following table contains data on the relationship between saving and income.

Rearrange these data into a meaningful order and graph them on the accompanying grid. What is the slope of the line? The vertical intercept? Interpret the meaning of both the slope and the intercept. Write the equation which represents this line. What would you predict saving to be at the $12,500 level of income? | | | |Income |Saving | |(per year)` |(per year) | | | | | | | |$15,000 |$1,000 | |0 |-500 | |10,000 |500 | |5,000 |0 | 20,000 |1,500 | Income column: $0; $5,000; $10,000, $15,000; $20,000. Saving column: $-500; 0; $500; $1,000; $1,500. Slope = 0. 1 (= $1,000 – $500)/($15,000 – $10,000). Vertical intercept = $-500. The slope shows the amount saving will increase for every $1 increase in income; the intercept shows the amount of saving (dissaving) occurring when income is zero. Equation: S = $-500 + 0. 1Y (where S is saving and Y is income). Saving will be $750 at the $12,500 income level. 1A-7(Key Appendix Question) The accompanying graph shows curve XX and tangents at points A, B, and C. Calculate the slope of the curve at these three points.

Slopes: at A = +4; at B = 0; at C = -4. ANSWERS TO END-OF-CHAPTER QUESTIONS Chapter 2 2-8(Key Question) With current technology, suppose a firm is producing 400 loaves of banana bread daily. Also, assume that the least-cost combination of resources in producing those loaves is 5 units of labour, 7 units of land, 2 units of capital, and 1 unit of entrepreneurial ability, selling at prices of $40, $60, $60, and $20, respectively. If the firm can sell these 400 units at $2 per unit, will it continue to produce banana bread? If this firm’s situation is typical for the other makers of banana bread, will resources flow to or away from this bakery good?

The firm will continue to produce as it is earning economic profits of $40 (Total revenue of $800 minus total cost of $760). If this firm is typical, more resources will flow toward banana bread as other potential firms are attracted to the economic profits. 2-9(Key Question) Some large hardware stores such as Canadian Tire boast of carrying as many as 20,000 different products in each store. What motivated the producers of those individuals to make them and offer them for sale? How did producers decide on the best combinations of resources to use? Who made these resources available, and why? Who decides whether these particular hardware products should continue to be produced and offered for sale?

The quest for profit led firms to produce these goods. Producers looked for and found the least-cost combination of resources in producing their output. Resource suppliers, seeking income, made these resources available. Consumers, through their dollar votes, ultimately decide on what will continue to be produced. 2-10What is meant by the term “creative destruction”? How does the emergence of MP3 (iPod) technology relate to this idea? Creative destruction refers to the process by which the creation of new products and production techniques destroys the market positions of firms committed to producing only existing products or using outdated methods.

The ability to download and store a large number of songs, and the superior quality of MP3 is causing a decline in the CD industry, just as CDs once replaced cassette tapes, which had previously replaced phonographs (records). 2-11In a sentence, describe the meaning of the phrase “invisible hand. ” Market prices act as an “invisible hand,” coordinating an economy by rationing what is scarce, and providing incentives to produce the most desired goods and services. 2-14(Key Question) What are the two characteristics of public goods? Explain the significance of each for public provision as opposed to private provision. What is the free-rider problem as it relates to public goods? Is the Canadian border patrol a public good or a private good? Why? How about satellite TV? Explain.

Public goods are non-rival (one person’s consumption does not prevent consumption by another) and non-excludable (once the goods are produced nobody—including free riders—can be excluded from the goods’ benefits). If goods are non-rival, there is less incentive for private firms to produce them – those purchasing the good could simply allow others the use without compensation. Similarly, if goods are non-excludable, private firms are unlikely to produce them as the potential for profit is low. The free-rider problem occurs when people benefit from the public good without contributing to the cost (tax revenue proportionate to the benefit received). The Canadian border patrol is a public good – my use and benefit does not prevent yours.

Satellite TV is a private good – if the dish, receiver, and service go to my residence it can’t go to my neighbors. The fact that I could invite my neighbor over to watch does not change its status from being a private good. 2-15(Key Question) Draw a production possibilities curve with public goods on the vertical axis and private goods on the horizontal axis. Assuming the economy is initially operating on the curve, indicate how the production of public goods might be increased. How might the output of public goods be increased if the economy is initially operating at a point inside the curve? On the curve, the only way to obtain more public goods is to reduce the production of private goods (from C to B).

An economy operating inside the curve can expand the production of public goods without sacrificing private goods (say, from A to B) by making use of unemployed resources. [pic] ANSWERS TO END-OF-CHAPTER QUESTIONS Chapter 3 3-3(Key Question) What effect will each of the following have on the demand for small automobiles such as the Mini Cooper and Smart car? a. Small automobiles become more fashionable. b. The price of large automobiles rises (with the price of small autos remaining the same). c. Income declines and small autos are an inferior good. d. Consumers anticipate the price of small autos will greatly come down in the near future. e.

The price of gasoline substantially drops. Demand increases in (a), (b), and (c); decreases in (d). The last one (e) is ambiguous. As autos and gas are complements, one could argue that the decrease in gas prices would stimulate demand for all cars, including small ones. However, one could also argue that small cars are attractive to consumers because of fuel efficiency, and that a decrease in gas prices effectively reduces the price of the “gas guzzling” substitutes. That would encourage consumers to switch from smaller to larger cars (SUVs), and demand for small automobiles would fall. [This presents a good illustration of the complexity of many of these changes. 3-6(Key Question) What effect will each of the following have on the supply of automobile tires? a. A technological advance in the methods of producing tires. b. A decline in the number of firms in the tire industry. c. An increase in the price of rubber used in the production of tires. d. The expectation that the equilibrium price of auto tires will be lower in the future than it is currently. e. A decline in the price of large tires used for semi-trucks and earth hauling rigs (with no change in the price of auto tires). f. The levying of a per-unit tax in each auto tire sold. g. The granting of a 50-cent-per-unit subsidy for each auto tire produced. Supply increases in (a), (d), (e), and (g); decreases in (b), (c), and (f). -8(Key Question) Suppose the total demand for wheat and the total supply of wheat per month in the Kansas City grain market are as follows: |Thousands |Price |Thousand |Surplus (+) | |of bushels |per |of bushels |or | |demanded |bushel |supplied |shortage (-) | | | | | |85 |$3. 40 |72 |_____ | |80 |3. 70 |73 |_____ | |75 |4. 0 |75 |_____ | |70 |4. 30 |77 |_____ | |65 |4. 60 |79 |_____ | |60 |4. 90 |81 |_____ | a. What is the equilibrium price? What is the equilibrium quantity? Fill in the surplus-shortage column and use it to explain why your answers are correct. b. Graph the demand for wheat and the supply of wheat. Be sure to label the axes of your graph correctly. Label equilibrium price P and the equilibrium quantity Q. c. Why will $3. 40 not be the equilibrium price in this market? Why not $4. 90? Surpluses drive prices up; shortages drive them down. ” Do you agree? Data from top to bottom: -13; -7; 0; +7; +14; and +21. [pic] (a)Pe = $4. 00; Qe = 75,000. Equilibrium occurs where there is neither a shortage nor surplus of wheat. At the immediately lower price of $3. 70, there is a shortage of 7,000 bushels. At the immediately higher price of $4. 30, there is a surplus of 7,000 bushels. (See graph above). (b)See graph above. (c) Because at $3. 40 there will be a 13,000 bushel shortage which will drive price up. Because at $4. 90 there will be a 21,000 bushel surplus which will drive the price down. Quotation is incorrect; just the opposite is true. -9(Key Question) How will each of the following changes in demand and/or supply affect equilibrium price and equilibrium quantity in a competitive market; that is do price and quantity rise, fall, remain unchanged, or are the answers indeterminate because they depend on the magnitudes of the shifts? Use supply and demand diagrams to verify your answers. a. Supply decreases and demand is constant. b. Demand decreases and supply is constant. c. Supply increases and demand is constant. d. Demand increases and supply increases. e. Demand increases and supply is constant. f. Supply increases and demand decreases. g. Demand increases and supply decreases. h.

Demand decreases and supply decreases. (a)Price up; quantity down; (b)Price down; quantity down; (c)Price down; quantity up; (d) Price indeterminate; quantity up; (e)Price up; quantity up; (f)Price down; quantity indeterminate; (g)Price up, quantity indeterminate; (h)Price indeterminate and quantity down. 3-12(Key Question) Refer to the table in question 8. Suppose that the government establishes a price ceiling of $3. 70 for wheat. What might prompt the government to establish this price ceiling? Explain carefully the main effects. Demonstrate your answer graphically. Next, suppose that the government establishes a price floor of $4. 60 for wheat.

What will be the main effects of this price floor? Demonstrate your answer graphically. At a price of $3. 70, buyers will wish to purchase 80,000 bushels, but sellers will only offer 73,000 bushels to the market. The result is a shortage of 7,000 bushels. The ceiling prevents the price from rising to encourage greater production, discourage consumption, and relieve the shortage. See the graph below. [pic] At a price of $4. 60, buyers only want to purchase 65,000 bushels, but sellers want to sell 79,000 bushels, resulting in a surplus of 14,000 bushels. The floor prevents the price from falling to eliminate the surplus. See the graph below. [pic] ANSWERS TO END-OF-CHAPTER QUESTIONS Chapter 4 -2(Key Question) Graph the accompanying demand data and then use the midpoints formula for Ed to determine price elasticity of demand for each of the four possible $1 price changes. What can you conclude about the relationship between the slope of a curve and its elasticity? Explain in a non-technical way why demand is elastic in the northwest segment of the demand curve and inelastic in the southeast segment. | | | |Product |Quantity | |price |demanded | | | | | | | | | |$5 | |1 | 4 | |2 | |3 | |3 | |2 | |4 | |1 | |5 | | | | | See the graph accompanying the answer to 4-4. Elasticities, top to bottom: 3; 1. 4; . 714; . 333. Slope does not measure elasticity. This demand curve has a constant slope of -1 (= -1/1), but elasticity declines as we move down the curve. When the initial price is high and initial quantity is low, a unit change in price is a low percentage while a unit change in quantity is a high percentage change.

The percentage change in quantity exceeds the percentage change in price, making demand elastic. When the initial price is low and initial quantity is high, a unit change in price is a high percentage change while a unit change in quantity is a low percentage change. The percentage change in quantity is less than the percentage change in price, making demand inelastic. 4-4(Key Question) Calculate total-revenue data from the demand schedule in question 2. Graph total revenue below your demand curve. Generalize on the relationship between price elasticity and total revenue. See the graph. Total revenue data, top to bottom: $5; $8; $9; $8; $5. When demand is elastic, price and total revenue move in the opposite direction.

When demand is inelastic, price and total revenue move in the same direction. [pic] 4-5(Key Question) How would the following changes in price affect total revenue. That is, would total revenue increase, decline, or remain unchanged? a. Price falls and demand is inelastic. b. Price rises and demand is elastic. c. Price rises and supply is elastic. d. Price rises and supply is inelastic. e. Price rises and demand is inelastic. f. Price falls and demand is elastic. g. Price falls and demand is of unit elasticity. Total revenue would increase in (c), (d), (e), and (f); decrease in (a) and (b); and remain the same in (g). 4-8(Key Question) What are the major determinants of price elasticity of demand?

Use these determinants and your own reasoning in judging whether demand for each of the following products is elastic or inelastic: (a) bottled water, (b) tooth paste; (c) Crest toothpaste; (d) ketchup, (e) diamond bracelets; (f) Microsoft Windows operating system. Substitutability, proportion of income; luxury versus necessity, and time. Elastic: (a), (c), (e). Inelastic: (b), (d), and (f). 4-11(Key Question) What is the formula for measuring the price elasticity of supply? Suppose the price of apples goes up from $20 to $22 a box. In direct response, Goldsboro Farms supplies 1200 boxes of apples instead of 1000 boxes. Compute the coefficient of price elasticity (midpoints approach) for Goldsboro’s supply. It its supply elastic, or is it inelastic? Es = percentage change in quantity supplied / percentage change in price. Using the midpoint formula, Es = 1. 1 {= (200/[(1000+1200)/2] / 2/[(20+22)/2]} Supply is price elastic (Es>1). 4-12(Key Question) Suppose the cross elasticity of demand for products A and B is +3. 6 and for products C and D it is -5. 4. What can you conclude about how products A and B are related? Products C and D? A and B are substitutes; C and D are complements. 4-13(Key Question) The income elasticities of demand for movies, dental services, and clothing have been estimated to be +3. 4, +1. 0, and +0. 5 respectively. Interpret these coefficients. What does it mean if the income elasticity coefficient is negative? All are normal goods—income and quantity demanded move in the same direction.

These coefficients reveal that a 1 percent increase in income will increase the quantity of movies demanded by 3. 4 percent, of dental services by 1. 0 percent, and of clothing by 0. 5 percent. A negative coefficient indicates an inferior good—income and quantity demanded move in the opposite direction. 4-15(Key Question) What is the incidence of a tax when demand is highly inelastic? Elastic? What effect does the elasticity have on the incidence of a tax? The incidence of a tax is likely to be primarily on consumers when demand is highly inelastic and primarily on producers when demand is elastic. The more elastic the supply, the greater the incidence of an excise tax on consumers and less on producers. -16(Key Question) Why is it desirable for ceiling prices to be accompanied by government rationing? And for price floors to be accompanied by programs that purchase surpluses, restrict output, or increase demand? Show graphically why price ceilings entail shortages and price floors result in surpluses. What effect, if any, does elasticity of demand and supply have on the size of these shortages and surpluses? Explain. A ceiling price that is set below the equilibrium price necessarily results in the quantity demanded being greater than the quantity supplied. To ensure that the restricted supply may be shared fairly among all those desiring it, government rationing is necessary.

A floor price that is set above the equilibrium price necessarily results in the quantity supplied being greater than the quantity demanded. This creates a surplus. The government must purchase the surplus (and store it and/or sell it abroad), or restrict supply to the quantity that will be bought at the floor price, or develop new uses for the product. If the elasticity of demand and/or supply were inelastic, the shortage or surplus created by the government-set price will be less than if the demand and/or supply were elastic. 4-20(Key Question) Use the ideas of consumer surplus and producer surplus to explain why economists say competitive markets are efficient.

Why are below- or above-equilibrium levels of output inefficient, according to these two sets of ideas? When the consumers’ utility exceeds the price paid, consumer surplus is generated. Likewise, when producers receive a price greater than marginal cost, producer surplus is created. By producing up to the point where MB = MC, the maximum potential consumer surplus and producer surplus is generated. Producing less than the equilibrium level means that potential surplus is left unrealized. Overproduction subtracts from the surplus because society values the use of the additional resources in other pursuits more than it values them in consumption of that good.

ANSWERS TO END-OF-CHAPTER QUESTIONS Chapter 5 5-1(Key Question) Complete the following table and answer the questions below: | | | | |Units consumed |Total utility |Marginal utility | | | | | | | | | | | | | |0 |0 | | | | |1 |10 |10 | | |2 |___ | |8 | | |3 |25 | |___ | | |4 |30 | |___ | | |5 |___ | |3 | | |6 |34 | |___ | | a. At which rate is total utility increasing: a constant rate, a decreasing rate, or an increasing rate? How do you know? b. “A rational consumer will purchase only 1 unit of the product represented by these data, since that amount maximizes marginal utility. ” Do you agree? Explain why or why not. c. “It is possible that a rational consumer will not purchase any units of the product represented by these data. ” Do you agree? Explain why or why not. Missing total utility data top – bottom: 18; 33.

Missing marginal utility data, top – bottom: 7; 5; 1. (a)A decreasing rate; because marginal utility is declining. (b)Disagree. The marginal utility of a unit beyond the first may be sufficiently great (relative to product price) to make it a worthwhile purchase. Consumers are interested in maximizing total utility, not marginal utility. (c)Agree. This product’s price could be so high relative to the first unit’s marginal utility that the consumer would buy none of it. 5-3(Key Question) Columns 1 through 4 of the accompanying table show the marginal utility, measured in utils, that Ricardo would get by purchasing various amounts of products A, B, C, and D.

Column 5 shows the marginal utility Ricardo gets from saving. Assume that the prices of A, B, C, and D are $18, $6, $4, and $24, respectively, and that Ricardo has an income of $106. | | | | | | |Column 1 |Column 2 |Column 3 |Column 4 |Column 5 | |Units | |Units | |Units | |Units | |No. of | | |of A |MU |of B |MU |of C |MU |of D |MU |$ saved |MU | | | | | | | | | | | | | | | | | | | | | | |1 |72 |1 |24 |1 | 15 |1 |36 |1 |5 | |2 |54 |2 |15 |2 |12 |2 |30 |2 |4 | |3 |45 |3 |12 |3 |8 |3 |24 |3 |3 | |4 |36 |4 |9 |4 |7 |4 |18 |4 |2 | |5 |27 |5 |7 |5 |5 |5 |13 |5 |1 | |6 |18 |6 |5 |6 |4 |6 |7 |6 |1/2 | |7 |15 |7 |2 |7 |3. |7 |4 |7 |1/4 | |8 |12 |8 |1 |8 |3 |8 |2 |8 |1/8 | | | | | | | | | | | | a. What quantities of A, B, C, and D will Ricardo purchase in maximizing his utility? b. How many dollars will Ricardo choose to save? c. Check your answers by substituting them into the algebraic statement of the utility-maximizing rule. (a)4 units of A; 3 units of B; 3 units of C, and 0 units of D. (b)Save $4. (c)36/$18 = 12/$6 = 8/$4 = 2/$1. The marginal utility per dollar of the last unit of each product purchased is 2. -4(Key Question) You are choosing between two goods, X and Y, and your marginal utility from each is as shown below. If your income is $9 and the prices of X and Y are $2 and $1 respectively, what quantities of each will you purchase to maximize utility? What total utility will you realize? Assume that, other things remaining unchanged, the price of X falls to $1. What quantities of X and Y will you now purchase? Using the two prices and quantities for X, derive a demand schedule (price-quantity-demanded table) for X. | | | | | |Units of X |MUx |Units of Y |MUy | | | | | | | | | | | | | | | 1 |10 |1 | | |8 | |2 |8 |2 | | |7 | |3 |6 |3 | | |6 | |4 |4 |4 | | |5 | |5 |3 |5 | | |4 | |6 |2 |6 | | |3 | | | | | | | | Buy 2 units of X and 5 units of Y. Marginal utility of last dollar spent will be equal at 4 (= 8/$2 for X and 4/$1 for Y) and the $9 income will be spent. Total utility = 48 (= 10 + 8 for X plus 8 + 7 + 6 + 5 + 4 for Y). When the price of X falls to $1, the quantity of X demanded increases from 2 to 4 (income effect). Total utility is now 58 (= 10 + 8 + 6 + 4 for X plus 8 + 7 + 6 + 5 + 4 for Y). Demand schedule for X: P = $2; Q = 2. P = $1; Q = 4. Chapter 5-Appendix Questions A-3(Key Appendix Question) Using Figure A5-4, explain why the point of tangency of the budget line with an indifference curve is the consumer’s equilibrium position. Explain why any point where the budget line intersects an indifference curve will not be equilibrium. Explain: “The consumer is in equilibrium where MRS = PB/PA. ” The tangency point places the consumer on the highest attainable indifference curve; it identifies the combination of goods yielding the highest total utility. All intersection points place the consumer on a lower indifference curve. MRS is the slope of the indifference curve; PB/PA is the slope of the budge line. Only at the tangency point are these two slopes equal.

If MRS > PB/PA or MRS < PB/PA, adjustments in the combination of products can be made to increase total utility (get to a higher indifference curve). ANSWERS TO END-OF-CHAPTER QUESTIONS Chapter 6 6-2(Key Question) What are the major legal forms of business organization? Briefly state the advantages and disadvantages of each. How do you account for the dominant role of corporations in the Canadian economy? The legal forms of business organizations are: sole proprietorship, partnership, and corporation. Proprietorship advantages: easy to start and provides maximum freedom for the proprietor to do what she/he thinks best. Proprietorship disadvantages: limited financial resources; the owner must be a Jack-or-Jill-of-all-trades; unlimited liability.

Partnership advantages: easy to organize; greater specialization of management; and greater financial resources. Disadvantages: financial resources are still limited; unlimited liability; possibility of disagreement among the partners; and precarious continuity. Corporation advantages: can raise large amounts of money by issuing stocks and bonds; limited liability; continuity. Corporation disadvantages: red tape and expense in incorporating; potential for abuse of stockholder and bondholder funds; double taxation of profits; separation of ownership and control. The dominant role of corporations stems from the advantages cited, particularly unlimited liability and the ability to raise money. 6-4(Key Question) Gomez runs a small pottery firm.

He hires one helper at $12,000 per year, pays annual rent of $5,000 for his shop, and materials cost $20,000 per year. Gomez has $40,000 of his own funds invested in equipment (pottery wheels, kilns, and so forth) that could earn him $4,000 per year if alternatively invested. Gomez has been offered $15,000 per year to work as a potter for a competitor. He estimates his entrepreneurial talents are worth $3,000 per year. Total annual revenue from pottery sales is $72,000. Calculate accounting profits and economic profits for Gomez’s pottery. Explicit costs: $37,000 (= $12,000 for the helper + $5,000 of rent + $20,000 of materials). Implicit costs: $22,000 (= $4,000 of forgone interest + $15,000 of forgone salary + $3,000 of entrepreneurship).

Accounting profit = $35,000 (= $72,000 of revenue – $37,000 of explicit costs); Economic profit = $13,000 (= $72,000 – $37,000 of explicit costs – $22,000 of implicit costs). 6-6 (Key Question) Complete the following table by calculating marginal product and average product from the data given. Plot total, marginal, and average product and explain in detail the relationship between each pair of curves. Explain why marginal product first rises, then declines, and ultimately becomes negative. What bearing does the law of diminishing returns have on short-run costs? Be specific. “When marginal product is rising, marginal cost is falling. And when marginal product is diminishing, marginal cost is rising. ” Illustrate and explain graphically. | | | | |Inputs of |Total |Marginal |Average | |labour |product |product |product | | | | | | | | | | | | | |0 |0 | |____ |____ | |1 |15 | |____ |____ | |2 |34 | |____ |____ | |3 |51 | |____ |____ | |4 |65 | |____ |____ | |5 |74 | |____ |____ | |6 |80 | |____ |____ | |7 |83 | |____ |____ | |8 |82 | |____ |____ | Marginal product data, top to bottom: 15; 19; 17; 14; 9; 6; 3; -1. Average product data, top to bottom: 15; 17; 17; 16. 25; 14. 8; 13. 33; 11. 86; 10. 25.

Your diagram should have the same general characteristics as text Figure 6-2. MP is the slope—the rate of change—of the TP curve. When TP is rising at an increasing rate, MP is positive and rising. When TP is rising at a diminishing rate, MP is positive but falling. When TP is falling, MP is negative and falling. AP rises when MP is above it; AP falls when MP is below it. MP first rises because the fixed capital gets used more productively as added workers are employed. Each added worker contributes more to output than the previous worker because the firm is better able to use its fixed plant and equipment. As still more labour is added, the law of diminishing returns takes hold.

Labour becomes so abundant relative to the fixed capital that congestion occurs and marginal product falls. At the extreme, the addition of labour so overcrowds the plant that the marginal product of still more labour is negative—total output falls. Illustrated by Figure 6-6. Because labour is the only variable input and its price (its wage rate) is constant, MC is found by dividing the wage rate by MP. When MP is rising, MC is falling; when MP reaches its maximum, MC is at its minimum; when MP is falling, MC is rising. 6-9(Key Question) A firm has fixed costs of $60 and variable costs as indicated in the table below. Complete the table. When finished, check your calculations by referring to question 4 at the end of Chapter 7. | | | | | | | | | |Total |Total variable | |Average |Average |Average | | |Total |fixed cost |cost |Total cost |fixed |variable |total |Marginal | |product | | | |cost |cost |cost |cost | | | | | | | | | | | | | | | | | | | |0 |$_____ |$ 0 |$_____ |$_____ |$_____ |$_____ | _____ | |1 |_____ |45 |_____ |_____ |_____ |_____ |_____ | |2 |_____ |85 |_____ |_____ |_____ |_____ |_____ | |3 |_____ |120 |_____ |_____ |_____ |_____ |_____ | |4 |_____ |150 |_____ |_____ |_____ |_____ |_____ | |5 |_____ |185 |_____ _____ |_____ |_____ |_____ | |6 |_____ |225 |_____ |_____ |_____ |_____ |_____ | |7 |_____ |270 |_____ |_____ |_____ |_____ |_____ | |8 |_____ |325 |_____ |_____ |_____ |_____ |_____ | |9 |_____ |390 |_____ |_____ |_____ |_____ |_____ | |10 |_____ |465 |_____ |_____ |_____ |_____ | | a. Graph total fixed cost, total variable cost, and total cost. Explain how the law of diminishing returns influences the shapes of the total variable-cost and total-cost curves. b. Graph AFC, AVC, ATC, and MC. Explain the derivation and shape of each of these four curves and their relationships to one another.

Specifically, explain in non-technical terms why the MC curve intersects both the AVC and ATC curves at their minimum points. c. Explain how the locations of each of the four curves graphed in question 6-9b would be altered if (1) total fixed cost had been $100 rather than $60, and (2) total variable cost had been $10 less at each level of output. The total fixed costs are all $60. The total costs are all $60 more than the total variable cost. The other columns are shown in Question 4 in Chapter 8. a) See the graph. Over the 0 to 4 range of output, the TVC and TC curves slope upward at a decreasing rate because of increasing marginal returns.

The slopes of the curves then increase at an increasing rate as diminishing marginal returns occur. b) See the graph. AFC (= TFC/Q) falls continuously since a fixed amount of capital cost is spread over more units of output. The MC (= change in TC/change in Q), AVC (= TVC/Q), and ATC (= TC/Q) curves are U-shaped, reflecting the influence of first increasing and then diminishing returns. The ATC curve sums AFC and AVC vertically. The ATC curve falls when the MC curve is below it; the ATC curve rises when the MC curve is above it. This means the MC curve must intersect the ATC curve at its lowest point. The same logic holds for the minimum point of the AVC curve. pic] [pic] (c1)If TFC has been $100 instead of $60, the AFC and ATC curves would be higher—by an amount equal to $40 divided by the specific output. Example: at 4 units, AVC = $25. 00 [= ($60 + $40)/4]; and ATC = $62. 50 [= ($210 + $40)/4]. The AVC and MC curves are not affected by changes in fixed costs. (c2)If TVC has been $10 less at each output, MC would be $10 lower for the first unit of output but remain the same for the remaining output. The AVC and ATC curves would also be lower—by an amount equal to $10 divided by the specific output. Example: at 4 units of output, AVC = $35. 00 [= $150 – $10)/4], ATC = $50 [= ($210 – $10)/4].

The AFC curve would not be affected by the change in variable costs. 6-12(Key Question) Use the concepts of economies and diseconomies of scale to explain the shape of a firm’s long-run ATC curve. What is the concept of minimum efficient scale? What bearing may the exact shape of the long-run ATC curve have on the structure of an industry? The long-run ATC curve is U-shaped. At first, long-run ATC falls as the firm expands and realizes economies of scale from labour and managerial specialization and the use of more efficient capital. The long-run ATC curve later turns upward when the enlarged firm experiences diseconomies of scale, usually resulting from managerial inefficiencies.

The MES (minimum efficient scale) is the smallest level of output needed to attain all economies of scale and minimum long-run ATC. If long-run ATC drops quickly to its minimum cost which then extends over a long range of output, the industry will likely be composed of both large and small firms. If long-run ATC descends slowly to its minimum cost over a long range of output, the industry will likely be composed of a few large firms. If long-run ATC drops quickly to its minimum point and then rises abruptly, the industry will likely be composed of many small firms. ANSWERS TO END-OF-CHAPTER QUESTIONS Chapter 7 7-3(Key Question) Use the following demand schedule to determine total and arginal revenues for each possible level of sales: |Product Price ($) |Quantity Demanded |Total Revenue ($) |Marginal Revenue ($) | |2 |0 | | | |2 |1 | | | |2 |2 | | | |2 |3 | | | |2 |4 | | | |2 |5 | | | a. What can you conclude about the structure of the industry in which this firm is operating? Explain. b. Graph the demand, total-revenue, and marginal-revenue curves for this firm. c. Why do the demand and marginal-revenue curves coincide? d. “Marginal revenue is the change in total revenue. ” Explain verbally and graphically, using the data in the table. Total revenue, top to bottom: 0; $2; $4; $6; $8; $10.

Marginal revenue, top to bottom: $2, throughout. (a)The industry is perfectly competitive—this firm is a “price taker. ” The firm is so small relative to the size of the market that it can change its level of output without affecting the market price. b) See graph. (c)The firm’s demand curve is perfectly elastic; MR is constant and equal to P. [pic] (d)Yes. Table: When output (quantity demanded) increases by 1 unit, total revenue increases by $2. This $2 increase is the marginal revenue. Figure: The change in TR is measured by the slope of the TR line, 2 (= $2/1 unit). 7-4(Key Question) Assume the following unit-cost data are for a perfectly competitive producer: | | | | | | |Average |Average |Average | | |Total |fixed |variable |total |Marginal | |Product |cost |cost |cost |cost | | | | | | | | | | | | | | | | | | | | | |0 | | | | | | |$45 | | |1 |$60. 00 | |$45. 00 | |$105. 00 | |40 | | |2 |30. 00 | |42. 50 | |72. 50 | |35 | | |3 |20. 00 | |40. 00 | |60. 00 | |30 | | |4 |15. 00 | |37. 50 | |52. 0 | |35 | | |5 |12. 00 | |37. 00 | |49. 00 | |40 | | |6 |10. 00 | |37. 50 | |47. 50 | |45 | | |7 |8. 57 | |38. 57 | |47. 14 | |55 | | |8 |7. 50 | |40. 63 | |48. 13 | |65 | | |9 |6. 67 | |43. 33 | |50. 00 | |75 | | |10 |6. 00 | |46. 50 | |52. 0 | | | | | | | | | | | | | | a. At a product price of $56, will this firm produce in the short run? Why, or why not? If it does produce, what will be the profit-maximizing or loss-minimizing output? Explain. What economic profit or loss will the firm realize per unit of output. b. Answer the questions of 4a assuming that product price is $41. c. Answer the questions of 4a assuming that product price is $32. d. In the table below, complete the short-run supply schedule for the firm (columns 1 to 3) and indicate the profit or loss incurred at each output (column 3). | | | | |(1) |(2) |(3) |(4) | | |Quantity | |Quantity | | |supplied, |Profit (+) |supplied, | |Price |single firm |or loss (l) |1500 firms | | | | | | | | | | | | | | | |$26 | |____ |$____ |____ | | |32 | |____ |____ |____ | | |38 | |____ |____ |____ | | |41 | |____ |____ |____ | | |46 | |____ |____ |____ | | |56 | |____ |____ |____ | | |66 | |____ |____ |____ | | | | | | | | e.

Explain: “That segment of a competitive firm’s marginal-cost curve which lies above its average-variable-cost curve constitutes the short-run supply curve for the firm. ” Illustrate graphically. f. Now assume there are 1500 identical firms in this competitive industry; that is, there are 1500 firms, each of which has the same cost data as shown here. Calculate the industry supply schedule (column 4). g. Suppose the market demand data for the product are as follows: | | | | |Total | | |quantity | |Price |demanded | | | | | | | | | | | |$26 | |17,000 | | 32 | |15,000 | | |38 | |13,500 | | |41 | |12,000 | | |41 | |10,500 | | |56 | |9,500 | | |66 | |8,000 | | | | | | | What will equilibrium price be? What will equilibrium output be for the industry? For each firm? What will profit or loss be per unit? Per firm? Will this industry expand or contract in the long run? (a)Yes, $56 exceeds AVC (and ATC) at the loss—minimizing output. Using the MR = MC rule it will produce 8 units. Profits per unit = $7. 87 (= $56 – $48. 13); total profit = $62. 96. b)Yes, $41 exceeds AVC at the loss—minimizing output. Using the MR = MC rule it will produce 6 units. Loss per unit or output is $6. 50 (= $41 – $47. 50). Total loss = $39 (= 6 €? $6. 50), which is less than its total fixed cost of $60. (c)No, because $32 is always less than AVC. If it did produce, its output would be 4—found by expanding output until MR no longer exceeds MC. By producing 4 units, it would lose $82 [= 4 ($32 – $52. 50)]. By not producing, it would lose only its total fixed cost of $60. (d)Column (2) data, top to bottom: 0; 0; 5; 6; 7; 8; 9, Column (3) data, top to bottom in dollars: -60; -60; -55; -39; -8; +63; +144. (e)The firm will not produce if P < AVC.

When P > AVC, the firm will produce in the short run at the quantity where P (= MR) is equal to its increasing MC. Therefore, the MC curve above the AVC curve is the firm’s short-run supply curve, it shows the quantity of output the firm will supply at each price level. See Figure 7-6 for a graphical illustration. (f)Column (4) data, top to bottom: 0; 0; 7,500; 9,000; 10,500; 12,000; 13,500. (g)Equilibrium price = $46; equilibrium output = 10,500. Each firm will produce 7 units. Loss per unit = $1. 14, or $8 per firm. The industry will contract in the long run. 7-6(Key Question) Using diagrams for both the industry and representative firm, illustrate competitive long-run equilibrium.

Assuming constant costs, employ these diagrams to show how (a) an increase and (b) a decrease in market demand will upset this long-run equilibrium. Trace graphically and describe verbally the adjustment processes by which long-run equilibrium is restored. Now rework your analysis for increasing- and decreasing-cost industries and compare the three long-run supply curves. See Figures 7-8 and 7-9 and their legends. See figure 7-11 for the supply curve for an increasing cost industry. The supply curve for a decreasing cost industry is below. [pic] 7-7(Key Question) In long-run equilibrium, P = minimum ATC = MC. Of what significance for economic efficiency is the equality of P and minimum ATC?

The equality of P and MC? Distinguish between productive efficiency and allocative efficiency in your answer. The equality of P and minimum ATC means the firms is achieving productive efficiency; it is using the most efficient technology and employing the least costly combination of resources. The equality of P and MC means the firms is achieving allocative efficiency; the industry is producing the right product in the right amount based on society’s valuation of that product and other products. ANSWERS TO END-OF-CHAPTER QUESTIONS Chapter 8 8-4 (Key Question) Use the demand schedule that follows to calculate total revenue and marginal revenue at each quantity.

Plot the demand, total-revenue, and marginal-revenue curves and explain the relationships between them. Explain why the marginal revenue of the fourth unit of output is $3. 50, even though its price is $5. 00. Use Chapter 5’s total-revenue test for price elasticity to designate the elastic and inelastic segments of your graphed demand curve. What generalization can you make regarding the relationship between marginal revenue and elasticity of demand? Suppose that somehow the marginal cost of successive units of output were zero. What output would the profit-seeking firm produce? Finally, use your analysis to explain why a monopolist would never produce in the inelastic region of demand. | | | | | |Quantity | |Quantity | |Price |Demanded |Price |Demanded | | | | | | | | | | | | | | | |$7. 00 | |0 |$4. 50 | |5 | |6. 50 | |1 |4. 00 | |6 | |6. 00 | |2 |3. 50 | |7 | |5. 50 | |3 |3. 00 | |8 | |5. 00 | |4 |2. 0 | |9 | | | | | | | | Total revenue, in order from Q = 0: 0; $6. 50; $12. 00; $16. 50; $20. 00; $22. 50; $10-00; $10-50; $10-00; $22. 50. Marginal revenue in order from Q = 1: $6. 50; $5. 50; $4. 50; $3. 50; $2. 50; $1. 50; $. 50; -$1. 50. See the accompanying graph. Because TR is increasing at a diminishing rate, MR is declining. When TR turns downward, MR becomes negative. Marginal revenue is below D because to sell an extra unit, the monopolist must lower the price on the marginal unit as well as on each of the preceding units sold. Four units sell for $5. 00 each, but three of these four could have been sold for $5. 0 had the monopolist been satisfied to sell only three. Having decided to sell four, the monopolist had to lower the price of the first three from $5. 50 to $5. 00, sacrificing $. 50 on each for a total of $1. 50. This “loss” of $1. 50 explains the difference between the $5. 00 price obtained on the fourth unit of output and its marginal revenue of $3. 50. Demand is elastic from P = $6. 50 to P = $3. 50, a range where TR is rising. The curve is of unitary elasticity at P = $3. 50, where TR is at its maximum. The curve is inelastic from then on as the price continues to decrease and TR is falling. When MR is positive, demand is elastic. When MR is zero, demand is of unitary elasticity.

When MR is negative, demand is inelastic. If MC is zero, the monopolist should produce 7 units where MR is also zero. It would never produce where demand is inelastic because MR is negative there while MC is positive. [pic] 8-5(Key Question) Suppose a monopolist is faced with the demand schedule shown below and the same cost data as the competitive producer discussed in question 4 at the end of Chapter 8. Calculate the missing total- and marginal-revenue amounts, and determine the profit-maximizing price and output for this monopolist. What is the monopolist’s profit? Verify your answer graphically and by comparing total revenue and total cost. | | | | | |Quantity |total |Marginal | |Price |demanded |revenue |revenue | | | | | | | | | | | | | |$115 | |0 |$____ |$____ | |100 | |1 |$____ |$____ | |83 | |2 |$____ |$____ | |71 | |3 |$____ |$____ | |63 | |4 |$____ |$____ | |55 | |5 |$____ |$____ | |48 | |6 |$____ |$____ | |42 | |7 |$____ |$____ | |37 | |8 |$____ |$____ | |33 | |9 |$____ |$____ | |29 | |10 |$____ | | | | | | | Total revenue data, top to bottom, in dollars: 0: 100; 166; 213; 252; 275; 288; 294; 296; 297; 290. Marginal revenue data, top to bottom, in dollars: 100; 66; 47; 39; 23; 13; 6; 2; 1; -7. Price = $63; output = 4; profit = $42 [= 4($63 – 52. 50)].

Your graph should have the same general appearance as Figure 10-4. At Q =4, TR = $252 and TC = $210 [= 4($52. 50)]. 8-6(Key Question) Suppose that a price discriminating monopolist has segregated its market into two groups of buyers, the first group described by the demand and revenue data that you developed for question 5. The demand and revenue data for the second group of buyers is shown in the accompanying table. Assume that MC is $13 in both markets and MC = ATC at all output levels. What price will the firm charge in each market? Based solely on these two prices, what can you conclude about the relative elasticities of demand in the two markets? What will be this monopolist’s total economic profit? Price |Quantity demanded |Total revenue |Marginal revenue | |$71 |0 |$0 | | | | | |$63 | |63 |1 |63 | | | | | |47 | |55 |2 |110 | | | | | |34 | |48 |3 |144 | | | | | |24 | |42



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