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MicroeconomicsTheory / Applications

ELEVENTH EDITION

INSTRUCTOR’S MANUAL AND TEST-ITEM FILE

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ELEVENTH EDITION

Edwin Mansfield • Gary Yohe

Kaye Husbands FealingWILLIAMS COLLEGE

William D. GuntherUNIVERSITY OF ALABAMA

Paul M. SommersMIDDLEBURY COLLEGE

Kathryn A. NantzFAIRFIELD UNIVERSITY

B W • W • NORTON & COMPANY • NEW YORK • LONDON


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W. W. Norton & Company has been independent since its founding in 1923, when William Warder Norton and Mary D.Herter Norton first published lectures delivered at the People’s Institute, the adult education division of New York City’sCooper Union. The Nortons soon expanded their program beyond the Institute, publishing books by celebrated academicsfrom America and abroad. By mid-century, the two major pillars of Norton’s publishing program—trade books and collegetexts—were firmly established. In the 1950s, the Norton family transferred control of the company to its employees, andtoday—with a staff of four hundred and a comparable number of trade, college, and professional titles published eachyear—W. W. Norton & Company stands as the largest and oldest publishing house owned wholly by its employees.

Copyright © 2004 by W. W. Norton & Company, Inc.

All rights reserved.Printed in the United States of America.

Composition by PennSet, Inc.Manufacturing by Sterling-Pierce—East Rockaway, New York.Production Manager: Ben Reynolds.Art by John McAusland.

ISBN 0–393–92402–5

W. W. Norton & Company, Inc., 500 Fifth Avenue, New York, N.Y. 10110-0017www.wwnorton.com

W. W. Norton & Company Ltd., Castle House, 75/76 Wells Street, London W1T 3QT

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Preface vii

Introduction ix

Part One Introduction

Chapter 1 | Microeconomics 1

Part Two Consumer Behaviorand Market Demand

Chapter 2 | Consumer Tastes and Preferences 13

Chapter 3 | Consumer Behavior and Individual Demand 28

Chapter 4 | Derivation of the Market Demand Curve 40

Chapter 5 | Choices Involving Risk 58

Part Three The Firm:Its Technology Costs

Chapter 6 | The Firm and Its Technology 69

Chapter 7 | Optimal Input Combination and Cost Functions 81

Part Four Market Structure,Price, and Output

Chapter 8 | Perfect Competition 97

Chapter 9 | Applying the Competitive Model 110

Chapter 10 | Monopoly 114

Chapter 11 | Monopolistic Competition 126

Chapter 12 | Oligopoly and Game Theory 132

Chapter 13 | Strategic Competition 140

Part Five Markets for Inputs

Chapter 14 | Price and Employment of Inputs 145

Chapter 15 | Investment Decisions 166

Part Six Information, Efficiency,and Government

Chapter 16 | General Equilibrium Analysis and Resource Allocation 177

Chapter 17 | Coping with Asymmetric Information 191

Chapter 18 | Public Goods, Externalities, and the Role of Government 195

Brief Answers to Problem Sets 209

Brief Answers to Even-Numbered Questions and Problems Found in the Text 273

v

CONTENTS

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At our respective institutions, we try to make the tradition-ally dry subject of microeconomic theory palatable, evenamusing, but always relevant. To do this, we distribute toour students numerous handouts that include problems,many of which appear in this instructor’s manual.

Students are often unclear about the practicality of text-book theories. We have found that problem sets laced withrelevant, real-world situations not only strengthen anddeepen their understanding of key concepts and terms, butalso encourage students to revisit the text to gain betterknowledge of the subject.

This manual offers over fourteen hundred questions,many new to this edition. Many of the questions are soberin tone and stick closely to the decision-making emphasisof the text. Many of the problem sets include exercises thatwill help develop the theory as a set of principles that yieldpowerful insights into everyday problems. Some of theproblems are clearly designed for advanced students. Yet,no attempt has been made to distinguish more difficult

problems from less difficult ones: experience has taught usthat easily discouraged students have the tendency to avoid“starred” problems, writing off attempts to solve them ashopeless. If a student does not know that a particular prob-lem is “starred,” then he or she may be more inclined totackle it.

Although we claim that the questions in this manual areour own, the fact is that we are all highly influenced by ourteachers, our colleagues, and of course our students. Eachhas contributed to the development of the questions in thismanual and we offer our thanks. Our contribution is ofcourse therefore “marginal” and, we hope, positive. If so,we are one step closer to the optimum instructor’s manual.

Kaye Husbands FealingWilliam D. GuntherPaul M. SommersKathryn A. Nantz

vii

PREFACE

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For each chapter of Gary Yohe and Edwin Mansfield’sEleventh Edition of Microeconomics, this manual featurescomments, as well as multiple-choice and problem-setquestions and their answers. This manual also contains briefanswers to the even-numbered questions and problems thatappear at the end of each textbook chapter. These, in addi-tion to the answers to the odd-numbered questions alreadylocated at the back of the textbook, provide a full set of so-lutions to the exercises.

Comments

In each chapter we provide a few tips on handling specificportions of the text. In these sections we take the opportu-nity to share with you, a fellow instructor, several class-room techniques and examples that have helped ourstudents through thorny concepts.

Many students first experience working with problemsduring the first exam. A few students invariably deludethemselves into believing that they understand the mate-rial—a delusion dispelled by their attempt at their firstexam question. To prevent such a calamity, we assign manyproblems during the course of the term, including sampletest problems before each exam. In addition, assign two orthree problems for homework between classes, giving stu-dents ample opportunity to think analytically and to prac-tice solving word problems.

Multiple-Choice Questions

The heart of the manual is the collection of approximatelyone thousand multiple-choice questions. Each multiple-choice question is keyed to pages in the text so that the in-structor may give students who miss a question specific

references for review. The correct answers to each questionare presented below the question.

Problem Sets

Each chapter contains a problem set, and we have suppliedanswers to all of the problems. The exercises that make up aproblem set are typically more challenging and unequivo-cally more time-consuming than are the multiple-choicequestions. There is an abundance of material in these prob-lem sets; the instructor would be ill-advised to assign all theproblems in a problem set at one time.

These exercises require students to write out short an-swers, draw diagrams, or, in some cases, use calculus tosolve, say, constrained maximization (minimization) prob-lems. Few of the exercises are trivial. Accordingly, to spareaverage and slower students the agony of hours of frustra-tion, you may elect to work through some of these exercisesas in-class examples.

Testing and Educational Objectives

There is perhaps no other issue quite as important to stu-dents as the manner in which they will be evaluated. Givingcareful thought to a few basic principles of testing mayyield significant benefits to student and teacher alike. Toteach without testing is to fail to monitor this process and isunfair to both student and teacher. In spite of all its limita-tions, testing still provides the only manner in which stu-dents can be informed of their progress, at the same timesimilarly informing us of our effectiveness.

Testing does not mean that we are limited to conven-tional testing techniques. When class size permits, judg-ments based on more intimate knowledge of the students’

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INTRODUCTION

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abilities can supplement traditional testing techniques. Fewwould argue, however, that complete reliance should begiven to the highly irregular, uncontrolled, subjective ob-servations of the teaching/learning process. Thus the princi-ples of good test construction should be of some value to usall.

Teaching requires planning, and planning in turn requiresthe identification of educational objectives. Good test con-struction begins by recalling the specific objectives of thecourse. The following general categories illustrate the typesof student behavior specific questions should test.

KnowledgeComprehensionApplicationAnalysisSynthesisEvaluation

Some questions will be more appropriate for one cate-gory than another, and any examination should test morethan one category. The mix of question types will vary withthe instructor and will depend on whether the exam is a quizor final comprehensive exam. We have tried to provide qus-tions of both types.

Planning the Examination

Testing requires some advanced planning and thought. Thefollowing issues should receive careful attention.

When to test (at what intervals during the term)How often to test (frequency)The types of questions to useThe emphasis to be given various topics or objectivesThe length of the testThe overall level of difficulty of the examinationThe balance between recent and older material on the

final exam

Many of these items must be considered together, such asthe types of questions asked and the length of the test. How-ever, each topic should receive careful attention before theconstruction of the examination begins.

Constructing the Examination

After deciding on the issues listed above, the task of con-structing the examination will consume most of our time.Some of the basic principles of good test construction areoutlined below.

MULTIPLE-CHOICE QUESTIONS

This objective form of testing is very popular especiallywhen class sizes are large. In spite of some limitations toobjective testing, multiple-choice questions are quite adapt-

able to the measurement of knowledge, understanding,judgment, analytical skills, and policy prescription. Indeed,the questions themselves are often less ambiguous thanmany essay questions. Again, several key recommendationscan be of immense value in selecting and writing multiple-choice questions.

Ask questions that relate independently to meaningfuland valid statements of important ideas.

Write questions in such a way as to maximize the dis-criminatory power of the examination. “Discrimi-natory power” means the ability to separate strongfrom weak students.

Begin each item with a stem question or incompletestatement to which a reasonable answer can bewritten, and to which some reasonable but incor-rect answers can be written.

Phrase the correct response in a thoroughly correctmanner without clues.

Write most of the incorrect answers so that they arethoroughly wrong, yet plausible to poorly preparedstudents.

Modify the questions based on experience so that it isreasonable to expect only one half of the class toanswer them correctly.

We have tried to follow these guidelines in writing and re-vising the questions in this manual.

PROBLEM SETS

These questions require students to organize and expressanswers in their own words. Since a considerable amount oftime will be spent thinking and then writing the answer,tests should contain relatively few items. Although thisform of question allows the greatest degree of individualfreedom, it suffers from a general lack of validity in thesense that different teachers may evaluate the same re-sponse in quite different ways. There are, however, somegeneral rules that offer some assistance in writing analyticalproblems (other than those contained in this manual).

Use questions that require the student to demonstratehis or her command of essential knowledge ofskills.

Use questions that are determinate (that is, the answersare obvious to someone familiar with the subjectmatter).

Use questions that explain the task to the student ascompletely as possible.

Use more, shorter questions rather than fewer, longerquestions.

Avoid giving a choice of questions to be answered.They tend to offer the unprepared students a bene-fit while offering no advantage to better-preparedstudents.

Always test the question by writing an “ideal” answer.

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Inform the class about the method that will be used tograde the questions (general information).

Evaluating the Test Results

After the examination has been administered, we have theopportunity to grade the examination and to determine itseffectiveness in determining the students’ progress. Weshould not simply assume that the test is a valid predictor ofstudent achievement. Item analysis, a technique available atmost institutions, provides us with documentation of thestudents’ performance on each question, the effectiveness ofeach question in discriminating between strong and weakstudents, and an overall picture of the validity of the exam-ination. We can use item analysis to identify vague ques-tions and the mis-keying of the answer sheet. Thisinformation allows us to judge the effectiveness of the examitself before assigning grades to students.

In ideal cases, multiple-choice questions should averageabout 50 percent correct response (this allows for maxi-

mum discriminatory power). However, many instructorswill include questions they expect every student to answercorrectly. Not only will such questions assure mastery ofsome topics, they will also build confidence in students, especially when the questions are placed early in the exam-ination.

The discriminatory power of a question refers to its abil-ity to elicit correct responses from strong students and in-correct responses from weak students. A question should besufficiently difficult so that it discriminates between the up-per and lower portions of the class. If it does not, it suggeststhat the question has hidden meanings that make the better-prepared student respond incorrectly while the weak stu-dent, unaware of any of the complications of the questions,responds correctly; if this occurs, we should rewrite thequestion before using it again.

Knowledge of the level of difficulty and discriminatorypower of the exam will be of immense value in interpretingthe validity of the overall test and responding to student questions regarding the test.

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ELEVENTH EDITION


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CHAPTER 1 MICROECONOMICS

Comments

1. You may want to spend some time on the scarcity issueas the economic problem. By linking scarcity to theneed to choose among alternatives, the notion of oppor-tunity costs emerges readily.

2. An interesting way to introduce the price system dis-cussion is first to raise the fundamental questions thatany society must solve (how, who, what, and the rate ofgrowth). Since there is more than one way to solve theproblem, even the choice of a price system (as opposedto a centralized authority, for example) is an economicchoice. The many reasons for choosing a price systemare, of course, the subject of this book.

3. Since students will become immersed in models through-out this text, it is important for them to understand why(in addition to how) modeling is so pervasive.

4. In a broad sense, the goals of science are to explain,predict, and control. Economics helps to explain phe-nomena in a world of scarcity and, based on the ac-curacy of those explanations, predicting these events.This is positive economics. The decision to control(that is, either to make an event occur or to prevent itsoccurrence) is the world of normative economics. Sim-ply put, positive economics tells us “what is,” whilenormative economics tells us “what should be.”

5. Not all students taking an intermediate level course inmicroeconomics are well trained in mathematics. Yet,those students thoroughly versed in the fundamentalsof calculus should be led through several constrainedmaximization problems. Such problems can be solved

by the use of Lagrange multipliers, a method presentedin the appendix to this chapter. Instructors will ap-proach the study of microeconomics with differentpreferences for the emphasis they wish to place on thequantitative parts of the material. Our attitude has beenthat when an economic problem can be posed andsolved mathematically, students should be encouragedto use mathematical tools not only because they help todevelop the theory but also because they add a dimen-sion of exactness to our study of individual decision-making agents we do not achieve through (sometimesshamefully contrived) diagrams. In short, for studentswho know how to take a derivative, a lecture on themathematics of constrained maximization might betime well spent.

6. The topic of supply and demand should be a good re-view for students. Little in-class time is required forthis material.

7. Above all else, stress the distinction between a changein demand and a change in the quantity demanded. Theformer refers to a shift in the whole demand curvewhereas the latter refers to movement along the un-changed demand curve. A few students will roll theireyes, considering this distinction as one more exampleof an economist’s flair for elegant phrasemaking. Still,a failure at the outset of the course carefully to definethe precise meaning of our profession’s jargon will in-variably make the student’s transition from words tographs tougher later on.

8. The timeless analysis offered by supply and demandcurves often leaves students a little bewildered. Ifprices change whenever supply or demand curveschange, then why aren’t prices changing every day? A

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simple answer that will serve at this point involves theuse of inventories and backorders to adjust to surplusesand shortages respectively. This allows the firm to ad-just production to meet demand over several periodsand not to be faced with a constant threat of shortagesor surpluses of the product.


1. Which of the following is not a task that every eco-nomic system must perform?a. Determine what goods and services will be pro-

duced.b. Determine how goods and services are to be

produced.c. Maintain and provide for an adequate rate of

economic growth.d. Determine the distribution of resources among

competing uses.e. Maintain a constant rate of economic growth.

Answer: e Pages: 3–5

2. Which of the following is true of a model?a. A model is composed of a number of assumptions

that are highly realistic.b. A model is applicable only to problems of norma-

tive economics.c. A model is not formulated to make predictions

about the real world.d. A model abstracts from the real situation.e. A model is useful if its underlying assumptions re-

fer to things that are directly measurable.

Answer: d Pages: 5–8

3. The most important test of a model is whether ita. is free of value judgments.b. predicts more accurately than any other model.c. embodies a highly realistic set of assumptions.d. yields verifiable predictions.e. contains more mathematical equations than any

other model.

Answer: b Pages: 5–8

4. Microeconomics can be defined as the branch of eco-nomics that deals with the economic behavior ofa. individual consumers, firms, and resource owners.b. groups of consumers, firms, and resource owners.c. single countries.d. government interest groups.e. none of the above.

Answer: a Page: 3

5. An economic system fundamentally provides answersto the following questions:a. What, where, how, and who?b. When, why, where, and who?c. Why does unemployment occur?d. Why does inflation occur?e. What, how, who, and what is the rate of growth?


6. Economics is important because ita. determines the answers to important social

problems.b. helps firms to make more money.c. provides added insights about the behavior of indi-

viduals and organizations.d. focuses attention on business rather than govern-

ment decisions.e. none of the above.

Answer: c Pages: 3–5

7. An example of a major microeconomic problem of the1990s in the United States isa. the high unemployment rate.b. determination of workers’ wages.c. the high rate of inflation.d. the large government budget deficits.e. the large trade deficit.


8. Technology is important because it determinesa. what will be produced.b. why things are produced.c. the amount of output possible with any given set of

inputs.d. a product’s price.e. none of the above.

Answer: c Page: 14

9. For a model to have predictive power, all assumptionsused in its construction must bea. realistic.b. descriptive.c. predictive.d. relevant.e. none of the above.


10. A model should not be used unless ita. is always correct in its predictions.b. is based on totally realistic assumptions.c. focuses only on a narrow range of issues.d. explains what it predicts.e. is the best one available.


2 | Part One


11. For there to be a market, there must bea. a well-defined center of exchange, such as a

building.b. perfect knowledge of prices and profit

opportunities.c. mobile resources.d. buyers and sellers.e. all of the above.

Answer: d Page: 10

12. A market demand curve showsa. the rate at which the consumption of a commodity

will decrease as income falls.b. the minimum price consumers will have to pay to

get a certain quantity.c. that as the price falls, consumers will spend less

money on a commodity.d. how much of a commodity will be purchased at

each price per unit of time.e. which price will prevail in the marketplace.

Answer: d Page: 11

13. Which of the following is not a determinant of themarket demand curve?a. The length of the time period to which the demand

curve pertainsb. The tastes of consumersc. The level of consumer incomesd. The equilibrium output pricee. The level of other prices


14. A shift in the demand curve for coal to the right maybe the result ofa. consumers’ becoming more energy conscious.b. a decrease in per capita income.c. a decrease in the price of coal.d. more favorable supply conditions.e. an increase in the price of natural gas.


15. Which of the following would result in a change in thequantity demanded?a. A change in the price of a related goodb. A change in incomec. A change in tastesd. An increase in populatione. A shift in the supply curve


16. Which of the following would cause the demand curvefor gasoline to shift to the right?1. A large increase in the price of public transportation2. A large decrease in the price of automobiles3. A large reduction in the cost of producing gasoline

a. 1 onlyb. 2 onlyc. 1 and 2 onlyd. 2 and 3 onlye. 1, 2, and 3


17. The discovery that printed circuits were a cheap sub-stitute for wire in radios probably led toa. a decrease in the demand for copper wire.b. an increase in the supply of copper wire.c. a decrease in the supply of copper wire.d. an increase in the demand for copper wire.e. no changes in the market for copper wire.

Answer: a Pages: 9–13

18. Which of the following would cause the demand curvefor airline tickets to shift to the right?1. Oil producers worldwide decrease the supply, lead-

ing to higher prices of jet fuel.2. Price wars break out among airline companies,

lowering fares for all travelers. 3. The price of rail tickets increases as railroad carri-

ers make upgrades in their capital equipment andbegin to offer high-speed service in some areas.



19. All but which one of the following events will increasethe demand for flyswatters?a. The price of insecticide or screening goes up.b. The rental rate on vacation cabins goes down.c. The price of flypaper goes up.d. The frog population explodes.e. Garbage collectors go on strike.


Chapter 1 | 3


20. The argument that price decreases should follow costdecreases ignoresa. the supply side.b. the demand side.c. the role of supply expectations.d. the price of resources.e. all of the above.


21. An increase in the price of oil should result in an in-crease in the price of coal becausea. the demand for coal will decrease.b. the supply of coal will increase.c. the demand for coal will increase.d. both the demand for and the supply of coal will

increase.e. the supply of coal will decrease.


22. If oil prices increase from $18 per barrel to $30 perbarrel the following is/are likely to occur over the longrun:a. The quantity demanded of gasoline will increase.b. The quantity supplied of gasoline will increase.c. The supply of all goods and services in the econ-

omy will increase.d. The demand for all goods and services in the econ-

omy will decrease.e. All of the above.


23. Which of the following is not a determinant of themarket supply curve?a. The length of the time period to which the supply

curve pertainsb. The equilibrium output pricec. Technological changed. The level of input pricese. The effect of changes in industry output on input

prices


24. Decreases in the price of inputs may causea. the demand curve to shift to the right.b. the demand curve to shift to the left.c. the supply curve to shift to the right.d. the supply curve to shift to the left.e. a movement along the supply curve.


25. Market supply curves tend to be more price elastic ifthe time period is long rather than short becausea. firms are better able to adapt their output rates to

price changes in the long run.b. external economies will be realized.c. consumers are better able to find substitute goods.d. input prices would be expected to increase with the

length of the time period.e. economic profits are reduced to zero in the long

run.


26. Suppose the number of tickets available to an athleticevent at your university is less than the number of fanswho would like to attend at the price printed on thetickets. On the day tickets go on sale, the lines to pur-chase the tickets are long and many students decidenot to go to the event, and when all the tickets aresold, there are no more students in line. You can con-clude thata. all students who wanted to go to the event at the

printed price will be able to go to the event.b. the actual price of the ticket includes the printed

price plus the opportunity cost of the time spent inthe line.

c. the actual price of the ticket equals the printed priceof the ticket.

d. there will be a shortage of seats at the event.e. there will be a surplus of seats at the event.


27. Instead of referring to shortages or surpluses, youcould say the market price isa. too high or too low respectively.b. too low or too high respectively.c. too high.d. too low.e. none of the above.


28. Suppose that a just-published report on the health ef-fects of riding bicycles causes demand to increase. Asa result of the increased demand, more firms enter themarket to produce bicycles and the supply of bicyclesincreases. We a. can predict that the price of bicycles will increase.b. can predict that the price of bicycles will decrease.c. can predict that the price of bicycles will remain

the same.d. cannot predict the impact on the price of bicycles

with the information provided.


4 | Part One


29. The Organization of Petroleum Exporting Countries(OPEC) announces a new agreement on productionquotas that will reduce the amount of oil produced bymember countries next year. In the market for oil, theannouncement willa. have the effect this year of shifting the supply curve

to the left.b. have the effect this year of shifting the supply

curve to the right.c. have the effect this year of shifting the demand

curve to the right.d. have the effect this year of shifting the demand

curve to the left.e. have no effect this year on supply or demand.


30. Suppose that the demand and supply for mountainbikes is given by the following data:

Qd Price Qs

500 $ 100 0400 200 50300 300 120200 400 200100 500 300

0 600 450

The equilibrium price and quantity exchanged area. $100 and 500 bikes.b. $400 and 200 bikes.c. $500 and 300 bikes.d. $400 and 400 bikes.e. nonexistent—there is no equilibrium in this market.


31. At the equilibrium price, which of the following is/aretrue?1. Quantity demanded equals quantity supplied.2. Excess demand equals zero.3. Price equals quantity.



32. If the quantity demanded were less than the quantitysupplied at a particular price, the equilibrium pricewould be achieved bya. a decrease in supply as firms reacted to the surplus

by producing less.b. the drawing down of inventories until firms raised

the price.c. an increase in demand.d. a decrease in the price, which would decrease

the quantity supplied and increase the quantity demanded.

e. a decrease in demand, which would induce firms tocut back production.


33. Which of the following would result in a shift of thesupply curve for sugar?a. The equilibrium price of sugar falls.b. The demand for sugar increases.c. Artificial sweeteners are found to aggravate high

blood pressure.d. The price of artificial sweeteners rises dramatically.e. The tariff rate on foreign sugar increases.


34. In the period October to December 1996, a pastry chefsold approximately 30,000 copies of his novel TheCrepes of Wrath at an average price of $12.95 percopy. In the period January to September 1997, 60,000copies were sold at an average price of $15.95 percopy. Assuming that supply and demand curves havethe usual slopes and that the market was in equilib-rium in both periods, the observed change is consistentwith there having beena. an increase in supply with demand unchanged.b. an increase in demand with supply unchanged.c. a decrease in supply with demand unchanged.d. a decrease in demand with supply unchanged.e. any of the above.


Chapter 1 | 5


35. Increases in the wage rates of coal miners and de-creases in the price of natural gas would cause theprice of coal toa. rise, but the quantity of coal bought and sold would

rise or fall depending on the magnitude of thechanges.

b. rise, but the quantity of coal bought and sold wouldfall.

c. fall, but the quantity of coal bought and sold wouldrise or fall depending on the magnitude of thechanges.

d. fall, but the quantity of coal bought and sold wouldfall.

e. rise or fall depending on the magnitude of thechanges, but the quantity of coal bought and soldwould fall.


36. The severe drought in Georgia and other peanut-growing states in late 1980 and early 1981 wreakedhavoc on the peanut crop. This development mostlikely caused thea. supply curve for peanut butter to shift to the left

and resulted in a higher price for peanut butter.b. supply curve for peanut butter to shift to the right

and resulted in a lower price for peanut butter.c. supply curve for peanut butter to shift to the right

and resulted in a higher price for peanut butter.d. demand curve for peanut butter to shift to the left

and resulted in a lower price for peanut butter.e. demand curve for peanut butter to shift to the right

and resulted in a higher price for peanut butter.


37. A substantial rise in butter production combined with alarge rise in the price of margarine would tend toa. raise the price of butter.b. lower the price of butter.c. leave the price of butter unchanged.d. raise or lower the price of butter, depending on the

magnitude of the two changes.e. decrease the supply of margarine.


38. Consider the market for medical care. The enactmentof Medicare and Medicaid in 1965 most likely causedthe demand curve for medical care to shift to thea. right, and resulted in a higher price for medical care

and a reduction in the amount consumed by theaged and poor.

b. right, and resulted in a higher price for medicalcare and a reduction in the amount consumed bypeople other than the aged and the poor.

c. left, and resulted in a lower price for medical careand an increase in the amount consumed by peopleother than the aged and the poor.

d. left, and resulted in a lower price for medical careand an increase in the amount consumed by theaged and poor.

e. right, and resulted in a lower price for medical carefor all consumers.


39. The price of a marketed good is determined either bythe intersection of supply and demand or by an en-forced, regulated price. A major difference betweenthe two price-determining techniques is thata. prices regulated at a level above the equilibrium

price will induce shortages.b. there are no shortages or surpluses with unregu-

lated prices.c. there are no shortages or surpluses with regulated

prices.d. regulated prices are fairer in the sense that more

people can afford the good.e. the government has more knowledge of the best

price and can therefore allocate more evenly thancan the unregulated market.


40. When Michael Jackson came to Kansas City, Missouri,in 1984 to give three concerts in Arrowhead Stadium,tickets averaging $30 apiece went on sale at variousoutlets around the state. At that price, the number ofstadium seats was insufficient to fill orders, and ticketswere rationed on a first-come, first-served basis. Hadthe ticket price been free to vary,a. the price would have been higher.b. the price would have been lower.c. tickets would still have had to be rationed.d. a and c.e. b and c.


6 | Part One


41. When the influenza vaccine first became available inthe United States, the government set the price belowits equilibrium value. Output was insufficient to fill or-ders and the government regulated the distribution ofthe vaccine. Had the vaccine been sold privately with-out government intervention, excess demand wouldhave been eliminated whena. price rose, demand decreased, and quantity sup-

plied increased.b. price fell, quantity demanded decreased, and supply

increased.c. price rose, quantity demanded decreased, and quan-

tity supplied increased.d. price rose, demand decreased, and supply

increased.e. price rose, demand increased, and quantity supplied

increased.


42. An unusually hot summer has increased the demandfor ice cream in North Anilorac. At the same time, anexcise tax is placed on ice cream. What can we sayabout equilibrium price and quantity?a. Equilibrium price increases while equilibrium

quantity decreases.b. Equilibrium price increases while equilibrium

quantity increases.c. Equilibrium price increases but the change in equi-

librium quantity is ambiguous.d. Equilibrium price decreases but the change in equi-

librium quantity is ambiguous.e. Equilibrium quantity increases but the change in

equilibrium price is ambiguous.


Multiple-Choice Questions with Diagrams

43. Consider the market for coal. Over the past fifteenyears, environmental concerns about acid rain moti-vated a search for alternative fuels. At the same time,changes in technology have made it easier for compa-nies to find and to mine coal. From the diagram below,we would expect to find the new equilibrium price andquantity exchanged in the market for coal at whichpoint?

a. A.b. B.c. C.d. D.e. E.


P1

Q1

D2

S1

S2

D1

B

P

A

C

D

Q

E

Chapter 1 | 7


44. Point O in the following diagram shows the equilib-rium price and quantity of U.S. domestically producedminivans. Suppose the government decides to subsi-dize the production of minivans by returning $500 toeach van produced and sold. The new equilibriumprice and quantity might best be represented by whichpoint on the diagram?

a. A.b. B.c. C.d. D.e. E.


45. If the actual price for coal were $34 per ton as shownin the figure below, this actual price woulda. be an equilibrium price, since all consumers willing

to pay $34 per ton would be able to buy a ton.b. not be an equilibrium price, since there is excess

demand at $34 per ton.c. be an equilibrium price, since suppliers can hold in-

ventories at that price.d. not be an equilibrium price, since the rate at which

coal is supplied would be greater than the rate atwhich it is demanded.

e. not be an equilibrium price, since the price at whichcoal is demanded is less than the price at which it isbeing supplied.

Answer: d Page: 16

THE GRAPH BELOW PERTAINS TO QUESTIONS 46 AND 47.

S

D

80 90 100 120 140

2.50

3.00

3.50

2.00

Quantity of corn(millions of bushels)

Priceperbushel

34

Quantity of coal(millions of tons)

Priceper ton

D

S

S2S1

S3

D1

Q1

P1

P

A

O

Q

B

C

E

0 D

8 | Part One


46. The equilibrium price is not $2.50 per bushel becauseat that price there would be an excessa. supply of 10 million bushels, tending to drive the

price up.b. supply of 30 million bushels, tending to drive the

price down.c. supply of 30 million bushels, tending to drive the

price up.d. demand of 30 million bushels, tending to drive the

price down.e. demand of 30 million bushels, tending to drive the

price up.


47. At the price of $3.50 per bushel of corn, there wouldbe an excessa. supply of 20 million bushels.b. supply of 30 million bushels.c. supply of 80 million bushels.d. demand of 20 million bushels.e. demand of 30 million bushels.


48. The equilibrium price of in-line skates, as defined inthe following, isa. $10.b. $100.c. $150.d. $300.e. none of the above.

Answer: b Page: 16

Problem Set

1. The disappearance of anchovies off the coast of Peru in1972 caused a scramble for protein-rich substitutes, no-tably soybeans. Because soybeans were used in animalfeed, higher soybean prices eventually translated intohigher cattle prices. Use demand and supply diagramsto show what happened in the anchovy, soybean, andcattle markets. Indicate which curves shifted in each in-stance and show the effects on the equilibrium priceand quantity in the relevant market.

2. Indicate whether each of the following will shift the de-mand curve for Honda cars to the right, left, or not atall: a. Ford introduces a new line of smaller, more fuel-

efficient cars.b. The International Trade Commission decides to rec-

ommend curbing the imports of Japanese subcom-pacts into the United States.

c. The prime interest rate charged by banks rises.d. Honda offers a temporary rebate on cars.e. Newsweek does a cover story unfavorable to

Hondas.

3. Sugar is an essential ingredient in moonshine but not in government whiskey. When sugar prices tripled,moonshiners in the South saw their sales go down astheir costs went up. As the number of illegal stillsdwindled, revenue agents spent less of their time onliquor offenses. a. Use demand and supply diagrams to show how the

rise in sugar prices affected the markets for moon-shine, government whiskey, and revenue agents.

b. If the quantity of moonshine demanded fell by 54percent when the price rose from $6 to $15 a gallon,what was the arc elasticity of demand?

c. If moonshine and tobacco are complementarygoods, what effect would an increase in the tax ontobacco have on the the moonshine market?

4. Consider and comment on the following hypotheticalstatement: “The practice of giving food stamps to thepoor is self-defeating. Food stamps effectively lowerthe price of food. And, when food becomes available atlow prices, demand for it will increase and therebyforce the price back up to its initial level. So, whogains?”

5. At a 1987 meeting of OPEC, Iran failed to get a desiredprice increase. It subsequently threatened to produceabove its quota of output if the desired price increasewas not agreed upon by all members. What effectwould this threat have had on the market price of crudeoil in world markets?

100

200

300

P

D

Q

S

100

5 15

Chapter 1 | 9


6. Numerous demographic models predict that the popu-lation of the United States is, on average, getting older.This means that the absolute number of people in theolder age groups (called cohorts) is increasing. Whatimpact will this have on the composition of output inthe economy? On the relative prices of various goodsin the economy?

7. The National Weather Service has just issued a freezewarning for Florida. You reason that if a freeze occursit will damage the just-maturing orange crop and or-ange juice prices will consequently rise. You run outand buy 10 times your normal purchase of orange juiceand put it in the freezer. What effect will your actionshave on the market price of orange juice? What if allconsumers behaved the same way? If all consumers be-haved this way but the freeze did not occur, whatwould happen to orange juice prices in subsequentmonths?

8. When demand curves are drawn, the relationship be-tween price and quantity demanded is inversely relatedceteris paribus. What impacts would the followingchanges have on the demand curve?a. A change in expectationsb. A change in technologyc. A change in price of the goodd. A change in the number of supplierse. A change in income levels of consumers

9. Suppose that you are given the following linear equa-tions for supply and demand:

D = 10 – 3PS = 5 + 2P

At what price will the quantity supplied equal the quan-tity demanded? What will occur if the price is $3?

10. Parking is a perennial problem on college campuses. Inthe short run, the supply of spaces is fixed. Assume thatthere is a critical shortage of parking space on yourcampus and subject this “economic problem” to thetools of supply and demand. What would you recom-mend to your college administration?

11. Over the past ten years, the prices of sugar and cocoabeans have fluctuated widely. Hershey’s, however, hasmaintained relatively stable prices. Is this evidence thatsupply-and-demand analysis is not capable of even pre-dicting the price of candy bars in the face of risingcosts?

12. If you expect the price of gasoline to increase as a re-sult of a shortage of oil in world markets, how are youlikely to react with respect to your car’s half-emptygasoline tank? Using a graph, describe how this expec-tation will impact the equilibrium price.

13. Consider the market for tickets to see the Baby Bears, afamous baseball team from the Midwest. Suppose thedemand curve is given by

Q = 50,000 – 5,000P

where P is dollars per ticket and Q is the number oftickets sold per game. The Baby Bears play in a 5,000-seat stadium and would like to sell exactly 5,000 tick-ets to every game.a. Calculate the equilibrium price and quantity ex-

changed in this market. Show this solution using adiagram.

b. Suppose the owner of the Baby Bears decides to set the ticket price at $7. Is this a good idea? Showand explain the effect that this would have on themarket.

c. Find the arc elasticity of demand between $7 and$9. Explain what this elasticity tells you about thedemand in this market in this price range. Wouldyou advise the owner of the Baby Bears to build anew stadium?

14. During the 1980s, the housing market in the Northeast-ern United States experienced an unprecedented boom.Demand and prices soared. Suppose the following equa-tions approximate the yearly demand for and supply ofhousing during this time period.

Qd = 1,000 – 0.001PQs = –100 + 0.01P

a. Find the equilibrium price and quantity of housesexchanged during this time period. Show this usinga diagram.

b. As the defense and financial services industries fal-tered in the late 1980s, the demand for housing inthis market declined by as much as 25 percent bysome estimations. Using the equations given, cal-culate the new equilibrium price and quantity ofhouses exchanged. Show the effects of this using adiagram.

15. In the spring of 1996, gasoline prices rose by 10 per-cent or more at the pump, with prices in some areastopping $2 per gallon. This price increase was causedby several factors, including a harsh winter that in-creased the demand for home heating oil. As a result,many state and federal legislators called for decreasesin gasoline taxes.a. Using diagrams of the markets for home heating oil

and gasoline, explain why the price of gasoline rose.b. Would you recommend decreases in taxes in re-

sponse to this change in prices? Why or why not?

10 | Part One


16. A July 12, 1999 Wall Street Journal article, “Lamb Tar-iffs Fleece U.S. Consumers,” describes a set of tariffsenacted by the Clinton Administration designed to pro-tect domestic sheep producers. These producers claimthat competition from Australia and New Zealand,large sheep exporting nations, threatens their liveli-hood. Explain, using market diagrams:a. how the competition from foreign producers affects

U.S. markets for lamb;b. how this set of tariffs will “protect” U.S. lamb pro-

ducers; andc. how this will lead to a “fleecing” of U.S. consumers.

Carefully explain your reasoning

17. Can the same resource or commodity be scarce at onetime or in one place and be free (or even an economicbad) at a different time or in another place? Give sev-eral examples.

18. Because individuals tend to follow their self-interest,Thomas Gresham stated: “Bad money drives goodmoney out of circulation.” What are some assumptionsthat underlie this statement that has come to be knownas Gresham’s law? Is the testable proposition of thislaw in agreement with observed results? How mightyou use this law to explain the disappearance from cir-culation of silver dimes, quarters, and half dollarsminted before 1965?

19. When maple syrup supplies are limited, prices andprofits go up. Would it be in each individual producer’sinterest to withhold maple syrup from the market?

20. A developer wants you to explain how the price ofidentical houses varies according to the characteristicsof the lots where they are located. What determinantswould you include in a model to predict high houseprices?

21. Suppose that you were given the task of constructing amodel that would test for bias in beauty pageant judg-ing. How would you go about it? What variables wouldyou include?

22. To construct an economic model, we must have someidea about which economic variables are important tothe issue at hand. The determination of which variablesare important to the issue is one of the results of mod-eling. This suggests that we have a circular argument:we need the data to construct the models, and we needmodels to tell us what data to collect. How would youresolve this apparent impasse?

23. Most of the economic models in the text are two di-mensional—that is, they are limited to two variables.The real world is far more complex than this; therefore,we can learn very little from such overly simplifiedmodels. Do you agree? Why or why not?

24. When students ask other students, “What do you do inyour economics class?” they often reply, “We drawgraphs.” Admittedly, you do draw a lot of graphs ineconomics. Why? Will you always have to rememberthese graphs in order to apply your understanding ofeconomics?

25. As the population of the earth grows, certain resourceswill become increasingly scarce. What does this implyabout the usefulness of the principles of economics?

26. A 1999 newspaper article presented evidence that theforecasts of a certain economist made in 1995 were nolonger valid, and used this to claim that modeling is anexercise in futility. Comment on this test of the accu-racy of model building and forecasting.

27. Discuss the roles of theory, intuition, and rationality ineconomics. Why do we use theory rather than just letthe facts speak for themselves? What are the strengthsand weaknesses of economic intuition? How do wedeal with its weaknesses?

28. Since the year 2000, the supply of natural gas in theUnited States has increased each year. Yet, the price ofnatural gas to consumers has risen. Using supply anddemand analysis, give two plausible explanations forthis phenomenon.

29. Consider the market for fluid milk. Illustrate with dia-grams and explain in words the effects on price andquantity exchanged of the following events:a. A decline in the birth rateb. The discovery of a superior breed of milk cowc. A rise in the price of beefd. The imposition of substantial taxes on processed

milk products

30. Suppose that the demand function for wheat is given byP = 20 - 0.25Q.a. What is total consumer outlay when Q = 40?b. If the government sets a support price for wheat that

is above the market equilibrium price, what is likelyto result? Why?

31. “Demand is self-regulating. If demand for a product in-creases, its price will go up; if its price goes up, thenthe demand will fall and the market price will soon re-vert to its initial equilibrium.” What is the flaw in thisreasoning?

32. An increase in the price of televisions will cause a de-crease in the demand for televisions. True or false?

Chapter 1 | 11


33. In the following situations, tell whether the demand for airplanes will increase, decrease, or remain un-changed. Distinguish between shifts in the demandcurve and movements along the curve. In each case,provide one- and two-sentence statements explainingyour diagram.a. Price of oil decreasesb. Price of airplanes decreasesc. Price of cars increasesd. Consumers’ income increases

34. In the following situations, will there be an increased,decreased, or constant market demand for bricks? Distinguish between shifts in the demand curve andmovements along the curve. Please explain your dia-grams.a. Price of wood decreasesb. Consumers’ income decreasesc. Price of bricks decreasesd. Price of cement mortar increasese. There is an increase in income tax rates

35. Suppose that the demand for milk increases because anew beauty treatment that uses milk is discovered.a. Analyze the effects of this change on the equilib-

rium price and quantity of cookies.b. Now, to convince yourself that your answer is right,

consider the following supply and demand equa-tions for milk and cookies.

QdM = 60 − 3PM − PC Qd

C = 60 − 3PC − PMQs

M = 2PM QsC = 2PC

Solve for the equilibrium prices and quantities.c. Now suppose that the demand for milk increases so

that the demand for milk is given by QdM = 90 −

3PM − PC. Solve for the new equilibrium prices andquantities of milk and cookies.

36. “A hypothesis is important if it explains much of theobserved behavior by abstracting the crucial elementsfrom a mass of complex circumstances of the phenom-enon to be explained and permits valid predictions onthe basis of them alone.” Write a brief paragraph de-fending or criticizing this statement by Milton Fried-man.

12 | Part One


CHAPTER 2 CONSUMER TASTES AND PREFERENCES

1. Because indifference curves are not all negativelysloped and convex to the origin, movement away fromthe origin does not always represent the attainment ofhigher levels of satisfaction. In dealing with various in-difference maps (for example, those depicted in Figure2.0 of the text), students may find it helpful to use ar-rows to indicate the directions of preference.

2. Some students will be puzzled when you tell them thatthe slope of a budget line is (–1 times) the price of thegood on the horizontal (or x) axis divided by the priceof the good on the vertical (or y) axis. Shouldn’t it bethe other way around? No. Divide the vertical interceptI/Py, or what some call the rise, by the horizontal inter-cept I/Px, or what some call the run, and multiply theresult by –1. This yields the slope of the budget line,–Px/Py.

3. Normally we illustrate consumer choice over twogoods on an indifference map. This may suggest thatthe indifference curve technique is more limited than isthe case. You may want to work a problem in which total money expenditures on all goods except x areshown on the vertical axis while good x is shown onthe horizontal axis. Changes in the total money ex-pended on all other goods then imply changes in the total expenditure on good x, and thus something aboutthe relative price elasticity of demand for good x, aconcept that is discussed in Chapter 4.

4. Remind students often that, from the firm’s point ofview, information on consumer behavior is very impor-tant. Without good estimates of the demand for the

goods and services that are produced, firms will makemistakes and produce too much of some items and toolittle of others. Also, effective development of new prod-ucts is dependent on consumer buying patterns.


1. If Fred prefers apples to oranges and oranges to pearsand if he is indifferent between apples and kiwi, hemusta. prefer kiwi to pears.b. prefer oranges to kiwi.c. be indifferent between oranges and kiwi.d. be indifferent between apples and pears.e. be indifferent between pears and kiwi.


2. Three individuals rank four candidates as shown in thistable (the most preferred candidate is listed first, and soforth). Which group(s) of three candidates could be usedto illustrate the intransitivity of majority rule?

Candidates Ranked by Individual

I II III

A C DB D BC B AD A C

a. ABCb. BCDc. ACDd. Both a and ce. Both b and c


13

PART TWO Consumer Behavior and Market Demand


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