1. You are trying to decide whether to take a vacation.

Most of the costs of the

vacation (airfare, hotel, and forgone wages) are measured in dollars, but the
benefits of the vacation are psychological. How can you compare the benefits to
the costs?

Ans: When the benefits of something are psychological, such as going on a vacation,
it is not easy to compare benefits to costs to determine if it is worth doing. But there
are two ways to think about the benefits. One is to compare the vacation with what
you would do in its place. If you did not go on vacation, would you buy something
like a new set of golf clubs? Then you can decide if you would rather have the new
clubs or the vacation. A second way is to think about how hard you had to work to
earn the money to pay for the vacation. You can then decide if the psychological
benefits of the vacation were worth the psychological cost of working.

2. Explain whether each of the following government activities is motivated by a

concern about equality or a concern about efficiency. In the case of efficiency,
discuss the type of market failure involved.
a) regulating cable TV prices
Efficiency: The market failure comes from the market power of the cable TV
firm.
b) providing some poor people with vouchers that can be used to buy food
Equity
c) prohibiting smoking in public places
Efficiency: An externality arises because secondhand smoke harms
nonsmokers.
d) breaking up Standard Oil (which once owned 90 percent of all oil refineries)
into several smaller companies
Equity
e) imposing higher personal income tax rates on people with higher incomes
Equity
f) instituting laws against driving while intoxicated
Efficiency: There is an externality because of accidents caused by drunk
drivers.

3. All of the following topics fall within the study of microeconomics EXCEPT
a) the impact of cigarette taxes on the smoking behavior of teenagers.
b) the role of Microsoft’s market power in the pricing of software.
c) the effectiveness of antipoverty programs in reducing homelessness.
d) the influence of the government budget deficit on economic growth.

Ans: d)

4. Which of the following is a positive, rather than a normative, statement?

a) Law X will reduce national income.
 b) Law X is a good piece of legislation.
c) Congress ought to pass law X.
d) The president should veto law X.

Ans: a)

5. The first principle of economics discussed in Chapter 1 is that people face trade-
offs. Use a production possibilities frontier to illustrate society’s trade-off between
two “goods”—a clean environment and the quantity of industrial output. What do
you suppose determines the shape and position of the frontier? Show what
happens to the frontier if engineers develop a new way of producing electricity that
emits fewer pollutants.

Ans: See the following Figure. The shape and position of the frontier depend on how
costly it is to maintain a clean environmentthe productivity of the environmental
industry. Gains in environmental productivity, such as the development of new way
to produce electricity that emits fewer pollutants, lead to shifts of the production-
possibilities frontier, like the shift from PPF1 to PPF2 shown in the figure.

6. An economy consists of three workers: Larry, Moe, and Curly. Each works 10 hours
a day and can produce two services: mowing lawns and washing cars. In an hour,
Larry can either mow one lawn or wash one car; Moe can either mow one lawn or
wash two cars; and Curly can either mow two lawns or wash one car.
a) Calculate how much of each service is produced under the following
circumstances, which we label A, B, C, and D:
 All three spend all their time mowing lawns. (A)
Ans: 40 lawns mowed; 0 washed cars
 All three spend all their time washing cars. (B)
Ans: 0 lawns mowed, 40 washed cars
 All three spend half their time on each activity. (C)
Ans: 20 lawns mowed; 20 washed cars
 Larry spends half his time on each activity, while Moe only washes cars
 and Curly only mows lawns. (D)
Ans: 25 lawns mowed; 25 washed cars

b) Graph the production possibilities frontier for this economy. Using your
answers to part a), identify points A, B, C, and D on your graph.
Ans: The production possibilities frontier is shown in the following figure. Points
A, B, and D are on the frontier, while point C is inside the frontier.

c) Explain why the production possibilities frontier has the shape it does.
Ans: Larry is equally productive at both tasks. Moe is more productive at
washing cars, while Curly is more productive at mowing lawns.

d) Are any of the allocations calculated in part a) inefficient? Explain.

Ans: Allocation C is inefficient. More washed cars and mowed lawns can be
produced by simply reallocating the time of the three individuals.

7. Suppose that there are 10million workers in Canada and that each of these workers
can produce either 2 cars or 30 bushels of wheat in a year.
a) What is the opportunity cost of producing a car in Canada? What is the
opportunity cost of producing a bushel of wheat in Canada? Explain the
relationship between the opportunity costs of the two goods.
b) Draw Canada’s production possibilities frontier. If Canada chooses to consume
10 million cars, how much wheat can it consume without trade? Label this
point on the production possibilities frontier.
c) Now suppose that the United States offers to buy 10million cars from Canada
in exchange for 20 bushels of wheat per car. If Canada continues to consume
10 million cars, how much wheat does this deal allow Canada to consume?
Label this point on your diagram. Should Canada accept the deal?

8. True or False: If a law were passed requiring all cars sold in China to get at most 5
liters per 100 km, then China would surely use less gasoline. [Hint: In addition to
telling true or false, you also need to tell why]
 Ans: False. Because people may drive more miles, and thus finally use more gasoline.

9. True or False: The discovery of a new method of birth control that is safer, cheaper,
more effective, and easier to use than any other method would reduce the number
of unwanted pregnancies. [Hint: In addition to telling true or false, you also need
to tell why]

Ans: False. Not necessary, because the people’s sex behaviors may be less cautious,
and thus lead to more unwanted pregnancies.

10. Can you think of some other “goods,” such as murder and reckless driving, that are
not traded in the traditional economic marketplace but for which people
nevertheless have demand curves? For each of these goods, what would it mean
for the demand curve to be unusually steep? Unusually flat?

Ans: Some other “goods” may be sexual relations, clean air, warm weather or
marriage. For the clear air and warm weather, the demand curve should be
unusually flat, while the sexual relations, the demand curve may be verticle.

11. Nosmo King is an anti-smoking crusader who finds that people who don’t
recognize him sometimes offer him a cigarette. He always takes the cigarette and
throws it away. This happens ten times a year, and Nosmo figures that this way
there are ten fewer cigarettes for other people to smoke.
a) How does Nosmo’s policy affect the demand and supply curves for
cigarettes?

Ans: The demand curve for cigarettes shifts rightward by 10 cigarettes per year..

b) How does Nosmo’s policy affect the equilibrium quantity of cigarettes?

Ans: The equilibrium quantity of cigarettes increases by less than 10 per year.

c) Is Nosmo correct in believing that he reduces the number of cigarettes that

other people smoke? Is he correct in believing that he reduces it by ten per
year? How do you know?

Ans: The number of cigarettes smoked by others is equal to the new equilibrium
quantity minus the ten that are thrown away. Thus Nosmo is correct in believing
that he reduces the number of cigarettes that other people smoke, but incorrect in
believing that he reduces that number by 10 per year

12. Tomato sauce is a complement for hot dogs. If the price of hot dogs rises, what
happens to the market for tomato sauce? For tomatoes? For tomato juice? For
orange juice? Note: For each question, please use a demand-supply graph to
CLEARLY demonstrate, if any, corresponding shifts of demand curve and supply
curve, and changes in equilibrium price and equilibrium quantity.
 Ans: Since tomato sauce is a complement for hot dogs, when the price of hot dogs
rises, the quantity demanded of hot dogs falls, thus reducing the demand for
tomato sauce, causing both price and quantity of tomato sauce to fall. Since the
quantity of tomato sauce falls, the demand for tomatoes by tomato sauce
producers falls, so both price and quantity of tomatoes fall. When the price of
tomatoes falls, producers of tomato juice face lower input prices, so the supply
curve for tomato juice shifts down, causing the price of tomato juice to fall and the
quantity of tomato juice to rise. The fall in the price of tomato juice causes people
to substitute tomato juice for orange juice, so the demand for orange juice declines,
causing the price and quantity of orange juice to fall. Now you can see clearly why
a rise in the price of hot dogs leads to a fall in price of orange juice!

13. The market for pizza has the following demand and supply schedules:

a) Graph the demand and supply curves. What is the equilibrium price and
quantity in this market?

Ans: Quantity supplied equals quantity demanded at a price of $6 and

quantity of 81 pizzas

b) If the actual price in this market were above the equilibrium price, what
would drive the market toward the equilibrium?
 Ans: If the price were above $6, quantity supplied would exceed quantity
demanded, so suppliers would reduce the price to gain sales.

c) If the actual price in this market were below the equilibrium price, what
would drive the market toward the equilibrium?

Ans: If the price were below $6, quantity demanded would exceed quantity
supplied, so suppliers could raise the price without losing sales. In both cases,
the price would continue to adjust until it reached $6, the only price at which
there is neither a surplus nor a shortage.

14. Suppose that the price of basketball tickets at your college is determined by
market forces. Currently, the demand and supply schedules are as follows:

a) Draw the demand and supply curves. What is unusual about this supply
curve? Why might this be true?

Ans: the supply curve is vertical. This is because the number of seats is fixed.

b) What are the equilibrium price and quantity of tickets?

Ans: Quantity supplied equals quantity demanded at a price of $8. The

equilibrium quantity is 8,000 tickets.
c) Your college plans to increase total enrollment next year by 5,000 students.
The additional students will have the following demand schedule:

Now add the old demand schedule and the demand schedule for the new
students to calculate the new demand schedule for the entire college. What
will be the new equilibrium price and quantity?

Ans: The new equilibrium price will be $12, which equates quantity
demanded to quantity supplied. The equilibrium quantity remains 8,000
tickets.

Price Quantity Demanded Quantity Supplied

$4 14,000 8,000
$8 11,000 8,000
$12 8,000 8,000
$16 5,000 8,000
$20 2,000 8,000