1. Describe some of the trade-offs faced by each of the following:

a. a family deciding whether to buy a new car b. a member of Congress deciding how much to spend on national parks

c. a company president deciding whether to open a new factory

d. a professor deciding how much to prepare for class

e. a recent college graduate deciding whether to go to graduate school

2. 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?

3. You were planning to spend Saturday working at your part-time job, but a friend asks you to go skiing. What is the true cost of going skiing? Now suppose you had been planning to spend the day studying at the library. What is the cost of going skiing in this case? Explain.

4. You win $100 in a basketball pool. You have a choice between spending the money now or putting it away for a year in a bank account that pays 5 percent interest. What is the opportunity cost of spending the $100 now?

5. The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction of competing products has reduced the expected sales of your new product to $3 million. If it would cost $1 million to finish development and make the product, should you go ahead and do so? What is the most that you should pay to complete development? 6. The Social Security system provides income for people over age 65. If a recipient of Social Security decides to work and earn some income, the amount he or she receives in Social Security benefits is typically reduced. a. How does the provision of Social Security

affect people‘s incentive to save while working?

b. How does the reduction in benefits associated with higher earnings affect people‘s incentive to work past age 65?

7. A 1996 bill reforming the federal government‘s antipoverty programs limited many welfare recipients to only two years of benefits. a. How does this change affect the incentives for working?

b. How might this change represent a trade-off between equality and efficiency?

8. Your roommate is a better cook than you are, but you can clean more quickly than your roommate can. If your roommate did all the cooking and you did all the cleaning, would your chores take you more or less time than if you divided each task evenly? Give a similar example of how specialization and trade can make two countries both better off.

9. 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

b. providing some poor people with vouchers that can be used to buy food

c. prohibiting smoking in public places d. breaking up Standard Oil (which once owned 90 percent of all oil refineries) into several smaller companies

e. imposing higher personal income tax rates on people with higher incomes f. instituting laws against driving while intoxicated

10. Discuss each of the following statements from the standpoints of equality and efficiency. a. ―Everyone in society should be guaranteed the best healthcare possible.‖

b. ―When workers are laid off, they should be able to collect unemployment benefits until they find a new job.‖

11. In what ways is your standard of living different

from that of your parents or grandparents when they were your age? Why have these changes occurred?

12. Suppose Americans decide to save more of their incomes. If banks lend this extra saving to businesses, which use the funds to build new factories, how might this lead to faster growth in productivity? Who do you suppose benefits from the higher productivity? Is society getting a free lunch?

13. In 2010, President Barack Obama and Congress enacted a healthcare reform bill in the United States. Two goals of the bill were to provide more Americans with health insurance (via subsidies for lower-income households financed by taxes on higher-income households) and to reduce the cost of healthcare (via various reforms in how healthcare is provided). a. How do these goals relate to equality and efficiency?

b. How might healthcare reform increase productivity in the United States?

c. How might healthcare reform decrease productivity in the United States?

14. During the Revolutionary War, the American colonies could not raise enough tax revenue to fully fund the war effort; to make up this difference, the colonies decided to print more money. Printing money to cover expenditures is sometimes referred to as an ―inflation tax.‖ Who do you think is being ―taxed‖ when more money is printed? Why?

15. Imagine that you are a policymaker trying to decide whether to reduce the rate of inflation. To make an intelligent decision, what would you need to know about inflation, unemployment, and the trade-off between them?

16. A policymaker is deciding how to finance the construction of a new airport. He can either pay for it by increasing citizens‘ taxes or by printing more money. What are some of the short-run and long-run consequences of each option?

1. Draw a circular-flow diagram. Identify the parts of the model that correspond to the flow of goods and services and the flow of dollars for each of the following activities. a. Selena pays a storekeeper $1 for a quart of milk.

b. Stuart earns $4.50 per hour working at a fastfood restaurant.

c. Shanna spends $30 to get a haircut. d. Sally earns $10,000 from her 10 percent ownership of Acme Industrial.

2. Imagine a society that produces military goods and consumer goods, which we‘ll call ―guns‖ and ―butter.‖

a. Draw a production possibilities frontier for guns and butter. Using the concept of opportunity cost, explain why it most likely has a bowed-out shape.

b. Show a point that is impossible for the economy to achieve. Show a point that is feasible but inefficient.

c. Imagine that the society has two political parties, called the Hawks (who want a strong military) and the Doves (who want a smaller military). Show a point on your production possibilities frontier that the Hawks might choose and a point the Doves might choose.

d. Imagine that an aggressive neighboring country reduces the size of its military. As a result, both the Hawks and the Doves reduce their desired production of guns by the same amount. Which party would get the bigger ―peace dividend,‖ measured by the increase in butter production? Explain.

3. 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.

4. An economy consists of three workers: Larry, Moe, and Curly. Each works ten 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)

? All three spend all their time washing cars. (B)

? All three spend half their time on each activity. (C)

? Larry spends half his time on each activity, while Moe only washes cars and Curly only mows lawns. (D)

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.

c. Explain why the production possibilities frontier has the shape it does.

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

5. Classify the following topics as relating to microeconomics or macroeconomics. a. a family‘s decision about how much income to save

b. the effect of government regulations on auto emissions

c. the impact of higher national saving on economic growth

d. a firm‘s decision about how many workers to hire

e. the relationship between the inflation rate and changes in the quantity of money 6. Classify each of the following statements as positive or normative. Explain.

a. Society faces a short-run trade-off between

inflation and unemployment.

b. A reduction in the rate of money growth will reduce the rate of inflation.

c. The Federal Reserve should reduce the rate of money growth.

d. Society ought to require welfare recipients to look for jobs.

e. Lower tax rates encourage more work and more saving.

7. If you were president, would you be more interested in your economic advisers‘ positive views or their normative views? Why? 1. Maria can read 20 pages of economics in an hour. She can also read 50 pages of sociology in an hour. She spends 5 hours per day studying. a. Draw Maria‘s production possibilities frontier for reading economics and sociology. b. What is Maria‘s opportunity cost of reading 100 pages of sociology?

2. American and Japanese workers can each produce 4 cars a year. An American worker can produce 10 tons of grain a year, whereas a Japanese worker can produce 5 tons of grain a year. To keep things simple, assume that each country has 100 million workers.

a. For this situation, construct a table analogous to the table in Figure 1.

b. Graph the production possibilities frontier of the American and Japanese economies. c. For the United States, what is the opportunity cost of a car? Of grain? For Japan, what is the opportunity cost of a car? Of grain? Put this information in a table analogous to Table 1. d. Which country has an absolute advantage in producing cars? In producing grain?

e. Which country has a comparative advantage in producing cars? In producing grain? f. Without trade, half of each country‘s workers produce cars and half produce grain. What quantities of cars and grain does each country produce?

g. Starting from a position without trade, give an example in which trade makes each country better off.

3. Pat and Kris are roommates. They spend most of their time studying (of course), but they leave some time for their favorite activities: making pizza and brewing root beer. Pat takes 4 hours to brew a gallon of root beer and 2 hours to make a pizza. Kris takes 6 hours to brew a gallon of root beer and 4 hours to make a pizza. a. What is each roommate‘s opportunity cost of making a pizza? Who has the absolute advantage in making pizza? Who has the comparative advantage in making pizza? b. If Pat and Kris trade foods with each other, who will trade away pizza in exchange for root beer?

c. The price of pizza can be expressed in terms of gallons of root beer. What is the highest price at which pizza can be traded that would make both roommates better off? What is the lowest price? Explain.

4. Suppose that there are 10 million 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 10 million 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?

5. England and Scotland both produce scones and sweaters. Suppose that an English worker can produce 50 scones per hour or 1 sweater per hour. Suppose that a Scottish worker can produce 40 scones per hour or 2 sweaters per hour.

a. Which country has the absolute advantage in the production of each good? Which country has the comparative advantage?

b. If England and Scotland decide to trade, which commodity will Scotland trade to England? Explain.

c. If a Scottish worker could produce only 1 sweater per hour, would Scotland still gain from trade? Would England still gain from trade? Explain.

6. The following table describes the production possibilities of two cities in the country of Baseballia:

Pairs of Red Socks Pairs of White Socks per Worker per Hour per Worker per Hour

Boston 3 3 Chicago 2 1

a. Without trade, what is the price of white socks (in terms of red socks) in Boston? What is the price in Chicago?

b. Which city has an absolute advantage in the production of each color sock? Which city has a comparative advantage in the production of each color sock?

c. If the cities trade with each other, which color sock will each export?

d. What is the range of prices at which trade can occur?

7. Suppose that in a year an American worker can produce 100 shirts or 20 computers, while a Chinese worker can produce 100 shirts or 10 computers.

a. Graph the production possibilities curve for the two countries. Suppose that without trade the workers in each country spend half their time producing each good. Identify this point in your graph.

b. If these countries were open to trade, which country would export shirts? Give a specific numerical example and show it on your graph. Which country would benefit from trade? Explain.

c. Explain at what price of computers (in terms of shirts) the two countries might trade. d. Suppose that China catches up with

American productivity so that a Chinese worker can produce 100 shirts or 20 computers. What pattern of trade would you predict now? How does this advance in Chinese productivity affect the economic well-being of the citizens of the two countries?

8. An average worker in Brazil can produce an ounce of soybeans in 20 minutes and an ounce of coffee in 60 minutes, while an average worker in Peru can produce an ounce of soybeans in 50 minutes and an ounce of coffee in 75 minutes. a. Who has the absolute advantage in coffee? Explain.

b. Who has the comparative advantage in coffee? Explain.

c. If the two countries specialize and trade with each other, who will import coffee? Explain.

d. Assume that the two countries trade and that the country importing coffee trades 2 ounces of soybeans for 1 ounce of coffee. Explain why both countries will benefit from this trade. 9. Are the following statements true or false? Explain in each case.

a. ―Two countries can achieve gains from trade even if one of the countries has an absolute advantage in the production of all goods.‖ b. ―Certain very talented people have a comparative advantage in everything they do.‖

c. ―If a certain trade is good for one person, it can‘t be good for the other one.‖

d. ―If a certain trade is good for one person, it is always good for the other one.‖

e. ―If trade is good for a country, it must be good for everyone in the country.‖

10. The United States exports corn and aircraft to the rest of the world, and it imports oil and clothing from the rest of the world. Do you think this pattern of trade is consistent with the principle of comparative advantage? Why or why not? 11. Bill and Hillary produce food and clothing. In an hour, Bill can produce 1 unit of food or 1 unit of clothing, while Hillary can produce 2 units

of food or 3 units of clothing. They each work 10 hours a day.

a. Who has an absolute advantage in producing food? Who has an absolute advantage in producing clothing? Explain.

b. Who has a comparative advantage in producing food? Who has a comparative advantage in producing clothing? Explain.

c. Draw the production possibilities frontier for the household (that is, Bill and Hillary together) assuming that each spends the same number of hours each day as the other producing food and clothing.

d. Hillary suggests, instead, that she specialize in making clothing. That is, she will do all the clothing production for the family; however, if all her time is devoted to clothing and they still want more, then Bill can help with clothing production. What does the household production possibilities frontier look like now?

e. Bill suggests that Hillary specialize in producing food. That is, Hillary will do all the food production for the family; however, if all her time is devoted to food and they still want more, then Bill can help with food production. What does the household production possibilities frontier look like under Bill‘s proposal? f. Comparing your answers to parts c, d, and e, which allocation of time makes the most sense? Relate your answer to the theory of comparative advantage.

1. Explain each of the following statements using supply-and-demand diagrams.

a. ―When a cold snap hits Florida, the price of orange juice rises in supermarkets throughout the country.‖

b. ―When the weather turns warm in New England every summer, the price of hotel rooms in Caribbean resorts plummets.‖ c. ―When a war breaks out in the Middle East, the price of gasoline rises, and the price of a used Cadillac falls.‖

2. ―An increase in the demand for notebooks raises

the quantity of notebooks demanded but not the quantity supplied.‖ Is this statement true or false? Explain.

3. Consider the market for minivans. For each of the events listed here, identify which of the determinants of demand or supply are affected. Also indicate whether demand or supply increases or decreases. Then draw a diagram to show the effect on the price and quantity of minivans.

a. People decide to have more children. b. A strike by steelworkers raises steel prices. c. Engineers develop new automated machinery for the production of minivans.

d. The price of sports utility vehicles rises. e. A stock-market crash lowers people‘s wealth. 4. Consider the markets for DVDs, TV screens, and tickets at movie theaters.

a. For each pair, identify whether they are complements or substitutes:

? DVDs and TV screens ? DVDs and movie tickets ? TV screens and movie tickets

b. Suppose a technological advance reduces the cost of manufacturing TV screens. Draw a diagram to show what happens in the market for TV screens.

c. Draw two more diagrams to show how the change in the market for TV screens affects the markets for DVDs and movie tickets. 5. Over the past 30 years, technological advances have reduced the cost of computer chips. How do you think this has affected the market for computers? For computer software? For typewriters?

6. Using supply-and-demand diagrams, show the effect of the following events on the market for sweatshirts.

a. A hurricane in South Carolina damages the cotton crop.

b. The price of leather jackets falls. c. All colleges require morning exercise in appropriate attire.

d. New knitting machines are invented. 7. A survey shows an increase in drug use by young people. In the ensuing debate, two hypotheses are proposed:

? Reduced police efforts have increased the

availability of drugs on the street.

? Cutbacks in education efforts have

decreased awareness of the dangers of drug addiction.

a Use supply-and-demand diagrams to show how each of these hypotheses could lead to an increase in quantity of drugs consumed. b How could information on what has happened to the price of drugs help us to distinguish between these explanations?

8. Suppose that in the year 2015 the number of births is temporarily high. How does this baby boom affect the price of babysitting services in 2020 and 2030? (Hint: 5-year-olds need babysitters, whereas 15-year-olds can be babysitters.)

9. Ketchup is a complement (as well as a condiment) for hot dogs. If the price of hot dogs rises, what happens to the market for ketchup? For tomatoes? For tomato juice? For orange juice? 10. The market for pizza has the following demand and supply schedules:

Price Quantity Demanded Quantity Supplied

$4 135 pizzas 26 pizzas 5 104 53 6 81 81 7 68 98 8 53 110 9 39 121

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

b. If the actual price in this market were above the equilibrium price, what would drive the market toward the equilibrium?

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

11. Consider the following events: Scientists reveal that consumption of oranges decreases the risk

of diabetes, and at the same time, farmers use a new fertilizer that makes orange trees more productive. Illustrate and explain what effect these changes have on the equilibrium price and quantity of oranges.

12. Because bagels and cream cheese are often eaten together, they are complements.

a. We observe that both the equilibrium price of cream cheese and the equilibrium quantity of bagels have risen. What could be responsible for this pattern—a fall in the price of flour or a fall in the price of milk? Illustrate and explain your answer.

b. Suppose instead that the equilibrium price of cream cheese has risen but the equilibrium quantity of bagels has fallen. What could be responsible for this pattern— a rise in the price of flour or a rise in the price of milk? Illustrate and explain your answer.

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

Price Quantity Demanded Quantity Supplied

$ 4 10,000 tickets 8,000 tickets 8 8,000 8,000 12 6,000 8,000 16 4,000 8,000 20 2,000 8,000

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

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

c. Your college plans to increase total enrollment next year by 5,000 students. The

additional students will have the following demand schedule:

Price Quantity Demanded

$ 4 4,000 tickets 8 3,000 12 2,000 16 1,000

20 0

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?

14. Market research has revealed the following information about the market for chocolate bars: The demand schedule can be represented by the equation QD = 1,600 – 300P, where QD is the quantity demanded and P is the price. The supply schedule can be represented by the equation QS = 1,400 + 700P, where QS is the quantity supplied. Calculate the equilibrium price and quantity in the market for chocolate bars.

1. For each of the following pairs of goods, which good would you expect to have more elastic demand and why?

a. required textbooks or mystery novels b. Beethoven recordings or classical music recordings in general

c. subway rides during the next six months or subway rides during the next five years d. root beer or water

2. Suppose that business travelers and vacationers have the following demand for airline tickets from New York to Boston:

Quantity Demanded Quantity Demanded Price (business travelers) (vacationers)

$150 2,100 tickets 1,000 tickets 200 2,000 800 250 1,900 600 300 1,800 400

a. As the price of tickets rises from $200 to $250, what is the price elasticity of demand for (i) business travelers and (ii) vacationers? (Use the midpoint method in your calculations.)

b. Why might vacationers have a different elasticity from business travelers?

3. Suppose the price elasticity of demand for heating oil is 0.2 in the short run and 0.7 in the long run.

a. if the price of heating oil rises from $1.80

to $2.20 per gallon, what happens to the quantity of heating oil demanded in the short run? In the long run? (Use the midpoint method in your calculations.)

b. Why might this elasticity depend on the time horizon?

4. A price change causes the quantity demanded of a good to decrease by 30 percent, while the total revenue of that good increases by 15 percent. Is the demand curve elastic or inelastic? Explain.

5. The equilibrium price of coffee mugs rose sharply last month, but the equilibrium quantity was the same as ever. Three people tried to explain the situation. Which explanations could be right? Explain your logic.

Billy: Demand increased, but supply was totally inelastic.

Marian: Supply increased, but so did demand.

Valerie: Supply decreased, but demand was totally inelastic.

6. Suppose that your demand schedule for DVDs is as follows:

Quantity Demanded Quantity Demanded Price (income = $10,000) (income = $12,000)

$ 8 40 DVDs 50 DVDs 10 32 45 12 24 30 14 16 20 16 8 12

a. Use the midpoint method to calculate your price elasticity of demand as the price of DVDs increases from $8 to $10 if (i) your income is $10,000 and (ii) your income is $12,000.

b. Calculate your income elasticity of demand as your income increases from $10,000 to $12,000 if (i) the price is $12 and (ii) the price is $16.

7. You have the following information about good X and good Y:

? Income elasticity of demand for good X: –3 ? Cross-price elasticity of demand for good X

with respect to the price of good Y: 2 Would an increase in income and a decrease in the price of good Y unambiguously decrease the demand for good X? Why or why not? 8. Maria has decided always to spend one-third of her income on clothing.

a. What is her income elasticity of clothing demand?

b. What is her price elasticity of clothing demand?

c. If Maria‘s tastes change and she decides to spend only one-fourth of her income on clothing, how does her demand curve change? What is her income elasticity and price elasticity now?

9. The New York Times reported (Feb. 17, 1996) that subway ridership declined after a fare increase: ―There were nearly four million fewer riders in December 1995, the first full month after the price of a token increased 25 cents to $1.50, than in the previous December, a 4.3 percent decline.‖ a. Use these data to estimate the price elasticity of demand for subway rides.

b. According to your estimate, what happens to the Transit Authority‘s revenue when the fare rises?

c. Why might your estimate of the elasticity be unreliable?

10. Two drivers—Tom and Jerry—each drive up to a gas station. Before looking at the price, each places an order. Tom says, ―I‘d like 10 gallons of gas.‖ Jerry says, ―I‘d like $10 worth of gas.‖ What is each driver‘s price elasticity of demand? 11. Consider public policy aimed at smoking. a. Studies indicate that the price elasticity of demand for cigarettes is about 0.4. If a pack of cigarettes currently costs $2 and the government

wants to reduce smoking by

20 percent, by how much should it increase the price?

b. If the government permanently increases the price of cigarettes, will the policy have a larger effect on smoking one year from now

or five years from now?

c. Studies also find that teenagers have a higher

price elasticity than do adults. Why might this be true?

12. You are the curator of a museum. The museum is running short of funds, so you decide to increase revenue. Should you increase or decrease the price of admission? Explain.

13. Pharmaceutical drugs have an inelastic demand, and computers have an elastic demand. Suppose that technological advance doubles the supply of both products (that is, the quantity supplied at each price is twice what it was).

a. What happens to the equilibrium price and quantity in each market?

b. Which product experiences a larger change in price?

c. Which product experiences a larger change in quantity?

d. What happens to total consumer spending on each product?

14. Several years ago, flooding along the Missouri and the Mississippi rivers destroyed thousands of acres of wheat.

a. Farmers whose crops were destroyed by the floods were much worse off, but farmers whose crops were not destroyed benefited from the floods. Why?

b. What information would you need about the market for wheat to assess whether farmers as a group were hurt or helped by the floods?

15. Explain why the following might be true: A drought around the world raises the total revenue that farmers receive from the sale of grain, but a drought only in Kansas reduces the total revenue that Kansas farmers receive.

1. Lovers of classical music persuade Congress to impose a price ceiling of $40 per concert ticket. As a result of this policy, do more or fewer

people attend classical music concerts?

2. The government has decided that the free-market price of cheese is too low.

a. Suppose the government imposes a binding price floor in the cheese market. Draw a supply-

and-demand diagram to show the

effect of this policy on the price of cheese and the quantity of cheese sold. Is there a shortage or surplus of cheese?

b. Farmers complain that the price floor has reduced their total revenue. Is this possible? Explain.

c. In response to farmers‘ complaints, the government agrees to purchase all the surplus cheese at the price floor. Compared to the basic price floor, who benefits from this new policy? Who loses?

3. A recent study found that the demand and supply

schedules for Frisbees are as follows:

Price per Quantity Quantity Frisbee Demanded Supplied

$11 1 million Frisbees 15 million Frisbees 10 2 12 9 4 9 8 6 6 7 8 3 6 10 1

a. What are the equilibrium price and quantity of Frisbees?

b. Frisbee manufacturers persuade the government that Frisbee production improves scientists‘ understanding of aerodynamics and thus is important for national security. A concerned Congress votes to impose a price floor $2 above the equilibrium price. What is the new market price? How many Frisbees are sold?

c. Irate college students march on Washington and demand a reduction in the price of Frisbees. An even more concerned Congress votes to repeal the price floor and impose a price ceiling $1 below the former price floor.

What is the new market price? How many Frisbees are sold?

4. Suppose the federal government requires beer drinkers to pay a $2 tax on each case of beer purchased. (In fact, both the federal and state governments impose beer taxes of some sort.) a. Draw a supply-and-demand diagram of the market for beer without the tax. Show the price paid by consumers, the price received by producers, and the quantity of beer sold. What is the difference between the price paid by consumers and the price received by producers?

b. Now draw a supply-and-demand diagram for the beer market with the tax. Show the price paid by consumers, the price received by producers, and the quantity of beer sold. What is the difference between the price paid by consumers and the price received by producers? Has the quantity of beer sold increased or decreased?

5. A senator wants to raise tax revenue and make workers better off. A staff member proposes raising the payroll tax paid by firms and using part of the extra revenue to reduce the payroll tax paid by workers. Would this accomplish the senator‘s goal? Explain.

6. If the government places a $500 tax on luxury cars, will the price paid by consumers rise by more than $500, less than $500, or exactly $500? Explain.

7. Congress and the president decide that the United States should reduce air pollution by reducing its use of gasoline. They impose a $0.50 tax for each gallon of gasoline sold. a. Should they impose this tax on producers or consumers? Explain carefully using a supply-and-demand diagram.

b. If the demand for gasoline were more elastic, would this tax be more effective or less effective in reducing the quantity of gasoline consumed? Explain with both words and a diagram.

c. Are consumers of gasoline helped or hurt by

this tax? Why?

d. Are workers in the oil industry helped or hurt by this tax? Why?

8. A case study in this chapter discusses the federal minimum-wage law.

a. Suppose the minimum wage is above the equilibrium wage in the market for unskilled labor. Using a supplyand- demand diagram of the market for unskilled labor, show the market wage, the number of workers who are employed, and the number of workers who are unemployed. Also show the total wage payments to unskilled workers.

b. Now suppose the secretary of labor proposes an increase in the minimum wage. What effect would this increase have on employment? Does the change in employment

depend on the elasticity of demand, the elasticity of supply, both elasticities, or neither?

c. What effect would this increase in the minimum wage have on unemployment? Does the change in unemployment depend on the elasticity of demand, the elasticity of supply, both elasticities, or neither?

d. If the demand for unskilled labor were inelastic, would the proposed increase in the minimum wage raise or lower total wage payments to unskilled workers? Would your answer change if the demand for unskilled labor were elastic?

9. The U.S. government administers two programs that affect the market for cigarettes. Media campaigns and labeling requirements are aimed at making the public aware of the dangers of cigarette smoking. At the same time, the Department of Agriculture maintains a price-support program for tobacco farmers, which raises the price of tobacco above the equilibrium price.

a. How do these two programs affect cigarette consumption? Use a graph of the cigarette market in your answer.

b. What is the combined effect of these two programs on the price of cigarettes?

c. Cigarettes are also heavily taxed. What effect does this tax have on cigarette consumption? 10. At Fenway Park, home of the Boston Red Sox, seating is limited to 39,000. Hence, the number of tickets issued is fixed at that figure. Seeing a golden opportunity to raise revenue, the City of Boston levies a per ticket tax of $5 to be paid by the ticket buyer. Boston sports fans, a famously civic-minded lot, dutifully send in the $5 per ticket. Draw a well-labeled graph showing the impact of the tax. On whom does the tax burden fall—the team‘s owners, the fans, or both? Why? 11. A subsidy is the opposite of a tax. With a $0.50 tax on the buyers of ice-cream cones, the government collects $0.50 for each cone purchased; with a $0.50 subsidy for the buyers of ice-cream cones, the government pays buyers $0.50 for each cone purchased.

a. Show the effect of a $0.50 per cone subsidy on the demand curve for ice-cream cones, the effective price paid by consumers, the effective price received by sellers, and the quantity of cones sold.

b. Do consumers gain or lose from this policy? Do producers gain or lose? Does the government gain or lose?

12. In the spring of 2008, Senators John McCain and Hillary Clinton (who were then running for president) proposed a temporary elimination of the federal gasoline tax, effective only during the summer of 2008, in order to help consumers deal with high gasoline prices. a. During the summer, when gasoline demand is high because of vacation driving, gasoline refiners are operating near full capacity. What does this fact suggest about the price elasticity of supply?

b. In light of your answer to (a), who do you predict would benefit from the temporary gas tax holiday?

a. During the summer, when gasoline demand is high because of vacation driving, gasoline refiners are operating near full capacity. What does this fact suggest about the price elasticity of supply?

b. In light of your answer to (a), who do you predict would benefit from the temporary gas tax holiday?

1. Melissa buys an iPod for $120 and gets consumer surplus of $80.

a. What is her willingness to pay?

b. If she had bought the iPod on sale for $90, what would her consumer surplus have been?

c. If the price of an iPod were $250, what would her consumer surplus have been?

2. An early freeze in California sours the lemon crop. Explain what happens to consumer surplus in the market for lemons. Explain what happens to consumer surplus in the market for lemonade. Illustrate your answers with diagrams.

3. Suppose the demand for French bread rises. Explain what happens to producer surplus in the market for French bread. Explain what happens to producer surplus in the market for flour. Illustrate your answers with diagrams. 4. It is a hot day, and Bert is thirsty. Here is the value he places on a bottle of water:

Value of first bottle $7 Value of second bottle 5 Value of third bottle 3 Value of fourth bottle 1

a. From this information, derive Bert‘s demand schedule. Graph his demand curve for bottled water.

b. If the price of a bottle of water is $4, how many bottles does Bert buy? How much consumer surplus does Bert get from his purchases? Show Bert‘s consumer surplus in your graph.

c. If the price falls to $2, how does quantity demanded change? How does Bert‘s consumer surplus change? Show these

changes in your graph.

5. Ernie owns a water pump. Because pumping large amounts of water is harder than pumping small amounts, the cost of producing a bottle of water rises as he pumps more. Here is the cost he incurs to produce each bottle of water:

Cost of first bottle $1 Cost of second bottle 3 Cost of third bottle 5 Cost of fourth bottle 7

a. From this information, derive Ernie‘s supply schedule. Graph his supply curve for bottled water.

b. If the price of a bottle of water is $4, how many bottles does Ernie produce and sell? How much producer surplus does Ernie get from these sales? Show Ernie‘s producer surplus in your graph.

c. If the price rises to $6, how does quantity supplied change? How does Ernie‘s producer surplus change? Show these changes in your graph.

6. Consider a market in which Bert from Problem 4 is the buyer and Ernie from Problem 5 is the seller.

a. Use Ernie‘s supply schedule and Bert‘s demand schedule to find the quantity supplied and quantity demanded at prices of $2, $4, and $6. Which of these prices brings supply and demand into equilibrium? b. What are consumer surplus, producer surplus, and total surplus in this equilibrium? c. If Ernie produced and Bert consumed one fewer bottle of water, what would happen to total surplus?

d. If Ernie produced and Bert consumed one additional bottle of water, what would happen to total surplus?

7. The cost of producing flat-screen TVs has fallen over the past decade. Let‘s consider some implications of this fact.

a. Draw a supply-and-demand diagram to show the effect of falling production costs on the price and quantity of flat-screen TVs sold.

b. In your diagram, show what happens to consumer surplus and producer surplus. c. Suppose the supply of flat-screen TVs is very elastic. Who benefits most from falling production costs—consumers or producers of these TVs?

8. There are four consumers willing to pay the following amounts for haircuts:

Jerry: $7 Oprah: $2 Ellen: $8 Phil: $5

There are four haircutting businesses with the following costs:

Firm A: $3 Firm B: $6 Firm C: $4 Firm D: $2

Each firm has the capacity to produce only one haircut. For efficiency, how many haircuts should be given? Which businesses should cut hair and which consumers should have their hair cut? How large is the maximum possible total surplus?

9. Suppose a technological advance reduces the cost of making computers.

a. Draw a supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and producer surplus in the market for computers.

b. Computers and typewriters are substitutes. Use a supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and producer surplus in the market for typewriters. Should typewriter producers be happy or sad about the technological advance in computers?

c. Computers and software are complements. Draw a supply-and-demand diagram to show what happens to price, quantity, consumer surplus, and producer surplus in the market for software. Should software producers be happy or sad about the technological advance in computers?

d. Does this analysis help explain why software producer Bill Gates is one of the world‘s richest men?

10. A friend of yours is considering two cell phone service providers. Provider A charges $120 per month for the service regardless of the number

of phone calls made. Provider B does not have a fixed service fee but instead charges $1 per minute for calls. Your friend‘s monthly demand for minutes of calling is given by the equation QD 5 150 2 50P, where P is the price of a minute.

a. With each provider, what is the cost to your friend of an extra minute on the phone? b. In light of your answer to (a), how many minutes would your friend talk on the phone with each provider?

c. How much would he end up paying each provider every month?

d. How much consumer surplus would he obtain with each provider? (Hint: Graph the demand curve and recall the formula for the area of a triangle.)

e. Which provider would you recommend that your friend choose? Why?

11. Consider how health insurance affects the quantity of healthcare services performed. Suppose that the typical medical procedure has a cost of $100, yet a person with health insurance pays only $20 out of pocket. Her insurance company pays the remaining $80. (The insurance company recoups the $80 through premiums, but the premium a person pays does not depend on how many procedures that person chooses to undertake.) a. Draw the demand curve in the market for medical care. (In your diagram, the horizontal axis should represent the number of medical procedures.) Show the quantity of procedures demanded if each procedure has a price of $100.

b. On your diagram, show the quantity of procedures demanded if consumers pay only $20 per procedure. If the cost of each procedure to society is truly $100, and if individuals have health insurance as just described, will the number of procedures performed maximize total surplus? Explain. c. Economists often blame the health insurance system for excessive use of medical care.

Given your analysis, why might the use of care be viewed as ―excessive‖?

d. What sort of policies might prevent this excessive use?

1. The market for pizza is characterized by a downward-sloping demand curve and an upward-sloping supply curve.

a. Draw the competitive market equilibrium. Label the price, quantity, consumer surplus, and producer surplus. Is there any deadweight loss? Explain.

b. Suppose that the government forces each pizzeria to pay a $1 tax on each pizza sold. Illustrate the effect of this tax on the pizza market, being sure to label the consumer surplus, producer surplus, government revenue, and deadweight loss. How does each area compare to the pre-tax case?

c. If the tax were removed, pizza eaters and sellers would be better off, but the government would lose tax revenue. Suppose that consumers and producers voluntarily transferred some of their gains to the government. Could all parties (including the government) be better off than they were with a tax? Explain using the labeled areas in your graph.

2. Evaluate the following two statements. Do you agree? Why or why not?

a. ―A tax that has no deadweight loss cannot raise any revenue for the government.‖ b. ―A tax that raises no revenue for the government cannot have any deadweight loss.‖

3. Consider the market for rubber bands. a. If this market has very elastic supply and very inelastic demand, how would the burden of a tax on rubber bands be shared between consumers and producers? Use the tools of consumer surplus and producer surplus in your answer.

b. If this market has very inelastic supply and very elastic demand, how would the burden of a tax on rubber bands be shared between

consumers and producers? Contrast your answer with your answer to part (a).

4. Suppose that the government imposes a tax on heating oil.

a. Would the deadweight loss from this tax likely be greater in the first year after it is imposed or in the fifth year? Explain. b. Would the revenue collected from this tax likely be greater in the first year after it is imposed or in the fifth year? Explain. 5. After economics class one day, your friend suggests that taxing food would be a good way to raise revenue because the demand for food is quite inelastic. In what sense is taxing food a ―good‖ way to raise revenue? In what sense is it not a ―good‖ way to raise revenue?

6. Daniel Patrick Moynihan, the late senator from New York, once introduced a bill that would levy a 10,000 percent tax on certain hollowtipped bullets.

a. Do you expect that this tax would raise much revenue? Why or why not?

b. Even if the tax would raise no revenue, why might Senator Moynihan have proposed it?

7. The government places a tax on the purchase of socks.

a. Illustrate the effect of this tax on equilibrium price and quantity in the sock market. Identify the following areas both before and after the imposition of the tax: total spending by consumers, total revenue for producers, and government tax revenue.

b. Does the price received by producers rise or fall? Can you tell whether total receipts for producers rise or fall? Explain.

c. Does the price paid by consumers rise or fall? Can you tell whether total spending by consumers rises or falls? Explain carefully. (Hint: Think about elasticity.) If total consumer spending falls, does consumer surplus rise? Explain.

8. Suppose the government currently raises $100 million through a 1-cent tax on widgets, and

another $100 million through a 10-cent tax on gadgets. If the government doubled the tax rate on widgets and eliminated the tax on gadgets, would it raise more tax revenue than it does today, less tax revenue, or the same amount? Explain.

9. This chapter analyzed the welfare effects of a tax on a good. Consider now the opposite policy. Suppose that the government subsidizes a good: For each unit of the good sold, the government pays $2 to the buyer. How does the subsidy affect consumer surplus, producer surplus, tax revenue, and total surplus? Does a subsidy lead to a deadweight loss? Explain.

10. Hotel rooms in Smalltown go for $100, and 1,000 rooms are rented on a typical day. a. To raise revenue, the mayor decides to charge hotels a tax of $10 per rented room. After the tax is imposed, the going rate for hotel rooms rises to $108, and the number of rooms rented falls to 900. Calculate the amount of revenue this tax raises for Smalltown and the deadweight loss of the tax. (Hint: The area of a triangle is 1?2 3 base 3 height.)

b. The mayor now doubles the tax to $20. The price rises to $116, and the number of rooms rented falls to 800. Calculate tax revenue and deadweight loss with this larger tax. Do they double, more than double, or less than double? Explain.

11. Suppose that a market is described by the following supply and demand equations:

QS 5 2P QD 5 300 – P

a. Solve for the equilibrium price and the equilibrium quantity.

b. Suppose that a tax of T is placed on buyers, so the new demand equation is

QD 5 300 – (P 1 T).

Solve for the new equilibrium. What happens to the price received by sellers, the price paid by buyers, and the quantity sold?

c. Tax revenue is T 3 Q. Use your answer to

part (b) to solve for tax revenue as a function of T. Graph this relationship for T between 0 and 300.

d. The deadweight loss of a tax is the area of the triangle between the supply and demand curves. Recalling that the area of a triangle is 1?2 3 base 3 height, solve for deadweight loss as a function of T. Graph this relationship for T between 0 and 300. (Hint: Looking sideways, the base of the deadweight loss triangle is T, and the height is the difference between the quantity sold with the tax and the quantity sold without the tax.) e. The government now levies a tax on this good of $200 per unit. Is this a good policy? Why or why not? Can you propose a better policy?

1. Mexico represents a small part of the world orange market.

a. Draw a diagram depicting the equilibrium in the Mexican orange market without international trade. Identify the equilibrium price, equilibrium quantity, consumer surplus, and producer surplus.

b. Suppose that the world orange price is below the Mexican price before trade and that the Mexican orange market is now opened to trade. Identify the new equilibrium price, quantity consumed, quantity produced domestically, and quantity imported. Also show the change in the surplus of domestic consumers and producers. Has total surplus increased or decreased?

2. The world price of wine is below the price that would prevail in Canada in the absence of trade. a. Assuming that Canadian imports of wine are a small part of total world wine production, draw a graph for the Canadian market for wine under free trade. Identify consumer surplus, producer surplus, and total surplus in an appropriate table.

b. Now suppose that an unusual shift of the

Gulf Stream leads to an unseasonably cold summer in Europe, destroying much of the grape harvest there. What effect does this shock have on the world price of wine? Using your graph and table from part (a), show the effect on consumer surplus, producer surplus, and total surplus in Canada. Who are the winners and losers? Is Canada as a whole better or worse off?

3. Suppose that Congress imposes a tariff on imported autos to protect the U.S. auto industry from foreign competition. Assuming that the United States is a price taker in the world auto market, show the following on a diagram: the change in the quantity of imports, the loss to U.S. consumers, the gain to U.S. manufacturers, government revenue, and the deadweight loss associated with the tariff. The loss to consumers can be decomposed into three pieces: a gain to domestic producers, revenue for the government, and a deadweight loss. Use your diagram to identify these three pieces. 4. When China‘s clothing industry expands, the increase in world supply lowers the world price of clothing.

a. Draw an appropriate diagram to analyze how this change in price affects consumer surplus, producer surplus, and total surplus in a nation that imports clothing, such as the United States.

b. Now draw an appropriate diagram to show how this change in price affects consumer surplus, producer surplus, and total surplus in a nation that exports clothing, such as the Dominican Republic.

c. Compare your answers to parts (a) and (b). What are the similarities and what are the differences? Which country should be concerned about the expansion of the Chinese textile industry? Which country should be applauding it? Explain. 5. Imagine that winemakers in the state of Washington petitioned the state government to tax wines imported from California. They argue

that this tax would both raise tax revenue for the state government and raise employment in the Washington state wine industry. Do you agree with these claims? Is it a good policy? 6. Consider the arguments for restricting trade. a. Assume you are a lobbyist for timber, an established industry suffering from lowpriced foreign competition. Which two or three of the five arguments do you think would be most persuasive to the average member of Congress as to why he or she should support trade restrictions? Explain your reasoning.

b. Now assume you are an astute student of economics (hopefully not a hard assumption). Although all the arguments for restricting trade have their shortcomings, name the two or three arguments that seem to make the most economic sense to you. For each, describe the economic rationale for and against these arguments for trade restrictions.

7. Senator Ernest Hollings once wrote that ―consumers do not benefit from lower-priced imports. Glance through some mail-order catalogs and you‘ll see that consumers pay exactly the same price for clothing whether it is U.S.-made or imported.‖ Comment.

8. The nation of Textilia does not allow imports of clothing. In its equilibrium without trade, a T-shirt costs $20, and the equilibrium quantity is 3 million T-shirts. One day, after reading Adam Smith‘s The Wealth of Nations while on vacation, the president decides to open the Textilian market to international trade. The market price of a T-shirt falls to the world price of $16. The number of T-shirts consumed in Textilia rises to 4 million, while the number of T-shirts produced declines to 1 million.

a. Illustrate the situation just described in a graph. Your graph should show all the numbers.

b. Calculate the change in consumer surplus, producer surplus, and total surplus that

results from opening up trade. (Hint: Recall that the area of a triangle is ? × base × height.)

9. China is a major producer of grains, such as wheat, corn, and rice. In 2008 the Chinese government, concerned that grain exports were driving up food prices for domestic consumers, imposed a tax on grain exports.

a. Draw the graph that describes the market for grain in an exporting country. Use this graph as the starting point to answer the following questions.

b. How does an export tax affect domestic grain prices?

c. How does it affect the welfare of domestic consumers, the welfare of domestic producers, and government revenue? d. What happens to total welfare in China, as measured by the sum of consumer surplus, producer surplus, and tax revenue?

10. Consider a country that imports a good from abroad. For each of following statements, say whether it is true or false. Explain your answer. a. ―The greater the elasticity of demand, the greater the gains from trade.‖

b. ―If demand is perfectly inelastic, there are no gains from trade.‖

c. ―If demand is perfectly inelastic, consumers do not benefit from trade.‖

11. Kawmin is a small country that produces and consumes jelly beans. The world price of jelly beans is $1 per bag, and Kawmin‘s domestic demand and supply for jelly beans are governed by the following equations:

Demand: QD 5 8 – P Supply: QS 5 P,

where P is in dollars per bag and Q is in bags of jelly beans.

a. Draw a well-labeled graph of the situation in Kawmin if the nation does not allow trade. Calculate the following (recalling that the area of a triangle is ? 3 base 3 height): the equilibrium price and quantity, consumer surplus, producer surplus, and total surplus.

b. Kawmin then opens the market to trade. Draw another graph to describe the new situation in the jelly bean market. Calculate the equilibrium price, quantities of consumption and production, imports, consumer surplus, producer surplus, and total surplus.

c. After a while, the Czar of Kawmin responds to the pleas of jelly bean producers by placing a $1 per bag tariff on jelly bean imports. On a graph, show the effects of this tariff. Calculate the equilibrium price, quantities of consumption and production, imports, consumer surplus, producer surplus, government revenue, and total surplus. d. What are the gains from opening up trade? What are the deadweight losses from restricting trade with the tariff? Give numerical answers.

12. Having rejected a tariff on textiles (a tax on imports), the president of Isoland is now considering the same-sized tax on textile consumption (including both imported and domestically produced textiles). a. Using Figure 4, identify the quantity consumed and the quantity produced in Isoland under a textile consumption tax. b. Construct a table similar to that in Figure 4 for the textile consumption tax. c. Which raises more revenue for the government—the consumption tax or the tariff? Which has a smaller deadweight loss? Explain.

13. Assume the United States is an importer of televisions and there are no trade restrictions. U.S. consumers buy 1 million televisions per year, of which 400,000 are produced domestically and 600,000 are imported. a. Suppose that a technological advance among Japanese television manufacturers causes the world price of televisions to fall by $100. Draw a graph to show how this change affects the welfare of U.S. consumers and U.S. producers and how it affects total surplus in

the United States.

b. After the fall in price, consumers buy 1.2 million televisions, of which 200,000 are produced domestically and 1 million are imported. Calculate the change in consumer surplus, producer surplus, and total surplus from the price reduction.

c. If the government responded by putting a $100 tariff on imported televisions, what would this do? Calculate the revenue that would be raised and the deadweight loss. Would it be a good policy from the standpoint of U.S. welfare? Who might support the policy?

d. Suppose that the fall in price is attributable not to technological advance but to a $100 per television subsidy from the Japanese government to Japanese industry. How would this affect your analysis?

14. Consider a small country that exports steel. Suppose that a ―pro-trade‖ government decides to subsidize the export of steel by paying a certain amount for each ton sold abroad. How does this export subsidy affect the domestic price of steel, the quantity of steel produced, the quantity of steel consumed, and the quantity of steel exported? How does it affect consumer surplus, producer surplus, government revenue, and total surplus? Is it a good policy from the standpoint of economic efficiency? (Hint: The analysis of an export subsidy is similar to the analysis of a tariff.)

1. Consider two ways to protect your car from theft. The Club (a steering wheel lock) makes it difficult for a car thief to take your car. Lojack (a tracking system) makes it easier for the police to catch the car thief who has stolen it. Which of these types of protection conveys a negative externality on other car owners? Which conveys a positive externality? Do you think there are any policy implications of your analysis? 2. Do you agree with the following statements?

Why or why not?

a. ―The benefits of corrective taxes as a way to reduce pollution have to be weighed against the deadweight losses that these taxes cause.‖ b. ―When deciding whether to levy a corrective tax on consumers or producers, the government should be careful to levy the tax on the side of the market generating the externality.‖

3. Consider the market for fire extinguishers. a. Why might fire extinguishers exhibit positive externalities?

b. Draw a graph of the market for fire extinguishers, labeling the demand curve, the social-value curve, the supply curve, and the social-cost curve.

c. Indicate the market equilibrium level of output and the efficient level of output. Give an intuitive explanation for why these quantities differ.

d. If the external benefit is $10 per extinguisher, describe a government policy that would yield the efficient outcome.

4. A local drama company proposes a new neighborhood theater in San Francisco. Before approving the building permit, the city planner completes a study of the theater‘s impact on the surrounding community.

a. One finding of the study is that theaters attract traffic, which adversely affects the community. The city planner estimates that the cost to the community from the extra traffic is $5 per ticket. What kind of an externality is this? Why?

b. Graph the market for theater tickets, labeling the demand curve, the social-value curve, the supply curve, the social-cost curve, the market equilibrium level of output, and the efficient level of output. Also show the per-unit amount of the externality. c. Upon further review, the city planner uncovers a second externality. Rehearsals for the plays tend to run until late at night, with actors, stagehands, and other theater

members coming and going at various hours. The planner has found that the increased foot traffic improves the safety of the surrounding streets, an estimated benefit to the community of $2 per ticket. What kind of externality is this? Why?

d. On a new graph, illustrate the market for theater tickets in the case of these two externalities. Again, label the demand curve, the social-value curve, the supply curve, the social-cost curve, the market equilibrium level of output, the efficient level of output, and the per-unit amount of both externalities. e. Describe a government policy that would result in an efficient outcome.

5. Greater consumption of alcohol leads to more motor vehicle accidents and, thus, imposes costs on people who do not drink and drive. a. Illustrate the market for alcohol, labeling the demand curve, the social-value curve, the supply curve, the social-cost curve, the market equilibrium level of output, and the efficient level of output.

b. On your graph, shade the area corresponding to the deadweight loss of the market equilibrium. (Hint: The deadweight loss occurs because some units of alcohol are consumed for which the social cost exceeds the social value.) Explain.

6. Many observers believe that the levels of pollution in our society are too high. a. If society wishes to reduce overall pollution by a certain amount, why is it efficient to have different amounts of reduction at different firms?

b. Command-and-control approaches often rely on uniform reductions among firms. Why are these approaches generally unable to target the firms that should undertake bigger reductions?

c. Economists argue that appropriate corrective taxes or tradable pollution rights will result in efficient pollution reduction. How do these approaches target the firms that should

undertake bigger reductions?

7. The many identical residents of Whoville love drinking Zlurp. Each resident has the following willingness to pay for the tasty refreshment:

First bottle $5 Second bottle 4 Third bottle 3 Fourth bottle 2 Fifth bottle 1 Further bottles 0

a. The cost of producing Zlurp is $1.50, and the competitive suppliers sell it at this price. (The supply curve is horizontal.) How many bottles will each Whovillian consume? What is each person‘s consumer surplus? b. Producing Zlurp creates pollution. Each bottle has an external cost of $1. Taking this additional cost into account, what is total surplus per person in the allocation you described in part (a)?

c. Cindy Lou Who, one of the residents of Whoville, decides on her own to reduce her consumption of Zlurp by one bottle. What happens to Cindy‘s welfare (her consumer surplus minus the cost of pollution she experiences)? How does Cindy‘s decision affect total surplus in Whoville?

d. Mayor Grinch imposes a $1 tax on Zlurp. What is consumption per person now? Calculate consumer surplus, the external cost, government revenue, and total surplus per person.

e. Based on your calculations, would you support the mayor‘s policy? Why or why not? 8. Ringo loves playing rock ?n‘ roll music at high volume. Luciano loves opera and hates rock ?n‘ roll. Unfortunately, they are next-door neighbors in an apartment building with paper-thin walls.

a. What is the externality here?

b. What command-and-control policy might the landlord impose? Could such a policy lead to an inefficient outcome?

c. Suppose the landlord lets the tenants do

whatever they want. According to the Coase theorem, how might Ringo and Luciano reach an efficient outcome on their own? What might prevent them from reaching an efficient outcome?

9. Figure 4 shows that for any given demand curve for the right to pollute, the government can achieve the same outcome either by setting a price with a corrective tax or by setting a quantity with pollution permits. Suppose there is a sharp improvement in the technology for controlling pollution.

a. Using graphs similar to those in Figure 4, illustrate the effect of this development on the demand for pollution rights.

b. What is the effect on the price and quantity of pollution under each regulatory system? Explain.

10. Suppose that the government decides to issue tradable permits for a certain form of pollution. a. Does it matter for economic efficiency whether the government distributes or auctions the permits? Why or why not? b. If the government chooses to distribute the permits, does the allocation of permits among firms matter for efficiency? Explain.

11. There are three industrial firms in Happy Valley.

Initial Cost of Reducing

Firm Pollution Level Pollution by 1 Unit

A 70 units $20 B 80 units $25 C 50 units $10

The government wants to reduce pollution to 120 units, so it gives each firm 40 tradable pollution permits.

a. Who sells permits and how many do they sell? Who buys permits and how many do they buy? Briefly explain why the sellers and buyers are each willing to do so. What is the total cost of pollution reduction in this situation?

b. How much higher would the costs of pollution reduction be if the permits could not be traded

1. Think about the goods and services provided by your local government.

a. Using the classification in Figure 1, explain which category each of the following goods falls into:

? police protection ? snow plowing ? education ? rural roads ? city streets

b. Why do you think the government provides items that are not public goods?

2. Both public goods and common resources involve externalities.

a. Are the externalities associated with public goods generally positive or negative? Use examples in your answer. Is the free-market quantity of public goods generally greater or less than the efficient quantity?

b. Are the externalities associated with common resources generally positive or negative? Use examples in your answer. Is the free-market use of common resources generally greater or less than the efficient use?

3. Charlie loves watching Teletubbies on his local public TV station, but he never sends any money to support the station during its fundraising drives.

a. What name do economists have for people like Charlie?

b. How can the government solve the problem caused by people like Charlie?

c. Can you think of ways the private market can solve this problem? How does the existence of cable TV alter the situation?

4. Wireless, high-speed Internet is provided for free in the airport of the city of Communityville. a. At first, only a few people use the service. What type of a good is this and why? b. Eventually, as more people find out about the service and start using it, the speed of the connection begins to fall. Now what type of a

good is the wireless Internet service? c. What problem might result and why? What is one possible way to correct this problem? 5. Four roommates are planning to spend the weekend in their dorm room watching old movies, and they are debating how many to watch. Here is their willingness to pay for each film:

Judd Joel Gus Tim

First film $7 $5 $3 $2 Second film 6 4 2 1 Third film 5 3 1 0 Fourth film 4 2 0 0 Fifth film 3 1 0 0

a. Within the dorm room, is the showing of a movie a public good? Why or why not? b. If it costs $8 to rent a movie, how many movies should the roommates rent to maximize total surplus?

c. If they choose the optimal number from part (b) and then split the cost of renting the movies equally, how much surplus does each person obtain from watching the movies? d. Is there any way to split the cost to ensure that everyone benefits? What practical problems does this solution raise? e. Suppose they agree in advance to choose the efficient number and to split the cost of the movies equally. When Judd is asked his willingness to pay, will he have an incentive to tell the truth? If so, why? If not, what will he be tempted to say?

f. What does this example teach you about the optimal provision of public goods?

6. Some economists argue that private firms will not undertake the efficient amount of basic scientific research.

a. Explain why this might be so. In your answer, classify basic research in one of the categories shown in Figure 1.

b. What sort of policy has the United States adopted in response to this problem?

c. It is often argued that this policy increases the technological capability of American producers

relative to that of foreign firms. Is this argument consistent with your classification of basic research in part (a)? (Hint: Can excludability apply to some potential beneficiaries of a public good and not others?) 7. There is often litter along highways but rarely in people‘s yards. Provide an economic explanation for this fact.

8. The town of Wiknam has 5 residents whose only activity is producing and consuming fish. They produce fish in two ways. Each person who works on a fish farm raises 2 fish per day. Each person who goes fishing in the town lake catches X fish per day. X depends on N, the number of residents fishing in the lake. In particular,

X = 6 – N.

Each resident is attracted to the job that pays more fish.

a. Why do you suppose that X, the productivity of each fisherman, falls as N, the number of fishermen, rises? What economic term would you use to describe the fish in the town lake? Would the same description apply to the fish from the farms? Explain.

b. The town‘s Freedom Party thinks every individual should have the right to choose between fishing in the lake and farming without government interference. Under its policy, how many of the residents would fish in the lake and how many would work on fish farms? How many fish are produced?

1. In a published source or on the Internet, find out whether the U.S. federal government had a budget deficit or surplus last year. What do policymakers expect to happen over the next few years? (Hint: The website of the Congressional Budget Office is http://www.cbo.gov.)

2. The information in many of the tables in this chapter can be found in the Economic Report of the President, which appears annually. Using a

recent issue of the report at your library or on the Internet, answer the following questions and provide some numbers to support your answers. (Hint: The website of the Government Printing Office is http://www.gpo.gov.) a. Figure 1 shows that government revenue as a percentage of total income has increased over time. Is this increase primarily attributable to changes in federal government revenue or in state and local government revenue? b. Looking at the combined revenue of the federal government and state and local governments, how has the composition of total revenue changed over time? Are personal income taxes more or less important? Social insurance taxes? Corporate profits taxes?

c. Looking at the combined expenditures of the federal government and state and local governments, how have the relative shares of transfer payments and purchases of goods and services changed over time?

3. The chapter states that the elderly population in the United States is growing more rapidly than the total population. In particular, the number of workers is rising slowly, while the number of retirees is rising quickly. Concerned about the future of Social Security, some members of Congress propose a ―freeze‖ on the program.

a. If total expenditures were frozen, what would happen to benefits per retiree? To tax payments per worker? (Assume that Social Security taxes and receipts are balanced in each year.)

b. If benefits per retiree were frozen, what would happen to total expenditures? To tax payments per worker?

c. If tax payments per worker were frozen, what would happen to total expenditures? To benefits per retiree?

d. What do your answers to parts (a), (b), and (c) imply about the difficult decisions faced by policymakers?

4. Suppose you are a typical person in the U.S. economy. You pay 4 percent of your income in a state income tax and 15.3 percent of your labor earnings in federal payroll taxes (employer and employee shares combined). You also pay federal income taxes as in Table 3. How much tax of each type do you pay if you earn $20,000 a year? Taking all taxes into account, what are your average and marginal tax rates? What happens to your tax bill and to your average and marginal tax rates if your income rises to $40,000?

5. Some states exclude necessities, such as food and clothing, from their sales tax. Other states do not. Discuss the merits of this exclusion. Consider both efficiency and equity.

6. When someone owns an asset (such as a share of stock) that rises in value, he has an ―accrued‖ capital gain. If he sells the asset, he ―realizes‖ the gains that have previously accrued. Under the U.S. income tax, realized capital gains are taxed, but accrued gains are not.

a. Explain how individuals‘ behavior is affected by this rule.

b. Some economists believe that cuts in capital gains tax rates, especially temporary ones, can raise tax revenue. How might this be so? c. Do you think it is a good rule to tax realized but not accrued capital gains? Why or why not?

7. Suppose that your state raises its sales tax from 5 percent to 6 percent. The state revenue commissioner forecasts a 20 percent increase in sales tax revenue. Is this plausible? Explain. 8. The Tax Reform Act of 1986 eliminated the deductibility of interest payments on consumer debt (mostly credit cards and auto loans) but maintained the deductibility of interest payments on mortgages and home equity loans. What do you think happened to the relative amounts of borrowing through consumer debt and home equity debt?

9. Categorize each of the following funding schemes as examples of the benefits principle or

the ability-to-pay principle.

a. Visitors to many national parks pay an entrance fee.

b. Local property taxes support elementary and secondary schools.

c. An airport trust fund collects a tax on each plane ticket sold and uses the money to improve airports and the air traffic control system.

10. Any income tax schedule embodies two types of tax rates: average tax rates and marginal tax rates.

a. The average tax rate is defined as total taxes paid divided by income. For the proportional tax system presented in Table 7, what are the average tax rates for people earning $50,000, $100,000, and $200,000? What are the corresponding average tax rates in the regressive and progressive tax systems? b. The marginal tax rate is defined as the extra taxes paid on additional income divided by the increase in income. Calculate the marginal tax rate for the proportional tax system as income rises from $50,000 to $100,000. Calculate the marginal tax rate as income rises from $100,000 to $200,000. Calculate the corresponding marginal tax rates for the regressive and progressive tax systems.

c. Describe the relationship between average tax rates and marginal tax rates for each of these three systems. In general, which rate is relevant for someone deciding whether to accept a job that pays slightly more than her current job? Which rate is relevant for judging the vertical equity of a tax system? 12. Each of the following expenditures is a deduction for the purposes of calculating a person‘s federal income tax liability: a. Mortgage interest b. State and local taxes c. Charitable contributions

If the income tax base were broadened by eliminating these deductions, tax rates could be

lowered, while raising the same amount of tax revenue.

For each of these deductions, what would you expect the likely effect on taxpayer behavior to be? Discuss the pros and cons of each deduction from the standpoint of efficiency, vertical equity, and horizontal equity. Would you keep or eliminate the deduction?

1. This chapter discusses many types of costs: opportunity cost, total cost, fixed cost, variable cost, average total cost, and marginal cost. Fill in the type of cost that best completes each sentence: a. What you give up for taking some action is called the ______.

b. _____ is falling when marginal cost is below it and rising when marginal cost is above it. c. A cost that does not depend on the quantity produced is a(n) ______.

d. In the ice-cream industry in the short run, ______ includes the cost of cream and sugar but not the cost of the factory.

e. Profits equal total revenue less ______. f. The cost of producing an extra unit of output is the ______.

2. Your aunt is thinking about opening a hardware store. She estimates that it would cost $500,000 per year to rent the location and buy the stock. In addition, she would have to quit her $50,000 per year job as an accountant. a. Define opportunity cost.

b. What is your aunt‘s opportunity cost of running a hardware store for a year? If your aunt thought she could sell $510,000 worth of merchandise in a year, should she open the store? Explain.

3. A commercial fisherman notices the following relationship between hours spent fishing and the quantity of fish caught:

Quantity of Fish Hours (in pounds)

0 hours 0 lb. 1 10 2 18 3 24

4 28 5 30

a. What is the marginal product of each hour spent fishing?

b. Use these data to graph the fisherman‘s production function. Explain its shape. c. The fisherman has a fixed cost of $10 (his pole). The opportunity cost of his time is $5 per hour. Graph the fisherman‘s total-cost curve. Explain its shape.

4. Nimbus, Inc., makes brooms and then sells them door-to-door. Here is the relationship between the number of workers and Nimbus‘s output in a given day:

Average

Marginal Total Total Marginal

Workers Output Product Cost Cost Cost

0 0 ___ ___ ___ ___ 1 20 ___ ___ ___ ___ 2 50 ___ ___ ___ ___ 3 90 ___ ___ ___ ___ 4 120 ___ ___ ___ ___ 5 140 ___ ___ ___ ___ 6 150 ___ ___ ___ ___ 7 155 ___ ___

a. Fill in the column of marginal products. What pattern do you see? How might you explain it?

b. A worker costs $100 a day, and the firm has fixed costs of $200. Use this information to fill in the column for total cost.

c. Fill in the column for average total cost. (Recall that ATC = TC/Q.) What pattern do you see?

d. Now fill in the column for marginal cost. (Recall that MC = ΔTC/ΔQ.) What pattern do you see?

e. Compare the column for marginal product and the column for marginal cost. Explain the relationship.

f. Compare the column for average total cost and the column for marginal cost. Explain the relationship.

5. You are the chief financial officer for a firm that sells digital music players. Your firm has the following average-total-cost schedule:

Quantity Average Total Cost

600 players $300 601 301

Your current level of production is 600 devices, all of which have been sold. Someone calls, desperate to buy one of your music players. The caller offers you $550 for it. Should you accept the offer? Why or why not?

6. Consider the following cost information for a pizzeria:

Quantity Total Cost Variable Cost

0 dozen pizzas $300 $ 0 1 350 50 2 390 90 3 420 120 4 450 150 5 490 190 6 540 240

a. What is the pizzeria‘s fixed cost? b. Construct a table in which you calculate the marginal cost per dozen pizzas using the information on total cost. Also, calculate the marginal cost per dozen pizzas using the information on variable cost. What is the relationship between these sets of numbers? Comment.

7. You are thinking about setting up a lemonade stand. The stand itself costs $200. The

ingredients for each cup of lemonade cost $0.50. a. What is your fixed cost of doing business? What is your variable cost per cup? b. Construct a table showing your total cost, average total cost, and marginal cost for output levels varying from 0 to 10 gallons. (Hint: There are 16 cups in a gallon.) Draw

the three cost curves.

8. Your cousin Vinnie owns a painting company with fixed costs of $200 and the following schedule for variable costs:

Quantity of

Houses Painted 1 2 3 4 5 6 7 per Month

Variable Costs $10 $20 $40 $80 $160 $320 $640

Calculate average fixed cost, average variable cost, and average total cost for each quantity. What is the efficient scale of the painting company? 9. A firm uses two inputs in production: capital and labor. In the short run, the firm cannot adjust the amount of capital it is using, but it can adjust the size of its workforce. What happens to the firm‘s average total cost curve, the average variable cost curve, and the marginal cost curve when a. the cost of renting capital increases? b. the cost of hiring labor increases?

10. The city government is considering two tax proposals:

? A lump-sum tax of $300 on each producer of

hamburgers.

? A tax of $1 per burger, paid by producers of

hamburgers.

a. Which of the following curves—average fixed cost, average variable cost, average total cost, and marginal cost—would shift as a result of the lump-sum tax? Why? Show this in a graph. Label the graph as precisely as possible.

b. Which of these same four curves would shift as a result of the per-burger tax? Why? Show this in a new graph. Label the graph as precisely as possible.

11. Jane‘s Juice Bar has the following cost schedules:

Quantity Variable Cost Total Cost

0 vats of juice $ 0 $ 30 1 10 40 2 25 55 3 45 75 4 70 100 5 100 130 6 135 165

a. Calculate average variable cost, average total cost, and marginal cost for each quantity. b. Graph all three curves. What is the relationship between the marginal-cost curve and the average-total-cost curve? Between the marginal-cost curve and the average-variable-cost curve? Explain.

12. Consider the following table of long-run total costs for three different firms:

Quantity 1 2 3 4 5 6 7

Firm A $60 $70 $80 $90 $100 $110 $120 Firm B 11 24 39 56 75 96 119 Firm C 21 34 49 66 85 106 129

Does each of these firms experience economies of scale or diseconomies of scale

1. A publisher faces the following demand schedule for the next novel from one of its popular authors:

Price Quantity Demanded

$100 0 novels 90 100,000 80 200,000 70 300,000 60 400,000 50 500,000 40 600,000 30 700,000 20 800,000 10 900,000 0 1,000,000

The author is paid $2 million to write the book, and the marginal cost of publishing the book is a constant $10 per book.

a. Compute total revenue, total cost, and profit at each quantity. What quantity would a profit-maximizing publisher choose? What price would it charge?

b. Compute marginal revenue. (Recall that MR = ΔTR/ΔQ.) How does marginal revenue compare to the price? Explain. c. Graph the marginal-revenue, marginal-cost, and demand curves. At what quantity do the marginal-revenue and marginal-cost curves cross? What does this signify?

d. In your graph, shade in the deadweight loss. Explain in words what this means.

e. If the author were paid $3 million instead of $2 million to write the book, how would this affect the publisher‘s decision regarding what price to charge? Explain.

f. Suppose the publisher was not profit-maximizing but was concerned with maximizing economic efficiency. What price would it charge for the book? How much profit would it make at this price?

2. A small town is served by many competing supermarkets, which have the same constant marginal cost.

a. Using a diagram of the market for groceries, show the consumer surplus, producer surplus, and total surplus.

b. Now suppose that the independent supermarkets combine into one chain. Using a new diagram, show the new consumer surplus, producer surplus, and total surplus. Relative to the competitive market, what is the transfer from consumers to producers? What is the deadweight loss?

3. Johnny Rockabilly has just finished recording his latest CD. His record company‘s marketing department determines that the demand for the CD is as follows:

Price Number of CDs

$24 10,000 22 20,000 20 30,000 18 40,000 16 50,000 14 60,000

The company can produce the CD with no fixed cost and a variable cost of $5 per CD. a. Find total revenue for quantity equal to 10,000, 20,000, and so on. What is the marginal revenue for each 10,000 increase in the quantity sold?

b. What quantity of CDs would maximize profit? What would the price be? What would the profit be?