Microeconomics, 11th Canadian Edition, Instructor Solution Manual

117 Pages·2004·1.509 MB·English

by  Christopher T.S. Ragan, Richard G. Lipsey

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Chapter 1: Economic Issues and Concepts
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Answers to Study Exercises
Question 1
Microeconomics is the study of the allocation of resources within and across individual markets,
and the determination of relative prices and quantities. Macroeconomics is the study of the
determination of aggregates such as aggregate output, employment, the price level, the
unemployment rates, and the exchange rate.
Question 2
Traditional systems: Behaviour is based primarily on tradition, custom, and habit.
Command systems: Decisions about production and consumption are determined by a central
planning authority.
Free-market systems: Production and consumption decisions are made privately, by
decentralized producers and consumers.
Mixed systems: Economic systems in which there are elements of tradition, command, and free
markets.
Question 3
Scarcity: The production possibilities boundary (PPB) separates attainable combinations of
goods from those that are unattainable. Thus scarcity is shown by the existence of some
unattainable bundles of goods.
Choice: Because of scarcity, societies must somehow choose how resources are to be allocated;
thus a particular point on the PPB must be chosen.
Opportunity Cost: The slope of the PPB is negative, revealing the opportunity cost that is
unavoidable every time a choice is made. For the economy as a whole, the decision to produce
more of one good must involve a decision to produce less of some other good.
Question 4
a) At point A, 2.5 tonnes of clothing and 3 tonnes of food are being produced per year. At point
B, annual production is 2.5 tonnes of clothing and 7 tonnes of food. At point C, annual
production is 6.5 tonnes of clothing and 3 tonnes of food.
b) At point A the economy is either using its resources inefficiently or it is not using all of its
available resources. Point B and C represent full and efficient use of available resources because
they are on the PPB.
c) At point B, the opportunity cost of producing one more tonne of food (and increase from 7 to
8) is the 2.5 tonnes of clothing that must be given up. The opportunity cost of producing one
more tonne of clothing (from 2.5 to 3.5) appears, from the graph, to be approximately 0.75
tonnes of food.
d) Point D is unattainable given the economy’s current technology and resources. Point D can
become attainable with a sufficient improvement in technology or increase in available
resources.
Question 5
Since individual abilities differ, specializing allows each person to focus their energies on what
they do best, leaving everything else to be done by others. As a result, total output will rise. In
addition, as people specialize, they often “learn by doing” and become even better at their
specific task. Thus specialization often leads to improvements in ability that would not otherwise
occur.
Question 6
a) As the table shows, there are only 250 workers in Choiceland, and to construct the production
possibilities boundary we must imagine all the combinations of workers in each sector. Using the
two middle columns from the table, we can plot the output levels on a graph to get the following:
b) If the economy is already producing 60 units of X and 600 units of Y, then 10 extra units of X can only be
produced by reducing the production of Y by 250 units. The opportunity cost of 10 units of X is therefore 250 units
of Y (or 25 units of Y per unit of X). If the economy is already producing 70 units of X, the opportunity cost of
producing an additional 5 units of X is the forgone 350 units of Y (or 70 units of Y per unit of X). Thus, we see that
the opportunity cost of X rises when more of X is already being produced.
c) If any given amount of labour can now produce 10 percent more of good Y, then the PPB shifts up in a particular
way. Specifically, the Y values increase by 10 percent for any given X value, as shown below.
Question 7
The diagram in part (c) of Question 6 shows immediately why a technological improvement in one industry means
that a country can now produce more of both goods. Since the PPB has shifted up (or out), there are many
combinations of goods that are now available that were not before, and some of these involve producing more of
both goods. For example, if the economy was initially producing 45 units of X and 900 units of Y (see point A), it
could now produce more than 45 units of X and more than 900 units of Y, such as at point B. This would require
shifting some resources away from sector Y and toward sector X.
Question 8
In general, the opportunity cost for any activity includes three things:
• the direct cost of the activity, plus
• whatever you give up in order to do the activity, minus
• whatever “savings” the activity generates
In this case, the direct cost of transportation, lift tickets and accommodation of $300 is definitely included. The
income of $120 that you give up also counts. Finally, we must deal with the restaurant meals of $75. Surely you
would have eaten some food even if you hadn’t gone skiing, so the full $75 is not included. But given the relatively
high price of restaurant meals compared to buying your own groceries, you will probably include most of the $75.
Thus the opportunity cost of the ski trip is $420 plus some (large) fraction of the $75.
Question 9
This question is good for forcing the student to think through the computation of opportunity cost and also in
showing how the allocation of labour in particular ways can maximize total output.
a) You can catch 3 rabbits or 6 fish in one day’s work. Thus, your opportunity cost for an additional rabbit is 2 fish.
For your friend, the opportunity cost of an additional rabbit is 4 fish.
b) To allocate tasks in the output-maximizing way, each person should do the task for which they have the lower
opportunity cost. You have the lower opportunity cost of catching rabbits. Your friend has the lower opportunity cost
for catching fish (0.25 of a rabbit for your friend as compared to 0.5 of a rabbit for you). So to maximize output you
should focus on catching rabbits and your friend should focus on catching fish.
c) If instead you catch rabbits and your friend catches fish, there would be a total output (after two days’ work) of 6
rabbits and 16 fish. The reverse allocation would yield only 4 rabbits and 12 fish, which is clearly inferior.

Answers to Discussion Questions
Question 1
By scarcity we mean simply an excess of wants over the resources available to satisfy those
wants. Poverty is concerned with a level of resources below some threshold of sufficiency. One
can conceivably eliminate poverty, but that would not eliminate scarcity. Even if everyone had
enough to eat, there would be demand for more food than the minimum required for survival if it
were available at a price of zero. Therefore food would still be scarce. Even if goods became
free, there would be a scarcity of time available to consume and enjoy them.
Question 2
This is a relatively straightforward exercise. The downward slope of the production possibility
curve arises because of scarcity and implies the need to choose. The slope itself reflects the
opportunity cost of having more of either of the variables. An improved fertilizer would shift the
entire curve outward. A pollutionfree fertilizer, if developed, would mean that there are no longer
any opportunity costs in terms of pollution, but of course there would be an opportunity cost of
producing it with respect to the resources used.
Question 3
This quote will stimulate much interesting discussion, not only about views on how alternative
economic systems work, but also about the words used to describe them. The term planned
economy, for example, describes the conscious use of centralized decision making for key
economic decisions, but the results of that process often look anything but planned, with shortages
in some sectors, surpluses in others, and often a rather dispirited and unmotivated private sector.
On the other hand, the unplanned decentralized market economy––though surely not perfect––
creates a much more orderly looking set of outcomes. A useful discussion would be to focus on the
availability of some unusual item and then to discuss how each of the two systems would come to
provide it.
Question 4
The market for physicians’ services depends heavily on the specialization of labour. A person with
back pain will not know what is wrong. They go to a general practitioner (GP) who is somewhat
familiar with a broad range of symptoms and illnesses. The GP may rule out the simplest possible
causes for the pain, and in the process determine that the patient requires the services of a doctor
who diagnoses and treats the back. The patient is referred to this specialist who may diagnose a
ruptured disk and perform the delicate surgery necessary to effect a cure. Given this reliance on
specialization, the market depends on having relatively more GPs who see a large number of
patients and act as “gatekeepers” for patients to the more specific specialists. However, there is no
reason to expect a unique “best” mix to exist, or at least to be easy to discern.
Question 5
This is one of the hardest lessons for many students to learn. The basic idea of the price system as a
control mechanism is that when people pursue their selfinterests, they do provide many of the
things that society requires, because they are motivated by profits, and profits usually depend on
satisfying customers. Although unrestricted selfinterest may not always produce the best of all
possible worlds, it is important for the student to realize that the operation of selfinterest can
produce many results that are socially desirable.
Question 6
The central ideas illustrated by the two-good version of the production possibilities boundary
(PPB) are scarcity, choice, and opportunity cost. Exactly the same ideas can be illustrated in a more
realistic three-good version of the model, which is more complicated to draw, or by the much more
realistic N-good version of the model (with N ‡ 4), which is impossible to draw. Thus the
assumption of only two goods is merely a simplifying one (cid:190) it allows us to easily grasp and
illustrate some central points that would be more difficult to understand in the more general N-
good case.
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Chapter 2: How Economists Work
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Answers to Study Exercises
Question 1
a) In the Canadian wheat sector, the amount of rainfall on the Canadian prairies is an
exogenous variable; the amount of wheat produced is an endogenous variable.
b) To the Canadian market for coffee, the world price of coffee is exogenous; the price of a cup
at your local café is endogenous.
c) To any individual student, the widespread unavailability of student loans is exogenous; their
own attendance at university or college is endogenous.
d) To any individual drivers, the tax on gasoline is exogenous; their own decisions regarding
which vehicles to purchase are endogenous.
Question 2
a) These data are best illustrated with a time-series graph, with the month shown on the
horizontal axis and the interest rate shown on the vertical axis.
b) These cross-sectional data are best illustrated with a bar chart.
c) These cross-sectional data are best illustrated in a scatter diagram; the “line of best fit” is
clearly upward sloping, indicating a positive relationship between average investment rates and
average growth rates.
Question 3
a) Along Line A, Y falls as X rises; thus the slope of Line A is negative. For Line B, the value of Y rises and X rises;
thus the slope of Line B is positive.
b) Along Line A, the change in Y is –4 when the change in X is 6. Thus the slope of Line A is ΔY/ΔX = -4/6 = -2/3.
The equation for Line A is:
Y = 4 – (2/3)X
c) Along Line B, the change in Y is 7 when the change in X is 6. Thus the slope of Line B is ΔY/ΔX = 7/6. The
equation for Line B is:
Y = 0 + (7/6)X
Question 4
Given the tax-revenue function T = 10 + .25Y, the plotted curve will have a vertical intercept of
10 and a slope of 0.25. The interpretation is that when Y is zero, tax revenues will be $10 billion.
And for every increase in Y of $100 billion, tax revenues will rise by $25 billion. The diagram is
as shown below:
Question 5
a) Begin computing the values of Y for each value of X for each functional relation. Construct
the following table:
(i) Y = 50 + 2X (ii) Y = 50 + 2X + .05X2 (iii) Y = 50 + 2X - .05X2
X Y X Y X Y
0 50 0 50 0 50
10 70 10 75 10 65
20 90 20 110 20 70
30 110 30 155 30 65
40 130 40 210 40 50
50 150 50 275 50 25
Now plot these values on scale diagrams. The diagrams are shown below. Notice the different vertical scale on the
three different diagrams.
b) For part (i), the slope is positive and constant and equal to 2. For each 10-unit increase in X,
there is an increase in Y of 20 units. For part (ii), the slope is always positive since an increase in
X always leads to an increase in Y. But the slope is not constant. As the value of X increases, the
slope of the line also increases. For part (iii), the slope is positive at low levels of X. But the
function reaches a maximum at X=20, after which the slope becomes negative. Furthermore,
when X is beyond 20, the slope of the line becomes more negative (steeper) as the value of X
increases.
c) For part (i), the marginal response of Y to a change in X is constant and equal to 2. This is the
slope of the line. In part (ii), the marginal response of Y to a change in X is always positive, but
the marginal response increases as the value of X increases. This is why the line gets steeper as X
increases. For part (iii), the marginal response of Y to a change in X is positive at low levels of X.
But after X=20, the marginal response becomes negative. Hence the slope of the line switches
from positive to negative. Note that for values of X further away from X=20, the marginal
response of Y to a change in X is larger in absolute value. That is, the curve flattens out as we
approach X=20 and becomes steeper as we move away from X=20.
Question 6
a) Using Calgary as the “base university” means that we choose $6.25 as the base price. This
means dividing all prices by $6.25 and then multiplying by 100. In this way, we will determine,
in percentage terms, how prices at other universities differ from Calgary prices. The index values
are as follows:
University Price per Index of pizza prices
p
i
z
z