Economics Today A Canadian Perspective Microeconomics, Canadian Edition, 1st edition Roger LeRoy Mi

INSTRUCTOR SOLUTIONS MANUAL Jim Higginson

Northern Alberta Institute of Technology

Lia Rizzo

Northern Alberta Institute of Technology

Economics Today: A Canadian Perspective, Microeconomics First Canadian Edition

Roger LeRoy Miller, Mushtaq Ahmad, James Higginson, Lia Rizzo, and George Sroka

Open-Book Testing: Why It Makes Sense iii

Table of Contents 1. The Nature of Economics (Appendix A: Reading and Working with Graphs) 2. Scarcity and the World of Trade-Offs 3. Demand and Supply (Appendix B: Calculating Equilibrium Price and Quantity Using Simple Linear Demand and Supply Equations) 4. Extensions of Demand and Supply Analysis (Appendix C: Consumer Surplus, Producer Surplus with a Price System) 5. Market Failures and the Public Sector 6. Demand and Supply Elasticity 7. Consumer Choice (Appendix D: More Advanced Consumer Choice Theory) 8. The Firm: Cost and Output Determination 9. Perfect Competition 10. Monopoly (Appendix E: Consumer Surplus and the Deadweight Loss Resulting from Monopoly) 11. Monopolistic Competition 12. Oligopoly and Strategic Behaviour 13. The Labour Market 14. Income, Poverty, and Health Care 15. Environmental Economics

Chapter 1

The Nature of Economics 

Answers to Questions for Critical Analysis

AI: DECISION MAKING THROUGH DATA Why do you suppose that economists sometimes disagree about whether to classify as a microeconomic or macroeconomic endeavor the application of big data analytics to massive volumes of information encompassing virtually all of a nation’s industries and interactions among those industries?

Because big data analytics uses such massive volumes of information, which can encompass virtually all a nation’s industries and interactions among those industries, it seems as if the endeavor is a macroeconomic application (large scale). However, in many cases, this big data just represents a small part of the economy, which could be perceived as a microeconomic application (individual scale or sub-scale).

THE INCENTIVES TO ATTEND POST-SECONDARY EDUCATION (P. 7) Sometimes adults tell young people to “get all the education you can get.” Does this mean that you should necessarily obtain an advanced degree?

Under special circumstances, your answer to this Real Application question would be, yes. Those special circumstances would involve being able to obtain an advanced degree at zero cost to you and simultaneously not having any job opportunities as an alternative. Otherwise, you should look at how much more you would expect to earn per year if you complete an advanced degree program compared with what you could have earned working rather than spending more time in a university. Plus, you would have to consider the out-of-pocket costs of pursuing an advanced degree.

ASSESSING WHETHER CHARITABLE DONATIONS REFLECT CARING FOR OTHERS OR FOR ONESELF How might the fact that the Canadian government allows larger tax deductions for some charitable donations than for others, how would this affect Canadian taxpayers’ incentives about how much to donate and to whom they direct their donations?

Canadian taxpayers are likely to donate to charities that will both help others and those in which will make them better off (either through a tax deduction or a charitable gift). If the government allows larger tax deductions for some charitable donations over others, taxpayers are likely to donate more to the charities where they receive a larger benefit (tax deduction).

GETTING DIRECTIONS In what way do small talk and gossip represent the use of simplifying assumptions?

Gossip and small talk usually deal with other persons or situations of interest to the persons engaged in the conversation. Often the people who are talking choose to leave out details which they consider unimportant or information that do not support their position. The interpretation of the situation or the behaviour of the person being talked about will be affected by which details are omitted. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition

Economics in Your Life

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GOVERNMENT PROVIDES INCENTIVE PROGRAM FOR ZERO-EMISSION VEHICLES (ZEV).

For Critical Thinking Overall, does it appear that the incentive provided to purchase ZEV arise from the application of centralized command and control, the price system, or a mix of the two? Explain your reasoning.

It appears that the government incentive provided to purchase ZEV is a mix of the two or a mixed economy. The market will determine what and how much ZEVs to produce. The government incentive or consumer subsidy will decrease the ZEV price and make the purchase more attractive to consumers.

Real Application Assume that you decide to buy a ZEV. Should you take advantage of the incentive?

Because the only cost to you, is your time to fill out the government application, you should definitely take advantage of the incentive. Assuming you comply with the government requirements you will benefit paying a lower price for your ZEV.

Issues & Applications

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WHY EDUCATION AND FINANCIAL INDEPENDENCE HELPS TO EXPLAIN WHY WOMEN ARE DELAYING MARRIAGE AND WHY FEWER WOMEN ARE MARRIED For Critical Thinking Why do you think that the prevalence of marriages by women to higher-income-earning partners has remained relatively steady in recent years? (Hint: More higher-income-earning partners have completed more years of education and have more stable employment prospects than those who earn less.)

The argument states that women choose to marry out of self-interest and will marry a partner that will be able to provide financially for the household. If women’s interests and actions do not change, then the prevalence of marriages to higher-income-earning partners should remain relatively steady.

Real Application Currently, a larger percentage of women are obtaining advanced degrees than are men. What are some of the real-world implications of this trend with respect to marriage?

Women with advanced degrees typically do not seek out spouses who have little or no education past high school. One might predict, that there will be a higher percentage of marriages among men and women who have advanced degrees.

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Answers to End-of-Chapter Questions

1-1.

Define economics. Explain briefly how the economic way of thinking—in terms of rational, self-interested people responding to incentives—relates to each of the following situations. a. A student deciding whether to purchase a textbook for a particular class b. Government officials seeking more funding for mass transit through higher taxes c. A municipality taxing hotel guests to obtain funding for a new sports stadium ..

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Chapter 1 The Nature of Economics Economics is the study of how individuals allocate limited resources to satisfy unlimited wants. a. Among the factors that a rational, self-interested student will consider are her income, the price of the textbook, her anticipation of how much she is likely to study the textbook, and how much studying the book is likely to affect her grade. b. A rational, self-interested government official will, for example, recognize that higher taxes will raise more funds for mass transit while making more voters, who have limited resources, willing to elect other officials. c. A municipality’s rational, self-interested government will, for instance, consider that higher hotel taxes will produce more funds if as many visitors continue staying at hotels, but that the higher taxes will also discourage some visitors from spending nights at hotels.

1-2.

Some people claim that the “economic way of thinking” does not apply to issues such as health care. Explain how economics does apply to this issue by developing a “model” of an individual’s choices.

This issue involves choice and, therefore, can be approached using the economic way of thinking. In the case of health care, an individual typically has an unlimited desire for good health. The individual has a limited budget and limited time, however. She must allocate her budget across other desirable goods, such as housing and food, and must allocate her time across waiting in a physician’s office, work, leisure, and sleep. Hence, choices must be made in light of limited resources.

1-3.

Does the phrase “unlimited wants and limited resources” apply to both a low-income household and a middle-income household? Can the same phrase be applied to a very high-income household?

Because wants are unlimited, the phrase applies to very high-income households as well as lowand middle-income households. Consider, for instance, a household with a low income and unlimited wants at the beginning of the year. The household’s wants will still remain unlimited if it becomes a high-income household later in the year.

1-4.

In a single sentence, contrast microeconomics and macroeconomics. Next, categorize each of the following issues as a microeconomic issue, a macroeconomic issue, or not an economic issue. a. The national unemployment rate b. The decision of a worker to work overtime or not c. A family’s choice to have a baby d. The rate of growth of the money supply e. The national government’s budget deficit f. A student’s allocation of study time across two subjects

Microeconomics is the study of individual decision making, whereas macroeconomics examines the aggregate behaviour of the entire economy. a. macroeconomics b. microeconomics ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition c. d. e. f.

1-5.

microeconomics macroeconomics macroeconomics microeconomics

One of your classmates, Sally, is a hardworking student, serious about her classes, and conscientious about her grades. Sally is also involved, however, in volunteer activities and an extracurricular sport. Could Sally be displaying rational behaviour? Based on what you read in this chapter, construct an argument supporting the conclusion that she is.

Sally is displaying rational behaviour if all of these activities are in her self-interest. For example, Sally likely derives intrinsic benefit from volunteer and extracurricular activities and may believe that these activities, along with good grades, improve her prospects of finding a job after she completes her studies. Hence, these activities are in her self-interest even though they reduce some available study time.

1-6.

Recently, a bank was trying to decide what fee to charge for “expedited payments”— payments the bank would transmit with extra speed so that customers could avoid late fees on cable TV bills, electric bills, and the like. To try to determine what fee customers were willing to pay for expedited payments, the bank conducted a survey. It was able to determine that many of the people surveyed already paid fees for expedited payment services that exceeded the maximum fees they said they were willing to pay. How does the bank’s finding relate to economists’ traditional focus on what people do, rather than what they say they will do?

This example illustrates that what people say they will do does not actually correspond to what matters in the economy, which is what they actually do.

1-7.

Explain, in your own words, the rationality assumption, and contrast it with the assumption of bounded rationality proposed by adherents of behavioural economics.

The rationality assumption states that people do not intentionally make choices that leave them worse off. The bounded rationality hypothesis suggests that people are almost, but not completely, rational.

1-8.

Why does the assumption of bounded rationality suggest that people might use rules of thumb to guide their decision making instead of considering every possible choice available to them?

The bounded rationality hypothesis indicates that because people cannot study every possible alternative available to them, they consider only the most obvious apparent choices. They find easy ways of deciding which of these obvious choices to select, and according to the hypothesis, these methods are simple rules of thumb.

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Chapter 1 The Nature of Economics 1-9.

Under what circumstances might people appear to use rules of thumb, as suggested by the assumption of bounded rationality, even though they really are behaving in a manner suggested by the rationality assumption?

Suppose that there is a change in the environment that a person faces, and the person adjusts to this change as predicted by the rationality assumption. If the new environment becomes predictable, then the individual who actually behaves as predicted by the traditional rationality assumption may settle into behaviour that appears to involve repetitive applications of a rule of thumb.

1-10. For each of the following approaches that an economist might follow in examining a decision-making process, identify whether the approach relies on the rationality assumption or on the assumption of bounded rationality. a. To make predictions about how many apps a person will download onto her tablet device, an economist presumes that the individual faces limitations that make it impossible for her to examine every possible choice among relevant apps. b. In evaluating the price that an individual will be willing to pay for a given quantity of a particular type of health-care service, a researcher assumes that the person considers all relevant health-care options in pursuit of his own long-term satisfaction with resulting health outcomes. c. To determine the amount of time that a person will decide to devote to watching online videos each week, an economist makes the assumption that the individual will feel overwhelmed by the sheer volume of videos available online and will respond by using a rule of thumb. a. Bounded rationality b. Rationality assumption c. Bounded rationality 1-11. For each of the following approaches that an economist might follow in examining a decision-making process, identify whether the approach relies on the rationality assumption or on the assumption of bounded rationality. a. An economic study of the number of online searches that individuals conduct before selecting a particular item to purchase online presumes that people are interested only in their own satisfaction, pursue their ultimate objectives, and consider every relevant option. b. An economist seeking to predict the effect that an increase in a state’s sales tax rate will have on consumers’ purchases of goods and services presumes that people are limited in their ability to process information about how the sales-tax-rate increase will influence the after-tax prices those consumers will pay. c. To evaluate the impact of an increase in the range of choices that an individual confronts when deciding among devices for accessing the Internet, an economic researcher makes the assumption that the individual is unable to take into account every new Internet-access option available to her.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition a. Rationality assumption b. Bounded rationality c. Bounded rationality 1-12. Which of the following predictions appear(s) to follow from a model based on the assumption that rational, self-interested individuals respond to incentives? a. For every ten exam points Myrna must earn in order to pass her economics course and meet her graduation requirements, she will study one additional hour for her economics test next week. b. A coin toss will best predict Leonardo’s decision about whether to purchase an expensive business suit or an inexpensive casual outfit to wear next week when he interviews for a high-paying job he is seeking. c. Celeste, who uses earnings from her regularly scheduled hours of part-time work to pay for her room and board at college, will decide to purchase and download a newly released video this week only if she is able to work two additional hours. a. Yes, because Myrna is acting in her own self-interest by establishing this allocation of her time to studying economics. b. No, because Leonardo is leaving an important decision affecting his self-interest to random chance, potentially leaving him worse off if he fails to obtain employment. c. Yes, because Celeste is basing her choice on a self-interest assessment of expenditures in light of available resources.

1-13. Write a sentence contrasting positive and normative economic analysis.

Positive economic analysis deals with economics models with predictions that are statements of fact, which can be objectively proved or disproved. Normative analysis considers subjective personal or social values concerning the way things ought to be.

1-14. Based on your answer to Problem 1–13, categorize each of the following conclusions as resulting from positive analysis or normative analysis. a. A higher minimum wage will reduce employment opportunities for minimum wage workers. b. Increasing the earnings of minimum wage employees is desirable, and raising the minimum wage is the best way to accomplish this. c. Everyone should enjoy open access to health care at no explicit charge. d. Health-care subsidies will increase the consumption of health care. a. b. c. d.

Positive Normative Normative Positive

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Chapter 1 The Nature of Economics 1-15. Consider the following statements, based on a positive economic analysis that assumes all other things remain constant. For each, list one other thing that could independently change in a way that offsets the outcome stated. a. Increased demand for digital devices will drive up their price. b. Falling gasoline prices will result in additional vacation travel. c. A reduction of income tax rates will result in more people working. a. An increase in the supply of digital devices, perhaps because of the entry of new device manufacturers into the market, pushes their price back down. b. Another factor, such as higher hotel taxes at popular vacation destinations, makes vacation travel more expensive. c. Some other factor, such as a fall in market wages that workers can earn, discourages people from working additional hours.

1-16. Suppose that the government has borrowed $50 billion to expand its total spending on goods and services across the entire economy in an effort to boost by $50 billion the aggregate production by the nation’s firms. Would we apply microeconomic or macroeconomic analysis to analyze this policy action?

This policy action involves billions of dollars in economywide total spending and aggregate production. Because the action involves the economy has a whole, macroeconomic analysis would be applied.

1-17. Suppose that the government has raised by $10 a per-carat tax rate it imposes on diamonds in an effort to influence production of this particular good by each of the firms that produce it and purchases by individual consumers. Would we apply microeconomic or macroeconomic analysis to analyze this policy action?

This policy action involves a tax per unit applied to sales of one specific item produced by a particular set of firms and bought by a particular group of consumers. Because the action involves a small part of the economy, microeconomic analysis would be applied.

1-18. Centralized command and control prevails throughout a certain nation’s economy. What three key economic questions have been addressed in this nation, and what has been the common element of the nation’s answers to those questions?

The three questions are as follows: What and how much will be produced? How will items be produced? For whom will items be produced? In this command-and-control economy, the common element of the nation’s answers to these questions is that the government makes all decisions.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 1-19. During her years of college, Dominique discovered that her three favorite subjects were astronomy, chemistry, and political science. She chose to major in astronomy because she had seen data indicating that science majors earn higher-than-average wages and because she liked astronomy better than both chemistry and political science. Upon graduation, however, she learned that average wages in chemistry fields were 20 percent higher than average wages earned by astronomers. Did Dominique’s behaviour violate the rationality assumption?

The rationality assumption states that individuals do not intentionally make decisions that would leave themselves worse off. When Dominique decided on astronomy over chemistry, she sought an enjoyable field of study within the generally higher-pay area of science. Thus, she did not intentionally make herself worse off. Indeed, with her training in astronomy she may still receive earnings higher than average pay in other non-science fields, including political science. She has ended up “less well off” only in the sense that she could have earned even higher wages if she had majored in chemistry and only after the fact—not because she intentionally made a decision that would leave her “worse off.”

1-20. Sebastian is a financial analyst who is convinced that his clients do not always make choices that are consistent with their long-term objectives. He has also determined that his clients do not consider every relevant choice and often fail to act in their own self-interest.

Does Sebastian perceive that his clients’ behaviour necessarily accords with the rationality assumption or the assumption of bounded rationality?

Sebastian perceives that the bounded rationality assumption applies, because he views their behaviour as inconsistent with their long-term goals, their capabilities to evaluate every relevant choice, and their own self-interest.

1-21. Maneesha has completed an analysis of the market for a prescription medication. She concludes that the policymaker should act to prevent an increase in the price of this drug on the grounds that the mainly older consumers of the medication have already spent their lives paying too much for pharmaceuticals. They ought not to have to pay higher prices, Maneesha has concluded, so the government should act to halt any further price increases in this market. Has Maneesha applied positive or normative economic analysis?

Maneesha has predicated her analysis on the basis of what the outcome “should” be, what price is “too much” to pay, and what people “ought not” be obliged to do. Consequently, her analysis is based on value judgments instead of purely descriptive considerations, and as such it is an example of normative economic analysis.

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Chapter 1 The Nature of Economics

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Appendix A: Answers to End-of-Appendix Questions

A-1. Explain which is the independent variable and which is the dependent variable for each of the following examples. a. Once you determine the price of a flash drive at the college bookstore, you will decide how many flash drives to buy. b. You will decide how many credit hours to register for this semester once the university tells you how many work-study hours you will be assigned. c. You anticipate earning a higher grade on your next economics exam because you studied more hours in the weeks preceding the exam. a. Independent: price of a flash drive; Dependent: quantity of flash drives b. Independent: work-study hours; Dependent: credit hours c. Independent: hours of study; Dependent: economics grade A-2. For each of the following items, state whether a direct or an inverse relationship is likely to exist. a. The number of hours you study for an exam and your exam score b. The price of pizza and the quantity purchased c. The number of games the university basketball team won last year and the number of season tickets sold this year a. direct b. inverse c. direct A-3. Review Figure A-4, plot the points on the coordinate axes, and then state whether each of the following paired observations is on, above, or below the x axis and on, to the left of, or to the right of the y axis. a. (–10, 4) b. (20, −2) c. (10, 0) a. above x axis; left of y axis b. below x axis; right of y axis c. on x axis; to right of y axis A-4. State whether each of the following functions specifies a direct or an inverse relationship. a. y = 5x b. y = 10 – 2x c. y = 3 + x d. y = –3x a. b. c. d.

direct (or positive); each 1-unit rise in x induces a 5-unit increase in y. inverse (or negative); each 1-unit rise in x induces a 2-unit decrease in y. direct (or positive); each 1-unit rise in x induces a 1-unit increase in y. inverse (or negative); each 1-unit rise in x induces a 3-unit decline in y. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition A-5. Given the function y = 5x, complete the following schedule and plot the curve.

Y −20 −10 0 10 20

x −4 −2 0 2 4

A-6. Given the function y = 8 – 2x, complete the following schedule and plot the curve. y

x

16 12 8 4 0

−4 −2 0 2 4

A-7. Calculate the slope of the function you graphed in Problem A-5.

Each one-unit increase in x yields a 5-unit increase in y, so the slope given by the change in y corresponding to the change in x is equal to 5.

A-8. Calculate the slope of the function you graphed in Problem A-6.

Each one-unit increase in x yields a 2-unit decrease in y, so the slope given by the change in y corresponding to the change in x is equal to −2.

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Chapter 2

Scarcity and the World of Trade-Offs 

Answers to Questions for Critical Analysis

WHY PEOPLE WITH THE HIGHEST HOURLY OPPORTUNITY COST ALLOCATE AS MUCH TIME TO LEISURE AS EVERYONE ELSE Why might a high-income individual perceive a substantial opportunity cost of devoting an available labour hour to a low-income task?

A high-income individual would need to give up a substantial amount (the cost of the time they could have spent working) to devote one hour to a low-income task (like watching TV). Whereas a low-income individual would need to give up less (the cost of the time they could have spent working) to devote one hour to a low-income task).

THE ECONOMIC EXPLANATION FOR SHRINKING AIRLINE RESTROOMS Why do you suppose that some airlines have simply removed a restroom or two from each of their passenger planes?

These airlines have found these additional restrooms have incurred a high opportunity cost. By reducing the number of restrooms, they can add additional rows of seats to the airplane, which can generate additional revenue for the airline (whereas the restrooms generate no revenue).

AI: CITY MANAGEMENT Who ultimately funds the information-gathering and decision-making activities of city governments that big data techniques are helping to guide?

Governments are mainly funded by taxpayer dollars. By using big data techniques for information-gathering and decision-making, city governments are using their scarce resources more efficiently.

CITY BICYCLE LANES ENCOUNTER THE LAW OF INCREASING ADDITIONAL COST Why might we anticipate a bowed shape for the production possibilities curve relating space taken up by a bicycle lane along a street to parking spaces along the street?

Cities will first convert parking spaces that are more suitable for bicycle lanes (those with fewer potholes) at a relatively low cost. As more and more spaces are being converted from parking spaces to bicycle lanes, eventually they will require resources that are not as suitable for bicycle lanes, thus increasing the costs associated with the change.

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Economics in Your Life

EXTREME SPECIALIZATION LEADS ONE PERSON TO PURSUE SMALL-ROCKET LAUNCHES For Critical Thinking As more aerospace firms set up in New Zealand to launch satellites and other payloads beyond the earth’s atmosphere, what is likely to happen to the opportunity cost of larger portions of the airspace above that nation? Explain briefly. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition As more aerospace firms set up to launch satellites in New Zealand, the opportunity cost of the portions of airspace would likely rise. The companies will first seek out the areas with the lowest opportunity costs (for example, inhabitable land that is not utilized). As more and more land is being used to launch satellites, however, areas with greater opportunity costs (for example, farmland) will need to be used.

Real Application Assume you are hired as part of the management team for a new aerospace company in New Zealand. It, too, wishes to launch satellites along paths very close to those of Rocket Labs. What would you tell the president of that new company about future opportunity costs?

You would have to point out that the opportunity cost of the airspace that your new company desires to use will definitely rise, and in particular it will rise more quickly, the more satellites Rocket Lab launches.

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Issues & Applications

ARE WE “LOSING” FARMLAND IN CANADA? For Critical Thinking What are some of the alternative uses for farmland? With your understanding of the concept of opportunity cost how do farmers evaluate the decision to sell their farmland? When farmland is converted to some of these alternative uses is it actually “lost”? What factors would help reverse the “loss” of farmland to urbanization?

There are many uses for land. Farmland could also be used for residential, commercial, industrial purposes (e.g. condominiums, business offices, shopping centers, parking lots, golf courses, manufacturing, etc.). The land could also be set aside as parks or wilderness preserves.

When deciding to convert or sell their farmland, farmers evaluate the value of the various alternative uses of their land. The decisions to convert or sell will depend on whether the value from continuing to use the land for farming is less than the next best alternative (e.g. using the land for a golf course).

The conversion of farmland does not necessarily mean it is “lost”. It is possible where converting the land back to farming becomes the next-best alternative.

Factors that could help reverse the “loss” of farmland to urbanization, are things that would increase the land’s value as farmland. This could be driven by factors that would improve the profitability of the farm. For example, higher crop prices, improved crop yields (perhaps through better fertilizer or pesticides), improvements in harvesting techniques/ equipment, etc.

Real Application Assume you are the owner of agricultural land. You discover that someone is willing to lease a section of your land that you set aside for the development of a large storage shed and workshop for $40,000 per year. Of the two options, how do you determine which makes you better off?

You already know that you can lease the land for $40,000 per year. You have to ascertain the costs associated with foregoing the large storage shed and workshop. If, for example, you believed that it would cost $25,000 per year to store your farm equipment elsewhere at a ..

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Chapter 2 Scarcity and the World of Trade-Offs neighboring farm, then the opportunity cost of that section of land is $25,000 per year. Your net gain of leasing the land would be $40,000 minus $25,000, or $15,000 per year, and you should lease the land. If the cost to store your farm equipment elsewhere was more than $40,000 per year, however, you should build the storage shed and workshop.

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Answers to End-of-Chapter Questions

2-1. Define opportunity cost. What is your opportunity cost of attending a class at 11:00 A.M.?

How does it differ from your opportunity cost of attending a class at 8:00 A.M.?

The opportunity cost of attending a class at 11:00 A.M. is the next-highest-valued use of that hour of the day. Likewise, the opportunity cost of attending an 8:00 A.M. class is the next-highestvalued use of that particular hour of the day. If you are an early riser, it is arguable that the opportunity cost of the 8:00 A.M. hour is lower because you will already be up at that time, but have fewer choices compared with the 11:00 A.M. hour when shops, recreation centers, and the like are open. If you are a late riser, it may be that the opportunity cost of the 8:00 A.M. hour is higher, because you place a relatively high value on an additional hour of sleep in the morning.

2-2. If you receive a ticket to a concert at no charge, what, if anything, is your opportunity cost of attending the concert? How does your opportunity cost change if miserable weather on the night of the concert requires you to leave much earlier for the concert hall and greatly extends the time it takes to get home afterward?

The opportunity cost of attending the concert is the next-highest-value use of the time spent at the concert. If bad weather extends the amount of time spent on an evening at the concert, then there is an additional opportunity cost in the form of the next-best uses of that additional time.

2-3. You and a friend decide to spend $100 each on concert tickets. Each of you alternatively could have spent the $100 to purchase a textbook, a meal at a highly rated local restaurant, or several Internet movie downloads. As you are on the way to the concert, your friend tells you that if she had not bought the concert ticket, she would have opted for a restaurant meal, and you reply that you otherwise would have downloaded several movies. Identify the relevant opportunity costs for you and your friend of the concert tickets that you purchased. Explain briefly.

The opportunity cost is the cost of the single, next-highest-valued foregone alternative to the $100 spent on the concert ticket, which for your friend was a restaurant meal she otherwise could have purchased and which for you was movie downloads that you otherwise could have bought.

2-4. After the concert discussed in Problem 2-3 is over and you and your friend are traveling home, you discuss how each of you might otherwise have used the four hours devoted to attending the concert. The four hours could have been used to study, to watch a streaming video of a sporting event, or to get some extra sleep. Your friend decides that if she had not spent four hours attending the concert, she would have chosen to study, and you reply that you otherwise would have watched the streaming video. Identify the relevant opportunity costs for you and your friend for allocating your four hours to attending the concert.

Explain briefly. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition The opportunity cost is the cost of the single, next-highest-value forgone alternative to the four hours spent attending the concert, which for your friend was time that she otherwise could have devoted to study and for you was time that you otherwise could have spent watching the streaming video of the sporting event.

2-5. Recently, a woman named Mary Krawiec attended an auction in Fredericton, New Brunswick. At the auction, a bank was seeking to sell a foreclosed property: a large Victorian house suffering from years of neglect in a neighborhood in which many properties had been on the market for years yet remained unsold. Her $10 offer was the highest bid in the auction, and she handed over a $10 bill for a title to ownership. Once she acquired the house, however, she became responsible for all taxes on the property and for an overdue water bill of $2,000. In addition, to make the house habitable, she and her husband devoted months of time and unpaid labour to renovating the property. In the process, they incurred explicit expenses totaling $65,000. Why do you suppose that the bank was willing to sell the house to Ms. Krawiec for only $10? (Hint: Contemplate the bank’s expected gain, net of all explicit and opportunity costs, if it had attempted to make the house habitable.)

The bank apparently determined that the net gain that it anticipated receiving from trying to sell the house to someone else, considering the opportunity cost of resources that the bank would have had to devote to renovating the house, was less than $10.

2-6. The following table illustrates the points a student can earn on examinations in economics and biology if the student uses all available hours for study. Plot this student’s production possibilities curve. Does the PPC illustrate the law of increasing additional cost?

Economics 100 90 80 70 60 50 40

Biology 40 60 75 85 93 98 100

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Chapter 2 Scarcity and the World of Trade-Offs Each additional 10 points earned in economics costs a greater number of biology points. For example, the opportunity cost to the student of increasing points earned in economics from 60 to 70 is 8 points forgone in biology, but the opportunity cost of increasing economics points from 90 to 100 rises to 20 points forgone in biology. Thus, the new PPC curve illustrates the law of increasing relative cost.

2-7. Based on the information provided in Problem 2-6, what is the opportunity cost to this student of allocating enough additional study time on economics to move her grade up from a 90 to a 100?

If the student allocates additional study time to economics in order to increase her score from 90 to 100, her biology score declines from 60 to 40, so the opportunity cost of earning 10 additional points in economics is 20 fewer points in biology.

2-8. Consider a change in the table in Problem 2-6. The student’s set of opportunities is now as follows: Does the PPC illustrate the law of increasing additional cost? What is the opportunity cost to this student for the additional amount of study time on economics required to move her grade from 60 to 70? From 90 to 100?

Economics 100 90 80 70 60 50 40

Biology 40 50 60 70 80 90 100

Each additional 10 points earned in economics costs 10 additional points in biology, so this PPC illustrates constant additional opportunity costs. It does not satisfy the law of increasing additional costs. For instance, the opportunity cost to the student of increasing points earned in economics from 60 to 70 is 10 points forgone in biology, and the opportunity cost of increasing economics points from 90 to 100 remains at 10 points forgone in biology.

2-9. Construct a production possibilities curve for a nation facing increasing opportunity costs for producing food and video games. Show how the PPC changes given the following events. a. A new and better fertilizer is invented. b. Immigration occurs, and immigrants’ labour can be employed in both the agricultural sector and the video game sector. c. People invent a new programming language that is much less costly to code and is more memory-efficient. d. A heat wave and drought result in a 10 percent decrease in usable farmland.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition

Consider the following diagram when answering Problems 2-10, 2-11, and 2-12.

2-10. During a debate on the floor of the House of Commons, Member of Parliament (MP) Creighton states, “Our nation should not devote so many of its fully employed resources to producing capital goods because we already are not producing enough consumption goods for our citizens.” Compared with the other labeled points on the diagram, which one could be consistent with the current production combination choice that MP Creighton believes the nation has made?

Point C

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Chapter 2 Scarcity and the World of Trade-Offs 2-11. In response to MP Creighton’s statement reported in Problem 2-10, MP Long replies, “We must remain at our current production combination if we want to be able to produce more consumption goods in the future.” Of the labeled points on the diagram, which one could depict the future production combination MP Long has in mind?

Point D 2-12. MP Borman interjects the following comment after the statements by MPs Creighton and Long reported in Problems 2-10 and 2-11: “In fact, both of my esteemed colleagues are wrong, because an unacceptably large portion of our nation’s resources is currently unemployed.” Of the labelled points on the diagram, which one is consistent with MP Borman’s position?

Point A 2-13. A nation’s residents can allocate their scarce resources either to producing consumption goods or to producing human capital—that is, providing themselves with training and education. The table below displays the production possibilities for this nation: Units of Production Consumption Units of Combination Goods Human Capital A 0 100 B 10 97 C 20 90 D 30 75 E 40 55 F 50 30 G 60 0 a. Suppose that the nation’s residents currently produce combination A. What is the opportunity cost of increasing production of consumption goods by 10 units? By 60 units? b. Does the law of increasing additional cost hold true for this nation? Why or why not? a. If the nation’s residents increase production of consumption goods from 0 units to 10 units, the opportunity cost is 3 units of human capital forgone. If the nation’s residents increase production of consumption goods from 0 units to 60 units, the opportunity cost is 100 units of human capital. b. Yes, because successive 10-unit increases in production of consumption goods generate larger sacrifices of human capital, equal to 3, 7, 15, 20, 25, and 30.

2-14. Like physical capital, human capital produced in the present can be applied to the production of future goods and services. Consider the table in Problem 2-13, and suppose that the nation’s residents are trying to choose between combination C and combination F. Other things being equal, will the future production possibilities curve for this nation be located farther outward if the nation chooses combination F instead of combination C? Explain. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition No, because combination F entails production of less human capital than combination C, so choosing combination F today would result in a smaller output shift in the production possibilities curve than would be experienced if combination C were chosen instead.

2-15. You can wash, fold, and iron a basket of laundry in two hours and prepare a meal in one hour. Your roommate can wash, fold, and iron a basket of laundry in three hours and prepare a meal in one hour. Who has the absolute advantage in laundry, and who has an absolute advantage in meal preparation? Who has the comparative advantage in laundry, and who has a comparative advantage in meal preparation?

Because it takes you less time to do laundry, you have an absolute advantage in laundry. Neither you nor your roommate has an absolute advantage in meal preparation. You require 2 hours to fold a basket of laundry, so your opportunity cost of folding a basket of laundry is 2 meals. Your roommate’s opportunity cost of folding a basket of laundry is 3 meals. Hence, you have a comparative advantage in laundry, and your roommate has a comparative advantage in meal preparation.

2-16. Based on the information in Problem 2-15, should you and your roommate specialize in a particular task? Why? If so, who should specialize in which task? Show how much labour time you save if you choose to “trade” an appropriate task with your roommate as opposed to doing it yourself.

Yes, you and your roommate should specialize in the task in which each of you has a comparative advantage. You should specialize in folding laundry and your roommate in preparing meals. If you fold a basket of laundry, you must forgo the time that it would take to prepare two meals. For your roommate to fold a basket of laundry, the time that it takes to prepare three meals must be given up.

Suppose that you “trade” folding a basket of laundry for preparing 2.5 meals. You gain 0.5 meals, which is equivalent to one-half hour of meal preparation time. Hence, you save one-half hour for every basket of laundry you fold for your roommate in exchange for an hour of meal preparation time.

2-17. Using only the concept of comparative advantage, evaluate this statement: “A professor with a Ph.D. in physics should never mow his or her own lawn, because this would fail to take into account the professor’s comparative advantage.”

It may be that the professor is very proficient at doing yard work relative to teaching and research activities, so in fact the professor may have a comparative advantage in doing yard work.

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Chapter 2 Scarcity and the World of Trade-Offs 2-18. Country A and country B produce the same consumption goods and capital goods and currently have identical production possibilities curves. They also have the same resources at present, and they have access to the same technology. a. At present, does either country have a comparative advantage in producing capital goods? Consumption goods? b. Suppose that country A now chooses to produce more consumption goods, compared with country B. Other things being equal, which country will experience the larger outward shift of its PPC during the next year? a. If the two nations have the same production possibilities, then they face the same opportunity costs of producing consumption goods and capital goods. Thus, at present neither has a comparative advantage in producing either good. b. Because country B produces more capital goods today, it will be able to produce more of both goods in the future. Consequently, country B’s PPC will shift outward by a greater amount next year.

2-19. Suppose that in Figure 2-1, a student currently is allocating her study time in such a way that she is earning a C in mathematics and a C in economics. What is the opportunity cost, measured in terms of the resulting grade change, if this student wishes to reallocate her study time in order to raise her mathematics grade by one letter, from a C to a B? According to the figure, if the student makes the required reallocation of study time to earn a B in mathematics, then she will earn a D in economics. Thus, the student’s opportunity cost of raising her grade by one letter grade, from a C to a B, is a one-letter grade drop in her economics grade, from a C to a D. 2-20. Suppose that in Figure 2-1, a student currently is allocating her study time in such a way that she is earning a C in mathematics and a C in economics. If the student desires to boost her economics grade to an A, how must she alter the number of hours per week that she studies economics? How must she alter the number of hours per week that she studies mathematics?

The student currently is allocating 3 hours per week of study time to mathematics and 3 hours per week of study time to economics. To boost her grade in economics from a C to an A, she must devote all 6 hours of available study time to economics, so she must increase the amount of time she spends studying economics by 3 hours per week. To attain a grade of A in economics, she can devote none of her weekly study hours to mathematics, so she must decrease the amount of time she devotes to studying mathematics by 3 hours per week.

2-21. Suppose that in Figure 2-2, the nation currently is producing combination D in the table and on the graph of the production possibilities curve. What is the opportunity cost of producing 5 million more smartphones and moving to production combination C? To move from combination D to combination C and produce 5 million more smartphones, instead of producing 30 million tablet devices at point D, at point C the nation is capable of producing only 20 million tablets. Thus, in order to move to point C, the nation must give up production of 10 million ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition tablets (30 million tablets – 20 million tablets = 10 million tablets). The opportunity cost of the additional 5 million smartphones, therefore, is 10 million tablets.

2-22. Suppose that in Figure 2-2, the nation currently is producing combination D in the table and on the graph of the production possibilities curve. What is the opportunity cost of producing 20 million more tablet devices and moving to production combination F? To move from combination D to combination F and produce 20 million more tablet devices at point F, instead of producing 45 million smartphones at point C, at point F the nation is capable of producing only 22.5 million smartphones. Thus, in order to move to point F, the nation must give up production of 17.5 million smartphones (45 million smartphones – 22.5 million smartphones = 17.5 million smartphones). The opportunity cost of the additional 20 million tablets, therefore, is 17.5 million smartphones.

2-23. Suppose that in Figure 2-4, the nation currently has sufficient resources to produce combinations located along only the innermost production possibilities curve. In addition, suppose that the nation’s residents have determined that smartphones function mainly as consumption goods while tablet devices function primarily as capital goods. If the nation produces no additional tablets this year, will the intermediate-shifted PPC resulting from minimal economic growth or the farthest-shifted PPC caused by more significant economic growth be more likely to apply next year?

The nation is said to have determined that tablet devices are capital goods that can be used to produce more items in the future, whereas smartphones are consumption goods that cannot.

Consequently, by producing no additional tablets this year, the nation has chosen to produce no new capital goods. Its economic growth will be minimal, so the intermediate-shifted PPC will result.

2-24. Suppose that in Figure 2-4, the nation with otherwise the same background conditions as in Problem 2-23 currently has sufficient resources to produce combinations located along only the innermost production possibilities curve. If the nation produces no additional smartphones this year, will the intermediate-shifted PPC resulting from minimal economic growth or the farthest-shifted PPC caused by more significant economic growth be more likely to apply next year?

The nation is said to have determined that tablet devices are capital goods that can be used to produce more items in the future, whereas smartphones are consumption goods that cannot.

Consequently, by producing no additional smartphones this year, the nation has chosen to produce as many tablets—that is, capital goods—as feasibly can produce. Its economic growth will be substantial, so the farthest-shifted PPC will result.

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Chapter 3

Demand and Supply 

Answers to Questions for Critical Analysis

THE SOARING RELATIVE PRICE OF RESTAURANT MEALS How might the law of demand help to explain why, in one recent year, the number of prepared lunches sold by Canadian restaurants dropped by more than 100 million units from the previous year? How might you respond in the future to an even higher relative price of restaurant meals?

Clearly, the law of demand is at work for both the total market and for you with respect to restaurant meals. As long as the relative price of prepared meals continues to rise, both other buyers in the market and you will probably respond by purchasing fewer prepared lunches. We are assuming here, obviously, that you are not making a much higher income during the time period in question.

ASSESSING THE QUALITY-ADJUSTED PRICES OF OLD AND NEW CONCERT VIOLINS If a concert violinist perceives that instruments that look very old enhance the experience of ticket-buying crowds, will that violinist be willing to pay more for an older violin?

Yes. To that violinist the quality of the experience is worth the higher price. In this instance, the quality-adjusted price for the older violin would be less than the quality-adjusted price for the newer violin.

WHY PAY-WHAT-YOU-WANT PRICING OFTEN PAYS OFF FOR CHARITABLE ORGANIZATIONS Why do you suppose that available evidence indicates that charitable organizations are more likely to offer “pay-what-you-want” pricing for items produced or obtained at relatively low cost per unit?

Charitable organizations are more likely to offer “pay-what-you-want” pricing for low-cost items because individuals who purchase from charities are likely to pay more than they would otherwise. The difference between the price of the item (low) and the price paid by the altruistic individual (high) can then be used for charity.

IN CHINA, LOWER-PRICED SOLAR ENERGY PUTS A DAMPER ON THE DEMAND FOR COAL What has happened to the position of China’s market demand curve for coal? Explain briefly.

The market demand curve for coal has shifted to the left (a decline in demand). Because the price of a substitute (solar energy) has declined, the demand for coal has also declined. This causes a decrease in the price for coal.

AI: THE GLOBAL TOURISM INDUSTRY Once the predicted position of the demand for tourism services has been determined, would an anticipated increase in the incomes of tourists generate a movement along that curve or a shift in the position of the curve?

An anticipated increase in the incomes of tourists would generate a shift in the demand curve to the right (increase).

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition TECHNOLOGICAL CHANGE BOOSTS SUPPLY IN THE JEWELLERY MARKET In what direction has the supply curve in the global jewellery market shifted? Explain briefly.

The supply curve in the global jewellery market has shifted to the right (increase). With the advances of technology, it is now less costly to produce jewellery, so a larger quantity can be supplied at every price.

A BRITISH VEGETABLE SHORTAGE HAS PREDICTABLE EFFECTS ON VEGETABLE PRICES Once the prices of vegetables stopped rising and reached new market clearing levels, what must have been true of the relationship between quantities demanded and supplied in the affected British vegetable markets?

Once the prices of vegetables stopped rising and reached equilibrium, quantity supplied was equal to quantity demanded. The increase in price reduced the quantity demanded and increased the quantity supplied until they were both equal at the new equilibrium.



Economics in Your Life

SPACE-CONSTRAINED RESTAURANTS DISCOVER THAT CUSTOMERS CARE ABOUT QUALITYADJUSTED LUNCH PRICES For Critical Thinking Did the decline in the quality-adjusted price of soup-and-sandwich lunches offered by Panera Bread and other soup-and-sandwich restaurant chains generate a rightward shift in the demand curve or a downward movement along that curve? Explain.

The decline in the quality-adjusted price of soup-and-sandwich lunches resulted in a downward movement along the demand curve. Changes in price result in movements along a curve, and changes in other determinants of demand result in shifts of the curve.

Real Application As a future entrepreneur or manager, what lesson can you learn from the actions of this realworld manager?

The full price of purchasing any good or service includes the time necessary to obtain that good or service. Hence, as a future entrepreneur or manager, you will want to consider the time cost of your customers when they purchase an item that you are offering for sale in the marketplace. As an example, assume that you are selling furniture or at-home gym equipment that requires the customer to put what they purchased together themselves. If considerable time is required to put together what you are selling, that implies a relatively higher full price. You might then, through experimentation and research, reduce the number of steps necessary to assemble the furniture or the at-home gym equipment.

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Issues & Applications

WORLD OIL PRICES COLLAPSE Identify one key factor noted in the Issues and Applications that could contribute to an increase in demand for oil.

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Chapter 3 Demand and Supply An effective vaccine is found and employees go back to work and travel bans are lifted, thus increasing the demand for oil.

Identify one factor noted in the Issues and Applications that could impact the supply of oil.

If an alternative, more efficient energy source is discovered, the rate of population growth changes, or agreements are made between top oil-producing countries it could affect the supply of oil.

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Answers to End-of-Chapter Questions

3-1. Suppose that in a recent market period, the following relationship existed between the price of tablet devices and the quantity supplied and quantity demanded: Price

Quantity Demanded

Quantity Supplied

$330

100 million

40 million

$340

90 million

60 million

$350

80 million

80 million

$360

70 million

100 million

$370

60 million

120 million

Graph the supply and demand curves for tablet devices using the information in the table.

What are the equilibrium price and quantity? If the industry price is $340, is there a shortage or surplus of tablet devices? How much is the shortage or surplus?

The equilibrium price is $350 per tablet device, and the equilibrium quantity is 80 million tablet devices. At a price of $340 per tablet device, the quantity of tablet devices demanded is 90 million, and the quantity of tablet devices supplied is 60 million. Hence, there is a shortage of 30 million tablet devices at a price of $340 per tablet. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 3-2. Suppose that in a later market period, the quantities supplied in the table in Problem 3-1 are unchanged. The amount demanded, however, has increased by 30 million at each price.

Construct the resulting demand curve in the illustration you made for Problem 3-1. Is this an increase or a decrease in demand? What are the new equilibrium quantity and the new market price? Give two examples of changes in ceteris paribus conditions that might cause such a change.

D1

If quantity demanded increases by 30 million at each price, then the new equilibrium price is $360 per tablet device, and the new equilibrium quantity is 100 million tablet devices. This is an increase in demand, which could be brought about by a change in any of the ceteris paribus conditions relating to the demand curve. For example, an increase in the demand for tablet devices could arise from either a decrease in the price of a complement, such as apps, or an increase in the price of a substitute, such as laptop computers or sophisticated smartphones.

3-3. Consider the market for cable-based Internet access service, which is a normal good.

Explain whether the following events would cause an increase or a decrease in demand or an increase or a decrease in the quantity demanded. a. Firms providing wireless (an alternative to cable) Internet access services reduce their prices. b. Firms providing cable-based Internet access services reduce their prices. c. There is a decrease in the incomes earned by consumers of cable-based Internet access services. d. Consumers’ tastes shift away from using wireless Internet access in favour of cablebased Internet access services. a. Wireless and cable Internet access services are substitutes, so a reduction in the price of wireless Internet access services causes a decrease in the demand for cable-based Internet access services. b. A decrease in the price of cable-based Internet access services generates an increase in the quantity of these services demanded. ..

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Chapter 3 Demand and Supply c. Cable-based Internet access services are a normal good, so a fall in the incomes of consumers reduces the demand for these services. d. If consumers’ tastes shift away from wireless Internet access services in favour of cable-based Internet services, then the demand for the latter services increases.

3-4. In the market for wireless earbuds (a normal good), explain whether the following events would cause an increase or a decrease in demand or an increase or a decrease in the quantity demanded. Also explain what happens to the equilibrium quantity and the market clearing price. a. There is an increase in the price in carrying cases for wireless earbuds. b. There is a decrease in the price of devices used to charge wireless earbuds. c. There is an increase in the number of consumers of wireless earbuds. d. A booming economy increases the income of the typical buyer of wireless earbuds. e. Consumers of wireless earbuds anticipate that the price of this good will decline in the future. a. Carrying cases are complements in the consumption of wireless earbuds, so increases in their prices cause the demand for wireless earbuds to decline. The market clearing price and equilibrium quantity of wireless earbuds both decline. b. Devices used to charge wireless earbuds are a complement in the consumption of wireless earbuds, so a fall in the price of this item generates an increase in the demand for wireless earbuds. The market clearing price and equilibrium quantity of wireless earbuds both increase. c. An increase in the number of consumers of wireless earbuds generates an increase in the demand for this item, which causes both the market clearing price and equilibrium quantity of wireless earbuds to increase. d. As long as wireless earbuds are a normal good, the rise in consumers’ incomes causes the demand for wireless earbuds to increase. This causes both the market clearing price and equilibrium quantity of wireless earbuds to increase. e. Because consumers expect a lower price of wireless earbuds in the future, their current demand for wireless earbuds decreases. The result is a decrease in both the market clearing price and equilibrium quantity of wireless earbuds in the present.

3-5. Give an example of a complement and a substitute in consumption for each of the following items: a. Bacon b. Tennis racquets c. Coffee d. Automobiles a. Complement: eggs; Substitute: sausage b. Complement: tennis balls; Substitute: racquetball racquets c. Complement: cream; Substitute: tea d. Complement: gasoline; Substitute: city bus

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 3-6. Listed below are some changes in (shifts in) demand for various items. In each case, the change in demand has been caused by a change in the price of a substitute or of a complement. Explain whether the price of the substitute or complement must have increased or decreased. a. A rise in the demand for a dashboard global-positioning-system device follows a change in the price of automobiles, which are complements. b. A fall in the demand for e-book readers follows a change in the price of e-books, which are complements. c. A rise in the demand for tablet devices follows a change in the price of ultrathin laptop computers, which are substitutes. d. A fall in the demand for physical books follows a change in the price of e-books, which are substitutes. a. Decrease in price of automobiles b. Increase in price of e-books c. Increase in price of ultrathin laptop computers d. Decrease in the price of e-books 3-7. Identify which of the following would generate an increase in the market demand for tablet devices, which are a normal good. a. A decrease in the incomes of consumers of tablet devices b. An increase in the price of ultrathin computers, which are substitutes c. An increase in the price of online apps, which are complements d. An increase in the number of consumers in the market for tablet devices b and d 3-8. Identify which of the following would generate a decrease in the market demand for e-book readers, which are a normal good. a. An increase in the price of downloadable apps utilized to enhance the e-book reading experience, which are complements b. An increase in the number of consumers in the market for e-book readers c. A decrease in the price of tablet devices, which are substitutes d. A reduction in the incomes of consumers of e-book readers a, c, and d 3-9. Consider the following diagram of a market for one-bedroom rental apartments in a college community.

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Chapter 3 Demand and Supply

a. At a rental rate of $1,000 per month, is there an excess quantity supplied, or is there an excess quantity demanded? What is the amount of the excess quantity supplied or demanded? b. If the present rental rate of one-bedroom apartments is $1,000 per month, through what mechanism will the rental rate adjust to the equilibrium rental rate of $800? c. At a rental rate of $600 per month, is there an excess quantity supplied, or is there an excess quantity demanded? What is the amount of the excess quantity supplied or demanded? d. If the present rental rate of one-bedroom apartments is $600 per month, through what mechanism will the rental rate adjust to the equilibrium rental rate of $800? a. At the $1,000 rental rate, the quantity of one-bedroom apartments supplied is 3,500 per month, but the quantity demanded is only 2,000 per month. Thus, there is an excess quantity of one-bedroom apartments supplied equal to 1,500 apartments per month. b. To induce consumers to lease unrented one-bedroom apartments, some landlords will reduce their rental rates. As they do so, the quantity demanded will increase. In addition, some landlords will choose not to offer apartments for rent at lower rates, and the quantity supplied will decrease. At the equilibrium rental rate of $800 per month, there will be no excess quantity supplied. c. At the $600 rental rate, the quantity of one-bedroom apartments demanded is 3,000 per month, but the quantity supplied is only 1,500 per month. Thus, there is an excess quantity of one-bedroom apartments demanded equal to 1,500 apartments per month. d. To induce landlords to make more one-bedroom apartments available for rent, some consumers will offer to pay higher rental rates. As they do so, the quantity supplied will increase. In addition, some consumers will choose not to try to rent apartments at higher rates, and the quantity demanded will decrease. At the equilibrium rental rate of $800 per month, there will be no excess quantity demanded.

3-10. Consider the market for economics textbooks. Explain whether the following events would cause an increase or a decrease in supply or an increase or a decrease in the quantity supplied.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition a. b. c. d.

The market price of editorial services increases.

The market price of economics textbooks increases.

The number of publishers of economics textbooks increases.

Publishers expect that the market price of economics textbooks will increase next month.

a. The rise in the price of editorial services, a key input in textbook production, causes a decrease in the supply of textbooks. b. An increase in the market price of economics textbooks causes an increase in the quantity of textbooks supplied. c. A rise in the number of textbook publishers increases the supply of textbooks. d. If publishers expect the market price of textbooks will rise next month, the current supply of textbooks will decline.

3-11. Consider the market for smartphones. Explain whether the following events would cause an increase or a decrease in supply or an increase or a decrease in the quantity supplied.

Illustrate each, and show what would happen to the equilibrium quantity and the market clearing price. a. The price of touchscreens used in smartphones declines. b. The price of machinery used to produce smartphones increases. c. The number of manufacturers of smartphones increases. d. There is a decrease in the market demand for smartphones. a. Because touchscreens are an input in the production of smartphones, a decrease in the price of touchscreens causes an increase in the supply of smartphones. The market supply curve shifts to the right, which causes the market price of smartphones to fall and the equilibrium quantity of smartphones to increase. b. Machinery used to produce smartphones is an input in the production of these devices, so an increase in the price of machinery generates a decrease in the supply of smartphones. The market supply curve shifts to the left, which causes the market price of smartphones to rise and the equilibrium quantity of smartphones to decrease. c. An increase in the number of manufacturers of smartphones causes an increase in the supply of smartphones. The market supply curve shifts rightward. The market price of smartphones declines, and the equilibrium quantity of smartphones increases. d. The demand curve for smartphones shifts to the left along the supply curve, so there is a decrease in the quantity supplied. The market price falls, and the equilibrium quantity declines.

3-12. If the price of flash memory chips used in manufacturing smartphones decreases, what will happen in the market for smartphones? How will the equilibrium price and equilibrium quantity of smartphones change?

Because flash memory chips are an input in the production of smartphones, a decrease in the price of flash memory chips generates an increase in the supply of smartphones. The market price of smartphones will decrease, and the equilibrium quantity will increase.

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Chapter 3 Demand and Supply 3-13. Assume that the cost of aluminum used by soft drink companies increases. Which of the following correctly describes the resulting effects in the market for soft drinks distributed in aluminum cans? (More than one statement may be correct.) a. The demand for soft drinks decreases. b. The quantity of soft drinks demanded decreases. c. The supply of soft drinks decreases. d. The quantity of soft drinks supplied decreases.

Aluminum is an input in the production of canned soft drinks, so an increase in the price of aluminum reduces the supply of canned soft drinks (option c). The resulting rise in the market price of canned soft drinks brings about a decrease in the quantity of canned soft drinks demanded (option b). In equilibrium, the quantity of soft drinks supplied decreases (option d) to an amount equal to the quantity demanded. The demand curve does not shift, however, so option b does not apply.

3-14. In Figure 3-2, what are the effects of a price decrease from $4 per wireless earbud to $2 per wireless earbud on the quantities of wireless earbuds demanded by buyer 1 and by buyer 2 individually and combined?

For buyer 1, the price decrease from $4 per wireless earbud to $2 per wireless earbud causes a 20-unit increase in the quantity of wireless earbuds demanded, from 20 to 40. For buyer 2, the price decrease generates a 30-unit increase in the quantity of wireless earbuds demanded, from 20 to 50. Thus, for the two buyers combined, there is a 50-unit increase in the total quantity demanded, from 40 units to 90 units.

3-15. In Figure 3-2, what are the effects of a price increase from $1 per wireless earbud to $3 per wireless earbud on the quantities demanded by buyer 1 and by buyer 2 individually and combined?

For buyer 1, the price increase from $1 per wireless earbud to $3 per wireless earbud causes a 20-unit decrease in the quantity of wireless earbuds demanded, from 50 to 30. For buyer 2, the price increase generates a 20-unit decrease in the quantity of wireless earbuds demanded, from 60 to 40. Thus, for the two buyers combined, there is a 40-unit decrease in the total quantity demanded, from 110 units to 70 units.

3-16. In Figure 3-4, the current position of the demand curve is D1, and the price of a wireless earbud is $3. If there is an increase in the price of tablet devices that are complements to wireless earbuds, will the demand curve shift to D2 or to D3? What is the change in the amount of wireless earbuds demanded?

The increase in the price of tablet devices that are complements to wireless earbuds causes a leftward shift in the demand for wireless earbuds, from D1 to D3. At the price of $3 per wireless earbud, the amount of wireless earbuds demanded decreases by 2 million units, from 6 million units to 4 million units.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 3-17. In Figure 3-4, the current position of the demand curve is D1, and the price of a wireless earbud, which is a normal good, is $3. If there is an increase in consumer incomes, will the demand curve shift to D2 or to D3? What is the change in the amount of portable power banks demanded?

The increase in consumer incomes generates a rightward shift in the demand curve, from D1 to D2. At the price of $3 per wireless earbud, the amount of wireless earbuds demanded increases by 4 million units, from 6 million units to 10 million units.

3-18. In Figure 3-7, what are the effects of a price decrease from $5 per wireless earbud to $3 per wireless earbud on the quantities supplied by supplier 1 and by supplier 2 individually and combined?

For supplier 1, the price decrease from $5 per wireless earbud to $3 per wireless earbud causes a 20-unit decrease in the quantity of wireless earbuds supplied, from 55 to 35. For supplier 2, the price decrease generates a 15-unit decrease in the quantity of wireless earbuds supplied, from 35 to 20. Thus, for the two suppliers combined, there is a 35-unit decrease in the total quantity supplied, from 90 to 55.

3-19. In Figure 3-7, what are the effects of a price increase from $2 per wireless earbud to $4 per wireless earbud on the quantities supplied by supplier 1 and by supplier 2 individually and combined?

For supplier 1, the price increase from $2 per wireless earbud to $4 per wireless earbud causes a 15-unit increase in the quantity of wireless earbuds supplied, from 25 to 40. For supplier 2, the price increase generates a 15-unit increase in the quantity of wireless earbuds supplied, from 15 to 30. Thus, for the two suppliers combined, there is a 30-unit decrease in the total quantity supplied, from 40 to 70.

3-20. In Figure 3-9, the current position of the supply curve is S1, and the price of a wireless earbud is $3. If suppliers anticipate a higher price of wireless earbuds in the future, will the supply curve shift to S2 or to S3? What is the change in the amount of wireless earbuds supplied?

The increase in the anticipated future price of wireless earbuds induces suppliers to withhold from the market part of their current supply, which causes a leftward shift in the supply curve for wireless earbuds, from S1 to S3. At the price of $3 per wireless earbud, the amount of wireless earbuds supplied decreases by about 3 million units, from 6 million units to about 3 million units.

3-21. In Figure 3-9, the current position of the supply curve is S1, and the price of a wireless earbud is $3. If the cost of inputs that suppliers use to produce wireless earbuds decreases, will the supply curve shift to S2 or to S3? What is the change in the amount of wireless earbuds supplied?

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Chapter 3 Demand and Supply The decrease in the cost of inputs used to produce wireless earbuds causes a rightward shift in the supply curve for wireless earbuds, from S1 to S2. At the price of $3 per wireless earbud, the amount of wireless earbuds supplied increases by about 3 million units, from 6 million units to about 9 million units.

Appendix B B-1 Suppose that in a recent market period, the following relationship existed between the price of tablet devices and the quantity supplied and quantity demanded. Using the table data below, answer the following questions:

a.

Price

Quantity Demanded

Quantity Supplied

$330

100 million

40 million

$340

90 million

60 million

$350

80 million

80 million

$360

70 million

100 million

$370

60 million

120 million

Calculate the linear demand equation for a tablet device.

Using points (330,100) and (340,90), calculate the slope: (90 − 100) / (340 − 330) = −1, so QD = b − 1P. Calculate the intercept term by using (330,100): 100 = b − 330, so b = 430.

The linear demand equation for a tablet device is QD = 430 − 1P.

b.

Calculate the linear supply for a tablet device.

Using points (330,40) and (340,60), calculate the slope: (60 − 40) / (340 − 330) = 2, so QS = b + 2P. Calculate the intercept term by using (330,40): 40 = b + 2(330), so b = −620.

The linear supply equation for a tablet device is QS = −620 + 2P.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition c.

Solve for the equilibrium quantity of tablet devices.

Set QD = QS and solve for Pe 430 − 1Pe = −620 + 2Pe −3Pe = −1050 Pe = 350

d.

Solve for the equilibrium price of a tablet device.

QS = −620 + 2(350) Qe = −620 + 700 Qe = 80

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Chapter 4

Extensions of Demand and Supply Analysis 

Answers to Questions for Critical Analysis

AI: TRANSACTION COSTS AND “PRICE STICKINESS” Why can we anticipate that retailers’ use of more machine learning to monitor consumers’ visits to their websites and competitors’ price adjustments could make prices less “sticky” in the future?

Using more machine learning to monitor consumers’ visits and competitors’ price adjustments will lower transaction costs, which will speed up price adjustments (make prices less “sticky”) in the future.

THE EFFECTS OF A SIMULTANEOUS DECREASE IN THE SUPPLY OF AND AN INCREASE IN THE DEMAND FOR VINYL RECORDS If some firms were to exit the market for vinyl records, what would happen to the market clearing price and equilibrium quantity? Explain briefly.

Firms existing the market for vinyl records would create a decrease in supply (a shift to the left).

This will raise the price of vinyl records even higher. The effect on equilibrium quantity can only be determined if we know how much supply decreases relative to the increase in demand (due to changes in tastes and preferences).

CUSTOMERS OF EWATER PREFER PRICE RATIONING OVER FIRST COME, FIRST SERVED AT A ZERO PRICE Why do you think that a number of people in Gambia and Tanzania are willing to pay to use eWater’s dispensers instead of public pumps available at no charge?

The total cost of using public pumps (zero price plus the opportunity cost of the time spent waiting in line) is greater than the total cost of using eWater’s dispensers. This suggests that the opportunity cost of the time spent waiting in line is more than the cost of using eWater’s dispensers.

“99-SEAT THEATERS” IN LOS ANGELES ADAPT TO A MINIMUM WAGE REQUIREMENT A certain percentage of those studying this textbook will attempt to become actors. You know that you need experience to become successful. How could you react to Los Angeles’ higher minimum wage?

Firstly, you could decide not to become a member of Actor’s Equity Association or if you are already a member, you could relinquish your membership. Secondly, you could seek out acting possibilities in cities that are not covered by the $15 minimum wage. Thirdly, you could let it be known at various theaters that you are willing to work as an unpaid volunteer. Consequently, you would have to earn a living at the same time by becoming a waiter or waitress or a salesperson in a retail outlet.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition EXPERIMENTAL EVIDENCE VERIFIES PREDICTIONS ABOUT THE EFFECTS OF IMPOSING A PRICE FLOOR IN A LABOUR MARKET Why do you suppose economists have found that firms sometimes respond to minimum wage requirements to pay higher explicit dollar wages by reducing fringe benefits such as premiums for health insurance coverage?

Minimum wage requirements will cause firms to face higher costs of employment. To recover these costs, they can reduce other costs they incur, like fringe benefits.

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Economics in Your Life

A MAYOR FAVORS THE MINIMUM WAGE UNTIL CONFRONTING ITS CONSEQUENCES For Critical Thinking Who unambiguously would have been harmed if the city council’s plan had gone into effect?

Any workers at the current minimum wage who would have lost their jobs due to the reduction in existing workforces and workers whose work locations would have relocated due to the increase in minimum wage would have harmed.

Real Application Assume that you are the owner of a fast-food restaurant in a city that is going to increase its minimum wage to, say, $20 per hour. What would be some of the ways you could legally react to such a higher minimum wage?

You could eliminate all or most of the benefits you are now providing to your employees.

These might include subsidized health insurance, paid vacation time, fully paid “personal” days, free-meals while working, etc. You might also explore greater use of tablet devices and mobile apps for ordering without human assistance. And, in the kitchen, you might explore the use of robots.

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Issues & Applications

WHY SHORTAGES OF SOME PHARMACEUTICALS GENERATE HIGHER PRICES FOR OTHER DRUGS For Critical Thinking If the demand for Medication B in panel (b) of Figure 4-8 were to rise significantly to push the market clearing price above a government price ceiling, what events would occur in the market for Medication B? Explain briefly.

Manufacturers would respond by cutting back or even halting production of Medication B until a new period begins with a higher government threshold price set at or above the market clearing price. Quantity supplied at the price ceiling drops below the quantity demanded, causing a shortage.

Real Application At some point in our lives, virtually all of us will become consumers of health care services, including the use of prescribed pharmaceuticals. Faced with a shortage of a prescribed drug, what are some of the ways you could react?

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Chapter 4 Extensions of Demand and Supply Analysis If your medical condition is not serious, you could “wait and see.” That is to say, you could wait to see when the prescribed pharmaceutical would become available. If your medical condition was more critical, you would obviously press your physician into prescribing a replacement drug or a combination of drugs that might result in a similar positive outcome for you. Lastly, you could engage in online research into alternative sources of the prescribed drug in other countries.

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Answers to End-of-Chapter Questions

4-1. In recent years, technological improvements have greatly reduced the costs of producing smartphones, and a number of new firms have entered the smartphone industry. At the same time, prices of substitutes for smartphones, such as various tablet devices, have declined considerably. Construct a supply and demand diagram of the market for smartphones. Illustrate the impacts of these developments, and evaluate the effects on the market price and equilibrium quantity.

The ability to produce smartphones at lower cost and the entry of additional producers shift the supply curve rightward, from S1 to S2. At the same time, reduced prices of substitute devices result in a leftward shift in the demand for smartphones, from D1 to D2. Consequently, the equilibrium price of basic smartphones declines, from P1 to P2. The equilibrium quantity may rise, fall, or, as shown in the diagram, remain unchanged.

Quantity of Smartphones

4-2. Advances in research and development in the pharmaceutical industry have enabled manufacturers to identify potential cures more quickly and therefore at lower cost. At the same time, the aging of our society has increased the demand for new drugs. Construct a supply and demand diagram of the market for pharmaceutical drugs. Illustrate the impacts of these developments, and evaluate the effects on the market price and the equilibrium quantity.

The ability to produce drugs at lower cost leads to an increase in the market supply of drugs, so the supply curve shifts rightward (from S1 to S2). At the same time, the increased demand for drugs by an aging population shifts the market demand curve rightward (from D1 to D2). Thus, ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition the equilibrium quantity of drugs increases (from Q1 to Q2), but the market clearing price may rise, fall, or remain unchanged (as shown).

4-3. There are simultaneous changes in the demand for and supply of global-positioning-system (GPS) devices, with the consequences being an unambiguous increase in the market clearing price of these devices but no change in the equilibrium quantity. What changes in the demand for and supply of GPS devices could have generated these outcomes? Explain.

An increase in demand for GPS devices and an accompanying reduction in supply of GPS devices could result in an unambiguous increase in the market clearing price but no change in the equilibrium quantity.

4-4. There are simultaneous changes in the demand for and supply of tablet devices, with the consequences being an unambiguous decrease in the equilibrium quantity of these devices but no change in the market clearing price. What changes in the demand for and supply of tablet devices could have generated these outcomes? Explain.

A simultaneous decrease in the demand for tablet devices and accompanying reduction in the supply of tablet devices could result in an unambiguous decrease in the equilibrium quantity of these devices but no change in the market clearing price.

4-5. The following table depicts the quantity demanded and quantity supplied of studio apartments in a small college town.

Monthly Rent $600 $650 $700 $750 $800

Quantity Demanded 3,000 2,500 2,000 1,500 1,000

Quantity Supplied 1,600 1,800 2,000 2,200 2,400

What are the market price and equilibrium quantity of apartments in this town? If this town imposes a rent control of $650 per month, how many studio apartments will be rented?

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Chapter 4 Extensions of Demand and Supply Analysis

The market rental rate is $700 per apartment, and the equilibrium quantity of apartments rented to tenants is 2,000. At a ceiling price of $650 per month, the number of apartments students desire to rent increases to 2,500 apartments. At the ceiling price, the number of apartments that owners are willing to supply decreases to 1,800 apartments. Thus, there is a shortage of 700 apartments at the ceiling price, and only 1,800 are rented at the ceiling price.

4-6. Suppose that the government places a ceiling on the price of a medical drug below the equilibrium price. a. Show why there is a shortage of the medical drug at the new ceiling price. b. Suppose that a black market for the medical drug arises, with pharmaceutical firms secretly selling the drug at higher prices. Illustrate the black market for this medical drug, including the implicit supply schedule, the ceiling price, the black market supply and demand, and the highest feasible black market price. a. At the ceiling price of the medical drug, P1, the quantity of the drug demanded exceeds the quantity of the drug legally supplied by pharmaceuticals firms, so there is a shortage of the drug. b. If a black market develops, then the implicit supply curve is S1, and the black market price will end up between P1 and P2. The highest feasible black market price is P2.

4.7. The table below illustrates the demand and supply schedules for seats on air flights between two cities: Quantity Quantity Price Demanded Supplied $200 2,000 1,200 $300 1,800 1,400 $400 1,600 1,600 $500 1,400 1,800 $600 1,200 2,000 What are the market price and equilibrium quantity in this market? Now suppose that federal authorities limit the number of flights between the two cities to ensure that no more

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition than 1,200 passengers can be flown. Evaluate the effects of this quota if price adjusts.

(Hint: What price per flight are the 1,200 passengers willing to pay?)

The market price is $400, and the equilibrium quantity of seats is 1,600. If airlines cannot sell tickets to more than 1,200 passengers, then passengers are willing to pay $600 per seat.

Normally airlines would be willing to sell each ticket for $200, but they will be able to charge a price as high as $600 for each of the 1,200 tickets they sell. Hence, the quantity of tickets sold declines from 1,600, and the price of a ticket rises from $400 to as high as $600.

4-8. The consequences of decriminalizing illegal drugs have long been debated. Some claim that legalization will lower the price of these drugs and reduce related crime and that more people will use these drugs. Suppose some of these drugs are legalized so that anyone may sell them and use them. Now consider the two claims—that price will fall and quantity demanded will increase. Based on positive economic analysis, are these claims sound?

The fact that drug sellers incur legal penalties if caught means that there is an extra cost of selling drugs over and above those associated with production and distribution of these substances. Legalization would eliminate these costs and cause the market supply curve to shift rightward. This would indeed reduce the market price and increase the equilibrium quantity. To the extent that drug users commit crimes to fund currently high-market prices, drug legalization could indeed reduce the incentive for such criminal activities. At the same time, to the extent that drug use causes a national health problem, increased use of legalized drugs could expand the scope of that problem. Thus, both sides have potentially legitimate points.

4-9. In recent years, the government of Pakistan has established a support price for wheat of about $0.20 per kilogram of wheat. At this price, consumers are willing to purchase 10 billion kilograms of wheat per year, while Pakistani farmers are willing to grow and harvest 18 billion kilograms of wheat per year. The government purchases and stores all surplus wheat. a. What are annual consumer expenditures on the Pakistani wheat crop? b. What are annual government expenditures on the Pakistani wheat crop? c. How much, in total, do Pakistani wheat farmers receive for the wheat they produce? a. Consumers buy 10 billion kilograms at the support price of $0.20 per kilogram and hence spend $2 billion on wheat. b. The amount of surplus wheat at the support price is 8 billion kilograms, so at the $0.20 per kilogram support price, the government must spend $1.6 billion to purchase this surplus wheat. c. Pakistani wheat farmers receive a total of $3.6 billion—the sum of the $2 billion in consumers’ purchases and the $1.6 billion of the government’s purchases—for the wheat they produce at the support price.

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Chapter 4 Extensions of Demand and Supply Analysis 4-10. Consider the information in Problem 4-9 and your answers to that problem. Suppose that the market clearing price of Pakistani wheat in the absence of price supports is equal to $0.10 per kilogram. At this price, the quantity of wheat demanded is 12 billion kilograms.

Under the government wheat price-support program, how much more is spent each year on wheat harvested in Pakistan than otherwise would have been spent in an unregulated market for Pakistani wheat?

In the absence of price supports, consumers would have bought 12 billion kilograms of wheat at the market price of $0.10 per kilogram, thereby spending $1.2 billion. Hence, under the government’s price support program, wheat farmers in Pakistan are receiving $2.4 billion more for wheat than they would have in the absence of the price support.

4-11. Consider the diagram below, which depicts the labour market in a city that has adopted a “living wage law” requiring employers to pay a minimum wage rate of $11 per hour.

Answer the questions that follow.

a. What condition exists in this city’s labour market at the present minimum wage of $11 per hour? How many people are unemployed at this wage? b. A city councilwoman has proposed amending the living wage law. She suggests reducing the minimum wage to $9 per hour. Assuming that the labour demand and supply curves were to remain in their present positions, how many people would be unemployed at a new $9 minimum wage? c. A councilman has offered a counterproposal. In his view, the current minimum wage is too low and should be increased to $12 per hour. Assuming that the labour demand and supply curves remain in their present positions, how many people would be unemployed at a new $12 minimum wage? a. At the present minimum wage of $11 per hour, the quantity of labour supplied is 102,000 workers, and the quantity of labour demanded by firms is 98,000. There is an excess quantity supplied of 4,000 workers, which is the number of people who are unemployed.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition b. At a minimum wage of $9 per hour, there would be nothing to prevent market forces from pushing the wage rate to the market clearing level of $10 per hour. This $10-perhour wage rate would exceed the legal minimum and hence would prevail. There would be no unemployed workers. c. At a $12-per-hour minimum wage, the quantity of labour supplied would increase to 104,000 workers, and the quantity of labour demanded would decline to 96,000. There would be an excess quantity of labour supplied equal to 8,000 workers, which would then be the number of people unemployed.

4-12. A city has decided to impose rent controls, and it has established a rent ceiling below the previous equilibrium rental rate for offices throughout the city. How will the quantity of offices leased by building owners change?

The reduction in the allowable rental rate, or price of rental offices, reduces the quantity of offices that owners are willing to supply. Hence, the quantity of offices leased to tenants declines.

4-13. In 2019, the government of a nation established a price support for wheat. The government’s support price has been above the equilibrium price each year since, and the government has purchased all wheat over and above the amounts that consumers have bought at the support price. Every year since 2019, there has been an increase in the number of wheat producers in the market. No other factors affecting the market for wheat have changed. Predict what has happened every year since 2019, to each of the following: a. Amount of wheat supplied by wheat producers b. Amount of wheat demanded by all wheat consumers c. Amount of wheat purchased by the government a. The rise in the number of wheat producers causes the market supply curve to shift rightward, so more wheat is supplied at the support price. b. The quantity of wheat demanded at the same support price is unchanged. c. Because quantity demanded is unchanged while quantity supplied has increased, the amount of surplus wheat that the government must purchase has risen.

4-14. The province of Ontario decided to boost its own minimum wage by an additional $1.60 per hour. This pushed the wage rate earned by Ontario teenagers above the equilibrium wage rate in the teen labour market. What is the predicted effect of this action by Ontario’s government on each of the following? a. The quantity of labour supplied by Ontario teenagers b. The quantity of labour demanded by employers of Ontario teenagers c. The number of unemployed Ontario teenagers a. The quantity of labour supplied by Ontario teenagers increases. b. The quantity of labour demanded by employers of Ontario teenagers decreases. c. There is an increase in the excess quantity supplied in the Ontario market for teen labour, so the number of unemployed Ontario teenagers increases.

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Chapter 4 Extensions of Demand and Supply Analysis 4-15. Consider Figure 4-1. The current demand and supply curves are D1 and S1, at which the equilibrium price and quantity are P1 and Q1. If there is a decrease in the price of an item that consumers regard as a substitute for this good, which curve shifts, and in which direction does it shift? What happens to the market clearing price and to the equilibrium quantity?

A decrease in the price of an item that consumers regard as a substitute for this good causes the demand curve for this good to shift leftward, as shown in panel (b) by the leftward shift from D1 to D3.

Consequently, there is a movement from equilibrium point E1 to equilibrium point E3 in panel (b). The market clearing price decreases, from P1 to P3, and the equilibrium quantity decreases, from Q1 to Q3.

4-16. Consider Figure 4-1. The current demand and supply curves are D1 and S1, at which the equilibrium price and quantity are P1 and Q1. If firms adopt a cost-reducing technique for producing this good, which curve shifts, and in which direction does it shift? What happens to the market clearing price and to the equilibrium quantity?

A technological improvement causes the supply curve for this good to shift rightward, as shown in panel (c) by the rightward shift from S1 to S2. Consequently, there is a movement from equilibrium point E1 to equilibrium point E2 in panel (c). The market clearing price decreases, from P1 to P2, and the equilibrium quantity increases, from Q1 to Q2.

4-17. Consider Figure 4-3. Suppose that the government reduces the ceiling price to $500 per unit. Would the shortage at the $500-per-unit ceiling price be greater than at the $600-perunit price ceiling?

The reduction in the ceiling price from $600 per unit to $500 per unit would generate a decrease in the quantity supplied and an increase in the quantity demanded. Consequently, the amount of the excess quantity demanded, or shortage, would increase to an amount exceeding 10,000 units.

4-18. Suppose that in Figure 4-4, the government raises the floor price of milk above the displayed $1.50 per litre floor price, to $1.75 per litre. Will the excess quantity of milk supplied increase or decrease as a consequence?

An increase in the floor price from $1.50 per litre to $1.75 per litre will cause the quantity of milk demanded to fall and the quantity of milk supplied to rise. Hence, the excess quantity of milk supplied will increase.

4-19. Suppose that in Figure 4-4, the government reduces the floor price of milk below the displayed $1.50 per litre floor price, to $1.00 per litre. Will the excess quantity of milk supplied increase or decrease as a consequence?

A decrease in the floor price from $1.50 per to $1.00 per litre will result in in an increase in the quantity of milk demanded, from 27.3 million hectolitres to 31.5 million hectolitres, and a decrease in the quantity of milk supplied, from 49.8 million hectolitres to 31.5 million hectolitres.

Thus, the excess quantity supplied decreases to zero. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 4-20. Suppose that Figure 4-7 applies to the labour market in British Columbia, in which Wm is the minimum wage established by the provincial government, and Qs – Qd therefore is British Columbia’s excess quantity of labour supplied as a result of the wage minimum.

What would happen to British Columbia’s excess quantity of labour supplied if the province were to decide to increase the minimum wagefurther?

If British Columbia were to further increase the minimum wagethan Wm, the quantity of labour demanded would decrease, and the quantity of labour supplied would increase. Thus, the amount of the excess quantity of labour supplied in British Columbia would increase.

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Chapter 5

Market Failures and the Public Sector 

Answers to Questions for Critical Analysis

BAD SMELLS HAVE NEIGHBOURS CRYING FOUL ABOUT AN ALBERTA COMPOST FACILITY Could negative externalities be addressed if compose facilities negotiated payments for the right to pollute air shared with properties owned by residential neighbours? Explain your reasoning.

If people could negotiate prices at which compost facilities would pay explicit fees for the right to pollute air shared with properties owned by residential neighbours, then the negative externalities for the property owners would have been internalized through the fees paid to the property owners.

AI: CONTEMPLATING BIG DATA AS A PUBLIC GOOD Over 2 billion people use Facebook. Consequently, Facebook has access to enormous amounts of Internet usage data. Facebook allowed access to such data as Microsoft, Spotify, and Netflix.

If you are a Facebook user, should you be worried?

Let’s face it: Social media have become ubiquitous. Typically, you pay nothing for access to and use of social media. Those companies that provide social media platforms, however, have to make a profit to survive. Social media platforms earn most of their revenue from selling advertising and their subscribers’ data. Facebook did not provide access to its customers’ Internet use data free of charge to Microsoft, Spotify, and Netflix. Rather, it charged for such access.

Should you be worried? Probably not, unless Facebook starts providing such data to the government, as is done in China today. That is to say, Internet usage data in China is used by government agencies to monitor your “social awareness.” If a citizen of that country does not appear to be “socially correct,” that person might not be able to reserve an airline ticket, as just one example. Remember, you always have the solution of cancelling your social media account.

GOVERNMENT SPONSORSHIP KEEPS LIGHT RAIL SYSTEMS IN OPERATION Why do you suppose that light rail service cutbacks take place when governments reduce their sponsorship funding even if an affected operating authority responds by charging riders slightly higher fares?

The government sponsorship (subsidy) results in higher quantity being produced than would be in a free market. Reducing the subsidy would decrease the amount of services supplied and increasing fares would decrease the amount of services demanded, resulting in rail service cutbacks (both on the supply side and demand side).

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition TO INHIBIT NICOTINE CONSUMPTION, SHOULD GOVERNMENT ASSUME THAT ALL CONSUMERS BEHAVE THE SAME? Why might imposing the same taxes on traditional cigarettes and e-cigarettes fail to generate the same changes in quantity demanded? (Hint: Is someone who is limiting nicotine consumption by exclusively “vaping” likely to cut back as much in response to a tax-induced price increase than someone who regularly smokes traditional cigarettes?)

Motives for using e-cigarettes differ from those affecting consumption of nicotine via traditional cigarettes. Because the motives are different, the taxes may not generate a cut back as much as expected.

GOVERNMENTS CONFRONT HIGHER DEBT REPAYMENT EXPENSES Who ultimately pays the debt repayment expenses owed by the federal government?

Taxpayers ultimately pay the debt repayment expenses in the form of taxes and user charges.

AVERAGE TAX RATES AND CANADIAN INCOME TAX PROGRESSIVITY If you have a chance in the future to invest in a risky, but potentially profitable venture, what is most important to you – your average tax rate or your marginal tax rate? Why? If you are trying to determine your overall after-tax income, your average tax rate allows you to do so easily. If you make $100,000 in a year and your average tax rate is 20 percent, you will be left with $80,000 in after-tax income. In contrast, if you have been offered the chance to place funds in a somewhat risky, but potentially highly profitable venture, then you must examine your marginal tax rate. Suppose you might make an extra $20,000 per year because of your involvement, and you want to know how much of that additional income will go into your pocket. Only by knowing your marginal income tax rate can you make this calculation. You might react differently to this risky, but potentially profitable opportunity if your marginal tax rate is 90 percent rather than 35 percent.

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Economics in Your Life

FAKE “SERVICE PETS” CREATE EXTERNAL COSTS ON AIRLINE FLIGHTS For Critical Thinking Why do you suppose that proposals have surfaced for the U.S. Transportation Department to allow airlines to charge special fees to passengers who wish to board planes accompanied by service pets?

The fees are an attempt to transfer the negative effects (externality) the pets have on other passengers to the owners of the service pets. The resulting increase in price to the passengers with service pets would reduce the quantity of service pets on board.

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Chapter 5 Market Failures and the Public Sector Real Application Airline companies are increasingly changing their rules about which animals they will accept as “service animals.” If by chance you require a service animal to enjoy less stressful airline flights, then the change in rules may affect you. What might be your options if your particular service animal is no longer accepted?

One option is for you to purchase another animal for emotional comfort that remains on the airlines’ accepted list. Another possibility is for you to consider driving or taking a train instead of taking a plane. Yet another action to consider is to reduce the overall amount of travel that you undertake each year.

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Issues & Applications

CANADIANS GET A LESSON IN EXTERNALITIES: LIBERALS PROPOSE A FIVE-FOLD INCREASE IN THE CARBON TAX TO MEET CLIMATE GOALS For Critical Thinking Using a supply and demand graph, show the impact a border adjustment tax would have on the equilibrium price and quantity for a Canadian good. (Hint: treat the foreign produced good as a substitute for the Canadian good).

The border adjustment tax, represents an increase in the price of a substitute good (i.e. the foreign product) for the Canadian good. This will cause the demand for the Canadian good to shift outward. Demand for the Canadian good will increase now that it is priced more attractively relative to the foreign good subject to the border adjustment tax. The shift out of the demand curve will result in a higher equilibrium price and quantity for the Canadian good than before the border adjustment tax was applied.

Real Application It is estimated that the new climate plan will increase the price of gasoline 37.57 cents a litre by 2030. What are the ways this price increase will directly and indirectly impact you? What tradeoffs will you have to make to accommodate this price increase?

The gasoline price increase will directly impact the costs associated with driving your vehicle to school or work, operating recreational vehicles, and operating any other gasoline powered device (e.g. lawnmower, snow blower, etc.). The higher cost of gasoline will also impact the price of any of the good/service that requires gasoline to make or transport them. So you may also be indirectly impacted by having to pay higher shipping costs on goods purchased online, food deliveries, public transportation fees, etc.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition There are many things you could do to mitigate the higher price of gasoline. For example, you could walk or bike to work instead of drive. You could trade-in your existing vehicle for a more fuel efficient one. You could move closer to your work or school to minimize the travel distance. Note how some of these changes are easier and less expensive than others.

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Answers to End-of-Chapter Questions

5-1. Many people who do not smoke cigars are bothered by the odor of cigar smoke. If private contracting is impossible, will too many or too few cigars be produced and consumed?

Taking all costs into account, is the market price of cigars too high or too low?

In the absence of laws forbidding cigar smoking in public places, people who are bothered by the odor of cigar smoke will experience costs not borne by cigar producers. Because the supply of cigars will not reflect these costs, from society’s perspective the market cigar supply curve will be in a position too far to the right. The market price of cigars will be too low, and too many cigars will be produced and consumed.

5-2. Suppose that repeated application of a pesticide used on orange trees causes harmful contamination of groundwater. The pesticide is applied annually in almost all of the orange groves throughout the world. Most orange growers regard the pesticide as a key input in their production of oranges. a. Use a diagram of the market for the pesticide to illustrate the implications of a failure of orange producers’ costs to reflect the social costs of groundwater contamination. b. Use your diagram from part (a) to explain a government policy that might be effective in achieving the amount of orange production that fully reflects all social costs. a. As shown in the figure, if the social costs associated with ground-water contamination were reflected in the costs incurred by orange producers, the supply schedule would be S2 instead of S1, and the market clearing price of oranges would be higher, at P2 instead of P1.

The equilibrium quantity of oranges produced would be lower, at Q2 instead of Q1.

b. The government could tax the production and sale of pesticide-treated oranges. If it is able set the tax at a level that reflects all social costs, the result is a shift of the supply 46

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Chapter 5 Market Failures and the Public Sector curve upward and to the left to a position, S2, that yields the socially optimal production of oranges using the pesticide.

5-3. Draw a diagram of the market for oranges. Explain how the government policy you discussed in part (b) of Problem 5-2 is likely to affect the market price and equilibrium quantity in the orange market. In what sense do consumers of oranges now “pay” for dealing with the spillover costs of pesticide production?

Imposing the tax on pesticides causes an increase in the price of pesticides, which are an input in the production of oranges. Hence, the supply curve in the orange market shifts leftward. The market price of oranges increases, and the equilibrium quantity of oranges declines. Hence, orange consumers indirectly help to pay for dealing with the spillover costs of pesticide production by paying more for oranges.

5-4. Suppose the Canadian government determines that cigarette smoking creates social costs not reflected in the current market price and equilibrium quantity of cigarettes. A study has recommended that the government can correct for the externality effect of cigarette consumption by paying farmers not to plant tobacco used to manufacture cigarettes. It also recommends raising the funds to make these payments by increasing taxes on cigarettes.

Assuming that the government is correct that cigarette smoking creates external costs, evaluate whether the study’s recommended policies might help correct this negative externality.

If the consumption of cigarettes creates social costs not reflected in the current market price and quantity, then from society’s point of view the supply curve is in a location below and to the right of the optimal position. Paying tobacco farmers not to plant tobacco would reduce the quantity supplied at each price of tobacco, which would shift the supply curve leftward and upward. So, would increasing taxes on cigarettes to raise the funds to pay the farmers. Both of these policy actions, therefore, would be consistent with helping to correct the negative externality.

5-5. A nation’s government has determined that mass transit, such as bus lines, helps alleviate traffic congestion, thereby benefiting both individual auto commuters and companies that desire to move products and factors of production speedily along streets and highways. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition Nevertheless, even though several private bus lines are in service, the country’s commuters are failing to take into account the positive externality associated with the use of mass transit. a. Discuss, in the context of demand-supply analysis, the essential implications of commuters’ failure to take into account the positive externality associated with bus ridership. b. Explain a government policy that might be effective in achieving the socially efficient use of bus services. a. As shown in the figure below, if the positive externality associated with bus ridership were considered, the demand schedule would be D' instead of D, and the market price would be higher. The equilibrium quantity of bus rides would be higher.

b. The government could pay commuters a subsidy to ride the bus, thereby shifting the demand curve outward and to the right. This would increase the market price and equilibrium number of bus rides.

5-6. Draw a diagram of this nation’s market for automobiles, which are a substitute for buses.

Explain how the government policy you discussed in part (b) of Problem 5-5 is likely to affect the market price and equilibrium quantity in the country’s auto market. How are auto consumers affected by this policy described in your answer to Problem 5-5?

Although the government subsidy for riding the bus raises the market price of bus rides, it reduces the effective price that consumers actually pay. Bus rides are a substitute for using an automobile for transit, so the demand for automobiles declines. Thus, in this case, automobile owners indirectly benefit, through lower prices, from the government subsidy that promotes bus ridership.

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Chapter 5 Market Failures and the Public Sector

5-7. Consider a nation with a government that does not provide people with property rights for a number of items and that fails to enforce the property rights it does assign for remaining items. Would externalities be more or less common in this nation than in a country such as the Canada? Explain.

If this nation’s government does not provide people with property rights for a number of items and fails to enforce the property rights that it does assign for remaining items, externalities would be more common than in a country such as the Canada. Any two parties to transactions in that nation would know that any third parties who might be subject to spillover effects from their production or consumption activities. Thus, any two parties undertaking such transactions would experience no incentives to reduce or eliminate the transactions’ spillover effects, resulting in widespread externalities.

5-8. Many economists suggest that our nation’s legal system is an example of a public good.

Does the legal system satisfy the key properties of a public good? Explain your reasoning.

Our nation’s legal system subjects every person to the same laws and to identical sets of penalties for violating these laws. Thus, the principle of rival consumption arguably does not apply. The experience of benefits provided by the legal system by one person does not necessarily reduce any other individual’s receipt of benefits. Furthermore, any person who has helped to pay for the legal system benefits from its existence only if the legal system applies to all others who might violate a law and infringe on that person’s property rights, whether or not those violators helped to pay for the legal system beforehand. Taken together, these arguments support the idea that the legal system is a public good.

5-9. Displayed in the diagram below are conditions in the market for residential Internet access in a Canadian province. The government of this province has determined that access to the Internet improves the learning skills of children, which it has concluded is an external benefit of Internet access. The government has also concluded that if these external benefits were to be taken into account, 3 million residences would have Internet access. Suppose that the provincial government’s judgments about the benefits of Internet access are correct and that it wishes to offer a per-unit subsidy just sufficient to increase total Internet access to 3 million residences. What per-unit subsidy should it offer? Use the diagram to explain

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition how providing this subsidy would affect conditions in the province’s market for residential Internet access.

At present, the equilibrium quantity of residences with Internet access is 2 million. To consider the external benefit of Internet access and boost the quantity of residences with access to 3 million, the demand curve would have to shift upward by $20 per month at any given quantity, to D2 from the current position D1. Thus, the government would have to offer a $20-per-month subsidy to raise the quantity of residences with Internet access to 3 million.

5-10. A few years ago, the French government allocated the equivalent of more than $120 million in public funds to Quaero (Latin for “I search”), an Internet search engine analogous to Google or Yahoo. Does an Internet search engine satisfy the key characteristics of a public good? Why or why not? Based on your answer, is a publicly funded Internet search engine a public good or a government-sponsored good?

A public good can be used by more and more people at no additional opportunity cost and without depriving others of any of the services of the good. In addition, it is difficult to design a ..

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Chapter 5 Market Failures and the Public Sector collection system for a public good on the basis of how much individuals use it. An Internet search engine satisfies neither property of a public good because access to a search engine can be restricted and the provider of an Internet search engine can require someone to pay to use the search engine. Thus, the French Internet search engine is a government-sponsored good, not a public good.

5-11. A government offers to let a number of students at public schools transfer to private schools under two conditions: It will transmit to private schools the same per-pupil subsidy it provides public schools, and the private schools will be required to admit the students at an out-of-pocket tuition rate below the market tuition rate. Will the economic outcome be the same as the one that would have arisen if the government instead simply provided students with grants to cover the current market tuition rate at the private school? (Hint: Does it matter if schools receive payments directly from the government or from consumers?)

No, the outcome will be different. If the government had simply provided grants to attend private schools at the current market tuition rate, parents and students receiving the grants would have paid a price equal to the market valuation of the last unit of educational services provided.

Granting a subsidy to private schools allows the private schools to charge parents and students a price less than the market price. Private schools thereby will receive a higher-than-market price for the last unit of educational services they provide. Consequently, they will provide a quantity of educational services in excess of the market equilibrium quantity. At this quantity, parents and students place a lower value on the services than the price received by the private schools.

5-12. After a government implements a voucher program, granting funds that families can spend at schools of their choice, numerous students in public schools switch to private schools.

The program’s per-unit subsidy is exactly equal to the external benefit from private educational services. Is anyone likely to lose out nonetheless? If so, who?

Public schools will lose students to private schools. The subsidized prices that public schools receive will also decline. Both of these changes will result in lower revenues for public schools.

5-13. Suppose that the current price of a tablet device is $300 and that people are buying 1 million devices per year. The government decides to begin subsidizing the purchase of new tablet devices. The government believes that the appropriate price is $260 per tablet, so the program offers to send people cash for the difference between $260 and whatever the people pay for each tablet they buy. a. If no consumers change their tablet-buying behaviour, how much will this program cost the taxpayers? b. Will the subsidy cause people to buy more, fewer, or the same number of tablets?

Explain. c. Suppose that people end up buying 1.5 million tablets once the program is in place. If the market price of tablets does not change, how much will this program cost the taxpayers?

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition d. Under the assumption that the program causes people to buy 1.5 million tablets and also causes the market price of tablets to rise to $320, how much will this program cost the taxpayers? a. $40 million b. The effective price of a tablet device to consumers will be lower after the government pays the subsidy, so people will purchase a larger quantity. c. $60 million d. $90 million 5-14. Scans of internal organs using magnetic resonance imaging (MRI) devices are often covered by Medicare. Consider the following table illustrating hypothetical quantities of individual MRI testing procedures demanded and supplied at various prices, and then answer the questions that follow.

Price

Quantity Demanded

Quantity Supplied

$100 $300 $500 $700 $900

100,000 90,000 80,000 70,000 60,000

40,000 60,000 80,000 100,000 120,000

a. In the absence of a government-subsidized coverage, what is the equilibrium price of MRI tests? What is the amount of society’s total spending on MRI tests? b. Suppose that the government establishes a health plan guaranteeing that all qualified participants can purchase MRI tests at an effective price (that is, out-of-pocket cost) to the individual of $100 per test. How many MRI tests will people desire to consume? c. What is the per-unit price that induces producers to provide the number of MRI tests demanded at the government-guaranteed price of $100? What is society’s total spending on MRI tests? d. Under the government’s coverage of MRI tests, what is the per-unit subsidy it provides? What is the total subsidy that the government pays to support MRI testing at its guaranteed price? a. b. c. d.

equilibrium price = $500; society’s total expense = $40 million 100,000 tests producers’ per-unit cost = $700; society’s total expense = $70 million government’s per-unit subsidy= $600; total subsidy = $60 million

5-15. Suppose that, as part of an expansion of its Province Care health system, a provincial government decides to offer a $50 subsidy to all people who, according to their physicians, should have their own blood pressure monitoring devices. Prior to this governmental decision, the market clearing price of blood pressure monitors in this province was $50, and the equilibrium quantity purchased was 20,000 per year. ..

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Chapter 5 Market Failures and the Public Sector a. After the government expands its Province Care plan, people in this province desire to purchase 40,000 devices each year. Manufacturers of blood pressure monitors are willing to provide 40,000 devices at a price of $60 per device. What out-of-pocket price does each consumer pay for a blood pressure monitor? b. What is the dollar amount of the increase in total expenditures on blood pressure monitors in this province following the expansion in the Province Care program? c. Following the expansion of the Province Care program, what percentage of total expenditures on blood pressure monitors is paid by the government? What percentage of total expenditures is paid by consumers of these devices? a. $60 – $50 = $10 b. Expenditures after the program expansion are $2.4 million. Before the program expansion, expenditures were $1 million. Hence, the increase in expenditures is $1.4 million. c. At a per-unit subsidy of $50, the share of the per-unit $60 price paid by the government is 5/6, or 83.3 percent. Hence, this is the government’s share of total expenditures on the 40,000 devices that consumers purchase. The consumers of these devices pay $10 of the per-unit $60 price, or 16.67 percent.

5-16. A government agency is contemplating launching an effort to expand the scope of its activities. One rationale for doing so is that another government agency might make the same effort and, if successful, receive larger budget allocations in future years. Another rationale for expanding the agency’s activities is that this will make the jobs of its workers more interesting, which may help the government agency attract better-qualified employees. Nevertheless, the agency will have to convince more than half of the House of Commons and the Senate to approve a formal proposal to expand its activities. In addition, to expand its activities, the agency must have the authority to force private companies it does not currently regulate to be officially licensed by agency personnel. Identify which aspects of this problem are similar to those faced by firms that operate in private markets and which aspects are specific to the public sector.

Seeking to increase budget allocations in future years and to make workers’ jobs more interesting can be consistent with the profit-maximizing objectives of firms in private markets.

Also, the government agency is promoting competition, which is analogous to behaving like a firm in a private market. Achieving these goals via majority rule and regulatory coercion, however, are aspects that are specific to the public sector.

5-17. Suppose that panel (a) of Figure 5-1 applies to Ontario’s steel market. Suppose that steel manufacturers in this province adopt a new, equal-cost technique for producing steel that entails a smaller external cost. In the absence of any government action to correct the negative externality from steel production, would the overallocation of resources to steel production in Ontario be larger or smaller following the adoption of the next steelmanufacturing technique?

The reduced external cost of producing steel would mean that the vertical distance added to the supply curve S1 would be smaller, so that the supply curve considering this external cost would ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition lie between S1 and S2. Thus, the amount of steel produced that would reflect all external costs would be greater than 100 million tons, which would imply a smaller degree of overallocation of resources to steel production.

5-18. Based on your answer to Question 5-17, if Ontario’s government aims to correct the steel market’s negative externality via an effluent fee, is the appropriate fee higher or lower now that steel producers have adopted the new technique? Why? Because the supply curve does not have to be shifted so far upward and to the left because the external cost of steel production is lower, the appropriate effluent fee to correct the negative externality is now lower.

5-19. Consider panel (b) of Figure 5-1. Assume that a careful study of the likely transmission of influenza in light of a changed population distribution has revealed that the external benefits from inoculations are greater than currently displayed in the graph. In light of this information, is the under allocation of resources to the provision of flu-vaccine inoculations larger or smaller than indicated in panel (b)?

The higher external benefits revealed by the study imply that the true demand curve reflecting these benefits lies to the right of D2. Thus, the amount of flu-vaccine inoculations provided that would reflect all external benefits would be greater than 200 million per year, which would imply a greater degree of under allocation of resources to the provision of inoculations.

5-20. Based on your answer to Question 5-19, if the government aims to correct the positive externality in the inoculation market via a per-unit subsidy to consumers, in the wake of study, is the appropriate per-unit subsidy higher or lower than before?

In light of the study’s revelation of higher external benefits, a higher per-unit subsidy is appropriate. This higher per-unit subsidy would shift the demand curve farther to the right in relation to D2 in order to reflect the increased external benefits of inoculations.

5-21. An online video game has the technical capability for a large number of players to participate, as long as a game administrator works to ensure constant functionality of the game. Adding more players deprives no other participants of the entertainment services provided by the online game. It has been easy, however, to set up a system for excluding participation by anyone who fails to contribute $5 per month to a fund that ensures covering extra expenses generated by that player’s participation. Is this game a public good?

One aspect of the online game that it shares with a public good is the fact that more and more people can participate in teams without depriving other participants of the game’s entertainment services. Nevertheless, the fact that it has been easy to design a collection system to exclude from participation anyone who fails to contribute to assuring provision of the game means that the game is not a public good.

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Chapter 5 Market Failures and the Public Sector 5-22. A senior citizen gets a part-time job at a fast-food restaurant. She earns $8 per hour for each hour she works, and she works exactly 25 hours per week. Thus, her total pretax weekly income is $200. Her total income tax assessment each week is $40. She pays $3 in taxes for the final hour she works each week. a. What is this person’s average tax rate each week? b. What is the marginal tax rate for the last hour she works each week? a. The average tax rate is the total tax of $40 divided by the $200 in income: $40/$200 = 0.2, or 20 percent b. The marginal tax rate for the last hour of work is the change in taxes, $3, divided by the change in income, $8: $3/$8 = 0.375, or 37.5 percent 5-23. For purposes of assessing income taxes, there are three official income levels for workers in a small country: high, medium, and low. For the last hour on the job during a 40-hour workweek, a high-income worker pays a marginal income tax rate of 15 percent, a medium-income worker pays a marginal tax rate of 20 percent, and a low-income worker is assessed a 25 percent marginal income tax rate. Based only on this information, does this nation’s income tax system appear to be progressive, proportional, or regressive?

Because the marginal tax rate increases as workers’ earnings decline, this tax system is regressive.

5-24. Consider the table below when answering the questions that follow. Show your work, and explain briefly.

Christino Jarius Meg Taxes Taxes Taxes Income Paid Income Paid Income Paid $1,000 $200 $1,000 $200 $1,000 $200 $2,000 $300 $2,000 $400 $2,000 $500 $3,000 $400 $3,000 $600 $3,000 $800

a. What is Christino’s marginal tax rate? b. What is Jarius’s marginal tax rate? c. What is Meg’s marginal tax rate? a. Christino’s marginal tax rate is

$300 − 200 $400 − 300 $100 = = = 0.1 , or 10 percent. $2,000 − $1,000 $3,000 − $2,000 $1,000

b. Jarius’s marginal tax rate is

$400 − 200 $600 − 400 $200 = = = 0.2 , or 20 percent. $2,000 − $1,000 $3,000 − $2,000 $1,000

c. Meg’s marginal tax rate is

$500 − 200 $800 − 500 $300 = = = 0.3 , or 30 percent. $2,000 − $1,000 $3,000 − $2,000 $1,000

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 5-25. Refer to the table in Problem 5-24 when answering the following questions. Show your work, and explain briefly. a. Does Christino experience progressive, proportional, or regressive taxation? b. Does Jarius experience progressive, proportional, or regressive taxation? c. Does Meg experience progressive, proportional, or regressive taxation? a. Christino experiences regressive taxation. This can be seen in one of two ways. First, as his income increases, his average tax rate declines from $200/$1,000 = 0.2 (or 20 percent) to $300/$2,000 = 0.15 (or 15 percent) to $400/$3,000 = 0.133 (or 13.3 percent). Thus, the proportion of income paid as taxes decreases as his income rises.

Second, his marginal tax rate of 10 percent is always less than his average tax rate. b. Jarius experiences proportional taxation. This can be seen in one of two ways. First, as his income increases, his average tax rate remains unaltered at $200/$1,000 = $400/$2,000 = $600/$3,000 = 0.2 (or 20 percent). Thus, the proportion of income paid as taxes remains unchanged as his income rises. Second, his marginal tax rate of 20 percent is always the same as his average tax rate. c. Meg experiences progressive taxation. This can be seen in one of two ways. First, as her income increases, her average tax rate rises from $200/$1,000 = 0.2 (or 20 percent) to $500/$2,000 = 0.25 (or 25 percent) to $800/$3,000 = 0.267 (or 26.7 percent). Thus, the proportion of income paid as taxes increases as her income rises.

Second, her marginal tax rate of 30 percent always exceeds her average tax rate.

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Chapter 6

Demand and Supply Elasticity 

Answers to Questions for Critical Analysis

THE PRICE ELASTICITY OF DEMAND FOR ILLICIT CANNABIS IN CANADA Imagine you are responsible for setting the price for licit or legal cannabis. How could knowing the elasticity of illicit cannabis help you set the price for licit cannabis?

One of the reasons Canada chose to legalize cannabis was to decrease the illicit cannabis market.

Knowing the price of illicit cannabis will help you set the price for licit cannabis, including medical cannabis. If you set the price of licit cannabis too low, this may attract youth and lowincome individuals to use cannabis. If the price of licit cannabis is too high, this may encourage the black market producers to increase supply and provide cheaper illicit cannabis. For the legal cannabis market to compete against the illegal market, policymakers need to remove regulatory burdens, fees, and taxes to lower its cost.

THE PRICE ELASTICITY OF DEMAND FOR TESLA VEHICLES IN HONG KONG Would the estimated price elasticity of demand for Tesla vehicles have been different if we had not used the average-values formula? How? The percentage change in quantity demand = change in quantity demanded/original quantity demanded = (500 – 30)/500 = 470/500 = 0.94.

The percentage change in price = change in price/original price = (130,000 – 75,000)/75,000 = 55,000/75,000 = 0.73.

Therefore, Ep = percentage change in quantity demanded/percentage change in price = 0.94/0.73 = 1.29.

If we had not used the average-values formula, the estimated price elasticity of demand for Tesla vehicles would have been lower at 1.29 instead of 3.3.

AI: IN THE PURSUIT OF “PRICE OPTIMIZATION” If the demand is relatively elastic for a particular retail item and all firms respond to AI guidance with an aim to boost their revenues and profits, should each one increase or decrease its production rate? Explain briefly.

If demand for an item is relatively elastic, an increase in price will decrease total revenue and a decrease in price will increase total revenue. If firms want to boost their revenues and profits, they should decrease prices and increase their production rates.

GETTING PAID TO WORK OUT Why do you suppose that developers have designed apps that allow people to give themselves incentives to exercise by providing payments for supplying gym workouts but that impose penalties for failing to do so?

The payments for supplying gym workouts and the penalties for not working out affect people’s incentives. By reducing the cost of working out (by providing payments), people should work out more than before, all other things held constant. In addition, by increasing the cost of not

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition working out (by imposing costs), people should work out more than before, all other things held constant.



Economics in Your Life

IMPOSING A BRITISH COLUMBIA CARBONATED BEVERAGE TAX REVEALS INFORMATION ABOUT THE PRICE ELASTICITY OF DEMAND For Critical Thinking Why might the fact that the demand for carbonated beverages is elastic help to explain why the $27 million in revenue from the sugary drink tax may turn out to be less than predicated?

When the price elasticity of demand is elastic, an increase in price causes a decrease in total revenues because the decrease in quantity demanded outweighs the increase in price.

Real Application Assume you are living in British Columbia and like carbonated drinks. You continue to buy almost the same quantity of such drinks. Does that mean that the law of demand is wrong?

You must always remember that change is on the margin. That is to say, not everyone has to react to an increase in the overall price of carbonated drinks for the law of demand to hold.

Rather, some individuals will react by finding substitutes to carbonated drinks that are not taxed.

If you wish to understand the world around you, don’t fall into the trap of saying to yourself “I don’t care what the price increase is for this good or service. Therefore, no one cares, and the law of demand does not operate here.”



Issues & Applications

VAPE PRODUCTS: SHOULD THEY BE TAXED SIMILAR TO CIGARETTES? For Critical Thinking How might some consumers react to an increase in taxes to both traditional cigarettes and vape products?

Increasing taxes on both traditional cigarettes and vape products will create a black market and reduce government revenue.

Real Application As a government policymaker, what do you have to consider when taxing vape products?

Vape products do contain fewer toxins and may be safer than traditional cigarettes. Do not tax vape products so that the price is higher than traditional cigarettes, since cigarettes are a proven carcinogen and health risk.

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Chapter 6 Demand and Supply Elasticity



Answers to End-of-Chapter Questions

6-1. When the price of shirts emblazoned with a college logo is $20, consumers buy 150 per week. When the price declines to $19, consumers purchase 200 per week. Based on this information, calculate the price elasticity of demand for logo-emblazoned shirts.

Ep = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 = (200 − 150)/(200 + 150)/2 / (19 − 20)/(19 + 20)/2 =50/(350/2) / 1/(39/2) = 50/175 / 1/19.5 ≈ –5.6. Thus, the absolute price elasticity of demand equals 5.6.

6-2. Table 6-2 indicates that the short-run price elasticity of demand for tires is 0.9. If an increase in the price of petroleum (used in producing tires) causes the market prices of tires to rise from $50 to $60, by what percentage would you expect the quantity of tires demanded to change?

To calculate the increase in tire prices using our formula for the price elasticity of demand, we take the difference between $60 and $50 ($10) and divide it by the average of the two prices ($55), which yields an 18.2 percent increase. Let X denote the predicted decrease in the quantity.

Then X / 18.2 percent = −0.9. Hence, X = −16.4 percent.

6-3. The diagram depicts the demand curve for “miniburgers” in a nationwide fast-food market.

Use the information in this diagram to answer the questions that follow.

a. What is the price elasticity of demand along the range of the demand curve between a price of $0.20 per miniburger and a price of $0.40 per miniburger? Is demand elastic or inelastic over this range? b. What is the price elasticity of demand along the range of the demand curve between a price of $0.80 per miniburger and a price of $1.20 per miniburger? Is demand elastic or inelastic over this range? c. What is the price elasticity of demand along the range of the demand curve between a price of $1.60 per miniburger and a price of $1.80 per miniburger? Is demand elastic or inelastic over this range?

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition a. Ep = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 = (90 − 80)/(90+80)/2 / (0.20 − 0.40)/(0.20 + 0.40)/2 = 10/(170/2) / –0.20/(0.60/2) = 10/85 / –0.20/0.30 ≈ −0.18. Consequently, the absolute price elasticity of demand is 0.18, so demand is inelastic over this range. b. Ep = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 = (60 – 40)/(60+40)/2 / (0.80 – 1.20)/(0.80 + 1.20)/2 = 20/(100/2) / –0.40/(2.00/2) = 20/50 / –0.40/1.00 ≈ −1.00. The absolute price elasticity of demand, therefore, equals 1.00, which implies that demand is unit-elastic over this range. c. Ep = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 = (20 – 10)/(20 + 10)/2 / (1.60 – 1.80)/(1.60 + 1.80)/2 = 10/(30/2) / –0.2/(3.4/2) = 10/15 / –0.2/1.70 ≈ −5.67. Thus, the absolute price elasticity of demand is 5.67, so demand is elastic over this range.

6-4. In a local market, the monthly price of Internet access service decreases from $20 per account to $10 per account, and the total quantity of monthly accounts across all Internet access providers increases from 100,000 to 200,000. What is the price elasticity of demand? Is demand elastic, unit-elastic, or inelastic?

Ep = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 = (200,000 – 100,000)/(200,000 + 100,000)/2 / ($10 – $20)/($10 + $20)/2 = 100,000/(300,000/2) / –10/(30/2) = 100,000/150,000 / –10/15 = –1.00. The absolute price elasticity of demand, therefore, equals 1.00, which implies that demand is unit-elastic over this range.

6-5. At a price of $57.50 to play 18 holes on local golf courses, 1,200 consumers pay to play a game of golf each day. A rise in the price to $62.50 causes the number of consumers to decline to 800. What is the price elasticity of demand? Is demand elastic, unit-elastic, or inelastic?

Ep = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 = (800 – 1,200)/(800 + 1,200)/2 / ($62.50 – $57.50)/($62.50 + $57.50)/2 = –400/(2,000/2) / 5/(120/2) = –400/1,000 / 5/60 ≈ –4.8. Hence, the absolute price elasticity of demand equals 4.8. Demand is elastic over this range.

6-6. It is very difficult to find goods with perfectly elastic or perfectly inelastic demand. We can, however, find goods that lie near these extremes. Characterize demands for the following goods as being near perfectly elastic or near perfectly inelastic. ..

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Chapter 6 Demand and Supply Elasticity a. b. c. d.

Corn grown and harvested by a small farmer in Manitoba Heroin for a drug addict Water for a desert hiker One of several optional textbooks in a pass–fail course

a. b. c. d.

Nearly perfectly elastic Nearly perfectly inelastic Nearly perfectly inelastic Nearly perfectly elastic

6-7. In the market for handmade guitars, when the price of guitars is $800, annual revenues are $640,000. When the price falls to $700, annual revenues decline to $630,000. Over this range of guitar prices, is the demand for handmade guitars elastic, unit-elastic, or inelastic?

Because price and total revenue move in the same direction, over this range of demand the demand for handmade guitars is inelastic.

6-8. Suppose that over a range of prices, the price elasticity of demand varies from 15.0 to 2.5.

Over another range of prices, the price elasticity of demand varies from 1.5 to 0.75. What can you say about total revenues and the total revenue curve over these two ranges of the demand curve as price falls?

Within the first range, demand is elastic. As price falls, therefore, total revenues increase. Within the second range, demand is at first elastic and then inelastic. When price falls, therefore, total revenues are initially rising. Eventually, total revenues reach the maximum point, which corresponds to the point of unit elasticity. Beyond this point, total revenues decline.

6-9. Based solely on the information provided below, characterize the demands for the following goods as likely to be more elastic or more inelastic. a. A 45-cent box of salt that you buy once a year b. A type of high-powered ski boat that you can rent from any one of a number of rental agencies c. A specific brand of bottled water d. Automobile insurance in a province that requires autos to be insured but has only a few insurance companies e. A 75-cent guitar pick for the lead guitarist of a major band a. More inelastic because it represents a smaller portion of the budget b. More elastic because there are many close substitutes c. More elastic, because there are a number of substitutes d. More inelastic because there are few close substitutes e. More inelastic because it represents a small portion of the budget

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 6-10. The value of cross price elasticity of demand between goods X and Y is 1.25, while the cross price elasticity of demand between goods X and Z is –2.0. Characterize X and Y and X and Z as substitutes or complements.

Goods X and Y are substitutes, and goods X and Z are complements.

6-11. Suppose that the cross price elasticity of demand between eggs and bacon is –0.5. What would you expect to happen to purchases of bacon if the price of eggs rises by 10 percent?

Let X denote the percentage change in the quantity of bacon. Then X / 10 percent = −0.5. X, therefore, X is −5 percent. Thus, purchases of bacon would be expected to decrease by 5 percent.

6-12. A 5 percent increase in the price of digital apps reduces the amount of tablet devices demanded by 3 percent. What is the cross price elasticity of demand? Are tablet devices and digital apps complements or substitutes?

The cross price elasticity of demand is –3 percent / 5 percent = –0.6, so tablet devices and digital apps are complements.

6-13. An individual’s income rises from $80,000 per year to $84,000 per year, and as a consequence the person’s purchases of movie downloads rise from 48 per year to 72 per year. What is this individual’s income elasticity of demand?

Ei = ∆Q/(Q1 + Q2)/2 / ∆I/(I1 + I2)/2 = (72 – 48)/(72+48)/2 / ($84,000 – $80,000)/($84,000 + $80,000)/2 = 24/(120/2) / 4,000/(164,000/2) = 24/60 / 4,000/82,000 ≈ +8.2.

6-14. Assume that the income elasticity of demand for hot dogs is –1.25 and that the income elasticity of demand for lobster is 1.25. What will happen to each good’s demand curve as income goes up?

Income elasticity of demand is measured as the percentage change in demand divided by the percentage change in income. A negative income elasticity of demand indicates that as income rises, the demand for hot dogs falls, so the demand curve for hot dogs shifts leftward. A positive income elasticity of demand indicates that as income rises, the demand for lobster rises, so the demand curve for lobsters shifts rightward.

6-15. At a price of $25,000, producers of midsized automobiles are willing to manufacture and sell 75,000 cars per month. At a price of $35,000, they are willing to produce and sell 125,000 a month. Using the same type of calculation method used to calculate the price elasticity of demand, what is the price elasticity of supply? Is supply elastic, unit-elastic, or inelastic? ..

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Chapter 6 Demand and Supply Elasticity Es = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 = (125,000 – 75,000)/(125,000 + 75,000)/2 / ($35,000 – $25,000)/($35,000 + $25,000)/2 = 50,000/(200,000/2) / 10,000/(60,000/2) = 50,000/100,000 / 10,000/30,000 = 1.5. Supply is elastic.

6-16. An increase in the market price of men’s haircuts, from $15 per haircut to $25 per haircut, initially causes a local barbershop to have its employees work overtime to increase the number of daily haircuts provided from 35 to 45. When the $25 market price remains unchanged for several weeks and all other things remain equal as well, the barbershop hires additional employees and provides 65 haircuts per day. What is the short-run price elasticity of supply? What is the long-run price elasticity of supply?

Short run: Es = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 = (45 – 35)/(45 + 35)/2 / ($25 – $15)/($25 + $15)/2 = 10/(80/2) / 10/(40/2) = 10/40 / 10/20 = 0.50 Long run: Es = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 = (65 – 35)(65 + 35)/2 / ($25 – $15)/($25 + $15)/2 = 30/(100/2) / 10/(40/2) = 30/50 / 10/20 = 1.2 6-17. Consider panel (a) of Figure 6-1. Use the basic definition of the price elasticity of demand to explain why the value of the price elasticity of demand is zero for the extremely rare situation of vertical demand curve?

For any price change along this demand curve, the change in quantity demanded is zero, so the percentage change in quantity demanded is zero. We know that by definition the price elasticity of demand is the percentage change in quantity demanded, which in this case is zero, divided by the percentage change in price, and this ratio equals zero.

6-18. Take a look at Figure 6-2. Work out the calculation for the price elasticity of demand between prices of $11 per reservation and $10 per reservation to prove that the value is 21.

Ep = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 = (100 – 0)/(100 + 0)/2 / ($10 – $11)/($10 + $11)/2 = 100/(100/2) / –1/(21/2) = 100/50 / –1/10.5 = 21 6-19. Consider Figure 6-2. Work out the calculation for the price elasticity of demand between prices of $1 per reservation and $2 per reservation to prove that the value is 0.158.

Ep = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition = (1,000 – 900)/(1,000 + 900)/2 / ($1 – $2)/($1 + $2)/2 = 100/(1,900/2) / –1/(3/2) = 100/950 / –1/1.5 = 0.158 6-20. Take a look at Figure 6-2. Work out the calculation for the price elasticity of demand between prices of $6 per reservation and $5 per reservation to prove that the value is 1.

Ep = ∆Q/(Q1 + Q2)/2 / ∆P/(P1 +P2)/2 = (600 – 500)/(600 + 500)/2 / ($5 – $6)/($5 + $6)/2 = 100/(1,100/2) / –1/(11/2) = 100/550 / –1/5.5 =1 6-21. Consider Figure 6-4. Following a price increase, is the quantity demanded more responsive to the price increase immediately, after an initial passage of time, and then after even more time has passed? Why is this so?

The quantity demanded is least responsive to the immediate price change, more responsive after an initial passage of time, and even more responsive after even more time has passed. This is so because as more and more time is available for adjustment to the price increase, buyers can more readily find substitutes for this particular good or service.

6-22. Take a look at Figure 6-6. Following a price increase, is the quantity supplied more responsive to the price increase immediately, after an initial passage of time, and then after even more time has passed? Why is this so?

The quantity supplied is least responsive to the immediate price change, more responsive after an initial passage of time, and even more responsive after even more time has passed. As more time initially is available for adjustment to the price increase, more resources will flow to existing sellers. After passage of more time, entry of additional firms further increases the quantity supplied.

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Chapter 7

Consumer Choice 

Answers to Questions for Critical Analysis

RATIONAL RATIONING OF CALORIES TO PREVENT NEGATIVE MARGINAL UTILITY FROM FOOD CONSUMPTION Assume that you are a person concerned about being overweight or becoming overweight. How might you change your method of shopping for food to improve the probability that you don’t “overeat”?

One possible way is to shift from purchasing food that you can physically see in a supermarket to purchasing food online. If you plan to reduce the number of food choices you have, this feat is perhaps more easily accomplished by buying your food online. You can plan and better follow calorie-restricted diets if you are not faced with an extremely large array of desirable foods.

There are diet systems advertised widely that use this theory. They send you prepared meals that restrict your caloric intake if you follow the prescribed diet.

AI: AN AID FOR ATTAINING A CONSUMER OPTIMUM How might the advent of machine-learning shopping apps undermine an oft-repeated media claim that consumers can be harmed by having to confront “too many choices”?

Because the machine-learning shopping apps would use your preferences to narrow the number of choices you face, the harm of having to confront “too many choices” is minimized. You spend less time comparing the different choices and more time on other activities from which you derive utility.

WHY A CONSUMER OPTIMUM CAN ENCOMPASS A $100 PLAIN WHITE COTTON T-SHIRT When you observe others’ behaviour, you see that some people purchase what appears to be outrageously expensive plain white cotton T-shirts as well as similarly high-priced designer goods. You may observe others who purchase relatively expensive cars. What type of analysis would you be undertaking if you judged such purchases as frivolous or unnecessary or stupid?

You may indeed find it ridiculous that people pay $100 for a designer plain white cotton T-shirt.

You may indeed also find it ridiculous that some individuals purchase jewellery that costs hundreds of thousands of dollars (or even millions of dollars). Whenever you judge the actions of such individuals as “stupid” or “frivolous,” you are engaging in normative analysis. That is to say, you are judging people’s behaviour based on your subjective ideas about how people should or should not behave. If you were engaging in only positive economic analysis, you would simply say that on the margin, the last dollar spent by an individual on a so-called frivolous purchase must have the same marginal utility as the last dollar spent on any other item in that person’s consumption set.

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Economics in Your Life

CANADA GOOSE JACKETS THAT SOME CONSUMERS TRULY ARE HAPPY TO BUY For Critical Thinking Under what specific consumer-optimum circumstances would a regular customer of Canada Goose have been willing to pay $90,000 for a sports car on the same day that they bought the latest Canada Goose winter jacket priced at $1,650?

A customer would choose to buy both the sports car and the Canada Goose jacket if the marginal utility per dollar spent was equal for each good.

Real Application Suppose that you end up with a very high annual income. Suppose further that there are several lines of designer shoes that you like. In spite of your high income, will you still shop “for the best deal” for those brands that you prefer?

Presumably, if you are earning a high annual income, the opportunity cost of your time will be greater than it is for someone earning a very low annual income. That means that you likely will not spend much time searching for the best deal on gasoline or bread. The potential “savings” would be less than the opportunity cost of your time.

In contrast, as you start contemplating searching for the best deal in designer shoes, the potential “savings” that you might obtain will be much greater and therefore you might actually be better off by spending at least a modest amount of time searching for the best prices on what you wish to buy.

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Issues & Applications

HOW MUCH “INTERMITTENTLY FUNCTIONING” HIGH-TECH AUTOMOTIVE GADGETRY FITS INTO A CONSUMER OPTIMUM? For Critical Thinking How might some individuals’ marginal utility per dollar spent be reduced by the inclusion of wireless systems that report data on driving speeds and vehicle movements accessible by insurers?

Individuals who tend to drive over the speed limit or drive erratically would face higher costs (in terms of insurance premiums) if these wireless systems are included. This additional cost will decrease their marginal utility for such systems, and they will be less likely to purchase a car that contains these features.

Real Application Learning how to use the numerous digital systems for a particular brand of automobile takes time. Once learned, however, most consumers can retain their proficiency in using such digital systems. In what ways might you avoid incurring the learning costs of future new digital systems in cars?

If you keep your current vehicle for a longer period of time, you will not have to incur the learning costs of any new digital system offered in a new car. As an alternative, you could purchase the same brand over and over. Most car brands do not dramatically change their digital interface from one year to another, or even from one model to another. Thus, if you ..

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Chapter 7 Consumer Choice purchase a new car of the same brand, you might have only a trivial number of new digital systems to learn about. All of your investment in learning the previous digital systems will still remain worthwhile.

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Answers to End-of-Chapter Questions

7-1. The campus pizzeria sells a single pizza for $12. If you order a second pizza, however, the pizzeria charges a price of only $5 for the additional pizza. Explain how marginal utility helps to explain the pizzeria’s pricing strategy.

The campus pizzeria indicates by its pricing policy that it recognizes the principle of diminishing marginal utility. As shown in Figure 7-1 (substituting slices of pizza for apps), a customer’s marginal utility for the second pizza is typically lower than for the first. Thus, the customer is likely to value the second pizza less and, therefore, only be willing to pay less for it.

7-2. As an individual consumes more units of an item, the person eventually experiences diminishing marginal utility. This means that to increase marginal utility, the person must consume less of an item. Explain the logic of this behaviour using the example in Problem 7-1.

To raise marginal utility, an individual would consume fewer pizzas. As long as marginal utility is positive, however, the individual’s total utility is rising with the second pizza even though marginal utility is falling.

7-3. Where possible, complete the missing cells in the table below.

Number of Cheeseburgers 0 1 2 3 4 5

Total Utility of Cheesebu rgers 0 20 36 — — —

Marginal Utility of Cheesebur gers — — — 12 8 4

Bags of French Fries 0 1 2 3 4 5

Total Utility of French Fries 0 — — — 21 21

Marginal Utility of French Fries — 10 8 2 — —

The total utility of the third, fourth, and fifth cheeseburgers is 48, 56, and 60, respectively. The marginal utility of the first and second cheeseburgers is 20 and 16, respectively. The total utility of the first, second, and third bags of french fries is 10, 18, and 20, respectively. The marginal utility of the fourth and fifth bags of french fries is 1 and 0, respectively.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition

Number of Cheeseburgers 0 1 2 3 4 5

Total Utility of Cheesebu rgers 0 20 36 48 56 60

Marginal Utility of Cheesebur gers — 20 16 12 8 4

Bags of French Fries 0 1 2 3 4 5

Total Utility of French Fries 0 10 18 20 21 21

Marginal Utility of French Fries — 10 8 2 1 0

7-4. From the data in Problem 7-3, if the price of a cheeseburger is $2, the price of a bag of french fries is $1, and you have $6 to spend (and you spend all of it), what is the utilitymaximizing combination of cheeseburgers and french fries?

The utility-maximizing combination of cheeseburgers and bags of french fries that equates marginal utility per dollar spent and exhausts the total $6 budget is two cheeseburgers and two bags of french fries. The individual purchases 2 cheeseburgers at $2 each, spends $4 on cheeseburgers, and has a marginal utility per dollar spent equal to the ratio of 16 units of utility to $2, or 8 units of utility per dollar. The individual buys 2 bags of french fries at $1 per bag, spends $2 on french fries, and has a marginal utility per dollar spent equal to the ratio of 8 units of utility to $1, or 8 units of utility per dollar. Thus, the individual equalizes marginal utility per dollar spent at 8 units of utility per dollar and spends the available $6.

7-5. Return to Problem 7-4. Suppose that the price of cheeseburgers falls to $1. Determine the new utility-maximizing combination of cheeseburgers and french fries.

The new utility-maximizing combination of bags of french fries and cheeseburgers that equates marginal utility per dollar spent and exhausts the total $6 budget is four cheeseburgers and two bags of french fries. The individual purchases 4 cheeseburgers at $1 each, spends $4 on cheeseburgers, and has a marginal utility per dollar spent equal to the ratio of 8 units of utility to $1, or 8 units of utility per dollar. The individual buys 2 bags of french fries at $1 per bag, spends $2 on french fries, and has a marginal utility per dollar spent equal to the ratio of 8 units of utility to $1, or 8 units of utility per dollar. Thus, the individual equalizes marginal utility per dollar spent at 8 units of utility per dollar and spends the available $6.

7-6. Suppose you observe that total utility rises as more of an item is consumed. What can you say for certain about marginal utility? Can you say for sure that it is rising or falling or that it is positive or negative?

When total utility is rising, the only thing we can say about marginal utility for certain is that it is positive.

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Chapter 7 Consumer Choice 7-7. You determine that your daily consumption of soft drinks is 3 and your daily consumption of tacos is 4 when the prices per unit are 50 cents and $1, respectively. Explain what happens to your consumption bundle, and, after your consumption choices adjust, to the marginal utility of soft drinks and the marginal utility of tacos when the price of soft drinks rises to 75 cents.

Other things being equal, when the price of soft drinks rises, the substitution effect comes into play and the individual tends to consume less of the more expensive item, soft drinks, and more of the item with the unchanged price, tacos. Hence, the marginal utility of soft drinks rises, and the marginal utility of tacos falls.

7-8. At a consumer optimum, for all goods purchased, marginal utility per dollar spent is equalized. A high school student is deciding between attending Northern University and Southern University. The student cannot attend both universities simultaneously. Both are fine universities, but the reputation of Northern is slightly higher, as is the tuition. Use the rule of consumer optimum to explain how the student will go about deciding which university to attend.

The student should compare the marginal utility per tuition dollar spent at the two universities.

Assuming that a “unit” of university is a degree, a high school student should divide the additional satisfaction derived from a degree at each university by the total tuition it would take to earn a degree at each institution. The university with the higher marginal utility per tuition dollar is the one the student should attend.

7-9. In the graph, consider the movements that take place from one point to the next (A to B to C and so on) along the total utility curve as the individual successively increases consumption by one more unit, and answer the questions that follow.

a. Which one-unit increase in consumption from one point to the next along the total utility curve generates the highest marginal utility? b. Which one-unit increase in consumption from one point to the next along the total utility curve generates zero marginal utility? ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition c. Which one-unit increase in consumption from one point to the next along the total utility curve generates negative marginal utility? a. Of all the possible one-unit increases in consumption displayed, the movement from point A to point B generates the highest marginal utility. Total utility rises by 5 units between these points, so the marginal utility of the first unit consumed is 5 units. b. Between points E and F, a one-unit increase in the quantity consumed leaves total utility unchanged at 11 units, so marginal utility is equal to zero. c. Between points F and G, a one-unit increase in the quantity consumed causes total utility to decline from 11 units to 10 units, so marginal utility is negative and equal to −1 unit.

7-10. Draw a marginal utility curve corresponding to the total utility curve depicted in Problem 7-9.

7-11. Refer to the table below. If the subscription price for a sports app is $2 per week, the subscription price of a game app is $1 per week, and a student has $9 per week to spend, what quantities will they purchase at a consumer optimum?

Quantity of Sports Apps per week 1 2 3 4 5 6

Marginal Utility (utils) 1,200 1,000 800 600 400 100

Quantity of Game Apps per Week 1 2 3 4 5 6

Marginal Utility (utils) 1,700 1,400 1,100 800 500 200

For this consumer, at these prices the marginal utility per dollar spent on 2 sports apps is 500 units of utility per dollar, and the marginal utility per dollar spent on 5 game apps is also 500

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Chapter 7 Consumer Choice units of utility per dollar. In addition, the entire budget of $9 is spent at this combination, which is the consumer optimum.

7-12. Refer to the table below, and assume that each week this consumer buys only weekly subscriptions to economics statistics apps and subscriptions to office productivity apps.

The price of a subscription to each type of economics statistics app is $2 per week, and the price of a subscription to each office productivity app is $60 per week. If the consumer’s available income is $128 per week, what quantity of each item will the individual purchase each week at a consumer optimum?

Quantity of Subscriptions to Economics Statistics Apps per Week 1 2 3 4 5 6

Quantity of Subscriptions to Office Productivity Total Utility Apps per Week (utils) 1 400 2 700 3 850 4 950 5 1,000 6 1,025

Total Utility (utils) 40 60 76 86 91 93

The table below displays the marginal utilities and the values of marginal utility per dollar spent at a price of $2 per economic statistics app and a price of $60 per office productivity app. The marginal utility per dollar spent is equalized at a value of 5, which yields a consumer optimum of 4 economic statistics apps and 2 office productivity apps per week, for which the consumer’s entire available income of $128 is spent. Note that the marginal utility per dollar spent is also equalized at 2.50 if 5 economic statistics apps and 3 office productivity apps are consumed, but the individual has insufficient income for this weekly consumption combination.

Quantity of Quantity of Subscriptions Subscriptions to Economics to Office Statistics Productivity Apps per Apps per Week TU MU MU/$ Week TU 1 40 40 20 1 400 2 60 20 10 2 700 3 76 16 8 3 850 4 86 10 5 4 950 5 91 5 2.5 5 1,000 6 93 2 1 6 1,025

MU MU/$ 400 6.7 300 5 150 2.5 100 1.7 50 0.8 25 0.4

7-13. In Problem 7-12, if the consumer’s income rises to $190 per week, what new quantities characterize the new consumer optimum? ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition The marginal utility per dollar spent is equalized at 2.50 if 5 economic statistics apps and 3 office productivity apps are consumed, and this consumption combination just exhausts the nowavailable $190 in weekly income.

7-14. At a consumer optimum involving goods A and B, the marginal utility of good A is twice the marginal utility of good B. The price of good B is $3.50. What is the price of good A? MUA/MUB = PA/PB. If MUA/MUB is 2, then PA/PB is 2. Therefore, the price of good A is twice the price of good B, or 2 × $3.50 per unit = $7.00 per unit.

7-15. At a consumer optimum involving goods X and Y, the marginal utility of good X equals 3 utils. The price of good Y is three times the price of good X. What is the marginal utility of good Y? MUY/MUX = PY/PX. If PY/PX is 3, then MUY/MUX is 3. The marginal utility of good Y is three times the marginal utility of good X, or 3 × 3 utils = 9 utils.

7-16. At a consumer optimum involving goods A and B, the marginal utility of good A is 2 utils, and the marginal utility of good B is 8 utils. How much greater or smaller is the price of good B compared with the price of good A? MUB/MUA = PB/PA. If MUA is 2 utils and MUB is 8 utils, then MUB/MUA = 8/2 = 4. Because the marginal utility of good B is four times greater than the marginal utility of good A, at a consumer optimum the price of good B must be four times greater than the price of good A. 7-17. At a consumer optimum involving goods X and Y, the price of good X is $3 per unit, and the price of good Y is $9 per unit. How much greater or smaller is the marginal utility of good Y than the marginal utility of good X? MUY/MUX = PY/PX. If PX is $3 and PY is $9, then PY/PX = 9/3 = 3. Because the price of good Y is three times greater than the price of good X, the marginal utility of good Y must be three times greater than the price of good X. 7-18. The marginal utility that an individual would experience if they were to consume the first unit of a digital app is 15 utils, and the marginal utility that they would experience if they were to consume a second unit is 18 utils. If one app is the amount that the individual decides to consume, what is the person’s total utility?

Consuming no digital apps would yield 0 units of total utility, so the fact that marginal utility derived from the first unit is 15 utils implies that the total utility of consuming 1 unit is 15 utils.

7-19. Take a look at Figure 7-1. Suppose that the individual currently consumes 5 digital apps.

What happens to the person’s total utility if they were to reduce their consumption to 4 units? Why does this fact imply that the marginal utility curve cuts through the horizontal axis of panel (c) between the fourth and fifth app consumed?

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Chapter 7 Consumer Choice As shown in the table in panel (a) and the graph in panel (b), reducing consumption from 4 apps to 5 leaves total utility unchanged at 20 utils. Hence, marginal utility between these two apps equals 0, which is the amount of marginal utility at the origin, which corresponds to the horizontal axis of the graph in panel (c). Thus, the marginal utility curve crosses this axis between units 4 and 5.

7-20. Consider Figure 7-1. If this individual were to contemplate consuming a seventh digital app and experience a total utility of 15 utils as a consequence, what would be the resulting marginal utility? Would the points on the total utility and marginal utility graphs in panels (b) and (c) lie higher and lower to the right of the current endpoints of those graphs?

The marginal utility would be 15 utils – 18 utils = –3 utils, so the person would experience even more marginal disutility than for the sixth digital app consumed. The 15 utils in total utility for 7 apps would be lower than the 18 utils for 6 apps in panel (b) and the marginal utility of –3 for the seventh app would be lower than the –2 for the sixth app in panel (c), so both new points would lie lower to the right on both graphs in panels (b) and (c).

7-21. Take a look at Table 7-1. Suppose that the price of each digital app rises to $5.97. At the same time, the price of each wireless earbud falls to $2.70. Income remains unchanged at $26. Rework the marginal-utility-per-dollars-spent columns and round each amount to the nearest one-tenth. What are the quantities of digital apps and wireless earbuds now purchased by this consumer?

As shown in the revised table after redoing the columns, the marginal utility per dollar spent is now equalized at 6.7 units of utility per dollar spent. The quantity of digital apps purchased is 3, and the quantity of wireless earbuds bought is 3.

Total and Marginal Utility from Consuming Digital Apps and Wireless Earbuds on an Income of $26.

(1) (2) (3) (4) (5) (6) (7) (8) Digital Apps per Period

TUd (utils)

0 1 2 3 4 5

0 50.0 95.0 135.0 171.5 200.0

MUd (utils)

(MUd /Pd) (price = $5.97)

Wireless Earbuds per Period

TUe (utils)

MUe

(MUe /Pe) (price = $2.70)

– 50.0 45.0 40.0 36.5 28.5

– 8.4 7.5 6.7 6.1 4.8

0 1 2 3 4 5

0 25 47 65 80 89

– 25 22 18 15 9

– 9.3 8.1 6.7 5.6 3.3

7-22. At the optimal quantities of digital apps and wireless earbuds determined in your answer to Problem 7-21, after rounding to the nearest 10 cents, is the $26 income all spent at the new consumer optimum?

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition Spending on digital apps is now 3 apps times $5.97 per app, or $17.91, which rounded to the nearest ten cents is $17.90. Spending on wireless earbuds equals 3 wireless earbuds times $2.70, which equals $8.10. Total spending is $17.90 + $2.70 = $26, so all income is spent.

7-23. Consider Figure 7-2, and suppose that the initial point is A. Explain why a decrease in the price of each digital app from $5 to $4 results in a change in the marginal utilities of digital apps in a direction that is consistent with re-attainment of a new consumer optimum at point B. At A, the marginal utility per dollar spent on apps was equalized with the marginal utility per dollar spent on any other item. When the price of apps falls, the marginal utility per dollar spent on apps rises. The rise in the quantity of apps demanded causes the marginal utility of apps to drop, which pushes the marginal utility per dollar spent on apps back up toward consistency with a consumer optimum at B.

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Appendix D: Answers to End-of-Appendix Questions

D-1. Consider the indifference curve illustrated in Figure D-1. Explain, in economic terms, why the curve is convex to the origin.

The indifference curve is convex to the origin because of a diminishing marginal rate of substitution. As an individual consumes more and more of an item, the less the individual is willing to forgo of the other item. The diminishing marginal rate of substitution is due to diminishing marginal utility.

D-2. Your classmate tells you that he is indifferent between three soft drinks and two hamburgers or two soft drinks and three hamburgers. a. Draw a rough diagram of an indifference curve containing your classmate’s consumption choices. b. Suppose that your classmate states that he is also indifferent between two soft drinks and three hamburgers or one soft drink and four hamburgers, but that he prefers three soft drinks and two hamburgers to one soft drink and four hamburgers. Use your diagram from part (a) to reason out whether he can have these preferences.

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Chapter 7 Consumer Choice a. The indifference curve appears in the figure below.

b. Your classmate cannot possibly have this set of preferences, because as stated the indifference curves intersect.

D-3. The table below represents Sue’s preferences for bottled water and soft drinks, the combination of which yields the same level of utility.

Combination of Bottled Water and Soft Drinks A B C D E

Bottled Water per Month 5 10 15 20 25

Soft Drinks per Month 11 7 4 2 1

Calculate Sue’s marginal rate of substitution of soft drinks for bottled water at each rate of consumption of water (or soft drinks). Relate the marginal rate of substitution to marginal utility.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition Sue’s marginal rate of substitution is calculated below: Combination of Bottled Water and Soft Drinks A B C D E

Bottled Water per Month 5 10 15 20 25

Soft Drinks per Month 11 7 4 2 1

MRS 5:4 5:3 5:2 5:1

The diminishing marginal rate of substitution of soft drinks for water shows Sue’s diminishing marginal utility of bottled water. She is willing to forgo fewer and fewer soft drinks to get an additional five bottles of water.

D-4. Using the information provided in Problem D-3, illustrate Sue’s indifference curve, with water on the horizontal axis and soft drinks on the vertical axis.

Plotting points A through E yields Sue’s convex indifference curve, along which she obtains equal utility from the alternative combinations of bottled water and soft drinks D-5. Sue’s monthly budget for bottled water and soft drinks is $23. The price of bottled water is $1 per bottle, and the price of soft drinks is $2 per bottle. Calculate the slope of Sue’s budget constraint. Given this information and the information provided in Problem D-3, find the combination of goods that satisfies Sue’s utility-maximization problem in light of her budget constraint.

Given that water is measured along the horizontal axis and soft drinks are measured along the vertical axis, the slope of Sue’s budget constraint is the price of water divided by the price of soft drinks, or PW/PS = $1 per bottle of water/$2 per unit of soft drinks = 0.5. The only combination of bottled water and soft drinks that is on Sue’s indifference curve and budget constraint is combination C, at which total expenditures on water and soft drinks equal (15 × $1) + (4 × $2) = $15 + $8 = $23.

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Chapter 7 Consumer Choice D-6. Using the indifference curve diagram you constructed in Problem D-4, add in Sue’s budget constraint using the information in Problem D-5. Illustrate the utility-maximizing combination of bottled water and soft drinks.

As shown in the figure, the utility-maximizing combination C is the point that the indifference curve is just tangent to the budget constraint. At this point, Sue has allocated her consumption of bottled water and soft drinks consistent with attaining the maximum feasible utility given her available budget.

D-7. Suppose that at a higher satisfaction level than in Problem D-3, Sue’s constant-utility preferences are as shown in the table below. Calculate the slope of Sue’s new budget constraint using the information provided in Problem D-5. Supposing now that the price of a soft drink falls to $1, find the combination of goods that satisfies Sue’s utilitymaximization problem in light of her budget constraint.

Combination of Bottled Water and Soft Drinks A B C D E

Bottled Water per Month 5 10 15 20 25

Soft Drinks per Month 22 14 8 4 2

With the quantity of bottled water measured along the horizontal axis and the quantity of soft drinks measured along the vertical axis, the slope of Sue’s budget constraint is the new price of soft drinks divided by the price of water, which equals $1 per unit/$1 per unit = 1. The only combination of bottled water and soft drinks that is on Sue’s indifference curve and budget constraint is combination C, where expenditures on water and soft drinks total $23.

D-8. Illustrate Sue’s new budget constraint and indifference curve in a diagram from the data in Problem D-3. Illustrate also the utility-maximizing combination of goods.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition

As shown in the figure, when the price of soft drinks drops to $1, the slope of the budget constraint changes to $1 per bottle of water/$1 per unit of soft drink = 1. Hence, the budget constraint rotates outward, and Sue can reach a new point of consumer optimum at the point where the higher indifference curve is tangent to the new budget constraint D-9. Given your answers to Problems D-5 and D-7, are Sue’s preferences for soft drinks consistent with the law of demand?

Yes, Sue’s revealed preferences indicate that her demand for soft drinks obeys the law of demand. When the price of soft drinks declines from $2 to $1, her quantity demanded rises from 4 to 8.

D-10. Using your answer to Problem D-8, draw Sue’s demand curve for soft drinks.

In the figure, the two price combinations from Problem D-8 have been drawn, and these two points lie along the demand curve.

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Chapter 8

The Firm: Cost and Output Determination 

Answers to Questions for Critical Analysis

THE FUTURE COST OF DELIVERING POST-SECONDARY COURSES The majority of post-secondary schools are now offering remote learning. Should the cost of post-secondary tuition decrease for students who choose to learn remotely?

The initial cost of delivering remote learning is high, and many of the schools need to pay down their initial fixed costs first before offering a reduced fee. Students do save on transportation and other expenses by learning remotely.

AIRLINES NEED TO REDUCE FIXED COSTS TO STAY ALIVE DURING COVID-19 Are the hourly wages that an airline pays to its maintenance workers fixed costs or variable costs?

These wages are variable costs because they change depending on the number of hours worked (output produced).

AI: USING AUGMENTED REALITY How do cost-reducing applications of virtual-reality technologies affect the position of a firm’s average total cost curve?

By reducing average total costs, the virtual-reality technologies have shifted the average total cost curve downward, so the ATC is less for each unit of output produced.

GOVERNMENT POLICIES MAY ENSURE ECONOMIES OF SCALE FOR A CHINESE BATTERY MANUFACTURER Is CATL’s long-run average cost of producing EV batteries currently higher or lower than it will be in future years following implementation of the Chinese government’s planned policies?

Explain briefly.

Currently, CATL’s long-run average cost of producing EV batteries is higher than it will be in future years (they are on the downward-sloping portion of the LAC curve). CATL expects that the increased output (due to the government policies) will enable CATL to move downward along its LAC curve to reach a minimum.

LONG-HAUL TRUCKING FIRMS SEEK TO ATTAIN A MINIMUM EFFICIENT SCALE ENCOMPASSING “LAST-MILE DELIVERIES” Why do you think some trucking firms have determined that including last-mile deliveries within their least-cost scale of operations would require providing large volumes of delivery services within densely populated cities? (Hint: Why might there be economies of scale in home deliveries, particularly in urban areas?)

The proximity of homes in populated cities means that trucking companies can visit more homes in a given area (10 miles or 50 miles) than would be possible in rural areas where the homes are more spread out. This proximity means fewer expenses on gasoline and wear and tear on the vehicle, which effectively lowers the average total cost per delivery. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition



Economics in Your Life

RETURNING TO THE DAYS OF SAILING SHIPS WITH HIGH-TECH WIND CYLINDERS For Critical Thinking Does Maersk’s use of sailing cylinders reduce its total fixed costs or its total variable costs?

Explain.

The use of sailing cylinders reduces total variable costs, because lower fuel expenses are incurred in the use of variable inputs such as labour and fuel to transport freight.

Real Application Suppose you and some friends have started a long-distance trucking business. You are considering adding wind-resistance-reducing equipment to your trucks. How will you decide whether to go ahead with this project?

Obviously, you have to consider the cost of the wind-resistance-reducing add-ons. If outfitting all of your trucks with such add-ons will cost you, say, $1 million, you will want to know how long it will take to “pay off” this “investment.” Thus, you will look at your annual fuel-cost reduction and compare that amount to the million-dollar investment. Clearly, you do not expect to save a million dollars in fuel the first year. Rather, you have to project out the annual fuel savings over time, then discount that stream of fuel-cost reductions back to the present. You will have to choose a discount rate that is at least equal to what it might cost you in forgone interest payments that you could have otherwise earned with the $1 million.

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Issues & Applications

RETAILERS EMPLOY AI AND ROBOTS IN PURSUIT OF ECONOMIES OF SCALE For Critical Thinking Why is it likely every bit as important, from a cost standpoint, for clothiers to know when upcoming orders for items should be raised or lowered considerably as it is to smooth out inventories over periods of steady sales?

If clothiers have too much inventory on hand (in times of low sales), then they face the additional costs of moving and storing that inventory. Alternatively, if they have to little inventory on hand (in times of high sales), then they face potential lost revenue on items people wished to purchase but couldn’t. Knowing ahead of time about these upswings or downswings in sales can help retailers greatly reduce moving and storage costs as well as lost revenue.

Real Application Perhaps you have read that AI-guided and robot-implemented systems will permanently reduce the need for human beings in the workforce. Should you be worried?

Machines have been replacing humans for a very long time, well before you were born.

Nonetheless, the labour force in Canada continues to grow, and the long-run rate of unemployment is not trending upward.

Yes, some will say that although this is true now, artificial intelligence is different and will change the world. The reality, however, is that AI is just a continuation of attempts at finding better ways to produce the goods and services that consumers wish to purchase. If, as ..

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Chapter 8 The Firm: Cost and Output Determination a result, the demand for your services is going to decrease over time, you will obviously want to prepare yourself by changing your occupation, learning new skills, going back to school, and so on.

In an unfettered labour market, there will always be a demand for workers, but perhaps not in the same occupations as before. When the demand for labour in one sector decreases because of the application of artificial intelligence, the demand for labour in another sector will increase over time.

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Answers to End-of-Chapter Questions

8-1. After graduation, you face a choice. One option is to work for a multinational consulting firm and earn a starting salary (benefits included) of $40,000. The other option is to use $5,000 in savings to start your own consulting firm. You could earn an interest return of 5 percent on your savings. You choose to start your own consulting firm. At the end of the first year, you add up all of your expenses and revenues. Your total includes $12,000 in rent, $1,000 in office supplies, $20,000 for office staff, and $4,000 in telecommunications expenses. What are your total explicit costs and total implicit costs?

Explicit costs are $12,000 in rent, $1,000 in office supplies, $20,000 for office staff, and $4,000 in telephone expenses for a total of $37,000. Implicit costs are the forgone $40,000 salary and the 5 percent interest on the $5,000 savings ($250) for a total of $40,250.

8-2. Suppose, as in Problem 8-1, that you have now operated your consulting firm for a year. At the end of the first year, your total revenues are $77,250. Based on the information in Problem 8-1, what is the accounting profit, and what is your economic profit?

Accounting profit is total revenue, $77,250, minus explicit costs, $37,000, for a total of $40,250.

Economic profit is total revenue, $77,250, less explicit costs, $37,000, and implicit costs, $40,250, for a total equal to zero.

8-3. An individual leaves a college faculty, where she was earning $80,000 a year, to begin a new venture. She invests her savings of $20,000, which were earning 10 percent annually.

She then spends $40,000 renting office equipment, hires two students at $30,000 a year each, rents office space for $24,000, and has other variable expenses of $80,000. At the end of the year, her revenues are $400,000. What is her accounting profit and her economic profit for the year?

The accounting profit is equal to revenue minus explicit costs. This is $400,000 minus $40,000 (office equipment), $60,000 (student labour), $24,000 (rent), $80,000 (variable expenses), which equals $196,000. Economic profit is derived by subtracting out opportunity costs, which equal the forgone salary of $80,000 and the interest she could have earned on her savings, 0.10 (10 percent) times $20,000, or $2,000. Economic profit is $114,000.

8-4. The academic calendar for a university is August 15 through May 15. A professor commits to a contract that binds them to a teaching position at this college for this period. Based on this information, explain the short run and long run that the professor faces. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition The short run is a time period during which the professor cannot enter the job market and find employment elsewhere. This is the nine-month period from August 15 through May 15. The professor can find employment elsewhere after the contract has been fulfilled, so the short run is nine months and the long run is greater than nine months.

8-5. The short-run production function for a manufacturer of wireless earbuds is shown in the table below. Based on this information, answer the following questions.

Input of Labour (workers per week) 0 1 2 3 4 5 6

Total Output of Wireless Earbuds 0 25 60 85 105 115 120

a. Calculate the average product at each quantity of labour. b. Calculate the marginal product of labour at each quantity of labour. c. At what point does marginal product begin to diminish? a.-b.

Input of Labour (workers per month)

Total Output of Wireless Earbuds

Average Product (a)

Marginal Product (b)

0 1 2 3 4 5 6

0 25 60 85 105 115 120

— 25.00 30.00 28.33 26.25 23.00 20.00

— 25 35 25 20 10 5

c. Marginal product begins to diminish when the firm raises employment from two to three workers. That is the employment level at which marginal product begins to decline from its peak of 35.

8-6. During the past year, a firm produced 10,000 laptop computers. Its total costs were $5 million, and its fixed costs were $2 million. What are the average variable costs of this firm?

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Chapter 8 The Firm: Cost and Output Determination Total variable costs are equal to total costs ($5 million) less total fixed costs ($2 million) which equals $3 million. Average variable costs are equal to total variable costs divided by the number of units produced. Average variable costs, therefore, equal $3 million divided by 10,000, or $300.

8-7. During the previous month, a firm produced 250 tablet devices at an average variable cost of $40 and at an average fixed cost of $10. What were the firm’s total costs during the month?

TC = ATC × Q = (AVC + AFC) × Q = $50 × 250 = $12,500 8-8. For the firm discussed in Problem 8-7, the total cost of producing 249 units was $12,425.

What was the marginal cost incurred by the firm in producing the final tablet device that month?

Marginal cost was equal to the change in total cost when the last tablet device was produced, which was $12,500 – $12,425 = $75.

8-9. The cost structure of a manufacturer of microchips is described in the table that follows.

The firm’s fixed costs equal $10,000 per day. Calculate the average variable cost, average fixed cost, and average total cost at each output level.

Output (microchips per day) 0 25 50 75 100 125 150

Total Cost of Output ($ thousands) 10 60 95 150 220 325 465

Output (microchips per day)

Total Cost of Output ($ thousands)

Average Total Costs ($ per unit)

Average Fixed Costs ($ per unit)

Average Variable Costs ($ per unit)

0 25 50 75 100 125 150

10

— 2.40 1.90 2.00 2.20 2.60 3.10

— 0.40 0.20 0.13 0.10 0.08 0.07

— 2.00 1.70 1.87 2.10 2.52 3.03

60 95 150 220 325 465

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 8-10. The diagram displays short-run cost curves for a facility that produces liquid crystal display (LCD) screens for cell phones:

a. What are the daily total fixed costs of producing 100 LCD screens? b. What are the total variable costs of producing 100 LCD screens per day? c. What are the total costs of producing 100 LCD screens per day? d. What is the marginal cost of producing 100 LCD screens instead of 99? (Hint: To answer this question, you must first determine the total costs—or, alternatively, the total variable costs—of producing 99 LCD screens.) a. Total fixed costs equal average fixed costs ($10 per LCD screen) times the quantity produced per day (100 LCD screens), which equals $1,000 per day. b. The total variable costs of producing 100 LCD screens equal average variable costs ($10 per unit) times the quantity produced per day (100 LCD screens), which equals $1,000 per day. c. The total costs of producing 100 LCD screens equal total fixed costs plus the total variable costs of producing 100 LCD screens, or $1,000 per day plus $1,000 per day, which equals $2,000 per day. d. The average total costs of producing 99 LCD screens equal the average fixed costs ($10.101) plus the average variable costs ($10.070), or $20.171 per LCD screen.

Thus, the total cost of producing 99 LCD screens equals $20.171 times 99, or $1,996.929. The marginal cost of producing the hundredth LCD screen equals the change in total costs from increasing production from 99 to 100, or $2,000 − $1,996.929, or $3.071 per LCD screen.

8-11. A watch manufacturer finds that at 1,000 units of output, its marginal costs are below average total costs. If it produces an additional watch, will its average total costs rise, fall, or stay the same?

Because marginal costs are below average total costs, average total costs are falling. If the firm increases its output, its average total costs will decline.

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Chapter 8 The Firm: Cost and Output Determination 8-12. At its current short-run level of production, a firm’s average variable costs equal $20 per unit, and its average fixed costs equal $30 per unit. Its total costs at this production level equal $2,500. a. What is the firm’s current output level? b. What are its total variable costs at this output level? c. What are its total fixed costs? a. Average total costs are $20 per unit plus $30 per unit, or $50 per unit, and total costs divided by average total costs equal output, which therefore is $2,500/$50 per unit, or 50 units. b. TVC = AVC × Q = $20 per unit × 50 units = $1,000. c. TFC = AFC × Q = $30 per unit × 50 units = $1,500; or TFC = TC – TVC = $2,500 − $1,000 = $1,500.

8-13. In an effort to reduce their total costs, many companies are now replacing paycheques with payroll cards, which are stored-value cards onto which the companies can download employees’ wages and salaries electronically. If the only factor of production that a company varies in the short run is the number of hours worked by people already on its payroll, would shifting from paycheques to payroll cards reduce the firm’s total fixed costs or its total variable costs? Explain your answer.

The wages paid to employees, the firm’s variable labour input, have not changed, so variable costs are unaffected. If the switch from issuing paycheques to payroll cards is cost reducing, this change will cut its fixed costs of meeting its payrolls.

8-14. During autumn months, passenger railroads across the globe deal with a condition called slippery rail. It results from a combination of water, leaf oil, and pressure from the train’s weight, which creates a slippery black ooze that prevents trains from gaining traction. a. One solution for slippery rail is to cut back trees from all of a rail firm’s rail network on a regular basis, thereby helping to prevent the problem from developing. If incurred, would this railroad expense be a better example of a fixed cost or a variable cost? Why? b. Another way of addressing slippery rail is to wait until it begins to develop. Then the company purchases sand and dumps it on the slippery tracks so that trains already en route within the rail network can proceed. If incurred, would this railroad expense be a better example of a fixed cost or a variable cost? Why? a. The expense incurred in cutting back trees on a regular basis would be unrelated to the quantity of rail services provided on the tracks and hence would represent a fixed cost. b. The expense of dumping sand on the slippery tracks in advance of trains would vary with the number of trains that run on the tracks and hence would constitute a variable cost.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 8-15. In the short run, a firm’s total costs of producing 100 units of output equal $10,000. If it produces one more unit, its total costs will increase to $10,150. a. What is the marginal cost of producing 101 instead of 100 units of output? b. What is the firm’s average total cost of producing 100 units? c. What is the firm’s average total cost of producing 101 units? a. Marginal cost is the addition to total costs when the 101st unit is produced, which is $10,150 – $10,000 = $150. b. ATC = TC/Q = $10,000/100 = $100. c. ATC = TC/Q = $10,150/101 = $100.50.

8-16. Suppose a firm’s only variable input is labour, and the constant hourly wage rate is $20 per hour. The last unit of labour hired enabled the firm to increase its hourly production from 250 units to 251 units. What was the marginal cost of producing 251 units of output instead of 250?

Hiring 1 more unit of labour at a wage rate of $20 to increase output by 1 unit causes total costs to rise by $20, so the marginal cost of the 251st unit is $20.

8-17. Suppose a firm’s only variable input is labour. The firm increases the number of employees from four to five, thereby causing weekly output to rise by two units and total costs to increase from $3,000 per week to $3,300 per week. a. What is the marginal product of hiring five workers instead of four? b. What is the weekly wage rate earned by the fifth worker? a. MP = 2 additional units of output / 1 additional worker = 2 additional units per additional worker. b. MC = ($3,300 – $3,000) / 1 additional unit of output = $300.

8-18. Suppose that a company currently employs 1,000 workers and produces 1 million units of output per month. Labour is its only variable input, and the company pays each worker the same monthly wage. The company’s current total variable costs equal $2 million. a. What are average variable costs at this firm’s current output level? b. What is the average product of labour? c. What monthly wage does the firm pay each worker? a. AVC = $2 million/1 million units = $2 per unit. b. AP = 1 million units/1,000 units of labour = 1,000 units of output per unit of labour. c. Wage rate = $2 million / 1,000 units of labour = $2,000 per unit of worker.

8-19. A manufacturing firm with a single plant is contemplating changing its plant size. It must choose from among seven alternative plant sizes. In the table, plant size A is the smallest it might build, and size G is the largest. Currently, the firm’s plant size is B. a. At plant size B, is this firm currently experiencing economies of scale or diseconomies of scale? b. What is the firm’s minimum efficient scale? ..

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Chapter 8 The Firm: Cost and Output Determination Plant Size A (smallest) B C D E F G (largest)

Average Total Cost ($) 4,250 3,600 3,100 3,100 3,100 3,250 4,100

a. Economies of scale, which will continue until plant size C. b. Plant size C, because this is the minimum output scale at which LAC is at a minimum level.

8-20. An electricity-generating company confronts the following long-run average total costs associated with alternative plant sizes. It is currently operating at plant size G. Plant Size A (smallest) B C D E F G (largest)

Average Total Cost ($) 2,000 1,800 1,600 1,550 1,500 1,500 1,500

a. What is this firm’s minimum efficient scale? b. If damage caused by a powerful hurricane generates a reduction in the firm’s plant size from its current size to B, would there be a leftward or rightward movement along the firm’s long-run average total cost curve? a. Plant size E, because this is the minimum output scale at which LAC is at a minimum level. b. Leftward movement, because the functioning plant size for the firm would decrease.

8-21. Take a look at Figure 8-2. Suppose that the firm decided to consider employing a twelfth unit of labour, which it has determined would result in a decrease in total product to 370 units of output. If it were to do this, what would be the resulting average product of labour and marginal product of labour?

The average product of labour would be 370 units of output / 12 units of labour, or 30.83 units of output per unit of labour.

The marginal product of labour would be the resulting reduction in total product from 380 units to 370 units resulting from hiring the additional unit of labour, or –10 units of output per unit of labour.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 8-22. Consider Figure 8-3. If this firm were to boost its output to 12 units of output and thereby raise its total variable costs to $54, what would be the resulting average fixed cost, average variable cost, average total cost, and marginal cost?

AFC = $10 / 12 units = $0.83 per unit AVC = $54 / 12 units = $4.50 per unit ATC = AFC + AVC = $0.83 per unit + $4.50 per unit = $5.33 per unit, or ATC = (TFC + TVC)/output = ($10 + $54)/12 units = $64 /12 units = $5.33 per unit MC = $54−$46, or $8 per unit 8-23. Consider Figure 8-4. If the firm were to employ an eighth unit of labour, its total product would rise to 380 units of output. What would be the resulting values of the average product of labour and of the marginal product of labour?

The average product of labour would equal 380 units of output / 8 units of labour = 47.5 units of output per unit of labour.

The change in total product from adding the eighth unit of labour would be 380 units of output less 360 units of output. Hence, the marginal product equals 20 units of output per unit of labour.

8-24. In Problem 8-23, if the firm were to employ the eighth unit of labour and produce 380 units of output, what would be the average variable cost and the marginal cost?

Average variable cost = $1,000 / 47.5 units of output, or $21.05 per unit of output.

Marginal cost = $1,000 / 20 units of output = $50 per unit of output.

8-25. Take a look at Figure 8-5. Suppose that the firm boosts its scale of operations from a level consistent with short-run average cost curve SAC3 to short-run average cost curve SAC5.

Explain what happens with respect to economies or diseconomies of scale.

Initially, at the scale consistent with SAC3, the firm was operating along the downward-sloping portion of its long-run average cost curve, so it experienced economies of scale. After increasing its scale of output to the level consistent with SAC5, the firm now operates along the upwardsloping portion of the LAC curve, so it is experiencing diseconomies of scale.

8-26. Consider Figure 8-7. Suppose that the current scale of output for a typical firm facing this LAC curve, which applies to all firms in this industry, is between points A and B, at about 500 units per period. If a new firm entering the industry desires to produce at the minimum efficient scale, would it wish to produce 10 units per period, 500 units per period, or 1000 units per period? Explain.

Although any of the three output rates is consistent with minimized long-run average cost, by definition the minimum efficient scale is the lowest rate of output per period that minimizes longrun average cost. Hence, the new firm entering the industry will wish to produce at any rate exceeding 10 and less than 1,000 units of output per period.

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Chapter 9 Perfect Competition 

Answers to Questions for Critical Analysis

AI: ACCESSING ALL RELEVANT INFORMATION FOR “DYNAMIC PRICING” You might be surveyed someday on whether you know the price per litre of gasoline that you purchased for your car. You might be one of those individuals who cannot remember that price.

Does that mean that the retail market for gasoline is not competitive?

Certainly not. Remember that it is movement on the margin that generates changes in quantities demanded. Just because a large percentage of automobile drivers do not know what they paid per litre for gas does not mean that every car owner ignores the price of gas in making a decision of how much gasoline to consume or where to purchase it.

Data have been collected on long stretches of urban roads that have numerous gas stations. It turns out on any particular day, the gas stations that publicly post the lowest prices per litre consistently sell larger quantities.

And do not forget that businesses that use many vehicles will insist that their vehicle drivers purchase fuel at the lowest price per litre.

REALLOCATING PASSENGER AIRCRAFTS TO CARGO AIRCRAFTS DURING THE PANDEMIC Why do you suppose that after the pandemic airlines will return the aircrafts back to passenger aircrafts?

After the pandemic, the demand for passenger air travel will increase. Since passenger aircrafts generate more revenue for airlines, by reallocating space to passengers owners of the airlines are responding to the market signal.

ASSESSING THE LONG-RUN INDUSTRY SUPPLY CURVE IN THE GROWING THIRD-PARTY FOOD DELIVERY INDUSTRY If a future technological change were to cause the price of food delivery services to drop below its existing level following entry of new firms even as market demand continued to increase, what type of industry would exist?

If the long-run market clearing price falls as demand increases and supply increases, the industry would be classified as a decreasing-cost industry.

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Economics in Your Life

FOR URBAN FARMERS, INDUSTRY ENTRY MAY BE RELATIVELY UNIMPEDED BUT STILL ENTAILS A KEY EXPENSE For Critical Thinking Why do you suppose that some enterprising urban farmers are growing their crops on tops of buildings?

By growing crops on tops of buildings, they are using a resource that has already been used (by the building itself The cost of acquiring the resource is likely pretty low (as it was most ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition likely not being used for anything else), but the costs of outfitting the top of the building for farming are probably high (reinforcements to the roof, waterproofing, and so on). If the overall cost of farming on the tops of buildings was the same as the overall costs faced by rural farmers, these roof-top farmers can enter the market and be competitive.

Real Application Assume you have access to funds that would allow you to enter the vegetable-growing business.

You have the choice of purchasing the rights to grow your vegetables in an urban setting or a rural setting. How will you decide where to grow your vegetables?

You will have to look at all of the costs involved. The cost of planting, growing, and harvesting your vegetables will be about the same in either a rural or urban setting. There will be a difference in the cost of land use, in contrast. It will cost you more to use land in the urban setting, because there are alternative high-value uses of that land (usually). In a rural setting, there are fewer alternative uses and therefore the opportunity cost is lower.

Your cost of distribution and establishing yourself as a reliable vegetable provider also will differ. In an urban setting, you can more quickly and perhaps more cheaply establish a distribution system. It may also be easier to develop a positive reputation among potential customers. In a rural setting, however, this will be more costly. Thus, you have to compare all of the different costs for each option before you can make the most profitable choice.

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Issues & Applications

CANADIAN FARMERS PIVOT AND PLANT MORE DURUM WHEAT For Critical Thinking If the price of durum wheat increases more than other grains, what is the effect on the supply and price of durum wheat in the next growing season?

The increase in the price of durum wheat will attract more farmers to grow this grain, which will cause the supply of durum wheat to increase and the price to decrease.

Real Application As a Canadian farmer, what would you consider when choosing a crop to grow?

After you decide what type of crop your soil will optimally produce, you should also consider historical prices of the crop, any possible impacts on global demand and supply, and weather forecasts.

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Answers to End-of-Chapter Questions

9-1. Explain why each of the following examples is not a perfectly competitive industry. a. One firm produces a large portion of the industry’s total output, but there are many firms in the industry, and their products are indistinguishable. Firms can easily exit and enter the industry. b. There are many buyers and sellers in the industry. Consumers have equal information about the prices of firms’ products, which differ moderately in quality from firm to firm. c. Many taxicabs compete in a city. The city’s government requires all taxicabs to provide identical service. Taxicabs are nearly identical, and all drivers must wear a designated ..

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Chapter 9 Perfect Competition uniform. The government also enforces a binding limit on the number of taxicab companies that can operate within the city’s boundaries. a. The single firm producing much of the industry’s output can affect price. Therefore, this is currently not a perfectly competitive industry. b. The output of each firm is not homogeneous, so this is not a perfectly competitive industry. c. Firms must obtain government permission to enter the industry and hence cannot easily enter, so this is not a perfectly competitive industry.

9-2. Consider a market for online movie rentals. The market supply curve slopes upward, the market demand curve slopes downward, and the equilibrium rental price equals $3.50.

Consider each of the following events, and discuss the effects each will have on the market clearing price and on the demand curve faced by the individual online rental firm. a. People’s tastes change in favour of going to see more movies at cinemas with their friends and family members. b. More online movie-rental firms enter the market. c. There is a significant increase in the price to consumers of purchasing movies online. a. The market demand for online rentals decreases, so the market demand curve shifts inward. The market clearing price falls. The marginal revenue curve that is horizontal at this price, which is the demand curve faced by the individual online movie-rental firm, shifts downward. b. The market supply of online movie rentals increases, so the market supply curve shifts outward. The market clearing price falls. The marginal revenue curve that is horizontal at this price, which is the demand curve faced by the individual online movie-rental firm, shifts downward. c. The market demand for online movie rentals increases, so the market demand curve shifts outward. The market clearing price rises. The marginal revenue curve that is horizontal at this price, which is the demand curve faced by the individual online movie-rental firm, shifts upward.

9-3. Consider the diagram below, which applies to a perfectly competitive firm, which at present faces a market clearing price of $20 per unit and produces 10,000 units of output per week. a. What is the firm’s current average revenue per unit? b. What are the present economic profits of this firm? Is the firm maximizing economic profits? Explain. c. If the market clearing price drops to $12.50 per unit, should this firm continue to produce in the short run if it wishes to maximize its economic profits (or minimize its economic losses)? Explain. d. If the market clearing price drops to $7.50 per unit, should this firm continue to produce in the short run if it wishes to maximize its economic profits (or minimize its economic losses)? Explain.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition

a. For a perfectly competitive firm, marginal revenue and average revenue are equal to the market clearing price. Hence, average revenue equals $20 per unit at each possible output rate. b. At the present output of 10,000 units per week, the firm’s total revenues equal price times output, or $20 per unit times 10,000 units per week, which equals $200,000 per week. The firm’s total costs equal ATC times output, or $15.75 per unit times 10,000 units per week, which equals $157,500 per week. Weekly economic profits equal total revenues minus total costs, or $200,000 − $157,500 = $42,500. The firm is maximizing economic profits because it is producing the output rate at which marginal revenue equals marginal cost. c. If the market clearing price were to fall to $12.50 per unit, the marginal revenue curve would shift down to this level. Average total costs would exceed the price at this output rate, but in the short run the firm would minimize its short-run economic losses by producing 8,100 units per week. d. If the market clearing price were to fall to $7.50 per unit, the marginal revenue curve would shift down to this level. Average variable costs at an output rate of 5,000 units per week would exceed the market clearing price, so total variable costs of producing 5,000 units per week would exceed total revenues. The firm should cease production if this event takes place.

9-4. The table below represents the hourly output and cost structure for a local pizzeria. The market is perfectly competitive, and the market price of a pizza in the area is $10. Total costs include all opportunity costs. Fixed costs equal zero.

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Chapter 9 Perfect Competition Total Hourly Output and Sales of Pizzas 0 1 2 3 4 5 6 7 8 9 10

Total Hourly Variable Cost ($) 5 9 11 12 14 18 24 32 42 54 68

a. Calculate the total revenue and total economic profit for this pizzeria at each rate of output. b. Assuming that the pizzeria always produces and sells at least one pizza per hour, does this appear to be a situation of short-run or long-run equilibrium? c. Calculate the pizzeria’s marginal cost and marginal revenue at each rate of output.

Based on marginal analysis, what is the profit-maximizing rate of output for the pizzeria? d. Draw a diagram depicting the short-run marginal revenue and marginal cost curves for this pizzeria, and illustrate the determination of its profit-maximizing output rate. a. Total revenues, total costs, and economic profits appear below.

Total Output

Total Variable Cost ($)

Total Revenue ($)

Total Economic Profits ($)

0 1 2 3 4 5 6 7 8 9 10

5 9 11 12 14 18 24 32 42 54 68

0 10 20 30 40 50 60 70 80 90 100

–5 1 9 18 26 32 36 38 38 36 32

b. This would be a short-run equilibrium because only the firm’s short-run cost curves are taken into account. c. As indicated in the table below, at the profit-maximizing rate of output, marginal cost equals marginal revenue, which occurs at eight pizzas.

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Total Output

Total Variable Costs ($)

Marginal Cost ($ per unit)

Marginal Revenue ($ per unit)

0 1 2 3 4 5 6 7 8 9 10

5 9 11 12 14 18 24 32 42 54 68

— 4 2 1 2 4 6 8 10 12 14

10 10 10 10 10 10 10 10 10 10 10

d.

9-5. Consider the information provided in Problem 9-4. Suppose the market price drops to only $5 per pizza. In the short run, should this pizzeria continue to make pizzas, or will it maximize its economic profits (that is, minimize its economic loss) by shutting down?

When the price of pizzas, and hence marginal revenue, falls to $5 per unit, marginal revenue will equal marginal cost at an output between 5 and 6 units. The $5 price covers the average variable cost between $3.60 and $4.00 per unit. Thus, the pizzeria should stay open.

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Chapter 9 Perfect Competition Total Output 0 1 2 3 4 5 6 7 8 9 10

TVC ($)

AVC ($ per unit)

MC ($ per unit)

MR ($ per unit)

5 9 11 12 14 18 24 32 42 54 68

— 9.00 5.50 4.00 3.50 3.60 4.00 4.57 5.25 6.00 6.80

— 4 2 1 2 4 6 8 10 12 14

5 5 5 5 5 5 5 5 5 5 5

9-6. Until today, a perfectly competitive producer of construction bricks manufactured and sold 10,000 bricks per week at a market price that was just equal to the minimum average variable cost of producing each brick. Today, all the firm’s costs are the same, but the market price of bricks has declined. a. Until today, if this firm has positive fixed costs, did the firm earn economic profits, economic losses, or zero economic profits yesterday? b. To maximize economic profits today, how many bricks should this firm produce today? a. Economic losses, because price is already less than AVC, which in turn is less than ATC, so economic profits, which equal (P – ATC)  Q, must be negative. b. None; the firm should halt production because if P < AVC, total revenues are less than total variable costs and the firm is below its shutdown point.

9-7. Suppose that a firm in a perfectly competitive industry finds that at its current output rate marginal revenue exceeds the minimum average total cost of producing any feasible rate of output. Furthermore, the firm is producing an output rate at which marginal cost is less than the average total cost at that rate of output. Is the firm maximizing its economic profits?

Why or why not?

In the described situation, the firm is producing an output rate at a point on the marginal cost curve below the average total cost curve. Marginal revenue is above the minimum point of the average total cost curve, however. Hence, marginal cost at the current rate of production is less than marginal revenue. The firm is not maximizing profit, and it should increase its rate of production.

9-8. A perfectly competitive industry is initially in a short-run equilibrium in which all firms are earning zero economic profits but in which firms are operating below their minimum efficient scale. Explain the long-run adjustments that will take place for the industry to attain long-run equilibrium with firms operating at their minimum efficient scale. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition As firms expand the scale of their operations to reduce their average total costs, their short-run average and marginal costs will also decline. The rightward shifts in marginal cost curves imply rightward shifts in the firms’ short-run supply curves, so market supply (the summation of all firms’ short-run supply curves) will rise and the market price declines. After these adjustments take place, in a long-run equilibrium the market price will equal long-run average total cost at the minimum point of the long-run average cost curve.

9-9. Two years ago, a large number of firms entered a market in which existing firms had been earning positive economic profits. By the end of last year, the typical firm in this industry had begun earning negative economic profits. No other events occurred in this market during the past two years. a. Explain the adjustment process that occurred last year. b. Predict what adjustments will take place in this market beginning this year, other things being equal. a. There was a significant increase in market supply as more firms entered the industry. A consequence for the typical firm was that the market price fell below the minimum average total cost, resulting in negative economic profits. b. Firms will consider leaving the industry, and some firms probably will leave the industry.

9-10. The minimum feasible long-run average cost for firms in a perfectly competitive industry is $40 per unit. If every firm in the industry currently is producing an output consistent with a long-run equilibrium, what is the marginal cost incurred by each firm? What is the market price?

Price and marginal cost are both equal to the minimum long-run average cost, which is $40.

9-11. In several markets for digital devices that can be viewed as perfectly competitive, steady increases in demand for the required minerals ultimately have generated long-run reductions in the market prices of these devices. Describe in words the types of adjustments that must have occurred in these markets to have brought about this outcome, and evaluate whether such digital-device industries are increasing-, constant-, or decreasing-cost industries.

Increases in demand have initially led to higher economic profits for incumbent firms, which has generated entry by other firms into digital-device industries and caused market supply curves to shift outward. As more firms have entered and increased production of digital devices, input prices have declined, so firms’ costs have decreased. On net, therefore, long-run equilibrium market prices have declined, implying that these digital-device industries are decreasing-cost industries.

9-12. In several perfectly competitive markets for minerals used as inputs in digital devices, persistent increases in demand eventually have generated long-run increases in the market prices of these devices. Describe in words the types of adjustments that must have occurred in these markets to have brought about this outcome, and evaluate whether such digital-extraction industries are increasing-, constant-, or decreasing-cost industries. ..

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Chapter 9 Perfect Competition Increases in demand have initially led to higher economic profits for incumbent firms, which has generated entry by other firms into mineral-extraction industries and caused market supply curves to shift outward. As more firms have entered and boosted mineral extraction, input prices have risen, so firms’ costs have increased. On net, therefore, long-run equilibrium market prices have increased, implying that these digital-device industries are increasing-cost industries.

9-13. Suppose that the firm with the costs and revenues tabulated in Figure 9-2 is contemplating whether to produce 12 units of output. If it were to produce this many units, what (if anything) would happen to the market price? What would be the firm’s marginal revenue for the twelfth unit produced? What would be the firm’s total revenues per hour?

This firm is perfectly competitive, so its output rate is so small in relation to the industry as a whole that its production could not influence the market price, which would remain at $5 per unit. The market price equals the firm’s marginal revenue, which therefore would be MR = $5 per unit. The firm’s hourly total revenues if it were to produce 12 units would equal 12 units times $5 per unit, or $60.

9-14. Consider the firm discussed in Problem 9-13. If the firm were to produce the twelfth unit and thereby incur hourly total costs of $65, what would be its marginal cost? Based on this answer and your answers to Problem 9-13, would producing 12 units maximize the firm’s profits? What would be its hourly economic profits?

Marginal cost would equal the addition to total cost of producing the twelfth unit, or $65 less the $56 total costs incurred to product 11 units, or MC = $9 per unit. This $9-per-unit marginal cost would exceed the $5-per-unit marginal revenue, so producing the twelfth unit would not satisfy the profit-maximizing rule MR = MC. Economic profits would equal total revenues of $60 minus total costs of $65, or −$5.

9-15. Take a look at Figure 9-3. This figure uses the data in the table from Figure 9-2, which indicates that the area of the blue rectangle displaying hourly economic profits is $5 per period. What prevents this firm from continuing to produce the same number of units per hour but raising the price that it charges for each unit in order to enlarge the area of the profit rectangle?

Recall that because this is a perfectly competitive firm, its product is indistinguishable from the products of all other firms. Thus, if the firm were to raise its price above the market clearing price of $5 per unit, all of its customers would substitute away from its product in favour of the identical products provided by other firms at the $5-per-unit market clearing price. The firm’s profits would disappear.

9-16. Consider Figure 9-5, and suppose that the price per unit corresponding to the position of d1 is at $4.50 per unit and that the quantity at point E1 is exactly 7 units per hour.

Calculate total revenues, total costs, and economic profits at point E1, and explain why it is called the short-run break-even point.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition Total revenues equal $4.50 per unit times 7 units per hour, or $31.50 per hour. Total costs equal $4.50 per unit times 7 units per hour, or $31.50 per hour. Hence, hourly economic profits equal $0 per hour. Thus, at this point the firm just “breaks even” in the sense that it earns sufficient accounting profits to cover all relevant opportunity costs—that is, an economic profit of zero.

9-17. Take a look at Figure 9-5, and suppose that the price per unit corresponding to the position of d2 is at $2.50 per unit and that the quantity at point E2 is exactly 5 units per hour. Calculate total revenues and total variable costs at point E2 and explain why it is called the short-run shutdown point.

Total revenues equal $2.50 per unit times 5 units per hour, or $12.50 per hour. Total variable costs equal $2.50 per unit times 5 units per hour, or $12.50 per hour. Consequently, at a price of $2.50 per unit, total revenues are just sufficient to cover the costs of employing labour and any other variable inputs. If the price were to fall further, revenues would not cover these costs, so the firm should halt production.

9-18. Consider Figure 9-8. Why does the output rate in panel (b) remain at qe units per hour even if the position of the AC curve shifts from AC1 to AC3 following an increase in fixed costs, and how do we know that economic profits then become negative?

The increase in fixed costs leaves marginal cost unaffected, so the profit-maximizing point at which MR = MC is unchanged. Thus, the firm’s profit-maximizing output remains at qe following the rise in fixed costs. At the quantity qe average cost exceeds price, so profits must be negative.

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Chapter 10

Monopoly 

Answers to Questions for Critical Analysis

TOUGH REGULATIONS LIMIT LICENCES FOR MOBILE FOOD VENDORS Are the profits of Toronto restaurants higher or lower than they otherwise would be if Toronto relaxed regulations and were to permit many more food trucks to operate within the city?

The barriers to entry to food trucks established by the City of Toronto’s regulations protects restaurants from competition, which results in higher restaurant prices.

AI: USING “DYNAMIC CLUSTERING ANALYSIS” TO MAXIMIZE PROFITS Why is the “dynamic”—meaning “in motion over time”—nature of demand a fundamental aspect of any monopoly’s problem in searching for the price that maximizes its profit during a given period?

Each time a ceteris paribus determinant of demand, such as consumers’ incomes or tastes and preferences, changes, so does the position of the demand curve and the associated marginal revenue curve, which requires a monopoly firm to search once more for the profit-maximizing quantity and price.

AI: PRICE DISCRIMINATION VIA “PERSONALIZED PRICING” If you regularly purchase items online via Amazon, how can you check to see if the company is engaged in personalized price discrimination?

You will need to conduct a simple experiment with one or more friends or family members who have separate Amazon accounts. You would choose several items for which you are going to query Amazon for pricing and availability. Then, at approximately the same time, those helping you with this experiment need to look up the price of the same item on Amazon. For consistency, each person must be looking for the price charged by the same seller; the most straightforward way to accomplish this is to ignore third-party sellers and only look at prices charged by Amazon itself. Each person should mark down the price at which the product is offered. Do this for several products, then compare the results. If all of the prices are the same, Amazon is not attempting personalized price discrimination. If, in contrast, the prices are different, then Amazon is probably engaging in personalized price discrimination tactics.

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Economics in Your Life

SO, YOU WANT TO PRACTISE MEDICINE IN CANADA? GET A LICENCE! For Critical Thinking What is the effect of Canada’s licensing requirement on the quantity medical services provided by doctors located in the country?

Canada’s licensing requirement for medical services constitutes a barrier to entry to foreigntrained doctors. The effect of this licensing requirement would therefore be a reduction in the quantity of services provided by doctors located in Canada and longer wait times for patients. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition Real Application Onerous licensing statutes for the provision of different services exist in many provinces, and these statutes are increasing in number and complexity. How could you protect yourself from a situation similar to what foreign-trained doctors face in Canada?

Thanks to the Internet, you can quickly and easily research any profession that you might wish to enter on a province-by-province or even city-by-city basis. If you wish to open a nail salon, you can find out the regulatory licensing requirements in different provinces and cities.

If you wish to open a hair-braiding salon, you can do the same. If you wish to provide massage services, you will find vastly different licensing requirements depending on the province or city. Some areas may require hundreds of hours of schooling and hundreds of hours of internships before you can legally offer to provide massages for a fee.

You can also research the standard rates of compensation for the service you plan to offer and then determine whether the occupation you are considering is worth the added effort of securing a provincial or local licence. If you decide that it is not worth the added effort, you can consider offering another service, possibly even online, that does not require licensing.

You can possibly offer services on crowdsourcing sites and apps that allow you to bid for various jobs without requiring a professional licence.

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Issues & Applications

THE UNRAVELLING OF TAXICAB MONOPOLIES For Critical Thinking How do you suppose that the substantial increase in profits by traditional taxicab firms between 2009 and 2012 affected the incentive for non-taxi drivers to offer services through ride-sharing firms such as Uber and Lyft?

In a perfectly competitive market, the substantial profits would induce more firms to enter the industry. However, due to the large barriers to entry in the taxicab industry, new firms had to be creative and “get around” the licences. They did so by offering similar, but not identical, services at a lower price.

Real Application Because of competition from Uber, Lyft, and other ride-sharing services, the cost of obtaining a licence to offer legal taxi services has fallen just about everywhere in the Canada. Does that mean you should be more interested in purchasing a taxi licence than you would have been when they were sold at much higher prices?

Probably not. At any point in time, the market value of a taxi licence reflects the discounted present value of the future stream of profits. When there was no competition from Uber and Lyft, those streams of profits were higher, and hence taxi licences were worth more.

Currently, because of increased competition, the expected discounted present value of the stream of profits from owning a taxi licence has been substantially reduced. The lower-priced taxi licences are not a “bargain.” If you decide to purchase one and offer taxi services, you can expect to make no more than a competitive rate of return.

You could, though, once you purchase such a licence, attempt to make higher profits.

You would do this by offering better service to customers who use your taxis. You could make sure that the taxis are cleaner than in the past and that the drivers offer better customer ..

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Chapter 10 Monopoly service than in the past. You could install easier-to-use credit card payments plus tablet-type entertainment for passengers in the rear seats.

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Answers to End-of-Chapter Questions

10-1. The following table depicts the daily output, price, and costs of a monopoly dry cleaner located near the campus of a remote college town.

Output (suits cleaned) 0 1 2 3 4 5 6 7 8

Price per Suit ($) 8.00 7.50 7.00 6.50 6.00 5.50 5.00 4.50 4.00

Total Costs ($) 3.00 6.00 8.50 10.50 11.50 13.50 16.00 19.00 24.00

a. Compute revenues and profits at each output rate. b. What is the profit-maximizing rate of output? c. Calculate the dry cleaner’s marginal revenue and marginal cost at each output level.

What is the profit-maximizing level of output? a. The total revenue and total profits of the dry cleaner are as follows.

Output (suits cleaned) 0 1 2 3 4 5 6 7 8

Price per Suit ($) 8.00 7.50 7.00 6.50 6.00 5.50 5.00 4.50 4.00

Total Costs ($) 3.00 6.00 8.50 10.50 11.50 13.50 16.00 19.00 24.00

Total Revenue ($) 0 7.50 14.00 19.50 24.00 27.50 30.00 31.50 32.00

Total Profit ($) –3.00 1.50 5.50 9.00 12.50 14.00 14.00 12.50 8.00

b. The profit-maximizing rate of output is between 5 and 6 units. c. The marginal cost and marginal revenue of the dry cleaner are as follows. The profitmaximizing rate of output is 6 units.

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Output 0 1 2 3 4 5 6 7 8

Price ($) 8.00 7.50 7.00 6.50 6.00 5.50 5.00 4.50 4.00

TC ($) TR ($) Profit ($) 3.00 0 –3.00 6.00 7.50 1.50 8.50 14.00 5.50 10.50 19.50 9.00 11.50 24.00 12.50 13.50 27.50 14.00 16.00 30.00 14.00 19.00 31.50 12.50 24.00 32.00 8.00

MC ($ per unit) — 3.00 2.50 2.00 1.00 2.00 2.50 3.00 5.00

MR ($ per unit) — 7.50 6.50 5.50 4.50 3.50 2.50 1.50 0.50

10-2. A manager of a monopoly firm notices that the firm is producing output at a rate at which average total cost is falling but is not at its minimum feasible point. The manager argues that surely the firm must not be maximizing its economic profits. Is this argument correct?

This statement is not correct. Profit maximization occurs at the output rate at which marginal revenue equals marginal cost. This rate of output may well occur at a point above and to the left of the point of minimum average total cost.

10-3. Use the graph below to answer the questions that follow.

a. What is the monopolist’s profit-maximizing output? b. At the profit-maximizing output rate, what are average total cost and average revenue? c. At the profit-maximizing output rate, what are the monopolist’s total cost and total revenue? d. What is the maximum profit? e. Suppose the marginal cost and average total cost curves in the diagram also illustrate the horizontal summation of the firms in a perfectly competitive industry in the long run.

What would the equilibrium price and output be if the market were perfectly competitive? Explain the economic cost to society of allowing a monopoly to exist.

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Chapter 10 Monopoly a. The profit-maximizing output rate is 5,000 units. b. Average total cost is $5 per unit. Average revenue is $6 per unit. c. Total costs equal $5 per unit × 5,000 units = $25,000. Total revenue equals $6 per unit × 5,000 units = $30,000. d. ($6 per unit – $5 per unit) × 5,000 units = $5,000. e. In a perfectly competitive market, price would equal marginal cost at $4.50 unit, at which the quantity is 8,000 units. Because the monopolist produces less and charges a higher price than under perfect competition, price exceeds marginal cost at the profitmaximizing level of output. The difference between the price and marginal cost is the per-unit cost to society of a monopolized industry.

10-4. The marginal revenue curve of a monopoly crosses its marginal cost curve at $30 per unit and an output of 2 million units. The price that consumers are willing to pay for this output is $40 per unit. If it produces this output, the firm’s average total cost is $43 per unit. What is the profit-maximizing (loss- minimizing) output? What are the firm’s economic profits (or economic losses)?

The firm’s loss-minimizing output is 2 million units, and its short-run economic losses equal ($40 per unit – $43 per unit) × 2 million units = –$6 million.

10-5. A monopolist’s maximized rate of economic profits is $5,000 per week. Its weekly output is 500 units, and at this output rate, the firm’s marginal cost is $15 per unit. The price at which it sells each unit is $40 per unit. At these profit and output rates, what are the firm’s average total cost and marginal revenue?

The monopolist’s total revenues equal 500 units per week × $40 per unit = $20,000 per week.

Thus, its total costs equal total revenues – economic profits = $20,000 per week – $5,000 per week = $15,000 per week. Average total cost equals the ratio of total costs to the output rate, or $15,000/500 units = $30 per unit. The firm has maximized profits by producing to the point at which marginal cost, which is $15 per unit, equals marginal revenue, so marginal revenue is $15 per unit.

10-6. Currently, a monopolist’s profit-maximizing output is 200 units per week. It sells its output at a price of $60 per unit and collects $30 per unit in revenues from the sale of the last unit produced each week. The firm’s total costs each week are $9,000. Given this information, what are the firm’s maximized weekly economic profits and its marginal cost?

The firm’s total revenues are $60 per unit × 200 units per week = $12,000 per week. Thus, its weekly economic profits equal $12,000 – $9,000 = $3,000. Its marginal revenue, which is $30 per unit, is equal to marginal cost when the firm maximizes profits, so marginal cost is equal to $30 per unit.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 10-7. Consider the revenue and cost conditions for a monopolist that are depicted in the figure below. a. If price exceeds AVC, what is this producer’s profit-maximizing (or loss-minimizing) output? b. What are the firm’s economic profits (or losses)?

a. The monopoly maximizes economic profits or minimizes economic losses by producing to the point at which marginal revenue is equal to marginal cost, which is 1 million units of output per month. b. The profit-maximizing or loss-minimizing price of 1 million units per month is $30 per unit, so total revenues equal $30 million per month. The average total cost of producing 1 million units per month is $33 per unit, so total costs equal $33 million per month. Hence, in the short run, producing 1 million units minimizes the monopoly’s loss at $3 million per month.

10-8. For each of the following examples, explain how and why a monopoly would try to price discriminate. a. Air transport for businesspeople and tourists b. Serving food on weekdays to businesspeople and retired people. (Hint: Which group has more flexibility during a weekday to adjust to a price change and, hence, a higher price elasticity of demand?) c. A theatre that shows the same movie to large families and to individuals and couples.

(Hint: For which set of people will the overall expense of a movie be a larger part of their budget, so that demand is more elastic?) a. The businessperson’s desire for air travel is less flexible than that of a tourist. The businessperson’s demand, therefore, is likely to be more inelastic. The pricediscriminating firm should charge the businessperson a higher price and the tourist a lower price. b. The businessperson is likely to have less flexibility in timing when choosing where to eat on a weekday than a retired individual, so the businessperson’s demand will be ..

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Chapter 10 Monopoly more inelastic than the retired person. The price-discriminating firm should charge the businessperson a higher price and the retired person a lower price. c. The cost of a movie for a family of four is a larger part of the family budget than for a couple only. The family’s demand for a movie will be more elastic than the couple’s demand. The price-discriminating firm should, therefore, charge a lower average price to the family and a higher average price to the couple. It can do this by admitting children at reduced ticket prices.

10-9. A monopolist’s revenues vary directly with price. Is it maximizing its economic profits?

Why or why not? (Hint: Recall that the relationship between revenues and price depends on price elasticity of demand.)

If price varies positively with total revenue, then the monopolist is operating on the inelastic portion of the demand curve. This corresponds to the range where marginal revenue is negative.

The monopolist cannot, therefore, be at the point where its profits are maximized. In other words, the monopolist is not producing where marginal cost equals marginal revenue.

10-10. A new competitor enters the industry and competes with a second firm, which had been a monopolist. The second firm finds that although demand is not perfectly elastic, it is now more elastic. What will happen to the second firm’s marginal revenue curve and to its profit-maximizing price?

Because demand is more elastic, the marginal revenue curve is also more elastic. It is likely that the price the monopolist can charge has fallen.

10-11. A monopolist’s marginal cost curve has shifted upward. What is likely to happen to the monopolist’s price, output rate, and economic profits?

Because marginal cost has risen, the monopolist will be operating at a lower rate of output and charging a higher price. Economic profits are likely to decline because even though the price is higher, its output will be more than proportionately lower.

10-12. Demand has fallen. What is likely to happen to the monopolist’s price, output rate, and economic profits?

When demand decreases, the demand curve and corresponding marginal revenue curve both shift leftward. Thus, the marginal revenue curve shifts to the left along the marginal cost curve, indicating a reduction in the profit-maximizing output rate. The leftward shift in demand means a reduced willingness to pay at any given quantity, so at the lower quantity the profit-maximizing price is likely to be lower, as is the maximum amount of economic profits.

10-13. Suppose that in Figure 10-4 the monopolist knows that if it were to reduce the price of its product to $19.00 per unit, the quantity demanded—and hence its output—would rise to 13 units per week. What would be the marginal revenue that the monopolist would derive from producing and selling a thirteenth unit?

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition Total revenues from production and sale of 13 units would equal $19.00 per unit times 13 units, or $247.00. Column (3) of panel (a) indicates that total revenues for 12 units equal $240.00, so marginal revenue from production and sale of the thirteenth unit would be $7 per unit.

10-14. Consider the information from Problem 10-13. If the total costs of producing 13 units were equal to $250.60 per week, would the marginal revenue of producing the thirteenth unit (your answer to Problem 10-13) be greater or less than the marginal cost of producing that unit? How would the firm’s weekly economic profits be affected if the firm were to produce the thirteenth unit?

The marginal cost of producing 13 units would equal the difference between $250.60 and $219.40 in total costs if it were to produce 12 units, or $31.20 per unit. This $31.20-per-unit marginal cost would exceed the $7-per-unit marginal revenue by $24.20 per unit and hence would reduce the firm’s profits by $24.20 per week.

10-15. Take a look at Figure 10-5. Suppose that Q1 is equal to 25 units of output per time period.

If the vertical distance to point A is $10 per unit and the vertical distance to point B is $4 per unit, then by how much does producing the twenty-fifth unit of output affect the firm’s economic profits?

The vertical distance to point A, $10 per unit, is the marginal revenue received as a result of producing and selling the twenty-fifth unit, and the vertical distance to point B, $4 per unit, is the marginal cost incurred in doing so. Consequently, producing the twenty-fifth unit adds the difference, $6, to the firm’s economic profits during this time period.

10-16. Look again at Figure 10-5. Suppose that Q2 is equal to 35 units of output per time period.

If the vertical distance to point C is $6 per unit and the vertical distance to point B is $3 per unit, then by how much does producing the thirty-fifth unit of output affect the firm’s economic profits?

The vertical distance to point C, $6 per unit, is the marginal cost incurred in producing and selling the thirty-fifth unit, and the vertical distance to point F, $3 per unit, is the marginal revenue received from doing so. Consequently, producing the thirty-fifth unit reduces the firm’s economic profits during this time period by $3.

10-17. Take a look at Figure 10-6. Suppose that quantity is 9.5 units per week, price is $6.10 per unit, and the average total cost of producing the 9.5 units is $4.26 per unit. What is the dollar amount of maximized monopoly profits displayed by the blue area?

The monopolist’s weekly economic profits equal the multiplication of the difference between price and average total cost ($6.10 per unit – $4.26 per unit = $1.84) times 9.5 units, or $17.48.

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Chapter 10 Monopoly 10-18. Suppose that initially the data in Problem 10-17 apply, but then an increase in fixed costs occurs. As a result, the ATC curve in Figure 10-6 shifts upward, Consequently, the average total cost of producing 9.5 units of output rises to $5 per unit. Does the monopolist’s profit-maximizing weekly output rise, fall, or remain the same? What is the new amount of maximized weekly economic profits?

A change in fixed costs leaves marginal cost unaffected, so the marginal cost curve remains in its current position. The profit-maximizing output rate at which MR = MC stays at 9.5 units per week, and the monopolist’s price remains at $6.10 per unit. Multiplying the new difference between price and average total cost ($6.10 per unit – $5 per unit = $1.10) by 9.5 units per week yields weekly profits of $10.45.

10-19. Suppose that in panel (a) of Figure 10-10, the vertical distances to points F and A are $10 per unit and $2 per unit, and Qm is 1,000 units. To measure the degree of monopoly power, economists often examine the differential between price and marginal cost as a percentage of the price. What would be the value of this measure of monopoly power for the natural monopolist depicted in panel (a) of the figure?

The difference between the monopolist’s price (vertical distance F) and marginal cost (vertical distance A) at the profit-maximizing quantity Qm is the difference between $10 per unit and $2 per unit. Expressed as a percentage of the $10-per-unit price, this amount equals ($8 per unit/$10 per unit) times 100, or 80 percent.

10-20. Consider panel (b) of Figure 10-10. The quantity Q1 is 2,000 units, the price P1 is $2 per unit, the average cost AC1 is $4 per unit, and the vertical distance to point C is $6 per unit. What is the dollar amount of the losses earned by this natural monopolist when its price is equal to its marginal cost of producing Q1 units?

Economic profits during the given time period equal the difference between price and average cost ($2 per unit – $4 per unit) multiplied by the quantity produced (2,000 units), which equals $4,000. Hence, the dollar amount of the area displayed in panel (b) of the figure would equal losses of $4,000.

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Chapter 11

Monopolistic Competition 

Answers to Questions for Critical Analysis

A NEW WAVE OF PRODUCT DIFFERENTIATION SWEEPS THE MOVIE THEATRE INDUSTRY How might offering cocktails and other drinks, unique food items, alternative viewing options, or more comfortable seats assist a movie theatre in distinguishing its service product from those of competitors showing the same films?

By offering additional services (drinks, unique food items, alternative viewing options, and more comfortable seats), a movie theatre is using product differentiation to distinguish itself from its competitors, so they can charge higher prices. By differentiating its product from those of other competitors, an individual theatre induces consumers to regard its particular product as having fewer close substitutes, which boosts the demand for its product and reduces the price elasticity of demand for that product. Both effects contribute to higher profits for the theatre.

WHY PHYSICIANS IN NORWAY BEHAVE DIFFERENTLY WHILE WORKING IN SECOND JOBS AT PRIVATE PRACTICES Why do you suppose that Norwegian physicians in the private sector have adapted individually unique ways of using phone apps that patients use to obtain information about health care recommendations?

By using apps to obtain information about characteristics of their patients, the physicians can engage in price discrimination by charging differing prices to different groups of patients.

AI: ANALYSIS OF BILLIONS OF PRICES Why might consumers be willing to pay a higher price for a particular firm’s product that is “different” from a close substitute sold by a competing company?

Even though the product is said to be a close substitute, the particular firm in question presumably has succeeded in differentiating itself from the competing company, perhaps in terms of method of product delivery, customer service, or brand-name recognition.

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Economics in Your Life

A&W Turns to Beyond Meat and Other Menu Changes to Differentiate Their Food For Critical Thinking If other fast-food restaurants introduce Beyond Meat burgers, how will this impact A&W? A&W would no longer have an advantage over their competitors in this regard and would have to consider other ways to differentiate their product.

Real Application Assume that someday you become the manager of a local hotel. Would you ever consider “borrowing” the product differentiation techniques of A& W for your restaurant?

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Chapter 11 Monopolistic Competition Every owner or manager of any business that operates in a monopolistically competitive industry has to consider using product differentiation to reduce competitors’ advantages.

That, after all, is one of the leading characteristics of monopolistically competitive industries.

So, yes, one way to distinguish your restaurant is to have higher-quality furnishings and services.

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Issues & Applications

CANADIAN INDUSTRIES THAT DIFFERENTIATE THEIR PRODUCTS VIA DIGITAL ADVERTISING For Critical Thinking Why might firms perceive that the interactive capabilities of digital advertising could offer more opportunities for immediate boosts to revenues and profits than other forms of advertising?

Today, many people spend most of their waking hours online. Digital ads make it easier for companies to connect with these potential customers and make it easier for customers to purchase products (through the interactive capabilities). This ease of use is likely to cost less in terms of expenditures and time than previous forms of advertising, which will likely improve revenues and profits.

Real Application You are now in charge of digital advertising for an online dating platform. Would you be better off advertising the vast scope of your platform the narrow focus of your dating service?

Online dating services have been around for a long time. Initially, they followed the dictum “the more the merrier.” In other words, the guiding principle of such services was to acquire an ever-larger customer database. Eventually, though, discerning customers demonstrated a preference for more narrowly focused dating platforms. Specifically, those that targeted specific age groups and sexual orientations became more profitable. Then those with other specific targeted niches, such as faith-based and occupation-based platforms, also became more profitable. Essentially, the industry learned that their customers do not want to search through many potential matches with whom they have nothing in common and a very low probability of dating. Thus, in your digital advertising messages, if you are working for a dating platform that is more narrowly focused, that would probably be the centrepiece of your digital advertising programs.

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Answers to End-of-Chapter Questions

11-1. Explain why the following are examples of monopolistic competition. a. There are a number of fast-food restaurants in town, and they compete fiercely. Some restaurants cook their hamburgers over open flames. Others fry their hamburgers. In addition, some serve broiled fish sandwiches, while others serve fried fish sandwiches.

A few serve ice cream cones for dessert, while others offer frozen ice cream pies. b. There are a vast number of colleges and universities across the country. Each competes for top students. All offer similar courses and programs, but some have better programs in business, while others have stronger programs in the arts and humanities. Still others are academically stronger in the sciences.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition a. There are many fast-food restaurants producing and selling differentiated products.

Both of these features of this industry are consistent with the theory of monopolistic competition. b. There are numerous colleges and universities, but each specializes in different academic areas and hence produces heterogeneous products, as in the theory of monopolistic competition.

11-2. Consider the diagram below depicting the demand and cost conditions faced by a monopolistically competitive firm. a. What are the total revenues, total costs, and economic profits experienced by this firm? b. Is this firm more likely in short- or long-run equilibrium? Explain.

a. The firm maximizes profits by producing to the point at which marginal revenue equals marginal cost, at 100 units per day. Its profit-maximizing price is $28 per unit, so its total revenues equal $2,800 per day. Its average total cost is $28 per unit, so its total costs equal $2,800 per day. Consequently, its economic profits equal $0 per day. b. Although it is possible that this is a short-run equilibrium situation, it is more likely, given that economic profits are zero, that this is a long-run equilibrium in which price equals average total costs, and there is no incentive for firms to enter or leave the industry.

11-3. In a perfectly competitive market, price equals marginal cost, but this condition is not satisfied for the firm with the revenue and cost conditions depicted in Problem 11-2. In the long run, what would happen if the government decided to require the firm in Problem 112 to charge a price equal to marginal cost at the firm’s long-run output rate?

If the firm had to reduce its price from the long-run equilibrium level of $28 per unit to marginal cost at $20 per unit, its revenues would drop from $2,800 per day for the long-run output rate of 100 units to $2,000 per day. Thus, it would experience a daily economic loss of $800 per unit and eventually choose to exit the industry rather than continue producing at a loss.

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Chapter 11 Monopolistic Competition 11-4. Based on your answer to Problem 11-3, is the firm with the revenue and cost conditions depicted in Problem 11-2 charging a price in excess of the minimum price necessary to induce it to provide this good in long-run equilibrium? Explain your reasoning.

There is no definite “right” or “wrong” answer to this question, which has long bedeviled economists. On one hand, the fact that price exceeds marginal cost can be interpreted as meaning that, by definition, monopolistically competitive firms behave in an “anti-perfectly competitive” manner. On the other hand, in a long-run monopolistically competitive situation such as that displayed in Problem 11-2, it is impossible for a firm to earn at least zero economic profits unless price exceeds marginal cost. Thus, some economists view the above-marginal-cost price as one that consumers must pay for the “differentness” of the item produced by a monopolistically competitive firm.

11-5. The table below depicts the prices and total costs a local used-book store faces. The bookstore competes with a number of similar stores, but it capitalizes on its location and the word-of-mouth reputation of the coffee it serves to its customers. Calculate the store’s total revenue, total profit, marginal revenue, and marginal cost at each level of output, beginning with the first unit. Based on marginal analysis, what is the approximate profitmaximizing level of output for this business?

Output 0 1 2 3 4 5 6 7

Price per Book ($) 6.00 5.75 5.50 5.25 5.00 4.75 4.50 4.00

Total Costs ($) 2.00 5.25 7.50 9.60 12.10 15.80 20.00 24.75

The values for marginal cost and marginal revenue appear below. Marginal revenue equals marginal cost at approximately the fifth unit of output, so marginal analysis indicates that 5 units is the profit-maximizing production level.

Output 0 1 2 3 4 5 6 7

Price ($) 6.00 5.75 5.50 5.25 5.00 4.75 4.50 4.00

TC ($) TR ($) MC ($) 2.00 0.00 — 5.25 5.75 3.25 7.50 11.00 2.25 9.60 15.75 2.10 12.10 20.00 2.50 15.80 23.75 3.70 20.00 27.00 4.20 24.75 28.00 4.75

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MR ($) — 5.75 5.25 4.75 4.25 3.75 3.25 1.00

Profit ($) −2.00 0.50 3.50 6.15 7.90 7.95 7.00 3.25

Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 11-6. Calculate total average costs for the bookstore in Problem 11-5. Illustrate the store’s shortrun equilibrium by calculating demand, marginal revenue, average total costs, and marginal costs. What is its total profit?

Expanding the table in Problem 11-5 yields the following values for average total cost and profit. Maximized profit at 5 units of production is $7.95.

Output

Price

TC

ATC

TR

Profit

MC

MR

0 1 2 3 4 5 6 7

6.00 5.75 5.50 5.25 5.00 4.75 4.50 4.00

2.00 5.25 7.50 9.60 12.10 15.80 20.00 24.75

— 5.25 3.75 3.20 3.03 3.16 3.33 3.54

0.00 5.75 11.00 15.75 20.00 23.75 27.00 28.00

–2.00 0.50 3.50 6.15 7.90 7.95 7.00 3.25

— 3.25 2.25 2.10 2.50 3.70 4.20 4.75

— 5.75 5.25 4.75 4.25 3.75 3.25 1.00

11-7. Suppose that after long-run adjustments take place in the used-book market, the business in Problem 11-5 ends up producing 4 units of output. What are the market price and economic profits of this monopolistic competitor in the long run?

After these long-run adjustments have occurred, the demand curve will have shifted to tangency with the average total cost curve at 4 units of output. At this production level, average total cost is $3.03, so this will be the long-run equilibrium price. Because price and average total cost will be equal, the firm will earn zero economic profits.

11-8. It is a typical Christmas electronics shopping season, and makers of ultra-high-definition TVs (UHDTVs) are marketing the latest available models through their own websites as well as via retailers such as Best Buy and Walmart. Each manufacturer offers its own unique versions of UHDTVs in differing arrays of shapes and sizes. As usual, each is hoping to maintain a stream of economic profits earned since it first introduced these most recent models late last year or perhaps just a few months before Christmas. Nevertheless, as sales figures arrive at the headquarters of companies such as LG, Samsung, Panasonic, and Sony, it is clear that most of the companies will end up earning only a normal rate of return this year. a. How can makers of UHDTVs earn economic profits during the first few months after the introduction of new models? b. What economic forces result in the dissipation of economic profits earned by manufacturers of UHDTVs? a. The introduction of new models induces increased demand for the new brands of ultrahigh-definition TVs at the various retailers, so the price of each firm’s brand rises above average total cost in the short run, and firms earn positive economic profits.

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Chapter 11 Monopolistic Competition b. Short-run economic profits induce new manufacturers of novel UHDTVs to enter the industry, and as this entry occurs, the demand for UHDTVs of existing manufacturers decline. As this occurs, the price of each firm’s brand falls toward average total cost, so that in the long run, firms earn zero economic profits.

11-9. Classify each of the following as an example of direct, interactive, mass marketing, or a combination of these advertising methods. a. The sales force of a pharmaceutical company visits physicians’ offices to promote new medications and to answer questions about treatment options and possible side effects. b. A mortgage company targets a list of specific low-risk borrowers for a barrage of email messages touting its low interest rates and fees. c. An online bookseller pays fees to an Internet search engine to post banner ads relating to each search topic chosen by someone conducting a search. In part, this helps promote the bookseller’s brand, but clicking on the banner ad also directs the person to a webpage displaying books on the topic that are available for purchase. d. A national rental car chain runs advertisements on all of the nation’s major television networks. a. b. c. d.

interactive direct mass and interactive mass

11-10. Classify each of the following as an example of direct, interactive, and/or mass marketing. a. A cosmetics firm pays for full-page display ads in a number of top women’s magazines. b. A magazine distributor mails a fold-out flyer advertising its products to the addresses of all individuals it has identified as possibly interested in magazine subscriptions. c. An online gambling operation arranges for pop-up ads to appear on a digital device’s screen every time a person uses a media player to listen to digital music or play video files, and clicking on the ads directs an individual to its online gambling site. d. A car dealership places advertisements in newspapers throughout the region where potential customers reside. a. b. c. d.

mass direct mass and interactive mass

11-11. Categorize each of the following as an experience good, a search good, or a credence good or service, and justify your answer. a. A heavy-duty filing cabinet b. A restaurant meal c. A wool overcoat d. Psychotherapy ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition a. Search good. Given the knowledge that it is a heavy-duty filing cabinet, a photo and description providing features such as dimensions are sufficient to evaluate the characteristics of a filing cabinet. b. Experience good. A meal must be eaten for its characteristics to be determined. c. Search good. Given the knowledge that the coat is made of wool, a photo and description providing size information are sufficient to evaluate the characteristics of the coat. d. Credence good. Psychotherapy services have characteristics that are likely to be difficult for consumers lacking expertise to assess without assistance from another health care provider, such as a general practitioner who guides someone experiencing depression in seeking psychotherapy treatment from a psychiatrist.

11-12. Categorize each of the following as an experience good, a search good, or a credence good or service, and justify your answer. a. Services of a carpet cleaning company b. A new cancer treatment c. Athletic socks d. A silk necktie a. Experience good. How well the company’s employees clean a carpet can be assessed only by observing the cleanliness of the carpet after they have concluded work. b. Credence good. The effectiveness of a new cancer treatment is difficult for a typical consumer to assess without the assistance of health care providers possessing expertise that the consumer lacks. c. Search good. A consumer can evaluate the features of athletic socks without actually wearing them while walking, running, or participating in sports. d. Search good. Given knowledge that the necktie is made of silk, a photo and description are sufficient to determine its characteristics.

11-13. In what ways do credence goods share certain characteristics of both experience goods and search goods? How do credence goods differ from both experience goods and search goods? Why does advertising of credence goods commonly contain both informational and persuasive elements? Explain your answers.

Consumers may be able to assess certain features of a credence good in advance of purchase, so in this sense a credence good is similar to a search good. Consumers lack expertise to evaluate the full qualities of a credence good until after they have purchased it, which is somewhat analogous to the characteristics of an experience good. Nevertheless, the fact that consumers cannot fully evaluate a credence good’s qualities in advance of purchase makes it different from a search good. Likewise, the inability to be certain, without assistance, of the qualities of a credence good following purchase of the good also distinguishes a credence good from an experience good. The fact that consumers can evaluate certain aspects of a credence good in advance of purchase, as in the case of a search good, explains why ads for credence goods, such as pharmaceuticals, often have informational elements. At the same time, however, the fact that consumers cannot truly evaluate credence goods until after purchase, and even then only with assistance, explains why ads for credence goods also commonly include persuasive elements. ..

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Chapter 11 Monopolistic Competition 11-14. Is each of the following items more likely to be the subject of an informational or a persuasive advertisement? Why? a. An office copying machine b. An automobile loan c. A deodorant d. A soft drink a. Informational advertising. A copying machine is a search good that provides basic functions, so photos and descriptions providing information are common in advertisements for this good. b. Persuasive advertising. Each lender provides different services that must be experienced to truly evaluate service quality, so this is an experience good, and persuasive advertising methods are most suitable. c. Persuasive advertising. A consumer must use a deodorant to assess its characteristics, so it is an experience good for which persuasive advertising is most likely to be used. d. Persuasive advertising. A soft drink must be consumed to determine its taste, so it is an experience good that most likely will be marketed using persuasive advertising.

11-15. Discuss the special characteristics of an information product, and explain the implications for a producer’s short-run average and marginal cost curves. In addition, explain why having a price equal to marginal cost is not feasible for the producer of an information product.

Typically, the fixed costs of producing an information product are relatively high, while average variable cost is equal to a very small per-unit amount. As a consequence, the average total cost curve slopes downward with increased output, and average variable cost equals marginal cost at a low, constant amount irrespective of the quantity produced. For an information product, marginal cost is always below average total cost. Consequently, if price were equal to marginal cost, it would always be less than average total cost, so the producer would always earn short-run economic losses.

11-16. A firm that sells e-books relating to do-it-yourself topics (home plumbing, gardening, and the like) at the same price. At present, the company can earn a maximum annual profit of $25,000 when it sells 10,000 copies within a year’s time. The firm incurs a 50cent expense each time a consumer downloads a copy, but the company must spend $100,000 per year developing new editions of the e-books. Under marginal cost pricing, it could sell 100,000 copies. a. In the short run, what is the profit-maximizing price of e-books relating to do-ityourself topics? b. At the profit-maximizing quantity, what is the average total cost of producing ebooks?

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition a. The firm’s total costs equal total fixed costs of $100,000 plus total variable costs, or $0.50 per unit × 10,000 units = $5,000, or $105,000. The firm earns economic profits equal to $25,000 at this rate of output, so its total revenues equal total costs plus economic profits, or $105,000 + $25,000 = $130,000. Hence, the profitmaximizing price equals total revenues divided by its profit-maximizing price, or $130,000/$10,000 = $13.00 per e-book. b. Average total costs equal total costs divided by quantity, or $105,000/$10,000 = $10.50 per e-book.

11-17. Take a look at panel (a) of Figure 11-1, and assume that it initially applies to a typical firm in a monopolistically competitive industry. Explain how it might be possible for this firm temporarily to find itself in a situation such as that depicted in panel (b) during the process of adjustment from panel (a) to a final long-run equilibrium as shown in panel (c).

In panel (a), the typical firm experiences positive economic profits. Substantial entry by new firms could cause demand curves at incumbent firms to shift inward substantially. Price could drop below ATC, as in panel (b), which results in negative economic profits at incumbent firms.

Exits by some firms then would raise demand at remaining firms, resulting in zero long-run economic profits in panel (c).

11-18. Take a look at panel (b) of Figure 11-1, and assume that it initially applies to a typical firm in a monopolistically competitive industry. Explain how it might be possible for this firm temporarily to find itself in a situation such as that depicted in panel (a) during the process of adjustment form panel (b) to a final long-run equilibrium as shown in panel (c).

In panel (b), the typical firm experiences negative economic profits. Exits by many firms could cause demand curves at incumbent firms to shift outward substantially. Price could rise above ATC, as in panel (a), which results in positive economic profits at incumbent firms. Entrances by some firms then would reduce demand at remaining firms, resulting in zero long-run economic profits in panel (c).

11-19. In what fundamental ways does the monopolistic competitor in panel (b) of Figure 11-2 behave similarly to the perfectly competitive firm in panel (a) in a long-run equilibrium?

In what fundamental ways does the monopolistically competitive firm behave differently?

Key similarities are that the monopolistically competitive firm faces competition from many other firms, produces to the point at which MR = MC, and has a price equal to the average total cost and hence earns zero economic profits. The key differences are that its demand curve slopes downward because of product differentiation and that its price exceeds MR and the minimum feasible ATC.

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Chapter 11 Monopolistic Competition 11-20. At every point along the AFC curve in Figure 11-4, what is true of the explicit dollar amount of this firm’s total fixed costs at any given point that one might select, such as the three points displayed along the AFC curve in the figure?

At every single point on the AFC curve, the total fixed costs are constant and equal to $250,000 irrespective of the firm’s output rate. At the top left point, TFC equals AFC times quantity, or $250,000 per unit times 1 unit = $250,000. At the second point lower down the AFC curve, TFC equals $50 per unit times 5,000 units, or $250,000. At the lower right point, TVC = $5 per unit times 50,000 units, or $250,000.

11-21. Take a look at panel (a) of Figure 11-5. Suppose that during the relevant time period, the firm’s marginal and average variable costs remain unchanged. The firm’s total fixed costs, however, rise from $250,000 to $300,000. If the firm had to set the price of its information product equal to marginal cost, what would be the amount of its economic profit, or loss following the increase in its total fixed costs?

Because marginal revenue has remained unchanged, MR = MC at the same output rate of 20,000 units per time period. Hence, the firm’s total revenues and total variable costs both remain equal to $2.50 per unit multiplied by 20,000 units, or $50,000. The firm’s total fixed costs have risen to $300,000, so this is the dollar amount of its economic loss per time period.

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Chapter 12

Oligopoly and Strategic Behaviour 

Answers to Questions for Critical Analysis

THE FOUR-FIRM CONCENTRATION RATIO IN THE GLOBAL TIRE INDUSTRY What was the five-firm concentration ratio in the global tire industry?

The five-firm concentration ratio in the global tire industry equals 14.2% + 13.1% + 9.7% + 8.2% + 3.8% = 49.0%.

THE HHI FOR THE CANADIAN INTERNET SERVICE PROVIDER (ISP) INDUSTRY What would be the revised HHI value if the top 10 firms decided to conduct a horizontal merger and offer a single “Top 10” product? (Assume the remaining five firms share equally the remaining 14.8 percent of total industry sales).

A horizontal merger of the top 10 firms would result in a total market share of 85.1 percent for the single “Top 10 ISP.” The revised HHI value would be 85.12 + 5(14.8/5)2 = 7,242.01 + 5 × 8.76 = 7,242.01 + 43.81 = 7,285.82.

SUCCESS IN GAME THEORY DOES NOT NECESSARILY REQUIRE COMPLEX THINKING How might the results of Gill and Prowse’s study support claims commonly made by company managers who are widely recognized as successful businesspeople that they have succeeded by making rapid “gut” decisions?

Managers who make rapid “gut” decisions may be subject to bounded rationality and stick to general rules of thumb. Alternatively, these managers may have a talent for identifying the best outcome within the game-based business situation they confront. Either way, the speediest correct decisions entail lower expenses and yield higher revenues and hence are more profitable.

AI: DEVELOPING A NEW SOURCE OF INDUSTRY CONCENTRATION How might the use of AI techniques to better attune platforms’ services to end users’ preferences enhance the emerging “big data network effect”?

If AI techniques can be used to better attune platforms’ services to end users’ preferences, then the end users will have a better experience and will want to continue using the platform.

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Economics in Your Life

SEARCHING FOR COSMETICS PRODUCTS WITH NETWORK EFFECTS For Critical Thinking Why do you suppose that the largest cosmetics companies have engaged in bidding wars to acquire smartphone apps that can be used to match cosmetics to skin tones or to provide guidance for applying cosmetics?

These cosmetics companies believe that these skin-matching and how-to apps will help improve customers’ experiences and thereby differentiate the companies’ products. By providing easier (and cheaper) ways for consumers to find products that work best for them, ..

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Chapter 12 Oligopoly and Strategic Behaviour customers are more likely to use makeup products more and recommend the company to their friends.

Real Application Let’s say that you have just been named the head manager of a small cosmetics firm. How will network effects influence the way you manage this firm?

Social media does not simply offer a convenient means for communicating with your friends and family. Social media has become an increasingly important platform for promoting products and services. Satisfied customers assist you in promoting your products by “liking” your social media profiles and posts. These positive network effects will become an important tool for effectively managing this cosmetics firm. That is to say, you or your staff will have to create a social media presence that will hopefully attain an increasing number of followers and likes. You will also have to use various human and AI techniques to monitor the trends in social media with respect to your products and clientele, and then adjust your business strategy accordingly.

Now let’s say that you see that there are negative feedbacks on your social media attempts. You and your staff will have to figure out ways to counter those negative feedbacks and, of course, you may have to change aspects of your products in the process.

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Issues & Applications

WHY PLATFORM FIRMS MUST BALANCE GETTING MORE CUSTOMERS VIS-À-VIS GETTING THE RIGHT CUSTOMERS For Critical Thinking Why do you think that OpenTable, a restaurant-reservation platform, almost failed when it initially sought many nationwide fine-dining restaurants but then recovered when it better linked customers to nearby restaurants?

Most often people that use OpenTable are looking for reservations at restaurants near where they are located. They don’t want to have to travel three hours to find a restaurant with an open reservation. OpenTable improved the customer experience by limiting the number of options available, causing customers to spend less time scrolling through restaurants that were too far away.

Real Application Suppose you want to create a news-feed app. In deciding what types of stories to put on this news app, how would you proceed?

According to this Issues and Applications feature, you want to consider “narrow-casting” rather than broadcasting. That is to say, you probably do not want to create a new news app that randomly samples news stories each day. Rather, you would probably try to seek out a narrow audience that would find your news app useful and who would consistently use it. In that way, you could obtain more revenues from advertising.

For example, you might pick a centre of interest for a specific group of people who frequent car auctions. Then you would seek out sources of daily news about car auctions and related matters. Then you would target this audience via, say, lists of subscribers to car auction magazines and online resources.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition

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Answers to End-of-Chapter Questions

12-1. Suppose that the distribution of sales within an industry is as shown in the first table.

Firm A B C D E F G H All others Total

Share of Total Market Sales 15% 14 12 11 10 10 8 7 13 100%

a. What is the four-firm concentration ratio for this industry? b. What is the eight-firm concentration ratio for this industry? a. 15% + 14% + 12% + 11% = 52%. b. 52% + 10% + 10% + 8% + 7% = 87%; or 100% − 13% = 87%.

12-2. The second table shows recent worldwide market shares of producers of inkjet printers.

Firm Brother Canon Dell Epson Hewlett-Packard Lexmark Samsung Other

Share of Worldwide Market Sales 3% 17 6 18 41 13 1 1

a. In this year, what was the four-firm concentration ratio in the inkjet-printer industry? b. In this year, what was the seven-firm concentration ratio in the inkjet-printer industry? a. 41% + 18% + 17% + 13% = 89%. b. 89% + 6% + 3% + 1% = 99%; or 100% – 1% = 99%.

12-3. If there are 13 “All others” in the industry in Problem 12-1, each of which has a share of sales equal to 1 percent, what is the value of the Herfindahl-Hirschman Index for this industry?

152 + 142 + 122 + 112 + 102 + 102 + 82 + 72 + 13×12 = 225 + 196 + 144 +121 + 100 + 100 + 64 + 49 + 13 = 1,012.

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Chapter 12 Oligopoly and Strategic Behaviour 12-4. What is the approximate value of the industry’s Herfindahl-Hirschman Index in Problem 12-2?

412 + 182 + 172 + 132 + 62 + 32 + 12 + 12 = 1,681 + 324 + 289 + 169+ 36 + 9 + 1 + 1 = 2,510.

12-5. Characterize each of the following as a positive-sum game, a zero-sum game, or a negative-sum game. a. Office workers contribute $10 each to a pool of funds, and whoever best predicts the winners in a professional sports playoff wins the entire sum. b. After three years of fighting with large losses of human lives and material, neither nation involved in a war is any closer to its objective than it was before the war began. c. Two collectors who previously owned incomplete and nearly worthless sets of trading cards exchange several cards, and as a result both end up with completed sets with significant market value. a. zero-sum game b. negative-sum game c. positive-sum game 12-6. Characterize each of the following as a positive-sum game, a zero-sum game, or a negative-sum game. a. You play a card game in your dorm room with three other students. Each player brings $5 to the game to bet on the outcome, winner take all. b. Two nations exchange goods in a mutually beneficial transaction. c. A thousand people buy $1 lottery tickets with a single payoff of $800. a. zero-sum game b. positive-sum game c. negative-sum game 12-7. Last weekend, Bob attended the university hockey game. At the opening faceoff, the crowd stood up. Bob therefore realized that he would have to stand up as well to see the game. For the crowd (not the hockey team), explain the outcomes of a cooperative game and a noncooperative game. Explain what Bob’s “tit-for-tat strategic behaviour” would be if he wished to see the game.

Bob is currently a participant in a noncooperative game, in which some people stand and block his view of the hockey game. His tit-for-tat strategy is to stand up as well. If he stands, however, he will block the view of another spectator. In a cooperative game, all would sit or stand up simultaneously, so that no individual’s view is blocked.

12-8. Consider two strategically dependent firms in an oligopolistic industry, Firm A and Firm B. Firm A knows that if it offers extended warranties on its products but Firm B does not, it will earn $6 million in profits and Firm B will earn $2 million. Likewise, Firm B knows that if it offers extended warranties but Firm A does not, it will earn $6 million in profits and Firm A will earn $2 million. The two firms know that if they both offer extended

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition warranties on their products, each will earn $3 million in profits. Finally, the two firms know that if neither offers extended warranties, each will earn $5 million in profits. a. Set up a payoff matrix that fits the situation faced by these two firms. b. What is the dominant strategy for each firm in this situation? Explain. a. The payoff matrix is displayed below. If Firm B does not offer an extended warranty, Firm A earns higher profits ($6 million instead of $5 million) by providing an extended warranty. If Firm B provides an extended warranty, Firm A earns higher profits ($3 million instead of $2 million) by providing an extended warranty. If Firm A does not offer an extended warranty, Firm B earns higher profits ($6 million instead of $5 million) by providing an extended warranty. If Firm A provides an extended warranty, Firm B earns higher profits ($3 million instead of $2 million) by providing an extended warranty.

Warranties No Warranties

Firm A

Firm B Warranties

No Warranties

$3 mil

$2 mil

$3 mil

$6 mil $6 mil

$2 mil

$5 mil

$5 mil

b. In equilibrium both firms will offer an extended warranty, with each firm earning $3 million in profits, even though each firm could earn $5 million in profits if both had chosen not to offer extended warranties.

12-9. Take a look back at the data regarding the inkjet-printer industry in Problem 12-2, and answer the following questions. a. Suppose that consumer demand for inkjet printers, the prices of which are readily observable in office supply outlets and on Internet sites, is growing at a stable pace.

Discuss whether circumstances are favourable to an effort by firms in this industry to form a cartel. b. If the firms successfully establish a cartel, why will there naturally be pressures for the cartel to break down, either from within or from outside? a. The fact that prices are growing at a stable rate and are readily observable favour enforcing a cartel agreement. So does the fact that there are only seven firms of significant size in the inkjet-printer industry, which is a relatively small number.

Therefore, much depends on degree of heterogeneity of inkjet printers; if these products are relatively homogeneous, then taken together these characteristics of the industry would generally support an effort to form a cartel.

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Chapter 12 Oligopoly and Strategic Behaviour b. Once the cartel is formed, any one of the firms that produce inkjet printers could enlarge its profits by expanding production at the higher cartel price, so there is always an incentive to cheat. In addition, the presence of positive economic profits in the industry could induce firms outside the cartel to begin manufacturing and selling inkjet printers.

12-10. Explain why network effects can cause the demand for a product either to expand or to contract relative to what it would be if there were no network effects.

Network effects arise when an individual’s willingness to consume an item depends on how many other people consume it. On one hand, this means that if more consumers demand the product, this can induce additional individuals to buy larger quantities, thereby boosting demand even more. On the other hand, if some consumers decide to cut back on their purchases of the product, others may also decide to follow suit, thereby reducing demand by an even greater amount.

12-11. List three products that you think are subject to network effects. For each product, indicate whether, in your view, all or just a few firms within the industry that produces each product experience market feedback effects. In your view, are any market feedback effects in these industries currently positive or negative?

Possible examples include office productivity software, online auction services, telecommunications services, and Internet payment services. In each case, more people are likely to choose to consume the item when others do, because the inherent usefulness of consuming the item for each person increases as the number of consumers rises.

12-12. Consider the following list and classify each item according to the appropriate type of two-sided market—audience making, matchmaking, shared input, or transaction based— and write a one-sentence answer justifying your classification. (Hint: You may wish to check out the firms’ websites to assist in answering this question.) a. Realtor.ca b. CalgaryHerald.com c. Linux.com d. Paypal.com a. Realtor.ca is a platform that links buyers and sellers of real estate in a matchmaking market. b. CalgaryHerald.com provides news content to attract an audience to advertisers within an audience-making market. c. Linux.com is an open-source operating system used within a shared-input market. d. Paypal.com is a platform for a transactions-based market that clears payments for end users transmitting funds in exchanges.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 12-13. Consider the following list and classify each item according to the appropriate type of two-sided market—audience making, matchmaking, shared input, or transaction based— and write a one-sentence answer justifying your classification. (Hint: You may wish to check out the firms’ websites to assist in answering this question.) a. Mastercard.com b. FreeBSD.org c. PlentyoFish.com d. WSJ.com a. Mastercard.com is a platform for linking people making payments with credit cards to banks that clear the payments in a transaction-based market. b. FreeBSD.org is an open-source operating system used within a shared-input market. c. PlentyofFish.com is a platform that links people seeking romantic matches in a matchmaking market. d. WSJ.com provides business news reporting to attract an audience to advertisers within an audience-making market.

12-14. Suppose that a company based in Victoria, British Columbia, confronts only four other rival firms. Its own market share is 35 percent, which ties it with the other largest producer and seller in the industry. The other three firms each have a 10 percent market share. What is the four-firm concentration ratio for this industry?

The four-firm concentration ratio is 35 percent + 35 percent + 10 percent + 10 percent = 90 percent.

12-15. In Problem 12-14, what is the value of the Herfindahl-Hirschman index?

HHI = 352 + 352 + 102 + 102 + 102 = 1,225 + 1,225 + 100 + 100 + 100 = 2,750.

12-16. Suppose that a firm located in Moncton, New Brunswick, has entered the same industry as the Victoria company discussed in Problem 12-14. The new firm captures a 5 percent market share, and the market share of one of the smallest three original incumbents declines to 5 percent as well. After the Moncton firm’s entry into the industry, what are the values of the four-firm concentration ratio and the Herfindahl-Hirschman index?

The four-firm concentration ratio remains unchanged at 90 percent, but the new value of the HHI is 352 + 352 + 102 + 102 + 52 + 52 = 1,225 + 1,225 + 100 + 100 + 25 + 25 = 2,700.

12-17. Consider Figure 12-2. Suppose conditions in the industry change in such a way that the amount that each firm makes if it charges a high price when the other firm charges a low price increases from $2 million to $3 million. Is the firm’s pricing decision altered by this change and, if so, in what way? Explain briefly?

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Chapter 12 Oligopoly and Strategic Behaviour As can be seen in the upper-right portion of the figure, if Firm 1 now makes $3 million if it charges a high price while Firm 2 charges a low price, it still can make a higher amount—$4 million on the lower right – if it charges a low price instead. Analogous reasoning holds true for Firm 2. Thus, both firms will maintain their decisions to charge low prices.

12-18. Take a look at Figure 12-3. What is the total dollar amount of the typical perfectly competitive firm’s economic incentive to join the proposed cartel, assuming that after the fact no firms cheat on the specified cartel agreement? Explain your reasoning?

Initially, the perfectly competitive firm’s price equals average total cost at $5 per unit, so its economic profits are equal to zero. If it joins the cartel, cuts its output from 5,000 units to 3,000 units (at which ATC = $6 per unit), and sells its product at a price of $7 per unit, its economic profits equal $3,000. These profits are the total dollar amount of this firm’s economic incentive to participate in the cartel.

12-19. Consider Figure 12-3 and suppose that this typical firm has agreed to participate in the proposed cartel. What is the total dollar amount of the firm’s economic incentive to cheat on the cartel agreement, assuming that all other firms continue to abide by the agreement? Explain your reasoning?

After all firms raise their product price to $7 per unit, this firm has an incentive to regard this per-unit amount as the available marginal revenue. The firm could then produce to the point at which this new marginal revenue equals marginal cost, at an output rate of 7,000 units per time period. Doing so would yield $4,000 in additional profits, which would be the dollar amount of the incentive to cheat.

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Chapter 13

The Labour Market 

Answers to Questions for Critical Analysis

A NEWLY DERIVED DEMAND FOR GERMAN COAL MINES RELATES TO ENERGY BUT NOT TO COAL How might an increase in demand for tourist destinations along with a higher demand for solar and wind energy have induced conversion of some German mines into lakes surrounded by cottages, solar panels, and wind turbines?

The increased demand for tourist destinations has caused an increase in the price of land for those tourist destinations. As land becomes scarcer, Germans have found unique ways to create land from existing sites, like German coal mines. The same is true of the higher demand for solar and wind energy. Due to the scarcity of land, the unused coal mines are an ideal place to locate tourist destinations and solar and wind farms.

SOMEDAY, YOU MAY PURCHASE A LARGELY ROBOT-CONSTRUCTED HOUSE Why might an employer choose not to hire some job candidates offering relatively high levels of marginal product if the price of the product the employer sells decreases considerably?

The firm’s demand curve is a derived demand based on, among other factors, the price of the product sold by the firm. If the price of the product falls, the MRP faced by the firm decreases, which causes the firm to hire fewer workers.

AI: MONOPSONISTIC DECISIONS FOR HIRING SERVICE PROVIDERS How legitimate would concerns be about the possibility of monopsonistic exploitation of labour via platform firms’ application of data analytics if providers of labour services can choose among a large number of potential employers?

The reason the MFC of labour is upward sloping and above the supply curve for labour is because the monopsonist faces no competition in the labour market. If there were more competition in the labour market, then workers could potentially move to other firms where the wage they are paid is equal to the marginal revenue product they provide.

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Economics in Your Life

WHY SUNCOR PLANS TO REPLACE 400 OILSANDS JOBS WITH DRIVERLESS TRUCKS For Critical Thinking Will other mining companies that choose to use Komatsu’s driverless trucks in its mines tend to adjust the number of human-driven trucks that it employs within its cost-minimizing combination of resources in an upward or downward direction? Explain your reasoning.

Because the productivity of driverless trucks is so high (compared to human-driven trucks), the mining company will likely substitute the driverless trucks for human-driven trucks, so it will hire fewer truck operators. This decrease in the number of truck operators employed will tend to increase the MP of labour (due to the law of diminishing returns), and the increase in ..

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Chapter 13 The Labour Market the driverless trucks will decrease the MP of capital (due to the law of diminishing returns) until the MP of labour/W = MP of capital/P.

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Issues & Applications

COVID-19 AND THE DISPROPORTIONATE IMPACT ON INDIGENOUS EMPLOYMENT For Critical Thinking What other demographic groups do you think may have been hit harder by the pandemic and public health measures? Why might that be the case?

Youth (aged 15 to 24) and women are other groups that have been disproportionately impacted by COVID-19. The reason for this is, in part, due to their higher concentration in service and sales occupations, which were impacted severely by the pandemic and public health measures.

Real Application Assume that you are a youth in the 15- to 24-year-old age bracket. How big an impact would you estimate the pandemic had on your job prospects? Would they be more or less negatively impacted than average? Explain your reasoning.

The pandemic disproportionately impacted the job prospects of young people (aged 15 to 24 years old). A key reason for this is that young people are overrepresented in occupations that were highly impacted by public health measures, like service and sales occupations.

According to the 2016 Census, more than half of the people in this age group were employed in sales and services jobs.

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Answers to End-of-Chapter Questions

13-1. The table below depicts the output of a firm that manufactures wireless earbuds. The earbuds sell for $3 each.

Labour Input (workers per hour) 10 11 12 13 14 15 16

Total Output (earbuds per hour) 200 218 234 248 260 270 278

Calculate the marginal product and marginal revenue product at each input level above 10 units. What is the maximum wage the firm will be willing to pay if it hires 15 workers?

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition Labour Input (workers per hour) 10 11 12 13 14 15 16

Total Output (earbuds per hour) 200 218 234 248 260 270 278

MP — 18 16 14 12 10 8

MRP ($) — 54 48 42 36 30 24

If the firm hires 15 workers per hour, the maximum wage rate it will be willing to pay is equal to the marginal revenue product, which is $30 per hour.

13-2. Explain how the following events would affect the demand for labour. a. A new education program administered by the company increases labour’s marginal product. b. The firm completes a new plant with a larger workspace and new machinery that workers can use and that does not substitute for the functions provided by workers’ labour.

In both examples, the marginal product of labour increases, so there is an increase in marginal revenue product and hence the demand for labour.

13-3. The table below depicts the product market and labour market a digital device manufacturer faces.

Labour Input (workers per hour) 10 11 12 13 14 15

Total Product 100 109 116 121 124 125

Product Price ($) 53 52 51 50 49 48

a. Calculate the firm’s marginal product, total revenue, and marginal revenue product at each input level above 10 units. b. The firm competes in a perfectly competitive labour market, and the market wage it faces is $26 per hour. How many workers will the profit-maximizing employer hire?

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Chapter 13 The Labour Market a.

Labour Input (workers per hour) 10 11 12 13 14 15

Total Product 100 109 116 121 124 125

Product Price 53 52 51 50 49 48

MP — 9 7 5 3 1

Total Revenue 5,300 5,668 5,916 6,050 6,076 6,000

MRP — 368 248 134 26 −76

b. The profit-maximizing firm would hire 14 workers, which is the quantity of labour beyond which the marginal revenue product of labour falls below the marginal factor cost.

13-4. Recently, there has been an increase in the market demand for products of firms in manufacturing industries. The production of many of these products requires the skills of welders. Because welding is a dirty and dangerous job compared to other occupations, in recent years fewer people have sought employment as welders. Draw a diagram of the market for the labour of welders. Use this diagram to explain the likely implications of these recent trends for the market clearing wage earned by welders and the equilibrium quantity of welding services hired.

The reduction in the number of people seeking employment as welders causes the labour supply schedule to shift leftward in the market for the labour of welders, from S1 to S2. The market clearing wage rate rises, from W1 to W2, and the equilibrium quantity of labour declines, from Q1 to Q2.

13-5. Since the beginning of this century, there has been a significant increase in the price of corn-based ethanol. a. A key input in the production of corn-based ethanol is corn. Use an appropriate diagram to explain what has likely occurred in the market for corn if the supply curve has not shifted. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition b. In light of your answer to part (a), explain why many hog farmers, who in the past used corn as the main feed input in hog production, have switched to cookies, licorice, cheese curls, candy bars, and other human snack foods instead of corn as food for their hogs. a. The rise in the price of ethanol results in an increase in the marginal revenue product of corn, the key input in the production of ethanol. Thus, each ethanol producer’s marginal revenue product curve shifts rightward, which ultimately translates into an increase in the demand for corn, from D1 to D2. The market clearing price of corn increases, from P1 to P2, and the equilibrium quantity of corn rises, from Q1 to Q2.

b. Human snack foods are a substitute input in the production of hogs, so the increase in the price of corn induced farmers to substitute in favour of snack foods.

13-6. A firm hires labour in a perfectly competitive labour market. Its current profitmaximizing hourly output is 100 units, which the firm sells at a price of $5 per unit. The marginal product of the last unit of labour employed is 5 units per hour. The firm pays each worker an hourly wage of $15. a. What marginal revenue does the firm earn from the sale of the output produced by the last worker employed? b. Does this firm sell its output in a perfectly competitive market? a. The firm maximizes profits, so marginal revenue product (the 5-unit marginal physical product multiplied by marginal revenue) equals the wage rate of $15. Hence, marginal revenue equals $3. b. At the profit-maximizing output, marginal revenue of $3 is less than the price of $5, so this firm does not sell its output in a perfectly competitive market.

13-7. A profit-maximizing monopolist hires workers in a perfectly competitive labour market.

Employing the last worker increased the firm’s total weekly output from 110 units to 111 units and caused the firm’s weekly revenues to rise from $25,000 to $25,750. What is the current prevailing weekly wage rate in the labour market? ..

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Chapter 13 The Labour Market The marginal product of labour is 1 unit, and marginal revenue is $750, so marginal revenue product is $750. Because the labour market is perfectly competitive and the firm is maximizing profits, marginal revenue product equals the wage rate, so the market wage must be $750.

13-8. A monopoly firm hires workers in a perfectly competitive labour market in which the market wage rate is $30 per day. If the firm maximizes profit, and if the marginal revenue from the last unit of output produced by the last worker hired equals $10, what is the marginal product of that worker?

The wage rate, $30 per unit of labour, equals marginal revenue product, so the marginal physical product of labour is $30 per unit of labour divided by the marginal revenue, $10 per unit of output, or 3 units of output per unit of labour.

13-9. The current market wage rate is $30, the rental rate of land is $1,000 per unit, and the rental rate of capital is $500. A firm’s managers find that under their current allocation of factors of production, the marginal product of labour is 300, the marginal product of land is 10,000, and the marginal product of capital is 4,000. Is the firm minimizing costs?

Why or why not?

In order to maximize profits, the firm should hire inputs up to the point where marginal revenue product per dollar spent is equalized across all factors. This is not true in this example, so the firm is not maximizing profits. The firm should reduce the number of capital units it uses and increase its use of labour and land.

13-10. The current wage rate is $30, and the price per service unit of capital is $500. A firm’s marginal product of labour is 600, and its marginal product of capital is 20,000. Is the firm maximizing profits for the given cost outlay? Why or why not?

In order to maximize profits, the firm should hire inputs up to the point at which the marginal physical product per dollar spent on the input is equalized across all inputs. This is not the case in this example. The marginal physical product of labour per dollar spent on wages is 600/$30 = 20 units of output per dollar spent on labour, which is less than the marginal physical product of capital per dollar spent on capital, which is 20,000/$500 or 40 units of output per dollar spent on capital. Thus, the firm should increase the additional output per dollar spent on labour by reducing the number of labour units it hires, and it should reduce the additional output per dollar spent on capital by increasing its use of capital, to the point where these amounts are equalized.

13-11. Consider Figure 13-1, and suppose that the firm is contemplating 14 units of labour, and it knows that doing so would cause its total product to increase to 4,075 units. What would be the resulting marginal product of the fourteenth unit of labour employed? What would be the resulting marginal revenue product of the fourteenth unit of labour hired?

The marginal product of the fourteenth unit of labour would be the difference between 4,075 units produced by 14 workers and 3,925 units produced by 13 workers, or 150 units of output per unit of labour. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition The fourteenth worker’s marginal revenue product would be its marginal product multiplied by marginal revenue, which for this perfectly competitive firm equals the product price. So the MRP for the fourteenth unit of labour is equal to 150 units of output per unit of labour times $5 per unit of output, or $750 per unit of labour.

13-12. Suppose that the MRP1 curve in Figure 13-2 is drawn under the assumption the product price is $5 per unit. Which alternative MRP curve – MRP2 or MRP3 – applies if the market clearing product price drops to $3 per unit? Why? At each point along the MRP curve, including at a quantity of labour input level of 12 units, marginal revenue product equals marginal product times the product price. Thus, a reduction in the product price reduces marginal product of labour at that quantity, resulting in a downward and leftward shift of the MRP curve, from MRP1 to MRP2.

13-13. Suppose that we were to observe unemployment in the labour market depicted in Figure 13-4. Would this imply that the current wage rate is above or below the $1,000 equilibrium weekly wage rate in the figure? Explain briefly?

A situation of unemployment is one in which the quantity of labour demanded by firms is less than the quantity that workers are willing to supply at the prevailing wage rate. This describes a surplus, which would occur in Figure 13-4 at a wage rate above the current equilibrium wage of $1,000 per week.

13-14. Consider Figure 13-5. Suppose that the monopolist is contemplating hiring 14 units of labour, which it knows would cause the marginal product to decline to 150 units of output per unit of labour. As a result, the product price would decrease to $4.50 per unit, and the firm’s marginal revenue declines to $3.20 per unit. What would be the firm’s marginal revenue product if it hires a fourteenth unit of labour?

Marginal revenue product equals the marginal product multiplied by marginal revenue. Hence, the MRP for the fourteenth unit of labour would equal 150 units of output per unit of labour times $3.20 per unit of output, or $480 per unit of labour.

13-15. In the short run, a manufacturer has a fixed amount of capital. Labour is a variable input.

The cost and output structure that the firm faces is depicted in the following table: Labour Supplied 10 11 12 13 14 15

Total Product per hour 100 109 116 121 124 125

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Hourly Wage Rate ($) 25 26 27 28 29 30

Chapter 13 The Labour Market Derive the firm’s marginal product, marginal revenue product, total wage costs, and marginal factor cost at each level of labour supplied. If the firm sells its output in a perfectly competitive market at which the equilibrium price is $8 per unit, how many workers will it hire, and what hourly wage rate will it pay?

Labour Supplied 10 11 12 13 14 15

Total Product 100 109 116 121 124 125

Hourly Wage Rate 25 26 27 28 29 30

MP — 9 7 5 3 1

MRP — 72 56 40 24 8

Total Wages MFC 250 — 286 36 324 38 364 40 406 42 450 44

The firm hires labour to the point at which marginal factor cost equals marginal revenue product (marginal revenue equal to the $8-per-unit price times the 5-unit marginal product, or at $40 per unit of labour), which equals $40 per unit of labour. This condition is met at an employment level of 13 units of labour. The firm will pay a wage equal to $28 per hour at this level of employment 13-16. A single firm is the only employer in a labour market. The marginal revenue product, labour supply, and marginal factor cost curves that it faces are displayed in the diagram.

Use this information to answer the following questions. a. How many units of labour will this firm employ to maximize its economic profits? b. What hourly wage rate will this firm pay its workers? c. What is the total amount of wage payments that this firm will make to its workers each hour?

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition a. 1,000 units of labour b. $20 per hour c. $20,000 13-17. In Figure 13-10, suppose that We is a wage rate of $30 per hour, and WU is a wage rate of $40 per hour. In addition, QD is 12,000 workers per hour, Qe is 15,000 workers per hour, and QS is 18,000 workers per hour. If each worker hired corresponds to a job available within the unionized industry, how many jobs must the union ration at the wage rate WU? What is the shortage of jobs?

At WU = $40 per hour, the quantity of labour demanded by firms is QD = 12,000 workers per hour, so this is the quantity of jobs that the union must ration across its membership.

The shortage of jobs at this wage rate is equivalent to the surplus of labour, which is the difference between the quantity supplied, QS = 18,000 workers per hour, and this quantity demanded, QD = 12,000, or 6,000 jobs per hour.

13-18. Given the information in Problem 13-17, how much more for less do the firms in this industry spend, in total, on the labour employed each hour as a consequence of establishment of the union wage WU = $40 per hour above the equilibrium wage We = $30 per hour?

At the equilibrium wage, the total wages paid to workers each hour equal $30 per hour times the 15,000 workers employed per hour, or $45,000 per hour. At the union wage, total hourly wage payments equal $40 per hour times the 12,000 workers employed per hour, or $48,000 per hour.

Thus, in this example, firms spend a total of $3,000 per hour more on unionized labour.

13-19. Suppose that the objective of a union is to maximize the total dues paid to the union by its membership. Explain the union’s strategy, in terms of the wage level and the employment level, under the following two scenarios. a. Union dues are a percentage of total earnings of the union membership. b. Union dues are paid as a flat amount per union members employed. a. The union would seek to maximize the total earnings of its membership. It would, therefore, negotiate for the wage level that is consistent with unit elasticity of demand for labour. b. The union would seek to maximize employment of all its members. It would negotiate for a wage that is equal to the maximum wage rate that the employer is willing to pay for that quantity of labour.

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Chapter 14

Income, Poverty, and Federal Income Support Programs 

Answers to Questions for Critical Analysis

WHY A RISE IN CANADIAN WEALTH INEQUALITY CAN BE BLAMED IN PART ON AGING “BABY BOOMERS” Why might we anticipate, other things being equal, that measured wealth inequality eventually will decrease as the baby boom generation gradually passes away?

As the baby boom generation gradually passes away, their wealth will be redistributed to the younger generations (their children and grandchildren). This redistribution of wealth will cause income inequality to decrease as the younger generations incorporate that wealth into their own accumulated wealth.

THE LASTING POSITIVE EFFECT ON LIFETIME EARNINGS ON CHILDHOOD ACCESS TO BOOKS AND PARENTAL READINGS Why do you suppose that behavioural researchers typically find evidence that people who had access to fewer books or heard fewer book readings when young tend to fall within the group of lower-income earners?

Children that begin reading at an earlier age have more experience in reading, which increases their marginal productivity. As they become adept readers, they can expend efforts on learning new tasks (like critical thinking) and increase their marginal productivity even further.

Alternatively, those children that do not learn to read at a young age have less experience reading and must use more effort attempting to learn how to read. Consequently, they may not be able to learn new tasks that could potentially increase their future income.

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Policy Example

COVID-19 PANDEMIC RENEWS INTEREST IN UNIVERSAL BASIC INCOME Real Application What are some of the benefits of UBI that could help “pay” for this type of program?

Reduced administration costs. UBI is given “no strings attached,” reducing the need for costly administration associated with most welfare programs and ensuring that recipients qualify for the benefit.

Reduced health care–related costs. The improved health outcomes of recipients could produce savings to health care services that could offset some of the UBI costs.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition

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Issues & Applications

THE EFFECTIVE MARGINAL TAX RATE FACED BY BENEFICIARIES OF ANTI-POVERTY PROGRAMS WHO WISH TO WORK For Critical Thinking What is the net additional income actually received by an average low-income person who chooses to earn an additional pre-income-tax, pre-lost-benefits dollar by working? Explain briefly.

If the total marginal tax rate of the average low-income earner is 40 percent, that means the individual spends $0.40 of every additional dollar earned on total taxes. Thus, the net additional income received by this earner is only $0.60 for each additional dollar earned by working.

Real Application Imagine that you are living in poverty and therefore benefit from numerous income support programs. You are offered a relatively good job. Are there any reasons why you might turn it down?

In taking the job, you probably will lose all of the income support program benefits—“free” income as it were. And you must pay out of your earnings CPP contributions, EI premiums, and perhaps some income taxes. When making the calculation of your net real income, you might find out that you are actually better off refusing the job. Also, you must consider the cost of transportation to the new job and any additional expenses, such as purchasing work clothes, that you might incur.

Otherwise stated, if you are receiving numerous government benefits that you will sacrifice when you take a job, the pay for that job is going to have to be quite high to provide you with an incentive to accept the employment offer.

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Answers to End-of-Chapter Questions

14-1. Consider the graph below, which depicts Lorenz curves for countries X, Y, and Z. a. Which country has the least income inequality? b. Which country has the most income inequality? c. Countries Y and Z are identical in all but one respect: population distribution. The share of the population made up of children below working age is much higher in country Z. Recently, however, birth rates have declined in country Z and risen in country Y. Assuming that the countries remain identical in all other respects, would you expect that in 20 years the Lorenz curves for the two countries will be closer together or farther apart? (Hint: According to the age-earnings cycle, what typically happens to income as an individual begins working and gets older?)

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Chapter 14 Income, Poverty, and Federal Income Support Programs

a. X, because for this country the Lorenz curve implies complete income equality. b. Z, because this country’s Lorenz curve is bowed farthest away from the case of complete income equality. c. Closer, because if all other things including aggregate income remain unchanged, when more people in country Y are children below working age, the share of income to people this age will decline, while the reverse will occur in country Z as more of its people reach working age and begin to earn incomes.

14-2. Consider the following estimates from the early 2020s of shares of income to each group.

Use graph paper or a hand-drawn diagram to draw rough Lorenz curves for each country.

Which has the most nearly equal income distribution, based on your diagram?

Country Bolivia Chile Uruguay

Poorest 40% 13 13 22

Next 30% 21 20 26

Next 20% 26 26 26

Richest 10% 40 41 26

Uruguay 14-3. Consider Figure 14-1 to answer the questions that follow. a. What is the value of the Gini coefficient if area B is twice as large as area A? b. Suppose that the Lorenz curve becomes more bowed, with the result that area B becomes exactly the same size as area A. What will be the new value of the Gini coefficient? a. The Gini coefficient is equal to A/(A + B). If B = 2A, then this ratio becomes A/(A + 2A) = A/(3A) = 1/3. b. The Gini coefficient is equal to A/(A + B). If B = A following the change in the shape of the Lorenz curve, then this ratio becomes A/(A + A) = A/(2A) = 1/2. ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 14-4. Suppose that a nation has implemented a system for applying a tax rate of 2 percent to the incomes earned by the 10 percent of its residents with the highest incomes. All funds collected are then transferred directly to the 10 percent of the nation’s residents with the lowest incomes. What is the general effect on the shape of a Lorenz curve based on incomes after collection and redistribution of the tax?

Less bowed 14-5. Estimates indicate that in recent years, the poorest 40 percent of the population earned about 15 percent of total income in Argentina. In Brazil, the poorest 40 percent earned about 10 percent of total income. The next-highest 30 percent of income earners in Argentina received roughly 25 percent of total income. In Brazil, the next-highest 30 percent of income earners received approximately 20 percent of total income. Can you determine, without drawing a diagram (though you can if you wish), which country’s Lorenz curve was bowed out further to the right?

Brazil 14-6. Explain why the productivity standard for the distribution of income entails rewarding people based on their contribution to society’s total output. Why does the productivity standard typically fail to yield an equal distribution of income?

Following the productivity standard entails rewards based on each individual’s additional product—that is, the person’s marginal product—which by definition is the amount that the person adds to total output of goods and services. Because marginal productivity varies across individuals according to their skills and abilities, applying the productivity standard must yield an unequal distribution of income.

14-7. Take a look at Figure 14-5. During the past decade, many members of the baby boom generation have passed through ages ranging from the middle 40s to the late 50s. Do you suppose the fact that there have been more members of this generation than other generations in the population during this past decade tends to imply that there was higher or lower measured inequality over the period? Why? Figure 14-5 indicates that most people earn their peak incomes between their middle 40s and late 50s. The fact that there are proportionately more members of the baby boom members among the population means that there have tended to be higher-income people, other things being equal. The consequence would be greater measured inequality of incomes—again, other things being equal.

14-8. What are the four main determinants of income differentials?

The four main determinants of income differences are age, productivity, inheritance, and discrimination.

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Chapter 14 Income, Poverty, and Federal Income Support Programs 14-9. What three measures of poverty are reported by Statistics Canada?

The three measures of poverty reported by Statistics Canada are the low-income cut-off, lowincome measure, and Canada’s official poverty line (formerly the market basket measure, MBM).

14-10. What are five major income support programs provided by the federal government?

Five major income support programs provided by Canada’s federal government are the Canada Workers Benefit, employment insurance, the Canada Child Benefit, the Canada Pension Plan, and Old Age Security.

14-11. What income support programs help ensure that Canadians have a dignified retirement.

The Canada Pension Plan and Old Age Security are key income support programs to assist seniors experiencing poverty.

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Chapter 15

Environmental Economics 

Answers to Questions for Critical Analysis

A POTENTIALLY HIGH MARGINAL COST OF PLASTIC-POLLUTION ABATEMENT IN KENYA Why do you suppose that some critics of the plastic-bag ban argue that the adverse effects of deforestation caused by increased production of paper bags should also be added to the marginal cost of plastic-pollution abatement?

To determine the optimal level of plastic-bag production, all the costs of plastic-pollution abatement must be considered. This includes costs of reducing pollution by plastic bags plus any other costs that society must bear. Because paper bags are a substitute for plastic bags, reducing the pollution caused by plastic bags will decrease production of plastic bags and increase production of paper bags. This, in turn, will cause additional social costs, like deforestation.

Therefore, this unintended effect must be considered to find the optimal level of plastic pollution.

AI: MANAGING DECISIONS WITHIN THE EUROPEAN EMISSIONS TRADING SYSTEM Why do you suppose that in light of the fact that European firms are increasing the use of AI systems in their emissions planning, some European policymakers have also begun to employ those same AI systems to guide their own policy actions?

The goal of European policymakers is to reduce future emissions and remain popular in the public’s eye. They can use these same AI systems to try to maximize expected future goals (reduction in emissions and increased popularity) given the uncertainty they face.

COMMON PROPERTY, THE “PARADOX OF PLENTY,” AND GAINS FROM ASSIGNING RESOURCE PROPERTY RIGHTS You have been named head resource manager in a small country with abundant supplies of cobalt. The politicians who hired you have promised the nation more jobs in that industry, which is 100 percent owned by the government. What will you do?

In order to please your bosses, your natural tendency is going to be to extract cobalt at a rapid pace such that you can justify hiring more citizens to work in that industry. You have less of an incentive to maximize the net present value of the cobalt within your country because that would most likely mean extracting it at a slower pace and therefore hiring fewer citizens in that industry.

Otherwise stated, you will decide to extract this nonrenewable resource at a faster pace than if cobalt reserves were owned by private individuals or companies. Your short-run goals matter more than the long-run benefit to the country of extracting cobalt at a slower pace.

COULD SOUTH AFRICAN RHINO POACHING BE STOPPED BY LEGALIZING TRADE IN RHINO HORNS? Critics of the idea of legalizing private rhino ranching and trade in rhino horns worry that it could generate an additional increase in demand for the horns. Is it possible that the overall population of rhinos still might increase even if a further rise in demand for legally traded rhino horns were to occur? Explain your reasoning. ..

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Chapter 15 Environmental Economics Yes. The increased demand for rhino horns would increase the price of the horns and increase the quantity sold. These increases could result in increases in economic profits for rhino ranchers. If there are no restrictions to entry in the rhino market, more ranchers will join the industry (an increase in supply), more rhinos will be bred, and more rhino horns will be produced.

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Economics in Your Life

REMOVING INDIVIDUAL TREES FROM VIEW TO ENSURE SEEING THE FOREST For Critical Thinking Can you think of any transaction costs that would hinder efforts to address common property problems associated with a forest by assigning property rights to plots of land containing trees that make up a forest?

Yes, you would need to locate the appropriate people to which you would assign the property rights (time costs). Then you would need to create enforceable contracts that give those people the rights to those lands.

Real Application If your house is located in a forested area, what is the optimal amount of forest maintenance that you should undertake?

First of all, we have to know whether you own the land around your house on which the trees grow. Undoubtedly, if the government owns that land, you probably cannot legally do any private maintenance to reduce the fire risk.

In contrast, if you do own forested land surrounding your house, you have an incentive to maintain that land. Maintenance here would involve clearing dead and diseased trees, and in general reducing the amount of potential “kindling” that could catch fire easily. You may even choose to conduct a “controlled burn” to eliminate dry shrubs and reduce fire risk.

The optimal amount of forest maintenance, however, is not infinite, to be sure. Rather, you will spend your own resources up to the point where the marginal benefit equals the marginal cost.

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Issues & Applications

EUROPEAN AUTHORITIES RESTRAIN THE SUPPLY OF EMISSIONS ALLOWANCES TO PUSH UP THEIR PRICE For Critical Thinking If carbon-dioxide-emission restrictions are working, what would you expect to see happen to our climate?

If these restrictions are working, overall pollution should be reduced and there should be a noticeable effect on the global temperature.

Real Application You have just been elected premier of a hypothetical mountain province with a small population and relatively little industry. Would you ask your provincial legislature to implement the equivalent of the European Emissions Trading System? Why or why not? ..

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition You probably would not consider such a political action to have much value either to the environment or to your province’s residents. After all, how much impact can any system of carbon dioxide reduction in your province have on the world’s production of carbon dioxide due to manufacturing and/or internal combustion vehicle use?

Moreover, with little industry in your province, the market for tradable carbondioxide-emission allowances would probably be nonexistent. Finally, in the political arena, there would probably be pressure for you to increase manufacturing activity rather than decrease it to fight carbon dioxide emissions.

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Answers to End-of-Chapter Questions

15-1. The market price of insecticide is initially $10 per unit. To address a negative externality in this market, the government decides to charge producers of insecticide for the privilege of polluting during the production process. A fee that fully takes into account the social costs of pollution is determined, and once it is put into effect, the market supply curve for insecticide shifts upward by $4 per unit. The market price of insecticide also increases, to $12 per unit. What fee is the government charging insecticide manufacturers? $4 per unit, which exactly accounts for the per-unit social cost of pollution.

15-2. One possible method for reducing emissions of greenhouse gases such as carbon dioxide is to inject the gases into deep saltwater-laden rock formations, where they would be trapped for thousands of years. Suppose that the federal government provides a fixed perunit subsidy to firms that use this technology in West Virginia and other locales where such rock formations are known to exist. a. Consider the effects of the government subsidy on the production and sale of equipment that injects greenhouse gases into underground rock formations. What happens to the market clearing price of such pollution abatement equipment? b. Who pays to achieve the results discussed in part (a)? a. Payment of the per-unit subsidy raises the demand for equipment that injects the greenhouse gases into underground rock formations. The resulting movement along the supply curve for such equipment will raise the market clearing price of the equipment. b. The government funds subsidy payments from tax receipts, so taxpayers finance the subsidy.

15-3. Examine the following marginal costs and marginal benefits associated with water cleanliness in a given locale:

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Chapter 15 Environmental Economics Quantity of Clean Water (%)

Marginal Cost ($)

Marginal Benefit ($)

0 3,000 200,000 20 15,000 120,000 40 50,000 90,000 60 85,000 85,000 80 100,000 40,000 100 Infinite 0 a. What is the optimal degree of water cleanliness? b. What is the optimal degree of water pollution? c. Suppose that a company creates a food additive that offsets most of the harmful effects of drinking polluted water. As a result, the marginal benefit of water cleanliness declines by $40,000 at each degree of water cleanliness at or less than 80 percent. What is the optimal degree of water cleanliness after this change? a. 60 percent b. 40 percent c. 40 percent 15-4. Consider the following diagram, which displays the marginal cost and marginal benefit of water pollution abatement in a particular city, and answer the following questions.

a. What is the optimal percentage degree of water cleanliness? b. When the optimal percentage degree of water cleanliness has been attained, what cost will be incurred for the last unit of water cleanup? a. 65 percent b. $10

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 15-5. Consider the diagram in Problem 15-4, and answer the following questions. a. Suppose that a new technology for reducing water pollution generates a reduction in the marginal cost of pollution abatement at every degree of water cleanliness. After this event occurs, will the optimal percentage degree of water cleanliness rise or fall?

Will the cost incurred for the last unit of water cleanup increase or decrease? Provide a diagram to assist in your explanation. b. Suppose that the event discussed in part (a) occurs and that, in addition, medical studies determine that the marginal benefit from water pollution abatement is higher at every degree of water cleanliness. Following both events, will the optimal percentage degree of water cleanliness increase or decrease? In comparison with the initial optimum, can you determine whether the cost incurred for the last unit of water cleanup will increase or decrease? Use a new diagram to assist in explaining your answers. a. There is a downward shift in the position of the marginal cost curve. The optimal degree of water cleanliness will rise above 65 percent, to a level such as 70 percent, and the cost incurred for the last unit of water cleanup will decrease to less than $10, such as a per-unit cost of $7.

b. The second event induces an upward shift in the marginal benefit curve. Taken together, as shown in the diagram below, the two events unambiguously indicate that the optimal degree of water cleanliness increases above 65 percent, such as a level of 85 percent. The cost incurred for the last unit of water cleanup may rise or fall, however, and could end up at the initial level, which is the situation illustrated in the diagram.

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Chapter 15 Environmental Economics

15-6. Under an agreement with Canadian regulators, Capital Power Corporation, and electric utility company in Alberta, has agreed to offset part of its 145 million metric tons of carbon dioxide emissions by paying another company to lay plastic tarps. These tarps cover farm lagoons holding rotting livestock waste that emits methane gas 21 times more damaging to the atmosphere than carbon dioxide. The annual methane produced by a typical 1,330-pound head of cattle translates into about 5 metric tons of carbon dioxide emissions per year. a. How many cattle’s worth of manure would have to be covered to offset the carbon dioxide emissions of this single electric utility? b. Given that there are about 10 million head of cattle in Canada in a typical year, what percentage of its carbon dioxide emissions could this firm offset if it paid for all cow manure in the entire nation to be covered with tarps? a. 145 million metric tons / 5 metric tons per head of cattle = 29 million head of cattle. b. 100 × ([10 million head of cattle × 5 metric tons per head of cattle] / 145 million) metric tons = 34.5 percent.

15-7. A government agency caps aggregate emissions of an air pollutant within its borders, establishes initial pollution allowances across all firms, and grants the firms the right to trade these allowances among themselves. The demand and supply curves for these pollution allowances have normal shapes and intersect at a positive price. Explain in your own words the government’s likely goal in establishing this private market for pollution allowances.

The positive market price of allowances is equivalent to a price that a firm must pay to release an additional unit of a pollutant. The idea behind establishing the market for pollution allowances, therefore, is to give firms an incentive to limit the quantity of pollutants released into the atmosphere.

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Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition 15-8. Suppose that a new chief of the government agency discussed in Problem 15-7 decides to reduce the supply of pollution allowances. Evaluate the effects this policy change will have on the market price of pollution allowances, and discuss whether the policy appears to be fully consistent with the original intent of creating the market for these allowances.

Reducing the supply of pollution allowances will raise the market clearing price and reduce the equilibrium quantity. The price that firms must pay to pollute increases, which thereby increases the incentive they have to limit the amount of additional pollutants they emit, which is consistent with the original intent of creating the market for these allowances.

15-9. The following table displays hypothetical annual total costs and total benefits of conserving wild tigers at several possible worldwide tiger population levels.

Population of Wild Tigers 0 2,000 4,000 6,000 8,000 10,000 12,000

Total Cost ($ millions) 0 25 35 50 75 110 165

Total Benefit ($ millions) 40 90 130 160 185 205 215

a. Calculate the marginal costs and benefits. b. Given the data, what is the socially optimal world population of wild tigers? c. Suppose that tiger farming is legalized and that this has the effect of reducing the marginal cost of tiger conservation by $15 million for each 2,000-tiger population increment in the table. What is the new socially optimal population of wild tigers? a. The marginal costs and benefits are tabulated below: Population of Wild Tigers 0 2,000 4,000 6,000 8,000 10,000 12,000

Marginal Cost ($) — 25 10 15 25 35 55

Marginal Benefit ($) — 50 40 30 25 20 10

b. 8,000 tigers c. The revised table displays the $15 million reduction in marginal cost at each population level. Marginal benefit and marginal cost now are equalized at $20 million at a population of 10,000 wild tigers.

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Chapter 15 Environmental Economics Population of Wild Tigers 0 2,000 4,000 6,000 8,000 10,000 12,000

Marginal Cost ($) — 10 — 0 10 20 40

Marginal Benefit ($) — 50 40 30 25 20 10

15-10. The following table gives hypothetical annual total costs and total benefits of maintaining alternative populations of Asian elephants.

Population of Asian Elephants 0 7,500 15,000 22,500 30,000 37,500 45,000

Total Cost ($ millions) 0 20 45 90 155 235 330

Total Benefit ($ millions) 0 100 185 260 325 375 410

a. Calculate the marginal costs and benefits, and draw marginal benefit and cost schedules. b. Given the data, what is the socially optimal world population of Asian elephants? c. Suppose that two events occur simultaneously. Technological development allows machines to do more efficiently much of the work that elephants once did, which reduces by $10 million the marginal benefit of maintaining the elephant population for each 7,500 increment in the elephant population. In addition, new techniques for breeding, feeding, and protecting elephants reduce the marginal cost by $40 million for each 7,500 increment in the elephant population. What is the new socially optimal population of Asian elephants? a. The marginal costs and benefits are tabulated below: Population of Asian Elephants 0 7,500 15,000 22,500 30,000 37,500 45,000

Marginal Cost — 20 25 45 65 80 95 ..

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Marginal Benefit — 100 85 75 65 50 35

Solutions Manual for Roger LeRoy Miller • Economics Today, 1st Canadian Edition b. 30,000 elephants c. The revised table displays the $10 million reduction in marginal benefit and the $40 million reduction in marginal cost at each population level. Marginal benefit and marginal cost are now equalized at $40 million at a population of 37,500 Asian elephants.

Population of Asian Elephants 0 7,500 15,000 22,500 30,000 37,500 45,000

Marginal Cost — — — 5 25 40 55

Marginal Benefit — 90 75 65 55 40 25

15-11. Take a look at Figure 15-1. Why does “including externalities” cause the supply curve S2 to lie above the supply curve S1 that has been drawn “excluding externalities”?

The answer hinges on the fact that supply curves reflect the marginal costs of firms that produce goods and services. The supply curve S2 includes additional costs associated with externalities that are not taken into account in the supply curve S1. Because the marginal costs involved in constructing S2 are higher than those for S1, the former supply curve must lie above and to the left of the latter supply curve.

15-12. Consider Figure 15-1. What is the specific reason that accounting for externalities and thereby shifting the market supply curve causes the equilibrium quantity of Good X to decline from Q1 to Q2?

After the supply curve shifts upward and to the left, there is an excess quantity demanded of Good X at the initial per-unit price P1. As a consequence, consumers bid up the price of the item to P2. This price increase generates an upward movement along the market demand curve that causes the equilibrium quantity of Good X to decline from Q1 to Q2.

15-13. Take a look at Figure 15-2. Suppose that initially society experiences a degree of air cleanliness that is lower than Q0. What would be true of the marginal benefit in relation to the marginal cost, and why would this fact induce society to increase the degree of air cleanliness toward Q0?

At a degree of air cleanliness that is lower than Q0, the marginal benefit derived from that level of air cleanliness would exceed the marginal cost of attaining that level. Adding the last unit of air cleanliness thereby has gained a net benefit for society, so society should add another unit of cleanliness and move toward Q0.

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Chapter 15 Environmental Economics 15-14. Consider Figure 15-2. Suppose that initially society were to opt for a degree of air cleanliness that is higher than Q0. What would be true of the marginal cost in relation to the marginal benefit, and why would this fact induce society to reduce the degree of air cleanliness toward Q0?

At a degree of air cleanliness that is higher than Q0, the marginal cost derived from that level of air cleanliness would exceed the marginal benefit of attaining that level. The last unit of air cleanliness added thereby would generate a net cost for society, so society should reduce the degree of air cleanliness and move toward Q0.

15-15. Take a look at Figure 15-2. Explain why 100 percent air cleanliness is not optimal.

At a 100 percent level of air cleanliness, the marginal cost of that level of air cleanliness normally will, as displayed in the figure, exceed the marginal benefit. Hence, the last unit of air cleanliness attained at a 100 percent cleanliness level would generate a net cost to society.

Society would gain from cutting back on air cleanliness instead of remaining at the 100 percent level.

15-16. Consider Figure 15-2. Explain why a society usually would not determine that a degree of 0 percent air cleanliness is optimal.

At a 0 percent level of air cleanliness, the marginal benefit of that level of air cleanliness normally will, as displayed in the figure, exceed the marginal cost. Therefore, the last unit of air cleanliness attained at a 0 percent cleanliness level would generate a net benefit to society.

Society would gain from increasing the degree of air cleanliness instead of remaining at the 0 percent level.

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