Type:
Instructor Manual
Resource:
Economics
Edition:
13th Edition
Author(s):
Michael Parkin
C h a p t e r
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WHAT IS ECONOMICS?
Answers to the Review Quiz Page 38 1.
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List some examples of the scarcity that you face. Examples of scarcity common to students include not enough income to afford both tuition and a nice car, not enough learning capacity to study for both an economics exam and a chemistry exam in one night, and not enough time to allow extensive studying and extensive socializing. Find examples of scarcity in today’s headlines. A headline in The Baltimore Sun on June 20, 2017 was “Davis Says Special Deployment Helped Stall Violence.” The story presented Police Commissioner Kevin Davis stating that a weeklong deployment of uniformed police officers on the streets of Baltimore helped reduce shootings in the city. But the story pointed out the role of scarcity when Commissioner Davis said that “the deployment was not sustainable over the long term” due to its cost. Find an example of the distinction between microeconomics and macroeconomics in today’s headlines. Microeconomics: On June 20, 2017 a headline in East Bay Times was “Reality vs Fantasy: FTC to Block FanDuel-DraftKings Merger.” This story covers a microeconomic topic because it discusses how two on-line fantasy sports sites, which were trying to merge, now faced opposition by the Federal Trade Commission (FTC) which announced it would challenge the merger. Macroeconomics: On June 20, 2017, a headline in The Wall Street Journal was “Ryan Talks Up Likelihood of Tax Overhaul.” This story covers a macroeconomic topic because it concerns taxes that affect every business and individual in the entire economy.
Page 43 1.
Describe the broad facts about what, how, and for whom goods and services are produced. What gets produced is significantly different today than in the past. Today the U.S. economy produces more services, such as medical operations, teaching, and hair styling, than goods, such as pizza, automobiles, and computers. How goods and services are produced is by businesses determining how the factors of production, land, labor, capital and
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entrepreneurship, are combined to make the goods and services we consume. Land includes all natural resources, both renewable natural resources such as wood, and nonrenewable natural resources such as natural gas. Labor’s quality depends on people’s human capital. In the U.S. economy, human capital obtained through schooling has increased over the years with far more people completing high school and attending college than in past years. Finally, for whom are goods and services to be produced depends on the way income is distributed to U.S. citizens. This distribution is not equal; the 20 percent of people with the lowest income earn about 5 percent of the nation’s total income while the 20 percent of people with the highest incomes earn about 50 percent of total income. On the average, men earn more than women, whites more than nonwhites, and college graduates more than high school graduates. Use headlines from the recent news to illustrate the potential for conflict between selfinterest and the social interest. One example of an issue concerns the use of a school board’s credit card to make personal purchases. A June 20, 2017 headline from Star Tribune was “Shakopee Board Approves Superintendent’s Resignation Will Pay Him $50,000.” This story discusses the superintendent’s use of a school board credit card to buy items such as a television and trip to Nashville. The superintendent was following his self-interest because he may not have repaid the purchases had they not been uncovered. The school board chair said “In light of the current issues facing the school district, the school board feel (sic) that a change in leadership is warranted.” The chair believes that the social interest is served by having a new superintendent without the issue of misuse of a credit card hanging over his or her head.
Page 46 1.
Explain the idea of a tradeoff and think of three tradeoffs that you have made today. A tradeoff reflects the point that when someone gets one thing, something else must be given up. What is given up is the opportunity cost of whatever is obtained. Three examples of tradeoffs that are common to students include: a) When a student sleeps in rather than going to his or her early morning economics class, the student trades off additional sleep for study time. The opportunity cost of the decision is a lower grade on the exam. b) When a student running late for class parks his or her car illegally, the student trades off saving time for the risk of a ticket. The potential opportunity cost of the decision is the goods and services that cannot be purchased if the student receives an expensive parking ticket. c) A student trades off higher income by spending time during the day working at a part-time job for .
WHAT IS ECONOMICS?
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less time spent at leisure time and study. The opportunity cost for the higher income is less leisure and lower grades in classes. Explain what economists mean by rational choice and think of three choices that you’ve made today that are rational. A rational choice is one that compares the costs and benefits of the different actions and then chooses the action that has the greatest benefit over cost for the person making the choice. Three rational choices made by students include: a) The choice to skip breakfast to go to class. In this case the benefit is the higher grade in the class and the cost is the breakfast forgone. b) The choice to stop talking with a friend on the phone and start studying for an impending exam. In this case the benefit is the resulting higher grade in the class and the cost is the conversation forgone. c) The choice to do laundry today rather than watch television. In this case the benefit is the fact the student will have clean clothes to wear and the cost is the loss of the entertainment the television show would have provided. Explain why opportunity cost is the best forgone alternative and provide examples of some opportunity costs that you have faced today. When a decision to undertake one activity is made, often many alternative activities are no longer possible. Often these activities are mutually exclusive so only the highest valued alternative is actually forgone. For instance, the decision to go to a student’s 8:30 AM class eliminates the possibility of sleeping in during the hour and of jogging during the hour. But in this case, it is impossible to both sleep in and to jog during the hour, so the opportunity cost cannot be both activities. What is lost is only the activity that otherwise would have been chosen—either sleeping in or jogging—which is whatever activity would have been chosen, that is, the most highly valued of the forgone alternatives. For students, attending class, doing homework, studying for a test are all activities with opportunity costs. Explain what it means to choose at the margin and illustrate with three choices at the margin that you have made today. Choosing at the margin means choosing to do a little more or a little less of some activity. Three common examples students encounter are: a) When a student faces a chemistry and an economics final exam in one day, the student must determine whether spending the last hour studying a little more chemistry or a little more economics will yield a better contribution (marginal benefit) to his or her overall GPA. b) A college student buying a computer must decide whether the marginal benefit of adding 1 GB of additional memory is worth the marginal cost of the additional memory. c) A student .
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football fan with a choice of a cheap seat in the student bleachers located at the far end of the playing field or a more expensive seat located on the 30 yard line must determine whether the marginal benefit of watching the game from a better seat is worth the marginal cost of the higher ticket price. Explain why choices respond to incentives and think of three incentives to which you have responded today. People making rational decisions compare the marginal benefits of different actions to their marginal costs. Therefore people’s choices change when their incentives, that is the marginal benefit and/or marginal cost, of the choice changes. Just as everyone else, students respond to incentives; a) A student studies because of the incentives offered by grades. b) A student is more likely to attend a class if attendance is factored into the grade. c) A student might attend a meeting of a club if the student’s significant other is eager to attend the meeting.
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Distinguish between a positive statement and a normative statement and provide examples. A positive statement is a description of how the world is. It is testable. A normative statement is a description of how the world ought to be. It is, by its very nature, not testable because there is no universally approved criterion by which the statement can be judged. “I will receive an A for this course,” is a positive statement made by an economics student— it might not be true, but it is testable. “I will receive a good grade for this course,” is a normative statement. Whether someone agrees with it depends on his or her interpretation of what makes for a “good” grade. What is a model? Can you think of a model that you might use in your everyday life? A model is a description of some aspect of the economic world. It includes only those features that are necessary to understand the issue under study. An economic model is designed to reflect those aspects of the world that are relevant to the user of the model and ignore the aspects that are irrelevant. A typical model is a GPS map. It reflects only those aspects of the real world that are relevant in assisting the user in reaching his or her destination and avoids using information irrelevant to travel. How do economists try to disentangle cause and effect? Economists use models to understand some aspect of the economic world. Testing the predictions of models makes it necessary to disentangle cause and effect. To overcome this problem, economists have three methods of testing their models: Using a natural experiment, using a statistical .
WHAT IS ECONOMICS?
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investigation, and using economic experiments. A natural experiment is a situation that arises in the ordinary course of life in which one factor being studied varies and the other factors are the same. This method allows the economist to focus on the effect from the factor that differs between the two situations. A statistical investigation looks for correlations between variables but then determining whether the correlation actually reflects causation can be difficult. An economic experiment puts people into decision making situations and then varies the relevant factors one at a time to determine each factor’s effect. How is economics used as a policy tool? Individuals, businesses, and governments use economics as a policy tool. Individuals use the economic ideas of marginal benefit and marginal cost when making decisions for such topics as attending college, paying cash or credit for a purchase, and working. Businesses also use the concepts of marginal benefit and marginal cost when making decisions about what to produce, how to produce, and even how many hours to stay open. Finally governments also use marginal benefit and marginal cost when deciding issues such as the level of property taxes, the amount to fund higher education, or the level of a tariff on Brazilian ethanol.
Page 49 1.
What types of jobs do economists do? Economists are found in a large variety of jobs. Many of these jobs are analysts of various sorts. Some economists are market research analysts—they work with data on sales and try to predict a product’s success and the price that should be set for it. Other economists are financial analysts—they work with data on interest rates, stock and bond prices to try to forecast the cost of borrowing the returns that can be expected on investments. Still other economists work as budget analysts—they use data on an organization’s cash inflows (its receipts) and its outflows (its payments) in order to prepare plans forecasting future cash flows. 2. What is the range and median level of economists’ pay? Economists’ pay ranges from $41,226 to $124,177 and has a median salary of $72,279. Students who earn a PhD in economics typically earn about $100,000 by mid-career. Economists who work as analysts have incomes that range from an average of $62,000 for market research analysts to $80,000 for financial analysts. 3. What are the skills needed for an economics job? Economists need five important skills:
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• Critical-thinking skills: Economists need the ability to use logical thinking to clarify and then solve real-world problems. • Analytical skills: Economists must be able to use economic ideas and tools to analyze data in order to determine important patterns and reach logical conclusions. • Math skills: Economists need to be able to use mathematical and statistical tools to explore and analyze data in order to reach valid conclusions. • Writing skills: Economists must be able to clearly write reports presenting ideas, conclusions from any analysis and reasons why the conclusions are valid. • Oral communication skills: Economists need the ability to orally explain ideas, conclusions, and the reasons why the conclusions are correct to a variety of people, including those with little knowledge of economics.
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WHAT IS ECONOMICS?
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Answers to the Study Plan Problems and Applications 1.
Apple Inc. decides to make iTunes freely available in unlimited quantities. a. Does Apple’s decision change the incentives that people face? Apple’s decision changes people’s incentives. For example, it increases people’s incentives to buy an iPod to take advantage of the newly “free” music available on iTunes. b. Is Apple’s decision an example of a microeconomic or a macroeconomic issue? Apple’s decision is a microeconomic decision because it affects a single company and a single market.
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Which of the following pairs does not match? a. Labor and wages Labor earns wages, so this pair matches. b. Land and rent Land earns rent, so this pair matches. c. Entrepreneurship and profit Entrepreneurship earns profit, so this pair matches. d. Capital and profit Capital earns interest, so this pair does not match.
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Explain how the following news headlines concern self-interest and the social interest. a. Starbucks Expands in China Starbucks’ expansion is a decision made by Starbucks to further Starbucks’ interest. Thus the decision is directly in Srarbucks’ self interest. The social interest is affected because Starbucks’ expansion will have an effect in China. For instance, more Chinese citizens might drink coffee rather than tea and fewer coffee shops run by Chinese firms might open. b. McDonald’s Moves into Gourmet Coffee McDonald’s decision to serve gourmet coffee is a decision made by McDonald’s to further McDonald’s interest. Thus the decision is directly in McDonald’s self interest. The social interest is affected because more people will drink coffee rather than other drinks such as sodas. c. Food Must Be Labeled with Nutrition Data The decision to require that food must be labeled with nutrition information is made in the social interest. This decision is not made by any one single firm and so does not (necessarily) reflect anyone’s self interest.
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The night before an economics test, you decide to go to the movies instead of staying home and working your MyEconLab Study Plan. Your grade on the test was 50 percent, lower than your usual 70 percent score. a. Did you face a tradeoff? Yes, you faced a tradeoff. The tradeoff was between a higher test score and an evening with your friends at the movies. .
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b. What was the opportunity cost of your evening at the movies? The opportunity cost of going to the movies is the fall in your grade. That is the 20 points forgone from choosing to see the movie rather than study. 5.
Cost of Rio Olympics Brazilian federal, state, and local governments spent R$2.8 billion and private sponsors spent R$4.2 billion on 17 new Olympic facilities, 10 of which will be used for sporting events after the Olympics. Source: Financial Times, August 6, 2016 Was the opportunity cost of the Rio Olympics R$2.8 or R$7 billion? Explain your answer. The R$7 billion spent on the 17 new Olympic facilities is an opportunity cost of the Olympics if the funds would not have spent otherwise. However, if there were already plans underway to build the 10 facilities that will be used after the Olympics, then their cost is not an opportunity cost of the Olympics because the cost would have been paid even if Rio did not host the Olympics.. The cost of the 7 facilities that will not be used afterwards, however, is definitely an opportunity cost of the Rio Olympics.
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Which of the following statements is positive, which is normative, and which can be tested? a. The United States should cut its imports. The statement is normative and cannot be tested. b. China is the largest trading partner of the United States. The statement is positive and can be tested. c. If the price of gasoline rises, people will drive less and use less gasoline. The statement is positive and can be tested.
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WHAT IS ECONOMICS?
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Answers to Additional Problems and Applications 7.
Kanye West Offers Free Concert Tickets Kanye West has teamed with Los Angeles inner-city schools to offer free passes for students. Source: consequenceofsound.net, November 27, 2016 When Kanye West gave away tickets, what was free and what was scarce? Explain your answer. The seats in the arenas are scarce—there are only a limited number. The time of school adminstrators used to distribute the tickets is also not free. In addition, if the students who are given the “free” ticket attended the concert rather than sell their free tickets, they incurred the opportunity cost of the foregone ticket price. So the concert was far from “free” for the concert-goers. The publicity that Kanye West receives is free to him but the publicity used reporters’ scarce time to report on the tickets rather than reporting on other news worthy events. 8.
How does the creation of a successful movie influence what, how, and for whom goods and services are produced? The “what” question is affected in two ways. First, one good or service that is produced is the successful movie. Second, spinoffs (Iron Man II) and/or similar films likely will be created in the future. The “how” question is affected to the extent that movies use different production methods. Some movies, for instance, have a lot of special effects while other movies have few or none. The “for whom” question is influenced because those people who, as the result of the blockbuster movie, have higher incomes so that more goods and services are produced for them.
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How does a successful movie illustrate self-interested choices that are also in the social interest? The a successful movie increases the income of the people involved with the movie. Hence these people’s choices are driven largely by self interest. However the creation of a successful movie also increases the quantity of widely enjoyed entertainment. The amount of entertainment available in the economy increases which benefits society. So the choices the people made in their self interest also reflected choices made in the social interest.
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Before starring in Guardians of the Galaxy, Chris Pratt had appeared in 11 movies that grossed an average of $7 million on the opening weekend. Guardians of the Galaxy grossed $94 million. a. How will the success of Guardians of the Galaxy influence the opportunity cost of hiring Chris Pratt? The salary that must be paid to Chris Pratt to appear in future movies increased because some of the success of Guardians of the Galaxy was attributed to Mr. Pratt. As a result the opportunity cost to movie producers of hiring Mr. Pratt increased. b. How have the incentives for a movie producer to hire Chris Pratt changed? There are two effects on the incentives of producers to hire Mr. Pratt. First, because the opportunity cost of hiring Mr. Pratt increased, the incentive to hire him decreased. However because part of the success of Guardians of the Galaxy was attributed to Mr. Pratt acting in the leading role, producers expect that his acting will lead to increased success for future movies. This belief increases producers’ incentives to hire Mr. Pratt.
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What might be an incentive for you to take a class in summer school? List some of the benefits and costs involved in your decision. Would your choice be rational? Early graduation, smaller class sizes, and/or retaining eligibility for a scholarship are examples of incentives that encourage taking summer classes. The benefits of taking summer classes might include early graduation, more personal attention from the instructor, retained eligibility for a scholarship, and increased knowledge about some aspect of the world. Costs potentially include forgone summer jobs or internships, less time to spend with friends, and additional tuition and other class-related expenses if the class I not one that would be taken otherwise. The choice is rational as long as the student determines that taking summer classes offers the highest benefit over cost for the use of his or time and efforts.
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Look at today’s Wall Street Journal. What is the leading economic news story? With big economic questions and tradeoffs does it discuss or imply? On June 20, 2017, the top economic news story discussed the Senates plan to vote on legislation repealing large parts of the Affordable Care Act. One option under consideration would cap the amount the federal government would pay toward the cost of Medicaid, the program that pays for healthcare for poor and disabled people. This story clearly discusses the “for whom” question: If Medicaid spending is reduced, fewer poor and disabled people will receive certain types of healthcare. It also discusses the “what” question: If fewer Americans have health insurance, .
WHAT IS ECONOMICS?
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less goods and services related to health care will be produced. The story implicitly illustrates a tradeoff: If choices are taken to limit the amount of healthcare poor and disabled people receive, their health will generally be worse than otherwise. 13.
Provide two microeconomic statements and two macroeconomic statements. Classify your statements as positive or normative, and explain your classifications. Microeconomic statements are: Fewer deep water oil wells should be drilled in the Gulf of Mexico. If less oil is produced, the price of oil will rise. The first statement is normative because it relies on what the person thinks “should” be done. The second statement is positive because it is possible to test the effect of less oil being produced. Macroeconomic statements are: The currently unemployment rate is too high. The current unemployment rate is higher for blacks than for whites. The first statement is normative because it depends on what is deemed “too high.” The second statement is positive because it can be checked to determine its validity.
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THE ECONOMIC PROBLEM
Answers to the Review Quizzes Page 72 1.
How does the production possibilities frontier illustrate scarcity? The unattainable combinations of production that lie beyond the PPF illustrate the concept of scarcity. There simply are not enough resources to produce any of these combinations of outputs. Additionally, while moving along the PPF to increase the production of one good requires that the production of another good be reduced, which also illustrates scarcity.
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How does the production possibilities frontier illustrate production efficiency? The combinations of outputs that lie on the PPF illustrate the concept of production efficiency. These points are the maximum production points possible and are attained only by producing the goods and services at the lowest possible cost. Any point inside the frontier reflects production where one or both outputs may be increased without decreasing the other output level. Clearly, such points cannot be production efficient.
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How does the production possibilities frontier show that every choice involves a tradeoff? Movements along the PPF frontier illustrate that producing more of one good requires producing less of other good. This observation reflects the result that a tradeoff must be made when producing output efficiently.
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How does the production possibilities frontier illustrate opportunity cost? The negative slope of the production possibility curve illustrates the concept of opportunity cost. Moving along the production possibility frontier, producing additional units of a good requires that the output of another good must fall. This sacrifice is the opportunity cost of producing more of the first good.
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Why is opportunity cost a ratio? The slope of the PPF is a ratio that expresses the quantity of lost production of the good on the y-axis to the increase in the production of the good on the x-axis moving downward along the PPF. The steeper the slope, the greater ratio, and the greater is the opportunity cost of increasing the output of the good measured on the horizontal axis.
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Why does the PPF bow outward and what does that imply about the relationship between opportunity cost and the quantity produced? Some resources are better suited to produce one type of good or service, like pizza. Other resources are better suited to produce .
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other goods or services, like DVDs. If society allocates resources wisely, it will use each resource to produce the kind of output for which it is best suited. Consider a PPF with pizza measured on the x-axis and DVDs measured on the y-axis. A small increase in pizza output when pizza production is relatively low requires only a small increase in the use of those resources still good at making pizza and not good at making DVDs. This yields a small decrease in DVD production for a large increase in pizza production, creating a relatively low opportunity cost reflected in the gentle slope of the PPF over this range of output. However, the same small increase in pizza output when pizza production is relatively large will require society to devote to pizza production those resources that are less suited to making pizza and more suited to making DVDs. This reallocation of resources yields a relatively small increase in pizza output for a large decrease in DVD output, creating a relatively high opportunity cost reflected in the steep slope of the PPF over this range of output. The opportunity cost of pizza production increases with the quantity of pizza produced as the slope of the PPF becomes ever steeper. This effect creates the bowed out effect (the concavity of the PPF function) and means that as more of a good is produced, the opportunity cost of producing additional units increases.
Page 75 1.
What is marginal cost? How is it measured? Marginal cost is the opportunity cost of producing one more unit of a good or service. Along a PPF marginal cost is reflected in the absolute value of the slope of the PPF. In particular, the magnitude of the slope of the PPF is the marginal cost of a unit of the good measured along the x-axis. As the magnitude of the slope changes moving along the PPF, the marginal cost changes.
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What is marginal benefit? How is it measured? The marginal benefit from a good or service is the benefit received from consuming one more unit of it. It is measured by what an individual is willing to give up (or pay) for an additional that last unit.
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How does the marginal benefit from a good change as the quantity produced of that good increases? As the more of a good is consumed, the marginal benefit received from each unit is smaller than the marginal benefit received from the unit consumed immediately before it, and is larger than the marginal benefit from the unit consumed immediately after it. This set of results is known as the principle of decreasing marginal benefit and is often assumed by economists to be a common characteristic of an individual’s preferences over most goods and services in the economy.
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What is allocative efficiency and how does it relate to the production possibilities frontier? Production efficiency occurs when production takes place at a point on the PPF. This indicates that all available resources are being .
THE ECONOMIC PROBLEM
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used for production and society cannot produce additional units of one good or service without reducing the output of another good or service. Allocative efficiency, however, requires that the goods and services produced are those that provide the greatest possible benefit. This definition means that the allocative efficient level of output is the point on the PPF (and hence is a production efficient point) for which the marginal benefit equals the marginal cost.
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What conditions must be satisfied if resources are used efficiently? Resources are used efficiently when more of one good or service cannot be produced without producing less of some of another good or service that is valued more highly. This is known as allocative efficiency and it occurs when: 1) production efficiency is achieved, and 2) the marginal benefit received from the last unit produced is equal to the marginal cost of producing the last unit.
Page 80 1.
What gives a person a comparative advantage? A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost than anyone else, If the person gives up the least amount of other goods and services to produce a particular good or service, the person has the lowest opportunity cost of producing that good or service.
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Distinguish between comparative advantage and absolute advantage. A person has a comparative advantage in producing a good when he or she has the lowest opportunity cost of producing it. Comparative advantage is based on the output forgone. A person has an absolute advantage in production when he or she uses the least amount of time or resources to produce one unit of that particular good or service. Absolute advantage is a measure of productivity in using inputs.
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Why do people specialize and trade? People can compare consumption possibilities from producing all goods and services through self-sufficiency against specializing in producing only those goods and services that reflect their comparative advantage and trading their output with others who do the same. People can then see that the consumption possibilities from specialization and trade are greater than under selfsufficiency. Therefore it is in people’s own self-interest to specialize. It was Adam Smith who first pointed out in the Wealth of Nations how individuals voluntarily engage in this socially beneficial and cooperative activity through the pursuit of their own self-interest, rather than for society’s best interests.
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What are the gains from specialization and trade? From society’s standpoint, the total output of goods and services available for consumption is greater with specialization and trade. From an individual’s perspective, each person who specializes enjoys being able to consume a larger bundle of goods and services after trading with others who have also specialized, than would otherwise .
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be possible under self-sufficiency. These increases are the gains from specialization and trade for society and for individuals.
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What is the source of the gains from trade? As long as people have different opportunity costs of producing goods or services, total output is higher with specialization and trade than if each individual produced goods and services under self-sufficiency. This increase in output is the gains from trade.
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Why does specialization and the gains from trade make the economy’s PPF outward bowed? Specialization and the gains from trade make the economy’s PPF bow outward because the resources that have the comparative advantage in producing a good or service are the first to be utilized to produce that good or service. Consequently when the good or service is first produced, its opportunity cost—the amount of the other good or service forgone—is small and so the PPF is relatively flat. Ultimately, when so much of the good or service is produced such that resources without a comparative advantage in it must be utilized, the opportunity cost becomes larger so that the PPF becomes steeper. When the PPF starts out flatter and becomes steeper, it bows outward.
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Why is not specializing and reaping the gains from trade inefficient? By not specializing and trading, some suppliers are not producing the good in which they have a comparative advantage. Consequently production occurs inside the PPF at a production inefficient point. All of the economy’s resources might be employed but they are misallocated.
Page 83 1.
What generates economic growth? The two key factors that generate economic growth are technological change and capital accumulation. Technological change allows an economy to produce more with the same amount of limited resources, Capital accumulation, the growth of capital resources including human capital, means that an economy has increased its available resources for production.
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How does economic growth influence the production possibilities frontier? Economic growth shifts the PPF outward. Persistent outward shifts in the production possibility frontier—economic growth—are caused by the accumulation of resources, such as more capital equipment or by the development of new technology.
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What is the opportunity cost of economic growth? When a society devotes more of its scarce resources to research and development of new technologies, or devotes additional resources to produce more capital equipment, both decisions lead to increased consumption opportunities in future periods at the cost of less consumption today. The loss of consumption today is the opportunity cost borne by society for creating economic growth.
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THE ECONOMIC PROBLEM
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Explain why Hong Kong has experienced faster economic growth than the United States. Hong Kong chose to devote a greater proportion of its available resources to the production of capital than the United States. This allowed Hong Kong to grow at a faster rate than the United States. By foregoing consumption and producing a greater proportion of capital goods over the last few decades, Hong Kong was able to achieve output per person equal to 94 percent of that in the United States.
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Does economic growth overcome scarcity? Scarcity reflects the inability to satisfy all our wants. Regardless of the amount of economic growth, scarcity will remain present because it will never be possible to satisfy all our wants. For instance it will never be possible to satisfy all the wants of the several thousand people who all would like to ski the best slopes on Vail with only their family and a few best friends present. So economic growth allows more wants to be satisfied but it does not eliminate scarcity.
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How does economic growth change the patterns of production? In low-income nations a large fraction of production is agriculture with distinctly less devoted to industry. For example, in Ethiopia agriculture accounts for 36 percent of production and industry for 17 percent. As the nation grows to middle income, investment in capital and new technology leads to an increase in the fraction of production that is industrial and a decrease in the fraction that is agricultural. For example, in China 9 percent of production is agriculture and 41 percent is industry. Finally, in high-income nations, services becomes an increasingly large proportion of production. In the United States, for example, services account for 80 percent of production while industry and agriculture together account for 20 percent of production.
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Why does economic growth destroy and create jobs? Economic growth leads to changes in the pattern of production—some sectors and products increase while others decrease. In the areas that increase in size, new jobs are created while in those that decrease, jobs are destroyed. Often workers who lose their jobs in the declining sectors need to acquire new skills for the new jobs and/or uproot their life to move to a new location. Some unemployed workers are unwilling to incur these costs and, as a result, remain unemployed, leading the economy to produce at a point inside its PPF.
Page 85 1.
Why are social institutions such as firms, markets, property rights, and money necessary? These social institutions factors necessary for a decentralized economy to coordinate production. Firms are necessary to allow people to specialize. Without firms, specialization would be limited because a person would need to specialize in the entire production of a good or service. With firms people are able to specialize in producing particular bits of a good or service. For a society to .
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enjoy the fruits of specialization and trade, the individuals who comprise that society must voluntarily desire to specialize in the first place. Discovering trade opportunities after a person has specialized in his or her comparative advantage in production is what allows that person to gain from his or her own specialization efforts. Trading opportunities can only take place if a market exists where people observe prices to discover available trade opportunities. Money is necessary to allow low-cost trading in markets. Without money, goods would need to be directly exchanged for other goods, a difficult and unwieldy situation. Finally people must enjoy social recognition of and government protection of property rights to have confidence that their commitments to trade arrangements will be respected by everyone in the market.
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What are the main functions of markets? The main function of a market is to enable buyers and sellers to get information and to do business with each other. Markets have evolved because they facilitate trade, that is, they facilitate the ability of buyers and sellers to trade with each other.
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What are the flows in the market economy that go from firms to households and the flows from households to firms? On the real side of the economy, goods and services flow from firms to households. On the monetary side of the economy, payments for factors of production, wages, rent, interest, and profits, flow from firms to households. Flowing from households to firms on the monetary side of the economy are the expenditures on goods and services and on the real side are the factors of production, labor, land, capital, and entrepreneurship.
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THE ECONOMIC PROBLEM
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Answers to the Study Plan Problems and Applications Use the following data to work Problems 1 to 3. Brazil produces ethanol from sugar, and the land used to grow sugar can be used to grow food crops. The table to the right sets out Brazil’s production possibilities for ethanol and food crops. 1. a. Draw a graph of Brazil’s PPF and explain how your graph illustrates scarcity. Figure 2.1 shows Brazil’s PPF. The production possibilities frontier indicates scarcity because it shows the limits to what can be produced. In particular, production combinations of ethanol and food crops that lie outside the production possibilities frontier are not attainable.
Ethanol (barrels per day) 70 64 54 40 22 0
and and and and and and
Food crops (tons per day) 0 1 2 3 4 5
b. If Brazil produces 40 barrels of ethanol a day, how much food must it produce to achieve production efficiency? If Brazil produces 40 barrels of ethanol per day, it achieves production efficiency if it also produces 3 tons of food per day.
c. Why does Brazil face a tradeoff on its PPF? Brazil faces a tradeoff on its PPF because Brazil’s resources and technology are limited. For Brazil to produce more of one good, it must shift factors of production away from the other good. Therefore to increase production of one good requires decreasing production of the other, which reflects a tradeoff.
2. a. If Brazil increases ethanol production from 40 barrels per day to 54 barrels per day, what is the opportunity cost of the additional ethanol? When Brazil is production efficient and increases its production of ethanol from 40 barrels per day to 54 barrels per day, it must decrease its production of food crops from 3 tons per day to 2 tons per day. The opportunity cost of the additional ethanol is 1 ton of food per day for the entire 14 barrels of ethanol or 1/14 of a ton of food per barrel of ethanol.
b. If Brazil increases food production from 2 tons per day to 3 tons per day, what is the opportunity cost of the additional food? When Brazil is production efficient and increases its production of food crops from 2 tons per day to 3 tons per day, it must decrease its production of ethanol from 54 barrels per day to 40 barrels per
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day. The opportunity cost of the additional 1 ton of food crops is 14 barrels of ethanol.
c. What is the relationship between your answers to parts (a) and (b)? The opportunity costs of an additional barrel of ethanol and the opportunity cost of an additional ton of food crop are reciprocals of each other. That is, the opportunity cost of 1 ton of food crops is 14 barrels of ethanol and the opportunity cost of 1 barrel of ethanol is 1/14 of a ton of food crops.
3.
Does Brazil face an increasing opportunity cost of ethanol? What feature of Brazil’s PPF illustrates increasing opportunity cost? Brazil faces an increasing opportunity cost of ethanol production. For instance, when increasing ethanol production from 0 barrels per day to 22 barrels the opportunity cost of a barrel of ethanol is 1/22 of a ton of food while increasing ethanol production another 18 barrels per day (to a total of 40 barrels per day) has an opportunity cost of 1/18 of a ton of food per barrel of ethanol. The PPF’s bowed outward shape reflects the increasing opportunity cost.
Use the above table (for Problems 1 to 3) to work Problems 4 and 5. 4. Define marginal cost and calculate Brazil’s marginal cost of producing a ton of food when the quantity produced is 2.5 tons per day. The marginal cost of a good is the opportunity cost of producing one more unit of the good. When the quantity of food produced is 2.5 tons, the marginal cost of a ton of food is the opportunity cost of increasing the production of food from 2 tons per day to 3 tons per day. The production of ethanol falls from 54 barrels per day to 40 barrels per day, a decrease of 14 barrels per day. The opportunity cost of increasing food production is the decrease in ethanol product, so the opportunity cost of producing a ton of food when 2.5 tons of food per day are produced is 14 barrels of ethanol per day.
5.
Define marginal benefit. Explain how it is measured and why the data in the table does not enable you to calculate Brazil’s marginal benefit from food. The marginal benefit of a good is the benefit received from consuming one more unit of the good. The marginal benefit of a good or service is measured by the most people are willing to pay for one more unit of it. The data in the table do not provide information on how much people are willing to pay for an additional unit of food. The table has no information on the marginal benefit of food.
6.
Distinguish between production efficiency and allocative efficiency. Explain why many production possibilities achieve production efficiency but only one achieves allocative efficiency. Production efficiency occurs when goods and services are produced at the lowest cost. This definition means that production efficiency occurs at any point on the PPF. Therefore all of the production points on the PPF are production efficient. Allocative efficiency occurs when goods and services are produced at the lowest cost and in the quantities that provide the greatest possible benefit. The
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allocatively efficient production point is the single point on the PPF that has the greatest possible benefit.
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Use the following data to work Problems 7 and 8. In an hour, Marco can produce 5 cups of pesto sauce or 15 platters of pasta and Giorgia can produce 8 cups of pesto sauce or 20 platters of pasta. 7. a. Calculate Marco’s opportunity cost of producing a cup of pesto sauce. Marco forgoes 15 platters of pasta to produce 5 cups of pesto sauce, so Macro’s opportunity cost of producing one cup of sauce is (15 platters of pasta)/(5 cups of pesto sauce) or 3 platters of pasta per cup of pesto sauce.
b. Calculate Giorgia’s opportunity cost of producing a cup of pesto sauce. Giorgia forgoes 20 platters of pasta to produce 8 cups of pesto sauce, so Giorgia’s opportunity cost of producing one cup of sauce is (20 platters of pasta)/(8 cups of pesto sauce) or 2.5 platters of pasta per cup of pesto sauce.
c. Who has a comparative advantage in producing pesto sauce? Giorgia’s opportunity cost of a cup of pesto sauce is lower than Marco’s opportunity cost, so Giorgia has a comparative advantage in producing pesto sauce.
d. If Marco and Giorgia specialize in producing the good in which they have a comparative advantage and then trade 11 platters of pasta for 4 cups of pesto sauce, who gains from the specialization and trade? Giorgia specializes in pesto sauce and Marco specializes in pasta. Both Marco and Giorgia gain from trade. Marco gains because he can obtain pesto sauce from Giorgia at a cost of (11 platters of pasta)/(4 cups of pesto sauce), which is 2.75 platters of pasta per cup of pesto sauce, a cost that is lower than what it would cost him to produce pesto sauce himself. Giorgia also gains from trade because she trades pesto sauce for pasta at 2.75 platters of pasta per cup of pesto sauce, which is higher than her cost of producing a cup of pesto sauce.
8.
Suppose that Giorgia finds a new way to cook pasta that enables her to make 30 platters an hour. (She can still make only 8 cups of pesto sauce an hour.) a. Who now has a comparative advantage in producing pasta? Marco forgoes 5 cups of pesto sauce to cook 15 platters of pasta, so Marco’s opportunity cost of producing pasta is (5 cups of pesto)/(15 platters of pasta) or 0.33 cups of pesto sauce per platter of pasta. Giorgia forgoes 8 cups of pesto sauce to produce 30 platters of pasta, so Giorgia’s opportunity cost of producing pasta is (8 cups of pesto)/(30 platters of pasta) or 0.267 cups of pesto sauce per platter of pasta. Giorgia has the comparative advantage in cooking pasta because her opportunity cost of a platter of pasta is lower than Marco’s opportunity cost.
b. Can Marco and Giorgia gain from trade? Marco and Giorgia can still gain from trade because Giorgia (now) has a comparative advantage in producing pasta and Marco (now) has a comparative advantage in producing pesto sauce. Giorgia will produce pasta and Marco will produce pesto sauce. .
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c. Would Marco and Giorgia still be willing to trade 11 platters of pasta for 4 cups of pesto sauce? Explain your answer. Marco and Giorgia will not be willing to trade 11 platters of pasta for 4 cups of pesto sauce. The (new) cost of pasta is (4 cups of pesto)/(11 platters of pasta) or 0.364 cups of pesto sauce per platter of pasta. In particular, Marco, whose comparative advantage lies in producing pesto sauce, can produce 1 platter of pasta at an opportunity cost of only 0.33 cups of pesto sauce. So Marco will be unwilling to pay any more than 0.33 cups of pesto sauce per platter of pasta.
9.
A farm grows corn and produces eggs. The marginal cost of producing each of these products increases as more of it is produced. a. Make a graph that illustrates the farm’s PPF. The PPF is illustrated in Figure 2.2 as PPF0. It shows increasing opportunity cost because the marginal cost of both corn and eggs increases as more of the good is produced, so it has the “conventional” bowed-outward shape.
b. The farm adopts a genetically modified method that allows it to increase its corn yield. On your graph, sketch the impact of this new method on the farm’s PPF. The genetically modified method rotates the PPF outward from PPF0 to PPF1.
c. With the farm using the new method described in part (b), has the opportunity cost of producing a carton of eggs increased, decreased, or remained the same? Explain and illustrate your answer. The opportunity cost of producing eggs has increased. The opportunity cost of a carton of eggs is equal to the magnitude of the slope of the PPF. As illustrated in Figure 2.2, for each quantity of eggs the slope of PPF1 has a bigger magnitude than the slope of PPF0 so the opportunity cost of a carton of eggs is higher along PPF1.
d. Is the farm more efficient with the new method of genetic engineering than it was without it? Why? The farm is able to produce more with the genetically modified method, but it is not necessarily more or less efficient. If the farm was producing on its PPF before this new method and after, the farm is production efficient before the new method and after. If it was producing inside the PPF before genetic engineering and after, then the farm is production inefficient in both cases.
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For 50 years, Cuba has had a centrally planned economy in which the government makes the big decisions on how resources will be allocated. a. Why would you expect Cuba’s production possibilities (per person) to be smaller than those of the United States? Cuba’s economy is almost surely less efficient than the U.S. economy. The Cuban central planners do not know people’s production possibilities or their preferences. The plans that are created wind up wasting resources and/or producing goods and services that no one wants. Because firms in Cuba are owned by the government rather than individuals, no one in Cuba has the self-interested incentive to operate the firm efficiently and produce goods and services that consumers desire. Additionally Cuba does not actively trade so Cuba produces most of its consumption goods rather than buying them from nations with a comparative advantage. Because Cuba uses its resources to produce consumption goods, it cannot produce many capital goods so its economic growth rate has been low.
b. What are the social institutions that Cuba might lack that help the United States to achieve allocative efficiency? Of the four social institutions, firms, money, markets, and property rights, Cuba’s economy has firms and money. Markets, however, are less free of government intervention in Cuba. But the major difference is the property rights in the Cuban economy. In Cuba the government owns most of the firms; that is, the government has the property right to run the producers. Because the firms are not motivated to make a profit, the managers of these firms have little incentive to operate the firm efficiently or to produce the goods and services that consumers desire. In the United States, firms are owned by individuals; that is, people have the property right that allows them to run firms. These owners have the self-interested incentive to operate the firm efficiently and to produce the goods and services people want, an incentive sorely lacking in the Cuban economy.
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Answers to Additional Problems and Applications Use the table to work Problems 11 and 12. Suppose that Yucatan’s production possibilities are given in the table. 11. a. Draw a graph of Yucatan’s PPF and explain how your graph illustrates a tradeoff. Yucatan’s PPF is illustrated in Figure 2.3. The figure illustrates a tradeoff because moving along Yucatan’s PPF producing more of one good requires producing less of the other good. Yucatan trades off more production of one good for less production of the other.
Food (pounds per month) 300 200 100 0
and and and and
Sunscreen (gallons per month) 0 50 100 150
b. If Yucatan produces 150 pounds of food per month, how much sunscreen must it produce if it achieves production efficiency? If Yucatan produces 150 pounds of food per month, then the point labeled A on the PPF in Figure 2.11 shows that Yucatan must produce 75 gallons of sunscreen per month to achieve production efficiency.
c. What is Yucatan’s opportunity cost of producing (i) 1 pound of food and (ii) 1 gallon of sunscreen? Yucatan’s PPF is linear so the opportunity cost of producing 1 pound of food is the same at all quantities. Calculate the opportunity cost of producing 1 pound of food when increasing the production of food from 0 to 100 pounds per month. Between these two ranges of production, the quantity of sunscreen produced falls from 150 gallons per month to 100 gallons per month, a decrease of 50 gallons. The opportunity cost is 50 gallons of sunscreen to gain 100 pounds of food. The opportunity cost per pound of food equals (50 gallons of sunscreen)/(100 pounds of food), or an opportunity cost of 0.5 gallon of sunscreen per pound of food. Yucatan’s PPF is linear so the opportunity cost of producing 1 gallon of sunscreen is the same at all quantities. Calculate the opportunity cost of producing 1 gallon of sunscreen when increasing the production of sunscreen from 0 to 50 gallons per month. Between these two ranges of production, the quantity of food produced falls from 300 pounds per month to 200 pounds per month, a decrease of 100 pounds. The opportunity cost is 100 pounds of food to gain 50 gallons of sunscreen, or (100 pounds of food)/(50 gallons of sunscreen) which yields an opportunity cost of 2.0 pounds of food per gallon of sunscreen. .
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e. What is the relationship between your answers to part (c)? Answers (c) and (d) reflect the fact that opportunity cost is a ratio. The opportunity cost of gaining a unit of a good moving along the PPF equals the quantity of the other good or service forgone divided by the quantity of the good or service gained. The opportunity cost of one good, food, is equal to the inverse of the opportunity cost of the other good, sunscreen.
12.
What feature of a PPF illustrates increasing opportunity cost? Explain why Yucatan’s opportunity cost does or does not increase. If opportunity costs increase, the PPF bows outward. Yucatan’s PPF is linear and along a linear PPF the opportunity cost is constant. Yucatan does not face an increasing opportunity cost of food because the opportunity cost remains constant, equal to 0.5 gallons of sunscreen per pound of food. Yucatan’s resources must be equally productive in both activities.
13.
In problem 11, what is the marginal cost of 1 pound of food in Yucatan when the quantity produced is 150 pounds per day? What is special about the marginal cost of food in Yucatan? The marginal cost of a pound of food in Yucatan is constant at all points along Yucatan’s PPF and is equal to 0.5 gallons of sunscreen per pound of food. The special point about Yucatan’s marginal cost is the fact that the marginal cost is constant. This result reflects Yucatan’s linear PPF.
14.
The table describes the preferences in Yucatan. a. What is the marginal benefit from sunscreen and how is it measured?
Sunscreen (gallons per month)
Willingness to pay (pounds of food per gallon) 3 2 1
The marginal benefit from sunscreen is the benefit enjoyed by the person who consumes one more gallon of 25 sunscreen. It is equal to the 75 willingness to pay for an additional 125 gallon. For example, in the table when 75 gallons of sunscreen are produced, the marginal benefit of a gallon is 2 pounds of food per gallon.
b. Use the table in Problem 11. What does Yucatan produce to achieve allocative efficiency? To achieve allocative efficiency, the marginal benefit of a gallon of sunscreen must equal the marginal cost of a gallon of sunscreen. Yucatan’s marginal cost of a gallon of sunscreen is 2 pounds of food per gallon. When Yucatan produces 75 gallons of sunscreen, the table shows that Yucatan’s marginal benefit is 2 pounds of food per gallon. Therefore allocative efficiency is achieved when 75 gallons of sunscreen and, from the PPF, 150 pounds of food are produced.
15.
Macy’s, Kmart, JCPenney: More Retailers Closing Brick-and-Mortar Stores As more people choose online shopping over brick-and-mortar stores, Macy’s, Kmart, JCPenney and others are closing stores. Source: Springfield News-Sun, March 24, 2017 a. Draw the PPF curves for brick-and mortar retailers and online retailers before and after .
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the Internet became available. Before there was an Internet, there were no online retailers and the production possibilities frontier was PPF0 in Figure 2.4, the flat line along the x-axis. The only sales of retail goods were from brick-and-mortar retailers. After the Internet was developed, online retailers were created and started to sell goods and services. The Internet is a technological advance that changed the production possibilities frontier to PPF1 in Figure 2.4.
b. Draw the marginal cost and marginal benefit curves for brick-and-mortar retailers and online retailers before and after the Internet became available. The marginal benefit for the goods is the same regardless of whether they came from an online store or a brick-and-mortar store. Therefore in Figure 2.5 the marginal benefit curve for retail goods is MB. The marginal cost of brick-and-mortar stores increases as the quantity increases, so both pre-and postInternet, the brick-and-mortar marginal cost curve is MCB&M. Before the Internet, no online retailing could occur so the marginal cost curve is the vertical marginal cost curve MCPRE-INT running along the y-axis. After the Internet was developed online retailers have a lower marginal cost than do brick-and-mortar retailers, so the marginal cost curve of online retailers is MCPOST-INT.
c. Explain how changes in production possibilities, preferences, or both have changed the way in which goods are retailed. The change in production possibilities, which created lower-cost online retailers, have changed the way retail goods are purchased. The expansion of the production possibilities did not change people’s preferences, so the marginal benefit does not change. But, .
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with the lower cost of retailing, the quantity of retailing increases. Because the marginal cost of these goods is less using an online retailer, today consumers are purchasing increasingly larger amounts online. Consequently brick-and-mortar retailers are shrinking and disappearing as they go bankrupt.
Use the following news clip to work Problems 16 and 17. Gates Doubles Down on Malaria Eradication The End Malaria Council, convened by Bill Gates and Ray Chambers, seeks to mobilize resources to prevent and treat malaria. The current level of financing is too low to end malaria. Bruno Moonen, deputy director for malaria at the Gates Foundation, says that more resources, more leadership, and new technologies are needed to eradicate malaria in the current generation. Source: Catherine Cheney, Devex, January 20, 2017, 16.
Is Bruno Moonen talking about production efficiency or allocative efficiency or both? Mr. Moonen is talking about allocative efficiency and production efficiency. The allocatively efficient quantity occurs when marginal cost equals marginal benefit. Mr. Moonen’s assessment is that from the current allocatively efficient quantity of malaria eradication more resources need to be devoted to malaria eradication if it is to be eliminated in the current generation. He suggests that production possibilities need to be increased by developing new technologies for fighting malaria. Once these technologies are developed, the production possibilities frontier and the production efficient points will shift outward. The new technologies will lower the cost of malaria eradication and thereby increase the allocatively efficient quantity of malaria eradication.
17.
Make a graph with the percentage of malaria cases eliminated on the x-axis and the marginal cost and marginal benefit of driving down malaria cases on the y-axis. On your graph, (i) Draw a marginal cost curve and marginal benefit curve that are consistent with Bruno Moonen’s opinion. (ii) Identify the quantity of malaria eradicated that achieves allocative efficiency. Figure 2.6 shows a marginal cost curve and a marginal benefit curve that are consistent with Mr. Moonen’s views. According to Mr. Moonen, the current allocatively efficient quantity of malaria eradicated will not eliminate 100 percent of malaria in the current generation. In the figure, the allocatively efficient quantity is 60 percent of malaria cases eliminated because this is the quantity at which the marginal benefit equals the marginal cost.
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Use the following data to work Problems 18 and 19. Fadi can produce 10 baklavas, a Turkish pastry, or 250 bars of chocolate an hour. Hania can produce 30 baklavas or 90 bars of chocolate an hour. 18. a. Calculate Fadi’s opportunity cost of a baklava and Hania’s opportunity cost of a baklava. If Fadi spends an hour baking baklavas, he can bake 10 baklavas but forgoes 250 pieces of chocolate. Fadi’s opportunity cost of 1 baklavas is (250 pieces of chocolate)/(10 baklavas), or 25 pieces of chocolate per baklavas. If Hania spends an hour baking baklavas, she could bake 30 baklavas but forgoes 90 pieces of chocolate. Hania’s opportunity cost of 1 baklavas is (90 pieces of chocolate)/(30 baklavas), or 3 pieces of chocolate per baklavas.
b. If each spends 30 minutes of each hour baking baklavas and 30 minutes producing chocolate, how many baklavas and chocolate bars does each produce? Fadi produces 5 baklavas and 125 pieces of chocolate. Hania produces 15 baklavas and 45 pieces of chocolate. The total number produced is 20 baklavas and 170 pieces of chocolate.
c. Who has a comparative advantage in producing (i) baklavas and (ii) chocolate? Hania has the comparative advantage in baking baklavas because her opportunity cost of a baklava is less than Fadi’s opportunity cost. Fadi has the comparative advantage in producing pieces of chocolate because his opportunity cost of a piece of chocolate is less than Hania opportunity cost.
19. a
Draw a graph of Fadi’s PPF and Hania’s PPF and show the point at which each produces when they spend 30 minutes of each hour producing baklavas and 30 minutes producing cakes.
Fadi’s PPF is illustrated in Figure 2.7; Hania’s PPF is illustrated in Figure 2.8. Point A in both figures shows their production points when each spends 30 minutes making pieces of chocolate and 30 .
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minutes baking baklavas: Fadi (5 baklavas, 125 pieces of chocolate), Hania (15 baklavas, 45 pieces of chocolate)
b. On your graph, show what Fadi produces and what Hania produces when they specialize. Fadi will specialize in chocolate so he produces 250 pieces of chocolate and 0 baklavas, and Hania will specialize in baklavas so she produces 0 pieces of chocolate and 30 baklavas. Point B in both figures shows the production points when each specializes.
c. When they specialize and trade, what are the total gains from trade? Fadi will specialize in chocolate and Hania will specialize in baklavas. If they specialize and trade, the total production of both pieces of chocolate and baklavas increase. When each spends 30 minutes making pieces of chocolate and 30 minutes baking baklavas, together they produce 170 pieces of chocolate and 20 baklavas. When they specialize, together they produce 250 pieces of chocolate and 30 baklavas. The 80 increase in pieces of chocolate and the 10 increase baklavas is the gains from trade.
d. If Fadi and Hania share the total gains equally, what trade takes place between them? Fadi will trade 40 pieces of chocolate (half of the gain in chocolate production) to Hania in exchange for 5 baklavas (half of the increase in baklava production). Both will benefit.
20.
Pierre and Antoinette produce cellos and double basses. The tables show their production possibilities. Pierre produces 30 cellos and 50 basses a month; Antoinette produces 40 cellos and 10 basses a month.
Pierre’s Production Possibilities Cellos Basses (units per (units per week) week) 50 and 0 40 and 25 30 and 50 20 and 75 10 And 100 0 And 125
Antoinette’s Production Possibilities Cellos Basses (units per (units per week) week) 80 and 0 40 and 10 0 and 20
a. Who has a comparative advantage in producing (i) cellos and (ii) basses? (i) Pierre’s opportunity cost of a cello is (50 basses)/(30 cellos), or 1.67 basses per cello. Antoinette’s opportunity cost of a cello is (10 basses)/(40 cellos), or 0.25 basses per cello. Antoinette’s opportunity cost of a cello is lower than Pierre’s opportunity cost, so Antoinette has the comparative advantage in cello production. (ii) Pierre’s opportunity cost of a bass is (30 cellos)/(50 basses), or 0.6 cellos per bass. Antoinette’s opportunity cost of a bass is (40 cellos)/(10 basses), or 4 cellos per bass. Pierre’s opportunity cost of a bass is lower than Antoinette’s opportunity cost, so Pierre has the comparative advantage in the production of basses. .
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b. If Pierre and Antoinette specialize and trade 5 cellos for 6 basses, what are the gains from trade? Pierre has a comparative advantage in producing basses, so he specializes in producing basses. Antoinette has a comparative advantage in producing cellos, so she specializes in cellos. Pierre now produces 125 basses and Antoinette produces 80 cellos. Before specializing, they produced a total of 60 basses (Pierre’s 50 plus Antoinette’s 10) and 70 cellos (Pierre’s 30 plus Antoinette’s 40). By specializing, the total production of basses increases by 65 and the total production of cellos increases by 10. This increase in total production is the gains from trade. By trading 6 basses for 5 cellos, they can share these gains. Pierre obtains cellos from Antoinette for less than it costs him to produce them and Antoinette obtains basses from Pierre for less than it costs her to produce them.
21.
Capital accumulation and technological change bring economic growth: Production that was unattainable yesterday becomes attainable today; production that is unattainable today will become attainable tomorrow. Why doesn’t economic growth bring an end to scarcity one day? Scarcity is always being defeated yet will never suffer defeat. Scarcity reflects the existence of unmet wants. People’s wants are infinite—regardless of what a person already possesses, everyone can easily visualize something else he or she wants, if only more time in the day to enjoy their possessions. Because people’s wants are insatiable, scarcity will always exist regardless of economic growth.
22.
SpaceX Plans to Send Two People Around the Moon SpaceX CEO Elon Musk announced that SpaceX has plans to send two private citizens on a one week, 300,000- to 400,000-mile trip around the moon in 2018. Source: The Verge, February 27, 2017 a. What is the opportunity cost of creating the technology for trips around the moon? The opportunity cost of creating the technology is the next best alternative forgone by the resources used to develop this technology. For example, the engineers who are working to develop SpaceX’s technology might otherwise be assisting in the production of technology used to more powerful batteries, so the opportunity cost is the more powerful battery.
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b. Sketch SpaceX’s PPF and production point in 2017 and its PPF and planned production in 2018. Figure 2.9 shows SpaceX’s PPF in 2017 and in 2018. The increase in SpaceX’s technology shifts its PPF outward so that its PPF in 2018 lies beyond its PPF in 2017. In 2017, a trip around the moon was beyond its PPF but with the technological advance it becomes possible. SpaceX’s production point in 2017 is labeled A, here it devotes all its resources to developing new technology. Its planned production in 2018 is labeled B, where it will produce 1 trip around the moon.
23.
On a graph of the circular flows in the market economy, indicate the real and money flows in which the following items belong: a. You buy an iPad from the Apple Store. Figure 2.10 shows the circular flows in a market economy. Your purchase of an iPad from Apple is the purchase of a good from a firm. This flow is in the black arrow indicated by point a in the figure. When you pay for the iPad, the corresponding money flow is in the grey arrow in the opposite direction to the black arrow labeled a.
b. Apple Inc. pays the designers of the iPad. Apple’s payment to the designers of the iPad is the payment of a wage to a factor of production. This flow is in the grey arrow indicated by point b in the figure. The flow of design services from the designer to Apple is in the black arrow in the opposite direction to the grey arrow labeled b.
c. Apple Inc. decides to expand and rents an adjacent building. Apple’s decision to expand by renting a building means that Apple is increasing the capital it uses. This flow is in the black arrow indicated by point c in the figure. The flow of the payment for the .
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rental services of the building is in the grey arrow in the opposite direction to the black arrow labeled c.
d. You buy a new e-book from Amazon. Your purchase of an e-book from Amazon is the purchase of a good from a firm. This flow is in the black arrow indicated by point d in the figure. When you pay for the e-book, the corresponding money flow is in the grey arrow in the opposite direction to the black arrow labeled d.
e. Apple Inc. hires a student to work as an intern. Apple’s decision to hire a student intern is Apple increasing the labor it uses. The flow of labor services is in the black arrow indicated by point e in the figure. The flow of the payment for the labor services is in the grey arrow in the opposite direction to the black arrow labeled c.
Economics in the News 24.
After you have studied Reading Between the Lines on pp. 86–87, answer the following questions. a. How have robots changed the U.S. production possibilities? Robots have increased the U.S. production possibilities and shifted the U.S PPF outward.
b. How have advances in technologies for producing services changed the U.S. production possibilities? Advances in technologies for producing services have also increased U.S. production possibilities.
c. If robots had been the only technological advance, how would the PPF have changed? If robots had been the only technological advance, the PPF would have rotated outward. The maximum quantity of other goods and services would not have changed but the maximum quantity of goods produced using robots, such as steel, would have increased. For any quantity of other goods and services, more steel could be produced after the introduction of robots.
d. If robots had been the only technological advance, how would the opportunity cost of producing steel have changed? Would it have been lower or higher than it actually was? If robots had been the only technological advance, the PPF would have rotated so that for any quantity of services the slope of the new PPF would be smaller than the slope of the initial PPF. Consequently, the opportunity cost of producing steel would have decreased. For any quantity of services the opportunity cost of producing steel would be lower after the introduction of robots.
25. YouTube Launches Live TV in the US Google has launched YouTube TV, a $35-amonth service that carries live streaming from all the major broadcast and sports networks as well as some cable networks and local sports and news channels. Users will be able to record an unlimited amount of content and multiple shows simultaneously, without using up any data space on mobile devices. Source: Mediatel, March 1, 2017
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a. How has live streaming changed the production possibilities of video entertainment and other goods and services? Live streaming has increased the production possibilities. For any quantity of other goods and services, now more video entertainment can be produced. The production possibilities frontier has changed so that the maximum quantity of video entertainment has increased but the maximum quantity of other goods and services has not changed.
b. Sketch a PPF for video entertainment and other goods and services before live streaming. The PPF should have video entertainment on one axis and other goods and services on the other as illustrated in Figure 2.11. The PPF is bowed outward as a conventional PPF.
c. Show how the arrival of inexpensive live streaming has changed the PPF. The arrival of inexpensive live streaming shifts the PPF outward as shown by the change from PPF0 to PPF1 in Figure 2.11. The intersection of the new PPF along the axis measuring video entertainment increases and the intersection of the new PPF along the axis measuring other goods and services does not change.
d. Sketch a marginal benefit curve and marginal cost curve for video entertainment before and after live streaming. In Figure 2.12, the marginal benefit and marginal cost from video entertainment is measured along the vertical axis and the quantity of video entertainment is measured along the horizontal axis. As the figure shows, the marginal benefit curve is a conventional downward-sloping marginal benefit curve and the marginal cost curve is a conventional upward-sloping marginal cost curve. The introduction of low cost live streaming does not change the marginal benefit curve—it remains MB. But it lowers the marginal cost and shifts the marginal cost curve from MC0 to MC1. .
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e. Explain how the efficient quantity of video entertainment has changed. As Figure 2.12 shows, the allocatively efficient quantity of video entertainment increases. In Figure 2.12, the allocatively efficient quantity increases from 4 million units per year to 6 million units per year
.