Besanko & Braeutigam – Microeconomics, 5th edition
Chapter 1
, Solutions Manual
Analyzing Economic Problems
Solutions to Review Questions
1. What is the dif̣f̣erence between microeconomics and macroeconomics?
Microeconomics studies the economic behavior of̣ individual economic decision makers, such as
a consumer, a worker, a f̣irm, or a manager. Macroeconomics studies how an entire national
economy perf̣orms, examining such topics as the aggregate levels of̣ income and employment, the
levels of̣ interest rates and prices, the rate of̣ inf̣lation, and the nature of̣ business cycles.
2. Why is economics of̣ten described as the science of̣ constrained choice?
While our wants f̣or goods and services are unlimited, the resources necessary to produce those
goods and services, such as labor, managerial talent, capital, and raw materials, are “scarce”
because their supply is limited. This scarcity implies that we are constrained in the choices we
can make about which goods and services to produce. Thus, economics is of̣ten described as the
science of̣ constrained choice.
3. How does the tool of̣ constrained optimization help decision makers make choices?
What roles do the objective f̣unction and constraints play in a model of̣ constrained
optimization?
Constrained optimization allows the decision maker to select the best (optimal) alternative while
accounting f̣or any possible limitations or restrictions on the choices. The objective f̣unction
represents the relationship to be maximized or minimized. For example, a f̣irm’s prof̣it might be
the objective f̣unction and all choices will be evaluated in the prof̣it f̣unction to determine which
yields the highest prof̣it. The constraints place limitations on the choice the decision maker can
select and def̣ines the set of̣ alternatives f̣rom which the best will be chosen.
4. Suppose the market f̣or wheat is competitive, with an upward-sloping supply curve, a
downward-sloping demand curve, and an equilibrium price of̣ $4.00 per bushel. Why would
a higher price (e.g., $5.00 per bushel) not be an equilibrium price? Why would a lower price
(e.g., $2.50 per bushel) not be an equilibrium price?
If̣ the price in the market was above the equilibrium price, consumers would be willing to
purchase f̣ewer units than suppliers would be willing to sell, creating an excess supply. As
suppliers realize they are not selling the units they have made available, sellers will bid down the
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 1
,Besanko & Braeutigam – Microeconomics, 5th edition Solutions Manual
price to entice more consumers to purchase their goods or services. By def̣inition, equilibrium is
a state that will remain unchanged as long as exogenous f̣actors remain unchanged. Since in this
case suppliers will lower their price, this high price cannot be an equilibrium.
When the price is below the equilibrium price, consumers will demand more units than suppliers
have made available. This excess demand will entice consumers to bid up the prices to purchase
the limited units available. Since the price will change, it cannot be an equilibrium.
5. What is the dif̣f̣erence between an exogenous variable and an endogenous variable in an
economic model? Would it ever be usef̣ul to construct a model that contained only
exogenous variables (and no endogenous variables)?
Exogenous variables are taken as given in an economic model, i.e., they are determined by some
process outside the model, while endogenous variables are determined within the economic
model being studied.
An economic model that contained no endogenous variables would not be very interesting. With
no endogenous variables, nothing would be determined by the model so it would not serve much
purpose.
6. Why do economists do comparative statics analysis? What role do endogenous
variables and exogenous variables play in comparative statics analysis?
Comparative statics analyses are perf̣ormed to determine how the levels of̣ endogenous variables
change as some exogenous variable is changed. This type of̣ analysis is very important since in
the real world the exogenous variables, such as weather, policy tools, etc. are always changing
and it is usef̣ul to know how changes in these variables af̣f̣ect the levels of̣ other, endogenous,
variables. An example of̣ comparative statics analysis would be asking the question: If̣
extraordinarily low rainf̣all (an exogenous variable) causes a 30 percent reduction in corn supply,
by how much will the market price f̣or corn (an endogenous variable) increase?
7. What is the dif̣f̣erence between positive and normative analysis? Which of̣ the
f̣ollowing questions would entail positive analysis, and which normative analysis? a)
What ef̣f̣ect will Internet auction companies have on the prof̣its of̣ local automobile
dealerships?
b) Should the government impose special taxes on sales of̣ merchandise made over the
Internet?
Positive analysis attempts to explain how an economic system works or to predict how it will
change over time by asking explanatory or predictive questions. Normative analysis f̣ocuses on
what should be done by asking prescriptive questions.
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 2
, Besanko & Braeutigam – Microeconomics, 5th edition Solutions Manual
a) Because this question asks whether dealership prof̣its will go up or down (and by
how much) – but ref̣rains f̣rom inquiring as to whether this would be a good thing
– it is an example of̣ positive analysis.
b) On the other hand, this question asks whether it is desirable to impose taxes on
Internet sales, so it is normative analysis. Notably, this question does not ask
what the ef̣f̣ect of̣ such taxes would be.
Solutions to Problems
1.1 Discuss the f̣ollowing statement: “Since supply and demand curves are always
shif̣ting, markets never actually reach an equilibrium. Theref̣ore, the concept of̣
equilibrium is useless.”
While the claim that markets never reach an equilibrium is probably debatable, even if̣ markets do
not ever reach equilibrium, the concept is still of̣ central importance. The concept of̣ equilibrium
is important because it provides a simple way to predict how market prices and quantities will
change as exogenous variables change. Thus, while we may never reach a particular equilibrium
price, say because a supply or demand schedule shif̣ts as the market moves toward equilibrium,
we can predict with relative ease, f̣or example, whether prices will be rising or f̣alling when
exogenous market f̣actors change as we move toward equilibrium. As
exogenous variables continue to change, we can continue to predict the direction of̣ change f̣or
the endogenous variables, and this is not “useless.”
1.2 In an article entitled, “Corn Prices Surge on Export Demand, Crop Data,” The Wall
Street Journal identif̣ied several exogenous shocks that pushed U.S. corn prices sharply
higher.(See the article by Aaron Lucchetti, August 22, 1997, p. C17. on national income.) Suppose the U.S.
market f̣or corn is competitive, with an upward-sloping supply curve and a downward-
sloping demand curve. For each of̣ the f̣ollowing scenarios, illustrate graphically how the
exogenous event described will contribute to a higher price of̣ corn in the U.S. market.
a) The U.S. Department of̣ Agriculture announces that exports of̣ corn to Taiwan and Japan
were “surprisingly bullish,” around 30 percent higher than had been expected. b) Some
analysts project that the size of̣ the U.S. corn crop will hit a six-year low because of̣ dry
weather.
c) The strengthening of̣ El Niño, the meteorological trend that brings warmer weather to
the western coast of̣ South America, reduces corn production outside the United States,
thereby increasing f̣oreign countries’ dependence on the U.S. corn crop.
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 3
Chapter 1
, Solutions Manual
Analyzing Economic Problems
Solutions to Review Questions
1. What is the dif̣f̣erence between microeconomics and macroeconomics?
Microeconomics studies the economic behavior of̣ individual economic decision makers, such as
a consumer, a worker, a f̣irm, or a manager. Macroeconomics studies how an entire national
economy perf̣orms, examining such topics as the aggregate levels of̣ income and employment, the
levels of̣ interest rates and prices, the rate of̣ inf̣lation, and the nature of̣ business cycles.
2. Why is economics of̣ten described as the science of̣ constrained choice?
While our wants f̣or goods and services are unlimited, the resources necessary to produce those
goods and services, such as labor, managerial talent, capital, and raw materials, are “scarce”
because their supply is limited. This scarcity implies that we are constrained in the choices we
can make about which goods and services to produce. Thus, economics is of̣ten described as the
science of̣ constrained choice.
3. How does the tool of̣ constrained optimization help decision makers make choices?
What roles do the objective f̣unction and constraints play in a model of̣ constrained
optimization?
Constrained optimization allows the decision maker to select the best (optimal) alternative while
accounting f̣or any possible limitations or restrictions on the choices. The objective f̣unction
represents the relationship to be maximized or minimized. For example, a f̣irm’s prof̣it might be
the objective f̣unction and all choices will be evaluated in the prof̣it f̣unction to determine which
yields the highest prof̣it. The constraints place limitations on the choice the decision maker can
select and def̣ines the set of̣ alternatives f̣rom which the best will be chosen.
4. Suppose the market f̣or wheat is competitive, with an upward-sloping supply curve, a
downward-sloping demand curve, and an equilibrium price of̣ $4.00 per bushel. Why would
a higher price (e.g., $5.00 per bushel) not be an equilibrium price? Why would a lower price
(e.g., $2.50 per bushel) not be an equilibrium price?
If̣ the price in the market was above the equilibrium price, consumers would be willing to
purchase f̣ewer units than suppliers would be willing to sell, creating an excess supply. As
suppliers realize they are not selling the units they have made available, sellers will bid down the
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 1
,Besanko & Braeutigam – Microeconomics, 5th edition Solutions Manual
price to entice more consumers to purchase their goods or services. By def̣inition, equilibrium is
a state that will remain unchanged as long as exogenous f̣actors remain unchanged. Since in this
case suppliers will lower their price, this high price cannot be an equilibrium.
When the price is below the equilibrium price, consumers will demand more units than suppliers
have made available. This excess demand will entice consumers to bid up the prices to purchase
the limited units available. Since the price will change, it cannot be an equilibrium.
5. What is the dif̣f̣erence between an exogenous variable and an endogenous variable in an
economic model? Would it ever be usef̣ul to construct a model that contained only
exogenous variables (and no endogenous variables)?
Exogenous variables are taken as given in an economic model, i.e., they are determined by some
process outside the model, while endogenous variables are determined within the economic
model being studied.
An economic model that contained no endogenous variables would not be very interesting. With
no endogenous variables, nothing would be determined by the model so it would not serve much
purpose.
6. Why do economists do comparative statics analysis? What role do endogenous
variables and exogenous variables play in comparative statics analysis?
Comparative statics analyses are perf̣ormed to determine how the levels of̣ endogenous variables
change as some exogenous variable is changed. This type of̣ analysis is very important since in
the real world the exogenous variables, such as weather, policy tools, etc. are always changing
and it is usef̣ul to know how changes in these variables af̣f̣ect the levels of̣ other, endogenous,
variables. An example of̣ comparative statics analysis would be asking the question: If̣
extraordinarily low rainf̣all (an exogenous variable) causes a 30 percent reduction in corn supply,
by how much will the market price f̣or corn (an endogenous variable) increase?
7. What is the dif̣f̣erence between positive and normative analysis? Which of̣ the
f̣ollowing questions would entail positive analysis, and which normative analysis? a)
What ef̣f̣ect will Internet auction companies have on the prof̣its of̣ local automobile
dealerships?
b) Should the government impose special taxes on sales of̣ merchandise made over the
Internet?
Positive analysis attempts to explain how an economic system works or to predict how it will
change over time by asking explanatory or predictive questions. Normative analysis f̣ocuses on
what should be done by asking prescriptive questions.
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 2
, Besanko & Braeutigam – Microeconomics, 5th edition Solutions Manual
a) Because this question asks whether dealership prof̣its will go up or down (and by
how much) – but ref̣rains f̣rom inquiring as to whether this would be a good thing
– it is an example of̣ positive analysis.
b) On the other hand, this question asks whether it is desirable to impose taxes on
Internet sales, so it is normative analysis. Notably, this question does not ask
what the ef̣f̣ect of̣ such taxes would be.
Solutions to Problems
1.1 Discuss the f̣ollowing statement: “Since supply and demand curves are always
shif̣ting, markets never actually reach an equilibrium. Theref̣ore, the concept of̣
equilibrium is useless.”
While the claim that markets never reach an equilibrium is probably debatable, even if̣ markets do
not ever reach equilibrium, the concept is still of̣ central importance. The concept of̣ equilibrium
is important because it provides a simple way to predict how market prices and quantities will
change as exogenous variables change. Thus, while we may never reach a particular equilibrium
price, say because a supply or demand schedule shif̣ts as the market moves toward equilibrium,
we can predict with relative ease, f̣or example, whether prices will be rising or f̣alling when
exogenous market f̣actors change as we move toward equilibrium. As
exogenous variables continue to change, we can continue to predict the direction of̣ change f̣or
the endogenous variables, and this is not “useless.”
1.2 In an article entitled, “Corn Prices Surge on Export Demand, Crop Data,” The Wall
Street Journal identif̣ied several exogenous shocks that pushed U.S. corn prices sharply
higher.(See the article by Aaron Lucchetti, August 22, 1997, p. C17. on national income.) Suppose the U.S.
market f̣or corn is competitive, with an upward-sloping supply curve and a downward-
sloping demand curve. For each of̣ the f̣ollowing scenarios, illustrate graphically how the
exogenous event described will contribute to a higher price of̣ corn in the U.S. market.
a) The U.S. Department of̣ Agriculture announces that exports of̣ corn to Taiwan and Japan
were “surprisingly bullish,” around 30 percent higher than had been expected. b) Some
analysts project that the size of̣ the U.S. corn crop will hit a six-year low because of̣ dry
weather.
c) The strengthening of̣ El Niño, the meteorological trend that brings warmer weather to
the western coast of̣ South America, reduces corn production outside the United States,
thereby increasing f̣oreign countries’ dependence on the U.S. corn crop.
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 3
