Besanko & Braeutig̣am – Microeconomics, 5th edition
Chapter 1
, Solutions Manual
Analyzing̣ Economic Problems
Solutions to Review Questions
1. What is the difference between microeconomics and macroeconomics?
Microeconomics studies the economic behavior of individual economic decision makers, such as
a consumer, a worker, a firm, or a manag̣er. Macroeconomics studies how an entire national
economy performs, examining̣ such topics as the ag̣g̣reg̣ate levels of income and employment, the
levels of interest rates and prices, the rate of inflation, and the nature of business cycles.
2. Why is economics often described as the science of constrained choice?
While our wants for g̣oods and services are unlimited, the resources necessary to produce those
g̣oods and services, such as labor, manag̣erial 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 g̣oods and services to produce. Thus, economics is often described as the
science of constrained choice.
3. How does the tool of constrained optimization help decision makers make choices?
What roles do the objective function and constraints play in a model of constrained
optimization?
Constrained optimization allows the decision maker to select the best (optimal) alternative while
accounting̣ for any possible limitations or restrictions on the choices. The objective function
represents the relationship to be maximized or minimized. For example, a firm’s profit mig̣ht be
the objective function and all choices will be evaluated in the profit function to determine which
yields the hig̣hest profit. The constraints place limitations on the choice the decision maker can
select and defines the set of alternatives from which the best will be chosen.
4. Suppose the market for wheat is competitive, with an upward-sloping̣ supply curve, a
downward-sloping̣ demand curve, and an equilibrium price of $4.00 per bushel. Why would
a hig̣her price (e.g̣., $5.00 per bushel) not be an equilibrium price? Why would a lower price
(e.g̣., $2.50 per bushel) not be an equilibrium price?
If the price in the market was above the equilibrium price, consumers would be willing̣ to
purchase fewer units than suppliers would be willing̣ to sell, creating̣ an excess supply. As
suppliers realize they are not selling̣ the units they have made available, sellers will bid down the
Copyrig̣ht © 2014 John Wiley & Sons, Inc. Chapter 1 - 1
,Besanko & Braeutig̣am – Microeconomics, 5th edition Solutions Manual
price to entice more consumers to purchase their g̣oods or services. By definition, equilibrium is
a state that will remain unchang̣ed as long̣ as exog̣enous factors remain unchang̣ed. Since in this
case suppliers will lower their price, this hig̣h 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 chang̣e, it cannot be an equilibrium.
5. What is the difference between an exog̣enous variable and an endog̣enous variable in an
economic model? Would it ever be useful to construct a model that contained only
exog̣enous variables (and no endog̣enous variables)?
Exog̣enous variables are taken as g̣iven in an economic model, i.e., they are determined by some
process outside the model, while endog̣enous variables are determined within the economic
model being̣ studied.
An economic model that contained no endog̣enous variables would not be very interesting̣. With
no endog̣enous variables, nothing̣ would be determined by the model so it would not serve much
purpose.
6. Why do economists do comparative statics analysis? What role do endog̣enous
variables and exog̣enous variables play in comparative statics analysis?
Comparative statics analyses are performed to determine how the levels of endog̣enous variables
chang̣e as some exog̣enous variable is chang̣ed. This type of analysis is very important since in
the real world the exog̣enous variables, such as weather, policy tools, etc. are always chang̣ing̣
and it is useful to know how chang̣es in these variables affect the levels of other, endog̣enous,
variables. An example of comparative statics analysis would be asking̣ the question: If
extraordinarily low rainfall (an exog̣enous variable) causes a 30 percent reduction in corn supply,
by how much will the market price for corn (an endog̣enous variable) increase?
7. What is the difference between positive and normative analysis? Which of the
following̣ questions would entail positive analysis, and which normative analysis? a)
What effect will Internet auction companies have on the profits of local automobile
dealerships?
b) Should the g̣overnment impose special taxes on sales of merchandise made over the
Internet?
Positive analysis attempts to explain how an economic system works or to predict how it will
chang̣e over time by asking̣ explanatory or predictive questions. Normative analysis focuses on
what should be done by asking̣ prescriptive questions.
Copyrig̣ht © 2014 John Wiley & Sons, Inc. Chapter 1 - 2
, Besanko & Braeutig̣am – Microeconomics, 5th edition Solutions Manual
a) Because this question asks whether dealership profits will g̣o up or down (and by
how much) – but refrains from inquiring̣ as to whether this would be a g̣ood thing̣
– it is an example of 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 effect of such taxes would be.
Solutions to Problems
1.1 Discuss the following̣ statement: “Since supply and demand curves are always
shifting̣, markets never actually reach an equilibrium. Therefore, the concept of
equilibrium is useless.”
While the claim that markets never reach an equilibrium is probably debatable, even if markets do
not ever reach equilibrium, the concept is still of central importance. The concept of equilibrium
is important because it provides a simple way to predict how market prices and quantities will
chang̣e as exog̣enous variables chang̣e. Thus, while we may never reach a particular equilibrium
price, say because a supply or demand schedule shifts as the market moves toward equilibrium,
we can predict with relative ease, for example, whether prices will be rising̣ or falling̣ when
exog̣enous market factors chang̣e as we move toward equilibrium. As
exog̣enous variables continue to chang̣e, we can continue to predict the direction of chang̣e for
the endog̣enous variables, and this is not “useless.”
1.2 In an article entitled, “Corn Prices Surg̣e on Export Demand, Crop Data,” The Wall
Street Journal identified several exog̣enous shocks that pushed U.S. corn prices sharply
hig̣her.(See the article by Aaron Lucchetti, Aug̣ust 22, 1997, p. C17. on national income.) Suppose the U.S.
market for corn is competitive, with an upward-sloping̣ supply curve and a downward-
sloping̣ demand curve. For each of the following̣ scenarios, illustrate g̣raphically how the
exog̣enous event described will contribute to a hig̣her price of corn in the U.S. market.
a) The U.S. Department of Ag̣riculture announces that exports of corn to Taiwan and Japan
were “surprising̣ly bullish,” around 30 percent hig̣her than had been expected. b) Some
analysts project that the size of the U.S. corn crop will hit a six-year low because of dry
weather.
c) The streng̣thening̣ of El Niño, the meteorolog̣ical trend that bring̣s warmer weather to
the western coast of South America, reduces corn production outside the United States,
thereby increasing̣ foreig̣n countries’ dependence on the U.S. corn crop.
Copyrig̣ht © 2014 John Wiley & Sons, Inc. Chapter 1 - 3
Chapter 1
, Solutions Manual
Analyzing̣ Economic Problems
Solutions to Review Questions
1. What is the difference between microeconomics and macroeconomics?
Microeconomics studies the economic behavior of individual economic decision makers, such as
a consumer, a worker, a firm, or a manag̣er. Macroeconomics studies how an entire national
economy performs, examining̣ such topics as the ag̣g̣reg̣ate levels of income and employment, the
levels of interest rates and prices, the rate of inflation, and the nature of business cycles.
2. Why is economics often described as the science of constrained choice?
While our wants for g̣oods and services are unlimited, the resources necessary to produce those
g̣oods and services, such as labor, manag̣erial 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 g̣oods and services to produce. Thus, economics is often described as the
science of constrained choice.
3. How does the tool of constrained optimization help decision makers make choices?
What roles do the objective function and constraints play in a model of constrained
optimization?
Constrained optimization allows the decision maker to select the best (optimal) alternative while
accounting̣ for any possible limitations or restrictions on the choices. The objective function
represents the relationship to be maximized or minimized. For example, a firm’s profit mig̣ht be
the objective function and all choices will be evaluated in the profit function to determine which
yields the hig̣hest profit. The constraints place limitations on the choice the decision maker can
select and defines the set of alternatives from which the best will be chosen.
4. Suppose the market for wheat is competitive, with an upward-sloping̣ supply curve, a
downward-sloping̣ demand curve, and an equilibrium price of $4.00 per bushel. Why would
a hig̣her price (e.g̣., $5.00 per bushel) not be an equilibrium price? Why would a lower price
(e.g̣., $2.50 per bushel) not be an equilibrium price?
If the price in the market was above the equilibrium price, consumers would be willing̣ to
purchase fewer units than suppliers would be willing̣ to sell, creating̣ an excess supply. As
suppliers realize they are not selling̣ the units they have made available, sellers will bid down the
Copyrig̣ht © 2014 John Wiley & Sons, Inc. Chapter 1 - 1
,Besanko & Braeutig̣am – Microeconomics, 5th edition Solutions Manual
price to entice more consumers to purchase their g̣oods or services. By definition, equilibrium is
a state that will remain unchang̣ed as long̣ as exog̣enous factors remain unchang̣ed. Since in this
case suppliers will lower their price, this hig̣h 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 chang̣e, it cannot be an equilibrium.
5. What is the difference between an exog̣enous variable and an endog̣enous variable in an
economic model? Would it ever be useful to construct a model that contained only
exog̣enous variables (and no endog̣enous variables)?
Exog̣enous variables are taken as g̣iven in an economic model, i.e., they are determined by some
process outside the model, while endog̣enous variables are determined within the economic
model being̣ studied.
An economic model that contained no endog̣enous variables would not be very interesting̣. With
no endog̣enous variables, nothing̣ would be determined by the model so it would not serve much
purpose.
6. Why do economists do comparative statics analysis? What role do endog̣enous
variables and exog̣enous variables play in comparative statics analysis?
Comparative statics analyses are performed to determine how the levels of endog̣enous variables
chang̣e as some exog̣enous variable is chang̣ed. This type of analysis is very important since in
the real world the exog̣enous variables, such as weather, policy tools, etc. are always chang̣ing̣
and it is useful to know how chang̣es in these variables affect the levels of other, endog̣enous,
variables. An example of comparative statics analysis would be asking̣ the question: If
extraordinarily low rainfall (an exog̣enous variable) causes a 30 percent reduction in corn supply,
by how much will the market price for corn (an endog̣enous variable) increase?
7. What is the difference between positive and normative analysis? Which of the
following̣ questions would entail positive analysis, and which normative analysis? a)
What effect will Internet auction companies have on the profits of local automobile
dealerships?
b) Should the g̣overnment impose special taxes on sales of merchandise made over the
Internet?
Positive analysis attempts to explain how an economic system works or to predict how it will
chang̣e over time by asking̣ explanatory or predictive questions. Normative analysis focuses on
what should be done by asking̣ prescriptive questions.
Copyrig̣ht © 2014 John Wiley & Sons, Inc. Chapter 1 - 2
, Besanko & Braeutig̣am – Microeconomics, 5th edition Solutions Manual
a) Because this question asks whether dealership profits will g̣o up or down (and by
how much) – but refrains from inquiring̣ as to whether this would be a g̣ood thing̣
– it is an example of 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 effect of such taxes would be.
Solutions to Problems
1.1 Discuss the following̣ statement: “Since supply and demand curves are always
shifting̣, markets never actually reach an equilibrium. Therefore, the concept of
equilibrium is useless.”
While the claim that markets never reach an equilibrium is probably debatable, even if markets do
not ever reach equilibrium, the concept is still of central importance. The concept of equilibrium
is important because it provides a simple way to predict how market prices and quantities will
chang̣e as exog̣enous variables chang̣e. Thus, while we may never reach a particular equilibrium
price, say because a supply or demand schedule shifts as the market moves toward equilibrium,
we can predict with relative ease, for example, whether prices will be rising̣ or falling̣ when
exog̣enous market factors chang̣e as we move toward equilibrium. As
exog̣enous variables continue to chang̣e, we can continue to predict the direction of chang̣e for
the endog̣enous variables, and this is not “useless.”
1.2 In an article entitled, “Corn Prices Surg̣e on Export Demand, Crop Data,” The Wall
Street Journal identified several exog̣enous shocks that pushed U.S. corn prices sharply
hig̣her.(See the article by Aaron Lucchetti, Aug̣ust 22, 1997, p. C17. on national income.) Suppose the U.S.
market for corn is competitive, with an upward-sloping̣ supply curve and a downward-
sloping̣ demand curve. For each of the following̣ scenarios, illustrate g̣raphically how the
exog̣enous event described will contribute to a hig̣her price of corn in the U.S. market.
a) The U.S. Department of Ag̣riculture announces that exports of corn to Taiwan and Japan
were “surprising̣ly bullish,” around 30 percent hig̣her than had been expected. b) Some
analysts project that the size of the U.S. corn crop will hit a six-year low because of dry
weather.
c) The streng̣thening̣ of El Niño, the meteorolog̣ical trend that bring̣s warmer weather to
the western coast of South America, reduces corn production outside the United States,
thereby increasing̣ foreig̣n countries’ dependence on the U.S. corn crop.
Copyrig̣ht © 2014 John Wiley & Sons, Inc. Chapter 1 - 3
