Solutions
Manual
Copyright © 2014 John Wiley & Sons,
nn nn nn nn nn nn Chapter 1 - 1
nn nn nn
Inc.
, Solutions
Manual
Chapter 1 nn
Analyzing Economic Problems nn nn
Solutions to Review Questions nn nn nn
1. What is the difference between microeconomics and macroeconomics?
nn nn nn nn nn nn nn
Microeconomics studies the economic behavior of individual economic decision makers,
nn nn nn nn nn nn nn nn nn
such as a consumer, a worker, a firm, or a manager. Macroeconomics studies how an
nn nn nn nn nn nn nn nn nn nn nn n n nn nn nn
entire national economy performs, examining such topics as the aggregate levels of
nn nn nn nn nn nn nn nn nn nn nn nn
income and employment, the levels of interest rates and prices, the rate of inflation,
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
and the nature of business cycles.
nn nn nn nn nn nn
2. Why is economics often described as the science of constrained choice?
nn nn nn nn nn nn nn nn nn nn
While our wants for goods and services are unlimited, the resources necessary to
nn nn nn nn nn nn nn nn nn nn nn nn
produce those goods and services, such as labor, managerial talent, capital, and raw
nn nn nn nn nn nn nn nn nn nn nn nn nn
materials, are “scarce” because their supply is limited. This scarcity implies that we are
nn nn nn nn nn nn nn nn n n nn nn nn nn nn
constrained in the choices we can make about which goods and services to produce.
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
Thus, economics is often described as the science of constrained choice.
n n nn nn nn nn nn nn nn nn nn nn
3. How does the tool of constrained optimization help decision makers make
nn nn nn nn nn nn nn nn nn nn
choices? What roles do the objective function and constraints play in a model of
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
constrained optimization?
nn nn
Constrained optimization allows the decision maker to select the best (optimal) alternative
nn nn nn nn nn nn nn nn nn nn nn
while accounting for any possible limitations or restrictions on the choices. The
nn nn nn nn nn nn nn nn nn nn nn n n
objective function represents the relationship to be maximized or minimized. For
nn nn nn nn nn nn nn nn nn nn n n
example, a firm’s profit might be the objective function and all choices will be evaluated
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
in the profit function to determine which yields the highest profit. The constraints
nn nn nn nn nn nn nn nn nn nn nn n n nn
place limitations on the choice the decision maker can select and defines the set of
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
alternatives from which the best will be chosen.
nn nn nn nn nn nn nn nn
4. Suppose the market for wheat is competitive, with an upward-sloping supply
nn nn nn nn nn nn nn nn nn nn
curve, a downward-sloping demand curve, and an equilibrium price of $4.00 per
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bushel. Why would a higher price (e.g., $5.00 per bushel) not be an equilibrium
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
price? Why would a lower price (e.g., $2.50 per bushel) not be an equilibrium price?
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
If the price in the market was above the equilibrium price, consumers would be willing
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
Copyright © 2014 John Wiley & Sons,
nn nn nn nn nn nn Chapter 1 - 2 nn nn nn
Inc.
, Solutions
Manual
to purchase fewer units than suppliers would be willing to sell, creating an excess
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
supply. As suppliers realize they are not selling the units they have made available,
nn n n nn nn nn nn nn nn nn nn nn nn nn nn
sellers will bid down the
nn nn nn nn nn
Copyright © 2014 John Wiley & Sons,
nn nn nn nn nn nn Chapter 1 - 3
nn nn nn
Inc.
, Solutions
Manual
price to entice more consumers to purchase their goods or services. By definition,
nn nn nn nn nn nn nn nn nn nn n n nn
equilibrium is a state that will remain unchanged as long as exogenous factors remain
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
unchanged. Since in this case suppliers will lower their price, this high price cannot be
nn n n nn nn nn nn nn nn nn nn nn nn nn nn nn
an equilibrium.
nn nn
When the price is below the equilibrium price, consumers will demand more units than
nn nn nn nn nn nn nn nn nn nn nn nn nn
suppliers have made available. This excess demand will entice consumers to bid up the
nn nn nn nn n n nn nn nn nn nn nn nn nn nn
prices to purchase the limited units available. Since the price will change, it cannot be
nn nn nn nn nn nn nn n n nn nn nn nn nn nn nn
an equilibrium.
nn nn
5. What is the difference between an exogenous variable and an endogenous
nn nn nn nn nn nn nn nn nn nn
variable in an economic model? Would it ever be useful to construct a model that
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
contained only exogenous variables (and no endogenous variables)?
nn nn nn nn nn nn nn nn
Exogenous variables are taken as given in an economic model, i.e., they are determined by
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
some process outside the model, while endogenous variables are determined within the
nn nn nn nn nn nn nn nn nn nn nn nn
economic model being studied.
nn nn nn nn
An economic model that contained no endogenous variables would not be very
nn nn nn nn nn nn nn nn nn nn nn
interesting. With no endogenous variables, nothing would be determined by the model
nn n n nn nn nn nn nn nn nn nn nn nn
so it would not serve much purpose.
nn nn nn nn nn nn nn
6. Why do economists do comparative statics analysis? What role do
nn nn nn nn nn nn nn nn nn
endogenous variables and exogenous variables play in comparative statics
nn nn nn nn nn nn nn nn nn
analysis?
nn
Comparative statics analyses are performed to determine how the levels of endogenous
nn nn nn nn nn nn nn nn nn nn nn
variables change as some exogenous variable is changed. This type of analysis is very
nn nn nn nn nn nn nn nn n n nn nn nn nn nn
important since in the real world the exogenous variables, such as weather, policy tools,
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
etc. are always changing and it is useful to know how changes in these variables affect
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
the levels of other, endogenous, variables. An example of comparative statics analysis
nn nn nn nn nn nn n n nn nn nn nn nn
would be asking the question: If extraordinarily low rainfall (an exogenous variable)
nn nn nn nn nn nn nn nn nn nn nn nn
causes a 30 percent reduction in corn supply, by how much will the market price for
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
corn (an endogenous variable) increase?
nn nn nn nn nn
7. What is the difference between positive and normative analysis? Which of
nn nn nn nn nn nn nn nn nn nn
the following questions would entail positive analysis, and which normative
nn nn nn nn nn nn nn nn nn nn
analysis?
nn
a) What effect will Internet auction companies have on the profits of local
nn nn nn nn nn nn nn nn nn nn nn
automobile dealerships?
nn nn
b) Should the government impose special taxes on sales of merchandise made over
nn nn nn nn nn nn nn nn nn nn nn
Copyright © 2014 John Wiley & Sons,
nn nn nn nn nn nn Chapter 1 - 4 nn nn nn
Inc.
Manual
Copyright © 2014 John Wiley & Sons,
nn nn nn nn nn nn Chapter 1 - 1
nn nn nn
Inc.
, Solutions
Manual
Chapter 1 nn
Analyzing Economic Problems nn nn
Solutions to Review Questions nn nn nn
1. What is the difference between microeconomics and macroeconomics?
nn nn nn nn nn nn nn
Microeconomics studies the economic behavior of individual economic decision makers,
nn nn nn nn nn nn nn nn nn
such as a consumer, a worker, a firm, or a manager. Macroeconomics studies how an
nn nn nn nn nn nn nn nn nn nn nn n n nn nn nn
entire national economy performs, examining such topics as the aggregate levels of
nn nn nn nn nn nn nn nn nn nn nn nn
income and employment, the levels of interest rates and prices, the rate of inflation,
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
and the nature of business cycles.
nn nn nn nn nn nn
2. Why is economics often described as the science of constrained choice?
nn nn nn nn nn nn nn nn nn nn
While our wants for goods and services are unlimited, the resources necessary to
nn nn nn nn nn nn nn nn nn nn nn nn
produce those goods and services, such as labor, managerial talent, capital, and raw
nn nn nn nn nn nn nn nn nn nn nn nn nn
materials, are “scarce” because their supply is limited. This scarcity implies that we are
nn nn nn nn nn nn nn nn n n nn nn nn nn nn
constrained in the choices we can make about which goods and services to produce.
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
Thus, economics is often described as the science of constrained choice.
n n nn nn nn nn nn nn nn nn nn nn
3. How does the tool of constrained optimization help decision makers make
nn nn nn nn nn nn nn nn nn nn
choices? What roles do the objective function and constraints play in a model of
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
constrained optimization?
nn nn
Constrained optimization allows the decision maker to select the best (optimal) alternative
nn nn nn nn nn nn nn nn nn nn nn
while accounting for any possible limitations or restrictions on the choices. The
nn nn nn nn nn nn nn nn nn nn nn n n
objective function represents the relationship to be maximized or minimized. For
nn nn nn nn nn nn nn nn nn nn n n
example, a firm’s profit might be the objective function and all choices will be evaluated
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
in the profit function to determine which yields the highest profit. The constraints
nn nn nn nn nn nn nn nn nn nn nn n n nn
place limitations on the choice the decision maker can select and defines the set of
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
alternatives from which the best will be chosen.
nn nn nn nn nn nn nn nn
4. Suppose the market for wheat is competitive, with an upward-sloping supply
nn nn nn nn nn nn nn nn nn nn
curve, a downward-sloping demand curve, and an equilibrium price of $4.00 per
nn nn nn nn nn nn nn nn nn nn nn nn
bushel. Why would a higher price (e.g., $5.00 per bushel) not be an equilibrium
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
price? Why would a lower price (e.g., $2.50 per bushel) not be an equilibrium price?
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
If the price in the market was above the equilibrium price, consumers would be willing
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
Copyright © 2014 John Wiley & Sons,
nn nn nn nn nn nn Chapter 1 - 2 nn nn nn
Inc.
, Solutions
Manual
to purchase fewer units than suppliers would be willing to sell, creating an excess
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
supply. As suppliers realize they are not selling the units they have made available,
nn n n nn nn nn nn nn nn nn nn nn nn nn nn
sellers will bid down the
nn nn nn nn nn
Copyright © 2014 John Wiley & Sons,
nn nn nn nn nn nn Chapter 1 - 3
nn nn nn
Inc.
, Solutions
Manual
price to entice more consumers to purchase their goods or services. By definition,
nn nn nn nn nn nn nn nn nn nn n n nn
equilibrium is a state that will remain unchanged as long as exogenous factors remain
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
unchanged. Since in this case suppliers will lower their price, this high price cannot be
nn n n nn nn nn nn nn nn nn nn nn nn nn nn nn
an equilibrium.
nn nn
When the price is below the equilibrium price, consumers will demand more units than
nn nn nn nn nn nn nn nn nn nn nn nn nn
suppliers have made available. This excess demand will entice consumers to bid up the
nn nn nn nn n n nn nn nn nn nn nn nn nn nn
prices to purchase the limited units available. Since the price will change, it cannot be
nn nn nn nn nn nn nn n n nn nn nn nn nn nn nn
an equilibrium.
nn nn
5. What is the difference between an exogenous variable and an endogenous
nn nn nn nn nn nn nn nn nn nn
variable in an economic model? Would it ever be useful to construct a model that
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
contained only exogenous variables (and no endogenous variables)?
nn nn nn nn nn nn nn nn
Exogenous variables are taken as given in an economic model, i.e., they are determined by
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
some process outside the model, while endogenous variables are determined within the
nn nn nn nn nn nn nn nn nn nn nn nn
economic model being studied.
nn nn nn nn
An economic model that contained no endogenous variables would not be very
nn nn nn nn nn nn nn nn nn nn nn
interesting. With no endogenous variables, nothing would be determined by the model
nn n n nn nn nn nn nn nn nn nn nn nn
so it would not serve much purpose.
nn nn nn nn nn nn nn
6. Why do economists do comparative statics analysis? What role do
nn nn nn nn nn nn nn nn nn
endogenous variables and exogenous variables play in comparative statics
nn nn nn nn nn nn nn nn nn
analysis?
nn
Comparative statics analyses are performed to determine how the levels of endogenous
nn nn nn nn nn nn nn nn nn nn nn
variables change as some exogenous variable is changed. This type of analysis is very
nn nn nn nn nn nn nn nn n n nn nn nn nn nn
important since in the real world the exogenous variables, such as weather, policy tools,
nn nn nn nn nn nn nn nn nn nn nn nn nn nn
etc. are always changing and it is useful to know how changes in these variables affect
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
the levels of other, endogenous, variables. An example of comparative statics analysis
nn nn nn nn nn nn n n nn nn nn nn nn
would be asking the question: If extraordinarily low rainfall (an exogenous variable)
nn nn nn nn nn nn nn nn nn nn nn nn
causes a 30 percent reduction in corn supply, by how much will the market price for
nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn nn
corn (an endogenous variable) increase?
nn nn nn nn nn
7. What is the difference between positive and normative analysis? Which of
nn nn nn nn nn nn nn nn nn nn
the following questions would entail positive analysis, and which normative
nn nn nn nn nn nn nn nn nn nn
analysis?
nn
a) What effect will Internet auction companies have on the profits of local
nn nn nn nn nn nn nn nn nn nn nn
automobile dealerships?
nn nn
b) Should the government impose special taxes on sales of merchandise made over
nn nn nn nn nn nn nn nn nn nn nn
Copyright © 2014 John Wiley & Sons,
nn nn nn nn nn nn Chapter 1 - 4 nn nn nn
Inc.
