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Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises 37 Chapter 11 The Labor Market Review Questions 2. The introduction of a new input that is complementary with labor will increase the marginal product of labor at any level of employment, and consequently shift the labor demand curve rightward. A sewing machine in a textile factory is complementary with labor. The introduction of a new input that is substitutable for labor will decrease the marginal product of labor at any level of employment, and consequently shift the labor demand curve leftward. A robot in an assembly line is substitutable for labor. 4. Marginal revenue (= ∆TR/∆Q) tells us the rise in total revenue from producing one more unit of output. Marginal revenue product (= ∆TR/∆ quantity of resource) tells us the change in total revenue per unit increase in the resource. Marginal product (= ∆Q/∆ quantity of resource) tells us how much additional output is produced from adding one more unit of an input. Marginal cost (= ∆TC/∆Q) tells us the rise in cost from producing one more unit of output. MFC (= ∆TC/∆ quantity of resource) tells us the rise in cost per unit increase in the resource. 6. Suppose the wage rate drops. A drop in the wage rate will generally lead the firm to hire not only more labor, but, in the long run, more of other inputs as well. As the firm uses more of these other inputs, the MRP curve shifts rightward. As a result, the new, profit-maximizing level of employment at the lower wage is greater than it would be along the original MRP curve. Thus, any given wage change causes a greater change in employment when other inputs can be varied (the labor demand curve is flatter). 8. An individual’s reservation wage for a labor market is the lowest wage that will induce the individual to supply labor in that market. Your reservation wage will be higher for jobs you find distasteful, and will be lower for jobs you enjoy. Two individuals’ reservation wages will generally be different for the same job because of their differing preferences for the job and also because of their different opportunity costs to taking the job. 10. False. When the labor demand curve shifts left, there is an excess supply of labor. If the wage rate falls to its new equilibrium level, the shift will not cause any unemployment. However, if the wage fails to adjust downward to its new equilibrium value—say, because the firm views the change in labor demand as temporary—then a labor surplus (unemployment) can result. 12. [Appendix] When all else is the same, monopsonists employ fewer workers, produce less output, and pay lower wage rates than firms in a perfectly competitive labor market. Problems and Exercises 2. Number of Workers Total Output MPL MRP 10 80 8 $220.00 11 88 6 $165.00 12 94 3 $82.50 13 97 2 $55.00 14 99 38 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises a. Your Mama will hire 13 workers. Hiring the fourteenth would not be profitable since wage ($80) would exceed MRP ($55) at this point. b. With the wage now $85 per day, the firm will hire only twelve workers. Hiring the thirteenth will no longer be profitable because for that increase in employment, the MRP is less than the wage. 4. a. There are increasing returns to labor over the output range 0 to 450. There are diminishing returns to labor over the output range 450 to 775. b. Marginal Factor Number of Packages Total Marginal Revenue Cost (for use in Workers per Week Revenue Product part (c)) 1 100 $600 $900 $700 2 250 $1500 $1200 $700 3 450 $2700 $900 $700 4 600 $3600 $600 $700 5 700 $4200 $300 $700 6 750 $4500 $150 $700 7 775 $4650 c. Byproducts should hire 4 workers and produce 600 units of output. 6. a. Wage LS A W1 B W2 L 1D L 2D L2 L1 Number of Physicists The cutbacks caused labor demand for physicists, equilibrium salary, and the number of physicists employed to fall. If the wage adjusts to the new equilibrium value, there is no unemployment among physicists. Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises 39 b. Wage LS B A W1 D L1 L 2D L2 L1 Number of Physicists In this case, wages cannot fall. At the original wage, labor supply exceeds labor demand, and there is unemployment. 8. While it is true that there is an inverse relationship between the wage rate and the number of workers a firm demands along a given labor demand curve, in this case each firm has moved to a new demand curve. 10. Prediction #1: In the aggregate market for these language speakers (incorporating both government agencies and other jobs), the increase in demand by government agencies increases the overall demand for these workers, shifting the labor demand curve rightward and driving up their wage rate. The wage rate will rise to W’ in all jobs for these workers (since if not, they would move from the lower wage markets to the higher wage markets until all earned the same wage). Prediction #2: In the long run—a time horizon long enough for people to learn these languages— the labor supply curve in the aggregate market will shift rightward, as the higher salaries for employees proficient in these languages attracts more people to study and become proficient in 40 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises them. The labor supply curve will stop shifting rightward when the wage rate reaches its new, long-run equilibrium value—higher than the initial wage, but lower than the wage in the temporary, short-run equilibrium. Note: In the long run, the wage cannot return to its original value, for at that value, many of the new entrants would leave, causing the wage rate to rise again. When the short-run labor supply curve has stopped shifting, the market wage rate will be higher than the original wage. Challenge Questions 2. Marginal Number of Packages Total Revenue Marginal Marginal Marginal Workers per Week Revenue Product Factor Cost Revenue Cost 1 100 $600 $900 $700 $6 $4.67 2 250 $1500 $1200 $700 $6 $3.50 3 450 $2700 $900 $700 $6 $4.67 4 600 $3600 $600 $700 $6 $7 5 700 $4200 $300 $700 $6 $14 6 750 $4500 $150 $700 $6 $28 7 775 $4650 In Problem 4, we found that when the wage rate was $700, the firm would hire 4 workers and produce 600 packages per week. Here we find that the firm will produce out to the point where marginal revenue exceeds marginal cost, which is again at 600 packages per week, produced with 4 workers. 4. Total Cost of P Q Labor TR MRP Labor MFC $10 300 5 $3000 $ 225 $150 $67.50 $9 400 9 $3600 $ 495 $66.67 $80 $8 500 15 $4000 $ 975 $28.57 $96.43 $7 600 22 $4200 $1650 -- $112.50 $6 700 30 $4200 $2550 The firm’s profit-maximizing employment level is 9 workers, price of output is $9, and daily output level is 400. Notice that the monopsonist in this question hires fewer workers, charges a higher price, and produces less output than the firm that hires its labor in a competitive labor market in question 3. Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises 41 Economic Applications Exercises 2. a. This varies by market. Some markets may see an increase in wages and hours worked, while others will see a reduction. b. Answers may vary. Chapter 12 Income Inequality Review Questions 2. a. Higher cost of living in New York. b. Greater human capital investment for the attorney. c. Differences in ability. (Larry King is an example of a superstar—someone regarded as ―the best‖ in his field.) d. Nonmonetary job characteristics might be more pleasant for the professor of philosophy. e. Barriers to entry keep German construction workers’ wages high. 4. True. One example is statistical discrimination, which can persist even when those who practice it have no trace of prejudice (emotional dislike for members of a group). 6. Statistical discrimination occurs when individuals are excluded from some opportunity (e.g., a job) based on the statistical probability of behavior in their group rather than their personal characteristics. The market, on its own, does not eliminate statistical discrimination. Government intervention such as affirmative action programs or tough enforcement of anti-discrimination laws) are solutions often proposed for statistical discrimination. 8. Unions can raise the wage above the equilibrium level. Ordinarily, excess supply of labor would drive the wage back down, but the union can prevent this by limiting membership in the union. 10. Our chief measures (the poverty rate and the Lorenz curve and its associated Gini ratio) measure earned income, rather than available income (which is influenced by transfer payments, transfers in kind, and fringe benefits). They also are static measures. They do not tell us whether the same families are stuck in the same relative position year after year, or whether there is substantial 42 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises mobility so that families are constantly moving up and down. In the latter case, income inequality measured over peoples’ lifetimes would be much less severe than income inequality measured in a given year. 12. The use of grievance procedures and other forms of communications with management can raise worker morale and reduce labor turnover. If this leads to greater productivity, the demand for labor in the union sector could increase, reducing or eliminating the drop in employment caused by higher union wages. Problems and Exercises 2. ca. b. The Gini coefficient for the curve without transfer payments [curve (a)] is roughly 0.5. c. The poverty line for those living alone would be three times the food budget, or an annual income of $9,000. Four of Dismal Seepage’s 10 citizens are below this line, yielding a poverty rate of 40 percent. 4. See graphs on next page. a. In panel b we see that firms will continue to hire N1 unskilled workers, although the higher wage rate being paid in the covered sector leads to an excess supply of labor there. b. The higher wage rate in the covered sector entices some workers to leave the uncovered sector and move to the covered sector. This decrease in labor supply leads to a higher wage rate in the uncovered sector. c. There will be no effect in the market for skilled workers, since there is no possibility of substitution between skilled workers and unskilled workers. Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises 43 44 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises 6. The Lorenz Curve is horizontal and corresponds to the horizontal axis until it reaches the point ―100 Percent of Households‖ and then it becomes vertical and corresponds to the right vertical axis. The Gini coefficient is 1. Challenge Questions 2. [Appendix Required] a. Q* workers will be hired by the monopsonist. This wage rate would maximize employment at the firm. Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises 45 b. Q* workers will be hired by the monopsonist. Employment will increase, although not by the maximum possible. c. If the wage rate is set above the MRP of the last worker hired by the monopsonist, then employment will fall. If the union cares only about making some subset of its workers happy (those who vote in union elections, or its most senior members, for example), then it may indeed bargain for such a high wage rate. d. Compared with the initial situation with no minimum wage, employment will not be reduced so long as the union wage rate is set at or above the wage rate found at the intersection of the Ls curve and the MRP, and at or below the wage rate found at the MRP of the last worker hired by the monopsonist in the absence of a union. Economic Applications Exercises 2. Answers may vary. 46 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises Chapter 13 Capital and Financial Markets Review Questions 2. If you receive $100 now, you can put it in the bank and earn interest; after one year you will have (1 + r)$100, where r is the interest rate. This amount exceeds the alternative of $100 received one year from now. That is, (1 + r) $100 > $100. 4. There is a positive relationship between the present value of a future payment and the size of that payment, and an inverse relationship between the present value of a future payment and the interest rate. The further in the future the date is at which the payment will be received, the smaller is the present value of that future payment. 6. Answers will vary. General human capital: ability to read or a course in plumbing repair. Specific human capital: Knowledge of the bookkeeping practices of Target, knowledge of inventory practices at GroceryWorks.com. 8. A corporation cares about the price of its stock in the secondary market because any new shares it issues will sell at the secondary market price, since the new shares are perfect substitutes for the shares already trading. 10. The efficient markets view is that stock prices reflect all information available in the market, and therefore each stock’s price reflects the best estimate of the present value of future receipts expected by shareholders. This implies that there are no exploitable patterns in stock prices, so no one can beat the stock market on a consistent basis. Problems and Exercises 2. a. Yes, you should approve the purchase of the inventory control software, because the total present value of salary savings = $60,000/(1.07) + $60,000/(1.07)2 + $60,000/(1.07)3 + $60,000/(1.07)4 = $203,232.68, which exceeds the $200,000 purchase price. b. The answer would change. You should not approve the purchase of the inventory control software if the annual interest rate is 9%, because the total present value of salary savings would only be $194,383.19 (= $60,000/(1.09) + $60,000/(1.09)2 + $60,000/(1.09)3 + $60,000/(1.09)), which is less than the $200,000 purchase price. c. The answer would change. You should not approve the purchase because the total present value of salary savings, $203,232.68, is less than the $220,000 purchase price. d. Compared to the answer in part (a), the answer would not change. You should approve the purchase of the software, because the total present value of salary savings = $60,000/(1.07) + $60,000/(1.07)2 + $60,000/(1.07)3 + $60,000/(1.07)4 + $60,000/(1.07)5 + $60,000/(1.07)6 = $285,992.38, which exceeds the $220,000 purchase price. 4. a. Your firm should purchase 2 computers, since the present value of the first two computers is greater than their purchase price of $2600. The present value of the first computer = $3000/(1.1)1 + $3000/(1.1)2 + $3000/(1.1)3 = $7460.55 The present value of the second computer = $2000/(1.1)1 + $2000/(1.1)2 + $2000/(1.1)3 = $4973.70 The present value of the third computer = $1000/(1.1)1 + $1000/(1.1)2 + $1000/(1.1)3 = $2486.85 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises 47 The present value of the fourth computer = $500/(1.1)1 + $500/(1.1)2 + $500/(1.1)3 = $1243.43 b. Your firm should purchase 3 computers, since the present value of the first three computers is greater than their purchase price of $2600. The present value of the first computer = $3000/(1.05)1 + $3000/(1.05)2 + $3000/(1.05)3 = $8169.79 The present value of the second computer = $2000/(1.05)1 + $2000/(1.05)2 + $2000/(1.05)3 = $5446.50 The present value of the third computer = $1000/(1.05)1 + $1000/(1.05)2 + $1000/(1.05)3 = $2723.25 The present value of the fourth computer = $500/(1.05)1 + $500/(1.05)2 + $500/(1.05)3 = $1361.62 6. a. Human capital investment would increase because the total present value of the additional future income increases. b. Human capital investment would increase because the total present value of the additional future income increases. c. Human capital investment would decrease because the total present value of the additional future income decreases. d. Human capital investment would decrease because the opportunity cost of acquiring the human capital increases. 8. The total value of your gold mine is $40,000 = (5 × $400)/0.05 = $2000/0.05. 10. a. If the interest rate is 5%, this bond will sell for $100,000. b. If the interest rate is 10%, this bond will sell for $87,565.74. 12. If the interest rate is 10 percent, people will pay $100 per share ($100 = $10/0.10). If, in the face of uncertainty, a discount rate of 15 percent is applied, people will pay $66.67 per share ($66.67 = $10/0.15). Challenge Questions 2. a. With the sequence of rising interest rates, Project A’s capitalized value is –$50 + $18.18 + $16.38 + $14.61 = –$0.83. With a negative value, it should not be undertaken. Project B has a capitalized value of –$33 + $18.18 + $24.57 + $29.22 = $36.97. Project B should be undertaken. b. With the sequence of falling interest rates, Project A’s capitalized value is –$50 + $18.18 + $16.68 + $15.43 = $0.29. Project B’s value is –$33 + $18.18 + $25.02 + $30.86 = $41.06. Both projects should be undertaken. c. For any given current interest rate, fewer projects will be viable if the interest rate is expected to rise over time, and more projects will be viable if the interest rate is expected to fall over time. Economic Applications Exercises 2. The marginal productivity of capital must have been much higher at that level of labor. 48 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises Chapter 14 Economic Efficiency and the Role of Government (Part II) Review Questions 2. a. A Pareto improvement. This is a voluntary exchange, so both parties must benefit. b. A Pareto improvement. Going to the movie is a voluntary decision for both you and your friend, so both of you must gain. c. Not a Pareto improvement (since you were harmed), although this could become a Pareto improvement if your friend compensates you for your loss through a side payment. 4. In a perfectly competitive market with no market failure, providing more than the equilibrium quantity cannot be economically efficient, because reducing output by one unit will increase total net benefits. 6. a. Criminal law limits exchanges to those that are voluntary. Voluntary exchanges lead to Pareto improvements. Involuntary exchanges, such as robbery, always harm at least one party. b. Property law gives precisely defined, enforceable rights over goods. If property rights are poorly defined, people waste resources trying to take away another person’s property—an activity that makes at least one party worse off—instead of devoting resources to Pareto improvements. c. Contract law enhances efficiency by extending the range of Pareto improvements that can take place. In particular, it enables Pareto improvements that involve the future actions of some other party. d. Tort law deals with relationships between people or businesses not linked by contracts. It creates incentives for businesses and individuals to account for the effects of their actions on others, thereby engaging in fewer acts that hurt others, and enhancing efficiency. Tort law also protects against fraud, thereby reducing the transactions costs associated with doing business. e. Antitrust law helps sustain and improve competition in industry by preventing certain practices that would limit competition and prevent Pareto-improving production from taking place. 8. The Coase theorem addresses market failure due to externalities. When side payments can be negotiated and arranged without cost, the private market will solve the externality problem on its own. 10. Marginal cost measures the cost to the producer of producing another unit of a good, while marginal social cost measures the full cost of producing another unit of a good, including the marginal cost to the producer and any harm caused to third parties. 12. A pure public good is one that is nonrival—consumption by one person does not affect the amount available to be consumed by others—and nonexcludable—there is no way to force consumers to pay for the good. A pure private good, by contrast, is rival and excludable. Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises 49 Problems and Exercises 2. 4. a. b. See graph in part (a). c. The dollar value of market consumer surplus = ((1.50 - $1.30) x 4000)/2 = $400. The dollar value of market producer surplus = ((1.30 - $1.10) x 4000)/2 = $400. The total net benefits in the market at equilibrium = $400 + $400 = $800. 6. a. Market consumer surplus = (($1.50 - $1.40) x 2000)/2 = $100. b. Market producer surplus = (($1.40 - $1.20) x 2000) + ((($1.20 - $1.10) x 2000)/2) = $400 + $100 = $500. c. Total net benefits in market = market consumer surplus + market producer surplus = $100 + $500 = $600. d. Welfare loss = The total net benefits in the market at equilibrium – total net benefits in market = $800 (from problem 4 (c)) - $600 = $200. 50 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises 8. The dollar value of the welfare loss = (($1.30 - $0.80) x 25 million)/2 = $6.25 million. 10. This is an example of the tragedy of the commons. Each roommate is getting a partial free ride in using the water paid for by the other. Since each does not consider the full costs of his actions, each is led to overuse water to the disadvantage of both. 12. A $0.50 tax imposed on gasoline consumers would shift the demand curve down by $0.50 at each level of output. As in Figure 11 (b), the total price paid by consumers would be $1.30, the total price received by firms would be $1.30 - $0.50 = $0.80, and the equilibrium quantity would be 100 million gallons. Challenge Questions 2. a. Assuming that the land will continue to generate $50,000 annual income forever, the value of the land will be $50,000/0.10 = $500,000. b. The minimum amount Haney will accept for restricting use of his land will be $300,000. This is because the value of the land in residential use is only $20,000/0.10 = $200,000. Thus, by limiting the land to residential use, Haney would lose $500,000 – $200,000 = $300,000. c. If Douglas and Ziffel offer Haney a total of $350,000, then Haney would be made better off. He is willing to restrict the use of his land for $300,000, so he would benefit by $50,000. Douglas and Ziffel would be no worse off because each is willing to pay the amounts stated to end pig farming. d. If Douglas and Ziffel offer a total of $300,000, then Haney would be neither better nor worse off. Ziffel, likewise, would be neither better nor worse off if he pays the maximum he is willing to pay. Douglas, however, would be better off if the deal is struck. He is willing to pay $200,000, but only has to pay $150,000, so he benefits by $50,000. Thus, the action would, indeed, be a Pareto improvement. Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises 51 Economic Applications Exercise 2. a. Answers may vary. b. MB, MC Consumer MSC Surplus MPC Loss to society Surplus lost in the form of tax revenue Demand Producer Surplus Quantity Chapter 15 Comparative Advantage and the Gains from International Trade Review Questions 2. A country has a comparative advantage in a good when it can produce it with a lower opportunity cost (in terms of other goods foregone) than some other country. A country has an absolute advantage when it can produce a good using fewer resources than some other country. A country can have an absolute advantage in a good without having a comparative advantage in that good, and vice versa. 4. Comparative advantage arises from differences in opportunity cost in production among countries. These differences, in turn, can arise from differences in endowments of natural resources, or from differences in available physical or human capital. 6. Multilateral trade agreements call for free trade to begin simultaneously in more than one country, thus creating a balance of influence that can enable governments to resist anti-trade lobbying. The World Trade Organization (WTO) sets standards for acceptable and unacceptable trade restrictions, and makes rulings in specific cases, thereby creating public-relations pressure. Finally, domestic industrial consumers, who hope to buy cheaper imports, may be able to successfully lobby against anti-trade measures. 8. Naïve arguments in support of protectionism—based on a misunderstanding of the effects of trade—include: (a) the wages of a higher-wage country will drop toward those of its lower-wage trading partner; (b) the country with lower productivity will be flooded with goods from the higher-productivity country, destroying its industries. More sophisticated arguments include the potential gains of a strategic trade policy and the infant industry argument. The argument for strategic trade policy is most persuasive when a market is dominated by a few large firms; the 52 Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises infant industry argument makes the most sense in poor countries with poorly developed financial markets. Problems and Exercises 2. a. In Paraguay, the pretrade price is $15; at that price 600 sides of beef are produced and sold. In Uruguay, the pretrade price is $30; 600 sides of beef are produced and sold at that price. b. The equilibrium posttrade price is $22.50. In Paraguay, 300 sides of beef are purchased at that price; 900 are purchased in Uruguay. c. In Paraguay, 900 sides of beef are produced; in Uruguay, 300 are produced. A total of 600 sides of beef are exported from Paraguay to Uruguay. d. Beef consumers in Paraguay lose (the price of beef there rises), and beef producers in Uruguay lose (the price of beef there falls). Gainers include beef producers in Paraguay, and beef consumers in Uruguay. 4. a. The price of beef in Uruguay will rise from $22.50 to $27.50, since at that price, domestic quantity supplied falls short of quantity demanded by 200 sides. Domestic consumption will fall from 900 sides to 700 and domestic production will rise from 300 sides to 500. b. The price of beef in Paraguay will fall from $22.50 to $17.50, since at that price 200 sides will be available for export to Uruguay. Domestic consumption will rise from 300 sides to 500; domestic production will fall from 900 sides to 700. 6. China United States Suits Computers Suits Computers Change in +15 -3 -8 +4 production Exports or -12 +3 +12 -3 Imports Net Gain +3 +0 +4 +1 Both countries still gain from trade. But since the U.S. gains more suits than China and it gains 1 computer, the U.S. gains more from trade than China. 8. Yes, trade will still take place because suits are still cheaper in China and computers are still cheaper in the United States. China United States Per Suit $2000 CNY $500 ($333) (3000 CNY) Per Computer $10,000 CNY $1000 ($1666.67) (6000 CNY) Solutions to Even-Numbered, End-of-Chapter Questions, Problems, and Exercises 53 Challenge Questions 2. a. The domestic price is $4 in country A and $8 in country B. The equilibrium quantity in each country is 7 units. b. The price will rise in country A, and will fall in country B. Consumption in country A will fall, while consumption will rise in country B. Production in country A will rise, while production in country B will fall. Country A has the competitive advantage in the production of Good X, and will export some units to country B. Economic Applications Exercises 2. Answers may vary.
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