 Answers to Exercises in the Text

1.1 Since Q1  3Q2,

Substituting back into the demand function for Q1 and settingQ2  6 yields:

1.2 Using the partial equilibrium condition, QSi  QDi in each market will yield functions that can be
solved for either price (e.g., p1). These equations can be used to solve for the other price (p2). The
prices can then be used to solve for the quantities in each market.

D1(p1, p2)  S1(p1)

p1  3.25  1/4p2
D2(p1, p2)  S2(p2)
p2  5/3  1/3p1
p1  $4.00, p2  $3.00
Q1  6, Q2  4

1.3 a. Demand functions:

(1)

(2)
Supply functions:

(3)

(4)

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The solution to the four equations above is:

If then the equilibrium prices and quantities are:

The effects of on the equilibrium prices are:

b. Now in the demand equations, and in the supply equations.

Demand side:

(1)

(2)
Supply side:

(3)

(4)

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 Chapter 10 General Equilibrium and Economic Welfare  197

The solution to equations (2), (3) and (4) is:

c. Assume all the revenues go to the salary. Then in the competitive medical checkup market, the
equilibrium salary of dentists per day is: while in the
insurance-company-dictated medical-doctor payments, the equilibrium salary of dentists per day
is: therefore the equilibrium salary of
dentists increases after the shift.

1.4 a. w  (a  c  e)/(b  d  f ). L1  a  b(a  c  e)/(b  d  f ).

L2  c  d(a  c  e)/(b  d  f ).
b. L1  a  bw. To solve for w2, set L2  L – L1  e  fw2  (a  bw),
so w2  (a  c  e  bw)/(d  f ). L2  c  d(a  c  e  bw)/(d  f ).
c. w  w. L1  a  bw. L2  c  dw. L  a  c  (b  d)w.

1.5 The labor demand in the “covered” sector decreases due to the tax. As a result, the total labor demand
decreases. Workers shift between sectors until the new wage is equal in both sectors. The new wage
and total employment decrease.

1.6 If Zagreb imposed a wage tax but the surrounding areas did not, then the demand curve for labor in
Zagreb would shift downwards and the demand curve for labor in the surrounding areas would not be
affected. Consequently, the total demand curve for labor in the region and the (net of tax) equilibrium
wage rate in the region would fall. That latter would cause employment in Zagreb to fall, the
employment in the surrounding areas rises, and the total employment in the region would decrease.

1.7 A subsidy is a negative tax. Thus we can use the same analysis that we used in Solved Problem 10.1
to answer this question by reversing the signs of the effects.

1.8 Because the subsidy is not tied to new job creation or per-hour wages, the new law does not directly
create employment in either sector. Firms in the subsidized sector can simply pocket the subsidy as
cash. The subsidy also causes secondary effects. Firms in the uncovered sector may switch to
producing products in the covered sector in order to be eligible for the subsidy. In this case, supply
decreases in the uncovered sector and increases in the covered sector. The changes in output cause
employment in the covered sector to increase and employment in the uncovered sector to decrease.

1.9 The tariff will decrease the total quantity of the good sold. The quantity sold in Europe will be lower
and the price will be higher, while the quantity and price in the United States will not be affected.

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2.1 As shown in the figure below, since a mutually beneficial trade took place, Vijay and Tara’s
indifference curves for onion bhajis and sheek kabobs were not tangent at the initial allocation. Since
the trade was optimal, utility is maximized for each person at the new allocation. Any form of shift
away from it would harm at least one of them. In other words, their indifference curves are tangent
and their marginal rates of substitution are equal at the new allocation.

2.2 A move from Point e to Point b will leave Jane indifferent, but Denise with more utility. A move to
Point c will leave Denise indifferent, but give Jane more utility. Thus, e is not Pareto efficient and
cannot be on the contract curve. In addition, at Point e Jane and Denise’s indifference curves cannot
be tangent.
2.3 Yes, they may want to trade. If two individuals are consuming different bundles and have identical
preferences, their marginal rates of substitution may be unequal and they may gain by trading. For
example, if each had the utility function U  XY, an initial allocation of 4X, 2Y for one person and
2X, 4Y for the other, each would have a utility level of 8, and their marginal rates of substitution would
differ. By trading 1 unit of X for 1 unit of Y, each can achieve a utility level of 9.

2.4 See the figure below. At point A, the individual’s indifference curves are tangent. At point B,
however, Joe is indifferent to point A, but Mary is happier, making the allocation implied by B
Pareto-superior to that at A.

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 Chapter 10 General Equilibrium and Economic Welfare  199

2.5 a. The marginal rate of substitution for each person is:

At the endowment point, the MRS for Arslan is and the MRS for Belgin is
which indicates that the endowment point is not Pareto efficient.
b. Along the contract curve,

Since both and

Thus, and the contact curve is the 45° line.

2.6 Adrienne’s Lagrangian is

L=Z A C A + λ ( Y A − pZ A−C A ) .

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200  Perloff • Microeconomics: Theory and Applications with Calculus, Fourth Edition, Global Edition

Maximizing with respect to ZA, CA, and λ and solving, Adrienne’s demand for good Z is
YA
Z A=
2p .

Stephen’s Lagrangian is
0.5 0 .5
L=(Z S ) ( C S ) + λ (Y S − pZ S −C S ) .

Maximizing with respect to ZS, CS, and λ and solving, Stephen’s demand for good Z is
YS
Z S=
2p .

To find p, set the demands for good Z from both consumers equal to supply (which equals the
endowment) and solve for p:
ZA + ZS = 30

YA YS
+ =30
2p 2p .

Since YA = 10p + 20 and YS = 20p + 10,

10p + 20 + 20p + 10 = 30(2p)

30p = 30

p = $1.

2.7 The contract curve is where each individual’s MRS are equal to each other. Note that MRSt (Ht/Gt)
and MRSm (Hm/2Gm). Also note that Gt  Gm  100, and Ht  Hm  50. As in Solved Problem 10.3,
equating the MRSs and using the information about endowments given in the problem we get the
following contract curve: 100Gm  100Hm  HmGm  0.

2.8 The demands for each good are found to be Gt  Yt /2P; Ht  Yt /2; Gm Ym/3P; and Hm  2/3Ym. To
find the price of G with the price of H normalized to 1, note that the sum of the individual demands for
G equals the supply of G, as in Solved Problem 10.4, or Gt + Gm  100. Substituting demands into this
equation and rearranging yields the equilibrium price:

Further simplifying,

Substituting 100 – Gt for Gm and 50 – Ht for Hm and simplifying,

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 Chapter 10 General Equilibrium and Economic Welfare  201

3.1 Refer to Figure 10.4 in the chapter. Allocation a (f in Figure 10.4) can be obtained from any endowment
that is on this particular budget line through trade without altering prices, as shown in panel (a). If prices
at the initial endowment e in panel (b) are not such that an equilibrium can be found, the auctioning
process will result in price adjustments until the budget line with the slope (the price ratio) that is
equal to the marginal rate of substitution of the indifference curves that are tangent at f is found.

4.1 If you draw the convex production possibility frontier on Figure 10.5, you will see that it lies strictly
inside the concave production possibility frontier. Thus more output can be obtained if Jane and
Denise use the concave frontier. That is, each should specialize in producing the good for which she
has a comparative advantage.

4.2 As Chapter 4 shows, the slope of the budget constraint facing an individual equals the negative of that
person’s wage. Panel (a) of the figure illustrates that Pat’s budget constraint is steeper than Chris’s
because Pat’s wage is larger than Chris’s. Panel (b) shows their combined budget constraint after they
marry. Before they marry, each spends some time in the marketplace earning money and other time at
home cooking, cleaning, and consuming leisure. After they marry, one of them can specialize in
earning money and the other at working at home. If they are both equally skilled at household work
(or if Chris is better), then Pat has a comparative advantage in working in the marketplace, and Chris
has a comparative advantage in working at home. Of course, if both enjoy consuming leisure, they
may not fully specialize. As an example, suppose that before they got married, Chris and Pat each
spent 10 hours a day in sleep and leisure activities, 5 hours working in the marketplace, and 9 hours
working at home. Because Chris earns $10 an hour and Pat earns $20, they collectively earned $150 a
day and worked 18 hours a day at home. After they marry, they can benefit from specialization. If
Chris works entirely at home and Pat works 10 hours in the marketplace and the rest at home, they
collectively earn $200 a day (a one-third increase) and still have 18 hours of work at home. If they do
not need to spend as much time working at home because of economies of scale, one or both could
work more hours in the marketplace, and they will have even greater disposable income.

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4.3 Yes. In this case, Britain is relatively more efficient at producing cloth than food (MRT  2), and
Greece is relatively more efficient at producing food than cloth (MRT  –0.5). Suppose that Britain
has a high preference for food relative to cloth and Greece has a high preference for cloth relative to
food. Thus if Greece trades 1 unit of food to Britain for 2 units of cloth, Greece would end up with 1
unit of food and 3 units of cloth per day, which is beyond its current production possibility frontier.
Britain gets to consume 9 units of cloth and 6 units of food per day, which it cannot achieve without
trade.

4.4 No. Trade is only valuable if one party has at least a comparative advantage over the other. With
identically sloped production possibility frontiers, there is no comparative advantage.

4.5 Jane, Denise, Harvey, Bill, and Helen can produce a total of 23 cords of wood or a total of 23 candy
bars. Among the five, Denise has a comparative advantage producing candy bars and Jane has a
comparative advantage producing cords of wood. Therefore, Denise should be the first to produce
candy bars, and Jane should be the last to produce candy bars instead of cords of wood. If only
Denise produces candy bars, then they can produce 6 candy bars and 20 cords of wood. Helen should
be the next to produce candy bars (if two produce candy bars, then they can produce 11 candy bars
and 16 cords of wood), then Harvey (if three produce candy bars, then they can produce 16 candy
bars and 11 cords of wood), and then Bill (if four produce candy bars, then they can produce 20
candy bars and 6 cords of wood). If only Jane produces cords of wood, then they can produce 20
candy bars and 6 cords of wood. This is illustrated below.

Production Possibilities Frontier

24
22
20
C
o 18
r 16
d
s 14
12
o
f 10
W 8
o 6
o
d 4
2
0
0 2 4 6 8 10 12 14 16 18 20 22 24
Candy Bars

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 Chapter 10 General Equilibrium and Economic Welfare  203

4.6 a. In the absence of trade, Country 1 can produce 10 units of good 1 and 2 units of good 2. Country
2 can produce 30 units of good 1 and 15 units of good 2.
b. Country 1 has a comparative advantage in producing good 1 (gives up 0.2 units of good 2 to
produce an extra unit of good 1 compared to 0.5 units of good 2 for Country 2). Country 2 has a
comparative advantage in producing good 2 (gives up 2 units of good 1 to produce an extra unit
of good 2 compared to 5 units of good 1 for Country 1).
c. Panels (a) and (b) below show the production possibility frontiers for Country 1 and Country 2.
d. Panel (c) below shows the joint production possibility frontier.
e. As shown in panel (c), if Country 2 were to produce 5 units of good 1 and 12.5 units of good 2,
and Country 1 were to produce 10 units of good 1 and 0 units of good 2, the total amount
produced would be larger than if there was no trade. Hence, both countries can benefit from
trade.

5.1 Assume a four-person economy with two goods. The welfare function W  (U1)(U2)(U3)(U4), where
for each individual Ui  XiYi would be maximized when each person receives an equal allocation of
each good.

5.3 In an economy with many individuals but the goal of maximizing the utility of only one, the welfare
function is W  max{U1, U2,…, Un}. An allocation with all goods for the best-off individual and no
goods for any other person would maximize this function. The individual chosen would be the person
who would receive the highest utility level from consuming all goods.

5.3 Perfect competition does not maximize consumer surplus. Consumer surplus would be maximized if
all goods were free, which would lead to the maximum consumption of each good, and the total area
under the demand curve in each market would be CS. A policy that could achieve this might be
extensive production subsidies, but the costs of such a program would far exceed the benefits.
(Arguably, if consumers are also taxpayers, free goods would not maximize CS.)

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6.1 In the absence of anti-price gouging laws, the demand curve is D1 and the equilibrium point is e1.
Price is higher than it would be in the absence of such laws, and total producer surplus clearly
increases. Although this depends on the exact demand curves, it is likely that the covered sector
consumers will be able to obtain more goods than before, and certainly less will be sold in the
uncovered market as the price rises. Total social welfare increases due to the increase in quantity, and
consumers may gain or lose depending on the extent to which the law reduced the quantity produced
(that is, the gains from consuming more may exceed the costs of the higher price). Thus, it is possible
that both consumers and producers will be better off, as groups, although the consumers who were
able to purchase the good at the low price will lose.

6.2 In the consumer market, the price and quantity sold would be lower, and there would be a shortage of
fresh oranges. Orange juice producers would be unaffected and could continue to buy as much as
they want at a lower market price. If unsatisfied consumers of fresh oranges substitute for orange
juice, then the orange juice producers’ demand will increase and the shortage in the fresh oranges
market will decrease.

6.3 The price ceiling will create excess demand in the city, which will spill out into the suburbs. As a
result, rental prices will increase in the suburbs, the number of rentals will increase in the suburbs but
decrease in the city, and the total number of units available in the metro area will remain the same
(assuming no change in the total population).

6.4 The law simply reduces the number of buyers in the market. Therefore, the quantity sold in New
York will be lower and so will the price. The price elsewhere will be lower and so will the quantity.

6.5 The price in the foreign market will be higher, while the quantity sold will be lower. On the other
hand, the price in the home country will be lower and quantity sold will be higher, assuming total
production remains the same.

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