Answers to Suggested Practice Problems Weeks 4 and 5

Week 4

Chapter 3

1. Choices (a) and (b) would increase the demand for beef; (c) and (d) would affect primarily the supply
of beef, rather than the demand; (e) leads to a change in quantity demanded, not a change in
demand.

7. The market price of a good or service is determined by the interaction of market supply and market
demand. At the market equilibrium price, quantity demanded is exactly equal to quantity supplied. If
the value to a consumer of an additional unit exceeds the opportunity cost of the additional unit, it is
economically efficient to produce and sell the unit. When the market for a product is in equilibrium, the
value to consumers of the last unit produced is exactly equal to its opportunity cost. At equilibrium, all
gains from trade have been realized. At quantities beyond the equilibrium quantity, the opportunity
cost of production exceeds the value consumers’ place on the unit. Production/consumption at such a
level would be inefficient.

15. Two goods are substitutes if there is a direct (positive) relationship between the price of one good
and the demand for the other. Goods X and Y are substitutes if an increase (decrease) in the price of X
increases (decreases) demand for Y.

Two goods are complements if there is an inverse (negative) relationship between the price of one
goods and the demand for the other. Goods W and Z are complements if an increase (decrease) in the
price of W decreases (increases) demand for Z.

Chapter 7

1. The change in revenue from the change in tuition pricing will be dependent on the
elasticity of demand for education at NSU.

(a) If demand for education at NSU is inelastic, a price increase will result in an increase
in revenue. Inelastic demand indicates that quantity demanded is relatively insensitive to
changes in price. NSU can raise its price without significantly reducing its enrollment.

(b) If demand for education at NSU is elastic, a price increase will result in a decrease in revenue.
Elastic demand indicates that quantity demanded is very sensitive to changes in price. If NSU
raises it price, it will experience a large decline in enrollment.
 (c) If demand for education at NSU is unit elastic, a price increase will not cause a change in
revenue. Unit elastic demand indicates that the percentage change in price is exactly matched
by the resulting percentage change in quantity demanded.

If the true price elasticity of demand is -1.2, demand is elastic. For elastic demand, revenue
changes in the opposite direction of a price change. The university should decrease tuition to
generate more revenue.

7. Determinants of elasticity of demand: availability of substitutes, product’s share of the

consumer’s total budget, time.

There are substitutes for Florida oranges, which are also a small share of a consumer’s total
budget.

Bayer aspirin is a small share of a consumer’s total budget. Alternative, or substitute, brands are
also available.

There are substitutes for watermelons, which are also a small share of a consumer’s total
budget.

A leisure traveler has the flexibility to schedule travel many weeks in advance. The traveler’s
period of adjustment is large.

13. a. -0.55

b. inelastic

c. Yes

d. -1.5

e. elastic

f. no

Chapter 8

9.The law of diminishing returns states that “as more and more units of a variable resource are
combined with a fixed amount of other resources, using additional units of the variable resource will
eventually increase output only at a decreasing rate.” Diminishing returns applies only in the short run,
when the firm has at minimum one fixed factor of production.
Diseconomies of scale occur when there is an increase in the firm’s per unit cost of production.
Diseconomies of scale are a long run concept. In the long run all factors of production are variable.

16. Implicit costs are “the opportunity costs associated with a firm’s use of resources that it owns.” Yes,
implicit costs together with explicit costs capture the total cost of production. An implicit cost should be
counted as a cost. Three examples of implicit costs include: the salary associated with an
entrepreneur’s alternative employment opportunity, forgone rent on a firm-owned building currently
used by the firm, and interest forgone by a firm owner providing equity capital to the firm. The firm’s
accounting statement does not typically reflect implicit costs.

Week 5

Chapter 19

1. The Japanese cameras will become more expensive, and the quantity purchased by Americans
will decline.

4. On February 2, the dollar appreciated against the British pound and depreciated against the
Canadian dollar.

5. Scenarios (a) and (g) would cause the dollar to appreciate; (b), (c), (d), (e), and (h) would cause the
dollar to depreciate; (f) would leave the exchange rate unchanged.

Practice Problems Key

 Discuss how real GDP, employment, and inflation tend to change during the phases of the
business cycle. Are the timing of the cycles and the durations of the phases consistent?

During the expansionary phase of a business cycle, real GDP (output) increases and employment
increases/unemployment decreases. Inflation, an increase in the overall price level, may result.

During the contractionary (recession) phase of a business cycle, real GDP (output) decreases and
employment decreases/unemployment increases. A slower rate of inflation or even deflation
(negative inflation) may result.

The timing and duration of the phases of the business cycle are irregular.

 Discuss expansionary fiscal policy as a way to stabilize the economy during a downturn.

Fiscal policy is the use of changes in government taxation and spending to influence the overall
economy. Expansionary fiscal policy is intended to spur an increase in production and spending
and decrease unemployment in the economy. Decreasing taxes, which increases the disposable
 income of consumers, or increasing government spending are examples of expansionary fiscal
policy.

 How would the purchase of bonds by the Federal Reserve impact the economy?

A purchase of bonds by the Federal Reserve will increase the money supply. Because our
economy uses a fractional reserve banking system, the total increase in the money supply
exceeds the initial deposit into the banking system due to the purchase by the Fed. The increase
in deposits permits banks to fund additional loans, further expanding the money supply. This
increase in the money supply lowers interest rates and stimulates investment, spending, and
production. The purchase of bonds by the Fed is an example of expansionary monetary policy.