Chapter 1

Problem 5
The firm cannot recoup the $5 million of its initial investment in the development of the product
implying that it is a sunk cost.
Apart from this, an extra $1 million is needed as an investement to complete the product's
development.
There will be a chance to recoup the $3 million loss if the firm invests the extra $1 million and
launch the product in the market. The firm should not consider the initial investment of $5
million since it is a sunk cost now and sjould not matter reagarding the new investment of $1
million.
investing $1 million, the firm can recover $3 million and therefore it will be able to earn $2
million at the margin.
As such, the maximum that the firm is willing to pay to complete the product development is $3
million since anything above it would imply a loss at the margin as well.
Chapter 3
Problem 6
- Without trade, the price of a pair of white socks (in terms of red socks) in Boston is 1 pair of
red socks, and in Chicago it is 2 pairs of red socks.

- Boston has an absolute advantage in the production of both red socks and white socks because
it can produce more of both goods per worker per hour.

- To determine comparative advantage, we need to look at the opportunity cost of producing

- If the cities trade with each other, Boston will export white socks, and Chicago will
export red socks.

- The price of white socks can be expressed in terms of red socks. The highest price at which
white socks can be traded that would make both cities better off is 2 pairs of red socks per pair
of white socks (the opportunity cost in Chicago), and the lowest price that makes both cities
better off is 1 pair of red socks per pair of white socks (the opportunity cost in Boston).
Problem 7
(a) Gains from trade will be possible when X does not equal 3. When X=3, the opportunity cost
of 1 car in France is 200 cases of wine, neither country has a comparative advantage. At all
other values of X, a comparative advantage will exist.
(b) Germany will export cars and import wine for all values of X<3. When X<3, Germany has
comparative advantage in producing car, and France has comparative advantage in producing
wine. Therefore, Germany exports cars and imports wine
Chapter 4
Problem 3
a. People decide to have more children.

If people decide to have more children, they will want larger vehicles for driving their
kids around, so the demand for minivans will increase. Supply will not be affected, the
demand curve shift to the right. As the result, both the price and the quantity sold of
minivan increase
b. A strike by steelworkers raises steel prices.

If a strike by steelworkers raises steel prices, the cost of producing a minivan rises and
the supply of minivans decreases. Demand will not be affected, the supply curve shifts to
the left. The result is a rise in the price of minivans and a decline in the quantity sold of
minivans.
c. Engineers develop new automated machinery for the production of minivans.

Technology improvement increases supply & shifts supply curve rightwards. New equilibrium
price decreases & quantity increases.
d. The price of sport utility vehicles rises.

Price of substitute good rise reduces their demand. It increases the good's demand & shifts
demand curve rightwards. New Equilibrium price & quantity decrease.
e. A stock market crash lowers people’s wealth.
Income fall decreases demand & shifts demand curve leftwards. New equilibrium price price &
quantity both decrease.
Problem 6
a. A hurricane in South Carolina damages the cotton crop:
 The hurricane damaging the cotton crop in South Carolina will reduce the supply of
cotton, a key input in the production of sweatshirts.
 This will shift the supply curve to the left, resulting in a decrease in the quantity supplied
and an increase in the equilibrium price of sweatshirts.
 The demand curve remains unchanged.
=> Decrease in supply, increase in price
b. The price of leather jackets falls:
 A decrease in the price of leather jackets, a substitute for sweatshirts, will lead to a
decrease in the demand for sweatshirts.
 This will shift the demand curve to the left, resulting in a decrease in the equilibrium
quantity and price of sweatshirts.
 The supply curve remains unchanged.
=> Decrease in demand, decrease in price
c. All colleges require morning exercise in appropriate attire:
 The requirement for morning exercise in appropriate attire by all colleges will increase
the demand for sweatshirts.
 This will shift the demand curve to the right, resulting in an increase in the equilibrium
quantity and price of sweatshirts.
 The supply curve remains unchanged.
=> Increase in demand, increase in price
d. New knitting machines are invented:
 The invention of new knitting machines will increase the productivity and efficiency of
sweatshirt production.
 This will shift the supply curve to the right, resulting in an increase in the equilibrium
quantity and a decrease in the equilibrium price of sweatshirts.
 The demand curve remains unchanged.
=> Increase in supply, decrease in price
Chapter 5
Problem 5
a. The price of of coffee beans increases due to the reduced supply.When a hurricane destroys
half of the crop, the supply of coffee beans decreases from S1 to S2, the price of coffee beans
increases, and the quantity decreases.
b. The price of a cup of coffee will increase due to the decreased supply of coffee.When the
price of coffee beans increases, the quantity supply of cups of coffee decreases, the price of a
cup of coffee increases, and the quantity decreases.
The total expenditure of coffee will rise. This is because for goods with inelastic demand
increase in price of a good raises the total expenditure on that good.
c. The price of donuts decreases.When the price of coffee increases and the quantity demanded
of coffee decreases, consumers demand fewer donuts because coffee and donuts are
complements. The demand for donuts will decrease from D2 to D2 as shown below , lowering
the donuts price.
The total expenditure of donuts will decrease. Donuts is an inelastic good and decrease in price
will result to decreased expenditure on donuts.
Problem 6
1. Darnell: Demand increased, but supply was perfectly inelastic
This explanation is not consistent with the situation. If demand increased and supply was
perfectly inelastic, we would expect the quantity sold to increase, not remain the same
2. Eleanor: Demand increased, but it was perfectly inelastic
This explanation is consistent with the situation. If demand is perfectly inelastic, the quantity
sold will not change regardless of the price. Therefore, an increase in demand could lead to a
higher price without changing the quantity sold.
3. Jacques: demand increased, but supply decreased at the same time
This explanation could be consistent with the situation, but it would depend on the elasticity of
supply. If supply is perfectly inelastic, a decrease in supply would not change the quantity sold.
However, if supply is not perfectly inelastic, a decrease in supply would likely decrease the
quantity sold.
4. Kyoko: supply decreased, but demand was unit elastic
This explanation is not consistent with the situation. If demand is unit elastic, a change in price
would result in a proportional change in quantity demanded. Therefore, a decrease in supply
would likely lead to a decrease in quantity sold, not a constant quantity.
5. Musashi: supply decreased, but demand was perfectly inelastic
This explanation is consistent with the situation. If demand is perfectly inelastic, the quantity
sold will not change regardless of the price. Therefore, a decrease in supply could lead to a
higher price without changing the quantity sold.
* In conclusion, the explanations provided by Eleanor and Musashi are the most consistent with
the situation described.
Chapter 6
Problem 3
a. The equilibrium price of frisbees is $8 and the equilibrium quantity is 6 million frisbees.
b. With a price floor of $10, the new market price is $10 since the price floor is binding. At that
price, only 2 million frisbees are sold, since that is the quantity demanded.
Note that there is a surplus of 10 million frisbees.
c. If there is a price ceiling of $9, it has no effect, since the market equilibrium price is $8,
which is below the ceiling. So the equilibrium price is $8 and the equilibrium quantity is 6
million frisbees.
Problem 4
a.

From the drawn graph we can conclude that There is no difference between the prices and the
price paid by the consumers of beer is equal to the price received by a producer of beer.
The Quantity sold of the beer would be Q*
b.

The price received of the producer is set where the D’ intersects the S at point E’ and the price
paid by the consumer is set at the old demand curve to correspond to the new equilibrium
quantity.
Chapter 7
Problem 6
a.
Price Quantity Supplied Quantity Demanded
$2 1 3
4 2 2
6 3 1
Only a price of $4 brings supply and demand into equilibrium, with an equilibrium
quantity of 2.
b. At a price of $4, consumer surplus is $4 and producer surplus is $4. Total
surplus is $4 + $4 = $8.
c. If Ernie produced one fewer bottle, his producer surplus would decline to $3. If Bert
consumed one fewer bottle, his consumer surplus would decline to $3. So total surplus would
decline to $3 + $3 = $6.
d. If Ernie produced one additional bottle of water, his cost would be $5, but the price is
only $4, so his producer surplus would decline by $1. If Bert consumed one additional
bottle of water, his value would be $3, but the price is $4, so his consumer surplus would
decline by $1. So total surplus declines by $1 + $1 = $2
Problem 11
a. The demand curve for medical care
b. The consumer has to pay $20 per procedure; the quantity demanded is Q2. However, the cost
to society is $100, and the quantity that maximizes the total surplus is Q1, which is less than
Q2.
c. The use of medical care is excessive because doctors receive extra payments for each
procedure (needed or not) they perform, which encourages them to seek extra procedures.
d. There are several ways to protect the excessive use of medical care. Correctly identifying the
marginal cost of insurance that must be paid by the consumer before determining the insurance
amount can reduce medical care use.