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Principles of Microeconomics 2e

Chapter 6

Principles of Microeconomics 2eChapter 6

Table of contents
  1. Preface
  2. 1 Welcome to Economics!
    1. Introduction
    2. 1.1 What Is Economics, and Why Is It Important?
    3. 1.2 Microeconomics and Macroeconomics
    4. 1.3 How Economists Use Theories and Models to Understand Economic Issues
    5. 1.4 How To Organize Economies: An Overview of Economic Systems
    6. Key Terms
    7. Key Concepts and Summary
    8. Self-Check Questions
    9. Review Questions
    10. Critical Thinking Questions
  3. 2 Choice in a World of Scarcity
    1. Introduction to Choice in a World of Scarcity
    2. 2.1 How Individuals Make Choices Based on Their Budget Constraint
    3. 2.2 The Production Possibilities Frontier and Social Choices
    4. 2.3 Confronting Objections to the Economic Approach
    5. Key Terms
    6. Key Concepts and Summary
    7. Self-Check Questions
    8. Review Questions
    9. Critical Thinking Questions
    10. Problems
  4. 3 Demand and Supply
    1. Introduction to Demand and Supply
    2. 3.1 Demand, Supply, and Equilibrium in Markets for Goods and Services
    3. 3.2 Shifts in Demand and Supply for Goods and Services
    4. 3.3 Changes in Equilibrium Price and Quantity: The Four-Step Process
    5. 3.4 Price Ceilings and Price Floors
    6. 3.5 Demand, Supply, and Efficiency
    7. Key Terms
    8. Key Concepts and Summary
    9. Self-Check Questions
    10. Review Questions
    11. Critical Thinking Questions
    12. Problems
  5. 4 Labor and Financial Markets
    1. Introduction to Labor and Financial Markets
    2. 4.1 Demand and Supply at Work in Labor Markets
    3. 4.2 Demand and Supply in Financial Markets
    4. 4.3 The Market System as an Efficient Mechanism for Information
    5. Key Terms
    6. Key Concepts and Summary
    7. Self-Check Questions
    8. Review Questions
    9. Critical Thinking Questions
    10. Problems
  6. 5 Elasticity
    1. Introduction to Elasticity
    2. 5.1 Price Elasticity of Demand and Price Elasticity of Supply
    3. 5.2 Polar Cases of Elasticity and Constant Elasticity
    4. 5.3 Elasticity and Pricing
    5. 5.4 Elasticity in Areas Other Than Price
    6. Key Terms
    7. Key Concepts and Summary
    8. Self-Check Questions
    9. Review Questions
    10. Critical Thinking Questions
    11. Problems
  7. 6 Consumer Choices
    1. Introduction to Consumer Choices
    2. 6.1 Consumption Choices
    3. 6.2 How Changes in Income and Prices Affect Consumption Choices
    4. 6.3 Behavioral Economics: An Alternative Framework for Consumer Choice
    5. Key Terms
    6. Key Concepts and Summary
    7. Self-Check Questions
    8. Review Questions
    9. Critical Thinking Questions
    10. Problems
  8. 7 Production, Costs, and Industry Structure
    1. Introduction to Production, Costs, and Industry Structure
    2. 7.1 Explicit and Implicit Costs, and Accounting and Economic Profit
    3. 7.2 Production in the Short Run
    4. 7.3 Costs in the Short Run
    5. 7.4 Production in the Long Run
    6. 7.5 Costs in the Long Run
    7. Key Terms
    8. Key Concepts and Summary
    9. Self-Check Questions
    10. Review Questions
    11. Critical Thinking Questions
    12. Problems
  9. 8 Perfect Competition
    1. Introduction to Perfect Competition
    2. 8.1 Perfect Competition and Why It Matters
    3. 8.2 How Perfectly Competitive Firms Make Output Decisions
    4. 8.3 Entry and Exit Decisions in the Long Run
    5. 8.4 Efficiency in Perfectly Competitive Markets
    6. Key Terms
    7. Key Concepts and Summary
    8. Self-Check Questions
    9. Review Questions
    10. Critical Thinking Questions
    11. Problems
  10. 9 Monopoly
    1. Introduction to a Monopoly
    2. 9.1 How Monopolies Form: Barriers to Entry
    3. 9.2 How a Profit-Maximizing Monopoly Chooses Output and Price
    4. Key Terms
    5. Key Concepts and Summary
    6. Self-Check Questions
    7. Review Questions
    8. Critical Thinking Questions
    9. Problems
  11. 10 Monopolistic Competition and Oligopoly
    1. Introduction to Monopolistic Competition and Oligopoly
    2. 10.1 Monopolistic Competition
    3. 10.2 Oligopoly
    4. Key Terms
    5. Key Concepts and Summary
    6. Self-Check Questions
    7. Review Questions
    8. Critical Thinking Questions
    9. Problems
  12. 11 Monopoly and Antitrust Policy
    1. Introduction to Monopoly and Antitrust Policy
    2. 11.1 Corporate Mergers
    3. 11.2 Regulating Anticompetitive Behavior
    4. 11.3 Regulating Natural Monopolies
    5. 11.4 The Great Deregulation Experiment
    6. Key Terms
    7. Key Concepts and Summary
    8. Self-Check Questions
    9. Review Questions
    10. Critical Thinking Questions
    11. Problems
  13. 12 Environmental Protection and Negative Externalities
    1. Introduction to Environmental Protection and Negative Externalities
    2. 12.1 The Economics of Pollution
    3. 12.2 Command-and-Control Regulation
    4. 12.3 Market-Oriented Environmental Tools
    5. 12.4 The Benefits and Costs of U.S. Environmental Laws
    6. 12.5 International Environmental Issues
    7. 12.6 The Tradeoff between Economic Output and Environmental Protection
    8. Key Terms
    9. Key Concepts and Summary
    10. Self-Check Questions
    11. Review Questions
    12. Critical Thinking Questions
    13. Problems
  14. 13 Positive Externalities and Public Goods
    1. Introduction to Positive Externalities and Public Goods
    2. 13.1 Why the Private Sector Underinvests in Innovation
    3. 13.2 How Governments Can Encourage Innovation
    4. 13.3 Public Goods
    5. Key Terms
    6. Key Concepts and Summary
    7. Self-Check Questions
    8. Review Questions
    9. Critical Thinking Questions
    10. Problems
  15. 14 Labor Markets and Income
    1. Introduction to Labor Markets and Income
    2. 14.1 The Theory of Labor Markets
    3. 14.2 Wages and Employment in an Imperfectly Competitive Labor Market
    4. 14.3 Market Power on the Supply Side of Labor Markets: Unions
    5. 14.4 Bilateral Monopoly
    6. 14.5 Employment Discrimination
    7. 14.6 Immigration
    8. Key Terms
    9. Key Concepts and Summary
    10. Self-Check Questions
    11. Review Questions
    12. Critical Thinking Questions
  16. 15 Poverty and Economic Inequality
    1. Introduction to Poverty and Economic Inequality
    2. 15.1 Drawing the Poverty Line
    3. 15.2 The Poverty Trap
    4. 15.3 The Safety Net
    5. 15.4 Income Inequality: Measurement and Causes
    6. 15.5 Government Policies to Reduce Income Inequality
    7. Key Terms
    8. Key Concepts and Summary
    9. Self-Check Questions
    10. Review Questions
    11. Critical Thinking Questions
    12. Problems
  17. 16 Information, Risk, and Insurance
    1. Introduction to Information, Risk, and Insurance
    2. 16.1 The Problem of Imperfect Information and Asymmetric Information
    3. 16.2 Insurance and Imperfect Information
    4. Key Terms
    5. Key Concepts and Summary
    6. Self-Check Questions
    7. Review Questions
    8. Critical Thinking Questions
    9. Problems
  18. 17 Financial Markets
    1. Introduction to Financial Markets
    2. 17.1 How Businesses Raise Financial Capital
    3. 17.2 How Households Supply Financial Capital
    4. 17.3 How to Accumulate Personal Wealth
    5. Key Terms
    6. Key Concepts and Summary
    7. Self-Check Questions
    8. Review Questions
    9. Critical Thinking Questions
    10. Problems
  19. 18 Public Economy
    1. Introduction to Public Economy
    2. 18.1 Voter Participation and Costs of Elections
    3. 18.2 Special Interest Politics
    4. 18.3 Flaws in the Democratic System of Government
    5. Key Terms
    6. Key Concepts and Summary
    7. Self-Check Questions
    8. Review Questions
    9. Critical Thinking Questions
    10. Problems
  20. 19 International Trade
    1. Introduction to International Trade
    2. 19.1 Absolute and Comparative Advantage
    3. 19.2 What Happens When a Country Has an Absolute Advantage in All Goods
    4. 19.3 Intra-industry Trade between Similar Economies
    5. 19.4 The Benefits of Reducing Barriers to International Trade
    6. Key Terms
    7. Key Concepts and Summary
    8. Self-Check Questions
    9. Review Questions
    10. Critical Thinking Questions
    11. Problems
  21. 20 Globalization and Protectionism
    1. Introduction to Globalization and Protectionism
    2. 20.1 Protectionism: An Indirect Subsidy from Consumers to Producers
    3. 20.2 International Trade and Its Effects on Jobs, Wages, and Working Conditions
    4. 20.3 Arguments in Support of Restricting Imports
    5. 20.4 How Governments Enact Trade Policy: Globally, Regionally, and Nationally
    6. 20.5 The Tradeoffs of Trade Policy
    7. Key Terms
    8. Key Concepts and Summary
    9. Self-Check Questions
    10. Review Questions
    11. Critical Thinking Questions
    12. Problems
  22. A | The Use of Mathematics in Principles of Economics
  23. B | Indifference Curves
  24. C | Present Discounted Value
  25. Answer Key
    1. Chapter 1
    2. Chapter 2
    3. Chapter 3
    4. Chapter 4
    5. Chapter 5
    6. Chapter 6
    7. Chapter 7
    8. Chapter 8
    9. Chapter 9
    10. Chapter 10
    11. Chapter 11
    12. Chapter 12
    13. Chapter 13
    14. Chapter 14
    15. Chapter 15
    16. Chapter 16
    17. Chapter 17
    18. Chapter 18
    19. Chapter 19
    20. Chapter 20
  26. References
  27. Index
1.

The rows of the table in the problem do not represent the actual choices available on the budget set; that is, the combinations of round trips and phone minutes that Jeremy can afford with his budget. One of the choices listed in the problem, the six round trips, is not even available on the budget set. If Jeremy has only $10 to spend and a round trip costs $2 and phone calls cost $0.05 per minute, he could spend his entire budget on five round trips but no phone calls or 200 minutes of phone calls, but no round trips or any combination of the two in between. It is easy to see all of his budget options with a little algebra. The equation for a budget line is:

Budget = P RT ×   Q RT   +   P PC   ×   Q PC Budget = P RT ×   Q RT   +   P PC   ×   Q PC

where P and Q are price and quantity of round trips (RT) and phone calls (PC) (per minute). In Jeremy’s case the equation for the budget line is:

$10 = $2  ×  Q RT   +  $.05  ×  Q PC $10 $.05 = $2Q RT   +   $.05Q PC   $.05 200 = 40Q RT   +  Q PC Q PC = 200  -  40Q RT $10 = $2  ×  Q RT   +  $.05  ×  Q PC $10 $.05 = $2Q RT   +   $.05Q PC   $.05 200 = 40Q RT   +  Q PC Q PC = 200  -  40Q RT

If we choose zero through five round trips (column 1), the table below shows how many phone minutes can be afforded with the budget (column 3). The total utility figures are given in the table below.

Round Trips Total Utility for Trips Phone Minutes Total Utility for Minutes Total Utility
0     0 200 1100 1100
1   80 160 1040 1120
2 150 120   900 1050
3 210   80   680   890
4 260   40   380   640
5 300     0       0   300

Adding up total utility for round trips and phone minutes at different points on the budget line gives total utility at each point on the budget line. The highest possible utility is at the combination of one trip and 160 minutes of phone time, with a total utility of 1120.

2.

The first step is to use the total utility figures, shown in the table below, to calculate marginal utility, remembering that marginal utility is equal to the change in total utility divided by the change in trips or minutes.

Round Trips Total Utility Marginal Utility (per trip) Phone Minutes Total Utility Marginal Utility (per minute)
0     0 - 200 1100 -
1   80 80 160 1040   60/40 = 1.5
2 150 70 120 900 140/40 = 3.5
3 210 60   80 680 220/40 = 5.5
4 260 50   40 380 300/40 = 7.5
5 300 40     0     0 380/40 = 9.5

Note that we cannot directly compare marginal utilities, since the units are trips versus phone minutes. We need a common denominator for comparison, which is price. Dividing MU by the price, yields columns 4 and 8 in the table below.

Round Trips Total Utility Marginal Utility (per trip) MU/P Phone Minutes Total Utility Marginal utility (per minute) MU/P
0 0 - - 200 1100 60/40 = 1.5 1.5/$0.05 = 30
1   80 80 80/$2 = 40 160 1040 140/40 = 3.5 3.5/$0.05 = 70
2 150 70 70/$2 = 35 120   900 220/40 = 5.5 5.5/$0.05 = 110
3 210 60 60/$2 = 30   80   680 300/40 =7.5 7.5/$0.05 = 150
4 260 50 50/$2 = 25   40   380 380/40 = 9.5 9.5/$0.05 = 190
5 300 40 40/$2 = 20    0      0 - -

Start at the bottom of the table where the combination of round trips and phone minutes is (5, 0). This starting point is arbitrary, but the numbers in this example work best starting from the bottom. Suppose we consider moving to the next point up. At (4, 40), the marginal utility per dollar spent on a round trip is 25. The marginal utility per dollar spent on phone minutes is 190.

Since 25 < 190, we are getting much more utility per dollar spent on phone minutes, so let’s choose more of those. At (3, 80), MU/PRT is 30 < 150 (the MU/PM), but notice that the difference is narrowing. We keep trading round trips for phone minutes until we get to (1, 160), which is the best we can do. The MU/P comparison is as close as it is going to get (40 vs. 70). Often in the real world, it is not possible to get MU/P exactly equal for both products, so you get as close as you can.

3.

This is the opposite of the example explained in the text. A decrease in price has a substitution effect and an income effect. The substitution effect says that because the product is cheaper relative to other things the consumer purchases, he or she will tend to buy more of the product (and less of the other things). The income effect says that after the price decline, the consumer could purchase the same goods as before, and still have money left over to purchase more. For both reasons, a decrease in price causes an increase in quantity demanded.

4.

This is a negative income effect. Because your parents’ check failed to arrive, your monthly income is less than normal and your budget constraint shifts in toward the origin. If you only buy normal goods, the decrease in your income means you will buy less of every product.

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