《微观经济学》题库章节练习题及答案(英文版).doc

Chapter 1: Preliminaries
PART I
INTRODUCTION:
MARKETS AND PRICES
CHAPTER 1
PRELIMINARIES
TEACHING NOTES
The first two chapters reacquaint students with the microeconomics that they learned in their introductory course: Chapter 1 focuses on the general subject of economics, while Chapter 2 develops supply and demand analysis. The use of examples in Chapter 1 facilitates students’ complete understanding of abstract economic concepts. Examples in this chapter discuss markets for prescription drugs (Section 1.2), introduction of a new automobile (Section 1.4), design of automobile emission standards (Section 1.4), the minimum wage (Section 1.3), the market for sweeteners (Section 1.3), and real and nominal prices of eggs and education (Section 1.3). Discussing some of these, or another, example is a useful way to review some important economic concepts such as scarcity, making tradeoffs, building economic models to explain how consumers and firms make decisions, and the distinction between competitive and non-competitive markets. Parts I and II of the text assume competitive markets, market power is discussed in Part III, and some consequences of market power are discussed in Part IV of the text.
Review Question (2) illustrates the difference between positive and normative economics and provides for a productive class discussion. Other examples for discussion are available in Kearl, Pope, Whiting, and Wimmer, “A Confusion of Economists,” American Economic Review (May 1979).
The chapter concludes with a discussion of real and nominal prices. Given our reliance on dollar prices in the chapters that follow, students should understand that we are concerned with prices relative to a standard, which in this case is dollars for a particular year.
QUESTIONS FOR REVIEW
1. It is often said that a good theory is one that can be refuted by an empirical, data-oriented study. Explain why a theory that cannot be evaluated empirically is not a good theory.
There are two steps to consider when evaluating a theory: first, you should examine the reasonability of the theory’s assumptions; second, you should test the theory’s predictions by comparing them with facts. If a theory cannot be tested, it cannot be accepted or rejected. Therefore, it contributes little to our understanding of reality.
2. Which of the following two statements involves positive economic analysis and which normative? How do the two kinds of analysis differ?
a. Gasoline rationing (allocating to each individual a maximum amount of gasoline that can be purchased each year) is a poor social policy because it interferes with the workings of the competitive market system.
Positive economic analysis describes what is. Normative economic analysis describes what ought to be. Statement (a) merges both types of analysis. First, statement (a) makes a positive statement that gasoline rationing “interferes with the workings of the competitive market system.” We know from economic analysis that a constraint placed on supply will change the market equilibrium. Second, statement (a) makes the normative statement (i.e., a value judgment) that gasoline rationing is a “poor social policy.” Thus, statement (a) makes a normative comment based on a conclusion derived from positive economic analysis of the policy.

b. Gasoline rationing is a policy under which more people are made worse off than are made better off.
Statement (b) is positive because it states what the effect of gasoline rationing is without making a value judgment about the desirability of the rationing policy.
3. Suppose the price of unleaded regular octane gasoline were 20 cents per gallon higher in New Jersey than in Oklahoma. Do you think there would be an opportunity for arbitrage (i.e., that firms could buy gas in Oklahoma and then sell it at a profit in New Jersey)? Why or why not?
Oklahoma and New Jersey represent separate geographic markets for gasoline because of high transportation costs. If transportation costs were zero, a price increase in New Jersey would prompt arbitrageurs to buy gasoline in Oklahoma and sell it in New Jersey. It is unlikely in this case that the 20 cents per gallon difference in costs would be high enough to create a profitable opportunity for arbitrage, given both transactions costs and transportation costs.
4. In Example 1.3, what economic forces explain why the real price of eggs has fallen while the real price of a college education has increased? How have these changes affected consumer choices?
The price and quantity of goods (e.g., eggs) and services (e.g., a college education) are determined by the interaction of supply and demand. The real price of eggs fell from 1970 to 1985 because of either a reduction in demand (consumers switched to lower-cholesterol food), a reduction in production costs (improvements in egg production technology), or both. In response, the price of eggs relative to other foods decreased. The real price of a college education rose because of either an increase in demand (e.g., more people recognized the value of an education), an increase in the cost of education (e.g., increase in staff salaries), or both.
5. Suppose that the Japanese yen rises against the U.S. dollar- that is, it will take more dollars to buy any given amount of Japanese yen. Explain why this increase simultaneously increases the real price of Japanese cars for U.S. consumers and lowers the real price of U.S. automobiles for Japanese consumers.
As the value of the yen grows relative to the dollar, more dollars exchange for fewer yen. Assume that the costs of production for both Japanese and U.S. automobiles remain unchanged. Then using the new exchange rate, the purchase of a Japanese automobile priced in yen requires more dollars. Similarly, the purchase of a U.S. automobile priced in dollars requires fewer yen.
6. The price of long-distance telephone service fell from 40 cents per minute in 1996 to 22 cents per minute in 1999, a 45-percent (18 cents/40 cents) decrease. The Consumer Price Index increased by 10-percent over this period. What happened to the real price of telephone service?
Let the CPI for 1996 equal 1 and the CPI for 1999 equal 1.1, which reflects a 10% increase in the overall price level. To find the real price of telephone service in each period, divide the nominal price by the CPI for that year. For 1996, we have 40/1 or 40 cents, and for 1999, we have 22/1.1 or 20 cents. The real price therefore fell from 40 to 20 cents, a 50% decline.

EXERCISES

1. Decide whether each of the following statements is true or false and explain why:
a. Fast food chains like McDonald’s, Burger King, and Wendy’s operate all over the United States. Therefore the market for fast food is a national market.
This statement is false. People generally buy fast food within their current location and do not travel large distances across the United States just to buy a cheaper fast food meal. Given there is little potential for arbitrage between fast food restaurants that are located some distance from each other, there are likely to be multiple fast food markets across the country.
b. People generally buy clothing in the city in which they live. Therefore there is a clothing market in, say, Atlanta that is distinct from the clothing market in Los Angeles.
This statement is false. Although consumers are unlikely to travel across the country to buy clothing, suppliers can easily move clothing from one part of the country to another. Thus, if clothing is more expensive in Atlanta than Los Angeles, clothing companies could shift supplies to Atlanta, which would reduce the price in Atlanta. Occasionally, there may be a market for a specific clothing item in a faraway market that results in a great opportunity for arbitrage, such as the market for blue jeans in the old Soviet Union.
c. Some consumers strongly prefer Pepsi and some strongly prefer Coke. Therefore there is no single market for colas.
This statement is false. Although some people have strong preferences for a particular brand of cola, the different brands are similar enough that they constitute one market. There are consumers who do not have strong preferences for one type of cola, and there are consumers who may have a preference, but who will also be influenced by price. Given these possibilities, the price of cola drinks will not tend to differ by very much, particularly for Coke and Pepsi.
2. The following table shows the average retail price of butter and the Consumer Price Index from 1980 to 2001.
ˇ
1980
1985
1990
1995
2000
2001

CPI
100
130.58
158.62
184.95
208.98
214.93
Retail Price of butter
$1.88
$2.12
$1.99
$1.61
$2.52
$3.30
(salted, grade AA, per lb.)

a. Calculate the real price of butter in 1980 dollars. Has the real price increased/decreased/stayed the same since 1980?
Real price of butter in year X = .
1980 1985 1990 1995 2000 2001
$1.88 $1.62 $1.25 $0.87 $1.21 $1.54
Since 1980 the real price of butter has decreased.

b. What is the percentage change in the real price (1980 dollars) from 1980 to 2001?
Percentage change in real price from 1980 to 2001 = .
c. Convert the CPI into 1990 = 100 and determine the real price of butter in 1990 dollars.
To convert the CPI into 1990=100, divide the CPI for each year by the CPI for 1990. Use the formula from part (a) and the new CPI numbers below to find the real price of milk.

New CPI 1980 63.1 Real price of milk 1980 $2.98
1985 82.3 1985 $2.58
1990 100 1990 $1.99
1995 116.6 1995 $1.38
2000 131.8 2000 $1.91
2001 135.6 2001 $2.43
d. What is the percentage change in the real price (1990 dollars) from 1980 to 2001? Compare this with your answer in (b). What do you notice? Explain.
Percentage change in real price from 1980 to 2001 = . This answer is almost identical (except for rounding error) to the answer received for part b. It does not matter which year is chosen as the base year.
3. At the time this book went to print, the minimum wage was $5.15. To find the current minimum wage, go to http://www.bls.gov/cpi/home.htm
Click on: Consumer Price Index- All Urban Consumers (Current Series)
Select: U.S. All items
This will give you the CPI from 1913 to the present.
a. With these values, calculate the current real minimum wage in 1990 dollars.
real minimum wage 2003 = .
b. What is the percentage change in the real minimum wage from 1985 to the present, stated in real 1990 dollars?
Assume the minimum wage in 1985 was $3.35. Then,
real minimum wage 1985 = .
The percentage change in the real minimum wage is therefore

CHAPTER 3
CONSUMER BEHAVIOR
TEACHING NOTES
Chapter 3 builds the foundation to derive the demand curve in Chapter 4. In order to understand demand theory, students must have a firm grasp of indifference curves, the marginal rate of substitution, the budget line, and optimal consumer choice. Utility theory may be discussed independently from consumer choice. Many students find utility functions to be a more abstract concept than preference relationships. However, if you plan to discuss uncertainty in Chapter 5, you will need to cover marginal utility. Even if you cover utility theory only briefly, make sure students are comfortable with the term utility because it appears frequently in Chapter 4.
When introducing indifference curves, stress that physical quantities are represented on the two axes. After discussing supply and demand, students may think that price should be on the vertical axis. To develop indifference curves, start with any point in the Cartesian plane and ask for points that are more (and less) preferred. This will divide the plane into four quadrants. Then ask between which points they will be indifferent. Once students grasp the concept of preference points, introduce the notion of a “preference hill.” Using the example of a topographical map or a well-drawn three dimensional figure, point out that a three-dimensional figure is being collapsed into two dimensions.
The marginal rate of substitution, MRS, is confusing to students. Some confuse the MRS with the ratio of the two quantities. If this is the case, point out that the slope is equal to the ratio of the rise, DY, and the run, DX. This ratio is equal to the ratio of the intercepts of a line just tangent to the indifference curve. As we move along a convex indifference curve, these intercepts and the MRS change. Another problem is the terminology “of X for Y.” This is confusing because we are not substituting “X for Y,” but Y for one unit of X. Exercise (6) discusses this point, but you may want to offer other exercises to stress it.
REVIEW QUESTIONS
1. What does transitivity of preferences mean?
Transitivity of preferences implies that if someone prefers A to B and prefers B to C, then he or she prefers A to C.
2. Suppose that a set of indifference curves was not negatively sloped. What could you say about the desirability of the two goods?
One major assumption of preference theory is that more is preferred to less. Thus, we can expect that consumers will experience a lower level of satisfaction if we take some of a good away from them. From this, we necessarily derive negatively sloped indifference curves. However, if one good is undesirable, then less of the undesirable good leaves the consumer better off, e.g., less toxic waste is preferred to more toxic waste. When one good is undesirable, the indifference curves showing the trade-off between that good and a desired good have positive slopes. In Figure 3.2 below, the indifference curve U2 is preferred to the indifference curve U1.

Figure 3.2
3. Explain why two indifference curves cannot intersect.
The explanation is most easily achieved with the aid of a graph such as Figure 3.3, which shows two indifference curves intersecting at point A. We know from the definition of an indifference curve that a consumer has the same level of utility along any given curve. In this case, the consumer is indifferent between bundles A and B because they both lie on indifference curve U1. Similarly, the consumer is indifferent between bundles A and C because they both lie on indifference curve U2. By the transitivity of preferences this consumer should also be indifferent between C and B. However, we see from the graph that C lies above B, so C must be preferred to B. Thus, the fact that indifference curves cannot intersect is proven.

Figure 3.3
4. Draw a set of indifference curves for which the marginal rate of substitution is constant. Draw two budget lines with different slopes; show what the satisfaction-maximizing choice will be in each case. What conclusions can you draw?
In Figure 3.4, Good X and Good Y are perfect substitutes and, thus, the indifference curves are