Answers to Exercises

1. All points on a PPC are technically efficient. Economic efficiency says that one person cannot be made better off without harming someone else. The point on the PPC chosen by the demands and supplies of individuals in a society would be a point of economic efficiency. A move from this point to another would make some people better off but would hurt others.

2. An externality refers to some costs or benefits that are not taken into account by the direct participants in a market transaction. Since they are not taken into account, the market is unable to determine the appropriate price and to allocate the externality among market participants. This is called a market failure. Each additional car on a highway causes some marginal increase in congestion and thus delays travel. This is a cost imposed by each car on all other drivers. Each additional car on a highway also raises the risk of accidents. This is a cost imposed by each car on all other drivers. These costs are externalities because you, the driver, do not have to take into account the additional costs you impose on others. One way the externality could be resolved is to use the available technology to impose a price on drivers depending on where they enter the highway, the time they enter the highway, and the distance traveled on the highway. A simple laser or radar machine could read a meter on the window or license plate and send the owner of the automobile a bill each month.

3. Radio broadcasts are public goods. Everyone who tunes in a station enjoys the benefits. A CD, however, is not a public good. If you pay for it, only you get to enjoy the benefits. Thus you have an incentive to purchase the CD. You don't have that incentive to purchase public goods. If you and I both benefit from the public good, who will buy it? I'd prefer that you buy it so that I receive its benefits at no cost. Conversely, you'd prefer that I buy it. The result may be that no one will buy it.

4. When goods are commonly owned, people have no incentive to save some of the goods for future use. If the buffalo had been owned by a rancher, then the rancher would have allowed the harvest of only the number that would provide him or her the greatest value over the years. Total destruction of the entire supply of buffaloes in a few years would not match the value to the rancher of a controlled harvest ensuring the supply of animals over the years.

5. Federal Reserve for a and b. Congress and the president for c, d, and e.

6. This is a microeconomic policy, known as antitrust. It is an attempt to ensure that markets are as competitive as possible.

7. A quota on imports means that fewer foreign-made goods will be purchased by U.S. consumers. As a result, U.S. consumers will need to purchase U.S.-made goods. The flow of dollars from the consumer or household sector will increase revenue to the business firms and induce them to hire more workers and use more of other resources. This will lead to an increase in the pay for the services or resources and thus to an increase in incomes. People working with and for the imported goods the quota was imposed on will be hurt. Consumers who purchased the imported goods will be hurt. The beneficiaries of the quota will be those workers and firms producing substitute products. The government might become involved in the economy through the imposition of quotas as a result of rent-seeking behavior by those who stand to benefit from the quotas.

8. Congestion and excessive driving are problems caused by "free" ways. One way to solve the problems is to impose tolls based on use of the "free" ways.

9. a. Part of the purchase price of any product is the explicit or implicit guarantee and the chance that the guarantee will not be supported. If there was no chance that any claim by a company would not be made good, that is, if the government would support any claim made by a company, then prices would have to be significantly higher or taxes would have to be significantly higher. The failure of a company to follow through with a promise is not a market failure requiring the support of the government. It is instead an unfortunate circumstance where the product purchased is not exactly the product consumers expected. You pay a lot more for a piece of jewelry in a jewelry store than you do for a piece of jewelry purchased on a street corner. This is mainly because of the implicit guarantee the jewelry store provides by being a store, having to pay rent, and so on, as compared to the corner salesman, who can pick up and disappear at the drop of a hat.
b. There are two sides to this story. If the cost of resources is much less in Korea than in the United States, then it is entirely possible the Korean microchips can be sold for less than it costs to produce them in the United States. According to comparative advantage, the chips ought to be produced in Korea. If, however, Korean costs are the same as costs in the United States, then Koreans are selling at below cost in order to damage the U.S. manufacturers. This type of policy often requires government action simply because the firms selling the chips, in this case the Korean firms, are being subsidized by their government.
c. Since 1946 it has been the responsibility of the federal government to ensure full employment and price stability. Macroeconomic policies are supposed to be used to increase employment. Fiscal policy is aimed at increasing the growth of jobs and monetary policy at reducing the interest rate. Whether the government should directly provide jobs or should do everything it can to ensure that the private sector creates jobs is a question of debate.
d. Health care is one of the most controversial issues in the United States. If the lack of health care is a market failure, then the government has a microeconomic role. If it is not a market failure, then government intervention will reduce economic efficiency; someone or some group will be hurt while some other group benefits.
e. The stronger dollar has made the foreign exchange price of U.S.-produced goods and services more expensive. However there is little the government can do to correct this because of the large volume of transactions taking place on foreign exchange markets (over a trillion dollars worth per day).
f. Although all sectors in society experienced rising incomes during the 1990s, the richest sector experienced the most rapidly rising incomes. If society decides that a more equal distribution of income is desirable, then higher taxes on the rich and lower taxes on the lower income levels will contribute.
g. Patents confer monopoly status on those acquiring them. Pharmaceutical companies are devoting enormous amounts of money to research and development in an attempt to discover drugs that help cure AIDS. Their incentive to spend these enormous amounts of money is the monopoly status their discoveries will acquire through patents.

10. Private property means that private citizens own resources and make the decisions about whether and how much of these resources to supply. Without a system of private property rights, individuals gain no income from their resources. They have no incentive to provide either high-quality resources or the required amounts of their resources.

11. Money flowing out of the household sector to government rises. The money must be made up somewhere. The household sector reduces spending and saving. Money flowing from the household sector to the business sector declines (fewer goods and services purchased) and money flowing from the household sector to financial institutions declines.

12. The difference between the money flowing out from the government and the money flowing in to the government must be made up somewhere. The way that it is made up is for the government to borrow from the private sector. Thus, another flow of dollars from the financial intermediaries to the government would have to be drawn. This would show that the more the government borrows, the less is available to firms.

13. You would argue that the government growth is the result of rent seeking.

14. If the externalities of smoking are a market failure, then some means to ensure that market participants take into account the externalities is implied. A smoking ban may not be the best way to solve the problem. See question 15.

15. If smokers and nonsmokers could solve the problem of smoking through the private market, there would be no need for government action. Because the business owners hold the property right to the air in their establishments, and because the owners want to maximize their incomes, the owners will be willing to do what their customers are willing to pay for. If customers want nonsmoking environments and are willing to pay for them, then the owners will surely provide them. Suppose that the business owners tell smokers that they own the rights to the air. Then nonsmokers would have to pay the smokers not to smoke or would have to frequent nonsmoking establishments. Conversely, if the business owners tell nonsmokers that they own the air, then smokers would have to pay the nonsmokers to be able to smoke. The government ban forces the transfer of ownership to the nonsmokers and allows neither party to negotiate with the other.

Answers to Study Guide Homework

1. Providing public goods, correcting externalities, and promoting competition

2. Fiscal policy includes government spending and taxes, determined in the U. S. by the president and Congress

3. Monetary policy includes control on money and credit, determined in the U. S. by the Federal Reserve

4. There is no practical way for the lighthouse's builder to collect money from the people who benefit: the ships that do not have accidents.

5. Transferable pollution permits, like the transferable fishing permits, would not only limit the amount of pollution but would also encourage economic efficiency by establishing a price for pollution, and by encouraging only efficient investment in pollution control.

Answers to Internet Exercise

Most students will have encountered information via media regarding the federal budget deficit and are therefore somewhat familiar with the concept. This exercise will allow them to access current information regarding both the federal and state and local budgets and determine any current trends in revenues and expenditures.

Students will graph information for the latest quarters available. Below are deficits (-) and surpluses (in billions) for the last quarter of 1996 and the four quarters of 1997.

1. Deficit

Surplus

The federal budget deficit is dropping and the state and local surplus seems to be growing.