Besanko & Braeutigam – Microeconomics, 5th edition Solutions Manual
Chapter 1
Analyzing Economic Problems
Solutions to Review Questions
1. What is the difference between microeconomics and macroeconomics?
Microeconomics studies the economic behavior of individual economic decision makers, such as
a consumer, a worker, a firm, or a manager. Macroeconomics studies how an entire national
economy performs, examining such topics as the aggregate levels of income and employment,
the levels of interest rates and prices, the rate of inflation, and the nature of business cycles.
2. Why is economics often described as the science of constrained choice?
While our wants for goods and services are unlimited, the resources necessary to produce those
goods and services, such as labor, managerial talent, capital, and raw materials, are “scarce”
because their supply is limited. This scarcity implies that we are constrained in the choices we
can make about which goods and services to produce. Thus, economics is often described as the
science of constrained choice.
3. How does the tool of constrained optimization help decision makers make choices?
What roles do the objective function and constraints play in a model of constrained
optimization?
Constrained optimization allows the decision maker to select the best (optimal) alternative while
accounting for any possible limitations or restrictions on the choices. The objective function
represents the relationship to be maximized or minimized. For example, a firm’s profit might be
the objective function and all choices will be evaluated in the profit function to determine which
yields the highest profit. The constraints place limitations on the choice the decision maker can
select and defines the set of alternatives from which the best will be chosen.
4. Suppose the market for wheat is competitive, with an upward-sloping supply curve,
a downward-sloping demand curve, and an equilibrium price of $4.00 per bushel. Why
would a higher price (e.g., $5.00 per bushel) not be an equilibrium price? Why would a
lower price (e.g., $2.50 per bushel) not be an equilibrium price?
If the price in the market was above the equilibrium price, consumers would be willing to
purchase fewer units than suppliers would be willing to sell, creating an excess supply. As
suppliers realize they are not selling the units they have made available, sellers will bid down the
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 1
,Besanko & Braeutigam – Microeconomics, 5th edition Solutions Manual
price to entice more consumers to purchase their goods or services. By definition, equilibrium is
a state that will remain unchanged as long as exogenous factors remain unchanged. Since in this
case suppliers will lower their price, this high price cannot be an equilibrium.
When the price is below the equilibrium price, consumers will demand more units than suppliers
have made available. This excess demand will entice consumers to bid up the prices to purchase
the limited units available. Since the price will change, it cannot be an equilibrium.
5. What is the difference between an exogenous variable and an endogenous variable
in an economic model? Would it ever be useful to construct a model that contained only
exogenous variables (and no endogenous variables)?
Exogenous variables are taken as given in an economic model, i.e., they are determined by some
process outside the model, while endogenous variables are determined within the economic
model being studied.
An economic model that contained no endogenous variables would not be very interesting. With
no endogenous variables, nothing would be determined by the model so it would not serve much
purpose.
6. Why do economists do comparative statics analysis? What role do endogenous
variables and exogenous variables play in comparative statics analysis?
Comparative statics analyses are performed to determine how the levels of endogenous variables
change as some exogenous variable is changed. This type of analysis is very important since in
the real world the exogenous variables, such as weather, policy tools, etc. are always changing
and it is useful to know how changes in these variables affect the levels of other, endogenous,
variables. An example of comparative statics analysis would be asking the question: If
extraordinarily low rainfall (an exogenous variable) causes a 30 percent reduction in corn supply,
by how much will the market price for corn (an endogenous variable) increase?
7. What is the difference between positive and normative analysis? Which of the
following questions would entail positive analysis, and which normative analysis?
a) What effect will Internet auction companies have on the profits of local automobile
dealerships?
b) Should the government impose special taxes on sales of merchandise made over the
Internet?
Positive analysis attempts to explain how an economic system works or to predict how it will
change over time by asking explanatory or predictive questions. Normative analysis focuses on
what should be done by asking prescriptive questions.
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 2
,Besanko & Braeutigam – Microeconomics, 5th edition Solutions Manual
a) Because this question asks whether dealership profits will go up or down (and by
how much) – but refrains from inquiring as to whether this would be a good thing
– it is an example of positive analysis.
b) On the other hand, this question asks whether it is desirable to impose taxes on
Internet sales, so it is normative analysis. Notably, this question does not ask
what the effect of such taxes would be.
Solutions to Problems
1.1 Discuss the following statement: “Since supply and demand curves are always
shifting, markets never actually reach an equilibrium. Therefore, the concept of
equilibrium is useless.”
While the claim that markets never reach an equilibrium is probably debatable, even if markets
do not ever reach equilibrium, the concept is still of central importance. The concept of
equilibrium is important because it provides a simple way to predict how market prices and
quantities will change as exogenous variables change. Thus, while we may never reach a
particular equilibrium price, say because a supply or demand schedule shifts as the market moves
toward equilibrium, we can predict with relative ease, for example, whether prices will be rising
or falling when exogenous market factors change as we move toward equilibrium. As
exogenous variables continue to change, we can continue to predict the direction of change for
the endogenous variables, and this is not “useless.”
1.2 In an article entitled, “Corn Prices Surge on Export Demand, Crop Data,” The Wall
Street Journal identified several exogenous shocks that pushed U.S. corn prices sharply
higher.(See the article by Aaron Lucchetti, August 22, 1997, p. C17. on national income.) Suppose the U.S.
market for corn is competitive, with an upward-sloping supply curve and a downward-
sloping demand curve. For each of the following scenarios, illustrate graphically how the
exogenous event described will contribute to a higher price of corn in the U.S. market.
a) The U.S. Department of Agriculture announces that exports of corn to Taiwan and
Japan were “surprisingly bullish,” around 30 percent higher than had been expected.
b) Some analysts project that the size of the U.S. corn crop will hit a six-year low because of
dry weather.
c) The strengthening of El Niño, the meteorological trend that brings warmer weather to
the western coast of South America, reduces corn production outside the United States,
thereby increasing foreign countries’ dependence on the U.S. corn crop.
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 3
,Besanko & Braeutigam – Microeconomics, 5th edition Solutions Manual
a) Surprisingly high export sales mean that the demand for corn was higher than
expected, at D2 rather than D1.
P
S
P2
P1
D2
D1
Q
b) Dry weather would reduce the supply of corn, to S2 rather than S1.
S2
P
S1
P2
P1
D
Q
c) Assuming the U.S. does not import corn, reduced production outside the U.S.
would not impact U.S. corn market supply. El Nino would, however, cause
demand for U.S. corn to shift out, the figure being the same as in part (a) above.
1.3 In early 2008, the price of oil on the world market increased, hitting a peak of about
$140 per barrel in July, 2008. In the second half of 2008, the price of oil declined, ending
the year at just over $40 per barrel. Suppose that the global market for oil can be described
by an upward-sloping supply curve and a downward-sloping demand curve. For each of
the following scenarios, illustrate graphically how the exogenous event contributed to a rise
or a decline in the price of oil in 2008:
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 4
, Besanko & Braeutigam – Microeconomics, 5th edition Solutions Manual
a. A booming economy in China raised the global demand for oil to record levels in
2008.
b. As a result of the financial crisis of 2008, the U.S. and other developed economies
plunged into a severe recession in the latter half of 2008.
c. Reduced sectarian violence in Iraq in 2008 enabled Iraq to increase its oil
production capacity.
a. Booming economy in China shifts the demand curve for oil rightward (from D 0 to
D1 below), contributing to an increase in the price of oil.
b. Recession in the U.S. and other developed economies shifts the demand curve for
oil leftward (from D0 to D1 below), contributing to a decrease in the price of oil.
c. Increase in oil production capacity in Iraq shifts the supply for oil rightward (from
S0 to S1 below), contributing to a decrease in the price of oil.
Price Booming economy in China
S0
D1
D0
Quantity
Price Recession in the U.S.
S0
D0
D1
Quantity
Price More oil production capacity in Iraq
S0
S1
D0
Quantity
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 5
, Besanko & Braeutigam – Microeconomics, 5th edition Solutions Manual
1.4 A firm produces cellular telephone service using equipment and labor. When it uses
E machine-hours of equipment and hires L person-hours of labor, it can provide up to Q
units of telephone service. The relationship between Q, E, and L is as follows: Q = EL .
The firm must always pay PE for each machine-hour of equipment it uses and PL for each
person-hour of labor it hires. Suppose the production manager is told to produce Q = 200
units of telephone service and that she wants to choose E and L to minimize costs while
achieving that production target.
a) What is the objective function for this problem?
b) What is the constraint?
c) Which of the variables (Q, E, L, PE, and PL) are exogenous? Which are
endogenous? Explain.
d) Write a statement of the constrained optimization problem.
a) The production manager wants to minimize total costs TC = PE*E + PL*L.
b) The constraint is to produce Q = 200 units, so the manager must choose E and L
so that EL = 200.
c) The endogenous variables are E and L, because those are the variables over which
the production manager has control. By contrast, the exogenous variables are Q,
PE, and PL because the production manager has no control over their values and
must take them as given.
d) Student answers will vary.
1.5 The supply of aluminum in the United States depends on the price of aluminum and
the average price of electricity (a critical input in the production of aluminum). Assume
that an increase in the price of electricity shifts the supply curve for aluminum to the left
(i.e., a higher average price of electricity decreases the supply of aluminum). The demand
for aluminum in the United States depends on the price of aluminum and income shifts the
demand curve for aluminum to the right (i.e., higher income increases the demand for
aluminum). In 2004, national income in the United States increased, while the price of
electricity fell, as compared to 2003. How would the equilibrium price of aluminum in 2004
compare to the equilibrium price in 2003? How would the equilibrium quantity in 2004
compare to the equilibrium quantity in 2003?
In 2003, the initial equilibrium is at price P1 and quantity Q1. As national income
increased, demand for aluminum shifted to the right. The fall in the price of electricity
shifted the supply curve to the right, from S1 to S2. Both shifts have the effect of
increasing the equilibrium quantity, from Q1 to Q2. However, it is unclear whether price
Copyright © 2014 John Wiley & Sons, Inc. Chapter 1 - 6
