ch01 - Chapter 1 Analyzing Economic Problems Solutions to...

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Chapter 1 Analyzing Economic Problems Solutions to Review Questions 1. 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. 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. 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. 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 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. Page 1 - 1
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5. 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. 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
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This note was uploaded on 09/24/2008 for the course PAM 2000 taught by Professor Evans,t. during the Fall '07 term at Cornell.

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ch01 - Chapter 1 Analyzing Economic Problems Solutions to...

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