Solution Manual for Economics 5th Edition By Paul
Krugman, Robin Wells. A+
CHAPTER 1
1. Explain how each of the twelve principles of economics is illustrated in this case.
Suggested Solution
1. Principle 1: People must make choices because resources are scarce. Neither money nor time is unlimited; they are both scarce
resources. Priceline caters to customers who have chosen to sacrifice some of their preferences about convenience or quality in
order to get a lower price.
Principle 2: The opportunity cost of an item—what you must give up in order to get it—is its true cost. The true cost of an empty
airplane seat or an empty hotel bed is the revenue the airline or hotel could have earned from the next best use of that seat or
bed—namely, the revenue earned from a paying customer.
Principle 3: “How much” is a decision at the margin. How much more a customer is willing to pay for a ticket to a destination
depends upon how much time and inconvenience is saved by purchasing the higher priced ticket.
Likewise, how much more a customer is willing to pay for a ticket purchased well in advance of his travel date depends upo
how much more security he gains by advance planning rather than waiting to purchase. The same principle applies to decision
about the qual- ity and location of hotels, and so on.
Principle 4: People usually respond to incentives, exploiting opportunities to make themselves better off. Priceline was successful
because its customers—
travelers, airlines, and hotels—were exploiting opportu- nities to make themselves better off by using its services. Priceline also
responded to incentives to make itself bet- ter off by expanding into new profitable markets such as Europe.
Principle 5: There are gains from trade. Travelers gain from using Priceline’s networks of hotels to find a hotel rather than
doing the research themselves. They gain from using Priceline’s services to book a flight rather than contacting each airline
individually. Also, travelers gain by using the services of airlines and hotels, rather than transporting themselves or pitch- ing
a tent overnight to sleep in. Hotels, particularly
in Europe, gain from using Priceline’s network rather than trying to contact potential customers directly.
, Principle 6: Because people respond to incentives, markets move toward equilibrium. Expedia and Orbitz moved into the online
travel service industry in order to exploit opportunities that had been pioneered by Priceline. In this way, the market for online
travel services will move toward equilibrium until there
are no more opportunities for new travel service companies to exploit.
Suggested Solutions for Business
Principle 7: Resources should be used efficiently to achieve society’s goals. Priceline exploited
Case Questions for Thought
an opportunity to use resources more efficiently. It is inefficient to have empty hotel rooms and airline seats if someone is willing to
pay some price to use them on short notice.
Principle 8: Because people usually exploit gains from trade, markets usually lead to efficiency. It is ineffi- cient to have planes
flying with empty seats and hotels with unoccupied beds. Thus, introducing a market for those items—which is what Priceline
did—improves efficiency.
Principle 9: When markets don’t achieve efficiency, government intervention can improve society’s welfare. It would have been
inefficient to have major airlines fail because of the public’s temporary fear of flying.
Vast resources would have been wasted as pilots and support staff lost their jobs, planes were mothballed, necessary trips
cancelled, and so on. It improved effi- ciency for the government to step in and temporarily aid the airline industry so that it could
survive the temporary downturn.
Principle 10: One person’s spending is another person’s income. In the aftermath of the attacks of September 2001, as people
stopped spending on items like travel, the income of airline workers was severely reduced.
Principle 11: Overall spending sometimes gets out of line with the economy’s productive capacity. The
overall economy went into a slump after the attacks of September 2001 as the economy’s productive capacity exceeded its spending.
Principle 12: Government policies can change spend- ing. The $15 billion aid appropriation by Congress was spent on stabilizing the
airline industry and prevented major airline failures.
CHAPTER 2
1. What is the opportunity cost associated with having a worker wander across the factory floor from task to task or in search of
tools and parts?
BCS-1
,BCS-2 S U G G E S T E D S O L U T I O N S F O R B U S IN E S S C A S E Q U E S T I O N S F O R T H O U G H T
Suggested Solution
1. The opportunity cost of a worker wandering across the factory floor is forgone output—the output that worker could have produced in
time spent wandering around.
2. Explain how lean manufacturing improves the econo- my’s efficiency in allocation.
Suggested Solution
2. Lean production (also known as lean manufactur- ing) improves the economy’s efficiency in allocation because, for example, an
automaker can more quickly switch to producing more of the types of cars that more consumers want and fewer of the types of c a
that fewer consumers want.
3. Before lean manufacturing innovations, Japan mostly sold consumer electronics to the United States. How did lean manufacturing
innovations alter Japan’s com- parative advantage vis-à-vis the United States?
Suggested Solution
3. Before the innovations in lean production, Japan had a comparative advantage vis-à-vis the United States in consumer electronics.
After the innovations, Japan’s comparative advantage vis-à-vis the United States shifted to auto production.
4. How do you think the shift in the location of Toyota’s production from Japan to the United States has altered the pattern of comparativ
advantage in automaking between the two countries?
Suggested Solution
4. The shift in the location of Toyota’s production from Japan to the United States means that it is likely that Japan will no longer have a
clear comparative advan- tage in automaking vis-à-vis the United States.
CHAPTER 3
1. What accounts for the fact that before Uber’s arrival, there were typically enough taxis available for every- one who wanted one on goo
weather days, but not enough available on bad weather days?
Suggested Solution
1. Before Uber’s arrival fares were set by city regulators. If everyone who wanted a taxi during good weather could get one, then we can
imply that the price set by regulators was approximately equal to the market- clearing price on good weather days. But bad weather, li
a snowstorm, produces two changes to supply and demand: an increase in demand (a rightward
, shift of the demand curve) as more people want rides, and a decrease in supply as more taxi drivers want
to stay warm and dry at home (a leftward shift of the supply curve). As a result of these two shifts, the market-clearing
price rises. But because the actual price was set by regulators and could not increase in the pre-Uber days, a shortage of
taxis arose.
2. How does Uber’s surge pricing solve the problem? Assess Kalanick’s claim that the price is set to leave as few people possible
without a ride.
Suggested Solution
2. Uber’s surge pricing solves this problem because it allows drivers to charge higher prices until supply equals demand. The
higher price increases the quan- tity of rides supplied while reducing the quantity of rides demanded until market
equilibrium is achieved. Kalanick’s claim is true: at any price lower than the equilibrium price there is a shortage of
taxis—more people want rides than are available.
3. Use a supply and demand diagram to illustrate how Uber drivers can cause prices to surge by taking coor- dinated breaks.
Why is this strategy unlikely to work in New York, a large city with an established fleet of taxis?
Suggested Solution
3. By taking coordinated breaks, Uber drivers in San Diego reduce the quantity supplied at every price. That is, they shift the
supply curve leftward. As a result, more riders want rides than are available, and surge pricing kicks in. This is unlikely to
work in a large city with an established fleet of cars like New York City. First, because it would be too difficult to coordinate
a large enough group of Uber drivers to affect the price. And second, taxi drivers would take the fares when Uber drivers
took breaks, preventing a surge in the Uber price.
S
E2
P2
E1
P1
Krugman, Robin Wells. A+
CHAPTER 1
1. Explain how each of the twelve principles of economics is illustrated in this case.
Suggested Solution
1. Principle 1: People must make choices because resources are scarce. Neither money nor time is unlimited; they are both scarce
resources. Priceline caters to customers who have chosen to sacrifice some of their preferences about convenience or quality in
order to get a lower price.
Principle 2: The opportunity cost of an item—what you must give up in order to get it—is its true cost. The true cost of an empty
airplane seat or an empty hotel bed is the revenue the airline or hotel could have earned from the next best use of that seat or
bed—namely, the revenue earned from a paying customer.
Principle 3: “How much” is a decision at the margin. How much more a customer is willing to pay for a ticket to a destination
depends upon how much time and inconvenience is saved by purchasing the higher priced ticket.
Likewise, how much more a customer is willing to pay for a ticket purchased well in advance of his travel date depends upo
how much more security he gains by advance planning rather than waiting to purchase. The same principle applies to decision
about the qual- ity and location of hotels, and so on.
Principle 4: People usually respond to incentives, exploiting opportunities to make themselves better off. Priceline was successful
because its customers—
travelers, airlines, and hotels—were exploiting opportu- nities to make themselves better off by using its services. Priceline also
responded to incentives to make itself bet- ter off by expanding into new profitable markets such as Europe.
Principle 5: There are gains from trade. Travelers gain from using Priceline’s networks of hotels to find a hotel rather than
doing the research themselves. They gain from using Priceline’s services to book a flight rather than contacting each airline
individually. Also, travelers gain by using the services of airlines and hotels, rather than transporting themselves or pitch- ing
a tent overnight to sleep in. Hotels, particularly
in Europe, gain from using Priceline’s network rather than trying to contact potential customers directly.
, Principle 6: Because people respond to incentives, markets move toward equilibrium. Expedia and Orbitz moved into the online
travel service industry in order to exploit opportunities that had been pioneered by Priceline. In this way, the market for online
travel services will move toward equilibrium until there
are no more opportunities for new travel service companies to exploit.
Suggested Solutions for Business
Principle 7: Resources should be used efficiently to achieve society’s goals. Priceline exploited
Case Questions for Thought
an opportunity to use resources more efficiently. It is inefficient to have empty hotel rooms and airline seats if someone is willing to
pay some price to use them on short notice.
Principle 8: Because people usually exploit gains from trade, markets usually lead to efficiency. It is ineffi- cient to have planes
flying with empty seats and hotels with unoccupied beds. Thus, introducing a market for those items—which is what Priceline
did—improves efficiency.
Principle 9: When markets don’t achieve efficiency, government intervention can improve society’s welfare. It would have been
inefficient to have major airlines fail because of the public’s temporary fear of flying.
Vast resources would have been wasted as pilots and support staff lost their jobs, planes were mothballed, necessary trips
cancelled, and so on. It improved effi- ciency for the government to step in and temporarily aid the airline industry so that it could
survive the temporary downturn.
Principle 10: One person’s spending is another person’s income. In the aftermath of the attacks of September 2001, as people
stopped spending on items like travel, the income of airline workers was severely reduced.
Principle 11: Overall spending sometimes gets out of line with the economy’s productive capacity. The
overall economy went into a slump after the attacks of September 2001 as the economy’s productive capacity exceeded its spending.
Principle 12: Government policies can change spend- ing. The $15 billion aid appropriation by Congress was spent on stabilizing the
airline industry and prevented major airline failures.
CHAPTER 2
1. What is the opportunity cost associated with having a worker wander across the factory floor from task to task or in search of
tools and parts?
BCS-1
,BCS-2 S U G G E S T E D S O L U T I O N S F O R B U S IN E S S C A S E Q U E S T I O N S F O R T H O U G H T
Suggested Solution
1. The opportunity cost of a worker wandering across the factory floor is forgone output—the output that worker could have produced in
time spent wandering around.
2. Explain how lean manufacturing improves the econo- my’s efficiency in allocation.
Suggested Solution
2. Lean production (also known as lean manufactur- ing) improves the economy’s efficiency in allocation because, for example, an
automaker can more quickly switch to producing more of the types of cars that more consumers want and fewer of the types of c a
that fewer consumers want.
3. Before lean manufacturing innovations, Japan mostly sold consumer electronics to the United States. How did lean manufacturing
innovations alter Japan’s com- parative advantage vis-à-vis the United States?
Suggested Solution
3. Before the innovations in lean production, Japan had a comparative advantage vis-à-vis the United States in consumer electronics.
After the innovations, Japan’s comparative advantage vis-à-vis the United States shifted to auto production.
4. How do you think the shift in the location of Toyota’s production from Japan to the United States has altered the pattern of comparativ
advantage in automaking between the two countries?
Suggested Solution
4. The shift in the location of Toyota’s production from Japan to the United States means that it is likely that Japan will no longer have a
clear comparative advan- tage in automaking vis-à-vis the United States.
CHAPTER 3
1. What accounts for the fact that before Uber’s arrival, there were typically enough taxis available for every- one who wanted one on goo
weather days, but not enough available on bad weather days?
Suggested Solution
1. Before Uber’s arrival fares were set by city regulators. If everyone who wanted a taxi during good weather could get one, then we can
imply that the price set by regulators was approximately equal to the market- clearing price on good weather days. But bad weather, li
a snowstorm, produces two changes to supply and demand: an increase in demand (a rightward
, shift of the demand curve) as more people want rides, and a decrease in supply as more taxi drivers want
to stay warm and dry at home (a leftward shift of the supply curve). As a result of these two shifts, the market-clearing
price rises. But because the actual price was set by regulators and could not increase in the pre-Uber days, a shortage of
taxis arose.
2. How does Uber’s surge pricing solve the problem? Assess Kalanick’s claim that the price is set to leave as few people possible
without a ride.
Suggested Solution
2. Uber’s surge pricing solves this problem because it allows drivers to charge higher prices until supply equals demand. The
higher price increases the quan- tity of rides supplied while reducing the quantity of rides demanded until market
equilibrium is achieved. Kalanick’s claim is true: at any price lower than the equilibrium price there is a shortage of
taxis—more people want rides than are available.
3. Use a supply and demand diagram to illustrate how Uber drivers can cause prices to surge by taking coor- dinated breaks.
Why is this strategy unlikely to work in New York, a large city with an established fleet of taxis?
Suggested Solution
3. By taking coordinated breaks, Uber drivers in San Diego reduce the quantity supplied at every price. That is, they shift the
supply curve leftward. As a result, more riders want rides than are available, and surge pricing kicks in. This is unlikely to
work in a large city with an established fleet of cars like New York City. First, because it would be too difficult to coordinate
a large enough group of Uber drivers to affect the price. And second, taxi drivers would take the fares when Uber drivers
took breaks, preventing a surge in the Uber price.
S
E2
P2
E1
P1
