SalvatoreMicroeconomics, 5th edition Web Examples

Chapter 4: The Human Development Index—A Better Measure of the Standard of LivingChapter 5: Estimation of the Demand for Oranges by Market Experiment Chapter 6: Returns on U.S.. Wheat Pr

Salvatore/Microeconomics, 5th edition /Web Examples

WEB SITE CONTENTS

Chapter 1: Fewer Guns Means a Lot More Butter

Chapter 1: Even the IBM PC and the Boeing 777 Are Not All American!

Chapter 2: Changes in Supply and Demand Cause Large Swings in Copper Prices

Chapter 3: Happiness and Life Satisfaction over Time in the U.S and the U.K

Chapter 4: The Human Development Index—A Better Measure of the Standard of LivingChapter 5: Estimation of the Demand for Oranges by Market Experiment

Chapter 6: Returns on U.S Asssets Are Higher for More Risky Investments

Chapter 7: How Motorola Stumbled and Failed to Avoid Diseconomies of Scale

Chapter 8: To Reduce Costs, Firms Often Look Far Afield

Chapter 9: The Russian Wheat Deal and U.S Wheat Prices

Chapter 10: Restrictions on Competition in the Pricing of Milk in New York City and the Nation

Chapter 11: The Monopolistically Competitive Restaurant Market

Chapter 12: The Objective and Strategy of Firms in the Cigarette Industry

Chapter 13: Transfer Pricing

Chapter 14: The Glut of Lawyers and Doctors in the United States

Chapter 15: Change in the Occupational Distribution of the U.S Labor Force: 1990–1999Chapter 16: Rates of Return on U.S and Foreign Share Price

Chapter 17: Exchange in POW Camps

Chapter 18: The Fable of the Apples and the Bees

Chapter 19: Information and the Limits to Workers Privacy

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Fewer Guns Means a Lot More Butter

With the collapse of communism in the former Soviet Union and its virtual removal as amilitary threat, the United States reaped a sizable “peace dividend”; that is, U.S militaryexpenditures (which in 1990 were 26% of the government’s total budget) were reducedsharply and redirected toward the private sector and other forms of government spending.Over a decade, the savings from military expenditures amounted to as much as $150 billionper year Growth was also stimulated by gradually redeploying toward civilian uses the 30%

of all scientists and engineers previously employed in defense-related research andproduction

There were many conflicting claims on such a peace dividend Some wanted to usethe money to help the Eastern European countries and the former Soviet republicsrestructure their economies to promote democracy Others wanted to use it to improvehealth, education, and infrastructure in this country Still others wanted to use it to reduce theimmense federal deficit; this would reduce public borrowing, lower interest rates, andstimulate housing and other private investments

Some thought that using of the peace dividend to improve health, education, andinfrastructure would increase long-term national growth considerably For example, a billiondollars could provide comprehensive prenatal care to an additional 1.5 million poor pregnantwomen or add 400,000 children to the Head Start program It has been estimated that eachdollar spent on Head Start saves almost $5 in welfare, remedial education, and other costslater Improving infrastructure would also be productive According to the FederalTransportation Department, urban areas waste 2 billion hours a year on highway delays.Flight delays at 21 primary airports amount to 20,000 hours per year As it turned out, thepeace dividend was in fact used to do a little of all the above

The same type of heated discussion arose during the 2000 Presidential election andafterwards on how to use the huge budget surplus that was developing when the Americaneconomy was growing very rapidly With sharp and unexpected decline in the growth of theU.S economy in 2001 and the huge tax cuts pushed by the newly elected BushAdministration, the budget surplus all but vanished—and so did the discussion of what to dowith it What did occur, however, was a major shift in budget priorities: Whereas in 195660% of federal spending went for defense and 22% for social security and other payments toindividuals, in 2006 60% went for the latter and 20% for the former

Source: “$150 Billion a Year—How to Spend It,” New York Times, March 9, 1990, p 34;

“The Defense Whizzes Making It in Civvies,” Business Week, September 7, 1992, pp 88-90; Allen Schick, “How the Federal Surplus Happened,” Brookings Review, Winter

2000, pp 36–39; “President’s Signature Turns Broad Tax Cut, and a Campaign Promise,

Into a Law,” New York Times, June 6, 2001, p 24; “Bush Projections in Budget Surplus,” New York Times, August 23, 2001, p 1; and “The Stubborn Welfare State,” Newsweek,

February 19, 2007, p 39

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Even the IBM PC and the Boeing 777 Are Not All American!

The following table shows that of the total manufacturing cost of $860 for the IBM PC in

1985, $625 was for parts and components made abroad (of which, $230 was from owned plants) Even though all the parts made overseas could be manufactureddomestically, they would have cost more and would have led to higher PC prices in theUnited States (and reduced competitiveness of IBM PCs in international markets) In fact,

U.S.-at the end of 2004, IBM sold its PC business to China’s Lenovo Similarly, only 13 of the

33 major components of the new Boeing 777 jetliner are made in the United States, 7 aremade in Japan, and another 13 in other countries (Australia, Canada, England, France,Italy, and South Korea)

Distribution of Manufacturing Costs for the IBM PC in the United States and Abroad

Distribution of manufacturing costs:

Case and final assembly (U.S.) 105

$860

Sources: “America’s High Tech Crisis,” Business Week, March 11, 1985, pp 56–67; Boeing news release 1998; and “IBM Strikes a Deal with Rival Lenovo,” Wall Street

Journal, December 9, 2004, p A3

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===============================================================Web Example 2-1

Changes in Supply and Demand Cause Large Swings in Copper Prices

Copper is an important mineral with a large variety of industrial uses, ranging fromelectrical wires, electrical appliances, and computers, and it is used in the construction ofautomobiles, homes and offices In terms of quantities consumed, copper is third amongmetals after iron and aluminum It is its properties of high thermal and electricalconductivity, malleability, and resistance to corrosion that make a readily available supply

of copper crucial for modern industrial production, and its price is an important part ofthe cost of many products There are, however, substitutes and a change in the price ofcopper in relation to the price of its substitutes can lead to the switching from one mineral

to others in production of many products

Changes in Demand and Supply can explain the sharp decline in the world’s price

of copper from about $1.20 per pound in mid-1997 to $0.62 per pound in mid-2001 Thedecline in copper prices during the second half of 1997 was triggered by the seriousfinancial and economic crisis in South-East Asia (South Korea, Thailand, Malaysia,Indonesia, and the Philippines), which reduced the world demand for copper By thebeginning of 1999, the price of copper had reached a low of $0.61 per pound From thenuntil the fall of 2000, the price of copper rallied to $0.89 per pound, as the demand forcopper increased with the end of the crisis in South-East Asia and as a result of rapidgrowth in the United States (then the world’s largest user of copper) From fall 2000 untilfall 2001, however, copper declined to $0.62 as a result of flat world consumption(because of the world economic slowdown) in the face of large increases in supply(rightward shift in the world supply curve) as several new large copper mines in SouthAmerica (especially Chile—the largest copper producer in the world) and in Asia startedproduction Since then, however, copper prices increased sharply and exceeded $3.50 perpound in fall 2006 as a result of production problems in various producing countries andsharply increased demand (especially from China, which has now the largest user,accounting for about 20% of world consumption)

Despite the recent sharp increase in the price of copper, U.S mining companiesare facing increasing pressure due to their high production costs, lower-quality copperore, and more stringent environmental regulations In recent years, U.S Miningcompanies have reduced costs by implementing new and cheaper smelting (refining)techniques and by mergers (so as to eliminate excess capacity) Despite these efforts, U.S.copper production declined from 2,140 metric tons in 1998 to 1,220 metric tons in 2006,while most other copper producing countries increased theirs (the United States, however,still remains the world’s second copper producer with 8 percent of world output afterChile, which has 35 percent of the world market)

Source : “Tough Times in Copper Pits,” New York Times, September 11, 1999, p C1 and Daniel E Eldstein, “Copper,” U.S Geological Survey Mineral Yearbook (Washington,

D.C.: U.S Government Printing Office, 2006).See also:

http://minerals.usgs.gov/minerals/pubs/commodity/copper/coppemcs07.pdf

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===============================================================Web Example 3-1

Happiness and Life Satisfaction Over Time in the U.S and the U.K.

The following table shows the proportions of people giving different happiness answers

in the United States and in the United Kingdom over the 1972–1998 period

Happiness and Life Satisfaction: Averages for Different Periods

a) The proportions of people giving different happiness answers in the United States 1972–98

1972–1976 1977–1982 1982–1987 1988–1993 1994–1998

All - not too happy 14% 12 12 10 12 All - pretty happy 52 54 56 58 58 All - very happy 34 34 32 33 30

Male - not too happy 14 12 13 9 11 Male - pretty happy 54 56 57 58 58 Male - very happy 32 32 30 34 31

Female - not too happy 13 12 12 11 13 Female - pretty happy 51 53 56 57 59 Female - very happy 36 35 33 32 29

White - not too happy 12 11 11 9 11 White - pretty happy 52 54 56 57 59 White - very happy 36 35 33 34 31

Black - not too happy 26 23 21 18 21 Black - pretty happy 54 54 58 60 58 Black - very happy 20 23 21 22 20

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b) The proportions of people giving different life-satisfaction answers in Great Britain 1973–98.

1972–1976 1977–1982 1983–1987 1988–1993 1994–1998 All - not at all 4% 4 4 4 3 All - not very 11 10 10 10 10 All - fairly 54 54 55 55 57 All - very 31 32 31 31 31

Male - not at all 4 4 4 4 4 Male - not very 11 10 10 10 10 Male - fairly 55 55 57 57 58 Male - very 30 31 29 29 29

Female - not at all 4 4 3 3 3 Female - not very 12 10 10 11 9 Female - fairly 53 53 54 54 55 Female - very 32 34 32 32 32

Source: D Blanchflower and A Oswald, “Well-Being Over Time in Britain and the USA,” NBER Working Paper 7487, January 2000, p 19.

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Web Example 4-1

The Human Development Index—A Better Measure the Standard of Living

The United Nations has recently devised a broader and better measure of a nation’s standard ofliving than just comparing per capita incomes, called the Human Development Index (HDI) TheHDI is a weighted average of life expectancy (as a measure of the general health conditions in thenation), an educational index (which includes the adult literacy rate and student enrolment ratio inthe nation), and real per capita income adjusted for differences in the purchasing power of thedollar (PPP—defined in Example 4–8) The table below shows the three components of the HDI,

as well as the HDI itself for the same 13 countries included in Table 4.3 in Example 4–8 Note thatthe PPP per capita incomes shown in the table below are different than those shown in Table 4.3because of different methods of adjustment

The table shows that Canada has the highest HDI, followed by Japan, France, UnitedStates, United Kingdom, Italy, and Germany among the developed countries, and Mexico, SouthKorea, Russia, Brazil, China and India among developing countries Note also that the difference

in the HDI among developed and developing countries is much less than if we compare only theirPPP per capita incomes

Life Expectancy, Education Index, PPP Per Capita Income, and Human Development Index:

Selected Developed and Developing Countries, 2005

Life Human Expectancy Education Per Capita Development Country at Birth Index Income Index (years) (PPP US $) (HDI)

Source : United Nations Development Program, Human Development Report New York:

Oxford University Press, 2007/2008, pp 229–232

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===============================================================Web Example 5-1

Estimation of the Demand for Oranges by Market Experiment

Researchers at the University of Florida conducted a market experiment in Grand Rapids,Michigan, in 1962 to determine the price elasticity and the cross-price elasticity ofdemand for three types of Valencia oranges: those from the Indian River district ofFlorida, those from the interior district of Florida, and those from California GrandRapids was chosen as the site for the market experiment because its size, demographiccharacteristics, and economic base were representative of other midwestern markets fororanges

Nine supermarkets participated in the experiment, which involved changing the price

of the three types of oranges, each day, for 31 consecutive days and recording thequantity sold of each variety The price changes ranged within 16 cents, in 4-centincrements, around the price of oranges that prevailed in the market at the time of thestudy More than 9,250 dozen oranges were sold in the nine supermarkets during the 31days of the experiment Each of the participating supermarkets was provided with anadequate supply of each type of orange so that supply effects could be ignored Thelength of the experiment was also sufficiently short so as to ensure no change in tastes,incomes, population, the rate of inflation, and determinants of demand other than price.The results, summarized in the following table, indicate that the price elasticity ofdemand for all three types of oranges was fairly high (the boldface numbers in the maindiagonal of the table) For example, the price elasticity of demand for the Indian Riveroranges of -3.07 indicates that a 1 percent increase in their price leads to a 3.07 percentdecline in their quantity demanded More interestingly, the off-diagonal entries in thetable show that while the cross-price elasticities of demand between the two types ofFlorida oranges were larger than 1, they were close to zero with respect to the Californiaoranges In other words, while consumers regarded the two types of Florida oranges asclose substitutes, they did not view the California oranges as such In pricing theiroranges, therefore, producers of each of the two Florida varieties would have to carefullyconsider the price of the other (as consumers switch readily among them as a result ofprice changes) but need not be much concerned about the price of California oranges

Price Elasticity and Cross Price Elasticity of Demand for Oranges

Florida Type of Orange Indian River Florida Interior California

Florida Indian River -3.07 +1.56 +0.01

Source: M B Godwin, W F Chapman, and W T Hanley, “Competition between Florida and

and California Valencia Oranges in the Fruit Market,” Bulletin 704 (Gainesville: University of

Florida, December 1965).

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Web Example 6-1

Returns on U.S Assets Are Higher for More Risky Investments

The following table shows the average annual return and standard deviation of the returns

on U.S stocks, U.S Treasury bonds, U.S Treasury bills, gold and silver holdings, as well

as the average annual rate inflation over the period 1990 to 1999

The table shows that U.S stocks had the highest average annual return but alsothe highest variability of returns or risk, as measured by the standard deviation U.S.Treasury bonds and bills had much lower average annual returns but also faced muchlower risk because the probability that the U.S government goes out of business ispractically nill U.S Treasury bills offer lower returns than U.S Treasury bonds becausethe former are more liquid (i.e., mature in less than one year, most commonly threemonths, while U.S Treasury bonds have a maturity of one year or more)

With the annual rate of inflation of 3.2 percent, this means that the average annual

real rate of return on U.S stocks was 6.8 percent (10.0%–3.2%) over the period 1990–

1999 On the other hand, the average annual real rate of return on U.S Treasury bondsand U.S Treasury bills was, respectively, 1.4 percent and 0.9 percent over the sameperiod The average real rate of return on holding gold and silver, however, was negative(-0.6 and–1.0, respectively) Thus, despite the claims often made that precious metals(particularly gold) offer the best protection against inflation, their price increased at aslower rate than the rate of inflation and so their real return was actually negative of thelast decade

Average Annual Rate of Return and Standard Deviation on U.S Assets

and Rate of Inflation, 1990–1999 _

Asset Annual Rate of Return Standard Deviation

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Web Example 7-1

How Motorola Stumbled and Failed to Avoid Diseconomies of Scale

Motorola, a leader in the worldwide revolution in wireless communications, grew byleaps and bounds from the mid-1980s to the mid-1990s In 1995, its revenues were $27

billion (with profits of $1.8 billion), propelling it to the twenty-fourth spot on the Fortune

500 list In fact, Motorola had been doubling in size every five years (its sales were $10

billion in 1989) The question in 1996 was “Can Motorola keep avoiding excessivebureaucracy, complacency, and diseconomies of scale as it grows larger and larger?” Thatquestion was answered in the second half of the decade, when Motorola stumbled In

2000, Motorola revenues had grown only to $37 billion (with profits of $1.3 billion) and

it had slipped to 109th place in the Fortune 500 list.

Until 1996, Motorola was considered by many to be the best-managed company inthe world It was described as an icon of innovation, a pioneer of self-directed teams, and

a prince of profits; it wrote the book on decentralization, job training, and promotingcooperation between labor and management Motorola was regarded as simply the best inthe world in almost everything it did—including cellular phones, pagers, two-way radios,semiconductors, and other electronic gadgets In 1995, Motorola had an incredible 85percent share of the world market in pagers, a 45 percent share of the world market forcellular phones, and $6 billion in semiconductor sales (making it the world’s number 3chip producer, after Intel and NEC), and it generated more than half of its revenuesabroad Contrary to many other large U.S firms at the time, this was a large companythat sizzled From a slowly declining electronics company in the 1970s, Motorola hadbecome a world technological leader, beating the best of its Japanese competitors—and inthe process becoming an industrial legend and management-books case study

By 1998, however, it was clear that Motorola had slipped very badly First, it failed toanticipate the rapid move to digital technology and so it lost market leadership in cellulartelephones, not only around the world but also on its home turf, to a relative new comer,Nokia of Finland Then, came its leadership crisis after its respected chief executive,George Fisher, left to head Eastman Kodak and Chris Galvin, the unseasoned and lessthan brilliant third-generation member of his family to run the company, took over.Finally, came its ill-fated move into Iridium, the ambitious new satellite world-widetelephone service, which failed to take off and filed for bankruptcy in August of 1999.The question is, How could this have happened to a company that until a few yearsearlier had been regarded as one of the best companies in the world?

In a nutshell, Motorola simply seemed to have lost its way during the second half ofthe 1990s It had grown arrogant with success, became self-satisfied, and becamesluggish in execution, in a world that had become increasingly competitive and fast.Motorola’s renowned “warring tribes” culture, which pitted one division against theother, backfired and became a stumbling block to change and renewal Since 1998,Motorola has tried to turn the company around by merging into one unit the cellular,paging, and the two-way radio

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operations, which previously had been separate and beset by warring divisions Motorolasold the low-end chip manufacturing operation, laid off more than 48,000 of its 150,000employees, and shifted more than 3,000 engineers to develop new digital handsets.Potentially more significant, Motorola tried to move into a new direction, whereby it notonly designed and produced the chips but also designed and developed the software thatran them, as well as working with customers to develop new products and services.Specifically, Motorola wanted mobile telephones, two-way pagers, personal organizers,and other hand-held devices to combine voice and Internet services and in the process,also regain market leadership in digital cellular telephones in the United States andaround the world By the end of 2001, Motorola had still not recaptured the marketleadership it had a decade earlier and in fact it incurred its first annual net loss in decades.After regaining some market share in recent years as a result of the introduction of itshighly successful Razor cellular telephone, Motorola’s market share fell again andreached 13% of the world market in 2007, while Nokia’s rose to 37%

Source: “Keeping Motorola on a Roll,” Fortune, April 18, 1994, pp 67–78; “How Motorola Lost Its Way,” Business Week, May 4, 1998, pp 140–148; “Motorola Can’t Seem to Get Out of Its Own Way,” Business Week, January 1, 2001, p 72; “Motorola Is Ringing Investors, But Will They Pick Up?” Wall Street Journal, January 21, 2002, p B3;

“Nokia: Lesson Learned, Reward Reaped,” The Economist, July 30, 2007, p 32; and

“Motorola Loses Market Share, Financial Times, August 23, 2007, p 13.

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Web Example 8-1

To Reduce Costs, Firms Often Look Far Afield

In order to increase productivity and cut costs to better compete, firms often seek creativeinsights in industries far afield from their own Of course, in a time of increased globalcompetition, firms routinely scrutinize competitors’ practices in their quest for innovativeproducts and processes But seeking inspiration only in one’s own industry haslimitations, and so more and more firms are increasingly looking in other industries andfields to come up with new products and better ways of doing things For example, whenSouthwest Airlines wanted to improve the turnaround of its aircraft at airports, it did notexamine other airlines’ practices but went to the Indianapolis 500 to watch how pit crewsfuel and service race cars in a matter of seconds The result was that Southwest was able

to cut its turnaround time by 50 percent Such a drastic increase in productivity couldhardly be accomplished by observing other airlines’ practices It is, of course, much moredifficult to adapt techniques from other industries, but when it is accomplished, thepotential rewards in terms of increased efficiency can be very great

The key to finding useful insights in seemingly unrelated fields is to focus onprocesses After all, all firms do basically the same things—hire employees, buy fromsuppliers, carry on production processes, sell to customers, and collect payments Forexample, a firm seeking to speed its production process might look at Domino’s Pizza, anoutfit that takes an order, produces the pizza, delivers it, and collects the money—all inless than 30 minutes A major gas utility firm discovered ways to greatly speed thedelivery of its fuel to customers by observing how Federal Express delivers packagesovernight Similarly, a firm delivering gravel learned how to greatly speed deliveries byhaving truck drivers plug a card into a machine requesting the quantity of gravel to loadwithout the need for the driver to get off the truck and waste a great deal of time fillingorder forms—just as automatic teller machines work at banks In 1999, General Motorsadopted the system used by the federal Centers for Disease Control and Prevention(CDC) to track down diseases and spot outbreaks to the industrial tasks of debugging itscars; this is expected to eliminate some nine million claims and save it $1.6 billion inwarranty repairs in two years and Motorola is using the biological code DNA to definecircuit patterns on semiconductors To build a better wind turbine, GE Build a globalteam of researchers from Germany, Chine, India, and the United States; to look for newmedicines, Novartis, the Swiss pharmaceutical company, went to a laboratory inShanghai specializig in ancient remedies; and the technology behind the Intel’s Centrino,now a $5 billion business, was born in an R&D lab in Israel

Source: “To Compete Better, Look Far Afield,” The New York Times, September 18,

1994, Sec 3, p 11; “GM Takes Advice from Disease Sleuths to Debug Cars,” The Wall Street Journal, April 8, 1999, p B1; “Motorola New Research Efforts Look Far Afield,” The Wall Street Journal, June 17, 1999, p B6; and “Te World of Ideas,” Fortune, July 25,

2005, pp 90–96

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