This action might not be possible to undo. Are you sure you want to continue?
Answers to CourseTutor Homework Questions
Suggested Answers to Text Questions and Problems for Chapter 1
1. Some reasons for the increase in economics majors might be: (1) The starting pay for economic majors upon graduation approaches $50,000 a year; (2) globalization trends are producing a greater interest in knowing how economies interact; and (3) economic analysis is now being applied to a broader range of topics including issues such as crime, AIDS, college and professional sports, and terrorism. 2. Many reasons could be advanced to explain why we think things were better in an earlier time including (a) media attention seems to focus on problems, (b) we romanticize earlier times, (c) we get used to what we have and wish we had more, and so on. Easterbrook provided a long list of other reasons as well. 3. Computers and other technologies require extensive training and experience, and firms must establish the organizational structure to make the investment truly effective. For example, it took Wal-Mart a number of years to develop, collect, process, and analyze the immense data it collects from its stores “to determine specific goods to stock at specific stores at specific times of year as well as their prices.” See “Computer Use and Productivity Growth,” National Economic Trends, The Federal Reserve Bank of St. Louis, December 2003. 4. It is probably bound to help somewhat. If only some have horns removed, however, poachers might still kill the rhino to keep from having to track this animal in the future. After all, poachers are concerned with efficiency as well. Thus, the more animals with horns removed, the better the result. Also, dehorning may make the animals more susceptible to predators. But incentives do matter, and removing the horn on balance may help the effort to save the black rhino. See Charles Wheelan, Naked Economics: Undressing the Dismal Science (New York: WW Norton), 2002, Chapter 2. 5. High-tech firms are hiring expensive, sophisticated people who are in high demand. This leads to better treatment of employees. If the firm does not offer these amenities to its employees, they soon become employees of other hightech companies. Individuals with low skill levels do not command high salaries or benefits. They are not in as high demand as highly skilled people. It is efficient, but many would argue that it is not fair. Markets, as you will see, are efficient allocative mechanisms, but fairness is difficult to determine. 6. Yes, clearly going to college instead of going immediately to work represents a choice to get additional skills now and enter the labor force later. Even if you are working and going to school, you are choosing between investing in your education versus another leisure activity. You will see the benefits in the future, when your skills command greater resources. 7. The government can subsidize hybrid purchases directly, by offering people, say, $2,000 to purchase cars that get greater than 40 miles per gallon, or offering tax credits. The government could add significant taxes on gasoline, increasing the price, making hybrid cars more attractive to consumers. 8. Your study time on Wednesday. 9. All of these groups benefit except the newly married couple trying to purchase their first home. When the housing market declines, the newly married couple gains and the others lose. For example, falling housing sales and prices mean
and less likely to wage war with their neighbors. 2. and the economy is operating within the production possibilities frontier. c 2. “Lasting peace can not be achieved unless large population groups find ways in which to break out of poverty. If the housing market is booming and the economy enters a recession. Economic development by individuals in the developing countries means that their children are more likely to be educated. Generation 1 2 3 4 Years 18 36 54 72 $400 $200 2% Growth 4% Growth $200 $400 $800 $1. c 3. b 6. When there are unemployed resources. and sales in housing markets will decline as well. b 8. the standard of living doubles in 36 years or roughly two generations. incomes will fall. 10. Micro credit (small loans to poverty stricken people for self-development and small businesses) provides people with a stake in their communities. d 4. whereas the bowed out (concave to the origin) curve has increasing opportunity costs as the production of one good is increased. prosper.4 Answers that real estate agents sell fewer houses. b 5. The harm is not to the current generation. a growth rate of 2% results in a standard of living that is one-quarter of that if growth is 4%. .” Answers to CourseTutor Homework Questions for Chapter 1 1. but to those generations further out. At 2%. d Suggested Answers to Text Questions and Problems for Chapter 2 1.A. As the Nobel committee noted. reducing poverty and promoting entrepreneurship. By the time we go out to your great-great-great grandchildren. leading to a reduction in individual susceptibility to extremes in political and violent behavior. d 7. while with a growth rate of 4%. we can expect that unemployment will rise. the economy doubles roughly every 18 years or one generation. so commissions are lower and their income is reduced. A straight line PPF curve has constant opportunity costs. at lower prices.600 3.
2. and capital is substituted for labor. Capital goods are those goods used to produce other goods. so wages are higher. 8. They will be able to share the excess through trade. and the level (or degree) of scarcity declines. making it profitable for both countries to specialize and ship shirts to the United States. a. or . Very much the same thing as for individuals. or technological advances in both products 5. Producing more capital goods represents an investment in the economy. so the job is done with a lot of labor and a little capital. 7. and time is still a limited resource for us all. capital. As rich as America is.2 orange must be given up for each jar of prickly pear jelly. While trade is typically beneficial to both countries in the aggregate. or 5 jars of prickly pear jelly for each orange. c. so any point inside the PPF represents unemployment. have limited resources and are unable to do everything a nation would like to do: providing good roads. The opportunity cost of a jar of prickly pear jelly: 50/2 25. or .Answers 4. The United States has less labor relative to capital. 12. individuals and groups within each country lose when their product faces competition from a country with a comparative advantage. Scarcity still exists in China. 14. The output of one product that must be given up for the increased output of the other is the opportunity cost of that new production. c. A-5 Florida’s opportunity cost of oranges: 2/50 . Full employment of resources is represented along the PPF. 15. b. while smaller. Improvements in technological progress can increase growth in an economy. and entrepreneurial activity. Arizona’s opportunity cost of oranges: 100/20 5. Economies can grow through increases in the quality or quantity of labor. 11. No. Increases in resources expand the PPF outward. 9. Thus. Technology will be most important in the how to produce question. have a comparative advantage in the production of shirts. This is larger than the sum of any two combinations available to both states. we still face scarcity. some resources will be unemployed. . 10. Nations (rich and poor). or 25 oranges must be given up for each jar of prickly pear jelly. but still there are tradeoffs between products. increases in resources or factors. communications services. 13. unemployment unattainable technical advances in shoe production economic growth. d. Total combined output for both states will rise to 250 oranges and 500 jars of prickly pear jelly. and education for its people. universal health care. b. This investment leads to the ability of the country to produce more goods and services in the future. Growth alone does not eliminate scarcity: the PPF shifts outward. 6. if the economy wants to produce more of one product. Both China and India have huge labor resources relative to available capital. it must accept less of the other. land.04 jar of prickly pear jelly for each orange.04. a. The opportunity cost of a jar of prickly pear jelly: 20/100 . Economic growth typically does improve standards of living. Costa Rica and Bangladesh. like families. Any time the economy is operating inside the PPF.
a 8. Higher gas prices ($3.A. prices of related goods. Improved technology improves productivity. Increase.6 Answers Answers to CourseTutor Homework Questions for Chapter 2 1. d 10. decreasing the rental rates. while a change in supply results from a change in one or more of the determinants. 5. increasing the rental price.00-plus per gallon) increased the demand for compact (fuel-efficient) vehicles. d 15. c 11. c 9. 7. the demand curve shifts. Supply will rise if any of the six determinants of supply change. c 19. 4. b 13. c 14. change in demand. b 2. d 16. c 17. so prices are undoubtedly higher. 2. and product availability. a 18. 6. d 20. income. but supply has not. d 6. Market demands are the horizontal summation of individual demands. the number of buyers. b Suggested Answers to Text Questions and Problems for Chapter 3 1. Rising gas prices decreased the demand for luxury vehicles and SUVs. Thus the scale on the horizontal (quantity) axis for market demands will be huge compared to individual demand curves. The determinants of demand are consumer tastes and preferences. c 5. Price can be a reflection of quality (albeit imperfectly). a 7. and expectations regarding future prices. Prices provide consumers with relative comparisons between products. 3. . d 4. and provide businesses with information about levels of demand. When a determinant changes. income. A change in quantity supplied results from a change in price. resulting in more output for lower costs. Demand has increased. The difference is in scaling. d 12. d 3.
Answers Demand Supply Decrease in Supply Increase in Demand Change in S2 Quantity Supplied c S0 A-7 a b Price Price Change in Quantity Demanded D1 Increase in Supply S1 c a Decrease in Demand D0 D2 b Quantity Quantity 8. 10. you want to distinguish between rising sales at existing prices due to an expanded advertising program. the fewer will be offered on the market. a market naturally opens up for these virtual characters and goods. A change in demand is a shift in the entire demand curve and is caused by a change in one or more of the determinants. Clearly. consumers are buying the intangible pleasure of owning a luxury brand. a. This distinction is important. and wholesale prices of foam blanks would probably rise in the future. You would probably increase the prices of existing inventory of surfboards. If everything were free. and it is unlikely that there would be a market for characters or weapons. a change in quantity demanded is a movement along an existing demand curve caused by a change in price. In a similar way. Thus. supply and demand play a role. the more sophisticated the offering. on the one hand. probably no one would play the game. etc. . See the figure above. The market demand for red wine would increase (shift to the right). the more people will be willing to pay. In this case. You would be expecting a shortage in the short run. for example. Assuming that both watches provide the same services (time and date. Markets exist because some people have goods or services that others want. It takes time to build and create characters and to acquire sophisticated weapons in the game. since it enhances the buyer’s overall success in the virtual world. 9. As Rob Walker asked. In contrast. In fact. while other have plenty of time but want (or need) money. The more difficult and time consuming any character or weapon is. most retail outlets increased the price of their boards from $100 to $300. A change in supply shifts the curve and is caused by a change in one or more of the determinants. and rising sales due to a sale or a reduction in price. More vineyards would plant grape varieties that produce red wines rather than white wines. Say.). on the other hand. some people have little time to play but have money to spend to enhance their online characters. A change in quantity supplied is caused by a change in price. “how much of that difference is ‘real’ and how much is essentially in the mind?” 11.
Answers b. First, in the very near term, surfboard prices will rise, and the stock of polyurethane boards will fall. Over time, other companies will supply alternative blanks that use alternative processes that avoid the use of TDI. Currently, epoxy is used along with polystyrene to create a blank, but some surfers say that these boards are slower in the water. Also, new approaches to making blanks may emerge. One defense contractor has developed foam material to protect the electronics in missiles that does not use TDI and is willing to license this for surfboards. 12. a. Market uncertainty is always a factor on the supply side of any market. The nuclear power industry was heavily encouraged by the U.S. government and initially subsidized, but when this encouragement and subsidy were subsequently withdrawn, the industry suffered considerable losses. Some polysilicon manufacturers suffered losses in the late 1990s when they invested in capacity only to see Asia and especially Japan suffer a slowdown in business.
b. They can wait and make sure that the solar industry is for real, but waiting can cause them to lose market share in the future. They can reach agreements with solar manufacturers to guarantee a certain level of purchases from any expanded capacity. They might work with the Chicago Commodities Exchange to develop a futures market in polysilicon so that they can hedge their capacity. 13. a. $20 a pound. See graph.
The Market for Vanilla S1 c b S0 a D0 D2 0 3 6 9 12 15 18 D1
50 40 30 20 10
Price ($/pound) Demand (D0 ) 0 10 20 30 40 50 20 16 12 8 4 0
Supply (S0 ) 0 6 12 18 24 30
Supply (S1 ) 0 1 2 3 4 5
Demand (D1 ) 25 20 15 10 5 0
Demand (D2 ) 4 3.2 2.4 1.6 .8 0
b. Supply has been cut by 5/6, so equilibrium price will rise to $40 a pound. See table and graph.
Coke’s impact on the demand curve is shown in the table and graph; equilibrium price will be somewhat above $40 a pound.
d. Demand falls to D2, while supply returns to S0; equilibrium price will be roughly $6 a pound, and equilibrium output will be roughly 3,600 pounds. 14. A growing demand will cause prices to rise as more consumers want what is initially only a modest available supply. Given the higher prices for premium coffee, more trees will be planted and supplies can be expected to rise in the longer term. A hard freeze results in lower supplies and higher prices. 15. Oranges and corn are ingredients in many products. Corn appears in nearly all food products, and oranges are one major ingredient in soft drinks and juices. Using corn for ethanol will increase its price, and a shortage of oranges will result in rising prices for drinks and juices. Overall, we would expect food prices to reflect these rising input prices.
Answers to CourseTutor Homework Questions for Chapter 3
1. c 2. d 3. a 4. d 5. d 6. b 7. c 8. b 9. b 10. c 11. b 12. c 13. d 14. b 15. a 16. c 17. c 18. b 19. c 20. c
Suggested Answers to Text Questions and Problems for Chapter 4
1. a. Firms would be willing to devote time and energy (not really compensated by the PPP approach) because they are motivated by social responsibility and by concern to enhance their corporate reputation. This might lower outside pressure on their prices for some of the drugs they have.
b. Several possibilities have been suggested including: broad public limits on liability for vaccine makers, government indemnification of vaccine makers for approved vaccines, and a sizable compensation fund for those injured as part of any bill that limits liability. c. Governments can agree to buy and stockpile enough to encourage research and development; they could offer a large prize for the first firm to develop a cure or significant aid (although this approach has a lot of potential problems in determining if the first drug should be compensated when a later drug does a better job); and finally one senator has suggested that drug firms who develop a product be given a 2-year extension on an existing patent of their choice.
2. In general the answer is yes. If you eliminate the profit, you eliminate the incentive to sell these goods. This is, however, easier said than done. In some
Answers instances, it may be accomplished fairly easily. For example, if you want to eliminate illegal immigration, establish a universal ID card and put a large penalty on employers who hire illegals. Treat illegal narcotics like liquor: legalize, regulate, and tax. While the economic answers are fairly straightforward, the politics of these measures are not. 3. To some degree it is probably a form of market failure. If consumers and markets were rational, tips would be based on the quality of service, but they appear not to be. Even returning customers often do not vary their tips (or overtip) based on service. This fact is probably recognition by customers that some jobs are underpaid, and tips are important and fair to bring the salary up. It is also a cultural norm to tip. 4. The minimum wage draws attention probably for several reasons. First is political: One party —Democratic—is more inclined toward government intervention in the marketplace, and raising the minimum wage is part of its platform. The Republican party generally favors freer markets, reacts to intervention with skepticism, and focuses on the unemployment caused by increasing the required wage above equilibrium. Second, $5.15 an hour seems unfairly low to many people, and they focus on this unfairness. Third, there is some evidence that increasing the minimum wage increases other wages as well. Thus, unions and others are in favor of increasing the minimum wage because this will enhance their chances of getting wage increases for their members in the future. 5. Adam Smith suggested that everyone, while working for his or her own interest, unknowingly and without any intention to do so, promotes the public interest as well. We know that markets are efficient and promote consumer interests as long as externalities, monopolies, and the like are not present. 6. Conferring tenure on professors after a short period of service introduces the problem of moral hazard. But that problem may be less severe that is often suggested. First, college professors are required to devote a long time in the educational process to learning specialized knowledge. The alternative would be to pay very high wages to get people to invest in such specialized training without job security. Second, senior professors with tenure are expected to hire junior faculty. Without tenure, they would be hiring competitors for their jobs, and this would introduce potentially greater problems for the university. 7. Yes. By buying brand names, you are minimizing the information requirements for shopping. 8. Most consumers would prefer the warranty that gives you your money back in a specified period. At that point, your choices are greater, and if you have problems with the current car dealer, you can shop elsewhere. 9. The downside is generally higher prices and farm program bureaucracy with a budget of over $75 billion. 10. If there were no deadline, only those who stood to benefit immediately would sign up for the drug benefit. Those who didn’t take drugs or only needed a few would wait until they faced substantial drug bills and then sign up. This is the classic adverse selection problem.
12. and national defense. NPR. A price floor is a government mandated minimum price that can be charged for a product or service. In a similar way. Second. Consumer surplus is the area under the demand curve above equilibrium price (area P0be) shown in the figure below. and once that good is provided to the market. weather forecasts. so many people can consume the good without paying. producer surplus is the total revenue firms receive from selling a product over what they would be willing to sell it for. Minimum wages are classic examples. b Consumer Surplus S0 Price e P0 P1 a S1 Producer Surplus 0 Q0 Q1 D0 Quantity 13. A price floor (minimum wage) set above equilibrium results in unemployment. no one else can be excluded from consuming the good (nonexclusion). Consumer surplus represents the total amount consumers would be willing to pay for a product over what they actually have to pay. Examples include PBS. when the minimum wage is higher. When production costs decline. no one can be excluded and one person’s consumption does not harm others. An effective price floor set above equilibrium price (PF in the figure) will result in surpluses. 14. . union labor looks relatively more attractive to firms.Answers A-11 11. The free rider problem arises because once a public good is provided. which leads consumer surplus to become larger and expand by area P1P0ea (the shaded area). Rent controls are a classic example. Producer surplus is the area above the supply curve below equilibrium price (area 0P0e). An effective price ceiling set below equilibrium price (PC in the figure on the next page) will cause a shortage. This free rider problem would tend to result in private underprovision of the good. Yes. Public goods are goods that one person can consume without diminishing the benefits of consuming that good for others (nonrivalry). supply increases to S1 in the figure. A price ceiling is a legally mandated maximum price that can be charged for a product or service. both are consistent with the analysis of price floors set above equilibrium.
Expecting low-skilled individuals to earn wages that yield a comfortable lifestyle is probably unrealistic. Some solutions include setting limits on use (restrictions on entry into the national parks and other scenic areas). d 7. Examples include marine fisheries.12 Answers S0 Price PF P0 PC Surplus e Shortage D0 0 Q0 Quantity 15. b 18. d 11. b 16. The problem is that everyone owns the resource. a . Poaching of African animals is a problem. national parks. a 15. and some governments are experimenting with private ownership as a way to protect the animals. b 6. b 2. c 3. so no one really owns it. b 10.A. a 9. c 5. a 14. getting their first job experience. Most workers earning the minimum wage are low-skilled teenagers. c 19. Probably not. d 4. c 17. The tragedy of the commons occurs because of the tendency for commonly held resources to be overused and overexploited. setting limits on fish catches. c 20. 16. or other very low-skilled employees. and issuing permits. c 8. Answers to CourseTutor Homework Questions for Chapter 4 1. b 12. b 13. and freeways that have become clogged. Raising minimum wages to the $13 to $16 range would price many of these workers out of the market.
55] . is a necessity. and so on. a. 100 CDs must be sold ($7 100 $700). Income elasticity of demand measures how responsive quantity demanded is to consumer income. plant capacity is fixed. and our gas-guzzling cars last a long time. 2. time to order raw materials. and if Exxon raises its price.044 .50 . The elasticity of supply will be most elastic in the long run. Exxon’s gas is just one brand of many.50 . total revenue equals 400 $. and beef and chicken are substitutes because chicken is substituted for beef when its price increases. The demand for gasoline as a whole is relatively inelastic because there are no close substitutes. 4.60)/(. cross elasticity will be negative and these are complements. but falls for inferior goods. Gasoline. Thus. Thus. When consumer income rises. we will all switch to another brand since gasoline is essentially a commodity (one brand is as good as another). When price is 60¢. so total revenue will rise.1818 1. the quantity demanded of chicken rises.2222 / . When price rises and total revenues fall. for example. 80 units are sold ($8 80 $640). less so in the short run. 6. the demand is elastic. the quantity demanded of normal goods rises as well. supplies are essentially fixed. In the market period.1064 1. and least in the market period. a. but in the long run all factors are variable. In the short run.60 $240. When price is $7 a unit and total revenue is $700.5) 7.Answers A-13 Suggested Answers to Text Questions and Problems for Chapter 5 1. A positive cross elasticity means that as the price of one product rises. . falls.60)/2] [100/450] [ .667 When coffee prices rise and donut sales fall. gas purchases are a small part of our overall budget.2222/ . 3. if the price of beef rises. the quantity demanded for the other also rises. For firms to expand output in response to price changes requires time: time to hire more labor.1111 / .1333 1.22 Demand is elastic over this price range. The elasticity of demand would equal [(500 400)/(500 400)/2] [(. b.22 1. Falls. The cross elasticity of demand (using the midpoint formula) is ( 100/900) / (10/94) .50 $250. and when price is 50¢ total revenue is equal to 500 $.010/. Cross elasticity of demand measures how responsive the quantity demanded of one product is to the price of another product. given our current lifestyles. When price rises to $8. the value of elasticity (using the midpoint formula) is ( 20/90) / (1/7. 5.
Therefore.800. and the like.00.000) / [(100. 15. 5 / 57. it will affect attendance because some of the fans will be bowling. Since the mayor seems to be saying that London can increase the charge by 60% and see total revenues rise. b. 16.000 $88 54. a big increase in supply would reduce total revenues to farmers. and the demand will become less inelastic.14 Answers b.5 / 2.395 . car pools.125 .22 . at least in the short run.000)/2] (48. Over a longer time horizon. individuals will find other ways to enter the central city. farmers’ net incomes (net of costs) would fall. and thus.33 .67 Ed .395 Bowling and attendance at night baseball are substitutes.22 .50 is 55. They must have assumed that demand was relatively inelastic. The cross elasticity of demand is 10/15 5 .A. so the cross elasticity will be positive. fewer trips. The amount of dental services will decline by 8%.20/1.79) / (100/800) .00 88. 12.33 20. (b).50)/2] c. With inelastic demand for agricultural products. Farm productivity has actually grown dramatically as described. sales rise to 60 in the sample. and when price drops to $2. He is undoubtedly correct.894 8. $4.000 / 90.000 80. When the local Cinnabon franchise drops the price of cinnamon rolls and the sales of Dunkin’ Donuts donuts falls.800. 11. 14.25 . Total revenue is maximized with a ticket price of $4. They must feel they have a strong brand. the cross elasticity of demand will be positive and these two goods are substitutes. 13. 100.00 2. Elasticity of demand is equal to (100.00) / [(48.000 $48 $4. Yes. 9.50) / [(2. more fuel efficient automobiles. (a). but the total spent on dental care will grow.00 88.67. The short-term elasticity of demand for crude oil is inelastic compared to longer-term demand because in the long-term consumers can adjust to higher prices by employing substitutes: mass transit. so they are substitutes. Total ticket sales at $2. Unless the total cost to farm dropped.087 . Business travelers have less flexibility (they need to solve some problem or make a sale tomorrow) and typically decide to travel with a shorter time horizon than do retirees who can travel when they can get better prices. a. A negative cross elasticity of demand means the goods are complements. b.00 2.5 0. the mayor must be assuming that the demand is inelastic.000.00.000 40 / 60 . The cross elasticity of demand (using the midpoint formula) is (.000 80.545 sweaters to generate the same revenue.00)/2] .1117 / . and (e) are the only complements. 10. Elasticity of demand is Ed (60 55) / [(60 55)/2] (2. a. First.
d 19.26)/(1. c 13. Computer chip factories are extremely expensive (approaching one billion dollars) and take a long time to obtain permits. Utility is maximized when the marginal utility per dollar of each product consumed is equal. a 12. When the cross elasticity estimate is 2. Inelastic c. the combination will be 2 units of A and 1 unit of B. and the time to increase production is much less. but computer chip manufacturers need to hire and train new employees. Potato chip manufacturing is not done on the same scale.0 b. c 2. Both can hire extra employees. Answers to CourseTutor Homework Questions for Chapter 5 1. Elastic 1. c 3. The first unit purchased will be a unit of A (20/5 5 4). 20. If you received 5 utils per dollar for one product and only 2 for another.3 would be an “inferior good” brand like the Geo Metro or other inexpensive brands. At $5 a unit for both products.26)/2] [8/996] 19. 2. the consumer will buy 2 units of each product.Answers A-15 17. d 7. we would look for a positive cross elasticity number: the higher the number. a 8. They must locate where a skilled labor force is available and where high-skilled high-tech workers want to live. these products are close substitutes.5 suggests a luxury brand like BMW or Mercedes. d 17. and a value of 1. a Suggested Answers to Text Questions and Problems for Chapter 6 1. b. b 6. d 11. [(1000 992)/(1000 992)/2] [(1. d 4. When the price of product B rises to $10. d 5. The car with the income elasticity equal to 0.01/1. This weighing process would continue until you no longer could gain by choosing one product over another. To find out if the products of two firms compete in the market. b 9. the products are really unrelated. c 18.7 would represent complements. a. total utility would be increased by consuming more of the first product and less of the second. a. a 16.3.008/. 18. a 14. c. and make ready for production. d 15. c 20. b.25 [ . the . a. b 10. Neither would be very responsive in the market period. the more competitive the products (substitutable). build.255] .25 1. An income elasticity of demand of 1. and this will take longer for them than for potato chip firms. for 0.008 1.1.
A decision that is significantly in the future will not seem as immediately important and is more likely to get a thoroughly reasoned approach.5) . you will go to 2 movies and drink 3 bottles of wine. 6.5) ( 5/7. . You still received utility from your total consumption. Luxury-goods consumers are not irrational. This is the typical outcome from an all-you-caneat buffet. c. You have consumed so much of a product that you are essentially satiated. as suggested by Thorstein Veblen in his book. Thus. The Theory of the Leisure Class. Air travel and many other activities have potential lethal effects. long-term decisions may well fit the marginal utility and indifference curve framework better. Waiting a week to get $15 more is a huge return (in annual percentage terms) compared to waiting one more week after a year. With the prices at $10 each.286/ . Rational choice would suggest you would wait a week for $15 more.A.43 5. Terrorism is the quintessential ambiguous risk with unknown odds. and finally the last $5 will be spent on a second unit of A (10/5 5 2). but eat so much that the extra dessert makes you feel bad for hours. Price may be an important characteristic of luxury goods.43 . you will go to 3 movies and drink 4 bottles of wine. 4. Luxury consumers may want to flaunt their wealth.667 . First-Run Movie Marginal Utility per Marginal Dollar Utility (P = $10) Quantity 0 140 120 100 80 60 — 14 12 10 8 6 0 1 2 3 4 5 Wine (bottle) Marginal Utility per Marginal Dollar Utility (P = $10) 0 180 160 120 50 30 — 18 16 12 5 3 Quantity 0 1 2 3 4 5 Total Utility 0 140 260 360 440 500 Total Utility 0 180 340 460 510 540 b. c. but if you consumed one more unit. 3. though still would be positive. Using the formula from Chapter 5. it doesn’t seem rational. but the probability is well known and may be no higher than that of being involved in a terrorist incident. and this insight helps to explain why it strikes so much fear into people. If the price of both products rises to $10. one unit each of A and B will be purchased. The marginal benefit from the product may drop off quickly when everyone can afford it if a large part of the benefit may come from conspicuous consumption. 7. elasticity of demand is equal to (1/3. the marginal utility would be negative and total utility would fall. compared to waiting one more week after a year. When the price of wine falls to $5 a bottle.16 Answers second unit purchased will be a unit of B (30/10 5 3). and quantity demanded has risen from 3 to 4 bottles. No. d. You enjoy the meal. a. Price of wine has fallen from $10 to $5.
the marginal utility framework seems to provide a reasonable guide to consumer decision making.000. Ad agencies realize this trend is happening. the measures may mean less. At that point. but one more banana. it is possible that Bill Gates gets just as much marginal utility out of his next $100 as you or I. but if the vast bulk of income is in a few hands. say. 6 5 First-Run Movies 4 3 2 1 I0 0 1 2 3 4 5 6 7 8 9 10 a b I2 I1 Bottles of Wine 2. Sometimes. 3B) must necessarily be preferred to the first (4A. but the last bundle (4A. 3. 9. One problem with this approach (relating happiness to income) ignores the income distribution question. in which your favorite TV show has characters. Additionally. since measuring utility is impossible. but that cannot be since each indifference curve represents a different level of satisfaction. 10. The first two bundles are fine. since it has the same four apples. and the prices are similar. The empirical data presented by Professor Layard does suggest a high positive correlation of happiness with per capita income below $20.Answers A-17 8. 2B). If you have indifference curves that intersect. suggesting that additional income when you are poor yields greater utility. and sponsoring of events. then you have two different indifference curves passing through the same point. more ad money is moving to alternative media: the Internet. Ads don’t go away—they just change forms. Sample Chapter 6 Appendix Answers 1. driving Ford cars and drinking Starbucks coffee. When the product choices are narrowed to two. the two curves would be indifferent. Income per capita may be high. cable. Not necessarily. The equilibrium points are shown in the graph below. Finally. ads build on this placement and look like a continuation of the show. Two indifference curves cannot have the same level of utility. and they are trying a host of new techniques such as product placements within the program itself. . it is difficult to compare individuals.
c 5. d 7.A. The four concepts are related in how they are defined. c Indifference Curve Analysis 1. b 12. Economic profits are profits after both explicit and implicit costs are deducted. c 4. c 11. b 4. a 2. a 5. a 9.33 8. b 15. Explicit costs are those out-of-pocket expenses paid to others. The long run differs for industries and firms because the time required to expand plant capacity differs . a. b 8. b 6.00 7. but in the long run all factors can vary. d 8.25 8. a 7. With the fourth worker. d 6. and firms can enter or leave the industry. c.50 8. b 13.18 Answers Answers to CourseTutor Homework Questions for Chapter 6 Marginal Utility Analysis 1. Up to three workers. with implicit costs playing an important role. d 9. Labor 0 1 2 3 4 5 6 Output 0 7 15 25 33 40 45 Marginal Product 0 7 8 10 8 7 5 Average Product — 7.50 b. 2. 3. d 14. d 2. b 10.00 7. d Suggested Answers to Text Questions and Problems for Chapter 7 1. c 3. while accounting profits typically do not have implicit costs deducted. c 10. while implicit costs are opportunity costs. d. No. d 3. one factor of production is fixed. In the short run.
11 12. Finally.42 10.88 10 11.33 16 26. As a firm expands its output.Answers A-19 among industries.28 6.2 11.08 2 11. and these regulations take more or less time to fulfill.50 11. economies of scale are encountered due to specialization of labor and management. Zero or near zero. Some industries are heavily regulated (chemical and nuclear power plants).20 14. a flat region is reached. Eventually. reflecting the fact that the firm can duplicate its operations at virtually the same cost. 45 40 35 30 25 20 15 10 5 25.42 10 8 5.5 8.08 13. and costs begin to rise. They simply need to maintain a database of users.33 10 9 8 7.33 13.50 2. L 0 Q 0 7 15 25 40 45 48 50 MP 0 7 8 10 15 5 3 2 AP 0 7 7. the firm gets so big that it begins to lose control.66 9.14 TFC 100 100 100 100 100 100 100 100 TVC 0 80 160 240 320 400 480 560 TC 100 180 260 340 420 500 580 660 ATC AVC AFC MC 1 2 3 4 5 6 7 b. while others are not (restaurants and retail establishments). a.66 4 2.60 8 8.66 40 MC ATC AVC AFC 0 0 10 20 30 40 50 60 5. .22 2. 6. 4.71 17.60 10.
Accounting profits are the difference between total revenues and explicit costs and a few implicit costs such as depreciation and depletion (tax and accounting rules allow for deduction of these particular implicit costs). with information and the Internet. a. food. Clearly. e. h. In fact. . and so on. Yes. Marginal cost is the change in total variable cost divided by the change in output or the cost associated with producing additional units of production. Thus. variable.A. clothes. 13. How much money you spent on insurance last year has nothing to do with whether you should purchase insurance this year. the NYSE and NASDAQ will undoubtedly be seeking foreign stock exchanges. so as more output is produced. d. A baseball player hitting . but SarbanesOxley added a significant layer of constraints on business and reporting requirements that these new companies are avoiding. they are unrelated to output. 12. variable. If the average income of your class is $15. So the relationship between marginal costs and marginal product is the formula MC 5 wage/MP. ARthurNASDAQ was trying to buy the London Stock Exchange (LSE). Economic profits are equal to total revenues minus all economic costs both explicit and implicit.20 Answers 7. But still. g. Yes. then average total cost is falling and vice versa. Further. fixed. Since fixed costs are fixed. 14. fixed. it seems to be a little hyperbolic. variable. economies of scale and scope may matter less than in manufacturing. 9. Sunk costs by definition have been spent and cannot be retrieved. variable 8. the marginal cost for each of these 10 units is $20 ($200/10). b. if an additional worker costs (or wage is) $200 a day. Initial public offerings represent new firms going public. fixed. in early 2006. All countries have corporate laws that are similar. Decision making is about the future. f. 11.333 (gets a hit one-third of the time on average) will see his average rise when he gets a hit and fall when he does not. and they now are subject to government oversight that previously didn’t apply to them as a private company. cars. total fixed costs do not vary. They are fixed costs. variable. and vice versa if someone with no income joins the class. most of the products and services we consume are subject to huge economies: air travel. i. and marginal productivity (the additional output associated with this new hire) is 10 units (marginal product). Average fixed cost.000 (some people work). variable. c. many large organizations generate a lot of content. They raise capital to expand. and Tom Cruise decides to take a refresher course in economics and joins your class. 10. average fixed costs continue to fall as the Q in TFC/Q gets larger. If marginal cost is less than average total cost. 15. and therefore sunk costs are irrelevant to future decisions. including both the opportunity cost of the entrepreneur and the firm’s cost of capital. average income rises. and this content is in high demand on the Web-generating economies.
00 7.42 10.11 12. c 15.00 5.14 TFC 100 100 100 100 100 100 100 100 TVC 0 80 160 240 320 400 480 560 TC 100 180 260 340 420 500 580 660 ATC AVC AFC MC 25. a 9.50 11. c 17. a 14.20 14.00 26. d 20.33 16.22 2. c 19. 45 40 35 30 25 20 15 10 5 AFC 0 0 10 20 30 40 50 60 MC Q 0 7 15 25 40 45 48 50 MP 0 7 8 10 15 5 3 2 AP 0. a 3.00 9. d 4.88 10. a 12.Answers A-21 Answers to CourseTutor Homework Questions for Chapter 7 1. d 2.00 7.00 2.42 10. d 8.60 8. c 10. b 13. L 0 1 2 3 4 5 6 7 b.00 8.50 8.00 ATC AVC .33 10. c 7.00 11. b 6. c 11.00 7.66 40. c Suggested Answers to Text Questions and Problems for Chapter 8 1.00 11.20 11. b 18.00 8.28 6.50 2.66 9.08 2. a.33 13. c 5.71 17.60 10. d 16.00 8.08 13.66 4.
at $25 a unit the firm produces 100 units and P > ATC. and its losses will equal fixed costs ($100). the firm will sell 100 units.50. Since the losses are smaller than the costs of shutting down (fixed costs). T. Since P < AVC. If price cannot cover the costs of the variable factors of production. resulting in higher prices and bringing profits up to normal levels. If they lower prices. at $12. At $16 a unit. Competitive firms are all so small relative to the market that they alone cannot affect the market. c. F. If they try to increase their prices. so the firm earns an economic profit. 2. Total profit is TR TC. When existing firms are earning economic profits. a price of $15 is just tangent to the minimum point on the ATC curve. Profit maximization requires that firms produce output where MR = MC. At a price of $10.50. Total cost is $500. so TFC = $6. so the firm earns a normal profit by producing 80 units. they will sell nothing as consumers will buy their standardized (homogeneous) products elsewhere. The price of $7. 6. AFC is roughly $6. If price is less than average variable costs. T. and loss per unit is roughly $2. since P = MR. For competitive firms this is where P = MC. P = MC at roughly 70 units. Thus. which equals roughly $360.00. Therefore. and thus economic profit would be about $400. TFC = AFC Q. P < AVC. T. at $20 per unit. e. These firms typically suffer short-term losses due to what they view as temporary changing conditions in their markets or from new competition. entry is encouraged. reducing supply. they will sell their production. d. . 7.50 3 70 $175.A. as we will see in the next two chapters. then the firm should close its doors. competitive firms are price takers.00 60.50. The firm will produce nothing (shutdown) if P < AVC and will produce output where P = MC if P AVC. and TR $16 45 $720. they continue to operate and try to react to the problems. so economic losses are $2. F. then losses will exceed fixed costs than if the firm closed its doors. at $9 a unit. the competitive firm’s supply curve is the output associated with the MC curve for P AVC. Just the opposite occurs when existing firms are earning losses. so total profit is $220. so the firm will shut down. ATC is roughly equal to $16. then losses are greater than AFC times output (or TFC). so the firm will shut down. This is a simple concept for competitive firms. Some of the existing firms leave the industry. MC MR P at 45 units of the product.22 Answers c. the firm’s total revenue and cost are equal at $420. so profit per unit is $4. e. 4. 3. but it becomes more complex for the other market structures. bringing prices down and returning industry profitability to normal. d. so at output of 60. Marginal revenue is equal to the change in total revenue from selling another unit of the product. but earn less. 8. For competitive firms this is just equal to market price. F.50 falls below the minimum point on the AVC curve. a. b. for instance. 5. and at that output. and the firm earns a normal profit (economic profit 0). Thus the loss per unit of the product would be (AVC – P) + AFC. Easy entry and exit are crucial in the long-run adjustment process in competitive markets. f.
and eBay. since there are still risks and different levels of service on the Internet. c 5. Beyond that point. d 4. where the competitive model’s predictions generally seem to have been borne out. 13. ATC is higher and rising. Answers to CourseTutor Homework Questions for Chapter 8 1. d 11. In the same way that honey attracts bears. a 7. The two characteristics that seem to be most important at this point are the number of buyers and sellers and the level of barriers to entry and exit. The nature of the product and control over price (which comes with a lower number of sellers and the extent of barriers to entry) seem secondary. b 20. Costs may increase in the long run if expanding the industry bids up resource or input costs. however.com have significantly reduced the entry costs. Easy entry and exit and a growing number of online merchants along with improved information with price comparison sites have all added to the competitiveness of many markets and industries. 12. c 12. New firms will enter the industry. lowering prices and reducing profits to normal. If the ATC curve shifts downward by $5. This is a case. d .Answers A-23 9. c 9. d 14. a 15. Costs might decline in the long run because of technological advances or if industry growth permits suppliers to gain economies of scale. c 2. short-run economic profits attract new firms to the industry in the long run. so profit per unit will be less. c 19. b 18. In general. d 8.com. 11. If price is greater than ATC. 14. All prices are not the same. d 17. d 3. the Internet has resulted in more small firms (and people) entering the business of selling both used (and new) books and antiques. Half. industry supply will rise.com. then the firm is producing more output than that associated with the minimum point on the ATC curve. c 13. These new entrants increase market supply. 10. It would be hard to argue that the growth of the Internet has not fostered more competitive markets as the competitive theory would predict. Web sites such as Amazon. but total profit will increase until it is maximized at the output where MR MC. a 10. 15. and the new equilibrium will be achieved at a price $5 less than before the technological change. c 16. A competitive firm maximizes profit where P MR MC. existing firms will now be making economic profits equal to roughly $5 a unit in the short run. c 6. Maximum profit per unit is at that output where ATC is at a minimum (profit per unit P ATC). The result has been that many used books and antiques have fallen in price as supply has greatly increased over the last decade.
price would equal $30. To sell more output.” 3. Barriers to entry are relatively low. although each has monopoly power. P MR MC would be the profit maximizing output at 100 million units. c.970 million. d. but to all customers. with a price of roughly $25. b.24 Answers Suggested Answers to Text Questions and Problems for Chapter 9 1. and total profits will equal $750 million [TR TC ($45 50 million) ($30 50 million)] $750 million. “Only the authentic ones will do. and economic profit would be zero. In their local realm they have considerable monopoly power. Using P ATC as the regulatory approach would lead to output of 260 million. so the total subsidy would have to be $9 330 million $2. on the other hand.A. Today’s big fast growing firms Google. a. so they take their price from the market and adjust output to maximize profits. Without such barriers new firms could (and would) enter. De Beers has had a virtual monopoly on diamonds up to a few years ago.540 million. a. innovation in the tech sector is paramount. 5. Monopoly output would be roughly 140 million units. Monopolies are inefficient because monopoly output is lower. and prices are higher when compared to competitive markets. From the demand curve. 8. Technology is changing so rapidly in these areas that what might be a monopoly today is rendered less so when the next new thing is introduced. Yes. then output would be roughly 330 million with P MC of $26. 2. price will be $45. MR P. So for each unit produced. total profit would equal the area under the demand curve above the MC curve. so their MR P. Neither are monopolies in the strictest sense. c.500 million. At an output of 330 million. b. Their demand is industry demand. If regulators required that P MC. and economic profits would be zero. If this were a competitive industry. She will know. are the market. eBay. driving prices lower and profits toward normal. 7. Thus. 6. 4. MR MC where output is 50 million units. the difference between ATC and P is roughly $9. The deadweight loss to monopoly is the consumer and producer surplus lost because prices are higher and output is less under monopolistic conditions (see Figure 5). If the monopolist could perfectly price discriminate. but in both cases there are numerous competitors a short drive away. Economic profit would equal ($42 $31) 140 million $1. they must lower market price not only to new customers. Monopolists. Significant or nearly impossible barriers to entry are vital to maintaining a monopoly. The deadweight loss is equal to the area under the demand curve above the MC curve between the competitive output and monopoly output. Don’t be such a cheapskate. and Yahoo were started on a . Their response to synthetic diamonds will be to advertise something such as. Thus profit is equal to [($60 $30) 100 million] 2 $1. with a price of $42. Both exploit location well. Competitive firms are so small they only have a negligible impact on the market. the deadweight loss would equal [($45 $30) (100 million 50 million)] 2 $375 million.
0B) JP Morgan Chase ($52. By giving the other firms 4–5 years notice. For 2005.2B) Major Integrated Oil & Gas: Exxon Mobil ($338. Another important benefit is that these firms are usually ignored for antitrust actions. and Chrysler were essentially the market—the Big Three. and regional retailers. Some cities like Houston. the number one. and all three firms are having trouble.Answers A-25 shoestring.4B) Chevron ($198. Probably not.6B) British Petroleum ($265. there are many other competitors.3B) Texas Instruments ($14. and three firms in several industries (data for 2005 sales in billions of dollars is in parentheses) was Auto Manufacturers—Major: Daimler Chrysler ($200.9B) Bank of America ($56. number two firms fly under the radar.4B) General Motors ($199. 10. Lobbying states to enact legislation that increases Wal-Mart’s costs is a form of rent seeking by competitors. Safeway. In 1960. Yes.4B) 13. existing competitors will be able to locate new supplies either by producing their own or other suppliers will ramp up production. Professor Glaeser has a point. Nearly all of these firms face a growing threat from the open source industry that spawned Linux.3) Semiconductor—Broad Line: Intel ($38. A merger then would have been unthinkable. two. 9. so it might pass merger authorities.0B) STMicroelectronics ($9. General Motors. This is an alternative approach to reducing Wal-Mart’s ability to expand and keep costs below the competition. but now they innovate to survive. and often they can merge with other firms with very little attention unless the difference between them and the top firm is trivial. the higher new housing will cost.7B) Glaxo Smith Kline ($42.2B) Drug Manufacturers-Major: Pfizer ($50. The more restrictive zoning and building codes are. 11. Ford. As the quote suggests. Wal-Mart is tough competition for union-organized grocery stores and other large enterprises such as Kmart.1B) Toyota ($183. Texas. 14. but not to the level of a monopolist because satellite services provide nearly perfect substitutes for cable TV.5B) Banks: Citigroup ($76. Today. . 12. The long time frame was probably used to prevent any antitrust action from the Swiss government. They would probably rise.9B) Johnson & Johnson ($50. Labor unions have unsuccessfully tried to unionize WalMart.
By giving current residents more say over new development. Dental labs tend to be local by necessity. capital costs are relatively small and entry is easy. d Suggested Answers to Text Questions and Problems for Chapter 10 1. resulting in rising prices. dentists do not want to send models long distances. and these mergers are often allowed even in relatively concentrated industries because this often results in another viable competitor to the larger firms at the top. b 15. aircraft engine.000. c 16. a 14.A. b 11. 16. the industry is unconcentrated. Unless it was two small firms in the industry. reducing individual firm demands until only normal profits are earned by all industry firms. c 3. 2. but unless this merger involved two very small firms. and electronic computing would be rejected since their HHIs are over 2. and housing costs are relatively lower as a result (but this is not the only reason). Economic profits in the short run attract new firms.500. b 9. Monopolistic competition involves differentiated products.000. The point of this question is that monopoly analysis often shows up in unexpected places. b 18. The kink in the demand curve results in a discontinuity in the MR curve. After the merger. Mergers of two small firms can increase competition in any industry. electric lamp. this would be dental labs and office furniture. Also. This leads to a kink in the demand curve at market price. d 10. there would be significant political pressure to restrict a merger given the nature of the industries. d 17. 15. Pharmaceutical manufacturing and petroleum refining would probably have postmerger HHIs below 1. b 7. and even though we all dislike monopolists. and the Justice Department would be likely to permit a merger.26 Answers have minimal zoning restrictions. this often means development will be severely restricted. Household vacuum cleaner mergers would probably be rejected as well. so MC can vary and market price remains constant. d 4. . c 13. if the HHI is under 1. c 8. c 20. c 12. we may find ourselves acting like them when it suits our self-interest. but will match any price reductions. Answers to CourseTutor Homework Questions for Chapter 9 1. Rivals will not follow price increases. d 5. 17. d 6. In the table. a 19. a 2.
Clearly monopolistic competition has elements of both market structures. 8. 7. Yahoo. this leaves a lot of potential sales (and profits) at prices above marginal costs if a cartel participant is willing to cheat. globalization makes domestic concentration estimates suspect and less meaningful and probably explains why there is significantly less government antitrust litigation today. Because rivals’ reactions must be considered. but monopolistic competition is much more like competition. 11. For example. 5. to enter the computer microchip–fabricating business (i. plenty of big firms are nipping at their heels (MSN. Oligopolists have fewer competitors and are able to achieve greater sales revenues and profits than monopolistic competitors. 4. While firms in oligopolistic industries are huge. and humans and firms are unique. 12. This element of oligopoly partly led to the development of modern game theory. Strategic behavior analysis and game theory like that discussed in this chapter probably played a role in the government’s decision. Many buyers and sellers.. A typical Intel fabrication plant alone can cost over a billion dollars to get up and running. a good argument can be made that these industries act more like monopolistic competitors today. Since prices are set at roughly monopoly levels. This is not really a factor in the other three market structures. Very few industries have the price and profit stability the old-line oligopolies had in the past.Answers A-27 3. the government felt Microsoft was abusing its monopoly position in operating systems to the detriment of competition in other areas (Internet browsers and the players for audio files). and others). Monopolists can maximize profit over the entire industry. Repeated games can take into account the past behavior of rivals and punish or reward that behavior with the intent of changing future behavior. Existing firms’ demand declines and shifts to the left. to compete with Intel and AMD) requires huge capital expenditures on plant. . are conditions that are more important than the small levels of monopoly power resulting from product differentiation. Oligopolistic industries tend to have significant barriers to entry and exit. First. and expertise. equipment. whereas oligopolists only have a portion (presumably large) of the market. A few firms relative to the market and few enough that each firm must consider the reactions of its rivals. Cartels typically set prices by joint profit maximizing and then allocate the permissible output to members. 9. and no barriers to entry or exit. Significant barriers to entry and mutual interdependence characterize oligopoly. 10. This profit incentive to cheat undermines cartel stability. Profit declines along with dropping demand.e. 6. this opens up a huge number of possible models for oligopolistic industries. The ATC curve does not change. because of globalization and foreign competition. Although Google currently has a large market share of search activity and the associated revenues. Yes. Mutual interdependence means that firms must take their competitors’ reactions into account when making their own decisions. and the monopolistic elements are relatively minor.
exports. d 13. Working part-time reduces the monetary loss.A. The only way P&G could get away disbanding its coupon program is if the other firms did not. Export Trading Companies. d 16.000 Coupons $8. 14. The decision to have children typically means that the mother (as the primary caregiver) will leave the labor force.000 $9. they earn $10. Answers to CourseTutor Homework Questions for Chapter 10 1.000. d 20. d 5. The cartels or export companies were designed to stimulate U. c 12. b 17. Payoff Matrix for P&G and Its Competitors Other Firms P&G No coupons Coupons No coupons $10. b 11. b 14.S. and that is not in their best interest. The Attorney General might have used a Prisoner’s Dilemma game like the one below to argue the case. Being out of the labor force for an extended period means that an attractive career ladder has been interrupted and lifetime earnings are reduced.$8. As a result. c 19.$12.M. Small firms typically do not have the expertise or capital to enter foreign markets. and empty seats are pure profits lost. d 8.000 profits each. and customs clearances would reduce costs. c 4. c 15.000 $12.000 If both P&G and the other firms don’t offer coupons. 15.28 Answers 13. and marketing. were designed to permit smaller firms to get together in a marketing and distribution organization to encourage economies of scale and exports. Hence. but the minimax solution is that both offer coupon programs. resulting in lost wages and a reduction in career activities. even if only temporarily. .000. d 18.$10. they can be directed to less desirable seats.000. a 2. d 3. common prices could be set. d Suggested Answers to Text Questions and Problems for Chapter 11 1. d 10. the suspicion is that not many good seats were released early since those willing to get up and order online early on the opening day must really want to go. distribution. These seats are harder to sell later. as they are formally known. d 9. c 7.000. Since my wife was ready at 6:00 A. to order online. By combining into a trading company. and they will buy them.$9. b 6. the suspicion of collusion.
This is a major obstacle to a policy that could cause a serious short-term brain drain from developing nations. When the demand for capital rises. Some adjustments are profitable. the substitution effect is operating: Leisure has become more expensive and work is substituted for it. As you probably remember from an earlier chapter. including Albert Einstein and other familiar names. creating “nicer” jobs involves costs. and this will dampen investment. The passage of fair wage and labor laws reducing wage discrimination has played a role because higher wages make work more attractive to women. can take home more of a given salary. helping to stem the decline in investment. P MR. the time required to do work at home such as preparing meals. When wages rise and you substitute work for leisure. who are often secondary workers. For competitive firms. First. This means women. Second. To encourage older workers to stay. dirty. This will also be a rational response given the deficits facing Social Security and Medicare partly because of these aging baby boomers. Recessions discourage investment because income is down (or growing slowly). and security positions are dangerous. Producing less means you will need fewer workers. Security tradeoffs are the biggest obstacles—checking people’s background requires a lot of employees. firms can make work more ergonomic. doing laundry. During recessions. The same is true for reducing marginal tax rates. If wages rise high enough. capital investment grows as well. Since time is a limited resource for all of us. Clearly. you can earn what you want to support a given lifestyle. Finally. 6. interest rates will rise. mining. 4. and for monopolies. 3. not all jobs can be made nicer. because a large flow of high-skilled workers would lower wages for a large section of Middle America. The United States has benefited handsomely from high-skilled immigrants over the years. such as “job splitting” (where two people share one full-time job). 5. These families may be partially responsible for the rapid growth in demand for dining out and the growth in the restaurant industry. facing the same problems. 7. and these costs must be balanced against the benefits of lower wages. or a combination of the two. Higher-skilled workers are paid more and contribute more to these programs than they get back in benefits. whereas the income effect results in less. will be competing to bring high-skilled foreign workers into the country to replace retiring baby boomers. . Firms hire labor where MRP W. and so on. Some construction. the United States and Europe.Answers A-29 2. When the economy is booming. flextime. The substitution effect results in more work with a rising wage. Dual-earner households have less time to spend preparing meals. has declined as home appliances have become more efficient. interest rates fall. Letting in unlimited numbers of immigrants would be a political risk. Meal preparation time has also been reduced by technology. so dining out probably represents a substitute. monopolies produce less and sell their product at a higher price than competitive industries. This has been met by a jump in child care facilities. and you work less and take more leisure time. and MRPL MPPL MR. so the income effect becomes more important. and demand for products falls. social norms have changed regarding mothers and working. 9. flexible. 8. and telecommuting from home. and offer part-time positions.
and engineering.1236 $890. and workers substitute work for leisure. Jerry Bruckheimer.000 $750. As wage rates rise.000 [(1. a. initially the substitution effect dominates.50) 2.06) (1.000 $1. productivity rises along with wage rates. 14. but the market judges their marginal revenue product as roughly equal to their salaries. Flooding a market with unskilled workers would likely result in less capital employed.000] 30.000 [($25. as well as lower productivity and wages.000.000 ($20. and so the income effect dominates. and to the extent that unskilled wages rise relatively faster than skilled wages. Also.000) 30. If the university simply paid an average wage to all. additional income is less important since these high wages yield high incomes with less work. 10. and TV shows such as the various CSI series and Cold Case) watched by millions. inequality could be reduced. The present value of the bond today is PV $1. ($12.000. and an increase in the cost of capital means labor will be substituted for capital. Individuals make tradeoffs between labor and leisure. and thus monopolies hire fewer workers. c.000) 45. but few can do what Bruckheimer can do: consistently produce successful films and TV shows. anything that increases labor’s productivity. recruiting people to teach in these areas would be nearly impossible. however. Anything that increases the demand for the products labor is producing.50 2.00 15. and Pirates of the Caribbean. or the quality of faculty hired would suffer.06)2 $1. Yes. 17. . Black Hawk Down. But as wages rise to high levels.000 $750. Top Gun.g. d. the supply curve bends backward. 16. when business faces expensive labor. For some professors in departments such as finance. Most college professors teach 200–300 students a year and have a positive impact.06)] $1. and the market judges his marginal revenue product quite highly. produces movies and television programs (e. resulting in workers substituting leisure for work: Thus. When labor works with technology or more capital.000 1. Market and industry labor supply curves do not bend backward since higher wages in one market (industry) elicit supplies from other industries. Yes. it is consistent with the competitive labor market outlined in the chapter.00 $12.000 (1 . broader market salaries are high.30 Answers P MR. 13.. many people can teach college.000.800. it will often innovate and substitute new technology and capital for labor.00 2.000 The firm is a competitor in the product market since its demand for labor is the VMP of labor. 12. accounting. b. 11. Beverly Hills Cop. so the MRPL for monopolies is less than for competitive industries. A reduction in supply of unskilled labor would drive up wages.A.
both countries are highly unionized. cuts are inevitable. Honda. and a willingness to give up some income for leisure. c 12. d 19. and fewer work hours may simply be a result of that power. fewer hours represent just a different preference for leisure among German. You can count on people being available in your firm and in other firms as well. There are hung complementarities by everyone essentially working the same 5 days. they and other intangibles. c 14. and American workers. Third. d 11. Four possibilities come to mind. a 15. Aging plants are not as productive as new plants run by Toyota. d 7. Workers are more likely to join. Both the UAW and the domestic auto companies are in difficult positions. and how much is to increase sales today? Other expenditures such as R&D and tuition grants are easier to account for. The problem is that accounting for some of these investments can be difficult. A firm with monopsony power hires fewer workers at lower wages than competitive firms. patents. should be treated as investments. The only way wages rise in competitive markets is if employment is reduced. we want leisure time when our friends and family are off. 3. a 10. 2. b 20. c 2. c 16. Second. and the union has more potential to increase wages without causing unemployment among its members. and enhancing a brand name. The UAW will have to be more flexible and probably have to give back some benefits. c 8. 5. Yes. newer companies have labor costs less than half of that of General Motors. Requiring that workers be paid whether they worked or not meant that GM had an incentive to keep producing even if demand declined. First. c 17. This was just the opposite of what made good economic sense. so most of what they need to do is done in fewer hours. The recent buyout helped. At the other end. pushing prices and profit margins downward. Because domestic firms are saddled with these high “legacy” costs (generous retirement and health plans). Fourth. c 4. b 6. both German and French workers are highly productive at work. highly progressive tax rates in both countries may reduce work effort. d 5. a 9. like investment in research and development. c Suggested Answers to Text Questions and Problems for Chapter 12 1. . 4. d 3. c 18. but the Job Bank provisions will probably not be in future GM contracts. How much of current advertising accounts for enhancing the brand. French.Answers A-31 Answers to CourseTutor Homework Questions for Chapter 11 1. a 13. copyrights. and others in the United States.
that individual loses. improvements in technology. Productivity can be increased through investments in human capital. the firm that discrimi- . competition from global firms has reduced former oligopoly markets: Before. When a higher-productivity individual is discriminated against because of race. The rise of global production powerhouses such as China. 9. if more people get college degrees. Since part-time and contract employees work only temporarily for firms and are geographically and industrially scattered. selecting the bargaining unit is virtually impossible. their costs could be passed on to consumers without real alternatives. or disability. agreeing on a contract would be virtually impossible. and Indonesia have made it extremely difficult for unions to pressure firms to raise wages. Fewer people would attend college (the rate of return has fallen). and once they graduate. leading to a reduction in the rate of return to your education. First.A. supply will eventually rise and wages will not rise as fast. color. Young people make up the bulk of college enrollment because their opportunity costs are lower (they don’t command high wages). Further. age. Korea. Further. 10. and those who do would be less likely to be poor or need to borrow. they can look forward to a long earning horizon. many jobs don’t lend themselves to union contract structure. Middle-aged people have high opportunity costs and a shorter future earning span. Second. 11. the firm looks to outsource production overseas. more flexible work rules. 12. religion. 13. when increasing costs affected all firms. Unions can work with management to implement all of these approaches. the acquisition of a set of analytical and communication skills. the costs of a college education go up if you must borrow. it also seems reasonable that a large part of a college education represents a broadening of your mind. Flight attendants have less training. but now. Fourth. some people have managerial responsibilities and are precluded from organizing a union or are excluded from the bargaining unit. If too much pressure is brought to bear. 7. However. the employer loses the added productivity. and increases in the amount of capital employed with each worker. All things equal. When both labor and product markets are competitive. The mix of skills and pay levels is so varied that even if all businesses were willing to bargain. sales. there are dues to pay. While unions clearly have benefits. gender. and legal services. and the airlines spend huge sums on pilot training (and retraining) and annual evaluations. Japan.32 Answers 6. Third. These might include software engineering. making negotiations difficult for the flight attendants unions. and there is a greater supply of people qualified and willing to be attendants. they also involve costs. Pilots are highly skilled. their salaries are a small part of the overall costs of the airline. 14. Yes it does. so high salaries have not been difficult to negotiate. If interest rates rise dramatically. and consumers and society lose the added output. highly competitive markets have left firms from the old oligopolies at a disadvantage. 8. along with self-selection into an area where you have an interest and show promise. higher wages mean fewer people are hired. and the higher future wages are discounted more heavily.
c 3.Answers A-33 nates and hires the lower-productivity individual will have higher costs as a result. It is a public good. Insurance is priced on an experience-based analysis and reflects different risks with different groups. there is the relative importance of earning a living versus going to the movies. we could wind up with the American Airlines bear and the Coca-Cola coyote. d 17. but selling the right to name new species seems a good idea. gender. c 16. c 18. d 6. c 14. Answers to CourseTutor Homework Questions for Chapter 12 1. d 12. c Suggested Answers to Text Questions and Problems for Chapter 13 1. c 19. age. so reducing that harm today could stand up to higher current costs. Yes. 3. and so on. 4. we now have the Golden Palace monkey. d 11. d 7. c 10. b 15. They support the cause and also “feel good” about their purchase. c 9. the more likely the project would be financed today since harm way into the future would compute as a higher value today. d 2. but competitors who do not discriminate will not. and the like. Since health insurance is important. The naming of a new species by auction was recently done by the discoverers of a new monkey in Bolivia. getting on board early allows companies to avoid lawsuits and punitive regulations later. Of course. d 8. neither rival nor exclusive. Bought by a Canadian online casino. It might not seem right to change a name at this point in time. People buy these tags for the same reason they support public radio and television. our general policies on discrimination may not be entirely consistent. Discriminators will earn lower profit than their competitors. There is an inherent unfairness in different wages for the same job based on race. 15. The lower the discount rate. a 5. Many existing species have names based on wealthy financiers of expeditions years ago. Firms can use these tags as a show of corporate support for green issues and get a head start on potential future environmental regulations. 2. The benefits are a better regulatory process faced by companies and better public relations. The answer depends on how concerned you are about the people who will live 80–100 years from now. . c 13. Using an 8% discount rate would mean the harm 100 years out would have a small present value today. b 4. Plus. b 20.
Working out an agreement was probably difficult for several reasons including the emotional bubble surrounding smoking (my right to smoke vs.A. Since the EU and other developing countries have spent more on environmental controls than developing nations. Note. Benefits such as a more informed electorate. given that many have a close mix of characteristics. your right to breathe clean air. This could easily result in people traveling by other forms of transportation that generate worse emissions.” and methane is a particularly potent global warming gas. It results in higher prices and reduced output and employment. a seat in a sports bar for Monday Night Football. From roughly the most public in nature to the most private: the Coast Guard. the other owners could have paid the smoker to quit. 8. the general rule for greater pollution is when the marginal cost of getting rid of it exceeds the marginal benefits. The Presidio in San Francisco is probably unique in that the value of the land for development is so great that just a small part of the land can be leased to generate enough revenue to run the park. so eliminating much of it is an efficient approach. the costs to prevent smoke penetration were probably large. music downloaded from iTunes. 7. and the impact of higher productivity on economic growth. and our huge environmental protection bureaucracy is testimony to that fact. cable TV. This is a difficult set to put in order. it pays to reduce those emissions where the world gets the most “bang for the buck. and I’ll do what I want). Now. a slice of pizza. an Oklahoma toll road. Few people would be willing to restrict airline travel by increasing costs to discourage its use by anyone but the wealthy. Limit the pollution impact of air travel by requiring carbon offsets equal to the impact of airline pollution at high altitudes. National Public Radio. Further. Yes. climate change is a global phenomenon. Public goods are nonrival in consumption (you and I can consume the same good with no loss of satisfaction to each of us) and exhibit nonexcludability (once the good is provided. If the HOA had lost. 12. the impact of reduced crime. internalizing externalities is the way to approach pollution control. restricting the market somewhat). Either judgment would be efficient. 10. In most other parks. 9. Private goods are both rival and exclusive (when I eat a candy bar. but the distribution of benefits and costs would differ. Since the four-condo complex was old. Globalization of production makes it easier for companies to shop for environmentally favorable venues when cleanup costs are significant. Implementing this concept is not easy in practice. and my house is my house. your economics class. . Airline pollution is a good case of where carbon trading will be used. increases in taxes over the working lives of college graduates.34 Answers 5. a ski patrol at Aspen Mountain. and reductions in global warming gases anywhere in the world are beneficial. Theoretically. 11. the smoker will have to quit smoking or sell out (presumably to nonsmokers. bought and resold the property to nonsmokers. such a plan would not work given the remoteness of the parks. you can’t eat that same bar). reducing the pollution that aggravates global climate change is cheaper (at the margin) in developing nations. summer spraying for mosquitoes. or rehabbed their condos enough to prevent smoking odor from penetrating the walls. no person can be kept from consuming it). 6.
g. d 12. freeways. d 18. Add refundable deposits to a lot of products and packages. c 3... and African animals)— they are typically overused. a 16. Regulation has been the traditional solution. national parks. there have been some experiments with the idea of selling these resources to private individuals to provide an incentive to protect and preserve the resource. 14. d 13. d 4. When resources are held in common—owned by everyone and not a single individual (e. d 2. c . environmental purity.g. b 15. a 9. c 10. and improving health). b 7.Answers A-35 13. Acquiring more goods and services ignores the environment since it can absorb considerable pollution at that point. and achieving a minimum standard of living is more important. a 5. but not for recycled containers. but recently. b 20. Once economies reach a given level of consumption (per capita income). so they could be redeemed for cash later (much like bottles today in some states). c 8. Manufacturers could be required—or given tax incentives along with subsidies to encourage recycling—to make as much of their packaging recyclable as possible. Answers to CourseTutor Homework Questions for Chapter 13 1. d 19. c 11. As very poor nations develop and incomes grow. policy turns to improving the quality of life (e. the focus is on acquiring a basic standard of living we take for granted. b 6. c 14. c 17. Another approach would be to charge for each container of garbage picked up. 15. and the community will not tolerate the same level of environmental degradation it accepted when providing minimum levels of food and shelter were the order of the day. surroundings. ocean fisheries.
The reasons are complex. All families have different life cycles. The more than ten million unskilled illegal immigrants reduce earnings in the lower quintiles. The efficiency-equity tradeoff exists in this instance because you are taking money from people who are working and earning to give to individuals who are not. 4. This question is designed to get you to think about the issue of setting poverty thresholds. keep in mind that any number is essentially arbitrary. Family incomes differ because of inherited wealth. but the distribution over time will be more equal than at a specific point in time. $20. and they may slip down a quintile or two. See graph above.A. 5. this seems like considerably small income to care for a family of four. Frankly. moving them out of the lower brackets into middle or upper quintiles. Both of these impacts probably account for a significant portion of the growing inequality of income in the U. attitudes. b. while giving money to those not working gives them an incentive not to work as well. while the dual-earner households increase the earnings in the upper quintiles. and this is why public policy in this area is so complex and clouded with emotion and politics. The efficiency issue is one of work effort on both ends. But. Both of these are more equal than the distribution in the United States. a. discrimination.S.000 a year is the equivalent of a wage of $10 an hour for full-time workers. physical and mental capabilities. The equity side is that people not working or not earning enough money need that help to survive. Over the life cycle of families. Distribution A c. . Taxing money from those earning it reduces their incentive to work. Eventually earnings peak and families retire. Yes. and luck. There is not a right or wrong answer. culture. 3. 6. 2. investment in human capital.36 Answers Suggested Answers to Text Questions and Problems for Chapter 14 100 80 Equal Distribution Percentage of Income 60 A B 40 20 0 20 40 60 80 100 Percentage of Families 1. young people gain skills and see their income rise.
This credit. many people are unable to work. 14. low-income individuals enter the United States. for various reasons. Probably. in effect. Just the opposite would happen if more low-skilled. making the distribution look more equal. but the Lorenz curve is graphical. but how it is changing. With 10 million more high-income immigrants. Also. many minimum wage jobs would be eliminated. 10. directly increases their income.50 an hour. and many new safety net programs have been introduced over this half century. 8. Note also that the poverty thresholds include some assumption of household efficiencies since the thresholds grow slower as family size grows. even if they owe no taxes. incentives to excel would be harmed and economic growth would slow.50 $25. Thus a full-time worker with a family would escape poverty. Without different wage rates (that lead to income inequality). a full-time minimum wage worker would earn $25. At $12. And. Income inequality is not inherently bad. If the goal is to help low-income working Americans. .000 (40 hours 50 weeks 2. and so on. Technology and Wal-Mart have increased the purchasing power of poor incomes. A big change in the direction of inequality might be a reflection of a growing problem. 13. whereby low-income families are given a credit that adds to their tax refunds.000). Both use the same data. Immediately the household income is split between two families. own cars. This would reduce the impact of the top group. so good. More of the poor today own their homes. use cell phones. but clearly life cycle effects do reduce the importance of oneperiod views of the income distribution. discrimination. many poor people do not have sufficient skills to be hired at a wage rate of $12.000 hours $12. Social Security payments. the Gini coefficient would fall as more of the population’s income would show up in the middle and higher income groups. 11. The Gini coefficient is the ratio of the area between the Lorenz curve and the equal distribution line divided by the total area below the equal distribution line. 9. With such a small fraction of personal income tax payments coming from the bottom half of the income distribution. They would exaggerate the impact of upper-income groups and the Gini coefficient would rise. and have better health care. 12. culture. and the rise of two-earner households. whereas the Gini coefficient provides a specific number representing inequality. which may take one middle-income family and create two lower-income families. attitudes about work and leisure. that help might be better addressed with the earned income tax credit (EITC). at $12. Unfortunately.Answers A-37 7. watch cable or satellite TV. It may not be the absolute distribution that is important. to differences in human capital. for example. So far. have air conditioning. tax relief is an oxymoron.50 an hour with all the other costs of employment associated with hiring another worker such as unemployment insurance. The Lorenz curve is a graphical device to depict the income or wealth distributions plotting the cumulative sum of quintile shares of income or wealth on the vertical axis and the cumulative sum of quintiles on the horizontal axis. so poverty would persist. Rising divorce rates would undoubtedly change both the distribution of income and levels of reported poverty.50 an hour. Income inequality is due.
taxes must be raised to pay off the bonds or continue paying interest. a 7. c 19. The principal problem is estimating the value of these intangibles. United States. c 15. rents. Spending on the elderly today does little to improve the economy of the future. b 14. How much is an unlicensed patent worth? If something takes several years to develop. Consequently. how could we account for a project’s “value” before it is completed. Further. Taxes. d 18. There seems always to be people who are in poverty for a short period (the poor are not all the same people year after year) as they acquire the skills needed to earn wages above poverty levels. We could conceivably be 6 months into a recession before policymakers are sure of the data. d 9. (China is just now beginning to develop environmental policies to deal with air pollution from burning coal and other problems associated with its rapid growth and industrialization. sometime in the future. disabilities. Only getting GDP and related data quarterly makes policymaking more difficult. or profits. employee training. and discrimination are other reasons a certain level of poverty remains. 4. they must rely on other economic data to con- . Reduced investment today means lower GDP in the future because investment in new capital.38 Answers 15.) 6. d 4. c 2. b 8. 2. not knowing if it will be completed or if it will be accepted by the market? For many intangibles. b 11. All spending in the economy necessarily equals payments to all of the factors of production. 5. A dollar spent adds up to a dollar in wages. and more new products and services in the future. d 16. c 6. c 20. b 5. Lifestyle choices. interest. and research and development mean higher output. making it a more accurate statistic of our national output. c 12. b 3. reasonable estimates could be made and included in GDP. higher salaries. but clearly a worthwhile goal. Norway. This particularly applies to immigrants and young people.A. b Suggested Answers to Text Questions and Problems for Chapter 15 1. 3. b 17. d 10. Designing equitable and efficient policies to reduce poverty below this apparent floor is difficult. Answers to CourseTutor Homework Questions for Chapter 14 1. c 13. China. These life-cycle aspects make it more difficult to get the poverty level below 10–15%.
44 14.44 15.51 19.83 18. 8. causing policies to heighten the business cycle. or actions are taken at the same time the economy is turning in the other direction. a $28. but by the National Bureau of Economic Research (NBER).52 G(%) 21.83 20.3 4220. Year 1965 1975 1985 1995 2005 GDP 719. The three major goals are full employment or low unemployment. then a downturn (or recession) as the economy cools off.3 4975. 12.75 Consumer spending (70.5 357.8 X–M 5.000 $15. land (rents). In the last few years (2005–07).8 1034.78 0.2 –91.19 1. I(%) 16. Consumer spending went from 61. 10.72 C(%) 61.2 230. a nonprofit research organization founded in 1920.14 64. .000 Toyota Prius has tires that Toyota paid $120 for.000.000 $120) when the car is sold. We would not want to increase GDP by $43. robust economic growth.4 a.7 12455. Business cycles are alternating increases and decreases in economic activity. I 118. $15. 11. Net exports.26 70. that $15. c.6 16 –115. and a depression is when you do. plus other parts that add up to. GDP accounting adds up only the final value of goods and services to avoid “double counting.Answers A-39 firm that the economy is turning down.” When the car is sold.120 ($28.2 2372. and to count them again would be to count them twice.1 1638.7 61. For example.46 67. growth has been a solid 2.05 X – M(%) 0.46 16.4 G 151. 7. The circular flow diagram shows how the product and factor markets interact to produce goods and services and pay the factors of production. and stable prices. though recently inflation has shown signs of exceeding 3% a year.120 in parts is already included in the $28.14).2 736.19 b.05 17. the final price on the lot includes the sum of the costs of the individual parts.24 –5.000 retail price.07 21. followed by investment. 9. capital (interest). whatever action they take may be too late or too little. when goods or services are produced and sold.72 63. that spending must somehow be split among the factors of production (and payments to): labor (wages).19.73 –1.98 –2.3 7397. The old joke is this: A recession is when your neighbor loses his job.2 1144 2057.8 8742.7 879 1369.5% per year. A recession tends to be a relatively short downturn of modest severity.71 to 70. Business cycles are not dated by a government agency. unemployment has hovered around 5%. and because of these information lags.4 –716.4 2720. say. Ignoring some of the statistical measurement difficulties. A depression is longer and more severe.5% to 3. and inflation has been low. Business cycles include a peak at the top of the cycle.8 C 443. and entrepreneurial activity (profits). Eventually the economy reaches the bottom of the cycle or the trough followed by a recovery as business picks up and the economy heads towards another peak.
Finally. GDP = C NI NNP I G (X – M) (3.400 7. but pollution costs are ignored. 15. a 13. The national income accounts take into account only market transactions and ignore nonmarket and underground economy transactions. Production that pollutes increases GDP. c 15. c 16. More people in the population have entered the labor force and are employed. but do not improve our lives. .000 4. d 17. b 3. these activities. suffered early on a serious recession (1981–82). No economy has a perfect record over 25-plus years. d Suggested Answers to Text Questions and Problems for Chapter 16 1.400 – 1. c 12. 3. d 2. c 18.500 9. A favorable new report on job gains could bring discouraged workers or others into the labor force. 2. If the number of newcomers is greater than available jobs. the unemployment rate would rise. Sales of existing houses are not included in GDP. c 10. but the United States has had a record-breaking run over the last three decades.A. GDP rises as they now pass through the market. you don’t consume the entire housing services of a new house in the year of purchase. d 4. b 20. d 14. A falling unemployment rate could conceivably be due to a large number of discouraged people dropping out of the labor force because they can’t find jobs. d 5. but if you hire someone to do these activities. New residential construction is included in investment because of the long life of housing.600 11.200 550 800 10.000 1. and then suffer two mild recessions. because GDP measures new production in that year. 14. All underground activities are also ignored. If you mow your yard or clean your house. d 7.000 900 150 1. so the number of people counted as unemployed declines. some activities increase GDP.000) (1. b 19. only to see unemployment grow in absolute numbers by 5% suggests that this has been a period representing a remarkably strong economy.900 2.800) 12.40 Answers 13.000 Answers to CourseTutor Homework Questions for Chapter 15 1. c 9. b 6. To have increased employment by more than 40%. d 8. which improve your standard of living.000 – 600 11.200 – 1. and so does the unemployment rate. a 11. are ignored.000 2.
PCE.60. 10.0837 = $40. and cyclical. then daily. and it is a little broader measure of consumer inflation. The four measures are the CPI. By 154. but must be available for work and have been actively seeking work in the previous 4 weeks. 12. 7. As hyperinflation continues. If people are permitted to change jobs or be fired. The unemployment . the number of job leavers would grow as people change jobs with ease. not being able to find a job is a serious psychological loss. It is the price of freedom in labor markets. 6. Workers lose temporarily (until adjustments are made over a longer time period). Creditors lose because inflation has reduced the value of the payments they receive. Teenagers and young people in general have not had enough time to acquire the kinds of skills that are associated with lower unemployment rates (college educations. real median household income has grown slightly. To be unemployed. During a mild recession. 44.960. and by January 2006. and workers must be paid daily so they can spend before the value of their wages declines. 15. new currency. Frictional. Stopping hyperinflation requires a new budget regime. The economy loses the output and income from those unemployed. The PPI reflects prices received by domestic producers at the wholesale level. but the goods and services they buy have gone up in price. People often revert to barter. 5. and a strong commitment to reduce the growth of the quantity of money in circulation. High rates of inflation caused by excessive government spending financed by printing money reduces the value of existing monetary assets to near zero. 13.389 ÷ 1.778). the PCE targets consumer expenditures in the GDP accounts. or trade skills beyond the apprenticeship period). we (the economy) lose jobs as well because the unemployed would have spent most of their earnings.Answers A-41 4. professional training. structural. but when the recession is deep. the number of discouraged workers would grow quite fast. The CPI focuses on retail prices to consumers. it includes all goods and services covered by the national income and product accounts.983). Adjusting 2004 median household income in real dollars. Extensive job training and retraining programs would be most useful for structurally unemployed people. All of this disrupts the normal operating of an economy. you must not have a job. generating abject poverty for many people. PPI.9%. In a boom. 14. You were not actively seeking work over the past 4 weeks. So. Cyclical unemployment is minimized with good monetary and fiscal policies to reduce the swings in the business cycle. college graduates in 1980 were paid $1.542 a month ($1. and the GDP deflator. For those who want to work. resulting in greater employment and income.200 . wages must increase weekly.512 ($3. 11. adjusted for inflation. A job-matching employment service would reduce search time for the frictionally unemployed. Not in the labor force.000 1. The GDP deflator is the broadest measure of inflation. the number of job losers would probably increase the most. Although the unemployed lose income directly. For our hypothetical example. frictional unemployment will exist. because their wages have risen. 8. 9. they received $1.
5 2.65 5 . a 14. [(34. c 15.7 250. and real GDP is GDP real GDP price level So the changes in the three variables over 1960 to 2000 should be the same.803.110. d 17. Yes.A. b 7. c.817/526.8 3.1 9. d 4.0 a.109.817/2.74 (4) The general relationship among GDP. a 11.817. GDP per capita reflects output and ignores the economy’s impact on the environment.789.00/20.0 7. b 9.3 5.763 14. 16.4 (1) 9.4 1.763 Year 1960 1970 1980 1990 2000 GDP (billions of dollars) 526.038. c 13.7 205.817. d 16. b . b 2.74 100 139. 18.99 (3) 9.626.393 22. d 20. b.06 81. c 5.53 54. This is an average number for the economy and doesn’t reflect any changes in the distribution of income and wealth.42 Answers rate is the number of unemployed divided by the labor force (the sum of the numbers employed and unemployed).772. These and other issues were discussed in the previous chapter. Real GDP per Capita (billions of 2000 dollars) 14.61 100.626. b 19.04 27. c 12.226/14.437 28. d 3.537] 100 (20.1 282.4 18. thus. c 6.1 227.1%.99 3 .0 Population (millions) 180. a 18. GDP Deflator (2000 = 100) 20.432 34.5 5. c 8.04 4.65 (2) 100. the price level.537 18. Answers to CourseTutor Homework Questions for Chapter 16 1.537)/14.8 9.00 Real GDP (billions of 2000 dollars) 2. c 10.8 5 3.537) people are 139% better off on average.
economy would be considerably smaller today and our standard of living would be lower.174 trillion) if it can continue to grow at a 10% rate in the next 50 years. 7. China would need to grow all three of these factors more than three times faster than the United States. 4. If for some reason people did save (Say’s law was not quite a law). Competition in product markets meant that worker’s wages were determined by productivity. 3. China would have a GDP of $115 trillion.000 4. but that lower growth rate compounded over the next 50 years would mean a significantly lower standard of living for your great grandchildren.300. If these kinds of freedoms are missing. so no surplus of output could result. dams. The magic of compound interest is most evident over long time periods. Competition in labor markets resulted in employment of all of those willing to work at market determined wages. the U. but not necessary to have a vibrant and prosperous economy.500 117. . However.000 ($7. half of the United States if its growth rate was just 3%. especially when you focus in on economic growth. and the United States’ would be $194.4). 5. Not well. If the United States only grows at 3%. Differential growth rates are the difference between abject poverty and prosperity. and the efficiencies of production and distribution are lost. Many industries in the United States are not competitive in the classical sense. for example. many businesses will be local and small. 6. Say’s law meant that workers spent their wages on products. and investments in education and schools. Without the investments of past generations in infrastructure (roads. Why one country grows and another doesn’t—leaving its population living on less than 2 dollars a day—is clearly one of the most intriguing and important questions in economics. or increase in capital. etc.). and Singapore are clear examples of countries without any significant resources that have high standards of living. as your time horizon expands and all variables in the economy can change. China’s per capita GDP in 50 years if it continues to enjoy real growth of 10% annually will be $880. At a 5% grow rate. Economic freedoms include everything from encouraging private markets to liberalized trade rules to free capital markets to protection of property rights. increase in labor. Hong Kong.2 trillion. A country’s standard of living is based on past growth rates. Without economic freedom. 2. competitive markets for capital and flexible interest rates would bring saving and investment into equilibrium and keep the economy humming around full employment. it will only be $57. A lower growth rate today would have little impact on our standard of living. Japan. Natural resources are helpful. This is one of the limitations of the model. and this seems unlikely over a 50-year horizon. 8.Answers A-43 Suggested Answers to Text Questions and Problems for Chapter 17 1. These countries do have large numbers of well educated productive people that have contributed to growth. Unions and labor laws all reduce flexibility.S.4). Classical theory suggests that growth comes from technology or innovation. China would be a huge economy ($1. firms have little incentive or the ability to grow and invest. and its per capita GDP would be $86. the classical model’s usefulness improves. To maintain a 10% real growth rate.000 ($44.
But for many countries. Economic freedoms also add to the quality of life. resulting in more. Technology can reduce the quantity of natural resources needed for modern products and reduce our overall usage. Also. are making energy use more efficient. or union membership may prevent them from working at the “prevailing” wage. and as income grows. Foreign investment can help to jump-start an economy. coal and oil take over. The goal is to see that these firms leave a permanent increase in economic growth and prosperity. per capita income will decline—more people to spread the slower growing pie. 14. and then power plants dispense power more efficiently as income grows even further. As economies grow and per capita income rises. As economies grow and prosper. and governments provide different levels of services (holding per capita income the same). with higher energy prices. but the birth of a child subtracts from it. Per capita income is a reasonable measure to compare countries.44 Answers 9. then some involuntary unemployment will exist. Investment in human capital such as education and improved health increase the standard of living for individuals as they become more productive and earn more throughout their working lives. population growth rates typically fall. When a country’s financial sector is subject to frequent crises or the currency is subject to wide fluctuations in value. For the economy as a whole there are positive spillovers from more productive workers. Capital markets today are highly competitive and global. more energyefficient lightbulbs. the usage of resources becomes more efficient. For example. Some people want jobs. businesses and consumers find their nor- . If the labor market is not highly competitive. 12. higher levels of education mean more workers are more able to use and create improving technologies. As income grows. Using investment tax credits that are an offset to tax liabilities reduces the cost of investing. 15. Saving can be encouraged by making more savings not subject to taxation. investment by government in basic research can often result in more research by private companies to turn these basic discoveries into potential products. but not perfect. other firms develop to provide services and goods to the employees of these foreign firms—now with higher incomes. Investment can be encouraged by tax policy as well. Peter T. 13. for example. Bauer suggested that the birth of a cow adds to per capita GDP. Areas where the population is poor can benefit from the jobs and income that foreign investment provides. 11.S. further slowing population growth. The 401(k) accounts used for private pensions in the United States are an example.A. something here is not quite right. 10. Energy is an example in which poor societies rely on wood. If population growth exceeds economic growth. labor markets much less so. Also. professional regulations. but policies like minimum wages. Focusing taxation more on consumption (sales taxes) rather than income will encourage saving. this is a balancing act to assure that foreign companies add to economic growth and development without simply exploiting natural resources or creating environmental problems. On the usage side. alternatives like solar and wind may eventually provide considerable power. and these add to standards of living. So this may keep population from covering all of the earth. Today. government has led to significant research and development by the drug industry into new treatments and drugs. further adding to income. the Human Genome Project started by the U.
4. k 1/(1 MPC) 1/MPS 1/. d 6. c 12. d 9. d 4. b 5. APC 1. whereas the MPC is the change in consumption associated with a change in income ( C/ Y). MPC and MPS were always constant at MPC 0. When Y MPC 0. Lower investment. c 10.043. so consumer spending falls. b 8. 2. We saw in problem 3 that at Y 2. Note . MPS 0. d 2. reduce a country’s overall growth rate. APC 1.6 and MPS 0. The APC is how much an individual consumes out of total income (C/Y). 2.800. c 3.4.300. Some consumers will decide not to purchase items normally purchased on credit. d. c 7. and APS 0. a. Higher interest rates mean the cost of borrowing rises. c 20. The APC and the APS are the proportion of total income that is spent and saved. and other poor economic decisions because of financial uncertainties. c 17.800. 3. d 14. APS 0. a 16. d Suggested Answers to Text Questions and Problems for Chapter 18 1. b. See figure below.500. b 18. d 13. Answers to CourseTutor Homework Questions for Chapter 17 1. S e Saving and Investment 120 I a 0 24 25 26 27 28 80 Income (hundreds) 4.4 5 2.6.035.5. Y 2.Answers A-45 mal activities interrupted. This leads to economic uncertainty and reduces investment in productive activities. d 19. When Y 2. But also in problem 3. b 11. e. c. d 15.
and research and development has the capacity to do the same.6 (300/500).000.000. and some is saved. 11. consumption falls so significantly that business can’t sell all it can produce and inventories grow more than expected. The multiplier is equal to 2. government spending would have to rise by $250. the initial impact of the tax reduction is muted by the portion that is saved. so an aggregate expenditure increase of $400 is required ($400 2. so with a multiplier of 4. infrastructure. When taxes are reduced by $100. 9. For example. With such excess capacity. and saving and investment will be equal to $500. .000.75. 6. so income rises by $400 to $3. We learned in question 12 that an increase in aggregate spending of $400 was needed to close the GDP gap of $1. This new spending (MPC new income) now becomes someone else’s income to be spent. The balanced-budget multiplier is equal to 1. When the economy falls into a depression. this is essentially the same as income rising by $100.4). 8.5 and income must grow by $1.000). Thus.A. c.400.46 Answers that the MPC and the MPS are equal to the change in consumption or saving associated with a change in income and not necessarily equal to the proportion spent or saved. The multiplier is 4. d. Because only 0. since the multiplier is 2.5 $1.6 (the MPC) of the tax reduction will be multiplied. we will need to reduce taxes by more than $400. MPC . an improvement in business expectations regarding the economy and improvements in technology that stimulate innovations in new products. so government spending and taxes would each have to rise by $1. Some of this increase in income is spent (consumed).25. Both of these may improve our standards of living in the future. few business are willing to invest in new capacity to produce more that can’t be sold. a. reducing the ultimate impact on the economy. potentially reducing our rate of economic growth. and so on. With a multiplier of 4.6 equals $400. The MPC is 0. Government spending on education. the MPS is 0. 13.5 (1/0. The multiplier exists because an initial expenditure becomes someone’s income and a portion of this new income is spent and some is saved. So the question boils down to what tax reduction times 0. if government spending is too high.000.6) 400/0. This is the recessionary gap.5. and the multiplier is 2. it can “crowd out” private investment. 7. a $667 tax reduction will close the GDP gap of $1. 12.6 x x $667 So. But some government spending is more like consumption and has little impact on the future. The algebra is 400 x(0. and MPS .4 (200/500).000. 10. As we will see in later chapters. The multiplier is equal to 1/(1 MPC) 1/MPS. b. Private investment typically leads to future increases in productive capacity and often to increases in productivity. The income gap is $1. 5.
800). an increase in AD just translates into higher prices (inflation). Since most of the benefits from IT are efficiency of production and distribution. our understanding of macroeconomics is better today. Some consumers will decide not to purchase items normally purchased on credit. c 15. b 4. Answers to CourseTutor Homework Questions for Chapter 18 1. c 8. but it quickly moves back along the LRAS curve and back to full employment. c 19. so consumer spending falls. the economy might expand beyond full-employment output. 5. A leftward shift in the AS curve causes two problems for policymakers: increased unemployment (lower output) and a higher price level (inflation). b 13. these were virtually nonexistent in the 1930s. unemployment compensation. c 17. . To bring the price level back to its original state would require AD to be reduced. d 7.67) 1/. d 9. 4. If aggregate supply declines. 3. 2. the price level falls (or inflation pressures are reduced). resulting in a higher equilibrium output at lower prices. d Suggested Answers to Text Questions and Problems for Chapter 19 1. Today we have many programs that help poor and unemployed people. Thanks to Keynes. d 16.33). and Medicaid. the inflationary gap is the reduction in aggregate expenditures needed to bring the economy down to $4. c 5. c 3. but now the price level is even higher.67. the multiplier is 3 (1/(1 . Temporarily. To reduce unemployment by increasing AD will cause more inflation. d 2. the price level rises. d 20. increasing unemployment even more. you should show a shifting of the AS curve to the right. Higher interest rates mean the cost of borrowing rises. b 10. If aggregate demand declines. and with an MPC of 0. b 18. during the 1930s we did not have a systematic process of data collection on the economy. d 12. a 6. So.800 and is equal to $300 ($900/3). When the economy is operating at full employment. The GDP gap is $900 ($5. so often policymakers made policy based on anecdotes.Answers A-47 14. 15. Unemployment during the Depression peaked at 25%. Less inflation is better than more. whereas today unemployment is around 5%.700 $4. Also. d 14. such as welfare. d 11.
a. a change in personal taxes. Unexpected events such as Hurricane Katrina or a war can alter government spending. For example. employment is below full employment. LRAS AS1 AS0 b e AD1 Aggregate Price Level (P) P2 P1 P0 AD0 0 Qf Q1 Aggregate Output (Q) Initially. regulations. labor and other input markets tighten. so an increase in aggregate demand simply results in a rising price level. exports or imports will shift the aggregate demand curve. Remember. so output can be increased with no effect on prices. wealth. when AD declines by x. During a depression. b. copper. AS0. 10. For example. increasing wages and costs. the recent worldwide increase of many commodity prices including oil. e b. 8. We will learn more about this in later chapters. where output grows to Q1 and a new price level of P1. so the simple multiplier is equal to 3. or business expectations about the economy will also shift aggregate supply. P2. and aluminum eventually will reduce aggregate supply. This causes the AS curve to shift to the left and continues until the economy returns to full employment.48 Answers 6. 7. and increasing output may require overtime (hiring and training of people takes time and adds to costs). and the economy has a lot of slack. Aggregate demand fell by 100.600. so prices rise somewhat. Changes in income or exchange rates (the value of one currency for another) can change imports or exports. and reach a temporary but short-lived equilibrium at point b. the economy is at full employment.A. the economy will expand along the AS curve. But in the long run. A change in productivity is another important factor that will shift the aggregate supply. government spending. or consumer confidence will change consumption. Any change in the price of inputs will shift the aggregate supply curve. The short-run equilibrium will be at point a where Q $2. resulting in a rise in the price level along with rising output. Any factor that changes consumption. At this point. and the gap in GDP is 300. In normal short-run circumstances. 9. the change in equilibrium income. divided by the change in aggregate demand is the multiplier. Changing tax rates. but at a higher price level. investment. Changes in interest rates or business forecasts for the economy will change investment. the unemployment rate is high and the economy has significant slack. .
Long-run output will be at 600. health costs. 15. Consumer confidence is one important factor driving consumer spending. 14. and lead to more productive employees. These programs reduce sick days. Japanese investment in the United States increased investment spending and reduced imports of Japanese cars. 12. 13. removing the responsibility of health care costs from private firms would reduce costs to businesses and increase aggregate supply (this is the equivalent of lower resource costs). P 100. with all workers covered. both situations represent firms seeking production costs that keep them competitive. c. Since consumer spending is roughly 70% of total spending. Yes. Many companies today have “wellness” programs that provide incentives (money and other rewards) to employees to eat right. exercise. policymakers can just reduce aggregate demand and the economy will return to full employment at the old price level. . b. increasing net exports.000 A-49 Aggregate Price Level (P) 150 125 100 Aggregate Output (Q) a. and generally take better care of their health. output falls and the price level and unemployment rise. workers might become healthier and more productive. Reducing aggregate demand makes the recession worse. First. The rising value of the yen made production in Japan relatively expensive. a small drop in consumer spending results in a large change in equilibrium output and income. Second. Q 800. so increasing aggregate demand to bring the economy back to full employment results in an even higher price level. producing in the United States made them more competitive. increasing aggregate supply. To solve demand-pull inflation. LRAS AS a e AD1 75 50 AD0 0 200 400 600 800 1.Answers 11. With costpush inflation. and the new price will be between 125 and 150. Q 600. It could affect aggregate supply on at least two possible levels. P 125.
High tax rates in this case are probably keeping development low. d 6. 8. d 14. cutting its impact on the economy. With half of the economy underground. or invest in new production capacity. these payments continue to be sent. 6. b 3. When the economy enters a recession. a recession could drag on for an extended period. cushioning consumer spending. As part of the automatic stabilizers. so only a part of the tax cut is spent. d 12.50 Answers Answers to CourseTutor Homework Questions for Chapter 19 1. but even if it comes a little late. there are lags in implementing fiscal policy. Without it. c 10. variations in output and employment may decline. Tax rates are relatively low. it is not entirely of no benefit. Buying goods from businesses increases aggregate demand. b 15. 5. so the big economic growth impact is muted. c 7. a 19. pay factors. 7.A. d 4. An annually balanced budget would eliminate the automatic stabilization aspect of the federal budget. High tax rates keep small firms in the informal market from becoming legal—the price is too high. With a balanced budget amendment. 2. who will use these funds to purchase other goods. leading to greater sales by firms. 3. When the economy enters a recession. and this explains Brazil’s high rate of poverty. d 17. c Suggested Answers to Text Questions and Problems for Chapter 20 1. surpluses will fall and deficits will rise. In contrast. the budget normally moves toward a deficit as transfer payments increase and tax collections decline. Dunn has it right. Rising government spending and declining taxes (via automatic stabilizers) will help to dampen a recession. Clearly. d 11. spending would have to be cut back or taxes raised. d 5. Increasing government purchases of goods and services is expansionary fiscal policy. Combined with a multiplier . and losses could continue to pile up. The benefit of such an amendment is that the growth (or size) of the federal government would be restricted. legitimate firms must bear a bigger burden of taxes. 4. Mankiw and Weinzierl’s study is more consistent with point a. c 13. and as the total number of payments increase with the retirement of the baby boomers. a 9. causing the recession to be deeper. c 16. d 20. All government spending affects the economy. When a recession hits. b 18. c 8. some of the tax cuts are saved. c 2.
so the decline in tax payments and the increase in disposable income would be less. people move into lower tax brackets. it is for current consumption and not public investment. The tax rebate checks to people were a one-shot injection of spending that may have helped cushion the impact of the recession. This leaves them with more disposable income. Often when governments run deficits. thus. since it turned out to be one of the mildest on record. As the baby boom generation retires and goes on Social Security and Medicare.Answers A-51 effect. Cutting taxes increases disposable income. aggregate demand. 14. Yes. 13. 9. Yes. acting as a buffer against the recession. and changes to income tax rates once they become law are implemented quite quickly through withholding tables. income and employment will expand. putting more income in the hands of households. A flat tax is a proportionate tax. leading to higher consumption and increasing aggregate demand. this proportion will likely rise. expansionary fiscal policy (increasing government spending or transfer payments. which affects consumer spending and. businesses are looking to invest to expand capacity or upgrade (modernize) existing facilities in an effort to increase productivity and reduce costs in the future. However. while lower tax rates encourage work effort because take-home pay is higher. When the economy is entering a recession. . 11. and their taxes fall faster than their income falls. reducing their consumption and acting as a brake to further economic growth. higher tax rates discourage work effort. Today’s citizens are often consuming at a higher rate. it is a reasonable argument. pushing these costs to future taxpayers. In dire times. By crowding out private investment. our economy is smaller in the future. and this is still probably enough discretionary spending to keep discretionary fiscal policy potent. 15. The mandatory part of the federal budget is approaching two thirds. people move into higher brackets and the amount of taxes they pay rises faster than their income. tax rates affect investment levels and the incentive to invest. tax rate changes affect consumer income. This process slows the growth of their disposable income. but their impact would be less. In normal times. Raising taxes or reducing transfer payments is contractionary since the government is reducing private income. Taxes would still be an automatic stabilizer. a decline in income leads to a greater-than-proportionate decline in tax liability. Further. When the economy is booming and income is rising. Further. As a result. consumption falls less than income. 10. Under a progressive tax system. On the demand side. Getting new government spending with a new program on line is a time-consuming process. Keynesian analysis is primarily concerned with moving the economy out of a depression. Just the opposite occurs when the economy slides into a recession. However. business is so pessimistic that investments are put off because excess capacity is abundant. 12. even one third of the federal budget will shortly approach $1 trillion. Tax rate changes also affect the supply side by altering incentives of labor to work. which will lead to reduced consumption. fiscal policy can be implemented much faster for existing programs. Incomes fall. reducing spending (or eliminating programs) is often extremely difficult given the vested interests in each government program. it would reduce the robustness of the personal income tax as an automatic stabilizer. or tax cuts) is called for.
and this reduces the money multiplier from its potential value. Money is less costly and easier to store than most of the goods we consume. d 15. No. b 6.52 Answers Answers to CourseTutor Homework Questions for Chapter 20 1. b 14. b 20. c 13. Money serves as a medium of exchange. d 8. When daily reserves are consistently below those required. M2 is a broader definition that includes M1 plus other near monies such as saving accounts and money market accounts. c 11. bank regulators tend to look unfavorably at banks that are always borrowing to shore up reserves. a unit of account. 3. . the FDIC has provided sufficient security that runs on the bank by depositors have been prevented. This is particularly true for digital money and credit cards.A. Modern economies are too complex with too many goods—barter would prevent the attainment of a modern economy. d 4. Reserves are required to prevent banks from becoming too extended financially and maintain that cushion to prevent the bank from not meeting its obligations. 6. Theoretically banks can create up to 1 4 reserve requirement (the money multiplier) of new money based on the initial deposit. 5. c 12. 8. and a store of value. Banks hold excess reserves for several reasons. d 10. Barter networks could exist. c 3. a 9. c Suggested Answers to Text Questions and Problems for Chapter 21 1. When these loans are deposited back into the banking system. b 16. 4. Some banks hold excess reserves to have sufficient cash for ATMs and branches. c 18. c 5. d 7. they create further excess reserves and loans. c 17. 2. and so on. Because required reserves make the banking system a “fractional reserve” system. d 2. 7. but the number of prices soon becomes unmanageable. More or less. M1 is essentially currency plus checkable deposits (demand deposits). so this is something to avoid. Finally. Barter requires a double coincidence of wants: You have to find someone who produces what you want and wants what you have to trade. banks can lend only excess reserves (those in excess of required). a 19. the bank must borrow from the Fed or the Federal Funds Market. and this involves costs. Checking accounts or demand deposits are liabilities to banks because depositors have loaned this money to the bank until they write checks and “demand” this money be paid to someone else.
This longevity of governors gives the Federal Reserve its independence in policymaking. 15. and reliably assets can be converted into cash.000. New York. 11. and robust economic growth. Recall what the impact of hyperinflation is and how it devastates existing financial assets. The degree of liquidity of the last three items on the list will depend on supply and demand. ■ cash ■ checking account ■ savings account ■ 100 shares of Google ■ 1-caret diamond ■ Harley Davidson motorcycle ■ your old leather jacket ■ house (real estate) 10. But. a coupon rate of 5% on a $1. then the market price of the bond will be $1. Most economists think that Fed independence permits the Fed to set the tradeoffs among the three goals of price stability. . in much the same way that tenure in universities fosters academic freedom. the seven governors are appointed for 14 years with one term expiring every 2 years. Thus. if market interest rates should rise to 10%. Remember that liquidity is determined by how quickly. Our money is fiat money—nothing but what it will buy is backing the currency. Open market operations are the most frequently used policy of the Fed. the price of the bond would fall to $500 because $50/$500 10%. 14.000 par value bond would result in $50 paid to holders of the bond each year. for example. Although Congress has supervisory authority over the Fed and consent over appointments to the Board of Governors. Inflation depreciates the currency’s value. The argument is that independence helps the Fed focus in a professional way on keeping long-run inflation in check without the short-run distraction and political pressure to expand the money supply to increase output and income beyond what is prudent. Reserve requirements are lumpy changes that would have big effects. and vice versa. full employment. 13. We all have faith that the government will not debase the currency by printing too much. and extreme inflation (hyperinflation) renders the currency worthless. bond prices fall. By keeping political pressure to continually expand the economy away from the Federal Reserve. and changing reserve requirements are the least. but real estate transactions nearly always involve a lot of time and transactions costs (real estate agent fees). If market interest rates are 5%.Answers A-53 9. creating a whole host of problems for society including stifling growth and forcing people to turn to barter. The New York bank is the only bank to execute through open market operations (buying and selling government bonds) the policy of the FOMC. The Federal Reserve opts for more subtle and precise changes: open market operations that can quickly adjust to changing conditions in a measured way. 12. Bonds have a fixed coupon rate of interest that results in a fixed dollar amount paid out each year as an interest (coupon) payment. easily. So. as interest rates rise. its decisions will reflect a more balanced approach to the economy.
the conclusion of monetarists and the classical school.000. c. 2. c 14. Increasing the cost of borrowing (interest rates) will reduce investment and consumer spending. and the price level and probably wealth as well. a. b. This often means slower growth and lower corporate profits. 3.860. and output will fall in the short run.000). b 20.860. If energy prices double. The relative price of energy has changed (one commodity). long-term inflation rates will not increase.000. c 6. These policies can also lead to excessive borrowing. so loans will rise by $650. the price level will rise. a 9. 5. Left alone. monetary expansion can increase output.000) in reserves. reducing output and economic growth. income. d. Second.54 Answers 16. then remain at the higher level. Total deposits will equal $2. insufficient saving. Higher interest rates might affect the stock market for at least two reasons.A.000. it would be subject to more political pressure. total loans will be $1.000/$2. and total reserves will equal $1.35 2. First.000. but unless the Fed accommodates the energy price rise by expansionary monetary policy (increasing the supply of money) to increase output. Easy money policies (lower interest rates and a more rapid growth in the money supply) ultimately lead to higher inflation rates in the long run. b 2. b 5. increases in the money supply simply turn into higher prices. along with appro- . Answers to CourseTutor Homework Questions for Chapter 21 1. thereby reducing inflationary pressures. d 19. c 12. c 13. but then fall back to the level targeted by the Fed. Independence permits the Fed to focus on fighting inflation.000. b Suggested Answers to Text Questions and Problems for Chapter 22 1. But over the long run. the economy will adjust to higher energy prices without increasing the long-term inflation rate. d 15. In the short run. The potential money multiplier is 1 reserve requirement 1/. high rates mean the Fed is trying in some way to restrain the economy.86. b 16. a 8. b 18. d 11. c 7. and unsustainable asset prices (bubbles). 4. c 10. 6. higher rates make bonds a more attractive investment.000. c 17. c 4. employment. If the Fed were not independent. The inflation rate will bump up temporarily. The reserve requirement is equal to 35% ($700. The bank must keep 35% ($350. a 3.
As a result. and choices are made for a variety of reasons. it seems to have worked. The equation of exchange helps explain the long-run relationship between the money supply (M) and the price level (P). contractionary policy will bring the economy back to point e. If a negative supply shock hits the economy (energy prices jump). the Fed may receive a lower price (the supply of bonds has now increased). By keeping rates low. But at full employment. aggregate demand shifts to AD1. Countries where the central bank is not independent tend to have higher long-run inflation rates. with some rise in the price level. the money supply immediately shrinks. now the Fed faces a dilemma: Expansionary policy will bring the economy back to output Q0. controversial. One reason is that the opportunity cost of holding money is the interest rate. The Fed either buys or sells government securities. The opposite is true when the Fed buys bonds. This leads to a further contraction in the money supply. 13. To entice buyers to purchase the bonds. as do bank reserves. making transparency easier. on the other hand. shifting the aggregate supply curve to AS1. When interest rates are low. In the long run. When the economy is considerably below full employment. they can focus their analysis and policy statements around that target. Either a business investment is worthwhile. 7. 9.Answers A-55 priate concerns about employment and output. people are willing (and want to) hold higher money balances. the Fed can use expansionary policy to return to the initial equilibrium point e. and these lower prices mean interest rates rise. There is rarely complete agreement among policymakers. and this investment somewhat offset the declines in investment following the dot-com bust and the downturn in 2001. velocity (V) is a function of institutions and technology. Using contractionary policy to return to the original price level will make the recession worse as output declines to Q2 (point c). 12. individual buyers or banks use checks or cash to buy those bonds. Supply shocks. This was a tough choice for the Fed. When central bankers have an explicit framework (inflation targeting). V and Q are fixed. The Federal Reserve’s response to demand shocks is effective because if. When the government sells securities. so changes in M lead directly to changes in P. for example. increases in the money supply lead primarily to increases in the price level. As a result. when it falls. it can be difficult for the Fed to get any traction in the economy by lowering rates further. The same is true if aggregate demand expands to AD2. but the price level will rise to P2 (point b). and undergoing debate and development. increases in the money supply will lead primarily to increases in output and income. where the price level and output fall. but may have resulted in the subprime lending binge that led to a housing bubble that showed signs of collapsing in 2007. The issue of transparency is difficult. . 10. and the economy hovers around full employment output (Q). 8. 11. pose a more difficult problem for the Fed. the Fed kept the housing-construction sector strong. or it is not.
d 12. Answers to CourseTutor Homework Questions for Chapter 22 1. Yes. and more importantly. Looking in the rearview mirror might be what the Fed would be doing if it let inflation expectations into economy-wide decision making. b 11. Information and recognition lags. d 9. and where they think it is going. d 6. a 19. c 15. but their policy changes take a long time to have an impact. c 18. Supply shocks (oil price increases) may take a while to work themselves through the economy. c 5. b 7. as consumers and businesses begin to build this inflation into their expectations about the future. Not only must the Fed worry about what consumers and businesses in the United States will do. They differ in that Fed policymakers have a more complex environment in which to make policy. The Fed makes policy based on where the economy is today. once they get a head of steam. d 4. c 3. b 13. But. c 8.56 Answers AS1 P2 b a P1 c P0 e AD2 AS0 Aggregate Price Level (P) AD0 AD1 Q2 Q1 Q0 Aggregate Output (Q) 14. b 16. c . they can become a difficult problem. b 10. 15. but they must also be concerned with international impacts and changes as well. d 14.A. it is very similar. d 17. d 2. c 20.
and quite probably. the more likely inflation will result. The closer the economy is to full employment. but both Social Security and Medicare can be altered by Congress. and constituents always seem to have unmet needs. One big benefit to business is that the government may be retiring (buying) debt. Notice that this is essentially the opposite of crowding out. 2. as we will see in the next chapter. and inflationary pressures. how close the economy is to full employment. 3. Corporations would have trouble altering their existing contracts with pensioners (unless the corporation is insolvent). 8. making more investment prospects more attractive to business. If the deficit is monetized ( M 0). so these funds are just transfers among Americans. or making a certain portion of savings tax-free. Shifting from income taxes to consumption taxes would encourage saving as well. 5. even with added economic growth. If the government (through the Fed) sells bonds ( B) to the public. The inflationary impact of budget deficits is contingent on several factors. Today. output. 7. the recession will be worse. 6. net foreign saving in United States will fall. 4. automatic stabilizers will reduce a surplus. the inflationary impact will be greater than if it is financed by bonds. interest rates rise. So. The government can encourage saving and matching a portion of savers funds—like 401(k) plans. the government only recovers 10–20% of the tax revenue lost from lowering tax rates. And. Some recent studies suggest that. Marginal income tax rates approaching 70% were a disincentive for work and a disincentive for a spouse to enter into the workforce as a second income earner. When the economy enters a recession. It probably would be a good idea to make such a calculation part of the budget document each year—if only to remind us of the size and how it is changing. One thing that differentiates the government from private corporations is its ability to print money (monetize the debt). the more likely price increases will result. Balancing the budget somewhat over the business cycle is preferred. much (about half) is owed internally. and the extent of the inflationary expectations in the economy. . so the government’s efforts to increase bond prices drives interest rates down. a deficit would only be inflationary to the extent that it is financed by M. or a determined effort by Congress to balance the budget. thus dampening investment. Since G T M B A. tax rates and high-income people are 35%.Answers A-57 Suggested Answers to Text Questions and Problems for Chapter 23 1. M will be smaller. the impact of these automatic stabilizers will be reduced. the greater inflationary expectations are. The United States is probably on the left side of the Laffer curve at this point. though most people are way below that. Congress finds it difficult to cut spending (no one likes to preside over dismantling of a program). Given that G T (S I) (M X). for a given deficit or surplus and a given level of investment and exports if S is larger. The surpluses generally require a booming economy in which tax revenues are streaming in faster than politicians can spend them (rare). By reducing spending or increasing taxes. Second. including how the deficit is financed.
Since some of our imports are from Europe. the same is true. Solving this problem will require increases in taxes. and banks hold government securities because they are “risk-free. many individuals. if G T went from a large positive to zero and (S I) did not change. more money currently paying interest on the debt could be used to support low-income families. since recoveries are typically longer than recessions. The other half is held by government agencies. Two problems. Given that G T (S I) (M X).58 Answers 9. for several reasons. the real cost of paying added interest each year is that it subtracts from money that could have been spent on other programs or projects. . This is especially true when interest rates are low. because our imports are greater than our exports. nor do we know how large a deficit is needed to help the economy begin to recover. roughly only one quarter of the debt is held by foreigners. In other words. Thus. so the left hand of the government owes the right hand money with half of the total debt. if all the debt were retired. or a combination of both. policymakers are politicians beset by special interest groups that always see the need for new programs and fight reductions in spending by the government. cuts in the entitlements themselves. Second. First. or cuts in other areas of the budget. In addition.A. when we are in recession. However. Ben Stein (and Standard & Poor’s) is referring to the fiscal imbalance caused by the growing entitlement liabilities of Social Security. then the debt as a percent of GDP is declining. In general. Probably not. Balancing the budget over the business cycle does seem like a reasonable approach. our position is becoming better. however. half of that is held domestically. The argument is that it’s mostly high-income (or wealthy) individuals who own treasury bonds and they receive the interest. Third. we don’t know how long it will last. if the debt were less. further skewing the income distribution in favor of high-income people. imports would have to fall or exports would have to rise. First. 12. In addition. no. Medicare. even if the absolute size of the debt is large. 13. First. only half of the debt is held by the public. this would complicate its efforts. if the economy is growing faster than the debt is growing. present themselves. 14. then (M X) would bear the brunt of the entire adjustment and would have to become smaller by $300 to $400 billion. but that is a lot less than what is implied by the gross public debt numbers. companies. open market operations are used as the primary tool of the Federal Reserve. slowing the growth of their economies. reducing income inequality. when in a recovery. so the tax payments to pay the interest on the debt goes to other Americans. 11. Second. adding to income inequality. and policymakers worry that the policies needed to run a surplus will bring a halt to the recovery. of the half held by the public. What programs are going to be cut? 15. 10. Second. and that is a real claim on our resources. when interest rates climb. To the extent that GDP reflects the ability of the country to pay for debt. and the prescription drug program. it is likely that their exports to the United States would fall.” This would make diversifying their portfolios more difficult.
d 10. Rational expectations imply that economic actors take into account all available information and put that information into a reasonable economic model. raising inflation even further. 2. Expansionary monetary and fiscal policy designed to keep the economy below the natural rate of unemployment leads to a higher rate of inflation (on the original Phillips curve). when the economy approaches full employment (when unemployment gets below 4%). When the economy has a lot of slack. 5.Answers A-59 Answers to CourseTutor Homework Questions for Chapter 23 1. d 17. there are different views on how low unemployment can be pushed before inflation becomes a problem. a low unemployment rate makes reelection easier. b 6. c 18. d 7. Products with falling demands and those with increasing supplies would not want prices raised since inventories of these unsold items would just rise. the economy can expand with little pressure on prices. 3. b 13. d 8. And thus the cycle repeats itself. b 4. d 3. d 20. d 19. This higher rate of inflation raises inflationary expectations. the vertical long-run Phillips curve (LRPC) means that expanding aggregate demand to move the economy to higher levels of employment when the economy is at full employment will simply mean a higher level of inflation. but the Fed does not have to push interest rates as severely because inflationary expectations are considerably less. Further. d 5. 7. Yes. c 12. shifting the Phillips curve right and worsening the inflation-unemployment tradeoff. 4. After the Fed’s performance over the last three decades. However. d 9. c 11. people are confident that Fed policy will be to keep inflation low over the long term. labor and other markets tighten and any further expansion is met by rapidly rising prices. Including product prices would be unworkable since many product prices are actually falling even if inflation exists. Now. d 16. some policymakers. First. but there are no systematic biases in their errors. Politicians. d Suggested Answers to Text Questions and Problems for Chapter 24 1. Economic actors are not always right. . d 15. No. say. when unemployment exceeds 6%. Oil prices are rising. and some academics see unemployment as a bigger problem than moderate inflation. b 2. For politicians. to keep the economy below the natural rate requires more expansionary policy. 6. a 14. adjusting all factor payments would remove some of the pressure to keep inflation low.
c 9. even with energy prices rising. Inflation would be very low (possibly even deflation). So firms are reluctant to hire new employees. High inflationary expectations make their job of reducing inflation harder. d 16. inflationary expectations are low because individuals and businesses have confidence in the Fed’s commitment to low inflation targets. d 13. d 3. c 2. Now. d 7. c 4. 9. both countries would be losing a lot of output and income as policymakers kept the economy below full employment. d 19. 10.60 Answers 8. A steep slope would mean that small reductions in the unemployment rate lead to large changes in inflation rates. a 11.A. Under this assumption. b 8. The speed at which policymakers increase aggregate demand to return the economy to full employment could affect inflationary expectations. Both show equilibrium points for the economy at full employment over the long run. reducing unemployment is costly in terms of inflationary pressures. d 6. Thus. It would shift out and to the right. but most important. The opposite is true for a shallow slope curve. people and business react in ways that are counterproductive and render policy ineffective. c 12. Probably. a 15. 11. 13. 12. The difficulties associated with firing and laying off workers in Europe mean that employment costs are higher. Today. Estimates of the natural rate of unemployment in most European countries exceed that of the United States. Thus. b 20. c 18. higher unemployment rates are temporarily associated with higher inflation rates. The long-run aggregate supply curve shows long-run equilibrium rates for the price level. the U. unless demand is high and is predicted to remain high over the long term. anytime unemployment slipped below 7%. policymakers typically try a slower growth path back to full unemployment to keep inflationary expectations muted. policymakers would prefer a shallow slope curve—low unemployment rates would be associated with lower inflation rates. Answers to CourseTutor Homework Questions for Chapter 24 1. For this reason. This low level of inflationary expectations probably makes their job easier. c 14.S. b 10. 15. Probably. Inflationary expectations shift the Phillips curve rightward. Those who believe the world is best modeled with rational expectations see policymaking as ineffective. d . c 17. worsening the tradeoff between inflation and unemployment for policymakers. If the economy consists of individuals and businesses that are governed by rational expectations. d 5. while the long-run Phillips curve shows equilibrium rates of inflation. There would be no impact on the long-run Phillips curve. when policymakers decided to implement some policy. 14. Federal Reserve and the Bank of Canada would tighten monetary policy.
American consumers would not gain from trade restrictions. there are clearly winners and losers. 8. goals. David Ricardo showed how specialization in those areas where a country has a comparative advantage. and they purchase the bulk of high-priced imports. Others have different grievances with trade. controlled by a central committee to ensure quality. it is difficult to see how UAW workers would gain. and objectives. 5. this assistance involves helping with retraining expenses. The states of the United States generally have the same objectives and goals. Michelle Wie would hire you to do laundry since your opportunity cost of doing laundry is less than hers. infrastructure. she could earn far more than what she would have to pay you. Since foreign firms are building more cars in the United States in nonunion plants. in effect. Many countries are not at the stage of development where they can afford to mimic U. Open source programs (Linux and Open Office. including environmental impacts and competition with low-paid foreign workers for production jobs. A recognition of this problem of many people gaining at the expense of a few workers prompted the federal government to provide trade assistance to those industries harmed by trade agreements. Foreign auto firms built modern factories in the United States and avoided the quota. Although this is not the stated goal. A comparative advantage exists when one country’s opportunity cost to produce a good is lower than another country’s.S.Answers A-61 Suggested Answers to Text Questions and Problems for Chapter 25 1. domestic film companies have a cultural role to play. 2. . 6. the argument for trade liberalization is that both countries stand to benefit or they would not voluntarily engage in trade. but do not charge for the product itself. In general. 4. Guaranteeing local production companies that their films will be shown exclusively half the time reduces the need (incentive) to be competitive. Although the gains from trade are indeed large. 7. Worker productivity in many countries is not high enough to support high wages or the tax rates necessary for the level of government services provided in the United States. whereas countries often have very different cultures. we have very little information on the distribution of the gains. for example) use the comparative advantage of programmers around the world. 9. Some would argue that the rich get the majority of gains because there is little competition for their jobs. 3. For workers. In the 2 or 3 hours that it takes to do her laundry. A country (or individual) has an absolute advantage when it can produce more of a good or service than another. and many groups on the losing end of trade would probably not support further trade. structure themselves in a similar way to the United States. then trading meant gains for both countries. Yes to both. it would be the impact if many foreign firms or countries were required to meet our environmental and labor laws and wage rates. Outsourcing is leveraging the comparative advantage of other programmers. Hollywood is their main competitor. While not an industry with a huge economic impact. Many countries feel that foreign films will swamp the existing industry and important art forms will be lost. But as we have seen. This is one of the difficulties the European Union is having in developing common rules to.
b. but as was the case in the early 1930s.S. domestic producers would probably not get much of a hearing (they would be encouraged to develop their own secret process). d. Italy’s opportunity cost for olives is lower. With the $5 tariff. so revenues have increased by $80 million. with imports equal to the difference between 16 million total sales and domestic supply of 4 million units. Trade barriers might save some jobs in specific industries. There really isn’t any real difference.A. and Australian (and other nations’) wine companies would clearly benefit.7 million tons of tea for 1 million tons of olives. they both are better off. and employment. total sales are 12 million and domestic supply is 8 million units. c. domestic sales revenue was $10 4 million units $40 million. It is very much like the gains from trade examples discussed in the chapter. so imports will be 12 million and as a percent of U. California. output. and consumers of wine would lose. income. Italy’s opportunity cost for olives is 1. b. 11. a. Before After Specialization Specialization 6 million tons 10 million tons 4 million tons 30 million tons 12 million tons 0 0 60 million tons After Trade 6 million tons 30 million tons 6 million tons 30 million tons Country and Product Italy India Olives Tea Olives Tea 13. Given that Brazil’s secret process is not cheap labor. 15. No wonder domestic industries like tariffs on foreign products. Yes. as shown in the last column. Imports are 4 million times $5 a unit. government. When the price was $10. sales revenue is $15 8 million units $120 million. so the total revenue from the tariff is $20 million. 14. retaliatory trade restriction around the world led to a decline of trade. a.62 Answers 10. 4 million. India’s opportunity cost for 1 million tons of olives is 15 million tons of tea. Developing nations send workers who produce output in developed countries. Italy in olives. 12. The U. so it will specialize in olive production. We benefit and they benefit. See the table below. sales are equal to 12/16 75%. Trade barriers lead to higher product prices paid by all consumers for the benefit of jobs for a few.S. at a price of $15 ($10 $5 tariff). . and the developing world gets some income (remittances) in return. unit total sales will be 16 million. At $10. This is very much like the domestic auto industry going to Washington for help in 2006 and being politely rebuffed. India in tea. comparative advantage is comparative advantage. Quite possibly the migrants to developed nations may reduce wages for some jobs that domestic workers in these countries might do if the pay was higher. so some domestic workers may suffer a loss as consumers reap the benefits.
b 2. c 19. Relative to the euro. the U. however. b 13. As wholesalers and other wine merchants need Australian dollars to purchase wine. and imports of the vehicles will decline. fewer MercedesBenz cars will be ordered. Thus.S. 5. c 11. The capital account summarizes the flows of funds in and out of domestic and foreign assets such as plant and equipment. a 20. 4. remittances from foreigners working in the United States and sending money home would be logged under the “Income Payments (outflow)” subsection “Net Transfers. and so on. The demand in this country for imports exceeds world demand for our exports. c 12. governments alter their macroeconomic policies to maintain the exchange rate at a set level. consumers. 8. In Table 1. Countries who adopt a flexible exchange rate system let exchange rate markets adjust the exchange rate to their macroeconomic policies.Answers A-63 Answers to CourseTutor Homework Questions for Chapter 25 1. As noted in an earlier chapter. d 4. as other Australian export products are now higher priced.S.” 3. 2. c 6. the dollar should become stronger as the exchange rate for the euro drops. causing the Australian dollar to appreciate. c 5. incomes. ownership of companies. d 3. d 10. . making them a little less competitive on world markets. The current account measures payments for exports and imports of goods and services. The balance of trade is the difference between exports and imports (X M). the demand for Australian dollars grows in the foreign exchange market. 6. c Suggested Answers to Text Questions and Problems for Chapter 26 1. c 14. and the trade deficit is affected by the low savings rate of U. d 17. a 15. Under a fixed exchange rate system. 7. and transfers of money in and out of the country. This would probably not affect the exchange rate between the dollar and the yen or other non-European currencies. b 18. budget deficit is contributing to the trade deficit. and European goods will now cost roughly 30% more in United States. c 9. d 7. This is a dual-edged sword. Most current exchange rates are determined in foreign exchange markets by the forces of supply and demand. c 8. An appreciating euro means that the dollar buys fewer euros. b 16.
The dollar appreciates. a 8. a 12. forcing a recession on their countries. d 3. goods become more expensive on world markets.6526 . Answers to CourseTutor Homework Questions for Chapter 26 1.95 Mexican pesos. c 16. This leads to a weakening of the dollar. It takes 29.S. b 4.69 Canadian (20 . Yes. it is the nominal rate times the ratio of the price levels of the two countries. d . The level of competition can also be important. An increase in the money supply leads to lower interest rates and therefore a capital outflow as investors seek higher returns elsewhere. 14. c 6. c 2.0914 29. so imports fall while exports rise. d 9. so French wine will be cheaper as the dollar now buys more euros. relative prices will differ. you could not afford the ferry trip because $20 U. improving income and output. dollar. c 11. Trade barriers and import taxes can play a role. they must contract the money supply. The real exchange rate takes the price levels of both countries into account. Yes.S. b 14. 11. The result is that to maintain a fixed exchange rate. The poor will not be holding as much as the wealthy. With a fixed exchange rate.8812 22. The other group harmed is black-market currency traders.02 Mexican pesos to get a Bahrain dinar (2. If a company has a monopoly in one country. Rising exports and falling imports increase aggregate demand. is equal to $22. 10. so 50 Argentinean pesos are equal to 177.02). People holding large hordes of cash will be unable to redeem them for the new notes.69).S. b 7. countries begin to run out of gold to back the currency. 15.55 Mexican pesos. and making monetary policy a little stronger. each Argentinean peso is worth 3. The nominal exchange rate is the price of one country’s currency for another. Exports in the United States will fall as U. b 15. d 18. it would be a good time to go to Australia when the Australian dollar is weak relative to the U. c 17. b 10. d 19. High inflation in one country puts downward pressure on that country’s currency. and competition prevails in the other. No. d 20. 12. a 5.A. 13. a 13.64 Answers 9.