Chapter 6/The Goals of Macroeconomic Policy

Solution Manual for Macroeconomics Principles and

Policy 13th Edition Baumol Blinder 1305280601
9781305280601
Download full solution manual at:
https://testbankpack.com/p/solution-manual-for-
macroeconomics-principles-and-policy-13th-edition-baumol-
blinder-1305280601-9781305280601/

Download full test bank at:

HTTPS://TESTBANKPACK.COM/P/TEST-BANK-FOR-MACROECONOMICS-PRINCIPLES-
AND-POLICY-13TH-EDITION-BAUMOL-BLINDER-1305280601-9781305280601/

CHAPTER 6
THE GOALS OF MACROECONOMIC POLICY
TEST YOURSELF
1. Two countries start with equal GDPs. The economy of Country A grows at an annual
rate of 3 percent, whereas the economy of Country B grows at an annual rate of 4
percent. After 25 years, how much larger is Country B’s economy than Country A’s
economy? Why is the answer not 25 percent?
After 25 years Country A‘s economy has grown by 109% because (1.03)25 = 2.09. After
25 years Country B’s economy has grown by 167% because (1.04)25 = 2.67. If we index
both countries’ GDP to be 100 at the start of the 25-year period, by the end of the period,
Country A’s GDP would be 209 and Country B’s would be 267. Therefore, Country B’s
economy would be roughly 28% larger than that of Country A because (267 - 209)/(209)
= .28.
The gap between the GDPs of the two countries is larger than 25% due to the compounding
of a 1% higher growth rate for 25 years.

2. If output rises by 35 percent while hours of work increase by 40 percent, has

productivity increased or decreased? By how much?
If output has not kept pace with the increase in hours worked productivity has decreased.
In this example productivity has decreased by approximately 9% (35%/40% = 8.8%).

© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Chapter 6/The Goals of Macroeconomic Policy

3. Most economists believe that from 2010 to 2013, actual GDP in the United States grew
slightly faster than potential GDP. What, then, should have happened to the
unemployment rate over those three years? Before that, from 2006 to 2010, actual
GDP grew slower than potential GDP, even contracting for several quarters. What
should have happened to the unemployment rate over those three years? (Check the
data on the inside back cover of this book to see what actually happened.)
If actual GDP grew faster than potential GDP from 2010 to 2013, unemployment
should have decreased, which it did. Similarly, from 2006 to 2010, unemployment
should have increased because actual GDP was growing slower than potential
GDP. Unemployment did, in fact, fall between 2010 and 2013 and increase between
2006 and 2010.

4. Country A and Country B have identical population growth rates of 1 percent per
annum, and everyone in each country always works 40 hours per week. Labor
productivity grows at a rate of 2 percent in Country A and a rate of 2.5 percent in
Country B. What are the growth rates of potential GDP in the two countries?
The growth rate of potential GDP is equal to the sum of the growth rate of the labor force
and the growth rate of labor productivity. Thus the growth rate of potential GDP for
Country A is 3% (1% + 2%); the growth rate of potential GDP for Country B is 3.5% (1%
+ 2.5%).
5. What is the real interest rate paid on a credit card loan bearing 12 percent nominal
interest per year, if the rate of inflation is
a. zero?
b. 4 percent?
c. 8 percent?
d. 15 percent?
(a) 12 percent (b) 8 percent (c) 4 percent (d) -3 percent

6. Suppose you agree to lend money to your friend on the day you both enter college at
what you both expect to be a zero real rate of interest. Payment is to be made at
graduation, with interest at a fixed nominal rate. If inflation proves to be lower during
your college years than what you both had expected, who will gain and who will lose?
If inflation is lower than expected, you the lender will gain and your friend the borrower
will lose. Since prices are lower than expected, the repaid money is worth more.

DISCUSSION QUESTIONS
1. If an earthquake destroys some of the factories in Poorland, what happens to
Poorland’s potential GDP? What happens to Poorland’s potential GDP if it acquires
some new advanced technology from Richland and starts using it?
The destruction of the factories reduces Poorland’s potential GDP. The acquisition and use
of the advanced technology will boost Poorland’s productive capability and hence its
potential GDP.

© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Chapter 6/The Goals of Macroeconomic Policy

2. Why is it not as terrible to become unemployed nowadays as it was during the Great
Depression?
There is a much stronger “safety net” now of programs to cushion the personal cost of
unemployment, including unemployment insurance and other welfare measures. In
addition, no recession since the 1930s has been as deep or as long-lasting as the Great
Depression, so the chances of a worker staying unemployed for a long period of time are
less.

3. “Unemployment is no longer a social problem because unemployed workers receive

unemployment benefits and other benefits that make up for most of their lost wages.”
Comment.
Unemployment still is a serious social problem, for two sets of reasons. First on a personal
level, unemployment benefits do not cover all the losses of the unemployed. The money
received is usually lower than the wages they would have earned, the benefits stop after a
maximum number of weeks, and some of the unemployed do not qualify for insurance in
the first place. Unemployment also carries with it a psychological cost. Second, society
loses the output that the unemployed would have produced had they had jobs.

4. Why is it so difficult to define full employment? What unemployment rate should the
government be shooting for today?
“Full employment” certainly implies some unemployment, that is to say, frictional
unemployment, and it is difficult to determine just how much that is. In addition, many
economists are willing to concede that some level of structural unemployment can remain
at “full employment,” since the attempt to eliminate it would entail more inflation than the
country should tolerate. The experience of the mid 1990’s indicates that a realistic goal
may be an unemployment rate in the neighborhood of 5 to 5.5percent.

5. Show why each of the following complaints is based on a misunderstanding about

inflation:
a. “Inflation must be stopped because it robs workers of their purchasing power.”
b. “Inflation makes it impossible for working people to afford many of the things
they were hoping to buy.”
c. “Inflation must be stopped today, for if we do not stop it, it will surely accelerate
to ruinously high rates and lead to disaster.”
(a) Inflation robs only those whose incomes rise slower than prices. Average wage
increases usually keep pace fairly closely with inflation.
(b) Working people often cannot buy many of the things they were hoping to buy, but
inflation does not make this problem more difficult unless wages rise more slowly than
prices.
(c) Neither economic theory nor historical experience confirms the view that creeping
inflation necessarily accelerates to hyperinflation. There can be many different causes
of creeping inflation, but the only plausible cause of hyperinflation is a rapid increase
in the money supply.

© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Chapter 6/The Goals of Macroeconomic Policy

ANSWERS TO APPENDIX QUESTIONS

TEST YOURSELF
1. Below you will find the yearly average values of the Dow Jones Industrial Average,
the most popular index of stock market prices, for five different years. The Consumer
Price Index for each year (on a base of 1982–1984 = 100) can be found on the inside
back cover of this book. Use these numbers to deflate all five stock market values. Do
real stock prices always rise every decade?
Year Dow Jones
Industrial Average
1970 753
1980 891
1990 2,679
2000 10,735
2010 10,663

1970 1980 1990 2000 2010

Dow Jones 753 891 2,679 10,735 10,663
Industrial
Average (DJIA)
CPI 38.8 82.4 130.7 172.2 218.1
Deflated DJIA 1,941 1,081 2,050 6,234 4,889

The deflated DJIA is found by dividing the DJIA by the CPI of the same year, then
multiplying by the base year CPI, which is 100. Stock prices do not rise every decade. They
declined notably during the decades between 1970 and 1980 and between 2000 and 2010
but rose between 1980 and 2000. Stocks were most valuable in 2000.

2. Below you will find nominal GDP and the GDP deflator (based on 2009 = 100) for the
years 1992, 2001, and 2012.
a. Compute real GDP for each year.
b. Compute the percentage change in nominal and real GDP from 1992 to 2002, and
from 2002 to 2012.
c. Compute the percentage change in the GDP deflator over these two periods.
GDP Statistics 1992 2002 2012
Nominal GDP 6,539 10,980 16,245
Real GDP
GDP deflator 70.6 85.1 105.0

© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Chapter 6/The Goals of Macroeconomic Policy

a)
1992 2002 2012
Nominal GDP 6,539 10,980 16,245
GDP Deflator 70.6 85.1 105.0
Real GDP 9,262 12,902 15,471
b), c)
1992-2002 2002-2012
Change in nominal GDP 67.9% 47.96%
Change in real GDP 39.3% 19.9%
Change in GDP deflator 20.5% 23.4%

3. Fill in the blanks in the following table of GDP statistics:

2010 2011 2012
Nominal GDP 14,958 16,245
Real GDP 14,779 15,052
GDP deflator 103.2 105.0

2010 2011 2012

Nominal GDP 14,958 15,534 16,245
Real GDP 14,779 15,052 15,471
GDP Deflator 101.2 103.2 105.0

4. Use the following data to compute the College Price Index for 2013 using the base
1983 = 100.
Item Price Quantity Price
in per Month in
1983 in 1983 2013
Button-down $10 1 $25
shirts
Loafers 25 1 55
Sneakers 10 3 35
Textbooks 12 12 40
Jeans 12 3 30
Restaurant 5 11 14
meals

© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Chapter 6/The Goals of Macroeconomic Policy

Expenditure,
2013 prices
Price in Quantity Expenditure in Price in on 1983
Item 1983 in 1983 1983 2013 quantity
Shirts $10 1 $10 $25 $25
Loafers 25 1 25 55 55
Sneakers 10 3 30 35 105
Textbooks 12 12 144 40 480
Jeans 12 3 36 30 90
Meals 5 11 55 14 154
Total $300 $909
CPI = (Cost of budget in 2013/Cost of budget in 1983) x 100
= (909/300) x 100 = 303

5. Average hourly earnings in the U.S. economy during several past years were as
follows:
1970 1980 1990 2000 2010
$3.40 $6.85 $10.20 $14.02 $19.07
Use the CPI numbers provided on the inside back cover of this book to calculate the real
wage (in 1982–1984 dollars) for each of these years. Which decade had the fastest
growth of money wages? Which had the fastest growth of real wages?

1970 1980 1990 2000 2010

Money wages $3.40 $6.85 $10.201 $14.02 $19.04
CPI 38.8 82.4 130.7 172.2 218.1
Real wages $8.76 $8.31 $7.80 $8.14 $8.73

1970-1980 1980-1990 1990-2000 2000-2010

Growth, money wages 101.5% 48.9% 37.5% 35.8%
Growth, real wages -5.1% -6.1% 4.3% 7.2%
Money wages grew fastest in the decade 1970–1980, but real wages grew fastest in 2000-
2010. In fact, real wages declined from 1970 to 1990.

6. The example in the appendix showed that the Student Price Index (SPI) rose by 42
percent from 1983 to 2013. You can understand the meaning of this better if you
do the following:
a. Use Table 5 to compute the fraction of total spending accounted for by each of
the three items in 1983. Call these values the “expenditure weights.”
b. Compute the weighted average of the percentage increases of the three prices
shown in Table 6, using the expenditure weights you just computed.
You should get 42 percent as your answer. This shows that inflation, as measured by the
SPI, is a weighted average of the percentage price increases of all the items that are
included in the index.
© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.
 Chapter 6/The Goals of Macroeconomic Policy

(a) Expenditure weights: Hamburgers: 56%

Jeans: 24%
Movie tickets: 20%
(b) Percent increase in price of:
Hamburgers: 50%
Jeans: 25%
Movie tickets: 40%
Weighted average price increase = (50% x .56)+(25% x .24)+(40% x .20) = 42%

© 2016 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license
distributed with a certain product or service or otherwise on a password-protected website for classroom use.