1 Chapter Answers to End-of-Chapter Problems and Applications 2. Yes, even Bill Gates faces scarcity because his wants exceed his resources. Gates has established a foundation with billions of dollars to spend on worthy causes like eradicating malaria and reducing homelessness. However, there are an unlimited number of worthy causes that Gates desires to fund, so even he faces scarcity. Secondly, even Gates has only twenty-four hours in a day, so he must make choices about how to spend his scarce time. Everyone I know faces scarcity, because human desires are virtually unlimited. Because the world's resources are limited, the only way to not face scarcity is to reduce one's wants to be less than one's resources. 4. The manager is failing to think at the margin. Dell has lost $400,000 on the last 10,000 laptops, so their profits would have been higher if they had not produced them. 6. Your friend is failing to think at the margin. It doesn't matter how much time has already been spent studying psychology. What matters is the marginal benefit to be received from studying psychology relative to the marginal cost, where cost is measured as the opportunity cost of lower grades in other subjects. If the course is required, that may raise the marginal benefit. 8. The contractors had little incentive to deliver the Indians to Oklahoma alive. Instead, they benefited when the Indians died along the way, because they had to spend even less money on food and transportation. One way to change the incentives to lower the death rate would have been to pay the contractors more if the Indians arrived safely in Oklahoma. 10. The problem with Dr. Strangelove's theory is that it cannot be tested unless we can devise a way to measure the emission of these subatomic particles, which seems to be impossible since they don't exist in our universe. Because we cannot test the model's predictions, it is not very useful to us even though it might be true, we have no way of knowing. 12. a. It is doubtful that centrally planned economies have been less efficient purely by chance. The underlying reason seems to be that centrally planned economies don't give as great incentives for hard work and innovation as market economies do. In addition, the people running centrally planned economies cannot make the most productive decisions because they don't have the information that is in the minds of all the decentralized decision makers in a market economy.
1
b. You might still prefer having a centrally planned economy if you considered it to be more equitable. (Also, you might prefer a centrally planned economy if you were in charge.) 14. a. The groups that are most likely to get the tickets will be those for whom the expected marginal benefit of going to City Hall on Monday morning is greater than the expected marginal costs. These might include people who have a very low opportunity cost of traveling to City Hall and standing in line, such as people who don't have a job in the morning and those who live or work very close by. These might also include people who see a large benefit from going to get the tickets, such as die-hard NASCAR fans or professional ticket scalpers. b. The major opportunity cost of distributing the tickets this way is the cost to the people who attempt to get the tickets the cost of travel to City Hall, the activities that cannot be done (such as earning money at work) when one is standing in line, and the costs to all those people who try to get tickets but don't get there soon enough. (There's also the cost of people blocking traffic in and around City Hall.) c. This isn't an efficient way to distribute the tickets, since it wastes so much time. Perhaps the most efficient way to distribute the tickets is to hand them out unannounced to people walking by this would take only a few minutes. Alternatively, the city could sell them back to NASCAR and have them distribute the tickets. d. Equity is hard to define. Some people will see this as equitable, since only the deserving, true fan will put up with the hassle of getting the tickets. Others will disagree, saying that no money was raised for the taxpayers of the city, who deserve to get the benefits of selling the tickets since they fund the police department. 16. a. and c. are positive statements; b. and d. are normative statements. 18. a. The proposal might protect consumers because lawyers are generally better trained and more knowledgeable about these matters than non-lawyers. b. The law will clearly protect lawyers by reducing the competition facing them and allowing them to increase their prices. The gains to consumers may be very small since consumers are often wise enough to know when going to a lawyer is their best decision and when relying on someone with less training is acceptable. c. Answers will vary, but people will tend to favor the law if they have financial ties to lawyers, or they suspect that the advice from these non-lawyers will be incompetent. Also, people will tend to oppose the law if they think that consumers are in a good position to decide for themselves who is offering good advice at a good price.
Answers to Problems and Applications in the Appendix
2.
4. 1.9%. The percentage change in real GDP from one year to the next is the economy's growth rate. 6. The triangle's area = 0.5 x 60,000 x $0.75 = $22,500. Chapter 2 Answers to End-of-Chapter Problems and Applications
2. Increased safety will decrease gas mileage, as shown in the figure. Tradeoffs can be between physical goods, such as cotton and soybeans in problem 1, or between less tangible things like mileage and safety.
4. a. The production possibility frontier will be concave like Figure 2-2 because some economic inputs are likely to be more productive when making capital goods, and others are likely to be more productive when making consumption goods.
b.
c. Because it will have more machinery and equipment, Country B is likely to experience more rapid growth.
6. a.
b. The opportunity cost of increasing your chemistry score by 4 points in moving from Choice C to Choice D is the 4 point decline in your economics score. c. Choice A might be sensible if the marginal benefits of doing well on the chemistry exam are low relative to the marginal benefits from doing well on the economics exam for example, the chemistry exam is only a small portion of your grade, but the econ exam is a large portion of your grade; or if your are majoring in economics and don't care much about chemistry; or if you already have an A sewn up in chemistry, but the econ professor will replace a low exam grade with this exam grade. 8. Most economists would argue that unless the costs of complying with environmental regulations are taken into account, society runs the risk of devoting too many resources to improving the environment compared with other goals. By ordering the EPA to ignore costs, Congress was forcing the EPA to approve regulations that it would not have approved if costs were taken into account. The decision to tell the EPA to ignore costs may have been a foolish mistake or a way of seeming very friendly to the environment to people who don't think about the opportunity cost of reducing air pollution. 10. Economic systems that do not allow people to keep most of the output they produce do not provide much incentive for people to work hard. Unfortunately, experience has shown that people are more selfinterested and less altruistic than would be necessary for the system used in Oz to work in the real world. 12. a. Neither country has a comparative advantage in either good. In both countries, the opportunity cost of one barrel of oil is one barrel of olive oil. Comparative advantage only arises if someone has a lower opportunity cost, but these two countries have the same opportunity cost.
b. No, the countries can't gain from trade. Trading across the border gives the same tradeoffs that can be made within each country. 14. Yes, the United States would have benefited from importing those products where Britain had a comparative advantage. 16. Adam Smith was making the "invisible hand" argument that, in pursuing their self-interest, business people end up producing the goods and services most desired by consumers. 18. Adam Smith realized as economists today realize that people's motives can be complex. But in analyzing people in the act of buying and selling, economists have concluded that in most instances, the motivation of financial reward provides the best explanation for the actions people take. Moreover, being self-interested looking out for your own well-being and happiness and being selfish caring only about yourself are not exactly the same things. Many successful business people are, in fact, generous: donating to charity, volunteering for activities, and otherwise acting in a generous way. This is not inconsistent with making business decisions that maximize profits for their companies. 20. Most economists would agree that this is a good basis to judge an economy. It's hard to disagree with respect to developing countries, where many people live in abject poverty and standards of living are low. It's easier to disagree if everyone in a society has a very high standard of living, but has to give up a lot to get it, by, say, working long hours. Any debate would probably center on what is meant by the "standard of living." 22. Falling transportation costs allowed people to trade more easily and to specialize on the basis of their comparative advantage. Chapter 3 Answers to End-of-Chapter Problems and Applications 2. a. substitutes b. complements c. complements d. probably unrelated
4. It is possible. For instance, someone who likes the taste of hamburger may consume a larger quantity of hamburgers as his income rises. Another person may only be consuming hamburgers because his income is low. As this person's income rises, he may substitute steak for hamburger in his diet. 6. The student's reasoning is incorrect. He should have said: "Increased production leads to a lower price, which increases the quantity demanded." 8. Quantity Supplied (pizzas per week) Price $5.00 5.50 5.75 6.00 6.25 Mark 25 30 35 40 45 Mike 30 40 50 60 70 Bill 20 25 30 35 40 Market 75 95 115 135 155
10. Zero would be the equilibrium quantity if the supply curve is always above the demand curve that is, if the lowest price at which anyone is willing to supply the good is above the highest price that anyone is willing to pay for the good. The quantity supplied and the quantity demanded will be zero in such a market. 12. a. Complements b. The answer to problem 12. b. consists of the following two graphs:
14. a. The supply of corn must be falling if output is falling and prices are rising. The fall in the corn supply may be due to farmers switching over to soybean production in response to higher soybean prices. The demand for soybeans must be increasing if the price rises when supply is increasing.
14. b.
16. The graph shows that there was a surplus of commercial real estate in the San Francisco market. The difference between Q2 and Q1 is four million square feet. Whenever there is a surplus in a market, we expect that the price will fall.
18.
20. Refrigeration allowed for the storage of perishable products. This removed some of the supply during the peak season, shifting the supply curve to the left from S1 to S2 and driving the price up from P1 to P2. During the off-season, the refrigerated supply could be offered for sale, shifting right the relatively small supply from S3 to S4 and causing the price to fall from P3 to P4.
22.
24. The shift to the left of the U.S. supply curve from S US1 to SUS2 increases the price from P1 to P2. In the non-U.S. market, the demand rises from D1 to D2 because the price of a substitute (American-grown cotton) had risen. This causes the movement along the non-U.S. supply curve shown by the arrow. (The price of both types of cotton probably rose by about the same amount, if they were close substitutes.)
26. The graph with the vertical demand curve is more likely to represent the market for the life-saving drug. If the price of this good rises, patients are unlikely to reduce the quantity they demand, but if the price of the BMW rises, households will reduce the quantity they demand as they switch to buying other luxury cars. Chapter 4 Answers to End of Chapter Problems and Applications
2. a. The equilibrium quantity is 100 million crates of kumquats per year and the equilibrium price is $20 per crate. Kumquat producers receive revenue of $2 billion.
b. Consumers will purchase 80 million crates of kumquats. Kumquat producers receive revenue of $2.4 billion.
c. Kumquat producers will receive the revenue in b. plus $30 x 100 million crates, for a total of $5.4 billion. The government will spend $3 billion purchasing the 100 million crates of surplus kumquats.
4. a. As the supply curve shifts inward from S1 to S2, consumer surplus will decrease from A + B + C + D to A. b. Producer surplus will change from E + F + G to B + E. This may be an increase or a decrease, depending on the size of B relative to F + G. c. Economic surplus will fall from A + B + C + D + E + F + G to A + B + E.
6. a. In the absence of control, the equilibrium price is $800 and the equilibrium quantity is 300,000. In this case, every renter who is willing to pay the market price of $800 will find an apartment and every landlord willing to accept the market price of $800 will find a renter. The demand and supply curve are shown in the figure, along with the equilibrium price (PE) and quantity (QE). b. At a price ceiling of $600, the quantity demanded is 350,000 but the quantity supplied is only 250,000, so there is a shortage of 100,000 apartments. c. If all landlords abide by the law, the quantity sold will fall to 250,000. As shown in the figure, consumer surplus with the price ceiling enforced is A + C, producer surplus is E, and deadweight loss is B + D. d. If landlords supply only 250,000 apartments and ignore the price ceiling, they can charge $1000. This is the amount that renters are willing to pay for the 250,000th apartment.
8. The first sentence of the student's argument is correct. The second sentence is incorrect. A price ceiling increases the quantity that consumers demand, but because it also reduces the quantity sellers supply, it reduces the amount of the product that consumers are actually able to buy. In the graph, without a price ceiling, consumers buy Q1, with a price ceiling consumers buy only Q2.
10. The people who benefit from rent controls are politically powerful and have resisted seeing them abolished. 12. The main beneficiaries are small and inefficient retailers who would not be able to match the discounts large and efficient retailers would offer if the law allowed them to. Consumers and large retailers lose as a result of this law.
14. a. If you are currently a renter, the law will probably make you better off, unless you are one of those whose landlord removes his apartment from the market. b. Worse off, since you'll probably not be able to find a vacant apartment. c. Worse off. d. Better off, unless you get caught and the penalty is large. 16. Drinking excessive amounts of alcohol is an example of consumption generating a negative externality. One example of production generating a positive externality is the production of honey. When bee hives are placed next to apple orchards, the bees pollinate the apple trees in the process of producing honey. Therefore, the production of honey has generated a positive externality. 18. The marginal benefit to reducing crime would include the reduction in losses to crime victims, including losses due to personal injury and anxiety. The marginal cost of reducing crime would include resources devoted to police, courts, and prisons. Just as with pollution, it would not be economically efficient to reduce the amount of crime to zero. 20. As the level of pollution falls, further reductions become increasingly costly. Cleaning up the first one percent is easy you merely scoop up oil that is floating in the water or lying on the shore. Cleaning up the last percent is hard because it has oozed into places that are hard to reach. To completely remove all of the oil from a spill can require very complex and expensive technologies. Removing the last one percent may even be more damaging to the ecosystem than leaving it there. Another tradeoff involves spending resources to completely clear an oil spill versus using those resources for other purposes. 22. A normal good is a product that consumers demand more of as income rises. Environmental protection is a normal good. The developed nations of the West already had higher incomes than third world countries do today when they first began to take significant steps to protect the environment. Because third world countries have low incomes, they do not demand nearly as much environmental protection as developed countries do. As an economy develops and people get richer and they can afford to pay more for a clean environment, their willingness to pay for a clean environment rises so the marginal benefit curve for pollution reduction rises. Economic development also brings new technologies that reduce the marginal cost of reducing pollution. 23. a. The tax should be the amount necessary to shift up the supply curve from S1 to S2. That amount is $7.50 $7.15 = $0.35 per item dry-cleaned.
24. a. Marginal external cost is the difference between the marginal social cost and the marginal private cost curve. Because marginal external cost rises as output rises, the gap between the marginal private cost curve and the marginal social cost curve gets larger as output rises. b. The optimal Pigovian tax can be found by first finding the efficient level of output, which is found at the intersection of the demand curve and the social cost curve. At this output, the optimal tax equals the gap between the social cost and the private cost curves that is, it equals the amount of the marginal external cost. Therefore, in the large city the optimal tax is $6.60 - $5.40 = $1.20, but in the small city the optimal tax is only $5.60 $5.00 = $0.60. Chapter 5
Answers to End-of-Chapter Problems and Applications
2. Limited liability is a major advantage of incorporation and some people fear that it gives the corporation's owners a license to skip out on their debts. Eliminating limited liability would probably cripple an advanced economy like ours, however. Most investors would be very wary of buying stock in corporations unless they were very, very sure about the personal integrity of top management and the financial soundness of the firm. Investors will generally be less willing to lend to (buy bonds from) a firm with limited liability knowing that they are less likely to be paid back. On the other hand, investors will generally be more willing to buy stock in a firm with limited liability knowing that their personal fortune isn't at stake, that they cannot lose more than what they've invested in the firm. 4. You would be better off if you had bought the stock, because it will have increased in value, while the interest on the bonds will have remained the same. 6. The argument is correct, unless an independent board of directors is able to monitor closely the top managers or has set up an effective incentive system. 8. If chief executives do not own much stock in a company, they may have goals other than maximizing profits. Boards of directors attempt to design compensation packages that will reward chief executives
for maximizing profits for example, paying bonuses based on profits. An owner-manager will already have an incentive to maximize profits, so he or she may not need bonuses or stock options as a further inducement. 10. Firms will weigh the costs and benefits of raising money in each way. If owners can borrow money at a lower cost, they will do this especially because they don't need to give up control of the firm. However, investors are wary of firms that borrow too much and in which the owners don't have much of a financial stake. 12. This bond had a smaller coupon than other bonds issued more recently. 14. The statement is false. These shares were traded in the secondary market (the NASDAQ), so the money went from the new shareholder to the previous shareholder. The money didn't go to Microsoft. 16. Generally accepted accounting principles are the rules that corporations are required to follow in preparing their financial statements. Top managers generally benefit from having earnings as large as possible, which allow them to earn higher salaries and bonuses and which increase the value of their stock options. Stockholders who relied on inflated earnings reports when they decided to buy WorldCom stock would have been hurt. Stockholders who sold WorldCom stock after its price had risen because of inflated earnings reports, but before the manipulation of the earnings reports had been publicly revealed, would have benefited. 18. Investors reward a company by their willingness to buy its stock and bonds, and punish a company by selling its stock and bonds. By doing this, investors can have an effect on the value of a company, and, thereby, on the compensation of the members of its board of directors and top managers. 20. a. Google's stock price will fall because its expected future revenues and profits have fallen. b. Stock price will rise because Google's after-tax profits will rise. c. Stock price will fall because expected future profits will fall. d. Stock price will rise because expected revenues and profits will rise. e. Stock price will be unchanged.
Answers to Appendix Problems and Applications
2. Because the formula divides by the interest rate, a higher interest rate yields a lower present value. 4. a. 25 x $1,440,000 = $36,000,000. b. $13,070,937.63 c. $20,295,280.18 d. 6.24% gives a present value of almost exactly $18 million.
6. Stock price =
Dividend $2.00 = = $2/0.08 = $25. If the interest rate is 5%, the (i - GrowthRate) (0.10 - 0.02)
maximum price you would pay is $2/0.03 = $66.66. Following this pattern, a lower interest rate means that stock prices should rise. 8. Figures are in millions.
Revenue Revenue from company restaurants Revenue from franchised restaurants Operating expenses Cost of operating company restaurants Interest expense General and administrative Cost of restaurant leases Other operating costs Total operating expenses Operating income Income before income taxes Income taxes Net income (accounting profit)
$19,065 $14,224 $4,841
$12,100 $338 $1,980 $1,003 $441 $15,862 $3,203 $3,203 $924 $2,279
10. Answer: Google's current ratio = difficult raising cash quickly.
Chapter 6
$2,693 = 7.9. Firms with a low current ratio may have $340
Answers to End of Chapter Problems and Applications 2. To maximize utility, Joe needs to make sure that the marginal utility per dollar is the same for both Twinkies and Ho-Hos, and that he has spent the $16. We can make the analysis easier by constructing a table. Twinkies Quantity 1 2 3 4 5 6 7 8 9 10 MU 10 8 6 4 2 0 0 0 0 0 MU/P 10 8 6 4 2 0 0 0 0 0 MU 18 16 14 12 10 8 6 4 2 0 Ho-Hos MU/P 9 8 7 6 5 4 3 2 1 0
Joe will maximize utility by buying four packs of Twinkies and six packs of Ho-Hos. 4. Mary is maximizing her utility if the (marginal utility)/price is the same for each good, and she is fully spending her budget allocated to corn chips and sodas. Since the marginal utility of both goods is 10, she is maximizing her utility only if the price of a bag of corn chips is the same as the price of a bottle of soda, and she is also spending the amount of her budget allocated to corn chips and sodas.
6. Network externalities can make it difficult for new products to enter certain markets. In the United States, more than 90 percent of personal computers run on the Windows operating system. Using an operating system other than Windows may make file sharing and other activities difficult. Because fewer people currently have personal computers in Asia, network externalities are less important than in the United States, and Linux may be more successful. 8. Once a team has drafted a player, the team's fans may be reluctant to see him traded to another team even if the trade would bring players of greater value. Knowing that their fans act according to the endowment effect, teams are often reluctant to draft a player if they intend to immediately trade him. 10. What you paid for your ticket is a sunk cost and, if you are rational, it should not affect your decision whether to attend. 12. You will want to compare the marginal benefit of spending $4,000 to have the car repaired against the benefits you would receive from spending the $4,000 in other ways, such as by making a down payment on another car. The price you paid for your car is irrelevant to the decision of whether you should repair it. 14. Elasticity = (percentage change in quantity)/(percentage change in price) = 3%/4% = 0.75. Because price rises and demand is price inelastic, revenue received by suppliers has increased. 16. a. The demand for soft drinks and the demand for canned soup are price elastic; the demand for cheese and the demand for toothpaste are price inelastic. Cheese and toothpaste probably have fewer substitutes than soft drinks and canned soup. b. Soft drinks: 31.8% decline in quantity demanded Canned soup: 16.2% decline in quantity demanded Cheese: 7.2% decline in quantity demanded Toothpaste: 4.5% decline in quantity demanded 18. Price inelastic, because the percentage change in price is much larger than the percentage change in quantity demanded. 20. Manager 2 is wrong. Cutting the price will increase revenue if demand is price elastic. Chapter 7
Answers to End of Chapter Problems and Applications 2. Quantity of Workers 0 1 2 3 4 5 6 7 Total Output 0 400 900 1500 1900 2200 2400 2300 Marginal Product of Labor -- 400 500 600 400 300 100 100 Average Product of Labor -- 400 450 500 475 440 400 329
4. a. Variable cost = total cost fixed cost = $30,000 - $10,000 = $20,000. b. AVC = VC/Q = $20,000/10,000 = $2; AFC = FC/Q = $10,000/10,000 = $1 c. The gap must get smaller as output rises because ATC = AVC + AFC and AFC falls as output rises. 6. As long as Sally's GPA for a semester is below her cumulative GPA, her cumulative GPA will fall. 8. Jill's reasoning is faulty. If she could rent out her current building for $4,000 per month, then she incurs an opportunity cost of that amount by using the building herself. 10. Although Franklin had no explicit expense when he advertised in his own paper, he did incur a cost. The space for his own advertisements could have been used for paid advertisements by other firms. 12. Fixed costs are like a lump-sum tax because both are fixed amounts that do not change as output changes. Because AFC = FC/Q, a tax becomes smaller per unit of output as output rises. 14. a. Jill's costs will be lower with a smaller store. b. Her costs will be lower with a larger store. c. Because of the effects of economies of scale. 16. AFC should be downward sloping, not U-shaped. ATC should be above AVC.
18. Ford would have ended up as the only automobile producer. Other producers would have had higher costs and, therefore, would not have been able to match his price cuts. 20. There must be economies of scale in book publishing. 22. Morita's short-run cost curve is described in the chapter opener. Its lowest point is at outputs between 10,000 and 30,000. If he wanted to produce more than 75,000, he would have built an additional factory, or, if there were economies of scale in manufacturing transistor radios, he would have built a larger factory. 24. eToys built the large distribution center represented by ATC2 because they expected their sales to be Q2. In that case, their average costs would have been AC1. In fact, their sales were only Q1, which meant their costs were AC3. If they had known how low their actual sales would have been, they would have been better off building the smaller distribution center represented by ATC1. This would have lowered their average costs to AC2. This is what the author meant when he wrote that eToys "needed to generate much higher sales to justify its costs."
26. DuPont had expected to be on ATC1, in which case as production of paint increased from Q1 to Q2, average cost would have decreased from AC1 to AC2. In fact, they were on ATC2, so average cost actually increased from AC3 to AC4, as production expanded.
28. The investors were expecting the long-run average cost curve to fall as output rose from the initial level, Q1, to the post-merger level Q2 , as shown by LRAC2. Instead, long-run average costs didn't fall. LRAC1 reflects the actual long-run average cost curve because average costs are no lower at Q1 than at Q2.
Chapter 8 Answers to End of Chapter Problems and Applications 2. The remark confuses the market demand for wheat with the demand facing one farmer selling wheat. Remember that the units used in drawing the market demand curve are much greater than the units used in drawing the individual farmer's demand curve. 4. No, because the opportunity cost to your sister of using the copiers is $1,500, which is equal to your cost of renting them.
b. Frances will charge $1 and produce 5 earrings. Her loss will be (5 x $1) - $5.20 = $0.20, which is smaller than the loss of $1 if she shuts down. 6. The company is a price taker because it is in a very competitive industry. The company should charge the market price.
8. a. Total cost = A + B + C b. Total revenue = A + B c. Variable cost = A d. Loss = C The firm will continue to produce in the short run because it has revenue greater than its variable costs.
10. Disagree no matter how great demand may be, if there are no barriers to firms entering the industry, profits will be competed away in the long run. 12. This argument is incorrect. In order to maximize profit, the firm should produce up to the point where marginal revenue equals marginal cost. By producing only Q1, the firm will miss out on all the profits to be made on units between Q1 and Q2 . 14. As shown in the figure, the cost curves have shifted upward so that the price of fertilizer is now below the minimum point on the average variable cost curve.
16. Airlines, like other businesses, will continue to operate so long as they can cover their variable costs. The statement that "revenues will cover a large part of their cost," refers to total costs. If revenues covered only a large part, but not all, of the firm's variable costs, it would shut down. These revenues seem to cover all of the variable costs plus some of the fixed costs. 18. In perfectly competitive markets, firms may temporarily earn greater profits from a reduction in costs. However, in the long run, lower costs result in lower prices, which benefit consumers, but not higher profits. 20. The remark is incorrect because the student has confused accounting profit and economic profit. Zero economic profit includes a normal rate of return on the investment of the owners of the firm. 22. The increase in the demand for laptop computers causes the demand curve to shift from D1 to D2 , temporarily driving the price up to P3. As the production of laptops increases, more orders are placed for
laptop displays. As production of laptop displays increases, their cost and price falls because of economies of scale. With increased demand and lower costs, the firms that assemble laptops can make economic profits at P3. The result is that new firms enter the industry, the industry supply curve shifts from S1 to S2, driving down the price to P2 and eliminating economic profits. Because the price of laptop computers declines as output increases, the long-run supply curve is downward sloping. This is a decreasing-cost industry.
Chapter 9 Answers to End of Chapter Problems and Applications 2. The USPS is probably not a natural monopoly. If it were, it wouldn't need a law banning competition. It would be able to produce at a lower cost and charge a lower price than potential competitors, so no one would want to enter the industry. If the current law banning competitors were removed, firms would likely enter this market. They have already entered portions of the market (such as package and overnight
letter delivery) where competition isn't banned and seem eager to expand into additional sectors in the mail delivery business. 4. Extending the life of pharmaceutical companies' patents would allow them to charge the monopoly price for their drugs for a longer period and earn higher profits. This potential for higher profits would encourage them to develop more new products. Consumers would gain from having a wider range or medicines, but they would lose because their prices would stay high longer. 6. You are likely to make a loss. If a profit was likely in this market, someone would probably have already entered it.
8. There are only a limited number of countries in the world, which limits the number of customers in this market. Also, printing currency that is difficult to counterfeit requires specialized printing methods. 10. a. The monopoly will produce 50 units and charge a price of $10. b. To achieve allocative efficiency, the regulatory agency should require the monopoly to charge a price equal to marginal cost, which in this case would be a price of $7. The regulated monopoly will produce 90 units. It will make a profit, because price is above average total cost. 12. We can calculate average total cost at every quantity.
Quantity (per day) (Q) 30 40 50 60 Total Cost (TC) $1,200 1,400 2,250 3,000
Average Total Cost
TC Q
$40 35 45 50
In order for the firm to have a natural monopoly, it must be able to produce at a lower average total cost than two firms. This is not the case here, because the firm's average total cost begins to increase after it has produced 40 units per day. 14. a. In the short run Comcast will continue to sell 6 subscriptions at $14 each. Its revenue is but $84, its cost is now $80 + $6, so its loss is $2. If this loss continues, in the long-run Comcast exit the market. b. The new tax increases the marginal cost by $0.50 per subscriber, as shown in the table:
Marginal Revenue Price $17 16 15 14 13 12 Quantity 3 4 5 6 7 8 Total Revenue $51 64 75 84 91 96 (MR = TR/Q) $13 11 9 7 5 Total Cost $57.50 65.00 73.50 83.00 93.50 105.00
Marginal Cost (MC = TC/Q) $7.50 8.50 9.50 10.50 11.50
Now Comcast will sell 5 subscriptions. It will charge a price of $15 per month, and earn profits of $75 $73.50 = $1.50.
16. The statement is incorrect. The monopolist charges the price that allows him to sell the level of output where marginal revenue equals marginal cost. He is able to charge a higher price, but would not be maximizing profit if he did. 18. Microsoft must believe that families have a lower price elasticity of demand for upgrading Office on multiple PCs than do the other groups mentioned.
20. The strategy might maximize profits because the person flying for $198 was willing to pay just a bit above this price. This low price gained US Airways an additional passenger and marginal revenue of approximately $198, which was well above the marginal cost. Meanwhile, the passenger who paid $638 was willing to pay a lot for the flight. The airline squeezed about as much marginal revenue as possible from this flyer, and again the marginal cost was very low. 22. Yes, because people who are willing to fill out a rebate form and mail it in are likely to have a higher price elasticity of demand than those who don't. 24. a. We need to calculate the Herfindahl-Hirschman Index (HHI). Before the merger: 20 x 52 = 500. After the merger: (15 x 52) + 202 = 375 + 400 = 775. Because the post-merger HHI is below 1,000 the merger will not be opposed. b. HHI before the merger: 5 x 202 = 2,000. After the merger: (3 x 202) + 402 = 1200 + 1600 = 2,800. Both before and after the merger, the HHI is above 1,800 so the merger will be opposed. 26. HHI before the merger, assuming 11 firms in the "other" category, each with a 1 percent share of the market: 372 + 352 + 172 + 11(12) = 2,894. So, even if no company other than Coca-Cola, Pepsi-Cola, and Cadbury Schweppes has a market share greater than 1 percent, the Department of Justice and the Federal Trade Commission would be likely to oppose a merger between two of the leading three firms. 28. The figure as drawn shows a monopoly producing the efficient level of output. Using different demand curves (and different sizes for the negative externality), it is possible to show that a monopoly may also produce an inefficiently high or low level of output in the presence of a negative externality.
Chapter 10 Answers to End of Chapter Problems and Applications 2. Profit = Revenue Cost = Quantity x (price average cost) = 350 x ($3.25 $3.00) = $87.50. 4. Remember that minimizing average costs is not the same as maximizing profits. Often where profits are maximized, average costs are not minimized. In this case, we do not have the information on the firm's revenues that would be necessary to calculate the profit-maximizing highway speed, nor do we know how other costs such as labor costs are related to the average highway speed. 6. The drop in profits per car doesn't necessarily indicate that cutting prices was a bad idea. If GM is maximizing profits, it will set its output where MC = MR and charge the highest price that people are willing to pay for this quantity. It may have been forced to cut its price (and profits per car) because demand fell. Keeping its price at the old level may have caused even greater losses of profit. 8. a. The demand for ordering books online must be price elastic. b. P1 is the non-profit-maximizing price Amazon was charging before the price cut. P2 is the profitmaximizing price.
10. Consumers gain from the lower prices productivity gains make possible. The firms are not more profitable because competition causes the prices they charge to fall to the level of the average total costs. 12. Competition is a risk because it can reduce a firm's profits. The barriers to entry are low in retailing, so the competition is intense. 14. The skeptics who think that "Starbucks' game is almost over" think that other firms will soon be copying Starbucks so well that the demand for Starbucks' products will shrink and it won't be able to earn high economic profits any more. 16. a. There would be one or more firms like LittleAuto. b. A single firm like BigAuto will probably dominate the market. c. There will probably be two or more firms like BigAuto, depending on the how large demand is. 18. If a firm doesn't match a price cut, its sales may fall considerably; if it doesn't match a price increase, its sales will rise. 20. a. It would appear that they are in a prisoners' dilemma. If large numbers of players take steroids or other illegal drugs, then the performance of each player does not improve relative to most other players. The players are worse off because of the side effects of the drugs. b. If the players are in a prisoners' dilemma, testing would make the players collectively better off their average pay should be unchanged, but their long-term health will improve because they won't use steroids any more. 22. a. Wal-Mart doesn't have a dominant strategy. If Target uses bar codes, Wal-Mart earns more profit when it also uses bar codes, but if Target uses RFID tags, Wal-Mart's best strategy is to use RFID tags. b. Target doesn't have a dominant strategy. If Wal-Mart uses bar codes, Target earns more profit when it uses bar codes, but if Wal-Mart uses RFID tags, Target earns more by using RFID tags. c. Recall the definition of a Nash equilibrium: A situation where each firm chooses the best strategy, given the strategies chosen by other firms. In this problem there are two Nash equilibria: Both firms choosing bar codes or both firms choosing RFID tags. In either of these situations, neither firm can increase its profits by changing its strategy, given the strategy chosen by the other firm. An important point to note is that it is possible to have a Nash equilibrium even when neither firm has a dominant strategy.
Chapter 11 Answers to End-of-Chapter Problems and Applications 2. We would prefer working in an industry producing a normal good during an economic expansion, but we would prefer working in an industry producing an inferior good during a recession. During an expansion, the increase in incomes would increase the demand for a normal good, which would increase the demand for jobs in the industry. The expansion, however, would decrease the demand for an inferior good and the jobs that produce them. During a recession, the decrease in incomes would decrease the demand for a normal good, which would decrease the demand for jobs in the industry, but would increase the demand for an inferior good and the jobs that produce them. 4. b., c., and d. -- the purchase of the aircraft carrier by the federal government, the French wine by a U.S. consumer, and the new machine tool by Ford represent purchases of final goods. The purchase of wheat from a wheat farmer by a bakery represents the purchase of an intermediate good. 6. The value of the house built in 2000 would not be included in GDP of 2006 because the sale does not represent new production. The value of the services of the real estate agent that helped sell or buy the house in 2006 would be included in GDP of 2006 because those services were newly provided in 2006. 8. a. Real GDP for 2006 = (100 x $50) + (100 x $2) + (50 x $30) = $6,700 Real GDP for 2007 = (100 x $50) + (120 x $2) + (65 x $30) = $7,190 b.
$7,190 - $6,700 x 100 = 7.3% $6,700
10. Value added subtracts only the cost of intermediate goods, but profits subtracts all costs the costs of intermediate goods along with the costs of the so-called primary factors of production (labor, capital, natural resources, and entrepreneurship).
12. Value added of the artist = ($800 x 10) - $5,000 = $3,000 Value added of the local art store = ($1,000 x 10) ($800 x 10) = $2,000 14. a. is likely to increase measured GDP, and c. is likely to reduce it. b. is also likely to increase measured GDP if it results in increased government expenditures on law enforcement and increased private expenditures on security. But an increase in the crime rate might indicate that the level of
production in the underground economy is increasing, which should reduce measured GDP, not increase it. 16. "Informal economic activities" refer to the underground economy. These activities are concealed and will not be counted in GDP. They make the comparison of standard of living across countries harder, because economists often use real GDP per capita as a general measure of standard of living. 18. a. Nominal GDP is greater than real GDP. b. Nominal GDP equals real GDP. c. Nominal GDP is less than real GDP.
20. 2000 2001 2002 2003 2004 Nominal GDP $9,817 10,128 10,470 10,971 11,734 Real GDP $9,817 9,890 10,049 10,321 10,756 GDP deflator 100.0 102.4 104.2 106.3 109.1
Percentage increase in the price level for: 2001:
102.4 - 100.0 x 100 = 2.4% 100.0 104.2 - 102.4 x 100 = 1.8% 102.4 106.3 - 104.2 x 100 = 2.0% 104.2 109.1 - 106.3 x 100 = 2.6% 106.3
2002:
2003:
2004:
The largest percentage increase in the price level occurred in 2004. Chapter 12 Answers to End-of-Chapter Problems and Applications
2. A recession or slowdown in the economy that decreases the demand for the company's products would cause a firm to lay off workers. Technological innovations or international competition that decrease the number of workers required in the domestic industry or decreases the size of the domestic industry could lead to layoffs. The firm falling behind its competition in the industry due to inadequate management or product development would cause layoffs. 4. Including homemakers as employed would decrease the unemployment rate because it increases the size of the labor force, but leaves unchanged the number of unemployed. Including homemakers as employed would increase the labor force participation rate because it increases the labor force, but leaves unchanged the working-age population. 6. For someone frictionally unemployed the advice would be to keep searching. The person has the required skills; it is an information/search issue. For someone structurally unemployed the advice would center on the need to retrain or to find another occupation. For someone cyclically unemployed the advice would be to realize that the search will take longer because of the recession, and to consider taking a lower paying job in the mean time or going back to school until the economy picks up. 8. a. and c. are likely to increase the unemployment rate. Lengthening the time workers are eligible to receive unemployment insurance lowers the opportunity cost of job search. An increase in union membership pushes more wages above market wages. B. and d. are likely to reduce the unemployment rate. Abolishing the minimum wage lowers the wage from above the market wage for some workers. Making information on job openings more available lowers the search involved in frictional unemployment. 10. The efficiency wage argument states, especially where it is difficult to monitor workers, that a firm may want to pay a wage higher than the equilibrium wage in order to increase worker productivity. 12. An increase in the number of discouraged workers who were previously unemployed could cause the number of people counted as unemployed (and the labor force) to fall by enough to decrease the unemployment rate, even though employment declined. 14. The statement misinterprets the CPI. The inflation rate in 2004 is the percentage change in the CPI since 2003, not since the base year.
16. Year 1929 1933 Nominal GDP (billions of dollars) $103.70 $56.40 GDP Price Deflator (1996 = 100) 12.62 9.36 Real GDP (billions of 1996 dollars) $821.71 $602.56
Percentage decline in real GDP = [($602.56 $821.71)/ $821.71] x 100 = 26.7%
18. Total Box Office Receipts ($) 198,655,278 184,208,842 460,935,655 163,214,286 153,000,000 260,000,000 434,949,459 600,779,824 431,065,444 356,784,000 436,471,036 403,706,375 377,019,252 373,377,893 370,270,943 Value of Box Office Receipts in 2004 Dollars 2,681,846,253 2,486,819,367 1,428,144,898 963,984,377 963,900,000 910,000,000 847,478,843 705,263,272 487,852,508 465,049,490 436,471,036 403,706,375 387,264,340 373,377,893 370,270,943
Original Rank 62 70 2 110 129 31 4 1 5 10 3 6 7 8 9
New Rank 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15
Film Gone with the Wind Snow White and the Seven Dwarfs Star Wars The Sound of Music One Hundred and One Dalmatians Jaws E.T. the ExtraTerrestrial Titanic Star Wars: Episode I The Phantom Menace Jurassic Park Shrek 2 Spider-Man Lord of the Rings: The Return of the King Spider-Man 2 The Passion of the Christ
Year Released 1939 1937 1977 1965 1961 1975 1982 1997 1999 1993 2004 2002 2003 2004 2004
CPI 14 14 61 32 30 54 97 161 167 145 189 180 184 189 189
To calculate the box office receipts for each film in 2004 dollars, multiple the box office receipts by the CPI for 2004 (189) divided by the CPI for the year the movie was released. 20. The reporter does not understand the definition of deflation. Deflation occurs when the price
level declines. Inflation, even if only half the national rate, increases the price level. It is not possible for the CPI to drop below zero.
22. When there is deflation, the real interest rate on loans increases. Therefore, the burden of
debt on farmers would have increased during these years.
Chapter 13
Answers to End-of-Chapter Problems and Applications 2. The $1 million per year would buy a lot of goods and services, but in 1900 there were no antibiotics, no automobiles, no televisions, no computers, no cell phones, and infant mortality was much higher.
4. Growth rate for 1991 =
7,101 - 7,113 x 100 = 0.17% 7,113
Growth rate for 1992 =
7,337 - 7,101 x 100 = 3.32% 7,101 7,533 - 7,337 x 100 = 2.67% 7,337 7,836 - 7,533 x 100 = 4.02% 7,533
% = 2.46%
Growth rate for 1993 =
Growth rate for 1994 =
Average annual growth = 6. Use the rule of 70: Number of years to double =
70 = 7. 10
8. In the long run, transforming the economy into a market system will be more important for China's economic growth. The movement of workers from agriculture to manufacturing represents a "one-shot" change that will eventually come to an end. Moving towards market principles will induce more technological advances and innovations. 10. a. Private saving: Sprivate = Y + TR C T = $11 trillion + $1 trillion - $8 trillion - $3 trillion = $1 trillion b. Public saving: Spublic = T G TR, but G not given. Use I = Sprivate + Spublic; $2 trillion = $1 trillion + Spublic; Spublic = $1 trillion c. Government purchases: Solve using Spublic = T G TR, or I = Y C G G = $1 trillion d. Government budget surplus = T G TR = $1 trillion 12. S and I must drop by $0.5 trillion. I = S = Y C G. With no change in Y and C, an increase in G must drop I and S by the same amount.
14. a. Both the equilibrium interest rate and the quantity of loanable funds increase. b. The demand for loanable funds increased. For a given demand for loanable funds, an increase in the interest rate does decrease the quantity of loanable funds demanded. c. If the interest rate had remained at i1, the quantity of loanable funds demanded would have increased from L1 to L3. d. With the increase in the interest rate from i1 to i2, the quantity of loanable funds supplied increase from L1 to L2. 16. An increase in business taxes will decrease the after-tax rate of return on investment projects, which will decrease the demand for loanable funds. The equilibrium real interest rate and quantity of loanable funds will both decrease, which will decrease the quantity of investment and the economy's future capital stock. 18. The after-tax return to savers would rise, which would increase the supply of loanable funds. The equilibrium real interest rate will fall, but the quantity of loanable funds would increase, as would the quantity of saving and investment. 20. Disagree, because economic growth is the percentage change in real GDP. The statement confuses the level of real GDP with the percentage change in real GDP. 22. Your firm will most likely still be operating below capacity. Also, before rehiring you will want to make sure that the increase in economic activity lasts. Chapter 14 Answers to End-of-Chapter Problems and Applications 2. a. A higher price level would cause a movement along the long-run aggregate supply curve. b. An increase in the labor force would cause the long-run aggregate supply curve to shift outward. c. An increase in the quantity of capital goods would cause the long-run aggregate supply curve to shift outward. d. Technological change would cause the long-run aggregate supply curve to shift outward.
4. Disagree. The increase in aggregate supply with the resulting drop in the price level will not cause a shift in aggregate demand, but simply a movement along the aggregate demand curve. 6. As explained in the text, most economists would say no. If workers and firms could always predict next year's price level with perfect accuracy, the SRAS would be a vertical line, just as the LRAS curve is.
8.
a.
In 2004 the actual market price of steel turned out to be higher than the expected
market price of steel when U.S. Steel negotiated the contracts before 2004.
b. The production of both will increase. With the price of steel in the U.S. Steel contracts below the market price of steel, companies using steel will demand more steel and produce more of their products. 10. a.
The increase in aggregate demand moves the economy from point A to point B with a higher price level and real GDP. Workers and firms will adjust to the price level being higher than they expected. Workers will push for higher wages and firms will charge higher prices, causing short-run aggregate supply to decrease. The economy will be back in long-run equilibrium at point C with a higher price level and potential GDP. b.
An unexpected increase in the price of an important raw material decreases short-run aggregate supply, moving the economy from point A to point B with a higher price level and lower real GDP. The drop in real GDP and the increase in unemployment leads workers to accept lower wages and firms to accept lower prices. Short-run aggregate supply shifts from SRAS2 to SRAS1, moving the economy from point B to point A. 12.
To go from potential real GDP in 2006 to potential real GDP in 2007 without inflation, aggregate demand, long-run aggregate supply, and short-run aggregate supply must all increase or, shift to the right on the graph by the same amount.
14.
a.
If firms operate beyond their normal capacity and structural and frictional unemployment drop
below their normal levels, then actual real GDP can be above potential real GDP.
b. The unemployment rate increased from 1969 to 1970 because the increase in actual real GDP was not as large as the increase in potential real GDP. c. If the recession was caused by a shift in aggregate demand (which, in fact, it was), the inflation rate is likely to have been lower in 1970 than in 1969. If the recession was caused by a shift in aggregate supply, the inflation rate was likely to have been higher. 16. a. Points A and C. b. Point D represents the short-run equilibrium and point C the long-run equilibrium. Workers and firms will adjust to the price level being higher than they expected. Workers will push for higher wages and firms will charge higher prices, causing short-run aggregate supply to decrease. 18. Disagree. The statement confuses the inflation rate with the price level. The decline in aggregate demand in 2001 did cause the inflation rate to fall, but the inflation rate was still positive, meaning that the price level increased. 20. A decline in stock prices would "weigh heavily" on businesses and consumers because it decreases household wealth, which decreases consumer spending. The drop in stock prices also made it harder for businesses to finance investment spending. These restraints on consumption and investment spending slowed down total spending in the economy and contributed to the slow recovery from the 2001 recession. 22. The economy, even though out of the recession, grew slowly in 2002 and was well below potential real GDP. The unemployment rate increased from 4.7 percent in 2001 to 5.8 percent in 2002. Chapter 15 Answers to End-of-Chapter Problems and Applications 2. As the Chinese government was being defeated, Chinese paper currency was ceasing to be fiat money, but, at least in Japan, had become a commodity money.
4. There is no effect on M1 because both currency and checking account balances are included in that measure of the money supply. Because M1 is not affected, neither is M2. 6. Deposits. Having more deposits allows these banks to make loans and other investments on which they are able to make profits. 8. There is no impact. The $100 was part of M1 when it was in your checking account and is still part of M1 when you hold it as currency. 10. Yes. The statement is correct. When bank reserves increases, they increase their loans, which creates new checking account deposits, thereby expanding the money supply.
12. a.
Bank of America
Assets Reserves +$2,000 Liabilities Deposits +$2,000
b.
Bank of America
Assets Reserves Loans +$2,000 +$1,600 Liabilities Deposits Deposits +$2,000 +$1,600
c.
Bank of America
Assets Reserves Loans +$400 +$1,600 Liabilities Deposits +$2,000
Citibank Bank
Assets Reserves +$1,600 Liabilities Deposits +$1,600
d. Change in checking account deposits = $2,000 x
1 0.20
= $2,000 x 5 = $10,000
Because checking account deposits are part of the money supply, it is tempting to say that the money supply has also increased by $10,000. But remember that your $2,000 in currency was counted as part of the money supply while you had it, but is not included when it is sitting in a bank vault. Therefore, Change in the money supply = Increase in checking account deposits Decline in currency in circulation = $10,000 $2,000 = $8,000.
14. a.
FNB
Assets Liabilities
Reserves
b. $10 million
+$10 million
Discount Loan +$10 million
c. Change in checking account deposits = $10 million x
1 = $100 million. 0.10
16. a.
Price deflation occurs when the price level declines from one year to the next.
b. Ordinarily, as the quantity theory of money indicates, assuming velocity does not decline, rapid increases in the money supply lead to inflation. c. If consumers believe that prices are falling, they may postpone purchases because they expect prices to be lower in the future. This decline in consumption may push the economy into recession. 18. Banks do not print money, but they create money, specifically checking account balances, when making loans from excess reserves. By creating loans, banks create checking account balances.
20. The large quantity of Confederate dollars would have generated high inflation, which would have decreased the value of the Confederate currency. With the war drawing to an end, Southerners would have been less and less willing to accept Confederate dollars. They could have made barter exchanges, or used dollars issued by the federal government of the United States. Chapter 16 Answers to End-of-Chapter Problems and Applications 2. To speed the recovery from the 2001 recession, the Federal Reserve pursued an expansionary monetary policy by lowering the target for the federal funds rate. The lower interest rates sustained and boosted the housing market even with the economy in recession.
4. a. Its original level must have been 1.75% + 4.75% = 6.5% b. As shown in Figure 16-4, an increase in the money supply will reduce interest rates.
6. The higher the interest rate, the more willing banks will be to make loans, everything else equal. The more loans banks make, the more money that is created. Therefore, there is good reason to think of the money supply curve as upward sloping.
With an upward sloping money supply curve, an increase in the demand for money will cause both the equilibrium interest rate and the equilibrium level of M1 to increase.
8. The author of the editorial confused the federal funds rate with the discount rate. The discount rate is the interest rate at which the Federal Reserve lends money to commercial banks.
10. Apparently banks in Japan were not lending out the new reserves being created by the Bank of Japan's expansionary monetary policy. For an expansionary monetary policy to be successful, banks have to lend out the reserves created by the central bank. Banks in Japan were having difficulty finding firms optimistic enough about the future to be willing to borrow in order to purchase new machinery, equipment, and buildings.
12. If the main economic problem is inflation, a central bank will keep interest rates high and the rate of growth of the money supply low. If the main economic problem is slow growth and unemployment, a central bank will keep interest rates low and the rate of growth of the money supply high.
14. a. Real GDP will be $12.6 trillion and the price level will be 109.0 b. The Fed should pursue a contractionary policy and the trading desk should sell Treasury bills. c. Without contractionary monetary policy, the inflation rate in 2008 =
109.0 - 104.7 100 = 4.1%. 104.7
With contractionary monetary policy, the inflation rate in 2008 =
107.0 - 104.7 100 = 2.2%. 104.7
16. The statement is incorrect. An increase in the money supply does not affect real GDP directly, and certainly not dollar-for-dollar. An increase in the money supply increases real GDP by lowering interest rates, which in turn increases spending. When interest rates are lower, households are more likely to buy new homes and automobiles and firms are more likely to buy new factories and computers. Lower interest rates also lead to a lower value of the dollar, which lowers the prices of exports and raises the prices of imports, thereby increasing net exports.
18. Policymakers at the Fed believe that although it is not perfect, active monetary policy is still able to play an important role in stabilizing the economy. Further, the monetary growth rule proposed by Friedman has its own problems, since the relationship between money growth and real GDP and the price level has weakened.
20. On the surface, the statement is incomplete. Any factor that causes aggregate demand to grow faster than aggregate supply, or causes aggregate supply to decrease will generate inflation. But, budget deficits (government spending more than it takes in) often lead, especially in the developing world, to the central bank purchasing the government bonds issued to finance the budget deficits. Purchases of government bonds by the central bank increase the money supply, which causes inflation. Chapter 17 Answers to End-of-Chapter Problems and Applications
2. Keynes is discussing the multiplier effect. By repercussions, he means the rounds of spending and new production set off by an initial increase in autonomous expenditures. Keynes believed that the government purchases multiplier was about 10. Therefore, even wasteful government spending would result in a substantial increase in the production of goods and services and in employment.
4. Balancing the federal government's budget in 1932 was not a good idea because the economy was in the midst of the Great Depression. Increasing taxes and cutting government purchases would reduce aggregate expenditures and further reduce real GDP.
6. The remark is half right. With a multiplier of 2, an increase of $125 billion in government spending will increase real GDP by $250 billion. But the multiplier does not apply to increases in the money supply.
8. As the demand for money increases, with the supply of money constant, households and businesses sell Treasury bills as they try to increase their holdings of cash. The increased supply of Treasury bills lowers their price and increases the interest rate.
10. Monetary policy is used more often than fiscal policy, which is why Alan Greenspan rather than President Bush and Congress is often referred to as steering the economy.
12. When tax revenues are not sufficient to pay the federal government's bills, the Treasury borrows the necessary funds. The Treasury is repaying the investors who had bought its bonds. The Treasury thought the federal budget would be in surplus, but it ended up in deficit.
14. As a budget surplus develops during a recovery but before the full employment level of real GDP is attained taxes are greater than government expenditures. Rising taxes reduce the ability of consumers and businesses to increase their spending. The federal government could have increased government purchases or cut taxes in order to avoid letting a large budget surplus develop and "choke off" the recovery.
16. Real GDP is likely to be lower than expected. The greater consumer spending that results from lower tax payments may keep the decline in real GDP from being as large as it would otherwise have been.
18. There may be some truth in the columnist's argument, but borrowing to pay the bills is a bad policy for a household, business, or government when the bills are for current expenses, but not a bad policy if the bills are for long-lived capital goods. The alternative is for the government to pay for long-lived capital goods out of the tax revenues received in the year the goods were purchased. But that means that the taxpayers in that year have to bear the whole burden of paying for the projects even though taxpayers for many years in the future will be enjoying the benefits.
20. Two arguments in favor of a flat tax would be the reduction in the paperwork and compliance cost of the income tax system and the potential increases in labor supply, savings, and investment that would result from a lower marginal tax rate. Two arguments against the flat tax would be that the complexities in the current tax code exist because the government pursues some other policy goals and the income distribution would become more unequal by reducing the marginal tax rate on high-income taxpayers. Chapter 18 Answers to End-of-Chapter Problems and Applications 2. Japan had a comparative advantage in producing these goods, even though it did not have an absolute advantage. 4. The opportunity cost of producing one good is the amount of the other good that has to be given up. To produce one cell phone, Japan has to give up 0.5 MP3 players. To produce one MP3 player, Japan has to give up two cell phones. To produce one cell phone, the United States has to give up two MP3 players. To produce one MP3 player, the United States has to give up 0.5 cell phones. 6. "Protectionist demands" refers to the use of tariffs, quotas and non-tariff barriers to protect domestic industries. Unilateral free trade would benefit American consumers because they could buy some goods more cheaply than before. In fact, it would benefit all the countries involved by allowing America's overseas trading partners to specialize more in the goods and services in which they have the lowest opportunity cost and to trade them for goods that the United States can produce at a lower opportunity cost.
8. a.
b.
Before the tariff, the quantity of beef sold by U.S. producers is Q1; after the tariff, the quantity of beef sold by U.S. producers is Q3. Before the tariff, the quantity of beef imported = Q2 Q1; after the tariff, the quantity of beef imported = Q4 Q3. 8. c. The winners from the tariff are domestic producers of beef and the government, which collects the tariff revenue. The losers are domestic consumers of beef. 10. Those industries that use sugar in their products will be hurt by the sugar quota. Producers of artificial sweeteners and other substitutes for sugar (like corn syrup) will be helped by the sugar quota because it raises the price of sugar.
12. These subsidies allow European farmers to sell sugar for a lower price than they otherwise would. This pushes down the world price for sugar and allows European producers to retain part of the sugar market they would otherwise lose to South African and other foreign producers of sugar. 14. When the U.S. government puts a tariff on steel imports, it protects steelworkers in West Virginia at the expense of steelworkers in South Korea (and elsewhere). Landsburg is making a normative statement. Redborn is also making a normative statement. 16. Trade allows a country to specialize in producing the goods in which it has a comparative advantage. After trading, the country can consume more. In this sense a country can "produce more with less" and consumers win. See Table 18-4 for a good example of trade leading to gains for consumers.
18. Without Quota World price of kumquats U.S. price of kumquats Quantity supplied by U.S. firms Quantity demanded Quantity imported Area of consumer surplus Area of domestic producer surplus Area of deadweight loss $0.75 $0.75 4 million 13 million 9 million A + B + C + D + E +F G 0 With Quota $0.75 $1.00 6 million 12 million 6 million A+B C+G D+F
20.
An increase in interest rates in Europe would increase the desire to invest in financial
assets in Europe relative to the United States. The demand for dollars would fall, causing the exchange rate for the dollar to fall. In the graph the exchange rate falls from 1 to 2.
22. a. The dollar appreciated against the yen. It takes 130 yen to purchase a dollar instead of 120 yen.
b. ii. or iii. could have caused the shift in demand shown.
24. A currency appreciation is good news for the country's consumers, because imports will cost less. It is bad news for the country's businesses that export their products, because the exports will cost more. If a business does not export products, but imports parts for its products, then the currency appreciation will be good news because the imported parts will cost less.