Solutions to Odd-Numbered End-of-Chapter Problems

Chapter 1

1.   The opportunity cost of going to school is \$9,600 of goods and services.

The opportunity cost of going to school this summer is the highest-valued activity that you will give up so that you can go to summer school. In going to summer school, you will forgo all the goods and services that you could have bought with the income from your summer job (\$6,000) plus the expenditure on tuition (\$2,000), textbooks (\$200), and living expenses (\$1,400).

3.       No, parking at this mall is not free. Yes, you did impose a cost on Harry.

Finding a parking space takes about 30 minutes, so you incur an opportunity cost when you park your car. The opportunity cost is the highest-valued activity that you forgo by spending 30 minutes parking your car. If you would have spent those 30 minutes studying, then the opportunity cost of parking at this mall is 30 minutes of studying.

The cost that you imposed on Harry is the additional 30 minutes that Harry will have to spend searching for a parking space.

Chapter 2

1a.  To make a time-series graph, plot the year on the x-axis and the inflation rate on the y-axis. The graph will be a line joining all the points.

1b.  (i) 1981 (ii) 1994 (iii) 1981, 1987, 1989, 1993, 1995 (iv) 1982–1986, 1988, 1990–1992, 1994, 1996, 1998 (v) 1987 (vi) 1983

1c.  Inflation has had a downward trend. The line tends to slope down to the right.

3.   To make a scatter diagram, plot the inflation rate on the x-axis and the interest rate on the y-axis. The graph will be a set of dots. The pattern made by the dots tells us that as the inflation rate increases, the interest rate usually increases.

5a.  To make a graph that shows the relationship between x and y, plot x on the x-axis and y on the y-axis. The relationship is positive because x and y move together: As x increases, y increases.

5b.  The slope increases as x increases. Slope is equal to the change in y divided by the change in x as we move along the curve. When x increases from 1 to 2 (a change of 1), y increases from 1 to 4 (a change of 3), so the slope is 3. But when x increases from 7 to 8 (a change of 1), y increases from 49 to 64 (a change of 15), so the slope is 15.

5c.  The taller the building, the bigger is the cost of building it. The higher the unemployment rate, the higher is the crime rate. The longer the flight, the larger is the amount of fuel used.

7.   The slope equals 8.

The slope of the curve at the point where x is 4 is equal to the slope of the tangent to the curve at that point. Plot the relationship and then draw the tangent line at the point where x is 4 and y is 16. Now calculate the slope of this tangent line. To do this, you must find another point on the tangent. The tangent line will cut the x-axis at 2, so another point is x equals 2 and y equals 0. Slope equals rise/run. The rise is 16 and the run is 2, so the slope is 8.

9.   The slope is 7.

The slope of the relationship across the arc when x increases from 3 to 4 is equal to the slope of the straight line joining the points on the curve at x equals 3 and x equals 4. In the graph, draw this straight line. When x increases from 3 to 4, y increases from 9 to 16. Slope equals rise/run. The rise is 7 (16 minus 9) and the run is 1 (4 minus 3), so the slope across the arc is 7.

11.  The slope is -5/4.

The curve is a straight line, so its slope is the same at all points on the curve. Slope equals the change in the variable on the y-axis divided by the change in the variable on the x-axis. To calculate the slope, you must select two points on the line. One point is at 10 on the y-axis and 0 on the x-axis, and another is at 8 on the x-axis and 0 on the y-axis. The change in y from 10 to 0 is associated with the change in x from 0 to 8. Therefore the slope of the curve equals -10/8, which equals -5/4.

13a.The slope at point a is -2, and the slope at point b is -0.75.

To calculate the slope at a point on a curved line, draw the tangent to the line at the point. Then find a second point on the tangent and calculate the slope of the tangent.

The tangent at point a cuts the y-axis at 10. The slope of the tangent equals the change in y divided by the change in x. The change in y equals 4 (10 minus 6) and the change in x equals -2 (0 minus 2). The slope at point a is 4/-2, which equals -2.

Similarly, the slope at point b is -0.75. The tangent at point b cuts the x-axis at 8. The change in y equals 1.5, and the change in x equals -2. The slope at point b is -0.75.

13b.The slope across the arc ab is -1.125.

The slope across an arc ab equals the change in y, which is 4.5 (6.0 minus 1.5) divided by the change in x, which equals -4 (2 minus 6). The slope across the arc ab equals 4.5/-4, which is -1.125.

15a.The relationship is a set of curves, one for each different temperature.

To draw a graph of the relationship between the price and the number of rides, keep the temperature at 10°C and plot the data in that column against the price. The curve that you draw is the relationship between price and number of rides when the temperature is 10°C. Now repeat the exercise but keep the temperature at 20°C. Then repeat the exercise but keep the temperature at 30°C.

15b.The relationship is a set of curves, one for each different price.

To draw a graph of the relationship between the temperature and the number of rides, keep the price at \$5.00 a ride and plot the data in that row against the temperature. The curve shows the relationship between temperature and the number of rides when the price is \$5.00 a ride. Now repeat the exercise but keep the price at \$10.00 a ride. Repeat the exercise again and keep the price at \$15.00 a ride and then at \$20.00 a ride.

15c.The relationship is a set of curves, one for each different number of rides.

To draw a graph of the relationship between the temperature and price, keep the number of rides at 32 and plot the data along the diagonal in the table. The curve is the relationship between temperature and price at which 32 rides are taken. Now repeat the exercise and keep the number of rides at 27. Repeat the exercise again and keep the number of rides at 18 and then at 40.

Chapter 3

1a.  Wendell's opportunity cost of an hour of tennis is 2.5 percentage points.

When Wendell increases the time he plays tennis from 4 hours to 6 hours, his grade in economics falls from 75 percent to 70 percent. His opportunity cost of 2 hours of tennis is 5 percentage points. So his opportunity cost of 1 hour of tennis is 2.5 percentage points.

1b.  Wendell's opportunity cost is 10 percentage points.

When Wendell increases the time he plays tennis from 6 hours to 8 hours, his grade in economics falls from 70 percent to 60 percent. His opportunity cost of 2 hours is 10 percentage points. So his opportunity cost of 1 hour is 5 percentage points.

3.   Wendell's opportunity cost of playing tennis increases as he spends more time on tennis.

When Wendell increases the time he plays tennis from 4 hours to 6 hours, his opportunity cost is 5 percentage points. But when he increases the time he plays tennis from 6 hours to 8 hours, his opportunity cost is 10 percentage points. Wendell’s opportunity cost of playing tennis increases as he spends more time on tennis.

5a. Wendell's grade in economics is 66 percent.

When Wendell increases the time he plays tennis from 4 hours to 6 hours, his opportunity cost of the additional 2 hours of tennis is 5 percentage points. So his opportunity cost of an additional 1 hour is 2.5 percentage points. But when he increases the time he plays tennis from 6 hours to 8 hours, his opportunity cost of the additional 2 hours of tennis is 10 percentage points. So his opportunity cost of the additional 1 hour of tennis is 5 percentage points. Wendell's opportunity cost of playing tennis increases as he spends more time on tennis. Opportunity cost is plotted at the midpoint of the range. This curve is Wendell's marginal cost of a additional hour of tennis.

Wendell uses his time efficiently if he plays tennis for 7 hours a week—marginal benefit from tennis equals its marginal cost. Wendell's marginal benefit is 5 percentage points and his marginal cost is 5 percentage points. When Wendell plays 7 hours of tennis, his grade in economics (from his PPF) is 66 percent.

5b. If Wendell studied for enough hours to get a higher grade, he would have fewer hours to play tennis. Wendell's marginal benefit from tennis would be greater than his marginal cost, so he would be more efficient if he played more hours of tennis and took a lower grade.

7a.  Leisureland's PPF is a straight line.

To make a graph of Leisureland's PPF measure the quantity of one good on the x-axis and the quantity of the other good on the y-axis. Then plot the quantities in each row of the table and join up the points.

7b.  The opportunity cost of 1 kilogram of food is 1/2 litre of sunscreen.

The opportunity cost of the first 100 kilograms of food is 50 litres of sunscreen. To find the opportunity cost of the first 100 kilograms of food, increase the quantity of food from 0 kilograms to 100 kilograms. In doing so, Leisureland's production of sunscreen decreases from 150 litres to 100 litres. The opportunity cost of the first 100 kilograms of food is 50 litres of sunscreen. Similarly, the opportunity costs of producing the second 100 kilograms and the third 100 kilograms of food are 50 litres of sunscreen.

The opportunity cost of 1 litre of sunscreen is 2 kilograms of food. The opportunity cost of producing the first 50 litres of sunscreen is 100 kilograms of food. To calculate this opportunity cost, increase the quantity of sunscreen from 0 litres to 50 litres. Leisureland's production of food decreases from 300 kilograms to 200 kilograms. Similarly, the opportunity cost of producing the second 50 litres and the third 50 litres of sunscreen are 100 kilograms of food.

9a.  The marginal benefit curve slopes downward.

To draw the marginal benefit from sunscreen, plot the quantity of sunscreen on the x-axis and the willingness to pay for sunscreen (that is, the number of kilograms of food that they are willing to give up to get a litre of sunscreen) on the y-axis.

9b.  The efficient quantity is 75 litres a month.

The efficient quantity to produce is such that the marginal benefit from the last litre equals the opportunity cost of producing it. The opportunity cost of a litre of sunscreen is 2 kilograms of sunscreen. The marginal benefit of the 75th litre of sunscreen is 2 kilograms of food. And the marginal cost of the 75th litre of sunscreen is 2 kilograms of food.

11.  Busyland's opportunity cost of a kilogram of food is 2 litres of sunscreen, and its opportunity cost of a litre of sunscreen is 1/2 kilogram of food.

When Busyland increases the food it produces by 50 kilograms a month, it produces 100 litres of sunscreen less. The opportunity cost of 1 kilogram of food is 2 litres of sunscreen. Similarly, when Busyland increases the sunscreen it produces by 100 litres a month, it produces 50 kilograms of food less. The opportunity cost of 1 litre of sunscreen is 1/2 kilogram of food.

13a.Leisureland sells food and buys sunscreen.

Leisureland sells the good in which it has a comparative advantage and buys the other good from Busyland. Leisureland’s opportunity cost of 1 kilogram of food is 1/2 litre of sunscreen, while Busyland’s opportunity cost of 1 kilogram of food is 2 litres of sunscreen. Leisureland’s opportunity cost of food is less than Busyland’s, so Leisureland has a comparative advantage in producing food.

Leisureland’s opportunity cost of 1 litre of sunscreen is 2 kilograms of food, while Busyland’s opportunity cost of 1 litre of sunscreen is 1/2 kilogram of food. Busyland’s opportunity cost of sunscreen is less than Leisureland’s, so Busyland has a comparative advantage in producing sunscreen.

13b.The gains from trade for each country are 50 kilograms of food and 50 litres of sunscreen.

With specialization and trade, together they can produce 300 kilograms of food and 300 litres of sunscreen. So each will get 150 kilograms of food and 150 litres of sunscreen—an additional 50 kilograms of food and 50 litres of sunscreen.

Chapter 4

1a.  The price of a tape will rise, and the quantity of tapes sold will increase.

CDs and tapes are substitutes. If the price of a CD rises, people will buy more tapes and fewer CDs. The demand for tapes will increase. The price of a tape will rise, and more tapes will be sold.

1b.  The price of a tape will fall, and fewer tapes will be sold.

Walkmans and tapes are complements. If the price of a Walkman rises, fewer Walkmans will be bought. The demand for tapes will decrease. The price of a tape will fall, and people will buy fewer tapes.

1c.  The price of a tape will fall and fewer tapes will be sold.

The increase in the supply of CD players will lower the price of a CD player. With CD players cheaper than they were, some people will buy CD players. The demand for CDs will increase, and the demand for tapes will decrease. The price of a tape will fall, and people will buy fewer tapes.

1d.  The price of a tape will rise, and the quantity sold will increase.

An increase in consumers' income will increase the demand for tapes. As a result, the price of a tape will rise and the quantity bought will increase.

1e.  The price of a tape will rise, and the quantity sold will decrease.

If the workers who make tapes get a pay raise, the cost of making a tape increases and the supply of tapes decreases. The price will rise, and people will buy fewer tapes.

1f.   The quantity sold will decrease, but the price might rise, fall, or stay the same.

Walkmans and tapes are complements. If the price of a Walkman rises, fewer Walkmans will be bought and so the demand for tapes will decrease. The price of a tape will fall, and people will buy fewer tapes. If the wages paid to workers who make tapes rise, the supply of tapes decreases. The quantity of tapes sold will decrease, and the price of a tape will rise. Taking the two events together, the quantity sold will decrease, but the price might rise, fall, or stay the same.

3a.  (ii), (iii), and (iv)

The demand for gasoline will change if the price of a car changes, all speed limits on highways are abolished, or robot production cuts the cost of producing a car. If the price of a car rises, the quantity of cars bought decrease. So the demand for gasoline decreases. If all speed limits on highways are abolished, people will drive faster and use more gasoline. The demand for gasoline increases. If robot production plants lower the cost of producing a car, the supply of cars will increase. With no change in the demand for cars, the price of a car will fall and more cars will be bought. The demand for gasoline increases.

3b.  (i)

The supply of gasoline will change if the price of crude oil changes. If the price of crude oil rises, the cost of producing gasoline will rise. So the supply of gasoline decreases.

3c.  (i)

If the price of crude oil (a resource used to make gasoline) rises, the cost of producing gasoline will rise. So the supply of gasoline decreases. The demand for gasoline does not change, so the price of gasoline will rise and there is a movement up the demand curve for gasoline. The quantity demanded of gasoline decreases.

3d.  (ii), (iii), and (iv)

If the price of a car rises, the quantity of cars bought decrease. So the demand for gasoline decreases. The supply of gasoline does not change, so the price of gasoline falls and there is a movement down the supply curve of gasoline. The quantity supplied of gasoline decreases.

If all speed limits on highways are abolished, people will drive faster and use more gasoline. The demand for gasoline increases. The supply of gasoline does not change, so the price of gasoline rises and there is a movement up along the supply curve. The quantity supplied of gasoline increases.

If robot production plants lower the cost of producing a car, the supply of cars will increase. With no change in the demand for cars, the price of a car will fall and more cars will be bought. The demand for gasoline increases. The supply of gasoline does not change, so the price of gasoline rises and the quantity of gasoline supplied increases.

5a. The demand curve is the curve that slopes down toward to the right. The supply curve is the curve that slopes up toward to the right.

5b. The equilibrium price is \$14 a pizza, and the equilibrium quantity is 200 pizzas a day.

Market equilibrium is determined at the intersection of the demand curve and supply curve.

7a. The equilibrium price is 50 cents a pack, and the equilibrium quantity is 120 million packs a week.

The price of a pack adjusts until the quantity demanded equals the quantity supplied. At 50 cents a pack, the quantity demanded is 120 million packs a week and the quantity supplied is 120 million packs a week.

7b.  At 70 cents a pack, there will be a surplus of gum and the price will fall.

At 70 cents a pack, the quantity demanded is 80 million packs a week and the quantity supplied is 160 million pack a week. There is a surplus of 80 million packs a week. The price will fall until market equilibrium is restored—50 cents a pack.

9.   The supply curve has shifted leftward.

As the number of gum-producing factories decreases, the supply of gum decreases. There is a new supply schedule, and the supply curve shifts leftward.

9b. There has been a movement along the demand curve.

The supply of gum decreases, and the supply curve shifts leftward. Demand does not change, so the price rises along the demand curve.

9c. The equilibrium price is 60 cents, and the equilibrium quantity is 100 million packs a week.

Supply decreases by 40 millions packs a week. That is, the quantity supplied at each price decreases by 40 million packs. The quantity supplied at 50 cents is now 80 million packs, and there is a shortage of gum. The price rises to 60 cents a pack, at which the quantity supplied equals the quantity demanded (100 million packs a week).

11.  The new price is 70 cents a pack, and the quantity is 120 million packs a week.

The demand for gum increases, and the demand curve shifts rightward. The quantity demanded at each price increases by 40 million packs. The result of the fire is a price of 60 cents a pack. At this price, there is now a shortage of gum. The price of gum will rise until the shortage is eliminated.

Chapter 5

1a.  The price elasticity of demand is 1.25.

The price elasticity of demand equals the percentage change in the quantity demanded divided by the percentage change in the price. The price rises from \$4 to \$6 a box, a rise of \$2 a box. The average price is \$5 a box. So the percentage change in the price equals \$2 divided by \$5, which equals 40 percent.

The quantity decreases from 1,000 to 600 boxes, a decrease of 400 boxes. The average quantity is 800 boxes. So the percentage change in quantity equals 400 divided by 800, which equals 50 percent.

The price elasticity of demand for strawberries equals 50 divided by 40, which is 1.25.

1b.  The price elasticity of demand exceeds 1, so the demand for strawberries is elastic.

3a.  The price elasticity of demand is 2.

When the price of a videotape rental rises from \$3 to \$5, the quantity demanded of videotapes decreases from 75 to 25 a day. The price elasticity of demand equals the percentage change in the quantity demanded divided by the percentage change in the price.

The price increases from \$3 to \$5, an increase of \$2 a videotape. The average price is \$4 a videotape. So the percentage change in the price equals \$2 divided by \$4, which equals 50 percent.

The quantity decreases from 75 to 25 videotapes, a decrease of 50 videotapes. The average quantity is 50 videotapes. So the percentage change in quantity equals 50 divided by 50, which equals 100 percent.

The price elasticity of demand for videotape rentals equals 100 divided by 50, which is 2.

3b.  The price elasticity of demand equals 1 at \$3 a videotape. The price elasticity of demand equals infinity at \$6 a videotape. The price elasticity of demand equals zero at \$0 a videotape.

The price elasticity of demand equals 1 at the price halfway between the origin and the price at which the demand curve hits the y-axis. That price is \$3 a videotape.

The price elasticity of demand equals infinity at the price at which the demand curve hits the y-axis. That price is \$6 a videotape.

The price elasticity of demand equals zero at the price at which the demand curve hits the x-axis. That price is \$0 a videotape.

5.   The demand for dental services is unit elastic.

The price elasticity of demand for dental services equals the percentage change in the quantity of dental services demanded divided by the percentage change in the price of dental services.

The price elasticity of demand equals 10 divide by 10, which is 1. The demand is unit elastic.

7a. Total revenue increases.

When the price of a chip is \$400, 30 million chips are sold and total revenue equals \$12,000 million. When the price of a chip falls to \$350, 35 million chips are sold and total revenue is \$12,250 million. Total revenue increases when the price falls.

7b.  Total revenue decreases.

When the price is \$350 a chip, 35 million chips are sold and total revenue is \$12,250 million. When the price of a chip is \$300, 40 million chips are sold and total revenue decreases to \$12,000 million. Total revenue decreases as the price falls.

7c.  Total revenue is maximized at \$350 a chip.

When the price of a chip is \$300, 40 million chips are sold and total revenue equals \$12,000 million. When the price is \$350 a chip, 35 million chips are sold and total revenue equals \$12,250 million. Total revenue increases as the price rises from \$300 to \$350 a chip. When the price is \$400 a chip, 30 million chips are sold and total revenue equals \$12,000 million. Total revenue decreases as the price rises from \$350 to \$400 a chip. Total revenue is maximized when the price is \$350 a chip.

7d.  The quantity will be 35 million chips a year.

The demand schedule tells us that when the price is \$350 a chip, the quantity of chips demanded is 35 million chips a year.

7e.  The demand for chips is unit elastic.

The total revenue test says that if the price changes and total revenue remains the same, the demand is unit elastic at the average price. For an average price of \$350 a chip, cut the price from \$400 to \$300 a chip. When the price of a chip falls from \$400 to \$300, total revenue remains at \$12,000 million. So at the average price of \$350 a chip, demand is unit elastic.

9.   The demand for chips is inelastic.

The total revenue test says that if the price falls and total revenue falls, the demand is inelastic. When the price falls from \$300 to \$200 a chip, total revenue decreases from \$12,000 million to \$10,000 million. So at an average price of \$250 a chip, demand is inelastic.

11. The cross elasticity of demand between orange juice and apple juice is 1.17.

The cross elasticity of demand is the percentage change in the quantity demanded of one good divided by the percentage change in the price of another good. The rise in the price of orange juice resulted in an increase in the quantity demanded of apple juice. So the cross elasticity of demand is the percentage change in the quantity demanded of apple juice divided by the percentage change in the price of orange juice. The cross elasticity equals 14 divided by 12, which is 1.17.

13.  Income elasticity of demand for (i) bagels is 1.33 and (ii) donuts is -1.33.

Income elasticity of demand equals the percentage change in the quantity demanded divided by the percentage change in income. The change in income is \$2,000 and the average income is \$4,000, so the percentage change in income equals 50 percent.

(i) The change in the quantity demanded is 4 bagels and the average quantity demanded is 6 bagels, so the percentage change in the quantity demanded equals 66.67 percent. The income elasticity of demand for bagels equals 66.67/50, which is 1.33.

(ii) The change in the quantity demanded is -6 donuts and the average quantity demanded is 9 donuts, so the percentage change in the quantity demanded is -66.67. The income elasticity of demand for donuts equals -66.67/50, which is -1.33.

15a.The elasticity of supply is 1.

The elasticity of supply is the percentage change in the quantity supplied divided by the percentage change in the price. When the price falls from 40 cents to 30 cents, the change in the price is 10 cents and the average price is 35 cents. The percentage change in the price is 28.57.

When the price falls from 40 cents to 30 cents, the quantity supplied decreases from 800 to 600 calls. The change in the quantity supplied is 200 calls, and the average quantity is 700 calls, so the percentage change in the quantity supplied is 28.57.

The elasticity of supply equals 28.57/28.57, which equals 1.

15b.The elasticity of supply is 1.

The formula for the elasticity of supply calculates the elasticity at the average price. So to find the elasticity at 20 cents, change the price such that 20 cents is the average price—for example, a fall in the price from 30 cents to 10 cents.

When the price falls from 30 cents to 10 cents, the change in the price is 20 cents and the average price is 20 cents. The percentage change in the price is 100. When the price falls from 30 cents to 10 cents, the quantity supplied decreases from 600 to 200 calls. The change in the quantity supplied is 400 calls and the average quantity is 400 calls. The percentage change in the quantity supplied is 100.

The elasticity of supply is the percentage change in the quantity supplied divided by the percentage change in the price. The elasticity of supply is 1.

Chapter 6

1a.  Equilibrium price is \$1.00 a floppy disk, and the equilibrium quantity is 3 floppy disks a month.

1b.  Consumer surplus is \$2.25.

The consumer surplus is the area of the triangle under the demand curve above the price. The price is \$1.00 a disk. The area of the triangle equals (2.50 - 1.00)/2 multiplied by 3, which is \$2.25.

1c.  Producer surplus is \$0.75.

The producer surplus is the area of the triangle above the supply curve below the price. The price is \$1.00 a disk. The area of the triangle equals (1.00 - 0.50)/2 multiplied by 3, which is \$0.75.

1d.  The efficient quantity is 3 floppy disks a month.

The efficient quantity is the quantity that makes the marginal benefit from the last disk equal to the marginal cost of producing the last disk. The demand curve shows the marginal benefit and the supply curve shows the marginal cost. Only if 3 floppy disks are produced is the quantity produced efficient.

3a.  The maximum price that consumers will pay is \$3.

The demand schedule shows the maximum price that consumers will pay for each sandwich. The maximum price that consumers will pay for the 250th sandwich is \$3.

3b.  The minimum price that producers will accept is \$5.

The supply schedule shows the minimum price that producers will accept for each sandwich. The minimum price that produces will accept for the 250th sandwich is \$5.

3c.  250 sandwiches exceeds the efficient quantity.

The efficient quantity is such that marginal benefit from the last sandwich equals the marginal cost of producing it. The efficient quantity is the equilibrium quantity—200 sandwiches an hour.

3d.  Consumer surplus is \$400.

The equilibrium price is \$4. The consumer surplus is the area of the triangle under the demand curve above the price. The area of the triangle is (8 - 4)/2 multiplied by 200, which is \$400.

3e.  Producer surplus is \$400.

The producer surplus is the area of the triangle above the supply curve below the price. The price is \$4. The area of the triangle is (4 - 0)/2 multiplied by 200, which is \$400.

3f.   The deadweight loss is \$50.

Deadweight loss is the sum of the consumer surplus and producer surplus that is lost because the quantity produced is not the efficient quantity. The deadweight loss equals the quantity (250 - 200) multiplied by (5 - 3)/2, which is \$50.

5a.  Ben's consumer surplus is \$122.50. Beth's consumer surplus is \$22.50, and Bo's consumer surplus is \$4.50.

Consumer surplus is the area under the demand curve above the price. At 40 cents, Ben will travel 350 kilometres, Beth will travel 150 kilometres, and Bo will travel 30 kilometres. To find Ben's consumer surplus extend his demand schedule until you find the price at which the quantity demanded by Ben is zero—the price at which Ben's demand curve cuts the y-axis. This price is 110 cents. So Ben's consumer surplus equals (110 - 40)/2 multiplied by 350, which equals \$122.50. Similarly, Beth's consumer surplus equals (70 - 40)/2 multiplied by 150, which equals \$22.50. And Bo's consumer surplus equals (70 - 40)/2 multiplied by 30, which equals \$4.50.

5b.  Ben's consumer surplus is the largest because he places a higher value on each unit of the good than the other two do.

5c.  Ben's consumer surplus falls by \$32.50. Beth's consumer surplus falls by \$12.50, and Bo's consumer surplus falls by \$2.50.

At 50 cents a kilometre, Ben travels 300 kilometres and his consumer surplus is \$90. Ben's consumer surplus equals (110 - 50)/2 multiplied by 300, which equals \$90. Ben's consumer surplus decreases from \$122.50.to \$90, a decrease of \$32.50. Beth travels 100 kilometres and her consumer surplus is \$10, a decrease of \$12.50. Bo travels 20 kilometres and her consumer surplus is \$2.00, a decrease of \$2.50.

Chapter 7

1a.  Equilibrium price is \$200 a month and the equilibrium quantity is 10,000 housing units.

1b.  The quantity rented is 5,000 housing units.

The quantity of housing rented is equal to the quantity supplied at the rent ceiling.

1c.  The shortage of housing is 10,000 housing units.

At the rent ceiling, the quantity of housing demanded is 15,000 but the quantity supplied is 5,000, so there is a shortage of 10,000 housing units.

1d.  The maximum price that someone is willing to pay for the 5,000th unit available is \$300 a month.

The demand curve tells us the maximum price that someone is willing to pay for the 5,000th unit.

3a.  The equilibrium wage rate is \$4 an hour, and employment is 2,000 hours a month.

3b.  Unemployment is zero. Everyone who wants to work for \$4 an hour is employed.

3c.  They work 2,000 hours a month.

A minimum wage rate is the lowest wage rate that a person can be paid for an hour of work. Because the equilibrium wage rate exceeds the minimum wage rate, the minimum wage is ineffective. The wage rate will be \$4 an hour and employment is 2,000 hours.

3d.  There is no unemployment

The wage rate rises to the equilibrium wage—the quantity of labour demanded equals the quantity of labour supplied. So there is no unemployment.

3e.  At \$5 an hour, 1,500 hours a month are employed and 1,000 hours a month are unemployed.

The quantity of labour employed equals the quantity demanded at \$5 an hour. Unemployment is equal to the quantity of labour supplied at \$5 an hour minus the quantity of labour demanded at \$5 an hour. The quantity supplied is 2,500 hours a month, and the quantity demanded is 1,500 hours a month. So 1,000 hours a month are unemployed.

3f.   The wage rate is \$5 an hour, and unemployment is 500 hours a month.

At the minimum wage of \$5 an hour, the quantity demanded is 2,000 hours a month and the quantity supplied is 2,500 hours a month. So 500 hours a month are unemployed.

5a.  With no tax on brownies, the price is 60 cents a brownie and 4 million a day are consumed.

5b.  The price is 70 cents a brownie, and 3 million brownies a day are consumed. Consumers and producers each pay 10 cents of the tax on a brownie.

The tax decreases the supply of brownies and raises the price of a brownie. With no tax, producers are willing to sell 3 million brownies a day at 50 cents a brownie. But with a 20 cent tax, they are willing to sell 3 million brownies a day only if the price is 20 cents higher at 70 cents a brownie.

7a.  The market price is \$1.50 per dozen, the quantity sold is 2,250 dozen per week, farm revenue is \$5,250 per week, and the surplus of eggs is 1,250 dozen per week.

The market price is the floor price of \$1.50 per dozen. The quantity sold is the quantity demanded at a price of \$1.50-2,250 dozen per week. When the price is \$1.50, the quantity supplied is 3,500 dozen per week and the quantity demanded is 2,250 dozen per week. The surplus is 1,250 dozen per week.For the floor price to be maintained, the government will have to buy the surplus from farmers at the floor price. Otherwise farmers will cut the price below the floor price to sell their surplus. In this case, farm revenue is the quantity supplied at \$1.50-3,500 per week multiplied by the price, which equals \$5,250 per week.

Chapter 8

1a.  To draw a graph of Jason's total utility from rock CDs, plot the number of CDs on the x-axis and Jason's utility from CDs on the y-axis. The curve will look similar to Fig. 8.2(a). To draw a graph of Jason's total utility from spy novels, repeat the above procedure but use the spy novel data.

1b.  Jason gets more utility from any number of rock CDs than he does from the same number of spy novels.

1c.  To draw a graph of Jason's marginal utility from rock CDs plot the number of CDs on the x-axis and Jason's marginal utility from CDs on the y-axis. The curve will look similar to Fig. 8.2(b). To draw a graph of Jason's marginal utility from spy novels, repeat the above procedure but use the spy novel data.

Jason's marginal utility from rock CDs is the increase in total utility he gets from one additional rock CD. Similarly, Jason's marginal utility from spy novels is the increase in total utility he gets from one additional spy novel.

1d.  Jason gets more marginal utility from an additional rock CD than he gets from an additional spy novel when he has the same number of each.

3a.  To draw a graph of Max's budget line, plot the hours spent on one activity (say, windsurfing) on the x-axis and the hours spent on the other activity of the y-axis. The budget line is a straight line running from 3.5 hours of windsurfing on the x-axis to 7 hours of snorkeling on the y-axis.

If Max spends all of his \$35 on windsurfing, he can rent the windsurfing equipment for \$35/\$10 an hour, which is 3.5 hours. If Max spends all of his \$35 on snorkeling, he can rent the snorkeling equipment for \$35/\$5 an hour, which is 7 hours.

3b.  To maximize his utility, Max windsurfs for 3 hours and snorkels for 1 hour.

Max will spend his \$35 such that all of the \$35 is spent and that the marginal utility per dollar spent on each activity is the same. When Max windsurfs for 3 hours and snorkels for 1 hour, he spends \$30 renting the windsurfing equipment and \$5 renting the snorkeling equipment—a total of \$35.

The marginal utility from the third hour of windsurfing is 80 and the rent of the windsurfing equipment is \$10 an hour, so the marginal utility per dollar spent on windsurfing is 8. The marginal utility from the first hour of snorkeling is 40 and the rent of the snorkeling equipment is \$5 an hour, so the marginal utility per dollar spent on snorkeling is 8. The marginal utility per dollar spent on windsurfing equals the marginal utility per dollar spent on snorkeling.

5a.  Max's budget line is the straight line running from 5.5 hours of windsurfing and no snorkeling to 11 hours of snorkeling and no windsurfing.

5b.  To maximize his utility, Max windsurfs for 4 hours and snorkels for 3 hour.

Max will spend his \$55 such that all of the \$55 is spent and that the marginal utility per dollar spent on each activity is the same. When Max windsurfs for 4 hours and snorkels for 3 hours, he spends \$40 renting the windsurfing equipment and \$15 renting the snorkeling equipment—a total of \$55.

The marginal utility from the fourth hour of windsurfing is 60 and the rent of the windsurfing equipment is \$10 an hour, so the marginal utility per dollar spent on windsurfing is 6. The marginal utility from the third hour of snorkeling is 30 and the rent of the snorkeling equipment is \$5 an hour, so the marginal utility per dollar spent on snorkeling is 6. The marginal utility per dollar spent on windsurfing equals the marginal utility per dollar spent on snorkeling.

7.   To maximize his utility, Max windsurfs for 6 hours and snorkels for 5 hours.

Max will spend his \$55 such that all of the \$55 is spent and that the marginal utility per dollar spent on each activity is the same. When Max windsurfs for 6 hours and snorkels for 5 hours, he spends \$30 renting the windsurfing equipment and \$25 renting the snorkeling equipment—a total of \$55.

The marginal utility from the sixth hour of windsurfing is 12 and the rent of the windsurfing equipment is \$5 an hour, so the marginal utility per dollar spent on windsurfing is 2.4. The marginal utility from the fifth hour of snorkeling is 12 and the rent of the snorkeling equipment is \$5 an hour, so the marginal utility per dollar spent on snorkeling is 2.4. The marginal utility per dollar spent on windsurfing equals the marginal utility per dollar spent on snorkeling.

9.   To maximize his utility, Max windsurfs for 5 hours and snorkels for 1 hour.

Because the equipment is free, Max does not have to allocate his income between the two activities; instead, he allocates his time between the two activities. Max spends 6 hours on these activities. Max allocates the 6 hours such that the marginal utility from each activity is the same. When Max windsurfs for 5 hours and snorkels for 1 hour, he spends 6 hours. His marginal utility from the fifth hour of windsurfing is 40 and his marginal utility from the first hour of snorkeling is 40—so the marginal utilities are equal.

11.  The market demand curve passes through the following points: 90 cents and 3 cartons; 70 cents and 6 cartons; 50 cents and 10 cartons; 30 cents and 14 cartons; and 10 cents and 18 cartons.

At each price, the quantity demand by the market is equal to the sum of the cartons of popcorn that Shirley demands and the cartons of popcorn that Dan demands. For example, at 50 cents a carton, the quantity demanded by Shirley and Dan is 10, the sum of Shirley's 6 and Dan's 4.

Chapter 9

1a.  Sara's real income is 4 cans of cola.

Sara’s real income in terms of cans of cola is equal to her money income divided by the price of a can of cola. Sara’s money income is \$12, and the price of cola is \$3 a can. Sara's real income is \$12 divided by \$3 a can of cola, which is 4 cans of cola.

1b.  Sara's real income is 4 bags of popcorn.

Sara’s real income in terms of popcorn is equal to her money income divided by the price of a bag of popcorn, which is \$12 divided by \$3 a bag or 4 bags of popcorn.

1c.  The relative price of cola is 1 bag per can.

The relative price of cola is the price of cola divided by the price of popcorn. The price of cola is \$3 a can and the price of popcorn is \$3 a bag, so the relative price of cola is \$3 a can divided by \$3 a bag, which equals 1 bag per can.

1d.  The opportunity cost of a can of cola is 1 bag of popcorn.

The opportunity cost of a can of cola is the quantity of popcorn that must be forgone to get a can of cola. The price of cola is \$3 a can and the price of popcorn is \$3 a bag, so to buy one can of cola Sara must forgo 1 bag of popcorn.

1e.  The equation that describes Sara's budget line is

QP = 4 – QC

Call the price of popcorn PP and the quantity of popcorn QP, the price of cola PC and the quantity of cola QC, and income y. Sara’s budget equation is

PPQP + PCQC = y

If we substituting \$3 for the price of popcorn, \$3 for the price of cola, and \$12 for the income, the budget equation becomes

\$3 ´ QP + \$3 ´ QC = \$12

Dividing both sides by \$3 gives

QP + QC = 4.

Subtract QC from both sides to give

QP = 4 – QC

1f.   To draw a graph of the budget line, plot the quantity of cola on the x-axis and the quantity of popcorn on the y-axis. The budget line is a straight line running from 4 bags on the y-axis to 4 cans on the x-axis.

1g.  The slope of the budget line, when cola is plotted on the x-axis is minus 1. The magnitude of the slope is equal to the relative price of cola.

The slope of the budget line is "rise over run." If the quantity of cola decreases from 4 to 0, the quantity of popcorn increases from 0 to 4. The rise is 4 and the run is -4. Therefore the slope equals 4/-4, which is -1.

3a.  Sara buys 2 cans of cola and 2 bags of popcorn.

Sara buys the quantities of cola and popcorn that gets her onto the highest indifference curve, given her income and the prices of cola and popcorn. The graph shows Sara's indifference curves. So draw Sara's budget line on the graph. The budget line is tangential to indifference curve I0 at 2 cans of cola and 2 bags of popcorn. The indifference curve I0 is the highest indifference curve that Sara can get onto.

3b.  Sara's marginal rate of substitution is 1.

The marginal rate of substitution is the magnitude of the slope of the indifference curve at Sara's consumption point, which equals the magnitude of the slope of the budget line. The slope of Sara's budget line is -1, so the marginal rate of substitution is 1.

5a.  Sara buys 6 cans of cola and 1 bag of popcorn.

Draw the new budget line on the graph with Sara's indifference curves. The budget line now runs from 8 cans of cola on the x-axis to 4 bags of popcorn on the y-axis. The new budget line is tangential to indifference curve I1 at 6 cans of cola and 1 bag of popcorn. The indifference curve I1 is the highest indifference curve that Sara can now get onto.

5b.  Two points on Sara's demand for cola are the following: At \$3 a can of cola, Sara buys 2 cans of cola. At \$1.50 a can of cola, Sara buys 6 cans.

5c.  The substitution effect is 2 cans of cola and -1.5 bags of popcorn.

To divide the price effect into a substitution effect and an income effect, take enough income away from Sara and gradually move her new budget line back toward the origin until it just touches Sara's indifference curve I0. The point at which this budget line just touches indifference curve I0 is 4 cans of cola and 0.5 bag of popcorn. The substitution effect is the increase in the quantity of cola from 2 cans to 4 cans and the decrease in the quantity of popcorn from 2 bags to 0.5 bag along the indifference curve I0. The substitution effect is 2 cans of cola and -1.5 bags of popcorn.

5d.  The income effect is 2 cans of cola and 0.5 bag of popcorn.

The income effect is the change in the quantity of cola from the price effect minus the change from the substitution effect. The price effect is 4 cans of cola (6 cans minus the initial 2 cans) and -1 bag of popcorn (1 bag minus the initial 2 bags). The substitution effect is an increase in the quantity of cola from 2 cans to 4 cans and the decrease in the quantity of popcorn from 2 bags to 0.5 bag of popcorn. So the income effect is 2 cans of cola and 0.5 bag of popcorn.

5e.  Cola is a normal good for Sara because the income effect is positive. An increase in income increases the quantity of cola she buys from 4 to 6 cans.

5f.   Popcorn is a normal good for Sara because the income effect is positive. An increase in income increases the quantity of popcorn she buys from 0.5 bags to 1 bag.

When Pam buys 30 cookies at \$1 each and 5 comic books at \$2 each, she spends \$40 a month. Now that the price of a cookie is 50 cents and the price of a comic book is \$5, 30 cookies and 5 comic books will cost \$40. So Pam can still buy 30 cookies and 5 comic books.

7b.  Pam will not want to buy 30 cookies and 5 comic books because the marginal rate of substitution does not equal the relative price of the goods. Pam will move to a point on the highest indifference curve possible where the marginal rate of substitution equals the relative price.

7c.  Pam prefers cookies at 50 cents each and comic books at \$5 each because she can get onto a higher indifference curve than when cookies are \$1 each and comic books are \$2 each.

The new budget line and the old budget line pass through the point at 30 cookies and 5 comic books. If comic books are plotted on the x-axis, the marginal rate of substitution at this point on Pam's indifference curve is equal to the relative price of a comic book at the original prices, which is 2. The new relative price of a comic book is \$5/50 cents, which is 10. That is, the budget line is steeper than the indifference curve at 30 cookies and 5 comic books. Pam will buy more cookies and fewer comic books.

7e.  There will be a substitution effect and an income effect.

A substitution effect arises when the relative price changes and the consumer moves along the same indifference curve to a new point where the marginal rate of substitution equals the new relative price. An income effect arises when the consumer moves from one indifference curve to another, keeping the relative price constant.

Chapter 10

1.   Explicit costs are \$30,000. Explicit costs are all the costs for which there is a payment. Explicit costs are the sum the wages paid (\$20,000) and the goods and services bought from other firms (\$10,000).

Implicit costs are the sum of the costs that do not involve a payment. Implicit costs are the sum of the interest forgone on the \$50,000 put into the firm; the \$30,000 income forgone by Jack not working at his previous job; \$15,000, which is the value of 500 hours of Jill's leisure (10 hours a week for 50 weeks); and the economic depreciation of \$2,000 (\$30,000 minus \$28,000).

3a.  All methods other than "pocket calculator with paper and pencil" are technologically efficient.

To use a pocket calculator with paper and pencil to complete the tax return is not a technologically efficient method because it takes the same number of hours as it would with a pocket calculator but it uses more capital.

3b.  The economically efficient method is to use (i) a pocket calculator, (ii) a pocket calculator, (iii) a PC.

The economically efficient method is the technologically efficient method that allows the task to be done at least cost.

When the wage rate is \$5 an hour: Total cost with a PC is \$1,005, total cost with a pocket calculator is \$70, and total cost with paper and pencil is \$81. Total cost is least with a pocket calculator.

When the wage rate is \$50 an hour: Total cost with a PC is \$1,050, total cost with a pocket calculator is \$610, and the total cost with paper and pencil is \$801. Total cost is least with a pocket calculator.

When the wage rate is \$500 an hour: Total cost with a PC is \$1,500, total cost with a pocket calculator is \$6,010, and total cost with pencil and paper is \$8,001. Total cost is least with a PC.

5a.  Methods a, b, c, and d are technologically efficient. Compare the amount of labour and capital used by the four methods. Start with method a. Moving from a to b to c to d, the amount of labour increases and the amount of capital decreases in each case.

5b.  The economically efficient method in (i) is method d, in (ii) is methods c and d, and in (iii) is method a.

The economically efficient method is the technologically efficient method that allows the 100 shirts to be washed at least cost.

(i) Total cost with method a is \$1,001, total cost with method b is \$805, total cost with method c is \$420, and total cost with method d is \$150. Method d has the lowest total cost.

(ii) Total cost with method a is \$505, total cost with method b is \$425, total cost with method c is \$300, and total cost with method d is \$300. Methods c and d have the lowest total cost.

(iii) Total cost with method a is \$100, total cost with method b is \$290, total cost with method c is \$1,020, and total cost with method d is \$2,505. Method a has the lowest total cost.

7a.  The four-firm concentration ratio is 60.49.

The four-firm concentration ratio equals the ratio of the total sales of the largest four firms to the total industry sales expressed as a percentage. The total sales of the largest four firms is \$450 + \$325 + \$250 + \$200, which equals \$1,225. Total industry sales equal \$1,225 + \$800, which equals \$2,025. The four-firm concentration ratio equals (\$1,225/\$2,025) ´ 100, which is 60.49 percent.

7b.  This industry is highly concentrated because the four-firm concentration ratio exceeds 60 percent.

9a.  The Herfindahl-Hirschman Index is 1,800.

The Herfindahl-Hirschman Index equals the sum of the squares of the market shares of the 50 largest firms or of all firms if there are less than 50 firms. The Herfindahl-Hirschman Index equals 152 + 102 + 202 + 152 + 252 + 152, which equals 1,800.

9b.  This industry is moderately competitive because the Herfindahl-Hirschman Index lies in the range 1,000 to 1,800.

Chapter 11

1a.  To draw the total product curve measure labour on the x-axis and output on the y-axis. The total product curve is upward sloping.

1b.  The average product of labour is equal to total product divided by the quantity of labour employed. For example, when 3 workers are employed, they produce 6 boats a week, so the average product is 2 boats per worker.

The average product curve is upward sloping when the number of workers is between 1 and 8, but it becomes downward sloping when 9 and 10 workers are employed.

1c.  The marginal product of labour is equal to the increase in total product when an additional worker is employed. For example, when 3 workers are employed, total product is 6 boats a week. When a fourth worker is employed, total product increases to 10 boats a week. The marginal product of going from 3 to 4 workers is 4 boats.

The marginal product curve is upward sloping when the number of workers is between 1 and 6, but it becomes downward sloping when 7 or more workers are employed.

1d.  (i) When Rubber Duckies produces fewer than 30 boats a week, it employs fewer than 8 workers a week. With fewer than 8 workers a week, marginal product exceeds average product and average product is increasing. Up to an output of 30 boats a day, each additional worker adds more to output than the average. Average product increases.

(ii) When Rubber Duckies produces more than 30 boats a week, it employs more than 8 workers a week. With more than 8 workers a week, average product exceeds marginal product and average product is decreasing. For outputs greater than 30 boats a week, each additional worker adds less to output than average. Average product decreases.

3a.  Total cost is the sum of the costs of all the inputs that Rubber Duckies uses in production. Total variable cost is the total cost of the variable inputs. Total fixed cost is the total cost of the fixed inputs.

For example, the total variable cost of producing 10 boats a week is the total cost of the workers employed, which is 4 workers at \$400 a week, which equals \$1,600. Total fixed cost is \$1,000, so the total cost of producing 10 boats a week is \$2,600.

To draw the short-run total cost curves, plot output on the x-axis and the total cost on the y-axis. The total fixed cost curve is a horizontal line at \$1,000. The total variable cost curve and the total cost curve have shapes similar to those in Fig. 11.4, but the vertical distance between the total variable cost curve and the total cost curve is \$1,000.

3b.  Average fixed cost is total fixed cost per unit of output. Average variable cost is total variable cost per unit of output. Average total cost is the total cost per unit of output.

For example, when the firm makes 10 boats a week: Total fixed cost is \$1,000, so average fixed cost is \$100 per boat; total variable cost is \$1,600, so average variable cost is \$160 per boat; and total cost is \$2,600, so average total cost is \$260 per boat.

Marginal cost is the increase in total cost divided by the increase in output. For example, when output increases from 3 to 6 boats a week, total cost increases from \$1,800 to \$2,200, an increase of \$400. That is, the increase in output of 3 boats increases total cost by \$400. Marginal cost is equal to \$400 divided by 3 boats, which is \$133.33 a boat.

The short-run average and marginal cost curves are similar to those in Fig. 11.5.

5.   The increase in total fixed cost increases total cost but does not change total variable cost. Average fixed cost is total fixed cost per unit of output. The average fixed cost curve shifts upward. Average total cost is total cost per unit of output. The average total cost curve shifts upward. Marginal cost and average variable cost do not change.

7a.  Total cost is the cost of all the inputs. For example, when 3 workers are employed they now produce 12 boats a week. With 3 workers, the total variable cost is \$1,200 a week and the total fixed cost is \$2,000 a week. The total cost is \$3,200 a week. The average total cost of producing 12 boats is \$266.67.

7b.  The long-run average cost curve is made up the lowest parts of the firm's short-run average total cost curves when the firm operates 1 plant and 2 plants. The long-run average cost curve is similar to Fig. 11.8.

7c.  It is efficient to operate the plant that has the lower average total cost of a boat. It is efficient to operate one plant when output is less than 27 boats a week, and it is efficient to operate two plants when the output is more than 27 boats a week.

Over the output range 1 to 27 boats a week, average total cost is less with one plant than with two, but if output exceeds 27 boats a week, average total cost is less with two plants than with one.

9a.  For example, the average total cost of producing a balloon ride when Bonnie rents 2 balloons and employs 4 workers equals the total cost (\$1,000 rent for the balloons plus \$1,000 for the workers) divided by the 20 balloon rides produced. The average total cost equals \$2,000/20, which is \$100 a ride.

The average total cost curve is U-shaped, as in Fig. 11.5.

9b.  The long-run average cost curve is similar to that in Fig. 11.8.

9c.  Bonnie's minimum efficient scale is 13 balloon rides when Bonnie rents 1 balloon.

The minimum efficient scale is the smallest output at which the long-run average cost is a minimum. To find the minimum efficient scale, plot the average total cost curve for each plant and then check which plant has the lowest minimum average total cost.

9d.  Bonnie will choose the plant (number of balloons to rent) that gives her minimum average total cost for the normal or average number of balloon rides that people buy.

Chapter 12

1a.  Quick Copy's profit-maximizing quantity is 80 pages an hour.

Quick Copy maximizes its profit by producing the quantity at which marginal revenue equals marginal cost. In perfect competition, marginal revenue equals price, which is 10 cents a page. Marginal cost is 10 cents when 80 pages an hour are produced.

1b.  Quick Copy's profit is \$2.40 an hour.

Profit equals total revenue minus total cost. Total revenue equals \$8.00 an hour (10 cents a page multiplied by 80 pages). The average total cost of producing 80 pages is 7 cents a page, so total cost equals \$5.60 an hour (7 cents multiplied by 80 pages). Profit equals \$8.00 minus \$5.60, which is \$2.40 an hour.

1c.  The price will fall in the long run to 6 cents a page.

At a price of 10 cents a page, firms make economic profit. In the long run, the economic profit will encourage new firms to enter the copying industry. As they do, the price will fall and economic profit will decrease. Firms will enter until economic profit is zero, which occurs when the price is 6 cents a copy (price equals minimum average total cost).

3a.  Pat's profit-maximizing output is 4 pizzas an hour. Pat's profit is \$2 an hour.

Pat maximizes its profit by producing the quantity at which marginal revenue equals marginal cost. In perfect competition, marginal revenue equals price, which is \$14 a pizza. Marginal cost is the change in total cost when output is increased by 1 pizza an hour. The marginal cost of increasing output from 3 to 4 pizzas an hour is \$13 (\$54 minus \$41). The marginal cost of increasing output from 4 to 5 pizzas an hour is \$15 (\$69 minus \$54). So the marginal cost of the fourth pizza is half-way between \$13 and \$15, which is \$14. Marginal cost equals marginal revenue when Pat produces 4 pizzas an hour.

Economic profit equals total revenue minus total cost. Total revenue equals \$56 an hour (\$14 a pizza multiplied by 4 pizzas). Total cost of producing 4 pizzas is \$54. Economic profit equals \$56 minus \$54, which is \$2 an hour.

3b.  Pat's shutdown point occurs at a price of \$10 a pizza.

The shutdown point is the price that equals minimum average variable cost. To calculate total variable cost, subtract total fixed cost (\$10, which is total cost at zero output) from total cost. Average variable cost equals total variable cost divided by the quantity produced. For example, the average variable cost of producing 2 pizzas is \$10 a pizza. Average variable cost is a minimum when marginal cost equals average variable cost. The marginal cost of producing 2 pizzas is \$10. So the shutdown point is a price of \$10 a pizza.

3c.  Pat's supply curve is the same as the marginal cost curve at prices equal to or above \$10 a pizza and the y-axis at prices below \$10 a pizza.

3d.  Pat will leave the industry if in the long run the price is less than \$13 a pizza.

Pat's Pizza Kitchen will leave the industry if it incurs an economic loss in the long run. To incur an economic loss, the price will have to be below minimum average total cost. Average total cost equals total cost divided by the quantity produced. For example, the average total cost of producing 2 pizzas is \$15 a pizza. Average total cost is a minimum when it equals marginal cost. The average total cost of 3 pizzas is \$13.67, and the average total cost of 4 pizzas is \$13.50. Marginal cost when Pat's produces 3 pizzas is \$12 and marginal cost when Pat's produces 4 pizzas is \$14. At 3 pizzas, marginal cost is less than average total cost; at 4 pizzas, marginal cost exceeds average total cost. So minimum average total cost occurs between 3 and 4 pizzas—\$13 at 3.5 pizzas an hour.

3e.  Firms with costs identical to Pat's will enter at any price above \$13 a pizza.

Firms will enter an industry when firms currently in the industry are making economic profit. Firms with costs identical to Pat's will make economic profit when the price exceeds minimum average total cost, which is \$13 a pizza.

3f.   The price in the long run is \$13 a pizza. This is the price that makes zero economic profit.

5a.  The market price is \$8.40 a cassette.

The market price is the price at which the quantity demanded equals the quantity supplied. The firm's supply curve is the same as its marginal cost curve at prices above minimum average variable cost. Average variable cost is a minimum when marginal cost equals average variable cost. Marginal cost equal average variable cost at the quantity 250 cassettes a week. So the firm's supply curve is the same as the marginal cost curve for the outputs equal to 250 cassettes or more. When the price is \$8.40 a cassette, each firm produces 350 cassettes and the quantity supplied by the 1,000 firms is 350,000 cassettes a week. The quantity demanded at \$8.40 is 350,000 a week.

5b.  The industry output is 350,000 cassettes a week.

5c.  Each firm produces 350 cassettes a week.

5d.  Each firm makes an economic loss of \$581 a week.

Each firm produces 350 cassettes at an average total cost of \$10.06 a cassette. The firm can sell the 350 cassettes for \$8.40 a cassette. The firm incurs a loss on each cassette of \$1.66 and incurs an economic loss of \$581a week.

5e.  In the long run, some firms exit the industry because they are incurring economic losses.

5f.   The number of firms in the long run is 750.

In the long run, as firms exit the industry, the price rises. In long-run equilibrium, the price will equal the minimum average total cost. When output is 400 cassettes a week, marginal cost equals average total cost and average total cost is a minimum at \$10 a cassette. In the long run, the price is \$10 a cassette. Each firm remaining in the industry produces 400 cassettes a week. The quantity demanded at \$10 a cassette is 300,000 a week. So the number of firms is 300,000 cassettes divided by 400 cassettes per firm, which is 750 firms.

7a.  The market price is \$7.65 a cassette.

When the price is \$7.65 a cassette, each firm produces 300 cassettes and the quantity supplied by the 1,000 firms is 300,000 cassettes a week. The quantity demanded at \$7.65 is 300,000 a week.

7b.  The industry output is 300,000 cassettes a week.

7c.  Each firm produces 300 cassettes a week.

7d.  Each firm makes an economic loss of \$834 a week.

Each firm produces 300 cassettes at an average total cost of \$10.43 a cassette. The firm can sell the 300 cassettes for \$7.65 a cassette. The firm incurs a loss on each cassette of \$2.78 and incurs an economic loss of \$834 a week.

7e.  In the long run, some firms exit the industry because they are incurring economic losses.

7f.   The number of firms in the long run is 500.

In the long run, as firms exit the industry, the price rises. Each firm remaining in the industry produces 400 cassettes a week. The quantity demanded at \$10 a cassette is 200,000 a week. So the number of firms is 200,000 cassettes divide by 400 cassettes per firm, which is 500 firms.

Chapter 13

1a.  Minnie's total revenue schedule lists the total revenue at each quantity sold. For example, Minnie's can sell 1 bottle for \$8 a bottle, which gives it a total revenue of \$8 at the quantity 1 bottle.

1b.  Minnie's marginal revenue schedule lists the marginal revenue that results from increasing the quantity sold by 1 bottle. For example, Minnie's can sell 1 bottle for a total revenue of \$8. Minnie's can sell 2 bottles for \$6 each, which gives it a total revenue of \$12 at the quantity 2 bottles. So by increasing the quantity sold from 1 bottle to 2 bottles, marginal revenue is \$4 a bottle (\$12 minus \$8).

3a.  Minnie's profit-maximizing output is 1.5 bottles.

The marginal cost of increasing the quantity from 1 bottle to 2 bottles is \$4 a bottle (\$7 minus \$3). That is, the marginal cost of the 1.5 bottles is \$4 a bottle. The marginal revenue of increasing the quantity sold from 1 bottle to 2 bottles is \$4 (\$12 minus \$8). So the marginal revenue from 1.5 bottles is \$4 a bottle. Profit is maximized when the quantity produced makes the marginal cost equal to marginal revenue. The profit-maximizing output is 1.5 bottles.

3b.  Minnie's profit-maximizing price is \$7 a bottle.

The profit-maximizing price is the highest price that Minnie's can sell the profit-maximizing output of 1.5 bottles. Minnie's can sell 1 bottle for \$8 and 2 bottles for \$6, so it can sell 1.5 bottles for \$7 a bottle.

3c.  Minnie's marginal cost is \$4 a bottle.

3d.  Minnie's marginal revenue is \$4 a bottle.

3e.  Minnie's economic profit is \$5.50.

Economic profit equals total revenue minus total cost. Total revenue equals price (\$7 a bottle) multiplied by quantity (1.5 bottles), which is \$10.50. Total cost of producing 1 bottle is \$3 and the total cost of producing 2 bottles is \$7, so the total cost of producing 1.5 bottles is \$5. Profit equals \$10.50 minus \$5, which is \$5.50.

3f.   Minnie's is inefficient. Minnie's charges a price of \$7 a bottle, so consumers get a marginal benefit of \$7 a bottle. Minnie's marginal cost is \$4 a bottle. That is, the marginal benefit of \$7 a bottle exceeds Minnie's marginal cost.

5a.  The profit-maximizing output is 150 newspapers a day.

Profit is maximized when the firm produces the output at which marginal cost equals marginal revenue. Draw in the marginal revenue curve. It runs from 100 on the y-axis to 250 on the x-axis. The marginal revenue curve cuts the marginal cost curve at the quantity 150 newspapers a day.

5b.  The price charged is 70 cents a paper.

The highest price that the publisher can sell 150 newspapers a day is read from the demand curve.

5c.  The daily total revenue is \$105 (150 papers at 70 cents each).

5d.  Demand is elastic.

Along a straight-line demand curve, demand is elastic at all prices above the midpoint of the demand curve. The price at the midpoint is 50 cents. So at 70 cents a paper, demand is elastic.

7a.  The efficient quantity is 250 newspapers—the quantity that makes marginal benefit (price) equal to marginal cost. With 250 newspapers available, people are willing to pay 50 cents for a paper. To produce 250 newspapers, the publisher incurs a marginal cost of 50 cents a paper.

7b.  The consumer surplus is \$22.50 a day.

Consumer surplus is the area under the demand curve above the price. The price is 70 cents, so consumer surplus equals (100 cents minus 70 cents) multiplied by 150/2 papers a day, which is \$22.50 a day.

7c.  The deadweight loss is \$15 a day.

Deadweight loss arises because the publisher does not produce the efficient quantity. Output is restricted to 150, and the price is increased to 70 cents. The deadweight loss equals (70 cents minus 40 cents) multiplied by 100/2.

9.   The maximum that will be spent on rent seeking is \$5.50 a day—an amount equal to Minnie's economic profit. The total social cost equals the deadweight loss plus the amount spent on rent seeking. To calculate the deadweight loss, first calculate the efficient output—the intersection point of the demand curve (marginal benefit curve) and the marginal cost curve. Do this by finding the equations to the two curves and solving them. The efficient output is 2.25 bottles. The deadweight loss equals \$1.125. The loss to society is \$6.625 (\$5.50 plus \$1.125).

11a.The firm will produce 2 cubic metres a day and sell it for 6 cents a cubic metre. Deadweight loss will be 4 cents a day.

Draw in the marginal revenue curve. It runs from 10 on the y-axis to 2.5 on the x-axis. The profit- maximizing output is 2 cubic metres at which marginal revenue equals marginal cost. The price charged is the highest that people will pay for 2 cubic metres a day, which is 6 cents a cubic metre. The efficient output is 4 cubic metres, at which marginal cost equals price (marginal benefit). So the deadweight loss is (4 minus 2 cubic metres) multiplied by (6 minus 2 cents)/2.

11b.The firm will produce 3 cubic metres a day and charge 4 cents a cubic metre. Deadweight loss is 1 cent a day.

If the firm is regulated to earn only normal profit, it produces the output at which price equals average total cost—at the intersection of the demand curve and the ATC curve.

11c.The firm will produce 4 cubic metres a day and charge 2 cents a cubic metre. There is no deadweight loss.

If the firm is regulated to be efficient, it will produce the quantity at which price (marginal benefit) equals marginal cost—at the intersection of the demand curve and the marginal cost curve.

Chapter 14

1a.  Lite and Kool produces 100 pairs a week.

To maximize profit, Lite and Kool produces the quantity at which marginal revenue equals marginal cost.

1b.  Lite and Kool charges \$20 a pair.

To maximize profit, Lite and Kool charges the highest price for the 100 pairs of shoes, as read from the demand curve.

1c.  Lite and Kool makes a profit of \$500 a week.

Economic profit equals total revenue minus total cost. The price is \$20 and the quantity sold is 100 pairs, so total revenue is \$2,000. Average total cost is \$15, so total cost equals \$1,500. Economic profit equals \$2,000 minus \$1,500, which is \$500 a week.

3a.  The firm produces 100 pairs and sells them for \$60 a pair.

To maximize profit, the firm produces the quantity at which marginal cost equals marginal revenue. Marginal cost is \$20 a pair. The firm can sell 200 pairs at \$20 a pair, so the marginal revenue is \$20 at 100 pairs. (Marginal revenue curve lies halfway between the y-axis and the demand curve.)

The firm sells the 100 pairs at the highest price that consumers will pay, which is read from the demand curve. This price is \$60 a pair.

3b.  The firm's economic profit is zero.

The firm produces 100 pairs and sells them for \$60 a pair, so total revenue is \$6,000. Total cost is the sum of total fixed cost plus total variable cost of 100 pairs. Total cost equals \$4,000 plus (\$20 multiplied by 100), which is \$6,000. The firm's profit is zero.

3c.  The firm produces 200 pairs and sells them for \$60 a pair.

To maximize profit, the firm produces the quantity at which marginal cost equals marginal revenue. Marginal cost is \$20 a pair. At \$20 a pair, the firm can sell 400 pairs (twice the number with no advertising), so the marginal revenue is \$20 at 200 pairs. (The marginal revenue curve lies halfway between the y-axis and the demand curve.)

The firm sells the 200 pairs at the highest price that consumers will pay—read from the demand curve. This price is \$60 a pair.

3d.  The firm makes an economic profit of \$1,000.

The firm produces 200 pairs and sells them for \$60 a pair, so total revenue is \$12,000. Total cost is the sum of total fixed cost plus the advertising cost plus total variable cost of 200 pairs. Total cost equals \$4,000 plus \$3,000 plus (\$20 multiplied by 200), which is \$11,000. The firm makes an economic profit of \$1,000.

3e.  The firm will spend \$3,000 advertising because it makes more economic profit than when it does not advertise.

5.   The firm will not change the quantity it produces or the price it charges. The firm makes less economic profit.

The firm maximizes profit by producing the output at which marginal cost equals marginal revenue. An increase in fixed cost increases total cost, but it does not change marginal cost. So the firm does not change its output or the price it charges. The firm's total costs have increased and its total revenue has not changed, so the firm makes less economic profit.

7a.  The price rises, output increases, and economic profit increases.

The dominant firm produces the quantity and sets the price such that it maximizes its profit. When demand increases, marginal revenue increases, so the firm produces a larger output. The highest price at which the dominant firm can sell its output increases. Because price exceeds marginal cost, economic profit increases.

7b.  The price rises, output increases, and economic profit increases.

The small firms are price takers, so the price they charge rises. Because these firms are price takers, the price is also marginal revenue. Because marginal revenue increases, the small firms move up along their marginal cost curves (supply curves) and increase the quantity they produce. Because price exceeds marginal cost, economic profit increases.

9a.  The game has 2 players (A and B), and each player has 2 strategies: to answer honestly or to lie. There are 4 payoffs: Both answer honestly; both lie; A lies, and B answers honestly; and B lies, and A answers honestly.

9b.  The payoff matrix has the following cells: Both answer honestly: A gets \$100, and B gets \$100; both lie: A gets \$50, and B gets \$50; A lies and B answers honestly: A gets \$500, and B gets \$0; B lies and A answers honestly: A gets \$0, and B gets \$500.

9c.  Equilibrium is that each player lies and gets \$50.

If B answers honestly, the best strategy for A is to lie because he would get \$500 rather than \$100. If B lies, the best strategy for A is to lie because he would get \$50 rather than \$0. So A's best strategy is to lie, no matter what B does. Repeat the exercise for B. B's best strategy is to lie, no matter what A does.

11a.The best strategy for each firm is to cheat.

If Sudsies abides by the agreement, the best strategy for Soapy is to cheat because it would make a profit of \$1.5 million rather than \$1 million. If Sudsies cheats, the best strategy for Soapy is to cheat because it would make a profit of \$0 (the competitive outcome) rather than incur a loss of \$0.5 million. So Soapy's best strategy is to cheat, no matter what Sudsies does. Repeat the exercise for Sudsies. Sudsies's best strategy is to cheat, no matter what Soapy does.

11b.Each firm makes a zero economic profit or normal profit.

If both firms cheat, each firm will lower the price in an attempt to gain market share from the other firm. In the process, the price will be driven down until each firm is making normal profit.

11c.The payoff matrix has the following cells: Both abide by the agreement: Soapy makes \$1 million, profit and Sudsies makes \$1 million profit; both cheat: Soapy makes \$0 profit, and Sudsies makes \$0 profit; Soapy cheats and Sudsies abides by the agreement: Soapy makes \$1.5 million profit, and Sudsies incurs a \$0.5 million loss; Sudsies cheats and Soapy abides by the agreement: Sudsies makes \$1.5 million profit, and Soapy incurs \$0.5 million loss.

11d.The equilibrium is that both firms cheat and each makes normal profit.

11e.Each firm can adopt a tit-for-tat strategy or a trigger strategy. Pages 305-306 give descriptions of these strategies.

Chapter 15

1a.  The wage rate is \$6 an hour. The wage rate adjusts to make the quantity of labour demanded equal to the quantity supplied.

1b.  The number of pickers hired is 400 a day. At a wage rate of \$6 an hour, 400 pickers a day are hired.

1c.  The income received is \$2,400 an hour. Income equals the wage rate (\$6 an hour) multiplied by the number of pickers (400).

3a.  Marginal product of labour is the increase in total product that results from hiring one additional student. For example, if Wanda increases the number of students hired from 2 to 3, total product (the quantity of fish packed) increases from 50 to 90 kilograms. The marginal product of hiring the third student is 40 kilograms of fish.

3b.  Marginal revenue product of labour is the increase in total revenue that results from hiring one additional student. For example, if Wanda hires 2 students, they produce 50 kilograms of fish and Wanda sells the fish for 50 cents a kilogram. Total revenue is \$25. If Wanda increases the number of students hired from 2 to 3, total product increases to 90 kilograms. Total revenue from the sale of this fish is \$45. Marginal revenue product resulting from hiring the third student is \$20 (\$45 minus \$25). Alternatively, marginal revenue product equals marginal product multiplied by marginal revenue (price). Marginal revenue product of hiring the third student is \$20, which is 40 kilograms of fish she sells at 50 cents a kilogram.

3c.  One point on Wanda's demand for labour curve: At a wage rate of \$20 an hour, Wanda will hire 3 students. The demand for labour curve is the same as the marginal revenue product curve.

3d.  Wanda hires 7 students.

Wanda hires the number of students that makes the marginal revenue product equals to the wage rate of \$7.50 an hour. When Wanda increases the number of students from 6 to 7, marginal product is 15 kilograms of fish an hour, which Wanda sells for 50 cents a kilogram. Marginal revenue product is \$7.50—the same as the wage rate.

5a.  Marginal product does not change. Marginal product that results from hiring the third student is still 40 kilograms of fish.

5b.  Marginal revenue product decreases.

If Wanda hires the third student, marginal product is 40 kilograms of fish. But now Wanda sells the fish for 33.33 cents, so marginal revenue product is now \$13.33, down from \$20.

5c.  Wanda's demand for labour decreases, and her demand for labour curve shifts leftward. Wanda is willing to pay the students their marginal revenue product, and the fall in the price of fish has lowered their marginal revenue product.

5d.  Wanda will hire fewer students. At the wage rate of \$7.50, the number of students Wanda hires decreases as the demand for labour curve shifts leftward.

7a.  Marginal revenue product does not change. If Wanda hires the third student, marginal product is 40 kilograms of fish and Wanda sells the fish for 50 cents a kilogram, so marginal revenue product remains at \$20.

7b.  Wanda's demand for labour remains the same because marginal revenue product has not changed.

7c.  Wanda will hire fewer students. At the wage rate of \$10 an hour, Wanda hires the number of students that makes marginal revenue product equal to \$10 an hour. Wanda now hires 6 students—down from 7. The marginal product that results when Wanda hires the sixth student is 20 kilograms of fish an hour, and Wanda sells this fish for 50 cents a kilogram. Marginal revenue product of the sixth student is \$10 an hour.

Wanda maximizes her profit when marginal revenue product equals the wage rate and when marginal revenue equals marginal cost.

When the wage rate is \$7.50 an hour, Wanda hires 7 students. Marginal revenue product is marginal product (15 kilograms of fish an hour) multiplied by the price of fish (50 cents a kilogram), which equals \$7.50 an hour.

Marginal revenue resulting from selling an additional kilogram of fish is 50 cents. The seventh student costs \$7.50 an hour and has a marginal product of 15 kilograms of fish. So the marginal cost of an additional kilogram of fish is \$7.50 an hour divided by 15 kilograms of fish, which is 50 cents. So when Wanda hires 7 students, marginal revenue equals marginal cost and profit is maximized.

11.  Venus installs three production lines.

With onœe production line: The present value of the marginal revenue product in the first year is \$590,000/1.05, which is \$561,904.76. The present value of the marginal revenue product in the second year is \$590,000/(1.05)2, which is \$535,147.39. So the present value of the flow of marginal revenue product is \$1,097,052.15. The cost of one production line is \$1 million. The net present value is \$97,052.15, so Venus buys the production line.

Similar calculations for 2 and 3 production lines give positive net present values, so Venus installs 3 production lines.

13.  To answer this problem, we need to know the interest rate and the price that Greg expects next year. If he expects the price to rise by a bigger percentage than the interest rate, he pumps none and waits for the higher price. If he expects the price to rise by a smaller percentage than the interest rate, he pumps it all now. If he expects the price to rise by a percentage equal to the interest rate, he doesn't mind how much he pumps.

15a.Income of \$2,400 a day is divided between opportunity cost and economic rent. Economic rent is the area above the supply curve below the wage rate. To show the economic rent on the graph, extend the supply curve until it touches the y-axis. Shade in the area above the supply curve up to the wage rate \$6 an hour.

15b.Opportunity cost is the area under the supply curve. To show the opportunity cost on the graph, shade in the area under the supply curve up to 400 pickers on the x-axis.

Chapter 16

1a.  The wage rate of low-skilled workers is \$5 an hour.

The wage rate adjusts to make the quantity of labour demanded equal to the quantity supplied.

1b.  Firms employ 5,000 hours of low-skilled workers a day. At a wage rate of \$5 an hour, 5,000 hours are employed each day.

1c.  The wage rate of high-skilled workers is \$8 an hour.

Because the marginal product of high-skilled workers is twice the marginal product of low-skilled workers, firms are willing to pay high-skilled workers twice the wage rate that they are willing to pay low-skilled workers. For example, the demand curve for low-skilled workers tells us that firms are willing to hire 6,000 hours of low-skilled workers at a wage rate of \$4 an hour. So with high-skilled workers twice as productive as low-skilled workers, firms are willing to hire 6,000 hours of high-skilled workers at \$8 an hour. That is, the demand curve for high-skilled labour lies above the demand curve for low-skilled workers such that at each quantity of workers the wage rate for high-skilled workers is double that for low-skilled workers.

The supply of high-skilled workers lies above the supply of low-skilled workers such that the vertical distance between the two supply curves equals the cost of acquiring the high skill—\$2 an hour. That is, high-skilled workers will supply 6,000 hours a day if the wage rate is \$8 an hour.

Equilibrium in the labour market for high-skilled workers occurs at a wage rate of \$8 an hour.

1d.  Firms employ 6,000 hours of high-skilled workers a day.

3a.  The wage rate is \$10 an hour.

With the amount of high-skilled workers equal to 5,000 hours a day, the demand for labour curve tells us that firms are willing to pay \$10 an hour to hire high-skilled workers.

3b.  The wage differential is \$5 an hour.

The demand for labour curves tells us that firms are willing to pay \$10 an hour to hire high-skilled workers and \$5 an hour to hire low-skilled workers.

5a.  The wage rate is \$6 an hour.

A minimum wage is the lowest wage rate that a low-skilled worker can be paid.

5b.  Firms hire 4,000 hours of low-skilled workers a day.

At the minimum wage of \$6 an hour, the demand for low-skilled labour tells us that firms will hire only 4,000 hours of low-skilled workers a day.

7a.  The wage rate is \$10 a day.

The monopsony firm maximizes its profit by hiring the quantity of labour that makes the marginal cost of labour equal to the marginal revenue product of labour (see Fig. 16.5). The marginal product of the fifth worker is 10 grains per day. Gold sells for \$1.40 per grain, so the marginal revenue product of the fifth worker is \$14 a day. The marginal cost of the fifth worker a day equals the total labour cost of 5 workers a day minus the total labour cost of 4 workers a day. The supply of labour tells us that to hire 5 workers a day, the gold company must pay \$10 a day, so the total labour cost is \$50 a day. The supply of labour also tells us that to hire 4 workers a day, the gold company must pay \$9 a day, so the total labour cost is \$36 a day. So the marginal cost of the fifth worker is \$14 a day (\$50 minus \$36).

The profit-maximizing quantity of labour is 5 workers because the marginal cost of the fifth worker equals the marginal revenue product of the fifth worker. The monopsony pays the 5 workers the lowest wage possible: the wage rate at which the 5 workers are willing to supply their labour. The supply of labour schedule tells us that 5 workers are willing to supply their labour for \$10 a day.

7b.  The gold company hires 5 workers a day.

7c.  The marginal revenue product of the fifth worker is \$14 a day.

A court-enforced wage rate above \$10 a day will increase the wage rate. The quantity of labour supplied will increase, and employment will increase. Marginal revenue product of the monopsony will decrease as more labour is hired.

Chapter 17

1a.  To draw the Lorenz curve, plot the cumulative percentage of households on the x-axis and the cumulative percentage of income on the y-axis. Make the scale on the two axes the same. The Lorenz curve will pass through the following points: 20 percent on the x-axis and 5 percent on the y-axis; 40 percent on the x-axis and 16 percent on the y-axis; 60 percent on the x-axis and 33 percent on the y-axis; 80 percent on the x-axis and 57 percent on the y-axis; and 100 percent on the x-axis and 100 percent on the y-axis.

1b.  Canadian income is distributed more equally than the income in the economy in this problem.

The line of equality shows an equal distribution of income. The closer the Lorenz curve is to the line of equality, the more equal is the income distribution. The Lorenz curve for the Canadian economy lies between the Lorenz curve for the economy in this problem and the line of equality.

3a.  The distributions of income and wealth are the same. Every 45-year-old person has income of \$30,000 a year and wealth of \$255,000.

Each 45-year-old person has earned \$30,000 a year for 31 years, a total of \$930,000. The lifetime income will be \$1,050,000 (35 multiplied by \$30,000). Because total income is consumed over the lifetime and at a constant rate, consumption is \$15,000 a year (\$1,050,000 divided by 70). Total consumption of a 45-year-old person is \$675,000 (45 multiplied by \$15,000). So the accumulated savings (wealth) at 45 years of age is \$255,000 (\$930,000 minus \$675,000).

3b.  Income is \$30,000 a year for the people aged 25, 35, and 45 and zero for the people aged 55 and 65. Wealth is distributed unequally. Wealth is -\$45,000 for the 25-year-old; \$105,000 for the 35-year-old; \$255,000 for the 45-year-old; \$225,000 for the 55-year-old; and \$75,000 for the 65-year-old. (Each calculation is similar to that in answer 1a.)

Case (a) shows greater equality than case (b). The distributions of wealth and income are equal in case (a) but unequal in case (b).

5a.  The average wage rate is \$3 an hour.

In an hour, the 10 people earn a total of \$30. So the average wage rate is \$3 an hour.

5b.  The ratio of the highest to the lowest wage is 5/1 (\$5/\$1).

5c. Average daily income is \$14.50 an hour.

To calculate the total income earned, start with a wage rate and find the number of hours each will work at that wage rate (first table); then find the number of people who work at that wage rate (second table). For example, if the wage rate is \$3 an hour, the people who work at this wage rate will work for 4 hours a day and the number of people who will work at \$3 an hour is 4 people. The total daily income of these 4 people is \$48 (\$3 multiplied by 4 multiplied by 4).

Total income of the 10 people is \$145 a day. Average daily income is equal to \$14.50.

5d.  The ratio of the highest to the lowest daily income is 40/1.

The highest daily income earned is \$40. At \$5 an hour, 1 person works and that person works for 8 hours a day. The lowest daily income is \$1. At \$1 an hour, 1 person works and that person works for 1 hour a day. The ratio of highest to lowest daily income is \$40/\$1.

5e.  The distribution of hourly wage rates is symmetrically around the average wage rate of \$3.00 an hour. At \$1 an hour, 10 percent of people (1 person) work; at \$2 an hour, 20 percent of people (2 people) work; at \$3 an hour, 40 percent of people (4 people) work; at \$4 an hour, 20 percent of people (2 people) work; at \$5 an hour, 10 percent of people (1 person) work.

5f.   The distribution of daily incomes is skewed to the left: \$1 a day is earned by 10 percent of people (1 person); \$4 a day is earned by 20 percent of people (2 people); \$12 a day is earned by 40 percent of people (4 people); \$24 a day is earned by 20 percent of people (2 people); \$40 a day is earned by 10 percent of people (1 person). The most common income (\$12 a day) is less than the average income (\$14.50 a day).

5g.  The distribution of income is skewed despite the equal distribution of abilities (as indicated by the distribution of wage rates). The distribution of income is influenced by the choices people make about how many hours to work.

7a.  To draw the Lorenz curve before redistribution takes place, calculate the percentage of income that each 20 percent of households receive. Then plot the cumulative percentage of households on the x-axis and the cumulative percentage of income after taxes and benefits on the y-axis. Make the scale on the two axes the same. The Lorenz curve passes through the following points: 20 percent on the x-axis and 5 percent on the y-axis; 40 percent on the x-axis and 15 percent on the y-axis; 60 percent on the x-axis and 33 percent on the y-axis; 80 percent on the x-axis and 61 percent on the y-axis; and 100 percent on the x-axis and 100 percent on the y-axis.

Now calculate the income after taxes and benefits for each 20 percent of households. The income for each 20 percent of households equals market income minus taxes plus benefits. For example, for the third lowest 20 percentage of households, income after taxes and benefits equals \$18 million minus taxes of \$2.7 million (15 percent of \$18 million) plus benefits of \$3 million, which equals \$18.3 million.

Now draw the Lorenz curve after redistribution takes place by plotting plot the cumulative percentage of households on the x-axis and the cumulative percentage of income after taxes and benefits on the y-axis. The Lorenz curve passes through the following points: 20 percent on the x-axis and 15.0 percent on the y-axis; 40 percent on the x-axis and 32.0 percent on the y-axis; 60 percent on the x-axis and 50.3 percent on the y-axis; 80 percent on the x-axis and 72.7 percent on the y-axis; and 100 percent on the x-axis and 100 percent on the y-axis.

7b.  The government of this economy redistributes income differently that does the Canadian government. Plot the Lorenz curves for market income and for income after redistribution on Fig. 17.5. Now, compare the amounts of redistribution in this economy with that in the Canadian economy. Income after redistribution f or the 20 percent of households in the Canadian economy with the lowest income increases from 1.6 percent of total income to 7.4 percent—an increase of 427 percent. Income after redistribution f or the 20 percent of households in the Canadian economy with the highest income decreases from 46.4 percent of total income to 36.4 percent—a decrease of 21.6 percent. In the economy in this problem, income after redistribution f or the 20 percent of households with the lowest income increases from 5 percent of total income to 15 percent—an increase of 200 percent. Income after redistribution f or the 20 percent of households with the highest income decreases from 39.0 percent of total income to 27.3 percent—a decrease of 30 percent.

Chapter 18

1a.  The capacity that achieves maximum net benefit is 2.5 million litres a day.

Net benefit is maximized at the capacity where marginal benefit equals marginal cost, which is 2.5 million litres a day.

1b.  \$62.50 per person.

The efficient capacity is the one that maximizes net benefit. Total cost of the sewerage system is the sum of the marginal cost of each additional litre of capacity. That is, total cost is the area under that marginal cost curve up to 2.5 million litres, which equals \$62.5 million. The population is 1 million, so each person will have to pay \$62.50.

1c.  The political equilibrium will be a sewerage system that has a capacity of 2.5 million litres.

If voters are well informed, the political equilibrium will be the efficient capacity.

1d.  Bureaucrats will provide a capacity of 5 million litres.

With voters rationally ignorant, bureaucrats will maximize the budget. That is, they will increase the capacity until net benefit is zero. The total benefit from a capacity of 5 million litres is \$250 million. The total cost of a capacity of 5 million litres is \$250 million. So the net benefit from a capacity of 5 million litres is zero.

3a.  Taxes will be progressive: B-type people will pay a higher tax rate than A-type people.

The median voter theorem tells us the tax arrangement will be that which minimizes the taxes of the median voter. The median voter is an A-type person.

3b.  The before-tax wage rate of A-type people will rise by the amount of the tax, and fewer A-type people will be employed. The after-tax wage rate will remain at \$10 an hour. The before-tax wage rate of B-type people will remain at \$100, and employment of B-type people will not change. The after-tax wage rate will fall by the amount of the tax.

5a.  The equilibrium wage rate is \$12 an hour, and 30 hours of work are done each week.

Equilibrium wage rate is such that the quantity of labour demanded equals the quantity of labour supplied. Hours of work done equal the equilibrium quantity of labour hired.

5b.  (i) The new wage rate is \$13.60 an hour. (ii) The new number of hours worked is 24 a week. (iii) The after-tax wage rate is \$9.60 an hour. (iv) The tax revenue is \$96.00 a week (v) Deadweight loss is \$12 a week.

To work this problem either draw an exact graph (like Fig. 18.8b) or use equations. The equation for the pre-tax demand for labour curve is W = -(8/30)L + 20, where W is the wage rate and L is hours of labour. The equation for the demand for labour curve once the employment insurance tax is imposed on employers is W = -(8/30)L + 16. The equation for the supply of labour curve is W = (12/30)L. So the equilibrium employment is 24 hours a week. To find the cost of labour, substitute 24 for L in the demand for labour curve. To find the after-tax wage rate, substitute 24 for L in the demand for labour curve after the tax is imposed. The tax revenue is \$4 an hour multiplied by the 24 hours employed. The deadweight loss equals the tax multiplied by half the cut in employment—that is, \$4 multiplied by (30 - 24)/2.

7a.  The equilibrium price is \$3 a kilogram, and the equilibrium quantity is 14 kilograms a month.

To work this problem either draw an exact graph (like Fig. 18.9) or use equations. The equation for the demand curve is P = -(1/2)Q + 10. The equation for the supply curve before the tax is imposed is P = (1/2)Q - 4. Solving these equations gives an equilibrium price of \$3 a kilogram and an equilibrium quantity of 14 kilograms a month.

7b.  (i) The new price is \$4 a kilogram. (ii) The new quantity is 12 kilograms a month. (iii) Tax revenue is \$24 a month. (iv) Deadweight loss is \$2 a month.

With the \$2 a kilogram tax, the supply curve becomes P = (1/2)Q - 2. Solving the new supply curve and the demand curve gives a price of \$4 a kilogram, and 12 kilograms a month are bought. The tax revenue is \$2 a kilogram multiplied by the 12 kilograms bought. The deadweight loss equals the tax multiplied by half the cut in the quantity bought¾that is, \$2 multiplied by (14 - 12)/2.

Chapter 19

1a.  The price is 30 cents a bottle.

Elixir Springs is a natural monopoly. It produces the quantity that makes marginal revenue equal to marginal cost, and it charges the highest price it can for the quantity produced. The marginal revenue curve is twice as steep as the demand curve, so it runs from 50 on the y-axis to 1.25 on the x-axis. Marginal revenue equals marginal cost at 1 million bottles a year. The highest price at which Elixir can sell 1 million bottles a year is 30 cents a bottle, read from the demand curve.

1b.  Elixir Springs sells 1 million bottles a year.

1c.  Elixir maximizes producer surplus.

If Elixir maximizes total surplus, it would produce the quantity that makes price equal to marginal cost. That is, it would produce 2 million bottles a year and sell them for 10 cents a bottles. Elixir is a natural monopoly, and it maximizes its producer surplus.

3a.  The price is 10 cents a bottle.

Marginal cost pricing regulation sets the price equal to marginal cost, 10 cents a bottle.

3b.  Elixir sells 2 million bottles.

With the price set at 10 cents, Elixir maximizes profit by producing 2 million bottles—at the intersection of the demand curve (which shows price) and the marginal cost curve.

3c.  Elixir incurs an economic loss of \$150,000 a year.

Economic profit equals total revenue minus total cost. Total revenue is \$200,000 (2 million bottles at 10 cents a bottle). Total cost is \$350,000 (total variable cost of \$200,000 plus total fixed cost of \$150,000). So Elixir incurs an economic loss of \$150,000 (a revenue of \$200,000 minus \$350,000).

3d.  Consumer surplus is \$400,000 a year.

Consumer surplus is the area under the demand curve above the price. Consumer surplus equals 40 cents a bottle (50 cents minus 10 cents) multiplied by 2 million bottles divided by 2, which is \$400,000.

3e.  The regulation is in the public interest because total surplus is maximized. The outcome is efficient.

The outcome is efficient because marginal benefit (or price) equals marginal cost. When the outcome is efficient, total surplus is maximized.

5a.  The price is 20 cents a bottle.

Average cost pricing regulation sets the price equal to average total cost. Average total cost equals average fixed cost plus average variable cost. Because marginal cost is constant at 10 cents, average variable cost equals marginal cost. Average fixed cost is total fixed cost (\$150,000) divided by the quantity produced. For example, when Elixir produces 1.5 million bottles, average fixed cost is 10 cents, so average total cost is 20 cents. The price at which Elixir can sell 1.5 million bottles a year is 20 cents a bottle.

5b.  Elixir sells 1.5 million bottles.

5c.  Elixir makes zero economic profit.

Economic profit equals total revenue minus total cost. Total revenue is \$300,000 (1.5 million bottles at 20 cents a bottle). Total cost is \$300,000 (1.5 million bottles at an average total cost of 20 cents). So Elixir makes zero economic profit.

5d. Consumer surplus is \$225,000 a year.

Consumer surplus is the area under the demand curve above the price. Consumer surplus equals 30 cents a bottle (50 cents minus 20 cents) multiplied by 1.5 million bottles divided by 2, which is \$225,000.

5e.  The regulation creates a deadweight loss, so the outcome is inefficient. The regulation is not in the public interest.

7a.  The price is \$500 a trip, and the quantity is 2 trips a day.

Regulation in the public interest is marginal cost pricing. Each airline charges \$500 a trip and produces the quantity at which price equals marginal cost. Each airline makes 1 trip a day.

7b.  The price is \$750 a trip, and the number of trips is 1 trip a day (one by each airline on alternate days).

If the airlines capture the regulator, the price will be the same as the price that an unregulated monopoly would charge. An unregulated monopoly produces the quantity and charges the price that maximizes profit¾that is, the quantity that makes marginal revenue equals to marginal cost. This quantity is 1 trip a day, and the highest price that the airlines can charge for that trip (read from the demand curve) is \$750.

7c. Deadweight loss is \$125 a day.

Deadweight loss arises because the number of trips is cut from 2 to 1 a day and the price is increased from \$500 to \$750. Deadweight loss equals (2 minus 1) trip multiplied by (\$750 minus \$500) divided by 2. Deadweight loss is \$125 a day.

Chapter 20

1a.  The efficient amount of waste is 3 tonnes a week.

The efficient amount of waste is the quantity that makes the marginal cost equal to marginal benefit. When the pesticide factory dumps 2 tonnes of waste, the trout farm's profit is \$875 per week. When the pesticide factory dumps 3 tonnes of waste, the trout farm's profit is \$775 per week. The loss of profit from the third tonne of waste is \$100. The marginal benefit to the pesticide factory of dumping the waste (the cost cut by not trucking the waste) is \$100 a tonne. That is, the marginal cost of the third tonne to the trout farm equals the marginal benefit of the third tonne to the pesticide factory.

1b.  If the trout farm owns the lake, the amount of waste is 3 tonnes a week.

The pesticide factory pays the trout farm \$100 a tonne for the right to dump 3 tonnes of waste a week.

1c.  If the pesticide factory owns the lake, the amount of waste is 3 tonnes a week.

The trout farm pays the pesticide factory \$300 a week for farming rights and for an agreement that the dumping of waste will not exceed 3 tonnes a week.

3a.  A tax of \$100 a tonne will achieve an efficient quantity of waste dumped into the lake.

The cost of dumping the waste is zero, so the pesticide factory will dump all its waste. A tax of \$100 a tonne will increase the marginal cost of dumping and reduce the amount of waste dumped to 3 tonnes a week.

3b.  If no one owns the lake (that is, property rights do not exist), the efficient amount of dumped waste can be achieved by imposing the appropriate tax on the polluter.

5a.  The market price of a permit is \$150 (or \$100 a tonne). The trout farm sells its permit to the factory.

The factory and the farm share equally the permits to dump 3 tonnes of waste. That is, each has a permit to dump 1.5 tonnes of waste. The efficient amount of waste is 3 tonnes, so the farm sells its permit to pollute to the factory for \$100 a tonne.

5c.  The cost of dumping the waste is zero, so the pesticide factory will dump all its waste. A marketable pollution permit of \$100 a tonne will increase the marginal cost of dumping and reduce the amount of waste dumped to 3 tonnes a week. In this problem, the factory has a permit to dump 1.5 tonnes of waste a week. To be able to dump another 1.5 tonnes a week, the factory must buy the permit from the trout farm. The alternative to dumping the 1.5 tonnes is to truck it at a cost of \$100 a tonne. So the opportunity cost of buying the permit is \$150.

7a.  If schools are competitive, 30,000 students enroll and tuition is \$4,000 a year.

In a competitive market, schools maximize profit. They produce the quantity at which the marginal benefit of the last student enrolled equals the marginal cost of educating the last student enrolled. Tuition is \$4,000 a student.

7b.  Efficient number of places is 50,000, and tuition is \$4,000 a student.

The efficient number of places is such that the marginal social benefit of education equals the marginal cost of education. The marginal social benefit equals the marginal private benefit plus the external benefit. For example, the marginal social benefit of 50,000 places equals the marginal private benefit of \$2,000 plus the external benefit of \$2,000, which is \$4,000.

Chapter 21

1.   Go to Economics in Action, Chapter 21, Problem 1, and use the graph provided to find the solution to this problem.

3a.  The growth rate in India was positive in every year from 1989 to 1996. The growth rate was fastest in 1989.

3b.  The growth rate was not negative in Pakistan in this period. The growth rate was slowest in 1993.

3c.  Between 1989 and 1990, growth rates in Pakistan and India both decreased. Between 1990 and 1991, the growth rate in Pakistan increased while the growth rate in India decreased. Between 1991 and 1992, both growth rates increased. Between 1992 and 1993, both growth rates decreased. From 1993 to 1995, both growth rates increased. In 1996, the two growth rates were approximately equal.

5a. Germany had one recession in the fourth quarter of 1992 and the first quarter of 1993.

The large black dots are the first quarter of each year and the small grey dots are the second, third, and fourth quarter. A recession is a period during which real GDP decreases for at least two successive quarters. Real GDP decreased in the fourth quarter of 1992 and the first quarter of 1993.

5b.  Germany experienced a business cycle peak in the first quarter of 1992.

A business cycle peak is the upper turning point. A peak occurs when real GDP stops growing and starts to decrease.

5c.  Germany experienced a business cycle trough in the first quarter of 1993.

A business cycle trough is the lower turning point of a business cycle where a recession ends and an expansion begins.

5d.  Germany experienced an expansion during the fourth quarter of 1991 and the first quarter of 1992 and in every quarter after the first quarter of 1993.

An expansion is a period during which real GDP increases.

7.   Go to Economics in Action, Chapter 21, Problem 7, and use the graph provided to find the solution to this problem.

9.   Go to Economics in Action, Chapter 21, Problem 9, and use the graph provided to find the solution to this problem.

Chapter 22

1.   Martha’s initial capital stock is 5 copiers, depreciation is 1 copier per year, gross investment is 3 copiers, net investment is 2 copiers, and the final capital stock is 7 copiers.

Final capital stock equals initial capital stock plus net investment. Net investment equals gross investment minus depreciation.

3a.  Aggregate expenditure is \$60 million.

Aggregate expenditure is the sum of consumption expenditure, investment, government expenditures, and net exports. In the figure, B is consumption expenditure, D is investment, C is government expenditures, and E is net exports. Therefore aggregate expenditure equals \$30 million plus \$15 million plus \$12 million plus \$3 million, which is \$60 million.

3b.  Aggregate income is \$60 million.

Aggregate income equals aggregate expenditure, which from 3a is \$60 million.

3c.  GDP is \$60 million.

GDP equals aggregate expenditure, which from 3a is \$60 million.

3d.  Government budget deficit is \$2 million.

Government budget deficit equals government expenditures minus taxes. C is government expenditures, and A is taxes. So the government budget deficit equals \$12 million minus \$10 million, which is \$2 million.

3e.  Household saving is \$20 million.

Household saving equals aggregate income minus consumption expenditure minus taxes. In the figure, B is consumption expenditure and A is taxes. Therefore household saving equals \$60 million minus \$30 million minus \$10 million, which is \$20 million.

3f.   Government saving is minus \$2 million.

Government saving equals taxes minus government expenditures. In the figure, A is taxes and C is government expenditures. Therefore government saving equals \$10 million minus \$12 million, which is minus \$2 million.

3g.  Foreign borrowing is \$3 million.

Foreign borrowing equals net exports. E is net exports, and net exports equals \$3 million. Lotus Island is in surplus, so foreigners are in deficit and they must borrow from us to pay for their deficit. Foreign borrowing equals \$3 million.

3h.  National saving is \$18 million.

National saving equals the sum of household saving and government saving. Household saving is \$20 million (see answer 3e). Government saving is minus \$2 million (see answer 3f). Therefore national saving equals \$20 million minus \$2 million, which is \$18 million.

5a.  Ecoland's GDP is \$1,100,000.

GDP equals the sum of consumption expenditure plus investment plus government expenditures plus net exports. That is, GDP equals \$600,000 plus \$250,000 plus \$200,000 plus \$300,000 minus \$250,000. GDP equals \$1,100,000.

5b.  Expenditure approach. Income approach cannot be used because there are no data on interest, rent, profits, depreciation, and indirect taxes and subsidies.

5c.  Injections equal leakages.

Injections are investment, government expenditures, and exports. Total injections are \$250,000 plus \$200,000 plus \$300,000 which equals \$750,000.

Leakages are saving, net taxes, and imports. Total leakages are \$300,000 plus \$200,000 plus \$250,000 which equals \$750,000.

7a.  The basket used in the CPI is 10 bottles of juice and 5 lengths of cloth.

The basket used in the CPI is the typical basket consumed in the base year. In the base year, the typical family spends \$40 on juice and juice costs \$4 a bottle, so the family buys 10 bottles of juice. In the base year, the typical family spends \$25 on cloth and cloth costs \$5 a length, so the family buys 5 lengths of cloth.

7b.  The CPI in the current year is 107.69

Expenditure on the CPI basket in the current year is 10 bottles of juice @ \$4 a bottle plus 5 lengths of cloth @ \$6 a length, which is \$70. The expenditure on the CPI basket in the base year is \$40 plus \$25, which is \$65. The CPI in the current year equals the expenditure on the basket in the current year divided by the expenditure on the basket in the base year, multiplied by 100. The CPI is 107.69.

7c.  The inflation rate in the current year is 7.69 percent.

The CPI in the base year is 100 and the CPI in the current year is 107.69, and the inflation rate is the rate of change of the CPI. The inflation rate equals (107.69 - 100)/100, which is 7.69 percent.

9a.  In 1997, GDP is \$7,000 and real GDP is \$7,000. In 1998, GDP is \$7,500 and real GDP is \$7,450.

GDP is equal to total expenditure on the goods and services produced by Bananaland in 1997. Expenditure on bananas is 1,000 bunches @ \$2 a bunch, which is \$2,000. Expenditure on sunscreen is 500 bottles @ \$10 a bottle, which is \$5,000. Total expenditure is \$7,000. So GDP in 1997 is \$7,000.

Real GDP in 1997 is equal to Bananaland’s 1997 output valued at base-year prices . Because 1997 is the base year, real GDP in 1997 equals \$7,000.

GDP in 1998 is equal to total expenditure on the goods and services produced by Bananaland in 1998. Expenditure on bananas is 1,100 bunches @ \$3 a bunch, which is \$3,300. Expenditure on sunscreen is 525 bottles @ \$8 a bottle, which is \$4,200. Total expenditure is \$7,500. So GDP is \$7,500.

Real GDP in 1998 is equal to Bananaland’s 1998 output valued at base-year prices (1997 prices). To value the 1998 output at 1997 prices, expenditure on bananas is 1,100 bunches @ \$2 a bunch (which is \$2,200), expenditure on sunscreen is 525 bottles @ \$10 a bottle (which is \$5,250). So real GDP in 1998 is \$7,450.

9b.  The growth rate of real GDP in 1998 is 6.43 percent.

The growth rate equals the increase in real GDP from 1997 to 1998 expressed as a percentage of real GDP in 1997. That is, the growth rate equals (\$7,450 - \$7,000)/\$7,000, which is 6.43 percent.

9c.  The GDP deflator in 1998 is 100.67.

GDP deflator equals GDP in 1998 divided by real GDP in 1998, multiplied by 100. GDP deflator equals (\$7,500/\$7,450) ´ 100 = 100.67.

Chapter 23

1a.  Unemployment rate is 9.5 percent.

The unemployment rate is the percentage of the labour force that is unemployed. The labour force is the sum of the people unemployed and the people employed. The labour force is 14,924,000 and the number of people employed is 13,506,000, so the number of people who are unemployed equals 14,924,000 minus 13,506,000, which is 1,418,000.

The unemployment rate equals (the number of people unemployed divided by the labour force) multiplied by 100. That is, (1,418,000/14,924,000) ´ 100, which is 9.5 percent.

1b.  The labour force participation rate is 64.8 percent.

The labour force participation rate is the percentage of the working-age population that is in the labour force. The working-age population is 23,027,000 and the labour force is 14,924,000, so the labour force participation rate equals (14,924,000/23,027,000) ´ 100, which equals 64.8 percent.

1c.  The employment-to-population ratio is 58.7 percent.

The employment-to-population ratio is the percentage of the people of working age who have jobs. The employment-to-population ratio is the number of people employed divided by the working-age population all multiplied by 100. The employment-to-population ratio is (13,506,000/23,027,000) ´ 100, which is 58.7 percent.

3.   Unemployment increased by 51,000. The number of discouraged workers has increased.

During 1996, employment in Canada increased by 170,000 and the labour force increased by 221,000. The number of unemployed is calculated as the labour force minus the number employed. When the labour force increased by 221,000 and employment increased by 170,000, unemployment increased by 51,000.

Discouraged workers are people who leave the labour force temporarily during a recession and re-enter the labour force and become job seekers during an expansion. To measure the number of discouraged workers, we need to know about new entrants and retirements. Because the labour force increased by less than the increase in the working-age population, it is likely that the number of discouraged workers increased.

5a.  The number of job losers probably decreased. The number of job leavers probably did not change much.

The decrease in the unemployment rate is an indication that the economy was in an expansion, and normally, in an expansion, the number of job losers decreases but the number of job leavers does not change much.

5b.  Labour force entrants and re-entrants probably increased.

In an expansion, discouraged workers re-enter the labour force. So it is likely that entrants and re-entrants increased.

7a. The labour force in July is 15,344,000. It is the number employed plus the number unemployed.

7b.  The unemployment rate in July is 10.1 percent. It is the number unemployed as a percentage of the labour force.

7c.  The working-age population is 22,729,000. It is the sum of the labour force and the number of people not in the labour force.

7d.  The employment-to-population ratio is 60.7. It is the number employed as a percentage of the working-age population.

7e   The number of people who are unemployed at the end of August is 1,546,995. It equals the number unemployed in July plus job losers, job leavers, entrants, and reentrants minus hires, recalls, and withdrawals.

7f.   The number of people who are employed at the end of August is 13,796,971. It equals the number employed in July minus job losers and job leavers plus hires and recalls.

7g.  The labour force at the end of August is 15,343,966. It equals the number employed plus the number unemployed.

7h.  The unemployment rate at the end of August is 10.1 percent. It equals the number unemployed as a percentage of the labour force.

7i.   The employment-to-population ratio at the end of August is 58.9. It equals the number employed as a percentage of the working-age population. The working-age population is the labour force multiplied by 100 and divided by the labour force participation rate.

9.   At the peak of a business cycle, the labour force participation rate is high, employment is high, the unemployment rate is low, the duration of unemployment is low, and fewer workers are discouraged.

Chapter 24

1a.  A deep recession in the world economy will decrease real GDP, and the price level will fall. A sharp rise in oil prices will decrease real GDP, and the price level will rise. When businesses expect huge losses in the near future, real GDP will decrease and the price level will fall.

(i) A deep recession in the world economy will decrease world income, which in turn will reduce Toughtimes' exports of goods and services. Toughtimes' aggregate demand curve will shift leftward. In Toughtimes, real GDP will decrease and the price level will fall.

(ii) A sharp rise in oil prices will decrease short-run aggregate supply and shift the short-run aggregate supply curve leftward. In Toughtimes, the real GDP will decrease and the price level will rise.

(iii) When businesses expect huge losses in the near future, they will reduce investment now. Aggregate demand will decrease, and the aggregate demand curve will shift leftward. In Toughtimes, real GDP will decrease and the price level will fall.

1b.  Real GDP will decrease and the price level might rise, fall, or stay the same.

In 1a, each of the events decreases real GDP, so together they will decrease real GDP. But the recession and the expected business losses will lead to a fall in the price level, while the sharp rise in the oil price will lead to a rise in the price level. So together, the price level might rise, fall, or stay the same.

1c.  To increase aggregate demand, the government might increase its expenditures or cut taxes and the central bank might increase the quantity of money and decrease interest rates. These policies will increase real GDP.

3a.  To plot the aggregate demand curve, plot the price and the quantity of real GDP demanded. To plot the short-run aggregate supply curve, plot the price and the quantity of real GDP supplied in the short-run.

3b.  Real GDP is \$400 billion, and the price level is 100.

Short-run macroeconomic equilibrium occurs at the intersection of the aggregate demand curve and the short-run aggregate supply curve.

3c   The long-run aggregate supply curve is a vertical line at real GDP of \$500 billion.

5.   Real GDP increases to \$450 billion, and the price level rises to 110.

Aggregate demand increases by \$100 billion at each value of the price level, and the aggregate demand curve shifts rightward by \$100 billion. The new aggregate demand curve intersects the short-run aggregate supply curve at a real GDP of \$450 billion and a price level of 110.

7.   Real GDP decreases to \$350 billion, and the price level rises to 110.

Short-run aggregate supply decreases by \$100 billion at each value of the price level and the short-run aggregate supply curve shifts leftward by \$100 billion. The new short-run aggregate supply curve intersects the aggregate demand curve at a real GDP of \$350 billion and a price level of 110.

9a.  The equilibrium point is point c.

The aggregate demand curve is the red curve AD1. The short-run aggregate supply curve is the blue curve SAS0. These curves intersect at point c.

9b.  The equilibrium point is point d.

The short-run aggregate supply curve is the red curve SAS1. The aggregate demand curve is now the red curve AD1 These curves intersect at point d.

9c.  Aggregate demand increases if (1) expected future incomes, inflation, or profits increase; (2) the government increases its expenditures or reduces taxes; (3) the central bank increases the quantity of money and decrease interest rates; or (4) the exchange rate decreases or foreign income increases.

9d.  Short-run aggregate supply decreases if resource prices increase.

Chapter 25

1a.  The marginal propensity to consume is 0.5.

The marginal propensity to consume is the fraction of a change in disposable income that is consumed. On Heron Island, when disposable income increases by \$10 million per year, consumption expenditure increases by \$5 million per year. The marginal propensity to consume is 0.5.

1b.  The table that shows Heron Island’s saving lists disposable income from zero to 40 in increments of 10. Against each level of disposable income are the amounts of saving, which equal disposable income minus consumption expenditure. These amounts run from –5 at zero disposable income to 15 at a disposable income of 40. For each increase in disposable income of \$1, saving increases by 50 cents.

1c. Marginal propensity to save is 0.5

The marginal propensity to consume plus the marginal propensity to save equals 1. Because consumption expenditure and saving exhaust disposable income, 0.5 of each dollar increase in disposable income is consumed and the remaining part (0.5) is saved.

3a.  Autonomous expenditure is \$2.0 billion

Autonomous expenditure is expenditure that does not depend on real GDP. Autonomous expenditure equals the value of aggregate planned expenditure when real GDP is zero.

3b.  Marginal propensity to consume is 0.6

When the country has no imports or exports and no income taxes, the slope of the AE curve equals the marginal propensity to consume. When income increases from 0 to \$6 billion, aggregate planned expenditure increases from \$2 billion to \$5.6 billion. That is, when real GDP increases by \$6 billion, aggregate planned expenditure increases by \$3.6 billion. The marginal propensity to consume is \$3.6 billion/\$6 billion, which is 0.6.

3c.  Equilibrium expenditure is \$5 billion.

Equilibrium expenditure is the level of aggregate expenditure at which aggregate planed expenditure equals real GDP. In terms of the graph, equilibrium expenditure occurs at the intersection of the AE curve and the 45° line. The equation to the AE curve is AE = 2 + 0.6y where y is real GDP. The equation to the 45° line is AE = y. The AE curve intersects the 45° line at a real GDP of \$5 billion.

3d.  Unplanned inventory investment is negative.

When real GDP is \$4 billion, aggregate planned expenditure exceeds real GDP, so firms sell more than they produce. Inventories run down.

3e.  Firms are accumulating inventories. That is, unplanned inventory investment is positive.

When real GDP is \$6 billion, aggregate planned expenditure is less than real GDP, so firms cannot sell all that they produce. Inventories pile up.

3f.   The multiplier is 2.5.

The multiplier equals 1/(1 - MPC). The marginal propensity to consume is 0.6, so the multiplier equals 1/(1 - 0.6), which equals 2.5.

5a.  The consumption function is C = 100 + 0.9(YT).

The consumption function is the relationship between consumption expenditure and disposable income, other things remaining the same.

5b.  The equation to the AE curve is:

AE = 600 + 0.9Y,

where Y is real GDP.

Aggregate planned expenditure is the sum of consumption expenditure, investment, government expenditure, and net exports. Using the symbol AE for aggregate planned expenditure, aggregate planned expenditure is:

AE = 100 + 0.9(Y – 400) + 460 + 400

AE = 100 + 0.9Y – 360 + 460 + 400

AE = 600 + 0.9Y

5c.  Equilibrium expenditure is \$6,000 billion.

Equilibrium expenditure is the level of aggregate expenditure that occurs when aggregate planned expenditure equals real GDP. That is,

AE = 600 + 0.9Y

and

AE = Y

Solving these two equations for Y gives equilibrium expenditure of \$6,000 billion.

5d.  Equilibrium real expenditure decreases by \$1,000 billion, and the multiplier is 10.

The multiplier equals 1/(1 - the slope of the AE curve). The equation to the AE curve tells us that the slope of the AE curve is 0.9. So the multiplier is 1/(1 - 0.9), which is 10.

The change in equilibrium expenditure equals the change in investment multiplied by 10.

7a.  The quantity demanded increases by \$1,000 billion.

The increase in investment shifts the aggregate demand curve rightward by the change in investment times the multiplier. The multiplier is 10 and the change in investment is \$100 billion, so the aggregate demand curve shifts rightward by \$1,000 billion.

7b.  In the short-run, real GDP increases by less than \$1,000 billion

Real GDP is determined by the intersection of the AD curve and the SAS curve. In the short run, the price level will rise and real GDP will increase but by an amount less than the shift of the AD curve.

7c.  In the long-run, real GDP will equal potential GDP, so real GDP does not increase.

Real GDP is determined by the intersection of the AD curve and the SAS curve. After the initial increase in investment, money wages increase, the SAS curve shifts leftward, and in the long run, real GDP moves back to potential GDP.

7d.  In the short run, the price level rises.

7e. In the long run, the price level rises.

Chapter 26

1a.  Equilibrium expenditure decreases by \$100 billion.

The government expenditures multiplier is the amount by which a change in government expenditures on goods and services is multiplied to determine the change in equilibrium expenditure that results. Zap has no induced taxes or imports, so the government expenditures multiplier is 1/(1 - MPC), which equals 10. The multiplier tells us that when government expenditures decrease by \$10 billion, equilibrium expenditure decreases by 10 times as much or \$100 billion.

1b.  The government expenditures multiplier is 10.

1c. Equilibrium expenditure increases by \$90 billion.

The autonomous tax multiplier equals -MPC/(1 - MPC), which is -9. That is, when autonomous taxes are changed by \$10 billion, equilibrium expenditure changes by -9 times the change in autonomous taxes. A cut in autonomous taxes of \$10 billion will increase equilibrium expenditure by \$90 billion.

1d.  The autonomous tax multiplier is -9.

1e.  Equilibrium expenditure decreases by \$10 billion.

The decrease in government expenditures decreases equilibrium expenditure by \$100 billion and the cut in taxes increases equilibrium expenditure by \$90 billion. So together, equilibrium expenditure decreases by \$10 billion.

3a.  The quantity of real GDP demanded increases by \$100 billion.

The government expenditures multiplier tells us that when government expenditures increase by \$10 billion, equilibrium expenditure increases by 10 times as much, or \$100 billion. At the price level 100, the quantity of real GDP demanded increases by an amount equal to the change in equilibrium expenditure. That is, the quantity of real GDP demanded increases by \$100 billion.

3b.  The aggregate demand curve shifts rightward by \$100 billion at each price level.

The AE curve shifts upward by \$10 billion, equilibrium expenditure increases by \$100 billion, and the AD curve shifts rightward by \$100 billion.

3c.  In the short run, real GDP increases by less than the \$100 billion increase in the quantity of real GDP demanded.

In the short run, short-run aggregate supply and aggregate demand determine real GDP. Because the short-run aggregate supply curve slopes upward, the price level rises and real GDP increases but by less than \$100 billion.

3d.  In the long run, the increase in real GDP will be zero. Real GDP will return to potential GDP.

In the short run, real GDP exceeds potential GDP and wage rates will start to rise. The short-run aggregate supply will begin to decrease and the price level will rise. The short-run aggregate supply will continue to decrease and the price level will continue to rise until real GDP equals potential GDP.

3e.  The price level rises.

In the short run, aggregate demand and short-run aggregate supply determine the price level. Because the short-run aggregate supply curve slopes upward and because aggregate demand increases, the price level rises.

3f.   The price level rises.

In the long run, aggregate demand and long-run aggregate supply determine the price level. The short-run aggregate supply curve shifts leftward because the money wage rate rises. Because the long-run aggregate supply curve is vertical and because aggregate demand increases, the price level rises. And it rises by more in the long run than it does in the short run.

5a.  The government budget balance is zero.

The government's revenues equal its outlays, so its budget is balanced.

5b.  Dreamland does not have a structural or a cyclical deficit.

Because at potential GDP, the budget is balanced, Dreamland does not have a structural surplus or deficit. Because real GDP equals potential GDP, Dreamland does not have a cyclical surplus or deficit.

5c.  The budget balance is a deficit of \$40 million.

At a real GDP of \$30 million, revenues equal \$80 million and outlays equal \$120 million, so the budget is in deficit. The size of the deficit is \$40 million.

5d.  Dreamland does not have a structural deficit, but it does have a cyclical deficit of \$40 million.

Because at potential GDP, the budget is balanced, Dreamland does not have a structural surplus or deficit. Because real GDP is less than potential GDP and it has a deficit, Dreamland's deficit is a cyclical deficit. The cyclical deficit is \$40 million.

5e.  Dreamland does not have a structural deficit but it does have a cyclical surplus of \$40 million.

Because at potential GDP, the budget is balanced, Dreamland does not have a structural surplus or deficit. Because real GDP exceeds potential GDP and it has a surplus, Dreamland's surplus is a cyclical surplus. The cyclical surplus is \$40 million.

Chapter 27

1.   Money in Canada includes the quarters inside public telephones and the Canadian dollar bills in your wallet.

Money is composed of currency outside the banks and deposits at banks and other financial institutions. Currency inside the cash machines, Visa cards, cheques, and loans are not money.

3.   M1 increases by \$1,000; M2+ does not change.

M1 is the sum of currency outside the banks plus demand deposits at chartered banks that are owned by individuals and businesses. M2+ is the sum of M1 plus personal savings deposits and nonpersonal notice deposits at chartered banks plus all types of deposits at trust and mortgage companies, credit unions, caisses populaires, and other financial institutions. The withdrawal of \$1,000 from a savings account leaves M2+ unchanged because the \$1,000 goes into M1 types of money, which is part of M2+. The \$50 held as cash and the \$950 held in a demand deposit account increase M1 by \$1,000.

5a.  The balance sheet has the following assets: Reserves, \$250 million; Loans, \$1,000 million; Other assets, \$1,250 million. It has the following liabilities: Deposits, \$2,000 million; Other liabilities, \$500 million.

5b.  The reserve ratio is 12.5 percent.

The reserve ratio is the percentage of deposits that are held as reserves. Reserves are \$250 million and deposits are \$2,000, so the reserve ratio is 12.5 percent.

5c.  The deposit multiplier is 8.

The deposit multiplier equals 1/(desired reserve ratio). The desired reserve ratio is 12.5, so the deposit multiplier is 8.

7a.  People buy bonds, and the interest rate falls.

7b.  People sell bonds, and the interest rate rises.

7c.  People neither buy nor sell bonds, and the interest rate remains constant at 4 percent a year.

With real GDP of \$20 billion (Y1 in the spreadsheet), column C shows the demand for money schedule. The quantity of money supplied is \$3 billion, so the equilibrium interest rate is 4 percent a year.

If the interest rate exceeds 4 percent a year, people are holding more money than they demand. So they try to decrease the amount of money held by buying bonds. The prices of bonds rise, and the interest rate falls.

If the interest rate is less than 4 percent a year, people are holding less money than they demand. So they try to increase the amount of money held by selling bonds. The prices of bonds fall, and the interest rate rises.

If the interest rate equals 4 percent a year, people are holding exactly the quantity of money that they demand. So they take no actions to try to change the amount of money held. The interest rate remains constant.

9a.  The interest rate rises to 5 percent a year.

9b.  The interest rate falls to 3 percent a year.

When real GDP increases in an expansion to \$30 billion (Y2 in the spreadsheet), column D shows the demand for money schedule. The quantity of money supplied is \$3 billion, so the equilibrium interest rate is 5 percent a year.

When real GDP decreases in a recession to \$10 billion (Y0 in the spreadsheet), column B shows the demand for money schedule. The quantity of money supplied is \$3 billion, so the equilibrium interest rate is 3 percent a year.

11a.The money supply curve is vertical at 100 billion 1992 yaks.

When the real money supply is 100 billion 1990 yaks, the equilibrium interest rate is 3 percent a year at the intersection of the demand for money and supply of money curves.

11b.Must increase the quantity of real money by 50 billion 1992 yaks.

When the quantity of real money increases to 150 billion 1992 yaks, the equilibrium interest rate falls to 2 percent a year.

13a. During the expansion phase of the cycle, the interest rate rises. When the interest rate rises, consumption expenditure decreases, investment decreases, the exchange rate rises, and net exports decrease.

13b. During the recession phase of the cycle, the interest rate falls. When the interest rate falls, consumption expenditure increases, investment increases, the exchange rate falls, and net exports increase.

Chapter 28

1a.  The monetary base is \$45 billion.

The monetary base is the sum of the central bank’s notes outside the central bank, banks’ deposits at the central bank, and coins held by households, firms, and banks. There are \$30 billion in notes held by households and firms, banks’ deposits at the central bank are \$10 billion (2/3 of \$15 billion), the banks hold other reserves of \$5 billion (which are notes), and there are no coins. The monetary base is \$45 billion.

1b.  The quantity of money is \$330 billion.

In Nocoin, deposits are \$300 billion and currency is \$30 billion, so the quantity of money is \$330 billion.

1c.  The banks’ reserve ratio is 5 percent.

The banks’ reserve ratio is the percent of deposits that is held as reserves. In Nocoin, deposits are \$300 billion and reserves are \$15 billion, so the reserve ratio equals (\$15 billion/\$300 billion) ´ 100, which is 5 percent.

1d.  The currency drain is 9.09 percent.

The currency drain is the percent of the quantity of money that is held as currency by households and firms. In Nocoin, deposits are \$300 billion and currency is \$30 billion, so the quantity of money is \$330 billion. The currency drain equals (\$30 billion/\$330 billion) ´ 100, which is 9.09 percent.

3.   The money supply increases to \$337.33 billion.

The money supply increases by the change in the monetary base multiplied by the money multiplier. The money multiplier is the ratio of the money supply to the monetary base, which equals \$330 billion divided by \$45 billion, which equals 7.33.

So when the monetary base increases by \$1 billion, the money supply increases by \$7.33 billion. Initially, the money supply was \$330 billion, so the new money supply is \$337.33 billion

The change in the money supply is not equal to the change in the monetary base because of the multiplier effect. The open market operation increases bank reserves and creates excess reserves which banks use to make new loans. New loans are used to make payments and some of these loans are placed on deposit in banks. The increase in bank deposits increases banks’ reserves and increases desired reserves. But the banks now have excess reserves which they loan out and the process repeats until excess reserves have been eliminated.

5a.  The price level is 130 and real GDP is \$200 billion.

The intersection of the aggregate demand curve, AD, and the short-run aggregate supply curve, SASA, determine the price level and real GDP.

5b.  Freezone has an unemployment problem.

Potential GDP is \$300 billion, but actual real GDP is \$200 billion. When real GDP is less than potential GDP, resources are not fully employed. Unemployment exceeds that at full employment.

5c.  Eventually, the real GDP will increase and full employment will be restored. The price level will fall.

With unemployment exceeding the natural rate of unemployment, the money wage rate will eventually fall. The SAS curve will shift rightward, the price level will fall, and real GDP will gradually increase to potential GDP. At potential GDP, the economy is at full employment. This automatic adjustment will take a long time to occur.

5d.  By buying securities on the open market, the central bank will increase the money supply, increase aggregate demand, and return the economy to full employment more quickly.

Currently real GDP is less than potential GDP and the economy is at a below full-employment equilibrium. If the central bank buys securities on the open market, then the quantity of money will increase and the aggregate demand curve will shift rightward. The economy returns to full employment but the price level will rise. If this process takes some time, the economy will experience inflation.

7a.  If the central bank buys securities on the open market, the money supply increases, aggregate demand increases, real GDP increases, and the price level rises.

When the central bank buys securities on the open market, the quantity of money increases, the interest rate falls, so consumption, investment, and net exports increase. Aggregate demand increases, and the aggregate demand curve shifts rightward. Real GDP increases and the price level rises.

7b.  If the central bank sells securities on the open market, the money supply decreases, aggregate demand decreases, real GDP decreases, and the price level falls.

When the central bank sells securities on the open market, the quantity of money decreases, the interest rate rise, so consumption, investment, and net exports decrease. Aggregate demand decreases, and the aggregate demand curve shifts leftward. Real GDP decreases and the price level falls.

7c.  To return the economy to full employment, the central bank would sell securities on the open market.

Currently real GDP is greater than potential GDP and the economy is at an above full-employment equilibrium. If the central bank sells securities on the open market, then the quantity of money decreases and the aggregate demand curve shifts leftward. The price level falls and the economy returns to full employment.

9a.  On the average, the interest rate in Minland is 3 percent a year.

The money supply curve is vertical at a quantity of \$150 billion. On the average, the demand for money curve is MDA. The intersection of the demand for money curve, MDA and the money supply curve determine the interest rate.

9b.  The interest rate ranges from 2 percent a year to 4 percent a year.

The demand for money fluctuates around an average level of MDA to a high of MDB and a low of MDC. As the demand for money fluctuates, the interest rate fluctuates. The interest rate is 2 percent a year when the demand for money is MDC, 3 percent a year when the demand for money is MDA, and 4 percent a year when the demand for money is MDB.

9c.  As the demand for money fluctuates, the interest rate changes, which will lead to changes in real GDP and the price level.

When the demand for money increases, the interest rate rises and aggregate demand decreases. With aggregate demand decreasing, real GDP decreases and the price level falls.

When the demand for money decreases, the interest rate falls, and aggregate demand increases. With aggregate demand increasing, real GDP increases and the price level rises.

Chapter 29

1a.  A decrease in government expenditures leads to a decrease in aggregate demand, which in turn sets up a process in which real GDP starts to decrease and the price level starts to fall.

The decrease in government expenditures has a multiplier effect on aggregate demand. Aggregate demand decreases and shifts the AD curve in figure 29.1(a) leftward. Real GDP begins to decrease and the price level starts to fall towards the new equilibrium.

1b.  Real GDP decreases and the interest rate falls.

In the first round, real GDP begins to decrease and the price level begins to fall. In the second round, as real GDP decreases the demand for money decreases. As the price level falls, the quantity of real money increases. As a result, the interest rate falls. The fall in the interest rate limits the decrease in real GDP.

1c.  Through the second round, real GDP decreases and the price level falls until the new equilibrium is reached. As real GDP decreases, the demand for money decreases and the money demand curve in figure 29.1(b), MD, shifts leftward. The interest rate falls. With a given quantity of nominal money, the falling price level increases the quantity of real money. In figure 29.1(b), the supply curve of real money, MS, shifts rightward and the interest rate falls further. As the interest rate falls, interest-sensitive expenditure increases. The increase in interest-sensitive expenditure increases aggregate demand and the aggregate demand curve starts to shift rightward. But aggregate demand increases by less than the initial decrease in aggregate demand. So at the new equilibrium, aggregate demand is less than initially.

Comparing the final equilibrium with the initial equilibrium, the decrease in government expenditures on goods and services has lead to a decrease in real GDP, a fall in the price level, and a fall in the interest rate.

3a.  A decrease in the money supply raises the interest rate and decreases interest-sensitive expenditure. The decrease in interest-sensitive expenditure has a multiplier effect on aggregate demand. Aggregate demand decreases. Real GDP and the price level begin to decrease.

A decrease in the money supply with a constant price level decreases the real money supply and shifts the real money supply curve in figure 29.1(b) leftward. The interest rate rises. The higher interest rate decreases interest-sensitive expenditure in figure 29.1(c). The decrease in interest-sensitive expenditure decreases aggregate demand and shifts the AD curve leftward in figure 29.1(a). Real GDP begins to decrease and the price level begins to fall towards the new equilibrium.

3b.  Real GDP decreases and the interest rate rises.

In the first round, real GDP begins to decrease and the price level begins to fall. In the second round, as real GDP decreases the demand for money decreases. As the price level falls, the quantity of real money increases. As a result, the interest rate falls. The fall in the interest rate limits the decrease in interest-sensitive expenditure and limits the decrease in real GDP.

3c.  In the second round, the decreasing real GDP decreases the demand for money. The money demand curve in figure 29.1(b) shifts leftward and the interest rate falls. The falling price level increases in the supply of real money and the real money supply curve shifts rightward. The interest rate falls further. As the interest rate falls, interest-sensitive expenditure increases. The increase in interest-sensitive expenditure increases aggregate demand and the aggregate demand curve starts to shift rightward. But aggregate demand increases by less than the initial decrease in aggregate demand. So at the new equilibrium, aggregate demand is less than initially.

5a.  An increase in government expenditures on goods and services has a larger effect on real GDP in Alpha.

The first round effects are the same in Alpha and Beta. In the second round, the increasing real GDP increases the demand for money. The demand for money curves in Alpha and in Beta shift rightward. In both countries, the interest rate rises, but it rises by a greater amount in Beta. The higher interest rate decreases interest-sensitive expenditure by more in Beta than in Alpha, and in Beta the aggregate demand curve shifts further to the left. Real GDP increases by a greater amount in Alpha than in Beta.

5b.  The crowding-out effect is weaker in Alpha.

The expansionary fiscal policies in Alpha and Beta increase the interest rates. As the interest rate rises, the interest-sensitive components of aggregate expenditure, including investment, decrease. The interest rate rises by more in Beta than in Alpha, so the decrease in investment will be greater in Beta than in Alpha. Beta will experience more crowding out.

5c.  A change in the money supply has a larger effect on equilibrium real GDP in Beta.

When the money supply increases, the interest rate falls by a greater amount in Beta than in Alpha. The lower interest rate in Beta increases interest-sensitive expenditure by a greater amount than in Alpha and shifts the aggregate demand curve further to the right than in Alpha. Equilibrium real GDP increases by more in Beta than in Alpha.

5d.  Beta is closer to the monetarist extreme. Alpha is closer to the Keynesian extreme.

Extreme monetarism hypothesizes that a change in the money supply has a large effect on aggregate demand. Beta has a money demand curve that is less sensitive to the interest rate than Alpha. A change in the money supply changes the interest rate and aggregate demand by a relatively large amount in Beta.

Extreme Keynesianism hypothesizes that a change in the money supply has no effect on aggregate demand. Alpha has a money demand curve that is more sensitive to the interest rate than Beta. A change in the money supply changes the interest rate by a small amount and aggregate demand by a relatively small amount in Alpha.

7a. An increase in government expenditures and a decrease in taxes are expansionary fiscal policies. Aggregate demand increases in the first round. Real GDP and the price level begin to increase. In the second round, the increasing real GDP increases the demand for money and the interest rate rises. The rising price level decreases the supply of real money and increases the interest rate further. Interest-sensitive expenditure decreases and limits the increase in real GDP. The decrease in interest-sensitive expenditure includes a decrease in investment and net exports.

An increase in the money supply lowers the interest rate, increases interest-sensitive expenditure and increases aggregate demand in the first round. Real GDP and the price level begin to increase. In the second round, increasing real GDP increases the demand for money and the interest rate rises. The rising price level decreases the supply of real money and the interest rate rises further. The increase in interest-sensitive expenditure limits the increase in real GDP. The resulting increase in interest-sensitive expenditure includes an increase in investment and net exports.

7b.  The expansionary fiscal policies raise the interest rate and the interest-sensitive expenditure component of aggregate demand decrease. The exchange rate rises, exports decrease, imports increase, and net exports decrease.

An increase in the money supply lowers the interest rate and the interest-sensitive expenditure component of aggregate demand increase. The exchange rate falls, exports increase, imports decrease, and net exports increase.

7c.  All policies increase real GDP and raise the price level.

7d.  The best policy is to increase the money supply.

Increasing the money supply results in a lower the interest rate and lowers the exchange rate. The lower interest rate increases investment and lowers the exchange rate increasing net exports.

9a.  A combination of an increase in the money supply and a decrease in government expenditures.

9b. An increase in the money supply lowers the interest rate and increases interest-sensitive expenditure including investment. The aggregate demand curve shifts rightward. A decrease in government expenditures decreases aggregate demand and shifts the aggregate demand curve leftward. Real GDP decreases, the interest rate decreases, and interest-sensitive expenditure, including investment, increases. If the decrease in government expenditures is of the correct magnitude, the leftward shift of the aggregate demand curve will offset the rightward shift created by the increase in the money supply. The price level will remain the same.

9c.  The lower interest rate will increase investment and consumption expenditure and the lower exchange rate will increase exports.

9d.  In the short run, real GDP and the price level do not change. The aggregate demand curve remains the same—only the composition of aggregate demand changes.

In the long run, the increase in investment will encourage economic growth. Real GDP will increase and the price level will remain the same.

Chapter 30

1a.  An increase in the quantity of money, an increase in government expenditures, a tax cut, an increase in exports.

Anything that increases aggregate demand can set off a demand-pull inflation. But to sustain such an inflation, the quantity of money must keep increasing.

1b.  Starting out on AD0 and SAS0, the price level is 120 and real GDP is at potential GDP of \$7 billion. Aggregate demand increases and the AD curve shifts rightward to AD1. The price level rises and real GDP increases to the intersection of AD1 and SAS0. There is now an inflationary gap.

1c.  Starting out on AD1 and SAS0 with an inflationary gap, the money wage rate rises and short-run aggregate supply decreases. The SAS curve starts to shift leftward toward SAS1. The price level keeps rising, but real GDP now decreases. The process now repeats. AD shifts to AD2, an inflationary gap opens again, the money wage rate rises again, and the SAS curve shifts toward SAS2.

3a.  The quantity of money is \$40 million.

Because MV=PY, we know that M=PY/V. With P=200, Y=\$400 million, and V=20, M=\$40 million.

3b.  The quantity of money is \$48 million.

Money grows by 20 percent, which is \$8 million. So the quantity of money increases from \$40 million to \$48 million.

3c.  The price level is 240.

Because the quantity theory holds and because the factors that influence real GDP have not changed, the price level rises by the same percentage as the increase in money, which is 20 percent. The price level rises from 200 to 240.

3d.  Real GDP is \$400 billion.

Because the factors that influence real GDP have not changed, real GDP is unchanged. It remains at \$400 billion.

3e.  Velocity of circulation is 20.

Because the factors that influence velocity have not changed, velocity is unchanged. It remains at 20.

5a.  An anticipated increase in the quantity of money, an increase in government expenditures, a tax cut, an increase in exports.

Anything that increases aggregate demand can set off an anticipated inflation as long as the event is anticipated. But to sustain such an anticipated inflation, the quantity of money must keep increasing along its anticipated path.

5b.  Starting out on AD0 and SAS0, the price level is 120 and real GDP is at potential GDP of \$7 billion. Aggregate demand increases, and the AD curve shifts rightward to AD1. The increase in aggregate demand is anticipated so the money wage rate rises and the SAS curve shifts to SAS1. The price level rises, and real GDP remains at potential GDP.

5c.  Starting out on AD1 and SAS1, a further anticipated increase in aggregate demand occurs. The AD curve shifts to AD2, and because the increase in aggregate demand is anticipated, the money wage rate rises again and the SAS curve shifts to SAS2. Again, the price level rises and real GDP remains at potential GDP.

7a.  If the natural unemployment rate and the expected inflation rate remain constant between 1999 and 2003, the SRPC is linear and passes through the data points listed in the table provided. Note that one of these points is the natural rate of unemployment (4 percent) and the expected inflation rate (6 percent). The LRPC is vertical at an unemployment rate of 4 percent.

7b.  If the actual inflation rate rises from 6 percent to 8 percent a year, the unemployment rate decreases from 4 percent to 3 percent. This change would occur if aggregate demand were expected to increase.

9a.  Both the inflation rate and the unemployment rate have increased. So the expected inflation rate has increased and the natural rate of unemployment might have increased (but has not definitely increased). Any of the events that can increase the expected inflation rate might have occurred. Most likely, the expected growth rate of the money supply has increased. If the natural rate of unemployment has not increased, the economy is in a recession, despite the fact that the inflation rate has increased.

9b.  If point a is a long-run equilibrium, the LRPC is vertical at an unemployment rate of 4 percent. The SRPC slopes downward and passes through point a. If point a is not a long-run equilibrium, the SRPC still passes through point a but the LRPC is vertical at whatever unemployment rate is the natural rate.

9c.  If point d is a long-run equilibrium, the LRPC is vertical at an unemployment rate of 8 percent. The SRPC slopes downward and passes through point d. If point d is not a long-run equilibrium, the SRPC still passes through point d but the LRPC is vertical at whatever unemployment rate is the natural rate.

Chapter 31

1a.  The graph plots leisure on the x-axis and real GDP on the y-axis. As leisure increases from zero to 12 hours a day, real GDP decreases from \$30 to \$0 a day.

1b.  The table replaces leisure with labour and labour equals 12 hours a day minus leisure hours. The graph plots labour on the x-axis and real GDP on the y-axis. As labour increases from zero to 12 hours a day, real GDP increases from \$0 to \$30 a day.

1c.  When labour increases from 0 to 2 hours a day, the marginal product of labour is \$5. When labour increases from 2 to 4 hours a day, the marginal product of labour is \$4. When labour increases from 4 to 6 hours a day, the marginal product of labour is \$3. When labour increases from 6 to 8 hours a day, the marginal product of labour is \$2. When labour increases from 8 to 10 hours a day, the marginal product of labour is \$1.When labour increases from 10 to 12 hours a day, the marginal product of labour is \$0.

Marginal product is the change in real GDP divided by the change in labour hours.

3a.  The demand for labour schedule is the same as the marginal product of labour schedule The marginal product of labour schedule is described in solution 1c. The marginal product must be aligned with the midpoint of the change in labour. So, for example, the marginal product of \$5 an hour is aligned with 1 hour of work¾the midpoint between 0 and 2 hours.

The graph plots a marginal product of \$5 at 1 hour and a marginal product of \$1 at 9 hours of labour and is a straight line between these points. At 2 hours of labour, the marginal product is \$4.50.

3b.  The table lists hours of labour from zero to 12 a day. Against each hour, the wage rate at which Crusoe is willing to supply labour is \$4.50 an hour.

Crusoe’s supply curve is horizontal at \$4.50 an hour.

3c.  The full-employment equilibrium real wage rate is \$4.50 an hour, and the quantity of labour employed is 2 hours a day.

The full-employment equilibrium real wage rate is \$4.50 an hour because Crusoe is willing to work any number of hours at this wage rate. The equilibrium level of employment is 2 hours a day because this is the number of hours at which Crusoe’s marginal product of labour is \$4.50 an hour.

3d.  Potential GDP is \$10 a day.

Potential GDP is \$10 a day because this quantity of real GDP is produced when labour is 2 hours a day.

5a.  The new production function table lists real GDP against labour hours. Real GDP is \$15 at 2 hours of labour, \$27 at 4 hours, \$36 at 6 hours, \$42 at 8 hours, \$45 at 10 hours, and \$45 at 12 hours.

The new demand for labour schedule has labour of 2 hours at \$6.75 and 9 hours at \$1.50.

To calculate the new demand for labour schedule, calculate the new marginal product (old marginal product multiplied by 1.5) at each level of employment.

5b.  The full-employment equilibrium real wage rate is \$4.50 an hour and the quantity of labour employed is 5 hours a day.

The equilibrium level of employment is 5 hours a day because this is the number of hours at which Crusoe’s marginal product of labour is \$4.50 an hour.

5c.  Potential GDP is \$31.50 a day.

Potential GDP is \$31.50 a day because this quantity of real GDP is produced when labour is 5 hours a day.

5d.  The increase in productivity shifts the production function upward by 50 percent. The marginal product of labour increases by 50 percent. Employment increases and so does potential GDP.

7a.  Real wage rate is \$3 an hour and employment is 3,000 hours a day.

This wage rate and quantity of labour are at the intersection of the demand curve and the supply curve in the figure.

7b.  Potential GDP is \$13,500 a day.

To calculate potential GDP, use the fact that the real wage rate on the demand for labour curve is the marginal product of labour. Remember that it is plotted midway between the initial and final level of real GDP from which it is calculated. Do the marginal product calculation in reverse and obtain the level of real GDP at 3,000 hours, which is \$13,500 a day.

7c.  The natural rate of unemployment is 25 percent.

The natural rate of unemployment occurs at full employment when job search is 1,000 hours. Employment is 3,000 hours, and job search, which is unemployment, is 1,000 hours. The labour force (employment plus unemployment) is 4,000 hours. The natural rate of unemployment is 25 percent (1,000/4,000 multiplied by 100).

Chapter 32

1.   The economy dos not conform to the one-third rule. It conforms to a one-half rule.

In this economy, an x percent increase in the capital stock per hour of work leads to a 0.5x percent increase in real GDP per hour of work. You can confirm this fact by calculating the percentage change in capital and real GDP at each of the levels provided in the table and then dividing the percentage change in real GDP by the percentage change in capital. For example, when capital increases by 100 percent from \$10 to \$20, real GDP increases by 50 percent from \$3.80 to \$5.70.

3a.  Yes, Longland experiences diminishing returns.

Diminishing returns are present if the marginal product of capital diminishes as capital increases, holding technology constant. You can calculate the marginal product of capital from the schedule provided and see that it does diminish. The increase in real GDP per hour of work that occurred in the question resulted from an increase in capital and an advance in technology. We know this because to produce \$10.29 in 1999 would have required a capital stock of \$60 per hour of work, and in 2001, this output can be produced by a capital stock of \$50. The change in real GDP divided by the change in capital is not the marginal product of labour because technology is not constant.

3b.  The contribution of the change in capital is \$1.04.

Along the productivity function, when capital per hour of work increases from \$40 to \$50, real GDP per hour of work increases from \$8.31 to \$9.35, a difference of \$1.04. This number is also calculated as the percentage increase in real GDP that is equal to one-half the percentage increase in capital.

3c.  The contribution of technological change is \$0.94.

This number is calculated as the change in real GDP minus the contribution of the change in capital to the growth of productivity, which is \$1.04.

5a.  Employment is 6 billion hours per year and the real wage rate is \$7 an hour.

The labour market is n equilibrium at the real wage rate at which the quantity demanded equals the quantity supplied. That real wage rate is \$7 an hour.

5b.  The real wage rate rises.

When the demand for labour increases, there is a shortage of labour at the current wage rate. So the real wage rate rises.

5c.  The population begins to grow.

The reason for the population growth is that the real wage rate exceeds the subsistence level.

5d.  Employment is 7 billion hours a year.

In long-run equilibrium, employment equals the quantity of labour demanded at the subsistence real wage rate of \$7 an hour. Only when the population has grown by enough to make the quantity of labour supplied equal 7 billion hours a year does the population stop growing.

7.   When the demand for capital raises the real interest rate above the target rate, the capital stock and real GDP begin to grow and keep on growing. In contrast, in the neoclassical Martha’s Island, as the capital stock grows, the real interest rate falls (because of diminishing returns) and growth eventually ends.

Chapter 33

1a.  Possible combinations are a or d, e or g, and i or k.

A Keynesian recession results from a decrease in investment caused by a decrease in expected profit. In an extreme case, no prices change, so the move is to a, e, and i. But a more general possibility is that the money wage rate doesn’t change but the price level falls, real wage rate rises, and the interest rate falls. In this case, the move is to d, g, and k.

1b.  The economy moves to d, g, and l.

A monetarist recession results from a decrease in the quantity of money. The interest rate rises, and investment decreases. Aggregate demand decreases, but the money wage rate doesn’t change. Real GDP and the price level decrease, the real wage rate rises, and employment decreases. The move is to d, g, and l.

1c.  The economy moves to d, g, and i, k, or l.

1d.  The economy moves to d, g, and i, k, or l.

Either type of rational expectations recession results from an unanticipated decrease in aggregate demand. Any of several factors could initiate the decrease in aggregate demand, and the interest rate could rise, fall, or remain constant. Aggregate demand decreases, but the money wage rate either doesn’t change or doesn’t change by enough to maintain full employment. So real GDP and the price level decrease, the real wage rate rises, and employment decreases.

1e.  The economy moves to c, e, g, or h, and k.

In a real business cycle recession, a decrease in productivity decreases the demand for labour and capital. The interest rate and the real wage rate fall, and investment and employment decrease. Aggregate demand and aggregate supply decrease, so real GDP decreases but the price level might fall, rise, or remain unchanged.

3.   This recession is consistent with Keynesian or rational expectations theories (see the solutions 1a, 1c, and 1d).

5.   This recession is consistent with real business cycle theory (see the solution 1e).

7.   This recession is not consistent with any of the theories and is an unlikely combination of events. The price level does not usually rise when the real wage rate rises.

9.   This recession is consistent with the real business cycle theory (see the solution 1e).

11.  This recession is consistent with monetarist theory (see the solution 1b).

13. This recession is not consistent with any of the theories and is an unlikely combination of events. The real wage rate does not usually fall when the price level falls.

Chapter 34

1.   Anything that slows investment in physical or human capital or slows the pace of technological change will create a productivity growth slowdown. For the factors at work during the Canadian productivity growth slowdown, review p. 731 of Chapter 32.

Improvements in incentives to invest in physical or human capital or to innovate and speed up the pace of technological change will counteract a productivity growth slowdown. See p.732 of Chapter 32 and pp. 776-778 of Chapter 34.

3a.  Real GDP is \$800 billion and the price level is 110.

These values are determined at the intersection of AD0 and SAS.

3b.  Real GDP falls to \$750 billion and the price level falls to 105. Then, as aggregate demand returns to AD0, the price level and real GDP return to their initial levels.

3c.  Real GDP falls to \$750 billion and the price level falls to 105. The government increases aggregate demand to AD0, and the price level and real GDP return to their initial levels. Aggregate demand then increases (because the decrease is temporary), and real GDP rises above potential GDP. An inflationary gap arises. The money wage rate rises and so does the price level. Real GDP moves back toward potential GDP.

3d.  Real GDP falls to \$750 billion, and the price level falls to 105. The economy is stuck at this point until the money wage rate falls, short-run aggregate supply increases, and the economy moves back to potential GDP at an even lower price level. This move will likely take a long time.

3e.  Real GDP falls to \$750 billion, and the price level falls to 105. The government increases aggregate demand to AD0, and the price level and real GDP return to their initial levels. Because the decrease in aggregate demand is permanent, this is the end of the action.

5a.  The economy might have got into its described state because of a combination of rapid money supply growth (which brings inflation) and large structural changes (which bring high unemployment and slow productivity growth).

5b.  A slowdown in money growth will lower the inflation rate. Improvements in incentives to invest in physical or human capital or to innovate and speed up the pace of technological change will speed productivity growth.

5c.  Study pp. 776-778 and pp. 786-789 for explanations of how these policy actions work.

7a.  These policy actions were part of a feedback rule. The actions were taken because of the crises.

7b.  The required domestic policies all decrease aggregate demand. They lower real GDP and lower the price level (compared with what would have happened).

7c.  A possible criticism, and one that some economists have made, is that the countries should have adopted policies to expand real GDP even at the risk of a rise in inflation, rather than adopt policies that decrease aggregate demand.

Chapter 35

1a.  0.10 computer per TV set at 10 TV sets.

1b.  0.40 computer per TV set at 40 TV sets.

1c.  0.70 computer per TV set at 70 TV sets.

1d.  The graph shows an upward-sloping line that passes through the three points described in solutions 1a, 1b, and 1c.

The opportunity cost of a TV set is calculated as the decrease in the number of computers produced divided by the increase in the number of TV sets produced as we move along the PPF. The opportunity cost of a TV set increases as the quantity of TV sets produced increases.

3a.  Virtual Reality exports TV sets to Vital Signs.

At the no-trade production levels, the opportunity cost of a TV set is 0.10 computer in Virtual Reality and 0.30 computer in Vital Signs. Because it costs less to produce a TV set in Virtual Reality, Vital Signs can import TV sets for a lower price that it can produce them. And because a computer costs less in Vital Signs than in Virtual Reality, Virtual Reality can import computers at a lower cost than it can produce them.

3b.  Virtual Reality increases the production of TV sets and Vital Signs decreases the production of TV sets. Virtual Reality decreases the production of computers and Vital Signs increases the production of computers.

Virtual Reality increases production of TV sets to export some to Vital Signs and Vital Signs decreases production of TV sets because it now imports some from Virtual Reality.

3c.  Each country consumes more of at least one good and possibly of both goods.

Because each country has a lower opportunity cost than the other at producing one of the goods, total production of both goods can increase.

3d.  The price of a TV set is greater than 0.10 computer and less than 0.30 computer.

The price will be higher than the no-trade opportunity cost in Virtual Reality (0.10 computer) and lower than the no-trade opportunity cost in Vital Signs (0.30 computer).

5a.  Free trade increases the production of at least one good (but not necessarily both goods) in both cases because each country increases the production of the good at which it has a comparative advantage.

5b.  In problem 3, the price of a TV set rises in Virtual Reality. In problem 4, it falls.

The reason is that in problem 3, Virtual Reality produces a small number of TV sets with no trade and has the lower opportunity cost per TV set. But in problem 4, Virtual Reality produces a large number of TV sets with no trade and has the higher opportunity cost per TV set. So in problem 3, Virtual Reality becomes an exporter and increases production. The price of a TV set rises. In problem 4, Virtual Reality becomes an importer and decreases production. The price of a TV set falls.

5c.  In problem 3, the price of a computer rises in Vital Signs. In problem 4, it falls.

The reason is that in problem 3, Vital Signs produces a small number of computers with no trade and has the lower opportunity cost per computer. But in problem 4, Vital Signs produces a large number of computers with no trade and has the higher opportunity cost per computer. So in problem 3, Vital Signs becomes an exporter of computers and increases production. The price of a computer rises. In problem 4, Vital Signs becomes an importer of computers and decreases production. The price of a computer falls.

7a.  The prices would be \$90 per tonne in the importing country and \$10 per tonne in the exporting country.

These are the prices at which each country wishes to import and export a zero quantity.

7b.  The terms of trade are \$50 per tonne.

This is the price at which the quantity demanded by the importer equals the quantity supplied by the exporter.

7c.  The quantity exported and imported is 40 million tonnes.

The quantity exported and imported is the equilibrium quantity—the quantity demanded and supplied at the equilibrium price.

7d.  The balance of trade is zero.

The balance of trade is zero because the value of soybeans imported equals the value of soybeans exported.

9a.  The price in the importing country is \$60 per tonne.

The quantity demanded by the importer equals the quantity available under the quota of 30 million tonnes at this price.

9b.  The revenue from the quota is \$600 million.

The price at which exporters are willing to sell 30 million tonnes is \$40 a tonne (read off the export supply curve). The price in the importing country is \$60 a tonne (read off the import demand curve), so the revenue from the quota is \$20 a tonne. The total revenue from the quota is 30 million multiplied by \$20 a tonne, which equals \$600 million.

9c.  The importing agents who have been allocated the quota.

Chapter 36

1a.  A table like Table 36.1 on p. 826 with the numbers provided in the problem.

The current account shows Imports of goods and services –350 billions of grains, Exports of goods and services, 500 billions of grains, Net interest payments, unknown, and Net transfers, unknown. You cannot calculate the current account balance from these numbers because of the two unknown items.

The capital account shows Foreign investment in Silecon, 60 billions of grains, Silecon investment abroad, -200 billions of grains, and a capital account balance of –140 billions of grains (a deficit).

The official settlements account shows Increase in official Silecon reserves, -10 billions of grains (minus because it is an increase).

Because the sum of the three balances is zero, you can now calculate the current account balance, 150 billions of grains, a surplus. Exports of goods and services minus imports of goods and services equal 150 billions of grains. So the sum of Net interest income and Net transfers is zero, but we don’t know the values of these two items separately.

1b.  The Silecon central bank intervenes in the foreign exchange market.

We know that the central bank intervenes in the foreign exchange market because its official reserves changed.

3a.  Net exports are –\$10 million.

Use the fact that

Y = C + I + G + NX and solve for NX as

NX = Y – C – I – G, which equals

NX = 60 – 36 – 20 – 14 = –10.

3b.  Saving is \$12 million.

Use the fact that

Y = C + S + NT and solve for S as

S = Y – C – NT, which equals

S = 60 – 36 – 12 = 12.

3c.  National saving and foreign borrowing finance investment.

I = S + NT – G – NX, which equals

I = 12 + 12 – 14 – (– 10) = 20.

5a.  Imports of goods and services are 26 billion bands.

Use the fact that

Y = C + I + G + X – M and solve for M as

M = – Y + C + I + G + X, which is

M = – 100 + 60 + 22 + 24 + 20 = 26.

5b.  The current account balance is – 6 billion bands (assuming that net interest income plus net transfers is zero).

Use the fact that

CAB = X – M

CAB = 20 – 26 = – 6.

5c.  The capital account balance is unknown.

The sum of the current account, capital account, and official settlements account is zero. The capital account balance cannot be calculated unless information is given about the official settlements account.

5d.  Net taxes are 20 billion bands.

Use the fact that

Gov. budget deficit = G – NT, so

NT = G – Gov. budget deficit, which is

NT = 24 – 4 = 20.

5e.  The private sector balance is –2 billion bands (a deficit).

Use the fact that

Private sector surplus = S – I, with

S = YC NT, or

Private sector surplus = Y – C – NT – I, which is

Private sector surplus = 100 – 60 – 20 – 22 = – 2.

7a.  The country intervenes in the foreign exchange market to limit movements in the exchange rate.

7b.  The central bank might have conducted an open market operation in the bond market to increase the interest rate.

The Central bank’s intervention in the foreign exchange market did not bring appreciation. On the contrary, its intervention limited the extent of the appreciation.

7c.  Private traders in the foreign exchange market might have increased their demand for the currency perhaps because they expected the exchange rate to appreciate in the future.