Solutions to OddNumbered
EndofChapter Problems
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 highestvalued 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 highestvalued 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 timeseries graph, plot the
year on the xaxis and the inflation rate on the yaxis. 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 xaxis and the interest rate on the yaxis.
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 xaxis
and y on the yaxis. 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 xaxis 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 yaxis divided by the change in
the variable on the xaxis. To calculate the slope, you must select two
points on the line. One point is at 10 on the yaxis and 0 on the
xaxis, and another is at 8 on the xaxis and 0 on the
yaxis. 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 yaxis 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 xaxis 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
xaxis and the quantity of the other good on the yaxis. 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
xaxis 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 yaxis.
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 gumproducing 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 yaxis. That price is $3 a
videotape.
The price
elasticity of demand equals infinity at the price at which the demand curve hits
the yaxis. That price is $6 a videotape.
The price
elasticity of demand equals zero at the price at which the demand curve hits the
xaxis. 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 yaxis. 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 $1.502,250 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 $1.503,500 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 xaxis and Jason's utility
from CDs on the yaxis. 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 xaxis and Jason's
marginal utility from CDs on the yaxis. 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 xaxis and
the hours spent on the other activity of the yaxis. The budget line is a
straight line running from 3.5 hours of windsurfing on the xaxis to 7
hours of snorkeling on the yaxis.
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
Q_{P} = 4 –
Q_{C}
Call the
price of popcorn P_{P} and the quantity of popcorn
Q_{P}, the price
of cola P_{C}
and the quantity of cola
Q_{C}, and
income y. Sara’s budget equation is
P_{P}Q_{P} +
P_{C}Q_{C} = 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
´
Q_{P} + $3 ´
Q_{C} = $12
Dividing
both sides by $3 gives
Q_{P} +
Q_{C} = 4.
Subtract
Q_{C} from both sides to give
Q_{P} = 4 –
Q_{C}
1f. To draw a graph of the budget line,
plot the quantity of cola on the xaxis and the quantity of popcorn on
the yaxis. The budget line is a straight line running from 4 bags on the
yaxis to 4 cans on the xaxis.
1g. The slope of the budget line, when cola
is plotted on the xaxis 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 I_{0} at 2 cans of cola
and 2 bags of popcorn. The indifference curve I_{0} 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 xaxis to 4 bags of popcorn on the
yaxis. The new budget line is tangential to indifference curve
I_{1} at 6 cans of cola and 1 bag of popcorn. The indifference
curve I_{1} 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 I_{0}. The
point at which this budget line just touches indifference curve
I_{0} 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 I_{0}. 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.
7a. Pam can still buy 30 cookies and 5 comic
books.
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.
7d. Pam will buy more cookies and fewer comic
books.
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 xaxis, 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 fourfirm concentration ratio is
60.49.
The
fourfirm 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
fourfirm concentration ratio equals ($1,225/$2,025) ´ 100,
which is 60.49 percent.
7b. This industry is highly concentrated
because the fourfirm concentration ratio exceeds 60
percent.
9a. The HerfindahlHirschman Index is
1,800.
The
HerfindahlHirschman 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
HerfindahlHirschman Index equals 15^{2} + 10^{2 }+
20^{2} + 15^{2 }+ 25^{2 }+ 15^{2}, which equals
1,800.
9b. This industry is moderately competitive
because the HerfindahlHirschman Index lies in the range 1,000 to
1,800.
Chapter
11
1a. To draw the total product curve measure
labour on the xaxis and output on the yaxis. 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 shortrun total cost curves, plot output on the xaxis and the total
cost on the yaxis. 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
shortrun 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 longrun average cost curve is made
up the lowest parts of the firm's shortrun average total cost curves when the
firm operates 1 plant and 2 plants. The longrun 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 Ushaped, as in Fig.
11.5.
9b. The longrun 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 longrun 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 profitmaximizing 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 profitmaximizing 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 halfway 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
yaxis 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 longrun 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 profitmaximizing 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 profitmaximizing output is 1.5
bottles.
3b. Minnie's profitmaximizing price is $7 a
bottle.
The
profitmaximizing price is the highest price that Minnie's can sell the
profitmaximizing 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 profitmaximizing 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
yaxis to 250 on the xaxis. 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
straightline 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 yaxis to 2.5 on the
xaxis. 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 yaxis 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 yaxis
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 titfortat strategy or a trigger strategy. Pages 305306 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 yaxis. 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
xaxis.
Chapter
16
1a. The wage rate of lowskilled 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 lowskilled
workers a day. At a wage rate of $5 an hour, 5,000 hours are employed each
day.
1c. The wage rate of highskilled workers is
$8 an hour.
Because
the marginal product of highskilled workers is twice the marginal product of
lowskilled workers, firms are willing to pay highskilled workers twice the
wage rate that they are willing to pay lowskilled workers. For example, the
demand curve for lowskilled workers tells us that firms are willing to hire
6,000 hours of lowskilled workers at a wage rate of $4 an hour. So with
highskilled workers twice as productive as lowskilled workers, firms are
willing to hire 6,000 hours of highskilled workers at $8 an hour. That is, the
demand curve for highskilled labour lies above the demand curve for lowskilled
workers such that at each quantity of workers the wage rate for highskilled
workers is double that for lowskilled workers.
The supply
of highskilled workers lies above the supply of lowskilled workers such that
the vertical distance between the two supply curves equals the cost of acquiring
the high skill—$2 an hour. That is, highskilled workers will supply 6,000 hours
a day if the wage rate is $8 an hour.
Equilibrium in the labour market for
highskilled workers occurs at a wage rate of $8 an
hour.
1d. Firms employ 6,000 hours of highskilled
workers a day.
3a. The wage rate is $10 an
hour.
With the
amount of highskilled 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 highskilled
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
highskilled workers and $5 an hour to hire lowskilled
workers.
5a. The wage rate is $6 an
hour.
A minimum
wage is the lowest wage rate that a lowskilled worker can be
paid.
5b. Firms hire 4,000 hours of lowskilled
workers a day.
At the
minimum wage of $6 an hour, the demand for lowskilled labour tells us that
firms will hire only 4,000 hours of lowskilled 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
profitmaximizing 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
courtenforced 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 xaxis and the cumulative
percentage of income on the yaxis. Make the scale on the two axes the
same. The Lorenz curve will pass through the following points: 20 percent on the
xaxis and 5 percent on the yaxis; 40 percent on the
xaxis and 16 percent on the yaxis; 60 percent on the
xaxis and 33 percent on the yaxis; 80 percent on the
xaxis and 57 percent on the yaxis; and 100 percent on the
xaxis and 100 percent on the yaxis.
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 45yearold person has income of $30,000 a year and wealth
of $255,000.
Each
45yearold 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 45yearold
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 25yearold; $105,000 for the 35yearold; $255,000 for the 45yearold;
$225,000 for the 55yearold; and $75,000 for the 65yearold. (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 xaxis and the cumulative percentage of income after taxes and
benefits on the yaxis. Make the scale on the two axes the same. The
Lorenz curve passes through the following points: 20 percent on the
xaxis and 5 percent on the yaxis; 40 percent on the
xaxis and 15 percent on the yaxis; 60 percent on the
xaxis and 33 percent on the yaxis; 80 percent on the
xaxis and 61 percent on the yaxis; and 100 percent on the
xaxis and 100 percent on the yaxis.
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 xaxis and the cumulative
percentage of income after taxes and benefits on the yaxis. The Lorenz
curve passes through the following points: 20 percent on the xaxis and
15.0 percent on the yaxis; 40 percent on the xaxis and 32.0
percent on the yaxis; 60 percent on the xaxis and 50.3 percent
on the yaxis; 80 percent on the xaxis and 72.7 percent on the
yaxis; and 100 percent on the xaxis and 100 percent on the
yaxis.
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: Btype
people will pay a higher tax rate than Atype 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 Atype
person.
3b. The beforetax wage rate of Atype
people will rise by the amount of the tax, and fewer Atype people will
be employed. The aftertax wage rate will remain at $10 an hour. The beforetax
wage rate of Btype people will remain at $100, and employment of
Btype people will not change. The aftertax 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 aftertax 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 pretax 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 aftertax 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 yaxis to 1.25 on the xaxis.
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 baseyear 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 baseyear 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 workingage population that is
in the labour force. The workingage 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 employmenttopopulation ratio is
58.7 percent.
The
employmenttopopulation ratio is the percentage of the people of working age
who have jobs. The employmenttopopulation ratio is the number of people
employed divided by the workingage population all multiplied by 100. The
employmenttopopulation 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 reenter 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 workingage 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 reentrants
probably increased.
In an
expansion, discouraged workers reenter the labour force. So it is likely that
entrants and reentrants 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 workingage 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 employmenttopopulation ratio is
60.7. It is the number employed as a percentage of the workingage
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 employmenttopopulation ratio
at the end of August is 58.9. It equals the number employed as a percentage of
the workingage population. The workingage 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 shortrun aggregate supply and shift the
shortrun 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 shortrun aggregate
supply curve, plot the price and the quantity of real GDP supplied in the
shortrun.
3b. Real GDP is $400 billion, and the price
level is 100.
Shortrun
macroeconomic equilibrium occurs at the intersection of the aggregate demand
curve and the shortrun aggregate supply curve.
3c The longrun 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 shortrun 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.
Shortrun
aggregate supply decreases by $100 billion at each value of the price level and
the shortrun aggregate supply curve shifts leftward by $100 billion. The new
shortrun 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 AD_{1}. The shortrun
aggregate supply curve is the blue curve SAS_{0}. These curves
intersect at point c.
9b. The equilibrium point is point
d.
The
shortrun aggregate supply curve is the red curve SAS_{1}. The
aggregate demand curve is now the red curve AD_{1} 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. Shortrun 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(Y – T).
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 shortrun, 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 longrun, 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, shortrun aggregate supply and aggregate demand determine real GDP.
Because the shortrun 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
shortrun aggregate supply will begin to decrease and the price level will rise.
The shortrun 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 shortrun aggregate supply determine the price
level. Because the shortrun 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 longrun aggregate supply determine the price
level. The shortrun aggregate supply curve shifts leftward because the money
wage rate rises. Because the longrun 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 (Y_{1} 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 (Y_{2} 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 (Y_{0} 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 shortrun
aggregate supply curve, SAS_{A}, 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
fullemployment 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
fullemployment 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 MD_{A}. The intersection of the demand
for money curve, MD_{A} 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 MD_{A} to a high
of MD_{B} and a low of MD_{C}. As the demand for
money fluctuates, the interest rate fluctuates. The interest rate is 2 percent a
year when the demand for money is MD_{C}, 3 percent a year when
the demand for money is MD_{A}, and 4 percent a year when the
demand for money is MD_{B}.
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, interestsensitive expenditure increases. The increase in
interestsensitive 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 interestsensitive expenditure. The decrease in
interestsensitive 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 interestsensitive expenditure in
figure 29.1(c). The decrease in interestsensitive 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
interestsensitive 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, interestsensitive
expenditure increases. The increase in interestsensitive 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 interestsensitive 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 crowdingout effect is weaker in
Alpha.
The
expansionary fiscal policies in Alpha and Beta increase the interest rates. As
the interest rate rises, the interestsensitive 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 interestsensitive
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. Interestsensitive expenditure
decreases and limits the increase in real GDP. The decrease in
interestsensitive expenditure includes a decrease in investment and net
exports.
An
increase in the money supply lowers the interest rate, increases
interestsensitive 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 interestsensitive expenditure limits the
increase in real GDP. The resulting increase in interestsensitive expenditure
includes an increase in investment and net exports.
7b. The expansionary fiscal policies raise
the interest rate and the interestsensitive 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 interestsensitive
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 interestsensitive 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
interestsensitive 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 demandpull inflation. But to
sustain such an inflation, the quantity of money must keep
increasing.
1b. Starting out on AD_{0} and
SAS_{0}, 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 AD_{1}. The price level rises and real GDP increases
to the intersection of AD_{1} and SAS_{0}. There
is now an inflationary gap.
1c. Starting out on AD_{1} and
SAS_{0} with an inflationary gap, the money wage rate rises and
shortrun aggregate supply decreases. The SAS curve starts to shift
leftward toward SAS_{1}. The price level keeps rising, but real
GDP now decreases. The process now repeats. AD shifts to
AD_{2}, an inflationary gap opens again, the money wage rate
rises again, and the SAS curve shifts toward
SAS_{2}.
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 AD_{0} and
SAS_{0}, 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 AD_{1}. The increase in aggregate demand is
anticipated so the money wage rate rises and the SAS curve shifts to
SAS_{1}. The price level rises, and real GDP remains at potential
GDP.
5c. Starting out on AD_{1} and
SAS_{1}, a further anticipated increase in aggregate demand
occurs. The AD curve shifts to AD_{2}, and because the
increase in aggregate demand is anticipated, the money wage rate rises again and
the SAS curve shifts to SAS_{2}. 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 longrun
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 longrun 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 longrun
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 longrun 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
xaxis and real GDP on the yaxis. 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 xaxis and real GDP on the yaxis. 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 fullemployment equilibrium real wage
rate is $4.50 an hour, and the quantity of labour employed is 2 hours a
day.
The
fullemployment 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 fullemployment 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
onethird rule. It conforms to a onehalf 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 onehalf 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
longrun 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. 776778 of Chapter 34.
3a. Real GDP is $800 billion and the price
level is 110.
These
values are determined at the intersection of AD_{0} and
SAS.
3b. Real GDP falls to $750 billion and the
price level falls to 105. Then, as aggregate demand returns to
AD_{0}, 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
AD_{0}, 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, shortrun 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
AD_{0}, 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. 776778 and pp. 786789 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 upwardsloping 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
notrade 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 notrade opportunity cost in Virtual Reality (0.10
computer) and lower than the notrade 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 =
Y – C – 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.