Foundations of Macroeconomics, 9th edition Robin Bade Solution Manual by TBtutors

Type:

Solution Manual

Resource:

Foundations of Macroeconomics

Edition:

9th Edition

Author(s):

Robin Blade Michael Parkin

Chapter

Getting Started ANSWERS TO CHAPTER CHECKPOINTS

 Problems and Applications 1.

Provide three examples of scarcity that illustrate why even the 1,826 billionaires in the formworld face scarcity. The 1,826 billionaires might want to be able to eat unlimited meals without gaining weight; live to be at least 140 years old and enjoy perfect health everyday; be able to wake up in San Francisco and go to sleep in Paris after spending no more than 3 hours on a plane. None of these wants can be fulfilled given the present state of technology and resources available.

Label each entry in the list as dealing with a microeconomic topic or a macroeconomic topic. Explain your answer. • Motor vehicles production in China is growing by 10 percent a year. This entry is a microeconomic topic because individuals and businesses make decisions whether to buy or sell cars. •

Coffee prices rocket. This entry is a microeconomic topic because individuals and businesses make decisions whether to buy or sell coffee.

•

Globalization has reduced African poverty. This entry is a macroeconomic topic because globalization is the result of choices made by billions of people rather than an individual or business.

•

The government must cut its budget deficit. This entry is a macroeconomic topic because neither an individual nor a business makes decision to cut expenditures.

•

Apple sells 20 million iPhone 6 smartphones a month. This entry is a microeconomic topic because individuals and Apple make decision whether to buy or sell iPhones.

Part 1 . INTRODUCTION

Use the following information to work Problems 3 to 6. Jurassic World had world-wide box office receipts of $1.66 billion. The movie’s production budget was $150 million with additional marketing costs. A successful movie brings pleasure to millions, creates work for thousands, and makes a few people rich. 3. What contribution does a movie like Jurassic World make to coping with scarcity? When you buy a movie ticket, are you buying a good or a service? Scarcity still exists but the amount of entertainment available in the economy increases. Buying a ticket to watch a movie is buying a service. 4.

Who decides whether a movie is going to be a blockbuster? How do you think the creation of a blockbuster movie influences what, how, and for whom goods and services are produced? The audience decides whether a movie will be a blockbuster because the audience decides whether to attend the movie. The “what” question is affected in three ways: First, one good or service that is produced is the blockbuster movie. Second, the people whose incomes are higher as a result of the blockbuster then buy an assortment of goods and services and so this assortment of goods and services is produced. Finally, the “what” question is influenced if the movie leads to spinoff goods (such as toys) or creates a series of sequels or similar films. The “how” question is affected to the extent that movies use different production methods. Some movies, for instance, have a lot of special effects while other movies have few or none. The “for whom” question is influenced because those people who receive the profits of a blockbuster movie have higher incomes and so more goods and services are produced for them.

What are some of the components of marginal cost and marginal benefit that the producer of a movie faces? Some of the marginal costs the producer faces are the cost of an actor or actress, the costs of the crew for a day, the costs of a location, and the costs of advertising in a newspaper. The marginal benefits the producer enjoys are his or her salary and/or profit participation from the movie, royalties from the movie, the prestige resulting from a successful movie, and any awards given to the producer of the movie.

Suppose that Chris Pratt had been offered a part in another movie and that to hire him for Jurassic World, the producer had to double Chris Pratt’s pay. What incentives would have changed? How might the changed incentives have changed the choices that people made? The higher pay would have increased Mr. Pratt’s incentive to make Jurassic World rather than the other movie and perhaps affected his choice to

Chapter 1 . Getting Started

make Jurassic World rather than the other movie. The higher pay would have increased the incentive of the producer to decrease the expense of other aspects of the movie so the producer might have chosen to reduce the pay of the other stars in the movie. 7.

What is the social interest? Distinguish it from self-interest. In your answer give an example of self-interest and an example of social interest. The social interest looks at what is best for society as a whole; choices that are best for society as a whole are said to be in the social interest. The selfinterest looks at what is best for the individual; choices that are best for the individual making the choice are said to be in the self-interest. An example of a choice made in the self-interest is a student’s decision to take an economics class. An example of a choice made in the social interest is a firm’s decision to reduce its air pollution.

Pam, Pru, and Pat are deciding how they will celebrate the New Year. Pam prefers to take a cruise, is happy to go to Hawaii, but does not want to go skiing. Pru prefers to go skiing, is happy to go to Hawaii, but does not want to take a cruise. Pat prefers to go to Hawaii or to take a cruise but does not want to go skiing. Their decision is to go to Hawaii. Is this decision rational? What is the opportunity cost of the trip to Hawaii for each of them? What is the benefit that each gets? Pam, Pru and Pat’s decision to go to Hawaii is rational. All three of them considered the cost and benefit of various New Year’s plans. All three were at least willing to go to Hawaii while Pam and Pat were unwilling to go skiing and Pru was unwilling to go on a cruise. The opportunity cost of the trip for Pam is a cruise; for Pru, it is skiing; and for Pat, it is a cruise. The benefit each receives is the pleasure, the relaxation, excitement, and/or knowledge gained from the trip.

Label each of the entries in the list as a positive or a normative statement. • Low-income people pay too much for housing. The entry that low-income people pay too much for housing is a normative statement. •

The number of U.S. farms has decreased over the past 50 years. The entry about the number of farms is a positive statement.

•

Toyota expands parts production in the United States. The entry about Toyota expanding parts production is a positive statement.

•

Imports from China are swamping U.S. department stores. The entry about imports is a normative statement.

•

The rural population in the United States is declining. The entry about the population in rural areas is a positive statement.

Part 1 . INTRODUCTION

Use the following information to work Problems 10 to 12. REI is paying its employees to take Black Friday, Thanksgiving off REI, the outdoor gear and apparel retailer, is paying employees to celebrate Thanksgiving 2015 by spending Black Friday outdoors with their families. Source: Sustainable Brands, October 28, 2015 10. With Black Friday off with full pay, explain what is free and what is scarce. The workers’ time remains scarce because Black Friday remains only one day. REI’s gear and apparel remain scarce because there is a still a limited amount of these products. The publicity that REI received is not free because the company paid for it with less production and, accordingly, less revenue and profit. 11. What is REI’s incentive to give its workers Black Friday off? Was REI’s decision made in self-interest or in the social interest? Explain your answer. REI’s managers have the incentive to give their employees the day off if they believe that the positive publicity that resulted could lead to increased future sales. The managers might also believe that the employees would feel grateful and would worker harder in the future. Of course, the managers also had the incentive to give their workers the day off because many other employers do so. REI’s decision to give its workers a paid day off had elements of both selfinterest and social interest. To the extent that his decision was motivated by the free publicity and a resulting rise in sales, or the expectation that its employees would work more diligently in the future, the decision was motivated by self-interest. However to the extent that a desire to allow the workers a chance to spend time with their families, the decision also had elements of social interest. 12. Do you think that REI workers will shop or spend the day with family? Explain your answer. REI workers will make a rational choice. People make a rational choice when they undertake an activity in which the marginal benefit of the activity exceeds the marginal cost of the activity. Some REI workers will shop and others will spend the day with their family, depending on which alternative’s marginal benefit exceeds its marginal cost. 13. Read Eye on the Benefit and Cost of School on p. 12 and explain why both you and Clayton Kershaw made the right decision. Clayton Kershaw made the right decision to skip college because his opportunity cost of attending college (which includes his forgone salary playing baseball) exceeded his benefits from attending college. For most students, the opportunity cost of attending college is not so large, so for most students the benefits from attending college exceed the opportunity cost of attendance. For these students, attending college is the right decision.

Chapter 1 . Getting Started

 Additional Problems and Applications 1.

Read Eye on the Benefit and Cost of School on p. 12 and explain which of the following items are components of the opportunity cost of being a full-time college student who lives at home. The things that the student would have bought with • A higher income The items the student would have purchased with the higher income he or she would have earned if he or she was not a full-time student are an opportunity cost of being a full-time student. •

Expenditure on tuition The cost of tuition is part of the opportunity cost of being a full-time student because this expense is paid only because the person is a student.

•

A subscription to the Rolling Stone magazine If the subscription was required by a class and the individual subscribed only because of the class requirement, then the cost of the subscription is an opportunity cost of being a student. However if the person would have subscribed to Rolling Stone even if he or she was not a student, then the cost of the subscription is not an opportunity cost of being a student.

•

The income a student will earn after graduating The income earned after graduation is not an opportunity cost of being a student.

Think about the following news items and label each as involving a what, how, or for whom question: • Today, most stores use computers to keep their inventory records, whereas 20 years ago most stores used paper records. Stores using computers for inventory records today versus paper 20 years ago answers the how question. •

Healthcare professionals and drug companies recommend that Medicaid drug rebates be made available to everyone in need. Deciding whether to offer lower Medicaid drug rebates, which would lower the prices for drugs, is a for whom question.

•

An increase in the gas tax pays for low-cost public transit. Building a low-cost public transit system answers a what question. Because not everyone will use the public transportation equally nor will everyone pay the same amount of taxes, there also is a for whom aspect of the headline.

The headlines in the list appeared in The Wall Street Journal. Classify each

Part 1 . INTRODUCTION

headline as a signal that the news article is about a microeconomic topic or a macroeconomic topic. Explain your answers. • U.S. hiring bounces back This entry is a macroeconomic topic because the hiring bounce concerns the hiring in the overall economy and neither an individual nor a business makes the decision to increase aggregate hiring. •

Sears to open three small-format stores This entry is a microeconomic topic because it concerns the decision made by one business, Sears.

•

Samsung expects 60% profit drop This entry is a microeconomic topic. It describes the change in profit of one business.

•

U.S. sees trade deal with China This entry is a macroeconomic topic because the trade deal affects a large number of imported and exported goods and services and thereby affects the national and global economies.

Your school decides to increase the intake of new students next year. To make its decision, what economic concepts would it have considered? Would the school have used the “economic way of thinking” in reaching its decision? Would the school have made its decision on the margin? The school would consider the extra revenue that each additional student would bring and compare that to the extra cost of providing each student with instruction and service. By comparing the extra revenue and the extra cost, the school is making its decision on the margin and is using the economic way of thinking. If the school compares the additional revenue to the additional cost, it makes its decision on the margin.

Provide examples of (a) a monetary incentive and (b) a non-monetary incentive, a carrot and a stick of each, that government policies use to influence behavior. (a) A monetary carrot that the students might answer because it is close to their lives is student aid, such as Pell grants. A monetary stick might be taxes on liquor. (b)

A non-monetary carrot is government support for youth sports, such as allowing little league teams to use a county park, and a nonmonetary stick is jail terms for illegal drug or alcohol use.

Think about each of the items in the list and explain how they affect incentives and might change the choices that people make: • A hurricane hits Central Florida. The hurricane affects the people in Central Florida and the consumers who purchase the products produced in Central Florida, such as orang-

Chapter 1 . Getting Started

es or vacation services. Residents’ incentives change if they suffered damage from the hurricane because they have the incentive to repair the damage. If the price of home repair rises, residents who specialize in home repair have an incentive to work longer hours to earn the higher price. If the hurricane raises the price of the goods and services produced in Central Florida, consumers have the incentive to buy less of these particular goods and services because they are more expensive. •

The World Series begins tonight but a storm warning is in effect for the area around the stadium. The report of the possible storm decreases fans’ incentive to attend the game. Some fans decide to stay at home and watch the game on television.

•

The price of gasoline falls as the supply of oil increases. The fall in the price of gasoline affects drivers’ incentives to buy gasoline and large gas-guzzling cars. Drivers decide to buy more gasoline and more large gas-guzzling cars. They also might decide to ride public transportation less often.

•

Economists expect hiring to increase. The report that economists expect that hiring will increase raises unemployed people’s incentives to look for a job. It also might lead some employed workers to look for a new, better job.

Does the decision to make a blockbuster movie mean that some other more desirable activities get fewer resources than they deserve? Is your answer positive or normative? Explain your answer. Making a blockbuster movie means that some other activities get fewer resources. But whether “more desirable” activities get fewer resources than they “deserve” is a normative answer for two reasons. First the question of whether an activity is more desirable or less desirable depends on the person’s judgment and values. Second the determination of whether an activity gets fewer resources than it deserves also involves the normative decision about the quantity of resources an activity deserves. So the answer to the question of whether making a blockbuster movie means that other more desirable activities get fewer resources than they deserve is a normative answer that depends on the student’s values.

Provide two examples of economics being used as a tool by (a) a student, (b) a business, and (c) a government. Classify your examples as dealing with microeconomic topics and macroeconomic topics. (a) Students might answer that they use economics as a tool when they budget their student aid and when they decided which college to attend based on the costs of their options. Both instances deal with microeconomics. (b)

A business uses economics as a tool when it decides the price it .

Part 1 . INTRODUCTION

(c)

charges for its product and the salaries it pays its managers. Both instances are microeconomic examples. The government use economics as a tool when it decides whether to increase taxes on cigarettes or lower the interest rate. The first example is microeconomic in nature and the second involves macroeconomics.

Use the following news clip to work Problems 9 to 11. Are carbon prices working? Economists say that raising the cost of burning coal, oil, and gas is a costeffective way to lower carbon emissions, but most countries that have tried this solution have not set prices high enough to bring large enough cuts. Source: New York Times, April 2, 2019 9. What are the benefits of burning less coal, oil, and gas to produce electricity? Who receives these benefits: the users of electricity or the owners of power plants, or both the users and the owners? Benefits include: (1) a reduction in carbon emissions, which brings a decrease in the contribution of human activity to global warming and climate change, and (2) cleaner air, which contributes to improved health. Both the users of electricity and the owners of power plants receive the benefits. 10. What are the costs of using less coal, oil, and gas to produce electricity? Who bears these costs: the users of electricity or the owners of power plants, or both the users and the owners? The cost of higher prices for using less coal, oil, and gas will be the directly higher price for these resources as well as the costs of any equipment that enables the power plant to use less coal, oil, or gas. Another cost could be the lost jobs in the coal, oil, and gas sectors. Users of electricity, who pay higher prices for electricity, will pay some of these costs and owners of power plants, who receive lower profits from producing electricity, also will pay some of the costs. 11. Explain whether lowering carbon emissions has an opportunity cost. Lowering carbon emissions has an opportunity cost because the resources devoted to this reduction could be used instead to producing other goods and services.

Chapter 1 . Getting Started

 Multiple Choice Quiz 1.

Which of the following describes the reason why scarcity exists? A. Governments make bad economic decisions. B. The gap between the rich and the poor is too wide. C. Wants exceed the resources available to satisfy them. D. There is too much unemployment. Answer: C Answer C uses the definition of scarcity on page 2. 2.

Which of the following defines economics? Economics is the social science that studies ___________. A. the best way of eliminating scarcity B. the choices made to cope with scarcity, how incentives influence those choices, and how the choices are coordinated C. how money is created and used D. the inevitable conflict between self-interest and the social interest Answer: B Answer B uses the definition of economics on page 2. 3.

Of the three big questions, what, how, and for whom, which of the following is an example of a how question? A. Why do doctors and lawyers earn high incomes? B. Why don’t we produce more small cars and fewer gas guzzlers? C. Why do we use machines rather than migrant workers to pick grapes? D. Why do college football coaches earn more than professors? Answer: C Answer C describes how grapes are picked. 4

Which of the following is not a key idea in the economic way of thinking? A. People make rational choices by comparing costs and benefits. B. Poor people are discriminated against and should be treated more fairly. C. A rational choice is made at the margin. D. Choices respond to incentives. Answer: B Answer B is not part of description of the economic way of thinking on page 8.

Part 1 . INTRODUCTION

A rational choice is ___________. A. the best thing you must forgo to get something B. what you are willing to forgo to get something C. made by comparing marginal benefit and marginal cost D. the best for society Answer: C Answer C is part of description of a rational choice on pages 8 and 9. 6.

Which of the following best illustrates your marginal benefit of studying? A. The knowledge you gain from studying 2 hours a night for a month B. The best things forgone by studying 2 hours a night for a month C. What you are willing to give up to study for one additional hour D. What you must give up to be able to study for one additional hour Answer: C Page 10 shows that answer C is the marginal benefit of studying. 7.

The scientific method uses models to ___________. A. clarify normative disagreements B. avoid the need to study real questions C. replicate all the features of the real world D. focus on those features of reality assumed relevant for understanding a cause and effect relationship Answer: D Answer D uses the definition of an economic model from Checkpoint 1.3.

Which of the following is a positive statement? A. We should stop using corn to make ethanol because it is raising the cost of food. B. You will get the most out of college life if you play a sport once a week. C. Competition among wireless service providers across the borders of Canada, Mexico, and the United States has driven roaming rates down. D. Bill Gates ought to spend more helping to eradicate malaria in Africa. Answer: C Answer C is a positive statement because it can, in theory, be tested.

Chapter

Appendix: Making and Using Graphs ANSWERS TO APPENDIX CHECKPOINT

 Problems and Applications The spreadsheet in the table provides data on the U.S. economy: Column A is the year; the other columns are quantities sold in millions per year of compact discs (column B), music videos (column C), and video streaming (column D). Use this spreadsheet to work Problems 1 and 2. 1.

2007

500

2009

297

2011

241

2013

174

5 Draw a scatter diagram to show the relationship between the quantities sold of compact discs 6 and music videos. Describe the relationship. Figure A1.1 illustrates the relationship of the data from the spreadsheet between the quantities sold of compact discs and the quantities sold of music videos. Over all the period, there appears to be a positive or direct relationship; that is, when more compact discs are sold, more music videos are sold.

2015

117

2017

125

Part 1 . INTRODUCTION

Draw a time-series graph of quantity of compact discs sold. Say in which year or years the quantity sold (a) was highest, (b) was lowest, (c) increased the most, and (d) decreased the most. If the data show a trend, describe it. Figure A1.2 illustrates the time series of the quantity of compact discs sold using the data from the spreadsheet. a. b. c. d.

The quantity sold was the highest in 2007. The quantity sold was the lowest in 2017. The quantity sold never increased. The quantity sold decreased the most between 2007 and 2009 when it decreased by 203 million. Over the entire time period covered in the figure, there is a downward trend in the quantity of compact discs sold.

The following data shows the relationship between two variables x and y. x

Is the relationship between x and y positive or negative? Calculate the slope of the relationship when x equals 2 and when x equals 4. How does the slope change as the value of x increases? The relationship is negative: When x increases, y decreases. The slope of the relationship equals the change in y divided by the change in x along the tangent line; that is, the slope of the relationship at a point equals the slope of the tangent line at that point. When x equals 2, the slope of the tangent line equals –4, so the slope of the relationship equals –4. When x equals 4, the slope of the tangent line equals –8, so the slope of the relationship equals –8. The slope of the relationship increases in magnitude (the line becomes steeper) as x increases.

Appendix 1 . Making and Using Graphs

The table provides data on the Price price of a balloon ride, the tem(dollars perature, and the number of per ride) rides a day. Draw graphs to 5 show the relationship between 10 • The price and the number of 15 rides, when the temperature 20 is 70°F. Figure A1.3 illustrates the relationship between the price and the number of rides when the temperature is 70°F.

• The number of rides and the temperature, when the price is $15 a ride. Figure A1.4 illustrates the relationship between the number of rides and the temperature, when the price is $15 a ride.

Balloon rides (number per day) 50°F

70°F

90°F

32 27 18 10

50 40 32 27

40 32 27 18

Part 1 . INTRODUCTION

 Additional Problems and Applications Use the information in the table to work Problems 1 and 2. Column A is the year; the other columns are quantities sold in millions per year of compact discs (column B), music videos (column C), and video streaming (column D). 1.

2007

500

2009

297

2011

241

4 Draw a scatter diagram to show the relationship between quantities sold of music 5 videos and video streaming. Describe the 6 relationship. Figure A1.5 illustrates the relationship of the data from the spreadsheet between the quantities sold of music videos and singles downloads. Over all the period, is negative or indirect relationship; that is, when fewer music videos are sold, more video is streamed.

2013

174

2015

117

2017

125

Appendix 1 . Making and Using Graphs

Draw a time-series graph of the quantity of music videos sold. Say in which year or years the quantity sold (a) was highest, (b) was lowest, (c) decreased the most, and (d) decreased the least. If the data show a trend, describe it. Figure A1.6 illustrates the time series of music videos sold using the data from the spreadsheet. a. The quantity sold was the highest in 2007. b. The quantity sold was the lowest in 2017. c. The quantity sold decreased the most between 2007 and 2009, when it decreased by 16 million. d. The quantity sold decreased the least between 2013 and 2015, when it decreased by 1 million. There is a downward trend in the quantity of music videos sold.

Use the following data on the relationship between two variables x and y to work Problems 3 and 4. x

Is the relationship between x and y positive or negative? Explain. The relationship is positive: When x increases, y also increases.

Calculate the slope of the relationship when x equals 2 and x equals 4. How does the slope change as the value of x increases? The slope of the relationship equals the change in y divided by the change in x along the tangent line; that is, the slope of the relationship at a point equals the slope of the tangent line at that point. When x equals 2, the slope of the tangent line equals 4, so the slope of the relationship equals 4. When x equals 4, the slope of the tangent line equals 8, so the slope of the relationship equals 8. The slope of the relationship increases as x increases.

Part 1 . INTRODUCTION

The table provides data on Price the price of hot chocolate, the (dollars temperature, and the cups of per cup) hot chocolate bought. Draw graphs to show the 2.00 relationship between 2.50 3.00 • The price and cups of hot 3.50 chocolate bought, when the temperature is constant. Figure A1.7 illustrates the relationship between the price and the number of cups bought holding constant the temperature. Note that there are three relationships, one for each temperature.

Hot chocolate (cups per week) 50°F

70°F

90°F

40 30 20 10

30 20 10 0

20 10 0 0

• The temperature and cups of hot chocolate bought, when the price is constant. Figure A1.8 illustrates the relationship between the number of cups bought and the temperature, holding constant the price. Note that there are four relationships, one for each price.

The U.S. and Global Economies ANSWERS TO CHAPTER CHECKPOINT

 Problems and Applications 1.

Which of the following items are not consumption goods and services? Explain why not. • A chocolate bar A chocolate bar is a consumption good. • A ski lift A ski lift is not a consumption good. It is capital that produces a service for skiers. • A golf ball A golf ball is a consumption good. 2. Which of the following items are not capital goods? Explain why not. • An auto assembly line An auto assembly line is a capital good. • A shopping mall A shopping mall is a capital good. • A golf ball A golf ball is not a capital good. It is a consumption good. 3. Which of the following items are not factors of production? Explain why not. • Vans used by a baker to deliver bread Vans used to deliver bread are capital, so they are factors of production. • 1,000 shares of Amazon.com stock 1,000 shares of Amazon.com stock are not a factor of production. The shares represent partial ownership of Amazon.com and therefore are financial capital. • Undiscovered oil in the Arctic Ocean Undiscovered oil is not a factor of production because it is not used to produce goods or services. Once it is discovered, it will become a factor of production.

Chapter

Part 1 . INTRODUCTION

Which factor of production earns the highest percentage of total U.S. income? Define that factor of production. What is the income earned by this factor of production called? Labor earns by far the largest percentage of total U.S. income, 68 percent of total income in 2017. Labor consists of the work time and the work effort that people devote to producing goods and services. The income earned by labor is a wage.

With more job training and more scholarships to poor American students, which special factor of production is likely to grow faster than in the past? As more people go to school and/or receive job training, the nation’s human capital will grow more rapidly. Human capital is the knowledge and skills people obtain from education, on-the-job training, and work experience. With more job training and more scholarships, human capital will grow more rapidly.

Define the factor of production called capital. Give three examples of capital, different from those in the chapter. Distinguish between the factor of production capital and financial capital. Capital is the tools, instruments, machines, buildings, and other items that have been produced in the past and that businesses now use to produce goods and services. Capital includes railroad engines and cars, servers, and ATMs. The factor of production “capital” is the actual good itself; “financial capital,” such as stocks and bonds, are the funds that provide businesses with their financial resources which can be used to acquire capital goods.

California added construction and manufacturing jobs. California added 25,000 jobs in March, particularly in construction and manufacturing. Construction jobs showed the most growth. Source: Los Angeles Times, April 19, 2019 Explain how you would expect these facts to influence what, how, and for whom goods and services are produced in the United States. Because more workers are hired in the construction and manufacturing sectors, what goods and services are produced as the new construction and manufacturing goods and. With the increase in employment, how the goods and services are produced is by using more labor. For whom goods and services depends on people’s incomes. Consequently, for whom goods and services are produced is determined by the income of the people employed in the 25,000 jobs.

Chapter 2 . The U.S. and Global Economies

In the circular flow model, explain the real flow and/or the money flow in which each item below belongs. Illustrate your answers on a circular flow diagram. • You buy a coffee at Starbucks. In Figure 2.1 the dark arrows represent money flows and the grey arrows represent flows of goods and services and factors of production. If you buy a coffee at Starbucks, your expenditure is a money flow from households to the goods market, labeled a in the figure. • The government buys some Dell computers. The purchase of computers by the government represents a flow of computers from the goods market to the government, labeled b in the figure. • A student works at a FedEx office. The student working at FedEx is a factor of production, so the flow is a flow of the services of factor of production from households to the factor markets, labeled c in the figure. • Donald Trump rents a Manhattan building to a hotel. Donald Trump’s building in Manhattan is a factor of production, so the flow is the services from this factor of production from households to the factor markets, labeled d in the figure. • You pay your income tax. Your income tax payment is a money flow from households to the government and is labeled e in the figure. Why you can get a free college education in Germany but not in California Even American students can get a free college degree in Germany, where

Part 1 . INTRODUCTION

high taxes pay for colleges. Despite college being free, fewer students in Germany earn college degrees than in the United States and more enter vocational apprenticeships. Source: Los Angeles Times, October 29, 2015 If California adopted the German model of higher education, how would that change for whom goods and services are produced? The students in California who otherwise would not have gone to college but who take advantage of the “free” college education will have higher incomes than otherwise. Consequently, more goods and services will be produced for them. The taxpayers who must pay the taxes necessary to fund these college educations will have less income to spend on goods and services, so fewer goods and services will be produced for them. 10. Read Eye on the Dreamliner on p. 43 and then answer the following questions: • How many firms are involved in the production of the Dreamliner and how many are identified in the figure on p. 43? Over 400 firms are involved in the production of the Dreamliner. Only 15 of them are identified in the figure. • Is the Dreamliner a capital good or a consumption good? Explain why? The Dreamliner is a capital good because it will be used to produce services (airline travel) throughout many future years. • State the factors of production that make the Dreamliner and provide an example of each. All the factors of production—land, labor, capital, and entrepreneurship—are used to make the Dreamliner. The copper used for wiring is an example of the land used; the engineer who helped design the landing gear is an example of labor; the huge cranes that lift the various pieces of the Dreamliner to assemble them is an example of capital; and the creative and imaginative input of Boeing’s top managers who organize the resources used to produce the Dreamliner exemplify entrepreneurship. • Explain how the production of the Dreamliner influences what, how, and for whom, goods and services are produced. Dreamliner influences “what” goods and services are produced by creating a demand for components manufactured around the world. It influences “how: goods are produced because Boeing and the other 400 firms all determine the best way to produce each particular part of the Dreamliner. It influences “for whom” because factors of production employed to make the Dreamliner receive income from this

Chapter 2 . The U.S. and Global Economies

•

production, thereby increasing the quantity of goods and services they can purchase. Use a graph to show where in the circular flow model of the global economy the flows of the components listed on p. 43 appear and where the sales of Dreamliners appear. Except for the components built in the United States, spending on the other components appear in the flow of expenditure on U.S. imports. Sales of Dreamliners appear in the flow of expenditure on U.S. exports.

Part 1 . INTRODUCTION

 Additional Problems and Applications 1.

Read Eye on the Dreamliner on p. 43 and then answer the following questions: • Why doesn’t Boeing manufacture all the components of the Dreamliner at its own factory in the United States? Boeing wants to manufacture the Dreamliner at the lowest possible cost. It would be more expensive for Boeing to manufacture Dreamliners at its own factory in the United States because Boeing does not have the expertise possessed by its subcontractors and because the wages Boeing pays U.S. workers exceed the wages its subcontractors pays their workers. • Describe some of the changes in what, how, and for whom, that would occur if Boeing manufactured all the components of the Dreamliner at its own factories in the United States. If Boeing manufactured all the components of the Dreamliner at its own factories in the United States, more components would be produced in the United States and more capital would have been used in their production. U.S. workers and investors would have received higher incomes but the Dreamliner would cost more to produce so Boeing would have earned a lower profit. • State some of the tradeoffs that Boeing faces in making the Dreamliner. Boeing faced a huge number of tradeoffs. For example, when designing the plane, Boeing’s engineers had to make decisions about fuel economy and passenger load. Increasing the passenger load decreased fuel economy, so the engineers traded passenger load for fuel economy. Another example revolves around the construction of the Dreamliner. Boeing could have constructed the plane using just a few companies but instead it used over 400. Boeing was trading off the simplicity of dealing with just a handful of companies for the increased specialization by dealing with many specialized companies. • Why might Boeing’s decisions in making the Dreamliner be in the social interest? Building the Dreamliner itself advances the social interest because it increases the quantity of comfortable, rapid transportation. The amount of high-quality transportation available in the economy increases, which benefits society. The decisions in making the Dreamliner advance the social interest because they were designed to make the Dreamliner at low cost and thereby avoid wasting resources.

Chapter 2 . The U.S. and Global Economies

The global economy has seen a fall in the number of landlines and rapid growth in the number of smartphones. In the United States, 51 percent of households have no landline and 95 percent have a smartphone. In Africa, 70 percent have a smartphone. Describe the changes in what, how, and for whom telecommunication services are produced in the global economy. What: As the number of cell phone users increases, the global economy has been producing more cell phone telecommunication services. More cell phones are produced, fewer land phones are produced, and presumably more cell phone frequencies are used. How: More telecommunication services are being produced using cell phones rather than fixed-line phones. For whom: While the amount of telecommunication services has been rising throughout the world, it has been increasing most rapidly in Africa. So more telecommunication services are being produced for residents of Africa as well as for residents in the rest of the world.

Which of the entries in the list are conList sumption goods and services? Explain your • An interstate highway choice. • An airplane A pack of bubble gum and a movie are • A school teacher consumption goods. They are purchased • A stealth bomber by consumers. • A garbage truck Which of the entries in the list are capital • A pack of bubble gum goods? Explain your choice. • President of the United States An airplane, a garbage truck, and an ATM • A strawberry field are capital goods. All provide services to • A movie produce other goods and services. The in• An ATM terstate highway and the stealth bomber also are capital goods. They also provide services (transportation and defense) that help produce other goods and services. Which of the entries in the list are factors of production? Explain your choice. An interstate highway, an airplane, a school teacher, a stealth bomber, a garbage truck, the President of the United States, a strawberry field, and an ATM are factors of production. A school teacher and the President are labor; an interstate highway, an airplane, a stealth bomber, a garbage truck, and an ATM are capital; and, a strawberry field is land.

Part 1 . INTRODUCTION

In the African nation of Senegal, to enroll in school a child needs a Birth Certificate that costs $25. This price is several weeks’ income for many families. Explain how this requirement is likely to affect the growth of human capital in Senegal. Human capital growth depends, in part, on the extent of schooling: More schooling means more human capital. Because of Senegal’s hefty fee for a required Birth Certificate, fewer children will enroll in school, thereby decreasing Senegal’s human capital growth.

China’s race to the top in income inequality China has lifted millions out of poverty, but inequality has also increased. In 2017, 8 million students graduated from Chinese universities, 10 times more than two decades ago and double the number at U.S. universities. But the gap in graduation rates between rural to urban areas and richer and poorer people widened. Source: Bloomberg, September 23, 2018 Explain how the distribution of personal income in China can be getting more unequal even though the poorest are getting richer. The distribution of income in China can be getting more unequal even when the poorest are getting richer if the richest are getting richer even faster. If the rich are getting richer faster, the fraction of the nation’s total income received by the poorest 20 percent falls, which makes the personal distribution of income more unequal.

Compare the scale of agricultural production in the advanced and developing economies. In which is the percentage higher? In which is the total amount produced greater? Agricultural is a small part of total production in advanced economies. It is a much larger part in developing economies. Even though advanced economies devote only a small part of their total production to agriculture, they still produce about one third of the world’s total production of food. The remaining two thirds is produced in the developing nations.

Chapter 2 . The U.S. and Global Economies

On a diagram of the circular flow model, indicate in which real or money flow each entry in the list belongs. • General Motors’ pays its workers wages. General Motors wage payment is a money flow that is a payment for use of the services of a factor of production and so flows out of the factor market to households (it flowed into the factor market from General Motors, a firm). In Figure 2.3 the dark arrows represent money flows and the grey arrows represent flows of goods and services and factors. The flow of wage payments to households is labeled a in the figure in Figure 2.3. • IBM pays a dividend to its stockholders. IBM’s dividend payment is a money flow that is a payment for use of the services of a factor of production and so flows out of the factor market to households (it flowed into the factor market from IBM, a firm). The flow to households is labeled b in the figure. • You buy your groceries. Your purchase of groceries represents a money flow from households to the goods market, labeled c in the figure. • Southwest rents some aircraft. The aircraft are factors of production, so the flow is the services from these factors of production from the factor markets to firms, labeled d in the figure. • Nike pays Serena Williams for promoting its sports shoes. Serena Williams is a factor of production, so the flow is a money flow .

Part 1 . INTRODUCTION

from the factor markets to households in exchange for Ms. Williams’ services of promoting the sports shoes. The flow is labeled e in the figure. 10. Led by China, a new billionaire is created in Asia every other day Billionaire wealth in Asia increased 17 percent to $6 trillion in 2016. Led by China, the number of the region’s billionaires surpassed the United States for the first time. Source: The Straits Times, October 26, 2017 How is the personal distribution of income in Asia changing? If the number of billionaires is growing more rapidly than the number of other income groups, it will be the case that the personal distribution of income in Asia is becoming less equally distributed.

Chapter 2 . The U.S. and Global Economies

 Multiple Choice Quiz 1.

Which of the following classifications is correct? A. City streets are consumption goods because they wear out with use. B. Stocks are capital goods because when people buy and sell them they make a profit. C. The coffee maker in the coffee shop at an airport is a consumption good because people buy the coffee it produces. D. White House security is a government service because it is paid for by the government. Answer: D Answer D is correct. 2.

Which of the following statements about U.S. production is correct? A. Construction accounts for a larger percentage of total production than does manufacturing. B. Real estate services account for 14.5 percent of the value of total production, larger than any other item of services or goods. C. Consumption goods and services represent 78.5 percent of U.S. production by value and that percentage doesn’t fluctuate much. D. The manufacture of goods represents more than 50 percent of total production. Answer: C Answer C is correct as the data on page 34 show. 3.

Which of the following items is not a factor of production? A. An oil rig in the Gulf of Mexico B. A ski jump in Utah C. A bank loan to a farmer D. An orange grove in Florida Answer: C Answer C is not a factor of production because it is financial capital; see page 37. 4.

What is human capital? A. A fruit picker B. Unskilled labor C. Your professor’s knowledge of the economy D. An auto assembly line robot Answer: C Answer C uses the definition of human capital on page 37.

Part 1 . INTRODUCTION

Which of the following statements is correct? A. Labor earns wages and entrepreneurship earns bonuses. B. Land earns interest and capital earns rent. C. Entrepreneurship earns interest and capital earns profit. D. Capital earns interest and labor earns wages. Answer: D Page 39 shows that answer D is correct. 6.

How are goods and services produced in the global economy? A. Developing countries use less human capital but just as much physical capital as advanced economies. B. Emerging economies use more capital-intensive technology than do developing economies. C. Human capital in all economies is similar. D. Advanced economies use less capital than developing economies. Answer: B Developing countries have less capital than emerging economies. 7.

In the circular flow model, which of the following items is a real flow? A. The flow of government expenditures to firms for the goods bought B. The flow of income from firms to households for the services of the factors of production hired C. The flow of U.S. borrowing from the rest of the world D. The flow of labor services from households to firms Answer: D Answer D is a real flow because it is a labor service.

The Economic Problem

Chapter

ANSWERS TO CHAPTER CHECKPOINTS

 Problems and Applications 1.

The table shows the quantities of corn and beef that a farm Corn can produce in a year. Draw a graph of the farm’s PPF. Mark (bushels) on the graph: 250 200 • An inefficient combination of corn and beef—label this 100 point A. 0 • An unattainable combination of corn and beef—label this point B. • An efficient combination of corn and beef—label this point C. The production possibilities frontier is illustrated in Figure 3.1. Any production point inside the PPF, such as the point marked A, is an inefficient combination of corn and beef. Any production point beyond the PPF, such as the point marked B, is an unattainable combination of corn and beef. Any production point on the PPF, such as the point marked C is a production efficient combination of corn and beef.

Use the following information to work Problems 2 and 3. The people of Leisure Island have 50 hours of labor a day that can be used to .

Beef (pounds) and and and and

0 300 500 600

Part 1 . INTRODUCTION

produce entertainment and good food. The Entertainment table shows the maximum quantity of either Labor (units) entertainment or good food that Leisure Is0 0 or 10 20 or land can produce with different quantities of 20 40 or labor. 30 60 or 2. Is an output of 50 units of entertainment 40 80 or 50 100 or and 50 units of good food attainable and efficient? With a production of 50 units of entertainment and 50 units of good food, do the people of Leisure Island face a tradeoff? Producing 50 units of good food and 50 units of entertainment is attainable. However, at this production point, Leisure Island’s resources are not fully employed or are misallocated. They are producing inside their PPF. As a result, the people of Leisure Island do not face a tradeoff—they can produce more entertainment without giving up any good food, or they can produce more good food without giving up any entertainment. 3.

What is the opportunity cost of producing an additional unit of entertainment? Explain how the opportunity cost of producing a unit of entertainment changes as more entertainment is produced. If production is initially inside the PPF, the opportunity cost of producing an additional unit of entertainment is zero. If production is on the PPF there is an opportunity cost of producing a unit of entertainment because good food must be forgone. The opportunity cost of producing a unit of entertainment while moving along the PPF equals the loss in good food produced divided by the gain in entertainment produced. For example, increasing production of entertainment by changing from the production of 20 units of entertainment and 65 units of good food (10 units of labor devoted to entertainment and 40 to good food) to 40 units of entertainment and 60 units of good food has an opportunity cost of 5 units of good food ÷ 10 units of entertainment = 1/2 of a unit of good food per unit of entertainment. On the PPF, as more entertainment is produced, the opportunity cost of producing an additional unit of entertainment increases. Use the following information to work Problems 4 to 6. Is a cure for Aids within reach? More than 50 years after one of the most devastating viruses to affect mankind, HIV remains a stubborn adversary. Treatment has improved dramatically over the past 20 years and now, a cure could be in sight. Source: The Guardian, November 30, 2018 4. Make a graph of the production possibilities frontier with HIV/AIDS cases treated on the x-axis and other goods and services on the y-axis before and after the advance in technology. Figure 3.2 (on the next page) shows the PPF. When the technology used to treat HIV/AIDS advances, the production possibilities increase so, as

Good food (units) 0 30 50 60 65 67

Chapter 3 . The Economic Problem

shown in Figure 3.2, the PPF shifts outward. 5.

How does the opportunity cost of treating HIV/AIDS changes as the number of cases treated increases with no change in technology? With no change in technology, moving along a PPF as the number of cases treated rises the opportunity cost of treating a case increases.

How has the opportunity cost of treating HIV/AIDS changed as the technology for treating it has advanced? With advances in technology in HIV/AIDS treatments, along the New PPF resources are more productive and fewer other goods and services must be given up to increase production of HIV/AIDS treatments. So the opportunity cost of producing HIV/AIDS treatments decreases.

Explain how the following events influence U.S. production possibilities: • Some retail workers are re-employed building dams and wind farms. When these former retail workers are re-employed at their new occupations, more dams and wind farms are produced and fewer retail services are produced. The opportunity cost of the increased numbers of dams and wind farms is the forgone production of retail services. There is a movement along the PPF. • More people take early retirement. As more people retire, the quantity of labor available in the economy shrinks. As a result, the nation’s PPF shifts inward. • Drought devastates California’s economy. The nation’s PPF shifts inward as a result of the drought. The drought decreases the amount of productive land, thereby decreasing production of agricultural products and shifting the PPF inward. Use the following information to work Problems 8 and 9. Figure 3.3 (on the next page) shows Tom’s production possibilities and Figure 3.4 (on the next page) shows Abby’s production possibilities. Tom uses all his resources and produces 2 rackets and 20 balls an hour. Abby uses all her resources and produces 2 rackets and 40 balls an hour. 8. What is Tom’s opportunity cost of producing a racket? What is Abby’s opportunity cost of a racket? Who has a comparative advantage in producing rackets? Who has a comparative advantage in producing balls? If Tom increases his production by 1 racket, he forgoes 10 balls. So his opportunity cost of 1 racket is 10 balls ÷ 1 racket, or 10 balls per racket.

Part 1 . INTRODUCTION

If Abby increases her production by 1 racket, she forgoes 20 balls. So her opportunity cost of 1 racket is 20 balls ÷ 1 racket, or 20 balls per racket. Tom has the comparative advantage in producing rackets. Tom’s opportunity cost of a racket is 10 balls per racket and Abby’s opportunity cost of a racket is 20 balls per racket. Abby has the comparative advantage in producing balls. Tom’s opportunity cost of a ball is 0.10 rackets per ball and Abby’s opportunity cost of a ball is 0.05 rackets per ball. 9.

If Tom and Abby specialize and trade 15 balls for 1 racket, what are the gains from trade? Both Tom and Abby gain from their specialization and trade. Tom could produce 4 rackets and then trade 2 of the rackets for 30 balls. Tom would wind up with 2 rackets and 30 balls, 10 more balls than he had without the specialization and trade. Abby could produce 80 balls and then trade 30 of them for 2 rackets. Abby would wind up with 2 rackets and 50 balls, also 10 more balls than she had without the specialization and trade.

10. Read Eye on the Environment on p. 68 and describe a tradeoff faced when deciding how to generate electricity and whether to use wind power. Using wind power to generate electricity requires that the wind turbines be located in areas with wind which often are not near population centers. Long transmission lines are required which means transmissions losses are large. Long transmission lines are not necessary if other sources are used to generate power, so smaller generating facilities are required because transmissions losses are less. If wind power is used to generate power, more resources are used and fewer other goods can be produced.

Chapter 3 . The Economic Problem

 Additional Problems and Applications Use the following information to work Problems 1 to 4. Representatives Waxman of California and Markey of Massachusetts proposed a law to limit greenhouse gas emissions from electricity generation and require electricity producers to generate a minimum percentage of power using renewable fuels, with some emission rights to be auctioned. The Congressional Budget Office estimated that the government would receive $846 billion from auctions and would spend $821 billion on incentive programs and compensation for higher energy prices. Electricity producers would spend $208 million a year to comply with the new rules. (Think of these dollar amounts as dollars’ worth of other goods and services.) 1. Would the Waxman-Markey law achieve production efficiency? Production efficiency requires producing on the PPF. Use a PPF showing the tradeoff between electricity and clean air. Production efficiency requires producing on the PPF so that gaining more clean air means giving up some electricity. Before the new law, production might have been on the PPF if the producers had used the most efficient technologies and taken account of the pollution they created. After the law is in place, production might be inside the PPF if the law requires more production of energy from renewable sources than is production efficient. 2.

Is the $846 billion that electricity producers would pay for the right to emit greenhouse gasses part of the opportunity cost of producing electricity? To the extent that the $846 billion pays for the cost that greenhouse gasses impose on society (by way of forgone production of other goods and services), the $846 billion is part of the opportunity cost of generating electricity.

Is the $821 billion that the government would spend on incentive programs and compensation for higher energy prices part of the opportunity cost of producing electricity? The incentive programs change what electricity providers buy in order to produce electricity with lower emissions. The goods and services forgone are the opportunity cost of these programs. Compensation for higher energy prices is a transfer payment from taxpayers to consumers. Nothing is forgone and so it is not an opportunity cost.

Is the $208 million that electricity producers will spend to comply with the new rules part of the opportunity cost of producing electricity? The electricity producers will spend $208 million on other goods and services to comply with the law. These goods and services had other alternative uses that are now foregone, so this expenditure is part of the opportunity cost of producing electricity.

Part 1 . INTRODUCTION

The people of Foodland have 40 hours of Bread labor a day to bake pizza and bread. The Labor Pizzas (loaves) 0 0 or 0 table shows the maximum quantity of 10 30 or 10 either pizza or bread that Foodland can 20 50 or 20 bake with different quantities of labor. 30 60 or 30 Can Foodland produce 30 pizzas and 30 40 65 or 40 loaves of bread a day? If it can, is this output efficient, do the people of Foodland face a tradeoff, and what is the opportunity cost of producing an additional pizza? Producing 30 pizzas and 30 loaves of bread is attainable and efficient. There is a tradeoff because the nation is operating on its production possibilities frontier. As a result, if the production of pizza increases, less bread can be produced and if the production of bread increases, less pizza can be produced. For the nation to produce 20 more pizzas requires 10 more hours of labor devoted to making pizza, which means 10 fewer hours devoted to making bread. Foodland gives up 10 loaves of bread. The opportunity cost of another pizza equals the loaves of bread forgone, 10 loaves, divided by the pizzas obtained, 20 pizzas, or 10 loaves of bread ÷ 20 pizzas, or 1/2 of a loaf of bread per pizza. Use the table, which shows a farm’s production Soybean Chicken (bushels (pounds possibilities, to work Problems 6 and 7. per year) per year) 6. If the farm uses its resources efficiently, what is the 500

and

opportunity cost of an increase in chicken production 400 and from 300 pounds to 500 pounds a year? Explain your 200 and 0 and answer. If the farm expands chicken production from 300 pounds to 500 pounds, soybean production decreases from 400 to 200 bushels. The opportunity cost of the additional 200 pounds of chicken is 200 bushels of soybean, or 1 bushel of soybeans per pound of chicken. 7.

If the farm adopted a new technology, which allows it to use fewer resources to fatten chickens, explain how the farm’s production possibilities will change. Explain how the opportunity cost of producing a bushel of soybean will be affected. The farm’s PPF rotates outward; the maximum quantity of soybeans (500 bushels) does not change but the maximum quantity of chicken increases. The opportunity cost of a bushel of soybeans increases because more chicken must be given up to produce additional soybeans.

In an hour, Sue can produce 40 caps or 4 jackets and Tessa can produce 80 caps or 4 jackets. Who has a comparative advantage in producing caps? If Sue and Tessa specialize and trade, who will gain? Sue forgoes 4 jackets to produce 40 caps, so Sue’s opportunity cost of pro.

0 300 500 550

Chapter 3 . The Economic Problem

ducing one cap is (4 jackets) ÷ (40 caps) or 0.1 jackets per cap. Tessa forgoes 4 jackets to produce 80 caps, so Tessa’s opportunity cost of producing one cap is (4 jackets) ÷ (80 caps) or 0.05 jackets per cap. Tessa’s opportunity cost of a cap is lower than Sue’s opportunity cost, so Tessa has a comparative advantage in producing caps. If Tessa specializes in caps and Sue specializes in jackets, both Sue and Tessa gain from trade. For instance, suppose they settle upon a price of 1 jacket for 15 caps. Sue gains because she can obtain caps from Tessa at a cost of (1 jacket) ÷ (15 caps), which is 0.067 jacket per cap, a cost that is lower than what it would cost her to produce caps herself. Tessa also gains from trade because she trades caps for jackets for 0.067 jacket per cap, which is higher than her cost of producing a cap. Use the following opinion to work Problems 9 to 11. Free Internet? Everyone should have free Internet access to education, news, jobs, and more. 9. Explain how Internet access has changed the production possibilities and the opportunity cost of producing education and news. Internet access is a technological advance that has increased the production possibilities of all goods and services. The opportunity cost of producing more education and news is the quantity of other goods and services that must be given up to get an additional unit of education and news. If Internet access expands the production possibilities of education and news by more than it expands the production possibilities of goods and services, fewer other goods and services must be given up to produce an additional unit of education and news. The opportunity cost of producing more education and news decreases. 10. Sketch a PPF with education and news on the x-axis and other goods and services on the y-axis before and after the Internet. The PPFs in Figure 3.5 have the conventional outward bowed shape. The figure shows that the introduction of the Internet shifted the production possibilities frontier outward from the PPF labeled “Initial PPF,” to the PPF labelled “New PPF.” The illustrated PPF assumes that effect on education and news is larger than the effect on other goods and services.

Part 1 . INTRODUCTION

11. Explain why it is not possible for everyone to have free Internet access to education, news, jobs, and more. Providing Internet access is not free because it takes resources. But the opportunity cost of Internet service increases as more people gain access , so the opportunity cost of giving everyone “free” access to the Internet would be extremely high, probably much higher than society is willing to pay.

Chapter 3 . The Economic Problem

 Multiple Choice Quiz 1.

The table shows the production possibilFish Berries ities of an island community. Choose the Possibility (pounds) (pounds) best statement. A 0 and 40 B 1 and 36 A. This community has enough reC 2 and 30 sources to produce 2 pounds of fish D 3 and 22 and 36 pounds of berries. E 4 and 12 B. This community cannot produce 2 F 5 and 0 pounds of fish and 36 pounds of berries because this combination is inefficient. C. This community will waste resources if it produces 2 pounds of fish and 22 pounds of berries. D. This community can produce 2 pounds of fish and 30 pounds of berries but this combination is inefficient. Answer: C The economy is wasting resources because if it produces 2 pounds of fish, it can also produce 30 pounds of berries (which is more than the 22 pounds it is producing), and if it produces 22 pounds of berries, it can also produce 3 pounds of fish (which is more than the 2 pounds it is producing). 2.

The table above shows the production possibilities of an island community. Choose the best statement. A. Suppose that this community produces 3 pounds of fish and 20 pounds of berries. If it decides to gather more berries, it faces a tradeoff. B. When this community produces 4 pounds of fish and 12 pounds of berries it faces a tradeoff, but it is inefficient. C. Suppose that this community produces 5 pounds of fish and 0 pounds of berries. If it decides to gather some berries, it will get a free lunch. D. If this community produces 3 pounds of fish and 22 pounds of berries, production is efficient but to produce more fish it faces a tradeoff. Answer: D Production of 3 pounds of fish and 22 pounds of berries is on the PPF and therefore efficient. To produce more fish, the community moves along its PPF, increasing production of fish and decreasing production of berries. The community faces a tradeoff. .

Part 1 . INTRODUCTION

The table above shows the production possibilities of an island community. This community’s opportunity cost of producing 1 pound of fish ______. A. is the increase in the quantity of berries gathered as the quantity of fish increases by 1 pound B. increases as the quantity of berries gathered increases C. is 10 pounds of berries if the quantity of fish increases from 2 to 3 pounds D. increases as the quantity of fish caught increases Answer: D Page 70 discusses why opportunity increases as production of the good increases. 4.

The table above shows the production possibilities of an island community. Choose the best statement. A. When a drought hits the island, its PPF shifts outward. B. When the islanders discover a better way of catching fish, the island’s PPF shifts outward. C. When islanders reduce the time they spend gathering berries, the PPF shifts inward. D. If the islanders decide to spend more time gathering berries but continue to spend the same amount of time fishing, they face a tradeoff. Answer: B Page 72 shows that technological progress, such as exemplified in answer B, shifts the PPF outward. 5.

Mary makes 10 pies and 20 cakes a day and her opportunity cost of producing a cake is 2 pies. Tim makes 20 pies and 10 cakes a day and his opportunity cost of producing a cake is 4 pies. If Mary and Tim specialize in the good in which they have a comparative advantage ______. A. Mary produces only pies B. Tim produces both pies and cakes C. Mary produces only cakes while Tim produces only pies D. Tim produces only cakes while Mary produces only pies Answer: C Answer C is correct because Mary has the lower opportunity cost of making a cake.

Chapter

Demand and Supply ANSWERS TO CHAPTER CHECKPOINTS

 Problems and Applications 1.

Explain how each of the following events changes the demand for or supply of air travel. • Airfares tumble, while long-distance bus fares don’t change. A change in the price of airfares does not change either the demand for or the supply of air travel. (It changes the quantity demanded and the quantity supplied of air travel.) •

The price of jet fuel rises. The rise in the price of jet fuel decreases the supply of air travel because it raises the cost of producing air travel.

•

Airlines reduce the number of flights each day. The reduction in the number of flights decreases the supply of air travel.

•

People expect airfares to increase next summer. The current demand for air travel increases when people expect airfares to increase next summer because people fly now, when airfares are relatively cheaper, rather than next summer.

•

The price of train travel falls. Train travel is a substitute for air travel. So a fall in the price of train travel decreases the demand for air travel.

•

The price of a pound of air cargo increases. Transporting cargo by air is a substitute in production for transporting people by air. So the rise in the price of air cargo decreases the supply of air travel for people.

Use the laws of demand and supply to explain whether the statements in Problems 2 and 3 are true or false. In your explanation, distinguish between a change in demand and a change in the quantity demanded and between a change in supply and a change in the quantity supplied. 2. The United States does not allow oranges from Brazil (the world’s largest

Part 1 . INTRODUCTION

producer of oranges) to enter the United States. If Brazilian oranges were sold in the United States, oranges and orange juice would be cheaper. The statement is true. Allowing Brazilian oranges into the United States increases the supply of oranges and the supply curve shifts rightward. The equilibrium price of an orange falls and the equilibrium quantity increases. The quantity of oranges demanded increases and there is a movement down along the demand curve. Oranges are a resource used in the production of orange juice. When the price of an orange falls, it costs less to produce orange juice and the supply of orange juice increases. The quantity of orange juice demanded increases and there is a movement down along the demand curve. The equilibrium price of orange juice falls and the equilibrium quantity increases. 3.

If the price of frozen yogurt falls, the quantity of ice cream consumed will decrease and the price of ice cream will rise. The statement is false. Frozen yogurt and ice cream are substitutes for consumers. When the price of frozen yogurt falls, people substitute frozen yogurt for ice cream. The demand for ice cream decreases and the demand curve shifts leftward. The equilibrium quantity of ice cream decreases but the equilibrium price of ice cream falls. There is a change in the quantity of ice cream supplied and a movement down along the supply curve.

The table shows the demand and supPrice Quantity Quantity ply schedules for running shoes. What (dollars demanded supplied per pair) is the market equilibrium? If the price (pairs per day) 60 1,000 400 is $70 a pair, describe the situation in 70 900 500 the market. Explain how market equi80 800 600 librium is restored. If a rise in income 90 700 700 increases the demand for running 100 600 800 shoes by 100 pairs a day at each price, 110 500 900 explain how the market adjusts to its new equilibrium. The market equilibrium occurs at a price of $90 a pair and 700 pairs of running shoes a day. At the price of $90 a pair, the quantity demanded equals the quantity supplied. If the price is $70 a pair, the quantity demanded is 900 pairs and the quantity supplied is 500 pairs. There is a shortage of 400 pairs a day and the price rises. As the price rises, the quantity demanded decreases, the quantity supplied increases, and the shortage decreases. The price rises until the shortage disappears. The table o the next page shows the new demand schedule after the increase in income has increased the quantity demanded by 100 pairs of shoes at each price. At the original equilibrium price of $90 a pair, there is

Chapter 4 . Demand and Supply

a shortage and the price rises. As the price rises, the quantity demanded decreases, the quantity supplied increases, and the shortage decreases. The price rises until the shortage disappears. The price rises to $95 a pair and the quantity increases to 750 pairs of running shoes a day.

Price (dollars per pair) 60 70 80 90 100 110

New Quantity Quantity demanded supplied (pairs per day) 1,100 400 1,000 500 900 600 800 700 700 800 600 900

“As more people buy fuel-efficient hybrid cars, the demand for gasoline will decrease and the price of gasoline will fall. The fall in the price of gasoline will decrease the supply of gasoline.” Is this statement true? Explain. The first statement is correct. As more people buy fuel-efficient cars, the demand for gasoline will decrease. The price of gasoline will fall. The second statement is false. The demand for gasoline decreases and the demand curve shifts leftward. There is a movement along the supply curve and a decrease in the quantity of gasoline supplied but no change in supply.

The table shows the demand and supply Wage rate Quantity Quantity (dollars demanded supplied schedules for student workers at campus per hour) (student workers) venues. If the college introduces a min10.00 600 300 imum wage of $11.50 an hour, how many 10.50 500 350 students are employed and how many 11.00 400 400 students want work at campus venue but 11.50 300 450 can’t find a job? 12.00 200 500 12.50 100 550 At the wage rate of $11.50 an hour, the quantity of student workers demanded is 300 workers and the quantity of student workers supplied is 450 workers. The number of student workers employed equals the quantity demanded, 300. The number of student workers who want to work at a campus venue but cannot find a job equals the quantity of student workers supplied, 450 workers, minus the quantity of student workers employed, 300 workers, so 150 student workers want jobs on-campus.

OPEC and allies agree to cut oil production With oil prices stuck at a low of $60-a-barrel , major oil producers agree to cut crude production. Source: CNBC, December 7, 2018 Explain and illustrate on a graph of the oil market the effect of this decision on the market equilibrium. The market initially is in equilibrium in Figure 4.1 with demand curve D and supply curve S0. The initial equilibrium price is $60 per barrel of oil

Part 1 . INTRODUCTION

and the initial equilibrium quantity is 100 million barrels per day. When OPEC agreed to decrease the supply, the supply curve shifts leftward, as illustrated in Figure 4.1 by the shift from S0 to S1. In the figure the price of a barrel of oil rises from $60 per barrel to $63 per barrel and the quantity decreases by 1.2 million barrels, from 100 million barrels per day to 98.8 million barrels per day.

Chinese hog farms ‘panic’ as swine virus shrinks herds China produces half the world’s pork, but 80 percent of China’s hog farms are not going to restock as a swine fever spreads. Farmers fatten hogs with soybean, so imports of soybeans are expected to fall by 85 million tons by September. Source: Bloomberg, April 22, 2019 8. Explain how the virus will change the prices of hogs, soybean, and pork. The virus decreases the supply of hogs and pork, so their prices will rise. Because farmers use soybeans to feed their hogs, fewer hogs decreases the demand for soybeans decreases, so the price of soybeans falls. 9.

Read Eye on the Price of Avocados on p. 107 and explain how we know that the price increased during August 2018 because the supply of avocados decreased and not because the demand for avocados increased. When the supply decreases, the price rises and the quantity decreases and when the demand increases the price also rises but the quantity increases. .The table shows that when the equilibrium price of an avocado rose during August, the equilibrium quantity decreased, so the price rise had to be the result of a decrease in supply rather than an increase in demand.

Chapter 4 . Demand and Supply

 Additional Problems and Applications 1.

Read Eye on the Price of Avocados on p. 103. Why can we be confident that the market for avocados is competitive and that a decrease in supply rather than the greed of avocado growers is the reason for the August 2018 rise in price? There are thousands of avocado growers and buyers, so the market for avocados is competitive—no one buyer or seller can influence the price. Greedy growers cannot successfully raise the price above its equilibrium. If greedy growers raised their price, there would be movements up along the demand curve, reducing the quantity demanded, and up along the supply curve, increasing the quantity supplied. The result would be a surplus of avocados, which would force the price to fall back to its equilibrium. What is the effect on the equilibrium price and equilibrium quantity of orange juice if the price of apple juice decreases and the wage rate paid to orange grove workers increases? Apple juice and orange juice are substitutes for consumers, so the fall in the price of apple juice decreases the demand for orange juice. The demand curve for orange juice shifts leftward. The increase in the wage rate paid to orange grove workers raises the cost of producing oranges and thereby boosts the cost of producing orange juice. The supply of orange juice decreases and the supply curve of orange juice shifts leftward. The net effect of these events decreases the equilibrium quantity but has an undetermined effect on equilibrium price. If supply decreases by more than the demand decreases, the equilibrium price rises. If demand decreases more than the supply decreases, the equilibrium price falls. And if they decrease by the same amount, the equilibrium price does not change. What is the effect on the equilibrium in the orange juice market if orange juice becomes more popular and a cheaper robot is used to pick oranges? Because orange juice becomes more popular, demand increases and the demand curve for orange juice shifts rightward. The cheaper picking robot lowers the production costs of orange juice, so the supply of orange juice increases and the supply curve of orange juice shifts rightward. The equilibrium quantity increases. But the effect on the equilibrium price is ambiguous. If the increase in supply is greater than the increase in demand, the equilibrium price falls. If the increase in demand is greater than the increase in supply, the equilibrium price rises. And if the increase is the same size, then the equilibrium price does not change. Why oil and gasoline prices are rising faster than expected The oil price has risen faster than expected because demand has been stronger than expected and U.S. sanctions on Iran and Venezuela have removed a cushion to absorb oil supply disruptions. Source: CNBC, April 3, 2019

Part 1 . INTRODUCTION

Using the information in the news clip, what can you say about the equilibrium quantities of oil and gasoline? In the market for oil, demand increased. By itself, an increase in demand increases the equilibrium quantity. The sanctions on Iran and Venezuela, however, decrease the supply of oil, which, by itself, decreases the equilibrium quantity. The effect on the equilibrium quantity of oil is ambiguous because we do not know if the demand effect is larger or if the supply effect is stronger. The news clip says that the price of oil rose. Because oil is a resource used to produce gasoline, the higher price of this factor of production decreases the supply of gasoline, so the equilibrium quantity of gasoline decreases. The table shows the demand and supply Price Quantity Quantity schedules for boxes of chocolates in an av(dollars demanded supplied per box) erage week. Use this information to work (boxes per week) 13.00 1,600 1,200 Problems 5 and 6. 14.00 1,500 1,300 5. If the price of chocolates is $17.00 a 15.00 1,400 1,400 box, describe the situation in the mar16.00 1,300 1,500 ket. Explain how market equilibrium 17.00 1,200 1,600 is restored. 18.00 1,100 1,700 At the price of $15.00 a box, the quantity supplied equals the quantity demanded. At a price of $17.00 a box, the quantity demanded is 1,200 boxes and the quantity supplied is 1,600 boxes. There is a surplus of 400 boxes a week and the price falls. As the price falls, the quantity demanded increases, the quantity supplied decreases, and the surplus decreases. The price falls until the surplus disappears. The market equilibrium occurs at a price of $15.00 a box and 1,400 boxes a week so the price falls to $15.00 a box. 6.

During Valentine’s week, more people buy chocolates and chocolatiers offer their chocolates in special red boxes, which cost more to produce than the everyday box. Set out the three-step process of analysis and show on a graph the adjustment process to the new equilibrium. Describe the changes in the equilibrium price and the equilibrium quantity. Starting with the demand side, Valentine’s week increases people’s preferences for boxes of chocolate so the demand for boxes of chocolate increases. The demand curve for chocolates shifts rightward, from D0 to D1 in Figure 4.2 (on the next page). Moving to the supply side, the fancy red box raises the cost of producing boxes of chocolate, which decreases the supply. The rise in the cost of producing boxes of chocolates shifts the supply curve leftward, from S0 to S1 in Figure 4.2. After these changes, at the initial price of a box of chocolate, $15.00, in Figure 4.2 there is a shortage of 600 boxes of chocolate per week. The shortage forces the price higher,

Chapter 4 . Demand and Supply

so the equilibrium price of a box of chocolate rises, to $18.00 in the figure. The problem points out that people buy more boxes of chocolate during Valentine’s week. This result means that the change in demand exceeds the change in the supply, that is, the magnitude of the increase in demand exceeds that of the decrease in supply. Figure 4.2 illustrates this situation and in the figure the equilibrium quantity increases from 1,400 boxes per week to 1,500 boxes per week. 7.

Some Seattle restaurants struggle with $15 minimum wage 5 years later Seattle’s $15 an hour minimum wage radically changed the way restaurants do business. Whether that is good or bad depends on who’s talking. Source: KOMO News, May 18, 2019 On a graph of the market for Seattle restaurant workers, show the effect of the $15 an hour minimum wage on employment of these workers. Source: KOMO News, May 18,2019 On a graph of the market for Seattle restaurant workers, show the effect of the $15 an hour minimum wage on employment of fast-food workers. Figure 4.3 shows the market for restaurant workers. In the figure the equilibrium wage rate before the increase in minimum wage is assumed to be $11 per hour. Consequently, before the hike in the minimum wage, the wage rate was $11 and employment was 2.2 million workers. After the boost in the minimum wage, the new minimum wage exceeds the equilibrium wage rate. The wage rate equals the minimum wage, $15 per hour. Employment decreases to 1.8 million workers, the quantity demanded at the minimum wage of $15 per hour.

Part 1 . INTRODUCTION

China turns caviar into a cheap snack The price of caviar crashed from $24 an ounce in January 2012 to a bit less than $10 an ounce in November 2018. China has become a big producer and from 2012 to 2017, U.S. imports of Chinese caviar increased fivefold. Source: The Washington Post, April 22, 2018 Use the demand and supply model to explain why the quantity of caviar consumed has increased and the price of caviar has fallen. What most likely happened to the demand for caviar and the quantity of caviar demanded? The increase in Chinese production of caviar increased the supply of caviar. Consequently, the price of caviar fell and the quantity sold increased. It is likely that the demand for caviar did not change. Instead, as Figure 4.6 illustrates, there is a movement down along the demand curve, which reflects in an increase in the quantity of caviar demanded.

Record number waiting to upgrade cell phones Faced with a $1,000 price tag for an old-tech phone, consumers may be waiting for the new 5G technology coming before buying a replacement phone. Source: Bloomberg, April 24, 2019 Explain how the expected arrival in 2020 of a new technology cell-phone service might influence the equilibrium price and quantity of cell phones in 2019 and 2020. Source: The Wall Street Journal, September 8, 2015 In 2019, the expected arrival of new technology cell-phone service might lead consumers to decrease their demand for phones in order to wait for new phones that they are certain can use the new technology. The decrease in the demand shifts the demand curve leftward, so the equilibrium price of a cell phone falls and the equilibrium quantity decreases. In 2020, new 5G compatible cell phones become available. For a given supply, if the demand for cell phones increases, the equilibrium price of a cell phone rises and the equilibrium quantity of cell phones increases.

Chapter 4 . Demand and Supply

 Multiple Choice Quiz 1.

Which of the following events illustrates the law of demand? Other things remaining the same, a rise in the price of a good will ________ . A. decrease the quantity demanded of that good B. increase the demand for a substitute of that good C. decrease the demand for the good D. increase the demand for a complement of that good Answer: A The law of demand is the inverse relationship between the price of a good and the quantity demanded. 2.

In the market for jeans, which of the following events increases the demand for a pair of jeans? A. The wage rate paid to garment workers rises. B. The price of a denim skirt (a substitute for jeans) rises. C. The price of denim cloth falls. D. New technology reduces the time it takes to make a pair of jeans. Answer: B The other factors listed change the supply; only answer B increases the demand. 3.

Other things remaining the same, a fall in the price of peanuts will ________. A. increase the supply of peanuts B. decrease the supply of peanut butter C. decrease the quantity supplied of peanuts D. decrease the supply of peanuts Answer: C A fall in the price of the good creates a movement along the supply curve and decreases the quantity supplied. 4.

In the market for cell phones, which of the following events increases the supply of cell phones? A. New technology lowers the cost of making a cell phone B. Rise in the price of an e-book reader (a substitute in production) C. An increase in people’s incomes D. A rise in the wage rate paid to electronics workers Answer: A Answers B and D decrease the supply of cell phones; answer C affects the demand for cell phones.

Part 1 . INTRODUCTION

When floods wiped out the banana crop in Central America, the equilibrium price of bananas ________ and the equilibrium quantity of bananas ________. A. rose; increased B. rose; decreased C. fell; increased D. fell; decreased Answer: B Figure 4.8(b) on illustrates this case of a decrease in supply. 6.

A decrease in the demand for chocolate with no change in supply will create a ________ of chocolate at today’s price, but gradually the price will ________. A. surplus; fall B. shortage; fall C. surplus; rise D. shortage; rise Answer: A Figure 4.7(b) on illustrates this case of a decrease in demand. 7.

A minimum wage set above the market equilibrium wage rate ________. A. increases both employment and the quantity of labor supplied B. decreases unemployment and raises the wage rate of those employed C. raises the wage rate of those employed and increases the supply of jobs D. increases unemployment and decreases employment Answer: D Because the minimum wage exceeds the equilibrium wage, it affects the market. Figure 4.12 illustrates that unemployment increases and employment decreases. 8.

A rent ceiling creates a ________ of housing if it ________ the equilibrium rent. A. surplus; is less than B. shortage; is less than C. surplus; exceeds D. shortage; exceeds Answer: B The rent ceiling has an effect only if it is set below the equilibrium rent, in which case it creates a shortage. Figure 4.14 on page 109 illustrates the effect of a price ceiling, such as a rent ceiling, that is set below the equilibrium price.

GDP: A Measure of Total Production and Income ANSWERS TO CHAPTER CHECKPOINTS

 Problems and Applications 1.

Figure 5.1 shows the flows of income and expenditure in an economy. In 2013, U was $2 trillion, V was $1.5 trillion, W was $7 trillion, J was $1.5 trillion, and Z was zero. Calculate total income, net taxes, and GDP. Total income (which is flow Q) equals total expenditure, the sum of consumption expenditure, investment, government expenditure on goods and services, and net exports of goods and services. Flow U is government expenditure on goods and services, G; flow W is consumption expenditure, C; flow J is investment, I; and flow Z is net exports of goods and services, NX. Total expenditure equals $7 trillion + $1.5 trillion + $2 trillion + $0, which is $10.5 trillion, so total income also equals $10.5 trillion. Net taxes equal total income minus consumption expenditure and saving. Total income is $10.5 trillion. Consumption expenditure is $7 trillion. Saving is the flow into the financial markets (flow V) and equals $1.5 trillion. So net taxes equal $10.5 trillion − $7 trillion − $1.5 trillion, which is $2 trillion. Total income equals total expenditure which equals GDP, so GDP equals $10.5 trillion.

Use the following information to work Problems 2 and 3. The national accounts of Parchment Paradise are kept on (you guessed it) parchment. A fire in the statistics office destroys some accounts, leaving only the following data: • GDP (income approach) $2,900

Chapter

Part 2 . MONITORING THE MACROECONOMY

• Consumption expenditure $2,000 • Indirect taxes less subsidies $100 • Interest, rent, and profit $500 • Investment $800 • Government expenditure $400 • Wages $2,000 • Net factor income from abroad $50 • Net exports –$200 2. Calculate GDP (expenditure approach) and depreciation. For the expenditure approach, GDP equals the sum of consumption expenditure, investment, government expenditure on goods and services, and net exports. Fortunately, these data were saved from the fire. Hence GDP = C + I + G + NX = $2,000 + $800 + $400 − $200 = $3,000. From the income approach, GDP equals the sum of wages plus interest, rent, and profit plus indirect taxes less subsidies plus depreciation. The value of the income approach GDP survived the fire and is $2,900. The sum of wages plus interest, rent, and profit plus indirect taxes less subsidies equals $2,000 + $500 + $100 = $2,600. So depreciation equals $2,900 − $2,600 = $300. 3.

Calculate net domestic product at factor cost, the statistical discrepancy, and GNP. Net domestic product at factor cost equals the sum of wages, interest, rent, and profit. Once again, all these data were fortunately saved from the fire, so net domestic product at factor cost = $2,000 + $500 = $2,500. The statistical discrepancy equals GDP from the expenditure approach, $3,000 from problem 2, minus GDP from the income approach, $2,900. So the statistical discrepancy is $100. GNP equals GDP plus net factor income from abroad. From problem 2, GDP is $3,000. Net factor income from abroad is $50. So GNP equals $3,000 + $50 = $3,050.

Use the following information to work Problems 4 to 6. An economy produces only fun and food. The table shows the prices and the quantities of fun and food produced in 2020 and 2021. The base year is 2020. 4. Calculate nominal GDP in 2020 and 2021. Nominal GDP in 2020 is equal to (40 units of fun × $2) + (60 units of food × $3) = $260. Nominal GDP in 2021 is equal to (35 units of fun × $3) + (65 units of food × $2) = $235.

GDP data for 2020 Item Quantity Price Fun 40 $2 Food 60 $3 GDP data for 2021 Item Quantity Price Fun 35 $3 Food 65 $2

Chapter 5 . GDP: A Measure of Total Production and Income

Calculate the percentage increase in real GDP in 2021. In the base year, real GDP equals nominal GDP, so real GDP in 2020 is $260. Using prices from 2020, real GDP in 2020 is $260 and real GDP in 2021 is $265. Using 2020 prices, real GDP grew [($265 − $260)/$260] x 100, or 1.9 percent.

If potential GDP was $270 in 2020 and it grew by 1 percent in 2021, in which phase of the business cycle is the economy? Explain. Real GDP in 2020 is $260 and in 2021 is $265. Between 2020 and 2021, real GDP grew so the economy is in the expansion phase of the business cycle.

Use the following information to work Problems 7 to 9. The Commerce Department reported that in May 2019, retail sales rose by 0.2, net exports decreased, inventories held by businesses rose by 0.3 percent, and total sales by businesses rose by 1.5 percent. Source: Commerce Department, July 2019 7. Which component of GDP changed because retail sales increased? Which component of GDP changed because business inventories increased? The increase in retail sales means that consumption expenditure on goods and services increased. The increase in inventories held by businesses means that investment increased. 8.

Explain the effect of the fall in net exports on GDP. Because net exports is part of GDP, the fall in net exports means that GDP decreases.

Does the statement that total sales by businesses rose by 1.5 percent mean that GDP increased by 1.5 percent? Explain your answer. If “total sales by businesses” include both final goods and intermediate goods, then GDP did not necessarily increase by 1.5 percent. If intermediate goods sales increased by more than 1.5 percent, then sales of final goods and services, hence GDP, increase by less than 1.5 percent.

10. Read Eye on the Booms and Busts on p. 556 and explain why the NBER reported that the 2008 recession began before real GDP had fallen for two successive quarters. The NBER dated the start of the 2008 recession before real GDP had fallen for two consecutive quarters because other relevant data, such as real personal income, real manufacturing, wholesale and retail sales, industrial production, and employment all peaked before real GDP had fallen for two successive quarters.

Part 2 . MONITORING THE MACROECONOMY

 Additional Problems and Applications 1.

Read Eye on Booms and Busts on p. 556 and work the following exercise: In Brazil, real GDP in the first quarter of 2019 was lower than in the fourth quarter of 2018 and was lower in the second quarter of 2019 than in the first quarter. In the United States, real GDP increased during the first two quarters of 2018. Based on this information, which country was in a recession in 2019? What features of the information provided led you to your conclusion? Brazil was in a recession because Brazil’s real GDP had decreased for two successive quarters.

Classify each of the following items as a final good or service or an intermediate good or service and identify it as a component of consumption expenditure, investment, or government expenditure on goods and services: • Banking services bought by Target Banking services purchased by Target is an intermediate service. •

Security system bought by the White House The security system purchased by the White House is a final good. It is part of government expenditure on goods and services.

•

Coffee beans bought by Starbucks Coffee beans purchased by Starbucks are an intermediate good.

•

New coffee machines bought by Starbucks New coffee machines purchased by Starbucks are final goods. They are part of investment.

•

Starbuck’s grande mocha frappuccino bought by a student The student’s purchase is a final good. It is part of consumption expenditure on goods and services.

•

New battle ship bought by the U.S. navy The new battle ship purchased by the U.S. navy is a final good. It is part of government expenditure on goods and services.

Use the following information to work Problems 3 and 4. Mitsubishi Heavy Industries makes the wings of the new Boeing 787 Dreamliner in Japan. Toyota assembles cars for the U.S. market in Kentucky. 3. Explain where these activities appear in the National Income and Product Accounts of the United States. When the Dreamliner wings are sent from Japan to the United States, they are counted in the U.S. National Income and Product Accounts as imports, which is a negative entry in the expenditure approach to U.S. GDP. If any U.S. factors of production are employed in Japan making these

Chapter 5 . GDP: A Measure of Total Production and Income

wings (say, a supervisor from Boeing or a Boeing engineer), their income is part of “net factor income from abroad” and will be counted as part of U.S. GNP but not U.S. GDP. Toyota’s production of cars in Kentucky is included in U.S. GDP because it represents production within the United States. Expenditure on the cars is counted as part of consumption expenditure (if the cars are purchased by U.S. consumers) or investment (if the cars are purchased by U.S. firms) or government expenditure (if the cars are purchased by a government) in the expenditure approach to GDP. If any of the parts of the cars are imported from Japan, the value of these parts is included among U.S. imports. The incomes earned by the factors of production that produce the cars are part of the wages, interest, rent, and profit income that are used in the income approach to GDP. Finally, if any of the factors of production are foreign—say a Japanese citizen who supervises the production—the income of that factor is part of U.S. GDP but not part of U.S. GNP. 4.

Explain where these activities appear in the National Income and Product Accounts of Japan. Mitsubishi Heavy Industries’ production of Dreamliner wings in Japan is included in Japanese GDP because it represents production within Japan. When these wings are sent to the United States, they are counted in the National Income and Product Accounts as part of Japanese exports. If any of the parts of wings are imported into Japan, the value of these parts is included among Japanese imports. The incomes earned by the factors of production that produce the wings are part of the wages, interest, rent, and profit income that are used in the income approach to GDP. Finally, if any of the factors of production are foreign—say a U.S. citizen who supervises the production—the income of that factor is part of Japan’s GDP but not part of Japan’s GNP. Toyota’s production of cars in Kentucky is not directly included in Japan’s GDP unless some of the parts for these cars are exported from Japan to the United States. In that case the value of the parts are included in Japan’s GDP as exports. The production of these cars is included in Japan’s GNP if any Japanese-owned factors of production are used to produce the cars, such as a Japanese engineer sent from Japan to the United States to supervise the production. The income of these factors appears in the Japanese National Income and Product Accounts as “net factor income from abroad.”

Use the following data on the economy of Iberia to work Problems 5 and 6. • Net taxes $18 billion • Government expenditure $20 billion • Saving $15 billion

Part 2 . MONITORING THE MACROECONOMY

• Consumption expenditure $67 billion • Investment $21 billion • Exports $30 billion 5. Calculate Iberia’s GDP. Because the value of income equals the value of production, that is, the value of income equals GDP, Y = C + S + NT = GDP. So for Iberia, GDP = $67 billion + $15 billion + $18 billion, which is $100 billion. 6. Calculate Iberia’s imports of goods and services. GDP equals C +I +G +NX. Rearranging, NX = GDP − C − I − G. So Iberia’s net exports equal $100 billion − $67 billion − $21 billion − $20 billion, which is −$8 billion. Net exports equal exports − imports, so imports equal exports minus net exports. Iberia’s imports equal $30 billion − (−$8 billion), which is $38 billion. Use the table, which shows an economy’s total production and the prices of the final goods it produced in 2020 and 2021, to work Problems 7 to 9. 7. Calculate nominal GDP in 2020 and 2021. Nominal GDP in 2020 is equal to (100 fish × $2) + (50 berries × $6) = $500. Nominal GDP in 2021 is equal to (75 fish × $5) + (65 GDP data for 2020 berries × $10) = $1,025. Item Quantity Price 8. The base year is 2020. Calculate real GDP in 2020 Fish 100 $2 and 2021. Berries 50 $6 In the base year, real GDP equals nominal GDP, so real GDP in 2020 is $500. Real GDP in 2021 uses GDP data for 2021 2021 quantities and 2020 prices and so equals (75 Quantity Price Item fish × $2) + (65 berries × $6) = $540. Fish 75 $5 Berries 65 $10 9. Calculate the percentage increase in real GDP in 2021. The percentage increase in real GDP equals [($540 − $500)/$500] x 100, or 8.0 percent. Use the following information to work Problems 10 and 11. Investors snapping up US homes at record levels With confidence in the housing market and low mortgage interest rates, U.S. investors are buying new and existing homes at a record high rate. Source: Fox News, August 8, 2019 10. Where do new-home sales appear in the circular flow of expenditure and income? Explain how a surge in new home sales affects real GDP. The purchase of a new home is counted as investment and so it appears with the rest of investment. An increase in new home sales increases real GDP.

Chapter 5 . GDP: A Measure of Total Production and Income

11. Where do sales and inventories of existing homes appear in the circular flow of expenditure and income? Explain how an increase in sales of existing homes and a low inventory of existing homes affects real GDP. Sales of previously owned homes are sales of used goods; they were not produced in the current time period. For that reason they also do not appear in the circular flow of expenditure and income. Just as a sale of a used good does not add to GDP, an increase in sales of previously owned homes have no direct impact on real GDP. (A real estate commission paid to sell a used home, however, does add to GDP because it is a part of current production.) 12. China GDP growth slows to 27-year low China’s economic growth slowed to 6.2% in the second quarter, its weakest pace in at least 27 years, as demand at home and abroad faltered in the face of mounting U.S. trade pressure. Source: Reuters, July 15, 2019 How does China’s real GDP growth compare with that of the United States? If China’s growth slows further, would that mean it was in a recession? Even at 6.2 percent, China’s real GDP is much higher than that of the United States. If China’s growth rate falls further, it is not in a recession. To be in a recession, the growth rate must be negative for at least two successive, not just falling for two successive quarters.

Part 2 . MONITORING THE MACROECONOMY

 Multiple Choice Quiz 1.

Gross domestic product is the market value of all the _______ in a given time period. A. goods and services bought by Americans B. goods and services produced by American companies in all countries C. final goods and services produced by all firms located in the United States D. U.S.-produced goods and services bought in the United States Answer: C Answer C is the definition of GDP. 2.

A ________ is a final good and ________ is an intermediate good. A. new car bought by a student; a used SUV bought by a dealer B. new textbook; a used textbook C. new iPhone bought by a student; a new computer bought by WalMart to manage its inventories D. tank of gasoline bought by you; jet fuel bought by Southwest Airlines Answer: D The gasoline has been purchased by its ultimate user, so it is a final good; the jet fuel purchased by Southwest Airlines will be used to help produce an service, airline flights, so it is an intermediate good. 3.

Saving equals ________. A. income minus consumption expenditure minus net taxes B. income minus net taxes C. total income minus total expenditure D. net taxes minus government expenditure Answer: A Saving is what is left from income after consumption expenditure and net taxes are paid. 4.

The expenditure approach to measuring U.S. GDP equals _________. A. the sum of U.S. consumption expenditure and U.S. investment B. U.S. government expenditure minus taxes paid by Americans C. all expenditure on final goods and services produced in the United States in a given time period D. all expenditure by Americans on goods and services produced in the United States in a given time period Answer: D Answer D is effectively the definition of the expenditure approach.

Chapter 5 . GDP: A Measure of Total Production and Income

When using the income approach to measure GDP at market prices, in addition to summing all factor incomes it is necessary to ________. A. subtract depreciation because profit is not reported as net profit B. add depreciation because capital depreciates when goods are manufactured C. add indirect taxes less subsidies to convert aggregate income from factor cost to market prices D. add a statistical discrepancy which is the sum of depreciation and indirect taxes less subsidies Answer: C Because factor cost does not include indirect taxes but does include subsidies, it is necessary to add indirect taxes and subtract subsidies to change the factor cost to the market prices. 6.

The following statements about the business cycle are correct except ______. A. it is a regular predictable cycle in real GDP around potential GDP B. from the peak to the trough, the economy is in a recession C. from the trough to the peak, the economy is in an expansion D. it is a periodic movement in economic activity including employment Answer: A The business cycle fluctuations around potential GDP are irregular and difficult to predict. 7.

Real GDP per person is not an accurate measure of the standard of living because it ______. A. includes the goods and services that governments buy B. omits the goods and services that people produce for themselves C. includes goods and services bought by firms D. omits the goods and services imported from other countries Answer: B In less developed nations, GDP is a poor measure of the standard of living because much of a person’s consumption is produced by the person themself.

Chapter

Appendix: Measuring Real GDP ANSWERS TO APPENDIX CHECKPOINTS

 Problems and Applications An island economy produces 2018 2019 only bananas and coconuts. The Item Quantity Price Quantity Price table gives the quantities produced and prices in 2018 and Bananas 100 $10 110 $15 in 2019. The base year is 2018. Coconuts 50 $12 60 $10 1. Calculate nominal GDP in 2018 and nominal GDP in 2019. Nominal GDP in 2018 = ($10 × 100) + ($12 × 50) = $1,000 + $600 = $1,600. Nominal GDP in 2019 = ($15 × 110) + ($10 × 60) = $1,650 + $600 = $2,250. 2.

Calculate the value of 2019 production in 2018 prices and the percentage increase in production when valued at 2018 prices. Using 2018 prices, the value of 2019 production is ($10 × 110) + ($12 × 60) = $1,100 + $720 = $1,820. In 2018 prices, GDP in 2018 is $1,600 so the value of production increased from $1,600 to $1,820, an increase of $220. The percentage increase is equal to ($220 ÷ $1,600) × 100, which is 13.75 percent.

Calculate the value of 2018 production in 2019 prices and the percentage increase in production when valued at 2019 prices. Using 2019 prices, the value of 2018 production is ($15 × 100) + ($10 × 50) = $1,500 + $500 = $2,000. In 2019 prices, GDP in 2019 is $2,250 so the value of production increased from $2,000 to $2,250, an increase of $250. The percentage increase is equal to ($250 ÷ $2,000) × 100, which is 12.5 percent.

Use the chained-dollar method to calculate real GDP in 2018 and 2019. In terms of what dollars is each of these two real GDPs measured? Real GDP in 2018 = $1,600. It is equal to nominal GDP because 2018 is the base year. To calculate real GDP in 2019 compute the growth rate of real GDP between 2018 and 2019. That growth rate is the average of the growth rates

Part 2 . MONITORING THE MACROECONOMY

between 2018 and 2019 using prices from 2018 and using prices from 2019. Taking the average of the answers to Problems 2 and 3 gives an average percentage increase of 13.13 percent. This result means that real GDP in 2019 is 13.13 percent greater than real GDP in 2018. Real GDP in 2018 was $1,600, so real GDP in 2019 equals ($1,600) × (1.1313), which is $1,810.08. These real GDPs are in terms of 2018 dollars. 5.

Using the chained-dollar method, compare the growth rates of nominal GDP and real GDP in 2019. Between 2018 and 2019, nominal GDP increased from $1,600 to $2,250, an increase of $650. The growth rate of nominal GDP is ($650 ÷ $1,600) × 100, which is 40.6 percent. The growth rate of real GDP is 13.13 percent, so nominal GDP grew much more rapidly than did real GDP.

If the base year is 2019, use the chained-dollar method to calculate real GDP in 2018 and 2019. In terms of what dollars is each of these two real GDPs measured? Real GDP in 2019 = $2,250. It is equal to nominal GDP because 2019 is the base year. To calculate real GDP in 2018 compute the growth rate of real GDP between 2018 and 2019. That growth rate is the average of the growth rates between 2018 and 2019 using prices from 2018 and using prices from 2019. Taking the average of the answers to Problems 2 and 3 gives an average percentage increase of 13.13 percent. This result means that real GDP in 2019 is 13.13 percent greater than real GDP in 2018 so real GDP in 2018 equals ($2,250) ÷ (1.1313), which is $1,988.86. These real GDPs are in terms of 2019 dollars.

If the base year is 2019, compare the growth rates of nominal GDP and real GDP in 2019. From Problem 5, the growth rate of nominal GDP is 40.6 percent. From Problem 6, the growth rate of real GDP in 2019 dollars is 13.13 percent.