Principles Of Macroeconomics , 5th Canadian Edition Solution Manual

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1WHAT’S NEW IN THEFIFTH EDITION?There are no substantial changes in this chapter.LEARNING OBJECTIVESBy the end of this chapter, students should understand:that economics is about the allocation of scarce resources.that individuals face tradeoffs.the meaning of opportunity cost.how to use marginal reasoning when making decisions.how incentives affect people’s behaviour.why trade among people or nations can be good for everyone.why markets are a good, but not perfect, way to allocate resources.what determines some trends in the overall economy.WHY IS THIS CHAPTER IMPORTANT TO STUDENTS?Chapter 1 is the first chapter in a three-chapter section that serves as the introduction to the text.Chapter 1 introduces ten fundamental principles on which the study of economics is based. In a broadsense, the rest of the text is an elaboration on these ten principles. Chapter 2 will develop howeconomists approach problems while Chapter 3 will explain how individuals and countries gain fromtrade.The purpose of Chapter 1 is to lay out ten economic principles that will serve as building blocksfor the rest of the text. The ten principles can be grouped into three categories: how people makedecisions, how people interact, and how the economy works as a whole. Throughout the text, referenceswill be made repeatedly to these ten principles.1TEN PRINCIPLES OF ECONOMICS

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2Chapter 1/Ten Principles of EconomicsIF NOTHINGELSE, MY STUDENTS SHOULD LEARN…1.The fundamental lessons about individual decision making are that people face tradeoffs amongalternative goals, that the cost of any action is measured in terms of forgone opportunities, thatrational people make decisions by comparing marginal costs and marginal benefits, and that peoplechange their behaviour in response to the incentives they face.2.The fundamental lessons about interactions among people are that trade can be mutually beneficial,that markets are usually a good way of coordinating trades among people, and that the governmentcan potentially improve market outcomes if there is some sort of market failure or if the marketoutcome is inequitable.3.The fundamental lessons about the economy as a whole are that productivity is the ultimate sourceof living standards, that money growth is the ultimate source of inflation, and that society faces ashort-run tradeoff between inflation and unemployment.WHAT CAN I DO IN CLASS?I.IntroductionA.The word “economy” comes from the Greek word meaning “one who manages ahousehold.”B.This makes some sense since in the economy we are faced with many decisions (just asa household is).C.Fundamental economic problem: resources are scarce.D.Definition ofscarcity: the limited nature of society’s resources.E.Definition ofeconomics: the study of how society manages its scarce resources.Because most college freshmen and sophomores have limited experiences withviewing the world from a cause-and-effect perspective, do not underestimate howchallenging these principles will be for the student.You will want to start the semester by explaining to students that part of learningeconomics is to understand new vocabulary.Economists generally use very precise(and sometimes different) definitions for words that are commonly used outside ofthe economics discipline.Therefore, it will be helpful to students if you follow thedefinitions provided in the text as much as possible.Begin by pointing out that economics is a subject that students must confront in theireveryday lives.Point out that they already spend a great deal of their time thinkingabout economic issues: prices, buying decisions, use of their time, etc.

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Chapter 1/Ten Principles of Economics3II.How People Make DecisionsA.Principle #1: People Face Tradeoffs1.“There is no such thing as a free lunch.”Making decisions requires trading offone goal for another.2.Examples include how a student spends her time, how a family decides to spendits income, how the Canadian government spends tax dollars, how regulationsmay protect the environment at a cost to firm owners.3.A special example of a tradeoff is the tradeoff between efficiency and equity.a.Definition ofefficiency: the property of society getting the most itcan from its scarce resources.b.Definition ofequity: the property of distributing economicprosperity fairly among the members of society.c.For example, tax dollars paid by wealthy Canadians and then distributedto those less fortunate may improve equity but lower the return to hardwork and therefore reduce the level of output produced by ourresources.d.This implies that the cost of this increased equity is a reduction in theefficient use of our resources.4.Recognizing that tradeoffs exist does not indicate what decisions should bemade.B.Principle #2: The Cost of Something Is What You Give Up to Get It1.Making decisions requires individuals to consider the benefits and costs of someaction.2.What are the costs of going to college?a.We cannot count room and board (at least all of the cost) because theperson would have to pay for food and shelter even if he was not inschool.b.We would want to count the value of the student’s time since he couldbe working for pay instead of attending classes and studying.3.Definition ofopportunity cost: whatever must be given up to obtainsome item.As you discuss the ten principles, make sure that students realize that it is okay ifthey do not grasp each of the concepts completely or find each of the argumentsfully convincing.These ideas will be explored more completely throughout the text.One of the hardest ideas for students to grasp is that “free” things are not truly free.Thus, you will need to provide students with numerous examples of such “free”things with hidden costs, especially the value of time.

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4Chapter 1/Ten Principles of EconomicsC.Principle #3: Rational People Think at the Margin1.Many decisions in life involve incremental decisions: Should I remain in schoolthis semester?Should I take another course this semester?Should I study anadditional hour for tomorrow’s exam?2.Definition ofmarginal changes: small incremental adjustments to a planof action.3.Definition ofrational people: systematically and purposefully do the bestthey can achieve their objectives, given the opportunities they have.4.Example: Suppose that flying a 200-seat plane across the country costs theairline $100,000, which means that the average cost of each seat is $500.Suppose that the plane is minutes from departure and a passenger is willing topay $300 for a seat.Should the airline sell the seat for $300?In this case, themarginal cost of an additional passenger is very small.5.Marginal decision making can help explain puzzling economic phenomena.a.Why is water to cheap while diamonds are so expensive?b.The reason is that a person’s willingness to pay for any goodis based onthe marginal benefit that an extra unit of the good would yield. Themarginal benefit, in turn, depends on how many units a person alreadyhas.6.A rational decision maker takes an action if and only if the marginal benefit of theaction exceeds the marginal cost.D.Principle #4: People Respond to Incentives1.Definition ofincentive: something that induces a person to act.2.Because people make decisions by weighing costs and benefits, they respond toincentives.a.When the price of a good rises, consumers will buy less of it because itscost has risen.b.When the price of a good rises, producers will allocate more resources tothe production of the good because the benefit from producing the goodhas risen.3.Sometimes policymakers fail to understand how policies may alter incentives andbehaviour.4.Example: Seat belt laws increase use of seat belts and lower the incentives ofindividuals to drive safely.This leads to an increase in the number of caraccidents.This also leads to an increased risk for pedestrians.If you include any incentive-based criteria on your syllabus, discuss it now.Forexample, if you reward class attendance (or penalize students who do not attendclass), explain to students how this change in the marginal benefit of attending classcan be expected to alter their behaviour.

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Chapter 1/Ten Principles of Economics5III.How People InteractA.Principle #5: Trade Can Make Everyone Better Off1.Trade is not like a sports competition where one side gains and the other sideloses.2.Consider trade that takes place inside your home.Certainly the family isinvolved in trade with other families on a daily basis.Most families do not buildtheir own homes, make their own clothes, or grow their own food.3.Just like families benefit from trading with one another, so do countries.4.This occurs because it allows for specialization in areas that countries (orfamilies) can do best.Activity 1—Getting Dressed in the Global EconomyType:In-class assignmentTopics:Specialization, interdependence, self-interest, consumer choice,international tradeMaterials needed:NoneTime:20 minutesClass limitations:Works in any class sizePurposeThe advantages of specialization and division of labour are very clear in this example.Theworldwide links of the modern economy are also illustrated.We depend on thousands ofpeople we don’t know, won’t see, and don’t think of in order to get dressed each morning.Self-interest follows naturally from interdependence.Wages, profits, and rents give peoplethe incentive to perform these varied tasks.We depend on them to clothe us and theydepend on our purchases for their incomes.InstructionsAsk the class to answer the following questions.Give them time to write an answer to eachquestion, then discuss their answers before moving on to the next question.The firstquestion can be answered with a brief phrase.The second question is the core of theassignment and takes several minutes.Ask them to list as many categories of workers aspossible.The third question introduces demand concepts; most of the determinants ofdemand can be introduced during this discussion.For the fourth question, ask the class tolook at the country-of-origin tags sewn in their garments.1.Where did your clothes come from?2.Who worked to produce your clothes?3.What things do you consider when buying a garment?4.Where were your clothes produced (what countries)?Common Answers and Points for Discussion1.Where did your clothes come from?There are many possible ways to answer, but many students will say “the mall” or anotherretail outlet.Some may say “a factory,” “a sweatshop,” or “a foreign country.”

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6Chapter 1/Ten Principles of EconomicsB.Principle #6: Markets Are Usually a Good Way to Organize Economic Activity1.Many countries that once had centrally planned economies have abandoned thissystem and are trying to develop market economies.2.Definition ofmarket economy: an economy that allocates resourcesthrough the decentralized decisions of many firms and households asthey interact in markets for goods and services.3.Market prices reflect both the value of a product to consumers and the cost ofthe resources used to produce it.Therefore, decisions to buy or produce goodsand services are made based on the cost to society of providing them.4.When a government interferes in a market and restricts price from adjustingdecisions that households and firms make are not based on the properinformation.Thus, these decisions may be inefficient.Explain to students that when households and firms do what is best for themselves,they often end up doing what is best for society, as if guided by market forces—or aninvisible hand.Spend some time and emphasize the magic of the market.Usenumerous examples to show students that the market most often allocates resourcesto their highest valued use.Mention the importance of markets here (this can be emphasized by asking “Is anyonewearing something made by themselves, a friend, or a relative?”) and discuss distributionversus production.2.Who worked to produce your clothes?There is no end to the possible answers; garment and textile workers are obvious but moststudents will also list workers dealing with raw materials, transportation, management, designor machinery.Some may think more broadly to investors, road crews, bankers, engineers, oraccountants.3.What things do you consider when buying a garment?Most answers focus on preferences (fit, style, quality, color).Price is cited less frequently.Ask about the importance of price until someone volunteers that income is important.Pricesof substitute goods should also be discussed.Expectations of price changes may also bementioned.Few students mention complementary goods and most students reject the ideaof choosing a sweater to match a particular outfit.4.Where were your clothes produced (what country)?A large number of countries will be represented, even in small classes.Students are usuallysurprised to find how many garments are domestically produced.Asia is always wellrepresented.Latin American and European goods appear in smaller numbers.Africanproducts are conspicuously absent.This pattern shows the limits of simple explanations such as “cheap labour.”Briefly discussthe importance of comparative advantage and specialization.

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Chapter 1/Ten Principles of Economics75.Centrally planned economies have failed because they did not allow the marketto work.6.In The News: Prices Convey Informationa.In many markets, prices are determined by the forces of supply anddemand.However, in markets where futures contracts are sold, pricesare based on the expectations of specific events taking place in thefuture.b.This article from theNational Post discusses the effectiveness of marketsto predict the future.7.FYI:Adam Smith and the Invisible Handa.Adam Smith’s 1776 work suggested that although individualsaremotivated by self-interest, an invisible hand guides this self- interest intopromoting society’s economic well-being.b.Smith’s astute perceptions will be discussed more fully in the chapters tocome.C.Principle #7: Governments Can Sometimes Improve Market Outcomes1.Markets work only if property rights are enforceda.Definition ofproperty rights: the ability of an individual to ownand exercise control over scarce resources.2.Government policy can be most useful when there is market failure.a.Definition ofmarket failure: a situation in which a market left onits own fails to allocate resources efficiently.3.Examples of Market Failurea.Definition ofexternality: the impact of one person’s actions onthe well-being of a bystander.b.Definition ofmarket power: the ability of a single economic actor(or small group of actors) to have a substantial influence onmarket prices.c.Because a market economy rewards people for their ability to producethings that other people are willing to pay for, there will be an unequaldistribution of economic prosperity.4.Note that the principle states that the governmentcan improve marketoutcomes.This is not saying that the government alwaysdoes improve marketoutcomes.

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8Chapter 1/Ten Principles of EconomicsIV.How the Economy as a Whole WorksA.Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods andServices1.Differences in living standards from one country to another are quite large.2.Changes in living standards over time are also large.3.The explanation for differences in living standards lies in differences inproductivity.4.Definition ofproductivity: the quantity of goods and services producedfrom each hour of a worker’s time.5.High productivity implies a high standard of living.6.Thus, policymakers must understand the impact of any policy on our ability toproduce goods and services.B.Principle #9: Prices Rise When the Government Prints Too Much Money1.Definition ofinflation: an increase in the overall level of prices in theeconomy.2.When the government creates a large amount of money, the value of moneyfalls.3.Examples: Germany after World War I (in the early 1920s), and Canada in the1970s.C.Principle #10: Society Faces a Short-Run Tradeoff between Inflation and Unemployment1.The short-run effects of monetary injection:a.Increasing the amount of money in the economy stimulates the overall levelof spending and thus the demand for goods and services.b.Higher demand may over time cause firms to raise their prices, it alsoencourages them to increase the quantity of goods and services theyproduce and to hire more workers to produce those goods and services.c.More hiring means lower unemployment.2.Some economists still question these ideas.3.Over a short period of time, economic policies push inflation and unemploymentin opposite directions.4.The policymakers face this trade-off regardless of whether inflation andunemployment both start out at high or low levels.5.The short run tradeoff between inflation and unemployment is important forunderstanding the business cycle.

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Chapter 1/Ten Principles of Economics96.Definition ofbusiness cycle: fluctuations in economic activity, such asemployment and production.7.Policymakers can exploit this short-run tradeoff by using various policyinstruments, but the extent and desirability of these interventions is of continuingdebate.D.FYI: How to Read this Book1.Economics is very useful to understand, but it can be a difficult subject to grasp.2.There are five tips to make reading and understanding the material inthe book easier.a.Summarize, don’t highlight.b.Test yourself.c.Practice, practice, practice.d.Study in groups.e.Don’t forget the real world.Activity 2—So Many Things to Do, So Little TimeType:In-class assignmentTopics:Tradeoffs, opportunity cost, thinking at the margin, incentivesMaterials needed:NoneTime:10 minutesClass limitations:Works in any class sizeGive students a list of activities with corresponding time requirements: sleep, 8 hours; sleep,6 hours; eat breakfast, 30 minutes; ride a bike, 1 hour; go hiking, 2 hours; study, 3 hours;study, 2 hours; go to class, 4 hours; go to class, 6 hours; watch TV, 2 hours; watch TV, 6hours; take a nap, 1 hour; work, 8 hours; work, 4 hours; etc.Make sure that there are many choices and that there are many pleasurable experiences—toomuch for a 24-hour period.Ask students which Principle of Economics this illustrates.If they do not say 1, 2, 3, and 4, help them see that this exercise has tradeoffs in the choicesthey make, that each choice has an opportunity cost, that deciding whether or not to sleep 4more hours may depend on whether you have already slept for 6, and that choices may beinfluenced by the incentives the student faces.For example, a student who is about to beplaced on academic probation has an incentive to study harder.

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10Chapter 1/Ten Principles of EconomicsSOLUTIONS TO TEXT PROBLEMS:Quick Quizzes1.The four principles of economic decision-making are:(1) people face tradeoffs; (2) the cost ofsomething is what you give up to get it; (3) rational people think at the margin; and (4) peoplerespond to incentives.People face tradeoffs because to get one thing that they like, they usuallyhave to give up another thing that they like.The cost of something is what you give up to get it,not just in terms of monetary costs but all opportunity costs. Rational people think at the marginby taking an action if and only if the marginal benefits exceed the marginal costs.Peoplerespond to incentives because as they compare benefits to costs, a change in incentives maycause their behaviour to change.2.The three principles concerning economic interactions are:(1) trade can make everyone betteroff; (2) markets are usually a good way to organize economic activity; and (3) governments cansometimes improve market outcomes.Trade can make everyone better off because it allowscountries to specialize in what they do best and to enjoy a wider variety of goods and services.Markets are usually a good way to organize economic activity because the invisible hand leadsmarkets to desirable outcomes.Governments can sometimes improve market outcomes becausesometimes markets fail to allocate resources efficiently because of an externality or marketpower.3.The three principles that describe how the economy as a whole works are:(1) a country’sstandard of living depends on its ability to produce goods and services; (2) prices rise when thegovernment prints too much money; and (3) society faces a short-run tradeoff between inflationand unemployment.A country’s standard of living depends on its ability to produce goods andservices, which in turn depends on its productivity, which is a function of the education ofworkers and the access workers have to the necessary tools and technology.Prices rise whenthe government prints too much money because more money in circulation reduces the value ofmoney, causing inflation.Society faces a short-run tradeoff between inflation and unemploymentthat is only temporary and policymakers have some ability to exploit this relationship usingvarious policy instruments.Questions for Review1.Examples of tradeoffs include time tradeoffs (such as studying one subject over another, orstudying at all compared to engaging in social activities) and spending tradeoffs (such as whetherto use your last ten dollars on pizza or on a study guide for that tough economics course).2.The opportunity cost of seeing a movie includes the monetary cost of admission plus the timecost of going to the theater and attending the show.The time cost depends on what else youmight do with that time; if it's staying home and watching TV, the time cost may be small, but ifit's working an extra three hours at your job, the time cost is the money you could have earned.3.The marginal benefit of a glass of water depends on your circumstances.If you've just run amarathon, or you've been walking in the desert sun for three hours, the marginal benefit is veryhigh.But if you've been drinking a lot of liquids recently, the marginal benefit is quite low.Thepoint is that even the necessities of life, like water, don't always have large marginal benefits.4.Policymakers need to think about incentives so they can understand how people will respond tothe policies they put in place.The text's example of seat belts shows that policy actions canhave quite unintended consequences.If incentives matter a lot, they may lead to a very

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Chapter 1/Ten Principles of Economics11different type of policy; for example, some economists have suggested putting knives in steeringcolumns so that people will drive much more carefully!While this suggestion is silly, it highlightsthe importance of incentives.5.Trade among countries isn't a game with some losers and some winners because trade can makeeveryone better off.By allowing specialization, trade between people and trade betweencountries can improve everyone's welfare.6.The "invisible hand" of the marketplace represents the idea that even though individuals andfirms are all acting in their own self-interest, prices and the marketplace guide them to do what isgood for society as a whole.7.The two main causes of market failure are externalities and market power.An externality is theimpact of one person’s actions on the well-being of a bystander, such as from pollution or thecreation of knowledge.Market power refers to the ability of a single person (or small group ofpeople) to unduly influence market prices, such as in a town with only one well or only one cabletelevision company.In addition, a market economy also leads to an unequal distribution ofincome.8.Productivity is important because a country's standard of living depends on its ability to producegoods and services.The greater a country's productivity (the amount of goods and servicesproduced from each hour of a worker's time), the greater will be its standard of living.9.Inflation is an increase in the overall level of prices in the economy.Inflation is caused byincreases in the quantity of a nation's money.10.Inflation and unemployment are negatively related in the short run.Reducing inflation entailscosts to society in the form of higher unemployment in the short run.Problems and Applications1.a.A family deciding whether to buy a new car faces a tradeoff between the cost of the carand other things they might want to buy.For example, buying the car might mean theymust give up going on vacation for the next two years.So the real cost of the car is thefamily's opportunity cost in terms of what they must give up.b.For a member of Parliament deciding whether to increase spending on national parks,the tradeoff is between parks and other spending items or tax cuts.If more money goesinto the park system, that may mean less spending on national defense or on the policeforce.Or, instead of spending more money on the park system, taxes could be reduced.c.When a company president decides whether to open a new factory, the decision is basedon whether the new factory will increase the firm's profits compared to otheralternatives.For example, the company could upgrade existing equipment or expandexisting factories.The bottom line is: Which method of expanding production willincrease profit the most?d.In deciding how much to prepare for class, a professor faces a tradeoff between thevalue of improving the quality of the lecture compared to other things she could do withher time, such as working on additional research.2.When the benefits of something are psychological, such as going on a vacation, it isn't easy tocompare benefits to costs to determine if it's worth doing.But there are two ways to think about

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12Chapter 1/Ten Principles of Economicsthe benefits.One is to compare the vacation with what you would do in its place.If you didn'tgo on vacation, would you buy something like a new set of golf clubs?Then you can decide ifyou'd rather have the new clubs or the vacation.A second way is to think about how much workyou had to do to earn the money to pay for the vacation; then you can decide if thepsychological benefits of the vacation were worth the psychological cost of working.3.If you are thinking of going skiing instead of working at your part-time job, the cost of skiingincludes its monetary and time costs, which includes the opportunity cost of the wages you aregiving up by not working.If the choice is between skiing and going to the library to study, thenthe cost of skiing is its monetary and time costs including the cost to you of getting a lower gradein your course.4.If you spend $100 now instead of saving it for a year and earning 5 percent interest, you aregiving up the opportunity to spend $105 a year from now.The idea that money has a time valueis the basis for the field of finance, the subfield of economics that has to do with prices offinancial instruments like stocks and bonds.5.The fact that you've already sunk $5 million isn't relevant to your decision anymore, since thatmoney is gone.What matters now is the chance to earn profits at the margin.If you spendanother $1 million and can generate sales of $3 million, you'll earn $2 million in marginal profit,so you should do so.You are right to think that the project has lost a total of $3 million ($6million in costs and only $3 million in revenue) and you shouldn't have started it.That's true, butif you don't spend the additional $1 million, you won't have any sales and your losses will be $5million.So what matters is not the total profit, but the profit you can earn at the margin.Infact, you'd pay up to $3 million to complete development; any more than that, and you won't beincreasing profit at the margin.6.Harry suggests looking at whether productivity would rise or fall.Productivity is certainlyimportant, since the more productive workers are, the lower the cost per gallon of potion.Ronwants to look at average cost.But both Harry and Ron are missing the other side of theequationrevenue.A firm wants to maximize its profits, so it needs to examine both costsandrevenues.Thus, Hermione is rightit’s best to examine whether the extra revenue wouldexceed the extra costs.Hermione is the only one who is thinking at the margin.7.a.The provision of welfare benefits lowers an individual’s incentive to save for retirement.The benefits provide some level of income to the individual when he or she retires.Thismeans that the individual is not entirely dependent on savings to support consumptionthrough the years in retirement.b.Since a person gets fewer after-tax welfare benefits the greater is his or her earnings,there is an incentive not to work (or not work as much) after age 65.The more youwork, the lower your after-tax welfare benefits will be.Thus the taxation of welfarebenefits discourages work effort after age 65.8.a.The loss of benefits means that someone who can't find a job will get no income at all,so the distribution of income will become less equal.But the economy will be moreefficient, since welfare recipients have a greater incentive to find jobs.b.The change in the law is one that increases efficiency but reduces equity.

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Chapter 1/Ten Principles of Economics139.By specializing in each task, you and your roommate can finish the chores more quickly. If youdivided each task equally, it would take you more time to cook than it would take yourroommate, and it would take him more time to clean than it would take you.By specializing, youreduce the total time spent on chores.Similarly, countries can specialize and trade, making both better off.For example, suppose ittakes Spanish workers less time to make clothes than French workers, and French workers canmake wine more efficiently than Spanish workers.Then Spain and France can both benefit ifSpanish workers produce all the clothes and French workers produce all the wine, and theyexchange some wine for some clothes.10.a.Being a central planner is tough!To produce the right number of CDs by the right artistsand deliver them to the right people requires an enormous amount of information.Youneed to know about production techniques and costs in the CD industry.You need toknow each person's musical tastes and which artists they want to hear.If you make thewrong decisions, you'll be producing too many CDs by artists that people don't want tohear, and not enough by others.b.Your decisions about how many CDs to produce carry over to other decisions.You haveto make the right number of CD players for people to use.If you make too many CDsand not enough cassette tapes, people with cassette players will be stuck with CDs theycan't play.The probability of making mistakes is very high.You will also be faced withtough choices about the music industry compared to other parts of the economy.If youproduce more sports equipment, you'll have fewer resources for making CDs.So alldecisions about the economy influence your decisions about CD production.11.These activities tend to lessen the efficiency of an economic system, hence reducing theeconomic productivity of a nation. Lower productivity means lower standards of living.12.a.Efficiency:The market failure comes from the monopoly by the cable TV firm.b.Equityc.Efficiency:An externality arises because secondhand smoke harms nonsmokers.d.Efficiency:The market failure from the monopoly occurring from the merger.e.Equityf.Efficiency:There is an externality because of accidents caused by drunk drivers.13.a.If everyone were guaranteed the best health care possible, much more of our nation'soutput would be devoted to medical care than is now the case.Would that be efficient?If you think that currently doctors form a monopoly and restrict health care to keep theirincomes high, you might think efficiency would increase by providing more health care.But more likely, if the government mandated increased spending on health care, theeconomy would be less efficient because it would give people more health care than theywould choose to pay for.From the point of view of equity, if poor people are less likelyto have adequate health care, providing more health care would represent animprovement.Each person would have a more even slice of the economic pie, thoughthe pie would consist of more health care and less of other goods.b.When workers are laid off, equity considerations argue for the unemployment benefitssystem to provide them with some income until they can find new jobs.After all, no oneplans to belaid off, so unemployment benefits are a form of insurance.But there’s anefficiency problemwhy work if you can get income for doing nothing?The economyisn’t operating efficiently if people remain unemployed for a long time, andunemployment benefits encourage unemployment.Thus, there’s a tradeoff between

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14Chapter 1/Ten Principles of Economicsequity and efficiency.The more generous are unemployment benefits, the less income islost by an unemployed person, but the more that person is encouraged to remainunemployed. So greater equity reduces efficiency.14.Since average income in Canada has roughly doubled every 35 years, we are likely to have abetter standard of living than our parents, and a much better standard of living than ourgrandparents.This is mainly the result of increased productivity, so that an hour of workproduces more goods and services than it used to.Thus incomes have continuously risen overtime, as has the standard of living.15.If Canadians save more and it leads to more spending on factories, there will be anincrease inproduction and productivity, since the same number of workers will have more equipment towork with.The benefits from higher productivity will go to both the workers, who will get paidmore since they're producing more, and the factory owners, who will get a return on theirinvestments.There is no such thing as a free lunch, however, because when people save more,they are giving up spending.They get higher incomes at the cost of buying fewer goods.16.To make an intelligent decision about whether to reduce inflation, a policymaker would need toknow what causes inflation and unemployment, as well as what determines the tradeoff betweenthem.Any attempt to reduce inflation will likely lead to higher unemployment in the short run.Apolicymaker thus faces a tradeoff between the benefits of lower inflation compared to the cost ofhigher unemployment.

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15WHAT’S NEW IN THEFIFTH EDITION?A newIn The Newsbox, ―Environmental Economists‖ replaces theold―Why Should You StudyEconomics‖ box.LEARNING OBJECTIVESBy the end of this chapter, students should understand:how economists apply the methods of science.how assumptions and models can shed light on the world.two simple models—the circular flow and the production possibilities frontier.the difference between microeconomics and macroeconomics.the difference between positive and normative statements.the role of economists in making policy.why economists sometimes disagree with one another.WHY IS THIS CHAPTER IMPORTANT TO STUDENTS?Chapter 2 is the second chapter in a three chapter section that serves as the introduction of the text.Chapter 1 introduced ten principles of economics that will be revisited throughout the text. Chapter 2develops how economists approach problems while Chapter 3 will explain how individuals and countriesgain from trade.The purpose of Chapter 2 is to familiarize students with how economists approach economicproblems. With practice, they will learn how to approach similar problems in this dispassionate systematicway. They will see how economists employ the scientific method, the role of assumptions in modelbuilding, and the application of two specific economic models. Students will also learn the importantdistinction between two roles economists can play: as scientists when we try to explain the economicworld and as policymakers when we try to improve it.2THINKING LIKE AN ECONOMIST

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Economics - Monopoly

Economics - Monopolistic Competition and Oligopoly

Economics - Money and Banking

Economics - Labor Market

Economics - Introduction

Economics - GDP, Inflation, and Unemployment

Economics - Fiscal and Monetary Policy

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