Solution Manual For Macroeconomics, 16th Edition

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INSTRUCTOR’SMANUALChristopher T.S. RaganMcGill UniversityMacroeconomicsSixteenthCanadian EditionChristopher T.S. Ragan

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ContentsPart One: What Is Economics?1Chapter 1: Economic Issues andConcepts3Chapter 2: Economic Theories, Data, and Graphs13Part Two: An Introduction to Demand and Supply26Chapter 3: Demand, Supply, and Price27Part Seven: An Introduction to Macroeconomics209Chapter 19: What Macroeconomics Is All About211Chapter 20: The Measurement of National Income218Part Eight: The Economy in the Short Run226Chapter 21: The Simplest Short-Run Macro Model228Chapter 22: Adding Government and Trade to the Simple Macro Model239Chapter 23:Real GDP and the Price Levelin the Short Run250Part Nine: The Economy in the Long Run261Chapter 24: From the Short Run to the Long Run: The Adjustment of Factor Prices262Chapter 25: Long-Run Economic Growth272Part Ten: Money, Banking, and Monetary Policy281Chapter 26: Money and Banking283Chapter 27: Money, Interest Rates, and Economic Activity291Chapter 28: Monetary Policy in Canada300Part Eleven: Macroeconomic Problems and Policies307Chapter 29: Inflation and Disinflation308Chapter 30: Unemployment Fluctuations and the NAIRU316Chapter 31: Government Debt and Deficits325Part Twelve: Canada in the Global Economy334Chapter 32: The Gains from International Trade335Chapter 33: Trade Policy344Chapter 34: Exchange Rates and the Balance of Payments352

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________________________________________Part OneWhat Is Economics?________________________________________This opening Part of the book provides an introduction to economics. The central themes of Chapter1 are scarcity,choice, opportunity cost, and the self-organizing role of markets. The chapter alsoexamines the gains from specialization and trade, the role of money, the effects of globalization, andends with a discussion of the various types of economic systems.Chapter 2 examines how economistsbuild their modelsand test their theories. It also addresses central methodological issues, the mostimportant being the idea that the progress of economics(like all scientific disciplines)depends onrelating our theories to what we observe in the world around us. Finally, the chapter has anextensivesection ongraphing.***Chapter 1opens with a brief tour of some key economic issues in Canada and other countries—fromrising protectionismandthe dangers ofclimatechange toaccelerating technological changeandgrowing income inequality. The purpose is to whet the reader’sappetite for the kinds of issueseconomists are thinking about today.This offers a natural segue to the discussionof scarcity, withoutwhichfew of these issues would be very interesting.The chapteraddresses the fundamental conceptsof scarcity, choice, and opportunity cost, illustrating these ideas with a production possibilitiesboundary. (It is worth noting that these concepts are relevant toalleconomies,whether they areorganized bycentral planning orbyfree markets.) We then examine thecomplexity of modernmarket economies, examining the decision makers, production, trade, money, and globalization.Finally, we examine different types of economic systems, including traditional, command, and free-market systems. We emphasize that all actual economies are mixtures, containing elements of allthree pure systems.Chapter 2 provides a longer introduction to the methodological issues of economics than isusually included in introductory texts. We do this because most students believe that the scientificmethod is limited to the natural sciences. But to appreciate economics, they must understand that itstheories are also open to empirical testing and that these theories continually change as a result ofwhat the empirical evidence shows. We understand that some instructors feel their time is so limitedthat they cannot spend class time on Chapter 2. We believe that even if it is not covered in class,students’ attention should be called to the issues addressed in the chapter. Our experience is thatstudents benefit from some discussion of the scientific method and from the insight that the socialsciences are not all that different from the “hard” sciences, at least in their basic approaches.

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition2The chapter begins by making the distinction between positive and normative statements. Wethen work carefully through the various elements of economictheories, including definitions,assumptions, and predictions.Testing theories is as important as developing them, so we emphasizethe interaction between theorizing and empirical observation. We then present various types ofeconomic data, and this gets us into a detailed discussion of index numbers, time-series andcross-section data, and graphs. The final section of the chapter goes through graphing in detail.

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_______________________________________Chapter 1: Economic Issues and Concepts_______________________________________This chapter is inthree mainsections, after a short introductory mention of some key economicissues of the day.The first substantive section develops the concepts of scarcity, choice, andopportunity cost. To ensure the student really understands what opportunity cost is all about, wehave a box that examines the opportunity cost of a university orcollege degree. This should be afamiliar example to which students can easily relate.The production possibilities boundary is thenintroduced, and it is shown to embody the three key concepts of scarcity, choice and opportunitycost. Its nature as a frontierbetween attainable andunattainable is worth stressing, as is the factthat what is attainable is itself subject to change. Four key economic problems are then discussed,and each one is expressed in terms of the production possibilities boundary. These questions givethe student an inkling of the types of questions addressed both in microeconomics and inmacroeconomics.Thechapter’s secondsection examines the complexity of modern economies, asking whythe things we want to purchase are almost always available. What produces this remarkablecoordination? We discuss the market as an instrument that brings order to the economy as a whole.Along the way, the student is introduced to Adam Smith’s “invisible hand”.The section alsodiscusseswho makes the choices in a market economy, and why incentives matter. We show thecircular flow of income and expenditure as a way of showing the interaction between consumersand producers. We also examine the nature of maximizing decisions (both utility and profit), andthe importance of decisions at the margin. Finally, on the production side, we examine the role ofspecialization, thedivision of labour, globalization, and the importance of money in facilitatingtrade.The chapter’sthird andfinal section deals with comparative economic systems. Studentswill read in almost every chapter of this book about a market economy. Contrasting it with plannedand traditional economies is a good way to gain some insight into the concept at the outset.Weemphasize that actual economies are rarely, if ever, well represented by the extremes; instead,actual economies are mixed economies, with varying degrees of government ownership andplanning. Students are introduced to Karl Marx’s argument for a centrally planned economy. WhileMarx had many things right, we argue that central planning has not been successful in provingitself as an efficient way of organizing an economy,allocating resources, or generating prosperityfor a large fraction of the population.

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition4Answers to Study ExercisesFill-in-the-Blank QuestionsQuestion 1a)land, labour, capital; factorsb)opportunity costc)production possibilities boundaryd)scarcity(because points outside the boundary are unattainable); downward (or negative); theopportunity cost associated with any choicee)constant; increasingf)increases(meaning that more units of good B must be given up to get an extra unit of good A)Question 2a)self;self-interestb)incentives created by market pricesc)firms; households; governmentsd)increase(maximize); increase (maximize)e)margin; (marginal) costQuestion 3a)division; specializationb)tradec)moneyd)globalization

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Chapter 1: Economic Issues and Concepts5Review QuestionsQuestion 4Any realistic production possibilities boundary displays scarcity, the need forchoice, andopportunity cost.Scarcity:The production possibilities boundary (PPB) separates attainable combinations of goodsfrom those that are unattainable. Thus scarcity is shown by the existence of some unattainablebundles of goods.Choice:Because of scarcity, societies must somehow choose how resources are to be allocated;thus a particular point on the PPB must be chosen.Opportunity Cost:The slope of the PPB is negative, revealing the opportunity cost that isunavoidable every time a choice is made. For the economy as a whole, the decision to producemore of one good must involve a decision to produce less of some other good.Question 5Consider any country’s production possibilities boundary, and suppose the two products are X andY. Atechnological improvement in industryX shifts the PPB out (along the X axis), increasingthe maximum amount of X that can be produced. Note that the maximum amount of Y that can beproduced has not changed. But since the PPB has shiftedout, there are manycombinationsofbothgoodsthat are now available that were not before, and some of these involve producingmore ofboth goods.Thus, even though the technology for producing Y has not changed, the technologicalimprovement in X does allow the country to choose to produce more of both products.Question 6The central ideas illustrated by the two-good version of the production possibilities boundary (PPB)are scarcity, choice, and opportunity cost. Exactly the same ideas can be illustrated in a more realisticthree-good version of the model, which is more complicated to draw, or by the much more realisticN-good version of the model (with N4), which is impossible to draw. Thus the assumption of onlytwo goods is merely a simplifying one: it allows us to easily grasp and illustrate some central pointsthatwould be more difficult to understand in the more general N-good case.Question 7a)IfallCanadian families had $80,000of after-tax income (roughly the Canadian average), itwould be difficult to say that real poverty existed in Canada. At this level of income, all familieswould easily have enough income to provide the essentials of food, shelter, and clothing, and couldalso have much beyond these essentials. However, there would still be many things that thesefamilies could not afford, such as expensive university education, expensive vacations, a cottage

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition6in the country, etc. Defining poverty with any precision is difficult, and we will say more aboutthis in Chapter 18.b) Would scarcity exist in such a setting? Yes, certainly. By scarcity we mean simply an excess ofwants over the resources available to satisfy those wants. And scarcity would exist for each ofthose families because most(if not all)of them would still desire to have more than they actuallyhad.c) Scarcity is an excess of wants over the resources available to satisfy those wants. Poverty—atleast in its “absolute form”—is concerned with a level of resources below some threshold ofsufficiency. One can conceivably eliminate poverty, as in part (a), but that would not eliminatescarcity.Question 8Microeconomicsis the study of the allocation of resources within and across individual markets,and the determination of relative prices and quantitiesin those specific markets.Little or noattention is paid to the behaviour of the aggregate economy.Macroeconomicsis the study of thedeterminationofaggregatessuchasaggregateoutput,employment,thepricelevel,theunemployment rate, and the exchange rate.When doing macroeconomics, little or no attention ispaid to what is going on in the individual markets for specific products.Question 9In the answers that follow, note that the statements are madeceteris paribus. In other words, thepredicted result of a change in some specific price is made under the assumption that nothing elsechanges.a)As the price of ski-lift tickets rises, you are likely to substitute toward other leisure activities(whose price has not increased) and thus reduce your purchases of ski-lift tickets.b)As the hourly wage for your weekend job rises, the opportunity cost ofnotworking rises. Soyou are more likely than before to decide not to go skiing, and to work instead.c)Asthe fine forspeeding rises, the cost of being caught speeding clearly increases. The benefitof drivingover the speed limitis presumably unchanged, however. So an increase in the value ofspeedingtickets is likely to cause you to reduce your speed (andtowatch more carefully for hiddenpolice cars!).d)The higher the weight placed on the assignment,the greater is the incentive for you to workhard on that assignment (and thus hopefully receive a higher grade on the assignment and on thecourse).This is one obvious reason why professors like to put significant weight on midterm exams–to get students to work hard early in the course rather than leaving all the work to the few daysbefore the final exam!e)As tuition fees for one specific institution increase,youare likely to substitute toward otherinstitutions whose fees have not increased, and thus reduce your desire to attendthe first institution.

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Chapter 1: Economic Issues and Concepts7(For small changes in tuition fees, this effect may be very small because of the perceived largedifferences between some educational institutions.)Question 10There are two reasons why thespecialization of labour is more efficient than self-sufficiency. First,since individual abilities differ, specializing allows each person to focus their energies on whatthey do best, leaving everything else to be done by others. As a result, total output will rise.Second,as people specialize, they often “learn by doing” and become even better at their specific task.Thus specialization often leads to improvements in ability that would not otherwise occur.Question 11The market for doctors’ services depends heavily on the specialization of labour. A person withback pain will not know what is wrong. They go to a general practitioner (GP) who is somewhatfamiliar with a broad range of symptoms and illnesses. The GP mayrule out the simplest possiblecauses for the pain, and in the process determine that the patient requires the services of a specialistwho diagnoses and treats thepatient’sback. The patient is referred to this specialist who maydiagnose a ruptured diskand perform the delicate surgery necessary tosolve the problem. Giventhis reliance on specialization, the market depends on having relatively more GPs who see a largenumber of patients and act as “gatekeepers” for patients to the more specific specialists.Question 12Traditional systems:Behaviour is based primarily on tradition, custom, and habit.Command systems:Decisions about production and consumption are determined by a centralplanning authority.Free-market systems:Production and consumption decisions are madeprivately, by decentralizedproducers and consumers.Mixed systems:Theseeconomic systems contain elements of tradition, command, and free markets.Question 13This quote, if put to a group of students,wouldstimulate much interesting discussion, not only aboutviews on how alternative economic systems work, but also about the words used to describe them.The termplanned economy, for example, describes the conscious use of centralized decision makingfor key economic decisions, but theresultsof that process often look anything but planned, withshortages in some sectors, surpluses in others, and often a rather dispirited and unmotivated privatesector. On the other hand, theunplanneddecentralized market economy––though surely notperfect—creates a much more orderly looking set of outcomes.

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition8ProblemsQuestion 14In general, the opportunity cost (measured in dollars) for any activity includes three things:thedirect (dollar) cost of the activity, plusthe dollar value of whatever you give up in order to do the activity, minuswhatever dollar “savings” the activity generatesIn this case, the direct cost of transportation, lift tickets and accommodation of $300 is definitelyincluded. The income of $120 that you give up also counts. Finally, we must deal with therestaurant meals of $75. Surely you would have eatensomefood even if you hadn’t gone skiing,so the full $75 is not included. But given the relatively high price of restaurant meals compared tobuying your own groceries, you will probably include most of the $75. Thus the opportunity costof the ski trip is $420 plussome (large) fraction of the $75.Question 15a)The budget line is shown below. If all $240,000 is spent on ATVs, you could purchase 30 ofthem; if all the money is spent on snowmobiles, you could purchase 20 of them. The downwardsloping line divides the attainable from the unattainable combinations ofATVs and snowmobiles.b) The opportunity cost of one ATV is the number of snowmobiles that must be given up topurchase an additional ATV. Since each ATV costs $8000 and each snowmobile costs $12000,the opportunity cost of one ATV is 2/3 of a snowmobile.c) Theopportunity cost of one snowmobile is the number of ATVs that must be given up topurchase an additional snowmobile. It is equal to 1.5 ATVs. Note that the opportunity cost of anATV (in terms of forgone snowmobiles) is the inverse of the opportunity costof a snowmobile (interms of forgone ATVs).

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Chapter 1: Economic Issues and Concepts9d) In this case, the prices of ATVs and snowmobiles are independent of how many are purchased.This fact is reflected by the budget line being linear (of constant slope). So both of the opportunitycosts are independent of how many are purchased.Question 16In each scenario, one could choose to plot the production possibilities boundary, where the twonumbers provided are the two intercepts along the two axes. The slope of the boundary wouldshow the opportunity cost of each door (or each window). Alternatively, one can compare the twomaximumvalues, as provided in the question.a) The factory could produceeither1000 windows or 250 doors (or many intermediatecombinations). In order to produce one extra door, it must give up 4 (=1000/250) windows. Inother words, the opportunity cost of one extra door is 4 windows.b) The opportunity cost of one extra door is 1 window (=500/500).c) The opportunity cost of one extra door is 3 windows(=1200/400).d) The opportunity cost of one extra door is 1.35 windows (=942/697).e) The opportunity cost of one extra door is 1.33 windows (=600/450).Question 17This question is good for forcing students to think through the computation of opportunity costand also in showing how the allocation of labour in particular ways can maximize total output.a) You can catch 6 fish or collect 3 bundles of firewood in one day’s work. Thus, your opportunitycost of one additional bundle of firewood is 2 fish. For your friend, the opportunity cost of oneadditional bundle of firewood is 4 fish.b) To allocate tasks in the output-maximizing way, each person should do the task for which theyhave the lower opportunity cost. You have the lower opportunity cost of collecting firewood. Yourfriend has the lower opportunity cost of catching fish (0.25of a bundle for your friend as comparedto 0.5 of a bundle for you). So for the two of you to collectively maximize output you shouldspecialize in collecting firewood and your friend should specialize in catching fish.c) What is the total amount of output after two days, if you allocate labour as in part (b)? In twodays, you would collect 6 bundles of firewood and your friend would catch 16 fish. The reversepattern of specialization would yield only 4 bundles of firewood and 12 fish, which is clearlyinferior.

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition10Question 18a)At point A, 2.5 tonnes of clothing and 3 tonnes of food are being produced per year. At point B,annual production is 2.5 tonnes of clothing and 7 tonnes of food. At point C, annual production is6.5 tonnes of clothing and 3 tonnes of food.b) At point A the economy is either using its resources inefficiently or it is not using all of itsavailable resources. Point B and C represent full and efficient use of available resources becausethey are on the PPB.c) At point B, the opportunity cost of producing one more tonne of food (and increase from 7 to8) is the 2.5 tonnes of clothing that must be given up. The opportunity cost of producing one moretonne of clothing (from 2.5 to 3.5) appears, from the graph,to be approximately 0.75 tonnes offood that must be given up.d) Point D is unattainable given the economy’s current technology and resources. Point D canbecome attainable with asufficient improvement in technology or increase in available resources.Question 19a)As the table shows, there are only 250 workers in Choiceland, and to construct the productionpossibilities boundary (PPB) we must imagine all thecombinations of workers in each sector.Using the two middle columns from the table, we can plot the output levels on a graph to get thefollowing PPB:b) If the economy is already producing 45 units of X and 900 units of Y, then 15 extra units of Xcan only be produced by reducing the production of Y by 300 units. The opportunity cost of 15units of X is therefore 300 units of Y (or 300/15 = 20 units ofY per unit of X). If the economy isalready producing 60 units of X (and 600 units of Y), the opportunity cost of producing anadditional 15 units of X is the full 600 units of Y that must be given up. This implies an opportunitycost of 600/15 = 40 unitsof Y per extra unit of X. Thus, we see that the opportunity cost of X riseswhen more of X is already being produced.

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Chapter 1: Economic Issues and Concepts11c) If the economy is producing 40 units of X and 600 units of Y, then either some resources arenot being used or they are being used inefficiently; the economy is operatinginsidethe productionpossibilities boundary. It would thus be possible to improve the use of resources and increaseoutput of X by 20 units without reducing the output of Y at all. In this sense, the extra output of Xhas no opportunity cost in terms of forgoneunits of Y.d) If any given amount of labour can now produce 10 percent more of good Y, then the PPB shiftsup in a particular way. Specifically, the Y values increase by 10 percent for any given Xvalue, asshown below.Question 20a)It doesn’t matter how the two axes are labelled in this case; just label them X and Y. The longcivil war destroys much of the country’s infrastructure and likely reduces the country’s ability toproduceallproducts. So the PPB shifts inwards, as shown below in part (a) of the figure.b)The axes are now labelled Food andClothing. The new technology doubles the maximumamount of food that can be produced, and so shifts the PPB outward in the manner shown in part(b) of the figure. Note that the vertical intercept (maximum amount of clothing) does not change.c) The axes are again labelled Food and Clothing, as in part (c). In this situation, the earthquakedestroys many clothing factories and so shifts the PPB inward, reducing the maximum possibleamount of clothing (but leaving unaffected the maximum possibleamount of food).d) The axes are labelled X and Y, as shown in part (d) of the figure. The immigration increases thelabour force and increases the country’s ability to produce all products. The PPB shifts outward,increasing the maximum possible amounts of both X and Y. Since the new level of immigration isoccurring each year, every year will see such an outward shift in the PPB.

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition12*****

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______________________________________________Chapter 2: Economic Theories, Data, and Graphs______________________________________________This chapter provides an introduction to the methods economists use in their research. We integratea detailed discussion of graphing into our discussion of how economists present economic data andhow they test economic theories.In our experience, students typically do not learn enough about the connection between theoryand evidence, and how both are central to understanding economic phenomena. We thereforerecommend that considerable emphasis be placed on Figure 2-1, illustrating the process of goingfrom model building to generating hypotheses to confronting data and testing hypotheses, and thenreturning to model building (or rebuilding). There is no real beginning or end to this process, so it isdifficult to call economics an entirely “theory driven” or “data driven” discipline. Without the theoryand models, we don’t know what to look for in the data; but without experiencing the world aroundus, we can’t build sensible models of human behaviour and interaction through markets. Thescientific approach in economics, as in the “hard” sciences, involves a close relationship betweentheory and evidence.***The chapter is divided into four major sections.In the first section, we make the importantdistinction between positive and normative statements and advice. Students must understand thisdistinction, and that the progress of any scientific discipline relies on researchers’ ability to separatewhat evidence suggests is true from what they would like to be true. We conclude this section byexplaining why economists are often seen to disagree even though there is a great deal of agreementamong them on many specific issues. This leads to abox on where economists typically get jobsand the kind of work they often do.The second section explains the elements of economic theories and how they are tested. Weemphasise how a theory’s or model’s definitions and assumptions lead, through a process of logicaldeduction, to a set of conditional predictions. We then examine the testing of theories. It is herethat we focus on the interaction of theory and empirical observation (Figure 2-1). We emphasizethe importance of the distinction between correlation and causation, with a simple example.The chapter’s third section deals with economic data. We begin by explaining theconstruction of index numbers, and we use them to compare the volatility of two sample timeseries. Index numbers are so pervasive in discussions of economic magnitudes thatstudents mustknow what these are and how they are constructed. We then make the distinction between cross-sectional and time-series data, and at this point students are introduced to two types of graph.

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition14This brings us to the chapter’s final section, on graphing. We show how a relation can beexpressed in words, in a table, in an equation, or on a graph. We then go into considerable detailon linear functions, slope, non-linear functions, and functions with minima and maxima. In thisdiscussion, the student is introduced to the concept of themargin, described as the change inYinresponse to a one-unit change inX. In all cases, the graphs apply to real-world situations ratherthan abstract variables. Pollution abatement, hockey-stick production, firm profits, and fuelconsumption are our main examples.Answers to Study ExercisesFill-in-the-Blank QuestionsQuestion 1a) models (or theories)b) endogenous; exogenousc) (conditional) prediction; empiricald) (positively) correlated; causale)self-interest; utility; profitsQuestion 2a)index; relativeb) absolute value of the price; absolute value of the pricec) cross-sectiond) scattere) time-series

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Chapter2:Economic Theories, Data, and Graphs15Question 3a)Y/Xb) 500; positively; 4c) 12;negatively;-0.2d) tangente) zero; zeroReview QuestionsQuestion 4a)normative (“The governmentshouldimpose…” is inherently a value judgement.)b)positive (In principle, we could determine the impact that foreign aid actually has.)c)positive (In principle, we could determine the extent to which fee increases affect access.)d)normative (What is or is not unfair is clearly based on a value judgement.)e)normative(Use of the expression “too much” is a value judgement.)Question 5a)In the Canadian wheat sector, the amount of rainfall on the Canadian prairies is an exogenousvariable; the amount of wheat produced is an endogenous variable.b)To the Canadian market for coffee, the world price of coffee is exogenous; the price of a cup ofcoffee at Tim Horton’s is endogenous.c)To any individual student, the widespread unavailability of student loans is exogenous; theirown attendance at university or college is endogenous.d)To any individual driver, the tax on gasoline is exogenous; his or her own decision regardingwhich vehicle to purchase is endogenous.Question 6The observed correlationcannotlead to a certain inference about causality. It is consistent withthe theory that the increase in demand for homes leads to an increase in the price of lumber(which is generally a pretty sensible theory!), but it is also consistent with a different theory–onein which some unobserved factor leads to both the increase in demand for homes andseparatelyto the increase in the price of lumber.Correlation does not imply causality!

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition16ProblemsQuestion 7a)Using 2009as the base year means that we choose $85 as the base price. We thus divide theactual prices in all years by $85 and then multiply by 100. In this way, we will determine, inpercentage terms, how prices in other years differ from prices in 2009. The index values are asfollows:YearPrice ($)Physics textbook price index200985(85/85)100 = 100201087(87/85)100 = 102.4201194(94/85)100 = 110.62012104(104/85)100 = 122.42013110(110/85)100 = 129.42014112(112/85)100 = 131.82015120(120/85)100 = 141.22016125(125/85)100 = 147.12017127(127/85)100 = 149.42018127(127/85)100 = 149.42019130(130/85) × 100 = 152.9b)The price index in 2014is 131.8, meaning that the price of the physics textbook is 31.8 percenthigher in 2014 than in the base year, 2009.c)From 2016 to 2019, the price index increases from 147.1 to 152.9but this isnotan increase of5.8 percent. The percentage increase in the price index from 2016 to 2019is equal to [(152.9-147.1)/147.1]×100 = 3.94 percent.d) These are time-series data because the data are for the same product at the same place but atdifferent points in time.Question 8a) Using Calgary as the “base university” means that we choose $6.25 as the base price. Thus wedivide all actual prices by $6.25 and then multiply by 100. In this way, we will determine, inpercentage terms, how prices at other universities differ from Calgary prices. The index values areas follows:

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Chapter2:Economic Theories, Data, and Graphs17UniversityPrice per pizzaIndex of pizza pricesDalhousie$6.50(6.50/6.25)100 = 104Laval5.95(5.95/6.25)100 =95.2McGill6.00(6.00/6.25)100 =96Queen’s8.00(8.00/6.25)100 = 128Waterloo7.50(7.50/6.25)100 = 120Manitoba5.50(5.50/6.25)100 =88Saskatchewan5.75(5.75/6.25)100 =92Calgary6.25(6.25/6.25)100 = 100UBC7.25(7.25/6.25)100 = 116Victoria7.00(7.00/6.25)100 = 112b) The university with the most expensive pizza is Queen’s, at $8.00 per pizza. The index value forQueen’s is 128, indicating that pizza there is 28 percent more expensive than at Calgary.c) The university with the least expensive pizza is Manitoba, at $5.50 per pizza. The index valuefor Manitoba is 88, indicating that the price of pizza there is only 88 percent of the price at Calgary.It is therefore 12 percent cheaper than at Calgary.d) These are cross-sectional data. The variable is the price of pizza, collected at different places ata given point in time (March 1, 2016). If the data had been the prices of pizza at a single universityat various points in time, they would be time-series data.Question 9a)Using 2012as the base year for an index number requires that we divide the value of exports(and imports) in each year by the value in 2012, and then multiply the result by 100.This is donein the table below.YearExportsExport IndexImportsImport Index201211225(11225/11225)(100) = 1003706(3706/3706)(100) = 100201311687(11687/11225)(100) = 104.13550(3550/3706)(100) = 95.8201411821(11821/11225)(100) = 105.33262(3262/3706)(100) = 88.0201512219(12219/11225)(100) = 108.93447(3447/3706)(100) = 93.0201612507(12507/11225)(100) = 111.43659(3659/3706)(100) = 98.7b) It appears thatimportswere more volatile over this period thanexports. Imports fell by about12 percent in the first two years, and then increased byabout 10 percent in thenext two.In contrast,exports increased fairly steadily, by a total of over 11 percent over the five years.

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition18c) From2014 to 2016, the export indexincreasesfrom 105.3 to 111.4. The percentage change isequal to (111.4–105.3)/105.3which is5.8percent. For imports the percentage change is (98.7-88.0)/88.0which is12.2percent.Question 10This is a good question to make sure students understand the importance of using weightedaverages rather than simple averages in some situations.a) The simple average of the three regional unemployment rates is equal to (5.5 + 7.2 + 12.5)/3 =8.4. Is 8.4% the “right” unemployment rate for the country as a whole? The answer is no becausethis simple, unweighted (or, more correctly, equally weighted)average does not account for thefact that the Centre is much larger in terms of the labour force than either the West or East, andthus should be given more weight than the other two regions.b) To solve this problem, we construct a weighted average unemployment rate. We do so byconstructing a weight for each region equal to that region’s share in the total labour force. Fromthe data provided, the country’s total labour force is 17.2 million(5.3+8.4+3.5). The threeweights are therefore:West:weight = 5.3/17.2 = 0.308Centre:weight = 8.4/17.2 = 0.488East:weight = 3.5/17.2 = 0.203These weights should sum exactly to 1.0, but due to rounding they do not quite do so. Usingthese weights, we now construct the average unemployment rate as the weighted sum of the threeregional unemployment rates.Canadian weighted unemployment rate= (.3085.5) + (.4887.2) + (.20312.5) = 7.75This is a better measure of the Canadian unemployment rate because it correctly weights eachregion’s influence in the national total. Keep in mind, however, that for many situations the relevantunemployment rate for an individual or a firm may be the more local one rather than the nationalaverage.Question 11a)These data are best illustrated with a time-series graph, with the month shown on the horizontalaxis and the exchange rate shown on the vertical axis.

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Chapter2:Economic Theories, Data, and Graphs19b)These cross-sectional data are best illustrated with a bar chart.c)These cross-sectional data are best illustrated in a scatter diagram; the“line of best fit” is clearlyupward sloping, indicating a positive relationship between average investment rates and averagegrowth rates.

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition20Question 12a)Along Line A,Yfalls asXrises; thus the slope of Line A is negative. For Line B, the value ofYrises asXrises; thus the slope of Line B is positive.b)Along Line A, the change inYis–4 when the change inXis 6. Thus the slope of Line A isΔY/ΔX=-4/6 =-2/3. The equation for Line A is:Y= 4–(2/3)Xc)Along Line B, the change inYis 7 when the change inXis 6. Thus the slope of Line B is ΔY/ΔX= 7/6. The equation for Line B is:Y= 0 + (7/6)XQuestion 13Given the tax-revenue functionT =10 + .25Y, the plotted curve will have a vertical intercept of 10and a slope of 0.25. The interpretation is that whenYis zero, tax revenue will be $10 billion. Andfor every increase inYof $100 billion, tax revenue will rise by $25 billion. The diagram is as shownbelow:

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Chapter2:Economic Theories, Data, and Graphs21Question 14a) The slope of the straight line connecting two points is equal to the change in Y between thepoints divided by the change in X between the points. In this case, the change in Y from the firstpoint to the second is 3; the change in X is 9. Thus the slope of the straight line is 3/9 = 1/3.b) From point A to point B, the change in Y is 20 and the change in X is-10. Thus the slope of thestraight line is-20/10 =-2.c) The slope of the function is the change in Y brought about by a one-unit change in X, which isgiven by the coefficient on X,-0.5.d) The slope of the function is the change in Y brought about by a one-unit change in X, which isgiven by the coefficient on X, 6.5.e) The slope of the function is the change in Y brought about by a one-unit change in X, which isgiven by the coefficient on X, 3.2.f) The Y intercept of a function is the value of Y when X equals 0. In this case the Y intercept is1000.g) The Y intercept of a function is the value of Y when X equals 0. In this case the Y intercept is-100.h) The X intercept of a function (if it exists) is the value of X when Y equals 0. In this case, whenY equals 0 we have the equation 0 = 10–0.1X which yields-10 =-0.1X which gives us X = 100.

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition22Question 15Let A be the firm’s annual spending on advertising and let R be the firm’s annual revenues.Theequation for advertising (A) as a function of revenues (R) isA = 100,000 + (0.15)R.Question 16a)For each relation, plot the values of Y for each value of X.Construct the following table:(i)Y =50 + 2X(ii)Y =50 + 2X+ .05X2(iii)Y= 50 + 2X-.05X2XYXYXY0500500501070107510652090201102070301103015530654013040210405050150502755025Now plotthese values on scale diagrams, as shown below. Notice the different vertical scale onthe three different diagrams.b)For part (i), the slope is positive and constant and equal to 2. For each 10-unit increase inX,there is an increase inYof 20 units. For part (ii), the slope is always positive since an increase inXalways leads to an increase inY. But the slope is not constant. As the value ofXincreases, theslope of the line also increases. For part (iii), the slope is positive at low levels ofX. But the functionreaches a maximum atX=20, after which the slope becomes negative. Furthermore, whenXisgreater than 20, the slope of the line becomes more negative (steeper) as the value ofXincreases.

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Chapter2:Economic Theories, Data, and Graphs23c)For part (i), the marginal response ofYto a change inXis constant and equal to 2. This is theslope of the line. In part (ii), the marginal response ofYto a change inXis always positive, but themarginal response increases as the value ofXincreases. This is why the line gets steeper asXincreases. For part (iii), the marginal response ofYto a change inXis positive at low levels ofX.But afterX=20, the marginal response becomes negative. Hence the slope of the line switches frompositive tonegative. Note that for values ofXfurther away fromX=20, the marginal response ofYto a change inXis larger in absolute value. That is, the curve flattens out as we approachX=20 andbecomes steeper as we move away (in either direction) fromX=20.Question 17The four scale diagrams are shown on the next page, each with different vertical scales. In eachcase, the slope of the line is equal toY/X, which is often referred to as “the rise over the run”–the amount by which Y changes when X increases by one unit. (For those students who knowcalculus, the slope of each curve is also equal to the derivative ofYwith respect toX,whichforthese curves is given by the coefficient onXin each equation.)Question 18The six required diagrams are shown below. Note that we have not provided specific units on theaxes. For the first three figures, the tax system provides good examples. In each case, think ofearned income as being shown along the horizontal axis and taxes paid shown along the verticalaxis. The first diagram might show a progressive income-tax system where the marginal tax raterises as income rises. The second diagram shows a proportional system with a constant marginaltax rate. The third diagram showsmarginal tax rates falling as income rises, even though total taxpaid still rises as income rises.

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition24For the second set of three diagrams, imagine the relationship between the number ofrounds of golf played (along the horizontal axis) and the golf score one achieves (along the verticalaxis). In all three diagrams the golf score falls (improves) as one golfs more times. In the firstdiagram, the more one golfs the more one improves on each successive round played. In the seconddiagram, the rate of improvement is constant. In the third diagram, the rate of improvementdiminishes as the number of rounds played increases. The actual relationship probably has bits ofall three parts—presumably there is a lower limit to one’s score so eventually the curve must flattenout.Question 19a)The slope of any curve at any point is equal to the slope of a tangent line to that curve at thatpoint. At point A on the curve shown in thequestion, the slope of the tangent line is ½ = 0.5, andhence this is the slope of the curve at point A. For point B, the slope of the tangent line is 1 and sothis is the slope of the curve at point B. For point C, the slope of the tangent line is 2/.5 =4 and sothis is the slope of the curve at point C.b)The marginal cost of producing good X is shown by the slope of the curve (the change in totalcost as output increases by one unit). The slope is clearly rising as the monthly level of productionrises, showing that marginal cost increases as output increases.c)The slope of the function is positive and increasing (getting steeper) as the level of monthlyproduction increases.*****

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_______________________________________Part TwoAn Introduction to Demand and Supply_______________________________________This Part of the book develops the core of the demand-and-supply apparatus. Chapter 3 presentsthe basics,explaining in detail the concepts of demand and supply. Chapter 4 presents a thoroughtreatment of elasticity. Chapter 5 offers many examples to help students put this basic economictheory to use, including an initial and intuitive discussion of economicsurplus and marketefficiency.***Chapter 3 covers the basic theory of demand, supply, and price. This is the student’s first reallydecisive hurdle. When it is cleared, students will have mastered some economic theory and will beready to start applying it. A box addresses the kinds of industries where the model of demand andsupply can usefully be applied, and also those where it can’t.Elasticity, examined in detail in Chapter 4, is a more advanced concept. There is somedisagreement among teachers about how much should be included in an introductory economicscourse, but some minimum is required to enable us to discuss the magnitude aswell as the directionof changes in prices and quantities. Since the discussion of the various elasticities tends to be ratherdry, we explore in detail an important situation in which elasticity is central to the analysis. This isthe issue of tax incidence, where we show that the burden of a sales tax depends on the demand andsupply elasticities.Chapter 5 is designed to illustrate that even the simple demand-and-supply apparatus can beusefully applied to important current problems. We think it is valuable early in the course to showthat microeconomics does shed insight on such problems. Students like to get a payoff inunderstanding from their investment in learning theory, and it is possible to give it to them.The firstsection discusses the effects of government-controlled prices. Following a general discussion of thetheory, we go on to examine the specific example of rent controls. We also have a box that presentsthe basic analysis of minimum wages as an example of a binding price floor. The chapter’s finalsection provides an intuitive introduction to the ideas of economic surplus and market efficiency,and then uses these concepts to circle back and examine the inefficiency of legislated price controls.

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___________________________________Chapter 3: Demand, Supply, and Price___________________________________This fundamental chapter is divided into three sections: demand, supply, and price determination.The first two sections of the chapter are treated with a conscious parallelism. We talk in some detailabout demand here, but virtually identical comments apply to supply.A point worth emphasizing to the students is that when we think about a demand curve, weare not asserting that price is the only, or even the most important, determinant of quantity demanded.Students are introduced to the important distinction between movements along curves and shifts ofcurves and the related terminology that distinguishes between “changes in quantity demanded” and“changes in demand”. Figures 3-3 and 3-4 are designed to clarify this distinction. The terminologyis important and we suggest that you spend some time on it in class. A mathematician woulddistinguish between the value of the function and the function itself. We label a shift in the demandcurve as an increase or a decrease in demand, in contrast to movements from one point to anotheralong a given demand curve, which we label a change in quantity demanded. Despite our renewedefforts at clarity on these points, students should be alerted to possible confusions, especially earlyin their use of the concepts of supply and demand. Careful attention to context almost always makesclear what is being discussed.Our use of the expressions “a change in quantity demanded” and “a change in demand”,although quite orthodox, have given some instructors trouble in the past. It is therefore worthwhileto spend some time explaining our approach. Since we do not want to teach students things that theywill have to unlearn in their subsequent courses, we follow the established practice of definingquantity demanded as the dependent variable in the demand function:Qid= D(pi,p-i, Y, tastes, ...),with pibeing the product’s own price,p-ibeing a vector of all other prices, and Y being moneyincome.With this definition, a “change in quantity demanded” occurs in response to a change inanyof the independent variables, not just the product’s own price. Thus a movement along a demandcurve isalwaysa change in the quantity demanded; but a change in quantity demanded is notnecessarily a movement along a demand curve, since it can have causes other than just a change inthe product’s own price.The demand curve––which is simply the relationship between price and quantity demanded,ceteris paribus––refers to the relationQid= d(pi),where all of the other independent variables are held constant. A “change in demand” refers to a shiftin this relation due to a change in any one of the variables that arenormally beingheld constant.

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Instructor’s Manual for Ragan,Economics, Sixteenth Canadian Edition28Confusion sometimes arises because some textbooks define a change in quantity demandedto beonlya movement along a demand curve. This begs the question of how to describe a change inQidwhen an independent variableother thanpichanges. Our usage conforms with common usagein economics in calling any change in Qida change in quantity demanded. A movement along a givendemand curve is only one such change.The final section of this chapter is both straightforward and basic. We begin with a briefdiscussion of the concept of a market. We have a box explaining that the demand-and-supply modelcan only be used in markets that satisfy some conditions, in particular large numbers of producersand consumers and more-or-less identical products. We then bring together a market demand curveand a market supply curve toexaminean equilibrium price. The next step is to introduce the standardshifts of the curves to derive the comparative static predictions, often called the laws of supply anddemand. We have added a worked-out numerical example of a market equilibrium.The chapter closes with a brief discussion of “Relative Prices”. The section explains theimportance of relative prices and how, in basic price theory, a “rise” or a “fall” in price means a riseor a fallrelativeto all other prices. Our own experience is that it is useful to meet this issue head onrather than sweeping it under the carpet.***A Caveat.Perhaps the biggest mistake that new instructors to a principles course make inteaching the material of this chapter is to assume that, because it is so basic to them, it can be coveredvery quickly. Our experience suggests that this is not the case and that a good deal of repetition isimportant. Figures 3-7 and 3-8 are worth developing on the blackboard or on an overhead, or byusing the Powerpoint slides for this text that are available from the publisher. You may also find itvaluable to spend the time necessary to work through a few numerical examples of marketequilibrium similar to the one in the main text or in the Study Exercises.Answers to Study ExercisesFill-in-the-Blank QuestionsQuestion 1a)desired; actualb) time;time; flowc) price; quantity demanded; increasesd) consumers’ income; prices of other goods; tastes; population; changes in weathere) ceteris paribus; constant

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Chapter3:Demand, Supply, and Price29Question 2a)desired; actualb) time; time; flowc) price; quantity supplied;increasesd) prices of inputs; technology; taxes or subsidies; prices of other products; number of suppliers;changes in weatherQuestion 3a)supply; left; decrease; supplyb)demand; right; increase; demandc)demand; right; increase; demandd)supply; left; decrease; supplye)supply; left; decrease; supplyf)demand; left; decrease; demandQuestion 4a)negativelyb)positivelyc)supply; demandd)equalse)rise; equilibrium quantityf)rise; equilibrium quantityReview QuestionsQuestion 5a)Decrease in quantity demanded of fish (movement up along the demand curve due to theresulting increase in price)

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