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Solution Manual for Macroeconomics, 5th Edition

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    BCS-1 Suggested Solutions for Business Case Questions for Thought This section offers suggested answers to the Questions for Thought at the end of each chapter’s business case. CHAPTER 1 1. Explain how each of the twelve principles of economics is illustrated in this case. Suggested Solution 1. Principle 1: People must make choices because resources are scarce. Neither money nor time is unlimited; they are both scarce resources. Priceline caters to customers who have chosen to sacrifice some of their preferences about convenience or quality in order to get a lower price. Principle 2: The opportunity cost of an item—what you must give up in order to get it—is its true cost. The true cost of an empty airplane seat or an empty hotel bed is the revenue the airline or hotel could have earned from the next best use of that seat or bed—namely, the revenue earned from a paying customer. Principle 3: “How much” is a decision at the margin. How much more a customer is willing to pay for a ticket to a destination depends upon how much time and inconvenience is saved by purchasing the higher priced ticket. Likewise, how much more a customer is willing to pay for a ticket purchased well in advance of his travel date depends upon how much more security he gains by advance planning rather than waiting to pur - chase. The same principle applies to decisions about the quality and location of hotels, and so on. Principle 4: People usually respond to incentives, exploiting opportunities to make themselves better off. Priceline was successful because its customers— travelers, airlines, and hotels—were exploiting opportu - nities to make themselves better off by using its services. Priceline also responded to incentives to make itself bet - ter off by expanding into new profitable markets such as Europe. Principle 5: There are gains from trade. Travelers gain from using Priceline’s networks of hotels to find a hotel rather than doing the research themselves. They gain from using Priceline’s services to book a flight rather than contacting each airline individually. Also, travelers gain by using the services of airlines and hotels, rather than transporting themselves or pitch - ing a tent overnight to sleep in. Hotels, particularly in Europe, gain from using Priceline’s network rather than trying to contact potential customers directly. Principle 6: Because people respond to incentives, markets move toward equilibrium. Expedia and Orbitz moved into the online travel service industry in order to exploit opportunities that had been pioneered by Priceline. In this way, the market for online travel services will move toward equilibrium until there are no more opportunities for new travel service companies to exploit. Principle 7: Resources should be used efficiently to achieve society’s goals. Priceline exploited an opportunity to use resources more efficiently. It is inefficient to have empty hotel rooms and airline seats if someone is willing to pay some price to use them on short notice. Principle 8: Because people usually exploit gains from trade, markets usually lead to efficiency. It is ineffi - cient to have planes flying with empty seats and hotels with unoccupied beds. Thus, introducing a market for those items—which is what Priceline did—improves efficiency. Principle 9: When markets don’t achieve efficiency, government intervention can improve society’s welfare. It would have been inefficient to have major airlines fail because of the public’s temporary fear of flying. Vast resources would have been wasted as pilots and support staff lost their jobs, planes were mothballed, necessary trips cancelled, and so on. It improved effi - ciency for the government to step in and temporarily aid the airline industry so that it could survive the temporary downturn. Principle 10: One person’s spending is another person’s income. In the aftermath of the attacks of September 2001, as people stopped spending on items like travel, the income of airline workers was severely reduced. Principle 11: Overall spending sometimes gets out of line with the economy’s productive capacity. The overall economy went into a slump after the attacks of September 2001 as the economy’s productive capacity exceeded its spending. Principle 12: Government policies can change spend - ing. The $15 billion aid appropriation by Congress was spent on stabilizing the airline industry and prevented major airline failures.

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    BCS-2 S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H T CHAPTER 2 1. What is the opportunity cost associated with having a worker wander across the factory floor from task to task or in search of tools and parts? Suggested Solution 1. The opportunity cost of a worker wandering across the factory floor is forgone output—the output that worker could have produced in the time spent wandering around. 2. Explain how lean manufacturing improves the econo- my’s efficiency in allocation. Suggested Solution 2. Lean production (also known as lean manufactur - ing) improves the economy’s efficiency in allocation because, for example, an automaker can more quickly switch to producing more of the types of cars that more consumers want and fewer of the types of cars that fewer consumers want. 3. Before lean manufacturing innovations, Japan mostly sold consumer electronics to the United States. How did lean manufacturing innovations alter Japan’s com - parative advantage vis-à-vis the United States? Suggested Solution 3. Before the innovations in lean production, Japan had a comparative advantage vis-à-vis the United States in consumer electronics. After the innovations, Japan’s comparative advantage vis-à-vis the United States shifted to auto production. 4. How do you think the shift in the location of Toyota’s production from Japan to the United States has altered the pattern of comparative advantage in automaking between the two countries? Suggested Solution 4. The shift in the location of Toyota’s production from Japan to the United States means that it is likely that Japan will no longer have a clear comparative advan - tage in automaking vis-à-vis the United States. CHAPTER 3 1. What accounts for the fact that before Uber’s arrival, there were typically enough taxis available for every - one who wanted one on good weather days, but not enough available on bad weather days? Suggested Solution 1. Before Uber’s arrival fares were set by city regulators. If everyone who wanted a taxi during good weather could get one, then we can imply that the price set by regulators was approximately equal to the market- clearing price on good weather days. But bad weather, like a snowstorm, produces two changes to supply and demand: an increase in demand (a rightward shift of the demand curve) as more people want rides, and a decrease in supply as more taxi drivers want to stay warm and dry at home (a leftward shift of the supply curve). As a result of these two shifts, the market-clearing price rises. But because the actual price was set by regulators and could not increase in the pre-Uber days, a shortage of taxis arose. 2. How does Uber’s surge pricing solve the problem? Assess Kalanick’s claim that the price is set to leave as few people possible without a ride. Suggested Solution 2. Uber’s surge pricing solves this problem because it allows drivers to charge higher prices until supply equals demand. The higher price increases the quan - tity of rides supplied while reducing the quantity of rides demanded until market equilibrium is achieved. Kalanick’s claim is true: at any price lower than the equilibrium price there is a shortage of taxis—more people want rides than are available. 3. Use a supply and demand diagram to illustrate how Uber drivers can cause prices to surge by taking coor - dinated breaks. Why is this strategy unlikely to work in New York, a large city with an established fleet of taxis? Suggested Solution 3. By taking coordinated breaks, Uber drivers in San Diego reduce the quantity supplied at every price. That is, they shift the supply curve leftward. As a result, more riders want rides than are available, and surge pricing kicks in. This is unlikely to work in a large city with an established fleet of cars like New York City. First, because it would be too difficult to coordinate a large enough group of Uber drivers to affect the price. And second, taxi drivers would take the fares when Uber drivers took breaks, preventing a surge in the Uber price. E 2 E 1 Price (dollars per mile) S S (during break time) D P 1 P 2 Q 1 Q 2 Quantity of taxi rides (millions of miles)

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    S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H T BCS-3 CHAPTER 4 1. How did lenders benefit from the restriction on the number of New York City taxi medallions? Suggested Solution 1. Lenders benefit from the restriction on the number of taxi medallions because as the price of taxi medal - lions goes up, purchasers have to borrow more. Hence the demand for loans increases. In addition, loans are secured by the medallions that were purchased using the lent funds. If the borrower is unable to pay, she has to surrender the medallion to the loan company. Hence those loans are worth more as the prices of medallions climb. So since fewer medallions lead to higher medallion prices, the lenders clearly benefit from the restriction on the number of medallions. 2. Use a graph to illustrate the effect of the entry of Uber on the incomes of taxicab drivers. Assume that Uber cars cannot pick up fares hailed from the street and that there are some people who prefer to hail cabs rather than use an app. How does your graph change if that restriction is lifted? Suggested Solution 2. To devise your graph, take Figure 4-8 as it is, then add to it a vertical line at 9 million rides, and arrows showing a horizontal shift from the vertical line at 8 million to the line at 9 million. Label the upper point on the 9 million line graph as C (at $5.50 fare) and the lower point as D (at $4.50 fare). Draw in the dotted lines from the vertical axis to points C and D . Label the shift “Uber Effect” with a balloon. 6 7 9 0 8 10 11 13 12 14 $7.00 6.50 6.00 5.50 5.00 4.50 4.00 3.50 3.00 Quantity of rides (millions per year) Fare (per ride) D S C E D B A Uber effect Quota The entry of Uber into the taxicab market will increase the number of rides offered. As shown here, the entry of Uber shifts the vertical line indicating the quota right - ward. As a result, the quota rent going to the owner of a medallion falls. Here we have shifted the quota line from 8 million rides pre-Uber to 9 million rides post-Uber, and the quota rent falls from $6 − $4 = $2 to $5.50 − $4.50 = $1. The $1 represents the quota rent that medallion holders still receive because some people still prefer to hail taxicabs rather than use Uber cars, and the number of taxicabs is still restricted. However, if the rules are changed and Uber cars are also allowed to pick up fares hailed from the street, the market will move to equilibrium E because the quantity control will have been completely eliminated. As a result, the quota rent will disappear. 3. Why has the fight between Uber and the taxicab indus - try turned political? Suggested Solution 3. It is predictable that the fight between Uber and the taxicab industry turned political because restrictions on how many cars can sell rides in New York City are creations of the city government. The taxi industry would like to maintain the quota so it can maintain the quota rents, while Uber would like to circumvent the quota so it can operate. CHAPTER 5 1. Why do you think it was profitable for Li & Fung to go beyond brokering exports to becoming a supply chain manager, breaking down the production process and sourcing the inputs from various suppliers across many countries? Suggested Solution 1. By sourcing inputs from various suppliers across many countries, Li & Fung was able to allocate production to where it is most cost effective. 2. What principle do you think underlies Li & Fung’s decisions on how to allocate production of a good’s inputs and its final assembly among various countries? Suggested Solution 2. Comparative advantage is the principle that under - lies Li & Fung’s decisions. Inputs that require more skill or are more capital-intensive can be produced in countries that have relatively higher-skilled work - ers or are relatively more abundant in capital, such as Hong Kong and Japan. Similarly, inputs that are more labor-intensive can be produced in countries that are relatively more abundant in labor, like mainland China and Thailand. 3. Why do you think a retailer prefers to have Li & Fung arrange international production of its jeans rather than purchase them directly from a jeans manufac - turer in mainland China? Suggested Solution 3. A retailer that purchased jeans directly from a manu - facturer in mainland China would not benefit from the gains from trade that arise from sourcing inputs from different countries according to those countries’ comparative advantage.

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    BCS-4 S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H T 4. What is the source of Li & Fung’s success? Is it based on human capital, on ownership of a natural resource, or on ownership of capital? Suggested Solution 4. The source of Li & Fung’s success is human capital. The company understands how to use the principle of comparative advantage to exploit gains from trade in the production process. In addition, it is skilled in providing quality control and logistics. CHAPTER 6 1. Why was it profitable for Montgomery Ward to close some of its stores during the Great Depression? Suggested Solution 1. It was profitable to close some of its stores because the large rise in unemployment meant people had less to spend and retail purchasing fell dramatically. It was not profitable to incur the costs of maintaining stores in which few sales were made. 2. Use Figure 6-1 to compare the nature of the Great Depression to the Great Recession. What about the Great Depression made Montgomery Ward’s deci - sion not to expand during the 1940s appear rational? Would the same decision be rational today, in the aftermath of the Great Recession? Explain. Suggested Solution 2. Figure 6-1 shows that although the U.S. economy in the first year of the Great Depression and the first year of the Great Recession were very similar, the later years were different. After the first year of the Great Recession, world industrial output stabilized and began to recover. In contrast, five years after the beginning of the Great Depression, world industrial output still had not recovered to its pre-depression level. The length and severity of the Great Depression led Montgomery Ward to believe that the economy of the 1940s was still vulnerable to another severe downturn, so it was better to hold cash than to invest in opening new stores. The same decision would not be rational today given that recessions have been of shorter duration, as shown by the recovery after the Great Recession. So, today, the company would be better off spending its cash instead of holding it. But instead of opening new stores, Montgomery Ward could use the cash to invest in new technologies in an effort to expand sales. 3. The National Retail Federation provides various kinds of economic data on its website, http://research .nrffoundation.com. Click on the link “Retail and Economy” and you will see five categories. Explain why, in light of this case, it is important for a retailer to have each of the five categories of information provided. Suggested Solution 3. The information supplied in the five categories helps retailers forecast their future sales. This can be a use - ful tool as they make decisions about how many stores to have and how much merchandise to stock. With this information, Montgomery Ward might have done a better job determining how to respond to the eco - nomic situation in the 1940s. (1) Economic Landscape: contains data on consumer confidence and on GDP, the total value of the economy’s output. Consumer confidence data gives retailers information on how willing consumers are to spend, and GDP gives retailers information on the overall state of the economy, which is another good indicator of how comfortable consumers will be to make purchases. (2) Employment Environment: contains a graph of U.S. employment over time. The strength of the employment environment indicates whether or not consumers will have income to spend on retail and how confident their spending will be. (3) Unemployment Environment: contains graphs of the U.S. unemployment rate over time, as well as graphs of the unemployment rate broken down by gender and age. As in (2), this information helps retailers make decisions about opening stores and how much stock to carry. A declining unemploy - ment rate means consumers will be more willing to spend. Also, by breaking down the figures accord - ing to age and gender, retailers can better predict which consumers might be more inclined to spend. (4) Consumer Income and Savings: contains informa - tion on the change in income earned by American consumers. The more income they have, the more resources they have to spend. A rising income level means that it is safe for retailers to expand, while a falling income level means they should cut back. (5) Consumer Price Index: contains information on how prices of consumer items are changing. It gives retailers an indication of whether the econ - omy is experiencing inflation or deflation, both of which could cause economic problems and make consumers less willing to spend. CHAPTER 7 1. Why would an economic downturn cause problems for Chinese companies that borrowed heavily? Suggested Solution 1. An economic slowdown occurs when the aggregate income in the economy declines. This includes income in the form of wages, profits, interest, and rents. A decline in income will result in reduced consumer spending, leading to reduced sales for Chinese com - panies. Reduced sales translate to less profit than the Chinese companies were expecting when they bor - rowed heavily. With lower than expected profit, the

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    S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H T BCS-5 firms will find it difficult to pay back their debt, which could lead some of them to fail. Companies that fail then create economic hardship for owners and employ - ees, further reducing aggregate income. 2. How do the three statistics that Li Keqiang cited fit into the three different ways to calculate GDP? Suggested Solution 2. Railway shipments measure goods being sent to customers, so they are related to GDP as measured by final spending. Electricity is used in production, so it’s related to GDP as measured by value added in produc - tion. Loans are based at least partly on the income of borrowers, so they are an indicator of how much factor income is being earned. 3. What business problems might China’s untrustworthy numbers create? Suggested Solution 3. It’s hard for governments and businesses to plan long-term when they don’t have reliable and accurate information about the state of the economy. Businesses will not know if it is prudent to expand or if they should wait for economic conditions to improve. Policy makers will be unsure of what steps to recommend to improve a troubled economy, or whether they should encourage investment because the economic environ - ment is good. Overall, unreliable economic data would lead to uncertainty and this would discourage invest - ment in the country’s economy . CHAPTER 8 1. How is the matching of job-seekers and employers through services like TaskRabbit likely to affect frictional unemployment? Suggested Solution 1. Frictional unemployment is created because as people quit or are let go from their jobs, it takes time to find new employment. Services like TaskRabbit can fill that down time and may lead to two possible outcomes. First, when people can easily find jobs through a ser - vice such as TaskRabbit, they find work faster and frictional unemployment declines. And second, if many workers depend solely on TaskRabbit for employment, there may be more people with short-term jobs, mov - ing from task to task in the case of Taskers, which would increase frictional unemployment. 2. What is the likely effect of such services on the num - ber of people considered to be in the labor force? Suggested Solution 2. Services like TaskRabbit provide employment oppor - tunities for people who want flexible employment and have not found jobs in more traditional occupations. These individuals are likely to include discouraged workers, marginally attached workers, and others. As these workers move back into the labor force and find jobs as Taskers, the size of the labor force will increase. 3. Some analysts suggest that most freelancers have other jobs, and only do gig economy work on the side. How does that statement help explain the lack of clear evidence for a growing gig economy? Suggested Solution 3. Official employment statistics count an individual worker only once. If many people work in the gig economy as a side job, only their primary jobs will be counted and the employment statistics will not reflect the gig economy jobs. And as long as many gig economy workers hold other jobs, there will be no clear evidence pointing to growth in the gig economy, even as the number of people in those jobs increase. However, if the number of people participating solely in the gig economy increased significantly, we would expect employment statistics to reflect an increase in the size of the gig economy. CHAPTER 9 1. Bar-code technology spurred a lot of investment in retailing. How did this alter the retailing production function? What would a similar amount of investment have accomplished without the new technology? Suggested Solution 1. Bar-code technology resulted in an upward shift of the production function. Without the technological advancement, a similar amount of investment would have produced a much smaller gain. Without the bar-code technology, investment would have resulted in only a movement along the old production function, which would have soon run into diminishing returns. 2. The spread of bar codes was delayed in the United States because everyone was waiting for someone else to move. What policy could have been adopted to address this? Would it have been a good idea? Suggested Solution 2. A government policy to subsidize the adoption of bar-code technology could have accelerated its adop - tion. Such a policy might have caused a faster rise in productivity, in which case it would have been a very good idea. 3. Use the case to explain why international growth rates vary. Suggested Solution 3. The case shows how differences in institutions and government policies affect economic growth, leading to variations in performance among different countries.

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    BCS-6 S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H T 4 . Despite initial barriers, bar codes have spread globally. What does this imply about differences in economic growth across countries? Suggested Solution 4 . While countries may differ in rates of economic growth, the spread of technology is a force for convergence in per capita GDP. CHAPTER 10 1. What market inefficiency is being exploited by Grameen Bank? What is the source of this inefficiency? Suggested Solution 1. Grameen Bank is exploiting the inefficiency that arises from the fact that there are borrowers who want to borrow at a given interest rate and lenders who want to lend at the same interest rate, but are unable to do so. The source of this inefficiency is the requirements imposed on borrowers by regular banks, such as credit history and collateral, that borrowers cannot meet. 2. What tasks of a financial system does microlending perform? Suggested Solution 2. Microlending performs the tasks of reducing transac - tion costs for people who need funds—for example, they can borrow from Grameen rather than having to sell possessions to raise needed funds. It reduces financial risk, allowing borrowers to overcome financial uncertainty. And it provides liquid assets, by allowing lenders to lend to borrowers but in a way that allows them to get their funds back quickly if they need to. 3. What do you predict is the effect of Grameen Bank’s lending on a community? Suggested Solution 3. We would expect communities that received Grameen Bank lending to have a higher growth rate and less financial uncertainty than those without this lending. But this is with an understanding that there are limits to what these loans can accomplish in terms of reducing poverty and improving family well-being. CHAPTER 11 1. Why did a national slump that began with housing affect companies like General Motors? Suggested Solution 1. As we learned in the chapter, a fall in current dispos - able income, as well as falls in wealth and expected future disposable income, lead to a fall in consumer spending. So the decline in housing, which reduced both wealth and income, led to a broad decline in consumer spending across America. The broad decline in consumer spending, in turn, hit auto companies particularly hard as many Americans decided against making new car purchases. 2. Why was it reasonable in June 2009 to predict that auto sales would improve in the near future? Suggested Solution 2. It was a good bet that things would eventually improve because recessions have always been followed by recoveries—at least so far! So government officials had good reason to believe that auto sales would be considerably higher in the future than they were in the first half of 2009. Looking at Figure 11-13 confirms this belief. Auto sales started to rise in 2010 and have continued to increase until they leveled off in 2015. 3. How does this story about General Motors help explain how a slump in housing—a relatively small part of the U.S. economy—could produce such a deep national recession? Suggested Solution 3. The story of GM illustrates how the multiplier process takes place. The fall in housing led to a fall in con - sumer spending which hurt auto manufacturers like GM. These companies, in turn, laid off workers, who reduced their consumer spending, hurting local retail - ers among others. So the story shows how a fall in investment spending—in this case, housing investment spending—can have an impact on the economy as a whole that is larger than the initial decline. CHAPTER 12 1. Why do you think gas prices rose in the recessions of the 1970s but fell after the Great Recession? Suggested Solution 1. The recessions of the 1970s were characterized by negative supply side shocks from OPEC oil shortages and accommodating monetary policy. Negative supply shocks shifted the short-run aggregate supply curve leftward and accommodating monetary policy shifted the aggregate demand curve to the right. Jointly, these shifts caused gas prices to increase throughout the recession. Although an increase in oil prices also preceded the Great Recession, larger negative demand shocks caused a leftward shift in aggregate demand placing downward pressure on prices. The decline in housing prices also caused consumer spending to expe - rience a substantial decline. In the end, the 1970s were characterized by negative supply shocks putting upward pressure on gasoline prices, and the Great Recession witnessed negative demand shocks placing downward pressure on overall prices, including gasoline. 2. What does this say about the causes of the recessions in each case?

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    S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H T BCS-7 Suggested Solution 2. In both cases, high oil prices were a contributing fac - tor to the recessions, but in addition to high oil prices, the Great Recession was largely impacted by a collapse of the housing bubble. Despite starting with a similar cause, the effect on the economy depends mostly on what follows the initial increase. In the case of the Great Recession, a large negative demand shock caused inflation to drop, altering the course of the recession. 3. In the 1970s, Toyota was able to increase its American sales despite interest rates on auto loans surging as high as 17.5%. In contrast, after 2007 auto loan rates fell to their lowest levels in history; car sales also declined. Explain why. ( Hint: Examine the connection between inflation and interest rates on loans.) Suggested Solution 3. Interest rates on car loans reflect both the real interest rate and future inflation. Because inflation increased significantly in the 1970s, lenders followed by also raising rates on car loans. During the Great Recession, the negative demand shock caused inflation to fall and in some periods actually turn negative. The low infla - tion rate allowed lenders to keep interest rates on cars and homes much lower during the Great Recession. CHAPTER 13 1. How did the political reaction to government funding for the Solana project differ from the reaction to more conventional government spending projects such as roads and schools? What does the case tell us about how to assess the value of a fiscal stimulus project? Suggested Solution 1. Unlike roads and schools, the Solana project was con- troversial for two reasons. First, government funds were paid to a non-American firm. Second, the proj- ect was controversial because the long-term viability of solar power depended upon future government subsidies—again, unlike roads and schools. However, the Solana case shows that the value of a fiscal stimu- lus project is a matter of whether or not it creates jobs at the right time. 2. In the chapter we talked about the problem of lags in discretionary fiscal policy. What does the Solana case tell us about this issue? Suggested Solution 2. Solana is a good example of lags in the implemen - tation of discretionary fiscal policy. Although the recession hit in 2008, most of the funds for the project weren’t disbursed until three to four years later. In a less severe recession, the economy would have already recovered by that point. However, since the recession that began in 2008 was very long and deep, the stimu - lus from the Solana project was still effective in 2011 and 2012. 3. Is the depth of a recession a good or a bad time to undertake an energy project? Why or why not? Suggested Solution 3. Assuming that a solar plant is a good thing to build, it was a very good idea to do it while many construction workers were unemployed and borrowing costs were very low. CHAPTER 14 1. Why are gift card owners willing to sell their cards for a cash amount less than their face value? Suggested Solution 1. A gift card is not as liquid as cash. Cash can be turned into merchandise in any store; a gift card can be used only at its issuer. 2. Why do gift cards for retailers like Walmart sell for a smaller discount than those for the Gap? Suggested Solution 2. Retailers like Walmart sell necessities, but the Gap sells non-necessities. There will be a larger pool of potential buyers for cards from retailers of necessi - ties than from sellers of non-necessities because more people have constrained budgets and so are shop - ping only for necessities. In addition, because people shop repeatedly for necessities, they know they are more likely to use up the face value of a card they can use for necessities than one usable only for non- necessities. So more potential buyers compete to buy cards for necessities, which drives their discount down compared to cards for non-necessities. 3. Use your answer from Question 2 to explain why cash never “sells” at a discount. Suggested Solution 3. Cash can be used to purchase any good or service, necessity or non-necessity; it is accepted everywhere. Also, it comes in any face value you want. So there will always be an extremely large number of people willing to “buy cash” because the price of a dollar will never be less than a dollar. 4. Explain why retailers prefer to reward loyal customers with gift cards instead of rebate checks. Suggested Solution 4. Most customers who receive a rebate check deposit the check into their checking account, withdraw the cash, and use it to pay for purchases. However, those pur - chases need not be from the issuer of the rebate check. In contrast, a gift card must be used at the retailer that issues it. Also, cash doesn’t expire, but gift cards often do. And because gift cards have a predetermined face value, it is more likely that a customer will not use it all up—unlike cash, which is always eventually

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    BCS-8 S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H T spent. For all these reasons, a retailer can capture breakage on a gift card but not on a rebate check. So retailers will prefer gift cards. 5. There are now laws restricting retailers’ ability to impose fees and expiration dates on their gift cards and mandate greater disclosure of their terms. Why do you think Congress enacted this legislation? Suggested Solution 5. Retailers have an incentive to adopt policies that increase breakage (the amount of a gift card that accrues to the retailer rather than the cardholder), such as imposing fees and expiration dates. Not telling customers about these policies increases breakage. So Congress has intervened to restrict these practices. CHAPTER 15 1. PayPal accounts aren’t counted as part of the money supply. Should they be? Why or why not? Suggested Solution 1. It depends on how consumers use their PayPal accounts. Many consumers use PayPal as a means of transferring money from a checking account or credit card to pay for goods and services purchased online. In this case, PayPal accounts should not be counted as part of the money supply. But, as we’ve seen, some indi - viduals keep money in their PayPal accounts instead of their bank account. In this case, PayPal is being used as a substitute for a non-interest-paying checking account and should be counted in the money supply. 2. In 2010, only around 25% of mobile phones in the United States were smartphones. In 2017, that number increased to more than 80%. How does this situation play into the PayPal story, and how does it fit into the broader pattern of monetary history? Suggested Solution 2. PayPal had always been a leader in mobile-phone pay- ments. Acquiring Venmo further enhanced the compa- ny’s mobile-payment offerings and made it the largest mobile-payment provider in the United States at a time when the number of smartphones in use was increas- ing. The broader pattern of monetary history since the 1960s shows that improvements in banking tech- nology are born of innovation, whether credit cards, debit cards, ATMs, or mobile-banking systems. These innovations typically followed from years of efforts to increase efficiency for consumers—to allow quick access to funds and make it easier for them to pay for goods and send money. 3. How might future actions by the Federal Open Market Committee affect the future of PayPal and similar services? Suggested Solution 3. PayPal and other money transmitters do not offer interest rates on funds stored in their accounts. As the Federal Open Market Committee gradually raises interest rates, banks will start offering higher interest rates on saving accounts. The increased competition from banks will incentivize customers to transfer money from PayPal to interest-earning bank accounts. Because there are no costs in transferring money between PayPal and bank accounts, it will be relatively easy to transfer money out of PayPal, which will likely impact its business. CHAPTER 16 1. What was the relationship between inflation and the Argentine government’s chronic budget deficits? Suggested Solution 1. Historically, Argentina’s government has struggled to manage its budget. Unable to borrow on foreign capital markets, raise taxes, or cut spending, the gov - ernment was forced to finance its budget deficit by printing money. As it became more reliant on printing money to finance spending, Argentina’s inflation rate increased, illustrating a direct correlation between budget deficits and increased inflation rates. 2. What were the implications of Argentina’s inability to get its government deficits under control for Argentine businesses? Suggested Solution 2. The high inflation caused by the Argentine govern - ment’s attempts to fund its budget deficits through the inflation tax created uncertainty for Argentine businesses. They could neither anticipate future costs nor make plans for the future, such as deciding how to invest in their businesses. For example, restaurant owners could not be sure about the wisdom of invest - ing in printed menus. Businesses that underestimated how much their costs would go up might lose money and go out of business. Businesses unable to plan for the future and make investments risked atrophy and failure. 3. Why did the Argentine government try to stop Argentinians from converting pesos into foreign currency, such as dollars? Suggested Solution 3. The Argentine government was trying to collect an inflation tax by using seigniorage to fund the budget deficit. This turned into a downward spiral of increas - ingly higher inflation. As the government printed more money, the inflation rate increased, and the peso lost value relative to foreign currencies. Argentinians began converting their pesos into foreign curren - cies, like the dollar, looking for stability. This in turn reduced the amount of seigniorage the government

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    S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H T BCS-9 was able to capture, forcing them to print even more money and leading to an even higher inflation rate. So in an effort to arrest the downward spiral, the Argentine government tried to stop citizens from converting their pesos into foreign currency. CHAPTER 18 1. Why would Abenomics lead to a weaker yen? Suggested Solution 1. We’ve seen that expansionary monetary policy weak - ens a currency because lower interest rates induce investors to move money to other countries, increas - ing the demand for foreign exchange. That’s basically what’s happening here, although Abenomics depends in part on promises to keep money loose—that is, to keep interest rates low for longer than previously expected—rather than just cutting rates now. 2. Why is a weaker yen good for the profits of Japanese auto companies? Suggested Solution 2. When a company like Toyota or Subaru exports cars from Japan, many of its costs—wages in particular— are presumably fixed in yen, while it is selling in markets where competitors have costs fixed in dollars or euros. So a fall in the yen gives the Japanese com - panies a cost advantage, raising their profits. 3. Why did Subaru gain more than Toyota? Suggested Solution 3. For Toyota, the benefits of a weaker yen apply only to the part of its production that is exported from Japan. As far as its U.S. plants are concerned, it is, in effect, an American company. So the benefits for Toyota are limited. Subaru, on the other hand, is still mainly a Japan-based producer, so it gets the full benefit of a weaker yen.

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    interactive activity Chapter 1 First Principles 1. In each of the following situations, identify which of the twelve principles is at work. a. You choose to purchase your textbooks online through Chegg rather than paying a higher price for the same books through your college bookstore. b. On your spring break trip, your budget is limited to $35 a day. c. Craigslist allows departing students to sell items such as used books, appli - ances, and furniture rather than giving them away as they formerly did. d. After a hurricane did extensive damage to homes on the island of St. Crispin, homeowners wanted to purchase many more building materials and hire many more workers than were available on the island. As a result, prices for goods and services rose dramatically across the board. e. You buy a used textbook from your roommate. Your roommate uses the money to buy songs from iTunes. f. You decide how many cups of coffee to have when studying the night before an exam by considering how much more work you can do by having another cup versus how jittery it will make you feel. g. There is limited lab space available to do the project required in Chemistry 101. The lab supervisor assigns lab time to each student based on when that student is able to come. h. You realize that you can graduate a semester early by forgoing a semester of study abroad. i. At the student center, there is a bulletin board on which people advertise used items for sale, such as bicycles. Once you have adjusted for differences in quality, all the bikes sell for about the same price. j. You are better at performing lab experiments, and your lab partner is better at writing lab reports. So the two of you agree that you will do all the experiments, and she will write up all the reports. k. State governments mandate that it is illegal to drive without passing a driving exam. l. Your parents’ after-tax income has increased because of a tax cut passed by Congress. They therefore increase your allowance, which you spend on a spring break vacation. 1. a. People usually exploit opportunities to make themselves better off. In this case, you make yourself better off by buying textbooks at a lower price. Solution b. Resources are scarce. Since you have only $35 a day, your resources are limited (scarce). c. Markets usually lead to efficiency. The market here is represented by the buyers and sellers who use Craigslist to trade goods, in contrast to the “nonmarket” of simply giving items away to one’s roommate. The market is efficient because it enables people who want to sell items to find those who want to buy those items. This is in contrast to a system in which items are simply left with a roommate, who may have little or no desire to have them. d. Overall spending sometimes gets out of line with the economy’s productive capacity. The spending by St. Crispin homeowners on building materials and workers fell short of the economy’s ability to produce those goods and services. As a result, prices on the island rose across the board (inflation). e. One person’s spending is another person’s income. Your spending on the used textbook is your roommate’s income. S-1

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    S-2 C h a p t e r 1 F i r s t P r i n c i P l e s f. “How much” is a decision at the margin. Your decision is one of “how much” coffee to consume, and you evaluate the trade-off between keeping yourself awake and becoming more jittery from one more cup of coffee. g. Resources should be used as efficiently as possible to achieve society’s goals. Allocating scarce lab space according to when each student can use that space is efficient. h. The real cost of something is what you must give up to get it. The real cost of a semester abroad is giving up the opportunity to graduate early. i. Markets move toward equilibrium. Any bicycle a buyer chooses will leave him or her equally well off. That is, a buyer who chooses a particular bicycle can - not change actions and find another bicycle that makes him or her better off. Also, no seller can take a different action that makes him or her better off: no seller can charge a higher price for a bicycle of similar quality, since no one would buy that bicycle. j. There are gains from trade. If each person specializes in what he or she is good at (that is, in comparison with others that person has an advantage in producing that good), then there will be gains from specialization and trade. k. When markets don’t achieve efficiency, government intervention can improve society’s welfare. Unsafe drivers don’t take into account the dangers they pose to others and often to themselves. So when unsafe drivers are allowed to drive, everyone is made worse off. Government intervention improves society’s wel - fare by assuring a minimum level of competence in driving. l. Government policies can change spending. In this case, a tax cut has increased spending. 2. Describe some of the opportunity costs when you decide to do the following. a. Attend college instead of taking a job b. Watch a movie instead of studying for an exam c. Ride the bus instead of driving your car Solution 2. a. One of the opportunity costs of going to college is not being able to take a job. By choosing to go to college, you give up the income you would have earned on the job and the valuable on-the-job experience you would have acquired. Another opportunity cost of going to college is the cost of tuition, books, supplies, and so on. Alternatively, the benefit of going to college is being able to find a better, more highly paid job after graduation, in addition to the joy of learning. b. Watching the movie gives you a certain benefit, but allocating your time (a scarce resource) to watching the movie also involves the opportunity cost of not being able to study for the exam. As a result, you will likely get a lower grade on the exam—and all that that implies. c. Riding the bus gets you where you need to go more cheaply than, but probably not as conveniently as, driving your car. That is, some of the opportunity costs of taking the bus involve waiting for the bus, having to walk from the bus stop to where you need to go rather than parking right outside the building, and probably a slower journey. If the opportunity cost of your time is high (your time is valuable), these costs may be prohibitive. 3. Liza needs to buy a textbook for the next economics class. The price at the col - lege bookstore is $65. One website offers it for $55, and another site, for $57. All prices include sales tax. The accompanying table indicates the typical shipping and handling charges for the textbook ordered online. Shipping method Delivery time Charge Standard shipping 3–7 days $3.99 Second-day air 2 business days 8.98 Next-day air 1 business day 13.98

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    C h a p t e r 1 F i r s t P r i n c i P l e s S-3 a. What is the opportunity cost of buying online instead of at the bookstore? Note that if you buy the book online, you must wait to get it. b. Show the relevant choices for this student. What determines which of these options the student will choose? Solution 3. a. The opportunity cost of buying online is whatever you must give up to get the book online. So the opportunity cost of buying online is the sum of the ship - ping charges plus the opportunity cost of your time spent waiting for the book to arrive (at the bookstore the book is available immediately) minus the cost saving you receive by buying online versus buying at the bookstore. b. Below is a list of all of Liza’s options and their purely monetary costs: Buy from bookstore $65 Buy from first site (price $55), 1-day delivery $55 + $13.98 = $68.98 Buy from first site (price $55), 2-day delivery $55 + $ 8.98 = $63.98 Buy from first site (price $55), 3- to 7-day delivery $55 + $ 3.99 = $58.99 Buy from second site (price $57), 1-day delivery $57 + $13.98 = $70.98 Buy from second site (price $57), 2-day delivery $57 + $ 8.98 = $65.98 Buy from second site (price $57), 3- to 7-day delivery $57 + $ 3.99 = $60.99 It is clear that Liza would never buy from the second site, where the book costs $57: for each delivery time, she is better off buying the book from the first site, where the book costs $55. It is also clear that she would never buy the book from the first site and have it delivered the next business day: it costs more that way ($68.98) than getting it from the bookstore (assuming that it is costless to get to and from the bookstore). But it is not clear whether she will buy the book from the bookstore or the first site with delivery times of 2 or 3–7 days: this depends on her opportunity cost of time. The higher the cost of waiting, the more likely she is to buy the book from the bookstore, where she does not need to wait. 4. Use the concept of opportunity cost to explain the following. a. More people choose to get graduate degrees when the job market is poor. b. More people choose to do their own home repairs when the economy is slow and hourly wages are down. c. There are more parks in suburban than in urban areas. d. Convenience stores, which have higher prices than supermarkets, cater to busy people. e. Fewer students enroll in classes that meet before 10:00 a . m . Solution 4. a. The worse the job market, the lower the opportunity cost of getting a graduate degree. One of the opportunity costs of going to graduate school is not being able to work. But if the job market is bad, the salary you can expect to earn is low or you might be unemployed—so the opportunity cost of going to school is also low. b. When the economy is slow, the opportunity cost of people’s time is also lower: the wages they could earn by working longer hours are lower than when the economy is booming. As a result, the opportunity cost of spending time doing your own repairs is lower—so more people will decide to do their own repairs. c. The opportunity cost of parkland is lower in suburban areas. The price per square foot of land is much higher in urban than in suburban areas. By creating parkland, you therefore give up the opportunity to make much more money in cities than in the suburbs. d. The opportunity cost of time is higher for busy people. Driving long distances to supermarkets takes time that could be spent doing other things. Therefore, busy people are more likely to use a nearby convenience store. e. Before 10:00 a . m . the opportunity cost of time for many students is very high—it means giving up an extra hour’s sleep. That extra hour is much more valuable before 10:00 a . m . than later in the day.

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    S-4 C h a p t e r 1 F i r s t P r i n c i P l e s 5. For the following examples, state how you would use the principle of marginal analysis to make a decision. a. Deciding how many days to wait before doing your laundry b. Deciding how much time to spend researching before writing your term paper c. Deciding how many bags of chips to eat d. Deciding how many class lectures to skip Solution 5. a. Each day that you wait to do your laundry imposes a cost: you have fewer clean clothes to choose from. But each day that you wait also confers a benefit: you can spend your time doing other things. You will wait another day to do your laundry if the benefit of waiting to do the laundry that day is greater than the cost. b. The more research you do, the better your paper will be. But there is also an opportunity cost: every additional hour you spend doing research means you cannot do other things. You will weigh the opportunity cost of doing one more hour of research against the benefit gained (in terms of an improved paper) from doing research. You will do one more hour of research if the benefit of that hour outweighs the cost. c. Each bag of chips you eat gives you a benefit: it satisfies your hunger. But it also has a cost: the money spent for each bag (and, if you are weight-conscious, the additional calories). You will weigh the cost against the benefit of eating one more bag. If the cost is less than the benefit, you will eat that one more bag of chips. d. Each lecture that you skip implies a cost: getting further behind with the material and having to teach it to yourself just before the exam. But each skipped lecture also means you can spend the time doing other things. You will continue to skip lectures if the cost of skipping is lower than the benefit of spending that time doing other things. 6. This morning you made the following individual choices: you bought a bagel and coffee at the local café, you drove to school in your car during rush hour, and you typed your course notes for your roommate because she was texting in class—in return for which she will do your laundry for a month. For each of these actions, describe how your individual choices interacted with the individual choices made by others. Were other people left better off or worse off by your choices in each case? 6. When you bought the bagel and coffee, you paid a price for them. You would not have bought that breakfast if your enjoyment of it (your welfare) had not been greater than the price you paid. Similarly, the café owner would not have sold you the bagel and coffee if the price he received from you were less than the cost to him of making them. This is an example of how everybody gains from trade: both you and the café owner are better off. Solution When you chose to drive your car during the rush hour, you added to the congestion on the road. Your choice had a side effect for other motorists: your driving slowed everybody else down just a little bit more. Your choice made other motorists worse off. Typing your notes for your roommate in exchange for her doing your laundry is another example of the gains that come from trade. Both of you voluntarily agreed to specialize in a task that each is comparatively better at because you expected to gain from this interaction. Your choice made both you and your roommate better off. 7. The Hatfield family lives on the east side of the Hatatoochie River, and the McCoy family lives on the west side. Each family’s diet consists of fried chicken and corn-on-the-cob, and each is self-sufficient, raising their own chickens and growing their own corn. Explain the conditions under which each of the follow - ing would be true. a. The two families are made better off when the Hatfields specialize in raising chickens, the McCoys specialize in growing corn, and the two families trade.

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    C h a p t e r 1 F i r s t P r i n c i P l e s S-5 b. The two families are made better off when the McCoys specialize in raising chickens, the Hatfields specialize in growing corn, and the two families trade. Solution 7. a. Gains from trade usually arise from specialization. If the Hatfields (compared to the McCoys) are better at raising chickens and the McCoys (compared to the Hatfields) are better at growing corn, then there will be gains from specializa - tion and trade. b. Similar to the answer to part a, if the McCoys (compared to the Hatfields) are better at raising chickens and the Hatfields (compared to the McCoys) are better at growing corn, then there will be gains from specialization and trade. 8. Which of the following describes an equilibrium? Which does not? If the situa - tion does not describe an equilibrium, what would an equilibrium look like? a. Many people regularly commute from the suburbs to downtown Pleasantville. Due to traffic congestion, the trip takes 30 minutes via highway but only 15 minutes via side streets. b. At the intersection of Main and Broadway are two gas stations. One station charges $3.00 per gallon for regular gas and the other charges $2.85 per gallon. Customers can get service immediately at the first station but must wait in a long line at the second. c. Every student enrolled in Economics 101 must also attend a weekly tutorial. This year there are two sections offered: section A and section B, which meet at the same time in adjoining classrooms and are taught by equally compe - tent instructors. Section A is overcrowded, with people sitting on the floor and often unable to see what is written on the board at the front of the room. Section B has many empty seats. Solution 8. a. This is not an equilibrium. Assume that all people care about is the travel time to work (not, for instance, how many turns they need to make or what the scenery is like). Some people could be better off using the side streets, which would cut down their travel time. Eventually, as the situation moves to equilib - rium (that is, as more people use the side streets), travel times on the highway and along the side streets will equalize. b. This might be an equilibrium. Those who buy gas at the first station would be worse off by buying gas at the second if the value of their time spent waiting exceeded the savings at the pump: they would save 15 cents per gallon but would incur the opportunity cost of waiting in a long line. You should expect very busy people (a high opportunity cost of time) to buy gas at the first station. Those who buy gas at the second station might be worse off by buying gas at the first: they would not have to wait in line but would pay 15 cents more per gallon. You should expect people with a lot of free time (a low opportunity cost of time) to buy gas at the second station. c. This is not an equilibrium. If students from section A attended section B instead, they would be better off: they could get seats and see the board without incurring any cost (since the section meets at the same time and is taught by an equally competent instructor). Over time, you should expect students to switch from section A to section B until equilibrium is established. 9. For each of the following, explain whether you think the situation is efficient or not. If it is not efficient, why not? What actions would make it efficient? a. Electricity is included in the rent at your dorm. Some residents in your dorm leave lights, computers, and appliances on when they are not in their rooms. b. Although they cost the same amount to prepare, the cafeteria in your dorm consistently provides too many dishes that diners don’t like, such as tofu casserole, and too few dishes that diners do like, such as roast turkey with dressing.

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