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Solution Manual for Principles of Macroeconomics, 6th Edition

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    1 C HAPTER 1 THINKING LIKE AN ECONOMIST Answers to Review Questions 1. Your friend probably means that the benefits from private solo lessons are greater (your tennis game will improve faster) than if you take group lessons. But private lessons are also more costly than group lessons. So those people who don’t care that much about how rapidly they improve may do better to take group lessons and spend what they save on other things. Learning Objective: 01 - 02 AACSB: Reflective Thinking Bloom’s: Understand 2. False. According to the Cost - Benefit Principle, your willingness to make the trip should depend only on whether $30 is more or less than the cost of driving downtown. Learning Objective: 01 - 03 AACSB: Reflective Thinking Bloom’s: Understand 3. Because the price of a movie ticket is a cost the patron must pay explicitly, it tends to be more noticeable than the money that she would fail to earn by seeing the movie. As Sherlock Holmes recognized, it’s easier to notice that a dog has barked than that it has failed to bark. Learning Objective: 01 - 03 AACSB: Reflective Thinking Bloom’s: Understand 4. Using a frequent flyer coupon for one trip usually means not having one available to use for another. By thinking of frequent - flyer travel as free, people fail to consider the opportunity cost of using the coupon, thereby making wasteful travel decisions. Learning Objective: 01 - 03 AACSB: Reflective Thinking Bloom’s: Understand 5. Your tuition payment is a sunk cost as long as it is non - refundable, since the payment cannot be recovered even if you drop out of school. If the payment is refundable until a certain date, it is not a sunk cost until after that date.

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    2 Learning Objective: 01 - 03 AACSB: Analytic Bloom’s: Analyze Answers to Problems 1. The economic surplus from washing your dirty car is the difference between the benefit you receive from doing so ($6) minus your cost of doing the job ($3.50), or $2.50. Learning Objective: 01 - 02 AACSB: Analytic Bloom’s: Apply 2. The marginal benefit of adding a pound of compost is the extra revenue you earn from the additional pound of tomatoes grown. T herefore , you should continue to add more compost as long as the marginal benefit exceeds or equals the marginal cost of adding another pound of compost (50 cents). This type of problem is best answered using a table such as the one below. Note that by add ing the fourth pound of compost you’ll get 2 extra pounds of tomatoes, or 60 cents in ext ra revenue, which covers the 50 cent cost of the extra pound of compost. However, the fifth pound of compost gives only 1 extra pound of tomatoes, so the corresponding revenue increase of 30 cents is less than the cost of the compost. So you should add 4 pounds of compost and no more. Pounds of compost Pounds of tomatoes Extra pounds of tomatoes Extra revenue or marginal benefit Extra or marginal cost 0 100 - - - 1 120 20 $6.00 $ 0 .50 2 125 5 $1.50 $ 0 .50 3 128 3 $ 0 .90 $ 0 .50 4 130 2 $ 0 .60 $ 0 .50 5 131 1 $ 0 .30 $ 0 .50 6 131.5 .5 $ 0 .15 $ 0 .50 Learning Objective: 01 - 02 AACSB: Analytic Bloom’s: Apply 3. Since you have already bought your ticket, the $30 you spent on it is a sunk cost. It is money you cannot recover, whether or not you go to the game. In deciding whether to see the game, then, you should compare the benefit of seeing the game (as measured by the largest dollar amount you would be willing to pay to see it) to only those additional costs you must incur to see the game (the opportunity cost of your time, whatever cost you assign to driving through the snowstorm, etc.). In Cost - Benefit, you must only consider the costs that actually change with

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    3 your decision, which is not the case with the $30 that you will never see again whether you go to the game or not. Joe, too, must weigh the opportunity cost of his time and the hassle of the drive in deciding whether to attend the game. But he must also weigh the $25 he will have to spend for his ticket. At the moment of deciding, therefore, the remaining costs Joe must incur to see the game are $25 higher than the remaining costs for you. And since you have identical tastes — that is, your respective benefits of attending the game are exactly the same — Joe should be less likely to make the trip. You might think the cost of seeing the game is higher for you, since your ticket cost $30, whereas Joe’s will cost only $25. But at the decision - making moment, only the ticket cost for Joe ($25) changes whether he goes or not, and is therefore the only cost that should be considered. Learning Objective: 01 - 02 AACSB: Analytic Bloom’s: Analyze 4. If Tom kept the $200 and invested it in additional mushrooms, at the end of a year's time he would have $400 worth of mushrooms to sell. Therefore, Dick must give Tom $200 in interest in order for Tom not to lose money on the loan. Learning Objective: 01 - 03 AACSB: Analytic Bloom’s: Apply 5. Even though you earned four times as many points from the first question than from the second, the last few seconds you spent on question 2 added a net of 6 points to your total score in comparison to the last few seconds spent on question 1. That means you should have spent more time on question 2. Learning Objective: 01 - 03 AACSB: Analytic Bloom’s: Apply 6. According to the Cost - B enefit principle, the two women should make the same decision. After all, the benefit of seeing the play is the same in both cases, and the cost of seeing the play — at the moment each must decide — is exactly $10. Some may think that in the case of the lost ticket the cost of seeing the play is not $10 but $20, the price of two tickets. However, in terms of the financial consequences, the loss of a ticket is clearly no different from the loss of a $10 bill. Both of these are examples of a sunk cost, as the $10 is lost whether one attends the play or not. So in each case, the question is whether seeing the play is worth spending $10. If it is worth $10 to see the play, both Martha and Sarah should see it ; otherwise they should not attend the performance. Whichever your answer, it must be the same for both Martha and Sarah .

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    4 Learning Objective: 01 - 03 AACSB: Analytic Bloom’s: Analyze 7 . In the current system , the cost is $6 per week no matter how many cans you put out, so the cost of disposing of an extra can of garbage (the marginal cost) is $0. Under the tag system, the cost of putting out an extra can is $2, regardless of the number of the cans. Since the marginal cost of putting out cans is higher under the tag system, we would expect this system to reduce the number of cans collected. Learning Objective: 01 - 04 AACSB: Analytic Bloom’s: Analyze 8 . At both house s , the cost of drinking a cola is that it’s not available to drink later, but at the Smith’s house, this cost is low because your sibling may drink the cola before the other is able to. This gives each Smith child a strong incentive to consume the cola s now. Jones, by contrast, has eliminated this incentive by not allowing either child to drink more than half the colas . As a result, his children can consume the cola at a slower, more enjoyable pace. Learning Objective: 01 - 04 AACSB: Reflective Thinking Bloom’s: Understand 9. For a seven - minute call the two phone systems charge exactly the same amount, 70 cents. But at that point under the new plan, the marginal cost is only 2 cents per minute , compared to 10 cents per minute under the current plan. And since the benefit of talking additional minutes is the same under the two plans, Tom is much more likely to make longer calls under the new plan. Learning Objective: 01 - 04 AACSB: Analytic Bloom’s: A nalyze 10. At University A, the marginal or extra cost for each additional pound of food is $0, so everybody will keep eating until the extra benefit from eating an extra pound is also equal to $0. At University B, however, the cost of eating an extra pound of food is $2, so people will stop eating when the benefit of eating an extra pound falls to $2. Food consumption will thus be higher at University A. Learning Objective: 01 - 04 AACSB: Analytic Bloom’s: A nalyze

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    1 CHAPTER 2 COMPARATIVE ADVANTAGE Answers to Review Questions 1. An individual has a comparative advantage in the pro duction of a particular good if she can produce it at a lower opportunity cost than other individuals. An individual has an absolute advantage in the production of a good if she can produce more of that good than another individual, using comparable amounts of time, raw materials and effort. Learning Objective: 02 - 01 AACSB: Reflective Thinking Bloom’s: Understand 2. A reduction in the number of hours worked each day will shift all points on the production possibilities curve inward, toward the origin, as this reduces the maximum amount that can be produced of either good. The graph below illustrates this situation. 2 C o f f e e ( l b / d a y ) N u t s ( l b / d a y ) P P C 1 P P C Learning Objective: 02 - 03 AACSB: Reflective Thinking Bloom’s: Understand 3. Technological innovations that boost labor productivity will shift all points on the production possibilities curve outward, away from the origin. The graph below illustrates this situation.

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    2 2 C o f f e e ( l b / d a y ) N u t s ( l b / d a y ) P P C 1 P P C Learning Objective: 02 - 03 AACSB: Reflective Thinking Bloom’s: Understand 4. According to the Principle of Comparative Advantage, people will perform their own services when the opportunity cost of doing so is low. This implies that performing services yourself is not a matter of whether you are rich or poor but rather the opportunity cost of your time . Furthermore, limited specialization will mean less overall production for a nation, which is usually interpreted as poverty. Learning Objective: 02 - 02 AACSB: Reflective Thinking Bloom’s: Understand 5. The fact that English has become the de facto international language has done muc h to stimulate international demand for American - made books, movies and popular music. The large size of the American market has given the United States an additional advantage over other English - speaking countries, like England, Canada, and Australia. Learning Objective: 02 - 03 AACSB: Reflective Thinking Bloom’s: Remember Answers to Problems 1. In the time it takes T ed to wash a car he can wax three cars , which is his opportunity cost of washing one car . In the time it takes Tom to wash one car, he can wax two cars, which is his o pportunity cost of washing one car .

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    3 Alternatively, you can compute how many cars each person can wash or wax in a certain time period, such as an hour, and then use these quantities to compute their respective opportunity costs: Ted can wash one car or wax three , so his opportunity cost of washing one car is 3 (or 3/1) wax jobs . Likewise, Tom can wash two cars or wax four, so his opportuni ty cost of washing one car is 2 (or 4/2) wax jobs . Because Tom’s opportunity cost of washing a car is lower than Ted’s, Tom has a comparative advantage in washing cars. Learning Objective: 02 - 01 AACSB: Analytic Bloom’s: Apply 2. In the time it takes Nancy to replace a set of brakes she can complete one - half of a clutch replacement ; her opportunity cost of replacing a set of brakes is therefore one - half of a clutch replacement. In the time it takes Bill to replace a set of brakes, he can complete one - third of a clutch replacement; his opportunity cost of replacing a set of brakes is therefore one - third of a clutch replacement. Alternatively, you can compute how many clutches or brakes each person can replace in a certain time period, such as 6 hours, and then use these quantities to compute their respective opportunity cost: Nancy can replace 1.5 clutches or 3 sets of brakes in that time, so her opportunity cost of replacing one set of brakes is one - ha lf of a clutch replacement (1.5/ 3). Likewise, Bill can replace 1 clutch or 3 sets of brakes, so his opportunity cost of replacing one set of brakes is one - t hird of a clutch replacement (1/ 3). Bill’s opportunity cost of replacing a set of brakes is lower than Nancy’s, so Bill has a comparative advantage in replacing brakes. This also implies that Nancy has a comparative advantage in replacing clutches. Finally, Nancy has an absolute advantage over Bill in replacing clutches since it takes her two hours less than it takes Bill to perform that job. Since Nancy and Bill take the same amount of time to replace a set of brakes, neither person has an absolute advantage in that task. Learning Objective: 02 - 01 AACSB: Analytic Bloom’s: Apply 3. a. Helen's production possibilities curve would look like the following:

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    4 0 3 2 6 4 D r e s s e s p e r d a y L o a v e s o f b r e a d p e r d a y b. As the graph shows, 28 dresses per day and 16 loaves of bread per day is outside the production possibilities curve (PPC) and is therefore an unattainable combination for Helen. The combination of 16 dresses per day and 32 loaves of bread per day is both attainable and efficient. Finally, 18 dresses per day and 24 loaves of bread per day is a combination that lies beneath the PPC, which is attainable but inefficient. Here, Helen could either complete more dresses or more loaves of bread per day. 0 3 2 6 4 D r e s s e s p e r d a y L o a v e s o f b r e a d p e r d a y a b c 3 2 1 6 2 4 2 8 1 6 1 8 Learning Objective: 02 - 03 AACSB: Analytic Bloom’s: Apply 4. a. As shown below, the new machine doubles the value of the vertical intercept of Helen’s PPC.

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    5 0 3 2 6 4 D r e s s e s p e r d a y L o a v e s o f b r e a d p e r d a y 6 4 b. Since Helen can sew twice as many dresses per hour as before, she can now sew any given number of dresses in half as much time as before. With the time saved, she can bake addit ional loaves of bread. c. The upward rotation of Helen’s PPC means that she is now able for the first time to produce at any of the points in the shaded region of the graph above. Note that her menu of opportunity increased with respect to dresses and with respect to bread as well. For example, she can now produce 32 dresses and 32 loaves of bread instead of 32 dresses and no loaves. Learning Objective: 02 - 03 AACSB: Analytic Bloom’s: Apply 5. a. Their maximum possible coffee output is 36 pounds per day (12 from Tom and 24 from Susan). b. Their maximum possible output of nuts is also 3 6 pounds per day (12 from Susan and 24 from Tom). c. Tom should be sent to gather nuts, since his opportunity cost (half a pound of coffee per pound of nuts) is lower than Susan’s (2 pounds of coffee per pound of nuts). Since it would take Tom only one hour to gather four pounds of nuts, he

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    6 can still pick 10 pounds of coffee in his 5 working hours that remain. Added to Susan’s 24 pounds, they will have a total of 34 pounds of coffee per day. d. Susan should be sent to pick coffee, since her opportunity cost (half a pound of nuts per pound of coffee) is lower than Tom’s (2 pounds of nuts per pound of coffee). It will take Susan 2 hours to pick 8 pounds of coffee, which means that she can still gather 8 pounds of nuts. So they will have a total of 32 pounds per day of nuts. e. To gather 26 pounds of nuts per day, Tom should work full time gathering nuts (24 pounds per day) and Susan should spend one hour per day gathering nuts (2 pounds per day). Susan would still have 5 hours available to devote to picking coffee , so she can pick 20 pounds of coffee per day. f. The point 30 pounds of coffee per day and 12 pounds of nuts per day can be produced by having Susan work full time picking coffee (24 pounds of coffee per day) while Tom spends 3 hours picking coffee (6 pounds of coffee) and 3 hours gathering nuts (12 pounds of nuts). g. The point 24 pounds of coffee per day and 24 pounds of nuts per day can be achieved if each works full time at his or her activity of comparative advantage. Both points are attainable and efficient. h. The points and the straight lines connecting them are shown in the graph below. The production possibilities curve for the two - person economy consisting of Susan and Tom shows the maximum possible amount of coffee production on the vertical axis for any given quantity of daily nut production on the horizontal axis.

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    7 Learning Objective: 02 - 03 AACSB: Analytic Bloom’s: Apply 6. a. By specializing completely, they can produce 24 pounds of coffee per day and 24 pounds of nuts (the point at which the kink occurs in the PPC in the diagram). If they sell this output in the wor ld market at the stated prices, t hey will receive a total of $96 per day. b. With $96 per day to spend, the maximum amount of coffee they could buy is 48 pounds per day, or they could buy 48 pounds of nuts per day. The combination of 40 pounds of coffee and 8 pounds of nuts would be unattainable for Susan and Tom if they were not able to buy and sell in the world market, as the maximum amount of coffee that can be picked is 36 pounds per day . However, if they buy and sell in the world market, 40 pounds of coffee would cost $80, and 8 pounds of coffee would cost $16, so they would have just enough money ($96 per day) to buy this combination of goods .

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    8 c. The points and the straight lines connecting them are shown in the diagram below. The resulting line is the production possibilities curve for the two - person economy consisting of Susan and Tom. Learning Objective: 02 - 04 AACSB: Analytic Bloom’s: Apply

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    1 CHAPTER 3 SUPPLY AND DEMAND Answers to Review Questions 1. Under the horizontal interpretation, we begin with a price for the good and then use the demand curve to read the quantity demanded at that price on the horizontal axis. Under the vertical interpretation, we start with a quantity produced and use the demand curve to read the marginal buyer’s reservation price for the product on the vertical axis. Learning Objective: 03 - 01 AACSB: Reflective Thinking Bloom’s: Understand 2. The equilibrium price of a good is determined by the intersection of its supply and demand curves. We can know everything about a good’s cost of production (that is we can know its supply curve exactly) but without the demand curve we will not know the quantity people will want to purchase and therefore we will not know what price must be charged to cover the cost. Learning Objective: 03 - 02 AACSB: Reflective Thinking Bloom’s: Understand 3. If price control regulation prevented the price of gasoline from rising to its equilibrium level, we would expect to see symptoms of excess demand for gasoline such as lines of cars waiting at the pumps to buy gas. Learning Objective: 03 - 02 AACSB: Analytic Bloom’s: Apply 4. A change in demand means a shift of the entire demand curve, whereas a change in the quantity demanded means a movement along the demand curve in response to a change in price of that specific good. Learning Objective: 03 - 0 3 AACSB: Analytic Bloom’s: Analyze

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    2 5. It is smart for each individual at a sporting event to stand up in order to get a better view of the game. However, it is dumb for all to stand up since no one sees any better than if all had remained seated. Learning Objective: 03 - 0 4 AACSB: Reflective Thinking Bloom’s: Understand Answers to Problems 1. a. The supply curve shift s to the right . The discovery is a technological improvement, so the improved technique would allow a farmer to use the same inputs to produce more corn. b . The supply curve shift s to the right . Fertilizer is an input into the production of corn , so this is an example of a decrease in an input price. A decrease in input prices shifts the supply curve to the right. c . The supply curve shift s to the right. N ew tax breaks make farming relatively more profitable than before , so those who were earning an income from a non - farming job that paid just a little bit more than farming would switch to farming if the tax break is big enough. d . The supply curve shift s to the left. A tornado would destroy corn fields , along with infrastructure used to harvest and store it. Thus , at every given price the quantity of corn supplied would be lower and the supply curve shift s to the left. Learning Objective: 03 - 01 AACSB: Analytic Bloom’s: Apply 2. a. The demand curve shifts to the right. Buyer income has risen and vacations are a normal good, so this increases the quantity demanded at every given price. b . The demand curve shift s to the left. Buyer preference will probably change because most people want to avoid foods that cause heart disease, so buyers will purchase fewer pizzas with pepperoni. c. The demand curve shift s to the right. Since these goods are substitute s, an increase in the price of MP3s would result in an increased demand for CDs. d. The demand curve remain s unchanged . An increase in the price of CDs decreases the quantity demanded of CDs, which causes movement along the demand curve. Learning Objective: 03 - 01

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    3 AACSB: Analytic Bloom’s: Apply 3. T he supply of binoculars will not be affected. The demand for binoculars might increase due to more people wanting to spot UFOs. This will lead to an increase in the equilibrium price of binoculars and the quantity of binoculars supplied . However, no change in the supply of binoculars should occur since nothing has changed with regard to input prices, technology, or any of the factors that determine supply. Learning Objective: 03 - 01 AACSB: Analytic Bloom’s: Apply 4. Two goods are complements if an increase in the price of one causes a leftward shift in the demand curve for the other or if a decrease in the price of one causes a rightward shift in the demand curve for the other . The oppos ite holds true for a substitute, where the price change of one good and the demand change of the other will be in the same direction (increase or decrease). a. Washing machines and dryers are complements. b. Tennis rackets and tennis balls are complements. c. Ice cream and chocolate are both complements and substitutes. d. Cloth diapers and disposable diapers are substitutes. Learning Objective: 03 - 03 AACSB: Reflective Thinking Bloom’s: Understand 5. An increase in the birth rate will increase the population of potential buyers of land. This will shift the demand curve for land to the right and increase the equilibrium price of land. Learning Objective: 03 - 03 AACSB: Analytic Bloom’s: Analyze

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