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Answers to the Practice Questions can also be found by selecting a chapter from the drop down menu on the left. CHAPTER 1 Page 6 a. The two variables are (i) the economic welfare of the country’s citizens, and (ii) the quantity of the country’s economic resources. b. The quantity of the country’s economic resources is the independent variable (since it is the cause) and the economic welfare of the country’s citizens is the dependent variable (since it is the effect). c. The relationship is direct, because a movement in the independent variable’s value leads to a movement of the dependent variable’s value in the same direction. d. The statement is positive, since it is a description of reality that does not depend on value judgements. e. For the country described in the statement, the economic problem of scarcity has become more severe. Page 11 1a. The opportunity cost of the first fish is 4 coconuts, since coconut production is reduced from 24 to 20 when the first fish is caught. Similarly, the opportunity costs of the second and third fish are 8 (= 20-12) and 12 (= 12-0) coconuts. b. These results conform with the law of increasing opportunity costs, because as fish production is increased so is the opportunity cost of each new caught fish. c. The curve bows out to the right, reflecting the law of increasing opportunity costs. d. Besides the assumption that only two goods are produced, we must assume that the quantity of the castaway’s resources and the technology he uses are fixed, and that his resources are employed to their full capacity. e. With more labour devoted to acquiring coconuts and fish, the castaway’s production possibilities curve shifts outwards, with both its vertical and horizontal intercepts increasing. f. With a new capital asset that can be used to acquire fish, the castaway’s production possibilities curve shifts outwards, with its horizontal intercept (but not its vertical intercept) increasing. 2a. Since 1 computer must be sacrificed to gain 600 new hamburgers when moving from points d to c, then the opportunity cost of each of these hamburgers is 1/600 of a computer. b. When moving from points b to c, 1 computer must be sacrificed to gain 300 new hamburgers, which means that the opportunity cost each of these hamburgers is 1/300 of a computer. 3a. b. Yes, the curve bows out to the right. This shows that, as more of one item (eg. fish) is produced, the higher the opportunity cost of these additional units of the item. Page 19 a. Beta is likely to have more economic freedom, given the greater importance of Beta’s private sector and the consumer sovereignty it promotes. b. Alpha is likely to have more economic stability, because of the relative importance of its traditional and public sectors. Both of these sectors tend to reduce economic instability. c. In Alpha, traditional culture and national planners are more likely to conflict, given its relatively large traditional and public sectors. d. In terms of the triangle shown in Figure 1.4, Alpha will be southeast of Beta because it has stronger elements of both a traditional economy and a command economy. CHAPTER 2 Page 34 1a. The three points are 8 [= (3+5)] milkshakes at a price of $1.50, 13 [= (5+8)] milkshakes at a price of $1, and 18 [= (7+11)] at a price of 50 cents. b. The law of demand is satisfied, because a fall in the price of milkshakes (from $1.50 to $1, or from $1 to 50 cents) increases quantity demanded (from 8 to 13 milkshakes, or again from 13 to 18 milkshakes). c. 2a. Because DVDs are a normal product, demand increases due to higher incomes. b. DVDs and DVD players are complementary products, so a drop in the price of players increases not just the quantity demanded of players but also the demand for DVDs. c. A sudden expectation by consumers of a fall in DVD prices means they will delay DVD purchases, decreasing current demand. d. Because DVDs and movie theatre tickets are substitute products, a rise in the price of movie tickets increases the demand for DVDs. 3a. A decrease in the price of DVDs, which raises the quantity demanded of DVDs, is associated with a movement along the demand curve for DVDs and is categorized as a change in quantity demanded. b. Because DVDs and videotapes are substitute products, a decrease in the price of DVDs decreases the entire demand curve for videotapes. This occurs because the quantity of videotapes is reduced at every possible videotape price. This is therefore categorized as a change in demand. Page 39 1a. The law of supply is satisfied, since a rise in the price of tomatoes (from $3 to $3.50, and then from $3.50 to $4) increases quantity supplied (from 5 to 6 millions kgs, and then from 6 to 7 million kgs). b. (i) As this resource price rises, the supply of tomatoes decreases, shifting the curve to the left. (ii) Because tomatoes and corn are supply-related products, a drop in the price of corn will increase the supply of tomatoes, shifting the curve to the right. (iii) An early frost decreases the supply of tomatoes, shifting the curve to the left. (iv) Technological progress in tomato cultivation increases the supply of tomatoes, shifting the curve to the right. (v) An expected fall in the price of tomatoes increases the current supply, as producers try and get today’s high price, shifting the curve to the right. c. 2a. A drop in the price of corn, which reduces the quantity supplied of corn, is associated with a movement along the supply curve for corn and is classified as a change in quantity supplied. b. Because corn and tomatoes are supply-related products, a drop in the price of corn causes a rightward shift in the entire supply curve for tomatoes. This happens because some farmers will respond by moving from corn to tomato production. The result is classified as a change in supply. Page 43 1a. Supply has decreased. On a graph, this is shown as a leftward shift, which is associated with a rise in equilibrium price. b. With a decrease in supply, equilibrium quantity decreases. c. The rise in equilibrium price and fall in equilibrium quantity are accompanied by a temporary shortage that occurs immediately after the decrease in supply. d. 2a. Demand has increased. On a graph, this is shown as a rightward shift, which is associated with a rise in equilibrium price. b. With an increase in demand, equilibrium quantity increases. c. The rise in equilibrium price and quantity are accompanied by a temporary shortage that occurs immediately after the increase in demand. d. CHAPTER 3 Page 59 1a. Total revenue is $30 million (= $3000 x 10 000) at a price of $3000, $40 million (= $2000 x 20 000) at $2000, and $30 million (= $1000 x 30 000) at a price of $1000. b. The market demand curve is elastic in the price range $3000 to $2000, since total revenue and price move in opposite directions. Total revenue rises as price falls. In contrast, the demand curve is inelastic in the range $2000 to $1000, because total revenue and price are moving in the same direction, with both falling. c. Between prices $3000 and $2000, the demand elasticity has a value of (-)1.67 [= ((20 000 - 10 000)/(15 000))/(($2000 - $3000)/($2500))], and between $2000 and $1000, it has a value of (-)0.60 [= ((30 000 - 20 000)/(25 000))/(($1000 - $2000)/($1500))]. d. Yes, the answers are consistent. The numerical value of elasticity between prices $3000 and $2000 is greater than one. This is consistent with part b. where demand in this price range was found to be elastic. Similarly, the numerical value between $2000 and $1000 is less than one, which is consistent with part b., where demand in this range was found to be inelastic. e. Yes. This graph is consistent with the answers above. In the $3000-to-$2000 price range, the rectangles expand as price falls, which indicates that demand is elastic. In the $2000-to-$1000 price range, the rectangles contract as price falls, which indicates that demand is inelastic. 2a. The cross-price elasticity has a value of 1.29 [= ((750 000 - 1 million)/(875 000))/(($20 000 - $25 000)/($22 500))]. b. The price elasticity of demand has a value of (-)0.54 [= ((17 500 - 15 000))/((16 250)/($90 - $120)/($105))]. c. The income elasticity has a value of -0.87 [= ((3000 - 2000)/(2500))/(($50 000 - $80 000)/($65 000))]. page 63 a. es is 0 [= ((80 000 - 80 000)/(80 000))/(($1.20 - $1)/($1.10))], and the immediate-run supply curve is vertical at the constant quantity supplied of 80 000 heads. b. es is 1 [= ((1.2 million – 1 million)/(1.1 million))/(($1.20 - $1)/($1.10))], and the short-run supply curve is positively sloped. c. The long-run supply curve is horizontal at the constant price of $1, and es is therefore undefined. d. This is a constant-cost industry, since its long-run supply curve is perfectly elastic. This means the industry is not a major user of any single resource, so price is always driven back to its original level in the long run after a change in production. e. Page 67 a. With a ceiling of $500 set below the equilibrium value of $650, a shortage of rental accommodation is created. Landlords will receive less revenue, and are harmed. Tenants able to find rental accommodation despite the shortage will gain. Tenants who are not able to find rental accommodation, however, will lose as they are end up being forced into the unregulated portion of the market, where rents are often higher than in the regulated market. b. With a price floor of $2 imposed above the equilibrium value of $1.50, a surplus will appear, and the government will be forced to purchase this surplus at $2 per kg. Cheddar consumers are hurt, as they pay a higher price and buy fewer units. Producers are helped, as they produce more cheddar and gain a greater price than before for the cheddar they sell. c. Because the price ceiling of $700 is set above the equilibrium value of $600, there will be no effect in the market. Page 71 a. Because the dance club disturbs nearby residents, it has a spillover cost. To deal with this cost, government officials could ban dance clubs in suburban neighbourhoods. b. By reducing traffic congestion, the subway has a spillover benefit. To take account of this benefit, use of the subway could be promoted by a government subsidy. c. Since throw-away batteries add to soil pollution, they have a spillover cost. This cost could be dealt with by imposing an excise tax to reduce their popularity, or this product’s use could be banned. CHAPTER 4 Page 88 a. With Process A, total daily costs of employing labour and capital are $400 [= ($80 x 2 workers) + ($40 x 6 machines)]. With Process B, these costs are $360 [= ($80 x 3 workers) + ($40 x 3 machines)]. Because Process B minimizes daily costs and maximizes productive efficiency, it will be chosen by the owner. b. $400 [= ($80 x 3) + ($40 x 3) + $30 + $10] c. $200 [= (.06 x 10 000) - $400]. d. Implicit costs are $180 [= ($150 + $30)]. Economic costs are $580 [= ($400 + $180)] e. $20 [= ($600 - $580)]. f. No, the owner should not consider closing, since the shop is making a positive economic profit. Page 96 1a. Marginal product is 50 [= (50 – 0)] pots for the first worker, 150 [= (200 – 50)] pots for the second worker, 70 [= (270 – 200)] pots for the third worker, 30 [= (300 – 270)] pots for the fourth worker, and -60 [= (240 – 300)] pots for the fifth worker. b. Marginal product rises when the first and second workers are hired. Marginal product falls and is positive when the third and fourth workers are hired. Marginal product is negative when the fifth worker is hired. c. This is because it becomes increasingly difficult for each of these new workers to raise output given the potter’s fixed inputs. d. Average product is 50 [= (50/1)] pots with one worker, 100 [= (200/2)] pots with two workers, 90 [= (270/3)] pots with three workers, 75 [= (300/4)] pots when four workers are employed, and 48 [= (240/5)] pots when five workers are employed. e. Marginal and average product are the same when the first worker is hired. As marginal product is rising (when the second worker is hired), marginal product is greater than average product. As marginal product falls (when the last three workers are hired), marginal product is less than average product. f. g. Marginal product reaches its peak where diminishing marginal returns set in. Total product rises less rapidly and finally becomes negatively sloped once diminishing marginal returns set in. Average product reaches its maximum where it equals marginal product. Then, because of diminishing marginal returns, with marginal product falling and below average product, average product declines. 2a. Variable costs are $0 at a zero output, $100 at an output of 50 pots, $200 at 200 pots, $300 at 270 pots, and $400 at 300 pots. Total cost is $100 [= ($100 + $0)] at 0 pots, $200 [= ($100 + $100)] at 50 pots, $300 [= ($100 + $200)] at 200 pots, $400 [= ($100 + $300)] at 270 pots, and $500 [= ($100 + $400)] at 300 pots. b. Marginal cost is $2.00 [= ($100 - $0)/(50 – 0)] when moving from 0 to 50 pots; $0.67 [= ($200 - $100)/( 200 – 50)] from 50 to 200 pots; $1.43 [= ($300 - $200)/(270 – 200)] from 200 to 270 pots; $3.33 [= ($400 - $300)/(300 – 270)] from 270 to 300 pots. c. Average fixed cost is $2.00 [= ($100/50) at 50 pots, $0.50 [= ($100/200)] at 200 pots, $0.37 [= ($100/270)] at 270 pots, and $0.33 [= ($100/300)] at 300 pots. Average variable cost is $2.00 [= ($100/50)] at 50 pots, $1.00 [= ($200/200)] at 200 pots, $1.11 [= ($300/270)] at 270 pots, and $1.33 [= ($400/300)] at 300 pots. Average cost is $4.00 [= ($200/50)] at 50 pots, $1.50 [= ($300/200)] at 200 pots, $1.48 [= ($400/270)] at 270 pots, and $1.67 [= ($500/300)] at 300 pots. d. e. Yes. The marginal cost and average variable cost curves are J-shaped, and the average cost curve is bowl-shaped, with the minimum points of both average variable cost and average cost occurring at the curves’ intersection with the marginal cost curve. Page 101 a. The percentage increase in the labour input is 50% [= ((9 – 6)/6)) x 100%] and the percentage increase in the capital input is also 50% [= ((3 – 2)/2)) x 100%], while the percentage increase in output is 100% [= (240 – 120)/120]. Because the relative increase in output exceeds the relative increase in each of the inputs, the business is experiencing increasing returns to scale. Long run average cost falls from $5.33 [= ((6 x $100) + (2 x $20))/120] to $4 [= ((9 x $100) + (3 x $20))/240]. b. The percentage increase in output is 50% [= (180 – 120)/120]. Because the relative increase in output equals the relative increase in each of the inputs, the business is experiencing constant returns to scale. Long run average cost at 120 units is $5.33 [= ((6 x $100) + (2 x $20))/120] and at 180 units is also $5.33 [= ((9 x $100) + (3 x $20))/180]. c. The percentage increase in output is 33% [= (160 – 120)/120]. Because the relative increase in output is less than the relative increase in each of the inputs, the business is experiencing decreasing returns to scale. Long run average cost rises from $5.33 [= ((6 x $100) + (2 x $20))/120] to $6 [= ((9 x $100) + (3 x $20))/160]. CHAPTER 5 Page 112 1a. The café is part of a monopolistically competitive market, since there are many cafés in the area, each providing a slightly different product b. The company operates in a monopoly, since the company is the sole provider of public transit in this area. c. The corporation is in an oligopoly, since a relatively small number of businesses make popular women’s perfumes. d. This share-owner is operating in a perfectly competitive market, since there are many buyers and sellers of BCE shares. 2a. Total revenue is $15 000 [= ($5 x 3000)] at 3000 kgs and $20 000 [= ($5 x 4000)] at 4000 kgs. Dividing this difference by the change in output gives the marginal revenue of $5 [= ($20 000 - $15 000)/(4000 – 3000)]. b. Since the fisherman is a perfect competitor, he faces a constant price (equal to average revenue). In this situation, marginal revenue and price are always the same. c. Yes, the curve is horizontal, as expected. Page 120 1a. This is his profit-maximizing point. Marginal cost, which is rising from $4.95 to $5.05 at the output of 4000 kgs, equals the fisherman’s marginal revenue of $5 at, or close to, 4000 kgs. b. The fisherman’s total loss is (-)$4000 [= ($5 x 4000) – ($6 x 4000) = ($20 000 - $24 000)]. c. Yes. Even though the fisherman is making a loss, his $20 000 in total revenue covers his variable costs of $16 000 [= ($4 x 4000)], with an amount left over to pay some of his fixed costs. d. See graph at 2e. 2a. Yes. The fisherman’s supply curve includes the profit-maximizing points at each possible price, and this is a profit-maximizing point. b. No. The $5.50 price associated with the breakeven point is the fisherman’s lowest possible average cost. At any price below $5.50, therefore, he is necessarily making a loss. c. No. At any price above $5.50, the fisherman can make a higher profit than he does at the breakeven point. This profit is necessarily positive, as long as the fisherman is at a profit-maximizing point. d. The shutdown point is at a price below $5.50. At this point, price equals minimum average variable cost, which is necessarily below the fisherman’s minimum average cost of $5.50 at the breakeven point. e. Page 123 1a. Because price exceeds average cost, businesses in this market are making a positive profit. These profits will attract new businesses to enter the market. As this happens, the market supply curve shifts to the right, putting downward pressure on equilibrium price. This process continues until price and average cost are equal. b. Yes, the minimum-cost pricing rule will be met. This is because new businesses will enter the market as long as price exceeds the lowest possible average cost, and positive profits are being made. Only once price has reached the lowest possible average cost will the influx of new businesses end. c. Yes, the marginal-cost pricing rule will also be met. In any perfectly competitive market, individual businesses face a constant price and average revenue (because they are price takers), which means that average revenue and marginal revenue are the same. Because businesses in this market maximize profits at the point where marginal cost and marginal revenue are equal, they will also be ensuring that price equals marginal cost. CHAPTER 6 Page 133 1a. The perfect competitor’s demand curve is perfectly elastic, since the business is a price taker. b. A relatively elastic curve applies to a monopolistic competitor, because of limited market power due to product differentiation. c. Because it is the sole seller of a product with no close substitutes, the monopolist has a demand curve that is less elastic than for businesses in other markets. d. A kinked demand curve applies to an oligopolist in a market where rivalry prevails. This is because of the differing reactions of the business’s rivals to an increase or decrease in price. Page 138 1a. The change in total revenue between the two output levels, which is $8 million [= ($20 x 400 000)] at 400 000 prescriptions and $7.5 million [= ($15 x 500 000)] at 500 000 prescriptions, is divided by the change in output [($8 million - $7.5 million)/(500 000 – 400 000) = ($500 000/100 000)]. This gives a marginal revenue of $5. b. Since demand (which equals average revenue) is downsloping for a monopolist, marginal revenue is below the demand curve and therefore less than price. This ensures that price falls as output expands. c. 2a. Yes, profit is maximized at this output and price, because this is where marginal cost (MC) and marginal revenue (MR) are equal. b. Output will now exceed 100 000 units and price will be less than $6. Perfectly competitive businesses operate at the intersection of the market demand (D) and supply (S) curves. While D is the same as in the case of monopoly, S is a portion of the monopolist’s MC curve. Because D and S cross at a point to the right of the intersection of the monopolist’s MC and MR curves, perfectly competitive output is higher. Moreover, the perfectly competitive price is found further along the downsloping D curve, so it is lower. Page 145 1a. Total revenue is $400 [= ($.04 x 10 000)] at 10 000 copies and $450 [= ($.03 x 15 000)] at 4000 kgs. Dividing this difference by the change in output gives the marginal revenue of 1 cent [= ($450 - $400)/(15 000 – 10 000)]. b. As in the case of monopoly, demand (which equals average revenue) is downsloping for a monopolistic competitor. To ensure that price falls as output expands, marginal revenue must be below the demand curve and therefore less than price. c. 2a. The business makes a short-run loss, with its $5 price below the $6 average cost. In the long run, as some of its competitors leave the market, this business will see an outward shift in its demand curve. The curve will also become less elastic, with fewer close substitutes for the business’s output. The short-run loss gradually disappears as the business moves towards its long-run equilibrium point. b. The business now makes a profit, with its $5 price greater than the $4 average cost. In the long run, new businesses enter the market. This business will see a leftward shift in its demand curve, and the curve will become more elastic, because there are more close substitutes for the business’s output. This time, the business’s profit gradually disappears as it approaches its long-run equilibrium point. 3a. At the output associated with the kink in the demand curve, the business’s marginal revenue (MR) curve is a vertical segment. This is because the MR curve has two downsloping segments – each associated with one part of the kinked demand curve – and the vertical segment running between these two downsloping MR segments. b. As long as the marginal cost curve continues to intersect marginal revenue along the MR curve’s vertical segment, there will be no change in the business’s profit-maximizing output or price. This is significant because it shows that oligopolists in markets characterized by rivalry are reluctant to vary their price. Page 150 1a. Total industry sales are $24 million [= (12 x $2 million)], while sales of four of the firms are $8 million [= (4 x $2 million)]. (There is no need to distinguish among the firms since all are exactly the same size.) Hence the four-firm concentration ratio is .33 [= ($8 million/$24 million)]. b. Given that the four-firm concentration ratio is below 50 percent, this industry can be classified as monopolistically competitive. c. A business in this market may choose to engage in non-price competition to distinguish its product from that of rivals. If so, the business’s motive would be to increase its demand and make demand less elastic, allowing the business to raise its price. d. No. Non-price competition is legal in Canada. e. It would be a horizontal merger, since both businesses are in the same industry. 2. No. While big businesses may be able to pass on cost-savings to consumers, they also tend to have significant market power, which means that consumers do not always benefit from these cost savings. Moreover, there is a good chance that technical innovation by these businesses will not be as rapid as in more competitive markets. CHAPTER 7 Page 163 1a.
b. In a perfectly competitive labour market, the farmer’s marginal resource cost is the hourly wage of $15. The profit-maximizing employment rule states that profit is maximized at the employment level where marginal revenue product and marginal resource cost are equal. Comparing marginal revenue product with this marginal resource cost, the farmer will hire 3 workers. Between 2 and 3 workers, marginal revenue product, at $18, exceeds the marginal resource cost of $15, whereas between 3 and 4 workers the marginal resource cost of $15 exceeds marginal revenue product, now at $12. c. d. With 10 000 identical employers in the labour market, each hires 3 workers at a wage of $15. So 30 000 [= (3 x 10 000)] workers are hired in the entire market. e. 2a. With an increase in product demand, the demand for unskilled labour used in the fruit-growing industry will also increase. b. Automated machinery likely represents a substitute resource for unskilled labour in this industry. The introduction of new automated techniques will therefore cause the demand for this labour to decrease. c. Because land and unskilled labour are complementary resources in the fruit-growing industry, a rise in land rents causes the demand for this labour to decrease. Page 169 1a. The Albertan carpenter is likely better paid. This is primarily due to regional disparities. b. The truck driver is likely better paid. This is primarily due to more unpleasant job conditions. c. The postal worker is likely better paid. This is primarily due to the fact that the postal worker is unionized while the courier company employee is probably not unionized. d. The warehouse clerk is likely better paid. This is primarily due to discrimination on the basis of gender. While restaurant jobs are dominated by low-paid female labour, warehouse clerks are usually men. e. The lawyer is likely better paid. This is primarily due to the greater amount of education required to be a lawyer. Page 173 1a. The oil spill decreases the demand for land in this region, causing rents to fall b. The gallery event increases the demand for this artist’s work, which raises her economic rent. c. The influx of European players increases the supply of talented hockey players, and reduces the economic rents received by those players already in North American leagues. d. Global warming reduces the supply of this country’s available land, which means land rents rise. 2a. The loan to the high-tech business will likely have the higher interest rate, because of the business’s greater credit risk. b. The five year loan will likely have the higher interest rate, due to its longer repayment period. c. The $10 000 loan will likely have the higher interest rate, since it is a smaller size. d. The personal loan will likely have the higher interest rate, because it is not secured with collateral assets. CHAPTER 8 Page 188 1a. Total income earned in Libra is $100 000 [= ($5000 + $10 000 + $15 000 + $30 000 + $40 000)]. The shares if income earned by the five households (ranked in reverse order) are 5% [= ($5000/$100 000) x 100%], 10% [= ($10 000/$100 000) x 100%], 15% [= ($15 000/$100 000) x 100%], 30% [= ($30 000/$100 000) x 100%], and 40% [= ($40 000/$100 000) x 100%]. b. The cumulative shares of income earned by each household (ranked in order) are 5%, 15% [= (5% + 10%)], 30% [= (5% + 10% + 15%)], 60% [= (5% + 10% + 15% + 30%)], 100% [= (5% + 10% + 15% + 30% + 40%)]. c. 2a. Statistics Canada defines LICO in reference to the average proportion of after-tax income that Canadians spend on food, clothing and shelter. LICO is the income level at which a household spends 20 percent more on these items than does the average Canadian. b. LICO is a relative measure of poverty, because it is an income cut-off that varies with Canadian prosperity. As the average Canadian household becomes more prosperous and spends a lower proportion of income on food, clothing and shelter, LICO expands in value, so that households in a greater income range are classified as poor. An absolute measure of poverty would stay constant regardless of changes in the average income of Canadians. Page 192 1a. The households’ incomes after transfer payments and taxes are (ranked in reverse order) $8750 [= ($5000 +$5000) – ($5000 x .25)], $12 500 [= ($10 000 +$5000) – ($10 000 x .25)], $16 250 [= ($15 000 +$5000) – ($15 000 x .25)], $27 500 [= ($30 000 +$5000) – ($30 000 x .25)], and $35 000 [= ($40 000 +$5000) – ($40 000 x .25)]. b. Total income received after transfer payments and taxes is still $100 000 [= ($8750 + $12 500 + $16 250 + $27 500 + $35 000)]. The shares of income received by the households (ranked in order) are now 8.75% [= ($8750/$100 000) x 100%], 12.5% [= ($12 500/$100 000) x 100%], 16.25% [= ($16 250/$100 000) x 100%], 27.5% [= ($27 500/$100 000) x 100%], and 35% [= ($35 000/$100 000) x 100%]. c. The cumulative shares of income received by the households (ranked in order) are now 8.75%, 21.25% [= (8.75% + 12.5%)], 37.5% [= (8.75% + 12.5% + 16.25%)], 65% [= (8.75% + 12.5% + 16.25% + 27.5%)], and 100% [= (8.75% + 12.5% + 16.25% + 27.5% + 35%)]. d. e. This distribution is more equal than it was before transfer payments and taxes, since the shares of income received by the poorest three households are higher (now 8.75%, 12.5% and 16.25%) than before (5%, 10%, and 15%), and the shares received by the richest two households (now 27.5% and 35% ) are lower than before (30% and 40%). CHAPTER 9 Page 210 1a. No. Purchases of used goods are not included. b. Yes. An addition to inventories represents investment. c. Yes, Purchases by a household represent consumption. d. Yes. Interest on a private business’s debt is included in interest income e. Yes. This expenditure represents a government purchase. f. No. Financial transactions are not included. g. No. Government transfer payments are not included. h. Yes. This purchase represents an export. 2a. The expenditure-based estimate of GDP is $162 billion [= $85 b. + $35 b. + 43 b. + ($14 b. – 15 b.]. b. The income-based estimate of GDP is $194 billion [= $76 b. + $38 b. + 17 b. + $29 b. + $25 b. + ($35 b. - $26 b.)]. c. The statistical discrepancy is $16 billion, found by taking the difference between the two GDP estimates [$32 billion = $194 b. - $162 b.] and then dividing by two [= ($32 billion/2)]. d. The economy’s GDP is halfway between the two estimates, or $178 billion [= $162 b. + $16 b. = $194 b. - $16 b.]. e. This economy’s depreciation is $9 billion, found by deducting net investment ($26b.) from gross investment ($35b.). Page 215 1a. Per capita GDP in terms of the country’s own dollars is $39 167 [= ($235 billion/6 million)]. b. Per capita GDP in terms of US dollars is $21 933 [= ($235 billion/6 million) x 0.56]. c. Per capita GDP in terms of PPP-adjusted US dollars is $23 500 [= ($235 billion/6 million) x 0.60]. d. Because the PPP-adjusted US-dollar value of the country’s currency is higher than the unadjusted US dollar value, prices in this country are lower than in the United States. Once this difference in the price levels in the two countries is taken into account, the purchasing power of this country’s income, as shown by per capita GDP in PPP-adjusted US dollars, is higher than is shown by the unadjusted per capita GDP in US dollars. 2a. A country’s GNP is higher than GDP when the country’s residents have significant holdings of foreign financial assets that exceed foreigners’ holdings of the country’s own financial assets. This means that there is a net inflow of financial investment income. b. Yes, the country’s citizens benefit, since incomes in the country exceed the country’s production. CHAPTER 10 Page 231 1a. Using 2003 prices, the 2003 shopping basket has a value of $25 [= ($2.50 x 5) + ($1.25 x 10)]. Using 2004 prices, the 2003 shopping basket has a value of $26.75 [= ($2.75 x 5) + ($1.30 x 10)]. b. With 2003 as the base year, the 2003 value of the index is 100 [= ($25/$25) x 100]. The 2004 value of the index is 107 [= ($26.75/$25) x 100] c. The inflation rate is 7 percent [= ((107 – 100)/100) x 100]. 2. Rearranging the formula for deriving real GDP, nominal GDP in 2001 is found by multiplying real GDP by the GDP deflator expressed as a decimal, or $205.3 billion [= ($210.7 billion x 0.97458)]. Because 2002 is the reference year, the 2002 value of the GDP deflator is 100, and real GDP has the same value as nominal GDP ($234.3 billion). The 2003 value of real GDP is $242.6 billion [= ($245.9 billion/1.01340)], found by dividing the year’s nominal GDP by the value of the GDP deflator expressed as a decimal. Rearranging the formula for deriving real GDP, the 2004 value of the GDP deflator is found by dividing nominal GDP by real GDP, then multiplying by 100 [102.945 = ($258.7 billion/$251.3 billion) x 100]. Nominal GDP in 2005 is found by multiplying real GDP by the GDP deflator expressed as a decimal, or $275.6 billion [= ($261.4 billion x 1.05438)]. Page 238 1a. The labour force is found by adding the number of unemployed members of the labour force, workers with full-time jobs, part-time workers who wish to have full-time jobs, and part-time workers who do not wish to have full-time jobs [31.4 million = (2.3 million + 21.4 million + 3.5 million + 4.2 million)]. b. The labour force population is found by rearranging the formula used to derive the participation rate, by dividing the labour force by the participation rate expressed as a decimal [49.1 million = (31.4 million/0.64)]. c. The official unemployment rate is found by dividing the total number of unemployed members of the labour force by the labour force, then multiplying by 100 [7.3 percent = (2.3 million/31.4 million) x 100]. 2. An unemployment rate that includes underemployment is found by summing the number of unemployed members of the labour force and the number of part-time workers who wish to have full-time jobs, dividing this amount by the labour force, then multiplying by 100 [18.5 percent = ((2.3 million + 3.5 million)/31.4 million) x 100]. CHAPTER 11 Page 253 1a. A reduction in household tax rates increases consumption, shifting aggregate demand to the right. b. A slump in share prices reduces household wealth, which decreases consumption and shifts aggregate demand to the left. c. A rise in the price level does not cause a shift in the aggregate demand curve. Instead, it causes a movement leftwards and upwards along the curve, due to the wealth and foreign trade effects. d. A fall in Canadian interest rates increases investment and the consumption of durable items. Both these trends cause aggregate demand to shift to the right. e. A rise in the US-dollar value of the Canadian dollar makes Canadian exports more expensive for Americans and imports from the US cheaper for Canadians. The result is a decrease in net exports, shifting aggregate demand to the left. f. A fall in business confidence decreases investment, shifting aggregate demand to the left. 2. Page 258 1a. A rise in the economy’s capital stock causes a long-run increase in aggregate supply. b. A strengthening of government regulations results in a long-run decrease in aggregate supply. c. An increase in the price of electricity causes a short-run decrease in aggregate supply. d. A reduction in wage rates leads to a short-run increase in aggregate supply e. A contraction in the amount of available land results in a long-run decrease in aggregate supply. f. A decline in the size of the labour force causes a long-run decrease in aggregate supply. g. Technological progress causes a long-run increase in aggregate supply. 2. Page 263 1a. When the price level starts above the equilibrium point, real output exceeds real expenditures. The result is an unintended increase in inventories, or positive unplanned investment, which reduces the price level. The price level continues to fall until the discrepancy disappears once equilibrium is reached. b. In the opposite case, when the price level begins below the equilibrium point, real expenditures exceed real output. The resulting unintended decrease in inventories, or negative unplanned investment, raises the price level until the discrepancy is eradicated at the equilibrium point. 2a. Investment is related to saving, because both are connected with financial markets. Government purchases are related to taxes, given that both are associated with government. Exports are related to imports, since both represent ties with the rest of the world. b. No. Investment does not need to equal saving. Nor are government purchases necessarily equal to taxes, or exports equal to imports. Only total injections and total withdrawals need to be in balance when the economy is in equilibrium. 3a. With a recessionary gap, actual output is below its potential level. Because the natural rate of unemployment is associated with potential output, the fact that actual output is lower than its potential means the actual unemployment is above its natural rate. b. With an inflationary gap, actual output exceeds its potential level, which means that the actual unemployment rate is temporarily less than its natural rate. c. In a protracted recessionary gap, not just cyclical unemployment but also structural unemployment gradually rises, as some cyclically unemployed workers become structurally unemployed after being out of work for an extended period. d. Page 269 1a. Expansions tend to be quite long – sometimes close to a decade or more. In contrast, contractions are often relatively short. b. The most dramatic contraction in Canadians’ per capita real output occurred during the Great Depression of the early to mid-1930s. The most dramatic expansion occurred during the latter part of the 1930s and then during the 1940s, as the Canadian economy recovered from the Depression and was stimulated by the spending associated with World War II. 2. At times, expectations by households and businesses can serve as a self-fulfilling prophecy, with widespread belief in a certain outcome ensuring that the outcome will occur. For example, if a burst of pessimism causes both households and businesses to believe that there will be an economic contraction, the decrease in spending by these sectors will reduce real output as aggregate demand shifts to the left. Similarly, a burst of optimism by households and businesses will increase spending and therefore raise real output as aggregate demand shifts to the right. But such self-fulfilling prophecies occur only at certain points in the business cycle, prompted by other events, such as an initial contraction in spending and output in the case of pessimistic expectations, or an initial expansion in spending and output in the case of optimistic expectations. CHAPTER 12 Page 285 1a. Because real output falls short of its potential level, an expansionary fiscal policy is called for, which means government purchases should be increased. b. With unemployment below its natural rate, a contractionary fiscal policy should be used. This means government purchases should be decreased. c. With the economy already at potential output and the corresponding natural rate of unemployment, there is no need for fiscal policy. 2a. With shrinking incomes and spending, tax revenues fall. Meanwhile government transfer payments and subsidies rise. The result is a reduction in net tax revenues, which has a stabilizing expansionary effect on the economy. b. With expanding incomes and spending, tax revenues rise. Government transfer payments and subsidies, meanwhile, fall. This leads to a rise in net tax revenues, which has a stabilizing contractionary impact on the economy. Page 292 1a. Withdrawals will have to rise by the same amount of $1 million to bring injections and withdrawals back into balance. b. With an MPW of 0.67, then incomes and output must rise by $1.5 million, since each $1.50 in extra income will create $1 [= (0.67 x $1.50)] in additional withdrawals. c. The $1.5 million found in part b can be derived by multiplying the initial $1 million increase in injections by the spending multiplier [= ($1 million x (1/0.67))]. 2a. With a $10 billion fall in government purchases, the AD curve shifts to the left by -$16.67 billion [= (-$10 billion x (1/0.60)]. b. The initial $25 billion rise in spending due to the tax cut causes the AD curve to shift to the right by $31.25 billion [= ($25 billion x (1/0.80)]. c. An MPC of 0.25 means that the economy’s MPW is 0.75 [= (1 – 0.25)]. Therefore, with a $15 billion rise in government purchases, the AD curve shifts to the right by $20 billion [= ($15 billion x (1/0.75)]. d. An MPC of 0.45 means the economy’s MPW is 0.55 [= (1 – 0.45)]. With a $30 billion tax rise, the AD curve shifts to the left by -$22.5 billion [= -(0.45 x $30 billion) x (1/0.60)]. Page 297 1a. With expenditures of $10 billion and tax revenues of $15 billion, there is a budget surplus of $5 billion [= ($15 billion - $10 billion)], and the government’s debt falls to $95 billion [= ($100 billion - $5 billion)]. b. If expenditures are $12.5 billion and tax revenues are $10 billion, there is a budget deficit of -$2.5 billion [= ($10 billion - $12.5 billion)]. The government’s debt therefore rises instead to $102.5 billion [= ($100 billion + $2.5 billion)]. 2a. If a government applies the guideline on annually balanced budgets, public debt does not rise, which is a potential advantage to the economy. However, this policy guideline has a potential problem, since its use worsens the severity of the business cycle. During economic contractions, falling tax revenues mean that the guideline can be met only by cutting government purchases. This magnifies the contraction in incomes and spending. Similarly, during economic expansions, the rise in tax revenues allows for an increase in government purchases, which magnifies the expansion in incomes and spending. b. If the guideline of cyclically balanced budgets is followed, public debt does not rise, as in the case of annually balanced budgets. Again, this is a potential advantage to the economy. The potential problem with this guideline, however, is the fact that governments may not succeed in meeting it, given the difficulty in ensuring that periods of budget deficits and budget surpluses exactly balance. c. The potential advantage of using the functional finance guideline is that unemployment is minimized. The potential problem, meanwhile, is the fact that public debt may rise to unsustainable levels. CHAPTER 13 Page 318 1. In a barter economy traded products themselves serve as a means of exchange. Particular durable items are kept as a store of purchasing power, and there is no common unit of account. All three of these choices mean that the three functions of money are not as effectively performed as they could be in an economy with money. Using traded products as a means of exchange is cumbersome because a coincidence of wants is required before exchange can take place. The use of particular durable items as a store of purchasing power is inconvenient, because while they are being stored it is impossible to consume them. Finally, given that there is no single unit of account, there is a multiplicity of relative values in a barter economy. 2a. M1 is the sum of currency outside chartered banks and publicly held demand deposits at chartered banks, or $54 billion [= ($20 b. + $34 b.)]. b. M2 is the sum of M1 and notice and personal term deposits at chartered banks, or $211 billion [= ($54 b. + $157 b.)]. Page 322 1a. With a nominal interest rate above its equilibrium level, there is a surplus in the money market. This surplus of money means that people will try to get rid of money and buy financial assets such as bonds. The result is a rise in the prices of these financial assets and a fall in the nominal interest rate until money market equilibrium is achieved. b. When the nominal interest rate is below its equilibrium level, the money market exhibits a shortage. People will try to acquire money by selling financial assets such as bonds. This causes a fall in the prices of these financial assets, and a rise in the nominal interest rate until the achievement of money market equilibrium. 2a. The bond’s annual interest payment is $1000 [= ($20 000 x .05)]. b. Because newly issued $20 000 bonds provide only $400 [= ($20 000 x .02)] per annum, this bond will have a price that is 2.5 [= ($1000/$400)] as much, or $50 000. c. Newly issued $20 000 bonds now provide $2000 [= ($20 000 x .10)] per annum. This bond will therefore have a price that is .5 [= ($1000/$2000)] as much, or $10 000. Page 327 1a. The bank’s reserve ratio of 4 percent [= (($40 000/$1 million) x 100)] is found by dividing desired reserves by deposits and multiplying the result by 100. b. The bank’s desired reserves increase by $4000 [= ($100 000 x .04)]. This is found by multiplying the increase in deposits by the reserve ratio. The bank’s excess reserves increase by $96 000 [= ($100 000 - $4000)]. This is found by subtracting the increase in desired reserves from the increase in deposits. 2a. The initial change in excess reserves is found by subtracting the $12 [= ($200 x 0.06)] increase in desired reserves from the $200 increase in total reserves, or $188 [= ($200 - $12)]. b. The maximum amount by which the money supply can change is found by multiplying the initial change in excess reserves by the money multiplier, or $3133.33 [= ($188 x (1/.06)]. CHAPTER 14 Page 338 1a. With high unemployment and falling inflation the economy faces a recessionary gap. Therefore, an expansionary monetary policy should be used. b. With an expansionary monetary policy, the Bank of Canada purchases government bonds in order to raise banks’ excess reserves. This results in a magnified rise in the money supply, thanks to the working of the money multiplier. The increase in the money supply causes the equilibrium nominal interest rate to fall, which raises investment by businesses and consumption spending on durables by households. The spending increase pushes up aggregate demand and raises both equilibrium output and the price level. As the economy expands, the recessionary gap shrinks and the unemployment rate falls. c. 2a. The nominal rate of interest on the treasury bill is 2.04 percent [= (($1 000 000 - $980 000)/$980 000) x 100], which is found by dividing the increase in the bill’s value during the year by the initial purchase price, with this ratio then multiplied 100 to turn it into a percentage. b. To raise the nominal interest rate on one-year treasury bills to 3 percent, the Bank must increase the supply of these bills in its auction. The result will be a drop in the purchase price of these bills, pushing up their nominal interest rate. Page 342 1a. The bond seller’s deposit increases by $10 000. b. The bank’s desired reserves rise by $500 [= ($10 000 x .05)]. c. The bank’s excess reserves increase by $9500 [= ($10 000 - $500)]. d. The maximum increase in the money supply is $200 000, which is found by adding the initial $10 000 rise in the money supply due to the expansion in the bond seller’s bank deposit and the maximum $190 000 [= $9500 x (1/.05)] increase in the money supply due to the rise in excess reserves multiplied by the money multiplier. 2a. The bond buyer’s deposit decreases by $2000. b. The bank’s desired reserves fall by $200 [= ($2000 x .10)]. c. The bank’s excess reserves decrease by $1800 [= ($2000 - $200)]. d. The maximum decrease in the money supply is $20 000, which is found by adding the initial $2000 fall in the money supply due to the reduction in the bond buyer’s bank deposit and the maximum $18 000 [= $1800 x (1/.10)] decrease in the money supply due to the fall in excess reserves multiplied by the money multiplier. Page 347 1a. A bout of cost-push inflation causes an outward shift in the Phillips curve, since this type of inflation is associated with a rise in the unemployment rate. This is the type of inflation that is not directly incorporated into the Phillips curve. b. A bout of demand-pull inflation moves the economy up and to the left along the economy’s stationary Phillips curve. This is the type of inflation that is directly incorporated into the Phillips curve. c. A contractionary monetary policy moves the economy down and to the right along the economy’s stationary Phillips curve, since such a policy reduces inflation and increases the rate of unemployment. 2a. With an initial equilibrium to the right of the long-run AS curve, real output exceeds its potential level, and the unemployment rate is below its natural rate. In the long run, the low unemployment rate will put upward pressure on wages, shifting the economy’s AS curve to the left. This gradual shift moves equilibrium leftwards towards the vertical long-run aggregate supply curve. b. If initial equilibrium is to the left of the long-run AS curve, then real output is below its potential level, and the unemployment rate exceeds its natural rate. In the long run, the high unemployment rate will put downward pressure on wages. This shifts the economy’s AS curve to the right, which gradually moves equilibrium rightwards towards the vertical long-run aggregate supply curve. CHAPTER 15 Paged 361 1a. trade in services, payment b. merchandise trade, receipt c. transfers, payment d. investment income, receipt 2a. financial account, portfolio investment, receipt. b. financial account, direct investment, payment c. capital account, receipt d. financial account, other financial investments, receipt Page 368 1a. A fall in Canadian interest rates makes Canadian bonds less appealing to financial investors in both Canada and the US. As Americans purchase fewer Canadian bonds, the demand for Canadian dollars in this foreign exchange market decreases. Meanwhile, because Canadians are more likely to buy American rather than Canadian bonds, the supply of Canadian dollars in this market increases. Both movements cause a fall in the price of the Canadian dollar in terms of US dollars. b. As Americans make fewer financial investments in Canada, the demand for Canadian dollars in this foreign exchange market decreases. Meanwhile, as Canadians make fewer financial investments in Canada, they increase the amount of financial investments they make in the US, which increases the supply of Canadian dollars in this market. Both movements cause a fall in the price of Canadian dollars in terms of US dollars c. Falling real output in Canada means a drop in Canadian spending on imports. This decreases the supply of Canadian dollars in this foreign exchange market. Constant real output in the US means that there is no change in the demand for Canadian dollars in this market. The result of the first trend is a rise in the value of the Canadian dollar in terms of US dollars. 2. 3a. Given an expectation that higher interest rates will push up the international value of the Canadian dollar, speculators will purchase Canadian dollars. b. Given an expectation that higher inflation rates will put downward pressure on the Canadian dollar, speculators will sell Canadian dollars. c. With a lower risk of Quebec separation, there will be an expectation of a higher value of the Canadian dollar, which will cause speculators to purchase Canadian dollars. Page 373 1a. A target value for the Canadian dollar set below the equilibrium level requires that the Bank of Canada sell Canadian dollars and buy foreign currency b. Because the Bank of Canada is selling Canadian dollars, the “changes in official reserves” account is negative, and there is a balance-of-payments surplus to ensure that the overall balance of payments sum to zero. c. 2a. With a fixed exchange rate set below the Canadian dollar’s equilibrium value, Canadian exports are relatively cheap and American imports are expensive. The beneficial result is an increase in net exports, which expands aggregate demand and pushes up real output and employment. The cost of this policy is higher inflation, as well as the possibility that Canada’s main trading partners (in particular, the US) will decrease the value of the US dollar in terms of the Canadian dollar. In practical terms, it is the inflation risk that is most significant in the Canadian context. b. If the fixed exchange rate is set above the Canadian dollar’s equilibrium value, American exports are relatively cheap, with the beneficial effect that inflation is reduced. The cost of this policy is associated with the fact that Canadian exports become relatively more expensive at the same time as American imports become cheaper. Canada’s net exports are reduced, pushing down aggregate demand, real output and employment. CHAPTER 16 Page 389 1a. Aries is more efficient at producing DVDs, since a worker’s daily output of DVDs is higher in Aries (25) than in Pisces (20). Pisces is more efficient at producing DVD players, since a worker’s daily output of DVD players is higher in Pisces (4) than in Aries (1). b. On the basis of absolute advantage, each country should specialize in the good that it is most efficient at producing. Therefore, Aries should make DVDs and Pisces should make DVD players. c. In Aries, the opportunity cost of DVD players is 25 DVDs, since a worker in Aries can produce 25 times as many DVDs (25) as DVD players (1) in a day. In Pisces the opportunity cost of DVD players is 5 DVDs, since a worker in Pisces can produce five times as many DVDs (20) as DVD players (4) in a day. Therefore, the terms of trade must be somewhere between 1 DVD player traded for 25 DVDs in Aries and 1 DVD player traded for 5 DVDs in Pisces. 2a. Virgo is more efficient at producing computer monitors, since a worker’s daily output of monitors is higher in Virgo (2) than in Taurus (1). Virgo is also more efficient at producing TVs, since a worker’s daily output of TVs is higher in Virgo (6) than in Taurus (2). b. In Taurus, the opportunity cost of computer monitors is 2 TVs (and the opportunity cost of TVs is 0.5 computer monitors), since a worker in Taurus can produce twice as many TVs (2) as monitors (1). In Virgo, the opportunity cost of computer monitors is 3 TVs (and the opportunity cost of TVs is 0.33 computer monitors), since a worker in Virgo can produce three times as many TVs (6) as monitors (2) in a day. c. On the basis of comparative advantage, each country should specialize in the good whose opportunity cost is lower than in the other country. This means that Taurus should produce computer monitors, since this good’s opportunity cost is lower in Taurus (2 TVs) than in Virgo (3 TVs). Meanwhile, Virgo should specialize in TVs, since this good’s opportunity cost is lower in Virgo (0.33 monitors) than in Aquarius (0.5 monitors). d. The terms of trade must be somewhere between 1 monitor traded for 2 TVs (Taurus) and 1 monitor traded for 3 TVs (Virgo). Page 395 1. Consumers are harmed by the tariff, because they pay a higher price and purchase fewer units of the good than previously. Domestic producers benefit from the good’s higher price and the greater number of units they are able to sell. In contrast, foreign producers are harmed. Though they receive the same price as previously, they sell fewer units of the good in this national market. Finally, the country’s government benefits because of the additional tax revenue raised by the tariff. 2. Foreign producers lose with both a tariff and an import quota, since both policies mean they sell fewer units in this national market. But, when able to decide between the two, foreign producers prefer an import quota, because with a quota they are able to charge a higher price than in the case where there is no trade protection. When they face a tariff, however, they cannot charge a price that is higher than in the case of no trade protection. Page 402 1a. Opponents of the agreement focused on the potential loss of political sovereignty for Canada, especially given the new limits on government attempts to screen foreign investment and restrict energy exports. They also emphasized the jobs lost in previously protected Canadian manufacturing industries. b. Supporters of the agreement emphasized the benefits of added specialization flowing from trade liberalization. They also suggested that it reduced the risk of American protectionism directed against Canadian exports. 2a. Supporters of the agreement again emphasized the benefits of added specialization by extending the previous Canada-US Free Trade Agreement to include Mexico. They also pointed to the new markets and investment opportunities provided to both Americans and Canadians in Mexico. b. Opponents of the agreement focused on the possible decline in environmental and safety standards in both the US and Canada. They also highlighted the possible decline in wages to unskilled workers in both the US and Canada due to the movement of production to Mexico. CHAPTER 17 Page 416 1a. 144 (= 72/0.5) years b. 2.67 (= 72/27) percent c. Because population doubles every 12 (72/6) years, it will double approximately twice in 25 years. 2. 3a. The main factors are the quantity of capital, technological progress, efficiency, and social and political factors. b. The other factor determining the growth in real GDP is population growth, since this determines the size of the labour force. Page 426 1a. Given the data in the table, 40.6% of the world’s population lives in low-income countries, 44.5 percent in middle-income countries, and 14.9 percent in high-income countries. b. Total world GNP is approximately $31,314,660 million (= $5170 x 6.065 billion). Total GNP in low-income countries is approximately $1,008,600 million (= $410 x 2.460 billion), or 3 percent. Total GNP in middle-income countries is $5,309,150 million (= $1970 x 2.695 billion), or 17 percent. Total GNP in high-income countries is $24,995,040 million (= $27 680 x .903 billion), or 80%. c. Yes, this statement is true. 2a. Based on the vicious circle of poverty, low investment and rapid population growth both lead to labour-intensive production, which means that productivity growth tends to be low, so that per capita incomes in these countries tends to stay low. b. Governments can break out of the circle of poverty through investments in resources and through population control programs. |