Solution Manual for Economics of Macro Issues, 8th Edition

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Online Solution ManualByNinos P. MalekSan Jose State University & De Anza CollegeForThe Economics of Macro IssuesEighth EditionRoger LeRoy MillerResearch Professor of EconomicsUniversity of Texas, ArlingtonDaniel K. BenjaminClemson University, South Carolinaand PERC, Bozeman, Montana

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Table of ContentsChapter 1:Rich Nation, Poor Nation .......................................................................................................1-1Chapter 2:Innovation and Growth...........................................................................................................2-1Chapter 3:Outsourcing and Economic Growth .......................................................................................3-1Chapter 4:Poverty, Capitalism, and Growth ...........................................................................................4-1Chapter 5:The Threat to Growth .............................................................................................................5-1Chapter 6:Hello Boomers, Goodbye Prosperity......................................................................................6-1Chapter 7:What Should GDP Include? ...................................................................................................7-1Chapter 8:What’s in a Word? Plenty, When It’s the “R” Word..............................................................8-1Chapter 9:The Disappearing Middle Class .............................................................................................9-1Chapter 10:Capital, Wealth, and Inequality ..........................................................................................10-1Chapter 11:The Great Stagnation..........................................................................................................11-1Chapter 12:The Case of the Missing Workers ......................................................................................12-1Chapter 13:The Gig Economy ..............................................................................................................13-1Chapter 14:Mobility in America ...........................................................................................................14-1Chapter 15:Inflation and the Debt Bomb ..............................................................................................15-1Chapter 16:Is It Real, Or Is It Nominal? ...............................................................................................16-1Chapter 17:Can We Afford the Affordable Care Act?..........................................................................17-1Chapter 18:WhoReallyPays Taxes? ....................................................................................................18-1Chapter 19:Are You Stimulated Yet? ...................................................................................................19-1Chapter 20:Higher Taxes Are in Your Future.......................................................................................20-1Chapter 21:The Myths of Social Security .............................................................................................21-1Chapter 22:The Fed and Financial Panics.............................................................................................22-1Chapter 23:The Fed Feeding Frenzy.....................................................................................................23-1Chapter 24:Deposit Insurance and Financial Markets ..........................................................................24-1Chapter 25:Revolutionizing the Way We Pay ......................................................................................25-1Chapter 26:Cryptocurrencies.................................................................................................................26-1Chapter 27:The Value of the Dollar......................................................................................................27-1Chapter 28:The Eurozone after Brexit ..................................................................................................28-1Chapter 29:The Global Power of the Big Mac......................................................................................29-1Chapter 30:The Opposition to Globalization ........................................................................................30-1Chapter 31:The $750,000 Job ...............................................................................................................31-1

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1-1Chapter 1Rich Nation, Poor NationChapter OverviewPerhaps the most important determinants of a country’s economic growth are the laws and institutionsunder which its citizens operate. Stable laws and mechanisms to protect citizens from the government andeach other are necessary for economic growth to be significant and lasting. The rationale behind this issimple: individuals will not choose to invest if they do not have a reasonable expectation of reaping therewards of their investment. This investment, in both physical and human capital, is required forprolonged economic growth.Descriptive AnalysisEconomic growth requires institutions that protect investment and its proceeds. Two major types of legalsystems are outlined in this chapter: common law and civil law. Common law legal systems grant judgesthe authority to decide the law when there is no other authoritative statement of the law. These decisionsare binding for all other cases that are similar until there is another authoritative statement of the law bya legislature or higher court. This statement of the law announces the “rules of the game” and enableseconomic participants to make investment decisions under relative certainty.Unlike the English-based common law system, civil law has its roots in Roman law. Civil law legalsystems draw on abstract rules that judges must apply to cases before them. Rather than relying onjudicial precedents, judges in civil law nations base their judgments on the provisions of codes andstatutes or the general principles of these codes. This tends to generate incentives for governing bodies inthese countries to pass statutes that deal with specific situations and can lead to preferential treatment ofspecial interests.Besides mixtures of common and civil law systems, two general other legal systems exist in the world:the Islam Fiqh system and legal systems based upon custom.The importance of the legal system to economic growth is tied to the protection of property rights.Citizens under the common law system, who can turn to precedents where courts have protected propertyrights, are more likely to make long-term investments that can lead to increased human and physicalcapital. Civil law nations, where property rights are more easily overturned through new codes, generate aless secure investment environment and hence generate lower amounts of capital. One study by Mahoneyargues that between 1960 and the 1990s, growth was one-third higher in common law nations relative tocivil law nations.The type of legal institution developed within a nation has much to do with its history. English coloniestended to adopt the common law system. However, other factors have influenced the development ofinstitutions. Tropical colonies tended to be affected by disease more than temperate colonies. As disease

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Miller,The Economics of Macro Issues, 8thEdition1-2shortened life expectancy, colonists were more interested in extracting resources rather than establishingpermanent institutions that would lead to long-term growth. Lacking these institutions historically mayexplain one reason why growth is much higher in temperate areas of the world.Teaching TipsOften students have trouble seeing the importance of institutions, especially if they have not traveled toother countries. To make this easier, start a discussion by asking a student to imagine a situation whereinstitutions do less to protect their investment. One simple method is to have students imagine that theircollege registrar has the habit of changing graduation requirements every few years. If all registrars actedthis way, how many students would seek to enroll in college? What would happen to the number ofeducated adults? What would happen to economic productivity?Chapter Answers1.In Country A, where profits are subject to confiscation by the government, few people wouldchoose to enter mining. While using fewer of their natural resources, the citizens of Country Aalso would have less employment, lower incomes, and lower production of goods than CountryB. Thus, in one sense, while the physical endowments are the same between A and B, the abilityto utilize those endowments is considerably lower in A than B.2.Often, situations like the one asked about in this question arise from a desire for income or wealthequality. Much of the rationalization for these policies ignores the importance of property rights.For instance, if we should confiscate miner’s profits so that all in society can benefit, then minerswill choose to reduce the amount of ore mined. The end result is that no mining occurs, no profitsare taxed and no income is generated, which perversely achieves the goal of equity espoused bythe group that wants to redistribute resources.3.This law would have far-reaching consequences. I will endeavor to outline only a few. A firstreaction might be to think that migration out of the state of college-bound students will occur. Toany extent this happens, this will benefit surrounding states, which will increase their talent poolin college and future labor markets. Of course, this will decrease the academic talent in thesubject state. The decrease in college applicants may cause in-state universities to lower tuition,which would attract out-of-state students (who probably wouldn’t stay in state to work upongraduating) and perhaps induce some in-state students to remain (especially if they were likely tomove out of state upon taking a job). At the same time, hoping to receive the benefits of thehigher tax base, it is likely that non-college-bound citizens will move to this state, whichperversely from the governor’s standpoint would drive down the wages of those not attendingcollegeand,possibly,makethewagegapbetweeneducationlevelslarger.Campaigncontributions to the governor are more difficult to predict. Parents of students who have beendriven from local colleges will dislike this policy, as will citizens who support higher education inthat state. On the other hand, those not subject to the tax may think their overall tax burden willfall and thus be in favor of the governor. These individuals are likely to be disappointed, though,given that the governor will probably not earn significant tax revenue from this policy becausecollege graduates are less likely to remain in the state.

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Chapter 1: Rich Nation, Poor Nation1-34.Note: All figures calculated using PPP. Source: CIA World Factbook.5.This chapter stresses the importance of property rights. In this light, aid in the form of capital mayhave less of a positive impact than the giving nation hopes. Capital that can be transferred orconfiscated may not be used optimally. For instance, when property rights are guaranteed, anindividual given a tractor may be more likely to buy a field and work it. Absent property rights, afarmer is less likely to buy the field and the tractor becomes less useful. Grants of consumergoods may reduce incentives for individuals to create their own consumer goods, which in turnmay reduce political pressure to force governments into protecting property rights.6.In 2016, Louisiana had a per capita personal income of $43,487 that ranked it 36th among the 50states and DC. In 2013, Quebec had a GDP per person of CAN $46,126 that ranked it 10th amongthe 13 provinces and territories. Both are below their national GDP per person averages.11Information for Louisiana:http://www.bea.gov/regional/bearfacts/action.cfm?geoType=3&fips=22000&areatype=22000Information for Quebec:https://en.wikipedia.org/wiki/List_of_Canadian_provinces_and_territories_by_gross_domestic_product(Sources from Wikipedia were based on information provided by Statistics Canada and Canada Revenue Agency.)2016 Real GDP Per CapitaCommon Law NationsCivil Law NationsAustralia48,800Brazil14,800Canada46,200Egypt12,100India6,700France42,400Israel34,800Greece26,800New Zealand37,100Italy36,300United Kingdom42,500Mexico18,900United States57,300Sweden49,700

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2-1Chapter 2Innovation and GrowthChapter OverviewInnovation is necessary to transform prior inventions into something useful for our everyday lives. Profitis the incentive for businesses to innovate and, when firms are successful, our standard of living increases.It is the introduction of new products that improves our lives and it is the potential profit for businessesthat leads to new investment, which contribute to economic growth. Property rights to ideas must besecure and being able to keep the fruits of one’s labor are necessary in order to create the properincentives to innovate. Governments need taxes to operate but the unintended consequence of taxingprofits is that there is less incentive for firms to innovate.Descriptive AnalysisEach of us today benefits from prior inventions and innovations to those inventions. We can communicatewith each other or send pictures to each other from across the world; we are able to obtain information ina matter of seconds that previously took hours; we can purchase groceries, other essential home products,and even electronic “toys” that entertain us at much lower prices due to innovation. Innovation eitherreduces production costs, which leads to lower prices, or it brings us new goods and services that makeour lives easier or give us more utility (pleasure, satisfaction).Just because someone invents something does not mean it will automatically reach the masses. In fact,some inventions in hindsight seem to be useless or have only narrow applications. It is innovation—theprocess of transforming the invention—that leads to the increase in the welfare of the masses.Innovation does not just happen by chance. In fact, inventions and innovation are a function of howmuch is spent on research and development (R&D). Large, private firms and government agenciesspend billions of dollars on R&D trying to create new inventions, but only a few actually are createdthat have useful applications, and even fewer might be successful commercially. However, not allinnovation is done by large firms or government. Small businesses and individuals invent andinnovate, too.Regardless of whom does the R&D, our standard of living increases when new products are broughtto market and when innovation transforms already made products or lowers production costs, whichlead to lower prices for consumers. These lower prices, in a very real sense, are equivalent to getting apay raise.Historically, when the rate of innovation was slow in the United States, the standard of living was low.However, as the rate of innovation has increased, so has the standard of living for the averageAmerican. It is innovation that is the foundation for economic growth. Innovation does not just happenin any economic system. The institutions (rules of the game) of a country affect the incentives to

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Miller,The Economics of Macro Issues, 8thEdition2-2innovate. If there is no stable judicial system that enforces property rights such as patents, then firmsand individuals will not have an incentive to invent or innovate. Moreover, if taxes are imposed on theprofits of large firms or small businesses, then the incentive to create a better product or to innovatewill be diminished.The notion that everything important has already been invented ignores the fact that previous inventionsand innovations were built on previous knowledge. So, the fact that we have more inventions andinnovations today than ever before means that there is fertile ground for even more inventions andinnovations that will improve and change our lives.Teaching TipsStudents might not appreciate how their lives have been impacted by entrepreneurs who had an idea andmade it into the “next big thing.” Our lives today are so much easier and we have so many more productsthat entertain us, allow us to communicate more easily and more productively, or even go on dates. Youcan use the television showShark Tankon ABC as an example. Ask your students why they think thesepeople come on the show? (They will most likely say, “To make money!” and that’s fine. It is this pursuitof money for themselves that gives others the value-enhancing goods and services.) Students mightunderestimate or negatively view the pursuit of profit. Some students might protest that profits are “evil”andcompaniestakeadvantageofus.ButthenaskstudentsiftheyneedtheiriPhoneorSonyPS4/Microsoft X-Box video game console that is currently in their hand or in their dorm room? Ask themif Apple or Sony or Microsoftforcedthem to buy their product? You can also turn the tables by askingthem if they would go to work if they did not receive a paycheck. What you want your students tounderstand is that those firms and individuals who invent and innovate respond to incentives just like theydo. This is also a good time to remind students of Adam Smith’s famous quote, “It is not from thebenevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard totheir own interest.” It is because of their own interest, that we don’t have to produce our own steak, bread,or beer that we enjoy eating and drinking.Chapter Answers1.It is better to live today. If the famous kings and queens of the past or John D. Rockefeller gotsick or suffered from medical problems, they were worse off than the average person today whocan get high-tech medical treatment and medicine. Individuals today can get better relief by justgoing to the pharmacy let alone to a physician who has much more human capital and physicalcapital to work with today than during the times of the kings and queens or Rockefeller.As far as homes, cars, communication devices, and entertainment products, the average income-earner today lives in a safer home, drives a more luxurious and safer car, can communicate bothverbally and visually with anyone across the globe, and can enjoy a beautiful high-definitionpicture on their flat television.2.Human beings are always thinking of new things to create or devising ways of making a bettermousetrap. The problem is that just because someone invents something, it does not necessarilymean others will benefit from it. First, the invention has to be something that truly has a benefit.Moreover, in order for it to be commercially successful, it has to benefit many people. This iswhy innovation is necessary and not just invention.

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Chapter 2: Innovation and Growth2-33.It depends on who does the spending. One can argue that government expenditures on basicresearch are necessary since private firms will not undertake this. On the other hand, governmentR&D can be wasteful since they are spending taxpayer dollars and not their own money.Therefore, the government agencies doing the R&D might not be as good of stewards with theirresources. On the other hand, it can be argued that if our knowledge has increased due to R&D,even if it isn’t profitable, that knowledge will make us better off and lead to more productiveavenues of R&D. Of course, private firms have the financial incentive to spend time and moneyresearching and developing products that will make a profit. And if the firm makes a profit, that isevidence that they did something right (solved a problem, alleviated suffering, created somethingpleasurable) since individuals cannot be forced to buy the products of the firms.4.Economic growth has an impact on individual welfare. Even small percentage changes, due tocompounding, have a large impact. So, while a small change might have a small impact on ourlives in the short-run, in the long-rung our standard of living will be greatly reduced.There is an easy way to determine the number of years it takes for an economy to double in size.The formula is equal to 70 divided by the growth rate (the rule of 70). So, using 2.1%, it wouldtake an economy approximately 33 years to double; however, using .9 %, it would takeapproximately 78 years.5.In Nation A, the after-tax profit will be $83,000 ($100,000 × .17 = $17,000) while in Nation B itwould be $93,000 ($1000, 000 × .07 = $7,000). Therefore, the preferred location is, of course,Nation B (assuming everything else is equal).The business is not the only one that will benefit by operating in Nation B—the citizens will alsobenefit. First, the business in Nation B will provide a service or product that can be directly soldto the citizens of Nation B. Second, the business will have to hire workers from among thecitizenry, thereby increasing employment in Nation B. Finally, the business in Nation B willinvest in physical capital and will continue to innovate which will lead to more growth.6.Answers will vary but most likely students will list the iPhone/Android phone, popular apps likeGPS navigation (Waze) and online banking, social media and dating, websites, improved videogame graphics, picture quality on televisions, online education innovations, and improvements inmedicine.It is difficult to put a precise dollar value on psychological utility, but students at least could beasked to estimate how much money they spent on the above items over the last five years.Students could be asked how much time and money they were able to save by not having tocommute to all of their classes on campus or they could be asked to consider how much moneythey would pay to avoid the pain and suffering they would have without their medicine. Finally, ifthey met someone online, ask how much that is worth to them.

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3-1Chapter 3Outsourcing and Economic GrowthChapter OverviewMany business commentators, politicians, and union leaders consider outsourcing harmful to the UnitedStates economy. Politicians oppose outsourcing because they are trying protect domestic workers whowill be affected by increased globalization. Because the cost is concentrated but the benefits aredispersed, outsourcing is seen as a losing policy for the United States. However, per capita income forcitizens is higher in countries that engage in international trade and outsourcing.Descriptive AnalysisBusiness commentators and politicians, both Republican and Democrat, argue that “Made in America” isgood for the United States economy. Therefore, outsourcing is depicted as harmful because it “sends jobsoverseas.”Outsourcing is simply hiring foreign workers to do the same jobs as some American workers. Of course,this reduces labor costs for firms that outsource. Outsourcing is just another part of international trade.People do not realize that when they watch a hockey game where the Detroit Red Wings play theVancouver Canucks in Detroit, that Detroit fans are outsourcing labor services from Canada.Trade creates wealth. This concept applies to two individuals who engage in voluntary trade or twocountries that trade. However, governments impose trade barriers such as tariffs and quotas in order toprotect domestic jobs. The empirical evidence is clear that countries that engage in international tradehave higher annual growth rates of per capita income. Yes, there are losers when there is free trade;however, the winners outnumber the losers.Some opponents of outsourcing even claim that the United States will become a Third World economybecause of cheap labor in other countries. The problem is that critics of trade are focusing on one group,not all groups. It is easy to see the pain of outsourcing when a company moves its production facilitiesoverseas. It is harder to see the benefits of trade and outsourcing to millions of consumers in the form oflower prices. In addition, lower prices means Americans have more money to spend on otherAmericanproducts.The discussion regarding outsourcing ignores that it is the result of trade liberalization among nations andthat prices adjust to keep markets in balance. Outsourcing to other nations means that the people in thosecountries will then have more income to demand American products.The other main point is that as the countries that we are outsourcing to become wealthier, then theirwages go up and they become less competitive in the labor market. For example, China now outsourceslabor to Vietnam and Cambodia.

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Miller,The Economics of Macro Issues, 8thEdition3-2United States firms are not the only ones that outsource. German companies like BMW and Mercedes-Benzand Japanese companies like Honda have set up production facilities here in the United States. Americanradiologists are hired by other countries to read MRI images. These are all examples of insourcing.While outsourcing does eliminate some American jobs, in the long run it creates more jobs. Every weekabout one million people lose their jobs; however, every week more than one million find a new job. Thisdynamic activity in the labor market is a sign of healthy economy. There are countries that try hard toprotect their jobs with restrictions on trade and other labor regulations. This has actually resulted in higherunemployment in those countries.Teaching TipsAsk students if they pay others to do things that they can do themselves. You can use examples likehaving papers typed for them, changing car oil, or growing their own vegetables. Then ask them if theyfeel that they are being harmed by “outsourcing” these services.Chapter Answers1.In reality, there is no difference. We do not normally hear about Michigan workers taking car jobsaway from Florida workers just as we do not hear about Florida orange workers taking jobs awayfrom Michigan workers. The reason is that Michigan and Florida are both part of the samecountry. Of course, when the example is the United States and China, the logic seems to bediscarded. Trade based on comparative advantage and outsourcing not only benefits two differentstates but also two different countries. The problem is that good economics and good politics donot always go together.2.Presumably, BMW is not opening a plant in the United State due to benevolence. It is clear thatthe German company is winning by making their product here. In addition, US workers arewinning because Americans are working at the BMW plant not Germans who commute to theUnited States from Germany on a daily basis.3.IBM’s main goal is to make a profit, not provide jobs to Americans. Due to labor cost differences,IBM can reduce their costs by outsourcing. The short-run cost is that some Americans (e.g.,programmers) will lose their job; however, IBM can expand in other areas due to cost savingsthereby increasing employment for other Americans. Moreover, IBM can pass down the costsavings in the form of lower prices to consumers. Now consumers of IBM products have moremoney left over to spend on otherAmericanbusinesses.4.The losers are the employees in India who lost their jobs; the winners are the Americans whohave replaced those Indian workers. As the Indian economy grew, wages increased. This wageincrease reduced the competitive advantage of the Indian worker over the American worker. Ofcourse, the companies doing this are taking actions that maximize profit. This in turn benefits allthe employees of the company who still get a paycheck.5.Germany is outsourcing its labor to the United States. When the cars are produced in the UnitedStates and sold to China, it is counted in US GDP as Net Exports.6.Outsourcing is a form of international trade. Restricting outsourcing is similar to a governmentimposing tariffs and quotas. Free exchange is prevented or greatly reduced. The winners aretypically well-organized special interest groups because the benefits to them are concentrated; thelosers are the millions of consumers who are not organized and who do not see the obviousbenefits of free trade and outsourcing because those benefits are dispersed.

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4-1Chapter 4Poverty, Capitalism, and GrowthChapter OverviewWhile it is easy to see that wealth can be accumulated quickly by a few “lucky ones” in capitalisticcountries, it is more difficult to evaluate how the poor in these countries fare relative to the poor in othernations. Do the poor in capitalistic countries do better than those in countries following other economicsystems? Does capitalism tend to improve the poor’s standardof living? Does capitalism improve theopportunities for movement out of poverty? This chapter provides affirmative answers to these questions.Descriptive AnalysisSince the beginnings of the Industrial Revolution 250 years ago, the ratio of the world’s population livingin abject poverty—that is, on less than=er people live in abject poverty today than fifty years ago despitethe doubling of the world’s population.In itself, this simple observation really is the most impressive andimportant economic fact of the past century. However, a cursory inspection will reveal that these gainshave been uneven. For instance, the extent of poverty in some African nations has changed little over thistime, while poverty has declined dramatically in countries like China and South Korea.One common thread that explains economic growth is the presence of capitalism. Capitalism allocatesresources more efficiently than other economic systems, which tends to encourage economic growth.At the same time, capitalism is often viewed as causing a greater income disparity within a country. Ifsome individuals command a high wage while others cannot, the end result of capitalism may beincome disparity. However, when analyzing cross-country data, this does not appear to be the case.First, when ranking countries by the degree of market openness, a number of studies, including that ofthe Fraser Institute cited by the authors, find that capitalistic countries grow faster than countriesutilizing other systems.Within the 40 most capitalist countries in the world, the poorest 10% of residents earn about 2.5% of totalincome. While there is some variation between nations, when looking across all countries, the poorest10% of residents receive between 2% and 2.5% of total income. Thus, while the shares may be somewhathigher for capitalist countries, the big impact on the poor is through the better performing rich countries.A 2.5% share of U.S. income provides a much better standard of living than a 2.5% share of a communistcountry. Further, the higher growth rates experienced by the capitalist countries inevitably aids the poor inthose countries. A 2.5% share in a country that is continuously growing implies a much better long-termstandard of living than a 2.5% share in a country with little or no growth. It appears that a rising tide(caused by capitalism) lifts all boats.These differences are reflected in other measures of life quality. Life expectancy is higher in capitalistcountries, while child labor and infant mortality is lower. All three of these increase the standard of livingsignificantly for the poor. Longer life expectancy allows the poor greater opportunity to accumulate

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Miller,The Economics of Macro Issues, 8thEdition4-2wealth, while less child labor provides an opportunity for education and growth out of poverty. As amatter of fact, some economists have argued that reducing poverty requires education, which occurs onlyas poverty is reduced. Non-capitalistic countries that grow slowly and do not provide markets that rewardhuman capital are less likely to see their citizens educating children, and thereby guarantee slow growthand high poverty rates in the future.Teaching TipsAlan Heston and Robert Summers have compiled perhaps the most frequently used data set to examineeconomic growth: the Penn World Tables (http://www.rug.nl/ggdc/productivity/pwt/). These are anoutstanding resource to instructors wishing to find easy-to-use data that can be shared with students orpresented during lectures. The tables contain data on about 30 variables for about 189 countries oversome or all of the years 1950-2014. The data provide purchasing power parity and national incomeaccounts that are comparable across nations. The data are easy to access and can be downloaded into anExcel spreadsheet with relative ease.Chapter Answers1.The empirical evidence suggests that noncash benefits are more prevalent in wealthy countriesthan poor countries. The reason behind this is simple: Wealthy countries are more able to fundbenefits for the poor than are poor countries. Of course, these types of benefits improve the livesof the poor in wealthy countries relative to those in poor countries. If non-cash benefits are higherin rich countries than poor countries, then the data on average income of impoverished citizenspresented in this chapter understate the actual incomes of the poor in rich countries more relativeto those in poor countries.2.It is easy for political leaders to exploit those with little ability to oppose them. In a nation with arule of law, it may continue to be difficult to protect the poor’s interests, but it is easier than in anation governed by the whims of the few. In other words, it is relatively less expensive and easyfor the poor to enforce their property rights in a system established on the rule of the law than it isfor the poor to curry the necessary political favor to accomplish their goals in a system withoutthe rule of law.3.Certainly strengthening the rule of law is something that could be done to help the poor, as wouldbe methods governments could use to encourage capitalism’s spread. These are difficult eventsfor a foreigner to cause to happen, though. Instead, foreigners could focus on the laws andregulations of their own governments that prevent the poor in other countries from prospering.Perhaps the domestic laws that have the most impact on the foreign poor are the laws that preventa free exchange of goods and services across borders. For instance, a domestic tariff or quota thatprevents foreigners from selling goods in the domestic country has the effect of reducing foreigndemand for labor, which in turn eliminates jobs and reduces wages for all foreigners, includingthe poor. By keeping foreigners from enjoying the benefits of trade, there is less reason to fightfor capitalism in the foreign country, as the benefits are not clearly seen. Of course, this cansimply prolong the cycle of poverty in those countries.4.Many factors make implementing capitalism difficult in countries under other regimes. Theserange from the religious, to historical, to protecting the interests of the ruling class from a moreopen society. One all too common occurrence is that nations follow a charismatic leader whoconsolidates political and economic power and thereby deters capitalism.

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Chapter 4: Poverty, Capitalism, and Growth4-35.Numerous answers can be given to this question; however, some specific reasons include highergovernmentspendingsincetheGreatRecessionandincreasedregulationsunderthelastadministration.6.The most recent (2016) rankings by the Fraser Institute (https://www.fraserinstitute.org/studies/economic-freedom-of-the-world-2016-annual-report) places the Democratic Republic of Congoat a very low 157 out 159 nations on their Economic Freedom Index.

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5-1Chapter 5The Threat to GrowthChapter OverviewAs discussed in Chapters 1 through 4, components to successful long-run economic growth include secureproperty rights in a system that allows individuals to freely participate in market activities. One possiblebarrier to free trade between individuals is government involvement in economic decisions. Whetherdirectly through regulation or indirectly through taxation, government involvement in economic decisionsmay lower social welfare and has the potential for reducing economic growth. Given the recent largebudget deficit run by the U.S. government, this chapter argues that a big threat to U.S. growth is a futureincrease in taxes.Descriptive AnalysisOver the past decade, the U.S. government has represented an increasing share of the economy. Federalgovernment spending represents one-quarter of gross domestic product (GDP). Combined with increasingshares of state and local government spending, all governments in the U.S. account for almost one-half ofGDP. The reasons for this expansion are many including war, recession, expansion of entitlementprograms, and subsidies. What is obvious from this experience is that taxes have not risen to meetincreased government spending resulting in growing budget deficits and debt.Regardless of changing the amount of government spending, the economy’s budget constraint remainsunchanged. In other words, U.S. output is dictated by the amount of labor, capital, entrepreneurship,innovation, and human capital available at any given time. As the government expands, the productioncreated by these inputs are redirected from consumers, investors, and foreigners to the government. Thisoccurs regardless of if the government pays for goods using tax revenues or by using borrowed funds. Inshort, increased government spending is paid for by citizens either immediately through taxes or overtime through increased taxes used to repay borrowed money.At first glance, it may appear that increased government spending has no impact on economic growth.After all, if the government spends taxed money something is being purchased and, presumably, thecitizen who was taxed is not spending. This is much like robbing Peter to pay Paul; Peter (the citizen)does not spend but Paul (the government) does. However, this analogy is not correct. The act of taxingPeter may influence Peter’s decisions in such a way as to reduce Peter’s future economic productivity.Because the U.S. government is in debt, it will need to repay that debt through increased future taxes.Higher taxes reduces the incentives for citizens to work, innovate, and invest. In short, increased tax ratesreduce the after-tax profits individuals earn on their economic activities and thus discourage the pursuit ofthose activities. The end result is that higher government spending today coupled with increased deficitsproduces higher future taxes and lower economic growth rates.

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Miller,The Economics of Macro Issues, 8thEdition5-2The link between higher taxes and reduced economic growth is straightforward to understand. First,consider a potential investor choosing between investing in a project that will create some future returnsand spending on a consumable good today. An increase in taxes reduces the after-tax returns on theinvestment and makes that investment less desirable relative to consumption. The end result is a reductionin investment demand and, in equilibrium, less capital created. Less capital means fewer inputs toproduction to create future GDP.The same occurs in labor supply decisions. Individuals choosing between working and an alternative(leisure, school, etc.) weigh the benefits and costs of each. Increased taxes reduce the benefits of workand make supplying labor less attractive. Individuals who were deciding between working and notworking will be less likely to work; those deciding between working overtime and not may be less likelyto work overtime. In short, higher taxes reduce labor supply and again, reduce inputs to production.While lower economic growth in and of itself is a poor outcome, one should remember that this is theresult of increased government purchases. If those purchases benefited society more than the decreasedfuture growth, then the government spending may be economically efficient.Teaching TipsThe connection between tax rates and labor supply is easy to demonstrate in a class if you are willing topay out a small amount of cash to a student. One way to do so is to create an auction for student labor todo a menial task during every remaining class in the semester (clean the chalkboard, etc.). Start with ahigh price ($5) and ask how many students would be willing to receive that price in exchange forcompleting the menial task. Reduce the price and count how many students supply labor. Repeat thisexercise and graph the labor supply curve. Finally, repeat the entire exercise after imposing a 25% incometax. Graphing both resulting labor supply curves demonstrates a decrease in the effective labor supplycurve under an income tax. It is easy to generate discussions involving the equilibrium effects of anincome tax (lower employment, raise the hiring cost of labor) and you get somebody to clean yourblackboards for you.Chapter Answers1.Higher debt implies that future taxes will be higher, though the extent of this increase is unclear.If the government can perpetually borrow to make payments on its current debt, then the timingof higher taxes can be postponed, perhaps indefinitely if the government’s ability to borrowremains unimpeded. For instance, if the economy grows quickly, individuals may have both theability and desire to make additional loans to the government. However, for most countries,including currently Greece, Spain and Italy, eventually investors are unwilling to lend togovernments and these governments respond by raising taxes and by reducing expenditures. Theend result seems to be that more debt today leads to higher future taxes.2.Any tax reduces the incentives for individuals to pursue the thing being taxed. A wealth tax willreduce the incentive to accumulate wealth, or at least cause individuals to try to avoid the tax(either legally or illegally). One possible response would be for individuals to reduce their networth by borrowing against paid-for assets. Another, which appears to be happening in someEuropean countries, is for the very wealthy to renounce citizenship and leave the country.Ultimately, a wealth tax will have long-run consequences on citizen’s work effort and holdings ofthings considered wealth by the taxing authorities.

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