Solution Manual for Macroeconomics, 5th Edition

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BCS-1Suggested Solutions for BusinessCaseQuestions for ThoughtThis section offers suggested answers to theQuestions for Thoughtat the end of each chapter’s business case.CHAPTER 11.Explain how each of the twelve principles ofeconomics is illustrated in this case.Suggested Solution1.Principle 1: People must make choices becauseresources are scarce. Neither money nor time isunlimited; they are both scarce resources. Pricelinecaters to customers who have chosen to sacrifice someof their preferences about convenience or quality inorder to get a lower price.Principle2: The opportunity cost of an item—whatyou must give up in order to get it—is its true cost.The true cost of an empty airplane seat or an emptyhotel bed is the revenue the airline or hotel couldhave earned from the next best use of that seat orbed—namely,the revenue earned from a payingcustomer.Principle3: “How much” is a decision at the margin.How much more a customer is willing to pay for aticket to a destination depends upon how much timeand inconvenience is saved by purchasing the higherpriced ticket.Likewise,how much more a customer is willingto pay for a ticket purchased well in advance of histravel date depends upon how much more security hegains by advance planning rather than waiting to pur-chase. The same principle applies to decisions aboutthe quality and location of hotels, and so on.Principle4: People usually respond to incentives,exploiting opportunities to make themselves betteroff. Priceline was successful because its customers—travelers, airlines, and hotels—were exploiting opportu-nities to make themselves better off by using its services.Priceline also responded to incentives to make itself bet-ter off by expanding into new profitable markets such asEurope.Principle5: There are gains from trade. Travelers gainfrom using Priceline’s networks of hotels to find ahotel rather than doing the research themselves. Theygain from using Priceline’s services to book a flightrather than contacting each airline individually. Also,travelers gain by using the services of airlines andhotels, rather than transporting themselves or pitch-ing a tent overnight to sleep in. Hotels, particularlyin Europe, gain from using Priceline’s network ratherthan trying to contact potential customers directly.Principle6: Because people respond to incentives,markets move toward equilibrium. Expedia and Orbitzmoved into the online travel service industry in orderto exploit opportunities that had been pioneered byPriceline. In this way, the market for online travelservices will move toward equilibrium until thereare no more opportunities for new travel servicecompanies to exploit.Principle7: Resources should be used efficientlyto achieve society’s goals. Priceline exploitedanopportunity to use resources more efficiently. It isinefficient to have empty hotel rooms and airline seatsif someone is willing to pay some price to use them onshort notice.Principle8: Because people usually exploit gains fromtrade, markets usually lead to efficiency. It is ineffi-cient to have planes flying with empty seats and hotelswith unoccupied beds. Thus, introducing a market forthose items—which is what Priceline did—improvesefficiency.Principle9: When markets don’t achieve efficiency,government intervention can improve society’s welfare.It would have been inefficient to have major airlinesfail because of the public’s temporary fear of flying.Vast resources would have been wasted as pilots andsupport staff lost their jobs, planes were mothballed,necessary trips cancelled, and so on. It improved effi-ciency for the government to step in and temporarilyaid the airline industry so that it could survive thetemporary downturn.Principle10: One person’s spending is another person’sincome. In the aftermath of the attacks of September2001, as people stopped spending on items like travel,the income of airline workers was severely reduced.Principle11: Overall spending sometimes gets outof line with the economy’s productive capacity. Theoverall economy went into a slump after the attacks ofSeptember 2001 as the economy’s productive capacityexceeded its spending.Principle12: Government policies can change spend-ing. The $15 billion aid appropriation by Congress wasspent on stabilizing the airline industry and preventedmajor airline failures.

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BCS-2S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H TCHAPTER 21.What is the opportunity cost associated with havinga worker wander across the factory floor from task totask or in search of tools and parts?Suggested Solution1.The opportunity cost of a worker wandering across thefactory floor is forgone output—the output that workercould have produced in the time spent wanderingaround.2.Explain how lean manufacturing improves the econo-my’s efficiency in allocation.Suggested Solution2.Lean production (also known as lean manufactur-ing) improves the economy’s efficiency in allocationbecause, for example, an automaker can more quicklyswitch to producing more of the types of cars thatmore consumers want and fewer of the types of carsthat fewer consumers want.3.Before lean manufacturing innovations, Japan mostlysold consumer electronics to the United States. Howdid lean manufacturing innovations alter Japan’s com-parative advantage vis-à-vis the United States?Suggested Solution3.Before the innovations in lean production, Japan hada comparative advantage vis-à-vis the United States inconsumer electronics. After the innovations, Japan’scomparative advantage vis-à-vis the United Statesshifted to auto production.4.How do you think the shift in the location of Toyota’sproduction from Japan to the United States has alteredthe pattern of comparative advantage in automakingbetween the two countries?Suggested Solution4.The shift in the location of Toyota’s production fromJapan to the United States means that it is likely thatJapan will no longer have a clear comparative advan-tage in automaking vis-à-vis the United States.CHAPTER31.What accounts for the fact that before Uber’s arrival,there were typically enough taxis available for every-one who wanted one on good weather days, but notenough available on bad weather days?Suggested Solution1.Before Uber’s arrival fares were set by city regulators.If everyone who wanted a taxi during good weathercould get one, then we can imply that the price set byregulators was approximately equal to the market-clearing price on good weather days. But bad weather,like a snowstorm, produces two changes to supplyand demand: an increase in demand (a rightwardshift of the demand curve) as more people want rides,and a decrease in supply as more taxi drivers wantto stay warm and dry at home (a leftward shift ofthesupply curve). As a result of these two shifts, themarket-clearing price rises. But because the actualprice was set by regulators and could not increase inthe pre-Uber days, a shortage of taxis arose.2.How does Uber’s surge pricing solve the problem?Assess Kalanick’s claim that the price is set to leave asfew people possible without a ride.Suggested Solution2.Uber’s surge pricing solves this problem because itallows drivers to charge higher prices until supplyequals demand. The higher price increases the quan-tity of rides supplied while reducing the quantity ofrides demanded until market equilibrium is achieved.Kalanick’s claim is true: at any price lower than theequilibrium price there is a shortage of taxis—morepeople want rides than are available.3.Use a supply and demand diagram to illustrate howUber drivers can cause prices to surge by taking coor-dinated breaks. Why is this strategy unlikely to workin New York, a large city with an established fleet oftaxis?Suggested Solution3.By taking coordinated breaks, Uber drivers in SanDiego reduce the quantity supplied at every price.That is, they shift the supply curve leftward. As aresult, more riders want rides than are available, andsurge pricing kicks in. This is unlikely to work in alarge city with an established fleet of cars like NewYork City. First, because it would be too difficult tocoordinate a large enough group of Uber drivers toaffect the price. And second, taxi drivers would takethe fares when Uber drivers took breaks, preventing asurge in the Uber price.E2E1Price(dollars permile)SS(during break time)DP1P2Q1Q2Quantity of taxi rides(millions of miles)

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S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H TBCS-3CHAPTER 41.How did lenders benefit from the restriction on thenumber of New York City taxi medallions?Suggested Solution1.Lenders benefit from the restriction on the numberof taxi medallions because as the price of taxi medal-lions goes up, purchasers have to borrow more. Hencethe demand for loans increases. In addition, loans aresecured by the medallions that were purchased usingthe lent funds. If the borrower is unable to pay, shehas to surrender the medallion to the loan company.Hence those loans are worth more as the prices ofmedallions climb. So since fewer medallions lead tohigher medallion prices, the lenders clearly benefitfrom the restriction on the number of medallions.2.Use a graph to illustrate the effect of the entry of Uberon the incomes of taxicab drivers. Assume that Ubercars cannot pick up fares hailed from the street andthat there are some people who prefer to hail cabsrather than use an app. How does your graph changeif that restriction is lifted?Suggested Solution2.To devise your graph, take Figure 4-8 as it is, thenadd to it a vertical line at 9 million rides, and arrowsshowing a horizontal shift from the vertical line at8 million to the line at 9 million. Label the upper pointon the 9 million line graph asC(at $5.50 fare) and thelower point asD(at $4.50 fare). Draw in the dottedlines from the vertical axis to pointsCandD. Labelthe shift “Uber Effect” with a balloon.679081011131214$7.006.506.005.505.004.504.003.503.00Quantity of rides (millions per year)Fare(per ride)DSCEDBAUber effectQuotaTheentry of Uber into the taxicab market will increasethe number of rides offered. As shown here, the entry ofUber shifts the vertical line indicating thequota right-ward. As a result, the quota rent going to theownerof a medallion falls. Here we have shifted thequotaline from 8 million rides pre-Uber to 9million ridespost-Uber, and the quota rent falls from $6−$4=$2to $5.50−$4.50=$1. The $1 represents the quota rentthat medallion holders still receive because some peoplestill prefer to hail taxicabs rather than use Uber cars,and the number of taxicabs is still restricted. However,if the rules are changed and Uber cars are also allowedto pick up fares hailed from the street, the market willmove to equilibriumEbecause the quantity control willhave been completely eliminated. As a result, the quotarent will disappear.3.Why has the fight between Uber and the taxicab indus-try turned political?Suggested Solution3.It is predictable that the fight between Uber and thetaxicab industry turned political because restrictionson how many cars can sell rides in New York City arecreations of the city government. The taxi industrywould like to maintain the quota so it can maintainthe quota rents, while Uber would like to circumventthe quota so it can operate.CHAPTER51.Why do you think it was profitable for Li & Fung togo beyond brokering exports to becoming a supplychain manager, breaking down the production processand sourcing the inputs from various suppliers acrossmany countries?Suggested Solution1.By sourcing inputs from various suppliers acrossmany countries, Li & Fung was able to allocateproduction to where it is most cost effective.2.What principle do you think underlies Li & Fung’sdecisions on how to allocate production of a good’sinputs and its final assembly among variouscountries?Suggested Solution2.Comparative advantage is the principle that under-lies Li & Fung’s decisions. Inputs that require moreskill or are more capital-intensive can be producedin countries that have relatively higher-skilled work-ers or are relatively more abundant in capital, such asHong Kong and Japan. Similarly, inputs that are morelabor-intensive can be produced in countries that arerelatively more abundant in labor, like mainland Chinaand Thailand.3.Why do you think a retailer prefers to have Li & Fungarrange international production of its jeans ratherthan purchase them directly from a jeans manufac-turer in mainland China?Suggested Solution3.A retailer that purchased jeans directly from a manu-facturer in mainland China would not benefit fromthe gains from trade that arise from sourcing inputsfrom different countries according to those countries’comparative advantage.

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BCS-4S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H T4.What is the source of Li & Fung’s success? Is it basedon human capital, on ownership of a natural resource,or on ownership of capital?Suggested Solution4.The source of Li & Fung’s success is human capital.The company understands how to use the principleof comparative advantage to exploit gains from tradein the production process. In addition, it is skilled inproviding quality control and logistics.CHAPTER61.Why was it profitable for Montgomery Ward to closesome of its stores during the Great Depression?Suggested Solution1.It was profitable to close some of its stores because thelarge rise in unemployment meant people had less tospend and retail purchasing fell dramatically. It wasnot profitable to incur the costs of maintaining storesin which few sales were made.2.Use Figure 6-1 to compare the nature of the GreatDepression to the Great Recession. What about theGreat Depression made Montgomery Ward’s deci-sion not to expand during the 1940s appear rational?Would the same decision be rational today, in theaftermath of the Great Recession? Explain.Suggested Solution2.Figure 6-1 shows that although the U.S. economy inthe first year of the Great Depression and the firstyear of the Great Recession were very similar, thelater years were different. After the first year of theGreat Recession, world industrial output stabilizedand began to recover. In contrast, five years after thebeginning of the Great Depression, world industrialoutput still had not recovered to its pre-depressionlevel. The length and severity of the Great Depressionled Montgomery Ward to believe that the economyof the 1940s was still vulnerable to another severedownturn, so it was better to hold cash than to investin opening new stores. The same decision would notbe rational today given that recessions have been ofshorter duration, as shown by the recovery after theGreat Recession. So, today, the company would bebetter off spending its cash instead of holding it. Butinstead of opening new stores, Montgomery Wardcould use the cash to invest in new technologies in aneffort to expand sales.3.The National Retail Federation provides various kindsof economic data on its website, http://research.nrffoundation.com. Click on the link “Retail andEconomy” and you will see five categories. Explain why,in light of this case, it is important for a retailer to haveeach of the five categories of information provided.Suggested Solution3.The information supplied in the five categories helpsretailers forecast their future sales. This can be a use-ful tool as they make decisions about how many storesto have and how much merchandise to stock. Withthis information, Montgomery Ward might have donea better job determining how to respond to the eco-nomic situation in the 1940s.(1)Economic Landscape: contains data on consumerconfidence and on GDP, the total value of theeconomy’s output. Consumer confidence data givesretailers information on how willing consumers areto spend, and GDP gives retailers information onthe overall state of the economy, which is anothergood indicator of how comfortable consumers willbe to make purchases.(2)Employment Environment: contains a graph ofU.S. employment over time. The strength of theemployment environment indicates whether or notconsumers will have income to spend on retail andhow confident their spending will be.(3)Unemployment Environment: contains graphs ofthe U.S. unemployment rate over time, as well asgraphs of the unemployment rate broken down bygender and age. As in (2), this information helpsretailers make decisions about opening stores andhow much stock to carry. A declining unemploy-ment rate means consumers will be more willing tospend. Also, by breaking down the figures accord-ing to age and gender, retailers can better predictwhich consumers might be more inclined to spend.(4)Consumer Income and Savings: contains informa-tion on the change in income earned by Americanconsumers. The more income they have, the moreresources they have to spend. A rising income levelmeans that it is safe for retailers to expand, while afalling income level means they should cut back.(5)Consumer Price Index: contains information onhow prices of consumer items are changing. Itgives retailers an indication of whether the econ-omy is experiencing inflation or deflation, both ofwhich could cause economic problems and makeconsumers less willing to spend.CHAPTER71.Why would an economic downturn cause problems forChinese companies that borrowed heavily?Suggested Solution1.An economic slowdown occurs when the aggregateincome in the economy declines. This includes incomein the form of wages, profits, interest, and rents. Adecline in income will result in reduced consumerspending, leading to reduced sales for Chinese com-panies. Reduced sales translate to less profit than theChinese companies were expecting when they bor-rowed heavily. With lower than expected profit, the

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S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H TBCS-5firms will find it difficult to pay back their debt, whichcould lead some of them to fail. Companies that failthen create economic hardship for owners and employ-ees, further reducing aggregate income.2.How do the three statistics that Li Keqiang cited fitinto the three different ways to calculate GDP?Suggested Solution2.Railway shipments measure goods being sent tocustomers, so they are related to GDP as measured byfinal spending. Electricity is used in production, so it’srelated to GDP as measured by value added in produc-tion. Loans are based at least partly on the incomeof borrowers, so they are an indicator of how muchfactor income is being earned.3.What business problems might China’s untrustworthynumbers create?Suggested Solution3.It’s hard for governments and businesses to planlong-term when they don’thave reliable and accurateinformation about the state of the economy. Businesseswill not know if it is prudent to expand or if theyshould wait for economic conditions to improve. Policymakers will be unsure of what steps to recommend toimprove a troubled economy, or whether they shouldencourage investment because the economic environ-ment is good. Overall, unreliable economic data wouldlead to uncertainty and this would discourage invest-ment in the country’s economy.CHAPTER 81.How is the matching of job-seekers and employersthrough services like TaskRabbit likely to affectfrictional unemployment?Suggested Solution1.Frictional unemployment is created because as peoplequit or are let go from their jobs, it takes time to findnew employment. Services like TaskRabbit can fill thatdown time and may lead to two possibleoutcomes.First, when people can easily find jobs through a ser-vice such as TaskRabbit, they find work faster andfrictional unemployment declines. And second, if manyworkers depend solely on TaskRabbit for employment,there may be more people with short-term jobs, mov-ing from task to task in the case of Taskers, whichwould increasefrictional unemployment.2.What is the likely effect of such services on the num-ber of people considered to be in the labor force?Suggested Solution2.Services like TaskRabbit provide employment oppor-tunities for people who want flexible employment andhave not found jobs in more traditional occupations.These individuals are likely to include discouragedworkers, marginally attached workers, and others.As these workers move back into the labor force andfind jobs as Taskers, the size of the labor force willincrease.3.Some analysts suggest that most freelancers haveother jobs, and only do gig economy work on the side.How does that statement help explain the lack of clearevidence for a growing gig economy?Suggested Solution3.Official employment statistics count an individualworker only once. If many people work in the gigeconomy as a side job, only their primary jobs willbe counted and the employment statistics will notreflect the gig economy jobs. And as long as many gigeconomy workers hold other jobs, there will be noclearevidence pointing to growth in the gig economy,even as the number of people in those jobs increase.However, if the number of people participating solelyin the gig economy increased significantly, we wouldexpect employment statistics to reflect an increase inthe size of the gig economy.CHAPTER91.Bar-code technology spurred a lot of investment inretailing. How did this alter the retailing productionfunction? What would a similar amount of investmenthave accomplished without the new technology?Suggested Solution1.Bar-code technology resulted in an upward shift ofthe production function. Without the technologicaladvancement, a similar amount of investment wouldhave produced a much smaller gain. Without thebar-code technology, investment would have resultedin only a movement along the old production function,which would have soon run into diminishing returns.2.The spread of bar codes was delayed in the UnitedStates because everyone was waiting for someoneelse to move. What policy could have been adopted toaddress this? Would it have been a good idea?Suggested Solution2.A government policy to subsidize the adoption ofbar-code technology could have accelerated its adop-tion. Such a policy might have caused a faster rise inproductivity, in which case it would have been a verygood idea.3.Use the case to explain why international growthrates vary.Suggested Solution3.The case shows how differences in institutions andgovernment policies affect economic growth, leading tovariations in performance among different countries.

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BCS-6S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H T4.Despite initial barriers, bar codes have spread globally.What does this imply about differences in economicgrowth across countries?Suggested Solution4.While countries may differ in rates of economicgrowth, the spread of technology is a force forconvergence in per capita GDP.CHAPTER101.What market inefficiency is being exploited byGrameen Bank? What is the source of this inefficiency?Suggested Solution1.Grameen Bank is exploiting the inefficiency that arisesfrom the fact that there are borrowers who want toborrow at a given interest rate and lenders who wantto lend at the same interest rate, but are unable to doso. The source of this inefficiency is the requirementsimposed on borrowers by regular banks, such as credithistory and collateral, that borrowers cannot meet.2.What tasks of a financial system does microlendingperform?Suggested Solution2.Microlending performs the tasks of reducing transac-tion costs for people who need funds—for example,they can borrow from Grameen rather than havingto sell possessions to raise needed funds. It reducesfinancial risk, allowing borrowers to overcomefinancial uncertainty. And it provides liquid assets,by allowing lenders to lend to borrowers but in a waythat allows them to get their funds back quickly if theyneed to.3.What do you predict is the effect of Grameen Bank’slending on a community?Suggested Solution3.We would expect communities that received GrameenBank lending to have a higher growth rate and lessfinancial uncertainty than those without thislending.But this is with an understanding that there arelimits to what these loans can accomplish in terms ofreducing poverty and improving family well-being.CHAPTER111.Why did a national slump that began with housingaffect companies like General Motors?Suggested Solution1.As we learned in the chapter, a fall in current dispos-able income, as well as falls in wealth and expectedfuture disposable income, lead to a fall in consumerspending. So the decline in housing, which reducedboth wealth and income, led to a broad decline inconsumer spending across America. The broad declinein consumer spending, in turn, hit auto companiesparticularly hard as many Americans decided againstmaking new car purchases.2.Why was it reasonable in June 2009 to predict thatauto sales would improve in the near future?Suggested Solution2.It was a good bet that things would eventually improvebecause recessions have always been followed byrecoveries—at least so far! So government officialshad good reason to believe that auto sales would beconsiderably higher in the future than they were in thefirst half of 2009. Looking at Figure 11-13 confirmsthis belief. Auto sales started to rise in 2010 and havecontinued to increaseuntil they leveled off in 2015.3.How does this story about General Motors helpexplain how a slump in housing—a relatively smallpart of the U.S. economy—could produce such a deepnational recession?Suggested Solution3.The story of GM illustrates how the multiplier processtakes place. The fall in housing led to a fall in con-sumer spending which hurt auto manufacturers likeGM. These companies, in turn, laid off workers, whoreduced their consumer spending, hurting local retail-ers among others. So the story shows how a fall ininvestment spending—in this case, housing investmentspending—can have an impact on the economy as awhole that is larger than the initial decline.CHAPTER121.Why do you think gas prices rose in the recessions ofthe 1970s but fell after the Great Recession?Suggested Solution1.The recessions of the 1970s were characterized bynegative supply side shocks from OPEC oil shortagesand accommodating monetary policy. Negative supplyshocks shifted the short-run aggregate supply curveleftward and accommodating monetary policy shiftedtheaggregate demand curve to the right. Jointly,these shifts caused gas prices to increase throughoutthe recession. Although an increase in oil prices alsopreceded the Great Recession, larger negative demandshocks caused a leftward shift in aggregate demandplacing downward pressure on prices. The decline inhousing prices also caused consumer spending to expe-rience a substantial decline. In the end, the 1970s werecharacterized by negative supply shocks putting upwardpressure on gasoline prices, and the Great Recessionwitnessed negative demand shocks placing downwardpressure on overall prices, including gasoline.2.What does this say about the causes of the recessionsin each case?

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S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H TBCS-7Suggested Solution2.In both cases, high oil prices were a contributing fac-tor to the recessions, but in addition to high oil prices,the Great Recession was largely impacted by a collapseof the housing bubble. Despite starting with a similarcause, the effect on the economy depends mostly onwhat follows the initial increase. In the case of theGreat Recession, a large negative demand shock causedinflation to drop,alteringthe course of the recession.3.In the 1970s, Toyota was able to increase its Americansales despite interest rates on auto loans surging ashigh as 17.5%. In contrast, after 2007 auto loan ratesfell to their lowest levels in history; car sales alsodeclined. Explain why. (Hint:Examine the connectionbetween inflation and interest rates on loans.)Suggested Solution3.Interest rates on car loans reflect both the real interestrate and future inflation. Because inflation increasedsignificantly in the 1970s, lenders followed by alsoraising rates on car loans. During the Great Recession,the negative demand shock caused inflation to fall andin some periods actually turn negative. The low infla-tion rate allowed lenders to keep interest rates on carsand homes much lower during the Great Recession.CHAPTER131.How did the political reaction to government fundingfor the Solana project differ from the reaction to moreconventional government spending projects such asroads and schools? What does the case tell us abouthow to assess the value of a fiscal stimulus project?Suggested Solution1.Unlike roads and schools, the Solana project was con-troversial for two reasons. First, government fundswere paid to a non-American firm. Second, the proj-ect was controversial because the long-term viabilityof solar power depended upon future governmentsubsidies—again, unlike roads and schools. However,the Solana case shows that the value of a fiscal stimu-lus project is a matter of whether or not it creates jobsat the right time.2.In the chapter we talked about the problem of lags indiscretionary fiscal policy. What does the Solana casetell us about this issue?Suggested Solution2.Solana is a good example of lags in the implemen-tation of discretionary fiscal policy. Although therecession hit in 2008, most of the funds for the projectweren’t disbursed until three to four years later. In aless severe recession, the economy would have alreadyrecovered by that point. However, since the recessionthat began in 2008 was very long and deep, the stimu-lus from the Solana project was still effective in 2011and 2012.3.Is the depth of a recession a good or a bad time toundertake an energy project? Why or why not?Suggested Solution3.Assuming that a solar plantisa good thing to build, itwas a very good idea to do it while many constructionworkerswere unemployedand borrowingcosts werevery low.CHAPTER141.Why are gift card owners willing to sell their cards fora cash amount less than their face value?Suggested Solution1.A gift card is not as liquid as cash. Cash can be turnedinto merchandise in any store; a gift card can be usedonly at its issuer.2.Why do gift cards for retailers like Walmart sell for asmaller discount than those for the Gap?Suggested Solution2.Retailers like Walmart sell necessities, but the Gapsells non-necessities. There will be a larger pool ofpotential buyers for cards from retailers of necessi-ties than from sellers of non-necessities because morepeople have constrained budgets and so are shop-ping only for necessities. In addition, because peopleshop repeatedly for necessities, they know they aremore likely to use up the face value of a card theycan use for necessities than one usable only for non-necessities. So more potential buyers compete to buycards for necessities, which drives their discount downcompared to cards for non-necessities.3.Use your answer from Question 2 to explain why cashnever “sells” at a discount.Suggested Solution3.Cash can be used to purchase any good or service,necessity or non-necessity; it is accepted everywhere.Also, it comes in any face value you want. So therewill always be an extremely large number of peoplewilling to “buy cash” because the price of a dollar willnever be less than a dollar.4.Explain why retailers prefer to reward loyal customerswith gift cards instead of rebate checks.Suggested Solution4.Most customers who receive a rebate check deposit thecheck into their checking account, withdraw the cash,and use it to pay for purchases. However, those pur-chases need not be from the issuer of the rebate check.In contrast, a gift card must be used at the retailerthat issues it. Also, cash doesn’t expire, but gift cardsoften do. And because gift cards have a predeterminedface value, it is more likely that a customer will notuse it all up—unlike cash, which is always eventually

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BCS-8S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H Tspent. For all these reasons, a retailer can capturebreakage on a gift card but not on a rebate check. Soretailers will prefer gift cards.5.There are now laws restricting retailers’ ability toimpose fees and expiration dates on their gift cardsand mandate greater disclosure of their terms. Why doyou think Congress enacted this legislation?Suggested Solution5.Retailers have an incentive to adopt policies thatincrease breakage (the amount of a gift card thataccrues to the retailer rather than the cardholder),such as imposing fees and expiration dates. Not tellingcustomers about these policies increases breakage. SoCongress has intervened to restrict these practices.CHAPTER151.PayPal accounts aren’t counted as part of the moneysupply. Should they be? Why or why not?Suggested Solution1.It depends on how consumers use their PayPalaccounts. Many consumers use PayPal as a means oftransferring money from a checking account or creditcard to pay for goods and services purchased online.In this case, PayPal accounts should not be counted aspart of the money supply. But, as we’ve seen, some indi-viduals keep money in their PayPal accounts insteadof their bank account. In this case, PayPal is beingused as a substitute for a non-interest-paying checkingaccount and should be counted in the money supply.2.In 2010, only around 25% of mobile phones in theUnited States were smartphones. In 2017, that numberincreased to more than 80%. How does this situationplay into the PayPal story, and how does it fit into thebroader pattern of monetary history?Suggested Solution2.PayPal had always been a leader in mobile-phone pay-ments. Acquiring Venmo further enhanced the compa-ny’s mobile-payment offerings and made it the largestmobile-payment provider in the United States at a timewhen the number of smartphones in use was increas-ing. The broader pattern of monetary history sincethe 1960s shows that improvements in banking tech-nology are born of innovation, whether credit cards,debit cards, ATMs, or mobile-banking systems. Theseinnovations typically followed from years of effortsto increase efficiency for consumers—to allow quickaccess to funds and make it easier for them to pay forgoods and send money.3.How might future actions by the Federal Open MarketCommittee affect the future of PayPal and similarservices?Suggested Solution3.PayPal and other money transmitters do not offerinterest rates on funds stored in their accounts. Asthe Federal Open Market Committee gradually raisesinterest rates, banks will start offering higher interestrates on saving accounts. The increased competitionfrom banks will incentivize customers to transfermoney from PayPal to interest-earning bank accounts.Because there are no costs in transferring moneybetween PayPal and bank accounts, it will be relativelyeasy to transfer money out of PayPal, which will likelyimpact its business.CHAPTER161.What was the relationship between inflation and theArgentine government’s chronic budget deficits?Suggested Solution1.Historically, Argentina’s government has struggledto manage its budget. Unable to borrow on foreigncapital markets, raise taxes, or cut spending, the gov-ernment was forced to finance its budget deficit byprinting money. As it became more reliant on printingmoney to finance spending, Argentina’s inflation rateincreased, illustrating a direct correlation betweenbudget deficits and increased inflation rates.2.What were the implications of Argentina’s inability toget its government deficits under control for Argentinebusinesses?Suggested Solution2.The high inflation caused by the Argentine govern-ment’s attempts to fund its budget deficits throughthe inflation tax created uncertainty for Argentinebusinesses. They could neither anticipate future costsnor make plans for the future, such as deciding howto invest in their businesses. For example, restaurantowners could not be sure about the wisdom of invest-ing in printed menus. Businesses that underestimatedhow much their costs would go up might lose moneyand go out of business. Businesses unable to plan forthe future and make investments risked atrophy andfailure.3.Why did the Argentine government try to stopArgentinians from converting pesos into foreigncurrency, such as dollars?Suggested Solution3.The Argentine government was trying to collect aninflation tax by using seigniorage to fund the budgetdeficit. This turned into a downward spiral of increas-ingly higher inflation. As the government printedmore money, the inflation rate increased, and the pesolost value relative to foreign currencies. Argentiniansbegan converting their pesos into foreign curren-cies, like the dollar, looking for stability. This in turnreduced the amount of seigniorage the government

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S U G G E S T E D S O L U T I O N S F O R B U S I N E S S C A S E Q U E S T I O N S F O R T H O U G H TBCS-9was able to capture, forcing them to print even moremoney and leading to an even higher inflation rate.So in an effort to arrest the downward spiral, theArgentine government tried to stop citizens fromconverting their pesos into foreign currency.CHAPTER181.Why would Abenomics lead to a weaker yen?Suggested Solution1.We’ve seen that expansionary monetary policy weak-ens a currency because lower interest rates induceinvestors to move money to other countries, increas-ing the demand for foreign exchange. That’s basicallywhat’s happening here, although Abenomics dependsin part on promises to keep money loose—that is,to keep interest rates low for longer than previouslyexpected—rather than just cutting rates now.2.Why is a weaker yen good for the profits of Japaneseauto companies?Suggested Solution2.When a company like Toyota or Subaru exports carsfrom Japan, many of its costs—wages inparticular—are presumably fixed in yen, while it is selling inmarkets where competitors have costs fixed in dollarsor euros. So a fall in the yen gives the Japanese com-panies a cost advantage, raising their profits.3.Why did Subaru gain more than Toyota?Suggested Solution3.For Toyota, the benefits of a weaker yen apply only tothe part of its production that is exported from Japan.As far as its U.S. plants are concerned, it is, in effect,an American company. So the benefits for Toyota arelimited. Subaru, on the other hand, is still mainly aJapan-based producer, so it gets the full benefit of aweaker yen.

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interactive activityChapter1First Principles1.In each of the following situations, identify which of the twelve principles is at work.a.You choose to purchase your textbooks online through Chegg rather thanpaying a higher price for the same books through your college bookstore.b.On your spring break trip, your budget is limited to $35 a day.c.Craigslist allows departing students to sell items such as used books, appli-ances, and furniture rather than giving them away as they formerly did.d.After a hurricane did extensive damage to homes on the island of St. Crispin,homeowners wanted to purchase many more building materials and hiremany more workers than were available on the island. As a result, prices forgoods and services rose dramatically across the board.e.You buy a used textbook from your roommate. Your roommate uses themoney to buy songs from iTunes.f.You decide how many cups of coffee to have when studying the night beforean exam by considering how much more work you can do by having anothercup versus how jittery it will make you feel.g.There is limited lab space available to do the project required in Chemistry101. The lab supervisor assigns lab time to each student based on when thatstudent is able to come.h.You realize that you can graduate a semester early by forgoing a semester ofstudy abroad.i.At the student center, there is a bulletin board on which people advertise useditems for sale, such as bicycles. Once you have adjusted for differences inquality, all the bikes sell for about the same price.j.You are better at performing lab experiments, and your lab partner isbetter at writing lab reports. So the two of you agree that you will do all theexperiments, and she will write up all the reports.k.State governments mandate that it is illegal to drive without passing a drivingexam.l.Your parents’ after-tax income has increased because of a tax cut passedby Congress. They therefore increase your allowance, which you spend on aspring break vacation.1.a.People usually exploit opportunities to make themselves better off. In thiscase, you make yourself better off by buying textbooks at a lower price.Solutionb.Resources are scarce. Since you have only $35 a day, your resources arelimited (scarce).c.Markets usually lead to efficiency. The market here is represented by thebuyers and sellers who use Craigslist to trade goods, in contrast to the“nonmarket” of simply giving items away to one’s roommate. The market isefficient because it enables people who want to sell items to find those whowant to buy those items. This is in contrast to a system in which items aresimply left with a roommate, who may have little or no desire to have them.d.Overall spending sometimes gets out of line with the economy’s productivecapacity. The spending by St. Crispin homeowners on building materialsand workers fell short of the economy’s ability to produce those goods andservices. As a result, prices on the island rose across the board (inflation).e.One person’s spending is another person’s income. Your spending on the usedtextbook is your roommate’s income.S-1

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S-2C h a p t e r 1F i r s tP r i n c iPl e sf.“How much” is a decision at the margin. Your decision is one of “how much”coffee to consume, and you evaluate the trade-off between keeping yourselfawake and becoming more jittery from one more cup of coffee.g.Resources should be used as efficiently as possible to achieve society’s goals.Allocating scarce lab space according to when each student can use that spaceis efficient.h.The real cost of something is what you must give up to get it. The real cost of asemester abroad is giving up the opportunity to graduate early.i.Markets move toward equilibrium. Any bicycle a buyer chooses will leave himor her equally well off. That is, a buyer who chooses a particular bicycle can-not change actions and find another bicycle that makes him or her better off.Also, no seller can take a different action that makes him or her better off: noseller can charge a higher price for a bicycle of similar quality, since no onewould buy that bicycle.j.There are gains from trade. If each person specializes in what he or she isgood at (that is, in comparison with others that person has an advantage inproducing that good), then there will be gains from specialization and trade.k.When markets don’t achieve efficiency, government intervention can improvesociety’s welfare. Unsafe drivers don’t take into account the dangers they poseto others and often to themselves. So when unsafe drivers are allowed to drive,everyone is made worse off. Government intervention improves society’s wel-fare by assuring a minimum level of competence in driving.l.Government policies can change spending. In this case, a tax cut hasincreased spending.2.Describe some of the opportunity costs when you decide to do the following.a.Attend college instead of taking a jobb.Watch a movie instead of studying for an examc.Ride the bus instead of driving your carSolution2.a.One of the opportunity costs of going to college is not being able to take a job.By choosing to go to college, you give up the income you would have earned onthe job and the valuable on-the-job experience you would have acquired. Anotheropportunity cost of going to college is the cost of tuition, books,supplies, and soon. Alternatively, the benefit of going to college is being able to find a better, morehighly paid job after graduation, in addition to the joy of learning.b.Watching the movie gives you a certain benefit, but allocating your time(ascarce resource) to watching the movie also involves the opportunity costof not being able to study for the exam. As a result, you will likely get a lowergrade on the exam—and all that that implies.c.Riding the bus gets you where you need to go more cheaply than, but probablynot as conveniently as, driving your car. That is, some of the opportunity costsof taking the bus involve waiting for the bus, having to walk from the bus stopto where you need to go rather than parking right outside the building, andprobably a slower journey. If the opportunity cost of your time is high (yourtime is valuable), these costs may be prohibitive.3.Liza needs to buy a textbook for the next economics class. The price at the col-lege bookstore is $65. One website offers it for $55, and another site, for $57. Allprices include sales tax. The accompanying table indicates the typical shippingand handling charges for the textbook ordered online.Shipping methodDelivery timeChargeStandard shipping3–7 days$3.99Second-day air2 business days8.98Next-day air1 business day13.98

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C h a p t e r 1F i r s tP r i n c iPl e sS-3a.What is the opportunity cost of buying online instead of at the bookstore?Note that if you buy the book online, you must wait to get it.b.Show the relevant choices for this student. What determines which of theseoptions the student will choose?Solution3.a.The opportunity cost of buying online is whatever you must give up to get thebook online. So the opportunity cost of buying online is the sum of the ship-ping charges plus the opportunity cost of your time spent waiting for the bookto arrive (at the bookstore the book is available immediately) minus the costsaving you receive by buying online versus buying at the bookstore.b.Below is a list of all of Liza’s options and their purely monetary costs:Buy from bookstore$65Buy from first site (price $55), 1-day delivery$55+$13.98=$68.98Buy from first site (price $55), 2-day delivery$55+$8.98=$63.98Buy from first site (price $55), 3- to 7-day delivery$55+$3.99=$58.99Buy from second site (price $57), 1-day delivery$57+$13.98=$70.98Buy from second site (price $57), 2-day delivery$57+$8.98=$65.98Buy from second site (price $57), 3- to 7-day delivery$57+$3.99=$60.99It is clear that Liza would never buy from the second site, where the book costs$57: for each delivery time, she is better off buying the book from the first site,where the book costs $55. It is also clear that she would never buy the book fromthe first site and have it delivered the next business day: it costs more that way($68.98) than getting it from the bookstore (assuming that it is costless to get toand from the bookstore). But it is not clear whether she will buy the book fromthe bookstore or the first site with delivery times of 2 or 3–7 days: this dependson her opportunity cost of time. The higher the cost of waiting, the more likelyshe is to buy the book from the bookstore, where she does not need to wait.4.Use the concept of opportunity cost to explain the following.a.More people choose to get graduate degrees when the job market is poor.b.More people choose to do their own home repairs when the economy is slowand hourly wages are down.c.There are more parks in suburban than in urban areas.d.Convenience stores, which have higher prices than supermarkets, cater to busypeople.e.Fewer students enroll in classes that meet before 10:00a.m.Solution4.a.The worse the job market, the lower the opportunity cost of getting a graduatedegree. One of the opportunity costs of going to graduate school is not being ableto work. But if the job market is bad, the salary you can expect to earn is low oryou might be unemployed—so the opportunity cost of going to school is also low.b.When the economy is slow, the opportunity cost of people’s time is also lower:the wages they could earn by working longer hours are lower than when theeconomy is booming. As a result, the opportunity cost of spending time doingyour own repairs is lower—so more people will decide to do their own repairs.c.The opportunity cost of parkland is lower in suburban areas. The price persquare foot of land is much higher in urban than in suburban areas. By creatingparkland, you therefore give up the opportunity to make much more money incities than in the suburbs.d.The opportunity cost of time is higher for busy people. Driving long distancesto supermarkets takes time that could be spent doing other things. Therefore,busy people are more likely to use a nearby convenience store.e.Before 10:00a.m.the opportunity cost of time for many students is veryhigh—it means giving up an extra hour’s sleep. That extra hour is much morevaluable before 10:00a.m.than later in the day.

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S-4C h a p t e r 1F i r s tP r i n c iPl e s5.For the following examples, state how you would use the principle of marginalanalysis to make a decision.a.Deciding how many days to wait before doing your laundryb.Deciding how much time to spend researching before writing your term paperc.Deciding how many bags of chips to eatd.Deciding how many class lectures to skipSolution5.a.Each day that you wait to do your laundry imposes a cost: you have fewer cleanclothes to choose from. But each day that you wait also confers a benefit: you canspend your time doing other things. You will wait another day to do your laundryif the benefit of waiting to do the laundry that day is greater than the cost.b.The more research you do, the better your paper will be. But there is also anopportunity cost: every additional hour you spend doing research means youcannot do other things. You will weigh the opportunity cost of doing one morehour of research against the benefit gained (in terms of an improved paper)from doing research. You will do one more hour of research if the benefit ofthat hour outweighs the cost.c.Each bag of chips you eat gives you a benefit: it satisfies your hunger. But it alsohas a cost: the money spent for each bag (and, if you are weight-conscious, theadditional calories). You will weigh the cost against the benefit of eating one morebag. If the cost is less than the benefit, you will eat that one more bag of chips.d.Each lecture that you skip implies a cost: getting further behind with thematerial and having to teach it to yourself just before the exam. But eachskipped lecture also means you can spend the time doing other things. Youwill continue to skip lectures if the cost of skipping is lower than the benefit ofspending that time doing other things.6.This morning you made the following individual choices: you bought a bagel andcoffee at the local café, you drove to school in your car during rush hour, and youtyped your course notes for your roommate because she was texting in class—inreturn for which she will do your laundry for a month. For each of these actions,describe how your individual choices interacted with the individual choices made byothers. Were other people left better off or worse off by your choices in each case?6.When you bought the bagel and coffee, you paid a price for them. You would nothave bought that breakfast if your enjoyment of it (your welfare) had not beengreater than the price you paid. Similarly, the café owner would not have soldyou the bagel and coffee if the price he received from you were less than the costto him of making them. This is an example of how everybody gains from trade:both you and the café owner are better off.SolutionWhen you chose to drive your car during the rush hour, you added to thecongestion on the road. Your choice had a side effect for other motorists: yourdriving slowed everybody else down just a little bit more. Your choice madeother motorists worse off.Typing your notes for your roommate in exchange for her doing your laundryis another example of the gains that come from trade. Both of you voluntarilyagreed to specialize in a task that each is comparatively better at because youexpected to gain from this interaction. Your choice made both you and yourroommate better off.7.The Hatfield family lives on the east side of the Hatatoochie River, and theMcCoy family lives on the west side. Each family’s diet consists of fried chickenandcorn-on-the-cob, and each is self-sufficient, raising their own chickens andgrowing their own corn. Explain the conditions under which each of the follow-ing would be true.a.The two families are made better off when the Hatfields specialize inraisingchickens, the McCoys specialize in growing corn, and the twofamilies trade.

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C h a p t e r 1F i r s tP r i n c iPl e sS-5b.The two families are made better off when the McCoys specialize inraisingchickens, the Hatfields specialize in growing corn, and the twofamilies trade.Solution7.a.Gains from trade usually arise from specialization. If the Hatfields (comparedto the McCoys) are better at raising chickens and the McCoys (compared to theHatfields) are better at growing corn, then there will be gains from specializa-tion and trade.b.Similar to the answer to part a, if the McCoys (compared to the Hatfields)are better at raising chickens and the Hatfields (compared to the McCoys) arebetter at growing corn, then there will be gains from specialization and trade.8.Which of the following describes an equilibrium? Which does not? If the situa-tion does not describe an equilibrium, what would an equilibrium look like?a.Many people regularly commute from the suburbs to downtownPleasantville.Due to traffic congestion, the trip takes 30 minutes via highway but only15minutes via side streets.b.At the intersection of Main and Broadway are two gas stations. One stationcharges $3.00 per gallon for regular gas and the other charges $2.85 pergallon.Customers can get service immediately at the first station but must wait in along line at the second.c.Every student enrolled in Economics 101 must also attend a weekly tutorial.This year there are two sections offered: section A and section B, which meetat the same time in adjoining classrooms and are taught by equally compe-tent instructors. Section A is overcrowded, with people sitting on the floorand often unable to see what is written on the board at the front of the room.Section B has many empty seats.Solution8.a.This is not an equilibrium. Assume that all people care about is the travel timeto work (not, for instance, how many turns they need to make or what thescenery is like). Some people could be better off using the side streets, whichwould cut down their travel time. Eventually, as the situation moves to equilib-rium (that is, as more people use the side streets), travel times on the highwayand along the side streets will equalize.b.This might be an equilibrium. Those who buy gas at the first station would beworse off by buying gas at the second if the value of their time spentwaitingexceeded the savings at the pump: they would save 15 cents per gallon butwould incur the opportunity cost of waiting in a long line. You should expectvery busy people (a high opportunity cost of time) to buy gas at the firststation. Those who buy gas at the second station might be worse off bybuyinggas at the first: they would not have to wait in line but would pay 15centsmore per gallon. You should expect people with a lot of free time (a lowopportunity cost of time) to buy gas at the second station.c.This is not an equilibrium. If students from section A attended section Binstead, they would be better off: they could get seats and see the boardwithout incurring any cost (since the section meets at the same time and istaught by an equally competent instructor). Over time, you should expectstudents to switch fromsection A to section B until equilibrium is established.9.For each of the following, explain whether you think the situation is efficient ornot. If it is not efficient, why not? What actions would make it efficient?a.Electricity is included in the rent at your dorm. Some residents in your dormleave lights, computers, and appliances on when they are not in their rooms.b.Although they cost the same amount to prepare, the cafeteria in your dormconsistently provides too many dishes that diners don’t like, such as tofucasserole, and too few dishes that diners do like, such as roast turkey withdressing.

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