Solution Manual for Principles of Macroeconomics, 6th Edition

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1CHAPTER 1THINKING LIKE AN ECONOMISTAnswers to Review Questions1. Your friend probably means that the benefits from private solo lessons are greater (your tennisgame will improve faster) than if you take group lessons.But private lessons arealso morecostly than group lessons.So those people who don’t care that much about how rapidly theyimprove may do better to take group lessons and spend what they save on other things.Learning Objective: 01-02AACSB: Reflective ThinkingBloom’s: Understand2. False.According to the Cost-Benefit Principle, your willingness to make the trip shoulddepend only on whether $30 is more or less than the cost of driving downtown.Learning Objective: 01-03AACSB:Reflective ThinkingBloom’s:Understand3. Because the price of a movie ticket is a cost the patron must pay explicitly, it tends to be morenoticeable than the money that she would fail to earn by seeing the movie. As Sherlock Holmesrecognized, it’s easier to notice that a dog has barked than that it has failed to bark.Learning Objective: 01-03AACSB: Reflective ThinkingBloom’s: Understand4. Using a frequent flyer coupon for one trip usually means not having one available to use foranother. By thinking of frequent-flyer travel as free, people fail to consider the opportunity costof using the coupon, thereby making wasteful travel decisions.Learning Objective: 01-03AACSB: Reflective ThinkingBloom’s: Understand5. Your tuition payment is a sunk cost as long as it is non-refundable, since the payment cannotbe recovered even if you drop out of school. If the payment is refundable until a certain date, itis not a sunk cost until after that date.

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2Learning Objective: 01-03AACSB: AnalyticBloom’s: AnalyzeAnswers to Problems1. The economic surplus from washing your dirty car is the difference between the benefit youreceive fromdoing so($6)minus yourcost of doing the job ($3.50), or $2.50.Learning Objective: 01-02AACSB: AnalyticBloom’s:Apply2.The marginal benefit of adding a pound of compost is theextra revenue you earn from theadditional poundof tomatoes grown. Therefore, you shouldcontinue to add more compost aslong as the marginal benefit exceeds or equals the marginalcost of adding another pound ofcompost (50 cents). This type of problem isbestanswered using a table such as the one below.Note that by adding the fourth pound of compostyou’ll get 2 extra pounds of tomatoes, or 60cents in extra revenue, which covers the 50cent cost of the extra pound of compost.However,the fifth pound of compost gives only 1 extra pound of tomatoes, so thecorresponding revenueincrease of 30 centsis less than the cost of the compost. So you should add 4 pounds of compostand no more.Pounds ofcompostPounds oftomatoesExtra pounds oftomatoesExtra revenue ormarginal benefitExtra or marginalcost0100---112020$6.00$0.5021255$1.50$0.5031283$0.90$0.5041302$0.60$0.5051311$0.30$0.506131.5.5$0.15$0.50Learning Objective: 01-02AACSB: AnalyticBloom’s:Apply3. Since you have already bought your ticket, the $30 you spent on it is a sunk cost. It is moneyyou cannot recover, whether or not you go to the game.In deciding whether to see the game,then, you should compare the benefit of seeing the game (as measured by the largest dollaramount you would be willing to pay to see it) to only thoseadditionalcosts you must incur tosee the game (the opportunity cost of your time, whatever cost you assign to driving through thesnowstorm, etc.).In Cost-Benefit, you must only consider the costs that actually change with

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3your decision, which is not the case with the $30 that you will never see again whether you go tothe game or not.Joe, too, must weigh the opportunity cost of his time and the hassle of the drive indeciding whether to attend the game. But he must also weigh the $25 he will have to spend forhis ticket.At the moment of deciding, therefore, theremainingcosts Joemustincur to see thegame are $25 higher than the remaining costs for you. And since you have identical tastes—thatis, your respective benefits of attending the game are exactly the same—Joe should be less likelyto make the trip. You might think the cost of seeing the game is higher for you, since your ticketcost $30, whereas Joe’s will costonly $25. But at the decision-making moment, only the ticketcost for Joe ($25) changes whether he goes or not, and is therefore the only cost that should beconsidered.Learning Objective: 01-02AACSB: AnalyticBloom’s:Analyze4. If Tom kept the $200 and invested it in additional mushrooms, at the end of a year's time hewouldhave $400 worth of mushrooms to sell.Therefore, Dick must give Tom $200 in interestin order for Tom not to lose money on the loan.Learning Objective: 01-03AACSB: AnalyticBloom’s: Apply5. Even though you earned four times as many points from the first question than from thesecond, the lastfew secondsyou spent on question 2 addeda net of6 points to your total scoreincomparison to the last few secondsspent on question 1. That means you should have spent moretime on question 2.Learning Objective: 01-03AACSB: AnalyticBloom’s: Apply6. According to theCost-Benefit principle, the two women should make the same decision.After all, the benefit of seeing the play is the same in both cases, and the cost of seeing theplay—at the moment each must decide—is exactly $10. Some may think that in the case of thelost ticket the cost of seeing the play is not $10 but $20, the price of two tickets.However, interms of the financial consequences, the loss of a ticket is clearly no different from the loss of a$10 bill.Both of these are examples of a sunk cost, as the $10 is lost whether one attends theplay or not. So in each case, the question is whether seeing the play is worth spending $10. If itis worth $10 to see the play,both Martha and Sarah should see it; otherwisetheyshould notattend the performance. Whichever your answer, it must be the samefor both Martha and Sarah.

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4Learning Objective: 01-03AACSB: AnalyticBloom’s: Analyze7. In thecurrent system, the cost is $6 per week no matter how many cans you put out, so thecost of disposing of an extra can of garbage(the marginal cost)is $0. Under the tag system, thecost of putting out an extra can is $2, regardless of the number of the cans. Since the marginalcost of putting out cans is higher under the tag system, we would expect this system to reduce thenumber of cans collected.Learning Objective: 01-04AACSB: AnalyticBloom’s: Analyze8. Atbothhouses,the cost of drinking a cola is that it’s not available to drink later, but at theSmith’s house, this cost is low because your sibling may drink the cola before the other is able to.This gives each Smith child a strongincentive to consume the colas now.Jones, by contrast, haseliminatedthisincentive bynot allowing eitherchildtodrink more than half the colas.As aresult,his childrencanconsumethe colaat a slower, more enjoyable pace.Learning Objective: 01-04AACSB:Reflective ThinkingBloom’s:Understand9. For a seven-minute call the two phone systems charge exactly the same amount, 70 cents. Butat that point under the new plan, the marginal cost is only 2 cents per minute,compared to 10cents per minute under the current plan.And since the benefit of talking additional minutes isthe same under the two plans, Tom is much more likely to make longer calls under the new plan.Learning Objective: 01-04AACSB: AnalyticBloom’s: Analyze10. At University A, the marginal or extra cost for each additional pound of food is $0, soeverybody will keep eating until the extra benefit from eating an extra pound is also equal to $0.At University B, however, the cost of eating an extra pound of food is $2, so people will stopeating when the benefit of eating an extra pound falls to $2. Food consumption will thus behigher at University A.Learning Objective: 01-04AACSB: AnalyticBloom’s: Analyze

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1CHAPTER 2COMPARATIVE ADVANTAGEAnswers to Review Questions1.An individual has a comparative advantage in the production of a particular good ifshe can produce it at a lower opportunity cost than other individuals. An individual has anabsolute advantage in the production of a good if she can produce more of that good thananother individual, using comparable amounts of time, raw materials and effort.Learning Objective: 02-01AACSB:Reflective ThinkingBloom’s: Understand2.A reduction in the number of hours worked each day will shift all points on theproduction possibilities curve inward, toward the origin, as this reduces the maximumamount that can be produced of either good. The graph below illustrates this situation.2Coffee(lb/day)Nuts(lb/day)PPC1PPCLearning Objective: 02-03AACSB: Reflective ThinkingBloom’s: Understand3.Technological innovations that boost labor productivity will shift allpoints on theproduction possibilities curve outward, away from the origin. The graph below illustratesthis situation.

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22Coffee(lb/day)Nuts(lb/day)PPC1PPCLearning Objective: 02-03AACSB: Reflective ThinkingBloom’s: Understand4.According to thePrinciple of Comparative Advantage, people will perform their ownservices when the opportunity cost of doing so is low. This implies that performingservices yourself is not a matter of whether you are rich or poor but rather theopportunitycost of your time. Furthermore, limited specialization will mean less overall productionfor a nation, which is usually interpreted as poverty.Learning Objective: 02-02AACSB: Reflective ThinkingBloom’s: Understand5.The fact that English has become thede factointernational language has done muchto stimulate international demand for American-made books, movies and popular music.The large size of the American market has given the United States anadditionaladvantage over other English-speaking countries, like England, Canada, and Australia.Learning Objective: 02-03AACSB:Reflective ThinkingBloom’s:RememberAnswers to Problems1.In the time it takes Ted to wash a car he can wax threecars, which is hisopportunity cost of washing one car. Inthe time it takes Tom to wash one car, he can waxtwo cars, which is his opportunity costof washing one car.

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3Alternatively, you can compute how many cars each person can wash or wax in a certaintime period, such as an hour, and then use these quantities to compute their respectiveopportunity costs: Ted can washonecar or waxthree, so his opportunity cost of washingone car is3 (or 3/1)wax jobs. Likewise, Tom can wash two cars or wax four, so hisopportunity cost of washing one car is2 (or 4/2)wax jobs.BecauseTom’sopportunity cost of washing a car is lower thanTed’s, Tomhas acomparative advantage in washing cars.Learning Objective: 02-01AACSB: AnalyticBloom’s: Apply2.Inthe time it takes Nancy to replace a set of brakes she can complete one-halfof aclutch replacement;her opportunity cost of replacing a set of brakes istherefore one-halfof a clutch replacement.In the time it takes Bill to replace a set of brakes, he cancomplete one-third of a clutch replacement; his opportunity cost of replacing a set ofbrakes is therefore one-third of a clutch replacement.Alternatively, you can compute how many clutches or brakes each person can replace ina certain time period, such as 6 hours, and then use these quantities to compute theirrespective opportunity cost: Nancy can replace 1.5 clutches or 3 sets of brakes in thattime, so her opportunity cost of replacing one set of brakes is one-half of a clutchreplacement (1.5/3). Likewise, Bill can replace 1 clutch or 3 sets of brakes, so hisopportunity cost of replacing one set of brakes is one-third of a clutch replacement (1/3).Bill’s opportunity cost of replacing a set of brakes is lower than Nancy’s, so Bill has acomparativeadvantageinreplacingbrakes.ThisalsoimpliesthatNancyhasacomparative advantage in replacing clutches.Finally, Nancy has an absolute advantageover Bill in replacing clutches since it takes her two hours less than it takes Bill toperform that job.Since Nancy and Bill takethe same amount of time to replace a set ofbrakes, neither person has an absolute advantage in that task.Learning Objective: 02-01AACSB: AnalyticBloom’s: Apply3.a.Helen's production possibilities curve would look like the following:

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403264DressesperdayLoavesofbreadperdayb.As the graphshows, 28 dresses per day and 16 loaves of bread per day is outsidethe production possibilities curve (PPC) and is therefore anunattainablecombination for Helen. The combination of 16 dresses per day and 32 loaves ofbread per dayis both attainable and efficient. Finally, 18 dresses per day and 24loaves of bread per day is a combination that lies beneath the PPC, which isattainable but inefficient. Here, Helen could either complete more dresses or moreloaves of bread per day.03264DressesperdayLoavesofbreadperdayabc321624281618Learning Objective: 02-03AACSB: AnalyticBloom’s: Apply4.a.As shown below, the new machine doubles the value of the vertical intercept ofHelen’s PPC.

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503264DressesperdayLoavesofbreadperday64b.Since Helen can sew twice as many dresses per hour as before, she can now sewany given number of dresses in half as much time as before. With the time saved,she can bake additional loaves of bread.c.The upward rotation of Helen’s PPC means that she is now able for the first timeto produce at any of the points in the shaded region of the graph above.Note thather menu of opportunity increased with respect to dressesandwith respect tobread as well. For example, she can now produce 32 dresses and 32 loaves ofbread instead of 32 dresses and no loaves.Learning Objective: 02-03AACSB: AnalyticBloom’s: Apply5.a.Their maximum possible coffee output is 36 pounds per day (12 from Tomand24fromSusan).b.Their maximum possible output of nuts is also 36 pounds per day (12 from Susanand24 from Tom).c.Tom should be sent togathernuts, since his opportunity cost (half a pound ofcoffee per pound of nuts) is lower than Susan’s (2 pounds of coffee per pound ofnuts). Since it would take Tom only one hour togatherfour pounds of nuts, he

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6can still pick 10 pounds of coffee in his 5 working hours that remain. Added toSusan’s 24 pounds, they will have a total of 34 pounds of coffee per day.d.Susan should be sent to pick coffee, since her opportunity cost (half a pound ofnuts per pound of coffee) is lower than Tom’s (2 pounds of nuts per pound ofcoffee).It will take Susan 2 hours to pick 8 pounds of coffee, which means thatshe can stillgather8 pounds of nuts. So they will have a total of 32 pounds perday of nuts.e.Togather26 pounds of nuts per day, Tom should work full timegatheringnuts(24 pounds per day) and Susan should spend one hour per daygatheringnuts (2pounds per day).Susan would still have 5 hours available to devote to pickingcoffee, so she can pick 20 pounds of coffee per day.f.Thepoint 30 pounds of coffee per day and 12 pounds of nuts per day can beproduced by having Susan work full time picking coffee (24 pounds of coffee perday) while Tom spends 3 hours picking coffee (6 pounds of coffee) and 3 hoursgathering nuts (12 pounds of nuts).g.Thepoint 24 pounds of coffee per day and 24 pounds of nuts per day can beachieved if each works full time at his or her activity of comparative advantage.Both points are attainable and efficient.h.Thepoints and the straight lines connecting them are shown in the graph below.The production possibilities curve for the two-person economy consisting ofSusan and Tom shows the maximum possible amount of coffee production on thevertical axis for any given quantity of daily nut production on the horizontal axis.

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7Learning Objective: 02-03AACSB: AnalyticBloom’s: Apply6.a.By specializing completely, they can produce 24 pounds of coffee per dayand 24 pounds of nuts (the point at which the kink occurs in the PPC in thediagram). If they sell this output in the world market at the stated prices,they will receive atotal of $96 per day.b.With $96 per day to spend, the maximum amount of coffee they could buyis 48 pounds per day, or they could buy 48 pounds of nuts per day.The combination of 40 pounds of coffee and 8 pounds of nuts would beunattainable for Susan and Tom if they were not able to buy and sell in theworld market,as the maximum amount of coffee that can be picked is 36poundsper day. However,if they buy and sell in the world market,40pounds of coffee would cost $80, and 8 pounds of coffee would cost $16,so they would have just enough money ($96 per day) to buy thiscombination of goods.

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

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1CHAPTER 3SUPPLY AND DEMANDAnswers to Review Questions1.Under the horizontal interpretation, we begin with a price for the good and then usethe demand curve to read the quantity demanded at that price on the horizontal axis.Under thevertical interpretation, we start with a quantity produced and use thedemand curve to read the marginal buyer’s reservation price for the product on thevertical axis.Learning Objective: 03-01AACSB:Reflective ThinkingBloom’s: Understand2.The equilibrium price of a good is determined by the intersection of its supply anddemand curves.We can know everything about a good’s cost of production (that iswe can know its supply curve exactly) but without the demand curve we will notknow the quantity people will want to purchase and therefore we will not know whatprice must be charged to cover the cost.Learning Objective: 03-02AACSB: Reflective ThinkingBloom’s: Understand3.Ifpricecontrolregulationpreventedthepriceofgasolinefromrisingtoitsequilibrium level, we would expect to see symptoms of excess demand for gasolinesuch as lines of cars waiting at the pumps to buy gas.Learning Objective: 03-02AACSB: AnalyticBloom’s: Apply4.A change in demand means a shift of the entire demandcurve, whereas a change inthe quantity demanded means a movement along the demand curve in response to achange in price of that specific good.Learning Objective: 03-03AACSB: AnalyticBloom’s: Analyze

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25.It is smart for each individual at a sporting event to stand up in order to get a betterview of the game.However, it is dumb for all to stand up since no one sees anybetter than if all had remained seated.Learning Objective: 03-04AACSB: Reflective ThinkingBloom’s: UnderstandAnswers to Problems1.a.Thesupply curve shiftsto the right. The discovery is a technologicalimprovement, so the improved technique would allow a farmer touse the same inputsto produce more corn.b.The supply curve shiftsto the right. Fertilizer is aninput intothe production ofcorn,so thisis anexample of a decrease in an input price. A decrease in input pricesshifts the supply curve to the right.c.Thesupply curveshiftsto the right. New tax breaks make farming relativelymore profitable than before,so those who were earning an income from a non-farming job that paid just a little bit more than farming would switch to farming if thetax break is big enough.d.Thesupply curveshiftsto the left.A tornado would destroy corn fields,alongwith infrastructureused to harvest and store it.Thus,at every given price thequantity of corn supplied would be lower and the supply curve shiftsto the left.Learning Objective: 03-01AACSB: AnalyticBloom’s:Apply2.a.Thedemand curveshiftsto the right.Buyer incomehas risen and vacations are anormal good, so this increases the quantity demanded at every given price.b.Thedemand curveshiftsto the left. Buyer preferencewill probably changebecause most people want to avoid foods that cause heart disease, so buyers willpurchase fewer pizzas with pepperoni.c.Thedemand curve shiftsto the right.Since these goods aresubstitutes, anincrease in the price of MP3s would result in an increased demand for CDs.d.Thedemand curveremainsunchanged.An increase in the price of CDs decreasesthe quantity demanded of CDs, which causes movementalongthe demand curve.Learning Objective: 03-01

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3AACSB: AnalyticBloom’s:Apply3.The supply of binoculars will not be affected.The demand for binoculars mightincrease due to more people wanting to spot UFOs.This will lead to an increase inthe equilibrium price of binoculars and thequantity of binoculars supplied. However,no change in the supply of binoculars should occur since nothing has changed withregard to input prices, technology, or any of the factors that determine supply.Learning Objective: 03-01AACSB: AnalyticBloom’s: Apply4.Two goods arecomplementsif an increase in the price of one causes a leftward shiftinthe demand curve for the otheror if a decreasein the price of onecauses arightward shiftin the demand curve for the other. The opposite holds true for asubstitute, where the price change of one good and the demand change of the otherwill be in the same direction (increase or decrease).a. Washing machines and dryers are complements.b. Tennis rackets and tennis balls are complements.c. Ice cream and chocolate are both complements and substitutes.d. Cloth diapers and disposable diapers are substitutes.Learning Objective: 03-03AACSB:Reflective ThinkingBloom’s: Understand5.An increase in the birth rate will increase the population of potential buyers of land.This willshift the demand curve for land to the right and increase the equilibriumprice of land.Learning Objective: 03-03AACSB: AnalyticBloom’s: Analyze

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