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EXTRA END OF CHAPTER QUESTIONS McConnell 10E Macroeconomics

Chapter One 1. Is rational self-interest the same thing as selfishness? Explain. No, they are not the same. Selfishness means that a person is only concerned with himself or herself to the exclusion of others. Rational self-interest simply means that people stri e to achie e personal satisfaction. !his personal satisfaction can "e achie ed in many ways, from "oth selfish and unselfish acts. #or example, a person may "e unselfish and olunteer time to help other people or ma$e donations to charities "ecause the person deri es personal satisfaction from doing so. In this case the person is not "eing selfish, "ut is acting to maximi%e the person&s well-"eing "y helping others. '. (hy are economic theories and principles imprecise? Shouldn&t they apply to e eryone? !he main reason is that they are generali%ations relating to economic "eha iour or the economy. !he economic facts used to de elop the theories and principles differ from person to person or economic institution to institution. !hey reflect tendencies or a erages across large groups that may not apply to a particular indi idual. #or example, if the price of a product drops significantly, the )uantity demanded among consumers as a group is expected to increase, "ut some consumers may not increase their purchases. *. Explain the economic fallacy in the statement+ ,If the -ones family would .ust cut up their credit cards and li e within their means, they&d "e "etter off. /nd if consumers in this nation cut up their credit cards and li ed within their means, the nation would "e "etter off.0 !his is an example of the fallacy of composition. 1utting up credit cards may "e good for the -ones family depending on their circumstances. If they ha e ta$en on too much de"t and are in financial trou"le, then cutting up credit cards would reduce their impulses to spend money. 2ut if all consumers cut up their credit cards this action would reduce consumer spending in the economy "ecause there would "e fewer transactions and it would ma$e the economy less efficient. Economic growth would decline "ecause of the reduced consumer spending.

Chapter Two 1 ,!he two cornerstones of economics are the scarcity of resources and the multiplicity of wants. !rue economy consists of deri ing maximum want satisfaction from a aila"le resources.0 Explain. !he first statement refers to the "asic economic pro"lem+ that society&s wants are unlimited relati e to the limited supply of producti e resources. !he second part of the statement refers to the concept of efficiency, "oth allocati e and producti e. Since resources are scarce, it is desira"le to achie e the most output from those a aila"le. 3therwise we waste resources and will not satisfy as many wants as we could from the resources that we ha e a aila"le, which would mean not achie ing producti e efficiency. /llocati e efficiency means the maximum satisfaction of wants with these resources. ' 4ow are tradeoffs illustrated "y the production possi"ilities cur e? 1onsider the case of federal go ernment spending on national defence and spending on social programs. In the production possi"ilities model, an increase in go ernment spending on national defence will come at the expense of go ernment spending on social programs. If the nation wants to "e more secure then it will ha e to gi e up the opportunities to use its scarce "udget resources for social programs. 1on ersely, if there is more spending on social programs, there will ha e to "e cuts to national defence, assuming that there is a fixed "udget constraint. 5o ing in either direction on the production possi"ilities cur e will in ol e trading off one desira"le pu"lic good for another. *. Explain the relationship "etween the increase in women in the la"our force o er the last forty years in 1anada and the production possi"ilities for the economy. !he increase in women in the la"our force represents a shift outward in the production possi"ilities cur e. !he reason for the shift is that there are now greater la"our resources a aila"le for production than there were in past decades. Chapter Three 1. (hat effect should each of the following ha e on the demand for gasoline in a competiti e mar$et? State what happens to demand. Explain your reasoning in each case and relate it to a demand determinant. 6a7 6"7 6c7 an increase in the num"er of cars the economy mo es into a recession an increase in the price of car insurance, taxes, maintenance

6d7

consumer expectations of su"stantial price increases in gasoline

6a7 8emand would increase "ecause there would "e more "uyers of gasoline. !he additional "uyers would come from the additional cars and truc$s. 6"7 8emand would decrease "ecause consumer and "usiness incomes would fall. 1onsumer and "usinesses would ha e less money to spend on gasoline. (c) 8emand would decrease "ecause of increase in the price of complementary goods. 1ar insurance, car taxes, and car maintenance expenses are complements to gasoline. (d) 1urrent demand for gasoline would increase "ecause expectations a"out the future ha e changed and may prompt consumers to ,"uy now0 to "eat the future price increases. '. (hat effect will each of the following most li$ely ha e on the supply of corn in a competiti e mar$et? State what happens to supply. Explain your reasoning in each case and relate it to a supply determinant. 6a7 the de elopment of an impro ed corn seed that resists drought conditions 6"7 an increase in the price of soy"eans which can also "e planted on land used for growing corn 6c7 an increase in go ernment payments for growing corn 6d7 an increase in the price of fertili%er 6a7!he supply of corn will increase "ecause of an impro ement in the technology of corn production. 5ore "ushels of corn will "e produced at each and e ery price. 6"7 !he supply of corn will decrease "ecause of a change in the price of another good that can "e produced. Some farmers will no longer use their land to grow corn, "ut instead will grow soy"eans. (c) !he supply of corn will increase "ecause of a go ernment su"sidy. !he go ernment payment reduces the costs of corn production at each and e ery price. 6d7 !he supply cur e for corn will decrease "ecause of a change in the price of a resource. #ertili%er is used to grow corn and it is now more costly to grow corn at each and e ery price. *. 61onsider !his7 Is demand more important than supply in determining e)uili"rium price and )uantity in a competiti e mar$et? Explain. 8emand and supply are e)ually important. It is the intersection of the demand and supply cur e that determines e)uili"rium price and )uantity. (ithout demand or without supply there would "e no intersection and no price determination. /lfred 5arshall li$ened supply and demand to a pair of scissors. Each "lade is needed for the scissors to operate properly and ma$e a cut. Chapter Four

1.

8escri"e the three ma.or irtues of a mar$et system. #irst, the mar$et system promotes efficient use of scarce resources. 9roducts are produced in the least costly way and the products most desired "y society get produced. Second, the mar$et system pro ides incenti es for continual impro ement and inno ation. Rewards are gi en to entrepreneurs, wor$ers, and consumers who attempt to ma$e the "est use of scarce resources. !hird, the mar$et system gi es great support to indi idual freedom for producers, consumers, and wor$ers. Each group is a"le to pursue their own self-interest and thus promote the social interest.

'.

(hy is there a free-rider pro"lem with pu"lic goods? 5ost pri ate goods and ser ices are su".ect to the exclusion principle which is the idea that those who pay for the product are the ones who get it, "ut those who don&t pay for it are excluded from the "enefits pro ided "y that product. !he free-rider pro"lem exists when it is not possi"le to exclude a person from the "enefit of a good e en if the person did not pay for its costs. Such is the case with a pu"lic good. 3nce a pu"lic good is pro ided, it is a aila"le to all people regardless of whether or not they pay for its cost.

Chapter Five 1. (hat is the alue added "y all the firms /:E from the production of a product as descri"ed "elow? (hat did each firm add separately in alue and what does it total? Stage of product on #irm / #irm 2 #irm 1 #irm 8 #irm E Sa!e" #a!ue of product ;<,=>> ?,@>> 1<,A>> '>,1>> *',*>>

!he alue added "y all firms is ;*',*>>, or the final sales alue. #irm /+ added ;<,=>>. #irm 2+ added ;<,1>>. #irm 1+ added ;@,1>>. #irm 8+ added+ ;=,<>>. #irm E+ added ;1','>>. !he alue added "y all firms totals ;*',*>> and e)uals the final sales alue "y #irm E 6;*',*>>7. '. (hich of the following are included and which are excluded in calculating this year&s B89? Explain in each instance. 6a7 / monthly scholarship che)ue recei ed "y an economics student 6"7 !he purchase of a new truc$ "y a truc$ing company 6c7 Bo ernment purchase of computers from a pri ate "usiness 6d7 !he purchase of a used tractor "y a farmer

6e7 !he alue of the purchase of shares of 2om"ardier "y an indi idual 6a7Scholarships are not included in B89. !hey are iewed as financial transactions and would "e either a pu"lic or pri ate transfer payment depending on the source of funds. !hey are awards for past performance and would not "e included in current production. !hey don&t represent income earned "y pro iding a producti e resource as defined in the B89 accounts. 6"7 !he truc$ is included "ecause it represents in estment. It is a final good that was produced in the current year. 6c7!he computer purchase is included as part of go ernment spending on goods and ser ices. (d) The used tractor is not included "ecause it was counted when it was new. (e) !he alue of a stoc$ purchase is not included "ecause it is .ust a swap of paper assets. *. 61onsider !his7 Explain how a reser oir can ser e as an analogy for thin$ing a"out a nation&s capital stoc$, in estment, and depreciation. !he amount of water in a reser oir is a ,stoc$.0 It is similar to the stoc$ of capital goods in an economy. !he inflow of water to the reser oir is a ,flow0 and would "e similar to gross in estment. !he outflow of water from the reser oir is also a ,flow0 and it is similar to depreciation. If the inflow is greater than the outflow, then gross in estment is greater than depreciation so there is an addition to the capital stoc$, or net in estment. If the inflow of gross in estment is less than depreciation, there is a decline in the capital stoc$, or negati e net in estment. Chapter S $ 1. In the ta"le "elow are statistics showing the ci ilian non-institutional population, the ci ilian la"our force and total employment in year 1 and year '. 5a$e the computations necessary to complete the ta"le. 6Num"er of persons is in thousands.7 %ear & %ear ' 1i ilian non-institutional population '11,?@< 1i ilian la"our force 1<1,?1= Employed 1*=,CA* Dnemployed EEEEEE Dnemployment rate EEEEEE (to one decimal place) '>C,@CC 1<>,?@' 1*=,'>? EEEEEE EEEEEE

Dnemployed Dnemployment rate '.

%ear & =,@=< <.>F

%ear ' @A<' <.?F

/nswer the next four )uestions "ased on the following data using year 1 as the "ase year. /ll dollars are in "illions. 1alculate to one decimal place. %ear 1 ' * < CPI 1@> 1@= 1A> 1AA

6a7(hat was the percentage rise in prices "etween years 1 and '? 6"7 (hat was the percentage rise in prices "etween years ' and *? (c) (hat was the percentage rise in prices "etween years * and <? 6a7 *.1F 61@= minus 1@> di ided "y 1@> e)uals .>*1. >.>*1 x 1>> G *.1F 6"7 *.>F 61A> minus 1@=7 di ided "y 1@= e)uals >.>*>. >.>*> x 1>> G *.>F 6c7 *.>F 61AA minus 1A>7 di ided "y 1A> e)uals >.><1. >.><1 x 1>> G <.1F *. 61onsider !his7 4ow was the practice of clipping coins during feudalism contri"uting to inflation? (ho "enefited from this inflation? /s peasants paid their taxes in gold coin, the prince would clip off some of the coin and use the clipping to mint new coins. !he additional coins increase the money supply, "ut the output in the economy was essentially constant. !he price le el rose "ecause there was ,too much money chasing too few goods.0 In this case, the inflation "enefited the issuers of the coin 6the feudal lords7 and hurt the peasants. Chapter Se#en 1. 8efine the multiplier. 4ow is it related to real B89 and the initial change in spending? 4ow can the multiplier ha e a negati e effect? !he multiplier is simply the ratio of the change in real B89 to the initial change in spending. 5ultiplying the initial change in spending "y the multiplier gi es you the amount of change in real B89. !he multiplier effect can wor$ in a positi e or a negati e direction. /n initial increase in spending will result in a larger increase in real B89, and an initial decrease in spending will result in a larger decrease in real B89. '. (hat is the relationship "etween the multiplier and the marginal propensities? !he multiplier is directly related to the marginal propensities. 2y definition, the multiplier is related to the marginal propensity to sa e "ecause it e)uals

1H59S. !hus, the multiplier and the 59S are in ersely related. !he multiplier is also related to the marginal propensity to consume "ecause it also e)uals 1H 61:5917. *. Explain why sa ing e)uals planned in estment at e)uili"rium B89. It is "ased on the fact that sa ing is income not consumed. Sa ing therefore represents a ,lea$age0 or di ersion of potential spending from the incomeexpenditures stream. 1onsumption falls short of total output "y the amount of sa ing. 4owe er, in estment spending can "e iewed as an ,in.ection0 into this income-expenditures stream. If planned in estment is e)ual to the amount of sa ing at a particular le el of B89, then lea$ages e)ual in.ections and B89 will "e in e)uili"rium. <. 6Iast (ord7 Explain Say&s law. Say&s law, attri"uted to the 1Cth-century #rench economist, is that ,supply creates its own demand.0 Essentially, this theory states that people engage in production in order to "e a"le to "uy or demand other things. (hate er one earns from production, one expects to spend on goods and ser ices of e)ui alent alue. !hus, supply 6production7 has created its own demand.

Chapter E ght 1. 8efine aggregate supply. 8escri"e the characteristics of the aggregate supply cur e from long-run and short-run perspecti es. !he aggregate supply is a cur e that shows the total )uantity of goods and ser ices that will "e produced 6supplied7 at different price le els. In the long run, the aggregate supply cur e is ertical at the full-employment le el of output for the economy "ecause the rise in wages and other inputs will match changes in the price le el. In the short run, the aggregate supply cur e is upsloping "ecause nominal wages and input prices ad.ust only slowly to changes in the price le el. (ith this cur e, an increase in the price le el increases real output and a decrease in the price le el reduces real output. '. Dse this aggregate demand:aggregate supply schedule for a hypothetical economy to answer the following )uestions. Rea! do(e"t c output de(anded ) n * !! on"+ Pr ce !e#e! ;*>>> ;<>>> ;=>>> ;@>>> ;A>>> ;?>>> *=> *>> '=> '>> 1=> 1>> Rea! do(e"t c output "upp! ed ) n * !! on"+ ;C>>> ;?>>> ;A>>> ;@>>> ;=>>> ;<>>>

6a7(hat will "e the e)uili"rium price le el and )uantity of real domestic output? 6"7 If the )uantity of real domestic output demanded increased "y ;'>>> at each price le el, what will "e the new e)uili"rium price le el and )uantity of real domestic output? 6c7Dsing the original data from the ta"le, if the )uantity of real domestic output demanded increased "y ;=>>> and the )uantity of real domestic output supplied increased "y ;1>>> at each price le el, what would the new e)uili"rium price le el and )uantity of real domestic output "e? 6a7 '>> and ;@>>> 6"7 '=> and ;A>>> 6c7*>> and ;C>>>

Chapter N ne 1. 1omment on the statement+ ,Increasing go ernment spending is preferred to a cut in taxes when the 1anadian go ernment see$s to fight a recession.0

!he statement is a normati e one. Either action, increased go ernment spending or taxation, can "e use to fight a recession. !he policy choice will depend on the preferences of the indi idual. !hose indi iduals who want to fight a recession with an increase in go ernment spending may want to preser e the si%e of go ernment in the economy and ha e specific go ernment programs they would li$e to see funded. !hose indi iduals who prefer a tax cut may want to reduce the si%e of go ernment and gi e people more money and the freedom to spend it as they chose. '. Explain the pro"lems gi ing rise to this statement+ ,Jou would thin$ the go ernment would want to do something to impro e economic conditions when the economy is in trou"le, "ut the go ernment is slow to act.0 #iscal policy is su".ect to timing pro"lems. !here are three timing lags that limit the speed with which fiscal policy can "e enacted and effecti e. #irst, there is a lag in recogni%ing the phase of the "usiness cycle to determine when the go ernment might want to pro ide help. Second, there is an administrati e lag in decision-ma$ing that in ol es deciding which specific policies should "e adopted. !hird, there is an operational lag "ecause the adoption of policies ta$es time to ha e an effect on output and employment. *. 4ow do expectations a"out the future "y households and "usinesses affect the effecti eness of fiscal policy? 1ite examples. If households or "usinesses expect that the fiscal policy changes are only temporary, they may not change their "eha iour in the expected way. #or example, if tax cuts are enacted to stimulate consumer spending, some consumers may not change their spending ha"its if they thin$ the tax change is only temporary. In the future, they will ha e to pay more in taxes, so they might increase their sa ing. Similarly, "usinesses may not in est in new plants and e)uipment if they get a tax cut, if they expect taxes in the future to rise or the fiscal policy to "e ineffecti e. Chapter &, 1. !he following ta"le shows go ernment spending and tax re enue for a hypothetical economy o er a fi e-year period. /ll figures are in "illions. %ear -o#ern(ent Spend ng Ta$ Re#enue" 1 ; 11>> ;1>=> ' 11=> 11>> * 1'=> 11=> < 1'=> 1*>> = 1*>> 1'=> 6a7In what years were there "udget deficits and what were the amounts? 6"7 In what year was there a "udget surplus and what was the amount? 6c7(hat is the pu"lic de"t in this economy o er the fi e years?

6d7 If the si%e of the economy 6B897 was ;@,>>> "illion what would the pu"lic de"t in year = as a percentage of B89. 6a7!here were "udget deficits in year 1 6:;=> "illion7, year ' 6-;=> "illion7, year * 6-;1>>7 and year = 6-;=>7 "illion. 6"7 !here was "udget surplus in year < 6;=> "illion7. (c) !he pu"lic de"t was ;'>> "illion. 6-;=> -;=> "illion -;1>> "illion K ;=> "illion :;=> "illion7 (d) *.*F 6;'>> "illionH ;@>>> "illion x 1>> G *.*F7 '. (hat information would "e important for assessing the si%e of the pu"lic de"t "eside the a"solute amount of the pu"lic de"t? (hen the pu"lic de"t is stated as an a"solute amount, the num"ers can often "e staggering and misleading. !he a"solute amount, howe er, needs to "e iewed in relation to the si%e of the economy 6its B897. If B89 is large relati e to the pu"lic de"t, then the nation has the capacity to ser ice that de"t. /lso, as the economy grows, the de"t as a percentage of B89 will tend to fall unless the economy continues to add su"stantially to the pu"lic de"t each year with large "udget deficits. Chapter E!e#en 1. 61onsider !his7 /re credit cards money? Explain. 1redit cards represent the a"ility to get an instant loan that can "e exchanged for goods or ser ices. /t some point, howe er, that loan must "e paid with money 6chec$s or currency7. So credit card transactions are short-term loans that must "e repaid with money. '. Explain what policies are used to sta"ili%e the alue of money. 5onetary policy is used to regulate the money supply in the economy. If too much money is a aila"le for the gi en le el of production of goods and ser ices, this situation can lead to inflation and reduce the alue of money. #iscal policy can also "e used to help maintain the alue of money. !he 1anadian go ernment needs to "e prudent in its spending and taxing actions 6fiscal policy7 so that it does not reduce the alue of money "y running large deficits when the economy is at full-employment. *. Suppose that a "ond ha ing no expiration date has a face alue of ;=,>>> and pays a fixed amount of interest of ;=>> annually. 1ompute and enter in the spaces pro ided the effecti e interest rate 6to one decimal place7 that a "ond "uyer could recei e at the new "ond price. .ond pr ce ; *,A=> <,'=> =,A=> Intere"t rate )/+ EEEE EEEE EEEE

@,=>> .ond pr ce ; *,A=> <,'=> =,A=> @,=>>

EEEE Intere"t rate )/+ 1*.* 11.? ?.A A.A

Chapter Twe!#e 1. Dsing the "alance sheet "elow and assuming a desired reser e ratio of **F, answer the following+ 6a7 (hat is the amount of excess reser es? 6"7 !his "an$ can safely expand its loans "y what amount? 6c7 2y expanding its loans "y this amount in part 6"7, its demand deposits would expand to what amount 6if all loans were made to che)ue account customers7? 6d7 If che)ues clear against the "an$ e)ual to the amount loaned in 6"7, how much would remain in reser es and in chec$a"le deposits? A""et" Reser es ; @>,>>> Ioans @>,>>> Securities <>,>>> 9roperty 'C>,>>> 0 a* ! t e" 8emand 8eposits;1=>,>>> 1apital Stoc$ *>>,>>>

6a7 ;1>,>>> "ecause desired reser es are ;=>,>>> 61H* of ;1=>,>>>7 while actual reser es are ;@>,>>>. 6"7 ;1>,>>> 6G ;@>,>>> : =>,>>>7. 6c7 ;1@>,>>> 6G ;1=>,>>> K 1>,>>>7. 6d7 ;=>,>>> in reser es, ;1=>,>>> in demand deposits. '. Dsing the "alance sheet "elow and assuming a desired reser e ratio of '>F, answer the following+ 6a7 (hat is the amount of excess reser es? 6"7 !his "an$ can safely expand its loans "y what amount? 6c7 2y expanding its loans "y this amount in part 6"7, its demand deposits would expand to what amount 6if all loans were made to che)uing account customers7? 6d7 If che)ues clear against the "an$ e)ual to the amount loaned in 6"7, how much would remain in reser es and in chec$a"le deposits? A""et" Reser es ; <>,>>> Ioans A>,>>> Securities =>,>>> 9roperty <>>,>>> 0 a* ! t e" 8emand 8eposits;1>>,>>> 1apital Stoc$ <@>,>>>

6a7;'>,>>> "ecause desired reser es are ;'>>>> 6'>F of ;1>>,>>>7 while actual reser es are ;<>,>>>. 6"7 ;'>,>>> 6G ;<>,>>> : '>,>>>7.

6c7 ;1'>,>>> 6G ;1>>,>>> K '>,>>>7. 6d7 ;'>,>>> in reser es, ;1>>,>>> in che)ua"le deposits. Chapter Thirteen 1. 3ne of the ad antages of monetary policy is its speed and flexi"ility, "ut there are limitations. Explain. 5onetary policy is not su".ect to an administration lag "ecause once the decision is made action can "e ta$en )uic$ly. !he ma.or timing pro"lems are recognition lags that occur "ecause it sometimes ta$e time to recogni%e or understand that there is a pro"lem that needs to "e addressed "y a change in monetary policy. /lso, there is an operational lag that occurs "etween the time that the pro"lem is recogni%ed and the monetary policy ta$es effect. It may ta$e * to @ months for interest rate changes to ha e the anticipated effect on the economy. '. Explain the de"ate o er whether monetary policy should "e conducted "y ,artful management0 or inflation targeting. !he term ,artful management0 refers to a discretionary approach to monetary policy to allow policyma$ers the discretion to set the course of monetary policy "ased on what they thin$ wor$s "est. !his discretion permits !he 2an$ of 1anada officials to change policy to address price sta"ility, economic growth, unemployment, or other ma.or economic aria"les. 2y contrast, inflation targeting would "e a more restricti e approach to monetary policy that would set numerical targets for the accepta"le range for inflation and then ad.ust policy to achie e those targets. It is argued that this approach would increase the transparency of monetary policy "ecause one o".ecti e would "e the focus and it would ma$e 2an$ of 1anada officials more accounta"le. In this iew, achie ing the inflation target would "e the "est way for the 2an$ of 1anada to also achie e full employment and healthy economic growth. 1ritics of this approach argue that it gi es too limited or restricti e of a role to the 2an$ of 1anada and it has not "een well-tested as an approach to monetary policy. Chapter Fourteen 1. 1ontrast ,supply-side0 economics with ,demand-side0 fiscal policy. ,Supply-side0 economics ad ocates the use of go ernment tax or spending policies to alter the supply schedule, that is, the production side of the economy. !ax reductions may ha e an expansionary effect on aggregate supply as well as aggregate demand. Some economists argue that as taxes are cut, sa ings and in estment will increase. /lso tax cuts could "e aimed specifically at encouraging "usiness in estment such as in estment tax credits. ,Supply-side0 economists also argue that tax increases can reduce

tax re enues rather than increasing them due to a leftward shift in the aggregate supply cur e which causes a decrease in domestic output. '. (hat is supply-side economics? (hat is the rationale for it? Is it effecti e? Some economists argue that a reduction in taxes will expand aggregate supply. #rom this perspecti e, fiscal policy can "e used to increase real B89 with little or no rise in the price le el, as would "e the case if tax cuts expanded aggregate demand. !here are three possi"le reasons for the supply-side effect of tax cuts. #irst, lower taxes increase disposa"le income that may increase household sa ing. !hey may also stimulate "usinesses& in estments "ecause they increase the after-tax profita"ility of "usinesses. Second, lower taxes also gi e people more incenti e to wor$ "ecause they $eep more of their income. !hird, lower taxes will encourage more ris$-ta$ing and entrepreneurship in society "ecause the after-tax reward has "een increased. 5any economists are sceptical a"out the supply-side effect of tax cuts. !he positi e effects on incenti es to sa e, in est, or wor$ may not "e ery large, and therefore the stimulus to the supply-side may "e minor. In other words, the demand-side effects of tax cuts appear to "e far greater, and more immediate than any of the supply-side effects. Chapter F fteen 1. 61onsider !his7 (hy do small differences in the rate of economic growth produce large differences in the si%e of the economy o er time? Illustrate with an example. Small changes in the rate of growth can "e ery important. 3 er a period of time small changes are cumulati e in the same way that compound interest payments are cumulati e in a "an$ account. Dsing the rule of A> to estimate the time it ta$es to dou"le B89, we can see that Nation /, whose growth rate is * percent ta$es '* years to dou"le its B89, "ut Nation 2 whose growth rate is only 'F may ta$e nearly *= years to dou"le its B89. '. 8iscuss the meaning of the statement+ ,4uman history teaches us that economic growth springs from "etter recipes, not .ust more coo$ing.0 Economic growth arises largely from increases in la"our producti ity 6,"etter recipes07 rather than increases in the )uantity of la"our inputs 6,more coo$ing07. /mong the most important factors increasing la"our producti ity, accounting for some <> percent of this factor, is technological ad ance. It includes not only new inno ations in production "ut also "etter managerial techni)ues that impro e the process of production. *. 4ow does in estment in capital goods and infrastructure contri"ute to economic growth?

1apital goods 6plant, e)uipment, tools7 are needed "y wor$ers to "e more producti e. New in estment in capital goods helps wor$ers produce more goods and ser ices per wor$ hour, thus increasing la"our producti ity. Ia"our producti ity is a $ey factor of economic growth. Infrastructure is also important "ecause there is a need for pu"lic capital goods 6highways, har"ours, "ridges, educational facilities7 that help "usinesses and their wor$ers get the .o" done sooner. #or example, if the highway infrastructure is poor, it will "e more difficult for "usinesses to get their products to mar$et and it will re)uire more wor$ time on the part of their wor$ers, thus reducing la"our producti ity. Chapter S $teen 1. Suppose that "y de oting all of its resources to the production of rice 6R7, -apan can produce <> units. 2y de oting all of its resources to corn 617, it can produce '> units. 1ompara"le figures for 5exico are 1= units of rice 6R7 and 1= units of corn 617. Explain why each nation will speciali%e in which product. (hat are the limits to the terms of trade? In -apan, the cost of producing 1 1 is ' R 6'> 1 G <> R7 gi en the stated cost conditions. In 5exico, the cost of producing 1 1 is only 1 R. !hus, in terms of opportunity costs or the amount of R that must "e gi en up to get each 1, 5exico can produce units of 1 more cheaply. !herefore, 5exico should produce 1s and -apan should produce units of R, and 5exico should trade away some of its 1 to -apan for some of the units of R produced in -apan. !he limits to the terms of trade are set "y the cost ratio in each country. In other words, it is to -apan&s ad antage to trade away units of R for as many units of 1 as it can get a"o e the lower limit of >.= 1, which is what each R costs in -apan. 4owe er, 5exico will not "e willing to trade more than one 1 for each R since any more than that could "e gotten more cheaply "y producing them at home. !herefore the limits to the terms of trade will "e "etween >.= 1 and 1 1 for each R. /nd 5exico will "e a"le to get "etween 1 R and ' R for each 1. '. 61onsider !his7 (hy is a trade war li$e shooting yourself in the foot? / trade war "etween Nation L and Nation J is destructi e to the economies of "oth nations. If Nation L "oycotts or slaps protecti e tariffs on the imports from Nation J, then Nation J will not "e a"le to export as many goods and ser ices. !he economy of Nation J will suffer and there will "e less income. /s a conse)uence, Nation J will not "e a"le to import as many goods and ser ices from Nation L, so the economy of Nation L will suffer. So trade wars hurt "oth nations "y reducing imports and exports of each nation. / trade war has no winners and only losers. It is li$e shooting yourself in the foot.

*.

(hat fi e trade li"erations is the (orld !rade 3rgani%ation see$ing to get adopted? /fter the 1CC< Druguay ,round0 of trade agreements, the (orld !rade 3rgani%ation was formed "y 1'> nations to o ersee the agreements and get them implemented "y '>>=. !he ma.or pro isions of the agreements included+ 617 widespread reduction in tariffs worldwideM 6'7 new rules to promote the growing trade in ser icesM 6*7 plans to cut su"sidies in agricultureM 6<7 the inclusion of protection for intellectual property rightsN patents, trademar$s, copyrightsNin trade rulesM and 6=7 phased reduction in )uotas on textiles and apparel.

Chapter Se#enteen 1. 4ow are changes in one currency mirrored in changes in some other foreign currency? 1urrencies are lin$ed "ecause an appreciation in the alue of one currency means that there has "een a depreciation in the alue of another currency. 1on ersely, if there is a depreciation in the alue of one currency, then there has "een an appreciation in the alue of another currency. So if one currency rises in alue, the other currency must fall in alue and ice ersa. '. 8escri"e how changes in tastes affect the alue of a nation&s currency. If consumer preferences for the products of a foreign nation change, then the demand for and supply of that country&s currency will change. If the demand for 2ritish clothing increases, then the demand for 2ritish pounds will increase causing the pound to appreciate. If the demand for 2ritish clothing declines, then the demand for 2ritish pounds will decrease causing the pound to depreciate. 1on ersely, if 2ritish preferences regarding some other country&s products change, then the supply of 2ritish pounds will change accordingly. *. Explain how changes in relati e income affect the alue of a nation&s currency. If a foreign nation&s income rises more rapidly than other nations& incomes, then its expenditures on imports are li$ely to grow along with expenditures on e erything else. !his will pro"a"ly cause the currency to depreciate as other nations are not growing as rapidly, and therefore, their demand for the nation&s currency is not $eeping pace with the change in supply. !he re erse would "e true if the nation&s income grew more slowly than other nations& incomes. <. 8o changes in relati e price-le els affect the alue of a nation&s currency? If prices in one country rise relati ely more than in another, the currency in the higher-priced country is li$ely to depreciate as domestic consumers see$

less expensi e foreign imports and increase the demand for foreign currency. /t the same time demand for domestic currency will fall since foreigners will find it less attracti e to "uy the higher-priced country&s goods. !his, too, adds to the depreciation of the higher-priced country&s currency. =. Explain how changes in relati e real interest rates affect the alue of a nation&s currency. 4igher relati e real interest rates in one country will cause an increase in demand for the currency of that country or an appreciation of that country&s currency as foreign in estors see$ higher rates of return. !he re erse would "e true of lower relati e real interest rates. @. 61onsider !his7 4ow can the 2ig 5ac index "e used to explain purchasing power parity theory? !he index shows the prices of a 2ig 5ac in currencies of other nations. If a 2ig 5ac costs ;*.>> in the 1anada and *>> yen in -apan, the exchange rate "ased on 2ig 5ac prices in the two nations should "e ;1 G 1>> yen. If the actual exchange rate was ;1.>> e)uals 11> yen, then the dollar is o er alued and the yen is under alued. !he dollar will depreciate and the yen will appreciate.

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