Principles of Macroeconomics: Ch 1 Problems and Applications

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1

Describe some of the trade-offs faced by each of the following:
a. a family deciding whether to buy a new car
b. a member of Congress deciding how much to spend on national parks
c. a company president deciding whether to open a new factory
d. a professor deciding how much to prepare for class
e. a recent college graduate deciding whether to go to graduate school

a. Money spent on a new car could of been put in saving or used for food, clothing, vacation expenses, education expenses etc.
b. When deciding how much money to allocate towards national parks, members of Congress much calculate the trade-off with other important expenses such as national defense, infrastructure (bridges and roads), social programs, education etc.
c. Opening a new factory may limit investments in other projects, operation expenses, capital on hand etc.
d. Trade-offs a professor should consider when deciding how much to prepare for a class include time spent with family, personal activities and research.
e. A recent college graduate that goes to graduate school would trade-off earning money now with a full time job and the money it costs to go to graduate school.

2

You are trying to decide whether to take a vacation. Most of the costs of the vacation (airfare, hotel, and forgone wages) are measured in dollars, but the benefits of the vacation are psychological. How can you compare the benefits to the costs?

The benefits of a vacation will vary from person to person. Most people associate a vacation with relaxation, peace and a chance to spend quality time with family. If a person feels they need these psychological benefits then the costs of a vacation may be worth it.

3

You were planning to spend Saturday working at your part-time job, but a friend asks you to go skiing. What is the true cost of going skiing? Now suppose you had been planning to spend the day studying at the library. What is the cost of going skiing in this case? Explain.

The cost of skiing instead of working a part-time job is the cost of lost wages plus the costs related to skiing.

The cost of skiing instead of going to the library to study is the costs associated with skiing along with the knowledge that could of been gained by going to the library. Since the cost of going to the library cannot be measured in monetary terms, it will vary from person to person. A person who needs to study for a final to be taken on Monday may give up more than someone who is going to the library to work on a project that is not due for a few weeks.

4

You win $100 in a basketball pool. You have
a choice between spending the money now or putting it away for a year in a bank account that pays 5 percent interest. What is the opportunity cost of spending the $100 now?

The opportunity cost of spending the $100 now is the additional $5 I would earn in interest after 1 year.

5

The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction of competing products has reduced the expected sales of your new product to $3 million. If it would cost $1 million to finish development and make the product, should you go ahead and do so? What is the most that you should pay to complete development?

If I do not go ahead with production I would lose what was invested which is $5 million.

If I go ahead with production it will cost me an additional $1 million.

Sales from the product will be $3 million.

The net loss will be $3 million. (5 + 1) - 3

I should go ahead with production since the loss is less ($3 million) than if I stopped production ($5 million).

The total cost that I should pay to complete development is $3 million.

6

The Social Security system provides income for people over age 65. If a recipient of Social Security decides to work and earn some income, the amount he or she receives in Social Security benefits is typically reduced.
a. How does the provision of Social Security affect people’s incentive to save while working?
b. How does the reduction in benefits associated with higher earnings affect people’s incentive to work past age 65?

a. People will save less knowing they will receive money from the government through the Social Security program.

b. The reduction in benefits based on the amount of earnings will cause people to work less or not at all.

7

A 1996 bill reforming the federal government’s antipoverty programs limited many welfare recipients to only two years of benefits.
a. How does this change affect the incentives for working?
b. How might this change represent a trade-off between equality and efficiency?

a. Because of the two year limit, welfare recipients are more likely to search for a job while receiving welfare since they know the payments will not last forever.
b. This change increases efficiency at the cost of equality. It creates pressure on recipients to search for a job.

8

Your roommate is a better cook than you are, but you can clean more quickly than your roommate can. If your roommate did all the cooking and you did all he cleaning, would your chores take you more or less time than if you divided each task evenly? Give a similar example of how specialization and trade can make two countries both better off.

Chores would take more time if we divided each task evenly since I am not a good cook and my roommate doesn't clean as quick as me. It is more efficient for me to do all the cleaning and my roommate to do all the cleaning.

The United States specializes in agriculture while Japan specializes in the production of electronics. It would be beneficial to both countries if the US imported electronics from Japan and Japan imported agricultural products from the US.

9

Explain whether each of the following government activities is motivated by a concern about equality or a concern about efficiency. In the case of efficiency, discuss the type of market failure involved.
a. regulating cable TV prices
b. providing some poor people with vouchers that can be used to buy food
c. prohibiting smoking in public places
d. breaking up Standard Oil (which once owned 90 percent of all oil refineries) into several smaller companies
e. imposing higher personal income tax rates on people with higher incomes
f. instituting laws against driving while intoxicated

a. This shows the government's concern about efficiency. The market failure involved is due to market power where small group of persons or a single person influences market prices.
b. This shows the government's concern about equality.
c. This shows the government's concern about efficiency. The market failure involved is known as an externality. It shows the negative impact of the smoker's actions on the well-being of others.
d. This shows the government's concern about efficiency. The market failure involved is due to market power, where Standard Oil would unduly influence the market prices of oil and exploit people.
e. This shows the government's concern about equality.
f. This shows the government's concern about efficiency. The market failure involved is known as an externality. It shows the negative impact of the intoxicated driver's actions on the well-being of others.

10

Discuss each of the following statements from the standpoints of equality and efficiency.
a. “Everyone in society should be guaranteed the best healthcare possible.”
b. “When workers are laid off, they should be able to collect unemployment benefits until they find a new job.”

a. Providing the best healthcare possible to everyone is an equality concern. Doing so would reduce our nation's efficiency since the costs of providing the best healthcare for all would be astronomically high. It would be more efficient to provide those who do not get healthcare through their employer with quality healthcare or at least provide a discount.

b. Providing unemployment benefits until a person finds a job is an equality concern. However, it would greatly hurt our economy since some may receive it for months or even years. A more efficient approach would be to provide it for a set period of time and to verify that the recipients are actively seeking employment.

11

In what ways is your standard of living different from that of your parents or grandparents when they were your age? Why have these changes occurred?

My standard of living is better than that of my grandparents' standard of living when they were my age. We have heating/air conditioning, reliable cars, vaccines, antibiotics, televisions with beautiful color displays, computers of all types and so much more. Most of these changes have occurred because of the advancement of technology and medicine.

12

Suppose Americans decide to save more of their incomes. If banks lend this extra saving to businesses, which use the funds to build new factories, how might this lead to faster growth in productivity? Who do you suppose benefits from the higher productivity? Is society getting a free lunch?

The savings made by people are mobilized by the banks. Banks in turn provide loans to the business firms which use the funds to expand their production by establishing new factories. This leads to faster growth in productivity because when production capacities are increased so is the per capita production.

The benefit from the increased productivity is enjoyed by workers, entrepreneurs and all households.

Society is not getting a free handout because when people are saving their money there is a trade-off. The people postponing their present needs and saving for the future helps the economy improve productivity.

13

In 2010, President Barack Obama and Congress enacted a healthcare reform bill in the United States. Two goals of the bill were to provide more Americans with health insurance (via subsidies for lower-income households financed by taxes on higher-income households) and to reduce the cost of healthcare (via various reforms in how healthcare is provided).
a. How do these goals relate to equality and efficiency?
b. How might healthcare reform increase productivity in the United States?
c. How might healthcare reform decrease productivity in the United States?

a. The goal of the healthcare reform bill is to provide more Americans with health insurance via subsidies to lower income households financed by taxes on higher income households which promotes equality. The second goal of the healthcare bill is to reduce the cost of healthcare which is an efficiency concern.
b. The healthcare reform might increase productivity because it makes healthcare affordable to lower income households which increases their capability to work.
c. The healthcare reform might decrease productivity by taxing higher income households decreasing their incentive to work more.

14

During the Revolutionary War, the American colonies could not raise enough tax revenue to fully fund the war effort; to make up this difference, the colonies decided to print more money. Printing money to cover expenditures is sometimes referred to as an “inflation tax.” Who do you think is being “taxed” when more money is printed? Why?

Inflation is an indirect tax on the people since it makes their money less valuable.

15

Imagine that you are a policymaker trying to decide whether to reduce the rate of inflation. To make an intelligent decision, what would you need to know about inflation, unemployment, and the trade-off between them?

In the short run inflation and unemployment move in the opposite direction. If unemployment is high then it would not be a good idea to reduce the rate of inflation since this would lead to greater unemployment.

16

A policymaker is deciding how to finance the construction of a new airport. He can either pay for it by increasing citizens’ taxes or by printing more money. What are some of the short-run and long-run consequences of each option?

Printing more money increases demand and employment in the short run, but causes severe effects of sustained higher inflation and unemployment in the long run.

Increasing citizens' taxes reduces demand and employment in the short run, but increases the value of money which increases investment stability in the economy in the long run.


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