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Contents
Introduction 2
Technical Support 2
What is Mastering Economics? 2
How Mastering Economics Episodes Proceed
Learning Beyond the Classroom
Applying Theory to Practice
How Do I Integrate Mastering Economics in My Course? 4
What is CanGo? 6
A Company for Today
The World of CanGo and the World Beyond
Mastering Economics and Mastering Business 7
Mastering Economics and MyPHLIP 7
Your Feedback 8
Appendix 1: Episode Topic Summary 9
Appendix 2: Suggested Class Activities 11
Appendix 3: Case discussion questions and answers 13
1
Introduction
Thank you for your interest in Mastering Economics, one of the principal components of our
Mastering Business series. By selecting Mastering Economics, you can incorporate into your
course an interactive multimedia resource that is at once exciting, challenging, and adaptable.
Through short dramatic videos and rigorous exercises, this resource will help you teach your
students how to apply the fundamental theories of economics to practical problems of business.
In the sections that follow, you will read about
1. how to run Mastering Economics on your computer;
2. the structure and features of Mastering Economics;
3. how you can use Mastering Economics in your course;
4. CanGo, the fictional Internet start-up around which Mastering Economics is built;
5. other resources that can help you manage your courses.
Technical Support
Both Mastering Economics and Mastering Business are supported by a skilled technical staff ready
to answer your questions. Contact them at media.support@pearsoned.com.
*Installation instructions are available on CD-ROM packaging.
What is Mastering Economics?
Mastering Economics is a unique educational tool that combines advanced multimedia and
interactive technologies with challenging instructional material. The program consists of twelve
episodes, each of which explores an important challenge in economic thought. These episodes
focus on the core topics covered in most economics textbooks. Thus, while we imagine students
reading relevant text chapters before proceeding to the appropriate episode, choosing to include
Mastering Economics in your course does not require you to adopt any particular textbook. You
will find a summary of episode topics in Appendix 1 of this guide.
How Mastering Economics Episodes Proceed
Once your CD-ROM has loaded, you will see the initial screen of Mastering Economics on which
appear icons that indicate where to click to begin the episode. Each episode proceeds as follows:
1. A brief text Introduction to the issue the episode will explore.
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2. The Introductory Video that dramatizes the challenge confronting CanGo.
3. A text Summary section that briefly discusses the theory and concepts addressed in the
Introductory Video.
4. The Exercises that ask the student to apply knowledge and skills to the issues explored in
the Introductory Video.
5. A brief text description of what the student will see in the Resolution Video.
6. The Resolution Video that presents how the CanGo team tried to resolve the issues.
7. A text description of what the student will see in the Case.
8. The Case Video that dramatizes a new issue related to the central challenge of the
episode.
9. The Discussion Questions that ask the student to reflect on the issues dramatized in the
Case Video.
At every point of transition you will find directions that clearly direct you to the next segment of
the episode. Your students should be able to complete each episode in 30 to 45 minutes.
3
Learning Beyond the Classroom
Mastering Economics offers you a rich set of learning materials that provides a starting point for
wide-ranging discussions of important business issues. Mastering Economics achieves this goal
of assisting you through the hard work of our team of talented experts: faculty with years of
experience in the classroom, as well as seasoned writers, actors,
directors, and videographers. Together, these people have created
a resource that will help you challenge your students with problems
that have a broad range of possible solutions. In so doing,
Mastering Economics reflects the realities of today’s business
world, providing students with an educational experience that
continues long after they finish their course-work.
Here are some highlights of the realistic situations your students will encounter:
! In the episode on the Economic Way of Thinking, CanGo
must deal with the opportunity cost of its decision to
launch an initial public offering.
! In a later episode, the management team considers the
consequences for CanGo of a proposed Federal tax on
the Internet retail industry.
Applying Theory to Practice
One of the guiding principles behind Mastering Economics is the importance of linking theory to
practice. In economics courses students learn the theoretical foundations of business. However,
one of the greatest challenges they face is understanding how they can use economic theories to
solve the problems they will face throughout their careers in business. Mastering Economics can
help you demonstrate the practical relevance of economic concepts in a variety of ways. For
example:
• Mastering Economics shows students examples of the CanGo
team using economic thought to respond to realistic business
problems as they unfold.
• Mastering Economics also asks them to apply their own
understanding of theory to those problems, thus giving them
valuable opportunities to sharpen their practical skills.
By presenting the material in this way, Mastering Economics not only enables students to relate
better to practical situations, but also helps them gain a superior understanding of the role theory
plays in business operations.
How Do I Integrate Mastering Economics into My Course?
Unlike most traditional educational tools, Mastering Economics offers you a variety of resources
easily adaptable to a broad range of instructional designs. Each episode of Mastering Economics
is a self-contained unit. This feature enables you to use some or all of the episodes in whatever
combination best fits your approach to economics.
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This flexibility allows you to build Mastering Economics into your course at any level. Mastering
Economics is fundamentally designed to reinforce what students read in their textbooks and learn
during course lectures. Consequently, Mastering Economics could serve as an integral part of
your entire economics course. Because every student will receive a copy of the CD-ROM with his
or her text, you can assign episodes as homework throughout the semester. Week by week,
your students can complete the episodes that correspond to the topics on your syllabus and
submit their completed exercises to you on paper or via email.
The flexibility of Mastering Economics allows you to use it in other ways as well.
1. Lecture. Since Mastering Economics topics correspond to the core topics of the major
economics textbooks, you could use episodes to launch your lectures. For example, as you
turn to the subject of Supply and Demand, you could assign your students the Mastering
Economics episode on that topic. After having them review the Introductory Video in
class, you could then use it as the starting point of your discussion of Supply and Demand
and its implications for business organizations.
2. In-Class Discussion. You could also add variety to your classes by using episodes to
stimulate discussion. For instance, your students could review the Case Video of the
episode on National Income before they come to class. Using the discussion questions and
previous class discussions as a launching point, your students would then debate how
CanGo should interpret unemployment figures and other key economic data.
3. Group Activities. Whole episodes or episode segments could also stimulate a variety of
in-class group activities. For example:
! You could have your students watch the Introductory Video of an episode before they
come to class. When the class begins, they could divide into groups, each group
discussing how the CanGo team might respond to the problem confronting it. You
could then have each group report its response to the class, preparing them to watch
the Resolution Video as an assignment for the next class. During that subsequent
class, your students could again break into groups to discuss how their responses
differed from the one presented in the Resolution.
! You might ask your class to view the Introductory and Resolution videos, and then
break the students into groups to critique the solution presented in the Resolution
and to formulate alternatives.
! After watching a video in which the CanGo managers debate a course of action, your
students could divide into groups, each of which takes the side of one of the
managers. When the class comes back together, the groups argue in support of their
character’s position, drawing on their understanding of the character’s point of view.
4. Assessment. Mastering Economics can also help you monitor and assess your students’
work. For example:
! In order to use Mastering Economics students need to have first read the textbook.
By using Mastering Economics you can thus ensure that your students keep up with
reading assignments.
! Mastering Economics gives only the instructor access to answers for the Case Video
discussion questions. Rather than appearing on the CD-ROM, these answers are
5
included in this manual, as well as in the faculty-support resources located on
MyPHLIP. Visit http://www.prenhall.com/myphlip.
! Additional assessment questions will be available on MyPHLIP. Instructors may use
these questions in a variety of ways. For example, you could assign them to your
students as homework, include them in quizzes or tests, or have students answer
them in preparation for class discussions.
In Appendix 2 of this guide, you will find a list of suggested class activities that demonstrates one
way you might build a course around Mastering Economics.
What is CanGo?
A Company for Today
Mastering Economics explores economics through CanGo, a fictional e-Business that retails a
variety of products, ranging from books and videos to online gaming
services. In each episode, students watch the CanGo management
team and staff deal with the challenge of using economic thought to
understand important business situations. This dramatic approach
enriches the learning experience by drawing students into the
personalities and developing professional relationships of the CanGo
team. Through CanGo, Mastering Economics presents an exciting
vision of economics as a creative process through which people
develop innovative solutions to the problem of maximizing limited resources.
In addition, through CanGo students are exposed to issues pertinent to business in general and
to the developing field of e-commerce in particular. For example:
! Students deal with growing pains of a new e-commerce company. They watch
Elizabeth, CanGo's visionary CEO, struggle to see her young company through the
process of launching its IPO.
• Students also follow CanGo's progress through a sequence
of important events. In addition to the IPO, the firm
confronts the challenges of a surprise Holiday rush and the
acquisition of an online gaming company.
! Students encounter compelling examples of the CanGo team
responding to a dynamic environment, forming the internal
and external alliances they need to ensure the firm’s healthy
growth.
The World of CanGo and the World Beyond
Part of the power of Mastering Economics as a teaching tool lies in the connections it asks
students to make between the imaginary operations of CanGo and the world of real business.
For example, Mastering Economics takes full advantage of the Internet by including exercises
that take students to the Web sites of some of today's most successful organizations. Such
exercises enable students to step out of the fictional world of CanGo and apply their growing
knowledge of economics to the work of actual firms.
6
Mastering Economics and Mastering Business
Mastering Economics is one component of the larger Mastering Business project. The project
includes seven other series: Accounting, Business Essentials, Finance, Marketing, Management,
Operations, and Strategy. Employing the same interactive features as Mastering Economics,
Mastering Business offers students the opportunity to enlarge their understanding of fundamental
business concepts by applying them to a wide range of practical problems.
Mastering Economics offers instructors ways to integrate the student’s educational experience
both within a single course and across entire business curricula. In today's global economy,
organizations need people who understand the theoretical foundations of business, people who
can use economic theory to evaluate the diverse factors that affect decisions in every area of
business. Showing students how to apply economic thought to the functional activities of
business is one of the greatest challenges instructors face. Mastering Business can help you
meet this challenge by giving your students compelling opportunities to consider how economic
concepts guide decision-making in Finance, Accounting, Human Resources, Strategy, and other
areas. Further, Mastering Business can unify the full range of business studies around a common
set of problems. Each component of Mastering Business is centered on a group of key events,
such as CanGo’s effort to launch its IPO. By applying a range of skills to the same events and
issues, students gain a better understanding of how the business disciplines relate to each other
and contribute to a shared goal.
To instructors of introductory business courses we offer Mastering Business Essentials, a package
that draws episodes and exercises from Mastering Business. By enabling students to practice the
full range of business skills, Mastering Business Essentials reinforces the comprehensive overview
of the introductory course.
For more information about Mastering Business please contact us at
masteringbusiness@pearsoned.com.
Mastering Economics and MyPHLIP
As you read earlier,
MyPHLIP contains
additional assessment
materials for Mastering
Economics. In
addition, MyPHLIP
offers comprehensive
support for education
through the Internet.
MyPHLIP enables
instructors to
customize Web sites
for their courses.
These sites can
significantly ease the
work of managing a
course. MyPHLIP features also include Internet exercises, online study guides, and systems for
generating electronic syllabi, maintaining class lists, and communicating with students.
7
In addition, MyPHLIP
offers a rich archive of
articles from
publications pertaining
to every facet of
business. Thoroughly
analyzed by a team of
award-winning
content developers,
these articles are
arranged topically and
come with valuable
supporting material.
This material provides
instructors with a wealth of resources for homework assignments, class discussions, and student
research projects. This archive is updated regularly by our content developers to reflect changes
in business theory and practice.
For more information on MyPHLIP, visit http://www.prenhall.com/myphlip.
Your Feedback
We hope that you find Mastering Economics a valuable addition to your course. We would
appreciate your feedback about your experience using Mastering Economics. Please contact us
at masteringbusiness@pearsoned.com.
8
Appendix 1: Episode Topic Summary
• The Economic Way of Thinking
CanGo is looking for ways to branch out in the e-commerce world. This episode addresses
decision-making and the trade-offs that come from making various choices. Online gaming is
thought to be a great way for CanGo to expand and compete, but since CanGo is a young
company and has not yet settled on an IPO, it is faced with the dilemma of how to expand
without the needed resources.
• Supply and Demand
CanGo is entertaining the thought of selling online games. However, before CanGo jumps in
with both feet it first researches the online gaming market. The managers also consider
ways to entice buyers to go to their online gaming site. This episode addresses the issue of
supply and demand along with the decisions facing buyers and sellers.
• Price Determination
This episode addresses the issue of price determination in the light of ever changing market
conditions. The management team at CanGo considers selling e-books. Some members of
the team raise the issue that consumers may not want to give up traditional books, making
this venture potentially unprofitable. Others raise concerns over CanGo’s ability to produce
e-books at a reasonable cost.
• Market Intervention
Taxation and price controls are the focus of this episode. Also addressed are price floors
and price ceilings. The latest news headline announces the possibility that the Internet will
become taxed. For CanGo, if this “virtual bill” were passed it would most likely mean
increased prices for its customers. The managers don’t want to be caught unprepared, so
the team brainstorms strategies that will help them adapt to the possibility of new taxes.
• Costs and Input Markets
This episode examines the link between inputs, costs, and productivity. CanGo’s recent
expansion in the e-commerce world has created the need for more employees. However,
despite CanGo’s growth the company is unable to compete with benefit packages and
salaries that other companies are offering. The management team examines the labor
market in order to come up with a solution to their hiring dilemma.
• Marginal Analysis and Perfect Competition
Since CanGo launched its IPO, its focus has been on ways to survive in a competitive
market. Liz, CanGo’s CEO, has just seen a report about profits from online gaming
subscriptions. She feels that going into online gaming will send a serious message to its
new stockholders. The management team researches the online gaming industry to come
up with a game plan. The notions of perfect competition and marginal analysis are
discussed in this episode.
• Imperfect Competition
Imperfect competition and market power are key topics in this episode. This episode tries
to answer the question of to set high prices or not. Andrew has found a way to put
characters from one game into another. This design puts CanGo ahead of any of its
competitors in the online gaming industry. Now CanGo must decide at what price it should
sell its new product.
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• National Income (Measurement of Key Economic Data)
CanGo is trying to decide when the timing would be ideal for launching the IPO. The
newspapers are speculating that CanGo will make the offer soon. The management team
scrutinizes the economic data (e.g. the Gross Domestic Product, the Consumer Price Index,
the Unemployment Rate, and Interest Rates) available to them in order to answer the
question of when to make a public offering.
• Business Cycles
CanGo is planning for the launch of the IPO. The CanGo team keeps their eyes on a variety
of economic data to help them determine the future direction of the economy, which will
determine when the IPO is launched. This episode addresses business cycles and the impact
they have on the economy.
• Fiscal Policy
Tax policy is the focus of this episode. CanGo is preparing for the IPO while there are talks
that Congress will implement tax cuts across the board. Some members of the management
team feel that the tax cuts will impact the IPO negatively. Others feel that the tax cuts are
positive because more money in people’s pockets will mean more spending. The team also
deals with the government spending side of fiscal policy.
• Monetary Policy
CanGo has taken all the right steps in preparation for its initial public offering. The Federal
government has raised interest rates and there are rumors that this might tighten the
money supply. The management team voices their concerns about what will happen to
CanGo when it goes public. The role that the Federal Reserve plays in the economy is
highlighted.
• International Trade
CanGo considers venturing into international markets with online gaming. The team
conducts some focused market research and considers the impact that the exchange rate
fluctuations will have on their global expansion. The episode addresses a number of
important factors that a firm needs to consider when thinking about moving into an
international market. The episode also draws connections between fluctuations in currency
and the demand for a company’s product in an overseas market.
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Appendix 2: Suggested Class Activities
What follows are some suggestions for how you might integrate Mastering Economics into your
economics course. Keep in mind that these are only suggestions and that this is by no means a
comprehensive list. These suggestions are simply meant to give you an idea of power and
flexibility of Mastering Economics as a teaching tool. You can assume that students have their
own copies of the CD-ROM, enabling them to work through episodes before they come to class.
Week 1
The Economic Way of Thinking
Before beginning the first lecture, the instructor shows the class the Introductory Video of the
episode. The video serves as a springboard for the instructor’s discussion of how organizations
deal with the problem of scarce resources by weighing the opportunity costs of alternative
courses of action. The instructor discusses and illustrates the concept of opportunity cost.
Week 2
Supply and Demand
The exercises included in this episode require students to address from an economic point of
view the challenge of introducing new products into markets. The instructor asks students to
complete the exercises as a homework assignment, and then leads students through an in-
class discussion of the results of their efforts.
Week 3
Price Determination
The instructor asks students to work through the episode videos and exercises and then write a
short reaction paper discussing how they think CanGo should price e-books so as to win profit
and cover costs. Students should also be encouraged to think how market price changes over
time.
Week 4
Market Intervention
The videos and exercises in this episode present to students the issues involved in government
intervention in markets. Students should complete this episode before class. During class they
discuss whether CanGo and, by extension, all businesses, can pass the cost of taxes to
consumers.
Week 5
Costs and Input Markets
Using this episode as a starting point, the instructor has students participate in a group project.
Each group researches the ways in which labor productivity is generally measured. Each then
develops a report in which it presents its findings and discusses which measure would best suit
the nature of CanGo's workforce.
Week 6
Marginal Analysis and Perfect Competition
Students complete the episode before class. Using the Case Discussion Questions as a starting
point, the instructor leads students in a debate concerning what factors will determine the
competitiveness of the online gaming market into which CanGo wants to expand.
Week 7
Mid-term Exam
The instructor draws one or more exam questions from Mastering Economics episodes.
Students are notified in advance that this will be the case.
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Week 8
Imperfect Competition
Students view the Introductory Video and complete the exercises before class. Once in class, the
instructor divides the students into groups. Each group decides which pricing strategy
CanGo should pursue and then presents its case to the class. The class then watches the
Resolution video and critiques the decision made by the CanGo team.
Week 9
National Income (Measurement of Key Economic Data)
The instructor assigns the class as homework the Introductory Video of the episode. The
instructor leads students through an in-class discussion of what "full employment" would
mean for CanGo.
Week 10
Business Cycles
After completing the episode, students choose one of the countries listed in Case Discussion
Question #4 (France, Germany, Great Britain, and Japan). Students prepare an oral report in
which they discuss whether or not the available economic data suggests that CanGo should
expand its operations into that country.
Week 11
Fiscal Policy
Students complete the episode exercises as a homework assignment. In class students
debate the points of view represented by Clark, the Director of Finance, and Warren, the
Director of Operations.
Week 12
Monetary Policy
Students watch the videos and complete the exercises before coming to class. In class students
discuss what affect the Fed's contractionary policy could have on CanGo's effort to launch a new
product like online gaming. They can also discuss the impact of monetary policy on the IPO.
Week 13
International Trade
Students use this episode as the basis for a final project. Each student chooses a country in
the English-speaking world (e.g. Canada, South Africa, Australia) and researches the current
economic conditions and future outlook in that country. Each student then writes an essay in
which they discuss whether CanGo should expand into that country.
Week 14
Final Exam
As part of the exam, the instructor shows a Case Video from a Mastering Economics episode.
Students write an essay in response to the video drawing on their knowledge of economics.
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Appendix 3: Case discussion questions and answers
The Economic Way of Thinking
1. Economics can be viewed as the science of optimal decision-making. We assume that
rational individuals routinely balance the costs and benefits of economic decisions. Yet, as is
the case at CanGo, the very act of balancing costs and benefits entails costs. It takes time to
make a decision; and time is valuable.
In your own life, how do you decide how much time to spend making a decision? Does it
depend on the decision or the magnitude of the expected costs and benefits? Do you follow
a “rule of thumb”? For example, when you go to a restaurant, do you spend a lot of time
ordering your food? Do you carefully examine the entire menu or do you quickly identify the
food you want?
Answer: It is difficult to devise an optimal rule for rules regarding appropriate decision-
making time. If you are hoping to make a movie, you may decide not to spend much time
ordering your food. If you have nothing better to do the rest of the night, you might spend a
great deal of time picking out your food. In some settings your time may be very valuable
while in others it may be of less value. Basic economic analysis usually ignores the actual
costs of decision-making.
2. Maria has found a copy of Adam Smith's Wealth of Nations. She is struggling to understand
the following passage:
"The word value it is to be observed, has two different meanings, and sometimes
expresses the utility of some particular object, and sometimes the power of purchasing
other goods which the possession of that object conveys. The one may be called
"value in use"; the other, "value in exchange." The things which have the greatest value
in use have frequently little or no value in exchange; and, on the contrary, those which
have the greatest value in exchange have frequently little or no value in use. Nothing is
more useful than water: but it will purchase scarce anything; scarce anything can be had
in exchange for it. A diamond, on the contrary, has scarce any value in use; but a very
great quantity of other goods may frequently be had in exchange for it."
Read Adam Smith's Wealth of Nations (http://www.prenhall.com/mbwtc/weblink.cfm?lid=96),
Chapter four of book one entitled Of the Origin and Use of Money. Smith was one of the
earliest and greatest economists. The above passage is found toward the end of the chapter.
Smith is correct in stating that the value, or price, of water is very low. Yet water is vital to
the maintenance of life. Maria thought that prices should correspond to benefits received.
Does the example of water contradict this?
Answer: No. But it does indicate that prices correspond to marginal benefits and not total
or average benefits. Though water is very useful on average and in total, the last cup of
water that we buy is probably not that important to our survival. The low price we pay
corresponds to the value of that last cup.
3. CanGo is a small company that is getting bigger. Its employees are doing a lot of traveling.
One way to buy airplane tickets is by going to a free Web site like Lowestfare.com
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=97) and buying online. Suppose you are
thinking of a vacation and wish to fly from New York City to San Francisco. Go to a travel site
on the Web, such as Lowestfare.com (http://www.prenhall.com/mbwtc/weblink.cfm?lid=97),
and compare different flights. Most flights involve stopovers. Compare the time for a
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nonstop flight to a flight that requires a stopover. How much more would you be willing to
pay for the nonstop flight? What does this say about how you value your time?
Answer: Here is a hypothetical answer. Suppose that a nonstop flight would save you 2
hours. If you were willing to pay $100 more for such a ticket, you are effectively valuing your
time at about $50 per hour. Of course, there are catches here. Do you work while you are
waiting? Do you get some other benefit from a stopover in Phoenix? Everyone's answer will
be different.
4. "Wimpy", a character in the cartoon Popeye, used to tell the restaurant chef that he
would gladly pay on Tuesday for a hamburger today (Monday.) Why is advantageous to be
able to pay costs in the future? What is the opportunity cost today of being able to pay a
$10,000 bill one year from now? Is it $10,000? Think about how much it would cost today to
guarantee that you would have the $10,000 one year from now. (Hint: Go to the Federal
Reserve Bank's Web site at (http://www.prenhall.com/mbwtc/weblink.cfm?lid=98) and look at
current interest rates. You can find them under the “Research and Data” page.) In answering
this question you should also gain an understanding of the opportunity cost of holding money.
By holding money in your pocket instead of putting it in an account that pays interest, you are
giving up extra interest payments!
Answer: A dollar in the future is worth less than a dollar today. For example, if the interest
rate is 10%, I can put aside 91 cents today and turn it into $1 next year. Thus, 91 cents
today is worth $1 next year. So, if you have the choice of paying $1 today or $1 next year,
you would prefer to pay next year. Opportunity costs are specific to a point in time. If you
could have earned interest but didn't, then the cost of holding money is the interest payments
that you give up.
Supply and Demand
1. The current demand curve for online gaming determines the relationship between quantity
sold and revenue earned. Warren implies that there is a potential trade-off between
generating revenue and generating sales. Is this true? Can you think of any conditions
under which the trade-off would be most severe?
Answer: Yes, there is a tradeoff. After all, if you set a price of zero you would maximize
‘sales’ though you wouldn’t generate any sales revenue. On the other hand, the shape of the
demand relationship determines the extent of the tradeoff. A vertical demand curve, where
buyers don't care about price changes would be one where any attempt to increase sales
would force price and revenue down a great deal. Verify this for yourself by looking at
different demand curves.
2. Liz implies that there is some benefit to maximizing the number of people visiting their online
gaming site, even if that means generating very little revenue from subscriptions. What
would be the benefit of offering subscriptions now at a very low price, or a zero price? Can
you see any other way of generating revenue? Go to Microsoft’s gaming site at
http://www.prenhall.com/mbwtc/weblink.cfm?lid=99. What else does Microsoft get from a
customer visiting its sight? In addition, might there be some future payoff?
Answer: Traditionally, economic analysis focuses on generating profits directly from selling a
good. In the “dot-com world” current profits seem to be illusory. Nevertheless, there may
be other sources of profits to consider. Advertising on-site is one possibility. Future profits
are another. Offering the service for free may be a way of encouraging consumers to learn
about products that they would otherwise find too risky to buy. Subscriber fees could be
raised in the future.
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3. Suppose that CanGo set a very low subscription price for its online gaming service.
Might sales and revenue respond differently over longer periods of time than shorter periods
of time? Assume that no new competitors enter the market.
Answer: Demand curves are usually more elastic in the long-run than in the short-run. This
means that a price cut might elicit a much greater increase in quantity demanded in the long
term than in the short term. Is this likely to be the case here? Maybe the new service would
induce consumers to buy newer, game-ready machines to take advantage of the service.
Once this response starts kicking in, the demand response will become more elastic. Sales
will climb. Might there be other factors at work?
4. Look for a gaming site on the Net. For example, you could go to Microsoft’s gaming site at
http://www.prenhall.com/mbwtc/weblink.cfm?lid=99. Are there any games that you have to
pay to play? Are there any games that are free? Why do you think that those games are
free? Which games seem to be most popular? Are they free games or pay games?
Answer: Many of the free games at the MSN gaming site are very basic games, like card
games, chess, and checkers. This may have something to do with the availability of
substitutes for the games and the ease of entry into those markets. Maybe some of the
games, like the fantasy role-playing games, are more costly to administer?
5. Traditionally, economists assume that the supply curve slopes up and to the righthigher
prices must be paid to induce suppliers to increase quantity supplied. How do you think
CanGo would respond to different market prices for gaming? What are the costs of servicing
one additional game player on the server?
Answer: This is another situation in which where traditional economics models have a hard
time adapting to the “dot-com world.” Supply curves slope up because of the increasing
costs of supplying additional units of a good. In this case, until the server’s capacity
constraint is reached, it is not clear how much costs will increase. Once the initial investment
is made, the product can be disseminated at very low additional cost, no matter how many
people play. This makes it something like a public good. A public good is a good that, once
produced, is available for all to consume, regardless of who pays and who does not pay. This
video also shows the need for a more dynamic understanding of the supply relationship.
Price Determination
1. Nick and Andrew mention the fact that more and more people are traveling with notebook
computers. At the same time, the technology for producing e-books is constantly improving.
This process will accelerate as more and more vendors get into the e-book market. What
other trends do you think will affect the demand and supply of e-books? What are these
trends likely to mean for the price of e-books in the future?
Answer: In addition to the increasing use of laptops, there has been a proliferation of sub-
notebook devices such as handhelds and PDAs. Moreover, companies such as Microsoft are
developing new e-book readers. These trends will likely lead to an increase in the demand for
e-books. As more vendors enter the market, and as technology continues to improve, there
will be an increase in the supply of e-books. Because demand and supply will increase, the
quantity of e-books sold will assuredly increase. Whether price increases or decreases in the
future depends on whether the demand increase is larger or smaller than the supply increase.
2. Warren thinks that people aren’t willing to give up the printed page and that they like the
feeling of holding a book in their hands. Liz believes that CanGo couldn’t charge the same
15
price for e-books that they do for traditional books. The implication is that people actually
prefer traditional books and will buy e-books only if the price is lower. Do you agree? What
are some of the features of e-books that might make them preferable to traditional books for
many people? If you need some help, go to some of the major online booksellers, such as
Amazon (http://www.prenhall.com/mbwtc/weblink.cfm?lid=100), Barnes and Noble
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=101), and Borders
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=102) to see what they say about e-books.
Answer: Because e-books are digital in nature, you can search the text for specific words or
phrases. In addition, it is easy to bookmark and highlight different parts of the text. Many e-
books also have glossaries and dictionaries. Further, as Andrew alluded to in the video,
traditional books take up valuable space in your briefcase when you are traveling, and e-
books can be downloaded and stored right in your computer or on a CD. They may also have
advantages when you’re not traveling. For example, many handheld devices have a backlight
option that enables people to read in bed.
3. Go to the Web site of Barnes and Noble.com
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=101) and find their e-book section.
Compare the prices of e-books with those of traditional texts. What do you find? Are e-
books priced substantially lower? What does this mean in terms of customers’ perceptions of
the relative advantages of these two types of products?
Answer: At the time this exercise was produced, the prices of e-books are comparable to the
price of paperbacks. This would indicate that not all consumers perceive e-books as having
fewer desirable characteristics.
4. Do you think that the price differential between e-books and traditional books is explained
solely by the differences in production costs between these two types of products?
Answer: The marginal cost of producing e-books is much lower than that of paperback
books. Thus, the “margin” for e-books is higher than that of paperbacks. While it is true that
many ‘wired’ consumers may prefer e-books, it is also likely that the demand for e-books is
relatively inelastic when compared to the demand for paperbacks. At the time of this writing,
there are fewer books available as e-books than there are in traditional form.
5. There has been much debate about whether the government should tax Internet commerce.
Do you think that such a tax would lead to a dramatic increase in the price of e-books?
Answer: Although market intervention is the subject of the following episode, it is useful for
students to anticipate the effects of taxes on product price. In the previous question, we saw
that many e-books are priced about the same as paperback books. These two products are
likely to be good substitutes for each other, at least for the near future. If so, then e-book
retailers would be constrained in their ability to pass a substantial portion of any new tax on
e-books on to consumers.
Market Intervention:
1. Compared to the pre-price control situation, what happens to consumers’ desire to purchase
gasoline and other petroleum products if price controls are imposed?
Answer: If prices are allowed to increase, consumers will want to purchase less of these
products. When price controls are imposed, consumers maintain their desire to purchase
these products because the price remains relatively low.
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2. How do consumers “pay” for products that are subject to price ceilings?
Answer: Price does not fully perform its rationing function. As a result, other means of
rationing the goods are utilized. These include waiting in line, making side payments, and so
forth.
3. One objective of price ceilings is to lower the price of certain goods. Do consumers pay less
in total for these products than they would without price controls?
Answer: When the “non-price” costs of rationing the goods are added to the money price of
the good, consumers can actually pay more than they would without price controls. For
example, when gasoline was rationed and people had to wait in line for long periods, the total
costs of both the price at the pump, and the opportunity costs of people’s lost time were very
high.
4. If price controls on petroleum products were maintained over a long period of time, what
would happen to market supply over time?
Answer: Because producers receive less for their product, there is less incentive to devote
resources to obtaining more of these goods. There will be less exploration for new reserves;
more shutdowns of some producing oil fields and other measures; all of which will lead to a
reduction in supply over time. This will further exacerbate the shortage caused by price
ceilings.
5. One of the effects of price controls is to dramatically dampen the ability of price to respond
to changes in supply and demand. In an unregulated market, price will respond to changes
in supply and/or demand. That is necessary in order to keep the producers and consumers
of a good or service coordinated so that the amount that is produced will match the amount
that consumers will purchase. Take a look below at the prices of a couple of common
products consumed by households, milk, and tomatoes. The Bureau of Labor Statistics (BLS)
keeps records on prices of several commonly consumed goods over time.
17
Describe the degree to which prices fluctuate for these items over time. Which good do you
think is subject to price controls? Why would one be subject to price controls and not the
other?
Answer: There is more volatility in the price of tomatoes than in the price of milk.
Obviously, milk prices are controlled. One can speculate about the relative abilities of
different producers to influence legislation as a possible explanation for the presence or
absence of price ceilings on different goods.
Costs and Input Markets
1. There is no single labor market in the United States. There are many, many markets.
That makes gathering information difficult. There are a variety of sources for job information
on the web. Go to America’s Job Bank (http://www.prenhall.com/mbwtc/weblink.cfm?lid=78)
and click on the “career infonet” link. What can you find out about the type of job you are
interested in, and the part of the country where you would like to work? What are the
current salaries? What are the educational demands for the job?
Answer: There is no single answer here. This assignment is most interesting in a large
group because people will investigate many different types of jobs, which pay different
amounts and make different educational demands. Some information will be expected and
some will be surprising.
2. Go to the section of the Bureau of Labor Statistics site that deals with computer
programmers (http://www.prenhall.com/mbwtc/weblink.cfm?lid=79). What personal
attributes are employers looking for in computer programmers? What attributes do you think
would be most important at CanGo? Are there many part-time computer programming jobs?
Are there many contract jobs? If so, CanGo's holiday rush could be met with part-time
employees.
Answer: The BLS gives a very detailed printout of the outlook for computer programmers of
the type probably employed at CanGo. It should be clear that the educational demands are
increasing and that the typical programmer is more knowledgeable today than a few years
ago. You may also see that many computer programmers are employed on a part-time basis.
18
3. CanGo is concerned about its workers’ productivity levels. We hear that the use of
computers and the Internet are making people more productive. Is this true? Try going the
Bureau of Labor Statistics “Quarterly Labor Productivity" page at
http://www.prenhall.com/mbwtc/weblink.cfm?lid=80. There are lots of productivity and unit
cost figures at this site. For example, take “Business Output per Hour”, and study the
trends over the past decade. What do you see? Does productivity generally go up? Down?
Up and down?
Answer: Productivity has been going up steadily over the past decade, with a slight
downward blip in 1993. The most recent years show the strongest growth. These also
happen to be the years during which the Internet has become a major communication
medium. Is this a coincidence?
4. CanGo is thinking of hiring temporary workers to meet its holiday rush. Another option
might be to contract out the work to an outside company. From a productivity standpoint,
what advantages would outside contracting have over utilizing in-house temporary
employees? Are there any?
Answer: This is a very open-ended question. One way of looking at it might be the
following. Temporary employees working within the firm have to work do with the supply of
machines and equipment on hand. They have to use the existing equipment more
intensively. This should lead to a decline in marginal productivity, even if the temporary
workers were just as skilled and motivated as the full time employees. Contracting outside
staff might allow the firm to take advantage not only of a larger work force, but also of more
capital. This might make capital and labor variable. If the outside workers have more capital
to work with, they should be more productive.
5. Hiring temporary workers to meet the holiday rush seems like the way to go at
CanGo. What are the pros and cons of temporary employment from the workers' standpoint?
Is there a downside? Do temporary workers get the same compensation as full-time
workers? Go to the United Automobile Workers of America Web site.
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=81). Do a search at the site for
“temporary workers.” What do you find? What seems to be the UAW's position?
Answer: There should be a number of articles at the UAW site. The tone is generally
negative, or at least cautious. This should provide the basis for a good discussion. Too often
economists write as if workers are automatons that can be manipulated at will. If the UAW
had its way, and temporary workers were compensated at a higher rate, this would clearly
affect the demand for these workers
Marginal Analysis and Perfect Competition
1. Is CanGo in a competitive market? The competitiveness depends on the number of
competitors. But just who are the competitors? How easy is it to define a market? What
are the boundaries of the market for online gaming? Who are the competitors? Are they
firms that only sell online gaming? Do we include firms like Sony and Nintendo that sell
traditional video games? (Try going to a company site, such as Sony.com
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=103) and see whether Sony offers the
same kinds of games for its PlayStation as those offered for computers and online gaming.) What
about manufacturers of board games? Where do we draw the line? If you were going to
identify the competitors, who would you pick? How many firms supply online gaming?
Answer: It is difficult to define the appropriate boundaries of a market. Where do you draw
the line when each firm produces a slightly different product? The boundary is critical in
19
determining the number of effective competitors and the competitiveness (from an economic
standpoint) of the market. Sony offers strategy, role-playing, and shooter games for its
PlayStation. These are the same categories of games as those played on the computer and
online.
2. The economic model of short and long term decision-making argues that a company like
CanGo could decide to continue in business despite recurring bouts of losses (as opposed to
profits) As long as the losses from staying in business are less than the losses from shutting
down operations, the company should continue to operate.
Go to an Internet company’s Web site. Try AOL
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=104), for example. Find its annual report
and look at its net income over the years. (You can do this by going to the site for the
annual report at http://www.prenhall.com/mbwtc/weblink.cfm?lid=105. What do the profits
look like? Do companies stay in business despite occasional losses?
Answer: This is another open- ended question. If you go to the AOL site you should see
that AOL has made substantial losses in certain years, and profits in others. Clearly, if AOL is
maximizing its profits it must have decided that shutting down would only make matters
worse. Students should also find it interesting to see the losses experienced by the Internet
oriented companies. It is a very risky business.
3. The competitiveness of markets depends not only on the number of buyers and sellers,
but also on whether or not they are well informed about the product and about market
conditions. There are many sources of information for buyers of online gaming. Does the
average buyer actually rely on these sources? What are they? How would you make a
decision about what game to buy, or subscribe to? Go to PCGamer.com
http://www.prenhall.com/mbwtc/weblink.cfm?lid=107 for one source of information
(PCGamer is also available as a traditional print magazine). PCGamer rates games as they
become available to buyers. What appear to be the important features of online games?
What are the primary categories of online games? Read and find out. Would you use a
magazine like this to help you make a decision?
Answer: There is no one answer here. There are many sources of information about
gaming. Specialty magazines are only one source. More general information magazines, such
as Consumer Reports, also review games from time to time. In addition, buyers get
information from other media outlets, from friends and from personal experience. How
informed are consumers of online gaming compared to consumers of other products?
4. The United States Bureau of the Census collects data on households and data on industries
and firms. The firm information is often used to provide a rough indication of the
competitiveness of a particular market. Go to the Economic Census section of the U.S.
Census Bureau's home page (http://www.prenhall.com/mbwtc/weblink.cfm?lid=108) and
read the document Software Reproducing at
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=109) This provides statistics for the
.
industry. Find out how many competitors there are, and how big they are. Do you think
that this looks like a perfectly competitive market?
Notice how many of the firms are located in California. Do you think that this industry is
fragmented by the state, or is it truly a national market? While you are at the Census site,
look at the number of manufacturers in other industry groups. Compare the number of
competitors in different markets.
20
Answer: The Census Bureau collects detailed information about the economy. The tables
show the number of firms in a market sector and the relative firm sizes. You should see that
different markets vary a great deal. Some have many competitors and some don’t; some
markets are more competitive than others are. The Software market has over 100
competitors. Are they all producing the same product and, therefore, in the same market?
Is the market regional or national?
Imperfect Competition
1. A tactic used by firms with a good deal of market power for some products is to bundle
several products together. Why do firms engage in such practices? Cite a prominent
example in the software industry.
Answer: Firms tie and bundle their products in order to extend their monopoly power into
other markets and thereby increase profits. For example, the federal government has alleged
that Microsoft Corporation bundled its Web browser, Internet Explorer, with its Windows
operating system.
2. The practice of tying and bundling products together often piques the interest of federal
antitrust authorities. What is wrong with such practices and why do antitrust authorities,
such as the Department of Justice and the Federal Trade Commission, investigate such
practices?
Answer: As indicated above, such practices often indicate that a firm has some degree of
monopoly power. Antitrust authorities, charged with promoting competition and preventing
monopolistic practices, want to ensure that tying and bundling arrangements are not harming
consumers. The fundamental problem with monopoly is that such firms restrict output in
order to raise price. Thus, consumers usually pay a higher price than would be the case if the
market were perfectly competitive.
Before we continue you should learn more about antitrust economics and the new information
based economy. Elizabeth’s comment that Microsoft got into trouble because of the same type
of practices that Clark is now proposing for CanGo reflects a real concern in the wake of the
Justice Department’s actions against Microsoft. The Microsoft case is arguably the most
important antitrust action in recent decades, and one with far reaching implications for the
technology industry in which CanGo operates. There are many good Web sites that can provide
you with the background and the most recent developments in the Microsoft case. Here are
some suggestions:
• Antitrust Policy at http://www.prenhall.com/mbwtc/weblink.cfm?lid=110
• Law and Economics at http://www.prenhall.com/mbwtc/weblink.cfm?lid=111
• The Information Economy at http://www.prenhall.com/mbwtc/weblink.cfm?lid=112
3. The Justice Department filed its latest antitrust suit against Microsoft in May 1998. What was
the action that precipitated the Justice Department’s action? How does this relate to CanGo’s
plans for its new online gaming service?
Answer: In early 1998, Judge Thomas Penfield Jackson ordered Microsoft to remove its Web
browser from its Windows 95 operating system. In May 1998, Microsoft began shipping its
Windows 98 operating system with its browser built in. That prompted the Justice
21
Department to file suit against Microsoft for bundling the two products together. This
bundling scheme is conceptually similar to CanGo’s tying plan.
4. What was the main issue in the Justice Department’s action against Microsoft?
Answer: The Justice Department was concerned that Microsoft was using its dominance in
the PC operating system market to try to monopolize the Web browser market. In addition,
the Justice Department claimed that Microsoft used its market power to impede competition in
the software market and raise prices on some of its products.
5. The trial that followed the Justice Department’s 1998 suit against Microsoft was a lengthy
one. What was the verdict in the case and what remedy did the presiding judge
recommend? What is likely to happen to Microsoft as a result of the suit?
Answer: Judge Jackson essentially agreed with the Justice Department and found Microsoft
guilty of several illegal monopolistic practices. In June 2000 Judge Jackson ruled that
Microsoft would be split into two companies. Microsoft appealed the ruling. At the time of
this writing, the appeals process is expected to last well into 2001, unless the Justice
Department and Microsoft reach a settlement.
National Income (Measurement of Key Economic Data)
1. CanGo is not alone in its concerns about inflation and its effect on the economy. High
inflation rates typically mean variable prices. Price variability increases the amount of risk in
the market. CanGo is also concerned about prices because some of their contracts may be
adjusted for inflation. Measuring the inflation rate is not a science; it is a highly refined art.
Go to the CPI Consumer Price Index's Frequently Asked Questions
http://www.prenhall.com/mbwtc/weblink.cfm?lid=113 page. What are the eight major
groups of goods and services that the CPI surveys? If you have time, look up the raw data
on the site and compare the price changes for the different categories of goods. Do the
inflation rates differ widely across different groups of goods? Is there a single inflation rate
applicable to everybody in all places?
Answer: The CPI measures the average price level faced by a typical urban family. The CPI
site explains this in more detail. Price changes are indeed variable. Over the past decade,
clothing prices have risen about 10%, while food prices have risen about 30%. Also during
the past decade, prices in the northeast have increased at a slightly slower rate than prices in
the west.
2. CanGo is affected by overall economic conditions. Prices, output, and employment statistics
give CanGo a sense of where the economy is going. CanGo also hears a lot about the Index
of Leading Economic Indicators. What is this index? What economic conditions does it
reflect and predict? To find out, go to the Conference Board Inc. Business Cycle Indicators
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=114). Page. The Conference Board is a
private organization that compiles this index and a few others. What has happened to the
index recently? What is in the index?
Answer: The answer to this question is time dependent. The index of leading indicators is a
compilation of data that, historically, leads the way for the rest of economy. When the index
goes up, the economy will go up in the future. When the index drops, the economy is
predicted to go down in the future.
22
3. The Bureau of Economic Analysis (BEA) is the arm of the United States Department of
Commerce that collects national income data. The BEA New Releases site
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=115) contains a calendar that announces
when data becomes available. It also links to the data. Look for Gross Domestic Product
announcements. They are identified by quarter. How many different estimates are provided
for each quarter? Why do you think this is done? How different are the estimates? When is
the first estimate released? As soon as the quarter ends?
Answer: There are four for each quarter. Typically, there is an advance estimate, a
preliminary estimate, and a final estimate. The advance estimate is published roughly one
month after the quarter ends. The preliminary estimate comes one year later, and the final
estimate comes one month later. Finally, there is a latest estimate which is an annual revision
carried out each summer. Typically, the sum total of all the revisions adjusts GDP figures by
between 1 and 2 percent.
4. The Bureau of Labor Statistics (http://www.prenhall.com/mbwtc/weblink.cfm?lid=116) (BLS)
collects labor market and national price information. Retrieve employment status information
and then unemployment rates. See how they vary over time. What is the lowest that the
unemployment rate has been since the end of World War II? Based on this data, do you
think unemployment rates can go lower than they are now? Do you think that the economy is
now at full employment?
Answer: The BLS has a wealth of information to examine. The unemployment rate
information shows that an unemployment rate of 0 has not happened since the end of World
War II. But you will probably find that there are years, particularly in the early 1950s, when
the unemployment rate was lower than it is currently. This shows that a “full employment”
unemployment rate is a matter of judgment. Economists differ on the actual meaning of full
employment.
Business Cycles
1. The staff at CanGo is continually looking for the most current information about the state of
the world economy. One of the best places to check is the White House Electronic Statistics
Briefing Room (http://www.prenhall.com/mbwtc/weblink.cfm?lid=117 ) (ESBR). Based on
this information, how do you think the economy is doing now?
Answer: For a quick snapshot view of the state of the economy, the ESBR is a good place to
start because it provides “easy access to current Federal economic indicators.” In terms of
the U.S. economy, some of the most useful data are classified under the categories listed in
the Statistics sidebar on the site. Under the first category, for example, there is data on
housing starts, durable goods, retail sales, capacity utilization and more. Under the Output
category, you’ll find data on such critical indicators as GDP, residential and nonresidential
investment, corporate profits, consumption expenditures, and more. From this small sample,
you can see that there is a wealth of information at this site. The answer to question one
about the current state of the economy depends on the latest data on the key indicators.
2. CanGo would like to launch its IPO when the economy is expansionary phase of the business
cycle. The National Bureau of Economic Research
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=118) is one of the best sources of
information on business cycles. It is the home of much important research and economic
data. Look around and familiarize yourself with the types of research conducted at NBER.
One of the roles that the NBER plays is to “call” the different phases of the business cycle.
Where can you find information about when business cycles have occurred during the past
23
150 years, including their timing and duration? How often do they occur? How long do they
last? Are business cycles getting longer or shorter?
Answer: To find data on the state of the economy, look under ‘Data’ category. To find the
information needed to answer this question, go to ‘Business Cycle Dates.’
In the postwar period, business cycles last about 5 years (61 months). Contractions last an
average of 11 months, while expansions last just over 4 years (50 months) in length. It
appears that the contractions are shorter and expansions longer than they were in the past.
3. Another great place to get easy access to the types of information analysts and investors use
to keep track of recent economic indicators, and to find out when key data is announced, is
the Yahoo! Finance Economic Calendar
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=119). What kinds of information do you
find there and what are some of the latest releases of key economic indicators?
Answer: The Economic Calendar shows the latest releases of major economic statistics on a
day-by-day basis. The information is presented in calendar form and displays the current
business week. You can also view past data or look ahead to upcoming weeks. The calendar
displays the time (ET) the data is released, the type of data (statistic), the actual statistic,
what market analysts were expecting, and changes from previous releases. View the current
calendar to see the latest releases.
4. Since CanGo is increasingly expanding into global markets, it would behoove the analysts to
check out what’s going on in other economies worldwide. One of the best places to do this is
a site for the latest key short-term indicators offered by the Organization for Economic
Cooperation and Development (OECD). Just as the analysts are concerned with some of the
major markets in which CanGo operates, so are we. We’ll check on the latest developments
in England, France, Germany, and Japan. Go to the Short Term Indicators
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=120) Web page. For these countries, as
well as the U.S., rank them in terms of their percentage change in GDP, their percentage
change in consumer prices (CPI), and their unemployment rates. Which country do you think
is most at risk in terms of future economic activity?
Answer: To answer this question, go to the Key Short-term indicator page at
http://www.prenhall.com/mbwtc/weblink.cfm?lid=120. Select Europe at
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=137) for information on England, France
and Germany. Select Asia at (http://www.prenhall.com/mbwtc/weblink.cfm?lid=138) for
information on Japan. Select the countries of interest and gather the requested data. Your
answer will depend on the states of the economies of those nations at the time you perform
these exercises.
5. The CanGo staff would also do well to get an idea of per capita income and purchasing
power in the countries in which CanGo operates. To do so, they would go to the OECD
National Accounts (http://www.prenhall.com/mbwtc/weblink.cfm?lid=121). Please go there
and describe the kinds of information that are available. Then, visit the page entitled GDP
per capita based on both exchange rates and on PPPs to assess how the aforementioned
countries fare in terms of the ability to purchase products from companies like CanGo.
Answer: The National Accounts page provides the following information: Quarterly growth
rates in GDP at constant prices, Gross Domestic Product table, GDP per capita based on both
exchange rates and on PPPs (purchasing power parities), PPPs and derived indices for all
OECD countries, PPP-based comparative price levels and PPPs for OECD countries, 1970-1999.
24
The page titled GDP per capita based on both exchange rates and on PPPs provides
comparisons of levels of GDP per capita based on both exchange rates and on PPPs.
Fiscal Policy
1. Warren is very concerned about taxes and spending. Both spending and taxation are federal
budgetary items. The government finances its spending through taxation and
borrowing. When the government spends more than it takes in, we say the budget is in
deficit and when the government spends less than it takes in, we say the budget is in
surplus. Go to the U.S. Bureau of the Budget
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=76) Web site and review the Economic
Report of the President: 2000. At the end of this document there are many tables of
economic statistics. Go to table B-76. Look at the figures for the total surplus. Do you see
any interesting trends? What appears to be the trend in the 1990s? What happens during
wartime? Why? What are the projections for the future?
Answer: The 1980s saw a ballooning of the deficit. The government was spending
substantially more than it was taking in. This has been sharply reversed in the 1990's, though
there have been ups and downs. It is also interesting to look at years during which the
United States has been at war. The deficit goes up. The World War II years are dramatic
evidence of this. The Vietnam years had much less of an impact. The United States appears
to finance its wars more through borrowing than through taxation. The projections show the
surplus getting even larger in 2001 and 2002.
2. Despite Warren's concerns, Maria and Liz are very optimistic. Maria is hopeful that the
government's policies will increase the supply of high-tech workers. Is this possible or likely?
Go to the U.S. Bureau of the Budget (http://www.prenhall.com/mbwtc/weblink.cfm?lid=76)
Web site and read Chapter 3: Technology and the American Economy of the Economic
Report of the President: 2000. It contains a discussion of the government role in research
and development. The Report argues that government spending on research and
development is a good way of stimulating supply of new products. What is the basic
argument?
Answer: The Report argues that there are important spillover effects to basic and applied
research. A positive spillover effect is a benefit that doesn't accrue to the immediate
developer of the research or new product. Because they can't “capture” this benefit, they
ignore it when they decide whether or not to market a new product. A producer will only
develop new products if the expected profits are positive. The producer doesn't care if you
get a benefit unless it increases the firm's profits. The patent system is a way of capturing
some, but not all of these benefits. The Report argues that the Internet is one such product
whose development required government investment. If this argument is correct, then
government spending has an important role to play in affecting the supply of new goods and
services.
3. There are a few people at CanGo who are concerned about the federal government and its
handling of the economy. Is the federal government a big part of our economy? Does it
play a big part in our economic lives? Go to the U.S. Bureau of the Budget
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=76) Web site and read the Citizens Guide
to the Federal Budget. It is a relatively short document. We hear a lot of talk about the
colossus that is the U.S. government. When you compare the levels of government spending
and taxation in this country to the levels in other capitalist countries, what do you find? Does
this surprise you?
25
Answer: The text and the tables show that the United States taxes and spends much less
than other wealthy countries, at least as measured as a percentage of GDP. The United
States is near the bottom, along with Japan. The differences between France and the United
States are particularly striking. The French tax and spend at a rate that is roughly double the
U.S. rate! You would expect the French economy to be a very different type of economy than
the U.S. economy.
4. People often confuse deficits with debts. A deficit represents the amount that you borrow
currently. Debt represents accumulated past borrowings. If you have been borrowing for a
long time then your debt could be much larger than your deficit. Go to the Web page for the
Bureau of the Public Debt (http://www.prenhall.com/mbwtc/weblink.cfm?lid=77). The
Bureau is a part of the United States Department of the Treasury. What is the current value
of the U.S. federal debt? Has it been increasing or decreasing? The US must pay interest on
its debt. How much interest does it have to pay each year?
Answer: The current figures are at the site, and they change continually. You should see
that the debt is enormousin the trillions of dollars. Many people are surprised that the U.S.
can actually survive with this much debt. The interest payments alone are
staggeringseveral hundred billion dollars annually!
Monetary Policy
1. You have to feel bad for Gail. Although the price of the car and the value of her trade-in
hadn’t changed, her delay in putting the deal together is costing her more. Gail now knows
that higher interest rates resulting from Fed policy make many items more expensive to
finance. This can come as quite a shock when we contemplate “big ticket” item purchases,
such as appliances, cars, and homes. Why would the Fed take these types of actions that
impose such hardships on U.S. households?
Answer: The down side of contradictory policy is that higher interest rates make it more
expensive to finance purchases and also reduce investment. However, when conducting
contractionary policy such as the one described in the videos in this episode, the Fed is
attempting to avoid the more serious problem of inflation. By keeping inflation low, real
interest rates in the long run will also remain low. This promotes economic growth in the long
run.
2. In the video, we saw that contractionary policy by the Fed will make big-ticket items more
expensive to finance. Such actions will generally raise interest rates throughout the
economy. Recall the components of aggregate demand. Explain how such moves by the
Fed will affect each component.
Answer: As we saw in the case of Gail’s new car, higher interest rates can make it more
costly for households to conduct purchases. Thus, consumption will decrease. In addition, it
is more costly for firms to acquire the funds necessary to finance new equipment and
construct or modify production facilities. Thus, investment spending will decrease. Finally,
higher interest rates will lead to dollar appreciation against other currencies. This will lead to
a decline in net exports.
3. The type of contractionary monetary policy that dimmed CanGo’s IPO prospects and proved
to be costly to the financing of Gail’s new car is an example of the Fed trying to maintain
long run interest rates that are good for investment and growth. Monetarists, however, have
criticized this type of policy. What are some other policy options that the Fed could pursue?
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Answer: Monetarists emphasize the importance of targeting the money supply. In their
view, maintaining a stable money supply is important to avoid inflation. Monetarists believe
that money supply growth is the primary underlying cause of inflation.
4. The Federal Reserve System’s Web sites have some of the best descriptions of what the Fed
is and what it does. In addition, many of the districts Federal Reserve banks have great Web
sites, full of good information. Let’s go to one of them now. Go to the Web site for the San
Francisco Federal Reserve Bank (http://www.prenhall.com/mbwtc/weblink.cfm?lid=126) and
access the Central Banking (http://www.prenhall.com/mbwtc/weblink.cfm?lid=128) page.
Work your way through the following: The Nation's Central Bank, Organization of the Fed, An
Overview of Fed Services, The Many Roles of the Fed, How the Fed Guides Monetary Policy,
A Little More About the FOMC, and Myths and Facts. Then address the following question:
How is the Fed organized and financed so that it maintains its political autonomy?
Answer: The main reason that the Fed was created was to help ensure a more stable
banking system in the U.S. As stated in the Web page entitled “Organization of the Fed”
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=182), the Fed was created to be
independent of the U.S. government to provide a safer, more flexible banking and monetary
system. The Fed's operations are self-financed to ensure autonomy and insulate the central
bank from short-term partisan political pressures. Although Congress can change the laws
governing the Fed, the reserve does not require Congressional or presidential approval for its
daily operation. Its members serve 14-year terms, arranged with one expiring every even-
numbered year. The terms were designed to be long enough to prevent day-to-day political
pressures from influencing the formulation of monetary policy and the supervision of the
operation of the 12 regional Reserve Banks.
Before we go on to the next questions, let's look more closely at the Fed and the Federal Open
Market Committee.
The Federal Open Market Committee (FOMC) conducts monetary policy. Go to the Federal
Reserve (http://www.prenhall.com/mbwtc/weblink.cfm?lid=127) Web page and read about who
they are and what they do. It's instructive to review the policy statements about their recent
meetings. You can find the calendar of recent meetings, with links to announcements and
statements, by scrolling down on the FOMC page linked above.
During 1999 and the first part of 2000, the FOMC continued its policy of raising interest rates and
tightening the money supply. For example, check out the statements from the FOMC meetings on
February 2, 2000 (http://www.prenhall.com/mbwtc/weblink.cfm?lid=129) and March 21, 2000
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=130). In each of those meetings, the FOMC
decided to raise the federal funds rate and the discount rate by 25 basis points each. The Fed
decided to be even more aggressive in May. You should read the statement for the Fed's May 16,
2000 (http://www.prenhall.com/mbwtc/weblink.cfm?lid=131) meeting too.
5. During 1999 and the first part of 2000, what were the Fed’s main concerns about the future
of the economy? What economic conditions contributed to this concern?
Answer: The Fed was concerned about rising demand exceeding the rate of growth in
potential GDP. Rising demand had been fueled primarily by large increases in consumer
spending. The record economic expansion had been fueled by rising demand, coupled with
growth in aggregate supply, which stemmed from dramatic increases in productivity and
technological innovation. However, if the growth of potential GDP slowed, then the continued
increase in aggregate demand would be inflationary.
6. During the February, March, and May meetings, the FOMC raised both the federal funds rate
and the discount rate. This was a bit of a departure for the Fed, which until that point,
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focused on raising the federal funds rate and changing the discount rate only intermittently.
What’s the difference between these key interest rates? If the Fed was interested in
targeting interest rates generally in the economy, why would it be more likely to change the
federal funds rate rather than the discount rate?
Answer: As described in the March 21, 2000 meeting statement, the “discount rate is the
rate charged to depository institutions when they borrow short-term adjustment credit from
their district Federal Reserve Banks.” The federal funds rate is the rate depository that
institutions charge when they borrow funds from each other.
International Trade
1. In the Case Study Video, Debbie, Nick, Gail, and Whitney had their doubts about the benefits
of free trade. According to economic theory, will trade that is based on comparative
differences between two nations be beneficial to both trading partners or is it a “zero sum
game” that will benefit one trading partner at the expense of the other? Why?
Answer: Conventional economic theory maintains that trade based on comparative
advantage will, in the aggregate, make both parties better.
2. In the video, Gail comments on what would happen to the prices of personal computers if
free trade were impeded. Can you expand on that and describe some of the benefits for U.S.
consumers that stem from the free trade of computer parts and other goods?
Answer: As Gail implied, if one country has a comparative advantage over the U.S. in the
manufacture of certain computer parts that means that they can produce them at a lower cost
than U.S. firms can. For example, the assembly of some components is relatively labor
intensive. In that case, countries with high labor/capital ratios may be able to produce the
components at relatively low cost. If there were trade restrictions on the importation of these
components, PCs in the U.S. would be more expensive than they are with relatively free trade.
3. Recall from the video that Whitney mentioned that the president, by favoring free trade,
“doesn’t get what’s going on down here where people are actually working for a living.” Can
you expand on that idea and explain some of the downsides of free trade?
Answer: Some firms that compete directly with low-cost foreign manufacturers are harmed
by free trade. For example, U.S. manufacturers that are producing PC components and
competing with foreign component makers may lose market share and would perhaps be
driven out of business by foreign competition. The firm’s owners and employees will be hurt
by free trade in those components.
4. Let’s assume that the benefits of free trade outweigh the costs. If that is so, why are
barriers to free trade so prevalent? Why are presidents generally in favor of free trade, while
members of Congress are so often opposed to free trade?
Answer: Economic theory suggests that the benefits of free trade are greater than the costs
for the economy as a whole. However, the benefits are often spread across the economy as a
whole. For example, consumers may enjoy lower prices for many consumer goods and
overall employment may be higher than without free trade. However, these benefits are
often difficult to see on an individual level. The costs of free trade, in terms of lower wages
or businesses closing in adversely affected domestic industries are often more apparent. We
can see factory closings and disgruntled workers on the evening news. While the president is
ostensibly interested in the well being of the nation as a whole, individual members of
Congress are more concerned with employment in their individual home districts. If firms in
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his/her district are hurt by free trade, a specific Congressperson will find it politically
advantageous to try to protect those firms.
5. One of the largest organizations in the world devoted to free trade is the World Trade
Organization (WTO). Go to the World Trade Organization
(http://www.prenhall.com/mbwtc/weblink.cfm?lid=132). Describe some of the features of
this site and some of the issues with which the WTO is involved.
Answer: The WTO site is a relatively large site rich in resources related to world trade,
intellectual property, the environment, and more. There are many publications, reports and
news items that are viewable online. There are also detailed files available for downloading.
The best place to go for an idea of the resources available here is the site directory or map.
The "General Information" category contains information about the WTO, news items and a
search function. Another category, "Trade Topics," contains information about specific trade
issues and other topics such as trade disputes, intellectual property agreements and more.
Under the third category, "Publications," you'll find links to online documents, news releases,
legal documents, archives, FAQ's and lists of relevant links.
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