Answers to the Questions in the Chapters
Page 12: The production is counted as part of the Gross Domestic Product when the
bread is bought at Vons by you.
Your buying of the Ford is an example of consumption.
General Motors buying the computer system is an example of business
Hondas sold in Japan are examples of exports.
The Department of Defense buying the new jets is an example of
Page 13 The $50 million (100 million times $0.50) that is produced in Mexico is
counted as GDP in Mexico. The other $39 million (100 million times $0.39) is
part of the GDP in the United States.
The rise in the divorce rate could cause the measure of Gross Domestic Product
to rise even though people’s standard of living has not risen because divorced
people will have two places to live, are more likely to eat in restaurants, are
more likely to pay for child care, laundry, house cleaning, etc.
“Nominal Gross Domestic Product (GDP)” is the value of all final goods and
services produced in the United States to be sold in a year.
A “final good” is one used by a final user while an “intermediate good” is used
as part of the production process.
The four groups of final users are consumers, businesses, the government, and
foreigners. “Consumption” is the buying of products to use them up. “Business
investment spending” is the buying by private businesses of new capital goods.
“Net exports” is exports minus imports.
“Capital goods” are goods produced by people to be used as part of production,
such as machines, tools, equipment, and so forth.
The workweek of the average American worker is about 25 hours less than it
was a century ago. People are enjoying more leisure time. Because leisure time
is not counted as part of Gross Domestic Product, the Gross Domestic Product
measure understates the increase in our actual standard of living.
Page 15: The Nominal Gross Domestic Product (GDP) in 1996 is equal to ($4 x 10) +
($12 x 20) + ($6 x 5) + ($25 x 10) = $560.
The Nominal Gross Domestic Product (GDP) in 2000 is equal to ($8 x 12) +
($36 x 15) + ($10 x 15) + ($30 x 12) = $1,146.
The Real Gross Domestic Product (Real GDP) in 2000 is equal to ($4 x 12) +
($12 x 15) + ($6 x 15) + ($25 x 12) = $618.
Page 16: From 1996 to 2000, the Real GDP rose from $560 to $618. This is a change of
$58. $58 as a percent of $618 is equal to 9.39%.
At 2%, Real GDP per capita would double every 36 years. In 72 years, it
would double twice. Therefore, it would be $40,000. At 3%, it would double
every 245 years. Therefore, it would double 3 times and be $80,000.
The Nominal Gross Domestic Product (GDP) is not a good measure of the
true standard of living of the people of a country because it does not consider
leisure, because it does not consider goods and services produced but not sold,
because it does not consider goods that have harmful effects, and because it
misses the underground economy.
The “underground economy” involves goods and services sold illegally or
sold without reporting in order to avoid taxation.
“Real Gross Domestic Product (GDP)” is the Gross Domestic Product adjusted
to the prices of 1996.I t is a better measure of aggregate production than
Nominal Gross Domestic Product (GDP) because it removes the effects of price
“Real Gross Domestic Product Per Capita” measures production of all goods
and services per person.
The rate of growth of Real Gross Domestic Product (GDP) from one year to
the next year is calculated as the difference in the Real GDP divided by the
original year’s Real GDP. The “Rule of 72” says that if something is growing
at a certain percent per year, divide that into 72 to determine how long it will
take to double.
“National Income” is the sum of all incomes earned. It is equal to the Real GDP
because people can only earn income by producing goods and services. The
value earned is equal to the value produced.
Page 18: Technological improvements allow modem speeds to increase from 2400 to 56K
are intensive growth.
A higher percent of American workers have a college education today than
before would be intensive growth.
Immigration increases the American population would be extensive growth.
Disease resistant seeds are developed which mean that fewer wheat plants will
die before harvest would be intensive growth.
Oil is discovered in Alaska would be extensive growth.
Page 19: If productivity is growing faster in other countries, their costs of production will
grow slower. American exports will decline as they become relatively more
expensive. American imports will rise as foreign products become relatively
Page 23: "Productivity" is Real GDP per hour worked. Since we earn income only by
producing goods and services, the greater our productivity, the greater our
The "productivity problem" experienced by the United States is that
productivity has been growing slower than in the past and also slower than our
trade partner countries.
The "productivity problem" has caused the American standard of living to grow
very slowly. This has changed American life by causing more people to work,
people to save less and go deeper in debt, a tax revolt, later marriage, and fewer
Factors might be responsible for the slowdown in productivity growth include
the low rates of business investment spending, the low rate of savings, too little
spending on infrastructure and R&D, poor education, an adversarial relation
between business and labor, poor management, and so forth.
Practice Quiz for Chapter 2 1. e 2. c 3. d 4. a 5. b 6. 6 7. d 8. c 9. d 10. a
Page 25: When real GDP (production) is rising, there is an expansion. Real GDP stops rising at the peak.
When real GDP is falling, there is a recession. If it falls greatly, there is a depression. When
Real GDP stops falling, there is a trough. Then, Real GDP begins to rise in the recovery.
Page 26: 1 Expansion. 2 Peak. 3. Recession 4. Trough 5. Recovery 6. Expansion 7. Peak
Page 27: 10 million are unemployed. The labor force is 100 million. The unemployment rate is 10%.
William is employed. Jose is not in the labor force. Jane is unemployed. Mary is not in the labor
force (a discouraged worker)
Page 28: The official unemployment rate may be understated because discouraged workers are not counted
as unemployed and because those working part-time involuntarily are counted as fully employed.
It may be overstated because those working in the underground economy may be counted as
When the economy is getting worse, the unemployed may give up looking for a job that they sure
does not exist. When they give up looking, they are no longer officially unemployed and the
official unemployment rate falls.
Page 29: Robert --- structural. Mary --- frictional. Maria --- cyclical.
Page 31: The administration of President Kennedy defined full employment as occurring when there is no
cyclical unemployment. In order words, full-employment exists if the economy creates a job for
every worker who wants one. The “natural rate of unemployment” was defined as the lowest
rate of unemployment that could occur before inflation accelerates.
Potential Real GDP is the amount of production needed to have full-employment. The difference
between the actual Real GDP and the Potential Real GDP is called the GDP Gap. If the actual
Real GDP is less (greater) than the Potential Real GDP, the difference is called a recessionary
Page 32: 1. Unemployment insurance may have raised the natural rate of unemployment by making it
possible for people to search for jobs for longer periods of time.
2. People in their 20s tend to go from job to job, becoming unemployed several times in a year.
If there are fewer of such people, the natural rate of unemployment will be lower.
3. 6.9% – 4% = 2.9%. 2.9% x 2 = 5.8%. 5.8% of $7,054 = $409.1 billion. Using this estimate,
had production been $409.1 billion greater, unemployment would have been 4%.
Page 33: When people’s incomes decline, their demand for certain durable goods declines greatly. This
occurs because people can postpone buying a new car, house, etc. Those who work to produce
these products are the most likely to lose their jobs. These are likely to be blue-collar workers
(factory or construction workers). On the other hand, the demand for services produced by
white-collar workers does not decline as much in a recession.
Practice Quiz for Chapter 3 1. c 2. b 3. c 4. b 5. d 6. b 7. a 8. b
Page 36: Take (10) ($3) + (5) ($4) + (20) ($10) = $250 and divide by (10) ($1) + (5) ($3) + (20) ($5)
= $125. $250 divided by $125 = 2. 2 times 100 = 200.
$30,000 in 2000 would buy the same as $15,000 in 1982.
82.4 – 72.6 = 9.8. 9.8 divided by 72.6 = 13.5%.
Page 38: The CPI overstated the actual rise in the cost of living because it did not consider that people
substitute cheaper goods for more expensive ones as prices rise, because it did not consider that
people shop in cheaper stores as prices rise, and because it did not adequately consider the quality
changes of products. The overstatement is important because so many people have COLAs.
Page 39: (15) ($3) + (10) ($6) + (20) ($15) = $405 and divide by (15) ($1) + (10) ($2) + (20) ($5) = $135.
$405 divided by $135 = 3. 3 times 100 equals 300.
The CPI and the GDP Deflator will show difference results because (1) they have different base
years, (2) they measure the prices of different goods and services, and (3) the CPI uses the fixed
quantities of the base year while the GDP Deflator uses the fixed quantities of the current year.
Page 40: 9% – 13.5% = - 4.5%. The bank was paying me to lend money to me!
Page 42: Joe expected 17% - 10% = 7%. Joe paid 17% - 3% = 14%.
1. People who already own homes are better off
2. People who want to buy homes are worse off
3. People on fixed incomes are worse off
4. People with large credit card debt are better off
5. People with a considerable amount of money in a savings account are worse off
6. The federal government is better off
If you believed that a high rate of inflation were coming soon,
1. The amount you would save in a bank would decrease
2. The amount of debt you would want to be in would increase
3. The number of homes you would want to own would increase
Page 44: Inflation increases consumer debt, reduced overall saving, mischannels savings into inflation
hedges, and decreases business investment spending by increasing uncertainty.
With $100,000 to save, the best places to save during times of high inflation are the inflation
hedges --- real estate, gold, silver, jewelry, antiques, art, and other collectibles.
Practice Quiz for Chapter 4 1. c 2. b 3. b 4. d 5. b 6. c 7. d 8. c 9. d 10. d
Page 49 Other factors affecting your demand for college courses include your income, the prices at
substitutes, such as CSU or UC, the prices of complements, such as books, your tastes for
education, and your expectations of future prices.
Page 53 1. decrease ----- move along 2. increase ----- shift right
3. increase ----- shift right 4. increase ----- shift right
5. increase ----- shift right 6. decrease ----- shift left
7. increase ----- shift right
Practice Quiz for Chapter 5 1. a 2. c 3. a 4. b 5. c 6. b 7. b 8. b
Page 58 1. shift to the left 2. shift to the right 3. shift to the left 4. move along 5. shift to the left
Page 60 The equilibrium price is $1,500 and the equilibrium quantity is 300. At a price of $2,000, there is
a surplus of 400 computers.
Page 64 When the price of gasoline rises, the demand for automobiles (a complement) falls. This is a shift
to the left. When the new equilibrium is reached, the price of automobiles will have fallen and
the quantity of automobiles sold will also have fallen.
Page 65 When the price of water rises, the supply of oranges decreases. This is a shift in supply to the
left. When the new equilibrium is reached, the price of oranges will have risen and the quantity
of oranges sold will have fallen.
Practice Quiz for Chapter 6 1. a 2. a 3. c 4. b 5. c 6. c 7. c 8. b 9. a 10. c
Page 71 Demand falls and Supply rises
Demand rises and Supply falls
Demand rises and Supply is not affected
Demand falls and Supply rises
Demand is not affected; Supply rises
Demand falls and Supply rises
Page 74 Demand rises and Supply falls. The price of the foreign money rises. The dollar depreciates.
Demand falls and Supply rises. The price of the foreign money falls. The dollar appreciates.
Demand falls and Supply rises. The price of the foreign money falls. The dollar appreciates.
Demand rises. The price of the foreign money rises. The dollar depreciates.
Demand rises and Supply falls. The price of the foreign money rises. The dollar depreciates.
Page 77 Savings Low Low Low High
CD Low Low Low High
MMF Low Low Low High
T-Bill Low Low Low High
T-Bond Higher Higher Low Lower
Corp. Bond Higher Higher Low Lower
Stock Higher Higher Low Lower
In this answer, these are in order by expected return, lowest to highest. They are also in order by
risk, lowest to highest, and by liquidity, highest to lowest. None of these assets have any
significant tax advantages.
People will buy the asset with the highest return, T-Bills. This will increase the price of the T-
Bill. As the return rises, the interest rate on the T-Bill falls. This will continue until the return on
the T-Bill is also 5%.
On average, stocks have earned a greater return because they carry greater risk and because they
are less liquid.
Practice Quiz for Chapter 7 1. b 2. b 3. c 4. b 5. a 6. c 7. a 8. b 9. a 10. a
Page 84 1. Any time there are price ceilings there will be shortages. The shortages have shown up as
rolling black outs or brown outs. The companies may have to choose between customers,
cutting off some but not others. The price ceiling reduces any incentive there might be to
2. Eliminating inflation by wage and price controls creates shortages. There were shortages of
workers and shortages of many goods. The rationing was commonly done through long lines
as well as seller choice of buyer. The were black and gray markets for many goods.
3. At the price of zero, the demand to enter the U.S. well exceeds the number of immigrants
allowed. There are long lists of people wanting to migrate, with a wait of many years. The
government resolves the shortage by choosing who will enter. Those with family members
already in the U.S. gain first priority. In other countries, those with certain skills are given
priority. The black market is shown by the large number of undocumented migrants.
Page 87 1. The minimum wage is a price floor. At this price fewer people will be hired. In reality, the
reduction in employment because of the minimum wage is very small. More people will desire
to work at the higher wage. There will be a surplus of workers --- unemployment. Today, the
minimum wage is so low that the number of unemployed is small.
2. The reduced demand for workers should lead to lower wages. But the union creates a wage
floor. Since wages do not fall, the number of workers hired is smaller and the number desiring
to work is larger. There is a surplus of workers --- unemployment. The persistence of
unemployment requires both a decrease in demand and a wage floor.
Practice Quiz for Chapter 8 1. a 2. d 3. b 4. b 5. b 6. a 7. b 8. e 9. d 10. c
Page 91 1. The Federal Reserve Decreases the Money Supply --- Shift Left
2. Workers Receive Higher Wages --- Shift Right
3. The American Dollar Depreciates --- Shift Right
4. Taxes on Personal Incomes are Decreased --- Shift Right
5. Taxes on Businesses are Increased --- Shift Left
6. Government Purchases Decrease --- Shift Left
7. Foreign Incomes Increase --- Shift Right
8. The GDP Deflator Rises --- Move Along
Page 93 1. The Productivity of American Workers Increases at a More Rapid Rate -- Shift Right
2. Workers Receive Higher Wages – Shift Left
3. An Increase in the Price of Oil, Used in the Production of Most Products – Shift Left
4. A Government Subsidy to Business to Buy More Capital Goods – Shift Right
5. Government Regulations Which Raise Costs of Production to Businesses – Shift Left
6. A Depreciation of the Dollar (Which Affects the Prices of Imported Parts and Materials
Used in Production) – Shift Left
7. An Increase in the GDP Deflator --- Move Along
Page 98 a. The three changes all would decrease aggregate demand (shift it to the left). Both Real
GDP and the GDP Deflator would decrease.
b. The depreciation of the peso would shift aggregate demand to the right and shift aggregate
supply to the left (by raising costs of imported materials). Both shifts cause the GDP
Deflator to rise. If the shift in supply is larger, the Real GDP falls.
c. Reduced wages would shift aggregate demand to the left and shift aggregate supply to the
right (by lowering costs of production). Both shifts would lower the GDP Deflator. If the
shift in aggregate demand is larger, the Real GDP will fall.
d. No statement can be made for sure concerning the GDP Deflator. But it is certain that the
Real GDP will fall. Mexico had a recession (actually a severe depression).
Practice Quiz for Chapter 9 1. c 2. d 3. d 4. b 5. b 6. a 7. b 8. c 9. d 10. c
Page 106 This economy will experience recession. The total spending (aggregate demand) of $9,000
--- $8,000 of consumption and $1,000 of business investment spending --- is not enough to
buy the Potential Real GDP of $10,000. Either production will fall (recession) or prices
will fall (deflation).
Page 109 In the first case, total spending would equal $95,000. This is “too low” and would cause a
recession. In the second case, total spending would equal $115,000. This is “too high” and
would cause inflation. The government should spend $15,000 to bring the total spending up
to $100,000. This would give the government a budget deficit of $5,000 ($15,000 –
$10,000). The budget deficit is paid for by borrowing $5,000 from the savers.
Page 110 A large budget surplus at a time of impending recession would tend to make the recession
worse. The government needs to add to total spending, not subtract from it. To reduce the
budget surpluses, the government could lower taxes, stimulating consumer or business
investment spending. It could increase its own purchases. Or it could pay off the national
debt, adding to the pool of savings.
Page 112 With the government, total spending (aggregate demand) equal $106,000 ($85,000 - $5,000 +
$10,000 + $6,000 + $10,000). This would cause inflation, as total spending exceeds Potential
Real GDP. To avoid the inflation, the government should spend only $4,000. This would make
the four categories of spending add up to $100,000. The government would then have a surplus
of $6,000 ($4,000 - $40,000) which it would add to the savings to pay for the additional desired
business investment spending and for the $1,000 extra on imports.
The amount of national income that households do not spend on goods and services produced
in the United States must be made up by the other spenders – businesses, government, and
foreigners. This means that Savings + Taxes + Imports must equal Investment Spending
+Government Purchases + Exports. If Savings are nearly equal to Business Investment
Spending, then if government purchases exceed tax revenues, the imports must exceed the
exports to make the two sides balance.
Practice Quiz for Chapter 10 1. c 2. a 3. b 4. a 5. a 6. c 7. b 8. c 9. a 10. a
Page 128 If interest rates fall, consumer spending will rise because it is less rewarding to save and
cheaper to borrow. Business investment spending will rise because it is cheaper to borrow. Net
exports will rise because the dollar will appreciate.
If there is an inflationary gap. Prices will rise, reducing aggregate demand, wages will rise
increasing costs of production and shifting aggregate supply to the left, and real interest rates
will rise shifting aggregate demand to the left. The gap will be eliminated.
Page 130 Aggregate supply is vertical because the Real GDP will always be the same (equal to the
Potential Real GDP). Except temporarily, it will not vary from that amount.
An increase in the money supply will shift aggregate demand to the right. The result is
That prices will rise --- inflation.
Page 132 A recession in the United States would reduce the demand for foreign money. The exchange
rate would fall. This would create a profitable opportunity. Someone would buy gold in other
countries, ship it to the United States, convert it to dollars in the United States, and sell the
dollars on the foreign exchange market for a profit. The money supply would rise in the
United States, reducing the recession. The money supply would fall in other countries,
spreading the recession to them. Selling the dollars on the foreign exchange market would
bring the exchange rate back to its original fixed level.
Page 133 The equation of exchange is M x V = P x Q. If V is constant and M does not grow because
there are no findings of gold, then aggregate demand will not change. If Q is growing, P must
fall. This is deflation. It was the main experience from 1876 to 1896.
Practice Quiz for Chapter 11 1. d 2. b 3. a 4. b 5. d 6. c 7. b 8. d 9. a 10. c
Page 141 1. 1929 5.85% 1934 1.02 – 2.6 = -1.58% 1938 .81 + 2.4 = 3.21%
1930 3.59 + 3 = 6.59% 1935 .75 – 2.5 = -1.75% 1939 .59 + 1.2 = 1.79%
1931 2.64 + 8.2 = 10.84% 1936 .75-1.25 = - .50% 1940 .56 – 1.2 = - 0.64%
1932 2.73 + 10.1 = 12.83% 1937 .94 – 3.7 = -2.66% 1941 .53 – 4.6 = - 4.07%
1933 1.73 + 5 = 6.73%
Real interest rates rose and were very high from 1929 to 1933. Through must of the rest of
the decade, they were negative, which should have increased consumer and business
2. M fell 26.5%. P fell about 24%. Q fell about 28.9%. To keep the equation of exchange in
balance, V must have fallen about 26%. V was not a constant, as predicted by the Classical
Page 143 1. A horizontal short-run aggregate supply means that, if aggregate demand increases for some
reason, production (Real Gross Domestic Product) will rise but prices will stay the same. In
a period of severe recession, companies would not have to raise their prices. When they
increase production, they need more workers. But in a period of severe recession, they can
hire more workers without having to pay higher wages. In a normal period, to hire some
workers as they increase production, companies would indeed have to raise wages. This
would force them to raise prices (yielding the upward-sloping aggregate supply curve we
2. In the 1990 recession, Keynes would advice that the government take action. Failing to act
will only cause the recession to go on and on. The action could be an increase in
government spending or a decrease in taxes (or both)
Page 144 The New Deal programs may have reduced the economic problem somewhat. They may have
also made the problem easier. But a look at the data for Real Gross Domestic Product,
unemployment, and wages shows that the Great Depression was far from over in 1941, eight
years after the New Deal began.
Practice Quiz for Chapter 12 1. b 2-5. a,b,e,g 6. c 7. b 8. c 9. c 10. a
Page 148 (1) Fill in the following consumption function:
Disposable Income Consumption Savings
0 1000 -1000
1000 1900 - 900
2000 2800 - 800
3000 3700 - 700
4000 4600 - 600
5000 5500 - 500
6000 6400 - 400
7000 7300 - 300
8000 7200 - 200
9000 9100 - 100
10,000 10,000 0
11,000 10,900 100
12,000 11,800 200
13,000 12,700 300
14,000 13,600 400
15,000 14,500 500
16,000 15,400 600
17,000 16,300 700
18,000 17,200 800
19,000 18,100 900
20,000 19,000 1000
21,000 19,900 1100
22,000 20,800 1200
23,000 21,700 1300
24,000 22,600 1400
25,000 23,500 1500
(2) Calculate the marginal propensity to consume. _____9/10___________
Calculate the marginal propensity to save. _______1/10______________
(3) If disposable income is 10,000, what is the average propensity to consume?
If disposable income is 20,000, what is the average propensity to consume?
Therefore, as disposable income rises from 10,000 to 20,000, consumption __rises_____
And the average propensity to consume ____falls_________ (answer “rises” or “falls”).
Page 150 (1)
National Income ($7,000)
Business Savings Loans Businesses
(2) Equilibrium Real GDP is equal to 12,000, where aggregate demand (C+I) is equal to National Income. If income
were 1000 (25,000), consumption plus investment spending equal 2100 (23,700). There would be shortages of 1100
(surpluses of 1700). This is a change in unintended inventory investment. Orders from manufacturers would rise (fall).
As a result, production (real GDP) would rise (fall).
Page 152 1. If income were 2000 (16,000), consumption plus investment spending plus government spending equal
3100 (15,700). There would be shortages of 1100 (surpluses of 300). This is a change in unintended inventory
investment. Orders from manufacturers would rise (fall). As a result, production (real GDP) would rise (fall).
Disposable Income National Income ($14,000)
($1,000 Net Taxes) Purchases
Business Savings Loans Businesses
(7,000 Widgets @ a Price of $20 Each)
3. Equilibrium Real GDP is equal to 13,000, where aggregate demand (C+I+G) is equal to
Page 153 1. If income were 2000 (16,000), consumption plus investment spending plus government spending plus
exports minus imports equal 3100 (15,700). There would be shortages of 1100 (surpluses of 300). This is a change in
unintended inventory investment. Orders from manufacturers would rise (fall). As a result, production (real GDP)
would rise (fall).
Disposable Income National Income ($14,000)
($1,000 Net Taxes) Purchases(G)
Bu siness Savings Loans(I) Businesses
3. Equilibrium Real GDP is equal to 13,000, where aggregate demand (C+I+G +Exports -
Imports) is equal to National Income.
Page 154. There is an inflationary gap of $3000 ($13,000 - $10,000)
Page 157. 5 3 10 1
Page 157. Decrease in government purchases of 500 times the government purchases multiplier of 10
equals a decrease in equilibrium real GDP of 5000. Since it was 13,000, it is now 8000. There is now a
recessionary gap of 2000 (8000 – 10,000). The multiplier is 1 divided by 1 – 9/10 = 10. 9/10 is the
marginal propensity to consume.
To eliminate all gaps, government purchases should have been reduced by 300 (to 700). 300
times 10 equals 3000. Starting from 13,000, the decrease of 3000 would bring equilibrium real GDP down
to 10,000 (equal to Potential Real GDP).
Practice Quiz for Chapter 13. 1. d 2. a 3. c 4. e 5. c 6. a 7. b 8. b 9. b 10. d
Page 163. Japanese workers treat their semi-annual bonuses as transitory income. Therefore, they save
most of them. They live on their regular monthly income.
Page 164. Since Japanese people are more likely than American people to work in family owned
businesses, their incomes are less certain from year to year. With less certain incomes, they are more likely
Page 166. Raising taxes on the rich to lower taxes for the middle class would increase consumer spending.
The rich people would be more likely to save while the middle class people would be more likely to spend.
Since 1980, the distribution of income in the United States has become more unequal. This
should have decreased consumer spending and increased saving because the richer people are more likely
Page 168. The average price would likely be close to $300,000 today. This is a large increase in wealth,
which would increase consumer spending.
Page 169. The rise in per capita income, the fall in interest rates, the slowing of the rise if prices
(disinflation), the rise in consumer confidence, and the rise in stock prices all point to an increase in
consumer spending. The rise is debt is the only statistic pointing to a decline in consumer spending.
Unless its effect is very large, one would expect consumer spending to rise in 1998. Indeed, that is what
Practice Quiz for Chapter 14. 1. B 2. D 3. A 4. A 5. A 6. A 7. B 8. B 9. A 10. B
Page 174 Depreciation rose from about 75% of business investment spending to about 85%. In some
years, it was over 90%. Thus, it rose, although not in every year.
The recession years were those years in which net investment spending as a percent of GDP fell.
Years such as 1974-75, 1982-83, 1990-92, and so forth. Other years where this ration fell were not
Examine the table for the net investment spending as a percent of GDP. Years in which this
number was close to 2 ½% or more are years of good performance. Years below this, and especially below
2% are poor performance. But you must also look at the trend of this number --- is it improving or falling.
Just about half of the rise in gross investment spending can be attributed to information
equipment and software.
Page 176 What trend there is suggests that the percent of corporate profits paid as taxes fell.
What trend there is suggests that the percent of corporate profits after taxes paid as dividends to
the owners has risen.
For the most part, retained after-tax profits were high in the years that business investment
spending was high and vice versa.
For the most part, stock prices were high and rising in the years that business investment
spending was high and vice versa.
Personal savings rates do not correlate well with business investment spending. This results
because businesses use corporate profits to finance business investment spending.
Page 178 Although the trend is not continuous, generally depreciation did become a higher percent of
gross private investment spending. And it did so especially in the years during which business investment
spending was low. This could indicate that the expected lifetime of capital goods is becoming shorter.
Page 179 Generally, capacity utilization was below 80% in recession years and above 80% in other
years. However, in some of the years with poor investment performance, capacity utilization was above
Page 181 Raw materials and labor costs rose greatly in the 1970s, when the investment performance was
poor. Since the early 1980s, these costs rose very slowly (except for raw materials prices in 2000). This
helped in the years when investment performance was good but did not cause the other years of poor
investment performance since 1980.
Page 182 This relies on your summary of the above information. In different years, the poor investment
performance was caused by different factors. The Internet assignment is left for you.
Page 185 This one is left for you.
Practice Quiz for Chapter 15 1. D 2. B 3. B 4. B 5. A 6. A 7. A 8. B 9. B 10. D
Page 188-189 Internet assignments are left for you. The answer will be different each year.
Page 190 Internet assignments are left for you. The answer will be different each year.
Page 192 Social Security and Medicare spending have risen because the proportion of the population
over age 65 has been rising. People are living longer. In addition, health care costs have risen due to
technology. And the COLA for Social Security is based on the CPI, which overstates the rise in the cost of
Calculate the real government spending by taking the actual government spending and
dividing by the GDP Deflator, expressed as a fraction. So, for example, in 1980 take $590.9 and divided
by .5704 and you get $1035.94. If you take the percentage change from 1980 to 1988 and again from 1989
to 1992 and compare your numbers with the percentage change from 1993 to 2000, you should see a slight
slowing of the growth rate.
Page 193 Internet assignments are left for you. The answer will be different each year.
Page 197 Social Security has probably led to earlier retirement by providing people income so that
they could afford to retire.
Social Security may have reduced savings, since people now need to save less for
retirement (a major reason for saving). However, it is possible that, if people are retiring earlier, they will
need to save even more in their working years.
The Internet question is left for you.
Practice Quiz for Chapter 16 1. A 2. B 3. A 4. C 5. D 6. A 7. D 8. A 9. B 10. D
Page 202 The Internet question is left for you. You will find that taxes as a percent of GDP are lower
in the United States than in most other countries.
Page 203 $0.14 $154.16
Page 204 4.5%
Page 204 34% 49% 68%
Page 205 regressive; regressive; proportional; regressive
Page 206 In both cases, poorer people devote a higher percent of their incomes to the item (gasoline or
cigarettes). Since more of their income is subject to the tax, these taxes are regressive. Even if a poor
person does not own a car, that person will pay the gasoline tax in bus fare.
Page 207 Average Tax Rate Marginal Tax Rate
The Internet Assignments are left for you.
Page 208 Tax is $1,389.20. The savings equal $453.80.
Page 209 1. All $10,000 of the capital gain is now taxable income. In addition, eliminate the deduction
for sales taxes paid and for consumer debt interest. The new adjusted gross income is now $20,000. This
puts the person in the 15% marginal tax rate. 15% of $20,000 equals $3,000. The person’s tax increased
by $1,610.80 because of the higher income taxed and the loss of two deductions. In this calculation, it is
assumed that the taxpayer can still take the business loss and the medical deduction. Such may not be the
2. In 1980, you would have paid 70% of $4,000, or $2,800. In 1986, you would have paid
28% of $10,000, or $2,800. In 1992, you would have paid 31% of $10,000, or $3,100.
Page 210 1. The adjusted gross income would still be $20,000. So, the tax due would still be 15% of
$20,000, or $3,000.
2. Today, you would pay 20% of $10,000, or $2,000.
Practice Quiz for Chapter 17 1. A 2. C 3. A 4. C 5. A 6. B 7. C 8. A 9. C 10. A
Page 217 4 2 10
Page 217 1. Government spending should increase by $8000.
Taxes should decrease by $10,000.
Transfers should increase by $10,000.
2. Equilibrium Real GDP is now $9,000.
There is a recessionary gap of $1,000.
3. Equilibrium Real GDP would be $10,000 with no gap.
Page 220 Because there are fewer tax brackets and because the rates became less progressive, the
Tax system came to have less of a stabilizing effect.
Year (Fiscal) Deficit (Billions) Unemployment Rate Structural Budget Deficit
1960 - 0.3 5.5% - 45.3
1961 3.3 6.7% -77.7
1962 7.1 5.5% -37.9
1963 4.8 5.7% -46.2
1964 5.9 5.2% -30.1
1965 1.4 4.5% -13.6
1966 3.7 3.8% 9.7
1967 8.6 3.8% 14.6
1968 25.2 3.6% 37.2
1969 –3.2 3.5% 11.8
1970 2.8 4.9% -24.2
1971 23.0 5.9% -34
1972 23.4 5.6% -24.6
1973 14.9 4.9% -12.1
1974 6.1 5.6% -11.9
1975 53.2 8.5% -81.8
1976 73.7 7.7% -37.3
1977 53.7 7.1% -39.3
1978 59.2 6.1% - 3.8
1979 40.7 5.8% -13.3
1980 73.8 7.1% -19.2
1981 79.0 7.6% -29
1982 128.0 9.7% -43
1983 207.8 9.6% 39.8
1984 185.4 7.5% 80.4
1985 212.3 7.2% 116.3
1986 221.2 7.0% 111.2
1987 149.8 6.2% 83.8
1988 155.2 5.5% 110.2
1989 152.5 5.3% 113.5
- = surplus rate taken in December
Examine the data. The correspondence between rising structural deficits and falling
unemployment (or vice versa) is a very weak one. Obviously, other factors have a stronger effect
2. Fiscal Year Official Budget Deficit (billions) Unemployment Rate
1992 $290 7.5% $185
1993 $255 6.9% 168
1994 $203 6.1% 140
1995 $164 5.6% 116
1996 $107 5.4% 65
1997 $ 22 4.9% - 5
1998 -$ 69 (Surplus) 4.5% - 84
1999 -$125 (Surplus) 4.2% -131
2000 -$236 (Surplus) 4.0% -236
2001 -$127 (Surplus) 4.8% -151
Fiscal policy was contractionary from 1992 to 2000? More of the $417 billion decline of the deficit (290
billion to minus $127 billion) is due to the actions of the government ($336 billion) than due to the
automatic stabilizers ($81 billion).
3. In 2001, the surplus was $127 billion. The unemployment rate was 4.8%. Therefore, using our
“ballpark” figure, 0.8 times $30 billion (=$24 billion) is due to the automatic stabilizers. (The CBO
estimate of this is $20 billion. So, our “ballpark” estimate is close.) The remaining $103 billion would be
the structural surplus. ($107 billion according to the CBO estimate.) In 2002, the projected deficit is $157
billion. The projected unemployment rate is 5.9%. So using our “ballpark” figure, 1.9 times $30 billion
(equals $57 billion) is due to the automatic stabilizers. The remaining $100 billion would be the structural
deficit. (The CBO estimate is that $40 billion is due to the automatic stabilizers and that the structural
deficit is $117 billion.) So the structural deficit went from a $103 billion surplus to a $100 billion deficit --
- a change of $203 billion in one year. (The CBO estimate is that the change was $224 billion.) Of the
actual change in the deficit of $284 billion ($127 billion plus $157 billion), $203 billion was caused by
government policies ($224 billion according to the CBO). Only $81 billion ($60 billion according to the
CBO) was caused by the worsening economy. According to the CBO estimate, of the change in the
structural deficit, about 39% was due to the tax reduction of 2001, another 28% was due to the Job Creation
and Worker Assistance Act, and another 21% was due to the increases in defense and related spending
following September 11, 2001. In 2003, the budget deficit is projected to drop to $145 billion. Since the
unemployment rate is projected to remain unchanged, none of this drop would be due to an improving
economy. The structural deficit for 2003 would be $145 billion minus $57 billion (1.9 times $30 billion),
which equals $88 billion. The structural deficit would drop from $100 billion to $88 billion due to the end
of some temporary changes that were made in 2001 (the shifting of the timing of some government
spending and some unusually large tax refunds due to excessive withholding in 2001 and to reduced capital
gains as the stock market plummeted.
Page 225 true; true; false; false; false; false
Page 228 85% percent of the total federal (national) debt has occurred since 1980?
Year Total Held by the Federal Government
1946 $270.9 $29.1
1970 380.9 97.7
1980 909.1 197.1
Year(2002) 6137.1 2,659.6
Page 230 The main advantage to paying off the national debt is that doing so would add to the pool of
savings. More savings would lower interest rates. Lower interest rates would encourage business
investment spending. More business investment spending on capital goods would increase Real GDP.
Practice Quiz for Chapter 18 1. C 2. C 3. D 4. B 5. A 6. D 7. B 8. D 9. B 10. A
Page 235 If there is a recession in the United States, the demand for yen would fall. The price of the yen
would fall. The dollar would appreciate and the yen would depreciate. This would lower American
exports and increase American imports.
Under the Gold Standard, gold would leave Japan and enter the United States. Gold entering
the United States would increase spending here, helping to end the recession. But gold leaving Japan
would reduce spending there, causing a recession in Japan.
Under Bretton Woods, the Federal Reserve Bank in New York and the Bank of Japan would
both buy yen (sell dollars). The increased number of dollars held by Americans would reduce the recession
here. The reduced number of yen held by Japanese would cause a recession there.
Practice Quiz for Chapter 19 1. B 2. C 3. C 4. B 5. D
Page 243 You need to plot the data yourself to see the trade-off in the 1960s, the shift to the right in the
1970s, and the shift back to the left since then. The combination of inflation and unemployment that
existed in 2000 represents both lower inflation and also lower unemployment than existed in the 1970s or
Page 246. You would expect the rise in the price of oil to cause Real GDP to fall, unemployment rates to
rise, and inflation rates to rise. Real GDP did indeed fall and unemployment rates did indeed rise.
However, there are many causes of these changes. The inflation rate did not rise. Partly this may result
because the price of oil did not stay high. Instead, after rising, it fell back. It also may be true that the
American economy is less dependent on oil than it was in the 1970s.
Practice Quiz for Chapter 20. 1. A 2. A 3. A 4. B 5. B
All of the assignments in this chapter are internet related assignments or are answered in the body of the
text. The answers will be different depending on the time that you look up the information.
Practice Quiz for Chapter 21. 1. B 2. A 3. B 4. A 5. F 6. D 7. G 8. I 9. A 10. B
Page 268. 1. Total Reserves = $10,000. Required Reserves = $2,000. Excess Reserves = $8,000
M-1 will grow by 0
2. Total Reserves = $10,000. Required Reserves = $2,000. Excess Reserves = $8,000
M-1 will grow by $8,000
Page 269 3. Bank A: Total Reserves = $2,000 Required Reserves = $2,000 Excess Reserves = 0
Bank B: Total Reserves = $8,000 Required Reserves = $1,600 Excess Reserves = $6,400
4. $10,000 times 5 = $50,000
Page 269 There would then be $1,000 of excess reserves. The bank could make a new loan of $1,000 and
The money supply would rise.
Page 270 1. If banks hold excess reserves, the money supply declines because they do not make new
2. As interest rates rise, the money supply rises because (1) people hold checking accounts
instead of currency (so the banks can make new loans) and (2) because people hold more
time deposits instead of checkable deposits (where the reserve requirement is lower).
Page 271 1. This is for you to do in your own words.
2. Excess reserves increase by $1,000. The money supply increases by $1,000 times 10 =
$10,000. The multiplier rises from 5 to 10.
Page 273 1. This is for you to do in your own words.
2. Monetary base rises by $1,000. Excess reserves rise by $1,000. The money supply rises
by $1,000 times 5 = $5,000.
Page 274 1. When the Fed sells Treasury securities, the dealer gets the securities. The Fed gets the IOU
of the Fed. Since the Fed would then owe itself, the debt ceases to exist. Since the debt is
money, the money supply decreases.
2. Monetary base rises by $1,000. Excess reserves rise by $1,000. The money supply rises
by $1,000 times 5 = $5,000.
Page 275 1. This is for you to do in your own words.
2. Since the interest payment is fixed, the interest rate adjusts as the price changes. Say there is
a $10,000 one-year security with an interest rate of 5%. At the end of the year, the recipient
will get $10,000 plus $500, or $10,500. Suppose the price falls to $9,000. The recipient
will still get $10,500 at the end of the year. This is a return of $1,500 on a payment of
$9,000,or 16 2/3%.
Practice Quiz for Chapter 22. 1. A 2. A 3. C 4. B 5. A 6. C 7. B 8. C 9. A 10. B
Page 282 1. shift to the right 2. shift to the right 3. move along 4. shift to the right
Page 282 The supply of money rises as interest rates rise because, as interest rates rise, people are more
likely to hold checking accounts rather than currency and also because people are more likely
to hold savings accounts, CDs, and so forth (that have a zero reserve requirement) rather than
Page 284 There is a recessionary gap of $100 billion. With a marginal propensity to consume of 9/10,
The expenditures multiplier is equal to 10 (1 divided by 1-9/10). Therefore, business
investment spending needs to increase by $10 billion ($10 billion times 10 = the needed $100
billion). This means that real interest rates need to fall by 2 percentage points. To make this
happen, the money supply needs to increase by $20 billion. (If the money multiplier is equal to
10, the monetary base would need to be increased by $2 billion, as $2 billion times 10 would
equal the needed $20 billion.)
Page 284 Both cases are identical. In both cases, shift the demand for money to the right. The result is
That interest rates rise.
Page 287 1. falls; rising
Page 288 2. Some reasons for the downward trend in the demand for money might be a better ability to
manage one’s money due to computer technology (this might be especially true for
businesses), the greater availability of credit cards (reducing the need to hold money), more
convenient ability to obtain funds through ATMs and so on, a greater number of savings
options that are alternatives to money, perhaps the advent of computer banking, and so on.
You may be able to come up with some other reasons.
Page 290 12.4 weeks is equal to .238 of a year (12.4 divide by 52). 4% of 140.9 million is equal to 5.636
million. So 5.636 million people were unemployed on average over the year. If each person
was unemployed an average of .238 of a year, then 23.681 million must have gone through the
job search process in the year (5.636 divided by .238). Of course, the real number is a bit
different because the unemployment rate and the duration of unemployment were not the same
Page 290 The use of temporary agencies has reduced the duration of unemployment by matching
workers with jobs. The reduction in the number of 16 to 19 year olds has reduced the number
of people who are likely to quit a job and look for a different job several times in a year. And
the greater experience of female workers means that they are likely to stay on a job longer and
that they do not need as long as they once needed to find a new job.
Page 293 1. Similarities include: velocity being seen as constant, there being no cyclical unemployment
except temporarily, production being at Potential Real GDP in the long run, inflation being
caused only by increases in the money supply, and so forth.
2. An increase in the price of oil would raise prices of goods and services that depend on oil
for their production. With only so much demand, if people had to spend more on these goods,
they would have to spend less on other goods. The average price would not change. Even if it
did, prices would rise but then stop rising. The analogy is to a campfire. If it is lit, it will burn.
But if you just watch it, it will burn itself out. Inflation, in their view, cannot persist without an
increase in the money supply.
Practice Quiz for Chapter 23 1. B 2. A 3. C 4. C 5. B 6. C 7. A 8. C 9. B 10. D
Page 305 Monetary policy is expansionary when the money supply is increasing at a faster rate and when
the interest rate is falling. It was quite expansionary during the recession years of 1969 to 1971
and 1974 to 1975. Otherwise, the effect is more modest.
Page 306 Assume that the natural rate of unemployment was 4.5%. The increase in the money supply
should be consistent with a rise in the rate of change of wages, a rise in the inflation rate, and a
fall in the unemployment rate. And it basically is. As unemployment falls below 4.5%, the
inflation rate should be rising faster and faster. This does not occur.
Page 306 Other factors include the rise in government spending, the budget deficits, the rise in oil prices
after 1972, and so on.
Page 306 decrease; increase; decrease; decreases; decreases; decrease; decrease
For the description of the short-run and the long-run as well as the graphs, see the next section
of the chapter.
Page 312 Based on the growth of the money supply and interest rates, monetary policy was expansionary
mainly until 1983. It was reasonably contractionary after that.
Page 313 The expansionary monetary policy period is associated with a rise in unemployment and a
decline in inflation. Clearly, the expansionary policy was a response to the economic
problems, not a cause. The contractionary period is associated with a fall in the unemployment
rate, a fall in the inflation rate, and a much slower growth of wages. This is exactly what the
view of the Monetarist economists would predict.
Page 313 Other factors would include the tax reductions, the defense spending, the very high budget
deficits, the decline in oil prices, and so forth.
Page 316 1. Keynesian 2. Monetarist 3. Classical and Monetarist 4. Classical
5. Monetarist 6. Keynesian 7. Monetarist 8. Monetarist
9. Monetarist 10. Monetarist
Practice Quiz for Chapter 24 1. C 2. A 3. B 4. A 5. B
6. B 7. A 8. B 9. A 10. A
Page 322 In 1980, the person would have been in the 39% marginal tax rate. So $3,900 would have
gone to the government in taxes. In 2000, the person would have been in the 28% marginal
tax rate. So $2,800 would have gone to the government in taxes. Keeping the additional
$1,100 might provide a greater incentive to earn the extra income.
Page 327 A supply side economist would recommend a reduction in marginal tax rates. This is indeed
what was proposed by President George W. Bush. The reduction in marginal tax rates, they
would argue, would provide greater incentives to work, save, and otherwise earn income.
Income would rise so much that the recession would end. Tax revenues would rise and the
budget deficits would decline. That, at least, would be their argument.
Page 330 You will see that government spending in California was reduced somewhat. And there were
small tax increases (called “revenue enhancements”). But these all were very small and will
have little overall economic effect. Had government spending been reduced more or taxes
increased more (as may have to happen in 2003), the effect could be to worsen the recession.
The state of California found legal ways to borrow, even though budget deficits are not
Page 330 You will see the answers you need when you read the next section of the text.