The instructor’s material that accompanies the five versions of Mankiw’s Principles of Economics, Fourth Edition textbooks address the needs of both novice and experienced instructors. To meet the needs of these two groups, this Instructor’s Manual with Solutions Manual comprises both chapter outlines and teaching tips as well as solutions to all of the questions and problems found in the textbook. Linda Ghent of Eastern Illinois University prepared the main portion of each chapter including a synopsis of what is new in this edition compared to the third edition. Her work for each chapter also includes a list of learning objectives and key points. These items are followed by detailed chapter outlines that focus on the content found in the textbook. Helpful tips and icons occasionally interrupt these outlines. The bomb icon (Warnings) indicates areas where students may have particular difficulty with the material. The light bulb icon (Bright Ideas) offers ideas for presenting the material in a new or more thoughtful way. Also included in each chapter of the Instructor’s Manual are classroom activities, developed in part by Charles Stull of Kalamazoo College. Each activity provides important details to assist in planning as well as clear instructions for leading the activity. Recommended “Points for Discussion” connect the activity to the relevant economic concepts discussed in the chapter. Using these resources, an instructor can quickly review the chapter learning objectives and chapter summaries to make sure their lecture notes cover everything in the text chapter. In addition, the chapter outlines are designed as a base for creating lecture notes for novice instructors. They may also be used as a complete set of notes for more experienced instructors. Therefore, this supplement is also available electronically from the product support Web site (http:mankiw.swlearning.com). For queries and grading, the Instructor’s Manual contains solutions to exercises from the textbook. Dean Croushore (University of Richmond) prepared many of the solutions for the “Quick Quizzes,” “ Questions for Review,” and “Problems and Applications” found in the textbook.
Trang 1Instructor's Manual with Solutions Manual
Eastern Illinois University
Trang 2Instructor’s Manual Principles of Macroeconomics, 4 th Edition
N Gregory Mankiw Prepared by Linda S Ghent
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Trang 3The instructor’s material that accompanies the five versions of Mankiw’s Principles of Economics, Fourth Edition textbooks address the needs of both novice and experienced instructors To meet the needs of these two groups, this Instructor’s Manual with
Solutions Manual comprises both chapter outlines and teaching tips as well as solutions
to all of the questions and problems found in the textbook.
Linda Ghent of Eastern Illinois University prepared the main portion of each chapter including a synopsis of what is new in this edition compared to the third edition Her work for each chapter also includes a list of learning objectives and key points These items are followed by detailed chapter outlines that focus on the content found in the textbook Helpful tips and icons occasionally interrupt these outlines The bomb icon (Warnings) indicates areas where students may have particular difficulty with the material The light bulb icon (Bright Ideas) offers ideas for presenting the material in a new or more thoughtful way Also included in each chapter of the Instructor’s Manual are classroom activities, developed in part by Charles Stull of Kalamazoo College Each activity provides important details to assist in planning as well as clear instructions for leading the activity Recommended “Points for Discussion” connect the activity to the relevant economic concepts discussed in the chapter.
Using these resources, an instructor can quickly review the chapter learning objectives and chapter summaries to make sure their lecture notes cover everything in the text chapter In addition, the chapter outlines are designed as a base for creating lecture notes for novice instructors They may also be used as a complete set of notes for more experienced instructors Therefore, this supplement is also available electronically from the product support Web site (http://mankiw.swlearning.com).
For queries and grading, the Instructor’s Manual contains solutions to exercises from the textbook Dean Croushore (University of Richmond) prepared many of the solutions for the “Quick Quizzes,” “ Questions for Review,” and “Problems and Applications” found in the textbook.
Trang 4Comparative Table of Contents
BriefMacro
7 Consumers, Producers, and the Efficiency of Markets 7 7 7
Part 5: Firm Behavior and the Organization of Industry Part 5 Part 5
34 The Influence of Monetary and Fiscal Policy on Aggregate Demand 21 24 16
Trang 5Chapter 3 Interdependence and the Gains from Trade 37 Chapter 4 The Market Forces of Supply and Demand 53
Chapter 6 Supply, Demand, and Government Policies 111 Chapter 7 Consumers, Producers, and the Efficiency of Markets 131 Chapter 8 Application: The Costs of Taxation 155
Chapter 13 Saving, Investment, and the Financial System 239
Chapter 18 Open-Economy Macroeconomics: Basic Concepts 323 Chapter 19 A Macroeconomic Theory of the Open Economy 341 Chapter 20 Aggregate Demand and Aggregate Supply 367 Chapter 21 The Influence of Monetary and Fiscal Policy
Trang 7WHAT’S NEW IN THE FOURTH EDITION:
The discussion of Principle #3, “Rational people think at the margin,” is more thorough and has a newexample The discussions of Principle #4, “People respond to incentives,” Principle #7, “Governmentscan sometimes improve market outcomes,” and Principle #10, “Society faces a short-run trade-offbetween inflation and unemployment” have been clarified Definitions for the terms “rational,”
“incentives,” and “property rights” have been added
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
¾ that economics is about the allocation of scarce resources
¾ that individuals face trade-offs
¾ the meaning of opportunity cost
¾ how to use marginal reasoning when making decisions
¾ how incentives affect people’s behavior
¾ why trade among people or nations can be good for everyone
¾ why markets are a good, but not perfect, way to allocate resources
¾ what determines some trends in the overall economy
CONTEXT AND PURPOSE:
Chapter 1 is the first chapter in a three-chapter section that serves as the introduction to the text.Chapter 1 introduces ten fundamental principles on which the study of economics is based In a broadsense, the rest of the text is an elaboration on these ten principles Chapter 2 will develop how
economists approach problems while Chapter 3 will explain how individuals and countries gain fromtrade
The purpose of Chapter 1 is to lay out ten economic principles that will serve as building blocksfor the rest of the text The ten principles can be grouped into three categories: how people make
Trang 82 ) Chapter 1/Ten Principles of Economics
decisions, how people interact, and how the economy works as a whole Throughout the text, referenceswill be made repeatedly to these ten principles
KEY POINTS:
1 The fundamental lessons about individual decisionmaking are that people face trade-offs amongalternative goals, that the cost of any action is measured in terms of forgone opportunities, thatrational people make decisions by comparing marginal costs and marginal benefits, and that peoplechange their behavior in response to the incentives they face
2 The fundamental lessons about interactions among people are that trade can be mutually beneficial,that markets are usually a good way of coordinating trades among people, and that the governmentcan potentially improve market outcomes if there is some sort of market failure or if the marketoutcome is inequitable
3 The fundamental lessons about the economy as a whole are that productivity is the ultimate source
of living standards, that money growth is the ultimate source of inflation, and that society faces ashort-run trade-off between inflation and unemployment
C Fundamental economic problem: resources are scarce
D Definition of scarcity: the limited nature of society’s resources.
E Definition of economics: the study of how society manages its scarce resources.
You will want to start the semester by explaining to students that part of learning
economics is understanding a new vocabulary Economists generally use very precise
(and sometimes different) definitions for words that are commonly used outside of
the economics discipline Therefore, it will be helpful to students if you follow the
definitions provided in the text as much as possible
Begin by pointing out that economics is a subject that students must confront in their
daily lives Point out that they already spend a great deal of their time thinking about
economic issues: prices, buying decisions, use of their time, etc
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II How People Make Decisions
A Principle #1: People Face Trade-offs
1 “There is no such thing as a free lunch.” Making decisions requires trading one
goal for another
2 Examples include how students spend their time, how a family decides to spend
its income, how the U.S government spends tax dollars, and how regulationsmay protect the environment at a cost to firm owners
3 A special example of a trade-off is the trade-off between efficiency and equity
a Definition of efficiency: the property of society getting the
maximum benefits from its scarce resources.
b Definition of equity: the property of distributing economic
prosperity fairly among the members of society.
c For example, tax dollars paid by wealthy Americans and then distributed
to those less fortunate may improve equity but lower the return to hardwork and therefore reduce the level of output produced by our
resources
d This implies that the cost of this increased equity is a reduction in the
efficient use of our resources
4 Recognizing that trade-offs exist does not indicate what decisions should or will
be made
B Principle #2: The Cost of Something Is What You Give Up to Get It
1 Making decisions requires individuals to consider the benefits and costs of some
action
2 What are the costs of going to college?
Because most college freshmen and sophomores have limited experiences with
viewing the world from a cause-and-effect perspective, do not underestimate how
challenging these principles will be for the student
Table 1
As you discuss the ten principles, make sure that students realize that it is okay if
they do not grasp each of the concepts completely or find each of the arguments
fully convincing These ideas will be explored more completely throughout the text
Trang 104 ) Chapter 1/Ten Principles of Economics
a We cannot count room and board (at least all of the cost) because the
student would have to pay for food and shelter even if he was not inschool
b We would want to count the value of the student’s time because he
could be working for pay instead of attending classes and studying
3 Definition of opportunity cost: whatever must be given up in order to
obtain some item.
C Principle #3: Rational People Think at the Margin
1 Economists generally assume that people are rational
a Definition of rational: systematically and purposefully doing the
best you can to achieve your objectives.
b Consumers want to purchase the bundle of goods and services that
allows them the greatest level of satisfaction given their incomes and theprices they face
c Firms want to produce the level of output that maximizes the profits they
earn
2 Many decisions in life involve incremental decisions: Should I remain in school
this semester? Should I take another course this semester? Should I study anadditional hour for tomorrow’s exam?
a Definition of marginal changes: small incremental adjustments to
a plan of action.
b Example: Suppose that flying a 200-seat plane across the country costs
the airline $100,000, which means that the average cost of each seat is
$500 Suppose that the plane is minutes from departure and a passenger
is willing to pay $300 for a seat Should the airline sell the seat for $300?
In this case, the marginal cost of an additional passenger is very small
c Another example: Why is water so cheap while diamonds are expensive?
Because water is plentiful, the marginal benefit of an additional cup issmall Because diamonds are rare, the marginal benefit of an extradiamond is high
D Principle #4: People Respond to Incentives
1 Definition of incentive: something that induces a person to act.
2 Because rational people make decisions by weighing costs and benefits, their
decisions may change in response to incentives
One of the hardest ideas for students to grasp is that “free” things are not truly free
Thus, you will need to provide students with numerous examples of such “free”
things with hidden costs, especially the value of time
Trang 11Chapter 1/Ten Principles of Economics ) 5
a When the price of a good rises, consumers will buy less of it because its
cost has risen
b When the price of a good rises, producers will allocate more resources to
the production of the good because the benefit from producing the goodhas risen
3 Many public policies change the costs and benefits that people face Sometimes
policymakers fail to understand how policies alter incentives and behavior
4 Example: Seat belt laws increase the use of seat belts and lower the incentives
of individuals to drive safely This leads to an increase in the number of caraccidents This also leads to an increased risk for pedestrians
III How People Interact
A Principle #5: Trade Can Make Everyone Better Off
1 Trade is not like a sports competition, where one side gains and the other side
loses
2 Consider trade that takes place inside your home Your family is likely to be
involved in trade with other families on a daily basis Most families do not buildtheir own homes, make their own clothes, or grow their own food
3 Countries benefit from trading with one another as well
4 Trade allows for specialization in products that countries (or families) can do
best
If you include any incentive-based criteria on your syllabus, discuss it now For
example, if you reward class attendance (or penalize students who do not attend
class), explain to students how this change in the marginal benefit of attending class
(or marginal cost of missing class) can be expected to alter their behavior
Activity 1—Getting Dressed in the Global Economy
Topics: Specialization, interdependence, self-interest, consumer choice,
The advantages of specialization and division of labor are very clear in this example The
worldwide links of the modern economy are also illustrated We depend on thousands of
people we don’t know, won’t see, and don’t think of in order to get dressed each morning
Self-interest follows naturally from interdependence Wages, profits, and rents give people
the incentive to perform these varied tasks We depend on them to clothe us and they
depend on our purchases for their incomes
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Instructions
Ask the class to answer the following questions Give them time to write an answer to eachquestion, then discuss their answers before moving on to the next question The first
question can be answered with a brief phrase The second question is the core of the
assignment and takes several minutes Ask them to list as many categories of workers aspossible The third question introduces demand concepts; most of the determinants ofdemand can be introduced during this discussion For the fourth question, ask the class tolook at the country-of-origin tags sewn in their garments
1 Where did your clothes come from?
2 Who worked to produce your clothes?
3 What things do you consider when buying a garment?
4 Where were your clothes produced (what countries)?
Common Answers and Points for Discussion
1 Where did your clothes come from?
There are many possible ways to answer, but many students will say “the mall” or anotherretail outlet Some may say “a factory,” “a sweatshop,” or “a foreign country.”
Mention the importance of markets here (this can be emphasized by asking, “Is anyonewearing something made by themselves, a friend, or a relative?”) and discuss distributionversus production
2 Who worked to produce your clothes?
There is no end to the possible answers; garment and textile workers are obvious but moststudents will also list workers dealing with raw materials, transportation, management,design, or machinery Some may think more broadly to investors, road crews, bankers,engineers, or accountants
3 What things do you consider when buying a garment?
Most answers focus on preferences (fit, style, quality, color) Price is cited less frequently Askabout the importance of price until someone volunteers that income is important Prices ofsubstitute goods should also be discussed Expectations of price changes may also bementioned
4 Where were your clothes produced (what countries)?
A large number of countries will be represented, even in small classes Asia is always wellrepresented Latin American and European goods appear in smaller numbers African
products are conspicuously absent
This pattern shows the limits of simple explanations such as “cheap labor.” Briefly discuss theimportance of comparative advantage and specialization
Trang 13Chapter 1/Ten Principles of Economics ) 7
B Principle #6: Markets Are Usually a Good Way to Organize Economic Activity
1 Many countries that once had centrally planned economies have abandoned this
system and are trying to develop market economies
2 Definition of market economy: an economy that allocates resources
through the decentralized decisions of many firms and households as they interact in markets for goods and services.
3 Market prices reflect both the value of a product to consumers and the cost of
the resources used to produce it
4 When a government interferes in a market and restricts price from adjusting,
household and firm decisions are not based on the proper information Thus,these decisions may be inefficient
5 Centrally planned economies have failed because they did not allow the market
to work
6 FYI: Adam Smith and the Invisible Hand
a Adam Smith’s 1776 work suggested that although individuals are
motivated by self-interest, an invisible hand guides this self-interest intopromoting society’s economic well-being
b Smith’s astute perceptions will be discussed more fully in the chapters to
come
C Principle #7: Governments Can Sometimes Improve Market Outcomes
1 The invisible hand will only work if the government enforces property rights
a Definition of property rights: the ability of an individual to own
and exercise control over scarce resources.
2 There are two broad reasons for the government to interfere with the economy:
the promotion of efficiency and equity
3 Government policy can be most useful when there is market failure
a Definition of market failure: a situation in which a market left on
its own fails to allocate resources efficiently.
Explain to students that when households and firms do what is best for themselves,
they often end up doing what is best for society, as if guided by market forces—or an
invisible hand Spend some time and emphasize the magic of the market Use
numerous examples to show students that the market most often allocates resources
to their highest valued use
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4 Examples of Market Failure
a Definition of externality: the impact of one person’s actions on
the well-being of a bystander.
b Definition of market power: the ability of a single economic actor
(or small group of actors) to have a substantial influence on market prices.
c Because a market economy rewards people for their ability to produce
things that other people are willing to pay for, there will be an unequaldistribution of economic prosperity
5 Note that the principle states that the government can improve market
outcomes This is not saying that the government always does improve marketoutcomes
IV How the Economy as a Whole Works
A Principle #8: A Country’s Standard of Living Depends on Its Ability to Produce Goods and
Services
1 Differences in living standards from one country to another are quite large
2 Changes in living standards over time are also great
3 The explanation for differences in living standards lies in differences in
productivity
4 Definition of productivity: the quantity of goods and services produced
from each hour of a worker’s time.
5 High productivity implies a high standard of living
6 Thus, policymakers must understand the impact of any policy on our ability to
produce goods and services
B Principle #9: Prices Rise When the Government Prints Too Much Money
1 Definition of inflation: an increase in the overall level of prices in the
C Principle #10: Society Faces a Short-Run Trade-off between Inflation and Unemployment
1 Most economists believe that the short-run effect of a monetary injection is lower
unemployment and higher prices
Trang 15Chapter 1/Ten Principles of Economics ) 9
a An increase in the amount of money in the economy stimulates spending
and increases the quantity of goods and services sold in the economy.The increase in the quantity of goods and services sold will cause firms
to hire additional workers
b An increase in the demand for goods and services leads to higher prices
over time
2 Some economists question whether this relationship still exists
3 The short-run trade-off between inflation and unemployment plays a key role in
the analysis of the business cycle
4 Definition of business cycle: fluctuations in economic activity, such as
employment and production.
5 Policymakers can exploit this trade-off by using various policy instruments, but
the extent and desirability of these interventions is a subject of continuingdebate
D FYI: How to Read this Book
1 Economics is very useful to understand, but it can be a difficult subject to grasp
2 There are five tips to make reading and understanding the material in
the book easier
a Summarize, don’t highlight
b Test yourself At the end of each section of the text, you will find a
“Quick Quiz.” Answers to these “Quick Quizzes” can be found in the back
of this textbook
c Practice, practice, practice
d Go online and use the website for this text
e Study in groups
f Don’t forget the real world
Trang 1610 ) Chapter 1/Ten Principles of Economics
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
The answers to the Quick Quizzes can also be found near the end of the textbook
1 The four principles of economic decision making are: (1) people face trade-offs; (2) the cost of
something is what you give up to get it; (3) rational people think at the margin; and (4) peoplerespond to incentives People face trade-offs because to get one thing that they like, theyusually have to give up another thing that they like The cost of something is what you give up
to get it, not just in terms of monetary costs but all opportunity costs Rational people think atthe margin by taking an action if and only if the marginal benefit exceeds the marginal cost.People respond to incentives because they choose activities by comparing benefits to costs;therefore, a change in these benefits or costs may cause their behavior to change
2 The three principles concerning people’s economic interactions are: (1) trade can make everyone
better off; (2) markets are usually a good way to organize economic activity; and (3)
governments can sometimes improve market outcomes Trade can make everyone better offbecause it allows countries to specialize in what they do best and to enjoy a wider variety ofgoods and services Markets are usually a good way to organize economic activity because theinvisible hand leads markets to desirable outcomes Governments can sometimes improvemarket outcomes because markets may fail to allocate resources efficiently due to an externality
or market power
Activity 2—So Many Things to Do, So Little Time
Topics: Trade-offs, opportunity cost, thinking at the margin, incentives
Materials needed: None
Class limitations: Works in any class size
Give students a list of activities with corresponding time requirements: sleep, 8 hours; sleep,
6 hours; eat breakfast, 30 minutes; ride a bike, 1 hour; go hiking, 2 hours; study, 3 hours;
study, 2 hours; go to class, 4 hours; go to class, 6 hours; watch TV, 2 hours; watch TV, 6
hours; take a nap, 1 hour; work, 8 hours; work, 4 hours; etc
Make sure that there are many choices and that there are many pleasurable experiences—toomuch for a 24-hour period
Ask students which Principle of Economics this illustrates
If they do not say 1, 2, 3, and 4, help them see that this exercise has trade-offs in the choicesthey make, that each choice has an opportunity cost, that deciding whether or not to sleep 4more hours may depend on whether you have already slept for 6, and that choices may be
influenced by the incentives the student faces For example, a student who is about to be
placed on academic probation has an incentive to study harder
Trang 17Chapter 1/Ten Principles of Economics ) 11
3 The three principles that describe how the economy as a whole works are: (1) a country’s
standard of living depends on its ability to produce goods and services; (2) prices rise when thegovernment prints too much money; and (3) society faces a short-run trade-off between inflationand unemployment A country’s standard of living depends largely on the productivity of itsworkers, which in turn depends on the education of its workers and the access its workers have
to the necessary tools and technology Prices rise when the government prints too much moneybecause more money in circulation reduces the value of money, causing inflation Society faces
a short-run trade-off between inflation and unemployment that is only temporary Policymakershave some short-term ability to exploit this relationship using various policy instruments
Questions for Review
1 Examples of trade-offs include time trade-offs (such as studying one subject over another or
studying at all compared to engaging in social activities) and spending trade-offs (such as
whether to use your last 15 dollars to purchase a pizza or to buy a study guide for that tougheconomics course)
2 The opportunity cost of seeing a movie includes the monetary cost of admission plus the time
cost of going to the theater and attending the show The time cost depends on what else youmight do with that time; if it is staying home and watching TV, the time cost may be small, but if
it is working an extra three hours at your job, the time cost is the money you could have earned
3 The marginal benefit of a glass of water depends on your circumstances If you have just run a
marathon or you have been walking in the desert sun for three hours, the marginal benefit isvery high But if you have been drinking a lot of liquids recently, the marginal benefit is quite low.The point is that even the necessities of life, like water, do not always have large marginalbenefits
4 Policymakers need to think about incentives so they can understand how people will respond to
the policies they put in place The text's example of seat belt laws shows that policy actions canhave unintended consequences If incentives matter a lot, they may lead to a very different type
of policy; for example, some economists have suggested putting knives in steering columns sothat people will drive much more carefully! While this suggestion is silly, it highlights the
importance of incentives
5 Trade among countries is not a game with some losers and some winners because trade can
make everyone better off By allowing specialization, trade between people and trade betweencountries can improve everyone's welfare
6 The "invisible hand" of the marketplace represents the idea that even though individuals and
firms are all acting in their own self-interest, prices and the marketplace guide them to do what isgood for society as a whole
7 The two main causes of market failure are externalities and market power An externality is the
impact of one person’s actions on the well-being of a bystander, such as from pollution or thecreation of knowledge Market power refers to the ability of a single person (or small group ofpeople) to unduly influence market prices, such as in a town with only one well or only one cabletelevision company In addition, a market economy also leads to an unequal distribution ofincome
Trang 1812 ) Chapter 1/Ten Principles of Economics
8 Productivity is important because a country's standard of living depends on its ability to produce
goods and services The greater a country's productivity (the amount of goods and servicesproduced from each hour of a worker's time), the greater its standard of living will be
9 Inflation is an increase in the overall level of prices in the economy Inflation is caused by
increases in the quantity of a nation's money
10 Inflation and unemployment are negatively related in the short run Thus, reducing inflation
entails costs to society in the form of higher unemployment in the short run
Problems and Applications
1 a A family deciding whether to buy a new car faces a trade-off between the cost of the car
and other things they might want to buy For example, buying the car might mean theymust give up going on vacation for the next two years So the real cost of the car is thefamily's opportunity cost in terms of what they must give up
b For a member of Congress deciding whether to increase spending on national parks, the
trade-off is between parks and other spending items or tax cuts If more money goesinto the park system, that may mean less spending on national defense or on the policeforce Or, instead of spending more money on the park system, taxes could be reduced
c When a company president decides whether to open a new factory, the decision is based
on whether the new factory will increase the firm's profits compared to otheralternatives For example, the company could upgrade existing equipment or expandexisting factories The bottom line is: Which method of expanding production willincrease profit the most?
d In deciding how much to prepare for class, a professor faces a trade-off between the
value of improving the quality of the lecture compared to other things she could do withher time, such as working on additional research
2 When the benefits of something are psychological, such as going on a vacation, it is not easy to
compare benefits to costs to determine if it is worth doing But there are two ways to think aboutthe benefits One is to compare the vacation with what you would do in its place If you did not
go on vacation, would you buy something like a new set of golf clubs? Then you can decide ifyou would rather have the new clubs or the vacation A second way is to think about how hardyou had to work to earn the money to pay for the vacation You can then decide if the
psychological benefits of the vacation were worth the psychological cost of working
3 If you are thinking of going skiing instead of working at your part-time job, the cost of skiing
includes its monetary and time costs, which includes the opportunity cost of the wages you aregiving up by not working If the choice is between skiing and going to the library to study, thenthe cost of skiing is its monetary and time costs including the cost of getting lower grades in yourcourses
4 If you spend $100 now instead of saving it for a year and earning 5 percent interest, you are
giving up the opportunity to spend $105 a year from now
5 The fact that you have already sunk $5 million is not relevant to your decision anymore, because
that money is gone What matters now is the chance to earn profits at the margin If you spendanother $1 million and can generate sales of $3 million, you'll earn $2 million in marginal profit,
Trang 19Chapter 1/Ten Principles of Economics ) 13
so you should do so You are right to think that the project has lost a total of $3 million ($6million in costs and only $3 million in revenue) and you should not have started it That is true,but if you do not spend the additional $1 million, you will not have any sales and your losses will
be $5 million So what matters is not the total profit, but the profit you can earn at the margin
In fact, you wouldd pay up to $3 million to complete development; any more than that, and youwill not be increasing profit at the margin
6 Harry suggests looking at whether productivity would rise or fall Productivity is certainly
important, since the more productive workers are, the lower the cost per gallon of potion Ronwants to look at average cost But both Harry and Ron are missing the other side of the
equation⎯revenue A firm wants to maximize its profits, so it needs to examine both costs andrevenues Thus, Hermione is right⎯it is best to examine whether the extra revenue wouldexceed the extra costs Hermione is the only one who is thinking at the margin
7 a The provision of Social Security benefits lowers an individual’s incentive to save for
retirement The benefits provide some level of income to the individual when he or sheretires This means that the individual is not entirely dependent on savings to supportconsumption through the years in retirement
b Since a person gets fewer after-tax Social Security benefits the greater his or her
earnings are, there is an incentive not to work (or not work as much) after age 65 Themore you work, the lower your after-tax Social Security benefits will be Thus, thetaxation of Social Security benefits discourages work effort after age 65
8 a When welfare recipients have their benefits cut off after two years, they have a greater
incentive to find jobs than if their benefits were to last forever
b The loss of benefits means that someone who cannot find a job will get no income at all,
so the distribution of income will become less equal But the economy will be moreefficient, because welfare recipients have a greater incentive to find jobs Thus, thechange in the law is one that increases efficiency but reduces equity
9 By specializing in each task, you and your roommate can finish the chores more quickly If you
divided each task equally, it would take you more time to cook than it would take your
roommate, and it would take him more time to clean than it would take you By specializing, youreduce the total time spent on chores
Similarly, countries can specialize and trade, making both better off For example, suppose ittakes Spanish workers less time to make clothes than French workers, and French workers canmake wine more efficiently than Spanish workers Then Spain and France can both benefit ifSpanish workers produce all the clothes and French workers produce all the wine, and theyexchange wine for clothes
10 a To produce the right number of CDs by the right artists and deliver them to the right
people requires an enormous amount of information You need to know about productiontechniques and costs in the CD industry You need to know each person's musical tastesand which artists they want to hear If you make the wrong decisions, you will beproducing too many CDs by artists that people do not want to hear, and not enough byothers
b Your decisions about CDs will carry over to other decisions You have to make the right
number of CD players for people to use If you make too many CDs and not enoughcassette tapes, people with cassette players will be stuck with CDs they cannot play The
Trang 2014 ) Chapter 1/Ten Principles of Economics
probability of making mistakes is very high You will also be faced with tough choicesabout the music industry compared to other parts of the economy If you produce moresports equipment, you will have fewer resources for making CDs So all decisions aboutthe economy influence your decisions about CD production
11 Countries that have corrupt police and court systems do not enforce individual property rights,
including the rights over the goods and services produced by households and firms Firms will notchoose to produce products and individuals will choose not to work if there is no guarantee thatthey will receive payment for their efforts Therefore, these countries end up with a lower
standard of living
12 a Efficiency: The market failure comes from the market power of the cable TV firm
c Efficiency: An externality arises because secondhand smoke harms nonsmokers
d Efficiency: The market failure occurs because of Standard Oil's market power
f Efficiency: There is an externality because of accidents caused by drunk drivers
13 a If everyone were guaranteed the best health care possible, much more of our nation's
output would be devoted to medical care than is now the case Would that be efficient?
If you believe that doctors have market power and restrict health care to keep theirincomes high, you might think efficiency would increase by providing more health care.But more likely, if the government mandated increased spending on health care, theeconomy would be less efficient because it would give people more health care than theywould choose to pay for From the point of view of equity, if poor people are less likely tohave adequate health care, providing more health care would represent an improvement.Each person would have a more even slice of the economic pie, though the pie wouldconsist of more health care and less of other goods
b When workers are laid off, equity considerations argue for the unemployment benefits
system to provide them with some income until they can find new jobs After all, no oneplans to be laid off, so unemployment benefits are a form of insurance But there is anefficiency problem⎯why work if you can get income for doing nothing? The economy isnot operating efficiently if people remain unemployed for a long time, and unemploymentbenefits encourage unemployment Thus, there is a trade-off between equity and
efficiency The more generous unemployment benefits are, the less income is lost by anunemployed person, but the more that person is encouraged to remain unemployed Sogreater equity reduces efficiency
14 Because average income in the United States has roughly doubled every 35 years, we are likely
to have a better standard of living than our parents, and a much better standard of living thanour grandparents This is mainly the result of increased productivity, so that an hour of workproduces more goods and services than it used to Thus, incomes have continuously risen overtime, as has the standard of living
15 If Americans save more and it leads to more spending on factories, there will be an increase in
production and productivity, because the same number of workers will have more equipment towork with The benefits from higher productivity will go to both the workers, who will get paidmore because they are producing more, and the factory owners, who will get a return on theirinvestments There is no such thing as a free lunch, however, because when people save more,they are giving up spending They get higher incomes at the cost of buying fewer goods
Trang 21Chapter 1/Ten Principles of Economics ) 15
16 To make an intelligent decision about whether to reduce inflation, a policymaker would need to
know what causes inflation and unemployment, as well as what determines the trade-off
between them This means that the policymaker needs to understand how households and firmswill adjust to a decrease in the money supply How much will spending decline? How much willfirms lower output? Any attempt to reduce inflation will likely lead to higher unemployment in theshort run A policymaker thus faces a trade-off between the benefits of lower inflation compared
to the cost of higher unemployment
17 Answers will vary
Trang 23WHAT’S NEW IN THE FOURTH EDITION:
The presentation of the production possibilities frontier has been extensively rewritten and augmented.There is a new FYI box on “Who Studies Economics?” There is a new In the News feature on “SuperbowlEconomics.” There is also a new Case Study about Greg Mankiw’s job as the chairman of the Council ofEconomic Advisers
LEARNING OBJECTIVES:
By the end of this chapter, students should understand:
¾ how economists apply the methods of science
¾ how assumptions and models can shed light on the world
¾ two simple models—the circular flow and the production possibilities frontier
¾ the difference between microeconomics and macroeconomics
¾ the difference between positive and normative statements
¾ the role of economists in making policy
¾ why economists sometimes disagree with one another
CONTEXT AND PURPOSE:
Chapter 2 is the second chapter in a three chapter section that serves as the introduction of the text.Chapter 1 introduced ten principles of economics that will be revisited throughout the text Chapter 2develops how economists approach problems while Chapter 3 will explain how individuals and countriesgain from trade
The purpose of Chapter 2 is to familiarize students with how economists approach economicproblems With practice, they will learn how to approach similar problems in this dispassionate systematicway They will see how economists employ the scientific method, the role of assumptions in modelbuilding, and the application of two specific economic models Students will also learn the importantdistinction between two roles economists can play: as scientists when we try to explain the economicworld and as policymakers when we try to improve it
Trang 2418 ) Chapter 2/Thinking Like an Economist
KEY POINTS:
1 Economists try to address their subject with a scientist’s objectivity Like all scientists, they makeappropriate assumptions and build simplified models in order to understand the world around them.Two simple economic models are the circular-flow diagram and the production possibilities frontier
2 The field of economics is divided into two subfields: microeconomics and macroeconomics
Microeconomists study decisionmaking by households and firms and the interaction among
households and firms in the marketplace Macroeconomists study the forces and trends that affectthe economy as a whole
3 A positive statement is an assertion about how the world is A normative statement is an assertionabout how the world ought to be When economists make normative statements, they are actingmore as policy advisers than scientists
4 Economists who advise policymakers offer conflicting advice either because of differences in scientificjudgments or because of differences in values At other times, economists are united in the advicethey offer, but policymakers may choose to ignore it
CHAPTER OUTLINE:
I The Economist as Scientist
A Economists follow the scientific method
1 Observations help us to develop theory
2 Data can be collected and analyzed to evaluate theories
3 Using data to evaluate theories is more difficult in economics than in physical
science because economists are unable to generate their own data and mustmake do with whatever data are available
4 Thus, economists pay close attention to the natural experiments offered by
history
B Assumptions make the world easier to understand
1 Example: to understand international trade, it may be helpful to start out
assuming that there are only two countries in the world producing only twogoods Once we understand how trade would work between these twocountries, we can extend our analysis to a greater number of countries andgoods
2 One important role of a scientist is to understand which assumptions one should
make
3 Economists often use assumptions that are somewhat unrealistic but will have
small effects on the actual outcome of the answer
Trang 25Chapter 2/Thinking Like an Economist ) 19
C Economists use economic models to explain the world around us
1 Most economic models are composed of diagrams and equations
2 The goal of a model is to simplify reality in order to increase our understanding
This is where the use of assumptions is helpful
To illustrate to the class how simple but unrealistic models can be useful, bring a
road map to class Point out how unrealistic it is For example, it does not show
where all of the stop signs, gas stations, or restaurants are located It assumes that
the earth is flat and two-dimensional But, despite these simplifications, a map
usually helps travelers get from one place to another Thus, it is a good model
Activity 1 — Realism and Models: An Analogy Type: In-class demonstration
Materials needed: Airplane kit, sheet of paper, gig wing toy (Note: the
whirl-a-gig wing toy is a helicopter wing on a stick; it is often sold in museumgift shops as well as toy stores.)
Class limitations: Works in any class size
Ask the class if a realistic model is better than an unrealistic model
Show them the airplane model kit Describe some of the details included in model (rivets,
canopy, struts, etc.) Shake the box to rattle the large number of parts This is a fairly
realistic model, although obviously not a real airplane Its complexity adds realism, but at a
cost; assembling the model is very time consuming Drop the box on the floor Tell the class,
“This model, even when completed, cannot fly.”
Take a sheet of paper and fold it into a paper airplane Show the class this new model Its
virtues include simplicity and ease of assembly, but it is less realistic than the airplane model
kit Throw the airplane and explain, “While less detailed, this model can glide through the
air.”
Show the students the whirl-a-gig wing toy This model looks nothing like an airplane – just a
T-shaped piece of wood Yet, this model does something that the other two models cannot
do: it actually generates lift This toy demonstrates the same aerodynamic principles as a real
airplane wing Twirl the stick between your palms and the whirl-a-gig wing toy will fly over
your head
Economic models are like the whirl-a-gig wing toy They are much less complex than the real
world, but they can show how markets actually work
Trang 2620 ) Chapter 2/Thinking Like an Economist
D Our First Model: The Circular Flow Diagram
1 Definition of circular-flow diagram: a visual model of the economy that
shows how dollars flow through markets among households and firms.
2 This diagram is a very simple model of the economy Note that it ignores the
roles of government and international trade
a There are two decision makers in the model: households and firms
b There are two markets: the market for goods and services and the
market of factors of production
c Firms are sellers in the market for goods and services and buyers in the
market for factors of production
Figure 1
Trang 27Chapter 2/Thinking Like an Economist ) 21
d Households are buyers in the market for goods and services and sellers
in the market for factors of production
e The inner loop represents the flows of inputs and outputs between
households and firms
f The outer loop represents the flows of dollars between households and
firms
E Our Second Model: The Production Possibilities Frontier
1 Definition of production possibilities frontier: a graph that shows the
combinations of output that the economy can possibly produce given the available factors of production and the available production technology.
2 Example: an economy that produces two goods, cars and computers
a If all resources are devoted to producing cars, the economy would
produce 1,000 cars and zero computers
b If all resources are devoted to producing computers, the economy would
produce 3,000 computers and zero cars
c More likely, the resources will be divided between the two industries
The feasible combinations of output are shown on the productionpossibilities frontier
Figure 2
Spend more time with this model than you think is necessary Be aware that the
math skills of many of your students will be limited It is important for the students
to feel confident with this first graphical and mathematical model Be deliberate with
every point If you lose them with this model, they may be gone for the rest of the
course
ALTERNATIVE CLASSROOM EXAMPLE:
A small country produces two goods: corn (measured in bushels) and trucks Points on aproduction possibilities frontier can be shown in a table or a graph:
The production possibilities frontier should be drawn from the numbers above
Students should be asked to calculate the opportunity cost of increasing the number of trucksproduced by ten:
• between 0 and 10
• between 10 and 20
• between 20 and 30
• between 30 and 40
Trang 2822 ) Chapter 2/Thinking Like an Economist
1,000
BC
Quantity of Cars Produced
700600300
0
2,0003,000
3 Because resources are scarce, not every combination of computers and cars is
possible Production at a point outside of the curve (such as C) is not possiblegiven the economy’s current level of resources and technology
4 Production is efficient at points on the curve (such as A and B) This implies that
the economy is getting all it can from the scarce resources it has available.There is no way to produce more of one good without producing less of another
5 Production at a point inside the curve (such as D) is inefficient
a This means that the economy is producing less than it can from the
resources it has available
b If the source of the inefficiency is eliminated, the economy can increase
its production of both goods
You may want to include time dimensions for variables to make it clear that the
production data are measured in terms of annual flows This will help students to
realize that a new production possibilities frontier occurs for each year Thus, the
axes show the levels of output per year
It is useful to point out that the production possibilities curve depends on two things:
the availability of resources and the level of technology
Trang 29Chapter 2/Thinking Like an Economist ) 23
6 The production possibilities frontier reveals Principle #1: People face tradeoffs
a Suppose the economy is currently producing 600 cars and 2,200
computers
b To increase the production of cars to 700, the production of computers
must fall to 2,000
7 Principle #2 is also shown on the production possibilities frontier: The cost of
something is what you give up to get it (opportunity cost)
a The opportunity cost of increasing the production of cars from 600 to
700 is 200 computers
b Thus, the opportunity cost of each car is two computers
8 The opportunity cost of a car depends on the number of cars and computers
currently produced by the economy
a The opportunity cost of a car is high when the economy is producing
many cars and few computers
b The opportunity cost of a car is low when the economy is producing few
cars and many computers
9 Economists generally believe that production possibilities frontiers often have this
bowed-out shape because some resources are better suited to the production ofcars than computers (and vice versa)
10 The production possibilities frontier can shift if resource availability or technology
changes Economic growth can be illustrated by an outward shift of theproduction possibilities frontier
Be aware that students often have trouble understanding why opportunity costs rise
as the production of a good increases You may want to use several specific
examples of resources that are more suited to producing cars than computers (e.g.,
an experienced mechanic) as well as examples of resources that are more suited to
producing computers than cars (e.g., an experienced computer programmer)
Figure 3
You may also want to teach students about budget constraints at this time (call them
“consumption possibilities frontiers”) This reinforces the idea of opportunity cost,
and allows them to see how opportunity cost can be measured by the slope Also, it
will introduce students to the use of a straight-line production possibilities frontier
(which is used in Chapter 3) However, be careful if you choose to do this as
students often find the difference between straight-line and concave production
possibilities frontiers challenging
Trang 3024 ) Chapter 2/Thinking Like an Economist
F Microeconomics and Macroeconomics
1 Economics is studied on various levels
a Definition of microeconomics: the study of how households and
firms make decisions and how they interact in markets.
b Definition of macroeconomics: the study of economy-wide
phenomena, including inflation, unemployment, and economic growth.
2 Microeconomics and macroeconomics are closely intertwined because changes in
the overall economy arise from the decisions of individual households and firms
3 Because microeconomics and macroeconomics address different questions, each
field has its own set of models which are often taught in separate courses
G FYI: Who Studies Economics?
1 Economics can seem abstract at first, but it is fundamentally very practical and
the study of economics is useful in many different career paths
2 This box provides a sample of well-known individuals who majored in economics
in college
II The Economist as Policy Adviser
A Positive Versus Normative Analysis
1 Example of a discussion of minimum-wage laws: Polly says, “Minimum-wage
laws cause unemployment.” Norma says, “The government should raise theminimum wage.”
2 Definition of positive statements: claims that attempt to describe the
world as it is.
ALTERNATIVE CLASSROOM EXAMPLE:
Ivan receives an allowance from his parents of $10 each week He spends his entire
allowance on two goods: ice cream cones (which cost $1 each) and tickets to the movies
(which cost $5 each)
Students should be asked to calculate the opportunity cost of one movie and the opportunity
cost of one ice cream cone
Ivan’s consumption possibilities frontier (budget constraint) can be drawn It should be
noted that the slope is equal to the opportunity cost and is constant because the opportunity
cost is constant
Ask students what would happen to the consumption possibilities frontier if Ivan’s allowance
changes or if the price of ice cream cones or movies changes
Trang 31Chapter 2/Thinking Like an Economist ) 25
3 Definition of normative statements: claims that attempt to prescribe
how the world should be.
4 Positive statements can be evaluated by examining data, while normative
statements involve personal viewpoints
5 Positive views about how the world works affect normative views about which
policies are desirable
6 Much of economics is positive; it tries to explain how the economy works But
those who use economics often have goals that are normative They want tounderstand how to improve the economy
7 In the News: Superbowl Economics
a Economists often offer advice to policymakers (including football
coaches)
b This is an article from The New York Times that describes how Bill
Belichick, the coach of the New England Patriots, uses economic analysis
to enhance his team’s performance
B Economists in Washington
1 Economists are aware that tradeoffs are involved in most policy decisions
2 The president receives advice from the Council of Economic Advisers (created in
1946)
3 Economists are also employed by administrative departments within the various
federal agencies such as the Department of Treasury, the Department of Labor,the Congressional Budget Office, and the Federal Reserve Table 1 lists theWorld Wide Web addresses of these agencies
4 The research and writings of economists can also indirectly affect public policy
Use several examples to illustrate the differences between positive and normative
statements and stimulate classroom discussion Possible examples include the
minimum wage, budget deficits, tobacco taxes, legalization of marijuana, and
seat-belt laws
Table 1
Have students bring in newspaper articles and in groups, identify each statement in
an editorial paragraph as being a positive or normative statement Discuss the
difference between straight news stories and editorials and the analogy to
economists as scientists and as policy advisers
Trang 3226 ) Chapter 2/Thinking Like an Economist
5 Case Study: Mr Mankiw Goes to Washington
a From 2003 to 2005, the author of this textbook was the chairman of the
Council of Economic Advisers
III Why Economists Disagree
A Differences in Scientific Judgments
1 Economists often disagree about the validity of alternative theories or about the
size of the effects of changes in the economy on the behavior of households andfirms
2 Example: some economists feel that a change in the tax code that would
eliminate a tax on income and create a tax on consumption would increasesaving in this country However, other economists feel that the change in thetax system would have little effect on saving behavior and therefore do notsupport the change
B Differences in Values
C Perception Versus Reality
1 While it seems as if economists do not agree on much, this is in fact not true
Table 2 contains ten propositions that are endorsed by a majority of economists
2 Almost all economists believe that rent control adversely affects the availability
and quality of housing
3 While most economists oppose barriers to trade, the Bush Administration
imposed temporary tariffs on steel in 2002
IV In the News: Why You Should Study Economics
A Training in economics helps us to understand fallacies and to anticipate unintended
consequences
B This is an excerpt from a commencement address by Robert D McTeer, Jr., the former
President of the Federal Reserve Bank of Dallas that describes why students should studyeconomics
Table 2
Emphasize that there is more agreement among economists than most people think
The reason for this is probably that the things that are generally agreed upon are
boring to most noneconomists
Trang 33Chapter 2/Thinking Like an Economist ) 27
V Appendix—Graphing: A Brief Review
A Graphs of a Single Variable
1 Pie Chart
2 Bar Graph
3 Time-Series Graph
B Graphs of Two Variables: The Coordinate System
1 Economists are often concerned with relationships between two or more
variables
2 Ordered pairs of numbers can be graphed on a two-dimensional grid
a The first number in the ordered pair is the x-coordinate and tells us the
horizontal location of the point
b The second number in the ordered pair is the y-coordinate and tells us
the vertical location of the point
3 The point with both an x-coordinate and y-coordinate of zero is called the origin
4 Two variables that increase or decrease together have a positive correlation
5 Two variables that move in opposite directions (one increases when the other
decreases) have a negative correlation
Figure A-1
Figure A-2
Many instructors may be unaware of how much trouble beginning students have
grasping the most basic graphs It is important for instructors to make sure that
students are comfortable with these techniques
When reviewing graphing with the students, it is best to bring students to the board
to be “recorders” of what the other students say as you give a series of instructions
like “Draw a pie chart” or ask questions like “How tall should the bar be if the value is
120 million?” Do not make the student at the board responsible for the answer
Instead, he or she should be simply recording what the other students say Students
are often uneasy about graphing at first and need to see that they are not alone
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C Curves in the Coordinate System
1 Often, economists want to show how one variable affects another, holding all
other variables constant
a An example of this is a demand curve
b The demand curve shows how the quantity of a good a consumer wants
to purchase varies as its price varies, holding everything else (such asincome) constant
c If income does change, this will alter the amount of a good that the
consumer wants to purchase at any given price Thus, the relationshipbetween price and quantity desired has changed and must be
represented as a new demand curve
d A simple way to tell if it is necessary to shift the curve is to look at the
axes When a variable that is not named on either axis changes, thecurve shifts
1 We may want to ask how strongly a consumer reacts if the price of a product
changes
a If the demand curve is very steep, the quantity desired does not change
much in response to a change in price
b If the demand curve is very flat, the quantity desired changes a great
deal when the price changes
2 The slope of a line is the ratio of the vertical distance covered to the horizontal
distance covered as we move along the line (“rise over run”)
3 A small slope means that the demand curve is relatively flat; a large slope means
that the demand curve is relatively steep
x
Trang 35Chapter 2/Thinking Like an Economist ) 29
E Cause and Effect
1 Economists often make statements suggesting that a change in Variable A
causes a change in Variable B
2 Ideally, we would like to see how changes in Variable A affect Variable B, holding
all other variables constant
3 This is not always possible and could lead to a problem caused by omitted
variables
a If Variables A and B both change at the same time, we may conclude
that the change in Variable A caused the change in Variable B
b But, if Variable C has also changed, it is entirely possible that Variable C
is responsible for the change in Variable B
4 Another problem is reverse causality
a If Variable A and Variable B both change at the same time, we may
believe that the change in Variable A led to the change in Variable B
b However, it is entirely possible that the change in Variable B led to the
change in Variable A
c It is not always as simple as determining which variable changed first
because individuals often change their behavior in response to a change
in their expectations about the future This means that Variable A maychange before Variable B but only because of the expected change inVariable B
SOLUTIONS TO TEXT PROBLEMS:
Quick Quizzes
The answers to the Quick Quizzes can also be found near the end of the textbook
Figure A-6
Figure A-7
There are two very good examples in the text that you should use in class To
discuss the omitted variable problem, point out to students that a rise in the sales of
cigarette lighters is positively related to the number of individuals diagnosed with
lung cancer To discuss reverse causality, show that an increase in minivan sales is
followed by an increase in birth rates
Trang 3630 ) Chapter 2/Thinking Like an Economist
1 Economics is like a science because economists devise theories, collect data, and analyze the
data in an attempt to verify or refute their theories In other words, economics is based on thescientific method
Figure 1 shows the production possibilities frontier for a society that produces food and clothing.Point A is an efficient point (on the frontier), point B is an inefficient point (inside the frontier),and point C is an infeasible point (outside the frontier)
Figure 1
The effects of a drought are shown in Figure 2 The drought reduces the amount of food thatcan be produced, shifting the production possibilities frontier inward
Figure 2
Microeconomics is the study of how households and firms make decisions and how they interact
in markets Macroeconomics is the study of economy-wide phenomena, including inflation,unemployment, and economic growth
Trang 37Chapter 2/Thinking Like an Economist ) 31
2 An example of a positive statement is “higher taxes discourage work effort.” It is a positive
statement because it is a claim that describes the world as it is An example of a normativestatement is “the government should reduce tax rates.” It is a normative statement because it is
a claim that prescribes how the world should be Many other examples are possible
Parts of the government that regularly rely on advice from economists are the Department of theTreasury in designing tax policy, the Department of Labor in analyzing data on the employmentsituation, the Department of Justice in enforcing the nation’s antitrust laws, the CongressionalBudget Office in evaluating policy proposals, and the Federal Reserve in analyzing economicdevelopments Many other answers are possible
3 Economic advisers to the president might disagree about a question of policy because of
differences in scientific judgments or differences in values
Questions for Review
1 Economics is like a science because economists use the scientific method They devise theories,
collect data, and then analyze these data in an attempt to verify or refute their theories abouthow the world works Economists use theory and observation like other scientists, but they arelimited in their ability to run controlled experiments Instead, they must rely on natural
experiments
2 Economists make assumptions to simplify problems without substantially affecting the answer
Assumptions can make the world easier to understand
3 An economic model cannot describe reality exactly because it would be too complicated to
understand A model is a simplification that allows the economist to see what is truly important
4 Figure 3 shows a production possibilities frontier between milk and cookies (PPF1) If a disease
kills half of the economy's cow population, less milk production is possible, so the PPF shiftsinward (PPF2) Note that if the economy produces all cookies, it does not need any cows andproduction is unaffected But if the economy produces any milk at all, then there will be lessproduction possible after the disease hits
Figure 3
Trang 3832 ) Chapter 2/Thinking Like an Economist
5 The idea of efficiency is that an outcome is efficient if the economy is getting all it can from the
scarce resources it has available In terms of the production possibilities frontier, an efficientpoint is a point on the frontier, such as point A in Figure 4 When the economy is using itsresources efficiently, it cannot increase the production of one good without reducing the
production of the other A point inside the frontier, such as point B, is inefficient since more ofone good could be produced without reducing the production of another good
Figure 4
6 The two subfields in economics are microeconomics and macroeconomics Microeconomics is the
study of how households and firms make decisions and how they interact in specific markets.Macroeconomics is the study of economy-wide phenomena, including inflation, unemployment,and economic growth
7 Positive statements are descriptive and make a claim about how the world is, while normative
statements are prescriptive and make a claim about how the world ought to be Here is anexample Positive: A rapid growth rate of money is the cause of inflation Normative: Thegovernment should keep the growth rate of money low
8 The Council of Economic Advisers is a group of economists who consult with the president of the
United States about economic matters The Council consists of three members and a staff ofseveral dozen economists It writes the annual Economic Report of the President
9 Economists sometimes offer conflicting advice to policymakers for two reasons:
(1) economists may disagree about the validity of alternative positive theories about how theworld works; and (2) economists may have different values and, therefore, different normativeviews about what public policy should try to accomplish
Trang 39Chapter 2/Thinking Like an Economist ) 33
Problems and Applications
1 See Figure 5; the four transactions are shown
Figure 5
2 a Figure 6 shows a production possibilities frontier between guns and butter It is bowed
out because the opportunity cost of butter depends on how much butter and how manyguns the economy is producing When the economy is producing a lot of butter, workersand machines best suited to making guns are being used to make butter, so each unit ofguns given up yields a small increase in the production of butter Thus, the frontier issteep and the opportunity cost of producing butter is high When the economy isproducing a lot of guns, workers and machines best suited to making butter are beingused to make guns, so each unit of guns given up yields a large increase in theproduction of butter Thus, the frontier is very flat and the opportunity cost of producingbutter is low
Trang 4034 ) Chapter 2/Thinking Like an Economist
Figure 6
b Point A is impossible for the economy to achieve; it is outside the production possibilities
frontier Point B is feasible but inefficient because it is inside the production possibilitiesfrontier
c The Hawks might choose a point like H, with many guns and not much butter The
Doves might choose a point like D, with a lot of butter and few guns
d If both Hawks and Doves reduced their desired quantity of guns by the same amount,
the Hawks would get a bigger peace dividend because the production possibilitiesfrontier is much flatter at point H than at point D As a result, the reduction of a givennumber of guns, starting at point H, leads to a much larger increase in the quantity ofbutter produced than when starting at point D
3 See Figure 7 The shape and position of the frontier depend on how costly it is to maintain a
clean environment⎯the productivity of the environmental industry Gains in environmentalproductivity, such as the development of new way to produce electricity that emits fewer
pollutants, lead to shifts of the production-possibilities frontier, like the shift from PPF1 to PPF2
shown in the figure
Figure 7
4 a A: 40 lawns mowed; 0 washed cars