Answers to Selected Student Guide Problems**Note to instructors: The answers to most of the data questions were taken from the 2009 Economic Report of the President.Some data for 2008 were taken from the Bureauof Economic Analysis and Department of Labor websites. The data may be revised inlater publications CHAPTER2The Data of MacroeconomicsData Questions1.a.The following 2008 data, in billions of dollars, were obtained from the Bureau ofEconomic Analysis Web site at http://www.bea.gov/. The data may be revised infuture publications. Table 2–7(1)Gross Domestic ProductEQUALSConsumption+Investment+Government Purchases of Goods and Services+Exports–Importsb.$10,057.9$ 1,993.5$ 2,882.4$ 1,859.4$ 2,528.6(2)$14,264.6GDP = $10,057.9 + $1,993.5 + $2,882.4 –$669.2 = $14,264.6 (billion)2.a. Table 2–8(1)(2)(3)% Changein CPI fromPreceding Year(4)GDPDeflator119.823.82008215.30122.502.2(5)% Changein GDP Deflator fromPreceding YearYear2007CPI207.34b. Imported oil is not part of U.S. GDP. Therefore, it is not included in the calcula-tion of the GDP deflator, although it is included in the calculation of the CPI whenit is purchased by consumers. Because the United States imports, rather thanproduces, a large portion of the oil households consume, the oil price increase hada greater effect on the CPI than on the GDP deflator from 2007 to 2008.203204Answers to Selected Student Guide Problems3.a. Table 2–9(1)(2)(3)(4)(5)% Changein Real GDPper Capita fromPreceding DecadeYear1978198819982008b.Total U.S.Real GDPPopulation($ in billions)(in millions)5,0156,7439,06711,652222.6245.0276.1304.1Real GDPper Capita$22,53022.2$27,52219.3$32,84016.7$38,316U.S. real GDP per capita grew the fastest from 1978 to 1988; it grew the slowestfrom 1998 to 2008.4.a. and c.Table 2–10(2)(3)(4)(5)GDP% ChangeReal% ChangeYearDeflator (P)in PGDP (Y)in Y($ in billions)20072008b.3.3119.822.2122.5011,65211,5241.114,265(1)(6)(7)Nominal% ChangeGDP (Y)in PY($ in billions)13,8083.3CHAPTER4Money and InflationProblems10.a.The costs of expected inflation are the shoeleather costs of inflation, the menucosts of changing prices, the cost of unindexed taxes, the cost of greater variabilityin prices, and the costs to people who receive incomes fixed in nominal terms (suchas private pensions) that were contracted before the inflation was expected.Although federal income taxes are now indexed for inflation, taxes on capitalgains and interest income are not. Consequently, if inflation were to fall from 2percent to 0 percent and, according to the Fisher effect, nominal interest rateswere to fall by 2 percentage points, the after-tax real return to saving and invest-ment would increase.3 percent, assuming a constant velocity of moneyExpected inflation would fall; the nominal interest rate would fall; real moneydemand would increase by more than the 3-percent growth in output; real moneybalances would increase by the same amount; the price level would fall; actualinflation would temporarily be negative.With 0 percent inflation, real wages can fall only if nominal wages decline, andworkers vigorously resist reductions in nominal wages.b.c.d.e.Chapter4Money and Inflation205Data Questions1.a. Table 4–9(1)(2)CPIAllItems65.281.4198819982008b.c.d.e.$8.491978 to 19881998 to 2008The OPEC oil shock in 1979 and the most recent shocks from 2002 to 2005 and in2008 account for the increase in the relative price of oil during those periods.118.337.8163.032.1215.3364.1242.150.4236.7138.674.7102.9130.0(3)(4)(5)Consumer Price IndicesCPI%Medical%ChangeCareChange61.8124.389.315.2(6)(7)Year1978CPIEnergy52.5%Change70.02.a. Table 4–10(1)(2)(3)(4)(5)(6)(7)(8)Nominal% ChangeM1(Dec.)M2(Dec.)GDP($ inGDPin GDP($ in% Change($ in% Changebillions)DeflatorDeflatorbillions)in M1billions)in M22,2955,1048,74714,26545.865.3198819982008b.75.727.596.526.9122.51,5961,09645.68,15478739.34,37886.2357120.42,99446.21,366119.2Year1978If the long-run growth rate of real GDP is 3 percent per year, or about 34 percentper decade, and velocity were constant, the quantity theory would predict thatπ= % Change in M – 34% per decade.If we use M1 as our measure of the money supply, the simple quantity theory pre-dicts 10-year inflation rates of 86.4 percent from 1978 to 1988; 5.3 percent from1988 to 1998, and 11.6 percent from 1998 to 2008.c.d.Using M1, the quantity theory is a fairly good predictor of inflation in the first andthird decades and a poor predictor in the middle decade.If we use M2 as our measure of the money supply, the simple quantity theory pre-dicts 10-year inflation rates of 85.2 percent, 12.2 percent, and 52.2 percent for thethree decades, respectively. It is a fairly good predictor for the first two decades,but not for the most recent decade.3.a. V for M2 in 1978 = 1.68; V for M2in 2008 = 1.75; obviously, M2 velocity has risena bit, contrary to the assumption of the simple quantity theory, but not much.206Answers to Selected Student Guide Problemsb.c.V for M1 in 1978 = 6.43, V for M1 in 2008 = 8.94; M1 velocity has risen a lot, con-trary to the assumption of the simple quantity theory.Even if velocity changes, MV= PYand the % change in M+ % change in Vapproximately equals the % change in P + % change in Y. Thus, if both velocityand real GDP change steadily over time, % change in P= % change in M+ %change in Y– % change in V, and any increase in the money supply will be accom-panied by an equal increase in the price level.CHAPTER5The Open EconomyProblems11.a.b.If the deficit were eliminated, public saving would rise. If taxes were cut, in thelong run private saving would also rise. Thus, national saving would rise.In a closed economy, the S curve shifts right (as saving increases), the real rate ofinterest falls, and the amount of investment increases although the investmentcurve does not shift:Graph for Problem 11(b)rS1S2Real interest rater1r2I1 = I20Investment, SavingI, SChapter5The Open Economy207c.Graph for Problems 11(c) and 11(d)r* = 2.5%d.e.Treating the United States as a small open economy, we once again shift the Scurve to the right as national saving increases. The real interest rate, however,remains fixed at r*. Consequently, investment does not change, but S– I increases.As the S – Icurve shifts right below, the U.S. real exchange rate falls and netexports rise.Graph for Problem 11(e)(S – I)1(S – I)2εε1ε2NX–0+S – I, NX208Answers to Selected Student Guide Problems17.The initial equilibrium is represented by points A in panels (A), (B), and (C) below. Graph for Problem 17rS1PAPanel anel BS2rrArBABABI + CFS , I + CFCF–0+CFCFrAPanel CCFrBεABεAεBNX–0+NXThe reduction in taxes and government spending would increase national saving andshift the Scurve right to S2in panel (A). The I + CF curve would not shift, so thedomestic real interest rate would fall to point B. Consequently, the level of net capitaloutflow would rise in panel (B). Since net capital outflow equals the trade surplus, thelatter would also rise, implying a decrease in the trade deficit. As NXrises, the realexchange rate will fall. As the domestic real interest rate falls, investment will rise.Data Questions1.a.Table 5–8(1)(3)Exports ofNominalGoods andGDP ($ inServicesbillions)($ in billions)2,2956,65714,265186.9655.81,859.4(2)(4)Exports as% ofNominal GDP8.19.913.0(5)(6)Imports ofGoods andImports asServices% of($ in billions)Nominal GDP212.3720.92,528.69.310.817.7Year197819932008Chapter6Unemployment209b. increased; morec.Table 5–9(1)Year197819932008(2)Net Exports of Goodsand Services ($ in billions)–25.4–65.1–669.2(3)Net Exports as% of Nominal GDP–1.1–1.0–4.7d.e.–25.4; –25.4–669.2; –669.2CHAPTER6Unemployment3.a.b.6.a.b.The Western European natural rate of unemployment in the 1960s was 2.5 per-cent, compared with the U.S. natural rate in the textbook of 4.76 percent.8 percentE/POP= E/L×L/POP, where POP= the noninstitutional population.E/POPindicates the portion of the population that has a job. In a healthy econo-my, this will be large. Furthermore, many of the unemployed may not really wantto work at the jobs that are available to them. While it may be difficult to measuretrue unemployment accurately, it is easier to measure Eand POP.The unemployment rate represents the portion of those who desire to work whocannot find work. Even if the employment-to-population ratio is high, a highunemployment rate will signify an economy that is producing much less than itspotential. Furthermore, if leisure is a normal good, the goal of society should be alow employment-to-population ratio coupled with a low unemployment rate.c.Data Questions1. a.Table 6–2Labor-Force Participation Rates (in percent)(1)Year196819882008b.(2)Male and FemaleTotal Civilian59.665.966.0(3)Civilian Males80.176.273.0(4)Civilian Females41.656.659.5The labor-force participation rate among civilian females has increased as moremarried women have entered the labor market. The labor-force participation rateamong civilian males has fallen because of earlier retirement and greater disabili-ty, among other reasons.210Answers to Selected Student Guide Problemsc.Real GDP has risen by the amount of extra output women produce in their newjobs. “Total production” does not rise as much as measured real GDP because thereduction in household production that was formerly performed by these womenmust be subtracted from the extra output produced in paid employment, especial-ly between 1968 and 1988. If we consider the fact that many of these women nowpay others to do some of this household production, the difference between thechange in real GDP and the change in “total production” is even greater.The median of a group of numbers is the “middle” number. Half of the numbersare greater than the median, and half are less than the median. The mean oraverage is equal to the sum of all the numbers divided by the number of numbers.The median duration of unemployment in 2008 was 9.4 weeks. The mean dura-tion of unemployment in 2008 was 17.9 weeks.Unemployment in the United States is characterized by many short spells and asmaller number of very long spells. Hence, the median duration of unemploymentis much smaller than the mean duration.Table 6–3(1)(2)UnemploymentRate4.6%4.6%5.8%(3)InflationRate(Year to Year)3.2%2.8%3.8%(4)ConventionalMiseryIndex7.87.49.6(5)NewMiseryIndex11.010.613.72.a.b.c.3.a., b., and c.Year200620072008d.Economic suffering increased more rapidly in 2008 using the new misery index,and even more so in 2009. CHAPTER7Economic Growth IData Questions1.a.Approximate Average Annual Percentage Growth Rates of Real GDP1990–1999United StatesJapanGermanyChinaIndiaAfricab.In the year 20383.11.52.39.95.62.32000–20082.41.61.59.97.25.5Chapter9Introduction to Economic Fluctuations211CHAPTER9Introduction to Economic FluctuationsProblems4.The short-run aggregate supply curve would shift downward, while the aggregate demandcurve would be unaffected. Output would rise, and the aggregate price level would fall.Data Questions1.a.Table 9–4(1)1979(in 1,000s)Civilian noninstitutional populationCivilian labor forceCivilian employmentCivilian unemployment164,863104,96298,8246,137(2)1982(in 1,000s)172,271110,20499,52610,678(3)% Change1979–19824.55.00.774.0b.c.During recessions, employment grows by a smaller rate than the labor force.Consequently, unemployment grows by a much larger rate than either employ-ment or the labor force. During economic recoveries, the reverse is true. The popu-lation grows at a more constant rate over time, although it, too, is affected by eco-nomic conditions in the long run.The actual unemployment rate would eventually have equaled 5.8 percent.2.In April 2009, the unemployment rate was 8.9 percent. If the unemployment rate forall of 2009 was 8.9 percent, Okun’s law would predict that the real GDP would fall by3.2 percent.CHAPTER100.75Aggregate Demand IProblems4.a.b.Graph for Problem 4(b)CCConsumption200Income, outputYslope of C= 0.6; yintercept = 20212Answers to Selected Student Guide ProblemsPEPEPlanned expenditure8000Income, outputYc.d.e.slope of PE = 0.6;y intercept = 8002,0000The government-purchases multiplier is 2.5. When Grises, the multiplier issmaller than 1/(1 – MPC) because any increase in income will be accompanied byan increase in taxes. Hence, the increase in disposable income in each round willbe smaller than the increase in income. Alternatively, the slope of the plannedexpenditure curve becomes MPC(1 – t), where tequals the income tax rate. Hence,the multiplier becomes 1/[1 – MPC(1 – t)].Planned investment might increase as Yrises (leading to the positively sloped linebelow) if investment depends on profits or sales expectations (along with r) andeither or both of these rise along with Y.IPlanned investmentI'I6.a.0Income, outputYb.i.The slope of the planned-expenditure curve would increase. ii.The government-purchases multiplier would increase. iii.The IS curve would be flatter, and the LM curve would be unaffected.Chapter10Aggregate Demand I213Data Questions1.Table 10–7(1)(2)Nominal M2in December($ in billions)1,473.78.619801981198219831,599.89.71,755.48.81,910.111.32,126.465.23,261.362.73,046.47.159.12,970.22.654.02,962.60.3(3)(4)(5)Real M2M2/P2,977.2–0.5(6)% Changein M2/PYear1979% Change inGDP DeflatorM2(2000 = 100)49.5The LMcurve implies that changes in the real money supply are the appropriatemeasures of monetary conditions. Using this measure, the Fed pursued mildlycontractionary monetary policy between 1979 and 1980, neutral policy between1980 and 1981, expansionary policy between 1981 and 1982, and very expansion-ary policy between 1982 and 1983. A better measure might be changes in thereal money supply in excess of the long-run growth rate of natural GDP of 3 per-cent. Using this measure, monetary policy was contractionary during the firstthree periods and expansionary in the fourth.CHAPTER11Aggregate Demand IIProblems4.a.The deficit would fall. The IScurve would shift to the left.Graph for Problem 4(a)rLMReal interest rater1r2IS1IS20Y2Y1YIncome, outputAs a result, the interest rate would fall, but so would real GDP. This last changeis contrary to some economists’ predictions.214Answers to Selected Student Guide Problemsb.If expansionary monetary policy is pursued simultaneously, the interest rate andthe deficit will still fall and real income may actually rise.Graph for Problem 4(b)rLM1LM2r1Real interest rater2IS20Y1Y2IS1YIncome, outputc.13.a.In part (a), the aggregate demand curve shifts left. In part (b), the aggregatedemand curve shifts right if Yrises.Graph for Problem 13(a)rALM2(πe = –10)LM1(πe = 0)Real Interest Rater1 + 10r2r1IS0Y2Y1Income, outputYb.If r is on the vertical axis, the IScurve will not shift in response to a change inexpected inflation, but the LMcurve will shift upward by 10 percentage points.Consequently, iand Yfall and rrises. Although the graph is different from theone in the textbook because r is now on the vertical axis, the changes to Y, i, and rare the same.If the money supply M increased as the interest rate increased, the money supplycurve would be upward sloping.14.Chapter11Aggregate Demand II215Graph for Problem 14rReal interest rateM/P(M/P)Real interest rate‹rBCLMLMA‹r2r2r1‹A0BCr2r2r1‹L2(Y2)L1(Y = Y1)(M/P)Real money balances0Y1Y2Income, outputYConsequently, an increase in income that increases the demand for real moneybalances would increase the interest rate and the money supply. The increase inthe interest rate would be less than when M is independent of the interest rate,resulting in a flatter LM curve.Data Questions1.a. Table 11–1(1)(2)(3)(4)(5)(6)(7)Real GDP%M1GDP%in billions ofChange inin Dec.DeflatorReal M1Change in2000 dollarsReal GDP($ in billions)(2000 = 100)(= M1/P)Real M15,173.4–0.2198019811982b.5,161.72.55,291.7–1.95,189.3474.862.7757.3436.759.1738.92.5408.554.0756.5–2.3381.849.5771.3–1.9Year1979The reduction in real GDP was much greater during the Great Depression, eventhough the reduction in real money balances from 1929 to 1933 was smaller thanduring the 1979–1981 period.(1)(2)Real GDPin billions of2000 dollars2,501.827.619653,191.14.28(3)%Change inReal GDP(4)Interest Rateon 10-Year U.S.Treasury Securities4.122.a. Table 11–2Year1960216Answers to Selected Student Guide Problemsb.Since the interest rate remained relatively constant while real GDP rose, it maybe presumed that both the LMand the IScurves shifted to the right and that thehorizontal shift was the same for both curves. Consequently, the Federal Reservemust have increased the money supply during this period.CHAPTER13Aggregate Supply and the Short-RunTradeoff Between Inflation and UnemploymentData Questions1.a. and b.Table 13–1(2)(3)(4)(5)Real GDPActual(billions%CivilianChange inof 2000Change inUnemploymentUnemploymentYeardollars)Real GDPRate (%)Rate20012002200320042005c.9,890.71.610,048.82.510,301.03.610,675.92.910,989.55.15.5–0.4+0.056.0–0.5–0.35.8+0.2+0.254.7+1.1+0.7(1)(6)PredictedChange inUnemploymentRateOkun’s law was fairly accurate during this period.CHAPTER15Stabilization PolicyProblems6.a.If capital gains taxes are reduced, the after-tax return to saving would increase.This might increase total saving, which would spur additional investment in aclosed economy or a large open economy.A capital gains tax reduction on past acquisitions will increase the after-taxreturns on past saving rather than future saving. The wealth effect might evenreduce new saving. Consequently, the revenue losses might not lead to additionalsaving and investment.Although the concentration of tax reductions on new acquisitions would solve theproblem in part (b), it might not spur additional saving and investment as muchas expected because individuals might expect the government to increase capitalgains taxes again in the future once their projects become “past acquisitions.”b.c.Chapter16Government Debt217Data Questions1.a.Table 15–1(1)Year20092010b.(2)RealGDPGrowthForecast (%)–2.02.2(3)ActualReal GDPGrowthRate (%)________________(4)(5)UnemploymentActualRateUnemploymentForecast (%)Rate (%)8.48.8________________The actual GDP growth rate and unemployment rate were not known when thisStudy Guidewent to press.CHAPTER16Government DebtProblems4.According to the traditional view, the future reduction in government spending wouldhave no effect on the sum of current and expected future income, current consumption,or current private saving. According to the Ricardian view, a future reduction in gov-ernment purchases will be accompanied by an expected future reduction in taxes. Thiswill increase the sum of current and expected future disposable income, increase cur-rent consumption, and decrease current private saving.5.a.b.c.d.e.f.Country A: $140 billion; Country B: $40 billionCountry A: $0 billion; Country B: –$100 billionCountry A: $2,000 billion; Country B: $1,900 billionCountry A: $2,000 billion; Country B: $1,900/0.95 = $2,000 billion$200 + 0.07 ($2,000) – $340 = $0 billion in both countries.understate; as the price level falls, the real value of outstanding government debtrises, but this increase is not included in the official deficit.Data Questions1.a.Table 16–3(1)FiscalYear20032004200520062007(Data in billions of $)(2)(3)(4)(5)Total FederalTotal FederalOfficialGross FederalGovernmentGovernmentFederal BudgetDebt Held byReceiptsOutlaysSurplusPublic (end of year)1,782.51,880.32,153.92,407.32,568.22,160.12,293.02,472.22,655.42,730.2–377.6–412.7–318.3–248.2–162.03,913.44,295.54,592.24,829.05,035.1218Answers to Selected Student Guide Problemsb.Table 16–4(1)(2)(3)PriceDeflator forGDPPercentage(2000 = 100)Change109.53.22005200620072008113.03.3116.72.7119.82.3122.55,035.14,829.0–50.94,592.2–124.24,295.5–176.5(4)(5)Gross Federal DebtApproximateHeld by Public (end“True” Federalof precedingfiscal year)Budget Surplus($ in billions)($ in billions)3,913.4–287.5CalendarYear2004CHAPTER17ConsumptionProblems4.a.b.6.a.C1= 100; C2= 125; S= 20C1= 93.33; C2= 140; S= 26.67A country with a rapidly increasing population will have a higher saving rate (anda lower aggregate APC) than a country with a steady population because each suc-cessive generation of workers, who do the saving, will be larger than the precedinggeneration of workers.A country with a rapidly growing real GDP per capita will have a higher savingrate (and a lower aggregate APC) than a country with a stagnant economy. Eachsuccessive generation of workers in the growing economy earns more per person(and hence saves more per person) than what the current generation of retireesearned (and saved) when it was working and from which it is now dissaving.b.10.After the legislation was passed, all the future tax cuts became expected. According tothis theory, people’s permanent incomes rose (and, hence, their consumption rose) onlyin the first year, 1981, which would be the only year in which consumption changed asa result of the tax changes unless people had borrowing constraints.Data Questions1.a.Table 17–5(1)(2)RealConsumptionExpenditures($ in billions)2,185.04,369.88,252.8(3)RealDisposableIncome($ in billions)2,475.94,874.58,664.0(4)AveragePropensity toConsume (APC)0.8830.8960.955Year196719872007Chapter18Investment219b.c.Percentage change in real disposable income equals 249.1 percent; percentagechange in APCis 8.2 percent.Over long periods of time, the APCis relatively constant.2.a. Table 17–6(1)(2)ConsumptionExpenditures($ in billions)507.8558.0648.5(3)DisposableIncome($ in billions)575.3625.0735.7(4)AveragePropensity toConsume (APC)0.8830.8930.881Year196719681970b.In 1968, Congress passed a temporary tax surcharge. This did not have a signifi-cant effect on people's permanent incomes, so they maintained their previous lev-els of consumption by reducing their current saving and temporarily increasingtheir APC.CHAPTER18InvestmentProblems9.a.b.c.An investment tax credit of 8 percent allows firms to deduct 8 percent of theirinvestment expenditures from their taxes.The cost of capital declines at each real interest rate. Consequently, the IScurveshifts to the right. The LMcurve does not shift.i.The IScurve shifts to the right for the same reason as in part (b). The LMcurve does not shift.ii.As the real domestic interest rate rises, U.S. net capital outflow falls.iii.The U.S. trade surplus also falls. Consequently, the real foreign exchangerate rises.The IScurve is flatter in a large open economy than in a closed economy. Giventhe same horizontal shift of the IScurve in both situations, the investment taxcredit would have a greater short-run effect on output in a closed economy, wherenet exports would not be “crowded out.” Since the interest rate rises by more inthe closed economy, however, the increase in investment will be greater in thelarge open economy.d.220Answers to Selected Student Guide ProblemsData Questions1.a.Table 18–3(1)(2)RealNonresidentialInvestment inStructures($ in billions)294.5243.5338.8(3)RealNonresidentialInvestment inEquipmentand Software($ in billions)745.6843.11,047.0(4)(5)RealChange inBusinessInventories($ in billions)72.614.3–29.0YearRealResidentialInvestment($ in billions)418.3509.4359.5199820032008b.The percentage change between the highest and lowest values was 39.1 percentfor investment in structures, 40.4 percent for investment in equipment and soft-ware, 41.7 percent for residential investment, and 350.4 percent or undefined forchanges in business inventories. Consequently, inventory investment was rela-tively the most volatile, and investment in structures was the least volatile duringthis period.Table 18–14(1)(2)AverageValue ofS&P500 Index1,281.47–31.9November 2008February 2008May 2009August 2009873.28________________________________________________________November 2009________2010: Q1________2009: Q4________________2009: Q3________________2009: Q2________________2009: Q111,340.9________(3)PercentageChangein S&P500 Index(4)(5)RealGDP(Billions of2000 $)11,522.1–1.6(6)PercentageChange in RealGDP2.Some of the data were not yet available when this book went to press.MonthAugust 2008Quarterand Year2008: Q4The fall in the stock market between August and November 2008 foretold the largesubsequent decline in real GDP. When this book went to press, it wasn’t clear whetherthe further stock market decline between November 2008 and February 2009 or thesubsequent recovery in the stock market correctly predicted future changes in realGDP.Chapter19Money Supply and Money Demand221CHAPTER19Money Supply, Money Demand,and the Banking SystemProblems9.(N*)2= iY/2F. Thus, FN*= iY/2N*Data Questions1.a. and b.Table 19–2(1)(2)(3)Monetary BaseM1in Dec.in Dec.($ in billions)($ in billions)239.8479.9823.3750.21,072.51,366.5(4)M1 MoneyMultiplier3.132.231.66(5)(6)M2in Dec.M2 Money($ in billions)Multiplier2,831.34,034.17,404.311.818.418.99Year198719972007c.If the Fed had preset targets for M1, it would have had to continually increase itstarget for the monetary base after 1987 to offset the decline in the M1 money mul-tiplier. If the Fed had preset targets for M2, it would have had to increase its tar-get for the monetary base between 1987 and 1997 to offset the decrease in the M2money multiplier.The average federal funds rate was 4.97 percent in 2006, 5.02 percent in 2007,and 1.92 percent in 2008. The rate was lowered in 2008 because the Fed wasfighting a recession.2.