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realize that this question is very simplified”it ignores
home equity, property taxes, etc.
3. In case (b), the production possibilities frontier will be
further from the origin in 2007, since Stromboli will have
Slope is 25 interpreted as 25 new economics students
more pizza ovens with which it can produce more pizzas.
each academic year.


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Licensed to:

F I GU R E 2
F I GU R E 1
(Pizza numbers in Millions; ovens in thousands)

D0 S1 S0

Pizza Ovens



160 S1
5 S0

0 15 30 45 60 75
20 27 31 35 36 40 44
Quantity (millions)

D0 to D1. Price falls from P0 to P1, and quantity falls from
Supply and Demand: An Initial Look
Q0 to Q1.
1. (a) The demand curve for a medicine that means life or (a) In a drought, people have less need for umbrellas, so
death for a patient will be vertical, provided the demand falls.
patient has access to any money at all. One would not (b) Popcorn is a complement for movie tickets, so when
expect a decline in quantity demanded as the price popcorn prices rise, the demand for tickets falls.
rises, if that decline meant that the patient would die.
(c) Coca-Cola is a substitute for coffee, so when the price
(b) The demand curve for french fries in a food court of the soda falls, the demand for coffee falls.
with many other stands will be fairly flat, perhaps
even horizontal. If the firm raises its price at all, many
F I GU R E 4
if not most of its customers will just move to a differ-
ent stand. Thus a small change in price results in a
large change in the amount of fries bought.
3. The answers to all three parts are shown in Figure 2.
(a) Initially, the equilibrium price is $250, and the D1 S
equilibrium quantity is 35 million bicycles, as shown
by the intersection of D0 and S0.
(b) If demand falls by 8 million bikes per year, the new

demand curve is D1. The price falls to $210, and P0
the quantity falls to 31 million, as shown by the
intersection of D1 and S0. Although demand falls by
8 million at each price, the quantity exchanged falls
by only 4 million because the price fall has induced a
movement out along the new demand curve, as well
S D1
as a movement back along the old supply curve.
(c) If supply falls by 8 million bikes per year, the new Q1 Q0
supply curve is S1. The price rises to $300, and the Quantity
quantity falls to 31 million, as shown by the intersec-
tion of D0 and S1. Although supply falls by 8 million
at each price, the quantity exchanged falls by only 4
million because the price increase has induced a
An Introduction to Macroeconomics
movement out along the new supply curve, as well as
a movement back along the old demand curve.
1. Microeconomist: (a) and (d); Macroeconomist: (b) and (c)
(d) If demand and supply each fall by 8 million bikes per
year, the equilibrium price is $250, and the equilib- 3. (a) Raises GDP by $50,000.
rium quantity is 27 million bicycles, as shown by the
(b) Raises GDP by $10,000.
intersection of D1 and S1.
(c) GDP does not rise, because there is no market
5. The same diagram, Figure 4, can be used for all three
cases, because they all entail a decline in demand, from

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Appendix 395

(d) GDP rises by $500,000, the value of the newly 3.
constructed house.
(e) GDP does not rise, because nothing new was 2005 2006 2007
Nominal GDP 12,434 13,195 13,843
(f) Raises GDP by $25,000.
Real GDP 11,003 11,319 11,567
(g) GDP actually falls by $100. The casino is selling
GDP Deflator 113.0 116.6 119.7
“gambling services” to you, which are measured by
how much you lose. Winning $100 therefore reduces
sales of gambling services. 5.
(h) GDP does not rise. Because nothing new is produced,
capital gains and losses do not count in GDP.
1970 1980 1990 2000
(i) GDP does not change because you did not produce a
Money wages $3.23 $6.66 $10.01 $13.75
good or service.
CPI 38.8 82.4 130.7 172.2
(j) Raises GDP by $100.
Real wages $8.32 $8.08 $7.66 $7.98

The Goals of Macroeconomic Policy 1970 “ 80 1980 “90 1990 “ 00
Growth, money wages 106.2% 50.3% 37.4%
1. After 25 years Country A˜s economy has grown by 109%
Growth, real wages “2.9% “5.2% 4.2%
because (1.03)25 5 2.09. After 25 years Country B™s econo-
my has grown by 167% because (1.04)25 5 2.67. If we
index both countries™ GDP to be 100 at the start of the 25-
Money wages grew fastest in the decade 1970“1980, but
year period, by the end of the period, Country A™s GDP
real wages grew fastest in 1990“2000. In fact, real wages
would be 209 and Country B™s would be 267. Therefore,
declined in the preceding two decades.
Country B™s economy would be roughly 28% larger than
that of Country A because (267 2 209)/(209) 5 .28.
The gap between the GDPs of the two countries is larger
than 25% due to the compounding of a 1% higher growth Economic Growth: Theory and Policy
rate for 25 years.
1. The productivity growth for each country is shown in the
3. If actual GDP grew slower than potential GDP from 2000
fourth column below.
to 2003, unemployment should have increased, which it
did. Similarly, from 2003 to 2006, unemployment should
have decreased because actual GDP was growing faster
1997 Output 2007 Output Productivity Growth
than potential. Unemployment did, in fact, fall between per Hour per Hour 1997“2007
2003 and 2006.
Country A $40.00 $48.00 20%
5. (a) 18 percent (b) 14 percent (c) 10 percent (d) 3 percent
Country B 25.00 35.00 40%
(e) 22 percent
Country C 2.00 3.00 50%
Country D 0.50 0.60 20%
Answers to Appendix Questions
1. Productivity growth was highest for Country C, which had
a very low initial level of productivity. But note that the pro-
ductivity growth for Country D lagged far behind countries
1970 1980 1990 2000
B and C despite Country D™s lower starting point. As men-
Dow Jones tioned in the text, not all countries (such as Country D here)
Industrial are able to participate in the convergence process. However,
Average (DJIA) 753 891 2,679 10,735 Countries B and C did close some of the gap on Country A.
CPI 38.8 82.4 130.7 172.2
3. The prices of items b, d, and e would be expected to
Deflated DJIA 1,941 1,081 2,050 6,234 rise rapidly over time, as each of these are personally
provided services for which productivity improvements
are difficult or impossible. By contrast, items a and c are
The deflated DJIA is found by dividing the DJIA by the
not personally provided. In fact, productivity in these
CPI of the same year, then multiplying by the base year
two electronically delivered services has increased
CPI, which is 100. Stock prices do not rise every decade.
dramatically over time, pushing down their prices.
They declined notably during the decade between 1970
and 1980 but then rose between 1980 and 2000. Stocks 5. Draw a graph similar to Figure 1 in the text. Higher levels
were most valuable in 2000. (Incidentally, both nominal of capital increase labor productivity, resulting in higher
and real stock prices fell between 2000 and 2003, before levels of output produced with the same quantity of labor.
recovering.) For example, in Figure 1 increasing the amount of capital
from K1 to K2 increases the output from Ya to Yb. Labor

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Licensed to:

Answers to Appendix Questions
productivity increases when the capital stock is larger
because workers can use the additional capital to produce
more goods and services. For example, imagine loading 1. (a) Included: GDP rises by $25,000.
and unloading a semitrailer truck by hand vs. using a
(b) Not included, because it was produced in another
forklift. One forklift operator can load and unload the
country. Actually, it is included as part of C, but then
truck in far less time then can be done by hand.
deducted as part of IM, which enters negatively in
C 1 I 1 G 1 (X 2 IM).
F I GU R E 1 (c) Not included, since it was not produced this year.
(d) Included: GDP rises by $500 million (in investment, I ).
(e) Not included; it™s a government transfer payment.
K3 (f) Included, as investment in inventory: GDP rises by
$15 million.
(g) Included, as consumption (legal services): GDP rises
by $10,000.

(h) Not included: previously produced.
GDP as the Sum of Final Demands (all figures in millions)

Specific Super Rest of
Motors Duper Government World Total
0 L1

C 4.8 14.0 1.0 19.8
Hours of Labor Input
I 0.8 0.8
G 0.3 0.8 1.1
x 0.9 0.9
Aggregate Demand and the
“IM “1.0 “1.0
Powerful Consumer
Y 21.6
1. Consumption (largest), government spending, investment,
net exports (smallest”actually negative in the U.S.)
3. Line C0 is the consumption function for Simpleland. The
marginal propensity to consume can be calculated from GDP as the Sum of Incomes (all figures in millions)
the data for any pair of years. For example, for the period


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