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CHAPTER 26
An Introduction to Macroeconomics
A. Short-Answer, Essays, and Problems
1. Classify the following questions as macroeconomics or microeconomics.
a) Why does a tax on soda increase consumption of ice tea?
b) Why are some countries rich while others are poor?
c) Why do some countries enjoy long-run increases in standards of living, while other countries have
stagnate growth?
d) Why are the prices of name-brand products higher than the prices of generic?
2. Macroeconomics is mainly concerned with two topics. What are these two topics and how are they related
to each other?
4. What is the difference between a slowdown in economic growth and a recession?
5. What are the three primary measures used in macroeconomics to assess the performance of an economy?
6. The three major indicators of the health and development of an economy include: real GDP,
unemployment, and inflation. All other things equal, would an economy prefer these numbers to be
7. Describe the difference between real GDP and nominal GDP. Which concept is more useful for measuring
change in the economy over time? Why?
8. Assume that a painter produces 20 paintings this year and 20 paintings next year. What is the annual
change in nominal GPD if the price of paintings rises from $1,000 this year to $1,500 next year? Can you
conclude that the economy grew from this year to next year based on your answer? Why?
9. Assume that in year 1 an economy produces 1000 units of output and they sell for $100 a unit, on average.
In year 2, the economy produces the same 1000 units of output, and sells it for $110 a unit, on average.
Use year 1 prices to calculate real GDP in Year 1 and Year 2. What happened to real GDP between years 1
and 2? Why?
10. What is the opportunity cost of unemployment for an economy? What social problems have been linked to
higher rates of unemployment?
11. Unemployment is not only bad for the economy due to the loss of goods and services. Describe some other
12. How does inflation affect people’s standards of living and savings?
13. Identify at least four important policy questions about the powers and limits of government economic
14. Compare and contrast the characteristics of economic growth in ancient or pre-industrial times with modern
15. What accounts for differences in living standards between rich and poor countries today?
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16. GDP figures can be used to make international comparisons of living standards. What are three
adjustments made by the International Monetary Fund (IMF) to each country’s GDP to allow for
17. Define saving.
18. Why are savings and investment so important for economic growth? How do savings and investment affect
19. (Consider This) What is the difference between economic investment and financial investment? Give an
20. “Households are the principal source of savings. But businesses are the main economic investors.” Briefly
21. How do uncertainty and expectations influence economic behavior?
22. What are demand shocks? Give an example of a positive and a negative demand shock.
24. Answer the next four questions based on the following demand and supply model for a business firm
producing motorcycles. Assume that 300 motorcycles is the optimal and most profitable level of
production for the firm. All dollars are in thousands.
(a) What are the equilibrium price and quantity at the medium level of demand (DM)?
(b) What will be the equilibrium price and quantity if there is a demand shock that unexpectedly lowers
demand (DL)?
(c) What will be the equilibrium price and quantity if there is a demand shock that unexpectedly increases
demand (DH)?
(d) What can you conclude will happen to prices and output when this model is shocked by changes in
demand?
25. How does an economy adjust to demand shocks when prices are inflexible?
0
P
ri
c
e
30
300
DH
Motorcycle
s
20
10
DM
DL
S
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26. The following is a demand and supply model for a business firm producing baseball caps. Assume that 100
baseball caps is the optimal ad most profitable level of production for the firm. Answer the next four
questions assuming that the price of baseball caps is inflexible.
(a) What are the equilibrium price and quantity at the medium level of demand (DM)?
(b) What will be the equilibrium price and quantity if there is a demand shock that unexpectedly lowers
demand (DL)?
(c) What will be the equilibrium price and quantity if there is a demand shock that unexpectedly increases
demand (DH)?
(d) What can you conclude will happen to prices and output when this model is shocked by changes in
demand?
27. How do companies deal with unexpected shifts in quantity demanded when prices are sticky?
28. Evaluate the statement that “unexpected declines in demand, with inflexible prices, generate a rise in
29. (Consider This) Describe the economic conditions of the Great Recession.
30. (Consider This) Which took the major brunt of the decline in total demand in the Great Recession, real
31. What happens to inventories when prices are sticky and there is a demand shock? Explain.
32. Give examples of the stickiness of prices based on the average number of months between price changes
34. Why do economists refer to prices as “sticky” rather than “stuck”?
35. How can price stickiness be used to categorize macroeconomic models?
0
P
ri
c
e
100
DH
Baseball
caps
20
DM
DL
5
0
150
S
B. Answers to Short-Answer, Essays, and Problems
1. Classify the following questions as macroeconomics or microeconomics.
a) Why does a tax on soda increase consumption of ice tea?
b) Why are some countries rich while others are poor?
c) Why do some countries enjoy long-run increases in standards of living, while other countries have
stagnate growth?
d) Why are the prices of name-brand products higher than the prices of generic?
2. Macroeconomics is mainly concerned with two topics. What are these two topics and how are they related
to each other?
3. Contrast the economic growth and business cycles.
4. What is the difference between a slowdown in economic growth and a recession?
5. What are the three primary measures used in macroeconomics to assess the performance of an economy?
6. The three major indicators of the health and development of an economy include: real GDP,
unemployment, and inflation. All other things equal, would an economy prefer these numbers to be
increasing or decreasing? Why?
7. Describe the difference between real GDP and nominal GDP. Which concept is more useful for measuring
change in the economy over time? Why?
8. Assume that a painter produces 20 paintings this year and 20 paintings next year. What is the annual
change in nominal GPD if the price of paintings rises from $1,000 this year to $1,500 next year? Can you
conclude that the economy grew from this year to next year based on your answer? Why?
9. Assume that in year 1 an economy produces 1000 units of output and they sell for $100 a unit, on average.
In year 2, the economy produces the same 1000 units of output, and sells it for $110 a unit, on average.
Use year 1 prices to calculate real GDP in Year 1 and Year 2. What happened to real GDP between years 1
and 2? Why?
10. What is the opportunity cost of unemployment for an economy? What social problems have been linked to
higher rates of unemployment?
26-537
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
been linked to a number of social problems such as crime, political unrest, depression, heart disease and
other illnesses.
11. Unemployment is not only bad for the economy due to the loss of goods and services. Describe some other
reasons why unemployment has a negative effect on the economy.
12. How does inflation affect people’s standards of living and savings?
13. Identify at least four important policy questions about the powers and limits of government economic
policy that macroeconomics models are able to answer.
14. Compare and contrast the characteristics of economic growth in ancient or pre-industrial times with modern
economic growth today.
15. What accounts for differences in living standards between rich and poor countries today?
16. GDP figures can be used to make international comparisons of living standards. What are three
adjustments made by the International Monetary Fund (IMF) to each country’s GDP to allow for
meaningful comparisons of living standards between countries? Explain.
17. Define saving.
26-538
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
Saving is generated when current consumption is less than current output (or when current spending is less
than current income). The economic term used to define a situation where current consumption is more
than current output (or current spending is more than current income) is dissaving.
18. Why are savings and investment so important for economic growth? How do savings and investment affect
present and future consumption? Explain.
19. (Consider This) What is the difference between economic investment and financial investment? Give an
20. “Households are the principal source of savings. But businesses are the main economic investors.” Briefly
explain.
21. How do uncertainty and expectations influence economic behavior?
22. What are demand shocks? Give an example of a positive and a negative demand shock.
26-539
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent
of McGraw-Hill Education.
economy, if prices of products are completely flexible, then output would remain the same but the price of
goods and services would have to change to maintain a constant level of output.
24. Answer the next four questions based on the following demand and supply model for a business firm
producing motorcycles. Assume that 300 motorcycles is the optimal and most profitable level of
production for the firm. All dollars are in thousands.
(a) What are the equilibrium price and quantity at the medium level of demand (DM)?
(b) What will be the equilibrium price and quantity if there is a demand shock that unexpectedly lowers
demand (DL)?
(c) What will be the equilibrium price and quantity if there is a demand shock that unexpectedly increases
demand (DH)?
(d) What can you conclude will happen to prices and output when this model is shocked by changes in
demand?
25. How does an economy adjust to demand shocks when prices are inflexible?
0
P
ri
c
e
30
300
DH
Motorcycle
s
20
10
DM
DL
S
26. The following is a demand and supply model for a business firm producing baseball caps. Assume that 100
baseball caps is the optimal ad most profitable level of production for the firm. Answer the next four
questions assuming that the price of baseball caps is inflexible.
(a) What are the equilibrium price and quantity at the medium level of demand (DM)?
(b) What will be the equilibrium price and quantity if there is a demand shock that unexpectedly lowers
demand (DL)?
(c) What will be the equilibrium price and quantity if there is a demand shock that unexpectedly increases
demand (DH)?
(d) What can you conclude will happen to prices and output when this model is shocked by changes in
demand?
27. How do companies deal with unexpected shifts in quantity demanded when prices are sticky?
28. Evaluate the statement that “unexpected declines in demand, with inflexible prices, generate a rise in
unemployment and a fall in output.”
0
P
ri
c
e
100
DH
Baseball
caps
20
DM
DL
5
0
150
S
29. (Consider This) Describe the economic conditions of the Great Recession.
30. (Consider This) Which took the major brunt of the decline in total demand in the Great Recession, real
output or prices?
31. What happens to inventories when prices are sticky and there is a demand shock? Explain.
32. Give examples of the stickiness of prices based on the average number of months between price changes
for selected goods and services.
33. Describe two reasons why businesses hesitate to change prices.
34. Why do economists refer to prices as “sticky” rather than “stuck”?
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35. How can price stickiness be used to categorize macroeconomic models?
36. Offer an explanation for how sticky the following prices are:
(a) Airline Tickets
(b) Coin-Operated Laundry Machines
(c) Gasoline
(d) Meals at Restaurants
37. (Last Word) Discuss two of the popular hypotheses economists offer for what caused the Great Recession.
The first hypothesis is the Minksy Explanation: Euphoric Bubbles. Economists Hyman Minksy believed
that recessions are often preceded by asset-price bubbles. In the case of the 2007-2009 recession, a massive
housing price bubble and home-mortgage loans was the driver. When the bubble collapsed many investors
and homeowners lost trillions of dollars. Sticky prices and a leftward shift in demand forced many
companies to reduce output and lay off workers. Weak firms exited the market by claiming bankruptcy and
firing all workers.
38. (Last Word) Explain the two popular opinions held by economists on how to improve the economy.
The first solution is the Stimulus Solution. The majority of economists argued that to improve the economy
shift in demand rightward was necessary. This could have been accomplished in a variety of ways. The