978-0077660772 Chapter 6 Solution Manual

Chapter 06 – An Introduction to Macroeconomics

McConnell, Brue, and Flynn 20e

DISCUSSION QUESTIONS

1. Why do you think macroeconomists focus on just a few key statistics when trying to

understand the health and trajectory of an economy? Would it be better to try to make examine all

possible data? LO1

Answer: Macroeconomists focus on a few key statistics, real GDP, unemployment, and

2. Consider a nation in which the volume of goods and services is growing by 5 percent per year.

What is the likely impact of this high rate of growth on the power and influence of its government

relative to other countries experiencing slower rates of growth? What about the effect of this 5

percent growth on the nation’s living standards? Will these also necessarily grow by 5 percent per

year, given population growth? Why or why not? LO2

Answer: If a country’s economic size is growing faster than the rest of the world then

this country will gain influence in the international sector. China is a classic example of

3. Did economic output start growing faster than population from the beginning of the human

inhabitation of the earth? When did modern economic growth begin? Have all of the world’s

nations experienced the same extent of modern economic growth? LO2

Answer: No, rapid and sustained economic growth is a modern phenomenon. Before the

Industrial Revolution began in the late 1700s in England, standards of living showed

No, the vast differences in living standards seen today between rich and poor countries

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Chapter 06 – An Introduction to Macroeconomics

4. Why is there a trade-off between the amount of consumption that people can enjoy today and

the amount of consumption that they can enjoy in the future? Why can’t people enjoy more of

both? How does saving relate to investment and thus to economic growth? What role do banks

and other financial institutions play in aiding the growth process? LO3

Answer: Individuals have 2 choices with their income: they can spend it or save it. If

they spend their income today they will not have it to spend in the future.

To increase consumption in the future, households must save so that firms can undertake

Typically a higher saving rate, the fraction of GDP not consumed today, results in higher

Banks, along with other financial institutions, act as financial intermediaries between

5. How does investment as defined by economists differ from investment as defined by the

general public? What would happen to the amount of economic investment made today if firms

expected the future returns to such investment to be very low? What if firms expected future

returns to be very high? LO3

Answer: Economic Investment refers to the purchase of machinery, tools, etc… that can

be used to produce goods and services in the future. This investment is undertaken by

firms and the way economists think about investment. Financial Investment captures

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Chapter 06 – An Introduction to Macroeconomics

6. Why, in general, do shocks force people to make changes? Give at least two examples from

your own experience. LO4

Answer: Shocks to the economy force people to make changes in expectations and actual

behavior. For example, you believe your annual income once you graduate will be

7. Catalogue companies are committed to selling at the prices printed in their catalogues. If a

catalogue company finds its inventory of sweaters rising, what does that tell you about the

demand for sweaters? Was it unexpectedly high, unexpectedly low, or as expected? If the

company could change the price of sweaters, would it raise the price, lower the price, or keep the

price the same? Given that the company cannot change the price of sweaters, consider the number

of sweaters it orders each month from the company that makes its sweaters. If inventories become

very high, will the catalogue company increase, decrease, or keep orders the same? Given what

the catalogue company does with its orders, what is likely to happen to employment and output at

the sweater manufacturer? LO4

Answer: If the inventories are rising for sweaters then we know that demand for sweaters

must be falling. This is because prices are fixed, so this implies that people are buying

less of the good due to a decrease in demand (see Figure 6.1). In most circumstances, this

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Chapter 06 – An Introduction to Macroeconomics

8. Are all prices in the economy equally inflexible? Which ones show large amounts of short-run

flexibility? Which ones show a great deal of inflexibility even over months and years? LO5

Answer: Different prices have different degrees of flexibility as can be seen from Table

6.1:

Goods such as Gasoline change price, on average, every 0.6 months and airline tickets

9. Why do many firms strive to maintain stable prices? LO5

Answer: There are two main reasons: 1) companies selling final goods and services

know that consumers prefer stable, predictable prices that do not fluctuate rapidly with

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Chapter 06 – An Introduction to Macroeconomics

10. Do prices tend to become more or less flexible as time passes? If there is a trend, how does it

affect macroeconomists’ choice of models? LO6

Answer: As the length of time increases so will the flexibility in prices. In the very short

run prices tend to be completely inflexible. As time moves on prices become more and

more flexible. This can be seen when an economy reacts to demand shocks with price

11. LAST WORD How do the Minsky and Austrian explanations for the causes of the Great

Recession differ? Explain how the proponents of government stimulus believe that it will affect

aggregate demand and employment (be specific!). How might government stimulus possibly

slow rather than accelerate a recovery?

Answer: Economist Hyman Minsky believes that the Great Recession was caused by

period(s) before the recession of euphoria and debt-fueled speculation that caused one or

more financial asset to become inflated beyond realistic levels and subsequently collapse.

The proponents of government stimulus thought that the government could shift

aggregate demand to the right by 1) pushing interest rates very low so that consumers and

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REVIEW QUESTIONS

1. An increase in _______ GDP guarantees that more goods and services are being produced by

an economy. LO1

a. Nominal.

b. Real.

The correct answer is that an increase in real GDP guarantees that more goods and services

2. True or False. The term economic investment includes purchasing stocks, bonds, and real

estate. LO3

This statement is false because the term economic investment is limited in scope and only

refers to spending on the production and accumulation of newly created capital goods such as

3. If an economy has sticky prices and demand unexpectedly increases, you would expect the

economy’s real GDP to: LO4

a. Increase.

b. Decrease.

c. Remain the same.

The correct answer is that if an economy has sticky prices and demand unexpectedly

increases, you would expect the economy’s real GDP to increase.

You would expect real GDP to increase because with prices sticky, the unexpected increase in

If firms have sufficiently large inventories, they may not increase output immediately when

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Chapter 06 – An Introduction to Macroeconomics

4. If an economy has fully flexible prices and demand unexpectedly increases, you would expect

that the economy’s real GDP would tend to: LO4

a. Increase.

b. Decrease.

c. Remain the same.

The correct answer is that if an economy has fully flexible prices and demand unexpectedly

increases, you would expect the economy’s real GDP to remain the same. This is true because

In addition, it is often hard for firms to make rapid adjustments to their output levels when

5. If the demand for a firm’s output unexpectedly decreases, you would expect that its inventory

would: LO4

a. Increase.

b. Decrease.

c. Remain the same.

d. Increase or remain the same, depending on whether prices are sticky.

Answer: d. Increase or remain the same, depending on whether prices are sticky.

If the demand for a firm’s output unexpectedly decreases, you would expect that its inventory

would increase or remain the same, depending on whether prices are sticky or not.

By contrast, if prices are sticky, then a decrease in demand will lead to a reduction in the

quantity sold because consumers will demand fewer units at the little-changed, sticky prices.

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Chapter 06 – An Introduction to Macroeconomics

6. True or False. Because price stickiness only matters in the short run, economists are

comfortable using just one macroeconomic model for all situations. LO6

PROBLEMS

1. Suppose that the annual rates of growth of real GDP of Econoland over a five-year period were

sequentially as follows: 3 percent, 1 percent, -2 percent, 4 percent, and 5 percent. What was the

average of these growth rates in Econoland over these 5 years? What term would economists use

to describe what happened in year 3? If the growth rate in year 3 had been a positive 2 percent

rather than a negative 2 percent, what would have been the average growth rate? LO1

Feedback:

To calculate the average annual rate of growth for this economy add each year’s rate of

growth then divide by the number of years.

2. Suppose that Glitter Gulch, a gold mining firm, increased its sales revenues on newly mined

gold from $100 million to $200 million between one year and the next. Assuming that the price of

gold increased by 100 percent over the same period, by what numerical amount did Glitter

Gulch’s real output change? If the price of gold had not changed, what would have been the

change in Glitter Gulch’s real output? LO1

Feedback: Since the price doubled and the sales revenue doubled between one year and

the next, this implies that the company sold and mined the same amount of gold over the

period. The change in real output is zero.

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Chapter 06 – An Introduction to Macroeconomics

3. A mathematical approximation called the rule of 70 tells us that the number of years that it will

take something that is growing to double in size is approximately equal to the number 70 divided

by its percentage rate of growth. Thus, if Mexico’s real GDP per person is growing at 7 percent

per year, it will take about 10 years (= 70/ 7) to double. Apply the rule of 70 to solve the

following problem. Real GDP per person in Mexico in 2005 was about $11,000 per person, while

it was about $44,000 per person in the United States. If real GDP per person in Mexico grows at

the rate of 5 percent per year, about how long will it take Mexico’s real GDP per person to reach

the level that the United States was at in 2005? (Hint: How many times would Mexico’s 2005 real

GDP per person have to double to reach the United States’ 2005 real GDP per person?) LO2

Feedback: Using the rule of 70 Mexico’s Real GDP per person will double every 14

This implies that in 14 years Mexico’s Real GDP per person will be $22,000. This is still

only half of the $44,000 Real GDP per person in the United States.

4. Assume that a national restaurant firm called BBQ builds 10 new restaurants at a cost of $1

million per restaurant. It outfits each restaurant with an additional $200,000 of equipment and

furnishings. To help partially defray the cost of this expansion, BBQ issues and sells 200,000

shares of stock at $30 per share. What is the amount of economic investment that has resulted

from BBQ’s actions? How much purely financial investment took place? LO3

Feedback: Economic Investment is the purchase of buildings and machinery that can be

used to produce goods and services in the future. The restaurant firm builds 10 new

restaurants at a cost of $1 million each, which results in $10 million ($1 million x 10

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Chapter 06 – An Introduction to Macroeconomics

5. Refer to Figure 6.1b and assume that price is fixed at $37,000 and that Buzzer Auto needs 5

workers for every 1 automobile produced. If demand is DM and Buzzer wants to perfectly match

its output and sales, how many cars will Buzzer produce and how many workers will it hire? If

instead, demand unexpectedly falls from DM to DL, how many fewer cars will Buzzer sell? How

many fewer workers will it need if it decides to match production to these lower sales? LO4

Feedback: If demand is DM and Buzzer Auto wants to perfectly match its output and

sales it will produce 900 cars. Buzzer Auto will want to employ 4,500 workers since it

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