978-1259723223 Chapter 26

Chapter 26 – An Introduction to Macroeconomics

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Chapter 26 – An Introduction to Macroeconomics

McConnell, Brue, and Flynn 21e

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

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

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

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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

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

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

your own experience. LO4

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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

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

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consent of McGraw-Hill Education.

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

26.1:

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

change price, on average, every month which is very quick. Coin-operated laundry on the

other hand is much more sticky, or inflexible, as its price stays the same for 46.4 months

– which is almost 4years.

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

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

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

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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

REVIEW QUESTIONS

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

an economy. LO1

a. Nominal.

b. Real.

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

estate. LO3

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.

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.

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consent of McGraw-Hill Education.

Answer: 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 with full flexible prices, the increase in demand will tend to bid up

prices for the amount of output that is already being supplied. That amount of output was

based on the expectations that firms had before demand unexpectedly increased. In

particular, firms chose how many factories to build, how many workers to hire, and how

much to produce based upon their expectations about what demand would be. So when

demand ends up being unexpectedly strong, firms are at least for a while stuck producing

what has turned out to be an insufficiently low level of output.

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

when demand ends up unexpectedly high. So what is likely to happen in this situation

where prices are fully flexible is that prices will rises as the unexpectedly high demand

interacts with a level of supply that is fixed in the short run (by the fact that increasing

output takes time).

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.

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

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consent of McGraw-Hill Education.

Answer: false.

As the time frame moves from a very short run to the long run prices will change from

being very sticky to flexible. Therefore, economists use 2 different models.

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

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

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

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consent of McGraw-Hill Education.

Answer: 28 years

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

years (= 70 / 5 or 70 divided by the rate of growth in Mexico).

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.

If we move ahead another 14 years Mexico’s Real GDP per person will double again to

$44,000 (from $22,000). Thus, after 28 years Mexico’s Real GDP per person will reach

the level of the United States in 2005.

(Mexico’s Real GDP per person will need to double twice.)

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

5. Refer to Figure 26.1b 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