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Solution Manual For ECON Macro, 1st Edition
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Solution Manual For ECON Macro, 1st Edition
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CHAPTER 1THE ART AND SCIENCE OF ECONOMIC ANALYSIS
ANSWERS TO END-OF-BOOK QUESTIONS AND PROBLEMS
1.1 (Definition of Economics) What determines whether or not a resource is scarce? Why is the concept of
scarcity important to the definition of economics?
A resource is scarce when the amount people desire exceeds the amount available at a price of zero. The
concept of scarcity is important to the definition of economics because scarcity forces people to choose how
they will use their resources in an attempt to satisfy their unlimited wants and desires. Economics is about
making choices. Without scarcity there would be no economic problem, and therefore no need to choose
between competing wants and desires.
1.2 (Definition of Economics) Identify each of the following as a resource, an economic actor, or a good or
service.
a. A stay-at-home parent
b. A computer
c. Oil
d. A hamburger
a. economic actor
b. good
c. resource
d. good
1.3 (Scarce Resources) How would you respond to the remark that clean water is free because you can simply
get a glass or even a jug from your home tap without paying anything?
Although you’re not paying for clean water at the tap, it’s not free to you if you pay taxes for the clean
water, or if someone else pays the taxes or related costs on your behalf.
2.1 (Rational Self-Interest) Discuss the impact of rational self-interest on each of the following decisions:
a. Whether to attend college full time or enter the workforce full time
b. Whether to buy a new textbook or a used one
c. Whether to attend a local college or an out-of-town college
a. Individuals will compare the expected benefits of attending college full time with the expected costs.
One benefit might be that the individual’s stock of knowledge and productivity will grow, and so will his
or her future wage. Costs include not only tuition, but also the wages that could have been earned by
working instead of attending college full time. If the expected benefits outweigh the costs, then the
rational person will choose to go to college full time.
b. Individuals will compare the expected benefits of a new textbook with the higher costs of purchasing a
new textbook. Benefits include not being confused by other students’ markings in the book and a higher
resale value. However, the out-of-pocket cost of a new book will be higher than the cost of a used book.
If the expected benefits outweigh the costs, then a rational person will purchase the new textbook.
c. Individuals will compare the expected benefits and costs associated with both colleges under
consideration and will choose the college at which the difference between benefits and costs is greater.
The costs of attending an out-of-town college may include greater travel costs and phone bills and
benefits such as learning about a different region.
Copyright © 2016 by Nelson Education Ltd.
,Chapter 1 The Art and Science of Economic Analysis C01-2
2.2 (Rational Self-Interest) If behaviour is governed by rational self-interest, why do people make charitable
contributions of time and money?
Rational self-interest is not blind materialism, pure selfishness, or greed. Rational self-interest means we
choose the option that maximizes expected benefits with a given cost. People will give more to charities
when the contribution is tax deductible. The lower the personal cost of helping others the more we are
willing to help and contribute. The benefits of contributing to charities may include feelings of well-being
and the recognition we receive from others when we contribute—for example, a wealthy donor having a
building named after her.
2.3 (Marginal Analysis) The owner of a small pizzeria is deciding whether to increase the radius of its delivery
area by two kilometres. What considerations must be taken into account if such a decision is to increase
profitability?
By increasing its delivery radius, the store will have greater sales. However, these marginal revenues must
be balanced against the additional costs incurred, such as greater consumption of pizza ingredients, more
gasoline for the delivery truck, and possibly the need to hire additional labour and increase advertising.
2.4 (Time and Information) It is often costly to obtain the information necessary to make good decisions. Yet
your own interests can be best served by rationally weighing all options available to you. This requires
informed decision making. Does this mean that making uninformed decisions is irrational? How do you
determine how much information is the right amount?
Rational decision makers will continue to acquire information as long as the benefit of the additional
information exceeds the additional costs. Oftentimes we are willing to pay others to gather and digest the
information for us.
2.5 (Time) A vacuum cleaner costs $600 and a high-quality broom costs only $5. Why would most people
purchase the more expensive vacuum cleaner to do their home cleaning?
You purchase a vacuum cleaner or a broom to help you clean. But to clean you must combine your labour
power with the vacuum cleaner or broom. It takes much longer to clean with a broom than with a vacuum
cleaner. To save on time costs (time is costly in terms of forgone uses of this time), most people would
purchase the vacuum cleaner to do major cleaning. Also, the vacuum does a better job of picking up the
dirt; it delivers a higher quality service.
2.6 (Information) You want to purchase a car. You, like most people, probably don’t want to spend too much
time searching for information. You certainly don’t want to check out all the dealers. You might simply do
an intensive search of one or two. How can you reconcile such normal behaviour with rational behaviour?
(Hint: think of the costs of information.)
If one starts with the assumption that most people are smart and in this sense rational, you would expect
them to take into consideration the cost of information when deciding how long to search. All other things
remaining the same, you’d expect that you’d spend less time searching for a car the more expensive are the
costs of information. More than this, smart people tend not to apply the marginal cost equals marginal
benefit rule when searching for a car. This tends to be too complex and time consuming. Rather, they apply
a stopping rule. They’ll stop searching when they find a car and dealer that meet their top three to five
characteristics—trustworthiness, model, size, warranty, etc.
Copyright © 2016 by Nelson Education Ltd.
,Chapter 1 The Art and Science of Economic Analysis C01-3
3.1 (Role of Theory) What good is economic theory if it can’t predict the behaviour of a specific individual?
This question highlights the fact that economics, like all social sciences, attempts to describe and explain
human behaviour. In doing so, it cannot measure and control for all factors influencing behaviour. The
result is that the behaviour of a specific individual cannot be explained or predicted, but the behaviour of
groups of individuals can be. We cannot, for example, predict any particular individual’s buying response
to a sale. We can, however, predict what kind of total selling volume will occur because of a sale.
3.2 (Normative versus Positive) Are the following statements normative or positive?
a. If the government wants to raise the price level it should increase the money supply.
b. Corporate taxes in Canada are too high.
c. Employment insurance programs cause the unemployment rate to rise.
a. Positive. One can collect data or evidence and see that a higher money supply will lead to a higher
price level.
b. Normative. Some individuals think that corporate taxes in Canada are too high, while others feel that
corporate taxes are too low, depending on their own feelings and beliefs about tax policy.
c. Positive. Again, one can collect data and see if changes in employment insurance programs cause
higher, lower, or the same amount of unemployment.
3.3 (Role of Theory) Some economists argue that economic theory should be based on realistic behavioural
assumptions. Why might realism of assumptions improve the capacity of theory to both predict and explain
economic outcomes?
If the assumptions generate accurate predictions of outcomes, many economists might say that this is good
enough. But other economists would argue that predicting outcomes reveals little about what caused or
produced the outcomes. Moreover, different sets of assumptions can generate the same prediction. To
identify cause and effect, one has to identify the set of realistic but simplifying assumptions that are able to
explain how the outcomes were produced—why firms actually become more efficient, why households
actually decide to have more or less children.
3.4 (Normative versus Positive) Determine whether each of the following statements is normative or positive:
a. The Canadian unemployment rate fell from 8.3 percent in October 2009 to 6.5 percent in October 2014.
b. The inflation rate in Canada is too high.
c. The Canadian government should increase the minimum wage.
d. Canadian restrictions in the dairy industry dramatically increase the cost of milk to Canadian consumers.
a. Positive—a statement of fact; b. Positive—for most economists, one can determine which rate of inflation
is “optimal” or best for the economy; c. Normative—a matter of opinion, although this opinion is rooted in
one’s scientific understanding of the implications of the minimum wage for the economy; d. Positive—a
statement of fact.
4.1 (Pitfalls of Economic Analysis) Review the discussion of pitfalls in economic thinking in this chapter. Then
identify the fallacy, or mistake in thinking, in each of the following statements:
a. Raising taxes always increases government revenues.
b. Whenever there is a recession, imports decrease. Therefore, to stop a recession, we should increase
imports.
c. Raising the tariff on imported steel helps the Canadian steel industry. Therefore, the entire economy is
helped.
Copyright © 2016 by Nelson Education Ltd.
, Chapter 1 The Art and Science of Economic Analysis C01-4
a. This assertion is a mistake because the secondary effects of taxes on production and the labour supply
are ignored. If the tax rate were raised to 100 percent, for example, no one would want to work or
produce.
b. This is the fallacy that association implies causation. It is more likely that recession causes a change in
imports than the other way around.
c. This is a fallacy of composition. True, the tariff may help the steel industry. But it hurts purchasers of
steel, including the automobile and construction industries. The overall effect on the economy is
unclear.
4.2 (Association Versus Causation) Suppose I observe that communities with lots of doctors tend to have
relatively high rates of illness. I conclude that doctors cause illness. What’s wrong with this reasoning?
The causality is undoubtedly in the other direction; that is, doctors will tend to locate where there is a lot of
disease and therefore a greater need for medical care.
4.3 (Secondary Effects) Cigarette smuggling often increases when taxes on cigarettes are raised. Should the
government eliminate cigarette taxes?
Taxes are imposed on cigarettes because cigarettes are bad for people’s health (that is, not just smokers,
but also those who live and work with smokers). The unintended consequence of more cigarette smuggling
needs to be weighed against the desire to curb smoking among the Canadian population. It may be that the
“right” amount of taxation will lower smoking in the community without increasing smuggling—this
becomes an empirical question of finding a balance between the two outcomes.
4.4 (Pitfalls of Economic Analysis) Prior to the financial crisis of 2008, most economists maintained the
economy was doing quite well, booming in fact. Discuss what was missing in this type of analysis. If an
economy is currently booming, does this necessarily mean that the economy is doing quite well?
This analysis assumed away the possibility certain markets, in this case financial markets, are subject to
booms and busts. It assumed that at all times share prices and housing prices pretty much reflected the
“true” or “real” value of these assets. It also ignored the history of booms and busts in markets. With a
better understanding of booms and the possibility of busts, the very real possibility of the housing and
financial markets crashing would have been on the radar. It is important to note that Canada did not do
that badly during the crisis, because (according to many experts) its housing and financial markets were
regulated differently from and better than the American.
5.1 (Studying Economics) According to the text, economics majors on average earn more money than most
other majors and have more job opportunities. Are these the primary motivations one might have for
studying economics? What are your motivations for studying economics?
Answers will vary.
SUPPLEMENTAL CASES, EXERCISES, AND PROBLEMS
Experiential Exercises
1. Send students to the Bank of Sweden’s page on the Nobel Prize in economic science at
http://nobelprize.org/nobel_prizes/economics/. They can review the descriptions of some recent awards and
try to determine whether those particular awards were primarily for work in macroeconomics or in
microeconomics.
Copyright © 2016 by Nelson Education Ltd.
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