Gabarito Blanchard 5º edição

Prévia do material em texto

ANSWERS TO END-OF-CHAPTER PROBLEMS
CHAPTER 1
Quick Check
1. a. True.
b. True.
c. True. 
d. Uncertain. It is true that the growth of output per worker increased in the mid-1990s, but 
economists disagree about the degree to which this increase in growth will persist. The 
growth of output per worker fluctuates a great deal from year to year, which makes it 
difficult to draw inferences from the data. 
e. True.
f. False. The European “unemployment miracle” refers to the low rate of unemployment 
in Europe in the 1960s.
g. False. The slump was triggered by the collapse of the Japanese stock market. 
h. False.
2. a. 1960-2000 1994-2000 2001-2004
 
US 3.2% 3.9% 2.45%
EU 3.1% 2.3% 2.3%
Japan 4.7% 1.4% 2.3%
Growth rates in all three regions are lower in the most recent period than over the period 
1960-2004. However, compared to the period 1994-2000, U.S. growth is lower in the 
most recent period, Japanese growth is higher, and European growth is unchanged.
b. Answers will vary. 
3. a. Low unemployment might lead to an increase in inflation. 
b. Tax cuts may have been useful to stimulate the U.S. economy during the 2001 recession. 
However, the tax cuts were permanent. The recession is over and the deficit remains 
high. 
c. Although labor market rigidities may be important, it is also important to consider that 
these rigidities may not be excessive, and that high unemployment may arise from flawed 
macroeconomic policies.
d. Although poor regulation of the financial system may be contributing to the length of 
Japan's slump, most economists believe that the collapse in Japanese asset prices 
triggered the economic downturn. Moreover, tightening regulation would likely involve 
more pain in the short run since some banks and firms would be forced to close. 
e. Although the Euro will remove obstacles to free trade between European countries, each 
country will be forced to give up its own monetary policy. 
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Dig Deeper
4. This is a discussion question, so answers will vary. Based on the discussion in the text, there are
clear similarities in the policy responses of the U.S. and Japanese governments. Central banks in 
both countries reduced interest rates, and governments in both countries tried to stimulate the 
economy with lower taxes. Government spending also increased in both countries; explicitly for 
economic stimulus in Japan, and as part of foreign and security policy in the United States. As 
for the differences, the text leaves the implication that Japanese banking system is less efficient 
than the U.S. banking system, which perhaps allows for easier recovery in the United States. 
There is also an allusion to the liquidity trap in Japan, since interest rates are zero. However, the 
mechanics of the liquidity trap are not discussed in detail until Chapter 22.
5. a. 10 years: (1.01)10≈1.10 or 10 % higher; 20 years: 22% higher; 
50 years: 64% higher
b. 22%; 49%; 169% higher
c. Take output per worker as a measure of the standard of living. 
10 years: 1.22/1.1≈1.11, so the standard of living would be about 11% higher; 
20 years: 22% higher; 50 years: 64% higher
d. No. Labor productivity growth fluctuates a lot from year to year. The last few years may 
represent good luck. Some economists believe there has been a lasting change in the 
U.S. economy that will lead to continued high productivity growth in the future, but we 
cannot be certain. 
6. China overtakes the United States in 2044, or 41 years from 2003. The problem asks students to 
find the answer by using a spreadsheet. Algebraically,
11(1.03)t=1.6(1.08)t
11/1.6 = (1.08/1.03)t
t = ln(11/1.6)/ln(1.08/1.03) ≈ 40.7 yrs
Explore Further
 7. a-c. As of June 2005, there have been 5 recessions since 1960. The numbers are seasonally-
adjusted annual percentage growth rates of GDP in chained 2000 dollars. 
1969:4 -1.9 1980:2 -7.8
1970:1 -0.7 1980:3 -0.7
 
1974:3 -3.8 1981:4 -4.9
1974:4 -1.6 1982:1 -6.4
1975:1 -4.8
 1990.4 -3.0
 1991:1 -2.0
8. a-b. % point increase in unemployment rate for the 5 recessions
1969-70 0.7 1981-82 1.1
1974-75 3.1 1990-91 0.9
1980 0.9 Jan. 2001 – Jan. 2002 1.5
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CHAPTER 2
Quick Check
1. a. False.
b. Uncertain. True for nominal GDP, false for real GDP.
c. True.
d. True.
e. False. The level of the CPI means nothing. Its rate of change tells us about inflation.
f. Uncertain. Which index is better depends on what we are trying to measure—inflation 
faced by consumers or by the economy as a whole. 
2. a. no change: intermediate good 
b. +$100; Personal Consumption Expenditures
c. +$200 million; Gross Private Domestic Fixed Investment
d. +$200 million; Net Exports
e. no change: the jet was already counted when it was produced, i.e., presumably when 
Delta (or some other airline) bought it new as an investment.
3. a. $1,000,000, the value of the silver necklaces.
b. 1st Stage: $300,000. 2nd Stage: $1,000,00-$300,000=$700,000. 
GDP: $300,000+$700,000=$1,000,000.
c. Wages: $200,000 + $250,000=$450,000. 
Profits: ($300,000-$200,000)+($1,000,000-$250,000-300,000)
=$100,000+$450,000=$550,000.
GDP: $450,000+$550,000=$1,000,000.
4. a. 2003 GDP: 10*$2,000+4*$1,000+1000*$1=$25,000
2004 GDP: 12*$3,000+6*$500+1000*$1=$40,000
 Nominal GDP has increased by 60%.
b. 2003 real (2003) GDP: $25,000
2004 real (2003) GDP: 12*$2,000+6*$1,000+1000*$1=$31,000
Real (2003) GDP has increased by 24%.
c. 2003 real (2004) GDP: 10*$3,000+4*$500+1,000*$1=$33,000
2004 real (2004) GDP: $40,000.
Real (2004) GDP has increased by 21.2%.
d. The answers measure real GDP growth in different units. Neither answer is incorrect, 
just as measurement in inches is not more or less correct than measurement in 
centimeters. 
5. a. 2003 base year:
 Deflator(2003)=1; Deflator(2004)=$40,000/$31,000=1.29
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Inflation=29%
b. 2004 base year:
Deflator(2003)=$25,000/$33,000=0.76; Deflator(2004)=1
Inflation=(1-0.76)/0.76=.32=32%
c. Analogous to 4d.
6. a. 2003 real GDP = 10*$2,500 + 4*$750 + 1000*$1 = $29,000
 2004 real GDP = 12*$2,500 + 6*$750 + 1000*$1 = $35,500
b. (35,500-29,000)/29,000 = .224 = 22.4%
c. Deflator in 2003=$25,000/$29,000=.862
 Deflator in 2004=$40,000/$35,500=1.127
Inflation = (1.13 -.86)/.86 = .307 = 30.7%.
d. Yes, see appendix for further discussion.
Dig Deeper
7. a. The quality of a routine checkup improves over time. Checkups now may include EKGs, 
for example. Medical services are particularly affected by this problem due to constant 
improvements in medical technology.
b. 10%.
c. The quality-adjusted price of checkups is 5% higher. The remaining 10% of the price 
increase reflects a quality improvement.
d. We need to know the price of checkups using the old method in the year the new 
ultrasound information is introduced. Even without this information, we can say that the 
quality-adjusted price increase of checkups is less than 15%, since there has been some 
quality improvement.
8. a. Measured GDP increases by $10+$12=$22. (Strictly, this involves mixing the final 
goods and income approaches to GDP. Assume here that the $12 per hour of work 
creates a final good worth $12.)
b. True GDP should increase by less than $22 because by working for an extra hour, you are 
no longer producing the work of cooking within the house. Since cooking within the 
house is a final service, it should count as part of GDP. Unfortunately, it is hard to 
measure the value of work within the home, which is why measured GDP does not 
include it. If we assume, for this problem, that the value of home cooking is equal to the 
value of restaurant cooking, and that eating out simply replaceshome cooking, then 
working late increases true GDP by only the value of the work, in this case $12. 
9. a. As of revisions through June 2005, there were 3 quarters of negative growth during the 
period 1999-2002. The numbers are seasonally-adjusted annual percentage growth rates 
of GDP in chained 2000 dollars. 
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2000:3 -0.5
2001:1 -0.5
2001:3 -1.4
b. The unemployment rose in 2001 and continued to rise until mid-2003, when it began to 
fall. Unemployment is not the whole story because discouraged workers may leave the 
labor force and thus not be counted as unemployed. The participation rate fell over 2001, 
and continued to all (albeit more slowly and with substantial monthly variation) over the 
period. 
c. Although we graph employment against time in this problem (since the book does not use 
logarithms), the result would be similar if we used a logarithmic scale. From the graph, 
employment growth was negative over 2001. Then, employment growth continued at 
roughly the same rate (perhaps lower, as would be clear with a logarithmic scale) as 
before the recession. In other words, employment did not rapidly catch up to its previous 
trajectory. Indeed, as of June 2005, the graph is consistent with a permanent, negative 
effect on employment. The employment to population ratio fell by about 1.5 percentage 
points over 2001 and continued to fall until August, 2003, when it leveled off and then 
rose slightly. 
d. Clearly, the labor market recovered much more slowly than GDP. 
CHAPTER 3
 
Quick Check
1. a. True.
b. False. Government spending without transfers was 19% of GDP.
c. False. The propensity to consume must be less than one for our model to be well defined.
d. True.
e. False.
f. False. The increase in output is one times the multiplier.
g. False.
2. a. Y=160+0.6*(Y-100)+150+150
Y=1000
b. YD=Y-T=1000-100=900
c. C=160+0.6*(900)=700
3. a. Equilibrium output is 1000. Total demand=C+I+G=700+150+150=1000. Total demand 
equals production. This is the equilibrium condition used to solve for output.
b. Output falls by: 40*multiplier = 40/.4=100. So equilibrium output is now 900. Total 
demand=C+I+G=160+0.6*(800)+150+110=900. Again, total demand equals production.
c. Private saving=Y-C-T=900-160-0.6*(800)-100=160. Public saving =T-G=-10. National 
saving (or in short, saving) equals private plus public saving, or 150. National saving 
equals investment. This statement is mathematically equivalent to the equilibrium 
137
condition that total demand equals production. Thus, national saving equals investment 
is an alternative statement of the equilibrium condition. 
Dig Deeper
4. a. Y increases by 1/(1-c1) 
b. Y decreases by c1/(1- c1)
c. The answers differ because government spending affects demand directly, but taxes 
affect demand through consumption, and the propensity to consume is less than one. 
d. The change in Y equals 1/(1-c1) - c1/(1- c1) = 1. Balanced budget changes in G and T are
not macroeconomically neutral.
e. The propensity to consume has no effect because the balanced budget tax increase aborts 
the multiplier process. Y and T both increase by on unit, so disposable income, and 
hence consumption, do not change.
5. a. Y=c0+c1YD+I+G implies
Y=[1/(1-c1+c1t1)]*[c0-c1t0+I+G]
b. The multiplier = 1/(1-c1+c1t1) <1/(1- c1), so the economy responds less to changes in 
autonomous spending when t1 is positive. After a positive change in autonomous 
spending, the increase in total taxes (because of the increase in income) tends to lessen 
the increase in output. After a negative change in autonomous spending, the fall in total 
taxes tends to lessen the decrease in output. 
c. Because of the automatic effect of taxes on the economy, the economy responds less to 
changes in autonomous spending than in the case where taxes are independent of income. 
So, output tends to vary less, and fiscal policy is called an automatic stabilizer. 
6. a. Y=[1/(1-c1+c1t1)]*[c0-c1t0+I+G]
b. T = t0 + t1*[1/(1-c1+c1t1)]*[c0-c1t0+I+G]
c. Both Y and T decrease. 
d. If G is cut, Y decreases even more, so the balanced budget reinforces (or amplifies) the 
effect of the fall in consumer confidence.
7. a. Disposable income and hence consumption both increase for any level of Y, so the ZZ 
curve shifts up, and equilibrium output increases.
b. There is no effect on equilibrium output, since T does not change.
c. Presumably, equilibrium output increases. The fall in consumption from the tax increase
is smaller in magnitude than the increase in consumption from the transfer increase, 
because of the difference in the propensities to consume. So, demand and equilibrium 
output increase.
d. People with high wealth probably have a lower propensity to consume than people with 
low wealth. At the extreme, those in poverty may spend most of any additional dollar on 
basic needs. Since wealth and income are usually related, people with high income 
probably have a lower propensity to consume than people with low income. Therefore, 
tax cuts are likely to be more effective at stimulating output when they are directed 
138
toward people with low income, who are likely to spend more of the extra disposable 
income.
8. a. Y= c0 + c1(Y-T) + b0+b1Y + G
Y=[1/(1- c1- b1)]*[c0 - c1T + b0 + G]
b. The multiplier is 1/(1- c1- b1), and increases with b1. Allowing investment to depend on 
output increases the multiplier. Intuitively, an increase in autonomous spending now has 
a multiplier effect through two channels, consumption and investment, so the multiplier 
increases. For the multiplier to be positive, we need c1+ b1<1. If this inequality were 
reversed, the economy would not have a well-defined equilibrium. One extra unit of 
autonomous spending would lead to a greater than one unit increase in spending 
(consumption plus investment) in every round of the multiplier, so the economy would 
explode into infinite output. 
c. Equilibrium output increases. Investment increases by more than the increase in business 
confidence, since the increase in output also leads investment to increase. In equilibrium, 
national saving equals investment. If investment increases in equilibrium, then so does 
national saving. 
9. Answers will vary depending upon when the website is accessed.
CHAPTER 4
Quick Check
1. a. False.
b. False.
c. True.
d. False.
e. False.
f. True.
2. a. i=0.05: Money demand = $18,000
i=0.10: Money demand = $15,000
b. Money demand decreases when the interest rate increases because bonds, which pay 
interest, become more attractive. For the same reason, bond demand increases.
c. The demand for money falls by 50%.
d. The demand for money falls by 50%.
e. A 1% increase (decrease) in income leads to a 1% increase (decrease) in money demand. 
This effect is independent of the interest rate.
3. a. i=100/$PB –1; i≈ 33%; 18%; 5% when $PB =$75; $85; $95.
b. When the price increases, the interest rate falls.
c. $PB =100/(1.08) ≈ $93
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4. a. $20=MD=$100*(.25-i)
i=5%
b. M=$100*(.25-.15)
M=$10
Dig Deeper 
5. a. BD = 50,000 - 60,000*(.35-i)
An increase in the interest rate of 10% increases bond demand by $6,000.
b. An increase in wealth increases bond demand, but has no effect on money demand, which 
depends on income (a proxy for transactions demand).
c. An increase in income increases money demand, but decreases bond demand, since we 
implicitly hold wealth constant.
d. When people earn more income, this does not change their wealth right away. Thus, they 
increase their demand for money and decrease their demand for bonds. 
6. An increase in the interest rate makes the purchase of bonds more attractive because it reduces 
their price. A purchaser of a bond can receive the samenominal payment for a lower price. 
7. a. $16 is withdrawn on each trip to the bank. 
Money holdings—day one: $16; day two: $12; day three: $8; day four: $4.
b. Average money holding is ($16+$12+$8+$4)/4=$10.
c. $8 dollar withdrawals. Money holdings of $8; $4; $8; $4.
d, Average money holdings is $6.
e. $16 dollar withdrawals; money holdings of $0; $0; $0; $16. 
f. Average money holding is $4.
g. Based on these answers, ATMs and credit cards have reduced money demand.
8. a. velocity=1/(M/$Y)=1/L(i)
b. Velocity increased from 3.7 to 9.1 between 1960 and 2003.
c. ATMS and credit cards reduced L(i) so velocity increased. 
9. a. Demand for central bank money=0.1*$5,000b*(.8-4i)
b. $100 b = 0.1*$5,000b*(.8-4i)
i=15%
c. M=(1/.1)*$100 b=$1,000 b 
M= Md at the interest derived in part (b). 
d. If H increases to $300 b, the interest rate falls to 5%.
e. The interest rate falls to 5%, since when H equals $300 b, M=(1/.1)*$300 b=$3,000 b. 
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10. The ratio of currency to total money (the parameter c in the text) would rise, leading to a fall in 
the money multiplier.
Explore Further 
11. Answers will vary depending upon when the website is accessed.
CHAPTER 5 
Quick Check
1. a. True.
b. True.
c. False.
d. False. The balanced budget multiplier is positive (it equals one), so the IS curve shifts 
right.
e. False.
f. Uncertain. An increase in G leads to an increase in Y (which tends to increase 
investment), but also to an increase in the interest rate (which tends to reduce 
investment).
g. True.
2. a. Y=[1/(1-c1)]*[c0-c1T+I+G]
The multiplier is 1/(1-c1).
b. Y=[1/(1-c1-b1)]*[c0-c1T+ b0-b2i +G]
The multiplier is 1/(1-c1-b1). Since the multiplier is larger than the multiplier in part (a), 
the effect of a change in autonomous spending is bigger than in part (a). An increase in 
autonomous spending now leads to an increase in investment as well as consumption.
c. Substituting for the interest rate in the answer to part (b):
Y=[1/(1-c1-b1+ b2d1/d2)]*[c0-c1T+ b0+(b2*M/P)/d2 +G]
The multiplier is 1/(1-c1-b1+ b2d1/d2).
d. The multiplier is greater (less) than the multiplier in part (a) if (b1- b2d1/d2) is greater 
(less) than zero. The multiplier is big if b1 is big, b2 is small, d1 is small, and/or d2 is big, 
i.e., if investment is very sensitive to Y, investment is not very sensitive to i, money 
demand is not very sensitive to Y, money demand is very sensitive to i.
3. a. The IS curve shifts left. Output and the interest rate fall. The effect on investment is 
ambiguous because the output and interest rate effects work in opposite directions. The 
fall in output tends to reduce investment, but the fall in the interest rate tends to increase 
it. 
b. From 2c: Y=[1/(1-c1-b1+ b2d1/d2)]*[c0-c1T+ b0+(b2*M/P)/d2 +G]
c. From the LM relation: i= Y*d1/d2 – (M/P)/d2
To obtain the equilibrium interest rate, substitute for equilibrium Y from part (b).
d. I= b0+ b1Y- b2i= b0+ (b1- b2d1/d2)*Y+ b2(M/P)/d2
To obtain equilibrium investment, substitute for Y from part (b).
141
e. From parts b and d, holding M/P constant, I increases by (b1- b2d1/d2)/ (1-c1-b1+ b2d1/d2), 
in response to a one-unit increase in G. So, if G decreases by one unit, investment will 
increase when b1<b2 d1/d2. 
f. A fall in G leads to a fall in output (which tends to reduce investment) and to a fall in the 
interest rate (which tends to increase investment). Thus, for investment to increase, the 
output effect (b1) must be smaller than the interest rate effect (b2 d1/d2). Note that the 
interest rate effect contains two terms: (i) d1/d2, the slope of the LM curve, which gives 
the effect of a one unit change in equilibrium output on the interest rate, and (ii) b2, which 
gives the effect of a one unit change in the equilibrium interest rate on investment. 
4. a. Y=C+I+G=200+.25*(Y-200)+150+.25Y-1000i+250
Y=1100-2000i
b. M/P=1600=2Y-8000i
i=Y/4000-1/5
c. Substituting b into a: Y=1000
d. Substituting c into b: i=1/20=5%
e. C=400; I=350; G=250; C+I+G=1000
f. Y=1040; i=3%; C=410; I=380. A monetary expansion reduces the interest rate and 
increases output. The increase in output increases consumption. The increase in output 
and the fall in the interest rate increase investment.
g. Y=1200; i=10%; C=450; I=350. A fiscal expansion increases output and the interest rate. 
The increase in output increases consumption.
Dig Deeper
5. Firms deciding how to use their own funds will compare the return on bonds to the return on 
investment. When the interest rate on bonds increases, they become more attractive, and firms 
are more likely to use their funds to purchase bonds, rather than to finance investment projects.
6. a. If the interest rate were negative, people would hold only money and not bonds. Money 
would be a better store of value than bonds.
b. See hint.
c. See hint. 
d. Little effect. If the interest rate is actually zero, than the increase in M has literally no 
effect.
e. No. If there is no effect on the interest rate, which affects investment, monetary policy 
cannot affect output.
7. a. The fall in T shifts IS right. The increase in M shifts LM up. Output increases. 
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b. Clinton-Greenspan (loosely): contractionary fiscal policy (IS left) and expansionary 
monetary policy (LM up).
c. There was a recession. The growth rate was low and for parts of the year, negative. 
The expansionary monetary and fiscal policy were partly in response to the recession. 
There were other shocks, especially a fall in investment spending after the fall in the 
stock market, and the events of September 11, which had direct effects and affected 
consumer confidence. The fall in investment spending was the proximate cause of the 
recession, which was well under way by September 11, 2001. 
8. a. Increase G (or reduce T) and increase M.
b. Reduce G (or increase T) and increase M. The interest rate falls. Investment increases, 
since the interest rate falls while output remains constant.
Explore Further
9. a. The IS curve shifts left and the LM curve shifts right. The interest rate falls and 
investment rises.
b. From the 2005 Economic Report of the President (ERP):
Receipts Outlays Surplus
(all numbers as % of GDP)
1992 17.5 22.1 -4.7
2000 20.9 18.4 2.4
c. The Fed kept the target federal funds rate at 3% from September 1992 until February 
1994. Then, the Fed increased the target rate steadily until February 1995, reduced the 
target rate (more or less steadily) until June 1999, and increased the target rate after that.
d. From the 2005 ERP, investment rose from 12.1% of GDP in 1992 to 17.7% of GDP in 
2000.
e. From the 2005 ERP, the average growth rate (GDP per capita) over 1992-2000 
was 2.5%.
10. a. As of June 2005, the quarters of negative growth in 2000 and 2001 were 2000:III, 2001:I, 
and 2001:3.
 b. Investment had the bigger percentage change.
c. As of June 2005, contributions to growth (seasonally adjusted at annual rates):
Consumption Investment
Avg. Change Avg. Change
1999 3.3 1.6
2000 2.7 -0.6 0.3 -1.3
2001 1.9 -0.9 -2.4 -2.6
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The fall in investment was the proximate cause of the recession.
d. Investment fell in the 2001:III and fell by a bigger percentage in 2001:IV. 
Nonresidential fixed investment continued to fall in the first two quarters of 2002, 
although overall investment (gross private domestic investment) grew. Consumption 
picked up strongly in the 4th quarter of 2001. Lower interest rates and discounts offered 
by automakers played a role. Perhaps psychology played a role as well. The recession 
was clearly underway before the events of September 11.
CHAPTER 6 
Quick Check
1. a. False.
b. False.
c. False. 44% of unemployed workers leave theunemployment pool each month.
d. True.
e. False.
f. Uncertain/False. Most workers have some bargaining power, depending upon how easy 
they are to replace. Workers in low skill, entry level jobs may have very little or no 
bargaining power.
g. True.
h. False.
 2. a. Putting aside the 3.5 million who move from job to job, the average flow is 
(1.5+1.7+1.8+1.5)/127=5.1%
b. 1.8/7.0=25.7%
c. (1.8+1.3)/7.0=44.3%. Duration is 1/.443 or 2.3 months.
d. (1.5+1.1+1.7+1.3)/66.7=5.6=8.4%.
e. As a percentage of flows into the labor force, new workers account for 
0.4/(1.5+1.8)=12%. As a percentage of flows into and out of the labor force, new 
workers account for 0.4/5.6=7%.
3. a. W/P=1/(1+µ )=1/1.05=.95
b. From the wage setting relation, un=1-W/P=5%
c. W/P=1/1.1=.91; u=1-.91=9%. The natural rate of unemployment rises. The increase in 
the markup is essentially a fall in labor demand (actually a shift of the labor demand 
curve). Intuitively, less competition in the product market leads to lower desired output 
by firms and therefore to a fall in labor demand. The fall in labor demand increases 
unemployment and reduces the real wage.
Dig Deeper 
4. a. Answers will vary.
144
b-c. Most likely, the job you will have ten years later will pay a lot more than your reservation 
wage at the time (relative to your typical first job). 
d. The later job is more likely to require training and will probably be a much harder job to 
monitor. So, as efficiency wage theory suggests, your employer will be willing to pay a 
lot more than your reservation wage for the later job, to ensure low turnover and low 
shirking. 
5. a. The computer network administrator has more bargaining power. She is much harder to 
replace. 
b. The rate of unemployment is a key statistic. For example, when there are many 
unemployed workers it becomes easier for firms to find replacements. This reduces the 
bargaining power of workers. 
c. Given the constant returns to labor assumption, the real wage is always determined by the 
price setting relation alone. Worker bargaining power has no effect.
6. a. As the unemployment rate gets very low, it gets very difficult for firms to find workers to 
hire. Therefore, worker bargaining power increases, and so does the wage. 
b. As the unemployment rate gets lower and lower, the wage gets higher and higher 
(tending toward infinity as the unemployment rate goes to zero). So, there is some 
unemployment rate at which the wage becomes so high that firms will not want to hire 
more workers.
7. a. EatIn EatOut
employment 70 95
unemployment 5 5
labor force 75 100
unemployment rate 6.7% 5%
participation rate 75% 100%
Measured GDP is higher in EatOut.
b. Measured employment, the measured labor force, the measured participation rate, and 
measured GDP increasae in EatIn. Unemployment is unchanged, but the measured 
unemployment rate falls.
c. It is difficult to measure the value of work at home. In this case, you could attempt to 
value food preparation at home by using the market price of food preparation in 
restaurants (assuming that eating at home has the same value for a given meal as eating 
out). This would be difficult in EatIn before there are restaurants. Likewise, you could 
count workers involved in food preparation at home as employed.
d. If food preparation at home is counted in GDP and workers involved in food preparation 
at home are counted as employed, then the labor market statistics and measured GDP 
would be the same in the two economies and the experiment in part (b) would have no 
effect.
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Explore Further
8. a. 2/3=67%; (2/3)2= 44%; (2/3)6 = 9%
b. 2/3 
c. second month: (2/3)2=44%; sixth month: (2/3)6 = 9%
d. Average proportion 27 weeks or more over 1990-1999= 16.1%
2000: 11.4% 2003: 22.1%
2001: 11.8% 2004: 21.8%
2002: 18.3%
Long-term unemployed exit unemployment less frequently than the average.
9. a-b. Answers will depend on when the page is accessed.
c. The decline in unemployment does not equal the increase in employment, because the 
labor force is not constant.
CHAPTER 7
Quick Check
1. a. True.
b. True.
c. False.
d. False.
e. True.
f. False.
g. False.
2. a. IS right, AD right, AS up, LM up, Y same, i up, P up 
b. IS left, AD left, AS down, LM down, Y same, i down, P down 
3. WS PS AS AD LM IS 
Short run: up same up same up same 
Medium run: up same up further same up further same 
Y i P 
Short run: down up up 
Medium run: down further up further up further
 
4. a. Money is neutral in the sense that the nominal money supply has no effect on output or 
the interest rate in the medium run. Output returns to its natural level. The interest rate is 
determined by the position of the IS curve and the natural level of output. Despite the 
neutrality of money in the medium run, an increase in money can increase output and 
reduce the interest rate in the short run. In particular, expansionary monetary policy can 
be used to speed up the economy's return to the natural level of output when output is 
low. 
b. In the medium run, investment and the interest rate both change with fiscal policy. 
146
c. False. Labor market policies, such as unemployment insurance, can affect the natural 
level of output. 
Dig Deeper
5. a. Open answer. Firms may be so pessimistic about sales that they do not want to borrow at 
any interest rate. 
b. The IS curve is vertical; the interest rate does not affect equilibrium output. 
c. No change.
d. The AD curve is vertical; the price level does not affect equilibrium output. 
e. The increase in z reduces the natural level of output and shifts the AS curve up. Since the 
AD curve is vertical, output does not change, but the price level increases. Note that 
output is above its natural level.
f. The AS curve shifts up forever, and the price level increases forever. Output does not 
change; it remains above its natural level forever. 
6. a. The LM curve is flat.
b. No effect.
c. The AD curve is vertical. A change in P, which affects M/P, has no effect on the interest 
rate or output.
d. There is no effect on output in the short run or the medium run. Since the money stock 
does not affect the interest rate, it does not affect output.
7. a. The AD curve shifts left in the short run. Output and the price level fall in the short run.
In the medium run, the expected price level falls, and AS shifts right, returning the 
economy to the original natural level of output, but at a lower price level.
b. The unemployment rate rises in the short run, but returns to its original level (the natural 
rate, which is unchanged) in the medium run.
c. The Fed should increase the money supply, which shifts the AD curve right. A monetary 
expansion of the proper size exactly offsets the effect of the decline in business 
confidence on the AD curve. The net effect is that the AD curve does not move in the 
short run or medium run, and neither does the AS curve.
d. Under the policy option in part (c), output and the price level are higher in the short run. 
In the medium run, output is the same in parts (a) and (c), but the price level is higher in 
part (c). 
e. The unemployment rate is lower in the short run in part (c). In the medium run, the 
unemployment rate is the same in parts (b) and (c).
147
8. a. The AS curve shifts up in the short run and shifts up further in the medium run. 
Output falls in the short run and falls further in the medium run. The price level rises in 
the short run andrises further in the medium run.
b. The unemployment rate rises in the short run and rises further in the medium run.
c. The Fed could increase the money supply in the short run and shift the AD curve to the
right. The AS curve would shift up over time.
d. Output and the price level are higher in the short run in part (c). Output is the same in the 
medium run in parts (a) and (c), but the price level is higher in part (c).
e. The unemployment rate in the short run is lower in part (c), but the same in the medium 
run in parts (a) and (c). 
9. The Fed’s job is not so easy. It has to distinguish changes in the actual rate of unemployment from 
changes in the natural rate of unemployment. The Fed can use monetary policy to keep the 
unemployment rate near the natural rate, but it cannot affect the natural rate.
10. a. The unemployment rate rises in the short run and rises further in the medium run. The 
real wage falls immediately to its new medium-run level. 
b. The unemployment rate falls in the short run but returns to the original natural rate in the 
medium run. The real wage is unaffected. However, after tax income rises.
c. In our model, the real wage depends only upon the markup. A fall in the markup 
increases the real wage. Policy measures that improve product market competition – for 
example, more vigorous anti-trust enforcement – could increase the real wage. 
d. The fall in income taxes tended to increase the after-tax real wage. The increase in oil 
prices tended to reduce the after-tax real wage. Intuitively, the immediate effect of an oil 
price increase is to reduce the real wage by increasing gas prices. Thus, the increase in 
gas prices tends to absorb the extra after-tax income provided by the tax cut. 
Explore Further
11. a. 1959:IV – 1969:IV 52.9%
1969:IV – 1979:IV 38.2%
1979:IV – 1989:IV 35.1%
1989:IV – 1999:IV 37.6%
b. The 70s, 80s, and 90s look remarkably similar. The 60s look most unusual.
Note, although the problem did not ask for the growth rates of per capita real GDP, the results 
would be similar. The growth rates of per capita GDP are: 
1959:IV – 1969:IV 33.9%
1969:IV – 1979:IV 24.4%
1979:IV – 1989:IV 23.0%
1989:IV – 1999:IV 21.8%
148
CHAPTER 8
Quick Check
1. a. True.
b. False.
c. False.
d. True.
e. False.
f. True.
2. a. No. In the 1970s, we experienced high inflation and high unemployment. The 
expectations-augmented Phillips curve is a relationship between inflation and 
unemployment conditional on the natural rate and inflation expectations. Given inflation 
expectations, increases in the natural rate (which result from adverse shocks to labor 
market institutions—increases in z—or from increases in the markup—which encompass 
oil shocks) lead to an increase in both the unemployment rate and the inflation rate. In 
addition, increases in inflation expectations imply higher inflation for any level of 
unemployment. (Increases in inflation expectations also tend to increase the 
unemployment rate in the short run from the supply side—think of an increase in the 
expected price level, given last period’s price, in the AD-AS framework. However, 
increases in inflation expectations may tend to increase short run output from the demand 
side, because of the real interest rate effect. The real interest rate is introduced in Chapter 
14.) In the 1970s, both the natural rate and expected inflation increased, so both 
unemployment and inflation were relatively high. 
b. No. The expectations-augmented Phillips curve implies that maintaining a rate of 
unemployment below the natural rate requires increasing (not simply high) inflation. 
This is because inflation expectations continue to adjust to actual inflation. 
3. a. un=0.1/2 =5%
b. πt =0.1-2*.03 = 4% every year beginning with year t.
c. πet= 0 and πt=4% forever. Inflation expectations will be forever wrong. This is
unlikely.
d. θ might increase because people’s inflation expectations adapt to persistently positive 
inflation. The increase in θ has no effect on un.
e. π5= π 4+.1-.06=4%+4%=8%
π6=12%; π7=16%
f. Inflation expectations will again be forever wrong. This is unlikely. 
4. a. A higher cost of production means a higher markup of prices over wages. The markup 
reflects all nonwage components of the price of a good.
b. un=(0.08+0.1µ )/2; Thus, the natural rate of unemployment increases from 5% to 6% as 
μ 
increases from 20% to 40%.
149
Dig Deeper
5. a. π t = π t-1 + 0.1 - 2ut = π t-1 + 2%=2%
π t = 2%; π t+1 = 4%; π t+2 = 6%; π t+3 = 8%.
b. π t = 0.5 π t + 0.5 π t-1 + 0.1 - 2ut
or, π t = π t-1 + 4%
c. π t = 4%; π t+1 = 8%; π t+2 = 12%; π t+3 = 16%
d. As indexation increases, low unemployment leads to a larger increase in inflation over 
time. 
6. a. Yes. The average rate of unemployment was lower in the 1990s. Indeed, even though 
the unemployment rate was at a historical low, inflation rose very little. 
b. The natural rate of unemployment probably decreased.
7. a. un=(µ +z)/α ; un = 6% if α =1; un = 3% if α =2
As α increases the natural rate of unemployment falls. Intuitively, higher wage 
flexibility 
allows the economy to respond to any given set of institutions (µ and z) with less 
unemployment.
b. un = 9% if α =1; un = 4.5% if α =2
In absolute terms, less wage flexibility (lower α ) implies that a given supply shock will
lead to a greater increase in the natural rate of unemployment.
Explore Further
8. a-c. The equation that seems to fit well is πt – πt-1 = 6 – ut, which implies a natural rate of
6%.
9. The relationships imply a lower natural rate in the more recent period.
CHAPTER 9 
Quick Check
1. a. False.
b. True.
c. True.
d. False.
e. False.
f. True.
g. True.
h. True.
i. True.
2. a. The unemployment rate will increase by 1% per year when g=0.5%. Absent output 
growth, productivity growth tends to increase the unemployment rate, since fewer 
workers are required to produce a given quantity of goods. Absent output growth, labor 
150
force growth also tends to increase the unemployment rate, since more workers are 
competing for the same number of jobs. Therefore, unemployment will increase unless 
the growth rate exceeds the sum of productivity growth and labor force growth. 
b. We want the unemployment rate to decrease by 0.5% per year for the next four years. 
We need growth of 4.25% per year for each of the next four years.
c. Okun’s law is likely to become: ut-ut-1=-0.4*(gyt-5%)
3. a. un= 5%
b. Assume the economy has been at the natural rate of unemployment for two years (this 
year and last year). Then, gyt = 3%; gmt = gyt + πt = 11%
c. π u gyt gmt
t-1: 8% 5% 3% 11%
 t: 4% 9% -7% -3%
t+1: 4% 5% 13% 17%
t+2: 4% 5% 3% 7%
t+3: 4% 5% 3% 7%
4. a. See text for full answer. Gradualism reduces need for large policy swings, with effects 
that are difficult to predict, but immediate reduction may be more credible and encourage 
rapid, favorable changes in inflation expectations. On the other hand, the staggering of 
wage decisions suggests that, if the policy is credible, a gradual disinflation is the option 
consistent with no change in the unemployment rate.
b. Not clear. Based in Ball's evidence, probably fast disinflation, depending on the features 
listed in part (c). 
c. Some important features: the degree of indexation, the nature of the wage-setting process, 
and the initial rate of inflation.
5. a. Inflation will start increasing. 
b. It should let unemployment increase to its new, higher, natural rate. 
Dig Deeper
6. a. sacrifice ratio=1
b. πt = 11%; πt+1 = 10%; πt+2 = 9%; πt+3 = 8%; πt+4 = 7%c. 10 years; sacrifice ratio=(10 point years of excess unemployment)/(10 percentage point 
reduction in inflation)=1
d. πt = 8.5%; πt+1 = 5.875%; πt+2 = 3.906%; πt+3 = 2.430%; πt+4 = 1.322%
 Less than 5 years are required. 
sacrifice ratio: 5/(12-1.322)=.468
The sacrifice ratio is lower because people are somewhat forward looking and 
incorporate the target inflation rate into their expectations.
151
e. The central bank can let the unemployment rate return to the natural rate beginnng at time 
t+1. The ex post sacrifice ratio from this scenario = (1 point year of excess 
unemployment)/(10 point reduction of inflation) = 0.1
f. Take measures to enhance credibility.
7. a. πt-πt-1= -(ut-.05)
ut- ut-1= -.4*(gmt-πt-.03)
b. Assuming gm,t-1=13%, πt-1= 10%, ut-1=5%, and gm=3% beginning in year t:
π u
t: 7.1% 7.9%
t+1: 3.1% 9.1%
t+2: -0.7% 8.8%
t+3: -3.2% 7.5%
t+4: -4.1% 5.9%
t+5: -3.5% 4.4%
t+6: -2.1% 3.6%
t+7: -0.5% 3.4%
t+8: 0.8% 3.7%
t+9: 1.5% 4.3%
t+10: 1.6% 4.9%
c. Inflation does not decline smoothly. In the early years, the large unemployment rates 
(relative to the natural rate) reduce inflation to negative values. Since money growth = 3 
% = normal output growth in this example, negative inflation drives real money growth 
(and hence output growth) above the normal output growth rate, and unemployment falls. 
Eventually, unemployment falls below the natural rate, inflation begins to increase again. 
These cycles continue, with decreasing amplitude.
d. u=5% and π=0% in the medium run.
Explore Further
8. a. Yes.
b. The unemployment rate increased from 5,8% in June 2002 to 6.3% in June 2003. 
c. Although growth was positive, it was low – well below 3% for most of the period. 
Growth was too low to prevent the unemployment rate. 
d. Employment fell by 0.7%.
e. Yes.
f. Productivity grew.
CHAPTER 10
152
Quick Check
1. a. True.
b. True.
c. False.
d. False.
e. True.
f. False.
g. True.
h. Uncertain.
2. a. Example: France: (1.04)50*5,519=$39.2 k. 
Japan: $85.8 k; UK: $25.0 k; U.S.: $34.7 k
b. 2.47
c. For Japan, yes; for France and the UK, no.
3. a. $5,000
b. 6000 pesos
c. $600
d. $800
e. Mexican standard of living relative to the U.S.—exchange rate method: 600/5000 =.12; 
PPP method: 800/5000=.16
4. a. Y=63
b. Y doubles.
c. Yes.
d. Y/N=(K/N)1/2 
e. K/N=4 implies Y/N=2. K/N=8 implies Y/N=2.83. Output less than doubles.
f. No.
g. No. In part (f), we are looking at what happens to output when we increase capital only, 
not capital and labor in equal proportion. There are decreasing returns to capital.
h. Yes.
Dig Deeper
5. a. ∆ Y/Y = .5 ∆ K/K 
growth rate of output = 1/2 growth rate of capital
b. 4 %
153
c. K/Y increases.
d. No. Since capital is growing faster than output, the saving rate will have to increase to 
maintain the same pace. Eventually, the required saving will exceed output. Capital 
must grow faster than output because there are decreasing returns to capital in the 
production function.
6. Even though the United States was making the most important technical advances, the other
countries were growing faster because they were importing technologies previously 
developed in the United States. In other words, they were reducing their 
technological gap with the United States. 
Explore Further
7. a-d. Convergence for the France, Belgium, and Italy; no convergence for the second set of
countries.
8. a. Russian GDP per capita in rubles = 7305.65/0.145612 ≈ 50,172 rubles
Russian GDP per capita in dollars = 50, 172/28.129 ≈ $1784 
b. U.S. GDP per capita = 9816.97/0.285003 ≈ $34445 
c. Russian GDP per capita/U.S. GDP per capita = 1784/34445 ≈ 5.2%
d. 28.6%
e. The Penn numbers are PPP numbers. They correct for the lower price of subsistence 
goods in Russia.
CHAPTER 11
Quick Check
1. a. True, if saving includes public and private saving. 
b. False.
c. True. A constant saving rate would produce a positive but declining rate of growth.
d. Uncertain.
e. True. (Output per capita equals output per worker times the participation rate, which is at 
about 66% for the United States today. So, roughly 60% is true.)
f. False.
g. Uncertain. The U.S. capital stock is below the golden rule, but that does not necessarily
imply that there should be tax breaks for saving. Even if the tax breaks were effective in 
stimulating saving, the increase in future consumption would come at the cost of current 
consumption.
h. Uncertain/false. Even if the endogenous growth model is true, the growth rate won't be 
related to the level of human capital. The statement could be true if higher education 
levels lead to a faster rate of technological progress. 
i. False. Even if you accept the premise (that educational investment increases output, as 
would be implied by the Mankiw, Romer, Weil paper), it does not necessarily follow that 
countries should increase educational saving, since future increases in output will come at 
the expense of current consumption. Of course, there are other arguments for subsidizing 
education, particularly for low-income households.
154
2. No. (1) The Japanese rate of growth is not so high anymore. (2) If the Japanese saving rate has
always been high, then this cannot explain the difference between the rate of growth in Japan and
the United States in the last 40 or 50 years. (3) If the Japanese saving rate has been higher than it
used to be, then this can explain some of the high Japanese growth. The contribution of high
saving to growth in Japan should, however, come to an end.
3. After a decade: higher growth rate. After five decades: growth rate back to normal, higher level 
of output per worker. 
Dig Deeper
4. a. Higher saving. Higher output per worker
b. Same output per worker. Higher output per capita. 
5. a. K/N=(s/(2δ ))2; Y/N=s/(4δ )
b. C/N=(1-s)Y/N=s(1-s)/(4δ )
c-e. Y/N increases with s; C/N increases until s=.5, then decreases.
6. a. Yes.
b. Yes.
c. Yes.
d. Y/N = (K/N)1/3
e. In steady state, sf(K/N) = δ K/N, which, given the production function in part (d), 
implies:
K/N=(s/δ )3/2
f. Y/N =(s/δ )1/2
 
g. Y/N = 2
h. Y/N = 21/2
7 a. Substituting from 6e: K/N=1
b. Substituting from 6f: Y/N=1
c. K/N=.35; Y/N=.71
d. Using equation (11.3), the evolution of K/N is: 0.9, 0.81, 0.74. 
The evolution of Y/N is: 0.97, 0.93, 0.91
8. b. K/N = (.15/.075)2 = 4
Y/N= (4)1/2=2
155
c. K/N=(.2/.075)2 =7.1
Y/N=(7.1)1/2=2.7
Capital per worker and output per worker increase.
Explore Further
9. a. For 2003, the national saving rate was approximately 13.5%. 
In steady state, K/N = (.135/.075)2 =3.24, and Y/N=(3.25)1/2 =1.8.
b. For 2003, the budget deficit (including the off budget items) was 3.5%.
If national saving increases to 17%, then in steady state, K/N = (.17/.075)2 ≈ 5.14, and 
Y/N=(5.14)1/2 =2.27. Steady-state output per worker increases by approximately 26%.
CHAPTER 12
Quick Check
1. a. True.
b. True.
c. False.
d. True.
e. False.
f. True.
g. False.
h. False.
2. a. Most technological progress seems to come from R&D activities. See discussion on 
fertility and appropriability in Chapter 12.2. 
b. Lower growth in poorer countries. Higher growth in rich countries.
c. Increase in R&D spending. If fertility does not fall, there will be higher technological 
progress and a higher rate of output growth.
d. A decrease in the fertility of applied research; a (small) decrease in growth.
e. A decrease in the appropriability of drug research. A drop in the development of new 
drugs. Lower technological progress and lower growth.
3. A shift to a fully funded system should increase output per worker in the long run. It should haveno effect on the long run growth rate of output per worker.
4. See discussion in Chapter 12.2.
Dig Deeper
5. a. Both lead to an initial decrease in growth. 
b. Only the first leads to a permanent decrease in growth.
6. a. Year 1: 3000; Year 2: 3960
b. Real GDP= 3300; growth rate of real GDP=10%
156
c. 20%
c. Real GDP/Worker=30 in both years; labor productivity growth is zero.
e. Using $13 as the price of banking services in Year 2: real GDP =3990; 
output growth= 33%.
f. -0.8%
g. Proper measurement implies real gdp/worker=36.3 in year 2. Labor productivity growth 
is 21%.
h. True, assuming there is progress in the banking services sector. 
7. a. (K/(AN)) = (s/(δ +gA+gN))2 = 1; (Y/(AN)) = (1); gY/(AN) = 0; gY/N = 4%; gY = 6%
b. (K/(AN)) = (4/5)2; (Y/(AN)) = (4/5); gY/(AN) = 0; gY/N = 8%; gY = 10%
c. (K/(AN)) = (4/5)2; (Y/(AN)) = (4/5); gY/(AN) = 0; gY/N = 4%; gY = 10%
People are better off in case a. Given any set of initial values, the level of technology is 
the same in cases a and c, but the level of capital per effective worker is higher at every 
point in time in case a. Thus, since Y/N=A*(Y/(AN))=A*(K/(AN))1/2, output per worker 
is always higher in case a. 
8. a. Probably affects A. Think of climate. 
b. Affects H and possibly A, if better education leads to more fertile research.
c. Affects A. Strong protection tends to encourage more R&D but also to limit diffusion of 
technology. 
d. May affect A through diffusion.
e. May affect K, H, and A. Lower tax rates increase the after-tax return on investment, and 
thus tend to lead to more accumulation of K and H and more R&D spending. 
f. If we interpret K as private capital, than infrastructure affects A (e.g., better 
transportation networks may make the economy more productive by reducing congestion 
time). 
g. Assuming no technological progress, lower population growth implies a higher steady 
state level of output per worker. Lower population growth leads to higher capital per 
worker. If there is technological progress, there is no steady-state level of output per 
worker. In this case, however, lower population growth implies that output per worker 
will be higher at every point in time, for any given path of technology. See the answer to 
problem 7c.
Explore Further
9. a. The quantity gK – gN is the growth rate of output per worker. The quantity gK – gN is the 
157
growth rate of capital per worker.
b. gK – gN = 3[gY – gN] – 2gA
c. United States
1950 – 1973: gK – gN = 3(2.7%) – 2(2.9%) = 2.3%
1974 – 2000: gK – gN = 3(1.2%) – 2(1.4%) = 0.8%
d. Japan
1950 – 1973: gK – gN = 3(7.1%) – 2(7%) = 7.3%
1974 – 2000: gK – gN = 3(2.1%) – 2(1.4%) = 3.5%
CHAPTER 13
Quick Check
1. a. False. Productivity growth is unrelated to the natural rate of unemployment. If the 
unemployment rate is constant, employment grows at same rate as the labor force.
b. False.
c. True.
d. True.
e. True. The jobless recovery of 2002-2003 perhaps provides a recent example.
f. True.
g. False.
2. a. u = 1-(1/(1+µ ))(A/Ae)
b. u = 1-(1/(1+µ )) = 4.8%
c. No. Since wages adjust to expected productivity, an increase in productivity eventually 
leads to equiproportional increases in the real wage implied by wage setting and the real 
wage implied by price setting, at the original natural rate of unemployment. Thus, 
equilibrium can be maintained without any change in the natural rate of unemployment.
3. Discussion question.
4. a. Reduce the gap, if this leads to an increase in the relative supply of skilled workers. 
b. Reduce the gap, since it leads to a decrease in the relative supply of unskilled workers.
c. Reduce the gap, if it leads to an increase in the relative supply of skilled workers.
d. Increase the gap, if U.S. firms hire unskilled workers in Central America, since it reduces
the relative demand for U.S. unskilled workers.
5. Consider an increase in the level of A in the AD-AS diagram. Combine the wage-setting and 
price-setting equations into an AS equation:
P = Pe(1+µ )(Ae/A)F(1-Y/(AL), z).
An increase in A has two effects:
158
i. To the extent that Ae lags behind A, Ae/A falls. This is the effect that tends to reduce the actual 
and natural rates of unemployment for a time.
ii. For a given level of Y, an increase in A reduces Y/A, increases u, reduces W (through the F 
function), and reduces P. This is the effect that tends to increase the actual rate of unemployment 
in the short run.
The effects in (i) and (ii) both shift the AS curve down, so output increases in the short run. The 
effect on short-run unemployment depends on the relative strength of the effects in (i) and (ii). 
 
Dig Deeper
6. Discussion question.
7. a. P = Pe(1+µ )(Ae/A)(Y/L)(1/A)
b. AS shifts down. Given Ae/A=1, an increase in A implies a fall in P, given Y. This 
occurs because for a given level of Y, unemployment is higher, so wages are lower and 
so, in turn, is the price level.
 
c. There is now an additional effect, a fall in Ae/A. In effect, workers do not receive as 
much of an increase in wages as warranted by the increase in productivity. Compared to 
part (b), nominal wages are lower, leading to a lower value of P given Y.
8. a. Labor supply slopes up. As N increases, u falls for given L, so W/P increases.
b. Labor demand slopes down. As N increases, the MPL falls, so W/P falls.
c. In the high skill market, labor demand shifts right, and W/P rises. In the low skill market, 
labor demand shifts left, and W/P falls.
d. In Europe, the minimum wage is binding, so the shift of labor demand to the left has
no effect on W/P but leads to a fall in N, and thus to an increase in the unemployment 
rate, given L. N
e. The increase in wage inequality is larger in the United States. However, in Europe there 
is an increase in unemployment in the low skill market.
f. The United States has had a large increase in wage inequality over the past 25 years, and 
Europe has had a large increase in the unemployment rate.
Explore Further
9. a. Some examples:
Stock clerks and order fillers – technological change
Textile winding, twisting, and drawing out machine setters, operators, and 
tenders – 
foreign competition (partly as a result of the end of the 
Multifiber Agreement)
b. Some examples:
159
Computer systems analysts – technological change.
Home health aides – aging
c. More occupations that are forecast to grow require degrees as 
opposed to on-the-job training.
10. a. For a given markup, the real wage grows at the rate of technological progress.
b. 1973: $8.98; 2003: 8:27
c. The real wage of low skill workers has fallen markedly.
d. The relative demand for low skill workers has fallen markedly.
CHAPTER 14
Quick Check
1. a. True.
b. True.
c. True.
d. False.
e. True.
f. False.
g. True.
h. True. The nominal interest rate is always positive.
i. False. The real interest rate can be negative.
2. a. Real. Nominal profits are likely to move with inflation; real profits are easier to forecast.
b. Nominal. The payments are nominal.
c. Nominal. If lease payments are in nominal terms, as is typical.
3. a. Exact: r = (1+.04)/(1+.02)-1 = 1.96%; Approximation: r ≈ .04-.02 = 2%
b. 3.60%; 4%
c. 5.48%; 8%
4. a. No. Otherwise, nobody would hold bonds. Money would be more appealing: it pays at 
least a zero nominal interest rate and can be used for transactions.
b. Yes. The real interest rate will be negative if expected inflation exceeds the nominal 
interest rate. Even so, the real interest rate on bonds (which pay nominal interest) will 
exceed the real interest rate on money (which does not pay nominal interest) by the 
nominal interest rate. 
c. A negative real interest rate makes borrowing very attractiveand leads to a large demand 
for investment. 
160
d. Answers will vary.
5. a. The discount rate is the interest rate. So EPDV are (i) $2,000*(1-.25) under either 
interest rate and (ii) (1-.2)*$2,000 under either interest rate.
b. The interest rate does not enter the calculation. Hence, you prefer (ii) to (i) since 
20%<25%.
Note that the answer to part (a) does not imply that saving will not accumulate. By 
retirement, the initial investment will have grown by a factor of (1+i)40 in nominal terms 
and (1+r)40 in real terms. As long as r is positive, the purchasing power of the initial 
investment will grow. 
Of course, it is possible that the tax rate you pay upon retirement is lower than the tax 
rate you will pay during your working years, which would alter this calculation. In 
addition, this simple example omits an important real-world feature of retirement 
savings: the tax-free accrual of interest. As a result of this feature, the effective interest 
rate on retirement saving is much higher than the effective (after-tax) interest rate on 
ordinary saving.
6. a. =$100/0.1 = $1000
b. Since the first payment occurs at the end of the year, 
$V = $z[(1+i)n-(1+i)]/[i*(1+i)n].
10 years: $575.90; 20 years: $836.49; 30 years: $936.96; 60 years: $996.39
c. i = 2%: consol $5000; 10 years: $816.22; 20 years: $1567.85; 30 years: $2184.44; 60 
years: $3445.61
i = 5%: consol $2000; 10 years: $710.78; 20 years: $1208.53; 30 years: $1514.11; 60 
years: $1887.58
7. a. In the medium run, changes in inflation are reflected one for one in changes in the 
nominal interest rate. In other words, in the medium run, changes in inflation have no 
effect on the real interest rate.
b. Support.
c. The line should not go through the origin. The real interest rate is positive.
d. No. Even if monetary policy does not affect output or the real interest rate in the medium
run, it can be used in the short run.
Dig Deeper
8. a. The IS shifts right. At the same nominal interest rate, the real interest rate is lower, so 
output is higher.
b. The LM curve does not shift. Money demand depends on the nominal interest rate, not 
the real interest rate.
161
c. Output increases. The nominal interest rate is higher than in Figure 14-5. Whether the 
nominal interest rate is lower or higher than before the increase in money growth is 
ambiguous. Thinking in terms of the money market equilibrium, the increase in the 
nominal money supply tends to reduce the nominal interest rate, but the increase in 
nominal money demand (because of the increase in output) tends to increase the nominal 
interest rate.
d. Output is higher than in Figure 14-5. Reasoning from the IS relation, the real interest rate 
must be lower, since no exogenous variables in the IS relation have changed. (In other 
words, while the nominal interest rate may increase relative to Figure 14-5, it increases 
by less than the increase in expected inflation. So the real interest rate decreases.)
Explore Further
9. Answers will vary depending upon when the website is accessed.
CHAPTER 15
Quick Check
1. a. False.
b. True.
c. True.
d. False.
e. True.
f. True.
g. False.
h. Uncertain/False. Some of the increase in the stock market was probably justified. 
However, most economists believe that there was a bubble in the stock market as well. A 
stock market correction followed.
 
2. a. 1+i =($F/$P)1/n
i =(1000/800)1/3-1 = 7.7%
b. 5.7%
c. 4.1%
3. The yield is approximately the average of the short term interest rates over the life of the bond.
a. 5%.
b. 5.25%
c. 5.5%
4. a. Unexpected shift down of the LM curve. Unexpected fall in the interest rate and increase 
in Y. Stock prices increase.
b. No change in stock prices.
162
c. Ambiguous effect on stock prices. Unexpected expansionary fiscal policy means the 
interest rate is higher than expected (after the expected expansionary monetary policy) 
but so is output. The interest rate effect tends to reduce stock prices; the output effect to 
increase them.
Dig Deeper
5. a. See Chapter 15. 
b. Initially after the increase, the yield curve will slope down out to one-year maturities, 
then slope up. After one year, the yield curve will slope up. After three years, the yield 
curve will be flat.
6. a. An inverted yield curve implies that the expected future interest rate is lower than the 
current interest rate. These expectations could arise from a belief that the IS curve will 
shift to the left in the future (and output will fall), say because future investment is 
expected to fall. 
b. Given the Fisher effect, a steep yield curve probably implies that financial market 
participants believe that future inflation will be substantially higher than current inflation.
7. Let r be the real interest rate, g the growth rate of dividends, and x be the risk premium. The price 
is given by:
1000/(1 + r + x) + 1000(1 + g)/(1 + r + x)2 + 1000(1 + g)2/(1 + r + x)3 . . . 
= [1000/(1 + r + x)][1 + (1 + g)/(1 + r + x) + (1 + g)2/(1 + r + x)2 + . . .] = 1,000/(r + x - g)
a. $50,000; $20,000
b. $10,000; $7692.31
c. $16,666.67; $11,111.11
d. Increase. A fall in the risk premium is like a fall in the real interest rate.
Explore Further
8. a. The Fed can reduce the growth rate of money. The nominal interest rate increases in the 
short run, but falls in the medium run.
b. Inflation was highest in early 1980. The 12-month inflation rate peaked at 14.6% in 
March and April of 1980.
d. A declining spread implies that future short-term interest rates are expected to decline in 
the future. The one-year T-bill rate was increasing the late 1970s, but the spread was 
declining, so markets were not expecting the trend to continue.
e. There spread declined by almost one percentage point in October 1979. The decline is 
consistent with expectations of lower inflation in the future.
f. The one-year interest rate fell.
163
g. During the rate cut in the recession, spreads went up, as short-term rates declined. 
However, long-term rates did not increase, which suggests that inflation expectations did 
not increase. Instead, the increase in spreads is consistent with the expectation that the 
anti-inflationary policy would continue with high short term interest rates after the 
recession. This is indeed what happened. 
9. Answers will depend on when the Web site is accessed. 
10. Answers will depend on when the Web site is accessed.
CHAPTER 16
Quick Check
1. a. False.
b. False.
c. False.
d. False.
e. False.
f. True.
g. True.
2. a. .75*(1+1.05+1.052)*$40,000=$94,575
b. $194,575
c. $19,457.50
d. by $2,000
e. Benefits imply extra annual consumption of: 0.6*(1.052)*$40,000*7/10=$18,522
3. EPDV is Π /(r+δ ) = $18,000/(r+0.08)
a. Buy. EPDV=$138,462>$100,000
b. Break-even. EPDV=$100,000
c. Do not buy. EPDV=$78,261<$100,000
4. a. $44,000*(1-.4)*36-$40,000*(1-.4)*38=$38,400
b. $44,000*(1-.3)*36-$40,000*(1-.3)*38=$44,800
Dig Deeper
5. a. EPDV of future labor income = $30; consumption=$10 in all three periods.
b. young: -5; middle age: 15; old: -10
c. Total saving =n*(-5+15-10)=0
164
d. 0 – 5n + 10n = 5n
e. young: 5; middle age: 12.5; old: 12.5; cannot borrow against future income when young.
f. 0 + 12.5n - 12.5n = 0
g. 0 + 0 + 12.5n = 12.5n
h. By allowing people to borrow to consume when young, financial liberalization may lead 
to less overall accumulation of capital. 
6. a. Expected value of earnings during middle age is .5*($40,000+$100,000)=$70,000.
EPDV of lifetime earnings = $90,000.
Consumption plan is $30,000 per year.
Consumer will save (-$10,000) when young.
b. In the worstcase, EPDV of lifetime earnings = $60,000. 
Consumption = $20,000 and saving=0 when young.
Consumption is lower than part a, and saving is higher.
c. Consumption: young: $20,000; middle age: $50,000; old: $50,000.
Consumption will not be constant over the consumer’s lifetime.
d. The uncertainty leads to higher saving by young consumers.
Explore Further
7. a-d. On average, consumption accounts for about 66% of GDP and investment for about 13%,
so consumption is more than four times bigger than investment. Relative to average
changes, movements in consumption and investment are of similar magnitude, which
implies investment is much more volatile than consumption. 
8. a. Consumers may be more optimistic about the future (and spend more) when disposable 
income is higher, so consumer confidence might be positively related to disposable 
income. However, consumer confidence should depend on expectations about the future, 
rather than on current variables per se. Hence, there are reasons to think changes in 
consumer confidence might not always track changes in disposable income.
b. There appears to be positive relationship between the variables, but it is not tight.
c. Personal disposable income increased at an annual rate of 11.5% in 2001:III and at an 
annual rate of 10.8% in 2002:I. Consumer confidence fell in 2001:III but rose in 2002:I. 
Clearly the events of September 11, as well as the ongoing recession, played in role in the 
consumer confidence numbers for 2001:III.
CHAPTER 17
Quick Check
1. a. False.
b. False.
165
c. False.
d. True/Uncertain (They can rely on forecasts by others, but somebody has to do it.)
e. False.
f. True.
g. False.
2. a. Higher real stock prices increase real wealth directly, and therefore tend to increase
consumption. Moreover, the hype about the New Economy, combined with increasing
stock prices, may have led to favorable expectations about future labor income, which
would also tend to increase consumption. 
b. Subsequent declines in the stock market decreased wealth and may have led consumers to
revise (downward) expectations about future labor income, effects that would tend to
reduce consumption.
3. a. IS shifts right.
b. LM shifts right.
c. There are three effects. First, an increase in expected future taxes tends to reduce 
expected future after-tax income (for any given level of income), and therefore to reduce 
consumption. This effect tends to shift IS to the left. Second, the increase in future taxes 
(a deficit reduction program) will lead to lower real interest rates in the future. The fall in 
the expected future interest rate tends to shift IS to the right. Third, the fall in future real 
interest rates leads to an increase in investment in the medium run and an increase in 
output in the long run. The increase in expected future output tends to shift IS to the 
right. The net effect on the IS curve is ambiguous. Note that the model of the text has 
lump sum taxes. More generally, the tax increase may increase distortions in the 
economy. These effects tend to reduce output (or the growth rate).
d. IS shifts left. 
4. Rational expectations may be unrealistic, but it does not imply that every consumer has perfect 
knowledge of the economy. It implies that consumers use the best available information—
models, data, and techniques—to assess the future and make decisions. Moreover, they do not 
have to work out the implications of economic models for the future by themselves; they can rely 
on the predictions of experts on television or in the newspapers. Essentially, rational expectations 
rules out systematic mistakes on the part of consumers. Thus, although rational expectations may 
not literally be true, it seems a reasonable benchmark for policy analysis.
5. The answers below ignore any effect on capital accumulation and output in the long run. 
Assume the tax cut policy in the future is temporary, so we need only worry about future short 
run effects.
a. The effect on current output is ambiguous. The tax cut in the future will lead to a boom. 
Output and the real interest rate will increase. The increase in expected future output 
tends to shift IS right; the increase in the expected future real interest rate tends to shift IS 
left. Finally, the fall in expected future taxes tends to increase expected future after-tax 
income (for any given level of income). This effect tends to shift IS right. 
166
b. This means that the Fed will increase the interest rate in the future (shift LM left). The 
expected interest rate will increase more, but there is still the effect of lower expected 
taxes on current consumption. The effect today on output is still ambiguous, but more 
likely to be negative than in part (a). 
c. Future output will be higher, the future interest rate will not increase, and future taxes 
will be lower. The current IS curve definitely shifts right, and current output increases. 
Dig Deeper
6. a-b. See the discussion in the text.
c. The gesture seemed to indicate that the Fed supported deficit reduction, and would be 
willing to conduct expansionary monetary policy in the future to offset the direct negative 
effects on output from spending cuts and tax increases. A belief that the Fed would be 
willing to act in this way would tend to increase expected future output (relative to the 
case where the Fed did nothing) and reduce expected future interest rates. Both of these 
effects tend to increase output in the short-run.
7. a. Future interest rates will tend to rise. Future output will tend to fall. Both effects shift 
the IS curve to the left in the present. Current output and the current interest rate fall. 
The yield curve gets steeper on the day of the announcement.
b. No.
c. Compared to original expectations, the nominee is expected to follow a more 
expansionary monetary policy. The yield curve will get flatter on the day of the 
announcement.
Explore Further 
8. a. The interest rate will increase in the short run, and increase even further in the medium 
run. The yield curve will get steeper.
b. The spread increased over the period.
5-Year Yield minus 3-Month Yield
August 2002: 1.64%
January 2003: 1.86%
August 2003: 2.4%
January 2004: 2.22%
CHAPTER 18
Quick Check
1. a. True.
b. False. 
c. False.
d. False.
e. False.
f. True.
167
g. False.
2. Domestic Country Balance of Payments ($)
Current Account
Exports 25
Imports 100
Trade Balance -75 (=25-100)
Investment Income Received 0
Investment Income Paid 15
Net Investment Income -15 (=0-15)
Net Transfers Received -25
Current Account Balance -115 (=-75-15-25)
Capital Account
Increase in Foreign Holdings of Domestic Assets 80 (=65+15)
Increase in Domestic Holdings of Foreign Assets -50
Net Increase in Foreign Holdings 130 (=80-(-50))
Statistical Discrepancy -15 (=115-130)
3. a. The nominal return on the U.S. bond is 10,000/(9615.38) –1 ≈ 4%.
The nominal return on the German bond is approximately 6%.
b. Uncovered interest parity implies that the dollar is expected to appreciate. Thus, the 
expected exchange rate is E*(1+i*)/(1+i)=0.75(1.06)/(1.04) ≈ .764 Euro/$.
c. If you expect the dollar to depreciate instead, purchase the German bond, since it pays a 
higher interest rate and you gain by holding Euros. 
d. The dollar depreciates by 4%, so the total return on the German bond (in $) is 
approximately 6% + 4% =10%. Investing in the U.S. bond would have produced a 4% 
return.
e. The uncovered interest parity condition is about equality of expected returns, not equality
of actual returns.
Dig Deeper
4. a. GDP is 15 in each economy. Consumers will spend 5 on each good.b. Each country has a zero trade balance. Country A exports clothes to Country B, Country 
B exports cars to Country C, and Country C exports computers to Country A.
c. No country will have a zero trade balance with any other country.
d. There is no reason to expect that the United States will have balanced trade with any 
particular country, even if the United States eliminates its overall trade deficit.
5. a. The relative price of domestic goods falls. Relative demand for home goods rises. The 
home unemployment rate falls in the short run.
168
b. The price of foreign goods in terms of domestic currency is P*/E. A nominal 
depreciation (fall in E) increases the price of foreign goods in terms of domestic 
currency. Therefore, a nominal depreciation tends to increase the CPI.
c. The real wage falls.
d. Essentially, a nominal depreciation stimulates output by reducing the home real wage, 
which leads to an increase in home employment. 
Explore Further
6. a. The yen appreciated form mid-1985 to mid-1995, depreciated until mid-1998, 
appreciated through the end of 1999, depreciated through the end of 2001, appreciated 
through 2004, and then began to depreciate.. From a broader perspective, between the 
end of 1984 and the end of 2004, the yen appreciated by about 100%. The yen reached 
its strongest value against the dollar in mid-1995.
b. Depreciation of the yen.
c. The yen appreciated from the end of 2001 to the end of 2004. This did not help the 
Japanese recovery. 
7. "U.S. Assets Abroad" refers to foreign assets acquired by the United States. The sign convention 
is that a negative number implies a capital outflow (not an outflow of assets), meaning U.S. 
acquisition of foreign assets. Loosely, a capital outflow is the exchange of home currency for 
foreign assets. During the period 1990-2004, the United States acquired a substantial amount of 
foreign assets. However, this is only one side of the capital account. Capital inflows are 
recorded in the category, "Foreign Assets in the U.S." In principle, the sum of "U.S. Assets 
Abroad" and "Foreign Assets in the U.S." (with the proper sign conventions) equals the U.S. 
current account. In practice, there are measurement errors, summarized in the category, 
"Statistical Discrepancy." 
Given that the United States had a substantial current account deficit in the 1990s (except during 
the first half of 1991), it received, on net, capital inflows, which means the inflow from "Foreign 
Assets in the U.S." should have exceeded the outflow from "U.S. Assets Abroad" by the amount 
of the U.S. current account deficit. In all quarters except 1991:1 and 1995:4, measured U.S. 
capital inflows exceeded measured U.S. capital outflows, although never by exactly the amount 
of the U.S. current account deficit. In some quarters the statistical discrepancy was positive; in 
others, negative.
8. Exact answers will depend upon when the website is accessed, but the basic point is that the 
United States is the world’s largest debtor, and borrows more than the net lending of all the other 
advanced economies combined.
CHAPTER 19
Quick Check
1. a. Uncertain.
b. False. 
c. False.
d. True.
169
e. True.
f. True.
g. False.
h. False.
2. a. There is a real appreciation over time. Over time, the trade balance worsens.
b. The currency depreciates at the rate of pi -pi *.
3. a. The share of Japanese spending on U.S. goods relative to U.S. GDP is (0.07)(0.1)=0.7%.
b. U.S. GDP falls by 2(.05)(.007)=0.07%.
c. U.S. GDP falls by 2(.05)(.1)=1%.
d. This is an overstatement. The numbers above indicated that even if U.S. exports fall by 
5%, the effect is to reduce growth by 1%. This is small relative to GDP, but large 
relative to normal growth (of around 3%).
4. Answers follow the model in the text.
Dig Deeper 
5. a. The ZZ and NX lines shift up. Domestic output and domestic net exports increase. 
b. Domestic investment will increase because output increases. Assuming taxes are fixed, 
there is no effect on the deficit.
c. Private saving must increase, since NX=S-I +T-G. Since the deficit is unchanged, and I 
and NX increase, S must increase. 
d. Except for G and (for our purposes) T, the other variables in equation (19.5) are 
endogenous. Exogenous shocks can affect all of them simultaneously.
6. a. There must be a real depreciation.
b. C+I+G must fall. The government can reduce G or increase T, which will reduce C. 
7. a. Y = C + I + G + X – IM = 20 + 0.8*(Y - 10) + G + 0.3Y*- 0.3Y
Y = [1/(1 - .8 + .3)](12 + G + 0.3Y*) = 2*(12 + G + 0.3Y*) = 44 + 0.6Y*
The multiplier is 2 (=1/(1-.8+.3)) when foreign output is fixed. The closed economy 
multiplier is 5 (=1/.5). It differs from the open economy multiplier because, in the open 
economy, only some of an increase in autonomous demand falls on domestic goods.
b. Since the countries are identical, Y=Y*=110. Taking into account the endogeneity of 
foreign income, the multiplier equals [1/(1-0.8 -0.3*0.6 +0.3)]=3.125. The multiplier is 
higher than the open economy multiplier in part (a) because it takes into account the fact 
that an increase in domestic income leads to an increase in foreign income (as a result of 
an increase in domestic imports of foreign goods). The increase in foreign income leads 
to an increase in domestic exports.
170
c. If Y=125, then foreign output Y*= 44+0.6*125=119. Using these two facts and the 
equation Y = 2(12+G+0.3Y*) yields: 125 = 24+2G+0.6*(119). Solving for G gives 
G=14.8. In the domestic country, NX = 0.3*(119)-0.3*(125) = -1.8; T-G = 10-14.8=-4.8. 
In the foreign country, NX*=1.8; T*-G*=0.
d. If Y=Y*=125, then we have: 125=24+2G+0.6*(125), which implies G=G*=13. In both 
countries, net exports are zero, but the budget deficit has increased by 3.
e. In part, fiscal coordination is difficult to achieve because of the benefits of doing nothing, 
as indicated from part (c).
Explore Further
8. a. NX=National Saving minus Investment.
b. As a % of GDP, gross private domestic investment was 3.6 percentage points higher in 
2004 than in 1981. NX were 5.6 percentage points lower. Since, National 
Saving=NX+I, national saving fell by 3.6 –5.6 = 2 percentage points relative to GDP.
c. Change in Investment Change in NX
 (% of GDP) (% of GDP)
1981-1990 -0.1% -0.1%
1990-2000 5.1% -3.1%
2000-2004 -0.1% -1.5%
Only in the 1990s was the fall in NX matched by an increase in investment.
d. Yes. An increase in investment leads to more capital accumulation and more output in 
the future, and therefore to a greater ability to repay foreign debt. 
CHAPTER 20
Quick Check
1. a. True.
b. False. 
c. True.
d. True.
e. Uncertain. If expected appreciation on the yen is greater than the interest rate in other 
countries, than foreign investors will hold yen bonds.
f. False. The money stock will change in response to shocks (including policy shocks) so 
that the home interest rate equals the foreign interest rate. 
2. The appropriate mix is a monetary expansion to depreciate the currency (and improve the trade 
balance) and a fiscal contraction to prevent output from increasing. 
3. a. Consumption increases because output increases. Investment increases because output 
increases and the interest rate falls.
171
b. A monetary expansion has an ambiguous effect on net exports. The nominal (and real) 
depreciation tends to increase net exports, but the increase in output tends to reduce net 
exports.
4. a. IS shifts right, because NX tend to increase.
b. IS shifts right, because the increase in i* tends to create a depreciation of the home 
currency and an increase in NX. The interest parity line also shifts up.
c. A foreign fiscal expansion is likely