Solutions
Edition
Mankiw MaSolutions
Macroeconomics
bSolutions Manual
Solutions
Manual Macroeconomics
Manual 12th12th
Macroeconomics
Macroeconomics Edition
12th
Edition byGregory
Edition
by N. N.
byGregory Mankiwnual
N. Gregory Mankiw12th
Mankiw.docxy N. Gregory
CHAPTER 1 The Science of Macroeconomics
Questions for Review
1. Microeconomics is the study of how individual firms and households make decisions, and
how they interact with one another. Microeconomic models of firms and households are
based on principles of optimization—firms and households do the best they can given the
constraints they face. For example, households choose which goods to purchase in order
to maximize their utility, whereas firms decide how much to produce in order to
maximize profits. In contrast, macroeconomics is the study of the economy as a whole; it
focuses on issues such as how total output, total employment, and the overall price level
are determined. These economy-wide variables are based on the interaction of many
households and many firms; therefore, microeconomics forms the basis for
macroeconomics.
2. Economists build models as a means of summarizing the relationships among economic
variables. Models are useful because they abstract from the many details in the economy
and allow one to focus on the most important economic connections.
3. A market-clearing model is one in which prices adjust to equilibrate supply and demand.
Market-clearing models are useful in situations where prices are flexible. Yet in many
situations, flexible prices may not be a realistic assumption. For example, labor contracts
often set wages for up to three years. Or, firms such as magazine publishers change their
prices only every three to four years. Most macroeconomists believe that price flexibility
is a reasonable assumption for studying long-run issues. Over the long run, prices
respond to changes in demand or supply, even though in the short run they may be slow
to adjust.
Problems and Applications
1. The many recent macroeconomic issues that have been in the news lately (early 2002)
include the recession that began in March 2001, sharp reductions in the Federal
Reserve’s target interest rate (the so-called Federal Funds rate) in 2001, whether the
government should implement tax cuts or spending increases to stimulate the economy,
and a financial crisis in Argentina.
2. Many philosophers of science believe that the defining characteristic of a science is the
use of the scientific method of inquiry to establish stable relationships. Scientists exam-
ine data, often provided by controlled experiments, to support or disprove a hypothesis.
Economists are more limited in their use of experiments. They cannot conduct controlled
experiments on the economy; they must rely on the natural course of developments in
the economy to collect data. To the extent that economists use the scientific method of
inquiry, that is, developing hypotheses and testing them, economics has the
characteristics of a science.
3. We can use a simple variant of the supply-and-demand model for pizza to answer this
question. Assume that the quantity of ice cream demanded depends not only on the price
of ice cream and income, but also on the price of frozen yogurt:
Qd = D(PIC, PFY, Y).
We expect that demand for ice cream rises when the price of frozen yogurt rises, because
ice cream and frozen yogurt are substitutes. That is, when the price of frozen yogurt goes
up, I consume less of it and, instead, fulfill more of my frozen dessert urges through the
consumption of ice cream.
3
,Solutions Manual Macroeconomics 12th Edition by N. Gregory Mankiw.docx
4 Chapter 1 The Science of Macroeconomics
The next part of the model is the supply function for ice cream, Q s = S(PIC). Finally,
in equilibrium, supply must equal demand, so that Qs = Qd. Y and PFY are the exogenous
variables, and Q and PIC are the endogenous variables. Figure 1–1 uses this model to
show that a fall in the price of frozen yogurt results in an inward shift of the demand
curve for ice cream. The new equilibrium has a lower price and quantity of ice cream.
Figure 1–1
PIC
S
Price of ice cream
D2
D1
Q
Quantity of ice cream
4. The price of haircuts changes rather infrequently. From casual observation, hairstylists
tend to charge the same price over a one- or two-year period irrespective of the demand
for haircuts or the supply of cutters. A market-clearing model for analyzing the market
for haircuts has the unrealistic assumption of flexible prices. Such an assumption is
unrealistic in the short run when we observe that prices are inflexible. Over the long run,
however, the price of haircuts does tend to adjust; a market-clearing model is therefore
appropriate.
,CHAPTER 2 The DaTa of Macroeconomics
Questions for Review
1. GDP measures both the total income of everyone in the economy and the total expendi-
ture on the economy’s output of goods and services. GDP can measure two things at once
because both are really the same thing: for an economy as a whole, income must equal
expenditure. As the circular flow diagram in the text illustrates, these are alternative,
equivalent ways of measuring the flow of dollars in the economy.
2. The consumer price index measures the overall level of prices in the economy. It tells us
the price of a fixed basket of goods relative to the price of the same basket in the base
year.
3. The Bureau of Labor Statistics classifies each person into one of the following three cat-
egories: employed, unemployed, or not in the labor force. The unemployment rate, which
is the percentage of the labor force that is unemployed, is computed as follows:
Number of Unemployed 100
Unemployment Rate = .
Labor Force
Note that the labor force is the number of people employed plus the number of people
unemployed.
4. Okun’s law refers to the negative relationship that exists between unemployment and
real GDP. Employed workers help produce goods and services whereas unemployed
workers do not. Increases in the unemployment rate are therefore associated with
decreases in real GDP. Okun’s law can be summarized by the equation:
%Real GDP = 3% – 2 (Unemployment Rate).
That is, if unemployment does not change, the growth rate of real GDP is 3 percent. For
every percentage-point change in unemployment (for example, a fall from 6 percent to 5
percent, or an increase from 6 percent to 7 percent), output changes by 2 percent in the
opposite direction.
Problems and Applications
1. A large number of economic statistics are released regularly. These include the following:
Gross Domestic Product—the market value of all final goods and services produced in a
year.
The Unemployment Rate—the percentage of the civilian labor force who do not have a
job.
Corporate Profits—the accounting profits remaining after taxes of all manufacturing
corporations. It gives an indication of the general financial health of the corporate sector.
The Consumer Price Index (CPI)—a measure of the average price that consumers pay
for the goods they buy; changes in the CPI are a measure of inflation.
The Trade Balance—the difference between the value of goods exported abroad and the
value of goods imported from abroad.
5
, 6 Answers to Textbook Questions and Problems
2. Value added by each person is the value of the good produced minus the amount the
person paid for the materials necessary to make the good. Therefore, the value added by
the farmer is $1.00 ($1 – 0 = $1). The value added by the miller is $2: she sells the flour
to the baker for $3 but paid $1 for the flour. The value added by the baker is $3: she sells
the bread to the engineer for $6 but paid the miller $3 for the flour. GDP is the total value
added, or $1 + $2 + $3 = $6. Note that GDP equals the value of the final good (the bread).
3. When a woman marries her butler, GDP falls by the amount of the butler’s salary. This
happens because measured total income, and therefore measured GDP, falls by the
amount of the butler’s loss in salary. If GDP truly measured the value of all goods and
services, then the marriage would not affect GDP since the total amount of economic
activity is unchanged. Actual GDP, however, is an imperfect measure of economic activity
because the value of some goods and services is left out. Once the butler’s work becomes
part of his household chores, his services are no longer counted in GDP. As this example
illustrates, GDP does not include the value of any output produced in the home.
Similarly, GDP does not include other goods and services, such as the imputed rent on
durable goods (e.g., cars and refrigerators) and any illegal trade.
4. a. government purchases
b. investment
c. net exports
d. consumption
e. investment
5. Data on parts (a) to (g) can be downloaded from the Bureau of Economic Analysis
(www.bea.doc.gov—follow the links to GDP and related data). Most of the data (not
necessarily the earliest year) can also be found in the Economic Report of the President.
By dividing each component (a) to (g) by nominal GDP and multiplying by 100, we obtain
the following percentages:
1950 1975 2000
a. Personal consumption expenditures 65.5% 63.0% 68.2%
b. Gross private domestic investment 18.4% 14.1% 17.9%
c. Government consumption purchases 15.9% 22.1% 17.6%
d. Net exports 0.2% 0.8% –3.7%
e. National defense purchases 6.7% 6.6% 3.8%
f. State and local purchases 7.1% 12.8% 11.7%
g. Imports 3.9% 7.5% 14.9%
(Note: These data were downloaded February 5, 2002 from the BEA web site.)
Among other things, we observe the following trends in the economy over the period
1950–2000:
(a) Personal consumption expenditures have been around two-thirds of GDP, although the
share increased about 5 percentage points between 1975 and 2000.
(b) The share of GDP going to gross private domestic investment fell from 1950 to 1975 but
then rebounded.
(c) The share going to government consumption purchases rose more than 6 percentage
points from 1950 to 1975 but has receded somewhat since then.
(d) Net exports, which were positive in 1950 and 1975, were substantially negative in
2000.
(e) The share going to national defense purchases fell from 1975 to 2000.
(f) The share going to state and local purchases rose from 1950 to 1975.
(g) Imports have grown rapidly relative to GDP.
Edition
Mankiw MaSolutions
Macroeconomics
bSolutions Manual
Solutions
Manual Macroeconomics
Manual 12th12th
Macroeconomics
Macroeconomics Edition
12th
Edition byGregory
Edition
by N. N.
byGregory Mankiwnual
N. Gregory Mankiw12th
Mankiw.docxy N. Gregory
CHAPTER 1 The Science of Macroeconomics
Questions for Review
1. Microeconomics is the study of how individual firms and households make decisions, and
how they interact with one another. Microeconomic models of firms and households are
based on principles of optimization—firms and households do the best they can given the
constraints they face. For example, households choose which goods to purchase in order
to maximize their utility, whereas firms decide how much to produce in order to
maximize profits. In contrast, macroeconomics is the study of the economy as a whole; it
focuses on issues such as how total output, total employment, and the overall price level
are determined. These economy-wide variables are based on the interaction of many
households and many firms; therefore, microeconomics forms the basis for
macroeconomics.
2. Economists build models as a means of summarizing the relationships among economic
variables. Models are useful because they abstract from the many details in the economy
and allow one to focus on the most important economic connections.
3. A market-clearing model is one in which prices adjust to equilibrate supply and demand.
Market-clearing models are useful in situations where prices are flexible. Yet in many
situations, flexible prices may not be a realistic assumption. For example, labor contracts
often set wages for up to three years. Or, firms such as magazine publishers change their
prices only every three to four years. Most macroeconomists believe that price flexibility
is a reasonable assumption for studying long-run issues. Over the long run, prices
respond to changes in demand or supply, even though in the short run they may be slow
to adjust.
Problems and Applications
1. The many recent macroeconomic issues that have been in the news lately (early 2002)
include the recession that began in March 2001, sharp reductions in the Federal
Reserve’s target interest rate (the so-called Federal Funds rate) in 2001, whether the
government should implement tax cuts or spending increases to stimulate the economy,
and a financial crisis in Argentina.
2. Many philosophers of science believe that the defining characteristic of a science is the
use of the scientific method of inquiry to establish stable relationships. Scientists exam-
ine data, often provided by controlled experiments, to support or disprove a hypothesis.
Economists are more limited in their use of experiments. They cannot conduct controlled
experiments on the economy; they must rely on the natural course of developments in
the economy to collect data. To the extent that economists use the scientific method of
inquiry, that is, developing hypotheses and testing them, economics has the
characteristics of a science.
3. We can use a simple variant of the supply-and-demand model for pizza to answer this
question. Assume that the quantity of ice cream demanded depends not only on the price
of ice cream and income, but also on the price of frozen yogurt:
Qd = D(PIC, PFY, Y).
We expect that demand for ice cream rises when the price of frozen yogurt rises, because
ice cream and frozen yogurt are substitutes. That is, when the price of frozen yogurt goes
up, I consume less of it and, instead, fulfill more of my frozen dessert urges through the
consumption of ice cream.
3
,Solutions Manual Macroeconomics 12th Edition by N. Gregory Mankiw.docx
4 Chapter 1 The Science of Macroeconomics
The next part of the model is the supply function for ice cream, Q s = S(PIC). Finally,
in equilibrium, supply must equal demand, so that Qs = Qd. Y and PFY are the exogenous
variables, and Q and PIC are the endogenous variables. Figure 1–1 uses this model to
show that a fall in the price of frozen yogurt results in an inward shift of the demand
curve for ice cream. The new equilibrium has a lower price and quantity of ice cream.
Figure 1–1
PIC
S
Price of ice cream
D2
D1
Q
Quantity of ice cream
4. The price of haircuts changes rather infrequently. From casual observation, hairstylists
tend to charge the same price over a one- or two-year period irrespective of the demand
for haircuts or the supply of cutters. A market-clearing model for analyzing the market
for haircuts has the unrealistic assumption of flexible prices. Such an assumption is
unrealistic in the short run when we observe that prices are inflexible. Over the long run,
however, the price of haircuts does tend to adjust; a market-clearing model is therefore
appropriate.
,CHAPTER 2 The DaTa of Macroeconomics
Questions for Review
1. GDP measures both the total income of everyone in the economy and the total expendi-
ture on the economy’s output of goods and services. GDP can measure two things at once
because both are really the same thing: for an economy as a whole, income must equal
expenditure. As the circular flow diagram in the text illustrates, these are alternative,
equivalent ways of measuring the flow of dollars in the economy.
2. The consumer price index measures the overall level of prices in the economy. It tells us
the price of a fixed basket of goods relative to the price of the same basket in the base
year.
3. The Bureau of Labor Statistics classifies each person into one of the following three cat-
egories: employed, unemployed, or not in the labor force. The unemployment rate, which
is the percentage of the labor force that is unemployed, is computed as follows:
Number of Unemployed 100
Unemployment Rate = .
Labor Force
Note that the labor force is the number of people employed plus the number of people
unemployed.
4. Okun’s law refers to the negative relationship that exists between unemployment and
real GDP. Employed workers help produce goods and services whereas unemployed
workers do not. Increases in the unemployment rate are therefore associated with
decreases in real GDP. Okun’s law can be summarized by the equation:
%Real GDP = 3% – 2 (Unemployment Rate).
That is, if unemployment does not change, the growth rate of real GDP is 3 percent. For
every percentage-point change in unemployment (for example, a fall from 6 percent to 5
percent, or an increase from 6 percent to 7 percent), output changes by 2 percent in the
opposite direction.
Problems and Applications
1. A large number of economic statistics are released regularly. These include the following:
Gross Domestic Product—the market value of all final goods and services produced in a
year.
The Unemployment Rate—the percentage of the civilian labor force who do not have a
job.
Corporate Profits—the accounting profits remaining after taxes of all manufacturing
corporations. It gives an indication of the general financial health of the corporate sector.
The Consumer Price Index (CPI)—a measure of the average price that consumers pay
for the goods they buy; changes in the CPI are a measure of inflation.
The Trade Balance—the difference between the value of goods exported abroad and the
value of goods imported from abroad.
5
, 6 Answers to Textbook Questions and Problems
2. Value added by each person is the value of the good produced minus the amount the
person paid for the materials necessary to make the good. Therefore, the value added by
the farmer is $1.00 ($1 – 0 = $1). The value added by the miller is $2: she sells the flour
to the baker for $3 but paid $1 for the flour. The value added by the baker is $3: she sells
the bread to the engineer for $6 but paid the miller $3 for the flour. GDP is the total value
added, or $1 + $2 + $3 = $6. Note that GDP equals the value of the final good (the bread).
3. When a woman marries her butler, GDP falls by the amount of the butler’s salary. This
happens because measured total income, and therefore measured GDP, falls by the
amount of the butler’s loss in salary. If GDP truly measured the value of all goods and
services, then the marriage would not affect GDP since the total amount of economic
activity is unchanged. Actual GDP, however, is an imperfect measure of economic activity
because the value of some goods and services is left out. Once the butler’s work becomes
part of his household chores, his services are no longer counted in GDP. As this example
illustrates, GDP does not include the value of any output produced in the home.
Similarly, GDP does not include other goods and services, such as the imputed rent on
durable goods (e.g., cars and refrigerators) and any illegal trade.
4. a. government purchases
b. investment
c. net exports
d. consumption
e. investment
5. Data on parts (a) to (g) can be downloaded from the Bureau of Economic Analysis
(www.bea.doc.gov—follow the links to GDP and related data). Most of the data (not
necessarily the earliest year) can also be found in the Economic Report of the President.
By dividing each component (a) to (g) by nominal GDP and multiplying by 100, we obtain
the following percentages:
1950 1975 2000
a. Personal consumption expenditures 65.5% 63.0% 68.2%
b. Gross private domestic investment 18.4% 14.1% 17.9%
c. Government consumption purchases 15.9% 22.1% 17.6%
d. Net exports 0.2% 0.8% –3.7%
e. National defense purchases 6.7% 6.6% 3.8%
f. State and local purchases 7.1% 12.8% 11.7%
g. Imports 3.9% 7.5% 14.9%
(Note: These data were downloaded February 5, 2002 from the BEA web site.)
Among other things, we observe the following trends in the economy over the period
1950–2000:
(a) Personal consumption expenditures have been around two-thirds of GDP, although the
share increased about 5 percentage points between 1975 and 2000.
(b) The share of GDP going to gross private domestic investment fell from 1950 to 1975 but
then rebounded.
(c) The share going to government consumption purchases rose more than 6 percentage
points from 1950 to 1975 but has receded somewhat since then.
(d) Net exports, which were positive in 1950 and 1975, were substantially negative in
2000.
(e) The share going to national defense purchases fell from 1975 to 2000.
(f) The share going to state and local purchases rose from 1950 to 1975.
(g) Imports have grown rapidly relative to GDP.
