ANSWERS TO PRACTICE QUESTIONS

CHAPTER 1

Page 6

1a.No, this person is not behaving rationally. In this case, the individual continues to engage in
an action they wish to stop because of physical addiction.
b. Someone trying to quit smoking might consciously decide to provide themselves with a small
reward every time they finish a predetermined period without smoking, and/or they may deny
themselves some pleasurable item or activity every time they smoke.

2. Because cattle require constant investment (in the form of cattlefeed and other forms of
upkeep), they are best seen as a capital resource.

3a. The two variables are (i) the economic welfare of the country's citizens, and (ii) the quantity
of the country's economic resources.
b. The quantity of the country's economic resources is the independent variable (since it is the
cause) and the economic welfare of the country's citizens is the dependent variable (since it is the
effect).
c. The relationship is direct, because a movement in the independent variable's value leads to a
movement of the dependent variable's value in the same direction.
d. The statement is positive, since it is a description of reality that does not depend on value
judgements.
e. For the country described in the statement, the economic problem of scarcity has become more
severe.

Page 12

1a. The opportunity cost of the first fish is 4 coconuts, since coconut production is reduced from
24 to 20 when the first fish is caught. Similarly, the opportunity costs of the second and third fish
are 8 (= 20-12) and 12 (= 12-0) coconuts.
b. These results conform with the law of increasing opportunity costs, because as fish production
is increased so is the opportunity cost of each new caught fish.
c. The curve bows out to the right, reflecting the law of increasing opportunity costs.
d. Besides the assumption that only two goods are produced, we must assume that the quantity of
the castaway's resources and the technology he uses are fixed, and that his resources are
employed to their full capacity.
e. With 12 instead of eight hours of labour devoted each day to acquiring coconuts and fish, the
castaway's production possibilities curve shifts outwards, with both its vertical and horizontal
intercepts increasing. If there are six instead of eight hours devoted each day by the castaway, the
production possibilities curve shifts inwards.
f. With a new capital asset that can be used to acquire fish, the castaway's production possibilities
curve shifts outwards, with its horizontal intercept (but not its vertical intercept) increasing.

2a. Since 1 computer must be sacrificed to gain 600 new hamburgers when moving from points
d to c, then the opportunity cost of each of these hamburgers is 1/600 of a computer.
b. When moving from points b to c, 1 computer must be sacrificed to gain 300 new hamburgers,
which means that the opportunity cost each of these hamburgers is 1/300 of a computer.

3a.

b. Yes, the curve bows out to the right. This shows that, as more of one item (e.g. fish) is
produced, the higher the opportunity cost of these additional units of the item.

4. If instead of exhibiting increasing opportunity costs, an economy is subject to constant

opportunity costs, its production possibilities curve will be a straight line stretching from the
vertical to horizontal axes, its slope based on the constant opportunity costs of the two products.

Page 24

1a. Beta is likely to have more economic freedom, given the greater importance of Beta's private
sector and the consumer sovereignty it promotes.
b. Alpha is likely to have more economic stability, because of the relative importance of its
traditional and public sectors. Both of these sectors tend to reduce economic instability.
c. In Alpha, traditional culture and national planners are more likely to conflict, given its
relatively large traditional and public sectors.
d. In terms of the triangle shown in Figure 1.4, Alpha will be southeast of Beta because it has
stronger elements of both a traditional economy and a command economy.

2. In this case, economic growth and environmental sustainability are conflicting, since China’s
high rates of economic growth have made it harder for the country to meet the goal of
environmental sustainability.

CHAPTER 2

Page 39

1a. The three points are 8 [= (3+5)] milkshakes at a price of $1.50, 13 [= (5+8)] milkshakes at a
price of $1, and 18 [= (7+11)] at a price of 50 cents.
b. The law of demand is satisfied, because a fall in the price of milkshakes (from $1.50 to $1, or
from $1 to 50 cents) increases quantity demanded (from 8 to 13 milkshakes, or again from 13 to
18 milkshakes).
c.

d. Kate now buys 6 and Carlo 10 milkshakes at a price of $1.50; Kate buys 10 and Carlo 16
milkshakes at a price of $1; and Kate buys 14 and Carlo 22 at a price of 50 cents. Therefore the
three points are 16[= (6+10)] at $1.50, 26 [= (10+16)] at $1, and 36 [= (14+22)] at 50 cents.
Because the entire market demand curve shifts rightward this is a change in demand.

2a. Because DVDs are a normal product, demand increases due to higher incomes.
b. DVDs and DVD players are complementary products, so a drop in the price of players
increases not just the quantity demanded of players but also the demand for DVDs.
c. A sudden expectation by consumers of a fall in DVD prices means they will delay DVD
purchases, decreasing current demand.
d. Because DVDs and movie theatre tickets are substitute products, a rise in the price of movie
tickets increases the demand for DVDs.
3a. A decrease in the price of e-book readers, which raises the quantity demanded of e-book
readers, is associated with a movement along the demand curve for e-book readers and is
categorized as a change in quantity demanded.
b. Because e-book readers and printed books are substitute products, a decrease in the price of e-
book readers decreases the entire demand curve for printed books. This occurs because the
quantity of printed books is reduced at every possible price of printed books. This is therefore
categorized as a change in demand.

Page 45

1a. The law of supply is satisfied, since a rise in the price of tomatoes (from $3 to $3.50, and
then from $3.50 to $4) increases quantity supplied (from 5 to 6 million kgs, and then from 6 to 7
million kgs).
b. (i) As this resource price rises, the supply of tomatoes decreases, shifting the curve to the left.
(ii) Because tomatoes and corn are supply-related products, a drop in the price of corn will
increase the supply of tomatoes, shifting the curve to the right. (iii) An early frost decreases the
supply of tomatoes, shifting the curve to the left. (iv) Technological progress in tomato
cultivation increases the supply of tomatoes, shifting the curve to the right. (v) An expected fall
in the price of tomatoes increases the current supply, as producers try and get today's high price,
shifting the curve to the right.
c.

d. A doubling of quantity supplied at each price means that the new market supply curve shifts
out to the right. Because the entire supply curve shifts, this is known as a change in supply

2a. A drop in the price of corn, which reduces the quantity supplied of corn, is associated with a
movement along the supply curve for corn and is classified as a change in quantity supplied.
b. Because corn and tomatoes are supply-related products, a drop in the price of corn causes a
rightward shift in the entire supply curve for tomatoes. This happens because some farmers will
respond by moving from corn to tomato production. The result is classified as a change in
supply.

Page 51

1a. Supply has decreased. On a graph, this is shown as a leftward shift, which is associated with
a rise in equilibrium price.
b. With a decrease in supply, equilibrium quantity decreases.
c. The rise in equilibrium price and fall in equilibrium quantity are accompanied by a temporary
shortage that occurs immediately after the decrease in supply.
d.

2a. Demand has increased. On a graph, this is shown as a rightward shift, which is associated
with a rise in equilibrium price.
b. With an increase in demand, equilibrium quantity increases.
c. The rise in equilibrium price and quantity are accompanied by a temporary shortage that
occurs immediately after the increase in demand.
d.
CHAPTER 3

Page 69

1. Yes, one should be careful when referring to a linear demand curve as either elastic or
inelastic. In their upper ranges, linear demand curves are elastic, while they are inelastic in their
lower ranges. Meanwhile, in their middle ranges they also pass through a point of unit-elasticity.

2a. Total revenue is $30 million (= $3000 x 10 000) at a price of $3000, $40 million (= $2000 x
20 000) at $2000, and $30 million (= $1000 x 30 000) at a price of $1000.
b. The market demand curve is elastic in the price range $3000 to $2000, since total revenue and
price move in opposite directions. Total revenue rises as price falls. In contrast, the demand
curve is inelastic in the range $2000 to $1000, because total revenue and price are moving in the
same direction, with both falling.
c. Between prices $3000 and $2000, the demand elasticity has a value of (-)1.67 [= ((20 000 - 10
000)/(15 000))/(($2000 - $3000)/($2500))], and between $2000 and $1000, it has a value of
(-)0.60 [= ((30 000 - 20 000)/(25 000))/(($1000 - $2000)/($1500))].
d. Yes, the answers are consistent. The numerical value of elasticity between prices $3000 and
$2000 is greater than one. This is consistent with part b. where demand in this price range was
found to be elastic. Similarly, the numerical value between $2000 and $1000 is less than one,
which is consistent with part b., where demand in this range was found to be inelastic.
e.
Yes. This graph is consistent with the answers above. In the $3000-to-$2000 price range, the
rectangles expand as price falls, which indicates that demand is elastic. In the $2000-to-$1000
price range, the rectangles contract as price falls, which indicates that demand is inelastic.

3a. The cross-price elasticity has a value of 1.29 [= ((750 000 - 1 million)/(875 000))/(($20 000 -
$25 000)/($22 500))].
b. The price elasticity of demand has a value of (-)0.69 [= ((17 500 - 15 000))/((16 250)/($400 -
$500)/($450))].
c. The income elasticity has a value of -0.87 [= ((3000 - 2000)/(2500))/(($50 000 - $80 000)/($65
000))].

Page 73

a. es is 0 [= ((80 000 - 80 000)/(80 000))/(($1.20 - $1)/($1.10))], and the immediate-run supply

curve is vertical at the constant quantity supplied of 80 000 heads.
b. es is 1 [= ((1.2 million – 1 million)/(1.1 million))/(($1.20 - $1)/($1.10))], and the short-run
supply curve is positively sloped.
c. The long-run supply curve is horizontal at the constant price of $1, and es is therefore
undefined.
d. This is a constant-cost industry, since its long-run supply curve is perfectly elastic. This means
the industry is not a major user of any single resource, so price is always driven back to its
original level in the long run after a change in production.
e.
Page 77

1a. This graph is similar to the first diagram in Figure 3.11, except with a somewhat steeper
demand curve. In this case, the proportion of the tax paid by consumers is event greater than that
shown in the corresponding diagram in Figure 3.11.
b. This graph is similar to the second diagram in Figure 3.12, except with a somewhat flatter
demand curve. In this case, the proportion of the tax paid by by producers is even greater than
that shown in the corresponding diagram in Figure 3.12.

Page 81

a. With a ceiling of $500 set below the equilibrium value of $650, a shortage of rental
accommodation is created. Landlords will receive less revenue, and are harmed. Tenants able to
find rental accommodation despite the shortage will gain. Tenants who are not able to find rental
accommodation, however, will lose as they are end up being forced into the unregulated portion
of the market, where rents are often higher than in the regulated market.
b. With a price floor of $2 imposed above the equilibrium value of $1.50, a surplus will appear,
and the government will be forced to purchase this surplus at $2 per kg. Cheddar consumers are
hurt, as they pay a higher price and buy fewer units. Producers are helped, as they produce more
cheddar and gain a greater price than before for the cheddar they sell.
c. Because the price ceiling of $700 is set above the equilibrium value of $600, there will be no
effect in the market.

CHAPTER 4
Page 98

a. With Process A, total daily costs of employing labour and capital are $400 [= ($80 x 2
workers) + ($40 x 6 machines)]. With Process B, these costs are $360 [= ($80 x 3 workers) +
($40 x 3 machines)]. Because Process B minimizes daily costs and maximizes productive
efficiency, it will be chosen by the owner.
b. $400 [= ($80 x 3) + ($40 x 3) + $30 + $10]
c. $200 [= (.06 x 10 000) - $400].
d. Implicit costs are $180 [= ($150 + $30)]. Economic costs are $580 [= ($400 + $180)]
e. $20 [= ($600 - $580)].
f. No, the owner should not consider closing, since the shop is making a positive economic
profit.

Page 98

1. As an NBA team manager wishing to increase the average height of players on your team you
should draft new players whose own height (the relevant marginal value) exceeds the team’s
current average height.

2a. Marginal product is 50 [= (50 – 0)] pots for the first worker, 150 [= (200 – 50)] pots for the
second worker, 70 [= (270 – 200)] pots for the third worker, 30 [= (300 – 270)] pots for the
fourth worker, and -60 [= (240 – 300)] pots for the fifth worker.
b. Marginal product rises when the first and second workers are hired. Marginal product falls and
is positive when the third and fourth workers are hired. Marginal product is negative when the
fifth worker is hired.
c. This is because it becomes increasingly difficult for each of these new workers to raise output
given the potter's fixed inputs.
d. Average product is 50 [= (50/1)] pots with one worker, 100 [= (200/2)] pots with two workers,
90 [= (270/3)] pots with three workers, 75 [= (300/4)] pots when four workers are employed, and
48 [= (240/5)] pots when five workers are employed.
e. Marginal and average product are the same when the first worker is hired. As marginal product
is rising (when the second worker is hired), marginal product is greater than average product. As
marginal product falls (when the last three workers are hired), marginal product is less than
average product.
f.
g. Marginal product reaches its peak where diminishing marginal returns set in. Total product
rises less rapidly and finally becomes negatively sloped once diminishing marginal returns set in.
Average product reaches its maximum where it equals marginal product. Then, because of
diminishing marginal returns, with marginal product falling and below average product, average
product declines.
Page 103

a. Variable costs are $0 at a zero output, $100 at an output of 50 pots, $200 at 200 pots, $300 at
270 pots, and $400 at 300 pots. Total cost is $100 [= ($100 + $0)] at 0 pots, $200 [= ($100 +
$100)] at 50 pots, $300 [= ($100 + $200)] at 200 pots, $400 [= ($100 + $300)] at 270 pots, and
$500 [= ($100 + $400)] at 300 pots.
b. Marginal cost is $2.00 [= ($100 - $0)/(50 – 0)] when moving from 0 to 50 pots; $0.67 [= ($200
- $100)/( 200 – 50)] from 50 to 200 pots; $1.43 [= ($300 - $200)/(270 – 200)] from 200 to 270
pots; $3.33 [= ($400 - $300)/(300 – 270)] from 270 to 300 pots.
c. Average fixed cost is $2.00 [= ($100/50) at 50 pots, $0.50 [= ($100/200)] at 200 pots, $0.37 [=
($100/270)] at 270 pots, and $0.33 [= ($100/300)] at 300 pots. Average variable cost is $2.00 [=
($100/50)] at 50 pots, $1.00 [= ($200/200)] at 200 pots, $1.11 [= ($300/270)] at 270 pots, and
$1.33 [= ($400/300)] at 300 pots. Average cost is $4.00 [= ($200/50)] at 50 pots, $1.50 [=
($300/200)] at 200 pots, $1.48 [= ($400/270)] at 270 pots, and $1.67 [= ($500/300)] at 300 pots.
d.
e. Yes. The marginal cost and average variable cost curves are J-shaped, and the average cost
curve is bowl-shaped, with the minimum points of both average variable cost and average cost
occurring at the curves' intersection with the marginal cost curve.
Page 109

a. The percentage increase in the labour input is 50% [= ((9 – 6)/6)) x 100%] and the percentage
increase in the capital input is also 50% [= ((3 – 2)/2)) x 100%], while the percentage increase in
output is 100% [= (240 – 120)/120]. Because the relative increase in output exceeds the relative
increase in each of the inputs, the business is experiencing increasing returns to scale. Long run
average cost falls from $5.33 [= ((6 x $100) + (2 x $20))/120] to $4 [= ((9 x $100) + (3 x
$20))/240].
b. The percentage increase in output is 50% [= (180 – 120)/120]. Because the relative increase in
output equals the relative increase in each of the inputs, the business is experiencing constant
returns to scale. Long run average cost at 120 units is $5.33 [= ((6 x $100) + (2 x $20))/120] and
at 180 units is also $5.33 [= ((9 x $100) + (3 x $20))/180].
c. The percentage increase in output is 33% [= (160 – 120)/120]. Because the relative increase in
output is less than the relative increase in each of the inputs, the business is experiencing
decreasing returns to scale. Long run average cost rises from $5.33 [= ((6 x $100) + (2 x
$20))/120] to $6 [= ((9 x $100) + (3 x $20))/160].

CHAPTER 5

Page 120

1a. The café is part of a monopolistically competitive market, since there are many cafés in the
area, each providing a slightly different product
b. The company operates in a monopoly, since the company is the sole provider of public transit
in this area.
c. The corporation is in an oligopoly, since a relatively small number of businesses make popular
women's perfumes.
d. This share-owner is operating in a perfectly competitive market, since there are many buyers
and sellers of RBC shares.
e. Because there are relatively few chartered banks in a country such as Canada, this firm
operates in an oligopoly.
f. Because there are many app creators, each producing different apps, this is a monopolistically
competitive market.

2. Razor manufacturers are making use of the lock-in effect. Once a consumer has bought a razor
handle at a relatively low price, they are less likely to purchase a competitor’s razor blades,
allowing the company to charge a relatively high price for blades.

Page 128

1a. Total revenue is $15 000 [= ($5 x 3000)] at 3000 kgs and $25 000 [= ($5 x 5000)] at 5000
kgs. Dividing this difference by the change in output gives the marginal revenue of $5 [= ($25
000 - $15 000)/(5000 – 3000)].
b. Since the fisher is a perfect competitor, he faces a constant price (equal to average revenue). In
this situation, marginal revenue and price are always the same.
c.
Yes, the curve is horizontal, as expected.

2a. This is his profit-maximizing point. Marginal cost, which is rising from $4.95 to $5.05 at the
output of 4000 kgs, equals the fisher's marginal revenue of $5 at, or close to, 4000 kgs.
b. The fisher's total loss is (-)$4000 [= ($5 x 4000) – ($6 x 4000) = ($20 000 - $24 000)].
c. Yes. Even though the fisher is making a loss, his $20 000 in total revenue covers his variable
costs of $16 000 [= ($4 x 4000)], with an amount left over to pay some of his fixed costs.
d. See graph at 3e.

3a. Yes. The fisher's supply curve includes the profit-maximizing points at each possible price,
and this is a profit-maximizing point.
b. No. The $6 price associated with the breakeven point is the fisher's lowest possible average
cost. At any price below $6, therefore, he is necessarily making a loss.
c. No. At any price above $6, the fisher can make a higher profit than he does at the breakeven
point. This profit is necessarily positive, as long as the fisher is at a profit-maximizing point.
d. The shutdown point is at a price below $6. At this point, price equals minimum average
variable cost, which is necessarily below the fisher's minimum average cost of $6.00 at the
breakeven point.
e.
Page 131

1a. Because price exceeds average cost, businesses in this market are making a positive profit.
These profits will attract new businesses to enter the market. As this happens, the market supply
curve shifts to the right, putting downward pressure on equilibrium price. This process continues
until price and average cost are equal.
b. Yes, the minimum-cost pricing rule will be met. This is because new businesses will enter the
market as long as price exceeds the lowest possible average cost, and positive profits are being
made. Only once price has reached the lowest possible average cost will the influx of new
businesses end.
c. Yes, the marginal-cost pricing rule will also be met. In any perfectly competitive market,
individual businesses face a constant price and average revenue (because they are price takers),
which means that average revenue and marginal revenue are the same. Because businesses in this
market maximize profits at the point where marginal cost and marginal revenue are equal, they
will also be ensuring that price equals marginal cost.

Page 139

a.
(1) (2) (3) (4) (5) (6)
Labour Total Marginal Product Total Marginal
(no. of Product Product Price Revenue Revenue
workers) (kilograms) (kilograms) ($ per kg.) ($ per hr.) Product
($ per hr.)
0 0 $1 $ 0
30 $30
1 30 1 30
24 24
2 54 1 54
18 18
3 72 1 72
12 12
4 84 1 84
6 6
5 90 1 90

b. In a perfectly competitive labour market, the farmer’s marginal resource cost is the hourly
wage of $15. The profit-maximizing employment rule states that profit is maximized at the
employment level where marginal revenue product and marginal resource cost are equal.
Comparing marginal revenue product with this marginal resource cost, the farmer will hire 3
workers. Between 2 and 3 workers, marginal revenue product, at $18, exceeds the marginal
resource cost of $15, whereas between 3 and 4 workers the marginal resource cost of $15
exceeds marginal revenue product, now at $12.
c.

d. With 10 000 identical employers in the labour market, each hires 3 workers at a wage of $15.
So 30 000 [= (3 x 10 000)] workers are hired in the entire market.
e.

Online Appendix, Resource Demand, Page 5

1a.
(1) (2) (3) (4) (5) (6)
Labour Total Marginal Product Total Marginal
(no. of Product Product Price Revenue Revenue
workers) (kilograms) (kilograms) ($ per kg.) ($ per hr.) Product
($ per hr.)
0 0 $ 0
30 $37.50
1 30 $1.25 37.50
24 9.00
2 54 1.00 54
18 0
3 72 0.75 54
12 -12.00
4 84 0.50 42
6 -19.50
5 90 0.25 22.50

b. In a perfectly competitive labour market, the farmer’s marginal resource cost is the hourly
wage of $8. The profit-maximizing employment rule states that profit is maximized at the
employment level where marginal revenue product and marginal resource cost are equal.
Comparing marginal revenue product with this marginal resource cost, the farmer will hire 2
workers. Between 1 and 2 workers, marginal revenue product, at $9, exceeds the marginal
resource cost of $8, whereas between 3 and 4 workers the marginal resource cost of $8 exceeds
marginal revenue product, now at $0.
c.

d. With 10 000 identical employers in the labour market, each hires 3 workers at a wage of $15.
So 30 000 [= (3 x 10 000)] workers are hired in the entire market.
e.

2a. With an increase in product demand, the demand for unskilled labour used in the fruit-
growing industry will also increase.
b. Automated machinery likely represents a substitute resource for unskilled labour in this
industry. The introduction of new automated techniques will therefore cause the demand for this
labour to decrease.
c. Because land and unskilled labour are complementary resources in the fruit-growing industry,
a rise in land rents causes the demand for this labour to decrease.

CHAPTER 6

Page 148

a. The perfect competitor's demand curve is perfectly elastic, since the business is a price taker.
b. A relatively elastic curve applies to a monopolistic competitor, because of limited market
power due to product differentiation.
c. Because it is the sole seller of a product with no close substitutes, the monopolist has a
demand curve that is less elastic than for businesses in other markets.
d. A kinked demand curve applies to an oligopolist in a market where rivalry prevails. This is
because of the differing reactions of the business's rivals to an increase or decrease in price.
Page 153

1a. The change in total revenue between the two output levels, which is $8 million [= ($20 x 400
000)] at 400 000 prescriptions and $7.5 million [= ($15 x 500 000)] at 500 000 prescriptions, is
divided by the change in output [($8 million - $7.5 million)/(500 000 – 400 000) = ($500
000/100 000)]. This gives a marginal revenue of $5.
b. Since demand (which equals average revenue) is downsloping for a monopolist, marginal
revenue is below the demand curve and therefore less than price. This ensures that price falls as
output expands.
c. Note that the single point on the MR curve that can be identified using the data provided is a
marginal revenue of $5 at a quantity of 400 500 prescriptions (the value on the quantity axis half-
way between 400 000 and 500 000 prescriptions). For explanatory purposes, the segment of the
MR curve on either side of this point is also drawn in the graph below.

2a. Yes, profit is maximized at this output and price, because this is where marginal cost (MC)
and marginal revenue (MR) are equal.
b. Output will now exceed 100 000 units and price will be less than $6. Perfectly competitive
businesses operate at the intersection of the market demand (D) and supply (S) curves. While D
is the same as in the case of monopoly, S is a portion of the monopolist's MC curve. Because D
and S cross at a point to the right of the intersection of the monopolist's MC and MR curves,
perfectly competitive output is higher. Moreover, the perfectly competitive price is found further
along the downsloping D curve, so it is lower.

Page 163
1a. Total revenue is $400 [= ($.04 x 10 000)] at 10 000 copies and $450 [= ($.03 x 15 000)] at 15
000 copies. Dividing this difference by the change in output gives the marginal revenue of 1 cent
[= ($450 - $400)/(15 000 – 10 000)].
b. As in the case of monopoly, demand (which equals average revenue) is downsloping for a
monopolistic competitor. To ensure that price falls as output expands, marginal revenue must be
below the demand curve and therefore less than price.
c. Note that the single point on the MR curve that can be identified using the data provided is a
marginal revenue of 1 cent at a quantity of 12 500 copies (the value on the quantity axis half-way
between 10 000 and 15 000 copies). For explanatory purposes, the segment of the MR curve on
either side of this point appears is included in the graph below.

2a. The business makes a short-run loss, with its $5 price below the $6 average cost. In the long
run, as some of its competitors leave the market, this business will see an outward shift in its
demand curve. The curve will also become less elastic, with fewer close substitutes for the
business's output. The short-run loss gradually disappears as the business moves towards its
long-run equilibrium point.
b. The business now makes a profit, with its $5 price greater than the $4 average cost. In the long
run, new businesses enter the market. This business will see a leftward shift in its demand curve,
and the curve will become more elastic, because there are more close substitutes for the
business's output. This time, the business's profit gradually disappears as it approaches its long-
run equilibrium point.
3a. At the output associated with the kink in the demand curve, the business's marginal revenue
(MR) curve is a vertical segment. This is because the MR curve has two downsloping segments –
each associated with one part of the kinked demand curve – and the vertical segment running
between these two downsloping MR segments.
b. As long as the marginal cost curve continues to intersect marginal revenue along the MR
curve's vertical segment, there will be no change in the business's profit-maximizing output or
price. This is significant because it shows that oligopolists in markets characterized by rivalry are
reluctant to vary their price.

4a. By both agreeing to stay silent, each prisoner receives 2 years jail time, with is better than the
other possibility that they might both agree on, which is 8 years jail time for each prisoner, if
they both confess.
b. If the two prisoners cannot communicate with one another, then each has an incentive to
choose the least harmful worst-case scenario for themselves, which is the option of confessing
(where the worst-case scenario for each is 8 years of jail time) as opposed to not confessing
(where the worst-case scenario for each is 15 years of jail time).

Page 168

1a. Total industry sales are $24 million [= (12 x $2 million)], while sales of four of the firms are
$8 million [= (4 x $2 million)]. (There is no need to distinguish among the firms since all are
exactly the same size.) Hence the four-firm concentration ratio is .33 [= ($8 million/$24
million)].
b. Given that the four-firm concentration ratio is below 50 percent, this industry can be classified
as monopolistically competitive.
c. A business in this market may choose to engage in non-price competition to distinguish its
product from that of rivals. If so, the business's motive would be to increase its demand and
make demand less elastic, allowing the business to raise its price.
d. No. Non-price competition is legal in Canada.
e. It would be a horizontal merger, since both businesses are in the same industry.

2. No. While big businesses may be able to pass on cost-savings to consumers, they also tend to
have significant market power, which means that consumers do not always benefit from these
cost savings. Moreover, there is a good chance that technical innovation by these businesses will
not be as rapid as in more competitive markets.

CHAPTER 7

Page 181

1. This concept of marginal benefit is closely associated with marginal utility, since both measure
the extra satisfaction gained by consuming an extra unit of a product. But marginal benefit is
measured in dollars, while marginal utility is measured in imaginary “utils”.

2a. The consumer surplus is similar to the top triangular area shown in Figure 7.4, and totals $4
million (= ($2 x 4 million litres)/2). The producer surplus is similar to the bottom triangular area
shown in Figure 7.4 and totals $4 million (= ($2 x 4 million litres)/2).
b. The deadweight loss is similar to the triangular area FG shown in Figure 7.5.
c. Consumers are hurt in two ways. First, a portion of their initial consumer surplus is transferred
to existing milk producers because of the higher milk price on the units still consumed. This area
is similar to the rectangle E shown in Figure 7.5. Second a portion of their initial consumer
surplus disappears because of the reduction in quantity supplied. This area is similar to the
triangle F shown in Figure 7.5. In addition, those prospective producers who would like to enter
the dairy industry are hurt by this policy. This is shown by the portion of the initial producer
surplus that disappears because of the reduction in quantity supplied – an area similar to the
triangle G shown in Figure 7.5. Overall economic welfare in this market is reduced by the
amount of the deadweight loss, as shown by the area similar to the triangular area FG in Figure
7.5.

Page 188

1a. Because the dance club disturbs nearby residents, it has a spillover cost. To deal with this
cost, government officials could ban dance clubs in suburban neighbourhoods.
b. By reducing traffic congestion, the subway has a spillover benefit. To take account of this
benefit, use of the subway could be promoted by a government subsidy.
c. Since throw-away batteries add to soil pollution, they have a spillover cost. This cost could be
dealt with by imposing an excise tax to reduce their popularity, or this product’s use could be
banned.
d. Because this bulb significantly reduces electricity use, and therefore carbon emissions, it has a
spillover benefit. To encourage consumers to switch to this new bulb, its use could be promoted
by a government subsidy.
e. Since this jetliner increases energy use, and therefore carbon emissions, it has a spillover cost.
This cost could be dealt with by imposing an excise tax on the jetliner itself, or simply by
imposing a carbon tax on aircraft fuel.

2a. The initial demand curve has as one of its points a price of $5 and a quantity of 200 000 units.
b. The new demand curve has as one of its points a price of $8 and a quantity of 200 000 units. It
is therefore vertically higher than the initial demand curve by an amount of $3 at every possible
quantity.
c. The government could provide a subsidy to consumers of $3 per unit.

3. A new global agreement to reduce greenhouse emissions would increase the demand for
carbon credits, thereby increasing their equilibrium price.

Page 197

1a. Total income earned in Libra is $100 000 [= ($5000 + $10 000 + $15 000 + $30 000 + $40
000)]. The shares if income earned by the five households (ranked in reverse order) are 5% [=
($5000/$100 000) x 100%], 10% [= ($10 000/$100 000) x 100%], 15% [= ($15 000/$100 000) x
100%], 30% [= ($30 000/$100 000) x 100%], and 40% [= ($40 000/$100 000) x 100%].
b. The cumulative shares of income earned by each household (ranked in order) are 5%, 15% [=
(5% + 10%)], 30% [= (5% + 10% + 15%)], 60% [= (5% + 10% + 15% + 30%)], 100% [= (5% +
10% + 15% + 30% + 40%)].
c.

2a. The Albertan carpenter is likely better paid. This is primarily due to regional disparities.
b. The truck driver is likely better paid. This is primarily due to more unpleasant job conditions.
c. The postal worker is likely better paid. This is primarily due to the fact that the postal worker
is unionized while the courier company employee is probably not unionized.
d. The warehouse clerk is likely better paid. This is primarily due to discrimination on the basis
of gender. While restaurant jobs are dominated by low-paid female labour, warehouse clerks are
usually men.
e. The lawyer is likely better paid. This is primarily due to the greater amount of education
required to be a lawyer.
f. The clerk who works on commission is likely to be better paid. This is due to the higher
income needed to remunerate the risks associated with commission income.
g. The landlord is likely to receive a higher income. This is primarily due to their greater
ownership of wealth.
h. The star poker player is likely to receive a higher income. This is because the demand by
spectator is greater for poker contests than for bridge contests.

Page 201

1a. Statistics Canada defines LICO in reference to the average proportion of after-tax income that
Canadians spend on food, clothing and shelter. LICO is the income level at which a household
spends 20 percent more on these items than does the average Canadian.
b. LICO is a relative measure of poverty, because it is an income cut-off that varies with
Canadian prosperity. As the average Canadian household becomes more prosperous and spends a
lower proportion of income on food, clothing and shelter, LICO expands in value, so that
households in a greater income range are classified as poor. An absolute measure of poverty
would stay constant regardless of changes in the average income of Canadians.

2. From most likely to least likely, the ranking is (1) persons under 18 in single-parent families
with a female head, (2) unattached males, (3) elderly unattached females, (4) persons between 18
and 64, and (5) persons in economic families.

Page 205

1a. The households' incomes after transfer payments and taxes are (ranked in reverse order)
$8750 [= ($5000 +$5000) – ($5000 x .25)], $12 500 [= ($10 000 +$5000) – ($10 000 x .25)],
$16 250 [= ($15 000 +$5000) – ($15 000 x .25)], $27 500 [= ($30 000 +$5000) – ($30 000 x .
25)], and $35 000 [= ($40 000 +$5000) – ($40 000 x .25)].
b. Total income received after transfer payments and taxes is still $100 000 [= ($8750 + $12 500
+ $16 250 + $27 500 + $35 000)]. The shares of income received by the households (ranked in
order) are now 8.75% [= ($8750/$100 000) x 100%], 12.5% [= ($12 500/$100 000) x 100%],
16.25% [= ($16 250/$100 000) x 100%], 27.5% [= ($27 500/$100 000) x 100%], and 35% [=
($35 000/$100 000) x 100%].
c. The cumulative shares of income received by the households (ranked in order) are now 8.75%,
21.25% [= (8.75% + 12.5%)], 37.5% [= (8.75% + 12.5% + 16.25%)], 65% [= (8.75% + 12.5% +
16.25% + 27.5%)], and 100% [= (8.75% + 12.5% + 16.25% + 27.5% + 35%)].
d.

e. This distribution is more equal than it was before transfer payments and taxes, since the shares
of income received by the poorest three households are higher (now 8.75%, 12.5% and 16.25%)
than before (5%, 10%, and 15%), and the shares received by the richest two households (now
27.5% and 35% ) are lower than before (30% and 40%).

Online Appendix, Wages, Rent, Interest, and Profit, Page 5

1a. The oil spill decreases the demand for land in this region, causing rents to fall
b. The gallery event increases the demand for this artist’s work, which raises her economic rent.
c. The influx of European players increases the supply of talented hockey players, and reduces
the economic rents received by those players already in North American leagues.
d. Global warming reduces the supply of this country’s available land, which means land rents
rise.

2a. The loan to the high-tech business will likely have the higher interest rate, because of the
business’s greater credit risk.
b. The five year loan will likely have the higher interest rate, due to its longer repayment period.

CHAPTER 8

Page 223

1a. No. Purchases of used goods are not included.

b. Yes. An addition to inventories represents investment.
c. Yes, Purchases by a household represent consumption.
d. Yes. Interest on a private business's debt is included in interest income
e. Yes. This expenditure represents a government purchase.
f. No. Financial transactions are not included.
g. No. Government transfer payments are not included.
h. Yes. This purchase represents an export.

2a. The expenditure-based estimate of GDP is $162 billion [= $85 b. + $35 b. + 43 b. + ($14 b. –
15 b.].
b. The income-based estimate of GDP is $194 billion [= $76 b. + $38 b. + 17 b. + $29 b. + $25 b.
+ ($35 b. - $26 b.)].
c. The statistical discrepancy is $16 billion, found by taking the difference between the two GDP
estimates [$32 billion = $194 b. - $162 b.] and then dividing by two [= ($32 billion/2)].
d. The economy's GDP is halfway between the two estimates, or $178 billion [= $162 b. + $16 b.
= $194 b. - $16 b.].
e. This economy's depreciation is $9 billion, found by deducting net investment ($26b.) from
gross investment ($35b.).

Page 228

1a. Per capita GDP in terms of the country's own dollars is $39 167 [= ($235 billion/6 million)].
b. Per capita GDP in terms of US dollars is $21 933 [= ($235 billion/6 million) x 0.56].
c. Per capita GDP in terms of PPP-adjusted US dollars is $23 500 [= ($235 billion/6 million) x
0.60].
d. Because the PPP-adjusted US-dollar value of the country's currency is higher than the
unadjusted US dollar value, prices in this country are lower than in the United States. Once this
difference in the price levels in the two countries is taken into account, the purchasing power of
this country's income, as shown by per capita GDP in PPP-adjusted US dollars, is higher than is
shown by the unadjusted per capita GDP in US dollars.

2a. A country's GNP is higher than GDP when the country's residents have significant holdings of
foreign financial assets that exceed foreigners' holdings of the country's own financial assets.
This means that there is a net inflow of financial investment income.
b. Yes, the country's citizens benefit, since incomes in the country exceed the country's
production.

CHAPTER 9

Page 244

1a. Using 2011 prices, the 2011 shopping basket has a value of $25 [= ($2.50 x 5) + ($1.25 x
10)]. Using 2012 prices, the 2011 shopping basket has a value of $26.75 [= ($2.75 x 5) + ($1.30
x 10)].
b. With 2011 as the base year, the 2011 value of the index is 100 [= ($25/$25) x 100]. The 2012
value of the index is 107 [= ($26.75/$25) x 100]
c. The inflation rate is 7 percent [= ((107 – 100)/100) x 100].

2. Rearranging the formula for deriving real GDP, nominal GDP in 2009 is found by multiplying
real GDP by the GDP deflator expressed as a decimal, or $205.3 billion [= ($210.7 billion x
0.97458)]. Because 2010 is the reference year, the 2010 value of the GDP deflator is 100, and
real GDP has the same value as nominal GDP ($234.3 billion). The 2011 value of real GDP is
$242.6 billion [= ($245.9 billion/1.01340)], found by dividing the year's nominal GDP by the
value of the GDP deflator expressed as a decimal. Rearranging the formula for deriving real
GDP, the 2012 value of the GDP deflator is found by dividing nominal GDP by real GDP, then
multiplying by 100 [102.945 = ($258.7 billion/$251.3 billion) x 100]. Nominal GDP in 2013 is
found by multiplying real GDP by the GDP deflator expressed as a decimal, or $275.6 billion [=
($261.4 billion x 1.05438)].

Page 252

1a. The labour force is found by adding the number of unemployed members of the labour force,
workers with full-time jobs, part-time workers who wish to have full-time jobs, and part-time
workers who do not wish to have full-time jobs [31.4 million = (2.3 million + 21.4 million + 3.5
million + 4.2 million)].
b. The labour force population is found by rearranging the formula used to derive the
participation rate, by dividing the labour force by the participation rate expressed as a decimal
[49.1 million = (31.4 million/0.64)].
c. The official unemployment rate is found by dividing the total number of unemployed members
of the labour force by the labour force, then multiplying by 100 [7.3 percent = (2.3 million/31.4
million) x 100].
2. An unemployment rate that includes underemployment is found by summing the number of
unemployed members of the labour force and the number of part-time workers who wish to have
full-time jobs, dividing this amount by the labour force, then multiplying by 100 [18.5 percent =
((2.3 million + 3.5 million)/31.4 million) x 100].

CHAPTER 10

Page 267

1a. A reduction in household tax rates increases consumption, shifting aggregate demand to the
right.
b. A slump in share prices reduces household wealth, which decreases consumption and shifts
aggregate demand to the left.
c. A rise in the price level does not cause a shift in the aggregate demand curve. Instead, it causes
a movement leftwards and upwards along the curve, due to the wealth and foreign trade effects.
d. A fall in Canadian interest rates increases investment and the consumption of durable items.
Both these trends cause aggregate demand to shift to the right.
e. A rise in the US-dollar value of the Canadian dollar makes Canadian exports more expensive
for Americans and imports from the US cheaper for Canadians. The result is a decrease in net
exports, shifting aggregate demand to the left.
f. A fall in business confidence decreases investment, shifting aggregate demand to the left.

2.

Page 272
1a. A rise in the economy's capital stock causes a long-run increase in aggregate supply.
b. A strengthening of government regulations results in a long-run decrease in aggregate supply.
c. An increase in the price of electricity causes a short-run decrease in aggregate supply.
d. A reduction in wage rates leads to a short-run increase in aggregate supply
e. A contraction in the amount of available land results in a long-run decrease in aggregate
supply.
f. A decline in the size of the labour force causes a long-run decrease in aggregate supply.
g. Technological progress causes a long-run increase in aggregate supply.
2.

Long-Run Aggregate Supply Curve

300

250
AS0 AS1

200
Price Level

150

100
Potential Potential
Output Output
50

0
600 650 700 750 800
Real GDP

Page 277

1a. When the price level starts above the equilibrium point, real output exceeds real expenditures.
The result is an unintended increase in inventories, or positive unplanned investment, which
reduces the price level. The price level continues to fall until the discrepancy disappears once
equilibrium is reached.
b. In the opposite case, when the price level begins below the equilibrium point, real
expenditures exceed real output. The resulting unintended decrease in inventories, or negative
unplanned investment, raises the price level until the discrepancy is eradicated at the equilibrium
point.

2a. Investment is related to saving, because both are connected with financial markets.
Government purchases are related to taxes, given that both are associated with government.
Exports are related to imports, since both represent ties with the rest of the world.
b. No. Investment does not need to equal saving. Nor are government purchases necessarily
equal to taxes, or exports equal to imports. Only total injections and total withdrawals need to be
in balance when the economy is in equilibrium.

3a. With a recessionary gap, actual output is below its potential level. Because the natural rate of
unemployment is associated with potential output, the fact that actual output is lower than its
potential means the actual unemployment is above its natural rate.
b. With an inflationary gap, actual output exceeds its potential level, which means that the actual
unemployment rate is temporarily less than its natural rate.
c. In a protracted recessionary gap, not just cyclical unemployment but also structural
unemployment gradually rises, as some cyclically unemployed workers become structurally
unemployed after being out of work for an extended period.
d.

Page 286
1a. 144 (= 72/0.5) years
b. 2.67 (= 72/27) percent
c. Because population doubles every 12 (72/6) years, it will double approximately twice in 25
years.

2.
3a. The main factors are the quantity of capital, technological progress, efficiency, and social and
political factors.
b. The other factor determining the growth in real GDP is population growth, since this
determines the size of the labour force.

Page 291

1a. Expansions tend to be quite long – sometimes close to a decade or more. In contrast,
contractions are often relatively short.
b. The most dramatic contraction in Canadians' per capita real output occurred during the Great
Depression of the early to mid-1930s. The most dramatic expansion occurred during the latter
part of the 1930s and then during the 1940s, as the Canadian economy recovered from the
Depression and was stimulated by the spending associated with World War II.

2. At times, expectations by households and businesses can serve as a self-fulfilling prophecy,

with widespread belief in a certain outcome ensuring that the outcome will occur. For example, if
a burst of pessimism causes both households and businesses to believe that there will be an
economic contraction, the decrease in spending by these sectors will reduce real output as
aggregate demand shifts to the left – a situation that most economists believe worsened the
worldwide recession that followed the 2008 financial crisis. Similarly, a burst of optimism by
households and businesses will increase spending and therefore raise real output as aggregate
demand shifts to the right. But such self-fulfilling prophecies occur only at certain points in the
business cycle, prompted by other events, such as an initial contraction in spending and output in
the case of pessimistic expectations, or an initial expansion in spending and output in the case of
optimistic expectations.

Online Appendix, The Aggregate Expenditures Model, Page 4

1. With a $100 billion increase in the consumption schedule at every possible disposable income
level, the saving schedule will decrease by $100 billion. This occurs because disposable income
can only be consumed or saved, so a rise in consumption must be balanced by an equal fall in
saving.

2a. At a GDP of $600 billion, aggregate expenditures are $700 billion. Because total spending
exceeds output, there is negative unplanned investment of $100 billion. With inventory stocks
falling, businesses will respond be expanding output, which increases GDP until the equilibrium
level of $1000 billion is achieved.

b. At a GDP of $1400 billion, aggregate expenditures are at $1300 billion. Because output
exceeds total spending, there is positive unplanned investment of $100 billion and inventory
stocks are rising. Businesses react by reducing output, which decreases GDP until the
equilibrium level of $1000 billion is reached.

Online Appendix, Economic Development, Page 8

1a. Given the data in the table, 20 percent of the world’s population lives in low-income
countries, 64 percent in middle-income countries, and 16 percent in high-income countries.
b. Total world GNP is approximately $52,618,300 million (= $7958 x 6.612 billion). Total GNP
in low-income countries is approximately $749,090 million (= $578 x 1.296 billion), or 2
percent. Total GNP in middle-income countries is $12,234,720 million (= $2872 x 4.260 billion),
or 23 percent. Total GNP in high-income countries is $39,669,700 million (= $37 566 x 1.056
billion), or 75%.
c. Yes, this statement is approximately true.

2a. Based on the vicious circle of poverty, low investment and rapid population growth both lead
to labour-intensive production, which means that productivity growth tends to be low, so that per
capita incomes in these countries tends to stay low.
b. Governments can break out of the circle of poverty through investments in resources and
through population control programs.

CHAPTER 11

Page 303

1a. Because real output falls short of its potential level, an expansionary fiscal policy is called
for, which means government purchases should be increased.
b. With unemployment below its natural rate, a contractionary fiscal policy should be used. This
means government purchases should be decreased.
c. With the economy already at potential output and the corresponding natural rate of
unemployment, there is no need for fiscal policy.

2a. With shrinking incomes and spending, tax revenues fall. Meanwhile government transfer
payments and subsidies rise. The result is a reduction in net tax revenues, which has a stabilizing
expansionary effect on the economy.
b. With expanding incomes and spending, tax revenues rise. Government transfer payments and
subsidies, meanwhile, fall. This leads to a rise in net tax revenues, which has a stabilizing
contractionary impact on the economy.

Page 311

1a. Withdrawals will have to rise by the same amount of $1 million to bring injections and
withdrawals back into balance.
b. With an MPW of 0.67, then incomes and output must rise by $1.5 million, since each $1.50 in
extra income will create $1 [= (0.67 x $1.50)] in additional withdrawals.
c. The $1.5 million found in part b can be derived by multiplying the initial $1 million increase
in injections by the spending multiplier [= ($1 million x (1/0.67))].

2a. With a $10 billion fall in government purchases, the AD curve shifts to the left by -$16.67
billion [= (-$10 billion x (1/0.60)].
b. The initial $25 billion rise in spending due to the tax cut causes the AD curve to shift to the
right by $31.25 billion [= ($25 billion x (1/0.80)].
c. An MPC of 0.25 means that the economy's MPW is 0.75 [= (1 – 0.25)]. Therefore, with a $15
billion rise in government purchases, the AD curve shifts to the right by $20 billion [= ($15
billion x (1/0.75)].
d. An MPC of 0.45 means the economy's MPW is 0.55 [= (1 – 0.45)]. With a $30 billion tax rise,
the AD curve shifts to the left by -$22.5 billion [= -(0.45 x $30 billion) x (1/0.60)].

Page 316

1a. With expenditures of $10 billion and tax revenues of $15 billion, there is a budget surplus of
$5 billion [= ($15 billion - $10 billion)], and the government's debt falls to $95 billion [= ($100
billion - $5 billion)].
b. If expenditures are $12.5 billion and tax revenues are $10 billion, there is a budget deficit of -
$2.5 billion [= ($10 billion - $12.5 billion)]. The government's debt therefore rises instead to
$102.5 billion [= ($100 billion + $2.5 billion)].

2a. If a government applies the guideline on annually balanced budgets, public debt does not rise,
which is a potential advantage to the economy. However, this policy guideline has a potential
problem, since its use worsens the severity of the business cycle. During economic contractions,
falling tax revenues mean that the guideline can be met only by cutting government purchases.
This magnifies the contraction in incomes and spending. Similarly, during economic expansions,
the rise in tax revenues allows for an increase in government purchases, which magnifies the
expansion in incomes and spending.
b. If the guideline of cyclically balanced budgets is followed, public debt does not rise, as in the
case of annually balanced budgets. Again, this is a potential advantage to the economy. The
potential problem with this guideline, however, is the fact that governments may not succeed in
meeting it, given the difficulty in ensuring that periods of budget deficits and budget surpluses
exactly balance.
c. The potential advantage of using the functional finance guideline is that unemployment is
minimized. The potential problem, meanwhile, is the fact that public debt may rise to
unsustainable levels.

Online Appendix, The Aggregate Expenditures Model and Government, Page 4

1a. Using the spending-output approach, a further $200 billion increase in G and T has two
effects: the aggregate expenditures (AE) line shifts up by $200 billion due to the increase in G,
and it also shifts down by $150 billion due to the tax-induced decrease in C. Overall the AE line
shifts up by $50 billion, and equilibrium output rises from $1200 billion to $1400 billion. Using
the injections-withdrawals approach, there are three effects: the total injections (I+G+X) line
shifts up by $200 billion due to the increase in G, the total withdrawals (S+T+M) line shifts up
by $200 billion due to the increase in T, and S+T+M also shifts down by $50 billion due to the
tax-induced decrease in S. Overall, total injections rise by $200 billion at every output level
while total withdrawals rise by $150 billion, so that equilibrium output again expands from
$1200 billion to $1400 billion.

2a. Total change in output = 1 x (change in G or T) = $200 billion

b. As shown in Figure B on page 303, the multiplier is accurate only if the AS curve is
horizontal. Once changes in the price level are taken into account then the overall change in real
output is less than the balanced budget multiplier would suggest.

CHAPTER 12

Page 335

1. In a barter economy traded products themselves serve as a means of exchange. Particular

durable items are kept as a store of purchasing power, and there is no common unit of account.
All three of these choices mean that the three functions of money are not as effectively
performed as they could be in an economy with money. Using traded products as a means of
exchange is cumbersome because a coincidence of wants is required before exchange can take
place. The use of particular durable items as a store of purchasing power is inconvenient, because
while they are being stored it is impossible to consume them. Finally, given that there is no
single unit of account, there is a multiplicity of relative values in a barter economy.

2a. M1 is the sum of currency outside chartered banks and publicly held demand deposits at
chartered banks, or $54 billion [= ($20 b. + $34 b.)].
b. M1+ is the sum of M1 and chequable notice deposits and chartered banks and near banks, or
$121 billion [= $54 b. + $30 b. + $37 b.]
c. M2 is the sum of M1+ and nonchequable notice and personal term deposits at chartered banks,
or $255 billion [= ($121 b. + $34 b. + $100 b.)].
d. M2+ is M2 plus corresponding deposits at near banks, or $375 billion [= $255 b. + $30b. +
$90 b.]

Page 340

1a. With a nominal interest rate above its equilibrium level, there is a surplus in the money
market. This surplus of money means that people will try to get rid of money and buy financial
assets such as bonds. The result is a rise in the prices of these financial assets and a fall in the
nominal interest rate until money market equilibrium is achieved.
b. When the nominal interest rate is below its equilibrium level, the money market exhibits a
shortage. People will try to acquire money by selling financial assets such as bonds. This causes
a fall in the prices of these financial assets, and a rise in the nominal interest rate until the
achievement of money market equilibrium.

2a. The bond's annual interest payment is $1000 [= ($20 000 x .05)].
b. Because newly issued $20 000 bonds provide only $400 [= ($20 000 x .02)] per annum, this
bond will have a price that is 2.5 [= ($1000/$400)] as much, or $50 000.
c. Newly issued $20 000 bonds now provide $2000 [= ($20 000 x .10)] per annum. This bond
will therefore have a price that is .5 [= ($1000/$2000)] as much, or $10 000.

Page 345

1a. The bank's reserve ratio of 4 percent [= (($40 000/$1 million) x 100)] is found by dividing
desired reserves by deposits and multiplying the result by 100.
b. The bank's desired reserves increase by $4000 [= ($100 000 x .04)]. This is found by
multiplying the increase in deposits by the reserve ratio. The bank's excess reserves increase by
$96 000 [= ($100 000 - $4000)]. This is found by subtracting the increase in desired reserves
from the increase in deposits.

2a. The initial change in excess reserves is found by subtracting the $12 [= ($200 x 0.06)]
increase in desired reserves from the $200 increase in total reserves, or $188 [= ($200 - $12)].
b. The maximum amount by which the money supply can change is found by multiplying the
initial change in excess reserves by the money multiplier, or $3133.33 [= ($188 x (1/.06)].

CHAPTER 13

Page 358

1a. With high unemployment and falling inflation the economy faces a recessionary gap.
Therefore, an expansionary monetary policy should be used.
b. With an expansionary monetary policy, the Bank of Canada purchases government bonds in
order to raise banks' excess reserves. This results in a magnified rise in the money supply, thanks
to the working of the money multiplier. The increase in the money supply causes the equilibrium
nominal interest rate to fall, which raises investment by businesses and consumption spending on
durables by households. The spending increase pushes up aggregate demand and raises both
equilibrium output and the price level. As the economy expands, the recessionary gap shrinks
and the unemployment rate falls.

c.

2a. The nominal rate of interest on the treasury bill is 2.04 percent [= (($1 000 000 - $980 000)/
$980 000) x 100], which is found by dividing the increase in the bill's value during the year by
the initial purchase price, with this ratio then multiplied 100 to turn it into a percentage.
b. To raise the nominal interest rate on one-year treasury bills to 3 percent, the Bank must
increase the supply of these bills in its auction. The result will be a drop in the purchase price of
these bills, pushing up their nominal interest rate.

3. A bank’s leverage ratio is the multiple by which a company’s liabilities exceed its
shareholders’ equity. The advantage to a bank of increasing its leverage ratio is that it enhances
is profit-making ability for shareholders by increasing revenue-generating loans in relation to
shareholders’ equity. The main disadvantage is the added risk this creates for shareholders. If a
significant proportion of a bank’s loans become non-performing – as during a recession or
financial crisis – then with a high leverage ratio shareholder bear more of a loss per share.

4. Quantitative easing is an example of open market operations since it involves the Bank of
Canada buying assets such as government bonds in the open market.

Page 362

1a. The bond seller's deposit increases by $10 000.

b. The bank's desired reserves rise by $500 [= ($10 000 x .05)].
c. The bank's excess reserves increase by $9500 [= ($10 000 - $500)].
d. The maximum increase in the money supply is $200 000, which is found by adding the initial
$10 000 rise in the money supply due to the expansion in the bond seller's bank deposit and the
maximum $190 000 [= $9500 x (1/.05)] increase in the money supply due to the rise in excess
reserves multiplied by the money multiplier.

2a. The bond buyer's deposit decreases by $2000.

b. The bank's desired reserves fall by $200 [= ($2000 x .10)].
c. The bank's excess reserves decrease by $1800 [= ($2000 - $200)].
d. The maximum decrease in the money supply is $20 000, which is found by adding the initial
$2000 fall in the money supply due to the reduction in the bond buyer's bank deposit and the
maximum $18 000 [= $1800 x (1/.10)] decrease in the money supply due to the fall in excess
reserves multiplied by the money multiplier.

Page 368

1a. A bout of cost-push inflation causes an outward shift in the Phillips curve, since this type of
inflation is associated with a rise in the unemployment rate. This is the type of inflation that is
not directly incorporated into the Phillips curve.
b. A bout of demand-pull inflation moves the economy up and to the left along the economy's
stationary Phillips curve. This is the type of inflation that is directly incorporated into the Phillips
curve.
c. A contractionary monetary policy moves the economy down and to the right along the
economy's stationary Phillips curve, since such a policy reduces inflation and increases the rate
of unemployment.
2a. With an initial equilibrium to the right of the long-run AS curve, real output exceeds its
potential level, and the unemployment rate is below its natural rate. In the long run, the low
unemployment rate will put upward pressure on wages, shifting the economy's AS curve to the
left. This gradual shift moves equilibrium leftwards towards the vertical long-run aggregate
supply curve.
b. If initial equilibrium is to the left of the long-run AS curve, then real output is below its
potential level, and the unemployment rate exceeds its natural rate. In the long run, the high
unemployment rate will put downward pressure on wages. This shifts the economy's AS curve to
the right, which gradually moves equilibrium rightwards towards the vertical long-run aggregate
supply curve.

CHAPTER 14

Paged 382

1a. trade in services, payment

b. merchandise trade, receipt
c. transfers, payment
d. investment income, receipt

2a. financial account, portfolio investment, receipt.

b. financial account, direct investment, payment
c. capital account, receipt
d. financial account, other financial investments, receipt

3a. This is portfolio investment, because the financial instrument involved is a government bond,
which cannot involve any direct controlling interest for the buyer.
b. This is direct investment, because the buyer is purchasing the entire company.
d. This is other investment, because it involves a day-to-day fluctuation in bank deposits.

Page 389

1a. A fall in Canadian interest rates makes Canadian bonds less appealing to financial investors
in both Canada and the US. As Americans purchase fewer Canadian bonds, the demand for
Canadian dollars in this foreign exchange market decreases. Meanwhile, because Canadians are
more likely to buy American rather than Canadian bonds, the supply of Canadian dollars in this
market increases. Both movements cause a fall in the price of the Canadian dollar in terms of US
dollars.
b. As Americans make fewer financial investments in Canada, the demand for Canadian dollars
in this foreign exchange market decreases. Meanwhile, as Canadians make fewer financial
investments in Canada, they increase the amount of financial investments they make in the US,
which increases the supply of Canadian dollars in this market. Both movements cause a fall in
the price of Canadian dollars in terms of US dollars
c. Falling real output in Canada means a drop in Canadian spending on imports. This decreases
the supply of Canadian dollars in this foreign exchange market. Constant real output in the US
means that there is no change in the demand for Canadian dollars in this market. The result of the
first trend is a rise in the value of the Canadian dollar in terms of US dollars.
2.

3a. Given an expectation that higher interest rates will push up the international value of the
Canadian dollar, speculators will purchase Canadian dollars.
b. Given an expectation that higher inflation rates will put downward pressure on the Canadian
dollar, speculators will sell Canadian dollars.
c. With a lower risk of Quebec separation, there will be an expectation of a higher value of the
Canadian dollar, which will cause speculators to purchase Canadian dollars.

Page 395

1a. A target value for the Canadian dollar set below the equilibrium level requires that the Bank
of Canada sell Canadian dollars and buy foreign currency
b. Because the Bank of Canada is selling Canadian dollars, the changes in official reserves
account is negative, and there is a balance-of-payments surplus to ensure that the overall balance
of payments sum to zero.
c.

2a. With a fixed exchange rate set below the Canadian dollar's equilibrium value, Canadian
exports are relatively cheap and American imports are expensive. The beneficial result is an
increase in net exports, which expands aggregate demand and pushes up real output and
employment. The cost of this policy is higher inflation, as well as the possibility that Canada's
main trading partners (in particular, the US) will decrease the value of the US dollar in terms of
the Canadian dollar. In practical terms, it is the inflation risk that is most significant in the
Canadian context.
b. If the fixed exchange rate is set above the Canadian dollar's equilibrium value, American
exports are relatively cheap, with the beneficial effect that inflation is reduced. The cost of this
policy is associated with the fact that Canadian exports become relatively more expensive at the
same time as American imports become cheaper. Canada's net exports are reduced, pushing
down aggregate demand, real output and employment.

CHAPTER 15

Page 412

1a. Aries is more efficient at producing discs, since a worker's daily output of discs is higher in
Aries (25) than in Pisces (20). Pisces is more efficient at producing players, since a worker's
daily output of players is higher in Pisces (4) than in Aries (1).
b. On the basis of absolute advantage, each country should specialize in the good that it is most
efficient at producing. Therefore, Aries should make discs and Pisces should make players.
c. In Aries, the opportunity cost of players is 25 discs, since a worker in Aries can produce 25
times as many discs (25) as players (1) in a day. In Pisces the opportunity cost of players is 5
discs, since a worker in Pisces can produce five times as many discs (20) as players (4) in a day.
Therefore, the terms of trade must be somewhere between 1 player traded for 25 discs in Aries
and 1 player traded for 5 discs in Pisces.

2a. Virgo is more efficient at producing computer monitors, since a worker's daily output of
monitors is higher in Virgo (2) than in Taurus (1). Virgo is also more efficient at producing
digital TVs, since a worker's daily output of TVs is higher in Virgo (6) than in Taurus (2).
b. In Taurus, the opportunity cost of computer monitors is 2 TVs (and the opportunity cost of
TVs is 0.5 computer monitors), since a worker in Taurus can produce twice as many TVs (2) as
monitors (1). In Virgo, the opportunity cost of computer monitors is 3 TVs (and the opportunity
cost of TVs is 0.33 computer monitors), since a worker in Virgo can produce three times as many
TVs (6) as monitors (2) in a day.
c. On the basis of comparative advantage, each country should specialize in the good whose
opportunity cost is lower than in the other country. This means that Taurus should produce
computer monitors, since this good's opportunity cost is lower in Taurus (2 TVs) than in Virgo (3
TVs). Meanwhile, Virgo should specialize in TVs, since this good's opportunity cost is lower in
Virgo (0.33 monitors) than in Aquarius (0.5 monitors).
d. The terms of trade must be somewhere between 1 monitor traded for 2 TVs (Taurus) and 1
monitor traded for 3 TVs (Virgo).

Page 419

1. Consumers are harmed by the tariff, because they pay a higher price and purchase fewer units
of the good than previously. Domestic producers benefit from the good's higher price and the
greater number of units they are able to sell. In contrast, foreign producers are harmed. Though
they receive the same price as previously, they sell fewer units of the good in this national
market. Finally, the country's government benefits because of the additional tax revenue raised
by the tariff.

2. Foreign producers lose with both a tariff and an import quota, since both policies mean they
sell fewer units in this national market. But, when able to decide between the two, foreign
producers prefer an import quota, because with a quota they are able to charge a higher price
than in the case where there is no trade protection. When they face a tariff, however, they cannot
charge a price that is higher than in the case of no trade protection.

Page 425

1a. Opponents of the agreement focused on the potential loss of political sovereignty for Canada,
especially given the new limits on government attempts to screen foreign investment and restrict
energy exports. They also emphasized the jobs lost in previously protected Canadian
manufacturing industries.
b. Supporters of the agreement emphasized the benefits of added specialization flowing from
trade liberalization. They also suggested that it reduced the risk of American protectionism
directed against Canadian exports.

2a. Supporters of the agreement again emphasized the benefits of added specialization by
extending the previous Canada-US Free Trade Agreement to include Mexico. They also pointed
to the new markets and investment opportunities provided to both Americans and Canadians in
Mexico.
b. Opponents of the agreement focused on the possible decline in environmental and safety
standards in both the US and Canada. They also highlighted the possible decline in wages to
unskilled workers in both the US and Canada due to the movement of production to Mexico.