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CHAPTER 1
1. 316.5 percent
2. 5 percent; 5.6 percent
3. Percentage change in M1 = 5.1 percent; percentage change in M2 = 7.9
percent
4. 1960: 0.075; 2001: 0.279. The U.S. economy is more open today.
CHAPTER 2
1. (a) $12,050 billion
(b) $9,700 billion
(c) $10,500 billion
(d) $800 billion
2. 2003 nominal GDP = $145; 2004 nominal GDP = $185
2003 real GDP = $145; 2004 real GDP = $145
3. 2003 GDP deflator = 1.0; 2004 GDP deflator = 1.276; inflation rate = 27.6
percent
4. $9,640 billion
CHAPTER 3
1. $3.3 trillion
2. a. 8
b. $4 trillion (in base-year dollars)
c. ys = $4 trillion (base-year dollars)
3. a. As long as Ms. Hansen does not suffer from money illusion, she will
save the same fraction of her income as before.
b. Ms. Hansen’s real wage is unchanged, so she will continue working 37
hours per week (as long as she does not suffer from money illusion).
4. Suppose that the total demand for labor in a nation is given by the
equation, W/P = 25 + 2N. The total supply of labor is given by the
equation W/P = -5 +2N.
a. 10
b. 7.5
c. Labor demand: W/(2P) = 25 - 2N; labor supply: W/(2P) = -5 +2N. The
euilibrium real wage is 10, and the equilibrium quantity of labor is 7.5.
CHAPTER 4
5. a. 14 percent
b. 11 percent
6. a. 3.2
b. 8
CHAPTER 5
1. a. C
b. A
2. a. After 21 years, Y will be 21 percent richer than X; after 50 years, Y will
be more than 62 percent richer.
b. It will definitely catch up, but it will take just over 71 years.
3. 2.3 percent
4. 0 percent
CHAPTER 6
1. MPIM = 0.06. Consumption would rise by $90 billion; saving would rise
by $4 billion; and imports would increase by $6 billion. Yes, these changes
sum to the $100 billion increase in disposable income.
2. yd = $50 billion: c = $60 billion; s = -$10 billion
yd = $150 billion: c = $140 billion; s = $10 billion
yd = $250 billion: c = $220 billion; s = $30 billion
3. Multiplier = 4 = 1/(MPS + MPIM). This means that 0.25 = (0.10 + MPIM),
so MPIM = 0.15.
4. In equilibrium with no international trade, x = im = 0, so s + t = i + g, or s
+ $100 billion = i + $200 billion, so that s – i = $100 billion; thus, real
saving always exceeds real investment by $100 billion in equilibrium.
5. a. $350 billion
b. $15 billion
CHAPTER 7
1. $4 billion
2. (a) 3.08; (b) 2.50; (c) 1.60. In the face of a change in autonomous
aggregate expenditures, equilibrium real income would be most stable if
the income tax rate is 0.50 (50 percent), because this tax rate yields the
smallest multiplier effect.
3. The result would be a movement to the left and upward along the Laffer
curve, so the government’s tax revenues would increase, and its deficit
would decline.
CHAPTER 8
1. LM: r = (0.9/80)y – (1.5/80), or r = (0.01125)y – (0.01875)
2. 0.06 (6 percent)
3. IS: r = (11.8/80)- (1/80)y, or r = (0.1475) – (0.0125)y
4. $7.8 trillion
5. r = 0.06 (6 percent); y = $7 trillion
CHAPTER 9
1. r = rw + [(f /h)  y] – [(e + g)/h], or y = [(e + g)/f]+ [(h/f)  (r - rw)]
2. The slope is r/y = f/h. As long as f and h are positive, the BP schedule
slopes upward. An increase in h means that capital flows are more
responsive to variations in the domestic interest rate relative to the world
interest rate. Thus, capital is more mobile, and the slope of the BP
schedule increases, so that the schedule becomes more shallow, exactly as
discussed in the chapter. By contrast, a decrease in h means that capital
flows are less responsive to changes in the domestic interest rate relative
to the world interest rate. Consequently, capital is less mobile, and the
BP schedule steepens.
CHAPTER 10
1. a. 10
b. 20; the aggregate demand schedule slopes downward
2. 1 percent
3. a. First, rewrite u = un - b  (-e) by adding b   to and by subtracting u
from both sides, to get b   = b  e + un – u. Then, divide both sides
by b, which gives  = e + (1/b)  (un - u).
b. 4 percent
CHAPTER 11
1. Of course, there is an infinite number of adaptive expectation schemes.
One would be to compute the simple average of the inflation rate over past
three years, which is 5 percent. Another is to give the inflation rate three
years ago a weight of 1/6, the inflation rate two years ago a weight of 1/3,
and last year’s inflation rate a weight of 1/2. Then the expected inflation
rate is equal to (1/6)(4) + (1/3)(5) + (1/2)(6) = 5 1/3.
2. A reasonable expectation given this information is that the inflation rate
will be 10 percent. Nevertheless, there is no guarantee that this
expectation will be correct.
3. a. P = [(a  Pe) +(b  M) - y*] / (a + c). If people have full information, then
P = Pe, and rearranging this expression gives P =[(b  M) - y*] / c. A
change in the money stock affects the equilibrium price level in this
case.
b. With full information, P = Pe, and real output equals y* irrespective of
the quantity of money.
4. People are indifferent between holding either bond when1 + rUS = (F/S) 
(1 + rE). Because F/S = 1 + (F -S )/S [see the hint], we can write this
condition as1 + rUS = [1 + (F -S )/S]  (1 + rE). Multiplying gives
1 + rUS = 1 + rE + (F -S )/S + {[(F -S )/S]  rE}. Because (F -S )/S and rE are
small fractions, the term in braces is approximately equal to zero.
Subtracting 1 from each side then gives rUS = rE + (F -S )/S, which is the
uncovered interest parity condition.
CHAPTER 12
1. a. The equilibrium real wage is N / (a + b), the equilibrium employment
level is b N / (a + b), and the equilibrium level of real output is c b N / (a
+ b).
b. Workers will seek to achieve the real wage that they anticipate would
arise without contracts, which is W / Pe = N / (a + b), so the contracted
nominal wage would be Wc = [ N / (a + b)]  Pe. The actual real wage,
therefore, is Wc / P = [ N / (a + b)]  (Pe / P), and the equilibrium
employment level is (from the labor demand schedule) equal to N -[a N
/ (a + b)]  (Pe / P).
c. Actual output is ys = c  { N -[a N / (a + b)] (Pe / P)}. When the actual
price level P increases relative to the expected price level Pe, the term
in solid brackets gets smaller, so that output increases. Hence, the
aggregate supply curve slopes upward.
d. Under full information, P = Pe, so that y = c  { N -[a N / (a + b)] = c b N /
(a + b). This is the same as the output solution without contracts in
part a.
2. In this case the real wage always equals the market-clearing real wage of
N / (a + b), so that the equilibrium employment level is b N / (a + b).
Using this in the labor demand equation gives the equilibrium level of
real output, which is c b N / (a + b). Hence, the equation of the aggregate
supply schedule in this case is ys = c b N / (a + b), which is vertical.
CHAPTER 13
1. a. Normally, the firm would change its price, because its profit would be
$5000 lower on net if it did not. When faced with the one-time cost of
$8,000, however, it will not necessarily wish to change its price,
especially if the decline in demand is not expected to be permanent.
b. In this case, the not changing price would reduce the firm’s profit by
$5,000 every year into the foreseeable futurenamely, infinity. The
discounted present value of a profit loss of $5,000 each year forever at
an annual rate of 5 percent is $5,000 / 0.05 = $100,000. In this case, it
definitely pays for the firm to change its price, all other things being
equal.
2. a. Equilibrium real salary = 10,000; equilibrium employment = 30,000
b. 15,000
c. 20,000
CHAPTER 14
1. a. 9 trillion real dollars
b. Mathematical approach: Rearrange the IS equation in the form y = 19
– (10/3)r. Thus, a leftward shift by 3 trillion real dollars implies a new
IS equation of y = 16 – (10/3)r, and at the interest rate target of 3
percent, equilibrium real income is 6 trillion real dollars. Graphical
approach: The LM schedule is horizontal at the 3 percent interest rate
target, so a leftward shift by 3 trillion real dollars reduces equilibrium
real income from 9 trillion real dollars to 6 trillion real dollars.
2. a. Target income level = 6 trillion real dollars; equilibrium interest rate =
5 percent
b. First, rewrite the IS equation as y = 16 - (2  r), which means that after
the IS schedule shifts leftward by 3 trillion real dollars, the new IS
equation is y = 13 - (2  r), or r = (13/2) - (0.5  y). With M = 1, the LM
equation is r = 2 + (0.5  y). Setting (13/2) - (0.5  y) = 2 + (0.5  y) and
solving for y gives 4.5 trillion real dollars.
c. At a targeted interest rate of 5 percent, equilibrium real income would
have been equal to 3 trillion real dollars after the leftward shift of the
IS schedule, so the Fed would have been worse off if it had used the
interest rate as an intermediate target.
CHAPTER 15
1. a. y - E(y) = [ya - E(ya)]+ [yp - E(yp)]
b. [y - E(y)]2 = [ya - E(ya)]2 + [yp - E(yp)]2 + 2  [ya - E(ya)][yp - E(yp)], so the
expected value is E[y - E(y)]2 = E[ya - E(ya)]2 + E[yp - E(yp)]2 + 2  E{[ya E(ya)][yp - E(yp)]}. Substituting the definitions of variances gives
Var(y) = Var(ya) + Var(yp) + 2  E{[ya - E(ya)][yp - E(yp)]}
2. Economists often use the notation x2 to denote the variance of a variable
x, so that x2 is simply another way to write Var(x).
a. Var(y) = Var(ya) + Var(yp) + 2  E{[ya - E(ya)][yp - E(yp)]}becomes y2 = a2 +
p2 + 2  E{[ya - E(ya)][yp - E(yp)].
b. y2 = a2 + p2 + 2  ra,p  a  p
c. We want for policy to give us y2 < a2. From part b, this means that
we want a2 + p2 + 2  ra,p  a  p < a2. If we subtract a2, we have
the requirement that p2 + 2  ra,p  a  p < 0, or 2  ra,p  a  p < p2.
Dividing both sides of this last expression by 2  a  p gives
ra,p < -(1/2)(p /a) < 0.
d. If ra,p is very close to a value of zero, policy fails to be stabilizing.
3. In this case, ra,p must be less than –3.
4. The correlation coefficient relating the movements of real income without
policy actions and the effects of policy actions has a value of –0.1. The
variance of policy effects on real income (measured in billions of real
dollars) equals 1, and the variance of real income in the absence of policy
actions equals 4.
a. In this case, ra,p = -0.1, so policy is countercyclical.
b. a = 2, and p = 1, so -(1/2)(p /a) = -1. Thus, the condition is not
satisfied, so policy is not sufficiently countercyclical to stabilize real
income.
CHAPTER 16
1. a. r = rw
b. y = (rw - c) / d.
c. M = [1/(dk)][(ad – bc) - (b-d)  rw]]
2. a. To maintain parity, the interest rate must increase.
b. To keep the exchange rate fixed, the money stock must decline to shift
the LM schedule leftward. This is consistent with the answer in part c
of question 3 as long as b is greater than d.