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CHAPTER 26
7. Private saving is equal to (Y – C – T) = 10,000 – 6,000 – 1,500 = 2,500.
Public saving is equal to (T – G) = 1,500 – 1,700 = -200.
National saving is equal to (Y – C – G) = 10,000 – 6,000 – 1,700 = 2,300.
Investment is equal to saving = 2,300.
The equilibrium interest rate is found by setting investment equal to 2,300 and solving for r:
3,300 – 100r = 2,300.
100r = 1,000.
r = 10 percent.
CHAPTER 27
2. a. The present value of $15 million to be received in four years at an interest rate of 11% is
$15 million/(1.11)4 = $9.88 million. Because the present value of the payoff is less than
the cost, the project should not be undertaken.
The present value of $15 million to be received in four years at an interest rate of 10% is
$15 million/(1.10)4 = $10.25 million. Because the present value of the payoff is greater
than the cost, the project should be undertaken.
The present value of $15 million to be received in four years at an interest rate of 9% is
$15 million/(1.09)4 = $10.63 million. Because the present value of the payoff is greater
than the cost, the project should be undertaken.
The present value of $15 million to be received in four years at an interest rate of 8% is
$15 million/(1.08)4 = $11.03 million. Because the present value of the payoff is greater
than the cost, the project should be undertaken.
b. The exact cutoff for the interest rate between profitability and nonprofitability is the
interest rate that will equate the present value of receiving $15 million in four years with
the current cost of the project ($10 million):
$10  15 /(1  x )4
10(1  x )4  15
(1  x )4  1.5
1  x  (1.5)0.25
1  x  1.1067
x  0.1067
Therefore, an interest rate of 10.67% would be the cutoff between profitability and
nonprofitability.
5. a. The insurance would increase the amount that individuals spend on clothing. The amount
of clothing purchased would likely be greater than the efficient level, because those
making the purchase decisions are not paying the entire cost.
b. Individuals who desire or need to spend a lot on clothing will be those most likely to buy
clothing insurance.
c.
Clothing insurance will cost more than $2,000. Only those who spend more than average
will want to purchase the insurance. The insurance company will have to set the
premium such that it covers expected losses and administrative costs. Due to the
adverse selection problem, the insurance company will end up providing insurance for
those who will spend more than $2,000 per year on clothing. Thus, the premium will
have to be greater than $2,000.
d. No, this is not a good idea. It leads to overspending on clothing. This issue is very
different from health insurance, because purchases of medical care can often be life-ordeath decisions. In addition, increases in health lead to higher productivity so total
output in the economy can be affected by improvements in health. Last, there may be
positive externalities associated with some health expenditures (such as vaccinations).
CHAPTER 28
3. Men age 55 and over experienced the greatest decline in labor-force participation. This was
because of increased Social Security benefits and retirement income, encouraging retirement
at an earlier age. The rise in female labor force participation may be the result of changes in
social attitudes, labor-saving devices in the home such as dishwashers and microwave ovens,
and lower fertility rates.
8. a. Figure 3 illustrates the effect of a union being established in the manufacturing labor
market. In the figure on the left, the wage rises from w1U to w2U and the quantity of
labor demanded declines from U1 to U2D. Because the wage is higher, the quantity
supplied of labor increases to U2S, so there are U2S − U2D unemployed workers in the
unionized manufacturing sector.
b. When those workers who become unemployed in the manufacturing sector seek
employment in the service labor market, shown in the figure on the right, the supply of
labor shifts to the right from S1 to S2. The result is a decline in the wage in the
nonunionized service sector from w1N to w2N and an increase in employment in the
nonunionized service sector from N1 to N2.
Figure 3