Download Most countries, including the United States, import substantial

1. Most countries, including the United States, import substantial amounts of goods and services
from other countries. Yet a nation can enjoy a high standard of living only if it can produce a
large quantity of goods and services itself. Can you reconcile these two facts?
2. Suppose that society decided to reduce consumption and increase investment.
a. How would this change affect economic growth?
b. What groups in society would benefit from this change? What groups might be hurt?
3. What is the opportunity cost of investing in capital? Do you think a country can “overinvest” in
capital? What is the opportunity cost of investing in human capital? Do you think a country can
“overinvest” in human capital? Explain.
4. Suppose a U.S. firm builds a factory in Malaysia.
a. What sort of foreign investment would this represent?
b. What would be the effect of this investment on GDP in Malaysia? Would the effect on
Malaysian GNP be larger or smaller?
5. International data show a positive correlation between political stability and economic growth.
a. Through what mechanism could political stability lead to strong economic growth?
b. Through what mechanism could strong economic growth lead to political stability?
6. For each of the following pairs, which bond would you expect to pay a higher interest rate?
a. A bond of the U.S. government or a bond of an East European government.
b. A bond that repays the principal in year 2005 or a bond that repays the principal in
year 2025.
c. A bond from Coca-Cola or a bond from a software company you run in your garage.
7. Explain the difference between saving and investment as defined by a macroeconomist. Which
of the following situations represent investment? Saving? Explain.
a. Your family takes out a mortgage and buys a new house.
b. You use your $200 paycheck to buy stocks in AT&T.
c. Your roommate earns $100 and deposits it in her account at a bank.
d. You borrow $1,000 from a bank to buy a car to use in your pizza delivery business.
8. Suppose GDP is $10 trillion, taxes are $2 trillion, private saving is $0.7 trillion, and public saving is
-$0.1 trillion. Assuming this economy is closed, calculate consumption, government purchases,
national saving, and investment.
1. The facts that countries import many goods and services yet must produce a large quantity of
goods and services themselves to enjoy a high standard of living are reconciled by noting that
there are substantial gains from trade. In order to be able to afford to purchase goods from
other countries, an economy must generate income. By producing many goods and services,
then trading them for goods and services produced in other countries, a nation maximizes its
standard of living.
2.
a. More investment would lead to faster economic growth in the short run.
b. The change would benefit many people in society who would have higher incomes as
the result of faster economic growth. However, there might be a transition period in
which workers and owners in consumption-good industries would get lower incomes,
and workers and owners in investment-good industries would get higher incomes. In
addition, some group would have to reduce their spending for some time so that
investment could rise.
3. The opportunity cost of investing in capital is the loss of consumption that results from
redirecting resources toward investment. Over-investment in capital is possible because of
diminishing marginal returns. A country can "over-invest" in capital if people would prefer to
have higher consumption spending and less future growth. The opportunity cost of investing in
human capital is also the loss of consumption that is needed to provide the resources for
investment. A country could "over-invest" in human capital if people were too highly educated
for the jobs they could get – for example, if the best job a Ph.D. in philosophy could find is
managing a restaurant.
4.
a. When a U.S. firm builds a factory in Malaysia, it is a foreign direct investment.
b. The investment increases GDP in Malaysia because it increases production in Malaysia.
The effect on Malaysian GNP would be smaller because the owners would get paid a
return on their investment that would be part of U.S. GNP rather than Malaysian GNP.
5.
a. Political stability could lead to strong economic growth by making the country
attractive to investors. The increased investment would raise economic growth.
b. Strong economic growth could lead to political stability because when people have
high incomes they tend to be satisfied with the political system and are less likely to
overthrow or change the government.
6.
a. The bond of an eastern European government would pay a higher interest rate than
the bond of the U.S. government because there would be a greater risk of default.
b. A bond that repays the principal in 2025 would pay a higher interest rate than a bond
that repays the principal in 2005 because it has a longer term to maturity, so there is
more risk to the principal.
c. A bond from a software company you run in your garage would pay a higher interest
rate than a bond from Coca-Cola because your software company has more credit risk.
7. To a macroeconomist, saving occurs when a person’s income exceeds his consumption, while
investment occurs when a person or firm purchases new capital, such as a house or business
equipment.
a. When your family takes out a mortgage and buys a new house, that is investment
because it is a purchase of new capital.
b. When you use your $200 paycheck to buy stock in AT&T, that is saving because your
income of $200 is not being spent on consumption goods.
c. When your roommate earns $100 and deposits it in her account at a bank, that is
saving because the money is not spent on consumption goods.
d. When you borrow $1,000 from a bank to buy a car to use in your pizza-delivery
business, that is investment because the car is a capital good.
8. Given that Y = 10, T = 2, Sprivate = 0.7 = Y −T − C, Spublic = -0.1 = T − G.
Because Sprivate = Y − T − C, then rearranging gives C = Y − T − Sprivate = 10 − 2 − 0.7 = 7.3.
Because Spublic = T − G, then rearranging gives G = T − Spublic = 2 − (-0.1) = 2.1.
Because S = national saving = Sprivate + Spublic = 0.7 + (-0.1) = 0.6.
Finally, because I = investment = S, I = 0.6.