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CHAPTER
Macroeconomics: The Big Picture
6
1. Which of the following questions are relevant for the study of macroeconomics and
which for microeconomics?
a. How will Ms. Martin’s tips change when a large manufacturing plant near the res-
taurant where she works closes?
b. What will happen to spending by consumers when the economy enters a downturn?
c. How will the price of oranges change when a late frost damages Florida’s orange
groves?
d. How will wages at a manufacturing plant change when its workforce is unionized?
e. What will happen to U.S. exports as the dollar becomes less expensive in terms of
other currencies?
f. What is the relationship between a nation’s unemployment rate and its inflation
rate?

S1o. lution
a. This is a microeconomic question because it addresses the effects of a single firm’s
actions (the closure of a manufacturing plant) on a single individual (the waitress).
b. This is a macroeconomic question because it considers how overall spending by
consumers is affected by the state of the macroeconomy.
c. This is a microeconomic question because it looks at how a single market (orang-
es) will be affected by a late frost.
d. This is a microeconomic question because it addresses how wages in a particular
plant will change when the firm’s workforce is unionized.
e. This is a macroeconomic question because it considers the change in the overall
level of exports as the value of the dollar changes.
f. This is a macroeconomic question because it addresses the relationship between
two aggregate measures of economic activity: inflation and unemployment.

2. When one person saves more, that person’s wealth is increased, meaning that he
or she can consume more in the future. But when everyone saves more, everyone’s
income falls, meaning that everyone must consume less today. Explain this seeming
contradiction.

S2o. lu tio n
n concerns the paradox of thrift; what is true for an individual—that
This question
saving makes you better off—is not always true for the economy as a whole. When
an individual saves, that person adds to his or her wealth, providing for higher con-
sumption in the future. However, if everyone saves, firms will not sell as much and
will lay off workers. Individuals find that their incomes fall as a result. So they must
consume less today.

3. Before the Great Depression, the conventional wisdom among economists and policy
makers was that the economy is largely self-regulating.
a. Is this view consistent or inconsistent with Keynesian economics? Explain.

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b. What effect did the Great Depression have on conventional wisdom?

c. Contrast the response of policy makers during the 2007–2009 recession to the
actions of policy makers during the Great Depression. What would have been the
likely outcome of the 2007–2009 recession if policy makers had responded in the
same fashion as policy makers during the Great Depression?

S3o. lution
a. The view that the economy is largely self-regulating is at odds with Keynesian
economics, which claims that managing the economy, via the tools of fiscal and
monetary policy, is the government’s responsibility.
b. The Great Depression was such a catastrophic occurrence that it shifted the con-
ventional wisdom away from the view that the economy is largely self-regulating to
the Keynesian view that the government should intervene to manage the economy.
c. In 2007–2009, policy makers actively used monetary and fiscal policy to boost the
economy. If they had done nothing, as policy makers did during the Great
Depression, it is very likely that the recession of 2007–2009 would have been even
longer and deeper.

4. How do economists in the United States determine when a recession begins and
when it ends? How do other countries determine whether or not a recession is
occurring?

S4o. lution
In the United States, economists assign the task of identifying recessions to an
independent panel of experts at the National Bureau of Economic Research who
determine when a recession begins and when it ends. It makes this determination
by looking at a variety of economic indicators, with the main focus on employment
and production. In many other countries, economists adopt the rule that a reces-
sion is a period of at least two consecutive quarters during which the overall output
of the economy shrinks.

5. The U.S. Department of Labor reports statistics on employment and earnings that
are used as key indicators by many economists to gauge the health of the
economy. Figure 6-4 in the text plots historical data on the unemployment rate
each month. Noticeably, the numbers were high during the recessions in the early
1990s, in 2001, and in the aftermath of the Great Recession, 2008–2014.
a. Locate the latest data on the national unemployment rate. (Hint: Go to the web-
site of the Bureau of Labor Statistics, www.bls.gov, and locate the latest release of
the Employment Situation.)
b. Compare the current numbers with those during the early 1990s, 2001, and dur-
ing 2008–2014, as well as with the periods of relatively high economic growth just
before the recessions. Are the current numbers indicative of a recessionary trend?

S5o. lution
a. Answers will vary. In the December 2011 Employment Situation, the Bureau of
Labor Statistics states that the October 2014 unemployment rate was 5.8%.
b. During the recession of the early 1990s, the unemployment rate rose from 5.5%
to 6.8%. During the recession of 2001, the unemployment rate rose from 4.3%
to 5.5%. During the recession of 2007–2009, the unemployment rate rose from
5% to 9.5%. The unemployment rate continued to rise for a time after the official
end of the recession, reaching a high of 10% in November of 2009. The current
numbers are not indicative of a recessionary trend. The current rate of 5.8% is the
lowest since unemployment surged in 2009 in the wake of the Great Recession.

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6. In the 1990s there were some dramatic economic events that came to be known as
the Asian financial crisis. A decade later similar events came to be known as the global
financial crisis. The accompanying figure shows the growth rate of real GDP in the
United States and Japan from 1995 to 2011. Using the graph, explain why the two
sets of events are referred to this way.
Growth rate
of real GDP
(percent) United States
6%
4
2
0
–2
–4 Japan
–6

Year

Source: Federal Reserve Bank of St. Louis.

S6o. lution
In the late 1990s, Japanese real GDP slumped, but U.S. growth continued without
interruption. So the recession of the late 1990s took place only in Asia—it was spe-
cifically an Asian crisis. By contrast, the slump in the late 2000s involved plunging
real GDP in both Japan and the United States, so it was a global crisis.

7. a. What three measures of the economy tend to move together during the business
cycle? Which way do they move during an upturn? During a downturn?
b. Who in the economy is hurt during a recession? How?
c. How did Milton Friedman alter the consensus that had developed in the after-
math of the Great Depression on how the economy should be managed? What is
the current goal of policy makers in managing the economy?

S7o. lution
a. The three measures that tend to move together are (1) industrial output, called
real gross domestic product, (2) employment, and (3) inflation. All three tend to
rise during an upturn and fall during a downturn.
b. Workers and their families experience a great deal of pain and hardship during
recessions because many people lose their jobs and many who retain their jobs see
their wages suffer. As a result, living standards decline and the number of people liv-
ing in poverty rises. Corporations also experience a fall in profits during recessions.
c. According to the Keynesian view that developed after the Great Depression, it was
the government’s responsibility to manage the economy to reduce the severity of
downturns. According to Milton Friedman, booms in the economy should also
be managed in order to reduce their magnitude. So the current goal of economic
policy makers is to “smooth out” the business cycle—to reduce the magnitude of
both booms and busts.

8. Why do we consider a business-cycle expansion different from long-run economic

growth? Why do we care about the size of the long-run growth rate of real GDP
relative to the size of the growth rate of the population?

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 S-98 CHAPTER 6 MACROECONOMICS: THE BIG PICTURE

S8o. lution
Long-run economic growth is the sustained upward trend in the economy’s output
over long periods of time. Long-run growth per capita is the key to rising wages
and sustained increases in the standard of living. A business-cycle expansion results
in a short-run (many months or a few years) increase in real GDP, but long-run
growth results in a long-run (many decades) increase in real GDP per capita. We
care about the relative size of the long-run growth rate of real GDP and the popu-
lation growth rate because living standards will fall unless the long-run growth rate
of real GDP is at least as high as the growth rate of the population.

9. In 1798, Thomas Malthus’s Essay on the Principle of Population was published. In it,
he wrote: “Population, when unchecked, increases in a geometrical ratio. Subsistence
increases only in an arithmetical ratio. . . . This implies a strong and constantly
operating check on population from the difficulty of subsistence.” Malthus was say-
ing that the growth of the population is limited by the amount of food available to
eat; people will live at the subsistence level forever. Why didn’t Malthus’s description
apply to the world after 1800?

S9o. lution
Malthus expected that life would continue as it had for the previous 800 or so years.
He did not know that advances in technology would bring large changes in produc-
tivity and that the long-run growth of the economy’s output would exceed popu-
lation growth. As we learned in the chapter, in the period before 1800, the world
economy grew extremely slowly by contemporary standards. Furthermore, the popu-
lation grew almost as fast, meaning that there was hardly any increase in output per
person. However, since 1800, long-run economic growth has resulted in sustained
increases in living standards.

10. Each year, The Economist publishes data on the price of the Big Mac in different
countries and exchange rates. The accompanying table shows some data from 2007
and 2014. Use this information to answer the following questions.
a. Where was it cheapest to buy a Big Mac in U.S. dollars in 2007?
b. Where was it cheapest to buy a Big Mac in U.S. dollars in 2014?
c. Using the increase in the local currency price of the Big Mac in each country to
measure the percent change in the overall price level from 2007 to 2014, which
nation experienced the most inflation? Did any of the nations experience deflation?

2007 2014
Price of Price of Price of Price of
Big Mac Big Mac Big Mac Big Mac
(in local (in U.S. (in local (in U.S.
Country currency) dollars) currency) dollars)
Argentina peso8.25 $2.65 peso21.0 $2.57
Canada C$3.63 $3.08 C$5.25 $5.64
Euro area €2.94 $3.82 €3.68 $4.95
Japan ¥280 $2.31 ¥370 $3.64
United States $3.22 $3.22 $4.80 $4.80

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 CHAPTER 6 MACROECONOMICS : THE B IG PICTURE S-99

S10o. lution
a. In U.S. dollars, a Big Mac was cheapest in Japan in 2007.
b. In U.S. dollars, a Big Mac was cheapest in Argentina in 2014.
c. First we must calculate the percent change of the local currency price of the Big
Mac during the period from 2007 to 2014.
Percent price change in Argentina = (peso21 − peso8.25)/peso8.25 × 100 = 155%
Percent price change in Canada = (C$5.25 − C$3.63)/C$3.63 × 100 = 45%
Percent price change in Euro area = (€3.68 − €2.94)/€2.94 × 100 = 25%
Percent price change in Japan = (¥370 − ¥280)/¥280 × 100 = 32%
Percent price change in the United States =
($4.80 − $3.22)/$3.22 × 100 = 49%
Argentina experienced the highest inflation over the period, a price change of
155%. Every country experienced a positive change in its price level, so no country
experienced deflation.

11. The accompanying figure illustrates the increasing trade deficit of the United States
since 1987. The United States has been consistently and, on the whole, increasingly
importing more goods than it has been exporting. One of the countries it runs a
trade deficit with is China. Which of the following statements are valid possible
explanations of this fact? Explain.

U.S. trade
deficit
(billions)
$800
700
600
500
400
300
200
100
0

Year

Source: Federal Reserve Economic Data.

a. Many products, such as televisions, that were formerly manufactured in the
United States are now manufactured in China.
b. The wages of the average Chinese worker are far lower than the wages of the aver-
age American worker.
c. Investment spending in the United States is high relative to its level of savings.

S11o. lution
a. This is not a valid possible explanation. The determination of where goods are pro-
duced around the world is a microeconomic phenomenon, based on comparative
advantage. Macroeconomics, not microeconomics, determines whether a country
runs a trade deficit or surplus.
b. This is not a valid possible explanation. Low Chinese wages could possibly
explain why some goods are produced in China and not in the United States, is
a microeconomic question. Macroeconomics, not microeconomics, determines
whether a country runs a trade deficit or surplus.

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c. This is a valid explanation. A country’s levels of savings and investment spending

are macroeconomic phenomena that determine whether it runs a trade surplus or
deficit.

12. College tuition has risen significantly in the last few decades. From the 1981–1982
academic year to the 2011–2012 academic year, total tuition, room, and board
paid by full-time undergraduate students went from $2,871 to $16,789 at public
institutions and from $6,330 to $33,716 at private institutions. This is an average
annual tuition increase of 6.1% at public institutions and 5.7% at private institu-
tions. Over the same time, average personal income after taxes rose from $9,785 to
$39,409 per year, which is an average annual rate of growth of personal income of
4.8%. Have these tuition increases made it more difficult for the average student to
afford college tuition?

S12o. lution
To determine whether it is more or less difficult for a typical person to afford college,
we would need to compare the increase in tuition to the average increase in personal
income after taxes. The average annual increase in tuition at public institutions of
6.4% was a 30% higher rate of increase than the average annual increase in personal
income (6.4% − 4.9%/4.9% = 0.30). The average annual increase in private institu-
tions of 6.5% was a 33% higher rate of increase (6.5% − 4.9%/4.9% = 0.33). Hence
it has become more difficult for a typical person to afford college.

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