Chapter 1
Practice Questions to accompany Mankiw & Taylor: Economics 1
Chapter 1
1. People respond to incentives. Governments can alter incentives and,
hence, behaviour with public policy. However, sometimes public policy
generates unintended consequences by producing results that were
not anticipated. Try to find an unintended consequence of each of the
following public policies.
a. To help the "working poor," the government raises the minimum wage
to €25 per hour.
Answer:
Many would want to work at €25/hour but few firms would want to hire low productivity
workers at this wage; therefore it would simply create unemployment.
b. To help the homeless, the government places rent controls on
apartments restricting rent to €50 per month.
Answer:
Many renters would want to rent an apartment at €50/month, but few landlords could produce
an apartment at this price. Therefore this rent control would create more homelessness.
c. To reduce its budget deficit and limit consumption of petrol, the
government raises the tax on petrol by €1.00 per litre.
Answer:
Higher petrol prices would reduce the miles driven. This would reduce the number of car
accidents, put less wear and tear on roads and cars, and reduce the demand for cars and
road repairs.
d. To reduce the consumption of drugs, the government makes drugs
illegal.
Answer:
This raises the price of drugs and makes selling them more profitable. This creates more
gangs and organized crime.
e. To raise the population of a rare bird of prey, the government prohibits
the killing of the birds and the collecting of their eggs.
Answer:
Restrictions on killing the birds leads to a reduction in the population of animals upon which
the birds feed —rabbits, mice, etc.
f. To improve the welfare of European sugar beet growers, the EU bans
imports of sugar from South America.
Answer:
South American growers have difficulty repaying their bank loans, some of which are owed to
the subsidiaries of EU banks. They turn to more profitable crops such as coca leaves and
marijuana.
Practice Questions to accompany Mankiw & Taylor: Economics 2
2. Opportunity cost is what you give up to get an item. Since there is no
such thing as a free lunch, what would likely be given up to obtain
each of the items listed below?
a. Susan can work full time or go to university. She chooses university.
Answer:
She gives up income from work (and must pay tuition).
b. Susan can work full time or go to university. She chooses work.
Answer:
She gives up a university degree and the increase in income through life that it would have
brought her (but she doesn’t have to pay tuition).
c. Farmer Jones has 100 hectares of land. He can plant wheat, which
yields 5 tonnes per hectare, or he can plant potatoes, which yield 35
tonnes per hectare. He chooses to plant wheat.
Answer:
He gives up 3,500 tonnes of potatoes.
d. Farmer Jones has 100 hectares of land. He can plant wheat, which
yields 5 tonnes per hectare, or he can plant potatoes, which yield 35
tonnes per hectare. He chooses to plant potatoes.
Answer:
He gives up 500 tonnes of wheat.
e. In (a) and (b) above, and (c) and (d) above, which is the opportunity
cost of which – college for work or work for college? Potatoes for wheat
or wheat for potatoes?
Answer:
Each is the opportunity cost of the other because each decision requires giving something up.
Chapter 1
1. People respond to incentives. Governments can alter incentives and,
hence, behaviour with public policy. However, sometimes public policy
generates unintended consequences by producing results that were
not anticipated. Try to find an unintended consequence of each of the
following public policies.
a. To help the "working poor," the government raises the minimum wage
to €25 per hour.
Answer:
Many would want to work at €25/hour but few firms would want to hire low productivity
workers at this wage; therefore it would simply create unemployment.
b. To help the homeless, the government places rent controls on
apartments restricting rent to €50 per month.
Answer:
Many renters would want to rent an apartment at €50/month, but few landlords could produce
an apartment at this price. Therefore this rent control would create more homelessness.
c. To reduce its budget deficit and limit consumption of petrol, the
government raises the tax on petrol by €1.00 per litre.
Answer:
Higher petrol prices would reduce the miles driven. This would reduce the number of car
accidents, put less wear and tear on roads and cars, and reduce the demand for cars and
road repairs.
d. To reduce the consumption of drugs, the government makes drugs
illegal.
Answer:
This raises the price of drugs and makes selling them more profitable. This creates more
gangs and organized crime.
e. To raise the population of a rare bird of prey, the government prohibits
the killing of the birds and the collecting of their eggs.
Answer:
Restrictions on killing the birds leads to a reduction in the population of animals upon which
the birds feed —rabbits, mice, etc.
f. To improve the welfare of European sugar beet growers, the EU bans
imports of sugar from South America.
Answer:
South American growers have difficulty repaying their bank loans, some of which are owed to
the subsidiaries of EU banks. They turn to more profitable crops such as coca leaves and
marijuana.
Practice Questions to accompany Mankiw & Taylor: Economics 2
2. Opportunity cost is what you give up to get an item. Since there is no
such thing as a free lunch, what would likely be given up to obtain
each of the items listed below?
a. Susan can work full time or go to university. She chooses university.
Answer:
She gives up income from work (and must pay tuition).
b. Susan can work full time or go to university. She chooses work.
Answer:
She gives up a university degree and the increase in income through life that it would have
brought her (but she doesn’t have to pay tuition).
c. Farmer Jones has 100 hectares of land. He can plant wheat, which
yields 5 tonnes per hectare, or he can plant potatoes, which yield 35
tonnes per hectare. He chooses to plant wheat.
Answer:
He gives up 3,500 tonnes of potatoes.
d. Farmer Jones has 100 hectares of land. He can plant wheat, which
yields 5 tonnes per hectare, or he can plant potatoes, which yield 35
tonnes per hectare. He chooses to plant potatoes.
Answer:
He gives up 500 tonnes of wheat.
e. In (a) and (b) above, and (c) and (d) above, which is the opportunity
cost of which – college for work or work for college? Potatoes for wheat
or wheat for potatoes?
Answer:
Each is the opportunity cost of the other because each decision requires giving something up.
Chapter 2
Practice Questions to accompany Mankiw & Taylor: Economics 1
Chapter 2
1. Identify the parts of the circular-flow diagram immediately involved in
the following transactions.
a. Mary buys a car from Jaguar for £40,000.
Answer:
£40,000 of spending from households to market for goods and services. Car moves from
market for goods and services to household. £40,000 of revenue from market for goods and
services to firms while car moves from firm to market for goods and services.
b. Jaguar pays Joe £2,500/month for work on the assembly line.
Answer:
£2,500 of wages from firms to market for factors of production. Inputs move from market for
factors of production to firms. Labour moves from households to market for factors of
production while £2,500 income moves from market for factors to households.
c. Joe makes £10 worth of calls on his Vodafone mobile phone.
Answer:
£10 of spending from households to market for goods and services. Service moves from
market for goods and services to household. Service moves from firms to market for goods
and services in return for £10 revenue.
d. Mary receives £1,000 of dividends on her Vodafone shares.
Answer:
£1,000 of profit from firms to market for factors of production. Inputs move from market for
factors of production to firms. Capital services move from households to market for factors of
production in return for £1,000 income.
2. The following table provides information about the production
possibilities frontier of Athletic Country.
Exhibit 1
Practice Questions to accompany Mankiw & Taylor: Economics 2
a. In Exhibit 2, plot and connect these points to create Athletic Country's
production possibilities frontier.
Exhibit 2
Answer:
See Exhibit 7.
Exhibit 7
b. If Athletic Country currently produces 100 bats and 400 rackets, what is
the opportunity cost of an additional 100 bats?
Answer:
40 rackets
c. If Athletic Country currently produces 300 bats and 300 rackets, what is
the opportunity cost of an additional 100 bats?
Answer:
100 rackets
Practice Questions to accompany Mankiw & Taylor: Economics 3
d. Why does the additional production of 100 bats in part (c) cause a
greater trade-off than the additional production of 100 bats in part (b)?
Answer:
Because as we produce more bats, the resources best suited for making bats are already
being used. Therefore it takes even more resources to produce 100 bats and greater
reductions in racket production.
e. Suppose Athletic Country is currently producing 200 bats and 200
rackets. How many additional bats could they produce without giving
up any rackets? How many additional rackets could they produce
without giving up any bats?
Answer:
200 bats; 160 rackets
f. Is the production of 200 bats and 200 rackets efficient? Explain.
Answer:
No. Resources were not used efficiently if production can be increased with no opportunity
cost.
3. The production possibilities frontier in Exhibit 3 shows the available
trade-offs between consumption goods and capital goods. Suppose
two countries face this identical production possibilities frontier.
Exhibit 3
a. Suppose Party Country chooses to produce at point A while
Parsimonious Country choose to produce at point B. Which country will
experience more growth in the future? Why?
Answer:
Parsimonious country. Capital (plant and equipment) is a factor of production and producing
more of it now will increase future production.
b. In this model, what is the opportunity cost of future growth?
Answer:
Fewer consumption goods are produced now. Practice Questions to accompany Mankiw & Taylor: Economics 4
c. Demonstrate in Exhibit 4 the impact of growth on a production
possibilities frontier such as the one shown above. Would the
production possibilities frontier for Parsimonious Country shift more or
less than that for Party Country? Why?
Exhibit 4
Answer:
See Exhibit 8. The production possibilities curve will shift more for Parsimonious Country
because they have experienced a greater increase in factors of production (capital).
Exhibit 8
Practice Questions to accompany Mankiw & Taylor: Economics 5
d. On the graph in Exhibit 5, show the shift in the production possibilities
curve if there was an increase in technology that only affected the
production of capital goods.
Exhibit 5
Answer:
See Exhibit 9.
Exhibit 9
e. Does the shift in part (d) above imply that all additional production must
be in the form of capital goods? Why?
Answer:
No, the outward shift improves choices available for both consumption and
capital goods.
Chapter 2
1. Identify the parts of the circular-flow diagram immediately involved in
the following transactions.
a. Mary buys a car from Jaguar for £40,000.
Answer:
£40,000 of spending from households to market for goods and services. Car moves from
market for goods and services to household. £40,000 of revenue from market for goods and
services to firms while car moves from firm to market for goods and services.
b. Jaguar pays Joe £2,500/month for work on the assembly line.
Answer:
£2,500 of wages from firms to market for factors of production. Inputs move from market for
factors of production to firms. Labour moves from households to market for factors of
production while £2,500 income moves from market for factors to households.
c. Joe makes £10 worth of calls on his Vodafone mobile phone.
Answer:
£10 of spending from households to market for goods and services. Service moves from
market for goods and services to household. Service moves from firms to market for goods
and services in return for £10 revenue.
d. Mary receives £1,000 of dividends on her Vodafone shares.
Answer:
£1,000 of profit from firms to market for factors of production. Inputs move from market for
factors of production to firms. Capital services move from households to market for factors of
production in return for £1,000 income.
2. The following table provides information about the production
possibilities frontier of Athletic Country.
Exhibit 1
Practice Questions to accompany Mankiw & Taylor: Economics 2
a. In Exhibit 2, plot and connect these points to create Athletic Country's
production possibilities frontier.
Exhibit 2
Answer:
See Exhibit 7.
Exhibit 7
b. If Athletic Country currently produces 100 bats and 400 rackets, what is
the opportunity cost of an additional 100 bats?
Answer:
40 rackets
c. If Athletic Country currently produces 300 bats and 300 rackets, what is
the opportunity cost of an additional 100 bats?
Answer:
100 rackets
Practice Questions to accompany Mankiw & Taylor: Economics 3
d. Why does the additional production of 100 bats in part (c) cause a
greater trade-off than the additional production of 100 bats in part (b)?
Answer:
Because as we produce more bats, the resources best suited for making bats are already
being used. Therefore it takes even more resources to produce 100 bats and greater
reductions in racket production.
e. Suppose Athletic Country is currently producing 200 bats and 200
rackets. How many additional bats could they produce without giving
up any rackets? How many additional rackets could they produce
without giving up any bats?
Answer:
200 bats; 160 rackets
f. Is the production of 200 bats and 200 rackets efficient? Explain.
Answer:
No. Resources were not used efficiently if production can be increased with no opportunity
cost.
3. The production possibilities frontier in Exhibit 3 shows the available
trade-offs between consumption goods and capital goods. Suppose
two countries face this identical production possibilities frontier.
Exhibit 3
a. Suppose Party Country chooses to produce at point A while
Parsimonious Country choose to produce at point B. Which country will
experience more growth in the future? Why?
Answer:
Parsimonious country. Capital (plant and equipment) is a factor of production and producing
more of it now will increase future production.
b. In this model, what is the opportunity cost of future growth?
Answer:
Fewer consumption goods are produced now. Practice Questions to accompany Mankiw & Taylor: Economics 4
c. Demonstrate in Exhibit 4 the impact of growth on a production
possibilities frontier such as the one shown above. Would the
production possibilities frontier for Parsimonious Country shift more or
less than that for Party Country? Why?
Exhibit 4
Answer:
See Exhibit 8. The production possibilities curve will shift more for Parsimonious Country
because they have experienced a greater increase in factors of production (capital).
Exhibit 8
Practice Questions to accompany Mankiw & Taylor: Economics 5
d. On the graph in Exhibit 5, show the shift in the production possibilities
curve if there was an increase in technology that only affected the
production of capital goods.
Exhibit 5
Answer:
See Exhibit 9.
Exhibit 9
e. Does the shift in part (d) above imply that all additional production must
be in the form of capital goods? Why?
Answer:
No, the outward shift improves choices available for both consumption and
capital goods.
Chapter 4
Practice Questions to accompany Mankiw & Taylor: Economics 1
Chapter 4
1. Suppose we have the following market supply and demand schedules
for bicycles:
a. Plot the supply curve and the demand curve for bicycles in Exhibit 1.
Exhibit 1
Answer:
See Exhibit 3.
Exhibit 3
Practice Questions to accompany Mankiw & Taylor: Economics 2
b. What is the equilibrium price of bicycles?
Answer:
€300
c. What is the equilibrium quantity of bicycles?
Answer:
50 bicycles
d. If the price of bicycles were €100, is there a surplus or a shortage?
How many units of surplus or shortage are there? Will this cause the
price to rise or fall?
Answer:
Shortage, 70 – 30 = 40 units, the price will rise
e. If the price of bicycles were €400, is there a surplus or a shortage?
How many units of surplus or shortage are there? Will this cause the
price to rise or fall?
Answer:
Surplus, 60 – 40 = 20 units, the price will fall
f. Suppose that the bicycle maker's labour union bargains for an increase
in its wages. Further, suppose this event raises the cost of production,
makes bicycle manufacturing less profitable, and reduces the quantity
supplied of bicycles by 20 units at each price of bicycles. Plot the new
supply curve and the original supply and demand curves in Exhibit 2.
What is the new equilibrium price and quantity in the market for
bicycles?
Exhibit 2
Answer:
See Exhibit 4. equilibrium price = €400, equilibrium quantity = 40 bicycles
Exhibit 4 Practice Questions to accompany Mankiw & Taylor: Economics 3
2. Each of the events listed below has an impact on the market for
bicycles. For each event, which curve is affected (supply or demand for
bicycles), what direction is it shifted, and what is the resulting impact on
equilibrium price and quantity of bicycles?
a. The price of cars increases.
Answer:
demand, shifts right, equilibrium price and quantity rise
b. Consumers' incomes decrease, if bicycles are a normal good.
Answer:
demand, shifts left, equilibrium price and quantity fall
c. The price of steel used to make bicycle frames increases.
Answer:
supply, shifts left, equilibrium price rises, equilibrium quantity falls
d. An environmental movement shifts tastes toward bicycling.
Answer:
demand, shifts right, equilibrium price and quantity rise
e. Consumers expect the price of bicycles to fall in the future.
Answer:
demand, shifts left, equilibrium price and quantity fall
f. A technological advance in the manufacture of bicycles occurs.
Answer:
supply, shifts right, equilibrium price falls, equilibrium quantity rises
g. The price of bicycle helmets and shoes is reduced. Practice Questions to accompany Mankiw & Taylor: Economics 4
Answer:
demand, shifts right, equilibrium price and quantity rise
h. Consumers' incomes decrease, if bicycles are an inferior good
Answer:
demand, shifts right, equilibrium price and quantity rise
3. The following questions address a market when both supply and
demand shift.
a. What would happen to the equilibrium price and quantity in the bicycle
market if there were an increase in both the supply and the demand for
bicycles?
Answer:
equilibrium quantity will rise; the effect on the equilibrium price is ambiguous
b. What would happen to the equilibrium price and quantity in the bicycle
market if the demand for bicycles increases more than the increase in
the supply of bicycles?
Answer:
equilibrium price and quantity will rise
Chapter 4
1. Suppose we have the following market supply and demand schedules
for bicycles:
a. Plot the supply curve and the demand curve for bicycles in Exhibit 1.
Exhibit 1
Answer:
See Exhibit 3.
Exhibit 3
Practice Questions to accompany Mankiw & Taylor: Economics 2
b. What is the equilibrium price of bicycles?
Answer:
€300
c. What is the equilibrium quantity of bicycles?
Answer:
50 bicycles
d. If the price of bicycles were €100, is there a surplus or a shortage?
How many units of surplus or shortage are there? Will this cause the
price to rise or fall?
Answer:
Shortage, 70 – 30 = 40 units, the price will rise
e. If the price of bicycles were €400, is there a surplus or a shortage?
How many units of surplus or shortage are there? Will this cause the
price to rise or fall?
Answer:
Surplus, 60 – 40 = 20 units, the price will fall
f. Suppose that the bicycle maker's labour union bargains for an increase
in its wages. Further, suppose this event raises the cost of production,
makes bicycle manufacturing less profitable, and reduces the quantity
supplied of bicycles by 20 units at each price of bicycles. Plot the new
supply curve and the original supply and demand curves in Exhibit 2.
What is the new equilibrium price and quantity in the market for
bicycles?
Exhibit 2
Answer:
See Exhibit 4. equilibrium price = €400, equilibrium quantity = 40 bicycles
Exhibit 4 Practice Questions to accompany Mankiw & Taylor: Economics 3
2. Each of the events listed below has an impact on the market for
bicycles. For each event, which curve is affected (supply or demand for
bicycles), what direction is it shifted, and what is the resulting impact on
equilibrium price and quantity of bicycles?
a. The price of cars increases.
Answer:
demand, shifts right, equilibrium price and quantity rise
b. Consumers' incomes decrease, if bicycles are a normal good.
Answer:
demand, shifts left, equilibrium price and quantity fall
c. The price of steel used to make bicycle frames increases.
Answer:
supply, shifts left, equilibrium price rises, equilibrium quantity falls
d. An environmental movement shifts tastes toward bicycling.
Answer:
demand, shifts right, equilibrium price and quantity rise
e. Consumers expect the price of bicycles to fall in the future.
Answer:
demand, shifts left, equilibrium price and quantity fall
f. A technological advance in the manufacture of bicycles occurs.
Answer:
supply, shifts right, equilibrium price falls, equilibrium quantity rises
g. The price of bicycle helmets and shoes is reduced. Practice Questions to accompany Mankiw & Taylor: Economics 4
Answer:
demand, shifts right, equilibrium price and quantity rise
h. Consumers' incomes decrease, if bicycles are an inferior good
Answer:
demand, shifts right, equilibrium price and quantity rise
3. The following questions address a market when both supply and
demand shift.
a. What would happen to the equilibrium price and quantity in the bicycle
market if there were an increase in both the supply and the demand for
bicycles?
Answer:
equilibrium quantity will rise; the effect on the equilibrium price is ambiguous
b. What would happen to the equilibrium price and quantity in the bicycle
market if the demand for bicycles increases more than the increase in
the supply of bicycles?
Answer:
equilibrium price and quantity will rise
Chapter 5
Practice Questions to accompany Mankiw & Taylor: Economics 1
Chapter 5
1. For each pair of goods listed below, which good would you expect to
have the more elastic demand? Why?
a. cigarettes; a trip to Florida
Answer:
a trip to Florida because it is a luxury while cigarettes are a necessity (to smokers)
b. an AIDS vaccine over the next month; an AIDS vaccine over the next
five years
Answer:
An AIDS vaccine over the next five years because there are likely to be more substitutes
(alternative medications) developed over this time period and consumers’ behaviour may be
modified over longer time periods.
c. beer; Budweiser
Answer:
Budweiser because it is a more narrowly defined market than beer so there are more
substitutes for Budweiser than for beer
d. insulin; aspirin
Answer:
aspirin because there are many substitutes for aspirin but few substitutes for insulin
2. Suppose the Daily News estimates that if it raises the price of its
newspaper from €1.00 to €1.50 then the number of subscribers will fall
from 50,000 to 40,000.
a. What is the price elasticity of demand for the Daily Newspaper when
elasticity is calculated using the midpoint method?
Answer:
(10,000/45,000)/(€0.50/€1.25) = 0.56
b. What is the advantage of using the midpoint method?
Answer:
With the midpoint method, the value of the elasticity is the same whether you begin at a price
of €1.00 and raise it to €1.50 or begin at a price of €1.50 and reduce it to €1.00.
c. If the Daily News's only concern is to maximize total revenue, should it
raise the price of a newspaper from €1.00 to €1.50? Why or why not?
Answer:
Yes. Since the price elasticity of demand is less than one (inelastic), an increase in price will
increase total revenue.
Practice Questions to accompany Mankiw & Taylor: Economics 2
3. The table below provides the demand schedule for motel rooms at
Small Town Motel. Use the information provided to complete the table.
Answer the following questions based on your responses in the table.
Use the midpoint method to calculate the percentage changes used to
generate the elasticities.
Answer:
a. Over what range of prices is the demand for motel rooms elastic? To
maximize total revenue, should Small Town Motel raise or lower the
price within this range?
Answer:
€80 to €120; lower its prices
b. Over what range of prices is the demand for motel rooms inelastic? To
maximize total revenue, should Small Town Motel raise or lower the
price within this range?
Answer:
€20 to €60; raise its prices
Practice Questions to accompany Mankiw & Taylor: Economics 3
c. Over what range of prices is the demand for motel rooms unit elastic?
To maximize total revenue, should Small Town Motel raise or lower the
price within this range?
Answer:
€60 to €80; it doesn’t matter. For prices in this range, a change in price proportionately
changes the quantity demanded so total revenue is unchanged.
4. The demand schedule from question 3 above is reproduced below
along with another demand schedule when consumer incomes have
risen to €60,000 from €50,000. Use this information to answer the
following questions. Use the midpoint method to calculate the
percentage changes used to generate the elasticities.
a. What is the income elasticity of demand when motel rooms rent for
€40?
Answer:
(10/25)/(€10,000/€55,000) = 2.2
b. What is the income elasticity of demand when motel rooms rent for
€100?
Answer:
(10/13)/(€10,000/€55,000) = 4.2
c. Are motel rooms normal or inferior goods? Why?
Answer:
Normal goods, because the income elasticity of demand is positive.
d. Are motel rooms likely to be necessities or luxuries? Why?
Answer:
Luxuries, because the income elasticity of demand is large (greater than 1). In each case, an
18 percent increase in income caused a much larger increase in quantity demanded.
Practice Questions to accompany Mankiw & Taylor: Economics 4
5. For each pair of goods listed below, which good would you expect to
have the more elastic supply? Why?
a. televisions; beach front property
Answer:
Televisions because the production of televisions can be increased in response to an
increase in the price of televisions while the quantity of beach front property is fixed.
b. crude oil over the next week; crude oil over the next year
Answer:
Crude oil over the next year because production of oil over the next year can more easily be
increased than the production of oil over the next week.
c. a painting by van Gogh; a print of the same painting by van Gogh
Top of Form
Answer:
A van Gogh print because more of them can be created in response to an increase in price
while the quantity of an original work is fixed.
Chapter 5
1. For each pair of goods listed below, which good would you expect to
have the more elastic demand? Why?
a. cigarettes; a trip to Florida
Answer:
a trip to Florida because it is a luxury while cigarettes are a necessity (to smokers)
b. an AIDS vaccine over the next month; an AIDS vaccine over the next
five years
Answer:
An AIDS vaccine over the next five years because there are likely to be more substitutes
(alternative medications) developed over this time period and consumers’ behaviour may be
modified over longer time periods.
c. beer; Budweiser
Answer:
Budweiser because it is a more narrowly defined market than beer so there are more
substitutes for Budweiser than for beer
d. insulin; aspirin
Answer:
aspirin because there are many substitutes for aspirin but few substitutes for insulin
2. Suppose the Daily News estimates that if it raises the price of its
newspaper from €1.00 to €1.50 then the number of subscribers will fall
from 50,000 to 40,000.
a. What is the price elasticity of demand for the Daily Newspaper when
elasticity is calculated using the midpoint method?
Answer:
(10,000/45,000)/(€0.50/€1.25) = 0.56
b. What is the advantage of using the midpoint method?
Answer:
With the midpoint method, the value of the elasticity is the same whether you begin at a price
of €1.00 and raise it to €1.50 or begin at a price of €1.50 and reduce it to €1.00.
c. If the Daily News's only concern is to maximize total revenue, should it
raise the price of a newspaper from €1.00 to €1.50? Why or why not?
Answer:
Yes. Since the price elasticity of demand is less than one (inelastic), an increase in price will
increase total revenue.
Practice Questions to accompany Mankiw & Taylor: Economics 2
3. The table below provides the demand schedule for motel rooms at
Small Town Motel. Use the information provided to complete the table.
Answer the following questions based on your responses in the table.
Use the midpoint method to calculate the percentage changes used to
generate the elasticities.
Answer:
a. Over what range of prices is the demand for motel rooms elastic? To
maximize total revenue, should Small Town Motel raise or lower the
price within this range?
Answer:
€80 to €120; lower its prices
b. Over what range of prices is the demand for motel rooms inelastic? To
maximize total revenue, should Small Town Motel raise or lower the
price within this range?
Answer:
€20 to €60; raise its prices
Practice Questions to accompany Mankiw & Taylor: Economics 3
c. Over what range of prices is the demand for motel rooms unit elastic?
To maximize total revenue, should Small Town Motel raise or lower the
price within this range?
Answer:
€60 to €80; it doesn’t matter. For prices in this range, a change in price proportionately
changes the quantity demanded so total revenue is unchanged.
4. The demand schedule from question 3 above is reproduced below
along with another demand schedule when consumer incomes have
risen to €60,000 from €50,000. Use this information to answer the
following questions. Use the midpoint method to calculate the
percentage changes used to generate the elasticities.
a. What is the income elasticity of demand when motel rooms rent for
€40?
Answer:
(10/25)/(€10,000/€55,000) = 2.2
b. What is the income elasticity of demand when motel rooms rent for
€100?
Answer:
(10/13)/(€10,000/€55,000) = 4.2
c. Are motel rooms normal or inferior goods? Why?
Answer:
Normal goods, because the income elasticity of demand is positive.
d. Are motel rooms likely to be necessities or luxuries? Why?
Answer:
Luxuries, because the income elasticity of demand is large (greater than 1). In each case, an
18 percent increase in income caused a much larger increase in quantity demanded.
Practice Questions to accompany Mankiw & Taylor: Economics 4
5. For each pair of goods listed below, which good would you expect to
have the more elastic supply? Why?
a. televisions; beach front property
Answer:
Televisions because the production of televisions can be increased in response to an
increase in the price of televisions while the quantity of beach front property is fixed.
b. crude oil over the next week; crude oil over the next year
Answer:
Crude oil over the next year because production of oil over the next year can more easily be
increased than the production of oil over the next week.
c. a painting by van Gogh; a print of the same painting by van Gogh
Top of Form
Answer:
A van Gogh print because more of them can be created in response to an increase in price
while the quantity of an original work is fixed.
Chapter 6
Practice Questions to accompany Mankiw & Taylor: Economics 1
Chapter 6
1. Use the following supply and demand schedules for bicycles to answer
the questions below.
a. In response to lobbying by the Bicycle Riders Association, the
government places a price ceiling of €700 on bicycles. What effect will
this have on the market for bicycles? Why?
Answer:
It will have no effect. The price ceiling is not binding because the equilibrium price is €500 and
the price ceiling is set at €700.
b. In response to lobbying by the Bicycle Riders Association, the
government places a price ceiling of €400 on bicycles. Use the
information provided above to plot the supply and demand curves for
bicycles in Exhibit 1. Impose the price ceiling. What is the result of a
price ceiling of €400 on bicycles?
Exhibit 1
Answer:
See Exhibit 5. The quantity demanded rises to 55 units, the quantity supplied falls to 40 units,
and there is a shortage of 15 units.
Practice Questions to accompany Mankiw & Taylor: Economics 2
Exhibit 5
c. Does a price ceiling of €400 on bicycles make all bicycle buyers better
off? Why or why not?
Answer:
No. It may make those bicycle buyers better off that actually get a bicycle. However, some
buyers are unable to get a bike, must wait in line, pay a bribe, or accept a lower quality
bicycle.
d. Suppose instead, in response to lobbying by the Bicycle Manufactures
Association, the government imposes a price floor on bicycles of €700.
Use the information provided above to plot the supply and demand
curves for bicycles in Exhibit 2. Impose the €700 price floor. What is
the result of the €700 price floor?
Exhibit 2
Practice Questions to accompany Mankiw & Taylor: Economics 3
Answer:
See Exhibit 6. The quantity supplied rises to 70 units, the quantity demanded falls to 40 units,
and there is a surplus of 30 units.
Exhibit 6
2. Use the following supply and demand schedules for bicycles to answer
the questions below.
Practice Questions to accompany Mankiw & Taylor: Economics 4
a. Plot the supply and demand curves for bicycles in Exhibit 3. On the
graph, impose a tax of €300 per bicycle to be collected from the sellers.
After the tax, what has happened to the price paid by the buyers, the
price received by the sellers, and the quantity sold when compared to
the free market equilibrium?
Exhibit 3
Answer:
See Exhibit 7. The price buyers pay rises to €700, the price sellers receive falls to €400, and
the quantity sold falls to 40 units.
Exhibit 7
Practice Questions to accompany Mankiw & Taylor: Economics 5
b. Again, plot the supply and demand curves for bicycles in Exhibit 4. On
the graph, impose a tax of €300 per bicycle to be collected from the
buyers. After the tax, what has happened to the price paid by the
buyers, the price received by the sellers, and the quantity sold when
compared to the free market equilibrium?
Exhibit 4
Answer:
See Exhibit 8. The price buyers pay rises to €700, the price sellers receive falls to €400, and
the quantity sold falls to 40 units.
Exhibit 8
Practice Questions to accompany Mankiw & Taylor: Economics 6
c. Compare your answers to questions (a) and (b) above. What
conclusion do you draw from this comparison?
Answer:
The impact of a tax collected from sellers is equivalent to the impact of a tax collected from
buyers.
d. Who bears the greater burden of this tax, the buyers or the sellers?
Why?
Answer:
The greater burden of the tax has fallen on the buyers. The free market equilibrium price was
€500. After the tax, the price the buyers pay has risen €200 while the price the sellers receive
has fallen €100. This is because demand is less elastic than supply.
Chapter 6
1. Use the following supply and demand schedules for bicycles to answer
the questions below.
a. In response to lobbying by the Bicycle Riders Association, the
government places a price ceiling of €700 on bicycles. What effect will
this have on the market for bicycles? Why?
Answer:
It will have no effect. The price ceiling is not binding because the equilibrium price is €500 and
the price ceiling is set at €700.
b. In response to lobbying by the Bicycle Riders Association, the
government places a price ceiling of €400 on bicycles. Use the
information provided above to plot the supply and demand curves for
bicycles in Exhibit 1. Impose the price ceiling. What is the result of a
price ceiling of €400 on bicycles?
Exhibit 1
Answer:
See Exhibit 5. The quantity demanded rises to 55 units, the quantity supplied falls to 40 units,
and there is a shortage of 15 units.
Practice Questions to accompany Mankiw & Taylor: Economics 2
Exhibit 5
c. Does a price ceiling of €400 on bicycles make all bicycle buyers better
off? Why or why not?
Answer:
No. It may make those bicycle buyers better off that actually get a bicycle. However, some
buyers are unable to get a bike, must wait in line, pay a bribe, or accept a lower quality
bicycle.
d. Suppose instead, in response to lobbying by the Bicycle Manufactures
Association, the government imposes a price floor on bicycles of €700.
Use the information provided above to plot the supply and demand
curves for bicycles in Exhibit 2. Impose the €700 price floor. What is
the result of the €700 price floor?
Exhibit 2
Practice Questions to accompany Mankiw & Taylor: Economics 3
Answer:
See Exhibit 6. The quantity supplied rises to 70 units, the quantity demanded falls to 40 units,
and there is a surplus of 30 units.
Exhibit 6
2. Use the following supply and demand schedules for bicycles to answer
the questions below.
Practice Questions to accompany Mankiw & Taylor: Economics 4
a. Plot the supply and demand curves for bicycles in Exhibit 3. On the
graph, impose a tax of €300 per bicycle to be collected from the sellers.
After the tax, what has happened to the price paid by the buyers, the
price received by the sellers, and the quantity sold when compared to
the free market equilibrium?
Exhibit 3
Answer:
See Exhibit 7. The price buyers pay rises to €700, the price sellers receive falls to €400, and
the quantity sold falls to 40 units.
Exhibit 7
Practice Questions to accompany Mankiw & Taylor: Economics 5
b. Again, plot the supply and demand curves for bicycles in Exhibit 4. On
the graph, impose a tax of €300 per bicycle to be collected from the
buyers. After the tax, what has happened to the price paid by the
buyers, the price received by the sellers, and the quantity sold when
compared to the free market equilibrium?
Exhibit 4
Answer:
See Exhibit 8. The price buyers pay rises to €700, the price sellers receive falls to €400, and
the quantity sold falls to 40 units.
Exhibit 8
Practice Questions to accompany Mankiw & Taylor: Economics 6
c. Compare your answers to questions (a) and (b) above. What
conclusion do you draw from this comparison?
Answer:
The impact of a tax collected from sellers is equivalent to the impact of a tax collected from
buyers.
d. Who bears the greater burden of this tax, the buyers or the sellers?
Why?
Answer:
The greater burden of the tax has fallen on the buyers. The free market equilibrium price was
€500. After the tax, the price the buyers pay has risen €200 while the price the sellers receive
has fallen €100. This is because demand is less elastic than supply.
Chapter 23
Practice Questions to accompany Mankiw & Taylor: Economics 1
Chapter 23
1. a. Complete the following table.
Answer:
b. What is the largest expenditure component of GDP?
Answer:
Consumption
c. Does investment include the purchase of company shares and bonds?
Why?
Answer:
No, because that transaction is a purchase of an asset, not a purchase of currently produced
capital goods.
d. Do government purchases include government spending on
unemployment benefit? Why?
Answer:
No, because unemployment benefits are expenditures for which the government receives no
production in return.
e. What does it mean to say that net exports are negative?
Answer:
It means that imports exceed exports.
2. Suppose the base year in the following table is 2004.
a. What is nominal GDP for 2004, 2005, and 2006?
Answer:
€100, €200, €400 Practice Questions to accompany Mankiw & Taylor: Economics 2
b. What is real GDP for 2004, 2005, and 2006?
Answer:
€100, €100, €100
3. Suppose the following table records the total output and prices for an
entire economy. Further, suppose the base year in the following table
is 2004.
a. What is the value of nominal GDP in 2004?
Answer:
€700
b. What is the value of real GDP in 2004?
Answer:
€700
c. What is the value of nominal GDP in 2005?
Answer:
€770
d. What is the value of real GDP in 2005?
Answer:
€720
e. What is the value of the GDP deflator in 2004?
Answer:
100
f. What is the value of the GDP deflator in 2005?
Answer:
107
g. From 2000 to 2001, prices rose approximately what percentage?
Answer:
(107 – 100)/100 = 0.07 = 7%
h. Was the increase in nominal GDP from 2000 to 2001 mostly due to an
increase in real output or due to an increase in prices?
Answer:
Percent increase in nominal GDP = (€770 – €700)/700 = 0.10 = 10%. Percent increase in
prices = 7%, therefore most of the increase was due to prices. Practice Questions to accompany Mankiw & Taylor: Economics 3
4. Complete the following table.
Answer:
a. What year is the base year? How can you tell?
Answer:
Year 1, because the deflator = 100.
b. From year 1 to year 2, did real output rise or did prices rise? Explain?
Answer:
Prices rose 20 percent and real output stayed the same.
c. From year 2 to year 3, did real output rise or did prices rise? Explain?
Answer:
Prices stayed the same and real output rose 25 percent.
Chapter 23
1. a. Complete the following table.
Answer:
b. What is the largest expenditure component of GDP?
Answer:
Consumption
c. Does investment include the purchase of company shares and bonds?
Why?
Answer:
No, because that transaction is a purchase of an asset, not a purchase of currently produced
capital goods.
d. Do government purchases include government spending on
unemployment benefit? Why?
Answer:
No, because unemployment benefits are expenditures for which the government receives no
production in return.
e. What does it mean to say that net exports are negative?
Answer:
It means that imports exceed exports.
2. Suppose the base year in the following table is 2004.
a. What is nominal GDP for 2004, 2005, and 2006?
Answer:
€100, €200, €400 Practice Questions to accompany Mankiw & Taylor: Economics 2
b. What is real GDP for 2004, 2005, and 2006?
Answer:
€100, €100, €100
3. Suppose the following table records the total output and prices for an
entire economy. Further, suppose the base year in the following table
is 2004.
a. What is the value of nominal GDP in 2004?
Answer:
€700
b. What is the value of real GDP in 2004?
Answer:
€700
c. What is the value of nominal GDP in 2005?
Answer:
€770
d. What is the value of real GDP in 2005?
Answer:
€720
e. What is the value of the GDP deflator in 2004?
Answer:
100
f. What is the value of the GDP deflator in 2005?
Answer:
107
g. From 2000 to 2001, prices rose approximately what percentage?
Answer:
(107 – 100)/100 = 0.07 = 7%
h. Was the increase in nominal GDP from 2000 to 2001 mostly due to an
increase in real output or due to an increase in prices?
Answer:
Percent increase in nominal GDP = (€770 – €700)/700 = 0.10 = 10%. Percent increase in
prices = 7%, therefore most of the increase was due to prices. Practice Questions to accompany Mankiw & Taylor: Economics 3
4. Complete the following table.
Answer:
a. What year is the base year? How can you tell?
Answer:
Year 1, because the deflator = 100.
b. From year 1 to year 2, did real output rise or did prices rise? Explain?
Answer:
Prices rose 20 percent and real output stayed the same.
c. From year 2 to year 3, did real output rise or did prices rise? Explain?
Answer:
Prices stayed the same and real output rose 25 percent.
Chapter 24
Practice Questions to accompany Mankiw & Taylor: Economics 1
Chapter 24
1. The following table shows the prices and the quantities consumed in
the country known as the University States. Suppose the base year is
2003. This is the year the typical consumption basket was determined
so the quantities consumed during 2003 are the only quantities needed
to calculate the CPI in every year.
a. What is the value of the CPI in 2003?
Answer:
(€1100/€1100) x 100 = 100
b. What is the value of the CPI in 2004?
Answer:
(€1600/€1100) x 100 = 145.5
c. What is the value of the CPI in 2005?
Answer:
(€2750/€1100) x 100 = 250
d. What is the inflation rate in 2004?
Answer:
[(145.5 – 100)/100] x 100 = 45.5 percent
e. What is the inflation rate in 2005?
Answer:
[(250 – 145.5)/145.5] x 100 = 71.8 percent
f. What type of bias do you observe in the CPI and corresponding
inflation rates you generated above? Explain.
Answer:
Substitution bias, because as the price of pens increased, the quantity consumed declined
significantly.
g. If you had a clause in your wage contract that increased your wage by
the rate of inflation as measured by the CPI calculated above, would
your standard of living increase, decrease, or stay the same over the
years 2003–2005? Why?
Answer:
Increase, because the CPI overstates the increase in the cost of living (assuming that your
expenditure reflects the typical consumption basket in each year).
Practice Questions to accompany Mankiw & Taylor: Economics 2
h. Again, suppose you had a clause in your wage contract that increased
your wage by the rate of inflation as measured by the CPI calculated
above. If you personally only consume pens (no paper or pencils),
would your standard of living increase, decrease, or stay the same over
the years 2003–2005? Why?
Answer:
Decrease, because the price of pens has increased a greater percentage than the CPI.
2. Suppose that you lend your flatmate €100 for one year at 9 per cent
nominal interest.
a. How many dollars of interest will your flatmate pay you at the end of
the year?
Answer:
€9
b. Suppose at the time you both agreed to the terms of the loan, you both
expected the inflation rate to be 5 per cent during the year of the loan.
What do you both expect the real interest rate to be on the loan?
Answer:
9 per cent – 5 per cent = 4 per cent
c. Suppose at the end of the year, you are surprised to discover that the
actual inflation rate over the year was 8 per cent. What was the actual
real interest rate generated by this loan?
Answer:
9 per cent – 8 per cent = 1 per cent
d. In the case described above, actual inflation turned out to be higher
than expected. Which of the two of you had the unexpected gain or
loss? Your flatmate (the borrower), or you (the lender)? Why?
Answer:
Your flatmate (the borrower) gained; you lost because the borrower repaid the loan with
dollars of surprisingly little value.
e. What would the real interest rate on the loan have been if the actual
inflation rate had turned out to be 11 per cent?
Answer:
9 per cent – 11 per cent = –2 per cent
f. Explain what it means to have a negative real interest rate.
Answer:
€3.80 x (172.2/130.7) = €5.01 < €5.15, so the standard of living of a worker earning the
minimum wage improved slightly during the 1990s.
Chapter 24
1. The following table shows the prices and the quantities consumed in
the country known as the University States. Suppose the base year is
2003. This is the year the typical consumption basket was determined
so the quantities consumed during 2003 are the only quantities needed
to calculate the CPI in every year.
a. What is the value of the CPI in 2003?
Answer:
(€1100/€1100) x 100 = 100
b. What is the value of the CPI in 2004?
Answer:
(€1600/€1100) x 100 = 145.5
c. What is the value of the CPI in 2005?
Answer:
(€2750/€1100) x 100 = 250
d. What is the inflation rate in 2004?
Answer:
[(145.5 – 100)/100] x 100 = 45.5 percent
e. What is the inflation rate in 2005?
Answer:
[(250 – 145.5)/145.5] x 100 = 71.8 percent
f. What type of bias do you observe in the CPI and corresponding
inflation rates you generated above? Explain.
Answer:
Substitution bias, because as the price of pens increased, the quantity consumed declined
significantly.
g. If you had a clause in your wage contract that increased your wage by
the rate of inflation as measured by the CPI calculated above, would
your standard of living increase, decrease, or stay the same over the
years 2003–2005? Why?
Answer:
Increase, because the CPI overstates the increase in the cost of living (assuming that your
expenditure reflects the typical consumption basket in each year).
Practice Questions to accompany Mankiw & Taylor: Economics 2
h. Again, suppose you had a clause in your wage contract that increased
your wage by the rate of inflation as measured by the CPI calculated
above. If you personally only consume pens (no paper or pencils),
would your standard of living increase, decrease, or stay the same over
the years 2003–2005? Why?
Answer:
Decrease, because the price of pens has increased a greater percentage than the CPI.
2. Suppose that you lend your flatmate €100 for one year at 9 per cent
nominal interest.
a. How many dollars of interest will your flatmate pay you at the end of
the year?
Answer:
€9
b. Suppose at the time you both agreed to the terms of the loan, you both
expected the inflation rate to be 5 per cent during the year of the loan.
What do you both expect the real interest rate to be on the loan?
Answer:
9 per cent – 5 per cent = 4 per cent
c. Suppose at the end of the year, you are surprised to discover that the
actual inflation rate over the year was 8 per cent. What was the actual
real interest rate generated by this loan?
Answer:
9 per cent – 8 per cent = 1 per cent
d. In the case described above, actual inflation turned out to be higher
than expected. Which of the two of you had the unexpected gain or
loss? Your flatmate (the borrower), or you (the lender)? Why?
Answer:
Your flatmate (the borrower) gained; you lost because the borrower repaid the loan with
dollars of surprisingly little value.
e. What would the real interest rate on the loan have been if the actual
inflation rate had turned out to be 11 per cent?
Answer:
9 per cent – 11 per cent = –2 per cent
f. Explain what it means to have a negative real interest rate.
Answer:
€3.80 x (172.2/130.7) = €5.01 < €5.15, so the standard of living of a worker earning the
minimum wage improved slightly during the 1990s.