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Chapter1

IntroductiontoMacroeconomics

Learning Objectives
I. GoalsofPartI
A. Introducestudentstothemainconceptsinmacroeconomics(Ch.1)
B. Introducenationalincomeaccountingandmajoreconomicmagnitudes(Ch.2)

II. GoalsofChapter1
A. Majormacroeconomicissuesgrowth,businesscycles,unemployment,inflation,the
internationaleconomy,macroeconomicpolicy,aggregation(Sec.1.1)
B. Whatmacroeconomistsdoforecasting,analysis,research,datadevelopment(Sec.1.2)
C. Whymacroeconomistsdisagreeclassicalsvs.Keynesians;thetextsapproach(Sec.1.3)

III. NotestoSixthEditionUsers:Thischapterislittlechanged;thedatawereupdated.

Teaching Notes
I. WhatMacroeconomicsIsAbout(Sec.1.1)
Macroeconomics:thestudyofstructureandperformanceofnationaleconomiesandgovernment
policiesthataffecteconomicperformance.Macroeconomistsstudy:
A. Longruneconomicgrowth
1. GrowthofoutputinUnitedStatesovertime
a. Figure1.1:OutputofUnitedStatessince1869
b. Notedeclineinoutputinrecessions;increaseinoutputinsomewars
2. Sourcesofgrowthpopulation,averagelaborproductivitygrowth

Thismaybeagoodplacetointroducestudentstothecalculationofagrowthrate,whichisused
throughoutthetextbook.Youcanwriteitfirstingeneralterms,as
%X[(Xt+1Xt)/Xt]100%[(Xt+1/Xt)1]100%.

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Thenyoumightuseanexamplewithsomethingyouretalkingabout,suchasrealGDP
growthoverthepastyear,ortheinflationrate.
Throughoutthetext,studentsmaycomeacrossmathematicalcalculationsthatareunfamiliar
tothem.TheAppendixtothetextbookcontainssomehelpfulbasicguidancetomathematical
topics,includingdiscussionsoffunctionsandgraphs,slopesoffunctions,elasticities,functionsof
severalvariables,shiftsofacurve,exponents,andgrowthrateformulas.

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3. Averagelaborproductivity
a. Averagelaborproductivity:outputproducedperunitoflaborinput
b. Figure1.2:AveragelaborproductivityofUnitedStatessince1900
c. Averagelaborproductivitygrowth:
(1) About2.5%peryearfrom1949to1973
(2) 1.1%peryearfrom1973to1995
(3) 1.7%peryearfrom1995to2008
B. Businesscycles
1. Businesscycle:Shortruncontractionsandexpansionsineconomicactivity
2. Downwardphaseiscalledarecession
C. Unemployment
1. Unemployment:thenumberofpeoplewhoareavailableforworkandactivelyseekingwork
butcannotfindjobs
2. U.S.experienceshowninFig.1.3
3. Recessionscauseunemploymentratetorise

AnalyticalProblem1asksstudentstothinkaboutaveragelaborproductivityandunemployment
andtheirrelationshiptooutput.

D. Inflation

AnalyticalProblem2asksstudentstothinkaboutthewelfareconsequencesofhavingahigher
pricelevel.

1. U.S.experienceshowninFig.1.4
2. Deflation:whenpricesofmostgoodsandservicesdecline
3. Inflationrate:thepercentageincreaseinthelevelofprices
4. Hyperinflation:anextremelyhighrateofinflation

Youmaywishtodiscusshowtocalculatetheinflationrate,whichisjustthegrowthrateofthe
pricelevel.Itcanbeexpressedas [(Pt+1/Pt)1]100%.NumericalProblem1givesstudents
practicecalculatinggrowthrates,includingthegrowthrateofaveragelaborproductivityandthe
inflationrate.

E. Theinternationaleconomy
1. Openvs.closedeconomies
a. Openeconomy:aneconomythathasextensivetradingandfinancialrelationshipswith
othernationaleconomies
b. Closedeconomy:aneconomythatdoesnotinteracteconomicallywiththerestof
theworld
2. Tradeimbalances
a. U.S.experienceshowninFig.1.5
b. Tradesurplus:exportsexceedimports
c. Tradedeficit:importsexceedexports

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F. Macroeconomicpolicy
1. Fiscalpolicy:governmentspendingandtaxation
a. Effectsofchangesinfederalbudget
b. U.S.experienceinFig.1.6
c. Relationtotradedeficit?

NumericalProblem2servestwopurposes:(1)togetstudentstolookatsomerealdataonthe
economyand(2)togivethemsomeideahowlargearethetradedeficitandgovernmentbudget
deficit.

2. Monetarypolicy:growthofmoneysupply;determinedbycentralbank;theFedinU.S.
G. Aggregation
1. Aggregation:summingindividualeconomicvariablestoobtaineconomywidetotals
2. Distinguishesmicroeconomics(disaggregated)frommacroeconomics(aggregated)

II. WhatMacroeconomistsDo(Sec.1.2)
A. Macroeconomicforecasting
1. Relativelyfeweconomistsmakeforecasts

Data Application
Therearemanyfirmsthatprovideforecastsforsomemacroeconomicvariables,butonlyafew
firmshavecomplete,largescalemacroeconomicmodelsthatincludedetailsoneverysectorof
theeconomy.ThemainforecastingfirmsintheUnitedStatesareGlobalInsightand
MacroeconomicAdvisers.Thesefirmsproducenewforecastseverymonthandanalyzethe
currenteconomicsituation.
Youdonthavetosubscribetooneoftheseservicestokeepuptodateonforecasts.Thereare
severalsurveysofforecastersavailabletothegeneralpublic,includingtheBlueChipsurvey,the
NABE(NationalAssociationofBusinessEconomists)survey,asurveyrunbytheWallStreet
Journal,theLivingstonsurvey,andtheSurveyofProfessionalForecasters.(Thelattertwoare
freeofchargeandrunbytheFederalReserveBankofPhiladelphia.)However,thesesurveyswill
notgiveyouthelevelofdetailthatthelargeforecastingfirmsprovide.

2. Forecastingisverydifficult

Data Application
AlanMeltzergivesagraphicexampleofhowdifficultitistoforecastthemacroeconomyinhis
article,LimitsofShortRunStabilizationPolicy,EconomicInquiry,January1987,pp.114.He
showsthattheforecasterrorsforrealoutputmadeatthebeginningofthequarterareverylarge,
makingitalmostimpossibletousetheforecaststomakepolicy.However,helookedonlyatthe
volatiletimeperiodfrommid1980toearly1985.Morerecentcurrentquarterforecastsseemto
bebetter.

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B. Macroeconomicanalysis
1. Privateandpublicsectoreconomistsanalyzecurrentconditions

Data Application
WallStreethiresalargenumberofeconomists,mostofwhomareengagedindataanalysison
adailybasis.Theirjobistotelltraderswhatnewlyreleasedeconomicdatameansforfinancial
marketsingeneral,aswellasforthepricesofindividualassets.ManyWallStreeteconomists
alsomaketheirowndetailedforecastsoftheeconomy.

2. Doeshavingmanyeconomistsensuregoodmacroeconomicpolicies?No,sincepoliticians,
noteconomists,makemajordecisions
C. Macroeconomicresearch
1. Goal:tomakegeneralstatementsabouthowtheeconomyworks
2. Theoreticalandempiricalresearcharenecessaryforforecastingandeconomicanalysis
3. Economictheory:asetofideasabouttheeconomy,organizedinalogicalframework
4. Economicmodel:asimplifieddescriptionofsomeaspectoftheeconomy

Thisisagoodpointforyoutotalkaboutyourownresearchinterests.Studentsareveryinterested
inlearningaboutthekindsofresearchtheirprofessorsdo.Youmaywanttotalkaboutyour
researchlater,whenyoucometoasectionofthetextbookthatdiscussesthetopiconwhichyou
doyourresearch.

5. Usefulnessofeconomictheoryormodelsdependsonreasonablenessofassumptions,
possibilityofbeingappliedtorealproblems,empiricallytestableimplications,and
theoreticalresultsconsistentwithrealworlddata
6. Box1.1:DevelopingandTestinganEconomicTheory
a. Step1:Statetheresearchquestion
b. Step2:Makeprovisionalassumptions
c. Step3:Workouttheimplicationsofthetheory
d. Step4:Conductanempiricalanalysistocomparetheimplicationsofthetheorywith
thedata
e. Step5:Evaluatetheresultsofyourcomparisons

Theoretical Application
TheclassicdiscussionofresearchissuesbyMiltonFriedmanis,TheMethodologyofPositive
Economics,EssaysinPositiveEconomics,Chicago:UniversityofChicagoPress,1953.

AnalyticalProblem3isanexerciseinhowtoformulateandtestatheory.

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D. Datadevelopmentveryimportantformakingdatamoreuseful

Data Application
AsheadoftheCouncilofEconomicAdvisersintheBushpresidency,MichaelBoskinledan
efforttogetmoreaccurateandtimelystatisticsintheUnitedStates.SeeImprovingtheQuality
ofEconomicStatisticsintheEconomicReportofthePresident,1990.
Agoodexampleofdatadevelopmentcameinearly1994,whentheCommerceDepartment
reviseditsquestionnairefortheCurrentPopulationSurvey.Thisisthesurveythatisusedto
determinetheunemploymentrate.Priorto1994thesurveydidnotdoagoodjobof
distinguishingbetweenpeoplewhowereunemployedandlookingforajobbutspendingmostof
theirweekdoingworkathome,andthosewhowereoutofthelaborforceandnotevenlooking
forajob.Asaresultofthechangeinthesurvey,thereisaonetimejumpintheunemployment
rateinJanuary1994,notbecauseofanychangeinthemacroeconomy,butjustbecausethemore
accuratequestionnairefoundthatmorepeoplewereunemployedthanintheprevioussurvey.
In1996thenationalincomeaccountsunderwentamajorrevision,changinghowitsprice
indexesarecalculated(movingtoachainweightedindex)andchanginghowgovernment
purchasesaremeasured(accountingmoreaccuratelyforgovernmentcapitalformation).These
changesarediscussedinChapter2.
Alsoin1996,amajorcontroversyaroseoverthecalculationoftheconsumerpriceindex
(CPI).EconomistsarguedthattheCPIwasbiasedupwardssignificantly,sothatinflationas
measuredbytheCPIwasaboutonepercentagepointgreaterthanthetrueincreaseinthecostof
living.ThistopicisalsodiscussedinChapter2.
Datamustchangetokeepupwithtechnology.InOctober1999,thenationalincomeaccounts
wererevisedinasignificantwaybytreatingcomputersoftwareasaninvestment.Thischange
raisedthemeasuredgrowthrateoftheeconomyinthelate1990s.

III. WhyMacroeconomistsDisagree(Sec.1.3)
A. Positivevs.normativeanalysis
1. Positiveanalysis:examinestheeconomicconsequencesofapolicy
2. Normativeanalysis:determineswhetherapolicyshouldbeused

AnalyticalProblem4givesstudentspracticeindistinguishingpositivefromnormativeanalysis.

B. Classicalsvs.Keynesians
1. Theclassicalapproach
a. Theeconomyworkswellonitsown
b. Theinvisiblehand:theideathatiftherearefreemarketsandindividualsconducttheir
economicaffairsintheirownbestinterests,theoveralleconomywillworkwell
c. Wagesandpricesadjustrapidlytogettoequilibrium
(1) Equilibrium:asituationinwhichthequantitiesdemandedandsuppliedareequal
(2) Changesinwagesandpricesaresignalsthatcoordinatepeoplesactions

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d. Result:Governmentshouldhaveonlyalimitedroleintheeconomy

Theoretical Application
Atthispointinthediscussion,youmaywanttotalkaboutphilosophiesofeconomics.Students
areoftenfascinatedbyhowphilosophicaldifferencesariseandwhattheymean,especiallyfor
policy.ThishelpstoreinforcetheideathattheKeynesianandclassicalmodelsareverydifferent
intheirimplications.Youmightsuggesttheideathateconomistswhoareskepticalofthe
governmentsroleintheeconomyaremorelikelytobelieveinaclassicalmodel,whilethosewho
believethegovernmentcandogoodaremorelikelytobecomeKeynesians.Youcanpointout,
however,thatthingsarechanging;someNewKeynesiansseemskepticalofgovernment
intervention.

2. TheKeynesianapproach
a. TheGreatDepression:Classicaltheoryfailedbecausehighunemploymentwaspersistent
b. Keynes:Persistentunemploymentoccursbecausewagesandpricesadjustslowly,so
marketsremainoutofequilibriumforlongperiods
c. Conclusion:Governmentshouldintervenetorestorefullemployment

AnalyticalProblem5asksstudentstodistinguishbetweenhowaclassicaleconomistanda
Keynesianeconomistwouldthinkaboutthesameissue.

3. TheevolutionoftheclassicalKeynesiandebate
a. KeynesiansdominatedfromWWIIto1970
b. Stagflationledtoaclassicalcomebackinthe1970s
c. Last30years:excellentresearchwithbothapproaches

Theoretical Application
Youmaywishtoaddadiscussionoftherecentprogressionofresearch.Youcouldstartbyabrief
overviewofhowthefailureofKeynesianmodelsinthestagflationofthe1970sledtothegrowth
ofrationalexpectationsmodeling,withitsfocusontheimportanceofmicrofoundations.Then
youcoulddiscussNewKeynesianmacroeconomics(discussedingreaterdetailinChapter11)
anditsattemptstoprovidesomemicrofoundationsforwageandpricestickinessinKeynesian
models.
AlthoughthetextbookpresentsjustafewversionsofclassicalmodelsandKeynesianmodels,
itisdifficulttofindaprototypicalclassicalorKeynesianeconomistwhobelievesfullyinthat
particularmodel.Thelackofconvincingevidenceonwhichmodeliscorrecthasled
macroeconomiststobeeclectic,sotheyoftenhedgetheirbets.Asaresult,aonearmed
macroeconomistishardtofind;analysistendstobeoftheontheonehand,ontheotherhand
variety.Andofcoursethatmeansthatifyoulaidallthemacroeconomistsontheearthendtoend,
theystillwouldntreachaconclusion!

C. Aunifiedapproachtomacroeconomics
1. TextbookusesasinglemodeltopresentbothclassicalandKeynesianideas
2. Threemarkets:goods,assets,labor
3. Modelstartswithmicrofoundations:individualbehavior
4. Longrun:wagesandpricesareperfectlyflexible

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5. Shortrun:Classicalcaseflexiblewagesandprices;Keynesiancasewagesandpricesare
slowtoadjust

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Additional Issues for Classroom Discussion

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1.What Are Societys Major Economic Problems Today?
Inthefirstclasssession,itmaybeinterestingtodiscussstudentsperceptionsofthemajoreconomic
problemsfacingtheeconomytoday.PublicopinionpollsshowthatAmericansviewsontheimportance
ofdifferentissuesvarysharplyoverthebusinesscycle.Inrecessions,peopleperceiveunemploymentand
economicgrowthasthemainproblems.Wheninflationishigh,reducingitisahighpriority.
Youmaywishtoaskyourstudentstoranktheimportancetothemofthefollowingeconomicissues:
(1)unemployment;(2)inflation;(3)economicgrowth;(4)stagnantincomes;(5)thetradedeficit;
(6)SocialSecurity;(7)thegovernmentbudget;and(8)incomeinequality.Somediscussionofallthese
topicsiscoveredlaterinthetext.

2.Lets Forecast!
Heresanexercisethatwillsurprisebothyouandyourstudents.Onthefirstdayofclass,beforetheyeven
knowmuchaboutthemacroeconomicvariablesthatwillbestudiedinthecourse,askthemtoforecast
suchthingsasinflation,unemployment,thegrowthrateofoutput,andinterestrates.Youcangivethema
handoutofthecurrentvaluesofkeyvariables.(Bytheway,itseasytopulldownsuchthingsoffthe
Internetfromanumberofsites;theeasiestistheFederalReserveBankofSt.LouisFREDdatabaseat
research.stlouisfed.org/fred2.)
Someofyourstudentswillhaveoutrageouslyhighforecastsforsomevariables,butotherswillbereally
low.Ifyoucalculatethemedianforecast,youandyourstudentsmaybeamazedathowcloseitistothe
medianforecastoftheBlueChipsurveyoroneoftheothermacroeconomicsurveys.Andattheendofthe
semester,youmaybesurprisedathowaccurateyourstudentsforecastswere.

3.Formulating a Model
Heresanexerciseinformulatinganeconomicmodelthatwillhelpstudentslearnhowtothinkabout
economicissuesandhowtomodelthem.Theideaisforyou(orthem)topickacurrenttopiclikeCPI
bias,thebasisofthebusinesscycle,theeffectofgovernmentdeficits,theeffectoftradedeficits,or
somethingelse.Itsusefultodothisnow,beforetheyvelearnedmuchaboutthetopic.Followthesteps
outlinedinthetextbookfordevelopingandtestinganeconomictheory.Thisexercisewillhelpthemget
anideaofhowresearchisactuallydone,startingfromapointwhenyoudontknowmuchaboutthe
answertoaquestion.Itsespeciallyimportanttoemphasizehowyoucouldconductanempiricalanalysis
totestthetheory.Youcanalsospendsometimetalkingaboutwhatkeyassumptionsyouneedtomaketo
simplifythetheory.

Answers to Textbook Problems


Review Questions
1. BothtotaloutputandoutputperworkerhaverisenstronglyovertimeintheUnitedStates.Output
itselfhasgrownbyafactorof100inthelast133years.Outputperworkerisnowsixtimesasgreat
asitwasin1900.Thesechangeshaveledtoamuchhigherstandardoflivingtoday.

2. Thebusinesscyclereferstotheshortrunmovements(expansionsandrecessions)ofeconomic
activity.Theunemploymentraterisesinrecessionsanddeclinesinexpansions.Theunemployment
rateneverreacheszero,evenatthepeakofanexpansion.

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3. Aperiodofinflationisoneinwhichprices(onaverage)arerisingovertime.Deflationoccurswhen
pricesarefallingonaverageovertime.BeforeWorldWarII,pricestendedtoriseduringwarperiods
andfallafterthewarsended;overthelongrun,thepricelevelremainedfairlyconstant.SinceWorld
WarII,however,priceshaverisenfairlysteadily.

4. Thebudgetdeficitistheannualexcessofgovernmentspendingovertaxcollections.TheU.S.federal
governmenthasbeenmostlikelytorundeficitsduringwars.Fromtheearly1980stothemid1990s,
deficitswereverylarge,evenwithoutamajorwar.TheU.S.governmentransurplusesforseveral
years,from1998to2001.

5. Thetradedeficitistheamountbywhichimportsexceedexports;thetradesurplusistheamountby
whichexportsexceedimports,soitisthenegativeofthetradedeficit.InrecentyearstheUnited
Stateshashadhugetradedeficits.Butfrom1900to1970,theUnitedStatesmostlyhadtrade
surpluses.

6. Macroeconomistsengageinforecasting,macroeconomicanalysis,macroeconomicresearch,anddata
development.Macroeconomicresearchcanbeusefulininvestigatingforecastingmodelstoimprove
forecasts,inprovidingmoreinformationonhowtheeconomyworkstohelpmacroeconomicanalysts,
andintellingdatadeveloperswhattypesofdatashouldbecollected.Researchprovidesthebasis
(resultsandideas)forforecasting,analysis,anddatadevelopment.

7. Thestepsindevelopingandtestinganeconomicmodelortheoryare:(1)statetheresearchquestion;
(2)makeprovisionalassumptionsthatdescribetheeconomicsettingandthebehavioroftheeconomic
actors;(3)workouttheimplicationsofthetheory;(4)conductanempiricalanalysistocompare
theimplicationsofthetheorywiththedata;and(5)evaluatetheresultsofyourcomparisons.The
criteriaforausefultheoryormodelarethat(1)ithasreasonableandrealisticassumptions;(2)itis
understandableandmanageableenoughforstudyingrealproblems;(3)itsimplicationscanbetested
empiricallyusingrealworlddata;and(4)itsimplicationsareconsistentwiththedata.

8. Yes,itispossibleforeconomiststoagreeabouttheeffectsofapolicy(thatis,toagreeonthepositive
analysisofthepolicy),buttodisagreeaboutthepolicysdesirability(normativeanalysis).Forexample,
supposeeconomistsagreedthatreducinginflationtozerowithinthenextyearwouldcausearecession
(positiveanalysis).Someeconomistsmightarguethatinflationshouldbereduced,becausetheyprefer
lowinflationevenatthecostofhigherunemployment.Otherswouldarguethatinflationisntas
harmfultopeopleasunemploymentis,andwouldopposesuchapolicy.Thisisnormativeanalysis,
asitinvolvesavaluejudgmentaboutwhatpolicyshouldbe.

9. Classicalsseewageandpriceadjustmentoccurringrapidly,whileKeynesiansthinkthatwagesand
pricesadjustonlyslowlywhentheeconomyisoutofequilibrium.Theclassicaltheoryimpliesthat
unemploymentwillnotpersistbecausewagesandpricesadjusttobringtheeconomyrapidlybackto
equilibrium.ButifKeynesiantheoryiscorrect,thentheslowresponseofwagesandpricesmeans
thatunemploymentmaypersistforlongperiodsoftimeunlessthegovernmentintervenes.

10. Stagflationwasacombinationofstagnation(highunemployment)andinflationinthe1970s.It
changedeconomistsviewsbecausetheKeynesianapproachcouldntexplainstagflation
satisfactorily.

Numerical Problems
1. (a) Averagelaborproductivityisoutputdividedbyemployment:

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2008:12,000tonsofpotatoesdividedby1000workers12tonsofpotatoesperworker
2009:14,300tonsofpotatoesdividedby1100workers13tonsofpotatoesperworker
(b) Thegrowthrateofaveragelaborproductivityis[(13/12)1]100%8.33%.
(c) Theunemploymentrateis:
2008:(100unemployed/1100workers)100%9.1%
2009:(50unemployed/1150workers)100%4.3%
(d) Theinflationrateis[(2.5/2)1]100%25%.

2. Theanswerstothisproblemwillvarydependingonthecurrentdate.Theanswersherearebasedon
theOctober2009SurveyofCurrentBusiness,Tables1.1.5and3.2.Numbersareatannualratesin
billionsofdollars.

2007 2008 2009Q2


GDP 14,077.6 14,441.4 14,151.2
Exports 1,655.9 1,831.1 1,493.7
Imports 2,369.7 2,538.9 1,832.8
FederalReceipts 2,660.8 2,475.0 2,211.4
FederalExpenditures 2,897.2 3,117.6 3,505.9
a.
Exports/GDP 11.8% 12.7% 10.6%
Imports/GDP 16.8% 17.6% 13.0%
TradeImbalance/GDP 5.1% 4.9% 2.4%
b.
FederalReceipts/GDP 18.9% 17.1% 15.6%
FederalExpenditures/GDP 20.6% 21.6% 24.8%
Deficit/GDP 1.7% 4.4% 9.1%

Analytical Problems
1. Yes,averagelaborproductivitycanfallevenwhentotaloutputisrising.Averagelaborproductivity
istotaloutputdividedbyemployment.Soaveragelaborproductivitycanfallifoutputand
employmentarebothrisingbutemploymentisrisingfaster.
Yes,theunemploymentratecanalsoriseeventhoughtotaloutputisrising.Thiscanoccuranumber
ofdifferentways.Forexample,averagelaborproductivitymightberisingwithemployment
constant,sothatoutputisrising;butthelaborforcemaybeincreasingaswell,sothatthe
unemploymentrateisrising.Oraveragelaborproductivitymightbeconstant,andbothemployment
andunemploymentcouldriseatthesametimebecauseofanincreaseinthelaborforce,withthe
numberofunemployedrisingbyagreaterpercentage.

2. Justbecausepriceswerelowerin1890thantheywerein2009doesnotmeanthatpeoplewerebetter
offbackthen.Peoplesincomeshaverisenmuchfasterthanpriceshaverisenoverthelast100years,
sotheyarebetterofftodayintermsofrealincome.

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3. Therearemanypossibletheories.Onepossibilityisthatpeoplewhoselastnamesbeginwiththe
lettersAthroughMvoteDemocratic,whilethosewhosenamesbeginwiththelettersNthrough
ZvoteRepublican.Youcouldtestthistheorybytakingexitpollsorcheckingthelistsofregistered
votersbyparty.However,thistheoryfailsthecriterionofbeingreasonable,sincethereisnogood
reasontoexpectthefirstlettersofpeopleslastnamestomatterfortheirpoliticalpreferences.
Abettertheorymightbeonebasedonincome.Forexample,youmightmaketheassumptionthatthe
RepublicanPartypromotesbusinessinterests,whiletheDemocraticPartyismoreinterestedin
redistributingincome.ThenyoumightexpectpeoplewithhigherincomestovoteRepublicanand
peoplewithlowerincomestovoteDemocratic.Takingasurveyofpeopleastheyleftthepollscould
testthis.Inthiscasetheassumptionsofthetheoryseemreasonableandrealistic,andthemodelis
simpleenoughtounderstandandtoapply.Soitispotentiallyausefulmodel.

4. (a) Positive.Thisstatementtellswhatwillhappen,notwhatshouldhappen.
(b) Positive.Eventhoughitisaboutincomedistributionissues,itisastatementoffact,notopinion.
IfthestatementsaidThepayrolltaxshouldbereducedbecauseit...,thenitwouldbea
normativestatement.
(c) Normative.Sayingtaxesaretoohighsuggeststhattheyshouldbelower.
(d) Positive.Sayswhatwillhappenasaconsequenceofanaction,notwhatshouldbedone.
(e) Normative.Thisisastatementofpreferenceaboutpolicies.

5. Aclassicaleconomistmightarguethattheeconomywouldworkmoreefficientlywithoutthe
governmenttryingtoinfluencetrade.Theimpositionoftariffsincreasestradebarriers,interfering
withtheinvisiblehand.Thetariffssimplyprotectanindustrythatisfailingtooperateefficientlyand
isnotcompetitiveinternationally.
AKeynesianeconomistmightbemoresympathetictoconcernsaboutthesteelindustry.Keynesians
mightarguethattheremayneedtobealongrunadjustmentinthesteelindustry,butwouldwantto
preventworkersinthesteelindustryfrombecomingunemployedintheshortrun.

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