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 persons 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 S private = 10
2 0.7 = 7.3.
Because Spublic = T G, then rearranging gives G = T S public = 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.