Answers to selected “Problems and Applications” Questions in Mankiw

Chapter 1:

4)

If you spend $100 now instead of saving it for a year and earning 5 percent

interest, you are giving up the opportunity to spend $105 a year from now. The idea that money has a time value is the basis for the field of finance, the subfield of economics that has to do with prices of financial instruments like stocks and bonds.

5)

The fact that you've already sunk $5 million isn't relevant to your decision

anymore, since that money is gone. What matters now is the chance to earn profits at the margin. If you spend another $1 million and can generate sales of $3 million, you'll earn $2 million in marginal profit, so you should do so.

You are right to think that the

project has lost a total of $3 million ($6 million in costs and only $3 million in revenue) and you shouldn't have started it. That's true, but if you don't spend the additional $1 million, you won't have any sales and your losses will be $5 million. not the total profit, but the profit you can earn at the margin.

So what matters is

In fact, you'd pay up to

$3 million to complete development; any more than that, and you won't be increasing profit at the margin.

Chapter 2:

4)
a.

Figure 1 shows a production possibilities frontier between guns and butter.

It

is bowed out because when most of the economy’s resources are being used to produce butter, the frontier is steep and when most of the economy’s resources are being used to produce guns, the frontier is very flat. When the economy is producing a lot of guns, workers and machines best suited to making butter are being used to make guns, so each unit of guns given up yields a large increase in the production of butter. Thus, the production possibilities frontier is flat.

When the economy is producing a lot of