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Solution Manual For ECON Macro, 1st Edition
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Solution Manual ForECON Macro, 1st Edition by
CHAPTER 1
THE ART AND SCIENCE OF ECONOMIC ANALYSIS
ANSWERS TO END-OF-BOOK QUESTIONS AND PROBLEMS
1.1 (Definition of Economics) What determines whether or not a resource is scarce? Why is the concept of
scarcity important to the definition of economics?
A resource is scarce when the amount people desire exceeds the amount available at a price of zero. The
concept of scarcity is important to the definition of economics because scarcity forces people to choose how
they will use their resources in an attempt to satisfy their unlimited wants and desires. Economics is about
making choices. Without scarcity there would be no economic problem, and therefore no need to choose
between competing wants and desires.
Sure! I’ll expand on the topics related to "Taxation of Business Entities," providing a more detailed exploration. This overview will cover fundamental concepts, applications, and implications relevant to the study of business taxation.---
### Overview of Business Entities#### 1. Types of Business EntitiesBusiness entities can be categorized based on ownership structure and tax treatment. Understanding these types is crucial for determining tax obligations and benefits.-
**Sole Proprietorships**: - Owned by a single individual, this is the simplest form of business entity. Income is reported on the owner’s personal tax return (Form 1040, Schedule C), which simplifies tax filing but also means personal
liability for debts and obligations.- **Partnerships**: - Consisting of two or more individuals, partnerships do not pay federal income taxes. Instead, they are considered pass-through entities, meaning income is taxed at the partners'
individual rates. Form 1065 is used to report partnership income, while partners receive Schedule K-1 to report their share on their returns.- **Corporations**: - Corporations are separate legal entities that provide limited liability
protection to their owners (shareholders). C-Corporations face double taxation: once at the corporate level on profits and again at the individual level when dividends are distributed. S-Corporations, on the other hand, are pass-through
entities but have restrictions on ownership and number of shareholders.- **Limited Liability Companies (LLCs)**: - LLCs combine the flexibility of partnerships with the liability protection of corporations. An LLC can choose to be taxed
as a sole proprietorship, partnership, or corporation, allowing for strategic tax planning. ### 2. Tax Implications of Each Entity TypeUnderstanding the tax implications of each entity type is critical for effective business planning.- **Sole
Proprietorships**: - Income is taxed at the owner’s individual tax rate. All profits and losses are reported on the owner’s tax return. This simplicity, however, can expose owners to significant personal risk.- **Partnerships**: - Each
partner reports their share of income and losses on their personal returns, allowing for loss deductions. Partners are also subject to self-employment taxes on their share of the income, which can significantly impact tax liability.-
**Corporations**: - C-Corporations are taxed at the corporate tax rate (currently 21%). Dividends are taxed again at the shareholder level. S-Corporations avoid double taxation, but there are restrictions on the number and type of
shareholders.- **Limited Liability Companies (LLCs)**: - By default, single-member LLCs are treated as sole proprietorships for tax purposes, while multi-member LLCs are treated as partnerships. However, they can elect to be taxed as a
corporation if beneficial.### Key Tax Concepts#### 1. Income RecognitionIncome recognition is a fundamental principle in taxation, determining when income must be reported.- **Cash vs. Accrual Accounting**: - Businesses can
choose between cash and accrual methods. Cash accounting recognizes income when received and expenses when paid, making it straightforward. Accrual accounting recognizes income when earned and expenses when incurred,
aligning revenue with the period it relates to, but can complicate cash flow management.#### 2. DeductionsDeductions reduce taxable income, directly impacting tax liability.- **Ordinary and Necessary Expenses**: - The IRS allows
deductions for expenses that are ordinary (common in the industry) and necessary (helpful and appropriate for the business). Common deductions include rent, utilities, salaries, and professional fees.- **Limits on Deductions**: -
Certain expenses, such as meals and entertainment, have specific limits (e.g., meals are typically only 50% deductible). Understanding these limits is vital for effective tax planning.#### 3. Tax CreditsTax credits directly reduce the tax
liability, providing a dollar-for-dollar reduction of taxes owed.- **Types of Tax Credits**: - Examples include the Research and Development (R&D) tax credit, which encourages innovation, and the Work Opportunity Tax Credit (WOTC)
for hiring individuals from certain target groups.### Specific Business Entity Taxation#### 1.
1.2 (Definition of Economics) Identify each of the following as a resource, an economic actor, or a good or
service.
a. A stay-at-home parent
b. A computer
c. Oil
d. A hamburger
a. economic actor
b. good
c. resource
d. good
1.3 (Scarce Resources) How would you respond to the remark that clean water is free because you can simply
get a glass or even a jug from your home tap without paying anything?
Although you’re not paying for clean water at the tap, it’s not free to you if you pay taxes for the
clean water, or if someone else pays the taxes or related costs on your behalf.
2.1 (Rational Self-Interest) Discuss the impact of rational self-interest on each of the following decisions:
a. Whether to attend college full time or enter the workforce full time
b. Whether to buy a new textbook or a used one
c. Whether to attend a local college or an out-of-town college
a. Individuals will compare the expected benefits of attending college full time with the expected costs.
One benefit might be that the individual’s stock of knowledge and productivity will grow, and so will his
or her future wage. Costs include not only tuition, but also the wages that could have been earned by
working instead of attending college full time. If the expected benefits outweigh the costs, then the
, rational person will choose to go to college full time.
b. Individuals will compare the expected benefits of a new textbook with the higher costs of purchasing a
new textbook. Benefits include not being confused by other students’ markings in the book and a higher
resale value. However, the out-of-pocket cost of a new book will be higher than the cost of a used book.
If the expected benefits outweigh the costs, then a rational person will purchase the new textbook.
c. Individuals will compare the expected benefits and costs associated with both colleges under
consideration and will choose the college at which the difference between benefits and costs is greater.
The costs of attending an out-of-town college may include greater travel costs and phone bills and
benefits such as learning about a different region.
Sure! I’ll expand on the topics related to "Taxation of Business Entities," providing a more detailed exploration. This overview will cover fundamental concepts, applications, and implications relevant to the study of business taxation.---
### Overview of Business Entities#### 1. Types of Business EntitiesBusiness entities can be categorized based on ownership structure and tax treatment. Understanding these types is crucial for determining tax obligations and benefits.-
**Sole Proprietorships**: - Owned by a single individual, this is the simplest form of business entity. Income is reported on the owner’s personal tax return (Form 1040, Schedule C), which simplifies tax filing but also means personal
liability for debts and obligations.- **Partnerships**: - Consisting of two or more individuals, partnerships do not pay federal income taxes. Instead, they are considered pass-through entities, meaning income is taxed at the partners'
individual rates. Form 1065 is used to report partnership income, while partners receive Schedule K-1 to report their share on their returns.- **Corporations**: - Corporations are separate legal entities that provide limited liability
protection to their owners (shareholders). C-Corporations face double taxation: once at the corporate level on profits and again at the individual level when dividends are distributed. S-Corporations, on the other hand, are pass-through
entities but have restrictions on ownership and number of shareholders.- **Limited Liability Companies (LLCs)**: - LLCs combine the flexibility of partnerships with the liability protection of corporations. An LLC can choose to be taxed
as a sole proprietorship, partnership, or corporation, allowing for strategic tax planning. ### 2. Tax Implications of Each Entity TypeUnderstanding the tax implications of each entity type is critical for effective business planning.- **Sole
Proprietorships**: - Income is taxed at the owner’s individual tax rate. All profits and losses are reported on the owner’s tax return. This simplicity, however, can expose owners to significant personal risk.- **Partnerships**: - Each
partner reports their share of income and losses on their personal returns, allowing for loss deductions. Partners are also subject to self-employment taxes on their share of the income, which can significantly impact tax liability.-
**Corporations**: - C-Corporations are taxed at the corporate tax rate (currently 21%). Dividends are taxed again at the shareholder level. S-Corporations avoid double taxation, but there are restrictions on the number and type of
shareholders.- **Limited Liability Companies (LLCs)**: - By default, single-member LLCs are treated as sole proprietorships for tax purposes, while multi-member LLCs are treated as partnerships. However, they can elect to be taxed as a
corporation if beneficial.### Key Tax Concepts#### 1. Income RecognitionIncome recognition is a fundamental principle in taxation, determining when income must be reported.- **Cash vs. Accrual Accounting**: - Businesses can
choose between cash and accrual methods. Cash accounting recognizes income when received and expenses when paid, making it straightforward. Accrual accounting recognizes income when earned and expenses when incurred,
aligning revenue with the period it relates to, but can complicate cash flow management.#### 2. DeductionsDeductions reduce taxable income, directly impacting tax liability.- **Ordinary and Necessary Expenses**: - The IRS allows
deductions for expenses that are ordinary (common in the industry) and necessary (helpful and appropriate for the business). Common deductions include rent, utilities, salaries, and professional fees.- **Limits on Deductions**: -
Certain expenses, such as meals and entertainment, have specific limits (e.g., meals are typically only 50% deductible). Understanding these limits is vital for effective tax planning.#### 3. Tax CreditsTax credits directly reduce the tax
liability, providing a dollar-for-dollar reduction of taxes owed.- **Types of Tax Credits**: - Examples include the Research and Development (R&D) tax credit, which encourages innovation, and the Work Opportunity Tax Credit (WOTC)
for hiring individuals from certain target groups.### Specific Business Entity Taxation#### 1.
2.2 (Rational Self-Interest) If behaviour is governed by rational self-interest, why do people make charitable
contributions of time and money?
Rational self-interest is not blind materialism, pure selfishness, or greed. Rational self-interest means we
choose the option that maximizes expected benefits with a given cost. People will give more to charities
when the contribution is tax deductible. The lower the personal cost of helping others the more we are
willing to help and contribute. The benefits of contributing to charities may include feelings of well-being
and the recognition we receive from others when we contribute—for example, a wealthy donor having a
building named after her.
2.3 (Marginal Analysis) The owner of a small pizzeria is deciding whether to increase the radius of its delivery
area by two kilometres. What considerations must be taken into account if such a decision is to increase
profitability?
By increasing its delivery radius, the store will have greater sales. However, these marginal revenues must
be balanced against the additional costs incurred, such as greater consumption of pizza ingredients, more
gasoline for the delivery truck, and possibly the need to hire additional labour and increase advertising.
2.4 (Time and Information) It is often costly to obtain the information necessary to make good decisions. Yet
your own interests can be best served by rationally weighing all options available to you. This requires
informed decision making. Does this mean that making uninformed decisions is irrational? How do you
determine how much information is the right amount?
Rational decision makers will continue to acquire information as long as the benefit of the additional
information exceeds the additional costs. Oftentimes we are willing to pay others to gather and digest the
information for us.
2.5 (Time) A vacuum cleaner costs $600 and a high-quality broom costs only $5. Why would most people
purchase the more expensive vacuum cleaner to do their home cleaning?
You purchase a vacuum cleaner or a broom to help you clean. But to clean you must combine your labour
power with the vacuum cleaner or broom. It takes much longer to clean with a broom than with a vacuum
cleaner. To save on time costs (time is costly in terms of forgone uses of this time), most people would
purchase the vacuum cleaner to do major cleaning. Also, the vacuum does a better job of picking up the
dirt; it delivers a higher quality service.
,2.6 (Information) You want to purchase a car. You, like most people, probably don’t want to spend too much
time searching for information. You certainly don’t want to check out all the dealers. You might simply do
an intensive search of one or two. How can you reconcile such normal behaviour with rational behaviour?
(Hint: think of the costs of information.)
If one starts with the assumption that most people are smart and in this sense rational, you would expect
them to take into consideration the cost of information when deciding how long to search. All other things
remaining the same, you’d expect that you’d spend less time searching for a car the more expensive are the
costs of information. More than this, smart people tend not to apply the marginal cost equals marginal
benefit rule when searching for a car. This tends to be too complex and time consuming. Rather, they apply
a stopping rule. They’ll stop searching when they find a car and dealer that meet their top three to five
characteristics—trustworthiness, model, size, warranty, etc.
3.1 (Role of Theory) What good is economic theory if it can’t predict the behaviour of a specific individual?
This question highlights the fact that economics, like all social sciences, attempts to describe and explain
human behaviour. In doing so, it cannot measure and control for all factors influencing behaviour. The
result is that the behaviour of a specific individual cannot be explained or predicted, but the behaviour of
groups of individuals can be. We cannot, for example, predict any particular individual’s buying response
to a sale. We can, however, predict what kind of total selling volume will occur because of a sale.
3.2 (Normative versus Positive) Are the following statements normative or positive?
a. If the government wants to raise the price level it should increase the money supply.
b. Corporate taxes in Canada are too high.
c. Employment insurance programs cause the unemployment rate to rise.
a. Positive. One can collect data or evidence and see that a higher money supply will lead to a higher
price level.
b. Normative. Some individuals think that corporate taxes in Canada are too high, while others feel that
corporate taxes are too low, depending on their own feelings and beliefs about tax policy.
c. Positive. Again, one can collect data and see if changes in employment insurance programs cause
higher, lower, or the same amount of unemployment.
3.3 (Role of Theory) Some economists argue that economic theory should be based on realistic behavioural
assumptions. Why might realism of assumptions improve the capacity of theory to both predict and explain
economic outcomes?
If the assumptions generate accurate predictions of outcomes, many economists might say that this is good
enough. But other economists would argue that predicting outcomes reveals little about what caused or
produced the outcomes. Moreover, different sets of assumptions can generate the same prediction. To
identify cause and effect, one has to identify the set of realistic but simplifying assumptions that are able to
explain how the outcomes were produced—why firms actually become more efficient, why households
actually decide to have more or less children.
3.4 (Normative versus Positive) Determine whether each of the following statements is normative or positive:
a. The Canadian unemployment rate fell from 8.3 percent in October 2009 to 6.5 percent in October 2014.
b. The inflation rate in Canada is too high.
c. The Canadian government should increase the minimum wage.
d. Canadian restrictions in the dairy industry dramatically increase the cost of milk to Canadian consumers.
a. Positive—a statement of fact; b. Positive—for most economists, one can determine which rate of inflation
is ―optimal‖ or best for the economy; c. Normative—a matter of opinion, although this opinion is rooted in
one’s scientific understanding of the implications of the minimum wage for the economy; d. Positive—a
statement of fact.
, 4.1 (Pitfalls of Economic Analysis) Review the discussion of pitfalls in economic thinking in this chapter. Then
identify the fallacy, or mistake in thinking, in each of the following statements:
a. Raising taxes always increases government revenues.
b. Whenever there is a recession, imports decrease. Therefore, to stop a recession, we should increase
imports.
c. Raising the tariff on imported steel helps the Canadian steel industry. Therefore, the entire economy is
helped.
a. This assertion is a mistake because the secondary effects of taxes on production and the labour supply
are ignored. If the tax rate were raised to 100 percent, for example, no one would want to work or
produce.
b. This is the fallacy that association implies causation. It is more likely that recession causes a change in
imports than the other way around.
c. This is a fallacy of composition. True, the tariff may help the steel industry. But it hurts purchasers of
steel, including the automobile and construction industries. The overall effect on the economy is
unclear.
4.2 (Association Versus Causation) Suppose I observe that communities with lots of doctors tend to have
relatively high rates of illness. I conclude that doctors cause illness. What’s wrong with this reasoning?
The causality is undoubtedly in the other direction; that is, doctors will tend to locate where there is a lot of
disease and therefore a greater need for medical care.
Sure! I’ll expand on the topics related to "Taxation of Business Entities," providing a more detailed exploration. This overview will cover fundamental concepts, applications, and implications relevant to the study of
business taxation.---### Overview of Business Entities#### 1. Types of Business EntitiesBusiness entities can be categorized based on ownership structure and tax treatment. Understanding these types is crucial for
determining tax obligations and benefits.- **Sole Proprietorships**: - Owned by a single individual, this is the simplest form of business entity. Income is reported on the owner’s personal tax return (Form 1040, Schedule C),
which simplifies tax filing but also means personal liability for debts and obligations.- **Partnerships**: - Consisting of two or more individuals, partnerships do not pay federal income taxes. Instead, they are considered
pass-through entities, meaning income is taxed at the partners' individual rates. Form 1065 is used to report partnership income, while partners receive Schedule K-1 to report their share on their returns.- **Corporations**:
- Corporations are separate legal entities that provide limited liability protection to their owners (shareholders). C-Corporations face double taxation: once at the corporate level on profits and again at the individual level
when dividends are distributed. S-Corporations, on the other hand, are pass-through entities but have restrictions on ownership and number of shareholders.- **Limited Liability Companies (LLCs)**: - LLCs combine the
flexibility of partnerships with the liability protection of corporations. An LLC can choose to be taxed as a sole proprietorship, partnership, or corporation, allowing for strategic tax planning. ### 2. Tax Implications of Each
Entity TypeUnderstanding the tax implications of each entity type is critical for effective business planning.- **Sole Proprietorships**: - Income is taxed at the owner’s individual tax rate. All profits and losses are reported on
the owner’s tax return. This simplicity, however, can expose owners to significant personal risk.- **Partnerships**: - Each partner reports their share of income and losses on their personal returns, allowing for loss
deductions. Partners are also subject to self-employment taxes on their share of the income, which can significantly impact tax liability.- **Corporations**: - C-Corporations are taxed at the corporate tax rate (currently
21%). Dividends are taxed again at the shareholder level. S-Corporations avoid double taxation, but there are restrictions on the number and type of shareholders.- **Limited Liability Companies (LLCs)**: - By default,
single-member LLCs are treated as sole proprietorships for tax purposes, while multi-member LLCs are treated as partnerships. However, they can elect to be taxed as a corporation if beneficial.### Key Tax Concepts#### 1.
Income RecognitionIncome recognition is a fundamental principle in taxation, determining when income must be reported.- **Cash vs. Accrual Accounting**: - Businesses can choose between cash and accrual methods.
Cash accounting recognizes income when received and expenses when paid, making it straightforward. Accrual accounting recognizes income when earned and expenses when incurred, aligning revenue with the period it
relates to, but can complicate cash flow management.#### 2. DeductionsDeductions reduce taxable income, directly impacting tax liability.- **Ordinary and Necessary Expenses**: - The IRS allows deductions for expenses
that are ordinary (common in the industry) and necessary (helpful and appropriate for the business). Common deductions include rent, utilities, salaries, and professional fees.- **Limits on Deductions**: - Certain expenses,
such as meals and entertainment, have specific limits (e.g., meals are typically only 50% deductible). Understanding these limits is vital for effective tax planning.#### 3. Tax CreditsTax credits directly reduce the tax liability,
providing a dollar-for-dollar reduction of taxes owed.- **Types of Tax Credits**: - Examples include the Research and Development (R&D) tax credit, which encourages innovation, and the Work Opportunity Tax Credit
(WOTC) for hiring individuals from certain target groups.### Specific Business Entity Taxation#### 1.
4.3 (Secondary Effects) Cigarette smuggling often increases when taxes on cigarettes are raised. Should the
government eliminate cigarette taxes?
Taxes are imposed on cigarettes because cigarettes are bad for people’s health (that is, not just smokers,
but also those who live and work with smokers). The unintended consequence of more cigarette smuggling
needs to be weighed against the desire to curb smoking among the Canadian population. It may be that the
―right‖ amount of taxation will lower smoking in the community without increasing smuggling—this
becomes an empirical question of finding a balance between the two outcomes.
4.4 (Pitfalls of Economic Analysis) Prior to the financial crisis of 2008, most economists maintained the
economy was doing quite well, booming in fact. Discuss what was missing in this type of analysis. If an
economy is currently booming, does this necessarily mean that the economy is doing quite well?
This analysis assumed away the possibility certain markets, in this case financial markets, are subject to
booms and busts. It assumed that at all times share prices and housing prices pretty much reflected the
―true‖ or ―real‖ value of these assets. It also ignored the history of booms and busts in markets. With a
better understanding of booms and the possibility of busts, the very real possibility of the housing and
financial markets crashing would have been on the radar. It is important to note that Canada did not do
that badly during the crisis, because (according to many experts) its housing and financial markets were
regulated differently from and better than the American.
5.1 (Studying Economics) According to the text, economics majors on average earn more money than most
other majors and have more job opportunities. Are these the primary motivations one might have for
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