Econ pt 2 – Flashcards
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What is an oligopoly?
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a market structure in which a small number of interdependent firms compete
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Three examples of an oligopoly.
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cigarettes, beer, aircraft, breakfast cereals, automobiles, pet food
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What barriers to entry have to do with the extent of competition?
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patents, occupational licenses, barriers to international trade, franchises governments are willing to erect barriers to entering an industry is that test barriers may improve the standard of living in the long run; granting patents encourages the development of new products and technologies
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What is a patent? If a patent serves as a barrier to entry, why do governments issue patents?
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Gives a firm the exclusive right to a product for a period of 20 years from the date the patent is filed with the government. Governments issue patents to encourage firms to carry out research and development, which increases output and living standards in the long run.
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A newspaper article referred to Saudi Arabia as "the cartel's enforcer and enabler." What cartel was the article referring to? In what way is Saudi Arabia an enabler and an enforcer?
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Article is referring to the cartel known as OPEC. Saudi Arabia, the largest producer within OPEC, can cut back production to enforce higher oil prices on by the cartel. Similarly, if world oil prices begin to rise above the cartel prices, Saudi Arabia can increase production to bring prices back down.
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In what sense is the demand for labor a derived demand?
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The derived demand for labor depends on the demand for the good labor produces.
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What is the difference between the marginal product of labor and the marginal revenue product of labor?
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The marginal product of labor is the marginal revenue product of labor, which equals the marginal product of labor multiplied by the marginal revenue from selling another unit. The MRPl slopes downward because the marginal product of labor eventually diminishes due to the law of diminishing returns.
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5 most important variables that cause the market demand curve for labor to shift
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-changes in human capital -changes in technology -changes in the quantity of other inputs -changes in the price of the product -changes in the number of firms in the market
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How can we measure the opportunity cost of leisure? What are the substitution effect and the income effect resulting from a wage shortage?
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Opportunity cost of leisure is the wage that could have been earned by working.
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What are the three most important variables that cause the market supply curve of labor to shift.
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-changes in population -changing demographics -changing alternatives to work in general or work within a particular sector of the economy
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What is the price of time?
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The value individuals put on a certain amount of time- for instance how much you value one hour of time. If real hourly wages have risen, then time becomes more valuable in terms of earning power, so the price of time will also have risen.
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Suppose a large oil field is discovered in Michigan. By imposing a tax on the oil the state government is able to eliminate the state income tax on wages. What is likely to be the effect on the labor supply curve in Michigan.
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Eliminating the income tax on wages increase the opportunity cost of leisure because the after tax wages is now higher than it was. Workers will also earn more income for any given number of hours worked.
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If the labor demand curve shifts to the left and the labor supply cure remains unchanged, what will happen to the equilibrium wage and the equilibrium level of employment?
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The equilibrium wage will fall, as will the equilibrium quantity of labor employed.
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What is a compensating differential?
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when a higher wage compensates workers for unpleasant aspects of a job; an example would be when workers need to be paid an extra 2$ an hour fin a job with a higher risk of injury
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What is economic discrimination? Is the fact that one group in the population has higher earnings than other groups evidence of economic discrimination? Explain.
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paying a person a lower wage or excluding a person from an occupation on the basis of a characteristic, such as skin color or gender- that is irrelevant to productivity in the job. The fact that one group (right-handed men for example) has higher average than another group (left-handed men)is not necessarily evidence of economic discrimination. Before concluding that economic discrimination is the reason for the pay gap, we must adjust for differences in the productivity of the two groups.
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In what sense do employers who discriminate pay an economic penalty? Is this penalty enough to eliminate discrimination?
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Decrease in supply of labor, which in turn puts pressure on wages. Employers who do not discriminate, on the other hand, will experience lower costs and subsequently, will be able to charge lower prices for their output and be more profitable than their discriminating competitors. Although this penalty should reduce discrimination, many economists doubt that the penalty is sufficient to eliminate discrimination.
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Why might employers be more likely to interview a job applicant with a white-sounding name instead of an African American sounding name? Aside legal penalties, will employers who follow this practice incur as an economic penalty?
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Employers will likely incur an economic penalty. Employers who discriminate will experience a decrease in their supply of labor, which in turn puts upward pressure on wages. The employers who do not discriminate will experience lower costs and subsequently will be able to charge lower prices for their output and be more profitable than their discriminating competitors.
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What is economic rent?
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Economic rent is the price paid for a factor of production that is fixed in supply.
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The total amount of oil in the earth is not increasing. Does this mean that in the market for oil, the supply curve is perfectly inelastic? Explain.
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The supply of oil is the quantity firms are willing to sell at each price. As price increases, firms are willing to extract harder to reach oil, so the quantity supplied will increase as the price of oil rises, even though the total amount of oil in the ground is not increasing. Therefore, the supply curve for oil is not perfectly inelastic.
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Four main components of expenditures in GDP and write the equation used to represent the relationship between GDP and the four expenditure components.
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GDP= C + I + G + NX. Consumption (C) is spending by households on goods, services and investments (I) is spending by firms on new plant, equipment, buildigs, and changes in inventories and by households and firms on new single-family and multi-unit houses. Government purchases (G) are made by the federal, state, and local governments for goods and services and net exports (NX) equal exports minus imports. Exports are goods and services produced in the United States that are purchased by foreign firms, households, governments, and imports are goods and services produced in foreign countries, but purchased by U.S. firms, households, and governments.
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Is the value of a house build in 2000 and resold in 2013 included in the GDP of 2013? Explain. Would the services of the real estate agent who helped sell or buy the house in 2013 be counted in GDP for 2013? Explain.
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Value of a house built in 2000 would not be included in the GDP of 2013 because the sale does not represent new production. The value of the services of the real estate agent that helped sell or buy the house in 2013 would be included in GDP of 2013
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What is the underground economy? Why do some countries have larger underground economies than do other countries?
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The underground economy is the buying and selling of goods and services that is concealed from the government to avoid taxes or regulations or because the goods and services are illegal. Some countries have larger underground economies than other countries due to high taxes and extensive government regulation.
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Why is GDP an imperfect measure of economic well-being? What types of producton does GDP not measure? Even if GDP included these types of production, why would it still be an imperfect measure of economic well-being?
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GDP does not include household production and the underground economy. Even if GDP included all production, it would still not be a perfect measure of economic well-being because it does not include the value of leisure and is not adjusted for the negative effects of pollution and social problems.
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Which of the following are likely to increase measured GDP and which are likely to reduce it? a- fraction of women working outside the home increases b- sharp increase in the crime rate c- higher tax rates cause some people to hide more of the income they earn
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a- likely to increase GDP b- likely to increase measured GDP if it results in increased government expenditures on law enforcement and increased private expenditures on security c-likely to reduce GDP
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Does the fact that the typical American works less than 40 hours per work week today and worked 60 hours per week in 1890 higher or lower than indicated by the difference in real GDP per capita today versus in 1890? Explain.
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Real GDP per capita is the level of real output or income per person. Real GDP per capita for the U.S. has risen since 1890. A higher income level today may be due to Americans working more hours of simply being more productive. The fact that the typical American today works fewer hours while earning a higher income level suggest that the economic well-being of the average American has increased more than is indicated by comparing 1890 real GDP per capita with current real GDP per capita.
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Report of the WB, an international organization devoted to increasing economic growth in developing countries, included the following statement: "Informal economic activities pose a particular measurement problem especially in developing countries where much economic activity may go unrecorded". What does the WB mean by informal economic activities? Why would these activities make it harder to measure GDP? Why might they make it harder to evaluate the standard of living in developing countries?
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"Informal economic activities" refer to the underground economy. These activities are concealed and will not be counted in GDP. Measure real GDP will represent a much larger proportion of total production in the United States than in countries with larger informal sectors, making comparisons of living standards based on real GDP misleading.
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Why does inflation make nominal GDP a poor measure of the increase in total production from on year to the next? How does the U.S. Bureau of Economic Analysis deal with the problem inflation causes with nominal GDP.
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Nominal GDP can change because of either quantity changes or price changes. When there is inflation, nominal GDP overstates the increase in total production. The Bureau of Economic Analysis separates price changes from quantity changes by calculating real GDP.
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What is the GDP deflator?
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GDP deflator is a measure of the average prices of the final goods and services included in GDP and equals nominal GDP divided by real GDP, multiplied by 100.
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Assuming that inflation has occured over time, what is the relationship between nominal GDP and real GDP in each of the following situations? a- years after the base year b- the base year c- years before the base year
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a- nominal GDP is greater than real GDP b- nominal GDP equals real GDP c- nominal GDP is less than real GDP
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Avatar overtook Titanic as the highest grossing movie of all time. An article on Forbes.com notes that they average ticket price in 2008 adjusted for inflation shows a more realistic view of Avatars performance. a- why would adjusting for the inflation show a more realistic view of Avatar's performance at the box office? b- Which would be a more accurate measure of how well a movie has performed at the box office: The dollar value of tickets sold or the number of tickets sold? Why don't newspapers report the number of tickets sold rather than the dollar value of tickets sold? Would comparing the total number of tickets sold by all movies in 1939 with the total number of tickets sold by all movies in 2011 be a good way to measure how the relative importance of movies in the economy has changed over time?
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a- Adjusting for inflation would remove the effect of higher ticket prices when comparing Avatar's box office receipts with Titanic's box office receipts. In general, real box office receipts adjusted for inflation would be a better way to measure box office receipts across time. b- the dollar value of tickets sold would be a more accurate measure of how well a movie performed at the box office, as long as the dollar value was adjusted for inflation. The number of tickets sold does not represent the monetary value of the movie. Comparing the total number of tickets sold by all movies in 1939 with the total number of tickets sold by all movies in 2011 would not include the monetary value moviegoers placed on movies relative to other goods and services.
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Difference between GDP and GNP? Briefly explain whether the difference is important for the United States.
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GDP is the market value of all final goods and services produced within the United States. GNP is the market value of all final goods and services produced by residents of the United States, even if the production takes place outside the United States. For the U.S. GDP is almost the same as GNP. In many countires GDP is much larger than GNP.
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Suppose a country has many of its citizens temporarily working in other countries, and many of its firms have facilities in other countries. Furthermore, relatively few citizens of foreign countries are working in this country, and relatively few foreign firms have facilities in this country. In these circumstances, which would you expect to be larger for this country, GDP of GNP?
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GNP would be larger than GDP. The country has relatively more of its firms and residents working in other countries.
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How is the unemployment rate measured? What are the three conditions someone needs to meet to be counted as unemployed?
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Unemployment rate is calculated monthly from dad gather by the U.S. Bureau of the Census in its household survey. The unemployment rate equals the percentage of the labor force that is unemployed: (Unemployed/Labor Force) x 100. The three conditions to be counted as unemployed are the person (1) did not work in the previous week, (2) was available for work, and (3) actively looked for work at some time during the previous four weeks.
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What are the problems in measuring the unemployment rate? In what ways does the official BLS measure of the unemployment rate understate the true degree of unemployment?
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The official BLS measure of the unemployment rate understates the true degree of unemployment to the extent that it does not count discouraged workers as unemployed because they have stopped looking for a job, and it counts involuntary part-time workers as employed even though these workers would prefer to work more hours. The official BLS measure overstates the true degree of unemployment because (1) some people claim to be actively looking for work but are not so they can remain eligible for government payments to be unemployed, and (2) some people have jobs in the underground that they do not claim.
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What dose the labor force participation rate measure? Since 1950, how have the labor force participation rates of men and women changed.
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The labor force participation rate measures the percentage of the working-age population that is in the labor force: (Labor Force/Working age population) x 100. Since 1950, the labor force participation rate has decreased for men and increased for women.
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What does the employment-population ratio measure? How does an unemployed person dropping out of the labor force affect the unemployment rate? How does it affect the employment-population ratio?
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The employment population ratio measures the percentage of the working-age population that is employed and: (Employment/Working-age population) x 100. An unemployed person dropping out of the labor force would decrease the unemployment rate, but it would not change the employment-population ratio.
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What is the difference between the household survey and the establishment survey?
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Household survey is a sample of 60,000 households chosen to represent the U.S. population and provides information on the employment status o everyone in the household 16 years of age and older. The establishment survey is a sample of 300,000 business establishments and gathers information on the total number of people employed and on a company payroll. The household survey includes information on both employment and unemployment, while the establishment survey includes information only on employment. Many economists prefer the establishment survey because it is based on actual payrolls, rather than on unverified answers as in the household survey.
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Home makers are not included in the employment or labor force totals compiled in the BLS household survey. They are included in the working-age population totals. Suppose that homemakers were counted as employed and included in the labor force statistics. How would that change affect the unemployment rate, the labor force participation rate, and the employment population ratio?
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Including homemakers as employed would decrease the unemployment rate because it increases the size of the labor force, but leaves unchanged the number of unemployed. Including homemakers as employed would increase the labor force participation rate because it increases the labor force, but leaves unchanged the working-age population. Including homemakers would increase the employment population ratio because it increases the number of employed, but does not change the working-age population.
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Why might the employment population ration provide the "best summary" of the state of the job market rather than the unemployment rate?
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A weakness of the unemployment rate is that if does not count as unemployed those workers who drop out of the labor force. As a result, some economists focus on the employment-population ratio because it measures the fraction of the working-age population that has jobs.
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Three types of unemployment
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Frictional, structural, and cyclical. Frictional- short term unemployment that arises from the process of matching workers with jobs. Structural- arises from a persistent mismatch between the skills and attributes of workers and the requirements of jobs Cyclical- caused by a business cycle recession.
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What is the relationship between frictional unemployment and job search?
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Frictional unemployment arises from the process of matching workers with jobs. Because job search takes time, there are always some workers who are frictionally unemployed because they have begun a job search and have not yet found a job.
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What is the natural rate of unemployment? What is the relationship between the natural rate of unemployment and full employment? Would it be better for economists to define full employment as being an unemployment rate equal to zero?
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Natural rate of unemployment is the normal rate of unemployment, consisting of frictional unemployment plus structural unemployment. The natural rate of unemployment is the full-employment rate of unemployment. Economists do not define full employment as being an unemployment rate equal to zero because the creating and destroying of jobs that leads to frictional unemployment and the structural changes in the economy from factors such as innovation that lead to structural unemployment are ongoing features of a growing dynamic economy. No economy attains an employment rate of zero even during wartime.
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What advice for finding a job would you give someone who is frictionally unemployed? What advice would you give someone who is structually unemployed? What advice would you give someone who is cyclically unemployed?
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Frictionally- keep searching, the person has the required skills but matching worker skills to job openings takes time structually- center on the needs to retrain or to find another occupation cyclically- to realize that the search will take longer because of the recession, and to consider temporarily taking a lower paying job or going back to school until the economy picks up.
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What effect does the payment of government unemployment insurance have on the unemployment rate? On the severity of recessions?
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The payment of government unemployment insurance likely raises the unemployment rate. The unemployment insurance payments lower the opportunity cost (the income lost by not working) of continuing to search for a job, which leads to unemployment to spend more time searching for a job. The payment of government unemployment insurance lessens the severity of recessions by helping the unemployed maintain their income and spending.
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Discuss the effect of each of the following on the unemployment rate. a- federal minimum wage law b- labor unions c- efficiency wages
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a- The federal minimum wage law and efficiency wages push the wage above the market wage, causing some unemployment. In unionized industries the wage is usually above what otherwise be the market wage, resulting in employers hiring fewer workers. Most economists do not believe that the existence of unions increases the overall unemployment rate, though, because fewer than 9 percent of workers outside the government sector are unionized.
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Why has the unemployment rate in the United States typically been lower than unemployment rates in Canada and other countries in Western Europe?
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More generous unemployment compensation payments and social insurance programs in Canada and Western Europe, which lower the opportunity costs of continuing to search for a job.
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Segolene Royal president hopeful proposed that workers who lost their jobs would receive unemployment payments equal to 90% of their previous wages during their first year of unemployment. If this proposal were enacted, what would likely be the effect on the unemployment rate in France?
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If proposal were enacted, the unemployment rate in France would be higher because the law would substantially reduce the opportunity cost of continuing to search for a job as measured by the income the unemployed give up by not working.
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If Congress eliminated the unemployment insurance system, what would be the effect on the level of frictional unemployment?
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The opportunity cost of job search would increase, decreasing the level of frictional unemployment. There would be conflicting effects on the level of real GDP. Lower frictional unemployment would increase real GDP, but the possibility effective matching of worker skills to jobs due to less job search would decrease real GDP. Well-being would probably decrease if the unemployment insurance system were eliminated because unemployment workers would suffer large drops in income.
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Explain the effect on unemployment rate by each of the following. a- length of time workers are eligible to receive unemployment insurance payments doubles b- minimum wage is abolished c- most U.S. workers join labor unions d- more companies make information on job openings easily available on internet job sites.
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a&c- likely to increase the unemployment rate; lengthening the time workers are eligible to receive unemployment insurance lowers the opportunity cost of a job search; an increase in union membership pushes more wages above market wages b&d- likely to reduce the unemployment rate; abolishing the minimum wage lowers the wage from above the market wage for some workers; making information on job openings more available shortens the search involved in frictional unemployment.
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Costco typically pays its workers higher wages than does Wal-Mart. One analyst argues "because it requires higher skilled workers to sell higher cost products to more affluent costumers." If this is true, can we conclude that Costco is paying efficiency wages and Wal Mart is not?
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We cannot conclude that Costco is paying efficiency wages and WalMart is not. The higher Costco wages would be due to the higher-skilled workers required to sell the Costco's higher products.
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The three major measurements of the price level.
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GDP deflator is the broadest measure of the price level because it includes the prices of all final goods and services included in GDP. The Consumer Price Index measures the prices of goods and services purchased by consumers. The Producer Price Index measures the prices of goods and services at all stages of the production prices.
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Which price index does the government use to measure changes in the cost of living.
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CPI is used to measure changes in the cost of living.
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What potential biases exist in calculating the consumer price index? What steps has the BLS taken to reduce the size of the biases?
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Potential biases include the substitution bias, the increase in quality bias, the new product bias, and the outlet bias. BLS updates the market basket every two years to reduce the substitution bias and the new product bias, uses statistical methods to reduce the quality bias, and conducts point of purchase surveys to track where consumers actually make their purchases to reduce the outlet bias.
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In calculating the consumer price index for the year, why does the BLS use the quantities in the market basket, rather than the quantities purchased during the current year?
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The CPI, at any point in time, uses a fixed market basket, comparing the cost of buying the fixed market basked in the current period to the cost of buying the fixed market basket in the base period. As a fixed market basket, the BLS uses the quantities in the market basket, not the quantities actually purchased in the current period.
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Apple introduced the iPhone 4S which has new features including an improved camera and voice control but sold at the same price as the old 4. How as the CSI affected by the introduction of the 4S?
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The BLS updates the CPI market basket every two years, so these new models would not be immediately included in CPI calculations. Once the new phone is included in the market basket, the CPI will overstate the inflation rate unless the BLS corrects the index to account for the new phone having features not included in the previous version of the phone.
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What is the difference between a nominal variable and a real variable?
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A nominal variable is a variable measured in current dollars, which means that it is measured using the actual prices from that year. A real variable is a variable measured in constant dollars, which means that it is measured using prices from the base year. That is, a real variable is adjusted for the effects of inflation.
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Briefly explain how you can use data on nominal wages for 2004-2011 an data on the consumer price index for the same years to calculate the real wage for these years.
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Real wage for a given year between 2004-2011 can be calculated by using the formula: Real wage = (nominal wage/CPI) x 100. For example, the real wage for 2005 wouldl be calculated as Real Wage 2005 = (nominal wage 2005/CPI 2005) x 100.
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The CPI in 1924 was 17 and the CPI in 2010 was 218. What income would you have needed in 2010 to have had the same purchasing power that Fitzgerald's $36,000 had in 1924?
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Convert Fitzgerald's 1924 nominal income of $36,000 to an equivalent income in 2010 by multiplying the 1924 nominal income by the ratio of the CPI for 2010 to the CPI in 1924: $36,000 x (218/17) = $461,647. So you would have needed an income of $461, 647 in 2010 to have the same purchasing power that Fitzgerald's $36,000 had in 1924.
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What is the difference between the nominal interest rate and the real interest rate?
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Nominal interest rate is the stated interest rate on a loan, while the real interest rate is the nominal interest rate minus the inflation rate.
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If inflation is expected to increase, what will happen to the nominal interest rate? Explain.
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The nominal interest rate is the real interest rate plus the inflation rate, an increase in expected inflation raises the nominal interest rate by the increase in the expected rate of inflation, assuming that the real interest rate remains constant.
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The chapter explains that it is impossible to know whether a particular nominal interest rate is "high" or "low". Briefly explain why.
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It is impossible to know whether a particular nominal interest rate is "high" or "low" without knowing the inflation rate. It is the real interest rate that matters to borrowers and lenders, not the nominal interest rate. A nominal interest rate of 5% with an inflation rate of zero has a higher real interest rate than a nominal interest rate of 20% with an inflation of 19%.
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Suppose you were borrowing money to buy a car. Which of these situations would you prefer: The interest rate on your car loan is 20% and the inflation rate is 19% or the interest rate on your car loan is 5% and the inflation rate is 2%? Explain.
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The real interest rate on a loan with a nominal interest rate of 20% and 19% inflation is 1%. The real interest rate on a loan with a nominal interest rate of 5% and 2% inflation is 3%. Therefore, you should prefer the loan with the 20% nominal rate.
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Describing the situation in England in 1920, the historian Robert Skidelsky wrote the following: Who would not borrow at 4% a year with prices going up 4% a month? What was the real interest rate paid by borrowers in this situation?
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If the monthly inflation rate is 4%, the annual inflation rate is about 60% To see this, notice that at a 4% inflation rate, the price level is rising 4% per month. if the price level starts at 100, after 2 months it would have increased to 100 x 1.04 x 1.04 = 108.2; after three months it would have increased to 100 x 1.04 x 1.04 x 1.04 = 122.5; and after 12 months to 100 x (1.04)12 = 160.1 or 60.1 percent. So, the real interest rate would be 4%-60% = -56%.
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what is the rule of 70? If real GDP per capita grows at a rate of 7 percent per year how many years will it take to double?
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The rule of 70 is a quick way to calculate the approximate number of years it will take for a quantity such as real GDP per capita to double. Dividing 70 by the growth rate per year yields the approximate number of years to double. If real GDP per capita grows at the rate of 7% per year, it will take ten years (70/7) for real GDP per capita to double.
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What is the most important factor in explaining increases in real GDP per capita in the long run?
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The most important factor that explains increase in real GDP per capita in the long run is labor productivity, which is the quantity of goods and services that can be produced by one worker or by one hour of hard work.
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What is the potential real GDP? Does potential real GDP remain constant over time?
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Potential GDP is the level of real GDP attained when all firms are producing at capacity. Historically, potential GDP has substantially increased over time.
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Real GDP per capita in the U.S. as mentioned in the chapter, grew from about $5,600 in 1900 to about $42,000 in 2010, which represents an annual growth rate of 1.8%. If the U.S. continues to grow at this rate, how many years will it take for real GDP per capita to double? If government economic policies meant to stimulate economic growth result in the annual growth rate increasing to 2.0%, how many years will it take for real GDP per capita to double?
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Using the rule of 70, it will take approximately 39 (70/1.8) years for real GDP per capita to double if it grows at 1.8% a year. If the annual growth rate increase to 2%, real GDP per capita would double in approximately 35 years (=70/2).
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A study conducted by the Moscow-based management consulting firm Strategy Partners found that average labor productivity in Russia is only 17% of labor productivity in the U.S. What factors would cause U.S. labor productivity to be nearly 6 times higher than Russian labor productivity ?
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More capital equipment and, more importantly better technology, are the primary reasons why labor productivity is higher in the U.S. than it is in Russia.
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How does the financial system - either financial markets or financial intermediaries- provide risk sharing, liquidity, and information for savers and borrowers?
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The financial system provides risk sharing by allowing savers to spread their saving among many financial investments. It provides liquidity by providing savers with markets in which they can sell their holding of financial securities. The financial system provides information by specializing in gathering information on borrowers and by communicating information on business by incorporating that information into the prices of stocks and bonds.
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An IMF factsheet makes the following observation regarding stable financial systems: " A sound financial system is ... essential for supporting economic growth." Do you agree?
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Agree. Capital investment is a key factor for economic growth. A sound financial system helps to channel saving to firms that need to borrow funds for capital investment.
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Describe the effect of the business cycle on the inflation rate and the unemployment rate. Why might the unemployment rate continue to rise during the early stages of a recovery?
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During an economic expansion, particularly near the end of the expansion, the inflation rate typically increases. During recessions, the inflation rate typically decreases. The unemployment rate rises during recessions and, after a delay, falls during expansions. The unemployment rate may continue to rise during the early stages of a recovery because employment may grow more slowly than the labor force and because some firms are operating well below capacity, these firms may be slow to hire laid-off workers or may continue to lay off more workers for a period.
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Explain whether production of each of the following goods is likely to fluctuate more or less than real GDP does during the business cycle: a- Ford F150 Trucks b- McDonalds Big Mac c-Kenmore fridge d-Huggies diapers e-Boeing passenger aircraft
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a, c, e- durable goods, and would be expected to fluctuate more than real GDP during the business cycle. b, d- nondurable goods and would be expected to fluctuate less than real GDP
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"Real GDP in 2010 was $13.1 trillion. This value is a large number. Therefore, economic growth must have been high during 2010." Briefly explain if you agree or disagree.
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Disagree. Real GDP itself is not a measure of economic growth which is the % change in real GDP from one year to the next. Despite the fact that $13.1 trillion for real GDP in 2010 is a large number, economic growth might have been small, or negative. To calculate economic growth during 2010, we also need to know the value of real GDP in 2009.
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What is the key idea in the aggregate expenditure macroeconomic model?
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Any particular year the level of real GDP is determined mainly be the level of aggregate expenditure.
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What is the main reason for changes in GDP in the short run?
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Main reason for changes in GDP in the short run is changed in the level of aggregate expenditure.
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What are inventories? What usually happens to inventories at the beginning of a recession?
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Inventories are good that have been produced but not yet sold. Inventories usually rise at the beginning of a recession and usually fall at the beginning of an expansion.
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In the aggregate expenditure model, why is it important to know the factors that determine consumption spending, investment spending, government purchases, and net exports?
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In the aggregate expenditure model real GDP changes only when aggregate expenditure changes, so it is crucial to understand the factors that change each of the four categories of aggregate expenditure
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What are the 5 main determinants of consumption spending? Which of these is most important? How would a rise in stock prices of housing prices affect consumption spending?
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5 main determinants of consumption -disposable income -household wealth -expected future income -price level -interest rate. The most important determinant is current disposable income. A rise in stock prices or housing prices would increase household wealth, which would increase consumption spending.
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4 main categories of investment? How would a change in interest rates affect investment?
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-Expectations of future profitability -interest rate -business taxes -cash flow. An increase in the interest rate would decrease investment spending.
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What are the main determinant of net exports? How would an increase in the growth rate of GDP in the BRIC nations (Brazil, Russia, India and China) affect the U.S. net exports?
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Three main determinants of net exports are the price level in the United States relative to the price level in other countries, the growth rate of GDP in the United States relative to the growth rate of GDP in other countries, and the exchange rate between the dollar and other currencies. An increase in the growth rate of GDP in the BRIC nations, for any given growth rate of GDP in the United States would increase U.S. net exports.
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Suppose a major U.S. furniture manufacturer is forecasting demand for its produces during the next year. How will the forecast be affected by each of the following? a- a survey shows a sharp rise in consumer confidence that income growth will be increasing b-real interest rates are expected to increase c- The exchange rate value of the U.S. dollar is expected to increase d- planned investment spending in the economy is expected to decrease
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a-cause the demand forecast to rise because it involved an increase in aggregate expenditure b, c, d- cause the aggregate demand forecast to fall because each involves a decline in aggregate expenditure
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Unemployed workers receive unemployment insurance payment from the government. Does the existence of unemployment insurance make it likely that consumption will fluctuate more of fluctuate less over the business cycle than it would in the absence of unemployment insurance?
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Consumption will fluctuate less. The 5 main determinants of consumption spending are current disposable income, household wealth, expected future income, the price level, and the interest rate. The most important determinant is current disposable income. Therefore, as unemployment insurance benefits reduce fluctuations in income, fluctuations in consumption are also reduced.
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45 degree diagram illustrating macroeconomic equilibrium showing aggregated expenditure function and the level of equilibrium real GDP and that your axes are properly labeled.
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What does the slope of the aggregate expenditure line equal? How is the slope of the aggregate expenditure line related to the slope o the consumption function.
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Slope of the AE expenditure line is the change in AE for a change in real GDP. The simple aggregate expenditure model assumes that tazed, planned investment spending, government purchaes, and net exports are independent of income. So, the slope of the AE line equals the slope of the consumption function, which is the marginal propensity to consume.
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What is the difference between AE and consumption spending?
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AE represents the total spending in the economy. Consumption spending is just one component of AE. The other components of AE are: planned investment, government purchases, and net exports.
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What is the multiplier effect? Draw a 45 degree line diagram to illustrate the multiplier effect of a decrease in government purchases.
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Multiplier effect is a process by which a change in autonomous expenditure leads to a change in real GDP. In the graph that follows, the decrease in government purchases causes the line representing the planned aggregate expenditure to shift down. Equilibrium real GDP declines by more than the drop in government purchases: Real GDP declines by the drop in government purchases multiplied by the value of the multiplier.
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What is the formula for the multiplier? Explain why this formula is considered to be too simple.
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Forumla = 1/1-MPC. This formula ignores the effect that changes in GDP can have on imports, the price level, income taxes, and interest rate. Ignoring these factors causes the multiplier formula to overstate the size of the real-world multiplier.
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If the marginal propensity to consume is 0.75, by hoe much will an increase in planned investment spending of $400 billion shift up the aggregate expenditure line? By how much will it increase equilibrium real GDP?
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Aggregate expenditure line will shift up by the $400 billion increase in planned investment spending. Equilibrium real GDP will increase by $400 billion times the expenditure multiplier. With a marginal propensity to consumer of 0.75, the expenditure multiplier equals 4. Equilibrium real GDP increases $1,600 billion ($400 billion x 4).
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Explain whether each of the following would cause the value of the multiplier to be larger or smaller. a- an increase in real GDP increases imports b-an increase in real GDP increases interest rates c-an increase in real GDP increases the marginal propensity to consumer d- an increase in real GDP causes the average tax rate paid by households to decrease e- an increase in real GDP increases the price level
answer
a, b, e- would cause the value of the multiplier effect to be smaller c, d- would cause the value of the multiplier to be larger
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Suppose booming economies in the BRIC nations causes net exports to rise by $75 billion in the United States. If the MPC is 0.8 what will be the change in equilibrium GDP?
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Multiplie = 1/1-.08 = 5 Change in equilibrium GDP = $75 billion x 5 = $375 billion
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Would a larger multiplier lead to longer and more severe recessions or shorter and less sever recessions? Briefly explain.
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A larger multiplier would be likely to lead to a longer and more sever recessions because it would magnify the effect on the economy of changes in autonomous expenditures.
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What relationship is shown by the aggregate demand curve? What relationship is shown by the aggregate supply curve?
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The AD curve shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government. The short-run aggregate supply curve shows the relationship in the short run between the price level and the quantity of real GDP supplied by the firms, and the long-run aggregate supply curve shows the relationships in the long run between the price level and the quantity of real GDP supplied by firms.
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What variable cause the AD curve to shift? For each variable, identify whether an increase in that variable will cause the AD curve to shift to the right or to the left.
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The variables that will cause the aggregate demand curve to shift are interest rates, government purchases, personal income taxes, household expectations of future incomes, firms expectations of the future profitability of investment spending, the growth rate of domestic GDP relative to the growth rate of foreign GDP and the exchange rate value of the dollar. Increases in government purchases, household expectations of their future incomes, and firms expectations of the future profitability of investment spending will cause the aggregate demand curve to shift to the right. Increases in interest rates, personal income taxes, or business taxes, the growth rate of domestic GDP relative to the growth rate of foreign GDP and the exchange rate value of the dollar will cause the aggregate demand curve to shift to the left.
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Explain how each of the following events would affect the AD curve? a- increase in price level b-increase in government purchases c- higher state income taxes d- higher interest rates e- faster income growth in other countries
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A- increse in price level would cause the aggregate demand curve to shift to the right b-increase in government purchases would cause the aggregate demand curve to shift to the right c- higher state income taxes would decrease disposale income, thereby decreasing consumption spending and causing the aggregate demand curve to shift to the left d- higher interest rates would decrease investment spending and consumer spending, particularly on durable goods, causing the aggregate demand curve to shift to the left e- faster income growth in other countries would increase U.S. exports, causing the aggregate demand curve to shift to the right
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Explain why long-run aggregate supply curve is vertical.
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Long run aggregate supply curve is vertical because in the long run changes in the price level do not affect the number of workers, the capital stock, or technology which are the factors that determine potential GDP.
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What variables cause the short run aggregate supply curve to shift? For each variable, identify whether an increase in that variable will cause the short-run aggregate supply curve to shift to the right or to the left.
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Variable that will cause the short-run aggregate supply to shift are: the size of the labor force, the size of the capital stock, productivity, the expected future price level, workers and firms adjusting to having previously underestimated the price level, and the expected price of an important natural resource. Increase in the labor force, the capital stock, or productivity will cause the short-run aggregate supply curve to shift to the right. Increases in the expected future price level, increases in the price of an important nature resources, and workers and firms adjusting to having previously underestimated the price level will cause the short-run aggregate supply curve to shift to the left.
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What is the relationship among the AD, SRAS, and LRAS curves when the economy is in long-run macroeconomic equilibrium?
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When the economy is in long-run equilibrium, the short-run aggregate supply curve and the aggregate demand curve intersect at a point on the long-run aggregate supply curve.
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Why might a supply shock lead to stagflation?
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An adverse supply shock causes the short-run aggregate supply curve to shift to the left, causing an increase in the price level and a decrease in real GDP. An increase in the price level occurring at the same time as a decrease in real GDP is known as stagflation.
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Why are the long-run effects of an increase in aggregate demand on price and output different from the short-run effects?
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Long run effects of an increase in aggregate demand differ from the short-run effects because the ling-run and the short run aggregate supply curves differ. With a vertical LRAS, changes in AD affect only the price level, not real GDP. With an upward sloping SRAS, changes in AD affect both the price level and the real GDP.
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Briefly explain how the economy adjusts from the short-run equilibrium to the long-run equilibrium.
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Workers will push for higher wages and firms will charge higher prices, causing the short-run aggregate supply cure to shift to the left until it reaches SRAS and long-run equilibrium is restored.
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What is the difference between commodity money and fiat money?
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Commodity money has value independent of its use as money, whereas fiat money, typically paper currency, does not have value independent of its use as money.
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Why do businesses accept paper currency when they know that, unlike a gold coin, the paper the currency is printed on is worth very little?
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Businesses accept paper currency because the paper currency is acceptable to other people and businesses in exchange for goods and services. Paper currency serves as money because people believe that other will accept it from them.
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An article in the NYTimes provides the following description of a hospital in Zimbabwe: "People lined up on the veranda of the American mission hospital here from miles around to barter for doctor visits and medicines, clutching scrawny chickens, squirming goats, and buckets of maize." Why wouldn't the people buying medical services at this possible use money to pay for the medical service they are buying?
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Hyperinflation in Zimbabe was so sever that local residents refused to accept Zimbabwean dollars in exchange for goods and services, so people had to restore to barter.
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According to Peter Heather, a historian at the University of Oxford, during the Roman Empire, the German tribes east of Rhine River produced no coins of their own but used Roman coins instead: Although no coinage was produced in Germaina, Roman coins were in plentiful circulation and could easily have provided a medium of exchange (already in the first century, Tacitus tells us Germani of the Rhine region were using good quality Roman silver coins for this paper.) a- what is the medium of exchange? b- What does the author mean when he writes that Roman coins could have provided the German tribes with a medium of exchange? c- Why would any member of a German tribe have been willing to accept a Roman coin from another member of the tribe in exchange for goods or services when the tribes were not part of the Roman Empire and were not governed by Roman law?
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a- a medium of exchange refers to anything that is generally accepted in exchange for goods and services b- because the german tribes widely used Roman coins as they bought and sold goods and services, the coins became the German tribes medium of exchange c-a member of the German tribe was willing to accept the Roman coins as long as he or she believed that the coins were acceptable to other people in the tribe
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What is the main difference between the M1 and the M2 definitions of the money supply?
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M2 includes M1 plus savings account balances, small denomination time deposits, money market deposit accounts in banks, and non institutional money market fund shares.
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Distinguish among money, income and wealth. Which one of the three does the central bank of a country control?
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Wealth equals the value of assets minus the value of any liabilities, or debts; income equals earnings during a period of time, such as a year; and money (using the M1 definition) equals currency plus checking account deposits. The central bank controls the quantity of money
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What does it mean to say that banks "create money"?
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To say that banks "create money" means that banks create checking account deposits, which are part of M1, when they make loans from their excess reserves.
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"Most of the money supply of the US is created by banks making loans." Briefly explain whether you agree with this statement.
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You should agree with this statement because when banks increase their loans, they create new checking account deposits and expand the money supply.
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What policy tools does the Fed use to control the money supply? Which tool is the most important?
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The three policy tools are open market operations, discount policy, and reserve requirements, with open market operations being the most important.
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Why does an open market purchase of Treasury securities by the Federal Reserve increase bank reserves? Why does an open market sale of Treasury securities by the Federal Reserve decrease bank reserves?
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When the Federal Reserve buys Treasury securities from the public, the sellers of the securities deposit the funds in their banks, increasing bank reserves. When the Federal Reserve sells Treasury securities to the public, the buyers of the securities pay with checks, decreasing bank reserves.
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What is the "shadow banking system"? Why were the financial firms of the shadow banking system more vulnerable than commercial banks to bank runs?
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"Shadow banking system" is a term used by the Treasury Secretary Timothy Geithner when referring to investment banks, money market mutual funds, hedge funds, and other firms engaged in similar activities to these firms. These firms raise funds from individual investors and from other financial firms and lend or invest the funds, either directly indirectly. In doing so, these firms are carrying out a function that at one time was almost exclusively the domain of commercial banks. The financial firms of the shadow banking system are more vulnerable than commercial banks to runs because they are more highly leveraged, they do not have federal deposit insurance, and the government agencies, including the Federal Reserve, that regulate the commercial banking system have not regulated there firms as closely.
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The text explains that the US has a "fractional reserve banking system." Why do most depositors seem to be unworried that banks loan out most of the deposits they receive?
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Withdrawals are typically not a problem for baks because as long as depositors have confidence in a bank, on a typical day about as much money is deposited as in withdrawn. Also, depositors know that the Federal Deposit Insurance Corporation insures their deposits up to $250,000 per deposit.
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Suppose that you are a bank manager, and the Federal Reserve raises the required reserve ratio from 10% to 12%. What actions would you need to take? How would your actions and those of other bank managers end up affecting the money supply?
answer
Bank managers would need to increase their reserves by holding a higher portion of new deposits as reserves and, possibly, failing to renew some loans until they meet the higher required reserve ratio. (Bank managers could also borrow reserves from other banks and sell some of your holdings of Treasury securities to increase reserves.) The increase in required reserves means that bank mangers have to reduce the amount of loans that their banks can make for a given amount of deposits. Fewer loans by banks means a decrease in the money supply.
question
In a speech delivered in June 2008, Timothy Geithner, then president of the Federal Reserve Bank of New York and later U.S. Treasury secretary said: The structure of the financial system changed fundamentally during the boom... The non-bank financial system grew to be very large. The institutions in this parallel financial system are vulnerable to a classic type of run, but without the protections such as deposit insurance that the banking system has in place to reduce such risks. a- what did Geithner mean by the "non-bank financial system"? b- What is a "classic type of run", and why were institutions in the nonbank financial system vulnerable to it? c- why would deposit insurance provide the banking system with protection against runs?
answer
a-By the "nonbank financial system" Geithner was referring to investment bank, money market mutual funds, hedge funds, and other firms in the "shadow banking system" b- a "classic type" of bank run is a situation in which many depositors simultaneously decide to withdraw money from a commercial bank. Institutions in the nonbank financial system were vulnerable to a bank run for several reasons. They were not closely regulated by the government agencies, including the Federal Reserve, that regulate commercial banks. These firms were also more highly leveraged than commercial banks. Also, unlike commercial banks, firms in the nonbank financial system were not covered by the federal deposit insurance program. c-Deposit insurance reassures depositors that their deposits are safe even if their bank goes out of business and, therefore, significantly reduces the likelihood of a bank run.
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When the Federal Reserve steps in as the lender of last resort to prevent a bank panic, does this constitute a "bail out of the banks"? Briefly explain.
answer
When the Federal Reserve acts as lender of last resort during a bank panic, it does not "bail out" banks in the way that the federal government is said to have "bailed out" private companies during the recession of 2007-2009 and its aftermath. The Federal Reserve does not use taxpayer funds to pay bank debts. Instead, the Federal Reserve offers to loan reserves to banks so that they can meet their depositors' desires to withdraw funds from their accounts. A bank panic is made possible by the nature of the fractional reserve system. Even banks that are well managed and profitable do not have enough reserves on hand to meet a large volume of deposit withdraws.
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What are the Fed's four monetary policy goals?
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price stability, high employment, economic growth, and stability of financial markets and institutions
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Why is the Fed sometimes said to have a "dual mandate"?
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The Federal Reserve has a dual mandate in the sense that the Employment Act of 1946 explicitly mentioned that it is the responsibility of the Federal Government (including the federal reserve) to promote maximum employment and stable prices.
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A former Federal Reserve official argued that at the Fed, "the objectives of price stability and low long term interest rate are essential the same objective." Briefly explain his reasoning.
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Nominal interest rates tend to be lower when inflation is low, and they tend to be higher when inflation is high. (The nominal interest rate equals the real interest rate plus the expected inflation rate.) Therefore, if the Fed achieves price stability, long-term interest rates are likely to be low.
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What is the federal funds rate? What role does it play in monetary policy?
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The federal funds rate is the interest rate banks charge each other for overnight loans. It is the interest rate that the Federal Reserve targets for monetary policy.
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difference between federal funds rate and discount rate
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the discount rate is the rate at which Federal Reserve charges banks for discount loans, whereas the federal funds rate is the rate banks charge each other for overnight loans.
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If the Federal Reserve purchases $100 million worth of U.S. Treasury bills from the public, predict what will happen to the money supply. Explain.
answer
The Fed's purchase of Treasury bills will increase reserves in the banking system. As banks use there reserves to make new loans, the money supply will increase.
question
What is the relationship between the federal funds rate falling and the money supply increasing? How does lowering the target for the federal funds rate "pour money" into the banking system?
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An increase in the money supply will lower interest rates as in show in Figure 26.4. When it lowers the target for the federal funds rate, the Fed buys Treasury bills, which increases banks' reserves, bank loans, and the money supply.
question
aggregate demand and aggregate supply
answer
a model that explains short-run fluctuations in real GDP and the price level
question
How does an increase in interest rates affect aggregate demand? Briefly discuss how how each component of aggregate demand is affected.
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Increase in interest rates decrease aggregate demand. Higher interest rates decrease investment spending, including new homes, consumption, and durable goods. Net exports also decline as higher interest rates increase the exchange rate between the dollar and foreign currencies. Government purchases are not affected by increases in the interest rate.
question
IF the Fed believes the economy is about to fall into recession, what actions should it take? If the Fed believes the inflation rate is about to increase, what actions should it take?
answer
If the Fed believes the economy is about to fall into a recession it should conduct expansionary monetary policy, increasing the money supply and reducing interest rates. If the Fed believes that the inflation rate is about to increase, it should conduct contradictory monetary policy, adjusting the money supply so as to increase interest rates.
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What were "quantitative easing" and "Operation Twist" and what was the Fed's objective in using them?
answer
Quantitative easing refers to the buying of securities (such as ten-year treasury notes and mortgage-backed securities) beyond the short-term Treasury securities (Treasury bills) that the Fed usually buys in open market operations. With Operation Twist, the Fed purchased long-term Treasury securities while selling an equal amount of shorter-term Treasury securities. Because the Fed could not reduce the federal funds rate below zero (it was already between 0-0.25%) it began purchasing longer-term securities to reduce long-term interest rates. The objective of both quantitative easing and Operation Twist was to reduce longer-term interest rates.
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a- What is a policy of money stimulus? b- if unemployed people have been out of work for a long time, why might policies that increase their ability to find jobs be more effective in reducing unemployment than a policy of monetary stimulus?
answer
a- Monetary stimulus refers to expansionary monetary policy, such as lowering the target for the federal funds rate and quantitative easing. b- If many unemployed people have been out of work for a long time and have become effectively unemployable, then they are structurally unemployed and part of the natural rate of unemployment. Expansionary monetary policy does not generally reduce structural unemployment and the natural rate of unemployment. Policies such as providing additional training can increase the ability of the structurally unemployed to find jobs and thereby reduce unemployment.
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A- Why might QE2 which resulted in a decline in interest rates on long-term Treasury securities, have resulted in an increase in stock prices?
answer
A- Any decline in long-term investment rates from QE2 would stimulate the economy and the prospects of future profits which would increase current stock prices. Lower interest rates also increase the present value of any expected future profits, increasing current stock prices. Looked at another way, because investors would be receiving only low interest rates on long-term bonds they might see stocks as a more attractive investment. The result would be an increase in the demand for stocks, thereby increasing stock prices.
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B- Why was the Fed hoping for consumers to increase their spending in late 2010?
answer
The Fed hoped that consumers would increase spending to stimulate the economy. Even though the recession officially ended in June 2009, the growth of the economy was slow and there was concern about a double dip into another recession.
question
For more than 20 years, the Fed has used the federal funds rate as its monetary policy target. Why doesn't the Fed target the money supply at the same time?
answer
The fed does not control the money demand, it cannot target both the federal funds rate and the money supply at the same time.
question
What is the Taylor rule? What is its purpose?
answer
The Taylor rule is a rule developed by John Taylor, an economist at Stanford University, that links the Federal Reserve's target for the federal funds rate to economic variables The purpose of the Taylor rule is to have a convenient way to determine approximately the target for the federal funds rate and to use that approximation to help evaluate whether the actual federal funds rate target set by the Federal Reserve is too high or too low.
question
If the core PCE is a better measure of the inflation rate than is the CPI why is the CPI more widely used? In particular, can you think of reasons the federal government uses the CPI when deciding how much to increase Social Security payments to retired workers to keep the purchasing power of the payments from declining?
answer
The core Personal Consumption Expenditures Price Index might better capture the underlying trends in inflation that the CPI does, but it excludes food and energy prices that affect the overall cost of living of the typical consumer. One of the reasons why the federal government continues to rely on the CPI instead of the PCE to adjust SS payments is that the CPI remains the most widely used measure of inflation and its market-basket approach better reflects the overall cost of living of the typical consumer The CPI is also a more familiar measure and, therefore, may be more politically acceptable to Congress in adjusting Social Security payments.
question
How might a lender intending to resell a mortgage act differently that a lender intending to hold a mortgage?
answer
Lenders would be more likely to grant mortgages if they intended to resell the mortgages than if they intended to hold them. Reselling reduces the risk of granting mortgages because lenders have less need to worry that borrowers will default on their mortgage loans.
question
What caused the change in the sources of mortgage finance? What would be the likely consequence of this change for the interest rates borrowers have to pay on mortgages? Explain.
answer
The establishment of Fannie Mae and Freddie Mac by Congress spurred the development of a secondary market in mortgage-backed securities. This, in turn, greatly expanded the sources of funding for mortgages. These developments meant that borrowers have been able to choose from a greater variety of lenders and small local banks face greater competition. This competition has reduced the interest rates borrowers have to pay on mortgages. In addition, the supply of funds available to finance mortgages also increased as investors purchased mortgage-backed securities. This increased supply has also contributed to lower mortgage interest rates.
question
What caused the change in the sources of mortgage finance? What would be the likely consequence of this change for the interest rates borrowers have to pay on mortgages? Explain.
answer
The establishment of Fannie Mae and Freddie Mac by Congress spurred the development of a secondary market in mortgage-backed securities. This, in turn, greatly expanded the sources of funding for mortgages. These developments meant that borrowers have been able to choose from a greater variety of lenders and small local banks face greater competition. This competition has reduced the interest rates borrowers have to pay on mortgages. In addition, the supply of funds available to finance mortgages also increased as investors purchased mortgage-backed securities. This increased supply has also contributed to lower mortgage interest rates.
