Study Questions

Study Questions Fall 2012 Chapter 5 Market failures, public goods and externalities 1. Explain the functions of government in an economy. Why do governments intervene in markets? 2. (a) Using the concept of allocative efficiency, explain the meaning of “market failure” and “externality”. Why is this is a type of market failure? (b) Explain the difference between the market equilibrium output and the efficient level of output when there are (i) negative externalities and (ii) positive externalities. c) Using diagrams provide an example of a negative externality (external cost) and a positive externality (external benefit) (other than the text examples).

(d) What kinds of policies can governments use to correct negative externalities and what kinds to correct positive externalities? Use diagrams to show how the externalities are corrected.3. (a) Explain the meaning of “rivalry” and “excludability”. (b) Use these concepts to distinguish between (i) private goods (ii) public goods. (c) Provide examples of each type of good. (d) Explain how governments reallocate resources to correct for the market’s failure to produce public goods.

e) What is the free rider problem? (g) Is U. S. border patrol a public good or a private good? Why? How about satellite TV? Explain. 4. Use the distinction between the characteristics of private and public goods to determine whether the following should be produced through the market system or provided by government: (a) French fries, (b) airport screening, (c) court systems, (d) mail delivery, and (e) medical care.

State why you answered as you did in each case. 5. Explain the difference between progressive, proportionate and regressive tax systems. 6.Suppose in Fiscalville there is no tax on the first $10,000 of income, but a 20% tax on earning between $10,000 and $20,000 and a 30% tax on income between $20,000 and $30,000.

Any income above $30,000 is taxed at 40%. If your income is $50,000, how much will you pay in taxes? Determine your marginal and average tax rates. Is this a progressive tax? Explain. Chapter 27 Measuring domestic output and income 1. (a) Why is domestic output measured in value terms; i.

e. why is it a monetary measure? (b) Why do economists include only final goods and services in measuring GDP for a particular year?Why don’t they include the value of stocks and bonds bought and sold? Why don’t they include the value of used furniture bought and sold? 2. What are transfer payments? Are they included in the measurement of GDP? Provide examples. 3. Use the concepts of gross investment and net investment to distinguish between an economy that has a rising stock of capital and one that has a falling stock of capital. “In 1933 net private domestic investment was minus $ 6 billion.

This means that in that particular year the economy produced no capital goods at all. ” Do you agree?Why or why not? Explain: “Though net investment can be positive, negative, or zero, it is quite impossible for gross investment to be less than zero. ” 4.

Why do national income accountants compare the market value of total outputs in various years rather than the physical volumes of production? What problem is posed by any comparison over time of the market values of various total outputs? How is this problem resolved? 5. (a) Calculate value added in the following production process. Firm| Sales| Value added| Firm A| $700|  | Firm B| $1100|  | Firm C| $1700|  | Total|  |  | b) Why is total value added equal to the selling price of firm C? 6. Explain why an economy’s output, in essence, is also its income. 7.

(a) Define GDP. (b) Define and explain the difference between the expenditures approach and the income approach to measuring GDP. 8. Define net exports. Explain how a nation’s exports and imports each affect domestic production.

How are net exports determined? Explain how net exports might be a negative amount. 9. Using the following national income accounting data, compute (a) GDP, (b) NDP, (c) NI. All figures are in billions. | | Compensation of employeesU. S.

xports of goods and servicesConsumption of fixed capital (depreciation)Government purchases Taxes on production and importsNet private domestic investmentTransfer paymentsU. S. imports of goods and servicesPersonal taxesNet foreign factor income Personal consumption expendituresStatistical discrepancy| $194171159145213164022190| | | 10. Below is a list of domestic output and national income figures for a given year. All figures are in billions. The questions that follow ask you to determine the major national income measures by both the expenditure and income methods.

The results you obtain with the different methods should be the same. | Personal consumption expendituresNet foreign factor income Transfer paymentsRentsStatistical discrepancyConsumption of fixed capital (depreciation)Social security contributionsInterestProprietors’ incomeNet exportsDividendsCompensation of employeesTaxes on production and importsUndistributed corporate profitsPersonal taxesCorporate income taxesCorporate profitsGovernment purchasesNet private domestic investmentPersonal saving| $2454121482720133311162231821261956723320| | | a. Using the above data, determine GDP by both the expenditure and the income approaches. Then determine NDP. b.Now determine NI: first, by making the required additions and subtractions from GDP; and second, by adding up the types of income and taxes that make up NI.

c. Adjust NI (from part b) as required to obtain PI. d. Adjust PI (from part c) as required to obtain DI. 11.

Explain the difference between real and nominal values. Why are economists interested in calculating real values (for example, real GDP, real income)? 12. The following table shows national income statistics for selected years. Year| 2006| 2007| 2008| 2009| 2010| Nominal GDP (billion $)| 19. 9| 20. 7| 21.

9| 22. 6| 22. 3| Price index| 98. | 100. 0| 102.

3| 107. 6| 103. 7| Real GDP (billion $)| | | | | | Real GDP per capita (thousand $)| | | | | | Rate of inflation| -| | | | | Rate of growth in real GDP| -| | | | | (a) Which year is the base year? (b) Calculate real GDP for each of the five years. (c) For which year is nominal GDP the same as real GDP? Why? (d) In 2008-09, nominal GDP increased but real GDP fell. Explain how this could have happened. (e) In 2009-10, nominal GDP fell, but real GDP increased.

Explain how this could have happened. (f) Calculate the rate of growth in real GDP in 2006-07, 2007-08, 2008-09, 2009-10. h) Calculate the rate of inflation (percentage change in the price level) as measured by the price index in the table, in 2006-07, 2007-08, 2008-09, 2009-10. 13. Suppose the population of the country above is the following: | 2009| 2010| Population (million)| 3. 0| 3.

3| Real GDP per capita (thousand $)| | | Rate of growth in real GDP per capita| -| | (a) Calculate real GDP per capita in 2009 and 2010. (b) Calculate the rate of growth in real GDP per capita in 2009-10. (c) Explain why real GDP per capita fell while real GDP increased in the period 2009-10. d) Explain whether real GDP per capita is an appropriate indicator of improvements in a population’s standard of living. 14. Explain some of the shortcomings of GDP as a measure of total output and wellbeing.

Chapter 29 Business cycles, unemployment and inflation 1What are the four phases of the business cycle? How long do business cycles last? How do seasonal variations and long-term trends complicate measurement of the business cycle? Why does the business cycle affect output and employment in capital goods and consumer durable goods industries more severely than in industries producing nondurables? Use the following data to calculate (a) the size of the labor force and (b) the official unemployment rate: total population, 500; population under 16 years of age or institutionalized, 120; not in labor force, 150; unemployed, 23; part-time workers looking for full-time jobs, 10. 3. Since most countries in the developed world have an unemployment compensation program which provides income for those out of work, why should we worry about unemployment? 4. Assume that in a particular year the natural rate of unemployment is 5% and the actual rate of unemployment is 9%.Use Okun’s Law to determine the size of the GDP gap in percentage-point terms. If potential GDP is $500 billion in that year, how much output is being foregone because of cyclical unemployment? 5.

What is the Consumer Price Index (CPI) and how is it determined each month? How does the statistical service in each country calculate the rate of inflation from one year to the next? What effect does inflation have on the purchasing power of a dollar? How does it explain differences between nominal and real interest rates? How does deflation differ from inflation? 6. Distinguish between demand-pull and cost-push inflation.Which of the two types is most likely to be associated with a negative GDP gap? Which with a positive GDP gap, in which actual GDP exceeds potential GDP? 7. Explain how an increase in your nominal income and a decrease in your real income might occur simultaneously. Who loses from inflation? Who loses from unemployment? If you had to choose between (a) full employment with a 6 percent annual rate of inflation or (b) price stability with an 8 percent unemployment rate, which would you choose? Why? 8. Explain, and provide examples for each of the following africtional unemployment bstructural unemployment cyclical unemployment dnatural unemployment 9.

(a) What is meant by “full employment” and “full employment unemployment”? (b) What unemployment is there when the economy produces potential output? 10. (a) Explain who gains and who loses from unanticipated inflation. (b) Why are the redistribution effects of anticipated inflation less severe than the effects of unanticipated inflation? (c) What steps can be taken to protect against inflation when this is anticipated? What is an “inflation premium”? Chapter 30 Basic macroeconomic relationships 1Precisely how do the APC and the MPC differ?Why must the sum of the MPC and the MPS equal 1? What are the basic determinants of the consumption and saving schedules? Of your personal level of consumption? 2Explain how each of the following will affect the consumption and saving schedules (as they relate to GDP) or the investment schedule: a. A large increase in the value of real estate, including private houses. b. A decline in the real interest rate.

c. A sharp, sustained decline in stock prices. d. An increase in the rate of population growth. e.

The development of a cheaper method of manufacturing computer chips. f. An increase in the Federal personal income tax. 3.Explain why an upward shift of the consumption schedule typically involves an equal downshift of the saving schedule.

What is the exception to this relationship? 4. Complete the accompanying table. | | | | | | Level of Outputand income| | | | | | (GDP = DI)| Consumption| Saving| APC| APS| MPC| MPS| | | | | | | | | | | | | | | | | | | $240260280300320340360380400| | $ _____$ _____$ _____$ _____$ _____$ _____$ _____$ _____$ _____| $-40481216202428| | _____________________________________________| _____________________________________________| _____________________________________________| _____________________________________________| Show the consumption and saving schedules graphically. b. Find the breakeven level of income. Explain how is it possible for households to dissave at very low income levels.

c. If the proportion of total income consumed (APC) decreases and the proportion saved (APS) increases as income rises, explain both verbally and graphically how the MPC and MPS can be constant at various levels of income. 5. What are the basic determinants of investment? Explain the relationship between the real interest rate and the level of investment. Why is investment spending unstable?How is it possible for investment spending to increase even in a period in which the real interest rate rises? Chapter 31 The aggregate expenditures model 1.

Assuming the level of investment is $16 billion and independent of the level of total output, complete the following table and determine the equilibrium levels of output and employment in this private closed economy. What are the sizes of the MPC and MPS? | | | | Possible levelsof employment(millions)| Real domesticoutput (GDP=DI)(billions)| Consumption(billions)| Saving(billions)| | | | | | | | | | | | 404550556065707580| $240260280300320340360380400| | $244260276292308324340356372| | $ _____$ _____$ _____$ _____$ _____$ _____$ _____$ _____$ _____| | | | | | | 2. Using the consumption and saving data in the question above and assuming investment is $16 billion, what are saving and planned investment at the $380 billion level of domestic output? What are saving and actual investment at that level? What are saving and planned investment at the $300 billion level of domestic output? What are the levels of saving and actual investment?Use the concept of unplanned investment to explain adjustments toward equilibrium from both the $380 and $300 billion levels of domestic output. 3. Why is saving called a leakage? Why is planned investment called an injection? Why must saving equal planned investment at equilibrium GDP in the private closed economy? Are unplanned changes in inventories rising, falling, or constant at equilibrium GDP? Explain. 4.

What effect will each of the following have on the equilibrium level of GDP in the private closed economy? Explain your answers. a. A large increase in the value of real estate, including private houses. . A decline in the real interest rate.

c. A sharp, sustained decline in stock prices. d. The development of a cheaper method of manufacturing computer chips. e. An increase in the Federal personal income tax.

5. What is the multiplier effect? What relationship does the MPC bear to the size of the multiplier? The MPS? What will the multiplier be when the MPS is 0. .4, . 6, and 1? What will it be when the MPC is 1, . 90, .

67, . 50, and 0? How much of a change in GDP will result if firms increase their level of investment by $8 billion and the MPC is . 80? If the MPC is . 7? 6. The data in columns 1 and 2 of the table below are for a private closed economy. | | | | | | (1)Realdomesticoutput(GDP=DI)billions| (2)AggregateExpenditures,private closedeconomy,billions| (3)Exports,billions| (4)Imports,billions| (5)Netexports,privateeconomy| (6)Aggregateexpenditures,openbillions| | | | | | | | | | | | | $200$250$300$350$400$450$500$550| $240$280$320$360$400$440$480$520| $20$20$20$20$20$20$20$20| $30$30$30$30$30$30$30$30| $ _____$ _____$ _____$ _____$ _____$ _____$ _____$ _____| $ _____$ _____$ _____$ _____$ _____$ _____$ _____$ _____| | | | | | | .

Use columns 1 and 2 to determine the equilibrium GDP for this hypothetical economy. b. Now open up this economy to international trade by including the export and import figures of columns 3 and 4. Fill in columns 5 and 6 to determine the equilibrium GDP for the open economy. Explain why this equilibrium GDP differs from that of the closed economy. c.

Given the original $20 billion level of exports, what would be the equilibrium GDP if imports were $10 billion greater at each level of GDP? d. What is the multiplier in this example? 7.By how much will GDP change if firms increase their investment by $8 billion and the MPC is . 80? if the MPC is . 67? 8.

Depict graphically the aggregate expenditures model for a private closed economy. Now show a decrease in the aggregate expenditures schedule and explain why the decrease in real GDP in your diagram is greater than the initial decline in aggregate expenditures. What would be the ratio of a decline in real GDP to the initial drop in aggregate expenditures if the slope of your aggregate expenditures schedule were . 8? 9. Refer to the table below in answering the questions that follow: | | | 1)Possible levelsof employment,millions| (2)Real domesticoutput,billions| (3)Aggregate Expenditures(Ca+Ig+Xn+G),billions| | | | | | | | | | | | | 90100110120130| | $500550600650700| | $520560600640680| | | | | | a. If full employment in this economy is 130 million, will there be an inflationary expenditure gap or a recessionary expenditure gap? What will be the consequence of this gap? By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the inflationary expenditure gap or recessionary expenditure gap? Explain.

What is the multiplier in this example? b.Will there be an inflationary expenditure gap or recessionary expenditure gap if the full-employment level of output is $500 billion? Explain the consequences. By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the gap? Explain. What is the multiplier in this example? c. Assuming that investment, net exports, and government expenditures do not change with changes in real GDP, what are the sizes of the MPC, the MPS, and the multiplier? 10. Suppose investment spending is $600, government spending is $400, and consumption spending is 75% if disposable income.

. Calculate the equilibrium level of income (output). b. For this economy, calculate the amount of (i) consumption spending and (ii) savings. c. Suppose the MPC = 0.

75, exports are $100 and imports are $70. (i) What is the trade deficit or trade surplus? (ii) What is the net effect on equilibrium income (output) if exports increase by $30? 11. Suppose an economy has autonomous investment of $100 million. Savings, which varies with national income, is 25% of income. a. Calculate the value of savings when income is $800 million.

b. Calculate the level of income where savings are equal to investment.Chapter 32 Aggregate demand and aggregate supply 1. Why is the aggregate demand curve downsloping? Specify how your explanation differs from the explanation for the downsloping demand curve for a single product.

2. What are the factors that cause shifts in the aggregate demand curve? What role does the multiplier play in shifts of the aggregate demand curve? 3. Why is the long-run aggregate supply curve vertical? Explain the shape of the short-run aggregate supply curve. Why is the short-run curve relatively flat to the left of the full employment output and relatively steep to the right? . What are the factors that shift the short run aggregate supply curve? 5.

What effects would each of the following have on aggregate demand or short run aggregate supply? In each case use a diagram to show the expected effects on the equilibrium price level and level of real output. Assume that all other things remain constant. a. A widespread fear of depression on the part of consumers. b. A $2 increase in the excise tax on a pack of cigarettes.

c. A reduction in interest rates at each price level. d. A major increase in Federal spending for health care. e.

The expectation of rapid inflation. f. The complete disintegration of OPEC, causing oil prices to fall by one-half. g. A 10 percent reduction in personal income tax rates. h.

A sizable increase in labor productivity (with no change in nominal wages). i. A 12 percent increase in nominal wages (with no change in productivity). j. Depreciation in the international value of the dollar 6. Suppose that the aggregate demand and aggregate supply schedules for a hypothetical economy are shown below.

Amount of real GDP demanded| Price level(price index)| Amount of real GDP supplied| $100| 300| $450| 00| 250| 400| 300| 200| 300| 400| 150| 200| 500| 100| 100| a. Graph the aggregate demand and aggregate supply curves. What is the equilibrium price level and equilibrium level of real output? Is the equilibrium level of real output also necessarily the full employment real output? Explain. b. Why will a price level of 150 not be an equilibrium price level in this economy? Why not 250? c. Suppose that buyers desire to purchase $200 billion of extra real output at each price level.

Sketch in the new aggregate demand curve. What factors might cause this change in aggregate demand?What is the new equilibrium price level and level of real output? 7. Explain: “Unemployment can be caused by a decrease of aggregate demand or a decrease of aggregate supply. ” In each case, specify the price-level outcomes. 8.

Use diagrams to explain the difference between demand-pull and cost-push inflation. What is stagflation? 9. Explain how an upsloping aggregate supply curve weakens the realized multiplier effect. Chapter 33 Fiscal policy, deficits and debt 1. Assume that a hypothetical economy with an MPC of . 8 is experiencing severe recession.

By how much would government spending have to increase to shift the aggregate demand curve rightward by $25 billion? How large a tax cut would be needed to achieve this same increase in aggregate demand? Why the difference? 2. What are government’s fiscal policy options for ending severe demand-pull inflation (an inflation gap)? Use the aggregate demand-aggregate supply model to show the impact of these policies on the price level and real GDP. Which of these fiscal policy options do you think might be favored by a person who wants to preserve the size of government? A person who thinks the public sector is too large? . Evaluate fiscal policy with respect to the following (a) problems of timing, (b) political considerations, (c) future policy reversals, (d) the crowding-out effect. 4. What is the crowding out effect? Explain under what conditions there will occur complete crowding out.

5. Explain the difference between “public debt”, “budget deficit” and “budget surplus”. 6. What are the likely effects on aggregate demand of an increase in the budget deficit? 7. Use the aggregate expenditures model to show how government fiscal policy could eliminate either a recessionary expenditure gap or an inflationary expenditure gap.

Explain how equal-size increases in G and T could eliminate a recessionary gap and how equal-size decreases in G and T could eliminate an inflationary gap. 8. Some politicians have suggested that the United States enact a constitutional amendment requiring that the Federal government balance its budget annually. Explain why such an amendment, if strictly enforced, would force the government to enact a contractionary fiscal policy whenever the economy experienced a severe recession Chapter 34 Money and banking, and financial institutions (p. 741-746) 1. What are the three basic functions of money?Describe how rapid inflation can undermine money’s ability to perform each of the three functions.

2. (a) Explain what “backs” the supply of money, in other words, what are the three factors that give money its value. (b) How does the purchasing power of money relate to the price level? (c) Explain what happens to the value of money in a hyperinflation. (d) Who is responsible for maintaining the value of money, and how is this done? Chapter 35 Money creation 1. Explain the meaning of “required reserve ratio”, “required reserves” and “excess reserves”.

2.Explain why a commercial bank can safely lend only an amount equal to its excess reserves, while the commercial banking system as a whole can lend by a multiple of its excess reserves. What is the monetary multiplier and how does it relate to the reserve ratio? 3. Suppose a bank receives a cash deposit of $500. The reserve requirement is 20%. (a) What is the amount of new deposits that an individual bank can create? (b) What is the amount of new deposits that the entire banking system can create? (Hint use the monetary multiplier.

) Chapter 36 Interest rates and monetary policy 1. What is the basic objective of monetary policy?What are the major strengths of monetary policy? Why is monetary policy easier to conduct than fiscal policy in a highly divided national political environment? 2. Why do people want to hold money? What is the basic determinant of (a) the transactions demand and (b) the asset demand for money? Explain how these two demands can be combined graphically to determine total money demand. 3. How is the equilibrium interest rate in the money market determined? Use a graph to show the impact of an increase in the total demand for money on the equilibrium interest rate (no change in money supply).

Explain how the market quickly adjusts to its new equilibrium interest rate. 4. Distinguish between the Federal funds rate and the prime interest rate. Why is one higher than the other? 5. Explain the three main tools of monetary policy and how each of these is used by the central bank to influence the ability of the commercial banking system to create money.

Which one of these tools is the most important? 6. What is the basic objective of monetary policy? What are the major strengths of monetary policy? Why is monetary policy easier to conduct than fiscal policy in a highly divided national political environment? . (a) Using a diagram, explain what kind of monetary policy is likely to be appropriate when the economy faces recession and unemployment?(b) How would a central bank use the tools at its disposal in this case? (c) What impact would the central bank’s actions have on the lending ability of the banking system, the interest rate, investment spending, aggregate demand, real GDP and unemployment? 8. (a) Using a diagram, explain what kind of monetary policy is likely to be appropriate when the economy faces a sharp rise in the inflation rate. b) How would a central bank use the tools at its disposal in this case? (c) What impact would the central bank’s actions have on the lending ability of the banking system, the interest rate, investment spending, aggregate demand, real GDP and the rate of inflation? 9.

Explain the links between changes in the nation’s money supply, the interest rate, investment spending, aggregate demand, real GDP and the price level, in the cases of (a) contractionary monetary policy, and (b) expansionary monetary policy.