Chapter 6 Practice Problems

#1 If the nominal interest rate is 8 % and the rate of inflation is 3%, the real interest rate is ______%

(Ans = 5%)

#2 A major difference between the CPI and GDP inflator is:

The GDP deflator reflects the prices of all final goods and services produced domestically, whereas the consumer price index reflects the prices of a market basket of goods and services bought by consumers.

#3 Describe 3 problems that make the consumer price index an imperfect measure of the cost of living.

1- substitution bias
2- introduction of new goods
3- unmeasured quality changes

Chapter 5 Practice Problems

CHAPTER 5

#1) Macroeconomists study decisions of economy wide phenomena. (T/F)
TRUE

#2)The basic tools of supply and demand are central to microeconomic analysis, but seldom used in macroeconomic analysis (T/F)
FALSE

#3) Many things that society values, such as good health, high-quality education, enjoyable recreation opportunities, and desirable moral attributes of the population, are not measured as part of GDP.

Therefore, GDP is not a useful measure of society's welfare. (T/F)
FALSE


#4) In a certain economy in 2005, households spent $1,200 on goods and services; purchases of capital equipment, inventories, and structures amounted to $250; government spent $350 on goods and services; and the value of imports exceeded the value of exports by $50. ( or NX =-50) It follows that 2005 GDP for this economy was:

ans: $1750 C =1200 I =250 G = 350 NX =-50
1200+250+350+(-50) =1750

#5) Write the equation that includes the four components of GDP and identify each component.

Y = C + I + G + NX

Y = GDP
C= consumption
I= investment
G= government purchases
NX= net exports

Chapter 3 Practice Problems

1) Explain how absolute advantage and comparative advantage differ.

Absolute advantage reflects a comparison of productivity for one person, firm, or nation. Being more productive gives one an absolute advantage.

Comparative advantage is based on the relative opportunity costs of the person, firm, or nation. Having lower opportunity costs gives one a comparative advantage.

Note: it is possible for one person or country to have an absolute advantage in everything, but it is impossible to have a comparative advantage in all goods and services.

2) Will a nation tend to import or export goods for which it has a comparative advantage? Explain.

A nation will export goods for which it has a comparative advantage. It will do this because it has a smaller opportunity cost of producing those goods.


3) Why do economists oppose policies that restrict trade among nations?

Restrictions on trade prevent countries from receiving gains from trade. Restrictions on trade prevent citizens from achieving greater prosperity. Restrictions on trade are harmful to all countries.


4) Production Possibilities Frontier and Trade

a) Draw a PPF for two goods

b) Show a point indicating a possible efficient level of production and consumption without trade, label it ‘A.’

c) Show a point of possible consumption with trade, label it ‘B.’

d) What does the location of this point in reference to the PPF indicate?

CH 4 PRACTICE PROBLEMS

#1 Describe the role of prices in market economies

Prices serve as signals that guide economic decisions and allocate scarce resources


#2 Even though all markets are not perfectly competitive, the study of perfect competition is worthwhile because:

Some degree of competition is present in most markets, not just in perfectly competitive markets.

#3 Answer the following:




a) a shift from D to D1 is called? A decrease in demand


b)A shift from D1 to D is called? An increase in demand

c) What would cause a shift in the demand curve? Changes in income, prices of related goods, tastes, expectations, the number of buyers - something other than the price of the good in question.

#4 (click to enlarge image)


a)Equilibrium price and quantity are: P = ? Q = ?

ans: 10 , 4

b) At a price of $14, here would be a ? of ? units.

ans: surplus , (6-2 )= 4

c)At a price of $6 there would be a ? of ? units.

ans: shortage , (6-2)=4


Note, in ‘b’ we have an example like with the minimum wage, where we get a surplus of labor and unemployment. In part ‘c’ we have an example of a price ceiling, like price controls that result in a shortage.


#5 Using a graph, demonstrate the difference between a change in ‘demand’ and a change in ‘quantity demanded’.



ans:


The movement from A to B along the demand curve is a change in quantity demanded. ( actually an inrease) A behavioral response to a change in the price of the good in question. A shift from D to D2 is a change in ‘demand’, ( actually an increase) a behavioral response to something other than the price of good in question.


#6 Using graphs, illustrate the difference between a change in ‘supply’ and ‘quantity supplied’



The shift from S1 to S2 is a change in ‘supply.’ A behavioral response to something other than price. The movement along the supply curve from point A to point B is a change in ‘quantity’ supplied, which is a behavioral response to price.



#7 What event would be consistent with the following graph ( movement from point A to B)?



a) An increase in gas taxes will reduce dependence on foreign oil
b) Gasoline and diesel are complements, and the price of gas decreased
c) A gas tax was imposed, resulting in higher price paid for gas and a reduction in consumption ( quantity demanded)
d) A gas tax was imposed, resulting in a higher price paid for gas and an increase in consumption ( quantity demanded)



ans: c

CH 2 PRACTICE PROBLEMS

1) Production Possibilities Frontier

a) Draw a production possibilities frontier for a society that produces corn and cars.

b) Show an efficient point of production –label it A

c) Show an inefficient point of production – label it B

d) Show an infeasible point of production – label it C

( Click for Larger Image to see the proper graph, and points a,b,c)



e) In a separate graph, show how the frontier changes with improved economic growth.

f) In a separate graph, show how the frontier changes with decreased economic growth.






2) What 3 concepts are illustrated by the production possibilities frontier?

a) efficiency , equity, tradeoffs
b) efficiency, equity, opportunity costs
c) equity, tradeoffs, opportunity costs
d) efficiency, tradeoffs, opportunity costs

ANS: D



3) Circular flow diagram:

a) What does the inner loop represent?

ANS: flow of inputs and outputs

b) What does the outer loop represent?

ANS: flow of dollars


4) In what way do economists take a scientific approach to studying the economy?

they develop theories; they collect and analyze data to evaluate theories



5) Which of the following statements ( there may be more than 1 ) are propositions about which most economists agree? Hint: compare these statements with the ones in your text on page 35 (5th edition)or notes from lecture.

a) A minimum wage helps reduce poverty among young and unskilled workers

b) Effluent taxes and marketable pollution permits represent a better approach to pollution control than imposition of pollution ceilings

c) Corporations should be taxed if profits become excessive

d) The government should pass regulations to limit pollution and protect the environment

e) A minimum wage increases unemployment among young and unskilled workers

ans: b,e

CH 1 PRACTICE PROBLEMS

1) What tradeoffs would be involved if society or government requires that firms reduce pollution?

COSTS
-some firms may have to close
-reduced profits and incomes to the firms owners and employees
-the cost of reducing pollution may fall on some firms more than others, giving some firms a competitive advantage

BENEFITS

-reduced pollution may lead to cleaner air and better health
-reduced pollution may reduce effects on the climate
-reduced pollution may improve water quality, biodiversity

2) Prices balance the marginal benefit of consuming a good with the marginal cost of supplying a good. Therefore a person’s willingness to pay for a good represents:

a) availability
b) corporate greed
c) profit
d) the marginal benefit that an extra unit of the good would provide for that person
Ans: D

3) Which statement best describes making rational decisions at the margin:

a) Making decisions that are associated with no marginal cost
b) Making only decisions that can easily be reversed
c) Making decisions only after comparing the marginal benefits and marginal costs
d) Only making decisions if the choices are certain
Ans: C

4) Define: see definitions in the text margins or the glossary in the back of the book

Market failure
Externality
Property Rights
Equity
Efficiency
Opportunity Cost
Market Economy
Marginal Changes
Incentive



5) Explain two main causes of market failure and give an example of each.

1)Market Power: ability of a single person or small group to influence market prices. Ex: town with only 1 cable company.

2) Externality: the impact of one persons actions on the well being of a bystander. Ex: pollution

6) What are two method s of correcting an externality that we spoke about in class?

In the case of a negative externality, such as pollution, two methods of correction include pollution taxes, or assigning property rights such as in the form of tradable pollution permits.

ECONOMICS PRACTICE PROBLEMS

These problems sets correspond roughly to chapters in Greg Mankiw's Brief Principles of Macroeconomics 4th Edition, and material will be very similar to the 5th Edition as well. 

CHAPTER 1
CHAPTER 2
CHAPTER 3
CHAPTER 4
CHAPTER 5
CHAPTER 6
CHAPTER 7
CHAPTER 8
CHAPTER 10
CHAPTER 11
CHAPTER 12
CHAPTER 13
CHAPTER 14
CHAPTER 15
CHAPTER 16

CH 16 PRACTICE PROBLEMS

1 What role do interest rates play according to the liquidity preference theory?

A)when the interest rate increases, the opportunity cost of money increases, so people hold less money
B) Equilibrium in the money market is achieved by adjustments in the interest rate

2 What determines the money supply according to liquidity preference theory? What happens if there is an increase in the money supply? What happens if there is a decrease in the money supply?

The federal reserve determines the money supply .

In the SHORT RUN:
If the Federal Reserve increases the money supply the money supply curve will shift right and interest rates will decrease. The Aggregate Demand curve will also shift right. If the Federal Reserve decreases the money supply, the money supply curve will shift left and interest rates will increase. The Aggregate Demand curve will shift left.

3. What effect does an increase in government spending have on the aggregate demand curve?

An increase in government spending initially shifts the aggregate demand curve to the right.

4. Explain the multiplier effect. Give an example:

With the multiplier effect, additional shifts in aggregate demand result when expansionary fiscal policy (government spending or tax refund checks) increases income and thereby increases consumer spending. Graphically there is an initial shift from the initial government spending, then an additional shift from the increases in consumer spending.

Example: The government spends money on roads and schools. The owners of the construction companies pay their workers and more teachers are hired to teach. The workers and teachers increase their spending. The firms that the workers and teachers buy goods from increase their production. Spending and income continues to increase, much more than the initial money spent by the government.

5. How does the crowding out effect impact the an increase in government spending?

According to the crowding out effect, an increase in government spending increases the interest rate and decreases investment spending. Graphically the aggregate demand curve may initially shift outward, but then may shift back in. As a result, the impact of government spending on ‘stimulating’ economic activity is less.

Note: The net effect of fiscal policy is uncertain. The multiplier effect increases the effects of an increase in government expenditures while the crowding out effect diminishes the effect of government expenditures. Both effects work against each other.

6. How might a tax cut affect the short run aggregate supply curve?

If the government cuts the tax rate, workers keep more of each dollar they earn, so they work more The quantity of goods and services supplied will be greater at each price level. As a result the short run aggregate supply curve shifts to the right and output increases.

Further, the cut in tax rates will stimulate enough additional production and income that tax revenue actually increases.

7. What is stabilization policy?

Stabilization policy is an attempt by policymakers and the federal reserve to control aggregate demand and stabilize the economy.

Ex: if there is a decrease in aggregate demand due to consumer and investor pessimism, the aggregate demand curve may shift left. A recession may result.
To combat this, the federal reserve may increase the money supply, or the government may increase spending in order to ‘shift ‘ the aggregate demand curve back out . The purpose would be to promote economic recovery from the recession or prevent it.

8. Why are many economists critical of stabilization policy?

A. There is a lag between the time policy is passed and the time policy has an impact on the economy.

B. The impact of the policy may last longer than the problem it was designed to offset

C. Policy can be a source of, instead of a cure for, economic fluctuations

Ex: During the Great Depression stabilization policies may have increased its severity and prolonged the time it normally would have taken to recover.

CH 15 PRACTICE PROBLEMS

1 A recession can be described as:

A short period of falling incomes and rising unemployment

2 What role does investment (I) play in economic fluctuations?

It is only a small part of real GDP, but it actually accounts for a large share of the fluctuation in real GDP ( in fact ~ 2/3 of the decline in GDP during recessions)



3 If an economic contraction is caused by a downward shift ( or decrease) in aggregate demand, how would the economy respond on its own i.e. how would the contraction ‘resolve itself’ without government intervention?

(see 4 steps from notes Ch 15, slides, or class discussion/review)

Summary: With the reduction in AD, over time, there is a fall in the expected price level and costs decline. This leads firms to expand output, shifting the short run aggregate supply curve to the right.
The situation is resolved with a lower price level as output returns to its natural rate.


4 What happens when the short run aggregate supply curve shifts to the left?
(see slides ch15 notes, or graph in class discussion /review)

Summary: A decrease in the short run aggregate supply curve leads to decreased output and higher prices. This situation where there is increasing prices and decreasing output is referred to as ‘Stagflation’.

CH 14 PRACTICE PROBLEMS

1) Write the equation for the market for loanable funds in an open economy:


S = I + NCO

2) In an open economy, the supply of loanable funds is determined by :

National saving, the same as in a closed economy

3) In an open economy, the demand for loanable funds is determined by: .

the sum of net capital outflow and domestic investment.

CH 13 PRACTICE PROBLEMS

CHAPTER 13 PROBLEMS

1) Write the equation for GDP for: a) a closed economy, b) an open economy

a) Y= C + I + G
b) Y = C + I + G +NX

2) What is the meaning and significance of the equation that NCO = NX?

Net capital outflow = net exports

If a country exports (sells) more goods than it imports (buys), it has a trade surplus, NX is positive. This means that Net Capital Outflow is positive.

If a country imports (buys) more goods than it exports (buys) it has a trade deficit, NX is negative, and NCO is also negative.

CH 11 PRACTICE PROBLEMS

#1 . The Federal Reserve has _____ regional banks. The Board of Governors has ____ members who serve 14-year terms.

ANS: 12, 7

#2 List the 3 primary functions of the Fed.

•Regulates banks to ensure they follow federal laws intended to promote safe and sound banking practices.

•Acts as a banker’s bank, making loans to banks and as a lender of last resort.

•Conducts monetary policy by controlling the money supply.


#3 How might the fed increase the money supply?

1-make open market purchases (which lowers the federal funds rate), 2-lower the discount rate 3 - lower the reserve requirement


#4 What is the federal funds rate, and how is it involved in monetary policy?

The interest rate banks charge each other for short-term loans of reserves. By increasing the money supply with open market purchases the fed lowers the federal funds rate. By decreasing the money supply through open market sales the fed increases the federal funds rate.



#5 If the reserve ratio is 5 percent, the money multiplier is _________________________.

(1/5)*100 = 20

CH 10 PRACTICE PROBLEMS

CH 10 PROBLEMS:

#1 . The natural rate of unemployment is the
a. unemployment rate that would prevail with zero inflation.
b. rate associated with the highest possible level of GDP.
c. difference between the long-run and short-run unemployment rates.
d. amount of unemployment that the economy normally experiences.

ANS: D

#2 T/F Cyclical unemployment is closely associated with long term economic growth;

FALSE It is associated with fluctuations in the business cycle.

#3 Give an example of frictional unemployment associated with a sectoral shift.

The decrease in jobs in cassette manufacturers due to the introduction of CD’s.

#4 Why might European countries( like Germany) have higher rates of unemployment in the United States

Due to high levels of unemployment insurance.

#5 Why do firms pay efficiency wages? (SKIP)


#6 ) A minimum wage set above equilibrium results in?

INCREASE the quantity of labor SUPPLIED and DECREASE the quantity DEMANDED. This results in a SURPLUS or UNEMPLOYMENT. You should be able to demonstrate this with a graph

CHAPTER 8 PRACTICE PROBLESM

# 1 What causes a government budget deficit? How does if affect interest rates and investment? What is this result referred to as?


A budget deficit occurs when the governments spending exceeds tax revenue.
By decreasing the supply of loanable funds, a budget deficit leads to a leftward shift in the supply curve for loanable funds, leading to an increase in the equilibrium interest rate.

This increase in the interest rate results in a decrease in the quantity of investment. This is referred to ‘crowding out.’

#2 What would be the result if instead of a budget deficit, the government had a budget surplus? Use a graph.

As shown in the graph below, the economy starts in equilibrium at point E0 with interest rate r0 and equilibrium quantity of saving and investment at q0. If the government succeeds in obtaining a surplus, there will be more public saving in the economy and so more national saving at each interest rate, and the supply of loanable funds curve will shift from S0 to S1. The new equilibrium will be at E1, with a lower interest rate, r1 and a higher quantity of saving and investment, q1. Hence, if the federal government succeeds in having a surplus, interest rates will fall and investment will increase.



#3 What happens if there is an increase in the demand for loanable funds?

An increase in the demand for loanable funds shifts the demand curve for loanable funds to the right, leading to an increase in the equilibrium interest rate.

CHAPTER 7 PRACTICE PROBLEMS

#2What are the 4 determinants of productivity?

A = Technology
K/L = physical capital per worker
H/L = human capital per worker
N/L = natural resources per worker

#3 Which of the following policy proposals would lead to increased growth in a poor country?

1. Reduce corruption in the legal system;

2. Reduce reliance on market forces because
they allocate goods and services in an unfair manner;

3. Restrict investment in domestic industries by foreigners
because they take some of the profits out of the country;

4. Encourage trade with neighboring countries

5. Increase the fraction of GDP devoted to consumption

ANS: #1, #4

#4 In a market economy, we know that a resource has become scarcer when :

ANS: The price of that resource has increased

#5 True or False: Historically, the market prices of most natural resources (adjusted for inflation) have
increased.

False-they have remained stable or decreased.