2A- Economic and Business Cycles - Measures and Indicators. Questions from review

OJO: The full-employment gross domestic product is $1.3 trillion, and the actual gross domestic product is $1.2 trillion. The marginal propensity to consume is 0.8. When inflation is ignored, what increase in government expenditures is necessary to produce full employment?

- 20 billion The proportion of the disposable income that individuals spend on consumption is the propensity to consume. The marginal propensity to consume (MPC) is the proportion of additional income that an individual will spend. The marginal propensity to save (MPS) is 1 - MPC. The multiplier is the combined effect of the additional spending once it ripples through the economy (if the MPC is 0.8, then each person is assumed to spend 80% of additional income received and save the other 20%). The multiplier equals 1/MPS; in this question, 1/0.2 = 5. Increasing government expenditures by $20 billion, when multiplied by the multiplier of 5, equals the desired increase in GDP of $100 billion ($0.1 trillion).

Which of the following would not be an indication of a contraction in the business cycle?

- A decrease in delivery times by vendors Although it seems counter-intuitive, an improvement in delivery times suggests an economic slowdown with declines in real GDP. Therefore, a decrease in delivery times would not be an indication of a contraction. Additional signs of a contraction in the business cycle would be higher unemployment claims, fewer new orders for consumer goods, and a decline in average hours worked.

How does a change in net investment affect the level of income?

- A decrease in net investment will cause a more than proportional decrease in the level of income. In macroeconomics, equilibrium national income is affected by changes in autonomous consumption, net investment, and government expenditures. The actual impact on national income will be multiplied, positively or negatively, by some multiple of the initial change. This is due to the "multiplier effect," which magnifies small changes in C, In, or G into larger overall changes to national income. Thus, a decrease in net investment (In) will decrease national income by a larger amount than the original decline in investment.

Which of the following would indicate that the economy is in an expansionary phase?

- Businesses increase capital investment. The business cycle is characterized by four phases: expansion, peak, contraction, and trough. During the expansion phase, more resources become employed (i.e., businesses increase capital investments) and actual output approaches potential output. Interest rates fall and business investment increases. An excess of inventories and underutilized resources occurs during a contraction and/or trough.

An increasing federal deficit implies which of the following conditions?

- Decreased tax revenues and increased entitlement payments An increasing federal deficit implies decreased tax revenues and increased entitlement payments. The federal deficit is the amount by which a government's expenditures (i.e., outlays) exceed its tax revenues (i.e., receipts). The difference is made up by borrowing from the public through the issuance of debt securities. In a recessionary period, tax revenues decline, causing the deficit to grow. As unemployment increases, entitlement payments (e.g., Medicare, Medicaid, Social Security, unemployment compensation, food stamps, and agricultural price support programs) tend to increase as well.

During which of the following periods will prices generally increase the fastest?

- Hyperinflation Deflation is a reduction in purchasing power, a decrease in price levels, not an increase in price levels. Recession is a decline in economic activity; it can be accompanied by either an increase or a decrease in the price level. Inflation means that the price level increases some amount, not necessarily a large amount.

Which of the following methods may the Federal Reserve use to reduce inflationary pressures?

- Increase margin requirements To reduce inflationary pressures, the Federal Reserve would adopt a restrictive monetary policy to reduce the money supply. As the money supply declines, interest rates will increase, reducing business investment and spending. Measures to reduce the supply of money include selling bonds and increasing margin requirements (also called the reserve requirement). Banks are limited to lending their excess reserves, that is, the difference between the bank's total reserves and its required reserves, so increases in the reserve requirement result in less funds available to loan out.

Which of the following changes would most effectively halt(stop) a period of inflation?

- Increasing interest rates by a large amount Monetary policy is one of the key policy tools that is available to attempt to influence the real GDP (gross domestic product) and the price level. To contain inflation, the Federal Reserve would have a restrictive monetary policy and sell bonds. Excess reserves would fall, and the money supply would fall. Interest rates would rise, and business investment would decline. Aggregate demand would fall, and the inflation rate would decline.

A country reduces its rate of monetary growth. Which of the following is the expected result for the country's economy?

- Lower GDP growth Monetary policy is one of the key policy tools that is available to attempt to influence the real GDP (gross domestic product) and the price level. A restrictive monetary policy which reduces the rate of monetary growth is likely to cause a decline in future real GDP, as follows: Nominal interest rates are determined by the interaction of the supply and demand for money in financial markets. Monetary policy can impact the supply of money and therefore nominal short-term interest rates. Increasing interest rates makes business investment less attractive by increasing a firm's weighted-average cost of capital, thereby reducing the net present value of a project's future cash flows. If business investment is reduced, then real GDP will decline by some multiple of the decline in investment (multiplier effect).

The political business cycle model explains all except one of the following:

- Monetary policy adjustments The political business cycle model explains the business cycle as resulting from interactions between economic policy decisions and political decisions designed to influence voter behavior. Monetary policy is created by the Federal Reserve and is typically nonpolitical. Politicians desire to have a growing economy and make political decisions, such as increased spending, to raise GDP. Fiscal policy is controlled by the executive and legislative branches of government, which are therefore politically motivated.

Which of the following characteristics is not exhibited by the real business cycle model?

- Recessionary gap The real business cycle model is based on the premise that fluctuations in output and employment result from real supply shocks that periodically hit the economy, and that markets adjust rapidly to the shock and always remain in equilibrium. Although recessionary gaps are part of the measure of economic growth, they are not part of the real business cycle model.

Full employment is not measured by which of the following?

- Retirement rates Although retirement rates are measured in demographics, they are not a standalone criterion for measuring full employment. Full employment is characterized by levels of unemployment where virtually all able-bodied workers who are seeking employment can obtain or have obtained employment. Full employment is defined as the level of employment where the actual unemployment rate is equal to the natural rate of unemployment (NRU). The NRU occurs when the number of job seekers is equal to the number of job vacancies, and actual unemployment would be greater than zero due to frictional unemployment.

If the Federal Reserve raises the discount rate, which of the following effects is likely to occur?

- Short-term interest rates will likely increase. The Federal Reserve (the Fed) serves as the "lender of last resort" for commercial banks and thrifts; the discount rate is the rate the Fed charges when it lends reserves to these member institutions. By providing a loan, the Fed creates excess reserves that allow the financial intermediaries to extend additional credit. Raising the discount rate would make borrowing money from the Fed less attractive, raising short-term interest rates, and sends a signal from the Fed to the banking system that they would prefer to slow the rate of growth of the money supply.

An increase in the federal debt may create inflationary pressures for which of the following reasons?

- The economy's money supply may increase. All things being equal, an increase in the federal debt means more money is being utilized by the Federal Government relative to their inflows. For debt to increase, the Federal Government must be running a deficit by spending more than it brings in. This deficit spending infuses more money into the financial markets (i.e., increases the money supply) than would be present otherwise. An increase in money supply in the long run leads to inflationary pressures, causing prices to rise.

Which of the following theories does not affect the business cycle?

- The nominal business cycle model There is no nominal business cycle model. There are several competing theories that try to explain the causes for the business cycle. Some of the more accepted theories include the real business cycle model, political business cycle model, insufficient aggregate expenditure model, and accelerator business cycle model.

Which of the following does not describe a relationship between unemployment and the business cycle?

- The unemployment rate serves as a leading indicator. Unemployment is a lagging indicator, and the unemployment rate does not begin to decline significantly until the economy is well into a downturn. Unemployment can expand through the bottom of a recession. Unemployment is associated with discouraged workers, existing workers working more hours and overtime, and more part-time workers being hired relative to full-time workers.

The federal budget deficit is the:

- amount by which the federal government's expenditures exceed its revenues in a given year. National debt: total accumulation of the federal government's surpluses and deficits. aggregate government budget deficit: Excess of state, local, and federal spending over their revenues.

The government has a number of policy options designed to stabilize the level of aggregate demand. If policy makers expected a recession, it might be expected that the government would pursue:

- an expansionary monetary policy and an expansionary fiscal policy. During a recession there is insufficient aggregate demand. An expansionary fiscal policy would increase government spending or cut taxes, both of which would increase the level of aggregate demand. An expansionary monetary policy would attempt to decrease interest rates to stimulate business investment and the consumption of durable goods.

There will be a national election in 15 months. Your planning team believes that the current administration in Washington will actively seek to follow the basic tenets of the political business cycle. Given that fact, as you develop your 2-year forecast, you are more likely to:

- increase your sales forecast for the near term and plan to access the debt markets earlier than you had otherwise anticipated. According to the political business cycle theory, politicians want the economy to be "pointed in the right direction" as the election approaches with the unemployment rate and the inflation rate falling. Thus, there would be relatively expansionary fiscal policy prior to the election, followed by more restrictive fiscal policy soon after the election, often placing the blame for the reversal on the previous administration if there were a change.

The economy appears to be poised to enter into the recovery phase of the business cycle. For firms in the capital goods sector, in terms of the inventory cycle, you would expect that:

- inventory levels are low as firms have intentionally sold off inventories as the economic contraction continued to bring inventories to their desired level. Inventory levels tend to be high as the economy begins the contraction phase of the business cycle and firms cut orders and use their unanticipated inventory to meet demand, attempting to bring inventory levels back to their desired level as contraction continues. Thus, inventory levels tend to be low at the end of the contraction phase due to deliberate management actions.

The velocity of money is generally measured as a ratio of the:

- nominal gross domestic product to the money supply. The velocity of money is the rate at which money is exchanged in an economy—the number of times that money moves from one transaction to another. The velocity of money is measured as a ratio of nominal gross domestic product (GDP) to the money supply.

During the recessionary phase of a business cycle:

- potential national income will exceed actual national income. A recession is defined as a period when real output, as measured by real national income, is decreasing. Thus, during a recession, actual real national income falls short of potential real national income, because some resources are unemployed and the economy operations below capacity.

The consumer price index (CPI) calculation includes all the following biases except:

- poverty bias. The CPI calculation includes new goods bias, quality change bias, and commodity substitution bias. Poverty bias is not an economic term. Biases in the CPI calculation include the new goods bias (new goods constantly replace old goods, and the index does not compare both the price and quality between the old and new goods); quality change bias (the quality of many items improves each year and the improvement must be compared to the increase in price of the good); commodity substitution bias (consumers have a tendency to cut back on the consumption of relatively more expensive goods and substitute relatively cheaper goods as prices rise); and the outlet substitution bias (as prices increase, there is a tendency for more people to shop at discount stores, and in recent years, online shopping has allowed consumers to search for lower prices for many products).

One of the measures economists and economic policy makers use to gauge a nation's economic growth is to calculate the change in the:

- real per capita output. A nation's economic growth is measured by gauging changes in the production of physical output per capita. Output indices such as the Federal Reserve Board's Index of Industrial Production are used in quantifying the amount of the change. Money supply, total wages, and general price levels are not good growth indicators because of their sensitivity to inflation and other factors.

Which of the following variables is not one of the variables traditionally found in national income calculations?

-Real per capita gross domestic product Real per capita gross domestic product is gross domestic product for a particular year adjusted for inflation compared to a base year using a price index. This adjusted number is then divided by population to derive real per capita GDP (gross domestic product). This measure is often used as an estimate of changes in well-being in a society over time, but it is not one of the variables one would traditionally see in national income calculations. you can see in the calculation: -Disposable income -Gross domestic product -Net domestic product

Inflation may be measured using each of the following measures,

-consumer price index. -gross domestic product deflator. - wholesale price index.

Which of the following is a monetary tool available to the Federal Reserve?

Monetary tools are used by the Federal Reserve (the Fed) to control the money supply. These tools include the reserve requirement (which requires banks to hold a certain percentage of their deposits in reserve), the discount rate (the rate the Fed charges member institutions), and open market operations (buying and selling U.S. Treasury securities). Lowering taxes and government spending are fiscal policy and are not controlled by the Federal Reserve.

Inflation is measured by all of the following except:

The price of producer goods is not reflected in inflation, as producers may or may not pass on access costs to the consumer. Inflation is a sustained increase in the average level of prices and is measured by using a fixed-weight price index, such as the consumer price index (CPI). Consumers are assumed to buy a specified group of goods and services—a "market basket of goods." The items in the market basket are "weighted" based on their relative importance in terms of consumer spending. The rate at which the weighted-average price for these goods increases is the inflation rate.