Exam Four: Topical Section Four Understanding International Trade, Growth and Crisis

Refer to the Exhibit below: In the Exhibit, the opportunity cost of one unit of Weapons Grade Plutonium in the United States is ___________

2/3 units of organic tofu

Review the excerpts below from an economics article and answer the question below: Economic Freedom, Prosperity, and Equality: A SurveySteve H. Hanke and Stephen J. K. Walters ... [There is a] positive linkage between per capita income and life expectancy for a cross-section of countries. ...the potential gains in life expectancy in poorer countries are quite large. ... for example, increasing a representative country's per-capita annual income from, say, $500 to $1,000 might increase life expectancy in that country by over 6 percent--or 3 3/4 years. In older models of economic growth, physical resources were all. In these formulations, output flowed from combinations of various inputs (land, labor, capital). In principle, then, it seemed logical to conclude that faster growth would result from infusions of additional inputs (chiefly capital) or better use of existing inputs (often thought to require centralized economic planning). In practice, however, such prescriptions often have been disastrous for less developed countries. Newer ("endogenous growth") models have identified many other variables that contribute to differences in growth rates--e.g., knowledge spillovers resulting from increases in the stock of physical capital, technology transfers, and human capital investment. Yet even these sophisticated formulations often fail to explain observed patterns of development. Most recently, however, some students of economic growth have returned to first principles. They have concluded that analysis of how markets operate may be a poor guide to how markets develop. They have focused on the nature of institutions and on the structure of rules and norms that constrain economic behavior as a way of understanding the development process. And they have rediscovered Smith's ancient insight that economic liberty is a crucial precondition for sustained, vigorous economic growth. Though scholars have yet to agree on a single, operational definition of economic liberty, there appears to be wide agreement on its central elements: • Secure rights to property (legally acquired);• Freedom to engage in voluntary transactions, inside and outside a nation's borders;• Freedom from governmental control of the terms on which individuals transact; and• Freedom from governmental expropriation of property (e.g., by confiscatory taxation or unanticipated inflation). Clearly, these elements prescribe an important but balanced role for government. The institutions of government will create and enhance economic freedom by making and enforcing rules governing behavior in the economic sphere--e.g., by preventing Paul from stealing Peter's property. But government might also diminish economic freedom by itself robbing Peter, whether to pay Paul or achieve some other objective. Three Freedom Surveys1. The Fraser Institute's Economic Freedom Index. ....The culmination of this effort was the publication in 1996 of Economic Freedom of the World: 1975-1995, which constructed three indices of economic liberty (using different weighting schemes for 17 components) for more than 100 nations over a period spanning two decades. Since economic institutions are ever-changing, and since enhanced economic freedom is likely to have favorable effects on welfare only with a time lag, this effort to evaluate freedom over a fairly broad time span was important. The study's authors concluded: Clearly, these data indicate that during the last two decades there has been a strong relationship between economic freedom and economic growth. Without exception, countries with either a high level or a substantial increase in economic freedom achieved positive growth. Correspondingly, the overwhelming majority of countries with low and/or contracting levels of economic freedom experienced declines in per capita GDP. 2. Freedom House's Economic Freedom Indicators. Freedom House's efforts to supplement its annual reports on worldwide political and civil liberty eventually culminated in a free-standing publication, World Survey of Economic Freedom: 1995-1996. ... the World Survey confirms the importance of economic freedom as a determinant of prosperity: Whereas only 27 of those nations sampled, with just 17 percent of the world's population, merited a "free" rating, these 27 nations produced 81 percent of total world output. By contrast, the 20 nations rated "not free" contain more than a third of the world's people yet produce only 5 percent of total output. 3. The Heritage Foundation's Indices of Economic Freedom. ...the study's authors added the following observations on U.S. foreign aid and growth: Of the 76 countries ranked as "mostly unfree" or "repressed" on the Index, 34 have received U.S. foreign aid for over 35 years, many for as long as 51 years. Of these 34 countries, 14 are poorer today than they were in 1965. Twelve more have essentially the same amount of wealth as they did some 30 years ago. Of the 34 long-term recipients of U.S. foreign aid ranked by the Index as lacking economic freedom, 26 are no better off than they were over three decades ago. . . .If development aid is essential to economic prosperity, why has there been so little progress by countries that are most dependent on foreign aid? The answer is simple: Economic freedom, not aid, is the key to economic development. --- The authors refer to growth rates in different countries as evidence that they are correct. Which of the following represent evidence they present:

27 free countries with 17% of the world population accounted for 81% of the world's output.

Refer to the Exhibit below: The opportunity cost of one unit of Plutonium in France is ____________ and the opportunity cost of one unit of Organic Tofu in France is _____________.

3 units of organic tofu; 1/3 unit of weapons grade plutonium

Real GDP in a small country is worth $6 billion. The population of the country is 200,000. What is per capita Real GDP?

$30,000

A German computer is priced at 1,000 Euros (EUR). If the exchange rate between the Euro and the Japanese Yen (JPY) is 0.0093 EUR = 1 JPY, approximately how many Yen will a Japanese buyer pay for the computer?

107,527 Yen

Review the excerpts below from an economics article and answer the question below: Economic Freedom, Prosperity, and Equality: A SurveySteve H. Hanke and Stephen J. K. Walters ... [There is a] positive linkage between per capita income and life expectancy for a cross-section of countries. ...the potential gains in life expectancy in poorer countries are quite large. ... for example, increasing a representative country's per-capita annual income from, say, $500 to $1,000 might increase life expectancy in that country by over 6 percent--or 3 3/4 years. In older models of economic growth, physical resources were all. In these formulations, output flowed from combinations of various inputs (land, labor, capital). In principle, then, it seemed logical to conclude that faster growth would result from infusions of additional inputs (chiefly capital) or better use of existing inputs (often thought to require centralized economic planning). In practice, however, such prescriptions often have been disastrous for less developed countries. Newer ("endogenous growth") models have identified many other variables that contribute to differences in growth rates--e.g., knowledge spillovers resulting from increases in the stock of physical capital, technology transfers, and human capital investment. Yet even these sophisticated formulations often fail to explain observed patterns of development. Most recently, however, some students of economic growth have returned to first principles. They have concluded that analysis of how markets operate may be a poor guide to how markets develop. They have focused on the nature of institutions and on the structure of rules and norms that constrain economic behavior as a way of understanding the development process. And they have rediscovered Smith's ancient insight that economic liberty is a crucial precondition for sustained, vigorous economic growth. Though scholars have yet to agree on a single, operational definition of economic liberty, there appears to be wide agreement on its central elements: • Secure rights to property (legally acquired);• Freedom to engage in voluntary transactions, inside and outside a nation's borders;• Freedom from governmental control of the terms on which individuals transact; and• Freedom from governmental expropriation of property (e.g., by confiscatory taxation or unanticipated inflation). Clearly, these elements prescribe an important but balanced role for government. The institutions of government will create and enhance economic freedom by making and enforcing rules governing behavior in the economic sphere--e.g., by preventing Paul from stealing Peter's property. But government might also diminish economic freedom by itself robbing Peter, whether to pay Paul or achieve some other objective. Three Freedom Surveys1. The Fraser Institute's Economic Freedom Index. ....The culmination of this effort was the publication in 1996 of Economic Freedom of the World: 1975-1995, which constructed three indices of economic liberty (using different weighting schemes for 17 components) for more than 100 nations over a period spanning two decades. Since economic institutions are ever-changing, and since enhanced economic freedom is likely to have favorable effects on welfare only with a time lag, this effort to evaluate freedom over a fairly broad time span was important. The study's authors concluded: Clearly, these data indicate that during the last two decades there has been a strong relationship between economic freedom and economic growth. Without exception, countries with either a high level or a substantial increase in economic freedom achieved positive growth. Correspondingly, the overwhelming majority of countries with low and/or contracting levels of economic freedom experienced declines in per capita GDP. 2. Freedom House's Economic Freedom Indicators. Freedom House's efforts to supplement its annual reports on worldwide political and civil liberty eventually culminated in a free-standing publication, World Survey of Economic Freedom: 1995-1996. ... the World Survey confirms the importance of economic freedom as a determinant of prosperity: Whereas only 27 of those nations sampled, with just 17 percent of the world's population, merited a "free" rating, these 27 nations produced 81 percent of total world output. By contrast, the 20 nations rated "not free" contain more than a third of the world's people yet produce only 5 percent of total output. 3. The Heritage Foundation's Indices of Economic Freedom. ...the study's authors added the following observations on U.S. foreign aid and growth: Of the 76 countries ranked as "mostly unfree" or "repressed" on the Index, 34 have received U.S. foreign aid for over 35 years, many for as long as 51 years. Of these 34 countries, 14 are poorer today than they were in 1965. Twelve more have essentially the same amount of wealth as they did some 30 years ago. Of the 34 long-term recipients of U.S. foreign aid ranked by the Index as lacking economic freedom, 26 are no better off than they were over three decades ago. . . .If development aid is essential to economic prosperity, why has there been so little progress by countries that are most dependent on foreign aid? The answer is simple: Economic freedom, not aid, is the key to economic development. What are the author's main points to achieve economic growth?

All of the above

Technological advance makes it possible to produce more goods with the same amount of input (labor, capital, etc.). What does this do to the country's Production Possibilities Frontier?

Expand by shifting outward.

The stimulus bill passed by the U.S. Congress in February 2009, is an example of:

Expansionary fiscal policy

The Federal National Mortgage Association (FNMA), also known as Fannie Mae, was established to _____________ demand in the housing market.

Increase

Keynesians would argue that Aggregate Supply _______________ while supporters of the Hayek or Friedman point of view would say that Aggregate Supply ______________

Is socially optimal only with government intervention; is subject to Say's Law and thus adjusts to equilibrium without government intervention.

The chart below shows a single exchange rate change from the Mexican point of view and the American point of view. Which Country's GDP increases in this example?

Mexico

Refer to the Exhibit below: When trading, France should specialize in ________________ and the United States should specialize in __________________.

Organic Tofu; Weapons Grade Plutonium

Review the article by an economist below. Economic Whodunit by Thomas Sowell During bad times, the blame game is the biggest game in Washington. Wall Street "greed" or "predatory" lenders seem to be favorite targets to blame for our current economic woes. When government policy is mentioned at all in handing out blame, it is usually blamed for not imposing enough regulation on the private sector. But there is still the question whether any of these explanations can stand up under scrutiny. Take Wall Street "greed." Is there any evidence that people in Wall Street were any less interested in making money during all the decades and generations when investments in housing were among the safest investments around? If their greed did not bring on an economic disaster before, why would it bring it on now? As for lenders, how could they have expected to satisfy their greed by lending to people who were not likely to repay them? The one agency of government that is widely blamed is the Federal Reserve System — which still keeps the heat away from elected politicians. Nor is the Fed completely blameless. It kept interest rates extremely low for years. That undoubtedly contributed to an increased demand for housing, since lower interest rates mean lower monthly mortgage payments. But an increased demand for housing does not automatically mean higher housing prices. In places where supply is free to rise to meet demand, such as Manhattan in the 1950s or Las Vegas in the 1980s, increased demand simply led to more housing units being built, without an increase in real prices — that is, money prices adjusted for inflation. What led to a boom in housing prices was increased demand in places where supply was artificially restricted. Coastal California was the largest of these places where severe legal restrictions on building houses led to skyrocketing housing prices. Just between 2000 and 2005, for example, home prices more than doubled in Los Angeles and San Diego, in response to rising demand in places where supply was not allowed to rise to meet it. At the height of the housing boom in 2005, the ten areas with the biggest home price increases over the previous five years were all in California. That year, the average home price in California was more than half a million dollars, even though the average size of the homes sold was just 1,600 square feet. Although California — and especially coastal California — was the biggest place with skyrocketing housing prices, it was not the only place. Other enclaves, here and there, with severe housing restrictions also had rapidly rising housing prices to levels far above the national average. If the housing boom was so localized, how did this become a national problem? Because the money that financed housing in areas with housing price booms was supplied by financial institutions across the country and even across the ocean. Mortgages made in California were sold to nationwide financial institutions, including Fannie Mae and Freddie Mac, and to firms in Wall Street which bundled thousands of these mortgages into financial securities that were sold nationally and internationally. The problem was that, not only were these mortgages based on housing prices inflated by the Federal Reserve's low-interest rate policies, many of the home buyers had been granted mortgages under federal government pressures on lenders to lend to people who would not ordinarily qualify, whether because of low income, bad credit history or other factors likely to make them bigger credit risks. This was not something that federal regulatory agencies permitted. It was something that federal regulatory agencies — under pressure from politicians — pressured and threatened lenders into doing in the name of "affordable housing." The housing market collapse was set off when the Federal Reserve returned interest rates to more normal levels, but it was a financial house of cards that was due to collapse, sending shock waves through the economy. It was just a matter of when, not if. ....It's not that politicians never learn. They learn how much they can get away with, when they can blame others. The author anticipates the argument that greed was to blame for the financial crisis by pointing out:

That housing used to be a 'safe' investment and that Wall Street has been around for a long time during which we did not have housing crisis.

If the United States goes into a recession, this tends to shift Japan's AD curve _____________ because Japan will __________________.

leftward; export less to the U.S.

Review the article by an economist below. Economic Whodunit by Thomas Sowell During bad times, the blame game is the biggest game in Washington. Wall Street "greed" or "predatory" lenders seem to be favorite targets to blame for our current economic woes. When government policy is mentioned at all in handing out blame, it is usually blamed for not imposing enough regulation on the private sector. But there is still the question whether any of these explanations can stand up under scrutiny. Take Wall Street "greed." Is there any evidence that people in Wall Street were any less interested in making money during all the decades and generations when investments in housing were among the safest investments around? If their greed did not bring on an economic disaster before, why would it bring it on now? As for lenders, how could they have expected to satisfy their greed by lending to people who were not likely to repay them? The one agency of government that is widely blamed is the Federal Reserve System — which still keeps the heat away from elected politicians. Nor is the Fed completely blameless. It kept interest rates extremely low for years. That undoubtedly contributed to an increased demand for housing, since lower interest rates mean lower monthly mortgage payments. But an increased demand for housing does not automatically mean higher housing prices. In places where supply is free to rise to meet demand, such as Manhattan in the 1950s or Las Vegas in the 1980s, increased demand simply led to more housing units being built, without an increase in real prices — that is, money prices adjusted for inflation. What led to a boom in housing prices was increased demand in places where supply was artificially restricted. Coastal California was the largest of these places where severe legal restrictions on building houses led to skyrocketing housing prices. Just between 2000 and 2005, for example, home prices more than doubled in Los Angeles and San Diego, in response to rising demand in places where supply was not allowed to rise to meet it. At the height of the housing boom in 2005, the ten areas with the biggest home price increases over the previous five years were all in California. That year, the average home price in California was more than half a million dollars, even though the average size of the homes sold was just 1,600 square feet. Although California — and especially coastal California — was the biggest place with skyrocketing housing prices, it was not the only place. Other enclaves, here and there, with severe housing restrictions also had rapidly rising housing prices to levels far above the national average. If the housing boom was so localized, how did this become a national problem? Because the money that financed housing in areas with housing price booms was supplied by financial institutions across the country and even across the ocean. Mortgages made in California were sold to nationwide financial institutions, including Fannie Mae and Freddie Mac, and to firms in Wall Street which bundled thousands of these mortgages into financial securities that were sold nationally and internationally. The problem was that, not only were these mortgages based on housing prices inflated by the Federal Reserve's low-interest rate policies, many of the home buyers had been granted mortgages under federal government pressures on lenders to lend to people who would not ordinarily qualify, whether because of low income, bad credit history or other factors likely to make them bigger credit risks. This was not something that federal regulatory agencies permitted. It was something that federal regulatory agencies — under pressure from politicians — pressured and threatened lenders into doing in the name of "affordable housing." The housing market collapse was set off when the Federal Reserve returned interest rates to more normal levels, but it was a financial house of cards that was due to collapse, sending shock waves through the economy. It was just a matter of when, not if. ....It's not that politicians never learn. They learn how much they can get away with, when they can blame others. From the article, you can assume that the author would agree that:

We should learn from and not repeat the actions of Fannie Mae and Freddie Mac along with financial institutions that bundled and sold mortgage securities internationally; the tinkering of the Federal Reserve in Keynesian stimulus with overly low-interest rate polices; the pressure applied to financial firms by federal regulators desiring to lend to people who would not ordinarily qualify for loans.

The chart below shows a single exchange rate change from the Mexican point of view and the American point of view. What happens to the value of the Dollar against the Peso?

appreciation

The chart below shows a single exchange rate change from the Mexican point of view and the American point of view. What happens to Mexican Imports from the U.S.?

decreases

The chart below shows a single exchange rate change from the Mexican point of view and the American point of view. What happens to U.S. Exports to Mexico?

decreases

The chart below shows a single exchange rate change from the Mexican point of view and the American point of view. What happens to the value of the Peso against the Dollar?

depreciation

If wages are __________________, the economy ____________________ remove itself from a recessionary gap, and thus __________________ government intervention is needed.

flexible; can; no

The chart below shows a single exchange rate change from the Mexican point of view and the American point of view. What happens to Mexican Exports to the U.S.?

increases

The chart below shows a single exchange rate change from the Mexican point of view and the American point of view. What happens to U.S. Imports from Mexico?

increases

Which of the following lists accurately summarize the facts related to globalization?

low tariff rates, increases in the number of countries importing and exporting, greater foreign exchange trading, more foreign direct investment, more people owning foreign stocks, countries joining the World Trade Organization, and an increase in Americans working for foreign companies in the U.S.

If Germany's Real GDP rises, this tends to __________________ United States exports, shifting the United States AD curve to the _____________________.

raise; right

A tariff is a:

tax imposed on imported goods.