Chapter 10

10.1.1 If Anthony invested $10,000 at 10% annual interest, and Artie invested $5,000 at 20% annual interest, at the end of 10 years, we can expect Anthony to have more money. Select one: True False

False Calculate how much Anthony will have at the end of 10 years. $10,000 (1 + .10)10 = $25,937.42 Now calculate how much Artie will have at the end of 10 years. $5,000 (1 + .20)10 = $30,958.68 Even though Artie had a smaller starting base than Anthony did, Artie's rate of interest was higher. The power of compounding propelled Artie ahead of Anthony.

10.1.4 Empirical evidence does not suggest a correlation between an economy's productivity and its standard of living. Select one: True False

False Empirical evidence does in fact support the notion that there is a positive correlation between productivity and the standard of living within a country. Rich economies are characterized by high productivity, while poor economies have relatively low productivity.

10.2.1 Holding the labor force, natural resources, and human capital constant, aquiring more capital goods will continue to increase production. Select one: True False

False The quantity of goods and services produced will increase with each addition to capital up to a certain point. After this point, each addition to capital will decrease output. This concept is known as diminishing marginal returns to investment. The correct answer is 'False'.

10.1.4 The ratio of an economy's production of goods and services to capital goods measures that economy's productivity. Select one: True False

False The ratio of goods and services to labor measures an economy's productivity. A rich economy's production is achieved with less effort in relation to a poor economy. This fact is based on the ratio of production to labor.

Because most developed economies are industrialized, transforming an agricultural economy to an industrial economy can only promote growth. Select one: True False

False nomies may find it beneficial to invest in improving agricultural production rather than transform into an industrial producer.

10.1.4 Increasing productivity allows firms to pay higher wages without causing inflationary concerns. Select one: True False

True Firms can afford to pay more productive workers higher wages without causing inflation. When the wage rate increases, aggregate demand increases, and the economy's standard of living improves.

10.2.1 As the cost of borrowing money decreases, capital accumulation increases. Select one: True False

True In other words, as the interest rate decreases, investment spending increases. The downward slope of the investment demand curve illustrates this inverse relationship between the interest rate (the cost of borrowing money) and investment spending (capital accumulation). The correct answer is 'True'.

10.2.2 Producing goods and services based on comparative advantage rather than absolute advantage allows for maximum economic growth. Select one: True False

True Producing with lower opportunity costs, rather than fewer resources, fosters economic growth.

10.3.1 Developed countries have always established institutions that support commerce and trade. Select one: True False

True The establishment and stability of commerce and trade institutions are the hallmarks of a developed country. Often an emerging economy lacks one or more of these institutions.

10.2.2 Import substitution increases the prices of domestic goods and services and decreases the quantity demanded. Select one: True False

True When countries engage in import substitution, they take away the choice for consumers to purchase cheaper imported goods. Allowing only the production of domestic goods will drive the price upward and decrease the quantity demanded. Not engaging in international trade may actually hurt domestic producers as well as consumers.

10.1.2 An outward shift of the long-run aggregate supply curve Select one: a. will raise an economy's standard of living. b. increases unemployment. c. is caused by a depletion of natural resources. d. increases the aggregate price level.

a. An outward shift of the long-run supply curve can occur as a result of an increase in an economy's resource base or an improvement in technology that makes production more efficient. Increasing long-run aggregate supply can only improve an economy's standard of living, because output is higher and prices are lower.

10.2.1 Which of the following factors explains why developing countries typically have high growth rates? Select one: a. The marginal product of capital is high. b. The marginal product of capital is low. c. Productivity is high. d. Productivity is low.

a. Because developing countries have relatively little capital, each unit of capital increases output by a lot. In contrast, in industrial economies, where the level of investment is already high, the increase in output generated by each additional unit of capital is lower. The correct answer is: The marginal product of capital is high.

10.1.3 An economy's production is a function of its Select one: a. technology. b. income. c. labor force. d. inflation rate.

a. Consider the production function: Y = f (L, K, N, H). An economy's resources consist of labor, capital goods, natural resources, and human capital. Technology, the function, determines how these resources are combined to produce output.

10.3.1 Which of the following expresses per capita GDP? Select one: a. GDP / population Correct b. Population / GDP c. GDP / average income d. Average income / GDP

a. Per capita GDP shows the average GDP per person in an economy.

10.1.3 Consider the production function Y = f(L, K, N, H). Increasing each component by 10% will increase output by _________. Select one: a. 10% b. 20% c. 40% d. an indeterminate amount

a. The concept of constant returns to scale holds that increasing the components that determine productivity will increase output by the same amount. In this example, if we increase labor, capital goods, natural resources, and human capital by 10%, we would expect our total output to increase by 10%.

10.1.4 All of the following will increase productivity except Select one: a. decreasing wages. b. technological advances. c. more skills and knowledge acquired by the labor force. d. accumulation of capital by businesses.

a. Wages are not a component of the production function. High worker productivity induces a firm to pay a higher wage. The standard of living improves, and the economy expands.

10.2.1 What is the effect of a trade deficit on domestic investment spending? Select one: a. Investment increases, because the supply of loanable funds increases. b. Investment decreases, because the supply of loanable funds decreases. c. Investment increases, because government spending increases. d. Investment decreases, because government spending decreases.

a. When a country runs a trade deficit, it means that foreigners are willing to provide them with more goods and services than they receive in return. The difference represents an increase in the supply of loanable funds, which reduces interest rates and increases investment. The correct answer is: Investment increases, because the supply of loanable funds increases.

10.1.2 Spending more on capital goods today will most likely lead to Select one: a. increased long-run economic growth. b. a narrower range of production possibilities. c. higher prices in the long run. d. all of the above.

a. When an economy chooses to spend more on capital, or investment, goods today, it is providing itself with a wider range of production possibilities tomorrow. Increasing the resource base will shift the long-run aggregate supply curve outward. After all adjustments, the long-run equilibrium will occur at a higher output level and lower prices.

10.1.2 Which of the following is a result of an outward shift of the long-run aggregate supply curve? Select one: a. Economic recession b. Lower price level c. Lower level of full employment d. Decreased aggregate demand

b. An outward shift of the long-run aggregate supply curve initiates a downward price adjustment. The new long-run equilibrium settles at a lower price level and higher output level.

10.1.3 The function that correctly measures productivity using constant returns to scale is Select one: a. Y / L = f (1, xK, xN, xH). b. Y / L = f (1, K / L, N / L, H / L). c. Y = f (L, K, N, H). d. xY = f (1, K / L, N / L, H / L).

b. Begin with the simple production function: Y = f (L, K, N, H). This expression can be written as xY = f (xL, xK, xN, xH). When x = 1/L, we can derive the equation Y / L = f (1, K / L, N / L, H / L) that tells us that productivity will increase by the amount that each component is increased.

10.2.2 What is the effect on growth of eliminating trade barriers? Select one: a. Domestic producers are forced out of business, and growth slows. b. Domestic producers are forced to compete with importers, and productivity and growth increase. c. The domestic economy is unaffected. d. Consumers tend to substitute domestic goods for imports.

b. Domestic producers that are less efficient than foreign producers can continue to produce only if they are protected by trade barriers. Once trade barriers are eliminated, domestic producers must produce goods and services that can compete with those produced abroad. Having to compete with world standards increases productivity, leading to higher growth.

10.1.4 A rich economy is able to produce __________ goods and services with relatively __________ effort than a poor economy. Select one: a. more; more b. more; less c. less; less d. less; more

b. Feedback The ratio of goods and services (output) to labor (input) measures an economy's level of productivity. Thus, rich economies are able to produce more goods and services while using a relatively small pool of its resources.

10.1.1 Suppose Glenn deposited $5,000 in his bank in 1990. By 2000, Glenn's money had grown to $10,000. Calculate the average interest rate that Glenn earned. Select one: a. 5% b. 7% c. 10% d. 12%

b. Glenn's money doubled over 10 years. According to the Rule of 70, if a sum of money doubles in 10 years, the interest earned on that sum would have to equal 7%.

10.1.2 _____________ measures both aggregate income and expenditures. Select one: a. Net national product b. Gross domestic product c. Gross national income d. Net domestic product

b. Macroeconomic equilibrium occurs when income equals output or when spending equals income. The transitive property allows us to express equilibrium as the equality of spending and output. Therefore, gross domestic product (a measure of output) can be used to measure both aggregate income and expenditures.

10.2.1 Which of the following best describes the relationship between capital and output? Select one: a. Output rises as capital rises, at an increasing rate. b. Output rises as capital rises, at a decreasing rate. c. Output falls as capital rises, at an increasing rate. d. Output falls as capital rises, at a decreasing rate.

b. Output rises as capital rises, but it does so at a decreasing rate. To see why, think about a clothing factory that was doing all of its stitching by hand. The initial increase in output as a result of purchasing a sewing machine would be enormous. Once the factory already had 100 sewing machines, however, the increase in output as a result of investing in an additional sewing machine would be small. The correct answer is: Output rises as capital rises, at a decreasing rate.

10.2.2 What is the effect of banning imports in order to encourage the development of domestic industries? Select one: a. Exports increase. b. People pay more for goods and services, because they are produced by less efficient domestic manufacturers, who are protected from foreign competition. c. People pay less for goods and services, because they are produced domestically. d. The quality of goods and services improves, because they are produced domestically rather than imported from abroad.

b. Protecting local producers raises the costs of goods and services and allows inefficient producers to remain in business. Mexico's experience with import substitution shows the effects of such a policy.

Which of the following is not a source of funds for investment in emerging economies? Select one: a. The World Bank b. A trade surplus c. The International Monetary Fund d. Household savings

b. Remember the savings function: I = S + (T − G) − NX. When an economy is operating with a trade deficit (an excess of imports over exports), the savings from foreigners is available to domestic firms for investment.

10.1.1 If Tom received a yearly raise of 7%, about how many years would it take for his salary to double? Select one: a. 7 years b. 10 years c. 14 years d. 21 years

b. The Rule of 70 is an equation that determines the number of years a sum of money requires to double when compounded with interest. When we divide .70 by Tom's yearly increase of .07 (or 7%), we calculate that it will take 10 years for Tom's salary to double.

10.1.2 If an economy's production possibilities frontier (PPF) curve shifts outward, we can expect the __________ to shift __________. Select one: a. aggregate demand curve; inward b. aggregate demand curve; outward c. long-run aggregate supply curve; outward d. long-run aggregate supply curve; inward

c. An outward shift of the PPF curve indicates an increase in production possibilities. Spending more on capital goods today allows for more production in the future. We can expect the long-run aggregate supply curve to shift outward and the economy's standard of living to improve.

10.3.1 Which of the following is not a characteristic of an emerging economy? Select one: a. Rapid population growth b. Low savings c. High demand d. Low productivity

c. Because emerging economies generally have low per capita GDP, they face low demand as well.

10.1.1 The term compounding refers to Select one: a. the increase in the growth rate over a period of time. b. the inflation adjustment to the growth rate of real GDP over a period of time. c. the accumulation of a growth rate over a period of time. d. none of the above.

c. Compounding increases a sum of money exponentially over time. Exponential growth can propel a country with a relatively smaller starting base and higher growth rate above a country with a higher base and smaller growth rate. This exponential growth is the result of compound interest.

10.2.2 Which of the following government policies does not increase human capital? Select one: a. Subsidizing job training b. Providing tax incentives for college education c. Increasing the rate of taxation d. Investing in clean air and water

c. Increasing the rate of taxation diminishes the amount of money individuals have to spend on all goods, including those, such as training and education, that increase human capital.

10.1.1 If you invest $20,000 for 5 years at 12%, how much will you have at the end of the 5th year? Select one: a. $22,400 b. $23,718 c. $35,247 d. $112,653

c. Multiply $20,000 × (1.12)5. You can see the power of compound interest when you raise the compounding term to the exponent of the number of years you choose to invest your money.

Which of the following has been voiced as a criticism of the policies of the World Bank and the IMF? Select one: a. Their policies cause inflation. b. Their policies reduce poor countries' trade surpluses. c. Their policies fail to help the poor. d. All of the above

c. Some critics claim that the policies of the World Bank and the IMF benefit the elites at the expense of poor workers.

10.1.1 The correct equation for the Rule of 70 is Select one: a. n = (.70) (r) b. n = 70/r c. n = .70/r d. n = (70) (r)

c. The Rule of 70 is derived from the natural log of two and is an equation that determines the number of years a sum of money requires to double when compounded with interest.

10.2.2 Which of the following statements about the World Bank is true? Select one: a. The World Bank specializes in investing in projects that commercial banks consider too risky. b. The World Bank invests only in projects that earn profits for investors. c. The World Bank is a financial intermediary that invests in projects that improve the standard of living for people in poorer countries. d. None of the above

c. The World Bank makes loans to countries for infrastructure and other projects intended to improve living standards.

10.1.3 Which of the following is not a component of the production function? Select one: a. Human capital b. Labor c. Interest rate d. Natural resources

c. The interest rate is irrelevant in determining an economy's level of output given its resource pool.

10.1.3 Water, minerals, and land are part of an economy's Select one: a. human capital. b. capital goods. c. natural resources. d. labor force.

c. Water, minerals, and land are an economy's natural resources. Natural resources are an important component of the production function that determines what an economy can produce. Correct

10.1.3 All of the following would be considered capital goods, except Select one: a. a dump truck. b. a new factory. c. on-the-job training. d. All of the above are capital goods.

c. While on-the-job training is used to produce other goods, it is instead considered to be human capital---acquired knowledge and skills.

One way that an emerging economy can foster growth is by allocating resources with central planning. However, the problem with central planning is Select one: a. the possibility of government corruption. b. the lack of information. c. the misallocation of resources. d. all of the above.

d. All of the above are problems with central planning. Emerging economies that implement policies to break out of poverty must realize the possible counter-productive effects of those policies. The allocation of resources by a central planner may promote and hinder growth at the same time in a poor economy.

10.3.1 Which of the following does not represent an institution that supports commerce? Select one: a. Property rights b. The rule of law c. Contract enforcement d. None of the above

d. All of the above represent institutions that support commerce.

10.1.1 Apply the Rule of 70 to the following question. If you invest $10,000 at 5% interest, how long will it take for your money to double? Select one: a. 5 years b. 7 years c. 10 years d. 14 years

d. Divide 70/5 = 14. If you invest $10,000 at 5% interest, your money to double in 14 years.

10.2.2 Which of the following statements about growth rates in developing countries is true? Select one: a. The marginal productivity of capital is lower than in industrial countries. b. Worker productivity is higher than in industrial countries. c. Growth rates are lower than in industrial countries. d. Growth rates are higher than in industrial countries.

d. Growth rates in developing countries tend to be high, because the marginal product of capital is high.

10.3.1 Which of the following explains the phenomenon of a low-level equilibrium? Select one: a. In countries in which GDP is low, aggregate demand is low. As a result, there are few job opportunities. b. In countries in which GDP is low, saving is low. As a result, little capital is available for investment. c. In countries in which GDP is low, investment is low. As a result, the stock of physical and human capital is low. d. All of the above

d. In poor countries, aggregate demand is low, because people have little income with which to purchase goods and services. Jobs are not created, and investment is not highly rewarded. Savings and consumption are functions of income. When income is low, savings is low. Because savings always equals investment, investment in poor countries is low. The lack of investment means that factories are not built, innovations are not adopted, training is not provided, and skills are not taught. This lack of investment leaves poor countries ill prepared to increase output (and per capita GDP).

10.2.1 Which of the following affects the level of investment spending in the economy? Select one: a. Savings of households b. Welfare payments c. Imports and exports d. All of the above

d. Investment spending is determined by the level of private savings of households; public savings of government (taxes less government spending); and savings of foreigners (imports less exports). The correct answer is: All of the above

What conclusion can be drawn from the fact that after World War II Japan promoted export industries and later achieved a very high level of per capita GDP? Select one: a. Countries that invest in export industries tend to grow rapidly. b. Japan would have grown even more rapidly had it promoted industries that supplied the large domestic market. c. Japan benefited significantly from outside aid in the years following World War II. d. None of the above

d. Japan did invest in export industries after World War II, and it did develop into one of the most successful economies in the world. Whether Japan's industrial policy caused its success is unclear, however. Japan might have grown just as rapidly had it pursued a different policy. Countries that are ill equipped to produce export goods would reduce their growth by investing in such industries. It is not clear what would have happened to the Japanese economy had it pursued a different course. Japan did receive foreign aid after World War II, but the fact that it did so is not implied by the fact that its per capita GDP rose rapidly.

10.1.4 Productivity measures the amount of goods and services produced Select one: a. per person in a country. b. by one country relative to another country. c. from each worker in a given year. d. from a given amount of resource inputs.

d. Productivity depends on the availability of capital goods, natural resources, human capital, and technology. Productivity is determined by an economy's resource inputs.

10.1.4 The production function mathematically expresses the relationship between Select one: a. production and spending. b. the behavior of workers and the behavior of consumers. c. gross domestic product and national income. d. the quantity of output from production and the quantity of inputs used in production.

d. Recall the production function: Y = f (L, K, H, N). Productivity depends on the availability of labor, capital goods, human capital, and natural resources. These variables as a function of technology determine an economy's productivity.

10.2.1 Which of the following government policies is likely to induce investment spending? Select one: a. Increasing taxes on savings b. Increasing taxes on investment c. Increasing government spending d. Reducing government spending

d. Reducing government spending lowers interest rates, which induces private firms to invest. The correct answer is: Reducing government spending

Which of the following policies would unambiguously help an economy move out of the cycle of poverty? Select one: a. Moving the economy from agricultural production to industrial production b. Producing products that foreigners want to purchase c. Adopting central planning of the economy d. None of the above

d. Some countries, like Japan, that fostered the development of export industries appear to have been successful. Others, however, have failed miserably. None of the policies represents a simple formula for success.

10.3.1 Which of the following policies would not help poor countries break out of the poverty trap? Select one: a. Transferring technology from abroad b. Increasing the stock of human capital c. Stabilizing the exchange rate d. Subsidizing imports

d. Subsidizing imports would decrease the amount of savings available in the economy and reduce the level of investment.

Which of the following institutions was not created at the Bretton Woods Conference? Select one: a. The World Bank b. The International Monetary Fund c. The Federal Reserve Correct d. All of the above were created at Bretton Woods.

d. The Federal Reserve is the central bank of the United States. The World Bank and the IMF were created at Bretton Woods and are international organizations.

10.3.1 Which of the following can help boost an emerging economy out of poverty? Select one: a. Improved public health care b. Political stability c. Incentives to increase savings d. All of the above

d. The implementation of all of the above policies can help break the cycle of poverty in an emerging economy.

10.3.1 The term economists use today to describe poor economies in which GDP is improving is Select one: a. underdeveloped countries. b. developing countries. c. less developed countries. d. emerging economies.

d. The terms used to refer to poor countries have changed over the years. The term used today to describe countries in which GDP is rising rapidly is "emerging economies."

10.1.3 Which of the following statements regarding human capital is false? Select one: a. Human capital is a produced factor of production. b. Knowledge acquired from grade school is considered human capital. c. The production of human capital requires inputs in the form of teachers. d. A classroom can be considered a form of human capital.

d. This statement is false. The classroom itself is physical capital. However, the knowledge and skills acquired in the classroom are considered human capital.