Principles of Macroeconomics (Chp 10-12)

Which of the following is a correct statement?

Inflation is measured as the percentage change in the CPI

Refer to Figure 12-1. If the economy is at point L, what will happen?

Inventories have risen above their desired level, and firms decrease production

An increase in the price level in the United States will shift the aggregate expenditure line upward.

false

Creative destruction means that

firms develop new products that replace old products in the economy, thereby encouraging economic growth

The purchase by an individual or firm of stock or bonds issued in another country is called

foreign portfolio investment

As the economy nears the end of an expansion, interest rates usually ________ and wages rise more ________ than prices.

rise; rapidly

If planned aggregate expenditure is below potential GDP and planned aggregate expenditure equals GDP, then

the economy is in a recession

Knowledge capital is nonrival in the sense that

two people can use the same knowledge to develop and produce a product.

Refer to Figure 12-4. Potential GDP equals $500 billion. The economy is currently producing GDP 1 which is equal to $450 billion. If the MPC is 0.8, then how much must autonomous spending change for the economy to move to potential GDP?

$10 billion

Refer to Figure 12-3. Suppose that investment spending increases by $10 million, shifting up the aggregate expenditure line and GDP increases from GDP 1 to GDP 2. If the MPC is 0.9, then what is the change in GDP

$100 million

Consider the following data for a closed economy: Y = $12 trillion C = $8 trillion I= $2 trillion G = $2 trillion TR = $2 trillion T = $3 trillion Refer to Scenario 10-1. Based on the information above, what is the level of private saving in the economy?

$3 trillion

If the MPC is 0.5, then a $10 million increase in disposable income will increase consumption by

$5 million

If real GDP per capita in the United States is $8,000, what will real GDP per capita in the United States be after 5 years if real GDP per capita grows at an annual rate of 3.2%?

$9,365

Refer to Table 10-1. Using the table above, what is the approximate average annual growth rate from 2013 to 2016?

2%

GDP in a country grew from $10 billion to $14 billion over the span of 5 years. The percentage change in GDP was

40% Over the 5 years, the GDP grew by ((14-10)/10)*100=40% The question does not ask about average growth rate.

Explain how a stock market crash has the potential to lead to a recession in an economy.

A stock market crash is essentially a substantial decrease in the average price of stocks. Stocks are a part of real wealth. A stock market crash decreases the value of stocks which decreases real wealth. Real wealth is an important determinant of consumption spending. If real wealth declines, so does consumption spending. Therefore, a stock market crash will result in a decline in consumer expenditures. This will result in a decline in GDP. If the decrease in GDP is substantial enough, this can lead to a recession.

Refer to Figure 11-1. Diminishing marginal returns is illustrated in the per-worker production function in the figure above by a movement from

A to C

Refer to Table 12-12. Using the table above, answer the following questions. The numbers in the table are in billions of dollars. a. What is the equilibrium level of real GDP? b. What is the MPC? c. If potential GDP is $7,000 billion, is the economy at full employment? If not, what is the condition of the economy? d. If the economy is not at full employment, by how much should government spending increase so that the economy can move to the full employment level of GDP?

A) equilibrium level of real GDP: ( C + I + G + NX) $4,000 --- $4,200 $5,000 --- $5,000 $6,000 --- $5,800 $7,000 --- $6,600 B) MPC is ΔC / ΔY ΔC = $800 billion ΔY = $1,000 billion $8,000b / $1,000b = 0.8 MPC C) No, the economy is not at full employment. The Equilibrium GDP is $5,000 billion, meaning it is less than the potential GDP = economy is in recession D) GDP must rise to $7,000 billion to be at full employment, meaning that the GDP must increase by $2,000 billion. ΔGDP = M x ΔG $2,000 billion = 5 x ΔG $2,000/ 5 = ΔG = $400 billion for economy to be full employment

Refer to Figure 11-5. Based on the "catch-up line" drawn above, poorer countries are more likely to be at a point like ________, where growth in GDP is relatively ________, while richer countries are more likely to be at a point like ________, where growth in GDP is relatively ________.

A; high; B; low

Refer to Figure 12-1. At point L in the figure above, which of the following is true?

Actual inventories are greater than planned inventories

Explain how advances in technology are critical to sustaining economic growth, even if capital per hour worked is consistently increasing. Provide a graph of a per-worker production function to support your answer.

As the level of capital per hour worked increases, an economy moves along the per-worker production function toward higher levels of real GDP per hour worked. However, diminishing returns imply that successive increases in capital per hour work increase real GDP per hour worked at a decreasing rate. As shown in the graph below, moving from point A to point B implies an increase in capital per hour worked. As a result, real GDP per hour worked increases from $780 to $800 (an increase of $20). Moving from point B to point C implies a similar increase in capital per hour worked, but real GDP per hour worked increases from $800 to $810 (an increase of only $10). Without technological change that shifts the per-worker production function upward, continual growth in real GDP per hour worked cannot be sustained even if capital per hour worked continues to increase.

Refer to Figure 11-1. Suppose the per-worker production function in the figure above represents the production function for the U.S. economy. If the United States decided to double its support of university research, this would cause a movement from

B to C

Refer to Figure 11-1. Technological change is illustrated in the per-worker production function in the figure above by a movement from

B to C

Refer to Figure 11-1. Using the per-worker production function in the figure above, the largest changes in an economy's standard of living would be achieved by a movement from

B to C to D

Under which of the following circumstances would the government be running a deficit?

G = $5 trillion T = $5 trillion TR = $1 trillion Correct

Refer to Figure 11-1. Within a country, the impact of wars and revolutions and their subsequent destruction of capital is reflected in the per-worker production function in the figure above by a movement from

C to A

Refer to Table 11-2. Calculate the GDP per capita for each country in the table. Which country has the highest standard of living? Why?

GDP per capita = GDP / Population. GDP per capita in Bulgaria: $55,700,000 / 7,200 = $7,736.11. GDP per capita in Indonesia: $888,500,000 / 254,500 = $3,491.16. GDP per capita in South Africa: $349,800,000 / 54,000 = 6,477.78. GDP per capita in Turkey: $186,200,000 / 90,700 = $2,052.92. Bulgaria has the highest standard of living as noted by their highest GDP per capita`

An increase in the price level in the United States will reduce imports and increase exports.

False

Higher interest rates increase both consumption and investment spending.

False

If planned investment is greater than actual investment, then aggregate expenditure is less than GDP.

False

Potential GDP is always greater than real GDP in an economy.

False

Explain, in detail, how the adjustment to macroeconomic equilibrium occurs when spending is less than production. Be sure to discuss how inventories play a crucial role in the adjustment process. State what happens to GDP and employment during the adjustment process.

If spending is less than production, then firms will not be selling as many goods and services as they had expected. Inventories of goods will start to build up. This sends a signal to those managing the retail firms to cut back on orders of goods from their distributors. Distributors cut back purchases from manufacturers. Manufacturers of the goods will cut back on production of the goods, and reduce purchases from their suppliers and lay off workers. The reduction in production will continue until inventories equal their desired levels, or until spending equals production. If this happens across many different industries, GDP and total employment will decline.

Refer to Figure 12-1. According to the figure above, at what point is aggregate expenditure greater than GDP?

J

Consider the following data for a closed economy: a. Y = $12 trillion b. C = $8 trillion c. I = $3 trillion d. TR = $2 trillion e. T = $3 trillion Use the data provided to calculate the level of private saving and the level of public saving and demonstrate their relationship to investment.

Level of Private Saving: (Y + TR - C - T) $12 trillion + $2 million - $8 trillion - $3 trillion = $3 trillion Level of Public Saving: (T - G - TR) (G = Y - C - I) (I = Sprivate + Spublic) $12 trillion - $8 trillion - $3 trillion = $1 trillion $3 trillion = $3 trillion + Spublic or $3 trillion - $1 trillion - $2 trillion = $0 trillion Spublic = $ 0 trillion Putting together both the private saving of $3 trillion and public saving of $0 trillion = $3 trillion total

Does globalization promote economic growth, and how does globalization affect the welfare of a given country's citizens?

More globalized countries generally experience much higher annual growth rates in real GDP per capita than countries that are less open to foreign trade and investment. As countries become more globalized, advances in technology in those countries become more likely, and advances in technology are a key to economic growth. However, foreign influences in some countries are not always viewed as positive, as they can have a greater impact on culture than some would like. In addition, multinational firms that operate in foreign countries may also pay very low wages or fail to uphold the same safety and environmental regulations they are required to follow in their own countries.

If inflation in the United States is higher than inflation in other countries, what will be the effect on net exports for the United States?

Net exports will decrease as U.S. exports decrease

Refer to Figure 10-2. Which of the following is consistent with the graph depicted above?

New government regulations decrease the profitability of new investment.

A small economy increased its capital per hour worked ( K/ L) from $40,000 to $50,000. As a result, real GDP per worker ( Y/ L) grew from $20,000 to $25,000. If the economy increases its capital per hour worked by another $10,000 to $60,000, but there is no change in technology, by how much more and in what direction will output per worker change?

Output per worker will increase by less than $5,000

Refer to Figure 10-3. Which of the following is consistent with the graph depicted above?

Taxes are changed so that real interest income is taxed rather than nominal interest income

The growth rate of real GDP in the United States rises from 4.2% to 4.4%. Explain and calculate how this increase in the growth rate of real GDP affects the number of years it will take for real GDP to double.

Rule of 70: the number of years to double = 70 / annual percentage growth rate growth rate: 4.2% - 70/ 4.2 = 16.67 years for the GDP to double growth rate: 4.4% - 70/4.4 = 15.9 years [The "Rule of 70" states that the number of years it takes for GDP to double is equal to 70 divided by the growth rate of real GDP. Given this formula, at a growth rate of 4.2%, it will take 70/4.2 = 16.67 years for GDP to double. If the growth rate increases by two-tenths of a percent (to 4.4%), the number of years it will take for GDP to double will decrease to 70/4.4 = 15.9 years.]

Given Table 12-9 below, fill in the values of the marginal propensity to save ( MPS) and the marginal propensity to consume ( MPC). Show that MPC + MPS = 1.

The MPC is defined as: MPC: ΔC / ΔY (change in consumption / change in income) $2,700 - 1,900/ $3,000 - 2,000 = $800/ $1,000 = 0.8 The MPS is defined as: MPS: ΔS / ΔY (change in saving / change in income) $300-100/ $3,000 -2,00 = $200/ $1000 = 0.2 At every level of income the MPC is 0.8 and at every level of income the MPS = 0.2. Therefore, MPC + MPS is always equal to 1.

Refer to Figure 12-2. If the U.S. economy is currently at point K, which of the following could cause it to move to point N?

The price level in the United States falls relative to the price level in other countries

Suppose you are a famous international economic advisor. You have been asked to asses the possibilities for growth in an African country. It is a country abundant in labor and some natural resources. The capital-to-labor ratio is low. It has a free market economy. You have found that this country does not have a very strong and healthy banking system, however the political system is stable and the government does a good job protecting property rights. Assess this country's prospects for growth. Recommend two things that would enhance the country's growth.

The prospects for this country's growth are fairly good. It has a lot of labor and natural resources. Having abundant factors of production can contribute to strong growth. The free market system is also another characteristic that should help enhance economic growth. Entrepreneurs can respond quickly and adopt technological innovations. We know that technological change can increase labor productivity. Also the fact that the government enforces property rights can help the free market to flourish. The political stability of the government is also a good sign. Investors won't be afraid to risk investing in the country. Two things the country could do to increase growth would be to raise the capital-to-labor ratio and develop the financial sector. The country could increase the capital-to-labor ratio by attracting foreign investment, or perhaps giving tax breaks to firms that increase the amount they invest. This is probably one of the most effective ways to increase growth.

Refer to Table 11-6. Consider the statistics in the table above in describing the developing countries. Are these consistent with the economic growth model? Briefly explain.

The statistics for developing countries are constant with the economic growth model. The countries with the lowest levels of real GDP per capita in 1960 had the highest growth rates betweens 1960 and 2000. The countries with the highest levels of real GDP per capita had the lowest growth rates.

Consumption is $5 million, planned investment spending is $8 million, government purchases are $10 million, and net exports are equal to $2 million. If GDP during that same time period is equal to $27 million, what unplanned changes in inventories occurred?

There was an unplanned increase in inventories equal to $2 million.

In 2003, Congress passed a tax cut that included a reduction in the marginal tax rate on stock dividends. This essentially increased the after-tax rate of return on stocks that offer dividends. Using the loanable funds market, describe what will happen to saving, investment, economic growth, the real interest rate, and the quantity of loanable funds exchanged.

To begin, dividends are the sum of money paid regularly or quarterly by a company to its shareholders out of its profits or reserves. So when taxes on dividends are decreased, this causes the after tax rate of return on stocks to rise (those offer dividends). Because the return to saving would increase, saving will increase as well as the supply of loanable funds. So, the supply curve for loanable funds will shift to the right and lower the real interest rate as well as increase the quantity of loanable funds exchanged. [Dividends are the portion of corporate profits paid to shareholders. They are taxed like other forms of income. When taxes on dividends are decreased, this raises the after-tax rate of return on stocks that offer dividends. Because the return to saving would increase, saving will increase and the supply of loanable funds will increase. The shift to the right by the supply curve for loanable funds should lower the real interest rate and increase the quantity of loanable funds exchanged. This will raise investment spending in the economy. As investment spending grows, the capital stock and capital per hour worked should grow, and the rate of economic growth should increase.]

Macroeconomic equilibrium can occur at any point on the 45-degree line.

True

Refer to Table 12-10. Using the table above, calculate the unplanned change in inventories for each level of GDP, and explain what will happen to GDP?

Unplanned change in Inventory = REAL GDP - (C+I) Real GDP: $2,000 - Aggregate Expenditure: $2,200 - Unplanned Change in Inventories: -$200 - Real GDP will increase Real GDP: $2,500 - Aggregate Expenditure: $2,600 - Unplanned Change in Inventories: -$100 - Real GDP will increase Real GDP: $3,000 - Aggregate Expenditure: $3,000 - Unplanned Change in Inventories: $0 - Real GDP will be in equilibrium Real GDP: $3,500 - Aggregate Expenditure: $3,400 - Unplanned Change in Inventories: $100 - Real GDP will decrease The macroeconomic equilibrium is determined where aggregate expenditure = real GDP. The values for aggregate expenditure for each level of real GDP are given in the table below. The unplanned change in inventories is the difference between aggregate expenditure and real GDP. If there is an unplanned decrease in inventories, firms are selling goods faster than they planned, and this is a signal for firms to increase production. If there is an unplanned increase in inventories, firms are selling goods more slowly than they expected, and this is a signal for firms to decrease production.

Explain and show graphically how an increase in government spending affects the equilibrium interest rate in the market for loanable funds.

When government spending increases, government saving (T - G - TR) falls. This decrease in government saving shifts the supply curve for loanable funds to the left, increasing the equilibrium interest rate as shown below. [and reducing the amount that the interest rate rises. The more elastic is the supply of loanable funds, the flatter the supply curve would be, so the interest rate would rise by less and thus national saving would fall by less. The more elastic the demand for loanable funds, the flatter the demand curve would be, so the interest rate would rise by less and thus national saving would fall by more.]

Under which of the following circumstances would private saving be positive in a closed economy?

Y = $10 trillion C = $5 trillion TR = $2 trillion G = $2 trillion public saving = $1 trillion

Which of the following government policies would most likely result in an increase in economic growth?

a decrease in the interest rate at which the government provides student loans

Refer to the Article Summary. If, after the outflow of educated workers in Mexico, it now takes more capital per hour worked to get the same amount of GDP per hour worked, this indicates ________ the per-worker production function in Mexico.

a downward shift of

Firms in a small economy planned that inventories would grow over the past year by $300,000. Over that year, inventories actually grew by $400,000. This implies that

aggregate expenditure that year was less than GDP that year

An unplanned increase in inventories results from

actual investment that is greater than planned investment.

Which of the following will increase investment spending in the economy, holding everything else constant?

an increase in the federal government surplus

If the economy is currently in equilibrium at a level of GDP that is below potential GDP, which of the following would move the economy back to potential GDP?

an increase in wealth

The period of expansion ends with a ________ and the period of recession ends with a ________.

business cycle peak; business cycle trough

A decrease in Social Security payments will

decrease consumption spending

A recession begins with a ________ in spending by firms on capital goods and a ________ in spending on durable goods by households.

decrease; decrease

Suppose that in 2016, real GDP grew in Estonia by 3% and the population increased by 5%. Therefore, in 2016, Estonia experienced

economic growth, but not an increase in living standards

Inflation tends to ________ during the expansion phase of the business cycle and ________ during the recession phase of the business cycle.

increase; decrease

An increase in the price level ________ real wealth, which causes consumption to ________.

lowers; decrease

An increase in the real interest rate will

most likely lower consumers' purchases of durable goods.

Consider the following data for a closed economy: Y = $12 trillion C = $8 trillion I= $2 trillion G = $2 trillion TR = $2 trillion T = $3 trillion Refer to Scenario 10-1. Based on the information above, what is the level of public saving?

negative $1 trillion (a deficit of $1 trillion)

Which of the following government provisions would help increase the accumulation of knowledge capital?

patents copyrights education subsidies

Refer to Figure 10-6. The loanable funds market is in equilibrium, as shown in the figure above. As a result of an increase in the government budget deficit, the ________ for loanable funds will ________, thereby ________ the equilibrium real interest rate and ________ the equilibrium quantity of loanable funds.

supply; fall; increasing; decreasing