Macroeconomics Final

Economists in Funlandia, which has a closed economy, have collected the following information about the economy for a particular year (see graph) Complete the following table by calculating private saving, public saving, national saving, investment, and the equilibrium real interest rate. Component vs. Amount 1) Private Saving 2) Public Saving 3) National Saving 4) Investment 5) Equilibrium Real Interest Rate

1) 2500 2) -200 3) 2300 4) 2300 5) 10%

Assume that the banking system has total reserves of $100 billion. Assume also that required reserves are 10 percent of checking deposits and that banks hold no excess reserves and households hold no currency. The money multiplier is _______. The money supply is_______ billion. Suppose the Fed raises required reserves to 20 percent of deposits. The new money multiplier is ______, and the money supply _______ to _______ billion.

10 1,000 5, decrease, 500

Consider the following data on U.S. GDP: Year Nominal GDP (Billions of dollars) GDP Deflator (Base year 2005) 2012: 15,676 115.4 2002: 10,642 92.2 The growth rate of nominal GDP between 2002 and 2012 was ________ , and the growth rate of the GDP deflator between 2002 and 2012 was ________. Measured in 2005 prices, real GDP was ________ in 2002 and _________ in 2012. The growth rate of real GDP between 2002 and 2012 was _________. The growth rate of nominal GDP between 2002 and 2012 was __________ than the growth rate of real GDP.

3.9% 2.3% $11,542.30 $13,584.06 1.6% Higher

Assume that the reserve requirement is 5 percent. If the Federal Reserve buys $2,000 worth of bonds, the largest possible increase in the money supply is ________. If someone deposits in a bank $2,000 that she had been hiding in her cookie jar, the largest possible increase in the money supply is _______. True or False: All other things equal, the money supply will expand more if the Federal Reserve buys $2,000 worth of bonds than if someone deposits in a bank $2,000 that she had been hiding in her cookie jar.

40,000 38,000 True

According to the most recent data, among workers who are paid at an hourly rate, about _______ percent have jobs that pay at or below the minimum wage.

5 Of those workers paid an hourly rate, about 4 percent of men and 6 percent of women reported wages at or below the prevailing federal minimum.

An economy consists of three workers: Larry, Moe, and Curly. Each works 10 hours a day and can produce two services: mowing lawns and washing cars. In an hour, Larry can either mow 1 lawn or wash 1 car; Moe can either mow 1 lawn or wash 2 cars; and Curly can either mow 2 lawns or wash 1 car. For each of the scenarios listed in the following table, determine how many lawns will be mowed and how many cars will be washed per day and enter these values into the corresponding row. Lawns Mowed & Cars Washed All three spend all their time mowing lawns. (A) All three spend all their time washing cars. (B) All three spend half their time on each activity. (C) Larry spends half his time on each activity, while Moe only washes cars and Curly only mows lawns. (D) Using the blue points (circle symbol), graph the production possibilities frontier (PPF) for this economy on the following graph. Then use the black point (plus symbol) to identify point A, the green point (triangle symbol) to identify point B, the orange point (square symbol) to identify point C, and the purple point (diamond symbol) to identify point D on the graph. True or False: The production possibilities frontier has this shape because each worker faces a constant trade-off between mowing lawns and washing cars. Indicate whether each of the following allocations is efficient or inefficient.

A) 40, 0 - efficient B) 0, 40 - efficient C) 20, 20 - inefficient D) 25, 25 - efficient True The production possibilities frontier is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and production technology. In this case, if all workers devote their time to mowing lawns, they can mow 40 lawns, so (0, 40) must be a point on the production possibilities frontier. Similarly, if all workers devote their time to washing cars, they can wash 40 cars, so (40, 0) must be another point on the production possibilities frontier. To construct the points in between, begin at the point where all three workers are mowing lawns (0, 40), and consider the person who has the lowest opportunity cost for washing cars. This person should be the first person to give up mowing lawns in exchange for washing cars. In this case, Moe's opportunity cost of washing a car is mowing half a lawn. So the first segment of the production possibilities frontier from (0, 40) to (20, 30) represents Moe's trade-off between washing cars and mowing lawns: Moe can wash 20 cars at a cost of mowing 10 lawns. Once Moe is washing as many cars as he can, then consider the person who has the next lowest opportunity cost of washing cars. In this case, Larry's opportunity cost of washing a car is mowing a lawn. So the second segment of the production possibilities frontier from (20, 30) to (30, 20) represents Larry's trade-off between washing cars and mowing lawns: Larry can wash 10 cars at a cost of mowing 10 lawns. To construct the final segment, only Curly remains. Therefore, the third segment of the production possibilities frontier from (30, 20) to (40, 0) represents Curly's trade-off between washing cars and mowing lawns. In this case, the production possibilities frontier is kinked because each worker faces a constant trade-off between mowing lawns and washing cars. Larry is equally productive at both tasks, Moe is twice as productive washing cars as he is mowing lawns, and Curly is twice as productive mowing lawns as he is washing cars. An outcome is said to be efficient if the economy is getting all it can from the scarce resources it has available. Points on (rather than inside) the production possibilities frontier represent efficient levels of production. Therefore, while all the allocations are feasible, only allocations A, B, and D are efficient.

Which of the following describe some of the trade-offs faced by a family deciding whether to buy a new car?

A larger vehicle means saving time by not having to make multiple trips somewhere, but a smaller vehicle is cheaper. An increase in the family's car payment means the family will be unable to afford a vacation. Fuel-efficient cars are more expensive, but regular cars require spending more on gas.

For each of the following pairs, indicate which bond you would expect to pay a higher interest rate: A bond of the U.S. government A bond of an Eastern European government A bond that repays the principal in year 2040 A bond that repays the principal in year 2020 A bond from a software company you run in your garage A bond from Coca-Cola A bond issued by the federal government A bond issued by New York State

A bond of an Eastern European government A bond that repays the principal in year 2040 A bond from a software company you run in your garage A bond issued by the federal government There are many different bonds in the world economy, and these bonds differ according to three characteristics: Term: Long-term bonds are riskier than short-term bonds because holders of long-term bonds have to wait longer for repayment of principal. To compensate for this risk, long-term bonds usually pay higher interest rates than short-term bonds. Credit risk: When bond buyers perceive that the probability of default is high, they demand a higher interest rate as compensation for this risk. Tax treatment: When state and local governments issue bonds, the bond owners are not required to pay federal income tax on the interest income. Because of this tax advantage, bonds issued by state and local governments typically pay a lower interest rate than bonds issued by corporations or the federal government. Given these characteristics, the bond of an Eastern European government would pay a higher interest rate than the bond of the U.S. government because there would be a greater risk of default. A bond that repays the principal in 2040 would pay a higher interest rate than a bond that repays the principal in 2020 because it has a longer term to maturity. A bond from a software company you run in your garage would pay a higher interest rate than a bond from Coca-Cola because your software company has more credit risk. And a bond issued by the federal government would pay a higher interest rate than a bond issued by New York State because an investor does not have to pay federal income tax on the bond from New York State.

(Continued) Indicate which of the points are impossible for the economy to achieve and which are feasible but inefficient. Check all that apply.

A- Feasible but inefficient D- Impossible for the economy to achieve The production possibilities frontier is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and production technology. Because resources are scarce, not every conceivable outcome is feasible. With the resources it has, the economy can produce at any point on or inside the production possibilities frontier, but it cannot produce at points outside the frontier. Therefore, points A, B, and C are feasible, but point D is impossible for the economy to achieve. An outcome is said to be efficient if the economy is getting all it can from the scarce resources it has available. Points on (rather than inside) the production possibilities frontier represent efficient levels of production. In this case, point A is feasible but inefficient, since it lies inside the production possibilities frontier.

Which of the following might lead to an increase in the equilibrium price of jelly and a decrease in the equilibrium quantity of jelly sold?

An increase in the price of grapes, an input to jelly If a change occurs in any of the factors that determine supply—such as an increase in the price of grapes, an input to jelly—the result is a shift of the supply curve. In this case, the change in the price of jelly causes the supply of jelly to fall. This leads to an increase in the equilibrium price of jelly and a decrease in the equilibrium quantity of jelly sold,

Assume that the reserve requirement is 20 percent. Also assume that banks do not hold excess reserves and there is no cash held by the public. The Federal Reserve decides that it wants to expand the money supply by $40 million using open-market operations. In order to accomplish its goal, the Fed needs to _______ ________ million worth of bonds.

Buy, $8 million

Because bagels and cream cheese are often eaten together, they are complements. Use the following graphs to help you answer the questions that follow about the markets for bagels and cream cheese. Complete the following table by indicating the chain of events caused by a change in the price of milk, an input to making cream cheese. Note: Ignore that milk could be considered a complement for bagels. Given the previous flows you defined, determine which event could be responsible for each of the following scenarios. Check all that apply. 1) Both the equilibrium price of cream cheese and the equilibrium quantity of bagels have risen. 2) The equilibrium price of cream cheese has risen but the equilibrium quantity of bagels has fallen.

Because flour is an ingredient in bagels, a decline in the price of flour would shift the supply curve for bagels to the right, causing the price of bagels to fall and the equilibrium quantity of bagels to rise. Because cream cheese is a complement to bagels, the fall in the equilibrium price of bagels increases the demand for cream cheese, causing the price and the quantity of cream cheese to rise. The opposite is true when the price of flour rises: The supply of bagels decreases, the price of bagels rises, the equilibrium quantity falls, the demand for cream cheese declines, the price of cream cheese falls, and the equilibrium quantity of cream cheese falls. Because milk is an ingredient in cream cheese, the fall in the price of milk leads to an increase in the supply of cream cheese. This leads to a decrease in the price of cream cheese and an increase in the quantity of cream cheese sold. Because bagels are a complement to cream cheese, the fall in the equilibrium price of cream cheese increases the demand for bagels, causing the price and quantity of bagels to rise. The opposite is true when the price of milk rises: The supply of cream cheese decreases, the price of cream cheese rises, the equilibrium quantity falls, the demand for bagels declines, the price of bagels falls, and the equilibrium quantity of bagels falls. 1) Fall in the Price of Flour 2) Rise in the Price of Milk If you observe that both the equilibrium price of cream cheese and the equilibrium quantity of bagels have risen, it must be that the price of flour fell, because this is the only event that would cause such a change. However, if you observe that the equilibrium price of cream cheese has risen but the equilibrium quantity of bagels has fallen, it must be that the price of milk rose.

Suppose that in the United States, producing an aircraft takes 10,000 hours of labor and producing a shirt takes 2 hours of labor. In China, producing an aircraft takes 40,000 hours of labor, while producing a shirt takes 4 hours of labor. What will these nations trade?

China will export shirts, while the United States will export aircraft. Economists use the term comparative advantage when describing the opportunity costs faced by two producers. The producer who gives up less of other goods to produce Good X has the smaller opportunity cost of producing Good X and is said to have a comparative advantage in producing it. In this case, the United States' opportunity cost of producing an aircraft is 5,000 shirts while China's opportunity cost of producing an aircraft is 10,000 shirts. Therefore, the United States has a comparative advantage in producing aircraft, so it will export aircraft, and China will import aircraft. Similarly, the Unites States' opportunity cost of producing a shirt is 1/5,000 aircraft while China's opportunity cost of producing a shirt is 1/10,000 aircraft. Therefore, China has a comparative advantage in producing shirts, so it will export shirts and the United States will import shirts.

In 1932 during the Great Depression, when higher interest rates caused many businesses and banks to fail, what did the Federal Reserve do to stabilize the economy?

Conducted Open Market Purchases to Increase Money Supply The Federal Reserve conducted Open Market Purchases to increase Money Supply in the Economy. This enabled banks to lend more money to businesses, and spur investment and help increase Aggregate Demand

An American buys a pair of shoes manufactured in Italy. How do the U.S. national income accounts treat the transaction?

Net exports fall, while GDP is unchanged. When an American purchases a good or service from abroad, net exports falls. However, consumption also rises by the same amount, therefore the net effect on GDP is zero (no change).

Nina wants to buy and operate an ice cream truck but doesn't have the financial resources to start the business. She borrows $5,000 from her friend Max, to whom she promises an interest rate of 7 percent, and gets another $10,000 from her friend David, to whom she promises a third of her profits. What best describes this situation?

David is a stockholder, and Max is a bondholder. Stockholders share in the profits of a corporation, offering both higher risk and potentially higher reward than bonds. Bondholders, on the other hand, receive a fixed interest payment, regardless of the company's profitability.

You are trying to decide whether to take a vacation. Most of the costs of the vacation (airfare, hotel, and forgone wages) are measured in dollars, but the benefits of the vacation are psychological. How can you compare the benefits to the costs?

Determine the benefits of what you give up by going on the vacation, and compare them to the benefits of going on vacation. It can be difficult to compare benefits to costs when costs are monetary but benefits are psychological. One way to achieve this is to determine the opportunity cost of going on vacation. The opportunity cost of an item is what you give up to get that item. For example, in this case you might give up a new television or a laptop. You can then compare the benefit you get from going on vacation with that of purchasing this alternative item. A second way to compare benefits to costs is to think about how hard you worked to earn the money to pay for the vacation. You can then decide whether the psychological benefits of the vacation are worth the cost of having to work for the money to pay for it.

England and Scotland both produce scones and _______ sweaters. Suppose that an English worker can produce 50 scones per hour or 1 sweater per hour. Suppose that a Scottish worker can produce 40 scones per hour or 2 sweaters per hour. _______ workers have an absolute advantage in producing scones, and workers have an absolute advantage in producing sweaters. _______ workers have a comparative advantage in producing scones, and workers have a comparative advantage in producing sweaters. If England and Scotland decide to trade, Scotland will trade ________ to England. If a Scottish worker could produce only 1 sweater per hour, Scotland _______ gain from trade, and England _______ gain from trade.

English Scottish English Scottish Sweaters Would still Would still

Suppose government spending increases. Would the effect on aggregate demand be larger if the Federal Reserve held the money supply constant in response, or if the Fed were committed to maintaining a fixed interest rate?

Fixed interest rate If government spending increases, aggregate demand rises, so money demand rises. The increase in money demand leads to a rise in the interest rate and, thus, a decline in aggregate demand if the Fed keeps the money supply constant. But if the Fed maintains a fixed interest rate, it will increase the money supply, so aggregate demand will not decline. Thus, the effect on aggregate demand from an increase in government spending will be larger if the Fed maintains a fixed interest rate.

Three students have each saved $1,000. Each has an investment opportunity in which he or she can invest up to $2,000. Here are the rates of return on the students' investment projects: Student vs. Return (Percent) Harry 5 Ron 8 Hermione 20 Assume borrowing and lending is prohibited, so each student uses only personal saving to finance his or her own investment project. Complete the following table with how much each student will have a year later when the project pays its return. Student Money a Year Later (Dollars) Harry Ron Hermione Now suppose their school opens up a market for loanable funds in which students can borrow and lend among themselves at an interest rate _______. A student would choose to be a borrower in this market if his or her expected rate of return is _______ than _______. Suppose the interest rate is 7 percent. Among these three students, the quantity of loanable funds supplied would be, and quantity demanded would be. Now suppose the interest rate is 10 percent. Among these three students, the quantity of loanable funds supplied would be, and quantity demanded would be. At an interest rate of, the loanable funds market among these three students would be in equilibrium. At this interest rate, _______ would want to borrow, and _______ would want to lend. Suppose the interest rate is at the equilibrium rate. Complete the following table with how much each student will have a year later after the investment projects pay their return and loans have been repaid. Student vs. Money a Year Later (Dollars) Harry Ron Hermione True or False: Only borrowers are made better off, and lenders are made worse off.

Harry- 1050 Ron- 1080 Hermione- 1200 greater 1000, 2000, 2000, 1000 8% hermione, harry Harry- 1020 Ron- 1020 Hermione- 1320 False

Which of the following is a good example of a Technology Shock according to Real Business Cycle Theory?

Hurricane Sandy

Investment can be increased both by reducing taxes on private saving and by reducing the government budget deficit. It is difficult to implement both of these policies at the same time because reducing taxes on private spending has the effect of _______ the government budget deficit. What would you need to know about private saving to judge which of these two policies would be a more effective way to raise investment? Check all that apply.

Increasing The response of private saving to changes in the government budget deficit The elasticity of private saving with respect to the after-tax real interest rate The elasticity of investment with respect to the interest rate

The idea that economic downturns result from an inadequate aggregate demand for goods and services is derived from the work of which economist?

John Maynard Keynes Economist John Maynard Keynes believed that recessions and depressions can occur because of inadequate aggregate demand for goods and services. Because of this, he advocated policies to increase aggregate demand during times of recession. This is in contrast to the classical approach of allowing the economy to correct itself in the long run.

Small differences in the rate of economic growth can lead to large differences in living standards. Consider two countries, Kharkeez and Snakistan. Currently, real GDP per person (average income) is $50,000 in Kharkeez and $16,667 in Snakistan. Suppose you want to project what the real GDP per person will be in each country 100 years from now. The following formula shows how to compute the average income in N years, where G represents the growth rate of real GDP per person (in decimal form—that is, 1.5% is entered as 0.015) and N represents the number of years: Use the growth formula to fill in the following table. Round your answers to the nearest dollar. Growth Rate (Percent) Average Income after 100 Years (Dollars) Kharkeez vs. Snakistan 1.5 1.7 4 4.2 Suppose Kharkeez is expected to grow at 1.7% for the next 100 years. Which of the following growth rates in Snakistan would cause the average income in Snakistan to exceed the average income in Kharkeez in 100 years? Check all that apply.

Kharkeez vs. Snakistan 221,602 73,869 269,815 89,940 2,525,247 841,766 3,060,144 1,020,068 4.0% 4.2%

Which of the following is a positive, rather than a normative, statement?

Law X will reduce national income. Positive statements are descriptive; they make a claim about how the world is. However, normative statements are prescriptive; they make a claim about how the world ought to be. Therefore, in this case, the only positive statement is Law X will reduce national income because it states what will happen if something is done rather than what should be done.

Suppose that people consume only three goods, as shown in this table: Tennis Balls Golf Balls Bottles of Gatorade 2014 Price $2 $4 $1 Quantity 100 100 200 2015 Price $2 $6 $2 Quantity 100 100 200 Complete the following table by computing the percentage change in price for each of the three goods. Tennis Balls, Golf Balls, Bottles of Gatorade Percentage Change Using a method similar to that used to calculate the consumer price index, the percentage change in the overall price level is ________. If you were to learn that a bottle of Gatorade increased in size from 2014 to 2015, that information would _______ your estimation of the inflation rate. If you were to learn that Gatorade introduced new flavors in 2015, that information would ________ your estimation of the inflation rate.

Percent change Tennis: 0% Golf: 50% Bottles of gatorade: 100% 50% lower lower

If all quantities produced rise by 10 percent, and all prices fall by 10 percent, which of the following occurs?

Real GDP rises by 10 percent, while nominal GDP is unchanged. Real GDP measures the production of goods and services valued at constant prices. Therefore, a 10 percent increase in quantity will increase real GDP by 10 percent, regardless of the change in prices. Nominal GDP, on the other hand, simply measures the production of goods and services valued at current prices. Therefore, a 10 percent fall in prices would exactly offset a 10 percent increase in quantities produced, and nominal GDP would not change.

In an hour, David can wash 2 cars or mow 1 lawn, while Ron can wash 3 cars or mow 1 lawn. Who has the absolute advantage in car washing, and who has the absolute advantage in lawn mowing?

Ron in washing, neither in mowing. Economists use the term absolute advantage when comparing the productivity of one person, firm, or nation to that of another. The producer that requires a smaller quantity of inputs to produce a good is said to have an absolute advantage in producing that good. In this case, Ron can wash a car in less time than it takes David, so he has an absolute advantage in washing, but it takes both of them the same amount of time to mow 1 lawn, so neither has an absolute advantage in mowing.

Suppose firms become very optimistic about future business conditions and invest heavily in new capital equipment. Show the short-run effect of this optimism on the aggregate-demand curve. Which of the following reasons could explain why the aggregate quantity of output supplied changes? Check all that apply. On the previous graph, show what happens to the short-run aggregate-supply curve in the long run. (Note: For now, assume there is no change in the long-run aggregate-supply curve.) The aggregate quantity of output demanded ______ between the short run and the long run because the price level _______. The investment boom might cause the long-run aggregate-supply curve to shift to the ______ if it results in a larger capital stock that increases productivity and output in the future.

See graph The price level has risen. Prices are sticky. People have misperceptions about the price level. decreases, rises right

Consider an economy with two labor markets: one for manufacturing workers and one for service workers. Suppose initially that neither is unionized. If manufacturing workers formed a union, show the impact this has on the manufacturing labor market by shifting the demand curve, supply curve, or wage line. Then use the black point to indicate the quantity of labor demanded at the new wage, and use the grey point to indicate the quantity of labor supplied. On the following graph, show how these changes in the manufacturing labor market affect the supply of labor in the market for service workers, which is not unionized. In the nonunionized market, the equilibrium wage ________, and the equilibrium quantity of labor ________.

See graphs decreases increases

Now suppose you had been planning to spend the day studying at the library. What is the cost of going skiing in this case?

The value of your time spent studying The rental of any ski equipment you need The cost of a lift ticket

The short-run economic outcome resulting from the increase in production costs is known as ________ Now suppose that the government decides not to take any action in response to the short-run economic impact of the severe weather. In the long-run, when the government does nothing, the output in the economy will be _______ billion and the price level will be _______.

Stagflation $110 110

Which of the following describe some of the trade-offs faced by a recent college graduate deciding whether to go to graduate school?

Taking out more student loans means she may not able to purchase the new car she needs. If she goes to graduate school, she won't be able to spend as much time with her family. Graduate school means fewer years of on-the-job experience.

Movie tickets and DVDs are substitutes. If the price of DVDs increases, what happens in the market for movie tickets?

The demand curve shifts to the right. When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. If movie tickets and DVDs are substitutes and the price of DVDs increases, this means the demand for movie tickets will also increase. This results in the demand curve shifting to the right.

The following graph shows the long-run aggregate-supply curve (LRAS), the short-run aggregate-supply curve (AS), and the aggregate-demand curve for an economy. Illustrate the effect of this open-market operation on the following graph. Show the resulting change in the interest rate.

The economy is in a *recession with *high unemployment and *low output. To return the economy to the natural rate of output, the Fed could *buy government bonds. The current state of the economy is given by the intersection of the short-run aggregate-supply curve and the aggregate-demand curve ( ). This intersection occurs at a level of output that is lower than the level given by the long-run aggregate-supply curve; therefore, the economy is in recession, with high unemployment and low output. To restore output to the long-run equilibrium, the Fed will want to stimulate aggregate demand. Thus, it will need to lower the interest rate by increasing the money supply. The Fed can achieve this if it purchases government bonds from the public. The Fed's purchase of government bonds shifts the supply of money to the right, lowering the interest rate. See Section: The Theory of Liquidity Preference. The Fed's purchase of government bonds will increase aggregate demand as consumers and firms respond to lower interest rates. Output and the price level will rise. See Section: The Theory of Liquidity Preference.

Between January 2010 and January 2013, total U.S. employment increased by 4.9 million workers, but the number of unemployed workers declined by only 2.7 million. Which of the following statements are consistent with this finding? Check all that apply.

The labor force increased. The fact that employment increased by 4.9 million while unemployment declined by 2.7 million is consistent with growth in the labor force of 2.2 million workers. The labor force constantly increases as the population grows and as labor-force participation increases, so it is possible for the increase in the number of people employed to always exceed the reduction in the number unemployed.

A change in which of the following will not shift the demand curve for hamburgers?

The price of hamburgers The demand curve for hamburgers shows the relationship between the price of hamburgers and the quantity of hamburgers demanded by consumers, assuming that all of the determinants of demand are held constant. The following list displays determinants of demand, which are the factors that affect the quantity of hamburgers consumers want to buy at a given price: Factors That Determine Demand • Price of a related good (complement or substitute) • Income of consumers • Tastes of consumers • Number of consumers • Expectations of consumers Therefore, if the price of hamburgers changes, the result is a movement along the demand curve from the old price to the new one. However, if a change occurs in any of the factors that determine demand—such as the price of hot dogs (a substitute), the price of hamburger buns (a complement), or the income of hamburger consumers—the result is a shift of the demand curve.

An economy is operating with output $400 billion below its natural level, and fiscal policymakers want to close this recessionary gap. The central bank agrees to adjust the money supply to hold the interest rate constant, so there is no crowding out. The marginal propensity to consume is 4/5, and the price level is completely fixed in the short run.

To close the recessionary gap, the government would need to *increase spending by $80 billion.

According to Keynesian Theory, recessions are caused by a downfall in Aggregate Demand

True

According to the Monetarists, excessive increase in Money Supply causes inflation

True

According to the quantity theory of money, which variable in the quantity equation is most stable over long periods of time?

Velocity Of the variables in the quantity equation, the velocity of money is most stable over long periods. Between 1960 and the present, the money supply and nominal GDP both increased more than twentyfold. By contrast, the velocity of money, although not exactly constant, has not changed dramatically.

Assume that the reserve requirement is 20 percent. Also assume that banks do not hold excess reserves and there is no cash held by the public. The Federal Reserve decides that it wants to expand the money supply by $40 million using open-market operations. In order to accomplish its goal, the Fed needs to ______ _______ million worth of bonds.

buy, 8

The Federal Reserve's target rate for the federal funds rate

commits the Fed to set a particular money supply so that it hits the announced target. When the Federal Reserve sets a target for the federal funds rate, it commits itself to adjusting the money supply to make the equilibrium in the money market hit that target. For any given money supply, fluctuations in money demand would lead to fluctuations in interest rates, aggregate demand, and output. By contrast, when the Fed announces a target for the federal funds rate, it essentially accommodates the day-to-day shifts in money demand by adjusting the money supply accordingly.

Which is the largest component of GDP?

consumption Consumption is the largest component of GDP. In 2012, consumption made up 71 percent of GDP.

Ketchup is a complement (as well as a condiment) for hot dogs. If the price of hot dogs rises, the quantity of hot dogs demanded ________, which __________ the demand for ketchup. Because of the change in the equilibrium quantity of ketchup, the demand for tomatoes by ketchup producers __________ , causing the equilibrium price of tomatoes to __________ . This means producers of tomato juice face _________ input prices, and the supply of tomato juiceincreases Correct . The resulting ________ in the price of tomato juice causes people to _____________, so the demand for orange juice ___________.

falls lowers falls decrease lower increases fall away from orange juice and toward tomato juice falls Ketchup is a complement for hot dogs. Therefore, when the price of hot dogs rises, the quantity of hot dogs demanded falls, and this lowers the demand for ketchup. The end result is that both the equilibrium price and the quantity of ketchup fall. Because the quantity of ketchup falls, the demand for tomatoes by ketchup producers falls, so the equilibrium price and the quantity of tomatoes fall. When the price of tomatoes falls, producers of tomato juice face lower input prices, so the supply curve for tomato juice shifts out, causing the price of tomato juice to fall and the quantity of tomato juice to rise. The fall in the price of tomato juice causes people to substitute tomato juice for orange juice, so the demand for orange juice declines, causing the price and quantity of orange juice to fall.

When the economy goes into a recession, real GDP ________, and unemployment ________.

falls, rises A recession is a period of economic contraction rather than growth. During such periods, the economy produces fewer goods and services; thus, real GDP falls and unemployment rises.

An increase in the aggregate demand for goods and services has a larger impact on output ________ and a larger impact on the price level ________.

in the short run, in the long run An increase in aggregate demand affects output in the short run. In the long run, however, an increase in aggregate demand has no impact on output and affects only the price level, as wages and prices adjust to bring output back to the natural rate of output.

The money supply includes all of the following EXCEPT

lines of credit accessible with credit cards. The money supply includes currency (paper bills and coins) and demand deposits (balances in bank accounts accessible by personal check or debit card) but not lines of credit accessible with credit cards, since the latter do not constitute means of payment but rather means of deferring payment until the buyer pays off her credit card bill.

In a system of fractional-reserve banking, even without any action by the central bank, the money supply declines if households choose to hold ________ currency or if banks choose to hold ________ excess reserves.

more, more The more money households hold (and thus the less they deposit), the less reserves banks have, and the less money the banking system can create. Similarly, the more excess reserves banks choose to hold, the fewer loans they make, and the less money the banking system can create.

Suppose an American buys stock issued by an Argentinian corporation. The Argentinian firm uses the proceeds from the sale to build a new office complex. This is an example of foreign ________ investment in Argentina. Which of the following policies are consistent with the goal of increasing productivity and growth in developing countries? Check all that apply. Which of the following are possible outcomes of rapid population growth?

portfolio Providing tax breaks and patents for firms that pursue research and development in health and sciences. Protecting property rights and enforce contracts. All of the above

The classical principle of monetary neutrality states that changes in the money supply do not influence ________ variables and is thought most applicable in the ________ run.

real, long Nominal variables are those measured in monetary units, while real variables are those measured in physical units. According to the classical principle of monetary neutrality, in the long run, changes in the money supply affect only nominal variables but not real ones. However, the classical principle of monetary neutrality may not be applicable in the short run, in which real variables may be temporarily affected by monetary changes.

The discovery of a large new reserve of crude oil will shift the ________ curve for gasoline, leading to a ________ equilibrium price.

supply, lower The supply curve for gasoline shows the relationship between the price of gasoline and the quantity of gasoline supplied by producers, assuming that all of the determinants of supply are held constant. The following list displays determinants of supply, which are the factors that affect the quantity of gasoline producers want to sell at a given price: Factors That Determine Supply • Price of inputs • Production technology • Number of producers • Expectations of producers Therefore, if the price of gasoline changes, the result is a movement along the supply curve from the old price to the new one. However, if a change occurs in any of the factors that determine supply, such as the discovery of a large new reserve of crude oil, the result is a shift of the supply curve. In this case, the supply of gasoline increases because of the new oil reserve, causing the equilibrium price to decline. The following graph shows this outcome.

An increase in ________ will cause a movement along a given demand curve, which is called a change in ________.

supply, quantity demanded The term demand refers to the position of the demand curve, whereas the term quantity demanded refers to the amount consumers wish to buy. Similarly, the term supply refers to the position of the supply curve, whereas the term quantity supplied refers to the amount suppliers wish to sell. In this case, an increase in supply will cause the equilibrium price to decrease, resulting in a movement along the demand curve. The demand curve itself remains unchanged, but the quantity demanded is affected.

If a nation has high and persistent inflation, the most likely explanation is:

the central bank creating excessive amounts of money. The usual suspect in cases of large or persistent inflation is growth in the quantity of money. When a government's central bank creates large quantities of money, the value of that money falls, causing prices to rise and resulting in inflation.

All of the following topics fall within the study of microeconomics EXCEPT

the influence of the government budget deficit on economic growth. Macroeconomics is the study of economy-wide phenomena. Therefore, the influence of the government budget deficit on economic growth is a macroeconomic topic, while the others are all microeconomic topics.

If nominal GDP is $400, real GDP is $200, and the money supply is $100, then

the price level is 2, and velocity is 4. Real GDP is equal to nominal GDP divided by the price level. The quantity equation states that the quantity of money (M) times the velocity of money (V) equals the price of output (P) times the amount of output (Y). Substituting the values from the problem yields the following:

Your opportunity cost of going to a movie is:

the total cash expenditure needed to go to the movie plus the value of your time. The opportunity cost of an item is what you give up to get that item.

A closed economy has income of $1,000, government spending of $200, taxes of $150, and investment of $250. What is private saving?

$300 In a closed economy (that is, an economy that does not trade with the rest of the world), total or national saving (private and public) must equal investment, S = I . National saving consists of income that is left after subtracting consumption and government spending, or Y - C -G . Private saving is equal to income minus consumption and taxes, while public saving is equal to taxes minus government spending; therefore, total saving can be rewritten as (Y - C - T) + (T - G)

Which of the following statements are true about transfer payments with regard to computing GDP?

*Transfer payments alter household income, but they do not reflect the economy's production. *Transfer payments are not accounted for in the consumption component of GDP. *Social security is an example of a transfer payment and is not included in GDP. The government purchases component of GDP does not include spending on transfer payments such as Social Security. With transfer payments, nothing is produced, so there is no contribution to GDP.

Suppose GDP is $8 trillion, taxes are $1.5 trillion, private saving is $0.5 trillion, and public saving is $0.2 trillion. Assuming the economy is closed, complete the following table by calculating consumption, government purchases, national saving, and investment. Component vs. Amount (Trillions of dollars) 1) Consumption 2) Government Purchases 3) National Saving 4) Investment

1) 6 2) 1.3 3) 0.7 4) 0.7

The Federal Reserve conducts a $10 million open-market purchase of government bonds. If the required reserve ratio is 10 percent, the largest possible increase in the money supply that could result is ______ million, and the smallest possible increase is _______ million.

100 10

The residents of Vegopia spend all of their income on cauliflower, broccoli, and carrots. In 2013, they spend a total of $200 for 100 heads of cauliflower, $75 for 50 bunches of broccoli, and $50 for 500 carrots. In 2014, they spend a total of $225 for 75 heads of cauliflower, $120 for 80 bunches of broccoli, and $100 for 500 carrots. Complete the following table by calculating the price of one unit of each vegetable in each year. Year, Cauliflower, Broccoli, Carrots 2013 2014 Using 2013 as the base year, the CPI for 2013 is _______, and the CPI for 2014 is ________. The inflation rate in 2014 isusing the CPI.

2013: 2:00, 1:50, 0.10 2014: 3.00, 1.50, 0.20 100, 146 46%

The Bureau of Labor Statistics (BLS) announced that in January 2013, of all adult Americans, 143,322,000 were employed, 12,332,000 were unemployed, and 89,008,000 were not in the labor force. What is the adult population? The size of the labor force is _________ , and the labor force participation rate is __________. What is the unemployment rate?

244,662,000 155,654,000, 63.6% 7.9% The adult population is equal to the sum of the number of adults employed, unemployed, and not in the labor force. The BLS defines the labor force as the sum of the employed and the unemployed. The BLS defines the unemployment rate as the percentage of the labor force that is unemployed.

A small nation of 10 people idolizes the TV show American Idol. All they produce and consume are karaoke machines and CDs, in the following amounts: Karaoke Machines vs. CDs Quantity Price (Dollars) Quantity Price (Dollars) 2014 10 40 30 10 2015 12 60 50 12 Using a method similar to that used to calculate the consumer price index, the percentage change in the overall price level is ________. (Note: Use 2014 as the base year, and fix the basket at 1 karaoke machine and 3 CDs.) Using a method similar to that used to calculate the GDP deflator, the percentage change of the overall price level is _______. (Note: Again, use 2014 as the base year.) The inflation rate in 2015 is not the same using the two methods because the _________ holds the basket of goods and services constant, while the allows it to change.

37.14% 34.69% CPI GDP deflator

The population of Ectenia is 100 people: 40 work full-time, 20 work half-time but would prefer to work full-time, 10 are looking for a job, 10 would like to work but are so discouraged they have given up looking, 10 are not interested in working because they are full-time students, and 10 are retired. What is the size of Ectenia's labor force?

70 The BLS defines the labor force as the sum of the employed and the unemployed. There are 60 employed people in this economy (full-time and part-time workers) and 10 unemployed. Therefore the size of the labor force is 70

Maria can read 20 pages of economics in an hour. She can also read 50 pages of sociology in an hour. She spends 5 hours per day studying. Use the blue line (circle symbol) to draw Maria's production possibilities frontier (PPF) for reading economics and sociology. Maria's opportunity cost of reading 100 pages of sociology is _______ pages of economics.

A production possibilities frontier is a graph that shows the various combinations of outputs that an economy can possibly produce given the available factors of production and production technology. If Maria spends all of her time studying sociology, she can read ; therefore, one endpoint of her production possibilities frontier is (250, 0). Alternatively, if Maria spends all of her time studying economics, she can read ; therefore, the other endpoint of her production possibilities frontier is (0, 100). Because she faces a constant trade-off between studying economics or sociology, her production possibilities frontier is a straight line. 40 pages

During the Revolutionary War, the American colonies could not raise enough tax revenue to fund the war effort fully; to make up the difference, the colonies decided to print more money. Printing money to cover expenditures is sometimes referred to as an inflation tax. Who is being taxed when more money is printed?

Anyone who is holding money When the government prints money, it imposes a tax on anyone who is holding money. This is because printing money decreases the value of money by causing inflation, or an increase in the overall level of prices in the economy.

If an economy always has inflation of 10 percent per year, which of the following costs of inflation will it NOT suffer?

Arbitrary redistributions between debtors and creditors. Many of the costs of inflation, such as shoe leather costs, menu costs, and distortions arising from the taxation of nominal capital gains, occur even if inflation is steady and predictable. Expected inflation differs from unexpected inflation, however, in that expected inflation does not cause arbitrary redistributions between debtors and creditors. That is, expected inflation can be built into loan and wage contracts and therefore does not arbitrarily benefit or harm one party when inflation increases or decreases the value of loans or wages.

Suppose a computer virus disables the nation's automatic teller machines, making withdrawals from bank accounts less convenient. As a result, people want to keep more cash on hand, increasing the demand for money.

Assume the Fed does not change the money supply. According to the theory of liquidity preference, the interest rate *rises, which causes aggregate demand to *fall. If instead the Fed wants to stabilize aggregate demand, it should *increase the money supply by *buying government bonds. When fewer ATMs are available, money demand is increased and the money-demand curve shifts to the right from to . If the Fed does not change the money supply, which is at , the interest rate will rise from to . The increase in the interest rate shifts the aggregate-demand curve to the left, as consumption and investment fall. If the Fed wants to stabilize aggregate demand, it should increase the money supply to , so the interest rate will remain at and aggregate demand will not change. To increase the money supply using open-market operations, the Fed should buy government bonds.

The market for pizza has the following demand and supply schedules: Price (dollars) Quantity Demanded (pizzas) Quantity Supplied (pizzas) 4 135 26 5 104 53 6 81 81 7 68 98 8 53 110 9 39 121 Use the blue points (circle symbol) to graph the demand for pizzas. Then use the orange points (square symbol) to graph the supply of pizza. Finally, use the black point (plus symbol) to indicate the equilibrium price and quantity in this market. If the actual price in this market were above the equilibrium price, quantity supplied would be _______ than quantity demanded, so there would be ________ pressure on prices. True or False: If the actual price in this market were below the equilibrium price, suppliers could raise the price without losing sales.

Each point on the demand curve for pizzas corresponds to an entry in the demand schedule. For example, at a price of $4 per pizza, the quantity of pizzas demanded is 135 pizzas. Therefore, the point (135, 4) lies on the demand curve for pizzas. Similarly, each point on the supply curve corresponds to an entry from the supply column. For example, at a price of $4 per pizza, the quantity of pizzas supplied is 26 pizzas. Therefore, the point (26, 4) lies on the supply curve. To generate demand and supply curves, you plot a point for each entry in the demand column and each entry in the supply column. The market equilibrium occurs at the price at which quantity demanded equals quantity supplied. In this case, the demand and supply curves intersect at a price of $6 per pizza and a quantity of 81 pizzas. Therefore, the point (81, 6) represents the equilibrium in this market. Greater, downward True

True or False: An increase in the demand for notebooks raises the quantity of notebooks demanded but not the quantity supplied.

False An increase in the demand for notebooks will cause the demand curve to shift to the right, resulting in a movement along the supply curve. Provided the supply curve is upward-sloping, both the quantity of notebooks demanded and the quantity supplied will increase.

True or False: Labor unions are the primary reason the standard of living in the United States has changed over time.

False The increase in average income, and thus in the standard of living, is mainly the result of increased productivity. In other words, an hour of work produces more goods and services than it used to in your grandparents' era.

Suppose that people expect inflation to equal 3 percent, but in fact, prices rise by 5 percent. Indicate whether this unexpectedly high inflation rate helps or hurts each of the following groups or individuals. 1) The government 2) A homeowner with a fixed-rate mortgage 3) A union worker in the second year of a labor contract 4) A college that has invested some of its endowment in government bonds that are not indexed Treasury bonds

Helps Helps Hurts Hurts Unexpectedly high inflation helps the government by providing higher tax revenue and reducing the real value of outstanding government debt. Unexpectedly high inflation helps a homeowner with a fixed-rate mortgage because he pays a fixed nominal interest rate that was based on expected inflation, and thus pays a lower real interest rate than was expected. Unexpectedly high inflation hurts a union worker in the second year of a labor contract because the contract probably based the worker's nominal wage on the expected inflation rate. As a result, the worker receives a lower-than-expected real wage. Unexpectedly high inflation hurts a college that has invested some of its endowment in government bonds because the higher inflation rate means the college is receiving a lower real interest rate than it had planned.

The participation of women in the U.S. labor force has risen dramatically since 1970. This rise likely ________ GDP in the U.S. Now imagine a measure of well-being that includes time spent working in the home and taking leisure. The change in this measure of well-being would be ________ the change in GDP.

Increased Less than The increased labor-force participation of women has increased GDP in the United States because it means more people are working and production has increased. If our measure of well-being included time spent working in the home and taking leisure, it would not rise as much as GDP because the rise in women's labor-force participation has reduced time spent working in the home and taking leisure.

From 2008 to 2012, the ratio of government debt to GDP in the United States

increased markedly. As the economy was experiencing a financial crisis and deep recession in 2008, the debt-to-GDP ratio in the United States increased markedly.

Which of the following statements support the reality that your standard of living is different from that of your parents or grandparents when they were your age?

Many families have two or more cars, whereas having any motor vehicle was a luxury in the early 20th century. In the United States, the average person's life expectancy was roughly 78 years in 2010, but only 70 years in 1960. A cutting-edge television comes with HD, 3D, and SmartTV technology, while your grandparents likely enjoyed at most a black-and-white television in the early years.

Which of the following describe some of the trade-offs faced by a member of Congress deciding how much to spend on national parks?

Money spent on national parks benefits park visitors, but alternatively the money could be spent on highways to benefit drivers. Congress can spend either a small amount on a lot of parks or a large amount on a single national park.

Pat and Kris are roommates. They spend most of their time studying (of course), but they leave some time for their favorite activities: making pizza and brewing root beer. Pat takes 4 hours to brew a gallon of root beer and 2 hours to make a pizza. Kris takes 6 hours to brew a gallon of root beer and 4 hours to make a pizza.

Pat's opportunity cost of making a pizza is 1/2 gallon of root beer, and Kris's opportunity cost of making a pizza is 2/3 gallon of root beer. Pat Correct has an absolute advantage in making pizza, and Pat has a comparative advantage in making pizza. If Pat and Kris trade foods with each other, Pat will trade away pizza in exchange for root beer. The price of pizza can be expressed in terms of gallons of root beer. The highest price at which pizza can be traded that would make both roommates better off is 2/3 gallon of root beer, and the lowest price that makes both roommates better off is 1/2 gallon of root beer per pizza.

If the economy goes into a recession and incomes fall, what happens in the markets for inferior goods?

Prices and quantities both rise. If the demand for a good rises when income falls, the good is called an inferior good. An increase in demand results in a rise in both the equilibrium price and quantity of a good

Which of the following actions by the Federal Reserve would reduce the money supply?

an increase in the interest rate paid on reserves An increase in the interest rate paid on reserves would reduce the money supply. The more interest banks receive on reserves, the more incentive they have to hold on to reserves rather than make loans, and the lower the reserve ratio. A lower reserve ratio means a lower money multiplier and, in turn, a lower money supply.

Once again, in an hour, David can wash 2 cars or mow 1 lawn, while Ron can wash 3 cars or mow 1 lawn. Who has the comparative advantage in car washing, and who has the comparative advantage in lawn mowing?

Ron in washing, David in mowing. Economists use the term comparative advantage when describing the opportunity costs faced by of two producers. The producer who gives up less of other goods to produce Good X has the smaller opportunity cost of producing Good X and is said to have a comparative advantage in producing it. In this case, David's opportunity cost of washing a car is 1/2 mowed lawns, while Ron's opportunity cost of washing a car is 1/3 mowed lawns. Therefore, Ron has a comparative advantage in washing cars. Similarly, David's opportunity cost of mowing a lawn is 2 washed cars, while Ron's opportunity cost of mowing a lawn is 3 washed cars. Therefore, David has a comparative advantage in mowing lawns.

Suppose that the price of basketball tickets at your college is determined by market forces. Currently, the demand and supply schedules are as follows: Price (dollars) Quantity Demanded (quantity) Quantity Supplied (quantity) 4 10,000 8,000 8 8,000 8,000 12 6,000 8,000 16 4,000 8,000 20 2,000 8,000 Use the blue points (circle symbol) to graph the demand for basketball tickets. Then use the orange points (square symbol) to graph the supply of tickets. Finally, use the black point (plus symbol) to indicate the equilibrium price and quantity in this market. Your college plans to increase total enrollment next year by 5,000 students. The additional students will have the following demand schedule: Price (Dollars) Quantity Demanded (Tickets) 4 4,000 8 3,000 12 2,000 16 1,000 20 0 Add the old demand schedule and the demand schedule for the new students to calculate the new demand schedule for the entire college. Use the purple points (diamond symbol) to draw this new demand curve on the previous graph. Then use the grey point (star symbol) to indicate the new equilibrium price and quantity.

See graph

Suppose the government borrows $20 billion more next year than this year. The following graph shows the market for loanable funds before the additional borrowing for next year. Use the orange line (square point) to graph the new supply of loanable funds as a result of this government policy to borrow $20 billion more next year than this year. As a result of this policy, the equilibrium interest rate ________. Indicate whether each of the following economy components rises or falls as a result of this policy change. Then determine if the magnitude of this change is less than, more than, or equal to the $20 billion of extra government borrowing. Component, Change, Magnitude of Change 1) Investment 2) Private saving 3) Public saving 4) National saving A more elastic supply of loanable funds would result in the interest rate rising by and, thus, national saving falling by ________. A more elastic demand for loanable funds would result in the interest rate rising by and, thus, national saving falling by ________. Suppose households believe that greater government borrowing today implies higher taxes to pay off the government debt in the future. This belief causes people to save _______ today, which private saving and ________ the supply of loanable funds. This will _______ the effect of the reduction in public saving on the market for loanable funds.

See graph rises 1) decreases, less than 20 billion 2) increases, less than 20 billion 3) decreases, exactly 20 billion 4) decreases, less than 20 billion less, less less, more more, increases, increases, reduce

True or False: Economic well-being rose more in 2014 than in 2015. (Milk and honey economy)

True Economic well-being rose more in 2014 than in 2015 because real GDP rose in 2014 but not in 2015. In 2014, real GDP rose but prices did not, while in 2015 real GDP did not rise but prices did.

Which of the following does NOT add to U.S. gross domestic product?

The federal government sends a Social Security check to your grandmother. Social Security checks are an example of a transfer payment. Transfer payments are not included in GDP because they do not reflect actual production within the economy.

Which of the following describe some of the trade-offs faced by a company president deciding whether to open a new factory?

The firm can either open a new factory or upgrade existing equipment. The firm can either pay out more of its profit to shareholders or earn additional profit next year by increasing production.

It is sometimes suggested that the Federal Reserve should try to achieve zero inflation. Assume that velocity is constant. What must the rate of money growth equal in order to achieve this zero-inflation goal?

The growth rate of output The quantity equation relates the quantity of money (M) to the nominal value of output (PxY) in the following way: MxV = PxY. With constant velocity, reducing the inflation rate to zero would require the money growth rate to equal the growth rate of output.

Suppose that a country's inflation rate increases sharply. Which of the following statements are true? Check all that apply.

The inflation tax on holders of money increases. Holders of savings accounts are hurt by the increase in the inflation rate because they are taxed on their nominal interest income. If a country's inflation rate increases sharply, the inflation tax on holders of money increases significantly. Wealth in savings accounts is not subject to a change in the inflation tax because the nominal interest rate will increase with the rise in inflation. But holders of savings accounts are hurt by the increase in the inflation rate because they are taxed on their nominal interest income, so their real returns are lower.

Which of the following describe some of the trade-offs faced by a professor deciding how much time to spend preparing for class?

The more he prepares, the better his lectures, but the less he prepares, the more free time he can enjoy doing something else. The better the lecture, the better his chances of tenure, but time spent preparing the lecture decreases the time he has available to work on research.

Consider the following events: Scientists reveal that eating oranges decreases the risk of diabetes, and at the same time, farmers use a new fertilizer that makes orange trees produce more oranges. Show the effect of these two events on the market for oranges. True or False: When the demand curve and the supply curve shift in the direction previously indicated, the effect on the equilibrium price is clear even without knowing the magnitude of the shifts.

The news of the increased health benefits from consuming oranges will increase the demand for oranges, increasing both the equilibrium price and the quantity. If farmers use a new fertilizer that makes orange trees more productive, the supply of oranges will also increase, leading to a fall in the equilibrium price but a rise in the equilibrium quantity. False If both occur at the same time, the equilibrium quantity will definitely rise, but the effect on equilibrium price will be ambiguous. In the previous graphical example, you see that the equilibrium price remains unchanged when both curves shift, but you could just as easily have the equilibrium price increase or decrease

Mark can cook dinner in 30 minutes and wash the laundry in 20 minutes. His roommate takes half as long to do each task. How should the roommates allocate the work?

There are no gains from trade in this situation. Economists use the term comparative advantage when describing the opportunity costs faced by of two producers. The producer who gives up less of other goods to produce Good X has the smaller opportunity cost of producing Good X and is said to have a comparative advantage in producing it. In this case, Mark gives up 3/2 loads of laundry when he cooks dinner, but his roommate faces the same opportunity cost. Similarly Mark gives up 2/3 dinners when he does the laundry, but again his roommate faces the same opportunity cost. Therefore, there are no gains from trade in this situation because neither individual has a comparative advantage in either activity.

As the chapter states, GDP does not include the value of used goods that are resold. True or False: Including the value of used goods that are resold would make GDP a less informative measure of economic well-being. If GDP included goods that are resold, it would _________

True If GDP included goods that are resold, it would make GDP a less informative measure of economic well-being, because it would double-count goods that were sold more than once and would count goods in GDP for several years if they were produced in one year and resold in another.

Which of the following statements explains the mechanism through which Wage Stickiness contributes to fall in Aggregate Demand?

Wages are sticky, so when revenues fall businesses cannot lower wages, so they lay-off people, this increases unemployment, so consumption falls, this leads to shrinking of other sectors in the economy

Structural unemployment is sometimes said to result from a mismatch between the job skills that employers want and the job skills that workers have. To explore this idea, consider an economy with two industries: auto manufacturing and aircraft manufacturing. If workers in these two industries require similar amounts of training, and if workers at the beginning of their careers can choose which industry to train for, what would you expect to happen to the wages in these two industries? Suppose that one day the economy opens itself to international trade and, as a result, starts importing autos and exporting aircraft. This would cause the demand for labor in the auto manufacturing industry to _________ and the demand for labor in the aircraft manufacturing industry to ________. Suppose that workers in one industry cannot be quickly retrained for the other. In the short run, wages in the auto industry would ________, and wages in the aircraft industry would ________. How would these shifts in demand affect equilibrium wages in the long run? If for some reason wages fail to adjust to the new equilibrium levels as a result of opening up to international trade, there will be a _______ of workers in the aircraft industry and a ________ of workers in the auto industry.

Wages between the two industries would be equal. fall, rise fall, rise Wages between the two industries would be equal. shortage surplus

In which of the following circumstances is expansionary fiscal policy more likely to lead to a short-run increase in investment? Check all that apply.

When the interest rate sensitivity of investment is small When the investment accelerator is large Expansionary fiscal policy is more likely to lead to a short-run increase in investment if the investment accelerator is large. A large investment accelerator means that the increase in demand caused by expansionary fiscal policy will induce a large increase in investment. Without a large accelerator, investment might decline because expansionary fiscal policy raises the interest rate. Expansionary fiscal policy is more likely to lead to a short-run increase in investment if the interest sensitivity of investment is small. An expansionary fiscal policy increases aggregate demand, thus increasing money demand and the interest rate, so the greater the sensitivity of investment to the interest rate, the greater the decline in investment will be, offsetting the positive accelerator effect.

Consider an economy that produces only chocolate bars. In year 1, the quantity produced is 3 bars and the price is $4. In year 2, the quantity produced is 4 bars and the price is $5. In year 3, the quantity produced is 5 bars and the price is $6. Using year 1 as the base year, compute nominal GDP, real GDP, and the GDP deflator for each year. Nominal GDP (dollars) Real GDP (dollars) GDP Deflator Year 1 Year 2 Year 3 The percentage growth rate of real GDP from year 2 to year 3 is ________% The inflation rate as measured by the GDP deflator from year 2 to year 3 is ________%

Year 1- 12, 12, 100 Year 2- 20, 16, 125 Year 3- 30, 20, 150 25% 20% Nominal GDP is the production of goods and services valued at current prices. To compute total spending in this economy, multiply the quantity of chocolate bars by its price. Similar calculations yield a nominal GDP of $20 in year 2 and $30 in year 3. Real GDP measures the production of goods and services valued at constant prices. To compute real GDP, use the price of chocolate bars in the base year to compute the value of goods and services in all the years. In other words, the prices in the base year provide the basis for comparing quantities in different years. Similar calculations yield a nominal GDP of $12 in year 1 and $20 in year 3. The GDP deflator measures the change in nominal GDP from the base year that cannot be attributed to a change in real GDP. Similar calculations yield a GDP deflator of 100 in year 1 and 125 in year 2.

Consider a small island country whose only industry is weaving. The following table shows information about the small economy in two different years. Complete the table by calculating physical capital per worker as well as labor productivity. Hint: Recall that productivity is defined as the amount of goods and services a worker can produce per hour. In this problem, measure productivity as the quantity of goods per hour of labor. Based on your calculations, _______ in physical capital per worker from 2027 to 2028 is associated with _______ in labor productivity from 2027 to 2028. Suppose you're in charge of establishing economic policy for this small island country. Which of the following policies would lead to greater productivity in the weaving industry? Check all that apply.

a decrease, a decrease Encouraging saving by allowing workers to set aside a portion of their earnings in tax-free retirement accounts Subsidizing research and development into new weaving technologies

Stagflation is caused by

a leftward shift in the aggregate-supply curve. Stagflation is a period of time where output is falling and prices are rising. When firms experience an increase in the costs of production, selling goods becomes less profitable, and firms supply less output at any given price level. This causes the aggregate-supply curve to shift to the left, resulting in lower output and a higher price level.

An economic model is

a simplified representation of some aspect of the economy. An economic model is a simplified representation of some aspect of the economy. Because including every detailed, realistic aspect of an economy would result in something that isn't tractable and informative, economists use models to learn about the world. Just as a model airplane does not include all of the interior details of the plane, an economist's model does not include every feature of the economy

Suppose that the reserve requirement for checking deposits is 10 percent and that banks do not hold any excess reserves. If the Fed sells $1 million of government bonds, the economy's reserves bymillion, and the money supply will _______ by _______ million. Now suppose the Fed lowers the reserve requirement to 5 percent, but banks choose to hold another 5 percent of deposits as excess reserves. This will ________ the money multiplier, and it will _______ the money supply.

decrease, 1 decrease, 10 not change, not change Banks might wish to hold excess reserves if they need to hold the reserves for their day-to-day operations, such as paying other banks for customers' transactions, making change, cashing paychecks, and so on. If banks increase excess reserves such that there is no overall change in the total reserve ratio, then the money multiplier does not change and there is no effect on the money supply.

If the government wants to contract aggregate demand, it can ________ government purchases or ________ taxes.

decrease, increase To contract aggregate demand, the government can either decrease its own purchases (directly reducing the quantity of output demanded), or increase taxes (indirectly reducing the quantity demanded by reducing disposable income).

Hyperinflations occur when the government runs a large budget ________, which the central bank finances with a substantial monetary ________.

deficit, expansion When the government runs a large budget deficit, tax revenue is insufficient to cover government spending. One way that the government can finance its spending is by printing money. Putting more money into the economy is known as monetary expansion; rapid monetary expansion in turn causes hyperinflation.

If the business community becomes more optimistic about the profitability of capital, the ________ curve for loanable funds would shift, driving the equilibrium interest rate ________.

demand, up The more profitable capital becomes, the more firms are rewarded for borrowing money to invest in new capital. Thus if capital is perceived as more profitable, the demand curve for loanable funds would shift to the right, driving the equilibrium interest rate up

A point inside the production possibilities frontier is

feasible, but not efficient. The production possibilities frontier is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and production technology. Because resources are scarce, not every conceivable outcome is feasible. With the resources it has, the economy can produce at any point on or inside the production possibilities frontier (such as points A and B on the following graph), but it cannot produce at points outside the frontier (such as point C). An outcome is said to be efficient if the economy is getting all it can from the scarce resources it has available. Points on (rather than inside) the production possibilities frontier, such as point B on the following graph, represent efficient levels of production.

According to the theory of efficiency wages,

firms may find it profitable to pay above-equilibrium wages. Efficiency wages are higher than the equilibrium wage determined by supply and demand, but nonetheless, paying efficiency wages may be profitable for some firms. Higher wages can increase productivity by increasing worker health, decreasing worker turnover, and increasing worker quality.

Complete the statements about the following three theories for the upward slope of the short-run aggregate-supply curve. According to the sticky-wage theory, the economy is in a recession because the price level has declined so that real wages are too ______; thus, labor demand is too _______. According to the sticky-price theory, the economy is in a recession because _______. According to the misperceptions theory, the economy is in a recession when the price level is _______ what was expected.

high low not all prices adjust quickly below According to the sticky-wage theory, the economy is in a recession because the price level has declined so that real wages are too high, thus labor demand is too low. Over time, as nominal wages are adjusted so that real wages decline, the economy returns to full employment. According to the sticky-price theory, the economy is in a recession because not all prices adjust quickly. Over time, firms are able to adjust their prices more fully, and the economy returns to the long-run aggregate-supply curve. According to the misperceptions theory, the economy is in a recession when the price level is below what was expected. Over time, as people observe the lower price level, their expectations adjust, and the economy returns to the long-run aggregate-supply curve.

Suppose that Intel is considering building a new chip-making factory. Assuming that Intel needs to borrow money in the bond market, an increase in interest rates affects Intel's decision about whether to build the factory, because now the cost of borrowing money becomes _______. True or False: If Intel has enough of its own funds to build the new factory without borrowing, an increase in interest rates still affects Intel's decision about whether to build the factory.

higher true

The circular-flow diagram illustrates that, in markets for the factors of production,

households are sellers, and firms are buyers. The circular-flow diagram simplifies the economy by including only two types of decision makers: firms and households. Firms produce goods and services using inputs, such as labor, land, and capital. These inputs are called the factors of production. Households own the factors of production and consume all the goods and services that the firms produce. Therefore, in the markets for the factors of production, households are sellers, and firms are buyers.

The largest component in the basket of goods and services used to compute the CPI is

housing The largest category of goods and services within the CPI basket is housing, which makes up 41% of the typical consumer's budget.

Economics is best defined as the study of:

how society manages its scarce resources. This includes studying how people make decisions and interact with one another, and the effects this has on the economy as a whole.

In the early 1980s, new legislation allowed banks to pay interest on checking deposits, which they could not do previously. If we define money to include checking deposits, this legislation ________ money demand. If the Federal Reserve had maintained a constant money supply in the face of this change, this would have ________ the interest rate, and ________ aggregate demand and aggregate output. To have maintained a constant market interest rate (the interest rate on nonmonetary assets) in the face of this change, the Federal Reserve would have had to _________ the money supply. As a result, aggregate demand and output would have _________.

increases, increased, decreased, increase, remained unaffected Legislation allowing banks to pay interest on checking deposits increases the return to money relative to other financial assets, thus increasing money demand. If the money supply remained constant (at ), the increase in the demand for money would have increased the interest rate. The rise in the interest rate would have decreased consumption and investment, thus decreasing aggregate demand and output. To maintain a constant interest rate, the Fed would need to increase the money supply from to

A marginal change is one that:

incrementally alters an existing plan. Economists use the term marginal change to describe a small incremental adjustment to an existing plan of action. Recall that margin means "edge," so marginal changes are alterations around the edges of what you are doing.

A 1996 bill reforming the federal government's antipoverty programs limited many welfare recipients to only two years of benefits. This change gives people the incentive to find a job ________ quickly than if welfare benefits lasted forever. The loss of benefits after two years will result in the distribution of income becoming ________ equal. In addition, the economy will be __________ efficient because of the change in working incentives.

more, less, more If welfare benefits lasted forever, there would be little incentive to find work once unemployed. However, if benefits last for only two years, there is a greater incentive for people to find work before the two years are up and they stop receiving financial support from the government. This change in the government's antipoverty program reduces equality in the distribution of income, since those who cannot find a job will get no income at all; however, the economy is more efficient given the increased incentive for the unemployed to find work and contribute to the nation's output.

An economy produces hot dogs and hamburgers. If a discovery of the remarkable health benefits of hot dogs were to change consumers' preferences, it would

move the economy along the production possibilities frontier. The production possibilities frontier is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and production technology. In this case, the trade-off between producing hot dogs and hamburgers doesn't change, because resources remain the same. However, the consumption point along the production possibilities frontier has changed, because consumers now prefer to consume more hot dogs. This is represented by a movement along the production possibilities frontier to a point with more hot dog production and less hamburger production.

If the government collects more in tax revenue than it spends, and households consume more than they get in after-tax income, then

private saving is negative, but public saving is positive. Private saving is the amount of income households have left after paying their taxes and paying for their consumption, or Y- T - C. Public saving is the amount of tax revenue that the government has left after paying for its spending, T - G. When consumption is greater than after-tax income (C > Y - T), private saving is negative; when the government collects more in taxes than it spends (T > G), public saving is positive.

Suppose that changes in bank regulations expand the availability of credit cards so that people need to hold less cash. Show how this event affects the demand for money. If the Fed does not respond to this event, the price level will __________. If the Fed wants to keep the price level stable, it should ________ the money supply.

see graph increase reduce The demand for money reflects how much wealth people want to hold in liquid form. Many factors influence the quantity of money demanded. The amount of currency that people hold in their wallets, for instance, depends on how much they rely on credit cards and on whether an automatic teller machine is easy to find. If people want to hold less cash, the demand for money shifts to the left, because there will be less money demanded at any price.

If a popular TV show on personal finance convinces more Americans about the importance of saving for retirement, the ________ curve for loanable funds would shift, driving the equilibrium interest rate ________.

supply, down The equilibrium interest rate is determined by the intersection of the supply and demand curves in the market for loanable funds. Saving makes up the supply of loanable funds; therefore, an increase in saving shifts the supply curve for loanable funds to the right. This drives the equilibrium interest rate down.

Because consumers can sometimes substitute cheaper goods for those that have risen in

the CPI overstates inflation. The CPI assumes that consumers will purchase the same basket of goods from year to year, but in reality, if consumers substitute cheaper goods for those that have risen in price, the total cost of living will rise by a smaller amount than is predicted by the CPI. The CPI therefore overstates inflation.

If a Pennsylvania gun manufacturer raises the price of rifles it sells to the U.S. Army, its price hikes will increase

the GDP deflator but not the CPI. The CPI takes into account only goods and services purchased by the typical consumer, whereas the GDP deflator takes into account all goods and services produced domestically, including goods purchased by the government (such as goods sold to the Army).

The consumer price index measures approximately the same economic phenomenon as

the GDP deflator. Both the consumer price index and the GDP deflator are measures of the overall price level.

A sudden crash in the stock market shifts

the aggregate demand curve. A stock market crash, or any event that causes consumers to cut back in spending and firms to cut back in their investments, reduces aggregate demand at any given price level (that is, causes a shift in the aggregate-demand curve).

Which goods will a nation typically import?

those goods in which other nations have a comparative advantage Because of the benefits of specialization and trade, countries tend to produce goods in which they have a comparative advantage. Therefore, a nation will typically import those goods in which other nations have a comparative advantage and export those goods in which it has a comparative advantage over other nations.

A bank has capital of $200 and a leverage ratio of 5. If the value of the bank's assets declines by 10 percent, then its capital will be reduced to

$100. If a bank has capital of $200 and a leverage ratio of 5, the value of the bank's assets is 5 times the value of its capital, or 200 x 5 = 1000, while the bank's deposits and debt will total 1000-200 = 800. If the value of the bank's assets declines by 10 percent, its assets fall to $900. Since the value of the bank's deposits and debt does not change, its capital is now 900 - 800 = 100. An alternative way of solving this is to consider that since the leverage ratio is the ratio of the bank's total assets to bank capital, when assets decline by a given percentage, the value of capital declines by that amount times the leverage ratio. In this case, 10 percent times a leverage ratio of 5 means a 50% decline in capital, or 200 ( 0.5 x 200) = 100.

Suppose the government reduces taxes by $20 billion, there is no crowding out, and the marginal propensity to consume is 3/4. The initial effect of the tax reduction is a ________ billion _________ in aggregate demand. The total effect of the tax cut on aggregate demand is a _________ billion ________. The total effect of this $20 billion tax cut is _________ the total effect that a $20 billion increase in government purchases would be. How could the government increase aggregate demand without changing the government's budget deficit?

$15, increase, $60, increase, less than, Increase taxes and government purchases by the same amount

A farmer grows wheat, which she sells to a miller for $100. The miller turns the wheat into flour, which she sells to a baker for $150. The baker turns the wheat into bread, which she sells to consumers for $180. Consumers eat the bread. GDP in this economy is _________. Value added is defined as the value of a producer's output minus the value of the intermediate goods that the producer buys to make the output. Assuming there are no intermediate goods beyond those previously described, complete the following table by calculating the value added for each of the three producers. Then enter the total value added in the final row. Producer Value Added (Dollars) Farmer Miller Baker Total True or False: The total value added for the three producers in this economy does not equal the economy's GDP.

$180 Farmer- 100 Miller- 50 Baker- 30 Total- 180 False

The economy of Elmendyn contains 2,000 $1 bills. For each of the following scenarios, determine the quantity of money in this economy. Scenario Quantity of Money $2,000 $1,818 $3,636 $10,000 $20,000 People hold all money as currency. People hold all money as demand deposits, and banks maintain 100 percent reserves. People hold equal amounts of currency and demand deposits, and banks maintain 100 percent reserves. People hold all money as demand deposits, and banks maintain a reserve ratio of 10 percent. People hold equal amounts of currency and demand deposits, and banks maintain a reserve ratio of 10 percent.

$2,000 $2,000 $2,000 $20,000 $3,636

With the economy in a recession because of inadequate aggregate demand, the government increases its purchases by $1,200. Suppose the central bank adjusts the money supply to hold the interest rate constant, investment spending is fixed, and the marginal propensity to consume is . How large is the increase in aggregate demand

$3,600 Because each dollar spent by the government can raise the aggregate demand for goods and services by more than a dollar, government purchases are said to have a multiplier effect on aggregate demand. The size of the multiplier is a function of the marginal propensity to consume (MPC), and is calculated using the following formula: multiplier = I / 1 - MPC In this case, that works out to be 3, so the total effect of a $1,200 increase in spending is 3 x 1200= 3600. This simple application of the multiplier assumes that the interest rate remains constant and that investment is unaffected by increased demand. One or both of these assumptions may not be true in reality.

If the reserve ratio is ¼ and the central bank increases the quantity of reserves in the banking system by $120, the money supply increases by

$480. The amount of money the banking system generates with each dollar of reserves is called the money multiplier, which is the reciprocal of the reserve ratio. If the reserve ratio is ¼, the money multiplier is equal to 4, and a $120 increase in reserves will increase the money supply by 120 x 4 = 480.

Angus the sheep farmer sells $20 worth of wool to Barnaby the knitter. Barnaby makes two sweaters, each of which has a market price of $40. Collette buys one of them, while the other remains on the shelf of Barnaby's store to be sold later. What is GDP here?

$80 Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time. The wool sold to Barnaby is an intermediate good and is therefore not counted as part of GDP. Because GDP measures the value of all goods produced (rather than sold) in a period, each of the two sweaters contributes $40 to GDP for a total of $80.

If the consumer price index is 200 in year 1980 and 300 today, then $600 in 1980 has the same purchasing power as ________ today.

$900 To convert a dollar amount in year to an equivalent dollar amount today (that is, the amount that would have the same purchasing power), you can use the following formula: Amount in T years dollars x (price level today / price level in year T)

The following table describes the production possibilities of two cities in the country of Baseballia: Pairs of Red Socks per Worker per Hour Pairs of White Socks per Worker per Hour Boston 3 3 Chicago 2 1 Without trade, the price of a pair of white socks (in terms of red socks) in Boston is ________ pair of red socks, and in Chicago it is ________ of red socks. ________ has an absolute advantage in the production of red socks, and has an absolute advantage in the production of white socks. _______ has a comparative advantage in the production of red socks, and has a comparative advantage in the production of white socks. If the cities trade with each other, Chicago will export ________ socks, and Boston will export _______ socks. The price of white socks can be expressed in terms of red socks. The highest price at which white socks can be traded that would make both cities better off is _______ of red socks per pair of white socks, and the lowest price that makes both cities better off is _______ of red socks per pair of white socks.

1 pair 2 pairs Boston Boston Chicago Boston Red White 2 pairs 1 pair

Your uncle repays a $100 loan from Tenth National Bank (TNB) by writing a $100 check from his TNB checking account. Assume these funds are the only loans and deposits available for your uncle and the bank. Complete the following T-accounts for your uncle and TNB before your uncle repays the loan. Your Uncle Assets ________ _________ Liabilities _________ __________ Tenth National Bank Assets ________ ________ Liabilities _________ _________ Complete the following T-accounts for your uncle and TNB after your uncle repays the loan. Your Uncle Assets ________ _________ Liabilities _________ __________ Tenth National Bank Assets ________ _________ Liabilities _________ __________ True or False: Your uncle's wealth has changed.

1) 100 2) 100 3) 100 4) 100 1) 0 2) 0 3) 0 4) 0 false A T-account is a simplified accounting statement that shows changes in a bank's or individual's assets and liabilities. When your uncle takes out a loan of $100 from TNB and deposits it into his checking account, this increases his assets by $100 but also increases his liabilities by $100 because the money represents a loan. From the bank's perspective, the loan increases its assets by $100 but also increases its liabilities by $100 when your uncle deposits the money into his checking account. When your uncle repays a $100 loan from Tenth National Bank by writing a check from his TNB checking account, his checking account balance falls to $0, leaving him with $0 in assets but also $0 in liabilities, since he has now retired his debt. These transactions are reflected in parallel but opposite changes in the T-account of TNB.

One day, Barry the Barber, Inc., collects $400 for haircuts. Over this day, his equipment depreciates in value by $50. Of the remaining $350, Barry sends $30 to the government in sales taxes, takes home $220 in wages, and retains $100 in his business to add new equipment in the future. From the $220 that Barry takes home, he pays $70 in income taxes. Based on this information, complete the following table by computing Barry's contribution to the measures of income listed. Measure of Income vs. Barry's Contribution (Dollars) 1) Gross Domestic Product 2) Net National Product 3) National Income 4) Personal Income 5) Disposable Personal Income

1) 400 2) 350 3) 350 4) 220 5) 150 Gross domestic product (GDP) is the market value of all final goods and services produced within a country in a given period of time. In this case, the $400 that Barry collects is equal to GDP. Net national product (NNP) is the total income of a nation's residents (GNP) minus losses from depreciation. In this case, NNP is equal to 400-50 = 350. National income is the total income earned by a nation's residents in the production of goods and services. It is almost identical to net national product. These two measures differ because of the statistical discrepancy that arises from problems in data collection. In this case, however, national income equals the net national product of $350. Personal income is the income that households and noncorporate businesses receive. Unlike national income, it excludes retained earnings, which is income that corporations have earned but have not paid out to their owners. It also subtracts indirect business taxes (such as sales taxes), corporate income taxes, and contributions for social insurance (mostly Social Security taxes). In addition, personal income includes the interest income that households receive from their holdings of government debt and the income that households receive from government transfer programs, such as welfare and Social Security. In this case, personal income is 350-100-30 = 220. Disposable personal income is the income that households and noncorporate businesses have left after satisfying all their obligations to the government. It equals personal income minus personal taxes and certain nontax payments. In this case, disposable personal income is 220-70 = 150.

Indicate what components of GDP (if any) each of the following transactions would affect. Check all that apply. (Consumption, Investment, Government Purchases, Net Exports) 1) A family buys a new refrigerator. 2) Aunt Jane buys a new house. 3) Ford sells a Mustang from its inventory. 4) You buy a pizza. 5) California repaves Highway 101. 6) Your parents buy a bottle of French wine. 7) Honda expands its factory in Marysville, Ohio

1) Consumption 2) Investment 3) Consumption, Investment 4) Consumption 5) Government purchase 6) Consumption, Net Export 7) Investment

Classify the following topics as relating to microeconomics or macroeconomics. 1) A family's decision about how much income to save 2) The effect of government regulations on auto emissions 3) The impact of higher national saving on economic growth 4) A firm's decision about how many workers to hire 5) The relationship between the inflation rate and changes in the quantity of money

1) micro 2) micro 3) macro 4) micro 5) macro

For each of the following statements, indicate whether it is true or false. 1) The aggregate-demand curve slopes downward because it is the horizontal sum of the demand curves for individual goods. 2) The long-run aggregate-supply curve is vertical because the price level does not affect long-run aggregate supply. 3) If firms adjusted their prices every day, then the short-run aggregate-supply curve would be horizontal. 4) Whenever the economy enters a recession, its long-run aggregate-supply curve shifts to the left.

1) False 2) True 3) False 4) False The statement "The aggregate-demand curve slopes downward because it is the horizontal sum of the demand curves for individual goods" is false. The aggregate-demand curve slopes downward because a fall in the price level raises the overall quantity of goods and services demanded through the wealth effect, the interest-rate effect, and the exchange-rate effect. See Section: Why the Aggregate-Demand Curve Slopes Downward. The statement "The long-run aggregate-supply curve is vertical because the price level does not affect long-run aggregate supply" is true. Economic forces of various kinds (such as population and productivity) do affect long-run aggregate supply, but the price level does not. See Section: Why the Aggregate-Supply Curve Is Vertical in the Long Run. The statement "If firms adjusted their prices every day, then the short-run aggregate-supply curve would be horizontal" is false. If firms adjusted prices quickly and if sticky prices were the only possible cause for the upward slope of the short-run aggregate-supply curve, then the short-run aggregate-supply curve would be vertical, not horizontal. The short-run aggregate-supply curve would be horizontal only if prices were completely fixed. See Section: Why the Aggregate-Supply Curve Slopes Upward in the Short Run. The statement "Whenever the economy enters a recession, its long-run aggregate-supply curve shifts to the left" is false. An economy could enter a recession if either the aggregate-demand curve or the short-run aggregate-supply curve were to shift to the left.

For each of the following activities, identify the flow of goods and services and the flow of dollars as either household to firm or firm to household. Flow of Goods and Services & Flow of Dollars 1) Selena pays a storekeeper $1 for a quart of milk. 2) Stuart earns $4.50 per hour working at a fast-food restaurant. 3) Shanna spends $30 to get a haircut. 4) Salma earns $10,000 from her 10% ownership of Acme Industrial.

1) Firm to Household & Household to firm 2) Household to firm & Firm to household 3) Firm to household & Household to firm 4) Household to firm & Firm to household The circular-flow diagram simplifies the economy by including only two types of decision makers: firms and households. Firms produce goods and services using inputs such as labor, land, and capital. These inputs are called the factors of production. Households own the factors of production and consume all the goods and services that the firms produce. In the markets for the factors of production, households are sellers, and firms are buyers; so goods flow from households to firms, and dollars flow from firms to households. In the markets for goods and services, households are buyers, and firms are sellers; so goods flow from firms to households, and dollars flow from households to firms. When Selena pays the storekeeper and Shanna pays her hairdresser, they are interacting with sellers in markets for goods and services. Therefore, goods and services flow from firm to household, and dollars flow from household to firm in these examples. When Stuart earns income from working and Salma earns money from owning Acme Industrial, they are interacting with buyers in the markets for factors of production. Therefore, goods and services flow from household to firm, and dollars flow from firm to household.

Indicate whether each of the following events will increase, decrease, or have no effect on long-run aggregate supply. Event vs. Effect on Long-Run Aggregate Supply Increase Decrease No Effect 1) The United States experiences a wave of immigration. 2) Congress raises the minimum wage to $10 per hour. 3) Intel invents a new and more powerful computer chip. 4) A severe hurricane damages factories along the East Coast.

1) Increase 2) Decrease 3) Increase 4) Decrease When the United States experiences a wave of immigration, the labor force increases, so long-run aggregate supply increases (curve shifts to the right). When Congress raises the minimum wage to $10 per hour, the natural rate of unemployment rises, so long-run aggregate-supply decreases (curve shifts to the left). When Intel invents a new and more powerful computer chip, productivity increases, so long-run aggregate supply increases because more output can be produced with the same inputs. When a severe hurricane damages factories along the East Coast, the capital stock is smaller, so long-run aggregate supply decreases.

the unemployment rate and the employment-population ratio (calculated as the percentage of the adult population that is employed). Indicate what happens to the unemployment rate and the employment-population ratio in each of the following scenarios. Effect On... Unemployment Rate & Employment-Population Ratio 1) An auto company goes bankrupt and lays off its workers, who immediately start looking for new jobs. 2) After an unsuccessful search, some of the laid-off workers quit looking for new jobs. 3) Numerous students graduate from college but cannot find work. 4) Numerous students graduate from college and immediately begin new jobs. 5) A stock market boom induces newly enriched 60-year-old workers to take early retirement. 6)Advances in health care prolong the life of many retirees.

1) Increases, Decreases 2) Decreases, Stays the same 3) Increases, Stays the same 4) Decreases, Increases 5) Increases, Decreases 6) Stays the same, Decreases When an auto company goes bankrupt and lays off its workers, who immediately start looking for new jobs, this increases the labor force and the number of people unemployed, decreases the number of people employed, and keeps the adult population unchanged. Therefore, the unemployment rate increases, and the employment-population ratio decreases. If some of the unemployed auto workers give up looking for a job, this decreases the labor force and the number of people unemployed, keeps the number of people employed unchanged, and keeps the adult population unchanged. Therefore, the unemployment rate decreases, and the employment-population ratio stays the same. If numerous students graduate from college and cannot find work, this increases the labor force and the number of people unemployed, keeps the number of people employed unchanged, and keeps the adult population unchanged. Therefore, the unemployment rate increases, and the employment-population ratio stays the same. If numerous students graduate from college and immediately begin new jobs, this increases the labor force and the number of people employed, keeps the number of people unemployed unchanged, and keeps the adult population unchanged. Therefore, the unemployment rate decreases, and the employment-population ratio increases. If a stock market boom induces earlier retirement, this decreases the labor force and the number of people employed, keeps the number of people unemployed unchanged, and keeps the adult population unchanged. Therefore, the unemployment rate increases, and the employment-population ratio decreases. If advances in health care prolong the lives of retirees, the only effect of this is to increase the adult population. Therefore, the unemployment rate stays the same, and the employment-population ratio decreases.

Indicate which of the problems in the construction of the CPI are illustrated in each of the following situations. Introduction of New Goods Unmeasured Quality Change Substitution Bias 1) The invention of the iPod 2) The introduction of air bags in cars 3) Increased personal computer purchases in response to a decline in their price 4) More scoops of raisins in each package of Raisin Bran 5)Greater use of fuel-efficient cars after gasoline prices increase

1) Introduction of New Goods 2) Unmeasured Quality Change 3) Substitution Bias 4) Unmeasured Quality Change 5) Substitution Bias The consumer price index is not a perfect measure of the cost of living. Its first problem is called substitution bias. The idea is that when prices change from one year to the next, they do not change proportionately. This causes consumers to substitute toward goods that have become relatively less expensive. Examples of this include increased personal computer purchases in response to a decline in their price and greater use of fuel-efficient cars after gasoline prices increase. The second problem with the consumer price index is the introduction of new goods. When a new good is introduced, consumers have more variety from which to choose, and this, in turn, reduces the cost of maintaining the same level of economic well-being. An example of this is the invention of the iPod. The third problem with the consumer price index is unmeasured quality change. If the quality of a good deteriorates from one year to the next while its price remains the same, the value of a dollar falls, because you are getting a lesser good for the same amount of money. Similarly, if the quality rises from one year to the next, the value of a dollar rises. Examples of this include the introduction of air bags in cars and more scoops of raisins in each package of Raisin Bran.

Saving vs. Investment Indicate whether each of the following descriptions represents saving or investment, as defined by a macroeconomist: 1) This occurs when a person or firm purchased new capital. 2) This occurs when a person's income exceeds his consumption. Indicate whether each of the following situations represents saving or investment: 3) Your family takes out a mortgage and buys a new house. 4) You use your $200 paycheck to buy stock in AT&T. 5) Your roommate earns $100 and deposits it in his account at a bank. 6) You borrow $1,000 from a bank to buy a car to use in your pizza delivery business.

1) Investment 2) Saving 3) Investment 4) Saving 5) Saving 6) Investment Private saving is the amount of income that households have left after paying their taxes and paying for their consumption. In the language of macroeconomics, investment refers to the purchase of new capital, such as equipment or buildings. See Section: The Meaning of Saving and Investment. When your family takes out a mortgage and buys a new house, that is investment because it is a purchase of new capital. When you use your $200 paycheck to buy stock in AT&T, that is saving because your income of $200 is not being spent on consumption goods. When your roommate earns $100 and deposits it in his account at a bank, that is saving because the money is not spent on consumption goods. When you borrow $1,000 from a bank to buy a car to use in your pizza-delivery business, that is investment because the car is a capital good. See Section: The Meaning of Saving and Investment.

Indicate whether each of the following function as a medium of exchange, a unit of account, or a store of value in the U.S. economy. Check all that apply. Medium of Exchange, Unit of Account, Store of Value 1) U.S. penny 2) Mexican peso 3) Picasso painting 4) Plastic credit card Given your answers to the previous task, indicate whether each of the following is considered money in the U.S. economy. Money: Yes, No 1) U.S. penny 2) Mexican peso 3) Picasso painting 4) Plastic credit card

1) Medium of Exchange, Unit of Account, Store of Value 2) Store of Value 3) Store of Value 4) None 1) Yes 2) No 3) No 4) No Money has three functions in the economy: 1. Medium of exchange 2. Unit of account 3. Store of value A medium of exchange is an item that buyers give to sellers when they purchase goods and services. A unit of account is the yardstick people use to post prices and record debts. A store of value is an item that people can use to transfer purchasing power from the present to the future. A U.S. penny is money in the U.S. economy because it is used as a medium of exchange to buy goods or services, it serves as a unit of account because prices in stores are listed in terms of dollars and cents, and it serves as a store of value for anyone who holds it over time. A Mexican peso is not money in the U.S. economy because it is not used as a medium of exchange in the United States, and it does not serve as a unit of account since prices are not given in terms of pesos. However, it can be use as a store of value, since value can be held in the form of pesos, which can later be exchanged for dollars. A Picasso painting is not money because it cannot be used as a medium of exchange or a unit of account. It can, however, serve as a store of value. A plastic credit card is not money. Rather, it is simply a means of deferring payment until a later day, when actual money must be used to pay debts incurred through the use of a credit card.

Classify each of the following statements as positive or normative. 1) Society faces a short-run trade-off between inflation and unemployment. 2) A reduction in the rate of money growth will reduce the rate of inflation. 3) The Federal Reserve should reduce the rate of money growth. 4) Society ought to require welfare recipients to look for jobs. 5) Lower tax rates encourage more work and more saving.

1) Positive 2) Positive 3) Normative 4) Normative 5) Positive

Use the graph to help you complete the task that follows. You will not be graded on your final placement of the curves on the graph. (Interest rate vs Quantity of Money) Supply of Money, Demand for Money, Interest Rate 1) The Fed's bond traders buy bonds in open-market operations. 2) An increase in credit-card availability reduces the cash people hold. 3) The Federal Reserve reduces banks' reserve requirements. 4) Households decide to hold more money to use for holiday shopping. 5) wave of optimism boosts business investment and expands aggregate demand.

1) Shifts to the right, No change, Decreases 2) No change, Shifts to the left, Decreases 3) Shifts to the right, No change, Decreases 4) No change, Shifts to the right, Increases 5) No change, Shifts to the right, Increases When the Fed's bond traders buy bonds in open-market operations, the money-supply curve shifts to the right from to . The result is a decline in the interest rate. When an increase in credit card availability reduces the cash people hold, the money-demand curve shifts to the left from to . The result is a decline in the interest rate. When the Federal Reserve reduces reserve requirements, the money supply increases, so the money-supply curve shifts to the right from to . The result is a decline in the interest rate. When households decide to hold more money to use for holiday shopping, the money-demand curve shifts to the right from to . The result is a rise in the interest rate. When a wave of optimism boosts business investment and expands aggregate demand, money demand shifts to the right from to . The increase in money demand increases the interest rate.

Money serves three functions in the economy: medium of exchange, unit of account, and store of value. For each of the following statements about inflation, indicate which function of money inflation is hindering. Statement Store of Value Unit of Account Medium of Exchange 1) Inflation erodes money's purchasing power. 2) Inflation causes menu costs. 3) In some countries with hyperinflation, prices are posted in terms of U.S. dollars rather than the local currency, even though the local currency is still used to purchase the good.

1) Store of value 2) Unit of account 3) Unit of account

Consider a simple economy whose only industry is printing. In this industry, productivity—the amount of goods and services a worker can produce per hour—is measured by the number of documents one worker prints per hour. In the following table, match each example to the productivity determinant it represents. Human Capital per Worker Natural Resources per Worker Physical Capital per Worker Technological Knowledge 1) A way of organizing workers among the printing presses that speeds up the printing process 2) The trees that are used to create pulp for the production of paper 3) The presses used to print documents 4) The knowledge workers receive from training sessions on how to use and repair the printing presses

1) Technological Knowledge 2) Natural Resources per Worker 3) Physical Capital per Worker 4) Human Capital per Worker Human capital is the knowledge and skills that workers acquire through training, education, and experience. Human capital is distinct from technological knowledge, which is society's understanding of how the world works. Human capital measures the resources expended (years of training, education, or experience) transmitting society's technological knowledge to workers. Natural resources are the inputs into the production of goods and services that are provided by nature, such as land, bodies of water, forests, and mineral deposits. Physical capital is the stock of tools, machinery, equipment, and structures that are used to produce goods and services.

Consider the market for DVDs, TV screens, and tickets at movie theaters. Pairs of Goods 1) DVDs and TV screens 2) DVDs and movie tickets 3) TV screens and movie tickets

1) complements 2) substitutes 3) substitutes

For each of the events in the table, indicate the short-run and long-run effects on output and the price level, assuming policymakers take no action. Note: You may use the graph to help you with your answers, but you will not be graded on the final position of any of the curves. Event vs. Long-Run Effect On... Output, Price Level 1) The stock market declines sharply, reducing consumers' wealth. 2) The federal government increases spending on national defense. 3) A technological improvement raises productivity. 4) A recession overseas causes foreigners to buy fewer U.S. goods.

1) no change, decrease 2) no change, increase 3) increase, decrease 4) no change, decrease Se graph When the stock market declines sharply, wealth declines, so the aggregate-demand curve shifts to the left, as shown in the following graph. In the short run, the economy moves from point A to point B as output declines and the price level declines. In the long run, the short-run aggregate-supply curve shifts to the right to restore equilibrium at point C, with unchanged output and a lower price level compared to point A. When the federal government increases spending on national defense, the rise in government purchases shifts the aggregate-demand curve to the right, as shown in the following graph. In the short run, the economy moves from point A to point B as output and the price level rise. In the long run, the short-run aggregate-supply curve shifts to the left to restore equilibrium at point C, with unchanged output and a higher price level compared to point A.

Complete the following table by indicating if each of the workers listed is more likely to experience short-term or long-term unemployment. Worker - Unemployment Short-Term vs. Long-Term 1) A construction worker laid off because of bad weather 2) A manufacturing worker who loses his job at a plant in an isolated area 3) A stagecoach-industry worker laid off because of competition from railroads 4) A short-order cook who loses his job when a new restaurant opens across the street 5) An expert welder with little formal education who loses his job when the company installs automatic welding machinery

1) short 2) long 3) long 4) short 5) long A construction worker who is laid off because of bad weather is likely to experience short-term unemployment because the worker will be back to work as soon as the weather clears up. A manufacturing worker who loses his job at a plant in an isolated area is likely to experience long-term unemployment because there are probably few other employment opportunities in the area. He may need to move somewhere else to find a suitable job, which means he will be out of work for some time. A worker in the stagecoach industry who was laid off because of the growth of railroads is likely to be unemployed for a long time. The worker will have a lot of trouble finding another job because his entire industry is shrinking. He will probably need to gain additional training or skills to get a job in a different industry. A short-order cook who loses his job when a new restaurant opens is likely to find another job fairly quickly, perhaps even at the new restaurant, and thus will probably have only a short spell of unemployment. An expert welder with little education who loses his job when the company installs automatic welding machinery is likely to be without a job for a long time because he lacks the technological skills to keep up with the latest equipment. To remain in the welding industry, he may need to go back to school and learn the newest techniques.

Explain whether each of the following government activities is motivated by a concern about equality or a concern about efficiency. Activity Equality Efficiency 1) Regulating cable TV prices 2) Providing some poor people with vouchers that can be used to buy food 3) Prohibiting smoking in public places 4) Breaking up Standard Oil (which once owned 90% of all oil refineries) into several smaller companies 5) Imposing higher personal income tax rates on people with higher incomes 6) Instituting laws against driving while intoxicated

1)efficiency 2)equality 3)efficiency 4)efficiency 5)equality 6)efficiency When the government takes action, it is constantly faced with the trade-off between efficiency and equality. Efficiency means that society is getting the maximum benefits from its scarce resources. Equality means that those benefits are distributed uniformly among society's members. In other words, efficiency refers to the size of the economic pie, and equality refers to how the pie is divided into individual slices. In this case, regulating cable TV prices, prohibiting smoking in public places, breaking up Standard Oil into several smaller companies, and instituting laws against driving while intoxicated are all examples of activities motivated by efficiency, while providing some poor people with vouchers that can be used to buy food and imposing higher personal income tax rates on people with higher incomes are examples of activities motivated by equality.

The New York Times cost $0.15 in 1970 and $2.00 in 2011. The average wage in manufacturing was $3.36 per hour in 1970 and $23.09 in 2011. By what percentage did the price of a newspaper rise? By what percentage did the wage rise? In order to earn enough to buy a newspaper, a worker had to work _______ minutes in 1970 and ______ minutes in 2011. Workers' purchasing power in terms of newspapers between 1970 and 2011.

1,233% 587% 2.68, 5.20 fell

The population of Ectenia is 100 people: 40 work full-time, 20 work half-time but would prefer to work full-time, 10 are looking for a job, 10 would like to work but are so discouraged they have given up looking, 10 are not interested in working because they are full-time students, and 10 are retired. What is the number of unemployed?

10 The category of unemployment includes those who are not employed, are available for work, and tried to find employment during the previous four weeks. It also includes those waiting to be recalled to a job from which they were laid off. In Ectenia, the 10 who are looking for a job are the only unemployed people; discouraged workers, students, and the retired are considered "not in the labor force" and are not counted as unemployed.

Let's consider the effects of inflation in an economy composed of only two people: Bob, a bean farmer, and Rita, a rice farmer. Bob and Rita both always consume equal amounts of rice and beans. In 2013, the price of beans was $1, and the price of rice was $3. Suppose that in 2014 the price of beans was $2 and the price of rice was $6. Inflation was _________. Indicate whether Bob and Rita were better off, worse off, or unaffected by the changes in prices. Better Off, Worse Off, Unaffected Bob Rita Now suppose that in 2014 the price of beans was $2 and the price of rice was $4. In this case, inflation was ________. Indicate whether Bob and Rita were better off, worse off, or unaffected by the changes in prices. Better Off, Worse Off, Unaffected Bob Rita Now suppose that in 2014 the price of beans was $2 and the price of rice was $1.50. In this case, inflation was _______. Indicate whether Bob and Rita were better off, worse off, or unaffected by the changes in prices. Better Off, Worse Off, Unaffected Bob Rita What matters more to Bob and Rita?

100% unaffected, unaffected 50% better off, worse off -12.5% better off, worse off The relative price of rice and beans

Happy Bank starts with $200 in bank capital. It then takes in $800 in deposits. It keeps 12.5 percent (1/8th) of deposits in reserve. It uses the rest of its assets to make bank loans. Complete the following balance sheet for Happy Bank. Happy Bank Assets Liabilities Reserves _______ Deposits ________ Loans _______ Bank Capital ________ Happy Bank's leverage ratio is _______. Suppose that 10 percent of the borrowers from Happy Bank default, and these bank loans become worthless. Complete Happy Bank's new balance sheet. Happy Bank Assets Liabilities Reserves _________ Deposits _________ Loans _______ Bank Capital __________ The bank's total assets decline by _______, and the bank's capital declines by _________.

100, 800 900, 200 5 100, 800 810, 110 9, 45

You take $100 you had kept under your mattress and deposit it in your bank account. Suppose this $100 stays in the banking system as reserves and banks hold reserves equal to 10 percent of deposits. The total amount of deposits in the banking system increases by _______ , and the money supply increases by _______.

1000 900 The amount of money the banking system generates with each dollar of reserves is called the money multiplier. The money multiplier is the reciprocal of the reserve ratio. If R is the reserve ratio for all banks in the economy, then each dollar of reserves generates 1/R dollars of money. If you take $100 that you held as currency and put it into the banking system, you can compute the increase in the total amount of deposits in the banking system

If the price of a hot dog is $2 and the price of a hamburger is $4, then 30 hot dogs contribute as much to GDP as _____ hamburgers.

15 If the price of a hotdog is $2, then the total contribution of 30 hotdogs to GDP will be 2x30= 60. If the price of a hamburger is $4, then it would take 60/4 = 15 to contribute the same amount to GDP.

Unionized workers are paid about _____ percent more than similar nonunion workers.

15% Economists who study the effects of unions typically find that union workers earn about 15 percent more than similar workers who do not belong to unions.

Suppose that there are 10 million workers in Canada and that each of these workers can produce either 2 cars or 30 bushels of wheat in a year. The opportunity cost of producing a car in Canada is _______ bushels of wheat, and the opportunity cost of producing a bushel of wheat in Canada is ________ cars. Use the blue line (circle symbol) to draw Canada's production possibilities frontier (PPF) on the following graph. Then use the black point (plus symbol) to indicate the consumption bundle Canada can achieve without trade if it chooses to consume 10 million cars. Now suppose that the United States offers to buy 10 million cars from Canada in exchange for 20 bushels of wheat per car. On the previous graph, use the grey point (star symbol) to indicate the consumption bundle Canada can achieve with trade if it continues to consume 10 million cars. Canada ________ accept the deal the United States proposes.

15, 1/15 Should

Suppose that this year's money supply is $500 billion, nominal GDP is $10 trillion, and real GDP is $5 trillion. The price level is ________, and the velocity of money is _________. Suppose that velocity is constant and the economy's output of goods and services rises by 5 percent each year. Use this information to answer the questions that follow. If the Fed keeps the money supply constant, the price level will _______, and nominal GDP will ________. If the Fed wants to keep the price level stable instead, it should ________ next year. If the Fed wants an inflation rate of 10 percent instead, it should ________-

2, 20 fall by 5%, stay the same increase the money supply by 5% increase the money supply by 15%

A German worker takes 400 hours to produce a car and 2 hours to produce a case of wine. A French worker takes 600 hours to produce a car and X hours to produce a case of wine. For what values of X will gains from trade be possible? Check all that apply. For what values of X will Germany export cars and import wine? Check all that apply.

2, 300 1, 2

Suppose economists observe that an increase in government spending of $10 billion raises the total demand for goods and services by $30 billion. If these economists ignore the possibility of crowding out, they would estimate the marginal propensity to consume (MPC) to be _______. Now suppose the economists allow for crowding out. Their new estimate of the MPC would be ________ than their initial one.

2/3, larger

Beleaguered State Bank (BSB) holds $250 million in deposits and maintains a reserve ratio of 10 percent. Complete the following T-account for BSB. Beleaguered State Bank Assets ________ Liabilities ________ Reserves _______ million Deposits _______ million Loans _______ million Now suppose that BSB's largest depositor withdraws $10 million in cash from her account. BSB decides to restore its reserve ratio by reducing the amount of loans outstanding. Complete BSB's new T-account. Beleaguered State Bank Assets ________ Liabilities _________ Reserves _______ million Deposits _________ million Loans ________ million Because BSB is cutting back on its loans, other banks will find they have too reserves, causing them to their loans. BSB may find it difficult to cut back on its loans immediately because it cannot force people to pay off loans. Which of the following ways represent an alternative for BSB to return to its original reserve ratio? Check all that apply.

250, 250, 225 24, 240, 216 little, decrease Attract additional deposits Borrow money from another bank Borrow money from the Fed If BSB's largest depositor withdraws $10 million in cash from her account and BSB decides to restore its reserve ratio by reducing outstanding loans, this would require the following reserves and loan amounts. Because BSB is cutting back on its loans, other banks will find themselves short of reserves, and they may also cut back on their loans. Because BSB cannot force people to pay off loans, BSB may find it difficult to cut back on its loans immediately since it can only stop making new loans. Therefore, for a time, it might find itself with more loans than it wants. As alternatives, it could try to attract additional deposits to get additional reserves or borrow from another bank or from the Fed.

You deposit $2,000 in a savings account, and a year later you have $2,100. Meanwhile, the consumer price index rises from 200 to 204. In this case, the nominal interest rate is ______ percent, and the real interest rate is ______ percent.

5, 3 The nominal interest rate measures the change in dollar amounts, so an increase from $2,000 to $2,100 represents a nominal interest rate of $2100 - $2000 / 2000 = 0.05 or 5%. The increase in the CPI from 200 to 204 reflects 2% inflation; therefore, the real interest rate (equal to the nominal interest rate minus the inflation rate) is equal to 5% - 2% = 3%

Suppose the tax rate is 40%. For each of the inflation rate and before-tax nominal interest rate combinations, complete the following table by computing the before-tax real interest rate, the after-tax nominal interest rate, and the after-tax real interest rate. Inflation Rate Before Tax After Tax Nominal Interest Rate Real Interest Rate Nominal Interest Rate Real Interest Rate 5 10 2 6 1 4

5, 6, 1 4, 3.6, 1.6 3, 2.4, 1.4 See graph

If Aggregate Demand falls because of falling Consumption, what would be an appropriate Fiscal Policy?

Decrease Tax rates to increase disposable income, so Consumption can increase When tax rates are increased, disposable income falls, and that causes Consumption and Aggregate Demand to Fall. So, the appropriate fiscal policy would be to decrease tax rates so that disposable income increases, so Consumption and Aggregate Demand increase as well.

Consider the market for minivans. For each of the following events, identify which of the determinants of demand are affected. If demand is unaffected by this event because it creates a supply change, select the "None" option. Event: 1) People decide to have more children. 2) A strike by steelworkers raises steel prices. 3) Engineers develop new automated machinery for the production of minivans. 4) The price of sports utility vehicles rises. 5) A stock-market crash lowers people's wealth. For each of the following events, identify which of the determinants of supply are affected. If supply is unaffected by this event because it creates a demand change, select the "None" option.

Demand Determinant: Tastes, none None, input prices None, technology Price of substitute or complement, none Income, none

Suppose that Congress passes a law requiring employers to provide employees some benefit (such as healthcare) that raises the cost of an employee by $4 per hour. Assume that firms were not providing such benefits prior to the legislation. On the following graph, use the green line (triangle symbol) to show the effect this employer mandate has on the demand for labor. Suppose employees place a value on this benefit exactly equal to its cost. On the previous graph, use the purple line (diamond symbol) to show the effect this employer mandate has on the supply of labor. Suppose the wage is free to balance supply and demand. Use the black point (plus symbol) to indicate the equilibrium wage and level of employment before this law, and use the grey point (star symbol) to indicate the equilibrium wage and level of employment after this law is implemented. True or False: Employers and employees are made worse off by this law. Suppose that, before the mandate, the wage in this market was $3 above the minimum wage. In this case, the employer mandate will decrease the equilibrium wage rate from $10 per hour to ________ per hour, causing employment to _______ and unemployment to _______. Now suppose that workers do not value the mandated benefit at all. Which of the following statements are true under this circumstance? Check all that apply.

False $7 decrease increase The wage rate will decline by less than $4. Employers are worse off than before the mandated benefit. The equilibrium quantity of labor will decline. The supply curve of labor doesn't shift at all. Employees are worse off than before the mandated benefit. The initial equilibrium wage and level of employment occurs at the intersection of the demand and supply curves, or $10 per hour and 5 workers. Because the demand and supply curves of labor both shift down by $4 as a result of the law, the equilibrium quantity of labor is unchanged and the wage rate declines by $4. Both employees and employers are just as well off as before. Employees receive a wage of $6 per hour but a benefit of $4 per hour, for a total of $10 per hour, whereas employers pay a wage of $6 per hour but incur an additional cost of $4 per hour for a net payout of $10 per hour. If the workers do not value the mandated benefit at all, the supply curve of labor does not shift down by $4 per hour. As a result, the wage rate will decline by less than $4, and the equilibrium quantity of labor will decline. Employers are worse off because they now pay a greater total wage plus benefits for fewer workers. Employees are worse off because they get a lower wage and fewer are employed.

Indicate whether the following statements are true, false, or uncertain. Statement 1) Inflation hurts borrowers and helps lenders because borrowers must pay a higher rate of interest. 2) If prices change in a way that leaves the overall price level unchanged, then no one is made better or worse off. 3) Inflation does not reduce the purchasing power of most workers.

False False True The statement Inflation hurts borrowers and helps lenders because borrowers must pay a higher rate of interest is false. Higher expected inflation means borrowers pay a higher nominal rate of interest but the same real rate of interest, so borrowers are not worse off, and lenders are not better off. Higher unexpected inflation, on the other hand, makes borrowers better off and lenders worse off. The statement If prices change in a way that leaves the overall price level unchanged, then no one is made better or worse off is false. Changes in relative prices generally make some people better off and others worse off, even though the overall price level does not change. The statement Inflation does not reduce the purchasing power of most workers is true, since most workers' incomes keep up with inflation reasonably well.

The following graph shows the short-run aggregate supply curve ( ), the aggregate demand curve ( ), and the long-run aggregate supply curve ( ) for a hypothetical economy. Initially, the expected price level is equal to the actual price level, and the economy is in long-run equilibrium at its natural level of output, $110 billion. Suppose a bout of severe weather drives up agricultural costs, increases the costs of transporting goods and services, and increases the costs of producing goods and services in this economy.

Firms experience higher production costs due to the severe weather. The increase in costs makes the sale of goods and services less profitable, so firms reduce the quantity of output they supply at each price level, causing the short-run aggregate supply curve to shift leftward and moving the economy from an output of $110 billion to $105 billion in the short run. Output falls below the natural level of output, and the price level increases from 110 to 115. The combination of stagnation (falling output) and inflation (rising prices) is known as stagflation.

Suppose that in a year an American worker can produce 100 shirts or 20 computers and a Chinese worker can produce 100 shirts or 10 computers. Use the blue line (circle symbol) to graph the production possibilities frontier (PPF) for the United States, and use the green line (triangle symbol) to graph the production possibilities frontier for China. Suppose that without trade the workers in each country spend half their time producing each good. Use the black point (plus symbol) to indicate this production and consumption point for the United States, and use the grey point (star symbol) to indicate this production and consumption point for China. If these countries were open to trade, ________ would export shirts and ________ would benefit from trade. The price of a computer can be expressed in terms of shirts. The highest price for which a computer can be traded that would make both countries better off is shirts per computer, and the lowest price that makes both countries better off is _______ shirts per computer. Suppose that China catches up with American productivity so that a Chinese worker can produce 100 shirts or 20 computers. True or False: There are no longer gains from trade.

If the United States spends all of its time producing shirts, it can produce 100 shirts; therefore, one endpoint of the United States' production possibilities frontier is (100, 0). Alternatively, if the United States spends all of its time producing computers, it can produce 20 computers; therefore, the other endpoint of its production possibilities frontier is (0, 20). Because the United States faces a constant trade-off between producing shirts and computers, its production possibilities frontier is a straight line in this case. Similar calculations yield a production possibilities frontier for China with the following endpoints: (100, 0) and (0, 10). China, both countries 10, 5 True

Imagine a society that produces military goods and consumer goods, which we'll call "guns" and "butter," respectively. The following graph shows the production possibilities frontier for guns and butter. The production possibilities frontier has a bowed-out shape because the quantity of guns the economy must give up in order to produce more butter _______ the more butter is produced. In other words, the opportunity cost of butter _______ with increased production.

Increases Rises The production possibilities frontier is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and production technology. In this case, the production possibilities frontier has a bowed shape because the opportunity cost of butter in terms of the number of guns is not constant. When the economy is using most of its resources to make guns, such as at point B, the resources best suited to butter production, such as farmers and cows, are being used in the weapons industry. Because these resources probably aren't very good for making guns, increasing butter production by one unit will cause only a slight reduction in the number of guns produced. At point B, the opportunity cost of butter in terms of guns is small, and the frontier is relatively flat. By contrast, when the economy is using most of its resources to make butter, such as at point C, the resources best suited to making butter are already at work in the butter industry. Producing additional butter means moving some of the best gun makers out of the weapons industry and turning them into farmers. As a result, producing additional butter will mean a substantial loss of gun output. The opportunity cost of butter is high, and the frontier is steep.

You were planning to spend Saturday working at your part-time job, but a friend asks you to go skiing. Which of the following are included in the true cost of going skiing?

The rental of any ski equipment you need The wages you forgo by going skiing The cost of a lift ticket

Suppose an economy is in long-run equilibrium. The central bank raises the money supply by 5 percent. Use your diagram to show what happens to output and the price level as the economy moves from the initial to the new short-run equilibrium. Now adjust the graph to show the new long-run equilibrium. What causes the economy to move from its short-run equilibrium to its long-run equilibrium? According to the sticky-wage theory of aggregate supply, nominal wages at the initial equilibrium are ________ nominal wages at the short-run equilibrium resulting from the increase in the money supply, and _______ nominal wages at the long-run equilibrium. Real wages at the initial equilibrium are _______ real wages at the short-run equilibrium resulting from the increase in the money supply, and ________ real wages at the long-run equilibrium. Judging by the impact of the money supply on nominal and real wages, this analysis _______ consistent with the proposition that money has real effects in the short run but is neutral in the long run.

See graph Nominal wages, prices, and perceptions adjust upward to this new price level. equal to, less than, greater than, equal to, is If the central bank increases the money supply, the aggregate demand curve shifts to the right, with the new short-run equilibrium at point B. Thus, in the short run, both output and the price level increase. Over time, as nominal wages, prices, and perceptions adjust to the new price level, the short-run aggregate-supply curve shifts to the left, returning the economy to the natural rate of output (point C). According to the sticky-wage theory, nominal wages at points A and B are equal. However, nominal wages at point C are higher. Real wages at point A are higher than real wages at point B. However, real wages at points A and C are equal. This analysis is consistent with long-run monetary neutrality. In the long run, an increase in the money supply causes an increase in the nominal wage but leaves the real wage unchanged.

The following graph shows a labor market with a binding minimum wage. Use the blue point (circle symbol) to indicate the quantity of labor demanded, and use the orange point (square symbol) to indicate the quantity of labor supplied in this case. Suppose there is an increase in the minimum wage. On the previous graph, shift the black line to show the effect this has on the wage paid to workers. Then use the green point (triangle symbol) to indicate the new quantity of labor demanded, and use the purple point (diamond symbol) to indicate the new quantity of labor supplied given this increase in the minimum wage. True or False: The amount of unemployment in this industry rises as a result of the minimum wage hike.

See graph True

In 1939, with the U.S. economy not yet fully recovered from the Great Depression, President Roosevelt proclaimed that Thanksgiving would fall a week earlier than usual so that the shopping period before Christmas would be longer. The following graph represents the state of the economy before this pronouncement. Using the model of aggregate demand and aggregate supply, illustrate what President Roosevelt might have been trying to achieve.

See graph During the Great Depression, equilibrium output (Y1) was lower than the natural rate of output (Y2). The idea of lengthening the shopping period between Thanksgiving and Christmas was to increase aggregate demand. As the following graph shows, this could increase output back to its long-run equilibrium level (Y2).

Suppose a hurricane in South Carolina damages the cotton crop. Show the effect this hurricane has on the market for sweatshirts. Suppose the price of leather jackets falls. Show the effect this price change of leather jackets has on the market for sweatshirts. Suppose all colleges require morning exercise in appropriate attire. Show the effect this new exercise requirement has on the market for sweatshirts. Suppose new knitting machines are invented. Show the effect this new technology has on the market for sweatshirts.

See graphs

The first principle of economics discussed in Chapter 1 is that people face trade-offs. The following production possibilities frontier illustrates society's trade-offs between spending money on two "goods": a clean environment and the quantity of industrial output. Show what happens to the production possibilities frontier (PPF) if new technology develops that makes cleaning the air cheaper.

The production possibilities frontier is a graph that shows the various combinations of output that the economy can possibly produce given the available factors of production and production technology. When new technology emerges that makes cleaning the air cheaper, this means that the air can be made cleaner than it was before at every level of industrial output, resulting in a pivot of the production possibilities frontier around the horizontal intercept. However, the maximum amount of industrial output that can be produced is unchanged by this technology. Therefore, the vertical intercept of the production possibilities frontier rises in this case, and the horizontal intercept remains at its original location.

For each of the following events, use the subsequent graph to illustrate the short-run effect on aggregate supply and aggregate demand. Households decide to save a larger share of their income. Florida orange groves suffer a prolonged period of below-freezing temperatures. Increased job opportunities overseas cause many people to leave the country.

See graphs If households decide to save a larger share of their income, they must spend less on consumer goods, so the aggregate-demand curve shifts to the left. The equilibrium changes from point A to point B, so the price level declines and output declines. If Florida orange groves suffer a prolonged period of below-freezing temperatures, the orange harvest will be reduced. This decline in output is represented in the graph by a shift to the left of the short-run aggregate-supply curve. The equilibrium changes from point A to point B, so the price level rises and output declines. Depending on how prolonged the period of below-freezing temperatures is, this may shift the long-run aggregate-supply curve as well, as shown by the shift from LRAS1 to LRAS2, but this is a long-run effect, not a short-run effect. If increased job opportunities cause people to leave the country, the short-run aggregate-supply curve will shift to the left because there are fewer people producing output. The aggregate-demand curve will also shift to the left because there are fewer people consuming goods and services. The result is a decline in the quantity of output, as the following graph shows. Whether the price level rises or declines depends on the relative sizes of the shifts in the aggregate-demand curve and the aggregate-supply curve. If the moves are permanent, this is likely to cause a shift in the long-run aggregate-supply curve as well, but this is a long-run effect.

Which of the following is FALSE about the Great Recession in the US?

TRUE- Risk Premium was higher, and there was a Real shock to the Housing Sector- explained by Real Business Cycle Theory TRUE- The Federal Reserve had followed a tight monetary policy prior to the Great Recession - explained by Monetary Theory TRUE- There was a Fall in Aggregate Demand- explained by Keynesian Theory FALSE-The inability of the Democrats and Republicans to agree on a correct policy - explained by Political Theories

You win $100 in a basketball pool. You have a choice between spending the money now or putting it away for a year in a bank account that pays 5% interest. Which of the following is included in the opportunity cost of spending $100 now?

The $105 you would have a year from now if you put it in the bank

Consider two policies: a tax cut that will last for only one year and a tax cut that is expected to be permanent.

The *permanent policy will stimulate greater spending by consumers. The *permanent policy will have the greater impact on aggregate demand. A tax cut that is permanent will have a bigger impact on consumer spending and aggregate demand. If the tax cut is permanent, consumers will view it as adding substantially to their financial resources, and they will increase their spending substantially. If the tax cut is temporary, consumers will view it as adding just a little to their financial resources, so they will not increase spending as much.

Which of the following is a good example of an expansionary monetary policy?

The Federal Reserve conducts Open Market Purchases to increase Money Supply Monetary Policy is conducted by the Federal Reserve, so Open Market Purchases to increase money supply would be the correct answer

The following table reports real income per person for several different economies in the years 1960 and 2010. It also gives each economy's average annual growth rate during this period. For example, real income per person in Zambia was $1,412 in 1960, and it actually declined to $1,309 by 2010. Zambia's average annual growth rate during this period was -0.15%, and it was the poorest economy in the table in the year 2010. The real income-per-person figures are denominated in U.S. dollars with a base year of 2005. The following exercises will help you to understand the different growth experiences of these economies. Consider the following list of four countries. Which economy began with a level of real income per person in 1960 that was well below that of Venezuela and grew fast enough to catch up with and surpass Venezuela's real income per person by 2010?

This economy experienced the fastest rate of growth in real income per person from 1960 to 2010: Botswana This economy had the highest level of real income per person in the year 2010: Austria Malaysia In 1960, Malaysia's real income per person was $1,624, less than one-fourth that of Venezuela's. From 1960 to 2010, Malaysia's real income per person grew at an average annual rate of 4.06%, whereas Venezuela's grew at a slower rate of 0.58% per year. By 2010, with real income per person of $11,863, Malaysia had surpassed Venezuela's real income per person of $9,762.

Indicate whether each of the following statements is true or false. 1. Two countries can achieve gains from trade even if one of the countries has an absolute advantage in the production of all goods. 2. Certain very talented people have a comparative advantage in everything they do. 3. If a certain trade is good for one person, it can't be good for the other one. 4. If a certain trade is good for one person, it is always good for the other one. 5. If trade is good for a country, it must be good for everyone in the country.

True False False False False 1) Two countries can achieve gains from trade even if one of the countries has an absolute advantage in the production of all goods. All that is necessary is that each country have a comparative advantage in some good. 2) No one can have a comparative advantage in everything. Comparative advantage reflects the opportunity cost of one good or activity in terms of another. If you have a comparative advantage in one thing, you must have a comparative disadvantage in the other thing. 3) It is not true that if a trade is good for one person, it cannot be good for the other one. Trades can and do benefit both sides when based on comparative advantage. If both sides did not benefit, trades would never occur. 4) To be good for both parties, the trade price must lie between the two opportunity costs. 5) Trade that makes the country better off can harm certain individuals in the country. For example, suppose a country has a comparative advantage in producing wheat and a comparative disadvantage in producing cars. Exporting wheat and importing cars will benefit the nation as a whole, as it will be able to consume more of both goods. However, the introduction of trade will likely be harmful to domestic auto workers and manufacturers.

American and Japanese workers can each produce 4 cars a year. An American worker can produce 10 tons of grain a year, whereas a Japanese worker can produce 5 tons of grain a year. To keep things simple, assume that each country has 100 million workers. Complete the following table with the number of workers needed to make one car or 1 ton of grain in the United States and Japan. Workers Needed to Make 1 Car vs. 1 Ton of Grain USA and Japan Complete the following table by determining the opportunity cost of a car and of a ton of grain for both the United States and Japan. Opportunity Cost of: 1 Car & 1 Ton of Grain (In terms of tons of grain and cars given up) Given this information, ________ has an absolute advantage in producing cars, and _________ has an absolute advantage in producing grain. Also, ________ has a comparative advantage in producing cars, and _______ has a comparative advantage in producing grain. Assume that without trade, half of each country's workers produce cars and half produce grain. Complete the following table with the quantities of cars produced and consumed in each country if there is no trade. Cars Produced and Consumed vs. Tons of Grain Produced and Consumed True or False: Both countries would be better off if they produced the good in which they have a comparative advantage and then traded 200 million tons of grain for 100 million cars.

USA- 1/4, 1/10 Japan- 1/4, 1/5 USA- 2 1/2, 2/5 Japan- 1 1/4, 4/4 Neither country, United States Japan, United States 200, 500 200, 250 True If American and Japanese workers can each produce 4 cars a year, then it takes 1/4 worker to make 1 car in each of these economies. Similarly, it takes 1/10 worker to make 1 ton of grain in the United States, and 1/5 worker to make 1 ton of grain in Japan. Economists use the term comparative advantage when describing the opportunity costs faced by of two producers. The producer who gives up less of other goods to produce Good X has the smaller opportunity cost of producing Good X and is said to have a comparative advantage in producing it. In this case, Japan has a comparative advantage in producing cars because it has a lower opportunity cost in terms of grain given up (1 1/4 tons of grain for Japan versus 2 1/2 tons for the United States). The United States has a comparative advantage in producing grain because it has a lower opportunity cost in terms of cars given up (2/5 cars for the United States versus 4/5 cars for Japan). If each country produces the good in which it has a comparative advantage, the United States will produce 1 billion tons of grain and Japan will produce 400 million cars. If they agree to trade 200 million tons of grain for 100 million cars, they will both end up at a consumption point outside their respective production possibilities frontiers. Therefore, specialization and trade have made each country better off.

The Federal Reserve expands the money supply by 5 percent. Use the theory of liquidity preference to illustrate the impact of this policy on the interest rate on the following graph. Use the model of aggregate demand and aggregate supply to illustrate the impact of this change in the interest rate on output and the price level in the short run. Is this analysis consistent with the proposition that the money supply has real effects in the short run but is neutral in the long run?

When the economy makes the transition from its short-run equilibrium to its long-run equilibrium, the price level will *rise. This change in the price level will cause the demand for money to *rise and the equilibrium interest rate to *rise (Note: Do not adjust the graphs to reflect the transition to the long run.) Yes The increase in the money supply will cause the equilibrium interest rate to decline. Households will increase spending and will invest in more new housing. Firms, too, will increase investment spending. This will cause the aggregate-demand curve to shift to the right. The increase in aggregate demand will cause an increase in both output and the price level in the short run. In the short run, the economy moved from point A to point B. When the economy makes the transition from its short-run equilibrium to its long-run equilibrium, short-run aggregate supply will decline, causing the price level to rise even further (point C). The increase in the price level will cause an increase in the demand for money, raising the equilibrium interest rate. This analysis is consistent with the proposition that money has real effects in the short run but is neutral in the long run. While output initially rises because of the increase in aggregate demand, it will fall once short-run aggregate supply declines. Thus, there is no long-run effect of the increase in the money supply on real output.

Over the past 30 years, technological advances have reduced the cost of computer chips. This has led to _______ in the supply of computers, causing the price of computers to _________. Because computers and computer software are _________, this change in price causes the demand for computer software to __________. However, computers and typewriters are __________, so the change in the price of computers _________ the demand for typewriters.

an increase fall complements increase substitutes decreases Technological advances that reduce the cost of producing computer chips represent a decline in an input price for producing a computer. The result is an increase in the supply of computers, causing the price of computers to fall and the quantity sold to rise. When a fall in the price of one good raises the demand for another good, the two goods are called complements. Complements are often pairs of goods that are used together, such as computers and computer software. Because computer software is a complement to computers, the lower equilibrium price of computers causes the demand for computer software to increase. As seen on the following graph, this results in a rise in both the equilibrium price and the quantity of software. When a fall in the price of one good reduces the demand for another good, the two goods are called substitutes. Substitutes are often pairs of goods that are used in place of each other, such as computers and typewriters. Because typewriters are substitutes for computers, the lower equilibrium price of computers reduces the demand for typewriters. As seen on the following graph, this causes a decline in both the equilibrium price and the quantity of typewriters.

The main policy goal of the unemployment insurance system is to reduce the

income uncertainty that workers face. The goal of unemployment insurance is to reduce income uncertainty by providing payments to those who are laid off. An undesired side effect is a reduction in the search effort of the unemployed and, thus, an increase in the amount of frictional unemployment. By making unemployment less difficult, unemployment insurance decreases the incentive to become employed again quickly.

If the central bank wants to expand aggregate demand, it can ________ the money supply, which would ________ the interest rate.

increase, decrease An increase in the money supply shifts the money-supply curve to the right. Because the money-demand curve has not changed, the interest rate falls to balance money supply and money demand. That is, the interest rate must fall to induce people to hold the additional money the Fed has created, restoring equilibrium in the money market.

According to the quantity theory of money and the Fisher effect, if the central bank increases the rate of money growth,

inflation and the nominal interest rate both increase. According to the principle of monetary neutrality, an increase in the rate of money growth does not affect any real variable. That is, the long-term effect of an increase of the rate of money growth is both a higher inflation rate and a higher nominal interest rate, but no change in the real interest rate. The real interest rate is equal to the nominal interest rate, corrected for inflation (real = nominal + inflation). If inflation rises, the nominal interest will rise by the same amount in the long run, and the two effects will cancel themselves out in the calculation of the real interest rate.

Chloe takes $100 of currency from her wallet and deposits it into her checking account. If the bank adds the entire $100 to reserves, the money supply ________, but if the bank lends out some of the $100, the money supply ________.

is unchanged, increases Depositing money into a bank reduces currency and increases demand deposits by equal amounts. If the bank keeps this entire deposit as part of its reserves, the $100 deposit has no effect on the money supply. However, if the bank lends a portion of this deposit—say, $10—that portion now exists both as a demand deposit and as currency, thereby increasing the money supply.

The Social Security system provides income for people over age 65. If a recipient of Social Security decides to work and earn some income, the amount he receives in Social Security benefits is typically reduced. The provision of Social Security gives people the incentive to save _________ while working. Moreover, the reduction in benefits associated with higher earnings gives people the incentive to ________ past age 65.

less not work The provision of Social Security benefits lowers an individual's incentive to save for retirement because it provides income to retired individuals once they've reached age 65. This means that even if an individual hasn't been saving for retirement while working, he can still count on Social Security benefits to support himself through the retirement years. Moreover, because a person gets fewer after-tax Social Security benefits the greater his earnings are, there is also an incentive not to work (or not work as much) once he has hit the retirement age of 65.

Suppose that a borrower and a lender agree on the nominal interest rate to be paid on a loan. Then inflation turns out to be higher than they both expected. The real interest rate on this loan is _______ than expected. The lender ________ from this unexpectedly high inflation, and the borrower _______ under these circumstances. Inflation during the 1970s was much higher than most people had expected when the decade began. Homeowners who obtained fixed-rate mortgages during the 1960s ________ the unexpected inflation, and the banks that made the mortgage loans were _______.

lower loses, gains benefited from, harmed

Which of the following is an example of an automatic stabilizer? When the economy goes into a recession,

more people become eligible for unemployment insurance benefits. Automatic stabilizers are changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action. For example, when the economy goes into a recession and workers are laid off, more people apply for unemployment insurance benefits, welfare benefits, and other forms of income support. This automatic increase in government spending stimulates aggregate demand at exactly the time when aggregate demand is insufficient to maintain full employment.

Governments may intervene in a market economy in order to:

protect property rights. correct a market failure due to externalities. achieve a more equal distribution of income. One reason we need government is that the invisible hand relies on the enforcement of property rights so individuals can own and control scarce resources. In addition, although the invisible hand can often guide market participants to a desirable market outcome, sometimes government intervention is necessary to correct for market failures. This term refers to a situation in which the market on its own will fail to produce an efficient allocation of resources. One example of a market failure is an externality; this occurs when one person's action inadvertently affects another person's well-being. Finally, the efficient outcome attained by the invisible hand doesn't necessarily result in equality among its participants. Depending on your political philosophy, this disparity in economic well-being may lead you to believe that government intervention is necessary.

The economy begins in long-run equilibrium. Then one day, the president appoints a new chair of the Federal Reserve. This new chair is well known for her view that inflation is not a major problem for an economy. Note: You will not be graded on any changes you make to the graph, but you may use it to help you understand the scenario described. As a result of this news, people will expect the price level to ________, which, in turn, will cause the nominal wage that workers and firms agree to in their new labor contracts to be than it would be otherwise. This ______ the profitability of producing goods and services at any given price level, which would cause the short-run aggregate-supply curve to shift to the ________. If aggregate demand is held constant, this shift in the aggregate-supply curve will cause the price level to ________ and the quantity of output produced to _______.

rise higher decreases left rise falls See graph

Suppose the economy is in a long-run equilibrium, as shown in the following graph. Now suppose that a stock market crash causes aggregate demand to fall. Use your diagram to show what happens to output and the price level in the short run. As a result of this change, the unemployment rate _______. Use the sticky-wage theory of aggregate supply to think about what will happen to output and the price level in the long run (assuming there is no change in policy). On the previous graph, illustrate the change that will occur in the long run.

rises Initially, the aggregate-demand curve (AD1) and short-run aggregate-supply curve (AS1) intersect at the same point on the long-run aggregate-supply curve. A stock market crash leads to a leftward shift of aggregate demand (to AD2). The equilibrium level of output and the price level will fall. Because the quantity of output is less than the natural rate of output, the unemployment rate will rise above the natural rate of unemployment. If nominal wages are unchanged as the price level falls, firms will be forced to cut back on employment and production. Over time, as expectations adjust, the short-run aggregate-supply curve will shift to the right (to AS2), moving the economy back to the natural rate of output.

The company that you manage has invested $5 million in developing a new product, but the development is not quite finished. At a recent meeting, your salespeople report that the introduction of competing products has reduced the expected sales of your new product to $3 million. If it would cost $1 million to finish development and make the product, you ________ go ahead and do so. The most you should pay to complete development is ________ million.

should $3 million Because the $5 million your company invested in a new product has already been spent, it should not be considered in the decision of whether to finish development, according to the principle of thinking at the margin. In this case, the additional cost to finish development is $1 million, whereas the expected additional benefit of the new product is $3 million in profit (assuming that the company receives zero profit if the product remains unfinished). Therefore, your company should go ahead and finish the product. In fact, your company should be willing to pay up to $3 million to finish development, since that is the marginal benefit from doing so.

Consider the economies of Sporon and Gribinez, both of which produce glops of gloop using only tools and workers. Suppose that, during the course of 10 years, the level of physical capital per worker rises by 5 tools per worker in each economy, but the size of each labor force remains the same. Complete the following tables by entering productivity (in terms of output per worker) for each economy in 2016 and 2026. Initially, the number of tools per worker was higher in Sporon than in Gribinez. From 2016 to 2026, capital per worker rises by 5 units in each country. The 5-unit change in capital per worker causes productivity in Sporon to rise by a amount than productivity in Gribinez. This illustrates the concept of ______, which makes it _______ for countries with low output to catch up to those with higher output.

smaller diminishing returns easier

Suppose the government increases its purchases by $1,200 while holding the money supply constant. The change in aggregate demand resulting from an increase in government purchases if the government allows interest rates to adjust (as compared to the change if it were to hold them constant) will be

smaller but still positive. As an increase in government spending increases aggregate demand, the demand for money increases as well. If the money supply is held constant, this leads to higher interest rates. Higher interest rates dampen private investment spending, one of the components of aggregate demand. This is known as the crowding-out effect, the result of which is a smaller, but still positive, increase in aggregate demand after an increase in government purchases.

Adam Smith's phrase "invisible hand" refers to:

the ability of free markets to reach desirable outcomes, despite the self-interest of market participants. In his 1776 book An Inquiry into the Nature and Causes of the Wealth of Nations, economist Adam Smith acknowledged that households and firms act as if they are guided by an "invisible hand" that leads to a desirable market outcome. Although participants in the market act with their own self-interest in mind (for example, households seek to maximize their happiness while firms seek to maximize profits), free markets can reach desirable outcomes without additional intervention under certain assumptions and market conditions.

A change in the expected price level shifts

the short-run aggregate-supply curve. A change in the expected price level shifts the short-run aggregate-supply curve. If people expect lower prices in the future, they will accept lower wages (that is, supply more labor for any given price level) and set lower prices (or produce more output at any given price level). This would be reflected in a rightward shift of the short-run aggregate-supply curve.

When two individuals produce efficiently and then make a mutually beneficial trade based on comparative advantage,

they both obtain consumption outside their production possibilities frontier. By producing efficiently and then making a mutually beneficial trade based on comparative advantage, both individuals obtain consumption outside their production possibilities frontier. This is because trade allows each individual to specialize in doing what he does best, leading to an overall increase in production and consumption for both parties