Chapter 4
Real GDP grew by 4.6% last year, while nominal GDP grew by 8.2%. Calculate inflation for the period. a. 0.56% b. 1.78% c. 3.60% d. 3.77%
c)Real GDP is the amount of output adjusted for the effects of inflation because it eliminates the impact of changes in the prices of goods and services on the amount of output produced during the year. Real GDP = Nominal GDP - Inflation; therefore Inflation = Nominal GDP - Real GDP.
What are some of the key differences between a positive and a negative output gap?
With a positive output gap, the economy is operating above capacity, meaning the economy is trying to produce more than it can with existing resources. Scarce labour fuels wage increases; other strains on productive resources place upward pressure on inflation. A negative output gap occurs when actual output is below potential output. In this case, there is spare capacity in the economy, meaning the economy can produce more output because its resources are not being used to their full capacity. Inflation will fall or remain steady.
Which of the following factors has the strongest impact on the current account balance? a) Interest rates b) Exchange rates c) Taxation of investment income d) Political stability
b) Although all of these factors will influence the amount of trade that occurs, the level of the exchange rate exerts the strongest influence, particularly for a country as dependent on trade as Canada. When the value of the Canadian dollar falls relative to one of its larger trading partners, the United States for example, exports to the United States rise while imports fall.
How do you identify if a recession is occurring?
An investor could use economic indicators to assess current business conditions for signs of a recession: 1. For example, start with the leading indicators. What is the trend in housing starts, new orders for durable goods, and how has the S&P/TSX performed over the last quarter? What you are looking for is a sustained declining trend in the leading indicators.2. What are the coincident indicators telling you? How did the most recent quarterly GDP report compare with the previous report? Are retail sales showing weakness?3. Finally, lagging indicators are useful to confirm that a business cycle pattern is occurring. A rising unemployment rate generally indicates that business conditions are worsening and that firms anticipate a downturn in the economy.
If the economy is indeed experiencing a period of inflation, what are some of the costs associated with rising prices?
High inflation negatively affects the economy because it: Erodes the standard of living of those on a fixed income or those who lack wage bargaining power, Reduces the real value of investments such as fixed-rate loans because the loans are paid back in dollars that buy less, Generally causes higher interest rates and potentially slower growth, Distorts the signal prices send to participants in market economies, where prices are critical for balancing supply with demand; rising prices draw resources into areas of scarcity, and falling prices move funds away from glutted areas.
How do higher interest rates affect the economy?
Higher interest rates have a negative effect on the economy. Businesses are faced with a higher cost of capital (i.e., borrowing costs rise). An investment should earn a greater return than the cost of the funds used to make the investment. Higher interest rates reduce the possibility of profitable investments, which in turn reduces business investment in the economy. By increasing the cost of borrowing, higher interest rates discourage consumers from spending, especially to buy houses and major durable goods like cars and furniture on credit. Higher borrowing costs encourage consumers to save more money. By increasing the portion of household income needed to service debt, such as mortgage payments, higher interest rates reduce the income available to spend on other items. This effect may offset income earned by savers. Less consumer spending and business investing slows the prospects for future growth, so higher interest rates have a negative effect on growth prospects. The effect of lower
What is the difference between inflation and disinflation?
Inflation is the overall increase in the cost of goods and services. Disinflation is a decline in the rate at which those prices rise, or a decrease in the rate of inflation—prices are still rising, but at a slower rate. Just as there are costs associated with rising inflation, a falling rate of inflation can have a negative impact on the economy.
Based on what you have learned so far about exchange rates, what factors do you think have contributed to Canada's current strong exchange rate relative to the US dollar?
There are a number of factors that have contributed to Canada's increasing exchange rate with the United States: Low and stable inflation, Current account surpluses, Prolonged economic expansion, Increasing demand for our resources, and Political stability. All of these factors contribute to a strong currency.
Which of the following questions does microeconomics answer? a) How do minimum wage laws affect the supply of labour? b) Why did total output shrink last quarter? c) Why has the number of jobs fallen in the past year? d) Will a decrease in interest rates stimulate economic growth?
a The question that microeconomics would answer is "How do minimum wage laws affect the supply of labour?" Microeconomics analyzes the market behaviour of individual consumers and firms, how prices are determined, and how prices determine the production, distribution, and use of goods and services. For example, consumers decide how much of various goods to purchase, workers decide what jobs to take, and firms decide how many workers to hire and how much output to produce.
Which of the following are considered to be leading indicators of the business cycle? a. Housing starts b. Unemployment rate c. Average hours worked per week d. Inflation rate a) a and c only b) b and d only c) a, b and d d) a, b, c, and d
a) Housing starts are one of the strongest leading indicators of business activity that Statistics Canada tracks. When housing starts rise, consumers will generally increase spending on durable goods such as washing machines and furniture. This spending has a strong positive impact on the economy.
Which of the following statements about lagging indicators is true? a) Lagging indicators may confirm that a change in the business cycle is occurring b) Lagging indicators change at the same time and in same direction as the overall economy c) Personal income is an example of a lagging indicator d) Average work week is an example of a lagging indicator
a) Lagging indicators are useful because they can confirm that a change in the business cycle is occurring. For example, a rising inflation rate typically leads to higher interest rates, and higher interest rates generally have a negative effect on the economy. So, if the inflation rate is increasing, investors should take this into consideration and plan for the possibility of slower growth.
If Canada's inflation rate is consistently lower than that in the U.S. what impact will this likely have on the value of the Canadian dollar relative to the U.S. dollar? a. Increase. b. Decrease. c. Increase, but only if nominal interest rates fall by the inflation differential. d. Inflation differentials do not impact exchange rate values
a) Predicting the direction of exchange rates consumes the attention of many economists and analysts. Over time, the currencies of countries with consistently lower inflation rise, reflecting their increased purchasing power relative to other currencies. If the inflation rate in Canada is consistently lower than the U.S. rate, the value of the Canadian dollar would most likely rise against the U.S. dollar.
If production capacity is growing, corporate profits are increasing, and job creation is steady; in which phase of the business cycle is the economy likely operating? a. Expansion. b. Recovery. c. Peak. d. Trough.
a) The economy is likely in the expansion phase of the business cycle. These are all signals of normal growth where the economy is steadily expanding.
What is the largest component of the current account? a) Trade b) Investment income c) Services d) Transfers
a) The largest component of the current account is trade. Trade includes merchandise and non-merchandise imports and exports. Activity in this account is by far the largest component of the current account.
What happens when the economy moves into the peak phase of the business cycle? a) Demand outstrips supply b)Bond prices rally c) Business investment increases d) Wage increases decline
a) The peak represents the final stage of the expansion. At this point in the business cycle, demand begins to outstrip the economy's ability to supply goods and services. There are labour and product shortages, which lead to higher wage demands. Interest rates rise, leading to lower bond prices, and businesses generally begin to reduce their capital investment in the economy.
Workers at the Sealy Foam Company were laid off last month because demand for mattresses and other furniture continues to fall. What type of unemployment does this represent? a) Cyclical b) Frictional c) Structural d) Natural
a) The workers at the Sealy Foam Company are experiencing cyclical unemployment because of declining demand for mattresses and other furniture. Cyclical unemployment is tied to changes in business conditions. When the economy is expanding, more people enter the labour force, companies hire more workers, and the unemployment rate typically falls. When the economy peaks and then moves into recession, business conditions decline and consumer demand for a product slows or declines so the unemployment rate rises.
Nigel has recently completed a certificate in financial accounting and has decided to leave his current employer. He will spend the next two months looking for a job that better suits his new skills. What type of unemployment would Nigel's situation be classified as? a. Cyclical. b. Frictional. c. Structural. d. Nominal.
b) Nigel's look for new work would be considered part of frictional unemployment, which is the result of normal labour turnover from people entering and leaving the work force and from the ongoing creation and destruction of jobs. Even in the best of economic times, people are looking for work because they have finished school, quit, been laid off or been fired from their most recent job. This is a normal part of a healthy economy.
What type of indicator is the S&P/TSX Composite Index considered? a. Leading. b. Lagging. c. Coincident. d. Contrarian.
a)The progress of the business cycle can be tracked by observing certain economic indicators. Leading indicators tend to peak and trough before the overall economy. They are the most useful and widely used of the business cycle indicators since they anticipate change by indicating what businesses and consumers have actually begun to produce and spend. Among the most important leading data series are housing starts (which precede construction) and manufacturers' new orders, especially for durables (which indicate expectations of higher levels of consumer purchases of such items as automobiles and appliances). Others include changes in profits (which when rising generate confidence and optimism and when falling suggest the need for caution), spot commodity prices (which reflect rising or falling demand for raw materials), average hours worked per week (which result from changes in the level of output and anticipate changes in employment), stock prices (which suggest changing levels of profits) and money flows (which indicate available liquidity).
Which one of the following conditions exists during a recession? a) Inflation continues to rise b) Inventory levels rise c) Employment levels expand d) Production levels increase
b) During a recession inventory levels typically rise. When the economy is in recession, economic growth is slowing or has turned negative, which implies that the economy is shrinking. At this stage of the business cycle, employment levels are falling and the unemployment rate is generally higher than during periods of expansion. Firms are typically faced with unwanted or rising inventories as a result of lower demand for their products and services.
There are three main groups that interact in the economy: Consumers Firms Governments Which one sets out to maximize profits in the economy? a) Consumers b) Firms c) Governments d) Firms and governments
b) Firms sell their goods or services to consumers, governments, or other firms and their primary goal is to maximize profits. Consumers buy goods and services to maximize their satisfaction or well-being within the limitations of their available resources (income from employment, investments, or other sources). Governments spend money on, for example, education, healthcare, employment training, and the military. They also oversee regulatory agencies and take part in public works projects, including highways, hydro-electric plants, and airports.
Which of the following factors generally contributes to growth in GDP? a) A falling unemployment rate b) An increase in capital stock c) An increase in interest rates d) A decrease in government spending
b) Growth in GDP results from a variety of factors. Among the more important are: Increases in the capital stock. As more workers are provided with additional equipment and as their skills improve with better training and education, individual productivity rises. Increases in population over time. Even if the output of every worker remained constant, GDP would rise as a result of the growing workforce. Improvements in technology. Technological innovation helps firms and workers recombine existing resources of land, capital, and labour in new and increasingly productive ways. Generally, innovation has involved the substitution of capital (i.e., improved machinery) for labour in the production of goods and services. A recent example is the continuing replacement of bank tellers with ATMs.
If productivity grew by 10% due to an increasing population, while unit costs of production grew by 6%, what impact would this have on GDP growth? a. GDP would increase as productivity is higher than the increase in unit costs. b. GDP would shrink as the growth of unit costs did not keep up with the growth in productivity. c. GDP would shrink by the amount that unit costs grew times the percent of increased population. d. GDP would grow by 10% as unit costs are not relevant to the growth of the economy.
b) If productivity growth exceeds increases in the unit costs of production, firms are able to lower the prices of the goods and services they sell. Gains in individual prosperity are ultimately related to increases in productivity.
If the Bank of Canada raised short-term nominal interest rates, what would be the impact on the exchange rate? a)The value of the Canadian dollar would fall. b)The value of the Canadian dollar would rise. c)The value of the Canadian dollar is not affected by short-term interest rates. d) Because the Canadian dollar is not fixed, its value cannot be determined.
b) If the Bank of Canada raises short-term rates, the value of the Canadian dollar would rise. Higher short-term interest rates make investing in Canadian dollar-denominated assets more attractive to foreign investors. This leads to an increase in the demand for Canadian dollars and an appreciation of the Canadian dollar However, for this policy to be effective, the inflation rate in Canada must be low and stable.
The Bank of Canada has just announced that M2 and M2+ have increased over the last three months. What does that indicate about the state of the economy? a. Production is growing, which will benefit the economy. b. Inflation is beginning to increase, which could harm the economy. c. Interest rates are about to rise, which will help the economy. d. Consumer spending is increasing, which will benefit the economy.
b) M1 gives information on the future level of production in the economy, while the broader aggregates, M2 and M2+, provide a useful leading indicator of the rate of inflation. By monitoring these aggregates, the Bank strives to keep the rate of money growth consistent with low inflation and long-term growth.
Statistics Canada reports that the unemployment rate rose by 0.1 percentage points last month to 6.4%. Which of the following would contribute to the rise in the unemployment rate? a)The number of people employed rose last month b) More people entered the labour force last month c) The number of people in the labour force fell last month d) The participation rate rose last month
b) More people entering the labour force may have contributed to a rise in unemployment. The unemployment rate represents the share of the labour force that is unemployed and actively looking for work. The unemployment rate may rise either because the number of employed fell or the number of people entering the workforce looking for work rose, or both. When more people enter the labour force they are counted as unemployed if they do not have a job but are actively looking for work.
Which of the following is not a component of the capital account? a) Foreign portfolio investments in Canada b) Net transfer payments c) Net Canadian claims d) Canadian direct investment abroad
b) Only net transfer payments are excluded from the capital account. The other accounts are all part of the capital account.
Stacy left her job as a retail salesperson at The Bay last month because she wants to find work related to her degree in advertising. What type of unemployment is this an example of? a) Cyclical b) Frictional c) Structural d) Natural
b) This is an example of frictional unemployment. Frictional unemployment is the result of normal labour turnover; in other words, from people entering and leaving the workforce and from the ongoing creation and destruction of jobs. This type of unemployment is a healthy and permanent phenomenon in a growing economy.
What is true about the unemployment rate? a) It is a leading indicator. b) It has an inverse relationship with phases of the business cycle. c) It has generally dropped over the past 40 years. d) It is skilled workers that are most at risk in economic downturns.
b) Unemployment rate has an inverse relationship with the phases of the business cycle. As the economy grows, more workers are needed, thus decreasing the unemployment rate. Conversely, when the economy worsens, more workers are laid off, resulting in a higher unemployment rate.
f the value of the Canadian dollar increases compared with the US dollar, what would this mean to a lumber mill that sells 75% of its goods to US buyers? a) Sales to the United States would rise. b) Sales to the United States would fall. c) Company revenue would rise. d) Company revenue would remain unchanged.
b) When the Canadian dollar rises in value against the US dollar, our exports become more expensive in the US market. In this case, the lumber would become less competitive and thus sales to the United States would fall.
In order for a country to achieve economic growth, what factor is required in addition to capital accumulation? a. High savings levels. b. Technological progress. c. Lower levels of current consumption. d. High interest rates.
b) current research on the determinants of economic growth (which are reflected in higher investment values) suggests the following conclusions: Capital accumulation alone cannot sustain growth. Eventually, increased capital leads to smaller and smaller gains in output. So a higher savings rate is not responsible for a sustained higher growth rate over long periods of time. Nonetheless, a higher savings rate can ultimately support a higher level of output per individual. Sustained growth requires technological progress which is associated with a complex pattern of basic research, applied research and product development situated in a supportive entrepreneurial context.
Which of the following sets of economic signals indicate that the economy is at the peak of the business cycle? a. Capacity utilization is low and the unemployment rate is high. b. Inflation is stable, corporate profits are increasing and unemployment is decreasing. c. Inflation is increasing, interest rates are increasing and business investment declines. d. Inventories are increasing, profits decline and employment decreases.
c) At the peak of the business cycle, demand exceeds the capacity of the economy. There are pressures on prices, wages and interest rates. These pressures begin to dampen demand for investments, housing and consumer goods.The role of inflation expectations is particularly important in determining the level of nominal interest rates. The nominal interest rate is one where the effects of inflation have not been removed. Other things equal, the higher the rate of inflation, the higher nominal interest rates will be. In contrast, the real interest rate is the nominal interest rate minus the expected inflation rate over the term of the loan.
Under what circumstances will Canada run a current account deficit? a) Merchandise exports are higher than non-merchandise exports. b) Net Canadian claims are higher than the net capital account. c) Total imports are higher than total exports. d) Investment income is higher than transfer payments.
c) Canada will run a current account deficit when total imports are higher than total exports. The current account is made up of merchandise and non-merchandise imports and exports, net investment income, and net transfer payments. Exports and imports are the largest component of the current account. When imports are higher than exports, Canadians are buying more goods from foreign markets than they are selling in a foreign market which leads to a current account deficit.
Which of the following is considered to be a coincident indicator? a) Real money supply b) Unemployment rate c) Gross domestic product d) Average work week
c) Gross domestic product (GDP) is an example of a coincident indicator. Coincident indicators tend to change at approximately the same time and in the same direction as the overall economy. These indicators provide useful information about the current state of the economy.
Nigel worked as a graphic design artist at a small film company in Toronto. The company recently upgraded the computer software it uses for animation and Nigel was laid off because his computer skills were no longer relevant for the work required. What type of unemployment is this an example of? a) Cyclical b) Frictional c) Structural d) Natural
c) Nigel's situation is an example of structural unemployment because he lacks the necessary skills to perform the work required. Structural unemployment occurs when workers are unable to find work or fill available jobs because they lack the necessary skills, do not live where jobs are available, or decide not to work at the wage rate offered by the market.
After reading the latest Bank of Canada report you believe the Bank is uncomfortable with the recent increases in the value of the Canadian dollar relative to its main trading partners. In this situation what policy action is the Bank of Canada most likely to take? a) Reduce the supply of Canadian dollars in the open market. b) Buy Canadian dollars on the open market c) Lower short-term interest rates. d) Raise short-term interest rates.
c) The Bank of Canada will most likely lower short-term interest rates. The central bank may intervene in the foreign exchange market if it thinks movements in the exchange rate are excessive or disorderly. If the bank believes the value of the dollar is rising too quickly, it can lower interest rates in the market. If Canadian interest rates fall relative to US rates, investors transfer out of Canadian investments and into US dollar-denominated investments. This has the effect of increasing the supply of Canadian dollars and leads to depreciation in the currency.
Which of the following are used to measure GDP using the expenditure approach? a) Personal consumption and business investment b) Government spending, taxation, and the value of traded goods c) Personal consumption, business investment, government spending, and net exports d) Business investment, government spending, transfers to provincial governments, and taxation revenue
c) The expenditure approach measures GDP as the sum of personal consumption, business investment, government spending, and net exports. Net Exports is simply the difference between what the country exports and what it imports during a given period.
Given the following information in the table, select the equilibrium price for this product. Market for PVRs Price Quantity Demanded (units) Quantity Supplied (units) $400 6000 1000 $450 5000 2500 $500 4500 3000 $550 4000 4000 $600 3500 4500 $650 2000 5000 $700 1000 6000 a. $400 b. $500 c. $550 d. $700
c) The one price that ensures a balance between the quantity demanded and the quantity supplied is $550. This intersection yields an equilibrium demand of 4,000 and an equilibrium supply of 4,000 units.
If inflation is expected to rise over the next year, what is the likely impact on short-term interest rates? a. Real interest rates will fall. b. Real interest rates will rise. c. Nominal interest rates will rise to reflect expansionary pressures in the economy. d. Nominal interest rates will fall because demand conditions will likely worsen.
c) The role of inflation expectations is particularly important in determining the level of nominal interest rates. The nominal interest rate is one where the effects of inflation have not been removed. Other things equal, the higher the rate of inflation, the higher nominal interest rates will be. In contrast, the real interest rate is the nominal interest rate minus the expected inflation rate over the term of the loan.
What does a negative output gap imply? a. The economy is operating at excess capacity. b. The economy is trying to produce more than it can with existing resources. c. Actual output is trending above potential output. d. Inflation will likely begin to rise.
c)A negative output gap occurs when actual output is below potential output. In this case, economists would say there is spare or excess capacity in the economy the economy can produce more output because its resources are not being used to their full capacity. Unemployed workers and unused plant and equipment resources can be called into service without impacting wages or prices. Thus, inflation will fall or remain steady.
A newspaper headline reports the following: "The bond market rallied for the third trading session in a row this week fuelled by lower interest rates." Based solely on this information, the economy is likely in what phase of the business cycle? a) Expansion b) Peak c) Contraction d) Trough
d) Based on the information provided, the economy is likely in a trough. By the time the economy moves into the trough phase of the business cycle, both inflation and interest rates have fallen. These lower rates help to trigger activity in the bond markets and it begins to rally, meaning that there is increased trading activity.
Under what circumstances can Canada become a creditor nation? a) When foreign direct investment grows in comparison to Canadian direct investment. b) When it records consecutive current account deficits. c) When the capital account is consistently negative. d) When it records successive current account surpluses.
d) Canada could become a creditor nation if it recorded successive current account surpluses. Current account surpluses occur when a nation continually exports more goods and services than it imports, which implies that it is selling more to foreign markets than it is buying abroad. This is generally good for a nation because stronger export markets have a strong positive effect on a nation's standard of living.
Higher interest rates affect the economy in all of the following ways, except: 1. They raise the cost of capital, reducing business investment. 2. They increase the portion of household income needed to service debt. 3. They increase the cost of borrowing, discouraging borrowers from spending. 4. They increase the possibility of profitable business investments.
d) Higher interest rates affect the economy in the following ways: * They raise the cost of capital for business investments. Since an investment should earn a greater return than the cost of the funds borrowed to make the investment, higher interest rates reduce the number of profitable investments and thus reduce business investment. * By increasing the cost of borrowing and the return from saving, higher interest rates discourage consumers from spending, especially to buy houses and major durable goods like cars and furniture on credit, and encourage them to save more. * By increasing the portion of household income needed to service debt, such as mortgage payments, they reduce the income available to be spent on other items. This effect may be offset by the higher interest income earned by savers.
Which of the following is an example of microeconomics? a. GDP rose by 3.2% last quarter. b. Employment growth in the housing industry was stronger than expected last year. c. The Bank of Canada expects to raise short-term interest rates gradually over the coming year. d. ABC Inc. believes that by cutting prices on product X sales revenue will increase by 10% this year.
d) Microeconomics analyzes the market behaviour of individual consumers and firms, how prices are determined, and how prices determine the production, distribution, and use of goods and services. For example, consumers are motivated by the price of a good or service. According to the law of demand, as the price of a good falls the demand for that good will likely rise.
How does real GDP differ from nominal GDP? a)Real GDP is a measure of growth expressed in current dollars. b)Real GDP adjusts output by removing the exchange rate impacts of net exports. c)Real GDP is the actual output that occurred in a given year while nominal GDP is a best estimate of forecast growth. d) Real GDP removes the impact of inflation from the measure of growth.
d) Real GDP removes the impact of inflation from the measure of growth. Real or constant-dollar GDP is the dollar value of all goods and services produced in a given year valued at prices that prevailed in some base year. Nominal GDP is the dollar value of all goods and services produced in a given year at prices that prevailed in that same year.
Which of the following is an example of the focus of macroeconomics? a) The reasons why consumers buy certain goods and services. b) How the tax on imports from the United States will affect the trade balance. c) The average salary of CEOs. d) The annual inflation rate.
d) The annual inflation rate is an example of the focus of macroeconomics. Whereas microeconomics looks at how individuals are affected by changes in prices or income levels, macroeconomics focuses on issues such as unemployment rates, inflation, recessions, and government policy.
How does the current account differ from the capital account? a) It records financial flows with the rest of the world. b) It records foreign direct investment in Canada. c) It records portfolio investments abroad. d) It records investment income flows with foreigners.
d) The current account records investment income flows from foreigners. Although trade is by far the largest component of the current account, investment income is also a factor. The current account records the interest Canadians pay on debt borrowed from foreign sources and the dividends paid to owners or investors in Canadian companies. The account also records the interest and dividends that flow from foreign sources to Canadians.
What does the participation rate represent? a) The number of people who are employed in a full-time job b) The percentage of the population aged 19 to 65 that is in the labour force c) The share of population that is employed either in part-time or full-time work d) The share of the working-age population that is in the labour force
d) The participation rate represents the share of the working-age population that is in the labour force. Statistics Canada defines the working-age population as those aged 15 years and older and the labour force as the working-age population who are either employed or unemployed.
If the actual unemployment rate is below the natural unemployment rate, what impact will this have on the economy? a. The shortage of workers could lead to slower productivity growth. b. The excess of workers could lead to higher unemployment, causing a recession. c. The excess of workers could lead to excess layoffs, higher corporate profits and higher GDP. d. The shortage of workers could lead to higher wages and an increase in inflation.
d) When the actual unemployment rate is below the natural rate, a shortage of workers contributes to an increase in wage gains and higher inflation.