ECON 3020 Final Review

Which of the following is NOT used in the calculations for the expenditure side of GDP? A. Consumption B. Government Transfer Payments C. Investment D. Imports

B. Government Transfer payments are part of the government budget, but not Government purchases of goods and services. Government Transfer Payments are not a measure of production, as nothing is received in return for the payment. These are included on the income side.

Which of the following would result in an increase in the desired level of capital, K*? A. An increase in the price of capital, PK. B. An increase in the rate of depreciation, d. C. An increase in the expected marginal product of capital, MPKe. D. An increase in the real interest rate, r.

C. The user cost of capital = (r+d)PK. An increase in any of these 3 variables would increase the user cost, and therefore K* would decrease. An increase in MPKe shifts the MPKe curve to the right, and the new intersection would be at a higher K*.

The marginal product of capital (MPK): A. is the demand curve for capital. B. equals the real rental price of capital when firms are maximizing profits. C. increases when the capital stock depreciates. D. All of the above.

D

If you expect to work for an additional 40 years from today, and expect to live for 10 years beyond that, and your income is $100,000 per year, then the life-cycle model predicts that your consumption per year will be: A. $50,000 B. $40,000 C. $100,000 D. $80,000

D. C = 40($100,000)/50 = $80,000.

The intertemporal budget constraint tells us that A. household consumption is based on permanent income and not transitory income. B. the income earned in a lifetime will be evenly divided between consumption and saving. C. consumption smoothing only occurs in years when income is greater than consumption. D. the present value of lifetime consumption equals the present value of lifetime income.

D. C1 + C2/(1+r) = Y1 + Y2/(1+r)

Contractionary fiscal policy would shift the: A. AE curve down in the aggregate expenditure model. B. AD curve left in the aggregate demand-aggregate supply model. C. IS curve left in the IS-MP model. D. All of the above.

D. Contractionary fiscal policy is a decrease in G or TR, or an increase in T. A decrease in TR or an increase in T decrease disposable income, and thus consumption, C. AE = C + I + G + NX as a function of income. G and C would decrease, and AE would shift down. AD = C + I +G +NX as a function of the price level. G and C would decrease, and AD would shift left. IS = C + I + G + NX as a function of the real interest rate. G and C would decrease, and IS would shift left.

True or False. The MP curve will shift UP when: A. The term structure effect, TSE, increases. B. The default risk premium, DP, increases. C. Expected inflation increases. D. All of the above. E. Both A and B are correct.

E. MP = i + TSE + DP - expected inflation. MP will increase if TSE and/or DP increase, but will decrease if expected inflation increases.

True or False. Traditional tools used by the Federal Reserve consist of 1) open market operations, where the Fed purchases or sells mortgage backed securities; 2) changing the discount rate; and 3) paying interest on excess reserves.

False. 1) The Fed was able to purchase mortgage-backed securities after Congress passed TARP in 2008, but open market operations consist of the purchase/sale of Treasury securities. Also, 3) the Fed sets the required reserve ratio to control the money multiplier. While it did start to pay interest on excess reserves after the financial crisis, this was a new tool.

True or False. Changes in total factor productivity (A) are due only to technological advancements.

False. Changes in A can be due to the quality of labor (health, education), government and social institutions, and the financial system, for example.

True or False. Government Purchases are the largest category of expenditures as a percentage of U.S. GDP.

False. Consumption is about 70% of U.S. GDP.

The hours worked per person is the most important factor in determining the level of GDP per capita.

False. GDP per capita = Y/population = Y/L * L/population = y*L/population. There are no limits to labor productivity, y, because A can continue to increase. There are limits to hours per person as there are only 24 hours in a day, and also because there are limits to the number of workers in a population (too young or too old).

True or False. If Tobin's q <1, a firm will increase investment spending.

False. If Tobin's q >1, a firm will increase investment spending.

True or False. If the real interest rate increases, the AE curve will shift up.

False. If the real interest rate increases, then C, I, and NX decrease, so the AE curve shifts DOWN.

True or False. Milton Friedman believed there was a structural relationship between unemployment and inflation, and that fiscal or monetary policy could be used so that a government could decide what level of inflation and unemployment they wanted to target.

False. Milton Friedman argued that if current inflation rates differed from past inflation rates (such as inflation resulting from expansionary monetary policy to reduce unemployment), then households and firms would change their inflation expectations, which could result in higher prices and wages, and thus higher actual inflation.

True or False. Okun's Law shows the mathematical relationship between structural unemployment and the output gap.

False. Okun's law shows the relationship between cyclical unemployment and the output gap.

True or False. The Federal Reserve mainly relies on the Consumer Price Index as a measure of inflation.

False. Since the CPI is a fixed-weight measure, and tends to overstate inflation, the Fed relies on the PCE (Personal Consumption Expenditures) Index, which the the portion of the GDP deflator that covers Consumption goods.

True or False. The Fed is currently targeting both the money supply growth rate and the Federal Funds rate.

False. The Fed cannot simultaneously target both the money supply and the interest rate. The Fed is currently targeting the Federal Funds rate, and changes the money supply to match shifts in money demand to maintain the short-term nominal interest rate target.

True or False. The GDP deflator and the CPI are calculated using the same methods.

False. The GDP deflator is calculated using the chain-weight method, whereas the CPI is calculated using the fixed-weight method.

True or False. The largest economy in the world today also has the highest GDP per capita.

False. The US (using market exchange rates) or China (using PPP exchange rates) have the highest GDP, but when adjusted by population, the US falls to #10 or 11, and China falls quite dramatically. (Using 2014 figures).

True or False. The aggregate expenditure model shows spending as a function of the price level.

False. The aggregate expenditure model shows spending as a function of income.

True or False. The implicit price deflator = Real GDP/Nominal GDP x 100.

False. The implicit price deflator = Nominal GDP/Real GDP x 100.

True or False. The long-run aggregate supply curve is upward-sloping.

False. The long-run supply curve is vertical. Y = AKalphaL(1-alpha) is not affected by the price level.

True or False. The long-run focus in Macroeconomics is on the business cycle.

False. The short-run focus is on the business cycle. The long-run focus is on growth.

True or False. The equation for the Phillips Curve is the following: πt = πet + a(Ut - UN) - st,

False. There is a negative relationship between inflation and cyclical unemployment (Ut - Un), so the slope should be -a.

True or False. Like capital and labor, total factor productivity (A) experiences diminishing marginal returns.

False. Y = AKalphaL(1-alpha). The exponent on A is 1, so there are no diminishing returns.

True or False. The 45° line represents all the points where actual aggregate expenditure equals income.

True

True or False. The Bureau of Economic Analysis (BEA) compiles the data for GDP, and the National Bureau of Economic Research (NBER) uses the data to decide the official dates of peaks and troughs of the U.S. business cycle.

True

True or False. If the economy experiences a negative supply shock, the Federal Reserve can either have inflation higher than expected inflation with the economy at potential GDP, or use contractionary monetary policy to bring inflation down to expected inflation, but with real GDP below potential.

True. A negative supply shock shifts the Phillips curve up, but does not change the IS or MP curves. Inflation is higher than expected inflation, but the output gap is still zero. The Fed can choose to remain there and ignore its mandate for low inflation. Or, the Fed can use contractionary monetary policy to shift the MP curve up. The output gap will become negative at the new equilibrium with the IS curve, and there will be movement down along the Phillips curve so that inflation equals expected inflation. So the Fed has to choose between high inflation or a recession.

True or False. Differences in the share of capital (alpha) cannot explain the difference in labor productivity, and thus the standard of living across countries.

True. Alpha, the share of income earned by capital, does not appear to change much across countries or across time, according to the data.

True or False. A car produced in November, 2015 but sold in January, 2016, would be counted in the GDP of 2015.

True. GDP measures production, not sales. The car is counted as a change in inventory under Investment in November, 2015.

True or False. If total factor productivity is the same across two countries, and capital can flow freely across borders, then labor productivity should converge (become equal).

True. If TFP (A) is the same, there is one production function. Differences in labor productivity, y, then are due to differences in the capital-labor ratio, k. If k is lower in one country, then the return to capital, MPK, will be higher in that country. Capital will flow into the country with lower y and lower k until y, k, and MPK all converge.

If wealth is above a desired level of wealth (precautionary savings), then households will increase consumption.

True. If wealth is higher than the desired level, households do not need to save as much and can consume more.

True or False. If there is an increase in A, then the marginal product of capital (MPK) will increase.

True. MPK = (1-alpha)Y/K. If A increases, then Y increases, so MPK increases. Or intuitively, faster computers can produce more.

True or False. The output gap is the percentage deviation of actual output from potential output.

True. Output gap = (Yt-YP)/YP.

True or False. If a firm wants to decrease its capital stock, it can just let the capital wear out.

True. Over time capital wears out or depreciates, so its value decreases, and thus the value of the capital stock decreases. In the aggregate, firms cannot sell capital to decrease the capital stock because 1) capital in real or physical form is not easily substitutable across industries and 2) it still remains in US capital stock even if it were sold across firms.

If the Fed wants to pursue contractionary monetary policy to fight inflation, it will raise the target interest rate.

True. The equation for the MP curve is r = i + TSE + DP - πe. If the Fed raises the target interest rate, i, then assuming that TSE, DP and πe are all constant, then r will increase and the MP curve will shift up. When r increases, then there is movement along the IS curve as C, I, and NX decrease. As C, I, and NX decrease, the output gap decreases. Then there is movement down along the Phillips curve as the output gap decreases, and inflation decreases.

True or False. The IS curve will shift if there is a change in autonomous spending.

True. There is movement along the IS curve if the real interest rate, r, changes, and a shift in the IS curve if autonomous spending, C, I, G, or NX, change.

True or False. If planned aggregate expenditure is less than production, there will be an unplanned increase in inventories and firms will cut production.

True. When spending is less than production, people are not buying goods, so inventories build up. Firms will then cut back on production.

True or False. Automatic stabilizers smooth the business cycle by making disposable income less volatile than income.

True. YD = Y - T + TR. As the economy enters an expansion, taxes increase and transfer payments decrease, so YD does not increase as much as Y. As the economy enters a recession, taxes decrease and transfer payments increase, so YD does not decrease as much as Y. Thus, disposable income is smoother than income, and thus changes in spending (in particular, consumption spending) do not vary as much.

The 2020 CARES Act passed by Congress in March of 2020 in response to the Coronavirus recession gives a one-time transfer payment of $1200 to individuals who earn less than $75,000. This is considered an example of _________ . When workers who lose their job apply for unemployment benefits, the benefit payments are an example of __________ .

discretionary fiscal policy; automatic stabilizers