GSBA544 - A Firm In A Global Economy

1) Which of the following would be directly counted in GDP in 2020? A) kitchen cabinets purchased from Home Depot in 2020 to be installed in a house built in 1997 B) kitchen cabinets built in 1887, extracted from the 1887 home, and installed in a brand new country-style home C) kitchen cabinets built in 1887, extracted from the 1887 home, and installed in a farmhouse built in 1950 D) none of the above

A) kitchen cabinets purchased from Home Depot in 2020 to be installed in a house built in 1997

What is the difference between economic efficiency and equity?

Economic efficiency is concerned with maximizing the value of output that can be generated by a given resource base while equity deals with the distribution of society's total output among the sectors and individuals of society.

How has the severity and duration of business cycles changed over time in the United States?

- Though it is a controversial subject, it appears that business cycles have become less severe over time. - Recessions have certainly been shorter since World War II than they were before 1929. - There is some disagreement about how severe they were before 1929, with Christina Romer arguing that measurement problems in the old data misled economists about how severe those recessions were. - But others find that the old data is just about right and conclude that the business cycle is much less severe today.

What are some of the reasons used to explain improvements in health, education, democracy, and political stability in many low-income countries?

Reasons include increases in technology and knowledge, such as the development in inexpensive vaccines or the use of mosquito nets, and changes in attitudes, such as placing greater value on education or increasing support for political freedoms.

When a recession occurs, do economists expect it to be a temporary phenomenon? Or is there some degree of permanence? What is the empirical evidence?

Recent research suggests that recessions may contain permanent components. Some economists argue that only the 1973-1975 recession led to a permanent change in the U.S. economy, because it changed the economy's use of oil permanently. Other studies suggest that perhaps 30% of changes in real output are permanent and 70% are temporary for the postwar United States.

On October 30, 2019 the Federal Reserve Board Open Market Committee voted to lower interest rates for the third time that year. Explain how lower interest rates affect the aggregate demand curve.

Reducing the interest rate lowers the cost of borrowing to firms and to households. As a result, both firms and households will increase expenditures. This increase in expenditures will shift the aggregate demand curve to the right.

Because of our high inflation rate, we must reduce the rate of money growth.

Normative

Explain how each of the following events would affect the aggregate demand curve. A decrease in the price level

A decrease in the price level would cause a movement down along the aggregate demand curve.

What impact does a higher price level have on interest rates, wealth, and investment spending?

A higher price level reduces the purchasing power of wealth, increases interest rates, and reduces investment spending.

Define allocative efficiency. Explain the significance of this concept in economics?

- Allocative efficiency is an efficiency criterion that describes a situation where the marginal benefit (or marginal valuation) of the last unit purchased is equal to the marginal cost of producing that unit. - In other words, allocative efficiency occurs when production reflects consumer preferences. This is a significant concept in that all societies face scarcity which necessitates that societies make choices about what goods and services to produce. -To maximize society's wealth, resources must flow to their highest-valued use. This value is determined by consumers.

How do economic growth rates affect a nation's standard of living?

The speed at which an economy grows determines the standard of living of its people. If an economy grows too slowly, then standards of living can decline. If a country is already poor, then slow growth can fail to raise standards of living of its citizens. This can result in people living in poverty, poor health, having poor nutrition, low life expectancy, high infant mortality, and an overall poor quality of life. On the other hand, more rapid rates of growth can improve standards of living. This can lift people out of poverty, raise life expectancy, improve health, eliminate hunger, and improve the general quality of life.

Determine whether each of the following is a positive or normative statement: Higher government budget deficits cause higher interest rates.

Positive

Determine whether each of the following is a positive or normative statement: The trade deficit should decline because of the fall in the value of the dollar.

Positive

Increased average labor productivity in a country should lead to faster growth.

Positive

What are sticky prices, and how can contracts make them "sticky"?

Prices or wages are said to be "sticky" when they do not respond quickly to changes in demand or supply. Contracts are legal agreements between the firm and another party that establishes a particular price to be paid over a period of time. Example: a union contract is a legal agreement between the firm and the union that workers are to be paid a certain wage. If conditions change over the contract period, the firm still must pay the wage agreed upon in the contract. That can make this firm's wages sticky. Firms also buy raw materials on contract. This fixes the price at which the firm buys the raw material over the contract period, so it also becomes a sticky price.

In 2017, Congress passed the Tax Cuts and Jobs Act which lowered income tax rates for most individuals. Explain how lower income taxes affect the aggregate demand curve.

Lowering the income tax increases the amount of disposable income available to households. Higher disposable income increases consumption at every price level. The result is a shift in the aggregate demand curve to the right.

While in office, President Obama discussed raising income taxes for individuals earning over $250,000 in income. Explain how these higher income taxes would affect the aggregate demand curve.

Raising the income tax decreases the amount of disposable income available to those households. Lower disposable income decreases consumption at every price level. The result is a shift in the aggregate demand curve to the left.

What variables cause the short-run aggregate supply curve to shift left?

Increases in the expected future price level Increases in the price of an important natural resource Workers and firms adjusting to having previously underestimated the price level

What are the four categories of aggregate expenditure?

1. consumption spending 2. planned investment spending 3. government purchases 4. net exports

What are the five main determinants of consumption spending? Which of these is the most important?

1. current disposable income (most important) 2. household wealth 3. expected future income 4. price level 5. interest rate

What variables cause the short-run aggregate supply curve to shift right?

Increases in the labor force Increases in capital stock Increases in productivity

What are inventories? What usually happens to inventories at the beginning of a recession, and what usually happens to inventories at the beginning of an expansion?

Inventories are goods that have been produced but not yet sold. Inventories rise at the beginning of a recession and fall at the beginning of an expansion.

How would each of the following events affect the level of employment and the real wage rate? Explain which curves in the labor market diagram would be affected and show your work. (a) The stock market falls sharply. (b) A war destroys a substantial amount of a country's physical capital. (c) A new law reduces immigration of workers into the country.

(a) Lower wealth shifts the labor supply curve to the right; the new equilibrium has higher employment and a lower real wage. (b) The loss of capital lowers the marginal product of labor, reducing labor demand; the shift of the labor demand curve to the left lowers the real wage and employment. (c) Reduced labor supply causes a rise in the real wage rate in equilibrium and a decline in equilibrium employment.

Compare and contrast the classical and Keynesian schools of thought for the following economic issues. (a) The flexibility of wages and prices. (b) The importance of macroeconomic policies.

(a) The flexibility of wages and prices is a principal point of disagreement between classical economists and Keynesians. Classical economists believe that wages and prices are quite flexible; in response to a change in market conditions, wages and prices adjust quickly to their new market-clearing levels. Keynesians believe that wages and prices are rigid or sticky; in response to changes in the economy, wages and prices adjust slowly to their new market-clearing levels. (b) Classicals and Keynesians also disagree about the use of macroeconomic policies. Given wage-price flexibility, classical economists believe that the market economy normally provides for full employment. They believe that government intervention in the form of macroeconomic fiscal and monetary policies is not needed to prevent recessions. Given slow adjustments in wages and prices, Keynesians believe that recessions could plague the economy for several years. They believe that efficient use of macroeconomic policies could return the economy to equilibrium more quickly.

Identify the comovement (i.e., direction and timing) of the following variables over a business cycle: (a) industrial production (b) unemployment (c) nominal interest rates (d) nominal money supply growth (e) investment.

(a) Industrial production: procyclical/coincident variable. (b) Unemployment: countercyclical variable whose timing is unclassified by the Conference Board. (c) Nominal interest rates: procyclical/lagging. (d) Nominal money supply growth: procyclical/leading variable. (e) Investment includes inventory investment and residential investment: procyclical/leading variables; -includes business fixed investment: procyclical/coincident variable.

Medical science cures the common cold, causing fewer work days lost due to illness, thus greatly increasing labor productivity.

Increased productivity increases the demand for labor; in equilibrium the real wage and employment increase.

Explain how each of the following events would affect the aggregate demand curve. Slower income growth in other countries

Slower income growth in other countries would decrease U.S. exports, which would cause the aggregate demand curve to shift to the left.

Discuss the likely impact of each of the following on the unemployment rate: The government passes a law making labor unions illegal.

The unemployment rate will likely decrease, since companies will no longer have to pay above-market union wages and will be able to afford to hire more workers.

Three main factors that cause the short-run aggregate supply curve to shift:

1. Changes in labor costs. 2. Changes in other input costs. 3. Changes in the expected price level.

What are some of the problems with using the leading indicators to forecast recessions? If you were a policymaker, would you rely on them?

1. The data is usually revised, sometimes substantially, so a signal from the leading indicators may be reversed later 2. They sometimes give incorrect signals. 3. They don't provide much information on the severity or exact timing of the coming recession. 4. Finally, structural changes in the economy mean the set of indicators must be revised periodically. Policymakers should use the leading indicators as additional information, but should not rely on them alone.

Ceteris paribus, how does a recession in the United States affect U.S. net exports?

As GDP decreases in the United States due to the recession, the incomes of households fall. Households respond by lowering their purchases of goods and services. Some of the decline in purchases includes domestic goods and services; some of the decline includes foreign produced goods and services. This essentially lowers imports. Assuming that exports do not change, net exports will rise.

How does government support of health and education programs foster economic growth?

As the health of the people in a nation improves, they become more productive. They become stronger and less susceptible to disease. For example, if the government provides vaccinations or access to clean water, people will be healthier and the economy is more likely to grow. By helping to finance education, the government can also improve economic growth. Since the benefits of an education do not accrue exclusively to the person receiving an education, the market may produce an inefficiently low level of education and training. If the government offers subsidies for education, more people will receive an education, and the increase in human capital will increase economic growth (particularly if there are increasing returns to human capital).

30) Which of the following explains why many European countries have unemployment rates that are higher than in the United States? A) Technological change occurs at a faster rate in Europe, so structural unemployment is higher in Europe. B) European countries offer higher unemployment benefits than the United States. C) Firms in European countries offer employees higher wages and higher benefits than do firms in the United States. D) The minimum wage in Europe is lower than it is in the United States.

B) European countries offer higher unemployment benefits than the United States.

Explain what economists mean by full employment and why this rate of unemployment is not zero.

- Full employment occurs in the macro economy when cyclical unemployment is zero. - The full-employment rate of unemployment is then made up of the frictional rate of unemployment and the structural rate of unemployment. - Because it will always take time to find a job, frictional unemployment will never be zero. - Also because demand and technology are constantly changing in an economy, structural unemployment will never be zero. That is, some workers will always lose their jobs as the demands for the products they make fall or disappear entirely.

What is the difference between nominal and real economic variables? Why do economists tend to concentrate on changes in real magnitudes?

- Nominal variables are in units of money, while real variables are in physical quantities of output. -We measure nominal variables using current market prices and real variables using market prices in a given base year. - Nominal variables may increase, but you don't know if the increase is due to higher prices and the same quantity, or a higher quantity with unchanged prices. -Real variables reflect just quantity changes. -For the most part, real variables (consumption, investment, and the capital stock) affect each other in the economy, with lesser roles played by nominal variables (money supply, and price level).

Describe the major features of the business cycle. Be sure to discuss what variables are affected by the cycle, a description of the key features that are apparent in the data, how variables are related to one another, how regular the cycle is, and how predictable the cycle is.

- The business cycle is defined as a fluctuation of aggregate economic activity. - There are recurrent but not periodic movements of aggregate activity, with many variables moving in the same direction at the same time (comovement). - Increases in aggregate economic activity are expansions, while reductions in aggregate economic activity are contractions, or recessions. - Both expansions and contractions exhibit persistence, so once an expansion or contraction begins, it tends to last some time.

The Bureau of Economic Analysis divides it's statistics on GDP into four major categories. List the categories of expenditures and define each.

1. Consumption Spending: The largest category of expenditures is consumption expenditures. These are purchases by households of final goods and services. They can be divided into purchases of services, nondurable goods (goods that last less than 3 years) and durable goods (goods that last for longer than 3 years). Consumption spending does not include purchases of housing. 2. Investment Spending: Spending by firms on new factories, office buildings, machinery and inventories and spending by households on new houses is the second category of spending called investment spending. 3. Government purchases: Government consumption and gross investment make up the third category of spending called government purchases. Government purchases include purchases by state, federal, and local governments. 4. Net export spending: makes up the last category of expenditures. This is exports minus imports. Imports are purchases of foreign goods and services by the domestic economy, and exports are purchases of domestic goods and services by foreigners.

Describe the three types of unemployment.

1. Frictional unemployment is short-term unemployment that arises from the process of matching workers with jobs. 2. Structural unemployment arises from a persistent mismatch between the skills and attributes of workers and the requirements of jobs. 3. Cyclical unemployment is caused by a business cycle recession.

To understand why someone cannot get a job, it helps to know the three types of unemployment. List the three types of unemployment and explain what causes each type. What advice for finding a job would be appropriate for someone in each type of unemployment?

1. Frictional unemployment is the unemployment that arises from the process of matching workers with jobs. These workers are qualified; they just need to search for a job. The advice for finding a job would be to keep searching, because there are jobs available for which they are qualified. 2. Structural unemployment is unemployment arising from a persistent mismatch between the skills and characteristics of workers and the requirements of the jobs. The advice for finding a job would be to retrain so that they can match up with the requirements of current jobs. 3. Cyclical unemployment is unemployment caused by a business cycle recession. The advice for finding a job would be to hang in there and continue searching, but realize that there are less jobs available than the number of applicants. The cyclically unemployed person could perhaps get a temporary job until the economy picks up, or perhaps consider continuing his or her education while the business cycle slowdown lasts.

In 1993, the debate heated up in the United States about the North American Free Trade Agreement (NAFTA), which proposed to reduce barriers to trade (such as taxes on or limits to imports) among Canada, the United States, and Mexico. Some people opposed strongly the agreement, arguing that an influx of foreign goods under NAFTA would disrupt the U.S. economy, harm domestic industries, and throw American workers out of work. How might a classical economist respond to these concerns? Would you expect a Keynesian economist to be more or less sympathetic to these concerns than the classical economist? Why?

A classical economist might argue that the economy would work more efficiently with NAFTA because it reduces trade barriers, making the invisible hand work even better. Workers could specialize even more than before so that total output produced by all three countries would be more. Though the industrial mix might change in each country, wages and prices across industries would adjust quickly, and people in industries that closed down in a particular country would quickly find new jobs. A Keynesian economist might be more sympathetic to concerns about NAFTA because of the belief that adjustment to the changes will not occur quickly. As a result, people in particular industries in a country may become unemployed. Wages won't adjust quickly to restore full employment, so some government action (like retraining programs to give displaced workers new skills) may be desirable.

Explain how each of the following events would affect the aggregate demand curve. A decrease in imports

A decrease in imports would cause net exports to be greater, causing the aggregate demand curve to shift to the right.

Explain how each of the following events would affect the aggregate demand curve. A decrease in net exports

A decrease in net exports would cause the aggregate demand curve to shift to the left.

What is a market economy?

A market economy is an economy in which the decisions of households and firms interacting in markets allocate economic resources.

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

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

What is a supply shock, and why might a supply shock lead to stagflation?

A supply shock is an unexpected event that causes a shift in short-run aggregate supply. An adverse supply shock causes the short-run aggregate supply curve to shift to the left, causing an increase in the price level and a decrease in real GDP. An increase in the price level occurring at the same time as a decrease in real GDP is known as stagflation. A positive supply shock causes the short-run aggregate supply curve to shift to the right, causing a decrease in the price level and an increase in real GDP.

One of the results of Paul Romer's new growth theory is that investment in research and development will be too low in an economy. Explain how he comes to this conclusion.

According to Romer, knowledge capital is a key determinant of economic growth. Firms contribute to an economy's knowledge capital by conducting research and development. But there is a problem. Knowledge capital is nonrival in that if one firm uses it, it does not prevent another firm from using it. Also knowledge capital is nonexcludable because if one firm gets it, all other firms get it too. That is, once the formula for a drug is known, it becomes widely available for other firms to use. If this is the case, when one firm invents a drug, once the formula for the drug is known, other firms cannot be prevented from benefiting from the research and development they did not pay for. These firms have the incentive to free ride. If this is the case, the original firm inventing the formula cannot capture all the benefits of the formula. Some of the marginal benefits will go to other firms. If this is the case, the firm will choose the amount of research and development equal to the amount that will equate the marginal costs and the marginal benefits for the firm. Since the marginal benefits to the firm will be low, then the firm will not invest enough in research and development.

Using aggregate demand and aggregate supply, explain what happens in the short run if the Federal Reserve raises interest rates in the economy. Be sure to detail what happens to aggregate demand, the price level, the level of GDP, and unemployment. Assume that the economy is at full employment before the interest rate increase.

An increase in the interest rate will cause aggregate demand to decline. Interest costs are part of the cost of borrowing and as they rise, both firms and households will cut back on spending. This shifts the aggregate demand curve to the left. This lowers equilibrium GDP below potential GDP. As production falls for many firms, they begin to lay off workers, and unemployment rises. The declining demand also lowers the price level. The economy is in recession.

Suggest two policies the government could pursue to help increase the accumulation of knowledge.

Any two of the following three explanations are correct. First, the government could increase the incentive to engage in research and development by giving firms the exclusive rights to their discoveries for a long period of time. The U.S. government does this by granting patents, or the exclusive right to produce a product, for 20 years to firms that invent new products or processes. This allows the company to capture the profits from selling this product exclusively. Second, the government can encourage research and development by directly subsidizing research and development. This can be done by granting tax benefits to the firm that invests in research and development, providing support for research at a university, or directly carrying out the research itself. Third, the government can subsidize education. This should increase the number of workers with technical training.

China's current rate of GDP growth is quite rapid. Its current growth rate is probably three times that of the United States. However, the levels of pollution are much higher in China. Would you consider China to be better off than the United States given this information? Why or why not?

China is not better off because of higher rates of growth of GDP. - GDP is not a perfect measure of well-being. - GDP is not adjusted for pollution or other negative effects of production. -Certainly the rapid growth of GDP raises the standards of living of many in China. However, this comes at a cost of dirty air and water. -According to the World Health Organization, seven of the ten most polluted cities in the world are in China. This pollution can result in negative health effects. -The improvement in standards of living affect well-being in a positive manner, but the increased pollution has a negative effect on well-being. -In addition, GDP per capita may be a better measure of standard of living rather than growth in GDP.

Explain the meaning of the word "convergence" in the context of economic growth and standards of living

Convergence is a term that describes a prediction of the economic growth model. The prediction states that the profitability of using additional capital or better technology is generally greater in developing countries than in a high-income country. This means that poorer countries ought to grow more rapidly than rich countries and as a result, they should eventually catch up to the richer countries. This phenomenon is also called catch-up.

Describe the process of "creative destruction" using a specific example.

Creative destruction, based on the ideas of Joseph Schumpeter, describes the process whereby older products are driven out of the market by newer products. New products that meet consumer wants in qualitatively better ways will increase the overall standard of living for an economy. Here are some current and historical examples of creative destruction: DVD players replaced video tapes and VHS recorders, calculators replaced slide rules, clocks replaced sundials, cars replaced horses and buggies, disposable diapers replaced cloth diapers, GameBoys and Xboxes replaced Ataris, Internet Explorer replaced NCSA Mosaic, CD players replaced tape players, indoor plumbing replaced outhouses, iPods replaced Walkmans, phones replaced the telegraph, planes replaced trains for travel, digital cameras replaced film cameras, and electricity replaced candlelight and gas lights.

You have been hired as an economic advisor for a developing country. You have been asked to focus on education as a means for the country's development. Explain to the prime minister how improving education and training can contribute to his country's economic growth, and why it is important for the government to take a proactive role in promoting education.

Education raises the level of human capital in an economy. Human capital is the accumulated knowledge and skills that workers acquire from education and training or from their life experiences. Human capital raises a worker's productivity. The increase in productivity increases growth, per capita GDP, and standards of living. Human capital is one of the main sources of technological change. One of the lessons of the economic growth model is that technological change is more important for raising productivity than are increases in capital. It is an important ingredient for rapid economic growth. The government's role in promoting investment in human capital is important, as the market might not provide the optimal amount of investment in human capital. Nobel laureate Robert Lucas argues that there are increasing returns to investments in human capital. These returns are not entirely captured by the individual, so if left to their own devices, individuals may not invest enough in education. Having the government invest in education will provide the country with a higher and more efficient level of education and training.

What is the main conceptual difference between GDP and GNP? How different are GDP and GNP for the United States? For countries with many citizens who work abroad?

GDP represents output produced within a country, while GNP represents output produced by a country's factors of production; the difference is net factor payments from abroad. For the United States there's little difference, but for countries that have many citizens working abroad, there may be a big difference.

Your friend does not understand the benefits of globalization. Outline for your friend the positive economic aspects of globalization.

Globalization is the process of countries becoming more open to foreign trade and investment. The increased investment either by foreign direct investment or foreign portfolio investment can give a low-income country access to funds and technology that it might not otherwise have. These funds can help the country invest in factories, machinery, and the equipment needed for economic growth. The extra capital can raise labor productivity, growth, and GDP per capita. Trade and investment can also provide the country with much needed upgrades in technology. One of the lessons of the economic growth model is that technological change is more important for raising productivity than are increases in capital. It is an important ingredient for rapid economic growth. Technological change is an important contributor to long-term economic growth. The bottom line is that trade and investment can cause standards of living to rise. Indeed, it has been empirically shown that growth and globalization are positively related. With growth in standards of living, the country can break the vicious cycle of poverty. Incomes will grow, the people of the country will be able to save and invest, and this saving and investment will fuel growth from within.

Describe the pattern of growth rates in real GDP per hour worked in the United States since the early nineteenth century. Has output per hour worked consistently increased at the same rate? Explain

Growth in real GDP per hour worked averaged 1.3% throughout the nineteenth century and then increased to over 2% until the mid-1970s, when it fell to 1.5%. Productivity slowed dramatically during the mid-1970s, but the growth in information technology saw average annual growth rates in GDP per hour worked rebound to 2.4% from 1996 - 2005, and then slowed to 1.3% from 2006-2018.

Suppose the United States experiences a long period of high inflation relative to other countries. How will this affect U.S. net exports?

If inflation in the United States is higher than inflation in other countries, then prices of products and services produced in the United States increase more rapidly than the prices of products and services of other countries. This difference in the price levels decreases the demand for U.S. goods relative to foreign goods. U.S. exports decrease, imports increase, and U.S. net exports decline.

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

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

Use a saving-investment diagram to explain what happens to saving, investment, and the real interest rate in each of the following scenarios in a closed economy. Current output rises due to a temporary productivity increase.

The rise in output raises desired saving, shifting the Sd curve to the right; in equilibrium, this reduces the real interest rate, increasing investment as well.

Why do we subtract import spending from total expenditures?

Import spending is defined as spending on goods and services that are produced in foreign countries. When we total up consumption expenditures, investment spending, and government spending, this total includes spending on goods and services, regardless of where they are produced. That is, it includes some import spending. We must then subtract the value of import spending from total expenditures because we would be including spending on goods and services that is not the result of production of newly produced goods and services in the United States. We want total expenditures to reflect expenditures on final goods and services produced in the domestic economy.

Explain how market economies are generally better able to achieve technological progress than are centrally planned economies.

In a centrally planned economy, decisions regarding the allocation of resources are made by government employees paid a salary, not by independent entrepreneurs whose own finances are at stake. Independent entrepreneurs make choices for the use of resources based on the expected profitability of various projects. This drive for profit provides an incentive for technological change that centrally planned economies are unable to duplicate. The result is that technological progress is more likely in market economies than in centrally planned economies.

How would each of the following events affect the level of employment and the real wage rate? (a) A tremendous boom occurs in the stock market, increasing people's wealth by $100 billion overnight.

Increased wealth reduces labor supply; the shift of the labor supply curve to the left brings a new equilibrium with lower employment and a higher real wage.

List two ways the labor force experience is different between workers in Europe and in the United States. How do these differences influence productivity?

It is harder to fire workers in many European countries as compared to the United States. Firms are less likely to want to hire workers in these European countries and younger workers will have a harder time finding a job. Workers stay on the job longer in these European countries, even if the job is not a good match. Put differently, the lower rate of mobility makes it more likely that the European workers' skills and preferences will not match well with job characteristics. This will lower their productivity relative to the U.S. worker, who tends to have a higher rate of job mobility. Workers in the United States tend to experience fewer long spells of unemployment than do European workers. This is in part due to unemployment insurance. Workers in the United States receive unemployment insurance for a shorter time and the payments are less compared to their European counterparts. They are employed for longer periods of time and tend to have higher skills and greater productivity as compared to European workers.

If you were a member of the NBER business-cycle dating committee, would you declare that the U.S. economy is now in a recession? Why? Describe the major variables that you would look at to determine whether the economy is in a recession or not, and what features of the data you would look for.

Many answers are possible. You should discuss GDP and other major macroeconomic variables. You should note that you are looking for co-movement and persistence.

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

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

Determine whether each of the following is a positive or normative statement: The Fed should lower interest rates to increase economic growth, because we're in a recession.

Normative

Government budget deficits are too high in the United States and should be reduced.

Normative

A generous unemployment insurance system is a primary cause of high unemployment in Europe.

Positive

By how much does the CPI overstate true increases in the cost of living, according to the Boskin Commission? What are the main reasons for this bias in the CPI? What are the economic implications of the bias?

The Boskin Commission reported that the CPI overstates inflation by 1 to 2 percentage points per year. The bias arises because of difficulty in measuring quality change (especially for services) and because the CPI doesn't account for the substitution that people make between goods when relative prices change. The bias implies that our measures of real income growth are understated and that Social Security benefits are being adjusted more than they should be to account for inflation.

What features made England in the eighteenth century the place where the Industrial Revolution occurred?

The British Parliament had just gained control over the government from the king; British courts became independent of the king, upheld property rights and protected wealth, and markets in England at the time were "efficient" in that prices for the same products were the same across regions after accounting for transportation costs.

Over the past 100 years, what has happened to the average workweek in the U.S. manufacturing industry? Why has this occurred? What are the implications for the size of the income and substitution effects?

The average workweek in manufacturing has declined from about 56 hours a week a century ago to just over 40 hours a week more recently. The primary reason for the decline in the workweek is the higher real wage. This suggests that the income effect of a permanently higher real wage dominates the substitution effect, as workers choose to have more leisure and to work fewer hours per week.

How would each of the following changes affect the steady-state values of the capital-labor ratio, output per worker, and consumption per worker? A change in social mores lowers the population growth rate.

The decline in n raises the capital-labor ratio, as well as output per worker and consumption per worker.

74) How would the expected real after-tax rate of return be affected by each of the following events? (1) the tax rate on interest income increases (2) expected inflation declines

The expected real after-tax rate of return is ra-t = (1 - t) i - expected inflation rate. (1) Clearly ra-t would decline if the tax rate on interest income increases. (2) From the formula, ra-t would increase if expected inflation declines.

Outline the various actions the government sector could take to promote growth.

The government should secure private property rights. Private property rights are crucial for a smoothly functioning market system. The government should create a court system that will enforce contracts. It should also assist in the development of the country's financial system. Additional endeavors include strengthening the education, communication, and transportation systems.

Is knowledge capital subject to the law of diminishing returns? Explain.

The law of diminishing returns states that successive increases in capital result in successively smaller and smaller increases in output. Knowledge capital may not be subject to the same law of diminishing returns that physical capital is. In fact, knowledge capital may experience increasing returns because knowledge, once discovered, is available to everyone and is therefore more likely to generate new technologies and economic growth.

Explain why the long-run aggregate supply curve is vertical.

The long-run aggregate supply curve is vertical because in the long run, changes in the price level do not affect the number of workers, the capital stock, or technology, which are the factors that determine potential GDP.

How would each of the following events affect the level of employment and the real wage rate? A nuclear mishap contaminates all auto plants in the Detroit area, destroying their capital.

The loss of capital lowers the marginal product of labor, reducing labor demand; the shift of the labor demand curve to the left lowers the real wage and employment.

How would each of the following events affect the level of employment and the real wage rate? A major government loan-guarantee program goes bust, losing $500 billion. To pay off the loss, the government announces that tax rates will rise 30% in the future.

The loss of wealth increases labor supply, leading to higher employment and a lower real wage.

What are the major factors affecting the long-term growth of the economy's output?

The major factors are population growth and average labor productivity.

What is the marginal propensity to consume, and why is it always less than one?

The marginal propensity to consume (MPC) is the amount by which desired consumption rises when current income rises by one unit. The marginal propensity to consume is less than one because a part of any increase in current income is saved.

What is the difference between the nominal interest rate and the real interest rate?

The nominal interest rate is the stated interest rate on a loan, while the real interest rate is the nominal interest rate minus the inflation rate.

What is the q theory of investment? Who developed it? What is q, and what do different values of q imply? How is q related to the stock market value of a firm and its capital stock?

The q theory of investment captures the relationship between stock prices and firms' investment in physical capital. The theory was developed by James Tobin. q = capital's market value/cost. When Tobin's q exceeds one, more investment should take place. When q < 1, there should be no investment. Tobin's q is related to the stock market value of the firm via the formula q = V/(pKK), where V = the stock market value of the firm pK = the price of capital K = the quantity of capital.

What are the economic consequences of reductions in defense spending by the government? What happens to national saving, the interest rate, and investment?

The reduction in defense spending increases national saving, so that the desired saving curve shifts to the right. As a result, the real interest rate declines, and investment increases.

How would each of the following changes affect the steady-state values of the capital-labor ratio, output per worker, and consumption per worker? A change in the composition of the capital stock raises the depreciation rate.

The rise in d reduces the capital-labor ratio, as well as output per worker and consumption per worker.

Use a saving-investment diagram to explain what happens to saving, investment, and the real interest rate in each of the following scenarios in a closed economy. The average educational level rises, inducing an increase in the future marginal productivity of capital.

The rise in future marginal productivity of capital raises desired investment, shifting the Id curve to the right; in equilibrium, this raises the real interest rate, increasing saving as well as investment.

Use a saving-investment diagram to explain what happens to saving, investment, and the real interest rate in each of the following scenarios in a closed economy. The government increases spending temporarily for a one-year project to turn mercury into gold.

The rise in government purchases reduces desired saving, shifting the Sd curve to the left; in equilibrium, this raises the real interest rate, reducing investment as well as saving.

Use a saving-investment diagram to explain what happens to saving, investment, and the real interest rate in each of the following scenarios in a closed economy. The tax code changes so that business firms face higher tax rates on their revenue (offset by other lump-sum tax changes so there's no overall change in tax revenue).

The rise in taxes reduces desired investment, shifting the Id curve to the left; in equilibrium, this reduces the real interest rate, reducing saving as well as investment.

Explain the three reasons the aggregate demand curve slopes downward.

The three reasons are the wealth effect, the interest-rate effect, and the international-trade effect. In the wealth effect, an increase in the price level decreases the real value of household wealth, which decreases consumption. In the interest-rate effect, an increase in the price level raises interest rates, which decreases investment spending and consumption spending, particularly on durable goods. In the international-trade effect, an increase in the price level makes U.S. exports more expensive and foreign imports less expensive, which decreases net exports.

What is the underground economy and how could it hurt an economy? How does it hurt developing economies?

The underground economy is that part of the economy involved in buying and selling of goods and services that are concealed from government to avoid taxes or regulations or because the goods and services are illegal. This sector of the economy can serve as a drag on the economy. Firms that participate in the underground economy face the possibility of the government finding out about their operations and shutting them down because they are acting illegally. They tend to be smaller, and invest less in capital. Since workers in this sector have less capital to work with, they are less productive, and produce fewer goods and services. The firm also incurs costs to avoid discovery by the government by paying bribes and hiring lookouts. These are resources that could be used in other productive activities. Because of these reasons, this sector of the economy is not as productive as it might be if it were legal. Less goods and services are produced. This is not an insignificant problem as the underground sector can be large in developing countries as high tax rates drive many firms to the underground sector to seek ways to avoid taxes.

Discuss the likely impact of each of the following on the unemployment rate: The length of time workers are eligible to receive unemployment insurance payments is cut in half.

The unemployment rate will likely decrease, since decreasing the time people are eligible to receive unemployment benefits will increase the opportunity cost of searching for a job.

Discuss the likely impact of each of the following on the unemployment rate: The government funds an Internet site where companies can post job openings at no charge.

The unemployment rate will likely decrease, since making information on job openings more available lowers the search involved in frictional unemployment.

Discuss the likely impact of each of the following on the unemployment rate: The minimum wage is raised by 50 percent.

The unemployment rate will likely increase since an increase in minimum wage will raise the wage above the market wage for some workers.

The owner of a firm wants some advice on how to increase productivity. Suggest three ways the entrepreneur could increase labor productivity through improving technology.

There are three main ways to improve technology. First, the entrepreneur could install the most up-to-date equipment and machinery. Second the owner could implement an on-the-job training program to improve the skills of his workers. He could even send a few of his workers to college. Finally, the owner could develop better means of organizing and managing the production process.

Define the two categories of saving in the economy.

There are two categories of saving in the economy: - Private saving is what is left of income after consumption expenditures and income taxes. - Public saving is the amount of tax revenue that the government collects minus government expenditures and transfer payments.

Identify two variables that shift the desired investment curve. Is desired investment negatively related or positively related to each of these variables?

Variables that shift the desired investment curve are: 1. real interest rate 2. expected future marginal product of capital 3. effective tax rate. Desired investment is positively related to the future marginal product of capital, but negatively related to the real interest rate and the effective tax rate.

A central concept in macroeconomics is the idea of the natural rate of unemployment. Why does it make sense to define full employment to occur when the unemployment rate equals the natural rate of unemployment, instead of when the unemployment rate equals zero? Elaborate and explain carefully.

With a growing, dynamic economy where businesses expand and contract, technological change regularly occurs, and people enter and leave the labor market on a continual basis, zero percent unemployment is not possible nor desirable. Frictional unemployment and structural unemployment are normal parts of a healthy, growing economy. With frictional unemployment, people and firms have to search for one another and that takes time. With structural unemployment, technology changes and international competition cause people to have to retrain to match up with the evolving job requirements. Economists, consequently, consider full employment to occur when the only unemployment is frictional unemployment and structural unemployment.

How do government policies that enforce property rights affect economic growth?

Without enforceable property rights, entrepreneurs lose the incentive to take on risk because they are not assured ownership of their resources. Economic growth suffers as a result. Failure to protect intellectual property rights has a similar impact. If the benefits of technological advances are shared with all firms, each individual firm has little incentive to invest in the costly research and development necessary for technological progress to continue.

What are some reasons why the unemployment rate is typically lower in the United States as compared to Canada and some Western European countries?

Workers in Western Europe and Canada are eligible for unemployment insurance benefits for about twice as long as in the United States. In addition, some of the social insurance programs in these countries are more generous as compared to the United States. This makes the opportunity cost of job search lower in Canada and Western Europe, so unemployed workers in those regions will search longer for jobs. This increase in the duration of unemployment raises the unemployment rate in these countries, relative to the United States.

Explain how each of the following events would affect the long-run aggregate supply curve. a. A lower price level b. A decrease in the labor force c. A decrease in the quantity of capital goods d. Technological change

a. A lower price level would cause a movement along the long-run aggregate supply curve. b. A decrease in the labor force would cause the long-run aggregate supply curve to shift to the left. c. A decrease in the quantity of capital goods would cause the long-run aggregate supply curve to shift to the left. d. Technological change would cause the long-run aggregate supply curve to shift to the right.

Explain how each of the following events would affect the short-run aggregate supply curve. a. A decrease in the price level b. A decrease in what the price level is expected to be in the future c. A price level that is currently lower than expected d. An unexpected decrease in the price of an important raw material e. A decrease in the labor force

a. A lower price level would cause a movement down along the short-run aggregate supply curve. b. A decrease in what the price level is expected to be in the future would cause the short-run aggregate supply curve to shift to the right. c. A price level currently lower than expected would lead firms to decrease prices, causing the short-run aggregate supply curve to shift to the right. d. An unexpected decrease in the price of an important raw material would cause the short-run aggregate supply curve to shift to the right. e. A decrease in the labor force would cause the short-run aggregate supply curve to shift to the left

Explain how each of the following events would affect the aggregate demand curve. Lower interest rates

a. Lower interest rates would increase investment spending and consumer spending, particularly on durable goods, which would cause the aggregate demand curve to shift to the right.