Econ002 Hw 4 Study Guide

What is a tariff?

A tax on imports

What is AD?

Aggregate demand

What is the net benefit?

Benefit-cost

What effect of recession of 2007-2009?

Caused the AD curve to shift left

What shifts the AD curve?

Changes in C, I, G, or NX

What shifts the LRAS curve?

Changes in labor hours, labor productivity

What shifts the SRAS curve?

Changes in labor hours, labor productivity or input prices

What is absolute advantage?

Characteristic of one person (or country) being able to produce more than other persons (or countries)

What is comparative advantage?

Characteristic of one person (or country) being able to produce something at a lower opportunity cost relative to other persons (or countries)

What is consumer surplus? Producer surplus?

Consumer surplus: net benefit to consumers of a market Producer surplus: net benefit to producers of a market

What is the definition of international trade?

Exchange of goods and services between countries

What is government revenue? Total surplus?

Government revenue: revenue earned from a tax (e.g., tariff) Total surplus: net benefit to society of a market

If exports, what happens due to trade? •How does world price compare with domestic equilibrium price?•Who gains from trade? Who loses?

If exports... •World price greater than domestic equilibrium price •Domestic producers gain as prices higher from trade •Consumers lose out as prices higher •Overall...Total surplus higher with trade

If imports, what happens due to trade? •How does world price compare with domestic equilibrium price? •Who gains from trade? Who loses?

If imports... •World price is less than the domestic equilibrium price •Consumers gain as prices cheaper •Domestic producers lose out as prices cheaper •Overall...Total surplus higher with trade

Is a tariff preferred or trade with no barriers?

In terms of total surplus, higher with no trade barriers, so no trade barriers preferred

What is LRAS?

Long run aggregate supply

How can we characterize international trade?

Prevalent, Beneficial, Controversial

What is SRAS?

Short run aggregate supply

Why is the SRAS curve upward sloping?

Sticky wage theory

What was effect of the fiscal stimulus?

Stimulus caused the AD curve to shift right

What happens due to a tariff?

Tariff causes domestic price to rise above the world price

Which surplus is most important?

Total surplus

When should countries trade? Why?

Two countries should trade when each country has a comparative advantage for some good or service relative to the other country

Why is the AD curve downward sloping?

Wealth effect

a) What are the arguments for restricting trade? b) What are the counterarguments for each?

a) 1st: Infant Industry Argument 2nd: Increases Jobs 3rd: Reduces Inequality 4th: Promotes Trade 5th: Major Supplies can be Disrupted b) 1st: Hard to know which industries will succeed; Hard to remove trade protections once applied 2nd: Trade can actually create more jobs 3rd: Most jobs lost due to technology; Better to redistribute trade gains 4th: Can backfire 5th: Concentrating all production domestically also risky

Suppose there is a massive drop in investment. According to the lecture slides, which of the following would be a likely result? a) A period of high unemployment b) A period of high inflation c) A period of high inflation and high unemployment d) A period of high inflation and high unemployment with a high trade deficit e) Investment never drops but keeps increasing

a) A period of high unemployment Like consumption, a change in investment will cause the AD curve to shift. Because investment falls, the amount of AD falls at a given price level. So, the AD curve shifts left (as shown in the graph for questions 4 and 7). As a result, the output falls below the long run equilibrium level, and the economy enters a recession. So, the result is...a period of high unemployment.

Again, consider the numbers from question 7. Suppose a tariff is then applied of $5. What is the change in total surplus from the tariff? a) Decrease of $2,500 b) Decrease of $10,000 c) Decrease of $20,000 d) Decrease of $32,500 e) Not enough information

a) Decrease of $2,500 If there is a tariff, the domestic market price is the sum of the world price and tariff. So, the domestic price is $5 + $5 = $10. Since the world price is $5 and the tariff is $5, the domestic price becomes $10 due to the tariff. As a result, we can draw the following graph which includes the quantity domestically demanded with and without the tariff and the quantity domestically supplied with and without the tariff. To find the total surplus, we must again find the consumer surplus, producer surplus and any tax revenue. As mentioned above (twice), the consumer surplus is the area below the demand curve and above the market price. As a result, the consumer surplus is shown by the green triangle below. As mentioned above (twice), the producer surplus is the area below the market price and above the supply curve. As a result, the producer surplus is shown by the red triangle below.Again, recall that a tariff is a tax on imports. This time, we do have a tariff. So, there istax revenue. The tax revenue is the tariff per unit times the amount of imports. The imports refer to the quantity domestically demanded that is not satisfied by the quantity domestically supplied. So, the tariff revenue is shown by the blue rectangle below. Using the formulas for the area of a triangle (1/2 x base x height) and the area of a rectangle (base x height), we can calculate the consumer surplus, producer surplus and the tax revenue.Consumer surplus = ½ x (3000) x (40-10) = 45,000Producer surplus = ½ x (1000) x (10-0) = 5,000Tax revenue = (3000-1000) x (10-5) = 10,000So, the total surplus is $60,000. Given that the total surplus without the tariff was $62,500, we know that the tariff of $5 causes the total surplus to fall by $2,500. So, the answer is the following: Decreases by $2,500.

If the economy is in its initial equilibrium and then the Federal Reserve decides to reduce the money supply, what is the effect in the long run (relative to the initial equilibrium) on the purchasing power of money (using the AD-AS model)? a) Increases b) Decreases c) Stays the same d) Unclear e) None of the above

a) Increases From the loanable funds market, a reduction in the money supply will cause the supply of loanable funds to decrease. We can see this change on the graph for this market. As a result, the real interest rate will increase which means it is more expensive to borrow for consumption and investment. So, people will spend less on consumption and firms will spend less on investment. So, consumption and investment will decrease which means a decrease in Aggregate Demand. As a result, the AD curve shifts left, and we see the short run effect on the graph.We can see the short run effect in terms of Y2 and P2 and how it compares with Y1 and P1. In the long run, the input prices will adjust and so will decrease. As a result, the SRAS curve shifts left until the long run equilibrium is restored - that is, where all three curves cross. Accordingly (and similar to question 5), we get the following graph: Comparing the new equilibrium with the initial equilibrium, we see that the price level falls while the output is unchanged. The decline in the price level means that items are less expensive than before (e.g., a gallon of milk whose price was $8 before is now only $5). As such, how much a given amount of money like $5 can buy has gone up. So, the purchasing power of money has now risen. So, the answer is the following: Increases.

a) What is the LRAS curve? b) Why is it vertical?

a) LRAS curve is the curve showing the amount of goods and services that households, firms and the government supply at a given price level in the long run b) Not affected by the price level

From the previous question, what happens in the long run (relative to the initial equilibrium)? a) Price levels falls and output is unchanged b) Price level rises and output is unchanged c) Price level rises and output falls d) Price level falls and output falls e) Not enough information

a) Price levels falls and output is unchanged In the long run, the input prices will adjust and so will decrease as well. As a result, the SRAS curve shifts right until the long run equilibrium is restored - that is, where the AD, SRAS and LRAS curves all cross. Accordingly, we get the following graph: As we can see, when comparing with the initial equilibrium, the price level falls and the output ends up being neither higher nor lower. So, the answer is the following: Price level falls and output is unchanged.

a) What is stagflation? b) Can the government solve stagflation?

a) Stagflation: High inflation and low growth (high unemployment) b) Government can only correct one of the problems of stagflation at a time-Can raise spending, lower taxes which... ...raises growth but worsens inflation-Can lower spending, raise taxes which... ...lowers inflation but worsens growth (and unemployment)

Which of the following about international trade is true? (Hint: See the arguments for restricting trade.) a) The trade protections implemented by Presidents Bush and Obama destroyed more jobs than they created b) Most jobs losses in the US are due to international trade rather than some other factor like automation c) International trade has decreased income inequality in the US d) Trade protections imposed on another country does not lead to retaliation by that other country e) All of the above are false

a) The trade protections implemented by Presidents Bush and Obama destroyed more jobs than they created For this problem, you can consider each answer choice one at a time. For example, on slides 14-19, we see that the tariffs implemented by Bush Jr. and Obama did indeed cause more job losses than gains. But on slide 22, we see that most jobs have not been lost due to international trade but instead have been lost due to automation. On slide 20, it mentions how international trade has raised inequality within countries not lowered it. Also, from slides 26 and 27, we see that trade protections imposed on another country can lead to retaliation. So, going through each answer choice, we find that only the first is valid. So, the answer is the following: The trade protections implemented by Presidents Bush and Obama destroyed more jobs than they created.

Recall the video provided in your lecture slides concerning the history of trade. What was a major point of this video? a) To show how the debate between protectionism and free trade goes back a long way b) To show how Presidential debates are nearly as boring as an economics lecture (in other words, pretty boring) c) To show the benefits and costs of trade are exactly what Nobel Prize winning economist Richard Thaler says they are d) To show the long run cost of greater trade is high inflation e) To show how international trade has enjoyed unanimous support for centuries

a) To show how the debate between protectionism and free trade goes a long way

Recall the trend over time of labor productivity increasing (because of technology advancement, increases in education, etc.). Given what the lecture slides say causes shifts in the LRAS curve, the LRAS curve would tend to shift right over time. a) True b) False

a) True

Suppose the US is exporting medical equipment. What can we say is true for the domestic market for medical equipment? a) World price exceeds the domestic equilibrium price b) US consumers are better off due to trade c) Total surplus is lower with trade than if trade was banned d) Less is sold by domestic producers when there is trade than if trade was banned e) US consumers are better off due to trade and less is sold by domestic producers when there is trade than if trade was banned

a) World price exceeds the domestic equilibrium price Recall from the lecture notes that if the US is exporting that means the country has an excess domestic supply - that is, the domestic supply exceeds the domestic demand. So, the graph would like the following (this picture is from lecture 10 part 1, slide 41): Notice the world price PW (when trade is allowed) is above the domestic equilibrium price P1 (the price that would make the domestic supply and domestic demand equal). Since the world price is higher than the domestic equilibrium price, the domestic supply is higher under trade than if trade was banned. So, the answer is the following: World price exceeds the domestic equilibrium price.

What can cause stagflation? a) A sudden drop in consumption b) An increase in the price of oil c) A decrease in exports d) A decrease in the cost of machinery e) A technological breakthrough that cuts business costs in half

b) An increase in the price of oil

Just as the founder of modern economics Adam Smith believed, two countries should only trade if each country has an absolute advantage over the other for some good or service. For example, a large and more technologically advanced country like the US should never trade with a smaller and less technologically advanced country. a) True b) False

b) False

According to the class, which of the following is FALSE concerning international trade? a) It is prevalent in the world b) It benefits everyone c) As a percentage of US GDP, it was higher in 2015 than in 1960 d) It is controversial e) It is conducted by every country in the world

b) It benefits everyone From the lecture slides, we saw that trade is prevalent, controversial and generally beneficial. But despite being generally beneficial and as can be seen by the effects of trade on consumer and producer surplus, trade does not benefit everyone. Consider if a country is importing a good, domestic producers for that good are harmed by having international trade (because the domestic price is lower due to international trade). If a country is exporting a good, domestic consumers for that good are harmed by having international trade (because the domestic price is higher due to international trade). This issue of international trade being harmful to some was also discussed in the video provided on slide 53. So, the answer of which is false is the following: Trade benefits everyone.

According to the class, why does the AD curve have a negative slope? a) When P rises, people substitute away from more expensive goods and services so AD decreases b) When P rises, the purchasing power of income falls so AD decreases c) When P rises, G decreases which means AD decreases d) When P rises, the supply of money shifts left so r falls so AD decreases e) Because your instructor says so

b) When P rises, the purchasing power of income falls so AD decreases

Consider the following information: Price Quantity domestically Quantity domestically supplied demanded $40 4,000 0 $35 3,500 500 $30 3,000 1,000 $25 2,500 1,500 $20 2,000 2,000 $15 1,500 2,500 $10 1,000 3,000 $5 500 3,500 $0 0 4,000 If there is no trade, what is the total surplus? a) $10,000 b) $20,000 c) $40,000 d) $62,500 e) Not enough information

c) $40,000 To find the total surplus, we need to find the consumer surplus, producer surplus and any tax revenue. To do so, we draw the domestic market. If there is no trade, the price is just the domestic equilibrium price where the domestic demand and the domestic supply are the same. This price is $20. With this price, we get a graph like the following: Remember that the net benefit (net gain of a decision) is the benefit minus the cost. Recall that the consumer surplus is the net benefit (net gain) to consumers and so is the area below the demand curve (which tells us the benefit to consumers) and above the market price (which tells us the cost to consumers). As a result, the consumer surplus is shown by the green triangle above. Also remember that the producer surplus is the net benefit (net gain) to producers and so is the area below the market price (benefit to sellers) and above the supply curve (cost to sellers). As a result, the producer surplus is shown by the red triangle above. There is no tariff (tax on imports) so there is no government revenue. We can now calculate the consumer surplus and producer surplus. Recall the area of a triangle is ½ x base x height. So, consumer surplus = ½ x (2000) x (40-20) = $20,000producer surplus = ½ x (2000) x (20-0) = $20,000 So, the total surplus is 20,000 + 20,000 = 40,000. So, the answer is the following: $40,000.

Consider the numbers from the previous problem. If the world price is $5, what is the total surplus from no tariff? a) $1,250 b) $25,000 c) $62,500 d) $85,000 e) $102,500

c) $62,500 To find the total surplus, we again need to find the consumer surplus, producer surplus and any tax revenue. To do so, we draw the domestic market. Since the world price is $5 and there is now trade with no trade barriers, the domestic market price is now the same as the world price. As a result, we get a graph like that below. As stated above, the consumer surplus is the net benefit (net gain) to consumers and so is the area below the demand curve and above the market price. As a result, the consumer surplus is shown by the green triangle above.Recall again that the producer surplus is the net benefit to producers and so is the area below the market price and above the supply curve. As a result, the producer surplus is shown by the red triangle above. As in the previous problem, there is no tariff so there is no government revenue. We can now calculate the consumer surplus and producer surplus. Recall the area of a triangle is ½ x base x height. So, consumer surplus = ½ x (3500) x (40-5) = $61,250producer surplus = ½ x (500) x (5-0) = $1,250 So, the total surplus is 61,250 + 1,250 = $62,500. So, the answer is the following: $62,500.

Which of the following causes the SRAS and the LRAS curve to shift right? a) A decrease in the money supply b) An increase in the Marginal Propensity to Consume c) An increase in the price of oil d) An increase in the amount of human capital e) A decrease in the actual price level

d) An increase in the amount of human capital For this question, recall that only two types of changes shift both the SRAS and LRAS curves. It is either a change in the number of resources or the productivity of those resources. Going through each answer choice, only one fits this description: an increase in the amount of human capital. Recall that human capital is the knowledge that people gain from training, experience or education. Higher human capital means a higher productivity of labor. So, this change in human capital would cause both the SRAS and LRAS curves to shift and to shift right. So, the answer is the following: An increase in the amount of human capital.

Suppose the economy is in its long run equilibrium. If there is a decrease in consumption, what happens in the short run? a) Price level rises and output rises b) Price level falls and output rises c) Price level rises and output falls d) Price level falls and output falls e)Not enough information

d) Price level falls and output falls This problem is similar to the first part of practice problem 37. A huge decrease in consumption means a decrease in Aggregate Demand (AD) and so the AD curve shifts left. The effect is drawn on the graph below. We can see the short run effect in terms of Y2 and P2 and how it compares with Y1 and P1. The output falls and the price level falls as well. As such, the answer is the following: Price level falls and output falls.

Recall when the coronavirus caused many businesses to stop running which started a major recession. According to the AD-AS model, what can the government do to try and lessen the severity of such a recession? a) Give everyone a shot of Tequila each day b) Lower government spending c) Raise taxes d) Raise government spending e) The government cannot do anything to lessen a recession's severity

d) Raise government spending Remember that a recession (as opposed to stagflation) is caused by a shift left of the Aggregate Demand (AD) curve. The closing of many businesses last year meant that the incomes of many workers plunged which meant less spending on goods and services. What can the government do? The government can try to shift the AD curve right by increasing government spending and/or lowering taxes. Because of the coronavirus, the federal government did pass the CARES Act which was a stimulus of trillions of dollars of government spending to lessen the recession's severity which it did. In fact, the federal government has passed three stimulus bills to help the economy which did help decrease the severity of the recession.So, the answer is...Raise government spending.

According to the lecture slides, how many countries in the world have some kind of trade protection? a) None b) Five c) Forty-seven (almost one quarter of the world's countries) d) All but a few countries e) All the countries in the world

e) All the countries in the world Although there are hundreds of countries in the world and each is different in many ways, there are some ways where they are all the same. As an example, every single country has some type of trade protection. It can be for economic or political reasons. So, the answer is the following: All the countries in the world.

According to the lecture slides, which of the following is true about John Maynard Keynes? a) He hated economics b) He believed the economy should be guided by markets and the government be kept out of the way c) He thought that recessions did not really happen but were only imagined d) He believed the long run means six months e) He thought government spending would be useful during recessions to lift the economy

e) He thought government spending would be useful during recessions to lift the economy

What is the definition of international trade? a) It is when you give something to somebody without getting anything in return b) It is an exchange of bads c) It is an exchange of goods and services between cities within a country d) It is an exchange of goods and services between countries without the use of money e) It is an exchange of goods and services between countries that includes money

e) It is an exchange of goods and services between countries that includes money