Macroeconomics CH 13 -15 homework Questions

Your current income is about £3,000 per month. When a researcher asks you what level of compensation you would feel adequate in the case of job loss, you estimate this at £5,000 per month. This indicates: A:You value the loss of status and general sense of wellbeing at £5,000 per month. B:You value the loss of status and general sense of wellbeing at £2,000 per month.

B

Assume that the level of consumption in an economy is given by the expression 1000 + 0.7Y, when Y = 50,000, consumption will be: A: 35,000 B: 36,000 C: 166,666 D: 72,428

B (1000 + .7 (50,000) = 36,000)

Suppose that in an economy with no taxation and no external trade, the marginal propensity to consume is 0.7. The size of the multiplier will be? A: 7 B:3.333 C: 1/3 D: 0.14

B (Since the simple multiplier formula is 1/(1-MPC), the multiplier here will be 1/0.3 = 3.333.)

In an economy where the MPC is 0.7, the proportional tax rate is 0.25 and the marginal propensity to import is 0.2, the multiplier will be: The value of the multiplier in this case is: 1/(1- 0.7 x 0.75) + 0.2)) = 1/(1-0.525 + 0.2) = 1.48.

1.48 [The value of the multiplier in this case is: 1/(1- 0.7 x (0.75) + 0.2) = 1/(1-0.525 + 0.2) = 1.48.] 1/ (1-c1 (1-t) + M) = multiplier Demand that doesn't depend on income = (Co + I(r) + G + X)

The GDP deflator differs from the CPI in the following way: A: It includes the price of exports. B:It only records the prices of goods while CPI includes the price of services. C:It includes the prices of exports but excludes the prices of imports. D:The GDP deflator gives higher measures of inflation than the CPI.

C (The GDP deflator includes the price of exports but excludes the price of imports. This is the opposite of the CPI. Remember the GDP deflator is measuring the price of components of GDP, hence C+I+G +X-M. By contrast, the CPI is measuring the prices of goods and services consumed by domestic residents.)

Which of the following best describes the short-run relationship between inflation (π) and unemployment (U), ceteris paribus? A: U falls; π falls B: U is unchanged; π falls C: U is unchanged; π rises D: U rises; π falls

D (An inverse relationship or 'trade-off' means that inflation and unemployment move in opposite directions.)

a flatter consumption function would indicate which of the following: A: A larger marginal propensity to consume and a larger multiplier B: A smaller marginal propensity to consume and a smaller multiplier C: A smaller marginal propensity to consume and a larger multiplier D: A smaller marginal propensity to save (MPS = 1-MPC) and a larger multiplier.

B ( MPC is equal to the slope of the line, the flatter the line is the smaller the slope is. The smaller the MPC, the smaller the multiplier will be. )

Since 2008 we have got used to the idea that the size and behaviour of the financial system can be a major source of economic instability. But can you think of ways in which the existence of a developed financial system may help to limit fluctuations in the economy? A: A developed financial system means that firms and households can always borrow. B: developed financial system can help households to 'smooth' their consumption over time. C: A developed financial system facilitates government borrowing. D: A developed financial system provides facilities for trading currencies and for lending and borrowing overseas.

B (A developed financial system can help households to smooth their consumption by helping them build up savings in times of surplus income and to borrow when they receive a negative income shock. This weakens the link between consumption and income and reduces the size of multiplier.)

According to the revised version of the Phillips curve, as shown in Figure 15.7, if the rate of inflation last year was 3 per cent and the bargaining gap this year and next year is 1 per cent, then inflation this year and next will be: A:3 per cent then 4 per cent B:4 per cent then 5 per cent C:4 per cent then 3 per cent D:3 per cent then 2 per cent

B (The rate this year will be 3 per cent + 1 per cent (= 4 per cent). And next year, if the bargaining gap persists it will be 4 per cent + 1 per cent (=5 per cent))

Assume that the central bank has an inflation target of 2% per year but inflation is currently running at 4%. The nominal policy (interest) rate is currently 5%. The central bank needs to create a negative bargaining gap and estimates that the real policy rate required to achieve this is 3%. Consequently it needs to set the nominal policy rate at: A:6% B:7% C:8% D:4%

B (The required rate is 4 + 3 = 7%.)

Inflation is best described as: A: A rise in prices B: A persistent rise in the general level of prices C:Too much money chasing too few goods. D:Fall in the value of the pound (dollar, euro etc.

B (This definition makes it clear that inflation is a process that continues for a while; it also stresses that it is prices in general that are rising, not just say the price of oil or houses.)

The 'paradox of thrift' is an example of: A: A contradiction in terms B: The fallacy of composition C: Positive feedback D: Negative feedback

B (the fallacy of consumption is the false assumption that what one does individually would be good for the whole economy)

A fall in output is caused by a reduction in investment. Which of the following would help restore output to its original level? A: A reduction in autonomous consumption B: An increase in target wealth C: An increase in expected current and future wealth D: A tightening of credit conditions

C

A fall in the world price of commodities will: A:Shift the profit curve down and the Phillips curve up B:Create a positive bargaining gap C:Shift the profit curve up and the Phillips curve down D:Trigger accelerating inflation

C

A new neighbour holds a party in order to get to know people. You notice that each time he greets someone he says his name is Joe and then says he's a dentist. Why do you think he feels that his occupation is so important? It signals that if a neighbour has a dental problem, they know where to get treatment. B: He thinks it confers a superior status. C: It's a powerful but simple signal to neighbours about his income, education, tastes, attitudes and other characteristics. D: He does not wish to be mistaken for a doctor or accountant.

C

An increase in the policy rate reduces aggregate demand because: A: It lowers the value of the domestic currency in terms of overseas currencies, encouraging an increase in net exports B:It increases the income earned by savers C:It depresses asset prices and makes people feel less wealthy D:It reduces the size of the multiplier.

C

An overseas bank announces that it is introducing a new type of savings account paying a 3 per cent fixed rate of interest for deposits of one year duration. This 3 per cent is: A:A real rate of interest B:A post-tax rate of interest C:A Nominal rate of interest D:A long-term rate of interest

C

Economic activity is subject to fluctuations (booms and slumps). Thinking about the US economy since 1800 which of the following statements is correct? A: The main cause of economic fluctuations over the years has been the size of the agricultural sector and the effects of weather. B: The main cause of economic fluctuations over the years has been the speculative nature of the financial system. C: In the early nineteenth century the effects of weather on a large agricultural sector were a major source of economic fluctuations but during the twentieth century these have been replaced by fluctuations in industrial investment. D: In the nineteenth century, bank failures (and the absence of a central bank) were the main causes of economic fluctuations.

C

Imagine that the rate of inflation has been 10 per cent per year for a number of years. The central bank then introduces a 'tight' monetary policy and the rate of inflation comes down to 5 per cent per year. This reduction is an example of: A:Deflation B:Falling prices C:Disinflation D:Austerity

C

In a situation of labour market equilibrium: A: Claims of workers (for wages) and owners (for profits) are inconsistent B:Firms have no incentive to invest C:There is no reason for prices or wages to change D:Unemployment will be zero

C

Why is investment spending likely to be more volatile than consumption spending? A:Because investment depends entirely on 'animal spirits'. B:Because firms cannot foresee the future. C:Because a large part of consumption spending is on items that cannot be postponed. ('non-discretionary') - food, heating, lighting, shelter, for example. D:Interest rates fluctuate.

C

If inflation is generally undesirable, why do policymakers choose inflation targets that are greater than zero? A;They don't believe they can achieve a zero rate B:Zero inflation is too costly in terms of unemployment C:If prices are generally rising, real wages can fall without a reduction in nominal wages D:The official figures exaggerate the true inflation rate

C (natural cut)

Ceteris paribus, an increase in household's expected current and future wealth is likely to: A: Increase the marginal propensity to consume (MPC). B: Increase the multiplier C: Increase saving D:Increase autonomous consumption

D

Imagine that at the end of 2014 your monthly income in money terms was £2000 per month while the index of retail prices was 100. At the end of 2015, your monthly income was £2100 while the index of retail prices was 110. During 2015, your real income had: A: Increased by £100 B:Fallen by 10 per cent C:Increased by 5 per cent D:Fallen by 5 per cent

D

In the expression for aggregate consumption C = C0 + C1Y, C1 is known as: A: Autonomous consumption B: The average propensity to consume C: The multiplier D: The marginal propensity to consume

D

Suppose that the economy enters a recession. Unemployment rises, which reduces workers' negotiating power. In terms of Figure 15.2: A: We move along the wage curve, to the right B: The wage curve moves up C:The wage curve moves down D:We move along the wage curve, to the left

D

Your monthly real wage is: A:The amount you earn each month B:The amount you earn each month after the deduction of taxes C:The amount you earn each month after the deduction of taxes and the addition of any benefits D:The amount you earn each month, divided by the average price of the goods and services that you buy

D

In the context of aggregate demand, which of the following constitutes investment: A: Putting money in a savings account B: Buying company shares C: Buying a new car for personal use D: Upgrading your firm's IT equipment

D ( form of investment in real capital equipment)

The rate of interest that you are paying on a mortgage loan is 6.5 per cent per year. Inflation is running at 3 per cent per year. The real rate of interest that you are paying is therefore: A:6.5 per cent B:9.5 per cent C:3 per cent D:3.5 per cent

D (According to the Fisher equation, the real rate is 6.5 - 3 = 3.5 per cent.)

When measured over time, the nominal value of many variables in economics grows more rapidly than their corresponding real values. Why might this be? A: Because of errors in the data recording process. B: Because of population growth. C: Increases in productivity D:Inflation

D (If inflation is positive, then nominal values will increase more rapidly than real values because nominal values incorporate two changes simultaneously: the change in volume or size and the change in price. This compares with real values that record only changes in volume or size.)

Some empirical evidence has shown that the value of the multiplier in Q8 above is unrealistically high for most economies. Accordingly to what we have seen in class, which of the following statements can justify a smaller multiplier? A: Households are financially constrained B:Investment is more volatile and expectation-driven C:Households can perfectly smooth consumption D: We have overlooked the effect of taxation and external trade

D (Imports also represent a 'leakage' and affect the multiplier in the same way as saving and taxation. Since all real world economies involve government and overseas trade, we need a formula for the multiplier including the marginal rate of tax (t) and the propensity to import (m). This is: 1/(1-MPC*(1-t)) + m.)

In an economy with no taxation and no external trade, the size of the multiplier depends on: A:Investment B:The current level of aggregate demand C:Autonomous consumption D: The marginal propensity to consume

D (In a closed economy with no government, the level of investment determines the current level of aggregate demand (Y= C + I) and the simple multiplier formula is 1/(1-MPC)

The central bank announces a rise in the official policy rate. Looking at Figure 14.10c the aggregate investment function in these circumstances is likely to shift ________(right/left/up/down)

left (at each interest rate level you are willing to invest less.)

Deflation refers to a situation where prices are generally falling. Why is deflation generally undesirable? A:It might lead to a cumulative reduction in aggregate demand as firms and households wait for prices to fall further B:It disadvantages creditors C:It reduces the value of debts D:It redistributes real income

A

A 'goods market equilibrium' refers to a situation where: A: Output is equal to aggregate demand and aggregate demand is equal to the sum of its own components B: Investment is large. C:The economy is using all the available resources. D: There is no unemployment.

A (Y=AD)

The fraction of income that households do not consume (savings) can be expressed as a fraction of their total income. This is known as the 'savings ratio' and fluctuates from year to year. Which of the following might cause a fall in the savings ratio? A: A fall in household wealth B: A relaxation of credit constraints C: A major event which causes an increase in uncertainty D: Official forecast of possible deflation in the future.

B: (because this makes it cheaper to borrow which will generally increase consumption. Al other options make the household more nervous and more likely to increase their precautionary savings. )

What is excluded when you calculate GDP by the expenditure method? Why?

When we calculate GDP by the expenditure method we must remember to exclude government transfers since these will be spent again by households (and would cause a 'double-counting' error) and spending on imports, since imports are not part of the home country's production.

In a severe recession, with falling prices, the economy may need a negative real interest rate in order to give sufficient stimulus to aggregate demand. What particular problem for conventional monetary policy do negative real interest rates pose?

Zero lower bound (The policy rate needs to be more negative than the rate of deflation but nominal rates cannot go below zero)

A spurious correlation is one in which:

one in which two variables move together in a way that might wrongly suggest a casual relationship

When a country's GDP is being measured by the output method, the total figure comes to $500bn. When measured by expenditure, we have the following components: Households' spending on consumption = $300bn Firms' spending on capital goods = $50bn Government spending on services = $80bn Government spending on capital goods = $ $50bn Government transfers (social security etc) = $10bn Exports = $10bn Imports = $20bn In the circumstances, how can we say the output and expenditure methods of calculating GDP are equivalent? A: There is no problem. The expenditures sum to $500bn which matches the output measure. B: One of the two methods must be wrong. C: Adding to stocks of unsold goods is treated as a form of investment. D: Type option here

(Don't double-count transfers. There appears to be $10bn of expenditure which has not been recorded.) C

Suppose that the bargaining power of workers rises relative to that of employers because government legislation improves the security of employment. In terms of Figure 15.2: A:We move along the wage curve, to the right B:The wage curve moves up C:The wage curve moves down D:The wage curve becomes flatter

B (The wage-curve shifts up because the improved security of employment encourages workers to seek higher wages at every level of employment.)

A temporary change in income affects the current consumption of credit-constrained households more than it does that of the unconstrained because: A: A credit-constrained household is unlikely to have savings to fall back on. B: If the household cannot borrow, its current consumption is limited by its current income. C: A credit-constrained household cannot foresee the future. D: Credit-constrained households are likely to be shortsighted.

B

Okun's Law tells us that: A: Unemployment and GDP growth are positively correlated. B: That unemployment goes down in booms and up in recessions. C: Every change in the level of employment is exactly matched by an opposite change in the level of unemployment. D: Output and unemployment are inversely correlated.

B

Which of the following propositions best sums up the core of 'Keynesian' economics? A: Technological progress and productivity is what matters in the short run. B: Stimulating the aggregate demand with higher government spending and lower taxation is a solution to escape from a recession. C: Governments should not play any role in the economy. D: An increase in government spending is likely to have no effects in the economy.

B

Which of the following statements regarding (government) primary budget deficit is correct. A: It is equal to government spending in highways and schools. B: It is equal to government spending + government transfers - total tax revenue. C: If it is negative there is a sovereign debt crisis. D:It is equal to total government debt minus interest payments.

B

The 'paradox of thrift' refers to the fact that: A: The aggregate attempt to increase savings leads to a fall in aggregate income. B: The wealthier I become, the more tax I have to pay C: Saving is a waste of time D: Inflation erodes the value of savings

A ( If an individual reduces his/her consumption in order to save more, he/she will usually be successful. But if we all save more, this reduces the level of aggregate demand. This in turn will reduce the level of employment and total income. Since saving (and consumption) depend upon the level of income, the fall in income will reduce the total level of saving. Hence a general attempt to save more leads to the paradox that less actual saving takes place.)

At the end of 2015 the UK consumer price index was 258; at the end of 2016 it was 267. According to this information, the annual rate of inflation during 2016 was approximately: A: 3.3 per cent B:9 per cent C:2.67 per cent D: 0.33 per cent

A (If the price index has risen from 258 to 267, it has risen by 9 points and 9/258 = 0.033 or 3.3 per cent.)

In the current year, your economy is expected to make exports of $100bn and to import $80bn-worth of goods and services. When it comes to measuring GDP (or aggregate demand) the net effect of your external sector is to: A: External trade contributes $20m. B: External trade reduces GDP by $20bn. C:We cannot tell. D:It depends on the composition of imports and exports.

A (X-M)

the distance between the profit curve and the wage curve at C indicates:

A negative bargaining gap

Figure 13.15 shows that total investment spending can be volatile because the interaction of individual firms' decisions can lead to vicious (low profit) or virtuous (high profit) circles. Which of the following might encourage firms to behave in such a way that they all increase their investment spending together. A: A fall in the exchange rate (the domestic currency becomes cheaper for foreign buyers). B: A major technological breakthrough - say in batteries for electric cars. C: The use by government of fiscal policy to increase aggregate demand. D: Calls from government for firms to increase investment.

C (b would only help with the automobile sector and not the economy as a whole)

Why is it fundamental for Keynesian economics to assume that the economy is not working at full capacity utilization? A: Because technological progress works only if firms are not overwhelmed. B: Because full capacity utilization implies that firms do not have an incentive to invest. C: Because production side needs to be always able to accommodate the demand side to have a positive feedback (multiplier process) after a fiscal stimulus. D: Because full capacity utilization implies that households will be more financially constrained.

C (B is wrong bc when a firm is at full capacity utilization, it still has an incentive to invest in order to be able to accomodate more demand.)

In figure 13.5, the data for Spain suggests that Okun's Law can be written as y = -0.3597x +1.741. What is the predicted change in unemployment if GDP grows by 2 per cent. A: Unemployment increases by 2.46 percentage points. B:Unemployment increases by 1.73 C:Unemployment increases by 1.02 percentage points. D: Unemployment increases by 1.67 percentage points

C (in Okun's law they already account for percentage change so when given 2 percent, don't turn it into .20 for x, just leave it as 2. Also, remember your negatives. 1.741 0 - 0.3597 (2) = 1.02)

Weakness of will' on behalf of households increases the effect of credit-constraints because: A: Households suffering from weakness of will are unlikely to make the effort to find alternative income and employment in the face of a negative shock. B: Households suffering from 'weakness of will' try to live beyond their means. C: Households suffering from 'weakness of will' are unlikely to have accumulated savings.. D: Weak-willed households have no savings because they are impatient to consume as much as possible in the present.

C ((If there are no savings, the credit-constraints bind consumption to current income more strongly.)

Your economy is estimated to be producing about $800bn-worth of goods and services this year. However, your official statisticians estimate that if all resources were fully-employed, it could produce about $1000bn. The figure 0.8 (or 80%) therefore indicates: A: The level of unemployment B: The savings ratio C: The degree of capacity utilization D: A budget surplus

C (By showing the current level of output against the maximum potential output)

Assume that a bargaining gap remains constant at 1 per cent. The rate of inflation in future years will: A:Remain constant at 1 per cent per year B:Remain unchanged C:Accelerate by 1 per cent per year D:Settle at 1 per cent

C (If the bargaining gap is constant at 1 per cent, this will be added to the rate of inflation each year and so inflation will increase (accelerate) by 1 per cent per year.)

The Consumer Price Index (CPI): A:Records the price of all goods and services in the economy. B:Records the price of all goods produced in the domestic economy, including exports. C:Measures the general level of prices that consumers pay for goods and services. D:Measures the rate of inflation.

C (It records the prices of goods and services in a typical 'shopping basket'. The items and their weights are based upon a continuous sampling of consumer spending habits.)

Compared with investment spending, government spending is relatively stable. Why might his be? A: A large part of government spending is on transfers (benefits and pensions) which are 'contractual' and have to be paid whatever the state of the economy. B:'The government can spend what it likes' C: Much government spending is independent of the state of the economy. D: Government spending is constrained by international agreements.

C (Leaving aside transfers, government spending consists of capital spending - on schools, health, roads, railways etc. These spending decisions are made largely with reference to social needs and political preferences. These do not change rapidly. Furthermore, the projects once begun, cannot easily be abandoned. Likewise with current spending - on salaries in education, health police etc. The level of service and hence the level of spending is dictated by the community's preferences which tend to be stable.)

The original Phillips curve (Figure 15.3) suggested that the policymaker could choose: A:Any preferred level of unemployment and inflation B:Any preferred rate of inflation, for a given level of unemployment C:A stable combination of inflation and unemployment D:A temporary combination of inflation and unemployment

C (The important message from the original Phillips curve was that this choice, once made, would be lasting. It need not change unless the policymaker chose a different combination. Not frequently changed)

Assume that a household has access to credit. Which of the following is likely to have a significant effect on long-run consumption? A: A temporary reduction in income. B: A rise in interest rates C: An unexpected promotion to a senior position. D: A freeze in the value of state retirement benefits

C (The level of interest rates varies, mainly as a result of monetary policy. Changes in interest rates are therefore likely to be seen as temporary and have little effect on consumption in the long-run.)

Assume that the government stimulates aggregate demand by increasing its spending. The effect on output and employment will be greater if: A:The economy has a high marginal propensity to import B:The spending is financed by additional taxation C:Its trading partners undertake a similar policy D:The economy has a low marginal propensity to consume.

C (The stimulus to aggregate demand in country A will be reinforced if the trading partners also adopt expansionary policies. This is because their expanding economies will require more imports and some of those will be exports from country A. This increase in exports constitutes a further addition to aggregate demand in country A.)

Which of the following is likely to lead to a fall in the level of investment spending? A:Increased optimism about future demand B:Central bank implies a decrease in the policy rate. C: An official forecast of a downturn in the economy D: A rise in the expected rate of profit

C (every other option would likely increase investment spending)

It is often said that independent central banks are more likely to run a successful monetary policy than governments because their commitment to low inflation is more 'credible' than government promises. One reason for this is that: A:Independent central banks are better at economic forecasting B:People who work in central banks have a strong dislike of inflation C:Central banks can set interest rates D:Central banks are less subject to political pressures (e.g. for lower unemployment) than governments

D (The argument for putting the decision in the hands of an independent central bank is based upon the view that central banks face fewer conflicts of interest, because they are not subject to political pressures. For instance, If inflation requires a very high (and unpopular) rate of interest, this is less of a problem for central banks than for governments whose electors may be more concerned about jobs.)

The weakness of the original Phillips curve is that it ignored: A:Time B:Household preferences C:Policymaker preferences D:Expectations

D (The problem was expectations. The original Phillips curve was based upon data drawn from a period when inflation was generally very low (excluding the two world wars). Therefore, in the process of wage bargaining, the future expected rate of inflation was not a major factor. In more inflationary times (1960+) it was inevitable that whatever the level of unemployment and the size of the bargaining gap, workers would also be trying to take account of what they expected inflation to be, guided by the most recent rate.)

Figure 14.1 shows that the severity of the business cycle has declined since 1945. Which of the following is most likely to have contributed to this moderation? A: A decline in the importance of agriculture B: A reduction in the inequality of income distribution C: The spread of home ownership D: The increase in size of government in the economy

D (large parts of government spending are independent of the state of the economy (autonomous) and continue unchanged, whatever may be happening in the private sector. This also provides a stabilising effect.)

In periods of rapid inflation, which of the following tend to lose out? A:Low-income households B:Households with substantial financial wealth C:Borrowers (debtors). D:Lenders (creditors).

D (reduces the value of real debt so the money a person owes you, even if they repay you fully is overall less)

A high rate of inflation is objectionable because: A: It reduces everyone's real wealth and real income B:It makes borrowing more expensive C:It makes poor people worse off D:It can distort price signals

D (you can't tell if somethings getting more expensive due to scarcity or inflation or demand, harder for consumers to make choices)