Economics Exam 3 Review

"Increasing the amount of consumption spending and reducing the amount of savings ________ investment expenditures, and ________ long-run economic growth of the economy."

"decreases, decreases"

"The ""new product bias"" in the consumer price index refers to the idea that"

"new products' prices often decrease after their initial introduction, and the CPI is adjusted infrequently and overestimates the cost to consumers."

CPI overstates Inflation by

0.5- 1%

Determination of Growth

1) Labor Productivity (measured by how much is produced) 2) Capital Stock (amount of factories, machinery, computers) 3) Human Capital (average intelligence) 4) Technology (improvements in computers)

Financial system has 3 Rules

1) Spread Risk 2) Provides Liquidity 3) Provides Information

Shortcomings of the CPI

1) Substitation Bias- the price changes of a product increase 2) Increase in Quality Bias 3) New Product Bias- caused by the CPI being updated infrequently 4) Outlet Bias- shoping online instead of stores

Three reasons why are business cycles less volatile?

1) US is transitioning from manufacturing to services. 2) Unemployment insurance 3) More active policy

Things that hinder growth

1) War 2) Governement Policy -Private property rights -Intellectual property rights 3) Disease

"If real GDP grows by 3% in 2005, 3.2% in 2006, and 2.5% in 2007, what is the average annual growth rate of real GDP?"

2.90%

1 out of 1 points "If the growth rate of real GDP rises from 3% to 4% per year, then the number of years required to double real GDP will decrease from"

23.3 years to 17.5 years.

"If the nominal rate of interest is 6.5% and the inflation rate is 3.0%, what is the real rate of interest?"

3.50%

Rule of 70

70/ Growth Rate

"If real GDP per capita measure in 2000 dollars was $6,000 in 1950 and $48,000 in 2000, we would say that in the year 2000, the average American could buy ______ times as many goods and services as the average American in 1950."

8

Real Interest rate

= Nominal - Real i - π (π is inflation)

Real interest rate expectation

= T - π^e (Ex Ante) Both borrower and lender are happy.

Effect of a recession on Y=GDP

GDP decreases

Effect of a expansion on Y=GDP

GDP increases

Good for the borrower, bad for the lender

If π^e < π = r^e>r (π= inflation, r=real interest rate, r^e=expected interest rate)

Bad for the borrower, good for the lender

If π^e > π = r^e<r (π= inflation, r=real interest rate, r^e=expected interest rate)

Savings=

Investment Spending

Which of the following is true about the consumer price index?

It assumes that consumers purchase the same amount of each product in the market basket each year.

Growth Rate

New-Old/ Old

S-pub=

T-G

How would the equilibrium quantity of loanable funds respond to a change from an income tax to a consumption tax?

The equilibrium quantity of loanable funds would rise.

"You earned $30,000 in 1980, and your salary rose to $80,000 in 2006. If the CPI rose from 82 to 202 between 1980 and 2006, which of the following is true?"

The purchasing power of your salary increased between 1980 and 2006.

"When prices are rising, which of the following will be true?"

The real interest rate will be lower than the nominal interest rate.

U.S. business cycle fluctuations have become milder.

U.S. business cycle fluctuations have become milder.

Formula of Savings =

Y-C-G GDP- Consumption- Government Spending

S-priv=

Y-T-C Income - Taxes - Consumption

Deflation

a decrease in the overall level of prices in the economy.

Disinflation

a period of slowing average price increases across the economy. ex. 3% - 1%

Which of the following would you expect to increase the equilibrium interest rate?

an increase in the budget deficit

Inflation

an increase in the overall level of prices in the economy.

"Suppose that in 2010, all prices in the economy double and that all wages and salaries have also doubled. In 2010, you"

are no better off or worse off than you were in 2009 as the purchasing power of your salary has remained the same.

The consumer price index is the

average of the prices of the goods and services purchased by a typical urban family of four.

"Suppose that at the beginning of a loan contract, the real interest rate is 4% and expected inflation is currently 6%. If actual inflation turns out to be 7% over the loan period, then"

borrowers gain 1%.

"When actual inflation is less than expected inflation,"

borrowers lose and lenders gain.

"The substitution bias in the consumer price index refers to the idea that consumers ________ the quantity of products they buy in response to price, and the CPI does not reflect this and _______ the cost of the market basket."

change; over-estimates.

Which of the following would be the best measure of the cost of living?

consumer price index.

The response of investment spending to an increase in government spending is called

crowding out.

"If the price level rose in three consecutive years from 100 to 120 to 140, then the annual inflation rate over those years would"

decrease.

"Borrowers are ________ of loanable funds, and lenders are _______ of loanable funds."

demanders; suppliers

"Suppose you lend $1,000 at an interest rate of 10% over the next year. If the expected real interest rate at the beginning of the loan contract is 4%, then what rate of inflation over the upcoming year would be most beneficial to you as the lender? An inflation rate"

equal to 0%.

Actual real GDP will be above potential real GDP if

firms are producing above capacity.

Nondurable goods

goods such as clothing and food.

Inflation tends to _______ during the expansion phase of the business cycle and _______ during the recession phase of the business cycle.

increase; decrease

Technological advances generally result in

increased life expectancy

Consumer Price Index

market basket of 211 goods and services purchased by the average family of four.

"The increase in quality bias in the consumer price index refers to the idea that price increases in the CPI reflect pure inflation, but ________ quality increases. This causes the CPI to _______ the cost of the market basket."

not; overstate

Most economists believe that the biases in the consumer price index cause the CPI to overstate the true inflation rate by about

one-half to one percentage point.

A period of expansion ends with a _______ and the period of recession ends with a ______.

peak; trough.

The nominal interest rate equals the real interest rate _______ the inflation rate.

plus.

Durable goods

products having a lifetime of 3 or more years (for example, large and small appliances, furniture, and carpets).

Purchases of diapers should

remain fairly constant over the business cycle.

"If your nominal wage (what you are paid in dollars) rises faster than the price level, we can say your real wage has _______ and the purchasing power of your income has _______."

risen; risen

What is the name of the organization that defines business cycles peaks and troughs in the United States?

the National Bureau of Economic Research.

Liquidity refers to

the ease in which a financial security can be traded for cash

Liquidity

the ease in which assets can be exchanged for goods and services.

Potential GDP

the level of GDP attainable when all firms hire normal amounts of worker-hours and operate during normal business hours.

The average price of goods and services in the economy is also known as

the price level.