Macro Exam 2
The consumer price index is computed using weights based on?
A survey of consumers. Of the major categories of goods and services, housing is the largest.
Nominal Wage vs Real Wage
-Nominal Wage: A worker's wage expressed in current dollars -Real Wage: The nominal wage adjusted for changes in price levels
Cyclical unemployment
-Caused by economic downturn -"worst kind" -occurs for an unknown period of time
3 types of unemployment
-Structural -Frictional -Cyclical
Classify the people described in each of the following scenarios as either frictionally, structurally, or cyclically unemployed. -Phil is currently unemployed because the tire factory where he used to work installed robots, which replaced 500 laborers, including Phil. -Jessica is unemployed because she is in the process of reentering the labor force after taking time off to have a baby. -Mary is unemployed because she lost her job at McDonald's after the state increased the minimum wage. -Barry is unemployed because he was laid off by the automobile factory when the economy entered a severe, prolonged recession. -Sandy left her former job at an accounting firm a month ago. She is in the process of interviewing for a similar position at six different accounting firms, although she has not accepted a job yet.
-A) Phil is structurally unemployed. -B) Jessica is frictionally unemployed. -C) Mary is structurally unemployed. -D) Barry is cyclically unemployed. -E) Sandy is frictionally unemployed.
List four reasons why some countries with limited natural resources, such as Japan and Singapore, have been able to achieve high rates of long-run economic growth.
1. Increases in human capital have made labor more productive. 2. Increases in physical capital have made labor more productive. 3. Technological improvements have increased total factor productivity. 4. Improvements in health care have increased labor productivity. 5. Improvements in infrastructure have increased total factor productivity. 6. Development and use of new technologies have reduced the need for natural resources, such as energy-saving capital, or use of fertilizers on inferior agricultural land.
Suppose the basket of goods used to compute the CPI includes 6 pieces of cake and 2 pints of ice cream and the base year is 2009. 2009: Piece of cake-$3 ; Pint of ice cream - $5 2010: Piece of cake -$4 ; Pint of ice cream - $4 What is the CPI for 2010?
114.3 -The price of the basket for 2009 is $3x6 + $5x2 = $28. -The price of the basket for 2010 is $4x6 + $4x2 = $32. -The CPI for 2010 is $28x100/$32 = 114.3.
If the nominal interest rate were 5% and the expected inflation rate were 2%, what would the real interest rate be?
3% -The nominal interest rate = the real interest rate - the inflation rate. So, the real interest rate = the nominal interest rate - the inflation rate. Here the real interest rate is 5% - 2% = 3%.
If the nominal interest rate were 8% and the CPI rose from 125 to 130, what was the real interest rate?
4% -The inflation rate was (130 - 125)/125 = 4%. The nominal interest rate = the real interest rate + the inflation rate. So, the real interest rate = the nominal interest rate - expected inflation. The real interest rate = 8% - 4% = 4%.
Using the following data, compute the following: Number of people employed 120,500 Number of people unemployed 4,050 A) The number of people in the labor force. B) The unemployment rate.
A) 4,050 + 120,500 = 124,550 B) (4,050 / (4,050+120,500) × 100) = 3.25%
If 2002 is the base year, then the inflation rate in 2010 = ?
CPI in 2010 - CPI in 2009 / (divided by) CPI in 2009 x 100
Decline in investor confidence
Confidence tends to decline when the economy slows, firms expect reduced sales & investors expect lower returns on their investments
True or False: If the short-run aggregate supply curve were to shift left, prices and output would fall.
False -If the short-run aggregate supply curve shifted left, prices would rise and output would fall.
True or False: Short-run fluctuations in output and the price level should be viewed as deviations from the continuing long-run trends of output growth and inflation.
False -Long-run trends are the background upon which short-run fluctuations are imposed.
True or False: An increase in the price level shifts the long-run aggregate supply curve to the right.
False -The long-run aggregate supply curve is based on the principle that over a period of many years a change in nominal variables, such as the price level, have no effect on real variables, such as production. The long-run aggregate supply curve is vertical because the price level has no effect on output in the long run. The position of the long-run aggregate supply curve depends on labor, capital (both physical and human), natural resources, and technological knowledge, but not the price level.
Which of the following would shift the aggregate demand curve to the right?
High growth of output in foreign economies. -A change in the price level is shown as a movement along the curve, it does not shift the curve. A decline in stock prices would make consumers feel poorer, so they would desire to spend less shifting aggregate demand to the left. High growth in foreign economies means that their incomes are rising so they can import more goods from the U.S. So, aggregate demand shifts to the right. A decrease in the money supply shifts the AD curve to the left.
Rule of 70
If the annual growth rate of a variable is x%, the size of that variable doubles doubles every 70/x years
Suppose that a sudden increase in aggregate demand moves the economy from its long-run equilibrium. What are the effects of this change in the short run and the long run?
In the short run, real GDP rises, the unemployment rate falls, and the price level rises. In the long run, real GDP goes back to the full employment level, the unemployment rate returns to the natural rate, and the price level rises further.
Inflation Rates
Inflation Rate (i) ; %change in price level (p) i = P2-P1 / P1 x 100
What can you deduce if the actual rate of unemployment exceeds the natural rate of unemployment?
Some workers are cyclically unemployed and the economy may be in a recessionary phase of the business cycle.
True or False: Interest rates are usually reported as nominal interest rates.
True -The interest rate is usually reported without a correction for inflation.
True or False: Indexation is the automatic correction by law or contract of a dollar amount for the effects of inflation.
True -This is the definition of indexation.
Loanable Funds Market
The market where savers supply funds to borrowers
What do economists mean by the natural rate of unemployment?
The natural rate of unemployment is the normal unemployment rate around which the actual rate of unemployment fluctuates. It is measured as follows: Natural rate of unemployment = Frictional unemployment rate + Structural unemployment rate
Loanable Funds "Law of Supply"
The quantity of savings rises when the interest rate rises. The interest rate is a reward for saving (you get interest $ when saving $ in a savings account)
Consider two economies, both in recession. In the first economy, all workers have long-term contracts that guarantee high nominal wages for the next five years. In the second economy, all workers have annual contracts that are indexed to changes in the price level. Which economy will return to the natural rate of output first? Explain your response.
The second economy will return to the natural rate of output faster. The adjustment from the SR to the LR equilibrium will be faster if wage contracts adjust quicker. Wages will be less "sticky."
Suppose that the CPI includes two goods, rice and bread which are substitutes. If the year after the base year the price of bread rises relative to the price of rice then____
The weight the CPI places on rice will be lower than actual expenditures indicate, so the inflation rate will be overstated.
True or False: If an improvement in the quality of a good is not fully measured than the consumer price index will overstate the increase in the cost of living.
True -Higher quality goods raise the value of a dollar.
True or False: The consumer price index for this year = price of basket goods and services this year/(divided by) price of basket goods and services in the base year
True
Your father graduated from school and took his first job in 1982, which paid a salary of $15,000. What is this salary worth in 2012 dollars? CPI in 1982 = 96.5 CPI in 2012 = 229.5
Value in 2012 dollars = 1982 salary × (CPI in 2012/CPI in 1982) Value in 2012 dollars = $15,000 × (229.5/96.5) = $35,674
If some firms have sticky prices and the price level rises more than had been anticipated, then in the short run those firms with sticky prices will have
an increase in customers and so increase production. -Sticky prices are one explanation for an upward sloping short-run aggregate-supply curve. If prices rise more than anticipated, the firms with sticky prices have prices that are relatively low and so will attract more customers. In the short run they respond by increasing production.
Which of the following shifts the long-run aggregate supply curve to the right?
both technological progress and an increase in human capital -Because output in the classical model depends on labor, capital (both physical and human), natural resources, and technological knowledge, we can categorize shifts in the long-run aggregate-supply curve as arising from these four sources.
The variable on the vertical axis of the aggregate demand and aggregate supply model
is a nominal variable. The variable on the horizontal axis is a real variable. The variable on the vertical axis is the price level. The variable on the horizontal axis is the quantity of output a real variable measured by real GDP.
Using CPI to equate $ values over time
price in todays dollars = price in earlier time x price level today / price level in earlier time
If firms and businesses became more optimistic about the future, what would happen to prices and output in the short run?
prices and output would rise -An increase in optimism leads consumers and firms to spend more. So aggregate demand shifts right. This shift causes prices and output to rise as the aggregate demand curve shifts along the short-run aggregate supply curve.
If the long-run aggregate supply curve was unchanged, but prices and output fell, how would the economy move back to long-run equilibrium?
the short-run aggregate supply curve would shift right -If output is below the natural rate, then eventually price expectations and wages will fall and the short-run aggregate supply curve will shift right back to the natural rate of output.
During recessions
unemployment rises and a decline in investment accounts for the majority of the decline in output.
Menu Costs
-Costs associated with changing prices; can cause output prices to be sticky EX: Gas stations-low menu costs; Restaurants-high menu costs -Relationship to aggregate supply: If the general price level falls, firms do not adjust their output price (due to menu costs), the quantity demanded of the product falls
Equilibrium in the Market For Loanable Funds
-Determines the level of interest rates in an economy -Savings = Investment
In 1970 tuition at Harvard was $4,070 per year. In 2010 it was $50,724. The CPI was 39.20 in September 1970 and 218.43 in September 2010. What is the amount in 2010 dollars of Harvard's tuition in 1970?
$29,219.90 -The value in today's dollar = $4,070x(218.43/39.20) = $22,678.83
Unexpected Shifts in AD
-Consumer confidence rises, and people start spending more. Result? AD shifts right: short run result or higher price level, higher output, and lower unemployment. As prices adjust toward LR equilibrium, SRAS shifts left: bringing us back to original output and unemployment, but prices are higher -Demand change: no real effects in long run, only affect price levels which is nominal
Chain of Borrowing
*Note about borrowing:Every dollar borrowed requires a dollar saved, lenders can't lend $ they don't have, they get that $ when you give them your savings* -GDP (output, production) requires investment -Investment requires borrowing -Borrowing requires savings
Consumer Price Index (CPI)
-A measure of the price level based on the consumption pattern of a typical consumer -Included in CPI: housing, transportation, food & beverage, medical care, recreation, communication, apparel, education -Computing CPI: price index = basket price / basket price in base year x 100
Supply Shock
-A surprise event that changes a firm's production cost EX: Drought, hurricanes, soil shock -When Supply Shocks are temporary they shift only the SRAS curve -Negative Supply Shocks lead to higher production costs; positive Supply Shocks reduce production costs
Aggregate Demand & Aggregate Supply Model
-Aggregate Demand (AD): Total demand for final goods & services in the economy -Aggregate Supply (AS): Total supply of final goods & services in the economy -Price Level(P): Nominal variable that reflects current price changes without adjusting for inflation -Real GDP(Y): Economy's outputs of goods & services, corrects the growth in the economy for prices
Factors That Can Shift AD
-Anything that changes major spending habits of individuals & firms will shift AD. This includes changes in real wealth; expected income; expected price levels; and foreign income and wealth EX: Stock market rises or falls; widespread change in real estate values -Real Wealth: Changes in an individual's wealth NOT caused by changes in price levels. -Expected Income: If people expect higher income in the future, they spend more today. -Expected Prices: When people expect higher prices in the future, they are more likely to spend today so current AD increases. -Foreign Income & Wealth: If foreign nations become wealthier, demand for U.S. goods increase (NX increases). If a foreign nation goes into recession, demand for U.S. goods decrease (NX decreases). *If the value of the U.S. dollar rises then the U.S. can buy more imports (decreasing NX) leading to a shift in AD*
Which of the following is a reason the aggregate demand curve slopes downward?
-As the price level falls, households demand less money, so the interest rate falls. As the interest rate falls spending by firms and households rise. -As the price level falls, wealth rises, so consumers desire to spend more -As the price level falls, the interest rate falls so U.S. savers will choose to buy more assets abroad. This increase in net capital outflow causes the exchange rate to fall. The decrease in the exchange rate makes U.S. goods less expensive compared to foreign goods and so net exports rise. -All of these choices are correct. These effects are called: the wealth effect, the interest rate effect, and the exchange rate effect.
Economic Growth
-Change in average person's income adjusting for price changes Economic Growth Rate = % change in Nominal (per capita) GDP - % change in Prices- % change in Population
Competitive Markets
-Characterisitics: Easy for firms to enter & exit w/ few licensing or regulatory hurdles. Buyers can expect to ind low prices and wide availability of goods. -Benefits to Society: Creative destruction occurs and new technologies replace outdated methods fueling economic growth. Only the fittest of firms survive so inefficiency is eliminated over time; innovation is encouraged
Private Property Rights
-Encompass the rights of individuals to own property, to use it in production, and own the relating output. -Workers & producers can own a share of what they produce so there is an incentive to produce more & grow. EX: Xiaogang, China agreement: farmers kept all output above gov quota-resulted in agricultural boom & more output. China grew because of the institution of private property rights.
Categorize the following people based on whether they are employed, unemployed, in the labor force, or not in the labor force. Looking at hypothetical family (described below), determine where they would be counted if the family were part of the CPS (current population survey). Are any of them discouraged or underemployed? -Female (head of household)—age 45, worked full time during the month as computer analyst -Male—age 50, laid off last year, did not work or look for work during the month. -Female—age 22, not working, applied for positions in retail sales during the month -Male—age 15, worked part time during the month at a restaurant -Male—age 70, retired. -Female—age 68, worked 30 hours per week as a substitute middle school teacher
-Female (head of household): Employed part of CPS -Male—age 50: Not in labor force, discouraged worker -Female—age 22: Unemployed in labor force, part of CPS -Male—age 70, retired: Not in labor force -Female—age 68: Employed, part of CPS, possibly underemployed
Expected Future Price Levels
-If workers & firms expect higher prices tomorrow, they negotiate those expectations into today's contracts -Costs are higher, the SRAS shifts left. However it does;t affect the long run production possibilities so the LRAS doesn't change
The Loanable Funds Market
-Includes places like stock exchanges, mutual fund firms, and commercial banks -Borrowers get funds to use for businesses ; savers lend to these businesses (banks take $ from savings accounts to lend)
Cost of Inflation
-Inflation: The growth in the overall level of prices in an economy -Future price level uncertainty -As prices go up it becomes more costly to hold money -shoe-leather costs: the resources that are wasted when people change behavior to avoid holding money -money illusion: the interpretation of nominal changes in wages or prices as real changes Ex: nominal wages go up by 3% but prices go up by 5%, money illusion may cause you to think of yourself as wealthier but your real wages have actually decreased. -Menu Costs: Costs of changing prices -Price Confusion: Difficulty analyzing price changes as a result of demand shifts or inflation -Tax Distortions: Capital gains taxes are taxes on the gains realized by by selling an asset for more than its purchase price. -Problem: often the price rises due to inflation rather than an increase in the value of the good. Example would be buying a house and later selling it, you have to pay taxes on the $ you make from the sale.
What factors shift the demand of loanable funds?
-Movement along the demand curve for loanable funds is caused by a change in the interest rate, which is the price of borrowing. -Factors: Changes in the productivity of capital (if capital becomes more productive the demand for loans will increase) ; changes in investor confidence (if a firm thinks the economy will grow in the future it will be more comfortable borrowing $)
What factors shift the supply of loanable funds?
-Movement along the supply curve for loanable funds is caused by a change in the interest rate, which is the price of borrowing. -Factors: Changes in income & wealth ; change in time preferences ; consumption smoothing (behavior occurring when people borrow and save in order to smooth consumption over their lifetime)
Unemployment rate denotions
-Natural rate of unemployment - u* -Actual rate of unemployment - u -Full employment output - Y* -Healthy economy - u=u* Recession - u>u* Expansion - u<u*
Long Run Equilibrium in the Economy
-Occurs after all prices have fully adjusted -The economy is operating at full employment -Short run expectations are consistent with the actual price levels LRAS = SRAS = AD or Y = C + I + G + NX
The Interest Rate Effect
-Occurs when a change in the price level leads to a change in interest rates and therefore in the quantity of aggregate demand -A reduction in the supply of loanable funds (caused by less saving) will increase the interest rate -Sequentially, price level increases so people need to spend more (save less) to maintain a standard of living. This causes interest rates to rise. Higher interest rates reduce overall spending, thus, a higher price level led to less spending , illustrating the negative AD slope
International Trade Effect
-Occurs when a change in the price level leads to a change in the quantity of of net exports demanded. *A change in the domestic price level leads to an inverse change in the quantity demanded for domestic goods* -Higher U.S. prices will lead people to buy less U.S. goods and buy more (relatively) cheaper foreign goods instead. This will decrease the quantity of domestic AD since NX(net exports) falls
Money Illusion
-Occurs when people irrationally interpret nominal wages as real wages -Relationship to aggregate supply: Workers are very reluctant to accept pay decreases, even if the pay is nominal. This reinforces input price stickiness. Firms will reduce output in response to decreases in the price level, rather than cut wages
Flow of Funds Across Borders
-Opportunities for investment expand if you have access to savings from around the globe -If foreigners funnel their savings into your economy your firms can use these funds to expand -Restrictions on the flow of capital across borders hurt domestic firms as they are relegated to seeking funds from sole domestic savers
Labor Force
-People who are employed or actively seeking work -NOT IN LABOR FORCE: jobless people not actively seeking employment ; retirees ; students ; institutionalized ; discouraged workers -Unemployment rate = u = #employed/labor force x100
Short Run Aggregate Supply (SRAS)
-Positively sloped, depends on price levels -Short run: time period in which not all prices have adjusted to some macroeconomic change -3 explanations for why the nominal price level affects Real GDP in the short run leading to an upward sloping SRAS: Sticky Input Prices; Menu Costs; Money Illusion
Inflation & Interest Rates
-Real Interest Rate: The investment rate corrected for inflation *Real Interest Rate = Nominal Interest Rate - inflation rate -Nominal Interest Rate: The interest rate before it is corrected for inflation *Nominal Interest Rate = Real Interest Rate + inflation rate
Sticky Input Prices
-Resource prices: tend to be sticky (not as flexible), set by contracts; fixed interest rates & yearly wage contracts -Output Prices: are more flexible & easier to change -Short run results if output prices (price levels) rise: With sticky resource prices output is increased to maximize profits. Many firms affected so aggregate output increases. -Short run result if output prices (price levels) fall: With sticky resource prices output will decrease
Sources of Economic Growth
-Resources: aka Factors of Production are the inputs used to produce goods & services *Examples: Physical land & natural resources; Labor-workers in an economy; Effective Labor-labor adjusted for training and education resulting in a more productive workforce; Capital- tools & equipment used in the production of goods -Technology: The knowledge that is available for use in production. *Examples: Technological advancements- introduces new techniques or methods so that firms can produce more valuable outputs per unit of input; Economic growth occurs when the resources & technology work together -Institutions: A significant practice, relationship, or organization in a society. Includes laws, regulations, government, work habits, expectations, and political behavior. *Important institutions for economic growth: Political Stability & Rule of law; Private Property Rights; Stable $ and prices; competitive markets; efficient taxes; international trade; flow of funds across borders
Shifts in the SRAS
-Suppose there is a short run supply shock caused by an oil pipeline break. Leftward shift in SRAS; break is only temporary & SRAS will eventually shift back to the right to original curve -End result: Short run disruptions in AS don't alter the long run equilibrium in the economy. Price level, output, and unemployment rte will eventually return to their long run levels
Efficient Taxes
-Taxes represent a trade off -They must be high enough to support efficient government spending -Taxes change incentives by doing less of the activity that is taxed, often wages and output are taxed -Import tariffs also impede growth *Efficient taxes are taxes sufficient to fund the activities of government while impeding production and consumption decisions as little as possible*
Aggregate Supply (AS)
-Tells us how many goods and services people want at different price levels -The slope of AS depends on the time horizon, either Short Run AS or Long Run AS
Labor Force Participation Rate
-Tells us the fraction of people who are working or looking for work Labor Force Participation Rate = labor force/population x100
Interest Rates
-The price of loanable funds -Savers: The reward for saving, receive $ for saving $ -Borrowers: The cost of borrowing, will pay more back than loaned due to interest rates -Affected by supply and demand
Natural Rate of Output
-The rate of production achieved by the economy in the long run when unemployment is at its natural state Y* = natural rate of output when u=u*
International Trade
-Trade creates value & allows counties to consume products they cannot make on their own -Output (GDP) increases when countries produce goods in which they have the comparative advantage (lowest opportunity cost) -Without trade many countries wouldn't be able to produce many resources necessary for production and growth would stop
Structural unemployment
-Unemployment caused by changes in the industrial makeup (structure) of the economy. -New industries are created and old ones are destroyed "creative destruction" -What can structurally unemployed people do? Retrain, reeducate, relocate, or change expectations about work and pay. -Gov can help with training programs or relocation subsidies.
Frictional Unemployment
-Unemployment caused by time delays in matching available jobs and workers. -People don't instantly take new jobs & they might not want to take the first available job -Can also be affected by Gov regulations that make it difficult to hire/fire.
Long Run Aggregate Supply (LRAS)
-Vertical (infinite) slope (full employment output) -Price levels have nothing to do with long term output & growth of the economy -Long Run: A period of time sufficient for all prices to adjust -Causes: Resources, Technology, Institutions -LRAS shifts when there is a long run change in a nation's ability to produce a product -Whenever the Long Run AS curve shifts, it takes the Short Run AS curve with it
Adjustments to errors in past price expectations
-We're not always correct in our assumptions about future prices. If we greatly underestimate inflation we'll want to renegotiate our wage contracts ASAP. Many workers will do this affecting SRAS as costs for a firm change
Factors That Increase AD
-Wealth Increase: Consumption -Higher Expected Prices: Consumption -Higher Expected Income: Consumption -Increased Consumer Confidence: Consumption -Increased Capital Productivity: Investment -Increased Investor Sentiment: Investment -Increased Foreign Income: Net Exports -Decreased Value of U.S. $: Net Exports
Wealth & Wealth Effect
-Wealth: The value of one's accumulated assets -Wealth Effect: The change in the quantity of aggregate demand that results from wealth changes due to price-level changes *Increasing price levels will decrease your purchasing power which reduces spending and decreasing the quantity of goods demanded*- one reason is the negative AD slope
Shifts In Short Run Aggregate Supply
-Whenever the Long Run AS curve shifts, it takes the Short Run AS curve with it -Factors that shift ONLY the Short Run AS curve: Temporary supply shocks; Changes in expected future prices; Adjustments to errors in past price expectations
Describe four factors that can affect the natural rate of unemployment and indicate the impact of each on the value of the natural rate of unemployment in an economy.
1) An increase in unemployment benefits can increase the natural rate of unemployment. 2) An increase in the number of new workers in the labor force increases the natural rate of unemployment. 3) A decline in union membership decreases the natural rate of unemployment. 4) An increase in labor productivity decreases the natural rate of unemployment.
Using the AD & AS Model
1) Begin with the model in long run equilibrium 2) Determine which curve(s) are affected by the change(s) and the direction(s) of the change(s) 3) Shift the curve(s) in the appropriate direction(s) 4) Determine the new short run and/or long run equilibrium points 5) Compare the new equilibrium with the starting point
List five ways firms use technology to increase productivity.
1) Conducting business meetings via video conferencing rather than by traveling to a destination for a meeting. 2) Computer-aided design programs used by architects and engineers to create and test their designs. 3) Computerized inventory control systems that are linked to check-out stations in stores. 4) E-mail used in place of traditional mail or paper documents. 5) Use of company or university Web pages to display information and reduce the need for printed documents
How would you respond to a friend who claims that the government should eliminate all purchases that are financed by borrowing because such borrowing crowds out private investment spending?
1. You might first acknowledge that, other things equal, when the government runs a budget deficit, there is an decrease in the supply for loanable funds (public savings decreases). The decrease in supply raises interest rates and decreases private investment spending. This means that businesses will add less physical capital each year and productivity growth may be slower than it would be if the government had not borrowed to cover its deficit. However, you might then explain that some government purchases are necessary for economic growth. Government funds much of the infrastructure within which the economy operates (for example, the legal framework, the court system, and the communications network), and the government also invests in education, roads, and airports necessary for economic growth.
The average student purchases three English, two math, and four economics textbooks per year. The prices of these books are given in the accompanying table. English textbook: 2010=$50 ; 2011=$55 ; 2012=$57 Math textbook: 2010=$70 ; 2011=$72 ; 2012=$74 Econ textbook: 2010=$80 ; 2011=$90 ; 2012=$100 A) What is the percent change in the price of an English textbook from 2010 to 2012? B) What is the percent change in the price of a math textbook from 2010 to 2012? C) What is the percent change in the price of an economics textbook from 2010 to 2012? D) Using 2010 as a base year, create a price index for these books for all years. E) What is the percent change in the price index (inflation rate) from 2010 to 2012?
A) 14% -((57-50)/50)x100 B) 5.7% -((74-70)/70)x100 C) 25% -((100-80)/80)x100 D) First calculate the cost of the market basket for each year (3 En, 2 M, 4 Ec books) in each of the three years. Add up the basket prices and divide by thee base year. IV 2010= 100 IV 2011= 109.7 IV 2012= 117.9 E) % change in price index for books from 2010-2012 = 17.9% -((117.9-100)/100)x100 = 17.9
How will the following changes affect the natural rate of unemployment? A) The government reduces the time during which an unemployed worker can receive unemployment benefits. B) More teenagers focus on their studies and do not look for jobs until after college. C) Greater access to the Internet leads both potential employers and potential employees to use the Internet to list and find jobs. D) Union membership declines
A) If the government reduces the time during which an unemployed worker can obtain benefits, workers will be less willing to spend time searching for a job. This will reduce the amount of frictional unemployment and lower the natural rate of unemployment. B) Since teenagers have a higher rate of frictional unemployment, this will lower the overall amount of frictional unemployment and lower the natural rate of unemployment. C) Greater access to the Internet would facilitate job searches, reducing frictional unemployment and lowering the natural rate of unemployment. D) Since strong unions negotiate wages above the equilibrium level, they are a source of structural unemployment. A decline in union membership will reduce structural unemployment and, with it, the natural rate of unemployment.
Describe whether the following changes cause the aggregate demand curve to increase, decrease, or neither. A) The price level increases. B) Investment decreases. C) Imports decrease and exports increase. D) The price level decreases. E) Consumption increases. F) Government purchases decrease.
A) Neither. A change in the price level (P) leads to a movement along the AD curve. When the price level rises, the quantity of aggregate demand declines along the curve. B) Investment (I) is one component of aggregate demand, so a decrease in investment decreases aggregate demand. C) Net exports (NX) is another component of aggregate demand. An increase in exports and a decrease in imports imply that net exports rise, so aggregate demand increases. D) Aggregate demand neither increases nor decreases with a change in the price level (P). A change in the price level leads to movement along the AD curve. When the price level decreases, the quantity of aggregate demand declines along the curve. E) Consumption (C) is a component of aggregate demand, so an increase in investment means an increase in aggregate demand. F) Government purchases (G) are a component of aggregate demand, so a decrease in government purchases causes a decrease in aggregate demand.
Describe whether the following changes cause the short-run aggregate supply to increase, decrease, or neither. A) The price level increases. B) Input prices decrease. C) Firms and workers expect the price level to fall. D) The price level decreases. E) New policies cause an increase in the cost of meeting government regulations. F) The number of workers in the labor force increases.
A) Neither. A change in the price level will only cause a movement along the curve for SRAS. So when the price level increases, quantity supplied increases. B) SRAS will shift to the right/increase. Since input prices are lower, then all else being equal, production is less expensive so at every price level firms can make more output. C) If workers and resource suppliers expect prices to fall in the future, they negotiate wages and prices at lower nominal levels. Short-run aggregate supply increases. It's like production has gotten less expensive, so at every price level, firms can make more output. D) Neither. A change in the price level will only cause a movement along the curve for SRAS. So when the price level decreases, quantity supplied decreases. E) SRAS will shift to the left/decrease. The government regulations have made the production of goods more expensive all other things being equal. The increase in production costs cause firms to produce less output at every price level. F) LRAS increases/shifts to the right with an increase in the number of workers. When LRAS shifts, it takes the SRAS with it. So the increase in LRAS causes an increase in SRAS as well.
Describe whether the following changes cause the long-run aggregate supply to increase, decrease, or neither. A) The price level increases B) The stock of capital in the economy increases C) Natural resources increase D) The price level decreases E) Firms and workers expect the price level to rise F) The number of workers in the labor force increases
A) Neither. In the LR, output does not depend on the price level. B) LRAS will increase since the workers in the economy will now have more capital to work with so the natural rate of output will increase. C) LRAS will increase. Think about an increase of natural gas or oil. These will help the natural rate of output to increase in the LR. D) Neither. In the LR, output does not depend on the price level. E) Neither. In the LR, the natural rate of output does not depend on the price level. F) LRAS will shift to the right since we have more workers our macroeconomy can now make more output when u=u*.
Assume that the residents of a nation become more patient (experience a reduction in their time preferences). A) What will happen to the interest rate in that nation? What will happen to the equilibrium level of investment in that nation? Explain your answers. B) In the long run, how will the lower time preferences affect the levels of capital and income growth in that nation?
A) Supply of loanable funds shifts to the RIGHT/INCREASE which will decrease the interest rate and increase the level of investment in the nation (otherwise known as the equilibrium quantity of loanable funds). Draw this graph as part of your explanation. B) Since Investment is going up from the increase in the supply of loanable funds, then GDP will increase (since I is a part of GDP), and income will grow!
Determine the effect on the short-run aggregate demand (AD) curve for each of the following scenarios and sketch a graph to illustrate each answer. A) Decrease in consumer wealth occurs due to a plunge in stock prices. B) Households and businesses have more optimistic expectations regarding future economic performance. C) There are higher levels of investment spending by businesses. D) The government cuts taxes for households and businesses. E) The Fed decreases the money supply.
A) The AD curve will shift to the left. B) The AD curve will shift to the right C) The AD curve will shift to the right D) The AD curve will shift to the right E) The AD curve will shift to the left
A) Why is the LRAS curve vertical? B) Can the LRAS curve shift?
A) The LRAS curve is vertical because despite any changes in the aggregate price level, aggregate output cannot change from its fixed level, known as potential output. This is due to the fact that all prices, including nominal wages, are fully flexible in the long run B) Due to long-run economic growth, the level of potential output can increase over time, resulting in a right-ward shift of the LRAS
Determine the effect on the short-run aggregate supply (SRAS) curve for each of the following scenarios. Demonstrate graphical analysis in each case. Remember to accurately label all lines, points, and axes when drawing the graphs for these exercises. A) Labor productivity increases in the macroeconomy. B) An earthquake destroys a significant amount of infrastructure in the economy. C) Technological progress occurs in the economy.
A) The SRAS curve will shift to the right B) The SRAS curve will shift to the left C) The SRAS curve will shift to the right
Suppose that you also take out a $1,000 loan at the Cavalier Credit Union. The loan agreement stipulates that you must pay it back with 4% interest in one year, and again, the inflation rate is expected to be 2%. A) If the inflation rate turns out to be 3% rather than 2%, who will be hurt by this? Why? B) If the inflation rate turns out to be 3% rather than 2%, who will be helped by this? Why?
A) The bank is hurt by this. They thought they were going to earning 2% real interest on the loan they gave you but it turns out that they will only earn 1% real interest on the loan due to the increase in inflation. B) You are. You expected to pay a real interest rate of 2% but now you only have to pay a real interest rate of 1%.
Year 1: Real GDP=$50,000 ; Population=200 Year 2: Real GDP=$51,400 ; Population=202 A) Calculate the growth rate of real GDP over the year. B) At this rate of growth, approximately how many years will pass before real GDP doubles? C) Find real GDP per capita in each of the two years. Using these two values, calculate the growth rate of real GDP per capita over the year. D) At this rate of growth, approximately how many years will pass before real GDP per capita doubles?
A) The rate of growth is [($51,400 - $50,000)/$50,000] x 100 = 2.8% B) The rule of 70 tells us that real GDP will double in approximately 70/2.8 = 25 years C) Real GDP per capita in year 1 is $50,000/200 = $250, while in year 2 it is $51,400/202 = $254.46. The growth rate of real GDP per capita is then found as [($254.46 - 250)/250] x 100 = 1.78% D) The rule of 70 suggests that real GDP per capita will double in approximately 70/1.78 = 39.3 years.
Compute the answers to the following questions. A) Samantha invested $2,500 of her savings in a certificate of deposit that pays an annual 4.25% rate of interest. The current annual inflation rate is 5%. Has Samantha made a wise investment from an economic perspective? B) William wants to earn a real annual interest rate on his investment of at least 7%. If the annual rate of inflation is 4%, what is the minimum nominal rate of interest William would be willing to accept on his investment?
A. Samantha has not made a wise investment, as the real interest rate she is earning on this investment is negative. The real interest rate Samantha is earning is computed as follows: Real interest rate = Nominal interest rate - Rate of inflation Real interest rate = 4.25% - 5% = -0.75% B) William must receive a minimum nominal annual rate of interest equal to 11%, which is computed as follows: Real interest rate = Nominal interest rate - Rate of inflation 7% = Nominal interest rate - 4% Nominal interest rate = 11%
Aggregate Demand (AD)
AD = C + I + G +NX -Has a negative slope due to wealth effect, interest rate effects, international trade effect
In comparing the CPI with the GDP deflator, which of the following is not correct?
Both the CPI and the GDP deflator are based on a basket of goods that changes infrequently. -The CPI compares the price of a fixed basket of goods and services to the price of the basket in the base year. The Bureau of Labor Statistics changes this basket infrequently. The GDP deflator compares the price of currently produced goods and services to the price of the same goods and services in the base year.
Using the rule of 70, compute the following: In 2000, GDP per capita in the United States was about eight times that of China. Let U.S. GDP per capita be $8,000 and China's GDP per capita be $1,000. Suppose that China grows at 10% and the United States grows at 3%. In about 23 years, the United States will be at $16,000. How large will China's GDP per capita be around the same time? What has happened to the gap in GDP per capita?
China's real GDP per capita will be $8,000. The gap goes from a 8 fold difference to a 2 fold difference.
The basket of goods is 3 footballs and 4 basketballs. Compute the cost of the basket in each year, the CPI for each year with Year 1 as the base year, and the rate of inflation for years 2 and 3. Year 1: $ of footballs=$10 ; $ of basketballs=$12 Year 2: $ of footballs=$12 ; $ of basketballs=$15 Year 3: $ of footballs=$14 ; $ of basketballs=$18
Compute the Cost of the Basket: Cost in Year 1 = (3 × $10) + (4 × $12) = $78 Cost in Year 2 = (3 × $12) + (4 × $15) = $96 Cost in Year 3 = (3 × $14) + (4 × $18) = $114 Using Year 1 as the base year, compute the index: CPI in Year 1 = ($78/$78) × 100 = 100 CPI in Year 2 = ($96/$78) × 100 = 123.08 CPI in Year 3 = ($114/$78) × 100 = 146.15 Compute the inflation rate: Inflation rate for Year 2 = [(123.08 - 100)/100] × 100 = 23.08% Inflation rate for Year 3 = [(146.15 - 123.08)/123.08] × 100 = 18.74%
Why does inflation have a positive effect on nominal interest rates?
Inflation has a positive effect on the nominal interest rate because individuals and firms care about the real interest rate. If you want a real return of 3% on your savings, then the nominal rate has to be that 3% plus whatever the rate of inflation is. (see the previous answer on the Fisher effect). Real Interest Rate = Nominal Interest Rate - Inflation OR Nominal Interest Rate = Real Interest Rate + Inflation If you want to keep the real interest rate constant at 3% and inflation increases, then the nominal interest rate must increase by the same amount.
You work for Dr. Zhang, the autocratic dictator of Zhouland. After taking an economics course, you decide that devaluing your currency (Zhoullars) is the way to increase GDP. Following your advice, Dr. Zhang orders massive increases in the supply of Zhoullars, which reduces the value of Zhoullars in world markets. Use the AD-AS model to determine the effects to real GDP, unemployment, and the price level in Zhouland in both the short run and the long run. Assume the economy was in long-run equilibrium before this change and consider only this stated change.
The reduction in the value of the Zhoullar means an increase or positive shift in the aggregate demand curve. This creates the same scenario pictured in the solution to problem #10; please refer again to that figure. In the short run, there is greater real GDP, lower unemployment, and a higher price level. This short-run equilibrium is pictured as point b in the figure. In the long run, the only change is an increase in the price level (P), as indicated by the new long-run equilibrium at point C in the figure. Note that this is consistent with the discussion of inflation in Chapter 9. That is, the cause of inflation is monetary expansion. When Dr. Zhang commanded that the number of Zhoullars should increase, this meant that inflation would eventually arrive.
College tuition has risen significantly in the last few decades. From the 1979-1980 academic year to the 2009-2010 academic year, total tuition, room, and board paid by full time undergraduate students went from $2,327 to $15,041 at public institutions and from $5,013 to $35,061 at private institutions. This is an average annual tuition increase of 6.4% at public institutions and 6.7% at private institutions. Over the same time, average personal income after taxes rose from $7,956 to $35,088 per year, which is an average annual rate of growth of personal income of 5.0%. Have these tuition increases made it more difficult for the average student to afford college tuition?
To determine whether it is more or less difficult for a typical person to afford college, we would need to know how much tuition had increased relative to average income in the United States. Average personal income after taxes rose from $7,956 to $35,088 from 1979 to 2009, or an average annual increase of 5.4%. So it was more difficult for the average person to afford to attend either a public institution, where tuition increased 6.4% annually, or a private institution, where tuition increased 6.7% annually.
True or False: The recession of 2008-2009 was associated with a decrease in aggregate demand.
True -As housing prices fell, spending on the construction of housing collapsed. Because of large losses many financial institutions did not have funds to lend out. Even creditworthy customers found themselves unable to borrow to finance investment spending.