Econ Exam 1

Question 1

What is the Paradox of thrift?

Answer 1

• When families and businesses are worried about the possibility of economic hard times, they prepare by cutting their spending. This reduction in spending depresses the economy as consumers spend less and businesses react by laying off workers.
  o As a result, families and businesses may end up worse off than if they hadn’t tried to act responsibly by cutting their spending
• This is a paradox because the responsible act of cutting spending actually hurts more than it does help individuals

Question 2

What are the monetary and fiscal policies?

Answer 2

Monetary Policy
o Changes in the quantity of money in circulation designed to alter interest rates and affect the level of overall spending
Fiscal Policy
o Changes in taxes and government spending to affect overall spending

Question 3

What is the business cycle?

Answer 3

The business cycle:
Recession
o A widespread downturn, in which output and employment in many industries fall.
Expansion
o When most economic numbers are following their normal upward trend
o Output and employment are rising
The alternation between these is known as the business cycle
o The short run

Question 4

What is the pain of recession?

Answer 4

• The most important effect is on the ability to find and hold a job
• The most widely used indicator is the unemployment rate
• There is a reduction in standard of living of households
• Bad for everyone

Question 5

How do you tame the business cycle?

Answer 5

• Monetary and fiscal policy

Question 6

What is long-run economic growth?

Answer 6

Definition
o The sustained upward trend in the economy’s output overtime
- Increases in the economies potential lead to economic growth overtime
- This is a modern invention
- Countries don’t necessarily grow at the same rate
- This is the key to higher wages and a rise in the standard of living

Question 7

What is inflation and Deflation?

Answer 7

Inflation
o A rise in the overall level of prices
Deflation
o A fall in overall level of prices

Question 8

What causes inflation and Deflation?

Answer 8

• In the short-run, movements are closely related to the business cycle
• When the economy is depressed and jobs are hard to find, inflation tends to fall; when the economy is booming, inflation tends to rise
  o when spending is at its highest companies are pressured to increase their prices, which in turn causes inflation
• In the long run, the overall level of prices is mainly determined by changes in the money supply

Question 9

What is the pain of inflation and deflation?

Answer 9

• Inflation discourages people from holding onto cash (because cash loses values if prices are rising). In extreme cases, people stop using cash altogether.
• Deflation can cause the reverse problem. Since cash gains value if the price level is falling, holding on to it is more attractive than investing in new factories and other productive assets. This deepens a recession.

Question 10

What are international imbalances?

Answer 10

Canada is an open economy:
o Meaning it trades goods and services with other countries
In 2015, Canada ran a trade deficit:
o Which is when the value of goods and services bought from foreigners is more than the value of goods and services sold to them
Trade surplus
o The value if goods and services bought from foreigners is less than the value of the goods and services sold to them

Question 11

What causes trade imbalances?

Answer 11

• The determinants of the overall balance between exports and imports lie in decisions about savings and investment spending
• Countries with high investment spending relative to savings run trade deficits; countries with low investment spending relative to savings run trade surpluses.

Question 12

What is GDP, and what does it tell us?

Answer 12

Gross domestic product (GDP):
- Is the total value of all final goods and services produced in an economy during a given period, usually in a year.

Question 13

What are the national accounts?

Answer 13

National income
Product accounts
o National accounts keep track of the spending of consumers, the sales of producers, business investment spending, government purchases, and a variety of other flows of funds between different sectors of the economy.
- Measures nations economic performance

Question 14

Final Vs Intermediate goods

Answer 14

Final Vs Intermediate goods
- Final goods
o Goods and services sold to final, or end, user.
- Intermediate goods
o Goods and services that are inputs for production of final goods and services.

Question 15

What is aggregate expenditure?

Answer 15

Aggregate expenditure
- Is the sum of government spending, consumer spending, investment spending, and exports minus imports.
- This is the total spending on domestically produced final goods and services in the economy.

Question 16

What are the 3 ways to calculate GDP?

Answer 16

• The value-added approach: adding up total value of all final goods and services produced.
• The expenditure approach: adding up spending on all domestically produced goods and services
  o GDP = C + I + G + NX
• The income approach: adding up total factor income earned by households from firms in the economy

Question 17

The value added approach

Answer 17

adding up total value of all final goods and services produced.
o Excludes intermediate goods and services
- Value added definition
o The value added of a producer is the value of its sales minus the value of its purchases of intermediate goods and services
o We subtract the cost of inputs

Question 18

The expenditure approach

Answer 18

• Adding up aggregate expenditure on domestically produced final goods and services.
• Denoting the variables in the GDP equation
  o Household consume = Consumption [C]
  o Firms invest [I]
   Ex: buying a NEW house is investment
  o Government spending [G]
   Building a highway, project development
   US military budget
  o Foreign sector buys our things = Net exports [NX]
• We must take into account the spending on imports, denoted by IM (it is an outflow of cash)
• GDP = C + I + G + X – IM

Question 19

The income approach

Answer 19

Factor incomes
 Income earned by factors of input or production.
 Examples are: (wages, interest, rent, dividends and profits) wages earned by workers, interest paid to those who lend their savings to firms, the rent earned by those who lease their land or structures to firms, dividends paid to shareholders, who own a firms physical capital; and other income earned by those who are directly involved in the production of goods and services

Non-factor payments
 Consists of the income earned by the federal government as a result of the production of goods and services.
 The difference between the prices paid for final goods and services and the amount received by factors of production
 Examples: provincial and federal sales taxes, less any subsidies paid to purchasers
* Capital depreciation

Question 20

Real GDP

Answer 20

Is a measure of GDP in which the quantities produced are valued at the prices in a base year rather than at current prices; real GDP measure the actual physical volume production.

Question 21

Nominal GDP

Answer 21

Is a measure of GDP in which the quantities produced are valued at current-year prices; nominal GDP measures the current dollar value of production

Question 22

What is the aggregate price level

Answer 22

o Is a measure of the overall level of prices in the economy
o A single number representing the overall level of prices

Question 23

What is Price Index and how is it calculated?

Answer 23

o Measures the cost of purchasing a given market basket in a given year, where that cost is normalized so that it is equal to 100 in the given base year
 Price index in a given year = Cost of market basket in a given year/cost of market basket in a base year x 100

Question 24

What is consumer price index and how is it calculated?

Answer 24

• Measures the cost of the market basket of a typical urban American family.
• Shows the changes of cost of all purchases by a typical Canadian family
• Formula:
  o Cost of (fixed) market basket in a given year/ Cost of (fixed) market basket in a base year X 100

Question 25

What is the definition of unemployment?

Answer 25

The total number of people aged 15 or older who are actively looking for work but aren’t currently employed

Question 26

What does the labour force consist of?

Answer 26

The sum of employment and unemployment

Question 27

How to calculate the labour force participation rate?

Answer 27

Labour force/population age 15 and older multiplied by 100

Question 28

What is the definition of unemployment rate? How is it calculated?

Answer 28

The percentage of the total number of people in the labour force who are unemployed

Number of unemployed workers/ labour force x 100

Question 29

How can the unemployment rate overstate the true level of unemployment?

Answer 29

Even if the labor market is healthy, it takes time to find the right job. (Meanwhile,
you’re “unemployed.”)

The unemployment rate never falls to zero even when jobs are plentiful

Question 30

How can the unemployment rate understate the true level of unemployment?

Answer 30

You are not “unemployed” if you have given up looking for a job because there are no jobs available.

When you stop looking for a job you drop out of the labour force

Question 31

What are the 3 categories in which workers are omitted?

Answer 31

1) Discouraged workers
- People not working who have sought employment within the last 12 months; however, they are not currently seeking work because they feel they have little hope of getting a job in the current market
-The deeper the recession, the more discouraged workers there are

2) Marginally attached workers
-People not working and have stopped seeking employment; however, they stopped because they’re waiting for employment to begin. Example is a layoff

3) Underemployed workers
-Do work, but not in a desired capacity
-Can be that they don’t receive enough hours

Question 32

Growth and Unemployment

Answer 32

Jobless recovery or growth recession
o A period in which GDP is growing at a below average rate and unemployment is rising

Question 33

What consists of the natural rate of unemployment?

Answer 33

• Frictional unemployment
  Unemployment due to the time workers spend in job search
• Structural unemployment
  Unemployment that results when there are more people seeking jobs in a particular labour market than there are jobs available at the current wage rate.

Question 34

What is actual unemployment and what does it consist of?

Answer 34

Natural unemployment + cyclical unemployment

Question 35

What is cyclical unemployment?

Answer 35

unemployment correlated with the business cycle— the deviation from the natural rate

Question 36

What are price indices?

Answer 36

one number that summarizes what happens with “prices” in the economy.

Such a number is called a Price index.

Question 37

What is the Consumer Price Index?

Answer 37

• It is a way to measure the price level and to calculate the rate of inflation.
• It is also a useful gauge of the cost of living.
• The CPI calculates the cost of a standard set (“basket”) of goods and services relative to the cost of that same set of goods and services in a fixed year, called the base year.

Question 38

How is CPI used to calculate the rate of inflation?

Answer 38

The CPI is a measure of the price level, so:

Inflation rate this year = (CPI this year – CPI last year)/CPI last year

Question 39

What is the definition of inflation?

Answer 39

Inflation is defined as the percentage change in the price index.

Question 40

What is indexing?

Answer 40

Increase nominal wage to compensate for inflation, to keep real wage constant.

Question 41

Nominal Vs Real interest rate?

Answer 41

Inflation that is higher than expected will reduce the real interest rate, this is good for borrowers and bad for lenders.

• Similarly lower than expected inflation will lead to higher real interest rates, this bad for borrowers and good for lenders.

Question 42

What is wrong with too much inflation?

Answer 42

It generates costs to the overall economy, where nobody gains

Unexpected redistributions of wealth

Question 43

What is wrong with too much Deflation?

Answer 43

Expectation of future lower prices reduces spending.

Unexpected deflation also leads to redistribution