Economic Concepts and Analysis Economic Measures/Indicators

Question 1

During the recessionary phase of a business cycle:

Answer 1

Cost go down
resources become unemployed and actual output falls below potential output
a decline in the number of hours in the average workweek since output falls.
the natural rate of unemployment will remain unchanged.

Question 2

monetary policy that the Federal Reserve Bank uses to control the supply of money (M1):

Answer 2

• Selling government securities
• Changing the reserve ratio
• Raising or lowering the discount rate

Question 3

M1 is:

Answer 3

M1 is the most narrowly defined component of the money supply. It consists of coins
and currency in the hands of the public and the checkable deposits held in commercial banks and thrift institutions.

Question 4

GDP EXPENDITURE APPROACH

Answer 4

The expenditure approach is the method of measuring the market value of all output by adding up the spending to purchase all final output, to yield gross domestic product and aggregate expenditure. It is a method of national income accounting and is analogous to the Income Approach. The expenditure approach is a macroeconomic concept.

GDP = Consumption expenditure + Investment expenditure + Government expenditure + Net exports.

GDP = C + I + G + (X - M)

Question 5

INCOME APPROACH

Answer 5

The income approach is the method of measuring the market value of all output by adding up the factor payments and claims on the value of all final output, to yield gross national product. It is a method of national income accounting and is used to compute net national income. Income approach analogous to the Expenditure Approach. It is a macroeconomic concept.

GNP = Factor Payments + Other Claims on the Value of Output
= Wages + Rent + Interest + Profits + Capital Consumption
Allowance
+ Indirect Taxes, Net of Subsidies

Question 6

Personal income is all income received by individuals whether earned or unearned and is computed before any deductions for personal income taxes. National income (NI) includes all income by American-used resources whether used/invested at home or abroad. Since all income earned is not received, we must adjust NI by deducting Social Security contributions, corporate income taxes and undistributed corporate taxes. Also, some income received is not earned and so we must add in transfer payments received by individuals, including such things as Social Security payments received, unemployment compensation, and welfare payments.

Answer 6

Gross domestic product (GDP) $4,000
- Depreciation (500)
——-
= Net domestic product (NDP)(at mkt cost) $3,500
- Indirect business taxes (210)
——-
= Net national income (NNI) (at factor cost) $3,290
- Corporate income taxes ( 50)
- Undistributed corporate profits ( 25)
- Social Security contributions (200)
+ Transfer payments 500
——-
= PERSONAL INCOME $3,515
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Question 7

Personal Income 2

Answer 7

Personal income is the measure of all income received by individuals (either earned or unearned) before income taxes. It is a macroeconomic concept.

       NI
     - Social Security contributions
     - Corporate income taxes
     - Undistributed corporate profits
     \+ Transfer payments
     -----------------------------------
       Personal income

Question 8

Net national product (NNP) is the sum of the four components of factor income: wages, rent, interest, and profits plus indirect taxes less government subsidies. It is a measure of national income computed by the income approach to national income accounting. It may also be determined as a GDP-Capital Consumption Allowance. It is a macroeconomic concept.

NNP is the maximum amount that can be consumed without reducing the economy’s existing capital stock.

Answer 8

NNP = NI + Indirect taxes - Subsidies
= Wages + Rent + Interest + Profits + Indirect taxes - Subsidies
GNP at market prices
- Capital consumption allowance (depreciation)
= NNP (at market prices)
- Indirect taxes, net of subsidies
= NI (at factor cost)
- Retained earnings and business taxes
+ Transfer payments to households
= Personal income
- Personal income taxes
= Disposable income
Indirect taxes represent taxes on the production and sale of commodities (i.e., the government’s claim on the value of output).

Question 9

Inventory cycle

Answer 9

Inventory levels tend to be high as the economy begins the contraction phase of the business cycle and firms cut orders and use their unanticipated inventory to meet demand, attempting to bring inventory levels back to their desired level as contraction continues. Thus, inventory levels tend to be low at the end of the contraction phase due to deliberate management actions

Question 10

Induced investment is the investment made in an economy in response to: changes in the level of national income.

Answer 10

The accelerator principle says that small changes in consumer spending can cause big percentage changes in investment. It plays a role in many business-cycle theories and is still used today to explain some of the fluctuation in investment.

In a very simple form, the accelerator principle assumes that the ratio of capital to output tends to remain constant. Suppose, for example, that normally it takes $1,000 worth of equipment to manufacture $1,000 worth of shoes each year. Suppose further that each year one-tenth of the equipment wears out. If there is no growth or decline, total investment each year will be $100, all for replacement.

Now suppose that the sales of shoes jump by 5%, to $1,050 each year. The new desired amount of equipment will also rise by 5%, to $1,050. However, to obtain this new level, investment will have to increase by 50%, to $150. Thus, if firms desire a constant capital-to-output ratio, a small percentage change (either an increase or decrease) in final sales, can lead to a big percentage change in investment.

Question 11

Effective ways to dampen the economy and prevent inflation include the following:
•The government can increase interest rates, thus increasing the cost of borrowing. This will decrease spending.
•The government can increase taxes, resulting in fewer dollars being available for spending.

Answer 11

• The government can decrease its own spending, thus reducing aggregate demand.
• The government can reduce the money supply, thus causing an increase in interest rates, resulting in a decrease in spending.

Question 12

the multiplier explains why:

a small change in investment can have a much larger impact on gross domestic product

Answer 12

A multiplier is the ratio of the change in national income (and subsequently national product) to the initial change in autonomous expenditure that brings it about. The central assumption in the multiplier effect is that an increase in autonomous expenditure, in this case investment expenditure, will result in a greater increase in national income (and subsequently national product). Policy setters can stimulate or depress an economy by changing autonomous expenditures, be it investment, government spending or exports.

Question 13

How does a change in net investment affect the level of income?

A decrease in net investment will cause a more than proportional decrease in the level of income.

Answer 13

In macroeconomics, equilibrium national income is affected by changes in autonomous consumption, net investment, and government expenditures.

The actual impact on national income will be multiplied, positively or negatively, by some multiple of the initial change. This is due to the “multiplier effect,” which magnifies small changes in C, In, or G into larger overall changes to national income.

Thus, a decrease in net investment (In) will decrease national income by a larger amount than the original decline in investment.

Question 14

Autonomous expenditure (AE) is independent of other variables. Specifically, AE is spending that is not dependent upon changes in national income, interest rates, or other variables. It is a variable that is explained by variables outside the model. AE is spending determined by factors or forces other than the variables of national income accounting theory. It is a macroeconomic concept.

Answer 14

Compare to Induced Expenditure.

AE may be expressed as the combination of autonomous expenditure and induced expenditure (from the basic national income equations), as the aggregate expenditure function, relating desired expenditure to income:

 AE = Autonomous expenditure + Induced expenditure
    = (a + I + G + X) + (bh - m)Y

Question 15

Dicsount rate down Economy expands

Answer 15

A discount rate is the minimum acceptable rate of return on an investment. It is used to calculate the present value of future cash flows.

Discount rates are used in net present value and internal rate of return calculations.

Question 16

Reserves

Reserves are that portion of a bank’s deposits held as vault cash or on deposit with the central bank. The size of reserves is mandated by the Federal Reserve (e.g., 12% of deposits). Control of the size of reserves also helps the central bank control the money supply; a macroeconomic concept.

Answer 16

Bank reserves are decreased (increased) by the sale (purchase) of government securities by the Federal Reserve (because the Fed receives a check drawn on the deposits in a buyer’s commercial bank; upon presentation of the check by the fed for payment, the bank’s reserves are decreased); and are increased by a decrease in currency held by the public, an increase in the Federal Reserve float, loans to several member banks by the Fed, and by the purchase of gold by the Fed.

Sale of securities by the Fed would also tend to increase interest rates (because member bank reserves are decreased and decreases in bank reserves result in a decrease in the potential money supply.)

Question 17

•Reserve ratio = Reserves / Total Demand Deposits,

Answer 17

• If reserves increase by $1 million and the reserve ratio is 20%,
• 0.20 = 1,000,000 / increase in deposits.

Question 18

Aggregate demand is defined as:

Answer 18

a schedule or curve that shows the amount of real GDP or output that buyers collectively desire to buy at every price level.

Aggregate demand is the amount of goods and services—the amount of real national income—that will be purchased at each possible price level. There is an inverse relationship between the price level and real GDP (gross domestic product). There are three different price effects that explain this inverse relationship. The real balance effect reduces the purchasing power effectiveness of accumulated public savings balances. Since consumers are now poorer in real terms, they will need to reduce their spending. The interest-rate effect causes consumers to need more money for their purchases as prices increase. The increase in demand for money will drive up interest rates which would reduce business investment and interest-related consumption spending, thus reducing demand. Finally, we have the foreign purchases effect. When prices of domestic goods rise relative to foreign prices, foreign consumers would buy fewer of our goods, and our consumers would buy more foreign goods.

Question 19

During the recessionary phase of a business cycle:

potential national income will exceed actual national income

Answer 19

A recession is defined as a period when real output, as measured by real national income, is decreasing. Thus, during a recession, actual real national income falls short of potential real national income, because some resources are unemployed and the economy operations below capacity.

Question 20

The dependency ratio is :

Answer 20

The dependency ratio is arbitrarily defined as the ratio of the elderly (those 65 years and over) plus the young (those under 15 years of age) to the population in the “working ages” (those 15–64 years of age).

Question 21

current pattern of FDI may be described as having:
investment flow from emerging market economies to other emerging market economies and more developed economies, as many of these emerging economies capture an increasing amount of foreign exchange earnings either from the sale of raw materials or rising trade surpluses from the export of manufactured goods.

Answer 21

Traditional patterns of foreign direct investment (FDI) saw funds flow from slower-growing, rich, developed economies to emerging market economies. There has been a dramatic shift in FDI such that today major flows go from emerging market economies to more developed economies.

The lack of well-functioning capital markets coupled with a lack of sufficient local investment opportunities has created a pool of funds available for investment. Some of the goals pursued when using SWFs (sovereign wealth funds) to invest these funds would be to acquire technologies, brands, resources, and better access to international markets while using technology to enhance productivity and gain Western management skills.

Question 22

Sovereign wealth funds (SWFs) are:
government investments funded by foreign currency reserves that are managed separately from official currency reserves and invested for profit.

Answer 22

Sovereign wealth funds (SWFs) are entities established by governments to make investments with foreign exchange reserves that are managed separately for official foreign exchange reserves managed by the country’s central bank within monetary policy goals. The underlying investments are made by SWFs with the goal of making a profit.

Many governments seek to attract foreign direct investment, and frequently, some governments seek to manipulate official currency reserves for political purposes.

Question 23

Globalization suggests that firms need to take a serious look at the variety of implications of globalization for business strategies. Among the major factors that need to be considered are:
the need for scenario planning, which causes the firm to look at a number of different future possibilities for the firm under varying conditions of high uncertainty.

Answer 23

In a world with a rapid pace of change and high levels of uncertainty, scenario planning has taken on increasing importance as it allows firms to effectively look at a series of different potential future possibilities as part of their planning process. Labor arbitrage is a key driver in which path globalization efforts will follow. However, the movement of production is not a static factor. Moving production facilities to one country to capture the benefits of low-cost labor has a tendency to drive up wages in that area, thus making then-lower labor costs in other countries more attractive.

Early globalization efforts were driven by low production costs in emerging markets, and today a rising middle class in emerging economies is shifting the focus as many of these nations are now seeing rapid increases in their level of consumption.

Terms

Question 24

sovereign wealth funds

A key agricultural goal would be to invest in staple crops with a protectionist impulse designed to circumvent world commodity markets. Many emerging market economies find investing in their own domestic agriculture to be problematic due to a scarcity of arable land and, more importantly, a shortage of water. They outsource food production, growing crops abroad and shipping them back to the home country.

Answer 24

Other investments by SWFs are designed to acquire technologies, brands, resources, and better access to international markets and to use technology to enhance productivity. A country like China is taking advantage of the low valuations of increasingly desperate foreign operations (particularly in strategically important sectors such as energy and raw materials) and is making investments in an attempt to achieve energy security and access to strategic materials at a known contract price.

Many SWFs are attempting to learn how U.S. companies operate and transfer those skills to improve the operation of their domestic firms.

Question 25

The primary sources of funds for sovereign wealth funds would be:
earnings from commodity-based exports and trade surpluses driven by the export of manufactured goods.

Answer 25

The primary sources of funds for sovereign wealth funds are export earnings from commodity (energy)-based exports and the trade surplus generated by the export of manufactured goods. The trade surplus is often tied to the country having a weak currency that causes a country’s goods and services to be priced lower in terms of a foreign currency.

Additionally, increases in commodity prices have shifted the terms-of-trade in favor of nations exporting goods from extractive- and commodity-based industries.

Question 26

Globalization has allowed for new technologies to be effectively utilized in areas where low-cost labor is available;

Answer 26

allowed for foreign direct investment to bring new technology and labor market skills to underdeveloped areas; and caused capital to flow to areas where its marginal product is higher, resulting in increased world output.

Question 27

The U.S. balance of trade is decreased by: U.S. imports.

Answer 27

The balance of trade comprises a subdivision of the balance of payments on current account. The balance of payments on current account includes all payments made because of current purchases of goods and services. The balance of trade is that part of the current account that denotes the difference between the dollar value of imports and exports in a given year. A favorable balance of trade occurs when exports exceed imports. Increases in U.S. imports will decrease the U.S. balance of trade.

Question 28

key characteristics of emerging market economies

Answer 28

・low debt-to-GDP ratios,

・ a significant increase in trade among and between emerging market economies,

・low-cost labor, high savings rates,

・ large currency reserves, and high investment in　infrastructure.

Question 29

calculating the current account balance：

(Export - Imports)+net investment income+ inflow of transfers

Answer 29

The balance of trade is calculated by subtracting merchandise imports from merchandise exports (15,760 Ptas. - 20,300 Ptas.) which shows a balance of trade deficit of 4,540 Ptas. The negative net investment income (3,700 Ptas.) is added to this balance, and it would be reduced by the positive inflow of transfers (1,240 Ptas.) leaving a current account deficit balance of 7,000 Ptas.

Question 30

The discount rate set by the Federal Reserve System is the rate that the central bank charges for loans to commercial banks.

Answer 30

・The federal funds rate is the rate paid by commercial banks when borrowing excess reserves from other institutions in the Fed Funds market.

・The prime rate is the base rate that banks use in pricing short maturity loans to their best, or most creditworthy, customers.

・The interest rate that commercial banks charge for loans to the general public is determined by conditions in the money market.

Question 31

One of the measures economists and economic policy makers use to gauge a nation’s economic growth is to calculate the change in the:

Answer 31

real per capita output

A nation’s economic growth is measured by gauging changes in the production of physical output per capita. Output indices such as the Federal Reserve Board’s Index of Industrial Production are used in quantifying the amount of the change. Money supply, total wages, and general price levels are not good growth indicators because of their sensitivity to inflation and other factors.

Question 32

The primary sources of funds for sovereign wealth funds would be:

Answer 32

earnings from commodity-based exports and trade surpluses driven by the export of manufactured goods.

Question 33

Demand management in the supply chain is designed to synchronize supply and

Answer 33

demand to reduce inventory and production is pulled through the plant in response to specific customer needs.

Question 34

Herfindahl index

Answer 34

this index is a measure of the size of firms in relation to the market, not a way to understand behavior of firms in such a market

Question 35

In monopolistic competition, the goal of product differentiation and advertising is to:

Answer 35

make the firm’s demand curve less elastic so that consumers are less responsive to changes in price.

Question 36

Disposable income is that income received by individuals which is available for consumption and saving (i.e., personal income minus personal income taxes). The example below demonstrates the calculation of disposable income:

Answer 36

Gross domestic product (GDP) $4,000
- Depreciation (500)
——-
= Net domestic product (NDP)(at mkt cost) $3,500
- Indirect business taxes (210)
——-
= Net national income (NNI) (at factor cost) $3,290
- Corporate income taxes ( 50)
- Undistributed corporate profits ( 25)
- Social Security contributions (200)
+ Transfer payments 500
——-
= PERSONAL INCOME $3,515
- Personal income taxes (250)
——-
= DISPOSABLE INCOME $3,265
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