Economics

Question 1

Economic Indicators Leading - Coincident - Lagging -

Answer 1

• Leading: Turning points occur ahead of peaks and throughs (Stock prices, initial unemployment claims, manufacturing new orders)
• Coincident: Turning points coincide with peaks and troughs (Nonfarm payrolls, personal income, manufacturing sales)
• Lagging: Turning points follow peaks and throughs (average duration of unemployment, inventory/sale ratio, prime rate)

Question 2

4 phases of the business cycle

Answer 2

• Expansion (real GDP is increasing)
• Peak (real GDP stops increasing and begins decreasing)
• Contraction or recession (real GDP is decreasing)
• Trough (real GDP stops decreasing and begins increasing)

Question 3

Expansionary and contractionary monetary policy

Answer 3

Monetary policy is expansionary when the policy rate is less than the neutral interest rate (real trend rate of economic growth + inflation target) and contractionary when the policy rate is greater than the neutral interest rate.

Question 4

Expansionary and contractionary fiscal policy

Answer 4

Fiscal policy is expansionary when a budget deficit is increasing or surplus is decreasing, and contractionary when a budget deficit is decreasing or surplus is increasing.

Question 5

Price Elasticity

Income elasticity

Cross price elasticity

Answer 5

Question 6

Breakeven and Shutdown

Answer 6

Breakeven: total revenue = total cost

Operate in short run:

Total variable cost < total revenue < total cost

Shut down in short run:

Total revenue < total variable cost

Question 7

Profit maximizing point

Answer 7

Marginal revenue = marginal cost

Question 8

Real GDP =

Answer 8

consumption spending + investment + government spending + net exports

Question 9

Savings, Investment, Fiscal Balance, and Trade Balance

Answer 9

(G - T) = (S - I) - (X - M)

Fiscal budget deficit = excess saving over domestic investment - trade balance

Question 10

Equation of exchange

Answer 10

money supply × velocity = price × real output (MV = PY)

Where velocity is the average times per year each unit of money is used to buy goods or services

Question 11

Money Neutrality

Answer 11

The belief that real variables (real GDP and velocity) are not affected by monetary variables (money supply and prices)

Question 12

Recessionary gap, inflationary gap, and stagflation

Answer 12

• Recessionary gap: Real GDP < full employment GDP
• Inflationary gap: Real GDP > full employment GDP
• Stagflation is simultaneous high inflation and weak economic growth, which can result from a sudden decrease in short-run aggregate supply.

Question 13

Type of unemployment

Answer 13

• Frictional: time lag in matching qualified workers with job openings.
• Structural: unemployed workers do not have the skills to match newly created jobs.
• Cyclical: economy producing at less than capacity during contraction phase of business cycle.

Question 14

Effective central bank

Answer 14

• Independence: The central bank is free from political interference.
• Credibility: The central bank follows through on its stated policy intentions.
• Transparency: The central bank makes it clear what economic indicators it uses and reports on the state of those indicators.

Question 15

Money multiplier

Answer 15

Money multiplier = 1 / reserve requirement

Money created = new deposit x money multiplier

Question 16

Fiscal multiplier

Answer 16

The fiscal multiplier determines the potential increase in aggregate demand resulting from an increase in government spending:

Fiscal multiplier = 1 / [1 − MPC(1−t)]

Where MPC = marginal propensity to consume

t = tax rate

Question 17

Balance of payments: current account, capital account, and financial account

Answer 17

• Current account: merchandise and services; income receipts; unilateral transfers.
• Capital account: capital transfers; sales/purchases of nonfinancial assets.
• Financial account: government-owned assets abroad; foreign-owned assets in the country.

Question 18

Regional Trading Agreements:

Free trade area

Customs union

Common market

Economic union

Monetary union

Answer 18

• Free trade area: Removes barriers to goods and services trade among members.
• Customs union: Members also adopt common trade policies with non-members.
• Common market: Members also remove barriers to labor and capital movements among members.
• Economic union: Members also establish common institutions and economic policy.
• Monetary union: Members also adopt a common currency.

Question 19

Real Exchange Rate

Answer 19

= nominal FX rate × ( base currency CPI / price currency CPI )

= (Price currency / base currency) x ( base currency CPI / price currency CPI )

Question 20

No-arbitrage relation (Forward / Spot)

Answer 20

The percentage difference between forward & spot exchange rate is approximately equal to the difference between the two countries’ interest rate:

Forward / Spot = (1 + i _{price currency}) / (1 + i _{base currency})

The currency with high interest rate should depreciation over time by approximately the amount of the interest rate differential

Question 21

Exchange rate regimes

Answer 21

• Formal dollarization: country adopts foreign currency.
• Monetary union: members adopt common currency.
• Fixed peg: ±1% margin versus foreign currency or basket of currencies.
• Target zone: Wider margin than fixed peg.
• Crawling peg: Pegged exchange rate adjusted periodically.
• Crawling bands: Width of margin increases over time.
• Managed floating: Monetary authority acts to influence exchange rate but does not set a target.
• Independently floating: Exchange rate is market- determined.

Question 22

Fisher effect

Answer 22

Nominal interest rate = real interest rate + expected inflation rate

Question 23

Business Cycle Theories:

Neoclassical economists

Keynesians

New Keynesians

Monetarists

Austrian-school economists

Real business cycle theory

Answer 23

• Classical: Cycles are temporary deviations from long-run equilibrium that self-correct
• Neoclassical economists: Business cycles are temporary and driven by changes in technology. Cycles are rational responses to changes in real economic variables. Rapid adjustments of wages and other input prices cause the economy to move downward.
• Keynesian economists: Excessive optimism or pessimism among business managers causes business cycles. Cycles do not self-correct due to “downward sticky” wages. Contractions can persist because wages are slow to move downward.
• New Keynesians: Input prices other than wages are also slow to move downward.
• Monetarists: Inappropriate changes in the rate of money supply growth cause business cycles. Money supply growth should be maintained at a moderate and predictable rate to support the growth of real GDP.
• Austrian-school economists: Business cycles are initiated by government intervention that drives interest rates to artificially low levels.
• Real business cycle theory: Business cycles result from utility-maximizing actions in response to real economic changes, such as external shocks and changes in technology. Policymakers should not intervene in business cycles.

Question 24

Price Discrimination

Answer 24

• First-degree price discrimination, where a monopolist is able to charge each customer the highest price the customer is willing to pay. the entire consumer surplus is captured by the producer, as such the consumer surplus falls to zero (diminished).
• Second-degree price discrimination the monopolist offers a menu of quantity-based pricing options designed to induce customers to self-select based on how highly they value the product.
• Third-degree price discrimination happens when customers are segregated by demographic or other traits.

Question 25

Laspeyres index

Paasche index

Fisher index

Answer 25

• Laspeyres index uses the base year composition of the basket (base year quantity)
• Paasche index uses the current year composition of the basket (current year quantity)
• Fisher index is the geometric mean of the two indice above
• Using a fixed basket of goods and services has three serious upward biases:
  
  • Substitution bias
  • Quality bias
  • New product bias

Question 26

Calculating GDP

Answer 26

The sum-of-value-added method involves summing the value added (or income created) at each step in the production and distribution process.

The value-of-final-output method is based on the final selling price consumers pay for products and services (the retailer’s receipt from the final customer).

Question 27

Marshall-Lerner condition and change in trade balance

Answer 27

The condition under which a depreciation of the domestic currency will decrease a trade deficit.

ε_ML = W_X ε_X + W_M (ε_M – 1) > 0

where:

• ε_ML = Marshall–Lerner trade-weighted elasticity
• W_x = proportion of total trade that is exports
• W_m = proportion of total trade that is imports
• ε_X = price elasticity of demand for exports
• ε_m = price elasticity of demand for imports

Change in Trade Balance = ε_ML × Total Trade × Depreciation

Question 28

Forward rate vs. spot rate

Answer 28

Forward rate = spot rate x [( 1 + Interest_{price currency} ) / ( 1 + Interest_{base currency} ​)]

Forward rate = spot rate + forward premium

Question 29

Policy rate

Answer 29

In the United States, banks can borrow funds from the Fed if they have temporary shortfalls in reserves.

An increase in the policy rate will likely raise the potential penalty that banks will have to pay if they run short of liquidity and thereby reduces their willingness to lend.

Commercial banks normally increase their base rates immediately (not gradually) following the announcement of an increased policy rate because they want to avoid the possibility of lending at rates lower than they might be charged by the central bank.

If policy rate < Neutral rate, expansionary. Vice versa.

Neutral rate = real trend rate of growth + long-run expected inflation

Question 30

Participation Rate and Unemployment Rate

Answer 30

Participation ration = number of people in the labor force / total population of working-age people

Unemployment rate = number of people unemployed / number of people in the labor force

Question 31

Crowding-out effect

Answer 31

The crowding-out effect is when the government runs a deficit and must borrow more, which increases the demand for loanable funds. This causes interest rates to increase. At the higher rates, firms invest less in physical capital. The effect of expansionary fiscal policy is reduced by the crowding-out effect.

Question 32

Three primary factors influencing the price elasticity of demand for a product

Answer 32

• The availability and closeness of substitute goods
• The proportion of income spent on the product, and
• The time since the price change.

Question 33

Calculate personal income and disposable income.

Answer 33

• Personal income = national income + transfer payments - indirect business taxes - corporate income taxes - undistributed corporate profits
• Disposable income = personal income - personal taxes

Question 34

Disinflation

Answer 34

Disinflation occurs when prices are increasing, but at a decreasing rate.

Question 35

Structural Deficit

Answer 35

The structural deficit is the deficit that would exist if the economy was at full employment (or full potential output)