Exam 2 - Practice Problems & Notes Flashcards
1) In the expansion phase of a business cycle
A) the inflation rate decreases, but productive capacity increases. B) employment and output increase.
C) the inflation rate and productive capacity decrease.
D) employment increases, but output decreases.
B. Employment and output increase
During a severe recession, we would expect output to fall the most in
A) agriculture.
B) the construction industry. C) the clothing industry.
D) the health care industry.
The construction industry
Full-time homemakers and retirees are classified in the BLS data as
A) employed.
B) part of the labor force. C) not in the labor force. D) unemployed.
Not in the labor force
The unemployment rate in an economy is 7.5%. The total population of the economy is 250 million and the size of the civilian labor force is 180 million. The number of employed workers in this economy is
A) 15.7 million. B) 166.5 million. C) 174.6 million. D) 13.5 million.
B. 166.5 million
At the economy’s natural rate of unemployment
A) only frictional unemployment exists.
B) the economy achieves its potential output.
C) only structural unemployment exists.
D) there is only a relatively small amount of cyclical unemployment.
B. The economy achieves its potential output
If the Consumer Price Index was 170 in one year and 180 in the next year, then the rate of inflation is approximately
A) 5.9%. B) 7.2%. C) 6.3%. D) 5.5%.
A. 5.9%
For a person to keep his real income steady at a certain level from one year to the next, his nominal income must
A) rise if the price index falls.
B) rise as fast as the price index.
C) fall if the price index rises.
D) stay the same as the price index rises.
B. Rise as fast as the price index
An MPC value of less than 1.0 indicates that as income increases consumption
A) also increases, and at the same rate as the increase in income. B) also increases, though not as much as income.
C) also increases, and by more than the increase in income.
D) will go in the opposite direction and decrease.
B. Also increases, though not as much as income
If, in an economy, a $200 billion increase in consumption spending creates $200 billion of new income in the first round of the multiplier process and $160 billion in the second round, the marginal propensity to consume and the multiplier are, respectively
A) 0.2 and 1.25. B) 0.8 and 5.0.C) 0.4 and 1.67. D) 0.4 and 2.5.
B. 0.8 and 5.0
The short term fluctuations experienced in an economy due to changes in levels of economic activity
The Business Cycle
4 phases of the Business Cycle
Peak
Recession
Trough
Expansion
Highest point of business cycle
peak
Downward sloping line of business cycle
Recession
Lowest point before going back up
Trough
From lowest to growing again
Expansion
The labor force does not include individuals who (4):
- Are under the age of 16
- Are institutionalized
- Have been out of work for less than a week
- Have not actively sought employment for the past 4 weeks
The number of people in the economy that hold a full or part time job
Employed
The number of people in the economy who have not had a job for at least a week but have actively searched for employment in the past 4 weeks
Unemployed
The skills that some workers have to offer simply don’t match the skills needed by the firms in the economy
Structural unemployment
Unemployment that results from fluctuations in the business cycle
Cyclical unemployment
Workers searching and waiting for jobs
Frictional unemployment
Unemployment rate formula
(Unemployment/Labor Force) x 100
Natural rate of unemployment formula
((Number of frictionally unemployed + number of structurally unemployed)/Labor Force) x 100
An economy that is operating at its natural rate of unemployment
Fully Employed Economy
Labor Force Participation Rate Formula
(Labor Force/Population over the age of 16) x 100
When unemployment rate decreases…
labor market improves
Workers dropping out of labor force can..
influence employment data
A general increase in the price of goods and services
Inflation
2 Causes of inflation:
- Economy-wide changes in demand for or supply of goods and services
- Changes in the money supply
Why do we care about inflation? (3)
- Changing inflation can make it difficult to plan
- Purchasing power of money decreases with inflation
- Retirees have fixed incomes
Very high, increasing rate of inflation, makes money worthless
Hyperinflation
An economic indicator used to measure over time the average price of a market basket of goods and services purchased by the typical consumer
Consumer Price Index
Steps to calculating CPI (4):
- Identify the basket of goods and services purchased by the typical consumer
- Collect the prices of the basket over a specific time period
- Calculate the market value of the basket for each time period
- Divide the market value for the time period by the market value of a base time period and multiply by 100
CPI Formula 1 and 2
(Market Basket Value1/Market Basket Value1) x 100
(Market Basket Value 2/Market Basket Value 1) x 100
The actual number of dollars received in exchange for the different resources available in the economy
Nominal Income
Represents the amount of goods and services that you can purchase with nominal income
Real Income
Real Income Formula
Nominal Income/CPI (Hundredths)
In regards to factories…
If expenditures rise…
If expenditures fall…
Rise: Factories hire more workers and produce more output
Fall: Factories idle or reduce workers and produce less output
Solution for Great Depression
Increase Expenditures
Aggregate Expenditures
Y = C + I + G + NX
If any aggregate expenditures spending increases..
aggregate expenditures will also increase
An increase in aggregate expenditures will lead to..
an increase in real GDP
ayment to agents that lend or save money, expressed as percentage of money lent or saved
Interest Rate
Interest rate when expected rate of inflation is zero
Real Interest Rate
Real interest rate is equal to..
nominal rate minus inflation rate
n anticipated increase in profit resulting from additional investment; expressed as a percentage of the monetary cost of the additional investment
Expected Rate of Return
Firms will invest when…
Expected rate of return is greater than real interest rate
Consumption changes as
Real GDP changes
Gross investment, government purchases, and net exports..
remain constant as real GDP changes
he concept that an additional dollar of expenditures will result in the creation of more than one dollar’s worth of real GDP
The Multiplier Effect
Expenditure Multiplier =
ChangeY=
MultiplierE = (1/(1-MPC))
ChangeY = MultiplierE x Change in Expenditures
What does the tax multiplier tell us?
How much output will eventually change for any initial change in taxes
The tax multiplier is directly related to..
marginal propensity to consume
As income decreases some consumption and some savings will be lost
Tax Multiplier =
(-MPC/(1-MPC))
The difference, or gap, between expenditure when real GDP is below the full employment level and the level of expenditure at full employment real GDP
Recessionary Gap
The difference, or gap, between expenditure when real GDP is above the full-employment level and the level of expenditure at full-employment real GDP
Inflationary Gap
The AD curve shows the relationship between the..
total amount of goods and services demanded and the overall price level
At a lower price level the amount of goods and services demanded ___
increases
There is a ___ relationship between the price ___ and ____
negative
level
aggregate demand
When the price level rises, the real value of people’s nominal assets (like money) falls, reducing the real value of their nominal wealth
Real balance
Higher interest rates mean (2)
less consumption and investment spending
Foreign Purchases: If the price level for a country rises, domestically-produced goods become _____ relative to foreign goods
more expensive
As imports rise and exports fall, net exports will
fall
Determinants of Aggregate demand (2)
Taxes
Consumer and investment spending
Represents the aggregate quantity of real GDP supplied in an economy at various price levels, all else held constant
Aggregate Supply
The higher the overall price level, the ____
more output the economy produces
The lower the overall price level, the _____
less output the economy produces
Determinants of Aggregate Supply (3)
Productivity
Resource Prices
Social Institutions
An increase in the cost of resources, ____ aggregate ____ supplied at a given price level
decreases
quantity
Rules or regulations that make it more expensive to produce output will ____
decrease aggregate supply
If output is below the full-employment level, input prices will ____, which shifts the aggregate supply to the ____
decrease
right
If output is above the full-employment level, input prices will ____, which shifts the aggregate supply to the ____
increase
left
Price up and supply down
Cost-push
Price up and demand up
Demand-pull
Inflation that occurs when an economy experiences both rising unemployment (a stagnating economy) and rising prices (inflation).
Stagflation
Expansionary fiscal policy ___ government purchases and ____ taxes
increases
decreases
Expansionary fiscal policy expands output by _____ government purchases, which _____ aggregate demand
increasing
increases
Contractionary fiscal policy contracts output by ____ government purchases which ____ aggregate demand
decreasing
decreases
The concept that an additional dollar of expenditures will result in the creation of more than one dollar’s worth of real GDP
Multiplier effect
Expansionary fiscal policy ____ taxes, which ____ consumption and thereby ___ aggregate demand
decreases
increases
increases
Contractionary fiscal policy ____ taxes, which _____ consumption and thereby ____ aggregate demand
increases
decreases
decreases
When a shock to aggregate demand or aggregate supply occurs, what all adjust to help the economy move back to full employment? (3)
tax revenue
government spending
prices
During GDP growth, taxation ____ and government purchases ____
increases
decrease
During GDP reduction, taxation _____
decreases
When a recession starts, we don’t know it immediately
Recognition lag
The government cannot quickly determine the appropriate policy
Legislative lag
The decided-upon policy is not immediately effective
Implementation lag
Current tax reform is to ____ economic growth and ____ wages
increase
increase
Any item that both buyers and sellers generally accept in exchange for goods and services
Money
Three functions of money
Unit of account
Medium of Exchange
Store of value
Consists of the most liquid assets
M1
Broader measure of the money supply, which includes less liquid assets
M2
The degree which an asset can be readily converted into currency
Liquidity
What is included in M1? (4)
- Demand deposits (checkable deposits and checking accounts)
- Travelers checks
- Other checkable deposits
- Actual currency
What is included in M2? (4)
- M1
- Savings deposits
- Small denomination time deposits
- Retail money funds
The actions of a country’s central bank to influence the supply of money and credit in the economy
Monetary Policy
The buying or selling of government securities in the open market to change the money supply
Open Market operations
The interest rate at which banks can borrow money directly from the Federal Reserve
Discount Rate
The fraction of checkable deposits that banks must keep on hand as reserves, either as currency or on deposit with the Federal Reserve
Reserve Requirement
A banking system in which banks have to keep only a fraction of checkable deposits on hand and available for withdrawal
Fractional Reserve banking
Required reserves =
Deposits x rr
The amount of reserves that a bank can lend out to earn interest; equal to total reserves minus required reserves
Excess Reserves
Excess reserves =
Total reserves - required reserves
An increase in reserves in the banking system will lead to a ___ in the money supply
increase
With more reserves on hand, banks will have additional ____ and will make more ___
excess reserves
loans
When banks make more loans, they ____
create more money
Change in money supply =
(1/rr) x Change in reserves
Money is often held for two reasons:
- Transaction demand
- Asset demand
