Econ 103 Exam 2

The objectives of the Federal Reserve System

Maximize employment, stabilizing prices and moderating long-term interest rates. Since 2009: supervising and regulating banks and maintaining and providing financial services

Why did Alexander Hamilton feel it was important to have a stable central bank with reputable bonds?

This bank would create a uniform currency for all states and provide a place for government to deposit its money or borrow when needed. Jefferson believed it should be state banks giving money.

Explain the cyclical demand for currency that led to the Panic of 1907

There were cyclical demands for currency that caused the value of T-Bills to fluctuate. Several rural banks tried to exchange T-Bills for currency, driving down the price of T-bills. There was no central bank to solve issues. These liquidity (shortage of cash) crises led to bank runs. 1907 due to failed attempt to corner copper market stock = bankruptcies and bank runs.

Why do people hold their money

why save it in checking or saving account? Transactions, precautionary motives, assets/speculation.

Two types of investments

Liquid – how quickly an asset can be sold without affecting its value. Money is most liquid illiquid – can’t be easily sold/ exchanged for cash. Illiquid investments would need higher rate of interest because the level of risk associated with purchasing an asset that cannot be easily converted into cash. Values fluctuate over time.

Money Multiplier Equation

1/ Reserve Ratio. Reserve ratio is what the bank cannot lend out. relationship between the reserves in a banking system and the money supply. Smaller the RR, the greater the multiplier – larger increase to money supply.

If the monetary base is $100 M and the RR is 20%. What is money multiplier and the total money supply?

Money multiplier: 1/.20 = 5 maximum money supply = Monetary base/ RR = 500 M

Open Market Operations

central banks buy and sell bonds to regulate the money supply in the economy. To increase the money supply, the federal bank will purchase bonds from banks. Pushes down interest rates. If fed sells bonds – it takes money out of system and pushes up interest rates. This is contractionary policy and increases RR. During expansion of economy – use contractionary

What are FOMC’s (Federal open market committee) main concerns

slower than expected economic recovery and low rates of resource utilization.

Rank most to least liquid: $50, house, funds in savings account, share of stock,

a boat, money in market account, $20, bond

$50, funds, stock , house $20, money in market, bond, boat

cigarettes are an example of — and have — value.

commodity. intrinsic – has value outside its use of being money. More likely to use if there is political instability/ recession. Opposite is fiat money – value derives from US gov.

M1 and M2

M1 includes currency (like the money in Brian’s checking account), traveler’s checks, and checkable deposits. M2 includes everything in M1 plus money market deposit accounts, savings account deposits, certificates of deposit (such as Hilary’s CD), and what are called miscellaneous near-monies.

There are —– members of the Federal Reserve Board of Governors.

7

The Federal Reserve’s role as a lender of last resort involves lending to which of the following financially troubled institutions?

U.S. banks that cannot borrow elsewhere
Governments in developing countries during currency crises
U.S. state governments when they run short on tax revenues

A.

The Federal Reserve’s primary tool for changing the money supply is —— . In order to increase the number of dollars in the U.S. economy (the money supply), the Federal Reserve will —– government bonds.

Open market operation, buy

While all members of the Federal Reserve Board of Governors vote at Federal Open Market Committee (FOMC) meetings, only —–of the regional bank presidents are members of the FOMC.

5

Which of the following contributes to making the Federal Reserve an independent policymaking body?

There are 12 Federal Reserve banks.
Members of the Board of Governors are appointed for 14-year terms.
Its role is written into the U.S. Constitution.

B

There are ——- Federal Reserve banks.

12

Which of the following is a responsibility of the Federal Open Market Committee
Making decisions regarding monetary policy
Issuing mortgages to homeowners
Buying and selling stocks

A

Suppose that Third Fidelity Bank currently has $150,000 in demand deposits and $97,500 in outstanding loans. The Federal Reserve has set the reserve requirement at 15%. What are the reserves, required reserves and excess reserves?

Reserves – Demand deposit – loan: 52,500 Required reserves – Demand Dep. x RR = 22,500 excess reserves – Reserves – Required Reserves: 30,000

Suppose that Second Republic Bank currently has $175,000 in demand deposits and $122,500 in outstanding loans. The Federal Reserve has set the reserve requirement at 20%.

Reserves: 52,500 Required Reserve: 35000 Excess reserves: 17500

Assume that banks do not hold excess reserves and that households do not hold currency, so the only form of money is demand deposits. To simplify the analysis, suppose the banking system has total reserves of $300. Determine the money multiplier and the money supply for each reserve requirement listed in the following table.
RR at 5 and 10 %
—-
Suppose the Federal Reserve wants to increase the money supply by $100. Again, you can assume that banks do not hold excess reserves and that households do not hold currency. If the reserve requirement is 10%, the Fed will use open-market operations to —– ——- worth of U.S. government bonds.
—-
Now, suppose that, rather than immediately lending out all excess reserves, banks begin holding some excess reserves due to uncertain economic conditions. Specifically, banks increase the percentage of deposits held as reserves from 10% to 20%. This increase in the reserve ratio causes the money multiplier to —– to —– . Under these conditions, the Fed would need to —— —- worth of U.S. government bonds in order to increase the money supply by $100

Money multiplier: 20 and 10. Money supply: 6,000 and 3,000. buy – to increase money supply gov. must buy bonds. $10 – take 10% of $100 and multiply it by multiplier. fall to 5. buy, $20 – take .20 x 100

Which of the following statements help to explain why, in the real world, the Fed cannot precisely control the money supply? Check all that apply.

The Fed cannot prevent banks from lending out required reserves.
The Fed cannot control the amount of money that households choose to hold as currency.
The Fed cannot control whether and to what extent banks hold excess reserves.

2,3

2 possible benefits of inflation

– deflation can be harmful and difficult to reverse. AD go down because people wait for prices to drop. = more unemployment – unions push for higher wages when firm is doing well. Difficult for firms to cut wages at that time because workers can buy less with nominal wage since prices increase and therefore experience a real (adjusted to account for inflation) wage cut.

Who is most negatively influenced by inflation?

1. "shoe leather cost" – not very applicable to today 2. When people hold money in checking accounts, the monetary value will decrease. Whereas with stock, if prices increase – values will most likely increase. Poorer people more likely to hold cash.

Inflation effects on borrowers/lenders

the lender is more hurt because they’d still be getting back what is owed to them, but the value is less.

Would Hamilton approve of printing a large amount of currency to pay off debt?

No, our $ would be worthless and people would not want to lend from us. Value of money decreases.

What can explain the drop in the velocity of money in recent years?

Velocity = how quickly money moves across economy. V = nominal GDP divided by quantity of money. A much higher percentage of money supply could be held abroad by foreign banks and gov. Some use USD as official currency.

What is long run relationship between inflation and money supply?

Long run = more money = higher prices. New Keynesians accept this relationship.

Quantitative easing and NK/ Monetarists

Much larger in scale than OMO. Included longer term bonds and mortgage backed securities. Driving interest rates to (and sometimes below zero) . Monetarist: increase of money leads to inflation NK: increase AD through increasing money supply in short run. So yes, buy bonds. Neither appear right.

Why were Monetarists and NKs wrong about QE

whole bunch of money was injected into economy by Fed. so that banks had/have a lot of extra cash. GDP didn’t go up and neither did prices. Could be due to low RR and psychology – QE is a drastic measure which sends a signal that these are drastic times = save money. Even though interest rates are low/non existent, they are still not taking off.

Why don’t we run to banks anymore?

FDIC was created. Banks had to pay a fee and abide by banking guidelines which allowed their depositors to have their accounts insured up to a certain amount – today its $250,000.

Assume you invest $12000 today at 10.5% interest rate. What would be the nominal value of that money in 40 years? Write the entire formula.

Rule of 72. Take interest rate (.105) and multiply by 100. (10.5). Take that number and divide by 72 – (72/10.5 is approximately 6 years). Money will double every 6 years. Year 1: 12,000 In 6 years: 24,000 12 years from start: 48,000 18 years: 96000 24 years: 192,000 30 years: 384,000 36 years: 768,000 42 years: 1,536,000. < closest to answer. refer to other example.

Assume you invest $100 at 12% interest rate. What would it be in 24 years?

Rule of 72. .12 x 100 = 12. 72/12 = 6. Every 6 years the investment will double. Initial year = 100 six years = 200 twelve years = 400 18 years = 800 24 years is $1600.

What are determinants of productivity

Productivity is the quantity of goods and services produced from each unit of labor output. Determinants: Physical capital – increases worker productivity, human capital, technological knowledge and natural resources.

what can contribute to economic growth

1. Saving and investment – don’t spend everything 2. Catch-up effect 3. Investments from abroad (foreign direct investment FDI) 4. Education – important investment in human capital (skills), but developing nations may be afraid of brain drains. 5. Health and nutrition – another form of human capital. Produce more if healthier 6. Property rights and political stability 7. Free trade – access to cheaper goods. Workers could lose jobs – outsourcing. 8. Research and development 9. Population growth vs Malthus.

What is catch up effect?

Can contribute to economic growth. As developed nations face diminishing returns (output per unit of capital begins to fall) other poorer nations have the opportunity to catch up. If having relatively little capital to begin with, their return to an additional unit of capital is quite high.

Why would FDI help poorer nations&gt;

If these countries have little capital to begin with, this can change and make the labor force more productive. Also has benefit of transferring tech and human capital. – Provides access.

How does property rights contribute to economic growth

If someone can steal/destroy/take over land, you are less inclined to invest in it and make it more productive.

The agency responsible for regulating the money supply in the United States is

The federal reserve

Under a fractional-reserve banking system, banks
A. hold more reserves than deposits.
B. cause the money supply to fall by lending out reserves.
C. generally lend out a majority of the funds deposited.
D. All of the above are correct.

C

The discount rate is the interest rate that
A. the Fed charges Congress for loans.
B. banks charge one another for loans.
C. the Fed charges banks for loans.
D. banks charge the Fed for loans

C

Which list ranks assets from most to least liquid?
A. currency, stocks, fine art
B. fine art, currency, stocks
C. fine art, stocks, currency
D. currency, fine art, stocks

A

An open-market purchase
A. decreases the number of dollars and the number of bonds in the hands of the public.
B. decreases the number of dollars in the hands of the public and increases the number of bonds in the hands of the public.
C. increases the number of dollars in the hands of the public and decreases the number of bonds in the hands of the public.
D. increases the number of dollars and the number of bonds in the hands of the public.

C

When there is inflation, the number of dollars needed to buy a representative basket of goods
A. decreases, and so the value of money rises.
B. decreases, and so the value of money falls
C. increases, and so the value of money rises.
D. increases, and so the value of money falls.

D

When inflation rises, firms make
A. more frequent price changes. This reduces their menu costs.
B. less frequent price changes. This raises their menu costs.
C. more frequent price changes. This raises their menu costs.
D. less frequent price changes. This reduces their menu costs.

C

The determinants of productivity:
method of coating the paper that goes through the printing presses and significantly reduces paper jams

The trees that are used to create pulp for the production of paper

The knowledge workers receive from training sessions on how to use and repair the printing presses

The presses used to print documents

Tech, Natural resource, human capital, physical capital

Which of the following policies would lead to greater productivity in the weaving industry? Check all that apply.

Subsidizing research and development into new weaving technologies
Imposing restrictions on foreign ownership of domestic capital
Offering free public education to every worker in the country
Imposing a tax on looms

1,3

Which of the following policies would lead to greater productivity in the fishing industry? Check all that apply.

Correct Imposing a tax on fishing poles
Correct Offering free public education to every worker in the country
Correct Subsidizing research and development into new fishing technologies
Correct Encouraging saving by allowing workers to set aside a portion of their earnings in tax-free retirement accounts

2,3,4

Suppose a wealthy French citizen buys $2 million worth of stock issued by an American corporation. The American firm uses the proceeds for a factory expansion.
This is an example of foreign — investment in the United States.
2. Suppose Yamahonda, a Japanese-owned motorcycle manufacturer, builds a production plant in Alabama.
This is an example of foreign—— investment in the United States.

1. Portfolio 2. Direct

Which of the following policies are consistent with the goal of increasing productivity and growth in developing countries? Check all that apply.

A. Providing tax breaks and patents for firms that pursue research and development in health and sciences.
B. Increasing taxes on income from savings.
C. Imposing restrictions on foreign ownership of domestic capital.
D. Protecting property rights and enforce contracts.

A, D,

Which of the following are possible outcomes of rapid population growth?

A reduction in human capital per worker
A reduction in capital per worker
An increase in technological knowledge
All of the above

All

What is a significant factor in long-run economic growth that Robert Fogel, an economic historian, is best known for suggesting?

Inward-oriented policies that protect domestic firms from foreign competition
Improvements in technology from the incentives created by a better patent system
Improvements in worker health from better nutrition
Improvements in the protection of property and enforcement of contracts through the maturation of the civil and criminal justice systems

C

Diminishing returns

Add another unit of capital, growth/production will eventually slow down.

Why may we see a lack of convergence amongst countries?

Political instability, corrupt government, lack of skilled labor, brain drain, etc.

What is the great divergence?

Western Europe and parts of North America had become fabulously wealthy. Almost everywhere else was horribly poor. Economic historians refer to this as the "Great Divergence". Could be due to agriculture, population size, technology, and social organization. Appears to have picked up after the Industrial Revolution. Location of resources.

Let’s suppose $1,000 was invested in 2000.
Suppose that the account earns 5% simple interest for 10 years.
What would its value be after 10 years?

1,500 Equation: number invested (1,000) X 1 + interest rate (.05) X the years (10)

Next, suppose $1,000 is invested, but the 5% interest compounds for 10 years.
What would its value be after 10 years?

1,629 Equation: number invested (1000) x 1 + interest rate to the exponent of the years. So, 1000 X (1.05^10)

What’s a good explanation as to why the import value has reduced down toward the value of exports the past couple of years in the U.S?

Perhaps the U.S. is producing more oil, rather than importing from the Middle East. Therefore, the price decreases as well as value.

A nation’s standard of living is best measured by its

Real GDP per person

Which of the following can be measured by the level of real GDP per person?

standard of living, but not productivity

The one variable that stands out as the most significant explanation of large variations in living standards around the world is

Productivity

Which of the following are residents of rich countries likely to have in greater quantities, or better quality, than residents of poor countries?
A. housing
B. healthcare
C. life expectancy
D. All

D

Country A and country B are the same except country A currently has more capital. Assuming diminishing returns, if both countries increase their capital by 100 units and other factors that determine output are unchanged, then
A. output in country A increases by less than in country B.
B. output in country A increases by the same amount as in country B.
C. output in country A increases by more than in country B.
D. None of the above is necessarily correct.

A

The level of real GDP person
A. and the growth rate of real GDP per person vary widely across countries.
B. differs widely across countries, but the growth rate of real GDP per person is similar across countries.
C. and the growth rate of real GDP per person are similar across countries.
D. is very similar across countries, but the growth rate of real GDP per person differs widely across countries.

A

Which of the following would, by itself, reveal the most about a country’s standard of living?
A. the number of hours worked
B. its availability of natural resources
C. its productivity
D. its level of capital

C

If there are diminishing returns to capital, then
A. increases in the capital stock increase output by ever smaller amounts.
B. capital produces fewer goods as it ages.
C. old ideas are not as useful as new ones.
D. increases in the capital stock eventually decrease output.

A

Why would have the Articles of the Confederation have been described as Ronald Reagan’s dream?

It left the central government without the ability to tax. Paying for its bills made it difficult to fund Revolutionary war.

Two tools of fiscal policy

1. Increase taxes to decrease AD (Contract) and vice versa (Expan) 2. Increase government purchases to attempt to increase AD. (Expan)Vice versa (contract)

MPC

Marginal propensity to consume. How much customers are willing to spend of their earnings

GDP multiplier equation

GDP change = (1/(1-MPC) X initial change in output spending. – government Taxes: GDP/ (-MPC/ (1-MPC)

To close a $400 B gap, gov. tries to increase government spending by $400 B. MPC is .8. What initial change do we need in output spending?

400B = (1/(1-.8) X initial change. 400 B = 5 x initial change $80 B = initial change

Suppose the natural level of GDP is $14T and the current level is $14.5T. If the gov. wanted to use fiscal tools to close gap, and the profit rate is 100%, MPC is .75. What type of monetary policy would they enact? How much would they have to change taxes by? How much would they have to change gov. purchases by?

Contractionary. Gov spending: -125 B (?). The gap was -500B. So, -500B = 1/(1-.75) X IOS. -500B = 4 X IOS -125B = IOS. They should decrease government spending by 125B. Taxes: 166.6B? -500B/ (-.75/1-.75)

Suppose national level of GDP for econ is $13.5 T but the economy is currently producing $13T.
1. What is GDP gap?
2. Suppose MPC is .8 what would be GDP multiplier?
3. What would be change in government?
4. What would change in tax be to close?

1. .5 T – would want expansionary policy 2. (1/1-MPC) = 5 3. .1T because .5 = 5 x gov expend. 4. Decrease tax by .125T

When discussing fiscal policy for active stabilization, would NK or Monetarists be more likely to raise concerns about lags?

?

What does the previous analysis suggest about the market for money?

The quantity of money demanded decreases as the interest rate falls.
The supply of money is independent of the interest rate.
The quantity of money demanded increases as the interest rate falls.

C

Suppose the Fed announces that it is raising its target interest rate by 50 basis points, or 0.5 percentage point. To do this, the Fed will use open-market operations to —— the —– of money by ——- the public.

decrease, supply, selling bonds to.

Suppose the following graph shows the aggregate demand curve for this economy. The Fed’s policy of targeting a higher interest rate will ——- the cost of borrowing, causing residential and business investment spending to —– and the quantity of output demanded to ——– at each price level.

Suppose the following graph shows the aggregate demand curve for this economy. The Fed’s policy of targeting a lower interest rate will —- the cost of borrowing, causing residential and business investment spending to —– and the quantity of output demanded to —– at each price level.

Increase, decrease, decrease reduce, increase, increase

Consider a hypothetical closed economy in which households spend $0.60 of each additional dollar they earn and save the remaining $0.40.
The marginal propensity to consume (MPC) for this economy is —— , and the spending multiplier for this economy is —– .

Suppose the government in this economy decides to increase government purchases by $400 billion. The increase in government purchases will lead to an increase in income, generating an initial change in consumption equal to ——- . This increases income yet again, causing a second change in consumption equal to ——- . The total change in demand resulting from the initial change in government spending is ——— .

.6, 2.5. .6 X 400B = 240B 240B X .6 = 144B Total change in demand: Initial change in spending X multiplier = 1 T

How is value typically determined in economics? How do we determine how much people are willing to pay?

We determine what people are willing to pay. What the market value is and how much people actually paid. Easy to do with goods that are traded but air, water, and information are harder to measure. How would we be able to determine the willingness people are willing to pay for housing/rent, food and medical care ( look at demand care).

What’s another approach to finding a socially optimal allocation? (value)

Maximize happiness. Example, consider the change in utility (happiness) for one more piece of bread for someone who is starving and bill gates. Difficult to come up with a math formula to assign values to those two things.

What is the laffer curve?

supposed relationship between economic activity and the rate of taxation that suggests the existence of a tax rate that maximizes revenue. According to curve, highest tax rates lead to lower revenues.

What’s a likely explanation for why tax revenue increased when JFK decreased the tax rate of the highest marginal bracket?

Took top rate of 91% down to 70%. When not taken to extreme, tax revenue will always increase with a tax cut. People more likely to purchase without high tax rates

What is the crowding out effect?

The tendency for an increase in government purchases to increase interest rates and reduce investment

Suppose the governments of two different economies, economy A and economy B, implement a permanent tax cut of the same size. The marginal propensity to consume (MPC) in economy A is 0.8 and the MPC in economy B is 0.75. The economies are identical in all other respects.
The tax cut will have a smaller impact on aggregate demand in the economy with the —— MPC .

smaller

The tax cut will have a larger impact on aggregate demand in the economy with the —— tax cut – permanent or temporary?

permanent

Suppose that in February the government undertakes the type of policy that is necessary to bring the economy back to the natural level of output given in the previous scenario. In April 2020, consumer confidence increases, leading to an increase in consumer spending. Because of the —–associated with implementing monetary and fiscal policy, the impact of the government’s new policy will likely——- once the effects of the policy are fully realized.

lags, push the econ. beyond the natural level of output

Suppose that in May the government undertakes the type of policy that is necessary to bring the economy back to the natural level of output given in the previous scenario. In September 2020, U.S. exports decrease because China implements trade restrictions on U.S. goods. Because of the —– associated with implementing monetary and fiscal policy, the impact of the government’s new policy will likely —— once the effects of the policy are fully realized.

lags, push the econ below the natural level of output

Which of the following are arguments in favor of active stabilization policy by the government? Check all that apply.

Correct Businesses make investment plans many months in advance.
Correct The current tax system acts as an automatic stabilizer.
Correct Changes in government purchases and taxation must be passed by both houses of Congress and signed by the president.
Correct The Fed can effectively respond to excessive pessimism by expanding the money supply and lowering interest rates.

4

Which of the following are examples of automatic stabilizers? Check all that apply.

Correct Corporate income taxes
Correct The federal funds rate
Correct The discount rate

1

Which of the following statements about the debate over stabilization policy are correct? Check all that apply.

Correct Advocates of active stabilization believe that automatic stabilizers have no effect on aggregate demand.
Correct Opponents of active stabilization believe that active fiscal and monetary policies have no effect on aggregate demand.
Correct Opponents of active stabilization policy believe that significant time lags in both fiscal and monetary policy often exacerbate economic fluctuations.
Correct Advocates of active stabilization policy believe that the government can adjust monetary and fiscal policy to counteract waves of excessive optimism and pessimism among consumers and businesses.

3,4

Which of the following are examples of automatic stabilizers? Check all that apply.

Correct The discount rate
Correct Corporate income taxes
Correct Personal income taxes

2,3

Which of the following are examples of automatic stabilizers? Check all that apply.

Correct Unemployment insurance benefits
Correct Personal income taxes
Correct The discount rate

1,2

Which of the following statements about the debate over stabilization policy are correct? Check all that apply.

Correct Advocates of active stabilization believe that automatic stabilizers have no effect on aggregate demand.
Correct Advocates of active stabilization policy believe that the government can adjust monetary and fiscal policy to counteract waves of excessive optimism and pessimism among consumers and businesses.
Correct Opponents of active stabilization believe that active fiscal and monetary policies have no effect on aggregate demand.
Correct Opponents of active stabilization policy believe that significant time lags in both fiscal and monetary policy often exacerbate economic fluctuations.

2,4

The marginal propensity to consume (MPC) is defined as the fraction of
A. total income that a household consumes rather than saves.
B. extra income that a household either consumes or saves.
C. total income that a household either consumes or saves.
D. extra income that a household consumes rather than saves.

D

The goal of monetary policy and fiscal policy is to
A. offset the shifts in aggregate demand and thereby eliminate unemployment.
B. enhance the shifts in aggregate demand and thereby increase economic growth
C. offset shifts in aggregate demand and thereby stabilize the economy.
D. enhance the shifts in aggregate demand and thereby create fluctuations in output and employment.

C

If the MPC = 0.75, then the government purchases multiplier is about
A. 1.33.
B. 7.
C. 4.
D. 3.

c

In a certain economy, when income is $400, consumer spending is $325. The value of the multiplier for this economy is 3.33. It follows that, when income is $450, consumer spending is
A. $341.67. For this economy, an initial increase of $50 in consumer spending translates into a $266.67 increase in aggregate demand.
B. $360. For this economy, an initial increase of $50 in consumer spending translates into a $166.50 increase in aggregate demand.
C. $341.67. For this economy, an initial increase of $50 in consumer spending translates into a $166.25 increase in aggregate demand.
D. $360. For this economy, an initial increase of $50 in consumer spending translates into a $266.67 increase in aggregate demand.

B

What actions could be taken to stabilize output in response to a large decrease in U.S. net exports?
A. increase taxes or increase the money supply
B. decrease taxes or decrease the money supply
C. decrease taxes or increase the money supply
D. increase taxes or decrease the money supply

c

Which of the following policies would Keynes’s followers support when an increase in business optimism shifts the aggregate demand curve away from long-run equilibrium?
A. increase the money supply
B. increase taxes
C. increase government expenditures
D. All of the above are correct.

B

The multiplier effect is exemplified by the multiplied impact on
A. tax revenues of a given increase in government purchases.
B. aggregate demand of a given increase in government purchases.
C. investment of a given increase in interest rates.
D. the money supply of a given increase in government purchases.

b

During recessions, taxes tend to
A. rise and thereby decrease aggregate demand.
B. fall and thereby decrease aggregate demand.
C. rise and thereby increase aggregate demand.
D. fall and thereby increase aggregate demand.

d

Mansa Musa

Wealthiest person to have ever lived – $400 b in today’s standards. Controlled areas in W. Africa. Would trade places? No – SOL is better today.

Consumer Price Index (CPI) what is CPI inflation equation

measure that examines the weighted average of prices of a basket of consumer goods and services. Similar to what typical household would consume. CPI inflation = CPIyr2 – CPIyr1/ CPIyear1 X 100.

CPI is used

to calculate the cost of living adjustments (COLA). CPI can overestimate because it sometimes doesn’t take new tech into account or substitutes.

Why COLA is good/bad for SS recepients

1. If CPI inflation increased then SS recepients automatically get that amount increase to their payments. Could have cheaper bundle if substitute 2. However, if the cost of your bundle (extra med. expenses) was going up at a faster rate than the CPI bundle it is bad. They can’t easily substitute either.

GDP deflator

ratio of nominal GDP of a given year to RGDP. 100 X (nom/RGDP) GDP inflator: GDP defl2 – GDPDefla1/ GDPdef1

To find price index

100 X costbasketyr2/ costbasketyr1

Which of the following, if true, would illustrate why price indexes such as the CSPI might overstate inflation in the cost of going to college? Check all that apply.

Correct As the price of textbooks increased, more and more students turned to the used-book market or chose not to buy textbooks at all, instead using the copies on reserve in the library.
Correct Professors required each student to buy 10 textbooks, regardless of the price.
Correct The quality and design of calculators improved dramatically from 2014 to 2016. For example, calculators made in 2016 accept memory cards, whereas those made in 2014 do not, but this quality change is hard to measure.
Correct A new, safe method of memory enhancement became available for purchase.

1,3,4

Which of the following, if true, would illustrate why price indexes such as the CSPI might overstate inflation in the cost of going to college? Check all that apply.

Correct Professors required each student to buy 10 notebooks, regardless of the price.
Correct As the price of energy drinks increased relative to the price of coffee between 2014 and 2016, students decreased their consumption of energy drinks and increased their consumption of coffee.
Correct A new type of personal transporter, which made it easier to get around places like university campuses, became available for purchase.
Correct The quality of textbooks increased dramatically from 2014 to 2016, with textbook companies bundling new online study aids with their books, but this quality change is hard to measure.

2,3,4

The GDP deflator for this year is calculated by dividing the ———– using ——– by the ——— using —– and multiplying by 100. However, the CPI reflects only the prices of all goods and services ——– .
However, the GDP deflator reflects only the prices of all goods and services ——– .

value of all goods and services produced in the economy this year this year’s prices value of all goods and services produced in the economy this year the base year’s prices bought by consumers produced domestically

CPI or GDP Defl?
A decrease in the price of a Waterman Industries deep-water reel, which is a commercial fishing product used for deep-sea fishing, made in the U.S., but not bought by U.S. consumers

An increase in the price of a Chinese-made television that is popular among U.S. consumers

GDP CPI

The CPI is a measure of the overall cost of
A. the goods and services produced in the economy.
B. the inputs purchased by a typical producer.
C. the stocks on the New York Stock Exchange.
D. the goods and services purchased by a typical consumer.

D

The consumer price index is used to monitor changes in an economy’s production of goods and services over time.
a. TRUE
b. FALSE

b

Suppose the typical household spends $3,500 on goods and services during the month of January, and $4,300 on the same goods and services in February. Using January as the base period, what is the consumer price index for February?
A. 81.4
B. 55.1
C. 122.9
D. 151.4

c

Babe Ruth, the famous baseball player, earned $80,000 in 1931. Today, the best baseball players can earn more than 400 times as much asTable 24-3 The table below pertains to Iowan, an economy in which the typical consumer’s basket consists of 4 pounds of pork and 3 bushels of corn.
Year Price of Pork Price of Corn
2012 $20 per pound $12 per bushel
2013 $25 per pound $18 per bushel
Refer to Table 24-3. If 2012 is the base year, then the CPI for 2012 was
A. 116.0.
B. 100.0.
C. 132.8.
D. 75.3.

c

Table 24-3 The table below pertains to Iowan, an economy in which the typical consumer’s basket consists of 4 pounds of pork and 3 bushels of corn.
Year Price of Pork Price of Corn
2012 $20 per pound $12 per bushel
2013 $25 per pound $18 per bushel
Refer to Table 24-3. If 2012 is the base year, then the CPI for 2012 was
A. 116.0.
B. 100.0.
C. 132.8.
D. 75.3.

B

In 1968, economist Milton Friedman published a paper criticizing the Phillips curve on the grounds that
A. Phillips had made errors in collecting his data.
B. the Phillips curve did not apply in the long run.
C. monetary policy was ineffective in combating inflation.
D. it seemed to work for wages but not for inflation.

B

The short-run relationship between inflation and unemployment is often called
A. Money Neutrality.
B. the Phillips curve.
C. the Classical Dichotomy.
D. None of the above is correct.

B

A given short-run Phillips curve shows that an increase in the inflation rate will be accompanied by a lower unemployment rate in the short run.
a. TRUE
b. FALSE

a

According to the long-run Phillips curve, in the long run monetary policy influences
A. neither the unemployment rate nor the inflation rate.
B. both the inflation rate and the unemployment rate.
C. the inflation rate but not the unemployment rate.
D. the unemployment rate but not the inflation rate

C

According to the Phillips curve, policymakers would reduce inflation but raise unemployment if they
A. increased government expenditures.
B. decreased the money supply.
C. decreased taxes.
D. None of the above is correct.

b

What relationship is phillips curve supposed to show?

Relationship between unemployment rate and inflation rate. Higher inflation = lower unemployment in the short run. Downwards because it responds to demand shocks.

What might policymakers want to do if there is high unemployment?

Stimulate AD, Fed. reserve cam increase money supply = inflation. If pump in money, consumer confidence will increase – sticky prices so less unemployment in short run – NK. Monetarists believes prices adjust super quickly.

High inflation case where relationship – phillips didn’t hold true

Stagflation – high inflation, unemployment remains high. Prices high. Ex: 1970s supply-side oil price shocks. There was a shift in AS. Revenue left economy. Stagflation is often caused by a supply side shock. For example, rising commodity prices, such as oil prices, will cause a rise in business costs (transport more expensive) and short run aggregate supply will shift to the left. This causes a higher inflation rate and lower GDP.

Low inflation case where phillips relationship didn’t hold true

1990s boom – low inflation but low unemployment. Explanation – increased demand, felt wealthier. Increased productivity.

Why doesn’t Phillips curve hold true in long run?

It is vertical. In the long run and inflation only affects prices, not the natural rate of unemployment.

Benefits/cost of inflation

Advantages: adjusting real wages, reduce UE rate in shortrun, not deflation. Costs: fixed incomes (if not indexed), changing prices/menu, tax distortion, uncertainty over bond returns

Should policy makers target the inflation rate to 0?

No, if low inflation = high unemployment. Avoids deflation.

Absolute advantage

producer has an absolute advantage over another when they require fewer inputs to produce the same output. Or whoever produces more

Comparative Advantage

Ability of a group to produce a good or service at a lower opportunity cost than another.

Who wins and loses in free trade agreements:

wins: consumers who get to pay lower prices for a wider variety of goods. Some firms can benefit from exporting more. loses: workers who lose jobs, some firms can’t compete with world prices, skills of workers may not transfer easily. politicians who advocate for free trade propose job re-training programs, but often hard to find new place with same pay and benefits.

1. If i can produce 3 new chairs in 6 hours and I can produce 4 tables in 2 hours, what is my opportunity cost of producing 1 chair?
2. If my brother can produce 6 chairs in 6 hours and 6 tables in 2 hours, what is his opportunity cost of producing 1 chair?
3. Who has absolute advantage in producing chairs and tables?
4. who has comparative advantage in producing chair and tables?

1. 4 tables 2. 3 tables 3. both brother 4. brother for chairs, and table for me.`

Tariff

A tax or duty to be paid on a particular class of imports or exports. Government and producers benefit. Prices increase and production decreases.

Import quota

limit on the quantity of a good that can be imported. benefits producers – protectionist trade practice.

What determined if people export or import more?

If domestic price is higher than world price = import If domestic price is lower than world price = export.

Let’s suppose farmers in a small, closed economy is producing sugar at $2 per unit in their equilibrium. If the world price is $2.25, who would benefit from opening to trade?

The world – country would export more. The price in the country would increase to meet equilibrium.

Suppose a small economy whose consumers are paying $40,000 for cars opens to trade. The global price is $30,000. What would those consumers pay after opening to trade? What effects would a tariff of $1,000 have on this car market.

After opening to trade, the domestic price will meet the world price so $30,000. After tariff, I think the market would be $31,000. Higher price, would help government, may not help consumer.

Inflation rate equation for philip’s curve

price yr2 – y1/ yr1 *100