Stephen's Study Guide for the Second Exam of Econ 202

 

• The second test is on Tuesday, April 1^st at 5:30 p.m. in  Wilson 402. 
• There is no lecture the day of the exam.
• There will be a question-and-answer style review session on Sunday, March 30^th at 6 p.m. at Gilmer 130.
• If you have a class, lab or University sponsored sporting event at 5 p.m. on the Tuesday of the test, you must see Gabe Murtaugh.
• Thursday's lecture (March 27^th) will not be covered in the exam, but you will be responsible for knowing the Chapter 11 material on Tuesday.

 

Sections of the text covered in the next exam:

1)      Savings and International Markets

a.       International Trade 17

b.      International Finance: BOP and Exchange Rates 18

2)      Economic Growth

a.       Empirical Observations 16

b.      Solow

c.       Modern Growth Theory ST 7

3)      Economic Fluctuations

a.       Aggregate Supply and Demand Model 9

b.      Working with AS/AD 10

c.       The Great Depression 11

 

The Checklist:

Thursday February 21^st

o         Read Ch. 17

o         Comparative Advantage

o         Why trade at an individual level?

o         Countries should produce with the lowest opportunity cost and import the rest

o         Voluntary trade helps both sides

o         Absolute advantage

o         Comparative Advantage

o         Voluntary Trade both sides benefit

o         Barriers to trade

¡ Natural Trade Barriers

Geographic

Language

¡ Un-natural Trade Barriers

Tariff

Import Quota

Tuesday February 26^th

o         Ch. 16

o         Exchange Rate = Price

o         Good = Foreign Currency

o         Why might the depreciation of the dollar be good?

o         US vs. European inflation

o         The big questions:

o         Why are some nations richer than others?

o         Why are some nations getting rich faster than others?

o         Can anything be done to help poor nations?

o         Rule of 70

Thursday February 28^th

o         Much of the next exam is about what is covered today. This material is not in the book.

o         Differences in growth rates have large effects on income.

o         Economic growth = percentage changes in real GDP per capita

o         US economic growth in the 20^th Century was 2%

o         Solow Growth Model

o         1) Rich Nations have more capital goods than poor nations

o         2) Periods of growth are also periods of investment

o         Conclusion: tools lead to growth

o         Y = F(L,K)

¡ Investments are costly

¡ Investments increase output at a decreasing rate

o         Marginal Product

o         Steady State

o         Net Investment

o         Implications: 1) No new growth and 2) Convergence

o         Problems with these models:

o         Poor nations aren't catching up

o         No one seems to be coming to a steady state

o         Lucas

Tuesday March 11^th

• Important Theoretical Contributions of Solow I:
  • Marginal product of capital is always positive
  • Marginal product of capital declines
• Important Results of Solow I
  • Steady State
  • Convergence
• Solow II
  • Technological Advance
  • Exogenous Technology Shocks
    • Versus endogenous technology shocks
  • Policy Implications:
    • Give poor nations investment goods
    • Give aid for investment
  • The record (50 years later)
    • No convergence
    • A series of failures
  • What is wrong with Solow II?
    • Answer: Exogenous growth
• Modern Growth Theory (MGT)
  • Institution
  • Incentives
  • Voluntary investment requires sacrifice and patience
  • Investment and production naturally occur when:
    • Expected Return > Costs
  • Many factors diminish expected returns
    • Political risk
    • Corruption
    • Inflation Risk
    • Taxes
  • What institutions foster growth?

Thursday March 13^th

• The Third Rotunda Principle: the three sources of economic growth are resources, technology and institutions
• Land (natural resources)
• Labor
• Capital
• The key: institutions
• Aggregate Demand
  • C + I + G + X
  • Real Balance Effect
    • Quantity of Aggregate Demand
  • Interest Rate Effect
    • Quantity of Aggregate Demand
  • Relative Price Level Effect
    • Price of U.S. Goods Exports; Imports Quantity of Aggregate Demand
• Aggregate Supply
  • If all prices change uniformly no change in aggregate supply

Tuesday March 18^th

• We are now in Chapter 10 of Gwartney
• Aggregate Supply: not only are prices changing but general price level is changing
• Long run vs. Short run
• Which prices adjust more slowly?
  • Input prices tend to be stickier than output prices
• LRAS curve vertical and SRAS curve increasing
• LR has full employment
• LRAS is determined and changed by: resources, technology and institutions
• SRAS changes:
  • supply shocks
  • resource prices
  • expected inflation

Thursday March 20^th

• LRAS result in Y* and u*
• Broken Window Fallacy
• Consumer Confidence and spending helps the economy in the short run
  • In the long run there is no effect

SR vs. LR effects on an increase in the AD
Short Run	Long Run
1)      Quantity of Aggregate Supply Increases 2)      Real Wage Falls 3)      Output greater than Full Employment 4)      Unemployment below natural rate	1)      Quantity of Aggregate Supply unchanged 2)      Real wages constant 3)      Y = Y* 4)      U = u*

o       Factors that shift the AD curve

                                                              i.      Real income and wealth

                                                            ii.      Foreign Income and Wealth

                                                          iii.      Expected Income and Wealth

                                                          iv.      Expected inflation

                                                            v.      Exchange rate

Tuesday March 25^th

• Five Causes of AD shift
  • Real income and wealth
  • Foreign income and Wealth
  • Expected income and wealth
    • consumer confidence
  • Expected inflation
  • Exchange rate
• not all prices are flexible in the short run
• Unanticipated Increase in AD
  • In SR
    • Not all prices are flexible
      • For example: some nominal wages should stay the same. Thus real wages are lower.
    • u < u*
    • Y>Y*
  • In LR
    • all prices rise
    • Y = Y*
    • u = u*
    • Real wages constant 
• Unanticipated Decrease in AD
  • adjustment takes longer
•  If prices don't adjust, then output must
• 2008 Problems:
• Decrease in Wealth
• Decrease in Expectations of Future Wealth
• Financial Market Instability
• Proposed Solutions
• Fiscal Policy
• Monetary Policy
• Classical Economists
• stability in the economy
• Focused on LRAS
• believed prices were flexible in both directions
• implications
• no extended unemployement
• no significant contradictions
• Great Depression
• Keynes' Theory
• Demand is important
• Y < Y* for long periods of time
• Government intervention is necessary
• economy inherently unstable
• Prices inflexible downward but flexible upward
• Output adjusts
• AD determines GDP
• LR equilibrium is not necessary

 

QUESTIONS

Note: ~ means it will be covered on Tuesday¡¯s lecture.

Note: Turn in your answers to all questions on the day of the exam as your Group Assignment 3. I will award 5 points based on whether or not you attempted every problem. Everyone must turn in their own copy.

 

From Gwartney:

Ch. 17 #2*, #10*, #16*

Ch. 18 #1*, #4*, #5*

Ch. 16 #10*

ST 7 #3

Ch. 9 #1, #6*, #7, #8*, #16*

Ch. 10 #1*, #2*, #4*, #18* (think Broken Window Fallacy)

~Ch. 11 #4*, #10*

            Note: the *ed questions have answers in the back of the book.

 

Short Answer:

 

1. Why do we have recessions?

 

2. Why are recessions now shorter and occur less often then in the history of the United States?

 

3. Describe in your own words what it means when a nation runs a current account deficit.

 

4. ~In recent years, approximately 35 percent of the income of Canadians has been spent on imports. In the United States, spending on imports constitutes about 12 percent of income. Would you expect the size of the multiplier to be larger or smaller in Canada than in the United States? Explain.

 

5. In 1999 the nominal interest rate on a 30-year bond was around 5.85%. Assuming investors have set these contracts expecting a real interest rate of 3%, what is the average rate of inflation that investors in the market are expecting over the next 30 years?

 

6. Explain whether each of the following events will increase, decrease, or have no effect on LRAS:

                                            i.                        The United States experiences a wave of immigration

                                          ii.                        The United Auto Workers union wins an unexpectedly high wage increase in its new contract.

                                        iii.                        Intel invents a new and more powerful computer chip.

                                        iv.                        A severe hurricane damages factories along the east coast.

 

7. ~In Solow's model, saving is good to the economy because more savings could bring more investments, which will induce the economic growth. But in Keynes' model, saving is bad because more savings will reduce the MPC (marginal propensity of consumption) and weaken the multiplier effects of government's fiscal policy. Write down your understanding on these different opinions. (This is an open question)

 

 

Multiple Choice:

 

1.      Which of the following would cause real wages to increase in the short-run? [Basic AD/AS model]

a.       An anticipated decrease in aggregate demand.

b.      An unanticipated decrease in foreign income.

c.       An anticipated decrease in prices.

d.      An unanticipated decrease in real interest rate.

 

2.      In which of the following situations would you expect to see a long-run increase in price level? [Basic AD/AS model]

a.       There is an increase in aggregate demand in the short run.

b.      There is an improvement in technology.

c.       There is a temporary positive shock to supply (such as especially good weather conditions).

d.      None of the above.

 

3.      Which of the following can never happen according to the Basic AD/AS Model?

a.       The full employment level can increase, while the natural rate of unemployment remains constant.

b.      The short-run output level can fall below full employment output level while unemployment rate falls below the natural rate of unemployment (i.e. there are fewer people unemployed).

c.       Price level can increase in the short run.

d.      Long run aggregate supply can shift permanently.

 

4.      ~Which of the following labels for the consumption function (see below) is not true? [Keynesian Model]

a.       ¡°C¡± is the aggregate consumption expenditure.

b.      ¡°a¡± is autonomous consumption expenditures.

c.       ¡°b¡± is the marginal propensity to save.

d.      ¡°Y_d¡± is disposable income.

 

5.      ~What four types of expenditure go into calculating aggregate expenditure? [Keynesian Model]

a.       Consumption, Inflation, Government, and Net Export expenditures.

b.      Consumption, Inflation, Government, and Export expenditures.

c.       Consumption, Investment, Government, and Net Export expenditures.

d.      Consumption, Investment, Defense, and Export expenditures.

 

6.      Based on the Solow Model discussed in class, an increase in savings will have what effect on k and y

a.       Increase in k, decrease in y

b.      Decrease in k, decrease in y

c.       Increase in k, increase in y

d.      Decrease in k, increase in y

 

7.      In the long-run if all prices, including the nominal wage, rate doubled, then aggregate output supplied would:

a.       double.

b.      rise.

c.       fall.

d.      remain unchanged.

 

Graph:

 

 

 

1. Explain in words what is happening in this graph.

 

2. What situations might cause shifts like the ones seen above?

 

3. Which of the equilibriums above are short-run equilibriums?  Which are long-run equilibriums?

 

4. In the short run, what happens to quantity of aggregate supply, real wages, firms' profits, output, and unemployment?  What happens to all of these things in the long-run?

 

5. Draw the graphs that correspond to the short-run and long-run changes that the individual firm experiences.  Draw the graph that corresponds to the short-run and long-run changes in the labor market.

 

6. Is the short-run shift in the graph anticipated or unanticipated?  How do you know?

 

 

 

~True or False

Determine True or False, and explain your answer.                        

 

1. If a new federal budget raises government purchases, G, by a $100 and increases taxes, T, also by a $100 so that the government deficit, T ¨C G, is unchanged, then GDP will also be unchanged.

 

2. If an economy's marginal propensity to consume is equal to 0.8, people consume 20% of their disposable income.

 

3. If the economy is experiencing a contractionary gap, it might be appropriate for the government to use fiscal policy to stimulate aggregate supply.

 

4. Because the aggregate supply curve slopes upward, expansionary fiscal policy tends to be accompanied by rising prices.

 

5. If people base decisions on their permanent income, the spending multiplier will be larger.