Stephen's Answers to the 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.

 

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:

Short Answer:

 

1. Why do we have recessions? Downward price adjustments are much more inflexible than upward. Thus a downward shift in the AD curve can keep Y < Y* for a long time.

 

2. Why are recessions now shorter and occur less often then in the history of the United States? We have monetary and fiscal policies to counter decreases in the AD curve.

 

3. Describe in your own words what it means when a nation runs a current account deficit. Value of Imports exceed Value Exports.

 

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. I would expect the multiplier to be larger in the US. Every additional unit of income in the US will have a larger impact on US comsumption (than will an additional unit of income in Canada on Canadian consuption).

 

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?

Year         Nominal Value of Bond         Prive Level                       Real Value of Bond

1999          100                                         100                                     100

2000          105.85                                    100 + inflation rate               103

 

Thus:  105.85 * 100 / (100 + inflation rate) = 103

Thus:  inflation rate = 2.766990291

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 increase in LRAS (there is a change in resources (people)

                                          ii.                        The United Auto Workers union wins an unexpectedly high wage increase in its new contract. no effect on LRAS (there is no effect on institutions, technology or resources)

                                        iii.                        Intel invents a new and more powerful computer chip. increase in LRAS (there is an increase in technology)

                                        iv.                        A severe hurricane damages factories along the east coast. decrease in LRAS (there is a decrease in the resources (the effectiveness of the factories) ).

 

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. A drecrease in AD from AD1 to AD2, thus decreasing equilibrium from E1 to e2. Thus price level decreases and GDP decreases. Generally prices are sticky downward, so not all prices decrease. However, evenually, all prices will decrease. Thus, eventually, input prices will decrease. When this happens, the SRAS cure will move from SRAS1 to SRAS2. Therefore justifying a vertical LRAS.

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

Deacrease in Real income and wealth

Decrease in Foreign income and Wealth

Decrease in Expected income and wealth

Decrease in Expected inflation

Decrease in Exchange Rate

3. Which of the equilibriums above are short-run equilibriums?  E1, e2 and E3 Which are long-run equilibriums? E1 and E3

 

4. In the short run, what happens to quantity of aggregate supply (decreases) , real wages (increase) , firms' profits (decrease) , output (decrease), and unemployment (increase)?  What happens to all of these things in the long-run? nothing.

 

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? unanticipated, because it affects output.

 

 

 

~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 - G, is unchanged, then GDP will also be unchanged. False. Only a proportion of income goes toward consumption, while all of Government Spending goes toward GDP. Therefore increases in taxes decreases consumption less than the increase in Government Spending.

 

2. If an economy's marginal propensity to consume is equal to 0.8, people consume 20% of their disposable income. False, they consume 80%.

 

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

 

4. Because the aggregate supply curve slopes upward, expansionary fiscal policy tends to be accompanied by rising prices. True, the government increases Agregate Demand, so we move up the SRAS curve.

 

5. If people base decisions on their permanent income, the spending multiplier will be larger. False. If their real wage is too high then their spending multiplier would be smaller.