ECON 204 (FTU) STUDY QUESTIONS FOR EXAM II

1. Which of the following is included in the labor force? A. A student who is still in school, but not working or looking for work B. A part-time store clerk who is looking for a full-time job C. A person who volunteers full-time for a charity D. A person who spends the entire day taking care of his or her young children at home E. None of the above is included in the labor force Suppose that in a population of 50 million persons, 40 million are in the labor force, 36 million are employed, 2 million are classified as unable to work, and 1 million are classified as unwilling to work. The unemployment rate is: A. 15 percent. B. 10 percent. C. 8 percent. D. 6 percent. E. Cannot be determined without additional information. Jack graduated from college last month, but he has not yet started looking for a job. Jack is: A. Frictionally unemployed. Unemployment due to job search / voluntary unemployment B. Structurally unemployed. Unemployment due to the mismatch between skills/locations C. A discouraged worker. D. Not in the labor force. E. None of the above According to Okun's Law, if unemployment rises by 2 percentage points, & if the size of the economy is $100 billion, the economy will lose output equal to: A. $10 billion B. $20 billion C. $30 billion D. $40 billion E. None of the above - $4 billion During an economic downturn, laid off workers are classified as: A. Cyclically unemployed.Unemployment due to shortage of jobs slow economic growth B. Structurally unemployed. C. Frictionally unemployed.

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D. E. 6.

Seasonally unemployed. None of the above

Full employment means that: A. Frictional unemployment equals zero. Never be the case B. Total unemployment equals zero. C. The economy has reached the lowest level of unemployment compatible with price stability. D. It is impossible to increase real GDP. E. None of the above All of the following would be hurt by inflation except A. Students who have to pay back loans B. Savers C. Banks D. Retired people on fixed incomes E. None of the above would be hurt by inflation Assume that the price index for 2005 is 105 and for 2007 it is 115. Then the price increase from 2005 to 2007 is A. 15.0 % B. 10.0% C. 5.0% D. 4.5% E. None of the above 9.52% Suppose nominal GDP in 1990 was 6 trillion dollars and nominal GDP in 2000 was 10.5 trillion dollars. If the price index in 1990 was 100 and in 2000 was 125, how much did real GDP increase? A. $4.5 trillion B. $3.375 trillion C. $3.0 trillion D. $1.875 trillion E. None of the above 1.5 T The base period used in computing a price index is: A. The year in which prices were the most stable. B. The year in which prices were at their average level. C. The year in which prices relative to unemployment were at their minimum. D. The year in which prices of consumer goods are applied to purchases of the same goods in other years. E. None of the above. Which year doesnt matter

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Say's Law states that: A. Demand creates its own supply. B. Shifts of either supply or demand can achieve a given market equilibrium. C. Wages and prices are inflexible, which prevents the achievement of market equilibrium. D. Increased prices lead to increased supply. E. None of the above. Supply creates its own demand What A. B. C. D. E. varies along the aggregate demand curve? Incomes Interest rates The price level Consumer preferences None of the above

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If OPEC raises the price of oil and production costs increase, this may cause: A. Cost-push inflation. B. Demand-pull inflation. C. Hyperinflation. D. Relative inflation. E. None of the above The aggregate supply curve is A. vertical as GDP approaches full-employment. B. horizontal at low levels of GDP. C. positively sloped during periods of normal economic growth. D. All of the above E. None of the above Keynes argued that business cycles were caused by A. shifts in aggregate supply. B. shifts in aggregate demand. C. mistakes in government fiscal & monetary policies. D. shocks to the national economy created by global economic imbalances. E. None of the above.

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As government grew during & after WWII, the business cycle A. became more severe. B. became less severe. C. varied in its severity compared to the pre-WWII period, but had the same causes. D. varied in its causes, but had the same severity as before WWII. E. None of the above When A. B. C. D. E. the AS curve is vertical, increases in AD will: Increase the average price level but have no impact on unemployment. Increase the average price level and decrease unemployment. Increase both the average price level and unemployment. Have no impact on either the average price level or unemployment. None of the above.

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Keynesian theory & monetary theory both explain business cycles in terms of A. B. C. D. E. Shifts in aggregate supply Shifts in aggregate demand Fiscal policy Monetary policy None of the above.

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The real balance effect is one explanation of A. The positive slope of the aggregate supply curve B. The negative slope of the aggregate demand curve C. The negative slope of the investment function D. The positive slope of the consumption function E. None of the above Planned investment is a negative function of A. Savings B. Real GDP C. Disposable income D. Interest rates E. None of the above

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Assume that C = 200 + 0.8 YD where C is consumption & YD is disposable income. Also assume that personal income = 1500 & personal taxes = 500. Then C = A. 1400 B. 1200 C. 1100 D. 1000 E. Cannot be determined without additional information Assuming the same information as in Question 21, what is the C when YD = 100? A. 300 B. 100 C. 80 D. 20 E. None of the above Assuming the same information as in Question 21, what is the marginal propensity to save? A. 1.0 B. 0.8 C. 0.2 D. 0.1 E. Cannot be determined without additional information Assuming the same information as in Question 21, if disposable income increases by 100, then autonomous consumption will increase by A. 1080 B. 880 C. 200 D. 0 E. Cannot be determined without additional information Assuming the same information as in Question 21, how much is saving? A. -200 B. 0 C. 200 D. 500 E. Cannot be determined without additional information

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Assume the same information as in question 21 plus the following: net investment = 200, planned inventory changes = 100, unplanned inventory changes = 100, government spending = 400, exports = 100, imports = 200. Then planned investment = A. 200 B. 300 - Planned Investment excludes unplanned inventory; G and (XM) is irrelevant C. 400 D. 500 E. None of the above Assume the same information as in Question 26. Then aggregate demand = A. 2000 B. 1900 C. 1700 D. 1600 = C + Ip + G + (X-M) = 1000 + 300 + 400 + (-100) E. None of the above If aggregate supply = aggregate demand = $10 trillion, & if full-employment GDP = $11 trillion, then A. The economy is in equilibrium B. There is a recessionary gap C. Total unemployment > frictional unemployment (?) D. Inventory changes are zero E. All of the above The law that states that the market system can automatically achieve & sustain full employment is called A. Law of supply B. Law of demand C. Says Law D. Keynes Law E. None of the above A change in interest rates will cause A. Movement along the investment function B. A shift in the consumption function C. A shift in aggregate demand D. A change in equilibrium real GDP E. All of the above

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ESSAYS, PROBLEMS, GRAPHS

1. Define full employment. Why is it defined in terms of inflation? Why isnt it equivalent to zero unemployment. Chapter 6 Slide 10

Full employment is the lowest sustainable level of unemployment that cannot cause inflation to accelerate. It must be consistent with labor market equilibrium. The definition in terms of inflation gives us a measurable approach toward full employment.

2. List & define the four types of unemployment. Which one(s) are involuntary? - Chapter 6 Slide 9 Seasonal Unemployment: unemployment due to seasonal changes in labor demand or labor supply. For example, during Christmas Eve, demand for goods increases but then decreases right after the vacation. This makes many people that are previously hired unemployed. This is an involuntary unemployment. Frictional Unemployment: unemployment caused by normal job searching and is a voluntary unemployment. Structural Unemployment: unemployment caused by the mismatch between the skills or locations of job seekers and the requirements or locations of available jobs. This is an involuntary unemployment. Cyclical Unemployment: unemployment caused by a shortage of jobs. Due to slow economic growth. This is an involuntary unemployment. Seasonal, Structural and Cyclical Unemployment are involuntary because in those situations the workers or job seekers have no job due to external reasons but not the willingness of them.

3. Explain the two major types of inflation. Illustrate each on an aggregate supply/aggregate demand graph. Chapter 7 Page 144 Demand-pull inflation happens when production is at capacity but the consumers are willing to buy more goods. This can be the result of savings or high availability of credit. This would be a signal for firms to raise the price. They are willing to do so because they can raise profit but all the goods still can be sold out due to scarcity (Supply < Demand). The result would be the demand-driven rise in average prices, aka demand-pull inflation Cost-push inflation happens when the cost of production increases, which may be the result of a rise in prices of resources. Producers must raise their prices to cover the higher costs. Beside material costs, wages can be a reason to the increase of prices if the labour unions are able to push up wage rates. All of those result in an increase in average prices.

4. List & explain three reasons for the negative slope of the aggregate demand curve. List & explain two reasons for the positive slope of the aggregate supply curve. Chapter 08 Slide 15~21 Negative slope of AD Real balance effect: cheaper prices make dollars more valuable because the real value of money is measured by how many goods and services each dollar will buy. With the same savings balance, the price level increases, one can buy less than before, the quantity of output demanded will decrease. Foreign-Trade effect: the downward slope is reinforced by changes in exports and imports. The decision factor that makes consumers choose between domestic or foreign goods is their relative prices. If the price of domestic increases, people prefer foreign goods which are cheaper, thus the demand for domestic goods decreases and vice versa. It is the same for international consumers. Interest-Rate effect: The changes in price level affect the amount of money people need to borrow. At lower price level, the borrowing needs are smaller, thus the interest rates tend to decline.

Positive Slope of AS Profit Effect: The primary motivation for supplying goods and services is the chance to earn a profit. Producers always have to pay some fixed cost like wages, renting, etc. So if the price level decreases, theyd rather cut down on productions so that they can afford those fixed costs. If price level goes up, of course producers want to maximize their profit by increasing production. Cost effect: The upward sloping can also be explained by rising costs. Not all costs will remain constant. Some costs like overtime wages or supply costs multiply overtime as the rate of output increases. Therefore, the producers have to increases the price level if they want to produce more.

5. Explain why the classical economists believed that a market system would automatically achieve full-employment & why Keynes thought that they were wrong. Be sure to explain Says Law & Keynes critique of it in your answer. Chapter 8 Slide 6~8

Jean-Baptiste Say, a conservative economist, stated that Supply creates its own demand. He proved the statement by the theory of price stability. According to Say, the price of unsold goods will decrease, thus all goods will be sold eventually. In case total consumption is less than total income due to savings, those savings will go to banks then to investment. Therefore, all income will eventually be consumed. Finally, Say argued that unemployed workers will accept low wages in order to have a job. Decrease in wages will make all workers employed. Say concluded that the market is strong enough to reach full employment by itself. However, Keynes did not think so. He argued it was not true that all the savings will go to investment. Even when the banks held a lot of saving and the interest rates were low. If people were pessimistic about the prospect of investing, they would not take the risk of borrowing money to invest. What is more, Keynes proved that Says idea about flexible wages is wrong because in fact, if the wages were decreased, the workers would go on strike!

6. Explain two potential problems with macro equilibrium. Use aggregate supply/aggregate demand graphs to illustrate each problem. Chapter 8 Slide 23~25

Undesirability: At the equilibrium point, we know for sure that people are willing to buy the same amount of goods that are produced. However, this quantity may be more or less than the level of Full-employment potential, which is the rate of output if we were fully employed. This leads to the situation of Undesirability, where we fail to achieve our goal of full employment. Similar problem may occur to the price. The actual price level can be higher or lower than the desired one, which is known as inflation or deflation. Instability: Even if full-employment is achieved, it will not last long due to the continuous shift of the supply and demand curve. A leftward shift of the AD can cause a recession while a rightward shift can cause a recovery. Similarly, shifts of the AS can cause upswings and downswings. The combination of recurrent shifts of AS and AD causes business cycle, which proves the instability of market equilibrium.

7. Draw an aggregate supply/aggregate demand graph showing a recessionary gap. Show what would happen if the government uses fiscal policies to eliminate the gap. Chapter 8 Page 171

This is easy

8. List & explain three theories of the business cycle. Chapter 8 Slide 26 Page 167~169

Keynesian theory: is a prominent theory in Demand-side. He argued that a deficiency of spending would tend to depress an economy. This is the result from either of consumer savings, inadequate investment and insufficient gov spending, either of which would leave goods unsold and production capacity unused. Keynes concluded that inadequate AD would cause persistently high unemployment. Monetary theory: Is another demand-side theory. Money and Credit affect the ability and willingness of people to buy goods and services. If credit is high or not available, people wont be able to buy much as well as investors cannot borrow much to invest. Adjustment in money supply can shift the AD curve to or away from the desired position. Monetary theory

attributes all macro success and failure to the management of money supply. Supply-side theory: Shifts in AS can cause downturns as well. The failure to achieve full employment may result from various reasons such as rise in costs, resource shortages or gov taxes and regulation. In adequate investment or skill training can limit supply potential, too.

9. Assume that C = 500 + 0.8YD where C is consumption & YD is disposable income. Calculate saving or dissaving when YD = 2000, 2500, & 3000. Draw a graph illustrating this consumption function & the saving or dissaving at those levels of YD.

This is easy 10.Assume that the economy is initially at full employment. Illustrate the impact of a decline in consumer confidence on an aggregate supply/aggregate demand graph. Do the same for an increase in government spending. Show any recessionary gaps and/or inflationary gaps. Chapter 9 Slide 13, 21,24~26 This is easy 11.Use aggregate supply/aggregate demand to illustrate: a) an inflationary gap, b) a recessionary gap, & c) an economy which is in neither an inflationary gap nor a recessionary gap. Chapter 9 Slide 26 This is easy 12. Why does Keynes theory of consumption emphasize the short-term? What is an alternative theory that emphasizes the long-term? Chapter 8 Page 170, 169 (Long-run Self-adjustment theory)

Keynes was interested in the short-run only, maybe because he is object to the classical economists, who favored the long-run. According to Keynes, in the long-run we are all dead, he pointed out that we can hardly wait to see the self-adjustment of the market in the long-run, with the evidence of the Great Depression, at which time people waited in vain in more than 10 years to see such a self-adjustment. Whatever the long-run may hold, it is the short-run that we must consume, invest and find a job. People care about the short-run changes of job prospects and prices. Short-run theory like Keynes highlights the necessity of policy intervention. An alternative theory that emphasizes the long run is the theory of Morgan Friedman, a conservative economist. He insists that the consumption is predicted by the average life-time income, which is shown in the long-run. Therefore, he argued that governments intervention like lowering taxes only give money to people temporarily in a short time, thus makes no sense in the long-run. The necessity of governments intervention is still the centre of debate these days.