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Economics Final
Questions to prepare for Macroeconimcs final
Undergraduate 2

Additional Economics Flashcards




What is Economics?
Economics is defined as the study of the choices people make, given their scarce resources and how scarce resources are allocated among alternative uses.
List five functions of any economic system?

Function of fixing standards - The economy functions in an efficient manner

Function of Organizing production - All resources are allocated and coordinated

Function of Distribution - Who gets the goods and how we get them to who deserves them. Maintaining and Improving Social Structure - Such as population, capital, technology and resources.

Adjusting Consumption to Production - Changes in production take time.

Describe six benefits associated with economic specialization?
  • Utilization of natural aptitudes
  • Development and utilization of knowledge
  • Task specialization - less moving between tasks so less to master
  • Natural advantages with regards to Natural Resources
  • Artificial specialization of material agents
Describe two costs associated with economic specialization?
  • Technical cost - involved in assembly and distribution
  • Independence - Everyone has to work as a group of specialization to function.
Why are property rights important?
People must be able to own their own stuff for markets to function correctly No one buys if someone doesn't own it People strive to acquire stuff
Why are prices important to the efficiency of markets?

They signal the sacrifice necessary to consumers and the profit to potential producers


-Ration goods to those willing and able to pay


-Relative prices compare sacrifices to satisfaction.

Why are transaction Costs important to the efficiency of markets?
  • They influence the incentive to engage in exchange
  • -Influence the desirability to establish property rights
  • Influence whether a market will develop and whether it will allocate its resources efficiently.
What are are Economic Models?
  • Simplified version of reality used to analyze real world situations
  • Cause/effect relationships
How do economic models relate to scientific analysis?
  • They state assumptions and then test with data to validate theory
  • -If it cannot be tested it is not a theory
  • -One must interpret the information correctly, similar to all scientific models
  • -The evidence must be viewed an interpreted in an accurate and concise manner, objectivity is important, one shouldn't strive to prove their theory to be correct.
Identify/ Explain four determinants of demand in a market?
  • -Tastes -
  • Demographics (Size of Market)
  • -Income and Wealth
  • -Prices of substitutes
  • -Expectation of future prices.
Identify/explain the determinants of supply in a market?
  • -Input prices
  • -Technology
  • -Expectations
  • -Size of Market
  • -Opportunity costs
Define Elasticity?
A measure of how much one economic variable responds to changes in another economic variable.
Identify/explain the price elasticity of demand?
  • -The sensitivity of quantity demanded to changes in price
  • -Inelastic consumers will pay almost any price for a product
  • -Elastic if consumers will only pay a certain price or a narrow range of prices
  • -If very elastic consumers may switch to substitutes.
Identify/Explain the income elasticity of demand?

-Ratio of the percentage change in quantity demand relative to the percent change in income

-If income increases by 10% and as a result the quantity of a good demanded increases by 20%. It will be 20%/10% = 2

Identify and give the significance of Gross Domestic Product?

The market value of all final goods produced in a country during a period of time, typically one year. -Represents the productivity of a country

-Adds together the values of multiple products

Y=C + I + G + NX

-More goods and services the better off they are.

Identify and give the significance of Gross National Product?

Value of final goods and services produced by residents of a country, even if production takes place outside of the country.


  • -US firms in foreign countries
  • -Used because it more accurately represents the production in foreign countries.
Identify and give the significance of Net National Product?

GNP minus depreciation (consumption of fixed capital)

-When you subtract depreciation from Gross National Product


  • -Shows how much has been lost due to depreciation
  •  -May be an indicator of future investment spending.
Identify and give the significance of National Income?

Value of sales taxes from Net national product

  • -Indirect business tax
Identify and give the significance of Personal Income?

Income received by households


  • -Subtract earnings that corporations retain rather than pay to shareholders in the form of dividends.
  •  -Also add in the payments received by households from the government in the form of transfer payments.
Identify and give the significance of Disposable personal Income?

Personal Income minus personal tax payments


  • -Eg. Federal personal income tax
  • -Best measure of the income households actually have available to spend.
Explain the calculation and the use of the GDP Deflator?

Measures the price level


  • -if prices increase while production is held constant, nominal GDP would rise and real GDP would remain the same
  • -This would cause the GDP deflator to increase
  •  -Monitors the price level over time
  • Nominal GDP/ Real Gdp x 100 = GDP Deflator
What problems do we encounter computing and using National Income Accounts?
  • -Leisure not included
  • -Not adjusted for pollution or other negative effects, particularly environmental
  • -Not adjusted for crime
  • -Measures pie, but not how divided up (disparity)
What is the definition of the Labor Force?
  • -The sum of employed and unemployed workers in the economy
  • -People who don't have a job and are not looking for a job are not considered in the labor force.
What is frictional unemployment?
  • -Short term unemployment that arises from the process of matching workers with jobs
  • -Some unavoidable
  • -Seasonal factors, such as weather, fluctuate the demand for some products
  • -Workers have different skills, interests and abilities and jobs have different skill requirements.
What is structural unemployment?
  • -Persistent mismatch between job skills or attributes of workers and the requirement of jobs
  • -Can last for longer periods (Workers need to learn skills)
What determines Labor Productivity? (Give the definition and explain the causes?)
  • -Increases in GDP per Capita depends on labor productivity.
  • -Which is the quantity of goods or services that can be produced by one worker or by one hour of work.
  • Two factors influence
  • Quantity of capital per hour worked
  • -manufactured goods used to produce other goods and services (cpu's, factories and machines)
  • -Physical capital
  • -Human capital - accumulated knowlege and skills workers acquire from educating, training and experience.
  • Technological change -Increase in the quantity of outputs firms can produce given a number of inputs.
Why isn't the rate of unemployment equal to zero in normal times?
  • Not equal to zero because there will always be some frictional and structural unemployment because jobs are always being created and destroyed
  • -Natural rate of employment
  • -normal rate of employment from F & S
Why would an unemployment rate of zero be undesirable?
  • Too much power in the hands of employees
  • -Employers would be at a disadvantage since demand for work would be low, employees would jump from job to job
  • -Cost employers to train and retrain.
What fractions of unemployment are due to job loss, job quits and new entrants in normal times?

1/4 Loser their jobs

1/4 leave their jobs

1/2 due to new entrants and re-entrants

-school -family -seasonal unemployment

How does GDP influence personal consumption?
  • GDP is a measurement of all the income households receive
  • -It can be calculated using wages
  • -When GDP increases it means that personal income is also rising, leaving households with higher incomes
  • -as income increases demand for all products increase, therefore increasing consumption
What are the three main forms of investment in real goods?

Business fixed investment -spending by firms on new factories, office buildings, and machinery used to produce other goods

Residential investment -Spending by households on new housing

Change in business inventories -Inventories are goods that have been produce but not yet sold.

How does the level of aggregate demand influence investment?
  • Aggregate Demand The collective demand by consumers in an economy
  • -As demand increases so does the level of prices -as prices increase it leads to a greater amount of borrowing and withdrawals from banks
  • -An increase in prices signals to firms the potential to make a profit, so investment increases.
  • -Eventually, as investment and consumption increase so do interest rates
  • -the increase in interest rates leads to less investment and more savings.
How are capacity utilization related to investment?
  • The level of productivity in an economy
  • -A high capacity utilization means a large portion of capital is being utilized and output and demand is high
  • - This leads to an increase in investment spending by firms because their is an opportunity to make a profit
  • -An increase in prices signal an opportunity to make a profit!
How is depreciation related to investment?
  • The wear and tear of property and equipment of time
  • -The using up of capital
  • -If net national product is low, as a result of large amounts of depreciation, it signals for an increase in capital
  • -If market interest rates are reasonable firms will invest and replace capital, especially during an expansion.
How do real interest rates influence investment?

Real interest rates = nominal interest rates - inflation

-High real interest rates, people more likely to save because they receive a greater return on their money

-If someone has 1,000 dollars trying to buy dvds at 10 each they could buy 100

-If the interest rate is 6% and inflation is 4$ you could invest the money for a year and DVDs would cost 10.40 but you'd have 1060 and could buy 102.

How do relative interest rates influence foreign exchange rates and thus imports and exports?
  • When interest rates are high it attracts foreign savings in US banks
  • -Increases the demand for the dollar because more people are saving, less dollars in circulation -Causes the value of the dollar to rise
  • -Exports become more expensive and imports become cheaper.
What are contributors to Economic growth? (Consider direct causes and pre-conditions)

Economic growth determined by Capital, Labor and Technology

Labor Productivity -Quantity of goods or services produced by one worker or one hour of work


  • -Increases in capital per hour worked and technological change
  • Capital - goods used to produce other goods and services
  • -Increase in capital = an increase in worker productivity
  • -Ex. one shovel vs. multiple shovels Human capital
  • - the accumulation of knowledge through work or education Growth cannot be only capital
  • -Must be accompanied by technological change -turning inputs into outputs
  • -rearrange storeroom floor/efficiency.
  • Other factors -Political/financial stability -Enforcement of property rights
  • -Innovation and invention more efficient ways of doing things
  • -ex. patents and copyrights
  • -Technology is nonrivalrous and non-excludable
How does economic growth in the last 200 years differ from prior periods?

Industrial revolution/ mass production and high rates of expansion

-prior economic growth was at a standstill -technology has increased efficiency

-more constant and stable growth rates.

How is technology produced?

Technology is turning inputs into outputs

  • -An example of an increase in technology would be using the same amount of inputs but increasing outputs
  • -Governments have patents/trademarks -Encourages firms to invest in R & D
  • -Come up with more efficient ways of doing things
  • -Without patents everyone would copy ideas and no one would be innovative.
Explain the growth accounting formula? What is the practical use of the growth accounting formula?

Technology x 1/3 Capital x 2/3 Labor -Determines the growth rate of GDP

-Predicts how fast a country will grow, an economy that grows too slowly will fail to raise living standards

-There is a relationship between growth rates, health and prosperity.

How do economists explain international differences in per capita income?

Usually poor countries are predicted to grow faster according to the growth model

  • -Poor/developing countries usually have difficulty maintaining a stable growth rate for a variety of reasons.
  • -Developed countries invested in capital, technology and work force
  • -Ex. Education
Why are some incomes among some developed nations converging, but incomes of the poorest nations are not?

Based on the stability of the governments and financial systems

-inability to protect and secure property rights -political corruption and insecure financial markets, foreign investors aren't willing to invest -lack of invest prohibits growth

-People receive little income, unlikely to save, hurts ability for firms to borrow and invest, halting expansion

-Restrictions and regulations such as tariffs, taxes and quotas

-Lack of investment in human capital -

People aren't healthy, educated, willing to be in the actual work force

-Don't enforce contracts and rights.

What is Export Led Growth? (Rationale, strategies, and policies) Why has it worked better than import substitution?

Export Led Growth (Open Market)


Rationale - benefit mutually, comparative advantages

Strategies - remove tariffs/quotas, free-trade zone, increased incentives for exports (decrease taxes)

Why work? More competition, Less inflation, increased efficiency and choices, balanced budget X>N, Increased productivity

What is Import Led Growth? (Rationale, strategies, and policies)

Import Led Growth (Protectionism)


-Rationale - Protect domestic industries, lower dependency


Strategies - tariffs and quotas


Why doesn't work? Increase in prices and inflation, less efficiency and choices.

What is Money?

Assets that people are generally willing to accept in exchange for goods and services or for payment of debts

Unit of Account -You can compare values


Store of Value -Won't go bad


Medium of Exchange -Can be used to exchange goods so you don't have to barter

How would you characterize the demand for money?

Three types of demand


Transaction demand - day to day spending


Precautionary demand - emergency and unexpected circumstances -recession/downturn

Speculative - take advantage of opportunities

Why is the quantity of money important?

If the FED buys large amounts of bonds/assets


  • -MS increases so that it is constantly higher than GDP - inflation!
  • -Producers will know there is more money and raise prices
  • -Too much $ will decrease the value
Why would you expect the income elasticity for money to be unity (E=1)? Why would you expect the price elasticity of demand for money to be One (neutrality)?

M x V = P x Q dM/M x dV/v = dP/P x dO/O


Change in Money M = Change in Price P + Change in Output O


So if Money goes up 10 either price our output must go up 10

Compare and contrast the current account and the capital account in the balance of payments?

Capital Account (Financial account)


Current account -

Trade Balances

-Interest/profits (made, assets abroad) -Unilateral Transfer (Go to another country to work, send money home)


Capital/Financial Account

International loans/Investment (borrowing/lending)

Buy/sell assets abroad


-If you buy stock in a foreign country it raises the capital account


-But if you pay dividends it increases the current account

-Current account must balance

What are the differences between the merchandise trade balance, the balance of goods and services and the current account balance?

Merchandise trade balance - the trade balance of just goods (excluding services)


Balance of Goods and services - includes good and services


Current Account Balance - Includes trade and unilateral transfers and interest/profits made on assets abroad.

How is the investment-savings gap related to the US trade deficit?

When I>S (Savings deficit) Credit: [I-S] + [G-T] = Change in MB + [IFCin - IFCout]


When investment goes up, savings goes down


-IR goes up International balance of payments


[IFCin -IFCout] + [Decrease X - Increase] = 0


Demand for US dollar increases


-Exchange rate increases Causing trade deficit to go up!

why is a global perspective on monetary policy necessary?
  • US policy has an impact on the rest of the world
  • -for example, changes in IR will affect our exchange rates
  • -G8 meets to work together
Business cycle theories focus on Aggregate demand; Economic growth theories focus on potential production. What determines each?

Aggregate demand is income, price, size of market (Total demand in the economy)


Business Cycle - Short run periods of expansion and recession that an economy goes through -


Demand correlates with supply

-When D>S, economy expanding

-Businesses invest, raises total income

-Leads to a raise in prices

-So business cycles influence prices Potential Production

- Capital, Labor and Technology and Full employment

-US sustainable level is U 4-4.5% and Capacity 82%

-They both signal where the economy is at

-If aggregate demand is high, potential production should be high (high demand = high employment

-When aggregate demand is high firms much more likely to invest in capital and technology because they see an opportunity to make a profit, these are determinants of potential production.


For example, increasing AD or D>S could be a signal of upcoming inflation, may influence FED to sell assets.

What causes an economy to recover after a recession?

D greater than S (Demands relation to supply is where we are)

D less than S - no inflation during a recession Decrease in interest rates (After a while investment spending will pick up and people begin borrowing as a result of low interest rates

IFCin increases and Exchange rate decreases -Less demand for $

-Our goods appear cheaper and Exports increase and Imports decrease

-This causes an increase in demand for domestically produced goods

A key component of getting out of a recession is to increase demand

-economy is stimulated

How do significance of inflation expectations determine the rate of price adjustment?

People generally expect small amounts of inflation, but if it rises too much it can hurt loyalty (consumer loyalty)

-Adjusting prices has repercussions

-Producers can adjust quantity rather than price In and expansion when demand is greater than supply just produce more

In a recession when demand is less than supply produce less.

How do implicit determine the rate of price adjustment?

Slashing employee wages hurts employee loyalty


-Want to keep employees happy at a stable wage rate

-Have an implicit contract with consumers, if keep prices stable they'll keep returning

-Better to fire half then cut all wages

How do staggered price setting determine the rate of price adjustment?

Prices are sticky, want prices to remain relatively constant

-Example, don't want to reprint new menu just because the price of an input rises.


-If minimum wage rises you can't just change prices


-Wait until the future, it's inefficient to always be changing prices in reaction to changes in cost of resources.

Derive the four sector spending multiplier?

dY = Final Change in Income (GDP) dY = Autonomous (Initial change) + Induced (Feedback mechanism)

-Multiplier indicates that a small change leads to a big change

dy = dA + dC + dI + dG + dX - dn

dy = dA + .63dy + .15 dy + 0 + 0 - .14dy


-Government spending is not a result of GDP -


They devise their budget separately Exports aren't influenced by our economy, a country may be in a recession while we're in an expansion


-Can't force them to buy our goods Wage starts at 100 - 30(Taxes) PDI = 70

We spend 90% of PDI (70) = 63% is the portion of our income we spend

dy -.64dy = dA + 0.64dy - .64dY


0.36dY/0.36dY = 1dA/0.36 dy= 2.78 dA


-If investment falls by 100 million the final impact on the economy is 278 million.

Why do we rarely observe the exact correspondence between a change in autonomous spending and the ensuing change in income predicted by the spending multiplier?

Various factors are out of our control


-Tax policy could change (especially during an expansion/recession)

- the 0.63C figure will be affected


- People may jump a tax bracket, lowers their PDI


-Causes consumption to be somewhat harder to predict

-Consumption is influenced by money supply

-FED may restrict money supply

-MS less than MD

-Cause our propensity to spend to change

-Also can't control how many imports are produced, even if we are in an expansion.

What causes inflation?

Constant increase in prices


-Demand greater than supply (usually in an expansion) D>S

Actual GDP greater than potential GDP


-Increase in money supply greater than the increase in GDP

What is necessary to reduce the rate of inflation?

FED decreases money base, therefore decreasing money supply


-FED sells assets IR increase during an expansion -Lowers investments (loans)


-IFCin increases, Exchange rate increases


-Exports become more expensive, demand for domestic goods increase

Taxes may also reduce PDI and lower spending, producers won't raise prices.

How, and why, does the gap between actual GDP and potential GDP influence the rate of inflation?

Actual GDP is greater than Potential GDP during an expansion Increase in demand leads to price increases and inflation 

Actual less than Potential


-Demand less than supply

Fall in production, excess inventory

-Unemployment increases, total income falls -People are buying few goods, suppliers can't increase prices, inflation decreases/stabilizes

Why do interest rates rise when inflation rises?

Banks need deposits to be able to lend out money to potential borrowers.

-Ideally, real interest rates should be between (2-5%) encourage people to borrow but also reward people for saving.

Real = Nominal IR - Inflation

3 = 5 - 2

-1= 5 - 6

3 = 9 - 6

-The banks adjust the interest rates naturally in accordance with inflation -no one will invest with a 0 interest rate

Why are investment and net exports negatively related to the level of domestic interest rates?

Higher Interest rates (vs world)


-Lower investment spending

-Increase foreign investment in and increase ER -Exports decrease and Imports Increase -(X-N) falls and net exports fall.

Why has unemployment frequently been followed by price shocks?

A price shock is a sudden increase in a key commodity

-Ex. Oil -Price of oil increases (shortage)


-Causes price of most good to Increase (inflation)


-Consumers buy less of all goods

-Income effect - income doesn't stretch as far Demand is less than supply so a decrease in production

-Firms lay off works which increases unemployment Stagflation

- unemployment and inflation.

Compare and contrast the determinants of Money supply in the United States and Nambia? (What factors determine money supply in the US? In nambia?)

US - floating exchange rate

Nambia - fixed exchange rate


-In the US

-MS = MB x MM

-MB = FED buys/sells assets

-MM = Banking

system -

Money supply is an indicator of monetary policy


Nambian $dollar is fixed to the African Rand -


Nambia accepts both Nambian dollar and African rand -there is a SA banking system in Nambia -


When MS is less than MD -People then borrow Rand and spend Rand in Nambia


-Nambian central bank has no control over the money supply

Explain in detail the process of Open Market Operations in the United States (What are the institutions and specific procedures, quarterly and daily?)


- meet every 6 weeks -

12 Reserve bank presidents -7 members Federal Reserve board


-Discuss goals of next 6 weeks

-Vote 7 FRB and 5 Presidents

-Vote to change interest rates (Monetary Policy)



- conference call

Federal Open market Committee (staff)

-FED staff (Bernanke)

-Reserve board president (NY president)

-Traders call the banks (Will hold offer for 30 mins) Example.

Want to buy/sell this many (bonds/securities) at a certain price

-Neutralize the economy

Compare and contrast the president's proposed budget deficit, the actual budget deficit and the structural deficit?

Presidents Proposed budget

-All agencies ask for how they need (Office of manpower & budget)

-Submit proposals to congress

-Congress spends next few months figuring out actual budget

Actual Budget -October 1st, passed by congress


Structural - what the deficit would be at full employment

Actual budget - what our deficit would be by just our budget

Structural Deficit - What our deficit would be if we at full employment


In a recession

-Actual greater than structural

Deficit 100 High unemployment 40 Structural 60


In an Expansion Actual less than structural Deficit 100 (3%) low unemployment - (-20) Structural - 120 Deficit - Revenue minus spending

What are automatic stabilizers and how do they work to reduce economic fluctuations?

Automatic stabilizers - cushion recessions and expansions (No Policy change - takes time)


-Policy could be too late

Income transfers -transfers from government to people


Unemployment insurance

-in a recession if you lose your job your income falls from 100 to 0 -only falls from 100 to 50 (because of government transfers)

-Doesn't fall as far




Social Security - Expansion people less likely to retire

-during a recession people more likely to retire early, so SS is a cusion

-Receive SS

-Instead of being unemployed they receive income in retirement


Progressive tax - different tax brackets


-lower incomes pay less proportion of their income in taxes

-some cushioning effect

Don't want too big of expansions

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