Questions and Answers of Economics Principles and Policy

The main categories of the U.S. financial services industry are commercial banks, thrifts, insurance companies, mutual fund companies, pension funds, securities firms, and investment banks. The
The TARP loans and the Fed’s lender-of-last-resort actions intensify the moral hazard problem. This is the tendency of financial investors and financial firms to take on greater risk when they
In 2008 Congress passed the Troubled Asset Relief Program(TARP), which authorized the U.S. Treasury to spend up to$700 billion to make emergency loans and guarantees to failing financial firms. The
The financial crisis of 2007–2008 consisted of an unprecedented rise in mortgage loan defaults, the collapse or nearcollapse of several major financial institutions, and the generalized freezing up
The Fed is essentially an independent institution, controlled neither by the president of the United States nor by Congress. This independence shields the Fed from political pressure and allows it to
The major functions of the Fed are to (a) issue Federal Reserve Notes, (b) set reserve requirements and hold reserves deposited by banks and thrifts, (c) lend money to financial institutions and
The U.S. banking system consists of (a) the Board of Governors of the Federal Reserve System, (b) the 12 Federal Reserve Banks, and (c) some 6,800 commercial banks and 8,700 thrift institutions
Money represents the debts of government and institutions offering checkable deposits (commercial banks and thrift institutions)and has value because of the goods, services, and resources it will
There are two major definitions of the money supply. M 1 consists of currency and checkable deposits; M 2 consists of M 1 plus savings deposits, including money market deposit accounts,
Anything that is accepted as (a) a medium of exchange, (b) a unit of monetary account, and (c) a store of value can be used as money.
Identify the main subsets of the financial services industry in the United States and provide examples of some firms in each category.
Discuss the actions of the U.S. Treasury and the Federal Reserve that helped keep the banking and financial crisis of 2007–2008 from worsening.
Identify and explain the main factors that contributed to the financial crisis of 2007–2008.
Identify the functions and responsibilities of the Federal Reserve.
Discuss the makeup of the Federal Reserve and its relationship to banks and thrifts.
Describe what “backs” the money supply, making us willing to accept it as payment.
Identify and explain the functions of money and the components of the U.S. money supply.
Suppose that the investment demand curve in a certain economy is such that investment declines by $100 billion for every 1 percentage point increase in the real interest rate. Also, suppose that the
Suppose that a country has no public debt in year 1 but experiences a budget deficit of $40 billion in year 2, a budget deficit of $20 billion in year 3, a budget surplus of $10 billion in year 3,
Refer to the accompanying table for Waxwania: LO2 , LO3a. What is the marginal tax rate in Waxwania? The average tax rate? Which of the following describes the tax system:proportional, progressive,
(For students who were assigned Chapter 28) Assume that, without taxes, the consumption schedule for an economy is as shown below: LO1a. Graph this consumption schedule. What is the size of the
Refer back to the table in Figure 29.7 in the previous chapter.Suppose that aggregate demand increases such that the amount of real output demanded rises by $7 billion at each price level. By what
Assume that a hypothetical economy with an MPC of .8 is experiencing severe recession. By how much would government spending have to rise to shift the aggregate demand curve rightward by $25 billion?
LAST WORD What do economists mean when they say Social Security and Medicare are “pay-as-you-go” plans?What are the Social Security and Medicare trust funds, and how long will they have money
Trace the cause-and-effect chain through which financing and refinancing of the public debt might affect real interest rates, private investment, the stock of capital, and economic growth. How might
Why might economists be quite concerned if the annual interest payments on the U.S. public debt sharply increased as a percentage of GDP? LO4
True or false? If false, explain why. LO4a. The total public debt is more relevant to an economy than the public debt as a percentage of GDP.b. An internally held public debt is like a debt of the
How do economists distinguish between the absolute and relative sizes of the public debt? Why is the distinction important?Distinguish between refinancing the debt and retiring the debt. How does an
Define the cyclically adjusted budget, explain its significance, and state why it may differ from the actual budget.Suppose the full-employment, noninflationary level of real output is GDP 3 (not GDP
Explain how built-in (or automatic) stabilizers work. What are the differences between proportional, progressive, and regressive tax systems as they relate to an economy’s built-in stability? LO2
Briefly state and evaluate the problem of time lags in enacting and applying fiscal policy. Explain the idea of a political business cycle. How might expectations of a near-term policy reversal
Some politicians have suggested that the United States enact a constitutional amendment requiring that the Federal government balance its budget annually. Explain why such an amendment, if strictly
(For students who were assigned Chapter 28) Use the aggregate expenditures model to show how government fiscal policy could eliminate either a recessionary expenditure gap or an inflationary
What are government’s fiscal policy options for ending severe demand-pull inflation? Which of these fiscal options do you think might be favored by a person who wants to preserve the size of
What is the role of the Council of Economic Advisers(CEA) as it relates to fiscal policy? Use an Internet search to find the names and university affiliations of the present members of the CEA. LO1
The increase in investment in public capital that may result from debt financing may partly or wholly offset the crowding-out effect of the public debt on private investment. Also, the added public
More substantive problems associated with public debt include the following: (a) Payment of interest on the debt may increase income inequality. (b) Interest payments on the debt require higher
In general, the public debt is not a vehicle for shifting economic burdens to future generations. Americans inherit not only most of the public debt (a liability) but also most of the U.S. securities
The concern that a large public debt may bankrupt the U.S.government is generally a false worry because (a) the debt needs only to be refinanced rather than refunded and (b) the Federal government
The public debt is the total accumulation of all past Federal government deficits and surpluses and consists of Treasury bills, Treasury notes, Treasury bonds, and U.S. savings bonds. In 2009 the
Most economists believe that fiscal policy can help move the economy in a desired direction but cannot reliably be used to fine-tune the economy to a position of price stability and full employment.
Certain problems complicate the enactment and implementation of fiscal policy. They include (a) timing problems associated with recognition, administrative, and operational lags; (b) the potential
The Federal government responded to the deep recession of 2007–2009 by implementing highly expansionary fiscal policy. In 2008 the Federal government passed a tax rebate program that sent $600
In 2001 the Bush administration and Congress chose to reduce marginal tax rates and phase out the Federal estate tax.A recession occurred in 2001, and Federal spending for the war on terrorism
Actual Federal budget deficits can go up or down because of changes in GDP, changes in fiscal policy, or both. Deficits caused by changes in GDP are called cyclical deficits. The cyclically adjusted
Built-in stability arises from net tax revenues, which vary directly with the level of GDP. During recession, the Federal budget automatically moves toward a stabilizing deficit; during expansion,
Discuss the size, composition, and consequences of the U.S. public debt.
Describe how the cyclically adjusted budget reveals the status of U.S. fiscal policy.
Explain the role of built-in stabilizers in moderating business cycles.
Identify and explain the purposes, tools, and limitations of fiscal policy.
Refer to Figure 2 in the Appendix and assume that Q 1 is$400 and Q 2 is $500, the price level is stuck at P 1 , and the slopes of the AE lines in Figure 2a are .75 and equal to the MPC. In what
Refer to Figures 1a and 1b in the Appendix. Assume that Q1 is 300, Q 2 is 200, Q3 is 100, P3 is 120, P2 is 100, and P1 is 80.If the price level increases from P 1 to P3 in graph 1b, in what direction
Suppose that the price level is constant and that investment decreases sharply. How would you show this decrease in the aggregate expenditures model? What would be the outcome for real GDP? How would
Explain carefully: “A change in the price level shifts the aggregate expenditures curve but not the aggregate demand curve.” LO5
With the price level held constant, increases in consumption, investment, government, and net export expenditures shift the aggregate expenditures schedule upward and the aggregate demand curve to
A change in the price level alters the location of the aggregate expenditures schedule through the real-balances, interest-rate, and foreign purchases effects. The aggregate demand curve is derived
Refer to the data in the table that accompanies problem 2.Suppose that the present equilibrium price level and level of real GDP are 100 and $225, and that data set B represents the relevant
Suppose that the table at the top right shows an economy’s relationship between real output and the inputs needed to produce that output: LO3a. What is productivity in this economy?b. What is the
Suppose that the aggregate demand and aggregate supply schedules for a hypothetical economy are as shown at the top left of the next page. LO3a. Use the data above to graph the aggregate demand and
Answer the following questions on the basis of the three sets of data for the country of North Vaudeville: LO2a. Which set of data illustrates aggregate supply in the immediate short-run in North
Suppose that consumer spending initially rises by $5 billion for every 1 percent rise in household wealth and that investment spending initially rises by $20 billion for every 1 percentage point fall
LAST WORD Go to the OPEC Web site, www.opec.org, and find the current “OPEC basket price” of oil. By clicking on that amount, you will find the annual prices of oil for the past five years. By
In early 2001 investment spending sharply declined in the United States. In the two months following the September 11, 2001, attacks on the United States, consumption also declined.Use AD-AS analysis
Use shifts of the AD and AS curves to explain ( a ) the U.S.experience of strong economic growth, full employment, and price stability in the late 1990s and early 2000s and( b ) how a strong negative
Explain: “Unemployment can be caused by a decrease of aggregate demand or a decrease of aggregate supply.” In each case, specify the price-level outcomes. LO4
Why does a reduction in aggregate demand in the actual economy reduce real output, rather than the price level?Why might a full-strength multiplier apply to a decrease in aggregate demand? LO3
Explain how an upsloping aggregate supply curve weakens the realized multiplier effect from an initial change in investment spending. LO3
Assume that ( a ) the price level is flexible upward but not downward and ( b ) the economy is currently operating at its full-employment output. Other things equal, how will each of the following
What effects would each of the following have on aggregate demand or aggregate supply, other things equal? In each case, use a diagram to show the expected effects on the equilibrium price level and
What assumptions cause the immediate-short-run aggregate supply curve to be horizontal? Why is the long-run aggregate supply curve vertical? Explain the shape of the short-run aggregate supply curve.
Distinguish between “real-balances effect” and “wealth effect,”as the terms are used in this chapter. How does each relate to the aggregate demand curve? LO1
Why is the aggregate demand curve downsloping? Specify how your explanation differs from the explanation for the downsloping demand curve for a single product. What role does the multiplier play in
Rightward shifts of the aggregate supply curve, caused by large improvements in productivity, help explain the simultaneous achievement of full employment, economic growth, and price stability that
Leftward shifts of the aggregate supply curve reflect increases in per-unit production costs and cause cost-push inflation, with accompanying negative GDP gaps.
Shifts of the aggregate demand curve to the left of the fullemployment output cause recession, negative GDP gaps, and cyclical unemployment. The price level may not fall during recessions because of
Increases in aggregate demand to the right of the fullemployment output cause inflation and positive GDP gaps (actual GDP exceeds potential GDP). An upsloping aggregate supply curve weakens the
The intersection of the aggregate demand and aggregate supply curves determines an economy’s equilibrium price level and real GDP. At the intersection, the quantity of real GDP demanded equals the
Figure 29.6 lists the determinants of aggregate supply: input prices, productivity, and the legal-institutional environment.A change in any one of these factors will change per-unit production costs
Because the short-run aggregate supply curve is the only version of aggregate supply that can handle simultaneous changes in the price level and real output, it serves well as the core aggregate
The immediate-short-run aggregate supply curve assumes that both input prices and output prices are fixed. With output prices fixed, the aggregate supply curve is a horizontal line at the current
The aggregate supply curve shows the levels of real output that businesses will produce at various possible price levels.The slope of the aggregate supply curve depends upon the flexibility of input
The determinants of aggregate demand consist of spending by domestic consumers, by businesses, by government, and by foreign buyers. Changes in the factors listed in Figure 29.2 alter the spending by
The aggregate demand curve is downsloping because of the real-balances effect, the interest-rate effect, and the foreign purchases effect. The real-balances effect indicates that inflation reduces
The aggregate demand curve shows the level of real output that the economy demands at each price level.
The aggregate demand–aggregate supply model (AD-AS model) is a flexible-price model that enables analysis of simultaneous changes of real GDP and the price level.
Suppose real output demanded rises by $4 billion at each price level. The new equilibrium price level will be:a. 108.b. 104.c. 96.d. 92.
At price level 92:a. a GDP surplus of $12 billion occurs that drives the price level up to 100.b. a GDP shortage of $12 billion occurs that drives the price level up to 100.c. the aggregate amount of
The AS curve slopes upward because:a. per-unit production costs rise as real GDP expands toward and beyond its full-employment level.b. the income and substitution effects are at work.c. changes in
The AD curve slopes downward because:a. per-unit production costs fall as real GDP increases.b. the income and substitution effects are at work.c. changes in the determinants of AD alter the amounts
(Appendix) Identify how the aggregate demand curve relates to the aggregate expenditures model.
Describe how the AD-AS model explains periods of demand-pull inflation, cost-push inflation, and recession.
Discuss how AD and AS determine an economy’s equilibrium price level and level of real GDP.
Define aggregate supply (AS) and explain the factors that cause it to change.
Define aggregate demand (AD) and explain the factors that cause it to change.
Answer the following questions, which relate to the aggregate expenditures model: LO5a. If C a is $100, I g is $50, X n is 2$10, and G is $30, what is the economy’s equilibrium GDP?b. If real GDP
Refer to the accompanying table in answering the questions that follow: LO5a. If full employment in this economy is 130 million, will there be an inflationary expenditure gap or a recessionary
ADVANCED ANALYSIS Assume that the consumption schedule for a private open economy is such that consumption C 5 50 1 0.8 Y . Assume further that planned investment I g and net exports X n are
Refer to columns 1 and 6 in the table for problem 5. Incorporate government into the table by assuming that it plans to tax and spend $20 billion at each possible level of GDP. Also assume that the
Assume that, without taxes, the consumption schedule of an economy is as follows. LO4 GDP, Consumption, Billions Billions$100 $120 200 200 300 280 400 360 500 440 600 520 700 600a. Graph this
The data in columns 1 and 2 in the table below are for a private closed economy. LO4a. Use columns 1 and 2 to determine the equilibrium GDP for this hypothetical economy.b. Now open up this economy

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