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essentials of economics

Questions and Answers of Essentials of Economics

a. If there is free trade, domestic butter producers want the government to impose a tariff of no less than $0.50 per pound.
1. Suppose the world price of butter is $0.50 per pound and the domestic price in autarky is$1.00 per pound. Use a diagram similar to Figure 18-10 to show the following.
2. What effect do you think this event will have on Mexican grape producers? Mexican grape pickers? Mexican grape consumers? U.S. grape pickers?
1. Due to a strike by truckers, trade in food between the United States and Mexico is halted. In autarky, the price of Mexican grapes is lower than that of U.S. grapes. Using a diagram of the U.S.
2. Explain the following patterns of trade using the Heckscher–Ohlin model.a. France exports wine to the United States, and the United States exports movies to France.b. Brazil exports shoes to the
1. In the United States, the opportunity cost of 1 ton of corn is 50 bicycles. In China, the opportunity cost of 1 bicycle is 0.01 ton of corn.a. Determine the pattern of comparative advantage.b. In
13. Because of an economic slowdown, the Federal Reserve Bank of the United States lowered the federal funds rate from 4.25% on January 1, 2008, to 2.00% on May 1, 2008. The idea was to provide a
12. During the Great Depression, business people in the United States were very pessimistic about the future of economic growth and reluctant to increase investment spending even when interest rates
11. The effectiveness of monetary policy depends on how easy it is for changes in the money supply to change interest rates. By changing interest rates, monetary policy affects investment spending
10. According to the European Central Bank website, the treaty establishing the European Community “makes clear that ensuring price stability is the most important contribution that monetary policy
9. An economy is in long - run macroeconomic equilibrium with an unemployment rate of 5% when the government passes a law requiring the central bank to use monetary pol ?
8. Continuing from the previous problem, now suppose that in the economy of Eastlandia the central bank decides to decrease the money supply.a. Using the diagram in Problem 7, explain what will
a. Using the accompanying diagram, explain what will happen to the interest rate if the central bank of Eastlandia keeps the money supply constant at M 1.
7. In the economy of Eastlandia, the money market is initially in equilibrium when the economy begins to slide into a recession.
6. An economy is facing the inflationary gap shown in the accompanying diagram. To eliminate the gap, should the central bank use expansionary or contractionary monetary policy?How will the interest
5. An economy is facing the recessionary gap shown in the accompanying diagram. To eliminate the gap, should the central bank use expansionary or contractionary monetary policy?How will the interest
b. How do the interest rates on the 2-year and 10-year notes relate to each other? Why is the interest rate on the 10-year note higher (or lower) than the interest rate on the 2-year note?
a. What are the interest rates on 2-year and 10-year notes?
4. Go to www.treasurydirect.gov. Under “Individuals,” go to“Learn about Treasury Bills, Notes, Bonds, and TIPS.” Click on “Treasury notes.” Under “at a glance,” click on “rates in
3.a. Go to www.treasurydirect.gov. Under “Individuals,” go to“Learn about Treasury Bills, Notes, Bonds, and TIPS.” Click on “Treasury bills.” Under “at a glance,” click on “rates in
2. How will the following events affect the demand for money? In each case, specify whether there is a shift of the demand curve or a movement along the demand curve and its direction.a. There is a
1. Go to the FOMC page of the Federal Reserve Board’s website(http://www.federalreserve.gov/FOMC/) to find the statement issued after the most recent FOMC meeting. (Click on“Meeting calendars,
5. In the long run, changes in the money supply affect the aggregate price level but not real GDP or the interest rate.Data show that the concept of monetary neutrality holds: changes in the money
4. The Federal Reserve and other central banks try to stabilize the economy, limiting fluctuations of actual output around potential output, while also keeping inflation low but positive. Under the
3. Expansionary monetary policy reduces the interest rate by increasing the money supply. This increases investment spending and consumer spending, which in turn increases aggregate demand and real
2. According to the liquidity preference model of the interest rate, the interest rate is determined in the money market by the money demand curve and the money supply curve. The Federal Reserve can
1. The money demand curve arises from a trade - off between the opportunity cost of holding money and the liquidity that money provides. The opportunity cost of holding money depends on short - term
2. Why does monetary policy affect the economy in the short run but not in the long run?
1. Assume the central bank increases the quantity of money by 25%, even though the economy is initially in both short - run and long - run macroeconomic equilibrium. Describe the effects, in the
2. What is the evidence that the Fed applies a version of the Taylor rule in setting monetary policy? In setting monetary policy, which central bank, the Fed or the Bank of England, is likely to
1. Suppose the economy is currently suffering from a recessionary gap and the Federal Reserve uses an expansionary monetary policy to close that gap. Describe the short -run effect of this policy on
2. Now assume that the Fed is following a policy of targeting the federal funds rate. What will the Fed do in the situation described in Question 1 to keep the federal funds rate unchanged?Illustrate
1. Assume that there is an increase in the demand for money at every interest rate. Using a diagram, show what effect this will have on the equilibrium interest rate for a given money supply.
16. Show the changes to the T-accounts for the Federal Reserve and for commercial banks when the Federal Reserve sells $30 million in U.S. Treasury bills. If the public holds a fixed amount of
15. Show the changes to the T-accounts for the Federal Reserve and for commercial banks when the Federal Reserve buys $50 million in U.S. Treasury bills. If the public holds a fixed amount of
c. How could better regulation of financial institutions have prevented these two instances?EXTEND YOUR UNDERSTANDING
b. What caused the drop in new housing starts in 2006–2008?
a. What caused the drop in new housing starts in 1984–1991?
14. The accompanying figure shows new U.S. housing starts, in thousands of units per month, between January 1980 and September 2008. The graph shows a large drop in new housing starts in 1984–1991
b. Do the Federal Reserve’s assets consist primarily of U.S.Treasury securities, as on September 5, 2007, which was a fairly typical day, or does the Fed still own a large number of other assets,
a. Under “Statement of Condition of Each Federal Reserve Bank,” look in the “Total” column. What is the amount displayed next to “Assets”? What is the amount displayed next to “U.S.
13. As shown in Figure 16-9, on September 5, 2007, about 90%of the Federal Reserve’s assets were made up of U.S. Treasury bills. However, on December 23, 2009, only 26% of the Federal Reserve’s
b. As of September 2008, the interest rate earned on one-year U.S. Treasury bills was 2.2%. At a 2.2% rate of interest, what is the amount of money U.S. taxpayers are losing per year because of these
a. Why do U.S. taxpayers lose because of North Korea’s counterfeiting?
12. The Congressional Research Service estimates that at least $45 million of counterfeit U.S. $100 notes produced by the North Korean government are in circulation.
11. Using Figure 16-6, find the Federal Reserve district in which you live. Go to http://www.federalreserve.gov/bios/pres.htm and click on your district to identify the president of the Federal
10. Although the U.S. Federal Reserve doesn’t use changes in reserve requirements to manage the money supply, the central bank of Albernia does. The commercial banks of Albernia have $100 million
9. What will happen to the money supply under the following circumstances in a checkable-deposits-only system?a. The required reserve ratio is 25%, and a depositor withdraws $700 from his checkable
8. In Westlandia, the public holds 50% of M1 in the form of currency, and the required reserve ratio is 20%. Estimate how much the money supply will increase in response to a new cash deposit of $500
d. Can the commercial banks increase checkable bank deposits? If yes, by how much can checkable bank deposits increase?
c. Are the commercial banks holding excess reserves?
b. What is the monetary base?
a. What is M1?
7. The government of Eastlandia uses measures of monetary aggregates similar to those used by the United States, and the central bank of Eastlandia imposes a required reserve ratio of 10%. Given the
d. If every time the bank decreases its loans, checkable bank deposits fall by the amount of the loan and the bank maintains a reserve ratio of 20%, by how much will the money supply contract in
c. If every time the bank decreases its loans, checkable bank deposits fall by the amount of the loan, by how much will the money supply in the economy contract in response to Ryan’s withdrawal of
b. If the bank maintains a reserve ratio of 10%, how will the bank respond to the withdrawal? Assume that the bank responds to insufficient reserves by reducing the amount of deposits it holds until
a. How will the withdrawal change the T-account of the local bank and the money supply?
6. Ryan Cozzens withdraws $400 from his checking account at the local bank and keeps it in his wallet.
d. If every time the bank makes a loan, the loan results in a new checkable bank deposit in a different bank equal to the amount of the loan and the bank maintains a reserve ratio of 5%, by how much
c. If every time the bank makes a loan, the loan results in a new checkable bank deposit in a different bank equal to the amount of the loan, by how much could the total money supply in the economy
b. If the bank maintains a reserve ratio of 10%, how will it respond to the new deposit?
a. How does the deposit initially change the T-account of the local bank? How does it change the money supply?
5. Tracy Williams deposits $500 that was in her sock drawer into a checking account at the local bank.
4. Indicate whether each of the following is part of M1, M2, or neither:a. $95 on your campus meal cardb. $0.55 in the change cup of your carc. $1,663 in your savings accountd. $459 in your checking
3. The table below shows the components of M1 and M2 in billions of dollars for the month of December in the years 1998 to 2007 as published in the 2008 Economic Report of the President. Complete the
2. There are three types of money: commodity money, commodity -backed money, and fiat money. Which type of money is used in each of the following situations?a. Bottles of rum were used to pay for
1. For each of the following transactions, what is the initial effect (increase or decrease) on M1? or M2?a. You sell a few shares of stock and put the proceeds into your savings account.b. You sell
13. Subprime lending during the U.S. housing bubble of the mid -2000s spread through the financial system via securitization. When the bubble burst, massive losses by banks and nonbank financial
12. During the mid -1990s, the hedge fund LTCM used huge amounts of leverage to speculate in global financial markets, incurred massive losses, and collapsed. LTCM was so large that, in selling
11. The savings and loan (thrift) crisis of the 1980s arose because insufficiently regulated S&Ls engaged in overly risky speculation and incurred huge losses. Depositors in failed S&Ls were
10. The Great Depression sparked widespread bank runs in the early 1930s, which greatly worsened and lengthened the depth of the Depression. Federal deposit insurance was created, and the government
9. In response to the Panic of 1907, the Fed was created to centralize holding of reserves, inspect banks’ books, and make the money supply sufficiently responsive to varying economic conditions.
8. Open-market operations by the Fed are the principal tool of monetary policy: the Fed can increase or reduce the monetary base by buying U.S. Treasury bills from banks or selling U.S. Treasury
7. The monetary base is controlled by the Federal Reserve, the central bank of the United States. The Fed regulates banks and sets reserve requirements. To meet those requirements, banks borrow and
6. When currency is deposited in a bank, it starts a multiplier process in which banks lend out excess reserves, leading to an increase in the money supply—so banks create money. If the entire
5. Banks have sometimes been subject to bank runs, most notably in the early 1930s. To avert this danger, depositors are now protected by deposit insurance, bank owners face capital requirements that
4. Banks allow depositors immediate access to their funds, but they also lend out most of the funds deposited in their care. To meet demands for cash, they maintain bank reserves composed of both
3. The Federal Reserve calculates two measures of the money supply. M1 is the narrowest monetary aggregate, containing only currency in circulation, traveler’s checks, and checkable bank deposits.
2. Over time, commodity money, which consists of goods possessing value aside from their role as money, such as gold and silver coins, was replaced by commoditybacked money, such as paper currency
1. Money is any asset that can easily be used to purchase goods and services. Money consists of cash, which is liquid by definition, as well as other highly liquid assets.Currency in circulation and
3. Describe the balance sheet effect. Describe the vicious cycle of de leveraging. Why is it necessary for the government to step in to halt a vicious cycle of de leveraging?
2. Why did the creation of the Federal Reserve fail to prevent the bank runs of the Great Depression? What measures did stop the bank runs?
1. What are the similarities between the Panic of 1907, the S&L crisis, and the crisis of 2008?
1. Assume that any money lent by a bank is always deposited back in the banking system as a checkable deposit and that the reserve ratio is 10%. Trace out the effects of a $100 million open-market
2. Take the example of Silas depositing his $1,000 in cash into First Street Bank and assume that the required reserve ratio is 10%. But now assume that each time someone receives a bank loan, he or
1. Assume that total reserves are equal to $200 and total checkable bank deposits are equal to$1,000. Also assume that the public does not hold any currency. Now suppose that the required reserve
2. A con artist has a great idea: he’ll open a bank without investing any capital and lend all the deposits at high interest rates to real estate developers. If the real estate market booms, the
1. Suppose you are a depositor at First Street Bank. You hear a rumor that the bank has suffered serious losses on its loans. Every depositor knows that the rumor isn’t true, but each thinks that
3. Explain why a system of commodity -backed money uses resources more efficiently than a system of commodity money.
2. Although most bank accounts pay some interest, depositors can get a higher interest rate by buying a certificate of deposit, or CD. The difference between a CD and a checking account is that the
1. Suppose you hold a gift certificate, good for certain products at participating stores. Is this gift certificate money? Why or why not?
c. Discuss the effectiveness of the policies in parts a and b in fighting stagflation.
b. What would be the appropriate fiscal policy response to this situation if the primary concern of the government was to maintain price stability? Illustrate the effect of the policy on the
a. What would be the appropriate fiscal policy response to this situation if the primary concern of the government was to maintain economic growth? Illustrate the effect of the policy on the
16. During an interview on May 16, 2008, the German Finance Minister Peer Steinbrueck said, “We have to watch out that in Europe and beyond, nothing like a combination of downward economic [growth]
b. If the government operates on a balanced budget before interest payments are taken into account, at what rate must GDP grow in order for the debt–GDP ratio to remain unchanged?
a. Calculate the dollar cost of the annual interest on the government’s total debt assuming the interest rate and debt figures cited above.
15. Unlike households, governments are often able to sustain large debts. For example, in September 2007, the U.S. government’s total debt reached $9 trillion, approximately 64% of GDP. At the
d. What happens to the debt–GDP ratio and the ratio of the budget deficit to GDP for the economy over time under the three different scenarios?

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