As described in the chapter, the Federal Reserve in 2008 faced a decrease in aggregate demand caused by the housing and financial crises and a decrease inshort-run aggregate supply caused by rising commodity prices. a. Starting from a long-run equilibrium, illustrate the effects of these two changes using both an aggregate-supply/aggregate-demand diagram and a Phillips-curve diagram. On both diagrams, label the initial long-run equilibrium as point A and the resulting short-run equilibrium as point B. For each of the following variables, state whether it rises or falls or whether the impact is ambiguous: output, unemployment, the price level, the inflation rate. b. Suppose the Fed responds quickly to these shocks and adjusts monetary policy to keep unemployment and output at their natural rates. What action would it take? On the same set of graphs from part (a), show the results. Label the new equilibrium as point C. c. Why might the Fed choose not to pursue the course of action described in part (b)?
> If the members of an oligopoly could agree on a total quantity to produce, what quantity would they choose?If the oligopolists do not act together but instead make production decisions individually, do they produce a total quantity more or less than in y
> Give two examples other than oligopoly that show how the prisoners’ dilemma helps to explain behavior.
> Explain the costs and benefits of reducing inflation to zero. Which are temporary and which are permanent?
> What are the pros and cons of in-kind (rather than cash) transfers to the poor?
> What is the prisoners’ dilemma, and what does it have to do with oligopoly?
> A large share of the world supply of diamonds come from Russia and South Africa. Suppose that the marginal cost of mining diamonds is constant at $1,000 per diamond and the demand for diamonds is described by the following schedule: Price …………………………….Qu
> This chapter considers the economics of discrimination by employers, customers, and governments. Now consider discrimination by workers. Suppose that some brunette workers do not like working with blonde workers. Can this worker discrimination explain lo
> Little Kona is a small coffee company that is considering entering a market dominated by Big Brew. Each company’s profit depends on whether Little Kona enters and whether Big Brew sets a high price or a low price: a. Does either playe
> Two athletes of equal ability are competing for a prize of $10,000. Each is deciding whether to take a dangerous performance-enhancing drug. If one athlete takes the drug, and the other does not, the one who takes the drug wins the prize. If both or neit
> Suppose there are two possible income distributions in a society of ten people. In the first distribution, nine people have incomes of $30,000 and one person has an income of $10,000. In the second distribution, all ten people have incomes of $25,000. a.
> Show the effect of each of the following events on the market for labor in the computer manufacturing industry. a. Congress buys personal computers for all U.S. college students. b. More college students major in engineering and computer science. c. Comp
> Draw some indifference curves for pizza and Pepsi. Explain the four properties of these indifference curves.
> Draw the budget constraint for a person with income of $1,000 if the price of Pepsi is $5 and the price of pizza is $10. What is the slope of this budget constraint?
> Explain how an increase in the wage can potentially decrease the amount that a person wants to work.
> Leadbelly Co. sells pencils in a perfectly competitive product market and hires workers in a perfectly competitive labor market. Assume that the market wage rate for workers is $150 per day. a. What rule should Leadbelly follow to hire the profit-maximiz
> Draw a budget constraint and indifference curves for pizza and Pepsi. Show what happens to the budget constraint and the consumer’s optimum when the price of pizza rises. In your diagram, decompose the change into an income effect and a substitution effe
> Pick a point on an indifference curve for wine and cheese and show the marginal rate of substitution. What does the marginal rate of substitution tell us?
> Draw a consumer’s indifference curves for wine and cheese. Describe and explain four properties of these indifference curves.
> A case study in the chapter describes a phone conversation between the presidents of American Airlines and Braniff Airways. Let’s analyze the game between the two companies. Suppose that each company can charge either a high price for tickets or a low pr
> When Alan Greenspan (who would later become chairman of the Federal Reserve) ran an economic consulting firm in the 1960s, he primarily hired female economists. He once told the New York Times, “I always valued men and women equally, and I found that bec
> A consumer has income of $3,000. Wine costs $3 per glass, and cheese costs $6 per pound. Draw the consumer’s budget constraint with wine on the vertical axis. What is the slope of this budget constraint?
> This chapter uses the analogy of a “leaky bucket” to explain one constraint on the redistribution of income. a. What elements of the U.S. system for redistributing income create the leaks in the bucket? Be specific. b. Do you think that Republicans or De
> Can an increase in the price of cheese possibly induce a consumer to buy more cheese? Explain.
> According to traditional Keynesian analysis, why does a tax cut have a smaller effect on GDP than a similarly sized increase in government spending? Why might the opposite be the case?
> What causes the lags in the effect of monetary and fiscal policy on aggregate demand? What are the implications of these lags for the debate over active versus passive policy?
> What are two situations in which most economists view a budget deficit as justifiable?
> Explain two ways in which a government budget deficit hurts a future worker.
> Explain how credibility might affect the cost of reducing inflation.
> What might motivate a central banker to cause a political business cycle? What does the political business cycle imply for the debate over policy rules?
> Policymakers who want to stabilize the economy must decide how much to change the money supply, government spending, or taxes. Why is it difficult for policymakers to choose the appropriate strength of their actions?
> The chapter suggests that the economy, like the human body, has “natural restorative powers.” a. Illustrate the short-run effect of a fall in aggregate demand using an aggregate-demand/aggregatesupply diagram. What happens to total output, income, and em
> What is the fundamental trade-off that society faces if it chooses to save more? How might the government increase national saving?
> The price of cheese rises from $6 to $10 per pound, while the price of wine remains $3 per glass. For a consumer with a constant income of $3,000, show what happens to consumption of wine and cheese. Decompose the change into income and substitution effe
> Explain how each of the following policies redistributes income across generations. Is the redistribution from young to old or from old to young? a. an increase in the budget deficit b. more generous subsidies for education loans c. greater investments i
> Suppose the federal government cuts taxes and increases spending, raising the budget deficit to 12 percent of GDP. If nominal GDP is rising 5 percent per year, are such budget deficits sustainable forever? Explain. If budget deficits of this size are mai
> Why are the benefits of reducing inflation permanent and the costs temporary? Why are the costs of increasing inflation permanent and the benefits temporary? Use Phillips-curve diagrams in your answer.
> The problem of time inconsistency applies to fiscal policy as well as to monetary policy. Suppose the government announced a reduction in taxes on income from capital investments, like new factories. a. If investors believed that capital taxes would rema
> Draw the Phillips curve. Use the model of aggregate demand and aggregate supply to show how policy can move the economy from a point on this curve with high inflation to a point with low inflation.
> What is the sacrifice ratio? How might the credibility of the Fed’s commitment to reduce inflation affect the sacrifice ratio?
> Give an example of a favorable shock to aggregate supply. Use the model of aggregate demand and aggregate supply to explain the effects of such a shock. How does it affect the Phillips curve?
> Draw the short-run Phillips curve and the long-run Phillips curve. Explain why they are different.
> Draw the long-run trade-off between inflation and unemployment. Explain how the short-run and long-run trade-offs are related.
> Draw the short-run trade-off between inflation and unemployment. How might the Fed move the economy from one point on this curve to another?
> Policymakers sometimes propose laws requiring firms to give workers certain fringe benefits, such as health insurance or paid parental leave. Let’s consider the effects of such a policy on the labor market. a. Suppose that a law required firms to give ea
> The Fed decides to reduce inflation. Use the Phillips curve to show the short-run and long-run effects of this policy. How might the short-run costs be reduced?
> Suppose a drought destroys farm crops and drives up the price of food. What is the effect on the short-run trade-off between inflation and unemployment?
> What is “natural” about the natural rate of unemployment? Why might the natural rate of unemployment differ across countries?
> Illustrate the effects of the following developments on both the short-run and long-run Phillips curves. Give the economic reasoning underlying your answers. a. a rise in the natural rate of unemployment b. a decline in the price of imported oil c. a ris
> Suppose the natural rate of unemployment is 6 percent. On one graph, draw two Phillips curves that describe the four situations listed here. Label the point that shows the position of the economy in each case. a. Actual inflation is 5 percent, and expect
> Suppose the Federal Reserve announced that it would pursue contractionary monetary policy to reduce the inflation rate. Would the following conditions make the ensuing recession more or less severe? Explain. a. Wage contracts have short durations. b. The
> Suppose the Federal Reserve’s policy is to maintain low and stable inflation by keeping unemployment at its natural rate. However, the Fed believes that the natural rate of unemployment is 4 percent when the actual natural rate is 5 percent. If the Fed b
> The inflation rate is 10 percent, and the central bank is considering slowing the rate of money growth to reduce inflation to 5 percent. Economist Milton believes that expectations of inflation change quickly in response to new policies, whereas economis
> Suppose the economy is in a long-run equilibrium. a. Draw the economy’s short-run and long-run Phillips curves. b. Suppose a wave of business pessimism reduces aggregate demand. Show the effect of this shock on your diagram from part (a). If the Fed unde
> How would a utilitarian, a liberal, and a libertarian each determine how much income inequality is permissible?
> Suppose that a fall in consumer spending causes a recession. a. Illustrate the immediate change in the economy using both an aggregate-supply/aggregate-demand diagram and a Phillips-curve diagram. On both graphs, label the initial long-run equilibrium as
> Use the theory of liquidity preference to explain how a decrease in the money supply affects the equilibrium interest rate. How does this change in monetary policy affect the aggregate-demand curve?
> Suppose a wave of negative “animal spirits” overruns the economy, and people become pessimistic about the future. What happens to aggregate demand? If the Fed wants to stabilize aggregate demand, how should it alter the money supply? If it does this, wha
> Suppose that the government reduces spending on highway construction by $10 billion. Which way does the aggregate-demand curve shift? Explain why the shift might be larger than $10 billion. Explain why the shift might be smaller than $10 billion.
> What is the theory of liquidity preference? How does it help explain the downward slope of the aggregatedemand curve?
> Give an example of a government policy that acts as an automatic stabilizer. Explain why the policy has this effect.
> Suppose that survey measures of consumer confidence indicate a wave of pessimism is sweeping the country. If policymakers do nothing, what will happen to aggregate demand? What should the Fed do if it wants to stabilize aggregate demand? If the Fed does
> Suppose a computer virus disables the nation’s automatic teller machines, making withdrawals from bank accounts less convenient. As a result, people want to keep more cash on hand, increasing the demand for money. a. Assume the Fed does not change the mo
> The Federal Reserve expands the money supply by 5 percent. a. Use the theory of liquidity preference to illustrate in a graph the impact of this policy on the interest rate. b. Use the model of aggregate demand and aggregate supply to illustrate the impa
> Explain how each of the following developments would affect the supply of money, the demand for money, and the interest rate. Illustrate your answers with diagrams. a. The Fed’s bond traders buy bonds in open-market operations. b. An increase in credit-c
> A person who consumes wine and cheese gets a raise, so her income increases from $3,000 to $4,000. Show what happens if both wine and cheese are normalgoods. Now show what happens if cheese is an inferior good.
> In which of the following circumstances is expansionary fiscal policy more likely to lead to a short-run increase in investment? Explain. a. When the investment accelerator is large or when it is small? b. When the interest sensitivity of investment is l
> Suppose government spending increases. Would the effect on aggregate demand be larger if the Federal Reserve held the money supply constant in responseor if the Fed were committed to maintaining a fixed interest rate? Explain.
> Suppose the government reduces taxes by $20 billion, that there is no crowding out, and that the marginal propensity to consume is ¾. a. What is the initial effect of the tax reduction on aggregate demand? b. What additional effects follow this initial e
> Suppose economists observe that an increase in government spending of $10 billion raises the total demand for goods and services by $30 billion. a. If these economists ignore the possibility of crowding out, what would they estimate the marginal propensi
> In the early 1980s, new legislation allowed banks to pay interest on checking deposits, which they could not do previously. a. If we define money to include checking deposits, what effect did this legislation have on money demand? Explain. b. If the Fede
> The economy is in a recession with high unemployment and low output. a. Draw a graph of aggregate demand and aggregate supply to illustrate the current situation. Be sure to include the aggregate-demand curve, the short-run aggregate-supply curve, and th
> Consider two policies—a tax cut that will last for only one year and a tax cut that is expected to be permanent. Which policy will stimulate greater spending by consumers? Which policy will have the greater impact on aggregate demand? Explain.
> List and discuss three key facts about economic fluctuations.
> Suppose that the election of a popular presidential candidate suddenly increases people’s confidence in the future. Use the model of aggregate demand and aggregate supply to analyze the effect on the economy
> Explain why the long-run aggregate-supply curve is vertical. Explain three theories for why the short-run aggregate-supply curve slopes upward. What variables shift both the long-run and short-run aggregate-supply curves? What variable shifts the short-r
> Show a consumer’s budget constraint and indifference curves for wine and cheese. Show the optimal consumption choice. If the price of wine is $3 per glass and the price of cheese is $6 per pound, what is the marginal rate of substitution at this optimum?
> Explain the three reasons the aggregate-demand curve slopes downward. Give an example of an event that would shift the aggregate-demand curve. Which way would this event shift the curve?
> How does the economy’s behavior in the short run differ from its behavior in the long run? Draw the model of aggregate demand and aggregate supply. What variables are on the two axes?
> List and explain the three reasons the aggregatedemand curve slopes downward.
> Draw a diagram with aggregate demand, short-run aggregate supply, and long-run aggregate supply. Be careful to label the axes correctly.
> What might shift the aggregate-supply curve to the left? Use the model of aggregate demand and aggregate supply to trace through the short-run and long-run effects of such a shift on output and the price level.
> What might shift the aggregate-demand curve to the left? Use the model of aggregate demand and aggregate supply to trace through the short-run and long-run effects of such a shift on output and the price level.
> List and explain the three theories for why the shortrun aggregate-supply curve slopes upward.
> Explain why the long-run aggregate-supply curve is vertical.
> Suppose an economy is in long-run equilibrium. a. Use the model of aggregate demand and aggregate supply to illustrate the initial equilibrium (call it point A). Be sure to include both short-run and long-run aggregate supply. b. The central bank raises
> Explain whether each of the following events will increase, decrease, or have no effect on long-run aggregate supply. a. The United States experiences a wave of immigration. b. Congress raises the minimum wage to $10 per hour. c. Intel invents a new and
> Mario consumes only cheese and crackers. a. Could cheese and crackers both be inferior goods for Mario? Explain. b. Suppose that cheese is a normal good for Mario while crackers are an inferior good. If the price of cheese falls, what happens to Mario’s
> Suppose the economy is in a long-run equilibrium. a. Draw a diagram to illustrate the state of the economy.Be sure to show aggregate demand, short-run aggregate supply, and long-run aggregate supply. b. Now suppose that a stock market crash causes aggreg
> Suppose firms become very optimistic about future business conditions and invest heavily in new capital equipment. a. Draw an aggregate-demand/aggregate-supply diagram to show the short-run effect of this optimism on the economy. Label the new levels of
> For each of the following events, explain the short-run and long-run effects on output and the price level, assuming policymakers take no action. a. The stock market declines sharply, reducing consumers’ wealth. b. The federal government increases spendi
> Explain whether each of the following events shifts the short-run aggregate-supply curve, the aggregatedemand curve, both, or neither. For each event that does shift a curve, draw a diagram to illustrate the effect on the economy. a. Households decide to
> The economy begins in long-run equilibrium. Then one day, the president appoints a new chairman of the Fed. This new chairman is well known for her view that inflation is not a major problem for an economy. a. How would this news affect the price level t
> For each of the three theories for the upward slope of the short-run aggregate-supply curve, carefully explain the following: a. how the economy recovers from a recession andreturns to its long-run equilibrium without any policy intervention b. what dete
> Explain why the following statements are false. a. “The aggregate-demand curve slopes downward because it is the horizontal sum of the demand curves for individual goods.” b. “The long-run aggregate-supply curve is vertical because economic forces do not
> In 1939, with the U.S. economy not yet fully recovered from the Great Depression, President Roosevelt proclaimed that Thanksgiving would fall a week earlier than usual so that the shopping period before Christmas would be longer. Explain what President R
> Suppose that Americans decided to spend a smaller fraction of their incomes. What would be the effect on saving, investment, interest rates, the real exchange rate, and the trade balance?
> In the model of the open economy just developed, two markets determine two relative prices. What are the markets? What are the two relative prices?
> You consume only soda and pizza. One day, the price of soda goes up, the price of pizza goes down, and you are just as happy as you were before the price changes. a. Illustrate this situation on a graph. b. How does your consumption of the two goods chan
> Describe the sources of supply and demand in the market for loanable funds and the market for foreign-currency exchange.
> Describe supply and demand in the market for loanable funds and the market for foreign-currency exchange. How are these markets linked?
