Bond A pays $8,000 in 20 years. Bond B pays $8,000 in 40 years. (To keep things simple, assume these are zero-coupon bonds, which means the $8,000 is the only payment the bondholder receives.) a. If the interest rate is 3.5 percent, what is the value of each bond today? Which bond is worth more? Why? (Hint: You can use a calculator, but the rule of 70 should make the calculation easy.) b. If the interest rate increases to 7 percent, what is the value of each bond? Which bond has a larger percentage change in value? c. Based on the example above, complete the two blanks in this sentence: “The value of a bond [rises/falls] when the interest rate increases, and bonds with a longer time to maturity are [more/less] sensitive to changes in the interest rate.”
> If a popular TV show on personal finance convinces Americans to save more for retirement, the ________ curve for loan able funds would shift, driving the equilibrium interest rate ________. a. supply, up b. supply, down c. demand, up d. demand, down
> Holding other things constant, an increase in a nation’s interest rate reduces a. national saving and domestic investment. b. national saving and the net capital outflow. c. domestic investment and the net capital outflow. d. national saving only.
> 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
> Explain the costs and benefits of reducing inflation to zero. Which are temporary and which are permanent?
> Explain how credibility might affect the cost of reducing inflation.
> Chapter 2 explains the difference between positive analysis and normative analysis. In the debate about whether the central bank should aim for zero inflation, which areas of disagreement involve positive statements and which involve normative judgments?
> Which of the following is NOT an argument for maintaining a positive rate of inflation? a. It permits real interest rates to be negative. b. It allows real wages to fall without cuts in nominal wages. c. It increases the variability of relative prices. d
> What is the sacrifice ratio? How might the credibility of the Fed’s commitment to reduce inflation affect the sacrifice ratio?
> 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?
> 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 under-
> Advocates of the theory of rational expectations believe that a. the sacrifice ratio can be much smaller if policymakers make a credible commitment to low inflation. b. if disinflation catches people by surprise, it will have minimal impact on unemployme
> 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
> 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.
> Advocates for setting monetary policy by rule rather than discretion often argue that a. central bankers with discretion are tempted to renege on their announced commitments to low inflation. b. central bankers following a rule will be more responsive to
> Define net exports and net capital outflow. Explain how they are related.
> With the economy in a recession because of inadequate aggregate demand, the government increases its purchases by $1,200. Suppose the central bank adjusts the money supply to hold the interest rate constant, investment spending is fixed, and the marginal
> 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
> Explain why the long-run aggregate-supply curve is vertical.
> 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
> An increase in the aggregate demand for goods and services has a larger impact on output ________ and a larger impact on the price level ________. a. in the short run, in the long run b. in the long run, in the short run c. in the short run, also in the
> What is capital flight? When a country experiences capital flight, what is the effect on its interest rate and exchange rate?
> An economist discussing trade policy in The New Republic wrote: “One of the benefits of the United States removing its trade restrictions [is] the gain to U.S. industries that produce goods for export. Export industries would find it easier to sell their
> The nation of Ectenia has long banned the export of its highly prized puka shells. A newly elected president, however, removes the export ban. This change in policy will cause the nation’s currency to ________, making the goods Ectenia imports ________ e
> Describe the economic logic behind the theory of purchasing-power parity.
> 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?
> How would the following transactions affect U.S. net capital outflow? Also, state whether each involves direct investment or portfolio investment. a. An American cellular phone company establishes an office in the Czech Republic. b. Harrods of London sel
> Define net exports and net capital outflow. Explain how and why they are related.
> When an adverse supply shock shifts the short-run aggregate-supply curve to the left, it also a. moves the economy along the short-run Phillips curve to a point with higher inflation and lower unemployment. b. moves the economy along the short-run Philli
> If a nation’s currency doubles in value on foreign exchange markets, the currency is said to ________, reflecting a change in the ________ exchange rate. a. appreciate, nominal b. appreciate, real c. depreciate, nominal d. depreciate, real
> 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
> The government spends $3 billion to buy police cars. Explain why aggregate demand might increase by more or less than $3 billion.
> 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’s target rate for the federal funds rate a. is an extra policy tool for the central bank, in addition to and independent of the money supply. b. commits the Fed to set a particular money supply so that it hits the announced target. c.
> Describe the difference between foreign direct investment and foreign portfolio investment. Who is more likely to engage in foreign direct investment—a corporation or an individual investor? Who is more likely to engage in foreign portfolio investment?
> If the value of a nation’s imports exceeds the value of its exports, which of the following is NOT true? a. Net exports are negative. b. GDP is less than the sum of consumption, investment, and government purchases. c. Domestic investment is greater than
> Explain the difference between nominal and real variables and give two examples of each. According to the principle of monetary neutrality, which variables are affected by changes in the quantity of money?
> It is sometimes suggested that the Federal Reserve should try to achieve zero inflation. If we assume that velocity is constant, does this zero-inflation goal require that the rate of money growth equal zero? If yes, explain why. If no, explain what the
> According to the quantity theory of money, which variable in the quantity equation is most stable over long periods of time? a. money b. velocity c. price level d. output
> Describe how banks create money.
> In what sense is inflation like a tax? How does thinking about inflation as a tax help explain hyperinflation?
> What are demand deposits and why should they be included in the stock of money?
> Your uncle repays a $100 loan from Tenth National Bank (TNB) by writing a $100 check from his TNB checking account. Use T accounts to show the effect of this transaction on your uncle and on TNB. Has your uncle’s wealth changed? Explain.
> If the reserve ratio is ¼ and the central bank increases the quantity of reserves in the banking system by $120, the money supply increases by a. $90. b. $150. c. $160. d. $480.
> Draw the supply curve and the demand curve for a labor market in which the wage is fixed above the equilibrium level. Show the quantity of labor supplied, the quantity demanded, and the amount of unemployment.
> Suppose that this year’s money supply is $500 billion, nominal GDP is $10 trillion, and real GDP is $5 trillion. a. What is the price level? What is the velocity of money? b. Suppose that velocity is constant and the economy’s output of goods and service
> Why is frictional unemployment inevitable? How might the government reduce the amount of frictional unemployment?
> The main policy goal of the unemployment insurance system is to reduce the a. search effort of the unemployed. b. income uncertainty that workers face. c. role of unions in wage setting. d. amount of frictional unemployment.
> Fortune magazine regularly publishes a list of the “most respected” companies. According to the efficient markets hypothesis, if you restrict your stock portfolio to these companies, will you earn a better-than-average return? Explain.
> What is diversification? Does a stockholder get a greater benefit from diversification when going from 1 to 10 stocks or when going from 100 to 120 stocks?
> Suppose that a country’s inflation rate increases sharply. What happens to the inflation tax on the holders of money? Why is wealth that is held in savings accounts not subject to a change in the inflation tax? Can you think of any way holders of savings
> If the interest rate is 10 percent, then the present value of $100 to be paid in 2 years is a. $80 b. $83. c. $120. d. $121.
> If more Americans adopted a “live for today” approach to life, how would this affect saving, investment, and the interest rate?
> What is national saving? What is private saving? What is public saving? How are these three variables related?
> Explain the difference between saving and investment as defined by a macroeconomist. Which of the following situations represent investment and which represent saving? Explain. a. Your family takes out a mortgage and buys a new house. b. You use your $20
> If the government collects more in tax revenue than it spends, and households consume more than they get in after-tax income, then a. private and public saving are both positive. b. private and public saving are both negative. c. private saving is positi
> The classical principle of monetary neutrality states that changes in the money supply do not influence ________ variables and is thought most applicable in the ________ run. a. nominal, short b. nominal, long c. real, short d. real, long
> According to traditional Keynesian analysis, which has a larger impact on GDP—a dollar of tax cuts or a dollar of additional government spending? Why?
> 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?
> 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?
> According to traditional Keynesian analysis, which of the following will increase aggregate demand the most? a. $100 billion increase in taxation b. $100 billion decrease in taxation c. $100 billion increase in government spending d. $100 billion decreas
> Hyperinflations occur when the government runs a large budget ________, which the central bank finances with a substantial monetary ________. a. deficit, contraction b. deficit, expansion c. surplus, contraction d. surplus, expansion
> 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.
> 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
> If the Federal Reserve increases the rate of money growth and maintains it at the new higher rate, eventually expected inflation will ________ and the short-run Phillips curve will shift ________. a. decrease, downward b. decrease, upward c. increase, do
> 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 or smaller than $10 billion.
> Use the theory of liquidity preference to explain how a decrease in the money supply affects the aggregate- demand curve.
> List and describe the three functions of money.
> 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
> If the government wants to contract aggregate demand, it can ________ government purchases or ________ taxes. a. increase, increase b. increase, decrease c. decrease, increase d. decrease, decrease
> 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?
> If the Fed wanted to use all of its policy tools to decrease the money supply, what would it do?
> Draw a diagram with aggregate demand, short-run aggregate supply, and long-run aggregate supply. Be careful to label the axes correctly.
> 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 $15 per hour. c. Intel invents a new and
> A sudden crash in the stock market shifts a. the aggregate-demand curve. b. the short-run aggregate-supply curve, but not the long-run aggregate-supply curve. c. the long-run aggregate-supply curve, but not the short-run aggregate-supply curve. d. both t
> 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?
> Why are budget deficits and trade deficits sometimes called the twin deficits?
> Suppose that Congress is considering an investment tax credit, which subsidizes domestic investment. a. How does this policy affect national saving, domestic investment, net capital outflow, the interest rate, the exchange rate, and the trade balance? b.
> Holding other things constant, an appreciation of a nation’s currency causes a. exports to rise and imports to fall. b. exports to fall and imports to rise. c. both exports and imports to rise. d. both exports and imports to fall.
> What distinguishes money from other assets in the economy?
> Define nominal exchange rate and real exchange rate, and explain how they are related. If the nominal exchange rate goes from 100 to 120 yen per dollar, has the dollar appreciated or depreciated?
> Explain the relationship among saving, investment, and net capital outflow.
> Who is responsible for setting monetary policy in the United States? How is this group chosen?
> Would each of the following transactions be included in net exports or net capital outflow? Be sure to say whether it would represent an increase or a decrease in that variable. a. An American buys a Sony TV. b. An American buys a share of Sony stock. c.
> In an open economy, national saving equals domestic investment a. plus the net outflow of capital abroad. b. minus the net exports of goods and services. c. plus the government’s budget deficit. d. minus foreign portfolio investment.
> List and describe six costs of inflation.
> According to the quantity theory of money, what is the effect of an increase in the quantity of money?
> Suppose that changes in bank regulations expand the availability of credit cards so that people need to hold less cash. a. How does this event affect the demand for money? b. If the Fed does not respond to this event, what will happen to the price level?
> If nominal GDP is $400, real GDP is $200, and the money supply is $100, then a. the price level is ½, and velocity is 2. b. the price level is ½, and velocity is 4. c. the price level is 2, and velocity is 2. d. the price level is 2, and velocity is 4.
> What are the primary responsibilities of the Federal Reserve? If the Fed wants to increase the supply of money, how does it usually do so?
> What is commodity money? What is fiat money? Which kind do we use?
> Which of the following are considered money in the U.S. economy? Which are not? Explain your answers by discussing each of the three functions of money. a. a U.S. penny b. a Mexican peso c. a Picasso painting d. a plastic credit card
> Explain whether each of the following events increases or decreases the money supply. a. The Fed buys bonds in open-market operations. b. The Fed reduces the reserve requirement. c. The Fed increases the interest rate it pays on reserves. d. Citibank rep
> Beleaguered State Bank (BSB) holds $250 million in deposits and maintains a reserve ratio of 10 percent. a. Show a T-account for BSB. b. Now suppose that BSB’s largest depositor withdraws $10 million in cash from her account. If BSB decides to restore it
> Chloe takes $100 of currency from her wallet and deposits it into her checking account. If the bank adds the entire $100 to reserves, the money supply ________, but if the bank lends out some of the $100, the money supply ________. a. increases, increase
> How would an increase in the world price of oil affect the amount of frictional unemployment? Is this unemployment undesirable? What public policies might affect the amount of unemployment caused by this price change?
> Is unemployment typically short-term or long-term? Explain.
> Explain whether each of the following events increases, decreases, or has no effect on the unemployment rate and the labor-force participation rate. a. After a long search, Jon finds a job. b. Tyrion, a full-time college student, graduates and is immedi
> Using the numbers in the preceding question, what is the size of Ectenia’s labor force? a. 50 b. 60 c. 70 d. 80
> Describe three ways that a risk-averse person might reduce the risk she faces.