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 remain low, how would the government’s action affect the level of investment? b. After investors have responded to the announced tax reduction, does the government have an incentive to renege on its policy? Explain. c. Given your answer to part b, would investors believe the government’s announcement? What can the government do to increase the credibility of announced policy changes? d. Explain why this situation is similar to the time-inconsistency problem faced by monetary policymakers.
> What are the three categories into which the Bureau of Labor Statistics divides everyone? How does the BLS compute the labor force, the unemployment rate, and the labor-force participation rate?
> Which kind of stock would you expect to pay the higher average return: stock in an industry that is very sensitive to economic conditions (such as an automaker) or stock in an industry that is relatively insensitive to economic conditions (such as a wate
> According to the efficient markets hypothesis, a. changes in stock prices are impossible to predict from public information. b. excessive diversification can reduce an investor’s expected portfolio returns. c. the stock market moves based on the changin
> What is a government budget deficit? How does it affect interest rates, investment, and economic growth?
> Suppose that Intel is considering building a new chip- making factory. a. Assuming that Intel needs to borrow money in the bond market, why would an increase in interest rates affect Intel’s decision about whether to build the factory? b. If Intel has en
> A closed economy has income of $1,000, government spending of $200, taxes of $150, and investment of $250. What is private saving? a. $100 b. $200 c. $300 d. $400
> If the business community becomes more optimistic about the profitability of capital, 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
> Explain how reducing a government budget deficit makes future generations better off. What fiscal policy might improve the lives of future generations better off. What fiscal policy might improve the lives of future generations better off. What fiscal po
> Why are some economists against a target of zero inflation?
> 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.
> Throughout U.S. history, what has been the most common cause of substantial increases in government debt? a. recessions b. wars c. financial crises d. tax cuts
> 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?
> Describe the sources of supply and demand in the market for loanable funds and the market for foreign-currency exchange.
> 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
> From one year to the next, inflation falls from 5 to 4 percent, while unemployment rises from 6 to 7 percent. Which of the following events could be responsible for this change? a. The central bank increases the growth rate of the money supply. b. The g
> Give an example of a government policy that acts as an automatic stabilizer. Explain why the policy has this effect.
> Give an example of a monetary policy rule. Why might your rule be better than discretionary policy? Why might it be worse?
> 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
> If the central bank in the preceding question instead holds the money supply constant and allows the interest rate to adjust, the change in aggregate demand resulting from the increase in government purchases will be a. larger. b. the same. c. smaller bu
> 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.
> List and explain the three theories for why the short-run aggregate-supply curve slopes upward.
> 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
> Stagflation is caused by a. a leftward shift in the aggregate-demand curve. b. a rightward shift in the aggregate-demand curve. c. a leftward shift in the aggregate-supply curve. d. a rightward shift in the aggregate-supply curve.
> Suppose the French suddenly develop a strong taste for California wines. Answer the following questions in words and with a diagram. a. What happens to the demand for dollars in the market for foreign-currency exchange? b. What happens to the value of th
> Describe supply and demand in the market for loanable funds and the market for foreign-currency exchange. How are these markets linked?
> A civil war abroad causes foreign investors to seek a safe haven for their funds in the United States, leading to ________ U.S. interest rates and a ________ U.S. dollar. a. higher, weaker b. higher, stronger c. lower, weaker d. lower, stronger
> If the Fed started printing large quantities of U.S. dollars, what would happen to the number of Japanese yen a dollar could buy? Why?
> 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?
> Would each of the following groups be happy or unhappy if the U.S. dollar appreciated? Explain. a. Dutch pension funds holding U.S. government bonds b. U.S. manufacturing industries c. Australian tourists planning a trip to the United States d. an Americ
> If a cup of coffee costs 2 euros in Paris and $6 in New York and purchasing-power parity holds, what is the exchange rate? a. 1/4 euro per dollar b. 1/3 euro per dollar c. 3 euros per dollar d. 4 euros per dollar
> According to the Fisher effect, how does an increase in the inflation rate affect the real interest rate and the nominal interest rate?
> Let’s consider the effects of inflation in an economy composed of only two people: Bob, a bean farmer, and Rita, a rice farmer. Bob and Rita both always consume equal amounts of rice and beans. In 2016, the price of beans was $1 and the price of rice was
> According to the quantity theory of money and the Fisher effect, if the central bank increases the rate of money growth, a. inflation and the nominal interest rate both increase. b. inflation and the real interest rate both increase. c. the nominal inter
> If the Fed wants to increase the money supply with open-market operations, what does it do?
> You take $100 you had kept under your mattress and deposit it in your bank account. If this $100 stays in the banking system as reserves and if banks hold reserves equal to 10 percent of deposits, by how much does the total amount of deposits in the bank
> Which of the following actions by the Fed would reduce the money supply? a. an open-market purchase of government bonds b. a reduction in banks’ reserve requirements c. an increase in the interest rate paid on reserves d. a decrease in the discount rate
> Japan generally runs a significant trade surplus. Do you think this is most related to high foreign demand for Japanese goods, low Japanese demand for foreign goods, a high Japanese saving rate relative to Japanese investment, or structural barriers agai
> Give four explanations for why firms might find it profitable to pay wages above the level that balances quantity of labor supplied and quantity of labor demanded?
> Comparing the U.S. economy today to that of 1950, one finds that today, as a percentage of GDP, a. exports and imports are both higher. b. exports and imports are both lower. c. exports are higher, and imports are lower. d. exports are lower, and imports
> How do unions affect the natural rate of unemployment?
> Economists use labor-market data to evaluate how well an economy is using its most valuable resource— its people. Two closely watched statistics are the unemployment rate and the employment–population ratio (calculated as the percentage of the adult popu
> Unionized workers are paid about _____ percent more than similar nonunion workers. a. 2 b. 5 c. 15 d. 40
> What factors should a stock analyst think about in determining the value of a share of stock?
> For each of the following kinds of insurance, give an example of behavior that can be called moral hazard and another example of behavior that can be called adverse selection. a. health insurance b. car insurance c. life insurance
> The benefit of diversification when constructing a portfolio is that it can eliminate a. speculative bubbles. b. risk aversion. c. firm-specific risk. d. market risk.
> Describe a change in the tax code that might increase private saving. If this policy were implemented, how would it affect the market for loan able funds?
> Economists in Funlandia, a closed economy, have collected the following information about the economy for a particular year: Y = 10,000 C = 6,000 T = 1,50 G = 1,700 The economists also estimate that the investment function is: I = 3,300 - 100r, Where r i
> 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.
> 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?
> 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
> 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?