Question: What is adverse selection? Give an example

> 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

> 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

> 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

> 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

> Approximately how long does it take a change in monetary policy to influence aggregate demand? a. one month b. six months c. two years d. five years

> Some income from capital is taxed twice. Explain.

> Some economists say that the government can continue running a budget deficit forever. How is that possible?

> 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.

> Why are some economists against a target of zero inflation?

> Two political candidates are vying for town mayor, and the key issue is how much to spend on the annual Fourth of July fireworks. Among the 100 voters, 40 want to spend $30,000, 30 want to spend $10,000, and 30 want to spend nothing at all. What is the w

> What adverse effect might be caused by tax incentives to increase saving?

> 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?

> 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

> 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

> 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/aggregate supply diagram. What happens to total output, income, and e

> When the Federal Reserve increases the money supply, it __________ aggregate demand and moves the economy along the Phillips curve to a point with __________ inflation and __________ unemployment. a. expands, higher, higher b. expands, higher, lower c. e

> From one year to the next, inflation rises from 4 to 5 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 go

> 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 go

> 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 th

> 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

> 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

> The Condorcet paradox illustrates Arrow’s impossibility theorem by showing that pairwise majority voting a. is inconsistent with the principle of unanimity. b. leads to social preferences that are not transitive. c. violates the independence of irrelevan

> 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

> If the central bank wants to expand aggregate demand, it can ________ the money supply, which would ________ the interest rate. a. increase, increase b. increase, decrease c. decrease, increase d. decrease, decrease

> Which of the following is an example of an automatic stabilizer? When the economy goes into a recession, a. more people become eligible for unemployment insurance benefits. b. stock prices decline, particularly for firms in cyclical industries. c. Congre

> 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

> 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

> A bank has capital of $200 and a leverage ratio of 5. If the value of the bank’s assets decline by 10 percent, then its capital will be reduced to a. $100. b. $150. c. $180. d. $185.

> 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.

> 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, increa

> The money supply includes all of the following EXCEPT a. metal coins. b. paper currency. c. lines of credit accessible with credit cards. d. bank balances accessible with debit cards.

> What are reserve requirements? What happens to the money supply when the Fed raises reserve requirements?

> What is the discount rate? What happens to the money supply when the Fed raises the discount rate?

> If the Fed wants to increase the money supply with open-market operations, what does it do?

> What are demand deposits and why should they be included in the stock of money?

> 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

> What distinguishes money from other assets in the economy?

> Two ice-cream stands are deciding where to set up along a 1-mile beach. The people are uniformly located along the beach, and each person sitting on the beach buys exactly 1 ice-cream cone per day from the nearest stand. Each ice-cream seller wants the

> According to the theory of efficiency wages, a. firms may find it profitable to pay above equilibrium wages. b. an excess supply of labor puts downward pressure on wages. c. sectoral shifts are the main source of frictional unemployment. d. right-to-work

> Unionized workers are paid about _________ percent more than similar nonunion workers. a. 2 b. 5 c. 15 d. 40

> According to the most recent data, among workers who are paid at an hourly rate, about _________ percent have jobs that pay at or below the minimum wage. a. 2 b. 5 c. 15 d. 40

> 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.

> Using the numbers in the preceding question, what is the size of Ectenia’s labor force? a. 50 b. 60 c. 70 d. 80

> The population of Ectenia is 100 people: 40 work fulltime, 20 work half-time but would prefer to work fulltime, 10 are looking for a job, 10 would like to work but are so discouraged they have given up looking, 10 are not interested in working because th

> Is unemployment typically short-term or long-term? Explain.

> Explain four ways in which a firm might increase its profits by raising the wages it pays.

> 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.

> What claims do advocates of unions make to argue that unions are good for the economy?

> Are minimum-wage laws a better explanation for structural unemployment among teenagers or among college graduates? Why?

> 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.

> Describe three ways that a risk-averse person might reduce the risk she faces.

> The interest rate is 7 percent. What is the present value of $150 to be received in 10 years?

> 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 changing

> 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.

> The ability of insurance to spread risk is limited by a. risk aversion and moral hazard. b. risk aversion and adverse selection. c. moral hazard and adverse selection. d. risk aversion only.

> 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 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

> A change in the expected price level 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

> Name two macroeconomic variables that decline when the economy goes into a recession. Name one macroeconomic variable that rises during a recession.

> Describe the sources of supply and demand in the market for loanable funds and the market for foreign-currency exchange.

> 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?

> George has a life insurance policy that pays his family $1 million if he dies. As a result, he does not hesitate to enjoy his favorite hobby of bungee jumping. This is an example of a. moral hazard. b. adverse selection. c. signaling. d. screening

> If business leaders in Great Britain become more confident in their economy, their optimism will induce them to increase investment, causing the British pound to __________ and pushing the British trade balance toward __________. a. appreciate, deficit b

> 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

> 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 ________

> The government in an open economy cuts spending to reduce the budget deficit. As a result, the interest rate __________, leading to a capital __________ and a real exchange rate __________. a. falls, outflow, appreciation b. falls, outflow, depreciation

> 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.

> 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.

> What is capital flight? When a country experiences capital flight, what is the effect on its interest rate and exchange 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

> Suppose that Americans decide to increase their saving. a. If the elasticity of U.S. net capital outflow with respect to the real interest rate is very high, will this increase in private saving have a large or small effect on U.S. domestic investment? b

> Suppose that real interest rates increase across Europe. Explain how this development will affect U.S. net capital outflow. Then explain how it will affect U.S. net exports by using a formula from the chapter and by drawing a diagram. What will happen to

> Because Elaine has a family history of significant medical problems, she buys health insurance, whereas her friend Jerry, who has a healthier family, goes without. This is an example of a. moral hazard. b. adverse selection. c. signaling. d. screening.

> Suppose the United States decides to subsidize the export of U.S. agricultural products, but it does not increase taxes or decrease any other government spending to offset this expenditure. Using a three panel diagram, show what happens to national savin

> A senator renounces his past support for protectionism: “The U.S. trade deficit must be reduced, but import quotas only annoy our trading partners. If we subsidize U.S. exports instead, we can reduce the deficit by increasing our competitiveness.” Using

> 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 do

> 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 chapter notes that the rise in the U.S. trade deficit during the 1980s was due largely to the rise in the U.S. budget deficit. On the other hand, the popular press sometimes claims that the increased trade deficit resulted from a decline in the quali

> 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.

> Over the past 20 years, Mexico has had high inflation and Japan has had low inflation. What do you predict has happened to the number of Mexican pesos a person can buy with a Japanese yen?

> Define net exports and net capital outflow. Explain how they are related.

> The theory of purchasing-power parity says that higher inflation in a nation causes the nation’s currency to _________, leaving the _________ exchange rate unchanged. a. appreciate, nominal b. appreciate, real c. depreciate, nominal d. depreciate, real

> 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

> Economist George Stigler once wrote that, according to consumer theory, “if consumers do not buy less of a commodity when their incomes rise, they will surely buy less when the price of the commodity rises.” Explain this statement using the concepts of i

> 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

> 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

> 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.

> 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

> Describe the economic logic behind the theory of purchasing-power parity.

> Explain the relationship among saving, investment, and net capital outflow.

> A can of soda costs $0.75 in the United States and 12 pesos in Mexico. What is the peso-dollar exchange rate if purchasing-power parity holds? If a monetary expansion caused all prices in Mexico to double, so that soda rose to 24 pesos, what would happen

> If an economy always has inflation of 10 percent per year, which of the following costs of inflation will it NOT suffer? a. shoeleather costs from reduced holdings of money b. menu costs from more frequent price adjustment c. distortions from the taxatio

> 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

> 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

> Explain why majority rule respects the preferences of the median voter rather than the average voter.

> 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

> 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.

> 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

> Explain how an increase in the price level affects the real value of money.