Part I. Multiple Choice Questions
- Which of the following is characteristic of a downturn in the business cycle?
- Lower unemployment rates
- An increase in population
- A decrease in real output
- A decrease in population
- Which of the following individuals is part of the labor force?
- The CEO of General Motors
- A retired schoolteacher
- A stay-at-home mom
- A woman serving seven years in the penitentiary for selling drugs
- Who among the following would be counted as unemployed?
- Amy, who is on vacation but will soon return to the same job.
- Bob, a college student looking for summer work.
- Carol, who is on welfare and not actively looking for a job.
- Dave, who is on strike.
- One reason our full employment goal is not zero percent is because:
- Frictional unemployment will always exist.
- Cyclical unemployment will always exist.
- Population growth makes such a goal impossible.
- Discouraged workers make such a goal impossible.
- Suppose a recent college graduate has an annual nominal income of $42,000 for the first year she works. If the annual inflation rate is 5 percent, what salary would she need in the second year to maintain the same real income?
- When a person’s nominal income falls in a period of inflation then the person’s real income:
- Definitely falls.
- Definitely rises.
- Depends upon relative price changes.
- Can rise or fall.
- If the CPI last year was 143 and the current CPI is 134, we have experienced:
- 6.3 percent deflation
- 9 percent inflation
- 6.7 inflation
- None of the above
- If the CPI is 137 in Year Y, then it costs _______ in Year Y to buy the same market basket that cost _______ in the base period.
- $37; $100
- $137; $37
- $100; $137
- $137; $100
- Figure 1—Aggregate supply and demand
In Figure 1, at which of the following price levels would a shortage occur?
- If the price level is:
- Above equilibrium, this results in excess supply.
- Above equilibrium, this results in a shortage.
- Below equilibrium, this results in an increase in the quantity of output offered for sale.
- Below equilibrium, this results in a surplus.
- Which of the following is likely to occur if OPEC increases the amount of oil it supplies and domestic energy prices fall, ceteris paribus?
- Aggregate supply will decrease or shift to the left.
- Aggregate supply will increase or shift to the right.
- Aggregate demand will increase or shift to the right.
- Aggregate demand will decrease or shift to the left.
- Which of the following will occur if aggregate demand is above full-employment GDP?
- A stable economy
- Which of the following is an example of fiscal stimulus?
- An increase in government spending on new military jet fighters
- An increase in consumption because of improved consumer confidence
- An increase in personal income taxes for families with children
- An increase in the purchase of office buildings by foreign investors
- If consumers spend 79 cents out of every extra dollar received, the:
- Multiplier is 0.79.
- MPC is 0.79.
- MPS is 0.79.
- MPC is 0.21.
- Which of the following economies has the largest multiplier?
- Economy A with an MPS of 0.5
- Economy B with an MPS of 0.1
- Economy C with an MPC of 0.8
- Economy D with an MPC of 0.6
- Assume an MPC of 0.75. The change in total spending for the economy as a result of a $20 billion new government spending injection would be:
- $80 billion.
- $27 billion.
- $22 billion.
- $15 billion.
- Martin takes $150 out of his checking account and hides it in his house as cash. The immediate result of this transaction is that M1:
- Does not change in value.
- Decreases by $150.
- Decreases by more than $150.
- Increases by $150.
- Money is functioning as a medium of exchange if you:
- Compare book prices at the university bookstore versus online.
- Spend less this week so you’ll have money for a concert next month.
- Purchase coffee at the local coffee shop before class.
- Share a ride with your roommate instead of buying gas.
- A bank may lend an amount equal to its:
- Required reserves.
- Total reserves.
- Total assets.
- Excess reserves.
- U.S. monetary policy relies on the:
- Federal Reserve System’s control over taxes.
- Federal Reserve System’s control over the money supply.
- President’s control over the printing of money.
- President’s control over interest rates.
- When the Fed raises interest rates they are attempting to:
- Increase aggregate demand.
- Decrease aggregate demand.
- Increase aggregate supply.
- Decrease aggregate supply.
- If the Fed wishes to increase the money supply it can:
- Raise the federal funds rate.
- Sell bonds on the open market.
- Decrease the discount rate.
- Increase the required reserve ratio.
- When the Fed announces that it is raising the federal funds rate, this signals its intention to _______ bonds in the open market and _______ the money supply.
- Buy; reduce
- Buy; increase
- Sell; reduce
- Sell; increase
- Supply-side policy includes:
- An increase in the reserve requirement.
- A decrease in spending on education.
- An increase in government-mandated fringe benefits.
- An increase in incentives for business investment.
- Stagflation is a situation in which the economy experiences both:
- Inflation and unemployment.
- Inflation and full employment.
- Deflation and unemployment.
- Deflation and full employment.
Part II. Problems
- Classify each of the types of unemployment described below as “frictional”, “structural”, or “cyclical”. Give a brief explanation of your characterization.
- a) (3 points) with the overall national unemployment rate at under 4%, hundreds of laid-off computer programmers cannot find new programming jobs.
- b) (3 points) a rise in oil prices brought about by a crisis in the Persian Gulf raises costs of production and reduces profits of U.S. manufactures and other firms which use inputs made from imported oil. The ensuing decline in business investment results in a recession, raising the unemployment rate from 4.5% to 9.5% over a period of 18 months.
- c) (3 points) With the Massachusetts economy expanding and the Commonwealth’s unemployment rate down to 2.5%, the state’s only auto plant shuts down, idling 1,000 workers in Framingham. These workers had been employed at the plant for an average of 20 years, and as a result had developed specialized skills which cannot readily be transferred to other occupations and industries.
- d) (3 points) A recent college graduate not yet employed but searching for a job.
- (4 points) Suppose, in April the number of employed stood at 137.7 million while the number of unemployed stood at 8.8 million. What was the unemployment rate in April?
- (4 points) In June there are 30,000 people classified as unemployed and the size of the labor force is 600,000. The only change between June and July is that 10,000 people give up looking for work. Compute unemployment rate in July.
- a) Fill in the table above.
- b) Based on Table 12.1, what is the marginal propensity to consume?
- c) Based on Table 12.1, what is the marginal propensity to save?
- d) Based on Table 12.1, what is the multiplier?
Use the following balance sheet for XYZ Bank, which is one of many banks in a banking system.
- With a required reserve ratio of 15 percent, what will be XYZ Bank’s excess reserves?
- If XYZ Bank has a required reserve ratio of 20 percent, by how much can it legally increase its loans?
- With total reserves of $50,000 and a required reserve ratio of 10 percent, what is the potential deposit creation for the banking system?
- With total reserves of $50,000 and a required reserve ratio of 25 percent, what is the potential deposit creation for the banking system?
- Based on the information in Table 14.1, what is the required reserve ratio?
- Based on the information in Table 14.1, what is the money multiplier?
- In Table 14.1, if the Fed changes the required reserve ratio to 5 percent, what will eventually happen to the lending capacity of the banking system? (increase/decrease and by which amount)
- In Table 14.1, what is the level of total reserves?
- Using the reserve requirement in Table 14.1, if the Fed sells $15 billion worth of bonds in the open market, what will be the effect on the lending capacity of the banking system? (increase/decrease and by which amount)
- This is a case of friction unemployment; these computer programmers have not found new programming jobs. This kind of unemployment occurs when workers lose their jobs when they the company lays them off.
- This is a cyclical unemployment, because it is due to contraction phase of the economy, there is low demand of their expertise in the job market that is why they cannot find new employment opportunities. This type of unemployment is common when the economy is in recession
- This is a case structural unemployment when shifts occur in the economy that creates a mismatch between the one specialized skilled workers have acquired over a long time that cannot be transferred to other occupations.
- This kind of unemployment that occurs when a student is looking for her first job is frictional unemployment.
- Unemployment rate in April
Unemployment rate = (number of unemployed persons labor force (both employed and unemployed))*100%
= 8800000/ (8800000+137700000)*100%
- Unemployment rate in July
Unemployed in June were 30,000
During this period, 10,000 gave up seeking employment, therefore in the month of July reduced to 20,000 and employed persons were 600,000.
Unemployment rate in July = 20,000/ (600,000+ 20,000)*100%
- Disposable income= consumption + savings.
So filling the table, we get,
|Disposable income ($ billions/year)||Total consumption ($ billions/year)||Savings ($ billions/year)|
- the marginal propensity to consume (MPC) is equal to;
Change in consumption/ change in income
= (155-80)/ (200-100)
- the marginal propensity to save(MPS) is given as;
Change in savings/ change in income.
= (45-20)/ (200-100)
- the multiplier is
= 1/ (1-mpc)
= 1/ (1-0.75)
= 1/ MPS
- XYZ banks’ excess reserves;
Required reserves =15/100*200,000
Excess reserve= total reserves- required reserves
- Required reserve ratio of 20% implies that out of the 200,000
= 40,000 is the reserve requirement but the bank can loan the remaining which is
XYZ bank can legally increase its loan by $160,000.
- Deposit creation for the banking system if required reserve ratio is 10% is
= required reserve/required reserve ratio
= Required reserve is
- the potential deposit creation for the banking system with a required reserve ratio of 25% is given by
=required reserve/ required reserve ratio
=required reserve is
- the required reserve ratio
=required reserve ratio* deposit accounts= required reserves
Therefore, required reserve ratio- required reserve/ deposit accounts
=0.1 or 10%
The required reserve ratio is 10%.
- Money multiplier
= 1/required reserve ratio
- By lowering the required reserve ratio to 5%, the Feds decreased required reserves this means they increased the lending amount.
Required reserve = 5/100*$80billion
The excess of $80billion minus $40billion is $40 billion.
Therefore, the banks’ lending amount increased by $40billion.
- Total reserves
Total reserves- required reserves= excess reserves
X- $80 billion = $120billion
X= $200 billion.
- If the feds sell bond, it decreases money supply by removing cash from the economy in exchange for the bond. The lending capacity of the bank will reduce by $15 billion.