ECON 272 End of Section Questions

ECON 272 - End of Section Questions

READ: These questions are not designed to take the place of studying your notes and the reading assignments. Do not e-mail me and ask me to answer all or some of these questions for you. If you have missed class, it is your responsibility to get the notes from another student. Once you have answered these questions yourself, if you are unsure of any of your answers, let me know and I will tell you if you are correct or not. Don't be afraid to ask me questions, I just want you to try to answer the questions yourself first.

Can You Answer These Questions Regarding the Material we have covered in the Introductory Notes? (p. 13)

1. What is economics? Why is economics a social science?

2. What axiom do most economists assume to be true about human behavior? How do incentives fit in with this assumption?

3. What does “self-interest” mean to an economist?

4. What two basic questions or problems do economists address? Explain what the problems are and why they exist.

5. What is scarcity? Are there any goods or services that are not scarce? What are they called?

6. Give an example of knowledge of “individual time and circumstances” and explain why that knowledge is important (this has to do with the coordination problem).

7. In an attempt to address the two basic economic problems, economists use what basic model?

8. Make sure you know the difference between the rules (institutions) and the outcomes of the rules (i.e., a change in the rules leads to a change in the incentives, then to a change in action or behavior, and this leads to a change in outcomes).

9. What are the two ways rules come about? What are the differences between these with respect to possible unintended outcomes?

10. Why do rules need to be predictable and steady to be followed and useful? Explain.

Can You Answer These Questions Regarding this section in the Introductory Notes? (p. 19)

What book did Adam Smith write that is considered a classic? What year was it published? What group, in general, did he write the book to and why?
What created wealth to Smith?
What does division and specialization mean? Give an example.
Why does division and specialization increase productivity, according to Smith (three reasons)?
Division and specialization creates interdependency. Explain. This was not a problem to Smith as long as what rule was in place? Explain.
Make sure you can relate productivity, division and specialization, interdependency, and trade.
To Smith, self-interest is not a bad thing -- in fact, with the right rules in place, it really does create a very good economic order. Explain Smith's invisible hand.
What rules did Smith recommend?
When two people trade, what happens? Why do they both benefit and how do we know they do? What is being assumed?
Is trade equal?
What does opportunity cost mean? Can you apply the concept?
What is absolute advantage? Example?
What is comparative advantage? Example?
Should trade be based upon comparative or absolute advantage?
What is wealth (as defined in class)?
How are wealth and efficiency (productivity) related to value?
What three ideas did we discuss regarding the definition of efficiency (i.e., what three things must be considered when determining if someone is more efficient than someone else when producing something)?

EXAM ONE STOPPED HERE

EXAM TWO STARTS HERE

Can You Answer These Questions Regarding this section in the Introductory Notes? (p. 26)

What is the production possibilities frontier (PPF)? Be able to draw a production possibilities frontier and understand it (as in the in class exercise we did).
What does marginal mean?
What does marginal opportunity cost mean as it relates to the PPF?
What is economic growth (given our definition of wealth)? How is this demonstrated on a production possibilities frontier?
What is happening along the frontier? Is every point efficient or not? Explain.
Relate the problems of choice and coordination to the PPF.
What rules appear to be important if a country wants more production of goods and services and why?
Why do many economists think that savings is important for economic growth?
What is a capital good? Consumer good?
What rule differentiates capitalism, socialism and communism?

Can You Answer These Questions Regarding the Notes on Gross Domestic Product? (p. 35)

1. What are the four major topics that are studied in macroeconomics?

2. What is Gross Domestic Product (GDP)? In one word, what is it trying to measure?

3. How is it measured using the expenditures approach?

4. What are the four categories of expenditures used when determining GDP?

5. Why aren't transfer payments and interest payments on the government debt (which are part of the government's budget) counted in GDP?

6. Why are only "final" goods and services counted in GDP? What are included as "final" goods and services?

7. Why do we subtract imports from GDP?

8. What are the four factors of production and the four "incomes" that go along with them.

9. What is National Income (Y)? This relates to the question above.

10. In the national income accounts (the government's accounting system) -- everything balances (theoretically). Show this using a circular flow diagram. In other words: Consumption + Investment + Government Spending + Net Exports = Y (National Income) = GDP and also Aggregate Supply (GDP) = Aggregate Demand.

11. What is the difference between real and nominal GDP?

12. What is per capita GDP? How is it calculated?

13. What are some problems with the GDP measure?

14. What are "regrettable necessitates"?

15. What other measures of the quality of life in a country might we look at (besides GDP)?

16. What does “correlation” mean? Is it the same thing as causation? Explain.

17. Provide an example of “empirical” evidence.

18. Are there quality of life measures that seem to be positively correlated with GDP when looking at empirical data -- if so, what are they and why the correlation – what are some theories regarding the causation?

Can You Answer These Questions Regarding the Notes on the Business Cycle and Unemployment? (p. 50)

1. What is a business cycle? What is the trough, peak, a contraction, an expansion as related to a business cycle.

2. How does the NBER define a recession?

3. What are the four economic indicators (measures) that the NBER looks at when deciding if there is a recession or not?

4. What are the "three D's" of a business cycle -- explain each.

5. What population does the government start with when determining the unemployment rate?

6. What does it mean to be "in the labor force" or "out of the labor force?"

7. Who would be considered "out of the labor force?"

8. How does the government calculate the unemployment rate? Remember, it is a % of the labor force.

9. What is the U-6 unemployment rate? How is it different from the official unemployment rate?

10. What are some of the problems with measuring unemployment (interview bias, underemployment, added worker theory, discouraged worker theory, etc.)? Do they overstate or understate the rate?

11. What does the Macro Issues book say about the discouraged worker argument -- what are the two sides of the argument?

12. What does the Macro Issues book say about disability insurance and unemployment?

13. What is frictional unemployment? Give an example of someone who might be frictionally unemployed.

14. What is structural unemployment? Give an example of someone who might be structurally unemployed.

15. Why is full employment not zero unemployment? What rate of unemployment is considered full employment now by most economists?

16. What is the labor force participation rate? How is it calculated?

17. What is the employment rate? How it is calculated?

18. What trends have occurred in the labor force participation rate over the last 50 years and why?

19. Be able to explain how jobs are actually created using an example (similar to Crusoe economics) AND be able to explain why it is unlikely that government create jobs.

EXAM TWO STOPPED HERE

EXAM THREE STARTS HERE

Can You Answer These Questions Regarding the Notes on Money? (p. 58)

1. What is money? What are the functions of money? Explain them.

2. Who invented money?

3. What is barter? What are the problems with barter?

4. What is commodity money (what determines if something will emerge as a commodity money and what makes it money)?

5. Explain the process of the emergence of commodity money.

6. What are the characteristics of a "good" commodity money?

7. What is fiat money (what makes it money)?

8. Explain a process by which fiat money might come about from commodity money.

9. What is a fully backed fiat money? Partially backed? Non-backed?

Can You Answer These Questions Regarding the Notes on Macro Policy and Inflation and Deflation? (p. 69)

1. What is monetary policy? Fiscal Policy?

2. Why do some economists think that the government should not undertake either monetary or fiscal policy?

3. What is inflation - standard definition? What does this definition leave out?

4. What is deflation - standard definition? What does this definition leave out?

5. What is the money supply or stock? What is M1? What is M2? How have they changed (generally) over the last 35-40 years?

6. What is the velocity of money?

7. What is the demand for money? Why is it also called the "transactions demand for money"?

8. Explain why, when the velocity of money increases, the transactions demand for money decreases and visa versa.

9. What is aggregate supply or "the pie"?

10. What is aggregate demand?

11. What causes inflation? What has been the major cause of inflation historically?

12. What causes deflation?

13. What is the purchasing power of money? What is the so-called price level? How do they relate to each other?

14. Explain the process of what happens to overall prices and the purchasing power of money when there is an increase in the money supply, while money demand, velocity and aggregate supply (the pie) remain the same.

15. What does the non-neutrality of money mean?

16. Realistically, when the money supply increases there are injection (or Cantillon) effects. Does money enter (and spread throughout) the economy evenly to everyone? If not, what happens? How do prices increase? Are all people affected in the same way? Explain.

17. And with injection effects, why are relative price changes important? How do they lead to a misallocation of resources?

Can You Answer These Questions Regarding the Notes on the CPI and the Effects of Inflation and Deflation? (p. 78)

1. What is the Consumer Price Index (CPI), what does it attempt to measure and how does the government determine the CPI? What is the Producer Price Index (PPI)?

2. What is the "core" CPI and explain why economists would look at it instead of at the usual CPI?

3. What are positive time preferences and how do they relate to real interest rates? How does risk relate to real interest rates?

4. Be able to explain the difference between the nominal and real interest rates.

5. Explain why debtors gain at the expense of lenders with unanticipated inflation. Relate this to the nominal interest rate.

6. Explain why inflation is a hidden tax? Why are people worse off with inflation?

EXAM THREE STOPPED HERE

EXAM FOUR STARTS HERE

7. What is a capital gain? Capital loss?

8. What are capital gains taxes? How can a person be made worse off when there is both inflation (causing a nominal capital gain) and a capital gains tax? Example with numbers as you did in the out of class exercise on inflation as an investment tax.

9. Inflation increases uncertainty - what changes take place because of this?

10. Why does inflation lead to lower savings and, therefore, lower economic growth?

11. Again, think about how inflation leads to relative price changes and a misallocation of resources. Why do resources move into industries that do not have sustainable profitability? Why does this eventually cause a downturn (or bust) in the economy - which leads to higher rates of unemployment?

12. Why might inflation lead to unemployment -- see reasons above that lead to misallocation of resources (as well as lower savings, etc.).

13. Explain why lenders gain at the expense of debtors with unanticipated deflation. Again - relate this to the nominal interest rate.

14. There are also relative price changes with deflation. Explain.

Can You Answer These Questions Regarding the Notes on the Myths Surrounding Inflation? (p. 85)

1. What are the myths surrounding inflation that we discussed in class? See the next few questions:

2. Is money wealth to an economy? Explain.

3. Do unions cause inflation? Does a shortage of goods cause inflation? Do minimum wage laws cause inflation (isn't this just the same question as unions causing inflation)? Explain.

4. Why is selling stocks known as "equity financing?" Why is selling bonds known as "debt financing?" (both done by private companies).

5. What is it called if G=T? G>T? G<T? (G = government spending and T = Tax Revenue)

6. How does the U.S. federal government finance its deficit spending? Which agency is in charge of this? What does this agency issue (sell)?

7. What is the difference between the government deficit and the debt?

8. Does the government debt cause inflation? Explain why people think it does.

9. What does it mean to "monetize the debt?" Be sure to include the roles of the FED and the Treasury here.

10. How large is the U.S. federal government’s debt (approximately) in dollar terms?

Can You Answer These Questions Regarding Why Does Inflation Occur - or Why Does the Government/Central Bank Inflate the Money Supply? (p. 93)

1. What are two main reasons governments/central banks inflate the money supply?

2. Explain why inflation is a hidden tax and how the government benefits from it. When the government increases the money supply (by let's say monetizing the debt), it has more money to spend (it has created more money in order to finance deficit spending). But after the government spends the money - there is an increase in aggregate demand - which leads to the shopkeepers increasing prices - therefore the value of the dollar goes down and ordinary Joe can't buy as much. Hence, he has been taxed. He can't buy as much but the government has more money to spend.

3. Explain what tax bracket creep is and how the government benefits from it (if the brackets are not indexed to the inflation rate).

4. Why does inflation stimulate exports and decrease imports in the short term. Explain.

5. What is a trade deficit?

6. How does the government - as a net debtor - benefit with unanticipated inflation?

7. Review - what is monetary policy? Fiscal policy? No government policy?

8. The Phillip's Curve theory is considered a Keynesian theory. What are two basic premises of Keynesian economics that are seen in this theory?

9. What is the Phillip's Curve theory regarding the trade-off between unemployment and inflation? Explain the short run trade-off. Why did Phillips say that wages would increase at a slower rate when unemployment was high - but at a higher rate when unemployment was relatively lower? This is the Keynes/Phillips part of the story (short-run). Then, when workers catch on (to what?), what happens in the long run? What does the long run Phillip's curve look like and why?

10. Now, the critics of the theory: Friedman -- explain what Friedman said would happen in the long run if the government repeated the short run policy. In your answer make sure you know what "adaptive expectations" mean and how they fit into the story.

11. Hayek - In the even longer run -- some economists (including Hayek) think that the Phillip's Curve theory trade-off (monetary policy in order to decrease unemployment) actually causes MORE unemployment (or stagflation - which means?) than what we started with. Explain why. Basically - see the effects of inflation we talked about earlier - especially relative price changes and how they lead to misallocation of resources. Or in what ways does inflation harm productivity?

12. Buchanan - we are likely to see high rates of inflation when governments use the Phillip's curve theory (now known as "quantitative easing") because of the incentives that politicians have to obtain votes. Explain his argument.

Can You Answer These Questions Regarding the Notes on the FED, Credit Expansion, and Monetary Policy? (p. 113)

What is the Federal Reserve System (FED)? When was it created? Why was the FED first created (supposedly)?
What is a fractional reserve banking system?
What is the required reserve ratio (definition)?
What are cash reserves and where are they held?
What are excess reserves?
What are required reserves?
By how much can a single bank potentially increase the money supply (when a deposit is made in the bank) - at any given time? Explain.
By how much can the entire system potentially increase the money supply (when a deposit is made in the bank)? Make sure you know what the simple money multiplier is.
What two assumptions are made in the above question?
Now explain when an increase in the money supply actually happens (regarding questions 7 and 8 above) and when it does not and why? This does not relate to the assumptions you discussed in question 9.

EXAM FOUR STOPPED HERE

FINAL EXAM STARTS HERE

Besides the Treasury simply printing up new money and then circulating it through the economy via government spending - the FED manipulates the money supply via credit expansion and contraction. Explain what credit contraction and expansion means.
What are the three ways by which this credit expansion/contraction is carried out by the FED (the traditional tools)? This question relates to the next few questions:
What are open market operations? How are they used to change the money supply (or credit)?
What is the federal funds market? What is the federal funds rate? How does the FED use open market operations to manipulate the federal funds rate?
Explain why the price of a bond and its yield (or interest rate) are inversely related? Example?
What is the discount rate? Does the FED set this rate or manipulate this rate? How does it change this rate to change credit expansion? Explain.
What is the required reserve ratio? How does the FED change this rate to manipulate credit expansion? Explain. The FED does not change the required reserve ratio very often - however it does change the amount of deposits that are exempt from the required reserve ratio. Explain what the FED would do with this amount if it was trying to decrease or increase credit expansion.
So to summarize the above questions -- Carefully explain the three major ways the FED changes the money supply (by increasing the reserves in the banking system) - thereby manipulating credit in the economy.
In 2008, the FED has made some changes in order to increase the liquidity of banks and other financial institutions (and in order to decrease interest rates - including mortgage rates). Make sure you know the major reasons for these new changes and give examples of how the FED has expanded the discount window and open market operations.
What is "quantitative easing."
There are many problems with monetary policy. For example, many economists believe the FED has been pro-cyclical and not counter-cyclical - partly due to lags. Explain.
The FED cannot control whom (when it comes to monetary policy)? Because of this, what has happened to a lot of the new money that was created during the most recent rounds of “quantitative easing’?
Keynes believed that people hold money for three different reasons – explain them.
Explain the speculative demand for money.
What is the Keynesian idea of a liquidity trap? Why/when does it happen? Why would it mean that monetary policy would not be effective?
The FED’s policies are short-term – but what can happen in the long-term because of monetary policies?
Why might the FED’s monetary policy actually create downturns (depressions, recessions) in the economy (due to malinvestment)? Discuss distortions of signals in the economy due to monetary policy.

Can You Answer These Questions Regarding the Notes on The Big Debate, Say’s Law and Economic Growth? (p. 133)

In your professor’s opinion, what are the two biggest differences among economists?
Generally speaking, which economists believe that productivity drives an economy and which economists believe that spending drives an economy?
What is Say's Law of Markets? Explain it! What was Say really saying? What is the difference between "wants" and demand? Relate this to Say’s Law.
What was F. Bastiat’s idea about trade? Where did the value of trade come from?
Bastiat discussed the relationship between wants, efforts and satisfaction. Explain this relationship and relate it to Say’s Law.
Say’s Law is not “build it and they will come.” Explain.
Explain why those who believe in Say’s Law are skeptical of monetary policy.
What is the equation of exchange (the quantity theory of money)? This theory is the formalization of the idea that money is not ______________ to an economy.
Explain why those who believe in Say’s Law are also skeptical about fiscal policy (with respect to income and capital gains taxes).
How did Say respond to the idea that there is a causation between an increase in taxes and an increase in prosperity for a country?
A modern theory regarding Say’s Law and taxes is known as Supply Side economics. What do supply side economists focus on?
What is the substitution effect? What is the income effect? Which effect do supply side economists think is more prevalent in the economy?
If supply side economists are correct, then explain why increases in income and capital gains taxes decrease productivity.
What is the tax base?
What are the two reasons supply side economists give regarding a tax cut leading to an increase in tax revenue?
What is the Laffer curve? Explain it and draw it.
What is the theory behind the idea that the relatively rich will end up paying more of the overall tax revenue with an income tax cut?
How does supply side economics relate to “trickle down” economics?
What conclusions do the supply side economists reach regarding policy? Why would supply side economists want to decrease capital gains taxes and income taxes?
Under what presidential regimes have there been major income tax cuts in the United States? What do those tax cuts indicate with respect to tax revenue and with respect to who ends up paying more of the overall tax to the government?
Explain why those who believe in Say’s Law are also skeptical about fiscal policy (with respect to government spending).
When the government spends taxpayer money – what cost comes about?
In Bastiat’s story of the broken window fallacy – he discussed three levels of analysis. What are they?
Be able to explain the third level in detail. What is not seen in the second level of analysis? And how does this relate to the idea that breaking a window is NOT good for the economy.
If the government did do something more productive (than the private sector) with taxpayer money – government spending would add to productivity. Why is this not likely?

Can You Answer These Questions Regarding the Notes on Fiscal Policy and Keynesian Economics? (p. 143)

1. What are the basic ideas of Keynesian economics?

2. Do Keynesians believe in Say's Law? Explain.

3. Although Keynesians will want the government to use both monetary and fiscal policy to increase aggregate demand, when will fiscal policy be more effective – according to Keynesians?

4. The following questions relate to the Keynesian model: What are the four components of aggregate demand in the Keynesian model?

5. What are the most important variables that determine consumption in the model?

6. Consumption is a function of what? Explain.

7. Saving is a function of what? Explain.

8. Graph the consumption function.

9. Investment in the model can be very volatile – explain what animal spirits are and how/why they can make investment (and sometimes consumption) decrease.

10. Graph the aggregate demand curve.

11. Add in a 45 degree line and show where equilibrium is on the model.

12. Show a recession on the model.

13. What is the Keynesian multiplier effect? Explain why an increase in C will lead to a greater increase in Y in the model.

14. What is the marginal propensity to consume? To save? Why do they add to one? How do they relate to the multiplier effect?

15. Why is saving bad in the Keynesian world?

16. What is the paradox of thrift?

17. What the options of Keynesian planners if they want to use fiscal policy to increase aggregate demand?

18. Which one is the most powerful and why?

19. Can you answer this question? What is the difference between a Keynesian and a Say's Law tax cut?

Can You Answer These Questions Regarding the Notes on The Critics of Government Deficit Spending? (p. 152)

When looking at government debt - we should compare it to GDP. Why?
Who holds the U.S. government debt? You don’t have to know percentages, just the basics as to who are holding U.S. Treasury bonds.
James Buchanan explained two criticisms of deficit spending. One has to do with the morality of deficits. Explain.
What was Buchanan’s second criticism?
Why do politicians like to deficit spend?
When the government borrows - there is less private spending. What is the opportunity cost argument here as to why this might be a bad thing for the economy? Who are some potential unseen parties that are hurt?
Explain why current deficits mean future taxes.
The theory that private investment is crowded out by government deficits holds that both savings and investment are a function of what?
Explain crowding out -- or why many economists believe that a large government debt (deficit spending) will decrease economic growth. In your answer explain the loanable funds market. GRAPH
What is a Keynesian counter argument to crowding out -- and a counter to the counter?

FINAL EXAM STOPS HERE

Can You Answer These Questions Regarding the Notes on Hayek vs. Keynes: The Business Cycle Revisited? (p. 164)

What was the "economic calculation debate" between Hayek and Keynes all about?
What does "economic calculation" mean?
What are the two types of knowledge Hayek talks about and why does he think government planning of the economy will fail? Relate this to economic calculation.
What was Hayek's answer to the question?
What was Keynes's answer to the question?
Why did Keynes think economic planners could plan successfully? What would they need to do so?
Is the debate over?
What are the main assumptions of the Austrian business cycle theory? Who are the two main economists that came up with the theory?
What is the difference between Austrian capital theory and mainstream capital theory? What does the Austrian capital theory
What is the Hayekian triangle? What does it represent?
How does time fit into the triangle?
What role does the entrepreneur play?
What are positive time preferences and how do they relate to savings and to interest rates?
Why are savings seen as future consumption to Austrians (and other economists)?
If time preferences decreased and people started saving more -- what would the interest rate do and what would that signal entrepreneurs to do (relate this to a shift in the Hayekian triangle).
What does a signal extraction problem mean?
What does "mal-investment" mean to an Austrian economist? What causes it to happen on a large scale?
Explain the Austrian theory of the business cycle.

Include in your analysis: the Hayekian triangle and it's meaning as a capital structure (higher order and lower order goods), a shifting of the triangle, a "cluster of errors", time preferences, signal extraction problem, relative price changes, mal-investment (on two levels), re-tooling of the capital structure and what that means. How does the FED factor into all of this?