ECN 203: Economic Ideas & Issues
Department of Economics
Exam 2 Study Guide
Test 1 Coverage:
∙ Lecture PPT slides & notes for chapters 11 to 18
∙ Quiz 2
∙ Textbook chapters 11 to 18
∙ Key equations will be provided on the exam.
∙ Bring a calculator to the test. Cell phone calculator will not be permitted.
1. Can actual GDP surpass full GDP? Why or why not?
Yes- full GDP is defined as the maximum and sustainable which means the economy can produce something greater
2. Explain the different types of unemployment
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Frictional- results because of a skill mismatch in a previous job, short-term Structural- results because of new technology and industrial reorganization, long term
3. What is the natural rate of unemployment?
Unemployment rate when the economy is producing at full GDP, frictional and structural unemployment are signs of a healthy economy
4. Is the population of a country equal to its labor force?
No, the labor force is the number of people employed + the number of people looking for work
5. Explain the equity and the efficiency costs of inflation.
Equity- negatively impacts fairness, hurts people receiving fixed income because the interest received will have less purchasing power
Efficiency- costs economy to produce less, inflation undermines money’s role, inflation increases cost of borrowing which leads to less investment, when inflation becomes very high (hyper-inflation) money becomes useless and the economy stalls
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6. Understand how CPI and GDP Deflator are calculated and how to derive the inflation rate using the two price indexes.
7. Understand the factors that shift the AD, SRAS, and LRAS curves and explain how the factors shift the curves.
AD- consumption investment, government spending/taxes, imports/exports SRAS- new technology, endowments (oil, resources), factor price (if oil price is high, SRAS will decrease)
LRAS- new technology, endowments (natural resources, population, workforce)
8. What is consumption smoothing?
A stable path of consumption regardless of current income. People try to optimize their lifetime standard of living by ensuring a proper balance of spending and saving during different phases of life.
9. What is marginal propensity to consume? We also discuss several other topics like hilly flanks theory
The proportion of aggregate raise in pay that a consumer spends on the consumption of goods and services as opposed to saving it
10.What is autonomous consumption?
The minimal level of consumption or spending that must take place even if a consumer has no disposable income, such as spending for non-basic necessities.
11.Understand and explain the factors that cause consumption (C), investment (I), or net exports (X – M) to change and their subsequent effects on AD. Factors that cause consumption to change are current income, long-term expected income (permanent income), consumption smoothing, future economic growth, and consumer confidence. When consumption declines, the AD curve shifts to the left. Factors that cause investment to change are long term capital market, supply of financial capital, and the demand for real investment. When investment declines, the AD curve shifts to the left. We also discuss several other topics like organotroph definition
Factors that cause net exports to change are the GDP of the country it exports to and the currency value. When exports decline, the AD curve shifts to the left.
12.Understand and explain the factors that cause the exchange rate to change. Illustrate and explain with a foreign exchange market graph.
Inflation rates, interest rates, current accounts/balance of payments, government debt, terms of trade, political stability and performance, recession, speculation.
13.Explain how the economy can recover from a recession without government help. Use the AD-AS diagram and the Labor Market diagram to help illustrate your answer.
GDP growth, stock market gains, unemployment decrease, higher consumer confidence
14.Compare and contrast the views held by Classical economists to those held by Keynesian economists.
Classical- government should adopt laissez-faire policies, wage and price adjust quickly to restore the economy to full GDP, the economy is too complex for people We also discuss several other topics like mountain of motor development
running the government to know what and how much to help, government help may even make things worse
Keynesian- government should actively intervene to steer the economy to full employment GDP, wage and price are sticky, particularly “downward sticky”, recession and high unemployment mat persist for many years
Both believe that the economy can adjust.
15.What is the fractional reserve system?
Banking system in which banks only hold a fraction of the deposits as reserves Reserves
Reserve Ratio =
16.How do banks create money? Explain using the T-accounts. They make profits by loaning out excess reserves, creating money in the process.
17.Explain how open market operations work and their effects on interest rate, supply of liquidity, and eventually on AD, price level, and actual real GDP. Differentiate the effects of open market purchases from the effects of open market sales. Illustrate and explain with the Long-Term Capital Market graph and the AD-AS graph. If you want to learn more check out in terms of making a purchase, the value of a product can derive from an enduring belief shared by a society that a specific mode of conduct is personally or socially preferable to another mode of conduct.
The Federal Reserve buys or sells securities from its member banks. When the Fed wants interest rates to rise, it sells securities to banks and when it wants interest rates to fall it buys securities.
18.Explain the effects of open market operations on exchange rate. Illustrate and explain using a foreign exchange market graph.
International trade (increase in foreign demand for home products = home product appreciation), international capital flows (increase in foreign demand for domestic assets = currency appreciation), appreciating currency reduces exports and increases imports, depreciating currency increases exports and reduces imports
19.How does government borrowing crowd out private investment? Illustrate and explain with the Long-Term Capital Market graph.
Increase in government budget means an increase in interest rate which means lower investment by private companies.
20.Explain the ‘twin deficits’.
The two twins are trade deficits and budget deficits. The phenomenon says that the two deficits happen together and the budget deficit tends to create a trade deficit. Interest rates are increased and cause currency to appreciate so exports become more expensive so we sell less of them and end up with a trade deficit.
21.Use the concepts of consumer surplus and producer surplus to explain the economic welfare impact in a market when a country goes from no trade (autarky) to free trade. Illustrate and explain with a supply-and-demand graph. Analyze the case of imports as well as the case of exports.
A country imports a good because other countries can produce it at a lower cost. This causes the price to decrease and the consumption to increase.
A country exports a food because other countries will pay a higher price for it. This results in an increase in price, an increase in production, and an increase in consumption.
22.Use the concepts of consumer surplus and producer surplus to explain the economic welfare impact in a market when the government of a country imposes a tariff on imports. Illustrate and explain with a supply-and-demand graph.
A tariff raises the product price and reduces the quantity of imports which results in a loss of economic welfare (deadweight loss)
23.Explain how the government of a country can keep its currency value low. Illustrate and explain with a foreign exchange market graph.
If the government wants to encourage domestic industries to export to other countries, it can keep its currency value low through currency manipulation. They
buy and sell foreign currency in exchange for their own domestic currency, generally with the intention of influencing the exchange rate.
24.What are some ways the government of a country can subsidize its domestic industries to encourage exports?
Keeping the value of currency low (currency manipulation), giving out loans with cheaper interest rates, giving out cash grants to domestic industries
25.Suppose the market for good X in country A can be represented by the supply and demand curves below (graph not to scale). In autarky (no trade), the equilibrium price is $16 and the equilibrium quantity is 1,400. Assume country A is a small economy and when it opens up to trade, it takes the world price of $6 as the price of good X. Answer the following questions. (Note: derive numerical answers)
400 800 1400 2000 2400 Q
a. What is the amount of consumer surplus in autarky? What is the amount of producer surplus in autarky?
Consumer Surplus = Producer Surplus =
2 = 9800
2 = 9800
b. How much quantity of good X does country A import after it opens up to trade? What is the total value of the imports? (Note: value = price x quantity)
Import – QP(FT) – QSC(FT) = 2400-400 = 2000
c. What is the amount of consumer surplus in free trade? What is the amount of producer surplus in free trade?
Consumer Surplus Free Trade = Producer Surplus Free Trade =
2 = 28,800
2 = 800
d. How big is the (net) gain from trade?
ΔCS = CSFT – CSAutarky = 28,800 – 9,800 = 19,000
ΔPS = PSFT – PSA = 800-9,800 = -9,000
Net Gain= ΔCS + ΔPS = 19,000 – 9,000 = 10,000
e. Suppose that the government of country A bows to pressure from domestic producers of good X and levies a tariff on good X imports. The tariff raises the price of good X from $6 to $10. How much tariff revenue does the government collect?
Tax revenue = (2,000-800)(10-6) = 4,800
f. (Continuing from e.) How big is the deadweight loss from the tariff?
Deadweight loss = DW1 + DW2 =
4,000 x 4
400 x 4
2 = 800 + 800 = 16,000