Deck 9: Business Cycles, Unemployment, and Inflation

Question 1

Assume that the following data characterize a hypothetical economy: money supply = $200 billion; quantity of money demanded for transactions = $150 billion; quantity of money demanded as an asset = $10 billion at 12 percent interest, increasing by $10 billion for each 2 percentage point fall in the interest rate.
a. What is the equilibrium interest rate Explain.
b. At the equilibrium interest rate, what are the quantity of money supplied, the total quantity of money demanded, the amount of money demanded for transactions, and the amount of money demanded as an asset

Answer 1

It is difficult to determine the unemployment rate because of the presence of the part-time employed workers and discouraged workers. In the former case the problem arises due to the fact that the people who worked part-time as a result of their personal choice and those who wanted to work full-time, and could not find suitable full time work.
It is difficult to distinguish between frictional, structural, and cyclical employment because certain types are transitory in nature while others are associated with much longer spell of unemployment. So, workers may move from one type of unemployment to another type.
Unemployment is an economic problem because it leads to a loss of potential output, and its burden falls unequally on different groups. And due to unemployment the economy works below its production possibility curve.
A negative GDP gap results in a loss of output and higher rate of unemployment.
The noneconomic effects of unemployment are poverty, loss of self-respect, family disintegration, higher racial and ethnic tensions, and ultimately leading to sociopolitical unrest.

Question 2

KEY QUESTION Refer to the table below in answering the questions that follow:
a. If full employment in this economy is 130 million, will there be an inflationary expenditure gap or a recessionary expenditure gap What will be the consequence of this gap By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the inflationary expenditure gap or the recessionary expenditure gap Explain. What is the multiplier in this example
b. Will there be an inflationary expenditure gap or a recessionary expenditure gap if the full-employment level of output is $500 billion Explain the consequences. By how much would aggregate expenditures in column 3 have to change at each level of GDP to eliminate the gap What is the multiplier in this example
c. Assuming that investment, net exports, and government expenditures do not change with changes in real GDP, what are the sizes of the MPC, the MPS, and the multiplier

Answer 2

NO ANSWER

Question 3

GDP GAP AND EXPENDITURE GAP The St. Louis Federal Reserve Bank at www.research.stlouisfed.org/fred2 provides data on both real GDP (chained 2000 dollars) and real potential GDP for the United States. Both sets of data are located as links under "Gross Domestic Product and Components." What was potential GDP for the third quarter of 2001 What was the actual level of real GDP for that quarter What was the size difference between the two-the negative GDP gap If the multiplier was 2 in that period, what was the size of the economy's recessionary expenditure gap

Answer 3

The Consumer Price Index Summary was summarized on August 2011.
The CPI-U for the month of July is 225.922
The rate of Inflation (change in the CPI-U) for the month is 3.6
The inflation rate of the previous month i.e., June is 0.1
The commodities such as Fuel Oil and Gasoline (All types) had registered the greatest price increases
The commodities such as Utility (Piped) Gas Services and Energy services had registered the lowest price increase for the month

Question 4

ADVANCED ANALYSIS Assume that the consumption schedule for a private open economy is such that consumption C = 50 + 0.8 Y. Assume further that planned investment I g and net exports X n are independent of the level of real GDP and constant at I g = 30 and X n = 10. Recall also that, in equilibrium, the real output produced ( Y ) is equal to aggregate expenditures: Y = C + I g + X n.
a. Calculate the equilibrium level of income or real GDP for this economy.
b. What happens to equilibrium Y if I g changes to 10 What does this outcome reveal about the size of the multiplier

Question 5

The $490 billion level of real GDP is not at equilibrium because:

A) investment exceeds consumption.
B) consumption exceeds investment.
C) planned C + I g exceeds real GDP.
D) planned C + I g is less than real GDP.

Question 6

Answer the following questions, which relate to the aggregate expenditures model:
a. If C a is $100, I g is $50, X n is -$10, and G is $30, what is the economy's equilibrium GDP
b. If real GDP in an economy is currently $200, C a is $100, I g is $50, X n is -$10, and G is $30, will the economy's real GDP rise, fall, or stay the same
c. Suppose that full-employment (and full-capacity) output in an economy is $200. If C a is $150, I g is $50, X n is -$10, and G is $30, what will be the macroeconomic result

Question 7

The recessionary expenditure gap depicted will cause:

A) demand-pull inflation.
B) cost-push inflation.
C) cyclical unemployment.
D) frictional unemployment.

Question 8

LAST WORD What is Say's law How does it relate to the view held by classical economists that the economy generally will operate at a position on its production possibilities curve (Chapter 1) Use production possibilities analysis to demonstrate Keynes' view on this matter.

Question 9

Suppose a bond with no expiration date has a face value of $10,000 and annually pays a fixed amount on interest of $800. Compute and enter in the spaces provided either the interest rate that the bond would yield to a bond buyer at each of the bond prices listed or the bond price at each of the interest yields shown. What generalization can be drawn from the completed table

Question 10

The $430 billion level of real GDP is not at equilibrium because:

A) investment exceeds consumption.
B) consumption exceeds investment.
C) planned C + I g exceeds real GDP.
D) planned C + I g is less than real GDP.

Question 11

In the economy depicted, the $5 billion inflationary expenditure gap:

A) expands real GDP to $530 billion.
B) leaves real GDP at $510 billion but causes inflation.
C) could be remedied by equal $5 billion increases in taxes and government spending.
D) implies that real GDP exceeds nominal GDP.

Question 12

Why is saving called a leakage Why is planned investment called an injection Why must saving equal planned investment at equilibrium GDP in the private closed economy Are unplanned changes in inventories rising, falling, or constant at equilibrium GDP Explain.

Question 13

In the table below you will find consolidated balance sheets for the commercial banking system and the 12 Federal Reserve Banks. Use columns 1 through 3 to indicate how the balance sheets would read after each of transactions a to c is completed. Do not cumulate your answers; that is, analyze each transaction separately, starting in each case from the figures provided. All accounts are in billions of dollars.



a. A decline in the discount rate prompts commercial banks to borrow an additional $1 billion from the Federal Reserve Banks. Show the new balance-sheet figures in column 1 of each table.
b. The Federal Reserve Banks sell $3 billion in securities to members of the public, who pay for the bonds with checks. Show the new balance-sheet figures in column 2 of each table.
c. The Federal Reserve Banks buy $2 billion of securities from commercial banks. Show the new balance sheet figures in column 3 of each table.
d. Now review each of the above three transactions, asking yourself these three questions: (1) What change, if any, took place in the money supply as a direct and immediate result of each transaction (2) What increase or decrease in commercial banks' reserves took place in each transaction (3) Assuming a reserve ratio of 20 percent, what change in the money creating potential of the commercial banking system occurred as a result of each transaction

Question 14

By how much will GDP change if firms increase their investment by $8 billion and the MPC is.80 If the MPC is.67

Question 15

In this figure, the slope of the aggregate expenditures schedule C + I g :

A) increases as real GDP increases.
B) falls as real GDP increases.
C) is constant and equals the MPC.
D) is constant and equals the MPS.

Question 16

Depict graphically the aggregate expenditures model for a private closed economy. Now show a decrease in the aggregate expenditures schedule and explain why the decline in real GDP in your diagram is greater than the initial decline in aggregate expenditures. What would be the ratio of a decline in real GDP to the initial drop in aggregate expenditures if the slope of your aggregate expenditures schedule was.8

Question 17

In the economy depicted:

A) the MPS is.50.
B) the MPC is.75.
C) the full-employment level of real GDP is $530 billion.
D) nominal GDP always equals real GDP.

Question 18

Suppose that you are a member of the Board of Governors of the Federal Reserve System. The economy is experiencing a sharp rise in the inflation rate. What change in the Federal funds rate would you recommend How would your recommended change get accomplished What impact would the actions have on the lending ability of the banking system, the real interest rate, investment spending, aggregate demand, and inflation

Question 19

What is the basic determinant of (a) the transactions demand and (b) the asset demand for money Explain how these two demands can be combined graphically to determine total money demand. How is the equilibrium interest rate in the money market determined Use a graph to show the impact of an increase in the total demand for money on the equilibrium interest rate (no change in money supply). Use you general knowledge of equilibrium prices to explain why the previous interest rate is no longer sustainable.

Question 20

KEY QUESTION The data in columns 1 and 2 in the accompanying table are for a private closed economy:
a. Use columns 1 and 2 to determine the equilibrium GDP for this hypothetical economy.
b. Now open up this economy to international trade by including the export and import figures of columns 3

and 4. Fill in columns 5 and 6 and determine the equilibrium GDP for the open economy. Explain why this equilibrium GDP differs from that of the closed economy.
c. Given the original $20 billion level of exports, what would be net exports and the equilibrium GDP if imports were $10 billion greater at each level of GDP
d. What is the multiplier in this example

Question 21

THE MULTIPLIER-CALCULATING HYPOTHETICAL CHANGES IN GDP Go to the Bureau of Economic Analysis at www.bea.gov , and use the BEA interactivity feature to select National Income and Product Account Tables. Then find Table 1.1, which contains the most recent values for GDP = C a + I g + G + ( X - M ). Assume that the MPC is.75 and that, for each of the following, the values of the initial variables are those you just discovered. Determine the new value of GDP if, other things equal, ( a ) investment increased by 5 percent, ( b ) imports increased by 5 percent while exports increased by 5 percent, ( c ) consumption increased by 5 percent, and ( d ) government spending increased by 5 percent. Which of the changes, ( a ) through ( d ), caused the greatest change in GDP in absolute dollars

Question 22

Assume that, without taxes, the consumption schedule of an economy is as follows:

a. Graph this consumption schedule and determine the MPC.
b. Assume now that a lump-sum tax is imposed such that the government collects $10 billion in taxes at all levels of GDP. Graph the resulting consumption schedule, and compare the MPC and the multiplier with those of the pretax consumption schedule.

Question 23

At all points on the 45° line:

A) equilibrium GDP is possible.
B) aggregate expenditures exceed real GDP.
C) consumption exceeds investment.
D) aggregate expenditures are less than real GDP.

Question 24

Explain graphically the determination of equilibrium GDP for a private economy through the aggregate expenditures model. Now add government purchases (any amount you choose) to your graph, showing its impact on equilibrium GDP. Finally, add taxation (any amount of lump-sum tax that you choose) to your graph and show its effect on equilibrium GDP. Looking at your graph, determine whether equilibrium GDP has increased, decreased, or stayed the same given the sizes of the government purchases and taxes that you selected.

Question 25

The inflationary expenditure gap depicted will cause:

A) demand-pull inflation.
B) cost-push inflation.
C) cyclical unemployment.
D) frictional unemployment.

Question 26

KEY QUESTION Refer to columns 1 and 6 in the table for question 9. Incorporate government into the table by assuming that it plans to tax and spend $20 billion at each possible level of GDP. Also assume that the tax is a personal tax and that government spending does not induce a shift in the private aggregate expenditures schedule. Compute and explain the change in equilibrium GDP caused by the addition of government.