Questions about course content for Econ 102, Section 100, Winter 2007: Apr 19 > I have a question about #17 on the practice final from 2006. The > question reads: > "according to the AS-AD model from class, and assuming that investment > depends only on the real interest rate, what will happen to investment if > the government reduces income taxes while holding government expenditure > constant?" > > I drew this graph as AD shifting to the right because consumption with > increase due to lower taxes. In the short run therefore, P and Y would > increase while in the long run P would increase but Y would return tot he > original. I thought this indicated that investment would rise in the > short run but return to normal level in the long run. However, the > answer is fall in the short run and remain below its initial level in the > LR. This is the crowding out effect that we saw in both the short run and the long run. In the short run, the rise in P and Y raises demand for money. With fixed money supply, this pushes up the interest rate and lowers investment. In the long run, we saw in the Loanable Funds model that a tax cut reduces saving and pushes up the interest rate, reducing investment. Or you can get the same thing in the AS-AD model, where in the long run P rises with unchanged Y, so again demand for money rises, raising r and lowering I below what it was initially. Apr 19 > My question is on number 29 of the 2004 exam. I understand, using > Mankiw's open economy model, that the US trade deficit will increase. > But if you use the ASAD model for the long run, G>0 leads to AD>0. In > the long run, SRAS brings the equilibrium back to the original level of > output with a higher permanent price level. Doesn't the increase in P > cause the US dollar to depreciate, assuming that PPP holds? Why don't > the two models agree? Is the ASAD model inappropriate in this case? Since PPP is assumed to hold, net exports do NOT depend on the real exchange rate and the NX curve in the open-economy model is horizontal. That still gives the result you say, that NX decreases when NCO decreases due to the rise in the interest rate. In the ASAD model in the long run, the rise in the price level also gives a rise in the interest rate and thus a fall in NCO, which must equal NX in equilibrium, so again, NX falls. There's no disagreement that I can see. > Also, on question 30, why is it better to buy bonds than to take out a > mortgage? Isn't inflation good for debtors because it means they have to > pay less back? We were looking at the implications of the money supply increase in the short run, as I think is implicit in the choice between doing things before and after the policy. The monetary expansion causes the interest rate to fall, which means that the prices of bonds go up. Buy buying the bonds before this happens, you benefit from capital gains. Buy them after and you are buying them after their price has already risen. Apr 19 > I am a bit confused about expected inflation. In the homework, problem > 3, I calculated the inflation to be 2% in 2004. Does this mean that in > 2003, the expected inflation is 2% even though the actual inflation is > 0%? No, since we started in a long-run equilibrium at the natural rate of unemployment, the expected rate of inflation was the initial actual rate of inflation, zero. > Also, I justed wanted to clarify movements of the Short Run Phillips > Curve. Movement along the curve occurs when expected inflation starts > rising but actual inflation stays low. The curve shifts entirely to the > right when both expected and actual inflation are high? Movement along the short-run Philips curve happens whenever Y and therefore u changes (which happens when equilibrium Y changes in the AD-AS diagram). The curve shifts whenever the expected rate of inflation changes. Apr 19 > I was looking at the Winter 2005 practice exam and I had a couple of > questions. > > 27) You are told that the labor market equilibrium wage is currently > above the minimum wage. Everything else being equal, the long-run > aggregate supply curve would shift right if the government were now to > a) Increase the minimum wage by law b) Decrease the minimum wage by law > c) Make unemployment benefits more generous d) Raise taxes on investment > spending e) None of the above > > I believed it was B due to my understanding of what shifts the LRAS curve > (i.e. anything that changes the production function Y=A F(K,L,N,H).) A > decrease in the minimum wage would be the opposite of an increase causing > unemployment to fall. With less people unemployed, more people are at > work, the 'L' in the production function is increased so the LRAS curve > should shift out. This isn't the case, however, E is the correct answer. > Could you help me figure out why? A decrease in the minimum wage has no effect if the wage is above the minimum, as it is here. This minimum wage is not binding. > Also, I was confused by number 8 > > 8. Assume the all US citizens are required to take Introduction to > Macroeconomics in high school. As a result, they can perfectly predict > short run and long run outcomes of fiscal policy. Consequently, future > expansionary fiscal policy would lead to ________ short-run increases in > real output and _________ increases in short-run price levels. a) Larger, > larger b) Larger, smaller c) Smaller, larger d) Smaller, smaller e) > Larger, no > > I have no idea why the answer is C. The upward sloping SRAS curve is a result of various stickinesses and misperceptions that we discussed when we introduced the curve. If people do not have these misperceptions, then a rise in the price will be associated with a smaller increase in output -- i.e., the SRAS curve will be closer to vertical. And that is what leads to the smaller increase in Y and the larger increase in P. Apr 18 > 1. Who regulates the FED, and do we need to know that? I know it's not > the President or Congress. The simple answer is that nobody regulates the Fed. It is an independent agency. And yes, you should know that. A more complete answer is that the governors of the Fed (the people who run it) are appointed by the President and confirmed by the Congress (the Senate, I think, though I'm not sure). But once they are appointed, they are explicitly free to do whatever they think is best for the economy. They do frequently report to Congress about the state of the economy and what they are doing, and Congress can certainly try to persuade them to change their policies, but they do not have to do it. And neither Congress nor the President can fire them; if they don't like what they are doing, they have to wait for their terms to expire. (On the other hand, it was Congress itself that created this system, so perhaps if the Fed behaved sufficiently badly, Congress could in fact change the system.) > > 2. Does any change in taxes, tax cut or increase, shift the SLF curve > left? Yes, for sure. A tax cut reduces government revenues and therefore government saving by the full amount of the tax cut, while it increases private savings by a fraction of the tax cut (the rest going to consumption). So a tax cut reduces national saving, shifting the SLF curve to the left. Apr 17 > I have a question about question 21 in the Winter 2006 practice final > exam. > > Question 21 asks "Which of the following would shift the AD curve to the > left?" > > The correct answer in the answer key is e) "A rise in the reserve > requirement." > > My questions is could it be that answer a) "A fall in saving" is the > correct answer too? Isn't it so that when saving decreases, investment > decrease as well, and if investment decreases, since it is a part of the > AD curve the AD curve would shift to the left. No, you are using the loanable funds market to determine the interest rate and therefore investment, and that doesn't apply in the short run, when the interest rate is determined in the money market instead. What happens instead is that a fall in saving means a rise in consumption, which is what shifts the AD curve to the right. At a given P and Y, demand for money is unchanged and therefore so is the interest rate, but as P and Y rise, demand for money rises, and this causes the interest rate to rise, not fall, and therefore investment actually falls in the short run. (This doesn't shift the AD curve left, though, but is part of the story (the crowding-out effect) that determines how far the AD curve shifts to the right when consumption increases.) Apr 17 > My first question regards the models we should use when answering any > question on the final this week: If a question contains nothing to > indicate that it's asking about an open economy, can we assume a closed > economy? Hopefully, if we don't specify, the answer will be the same whichever you choose. But if that's not the case, then you should assume an open economy, since that is the more normal case (there are hardly any closed economies in the world today). The AD-AS model, for example, is of an open economy, since one of the reasons given for the slope of the AD curve is an exchange- rate effect. Apr 17 > I have > written in my notes two seemingly contradictory notions. In one place I > have written that the only way to effect the LR growth rate of GDP is by > increasing technology, A. In another place I have written that only I, > by increasing the capital stock, K, can increase Y. I'm confused about > which one plays the predominate role in determining growth, or if both of > them do so equally. Any help would be much appreciated. It is true that the only way we know of to increase the long run rate of growth of GDP -- that is, to increase it forever -- is to increase the rate of growth of technology, A. That's because all of the other sources of growth, which enter as arguments inside the production function, are subject to the Law of Diminishing Returns. So by increasing investment you can indeed increase GDP, but as the capital stock increases the extra output that you get diminishes and you don't therefore get a permanent increase in the rate of growth. The same holds for increases in human capital and natural resources. However, even though that does not increase the rate of growth in the long run, it does increase the level of GDP in the long run. So it is true that by increasing I you can increase Y in the long run. That is not the only way of doing that, though. Spending more on education, for example, will increase human capital, and this too increases Y. And so does a one-time improvement in technology. So there are lots of ways of increasing the long- run level of GDP, but only one way to increase the long-run rate of growth of GDP. Apr 5 > Could you please clarify question 2.d. on homework 8: my interpretation > of this question is that it deals with an individual firm and their > relative price, not the expected price level in the economy, is this > correct? And therefore, the changes could not be represented in the > AS/AD model? No, we had in mind that all firms experience this change in expectations, although they apparently don't know that others are doing the same thing. Mar 17 > In form 1, question number 10 says: Which of the following is NOT a > function of money? a) Medium of exchange. b) Unit of account. c) > Liquidity. d) Store of value. e) They are all functions of money. > It says the answer is liquidity but in the book under the functions of > money, liquidity is there as a function. Is this wrong on the test? The term is defined in the section on the functions of money, but it is not listed as one of the three functions of money. Those are given in the first sentence of that section, on page 226, and also were listed by me in lecture. Mar 16 > I have a problem involving one of the questions on the exam we just took. > My question is about number 19, involving the raising of the minimum wage > and its effects. The correct answer is arguably B. However, I think this > is flawed because B would hold true only if the former minimum wage level > was at or above the labor market equilibrium, where the supply and demand > of workers was equal. A raise of the minimum wage that was previously at > or above equilibrium would certainly cause the wage level to increase as > well as unemployment. However, it is unclear as to what exactly the > minimum wage level was before the raise. Perhaps it was below the > equilibrium. The question is unclear. If this was true, the increase in > minimum wage could actually raise employment and lower unemployment, > bringing the labor market closer to equilibrium. Since the question is > unclear as to where the minimum wage level was before the shift, the > effect the unemployment rate is then uncertain (this is the reason why I > chose C over B). The wage level change is uncertain as well because if > the minimum wage was below equilibrium, workers may have been paid more > than the minimum wage anyways. The raise could also increase the wage > level. Either way, I feel the question is too vague to be confident that > the wage level and unemployment rate will certainly increase (and for > answer B to hold true). This is precisely why we included the phrase "to a level above what some workers are paid." That assures that, whatever the old minimum wage, the new one both raises the wage and increases unemployment. (Had the old minimum been below the market-clearing wage, then raising it to the market- clearing wage would not have "raised employment and reduced unemployment," since the lower minimum would not have been paid.) Mar 15 > For question #1 on the W05 exam, it seems to me that B should not be > true. If I=S(priv)+S(gov), and if S(gov)<0, then shouldn't I Also, for part c or short answer #2, I realize that Nx increases, but how > do you know that imports must fall? Depending on the performance of > exports, imports can potentially rise and fall. Or must imports always > fall in response to depreciation of the dollar (or whichever currency)? Yes, unless something happens to change exports and/or imports for a given real exchange rate, thus shifting the NX curve (which doesn't happen here), a depreciation of the currency causes exports to rise (because they're cheaper) and imports to fall (because they're more expensive). Indeed, that is why the NX curve slopes the way it does. Mar 15 > 1) winter04-q8: an american chooses to buy a maserati(italian car) > instead of the american chevvy camaro. What impact will tht cause? > > my answer: italy's exports and GDP increase; US imports increase, but US > GDP falls. > correct answer: none of the above, which excludes my answer. > > why is that? shouldn't a purchase of an italian car decrease us gdp and > increase italian gdp? I don't much like this question, but I think the point is that GDP depends on the production function, and nothing has changed in that. If he buys the Italian car instead of the American car, US car inventory will be one higher and Italian car inventory will be one lower, so investment in each country will change to offset the other changes. > 2)winter05-q22: a higher than expected inflation rate would cause: > a)a U of M student who borrowed his tuition with a fixed interest rate of > 4% > b)a retiree whose sole asset is a house in Ypsilanti > c)a professor who invested in his small salary in a 4-year AAA corporate > bonds in september '04 > d)a gsi who has no savings account at all > > my answer: (a) > correct answer: (c) > > but why? how large is the impact on (c) as compared to others? how minor > are the impacts of (a),(b) and (d) The UM student is actually better off, since he pays back his loan with dollars that are worth less. The retiree is presumably unaffected, since the value of the house rises with the rate of inflation. The GSI with no savings is also unaffected, since he has no assets or liabilities whose values may change. But the professor who bought bonds now finds them worth less, in real terms, so he loses. Mar 15 > Hi Professor Deardoff. I am in your Econ 102 class and I had a question > about the reading. In chapter 12 on pg 262 and 263 Mankiw talked about > Inflation-Induced Tax Disortions. He says that taxes on capital gains are > exagerated because it taxes the nominal interest rather than the real > interest. I don't really understand how this is different from taxing the > rest of your income. They tax your nominal salaray and not your real > salary right? > > For instance, in the example in the book they say that you buy stock for > $10 in 1980 and in 2005 you sell is for $50. Well, if you have sold it > for $50 this does account for the change in the price level, because with > the higher price level whoever bought it from you was probably willing to > pay more for it. This is just like the rest of your income, like your > salary. Just like the company you work for pays you more, the stock you > sold sells for more. > > I'm not sure if how I am phrasing this makes sense but basically, I don't > really understand why capital gains shouldn't be taxed like the rest of > your income. Suppose that your income comes entirely from a wage that rises at the rate of inflation, and that the government taxes it at 20%. Then your real wage is constant, and the tax you pay is also constant independent of the rate of inflation, just 20% of your real wage. But now suppose that in addition to your wage, you have an asset that, to keep it simple, pays you no income at all. But the price of the asset makes it worth, let's say, exactly the same as your wage, and that price, like the wage, also rises over time at the rate of inflation. If the rate of inflation were zero, then you'd pay no tax on that asset, since its price wouldn't rise and there would be no capital gains, so you'd still just pay tax equal to 20% of your wage. But suppose the rate of inflation is 10%. Then you have capital gains of 10% of the price of the asset, thus 10% of your wage, and you pay a tax of 20% of that 10%, thus an additional 2% of your wage. So your total tax rises from 20% of your wage to 22% of your wage. That's what he means. Mar 14 > On the W06 exam, question 6, the question states: "Suppose that the > original total value of stone wheels (used as money) on the Island of Yap > is 1000 fei." For the question to work out, it seems we have to interpret > the 1000 fei as the bank's reserves. Why is the 1000 fei interpreted as > reserves? Because "no stone wheels are held in the hands of islanders." So all are deposited in the bank, becoming reserves. Mar 13 > On the old exams it appears that the answer to the question of whether or > not the Bureau of Labor Statistics ever double counts someone is no. > However, I thought that in one of the assigned readings it said under > certain circumstances they did double count one person as employed. I don't think so. If that's in one of the readings, I hope you can tell me where, because I'm not aware of it. Mar 13 > As I'm going back over my notes I'm noticing some inconsistency with the > letter Y being used to represent GDP. At first, in the equation > Y=C+I+G+NX I assumed the Y represented nominal GDP. Later, in the > production function Y=AF(L,K,H,N) we used Y as the quantity of output or > real GDP. Also in today's lecture you at one point used Y to represent > real GDP. Can it be used for either? If not, which measure should we > assume when we see "Y"? You should always interpret Y as real GDP. That is true also in the equation Y=C+I+G+NX, where C is real consumption, I is real investment, etc. When you first saw that equation, we had not made the distinction between real and nominal, so it is understandable that you interpreted it as being nominal. But in our models, it is real. Mar 13 > This question (21 from W06) addresses the British govt's perpetuity and then exchanging > it for what an American would have to pay in US dollars for one. > It pays 90 pounds interest/yr and exchange rate is $1=0.5 pounds with > nominal interst rate in UK being 3% . > The correct answer is $6000, but I have not a clue how to arrive at that. Since the bond pays the same amount every year forever, its present value is just the interest payment divided by the interest rate: 90/.03 = 3000 pounds. (That is, if you buy the bond for 3000, year earn interest on that of 3% of 3000, or 90 pounds, every year thereafter.) At the exchange rate of $1= 0.5 pounds, or $2 per pound, this 3000 pounds costs $6000. Mar 13 > The Question asks: > Which of the following statements about the functions of the Federal > Reserve is INCORRECT? > a)The Fed can increase money supply by purchasing govt bonds. > b)The Fed can increase money supply be decreasing the reserve requirement. > c)The Fed can increase money supply by decreasing the discount rate. > d)The Fed can increase money supply by decreasing the reserve holdings of > the commerical banks. > e)The Fed can increase money supply by decreasing the interest rate on > the loans that the Fed makes to banks. > > I know that the correct answer is d. But, I don't understand why > decreasing the reserve requirement does not have the same effect as > decreasing the reserve holdings of the commercial banks. > Am I just missing something here? Yes, you are. If the Fed decreases the reserve holdings of commercial banks without changing the amount of reserves that they are required to hold, then they find themselves with a shortage of reserves and have to reduce deposits in order to achieve the requirement. But if the Fed decreases the reserve requirement while keeping reserves unchanged, the banks then find themselves with more reserves than they need (excess reserves) and will behave in the opposite way. Mar 12 > Question 10 on the final exam from 2005 discusses the topic of expected > net present value. Is this topic going to appear on the midterm? I don't > believe that we have discussed it in class..... I believe that you should be able to answer this question from what was covered in Chapter 9. Mar 8 > I have a question about the NCO/Nx handout from last lecture. Under the > Nx section, the second half of the list, I disagree with this: "If the > real exchange rate decreases, then the Nx will decrease (movement left > along the curve)." If the real exchange rate decreases, wouldn't the Nx > increase (movement right along the curve)? The handout does not make the statement that you quote. What I read it (and wrote it) as saying is that NX depends negatively on the real exchange rate. To me that means that if the real exchange rate rises (appreciates), NX will fall. It is not clear to me why you though it was talking about a decrease, not an increase, in the variables listed. > Also, the handout is pretty confusing. It is never clearly stated if > each one of the points listed are being increased or decreased. Evidently it is confusing, since you were confused. I guess I thought that saying that something depends positively, or negatively, on something else was pretty clear. If you have a suggestion for revising the handout, let me know. Feb 28 > I have a question about Homework 5, question 6, part (a). The question > is to calculate the velocity of money. > The answer key says V = 9. Shouldn't the answer be 900? > > V = (P*Y)/M, therefore V = (100*9000)/1000 = 900 > > The point of confusion I think is P = 100, not P=1, since the 1 must be > multiplied by 100 to be the GDP deflator. Multiplying by 100 in a price index is just for the convenience of reporting it and using it. P*Y is just nominal GDP. Feb 18 > I have a concern with the money multiplier handout. > > With my calculations, your amount for loans for 6a and 6b is off (you put > 301, but I think it should be 267 [234+33=267]). Also, for 4a and 4b, > you put 193 but I think it should be 195. You are quite right. It appears that in 4a I switched to adding the new "Gold" number to the loans instead of adding the new loan. I've now corrected it and posted a new version online. Thank you for catching this. I've been using this handout for quite a few years without anybody telling me about the error. Feb 8 > I have a question on the short answer #1 of the 2006 exam. I don't > understand why the coconuts consumed by Robinson in the first year are > included in consumption with dollar values. Robinson consumes something > he produced himself. In analogy, if a U.S. citizen grows vegetables in > her backyard and consumes them instead of selling them, does that > contribute to the consumption (and gdp) as well? If so, why don't a > housewife's services in the house contribute to gdp? If she worked > outside the house, she'd earn an income. The household is paying for her > to stay at home by sacrificing her income, just like Robinson is paying > for his coconuts by sacrificing the profit that the coconuts would have > brought him. Yes, your question makes sense. And as I recall, we had some difficulty defending our answer to this one. You are quite right that vegetables grown and consumed at home do not get included in GDP. Of course, by that convention, if Robinson Crusoe did not trade with the other island, none of his consumption would be measured or count in GDP. We interpreted the question, and so did most students, as not following that convention of excluding household production from GDP in this one-person economy. Feb 7 > I was hoping you could answer a question I have on question 12 of the > 2006 exam. I understand why the answer would include imports rising by > 20300, but why does investment rise by the same amount? the extra 300 > was spent getting help from a software engineer, and since investment > only includes physical capital used for future production, I don't > understand why the 300 should count as investment. As I recall, we got a lot of disagreement with our answer to that question, perhaps for the reason that you state. We regarded the instructions for using the software as part of the cost of getting it to work, and therefore part of the investment. I can see that it was not "physical," but the costs of physical capital must include the costs of installing and getting it to work. > Also, the correct > answer D doesn't include the effects of this transaction on the US GDP > (which I assume would rise by 20300 in exports...), hence it's not > complete. On the exam, will there be incomplete correct answers that > have correct components of a complete answer? Yes, a multiple choice question might certainly ask about just parts of a problem. If the question had stated, "which of the following includes all of the effects of these transactions on every country in the world," then of course answer D would not be correct. Feb 5 > I had a question about one of the questions you posted on the > WSJ article on Housing and Inflation. > > The question was: Four different measures are reported and graphed in > this article, > two variants of one thing and two variants of another. What are they, > what do they > mean, and how do the variants differ from each other? > > I don't know how to solve this problem, so if you could explain it, that > would be great. It's not really a problem to "solve." I'm just asking you to read the graphs, see what they display, and then describe the difference. Unfortunately, the graphs don't appear online as they did in the paper version of the newspaper. That had two graphs, one that contained both the CPI and the Core CPI, the other that contained both Total Housing Starts and Single Family Housing starts. The article says a bit more about each of these. Jan 29 > I had trouble understanding an important sentence from the assigned > article "Uptick in Inflation, Home Starts Seen as Aberration." > > "...in line with economists' expectations, as apparel retailers ratcheted > back holiday discounts." > > Does "ratcheted back" holiday discounts mean stores increased the prices > after the holidays, or that the holiday discounts this year were not as > low as previous years? I don't really know what they mean. I interpreted it as saying that they made the holiday discounts smaller (and thus prices higher) than they had been earlier in the holiday season, but still during the holidays. But I'm not at all sure. Jan 27 > In the case of diminishing returns for the production function, will > there always be at least one factor of production that will remain > constant? The Law of Diminishing Returns does not mean that one factor actually WILL remain constant. It simply says that IF the quantity of one factor remains constant while the quantities of one or more other factors increase, output will rise at a diminishing rate. Jan 22 > I was reading chapter 4 to prepare for tomorrow’s lecture, but one thing > puzzles me. Does the growth in GDP result in an increase of income in the > short-run? Growth of GDP is, by definition, an increase in income. So I guess the answer is yes. However, what the growth chapter is about (and it's chapter 7, not chapter 4) is really the growth in the potential GDP -- that is, the economy's capacity to produce, whether or not it actually uses that capacity. In the long run, it does use it, and that is what the chapter is about. Later in the course we will look at the short run, in which we will see that the economy doesn't always produce at its capacity, and therefore in the short run growth of potential GDP doesn't necessarily mean growth of actual income. Jan 13 > I have a few short question concerning the homework. > > 1) Would you consider shares on the stock market goods and services? No, not at all. > 2)If consumers do not purchase a certain good, should it be included in > the fixed basket of goods and services used in calculating the CPI? We haven't yet talked about the CPI basket. It is a selection of goods and services that are picked because they are representative of what consumers buy. The textbook explains this a bit more. > 3)If you are trying to compare well-being of middle class citizens over a > span of several years, are you trying to compare ther incomes in terms of > dollars of a certain year (converting nominal income to real income)? In > other words, does a larger income result in a higher well-being? A larger real income is taken to represent a higher well being, yes.