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Questions and Answers of Economics

Three students have each saved $1,000. Each has an investment opportunity in which he or she can invest up to $2,000. Here are the rates of return on the students’ investment projects:
Suppose the government borrows $20 billion more next year than this year.a. Use a supply-and-demand diagram to analyze this policy. Does the interest rate rise or fall?b. What happens to investment?
In the summer of 2010, Congress passed a farreaching financial reform to prevent another financial crisis like the one experienced in 2008–2009. Consider the following possibilities:a. Suppose
This chapter explains that investment can be increased both by reducing taxes on private saving and by reducing the government budget deficit.a. Why is it difficult to implement both of these
Describe three ways that a risk-averse person might reduce the risk he faces.
Fortune magazine regularly publishes a list of the “most respected” companies. According to the efficient markets hypothesis, if you restrict your stock portfolio to these companies, will you
The interest rate is 7 percent. Use the concept of present value to compare $200 to be received in 10 years and $300 to be received in 20 years.
What benefit do people get from the market for insurance? What two problems impede the insurance company from working perfectly?
What is diversification? Does a stockholder get more diversification going from 1 to 10 stocks or going from 100 to 120 stocks?
Comparing stocks and government bonds, which has more risk? Which pays a higher average return?
Describe the efficient markets hypothesis and give a piece of evidence consistent with this hypothesis.
Explain the view of those economists who are skeptical of the efficient markets hypothesis.
A company has an investment project that would cost $10 million today and yield a payoff of $15 million in 4 years. a. Should the firm undertake the project if the interest rate is 11 percent 10
Bond A pays $8,000 in 20 years. Bond B pays $8,000 in 40 years. (To keep things simple, assume these are zero-coupon bonds, which means the $8,000 is the only payment the bond holder receives.)a. If
Your bank account pays an interest rate of 8 percent. You are considering buying a share of stock in XYZ Corporation for $110. After 1, 2, and 3 years, it will pay a dividend of $5. You expect to
For each of the following kinds of insurance, give an example of behavior that can be called moral hazard and another example of behavior that can be called adverse selection.a. Health insuranceb.
Which kind of stock would you expect to pay the higher average return: stock in an industry that is very sensitive to economic conditions (such as an automaker) or stock in an industry that is
You have two roommates who invest in the stock market. a. One roommate says that he buys stock only in companies that everyone believes will experience big increases in profits in the future. How do
When company executives buy and sell stock based on private information they obtain as part of their jobs, they are engaged in insider trading. a. Give an example of inside information that might be
Jamal has a utility function U = W1/2, where W is his wealth in millions of dollars (which determines how much he gets to buy and consume over his lifetime) and U is the utility he obtains.a. Graph
How is the unemployment rate measured? How might the unemployment rate overstate the amount of joblessness? How might it understate the amount of joblessness?
How would an increase in the world price of oil affect the amount of frictional unemployment? Is this unemployment undesirable? What public policies might affect the amount of unemployment caused by
Draw the supply curve and the demand curve for a labor market in which the wage is fixed above the equilibrium level. Show the quantity of labor supplied, the quantity demanded, and the amount of
How does a union in the auto industry affect wages and employment at General Motors and Ford? How does it affect wages and employment in other industries?
Give four explanations for why firms might find it profitable to pay wages above the level that balances quantity of labor supplied and quantity of labor demanded.
What are the three categories into which the Bureau of Labor Statistics divides everyone? How does the BLS compute the labor force, the unemployment rate, and the labor-force participation rate?
Is unemployment typically short term or long term? Explain.
Why is frictional unemployment inevitable? How might the government reduce the amount of frictional unemployment?
Are minimum-wage laws a better explanation for structural unemployment among teenagers or among college graduates? Why?
How do unions affect the natural rate of unemployment?
What claims do advocates of unions make to argue that unions are good for the economy?
Explain four ways in which a firm might increase its profits by raising the wages it pays.
The Bureau of Labor Statistics announced that in April 2010, of all adult Americans, 139,455,000 were employed, 15,260,000 were unemployed, and 82,614,000 were not in the labor force. Use this
Between 2004 and 2007, total U.S. employment increased by 6.8 million workers, but the number of unemployed workers declined by only 1.1 million. How are these numbers consistent with each other? Why
Economists use labor-market data to evaluate how well an economy is using its most valuable resource—its people. Two closely watched statistics are the unemployment rate and the
Are the following workers more likely to experience short-term or long-term unemployment? Explain.a. A construction worker laid off because of bad weather.b. A manufacturing worker who loses her job
Using a diagram of the labor market, show the effect of an increase in the minimum wage on the wage paid to workers, the number of workers supplied, the number of workers demanded, and the amount of
Consider an economy with two labor markets—one for manufacturing workers and one for service workers. Suppose initially that neither is unionized.a. If manufacturing workers formed a union, what
Structural unemployment is sometimes said to result from a mismatch between the job skills that employers want and the job skills that workers have. To explore this idea, consider an economy with two
Suppose that Congress passes a law requiring employers to provide employees some benefit (such as healthcare) that raises the cost of an employee by $4 per hour.a. What effect does this employer
List and describe the three functions of money.
What are the primary responsibilities of the Federal Reserve? If the Fed wants to increase the supply of money, how does it usually do so?
Describe how banks create money. If the Fed wanted to use all three of its policy tools to decrease the money supply, what would it do?
What is commodity money? What is fiat money? Which kind do we use?
What are demand deposits and why should they be included in the stock of money?
Who is responsible for setting monetary policy in the United States? How is this group chosen?
If the Fed wants to increase the money supply with open-market operations, what does it do?
Why don’t banks hold 100 percent reserves? How is the amount of reserves banks hold related to the amount of money the banking system creates?
Bank A has a leverage ratio of 10, while Bank B has a leverage ratio of 20. Similar losses on bank loans at the two banks cause the value of their assets to fall by 7 percent. Which bank shows a
What is the discount rate? What happens to the money supply when the Fed raises the discount rate?
What are reserve requirements? What happens to the money supply when the Fed raises reserve requirements?
Why can’t the Fed control the money supply perfectly?
Which of the following are money in the U.S. economy? Which are not? Explain your answers by discussing each of the three functions of money.a. A U.S. pennyb. A Mexican pesoc. A Picasso paintingd. A
Your uncle repays a $100 loan from Tenth National Bank (TNB) by writing a $100 check from his TNB checking account. Use T-accounts to show the effect of this transaction on your uncle and on TNB. Has
Beleaguered State Bank (BSB) holds $250 million in deposits and maintains a reserve ratio of 10 percent.a. Show a T-account for BSB.b. Now suppose that BSB’s largest depositor withdraws $10 million
You take $100 you had kept under your mattress and deposit it in your bank account. If this $100 stays in the banking system as reserves and if banks hold reserves equal to 10 percent of deposits, by
Happy Bank starts with $200 in bank capital. It then takes in $800 in deposits. It keeps 12.5 percent (1/8th) of deposits in reserve. It uses the rest of its assets to make bank loans.a. Show the
The Federal Reserve conducts a $10 million open-market purchase of government bonds. If the required reserve ratio is 10 percent, what is the largest possible increase in the money supply that could
Assume that the reserve requirement is 5 percent. All other things equal, will the money supply expand more if the Federal Reserve buys $2,000 worth of bonds or if someone deposits in a bank $2,000
Suppose that the T-account for First National Bank is as follows:a. If the Fed requires banks to hold 5 percent of deposits as reserves, how much in excess reserves does First National now hold?b.
Suppose that the reserve requirement for checking deposits is 10 percent and that banks do not hold any excess reserves.a. If the Fed sells $1 million of government bonds, what is the effect on the
Assume that the banking system has total reserves of $100 billion. Assume also that required reserves are 10 percent of checking deposits and that banks hold no excess reserves and households hold no
Assume that the reserve requirement is 20 percent. Also assume that banks do not hold excess reserves and there is no cash held by the public. The Federal Reserve decides that it wants to expand the
The economy of Elmendyn contains 2,000 $1 bills.a. If people hold all money as currency, what is the quantity of money?b. If people hold all money as demand deposits and banks maintain 100 percent
The government of a country increases the growth rate of the money supply from 5 percent per year to 50 percent per year. What happens to prices? What happens to nominal interest rates? Why might the
List and describe six costs of inflation.
According to the quantity theory of money, what is the effect of an increase in the quantity of money?
Explain the difference between nominal and real variables and give two examples of each. According to the principle of monetary neutrality, which variables are affected by changes in the quantity of
What are the costs of inflation? Which of these costs do you think are most important for the U.S. economy?
Suppose that this year’s money supply is $500 billion, nominal GDP is $10 trillion, and real GDP is $5 trillion.a. What is the price level? What is the velocity of money?b. Suppose that velocity is
Suppose that changes in bank regulations expand the availability of credit cards so that people need to hold less cash.a. How does this event affect the demand for money?b. If the Fed does not
Suppose that a country’s inflation rate increases sharply. What happens to the inflation tax on the holders of money? Why is wealth that is held in savings accounts not subject to a change in the
Hyperinflations are extremely rare in countries whose central banks are independent of the rest of the government. Why might this be so?
Let’s consider the effects of inflation in an economy composed of only two people: Bob, a bean farmer, and Rita, a rice farmer. Bob and Rita both always consume equal amounts of rice and beans. In
If the tax rate is 40 percent, compute the before tax real interest rate and the after-tax real interest rate in each of the following cases.a. The nominal interest rate is 10 percent, and the
What are your shoeleather costs of going to the bank? How might you measure these costs in dollars? How do you think the shoe leather costs of your college president differ from your own?
Recall that money serves three functions in the economy. What are those functions? How does inflation affect the ability of money to serve each of these functions?
Suppose that people expect inflation to equal 3 percent, but in fact, prices rise by 5 percent. Describe how this unexpectedly high inflation rate would help or hurt the following:a. The governmentb.
Explain one harm associated with unexpected inflation that is not associated with expected inflation. Then explain one harm associated with both expected and unexpected inflation.
Explain whether the following statements are true, false, or uncertain.a. “Inflation hurts borrowers and helps lenders, because borrowers must pay a higher rate of interest.”b. “If prices
Define net exports and net capital outflow. Explain how they are related.
Define nominal exchange rate and real exchange rate, and explain how they are related. If the nominal exchange rate goes from 100 to 120 yen per dollar, has the dollar appreciated or depreciated?
Over the past twenty years, Mexico has had high inflation, and Japan has had low inflation. What do you predict has happened to the number of Mexican pesos a person can buy with a Japanese yen?
Define net exports and net capital outflow. Explain how and why they are related.
Explain the relationship among saving, investment, and net capital outflow.
If a Japanese car costs 500,000 yen, a similar American car costs $10,000, and a dollar can buy 100 yen, what are the nominal and real exchange rates?
Describe the economic logic behind the theory of purchasing-power parity.
If the Fed started printing large quantities of U.S. dollars, what would happen to the number of Japanese yen a dollar could buy? Why?
How would the following transactions affect U.S. exports, imports, and net exports?a. An American art professor spends the summer touring museums in Europe.b. Students in Paris flock to see the
Would each of the following transactions be included in net exports or net capital outflow? Be sure to say whether it would represent an increase or a decrease in that variable.a. An American buys a
Describe the difference between foreign direct investment and foreign portfolio investment. Who is more likely to engage in foreign direct investment—a corporation or an individual investor? Who is
How would the following transactions affect U.S. net capital outflow? Also, state whether each involves direct investment or portfolio investment.a. An American cellular phone company establishes an
The business section of most major newspapers contains a table showing U.S. exchange rates. Find such a table in a paper or online and use it to answer the following questions.a. Does this table show
Would each of the following groups be happy or unhappy if the U.S. dollar appreciated? Explain.a. Dutch pension funds holding U.S. government bondsb. U.S. manufacturing industriesc. Australian
What is happening to the U.S. real exchange rate in each of the following situations? Explain.a. The U.S. nominal exchange rate is unchanged, but prices rise faster in the United States than
A can of soda costs $0.75 in the United States and 12 pesos in Mexico. What would the peso-dollar exchange rate be if purchasing-power parity holds? If a monetary expansion caused all prices in
Assume that American rice sells for $100 per bushel, Japanese rice sells for 16,000 yen per bushel, and the nominal exchange rate is 80 yen per dollar.a. Explain how you could make a profit from
A case study in the chapter analyzed purchasing power parity for several countries using the price of Big Macs. Here are data for a few more countries:a. For each country, compute the predicted
Purchasing-power parity holds between the nations of Ectenia and Wiknam, where the only commodity is Spam.a. In 2000 a can of Spam costs 2 dollars in Ectenia and 6 pesos in Wiknam. What is the
Describe the sources of supply and demand in the market for loanable funds and the market for foreign-currency exchange.

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