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Macroeconomics Private And Public Choice 2nd Edition James D Gwartney; Richard Stroup; A H Studenmund - Solutions
(a) A reduction in the discount rate
5. How will the following actions a ffect the money supply:
4. In your own words, explain how the creation of new reserves would cause the supply of money to increase by some multiple of the newly created reserves.
3. "People are poor because they don't have very much money. Yet central bankers keep money scarce. If poor people had more money, poverty could be eliminated."Explain the confusion of this statement.
2. What makes money valuable? Does money perform an economic service? Explain.Could money better perform its function if there were twice as much of it? Why or why not?
I. Why can banks continue to hold reserves that are only a fraction of the demand deposits of their customers? Is your money safe in a bank? Why or why not?
(a) Establishment of the Required Reserve Ratio. Under a fractional reserve banking system, reserve requirements limit the ability of commercial banks to expand the money supply by extending more loans. When the Fed lowers the required reserve ratio, it 249
6. The Fed has three major tools with which to control the money supply.
5. The Federal Reserve System is a central banking authority designed to provide a stable monetary framework for the entire economy. It establishes regulations that determine the supply of money. It issues most of the currency in the United States. It is a banker's bank.
4. Banking is a business. Commercial banks provide their depositors with safekeeping of money, check-clearing services on demand deposits, and interest payments on time deposits. Banks derive most of their income from the extension of loans and investments in interest-earning securities.
3. In recent years, institutional changes have blurred the distinction between demand(checking) and time (savings) deposits. As a result, future economists will no doubt place greater emphasis on broader definitions of the money supply that incorporate time deposits and savings deposits in
2. There is some debate among economists as to precisely how the money supply should be defined. The narrowest and most widely used definition of the money supply(M1) includes only (a) currency in the hands of the public and (b) demand deposits with commercial banks. Neither has significant
1. Money is anything that is widely accepted as a medium of exchange. It also acts as a unit of account and provides a means of storing current purchasing power into the future. Without money, exchange would be both costly and tedious.
6. What are automatic stabilizers? Explain the one big advantage of automatic stabilizers.
5. "In the real world, it is wrong to expect that fiscal policy will be symmetric.Politicians will be glad to run a deficit during bad times to stimulate the economy, but they will surely fail to plan a surplus when it is needed to halt inflationary pressures.Thus, fiscal policy has an inflationary
4. If an economy were experiencing 7 percent unemployment while prices were rising at a 2 percent annual rate, indicate your view on proper fiscal policy. Explain your reasons.
3 . Suppose that you are a member of the Council of Economic Advisers. The president has asked you to prepare a statement on,"What is the proper fiscal policy for the next 1 2 months?" Prepare such a statement, indicating (a) the current state of the economy(that is, unemployment rate, growth in
2. Suppose that investment tax credits were raised, granting $20 billion of tax relief to the business sector. Indicate the impact of this policy. Use graphic analysis to illustrate how both investment and the equilibrium level of income would be affected.
I . Explain what is likely to happen to unemployment, real income, and prices as a result of a tax reduction when the unemployment rate is (a) 3.8 percent, (b) 5.0 percent,(c) 7.2 percent.
10. The burden of the national debt has long been a controversial issue. It is not true that the debt wi)) eventually have to be paid off. Nor does the debt indicate that the federal government is about to go bankrupt. During the last 25 years, private debt has grown more rapidly than the federal
9. Unemployment compensation, corporate taxes, and the progressive income tax act as automatic stabilizers because they automatically contribute to a budget deficit during slack times and a budget surplus when the economy is at fu11 employment.
8. Improper fiscal policy can be destabilizing. Fiscal policy deceleration during a recession can both lengthen the duratiqn and heighten the severity of an economic slowdown. Similarly, fiscal acceleration is a potential source of inflation. The historical record reveals that fiscal policy has, at
7. The effectiveness of fiscal policy may also suffer as a result of political considerations.Political entrepreneurs find spending attractive but dislike imposing taxes. Thus, they are likely to run a deficit most of the time and thereby introduce an inflationary bias to fiscal policy. In
6. Economic theory indicates that there are limitations on the expected effectiveness of discretionary fiscal policy as a stabilization tool. There is often a lag between the time when a policy change is needed and the time when legislative authority is granted. Even after a fiscal policy change
5. The full-employment budget 1s a measure of what expenditures and revenues would be if the economy were at foll employment. I t is a useful summary statistic on the degree to which fiscal policy is expansionary or restrictive because it eliminates the impact of changing economic conditions on the
4. The Keynesian analysis suggests that general economic conditions should be the prime determinant of proper fiscal policy. An annual balanced budget may actually contribute to economic instability. When the economy is slack, budget authorities should plan a deficit. When the economy is
3. Restrictive fiscal policy (higher taxes or reduced government expenditures) can be used to combat inflationary pressure. In the face of inflation, a planned government surplus would be in order.
2. A tax reduction can also be used to push an economy to full employment. When taxes are reduced, the disposable income of consumers will increase, stimulating consumption. At the higher level of consumption, both real income and employment will expand. Tax reductions can usually influence
I . When an economy's resources are underutilized, an increase in government expenditures, holding taxes constant, will increase aggregate demand and push the economy to a higher level of real income and employment.
6. Indicate several factors that would cause the aggregate demand function to shift.What factors would cause movement along the aggregate demand function?
. "How can the Keynesian model be correct? According to Keynes, falling income, unemployment, and bad times result because people have so much income that they fail to spend enough to buy all of the goods produced. Pa1adoxically, rising income and good times result because people are reducing their
4. What is the multiplier principle? What determines the size of the multiplier? Does the multiplier principle make it more or less difficult to stabilize the economy? Explain.
3. Explain the paradox of thrift. Was Ben Franklin wrong to sanctify savings? Is saving necessary for investment and economic growth? Should we try to save more or less next year? Why?
2. Explain in your own words how the multiplier and accelerator reinforce each other to generate cyclical business conditions.
l. "The best cure for unemployment and a recession is for everybody, including government, to tighten their belts, cut down on unnecessary spending, and forego luxury items until the recession is over." Do you agree? Why or why not?
5. The early classicists thought that (a) flexible wages and prices and (b} the interest rate would ensure that a market economy would reach an equilibrium only at full employment. \Vhy did Keynes disagree? Explain.
Write a short essay explaining to the president the Keynesian view of why a market economy may be unable to generate the full-employment level of income. Be sure to explain why equilibrium may result at less than full employment.
4. You have just been appointed to the President's Council of Economic Advisers.
(g} A redistribution of income from the wealthy to the poor
(f) A redistribution of income from older workers (age 45 and over} to the young (less than 3 5}
(e) A decline in stock prices
(d) An increase in the interest rate
(c) A reduction in income taxes
(b) Pessimism about future employment conditions
(a) The expectation that consumer prices will rise more rapidly in the future
3. How will each of the following factors influence the consumption schedule?
2. \Vhen is an economy in Keynesian aggregate equilibrium? Explain in your own words why an economy will return to aggregate equilibrium from a position of excess aggregate demand or from a position of insufficient aggregate demand.
1 . Explain why it sometimes may be impossible for the plans of savers and investors to be fulfilled simultaneously.
depending on the level of aggregate demand. Equilibrium may exist at less than full employment.
8. Equilibrium can also be viewed from the standpoint of injections into, and leakages from, the income stream. Investment and government spending are injections into the income-expenditure stream. They add to aggregate demand. Saving and taxes are withdrawals from the income-expenditure stream.
If planned aggregate demand is temporarily in excess of output, businesses will sell more of their products than they anticipate. Their inventories will be depleted below the desired level. In an effort to restore the depleted inventories, they will expand future output, and income will rise to the
7. When an economy is in equilibrium, planned aggregate demand will be just equal to aggregate supply. If planned aggregate demand is temporarily less than output, businesses will be unable to sell as much as they had anticipated (planned). Rather than continue to accumulate undesired inventories,
6. In the Keynesian model, which includes government, planned aggregate demand is the smn of the planned consumption, investment, and government expenditures.Aggregate demand is the moving force in the Keynesian model.
5. 111e major determinants of investment are (a) current sales relative to the productive capacity of the existing productive facilities, (b) expectations about future sales, and• (c) the interest rate. Keynes perceived that, during a period of depressed economic conditions, investment would be
4. Historical data indicate that, in the long run, consumption expenditures comprise an approximately constant percentage of income. Thus, even though the short-run cross-sectional data indicate that the marginal propensity to consume declines with income, in the long run this has not been the
3 . The primary determinant of consumption is disposable income. As Q.isposable income increases, consumption expenditures will rise, although in the short run they will generally rise less rapidly than income.
(b) Wages and prices in the real world tend to be inflexible downward. Therefore, falling wages cannot restore full employment. Even if wages were flexible, falling wages would not restore full employment because declining wage rates would also reduce income, consumption, and aggregate demand.
(a) Saving and investment are carried out by different people and for different reasons.When conditions are depressed, investment is likely to be far more responsive to business expectations, technological changes, and innovation than to the interest rate.Similarly, income, rather than the interest
9. How does the rate of employment differ from the rate of unemployment? Which is the better indicator of employment opportunity? Why?1 61
8. Do you think that full employment is a sound policy objective? Why or why not?
7. What is full employment? How does public policy affect the percentage of the labor force that will be employed at full employment? What other factors influence the level of full employment? Give an example of a public policy that decreases (increases) the number of persons who will be employed
6. What's Wrong with This Way of Thinking?"The value of today's dollar is only one-fourth of what it was in 1940. Five years from now it will be worth only 20 cents. We cannot maintain our standard of living when the value of our currency is declining so rapidly."
5. What are the most harmful effects of inffation? Explain why it matters whether inffation is accurately anticipated.
4. "My money wage rose by 6 percent last year, but inffation completely erased these gains. How can I get ahead when inffation continues to wipe out my increases in earnings?" Evaluate. Do you agree with the view implicit in this question?
3. Explain the monetarist view of the business cycle. What do the monetarists believe to be the major source of economic instability? What is their solution?
I . Explain why even an efficiently functioning economic system will have some unemployed resources.2. What is the Keynesian explanation of the business cycle? What solution to the business cycle is suggested by the Keynesian theory?
7. What's Wrong with This Way of Thinking?"An agricultural program that pays farmers to reduce their planted acreage and cut back on the production of farm products can increase everyone's income. The reduction in the supply of farm products will cause their prices to rise, which will result in an
6. "GNP counts the product of steel but not the disproduct of air poUution. It counts the product of automobiles but not the disproduct of 'blight' due to junkyards. It counts the product of cigarettes but not the disproduct of a shorter life expectancy due to cancer. Until we can come up with a
5. Why might the GNP be a misleading index of changes in output between 1900 and 1980 in the United States? of differences in output between the United States and Mexico?
(i) Deterioration of the water quality of Lake Michigan
h) A multibillion doUar discovery of natural gas in Oklahoma
(g) Family lawn services purchased from the neighbor's 1 6-year-old, who has a lawn-mowing business
(f) Family lawn services provided by a 1 6-year-old
(e) Interest on a bond issued by AT&T
(d) The purchase of 100 shares of AT&T stock
(c) Frank Murry's rental payments on a 1979 Chevrolet
(b) Frank Murry's purchase of a 1979 Chevrolet
(a) The services of a housewife
4. Indicate which of the following activities are counted as part of GNP:
3. What is real GNP? How is it determined? Calculate the change in real GNP between 1970 and 1978.
2. Explain why the rate of growth in GNP in current dollars can sometimes be a misleading statistic.
1 . Why does a pound of beef add more to GNP than a pound of wheat? Does it reflect demand or costs? Comment.
1 0. The circular flow model illustrates that the aggregate supply of goods ????nd services to households, businesses, governments, and foreigners and the aggregate income of resource suppliers are merely alternative methods of viewing the same thing. Thus, actual aggregate output and actual
9. Economists are currently seeking to develop alternative measuring rods of economic well-being. A recently devised measuring device, the measure of economic welfare(MEW), includes many nonmarlcet economic goods consumed during the period, subtracts the estimated cost of economic bads, and
8. Economists frequently refer to four other income measures that are related to GNP:net national product, national income, personal income, and disposable income. All of these measures of income tend to move together.
7. Despite all its limitations, GNP is of tremendous importance because it is an accurate tool enabling us to identify short-term economic fluctuations. Without such a reliable indicator, economic theory would be unable to determine the cause of economic slowdowns and economic policy would be
6. GNP is an imperfect measure of current production. It excludes household production. It fails to account for the negative side effects of current production such as air and water pollution, adverse impacts on health, depletion of natural resources, and other factors that do not flow through
5. GNP may increase because of an increase in either output or prices. Price indices are used to measure the impact of price changes. Real GNP can be determined by adjusting money GNP to account for price changes between periods.
(e) corporate profits, and (f) nonincome expenses, primarily depreciation and indirect business taxes.
4. The major components of GNP as calculated by the resource cost-income approach are (a) wages and salaries, (b) self-employment income, (c) rents, (d) interest,
3. When the expenditure approach is utilized, there are four major components of GNP: (a) consumption, (b) investment, (c) government, and (d) net exports.
2. Dollars act as a common denominator for GNP. Production of each final product is weighted according to its selling price. Alternatively, GNP can be calculated by adding up the dollar factor cost of producing the final goods. The two methods sum to an identical result.
1 . Gross national product is a measure of the market value of the final goods and services produced during a specific time period.
7. What's Wrong with This Way of Thinking?"Antiunion Congressmen argue that the social security payroll tax should continue to be divided equally between the employer and his employees. My bill would levy five-sixths of the tax on the employer, whereas the employee would pay only one-sixth.This
6. Do you think it would be a good idea to adjust tax brackets for inflation and thereby prevent the automatic raising of taxes by inflation? Why or why not?
5. Do you think that legislators really attempt to design taxes in a manner that conceals the cost imposed on their constituents? Give evidence to support your view. Do legislators act rationally? Does the political process encourage them to act rationally?Discuss.
4. "Transfer payments exert no influence on our economy because they merely transfer income from one group of individuals to another." Evaluate.
3. The progressive personal income tax is the major source of tax revenue in the United States. What do you think is good about this tax? What is bad about it? What changes, if any, would you make in the nature of this tax? Why?
9. Public choice theory suggests that several characteristics of our current tax structure reflect the desire of political entrepreneurs to conceal the costs of government activities from the voter. The splitting of the payroll tax into an employee-employer share can be explained by the desire of
8. Studies of tax incidence suggest that both the very poor and very rich pay a greater percentage of their income in taxes. The bulk of a11 tax revenues comes from taxpayers with incomes in the range of $5000 to $50,000, where tax rates are approximately proportional.
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