Questions and Answers of Principles Of Economics

If the central bank wants to increase the money supply with outright open market operations, what does it do?
How do banks make profit and what considerations must banks give to the trade-off between security and profit?
What is the refinancing rate? What happens to the money supply when the European Central Bank raises its refinancing rate?
What is the difference between the price level and inflation? Explain how an increase in the price level affects the real value of money.
Why is deflation a potentially damaging phenomenon?
What characteristics of an asset make it useful as a medium of exchange? As a store of value?
Should central banks place as much emphasis on financial stability as on price stability? Justify your answer.
Should financial markets be subject to more or less regulation if we are to avoid another financial crisis of the scale of that witnessed between 2007 and 2009? Justify your answer.
In what way can central banks attempt to control the broad money stock in an economy? What limitations does a central bank face in this task?
Why must banks have a portfolio of assets and liabilities on its balance sheet to enable them to manage risk? If banks commit to a large proportion of short-term lending, how might this affect its
The economist John Maynard Keynes wrote:Lenin is said to have declared that the best way to destroy the capitalist system was to debauch the currency.By a continuing process of inflation, governments
The value and volume of trade between a country and its trading partners and the flows of capital and assets are monitored and reported on by most countries. In the UK, the ONS publishes what is
Why do economists sometimes conduct analysis under assumptions of a closed economy? What do you understand by the term an ‘open economy’?
What effect does a government budget deficit have on the interest rate? Draw a diagram to illustrate your answer.
What effect would you expect a government budget surplus to have on the exchange rate? Explain.
Suppose that a steel workers’ union encourages economic actors to buy only European steel. What would this policy do to the European overall trade balance and the real exchange rate? What is the
What effect would you expect a tariff to have on the real exchange rate? Explain using appropriate diagrams.
How would the following transactions affect UK exports, imports and net exports?a. A British art lecturer spends the summer touring museums in Italy.b. Students in Paris flock to see the latest Royal
How would the following transactions affect UK net capital outflow? Also, state whether each involves direct investment or portfolio investment.a. A British mobile telephone company establishes an
Germany generally runs a trade surplus. Do you think this is most related to high foreign demand for German goods, low German demand for foreign goods, a high German saving rate relative to German
Assume that there is a rise in the trade deficit of a country due largely to the rise in a government budget deficit. Assume also that some commentators in the popular press claim that the increased
Expectations play a key role in modern macroeconomic modelling. Decisions are made not only with the past and present in mind, but also the future. People are aware that central banks control
What are time-series data? Give three examples of key macroeconomic variables that are examples of time-series data.
What are the main stages of a typical business cycle and how long do these stages last?
Would you expect the following variables to be procyclical or countercyclical if GDP was above trend? Explain.a. inflationb. unemploymentc. employmentd. real wagese. nominal interest rates
Unemployment is classified as a ‘lagging indicator’. Explain what this means and why unemployment is classed as such.
Why might changes in household decision-making cause a deviation in GDP from trend?
What role does household and firms’ confidence play in business cycles?
What is the role of unanticipated price changes in the new classical model of business cycles?
What is the key difference between real business cycle models and other business cycle models?
What are the principal features of DSGE models?
In one time period, the growth rate of GDP of a country is recorded as 3.4 per cent against a trend growth rate of output of 2.8 per cent. In the next two time periods, the growth rate of GDP is
Go to the national statistics office website for your country (this could be the ONS in the UK or Eurostat for the EU) and look up unemployment and inflation figures over the last 30 years. Plot the
Is it always possible to discern a trend in any time-series data? What problems might arise if trends are apportioned to time-series data that are not really present?
Look up the following comovements for the country in which you are studying on an appropriate website. Explain whether the comovements are procyclical or countercyclical; GDP and:a. inflationb.
Firms experience a rise in stocks. Explain why this might have occurred and what you expect firms’ response to this event might be and how this might affect output.
Why might household and firms’ confidence and expectations change leading to deviations in output from trend? Is there any way in which changes in confidence can be measured to provide an indicator
Critics of DSGE models argue that despite their complexity and sophistication, they failed to provide indications of the shock that was the Financial Crisis. Apart from the lack of a financial
To what extent do you think that workers are always fooled by the inflation fallacy?
Which business cycle model do you find the most compelling and why?
Keynesianism has been subject to much debate over the years. To what extent is the idea that demand management in a period of economic stagnation a recipe for stimulating economic growth once again?
Distinguish between planned expenditure and actual expenditure.
Draw a Keynesian cross diagram to show the effects of a rise in autonomous expenditure on an economy operating below full employment output.
What is meant by the terms: inflationary gap and deflationary gap?
Why does the MPC 1MPS 51?
What is the multiplier? Can the multiplier be negative as well as positive? Explain.
Explain how the marginal propensity to withdraw affects the outcome of a rise in autonomous expenditure.
Use diagrams to describe how the IS and LM curves are derived.
Using the IS–LM model, explain the effect on the economy of a reduction in autonomous expenditure resulting from a cut in public spending by the government.
A central bank wishes to reduce inflationary expectations by increasing interest rates. Use the IS–MP model to analyze the effect on the economy of such a move.
What, according to Keynes, was the main reason why recessions and depressions occurred? As a result of identifying this key reason, what did Keynes suggest was an appropriate policy repose?
Explain, using an appropriate diagram, how a deflationary gap can occur and how this gap can be eliminated.
Suppose the government reduces taxes by €2 billion, that there is no crowding out and that the MPC is 0.75.a. What is the initial effect of the tax reduction on AD?b. What additional effects follow
Assume the economy is in equilibrium. Analyze the effect of a cut in autonomous expenditure on economic activity and the level of unemployment. You should use a diagram to help illustrate your answer.
What does the IS curve show? What does the LM curve show?
What determines the slope of the IS curve? What determines the slope of the LM curve? In relation to your answer to these questions, explain why these determinants can be a source of disagreement
Use the IS–LM model to explain the following:a. The government institutes significant cuts in public expenditure.b. The central bank institutes an asset purchasing facility (quantitative easing)
Assume that a period of deflation leads to a rise in the supply of real money balances. Explain the effect of this change on the economy using the IS–LM model and then what effect it would have on
Do you think that Keynes’ ideas still have some relevance today? Explain.
In a number of European countries, economies have gradually returned to growth following the Financial Crisis.In 2009, growth in the EU was at 24.39 per cent and from 2012, when GDP growth was 20.4
What do you understand by the term ‘economic activity’?
What is the official definition of a recession?
Draw a diagram with AD, SRAS and LRAS. Be careful to label the axes correctly.
List and explain the three reasons why the AD curve is downwards sloping.
Explain why the LRAS curve is vertical.
List and explain the three theories for why the SRAS curve is upwards sloping.
What might shift the AD curve to the left? Use the model of AD and AS to trace through the effects of such a shift.
What might shift the AS curve to the left? Use the model of AD and AS to trace through the effects of such a shift.
What outcomes are possible if AD and AS are both shifting? Use the model of AD and AS to outline some of these possible outcomes
Why do you think that investment is more variable over the business cycle than consumer spending? Which category of consumer spending do you think would be most volatile: durable goods (such as
Explain whether each of the following events will increase, decrease or have no effect on LRAS.a. A country experiences a wave of immigration.b. A government raises the minimum wage above the
Explain why the following statements are false.a. ‘The AD curve slopes downwards because it is the horizontal sum of the demand curves for individual goods.’b. ‘The LRAS curve is vertical
Suppose the central bank expands QE and, as a result, expectations of a rise in the price level increase. What will happen to output and the price level in the short run? Compare this result to the
Suppose workers and firms suddenly believe that inflation will be quite high over the coming year. Suppose also that the economy begins in long-run equilibrium, and the AD curve does not shift.a.
The theory seems intuitive enough – if government spends money on a major infrastructure project, it is logical that the income received will be spent and fed through to other parts of the economy,
What are the three ways in which monetary policy affects AD?
What is the theory of liquidity preference?
How does the theory of liquidity preference help explain the downwards slope of the AD curve?
The government spends €500 million improving canals for trade and leisure use. Explain why AD might increase by more than €500 million. Explain why AD might increase by less than €500 million.
If governments commit to demand management policies to maintain the economy as near to full employment output as possible, what effect do you think this may have on expectations and economic
Suppose that survey measures of consumer confidence indicate a wave of pessimism is sweeping the country. If policymakers do nothing, what will happen to aggregate AD? What should the government do
How might a government use taxation as a tool in expansionary fiscal policy?
Outline the arguments for and against an active stabilization policy.
Suppose banks install automatic teller machines on every street corner and, by making cash readily available, reduce the amount of money people want to hold.a. Assume the central bank does not change
This chapter explains that expansionary monetary policy reduces the interest rate and thus stimulates demand for investment goods. Explain how such a policy also stimulates the demand for net exports.
Suppose government spending increases. Would the effect on AD be larger if the central bank took no action in response, or if the central bank were committed to maintaining a fixed interest rate?
Assume the economy is in a recession. Explain how each of the following policies would affect consumption and investment. In each case, indicate any direct effects, any effects resulting from changes
Assume that a law has been proposed that would make price stability the sole goal of monetary policy. Suppose such a law were passed.a. How would the central bank respond to an event that contracted
An economy is operating with a negative output gap of €400 billion. The government of this economy wants to close this output gap. The central bank agrees to adjust the money supply to hold the
The initial years after the Financial Crisis saw inflation in the UK stubbornly hovering well above the 2.0 per cent target, before slowing considerably and languishing around zero throughout 2015
Phillips originally looked at the rate of change in money wages rather than inflation, but the Phillips curve has come to be associated with the trade-off between inflation and unemployment. What is
Explain why, in the short run, there might be a trade-off between inflation and unemployment.
Why do economists place such importance on the role of expectations in macroeconomic policy?
Explain how expected inflation might cause a shift in the short-run Phillips curve.
What reasons are put forward for keeping central banks independent in setting monetary policy?
What are the main differences between inflation targeting and NGDP targeting?
Suppose the central bank believed that the natural rate of unemployment was 6 per cent when the actual natural rate was 5.5 per cent. If the central bank based its policy decisions on its belief,
Some economists believe that the short-run Phillips curve is relatively steep and shifts quickly in response to changes in the economy. Would these economists be more or less likely to favour
Imagine an economy in which all wages are set in three-year contracts. In this world, the central bank announces a disinflationary change in monetary policy to begin immediately. Everyone in the
Some economists have proposed that central banks should use the following rule for choosing their target interest rate (r):where:p is the average of the inflation rate over the past year y is real

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