Final Exam Study Guide Final Exam: Wednesday, May 11th 5:30pm-7:30pm DeBartolo Hall Room 356

1. What is the definition of GDP? The market value of all final goods and services produced in a country in a given time period. 2. Identify if each item would be counted towards the current year’s GDP measure: -You buy a new car in 2011: Counted -You work in London for 6 months in 2011: Not Counted -A foreign-owned Honda plant in Iowa produces $10 million worth of goods in 2011: Counted 3. Find GDP, given the following data: -Consumption = $12 billion -Investment = $5 billion -Government Spending = $6 billion -Imports = $ 4 billion -Exports = $2 billion GDP = (2-4) = $21 billion

4.If a basket of goods cost $400 in the base year and $700 in the current year, what is the value of the CPI for the current year? CPI = current year prices/base year prices $700/$400 = If the CPI were 2.6 in 2009 and 2.9 in 2010, what is the inflation rate? Inflation rate = (current year CPI – previous year CPI)/previous year CPI ( )/2.6 = 11.5% 6. If a candy bar cost $0.10 in 1925 with a CPI value of 0.15 and the same candy bar cost $1.50 in 2010 with a CPI value of 2.05, what is the real cost of the candy bar in 1925 and in 2010? Real Value = Nominal Value/CPI 1925: 0.10/0.15 = $ : 1.50/2.05 = $0.73

7. If the nominal interest rate is 5% and the rate of inflation is 2%, what is the real interest rate? Real Interest Rate = Nominal Interest Rate – Inflation 3% = 5% - 2% 8. How will each scenario affect the demand for labor? -The price of the good decreases. Demand for labor will: Increase -The productivity of workers increases. Demand for labor will: Increase 9. Find the unemployment rate given the following information: Employed: 100 million Unemployed: 10 million Unemployment Rate = unemployed/labor force 10% = 10 million/110 million

10. What are discouraged workers? Discouraged workers are those who would like to have a job but they have not looked for work in the past four weeks. 11. What are involuntary part-time workers? Involuntary part-time workers are people who would like to work full-time but cannot find a full-time job. 12. Explain frictional, structural, and cyclical unemployment. Frictional – workers are between jobs; person is taking time to find suitable employment Cyclical – unemployment caused by economic downturns Structural - long-term, chronic unemployment in a well-functioning economy; caused by lack of skills, discrimination, language barriers

13. For each person, state whether they are a member of the labor force or not a member of the labor force: Your father, who is enjoying his retirement Not a member Your brother, who is unemployed, but is looking for a job member Your sister, who does not have a job and gave up looking a year ago Not a member Your mother, who stays home to take care of the house Not a member 14. What is the private savings level if income = $50,000, taxes = $4,000, and consumption = $40,000? 50,000-4,000-40,000 = $6,000 in private savings 15. If the government budget deficit decreases, what will happen to the real interest rates, savings, and investment? There will be a rightward shift in the savings curve, causing the real interest rate to decrease. There will be higher levels of both savings and investments.

16. A bank has $100,000 in deposits, and the reserve-deposit ratio is 10%. If their current reserve level is $19,000, how much are they going to loan out in order to meet the reserve-deposit ratio? $9,000 (The bank only needs $10,000 in reserves since this is 10% of their deposits) 17. A bank has reserves of $30,000 and the reserve-deposit ratio is 10%. The residents of the country hold $100,000 in currency. What is the total money supply? Money Supply = Currency held by public + (bank reserves/reserve-deposit ratio) 100, ,000 = $400, The citizens of a country hold $1000 in currency. The bank has $500 in reserves, and the reserve-deposit ratio is 5%. The Federal Reserve conducts open-market operations to stimulate the economy, and purchases bonds for $100. Assume the $100 from the Federal Reserve is deposited completely into the bank. What was the money supply before the Fed’s action, and what is the money supply after the Fed’s action? Before: $ (500/.05) = $11,000 After: $ (600/.05) = $13,000 ~The Federal Reserve’s $100 in open-market operations increased the money supply by $2,000.

19. If potential output is $50 billion and actual output is $46 billion, what is the value of the output gap? Is this a recessionary or expansionary gap? Output gap = $4 billion; since actual is below potential output, this is a recessionary gap 20. If frictional unemployment is 2%, structural unemployment is 4%, and cyclical unemployment is 3%, what is the natural rate of unemployment? Is this situation representative of a recessionary gap or expansionary gap? Natural Rate of Unemployment = 2% (frictional) + 4% (structural) = 6% This is a recessionary gap, since total unemployment (9%) exceeds the natural rate of unemployment. 21. What are the four components of planned aggregate expenditure? Consumption, Planned Investment, Government Spending, Net Exports

22. Identify whether the government or consumption component of aggregate demand would be affected by each fiscal policy action: The government increases spending on alternative energy plants. G The government passes a 3% income tax cut. C The government increases unemployment benefit payments. C 23. What are automatic stabilizers? An increase in government spending or decrease taxes when real output declines; Built into laws so no decision is required; Example: unemployment benefits 24. What are the two fundamental responsibilities of the Federal Reserve? Conduct monetary policy & Oversight and regulation of financial markets

25. If interest rates are increased, will this cause an increase or a decrease in business investment? Decrease 26. If the Fed wants to close a recessionary gap, will they increase or decrease interest rates? Decrease 27. Will a higher interest rate lead to an increase or decrease in the quantity demanded of money? Decrease

M i* 28. On the following graph, identify the effect of an increase in the money supply by the Federal Reserve (draw new supply or demand line, and identify the new equilibrium interest rate) :

29. Explain how a decrease in the reserve requirement will increase the money supply. When the reserve requirement is decreased, this allows banks to loan out more of their funds to businesses and consumers, which will increase the money supply. 30. If the Federal Reserve increases interest rates, will this cause the aggregate demand curve to increase or decrease? Decrease 31. What two factors can shift the aggregate supply curve? Inflation expectations Inflation shocks

32. What are anchored inflation expectations? People's expectations of future inflation do not change even if inflation rises temporarily 33. What two factors are excluded from the core inflation measure? Energy & Food prices 34. What three factors affect the credibility of a central bank’s monetary policy? Degree of central bank's independence The announcements of explicit inflation targets Established reputation for fighting inflation 35. Are inside lags longer for monetary policy or for fiscal policy? Fiscal Policy

Good Luck!! Final Exam: Wednesday, May 11 th 5:30pm-7:30pm DeBartolo 356 See you there!