ECONS EXAM 3

Unemployment rises and real gross domestic product (GDP) growth slows during the __________ business cycle.

a. expansionary phase of a

b. recovery phase of a

c. recessionary phase of a

d. short-run phase of a

e. entire

recessionary phase of a

When prices in the economy have not fully adjusted, we say that …

a. we are in the short run.

b. we are in the long run.

c. it is a period of time less than one year.

d. it is a period of time more than five years.

e. the market is not in equilibrium.

we are in the short run.

Over the next 20 years, more and more Baby Boomers are expected to retire. Which of the U.S. government’s budget categories is likely to be most affected by this trend?

a. Discretionary

b. Mandatory

c. Interest

d. both discretionary and mandatory

e. discretionary, mandatory and interest

Mandatory

To have the economy which is not in a long run equilibrium get back to the long run the ______ curve will slowly adjust until we are back to the long run without government intervention.

a. SRAS

b. LRAS

c. AD

d. SRAS and LRAS

e. This is not possible, there needs to be government intervention

SRAS

The multiplier effect of fiscal policy predicts that an increase in government spending of $150 billion will increase total income by $750.00 billion if the marginal propensity to consume is 0.80. If we account for crowding-out, then the increase in aggregate demand will be …

a. less than $750.00 billion.

b. exactly $750.00 billion.

c. more than $750.00 billion.

d. not enough information to tell

less than $750.00 billion.

Country Z is suffering from the effects of a negative supply shock. If the government’s main goal is to return output to potential, then it will __________. If the government’s main goal is to maintain low and stable inflation, then it will __________.

a. pursue expansionary fiscal policy; take no action

b. pursue contractionary fiscal policy; pursue expansionary fiscal policy

c. pursue contractionary fiscal policy; take no action

d. pursue expansionary fiscal policy; pursue expansionary fiscal policy

e. take no action; take no action

pursue expansionary fiscal policy; take no action

How are unemployment and output related in the AD-AS model?

When we are in a LR equilibrium, actual output is equal to full employment (Y=Y*) output and unemployment is equal to the natural rate (U=U*).

When the economy is in a recession, (Y<Y*) and (U>U*)

When we are in an expansion, (Y>Y*) and (U<U*)

This implies that output and unemployment are inversly related.

What are the components that shift the AD curve and how do they relate to GDP?

Consumption, Investment, Government Spending, NX Exports (Imports - Exports).

These are the components of GDP

What is social security?

US Gov administered retirement workers contribute a portion of their income while working and the government will send them a monthly check when they retire.

How could the government fix social security funding?

Increase retirement age means test for benefits. Adjust the benefits computation the consumer price index.

What is fiscal policy?

The use of government’s budgeting tools, gov. spending and taxes to influence the macroeconomy

How does fiscal policy relate to the business cycle?

1. Government trying to get US out of recession quicker than how we would naturally get off of it.

2. Countercyclical fiscal policy seeks to counteract business cycle fluxucation

How do you find marginal tax rate?

It is the last tax rate (highest) you pay. The % of tax you pay on the next dollar earned.

Which curve(s) shifts? The federal government passes a basic-income law, giving thousands of dollars of extra income for each household to spend.

AD shifts right

What happens to SRA and LRA in this situation? The federal government passes a basic-income law, giving thousands of dollars of extra income for each household to spend.

SRA

Output = Increases

Price Level = Increases

LRA

Output = —

Price Level = Increases

In the long run,
a. the economy has gone through a full business cycle.

b. at least five years have passed.

c. some prices have adjusted.

d. all prices have adjusted.

e. the majority of firms are making a profit.

all prices have adjusted.

When the price level falls, __________ increases from the wealth effect, __________ increases from the interest rate effect, and __________ increase from the international trade effect.

a. government spending; consumption; net imports

b. consumption; investment; net exports

c. investment; government spending; net exports

d. investment; consumption; net exports

e. investment; consumption; net imports

consumption; investment; net exports

Which of the following is considered discretionary government spending?

a. retirement checks to former government employees

b. Medicare payments

c. payments to food stamp recipients

d. funding for federal highway repairs

e. interest on Treasury bonds held by foreign owners

funding for federal highway repairs

Fiscal policy is the use of…

a. the money supply to influence the economy.

b. budgeting, spending, and taxes to influence the economy.

c. taxes and spending to increase exports and reduce imports.

d. taxes to balance the government’s operating budget.

e. spending to promote a legislative agenda.

budgeting, spending, and taxes to influence the economy.

Social Security and Medicare spending continue to grow and take up larger shares of the federal budget because life expectancy is __________, the number of people receiving benefits is __________ quickly, and the growth in the number of people paying into the programs is __________.

a. increasing; increasing; decreasing

b. increasing; increasing; increasing

c. decreasing; increasing; decreasing

d. decreasing; decreasing; increasing

e. increasing; decreasing; decreasing

increasing; increasing; decreasing

Countercyclical fiscal policy seeks to

a. maximize political stability.

b. minimize business-cycle fluctuations.

c. minimize changes in the size of the money supply.

d. maintain consistent tax rates.

e. avoid government budget deficits.

minimize business-cycle fluctuations.

An increase in aggregate demand (AD) is beneficial in the short run because __________ but not in the long run because __________.

a. output decreases; the unemployment rate falls

b. the unemployment rate falls; the price level rises

c. wages decrease; wages increase

d. real wealth decreases; real wealth increases

e. wages increase; the unemployment rate rises

the unemployment rate falls; the price level rises

What is the main difference between the wealth effect and changes in wealth?

a. The wealth effect occurs only when interest rates change while changes in wealth occur whenever the price level changes.

b. The wealth effect occurs due to changes in government wealth while changes in wealth occur when consumer wealth changes.

c. The wealth effect occurs due to a change in the price level while changes in wealth are not related to the price level.

d. The wealth effect is not related to the price level, while changes in wealth are related.

e. The wealth effect occurs when savings increases, while changes in wealth occur no matter what the rate of savings.

The wealth effect occurs due to a change in the price level while changes in wealth are not related to the price level.

What is the relationship between the business cycle and the AD-AS model?

The business cycle describes fluctuations in real economic activity, expansions and recessions, over time, and these fluctuations can be explained using the AD–AS model. In the AD–AS framework, business cycle phases are driven by shifts in aggregate demand, aggregate supply, or both. An expansion occurs when AD or AS shifts to increase output, while a recession occurs when negative shocks reduce output.

Suppose we are in a short run equilibrium and the economy naturally adjusts to the long run equilibrium. How do we get this adjustment? Why do we get this adjustment?

Through SRAS. The adjustment from short-run to long-run equilibrium occurs through changes in wages and other input prices. If output is above potential, high demand for labor pushes wages up; if output is below potential, weak labor demand causes wages to fall. These wage changes shift the short-run aggregate supply curve until output returns to its natural (long-run) level. We get this adjustment because workers and firms respond to shortages or surpluses in labor markets and seek to restore equilibrium

What is the problem with baby boomers starting to retire and draw their social security? Also propose one way to help fix the problem

When baby boomers started to retire, that caused a big shift in the population from working to retired. They start drawing social security benefits and there are less people contributing per beneficiary than there were previously. Lots of options to fix the problem: means test for benefits, raise the full retirement age, adjust social security with the CPI, etc.

What is the relationship between debt and deficit?

Deficit is measured in a single period. Debt is accumulation (sum of) deficits. Some periods you could have a deficit, and some could be a surplus. If you have a surplus, debt declines.

How does real GDP (output) and unemployment relate to fiscal policy (i.e. when would the government want to enact expansionary or contractionary fiscal policy)?

Real GDP and unemployment help signal when fiscal policy is needed to stabilize the economy. If real GDP is below potential and unemployment is high, the government may enact expansionary fiscal policy (higher spending or lower taxes) to boost demand and create jobs. If real GDP is above potential and unemployment is very low, inflationary pressure may arise. In that case, the government may use contractionary fiscal policy (lower spending or higher taxes) to slow the economy.

Explain at least one automatic stabilizer the government has in place to counteract recessions and how that helps the economy when it slips into a recession. What is automatic about the specific stabilizer you chose?

One automatic stabilizer is unemployment benefits. During a recession, businesses may experience lower demand and lay off employees. When workers lose their jobs, eligible individuals can receive unemployment benefits from the government. This helps people maintain some income and continue purchasing necessities, which supports consumer spending and reduces the severity of the recession. It is considered automatic because the unemployment benefits program is already established, and spending on benefits increases as more people become unemployed without requiring the government to pass new legislation or create a new program.

What other taxes might this person have to pay on their income? List at least two and explain what each is.

Social Security is a federal program that provides income to retired workers, people with disabilities, and surviving family members. It is funded through payroll taxes paid by workers and employers and serves as a safety net in old age or when earnings are lost. [Flat tax rate]

Medicare is a federal health insurance program primarily for people aged 65 and older, as well as some younger individuals with disabilities. It helps cover medical expenses such as hospital care, doctor visits, and prescription drugs. [Flat tax rate]

Which curve(s) shifts? Optimism about its value as a reserve currency cause investors to buy dollars, increasing their value relative to other currencies.

AD shifts down

What happens to SRA and LRA in this situation? Optimism about its value as a reserve currency cause investors to buy dollars, increasing their value relative to other currencies.

SRA

Output = Decreases

Price Level = Decreases

LRA

Output = —

Price Level = Decreases

Which curve(s) shifts? Infrastructure is not replaced as quickly as it wears out, causing the amount of usable infrastructure to decrease.

SRA shifts left

LRA shifts left

What happens to SRA and LRA in this situation? Infrastructure is not replaced as quickly as it wears out, causing the amount of usable infrastructure to decrease.

SRA

Output = Decreases

Price Level = Increases

LRA

Output = Decreases

Price Level = Increases

Which curve(s) shifts? Institutions become better (less corruption, more stability, more secure property rights) while at the same time households become more optimistic about economic conditions.

AD shifts right

SRA shifts right

LRA shifts right

What happens to SRA and LRA in this situation? Institutions become better (less corruption, more stability, more secure property rights) while at the same time households become more optimistic about economic conditions.

SRA

Output = Increases

Price Level = Indeterminate

LRA

Output = Increases

Price Level = Indeterminate

Use the following tax table to determine the amount of federal income tax owed by someone (like, say, a ski instructor —in this example, an unmarried one) who earned a taxable income of 40,000 francs in 2024. Taxable income is what is left after subtracting off the personal exemption and deductions from the gross income.

Calculate town until 40,000 francs

Given that the taxable income for this person will be 40,000 francs, what is the average tax rate (or “effective tax rate”) given the amount of tax?

6030

6030/40000 = 0.1575 × 100 = 15.075%

Assume that when aggregate income (i.e., aggregate output, or Y) increases by $200 million in the country of PortOr aggregate consumption (C) there increases by $75 million.

Using the pieces of information just given, find the marginal propensity to consume (MPC) for the economy of PortOr? Show your work. Express your answer as either a fraction or the appropriate decimal.

75 / 200 = 0.375

Assume that when aggregate income (i.e., aggregate output, or Y) increases by $200 million in the country of PortOr aggregate consumption (C) there increases by $75 million.

What is the numerical value of the government-spending multiplier for the economy of PortOr? Show your work. Express your answer as either a fraction or a decimal.

MPC = 0.375

MS = 1 / (1-0.375) = 1/0.625 = 1.6

Assume that when aggregate income (i.e., aggregate output, or Y) increases by $200 million in the country of PortOr aggregate consumption (C) there increases by $75 million.

c. PortOr’s government passes legislation to increase government spending by $10 million. What will the overall impact on the economy be?

MS = 1.6

Gov Spending x MS
10 X 1.6 = $16 MILLION

Assume that when aggregate income (i.e., aggregate output, or Y) increases by $200 million in the country of PortOr aggregate consumption (C) there increases by $75 million.

d. Suppose the government of PortOr passed the legislation in part c while the economy was in an expansion. Draw the equilibrium before they passed the legislation in part c and label it A. Then draw what happens after they spend $10 million and label the new equilibrium as B. Did the government help “smooth” the business cycle with this increase in spending?

AD shifts right

No, we made it worse, because now we are further from the expansion

Which curve(s) shifts? Input prices decrease temporarily.

AD shifts right

What happens to SRA and LRA in this situation? Input prices decrease temporarily.

SRA

Output = Increases

Price Level = Increases

LRA

Output = —-

Price Level = —-

Which curve(s) shifts? Households are increasingly pessimistic about future economic conditions.

AD shifts left

What happens to SRA and LRA in this situation? Households are increasingly pessimistic about future economic conditions.

SRA

Output = Decreases

Price Level = Decreases

LRA

Output = —-

Price Level = Decreases

Which curve(s) shifts? Demographic factors lead to a dramatic increase in the labor force. Additionally, these new workers increase overall consumption spending.

AD shifts right

LRAs shift right

SRAs shift right

What happens to SRA and LRA in this situation?

Demographic factors lead to a dramatic increase in the labor force. Additionally, these new workers increase overall consumption spending.

SRA

Output = Increases

Price Level = —

LRA

Output = Increases

Price Level = —-

Which curve(s) shifts? Institutions deteriorate (increased corruption, less stability, less secure property rights).

LRAs shifts left

SRAs shift left

What happens to SRA and LRA in this situation? Institutions deteriorate (increased corruption, less stability, less secure property rights).

SRA

Output = Decreases

Price Level = Increases

LRA

Output = Decreases

Price Level = Increases

Use the following tax table to determine the amount of federal income tax owed by someone (like, say, a college professor—in this example, an unmarried one) who earned a taxable income of $150,000 in 2024. Taxable income is what is left after subtracting off the personal exemption and deductions from the gross income.

Calculate each percentage bracket and then add them together to get taxable income

How do you find marginal tax rate?

Marginal tax rate means if you earn $150,001 after $150,000 what percent tax do you pay on that extra dollar earned

Given that the taxable income for this person will be $150,000, what is the average tax rate (or “effective tax rate”) given the amount of tax you calculated previously?

$25,000

$25,000/$150,000=0.166666 or 16.67%

What other taxes might this person have to pay on their income? List at least two and explain what each is.

Social Security is a federal program that provides income to retired workers, people with disabilities, and surviving family members. It is funded through payroll taxes paid by workers and employers and serves as a safety net in old age or when earnings are lost.

Medicare is a federal health insurance program primarily for people aged 65 and older, as well as some younger individuals with disabilities. It helps cover medical expenses such as hospital care, doctor visits, and prescription drugs.

Assume that when aggregate income (i.e., aggregate output, or Y) increases by $300 million in the country of VancougerVille aggregate consumption (C) there increases by $75 million.

Using the pieces of information just given, find the marginal propensity to consume (MPC) for the economy of VancougerVille? Show your work. Express your answer as either a fraction or the appropriate decimal (don’t round).

MPC -> $75/300 = 0.25

What is the numerical value of the government-spending multiplier for the economy of Vancougerville? Show your work. Express your answer as either a fraction or a decimal.

1/(1-0.25)= 1.333

Vancougerville finds itself in a recession and the government has decided to intervene to raise aggregate output (GDP, or Y) from its current level of $500 billion. The government of Vancougerville would like to raise GDP (i.e., Y) to $750 billion. Using the answer for the multiplier calculated in part (b), what change in government spending will be required to lift Vancougerville’s GDP from $500 billion to $750 billion? Show your work.

Target GDP (750) — Current GDP (500) = 250

250 / 1.3333 =

Change in government spending = $187.5 billion