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Week 3 Questions

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In what way is a college degree a form of capital? Its a form of capital because its something
that you invest in. And when investing in something you are hoping to get something out of it in
return. Making an investment in getting a college degree your hoping to be able to hopefully find
a good paying job with you having that degree.

Does a higher rate of saving lead to higher growth temporarily or indefinitely? A higher rate of
saving lead to a higher growth temporarily because higher saving rate allows more capital to be
accumulated, and additional capital will become smaller over time and growth will slow down.
(page 541) With the saving rate being higher your productivity and income is higher but not to
high growth. And it states the because of diminishing returns, an increase in saving rate leads to
higher growth only for a while.(page 541)

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What is investment? How is it related to national saving? Investment is spending on capital
equipment, inventories, and structures, including household purchases of new housing.
Investment relates to national saving because national savings is the total income in the economy
that remains after paying for consumption and government purchases.
S=I is the equation for national savings meaning savings equal investments. The equations starts
from the GDP equation Y=C+I+G+NX. NX is zero and subtracting C and G from both sides
will give you the national savings. You then replace the S in place of the C,G, and Y.

What distinguishes money from other assets in the


There are three things that distinguish money from

other assets in the economy. Its a medium of
exchange, a unit of account and a store of value.
Money is the considered the most liquid asset
available. You can use money to buy anything that
you want when you go to the store. For example I go
and buy shoes Ill give the cashier money in
exchange for the shoes. We also borrow money(loan)
to make more money and have to repay it back most
of the time with interest.
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Explain how an increase in the price level affects the
real value of money.
An increase in the price level will affect the value of
money because if the price level goes up then the
value of a dollar (money) is going to be lower. The
value of money will drop. For example you could
buy regular gas for .99, nowadays .99 will not even
get you 1 gallon of gas
Define net exports and net capital outflow. Explain
how and why they are related.
Net exports are the value of a nations exports minus
the value of its imports. It can also be called the trade
balance. Net capital outflow is the purchase of
foreign assets by domestic residents minus the

purchase of domestic assets by foreigners. For the

economy as a whole net capital outflow (NCO) must
always equal net exports (NX).
Every transaction that affects one side of the
equation will equally affect the other side by the
exact same amount. Example when the US exports
something to a foreign country and the foreign
countries pays for it with their currency now the US
has foreign assets (currency). The US net exports is
matched by an increase in the US net capital

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Why are budget deficits and trade deficits sometimes
called the twin deficits?
Budget deficit is a shortfall of tax revenue from
government spending and trade deficit is an excess
of imports over exports. In 1980 the fiscal policy of
the U.S government changed. The president and
Congress enacted large cuts in taxes, but didnt cut
government spending which resulted in a large
budget deficit. It was predicted that it would lead to
a trade deficit which it did. Because both the trade
deficit and budget deficit happened happen during

the same time and was closely related the nicked

named them the twin deficits. (page 706)
If the Fed wants to increase the money supply
through open-market operations, what does it do?
If the Fed wants to increase the money supply
through open-market operations they create money
and use it to buy government bonds from the public
in the nations bond markets. The money the Feds
pay for the bonds increase the number of dollars in
the economy. 2. If inflation is less than expected, who
benefitsdebtors or creditors? Explain Who would
benefit is the debtor because they (businesses,
individuals etc) borrow from banks it most likely at a
fixed rate and if higher than expected inflation occurs
then the real value of the borrowers debt is reduced.
3. Should the federal government always balance its
budget? Why or why not? Pro: If the federal
government balances its budget future taxpayers
would have to choose to whether to either pay higher
taxes and less government spending to make
resources available to pay off their debt. or they can
put the government into a deeper debt by borrowing
to pay off the old debt and interest. (page823) Also
with balancing the budget can be justified by our
military and war. It is ok for the government borrow

and finance them because taxes during a war could

rise. And itd be unfair to future taxpayers who also
have to fight the war. Balancing the budget means
greater national savings, investment and economic
growth. And future graduates will have a more
prosperous economy. Cons: If the government didnt
balance its budget it would mess up the future
generation thats if the government cuts the budget
deficit. Right now the US is most indebted today
than it was years ago. To offset the government
balancing the budget parents would have to start
saving and leave a bigger inheritance for their
children. The more that technology and the
population grows the more in debt the government
will also grow. Looking at both, with the federal
government balancing the budget or not it can be a
good thing and it could be a bad thing. As far as
parents saving up for their children the way the
economy is now that is going to be hard for some
families and then if they do budget their future could
be better in the economy but they would have to
choose paying higher taxes or not. Its almost a darn
if you do or darn if you dont situation. 4. How do
falling interest rates and falling prices influence total

demand in the economy? Include the wealth effect

in your answer.
The price level and consumption: The Wealth Effectthe nominal value of money is fixed. But the real
value of a dollar is not fixed. When prices decrease it
raises the value of money and consumers will spend
more on goods and services. The price level and
investment: The Interest-Rate Effect- a lower price
level reduces the interest rate and consumers will
spend more on investment goods which increases the
quantity of goods and services demanded. A higher
price level raises interest rates and consumers invest
less decreasing the quantity of goods and services
demanded. The price level and Net Exports: The
Exchange-Rate Effect- When U.S. price level fall the
U.S. interest rates fall, and the real value of the dollar
declines in foreign exchange markets.