Principle Economics Review

1. CO.OP Mart decides to open up a Market in Iran, the company…

a. Decreases the net capital outflow in Vietnam
b. Increases the net export in Vietnam
c. Decreases the net export in Vietnam
d. Causes a trade deficit in Vietnam

2. Explain how inflation causes an increase in demand for goods and services
The government decides to inject money into the economy through the Federal Reserve, which creates a large supply of
money. With people having more money in their wallets, more than they want. At the current price level, the quantity of
money supplied exceeds the quantity demanded. People try to get rid of the excess supply of money, by buying goods
and services, depositing into their bank accounts or buying bonds and stocks, which allow other people to buy goods and
services. In either case, the injection of money has caused an increase in demand for goods and services.

3. A shoeleather cost is a resource wasted when inflation encourages people to reduce their money holding by holding their
money in the bank and having to run back and forth to withdrawal money every time they need it
a. True
b. False

4. Explain an investment tax credit

An investment tax credit is an incentive for firms to invest more which would increase the demand for loanable funds,
thereby raising the equilibrium interest rate which will raise the equilibrium quantity of loanable funds

5. Suppose the government borrows $10 million more next year than this year

a. Use a supply and demand diagram to analyze this policy. Does the interest rate rise or fall
Interest rate rises

b. What happens to investment? To private saving? To public saving? To national saving? Compare the size of the
changes to $10 million of extra government borrowing
o National savings decreases by less than $10 million
o Investment also decreases by less than $10 million
o Public savings decreases by exactly $10 million
o Private saving increases by less than $10 million

c. How does the elasticity of supply for loanable funds affect the size of these changes?
Recall that elasticity of supply is the slope of the supply curve. The more elastic the supply curve, the flatter the slope
is and vice versa. The more elastic the supply curve is the smaller the responding interest rate changes will be based
on changes in Q. If the supply curve is more inelastic, the responding interest rate changes will be larger.
 d. How does the elasticity of demand for loanable funds affect the size of these changes?
Elasticity of demand is going to have the same corresponding changes in interest rate. If the demand curve is more
elastic, the changes in Q will lead to smaller changes in interest rate. The inelastic demand curve will have the
opposite effects on interest rate based on changes in Q.

e. Suppose households believe that greater government borrowing today implies higher taxes to pay off the government
debt in the future. What does this belief do to private saving and the supply of loanable funds today? Does it increase
or decrease the affects you discussed in parts (a) and (b)?
 This belief will increase private savings. If people see this government action and are worried about paying
higher taxes in the future, these people will start to save more money instead of using it for consumption.
This increase in private savings actually increases the supply of loanable funds.
 Recall that national savings = private savings + public savings. We found that public savings decreases by
exactly $10 million and national savings decreases by some number less than $10 million. Private savings is
going to increase by a number that will allow us to solve the national savings equation.
 This increase in the supply of loanable funds will reduce the interest rate increase, reduces the amount that
national savings declines, and reduce the amount that investment declines by.

6. Economists in Tuperware, a closed economy, has the following data;

Y = 10,000 C = 6,000 T = 1,500 G = 1,700 I = 3,300 – 100r

Public Saving T – G = 1,500 – 1,700 = -200

Private Saving Y – T – C = 10,000 – 1,500 – 6,000 = 2,500
National Saving (Y – T – C) + (T – G) = 2,500 + (-200) = 2,300
Investment I = S, I = (Y – T – C) + (T – G) = 2,500 + (-200) = 2,300
Real interest rate I = 3,300 – 100r = 2,300, (- 1,000) = (- 100r), r = 10

Use the information to calculate Private Saving, Public Saving, National Saving, Investment, Real interest rate

7. In the market for loanable funds of a closed economy, the amount of funds loaned depends on national saving alone?
a. True
b. False

8. Bonds are risker than stocks

a. True
b. False

9. Explain how unemployment insurance (a government policy designed to protect workers’ incomes) increases
unemployment
Unemployment insurance is given to those workers that were laid off because their previous employer no longer needed
their skills, reducing the hardship of unemployment. Because the benefits of the insurance stops when a worker takes a
new job, the unemployed devote less effort to job search.

10. The country of blah blah blah has reported to have 40,000,798 employed adults, 439,686 unemployed adults, 63,862
retired adults, and 33, 975 adults in school. Use this information to calculate:

a. The adult population

Adult population = 40,000,798 + 439,686 + 63,862 + 33, 975 = 40,538,321

b. The labor force

Labor force = 40,000,798 + 439,686 = 40,440,484

c. The unemployment rate

Unemployed rate = (439,686 / 40,440,484) x 100 = 1.09

d. The labor force participation rate

Labor force participation rate = (40,440,484 / 40,538,321) x 100 = 99.76
11. Explain Commodity money
Commodity money has intrinsic value which means that the item would have value even if it were not used as money. An
example of commodity money is gold. Gold has intrinsic value because it is used in industry and in the making of jewelry.
During World War II, prisoners traded goods and services with one another using cigarettes as the store of value, unit of
account, and medium of exchange. Cigarettes have intrinsic value and is therefore a form of commodity money.

12. Explain the Money Multiplier

The money multiplier is the amount of money that the bank adds to the money supply with every $1 in reserves. Because
the money multiplier is the reciprocal of the reserve ratio (R), which is the fraction of deposits that banks hold as reserves,
meaning the bank holds 1/R times as much in deposits as in reserves, implying a money multiplier of 1/R. if a bank holds
$1000 in deposits, then a reserve ratio of 1/20 (5%) means that the bank must hold $50 in reserves. In other words, the
bank would have 20 times as much in deposits as in reserves, which is a money multiplier of 20, meaning that each dollar
in reserves would generate $20 of money in the money supply. The higher the reserve ratio, the less banks loan out, the
smaller the money multiplier.

13. Explain the Open Market Operations and how the Federal Reserve reduces the amount of lending banks can do.
Open Market Operations is the purchasing or selling of U.S. government bonds by the Federal Reserve to increase or
decrease respectively, the money supply in the economy. When the Federal Reserve sells government bonds it
decreases the number of dollars in the economy (reducing the amount of money in circulation). Because people make
withdrawals from banks to buys these bonds, banks have a smaller quantity of reserves. Due to the smaller reserves,
banks reduce the amount of lending, leading to a decrease of money supply in the economy.

14. Explain the catch-up-effect

Other things being equal, it is easier for a country to grow fast if it starts out relatively poor. This effect of initial conditions
on subsequent growth is sometimes called the catch-up effect. In poor countries, workers lack even the most rudimentary
tools and, as a result, have low productivity. Thus, small amounts of capital investment can substantially raise these
workers’ productivity.

15. Although higher savings leads to higher growth for a period of time, growth eventually slows down as capital, productivity,
and income rise
a. True
b. False

16. Government policies try to influence the economy’s growth rate in many ways: by encouraging saving and investment,
encouraging investment from abroad, fostering education, promoting good health, allowing free trade, promoting the
research, development of new technologies, and…
a. Maintaining property rights
b. Conquering new countries
c. Declaring war against another country
d. Stop international trading

17. More rapid population growth may lower productivity by stretching the supply of natural resources and by reducing the
amount of capital available for each worker.
a. True
b. False

18. Use the Table below

Year Price of Coffee Quantity of Coffee Price Of Bananas Quantity Of Bananas

2012 1 100 2 50
2013 2 150 3 100
2014 3 200 4 150

a. Calculate the Real GDP using base year of 2012

2012: ($1 per Coffee x 100 Coffee) + ($2 per Banana x 50 Bananas) = $200
2013: ($1 per Coffee x 150 Coffee) + ($2 per Banana x 100 Bananas) = $350
2014: ($1 per Coffee x 200 Coffee) + ($2 per Banana x 150 Bananas) = $500

b. Calculate the GDP Deflator

First calculate the Nominal GDP
 2012: ($1 per Coffee x 100 Coffee) + ($2 per Banana x 50 Bananas) = $200
2013: ($2 per Coffee x 150 Coffee) + ($3 per Banana x 100 Bananas) = $600
2014: ($3 per Coffee x 200 Coffee) + ($4 per Banana x 150 Bananas) = $1200
Then, use the Nominal GDP and Real GDP to calculate the GDP Deflator
2012: ($200 / $200) x 100 = 100
2013: ($600 / $350) x 100 = 171
2014: ($1200 / $500) x 100 = 240

c. What was the inflation rate for 2013 and 2014

Inflation rate year 2013 = (171 – 100) / 100 x 100 = 71 / 100 x 100 = 0.71 x 100 = 71%
Inflation rate year 2014 = (240 – 171) / 171 x 100 = 69 / 171 x 100 = 0.4035 x 100 = 40%

19. A couch today will cost you $150. You are given $1,500 that allows you to purchase 10 couches. However, you decide to
deposit your $1,500 for 1 year at 10% interest. A year later you decide that you want to buy couches for your family and
friends. You find out that you are able to buy 11 couches. The couches experienced a…
a. Zero inflation
b. Six percent inflation
c. Ten percent inflation
d. Two percent deflation

20. A dozen eggs cost $0.88 in January 1980 and $2.11 in January 2015. The average wage for production workers was
$7.58 per hour in January 1980 and $19.64 in January 2015

a. By what percentage did the price of eggs rise?

($ 2.11- $ 0.88) / $ 0.88 × 100% = 139.77%

b. By what percentage did the wage rise?

($ 19.64- $ 7.58) / $ 7.58 × 100% = 159.1%

c. In each year, how many minutes did a worker have to work to earn enough to buy a dozen eggs?
Year 1980:
Eggs PER dozen: $0.88
Worker's Wage PER hour: $7.58
Worker's Wage PER minute: ($7.58 / 60 minutes) = $0.1263
Minutes to BUY Dozen eggs: $0.88 / $0.1263 = 6.97
It takes the worker 7 minutes of work to reach $ 0.88, the amount of a dozen eggs

Year 2015:
Eggs PER dozen: $2.11
Worker's Wage PER hour: $19.64
Worker's Wage PER minute: ($19.64 / 60 minutes) = $0.3273
Minutes to BUY Dozen eggs: $2.11 / $0.3273 = 6.45
It takes the worker 6.5 minutes of work to reach $ 2.11, the amount of a dozen eggs

d. Did workers’ purchasing power in terms of eggs rise or fall?

Workers purchasing power in terms of eggs rises. It takes less time working to buy a dozen of eggs in 2015
compared to 1980.

21. Explain the difference between CPI (Consumer Price Index) and GDP (Gross Domestic Product)
CPI is the measure of the overall cost of the goods and services bought by a typical consumer, whereas the GDP is the
measure of the quantity of goods and services that the economy is producing. The CPI measures the overall cost of living
by looking at the purchasing power. The GDP measures the economic well-being through the total income of everyone in
the economy and the total expenditure on the economy’s output of goods and services
- The CPI reflects all goods and services produced domestically
- The GDP reflects all goods and services bought by consumers
Suppose that the price of an airplane produced by Boeing and sold to the Air Force rises, Even though the plane is part of
GDP, it is not part of the basket of goods and services bought by a typical consumer. Thus, the price increases shows up
in the GDP deflator but not in the CPI.
Suppose that Volvo raises the prices of its cars. Because Volvos are made in Sweden, the car is not part of U.S. GDP, but
U.S. consumers buy Volvos, so the car is part of the typical consumer’s basket of goods. Thus, a price increase in an
imported consumption good, such as a Volvo, shows up in the CPI but not in the GDP deflator.
22. Suppose that when people’s income increase by 20%, they buy 10% less fast food. In this situation, what type of good would fast food
be? And calculate the income elasticity of demand?
a. Normal Good, 0.5
b. Inferior Good, 2
c. Inferior Good, -0.5
d. Normal Good, -2

23. The price of a haircut is generally higher in Hanoi than in Ho Chi Minh City. So, the Vietnamese Government passed a
law forbidding Salons from charging a price higher than the average price of haircuts in Ho Chi Minh City. This is an
example of:
a. a price floor.
b. a price ceiling.
c. a quota.
d. a tax.

24. The following table gives the daily supply and demand for hot dogs at a sporting event:
Price, $ Quantity demanded Quantity supplied
2.10 800 7,200
1.80 1,600 4,800
1.60 2,400 2,400
1.40 3,200 800
1.20 4,100 200

a. What is the equilibrium price of hot dogs? What makes you think so?

According to the definition, the equilibrium price is the price at which quantity supplied equals quantity
demanded. From the table we can see that at $1.60, Qs = Qd = 2,400. Therefore $1.60 is the equilibrium price.

c. If the organizers of the sporting event decide to set the price at $1.80, how many hot dogs will be sold? Explain

At $1.80, 4,800 hot dogs will be offered for sale, but only 1,600 will be demanded. Therefore, only 1,600 hot dogs
will be sold.

25. Use the Table below

% Change in % Change in
Price Quantity Total Revenue Elasticity Description
Price Quantity
10 0 0
22 200 9.1 Elastic
8 2 16
29 67 2.3 Elastic
6 4 24
40 40 1 Unit Elastic
4 6 24
67 29 0.4 Inelastic
2 8 16
200 22 0.11 Inelastic
0 10 0

a. Finish the table. Calculate the missing numbers.

Total Revenue = Price x Quantity
10 x 0 = 0
8 x 2 = 16
% Change in Price = [(P2-P1) / (P2+P1 / 2] x 100
[(2-0) / (2+0) / 2] x 100 =
[(2) / (2 / 2)] x 100 =
[(2) / 1] x 100 =
 2 x 100 = 200%
% Change in Quantity Demanded = [(Q2-Q1) / (Q2+Q1 / 2)] x 100
[(10-8) / (10+8) / 2] x 100 =
[(2) / (18 / 2)] x 100 =
[(2) / 9] x 100 =
.22 x 100 = 22%
Elasticity = % Change in Quantity Demanded / % Change in Price
200 / 22 = 9.1
Elastic >1
Unit Elastic = 1
Inelastic <1

b. Draw the graph. Is the slope of this line constant? Why or why not?
Yes
The slope is rise (change in price) over run (change in quantity) meaning that for every price change (increase or
decrease) of 2 dollars, a quantity change (increase or decrease) of 2 is seen.

c. Explain the relationship between the total revenue and Elasticity

As elasticity increases, total revenue decreases (total revenue has an inverse relationship with elasticity) and as
inelasticity decreases, total revenue decreases (total revenue has direct relationship with inelasticity)