IB ECONOMICS SL: The BIG 78

Exam Review 2013-2014

Please answer all of the questions completely to earn full credit.
Bring this packet with you to class on 4/21 and 4/29-4/30 for check-in and review.

Unit 0: Introduction to Economics

1. Define the following terms:

a. Scarcity: The situation in which available resources, or factors of production, are finite where as wants
are infinite. There are not enough resources to produce everything that human beings need and want.
b. Trade-off/choice: Since resources are scarce, economics is a study of choices . Economic decision
makers continually make choices between competing alternatives and economics studies the
consequences of these choices , both present and future.
c. Opportunity cost: The value of the next best alternative that must be sacrificed to obtain something else
, is central to the economic perspective of the world, and results from the scarcity that forces choices to
be made.
d. Utility: The satisfaction that consumers gain from consuming something.
e. Positive economics: The body of economics based on positive statements, which are about things that
are, were, or will be. Positive statements may be true or false so they can be refuted. They form the basis
of theories and models that try to explain economic events.
f. Normative economics: The body of economics based on normative statements, which involve beliefs,
or value judgements about what ought to be. Normative statements cannot be true or false. They cannot
be refuted, they can only be assessed relative to beliefs and value judgements. Normative economics
forms the basis of economic policies.

2. What are the three parts of the “basic economic problem”? Why are these problems?

-What to produce- All economies must choose what particular goods/services and what quantities of these they
wish to produce.

-How to produce- All economies must make choices on how to use their resources in order to produce goods
and services.

-For Whom to produce- All economies must choose how the goods and services produced are to be distributed
among the population.

They are problems due to the scarcity of resources; as the needs and wants of people are endless, the
resources available to satisfy the needs and wants are limited. It is a problem of how to make the best use of
scarce resources.

3. Define factors of production and list them.

(i) Land- all-natural resources. Households let firms use the resources. Households receive rent.

(ii) Labor- Physical and mental effort that people contribute to the production of a goods and services.
Households provide labor. Households receive wages.
(iii) Capital- Man made factors of production used to produce goods and services. Households own capital.
Households receive interest.

(iv) Entrepreneurship- (management) is a special human skill possessed by some people, including the ability
to innovate by developing new ways of doing things, to take business risks, to seek new opportunities.
Households provide risks and ideas. Households receive profit.

4. Draw a production possibilities curve (PPC) for any two items. Label your diagram completely.
On your diagram, illustrate and label the following:
a. A point where all the economy’s resources are fully utilized, given currently available technology.
b. A point where all the economy’s resources are not fully utilized.
c. An increase in the productive potential of the economy.

Here is a production possibility curve (PPC) for Microwave ovens

and computers.

Unit 1: Microeconomics

5. What is demand? How is quantity demanded different?

The demand of an individual consumer determines the various quantities of a good (or service) the consumer is
willing and able to buy at any different possible prices during a particular time period, Ceteris Paribus.
Where a change in demand means that the entire demand curve shifts right or leftward, a change in quantity
demanded refers to a movement along the demand curve. Quantity demanded is the amount of a good/service
consumers demand over a given period of time. It is a result of a change in price.

6. Explain the law of demand. Why is this the case?

According to the law of demand, there is a negative casual relationship between the price of the good and its
quantity demanded over a particular time period. Ceteris Paribus- As the price of a good increases, the quantity
demanded falls; As the price falls, quantity demanded increases, due to Ceteris Paribus.

7. Define and explain the following:

a. Income effect :How a change in demand for a good is affected by a change in real disposable income.
Ex. If the price of school fees rises, this reduces disposable income and therefore, demand will fall.

b. Substitution effect: How a change in the price of a good affects demand compared to others.
Ex. If price of apples rises, consumers will substitute apples for other goods like bananas.
c.
8. What is the difference between the following? Give examples of each.

a. Normal and inferior goods

Normal Goods
A good when demanded for it increases in
response to an increase in consumer
income (the demand for a good varies
directly with income).
Inferior Goods
Goods for which when income increases,
demand falls. (The demand of the good
varies inversely with income).

b. Substitute and complementary goods

Substitute Goods
Two goods are substitutes; if they satisfy a
similar need. If any two goods are
substitutes of each other (x & y) , a
decrease in the price of x produces ma
leftward shift in the demand for y.
Therefore, in the case of substitute goods,
the price of x and demand for y change in
the same direction (they both increase or
they both decrease).
Complementary Goods
Two goods are complements if they tend to
be used together. Any two complementary
goods (x & y), a fall in the price of x leads
to a rightward shift in demand for y. In the
case of complementary goods, the price of
x and the demand for y change in opposite
directions (as one increases, the other
decreases).

9. Explain and give examples of some factors that will affect the demand for a product.

The Determinants of Demand:

1. I
ncome: In the case of a Normal Good and Inferior Goods. For a Normal Good (when demand for it
increases, in response to an increase in income) the increase income leads to a greater demand, ex. Food
staples, household items, clothing, etc. For an Inferior Good for which when income increases, the
demand falls (opposite relationship), examples are- second hand items, used cars, bus tickets. This is
because they can upgrade with their higher income and buy new items instead.

2. P
reference & Tastes: If preferences and tastes change in the favor of a product (the good becomes more
popular), the demand increase, and the demand curve shifts to the right; if tastes change against the
product (it becomes less popular), demand decreases, and the demand curve shifts to the left.

3. S
ubstitutes & Complements: If two goods are substitutes like Pepsi and Cola, the demand for it will
varies directly with income. If two goods are complements (goods that are used together) like DVDs and
DVD players, as the price of one increases the demand for the other decreases (opposite relationship).
 4. D
emographic (population) changes: There can be an increase in demand if there is an increase in the
population as there are more consumers. If there are fewer buyers, demand is lower.

5. E
xpectations: Consumers often demand larger quantities of a commodity if they expect the price of it to
rise in the future. Conversely, they wait to buy it later in the future (meaning less demand now) if they
expect the price to fall in the future. For ex. Real estate.

A shift to the right of the demand curve means an increase in demand (more consumers want this
good/service), and a shift to the left of the demand curve means a decrease of demand (fewer
consumers want this good/service). Therefore, when, for example a good becomes more popular,
demand shifts rightward (an increase in demand).

10. What is supply? How is quantity supplied different?

The supply of an individual firm indicates the various quantities of a good/service a firm is willing and able to
supply for a market for sale, at different possible prices, during a particular time period, ceteris paribus.
Quantity supplied is the amount of good/service a producer is willing to sell at a given price. Any change in
price produces a change in quantity supplied. Whereas the supply is the relationship between price and the
quantity supplied. Price is the only thing that influences how much the firm supplies to the market.

11. Explain the law of supply. Why is this the case?

According to the law of supply, there is a positive casual relationship between the quantity of a good/service
supplied over a particular time period and its price, ceteris paribus; as the price of the good increases, the
quantity supplied also increases, as the price falls, the quantity supplied also falls, due to ceteris paribus.

12. Explain and give examples of some factors that will affect the supply of a product.
The determinants of Supply

1. C
osts of the factors of production- The firm buys various factors of production (land, labor, capital,
entrepreneurship) that it uses to produce its products. Prices of the factors of production are important in
determining the firm’s costs of production. If a factor price rises, production costs increase, production
becomes less profitable and the firm produces less; the supply curve shifts to the left. If a factor price
falls, costs of production fall, production becomes more profitable and the firm produces more; the
supply curve shifts to the right. For example, if the price of wheat increases, then less bread would be
produced.

2. T
echnology- A new improved technology lowers costs of production, thus making production more
profitable. Supply increases and the supply curve shifts to the right. In the (less likely) event that a firm
uses less productive technology, costs of production increase and the supply curve shifts leftward. For
example, new machinery can allow the caps of toothpaste tubes to be fit on automatically.

3. P
rices of related goods; competitive supply & Joint supply- Competitive supply of two or more
products refers to the production of one or the other by a firm; the goods compete for the use of the same
 resources, and producing more of one means producing less of the other. For example, a farmer, who
can grow wheat or corn, chooses to grow wheat. If the price of corn increases, the farmer may switch to
corn production as this is now more profitable, resulting in a fall in wheat supply and a leftward shift of
the supply curve. A fall in the price of corn results in an increase in wheat supply and a rightward shift
of the supply curve.

Joint supply of two or more products refers to the production of goods that are derived from a single
product, so that it is not possible to produce more of one without producing more of the other. An
increase in the price of one lead to an increase in the quantity supplied and also an increase in supply of
the other joint products.

4. P
roducer Expectations- If firms expect the price of their products to rise, they may withhold some of
their current supply from the market (not offer it for sale), with the expectation that they will be able to
sell it at a higher price in the future; in this case, a fall in supply in the present results in a leftward shift
of the supply curve. If the expectation is that the price of their product will fall, they increase the price in
the present to take advantage of the current higher price, and hence there is a rightward shift of the
supply curve.

5. T
axes- Firms treat taxes as if they were costs of production. Therefore, the imposition of a new tax or an
increase of an existing tax represents an increase in production costs, so supply will fall, and the supply
curve will shift left. The elimination of a tax or a decrease in an existing tax represents a fall in
production costs; supply increases and the supply curve shift right.

6. S
ubsidies- A subsidy is a payment made to a firm by the government and so, also has the opposite effect
of the tax. (subsidies may be given in order to increase the incomes of producers or to encourage an
increase in the production of a good). The introduction of a subsidy or an increase in an existing subsidy
is equivalent to a fall in production costs, and gives rise to a rightward shift in the supply curve, while
the elimination of a subsidy or a decrease in an existing subsidy shifts supply leftwards. For example, if
the governments choose to support farmer, so they can increase the production of agriculture goods, they
subsidize them.

7. T
he Number of Firms- An increase in the number of firms producing the good increases supply and
gives rise to a rightward shift in the supply curve; a decrease in the number of firms decreases supply
and produces a leftward shift. This follows from the fact that market supply is the sum of all individual
supplies.

8. S
hock- The sudden unpredictable events. These can affect supply (mostly negative), for example, weather
conditions, war, natural or man-made disasters, etc. A real life example is the Louisiana Oil spill in 2012
resulted in a decrease in supply of locally produced seafood. A positive shock could be bumper crops
which is when we receive a better outcome than anticipated (in agriculture).

When the supply curve shifts rightward, the quantity supplied is greater, and when it shifts
leftward, the quantity supplied is lesser. Therefore, when, for example, a good receives support
 (subsidy) its production increases, and more of it is produced (a rightward shift of the supply
curve).

13. Define price mechanism and its effect on demand and supply of a good/service.
Price Mechanism is when there is a change in price, it acts as a signal for producers to produce more and an
incentive for consumers to consume more. For example, when consumer demand more of a good, say
strawberries, the price increases, which signals the producers to produce more, so they have an incentive to
produce more. When the price increases for a good, consumers are signaled and motivated (have an incentive)
to purchase less of the good.

14. Draw demand and supply diagrams to illustrate the following situations:
a. Equilibrium
b. Change in price (for demand and for supply, both increase and decrease)

15. What factors would cause demand to shift? What would have to happen for it to shift right or left.

SHIFT LEFT SHIFT RIGHT

16. What factors would cause supply to shift? What do these shifts represent in terms of supply for the good,
and why?

SHIFT LEFT SHIFT RIGHT

17. Define and graph the following situations:

 a. M
inimum price scheme (price floor): A price floor is a legally set minimum price for a good/service set
by the government.

b. Maximum
set by the government.

If we have a minimum price and surplus of goods, the government buys the
surplus then has the ability to export it for cheap.

c. C
onsumer surplus: refers to the difference
between the highest prices consumers are
willing to pay for a good and the price
actually paid. In a diagram, it is shown
by the area under the demand curve and
above the price paid by consumers.

d. P
roducer surplus: Refers to the difference
between the price received by firms for
selling their good and the lowest price
they are willing to accept to produce the
good. In a diagram, it is shown as the area
under the price received by
producers and
above the supply curve.

18. Complete the diagram with

lines representing “unitary”,
“elastic”, and “inelastic”
elasticities. Then, draw in a perfectly
elastic line and perfectly
inelastic line. Label all of your lines.
19. What values are associated with unitary, elastic, and inelastic elasticities? Write in their values below.

Elastic ______ 1 Unitary _____ 1 Inelastic _______1

20. Define price elasticity of demand (PED) and write the formula for solving a problem.
Price elasticity of demand is the measure of responsiveness of quantity demanded to a price change.
PED= % change in Qd/ % change in P

21. Fill in the blanks/explain reasons for each of the following scenarios.
a. If
a good has an inelastic PED and a firm raises its price, the firm’s revenue will increase because when a
good is inelastic, even if the price increases, the good will be demanded as it does not have many
substitutes (it is essential).
b. If
a good has an elastic PED and a firm raises its price, the firm’s revenue will decrease because an elastic
demanded product has many substitutes, and consumers will buy a substitute product if the price
increases.

22. What factors would affect the elasticity of demand for a product?
The determinants of PED-

-The number of substitutes- The more substitutes it has, the more elastic demand tends to be. The fewer
substitutes it has, the less elastic demand tends to be.

-The proportion of consumers’ income- If a product is fairly low priced and takes up little of our income, we
will continue to buy it even if the price rises, because it has little effect on our standard of living. These
products would be relatively inelastic. Ex. Newspapers, gum.

-Luxury or Necessity- Necessities need to be bought regardless of the price and therefore, tend to be more
inelastic than luxuries.
-Addictiveness- Addictive goods tend to have a highly inelastic demand, because they are addictive. Ex.
Cigarettes, alcohol.

-Time- The amount of time following a price change. Consumers need more time to notice price changes. So, in
short term, following a price change, demand tends to be relatively inelastic. But, in long term, consumers are
more responsive.

23. Define cross-price elasticity of demand (XED) and write the formula for solving a problem.
Cross price elasticity of demand is the responsiveness of demand for one good to the change in the price of
another good and involves demand curve shifts.
XED= % change in Qd of good x/ % change in P of good y

24. Fill in the blanks/explain reasons for each of the following scenarios.
a. If XED between two products is negative, they are said to be complements because when the demand of
one good increases, the demand for the other decreases.
b.
c. If XED between two products is positive, they are said to be substitutes because when the price of one
good increases, the demand for the other also increases.
d.

25. Define income elasticity of demand (YED) and write the formula for solving a problem.
Income elasticity of demand is the measure of the responsiveness of demand to the changes in income, and
involves demand curve shifts. It provides information on the direction of change of demand given a change in
income (increase or decrease) and on the size of the change (size of the demand curve shifts).
YED = % change in the Qd/ % change in the Y (income)

26. Fill in the blanks/explain reasons for each of the following scenarios.
a. If YED of a product is negative, it’s said to be inferior because demand for the goods and income move
in opposite directions (as one increases, the other decreases).

b. If YED of a product is positive, it’s said to be normal because the demand and income change in the
same direction (both increase or decrease).

27. Define price elasticity of supply (PED) and write the formula for solving a problem.
Price elasticity of supply is the measure of the responsiveness of the quantity of a good supplied to changes in
its price.

PES = % change in Qs / % change in P

28. What factors would affect the elasticity of supply for a product?
The determinants of PES-

-The length of time- Over a short period of time, the firm may be unable to increase or decrease any of its
inputs to change the quantity it produces, so PES= inelastic.
As the length of time increases, the responsiveness to the quantity supplied to price changes begins to rise.
Therefore, the larger the time period, the greater the response firms can give. The larger the amount of time, the
larger the PES.

-Mobility of factors of production- The more easily resources can be shifted from one line of production into
another (where price is increasing), the greater the responsiveness of Qs to changes in P, therefore, the greater
the PES.

-spare (unused) capacity of firms- The greater the spare (unused) capacity, the higher the PES (more elastic
the supply). The less the spare capacity, the smaller the PES (the less elastic the supply).
-Ability to store stocks- Some firms store stocks of output they produce but do not sell right away, the firms
that have an ability to store stocks are likely to have a higher PES for the products, than firms that cannot store
stocks. Note, that this is something that can affect PES over short periods of time, because once stocks are
released in the market and sold, other factors determining PeS come into play.

29. What is the difference between direct and indirect taxes? Give an example for each.
Indirect taxes differ from direct taxes as direct taxes involve the payment of the tax payers directly to the
government.
a. A specific tax is: A fixed amount of tax per unit of the good or service sold.

b. An ad valorem tax is: A fixed percentage of the price of the good or service; in this case, the amount of
tax increases as the price of the good or service increases.

30. Draw a diagram to illustrate each of the following situations and explain what
is happening in each graph.
a. Imposition of an ad valorem tax on a good

b. Imposition of a specific tax on a good

31. How would the situations above change if the product became:
a. More elastic:

b. More inelastic:

32. What is a subsidy?

A subsidy refers to assistance by the government to individuals or groups, such as firms, consumers, industries,
or sectors of an economy.

33. Draw a diagram to illustrate what happens when a subsidy is introduced for a particular product. Then
explain how elasticity of supply and demand will affect the diagram.
34. When, in a market/society, it is impossible to make one person better off without making someone else
worse off, the situation is referred to as:

Pareto optimality (also referred to as Pareto efficiency) describes a situation where no further improvements to
society's well being can be made through a reallocation of resources that makes at least one person better off
without making someone else worse off.

35. Define the following terms and give an example of each.

a. Imperfect competition : Refers to the situation where firms face some degree of competition (therefore
they are not monopolies) but also have some degree of market power (therefore they are not perfectly
competitive); include monopolistic competition and oligopoly.
b. Public goods (give two types): A good that is non-rivalrous ( its consumption by one person does not
reduce consumption by someone else) and non-excludable (it is not possible to exclude someone from
using the good). Since it is not possible to exclude someone from using the good even though they do
not pay for it, firms do not have an incentive to produce it. Public goods are therefore provided by the
government. This is a type of market failure.
c. Merit goods: Goods that are held to be desirable for consumers, but which are under provided but the
market. Reasons for under provision are usually that the goods have positive consumption externalities,
in addition, consumers with low incomes may be unable to afford them (and so do not demand them), or
there is a consumer ignorance about the benefit of goods.
d. Demerit goods: Goods that are considered to be undesirable for consumers and are under provided but
the market. Reasons for over provisions

36. Why do the following situations occur?

a. Why will public goods not be provided in a free-market economy?
A public good is often (though not always) under or not -provided in a free market because its characteristics of non-
rivalry and non-excludability mean there is an incentive not to pay. In a free market, firms may not provide the good as
they have difficulty charging people for their use.

b. Why are merit goods under-provided in a free-market economy?

Merit goods are those goods and services that the government feels that people will under-consume, and which

ought to be subsidised or provided free at the point of use so that consumption does not depend primarily on the

ability to pay for the good or service.

c. Why are demerit goods Over-supplied in a free-market economy?
The society wants less of these demerit goods (such as cigarettes) so the society wants less of these to be
produced, which means now they are being over supplied.

37. Define the following key terms:

a. M
arginal social cost (MSC)- refers to the costs to the society of producing more than one unit of a good.
b. M
arginal social benefit (MSB)- refers to the benefits to society from consuming more than one unit of a
good.
 c. M
arginal private cost (MPC)- refers to the costs to producers of producing more than one unit of a good.
d. M
arginal private benefit (MPB)- refers to the benefits to consumers for consuming more than one unit of a
good.
e. E
xternalities- An externality occurs when the actions of consumers or producers give rise to negative or
positive side effects to third parties.

38. There are four different situations where externalities can occur. For each
of these, define the term, draw a diagram and explain the situation. Include a(n)
example(s) in your explanations.

a. Negative

The supply curve, s=MPC, reflects the firm’s private costs pf production,
and the MSC- Marginal social curve represents the full cost to society of
producing cement. For each level of output Q, the social costs for producing
cement (MSC) are much greater than the firm’s private costs (MPC). The
vertical difference between the MSC and MPC represents the external costs.
Since the externality involves only production (the supply curve), the
demand curve represents both the Marginal Private benefits (MPB) and the
Marginal Social Benefits (MSB). The free-market outcome is determined by the intersection of MPB with
MPC at Qm & Pm. The social optimum is given by the intersection between MSB and MSC at opt and Popt.
Example: The problem of environmental pollution. As a cement factory emits smoke into the air and disposes its waste
by dumping it into the ocean. There are consequences for local inhabitants, swimmers, sea life, the fishing industry,
and the marine ecosystem.

b. Positive e

The MSC curve lies below the S=MPC curve. The difference between the
two curves is the value of the external benefits. The demand curve
represents both the MPB and MSC. The optimum is at Qopt and Popt, by
the intersection between MSC with MSC. As the Qm<Qopt, the market
under allocates resources (just like in all positive externalities).

Example: -If a firm engages in research and development, and succeeds in

developing a new technology, that spreads throughout the economy, there are
external benefits for the society as well, as they are able to utilize those
technologies.

-Firms can train workers to who later switch jobs and work elsewhere; external benefits are created as the new
employers and society benefit from the trained workers.

-A pharmaceutical company develops a new medication that benefits not only its
users but also those around them from the improved quality of life and increased
life expectancy.
 c. N
egative externalities of consumption- The external costs created by consumers.

The MPB does not reflect the MSB. The external costs cause the MSB curve to lie below the MPB. The
vertical distance between the MPB and MSB represents the external costs. Since the externality involves
consumption, (demand curve) the Supply curve represents both the MPC and MSC. The market determines
equilibrium at Qm Pm , given by the intersection of the MPB and MPC curves. The social optimum at Qopt
and Popt is determined by the intersection of the MSB and MSC curves.
Example: -When consumers smoke in public places, there are external costs that spill-over to society (second-hand
smoking).

-Heating homes and driving cars by the use of fossil fuels that pollute the atmosphere.

-Partying with loud +music until the early hours of the morning, and disturbing
the neighbors.

d. Positive e
.

The MSB curve lies above the MPB. The difference between the two curves are
the external benefits to society. Qopt is given where MSB=MSC, Qm is given by
MPB= MPC. Since Qopt>Qm, the market under allocates resources to the
production of the good; too little is produced. (just like all positive externalities .
Example: -The consumption of education benefits the person who receives the
education, but it also gives additional external benefits, involving social benefits
for a more productive workforce, lower unemployment, higher rate of growth,
more economic development, lower crime rates, etc.
-The consumption of healthcare benefits society similarly.

How might taxes or subsidies change the graphs above?

For positive production and consumption externalities, subsidies can help correct
it and lead to allocative efficiency. For positive production externalities, if the
government provides a subsidy per unit of the good which is equal to the external
benefits, the MPC shifts downwards (rightwards) until it coincides with MSC.
This increases to Qopt which is the optimal quantity and lowers the price to Qopt.
Therefore, allocative efficiency is reached.
For Positive consumption externalities, subsidies are given to the firms in order to
increase production which can increase consumption as more is produced, the
market at Pc and Qopt is where allocative efficiency is achieved.

39. What types of responses could a government have to externalities? Explain.

Negative Production Externality

-Government Regulations- The Government can impose regulations to correct a negative production
externality by lowering the quantity of the good produced.

-Tax- By imposing a tax per unit produced of a good, the government can reduce the quantity produced.

-Tax on Emissions- By imposing a tax on emissions (a tax on a factor of production for the good)

-Tradeable Permits- These are rights granted by the government which can be traded. The firms which hold
the permits are allowed to produce their goods. These permits have the aim of decreasing the production of
goods with negative externalities.

Negative Consumption Externality

-Government Regulations- Regulations can be imposed to prevent or limit consumer activities that impose
costs on third parties.
-Advertising- Negative advertising by the government can help reduce consumption.

-Market-Based Policies- The Government can impose a tax on the production of the good (so it can reduce
consumption). These taxes are placed on the production as it has the same effect if it ere imposed on consumers,
however more convenient.

Positive Production Externalities

-Direct Government Provision- The government can intervene by providing goods and services in order to
increase production.

-Subsidies- If the government subsidizes the production of a good with positive externalities, it can increase its
production.

Positive Consumption Externality

-Advertising- Government can encourage the use of certain goods/services.

-Legislation- The government can make the consumption of certain goods/services compulsory.

-Direct Government Provision- The government can directly intervene.

-Subsidy- By subsidizing the good, the consumption can be increased.

40. When should the government respond to market failure?

If the benefit to solve the problem is greater than the cost to solve the problem. The government has a choice to
choose which externality they want to correct as there are opportunity costs.

41. Draw a diagram illustrating a simple circular flow of income and a diagram illustrating a complex circular
flow of income (label leakages and injections and types of each).
42. Define each of the measurements of national income:
a. O
utput method: A method used to measure the value of aggregate output of an economy, which
calculates the value of all final goods and services produced in a country within a given time period. As
suggested by the circular flow model, it is equivalent to measurement by the expenditure approach and
the income approach.
f. I
ncome method: A method used to measure the value of aggregate output of an economy, which adds up
all income earned by the factors of production in the course of producing all goods and services within a
country in a given time period. As suggested by the circular flow model it is equivalent to measurement
by the expenditure approach and the output approach.
g. E
xpenditure method: A method used to measure the value of aggregate output of an economy, which
adds up all spending on final goods and services produced within a country within a given time period
(C + G + I (X-M)). As suggested by the circular flow model, it is equivalent to measurement by the
output approach and the income approach.

43. Define the following terms:

a. g
ross national product (nominal GDP): A measure of the value of aggregate output of an economy, it is
the final market value of all final goods and services produced within a country during a given time
period (usually a year); may be contrasted with gross national income (GNI).
e. r
eal gross national product (and, how do you calculate it?) : Gross domestic product (GDP) measured
in constant prices, I.e. prices that prevail in one particular year, called a ‘base year’; this is useful for
making comparisons of changes in GDP over time that have taken into account the influence of
changing prices. It is calculated by dividing nominal GDP by the GDP deflator.
f. G
DP per capita: Gross domestic product divided by the number of people in the population; is an
indicator of the amount of domestic output per person in the population.

44. What are some of the limitations of using GDP as a measure of a country’s standard of living?

The exclusion of non-market transactions. The failure to account for or represent the degree of income inequality
in society. The failure to indicate whether the nation's rate of growth is sustainable or not.

45. The Lorenz curve is used to measure: The quality of life, with the Gini Index/Coefficient.

46. What is the Gini coefficient and how is it related to the Lorenz curve?
A summary measure of the information contained in the Lorenz curve of an economy defined as the area
between the diagonal and the Lorenz curve, divided by the entire area under the diagonal. The Gini coefficient
has a value between 0 and 1; the larger the Gini coefficient, and the closer it is to 1, the greater the income
inequality.

47. Complete the question below.

The green line is the perfect equality line. The blue/red line is the Lorenz curve which depicts the actual income

distribution. The further the blue/red line is from the green line of perfect equality, the more income inequality
there is.

Unit 2: Macroeconomics
AGGREGATE DEMAND
GDP=output=AD= C + I + G + (X-M)
48. Define aggregate demand. How is it different from demand?
The total quantity of goods and services that all buyers in an economy (consumers, firms, the government, and
foreigners) want to buy over a particular time period, at different possible price levels, ceteris paribus.

49. For each of the parts of the equation (C, I, G, (X-M)):

a. Explain what each represents and why it is part of the equation

b. Suggest reasons why each part might increase

c. Suggest reasons why each part might decrease

Demand-Side Policies
50. What is the goal of demand-side policy? Why?

51. Define fiscal policy and monetary policy.

Fiscal policy: Manipulations by the government of its own expenditures and taxes in order to influence the level
of aggregate demand; it is a type of demand-side policy or demand management.

Monetary Policy: A policy carried out by the central bank, aiming to change interest rates in order to influence
aggregate demand; it is a type of demand-side policy, or demand management.
 a. What is an expansionary fiscal policy? When would this be used and by whom?

b. What actions might be taken in expansionary policy?

c. What is a contractionary fiscal policy? When would this be used and by whom?

d. What actions might be taken in contractionary policy?

e. Explain the two methods of monetary policy. When might these be used and by whom?

52. Label the parts of the business cycle and explain when expansionary policy and contractionary policy might
be used.
AGGREGATE SUPPLY
53. Define aggregate supply.
The total quantity of goods and services produced in an economy over a particular time period at different price
levels, ceteris paribus.

54. Draw a diagram to illustrate the following, then respond to the question.
a. A short-run aggregate supply (SRAS) curve. What factors might cause AS to increase or decrease?

b. A monetarist (neo-classical) long-run aggregate supply curve (LRAS). Explain why LRAS is
different than SRAS and explain why the LRAS curve is vertical.
 c. A Keynesian long-run aggregate supply curve (LRAS). Why is it different than the neo-classical
LRAS curve?

d. For both LRAS diagrams above, using a different color, illustrate an increase in economic growth. What
might cause this growth?

Supply-side Policies
55. What is the goal of supply-side policy? Why?

56. Define market-oriented and interventionist supply-side policy

Market oriented: A policy in which government intervention is limited, economic decisions are made mainly
by the private decision-makers (firms and consumers) and the market has significant freedom to determine
resource allocation.
Interventionist supply-side policy: Any policy based on government intervention in the market intended to
affect the supply-side of the economy, usually to shift the LRAS curve to the right, increase potential output and
achieve long term economic growth.

.
a. What supply-side policies could a government use to shift the AS curve to the right?

57. Draw a diagram illustrating the following situations:

a. Long-run equilibrium from Keynesian perspective

b. Long-run equilibrium from a monetarist perspective

c. Increase in LRAS for Keynesians

 d. Increase in LRAS for monetarists

For each of the diagrams, complete the following:

a. Illustrate an increase in the AD

b. What happens to the price level as AD increases?

c. Explain why this occurs according to each theory

d. (for c/d above) Explain what the effects of this increase have on the economy as a whole

58. Define the following terms and explain what causes them to occur.
a. Inflation: A continuing or sustained increase in the general price level.
· Creeping

· Hyper-

b. Deflation: A continuing or sustained decrease in the general price level.

c. Disinflation: Refers to a fall in the rate of inflation; it involves a positive rate of inflation.

59. Explain the negative side-effects of inflation and situations in which inflation could be positive.
60. How is inflation measured?

61. Define unemployment and how it is measured by governments.

62. What are the costs of unemployment to unemployed workers, society, the economy, and the government?

63. Describe each of the following types of unemployment and potential government solutions to each. Where
possible, draw a diagram to illustrate.

a. Real-wage/classical

b. Demand-deficient/cyclical
c. Equilibrium (natural)

d. Frictional

e. Seasonal

f. Structural
64. Define the following key terms and give an example of each.
a. Progressive tax: Taxation where, as income increases, the fraction of income paid as taxes increases;
there is an increasing average tax rate.
b. Regressive tax: Taxation where, as income increases, the fraction of income paid as taxes decreases;
there is a decreasing average tax rate.
c. Proportional tax: Taxation where, as income increases, the fraction of income paid as taxes remains
constant; there is a constant average tax rate.
d. Transfer payments: Payments made by the government to individuals specifically for the purpose of
redistributing income, thus transferring income from those who pay taxes towards those who cannot
work and need assistance. Groups receiving transfer payments may include older people. Sick people,
very poor people, children of poor families, unemployed people and others; referred to as ‘vulnerable
groups’.
e. “Sticky wages”: Sticky wages are when workers' earnings don't adjust quickly to changes in labor
market conditions. For example, in the event of a recession, like the Great Recession of 2008, nominal
wages didn't decrease, due to the stickiness of wages.

Unit 3: International Economics

65. What are the benefits of trade? How is specialization linked to trade?

66. Define protectionism and explain why countries would engage in protectionism.

67. Define and draw a diagram of the following words:

a. Tariff: Taxes on imported goods; they are the most common form of trade restriction. Tariffs may
serve two purposes: to protect domestic industry from foreign competition (a protective tariff); or
to raise revenue for the government (a revenue tariff).
b. Subsidy: An amount of money paid by the government to first for a variety of reasons: to prevent
and industry from falling, to support producers’ income, or as a form of protections against
imports. (Due to lower costs and lower prices that arise from the subsidy). A subsidy given to a
firm results in a higher level of output and lower price for consumers. May also be paid to
consumers as financial assistance or for income redistribution.
c. Quota (voluntary export restraint): A type of trade protection that involves setting a legal limit to
the quantity of a good that can be imported over a particular time period (typically a year) .
(More generally a quote is a mixed or fixed number of things).
d. Embargo: A ban on imports, usually used for political reasons rather than economic reasons.
68. What effects do each of the above have on consumers, producers, and the government (foreign/domestic).

69. What is the World Trade Organization (WTO), and what are its aims?

70. Explain why “dumping” is a controversial topic and why protectionist measures are often used to combat it.

71. What is the difference between free-floating/floating, managed, and fixed exchange rates?

a. Draw a diagram of each if demand increased for currency

b. Draw a diagram of each if demand decreased for currency

72. Explain globalization’s link to multi-national corporations (MNCs). Give examples of each.

73. Trading blocs can vary depending on the level of integration involved. Complete the table below with a
short summary of each type of trading bloc and examples:
Type of bloc Explanation Examples
Preferential trading area
Free trade area

Customs union

Common market
 Economic and monetary union

74. What factors could affect the demand for a currency? The supply of a currency?

75. Explain the advantages and disadvantages of high and low exchange rates.

76. How can the government intervene in currency markets?

77. What is the balance of payments? A record (usually for a year) of all transactions between the residents of
a country and the residents of all other countries , showing all payments received from other countries (credits),
and all payments made to other countries (debits).

a. What is the current account? In Balance of payments, this includes the balance of trade ( recording
exports minus imports of goods) plus the balance on services (recording exports of services minus
imports of services), plus inflows minus outflows of income and current transfers. The most important
part of the current account in most countries is the balance of trade.

b. What is the capital account? In balance of payments, refers to the inflows minus outflows of funds for
(i) capital transfers ( including such things as debt forgiveness and non-life insurance claims), (ii) the
purchase or use of non-produced natural resources (such as mineral rights, forestry rights,, fishing rights,
and airspace); it is a relatively unimportant part of the balance of payments.

c. What is the financial account? In balance of payments, refers to inflows minus outflows of funds due
to foreign direct investment, portfolio investment, changes in reserve assets and changes in official
borrowing.

d. What parts are included in each of these accounts?

Each account includes the inflows minus outflows of income and current transfers.

78. What are the consequences of a surplus or deficit on the current or capital account?