Exam

Name___________________________________

1) How does the production of a U.S. firm located in France affect U.S. GDP? How does the production of a French
firm located in Ohio affect U.S. GDP?

2) Is every product produced in the United States included in U.S. gross domestic product?

3) Neither intermediate goods nor used goods are included in GDP. Explain why these expenditures are not included
in GDP.

4) List and compare the four components of the expenditure approach to calculating GDP.

5) What is the difference between real and nominal GDP and why do economists make this distinction?

6) Can nominal GDP ever be less than real GDP?

7) Assume a small nation has the following statistics: its consumption expenditure is $15 million, investment is $2
million, government purchases of goods and services is $1 million, exports of goods and services to foreigners is $1
million, and imports of goods and services from foreigners is $1.5 million. Calculate this nation's GDP.

Billions of
Item
dollars
Consumption expenditure 6,258
Investment 1,623
Government expenditure on
1,630
goods and services
Exports of goods and services 998
Imports of goods and services 1,252

8) The table above gives the values of different expenditures in the United States during 1999. Answer the following
questions about the United States.
a) What was the value of net exports of goods and services in 1999?
b) What was (nominal) GDP equal to in 1999?
c) What was the (nominal) value of total production equal to in 1999?

9) How is the unemployment rate calculated? Include in your answer the process by which the U.S. Census Bureau
classifies the data it collects in its Current Population Survey.

10) Define the unemployment rate and labor-force participation rate. Discuss the differences between these two rates.

11) List and define the three types of unemployment.

12) Why is there unemployment even when the economy is at "full employment"?

13) Is the CPI a biased measure of the inflation rate? Explain your answer.

14) Suppose the current unemployment rate is 5 percent, the labor force is 400 million people, the labor force
participation rate is 80 percent and the working-age population is 500 million people. What number of people are
unemployed?

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 15) Suppose the population is 220 million people, the labor force is 150 million people, the number of people employed
is 130 million and the working-age population is 175 million people. What is the unemployment rate?

16) Suppose the working-age population is 150 million, the labor force is 125 million, and employment is 120 million.
a) What is the unemployment rate?
b) Now suppose that 2 million students graduate from college and begin to look for jobs. What is the new
unemployment rate if none of the students have found jobs yet?
c) Suppose that all 2 million students find jobs. What is the unemployment rate now?

17) Suppose there are 180 million employed people and 20 million unemployed people.
a) What is the unemployment rate?
b) Suppose that 5 million unemployed people give up their search for jobs and become discouraged workers.
What is the new official unemployment rate?

Labor demand Labor supply

Real wage rate
(billions of (billions of
(2009 dollars)
hours per year) hours per year)
0 30 6
1 25 5
2 20 4
3 15 3
4 10 2

Employment Real GDP

(billions of (billions of 2009
hours per year) dollars)
6 95
5 90
4 80
3 60
2 30

18) The first table above gives the labor demand and labor supply schedules for a nation. The second table gives its
production function.
a) What are the equilibrium real wage rate and the level of employment?
b) What is potential GDP?

19) Explain the relationship between the real interest rate and the demand for loanable funds. Compare that
relationship to the relationship between expected profit and the demand for loanable funds.

20) Explain how each of the following events affect the supply of loanable funds curve:
a) The economy is in a recession so people's disposable income is lower.
b) The stock market is booming so the people's wealth is higher.
c) Fewer college graduates are finding jobs so expected future income is lower.
d) The real interest rate increases.

21) How do banks create liquidity?

22) Explain the process by which the banking system creates money.

23) What factors affect the demand for money?

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Real interest Loanable funds Loanable funds
rate demanded supplied
(percent per (trillions of (trillions of
year) 2009 dollars) 2009 dollars)
10 0.7 1.5
8 0.9 1.3
6 1.1 1.1
4 1.4 0.9
2 1.7 0.7

24) The table above shows the loanable funds supply and demand schedules.
a) What is the equilibrium real interest rate and the equilibrium quantity of loanable funds?
b) If the real interest rate is 4 percent, is there a shortage or surplus? What will happen in the market?

25) Explain which of the following count as money.

a) a check in Ann's checkbook
b) currency in Ann's bank
c) currency in Ann's purse
d) Ann's checking deposit

26) If you hold $25 in cash, have $150 in a checking account, and have $250 in a savings account, how much of M2 do
you have?

27) The First National Bank of Townville has $125,000 in U.S. government securities, $200,000 in savings accounts,
$300,000 in checking accounts, $50,000 in its reserve account at the Fed, $10,000 of currency in its vault, and loans of
$250,000. What is the amount of its reserves?

28) A bank has checking deposits of $400, saving deposits of $900, time deposits of $900, loans of $950, government
securities of $900, outstanding credit card balances of $400, currency in its vault of $40, and deposits in its reserve
account at the Fed of $40.
a) What is the amount of this bank's deposits that are in M1?
b) What is the amount of this bank's deposits that are in M2?
c) What is the amount of this bank's reserves?

Quantity of money
Interest rate
demanded (trillions
(percent per year)
of 2005 dollars)
3 2.0
4 1.5
5 1.0
6 0.5

29) The above table has the demand for money schedule.
a) If the Fed sets the quantity of money equal to $1.0 trillion, what is the equilibrium interest rate?
b) If the Fed wants the interest rate to be 4 percent, what must it do?

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Answer Key
Testname: UNTITLED1

1) U.S. GDP includes all production in the United States, regardless of who owns the factors of production used. Therefore,
the production by the U.S. firm in France won't be counted in U.S. GDP because the production does not take place in the
United States. However, the production by the French firm in the United States will be counted as part of U.S. GDP
because the production has taken place in the United States.
2) No, not every product produced is included in U.S. GDP. For instance, goods produced as intermediate goods are
excluded. Only FINAL goods and services are included. In addition, GDP counts only goods traded in markets, so goods
and services that people produce for their own use are excluded.
3) Intermediate goods and used goods are not included in the measurement of GDP because they do not represent final
expenditures on goods and services produced within the relevant time period. Intermediate goods are inputs used in the
production of final goods and services. To count them twice would be double counting and inflate the level of GDP. Used
goods already have been counted in GDP during the year in which they were produced. They were not produced in the
current time period and therefore are not included in GDP.
4) The 4 parts can be summarized according to the formula GDP = C + I + G + (X - M). The first part, C, is consumption
expenditure, which measures household spending and is the largest component accounting for around 70 percent of GDP.
The next category, I, is investment and refers to the purchase of new capital, the purchase of new homes and changes in
inventories. This fluctuates a great deal but generally accounts for 15 to 20 percent of GDP. Next is G, which government
expenditure on goods and services. This component includes purchases by all levels of government on new goods and
services and is about 20 percent of GDP. The final category, (X - M), is net exports. In it, exports are added and imports are
subtracted. This component is typically negative in the United States because we typically run a trade deficit. It is
generally around -1 to -5 percent or so of GDP.
5) Real GDP is a measure of the final goods and services produced in a year valued at constant prices. Nominal GDP is the
final goods and services produced in a year valued at the prices that existed during the year. Economists make the
distinction between real GDP and nominal GDP because nominal GDP changes for two reasons: When the production of
goods and services changes and when the prices of the goods and services change. Economists want to be able to
distinguish between changes brought about by production changes and changes brought about by price changes. Real
GDP allows economists to make this distinction. In particular, by using prices that are constant, a change in real GDP
represents a change in the production of goods and services and factors out the change in prices. Thus real GDP removes
the effect from changes in prices and thereby reveals the change in the underlying production of goods and services.
6) Yes, nominal GDP can be less than real GDP. If prices generally fall from one period to the next, then nominal GDP is less
than real GDP. However, in the U.S. economy, because prices generally rise, nominal GDP typically is greater than real
GDP (except in the base period.) But, there is no economic law that states that prices must generally rise and so there is no
necessity for nominal GDP to be larger than real GDP.
7) The nation's GDP equals the sum of consumption expenditure, investment, government purchases of goods and services,
and net exports of goods and services, where net exports of goods and services equals of goods and services exports minus
imports of goods and services. So, GDP = $15 million + $2 million + $1 million + $1 million - $1.5 million = $17.5 million.
8) a) Net exports of goods and services equals the value of exports of goods and services, $998 billion, minus the value of
imports of goods and services, $1,252 billion, or -$254 billion.
b) GDP equals the sum of consumption expenditure, $6,258, plus investment, $1,623, plus government expenditure on
goods and services, $1,630, plus net exports, -$254, or $9,257 billion.
c) The value of total production equals the value of GDP, so total production was $9,257 billion in 1999.
9) The U.S. Census Bureau conducts the Current Population Survey which asks questions about the age and employment
status of household members. The population is divided into the working-age population (everyone 16 or older who is
available to work) and all the others. The working age population is divided into the labor force and those not in the labor
force. The labor force includes all those who are working (either part-time or full-time) and those who are unemployed.
The unemployment rate is the ratio of the unemployed to the labor force multiplied by 100 to convert it into a percentage.
10) The unemployment rate is defined as [(number of unemployed) ÷ (labor force)] × 100, and the labor force participation
rate is defined as is [(labor force) ÷ (working-age population)] × 100. The two measures give different perspectives on the
labor market. The labor force participation rate tells the percentage of the working-age population that is either working
or is available for work. The unemployment rate tells the percentage of the people working or available for work (the
labor force) who do not have jobs.

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Answer Key
Testname: UNTITLED1

11) The three types are frictional, structural and cyclical. Frictional unemployment is defined as the normal turnover in the
labor market of workers entering and leaving the work force. Structural unemployment is caused by technological change
or international competition that causes jobs to disappear. Cyclical unemployment is caused by business cycle fluctuations
that change the unemployment rate.
12) There is unemployment even at "full employment" because there always will be unemployment. Unemployment is a
natural occurrence in any economy with changes, such as high school or college graduates entering the labor force, or
technological advances in one sector, or consumer preferences changing to favor one product over another. Frictional and
structural unemployment will always exist. Cyclical unemployment, however, is a different matter. Cyclical
unemployment does not seem to have the same degree of inevitability and hence full employment is defined as occurring
when cyclical unemployment equals zero.
13) There are at least four sources of bias in the CPI measure. The first bias is the new goods bias, which refers to the fact that
new goods are continuously replacing old ones. Because the new goods are often both of higher quality and higher priced,
their introduction complicates measuring the CPI. The new goods bias biases the CPI upwards. Second, the CPI is not
always adjusted for improvements in the quality of the products, which is the quality change bias. A price hike that
reflects a quality increase often is mistakenly recorded as only a price hike, with no recognition given to the higher quality.
Third, consumers substitute relatively lower priced goods for goods that increase in price, which is called commodity
substitution. However, the CPI doesn't take this substitution into account, thereby giving rise to the commodity
substitution bias. Fourth, when faced with price hikes, consumers switch away from buying at full service stores to buying
from discount stores because the prices in the discount stores are lower. Once again, the CPI does not take account of this
outlet substitution and so the CPI suffers from the outlet substitution bias.
14) The number of unemployed people equals the labor force multiplied by the unemployment rate. So the number of
unemployed people is (400 million) × (5 percent) = 20 million people.
15) The unemployment rate is (20 million unemployed) ÷ (150 million labor force) × 100 = 13.3 percent.
16) a) The unemployment rate is (5 million unemployed) ÷ (125 million labor force) × 100 = 4.0 percent.
b) The unemployment rate is (7 million unemployed) ÷ (127 million labor force) × 100 = 5.5 percent.
c) The unemployment rate is (5 million unemployed) ÷ (127 million labor force) × 100 = 3.9 percent.
17) a) The unemployment rate is (20 million unemployed) ÷ (200 million labor force) × 100 = 10.0 percent.
b) The unemployment rate is (15 million unemployed) ÷ (195 million labor force) × 100 = 7.7 percent.
18) a) The equilibrium real wage rate is $15 an hour because this is the real wage rate for which the quantity of labor
demanded equals the quantity supplied. The equilibrium level of employment is 3 billion hours a year.
b) With employment equal to 3 billion hours per year, potential GDP is equal to $60 billion.
19) The real interest rate determines the quantity of loanable funds demanded. There is an inverse relationship between the
real interest rate and the quantity of loanable funds demanded. Expected profit affects investment and, because
investment is a major source of the demand for loanable funds, the expected profit rate affects the demand for loanable
funds. An increase in the expected profit from investing increases investment and thereby increases the demand for
loanable funds. Hence there is a positive relationship between the demand for loanable funds and the expected profit rate.
20) a) Disposable income is lower, so saving is decreased. The supply of loanable funds curve shifts leftward.
b) People are wealthier, so they save less. The supply of loanable funds curve shifts leftward.
c) Expected future income is lower, so people save more. The supply of loanable funds curve shifts rightward.
d) The quantity of saving increases. There is an upward movement along the supply of loanable funds curve but no shift
in the curve.
21) Banks create liquidity because they accept short-term deposits and make long-term loans. The short-term deposits can be
quickly and easily changed into moneyindeed, some of the deposits are money itself! In exchange, the bank makes
long-term loans that cannot be converted to money until their due date is reached.
22) When a bank gains reserves above the amount it desires, it uses the unplanned reserves to make a loan. The person or a
business receiving the loan receives a depositmoney! The borrower then generally spends the loan and it ends up as a
depositmoneyin another company's account. That company's bank then gains some unplanned reserves, which it
loans, and so more money is created. Thus the banking system creates money by making loans.

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Answer Key
Testname: UNTITLED1

23) Four factors influence the demand for money. First is the price level. An increase in the price level increases the
NOMINAL demand for money. Second is the interest rate. An increase in the interest rate raises the opportunity cost of
holding money and decreases the quantity of money demanded. Third is real GDP. An increase in real GDP increases the
demand for money. Fourth is financial innovation. Innovations that lower the cost of switching between money and other
assets decrease the demand for money.
24) a) The equilibrium real interest rate is 6 percent and the equilibrium quantity of loanable funds is $1.1 trillion.
b) If the real interest rate is 4 percent, there is a shortage of loanable funds. The shortage means that the quantity of funds
demanded for investment exceeds the quantity supplied, so the real interest rate will rise to its equilibrium of 6 percent.
25) Only parts (c), currency in Ann's purse, and (d), Ann's checking deposit, are money. Ann's check, given in part (a), is a
method of transferring money from Ann to someone else. Thus the check (itself) is not money. Part (d), the currency in
Ann's bank, is not money until someone withdraws it because currency inside a bank does not count as money.
26) All of the assets mentioned are included in M2, so you have $25 + $150 + $250 = $425 of M2.
27) Reserves include the bank's deposit in its reserve account at the Fed and the currency in its vault. Therefore the First
National Bank of Townville has $50,000 + $10,000 = $60,000 in reserves.
28) a) The only deposit that is in M1 is the checking deposits, so the amount of this bank's deposits that are in M1 is $400.
b) Deposits in M2 include checking deposits, saving deposits, and time deposits. Therefore the amount of this bank's
deposits that are in M2 equals $400 + $900 + $900 = $2,200.
c) Reserves are the sum of the currency in the bank's vault plus its deposits in its reserve account at the Fed. Therefore
the bank's reserves are $40 + $40 = $80.
29) a) If the Fed sets the quantity of money equal to $1.0 trillion, the equilibrium interest rate is 5 percent.
b) If the Fed wants the interest rate to be 4 percent, it must set the quantity of money equal to $1.5 trillion.