Midterm Review

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EC301 Open-Book Midterm Exam (Weight 110 points) NAME: Elizabeth Crabtree

Submit your answers in the Dropbox or fax them. You may discuss concepts in the Q&A thread and where to find answers but do not give specific answers to specific questions.

1. (7 points) How are presidential election outcomes related to the performance of the economy?

There is a direct correlation between whether an incumbent will be reelected or voted out. If the economy is doing well they have a better chance for reelection. If the economy is bad, it is likely they will elect a new person. People vote based on their own economic needs; ie do they have a job) regardless of the fact that the Executive Branch has minimal influence over the macroeconomic business cycle.

2. (7 points) Discuss the difference between Microeconomics and Macroeconomics.

Microeconomics is the study of the economic behavior of individual units of an economy such as a household, business, or an industry. Macroeconomics is the study of the economic behavior of the total or aggregate of the economy. Macroeconomic theory examines the behavior of aggregates, like the unemployment rate or the inflation rate, while ignoring differences among individual households.

3. (10 points) Use the concepts of gross and net investment to distinguish between an economy that has a rising stock of capital and one that has a falling stock of capital. “In 1933 net private domestic investment was minus $6 billion. This means that in that particular year the economy produced no capital goods at all.” Do you agree? Why or why not? Explain: “Though net investment can be positive, negative, or zero, it is quite impossible for gross investment to be less than zero.”

I do not agree with the statement about 1933 net private domestic investment. It does not mean that the economy “produced no new capital goods” that year. It means depreciation exceeded gross investment by $6 billion. So the economy ended the year with $6 billion less capital.

The second statement is correct. If only one $15 tree is bought by a landscape company in the entire economy in a year and no other physical capital is bought, then gross investment is $15—a positive amount. This is true even if net investment is highly negative because depreciation is well above $15. If this $15 tree had not been bought, gross investment would be zero. But gross investment can never be less than zero.

4. (7 points) What are the major factors that have affected U.S. household consumption since the recession in 2001?

The major factors that have affected US consumption are changes in interest rates, household wealth, and the ability to obtain loans.

Consumers make their spending decisions based not only on current income, wealth, etc., but also with an eye toward future conditions. Consumers still worry with high unemployment rates, the uncertainties of Europe, the failure of housing prices bouncing back, and their inability to get loans. Thus, expectations matter for consumption.

5. (7 points) Briefly explain how the following would shift the IS function to the right.

a.A change to lump-sum taxation (Specify whether increase or decrease is needed to shift IS curve to the right.) A decrease in taxes would shift the curve to the right.

b.A change to government spending (Specify whether increase or decrease is needed to shift IS curve to the right.) An increase in government spending will shift the IS curve to the right. Higher government spending shifts reduce consumption.

6. (7 points) Explain briefly how a change to the following MS, MD, or P (ceteris paribus) would shift the LM function to the right. Include in your discussion whether the variable would have to increase or decrease to cause the rightward LM shift. Discuss which of these the FED exercises control over.

a. MS. – An increase in the money supply will shift the LM curve to the right. The FED...
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