IVY SOFTWARE MBA PREPWORKS FUNDAMENTALS OF ECONOMICS PRACTICE EXAM 2024 -2025 | Exams Nursing | Docsity (2024)

Download IVY SOFTWARE MBA PREPWORKS FUNDAMENTALS OF ECONOMICS PRACTICE EXAM 2024 -2025 and more Exams Nursing in PDF only on Docsity! 1 | P a g e IVY SOFTWARE MBA PREPWORKS FUNDAMENTALS OF ECONOMICS PRACTICE EXAM 2024 -2025 WITH ACTUAL CORRECT QUESTIONS AND VERIFIED DETAILED ANASWERS |FREQUENTLY TESTED QUESTIONS AND SOLUTIONS |ALREADY GRADED A+|BRANDNEW!! |LATEST UPDATE |GUARANTEED PASS The main concept demonstrated in the production possibilities frontier is Opportunity cost When country A has a lower opportunity cost of producing sugar relative to country B, then country A is said to have Comparative Advantage A graph that shows the combinations of two goods that the economy can produce given the available scarce resources and available technology is called a Production Possibilities Frontier Assume a production possibilities frontier for pickup trucks and big Mac hamburgers. The economy is producing 20 big Mac hamburgers and 65 pickup trucks (point 20, 65). What is the opportunity cost of producing an additional 20 Big Mac hamburgers (point 40, 60)? Five Pickup Trucks The opportunity cost of an item is whatever must be given up to obtain the item. 2 | P a g e Consider market for pork, suppose that price of beef, a substitute for pork, increases. Because of the change in price of beef, the equilibrium price of pork...? Increases Consider the market for pork, suppose that the price of beef, a substitute for pork, increases. Because of this change in the price of beef, the equilibrium quantity of pork will...? Increase because increase in price of beef causes demand curve for pork to shift North East. B/c of this shift, the equilibrium quantity of pork will increase. Consider the market for pork. Suppose that the price of hog feed, an input to the production of pork, increases. Because of that change in the price of hog feed, the equilibrium quantity of pork ...? Decreases because the increase in price of hog feed causes the supply curve for pork to shift NW. B/c of this shift, the quantity of pork decreases. Consider the market for pork. Suppose that disposable income increases and pork is an inferior good. Because of that change in income, the equilibrium price of pork...? Decreases because the increase in disposable income causes the demand curve for pork to shift south west, because pork is an inferior good. because of this shift, the equilibrium price of pork decreases. Consider the market for pork. Suppose that 1) disposable income increases and pork is a normal good, And 2) the price of hog feed decreases. Because of these changes, the equilibrium price of pork is... Indeterminate because the increase in disposable income causes the demand curve for pork to shift north east because pork is a normal good. The decrease in price of hog feed causes the supply curve to shift to the south east. The net effect of these shifts leaves us unable to say waht will happen to the equilibrium price of pork. Consider the market for pork. Suppose that disposable income increases and pork is a normal good and the price of hog feed decreases. The equilibrium quantity of pork...? Increases. Suppose the price elasticity for demand for retail phone service in the US is 0.95. If the # of retail substitutes for retail telephone service increases, will the price elasticity of demand become more elastic or more inelastic? Elastic. When the number of substitute products increases, the price elasticity of demand will become more elastic. consumers become more sensitive to price when they have more options to chose among. True or False: the law of demand states that if the price of a good increases, CP, then the quantity demanded of that good will increase. False. quantity demanded of that good will decrease. Suppose the cross-price elasticity of demand for home heating oil with respect to the price of natural gas is +0.6. This number tells us that home heating oil and natural gas are substitute or compliment goods? 5 | P a g e diseconomies of scale occur over a range of output in which average total costs increase as output increases constant economies of scale occur over a range of production where constant average total cost as output increases economies of scope occur when an organization can produce several products together at less cost than could a group of single product firms operating independently whenever marginal cost is higher than average variable cost or average total cost, the average variable cost or average total cost must increase decrease stay the same increase whenever marginal cost is lower than average variable cost or average total cost, then the average variable cost or the average total cost must increase decrease stay the same decrease whenever the marginal cost curve crosses the average variable or total cost curve then the values are higher lower equal equal price takers businesses operating in a perfectly competitive industry in a perfectly competitive industry, market prices are determined by the interaction of the market demand and market supply curves total revenue calculated by multiplying price and quantity or Marginal Revenue and quantity market price change in total revenue resulting from a on-unit increase in the quantity sold equals the market price. in the pursuit of maximizing profits, business owners are constrained in two fundamental ways: 6 | P a g e 1) the competency of its employees and the market prices of inputs into the production process dictate the costs of producing output 2) the price that a perfectly competitive business can charge is determined by the market, and not the business owner long run decision states that a business should exit the industry if production at the profit maximizing quantity where (MR=MC) generates total revenues that are less than total cost. Otherwise they stay open. three characteristics of a monopolistic industry include: 1) there are many buyers and only one seller 2) the good is heterogeneous, and 3) barriers to entering the market exist (ie: patents are barriers that make it illegal for someone to produce a product without permission from the patent owner) price setter in a monopolistic industry, because there is only one seller of a product the business owner actually goes through a process of setting the price of its product, a task that competitive firms are unable to do. Thus monopolistic firms are called price setters. constraints of a monopoly 1) ....? 2) the market demand three decisions faced by a monopoly 1) determine the profit maximizing quantity to produce 2) decide what price to charge 3) because this is the short run, decide whether to produce or shut down the business for a short period of time. profit maximizing quantity marginal revenue equals marginal cost Marginal cost is the increase in total cost that arises from an extra unit of production (T/F) True. A production process has economies of scale if average total cost decreases as production increases (true or false) True A production process has diseconomies of scale if average total costs increase as output increases (T/F) 7 | P a g e True. The production of a product has either economies of scale, constant economies of scale, or diseconomies of scale (t/F) True If a company's average total costs remain constant as output increases, then the company has constant economies of scale. (t/F) TRUE A sunk cost is a cost that has already been committed and can be recovered. false. can never be recovered. in contrast, any product that can be re-sold for a positive dollar amount would not be considered a sunk cost. A business always maximizes profits when it produces where total revenue equals total cost (t/f) False. the profit maximizing rule states that a business maximizes profits when it produces a quantity where the MR from selling another unit equals the MC of producing an additional unit. A business should shut down if production at the profit maximizing quantity generates total revenues that are less than total fixed costs. (t/f) false. a business should shut down when the losses from operating are greater than the total fixed costs. short run shutdown rule. a business should shut down if production at the profit maximizing quantity The accountants hired by Costa law firm have calculated that at the profit maximizing quantity, total fixed costs equal $56,791, total variable costs equal $113,555 and total revenue equals $112,000. Because of this info, Costa Law firm decides: A) to exit the industry B) to shut down C) decides to stay open because shutting down would be more expensive D) decides to stay open because they are making an economic profit B. to shut down. the shutdown rule states that a business should shut down in the short run only if total revenue is less than total variable costs. In this case, total revenue is $112,000 and total variable cost is $113,555. Because total variable cost exceeds total revenue, CLF should shut down. How can you tell if a business is operating in a perfectly competitive market? the marginal revenue from selling an additional unit does not change as output increases. They are also known as a price taker. You will notice the Marginal revenue column stays constant as output increases. What is the per unit price in a perfectly competitive market? The market equilibrium price is equal to marginal revenue total cost equals 10 | P a g e Unemployment Rate defined as the percent of people who do not want a job right now, have been looking for work, but have not found a job that they would take divided by the labor force macroeconomics offers a set of tools and concepts that both economists and policy makers use to try to figure out the overall pulse of the economy The term "gross" in GDP means that the data are not adjusted for depreciation- a term that represents the reduction in market value of economic capital as it slowly wears out and approaches the end of its useful life. Net domestic product the calculation of GDP which adjusts for depreciation Product in GDP equals the market value of final goods and services produced over the course of a year in the domestic economy nominal GDP equals the market value of final goods and services produced at current year prices. -almost always useless at telling us the true value of final goods and services because it confuses changes in the inflation or deflation with changes in total production. = C + I + G + NX -economies reject nominal GDP and use real GDP per capita means that total GDP is divided by the U.S. population. This is done to control for changes, positive or negative, in the U.S. population Intermediate goods and services used in the production of final goods and services. not included in GDP. ie: Starbucks purchasing coffee beans is an intermediate good. business cycles irregular changes in the level of total output measured by real GDP economic contraction the negative movement from peak to trough in a business cycle because real GDP is smaller than the previous period recession 11 | P a g e if a contraction moves below the trend line for two or more quarters of a year then it is called a recession economic expansion (or recovery) the positive movement from trough to peak because real GDP is larger than the previous period who measures GDP in the U.S.? the U.S. Department of Commerce's Bureau of Economic Analysis (BEA) Aggregate Expenditure BEA sum of GDP from four main components: consumption expenditures, investment expenditures, government expenditures, and net exports is a measure of nominal GDP and is also known as the national income identity. Consumption spending (C) is made up of all the final goods and services that are ultimately bought and used by households, except for newly constructed buildings Investment spending (I) is made up of all the final goods and servicesthat become part of the business or residential capital stock, including newly constructed buildings Government spending (G) is made up of all the final goods and services bought by the government like lumber and raw materials purchased and deployed to Iraq for the reconstruction effort transfer payments like welfare benefit or unemployment insurance are not included in G Net Exports (NX) is made up of the difference between exports (E) and imports (I) Exports final goods and services produced in the U.S. and purchased by foreigners living outside the U.S. Imports include all final goods and services produced by foreigners outside the U.S. and purchased by a member of the domestic population. domestic entry bookkeeping ensures that the expenditure on final goods and services in the domestic economy equals the total incomes paid for the scare factors of production used to produce those final goods and services (ie wages, rent, interest and profit earned from production). Aggregate income 12 | P a g e equald the sum of income paid for the scarce factors of production used to produce total final output in the domestic economy. Aggregate expenditure = GDP = Aggregate income price level is a composite measure reflecting the pricews of all goods and services in the economy relative to prices in a base year Nominal GDP measures the economic value of all goods and services produced inside the boundaries of a country, not adjusted for the changes in the price level (T/F) True The circular flow diagram demonstrates that the expenditures on final goods and services in the domestic economy is equal to the total income paid for the scarce factors of production used to produce those final goods and services. (T/F) True. double entry bookkeeping insures that the expenditures on final goods and services in the domestic economy is equal to the total income paid for these scare factors of production used to produce those final goods and services. The labor force is defined as all those who are employed and all those who have been looking for work. T/F True. LF= employed + have been looking for work Frictional unemployment occurs because it takes time for workers to search for new jobs that best suit their tastes and job skills (t/f) True Cyclical unemployment occurs because the number of jobs available in a labor market is insufficient to provide jobs for all those who want one. (t/f) False The following is called the national income identity: C + I + G + NX = Aggregate Expenditure = Real GDP (true or false) False = Nominal GDP The unemployment rate is defined as all those who are employed divided by those looking for work (T/F) False. = have been looking for work divided by labor force (employed + have been looking for work) The largest component of the U.S. real GDP is consumption Trade deficit 15 | P a g e the liabilities of the commercial banking system equal the deposits of the banks' customers, since checking account balances represent money owed by the banks to the depositors. bank reserves equal the currency that is held by banks 100 percent reserve banking when 100% of bank's currency is being held in reserves fractional-reserve banking system a banking system in which banks have checkable deposits that exceed annual reserves checkable deposit balances are counted as money and therefore are part of the money supply because they may be used in making transactions throughout the economy. (t/F) True the sum of checkable deposits and currency in circulation is money supply reserve-deposit ratio bank reserves divided by checkable deposits What is the Federal Reserve's most important tool that it uses to increase the money supply? buying and selling government securities desired reserve deposit ration equals bank reserves divided by checkable deposits checkable deposits equals bank reserves divided by desired reserve deposit ratio The banking system's ability to create money depends on the amount of bank reserves and the desired reserve deposit ratio monetary policy any action that changes the supply of money and alters the interest rate. In the U.S. it is implemented by the Federal Reserve System. Three tools that the Federal Reserve can use to alter the money supply: 16 | P a g e 1) open market operations 2) reserve requirement changes 3) changes to the Federal Reserve's discount rate open market operations purchases and sales of government securities by the Federal Reserve in an effort to influence the money supply. when the Federal Reserve decides to purchase government securities (ie: Treasury bills) it is choosing to _______ the money supply increase decrease increase when the Federal Reserve desides to sell government securities (ie: treasury bills) it is choosing to ________ the money supply increase decrease decrease An increase in the required reserve deposit ration will lead to a _________ in the money supply increase/decrease decrease a decrease in the required reserve deposit ratio will lead to a _____ in the money supply increase/decrease increase A bank borrows from the Federal Reserve when it has too few reserves to meet reserve requirements an increase in the discount rate____________ the quantity of reserves in the banking system which in turn ______________ the money supply reduces/reduces A decrease in the discount rate, encourages borrowing reserves from the Federal Reserve, which in turn _______ the money supply increases As the overall level of prices increases, the value of a unit of money decreases money creation process 17 | P a g e a process that describes the amount of money the banking system creates with each dollar held in reserve (ie: dollars that have not been loaned out by a bank). The banking system's ability to create money depends on the amount of currency held in bank reserves and the required reserve deposit ratio, which is the ratio of bank reserves divided by the checkable deposits Currency is defined as paper bills, traveler's checks, and coins in the hand of the public. (T/F) False. currency is just the paper bills and coins in the hands of the public. Small time deposits are deposits against which checks may be written. (T/F) False. The basic functions of money are: a medium of exchange, a store of value, and a unit of account. (T/F) True Fiat Money is paper money with intrinsic value (T/F) False. fiat money has no intrinsic value Federal Reserve notes are printed by a division of the Treasury Department. (T/F) True. All federal reserve notes are printed at the Bureau of Engraving and Printing at the Department of Treasury, but they are issued by the regional Federal Reserve banks. The Federal Reserve Bank has three monetary policy tools: open market operations, reserve requirement changes, and changes to the Federal Reserve's discount rate (T/F) True The Federal Open Market Committee decides on changes to the fiscal policy. (T/F) False. The Banking Acts of 1933 and 1935 centralized power of the Federal Reserve Bank in Washington DC and established the FOMC. The FOMC meets about every 6 weeks in DC in order to discuss the condition of the economy and consider changes to monetary policy- most important of which is open market operations. Federal Reserve discount rate is the interest rate on loans the Federal Reserve charges to other banks. If the price level increases, the value of money decreases (T/F) True. the price level and the value of money are directly related. As the overall level of prices increases, the value of a unit of money decreases. For example: if a bottle of soda increases in price from 5 cents to $1.25 over 80 years, it is likely that the satisfaction level has stayed the same and the money used to purchase the soda has decreased in value because of an increase in the price level. Supposed the price level equals 5 (P=5). The value of one unit of money is 1/5 or .2. 1/P The value of one unit of money is calculated by 20 | P a g e An increase in the required reserve deposit ratio causes the money supply to increase (true or false) False. An increase in the required reserve deposit ratio will lead to a decrease in the money supply. Open market operations are purchases and sales of government securities by the Federal Reserve Bank in an effort to change the money supply. (True or False) True The money supply decreases when the Federal Reserve Bank increases the Federal Reserve discount rate. (T/F) True inflation an increase in the price level from one period to the next an increase in the value of money from one period to the next is called inflation (T/F) false deflation a decrease in the price level from one period to the next aka an increase in the value of money from one period to the next Equilibrium exists where the price level is 9 and the money supply equals 25 billion. What is a new possible equilibrium when the Federal Reserve Bank sells some government bonds? P= 4 and MS = 21 when the federal reserve bank sells government bonds, ceteris paribus, it decreases the supply of money circulating in the economy. In this example, the money supply would shift left from MS2 to MS1. Money's basic function is: a medium of exchange a store of value a unit of account all of the above all of the above An item that buyers give sellers when they want to purchase goods and services is called: a medium of exchange a unit of account liquidity a medium of exchange 21 | P a g e A decrease in the value of money from one period to the next is called: deflation inflation an expansion unemployment inflation An increase in the required reserve deposit ratio causes the money supply to: increase decrease not change not enough info decrease The money supply increases when the Federal Reserve Bank decreases the Federal Reserve discount rate (T/F) True Open market operations are purchases and sales of government securities by the Federal Reserve Bank in an effort to change the money demand (T/F) False long-run aggregate supply curve is vertical and the location of the curve depends on the economy's supply of land, capital, labor, and entrepreneurial ability and the productivity of these resources. LRAS located at the economy's potential real GDP, which is defined as the economy's maximum sustainable output level given the supply of factors of production, the state of technology, and formal and informal institutions supporting the economy and NOT the price level. Inflationary gap the amount by which the equilibrium level of real GDP exceeds the potential real GDP deflationary gap the amount by which the equilibrium level of real GDP falls short of potential real GDP. an economy that is in a deflationary gap experiences an unemployment rate that is higher than the natural rate of unemployment because cyclical unemployment is now added to the natural rate of unemployment. fiscal policy the government's plan for managing aggregate demand through government's power to tax individuals and businesses and its power to spend and transfer tax revenues that it collects. Can be used to: 22 | P a g e 1) stimulate aggregate demand when the economy is in a deflationary gap 2) slow the economy down when it is in an unsustainable inflationary gap automatic stabilizers automatically stimulate the economy when it enters a deflationary gap and automatically cools the economy down when it enters an inflationary gap. They are a just-in-time fiscal policy, because they operate without policymakers having to take any deliberate action. Examples include unemployment insurance, welfare benefits, and income taxes. short run aggregate supply curve reflects the total quantity of goods and services that producers in the economy are willing and able to produce at any given price level. the short run aggregate supply curve is upward sloping because of the profit effect, the misperception effect, and the menu costs effect. profit effect a concept that, ceteris paribus, sticky wages in the short run 1) induce firms to increase the production of goods and services when the price level increases 2) induce firms to decrease their production of goods and services when the price level decreases because it lead to an increase in real profits misperception effect argues that in the short run, producers are temporarily fooled about what is really causing price changes in the markets in which they sell their products. Because of these misperceptions, producers respond to changes in the price level despite no change in a product's real price, and this response leads to an upward sloping supply curve The menu costs effect argues that because it can be expensive to change menus and pricing boards and because the business owners don't want to constantly tell their customers that they have changed their prices, they don't do it often. This implies that when there is a change in the price level because of a contraction in the economy, for example, producers keep their prices unchanged. Aggregate demand curve reflects the real GDP demanded by all groups in the economy at any given price level. The aggregate demand curve is negatively sloped because of the interest rate effect, the wealth effect, and the open economy effect. May shift to the NE and to the SW The interest rate effect a reduction in the price level causes people to convert cash to interest bearing assets (ie: bonds and certificates of deposit)- aka Loanable funds. An increase in the supply of loanable funds causes a south- east shift of the supply of loanable funds, which leads to a lower interest rate. Since the interest rate is equal to the price of investment goods, a decrease in the interest rate causes an increase in spending on investment goods (I) which by definition increases real GDP 25 | P a g e - productivity advances - an increase in labor Favorable weather Decrease in Aggregate Supply (SRAS: NW shift) (LRAS: Leftward shift) Higher costs - higher wages - other input prices rise - higher oil prices Government policy - tax increases - overregulation - higher trade barriers - a decline in labor productivity Terrorist Attacks Natural Disasters Unfavorable weather The idea that there is a separation of real and nominal variables in the long run is called the classical dichotomy (T/F) True. the aggregate demand curve reflects the nominal GDP demanded by all groups in the economy at any given price level (T/F) False. reflects the REAL GDP not nominal The open economy effect is observed when a decrease in the price level causes the real exchange rate to depreciate, which subsequently causes an increase in net exports. (T/F) True The short run aggregate supply curve is upward sloping because of a combination of the profit effect, the misperception effect, and the menu cost effect. (T/F) True Sticky wages induce firms to increase their production of goods and services when the price level decreases (T/F) False. The menu cost effect tells us that when there is a real price level decrease in the economy, businesses do not quickly change the price of their products. This behavior generates a real price increase for their products, thereby decreasing the quantity that they sell. (T/F) True. 26 | P a g e The location of the long run aggregate supply curve depends on the economy's supply of land, capital, labor, entrepreneurial ability, and productivity of its scarce resources. The location of the long run aggregate supply curve does not depend on the price level. (T/F) True. The long aggregate supply curve shifts to the right when the government permanently lowers trade barriers (T/F) True. Determine how the aggregate demand curve is affected because of the following: There is a decrease in government purchases shifts to the south-west Determine how the aggregate demand curve is affected because of the following: The President and Congress implement lower marginal federal income tax rates. shifts to north-east Determine how the aggregate demand curve is affected because of the following: Price level decreases the statement causes a movement along the aggregate demand curve. A decrease in the price level causes an increase in the real GDP demanded by all groups in the economy. This is a movement along the aggregate demand curve because of a change in some exogenous factor. The aggregate demand curve does not shift in this case. Determine how the aggregate demand curve is affected because of the following: The Federal Reserve Bank increases the required deposit-reserve ratio. shifts to the south-west Determine how the aggregate demand curve is affected because of the following: The United States and China are major trading partners. Suppose that the Chinese evonomy goes into a recessionary period, causing their national income to decrease. shifts to the south-west Determine how the long run aggregate supply curve is affected because of the following: A permanent technological change occurs LRAS shifts to the right. Since there is a permanent increase in a technology, then the LRAS shifts to the right. Determine how the long run aggregate supply curve is affected because of the following: The labor force decreases LRAS shifts to the left 27 | P a g e Determine how the long run aggregate supply curve is affected because of the following: The President and Congress permanently repeal all inter-state trade restrictions on the sale of wine. LRAS shifts to the right Determine how the long run aggregate supply curve is affected because of the following: The price level decreases The statement does not affect the location of the LRAS Determine how the long run aggregate supply curve is affected because of the following: The price of crude oil (an input into many production processes) temporarily decreases The statement does not affect the location of the LRAS since it is a price change. Determine how the short run aggregate supply curve is affected because of the following: The price level increases The SRAS does not shift because of a change in the price level. There is movement along the upward sloping SRAS Determine how the short run aggregate supply curve is affected because of the following: There is a decrease in the labor force SRAS shifts to the north-west. A decrease in the labor force causes a decrease in the supply of labor, which causes the price of labor to increase, ceteris paribus. Higher labor prices (ie: wages) cause the SRAS to shift NW Determine how the short run aggregate supply curve is affected because of the following: The President and Congress lower corporate tax rates. SRAS shifts to the south-east Determine how the short run aggregate supply curve is affected because of the following: The price of crude oil (an input to many production processes) decreases. SRAS shifts to the south-east Determine how the short run aggregate supply curve is affected because of the following: The Federal Reserve increases the money supply THe SRAS does not shift when the Fed increases the money supply. The aggregate demand curve shifts to the north-east because of an increase in the money supply. The shifting aggregate demand curve moves along the SRAS. If corporate taxes are temporarily lowered, ceteris paribus, the policy change will cause the economy to move into a(n) ______ gap and will cause the price level to _______ inflationary/decrease If consumers' expectations about the state of the economy improve, ceteris paribus, the change will cause the economy to move into a(n)______ gap and will cause the price level to _______ 30 | P a g e B) it is in a deflationary gap C) there is no unemployment D) the economy is operating at the natural rate of unemployment B. it is in a deflationary gap Suppose that the economy is in a deflationary gap. Which of the following public policies would help the economy get back to potential real GDP? A) decrease the required reserve deposit ratio B) have the Federal Reserve buy back government bonds C) have the President and Congress cut marginal tax rates D) all of the above are correct D. all of the above are correct One explanation for a positively sloped short run aggregate supply curve is that businesses sometimes mistake changes in the price level for a change in the value that consumers have for their product. (T/F) True When there is a decrease in the price level, consumers feel wealthier because each nominal dollar can purchase more goods and services relative to before the price level decrease. This is called the wealth effect of a price level change. (T/F) True The location of which curve depends on the economy's supply of land, capital, labor, entrepreneurial ability, and productivity of its scare resources; it does not depend on the price level? long-run aggregate supply curve factors of production encompass all the possible resources used to produce goods and services. Labor, capital, land, and entrepreneurial ability are the four categories of factors of production and encompass all the possible productive resources used to produce goods and services. production possibilities frontier is a model of a two-good economy that shows how much the economy can produce using all of its factors of production efficiently increasing opportunity cost as more and more of an economy's factors of production are employed in the production of a good, the economy must sacrifice the production of other goods at an increasing rate. Absolute advantage means that one has the lowest absolute production cost relative to those with whom they are compared comparative advantage 31 | P a g e one has the lowest opportunity cost relative to those with whom they are compared Law of increasing opportunity cost once all factors of production are at maximum output and efficiency, producing more will cost more than average. As production increases, the opportunity cost does as well. as more and more of an economy's factors of production are employed in the production of a good, the economy must sacrifice the production of other goods at an increasing rate. demand schedule A table showing the relationship between price and the quantity of a good that buyers are willing to buy demand curve a picture of the way an individual responds to changing prices of a good demand function a relationship between independent demand variables such as the price of good X and the price of a substitute good Y, and the dependent variable, the quantity demanded of good X. law of demand as the price of a good increases, ceteris paribus, the quantity demanded of the good decreases market demand curve the horizontal summation of individual demand curves yields the market demand curve market demand schedule the market demand schedule is a table that is calculated by summing up how many units of a good buyers are willing to purchase at every market price price elasticity of demand a measure of the relationship between a percentage change in the market price of product and a consequential percentage change in the quantity demanded of a product. cross price elasticity of demand a measure of the relationship between a percentage change in the market price of product X and a consequential percentage change in the quantity demanded of product Y. income elasticity of demand a measure of the relationship between a percentage change in income and a consequential percentage change in the quantity demanded of a product supply schedule a table showing the relationship between price and the quantity of a good that sellers are willing to produce. 32 | P a g e supply curve a picture of the way in which a producer responds to changing market prices of a good supply function a relationship between independent supply variables, such as the price of inputs and technology, and the dependent variable, the quantity supplied of a good. law of supply as the price of a good increases, ceteris paribus, the quantity supplied of the good increases market supply curve the horizontal summation of individual supply curves yields the market supply curve market supply schedule is calculated by summing up how many units of a good sellers are willing to produce at every market price elasticity of supply a measure of the relationship between a percentage change in the market price of a product and a consequential percentage change in the quantity supplied of a product. market equilibrium an economic balance in which no individual would be better off doing something different; an equality of supply and demand comparative-static analysis the process of comparing two market equilibrium (static) points, one equilibrium point before and the other after a change in an independent variable opportunity cost whatever must be given up to obtain the item comparative advantage one who has the LOWEST opportunity cost (one with the comparative advantage should specialize in) factors of production (scarce economic resources) 1. land (rent) 2. labor (wage) 3. capital (interest) 4. entrepreneurial ability (profit) production possibilities frontier (PPF) 35 | P a g e demand curve line D; picture of the way consumer responds to changing prices 1. shifts only when an independent variable changes 2. shifts only to the south-west or north-east 1. independent variable 2. dependent variable independent or dependent? 1. price on the vertical axis 2. quantity on the horizontal axis complementary goods Goods purchased together because they are consumed together (i.e., cheese & wine) -if one increases the other has to decrease to reach equilibrium because they're bought together -increase in the price of a complement, shifts south-west -equilibrium price decreases and quantity demanded decreases -decrease in the price of a complement, shifts north-east (people are willing to purchase more goods at any given price) substitute goods goods that can be used to replace the purchase of similar goods when prices rise (i.e., orange & apple juice) -increase in the price of a substitute, shifts north-east -equilibrium price increases and quantity demanded increases normal good a good that consumers demand more of when their incomes increase (i.e., fancy dinner) 36 | P a g e -decrease in income, shifts south-west -equilibrium price decreases and quantity demanded decreases inferior good a good that consumers demand less of when their incomes increase (i.e., bus pass) -decrease in income, shifts north-east -equilibrium price increases and quantity demanded increases tastes & preferences higher satisfaction leads to purchasing more; lower pleasure leads to purchasing less expectations of the future shortage- willing to buy more (a gasoline shortage = equilibrium price & quantity increase) demand function Qd = f(Pgood; Pcomplement; Psubstitute, I, T & P, E) Qd = quantity demanded f = general function Pgood = market price of a good Pcompliment = price of complements Psubstitute = price of substitutes I = income T & P = tastes & preferences E = consumers' expectations of future law of demand if the price of a good increases, then ceteris paribus the quantity demanded will decrease if the price of a good decreases, then ceteris paribus the quantity demanded will increase market demand schedule table that sums up consumers' demand schedules; market demand function Qd = f(Pgood; Pcomplement; Psubstitute, I, T & P, E, # of buyers) 37 | P a g e Qd = quantity demanded (dependent) f = general function Pgood = market price of a good Pcompliment = price of complements Psubstitute = price of substitutes I = income T & P = tastes & preferences E = expectations of the future market demand curve picture of the way all consumers respond to changing prices 1. as # of buyers in the market increases, ceteris paribus, the market demand curve shift to the north- east 2. if the # of buyers in the market decreases, ceteris paribus, the market demand curve shifts to the south-west price elasticity of demand measure of the relationship between... numerator: percentage change in the quantity demanded denominator: percentage change in the market price "a 1% change in the price of good X, causes a -0.123 change in the quantity demanded of good X" mid-point formula used to calculate 1. price elasticity of demand 2. cross price elasticity of demand 3. income elasticity of demand 4. price elasticity of supply price elasticity of demand coefficient 40 | P a g e Pland = price of land P1...Pn = price of other inputs TECH = technology E = expectations of market # of sellers market supply curve 1. as # of sellers in the market increases, the curve shifts to the south-east 2. if # of sellers in the market decreases, the curve shifts to the north-west price elasticity of supply measure of the relationship between... numerator: % change in quantity of product supplied denominator: % change in price of product market equilibrium point only point where the market demand curve crosses the market supply curve comparative-static analysis compares 2 market equilibrium points (1 before & 1 after change in independent variable) when an independent variable changes... 1. determine if demand or supply curve is affected 2. determine direction shift (demand shifts N-E or S-W; supply shifts S-E or N-W) 3. compare equilibrium price & quantity before & after change (price & quantity may increase, decrease, remain unchanged, or be ambiguous) land (rent) -increase in price of land, market supply curve shifts north-west labor (wage) -increase in price of labor, market supply curve shifts north-west (more expensive to produce each unit) -equilibrium price increases and quantity demanded decreases 41 | P a g e -decrease in price of labor, market supply curve shifts south-east (less expensive to produce each unit) capital (interest) -decrease in price of capital, market supply curve shifts south-east (less expensive to produce each unit) -equilibrium price decreases and quantity demanded increases entrepreneurial ability (profit) net effect 1. ambiguous: equilibrium quantity doesn't change (would need additional info about the magnitude of shifts) 2. increase: if demand curve shifts twice or supply curve shifts half the distance 3. decrease: if demand curve shifts half or supply curve shifts twice the distance price ceiling government imposed and legally enforced MAXIMUM market price binding: price ceiling below market price (causes shortage) non-binding: price ceiling above market price (no effect on equilibrium price or quantity) price floor government imposed and legally enforced MINIMUM market price binding: price floor above market price (causes surplus) non-binding: price floor below market price (no effect on equilibrium price or quantity) tax on buyers makes buying less attractive, demand curve shifts south-west -buyers carry legal responsibility of the tax -buyers & sellers carry/ share economic burden of the tax tax on sellers market supply curve shifts north-west -sellers carry legal responsibility of the tax -sellers & buyers carry/ share economic burden of the tax fixed costs do not vary with increases in the quantity produced variable costs do vary with increases in the quantity produced sunk cost 42 | P a g e useless to anyone else; cost can never be recovered short run -time horizon where some fixed costs exist -produce or shut down for a short period of time short run shut-down rule: -shut down if production at the profit maximizing quantity (where MR=MC) generates total revenues that are less than VARIABLE costs -otherwise stay open long run -everything in the economy is variable -situation where fixed costs (the inputs) become variable/ no fixed costs -produce or exit the industry forever -separation of real & nominal variables -MONEY SUPPLY AFFECTS ONLY NOMINAL VARIABLES AND NOT REAL VARIABLES (monetary neutrality) long run exit decision: -exit if production at the profit maximizing quantity (where MR=MC) generates total revenues that are less than TOTAL cost -otherwise stay open average fixed cost (AFC) fixed cost / quantity produced curve declines as output increases total fixed cost (TFC) all the expenses a firm pays when the quantity produced is zero average variable cost (AVC) variable cost / quantity produced total variable cost (TVC) = total variable capital costs + total variable labor cost (labor cost at X quantity - labor cost at 0 quantity) + total variable material cost (material cost at X quantity - material cost at 0 quantity) average total cost (ATC) total cost / quantity produced average fixed cost + average variable cost marginal cost (MC) 45 | P a g e -per capita: total GDP is divided by the US population -intermediate goods & services: not included in GDP, used in production of final goods & services -final goods & services: GDP only includes items sold to end user nominal GDP measures market value of all goods & services produced at current year prices, NOT adjusted for changes in price level; economists reject nominal GDP business cycles the periodic rises and falls that occur in economies over time -economic contraction (recession): peak to trough, real GDP is smaller than previous period, unemployment rate rises -economic expansion (recovery): trough to peak, real GDP is larger than previous period, unemployment rate falls nominal GDP formula Nominal GDPyear1 = (Qgood1 x Pgood1) + (Qgood2 x Pgood2) + (Qgood3 x Pgood3) Q: quantity P: price real GDP formula value the quantities in year 2 using prices from base year Nominal GDPyear2 = (Qgood1year2 x Pgood1year1) + (Qgood2year2 x Pgood2year1) + (Qgood3year2 x Pgood3year1) Q: quantity P: price nominal & real GDP are the same only in the BASE YEAR GDP percentage change formula 46 | P a g e aggregate expenditure Bureau of Economic Activity (BEA) measures US gross domestic product 1. consumption spending (C): goods bought and used by households 2. investment spending (I): goods part of the business or residential capital stock 3. government spending (G): good bought by government- doesn't include transfer payments 4. net exports (NX): difference between exports & imports -change in one of the 4 causes aggregate demand curve to shift National income identity = C + I + G + NX = aggregate expenditure on wages, interest, rents, and profits = NOMINAL GDP C: consumption I: investment G: government expenditures NX: net exports circular flow diagram/ national income identity aggregate expenditure (on final goods & services) = GDP = aggregate income (for factors of production used to produce those final goods & services) consumer price index (CPI) CPI = (price of good TODAY / price of good BASE YEAR) x good weight measures changes over time in the cost of buying a "market basket" of goods & services purchased by a typical family -calculated & reported monthly by Bureau of Labor Statistics (BLS) -100 in the formula is interchangeable with a good's weight 47 | P a g e inflation rate changes in the cost of living; given in percent per year producer price index (PPI) *calculated exactly how we calculate CPI measures change over time in the cost of buying a "market basket" of inputs purchased by producers unemployment rate BLS calculates rate using Current Population Survey (CPS) 1. employed 2. out of labor force/ don't want a job 3. want a job/ haven't been looking 4. want a job/ have been looking/ can't find one LABOR FORCE = (employed) + (have been looking for work) UNEMPLOYMENT RATE = (have been looking for work) / (labor force) types of unemployment 1. frictional: takes time to find a job 2. structural: aren't enough jobs out there 3. cyclical: declines in aggregate output (GDP)/ layoffs money any asset used to carry out a transaction between a buyer and a seller (ex. currency, dollar bills, coins, bank accounts, money market accounts) 3 basic functions of money 50 | P a g e 3. changes to the discount rate (interest rate) -increase in discount rate reduces quantity of reserves which reduces money supply, decrease in discount rate encourages borrowing reserves which increases money supply Federal Reserve Bank monetary authority in the US (somewhat independent from the government, unlike other countries) -12 regional banks -monetary policy: control of the money supply supply of money curve (money supply curve) - price level (P) & value of money (1/P) are directly related -as overall prices increase, value of a unit of money decreases -overall level of price (P) adjusts to the level at which demand for money equals supply of money (equilibrium) shifts in the supply of money curve -if Federal Reserve BUYS gov't bonds in open market operations, it pays out dollars (shift right). if SELLS, it takes in dollars (shift left); sale of bonds = price level DECREASE -if Federal Reserve DECREASES required reserve requirement (shift right). if INCREASES (shift left) -if Federal Reserve DECREASES discount rate (shift right), if INCREASE (shift left) -INCREASE in money supply, shift RIGHT classical dichotomy long run- separation of real (adjusted for price level changes) and nominal (not adjusted) variables monetary neutrality -money supply affects only nominal variables & not real variables a change in the money supply causes the price level to change (causes inflation or deflation), but has no effect on real value of goods & services aggregate demand curve reflects the real GDP demanded by all groups in an economy at any given price level/ total demand for goods & services within a particular market/ an economy has just 1 51 | P a g e negative slope of the aggregate demand curve -interest rate effect: decrease in price level causes people to convert cash to loanable funds/ interest bearing assets (IBA: assets for financing), causes decrease in interest rate & increase in real GDP demanded -wealth effect: decrease in price level makes consumers feel wealthier b/c each nominal $ can purchase more goods -open economy effect: decrease in price level causes real exchange rate (RER: rate foreign goods can be bought/sold for domestic goods) to depreciate, causes increase in net exports Increases in aggregate demand (north-east shift) consumption (C)- optimistic consumer confidence investment (I)- optimistic business forecasts government purchases (G)- increase net exports (NX)- increase exports decreases in aggregate demand (south-west shift) consumption (C)- lower consumer confidence investment (I)- pessimistic business forecasts government purchases (G)- decrease net exports (NX)- decrease exports aggregate supply surve reflects total quantity of goods & services that producers in an economy are willing & able to produce at any given price level; short and long run positive slope of the aggregate supply curve (short run) -profit effect: STICKY WAGES causes firms to 1. increase production when price level increases, 2. decrease production when price level decreases -misperception effect: producers respond to changes in price level despite no change in real price -menu costs effect: b/c it's expensive to change menus, firms don't do it often 52 | P a g e vertical slope of the aggregate supply curve (long run) long run provides enough of a time horizon for producers to figure out whether a market price fluctuation is due to a change in consumer valuation or a change in price level (potential real GDP: an economy's maximum sustainable output level given factors of production) -location of the long run aggregate supply curve DOESN'T DEPEND ON THE PRICE LEVEL natural rate of unemployment unemployment existing when the economy is operating at potential real GDP; includes structural & frictional unemployment, not cyclical; currently between 4-5% increase in aggregate supply (SRAS: south-east shift, LRAS: rightward shift) lower costs, lower government policy, economic growth, favorable weather decrease in aggregate supply (SRAS: north-west shift, LRAS: leftward shift) higher costs, higher government policy, terrorist attacks, natural disasters, unfavorable weather inflationary gap expansion- economy is producing above it's potential real GDP (equilibrium level of real GDP exceeds the potential real GDP) inflation: decrease in the value of money from one period to the next (everything is more expensive because money is low in value) deflationary gap recession- economy is producing below it's potential real GDP (equilibrium level of real GDP falls short of potential real GDP) deflation: increase in the value of money from one period to the next (everything is cheaper because money is high in value) fiscal policy 55 | P a g e T/F Suppose the cross price elasticity of demand for home heating oil with respect to the price of natural gas is -0.9. This number tells us that home heating oil and natural gas are substitute goods. FALSE In words, what does it mean when an economic consultant states: Carl's income elasticity of chicken is equal to +2? Select one: a.If Carl's quantity demanded of chicken increases by 1 percent, then his income increases by 2 percent. b.If Carl's income increases by 1 percent, then his quantity demanded of chicken will increase by 2 percent. c.If Carl's income increases by 2 percent, then his quantity demanded of chicken decreases by 1 percent. d.If Carl's quantity demanded of chicken increases by 1 percent, then his income decreases by 2 percent. If Carl's income increases by 1 percent, then his quantity demanded of chicken will increase by 2 percent. The accountants hired by Truscott & Associates have calculated that at the company's current production level, total fixed costs to equal $21,000, total variable costs to equal $42,000 and total revenue to equal $45,000. Because of this information, Truscott & Associates decide Select one: a.to exit the industry. b.to shut down. c.to stay open because shutting down would be more expensive. d.to stay open because they are making an economic profit. to stay open because shutting down would be more expensive Suppose the economy is in an inflationary gap. Which of the following public policies could help the economy get back to potential real gross domestic product? Select one: a.increase unemployment insurance benefits b.decrease the required reserve deposit ratio c.increase the discount rate d.have the Federal Reserve buy back government bonds increase the discount rate An inflationary gap occurs when an economy's Select one: a.real GDP is greater than its potential real GDP. b.real GDP is less than its potential real GDP. c.real GDP is equal to its potential real GDP. d.nominal GDP is less than its real GDP. 56 | P a g e real GDP is greater than its potential real GDP. If an economy is producing below its potential real gross domestic product, then Select one: a.it is in an inflationary gap. b.it is in a deflationary gap. c.there in no unemployment. d.the economy is operating at the natural rate of unemployment. it is in a deflationary gap. The idea that the money supply affects only nominal variables and not real variables is formally known as the realistic view of classical economics. Select one: a.TRUE b.FALSE FALSE Suppose that the economy is in an inflationary gap. Which of the following public policies could help the economy get back to potential gross domestic product? Select one: a.decrease the required reserve deposit ratio b.have the Federal Reserve sell government bonds c.have the President and Congress cut marginal tax rates d.all of the above are correct have the Federal Reserve sell government bonds When there is a decrease in the price level, consumers feel wealthier because each nominal dollar can purchase more goods and services relative to before the price level decrease. This is called the wealth effect of a price level change. Select one: a.TRUE b.FALSE TRUE A permanent increase in productivity in the economy causes Select one: a.the long-run aggregate supply curve to shift to the left. b.the aggregate demand curve to shift to the south-west. 57 | P a g e c.the aggregate demand curve to shift to the north-east. d.the long-run aggregate supply curve to shift to the right. the long-run aggregate supply curve to shift to the right. A permanent decrease in productivity in the economy causes Select one: a.the long-run aggregate supply curve to shift to the left. b.the aggregate demand curve to shift to the south-west. c.the aggregate demand curve to shift to the north-east. d.the long-run aggregate supply curve to shift to the right. the long-run aggregate supply curve to shift to the left. Suppose that the economy is in a deflationary gap. Which of the following public policies would help the economy get back to potential real gross domestic product? Select one: a.decrease the required reserve deposit ratio b.have the Federal Reserve buy back government bonds c.have the President and Congress cut marginal tax rates d.all of the above are correct all of the above are correct - decrease the required reserve deposit ratio, have the Federal Reserve buy back government bonds, have the President and Congress cut marginal tax rates Misperceptions, sticky wages, and sticky prices are each theories that explain why in the short run the Select one: a.aggregate demand curve has a negative slope. b.aggregate supply curve has a positive slope. c.money supply curve has a positive slope. d.money demand curve has a negative slope. aggregate supply curve has a positive slope. Money demand decreases when the Federal Reserve Bank buys back government bonds. Select one: a.TRUE b.FALSE FALSE Open market operations are purchases and sales of government securities by the Federal Reserve Bank in an effort to change the money demand. Select one: