Econ 2630
STUDY GUIDE FOR MIDTERM 2*
* The exam will be Thursday, 3/27. This study guide is not necessarily exhaustive. It is intended to give you direction as to what you should focus on understanding given your limited study time.
-The current economic situation
-The Great Recession and it’s comparison with the Great Depression and previous recessions
-Basic statistics about the depth of the Great Recession and the strength of the recovery
-Aggregate Expenditures (Keynesian) Model
-The multiplier effect and it’s relationship with the marginal propensity to consume
-John Maynard Keynes, his book, and why it was important
-“Meeting the demand”
-Aggregate Expenditures
-Initial expenditures and the marginal propensity to consume
-Calculating the short-run equilibrium given an AE function
-Calculating and graphing changes in output when AE changes
-Changes to unemployment (Okun’s Law) when output changes
Aggregate Supply and Demand
-Why the Aggregate Demand curve is downward sloping
-Interest rate and real balances effects
-What can cause AD to shift
-Effects of appreciation or depreciation of U.S. dollar on net exports
-Why the Aggregate Supply curve is upward sloping and what can cause it to shift
-Long Run Aggregate Supply (Potential Output)
-Expansionary and Recessionary Gaps on AD/AS diagram
-What happens to output and inflation in the short run and long run when AD/AS change
-Understanding historical economic situations (by decade) and it’s relationship with AD/AS
-Fiscal policy
-Expansionary and contractionary policies
-Political biases
-Automatic stabilizers
-Progressive tax system
-Tax brackets and average tax rates
-Deficits and the national debt
-Net and gross debt
-Current situation and comparisons with other countries
-History and Future Projections
-Social Security and Medicare
-Supply side economics
-The Laffer Curve
-What could be done to reduce the deficit or debt
Practice Problems:
1. What is the current economic situation in the U.S.? How bad was the Great Recession compared to the Great Depression and previous recessions? What economic indicators have rebounded since the Great Recession ended? What are projections for GDP, unemployment, and inflation in the next few years?
2. Explain the basic difference between Keynes’ argument and Classical Economists’ argument about the role of government during the Great Depression.
3. The larger the mpc, the ____ the multiplier and the ____ the effect of a change in initial spending on short-run equilibrium output.
4. Suppose the marginal propensity to consume is 0.67, and the change in initial spending is $50 million. What is the estimated change to GDP?
5. If aggregate expenditure in an economy equals 1,000 + .9Y, initial spending equals _____, the MPC equals ___, and the multiplier equals ____.
6. If aggregate expenditure in an economy equals 1,000 + .9Y and potential output (Y*) equals 9,000, then this economy has a(n) ______output gap equal to ______.
7. If short-run equilibrium output equals 9,000, the MPC equals .8, and potential output (Y*) equals 10,000, then spending must be ______by ______to eliminate any output gap.
8. Suppose the potential output in an economy is $8 trillion, actual output is $7 trillion, and the multiplier is 4. To remove this output gap, what must the change in initial expenditures equal?
9.Refer to the figure above. Based on the figure and starting from an initial short-run equilibrium where output equals 20,000, if initial spending decreases by 1,000, then the new short-run equilibrium is at an output equal to:
10.Based on the figure, if the economy is in short-run equilibrium with output equal to 16,000, then there is a(n) _____ gap and a _____ in government spending would return the economy to potential output (Y*).
11.Based on the figure, suppose output is currently at 16,000. According to Okun’s Law, what is the level of cyclical unemployment?
12.Based on the figure above, if the economy is in short-run equilibrium with output equal to 24,000, then there is a(n) _____ gap and a _____ in government spending would return the economy to potential output (Y*).
13. Based on the figure above, the multiplier in the economy equals ____.
14. a.) Suppose Aggregate Expenditures (AE) in an economy are given by: 400 + 0.6Y. Calculate the short run equilibrium output for this economy.
b.) If AE are reduced to 300 + 0.6Y, what is the new short run equilibrium? If your answer for a.) is the potential output, what is the output gap in this economy?
c.) According to Okun’s Law, what is the change to cyclical unemployment as a result of this change in output?
d.) What could the government do to government expenditures and/or taxes to address this output gap? By how much should they try to change AE to address this output gap?
e.) Depict this situation on the following set of axes. Graph both AE lines and show the equilibrium output levels associated with each AE.
15. An increase in inflation causes a(n) ______in aggregate quantity demanded and a(n) ______in aggregate quantity supplied, other things constant.
16. Suppose there is a boom in the stock market that increases wealth in the economy. How would this affect the AD and/or AS curve? How would this affect inflation in the short-run
17. Consider a situation where the economy is initially in a long-run equilibrium and a decrease in housing prices induces a large decrease in consumer spending. How would this affect inflation and output in the short-run?
Consider the following graph:
18. At point A there is a ______gap equal to ______.
19. Suppose the economy starts at point A in the diagram above. What is the appropriate fiscal policy to bring the economy back to potential?
20. As the U.S. dollar appreciates in value compared to foreign currencies, what will happen to the prices of U.S. exports and foreign imports, as well as net exports?
21. Suppose the invention of a new computer system permanently increases worker productivity. What will happen to output and inflation in the long-run?
22. What is stagflation and what is it associated with in the AD/AS model?
23. Fill in the first two blanks with high or low. Then explain what was true of AD or AS to explain that situation (AD was higher, AD was lower, AS was higher, AS was lower).
a. For most of the 1960s there was ______inflation and ______unemployment. This is because ______than normal.
b. For most of the 1970s there was ______inflation and ______unemployment. This is because ______than normal.
c. For most of the 1990s there was ______inflation and ______unemployment. This is because ______than normal.
d. Today there is ______inflation and ______unemployment. This is because ______than normal.
24. Suppose an economy’s aggregate demand function is given by: Y=13,000 – 20,000π
Where Y is output and π is inflation. Initially the inflation rate is 0.04 (4%). Potential output is 12,000.
a.) What is the output level in the short – run? What does the output gap equal? Is it expansionary or recessionary?
b.) What is the inflation rate in the long run equilibrium (when output is at its potential level)?
25. Suppose that a permanent increase in oil prices creates both an inflationary shock and reduces potential output (LRAS). Use an AD-AS diagram to show the effects of the oil price increase on output and inflation in the short run and the long run. Label everything.
26. What are automatic stabilizers?
27. The U.S. income tax system is (progressive or regressive), which means that as GDP rises, average tax rates (fall or rise).
28. The following table shows U.S. income tax brackets in the U.S. in 2014
Tax Bracket / Taxable Income10% / $0–$8,925
15% / $8,925– $36,250
25% / $36,250 –$87,850
28% / $87,850 –$183,250
33% / $183,250 –$398,350
35% / $398,350 - $400,000
39.6% / $400,000 and above
Calculate the amount paid in taxes for an individual who earns $50,000 in taxable income. What is their tax rate?
29. Someone who earns $450,000 falls into a tax bracket of 39.6% in the U.S. The percent of their income paid in federal taxes will be (greater than, less than, equal to) 39.6%.
30. Explain why most billionaires in the U.S. pay a tax rate on their income that is below 25%.
31. The U.S. deficit currently equals approximately ______, and the national debt currently equals approximately ____.
32. What is the difference between gross and net public debt?
33. What are the major problems associated with a large amount of government debt?
34. What are the future projections regarding the U.S. debt situation?
35. Currently, approximately ______% of the federal U.S. budget is ‘discretionary’. If fiscal policy is not changed, it is projected that ______% of the federal U.S. budget will be discretionary by 2030.
36. What could be done to address the growing burden of Social Security and Medicare?
37. Laffer curve shows the relationship between ______and ______.
38. Empirical studies suggest that the peak of the Laffer curve is equal to approximately ___.