Free Response Questions for Spring Break
Use a separate sheet of paper to COMPLETELY answer these questions.
1. On the graph above, demonstrate each of the following:
a) The effect of an increase in the incomes of all consumers in this market.
b) The introduction into this market of an appealing substitute good with a lower price.
c) A decrease in the price of a complimentary good.
d) The belief that in the near future this product will become less expensive.
2. Econ Island is a very small island that produces a limited amount of products each year. The table below shows this year’s prices and purchases of products on the island.
This Year’s Output / This Year’s Prices1,000 pounds of hamburger / $2 per pound
2 cars bought from the used car lot / $10,000 per car
10 clothing outfits imported from another island / $20 per outfit
10,000 pounds of ice (8,000 used on the island, 2,000 exported) / $1 per pound
Government spending for workers to clean the beach / $5,000
1 meat processing machine bought from a local producer / $250
Illegal drugs produced and sold on the island / $1,000
(a)Using the data, calculate this year’s nominal GDP for Econ Island.
(b)If the price index is 110, calculate this year’s real GDP for Econ Island.
(c)Identify two factors in the table that would not be included in GDP using the expenditure model. For each factor, complete the following:
(i)Identify the factor that would not be included in GDP.
(ii)Explain why the factor would not be included in the GDP calculation.
(d)Explain one shortcoming of using GDP as an accurate measure of the standard of living for residents of a country.
3. Answer each of the following for an economy with a marginal propensity to consume of .80; a reserve requirement of .25, and which is operating at a level of GDP that is $1,000 less than the desired level.
a)Identify two specific fiscal policy tools that could be used to increase GDP to the desired level.
b)Identify the appropriate size of each of the fiscal policy measures you listed in part A.
c)Identify on monetary policy tool that could be used to increase GDP to the desired level.
d)Identify the appropriate size of the monetary policy measure listed in part C.
4. Assume that the following figures represent the existing condition in an economy.
Unemployment Rate4%
Inflation Rate3%
Annual Rate of GDP Growth3.5%
a) Is this economy facing any economic problems as describe by the data above? Explain
b) Draw an aggregate supply and demand diagram to demonstrate the current condition for this economy.
c) On the diagram you drew for part B demonstrate the effect of the federal government engaging in a massive new nationwide road building project.
d) Analyze the effect of this massive new nationwide road building project on each of the following:
i) the level of output
ii) the level of unemployment
iii) the price level
5. If an economy’s productivity has been increasing at a slower rate than nominal wages, graph and analyze the short run effects of this on:
a) Aggregate demand
b) Aggregate supply
c) Price level
d) Output
e) Employment
6. Assume that the United States economy is currently in a recession in a short-run equilibrium.
(a)Draw a correctly labeled graph of the short-run and long-run Phillips curves. Use the letter A to label a point that could represent the current state of the economy in recession.
(b) Draw a correctly labeled graph of aggregate demand and aggregate supply in the recession and show each of the following.
(i) The long-run equilibrium output, labeled Yf
(ii) The current equilibrium output and price levels, labeled Ye and PLe, respectively
(b)To balance the federal budget, suppose that the government decides to raise income taxes while maintaining the current level of government spending. On the graph drawn in part (b), show the effect of the increase in taxes. Label the new equilibrium output and price levels Y2 and PL2, respectively.
(d) Assume that the Federal Reserve uses monetary policy to stimulate the economy.
(i) What open-market policy should the Federal Reserve implement?
(ii) Using a correctly labeled graph of the money market, show how the policy in part (d)(i) affectsnominal interest rates.
(iii)What will be the impact of the policy on the price level? Explain.
(e) Now assume instead that the government and the Federal Reserve take no policy action in response to therecession.
(i) In the long run, will the short-run aggregate supply increase, decrease, or remain unchanged? Explain.
(ii) In the long run, what will happen to the natural rate of unemployment?