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ECONOMICS 2040 -- STUDY QUESTIONS NO. 1 1. Define each of the following terms: a) aggregate demand b) aggregate supply c) Gross Domestic Product (GDP) d) price index e) real GDP f) GDP in constant dollars g) nominal GDP h) GDP in current dollars i) investment j) labor force k) unemployed l) inflation m) potential GDP n) o) p) q) r) s) t) u) v) w) x) y) short run short-run aggregate supply long run long-run aggregate supply economic growth productivity industrial revolution neoclassical growth model New Growth Theory recession capital saving 2. How is the unemployment rate determined in the U.S.? What must a person do to be counted as unemployed? 3. The following table gives information about prices and output in the U.S. economy: Year 1970 1980 1985 1990 1998 a) b) c) $'s need to buy the average market basket 800 1600 1900 2400 3000 GDP in trillions of current dollars Price Index (1970 = 100) Real GDP 1 2.3 3 4.5 7 fill in the two blank columns. what was the rate of inflation from 1970 to 1998? what was the rate of inflation from 1985 to 1990? 4. In calculating GDP, why is it important to measure only final sales of goods and services? 5. In discussing the circular flow of income and expenditure, we saw that households give _____________ to business firms in exchange for __________, while business firms give __________ to households to buy their ___________. Accordingly, the business firms' costs are the households' __________. 6. Think about the circular flow of income. If investment spending fell sharply, where would this first appear? What impact will the decline have on business firms? On business firms' payments for inputs? On household income? ECO2040 study questions #1, p. 2 The following diagram is for questions 7 – 13: Goods Markets C B Households D A Business Firms Resource Markets 7. In this diagram, if we measured the size of the flow of spending at D, we would be measuring _______; if we measured the size of the flow at C, we would be measuring __________. 8. The little loop at B represents ____________, an activity in which business firms are the final buyers from other business firms. 9. Box A represents ___________. If the size at D = size at C, then necessarily, A = ________. 10. If the economy is in equilibrium, then ______ = ________, or, what is the same thing, ______ = ______. 11. Give a general definition of the term equilibrium as the concept is used in economics, then explain how that relates to the particular definition given for equilibrium in the circular flow diagram. 12. What important factors in the economy have been left out of this sketch? Draw them in. 13. In the circular flow diagram, the economy is in equilibrium if E = Y. a) Explain what this condition means. b) What will happen if E > Y? c) What will happen if E < Y? d) What variable changes to bring the economy back into equilibrium? e) Explain why E = Y is equivalent to I = S. 14. Why is there a difference between the long-run aggregate supply curve and the short-run aggregate supply curve? What is changing as prices change along each of these curves? 15. Suppose that the rent on your apartment or dorm room were doubled. What adjustments would you make in the short run? In the long run? ECO2040 study questions #1, p. 3 16. In the short run, if a business firm finds that the prices for which it can sell its goods have increased while its wages and other resource payments have not, what is the firm most likely to do? 17. Fill in the blanks: As the price level rises, nothing else changing, business firms will want to _________ output; to increase output, firms must hire ______ labor and other resources; as firms attempt to hire more labor, _______ will rise. 18. Explain why, in the short run, an increase in the price level causes firms to offer more for sale but not in the long run. 19. The following sketch illustrates long-run and short-run aggregate supply curves: label the axes and all the curves properly. 20. What will cause short-run aggregate supply (hereafter SRAS) to increase? Use the sketch above to show an increase in SRAS. 21. What will cause SRAS to decrease? Use the sketch above to illustrate a decrease in SRAS. 22. What will cause long-run aggregate supply (hereafter LRAS) to increase? What will cause potential GDP to increase? Use the sketch above to illustrate an increase in LRAS. 23. Why do we seldom have reason to talk about a decrease in LRAS? 24. What components make up aggregate demand? 25. Why does the aggregate demand curve slope downwards? 26. What will cause aggregate demand to increase? To decrease? 27. What will cause consumption spending to increase? To decrease? 28. What will cause business investment spending to increase? To decrease? ECO2040 study questions #1, p. 4 ECO2040 study questions #1, p. 5 29. The following sketch illustrates an aggregate demand curve. Label the axes and curve correctly. 30. Use the sketch above to illustrate the effect of each of the following events: a) an increase in household wealth caused by increasing stock-market prices. b) Gloomy economic news which causes people to feel less secure about keeping their jobs in the future. c) Lower interest rates for borrowing money. d) Economic growth abroad causes foreigners to want to buy more U.S.-made goods. e) Al Gore is elected and gets major new government spending programs through Congress. Price Level (Index) LRAS SRAS Aggregate Demand Q* Real GDP 31. In the sketch above, indicate the equilibrium levels of output and the price level. 32. Use the sketch above to illustrate each of the following events: a) Oil producing nations agree to restrict output and raise the price of oil. b) The construction of the Interstate Highway System. ECO2040 study questions #1, p. 6 c) A continued rise in the value of stock shares of U.S. corporations. d) Labor union contracts force 20% of U.S. employers to accept a very large wage increase. e) Because of the long boom, families generally come to feel that the economic future will be better and they'll always be able to find a job. f) Under President Gore, the federal government expands construction of low-income housing and puts 100,000 new cops on the streets. 33. Historically, what has been the major force in expanding aggregate supply or potential GDP? 34. Explain how a supply shock can cause a recession. 35. What caused the Great Depression of the 1930’s? How long was the short run in this case? 36. Why is it that increasing government spending can create a short-run increase in output (a “boom”) but not a long-run increase in output? 37. During the 1990’s aggregate demand soared, yet prices increased relatively little. What accounts for this benign state of affairs? 38. What are the indispensable prerequisites for sustained economic growth? 39. About when did the Industrial Revolution begin? What did it represent in terms of standards of living? 40. Is there a single, agreed-upon explanation for the timing and location of the Industrial Revolution? 41. If a nation is to have higher levels of consumption, it must have higher levels of __________. 42. What are the principal sources of economic growth? 43. Fill in the blanks: Just like Robinson Crusoe, if a modern nation is to have more _______, it must forego some current __________. 44. What is “neoclassical growth theory?” What is the key difference between that and the “New Growth Theory?” 45. State the "Rule of 72." Use this rule to answer the following questions: a) The population of Lower Slobbovia is growing at 5% per year. If the population is currently 40 million, in approximately what year will it reach 80 million? b) An inflation rate of 6% a year would not be unusual; at this inflation rate, how long will it take the price level to double? To quadruple? c) In the 1960's Japan often had annual economic growth of 12% or more. At that rate, how long does it take output to double? 46. On average, each generation of Americans has enjoyed about ________ the real income of their parents at the same age and about _______ times the income of their grandparents. 47. What are some reasons that have been advanced to explain the slowdown in productivity growth after 1970? 48. What’s happened to productivity in recent years?