PART TWELVE: THE ECONOMY

1. Look at the list of goals for the economy. Choose one of the goals and explain why it is a valuable goal.
   1. Full employment – It enables everyone who wants a job at the prevailing wage rate to find one, adjusting for frictional and seasonal unemployment.
   2. Price control: limited to no inflation – Inflation is a “hidden tax” on the economy and diminishes buying power.
   3. Economic growth – an expanding economy improves the standard of living for the population as a whole.
   4. Favorable balance of payments – The total receipts from abroad (exports plus the inflow of capital and gold) exceeds the total payments to foreign countries. This injection into the circular flow allows businesses to hire more workers, ultimately expanding the economy as a whole.
2. Describe the form that demand takes as it moves from households to firms. Household demand goes to the market for goods and services and revenue flows through to the firms from that market.
3. Describe the form that supply takes as it passes from households to firms. Households supply their land, labor, plant and equipment, and managerial skill to the market for productive resources which in turn supplies firms with those productive resources.
4. The four productive resources are: land, plant and equipment, labor, and management/entrepreneurial skills. What specific word is used to describe the income produced by each?
   1. Land = rent
   2. Labor = wages
   3. Plant/equipment = interest
   4. Managerial skills = profit
5. As you look at the four boxes, who produces goods and services? Firms produce goods and services.
6. Explain why consumer savings is a withdrawal from the economy. Because the savings represents the amount unavailable to pay for goods and services produced by firms.
7. Explain why business investment is an injection into the economy. Business invests by purchasing productive resources providing an influx of income to households.

PART THIRTEEN: MEASURING THE ECONOMY

1. Explain the equation: AD = C + I + G + X. Aggregate Demand equals Consumption Spending plus Investment plus Government Spending plus net exports.
2. Define fiscal policy in your own words. Answers will vary. It is the use of the federal budget (taxes and spending) by the Congress and President, to achieve economic goals.
3. You are the President of the United States. How would you explain to the American people how a change in government spending can be used to ease unemployment? Answers will vary but should indicate an understanding that by injecting cash into the economy government can provide the necessary additional liquidity for businesses to hire more workers, thus lowering unemployment.
4. Explain the difference between the employment rate and the unemployment rate. Why does the distinction matter? The unemployment rate is the number of unemployed workers under the age of 16 divided by the labor force. The employment rate is the number of employed citizens divided by the population over the age of 16. The unemployment rate provides information on how many people are looking for jobs but can’t find them. The employment rate provides information about how many jobs have been created in the economy.
5. Consider the list of productive activities that are not included in the GDP. Choose one and discuss some of the reasons economists exclude it from the GDP.
   1. Non-market transactions. In these situations, money does not exchange hands, making the value of the transaction difficult to ascertain. The value a non-employed spouse can be said to contribute to the family is one such example.
   2. Underground economy. In this case, although money often does exchange hands, the participants go to great lengths to hide the transaction, making it impossible to quantify. The drug trade is an example.
   3. Leisure. This presents a quality of life issue and has to do with creating an additional sense of well-being. While this certainly has value, it is not measured in the economy.
   4. Quality/Price. Improvements in goods are not always reflected in a price change. Consider the effect of technological improvement on computer equipment – although the quality of the products are clearly improving, the price for the products is declining, generating an increase in value not reflected in the GDP.
   5. Economic bads. The argument is made that if GDP measures improvements and growth of “goods” in the economy, then things which harm or reduce the economy (the “bads”) should be deducted from the GDP. Pollution is one example.
   6. Distribution of GDP. When an economy grows, the issue of who has access to the expanded goods and services is not given any weight. Although it is clear that extreme disparity creates problems that have adverse effects on an economy, we do not have a way to measure the correlation between specific amounts of disparity and the specific effect it produces.
6. Professor Swanson says that it is “okay the GDP is not exact.” What caveat does he give to justify it as a viable measurement? It is “okay” because the real value of GDP is to measure trends in the economy. So long as the measurement criteria are consistent, trends will become evident.

PART FOURTEEN: INFLATION

1. Why do we need a base year for the CPI? Because it is a measure of the increase in price over time.
2. Why have apparel prices stayed so low? The elimination of trade barriers and increased globalization have expanded low cost imports from countries with lower labor costs. This competition prevents domestic producers from raising prices.
3. Why are energy and food left out of the calculation of core inflation? Typically, there is a lot of short-term (monthly) fluctuation in these two items. The core inflation rate seeks to measure a more constant, longer-term rate because it is used to trigger inflation-fighting tools that are fairly slow-acting. It is believed that a more accurate picture of inflation can be obtained by capturing the effect of food and energy volatility on the cost of other goods.
4. Give some examples illustrating the difference between a price increase and inflation. Answers should indicate an understanding that inflation measures the aggregate effect of price increases of goods or services. The price increase of a single good or service by itself is not an indication of inflation.
5. Who is hurt and who benefits as inflation rises? Savers and people on a fixed income are hurt and borrowers are helped.

PART FIFTEEN: WHAT IS MONEY?

1. What is the basic test of money? Is it accepted in exchange?
2. Briefly describe the inefficiencies of a barter system. Answers will vary. Primarily, the inefficiencies stem from the fact that the price of each product must be known in terms of every other available product.
3. What do we mean by stating that money provides a standard of value? By attaching a monetary value to something, we can compare it to other things with that same monetary value.
4. When we have money, we can choose to hold it or to spend it. What is the cost to society of individuals holding money? Holding money takes it out of the circular flow of the economy and does not allow it to be used by any of the productive sectors for economic growth.

PART SIXTEEN: THE FEDERAL RESERVE AND THE MONEY SUPPLY

1. Describe the process by which money is expanded from an initial bank deposit. Include an explanation of the money multiplier in your answer. When a person deposits a check in the bank, the bank is required to hold on to a certain percentage, but is allowed to lend the rest. As it lends money out, that money will in turn be deposited into a bank which will also be able to lend a percentage of it and so on. This continues until the initial deposit has been expanded to the limit of the current money multiplier. The multiplier is the mathematical limit of the expansion capability of the initial deposit in the banking system.
2. Explain how the Federal Reserve uses the reserve requirement to manipulate the money supply. The reserve requirement is the percentage of a deposit the bank must hold in reserve. If the Federal Reserve wants banks to be able to lend more money and thereby increase the money supply, it can lower the reserve requirement. However, if it wants to tighten or reduce the money supply, it can raise the reserve requirement and banks will have less money to lend out.

PART SEVENTEEN: ADDITIONAL TOOLS OF MONETARY POLICY

1. Explain the difference between the Discount Rate and the Federal Funds Rate. The discount rate is the interest rate the Federal Reserve charges its member banks to borrow money. The federal funds rate is the interest rate that banks charge each other to borrow money.
2. Describe how both increases and decreases in these rates would affect the money supply. Increases in these rates would make it harder to get a loan and would therefore tighten or decrease the money supply. Decreasing the rates would make it easier to get a loan and would increase the money supply.
3. Explain how the Federal Reserve would use open market operations to lower interest rates and why it would be effective. If the Federal Reserve wanted to lower interest rates, it would begin to buy bonds in the open market which would substitute cash for the bonds. Bank reserves would increase and they would have more money to loan out. When banks have excess cash to loan, they typically charge lower interest rates to draw customers, in effect, putting the money “on sale.”
4. What problem in the economy is the Federal Reserve likely trying to address if it raises the reserve requirement and the discount rate and begins selling bonds in the open market? These are all inflation-fighting tools. By selling bonds and raising the reserve requirements and discount rate, the Federal Reserve is trying to pull money out of the economy and make it harder to borrow. This is intended to slow spending, stop prices from rising, and possibly allow prices to adjust downward.

PART EIGHTEEN: FISCAL POLICY AND THE NATIONAL DEBT

1. Name the two components of fiscal policy. Government spending and taxes.
2. Explain how a built-in and automatic stabilizer like unemployment compensation helps the government reach its economic goals. Full employment is one of the economic goals. Unemployment compensation mitigates the problem of short-term unemployment.
3. Describe each of the three fiscal policy lags below and explain why they are problematic.
   1. The RECOGNITION LAG points to the time lapse between the actual occurrence of a problem and the recognition that a problem exists. It is problematic when there is disagreement over the nature or extent of the problem.
   2. The DECISION LAG describes the difficulty in deciding what to do about the problem. The difficulty may be caused by a lack of full understanding of the problem, a lack of available options to solve the problem, or even contention among the problem-solvers. Compromises often fail to adequately address the problem.
   3. The EXECUTION LAG is the amount of time between the decision to act and the ability to implement the solution. This is problematic because it involves government spending, is often a large-scale project, and often requires years of preliminary preparation before any real action can be taken.
4. Describe both the present costs and future costs of the national debt. Present costs: Money used to pay interest on the debt cannot be used for anything else. Future costs: Government borrowing “crowds out” other borrowers such as businesses and individuals by diminishing the pool of money available for lending, thus handicapping the productive sector of the economy.