Study Guide for Final, ECO 201: Principles of Macroeconomics
Bring a SIMPLE calculator.
The exam, as usual, will be based on the homework, with some short-answer questions and some longer problems. There will be some calculation and a lot of graphs.
Just over half of the questions and the points of the exam come from chapters 22, 24,
and 30.
Chapter
Study
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Make sure you are familiar with Supply / Demand: how do you find equilibrium? What is the difference between a movement along the curve and a
shift of the curve?
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Learn the definitions of the Key Terms at the end of the chapter.
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Learn very well the expenditure method of measuring GDP
What is the difference between Nominal and Real GDP?
What is unemployment? Is a full-time student unemployed? (Ans.: no)
Learn the definitions of the Key Terms at the end of the chapter.
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Difference between inflation and the price level.
Difference between nominal and real interest rates.
Learn the definitions of the Key Terms at the end of the chapter.
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1. What has happened to living standards in recent history? What is the
best economic measure of standards of living?
2. What is GDP per capita? Why do we care about GDP per capita and
not (so much) about GDP per worker?
3. Suppose a government enacts a policy that causes the long-run growth
rate of average labor productivity to increase by 0.2 percentage points.
Why would such a small improvement matter?
4. What is the largest source of increased GDP per capita? (Answer: increased labor productivity, but higher labor participation helps).
5. Why is average labor productivity so important? What are the determinants of average labor productivity? Make sure you understand the
role of each one.
a. Define human capital. If you were the Minister of Education
of a small, poor country, what would you do to improve the
human capital of the average citizen of your country?
i. Suppose the Minister of the Treasury says, “that’s a
waste of time. Farm workers don’t really need to
know algebra.” What would you answer?
b. Define physical capital (your definition, maybe drawn from
chapter 18, p. 450, should make clear why more physical cap1
Output
ital leads to economic growth).
i. In a free-market economy, who accumulates physical
capital? (Answer: private businesses). What kinds of
policies can a government enact that will encourage
private firms to accumulate capital?
ii. Remember that there’s no free lunch: more factories
mean giving up current consumption of pizzas. So
you’ve got to be sure that the extra investment is
worthwhile.
c. What are diminishing returns to capital? Explain Table 20.2,
the similar table in the slides, Question 4, and Problem 6.
Think up two other examples of a situation where adding
more of just one factor of production leads to more output,
but at a decreasing rate.
Amount of Capital
d. What is the role of land and natural resources?
i. Can a country grow without them?
ii. Even though individual countries can import natural
resources, the whole world can’t. So the environment
needs to be protected, even on economic grounds.
e. Explain this sentence: “economists would agree that new technologies are the single most important source of productivity improvement, and hence economic growth in general.
i. When we say “productivity” we really mean the same
as “average labor productivity.”
ii. What kinds of policies encourage technological development, research, etc.?
iii. What is the role of population in technological development?
f. What is the role of entrepreneurship and management in
economic growth? Why is social capital important? All of
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these are essential to a free-market economy (and not necessary for a communistic one).
g. What policies increase economic growth?
h. What is the specific role of government in economic growth?
(Besides broader policies, how does the specific function of
government contribute to economic growth? In this, the caveat is also clear: a government that does too little, or too
much, or badly, will hurt economic growth.)
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Suppose the productivity of workers improves. How does the demand for
labor change? What happens to wages?
What are the three kinds of unemployment?
Learn the definitions of the Key Terms at the end of the chapter.
Learn the definitions of the Key Terms at the end of the chapter.
1. Definitions: saving, saving rate, wealth, assets, liabilities, stocks,
flows, capital gains and losses. Relationship between saving and
wealth, etc.
2. Difference between stocks and flows
3. Relationship between saving and the interest rate: why does saving
rise when r rises? Draw the relation between saving and the real interest rate.
4. Measurement of national saving. Private and public saving; components. Define National Saving, Private Saving, and Public Saving. Suppose private saving stays constant: what happens to National Saving if the government deficit increases?
5. Define Investment and Capital. Determinants of investment: interest rates, VMP, etc. An exercise (like in the slides or in the homework) dealing with the effects of changes in interest rates, productivity, price of the good produced, etc. Calculation is likely.
6. Draw the relation between investment and the real interest rate.
7. In Figure 22.7, how is the real interest rate determined? What does
an increase in the budget deficit do to the real interest rate?
8. Financial markets: determination of the interest rate in a closed
economy and the equilibrium quantity of saving/investment.
9. Shocks to financial markets: effects of changes in the determinants
of saving and investing. Exercise 9 is a good example. Try many
other “shocks” by changing the determinants: this will help you
learn about the reasons for saving, the effects of government deficits
on national saving, and the macroeconomic effects of microeconomic changes in investment. There will be graphing questions on this
topic for sure.
Use the three functions of money to define what money is.
What kind of policy does a Central Bank carry out? Answer: monetary
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policy. What are open market operations? What does an open market
sale/purchase do to the money supply?
Assuming velocity is constant and output is equal to potential output,
what is the long-run impact of an increase in the money supply on output?
Learn the definitions of the Key Terms at the end of the chapter.
Learn the definitions of the Key Terms at the end of the chapter.
1. What is the main function of the financial system? How do financial intermediaries perform this function? This is an important topic.
2. What are international capital flows? What is their relation with the
trade balance? Why are we sure that NX + KI = 0? Explain this equation. What are the determinants of capital flows? Graph is likely.
3. Draw the relation between capital inflows and the real interest rate.
4. Using the definitions of national saving and the relation between
NX and KI, how are government budget deficits, savings, investment, and net exports related? Recall S + KI = I.
5. How does an increase in the country’s riskiness affect capital flows?
(Answer: it shifts the KI curve. See Figure 24.3)
6. Make sure you understand Figure 24.4 and equation 24.2 very well.
7. Using lots and lots of graphs, talk about how the determinants of
private saving, investment, public saving, and foreign saving (KI)
are affect the real interest rate and the equilibrium quantity of saving/investment.
Learn the definitions of the Key Terms at the end of the chapter.
Very important chapter.
1. The main differences between Classical economics and Keynesian
economics.
2. What are the components of aggregate expenditure?
3. What is the Marginal Propensity to Consume?
4. What is the PAE function? How is it distinct from the Consumption
function? What shifts the PAE function? (Answer: a change in autonomous expenditure). Suppose income rises by ∆Y: what happens to PAE? (Answer: induced expenditure rise by the MPC x ∆Y)
a. PLEASE NOTICE the consumption function and the PAE
function are different: the PAE function includes the C function, but it adds I, G, and NX.
5. How is short-run equilibrium output determined? By setting two
equations equal: Y=PAE (the equilibrium condition) and PAE = Cbar +c(Y-T) + IP + G + NX. We find equilibrium by solving equation, 26A.1 for Y. The result is equation 26A.2.
6. Understand Tables 26.1 and 26.2 very well.
7. What is the difference between potential output and actual output?
Are there any forces in the short run model that make sure ac4
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tual=potential? (Answer: “no”).
8. Fiscal policy: define it. What happens to PAE if G increases? What
happens in T increases?
9. How can fiscal policy bring an economy back to full employment?
(from either a recessionary gap —excess unemployment— or from
an expansionary gap —over-employment)
Learn the definitions of the Key Terms at the end of the chapter.
1. Draw the money demand curve. What causes a movement along the
money demand curve? What causes a shift of the money demand
curve?
2. Who determines the supply of money? Draw the money supply curve.
3. How does the Central Bank raise or lower interest rates?
4. Which components of spending are affected by the real interest rate?
What will happen to them if the CB raises interest rates? Explain, with
words, in a graph, and with algebra, how and why this happens.
5. What will the CB do to interest rates if there’s a recessionary gap?
What if there’s an expansionary gap?
Learn the definitions of the Key Terms at the end of the chapter.
6. What is the main reason the AD curve slopes down? What are other
reasons? Use equations 27A.1, 28A.1, and 28A.2 to understand this.
7. The AD curve is a negative relation between inflation and equilibrium
output because of the policy reaction function. This means that, as inflation changes, the Fed moves along its PR function and the economy
moves along its AD function. Understand this logic well.
8. Why does the AD curve shift? Show this with words, in a graph, and
with algebra.
9. Draw the SRAS curve. Why is it horizontal?
10. What is the relation between output gaps and inflation? In other
words, why does inflation fall if there’s a recessionary gap? Why does
inflation rise if there’s an expansionary gap? What happens to the
SRAS curve in both of these cases?
11. How is short-run equilibrium determined? Show this with words,
graphically, and with algebra.
12. Why is the LRAS vertical? What happens to the SRAS if short-run
equilibrium happens either to the left or to the right of the LRAS?
What happens if short-run equilibrium is found on the LRAS?
13. The book says the economy is self-correcting in the long run. Why is it
self-correcting? Suppose adjustment is very slow. Using the slides,
show why it is that a slowly self-correcting economy can benefit from
government intervention, but a quickly self-correcting economy would
become unstable if the government intervened too much.
14. What is the effect on short-run and long-run equilibrium of a) a demand shock; b) an inflation shock; c) a shock to potential output.
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15. What kinds of policies can a government follow in response to the three
kinds of shocks outlined in question 9?
16. Suppose the economy is at potential output, but inflation is very high.
Describe how a sharp contractionary policy would reduce inflation in
the long run (with no change in output) but only at the cost of reducing
output in the short run. Do you think it’s worth it?
Learn the definitions of the Key Terms at the end of the chapter.
Learn the definitions of the Key Terms at the end of the chapter.
1. Notice that nominal exchange rates are determined in the foreign exchange market. Real exchange rates aren’t, not directly.
2. How is the real exchange rate calculated? Do a couple examples. Why
is the real exchange rate more important for exports and imports than
the nominal exchange rate?
3. What is the Law of one price? Use an example to show it makes sense.
4. How does PPP follow from the law of one price? Give reasons for why
this makes sense: “PPP seems to hold in the long run but not in the
short run.” That is, why would real exchange rates deviate from PPP?
The book gives two reasons.
5. Use a supply and demand diagram to show how exchange rates are determined. What is the “fundamental” value of the exchange rate?
6. What determines the demand for dollars? Give three examples of factors that shift the dollar demand curve.
7. What determines the supply of dollars? Give three examples of factors
that shift the dollar supply curve.
8. What happens to a) interest rates, b) the exchange rate, and c) output
when the Central Bank uses expansionary monetary policy? Is the Central Bank more or less effective in an open economy (that is, in an economy that trades with the rest of the world so exchange rates matter).
9. Why is it that “the Central Bank gives up monetary policy under fixed
exchange rates because it cannot use monetary policy to stabilize the
economy”?
10. What does it mean for a currency to be “overvalued” or “undervalued”? What policies can the Central Bank use to keep the exchange
rate at the fixed level? What are the limitations of using monetary policy to fix an exchange rate; or of using international reserves?
11. What is a speculative attack? Describe why and how it happens.
12. What do you think: should exchange rates be fixed or flexible?
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