Most of the economics that is usable for
advising on public policy is at about the
level of the introductory undergraduate
course. Unfortunately, however, economists
don't know very much;
but
other people, including politicians who
make economic policy, know even less
about economics than economists do.
Most of the economists who catch on do so long
after graduate school, while teaching classes or
advising governments: that's when I learned to
think like an economist. I think economics, like
philosophy, cannot be taught to nineteen-year
olds. It's an old man's field. Nineteen-year olds
are, most of them, romantics, capable of
memorizing and emoting, but not capable of
thinking coldly in the cost-benefit way. A
nineteen-year old has intimations of immortality,
comes directly from a socialized economy (called
a family), and has no feel on his pulse for those
tragedies of life that economists call scarcity and
choice.
I have never known anyone skillful in economics
who claimed to have acquired this skill solely
through extensive study of textbooks. Virtually
unanimously, individuals report acquiring skill
through practice. Even a diligent student, who
has learned all the basic principles, when faced
with his or her first problem has no meaningful
way of deciding which of these principles would
be most useful to apply. Perhaps it is not
surprising, then, that students so often complain
that although they study the text they are largely
unable to solve problems.
1. What are discouraged workers?
2. Explain what impact an increase in the number of
discouraged workers would have on the measured level
of unemployment.
3. An increase in the number of discouraged workers will
a) increase the labor force
b) raise the participation rate
c) decrease the number of jobs
d) lower the measured unemployment rate
4. "For example, Canada's jobless rate fell to 7% last
month, the lowest number in 2 years. But if you think
it's a sign that the economy is suddenly moving up, look
again."
How could a fall in the unemployment rate not be a sign
that the economy is moving up?
A lady arrives at a river with a fox, a
chicken and a bag of grain. There is a raft
which can carry her and one of her
belongings. If she leaves the fox alone with
the chicken, the fox will eat the chicken; if
she leaves the chicken alone with the grain,
the chicken will eat the grain. How does she
cross the river?
Week 1: Intro: Supply and Demand
1. What is economics?
micro- versus macro- economics
2. A microeconomic example
why demand is downward-sloping
why supply is upward-sloping
equilibrium price and quantity
shifts in supply and demand curves
reaction to a shock
shifts in versus movements along
3. The Four Fundamental Macro Markets
Goods and Services Market
Determining GDP and the P level
Money Market
Determining the interest rate
Labor Market
Determining the wage rate
Foreign exchange market
Determining the exchange rate
4. The AS/AD diagram
Week 2A: Measuring Output
1. National Income Accounts
GDP vs GNP
national output, national income, aggregate supply, etc.
2. Adding Spending
(C + I + G + X - M)
role of imports, inventories
antiques, intermediate goods
3. Adding Incomes
(wages, profits, interest, rent)
role of indirect taxes, depreciation, subsidies, transfers, capital gains
4. Statistical discrepancy
5. Use as a welfare index:
exchange rates
illegal activities
market transactions, leisure
day-care, maids, etc.
pollution, police
war goods vs consumer goods
climate
distribution
Example Exam Questions for Week 2
1. Explain the difference between the two different ways of calculating GDP.
2. From the data below, what is the official measure of GDP?
Personal Consumption Expenditures
Depreciation
Wages
Indirect Business Taxes less Subsidies
Interest and Rental Income
Gross Private Domestic Investment
Corporate Profits
Net Exports
Government Purchases of Goods and Services
Government Transfer Payments
62.0
5.0
80.0
1.0
3.0
15.0
7.0
1.0
20.0
4.0
3. Which of the following will be added to GDP as conventionally calculated?
a) a welfare payment
b) the cost of cleaning up an oil spill
c) dividends earned by an American on shares in a British company
d) the value of work done by a parent staying home to care for children
4. "Almost all of the fourth quarter increase in GDP wound up as unsold inventory
sitting on shelves." If it doesn't get sold, how could it get counted into GDP?
Week 2B: Measuring the Price Level and Inflation
1. Nominal versus real variables
2. Calculating the CPI
cost of a typical bundle of g&s
measuring inflation: the rate of change of the CPI
meaning of the base year
problems: quality changes; new products; relative price changes
3. The GDP deflator
4. How to convert nominal to real
5. Costs of inflation
illusory costs
income redistribution
wealth redistribution
tax increases
resource misallocation/inefficiencies
inflation avoidance
unpredictability
inconvenience (shoe-leather cost)
Week 2C: Measuring Unemployment
1. Definitions: Labor force
Participation rate
Unemployment rate
2. A Paradox: High job creation but growing unemployment
2. Varieties: Frictional
Structural
Institutionally-induced
Cyclical
3. Full employment defined; the NRU
4. Cost of unemployment: output gap
5. Measurement problems
Underestimate: discouraged workers part-time jobs
Overestimate: unemploy insurance underground economy
6. Use as a welfare index
composition of unemployed
safety nets
Even More Example Exam Qs for Week 2
1. What are "discouraged workers"?
2. Explain what impact an increase in the number of
"discouraged workers" would have on the measured level
of unemployment.
3. An increase in the number of "discouraged workers" will
a) increase the labor force
b) raise the participation rate
c) decrease the number of jobs
d) lower the measured unemployment rate
4. "For example, Canada's jobless rate fell to 7% last month,
the lowest number in 2 years. But if you think it's a sign
that the economy is suddenly moving up, look again."
How could a fall in the unemployment rate not be a sign that
the economy is moving up?
Week 3: Demand Equilibrium and the Multiplier
1. Defining agg D for goods and services
explaining consumption
explaining investment
2. Reaction to disequilibrium
inventory behavior
flowchart explanation
3. "The" multiplier
4. Graphical interpretation
45o - line diagram
Agg S / agg D diagram
5. Using the multiplier
Example Exam Questions for Week 3
1. What is fiscal policy?
2. A stimulating dose of fiscal policy can be applied either by
increasing government spending or by decreasing taxes.
What is the main reason why someone would prefer one to
the other?
3. Which of the following will tend to increase the size of
"the" multiplier?
a) a higher marginal tax rate
b) a higher marginal propensity to consume
c) a higher marginal propensity to import
d) a higher level of government spending
4. "For Canada, the demand pressures generated by the U.S.
tax cuts and the spillover effects of increased U.S. defense
spending will push the Canadian economy further into an
excess demand situation."
a) What kind of U.S. macroeconomic policy is referred to here?
b) Why will this policy affect Canada?
More Example Exam Qs for Week 3
1. Define "the" multiplier.
2. Is it better for an economy to have a larger or a smaller
multiplier? Explain.
3. If "the" multiplier is 5 and income increased by $65 billion,
the increase in autonomous spending must have been
a) $11 billion
c) $325 billion
b) $13 billion
d) $0.077 billion
4. "For the people around here this extra million dollars of
government spending means 42 direct jobs and, depending
on the employment multiplier you prefer, another 120 or
160 indirect jobs. In the bush. On the booming grounds. In
the drugstore.
a) What is meant by the "employment multiplier"?
b) What is the magnitude of the employment multiplier if 120 indirect
jobs are created?
Week 4: The Supply Side
1. LR growth/productivity/standard of living
creative destruction
national saving
2. AS/AD model
rationale for AS curve; shifts
modified multiplier
long run vs short run
3. Reaction to shock at FE
inflationary gap
fooling workers in the short run
information problems
contract obligations
4. Implications from the theory
stagflation
accelerating prices
5. Supply-side shock
6. Supply-side policy
recessionary gap
downward-sticky wages & prices
contracts
unemployment policy
co-ordination problem
efficiency wages
Example Exam Questions for Week 4
1. Explain why the aggregate demand curve is downwardsloping
2. Explain two different ways in which stagflation could come
about.
3. The aggregate supply curve will shift up for all the
following except
a) an increase in wage rates
b) an increase in the price level
c) an increase in the price of raw materials
d) a decrease in productivity
4. "He favors a slow recovery, for example, partly because the
'natural rate of unemployment' may turn out to be higher
than anyone thinks."
a) What is the 'natural rate of unemployment'?
b) Explain the rationale behind the suggestion that policy should
push the economy out of recession slowly rather than quickly.
Week 5: Money, Banking and Inflation
1. Crowding out
2. Defining money
M1 vs M2
banking innovations
3. Fractional reserve banking
legal reserves/ money base
the money multiplier
open market operations
4. The quantity theory: Mv = PQ
velocity
the "new" quantity theory
a long-run rule for inflation
5. The monetarist rule
discretion vs rules debate
6. What about the interest rate?
Example Exam Questions for Week 5
1. What is the monetarist rule?
2. Suppose the economy is at full employment with a real rate
of growth of 3%. If innovations in the banking system are
reducing, ceteris paribus, the need for money at 1% per
year, what rate of growth of the money supply would you
recommend to achieve a long-run inflation rate of 4%?
3. Believers in the monetarist rule assert that
a) lags are long and variable
b) the central bank should keep the money supply growth constant
c) the economy can be stabilized by automatic mechanisms
d) all of the above
4. "Far better for central bankers to get out of the fine tuning
business. Instead they should try to keep ....."
Finish this clipping.
Week 6: Interest Rates and Monetary Policy
1. Interest rates and the price of bonds
2. Treasury bills
calculating yields
the discount rate; federal funds rate
3. Real versus nominal interest rates
4. Monetary policy and interest rates
if at less than FE
if at FE
impact on bond market
5. interest rates and the quantity theory
6. international influences (reminder)
The Many Roles of Real vs Nominal Interest Rates
1. The real i rate affects agg D for g&s
2. Uncertain reaction of i rate to monetary policy
3. SR vs LR reaction to a rise in money growth
4. Forecasting i rate relies mainly on forecasting inflation
and central bank reactions
5. Reduce i rate by reducing money growth
6. Beware using nominal i rate as a policy target
7. Bad economic news increases bond prices
8. International roles to be discussed later.
Example Exam Questions for Week 6
1. Explain why the price of bonds falls when interest rates rise.
2. The current price of a Treasury bill due to pay $1000 in one
year's time is $930. If the central bank announces that the
money supply growth rate will jump from 6% to 8%, what
should the interest rate become?
3. Suppose the interest rate is 8%, and a bond with an annual
coupon of $75 matures in one year's time, paying its face
value of $1000. This bond's current price should be
a) below $1000 b) $1000 c) above $1000 d) not enough
information to tell
4. "The principle power of the Bank to lower interest rates lies
in its ability to contribute to a lower rate of inflation, and
that takes time."
a) How would the central bank contribute to a lower rate of inflation?
b) How would this lower interest rates?
c) Why would this take time?
More Example Exam Qs for Week 6
1. Explain the difference between real and nominal interest
rates.
2. Explain how an increase in the money supply affects the
interest rate.
3. Suppose interest income is taxed at 50%. If the real interest
rate is 3%, how much extra tax is paid on interest earned
from $10,000 if expected inflation were 6% rather than
2%?
a) $150 b) $200 c) $250 d) $400
4. "Capacity utilization, at 82.4%, was unchanged in January
for mines, factories and utilities. Economists are worried
that demands on industry may soon outstrip capacity,
thereby encouraging producers to raise prices. Inflation,
the undisputed Achilles heel of bonds, would result."
Explain why inflation is the Achilles heel (weak spot) of
bonds.
Week 7A: Policy Debates
1. Fiscal versus Monetary Policy
multiplier magnitudes
increasing G vs decreasing taxes
policy vs expenditure lags
discrimination
monetarist view of fiscal policy
2. Rules vs discretion
3. Supply-side policy
4. International forces (reminder)
Week 7B: Budget Deficits and the National Debt
1. The Keynesian legacy
balanced-budget multiplier
2. The structural deficit
definition: difference between actual deficit and deficit
corresponding to zero change in long-run public
debt/GDP ratio
adjustments to calculate structural deficit
cyclical effects
growth
seigniorage
4. Burdening future generations
purpose of borrowing
at full employment?
5. Generational accounting
Example of Structural Deficit Calculation
current deficit: $40b
real growth: 2%;
inflation: 4%
unemployment: 9%
money supply: $500b
publicly-held national debt: $400b
money multiplier: 5
long run average unemployment rate: 7%
change in deficit due to 1% pt. change in unemployment: $4b
Cyclical correction: 2*4 = $8b
Growth correction: (2+4)%*400 = $24b
Seigniorage correction: (2+4)%*500/5 = $6b
Structural deficit: 40 - 8 - 24 - 6 = $2b
Example Exam Questions for Week 7
1. What is the structural deficit?
2. Suppose an economy is at its long-run average rate of unemployment,
and has a nominal growth rate of 5%, a budget deficit of $30 billion, a
money multiplier of 4, a publicly-held national debt of $400 billion
and a money supply of $200 billion.
What is its structural deficit?
3. The cyclical correction makes the structural deficit bigger if
a) inflation is zero
b) the economy is in a boom
c) the current budget is in surplus
d) real growth is less than nominal growth
4. "The arithmetic is straightforward. If growth falls one percentage point
below the government's 3 per cent forecast, the deficit would widen by
about $1.5 billion.
a) How can growth affect the government's budget deficit?
b) How would the structural deficit be affected here?
Week 9A: The Exchange Rate
1. Definition of the exchange rate
2. Foreign exchange market
supply and demand curves for $
sources of demand: exports
capital inflows
sources of supply: imports
capital outflows
3. Other determinants (via shifting curves)
income
interest rate
price level
expectations
4. Reaction to disequilibrium
flexible exchange rate
fixed exchange rate
5. Government intervention
direct intervention
interest rates
rationale (reduce volatility)
Week 9B: Balance of Payments
1. Definition: demand for $ minus supply of $ on
foreign exchange market
2. Influence of B of P imbalance
flexible exchange rate
fixed exchange rate
3. Components
current account
balance of trade
invisibles
capital account
4. The twin deficits
5. Law of comparative advantage
Example Exam Questions for Week 9
1. What is the balance of payments?
2. Suppose the Fed has intervened in the foreign exchange market to fix
the exchange rate by selling $4b. If the current account deficit is $10b,
what is the capital account balance?
3. If the Fed is buying $ in the foreign exch. market to maintain the value
of the $, then
a) the U.S. has a B of P surplus
b) the U.S. dollar is undervalued
c) the U.S. money supply is shrinking
d) U.S. foreign exchange reserves are rising
4. "While some in the U.S. put the trade deficit down to failing U.S.
competiveness, or protectionist policies abroad, he claims its genesis
lies in the budget deficit, and the consequent shortfall in U.S. domestic
saving relative to investment."
Explain how the U.S. budget deficit could be responsible for the U.S.
trade deficit.
Week 10: Policy in an Open Economy
1. Fiscal policy, flexible exchange rate
assume mobile international capital
weakened by  $C
2. Fiscal policy, fixed exchange rate
strengthened by  money supply
3. Monetary policy, flexible exchange rate
strengthened by  $C
4. Monetary policy, fixed exchange rate
fully (!) offset by  money supply
5. Fixed exchange rate implies monetary policy determined
by trading partners - used to fix exchange rate and so not
available for other purposes
6. Sterilization policy
purpose; drawback
7. Fixed or flexible?
Example Exam Questions for Week 10
1. Explain why monetary policy is ineffective under fixed exchange rates.
2. Why with a fixed exchange rate would the U.S. dictate Canadian
monetary policy?
3. Expansionary monetary policy under fixed exchange rates in the short
run tends to
a) reduce an inflationary gap and reduce a trade surplus
b) reduce a recessionary gap and increase short-term capital outflows
c) lower the domestic rate of interest and increase a trade surplus
d) decrease a trade surplus and increase short-term capital inflows
4. "Finally, there is the question of monetary policy and imported
inflation. Under a fixed exchange rate, Canadian inflation would be
much more closely tied to that of the U.S. Given the experience of the
last few years, that may not be a bad thing."
a) Explain why inflation would be more closely tied to that of the U.S.
b) Would monetary policy ease or tighten here if a fixed exchange rate were
adopted?
Week 11: PPP and IRP Purchasing Power Parity
1. Role of arbitrage
2. PPP in terms of inflation differentials
LR rule of thumb:
rate of change of ex rate = foreign inflation - domestic inflation
short-run failure (real ex rate changes)
real interest rate differences
trade barrier changes
productivity growth differences
natural resource discoveries
terms of trade changes
3. Real versus nominal exchange rate
4. Calculating the PPP exchange rate and comparing standards of living
Interest Rate Parity
1. World real interest rate
differentials for risk
2. Why not equal nominal rates?
exchange rate changes
hedging costs
US Can Can
real growth
money supply growth
real interest rate
inflation
nominal interest rate
rate of change of ex rate
net real return to
an American investing
2%
7%
3%
2% 2%
7% 13%
4% 4%
Sample Exam Questions for Week 11
1. What is purchasing power parity?
2. In 1975 the Canada/US exchange rate was 0.95 (i.e., 1$C bought
.95$US). The Canadian price level rose by 52% between 1975 and
1980, while the US price level rose by 41%. What does PPP predict is
the 1980 exchange rate?
3. If the Canadian i rate is 10%, the U.S. rate is 15%, the risk differential
is 2% and the two economies are in mutual equilibrium
a) the $C is appreciating
b) the $C is depreciating
c) Can. exports are rising and imports falling
d) Can. exports are falling and imports rising
e) both a) and d)
4."News that job creation in January was more robust than anticipated sent
a signal to currency markets to expect a stepped-up fight against
inflation, unleashing a bout of buying fervor for the dollar."
Why would a tougher expected fight against inflation cause people to buy
the dollar?
More Sample Exam Qs for Week 11
1. What is interest rate parity?
2. Canada, on a fixed exchange rate, has real growth of 2% and is in
equilibrium with money growth of 10%. Changes cause the U.S. real i
rate to rise by 1% pt., U.S. inflation to rise by 2% pts., and its risk
differential with Canada to drop by 0.5% pt. When the Canadian
economy has settled to its new equilibrium, what is its change in
nominal interest rate?
3. If there is a risk differential of 1% pt. between countries A and B then
their
a) nominal i rates should differ by 1% pt.
b) real i rates should differ by 1% pt.
c) nominal i rates should differ by 1% pt. plus the difference in their real
growth rates
d) real i rates should differ by 1% pt. plus the difference in their real growth
rates
4. "He can't understand why Canadians would put their money in threeyear paper at 9% when they can get double-A rated New Zealand
bonds at 19%."
What explanation would you offer for this?
Week 12: Stagflation
1. The Phillips curve
historical development
modern interpretation
shifting curve
reversed causation
short-run vs long-run
2. Role of inflation expectations
the accelerationist hypothesis
the policy ineffectiveness debate
rational expectations
wage/price flexibility
asymmetric SR Phillips curve
Week 12: Stagflation (continued)
3. Policy implications
reducing the NRU
fighting inflation with recession
credibility effect
co-ordination problem
wage/price guidelines/controls
complementary monetary policy
costs vs benefits
4. The real cause of inflation: losing control of the money supply
underestimating the NRU
negative supply-side shock
fixing the interest rate
fixing the exchange rate
financing government spending
the political business cycle
Sample Exam Questions for Week 12
1. What is the Phillips curve?
2. Explain the nature of the long-run trade-off of the
accelerationist hypothesis and how it comes about.
3. An incomes policy is designed to
a) increase everyone's real income
b) increase the income of the unemployed
c) redistribute income from rich to poor
d) curb inflation without reducing aggregate demand
4. "We're not likely to see a really tight monetary policy; he
made clear that the Bank is following an 'intentionally
moderate' monetary policy in order to 'minimize the strains
involved in adjusting to a less inflationary economy.' He
points to the 'awkward economic fact that in the short run
anti-inflationary policies tend to restrain output more than
prices'."
Explain the rationale behind all this.
Really-Important Macro Concepts
1. The role of productivity.
2. Gross deceptive product
3. Discouraged/encouraged workers.
4. The multiplier.
5. Inventories and forecasting
6. Crowding out.
7. The structural deficit.
8. Burdening future generations
9. Fractional reserve banking; money multiplier
10. Inflation and money supply growth.
11. The monetarist rule
12. Interest rates and bond prices.
13. Real versus nominal interest rates.
14. How bad news affects bond prices
15. The real cause of inflation
16. NRU and inflation/unemployment tradeoff
17. Inflation asymmetry.
18. Monetary policy lost under fixed exchange rates.
19. Purchasing power parity.
20. Interest rate parity.