ECON 233APMacro3Test Test: Basic Economic Concepts 1. The circular flow model presents a simplified picture of how money flows through a market economy. A. There are three important equations that come out of the circular flow model. They come from looking at flows into and out of households, firms, and if you choose to think of it this way, financial markets. i. What equation is related t
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APMacro3Test
Test: Basic Economic Concepts
1. The circular flow model presents a simplified picture of how money
flows through a market economy.
A. There are three important equations that come out of the circular
flow model. They come from looking at flows into and out of
households, firms, and if you choose to think of it this way, financial
markets.
i. What equation is related to flows into and out of households?
Explain which components are flows in and which are flows out. (2
points)
ii. What equation is related to flows into and out of firms? Explain
which components are flows in and which are flows out. (2 points)
iii. What equation is related to flows into and out of financial
intermediaries? Explain which components are flows in and which are
flows out. (2 points)
B. Consider an economy in which Y = 1800, I = 400, G = 400, T = 300,
and with M = X. Solve for consumption spending and household
saving. (2 points)
C. Consider an economy in which I = 800, S = 700, T = 500, G = 600,
and with M = X.
i. Using the third equation you found in part A, show that the financial
market is not in equilibrium. (2 points)
ii. What should happen to the interest rate to bring the financial
market into equilibrium? Explain your answer. (3 points)
2. The reason governments calculate things such as GDP and
unemployment rates is to get a picture of what’s happening with their
large, complicated economies, and to judge whether the well-being of
their population is improving or deteriorating. What would you learn
about an economy if you determined that its GNP was growing more
quickly than its GDP? Discuss this in a sentence or two. Hint: Be sure
to include a definition of GNP and GDP in your answer. (6 points)
3. The two least-discussed sectors of the economy are the
government (also called the public sector) and the rest of the world
(also called the foreign sector). An economy that includes foreign
trade, or trade with the rest of the world, is called an open economy,
and its opposite is a closed economy.
A. Consider the savings equals investment equation, I = S + (T - G) +
(M - X). How is investment affected when an economy moves from
being closed to being open? Explain your answer. (4 points)
B. Consider the leakages equals injections equation, I + G + X = S + T
+ M. What is the effect of a public sector balanced budget (where G=T)
on the economy, according to this equation? What if the government
runs a budget deficit? (4 points)
4. Economic growth is a very important topic. To the extent that GDP
measures the well-being of people in an economy, increases in GDP
should translate into increases in standard of living.
A. What measure of GDP is most closely related to the economic
B. If Y = C + I + G + (X - M), is it necessarily true that decreased
consumption and increased saving by households will result in lower
GDP in the short run? (4 points)
C. The production possibilities frontier shows output combinations at
which an economy can produce given its current resources. On a PPF
graph, show the long-term effect of increased household saving, and
explain the effect in words. (5 points)
D. On a production possibilities frontier, the two goods may be
classified as "consumption" and "investment" goods. How will the
shift in the PPF from this year to, say, five years from now differ if we
choose a point with high consumption as opposed to choosing a
point with high investment? Or a point with high investment goods?
Explain in words and with graphs. (6 points)
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