Answers to Review Questions

Macro Chapters 7a-8a

Extra Stuff . . Chapter 7a . . Chapter 8a

 Answers to questions as they were in July, 2006


Exploring GDP

1. The reading gives us GDP data for three years that you probably do not remember. You can update the table using the internet. What would the table look like with the most current data available? (You can find the data in several places. One place you might look is <http://www.bea.gov/>. You will have to search a bit, but it would not be an assignment if you did not have to work.)

 Internet exploration--answers will vary over time.

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Exploring Say's Law

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Exploring Aggregated Markets

5. In 1963 savings by the private sector in the United States was $95.2 billion. The government ran a deficit of $3.8 billion, and the U.S. invested a net of $3.8 billion in foreign countries. What was gross private investment in the United States in 1963? (Source of data: Economic Report of the President, January 1987, Table B-27, p. 276.)

Savings is a source of funds, the deficit and investment in foreign countries uses, Hence,

85.2-3.8-3.8 = 77.6

6. The readings explained a budget constraint for an economy based on the idea that every sale must be matched with a purchase, and any purchase must be matched with a sale. This budget constraint looks at borrowing and lending, which is a form of buying and selling the use of funds. When we aggregate people and institutions who can borrow or lend, we get:

lending by the private sector + lending by the government sector + lending by foreigners = 0

In terms of symbols, this equation becomes:

(Y-C-I) + (Tx-G-Tn)+ NetImports=0

The first term has the income of the private sector less consumption and investment, the two forms of spending it can do. (Notice that Y-C=S, so the first term could be S-I, as it is in the text.) The second term has the revenue of the government (taxes) less what it spends to buy goods and services and less what it gives away (transfers). In the last term, what we import provides revenue to the foreign sector which it can either spend by buying our exports or lend back to us.

a. Suppose in the above equation Y is 1000, C is 800, I is 100, Tx is 300, G is 150, Tn is 150. What must net imports be?

(1000-800-300) + (300-150-150) + NetImports = 0

(-100) + 0 = -NetImports

100 = Net Imports

b. In the equation above, one cannot change just one thing. If one item changes, something else must change as well. Suppose that government spending (G) rises to 200. List at least five ways to make this equation come out right.

Income could increase
Investment could decrease
Net imports could increase
Consumption could decrease
Taxes could increase

c. Become an economic theorist. Pick one of the changes from part b and explain why it will happen. (Postulate a chain of cause and effect: Government spending rises. This causes...)

Answers will vary


Extra Stuff . . Chapter 7a . . Chapter 8a


Financial Markets


Exploring Liquidity and Intermediaries

1. Arrange these assets from the most liquid to the least liquid: cash, old master paintings, U.S. savings bond, bonds of AT&T, passbook savings account at a bank; Kruggerands; medical school training.

Most liquid: cash, passbook savings

moderately liquid: U.S. savings bond, bonds of AT&T, Kruggerands

Illiquid: old master paintings

Most illiquid: medical school training

(Kruggerands are a gold one-ounce coin produced by the Republic of South Africa as a way of marketing gold.

2. Medical school training is an example of what economists call "human capital." Human capital theory says that we gain insights if we value people as if they were machines. Assuming everything else is equal, which machine is worth more, one that produces $100 of output per hour or one that produces $1000?
Assuming everything else is equal, which machine is worth more, one that will last one year or one that will last ten years?


As a machine gets old, it may not produce as well as it did when it was newer. It may break down more frequently, and the quality of its output may fall. As this happens, its value will also fall. Similarly, as people get really old, the bodies and minds often do not work as well as they did when they were younger. The value of their human capital falls as well, and can fall to zero.

a) If you want to live beyond that age, how can you use financial markets to get ready for that point in life?

You save when you are young so you can retire when you are old.

b) Financial markets are a modern invention--they hardly existed 250 years ago. How did your ancestors who lived 200 years ago deal with the decline in their human capital?

A reason that being childless was such a bad thing in the past was children were expected to help parents once they no longer were productive. So having kids is an important answer.

3. We may think of financial intermediaries as the heart of capitalism where profit and loss determine everything and today most financial intermediaries are designed to make profits for their capitalist owners. Although commercial banks have always been designed to make a profit for their owners, many other financial institutions were developed for different purposes (even though today most of them are fairly standard for-profit enterprises). See what you can find about those origins by doing an internet search for the four following sets of words: history "savings and loan associations"; history "credit unions"; history "savings banks"; and history "mutual insurance".

What was the purpose behind the development of each type of financial intermediary?
What is the point of setting up a mutual organization?

 Internet exploration--answers will vary.

(Many were established to help the poor or lower classes rise. Giving the poor access to credit can, if done carefully, be a major source of economic growth. This is still true in many nations today.)

Exploring the FOMC

4. Who are the current members of FOMC? You should be able to find them here <http://www.federalreserve.gov/FOMC/>.

 Internet exploration--answers will vary over time.

5. On older Federal Reserve notes the bank that issued the note was identified. For example, you can see that the Federal Reserve note shown here was issued by the Federal Reserve Bank of New York. You might also notice that there is a B in the circle to the left of Washington, and the number "2" appears twice, to the left of the circle. The Federal Reserve Bank of New York serves the second reserve district and B is the second letter of the alphabet. However, in the new designs of currency, the name of the issuing Federal Reserve bank no longer appears, but the letter of the bank and the number are still there. (Check a new bill and see if you can see them.) Here is a test of your web searching abilities. If you have a ten-dollar bill that has an F6 on it, which Federal Reserve bank issued it? What letter and number will appear on a ten-dollar bill issued by the Federal Reserve Bank of Kansas City?

Internet exploration--

Exploring Debt

6. The reading gave a breakdown of the U.S. debt by instrument and holder for two years that show a rapid increase in the growth of the debt. What has happened in the years since 1995? See if you can update this table. (One place you will find some of the information is <http://www.publicdebt.treas.gov/bpd/bpdhome.htm>. It shows total debt and the amount help by the public. You can also find some of the data at <http://www.stls.frb.org/fred/index.html>. A good place to start a search for economic data is at Resources for Economists on the Internet, <http://rfe.org/showCat.php?cat_id=2>. Have fun searching!)

 Internet exploration--answers will vary over time.

7. What has been happening to interest rates? You can get data on interest rates from the web. Many interest rates are reported at <http://www.federalreserve.gov/releases/H15/Current/>, and historical data for many of them is available at <http://www.stls.frb.org/fred/index.html>. Many interest rates are also reported in the many financial sites on the web.

a. What is the current federal funds rate?
b. Economists and people involved in financial markets pay attention to the yield curve, which graphs interest rates on the vertical axis and time to maturity on the horizontal axis. Plot the current yield curve for Treasury debt. (Hint: you can either get the data from one of the sites given above, or do a search on the internet for "yield curve." You might find it already plotted for you.)

 Internet exploration--answers will vary over time.

8. Search the web and find where you can trade options and where you can trade futures. Why would people want to use these markets?

 Internet exploration--answers will vary. You should find the Chicago Board of Trade and the Chicago Mercantile Exchange, among others. Options are a form of insurance, and futures contracts can reduce risk. Whole courses are taught explaining these simple questions.

Simple Balance Sheet Problem

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10. Here are balance sheets showing the assets, liabilities, and net worth of Jack and Jill:



Liabilities & Net Worth


Liabilities & Net Worth

Cash $200

Net Worth $1000

Cash $10

Student loan $200

Value of personal items $800


Value of personal items $500

Net Worth___

a) What number belongs in Jill's Net Worth?


b) Suppose that these are their balance sheets immediately prior to the U.S. presidential election of 1976. Jack bets Jill $20 that Gerald Ford will win. After the results are in, but before the bet is paid, what will their balance sheets look like? (Hint: You must add new categories to these balance sheets. Do what is logical.)



Liabilities & Net Worth


Liabilities & Net Worth

Cash $200

Net Worth $980

Cash $10

Student loan $200

Value of personal items $800

IOU to Jill 10

Value of personal items $500

Net Worth $420

IOU from Jack $10

11. For a plantation in the South before the U.S. Civil War, slaves were an asset that would have appeared on the balance sheet of the plantation. What were the effects on the balance sheet of the plantation of the liberation of the slaves following the war?


Liabilities + Net Worth

loss of value of slaves


loss of net worth




b) The value of the plantation fell with the liberation of slaves. Where did that value go?

The slaves got it. They now owned themselves.

Exploring Efficient Markets

12. You can find more about some of the topics discussed in this chapters with careful searches on the internet.

a. Search the internet for "efficient-market hypothesis." How is it defined? Why are people writing about it?
b. Search the internet for "greater fool." In what markets may fools be lurking?
c. Search the internet for "market bubbles." In what markets are they thought to exist or to have existed? Have any popped lately?

Internet exploration--answers will vary.

Exploring Exchange Rates

13 You are the ruler of a country that has exchange rate controls. You find the views of one of the major newspapers irritating. The head of your secret police suggests that a few killings and beatings will solve your problem. Your director of public information suggests that you impose censorship. Your economic advisor, however, tells you that newspapers must import the paper they use. As a result, he knows a way to silence this opposition that will not be noticed by human-rights organizations. What will he suggest?

Deny the newspaper the foreign currency they need to buy paper.

Extra Stuff . . Chapter 7a . . Chapter 8a