ECON102(RATNA)FINALEXAMREVIEWSESSION

BYPHUONGVU

TABLEOFCONTENT

I. Chapter19&20II. Chapter21&22III. Chapter23,24&25.IV. Chapter26V. Chapter27,28&29.VI. Chapter27,28&29(cont.)VII. Chapter30VIII. Chapter34IX. PracticeProblems:IntroductionX. PracticeProblem1XI. PracticeProblem2XII. PracticeProblem3XIII. PracticeProblem4XIV. PracticeProblem5

Introduction:

• ThankyouforcomingtoCommerceMentorshipProgram’sReviewSessionforECON102–customizedforProfessorRatnaK.Shrestha’ssession.ThesematerialswerepreparedbyCMP’ssecond-yearAcademicConsultantPhuongVu,basedonProfessorShrestha’scurriculumandRaganMacroeconomicstextbook.

• ThisfinalexamisCUMULATIVE,coverschapters19-30and34.ThetermreviewandpracticequestionsareheretohelpyoutosolidifyyourunderstandingaboutECON102.Formatontheactualexamsmightinclude:True/False,MultipleChoiceandLongAnswersquestions(bothquantitativeandqualitative).

• Besidestoday’ssession,I’llholdofficehoursonTuesday,April25th,from1-3PMatHA194.ComefindmewithanyquestionsyouhaveandI’llbeveryhappytohelpout!

CHAPTER19&20:IntroductiontoMacroeconomicsandtheMeasurementofNationalIncome

1. OutputGap=Y–Y*=ActualOutput–PotentialOutput

2. Thereistwowaystomeasurechangesinpricelevel:

RateofInflation=𝑷𝒓𝒊𝒄𝒆𝒐𝒇𝑪𝑷𝑰𝑩𝒂𝒔𝒌𝒆𝒕𝑪𝒖𝒓𝒓𝒆𝒏𝒕𝒀𝒆𝒂𝒓3𝑷𝒓𝒊𝒄𝒆𝒐𝒇𝑪𝑷𝑰𝑩𝒂𝒔𝒌𝒆𝒕𝑩𝒂𝒔𝒆𝒀𝒆𝒂𝒓

𝑷𝒓𝒊𝒄𝒆𝒐𝒇𝑪𝑷𝑰𝑩𝒂𝒔𝒆𝒀𝒆𝒂𝒓

GDPDeflator=𝑵𝒐𝒎𝒊𝒏𝒂𝒍𝑮𝑫𝑷𝑹𝒆𝒂𝒍𝑮𝑫𝑷

∗ 𝟏𝟎𝟎

3. Unemploymentratemeasuresthenumberofpeople(>=15yearsofage)whoarenotemployedandareactivelysearchingforajob,expressedasapercentageofthelabourforce.

Unemploymentrate=𝑵𝒖𝒎𝒃𝒆𝒓𝒐𝒇𝒑𝒆𝒐𝒑𝒍𝒆𝒘𝒉𝒐𝒂𝒓𝒆𝒖𝒏𝒆𝒎𝒑𝒍𝒐𝒚𝒆𝒅𝑵𝒖𝒎𝒃𝒆𝒓𝒐𝒇𝒑𝒆𝒐𝒑𝒍𝒆𝒊𝒏𝒕𝒉𝒆𝒍𝒂𝒃𝒐𝒖𝒓𝒇𝒐𝒓𝒄𝒆

∗ 𝟏𝟎𝟎

4. (*)Interestrateisthepricepaidperdollarborrowedperperiodoftime,couldbemeasuredbynominaltermorrealterm.

5. Tomeasurethecontributionofafirmtoitstotaloutput,wecanusetheconceptofValueAdded.

ValueAdded=SalesRevenue–CostofintermediateGoods

6. GDPmeasurestotalvalueofgoodsandservicesproducedintheeconomyduringthegivenperiod.

GDP(Expenditure)=C+I+G+(X-M)PleasenotethatonlypurchasesactivitiesareincludedinGDPExpenditure,becauseGDPExpenditureisanestimationofthevalueofgoodsandservicesproducedintheeconomy.Forthatreason,transferpaymentsisnotincludedinGDPExpenditure.GDP(Income)=FactorIncome+Non-factorPayments

=(Wages/Salaries+Interest+BusinessProfits)+(IndirectTaxes–Subsidies+Depreciation)

CHAPTER21&22:Short-runMacroModel

1. ConsumptionFunction:ConsumptionFunctiondeterminestherelationshipbetweenconsumption,investment,governmentexpenditureandnetexports(=X–M)

2. AggregateExpenditureformula:WithoutGovernmentandTrade

z=MPC

Simplemultiplier=CC3D

= CC3EFG

AE=C+I

WithGovernmentandTradez=MPC(1–t)-m

Simplemultiplier=CC3D

=C

C3[EFG∗ C3I 3J}

AE=AutonomousExp.+InducedExp.=[c+I+G+X]+[MPC*(1–t)–m]YNotes:cstandsforautonomousconsumption.mstandsformarginalpropensitytoimport.tstandsfortaxrate.

3. TheEquilibriumNationalIncomeconditionoccurredwhereAE=Y,andisoccurredattheintersectionofAggregateExpenditurecurveandthe45-degreeline.

Chapter23&24:AggregateDemand&Supply

TheAD/ASmodelexplainsthemovementsofpricelevelandrealGDPthroughtherelationshipofADandAS.

AggregateDemand

AggregateSupply

ExpansionaryADShock:

Example:NegativeASshock.

ContradictionaryADShock:

CHAPTER25:GDPAccounting

Given:F=totalavailablestockoffactors.

Fe=employedstockoffactors.

TheGDPAccountingEquationcanbewrittenas:

GDP=F*Fe/F*GDP/Fe

1. Short-runChangeinGDP 2. Long-runChangeinGDP-Factorutilizationrate(Fe/F):Intheshortrun,tocatchtheopportunityofmakingaprofitablesalefromanincreaseindemandofthegoods,firmsincreasetheirFactorUtilizationRatefromhiringmoreworkersandincreasingtheoperationsofphysicalcapitals,etc.

-Supplyoffactors:Inlong-termfuture,theeconomyiscapabletoleveragecapitalandlaboursupply,thereforechangesinthesupplyoffactorsaffectsGDPinthelongrun.-Factorproductivity:Productivitygrowthchangesslowlyovertime,duetobetterproductiontechnologyandhumancapital.

CHAPTER26:Long-runEconomicGrowth

EconomicGrowth:Sustainedandlong-runincreasesinthelevelofrealGDP.

TheoriesofInvestment,SavingsandGrowth.Inlong-runanalysis:RealGDP=Y*(desiredoutput)andinterestratevariestodetermineequilibrium.Inthelongrun,savingequalsinvestment.(S=I).NationalSavings=PrivateSavings+PublicSavings

=Y*–T–C+T–G

=Y*–C–G

Considerthetwoscenarios:-Ifnationalsavingssupplyincreases:

• Savingssupplyshifttotheright.• Interestratedrop,makingit

cheapertoloan.Asaresult,quantityofinvestmentandsavingsincreases.

-Ifinvestmentdemandincreases:• Investmentdemandshiftstothe

right,pushinginterestrateup.Lenderswanttolendmoremoneybecausetheycanmakegreaterreturn,henceatthenewequilibrium,interestrateandquantityofinvestmentandsavingsincreases.

Neoclassicaltheoryofgrowth:

Econom

icGrowth LabourForce

HumanCapital

PhysicalCapitalTechnologyImprovement

Interest

rate(%

)

Qtyof.I&S

NS=Y*-C-G

I

I*=NS*

Neoclassicaltheoryofgrowthisbasedontheideathat4forcesofeconomicgrowthcanbeconnectedbyTheAggregateProductionfunction.

GDP=FT(L,K,H)Where:FT=AggregateProductionFunctionL=LabourK=CapitalH=HumanCapital

Thisfunctionsuggests:1. Diminishingmarginalreturns.Addingoneadditionalworkerwilladdlesstototaloutput.2. ConstantreturnstoscaleIfallinputs(L,KandH)areincreasedbyXtimes,totaloutput(GDP)isalsogoingtobeincreasedbyXtimesduetogreaterscaleofproduction.

Newergrowththeories:1. Newknowledgeisnotsubjecttodiminishingmarginalreturnbecauseofthegrowingpotential

ofknowledgedriventechnologicalchange.2. Embodyingnewtechnologyincrease,ratherthandecreasemarginalreturns,explaining

growthinpercapitaincome.3. Endogenoustechnologychangesrespondtomarketsignals,includingpricesandprofits.These

technologicalchangesrisefromintentionalinvestmentdecision(R&Ddecisions)madetomaximizeprofits.

CHAPTER27,28&29:Money,InterestandEconomicActivity.

Expansionofmoneyfromasinglenewdeposit:Supposethatthebankhasatargetreserveratioofv(%),whichmeansthattheywanttokeepv%fromalldepositsonthebank’sreserveandloantherest:

Dindeposit=∆MNONPQNOQ

Inthecaseofcashdrain,ifpeoplewanttomaintainc(%)ofthecashtheydepositedintotheaccount,andthebankstillhasatargetreserveratioofv(%):

Dindeposit=RNSGTOUVNWXOYI

Z[Q

Functionsof

Money

MediumofExchange

Store ofValue

UnitofAccount

PresentValueandInterestRate:(Pleaserefertothesessionlivestreamfordetailsolution)

CottontheCatisbuyingaGovernmentBond.

• FaceValue=1000• Term=1year• Couponrate=8%• Marketrate=9%

Coupon=1000*8%=$80

PV= C\]\(C[\.\`)

=$930.83Whatifthetermis2years?

PV= ]\(C[\.\`)

+ C\]\(C[\.\`)b

=982.41

Mr.GrumpyisalsobuyingGovernmentBond.• FaceValue=1000• Term=1year• Couponrate=8%• Marketrate=7%

PV= C\]\(C[\.\c)

=1009.35Whatifthetermis2years?

PV= ]\C[\.\c

+ C\]\C[\.\c b=1018.08

-Ifmarketrate>couponratethenbondyieldisincreasedandbondpriceisdecreased.(Sellingatadiscount)-Ifmarketrate<couponratethenbondyieldislowerandbondpriceisincreased.(Sellingatapremium)MoneyMarket:

• Expansionarymonetarypolicies:Reducinginterestrate,whichincreasesconsumption,increasingAEandshiftADrightward.

• Contractionarymonetarypolicies:Increasinginterestrate,andasaresult,consumptiondecreases,AEdecreasesandADisshiftedtotheleft.s

FactorsthatinfluenceMd:

Md=Md(i-;Y+;P+)Examples:-Interestratedecreases,Mdshiftsrightward.-GDPincreases,transactionsincreasesandMdshiftsrightward.-Pricelevelincrease,moneydepreciatesandMdshiftsrightward.Themonetarytransmissionmechanism:TheprocesswherechangeinMdaffectsAD.1.∆Interestrate:Md/Mschanges(shiftrightorleft),henceinterestratewillchange.2.∆DesiredInvestmentandConsumption:Interestchange,leadingtoanincreaseininvestment,andthischangeisdirectlytightuptoachangeinconsumption.3.ChangeinAggregatedemand:ChangeinconsumptionwillleadtoachangeinAE,whichwilldirectlyshiftADcurve.

Ms

Md

InterestRate

InterestRate

QuantityofMoney

MoneyEquilibrium

CHAPTER30:Inflation&Disinflation

Overallinflationeffectsonwages:ChangeinNominalWages=Output-gapeffect+Expectationaleffect

ChangeinRealWages=ChangesinNominalWages–InflationRate

ActualInflation=Output-gapInflation+ExpectedInflation+Supply-shockInflation

-Wheninflationistoohigh,thereisDisinflation.Disinflationistheprocessofreducingsustainedinflation.DisinflationPhase1:Removingmonetaryvalidationbyincreasinginterestratetotightenthemonetarypolicy,hencedecreasinggrowthrateofmoneysupply.ADcurvestopsshifting,whileAScurvecontinuestoshiftupwardduetocontinualexpectationsaboutinflation.DisinflationPhase2:Stagflationhappensduetoexpectationsandincreaseinrate.Outputfalls,inflationcontinues.Actualoutputisnowsmallerthandesiredoutput,leadingtotwopossiblescenarios:ADmovesup,orAStomovedown.-ThecostofDisinflationisthelossofoutputthatwasgeneratedintheprocessandismeasuredbysacrificeratio.

Sacrificeratio= 𝑳𝒐𝒔𝒔𝒊𝒏𝒓𝒆𝒂𝒍𝑮𝑫𝑷 %%𝒑𝒐𝒊𝒏𝒕𝒐𝒇𝒊𝒏𝒇𝒍𝒂𝒕𝒊𝒐𝒏𝒓𝒆𝒅𝒖𝒄𝒆𝒅

CHAPTER34:

ExchangeRatesandBalanceofPaymentsTheBalanceofPayments:

ExchangeRates:

• WhenCanadiandollarsappreciate,exchangeratedecreases.Soittakeslessunitsofdomesticcurrencytopurchaseforeigncurrency.

• WhenCanadiandollarsdepreciate,exchangerateincreases.Soittakesmoreunitsofdomesticcurrencytopurchaseforeigncurrency.

TheForeign-ExchangeMarket

Shiftsintheforeign-exchangemarket:

• WhentheworldpricesofaCanadianexportincreases,itischeapertobuyfromCanada,hencedemandforCanadiandollarwillshifttotheright,andeventually,Canadiandollarsappreciate.

• Whentheforeignpriceofimportsdecreases,itismoreexpensivetobuyfromCanada,hencedemandforCanadiandollarwillshifttotheleft,andeventually,Canadiandollarsdepreciate.

CurrentAccountDeficit:Borrowingmoneyfromtherestiftheworldorsellingcapitalassetstotherestoftheworld.

InChapter34,welearntthefollowingequation:

CA=(S-I)+(T-G)

Meaningthatchangesinprivatesavings,investmentandgovernmentbudgetdeficitcouldcauseAccountDeficit.

However,currentaccountdeficitisnotundesirableatalltimes.

PRACTICEPROBLEMSNotes:

Theproblemsbelowareaimedtopreparestudentsforlonganswers/calculationquestioninECON102exam.Inthesecondhalfoftoday’ssessionwillgooversomesampleMultipleChoicequestionsonagame-basedplatformnamedKahoot!,andgooverthepracticeproblemsafterthat.

Kahootcanbeaccessedthroughhttps://kahoot.it/#/,andtheGamePINwillbeprovidedduringthesession.

1. MeasurementofNationalIncomeandPriceLevel.

Thevastmajority(99.9%)ofCountryofManyPenguin’spopulationarePenguinsStudents,sothecountryconsumes4goods:Candy,CoffeeandBagels.Detailsaboutthegoodisenclosedinthefollowingtable:

2012 2013 2014 Qty Price Qty Price Qty PriceCandy 10 1 12 2 7 2.5Coffee 7 2 19 2 15 2Bagels 19 1 21 2 17 2

Requirements:1.Ifweuse2012asthebaseyear,what’stheCPIin2014?Howaboutweset2013asthebaseyear?ComparethetwoCPIsandinterpretthedifferenceinthetwofigures.

CPI2014(baseyear2012)=f.g∗c[f∗Cg[f∗CcC∗c[f∗Cg[C∗Cc

=1.51

CPI2014(baseyear2013)=f.g∗c[f∗Cg[f∗Ccf∗c[f∗Cg[f∗Cc

=1.045

CPI2014(baseyear2012)isgreaterthanCPI2014(baseyear2013).Thereasonbehindthisdifferenceisbecausebetween2012and2014,priceshavebeenincreasingbysomuchmorecomparingtopricechangesbetween2013and2014.Hence,using2013asabaseyearwillleadtoasmallerfigureforCPI2014comparingtousingbaseyear2012.2.Using2013asthebaseyear,calculatethe2014GDPdeflatorandinterpretthemeaningofthiscalculation.NominalGDP=7*2.5+15*2+17*2=81.5RealGDP=7*2+15*2+17*2=78GDPDeflator=81.5/78*100=104.5GDPDeflator=104.5meansthatthepricelevelhasincreasedby4.5%from2013to2014.3.Continuetouse2013asthebaseyear,calculatetheinflationratefortheyear2014andinterpretthisanswer.Howdoesinflationrate(obtainedfromCPI)differfromGDPDeflator?CPIbasketin2014=7*2.5+15*2+17*2=81.5CPIbasketin2014(2013baseyear)=7*2+15*2+17*2=78Rateofinflation=(81.5–78)/78*100%=4.5%Inthiscase,GDPdeflatorandInflationratemeasurethesamething:theybothmeasurechangesinpricelevel.(Don’tletthequestiontrickyou!)However,ifweextendthistypeofquestionstomorecomplexproblems,wecansaythatCPIcalculationcanincludeanythingboughtbyconsumers(includingforeigngoods),whileGDPDeflatormeasuresthepriceofdomesticgoodsandnothingimports.Also,GDPDeflatortookintoaccountallgoodsandservices,whileCPIcalculationisonlymadeupofconsumer’spurchases.

2. Expansionofmoneyfromdeposit.Recently,theBOP(BankofPenguins)havereleasedtheseinformation:

ASSETS LIABILITIESLoans $220000 Deposits $270000Reserve $50000

Requirements:1. IftheBankofPenguinshaslentoutallthemoneythatitcan,whatisitsreserve

ratio?ReserveRatio=TotalReserve/TotalDeposits

=50000/270000=0.1852or18.52%

2. Iftheminimumreserveratiois4%,howmuchinexcessreservedoestheBankofPenguinsnowhold?Ifthebankdoesthenotholdanyexcessreserve,howwillitsassetsandliabilitieschanges?Ifthebankholdminimumreserve,hence:Reserves=TotalDeposit*MinimumReserveRatio

=270000*4%=$10800

Amountofexcessreserveis=50000–10800=$39200Ifthebankdoesnotholdexcessreserve,thenitsnewassetsandliabilitieswillbe:Deposit:$270000(achangeinthedecisionofholdingexcessreservehasnothingtodowithchangingamountofdeposit).Reserve:$10800(minimumreserveat4%requiredreserveratio).Loans:$280000–10800=$269200

3. Outofthe$270000deposited,nowpeoplewanttoholdontoanother$15000incash,andholdanother$20000inexcessreserve.Theminimumreserveratiois4%.Whatisthechangeindepositinthissituation?Keepinmindthatpeoplenowwouldliketokeep15000incash.Theamountkeptforreserve=270000*0.04+20000=30800Therefore,thenewchangesindepositwouldbe:Deposit:$270000Amountretainedtocashforcustomers:$15000Reserve:$30800Loans:270000–15000–30800=$224200

3. Bonds&PresentValue.(ForinformationaboutPV“timeline”,pleaserefertothelivestreamoftoday’ssession).LindaisconsideringbuyingabondissuedbyGovernmentofCanada.Theinformationincludes:(1) Facevalue=$3500(2) Couponrate=7%,couponpaidannually(3) Marketrate=10%(4) Term=2years

Requirements:

1. Calculatethecurrentpriceofthebond.ComparethePresentValueofthebondtoitsfacevalue.UsingwhatyoulearntfromECON102,explainwhyisthatthecase?

Coupon=$3500*7%=245

Inyear1:Received$245incoupon

Inyear2:Received$245incouponand3500inFaceValue

PV= fhg(C[\.C)

+fhg[ig\\(C[\.C)b

=$3317.77

2. Calculatetheyieldonthisbond.Whydobondyieldandmarketinterestnormallygoonthesamedirection?

Thetotalamountthatbondissuerpaidatmaturityis3500+245*2=3990

Let’scalltheyieldonthisbondr.Wehavethefollowingequation:

3317.77*(1+r)2=3990

(1+r)2=1.2026

r=0.097=9.7%

3. Lindadecidedtogoandpurchasethebondsyesterday.Thismorning,whilereadingthenews,Lindafoundoutthatcurrentmarketratejumpedto6%,andshebecameconfused.HelpLindatocalculatethecurrentpriceofasimilarbond,andexplaintoherwhetherifsheshouldbeupset.

Thecurrentmarketpriceofthissimilarbondis:

PV= fh(C[\.\j)

+fhg[ig\\(C[\.\j)b

=$3564.17

LindashouldNOTbenervous,becausethischangeinmarketratehasincreasedthepriceofthissimilarbondonthemarket.Lindawasabletopurchasethebondatacheaperprice($3317.77comparingto$3564.17),thereforesheshouldbehappy!

4. Moneydemandandsupply:

Thediagrambelowshowsthedemandformoneyandthesupplyofmoney.

1. IsitpossiblefortheeconomytooperateatpointAandB?Explain.No,itisnotpossibleforaneconomytooperateatpointAorB.AtpointA,theinterestwastoohighcomparingtotheMoneyDemand.Suchquantityofmoneyshouldresultinalowerinterestrate.ThesituationatpointBistheopposite:theinterestatpointBistoolow.Atsuchlowamountofquantityofmoneyavailableonthemarket,interestrateshouldbesomuchhigher.

2. Describetheprocesstobringaneconomywithexcessmoneysupplybacktoequilibrium.Whatabouttheprocessforexcessmoneydemand?Forexcessmoneysupply:Becausethereismoremoneysupplycomparingtomoneydemandonthemarket,interestratewillgraduallydecrease.Astheinterestratenowdecrease,ahigherquantityofmoneyisfavoredbecausethelowerinterestratestimulatesconsumption.Theresultisagreaterquantityofmoney,alongwithalowerinterestrateonthemarket.Forexcessmoneydemand:Becausethereismoremoneydemandcomparingtosupplyonthemarket,theinterestratewillbepushedupwards,sincepeoplearecurrentlywillingtopaymoreoninteresttoobtainthemoneytheyneed.Astheinterestisnowshiftupwards,somepeoplewhocannotaffordthehigherinterestpaymentwillbenolongerinterested,whichdecreasesthequantityofmoneyrequiredonthemarket.Atthenewequilibriumisahigherinterestrateandlowerquantityofmoney.

5. InflationandDisinflation.ConsiderthefollowingAD/ASgraph.Recently,acontractionaryASShockoccursinCountryofManyPenguins,shiftingaggregatedemandtoAS1,

a. ExplaintheinitialeffectofthiscontractionaryASshocktotheeconomy.Illustrateyouransweronthediagramabove.ThecontractionaryASShockshiftAScurvetotheleft,reducingtheamountofRealOutputproduced.Arecessionarygapiscreated,sinceoutputisnolongeratitsdesiredstate.Andfinally,pricelevelincreases,purchasingpowerdecreases,anddollardepreciates.

b. WhatkindofactionscantheBankofPenguinstaketomaintaintheeconomy’sDesiredOutput?Explaininwordsandillustrateitonthediagramabove.

BankofPenguinscanfirstofall,tightenupthemoneysupplyonthemarket,tomakesurethattheADcouldnotshift.Duetoexpectationsaboutinflationandoutputgap,thewagesriseandASshiftleftwards.Asoutputcontinuestofall,therecessionarygapgrows.Inflationkeepsgrowing,however,atasmallerrate.However,therecessiongapcausesthewagesratetofallslowly,thenRealGDPisachieved,therecessionarygapisclearedandinflationalsodecrease.

c. 1yearafterthecontractionaryASshock,PresidentofBankofPenguinsannouncedaplantoendthesustaininflation.Whatisthemeasureofthecostofthisprocessandhowisitcalculated,giventhatthePresidentofBoPwantstoreduceinflationby12%withanOutputLossof$120m,withapotentialoutputof720m?Thecostofdisflationismeasuredbysacrificedratio.%lossinrealGDP=$120m/$720m=16.67%SacrificeRatio=%lossinGDP/%reductionintherateofinflation

=16.67%/12%=1.39