Economic Interest & Product Resources – Principles of Macroeconomics
This lesson is about Economic Interest & Product Resources and Principles of Macroeconomics
A change in Americans’ habits makes people less patient and more susceptible to instant gratification, causing their time preferences to become stronger.
Therefore we can say in the loanable funds market:
supply curve shifts left – Correct
demand curve shifts right
demand curve shifts left
supply curve shifts right
Explanation: In the loanable funds market, supply comes from savings. If people are more impatient, then they will prefer to consumer sooner rather than later. What does this imply about how much they will save?
Assume that the residents of a nation become more patient (experience a reduction in their time preferences). In the long run, how will the lower time preferences affect the levels of capital and income growth in that nation?
Capital and income growth will both increase – Correct
Capital and income growth will both decrease.
Capital will increase, but income growth will decrease.
Capital will decrease, but income growth will increase.
Explanation: Capital and income growth typically move in the same direction. Investment is tied directly to the purchase of capital goods.
Imagine you live on the planet Krypton. The loanable funds market on Krypton is thriving and life is good. However, the planet is very, very old and the great scientists and philosophers on the planet have begun discussing openly that the planet may be on the verge of destruction. Even if the great thinkers are wrong, the loanable funds market will change in the short term. Specifically, the supply of loanable funds is expected to ____________ and as a result the amount of economic output in the future is expected to _______________.
stay the same; stay the same
fall; decrease – Correct
Explanation:How will this alter the desire of people to save? If you thought your planet might be destroyed in the near future, would you bother to save for retirement or would you go on a shopping spree? The fear of destruction will create longer time preferences for the citizens of Krypton and thus, the supply of loanable funds will shift left. This means, even if the planet doesn’t fall apart, there will be less economic output in the future.
Many interest rates in the United States recently fell. Which of the following factors could not have been the cause?
increase in the supply of loanable funds
increase in the demand for loanable funds – Correct
decrease in the demand for loanable funds
Explanation:The possible causes are an increase in supply of loanable funds and a decrease in demand for loanable funds. Either of these events would cause a surplus of loanable funds, putting pressure on interest rates to fall. An increase in demand for loanable funds would cause a shortage in the market for loanable funds. This would lead to the opposite effect: an increase in the interest rate.
Put the phrases in order from first to last to best illustrate the progression of a properly functioning loanable funds market.
Investment requires borrowing; borrowing requires saving; output (GDP) requires investment
Borrowing requires saving; investment requires borrowing; output (GDP) requires investment Correct
Explanation: Saving is necessary for investment to take place. Investment requires borrowing money from the loanable funds market. Investment is a component of GDP and is necessary to sustain output growth. To start the process you must have funds in the loanable funds market, which comes from savers. Thus, borrowing requires saving. Borrowers may want to borrow, but unless there is savings, they have nothing to borrow.
Suppose Congress is considering an increase in the retirement age for U.S. citizens. Based on this, which of the following is a true statement?
The supply would increase (shift outward)
Demand curve would shift inward.
The equilibrium interest rate would fall, and investment would increase – Correct
Real GDP would be smaller
Explanation: If U.S. workers start working longer, this would delay the dissaving period in their life and increase their savings. So supply would increase (shift outward). Demand would not change. The equilibrium interest rate would fall, and investment would increase. Real GDP would be greater, all else equal, due to the increase in investment. Basically, the new savings would become investment in capital.
Thus, in the future there would be more tools for production in the United States, and output would be higher.
Suppose the economies of China and India have begun to slow down very rapidly. Based on this scenario,
the quantity of investment increases.
the demand curve for loanable funds will shift to the right.
GDP will be higher in the United States.
interest rates on loanable funds will increase – Correct
Explanation:This decreases their citizens’ income and wealth. In turn, these citizens decrease their savings in their country and also in the United States. The supply of loanable funds decreases as savings decrease. When the interest rate rises, the quantity of investment decreases. Firms will borrow less to build and expand their businesses. This decrease in investment means that future output, or GDP, will be lower in the United States.
There is a widespread fear that the Social Security retirement system will collapse. As a result, people begin to assume that they will need to pay their own way in retirement. Therefore in the loanable funds market:
supply curve shifts left
demand curve shifts right
supply curve shifts right – Correct
demand curve shifts left
Explanation: If one retirement safety net isn’t there, people will now have to consider creating another one. People are more likely to plan for the future. As time preferences decrease, the supply of loanable funds will increase.
Use the Fisher equation to fill in the blanks in the following table.
|Inflation rate||Real interest rate||Nominal interest rate|
A=, 7%; B=, 6%; C=, 2%
A=, 2%; B=, 2%; C=, 2%
A=, 5%; B=, 4%; C=, 4% – Correct
Explanation: The Fisher equation is: real interest rate = nominal interest rate – inflation rate.
Row 1 – 2% = 7% – x, thus missing value is 5%.
Row 2 – x = 6% – 2%, thus missing value is 4%.
Row 3 – 2% = x – 2%, thus missing value is 4%.
Which of the following is a true statement?
If the rates of return on fine art purchases fall, savers will be more inclined to put their savings into art as an investment
when making decisions about saving and borrowing, people care about the nominal interest rate
a falling interest rate will lead to a movement along the demand curve for loanable funds – Correct
Profit-maximizing firms will borrow to fund an investment if and only if the expected return on the investment is equal to the interest rate on the loan
Explanation: When making decisions about saving and borrowing, people care about the real interest rate, because it is corrected for inflation. It is the rate of return in terms of real purchasing power. Profit-maximizing firms will borrow to fund an investment if and only if the expected return on the investment exceeds the interest rate on the loan. Savers will be more inclined to take their savings elsewhere if the rates of return on fine art purchases fell. In the loanable funds market, the interest rate is the price. Remember that price affects quantity demanded, and not demand. So the interest rate affects quantity demanded and is a slope factor, and involves a movement along the demand curve.
You work as a consultant to firms deciding whether to borrow funds to invest in new projects. For each of your clients listed in the table, suppose that you have determined the interest rate they can borrow at, and also the expected rate of return on their investment. Which of these firms should you tell to NOT go ahead with their investment?
|Project||Interest rate to borrow funds||Expected rate of return|
|A popular café wants to open a second location across town.||3%||8%|
|A professional soccer team is considering building a new arena.||4%||5%|
|A water park is thinking about building a new section just for people’s pets.||6%||4%|
|A small local producer of organic sodas thinks about expanding its operation.||7%||5%|
|A candy company considers modernizing the equipment in its chocolate factory.||9%||11%|
the candy company
the soccer team
the water park – Correct
Explanation: How do you know which projects are worth investing in? Compare the cost of borrowing against the expected rate of return. If a firm can earn more through the project than it will cost them in interest payments, then it is justified in going ahead with it.
All of the following can lead to economic growth except
protection of private property rights.
an increase in the quantity of capital.
an increase in the level of skills of the labor force.
an increase in the quantity of money. Correct
Explanation:An increase in the skill level of the labor force, higher availability of capital as well as protection of private property rights can lead to economic growth. Recall that resources, technology, and institutions—not money—are sources of economic growth. An increase in the quantity of money would increase price levels and cause inflation, but wouldn’t affect real variables in the long run.
Consider the case of long-distance telephone service. In country X, there are 20 providers of long-distance telephone service in a highly competitive market environment. On the other hand, in country Y, long-distance telephone service is largely regulated by the government, with the firm Horizon as the sole provider of this service. Under these circumstances, it is expected that
More information is needed to comment on the growth potential.
countries X and Y will have similar growth potential.
country X will have lower growth potential than country Y.
country X will have higher growth potential than country Y. – Correct
Explanation: When markets aren’t competitive, people who want to participate face barriers to entry. This inhibits competition and innovation, which limits economic growth. Thus, country X, with a highly competitive market environment, is likely to have a higher growth potential than country Y, with a regulated market structure.
Countries A and B are exactly similar in terms of resources and technology. However, country A reported a higher growth rate than country B last year. Which of the following could not explain this anomaly?
higher population growth in country B
favorable climate in country A – Correct
lack of proper institutions in country B
Explanation: Remember that economic growth is due to more output per capita. Thus, even if countries A and B produce the same level of GDP, country B could have a lower GDP per capita growth rate because of its differences in population changes. At the same time, having similar levels of resources and technology is not sufficient for equal growth rates in countries A and B unless both of them also have identical institutional setups. Finally, country A cannot have a more favorable climate than country B, since the question says that both countries have identical resources, which includes natural resources.
For each of the following policies, select the type of resource that is the primary focus of the policy.
(i) Aid from the IMF for the education for technology workers.
(ii) A piece of legislation that bans drilling for oil in Alaska.
(iii) Laws mandating school attendance for children younger than 18.
(iv) State tax credits for the construction of new company headquarters within the state.
(i) human capital; (ii) natural resources; (iii) human capital; (iv) physical capital – Correct
(i) physical capital; (ii) natural resources; (iii) human capital; (iv) human capital
(i) human capital; (ii) physical capital; (iii) human capital; (iv) natural resources
(i) human capital; (ii) physical capital; (iii) natural resources; (iv) physical capital
Explanation: Resources are inputs that can be used to produce goods and services. Natural resources include physical land and the inputs that occur naturally on the land. Physical capital comprises the tools and equipment used in the production of goods and services. Human capital is the resource represented by the quantity, knowledge, and skills of workers in the economy.
Policies governing the education of technology workers and students under 18 deal with human capital. The policy about oil extraction deals with a natural resource, and the policy that deals with the construction of company headquarters deals with physical capital.
Real per capita GDP in China in 1959 was about $350, but it doubled to about $700 by 1978, when Deng Xiao Ping started market reforms. What was the average annual economic growth rate in China over the 20 years from 1959 to 1978?
3.5% – Correct
Explanation: According to the rule of 70, for a given growth rate x, real per capita GDP would double in 70 ÷ x years. If China’s economy doubled in 20 years, then we can find the average annual economic growth rate by solving 70/20 = x = 3.5%.
Real per capita GDP in China in 1959 was about $350, but it doubled to about $700 by 1978, when Deng Xiao Ping started market reforms. Chinese per capita real GDP doubled again in only seven years, reaching $1,400 by 1986. What was the average annual economic growth rate between 1979 and 1986?
10% – Correct
Explanation:We can calculate the average annual economic growth rate by solving 70/7 = x = 10%.
The table shown here indicates world economic growth rates for specific historical eras. During which of the following time periods will it take real per capita GDP approximately 109 years to double?
1800–1900 – Correct
Explanation: According to the rule of 70, for a given interest rate x, per capita real GDP doubles in 70 ÷ x years.
At a growth rate of 0.02%, average per capita real GDP would double in 70 ÷ 0.02 = 3,500 years.
At a growth rate of 0.64%, average per capita real GDP would double in 70 ÷ 0.64 = 109 years.
At a growth rate of 1.04%, average per capita real GDP would double in 70 ÷ 1.04 = 67 years.
Most recently, at a growth rate of 2.12%, average per capita real GDP will double in a remarkable 70 ÷ 2.12 = 33 years.
Use the data in the table to compute economic growth rates for the United States from 2008 to 2009. Note that all data is from the end of the year specified.
|Date||Nominal GDP (billions of current $)||GDP deflator||Population growth|
–3.52% – Correct
Explanation: We use this equation to solve for economic growth: economic growth = %Δ in nominal GDP – %Δ price level – %Δ population. From 2008 to 2009, economic growth was –3.52%.
nominal GDP fell: [(14,119.0–14,369.1) ÷ 14,369.1] × 100 = –1.74%
prices grew: [(109.61–108.62) ÷ 108.62] × 100 = 0.91%
the economy contracted: –1.74% – 0.91% – 0.87% = –3.52%
Use the rule of 70 to determine which of the following is not true.
If the economic growth rate is 7%, per capita real GDP will double in 10 years.
If hyperinflation causes a country’s price level to double every 2 years, average yearly inflation is 140%. – Correct
A job with a starting salary of $50,000 and a guaranteed annual raise of 2% will have a salary of $100,000 in 35 years.
Explanation: A job with a guaranteed annual raise of 2% will have double the salary in (70/2) years. A country with an economic growth rate of 7% will double its per capita GDP every (70/7) = 10 years.
Which of the following countries has almost no natural resources and agriculture of its own, has one of the world’s lowest unemployment rates, a literacy rate of 96%, a per capita GDP of over $35,000, and one of the densest populations per square mile on the planet?
Singapore – Correct
The United States
Explanation: Singapore is a country with few national resources that does well on measures of human welfare.
Which of the following explains why technological innovations are often clustered in particular locations?
Institutions – Correct
Explanation:Technological innovations are often clustered in particular locations because of institutions that foster economic growth because of concentrations of capital in those locations (Silicon Valley, for example).
Which of the following institutions will most accurately explain the impact of corruption on economic growth?
competitive and open markets
political stability and the rule of law – Correct
stable money and prices
Explanation: Consistent and trustworthy enforcement of a nation’s laws is crucial for economic growth. Corruption is one of the most common and dangerous impediments to private investment and hence economic growth. Thus, the rule of law is able to explain why nations with the highest levels of corruption are also those with the lowest levels of income.
Which of the following statements is false?
Economic growth is measured by looking the growth rate of per capita real GDP
The economic success of the United States can be attributed to its abundance of natural resources
The difference between 1% growth and 2 % growth is insignificant over time – Correct
The rule of 70 tells us that we can divide 70 by the rate of growth to approximate the number of years it takes for a variable to double.
Explanation:Since growth compounds over time, the difference of between 1% and 2% can add up over time. Using the rule of 70, the economy will double every 70 years with 1 percent growth. With a growth rate of 2% the economy would double every 35 years. Economic growth measures how an average individual’s income changes over time, accounting for price changes. Natural resources are important, but they are not the only source of economic growth. Two other important factors are technology and institutions. A simple rule known as the rule of 70 determines the length of time necessary for a sum of money to double at a particular growth rate. According to the rule of 70. If the annual growth rate of a variable is x%, the size of that variable doubles approximately every 70 , x years. The rule of 70 is an approximation, but it works well with typical economic growth rates.
the difference in output from the increase in capital from K1 to K2 is larger than the change in output from a change in capital from K3 to K4. – Correct
the difference in output from the increase in capital from K1 to K2 is the same as the change in output from a change in capital from K3 to K4.
the slope of the function is always increasing.
the difference in output from the increase in capital from K1 to K2 is smaller than the change in output from a change in capital from K3 to K4.
Explanation:Notice that the slope of the function is positive, which indicates positive marginal product. But the marginal product of capital also declines as more capital is added. the difference in output from the increase in capital from K1 to K2 is larger than the change in output from a change in capital from K3 to K4. This outcome illustrates the declining marginal product of capital.
Consider the Solow growth model. When the economy has reached the point of ____________ it is said to have achieved _______________.
no new net investment; convergence
no new net investment; a steady state – Correct
depreciation; economic growth
Explanation: A steady state is a condition when there is no new net investment. Because capital is the primary source of growth in the Solow model, then no new output is created at steady state. When investment exceeds depreciation, net investment is positive and the economy is growing, according to the Solow model.
Consider this version of the equation for a production function: Y = A × F (natural resources, human capital, physical capital). In the Solow model, the letter A in this equation represents:
the convergence rate, an exogenous change.
the convergence rate, an endogenous change.
technology, an endogenous change.
technology, an exogenous change. – Correct
Explanation: This equation is the production function for the economy in the Solow model. The letter A represents technology. This model doesn’t explicitly state how technology is determined, so technology is exogenous to the mode
Determine whether the following statement is consistent with the Solow model, modern growth theory, neither, or both.
The U.S. government is hoping to increase GDP growth by building a dam on the Mississippi River. Funding construction for the dam is dependent upon efficient taxes and the rule of law.
This is consistent with only modern growth theory
This is consistent with both the Solow model and modern growth theory – Correct
This is consistent with only the Solow model
Neither theory applies here
Explanation:The construction of a dam on the Mississippi River is additional physical capital for the United States. This is consistent with the Solow model. Since the construction funding is determined by efficient taxes and the rule of law, both being institutions, then this statement is also consistent with modern growth theory.
Growth theory began with _____________, which was introduced in _____________.
The book An Inquiry into the Nature and Causes of the Wealth of Nations; the 1950s
The Solow growth model; the late 1800s
The Solow growth model; the 1950s – Correct
The Solow growth model; 1776
The book An Inquiry into the Nature and Causes of the Wealth of Nations; the late 1800s
Explanation: Adam Smith’s An Inquiry into the Nature and Causes of the Wealth of Nations was an important economic text focused on what made nations wealthy. However, it wasn’t until the 1950s that economists began to focus more on economic growth with the Solow growth model.
If farmers adhered to the Solow growth model, which items would they not view as most important to economic growth?
their time and knowledge – Correct
grain storage facilities
Explanation:If the farmers adhere to the Solow growth model, they view physical capital as most important to economic growth. This isn’t to say that time and knowledge aren’t important; they are just not the primary focus. Therefore, farmers view the physical capital as primary to growth: tractors, grain storage facilities, and irrigation equipment.
Some economies grow faster for reasons particular to those economies.
This statement refers to an economy’s:
exogenous and endogenous growth.
technological innovation and endogenous growth. – Correct
capital accumulation and exogenous growth.
technological advances and exogenous growth.
Explanation: Endogenous growth is growth driven by factors inside the economy. Technological innovation has largely been considered exogenous. As institutions, which are endogenous, change to be more favorable for economic growth, technological innovation follows through incentives.
6; 2 – Correct
Explanation:The marginal product of an input (in this case, a ladder) is the change in output from a one-unit change in the input. When a second ladder is added, as a productive input, to the first ladder, the output increases from 10 to 16 bushels. So we say that the marginal product of the second ladder is 16 – 10 = 6 bushels.
Diminishing marginal product occurs when the marginal product of an input is not as large as the previous marginal product. When the second ladder is added, the marginal product is 6. In comparison, the marginal product of the first ladder is 10, so the marginal product has started to decrease with the second ladder.
When looking at modern growth theory, how does it look at technology and technological change
technological change in a country is endogenous and occurs due to factors that will currently exist in that country. – Correct
technology changes is exogenous and convergence will occur.
technological advances occur at diminishing rates.
Explanation: Modern growth theory states that institutions have an effect on how technological progress and innovation occur. Therefore technology will now be endogenous and depends on the current state of an economy
Which of the following do not provide the right incentives for economic growth?
private property rights
political instability – Correct
Explanation:Private property rights, efficient taxes, and competitive markets are three of seven institutions that provide the right incentives for economic growth. The other four are: political stability and the rule of law, international trade, the flow of funds across borders, and stable money and prices. Political instability does not provide the wrong incentives for economic growth.
Which of the following provides the correct interplay between the real world and economic theory?
real-world observations lead to economic theory, which then leads to policy – Correct
policy leads to economic theory, which then leads real-world observations
real-world observations lead to policy, which then leads to economic theory
Explanation:Economists observe events in the real world and create theories based on these observations. Once these theories are established, policies are formed. The implementation of policies affects the real world. Further data is collected, and theories and policies may be revised.
Which of the following statements is true?
Convergence in the Solow growth model is due to constant marginal product
Solow’s assumption about technological progress means that technological advances, where and when they happen are planned.
If people in the United States increased their savings rate, this will less lead to less spending and less economic growth.
According to modern economy theory, there are 3 sources of economic growth – Correct
Explanation:If people increased their savings rate, this will allow us to acquire more capital resources, which in turn enables the United States to produce more output and earn more income. Therefore economic growth will be greater than if people had not saved. Solow’s assumption about technological progress means that when and where the advances happen are random. In order for convergence to occur, there needs to be declining marginal product of capital and this implies that poorer nations will grow more from a given level of investment than richer nations will. What makes the modern growth model differ from the Solow growth model, is that there is 3 sources of economic growth: resources, technology, and institutions.