Economics 202

NOTE: To ensure proper grading, write your answers in the area indicated. 1. (2 points) In each of the situations described, state which component of aggregate demand of the United States (C, I, G, or NX) is affected and whether U.S. aggregate demand will increase or decrease as a result. Briefly explain. a. A government shutdown triggered by congressional gridlock leaves firms with more uncertainty and pessimism about future economic conditions. b. Improvements in hardware and software allow industrial machines to work faster and more precisely while requiring less supervision or maintenance. c. Buoyed by news of low unemployment rates and high stock returns, households are increasingly optimistic about future economic conditions. d. Fears about its value as a reserve currency cause investors to sell dollars, decreasing their value relative to other currencies. e. The crisis in Greece leads to more uncertainty about both monetary policies within the eurozone and political questions within the European Union, which in turn tip much of Europe into recession. f. In order to further reduce the budget deficit the federal government cuts spending on a wide variety of programs. g. Reforms in Japan help its long-moribund economy begin to grow at a faster pace. h. The federal government passes a basic-income law, giving thousands of dollars of extra income to each household. EC 202, Fall 2015 Problem Set 3 University of Oregon Page 2 of 8 2. (4 points) For each situation, draw the necessary shift (or shifts) of a curve (or curves) on the graph, drawing any appropriate arrows and labeling any newly drawn curves. On the side, indicate whether the overall price level and the level of output (GDP) will increase, decrease, stay the same, or change ambiguously over the time frame described. a. The country’s currency becomes weaker, meaning—in part—that foreign goods and services become more expensive. In the long run the overall price level • increases. • decreases. • stays the same. • changes in an ambiguous way. [Circle one of the above.] In the long run the level of output (GDP) • increases. • decreases. • stays the same. • changes in an ambiguous way. [Circle one of the above.] b. An increase in violence and corruption cause the quality of institutions to deteriorate while at the same time households and firms become less confident about the future performance of the economy. In the short run the overall price level • increases. • decreases. • stays the same. • changes in an ambiguous way. [Circle one of the above.] In the short run the level of output (GDP) • increases. • decreases. • stays the same. • changes in an ambiguous way. [Circle one of the above.] EC 202, Fall 2015 Problem Set 3 University of Oregon Page 3 of 8 3. (2.5 points) Lisa is single and works as a dean of medicine at a hospital in New Jersey. Assume for 2014 her taxable income after her personal exemption and the standard deduction was $353,400 and that she will take no other deductions. Use the following table of the tax brackets for 2014 to answer the following questions. 2014 Federal Tax Brackets Rate Single Filers 10% $0 to $9,075 15% $9,075 to $36,900 25% $36,900 to $89,350 28% $89,350 to $186,350 33% $186,350 to $405,100 35% $405,100 to 406,750 39.6% $406,750+ a. What was Lisa’s marginal tax rate for 2014? Briefly explain. Lisa’s marginal tax rate % b. Calculate the amount of income tax that Lisa owed for 2014. Show your work. Round your answer to the nearest penny. amount of income tax Lisa owed for 2014 c. Given Lisa’s taxable income listed above, what was the average tax rate for her federal income tax? Show your work. Express your answer as a percentage and round that percentage to one decimal place. Lisa’s average tax rate % EC 202, Fall 2015 Problem Set 3 University of Oregon Page 4 of 8 4. (2 points total) Consider the government of the country of Yed, which ends 2010 with a debt of $460 billion. Over the following four years, Yed’s government has revenues and expenditures as given in the following table. a. Fill out the “Amount of deficit” column in the table above for each of the four years given. Enter deficits as positive numbers and surpluses (if any) as negative numbers. This usage of signs seems counterintuitive, but it will make the next part simpler. Show your work below. b. Fill out the “Running total of debt” column in the table above for each of the four years based on what the previous year’s debt was and how the new year’s deficit or surplus changes it. Remember that Yed ended 2010 with a debt of $460 billion and that all numbers in the table are in billions of dollars. Now the assignment of positive and negative signs becomes more useful: deficits add to an existing pile of debt, and any surpluses cause the debt to decrease by that amount. Show your work below. Year Government tax revenues (billions of dollars) Government expenditures (billions of dollars) Amount of deficit (billions of dollars) Running total of debt (billions of dollars) 2011 720 710 2012 740 760 2013 710 810 2014 750 820 EC 202, Fall 2015 Problem Set 3 University of Oregon Page 5 of 8 5. (3.5 points total) Assume that when aggregate income (i.e., aggregate output or Y) increases by $400 million in the country of Intrometida aggregate consumption (C) there increases by $80 million. a. Using the pieces of information just given, find the marginal propensity to consume (MPC) for the economy of Intrometida? What is the marginal propensity to save (MPS)? Show your work. Express your answers as either fractions or the appropriate decimals. MPC MPS b. What is the numerical value of the government spending multiplier for the economy of Intrometida? What is the tax multiplier? What is the balanced budget multiplier? Show your work. Express your answers as either fractions or the appropriate decimals. government-spending multiplier tax multiplier balanced-budget multiplier c. The government has decided that the current level of aggregate output (Y) in Intrometida, $800 billion, is too low. In response, the government of Intrometida has decided to increase government spending by $60 billion. Using the appropriate multiplier from part b), what will the new level of aggregate output be (per year) as a result of the spending policy? Show your work. [Hint: First, solve for the change in output using the change in government spending and the appropriate multiplier. Then add the change to the previous level of output (Y) given in the statement of this part. The handout from section on Nov. 20th will be helpful for this part.] new aggregate output EC 202, Fall 2015 Problem Set 3 University of Oregon Page 6 of 8 d. What if the government of Intrometida had decided to cut taxes instead of increase government spending? That is, given your answers to parts a) and b), by how much would taxes in Intrometida have to be cut to increase output from $800 billion to the value found in part c)? Show your work. [Hint: Recall the change in output caused by the increase in government spending of $60 billion, which was an intermediate step of solving part c); now use the tax-cut multiplier to solve for the size of the tax cut required to produce that same change in output (Y). Again, the handout from section on Nov. 20th will be helpful for this part.] value of tax cuts required to have the same impact 6. (1 point) Read the following New York Times post on the coming hike in the federal funds rate target: http://www.nytimes.com/interactive/2015/business/economy/fed-interest-rates.html [Link also available in the Canvas module “Problem Set 3 links”.] Make sure to watch the short video as well. a. According to the video, what is the concern if the economy grows too quickly? b. Why do most observers think that the Federal Reserve will announce the “liftoff” of the federal funds rate from its seven-year on December 16 (rather than wait until January or March)? [Hint: What recent data have made the Federal Reserve and others more confident about the current state of the economy?] EC 202, Fall 2015 Problem Set 3 University of Oregon Page 7 of 8 7. (2 points total) Watch “Deficits & Debts”, episode 9 of Crash Course Economics: https://www.youtube.com/watch?v=3sUCSGVYzI0 [Link also available in the Canvas module “Problem Set 3 links”.] a. Rounded to the nearest trillion dollars, how high is the federal debt of the United States? trillion dollars b. The animated “Thought Bubble” feature discussed two reasons why governments might be worried about borrowing or unable to borrow more money indefinitely. Explain the first of these reasons in your own words. c. The animated “Thought Bubble” feature discussed two reasons why governments might be worried about borrowing or unable to borrow more money indefinitely. Explain the second of these reasons in your own words. d. Why does the existence of the federal debt ceiling in the United States NOT eliminate concerns about the level of debt running out of control? EC 202, Fall 2015 Problem Set 3 University of Oregon Page 8 of 8 8. (2 points total) Watch “What’s all the Yellen About? Monetary Policy and the Federal Reserve”, episode 10 of Crash Course Economics: https://www.youtube.com/watch?v=1dq7mMort9o [Link also available in the Canvas module “Problem Set 3 links”.] a. According to the video, who is arguably the most influential person on Earth, whose decisions (good or bad) likely affect billions of people? b. The Federal Reserve cannot simply tell commercial banks what interest rates to charge borrowers. Instead, how does the Federal Reserve indirectly manipulate interest rates? c. In response to the high inflation of the late 1970s the Federal Reserve (led at the time by its Chair, Paul Volcker) decreased the money supply. This contractionary monetary policy succeeded in driving down inflation, but what was the downside? d. According to the video, what is quantitative easing?