Chapter 34

Q:

1. What is the theory of liquidity preference and how does it help explain the downward slope of the aggregate demand curve?
2. Use the liquidity preference theory to explain how decreases in the money supply affect the AD curve.
3. Give an example of a government policy that acts as an automatic stabilizer. Explain why the policy has this effect.

A:

1. The theory of liquidity preference is a theory that states that interest rate adjusts to bring money supply and demand into balance. What this means is that the supply and demand of money will affect how "easy" (cheap) it is to borrow that money, or money will be available to be borrowed at a lower interest rate. This theory helps to explain the downward slope of the aggregate demand curve, basically, the higher the supply of money, the easier(cheaper) it would be for a borrower to obtain an investment loan. The higher the interest rate, the less demand there is for loans. This inverse relationship produces a negative curve.

2. If the quantity of money supplied by the fed decreases, money will be in higher demand, thus yielding a higher interest rate for those that wish to borrow money. Because of a higher interest rate, the quantity demanded of goods and services will decrease. This inverse relationship between money supply and interest rates produces the downward curve.

3. An example of an automatic stabilizer is the government giving unemployment benefits. During an economic downturn, unemployment benefits could possibly allow families to keep "demanding" products that they would not otherwise be able to continue consuming. This lessens the blow of rapidly decreasing demand on an already weak economy. However, when far more unemployment benefits are given out then revenue received, deficits skyrocket. In the short term, however, these benefits can soften the blow of sudden, decreased employment and decreased demand.

Chapter 30

Q:

1. What do we mean when we say, "money is whatever society says it is?"
2. Describe the components of M1, M2 and M3. In general, how do they differ?
3. What is "the Fed" and its main purpose?
4. Take a look at the following banking in-class demonstrations. Pick one of the three demos to perform with some friends, relatives, or other persons who owe you a favor:-) You are to act as the teacher in the demonstration and you are to attempt to teach the group the concept the demonstration is attempting to illustrate. Once the role playing is completed, answer the following questions.
1. Which demonstration did you choose and why?
2. Give a general description of your volunteers - approx age, gender, etc.
3. How did the demonstration go overall?
4. Did the volunteers seem to understand the concept being demonstrated? Why or why not?
5. Add any other comments you feel are relevant.
6. Did you enjoy this exercise and did you learn anything new by performing the demonstration? Why or why not?

A:

1. "Money is whatever society says it is" means that the inherent value of money depends on what it represents in the a society. As stated in the Mankiw book, money itself, as in the paper and ink that is used to make money, does not have much value. What the money represents in a society is of the greatest importance, the amount of money that a good or service cost represents the relative scarcity of that good or service in the society. Everyone in a society that is choosing to use government issued money is accepting that the money has value in that society, and by using it, an individual is accepting the relative value that all the other members of society place on that individual unit of money.

2. The components of M1 include, but are not limited to: deposits, travelers checks, checked deposits, and currency. M2 components include all of M1, and in addition, savings deposits, small deposits, and money market and mutual funds. M3 is no longer measured, but would include all of M1 and M2, plus large, long term deposits. Each category differs from one another by including one more, generally larger, more encompassing measure of money.

3. The "Fed" is the Federal Reserve, a central bank organization that is responsible for regulating the monetary system, including the quantity of money in the economy. Its two main purposes are to regulate banks and the banking system including acting as a "bank's bank"...and the second purpose is to regulate the amount of money in the economy.

4. I chose the third demonstration, "The Inflation Fairy". I chose this because it seemed the easiest to do with 2 people, seeing as how I only had my husband as a volunteer. He is 26 yr old male. In order to conduct the demonstration, I read the senario about overnight inflation, and asked him what he thought about what it would do to us, and the economy. He had a very good understanding of what I was asking him, and was able to easily follow along. His first reaction to the question of what would happen if prices and incomes doubled overnight, was correct, he said "nothing". As we were talking more about it, he mentioned that you would be hurt if you were a family or business that holds a great deal of cash on hand. For example, we are in the process of saving so that I can go back to school. If prices doubled overnight, essentially, we would have half the savings we have now. True, we would be making more money, but all the work we had put into saving would be halved, as now everything is just as proportionally expensive. In the short term, businesses would have a major cash shortage. All payroll expenses would be twice as much, but the money from adjusted, inflated prices, may not have flown in yet. Overall, this demonstration was interesting, because we had a good discussion about inflation. I did learn something new, my husband really brought up the point about people that deal primarily in cash, and that was somewhat on the answer sheet, but a really good point for further discussion.

Chapter 24 hw: Group C

1. What is the CPI and what is its purpose?


2. Fix the basket at 3 footballs and 4 basketballs.

Year	Price of Footballs	Price of Basketballs
Year 1	$10	$12
Year 2	12	15
Year 3	14	18

1. Compute the cost of the basket:
   Cost in Year 1
   Cost in Year 2
   Cost in Year 3


2. Using Year 1 as the base year, compute the index:
   CPI in Year 1
   CPI in Year 2
   CPI in Year 3


3. Compute the inflation rate:
   Inflation rate for Year 2
   Inflation rate for Year 3


4. Take a look at the following link. Notice all the different measures of a country's "Standard of Living." Which do you think is the best measure and why?

A: 1. The CPI is defined as the measure of the overall cost of goods and services bought by the typical consumer. Its purpose is to determine changes in the cost of living for a typical consumer, and as the Mankiw book states, to gauge how much incomes must rise to maintain a constant standard of living.

1. Compute the cost of the basket:

Cost in Year 1: 3(10) + 4(12) = 78

Cost in Year 2: 3(12) + 4(15) = 96

Cost in Year 3: 3(14) + 4(18) = 114

2. Using year one as the base year, compute the index:

CPI in year 1: (78/78)*100 = 100

CPI in year 2: (96/78)*100 = 123

CPI in year 3: (114/78)*100 = 146

3. Compute the inflation rate:

Inflation rate for Year 2: (123-100) = (23/100)*100 = 23%

Inflation rate for Year 3: (146-123) = (23/100)*100 = 23%

4. I believe that one of the best measures of the standard of living of a country can be found by comparing the Human Development Index (HDI) between countries. According to the link, this index is a comprehensive measure of all the facets that make up a "good" standard of living, including life expectancy, literacy, well being, and child welfare. I thought that it was very interesting that a measure was included that factors in how a countries' economic policies affect the standard of living. This makes the HDI an invaluable measure for economists, that could use the index to lobby for the continued use of certain economic principles by a countries' government in order to maintain a certain HDI ranking.

Q: Consider the market for minivans. For each of the events listed below, identify which of the determinants of demand or supply are affected. Also, indicate whether demand or supply increases or decreases and the resulting effect on price and quantity demanded.

1. People decide to have more children.
2. A strike by steelworkers raises steel prices.
3. The price of sport utility vehicles rise.
4. A stock market crash lowers people's income.

A:

1. People decide to have more children: I assumed from this statement, that it would be safe to say that the number of buyers in the minivan market has increased, or the demand for minivans has increased. As more families have an increased number of children then the "normal" number of children/family, it stands to reason that each family that is in the position to afford a choice in transportation would choose a vehicle that accommodates additional family members. Minivans are a type of vehicle that meets that criteria. An increase in the demand for minivans shifts the equilibrium curve of the minivan market, and could result in buyers willing to pay an increased price/minivan that the car dealer has in stock, and an increased number of minivans are sold. If this trend continues, an auto manufacturer could then choose to increase the number of minivans that the company produces each year, an increased supply in order to meet the increased demand in the minivan market. However, this assumption is based on the buyers' preference of a minivan to another type of vehicle, not the preference of one type of minivan to another type of minivan.

2. A strike by steelworkers raises steel prices: Steel is a critical input item used to make a minivan. In this case, the supply of steel is affected (decreased) by a steel worker strike, not necessarily the demand of buyers in the minivan market. Therefore, the equilibrium price of a complete minivan is going to increase as a result of the decreased will of the auto dealers to sell a complete minivan at any given price. With an increased price, comes a decreased quantity of minivans that are sold.

3. The price of sport utility vehicles rises: A family that is looking to buy a new vehicle has the choice between many different types. However, a sport utility vehicle and a minivan may have overlapping markets, both are vehicles that can accommodate more people then a standard car. Therefore, it may be assumed that as the price of a sport utility vehicle increases, there will be less quantity of sport utility vehicles sold. However, that does not necessarily mean that the demand for larger vehicles has decreased. For this reason, I determined that the number of buyers in the minivan market will increase. As seen in the first question, as the demand for minivans increases, the equilibrium curve will shift, and people will be willing to pay more per minivan then they once were, and the price for minivans will also increase.

4. A stock market crash lowers peoples' incomes: I considered minivans as a "normal good", meaning, that as peoples' incomes fell, the demand that people had for a minivan at any price would also fall. At any given price, the quantity of minivans sold would decrease. This could result in a surplus of minivans. As a result of having a surplus that cannot be sold, dealers may choose to decrease the price/minivan, and to also decrease the amount of minivans that they are manufacturing, until a new equilibrium is reached, that balances peoples new, lower income with minivan demand