ECO 105

Study Guide for Exam 3

Labor Market

You should be able to answer the following questions:

• What factors affect the demand for labor
  • at the firm level?
  • at the market level (e.g., the market for computer programmers or nurses)?
  • at the aggregate level?
• Be able to determine the optimal quantity of labor a firm should employ.
• How do relatively high wages affect the supply of labor in particular markets?
• Be able to work with the labor-market model to determine the effect on the wage rate of
  • changes in population,
  • changes in labor force participation,
  • changes in product prices,
  • and changes in labor productivity.
• Why, in the long run, are wages so closely related to labor productivity?
• Can you use the Rule of 70 to answer applied questions?
• Be able to define "unemployed" and distinguish between "unemployed" and "not in the labor force."
• What is the equation for the unemployment rate?

Natural Rate of Unemployment

You should be able to answer the following questions:

• What is the natural rate of unemployment?
• Why does some unemployment always exist?
• When is a person officially classified as unemployed?
• How does the government calculate the unemployment rate?
• How do economists define the labor force?
• Why do minimum wage laws, labor unions, and efficiency wages necessarily create some unemployment?
• Why does the absence of perfect information and perfect labor mobility guarantee some unemployment all the time?
• Why might firms choose to pay a wage higher than strictly necessary to employ the desired number of workers?

Macroeconomics

• What is the subject about? What are the sorts of issues and questions that are classified as "macroeconomic"?

Gross Domestic Product

Measurement is a big issue in macroeconomics. GDP is a measure of the economy's production.

• Be able to define GDP precisely.
• Know how to calculate GDP, given data on a ridiculously simple economy.
• What is the difference between GDP and real GDP?
• How does one calculate real GDP?
• What is the GDP deflator? Be able to calculate it, given appropriate data.
• What are the components of GDP, according to the expenditure approach?
• What is included in each component of GDP?
• What are the relative sizes of the four components of GDP?
• Why is real GDP a less-than-perfect measure of economic well-being, but nevertheless a valuable measure?

Standard of Living

How well off we are economically depends on how many goods and services our incomes will buy.

• Be able to calculate the consumer price index (CPI), given appropriate data.
• Understand how the CPI is defined.
• What are the differences between the CPI and the GDP deflator? Why are they are important?
• How do you calculate an annual inflation rate, given CPI data?
• What are the major problems affecting the accuracy of the CPI? How do these problems affect the CPI's accuracy?

Economic Growth

This is one of the most important topics in economics. Be prepared to answer a substantial number of questions on this topic.

• Why is economic growth so important?
• Why are small differences in economic growth rates so important?
• What does history tell us about wealth and poverty, economic growth and stagnation? Which have prevailed most of the time?
• "Once an economy begins to grow, it will always continue to grow (with the exception of temporary recessions or depressions)." True or False? Explain.
• The Chinese economy was very successful for more than a thousand years, up until around 1500. European economies became very successful after about 1500. What similarities existed between the economies of the two areas? What differences were important?
  • What is the probable reason that the Chinese economy stopped growing? What lessons can we learn from this?
• What is the output equation upon which we base our analysis of growth? What do all the terms in the model mean?
• Why is the distinction between "ideas" and "things" important in understanding economic growth? What do we mean by each term?
• What is diminishing marginal productivity? Why does it arise? Does it affect A? Does it affect K/L? How about H/L?
• What drives Solovian growth? Why are all growth processes Solovian to some extent? Why can we be sure that a growth process that is solely Solovian will slow down over time?
• What was common about the growth experiences of the Soviet Union from the 1950s into the 1970s and the Asian Tigers from around 1960 into the 1990s? What important difference explains the collapse of the Soviet economy and the continued success of the Tiger economies?
• What characterizes Smithian growth? Why is Smithian growth limited by the extent of the market?
• What type of factory did Adam Smith use as his primary example in Chapter 1 of The Wealth of Nations? What principle did he illustrate with the example?
• How do important innovations in transportation, such as better sailing ships or the steam locomotive, affect Smithian growth?
• What is the driving force underlying Schumpeterian growth? (Note: It comes in two variants.)
• What is creative destruction? Use the Schumpeterian vision to explain how creative destruction occurs in the growth process.
• What role do monopoly profits play in the Schumpeterian growth process?
• What three conditions appear necessary for a society to be technologically creative?
  • What are the most important cultural factors in growth?
  • What are the most important institutional factors in growth?
  • What sort of "diversity and tolerance" is necessary for growth to occur?
• What are the two reasons (raised by Friedrich Hayek) why markets are indispensible to economic growth?
• What are the most important first steps the government of a poor country can take to improve the chances that economic growth will occur?
• Why is saving important to economic growth?
• In what two ways does openness to international trade appear to encourage economic growth?
• What does the development of the U.S. automobile industry teach us about economic growth?

Saving and Investment/Loanable Funds Model

• Define the terms "saving" and "investment."
• How do household savings find their way to business firms?
• What is the difference between financial markets and financial intermediaries?
• What is the difference between stocks and bonds?
• What is the source of the demand for loanable funds? What is the source of the supply?
• What is the difference between a nominal interest rate and a real interest rate?
• Be able to calculate the real interest rate, given appropriate data.
• Why is the demand for loanable funds related negatively to the real interest rate?
• How do each of the following affect the equilibrium real interest rate?
  • An increase in the perceived profitability of capital goods
  • An increase in the willingness of households to save
  • An increase in the government budget deficit (or decrease in the surplus)
  • An increase in taxes on the earnings from capital

Money and the Federal Reserve System

It may not make the world go 'round, but money sure does put goods and services in motion. And the Federal Reserve System has a huge influence on America's monetary system.

• What are the functions served by the stuff we call "money"?
• What is the meaning of "liquidity"?
• What is the difference between commodity money, fiat money, and fiduciary money?
• What is included in the basic measures of US money: M1 and M2?
• What is the basic organizational structure of the Federal Reserve System?
• Why is the Federal Open Market Committee so important?
• Who creates most of the money in the United States?
• How do banks create money? What limits the amount of money they can create?
• Understand the logic of the money multiplier (you will not be asked to work problems with it).
• What are the Fed's tools of monetary policy? Which is most important? How does each tool affect the money supply?
• What is a bank run? How can a run be stopped?