Economic Growth, the Financial System, and the Business Cycle

Chapter 9 9.1 Economic Growth, the Financial System, and the Business Cycle Long Run Economic Growth 1. Which of the following statements describes the experiences of the Boeing Corporation since it was established in 1916? little or no growth in the long run, and unaffected by the business cycle. strong growth interrupted by periods of business cycle recession strong uninterrupted growth in demand little or no growth in the long run, but very vulnerable to the business cycle. B Diff: 1 Page Ref: 694/274 Long-run economic growth Factual LO1: Discuss the importance of long-run economic growth Chapter Opener: Growth and the Business Cycle at Boeing 2. 153

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Technological advances generally result in increased life expectancy. increased infant mortality rates. increased average number of hours worked per day. decreased incomes. A Diff: 1 Page Ref: 696/276 Long-run economic growth Conceptual LO1: Discuss the importance of long-run economic growth 3. A good measure of the standard of living is total real GDP. real GDP per capita. 154

Chapter 9: Economic Growth, the Financial System, and the Business Cycle total nominal GDP. nominal GDP per capita. B Diff: 1 Page Ref: 697/277 Long-run economic growth Conceptual LO1: Discuss the importance of long-run economic growth 4. Since 1990, real GDP per capita has and this measure the actual growth in standards of living in the U.S. over this time. decreased; overstates decreased; understates increased; understates 155

Chapter 9: Economic Growth, the Financial System, and the Business Cycle increased; overstates C Diff: 1 Page Ref: 697/277 Long-run economic growth Factual LO1: Discuss the importance of long-run economic growth 5. Since 1900, real GDP in the U.S. has grown in a random unpredictable manner relative to the population. more rapidly than the population. more slowly than the population. as rapidly as the population. B Diff: 1 Page Ref: 697/277 156

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Long-run economic growth Factual LO1: Discuss the importance of long-run economic growth Analytic Skills 6. If real GDP per capita measured in 2000 dollars was $6,000 in 1950 and $48,000 in 2010, we would say that in the year 2010, the average American could buy times as many goods and services as the average American in 1950. 12 times 1/8 times 4 times 8 times D Diff: 1 Page Ref: 697/279 Long-run economic growth Analytical 157

Chapter 9: Economic Growth, the Financial System, and the Business Cycle LO1: Discuss the importance of long-run economic growth Analytic Skills 7. If real GDP in a small country in 2005 is $8 billion and real GDP in the same country in 2006 is $8.3 billion, the growth rate of real GDP between 2005 and 2006 is 3.6%. is 3.0%. is 3.75%. cannot be determined from the information given. C Page Ref: 697/279 Calculating growth rates 158

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Analytical LO1: Discuss the importance of long-run economic growth Analytic Skills 8. If real GDP per capita doubles between 2005 and 2020, what is the average growth rate of real GDP per capita? 15% 21% 4.7% 10.5% C Page Ref: 697/279 Calculating growth rates Analytical LO1: Discuss the importance of long-run economic growth Analytic Skills 159

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 9. If you invest $10,000 in a bond that earns 8% interest, how many years will it take to double your money? 8 years and 9 months 2 years and 6 months 8 years 1 year and 3 months A Page Ref: 697/279 Calculating growth rates Analytical LO1: Discuss the importance of long-run economic growth 10. 160

Chapter 9: Economic Growth, the Financial System, and the Business Cycle If the growth rate of real GDP rises from 3% to 4%, the number of years required to double real GDP will decrease from 11.2 years to 10.8 years. 23.3 years to 17.5 years. 23.3 years to 20.6 years. 28.0 years to 21.0 years. B Diff: 3 Page Ref: 697/279 Calculating growth rates Analytical LO1: Discuss the importance of long-run economic growth Analytic Skills Table 9 1 Year 2002 2003 2004 2005 Real GDP (Billion of 2000 dollars) $8,700 8,875 9,000 9,280 11. 161

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Refer to Table 9-1. Calculate the growth rate of real GDP from 2004 to 2005 using the table above. 2% 3% 1% 4% B Page Ref: 697/279 Calculating growth rates Analytical LO1: Discuss the importance of long-run economic growth 162

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 12. Refer to Table 9-1. Calculate the average annual growth rate from 2002 to 2005 using the table above. 1.5% 1% 2% 3% C Page Ref: 697/279 Calculating growth rates Analytical LO1: Discuss the importance of long-run economic growth 13. Increases in real GDP since 1900 can actually underestimate growth in the standard of living for Americans since 1900 because goods and services are more expensive today as compared to 1900. 163

Chapter 9: Economic Growth, the Financial System, and the Business Cycle the crime rate was higher in 1900 than it is today. the quality of health care that exists today was not available in 1900. the level of pollution in 1900 was much higher than it is today. C Page Ref: 697/277 Long-run economic growth Conceptual LO1: Discuss the importance of long-run economic growth 14. Economist Robert Fogel has estimated that, by the year 2040, individuals in the United States will be spending less time in the workforce and less time in leisure activities than they do today. more time in the workforce and less time in leisure activities than they do today. less time in the workforce and more time in leisure activities than they do today. 164

Chapter 9: Economic Growth, the Financial System, and the Business Cycle more time in the workforce and more time in leisure activities than they do today. C Diff: 1 Page Ref: 698/278 Long-run economic growth Factual LO1: Discuss the importance of long-run economic growth Making the Connection: The Connection between Economic Prosperity and Health 15. If real GDP grows by 3% in 2005, 3.2% in 2006, and 2.5% in 2007, what is the average annual growth rate of real GDP? 2.6% 3.1% 4.2% 2.9% 165

Chapter 9: Economic Growth, the Financial System, and the Business Cycle D Page Ref: 699/279 Calculating growth rates Analytical LO1: Discuss the importance of long-run economic growth 16. Countries with high rates of economic growth tend to have a labor force that is more productive. a lower life expectancy at birth. a declining incidence of business cycle fluctuations. longer workweeks. A Diff: 1 Page Ref: 700/280 Long-run economic growth 166

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Factual LO1: Discuss the importance of long-run economic growth Analytic Skills 17. According to the "Rule of 70", how many years will it take for real GDP per capita to double when the growth rate of real GDP per capita is 5%? less than 1 year 14 years 35 years 5 years B Page Ref: 700/280 The Rule of 70 Analytical LO1: Discuss the importance of long-run economic growth Analytic Skills 167

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 18. The quantity of goods and services that can be produced by one worker or by one hour of work is referred to as human capital. real GDP. labor productivity. technology. C Diff: 1 Page Ref: 700/280 Labor Productivity Definition 168

Chapter 9: Economic Growth, the Financial System, and the Business Cycle LO1: Discuss the importance of long-run economic growth Analytic Skills 19. Which of the following increases labor productivity? inventions of new machinery, equipment, or software an increase in the aggregate hours of work decreases in the availability of computers and factory buildings a decline in health of the population A Diff: 1 Page Ref: 700/280 Labor Productivity Conceptual LO1: Discuss the importance of long-run economic growth 169

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 20. The total amount of physical capital available in a country is know as the country's labor productivity. capital stock. investment. savings. B Diff: 1 Page Ref: 700/280 Determinants of Economic Growth Definition LO1: Discuss the importance of long-run economic growth 21. 170

Chapter 9: Economic Growth, the Financial System, and the Business Cycle What two factors are the keys to determining labor productivity? the average level of education of the workforce and the price level technology and the quantity of capital per hour worked the business cycle and the growth rate of real GDP the growth rate of real GDP and the interest rate B Diff: 1 Page Ref: 700/280 Labor Productivity Conceptual LO1: Discuss the importance of long-run economic growth Analytic Skills 22. Which of the following is an example of human capital? a college education a factory building 171

Chapter 9: Economic Growth, the Financial System, and the Business Cycle a computer a software program A Page Ref: 700/280 Determinants of Economic Growth Conceptual LO1: Discuss the importance of long-run economic growth 23. Human capital refers to which of the following? the quantity of goods and services that can be produced by one worker or by one hour of work manufactured goods that are used to produce other goods and services the accumulated knowledge and skills workers acquire from education and training or from their life experiences physical equipment that is made by human laborers, not machines C Diff: 1 172

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Page Ref: 700/280 Determinants of Economic Growth Definition LO1: Discuss the importance of long-run economic growth 24. Long-run economic growth requires all of the following except increases in capital per hour worked. political instability technological change. 173

Chapter 9: Economic Growth, the Financial System, and the Business Cycle government provision of secure property rights. B Diff: 1 Page Ref: 700-1/280-1 Determinants of Economic Growth Conceptual LO1: Discuss the importance of long-run economic growth 25. Which of the following would contribute to a sustained high rate of economic growth in the long run in an economy? increases in labor force participation rates as workers who are out of the labor force pursue rising wages an influx of immigrant labor into an economy without any accompanying technological change growth in capital per hour accompanied by technological change a shift of workers in the economy from the agricultural sector to the nonagricultural sector C Page Ref: 700/280 174

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Determinants of Economic Growth Conceptual LO1: Discuss the importance of long-run economic growth Solved Problem: The Role of Technological Change in Growth 26. Botswana's rapid growth can be explained by an increase in labor force participation. protection of private property and avoiding political instability. investment in human capital from 1960 through 2007. the movement of workers from the agricultural sector to the manufacturing sector. B Page Ref: 702/282 Determinants of Economic Growth Factual LO1: Discuss the importance of long-run economic growth 175

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Making the Connection: What Explains Rapid Economic Growth in Botswana? 27. Which of the following do not describe governmental policy actions that are helpful in supporting growth in an economy? Governmental policies that establish an independent court system that enforces contracts. avoid playing any role in developing communication systems. provide secure rights to private property. facilitate the development of an efficient financial system. B Page Ref: 702-3/282-3 Determinants of Economic Growth Conceptual 176

Chapter 9: Economic Growth, the Financial System, and the Business Cycle LO1: Discuss the importance of long-run economic growth 28. Potential GDP refers to the extent to which real GDP is above or below nominal GDP. the difference between the highest level of real GDP per quarter and the lowest level of real GDP per quarter within any given year. the level of GDP attained by the country with the highest growth in real GDP in a given year. the level of GDP attained when all firms are producing at capacity. D Diff: 1 Page Ref: 703/283 Long-run economic growth Definition LO1: Discuss the importance of long-run economic growth 29. 177

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Growth in potential GDP is estimated to be about 8% per year. 3.5% per year. 2% per year. 5% per year. B Diff: 1 Page Ref: 703/283 Potential GDP Factual LO1: Discuss the importance of long-run economic growth 30. 178

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Actual real GDP will be above potential GDP if firms are producing above capacity. firms are producing at capacity. inflation is rising. firms are producing below capacity. A Page Ref: 703/283 Long-run economic growth Conceptual LO1: Discuss the importance of long-run economic growth 31. Three factors that affect China's airline industry's profitability and growth are a lack of human capital, small investments in new planes, and the government's failure to liberalize the air travel market. an abundance of human capital, large investments in new planes, and the government's failure to liberalize the air 179

Chapter 9: Economic Growth, the Financial System, and the Business Cycle travel market. a lack of human capital, large investments in new planes, and the government's failure to liberalize the air travel market. a lack of human capital, large investments in new planes, and the government's liberalization of the air travel market. C Page Ref: 722/302 Determinants of Economic Growth Conceptual LO1: Discuss the importance of long-run economic growth An Inside Look: China's Airlines Are Falling to Translate Rapid Growth into Profits 32. Which of the following would benefit China's airline industry in terms of profitability? deregulating airline ticket prices restricting the government sector from building airports mandating that airlines only buy domestically produced aircraft 180

Chapter 9: Economic Growth, the Financial System, and the Business Cycle preventing foreign companies from supplying jet fuel A Page Ref: 722/302 Long-run economic growth Analytical LO1: Discuss the importance of long-run economic growth An Inside Look: China's Airlines Are Falling to Translate Rapid Growth into Profits 33. Accumulating a greater number of inputs will ensure that an economy will experience economic growth. True False Diff: 1 Type: TF Page Ref: 700/280 Determinants of Economic Growth 181

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Conceptual LO1: Discuss the importance of long-run economic growth Analytic Skills 34. Increases in capital per hour worked cannot sustain high rates of economic growth unless accompanied by technological change. True False Diff: 1 Type: TF Page Ref: 700/280 Determinants of Economic Growth Conceptual LO1: Discuss the importance of long-run economic growth Analytic Skills 35. Potential GDP is the maximum output a firm is capable of producing. True False Diff: 1 182

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Type: TF Page Ref: 703/283 Potential GDP Conceptual LO1: Discuss the importance of long-run economic growth 36. The growth rate of real GDP in the United States rises from 4.2% to 4.4%. Explain and calculate how this increase in the growth rate of real GDP affects the number of years it will take for real GDP to double. The "Rule of 70" states that the number of years it takes to double GDP is equal to 70 divided by the growth rate of real GDP. Given this formula, at a growth rate of 4.2%, it will take 70/4.2 = 16.67 years for GDP to double. If the growth rate increases by two-tenths of a percent (to 4.4%), the number of years it will take for GDP to double will decrease to 70/4.4 = 15.9 years. Type: SA Page Ref: 697-9/277-9 Long-run economic growth Analytical LO1: Discuss the importance of long-run economic growth 183

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 37. How has economist Robert Fogel explained that economic growth is connected to life expectancy? Based on this connection, what country would you expect to have a longer life expectancy, the United States or India? Explain. According to Robert Fogel's research, countries with the lowest levels of GDP per capita also have the shortest life expectancies. Technological advances in medicine, agriculture, and water purification improve nutrition and increase incomes. Since economic growth in the U.S. has historically been greater than that in India, we would expect U.S. residents to have a longer life expectancy than residents of India. However, as India's economy begins to grow more dramatically, life expectancy in India is rapidly approaching that of the United States. Type: SA Page Ref: 698/278 Long-run economic growth Analytical LO1: Discuss the importance of long-run economic growth Making the Connection: The Connection between Economic Prosperity and Health 38. What is "human capital", and how does human capital affect labor productivity and economic growth? Human capital is the accumulated knowledge and skills workers acquire from education and training or from their life experiences. Increases in human capital increase labor productivity, which will eventually increase real GDP per capita. Diff: 1 Type: SA Page Ref: 700-1/280-1 184

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Long-run economic growth Conceptual LO1: Discuss the importance of long-run economic growth Solved Problem: The Role of Technological Change in Growth 39. What factors increase potential GDP? Include a definition of potential GDP in your answer. Potential GDP is the level of GDP attained when all firms are producing at capacity. Growth in potential GDP is determined by growth in the labor force and the capital stock and by technological change. Capital investments accompany growth in the labor force, encouraging technological progress and increasing potential GDP. Type: SA Page Ref: 703/283 Long-run economic growth Conceptual LO1: Discuss the importance of long-run economic growth 40. When potential GDP increases, is it necessarily the case that real GDP increases as well? Explain. 185

Chapter 9: Economic Growth, the Financial System, and the Business Cycle An increase in potential GDP is a result of an expanding labor force, growth in the capital stock, and technological change. The actual level of real GDP may be higher or lower than potential GDP. If firms are all producing at capacity, we would expect potential GDP and real GDP to be equal. If firms are producing below capacity, we would expect real GDP to be below potential GDP. And if firms are temporarily producing above capacity, real GDP will be above potential GDP. Type: SA Page Ref: 703/283 Long-run economic growth Conceptual LO1: Discuss the importance of long-run economic growth 9.2 Saving, Investment, and the Financial System 1. Increasing the amount of consumption spending and reducing the amount of savings investment expenditures, and economic growth in the economy. increases; decreases decreases; decreases decreases; increases increases; increases B 186

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Page Ref: 705/275 Determinants of Economic Growth Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. Economics in YOUR Life!: If You Spend More, Will the economy Grow More? 2. A firm can fund an expansion of its operations by buying stock. paying dividends. issuing bonds. loaning money. C Diff: 1 Page Ref: 705/285 Financial Securities Conceptual 187

Chapter 9: Economic Growth, the Financial System, and the Business Cycle LO2: Discuss the role of the financial system in facilitating long-run economic growth. 3. Which of the following is most liquid? a mutual fund share a corporate bond a dollar bill a government bond C Diff: 1 Page Ref: 705/285 Saving, Investment, and the Financial System Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 188

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 4. When a mutual fund company issues mutual fund shares that it will buy back at a price that reflects the underlying value of the financial securities owned by the fund, this kind of mutual fund is called a(n) mutual fund. liquid stock and bond closed-end open-end D Diff: 1 Page Ref: 705/285 Saving, Investment, and the Financial System Definition LO2: Discuss the role of the financial system in facilitating long-run economic growth. 5. Financial securities that represent promises to repay a fixed amount of funds are known as insurance premiums. 189

Chapter 9: Economic Growth, the Financial System, and the Business Cycle pension funds. bonds. stocks. C Diff: 1 Page Ref: 705/285 Financial Securities Definition LO2: Discuss the role of the financial system in facilitating long-run economic growth. 6. One difference between stocks and bonds is that stocks are usually issued in electronic form, while bonds are usually issued in paper form. 190

Chapter 9: Economic Growth, the Financial System, and the Business Cycle stocks do not involve a promise to repay a purchaser of the stock, while bonds represent a promise to repay the purchase price of the bond. stocks are financial securities, while bonds are labor market securities. stocks represent ownership in companies, while bonds represent ownership in banks. B Diff: 1 Page Ref: 705/285 Saving, Investment, and the Financial System Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 7. Which of the following is not a key service the financial system provides to borrowers and savers? liquidity risk sharing information 191

Chapter 9: Economic Growth, the Financial System, and the Business Cycle risk exposure D Diff: 1 Page Ref: 705/285 Saving, Investment, and the Financial System Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 8. All else equal, how would you expect the price of one share of stock in Microsoft to change if there is news that Microsoft has lost a court battle over copyright infringement? The value of a share of stock in Microsoft will decrease in response to this information. The value of a share of stock in Microsoft will be unaffected. The value of a share of stock in Microsoft will change, but the impact of this information cannot be predicted. The value of a share of stock in Microsoft will increase in response to this information. A Diff: 1 192

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Page Ref: 705/285 Saving, Investment, and the Financial System Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 9. In a closed economy, which of the following components of GDP is not included? net exports investment government spending consumption A Diff: 1 Page Ref: 706/286 Open and Closed Economies Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 193

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Analytic Skills 10. In a closed economy, which of the following equations reflects investment? (Y = GDP, C = Consumption, G = Government purchases, T = Taxes, and TR = Transfers) Y-C-T Y-C-G Y - T + TR C + G -T B Page Ref: 706/286 Open and Closed Economies Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 11. In a closed economy, private saving is equal to which of the following? (Y = GDP, C = Consumption, G = Government purchases, T = Taxes, and TR = Transfers) 194

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Y-C-T Y-G-T Y - C - T + TR Y - G - T + TR C Page Ref: 706/286 Open and Closed Economies Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 12. 195

Chapter 9: Economic Growth, the Financial System, and the Business Cycle In a closed economy, public saving is equal to which of the following? (Y = GDP, C = Consumption, G = Government purchases, T = Taxes, and TR = Transfers) Y-C-T T - G - TR Y - C - T + TR Y-G-T B Page Ref: 706/286 Open and Closed Economies Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills Scenario 9-1 Consider the following data for a closed economy: Y = $12 trillion C = $8 trillion I= $4 trillion TR = $2 trillion T = $3 trillion 13. 196

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Refer to Scenario 9-1. Based on the information above, what is the level of private saving in the economy? $8 trillion $3 trillion $4 trillion $5 trillion B Diff: 3 Page Ref: 706-7/286-7 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 14. 197

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Refer to Scenario 9-1. Based on the information above, what is the level of public saving? $2 trillion $1 trillion $0 negative $1 trillion (a deficit of $1 trillion) B Page Ref: 706-7/286-7 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 15. In a closed economy, public saving plus private saving is equal to taxes minus transfers. investment. 198

Chapter 9: Economic Growth, the Financial System, and the Business Cycle the budget surplus. the budget deficit. B Page Ref: 706-7/286-7 Open and Closed Economies Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 16. 199

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Under which of the following circumstances would the government be running a deficit? G = $5 trillion T = $7 trillion TR = $1 trillion G = $7 trillion T = $10 trillion TR = $3 trillion G = $7 trillion T = $7 trillion TR = $0 G = $5 trillion T = $5 trillion TR = $1 trillion D Page Ref: 706-7/286-7 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 17. Under which of the following circumstances would private saving be positive in a closed economy? 200

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Y = $9 trillion C = $5 trillion TR = $1 trillion G = $1 trillion public saving = $3 trillion Y = $6 trillion C = $2 trillion TR = $8 trillion G = $3 trillion public saving = $1 trillion Y = $10 trillion C = $5 trillion TR = $2 trillion G = $2 trillion public saving = $1 trillion Y = $8 trillion C = $2 trillion TR = $4 trillion G = $2 trillion public saving = $4 trillion C Diff: 3 Page Ref: 706-7/286-7 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. 201

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Analytic Skills 18. What is investment in a closed economy if you have the following economic data? Y = $10 trillion C = $5 trillion TR = $2 trillion G = $2 trillion $3 trillion $2 trillion $5 trillion cannot be determined without information on taxes (T) A Page Ref: 706-7/286-7 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 202

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 19. There is a government budget surplus if T-Tr > G. Tr < T. G > Tr. G > T. A Page Ref: 707/287 Budget Deficit or Budget Surplus Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 203

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 20. If government saving is negative, then T - TR < G. T > TR. Y + TR < C - T. G > T. A Page Ref: 707/287 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 21. When the government runs a budget deficit, we would expect to see that G + TR < T. 204

Chapter 9: Economic Growth, the Financial System, and the Business Cycle investment will fall. public saving is positive. private saving will fall. B Page Ref: 707/287 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 22. Which of the following will increase investment spending in the economy, all else being equal? an increase in the federal government surplus an increase in the budget deficit an increase in transfer payments an increase in consumer dissavings 205

Chapter 9: Economic Growth, the Financial System, and the Business Cycle A Page Ref: 707/287 Saving, Investment, and the Financial System Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 23. Borrowers are of loanable funds, and lenders are of loanable funds. demanders; suppliers suppliers; suppliers demanders; demanders 206

Chapter 9: Economic Growth, the Financial System, and the Business Cycle suppliers; demanders A Diff: 1 Page Ref: 707/287 Demand and Supply of Loanable Funds Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 24. The demand for loanable funds is downward sloping because the the interest rate, the the number of profitable investment projects a firm can undertake, and the the quantity demanded of loanable funds. greater; greater; greater lower; smaller; greater lower; greater; greater greater; smaller; greater C 207

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Page Ref: 708-10/288-90 Demand and Supply of Loanable Funds Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 25. If Ebenezer Scrooge spends rather than saves his vast wealth he will promote economic growth because he is decreasing the amount of funds available for investment. promote economic growth because he is increasing the amount of funds available for investment. slow economic growth because he is increasing the amount of funds available for investment. slow economic growth because he is reducing the amount of funds available for investment. D Page Ref: 708-9/288-9 Demand and Supply of Loanable Funds Conceptual 208

Chapter 9: Economic Growth, the Financial System, and the Business Cycle LO2: Discuss the role of the financial system in facilitating long-run economic growth. Making the Connection: Ebenezer Scrooge: Accidental Promoter of Economic Growth 26. A government budget surplus from reduced government spending (no change in net taxes) will the level of investment in the economy and the level of saving (private plus public) in the economy. decrease; increase increase; increase increase; decrease decrease; decrease B Page Ref: 709-11/289-91 Crowding Out Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 27. 209

Chapter 9: Economic Growth, the Financial System, and the Business Cycle If consumers decide to be more frugal and save more out of their income, then this will cause a shift in the supply for loanable funds to the right. a movement along the supply for loanable funds curve to the right. a shift in the supply for loanable funds to the left. a movement along the supply for loanable funds curve to the left. A Diff: 1 Page Ref: 710/290 Demand and Supply of Loanable Funds Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 28. Which of the following would you expect to increase the equilibrium interest rate? a change from an income tax to a consumption tax an increase in the budget deficit 210

Chapter 9: Economic Growth, the Financial System, and the Business Cycle an increase in the percentage of income after net taxes that households save a decrease in the profitability of investment projects firms are considering B Page Ref: 710/290 Demand and Supply of Loanable Funds Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills Figure 9-1 211

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 29. Refer to Figure 9-1. Which of the following is consistent with the graph depicted above? Technological change increases the profitability of new investment. The government runs a budget surplus. An expected recession decreases the profitability of new investment. Households become spendthrifts and begin to save less. A Page Ref: 710-2/290-2 Demand and Supply of Loanable Funds Analytical 212

Chapter 9: Economic Growth, the Financial System, and the Business Cycle LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills Figure 9-2 30. Refer to Figure 9-2. Which of the following is consistent with the graph depicted above? There is a shift from an income tax to a consumption tax. New government regulations decrease the profitability of new investment. 213

Chapter 9: Economic Growth, the Financial System, and the Business Cycle An expected expansion increases the profitability of new investment. The government runs a budget surplus. B Page Ref: 710-2/290-1 Demand and Supply of Loanable Funds Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills Figure 9-3 214

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 31. Refer to Figure 9-3. Which of the following is consistent with the graph depicted above? Taxes are changed so that real interest income is taxed rather than nominal interest income. An expected recession decreases the profitability of new investment. Technological change increases the profitability of new investment. The government runs a budget deficit. A Page Ref: 710-1/290-1 Demand and Supply of Loanable Funds Analytical 215

Chapter 9: Economic Growth, the Financial System, and the Business Cycle LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills Figure 9-4 32. Refer to Figure 9-4. Which of the following is consistent with the graph depicted? an increase in tax revenues collected by the government an increase in household income 216

Chapter 9: Economic Growth, the Financial System, and the Business Cycle an increase in the proportion of income after net taxes used for consumption an increase in transfer payments to households C Page Ref: 710-1/290-1 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 33. In comparison to a government that runs a balanced budget, when the government runs a budget deficit, firm investment will fall. household savings will fall. the equilibrium interest rate will fall. none of the above. A 217

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Page Ref: 710/290 Crowding Out Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 34. The response of firm investment to an increase in the government budget deficit is called crowding out. private dissaving. income minus net taxes. expansionary investment. A Page Ref: 710/290 218

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Crowding Out Definition LO2: Discuss the role of the financial system in facilitating long-run economic growth. 35. If the economy enters into a recession, the equilibrium quantity of loanable funds should and the real interest rate should. rise; fall fall; fall fall; rise rise; rise C Page Ref: 710-1/290-1 Demand and Supply of Loanable Funds Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. 219

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Analytic Skills Figure 9-5 36. Refer to Figure 9-5. "Crowding out" of firm investment as a result of a budget deficit is illustrated by the movement from in the graph above. C to A 220

Chapter 9: Economic Growth, the Financial System, and the Business Cycle B to A A to B B to C C Page Ref: 710/290 Crowding Out Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 37. How will an increase in the government budget surplus as a result of lower government spending (with no change in net taxes) affect private saving in the economy? Private saving will increase by the amount of increase in the budget surplus. Private saving will be unaffected by the increase in the budget surplus. Private saving will decrease by less than the amount of increase in the budget surplus. 221

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Private saving will decrease by the amount of increase in the budget surplus. C Diff: 3 Page Ref: 710-1/290-1 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 38. How would changing a tax on nominal interest income to a tax on real interest income affect the supply of loanable funds? The supply of loanable funds would be unaffected. The supply of loanable funds would increase. The supply of loanable funds would decrease. The supply of loanable funds would become steeper. B Page Ref: 710-1/290-1 222

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Saving, Investment, and the Financial System Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 39. How would the equilibrium interest rate respond to a change from an income tax to a consumption tax? The equilibrium interest rate may rise or fall based on whether the demand or supply of loanable funds changes. The equilibrium interest rate would fall. The equilibrium interest rate would rise. The equilibrium interest rate would be unaffected. B Page Ref: 710-1/290-1 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. 223

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Analytic Skills 40. How would the equilibrium quantity of loanable funds respond to a change from an income tax to a consumption tax? The equilibrium quantity of loanable funds may rise or fall based on whether household savings increase or decrease as a result of the change from an income tax to a consumption tax. The equilibrium quantity of loanable funds would fall. The equilibrium quantity of loanable funds would be unaffected. The equilibrium quantity of loanable funds would rise. D Page Ref: 710-1/290-1 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 224

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 41. Which of the following would encourage economic growth through increases in the capital stock? a decrease in the government deficit an increase in household savings a change from an income tax to a consumption tax all of the above D Page Ref: 710-1/290-1 Saving, Investment, and the Financial System Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 42. If net taxes fall by $80 billion, we would expect household savings to rise by less than $80 billion. 225

Chapter 9: Economic Growth, the Financial System, and the Business Cycle household savings to rise by $80 billion. household savings to fall by more than $80 billion. the government deficit to fall by $80 billion. A Diff: 3 Page Ref: 710-1/290-1 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 43. Which of the following will not occur as the result of a decrease in net taxes? a shift the supply of loanable funds to the left decreased household saving decreased government saving all of the above 226

Chapter 9: Economic Growth, the Financial System, and the Business Cycle B Diff: 3 Page Ref: 710-1/290-1 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 44. If the government decided to tax real interest income rather than nominal interest income, this change would cause the real interest rate to and the equilibrium quantity of loanable funds to. rise; rise rise; fall 227

Chapter 9: Economic Growth, the Financial System, and the Business Cycle fall; rise fall; fall C Page Ref: 711-2/291-2 Demand and Supply of Loanable Funds Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills Solved Problem: How Would a Consumption Tax Affect Savings, Investment, the Interest Rate, and Economic Growth? 45. Countries without well-developed financial systems are able to sustain high levels of economic growth. True False Diff: 1 Type: TF Page Ref: 704/284 Long-run economic growth Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 228

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 46. In an open economy, there is interaction with other economics in terms both trading of goods and services and borrowing and lending. True False Diff: 1 Type: TF Page Ref: 706/286 Open and Closed Economies Definition LO2: Discuss the role of the financial system in facilitating long-run economic growth. 47. If there is public dissaving, investment spending in the economy will decline, holding all else constant. True False Type: TF Page Ref: 706/286 229

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Budget Deficit or Budget Surplus Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. 48. Using equations for public and private saving, demonstrate how total saving in the economy equals investment. Private saving is equal to Y + TR - C - T, and public saving is equal to T - G - TR. Adding private saving and public saving together yields (Y + TR - C - T) + (T - G - TR) = Y - C - G. In a closed economy (with no net exports), Y= C + I + G, so Y - C - G = I, and the sum of public and private savings is equal to investment. Type: SA Page Ref: 706-7/286-7 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 49. Consider the following data for a closed economy: a. b. c. d. e. Y = $12 trillion C = $8 trillion I= $3 trillion TR = $2 trillion T = $3 trillion 230

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Using the data provided, calculate the level of private saving and the level of public saving, and demonstrate their relationship to investment. Private saving is equal to Y + TR - C - T, and public saving is equal to T - G - TR. Plugging in the appropriate numbers for private saving, private saving = Y + TR - C - T = $12t + $2t - $8t - $3t = $3 trillion. Using the identity for output in a closed economy, G = Y - C - I = $12t - $8t - $3t = $1t, so public saving = $3t - $1t - $2t = $0. Adding together private savings of $3 trillion and public savings of $0 yields savings of $3 trillion, which is exactly equal to investment of $3 trillion. Diff: 3 Type: SA Page Ref: 706-7/286-7 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 50. Briefly explain how the miserliness of Ebenezer Scrooge might actually be beneficial for economic growth. 231

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Ebenezer Scrooge is known for his unwillingness to spend money. Refusing to use his money for consumption spending, Scrooge saves his money instead. This savings then becomes available for firms to borrow to finance the building of new factories or research and development. Since growth in the capital stock and technological advance are keys to economic growth, the "stingy" Scrooge may actually be beneficial for economic growth. Type: SA Page Ref: 708-9/288-9 Saving, Investment, and the Financial System Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. Making the Connection: Ebenezer Scrooge: Accidental Promoter of Economic Growth 51. Explain and show graphically how an increase in household savings affects the equilibrium interest rate and the equilibrium quantity of loanable funds. An increase in household savings increases the supply of loanable funds, shifting the supply of loanable funds curve to the right, as shown below. The increase in the supply of loanable funds results in a decrease in the equilibrium interest rate and an increase in the equilibrium quantity of loanable funds. Type: SA 232

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Page Ref: 710-1/290-1 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 52. Explain and show graphically how government deficits can "crowd out" private investment. When the government runs a deficit, public saving falls, reducing the supply of loanable funds and shifting the supply of loanable funds to the left, as shown below. The decrease in the supply of loanable funds results in an increase in the equilibrium interest rate, and a decrease in the equilibrium quantity of loanable funds, moving from point A to point B below. As the equilibrium interest rate rises, the quantity of loanable funds demanded by firms for investments in capital decreases. Increased government deficits raise interest rates, thereby "crowding out" private investment by firms. Type: SA 233

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Page Ref: 710/290 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 53. Explain and show graphically how an increase in government spending affects the equilibrium interest rate in the market for loanable funds. 234

Chapter 9: Economic Growth, the Financial System, and the Business Cycle When government spending increases, government saving (T - G - TR) falls. This decrease in government saving shifts the supply of loanable funds curve to the left, increasing the equilibrium interest rate as shown below. Type: SA Page Ref: 710-1/290-1 Saving, Investment, and the Financial System Analytical LO2: Discuss the role of the financial system in facilitating long-run economic growth. Analytic Skills 7. If net taxes rise by $150 billion, would you expect household savings to fall by $150 billion, by more than $150 billion, or by less than $150 billion? Support your answer with a graph of the market for loanable funds. Private savings are equal to Y - C - T, so if taxes increase private savings will fall. When taxes increase, however, disposable income also falls, so households will consume less. With the increase in taxes and the decrease in consumption, savings will fall, but buy less than $150 billion. Some of the decrease in taxes will be reflected by reduced consumption, not simply reduced saving. Diff: 3 Type: SA 235

Chapter 9: Economic Growth, the Financial System, and the Business Cycle Page Ref: 711/291 Saving, Investment, and the Financial System Conceptual LO2: Discuss the role of the financial system in facilitating long-run economic growth. Solved Problem: How Would a Consumption Tax Affect Savings, Investment, the Interest Rate, and Economic Growth? 9.3 The Business Cycle 1. Which of the following explains the causes of the changes in the unemployment rate at the end of a recession? Discouraged workers leave the labor force and this makes the unemployment rate rise. Firms are hesitant to rehire laid off workers as they continue to operate below capacity. Firms rapidly hire new workers at the first sign of on an increase in demand for their goods. Discouraged workers return to the labor force and this makes the unemployment rate fall. B Diff: 3 Page Ref: 708/298 236

Chapter 9: Economic Growth, the Financial System, and the Business Cycle The Effects of Recession on the Economy Conceptual LO3: Explain what happens during a business cycle 2. During the expansion phase of the business cycle, which of the following eventually increases? employment income production all of the above D Diff: 1 Page Ref: 713/293 The Effects of Expansion the Economy Conceptual LO3: Explain what happens during a business cycle 237

Chapter 9: Economic Growth, the Financial System, and the Business Cycle 3. During the recession phase of the business cycle, income is usually rising. interest rates are usually falling. production is usually rising. unemployment is usually falling. B Diff: 1 Page Ref: 713/293 The Effects of Recession on the Economy Conceptual LO3: Explain what happens during a business cycle 4. 238

Chapter 9: Economic Growth, the Financial System, and the Business Cycle The period between a business cycle peak and a business cycle trough is called recalculation. expansion. recession. diffusion. C Diff: 1 Page Ref: 713/293 The Business Cycle Definition LO3: Explain what happens during a business cycle 5. From 1991 until 2001, the United States was in a period of recession. business cycle peaks. 239