Scroll down to see all Chapters
Chapter 26
Practice Questions to accompany Mankiw & Taylor: Economics 1
Chapter 26
1. Fly-by-night Corporation is in need of capital funds to expand its
production capacity. It is selling short- and long-term bonds and is
issuing shares. You are considering the prospect of helping finance
their expansion.
a. If you were to buy both short- and long-term bonds from Fly-by-night,
from which bond would you demand a higher rate of return: short or
long term? Why?
Answer:
Long term, because it is more likely that you may need to sell the long-term bond at a
depressed price prior to maturity.
b. If Standard and Poor's lowered the credit worthiness of Fly-by-night,
would this affect the rate of return you would demand when buying
their bonds? Why?
Answer:
Yes, the credit risk has increased and lenders would demand a higher rate of return.
c. If Fly-by-night is issuing both shares and bonds, from which would you
expect to earn the higher rate of return over the long run? Why?
Answer:
Owners of shares demand a higher rate of return because it is riskier.
d. Which would be safer: putting all of your personal saving into Fly-by-
night shares, or putting all of your personal saving into an investment
fund that has some Fly-by-night shares in its portfolio? Why?
Answer:
It is safer to put money in an investment fund because it is diversified (not all of your eggs are
in one basket).
2. Use the saving and investment identities from the National Income
Accounts to answer the following questions. Suppose the following
values are from the national income accounts of a country with a
closed economy (all values are in billions).
Y = €6,000
T = €1,000
C = €4,000
G = €1,200
a. What is the value of saving and investment in this country?
Answer:
(€6,000 – €1,000 – €4,000) + (€1,000 – €1,200) = €800 billion
Practice Questions to accompany Mankiw & Taylor: Economics 2
b. What is the value of private saving?
Answer:
€6,000 – €1,000 – €4,000 = €1,000 billion
c. What is the value of public saving?
Answer:
€1,000 – €1,200 = –€200 billion
d. Is the government's budget policy contributing to growth in this country
or harming it? Why?
Answer:
It is harming growth because public saving is negative so less is available for investment.
3. The following information describes a loanable funds market. Values
are in billions.
a. Plot the supply and demand for loanable funds in Exhibit 1. What is the
equilibrium real interest rate and the equilibrium level of saving and
investment?
Exhibit 1
Answer:
Equilibrium real interest rate = 4%, equilibrium S and I = €1000 billion.
Practice Questions to accompany Mankiw & Taylor: Economics 3
Exhibit 4
b. What "market forces" will not allow 2 per cent to be the real interest
rate?
Answer:
At 2 per cent interest, the quantity demanded of loanable funds exceeds the quantity supplied
by €900 billion. This excess demand for loans (borrowing) will drive interest rates up to
4 per cent.
c. Suppose the government suddenly increases its budget deficit by €400
billion. What is the new equilibrium real interest rate and equilibrium
level of saving and investment? (Show graphically in Exhibit 2.)
Exhibit 2
Answer:
Equilibrium real interest rate = 5%, equilibrium S and I = €800 billion.
Practice Questions to accompany Mankiw & Taylor: Economics 4
Exhibit 5
d. Starting at the original equilibrium, suppose the government introduces
an investment tax credit that stimulates the demand for loanable funds
for capital investment by €400 billion at any real interest rate. What is
the new equilibrium real interest rate and equilibrium level of saving
and investment? (Show graphically in Exhibit 3.)
Exhibit 3
Answer:
Equilibrium real interest rate = 5%, equilibrium S and I = €1200 billion.
Practice Questions to accompany Mankiw & Taylor: Economics 5
Exhibit 6
e. With regard to (c) and (d), which policy is most likely to increase
growth? Why?
Answer:
An investment tax credit, because it shifts the demand for loanable funds to invest in capital to
the right, raising the level of investment in capital and stimulating growth.
Chapter 26
1. Fly-by-night Corporation is in need of capital funds to expand its
production capacity. It is selling short- and long-term bonds and is
issuing shares. You are considering the prospect of helping finance
their expansion.
a. If you were to buy both short- and long-term bonds from Fly-by-night,
from which bond would you demand a higher rate of return: short or
long term? Why?
Answer:
Long term, because it is more likely that you may need to sell the long-term bond at a
depressed price prior to maturity.
b. If Standard and Poor's lowered the credit worthiness of Fly-by-night,
would this affect the rate of return you would demand when buying
their bonds? Why?
Answer:
Yes, the credit risk has increased and lenders would demand a higher rate of return.
c. If Fly-by-night is issuing both shares and bonds, from which would you
expect to earn the higher rate of return over the long run? Why?
Answer:
Owners of shares demand a higher rate of return because it is riskier.
d. Which would be safer: putting all of your personal saving into Fly-by-
night shares, or putting all of your personal saving into an investment
fund that has some Fly-by-night shares in its portfolio? Why?
Answer:
It is safer to put money in an investment fund because it is diversified (not all of your eggs are
in one basket).
2. Use the saving and investment identities from the National Income
Accounts to answer the following questions. Suppose the following
values are from the national income accounts of a country with a
closed economy (all values are in billions).
Y = €6,000
T = €1,000
C = €4,000
G = €1,200
a. What is the value of saving and investment in this country?
Answer:
(€6,000 – €1,000 – €4,000) + (€1,000 – €1,200) = €800 billion
Practice Questions to accompany Mankiw & Taylor: Economics 2
b. What is the value of private saving?
Answer:
€6,000 – €1,000 – €4,000 = €1,000 billion
c. What is the value of public saving?
Answer:
€1,000 – €1,200 = –€200 billion
d. Is the government's budget policy contributing to growth in this country
or harming it? Why?
Answer:
It is harming growth because public saving is negative so less is available for investment.
3. The following information describes a loanable funds market. Values
are in billions.
a. Plot the supply and demand for loanable funds in Exhibit 1. What is the
equilibrium real interest rate and the equilibrium level of saving and
investment?
Exhibit 1
Answer:
Equilibrium real interest rate = 4%, equilibrium S and I = €1000 billion.
Practice Questions to accompany Mankiw & Taylor: Economics 3
Exhibit 4
b. What "market forces" will not allow 2 per cent to be the real interest
rate?
Answer:
At 2 per cent interest, the quantity demanded of loanable funds exceeds the quantity supplied
by €900 billion. This excess demand for loans (borrowing) will drive interest rates up to
4 per cent.
c. Suppose the government suddenly increases its budget deficit by €400
billion. What is the new equilibrium real interest rate and equilibrium
level of saving and investment? (Show graphically in Exhibit 2.)
Exhibit 2
Answer:
Equilibrium real interest rate = 5%, equilibrium S and I = €800 billion.
Practice Questions to accompany Mankiw & Taylor: Economics 4
Exhibit 5
d. Starting at the original equilibrium, suppose the government introduces
an investment tax credit that stimulates the demand for loanable funds
for capital investment by €400 billion at any real interest rate. What is
the new equilibrium real interest rate and equilibrium level of saving
and investment? (Show graphically in Exhibit 3.)
Exhibit 3
Answer:
Equilibrium real interest rate = 5%, equilibrium S and I = €1200 billion.
Practice Questions to accompany Mankiw & Taylor: Economics 5
Exhibit 6
e. With regard to (c) and (d), which policy is most likely to increase
growth? Why?
Answer:
An investment tax credit, because it shifts the demand for loanable funds to invest in capital to
the right, raising the level of investment in capital and stimulating growth.
Chapter 28
Practice Questions to accompany Mankiw & Taylor: Economics 1
Chapter 28
1. Use the following information about Employment Country to answer
question 1. Numbers are in millions.
a. What is the labour force in 2004 and 2005?
Answer:
2004: 7.4 + 105.2 = 112.6 million
2005: 8.1 + 104.2 = 112.3 million
b. What is the labour force participation rate in 2004 and 2005?
Answer:
2004: (112.6/168.2) x 100 = 66.9%
2005: (112.3/169.5) x 100 = 66.3%
c. What is the unemployment rate in 2004 and 2005?
Answer:
2004: (7.4/112.6) x 100 = 6.6%
2005: (8.1/112.3) x 100 = 7.2%
d. From 2004 to 2005, the adult population went up while the labour force
went down. Provide a number of explanations why this might have
occurred.
Answer:
Earlier retirements, students staying in college longer, more parents staying at home with
children, discouraged workers discontinuing their job search.
e. If the natural rate of unemployment in Employment Country is 6.6
percent, how much is cyclical unemployment in 2004 and 2005? Is
Employment Country likely to be experiencing a recession in either of
these years?
Answer:
2004: 6.6% – 6.6% = 0%
2005: 7.2% – 6.6% = 0.6%
In 2004, unemployment is "normal" for Employment Country; therefore, there is no recession.
However, in 2005, unemployment is above normal (positive cyclical unemployment), so
Employment Country may be in a recession.
Practice Questions to accompany Mankiw & Taylor: Economics 2
2. Suppose the labour market is segmented into two distinct markets: the
market for low-skill workers and the market for high-skill workers.
Further, suppose the competitive equilibrium wage in the low-skill
market is €3.00/hour while the competitive equilibrium wage in the
high-skill market is €15.00/hour.
a. If the minimum wage is set at €5.00/hour, which market will exhibit the
greatest amount of unemployment? Demonstrate it graphically in
Exhibit 1.
Exhibit 1
Answer:
The low-skill market will experience unemployment because there will be an excess supply of
labour. (See Exhibit 2.)
Exhibit 2
b. Does the minimum wage have any impact on the high skill market?
Why?
Answer:
No, because the competitive equilibrium wage is above the wage floor.
Practice Questions to accompany Mankiw & Taylor: Economics 3
c. Do your results seem consistent with labour market statistics? Explain.
Answer:
Yes. We observe a greater amount of unemployment among low-skill workers who are often
young and inexperienced.
d. Suppose the high-skill market becomes unionised and the new
negotiated wage is €18.00/hour. Will this have any affect on the low
skill market? Explain.
Answer:
Yes. There will now be excess supply of skilled workers, and this may cause some skilled
workers to move to the unskilled market increasing the supply of labour in the unskilled
market, further reducing the competitive equilibrium wage and causing even more
unemployment there.
3. Answer the following questions about the composition of
unemployment.
a. What are some of the sources of unemployment?
Answer:
Job search, minimum wage, unions, efficiency wages.
b. Which type of unemployment is initiated by the firm?
Answer:
Efficiency wages.
c. Why might a firm pay wages in excess of the competitive equilibrium?
Answer:
To improve worker health, lower worker turnover, increase worker effort, improve worker
quality.
d. Which type of efficiency wage is unlikely to be relevant in the west
European economies? Why?
Answer:
Worker health, because in western Europe workers’ wages are significantly above
subsistence.
e. How does frictional unemployment differ from the other sources of
unemployment?
Answer:
Frictional unemployment exists even when the wage is at a competitive equilibrium.
Chapter 28
1. Use the following information about Employment Country to answer
question 1. Numbers are in millions.
a. What is the labour force in 2004 and 2005?
Answer:
2004: 7.4 + 105.2 = 112.6 million
2005: 8.1 + 104.2 = 112.3 million
b. What is the labour force participation rate in 2004 and 2005?
Answer:
2004: (112.6/168.2) x 100 = 66.9%
2005: (112.3/169.5) x 100 = 66.3%
c. What is the unemployment rate in 2004 and 2005?
Answer:
2004: (7.4/112.6) x 100 = 6.6%
2005: (8.1/112.3) x 100 = 7.2%
d. From 2004 to 2005, the adult population went up while the labour force
went down. Provide a number of explanations why this might have
occurred.
Answer:
Earlier retirements, students staying in college longer, more parents staying at home with
children, discouraged workers discontinuing their job search.
e. If the natural rate of unemployment in Employment Country is 6.6
percent, how much is cyclical unemployment in 2004 and 2005? Is
Employment Country likely to be experiencing a recession in either of
these years?
Answer:
2004: 6.6% – 6.6% = 0%
2005: 7.2% – 6.6% = 0.6%
In 2004, unemployment is "normal" for Employment Country; therefore, there is no recession.
However, in 2005, unemployment is above normal (positive cyclical unemployment), so
Employment Country may be in a recession.
Practice Questions to accompany Mankiw & Taylor: Economics 2
2. Suppose the labour market is segmented into two distinct markets: the
market for low-skill workers and the market for high-skill workers.
Further, suppose the competitive equilibrium wage in the low-skill
market is €3.00/hour while the competitive equilibrium wage in the
high-skill market is €15.00/hour.
a. If the minimum wage is set at €5.00/hour, which market will exhibit the
greatest amount of unemployment? Demonstrate it graphically in
Exhibit 1.
Exhibit 1
Answer:
The low-skill market will experience unemployment because there will be an excess supply of
labour. (See Exhibit 2.)
Exhibit 2
b. Does the minimum wage have any impact on the high skill market?
Why?
Answer:
No, because the competitive equilibrium wage is above the wage floor.
Practice Questions to accompany Mankiw & Taylor: Economics 3
c. Do your results seem consistent with labour market statistics? Explain.
Answer:
Yes. We observe a greater amount of unemployment among low-skill workers who are often
young and inexperienced.
d. Suppose the high-skill market becomes unionised and the new
negotiated wage is €18.00/hour. Will this have any affect on the low
skill market? Explain.
Answer:
Yes. There will now be excess supply of skilled workers, and this may cause some skilled
workers to move to the unskilled market increasing the supply of labour in the unskilled
market, further reducing the competitive equilibrium wage and causing even more
unemployment there.
3. Answer the following questions about the composition of
unemployment.
a. What are some of the sources of unemployment?
Answer:
Job search, minimum wage, unions, efficiency wages.
b. Which type of unemployment is initiated by the firm?
Answer:
Efficiency wages.
c. Why might a firm pay wages in excess of the competitive equilibrium?
Answer:
To improve worker health, lower worker turnover, increase worker effort, improve worker
quality.
d. Which type of efficiency wage is unlikely to be relevant in the west
European economies? Why?
Answer:
Worker health, because in western Europe workers’ wages are significantly above
subsistence.
e. How does frictional unemployment differ from the other sources of
unemployment?
Answer:
Frictional unemployment exists even when the wage is at a competitive equilibrium.
Chapter 29
Practice Questions to accompany Mankiw & Taylor: Economics 1
Chapter 29
1. Suppose the Bank of England purchases a UK government bond from
you for £10,000.
a. What is the name of the Bank’s action?
Answer:
Open market operations
b. Suppose you deposit the £10,000 in First Student Bank. Show this
transaction on First Student Bank's T-account.
Answer:
c. Suppose the reserve requirement is 20 percent. Show First Student
Bank's T-account if they loan out as much as they can.
Answer:
d. At this point, how much money has been created from the Bank of
England’s policy action?
Answer:
£10,000 + £8,000 = £18,000
Practice Questions to accompany Mankiw & Taylor: Economics 2
e. What is the value of the money multiplier?
Answer:
1/.20 = 5
f. After infinite rounds of depositing and lending, how much money could
be created from the Bank of England's policy action?
Answer:
£10,000 x 5 = £50,000
g. If during the rounds of depositing and lending some people keep extra
currency and fail to deposit all of their receipts, will there be more or
less money created from the Bank of England's policy action than you
found in part (f)? Why?
Answer:
Less, because a smaller amount of each loan gets re-deposited to be available to be loaned
again.
h. If during the rounds of depositing and lending, some banks fail to loan
the maximum amount of reserves allowed but instead keep excess
reserves, will there be more or less money created from the Bank of
England's policy action than you found in part (f)? Why?
Answer:
Less, because a smaller amount of each deposit gets loaned out to be available to be
deposited again.
2. Suppose the entire economy contains €1,000 worth of one euro notes.
a. If people fail to deposit any of the euro notes but instead hold all
€1,000 as currency, how large is the money supply? Explain.
Answer:
€1,000, because there is €1,000 of currency and €0 of deposits.
b. If people deposit the entire €1,000 worth of euro notes in banks that
are required to observe a 100 percent reserve requirement, how large
is the money supply? Explain.
Answer:
€1,000, because there is now €0 of currency and €1,000 of deposits.
c. If people deposit the entire €1,000 worth of euro notes in banks that
are required to observe a 20 per cent reserve requirement, how large
could the money supply become? Explain.
Answer:
€1,000 x (1/0.20) = €5,000, because €1,000 of new reserves can support €5,000 worth of
deposits.
Practice Questions to accompany Mankiw & Taylor: Economics 3
d. In part (c), what portion of the money supply was created due to the
banks? (Hint: €1,000 of euro notes already existed).
Answer:
The total potential increase is €5,000, but €1,000 was currency already in the system. Thus,
an additional €4,000 was created by the banks.
e. If people deposit the entire €1,000 worth of euro notes in banks that
are required to observe a 10 per cent reserve requirement, how large
could the money supply become?
Answer:
€1,000 x (1/0.10) = €10,000.
f. Compare your answer in part (e) to part (c). Explain why they are
different.
Answer:
Banks can create more money from the same amount of new reserves when reserve
requirements are lower because they can lend a larger portion of each new deposit.
g. If people deposit the entire €1,000 worth of bills in banks that are
required to observe a 10 per cent reserve requirement, but they choose
to hold another 10 per cent as excess reserves, how large could the
money supply become?
Answer:
€1,000 x 1/(0.10+0.10) = €5,000.
h. Compare your answer in part (c) to part (g). Are these answers the
same? Why?
Answer:
Yes, they are the same. With regard to deposit creation, it doesn’t matter why banks hold
reserves. It only matters how much they hold.
Chapter 29
1. Suppose the Bank of England purchases a UK government bond from
you for £10,000.
a. What is the name of the Bank’s action?
Answer:
Open market operations
b. Suppose you deposit the £10,000 in First Student Bank. Show this
transaction on First Student Bank's T-account.
Answer:
c. Suppose the reserve requirement is 20 percent. Show First Student
Bank's T-account if they loan out as much as they can.
Answer:
d. At this point, how much money has been created from the Bank of
England’s policy action?
Answer:
£10,000 + £8,000 = £18,000
Practice Questions to accompany Mankiw & Taylor: Economics 2
e. What is the value of the money multiplier?
Answer:
1/.20 = 5
f. After infinite rounds of depositing and lending, how much money could
be created from the Bank of England's policy action?
Answer:
£10,000 x 5 = £50,000
g. If during the rounds of depositing and lending some people keep extra
currency and fail to deposit all of their receipts, will there be more or
less money created from the Bank of England's policy action than you
found in part (f)? Why?
Answer:
Less, because a smaller amount of each loan gets re-deposited to be available to be loaned
again.
h. If during the rounds of depositing and lending, some banks fail to loan
the maximum amount of reserves allowed but instead keep excess
reserves, will there be more or less money created from the Bank of
England's policy action than you found in part (f)? Why?
Answer:
Less, because a smaller amount of each deposit gets loaned out to be available to be
deposited again.
2. Suppose the entire economy contains €1,000 worth of one euro notes.
a. If people fail to deposit any of the euro notes but instead hold all
€1,000 as currency, how large is the money supply? Explain.
Answer:
€1,000, because there is €1,000 of currency and €0 of deposits.
b. If people deposit the entire €1,000 worth of euro notes in banks that
are required to observe a 100 percent reserve requirement, how large
is the money supply? Explain.
Answer:
€1,000, because there is now €0 of currency and €1,000 of deposits.
c. If people deposit the entire €1,000 worth of euro notes in banks that
are required to observe a 20 per cent reserve requirement, how large
could the money supply become? Explain.
Answer:
€1,000 x (1/0.20) = €5,000, because €1,000 of new reserves can support €5,000 worth of
deposits.
Practice Questions to accompany Mankiw & Taylor: Economics 3
d. In part (c), what portion of the money supply was created due to the
banks? (Hint: €1,000 of euro notes already existed).
Answer:
The total potential increase is €5,000, but €1,000 was currency already in the system. Thus,
an additional €4,000 was created by the banks.
e. If people deposit the entire €1,000 worth of euro notes in banks that
are required to observe a 10 per cent reserve requirement, how large
could the money supply become?
Answer:
€1,000 x (1/0.10) = €10,000.
f. Compare your answer in part (e) to part (c). Explain why they are
different.
Answer:
Banks can create more money from the same amount of new reserves when reserve
requirements are lower because they can lend a larger portion of each new deposit.
g. If people deposit the entire €1,000 worth of bills in banks that are
required to observe a 10 per cent reserve requirement, but they choose
to hold another 10 per cent as excess reserves, how large could the
money supply become?
Answer:
€1,000 x 1/(0.10+0.10) = €5,000.
h. Compare your answer in part (c) to part (g). Are these answers the
same? Why?
Answer:
Yes, they are the same. With regard to deposit creation, it doesn’t matter why banks hold
reserves. It only matters how much they hold.