Chapter 1

Question 1

What is a market?

Answer 1

Something that brings together buyers and sellers

Question 2

Characteristics of a perfectly competitive market

Answer 2

• Large # of buyers and sellers
• No barriers to entry/exit
• A standardized product

Question 3

Demand

Answer 3

A schedule showing the amount of an item that buyers can and will purchase at various price levels during a given period of time.

• A demand curve has a negative slope due to the inverse relationship between prices and quantity demanded. As prices rise, quantity demanded decreases. This is called the law of demand.

Question 4

Non-price determinants that affect demand

Answer 4

• The income of buyers
• The # of buyers
• Preferances of buyers
• Buyers’ expectations about future events
• Prices of related items

Question 5

True or false: Substitutes have a direct relationship w/ the other goods?

Answer 5

True. (Ex: if the price of airfare increases, the demand for railway travel increases).

Question 6

True or false: Complimentary goods/services have a direct relationship w/ the other goods?

Answer 6

False, inverse relationship. (ex: If the price of peanut butter increases, the demand for jelly decreases).

• Independent goods have no relationship. (ex: An increase in the price of peanut butter has no affect on the price of golf balls).

Question 7

Supply

Answer 7

A schedule showing the amount of an item that sellers can and will supply at various price levels during a given period of time.

• The supply curve has a positive slope indicating that at higher prices, more will be supplied - the law of supply.

Question 8

Non-price determinants that affect supply

Answer 8

• The # of sellers
• The price of inputs
• Tech
• Taxes/subsidies
• Sellers’ expectations of future events
• Prices of related items

Question 9

Elasticity of demand

Answer 9

The degree to which the Qd would change for a given change in price.

Formula: Ed = % ▵ Qd ÷ % ▵ price

In the formula, use the absolute value. Also, use the midpoint value.

• If elasticity is greater than 1 (100%), it’s referred to as being elastic or relatively elastic. This means the Qd will change by a larger % than the price change. In this case, a price decrease will increase total revenue and vice versa.
• If elasticity is less than 1, demand is inelastic or relatively elastic. This means the Qd will change by a smaller % than the price change. In this case, a price decrease will decrease total revenue and vice versa.
• If elasticity = 1, it’s called unit elastic, meaning the % change in demand = the % change in price.

Question 10

Elasticity of demand example:
Suppose a demand schedule shows a $10 unit price corresponds to Qd of 5,000 units. A $8 unit price corresponds to Qd of 6,000 units. What is the elasticity of demand?

Answer 10

1. (6,000 - 5,000) ÷ 5,500 = 0.1818 or 18%
2. ($10 - $8) ÷ $9 = 0.22 or 22%
3. 18% ÷ 22% = 81.81%

• Use 5,500 because it’s the midpoint between 6,000 and 5,000. Similarly, we use $9 since it’s the midpoint between $10 and $9

Question 11

True or false: Demand for an item tends to be elastic at lower prices and inelastic at higher prices?

Answer 11

False, demand for items tends to be elastic at higher prices and inelastic at lower prices.

Question 12

Factors that affect elasticity of demand:

Answer 12

• Time: The longer the time period examined, the more elastic demand tends to be
• Availability of substitutes: The larger # of substitute products available, the greater the elasticity.
• Proportion of a budget devoted to the item: The larger the % of a budget devoted to a particular good, the more elastic the demand will be.
• Whether an item is a necessity or not

Question 13

Supply elasticity

Answer 13

The degree to which the Qs would change for a given change in price.

• The main factor affecting elasticity of supply is time- how quickly a producer can change production to increase or decrease the supply of a product.

Question 14

How to calculate the % increase in sales required to maintain the same revenue:

Answer 14

Price decline % ÷ complement of the price decrease

Ex: If you lowered the price of a product by 5% but wanted to maintain the same revenue, you would need to increase sales by: 0.05 ÷ 0.95 = 5.26%

Question 15

How to calculate the % increase in sales required to increase revenue:

Answer 15

[ (1 + revenue increase %) - complement of the price decrease ] ÷ complement of the price decrease

Ex: If you lowered the price of a product by 5% and want to increase revenue by 8%, you need to increase sales by: [ (1.08) - 0.95 ] ÷ 0.95 = 0.137

Question 16

Price system

Answer 16

While supply and demand curves reveal the relationship between price, supply, and demand for a specific item, consideration must be given to how prices in the overall economy are set.

Question 17

Economic costs

Answer 17

Payments that a business must make to secure the required amount of productive resources

Question 18

Capital

Answer 18

Capital refers to man-made resources that are used to produce other goods and services (ex: machinery).

• Money capital refers to currency and real capital refers to #18.
• Interest is the cost of money capital, and since money capital is used to purchase/build real capital, interest rates ration the use of capital.

Question 19

Normal profit

Answer 19

The cost of obtaining and retaining entrepreneurial ability. The entreprenuer is paid for the function of organizing the business and combining the proper resources into a sellable good or service.

Question 20

Economic profit

Answer 20

Economic profits are excess earning over and above capital expenditures and normal profit.

Question 21

Input-output analysis

Answer 21

In a perfectly competitive economy, capital is allocated to booming industries/companies and taken away from oversaturated markets. Economists use input-output analysis to investigate the consequences of such changes in an economy. Using this technique, the economy is divided into constituent industries and among these is divided into consumers and producers. For example, constituent A might have 10 units consumed by constituent A itself and 20 units consumed by constituent B.

Question 22

Short-run

Answer 22

A period of time where fixed costs cannot be changed but variable costs can be changed

Question 23

True or false: The law of diminishing marginal returns states that as more and more variable resources are combined w/ fixed resources, there will be a point that the marginal output will begin to level off?

Answer 23

True

Question 24

Relationship between average cost and quantity produced

Answer 24

Avergage total cost: Declines initially but eventually reaches a inflection point and begins to increase

Average variable cost: Declines initially but eventually reaches a inflection point and begins to increase. Reaches inflection point quicker than ATC.

Average fixed cost: Declines as output rises

• ATC = (Fixed costs + variable costs) ÷ Output
• AFC = Fixed costs ÷ Output
• AVC = Variable cost ÷ Output

Question 25

Marginal cost

Answer 25

The additional cost of producing one more unit of output Calculation: ▵ in total cost ÷ ▵ in output

Question 26

Relationship between MC and AVC

Answer 26

If MC < AVC, AVC will continue to fall. Once MC > AVC, AVC will begin to rise | * The relationship is the same for ATC.

Question 27

Long run

Answer 27

A period of time where all costs are variable. ## Footnote * The long-run ATC curve can be derived from a series of short-run ATC curves.

Question 28

Minimum efficient scale

Answer 28

The smallest level of output where a firm can achieve minimum ATC

Question 29

True or false: Initially, the ATC curve will decrease due to economies of scale, but the curve will reach a minimum and begin to rise as diseconomies of scale begin to have an effect?

Answer 29

True ## Footnote * The ATC curve will reflect the structure of the industry. In some industries, diseconomies of scale are encountered quickly and MES will occur at low levels of output. This occurs in industries w/ a large # of small producers.

Question 30

Economies of scope

Answer 30

Efficiencies formed by variety, not volume. Often companies will use M&A to have many different product lines sold under one name, this is an example of economies of scope.

Question 31

Gross national product (GNP)

Answer 31

GNP measures the total value of all goods and services produced by a national economy. ## Footnote * Ex: For the U.S., GNP includes all goods/services produced inside the U.S. and those produced overseas by a U.S. company

Question 32

Gross domestic product (GDP)

Answer 32

The value of all final goods/services produced within a country within a given period of time.

Question 33

GDP deflator

Answer 33

Measures how much of the change in GDP is based on inflation, rather than an actual increase in economic output. Calculation: (Nominal GDP ÷ Real GDP) * 100

Question 34

Real interest rate

Answer 34

The rate an investor in fixed-income securities actually receives once inflation is taken into account. Ex: A 10-year bond yields 7% and inflation is 3%, the real interest rate = 4%.

Question 35

True or false: Interest rates begin to rise during the expansion phase of the business cycle?

Answer 35

True, since consumers and businesses want to grow their business, they borrow money, causing interest rates to rise.

Question 36

True or false: Inflation is usually high during recessions?

Answer 36

False

Question 37

True or false: A depression occurs when real GDP declines for 6 months or more?

Answer 37

False, 2 years or more

Question 38

Examples of leading indicators

Answer 38

1. Avg. workweek for production workers in manufacturing 2. Avg. weekly initial claims for unemployment 3. New order for consumer goods and materials 4. Vendor performance (firms receiving slower deliveries from suppliers) 5. Contracts/orders for plant and equipment 6. New building permits for private housing units 7. The prices for the S&P 500 common stocks 8. The money supply 9. Change in credit outstanding for business and consumer borrowing 10. Interest rate spreads (10-year Treasuries minus Fed Funds) 11. Index of consumer expectations

Question 39

Examples of coincident indicators

Answer 39

1. Employees on non-ag payrolls 2. Personal income less transfer payments 3. The index of industrial production 4. Manufacturing and trade sales

Question 40

Examples of lagging indicators:

Answer 40

1. The avg. duration of unemployment 2. The relationship of inventories to sales, manufacturing, and trade 3. Labor cost per unit of output for manufactured goods 4. The avg. prime rate charged by banks 5. C&I loans outstanding 6. The relationship of consumer installment credit to personal income 7. The CPI for services

Question 41

True or false: Event risk is the same as exogenous risk?

Answer 41

True, at least for the sake of this exam

Question 42

Keynesian economics

Answer 42

Incorporates fiscal policy to stimulate economic growth and employment.

Question 43

Supply-side economics

Answer 43

Focuses on reducing taxes and the size of the government to stimulate the economy.

Question 44

Composition of the money supply

Answer 44

M1: Currency in circulation + DDAs + other checking accounts M2: M1 + MMDAs + savings + balances at money funds + overnight repo agreements at banks M3: M2 + large time deposits + term repo agreements at banks + Eurodollars ## Footnote * Eurodollars are no long published by the FRB.

Question 45

Tools the FRB uses to implement monetary policy:

Answer 45

- Reserve requirement - Setting the discount rate: DW rate - Open market operations - Setting margin requirements - Moral suasion

Question 46

Excess reserves

Answer 46

The amount of money a bank has in excess of the Fed's reserve requirement

Question 47

Multiplier effect

Answer 47

The rate at which banks create new money by relending deposits and in turn create new deposits.

Question 48

Open market operations

Answer 48

Involves the purchase and sale of U.S. government securities, primarily Treasury bills. The FRB, however, also trades government notes and bonds. These trades are executed through primary dealers, banks, and brokerages appointed by the FRB. Ex: The FRB buys securities from primary dealers and pays for the securities, which are then deposited in a bank.

Question 49

Repurchase agreement (repo)

Answer 49

A contract where the FRB purhcases U.S. government securities from a primary dealer at a fixed price with a provision to sell them back to the dealer at the fixed price + interest. Reverse repo is the opposite.

Question 50

Margin requirements

Answer 50

The Act of '34 gave the FRB the power to determine the amt of credit that can be extended to purchase securities. Reg T applies to brokerages. Reg U applies to banks and all other lenders. By increasing margin requirements, lendable money decreases, causing the money supply to tighten.

Question 51

Intermediation

Answer 51

The abilitiy of financial institutions to attract deposits and then extend credit

Question 52

Disintermediation

Answer 52

The process by which investors withdraw funds from banks and seek higher-yielding investments elsewhere.

Question 53

How do interest rates affect exchange rates?

Answer 53

If the U.S. has higher interest rates, foreign investors wishing to earn higher return wil invest in the U.S. In order for them to invest, they must convert their currency into dollars, and thus the demand for the dollar increases, and therefore the price of dollars (the exchange rate) will increase. However, if interest rates are high and the dollar is strong, U.S. consumers can purchase more foreign goods, thus increasing imports. Conversely, foreign consumers w/ weaker currencies will be unable to purchase the relatively more expensive U.S. goods.

Question 54

Balance of payments

Answer 54

The method by which countries measure all of the international monetary transactions within a certain period. (X- IM) = S - I + (T - G)

Question 55

Current account

Answer 55

The results for trade transactions completed in the current year.

Question 56

Capital account

Answer 56

Deals w/ long-term transactions, usually involving property or financial assets. Ex: A U.S. corporation investing in a factory in a foreign country is an outflow, while the purchase of U.S. common stock by a foreign investor is an inflow. ## Footnote * A current account deficit must be balanced by a capital account surplus and vice versa. The net of the two accounts must be zero.

Question 57

Interbank system

Answer 57

An open market trading system where conversion rates for currencies are set.

Question 58

True or false: Regular supply and demand curves are useful for determining the supply and demand for currencies?

Answer 58

True

Question 59

Nonprice determinants that alter supply and demand schedules for currencies:

Answer 59

- Changes in income: As countries become wealthier, consumers, in general, purchase more goods, including imported goods. - Changes in preferences for goods of a particular country: If German cars become a status item, demand will increase. - Changes in real interest rates: If domestic prices are rising more rapidly than the prices of foreign goods, imports will increase. - Price changes: If domestic prices are rising more rapidly than the prices of foreign goods, imports will increase. - Speculation: Expectations of political or economic changes may result in the buying/selling of currency by speculators.

Question 60

True or false: Changes in currency rates can have a significant impact on revenue, COGS, and operating profit margins for companies?

Answer 60

True. Ex: If a U.S. firm receives revenue from Europe and the price of the dollar decreases against the Euro, the company will report higher revenues since the value of the Euro has increased. Similarly, if a U.S. firm manufactures products in Japan and the price of the dollar declines against the yen, the firm's COGS will increase since the value of the yen has increased.