ECON 1250

Introduction to Economics

1. What are the 5 basic questions in determining the allocation of resources?

1- What good and services are to be produced?

2- Where are these goods and services to be produced?
3- Who will receive these goods and services produced?
4- How will these goods and services be produced?
5- How many goods and services are to be produced?

The four basic economic questions are (1) what goods and services and how much of each to
produce, (2) how to produce, (3) for whom to produce, and (4) who owns and controls the
factors of production.

2. Define economics.

The study of mankind in the ordinary business of life. - Alfred Marshall (1842 - 1924)
Economics is the study of the efficient allocation of scarce resources to satisfy unlimited human
wants.

3. Explain what a resource is and what the three categories of resource are. Provide two
examples of each.

Anything that can be used in the production process. Resources or Factor of Productions goes
through Production Process and produce Final Goods and Services.
Land, Labour and Capital are the three resources. Examples:
Land - Trees, natural gas
Labour - mental ability, physical ability
Capital - Computers, buildings, etc.

4. Describe the three basic allocation mechanisms.

3 basic allocation mechanisms

Traditional (Customary) - All allocations questions are determined by custom or tradition.

Example: Somalia, Ethiopia, etc. where allocations of resources are done customarily.

Command - A small group or an individual decides all allocation questions. Example: N. Korea,
Albania, Cuba, etc.

Free Market - every individual endeavours as much as he can to employ his capital in support of
the domestic industry. Characteristics of Market economy:
Self interest - utility/profit maximization
Incentives
Decisions made at the margin
Specialization and division of labor
Money and trade
Institutions - including property rights

5. What is meant by the scientific method?

a method of research in which a problem is identified, relevant data are gathered, a hypothesis
is formulated from these data, and the hypothesis is empirically tested (Pls. see diagram from
class presentation below).

6. Explain why economists use models to explain the world.

An economic model is a simplified description of reality, designed to yield hypotheses about

economic behavior that can be tested. ... For example, a theoretical model of an agent's
consumption behavior would generally suggest a positive relationship between expenditure and
income.
7. Illustrate the difference between a positive and a normative statement.

Normative: statements those are based on opinions, often insupportable with rational argument.
Example:
1. Government should not spend taxpayers money in supporting commercial banks.
2. The majority of the population would prefer a policy that reduced unemployment to one
that reduced inflation.

Positive: statements based on fact or theory, can be supported by logical argument.

Example:
1. Raising interest rates encourage people to save
2. Unemployment is a more important social problem than inflation.

8. With the use of examples, distinguish between microeconomic and macroeconomic

problems.

Microeconomics - deals with questions pertaining to individual decision makers, individual

markets, and individual prices. For example: how an individual person or market demand or
supply react with increase or decrease of price of some certain commodity.

Macroeconomics - deals with questions pertaining to the economy as a whole - the decision of
consumers and firms in general, total consumption and price level. Inflation, unemployment,
interest rate, exchange rate, etc. are major concern of macroeconomics.

9. Briefly explain why people continue to use cell phones when they drive, even though
they know that it is illegal.

Introduction and PPC

1. Explain why a Production Possibilities Frontier can never be upward sloping.

The outward-bowed shape of the PPF reflects increasing opportunity cost.

The PPF is bowed outward because resources are not all equally productive in all activities. If
some of the people, who are expert in producing product A, is moved to produce product B, they
might not be equally productive. So, well get small increase in product B, but a large decrease
in the quantity of product A; and vice-versa.

2. Use a Production Possibilities Frontier to explain the effects of a change in technology

on the output of the economy.
3. Use an example to illustrate that you understand the difference between absolute and
comparative advantage.

Absolute advantage means being more productive or cost-efficient than another country
whereas comparative advantage relates to how much productive or cost efficient one country is
than another.

In order to understand how the concept of comparative advantage might be applied to the real
world, we can consider the simple example of two countries producing only two goods - motor
cars and commercial trucks.

Here, Country B has absolute advantage in producing both Cars and Trucks. But,
country A has comparative advantage of producing Cars, since it can produce one car
sacrificing less number of trucks than the other country.
4. Use a Production Possibilities Frontier to explain why a traditional economy was efficient
during the Middle Ages.

In the middle ages, an economy that chose point B in the PPF shown above, would not have
enough food to feed its entire population. Starvation, death and civil unrest are likely to follow.
This outcome is true for every point on the PPC below the subsistence level, so the optimal
choice for the economy in this situation is point A. they must devote all of their resources to the
production of food.
So, there were no resources available to devote to research and development and no new
technologies are discovered, and they were affected some natural diseases like plague. A good
number of population died from these diseases and subsistence level dropped, since there
were less food requirement during the upcoming years. Then they could deploy the additional
resources to development of tools, researches etc.

5. How will the current choice of position on the Production Possibilities Frontier influence
the future growth rate of the economy?

On a PPF, if a country choose a point that produces more tools than consumables, future
growth rate of the economy will expedite. But if the country choose a point that produces more
consumables than tools, future growth rate will be slower.
6. Explain why governments may be loathe to increase spending on education. Use a PPF
in your answer.

7. Use a PPF to explain why Canada is experiencing a higher growth rate than Ethiopia.

8. In the mythical country of Margaritaville, they produce only two products: cheeseburgers
and boat drinks. The following table indicates how much of each product each resident can
produce in a week. Draw and correctly label the PPF for Margaritaville.

Cheeseburgers Boat Drinks

Jimmy Buffett 30 5

Mac MacAnally 12 3

Roger Guth 4 2

John Mayer 40 8

Michael Utley 12 4

Robert Greenidge 1 1
 Cheeseburgers Boat Opportunity cost (1 Boat
Drinks drinks/cheeseburger)

Jimmy Buffett 30 5 1/6

Mac MacAnally 12 3 1/4

Roger Guth 4 2 1/2

John Mayer 40 8 1/5

Michael Utley 12 4 1/3

Robert 1 1 1
Greenidge

Total 99 23

Sort the table above by opportunity cost column

Cheeseburgers Boat Drinks

All works in Cheese burgers 99 (total) 0

Remove Robert Greenidge (from 98 (99 - Roberts 1 (0 +Robert

Cheeseburger to boat drinks) capacity 30) Greenidges capacity)

Roger Guth 94 (98 -Guths capacity 3 (1 + Guths capacity 2)

4)

Michael Utley 82 (ditto) 7 (ditto)

Mac MacAnally 70 (ditto) 10 (ditto)

John Mayer 30 (ditto) 18 (ditto)

Jimmy Buffett 0 (ditto) 23 (total)

Plot the above points into a graph:

Supply Demand

1. If the supply and demand for a particular good can be expressed as follows, what will the
amount of consumer and producer surpluses be at the equilibrium price?
Q = 1600 - 400P
d
Q = -200 + 500P
s

At equilibrium Qd = Qs or -200 + 500P = 1600 - 400P or 900P = 1800 or P* = 2; and Q* = 800

At price axis, demand curve cuts at Q = 0, or 0 = 1600 - 400P, or P = 4
At price axis, supply curve cuts at Q = 0, or 0 = -200 + 500P, or P = 0.4
From the diagram below: area of a triangle = 0.5 * Base * height
2 If there is a devastating typhoon in Sri Lanka, what will likely happen to the street price
of cocaine in Vancouver? Explain your answer.

After a devastating typhoon in Sri Lanka, tea price will increase worldwide and that will increase
the demand for coffee. Some South American countries will allocate their resources towards
producing of coffee instead of cocaine. That will cause increase in cocaine price in Vancouver
street.

3 Explain why demand curves are downward sloping.

For the following reasons demand curves are downward sloping:

1. Income effect
2. Substitution effect, and
3. Diminishing marginal utility

4. If there is a technological breakthrough in the production of an absolute necessity, will

this lead to a lower price and larger quantity produced? Explain.
Demand curve is vertical and the demand is inelastic. After technological breakthrough supply
will be increased. It will decrease the equilibrium price but quantity will not be increased at all.

5. List the variables that will cause the supply and demand curves to shift. (5 for each).

Non-price determinants of supply those will cause the supply curves to shift:
Technology, input prices (W), number of sellers, price of other goods, expectations (future price
and future input prices). (in short TINPE)

Non-price determinants of demand those will cause the demand curves to shift:
Tastes, preference & demographics, Income, Number of consumers, price of other goods, and
Expectations (future price and future income). (in short TINPE)

6. Wheat and oats are grown under similar conditions and are both used in breads and
cereals. What will happen to the quantity of oats grown if the price of wheat were to rise?

7. Explain the relationship between the shapes of the PPF and the supply curve.
8. Both sellers and buyers of gasoline expect that the price will increase tomorrow. What are
the likely effects on the equilibrium quantity and price today. Use a diagram in your answer.
Equilibrium quantity is uncertain, though the increase of price is certain.

9. A recent news report suggested that university enrollment was rising as a result of the
recession. Does this imply that education is an inferior good? Explain your answer.
The opportunity cost of going to college the job opportunities a person forgoes while in college
drops very dramatically during recessions. It is harder to find a job, to keep a job or to get a
promotion. Thus, some people who would not enroll do enroll. People who would drop out stay
enrolled. It does not imply that education is an inferior good.

10. Suppose that the market for ice cream cones can be expressed using the following
equations.
Q = 2100-300(P)
d
Q = -100+250(P)
s

What is the total expenditure by consumers on ice cream?

At equilibrium, Qs = Qd, or, -100+250P = 2100-300P, or, 550P = 2200, or P* = 4 and Q* = 900
Total expenditure by consumers on ice cream is P* x Q* = 4 x 900 = 3600

11. If the supply and demand for a particular good can be expressed as follows.
Q = 600 + 100Y - 400P
d
Q = -200 + 500P
s

Where Y stands for income. Determine the increased expenditure when income rises from 10 to
12.

When Y = 10, Qs = Qd, or, -200+500P = 600+100x10-400P, or, P* = 2 and Q* =800

Expenditure = PQ = 1600
When Y = 12, Qs = Qd, or, -200+500P = 600+100x12-400P, or, P* = 2.22, Q* = 911
Expenditure = PQ = 2.22 x 911 = 2022
Therefore, increase in expenditure (2022 - 1600) = 422

12. When studying comparative statics, there are eight possible outcomes. What are they?
From, class presentation of week 3:

Circular Flow

1. Draw and correctly label a circular flow model for an economy with a budget deficit, a trade
deficit, a capital account surplus and GDP > GNI.
A surplus in the capital account means money is flowing into the country, but unlike a surplus in
the current account, the inbound flows effectively represent borrowings or sales of assets rather
than payment for work.

Here, government takes money from financial market which indicates budget deficit
Foreign sector takes money from financial market which indicates trade deficit
Resource market takes money from foreign sector, which indicates capital account surplus (not
sure of it) again since, GDP > GNI, net factor payments to foreigners.
2. The circular flow model works on the premise that arrows in equal arrows out. Explain
why this is true for both the firms and the households.

(from class presentation)

3. Use a circular flow model to explain what Friedman and Schwartz believed led to the
depression of the 1930s.

(from class presentation)

4. Show how the Production Possibilities curve is related to the circular flow.
(from class presentation)

5. What happens to the rate of economic growth when the government runs a budget deficit in a
closed economy?

When the government runs a budget deficit in a closed economy, the government borrows
funds from financial institutions. Therefore, the firms do not get sufficient funds from the financial
institutes for investment.

6. What happens to the rate of economic growth when the government runs a budget deficit in
an open economy with free capital flows?
7. If there are free capital flows between nations, then all small countries should have the same
interest rate. Why dont they?

8. Use a circular flow model for an open economy to show how the exchange rate between two
countries is determined.

9. Why would the Canadian dollar likely rise against the US dollar if Stephen Poloz decided to
raise the target rate for overnight money?
Measuring the Economy

1. List the components of GDP for both the expenditure approach and the income
approach.
Expenditure Approach
Consumption
o Durable Goods (automobile)
o Semi Durable Goods (clothing)
o Nondurable Goods
o Services
Investment
o Fixed capital formation
o All new construction
o Change in inventories
o Non-military durable purchases by government
Government Expenditure
o Current Expenditure by all four levels of government
o Excludes transfer payments, non-military durables, interest on the public debt
Exports
 o Goods and services produced in Canada and sold to residents of another
country/Causes money to flow into Canada
Imports
o Goods and services produced in another country and sold to residents of Canada
o Causes money to flow out Canada
Income Approach
Wages, salaries and supplementary labour income
Interest and miscellaneous investment income
o Excluding interest on personal and government debt
Corporate profits before taxes
Accrued net income of farm operators
Net income on non-farm unincorporated business, including rent
Inventory valuation adjustment

2. The Consumer Price Index for September 2013 was 115.7 (2002=100). The same index
was 111.9 in September 2014. What was Canadas inflation rate for that period?
CPIseptember2014 - CPIseptember2013/CPIseptember2013 x100%=-3.28%

3. List 4 of the 5 different types of unemployment. What are their causes and their cures.
Seasonal unemployment: Unemployment that occurs at the same time every year (teachers)
Frictional Unemployment:
Causes New entrants to labour force, awaiting a definite start date,
temporarily between jobs
Solution Reduce search time and search costs
Structural Unemployment: Indicated by simultaneously high unemployment and a high help
wanted index. Caused by structural changes in the economy.
Policy Induced Unemployment: Price Controls, Disincentives
Natural Rate of Unemployment: Full employment rate of unemployment, non accelerating
inflation rate of unemployment (NAIRU) The level of unemployment that is consistent with an
economy operating at capacity = Frictional + Structural + Policy Induced
Cyclical/Demand Deficient Unemployment: Economic activity is insufficient to employ
everyone that is willing to work, caused by short run economic fluctuations.

4. What is the relationship between the GINI index and the Lorenz curve? What are they
used for?
The Line of Perfect Inequality. The GINI coefficient is the ratio of the area between the line of
perfect equality and the observed Lorenz curve to the area between the line of perfect equality
and the line of perfect inequality. The higher the coefficient, the more unequal the distribution is.
Gini index = a/(a+b)
Lorenz Curves -
The Lorenz curve is a graphical representation of income inequality or wealth inequality
developed by American economist Max Lorenz in 1905. The graph plots percentiles of
the population according to income or wealth on the horizontal axis. It plots cumulative
income or wealth on the vertical axis,

5. State and define the four elements of Consumption in national income accounting.

Personal consumption expenditure is what households buy (except houses). It is made

of durables (cars, appliances), semi-durables, nondurables (clothing, food) and services
(haircuts, doctor visits, airline tickets). A convention is made on nondurables to be all
items which last less than a year, including clothing.

6. Ford Canada builds a new F150 pickup truck in its Ontario plant. Explain how this may
be counted in national income accounting.

Increase of inventory of a durable goods. This is an investment activity (changes in

inventory). Households or firms might buy this for consumption or investment purpose.
7. Do the income approach and the expenditure approach to national income accounting
always equal each other? Explain your answer.
These two primary methods for measuring GDP should yield the same result even
though they measure completely different factors.
The income approach: measures the total incomes earned by households
in a nation in a year.
The expenditure approach: measures the total amount spent on the goods
produced by a country in a year.

By examining the circular flow model of a nations economy, we see every dollar earned
by a household in a nations resource market will ultimately be spent in the product
market, or leaked through taxes, savings, and import spending, leading to injections in
the form of government spending, investment and export sales.
econclassroom.com

8. Explain 4 reasons why GDP is not a good measure of national welfare

GDP does not give us any idea about the quantity of the goods produced
GDP does not measure per capita
GDP does not measure welfare - Lorenz curve, GINI ratio
Others - illegal activities, underground economy, leisure, pollution, product quality

Illegal activities - gambling, prostitution, drug trade

Unreported activities - underground economy
Nonmarket activities - do it yourself activities, leisure
Externalities - pollution, congestion
Product quality - technological improvements

9. Define the Labour Force.

All persons, age 15 and over, that are willing and able to work, excluding:
Residents of the Yukon, Northwest and Nunavut territories
Residents of Indian Reserves
Full-time members of the Canadian Armed Forces
Persons who are institutionalized

10. What is the difference between frictional and structural unemployment? Use an
example in your answer.
Frictional Unemployment
Causes
o New entrants to the labour force
o Awaiting a definite start date
o Temporarily between jobs
Solution
o Reduce search time and search costs
Structural Unemployment
Indicated by simultaneously high unemployment and a high help wanted index
Caused by structural changes in the economy
o Cure: Education and Training

11. Explain what is meant by efficiency wages and why they may lead to unemployment?
Efficiency Wages - Employers paying above equilibrium wages
Better paid workers eat more nutritious diets and are therefore healthier and more
productive
Reduces turnover costs - hiring is a costly process and new workers are less productive.
Increases the opportunity cost of shirking - reduces monitoring costs.
Higher wages attract better quality workers
As workers are being paid higher than equilibrium wages, the price equilibrium is
disturbed and the market doesnt clear resulting in unemployment=

12. Explain what is meant by the Natural Rate of Unemployment.

The level of unemployment that is consistent with an economy operating at capacity = Frictional
+ Structural + policy induced
13. What is the relationship between GDP and the unemployment rate?

Okun's law states that a one point increase in the cyclical unemployment rate is
associated with two percentage points of negative growth in real GDP. The relationship
varies depending on the country and time period under consideration.

14. What is the difference between cost-push and demand-pull inflation? How would we be
able to distinguish between the two?
Demand Pull
As if all product demand curves shift right at the same time
Originates in product markets
CPI rises first, followed by IPPI then RMPI
Associated with rising GDP
Cost Push Inflation
As if all product supply curves shift left at the same time
Originates in resource markets
RMPI rises first, followed by IPPI then CPI
Associate with falling GDP

15. State and explain 4 costs of inflation.

Inflation tax - government revenue from printing money
Shoeleather costs - cost of of converting money into real assets
Menu costs - cost of changing prices
Misallocation of resources due to relative price uncertainty
Arbitrary redistribution of wealth from creditors to debtors if inflation is unexpected
16. What is the Fisher Effect?
When inflation is expected, creditors will demand and debtors will pay an inflation
premium
 o (l + i) = (L = r)(I + pe)
If r and pe are relatively small, then (approx.)
o I: nominal interest rate
o R: real interest rate
o Pe: expected rate of inflation
Economic Growth and Aggregate Supply

1. Draw the Solow growth model for a catch-up economy.

Because developing markets have access to the technological know-how of the advanced
nations, they often experienced rapid rates of growth. However, although developing countries
can see faster economic growth than more economically advanced countries, the limitations
posed a lack of capital can greatly reduce a developing country's ability to catch-up. - from
Investopedia

In Figure above: k = K/L (Capital per capita) and y = Y/L (Income per capita)
(to understand this mode better, please see the video here:
https://www.tutor2u.net/economics/reference/economic-growth-neo-classical-growth-the-solow-
model)

2. Does the Solow growth model predict that the real GDP of an economy will eventually
stop growing? Explain your answer.

No. By changing the following things an economy can continue growing even it reaches steady-
state:
a. Population - when population increases, per capita capital (k) comes down from the
steady state, so saving becomes greater than depreciation
b. Technology - as technology increases, output (and thus savings) per capita increases
c. Savings rate, s - when the nation start saving more, savings curve goes up and the steady
state point moves right;

3. Use either the Production Possibilities Curve or the Solow growth model to explain how
an economy can grow over time.

4. Use the Solow Growth Model to explain the effects of an increase in the average
propensity to save.

When average propensity to save goes up, total investment goes up. Savings curve moves up and
steady state point goes rightward;

5 Show how a change in technology affects the steady state in the Solow model. Explain
the adjustment process.

Change in technology shifts the total output curve upward. Since, investment curve is a function
of total output curve, it moves upward, too. Thus the steady state point moves rightward.

6. Explain how the Aggregate Supply curve and the Production Possibilities Boundary are
related.

The PPF shows the combination of capital and consumer goods that can be produced within the
economy. The PPF shows what the economy can produce. If the economy is producing inside the
PPF, point X, it is in a recession. Unemployment is high and the economy is not producing at its
full productive capacity.
When the economy is producing on the PPF, point Y, it is producing at its full productive
capacity. It is also producing on the LRAS curve, point V on the supply/demand diagram. Real
national output is YFE and the price level is P1. Full employment of resources has been
achieved, which means that the labour force is fully employed. The only way to increase output
is by increasing investment in capital goods (which increases consumer goods) thereby
increasing LRAS.

If this happens, economic growth is occurring in the long run. LRAS1 moves rightward to
LRAS2 and thus SRAS1 shifts rightward to SRAS2. Real national output in the economy has
increased from YFE to YFE2.

(please see the video to understand the problem

https://www.tutor2u.net/economics/reference/aggregate-supply)

Aggregate Demand

1. Investment spending includes the production or purchase of capital goods. List the
variables that effect investment and indicate whether an increase in each variable causes
investment to rise or fall.
I = f (Technology +, L(labor) + , T(land) + , K(capital) -, P (expected price level) +, Y (expected
g
e e

income) +, w (expected wage) -, i(interest) -, d(delta, depreciation) +)

e

2. What are the determinants of desired consumption spending?

Income, Savings, Taxes

From slide
Disposable Income (Income, Taxes)
Wealth - households save to accumulate wealth (Real Assets, Financial Assets)
Expectations (about prices, income, taxes)
Interest rates (income effect, intertemporal substitution)
 Prices (as prices rise, real wealth falls, savings increases and consumption fall, Pigou
Wealth Effect)

3. Explain why the Keynesian consumption function may not be utility maximizing.
The Keynesian consumption function may not be utility maximizing because Suppose income
fluctuates the diminishing marginal utility, utility function increases at decreasing rate, keynesian
model suggests behaviour that is not utility maximizing, we assume consumer utility maximizer
however its not utility maximizer, keynesian model was a reaction to the depression, no basis in
microeconomics.

4. Show how an unexpected increase in income affects consumption differently in each of

the Modigliani and Friedman models.

5. What is the fundamental difference between the Keynesian, Life-Cycle and Permanent
Income models of consumption?

The difference between the three theories is the size of the marginal propensity to consume.
Keynes theory suggests that it is quite large, Modigliani suggests that the mpc is smaller and
Friedman suggests that the mpc may be negligible for transitory or temporary changes in income.
(from slide)

6. What would happen to desired investment spending if the rate of depreciation increased?
Explain.

I = f(tech, L, T, K, P , Y , w , i, d)
g
e e e

We know, I varies positively with d(delta, depreciation). So, if d increased, I will also increase.
g g

7. What are the major determinants of net exports?

Net exports is determined by:
National income (not disposable income), Y
Domestic prices, P
Foreign prices, P F

Exchange rate ($/C$)

Tariffs and other trade barriers

8. State and explain the three reasons that the Aggregate Demand curve is downward
sloping.

The aggregate demand curve slopes downward for the following reasons:
1. A lower price level decreases the rate of interest, which increases private investment and
consumption.
 2. A lower price level makes exports less expensive, thereby increasing net exports.
3. A lower price level increases the real wealth of households, thereby increasing household
consumption.

(other probable answer: Y = C + I + G + NX

G is affected by policy makers.
Other three remaining components of GDP consumption, investment and net exports are affected
by change of price level.

The Wealth Effect: when the price level falls, the real value of household wealth rises, and the
consumption goes up.

The Interest-Rate Effect: a lower price level will decrease the interest rate and increase
investment spending, thereby increasing the quantity of goods and services demanded.

The International-Trade Effect: a lower price level (in domestic market) causes net exports to
rise that increases the quantity of goods and services demanded.
)

9. With the use of an AS-AD diagram, illustrate the effect of a US recession on the
Canadian unemployment rate.

USA is Canadas trading partner. When USA went into recession, AD curve shifted towards left
(due to The International-Trade Effect). So, Canadian economy was working below full capacity
and there was excess supply of factor of production and unemployment rate was high. (This
leads to Canadas lower GDP and price level also).

MONEY AND BANKING

1. State and explain the three use of money.

Money is any good that is widely accepted in exchange of goods and services, as well as
payment of debts. Most people will confuse the definition of money with other things, like
income, wealth, and credit. Three functions of money are:

1. Medium of exchange: Money can be used for buying and selling goods and services. If there
were no money, goods would have to be exchanged through the process of barter (goods would
be traded for other goods in transactions arranged on the basis of mutual need). For example: If I
raise chickens and want to buy cows, I would have to find a person who is willing to sell his
cows for my chickens. Such arrangements are often difficult. But Money eliminates the need of
the double coincidence of wants.

2. Unit of account: Money is the common standard for measuring relative worth of goods and
service.
3. Store of value: Money is the most liquid asset (Liquidity measures how easily assets can be
spent to buy goods and services). Moneys value can be retained over time. It is a convenient
way to store wealth.

2. What are the 6 characteristics that a commodity must possess to function as money?

(learning objective 10.1, from Textbook)

(from class presentation) Top six qualities of an ideal money material are:
A. Easily standardized
B. Distinguishable
C. Generally accepted
D. Divisible
E. Durable
F. Portable

3. Use an example to clearly demonstrate that you understand the difference between
brassage and seigniorage.
Brassage - a charge made to an individual under a system of free coinage for the minting of any
gold or silver brought to the mint and usually calculated to cover various costs
Seigniorage - a government revenue from the manufacture of coins calculated as the difference
between the face value and the metal value of the coins

Canadian Royal Mint sells gold coins of which market price is CAD 1200.
To buy this RCM (Royal Canadian Mint) spend 8 X CAD 100.00 bill, that cost them CAD 0.25
X 8 = CAD 2.00 to make (the gap CAD 798 is called seigniorage); later they sell it for CAD
1200.00, this profit from selling is CAD 400.00. This is called brassage.

4. Use an example to illustrate Greshams Law.

Gresham's law is a monetary principle stating that "bad money drives out good". For example, if
there are two forms of commodity money in circulation, which are accepted by law as having
similar face value, the more valuable commodity will disappear from circulation.

5. Derive the transaction demand for money from the Quantity Theory of Money.

6. How does the Cambridge Approach differ from the Quantity Theory of Money? Which
predicts the more elastic demand for money?

file:///C:/Users/User/Downloads/9783540710028-c1.pdf

7. What is a liquidity trap?

8. What are the major functions of the Bank of Canada?

9. Show how a $100 increase in the monetary base affects the money supply if the target
reserve ratio is 10%.

10. Explain the shape of the money supply curve in Canada, and why it is that way.

EXCHANGE RATES

1. Show the relationship between the circular flow and the determination of the exchange
rate.
(from note Circular flow of Money, we get these 2 diagrams)
2. Indicate the variables that influence the exchange rate and state in which direction they
change the exchange rate.

Inflation: Decrease
Interest: Increase
Government Debt: Decrease
Terms of Trade: Increase if Export price rises at greater rate than import
Stability: Increase
Recession: Decrease

3. Show that you understand the Interest Rate Parity Theorem.

Interest rate parity is a theory in which the interest rate differential between two countries is
equal to the differential between the forward exchange rate and the spot exchange rate. Interest
rate parity plays an essential role in foreign exchange markets, connecting interest rates, spot
exchange rates and foreign exchange rates.

4. Show that you understand the Purchasing Power Parity Theorem.

(from textbook)

5. Explain what happens to a fixed exchange rate when a country runs out of foreign
reserves.

FISCAL AND MONETARY POLICY

1. Use a circular flow diagram to illustrate the multiplier effect as it pertains to fiscal policy.

(draw a circular diagram first)

2. In theory, why does a $100 million increase in government spending have a greater
stimulative effect than a $100 million tax cut?

From textbook 12.4 learning objectives

Because as the $100 million moves through the circular flow, the total is divided up into savings,
consumption and taxes. As it moves it ends up being more than original, multiplier effect works
better in closed economy than open. The higher the tax rate, the lower the multiplier effect. Part
of tax cut goes into saving whereas government spending goes around.

3. Use an AS-AD model to show the effect of expansionary fiscal policy.

(from textbook)
4. Show how an increase in the governments budget deficit may crowd out private
spending.

(https://www.slideshare.net/kmadeiras/loanable-funds)
5. Why would have Keynes suggested to President Roosevelt that he fund the construction
of pyramids in the US during the depression?

Keynes suggested building pyramids and burying bank notes in deep mine shafts that had been
filled in. As people tried to dig up the money, they would be forced to employ labor and
purchase equipment that would raise spending and thereby growth.
(https://www.forbes.com/2008/12/04/depression-deflation-velocity-oped-
cx_bb_1205bartlett.html#588f717461b9)

During the Great Depression, economist John Maynard Keynes recommended increasing federal
government spending, financed by borrowing, to boost the U.S. economy. It didnt matter how
the new money was spent. If no better use could be found, Keynes suggested building pyramids.
(http://www.independent.org/newsroom/article.asp?id=2863) (this one is more correct)

6. List all the conditions in the Keynesian monetary transmission that must be true for
monetary policy to be effective.

Who cares (till we live in Canada) :)

7. How does a change in the Bank of Canadas target overnight rate influence the Aggregate
Demand Curve?
(learning objective 11.3)

8. Does monetary policy work better with flexible or fixed exchange rates. Explain your
answer.

Some countries simply allow the exchange rate to be determined by demand and supply, just as other
prices are. This is called to have a floating currency. Some countries attempt to keep the exchange rate
between their currency and another currency constant. Currently, many countries, including Canada and
the US, allow their currencies to float most of the time, although they occasionally intervene to buy and
sell their currency or other currencies to affect exchange rates. As a result, the current exchange rate
system is a managed float exchange rate system. (from textbook Learning objective 15.1)
9. List and explain 4 lags the exist when using fiscal policy.
recognition lag, decision lag, implementation lag and take-effect lag.

When it comes to fiscal and monetary policy, timing is very important.

Recognition Lag
Recognition lag is the amount of time it takes for fiscal or monetary authorities to recognize a problem in
the economy. This type of lag occurs primarily because it takes time for the economy to be tracked and
for economic reports to be published.

Decision Lag
Once government leaders identify an economic problem such as recession, the legislature must agree on
a course of action. This often requires a law to be written, passed, and signed by the head of the
executives.

Implementation Lag
Since the federal government is such a large organization, it may take weeks or months for the
appropriate agencies to be contacted and for decisions to be carried out after fiscal policy actions have
been decided on.

Effectiveness Lag
Effectiveness lag is the amount of time it takes for a fiscal or monetary policy's effects to produce the
desired result. Even after a policy is implemented, it still takes time for it to work.