BACKGROUND AND MICRO ISSUES
1. How do economists measure the value of anything?
• Supply and Demand and market price determines this
2. What determines the price and quantity of any good or service? Graph
• Market/ price elasticity
3. What is opportunity cost and why is there no free lunch?
• What you give up for something else. Not possible to get something for nothing.
4. What does the invisible hand mean, and why does it suggest laissez-faire?
• Free market capitalism is efficient
• Self-interest and competition in the market system leads to the optimal outcome
5. What are the three questions answered by any economic system and how are they
answered under a market-based system
• What to produce
• How to produce it
• Who gets it
6. What is the difference between capitalism, socialism, communism
• Capitalism: an economic system where most property is privately owned. Private markets are the primary
vehicles used to allocate resources and generate incomes
• Socialism: Theory that all the means of production should be owned by the community
• Communism: State owns and controls the means of production
7. What is the definition of Microeconomics? Macroeconomics? Economics?
• Macro: study of the behavior of the economy as a whole
• Micro: studies individual prices, quantities and markets
CIRCULAR FLOW,NATIONAL INCOME ACCOUNTING AND OTHER
1. 2 Important points of the Circular flow model
• GDP can be measured as either a flow of final products or as a flow of earnings or incomes
• Leakages (saving, tax, imports) and Injections (investment, exports)
2. What are 4-5 key points in the definition of GDP (i.e., define GDP carefully)?
• C+I+G+nx= GDP
• Government spending
• Net exports
3. 3 Ways to calculate GDP (Value Added is one)
• Value added: difference between the value of goods produced and the cost of materials and supplies used in
• a flow of final products
• a flow of earnings or incomes
4. What is the relation between Gross and Net Investment and Depreciation
• Gross investment is everything that remains of total expenditure after consumption government spending and net
exports are subtracted. Net investment subtracts depreciation from gross investment. Depreciation: decline in the
value of an asset
5. Definition of Real and Nominal GDP
• real: quantity of goods and services produced in a nation during a year. Corrects nominal gdp for inflation
• nominal: the value, at current market prices, of the total final output produced inside a country during a given year 6. How do you calculate real gdp from nominal? Formula
• real GDP= nominal gdp / gdp price index
7. What is meant by deflating nominal gdp?
• Factoring out inflation
8. How do we measure/calculate Unemployment, Labor Force, Employment
• Unemployed/ labor force x100= unemployment
• Labor force= employed + unemployed
• Employment= employment/ civilian non-institutionalized population
9. What are Discouraged Workers and Hidden Unemployment
• Discouraged worker= aren’t looking for jobs.
• Hidden unemployment= Hidden, or covered, unemployment is the unemployment of potential workers that is not
reflected in official unemployment statistics, due to the way the statistics are collected
10. What is the CPI? What is it used for?
• Consumer price index : the measure of the average price paid by urban consumers for a market basket of
consumer goods and services
11. How is the CPI calculated, very roughly (in a sentence)?
• Weighing each price according to the economic importance of the commodity in question
12. What are shortcomings of the CPI?
• Doesn’t factor in inflation
13. What is the GDP deflator?
• The difference between nominal gdp and real gdp; price of gdp
14. What is meant by chained ($2005) GDP?
• They factor in inflation from year to year to be more realistic; the nominal dollars have been adjusted to the value
of the dollar in 2005 so u can make comparisons on a real basis
15. What is meant by seasonally adjusted data?
16. What are some shortcomings of GDP as measure of economic activity and well-being?
• Nonmarket transactions; are not included
• Black market exists
• Doesn’t take the affects of the environment into consideration
1. What is the economic role of the financial system – what useful purpose does is serve for the overall economy?
• it makes saving and investment easier to do and more effective, which causes faster economic growth
2. What are Stocks?
• Share of the ownership of a company
3. What is the major reason people buy stock?
• Capital gains
• To get a return on their investment; historically stocks do well against inflation and they increase in value
4. What is leverage, liquidity, buying on margin, selling short?
• Selling short: u buy a stock in hopes the price goes down
• Leverage: when a company borrows money to invest; they can make more money this way
• Liquidity: how easily something is converted to money
• Buy on margin: borrowing to buy additional shares, leverage
5. What are the roles of dividends and the risk-adjusted discount rate in determining the
fundamental price of a stock (Stock Price=Dividends/(risk adjusted discount rate dividend growth rate)?
6. What is a speculative bubble?
• A spike in asset values within a particular industry, commodity, or asset class; rapid asset price increase or
7. How do stocks compare to bonds?
• Stocks are equity. Bonds are debt. Bonds offer an interest rate. Stocks are unpredictable.
8. How and why should you invest in stocks?
• In order to avoid inflation. Call a broker.
9. What is the advantage of diversification?
• By putting funds in a number of different investments, you can continue to average a high yield while reducing
10. What is the efficient markets hypothesis, and how does it relate to random walks?
• Efficient market hypothesis: market prices contain all available information. It is not possible to make profits by
acting on old information or at patterns of past price changes. Random walks: movements over time are
• In an efficient market, all predictable things have already been built into the prices; efficient market theory
explains why stock prices look so erratic. Stock prices move in response to erratic events so prices do also.
11. What are Bonds? Bond Ratings, Junk Bonds, Treasury Bonds, Corporate Bonds,
• Bond: certificate of indebtedness
• Bond ratings: A grade given to bonds that indicates their credit quality
• Junk Bonds: high yield high risk bonds
• Treasury Bond: A government bond issued by the US Treasury
• Corporate Bond: a bond issued by a corporation; carries no claim to ownership and pays no dividends but
payments to bondholders have priority over payments to stockholders
• Municipal Bond: A security issued by or on behalf of a local authority.
12. What are Mutual Funds?
• Money market mutual funds: Interest earning checking account
• A mutual fund is a professionally managed type of collective investment scheme that pools money from many
investors and invests it in stocks, bonds, short-term money market instruments, and/or other securities
13. What is a hedge fund? An ETF?
• Hedge fund:
o Loosely regulated mutual fund
o A hedge fund is an investment fund open to a limited range of investors that undertakes a wider range of
investment and trading activities than long-only investment funds, and that, in general, pays a
performance fee to its investment manager in hopes of a large capital gain
• ETF: (exchange traded fund) A security that tracks an index, a commodity or a basket of assets like an index fund,
but trades like a stock on an exchange. ETFs experience price changes throughout the day as they are bought and
14. What is a stock index mutual fund?
• Mutual fund that buys stock
15. What is a 401k? What should be in it?
• A qualified plan established by employers to which eligible employees may make salary deferral (salary
reduction) contributions on a post-tax and/or pretax basis
16. What are derivatives?
• A security: (instrument representing ownership) whose price is dependent upon or derived from one or more
underlying assets. The derivative itself is merely a contract between two or more parties • Use them because of arbitrage: (The simultaneous purchase and sale of an asset in order to profit from a
difference in the price)
• Use in: futures contracts and option contracts
17. What’s an option? A futures contract? A call option?
• Option: A financial derivative that represents a contract sold by one party (option writer) to another party (option
• Futures contract: agreement to buy or sell a particular commodity or financial instrument at a pre-
determined price in the future
• Call option: An agreement that gives an investor the right (but not the obligation) to buy a stock, bond,
commodity, or other instrument at a specified price within a specific time period.
18. What’s an IPO? (initial public offering)
• The first sale of stock by a private company to the public. IPOs are often issued by smaller, younger companies
seeking the capital to expand, but can also be done by large privately owned companies looking to become
19. What are primary and secondary financial markets?
• Primary: The primary market is that part of the capital markets that deals with the issuance of new securities.
Companies, governments or public sector institutions can obtain funding through the sale of a new stock or bond
issue.; securities are sold for the first time
• Secondary: The secondary market, also known as the aftermarket, is the financial market where previously issued
securities and financial instruments such as stock, bonds, options, and futures are bought and sold
20. What are financial intermediaries?
• Institutions which provide financial services and products/ includes banks and mutual funds.
MONEY AND THE FED
1. What is Money? Wealth? Income? How are they different?
• Money: anything that serves as a commonly accepted medium of exchange; means of payment or medium of
• Wealth: the net value of tangible and financial items owned by a nation or person at a point in time. Equals assets
• Income: the flow of wages, interest payments, dividends, and other receipts accruing to an individual or nation
during a time period
2. Define M1, M2
• M1: coins, paper currency (fiat money), and demand or checking deposits (transactions money)
• (not important) M2: M1 + savings accounts & money market accounts; M2 is a refinement of M1.
3. What are the three functions of money?
• Medium of exchange: make transaction process easier
• Standard Unit of Account: Money is used as a numeric to determine the value of goods and services
• Store of value: value refers to the power that's able to satisfy the consumers by buying goods and services
4. Why are the advantages of an economy using money rather than barter?
• It is a slightly less liquid using money rather than barter
5. What is barter and what are the shortcomings of barter?
• Barter: exchange of goods for other goods
• Rare to find someone with a common interest to trade with
6. What is the Fed? Describe its structure. Why does the Fed have the structure it does (12
• 12 member banks, Board of Governors – 7 members, 14 year, non-renewable terms, one is appointed by President
with consent of Senate for 4 year term as chair.
• FOMC central policy group – 7 BOG members, 5 Bank Presidents, rotating (NY Fed always on FOMC) • Why? Independent Central Banks conduct better policies – less inflation/ same unemployment
o Without independence, tendency to overexpand Ms -> inflation
7. What are the goals, tools/instruments, targets of the Fed?
• Target: Federal Funds Rate
• Goals: see 11
o Open-market Operations: buying or selling US government securities in the open market to influence
level of bank reserves
o Reserve Requirements policy: setting and changing the legal reserve-ratio requirements on deposits with
banks and other financial institutions
o Discount window lending: setting the interest rate, discount rate, and the collateral requirements with
which commercial banks, other depository institutions, and primary dealers can borrow from the Fed
o Lender of last resort
8. Using T-Accounts, explain how a Fed open market purchase increases the money supply
9. What is the operating target of the Fed?
• Federal Funds rate
10. What is the primary ‘traditional’ policy tool of the Fed?
• Open Market Operations (omos)
11. What are the ultimate goals of the Fed?
• Low unemployment
• Stable prices
• High and sustained growth
12. What is the Taylor Rule?
• The Fed should adjust the Federal funds rate when we have an inflation gap and an output gap
13. What is inflation targeting?
• policy in which central bank "target" an inflation rate and use the monetary tools such as open market operations
etc to achieve that goal. Used in Uk, Canada, and Australia
14. Is the Fed Independent? Why? How?
(more on the Fed below)
SHORT RUN KEYNESIAN MODEL (all of the following refers to the Keynesian model and
the short-run only)
1. What determines aggregate prices and output? Graph
• Aggregate supply and demand
2. What determines interest rates? Graph
• Md&Ms = demand and supply of bank reserves determined by the Fed
3. What are the components of aggregate demand?
• Agg D=C+I+G+X-M, if Agg D too low (because C and/or I too low) then Gov’t can raise G to raise agg D
4. Why is the aggregate demand curve downward sloping?
• There are some elements of income or wealth that do not rise when the price level rises
• Interest rate effect, real balance effect, foreign purchases effect
5. What are the determinants of Consumption? Saving? Investment? Government Expenditures? Exports? Imports?
• Consumption: Y (total expenditures) – taxes, wealth, Disposable income, wealth, consumer sentiment (animal
• Saving: Y (total expenditures) – taxes , wealth
• Investment: interest rates, expectation (animal spirits)s
• Government expenditures: government spending needs such as fiscal policy
• Exports: foreign income • Imports: us income
6. What are the condition(s) for equilibrium?
• aggregate D = Agg S=y
• unintended inventories=0
• planned=actual investment
• desired leakages=desired investment (without G,T,NX) -> I=S (or I=S+(T-G)+(M-X)
• Agg D = y
7. What is the role of inventories?
8. What factors shift the aggregate demand curve? The aggregate supply curve?
• Exogenous changes in C+I+G+X-M, monetary and fiscal policy
9. How does the stock market affect the economy?
• Consumption in an economy tends to increase if consumers feel that their wealth has increased, even if their
disposable income remains unchanged. Wealth up, consumption increases, D, Y does too
10. What are the ‘types’ of unemployment?
• Structural: changes is the economy eliminate some jobs and create others for which the unemployed are
unqualified; mismatch of jobs and services
• Frictional: qualified individuals with transferable skills who change jobs ; people looking and switching jobs
• Cyclical unemployment: contractions in the economy result from low levels of aggregate demand in context of
sticky wages and prices
• Discouraged workers: a person who has given up looking for a job
• Hidden unemployment: not included in the count such as those in the military
11. What is inflation and what causes it in the short-run?
• Increase in price level
• Demand and/or Supply shifts/shock – demand pull/cost push
• Demand pull inflation caused by increases (shifts or shocks) in aggregate demand which increases prices AND