Questions about course content for Econ 102, Section 100, Winter 2006:

Aor 28

> I understand that consumption is a component of AD, however so is
> investment.  Therefore, wouldn't the movement of the AD depend on whether
> the multiplier effect or crowding effect are more dominant.  Furthermore,
> I still find it confusing that Mankiw would specifically point out that
> 2/3 of declines in GDP would be a result of a decline in investment
> (chapter 15) if investment were not the more dominant of the two
> components.  Though I understand that consumption is a large component of
> GDP, it's ability to move the AD curve to the right appears contingent on
> many variables and conditions that unless specified would not rule out
> the possibility that a tax cut could move the AD curve to the left.  

The crowding-out effect only operates at all to the extent the GDP goes up, 
since this is what raises demand for money, lowers the interest rate, and 
cuts investment.  Thus it cannot cause aggregate demand for fall, since if 
it did it wouldn't have happened in the first place.

There is nothing wrong with Mankiw pointing out that most declines of GDP 
result from declines of investment, and if a decline of investment had been 
one of the options here, it would have been correct.  But the only decline 
of investment that would occur in this case would happen as I just said, 
only if income went up, not down, and that's not what the figure shows.

Finally, now that I have the textbook with me, I can point you to the 
textbook, starting the last line on page 361.  You apparently didn't 
understand WHY this was true, but you shouldn't have trouble knowing THAT 
it was true.

Apr 27

> I was looking over the solution to the final problem and I don't
> understand why a fall in taxes would not cause AD to shift down.  Early
> on in the semester we showed that a fall in taxes would cause an overall
> fall in National Savings
> 
> NS = MPS(Y - T) + (T-G)  <-- Larger fall than gain in Savings
> 
>     therefore: If National Savings falls than Investment should fall
> 
>     furthermore: According to Mankiw "Declines in investment account for
> about two-thirds of the declines in GDP"

You are using the long-run model to draw conclusions for the short-run model.  
Although I don't have the textbook with me right now, I'm sure you will find 
in it the case of a tax cut, which shifts the AD curve to the right, not the 
left.  The reason is that the tax cut increases disposable income and thus 
consumption, which is a component of aggregate demand.

Apr 27

> -- For question 4, shouldn't productivity rise by more than 10% because
> technology increases as well? Would it not rise by exactly 10% if
> technology was constant but all the other factors of production increased
> by 10%?

No, if technology were constant and all other factors, including labor, 
were increased by 10%, then productivity would not change at all.  That is, 
Y would rise by 10%, but L would also rise by 10%, so that Y/L would be 
constant.

> -- For question 6, a decrease in government expenditure would increase
> SLF and a simultaneous decrese in the amount of taxes (by the same
> amount) would decrease SLF by exactly the same amount. Thus, shouldn't
> national saving and investment remain the same?

You're right that government saving does not change here, but private saving 
does, since the private sector gets higher disposable income due to the tax 
cut.

> -- For question 28, I think (I dont have the text with me right now)
> Mankiw stated that if people become optimistic about the future, they
> will increase investment. Moreover, as the government increases payments,
> G should rise too. Thus, I felt that I and G rises.

Social security payments go to households, not firms, so investment is not 
affected.  And G is government purchases of goods and services, not transfer 
payments.

> -- For question 29, why isn't (b) the right answer? A decrease in tax
> revenue by $20 million would decrese G by $20 million.

Again, G is government purchases.  It is a policy variable and not linked to 
tax collections.  (If it were somehow constrained by tax collections, then 
we wouldn't ever have a government budget deficit.)

> -- For question 33, my reasoning is as follows: If out put were not to
> change, the total output for the four years would be 20 million. However,
> now, as the output is 100,000 less every year, the output after 4 years
> would be 19,600,000. Thus, you are sacrifising (400,000/20,000,000)*100
> which is 2%. And the inflation also reduces by 2%, thus the ratio is 1.

No.  If cutting output by 2% for just one year was enough to reduce inflation 
by 2 percentage points, then the sacrifice ratio would be one.  But here were 
are giving up that output for four years, so the sacrifice is four times as 
large and the ratio is 4.

> -- For question 35, I thought the answer should be (e). The artice says,
> "Some consumer skepticism is inherent in the way a price index is
> calculated. It is an average -- and no one is average. It measures the
> change in prices in a basket of goods and services that matches no one
> person's shopping list: Medical care accounts for 4.8% of the CPI..."
> This shows that the CPI is based on an economic model.

No, saying that it is an average doesn't make it a model, and it certainly 
doesn't make it not a measurement of actual prices.  The CPI is an average 
of actual prices that the BLS goes to great lengths to measure.

> -- For short answer question 2, part (e), can an alternative suggestion
> be: I would recommend that the central bank lower the interest rates.
> This would discourage savings (as the returns are lower) and promote
> investment, leading to a rightward shift of the AD curve, back to AD1?

Yes, probably, if you say it clearly enough.  The Fed doesn't actually itself 
directly control "interest rates," but only the discount rate that it charges 
commercial banks.  (Recall the tools of monetary policy.)  But I guess that's 
close enough.

Apr 27

> In the textbook, it says that a trade deficit isn't nessecarily a bad
> thing as long as the country in debt is willing to pay its loans off.
> However, the last wsj article you assigned us to read seems to
> characterize trade deficit as a bad thing. What is the truth?

Well, first, most press coverage will always say that a trade deficit is 
a bad thing, even though economists won't agree with that.  As we 
discussed earlier in the course, there are lots of misunderstandings of 
the trade balance that are very common.  So the textbook is certainly 
right that a trade deficit is not necessarily a bad thing.

On the other hand, I wouldn't say that all that matters is whether the 
country "is willing to pay its loans off."  Perhaps from just the 
country's own point of view, if it is willing and likely to pay off its 
loans, then I might not want to second guess its choice to borrow 
against the incomes of its own future generations.  But then again, I 
might.  In the U.S., I certainly don't think we are behaving responsibly 
towards our descendents by going ever further into debt. 

Also, there is the question of whether our deficit is good for the world.  
For the richest country in the world to borrow from others, including 
some of the poorest, to finance our excessive consumption, strikes me 
as just wrong.

But none of that says that a trade deficit is bad in all circumstances.  
On the contrary, a developing country that has productive investments to 
be made in its own future absolutely should run a trade deficit, financed 
if necessary by borrowing, and pay off the loans out of its future 
increased productivity.

Apr 26

> Can you explain to me number 1 on the Winter 2003 exam? There is a graph
> that shows a shift in the MD curve up, and asks " All of the following
> are valid causes of the events depicted in the diagram and model below,
> EXCEPT."
> 
> a. an increase in the price level, P.
> b. a decrease in the velocity of moeny (v).
> c. an increase in the natural rate of output (Yn).
> d. an increase inthe desire of individuals to hold money rater than bonds.
> e. none of the above. they are all valid explanations.
> 
> 
> The answer is A, but I thought an increase in price level WOULD increase
> the demand for money, since goods are now more expensive. I also don't
> see how B, the decrease in the velocity of money, is a valid cause for
> the shift in money demand. Have I completely misunderstood the question?

Yes, I think you have.  You didn't look at the axes in the diagram.  The 
vertical axis has 1/P, so this is the long-run money market (or quantity 
theory of money) that we studied earlier in the term.  You are right that a 
rise in P increases demand for money, but this would appear in this diagram 
as a movement along a given demand curve (since price is on the axis), not 
as a shift of the curve.  And incidentally, what is shown here is a rise in 
1/P and thus a fall in P, not a rise in P.

As for answer B, recall that this version of the money market is obtained 
from the quantity equation, MV=PY, by rewriting it as M=PY/V, where the 
left side is supply of money and the right side is the demand for money 
that is in the graph.  As you see, a decrease in V increases this demand.

> Also, number 22 on the same exam (2003).
> 
> Consider the AD/AS model, starting at a long-run equilibrium. Suppose
> that there is an increase in the money supply. When the economy reaches a
> new long run equilibrium, the change in I will be ______ and the change
> in NX will be ______.
> 
> a. negative; negative
> b. positive; positive
> c. negative; positive
> d. positive; positive
> e. none of the above alternatives is correct.
> 
> The answer is e.) none of the above. I am just wondering what the changes
> in I and NX WOULD be.

The answer we were looking for was that both would be zero, just as in the 
long-run model in the first part of the course.  The rise in money supply 
leads to a rise in price level that maintains money-market equilibrium at 
the same interest rate as before.  That is, the interest rate falls in the 
short run but then rises back up as we move up along the AD curve to the 
long-run equilibrium.  With the same interest rate, we have the same level 
of investment, NFI, and thus NX.

Apr 26

> 1) On the open market economy model, she said that anytime the Demand for
> loanable funds curve shifts (which depends on I and NFI) then the NFI
> curve on the second graph will shift also. This confused a lot of people
> in the review session and I think i learned differently. I thought that a
> change in investment would change only the DLF curve while a change in
> NFI would change both curves. Does a change in investment change both
> curves or just the DLF?

No, if she said that she was incorrect.  As you thought, while a shift of 
NFI shifts both curves, a shift of I does not.

> 2) With the AS/AD model after a shock which changes the cost of
> productoin, for example a change in the price of oil, the SRAS curve will
> shift accordingly. My question is, when going back to equilibrium, will
> the SRAS curve shift back to the original position, or will the AD curve
> shift accordingly to move the intersection back to Y0. I learned, and it
> says in the homework, that the SRAS curve shifts to move the market back
> to equilibrium always but she said in the review session that and
> increase/decrease in the price level caused a increase/decrease in wage
> to workers which caused a shift in the AD curve.

No, the AD curve does not shift.  The SRAS curve shifts back to where it was.

Apr 26

> I was looking over the material and I know that when Money Supply is
> increased it in turn decreases the Interest Rate, Investment increases,
> GDP increases, and and Price Level increases.  I also know that when
> there is an increase in the Price Level, Money Demanded increases.  So
> when there's an increase in Money Supply is there an increase in Money
> Demanded as a result of that? And if there is, does it offset the initial
> decrease in the Interest Rate?

Yes, but only partially in the short run.  In the long run, when the price 
level rises further, the offset is complete and the interest rate and 
investment both go back to where they were before, with GDP back at YN.

Apr 26

> and about 'alternative mininum tax' the tax is aiming for helping for
> middle class or burdening for middle class?
> 
> For me, the tax seemed like tax cut, but it give a lot of burden in
> middle class.
> 
> so i'm confusing that
> 
> what is about alternative mininum tax?

It is not actually intended to affect the middle class at all, but it 
turns out that, as incomes rise due to inflation, it is beginning to 
affect the middle class.  The purpose of the AMT was to raise taxes on 
high income people by blocking various methods they were using to avoid 
paying tax.  But as (nominal) incomes have risen, more and more of the 
"middle class" has moved to levels at which the AMT takes effect for 
them, raising their taxes.

Apr 25

> I noticed a discrepency between the book and the lecture notes.  The
> equation for SRAS is y=yn+a(P-Pe).  This makes sense with what the book
> says, that when expected price level decreases then SRAS shifts to the
> right.  But in the lecture notes it says that when there is an increase
> in firms costs, SRAS shifts to the left and expected price level is lower
> than the actual price level. But if this were true then according to the
> equation for SRAS, y would be greater than yn, which is not the case when
> SRAS shifts left.  My GSI also seemed to think that when expected is
> below actual, SRAS shifts left.  I was wondering if you could clear up
> the discrepency between the book and the lecture notes/my GSI's thoughts.

I don't agree with the sentence that you attribute to the lecture notes:  
"that when there is an increase in firms costs, SRAS shifts to the left and 
expected price level is lower than the actual price level."  I would say 
that "lower" should be "higher."  Either I mis-spoke in class or you 
recorded it incorrectly.

Apr 25

> I have the following doubts on the Winter 2004 paper:
> 
> 
> -- Question 15
> 
> While digging through the pockets of an old pair of jeans, you discover a
> $20
> bill. Since you happen to be walking by an ATM machine, you decide to
> deposit it into your checking account. With fractional reserve banking,
> where
> the reserve ratio is 3%, your original $20 deposit eventually increases
> loans by
> ______ and the money supply by _______.
> a. $667, $667
> b. $667, $647
> c. $647, $647
> d. $19.40, $19.40
> e. $19.40, ?$0.60
> 
> Doubt: The correct choice is (c). I think I got it. Just wanted to know
> that were we asked for the "money supply" rather than "increase in money
> supply," would it be $667?

You have no way of knowing what the total money supply is.  The only thing 
you can answer here is the change in the money supply, which includes both 
the eventual increase in bank deposits and the decrease in currency in 
circulation.

> -- Question 20
> 
> If Congress passed a tax increase at the request of the president to
> reduce the
> budget deficit, but the Fed held the money supply constant, then the two
> policies together would generally lead in the short run to ______ income
> and a
> ______ interest rate.
> a. lower; lower
> b. lower; higher
> c. higher; no change
> d. no change in; lower
> e. no change in; higher
> 
> Doubt: The correct choice is (a). I felt that it should be (b) because
> the supply of money is constant but demand for money will increase as
> people will need more money to maintain their same standard of living,
> resulting in a higher interest rate.

No, demand for money has nothing to do with maintaining a standard of living.  
Standard of living is determined by the real output of the economy and can't 
be increased by just holding more money.  Demand for money refers to the 
portion of people's wealth that they choose to hold as money, rather than in 
other forms.  There is nothing in this question to change that.

> -- Question 30
> 
> Suppose you expect the Fed to increase the money supply to a new higher
> level. Which of the following would it be better for you to do before,
> rather than after, the change in the money supply?
> a. Consolidate your student loans.
> b. Take out a mortgage.
> c. Sell stocks.
> d. Buy a car on credit.
> e. Buy bonds.
> 
> Doubt: The correct choice is (e). Why not (b) as you are buying on credit
> when the prices are lower, before rise in inflation?

I had a similar question from a student a few minutes ago, about a similar 
question from another exam.  You are right that as a borrower you would 
benefit from the rise in price.  However, since the full rise in price happens 
only in the long run, you might as well wait until after interest rates have 
fallen (which they will, here, due to the increase in money supply) to take out 
the mortgage at a lower rate.  You'll still benefit from the rise in the price 
level later on.  On the other hand, by buying bonds, you benefit immediately 
from the policy change, since the prices of bonds rise (hence capital gains) 
when the interest rate falls.

Apr 25

> I have the following doubts in the Winter 2003 exam:
> 
> 
> -- Question 20
> 
> Money velocity in New Caledonia is constant. The money supply grows at 10%
> annually, the population grows at 2% every year, and the inflation rate
> is always 3%. The growth rate of nominal GDP per capita is ______ %, and
> the growth rate of real GDP per capita is _____ %.
> a) 5; 5
> b) 8; 5
> c) 8; 7
> d) 10; 7
> e) 10;5
> 
> Doubt: (1)Why is the correct answer 8;5? How do I go about calculating
> it? (2)When it says that "the inflation rate is always 3%," does it imply
> that the change in the rate of inflation is 0% or 3%?

The money supply is growing at 10%, so with constant velocity nominal GDP must 
also be growing at 10%.  Inflation is 3%, so real GDP must be growing at 
10-3=7%.  With population growing at 2%, each of these will be growing in per 
capita terms by two percentage points less, or 8% and 5%.  As for your second 
question, I don't know what change you are asking about.  The rate of  
inflation is not changing here.

> -- Question 27
> 
> Suppose that you find the coolest summer job around: substituting for Alan
> Greenspan at the Fed! Judging from your friends’ recent job market
> experiences, you are a bit worried about finding a job once you graduate
> from the University of Michigan. How can you use your summer job most
> effectively to improve your
> chances of finding a job in the next couple of years?
> a) Vote to increase government spending.
> b) Convince foreigners to increase their foreign direct investment in the
> U.S.
> c) Print lots of money and keep it in the vault at the Fed.
> d) Talk to your relatives and friends to convince them to hold more cash.
> e) Buy bonds through open market operations.
> 
> Doubt: The correct choice is (e) but how will buying bonds help to find a
> job in the future?

When the Fed buys bonds, that expands the money supply, shifting AD to the 
right, expanding Y, and thus expanding employment.

> -- Question 36
> 
> “Disinflation” is caused by
> a) expanding the money supply less rapidly than money demand.
> b) falling prices.
> c) a rate of unemployment that is higher than the natural rate of
> unemployment.
> d) a real rate of interest that is higher than the nominal rate of
> interest.
> e) taxation of dividends.
> 
> Doubt: The correct choice is (c). Can it be (b) also?

No.  Falling prices is "deflation".  "Disinflation" means a reduction in the 
rate of inflation.

> -- Question 37
> 
> Which of the following is greater in the long run than in the short run?
> a) The effect of an increase in government purchases on GDP.
> b) The effect of a tax cut on unemployment.
> c) The effect of an open market purchase of bonds on the price level.
> d) The effect of an increase in the preferences to holding money on
> investment.
> e) The effect of an increased preference for imports on the trade deficit.
> 
> Doubt: The correct choice is (c). Why? I felt that (d) would be a
> reasonable choice as an increase in investment would have a greater
> impact in the future (long run) than immediately (short run).

Answer (c) is correct because the price level moves up only along the fixed 
SRAS curve in the short run but then moves up further, as SRAS shifts up, 
along the AD curve in the long run.

Answer (d) isn't about the effect OF investment, but rather the effect ON 
investment.  And I don't see any reason for this change in preference (which 
by the way raises the interest rate and lowers investment) to have a larger 
effect on investment in the long run than in the short run.

Apr 25

> I was reviewing the textbook and I was a little bit confused about its
> explanation on the consequences of shift in AD. On page 336, it says that
> when the AD curve shifts to the left due to pessimism, the fall in the
> expected price level alters wages, prices, and perceptions and it shifts
> the SRAS curve to the right. I guess I can understand this reasoning,
> because as expected price falls, SRAS shifts to the right. But as price
> falls, doesn't the real wage increase, thereby increasing the real cost
> for firms, resulting in leftward shift in SRAS?

No, the idea is that wages do not fall fully in the short run, due to wage 
stickiness, and then during the adjustment from short run to long run both 
wages and prices fall further.

Apr 25

> Can you explain question 30 on the Winter 2004 test for me? The question
> is
> 
> Suppose you expect the Fed to increase the money supply to a new higher
> level. Which of the following would be better for you to do before,
> rather than after, the change in the money supply?
> 
> The answer is e.) Buy Bonds. What I don't understand is that if you
> expect there to be higher inflation, wouldn't you rather be on the
> borrowing side rather than the lending? After inflation, the fixed
> interest that you earn on your bonds will be worth less, won't it?

Hmmm, good point.  You are right that a borrow gains, while a lender loses, 
from an unexpected rise in the price level.  I don't think we thought about 
that.  What we were thinking about was the effect on the prices of bonds 
themselves, which will rise when the interest rate falls, giving you a 
capital gain if you bought the bonds before it happened.  In the short run, 
especially since the price level doesn't respond quickly to the increase in 
money supply, this effect must be larger than the one that you are worried 
about.  But I admit that we didn't think about it fully.

Apr 25

> Why does a shift in AD produce a shift along the Phillips Curve instead
> of shifting the Phillip curve itself? Thanks. 

In the short run, expectations are given, so any movement is just along 
whatever short-run Phillips Curve you happen to have.  Over time, however, 
if this movement takes the economy to a rate of inflation different from 
what is expected (as it will if it moves away from uN), then expected 
inflation will change and the short-run Phillips Curve will shift.  So a 
shift in AD, due, say, to a change in macro policy, typically DOES cause 
the Phillips Curve to shift, but not right away.

Apr 25

> I am getting a bit confused about the expected price level and its affect
> on the quantity supplied. Pg. 332 of Mankiw and answer 2d) of HW 8 says
> that an increase in a firm's expectations about the relative price of
> their output compared to others, causes them to increase production
> (rightward shift of supply curve). However, this is quite the opposite of
> what the identity, Y = Yn + a(P-Pe), suggests. According to this
> equation, an increase in the expected price level should shift the supply
> curve left.

Yes, this is confusing, I agree.  Since a firm presumably knows the price of 
its own output (P), what is stated here as "an increase in a firm's 
expectations about the relative price of their output compared to others" is 
actually a reduction in its expectation of the prices of others, (Pe).  So 
what is happening here is a fall in Pe, not a rise, and thus a rightward shift 
of the SRAS curve.

Apr 25

> Is there anything that can change the LR quantity of production other
> than what we learned for the first exam (technology, natural resources,
> population, etc.)?

No, that was it, as long as you include the natural rate of unemployment 
and the rate of labor force participation along with the various variables 
involved in the production function.

Apr 25

> I have a few questions concerning the practice final exam from 2005.  
> 
> For number 2, why does net foreign portfolio investment decrease? And
> what exactly is "net foreign portfolio investment"?  I thought there was
> only "foreign portfolio investment."

Net foreign investment is defined as our acquisition of assets abroad minus 
foreign acquisition of assets here.  Net foreign portfolio investment is 
the same thing, except including only financial (as opposed to real) 
assets.  In this case, the German company is adding to its holding of US 
assets, while the British company is not changing the value of its holdings 
of US assets (merely changing their form), so foreigners are increasing 
their holdings of financial assets in the US.  This, then, is a decline in 
US net foreign portfolio investment.

> For number 17, how do you figure this out? Is it Real GDP for the year
> divided by the population? And in order to correctly increase the
> population by 20% each year, do you use the present value formula (in
> this case, [(1+.2)^t]*1,000,000 )?

I wouldn't call that the present value formula, but it is the right formula.  
But you shouldn't need to do the math, since it should be obvious that real 
GDP rose less than 20% the first year, at a rate of slightly less than 20% 
over the first two years (since compounding would have raised it somewhat 
beyond 140, and less than 20% during the 3rd year.  So per capita real GDP 
must be lower each year than it was in 2001.

> For number 18, is D the answer because of the catch up effect or is there
> something else that needs to be considered for this problem? 

Yes, I think the catch-up effect is enough here.

> For number 22, the correct answer is 3 percentage points.  However, when
> I did my calculations, I ended up with a much larger number.  Including
> the discouraged workers, would you have a total labor force of 55,000? 
> What are the calculations for this one? For the related question number
> 21, I got the correct answer with an unemployment rate of approximately
> 14.8%. 

Using the normal definition, in which discouraged workers are not part of 
the labor force, the unemployment rate is 4/(4+21+2) = 14.8%.  There are 
1000 discouraged workers (28,000 - 4,000 - 21,000 - 2,0000), so if we add 
these to the unemployed (and thus also to the labor force) we get an 
unemployment rate of 5/(5+21+2) = 17.9%, which is a 3 percentage point 
increase.  I have no idea where you got a labor force of 55,000.

> Finally, for the first short answer question, part a, I don't understand
> why the nominal interest rate is lower than the original nominal interest
> rate and how you can be certain of this.  For part b, I also wasn't sure
> how you could be certain that the nominal interest rate is 5.5%.  Why is
> this?

In the short-run money market, where the interest rate is determined by the 
intersection of a vertical supply curve and a downward-sloping demand curve, 
the expansion of the money supply shifts supply to the right, causing the 
intersection to move down the demand curve.

In the long run, the price level rises at the same rate as the money supply 
(since there is no growth in real GDP), so the rate of inflation is 3.5%.  
With the real interest rate still at 2% (since in the long run real 
variables are not affected by money), the nominal interest rate must be 
2+3.5 = 5.5%.

Apr 25

> I am studying and I have a question for you if you don't mind answering.
> I am a little confused about the long-term effects with a shift in the
> short-run aggregate supply.  If the SRAS shifts left, for example, in the
> long run, do prices rise or do the return to their original level?  The
> study guide says that they return to normal, but I don't understand this
> because a leftward shift in the AD curve would cause the price level to
> drop in the long-run, correct?

The answer depends on WHY the SRAS curve has shifted to the left.  If it 
shifts to the left because of an external rise in costs, such as an oil 
shock, then because with an unchanged AD curve the long run equilibrium will 
not be changed, it will have to shift over time back to where it started.  
But if it shifts to the left because some other shock to AD has put Y above 
YN, then it moves to the corresponding new long-run equilibrium, not back to 
the old one.

It is also true what you say in the last sentence, that a leftward shift of 
the AD curve would cause the price level to drop in the long run.  I'm not 
sure, though, what this has to do with the rest of your question, since that 
was about a leftward shift of SRAS, not AD.

Apr 25

> So, I've been wondering all year how stock prices are factored into
> inflation (whether in the AD-SRAS,LRAS model or something else). I
> understand the idea Mankiw goes over about a booming stock market pushing
> AD higher, and that effect on prices, but I wonder how that effects the
> value of money - if it takes more money to purchase all stocks, doesn't
> this mean that money is less valuable (especially in the investing world)
> and thus inflationary effects have taken place? (For example: Imagine a
> new person who has jsut gotten money to invest investing for the first
> time, they are facing higher prices on stocks then others that invested
> before - meaning their return has a lower relative value?)  Where would i
> look for data on inflation coorelating with stock market movements? 

The prices of stocks are not included in any measurement of inflation, and 
I don't think that they should be.  You are right that if the prices of 
stocks go up, you need more money to buy them.  But on the other hand, if 
you are just looking for a return on your money, you can still get that by 
buying fewer stocks.  For example, suppose you were thinking of using $1000 
to buy 100 shares of a stock the price of which was $10.  If the price of 
the stock now goes up (before you've bought it) to, say, $20, are you worse 
off?  No.  You just buy 50 shares instead of 100.  Whatever may be the 
percentage yield on the stock, you'll still get it on your $1000.

That does not mean that the stock market has nothing to do with inflation 
and other aspects of the macroeconomy.  As you note, a rise in the stock 
market increases people's wealth, causing them to consume more and 
stimulating aggregate demand, for example.  And in the other direction, if 
something else causes inflation, that may increase the profits of the 
companies whose stocks are being traded, causing them to rise.  So there 
might well be a correlation between inflation and the prices of stocks.  
(None of this, of course, is included in our models in this course, which 
don't attempt to explain the stock market.)

> The second part to the question is even more obscure, but maybe you'll
> have something for me.  So increasing the interest rate, decreases
> Aggregate Demand- stimulating people to put more money into bonds,
> removing money from stocks (and also people think maybe the economy is
> headed into a recession and if so profits will be less - thus possibly
> decreasing the value of the stock). And according to the AD-SRAS-LRAS
> model prices would decrease with an increase in the interest rate.  But
> wouldn't inflation actually increase? My thinking is that it becomes much
> easier for people to invest and receive a higher return on their
> investment.  This higher return on the investment means they are
> gaurenteed to have more money from investments, but also lowering the
> relative value of money (because everyone will have access to the same
> higher interest rates). 

The return on lending and saving does go up, so there is more saving and 
thus less consumption.  And it's true that holding money become less 
attractive compared to holding bonds.  But while one might say that this 
lowers the value of money in terms of bonds, it doesn't lower it in terms 
of goods, which is the 1/P version of the "value of money" that we spoke 
of earlier in the course.

Apr 24

> In reviewing the March 31st WSJ article on Labor Participation rate, i
> noticed a confusing line:
> 
> "Their findings, presented at a conference organized by the Brookings
> Institution, suggest the Fed could see strong job growth as an
> inflationary risk in the coming year." According to the Philips curve
> wouldn't strong job growth correlate negatively with inflation in the
> short run?

I think I see why you are confused, but what they meant by "strong job 
growth" is a decline in the unemployment rate, and therefore movement to 
higher inflation along the short-run Phillips Curve.

Apr 17

> I've been trying to use the information we've learned about "sticky
> wages" (in econ 102) and monetary policy to figure out what is meant by
> "keynesian", "monetarist" and other forms of economic theory.  I've come
> to think that "neo-keynesians" believe in sticky wages impact on the
> economy and also that monetary policy plays a large role in the short run
> economy.  What, briefly, is the main difference between a "keynesian",
> "neo-keynesian", "monetarist", and "classical" economist?  If you could
> answer this I would appreciate it, but if it's not something that can
> really be explained in an email, I understand also.

I doubt I can give a complete answer, since such terms are inevitably not 
very well or uniquely defined.  

I'd say that Keynesian's believe in the ability, and probably the 
desirability, of using fiscal policy to influence the macroeconomy, and an 
extreme Keynesian might have discounted the ability of monetary policy to 
do this.  

This was in contrast to a classical economist who believed that the real 
side of the economy both could not and should not be managed by government 
policy of any sort, while monetary policy was relevant only for nominal 
variables (inflation).  The classical economists believed, I suppose, that 
markets worked and that attempts to interfere with them would be 
ineffective, at best.  

A neo-Keynesian takes some elements of the underpinnings of the Keynesian 
perspective, especially sticky wages, and concludes from this that fiscal 
and monetary policies both can be effective.  From this, though, they 
would not necessarily conclude that such policies should be used very 
actively, for reasons we'll be discussing tomorrow.  Mankiw would probably 
identify himself as a neo-Keynesian.

Finally, a monetarist mainly believes in the importance of money, although 
they tend to see activist monetary policy as likely to cause more harm than 
good.

Apr 17

> I have a question regarding oil shock, which is related to homework set9
> 5(b). My question is, is imported oil counted in the formula
> Y=Af(L,K,H,N). When the world oil price decrease, importing country can
> buy more oil, and their factor of production increase, which mean they
> can increase their capacity of production without problem such as
> inflation (in other word LRAS also shift to the right)... but isn't it
> weird to include imported stuffs into the model of LRAS.  

No, I wouldn't include imported oil as an argument in the production 
function.  I wouldn't include domestically extracted oil in it either.  
What belongs -- as part of natural resources, N, presumably -- would be 
the quantity of oil that is available to it under the ground.  It is this 
that expands its long term capacity to produce.

Apr 9

> The book mentions that due to money neutrality, monetary policy cannot
> affect unemployment rate in the long run--thus the phillips curve is
> vertical. However, can fiscal policy still affect unemployment rate in
> the long run?

That depends on what we mean by fiscal policy, which is a more general 
term than monetary policy.  If by fiscal policy we just mean the overall 
levels of spending and taxing, then no.  This won't change the natural 
rate of unemployment.  And that is what we usually mean by fiscal policy.

However, there are particular policies that might be included under 
"fiscal policy," such as the payment of unemployment compensation, that 
because they alter the incentives in the labor market can change the 
natural rate of unemployment.  So in that sense the answer is yes.

Apr 9

> -When the prices of bonds rise(i.e. yield falls), does this only imply
> that the investors' demand for bonds increased? Or could the monetary
> policy of the Fed have influenced the prices of bonds? I guess my main
> question is "Can the Fed's actions influence the actual price of bonds?"

For your last question, yes.  The Fed very much influences interest rates 
and therefore bond prices.  In fact when it uses open market operations, 
it is buying and selling bonds themselves, so the effect on bond prices 
is pretty direct.

As usual in any market, price changes can occur as a result of shifts in 
either supply or demand, so it is a mistake ever to think that a price 
increase must be the result of just one or the other.

Apr 9

> I have two questions on this past weeks homework just for clarification.
> On question 5, does GDP (after the shock in investment) go back to its
> natural level after 2 years, or will it be permanently a little higher?

That's a good question.  It does make sense that an increase in investment, 
even temporary, would increase the capital stock and raise the natural 
rate of output.  So that would happen in parts a and b.  I ignored that, 
and in fact I would tend to view this as a small effect that can 
legitimately be ignored (but in fact I just forgot to think about it).

> On question 2 part A. When it is back in the LR, prices are lower and
> output is the same.  However, that doesn't hold true with the quantity
> theory of money: MV=PY (assuming all are constant)  I think that i am
> going to far and I am mixing things up.  So maybe you could clarify.

No, you are right that the quantity theory of money doesn't get this 
exactly right.  What is actually happening here is that the velocity of 
money depends somewhat on the interest rate.  This is something that we 
haven't discussed (and won't) that is missing from the quantity theory.

Apr 5

> I don't know how to get the answers for part 5 of the homework. I guess I
> don't understand what to do with it and how to get to a final answer. I
> know that my GSI wanted us to show the shifts in AD and AS curves so she
> would know how we got our final answer. 

You are dealing with changes in investment, shown to occur in various 
patterns over time.  Use the AS/AD model to work out how each of these 
changes in investment will affect Y, both in the short run (immediately) 
and in the long run (moving smoothly from the short run to the long run 
over two years.  Then just graph the path of Y over time.  If a second 
change in I occurs before the full adjustment to the long run from a 
previous change has finished, then you have the effects of the second 
change start from the position that Y happens to be in, rather than from 
a long-run equilibrium.

Apr 5

> I have a doubt in question 3c) of HW 7. The solutions say:
> 
> "c) In a quest for re-election, the president pushes for more tax cuts.
> -- A reduction in taxes increases households’ disposable income.
> Therefore, we’d expect consumption to increase. Because C is a component
> of aggregate demand, the increase in C shifts the AD curve to the right.
> (For simplicity we ignore the long run effects of an induced increase in
> the real interest rate: C, I, and NX would decrease ? shifting AD to the
> left ?, and the LRAS would shift to the left.)"
> 
> Though it says to ignore the long run effects, why would the real
> interest rate increase in the long run? And then it goes on to say that C
> would decrease whereas, in the opening sentence, it says that C
> increases. I am a bit confused about the part within ().

As it says in the portion you are asking about, these are changes in the 
long run.  That is, as we learned earlier in the course, a tax cut reduces 
government saving and thus the supply of loanable funds, causing the 
interest rate to increase in the long run.  (Actually, it will increase 
also in the short run, as the rise in Y raises demand for money.)  This in 
turn reduces investment, and also increases saving out of given income, 
thus reducing consumption.  So the long run effect of the tax cut on 
consumption is opposite to the short run effect.

Mar 23

> While reviewing today's lecture notes, I got confused. In wealth effect,
> you said that as price rises, people's real wealth gets reduced, and so
> people save more. But why would they save more? Is this because the real
> interest rate rises due to the intrest rate effect?

No (although that is another effect that would be plausible, I guess).  
They save more simply to replace their lost wealth.

Mar 23

> Why is it that we have SRAS & SRAD graphs but we don't have a long run
> aggregate supply graph or a long run aggregate demand graph? Thanks. 

Good question, though actually you may have mis-stated it: what we have is 
short- and long-run curves for aggregate supply -- SRAS and LRAS -- but 
only a single curve AD for aggregate demand, which applies in both the 
short run and the long run.  

The reason for this asymmetry is that we have good reasons to expect the 
supply side of the economy to behave differently over these two horizons, 
for the reasons I talked about in class on Tuesday, and we also know from 
experience that these differences are crucial for understanding how the 
macroeconomy behaves over time.  On the demand side, while I don't doubt 
that one could come up with reasons for it too to behave differently in 
the short- and long-runs, such differences do not seem 

Mar 21

> for question #15 as posted online, would you know that a higher savings
> rate will lead to a higher GDP per capita in the long run even though you
> do not know of population changes in the long run? wouldnt the most
> likely scenario be that a higher savings rate leads to higher investment
> and thus higher growth, but not necessarily in GDP/capita because of
> potential, or probable, population changes?

I don't see any reason for higher saving and investment to increase 
population.  If population was growing anyway, then the extra capital will 
lead to higher GDP per capita, given that higher population, compared to 
what would have happened without the higher saving.

Mar 18

> I have a doubt on Quiz 2B, Question 3:
> 
> "(2 points) In the graph below, draw curves representing supply and
> demand for money as they appear in the quantity theory of money. Then use
> the diagram to determine how an increase in the velocity of money would
> affect the “value of money.”"
> 
> The solutions says that the demand curve should shift inward to the left.
> According to the identity, V=(Nominal GDP/Money Supply), which can be
> re-written as Money Supply=(Nominal GDP/Velocity). Now if the velocity
> increases, it can also mean that the money supply has decreased, thus
> shifting the supply curve to the left. Moreover, the question has not
> told us to hold the supply of money constant. I would appreciate if you
> could you consider my reasoning.

I think I was quite clear, in deriving this model in class, that we were 
graphing the right-hand side of the equation as the demand for money.  I 
think I was also clear that the process for determining the supply of money 
does not involve velocity.  So no, I do not regard shifting the supply curve 
to the left as an appropriate answer.  As for holding the money supply 
constant, the model has consistently taken the money supply as exogenous 
(that is, not determined inside the model).

Mar 17

> -- I went through the "correct answers." I had a doubt regarding question
> 20 which talks about the relationship between the trade deficit and
> employment. Scott and Griswold, both have different opinions and as
> nobody's name was mentioned in this question, I thought about the
> lecture. You had mentioned that Griswold is not establishing any cause
> and effect (he is only observing) and as this question asked for the
> reason as well, I was under the impression that you were relating to
> Scott's article, thus (a) is the correct choice. Please may you
> reconsider this question.

My lecture went on to say that Scott's argument was incorrect, and I gave 
the reason given in answer C myself.

> -- Also, the short answer question on increase in capital inflows, it
> says that "foreigners decide to increase the amounts that they will lend
> to the domestic country for any given level of real interest rate." This
> statement made me believe that domestic people can acquire more foreign
> assets at the same rate, thus increasing the NFI (rightward shift).

Nope.  Foreigners lending to us is them acquiring assets, not us.  NFI 
shifts right when we acquire more assets abroad -- that is, when we lend, 
not when we borrow.

Mar 17

> 	I have a question concerning question 20, on form 1, on the 2nd
> midterm which asks about the trade deficit and employment.  According to
> Scott, jobs are destroyed when our deficit rises but  about employment;
> however both of them realize that the deficit is rising, but the question
> doesn't say according to either of these men .  Therefore we are left with
> two answers depending on whose opinion you take.  If you believe Scott's
> opinion is right then choice e is your answer.  I think choice e should
> also be taken as a right answer because if you read Scott's article then
> it is right.  Hopefully, you will see my side of the argument in this
> question and give people points back who made the same mistake that I
> did.  

On this, you should base your answer on what I taught you in class when I 
discussed these articles.  Based on that, only answer C is correct.

Mar 17

> I was looking over the answers to the exam and I had a question about #25
> (why paper currency is important.)  During the test, I knew for sure
> that, (b) because it is accepted in exchange for goods and services) was
> a correct answer, but I wasn't sure about the other choices.  I ended up
> putting down e) all of the above.  My reasoning was that, even though the
> US does not use the gold standard, old gold coins can still be purchased
> from the US government, as I read from a website after the exam.  As for
> c), there are rare coins that are considered to be more than their face
> value.  I wasn't sure of d), mostly because of the the words "guarantees"
> and "specifies," but since the other three fit, I figured I should put e.
> Could you let me know what was wrong with the reasoning that I used?

Mainly because I stressed in class that the only reason our money has value 
is that it is accepted in exchange.  The government does NOT promise to 
redeem it in gold.  And the coins that are in circulation are certainly NOT 
worth as much as their face value as metals.  All of these are things that 
I said in class.

Mar 17

> I have a question regarding #15 on Exam 2.  According to the solutions,
> Country A, who saves more than country B will not have a higher growth
> rate than country B.  However, on page 169 of the book, Mankiw states
> "Higher investment, in turn, means greater capital accumulation and more
> rapid economic growth." 
> Country A's increase in saving should shift the SLF curve to the right,
> bringing down the real interest rate.  With the reduced interest rate,
> there will be more investment, and country A will experience more growth.
> 
> Thus I believe the answer should be C, country A will have both a higher
> GDP per capita and a higher growth rate.
> 
> If this is wrong could you please explain why their growth rate does not
> increase. 

It will have higher growth in the short run, but in the long run (which is 
what is asked for here), the law of diminishing returns reduces the growth 
effect of increased investment.

Mar 16

> -- If the domestic real interest rate increases,
> Then, domestic investment decreases, NFI decreases (that is, purchase of
> foreign assets decreases and purchase of domestic assets by foreigners
> increases). Is this correct?

Yes, these are the direct effects of the increase in the domestic real 
interest rate.  But since that interest rate is determined inside the model, 
something must have caused it to change, and whatever that is might change 
the conclusion.  

For example, the domestic interest rate might have risen BECAUSE there was 
an increase, for any given interest rate, in the desire to engage in 
domestic investment, thus shifting the DLF curve to the right.  In that 
case, the rise in the interest rate is accompanied by an increase, not a 
decrease, domestic investment, even though the effect of the rise in 
interest rate alone is to decrease it.  Similarly, if the cause was an 
increase, for any given domestic interest rate, in net foreign investment, 
then the result for NFI would be different.

On the other hand, if the cause of the interest rate increase has nothing 
to do with either kind of investment, such as a decrease in saving, then 
the effects on I and NFI are as you say.

> -- If the foreign real interest rate increases,
> Then, domestic investment in unaffected, NFI increases (that is, purchase
> of foreign assets increases and purchase of domestic assets by foreigners
> decreases). Is this correct?

This is correct to the extent that there is no direct effect on domestic 
investment.  However, the increase in NFI for any given domestic interest 
rate shifts to the right both the NFI and the DLF curves, the latter 
causing the domestic real interest rate to rise, which in turn causes 
domestic investment to fall.

Mar 16

> I had a question about number 23 on the winter 2004 exam. If the central
> bank increases the reserve ratio, doesn't that lower money supply and
> then lower the price level and inflation as well? The answer says that
> the inflation rate is not lowered.

It lowers the price level, but to a new lower level.  It doesn't (except 
temporarily, I guess) change its rate of change, which is the rate of inflation.

Mar 16

> Prof. deardorff, sorry to bother you again. I'm not sure I understand
> what you're saying. Because in homework 5, number 5, this is not the
> case--the money supply is equal to deposits as opposed to loans, and I
> thought this was what the book said as well. are you saying that if I
> deposited $75 in U.S. dollars into a U.S. bank, the money supply would be
> 525 and not 600?

No, I agree that the money supply includes deposits, not loans.  But when 
you deposit $75 that was already part of the money supply (out in 
circulation as currency), the immediate effect (before the reserve ratio 
is restored) is to leave the money supply unchanged, merely changing $75 
of it from currency to deposits.  Then, as the banks start making loans 
in an effort to restore the reserve ratio, and the proceeds of these 
loans are deposited, both loans and deposits now expand.  So when the 
process ends, the money supply will have expanded by the same amount as 
loans.

Mar 15

> 1) Does frictional unemployment contribute to the natural rate of
> unemployment or to cyclical unemployment? 

Frictional unemployment is a part of the natural rate of unemployment.

> 2) Do changes in the money supply affect the nominal exchange rate?

Yes.  Since changing the money supply does not affect the real exchange 
rate but does affect the price level, it follows that it must affect 
the nominal exchange rate.

> 3) When the NFI curve shifts, sometimes NFI itself stays constant and
> other times it changes. How can it be determined which is the case? 

Actually, I don't recall a case where the NFI curve shifts but the 
level of NFI itself stays constant.  It could happen, of course, if 
something else happened at the same time that caused the interest rate 
to change even more than would happen just due to the NFI curve shifting, 
but that would be very coincidental.

> 4) If an American owns foreign currency does it count as FPI or FDI? 

An increase in American holdings of foreign currency is part of FPI, 
not FDI.

Mar 15

> prof deardorff, concerning the winter 2004 exam, the first open question,
> the one about the Island of Yap and the stone wheels, the answer is that
> the supply of money goes up by 525, which is also the number that the
> loans go up by. Now I am wondering if the supply goes up by 525 only
> because the stone wheels are no longer being used, or if this would apply
> for dollars. If stone wheels were still being used as currency, but just
> stored in the bank as reserves and for loans, would the money supply then
> go up by 600? Or would it be in any case, (even in the U.S. economy) that
> the increase in money supply is actually equal to the increase in loans
> as opposed to deposits?

The answer would be the same in the US economy.  If something (wheels, gold, 
paper, whatever) that has been circulating outside of banks as currency is 
instead deposited and becomes part of reserves, then it ceases to be part of 
the money supply.  But all of the deposits that are created as a result, 
including the initial deposit of this stuff, ARE counted as part of the 
money supply.  And all deposits after the initial deposit are the result of 
loans, so it will be true, as here, that the increase in the money supply 
equals the increase in loans.

Mar 15

> -- 5) The government of Sweden has recently announced a five-year plan
> for economic growth and it includes a more comfortable business
> environment for foreign investors, intended to attract foreign capital.
> Investors in the US (especially those in Ypsilanti) are enchanted by this
> opportunity and decide to build several plants in Swden. According to the
> long run open economy model, which of the following is TRUE about the US
> economy?
>    A. Net exports increase by the same amount as the amount of foreign
> direct investment made on Slovakian plants.
>    B. Supply of US dollar in foreign exchange market will not be affected
> because US monetary policy has not changed.
>    C. Net foreign portfolio investment will increase due to a rise in
> real interest rate.
>    D. Government saving will increase due to a rise in real interest rate.
>    E. none of the above
> Correct Choice) E
> Doubt) Why can it not be C? If C had "foreign direct investment" instead
> of "foreign portfolio investment," then would C be the correct answer?

The rise in the domestic real interest rate actually reduces our net foreign 
portfolio investment, since foreign assets now look less attractive relative 
to domestic ones.  If C had said foreign direct investment, which would 
include the assumed investment in Swedish plants, then yes, foreign direct 
investment would go up, though with the offsetting effects of the initial 
increase followed by a decrease due to the rise in domestic interest rate, 
this result takes some work to see.  And one could argue that this increase 
is not, as stated in answer C, "due to a rise in real interest rate."

Mar 15

> I have a couple of questions for the exam and I would greatly appreciate
> it if you could answer them.
> 
> 1) Exchange rates don't affect NFI, but they affect NX. How can this be
> if NFI=NX?

It is in equilibrium that NFI=NX, and it is the adjustment of the exchange 
rate that makes this happen.  Your question is analogous to asking, in the 
microeconomics of a market, how it can be that supply depends positively 
on price while demand depends negatively on price when it is also true 
that S=D.

> 2) What is an easy way to determine whether a change causes a shift in
> NFI? Does government restrictions on foreign ownership of domestic assets
> cause a shift in NFI?

Yes, to your second question.  To the first, look back at the table I gave 
you of "What Does NFI Depend On?"  Everything there, except the domestic 
real interest rate (since that is on the axis and therefore causes movement 
along curves), will shift the two curves that include NFI.

> 3) On the practice tests, there are quite a few questions testing solely
> the material that was learned before the first exam. Is this going to be
> the case on our exam? 

As I said in class and on the website, this exam is cumulative but there 
are only a handful of questions from before the first exam.

Mar 15

> I was wondering what can increase GDP per capita level in the long run,
> GDP per capita level in the short run, GDP per capita growth rate in the
> long run, and GDP per capita growth rate in the short run. Thanks

Let's see.  I guess the level of GDP per capita will increase, in the short 
run, with an increase in the level of technology, capital, human capital, 
or natural resources.  If that increase is sustained -- that is, if it does 
not reverse and go back to where it was before -- (and if population 
doesn't grow), then that increase in level will also be sustained into the 
long run.

As for increasing the growth rate of per capita GDP, anything that 
increases the level must also increase the growth rate in the short run, 
since that's the only way to get to the new higher level.  However, to 
increase the growth rate in the long run you need for whatever caused the 
initial increase to be repeated every year thereafter, and you also need to 
avoid the law of diminishing returns undermining its effect.  We usually 
say that only improvements in technology, such as might be obtained by 
increasing the resources devoted year after year to research and 
development, will do this.

Mar 15

> I have a couple of doubts on Winter 2002:
> 
> -- Q2) Which of the following best illustrates frictional unemployment?
> Correct Ans) Upon finishing his grading for the final exam, Alan quits
> his job as a Professor at the University of Michigan and actively looks
> for a job as an extra in action movies.
> Doubt) Is "Waldery loses his job at the bank after the bank president
> replaces him with an ATM." also an example of frictional unemployment?

Well, I don't now think this was a very good question.  I think our idea 
was that, in the first case there are plenty of jobs in the movies, so it 
was just a matter of time before Alan would find one, but in the second 
case the jobs had been destroyed by the new technology, so there was now 
an excess of workers over jobs.  

> -- Q11) Wogzania is a small nation in Europe with an open economy. The
> Wog is Wogzania’s national currency. Use the following table to answer
> the next question. (I have not copied the table here)
> Assume that Purchasing Power Parity holds for these two nations between
> 1990 and 2000 and that the nominal exchange rate in 1990 was 60 Wogs per
> US dollar. In the year 2000 the nominal exchange rate should be
> approximately __________.
> Correct Ans) 51 Wogs per US dollar
> Doubt) How is this calculated? (I did get the answer but my calculation
> took quite a lot of time, so I feel I went wrong somewhere.)

From the table, you see directly that the US price level rose 12/40 = 30%.  
For Wogzania, the money supply rose 7/35 = 20% and real GDP rose 21/420 = 5%.  
Using the quantity equation, it follows that the price level in Wogzania 
must have risen approximately 20-5 = 15%.  Thus, from PPP, since US had 15% 
more inflation than Wogzania, the dollar should have fallen 15%.  Starting 
at 60, a 15% decline takes it to 51.

Mar 15

> For number 23 on Winter 2002, the answer says that all of the above are
> correct.  However, I thought that a person who did not work for money was
> not considered to be employed (letter b). (At least this is what Mankiw
> says).  Is it correct to say that someone who works for no pay is
> employed? If so, how do you distinguish them from other people who aren't
> paid, but say they work at their house?

See the definition of "employed" in the assigned reading from the BLS.  It 
includes:  "worked 15 hours or more as unpaid workers in a family-operated 
enterprise"

> Also, when the US buys foreign currency on the foreign currency exchange
> market to fund foreign direct investment in another country, does the FDI
> AND the foreign currency obtained (FPI?) both go into NFI separately or
> are they linked somehow? (This relates to problem #20 on Winter 2002).

If they use the foreign currency to buy foreign real capital, then they are 
not increasing their holding of foreign currency and there is therefore no 
FPI, only FDI.  Remember that all the pieces of NFI are defined as changes 
in the holdings of assets.  Acquiring a currency and then spending it on 
something does not change your holdings of it.

Mar 15

> What again were the fallacies and biases in the arguments of these  two
> authors that you mentioned in lecture?

As I recall, what I said was that Griswold seemed to imply that the trade 
deficit was the cause of the rising income and employment, when in fact the 
causation went the other direction.  And Scott assumed that all imports 
would have been produced domestically if they were not imported, ignoring 
that the economy was close enough to full employment that this would not be 
possible.

Mar 15

> I had two questions about terms I found on olde exams and am unfamiliar
> with and was wodering whether we have learnt them yet and whether or not
> they would be dealt with on the exam.
> 
> The terms are "Ricardian Equivalence" and "the liquidity trap"

Certainly not the liquidity trap.  That was in an outside reading that I 
used in an earlier year, but not now.  As for Ricardian equivalence, I sort 
of thought it was in the book, but I haven't been able to find it.  In any 
case, it won't be on this exam.  If I find it, it might show up on the final.

Mar 15

> I had the following doubts on the W04 paper:
> 
> -- Q1) Which of the following is NOT an effect of the rate of inflation
> being low, as opposed to high?
> Correct Ans) Consumers spend more time and effort managing their wealth,
> trying to keep it in forms that earn interest.
> Doubt) Why is this the correct answer?

This is an effect of the rate of inflation being high, not low.  And that's 
because a high rate of inflation will mean (from the Fisher equation) a 
high nominal interest rate, and thus a high opportunity cost of keeping 
wealth as non-interest-bearing money.

> -- Q8) Your father is going through a mid-life crisis and wants to buy a
> fast sports car. You are concerned about the impact of his decision on
> U.S. GDP. If he buys a Maserati (made in Italy) instead of a Chevy Camaro
> (made in the
> U.S.), then which of the following statements is true?
> Correct Choice) None of the above.
> Doubt) Why isn't "Italy’s net exports increase and consumption decreases;
> US net exports decrease and consumption increases" an appropriate choice?
> What is the actual answer to this question?

I guess it's because our buying a car from Italy doesn't reduce Italy's 
consumption.  I don't know what you mean by the "actual answer to this 
question," since the only question here is "which of the following 
statements is true."  If you mean, what is the impact of the decision on 
U.S. GDP, I think that depends on what else one holds fixed.  One answer 
would be that buying the Chevy would raise US GDP by the difference between 
its retail price and its price in inventory (since inventories decline by 
the value of the car), while buying the Maserati has no effect (unless it 
is sold through a US distributor who also charges a markup). 

> -- Q16) Japan reduces its budget deficit by reigning in its spending.
> According to the long run open economy model, the quantity of U.S.
> domestic investment will _______ and the quantity of U.S. national saving
> will _______ .
> Correct Answer) rise; fall
> Doubt) Why is this the answer? Why is US domestic investment and national
> saving affected by Japan's budget deficit?

To answer this question, you need first to apply the open-economy model to 
Japan to find out how its interest rate changes.  It falls, due to the 
increase in SLF there.  Then apply the open-economy model again to the US 
to see the effect of this fall in the foreign interest rate.  It shifts 
both DLF and NFI to the left, causing the US interest rate to fall.  It is, 
finally, this fall in the US interest rate that increases US domestic 
investment and reduces US saving.

> -- Q25) According to The Nalin Report on Matostan’s economy, 3400 people
> are
> employed. 600 people are unemployed and looking for a job. The cyclical
> rate of unemployment is currently at 2.5 percentage points. Then it must
> be true that the natural rate of unemployment is ________ 15% and, in the
> long run, the rate of job finding is approximately _______ than the rate
> of job separation.
> Correct Answer) less than; 7.0 times larger
> Doubt) How do we arrive at "7.0 time larger"/how do we calculate it?

First, the actual unemployment rate is 600/(3400+600) = 15%.  Next, since 
cyclical unemployment is actual unemployment minus the natural rate, the 
natural rate must be 15-2.5=12.5%, which is less than 15%.  Finally, using 
our little model of the natural rate in terms of rates of job separation, s, 
and job finding, f, we know that the natural rate is s/(s+f) = 1/(1+f/s) 
= .125 = 1/8.  Solving this, f/s = 7.

Mar 15

> I have a question on Structural vs. Frictional Unemployment.  In the book
> (p 199), it defines structural unemployment as resulting from an
> insufficient number of jobs available in a labor market to provide for
> all those individuals who want a job.  Frictional unemployment is defined
> as resulting from the time it takes to search for jobs that best suit a
> worker's skills and tastes.
> 
> On p.200, it continues to say that changes in the composition of demand
> among industries or regions are sectoral shifts which are included as
> frictional unemployment.  It seems to me that this would better be
> considered as structural because each region or industry is a different
> labor market.  When these regions/industries shift, the number of jobs
> available in that market shift, thus the workers must find new jobs.
> 
> Granted, there will be some time before they find a new job, but in that
> sense all unemployment could be considered frictional because all
> unemployment lasts for a finite period of time.  All unemployment could
> thus be considered frictional because of the time involved.

I think that, as defined in the text, it is not true that structural 
unemployment "lasts for a finite period of time."  That is, if features of 
the economy such as a minimum wage cause there to be more labor supplied 
than demanded, that amount of unemployment will not decline over time, even 
though the particular people who experience it may (or may not) change.  
The intent here is not to identify, for particular individuals who are 
unemployed, whether they are "frictionally" or "structurally" unemployed.  
Rather, the intent is to distinguish, among the various causes for 
unemployment, between those that involve the process of getting workers and 
jobs together (frictional) from those that involve there just being too few 
jobs or too many workers.

Mar 15

> I had the following doubts on the W03 paper:
> 
> -- Q5) If the velocity of money increases, then:
> Correct Ans) "the value of money decreases all else constant."
> Doubt) Why isn't "the supply of money shifts back all else contant" a
> correct choice because if the supply of money decreases, the velocity
> increases if everything else is held conatant?

Because the supply of money is determined outside this model, while the 
value of money (1/P) is determined inside it.

> -- Q20)According to the theory of Ricardian equivalence:
> Doubt) What is the theory of Ricardian equivalence?

It is the theory that people base their spending decisions on what they 
expect their future income to be, as well as their present income, and 
also that they expect the government to balance its budget in the long 
run.  Therefore a spending increase by the government has the same effect 
today whether it is financed by current taxes or by government borrowing, 
since the public believes, in the latter case, that taxes will rise in 
the future to pay off the loan.

I seem to recall that this was mentioned somewhere in the textbook, 
although  right now I can't seem to find it.  Perhaps it only appeared in 
an earlier edition.

> -- Q24)Suppose the US CPI....The US CPI will:
> Correct Ans) "rise because the dollar will depreciate"
> Doubt) I did not get the reason for this. Why isn't it the other way
> round? Shouldn't the CPI fall when the dollar depreciates?

No.  If the dollar depreciates, this makes imported goods more expensive 
in dollars and therefore raises the prices of imported goods in the CPI 
basket.

Mar 14

> Is it true to say that in Mankiw's Open Economy Model, that imposing an
> import quota will only cause a change in the exchange rate? (it will not
> affect the market for loanable funds, or NFI?)

Yes.  The exchange rate must change to keep NX equal to the unchanged NFI.

Mar 13

> If the money supply formula is:
> 
> Msupply = reserves x (1/reserve ratio)
> 
> Then wouldnt the Msupply just equal the original deposits? (the reserves
> are a fraction of the deposits, then being multiplied by the reciprocal,
> giving the original number again)

Assuming that the public holds no cash, so that we're in the simple 
situation where Msupply = deposits, then by definition 

reserve ratio = reserves / Msupply

and the equation you wrote above is correct.  And it's true that the money 
supply equals deposits, by definition.  But the point is that the amount of 
deposits is a variable determined within the banking system, as banks lend 
excess reserves which are then deposited, changing the amount of deposits.  
The amount of reserves, on the other hand, is basically controlled by the 
Fed in our economy, or it is determined by the amount of whatever is used 
as reserves (such as gold) in economies based on commodities.  

We sometimes use examples in which something that can serve as reserves is 
discovered and added to the system, increasing "initial deposits."  But that 
adds equally to reserves and deposits, thus upsetting the reserve ratio and 
causing banks to start the process of lending and redepositing, so that the 
deposits and money supply eventually rise to the level implied by the money 
multiplier in your equation.

Mar 11

> I have a question about reserve requirement. In my notes, I found that
> the Fed uses reserve requirement to set target federal funds rate( which
> is interest rate among banks), but I don't really understand how this
> works, or why. Could you explain a little please?

No, I wouldn't quite say that.  The Fed uses three tools of monetary policy, 
all of which it controls directly:  the required reserve ratio, the discount 
rate, and open market operations.  It uses all of these to influence the 
size and growth of the money supply, but what it announces to the world is 
its target for the federal funds rate, an interest rate that it does not 
itself directly control.  Since the federal funds rate is very similar to 
the discount rate -- both are charged to commercial banks for very short 
term borrowing, one from the Fed and the other from other commercial banks 
-- the discount rate is probably the tool that I would identify as being 
used most directly to influence the federal funds rate.  In practice, as 
far as I know, the Fed seldom changes reserve requirements.

Mar 8

> Is the correct formula for the Money Supply with fractional reserve
> banking:
> 
> Msupply = deposits x (1/reserve ratio)

No.  The reserve ratio = reserves / deposits, so a correct formula would 
be deposits = reserves x (1/reserve ratio).  If the public holds no cash, 
then the money supply consists only of deposits, so this becomes: 
Msupply = reserves x (1/reserve ratio).

Mar 9

> I wanted to ask for clarification about the claim that NFI=NX because the
> two represent two sides of the same transaction:
> 
> Mankiw has an example where he shows that if the US exports cars to
> Japan, US NX increases because X rises; and NCO/NFI rises because the US
> is investing in yen (foreign asset).

That's right, but it implicitly assumes that the US exporter chooses to hold 
the proceeds of the sale as yen.  If he does not, especially if he exchanges 
the yen with somebody else who uses them for some other purpose, then the 
story would be different.  It will not always be the case that a transaction 
that increases NX will increase NFI.  It might instead simply reduce NX (as 
if the proceeds of the sale are used, perhaps by someone else, to buy imports 
from Japan).

> However, I have run into trouble several times while trying to do an
> example with imports:
> 
> if the US imports Japanese cars: US NX falls (because IM rise) but how do
> you reason that NCO/NFI falls?

Well, if the US importer started with a large holding of yen, which they use 
to pay for the car, then that's a fall in US holding of assets abroad.  Or if 
the Japanese exporter accepts payment in dollars, which he then holds, that's 
an increase in foreign holdings of assets (dollars) in the US.

Of course, as above, the most likely thing is probably that either the importer 
or the exporter exchanges dollars for yen on the foreign exchange market, in 
which case the answer depends on what someone else does with those dollars.

Mar 9

> 1. If NFI increases or decrease, does this always shift BOTH the DLF
> curve of the first chart and the NFI curve of the second chart the same
> amount?

Yes, if the change in NFI is NOT due to the domestic interest rate changing.  
In that case, it's just a movement along these curves.  But for any other 
reason that changes NFI, it will shift both curves and by the same 
(horizontal) amount.

> 2. I'm a little confused by the concept of NFI and what makes it increase
> and decrease. Does an exchange of currency change NFI?

NFI is the net changes in asset holdings, and it responds mainly to changes 
in the attractiveness of domestic versus foreign assets.  A currency 

exchange is not a cause of a change in NFI, since currencies are bought in 
order to use them for something, and that could be for purchasing goods.  
But on the other hand, if someone wants to hold more of a foreign asset 
(for reasons of its attractiveness), then they'll have to first buy the 
foreign currency in order to purchase it.

Mar 9

> Why is it that when interest rates rise, NCO falls and exchange rates
> increase?

When our interest rate rises, that makes our bonds more attractive compared 
to foreign bonds, so our residents buy fewer foreign bonds (less acquisition 
of foreign assets) and foreign residents buy more of our bonds (more 
acquisition of domestic assets by foreigners.  Both of these are decreases 
in NFI.  

As for the exchange rate, the easiest way to see it is that in order to buy 
our bonds, foreigners (as well as domestic residents who are cashing in 
foreign bonds) need first to buy our currency, and this bids up its price.

Mar 8

> I had a question on #3.  I know that NFI (or net capital outflow)  = NX.
> For Part A, I think that US NX increases because of the export of the
> truck to Canada.  However, I found that NFI is unchanged because the
> Canadian purchases the domestic asset, and then the dealer takes all of
> that money and makes a foreign portfolio investment in Canada.  Could you
> please let me know what I am doing wrong?

The only international transaction by the Canadian is the purchase of the 
truck.  The Canadian doesn't do anything with holdings of assets abroad.  
But you seem to be thinking otherwise.  Without that, then the only 
international asset transaction is by the US dealer, adding to assets in 
Canada, which is the NFI.

Mar 1

> I am a student in ECON 102. Looking at HW#3, i was wondering if there was
> a difference between Net Capital Outflow and Net Foreign Investemnt---
> the book seems to state that they are substitutable names for the same
> thing.

Yes, I would say that those two terms mean the same thing.

Feb 24

> How does the graph of money supply and money demand relate to the  real
> interest rate?

The two are not related at all.  In the long run, the real interest rate 
depends entirely on real variables, through savings and investment as we 
depict in the market for loanable funds.  And in the long run, money 
matters only for nominal variables, such as the price level.

In the last part of the course, when we deal with the short run, this will 
change, and money will then matter a great deal for interest rates.

Feb 22

> I have a quick question concerning 10a on the homework.  When I go to
> table H.8 on the Federal Reserve website, under Assets it has listed Bank
> Credits. Are bank credits the same thing as bank reserves? Thanks!

No, I don't think so.  The table spells out what bank credit is by showing 
all of its components right below it.  That is, bank credit seems to be the 
assets of the banks that consist of it extending credit others, by buying 
their bonds ("securities in bank credit") and by making loans to them 
("loans and leases in bank credit," which includes loans to banks, mortgages, 
and consumer credit).  The "cash assets" item, if you look at its definition 
in footnote 6, seems to be bank reserves.

Feb 17

> I was talking to my friend who is currently taking Econ 401 and we were
> discussing the CPI basket.  In the course of our discussion, I learned
> that in 2002, the CPI basket is now updated every 2 years instead of once
> a decade as you informed us in lecture.  I don't know if this is a major
> issue, but I thought you might want to know. 

Yes, thanks for telling me.  I didn't know that.  On the BLS web site, they 
say "For the current CPI, this information was collected from the Consumer 
Expenditure Survey over the two years 2001 and 2002."  Of course, it may 
be that they updated the basket but not the web site.  Or maybe they are 
just about to update the basket.  I'll have to keep watching.

Feb 15

> I was in lecture on tuesday when you said that there was a typo in the
> homework for 2f but I didn't write it down because I hadn't printed it
> out. I just printed it and it says that 1985 was at the natural rate.
> Did you say it was supposed to be 2005?  

Thanks.  I did try to upload a revised version, but I remember now that 
my connection crashed, apparently before it was done.  I think I've got 
it right now.  It says that 1995 had the natural rate.

Also, if the natural rate of
> unemployment is 7% and the rate for a certain year is 5%, is the cyclical
> rate -2% or just 2%?

That would be 2%.  That is, the extra unemployment, over and above the 
natural rate, is considered cyclical.

Feb 15

> i am in one of your sections and i think
> there might be a problem with part c of question 4.  I am pretty sure i
> found the proper page with the info for new and reentrant numbers as a
> part of unemployment...
> 
> http://www.bls.gov/news.release/empsit.t08.htm
> 
> ...however, these numbers are only for individual months of 2005, not the
> entire year altogether.  (and it doesnt even give all of the months).  am
> i looking at the wrong page, or should i just take one of the months and
> multiply by 12 or something to get an estimate.

You are looking at the wrong page.  One of the pages that I gave you includes links to tables of "Annual average data."  Look there.

Feb 12

> Also in question 3, doe the "f" comes out as a decimal or as a whole
> number? Are we ssupposed to just plug the numbers into the formula?

It's a percentage, so when you calculate it, it will be a decimal.

Feb 12

> As I am reading the textbook about reserve requirements, it keeps using
> the word "banks." In today banking industry, banks are owned by huge
> corporations that own many banks. When the "bank" must hold a certain
> reserve requirement, does that mean that in each physical branch of the
> banking corporation must hold some ratio of their deposits to reserves in
> their vault, or does it mean that as a corporation as a whole, it must
> have a certain amount of un-loaned money available for immediate
> withdrawal (I believe it is called M1 money). 

Good question.  I'm sure that the commercial banking operations of 
corporations such as CitiCorp are kept separate from the other things they 
do, and that the reserve requirements are checked within the banking 
operations alone.  They do not, however, have to hold all of their reserves 
in their vaults.  Reserves also include much larger amounts that the banks 
keep on deposit at the Federal Reserve Bank, and I would imagine that the 
adequacy of reserve is checked for all of the banking operations of a given 
company at once, not separately by each branch.

Feb 12

> I do know how to define cyclical unemployment but how am I supposed to
> calculate it. Do I suppose that the natural rate in '85 is 5.5%.Thanks

Oops.  I neglected to change the dates in part (f) of the question.  It 
should have said (and will, after I now revise it) "Suppose that 
unemployment in 1995 was at its natural rate. Define and calculate the 
cyclical unemployment in years 2000 and 2005."  Thanks for alerting me.

Feb 10

> I like to raise a question relating to this midterm #1
> 
> number 12, question about asking German citizen, Hans,
> 
> I answer choice was 5, because when he paid a engineer to show, "for the
> demonstration" this can count as a education which is a part of
> CONSUMPTION in GDP.
> 
> wording "demonstration" should not be considered as a investment, it
> should be count as a form of education thus I think answer choice should
> be 5

But it was a business expense, and businesses don't consume.  The training 
to use a machine is just one of the expenses needed to use it, and that has 
to be part of investment.

Feb 9

>>> On a previous exam, Winter 05, #18-19, the question fixes the basket of
>>> goods with different quantities than the base year. According to the
>>> textbook, "[the base year] must be the same year you surveyed consumers
>>> and fixed the quantities in the consumption basket." This seems to be
>>> contradictory to what the answer to the question is.

>> Where are you finding the statement that you quote?  It certainly
>> disagrees  with what I believe to be true, and I've now looked in the
>> textbook and was  not able to find it.
 
> It is on page 106 of the study guide book, and I have to double check if
> that is in the textbook.

I see.  Thanks.  That is simply wrong, and I hope you don't find anything 
like it in the textbook.  Not only can I think of no reason why the base 
year should be the same year as the basket, but I just checked on the BLS 
website and, while the base year currently being used for the CPI is 1982-4 
(and they also report it with a base of 1967), they state the following 
about the basket:  "For the current CPI, this information was collected 
from the Consumer Expenditure Survey over the two years 2001 and 2002."

--On Thursday, February 09, 2006 1:05 PM -0500 "Evan C. Lieberman" <elieber@umich.edu> wrote:

> Sure,
> 
> It is on page 106 of the study guide book, and I have to double check if
> that is in the textbook.
> 
> Thanks,
> 
> 
> Evan Lieberman
> 
> -----Original Message-----
> From: alandear@mail.umich.edu [mailto:alandear@mail.umich.edu] On Behalf
> Of alandear@umich.edu
> Sent: Thursday, February 09, 2006 1:00 PM
> To: Evan C. Lieberman
> Subject: Re: Previous Exam question
> 
> 
> --On Thursday, February 09, 2006 12:30 PM -0500 "Evan C. Lieberman" 
> <elieber@umich.edu> wrote:
> 
>> 
>> 
>> Professor Deardorff,
>> 
>> 
>> 
Feb 9

> But when government enacts an income tax, this lowers EQ interest rate,
> which results in an increased consumption? So even though the Private
> savings initially falls the same amount as the Public savings increase,
> the decrease in private savings is less because of increased consumption?
> AM i correct in saying this?   thus couldn't this phenomenon explain why
> Private savings decrease less than the increase in government savings? 

Yes, the fall in the interest rate does reduce private savings still further.  
But if, as you state here, private savings had initially fallen by the same 
amount that government savings increased, then the supply of loanable funds 
would not have shifted and the interest rate would not have fallen.  So the 
important thing for getting any result at all is to realize that, at the 
initial interest rate, private savings falls by less than government savings 
rises, due to the fact that private savers reduce both savings and 
consumption.

Feb 9

> 1.  Practice exam 2004- short answer #2
>         I understand why the demand for LF shifts to the left, but I
> thought that SLF would shift to the right because people are saving more
> of the non-taxed income.  Please explain why SLF does not shift.

Because the total amount of taxes is unchanged (it says that).  That is, 
they are paying less taxes on income, but more taxes on property.  So 
their disposable income and thus saving are unchanged for a given interest 
rate.

> 2.  Practice exam 2003- MC 13
>         I do not understand why the answer was e.none of the above
> because a tax reduction will cause people to save more but not by as much
> as government savings decreases.  This would cause a shift of the SLF to
> the left and increase the interest rate.  (I put B for my answer)

The main effect of b, which is a tax reduction on amounts people save for 
their retirement, is that it increases the incentive to save.  You are 
right that there is also an effect more directly on government saving, but 
we implicitly assumed that this effect was smaller.  For this reason, in 
the last couple of years I've tried to be more careful and would have 
reworded answer b to say, perhaps, "a revenue-neutral tax reduction on ...".

Feb 9

> Oh and also, why does an increase in income tax result in Private savings
> decreasing less than Public Savings Increasing. 
> 
>   
> 
> I know this has something to do with Marginal Propensity, but I still
> can't figure out the connection. 

Because all of the increased tax revenue is saved by government (since we 
assume that G doesn't change), but the decreased disposable income of those 
who pay more taxes is split between reducing saving and reducing consumption, 
so the reduction in private saving is smaller than the tax increase, and 
thus smaller than the increase in government saving.  

More formally, the marginal propensities to save and consume are both less 
than one (since they sum to one), and therefore the fall in private saving, 
which equals the change in disposable income times the marginal propensity 
to save, is less than the change in disposable income itself.

Feb 9

>             Does an increase or Decrease in GDP have any affect on EQ
> real interest rate? 

I'd say that depends on the reason for the increase in GDP, since some 
reasons (such as an increase investment and thus the capital stock) have 
their own effect on the loanable funds market.  But if the reason has 
nothing to do with loanable funds, as for example, I guess, if technology 
simply improves so that output goes up for given unchanged inputs, then 
that rise in income will cause an increase in saving, a rightward shift 
in supply of loanable funds, and thus a fall in the equilibrium real 
interest rate.

Feb 8

> I had a quick question regarding the catch-up affect.  From my notes I
> understand how to calculate when one countries GDP will double compared
> to the others if given the GDP growth rates of each.  However, for
> example, if you have one country with 40,000 GDP per capita and 2.5%
> growth, and another with 17,000 GDP per capita but 4% growth, How would
> you go about calculating how many years it will take for the lower GDP
> country to attain the same level of GDP per person as the higher one.

That is not actually what is meant by the catch-up effect.  And it is not 
a question that we would ask you, since to answer it would require a more 
complex calculation that we expect in this course.  The reason is that the 
only method of calculation we've given you is the Rule of 70, which is 
just a rule of thumb for how long it takes for something to double.  If, 
in your example, the poorer country had started with a per capita GDP of 
20,000 instead of 17,000, so that the ratio of the two just needed to 
double in order for it to catch up (the ratio then being 1/2 and doubling 
to 1), then the rule of 70 would say that this would happen in 70/1.5=47 
years (1.5 being the percentage growth rate of the ratio).  But with the 
ratio instead starting at 17/40=.425, the rule of 70 only tells you that 
somewhat more than this number of years is needed. (I'm sure that your GSI 
will be happy to show you how to do this using logarithms, if you really 
want to know, but you don't need it for this course.)

As for the "catch-up effect" mentioned in lecture and by Mankiw, this 
refers to the reason why the growth rate of the poorer country might well 
be higher than that of the rich country:  Due to the law of diminishing 
returns, an equal increment to, say, capital will yield a larger increase 
in GDP in a country with little capital than in one with lots of capital.

Feb 8

> If government deficit increases, then the supply of loanable funds
> shifts to the left. I understand why this will cause a decrease in
> investment, but I don't understand why this will also cause a  decrease
> in savings. When the loanable supply curve shifts left, it  increases the
> interest rate. Doesn't an increase in interest rates  cause an increase
> in the amount of savings?

Yes, it causes an increase in private savings, and indeed the level of 
private savings goes up in this example.  But national saving also includes 
government saving, which has gone down.  And we know that in equilibrium 
(in a closed economy) national savings equals investment, which has fallen, 
so the fall in government saving must be bigger than the rise in private 
savings.  Or, more simply, since S=SLF, I=DLF, and SLF=DLF, you can read 
off the diagram that S has fallen.

Feb 8

> What exactly is the definition- or what exactly constitutues- inventories?
> In our homework when Country A sells "bricks" to Country B to build a
> house, it reduces Country A's Investment because of the loss in
> inventories.  In other problems, when Country A sells "componets" to
> Country B to build a TV it does not count as a loss in inventories.  Any
> help clarifying what counts as inventories would help a lot.

Inventories are any materials or product that a firm has on hand.  So both 
bricks and components would count as inventories, as would amounts of what a 
firm produces that it has not yet sold.  Of course these show up in 
investment only if the level of inventories changes during the year in 
question.  Thus if you use something that you produced during the previous 
year, it must have been in inventories at the start of the year and 
inventories fall.  But if you use something that you produced this year, 
then inventories do not change (or, if you prefer, they first rise, then 
fall, so that the net change is zero).

Feb 6

> 1) If a citizen of country A vacations in country B and buys goods  and
> services from country B, should the goods and services be  considered
> import/export?

Yes.  That is, these purchases are an export of country B and both an 
import of A and consumption of A.

> 2) If Mexico makes car parts and puts them into inventory and then  sells
> them a year later, why is it considered a change in investment  for
> Mexico?

Because investment includes any change in inventories.  That is, the term 
"investment" is defined as the increase in plant, equipment, and inventories.

> 3) This question concerns Quiz #1 version A. When Mexico makes car  parts
> in 2004 and then exports them in 2005, shouldn't the net  investment
> change be zero instead of -$20,000? The way I see it,  Mexico adds
> +$20,000 to the inventory in 2004 and then subtracts - $20,000 from
> inventory in 2005 when it exports the parts to England.

That's right.  But the question only asked about the change in 2005.

Feb 3

> Is earnings per share and price earning ratio the same thing?

No.  The PE ratio is the ratio of the price per share to the earnings per share.

Feb 2

> I had a question about something you said in lecture today about
> unemployment.. I was wondering are employees on strike, or on
> medical/maternity leave considered unemployed? technically they arent
> working.. but, at least in the case of the medical and maternity leave,
> they are being paid. so im just a little confused about the exceptions.

Good questions.  The actual definitions are more detailed than I gave in 
class, and you can find them in the assigned reading from the BLS.  (I 
should have mentioned that in class.)  There you will find that the 
"employed" includes the two groups you mention -- workers on strike and 
workers on medical or maternity leave -- as well as various others who 
are temporarily absent from jobs (such as on vacation).

Jan 31

> I was wondering if we should focus on the questions you asked for the
> readings from the web, or should we also worry about the details of the
> readings for the exam?

Focus on the questions.

Jan 23

> After reading Chapter 8, it seems like there are no losers in the
> financial markets. Lenders win because they gain interest and  increase
> their purchasing power. Borrowers (Investors) win because  with the money
> they invest in starting their own business, they will  most likely earn a
> greater profit than the interest that they have to  pay back. Is there a
> loser in all of this?

No, there is no loser in what you've described, and you wouldn't expect 
there to be, since both parties enter into the transaction voluntarily.  
In this, a financial market is just like any other market.  However, this 
does not mean that, as you state, "there are no losers in the  financial 
markets."  Financial markets involve people holding assets and liabilities 
that change in value over time, and every time they do, someone loses and 
someone gains.

Jan 18

> How am I suppossed to use the CPI to calculate the well-being?

You are just turning a nominal variable (income) into a real variable.  
Use the method that I explained in class.

Jan 18

> anyway when i'm doing my assignment, i found that i have to know wage
> data since 1950 to solve number 3 on first assignment. but i come from
> korea, so it is not easy to ask the question for my parents.
> 
> could you give me some source or web address to find the data?

I think that you've misunderstood what I asked in question 3.  I want you 
to find somebody who is old enough to remember either a price or a wage 
from the past.  It doesn't have to be a wage, and it doesn't have to be in 
Korea.  You must know somebody here in Ann Arbor who is older -- perhaps 
one of the staff in your dorm, or somebody who works in a store or 
restaurant that you go to.  Just ask them if they can remember what they 
paid for something when they were younger, and be sure to find out 
approximately what year it was.  Then use the US CPI from the BLS to 
convert it to today's prices.

Jan 18

> I'm sorry that I am emailing you so much. If it bothers you please tell
> me.

No, I don't mind the questions.  As you know, I post the questions and 
answers for everyone to read if they wish, and this gives me something to 
work with.  Also, it helps to alert me to problems.

 What is the aggregate nominal income? I can't seem to find it. Is it
> the income in a specific year for a whole group of people, in this case
> middle class citizens?

In the homework, that is just what we called the numbers in the table in 
questions 2-d, and the point is just to convert them to real amounts 
using the price index that you've previously calculated.  I suppose that 
aggregate nominal income would be the sum of the nominal incomes of all 
the people represented, here the middle class, but that's not really 
important for answering the question since you are given the numbers.  
(And strictly speaking, we probably should have said "average per capita" 
rather than "aggregate", if we want to use these numbers to infer well-
being. Otherwise, is the number of people changed from year to year, you'd 
have no way of knowing whether a higher real aggregate income corresponds 
to those people being better off.)

 In question four when they ask for nominal and
> real rate returns, what is the difference between each?

I defined these in lecture:  the real rate is equal to the nominal rate 
minus the rate of inflation.  In question 4, the rate of inflation is 
simple, since there is only one good consumed, so you just need its price.

Jan 17

> Do we have to include the coolers when we are finding the nominal GDP?
> Problem 2 part b of the homework.

If they are produced, then they should be part of GDP.

Jan 17

> I have a doubt. When someone purchases stock shares from another country
> do both the Investment component and the Net Export component of both
> countries get affected? I will be waiting for your response. 

Neither are affected.  Purchase of shares of stock has nothing to do with 
production, or investment (as we define it -- remember, investment is the 
purchase of real plant and equipment), or net exports.

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