PART I.  Questions covering the material since Midterm #2

1.    What is included in M1 in the United States?  Who creates money in the United States?  Briefly, how?

2.    In the U.S. in the 1950s and 1960s, imports were a constant 4 percent of GDP.  Today, imports as a share of U.S. GDP is about 17 percent, and that share is rising.  Explain why, all else constant, fiscal policy had a larger effect on GDP in 1960 than it does today.

3.    Inflation in China reached 3.3 percent in March, the highest rate in more than two years and above the target of three percent set by China’s central bank, the People's Bank of China.  China’s GDP grew in early 2007 at an annual rate of 11 percent.   Analysts recommend that China’s central bank raise interest rates. 

China pegs its exchange rate of the yuan (China’s currency) to the U.S. dollar.  If the Chinese yuan was instead allowed to freely (cleanly) float against the U.S. dollar, what effect would China’s increase in interest rates have on the exchange rate between the yuan and the dollar (that is, on the price in dollars of 1 yuan)? Would the yuan appreciate or depreciate relative to the U.S. dollar?   Explain.  Supplement your answer with a graph.

4.    Robert Samuelson (article #25) entitled his article “How Baby Boomers are Robbing Our Grandchildren.”  He says that baby boomers (those born between 1946 and 1964) are in a “state of denial about the true cost of” Social Security and Medicare and that “their blindness could put the country’s future at risk.”  Explain why future Social Security and Medicare spending is potentially a problem.

5.    Federal Reserve Board Vice Chairman Roger Ferguson ended his speech (article #29, “The Importance of Education”) by saying “the economy of the United States depends greatly on an educated workforce – one with the skills to tackle new ideas and new technologies, one in which morals and ethics are deeply instilled, and one with a love of learning, exploring, and questioning that lasts a lifetime.”

A.    What effect does the education of the workforce have on living standards (that is, on output per person)?

B.    What was the focus of Ferguson’s speech?  Provide enough illustrations from his speech to indicate that you read it.  (If you didn’t read the article, save yourself and your GSI time by just saying so and going to the next question.)

PART II.  Questions covering the entire course

6.    The price of gas increased to a nationwide average of $3.07 per gallon last week.  Analysts blamed the increase on temporary decreases in supply of gas by refineries. 

A.    Using supply and demand analysis, explain and show how the temporary decreases in supply of gas by refineries could affect the price of gas.  Supplement your answer with a graph.

B.    By late May, refineries will increase how much gas they produce. But in late May, the “summer driving season” begins, when many people take long vacations by car.  Do you think the nationwide average price of gas in early June will be more than $3.07, less than $3.07, or equal to $3.07 per gallon?  Explain.  Supplement your answer with a graph.

7.    Your sister and brother-in-law have been doing well.  They are very happy with their dance club, RROYB (Rock-and-Roll On You Bears).  Several other clubs have opened near by.  They lost some business to some of those clubs.  But generally, things have been going well.  They are doing just as well running the dance club as they could working anywhere else. 

    There is just one problem: they received a letter in the mail this morning notifying them that the cost of insurance for the club has jumped from $6,000 to $24,000 per year.  The cost of the insurance doesn’t depend upon how many nights a week they are open nor how many customers they serve.  Your cell phone rings.  It’s your sister.  She wants to know what you think they should do.  “Should we raise our prices? Should we close the club?  If we close, should we do so now?  Or later?”  What do you tell your sister?  Why?

8.    The day after a tanker fire closed two key overpasses at the MacArthur Maze, BART dropped their price to zero and offered free rides.  The number of people riding BART increased about 25 percent.  Does the increase in riders indicate that demand for BART rides is price elastic?  Explain.

9.    Because of the freeway ramp closure at the MacArthur Maze, the number of cars driving through city streets in West Oakland has increased from 5,000 to 30,000 per day.  The residents of West Oakland are suffering from increased noise, traffic, congestion, and pollution. 

A.   What is the socially optimal quantity of traffic in West Oakland?  What strategies might local government take to generate this socially optimal amount of traffic in West Oakland?  Explain.  Supplement your answer with a graph.

B.    Is this a situation in which the Coase Theorem applies?  Explain.

10.    On CNN.money, readers were asked what they would do if they unexpectedly received $5,000.  The results were:  25 percent would spend the money, 30 percent would use it to pay off credit card debt, and 40 percent would save the money.  An advisor to President Bush points to these results and says “See, the government can cut taxes even when the economy is booming, and our tax cut won’t have much effect on the inflation rate.”  Explain how the advisor draws this conclusion from the CNN.money results. 

Part III.  Comprehensive Essay

    Congratulations!  You landed an internship with Dr. Janet Yellen, President of the S.F. Fed. Your first task: write a background paper she can use to decide whether to advocate for Fed intervention in the U.S. housing market.  In your analysis, you want to explain the economics carefully.  Clearly indicate where you have invoked assumptions and what those assumptions are.  Supplementing your written analysis with clear and well-explained graphs is acceptable.   Including information from articles you have read is appropriate. Here is Dr. Yellen’s memo to you:

    Welcome to the San Francisco Federal Reserve Bank!  I’m very happy to have you here with us for the summer.  I know what a fine education in economics you are receiving.  I am looking forward to both teaching and learning from you.  And as a member of the Cal faculty (on leave), I must add:  Go Bears!
    The housing market is an ongoing concern of the Fed.  At the regional Federal Reserve Banks, we are concerned about the impact of the housing market on our local economies.  At a national level, we are considering whether intervention in the home mortgage market is called for.  I need some background information and analysis to guide my public statements in the months to come.
    There are two interrelated issues, as I’m sure you know.  One is the housing market itself.  The other is the subprime mortgage market.  The housing market issues are largely regional.  To the extent there is or was a housing bubble, it is (or was) regionally-specific.  The subprime mortgage market issue, however, is national in scope.  These lenders all operate in the national marketplace.  Few are specific to one region.
    There is pressure on the Fed to intervene in the housing market and in the subprime mortgage market.  Before I decide my position, I need to analyze the causes and effects of the problems.  I need your help.  Please prepare a position paper for me on the questions: Should the Fed intervene in the housing market?  Should it intervene in the subprime mortgage market?  I think the following issues are probably relevant.

•    Many pundits are talking about a “housing bubble.”  Certainly we’ve seen housing prices rise in the West in recent years, although in the last year prices have been steady or in some cases have fallen.  What forces could account for the rise in prices?  What is the evidence that this was a “bubble”?
•    The West and Southwest have been magnets for undocumented workers, many of whom get day work in construction.  Some politicians blame border enforcement for the large numbers of undocumented workers.  But does the housing market have anything to do with this?  For instance, is there any connection between the housing market and wages paid to construction workers?
•    Then there is the whole subprime mortgage market.  Perhaps you could start by explaining what a subprime mortgage is, and who is involved in this market.  Is there a connection between the pattern of prices in the housing market and the subprime mortgage market?
•    More and more of these mortgages are going into foreclosure due to default.  Several subprime lenders have gone out of business recently because they lost so much money on mortgage defaults.   The Fed controls the federal funds rate, as you know, and leaves determination of long-term interest rates to the market. How might all of this affect long-term interest rates?  Is this a cause for Fed intervention?
•    As we think about foreclosures, we probably want to think about both the housing market too.  What’s the impact of foreclosures on the housing market? 
•    The Fed has been successfully managing the macroeconomy for some time now.  But now there are apparently signs that the problems in the housing and subprime mortgage markets could push the economy into a recession.  How might that happen?  That is, how do we logically go from the problems in the housing and subprime mortgage markets to a macroeconomic recession?
•    At the same time, there seem to be signs that inflation is rising.  Is the inflation at all part of this story, or are its causes separate?  How does all this impact the Fed’s decisions about the federal funds rate?
•    Finally, your opinion!  Should I support Fed intervention in the housing market?  In the subprime mortgage market?  I’m interested particularly in the reasons for your opinion.

Part I.  Questions from any part of the course

1.  Consider this edited statement from an opinion article by Heiko Wijnholds in the 12/12/2005 Richmond (VA) Times-Dispatch: (The numbers refer to sentences.  Use the numbers in your answers to part a.)

    (1) Massive layoffs and plant closings are coming at GM and Ford, and auto-parts supplier Delphi is asking for bankruptcy protection. (2) The closings and layoffs [are due to] too much unsold inventory and too many cars sold at little or no profit.  (3) Costs are part of the problem:  [their fixed costs], in the form of older and less efficient plants and high-paid union labor with generous benefits, are simply too high.  (4) American consumers are buying Japanese and other models in increasing numbers.  (5) U.S. automakers will have to be more willing to take greater risks and invest more money in the development of new technology and models.  (6) The focus now should be on rebuilding market share on a more permanent basis.

a.    In general, what is a “positive statement”?  Using the sentence numbers, which sentences are positive statements?  What is a “normative statement”?  Which sentences are normative statements?

b.    What additional information do you need in order to evaluate whether the normative statements are valid?

2.  In the United States, why is the aging of the population – all else constant – increasing the federal government’s budget deficit?  State and explain any one option that Congress could pursue that would offset the effect of aging on the budget deficit.

3.  Students living on campus purchase meal plan points at the beginning of the term and use those points to pay for items purchased from Cal Dining.  Meal plan points expire at the end of the fall term; only 100 points can be carried over to the spring term.  At the beginning of December, lots of undergrads had lots of points left on their meal plan cards and were rushing to spend the points at Cal Dining.  Cal Dining – the dining commons, campus restaurants, and the Bear Market – sells not just perishable food but also non-perishable food and other goods. 

a.    If Cal Dining was a perfectly competitive market, what effect would the December rush of students with meal plan points have on prices at Cal Dining?  Would the prices of all products – perishable food and non-perishable products – be affected equally?  Explain, using graphs (of the perishable food market, and of the non-perishable products market) to supplement your answer.

b.    Suppose instead that Cal Dining is a monopoly.  Would you get the same results you predicted in part (a)?  Explain, using a graph to supplement your answer.

c.    Do you think Cal Dining is best characterized as perfect competition, monopoly, or monopolistic competition?  Why?

4.  A factory employing 10,000 workers in a town with population 100,000 threatens to close.  The mayor fears the closure will devastate the town’s retail district.  The town council counters that the mayor worries without reason; most of the goods the workers buy are imports.

a.    Explain why the mayor is worried about the retail district when it’s a manufacturing company that might close.

b.    Explain why the town council thinks the level of imports matter.

c.    Whose side would you take – the mayor or the town council?  Why?

5.  a.    BART needs to increase revenue.  Should BART increase fares?  Explain your answer.

b.    Delta Airlines also needs to increase revenue.  Should Delta pursue the same strategy as BART?  Explain.

6.  Why does the Federal Reserve increase interest rates in order to fight inflation?  (Be clear and complete.  At each step of the process from interest rates to inflation, be sure you explain why the effect you predict happens.)


Part II.  Questions covering material since 2nd midterm

7.  State and explain any two reasons that economists think productivity growth is good for the economy.

8.  On Monday December 12, Japan ended its embargo that since 2003 had banned beef imports from the United States.  Japan had been the largest foreign consumer of U.S. beef. 

a.    All else constant, what is the effect of ending the beef embargo on the dollar/yen exchange rate?  Does the dollar rise or fall?  Get stronger or weaker against the yen?

b.    On Tuesday December 13, the FOMC announced another 1/4 point increase in the federal funds rate.  What do you suppose is the combined effect on the U.S.  trade deficit with Japan of ending the embargo and the Fed's action?  What is the combined effect on net capital inflows (imports) from Japan?

9.  Which cause of inflation would the Fed prefer to fight: an increase in aggregate demand (aggregate expenditures) or a supply shock?  Why?

10.  a.    At right, draw a Phillips curve.

b.    Between 1970 and 1980, the United States experienced “spiraling inflation.”  What did the phrase “spiraling inflation” mean?  What was one cause of the spiral?

c.    Since 1990, has the U.S. economy moved along a Phillips curve, experienced a shift of the Phillips curve, or both?  Explain.


Part III.  The Comprehensive Essay Question

    Congratulations!  You landed an internship with Senator Dianne Feinstein.  Your first task: write a background paper she can use to decide whether or not to support federal tax incentives that will increase investment in IT and computer ownership. In your analysis, you want to explain the economics very carefully.  Clearly indicate where you have invoked assumptions and what those assumptions are.  Your analysis will serve as background for her public statements on the issue so supplementing your written analysis with clear and well-explained graphs is appropriate as is including information from articles you have read. Here is the memo to you from the Senator:

    Information technology (IT) – computers and software for processing information – is widely heralded as the key to the U.S. productivity growth surge of the late 1990s.  The gains in productivity came from two sources: greater use of computers, and greater processing speed of those computers.  Greater use of computers in the home, in school, in the office, and in the factory transformed how and what we produce. Faster processing speed and faster internet connectivity makes many tasks possible that simply were not feasible just a few years ago.
    But the good news of gains from IT may be over.  In nominal terms, in real terms, relative to total investment spending, and relative to GDP, business spending for IT has fallen since 2000. 
    The Bush Administration in Spring 2004 launched its Broadband Initiative, which through tax incentives aims for a goal of universal, affordable access for broadband technology by the year 2007 (http://www.whitehouse.gov/infocus/technology/economic_policy200404/chap4.html).  A number of states have implemented tax incentives encouraging investment in IT. For example, Ohio (http://www.odod.state.oh.us/tech/titc/) offers tax credits to anyone who invests financially in an IT business as does Hawaii (http://www.state.hi.us/tax/a2_b2_6hi_tech.htm).
    As the federal government considers whether to create its own tax incentive to encourage new investment in IT, it is important to analyze the economic effects of the earlier rise in IT.  That’s where I need your help.

•    Economists’ excitement over 1990s investment in IT stemmed from the effect on economic growth.  Why and how does IT affect growth?
•    The 1990s witnessed strong increases in demand for computers coupled with astounding reductions in costs of production.  What does logic say should have been the short run and long run effects on prices and quantity sold, on profits in IT firms, and on the number of firms?  If effective new incentives to investment in IT are put into place, what effects might we expect to see?
•    One downside to the rise of IT is the environmental effect.  Old discarded computer equipment is hardly biodegradable; once put into the landfill, it stays there.  Moreover many of the parts are downright toxic. On December 6, environmental activists from Greenpeace protested outside Hewlett-Packard headquarters in Palo Alto (http://www.mercurynews.com/mld/mercurynews/13341833.htm) What, if anything, should be done to minimize the environmental effect?
•    What about labor markets for computer scientists and similar skilled workers in IT?  In 1980, fewer than 2 percent of Bachelor’s degrees were granted in computer and information sciences (CS); now it is over 4 percent.  Since 1999 alone, the number of students majoring in CS has nearly doubled.  What ought to be happening to wages in IT?
•    Ownership of personal computers varies strongly with race and income, an effect called the “Digital Divide.” (www.ntia.doc.gov/ntiahome/fttn99/contents.html) Controlling for race, higher income families are more likely to have a computer in the home than are lower income families.  At all levels of income, Black families are less likely than White families to have a computer in the home.  Very poor Asian families are more likely to own a computer than are other poor families.  But use of computers in the home and in school is vital; more and more workers – not just computer scientists – are expected to be able to use computers in the workplace.  How might the Digital Divide affect the distribution of income?  Should tax incentives for family ownership of computers take the Digital Divide into account?  Should the President’s Broadband Initiative do so?
•    Increased investment in IT will have macro effects.  How might real GDP and unemployment be affected?  What about inflation?  Would increased IT investment have any effect on the Fed’s ability to conduct monetary policy?
•    Finally, your opinion!  Should I support federal tax incentives to encourage business investment in IT and personal ownership of computers? 

Part I.  Questions from any part of the course

1.   In Oregon, they grow trees which are used to produce wood products, and they fish salmon which are eaten for dinner. 
A)  Draw a production possibilities frontier (PPF) showing possible combinations of wood products and salmon dinners that can be produced with the available resources in Oregon.  Is the PPF upward sloping or downward sloping?  Why?  Is it linear or non-linear?  Why?

B)  Suppose the people of Oregon begin to study forestry and fishing, increasing their human capital.  What effect will their studies have on Oregon’s PPF?  Why?  Show the effect on your graph.

2.  Salmon are caught by a fisherman, who sells them to a fish seller, who sells a pound of salmon to a salmon-loving family, who grills it for a yummy summer dinner.  Anyone who wants to be a fish seller can go to the wharf early in the morning and buy salmon from the fishermen.  There are hundreds of fish sellers, selling salmon that look almost identical.  So many people sell salmon that no individual fish seller has control over the price of a pound of salmon.

A)   What sort of market is salmon fish selling: perfectly competitive, oligopolistic, monopolistic, or monopolistically competitive?  Explain, by listing three characteristics for that sort of market and noting how salmon fish selling shares those characteristics.

B)    Suppose each fish seller has minimum average total cost of $10 per pound of salmon, and minimum average variable cost of $8 per pound of salmon. Suppose the market is in long-run equilibrium.  Draw a graph showing the determination of the profit-maximizing quantity of fish sold by the individual fish seller.  Label your graph.  How much will a family pay for a pound of salmon?  How much profit is earned by the typical individual fish seller?

C)  Suppose that Harry the fish seller – and only Harry – finds that his average variable costs rise by $3 per pound of salmon.  How many fish will Harry now sell?  Explain.

Due to low rainfall in the Pacific Northwest, the summer 2005 salmon crop is expected to be much lower than usual.  The salmon fishermen, with fewer fish to sell, will raise the price that they charge all fish sellers. 

D)    Draw a graph that shows what happens in the retail market for salmon, where the fish sellers and the fish-loving families meet.  What effect will the shortage of salmon have on the market price of a pound of salmon this summer?  What effect will it have on the market equilibrium quantity of salmon sold?  What effect will the shortage have on the total consumer surplus enjoyed by salmon-lovers?

E)    Suppose that every fish seller – not just Harry – finds that the marginal cost and the average variable cost rise by $3 per pound of salmon.  Comparing your answer with part (C), will every fish seller now sell the quantity of fish you predicted in part (C)?  Explain.  Draw a graph for a typical fish seller that shows the old and new cost curves, and the old and new profit-maximizing quantity.


3.  Some people say “Ending world hunger is a public good.”  What does it mean for “ending world hunger” to be a “public good”?  Can we rely on private charity to end world hunger?  Explain.  Be sure to make any assumptions clear.


4.  New – stringent! – bankruptcy rules were signed into law by President Bush last month.  It now will be much more difficult for people who have too much credit card debt to get out of paying their credit card bills. 

Suppose that one effect of the new bankruptcy law is to change consumption behavior: families save part of any increase in disposable income, but when their disposable income drops, they cut their spending by the full amount of that drop.  Suppose that when government spending increases by $100 billion, real GDP increases by $200 billion. When government spending decreases by $100 billion, will real GDP decrease by $200 billion?  Explain

Part II.  Questions covering material since 2nd midterm

5.  A)    Why does an increase in real GDP lead to an increase in prices?  Why is the increase in prices so much larger when the economy is close to full employment than when there is lots of unemployment?

B)    In a Business Week Online article published May 2, the authors compared today’s sharp increase in oil prices with the 1970s increases.  But they said, “[T]here are some key differences between today’s economy and the stagflation mess of the 1970s. . . . The runup [of oil prices today] is a result of soaring demand, not OPEC cutbacks.”  Refer to the AS curve as you explain why it matters whether the oil price increase is due to “soaring demand” or “OPEC cutbacks.”

6.  Suppose the Fed increases interest rates in the United States.  What effect does their action have on exchange rates?  Does the dollar rise or fall?  What effect does their action have on net exports?  Explain your answers.  Supplement your answer with a graph of the foreign currency market.

7.  Draw a Phillips curve in the graph at the right.  Suppose the public for years had been expecting the inflation rate to be 2 percent, but suddenly they begin to expect a 5 percent inflation rate.  Show and explain what effect this change has on the Phillips curve.

8.  In 1969 the United States economy was nearly at full employment.  The government increased U.S. involvement in the Vietnam War, greatly increasing military expenditures. 

A)   Draw the AS/AD graph that illustrates the effect of increasing military spending in 1969.  Use the model to predict the effect on the economy’s price level, inflation rate, and output level.  Explain.

B)   In 1969, the Fed held the money supply constant.  Suppose instead the Fed had been held interest rates constant in 1969.  Would the effects on inflation and output have been the same as predicted in part (A)?  Explain.


Part III. Comprehensive Essay Question

    Congratulations! You nailed a summer internship with a California state legislator.  Your first task: write a background paper assessing State Senator Don Perata’s recent proposal to increase state taxes to fund K-12 education in California. In your analysis, you want to explain the economics very carefully. Clearly indicate where you have invoked assumptions and what those assumptions are. Your analysis will serve as background for your boss’ public statements on the issue, so supplementing your written analysis with graphs is appropriate as is including information from articles you have read in your economics course. Here is the memo to you from your boss.

California is home to the world’s greatest public university – the University of California, Berkeley – but lags far behind in its provision of public education at the K-12 level.  Thirty years ago, California was the envy of the nation in public education. But now California routinely falls in the bottom 10 states in high school graduation rates, test scores, computers per pupil, and various other measures of the quality of education.  In 2003, California spent $7,523 per pupil in the public schools, ranking 35th. Connecticut, which ranked #1, spent $12,014 per pupil. State Senate President pro Tem Don Perata (D-Oakland) recently proposed that California increase taxes in order to increase spending on public education. Increased funding could increase teacher pay; increase funding for music, sports, art, school nurses, and libraries; and increase funding for books and school supplies.  Please analyze the economic aspects of Senator Perata’s proposal by addressing the following points:

∙    Does increasing teacher pay make any difference to the quantity and quality of people who apply for teaching jobs?  Some argue that teachers are motivated primarily by the satisfaction they derive from teaching and pay is irrelevant. Others argue that teachers have opportunities other than teaching and salaries must therefore be competitive.  Please provide some economic analysis (and jargon) that helps me evaluate these arguments.

∙    Because of perceived poor quality of our public schools, many California parents pay for private schools for their kids. If funding increases public school quality, what impact will increased funding of public schools have on private K-12 schools in California?  Is there a difference between short-run and long-run effects?

∙    Many of my constituents argue their children are grown or are in private school, and they shouldn’t be expected to pay taxes for someone else’s kid’s education.  Are there any economic arguments to the contrary?

∙    Increasing taxes by $500 per person would allow California to increase public school funding to over $10,300 per pupil, moving California to the #10 ranking.  Businesses are protesting that this tax increase will hurt businesses because people will spend less and state unemployment will rise.  Is there any validity to their argument?  Are there any economic arguments to the contrary?

∙    Were California a nation, it would be the world’s 5th or 6th largest economy.  But if California’s public education continues to lag behind, its economy could falter.  Explain how funding education could enhance California’s future economic growth.  Are there any arguments to the contrary?

∙    Finally, I’m interested in your opinion (and its logic): Should I support Sen. Perata’s proposal?

I’ll be working late Friday.  Please have your paper on my desk by 8 p.m. on Friday May 13.  Thanks for your help.
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