Economics 104Chapter 5 Review Questions & AnswersANSWERS TO QUESTIONS FOR REVIEW1. (The National Economy) Why do economists pay more attention to national economies (for example, theU.S. or Canadian economies) than to state or provincial economies (such as California or Ontario)?Each national economy has its own rules of the game, that is, its own laws, regulations, customs, andconventions for conducting economic activity. U.S. gross domestic product provides a measure of theperformance of the national economy and of how it interacts with the rest of the world.2. (The Human Body and the U.S. Economy) Based on your own experiences, extend the list of analogiesbetween the human body and the economy as outlined in this chapter. Then determine which variables inyour list are stocks and which are flows.Answers will vary. Students could describe parallels between the food that the body needs for energy andgrowth with the savings that an economy must generate to fuel investment and economic growth. Foodand savings are examples of flow variables, are measured over a period of time. When a body is weighed,a human has an objective idea of his or her size at a certain point in time. When the governmentmeasures the inventory of the economy, the economy has a measure of its size at a particular point intime. Weight and inventory are examples of stock variables.3. (Stocks and Flows) Differentiate between stock and flow variables. Give an example of each. Stock variables are measures at a given point in time such as height, weight, checking account balance.Flow variables measure something over an interval such as annual income, monthly budget. 4. (Economic Fluctuations) Describe fluctuations in economy activity over time. Because economic activityfluctuates, how is long-term growth possible?The economy moves through periods of expansion and periods of contraction. Contractions includerecessions in which total output and employment decline over a six-month period and more seriousdepressions in which sharp reductions occur in output and employment that last more than a year. Theend of a contraction is marked by the trough, or lowest point. After the trough, the economy enters anexpansion period in which total output increases until the economy reaches its peak.The economy grows over time. This is possible because the growth during expansions more thanoffsets the decline during recessions. In fact, expansions and contractions are measured as movementsabove and below the long-term trend line.5. (Economic Fluctuations) Why doesn’t the National Bureau of Economic Research identify the turningpoints in economic activity until months or even a year after they occur?The economy does not move smoothly through recessions and expansions. Throughout each year, theeconomy goes through seasonal fluctuations, for example, the tourist industry in Colorado expandsduring the winter months. In addition, the economy experiences random disturbances, such as the impactdue to hurricanes or earthquakes. The NBER must wait to determine whether a change in the direction ofthe economy is sustained in order to distinguish the impact of seasonal fluctuations and randomdisturbances and the movement into a recession or expansion. 6. (The Great Recession) The recession of 2007-2009 was made worse by a global financial crisis. Showthe effect of the Great Recession on the economy by shifting aggregate demand and/or aggregate supplycurves as appropriate.7. (The Global Economy) How are economic fluctuations linked across national economies? How could arecession in the United States trigger a recession abroad or vice-versa?Major economies around the world often fluctuate together. Economies are related through internationaltrade, finance, and migration, and ties grow stronger each year. A recession in the U.S. increasesunemployment and decreases production in the U.S. The U.S. will export fewer goods and services (sincetotal production declined) and will import fewer goods and services (since income declined). Foreignproduction goes unsold and foreign firms eventually cut back production and lay off workers. Foreigncountries experience lower output and higher unemployment, a recession. 8. (Leading Economic Indicators) Define leading economic indicators and give some examples. You may wish to take a look at The Conference Board’s index of leading economic indicators at http://www.conference-board.org/data/.Leading economic indicators are economic statistics that change prior to a change in the overalleconomy. That is, they turn downward before a recession and upward before an expansion, thus pointingto the future direction of the overall economy. Examples include orders for machinery and equipment, thestock market index, consumer confidence, and household spending on durable goods.9. (Aggregate Demand and Aggregate Supply) Why does a decrease of the aggregate demand curve result inless employment, given an aggregate supply curve?When aggregate demand decreases along a fixed aggregate supply curve, both the price level and theoutput level drop. As aggregate output declines, fewer workers are needed and unemployment rises.10. (Aggregate Demand and Aggregate Supply) Is it possible for the price level to fall while production andemployment both rise? If it is possible, how could this happen? If it is not possible, explain why not.Yes, this could occur if aggregate supply and aggregate demand increased. Both curves would shift tothe right, but the aggregate supply curve would shift more than the aggregate demand curve. This wouldforce down the price level while increasing production. Increased production and a lower price level would also occur if aggregate supply increased along afixed aggregate demand curve.11. (Aggregate Demand Curve) Describe the relationship illustrated by the aggregate demand curve. Whydoes this relationship exist?Aggregate demand describes an inverse relationship between the average price level of all goods andservices and the total quantities of goods and services demanded throughout the entire economy. Thequantity of aggregate output demanded depends in part on household wealth. An increase in the pricelevel decreases the purchasing power of bank accounts and currency. Thus, households are poorer whenthe price level increases, so they decrease the quantity of aggregate output
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