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5. After Bank X sells the $300,000 of U.S. government securities to the Fed, Bank X’s holdings of U.S. government securities decrease by $300,000 and its reserves increase by $300,000. Bank X now has $300,000 in excess reserves, which it may loan out, triggering the money creation process. Bank X– Balance Sheet Liabilities: Checkable Deposits $50,000,000 Assets: Reserves; Vault Cash $500,000 Deposit with the Fed $4,800,000 (+$300,000) Loans Outstanding; Mortgage Loans $20,000,000 Business Loans 13,000,000 Personal Loans 11,000,000 U.S. Government Securities 700,000 (-$300,000) Total Loans Outstanding $44,700,000 Total Assets $50,000,000 2. Changing the reserve requirement. The Fed sets the required-reserve ratio. Lowering the reserve ratio would give banks excess reserves. The excess reserves would allow the banks to make new loans, which would trigger the money creation process. Thus, lowering the reserve ratio will cause the money supply to increase. If the Fed raises the reserve ratio, the money supply will decrease. Example 4: Refer to Example 3. Initially the reserve ratio is 10%. Bank X has deposits of $50,000,000, and is required to hold $5,000,000 in reserves. If the Fed lowers the reserve ratio to 9%, Bank X would be required to hold only $4,500,000 in reserves. Bank X would now have $500,000 of new excess reserves, which it could loan out, triggering the money creation process. 3. Changing the discount rate. A bank in need of reserves can borrow reserves from other banks or from the Fed. A bank can borrow reserves from other banks in the federal funds market. The interest rate charged in the federal funds market is the federal funds rate. Federal funds rate – the interest rate one bank charges another bank to borrow reserves. A bank also can borrow reserves from their Federal Reserve District Bank. When a bank borrows reserves from the Fed, the interest rate charged is the discount rate. Discount rate – the interest rate the Fed charges banks that borrow reserves from it. If a bank borrows reserves from other banks, the money supply is not changed. The borrowing bank has more reserves, but the lending bank has fewer reserves. There is no change in overall bank reserves. Thus, the money supply is not changed. If a bank borrows reserves from the Fed, the Fed is injecting new reserves into the financial system and the money supply increases. To encourage borrowing from the Fed, the Fed would lower the discount rate. Thus, lowering the discount rate will increase the money supply. To discourage borrowing from the Fed, the Fed would raise the discount rate. Thus, raising the discount rate will decrease the money supply. FOR REVIEW ONLY - NOT FOR DISTRIBUTION During the credit crisis resulting from the bursting of the housing bubble, the Fed began using a new monetary policy called quantitative easing. Quantitative easing is discussed in an appendix at the end of this chapter. 11 - 3 The Federal Reserve System
The Housing Bubble and the Subsequent Recession The economy entered into a recession (the Great Recession) in December of 2007. Real GDP was flat in 2008 and decreased by 2.9% in 2009. Real GDP grew slowly, averaging slightly over 2% annual growth, from 2010 through 2013. The unemployment rate increased from 4.7% in November of 2007 to 10.0% in October of 2009. Though the recession officially ended in June of 2009, the unemployment rate was still at 9.0% in September of 2011 and did not fall below 7% until December of 2013. The Dow Jones Industrial Average (DJIA) reached a peak of 14,279.96 on October 11, 2007, and then fell to 6,440.08 on March 9, 2009, a drop of almost 55% from the peak. The federal budget deficit increased from $161 billion in 2007 to $459 billion in 2008 and then to $1,413 billion in 2009. The deficit was $1,294 billion in 2010, $1,300 billion in 2011, $1,087 billion in 2012, $680 billion in 2013, and $483 billion in 2014. Most economists agree that the primary cause of the recession was the bursting of the housing bubble and the subsequent credit crisis. Home prices nationwide were relatively flat throughout most of the 1990s. According to the S&P/Case-Shiller Index, real home prices increased by about 7.6% from July of 1990 to July of 1996. Then real home prices began a rapid increase, peaking in July of 2006, at over 121% higher than they had been in July of 1996. By July of 2012, home prices had decreased by over 27% from their 2006 peak. However, home prices were still 60% higher than they had been in July of 1996. (See Example 5 below.) Why did the housing bubble arise and why did its bursting cause a credit crisis leading to a severe recession? The four primary causes of the housing bubble and the credit crisis arising from the bursting of the housing bubble are discussed in this chapter. Example 5: The graph below illustrates the Case-Shiller Index of home prices for the years from 1990 to 2012. Case- Shiller Index 190 - 170 - 150 - 130 - 110 - 90 - 70 - z . . . . . 0 90 92 94 96 98 00 02 04 06 08 10 12 Years (July) FOR REVIEW ONLY - NOT FOR DISTRIBUTION . . . . . . . The Federal Reserve System 11 - 4
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PRINCIPLES OF ECONOMICS JEFF HOLT S
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Principles of Economics, 6th Editio
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16. Study Guide for Chapter 7 17. C
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11. Appendix: Book Review - “The
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20. Appendix: The NCAA Cartel 21. S
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Introduction: A Brief History of U.
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In the twentieth century, per capit
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Appendix: The 35 Largest National E
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Multiple Choice: ___ 1. The Jamesto
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2. Describe the economic cost of th
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Chapter 1 Scarcity and Choices The
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Example 5B: At the end of 1982, the
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Example 11: When Cindy quits her jo
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consequences may result in failure
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An upward sloping curve (as in Exam
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In making decisions, humans tend to
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5. ______________________ _________
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___ 13. If the value of one variabl
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Y Point X Y A 0 1 B 3 3 C 6 5 D 9 7
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Chapter 2 Trade and Economic System
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Example 4B: The following quantitie
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1. An increase in the quantity of r
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3. For whom to produce? This is det
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The graph below illustrates the shi
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The two primary economic systems ar
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___ 12. The capitalist vision sees
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___ 25. According to the book “Ca
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Chapter 3 Demand, Supply, and Equil
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. For inferior goods, income and de
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The same information can be placed
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Not only does a free market elimina
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$7 - 6 - 5 - S 3 S1 S 2 Price 4 - 3
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Example 17: The graph below illustr
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Questions for Chapter 3 Fill-in-the
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___ 12. Assuming a market originall
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$8 - 7 - 6 - 5 - Price 4 - 3 - 2 -
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Chapter 4 Inflation and Unemploymen
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Computing the Rate of Inflation The
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Full Employment Though unemployment
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3. Cyclical unemployment - due to d
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During the Great Depression, the ec
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Appendix: Think Like an Economist -
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Answer questions 8. and 9. based on
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___ 25. The extension of unemployme
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Chapter 5 Measuring Total Output: G
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5. Leisure. Leisure time is by defi
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The U.S. is a high per capita GDP c
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Example 17: In “An International
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The simple circular flow diagram be
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___ 3. Which of the following would
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2. Explain what nonproduction trans
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Chapter 6 The Aggregate Market The
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Example 2C: Assume the same facts a
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Example 5B: The price of crude oil
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Price Level Real GDP SRAS AD 2 AD 1
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Appendix: Why the Aggregate Demand
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___ 3. DEF Company can invest in ne
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2. List and explain the two factors
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Chapter 7 Classical Economic Theory
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Notice that the investment demand c
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Long-Run Equilibrium If Real GDP is
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Example 6B: When the economy is in
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Laissez-faire If the economy is sel
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___ 5. According to Say’s Law: a.
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3. On the graph below, draw an aggr
Page 132 and 133: Chapter 8 Keynesian Economic Theory
Page 134 and 135: Example 2B: The graph below illustr
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Page 138 and 139: Notice on the graph on the previous
Page 140 and 141: According to Keynesian theory, a ch
Page 142 and 143: “The General Theory” also inclu
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Page 146 and 147: 3. If the MPC is .667, and investme
Page 148 and 149: Chapter 9 Fiscal Policy The basic e
Page 150 and 151: Keynesian Fiscal Policy Theory and
Page 152 and 153: Example 5A: The federal government
Page 154 and 155: The Laffer Curve What will happen t
Page 156 and 157: Appendix: The Importance of Incenti
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Page 162 and 163: Chapter 10 Money, Money Creation, a
Page 164 and 165: Example 4B: The castaways on Gillig
Page 166 and 167: Looking at the balance sheet below,
Page 168 and 169: Demand-side One-shot Inflation Exam
Page 170 and 171: 4. Inflation increases uncertainty
Page 172 and 173: life; it came into existence not by
Page 174 and 175: calculated by using the potential d
Page 176 and 177: ___ 12. If the required-reserve rat
Page 178 and 179: 4. Referring to the balance sheet f
Page 180 and 181: Chapter 11 The Federal Reserve Syst
Page 184 and 185: Low Mortgage Interest Rates Mortgag
Page 186 and 187: Relaxed Standards for Mortgage Loan
Page 188 and 189: The Bursting of the Housing Bubble
Page 190 and 191: On February 17, 2009, the federal g
Page 192 and 193: Fed policies caused short-term inte
Page 194 and 195: ___ 10. The Fed’s most important
Page 196 and 197: ___ 25. In response to the recessio
Page 198 and 199: Chapter 12 Monetary Policy The basi
Page 200 and 201: 2. A change in aggregate demand (AD
Page 202 and 203: Monetarist Transmission Mechanism C
Page 204 and 205: 3. Borrowers do not have to seek ou
Page 206 and 207: Appendix: Book Review - “The Age
Page 208 and 209: Questions for Chapter 12 Fill-in-th
Page 210 and 211: ___ 16. The primary source of incom
Page 212 and 213: 7. According to Alan Greenspan, wha
Page 214 and 215: Chapter 13 Taxes, Deficits, and the
Page 216 and 217: Example 5: In 2015, Taxpayer A had
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Page 220 and 221: The complexity of the tax law also
Page 222 and 223: the current government spending and
Page 224 and 225: cut of 1964. The top rate was lower
Page 226 and 227: ___ 6. Federal excise taxes: a. are
Page 228 and 229: 3. How would eliminating the loopho
Page 230 and 231: Chapter 14 Economic Growth The basi
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2. Labor. Labor can contribute to e
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estricting international trade (e.g
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An improvement in technology (e.g.
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The table below shows the economic
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will increase both Real GDP and per
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___ 8. Which of the following is co
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___ 26. The opinion that economic g
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Chapter 15 Less Developed Countries
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Example 8: Countries A, B, C, and D
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Obstacles to Economic Development f
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c. Restrictions on international tr
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Appendix: Book Review - “The Powe
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Example 25: In Brazil, about half t
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Study Guide for Chapter 15 Chapter
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___ 13. Among the counterproductive
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4. List four ways that governments
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Chapter 16 International Trade The
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Other Benefits of Free Internationa
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Example 6: The graph below illustra
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competitive disadvantage. But dumpi
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is only 25% as productive as before
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Smith was skeptical of government a
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___ 4. For Country X, what is the o
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___ 18. Frédéric Bastiat’s “P
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4. On the graph below: (1) What is
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Chapter 17 Elasticity We are often
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Example 4A: What is price elasticit
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Example 5A: Gertie’s Gas and Go i
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Example 10A: When the price of Good
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Example 13B: On the graph below, su
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$7 - 6 - 5 - Price 4 - 3 - 2 - 1 -
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In the long run, would the deadweig
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___ 7. The factors that determine w
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3. a. Which price (or prices) from
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Chapter 18 Utility The basic econom
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Nonetheless, society generally assu
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Example 9: Capital City operates a
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Marginal rate of substitution - the
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The diamond-water paradox is the ob
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Complete the table below to answer
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4. The graph below shows indifferen
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Chapter 19 The Firm The basic econo
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than contributing to team productio
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1. Difficulty in raising large amou
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Corporations also use self-financin
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Example 24: A blacksmith who produc
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For financing needs, proprietorship
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___ 13. Corporations: a. are comple
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5. List two things that the absence
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Chapter 20 Production and Costs The
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In Example 5B, Birdwell finds that
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variable cost initially decreases,
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Quantity TC MC AFC AVC ATC 0 240 X
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If the scale of operation is increa
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average total cost. Average fixed c
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___ 11. Concerning the cost curves:
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5. Complete the following cost tabl
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Chapter 21 Perfect Competition The
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Even though a perfect competitor ca
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Example 6C: This example builds on
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At what price will there be neither
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Appendix: Perfect Competition in th
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Multiple Choice: ___ 1. A perfect c
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___ 17. Perfect competition: a. req
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Answers for Chapter 21 Fill-in-the-
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Chapter 22 Monopoly Of the four mar
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3. Exclusive ownership of an essent
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maximizing quantity (4 units) creat
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$22 - 20 - 18 - 16 - 14 - Deadweigh
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2. Negotiating, beginning at a high
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Legal barriers are created by gover
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___ 8. The slope of the demand curv
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Price Quantity 3. List some of the
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Chapter 23 Monopolistic Competition
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For Percomp (the perfect competitor
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Example 7A: The graph below represe
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Example 9: The Organization of the
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Example 12 illustrates the dilemma
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its current price and quantity. The
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___ 14. Game theory: a. is a method
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Answers for Chapter 23 Fill-in-the-
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Chapter 24 Factor Markets The basic
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$ $240 - 200 - 160 - 120 - 80 - 40
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Since producers will attempt to equ
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2. Differences in nonmoney aspects
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were his strikeouts, walks, and hom
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___ 3. To maximize profits, a produ
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___ 19. According to the book, “M
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Multiple Choice: 1. a. 8. c. 15. d.
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Chapter 25 Labor Unions The primary
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The elasticity of demand for union
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Example 4A: Assume that the graph b
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Notice from the graph in Example 6
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Wage Factory A Quantity of Labor S
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As a cartel, a labor union faces a
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___ 10. For a monopsony: a. there i
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3. The graph below represents a lab
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Chapter 26 Interest, Present Value,
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An increase in expected rates of re
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An asset is valuable because we exp
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Example 13B: General Ordnance prove
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Appendix: Present Value Table One f
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___ 4. An increase in expected rate
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Problems: 1. List and explain the t
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Chapter 27 Market Failure The basic
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External Benefit If a market genera
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Example 2: To encourage the consump
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$100 - 90 - 80 - MSC 70 - $ 60 - 50
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A common good is nonexcludable. Non
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___ 5. What government policy would
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4. Based on the information on the
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Chapter 28 Public Choice and Govern
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Candidates and the Median Voter Mod
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Example 8: According to State and F
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Example 10: When Elvis Presley was
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4. Pessimistic bias. This is the te
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___ 5. An elected official will: a.
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2. If a certain policy will yield s
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Chapter 29 Government Regulation of
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underproduction is the amount that
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micromanagement results in business
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market. They may agree with their c
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Questions for Chapter 29 Fill-in-th
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___ 10. The public interest theory
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4. List the four types of costs imp
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Chapter 30 Agriculture and Health C
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weather may cause bumper crops. Bad
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Security and Rural Investment Act o
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Example 12: From 1960 to 2013, the
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1. NHI would provide universal heal
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d. Insurance providers are not allo
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Answer questions 7. through 10. by
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___ 21. If there were no individual
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Chapter 31 Income Distribution and
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Income is more equally distributed
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over a typical career is the accumu
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Ideal Income Redistribution The ide
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Poverty - a family whose income fal
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Appendix: Income Inequality around
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How is this story an analogy for th
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___ 2. In 2013, the Lowest Income 6
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Problems: 1. Explain the two primar
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Absolute advantage - when one natio
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Fiat money - money by government de
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Nonrivalrous good - a good for whic
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Absolute advantage, 16-9 Absolute e
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“Company town”, 25-6 Comparativ
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Eli Lilly and Company, 22-1 Emergen
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Houston, Texas, 15-10 Human capital
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Market, 3-1, 3-8-9 Market basket, 4
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Political bias, 9-4, 12-7 Political
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Short run production, 20-2-3 Short-
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Upturns, 9-4 USDA, 27-9, 30-1-2, 30
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