1. Over the past two decades, the United States has

a.  generally had, or been very near to a trade balance.

b.  had trade deficits in about as many years as it has trade surpluses.

c.  persistently had a trade deficit.

d.  persistently had a trade surplus.



2. In the open-economy macroeconomic model, the market for loanable funds identity can be written as

a.  S = I

b.  S = NCO

c.  S = I + NCO

d.  S + I = NCO


Figure 1.






3. Refer to Figure 1 above. Which of the following shifts show the effects of an import quota?

a.  shifting the middle supply curve in panel c to the one to its left.

b.  shifting the demand curve from the right to the left in panel c.

c.  shifting the demand curve from the left to the right in panel c.

d.  None of the above is correct.



4. Refer to Figure 1 above. If the interest rate were initially at r2 and an import quota were imposed, the interest rate would

a.  stay at r2.

b.  decrease because supply would shift right.

c.  increase because supply would shift left.

d.  decrease because demand would shift left.



5. Refer to Figure 1 abvove.  If the economy were initially in equilibrium at r2 and E3 and the government removed import quotas, the exchange rate would

a.  appreciate to E4.

b.  appreciate to E2.

c.  depreciate to E1.

d.  depreciate to E2.


6. Suppose that U.S. citizens start saving more. What does this imply about the supply of loanable funds and the equilibrium real interest rate? What happens to the real exchange rate?



If the US starts saving more, the supply of loanable funds will increase, and the equilibrium real interest rate will fall. Due to the lower interest rate, U.S. net capital outflow rises. This increase makes the supply of dollars shift to the right, and the real exchange rate of the dollar depreciates.





7. Aggregate demand shifts to the left if the money supply decreases. (True or False)


8. Which of the following adjusts to bring aggregate supply and demand into balance?

a.  the price level and real output

b.  the real rate of interest and the money supply

c.  government expenditures and taxes

d.  the saving rate and net exports


9. Other things the same, the aggregate quantity of goods demanded decreases if

a.  real wealth falls.

b.  the interest rate rises.

c.  the dollar appreciates.

d.  All of the above are correct.


10. State at least 4 variables besides real GDP tend to decline during recessions? Given the definition of real GDP, argue that declines in these variables are to be expected.


The variables include employment, sales, income, home purchases.

GDP can be measured either as the production or expenditure of final goods and services. This implies that any variable that can be used to measure production or expenditure for example sales or employment will move in the same direction as the real GDP






11.  Make a list of at least 5 things that would shift the aggregate demand curve to the right.


Examples include:

A stock market boom that increases consumption spending,

A tax cut that increases consumption,

An increase in government expenditure,

Improvements in the capital goods like computers that increase investment,

An increase in economic expansion.

Investment tax credit

An increase in money supply





Figure 2.






12. Refer to Figure 2 above. An increase in the money supply would move the economy from C to

a.  B in the short run and the long run.

b.  D in the short run and the long run.

c.  B in the short run and A in the long run.

d.  D in the short run and C in the long run.

13.  Refer to Figure 2 above. If the economy is at A and there is a fall in aggregate demand, in the short run the economy

a.  stays at A.

b.  moves to B.

c.  moves to C.

d.  moves to D.


14. During recessions which type of spending falls?

a. consumption and investment
b. investment but not consumption
c. consumption but not investment
d. neither consumption nor investment





15. According to the theory of liquidity preference, the money supply

a.         and money demand are positively related to the interest rate.

b.         and money demand are negatively related to the interest rate.

c.         is negatively related to the interest rate while money demand is positively related to the interest rate.

d.         is independent of the interest rate, while money demand is negatively related to the interest rate.



16. The multiplier is computed as MPC/(1 – MPC). (True or False)

Should be 1/(1-MPC)


Figure 3



17.  In Figure 3 above, which of the following sequences shows the logic of the interest rate effect?

a.  1, 2, 3, 4

b.  1, 4, 3, 2

c.  3, 4, 2, 1

d.  3, 2, 1, 4



18. Other things the same, which of the following responses would we expect to result from an decrease in U.S. interest rates?

a.  U.S. citizens decide to hold more foreign bonds.

b.  people choose to hold more currency.

c.  You decide to purchase a new oven for your cookie factory.

d.  All of the above are correct.


19.  What is the difference between monetary policy and fiscal policy?


The difference between monetary policy and fiscal policy is that monetary policy relates to raising or lowering of tax rates and is naturally implemented by a central bank, while fiscal policy are usually the decisions that are set by the national government and relate to taxes and the spending thereof. Nevertheless, both policies may be used to influence the performance of the economy in the short run.





20. Suppose that there are no crowding-out effects and the MPC is .9. By how much must the government increase expenditures to shift the aggregate demand curve to the right by $10 billion?


From the Multiplier formula, we know that 1/(1-MPC). This implies that an MPC of .9 means the multiplier = 1/(1 – .9) = 10. The increase in aggregate demand equals the multiplier times the change in government expenditures. Therefore, the increase in aggregate demand by $10 billion implies that the government would have to increase expenditures by $1 billion.







21. When the Fed increases the money supply, the interest rate decreases. This decrease in the interest rate increases consumption and investment demand so the aggregate demand curve shifts to the right. (True or False)




22.    The misery index is calculated as the

a.  inflation rate plus the unemployment rate.

b.  unemployment rate minus the inflation rate.

c.  actual inflation rate minus the expected inflation rate.

d.  natural unemployment rate plus the long-run inflation rate.


23.    In the long run,

a.  the natural rate of unemployment depends primarily on the level of aggregate demand.

b.  inflation depends primarily upon the money supply growth rate.

c.  there is a tradeoff between the inflation rate and the natural rate of unemployment.

d.  All of the above are correct.


24.    In the short run, policy that changes aggregate demand changes

a.  both unemployment and the price level.

b.  neither unemployment nor the price level.

c.  only unemployment.

d.  only the price level.





Figure 4.



25. Refer to Figure 4 above. If the economy starts at c (left graph) and 1(right graph), then in the short run, an increase in government expenditures moves the economy to

a.  b and 2.

b.  b and 3.

c.  d and 3.

d.  None of the above is correct.


26 . Refer to Figure 4 above. If the economy starts at c (left graph) and 1(right graph), then in the short run, a decrease in aggregate demand moves the economy to

a.  a and 2.

b.  d and 3.

c.  e and 3.

d.  None of the above is correct.



27.  If macroeconomic policy expands aggregate demand, unemployment will fall and inflation will rise in the short run. (True or False)


28. Suppose that the Fed unexpectedly pursues contractionary monetary policy. What will happen to unemployment in the short run? What will happen to unemployment in the long run?


If the Fed unexpectedly pursues contractionary monetary policy, then in the short run, unemployment will increase as the policy reduces actual inflation thus moving the economy down the Philips curve. However, in the long run, the economy will have returned to its normal rate of unemployment and thus the Philips curve will shift to the left as inflation expectations fall.








29. President George W. Bush and congress cut taxes and raised government expenditures in 2003. According to the aggregate supply and aggregate demand model

a.  both the tax cut and the increase in government expenditures would tend to increase output.

b.  only the tax cut would tend to increase output.

c.  only the increase in government expenditures would tend to increase output.

d.  neither the tax cut nor the increase in government expenditures would tend to increase output.


30.  If the unemployment rate rises, which policies would be appropriate to reduce it?

a.  increase the money supply, increase taxes

b.  increase the money supply, cut taxes

c.  decrease the money supply, increase taxes

d.  decrease the money supply, cut taxes


31. Explain the main arguments in favor of economic stabilization.



Fluctuations in the economy during recessions and booms are very costly. Especially during recession, a lot of resources are wasted since people and machines are inoperative instead of producing goods and/or services. This means that stabilization policies can help in eliminating these wastes.







32. Which of the programs below would transfer wealth from the young to the old?

a.  Taxes are raised to provide better education.

b.  Taxes are raised to improve government infrastructure such as roads and bridges.

c.  Taxes are raised to provide more generous Social Security benefits.

d.  None of the above transfer wealth form the young to the old.


33. Some countries have had high inflation for a long time. Others have had low or moderate inflation for a long time. Which of the following, at least in theory, could explain why some countries would continue to have high inflation?

a.  High inflation countries have relatively small sacrifice ratios and so see no need to reduce inflation.

b.  Inflation reduction works best when it is unexpected, and people in high inflation countries would quickly anticipate any change in monetary policy.

c.  In a country where inflation has been high for a long time, people are likely to have found ways to limit the costs.

d.  All of the above are correct.

34.  A consumption tax is a tax strictly on spending, while an income tax is a tax on salary paid for work. You are contemplating a run for the presidency in 2012 and some of your economic advisors have argued that you should campaign to replace the income tax with a consumption tax.  What argument for a consumption tax might they put forward to you?


  • We have to compare the two types of taxes.
  • In comparing the income tax, a consumption tax would place a levy on money spent on goods and services.
  • By levying a consumption tax, the Fed government will expand its tax base by capturing the money spent by all segments of the society including corporations, individuals especially the rich who seem to spend more.
  • A consumption tax will also reduce the number of tax evaders by placing a tax on transactions as opposed to income.
  • This type of tax will also simplify the current cumbersome system meaning that it will accomplish the much needed tax reform as well as enable the elimination of tax shelters and eliminate tax evasion.
  • Under the consumption tax, we will see that personal savings being excluded from the taxable base while the savings would encourage economic growth and help stabilize the economy


























EC1. Suppose that the government increases expenditures by $150 billion while increasing taxes by $150 billion. Suppose that the MPC is .80 and that there are no crowding out or accelerator effects.


  1. What is the combined effects of these changes? Why is the combined change not equal to zero?  Hint: Calculate the Multiplier and apply it to obtain a multiplier effect




We will use the multiplier formula, 1/(1-MPC).

Therefore, 1/(1-MPC) = 1/(1-.8) = 1/.2 = 5.

This means that an increase of $150 billion in the government expenditures will result to a shift of $750 billion ($150b * 5) in aggregate demand.  The increase in taxes will decrease income by $150 billion and so the initial decrease consumption of $150 billion * MPC will be: $150 billion * 0.8 = $120 billion and the multiplier effect created will be $120 billion * 5 = $600 billion. This basically means that the net change will be $750 billion –  $600 billion = $150 billion.

This implies that the changes do not cancel each other out because a tax increase will decrease consumption by less than the increase in tax.






  1. Using the IS-LM framework, sketch a graph that would indicate the fiscal policy initiative’s impact on equilibrium interest (r)  and income (Y) and suggest what, if any, monetary policy could the Federal Reserve implement to accommodate the government expenditure increase.


Figure 1









The IS-LM model determines the equilibrium interest rate as well.

The IS curve shifts right if there is: an increase in Co + Io + G, or a decrease in T

V The LM curve shifts right if: M/P or Eπ increases, or Lo decreases









EC2.          Fill in the table below with the direction of the variables that change in response to the events in the first column.


Event (1st Column)


U.S. real

interest rate


U.S. domestic



U.S. net



U.S. real

exchange rate

of domestic



U.S. trade


U.S. government

budget deficit


Rises Falls Falls Appreciates Falls
U.S. imposes

import quotas


No change No change No change Appreciates No change
capital flight

from the United


Rises Falls Rises Depreciates Rises




EC3. Economist John Taylor has suggested that the Fed use the following rule for chosing its target for the federal funds interest rate (r):




Where π  is the average of the inflation rate over the past year, y is real GDP as recently measured, y* is an estimate of the natural rate of output, and π* is the Fed’s goal for inflation.


  1. a.  Explain the logic that might lie behind this rule for setting interest rates. Would you support the Fed’s use of this rule?



The John Taylor rule is to basically help the Fed government to adjust its interest rates accordingly to adjust and balance out inflation. The above rule is an interest rate forecasting model that Taylor suggested should be used to determine interest rates by the Fed based on the country’s rational expectations theory. The equation basically says that the nominal and real interest rate is inflation and as such real interest rates should be factored in inflation.
b. Some economists advocate such a rule for monetary policy but believe p  and y should be the forecasts of future values of inflation and output. What are the advantages of using forecasts instead of actual values?  What are the disadvantages?


Since the federal funds rate is determined in a market, manipulation of that rate by the authorities presents a problem in that they will have difficulty determining whether a particular movement in the rate was a result of their actions or a consequence of market forces. This implies that they cannot be sure precisely how much of an observed change was policy-induced.

Moreover, quite aside from this problem, high nominal interest rates do not necessarily imply that money is tight but may be an indication that the expected future inflation rate is high.

According to this model, the advantage is that the nominal interest rate should respond to divergences of actual inflation rates from target inflation rates.

Source : Homework Help Online






Principal of Economics


This paper will create a table that lists at least four sources of growth in the economy along with two examples of each source


Sources Of Growth In The Economy



Physical Capital/ Natural Resources i.  Diamonds

ii. Oil

  • This is important to countries and without them countries will need to import the resources hence costly
  • Countries with a lot of natural resources can trade them with other countries to make more money for their economy
Human Capital i. Training

ii. Education

  • This is the value that humans bring to the market place
  • For example, a country’s literacy rate will impact human capital depending on the percentage who are able to read/write, skilled/non-skilled labor
  • Countries that invest in health, education will have a more valuable workforce with more production of goods and services
  • People with education are likely to contribute to technological advances
Natural Capital i. Factories

ii. Tools/Machinery

  • To increase its GDP, a country will have to invest in capital goods
  • The more capital goods a country has, the more goods they are able to produce and hence more money they can make
Entrepreneurship i.  Technology

ii. Organize the three sources for creation of jobs

  • Involves people who take risks to start and operate a business
  • The people organize their business well for it to be successful
  • They bring together the above natural, human and capital resources for the business
  • Create jobs & lessens unemployment
  • The more entrepreneurs a country has the higher the GDP of such a country


Bank Deregulation


Table of contents


Introduction ……………………………………………………………………………………4

Literature review………………………………………………………………………………..5

Beneficiaries of bank deregulation…………………………………………………………….6

Federal Reserve and Recession………………………………………………………………..9

Conclusion ……………………………………………………………………………………10


Table of figures

Figure 1: Income Stabilization After and Before Deregulation………………………… 7









This paper clearly summarizes the effects of banking deregulation of limitations on bank expansion and entry on the overall economic growth in the United States. Several states relaxed the restrictions regarding intra-state bank branching starting 1960s by permitting bank holding corporations to change subsidiaries to become branches and also by allowing nationwide de novo branching. Consequently, it increased the competition within the banking sector forcing the financial intermediaries to turn out to be more efficient. The proof suggests that economic growth within the states accelerated following the deregulation of restrictions in the country. A superior growth was actually noticed within the entrepreneurial sector.

Additionally, macroeconomic stability picked up as a result of interstate deregulation that enabled the banking system to integrate transversely within state borders. Studies extend to reveal that one of the strategies that helped the banking sector to be efficient was basically the focus on bank lending where different institutions have varying levels of dependence towards the external financing. Most of the industries and financial institutions that are likely to be dependent on the external financing will experience a rapid growth during the post-deregulation although other studies reveal that some of the banking institutions in the United States that borrow less funds grew rapidly after the deregulation.





1. Introduction

Banking deregulation refers to the elimination of regulations that revolve around the finance industry. It will be documented that in 1980 the Act related to bank deregulation was passed that did away with the interest rate regulation in the savings accounts and other things. This made most of the finance institutions to surpass the other companies in the market. The larger banks merged with one another while others acquired the smaller banks The American history regarding banking began from the establishment of Pennsylvania Bank in Philadelphia in 1780 which was geared at providing funding to the Continental Army that fought the Revolutionary War and the Philadelphia merchants (Mullineux, 2012).

During 1970s, the commercial banks in the United States faced stiff restrictions towards the interest rates which applied both on the lending as well as the deposit sides of the financial institutions. They were actually constrained for the most fragments to typical financial intermediation where they were restricted from lending and deposit taking for instance underwriting insurance products and corporate securities. It will also be documented that the financial institutions were also limited in terms of geographical scope for most of their operations. This ensured that a state could not allow those banks which were actually headquartered in other countries or states to acquire their banks or open branches which made many of the states to restrict or prohibit intrastate branching. Currently, most of these restrictions have truly been lifted. The ceilings on interest rate particularly on the deposits were fully phased out during 1980s and the laws regarding the state usury have weakened since the banks can lend anywhere and the limitations on the ability of the banks to engage in supplementary financial activities have truly been eliminated. This has made the banking system in the United States to be more consolidated both horizontally and vertically as well as being more competitive.

2.0 Literature review

There is a large quantity of literature on the effect of financial development towards the economic growth of any state although several economists refute this ideology. This argument developed from the differing views of Robison (1979), who claimed that causality originated from growth of the economy towards financial development since the states with excellent growth prospects are likely to build up their financial segment while Schumpeter and Röpke (2006), claimed that causality originated from financial development towards economic growth for the reason that a state that was obstructed by inadequate capital may possibly not grow.  A massive body of work based on this argument has been carried out since then regarding money and banking particularly on the empirics, theory as well as the banking deregulation of within different states (Holmstrom and Tirole, 1997). Holmstrom and Tirole further argued that bankers can decrease volatility through a clear monitoring within the firms and can also augment the level of volatility by dodging their responsibilities in monitoring.

Studies have been carried out to show that control of several factors such as economic shocks and macroeconomic conditions, institutional quality as well as regulatory policies then systematic or regular banking crises are not expected in those states with excessive concentrated banking structures that have smaller number banks (Beck and Demirguc-Kunt,  2003). Concentration is obtained by taking the assets ratio of the largest three banks to the total assets of the banks in the state. A systematic or regular crisis refers to the period when the banking system is incapable to carry out any intermediary role towards the economy and urgent assistance is provided to the particular banking system.

It will be documented that fewer banks results to an extra market power as well as higher profits which help these banks to be in good health during adverse shocks. Sky-scraping profits raise the banks’ charter value hence decreasing the risk-taking inducements for managers. It also becomes easier to regulate small number of banks in the industry. This is because the huge number of banks in the United States had more unstable history in there financial status as compared to Canada and U.K which have fewer banks (Allen and Gale, 2000).The bank integration witnessed in U.S as a result of the deregulation lessened the   financial constraints within most of the publicly-traded corporations that greatly depend on the exterior financing by increasing the shares of those banks that are locally headquartered and diversified (Correa, 2008). Those banks that are technologically advanced acquire the local community banks which in turn help them to obtain larger credits. Deregulation permits most of the banks to obtain supplementary business loans with no increment in their overall risk making them to pass on the economies and become external finance-dependent corporations.

3.0 Beneficiaries of bank deregulation

Bank deregulation helps in increasing the level of competition as well as encouraging cost savings. It actually reduces the entry barriers for the potential entrants in the market. Studies reveal that when new firms enter in the industry, the level of competition increases making the customers to have supplementary choices for services and products in the market (Calomiris, 2000).Through bank deregulation, a financial institution is able to reduce its prices so as to achieve an extra competitive position within the market. In addition, deregulation actually provides cost savings to their customers. Through the elimination or reduction of tariffs, prices tend reduce increasing customers demand as well as the company’s profits while passing a cost reduction to the customers.

Deregulation truly began in 1970s which constituted of the intrastate and interstate deregulation that enabled nationwide branching through acquisitions and mergers plus the free creation of multistate bank holding corporations. The banking deregulation has helped most of the small banks within the United State to survive in the competitive environment. Intrastate branching limitations, in collaboration with restrictions that revolve around the creation of multistate bank investment corporations strictly limited the ability of the banks to diversify most of their portfolios geographically.  These made most of the banks in regulated states to be tied more closely to the local economy leading to limited capacity to either assist local businesses put up with their risks or endure local shocks within the economy (Demyanyk, Ostergaard & Sorensen 1b, 2007). The home office laws of protection prohibited most of the outside banks from establishing new branches in the rural areas or small towns where another bank already existed. These regulations helped most of the small community banks to be shielded from the competitive pressures within the growing banking system by ensuring that the more-efficient banks do not enter in the market. This prevents the small banks from being kicked out of the market.

Figure 1

Income Stabilization After and Before Deregulation


SOURCE: (Demyanyk, Ostergaard and Sorensen 1a, 2007).

It will be realized that small banks actually depend on the bank finance by a larger proportion than the large businesses that are capable of issuing stocks and bonds. Due to their continued dependence on banks, most of the owners of the small businesses had an inferior ability in stabilizing their revenues during the periods of high regulations of the banking industry.  From the figure above it will be realized that those states which had comparatively more small banks had actually smaller degree of stabilizing their income on average before the deregulation as compared those that had less small businesses. The banking industry turned out to be more integrated, geographically diversified and competitive after the deregulation which by a large extend helped in stabilizing the income of the small businesses.

This was further fueled by the fact that the bank lending level towards the businesses increased as those banks that were more efficient could screen most of the business projects. The banks also improved the relationships that existed between the business borrowers which necessitated the banks to offer credits even during periods of economic recessions. On the other hand, interstate deregulations affect the bank corporations’ consolidation across the state margins and in turn will have a less impact towards the local markets. The aptitude to run multistate bank investment corporations is probable to have an affirmative impact on risk-sharing as well as banking efficiency although such improvements will actually benefit both the small and large business owners.




4.0 Federal Reserve and recession

Although bank deregulation leads to price reduction of the bank’s products and services which is very essential for its customers, it has a negative impact to most of the financial institutions particularly the small banks. Bank deregulation may reduce the interest rates for the savings account which makes threatens the survival of the smaller banks in the competitive market. Most of these smaller financial institutions have been acquired by the larger banks hence been swept out of the market. Additionally, bank deregulation has resulted to poor service quality offered by some of the financial institutions (Matasar & Heiney, 2002). Deregulation which was highly upheld by the Republicans ever since 1980s is actually behind most of the recessions that occurred in the country particularly the economic meltdown of 2008. The contractionary monetary policy that was adopted by Federal Reserve System in their view to control inflation necessitated the continued recessions within the states.

Banking deregulation which phased out several restrictions on the financial practices of the banks truly widened the lending powers of the banks as well as raising the limit of the deposit insurance which in turn increased the moral hazard problem. The Federal Reserve has in fact taken measures in order to repair the economy in during recessions. Monetary policy strategies are adopted by the American central bank to ensure that economy pulls out of the economic meltdown (Seidman, 2004).  It considers lowering the interest rates so as encourage more investments that help in increasing its gross domestic product. Another monetary policy option that is geared at fighting recession is through lowering the reserve requirements. In addition, the Federal Reserve buys government securities such as treasury notes and bills that by a large extend helps repairing the economy (Brezina, 2012).


5.0 Conclusion

The restrictions associated with the banking deregulation especially on the interstate banking and branching have led to emergence of constraints that prevent large efficient banks from surpassing their efficient rival competitors. The changes within the banks have also necessitated better services towards their customers as well as passing lower prices to them. On the other hand, bank deregulation has been associated with recession though the Federal Reserve uses monetary policy strategies to bring back the economy in operation.














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Beck, T., & Kunt, A. (2003). Bank competition, financing obstacles, and access to credit. Washington, D.C.: World Bank, Development Research Group, Finance.

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