Political Economy
Midterm Examination 2

Short Answer Essay

1. Two countries, the United States and China, produce computer chips and soybeans. China can produce either 100 computer chips or 50 bushels of soybeans, while the United States produces either 25 computer chips or 100 bushels of soybeans.

(a) Draw the straight-line Production Possibilities Curve (PPC) for both countries.

(b) If both countries do not trade, what is China's and United State's production levels if both produce 50/50 of each product?

(c) If both countries open up their economies to free trade, which products do the countries specialize in, and what is the increase in production for both countries?

2. What are four reasons why government intervenes in free trade?

3. Which strategy do the Asian Tigers and China use on their currencies?

(a) Which strategy does the U.S. use for the dollar? What kind of problems does it cause?

(b) What is the Dutch Disease?

4. What are four important characteristics of Asian Tigers?

5. Why does the Aggregate Demand Function have a negative slope? Please include the Real Balance Effect and Foreign Purchases Effect in your answer.

6. Please draw an Aggregate Demand and short-run Aggregate Supply for a country with an equilibrium price level of P* and equilibrium GDP*.

(a) What happens if the price level increases above P* and the AD and AS functions did not shift.

(b) What happens if the price level decreases below P* and the AD and AS functions did not shift.

7. Please draw an Aggregate Demand and short-run Aggregate Supply for a country with an equilibrium price level of P* and full employment at GDP _FE. What happens if the government increases taxes on business machines and equipment?

8. Please draw an Aggregate Demand and short-run Aggregate Supply for a country with an equilibrium price level of P* and full employment at GDP _FE. What happens if wealth increases for the country, because the country's stock market is rapidly increasing?

9. What is price stickiness? For each of the following items, please describe using at least one sentence.

(a) Price War

(b) Menu Cost

(c) Labor Market Restrictions

(d) Efficiency Wages

10. What is expansionary fiscal policy?

(a) Please show expansionary fiscal policy on the AS-AD graph.

(b) Why does government use expansionary fiscal policy?

(c) How much does government have to increase spending if the multiplier is 2, the GDP _FE = $10 trillion, and the current GDP is $6 trillion?

11. What is contractionary fiscal policy?

(a) Please show contractionary fiscal policy on the AS-AD graph.

(b) Why does government use contractionary fiscal policy?

(c) How much does government have to decrease spending if the multiplier is 2, the GDP _FE = $12 trillion, and the current GDP is $14 trillion?

12. What are the problems of the fiscal policy?

(a) Lags

(b) State and local governments

(c) Crowding out effect

(d) Political Business Cycle

13. What are the problems of a large government debt?

(a) Interest

(b) Crowding out effect

(c) Future generations

(d) Size and scope of government

(e) Monetizing the debt

14. What are the three reasons why people demand money?

15. What is contractionary monetary policy?

(a) Please show contractionary monetary policy on the AS-AD graph and interest rate-money graph.

(b) Why does central bank use contractionary monetary policy?

(c) What happens to the currency's exchange rate, if the central bank pursues contractionary monetary policy?

16. What is expansionary monetary policy?

(a) Please show expansionary monetary policy on the AS-AD graph and interest rate-money graph.

(b) Why does the central bank use expansionary monetary policy?

(c) What happens to the currency's exchange rate, if the central bank pursues expansionary monetary policy?

17. What are the problems of monetary policy?

18. What is cyclical asymmetry in regards to monetary policy?

(a) What target should a central bank pursue?