Econ 102 Exam Study Guide – Macroeconomics Concepts and Practice Questions

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Q1. What are the main components of a bank's balance sheet?

Background

Topic: Bank Balance Sheets (Text Section 10.2)

This question tests your understanding of how banks organize their assets, liabilities, and equity, and why these categories matter for financial stability and regulation.

Key Terms and Formulas

Assets: What the bank owns (e.g., loans, reserves, securities).
Liabilities: What the bank owes to others (e.g., deposits, borrowings).
Bank Capital (Equity): The difference between assets and liabilities; the bank's net worth.
Balance Sheet Equation:

Step-by-Step Guidance

List the typical assets a bank holds, such as reserves, loans, and securities.
Identify the main liabilities, including customer deposits and any borrowed funds.
Recall that equity (or capital) is the difference between assets and liabilities.
Write out the balance sheet equation and check that the numbers balance.

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Q2. What are the primary functions of banks in the economy?

Background

Topic: Functions of Banks (Text Section 10.3)

This question examines your understanding of the roles banks play, such as facilitating payments, channeling savings to investment, and managing risk.

Key Terms

Financial Intermediation: Connecting savers and borrowers.
Liquidity Provision: Allowing depositors to withdraw funds on demand.
Risk Management: Diversifying and managing financial risks.

Step-by-Step Guidance

List the main functions banks perform for individuals and businesses.
Explain how banks facilitate payments and transactions in the economy.
Describe how banks help allocate resources from savers to borrowers.
Discuss how banks manage risk through diversification and other tools.

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Q3. What is a bank run, and how does the FDIC help prevent them?

Background

Topic: Bank Runs and the FDIC (Text Section 10.3)

This question tests your understanding of why bank runs occur and the role of deposit insurance in maintaining financial stability.

Key Terms

Bank Run: When many depositors withdraw funds simultaneously due to fears about the bank's solvency.
FDIC (Federal Deposit Insurance Corporation): Insures deposits up to a certain limit to prevent panic withdrawals.

Step-by-Step Guidance

Define what a bank run is and why it can be destabilizing.
Explain the role of the FDIC in insuring deposits and how this reduces the risk of runs.
Discuss the psychological effect of deposit insurance on depositor confidence.

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Q4. What is a Systemically Important Financial Institution (SIFI), and how are such institutions regulated?

Background

Topic: Regulation of SIFIs (Text Section 10.3)

This question focuses on the concept of 'Too Big To Fail' and the regulatory measures designed to oversee large, interconnected financial institutions.

Key Terms

SIFI: A financial institution whose failure could trigger a financial crisis.
Regulation: Enhanced oversight, higher capital requirements, and stress testing.

Step-by-Step Guidance

Define what makes an institution 'systemically important.'
List the main regulatory tools used to monitor and control SIFIs.
Explain why these regulations are stricter than for smaller banks.

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Q5. What are the main characteristics of money?

Background

Topic: Characteristics of Money (Text Section 11.1)

This question tests your knowledge of what makes something suitable to be used as money in an economy.

Key Terms

Medium of Exchange: Used to buy and sell goods and services.
Unit of Account: Provides a common measure for valuing goods and services.
Store of Value: Retains value over time.
Other characteristics: Durability, portability, divisibility, uniformity, acceptability, limited supply.

Step-by-Step Guidance

List the three main functions of money.
Describe each function and why it is important.
Identify additional desirable characteristics of money.

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Q6. What is the Quantity Theory of Money, and how does it relate to inflation?

Background

Topic: Quantity Theory of Money (Text Section 11.2)

This question tests your understanding of the relationship between the money supply, velocity, price level, and output.

Key Formula

Quantity Equation:
Where:
- = Money supply
- = Velocity of money
- = Price level
- = Real output (real GDP)

Step-by-Step Guidance

Write out the quantity equation and define each variable.
Explain how changes in the money supply can affect the price level, assuming velocity and output are constant.
Discuss the implications for inflation if the money supply grows faster than real output.

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Q7. What are the costs of unexpected changes in inflation?

Background

Topic: Costs of Unexpected Inflation (Text Section 11.3)

This question examines your understanding of how unanticipated inflation affects borrowers, lenders, and the overall economy.

Key Terms

Shoe-leather costs: Costs of managing cash balances in high inflation.
Menu costs: Costs of changing prices frequently.
Redistribution effects: Unexpected inflation benefits borrowers and hurts lenders.

Step-by-Step Guidance

List the main costs associated with unexpected inflation.
Explain how these costs affect different groups in the economy.
Discuss why predictable inflation is less damaging than unexpected inflation.

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Q8. What are the main roles of the Federal Reserve (the Fed)?

Background

Topic: Roles of the Fed (Text Section 11.4)

This question tests your knowledge of the Fed's responsibilities in the U.S. economy.

Key Terms

Monetary Policy: Managing the money supply and interest rates.
Bank Supervision: Regulating and supervising banks.
Financial Stability: Acting as lender of last resort.
Payment Systems: Facilitating payments between banks.

Step-by-Step Guidance

List the four main functions of the Fed.
Describe each function and its importance to the economy.
Explain how the Fed's actions can influence economic outcomes.

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Q9. What is the federal funds market?

Background

Topic: Federal Funds Market (Text Section 11.5)

This question tests your understanding of how banks lend reserves to each other overnight and why this market is important for monetary policy.

Key Terms

Federal Funds Rate: The interest rate at which banks lend reserves to each other overnight.
Reserves: Deposits that banks hold at the Fed or as cash in their vaults.

Step-by-Step Guidance

Define the federal funds market and its purpose.
Explain how the federal funds rate is determined by supply and demand for reserves.
Discuss why the Fed targets the federal funds rate as part of monetary policy.

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Q10. What does the federal funds market graph show?

Background

Topic: Federal Funds Market Graph (Text Section 11.5)

This question tests your ability to interpret the supply and demand for reserves and the equilibrium federal funds rate.

Key Terms and Concepts

Supply of Reserves: Controlled by the Fed through open market operations.
Demand for Reserves: Determined by banks' needs to meet reserve requirements.
Equilibrium: Where supply and demand for reserves intersect, determining the federal funds rate.

Step-by-Step Guidance

Draw or visualize the supply and demand curves for reserves.
Identify what shifts each curve and how that affects the equilibrium rate.
Explain how the Fed can influence the equilibrium by changing the supply of reserves.

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Q11. What is liquidity, and why is it important for banks?

Background

Topic: Liquidity (Text Section 11.5)

This question tests your understanding of the concept of liquidity and its significance for financial institutions.

Key Terms

Liquidity: The ease with which assets can be converted to cash without significant loss of value.
Illiquid Assets: Assets that cannot be quickly sold without a loss.

Step-by-Step Guidance

Define liquidity and give examples of liquid and illiquid assets.
Explain why banks need to maintain a certain level of liquidity.
Discuss the risks of holding too many illiquid assets.

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Q12. What causes shifts in the demand for reserves?

Background

Topic: Shifts in Demand for Reserves (Text Section 11.5)

This question tests your understanding of the factors that can increase or decrease banks' demand for reserves.

Key Terms

Reserve Requirements: Regulations on the minimum reserves banks must hold.
Payment Uncertainty: Unexpected payment flows can increase demand for reserves.

Step-by-Step Guidance

List factors that can shift the demand for reserves (e.g., changes in reserve requirements, payment uncertainty).
Explain how each factor affects the demand curve for reserves.
Discuss the implications for the federal funds rate when demand shifts.

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Q13. What causes shifts in the supply of reserves?

Background

Topic: Shifts in Supply of Reserves (Text Section 11.5)

This question tests your understanding of how the Fed can change the supply of reserves in the banking system.

Key Terms

Open Market Operations: The Fed buys or sells government securities to change reserves.
Discount Lending: The Fed lends reserves to banks directly.

Step-by-Step Guidance

List the main tools the Fed uses to change the supply of reserves.
Explain how each tool increases or decreases the supply of reserves.
Discuss the effect on the federal funds rate when supply shifts.

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Q14. What policy tool would help the Fed solve certain problems?

Background

Topic: Fed Policy Tools (Text Section 11.5)

This question tests your ability to match specific monetary policy tools to different economic problems.

Key Terms

Open Market Operations: Buying/selling government securities.
Discount Rate: Interest rate the Fed charges banks for loans.
Reserve Requirements: Minimum reserves banks must hold.

Step-by-Step Guidance

Identify the economic problem (e.g., high inflation, recession, liquidity crisis).
Recall which policy tool is most effective for each problem.
Explain how the tool works to address the problem.

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Q15. What are the main phases of the business cycle?

Background

Topic: Business Cycle Definitions (Text Section 12.1)

This question tests your understanding of the different stages of the business cycle and their characteristics.

Key Terms

Expansion: Period of rising output and employment.
Peak: The highest point before a downturn.
Recession: Period of declining output and employment.
Trough: The lowest point before recovery begins.

Step-by-Step Guidance

List the four main phases of the business cycle.
Describe the characteristics of each phase.
Explain how economists identify transitions between phases.

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Q16. What causes shifts in labor demand?

Background

Topic: Shifts in Labor Demand (Text Sections 12.2, 12.3)

This question tests your understanding of the factors that can increase or decrease the demand for labor in the economy.

Key Terms

Labor Demand: The number of workers firms are willing to hire at each wage rate.
Productivity: Increases in productivity can shift labor demand right.
Output Prices: Higher prices for goods/services can increase labor demand.

Step-by-Step Guidance

List the main factors that can shift the labor demand curve.
Explain how changes in productivity or output prices affect labor demand.
Discuss how technological change or government policy can also shift labor demand.

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Q17. The Stock Market crash of 1929: Which statement is most accurate?

Background

Topic: Great Depression Causes (Chapter 12)

This question tests your understanding of the causes and effects of the 1929 stock market crash.

Key Terms

Expectations: How investor beliefs about profitability affect markets.
Direct vs. Indirect Effects: Distinguishing between immediate and secondary impacts.

Step-by-Step Guidance

Review the main theories about the causes of the 1929 crash.
Consider whether the crash directly caused the Great Depression or reflected changing expectations.
Eliminate options that are factually incorrect (e.g., direct impact on more than half the population).

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Q18. Which of the following contributed to the Great Depression?

Background

Topic: Great Depression Causes (Chapter 12)

This question tests your ability to identify multiple factors that led to the Great Depression.

Key Terms

Bank Diversification: Importance of diversified assets for stability.
Self-fulfilling Expectations: How fear of bank failures can cause actual failures.
Fed Policy: The role of the Federal Reserve in crisis management.

Step-by-Step Guidance

Review each option and consider its historical accuracy.
Recall the role of inadequate diversification and self-fulfilling expectations in bank failures.
Consider the Fed's actions (or inaction) during the crisis.

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Q19. Which of the following likely contributed to the Great Depression?

Background

Topic: Great Depression Causes (Chapter 12)

This question tests your ability to distinguish between direct and indirect causes of the Great Depression.

Key Terms

Tariffs: The Smoot-Hawley tariff and its economic effects.
Bank Behavior: Moral hazard and risk-taking by large banks.
Labor Markets: The role of unionization and wage flexibility.

Step-by-Step Guidance

Review the impact of the Smoot-Hawley tariff on international trade and the U.S. economy.
Consider the evidence for each option as a cause of the Depression.
Eliminate options that are less supported by historical evidence.

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Q20. Out of fear that negative supply shocks would lead to inflation, the Fed during the Great Depression raised the discount rate on its loans to banks. This would most likely have contributed to _ stock prices and to __ bond yields.

Background

Topic: Monetary Policy and Asset Prices (Chapter 12)

This question tests your understanding of how changes in the discount rate affect financial markets.

Key Terms

Discount Rate: The interest rate the Fed charges banks for loans.
Stock Prices: How higher rates can reduce stock values.
Bond Yields: The inverse relationship between bond prices and yields.

Step-by-Step Guidance

Recall what happens to borrowing costs when the Fed raises the discount rate.
Explain how higher borrowing costs can affect stock prices.
Discuss the relationship between bond prices and yields when interest rates rise.

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Q21. Demand-side (Keynesian) shocks to “animal spirits” tend to cause prices to during expansions, whereas Supply-side (Real Business Cycle) shocks leading to expansions are associated with .

Background

Topic: Business Cycle Theories (Chapter 12)

This question tests your understanding of how different types of economic shocks affect prices during expansions.

Key Terms

Animal Spirits: Keynesian term for changes in confidence affecting demand.
Supply-side Shocks: Changes in productivity or technology.

Step-by-Step Guidance

Recall how demand-side expansions typically affect prices.
Consider the effect of supply-side expansions on prices (can be ambiguous).
Match the correct pattern to the options provided.

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Q22. Following the energy shocks of 1973 and 1979, the Fed chose to prioritize __ in its dual mandate and so it set a dramatically target federal funds rate.

Background

Topic: Fed Policy Response to Supply Shocks (Chapter 12)

This question tests your understanding of the Fed's dual mandate (price stability and employment) and its policy choices in response to inflationary shocks.

Key Terms

Dual Mandate: The Fed's goals of price stability and maximum employment.
Federal Funds Rate: The main policy rate targeted by the Fed.
Inflation vs. Employment: Trade-offs in monetary policy decisions.

Step-by-Step Guidance

Recall the economic context of the 1970s (high inflation due to energy shocks).
Identify which part of the dual mandate the Fed prioritized.
Explain how the Fed's choice affected the target federal funds rate.