Part I.  Questions covering the last third of the course (50 points total; 35 minutes total)
1.    (10 points; 7 minutes) During the financial crisis of Fall 2008, there was a worldwide “flight to liquidity”: many Europeans moved some of their wealth into U.S. Treasuries (government bonds).  What effect did their action have on the euro-dollar exchange rate?  Explain.  Supplement your answer with a graph.

2.    (16 points total; 11 minutes total)
a.    (10 points)  Why does the inflation rate tend to rise when the unemployment rate falls (that is, why does the Phillips curve slope down)?  Draw a graph that illustrates this relationship.
b.    (6 points)  If the price of oil rises due to supply restrictions in the Middle East, but businesses that pay higher oil prices do not increase the prices they charge consumers, what is the effect on the Phillips curve?  Explain.

3.    (12 points total; 8 minutes total)
a.    (6 points)  What is the definition of “federal funds rate”?  Why do we say the Fed “targets” a federal funds rate instead of saying the Fed “sets” the federal funds rate?
b.    (6 points) What is an inflation hawk?  What is an inflation dove?  Connect your answers to the Taylor Rule:
FFR = neutral interest rate + A(actual - goal inflation rate) + B(actual - goal %ΔGDP)

4.    (12 points total; 8 minutes total)
a.    (6 points)  What is the definition of the government’s budget deficit?  What is the definition of the government’s structural deficit? 
b.    (6 points)  Would raising taxes on high income individuals lower the structural deficit?  Would decreasing transfer payments to people who are unemployed for more than 52 weeks lower the structural deficit?  Explain your answers.

Part II.  Questions Covering Any Part of the Course (90 points total; 63 minutes total)

5.    (24 points total; 17 minutes total) Smoking not only kills smokers, it creates negative externalities for nonsmokers. Therefore the federal government imposes a tax on cigarettes.  Assume cigarettes are sold in a perfectly competitive market that was at long-run competitive equilibrium before the tax mentioned in part (a) was imposed.
a.    (10 points) In 2009, the federal government increased the cigarette tax by 62¢ per pack.  In the short run, how does the increase in the cigarette tax affect the price and quantity of a pack of cigarettes?  Explain.  Supplement your answer with a graph of the market for cigarettes. 
b.    (6 points) What can you say about who bears the greater burden of the cigarette tax: consumers or sellers?  If you need to make an assumption in order to answer the question, make that assumption explicit (that is, write it down).
c.    (8 points) In the long run, what is the effect of the higher cigarette tax on the equilibrium quantity and price of a pack of cigarettes?  Explain.

6.    (6 points; 4 minutes) Vodka is a liquor that is odorless, colorless, and tasteless.  A greater number of people want to buy a higher quality vodka than want to buy a lower quality vodka.  Even though there are no true differences in quality – one odorless, colorless, and tasteless vodka is indistinguishable from another – many people believe that a higher priced vodka is a higher quality vodka.  What does this belief imply about the demand curve for vodka?  Explain and supplement with a graph.

7.    (16 points total; 11 minutes total)
a.    (10 points) When a war ends, the government’s military spending declines.  All else constant, what effect does the drop in military spending have on GDP?  On employment?  On unemployment?  Explain.
b.    (6 points)  When World War II ended, U.S. women’s labor force participation rate fell from 38 to 30 percent.  Why is this fact relevant when considering how a drop in military spending affects unemployment?

8.    (20 points total; 14 minutes total) There are two types of bookstores: [1] large online and chain bookstores such as Amazon.com or Barnes & Noble, and [2] small independent bookstores.  Independent bookstores operate in a monopolistically competitive industry.
a.    (6 points)  Suppose before Amazon or Barnes & Noble existed, the typical independent bookstore was earning zero economic profit.  Draw a graph at the right that illustrates this initial condition.
b.    (8 points)  Online and chain bookstores now exist.  They compete with independent bookstores.  Why has the entry of  online and chain bookstores led to a decrease in the number of independent bookstores?
c.    (6 points)  A Different Light, an independent bookstore in the Castro in San Francisco, closed permanently in April 2011.  Early in April, a store manager said, “The closing date will be determined by sales.  Any day could be the last.”  Explain her statement using economic concepts.

9.    (24 points total; 17 minutes total) Housing played a key role in the Great Recession of 2007-2009.
a.    (8 points)  Mortgages and houses are complements.  Use the supply and demand model to explain how the drop in mortgage costs after about 2000 affected house prices.  Supplement your answer with a graph.
b.     (8 points)  What effect did the change in house prices you predicted in part (a) have on investment spending for residential construction in about 2000-2005?  Explain.
c.    (8 points)  What is the connection between the drop in mortgage costs in part (a) and employment in restaurants?  Explain.

Part III.  Comprehensive Essay (60 points; 60 minutes)
You are a journalist for a major news source that is read by educated people without a background in economics.  Because you are one of the few people on staff who has taken even one semester of economics, your editor has assigned you a feature article that explains to the public the dilemma the Fed faces: spur economic growth or react to rising commodity prices.  You read the FOMC’s statement after their April 27 meeting (http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm) and attended the historic first press conference by a Fed chairman on April 27 (transcript available online).  Your editor gave you the memo and outline below.  You know your editor well: you must cover all the topics in the outline in your piece; if you can write a much more compelling essay by re-ordering the outline, that’s ok, but you shouldn’t change the order of the outline for any other reason.  Your draft is due to your editor by 6 p.m. on Monday May 9.

We’re so glad we have someone on staff who has taken economics and can explain all of this to our readers.  You’ve got your notes from the April 27 press conference as well as the FOMC’s April 27 statement in which they announced: “The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and . . . will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.”  In your article, please address the following:

The major point of your article should be to explain why slow economic growth coupled with rising commodity prices creates a dilemma for the Fed.

• Start with some background. 
• The distinction between monetary and fiscal policy: who does what
• The Fed’s typical action when economic growth is too slow & how the economy reacts
• The Fed’s typical action when inflation is too high & how the economy reacts
• Why the Fed can’t simultaneously spur growth and fight inflation
• Then incorporate current issues
• Some data on the current state of the macroeconomy (put the data in an historical context)
• Commodity prices and what explains their rise
• When commodity prices started rising last year, we didn’t experience increases in consumer prices.  But several major firms recently announced pending price increases: Proctor & Gamble, Kimberly-Clark, and several clothing retailers.  There seems to be a microeconomics story in here somewhere.  Why would prices for some consumer products rise more than others? 
• In their April 27 statement, the Fed said, “The Committee . . .will pay close attention to the evolution of inflation and inflation expectations.”  Why does the FOMC seem to care more about inflationary expectations than about commodity prices?
• The current push to lower the structural deficit and how that affects fiscal policy’s ability to spur economic growth
• At the end of your article, readers want to know “What should the Fed do?”  Spell it out clearly:  what are the Fed’s options and what determines which option the reader might prefer.

I look forward to reading your piece.  The usual limit for a feature is 750 words, so that’s a reasonable length to shoot for.  This is your first draft, though, so it might run a bit long.  Thanks.
And, as always, Go Bears!

Part I.  Questions covering the last third of the course
1.  Greece is a European country whose currency is the euro (€).  Greece’s government has been borrowing because of its large budget deficits.  There is widespread fear that Greece will be unable to repay the people and institutions that have lent it money.  This is being called the “Greek Debt Crisis.” 
a.     Last week, wealth holders around the world reacted to the Greek Debt Crisis by selling European financial assets and buying U.S. financial assets.  Explain why their action changed the exchange rate between euros and dollars.  Did their action strengthen or weaken the dollar relative to the euro?  Supplement your explanation with a graph of the market for euros.
b.    The Greek legislature approved “austerity measures” last week:
            •    increased taxes
            •    reduced pensions (the equivalent of our Social Security), and
            •    reduced pay for government workers. 
    Define government budget deficit.  Define government debt.  What effect will these austerity measures have on Greece’s government budget deficit?  Will the austerity measures definitely lower Greece’s debt?  Explain.

2.  Greece is part of the “Eurozone” – 16 countries that each use the euro (€) as its currency.  The European Central Bank (ECB) sets monetary policy for the Eurozone. (You can think of the ECB as “Europe’s Fed.”)  One monetary policy applies to all 16 countries of the Eurozone.
a.   The austerity measures described in Question 1b will increase Greek unemployment.  If the ECB wanted to use interest rates to help Greece’s economy following imposition of the austerity measures, should the ECB increase interest rates or decrease interest rates?  Why?  Explain fully.
b.  Suppose the ECB takes the action you propose in Question 2a.  In Eurozone countries that are currently at or near full employment, what impact will that change in interest rates have on inflation?  Explain.
c.  Germany’s representative to the ECB, Mr. Axel Weber, is a strong inflation hawk.  What does it mean to be “an inflation hawk”?  Would Mr. Weber support or oppose the ECB using interest rates to help Greece’s economy following imposition of the austerity measures?  Explain.
d.  ECB decisions about interest rates can be described by a Taylor rule.  What is a Taylor rule?  Does the statement “ECB decisions about interest rates can be described by a Taylor rule” mean that the people at the ECB actually use the rule to make their interest rate decisions?  Explain.

Part II.  Questions Covering Any Part of the Course
3.  One estimate states that for every 1 euro (€) drop in government spending, Greek GDP drops by 2.5€.  The austerity measures described in Question 1b will reduce Greece’s budget deficit by 30 billion € in 2010 and 2011.  Greece’s GDP was just under 300 billion € in 2009. 
a. Explain why the drop in GDP is greater than the drop in government spending.
b. What effect will the austerity measures have on Greece’s GDP?  Explain.  If you need more information to answer the question, what information do you need and why?

4.  Bridges to Prosperity (http://www.bridgestoprosperity.org) is a nonprofit that constructs and repairs bridges in Asia, Africa, and South America.  Founder Ken Frantz states, “A simple cable-suspended footbridge can boost economic activity and improve life for isolated populations around the world.”  Villagers can travel across otherwise impassable rivers to attend schools, find jobs, reach markets to sell crops and livestock, and visit clinics to get their children medical care.

Explain how a footbridge over an otherwise impassable river will affect the economy of a village that had previously been isolated.  Illustrate with a graph of the production possibilities frontier.

5.  Suppose the economy can be described by the following equations (all values are billions of dollars per year):

            C =   800 + 0.8Yd        EX = 1,000        TR =   500              I = 1,500                       IM = 1,500        TA = 1,500                G = 2,000

What is the equilibrium level of output and income?  Show all your work or you will receive zero (0) points on this question.  If you cannot solve this problem without a calculator, set it up and go as far as you can to receive as much partial credit as possible.  No calculators allowed during the exam.

6.  Your sister is having a garage sale (also known as a yard sale, tag sale, or rummage sale).  She will sell her old clothes, books, toys, and lots of other things from your driveway on Saturday from 9 a.m. until 2 p.m.  She wants to earn as much revenue as possible.  Should she charge a lot or a little for each item she offers for sale?  What does this have to do with price elasticity?

7.  Crude oil (or, petroleum) is used to produce gasoline which we use to drive cars.  An offshore oil drill owned by British Petroleum (BP) recently exploded in the Gulf of Mexico.  Now 200,000 gallons of oil are gushing into the gulf waters every day.  The oil is contaminating the coasts of Louisiana, Mississippi, Alabama, and Florida.  Many people believe this will be the worst environmental disaster in U.S. history. 

The United States imposes a 5-cent-per-barrel tax on crude oil (petroleum) produced in or imported to the United States.  (A barrel equals 42 gallons.)  The tax goes into an environmental clean-up fund which is used following disasters of this type.  Is 5 cents the socially-optimal tax?  Explain.  Supplement your answer with a graph.

8.  Louisiana provides a third of the oysters and shrimp sold in America.  Due to the massive oil spill described in Question 7, fishing has been banned in the waters off of Louisiana. 
a. What will happen in the short run to the equilibrium price and quantity of shrimp in the U.S.?  Supplement your answer with a graph.
b.  Many seafood restaurants in Louisiana have shut their doors.  What is the economic rationale for shutting down?
c.  If seafood from the Gulf is not available for many years, what will happen over the next several years to the number of seafood restaurants?  To the profits of the seafood restaurants that survive?  Explain.

Part III.  Comprehensive Essay

Your task is to write an op-ed (opinion/editorial) article for your hometown newspaper.  Op-ed’s should be written to an audience of educated people who may be unfamiliar with the specific topic you are discussing.  Background information and explanation of unfamiliar terms are therefore important. There should be a position (an opinion) that you are presenting and defending.  Your analysis must be sound and should consider both sides of the issue. It is unusual for an op-ed to include a graph, though it’s not unheard of. 

To help guide your article, we’ve provided an outline below.  Please follow the outline if at all possible.

Part I. Last third of course

1.  Suppose the economy can be described by the following equations (all values are billions of dollars per quarter)
        C = 300 + 0.60Yd        EX = 420           I = 500 + 0.15Y        IM = 100 + 0.25Y           G = 500            TR = 300            TA = 500
a.    What is the equilibrium level of output and income, Y*?  Show all your work or you will receive zero (0) points on this question.  If you cannot solve this problem without a calculator, set it up and go as far as you can (cost of not fully solving = loss of 3 points).  No calculators allowed during the exam.
b.    Would the formula 1/(1-mpc+mpm) give you the value of the multiplier in this economy?  Why or why not?

2.  “Is monetary policy more effective in an open economy than it is in a closed economy?” The answer to the question is, “It depends.”  Explain what it depends upon.

3.  Addressing today’s macroeconomic problems is challenging, to say the least.  Now another threat has appeared: wage cuts. 
a.    Drawing on the articles “Falling Wage Syndrome,” by Paul Krugman (New York Times, May 3, 2009) and “U.S. Workers' Wages Stagnate As Firms Rush to Slash Costs,” by Annys Shin (Washington Post, May 3, 2009), describe the prevalence of wage cuts in today’s U.S. economy.  How can wage cuts “make a sick economy even sicker”? In your answer, include enough detail from the article so that we know you read the article.  An answer that makes stuff up gets fewer points than an answer which honestly states “I didn’t read the articles”
b.    What is price deflation?  Are we experiencing deflation today?
c.    Draw and label a Phillips Curve at the right.  Indicate with the label “A” where the U.S. economy was about a year ago.  Indicate with the label “B” where the U.S. economy is today.  Briefly explain the relationship that the Phillips Curve depicts. 
d.    If we all begin to expect wage and price cuts, what impact will this have on the Phillips Curve?  What impact will-it have on inflation?  Explain.

Part II.  Questions covering the entire course

4.  In late April 2009, concern about the spread of H1N1 “swine” flu took over the world.  This question explores some of the economic effects of the reactions to the H1N1 flu.  (Each part of the question can be considered independently.  The parts do not build on each other.)
a.    Everyone wanted to buy hand sanitizer to prevent the spread of germs.  What effect should this change in preferences have had on the price and quantity of hand sanitizer?  Draw and label a graph at the right to supplement your answer.  Discuss whether this was an instance of “price gouging.”  Be sure to define “price gouging” in your response.
b.    When U.S. tourism to Mexico dropped, what impact did this have on the dollar price of the Mexican peso?  Explain.  Draw and label a graph at the right to supplement your answer. 
c.    H1N1 flu spreads by human-to-human contact.  To prevent the spread of disease, schools were shut down when someone became ill.   Rather than shutting down schools, an alternative response when someone becomes ill is to impose a fine or penalty on people who leave their home when they are sick.  What determines the optimal response to someone becoming ill?  Using economic language, explain.

5.  In 2007, the state of Massachusetts instituted universal health care.  Everyone in the state was required to purchase health insurance.  Does requiring everyone to purchase health insurance address adverse selection problems?  Does it address moral hazard problems?  Explain.

6.  Yogurt Park is a frozen yogurt store on Durant Avenue that has been in business since the 1970s.  (Perhaps you’ve heard it mentioned.)  Yogurt Land is a new frozen yogurt store on Telegraph Avenue.
a.    What type of industry are Yogurt Park and Yogurt Land in?  Explain.  Include the characteristics of that type of industry in your answer.
b.    What does the Spring 2009 opening of Yogurt Land tell you about Yogurt Park’s 2008 profit?  Explain.

c.    What effect do you expect Yogurt Land’s opening to have on the price of frozen yogurt sold by Yogurt Park?  On Yogurt Park’s profit?  Briefly explain.  Draw a graph at right to supplement your answer.
d.    What impact do you think the recession is having on the price of frozen yogurt sold by Yogurt Park and on Yogurt Park’s profit?  Why?  What does your answer say about the income elasticity of demand for frozen yogurt?  (Be sure to define “income elasticity of demand” in your answer.)
e.    If Yogurt Land finds its profits are negative, should Yogurt Land keep its store open through the end of May?  Explain.

7.  The unemployment rate in April 2009 was 8.9 percent.  The unemployment rate in April 2008 was 5.0 percent.  Between April 2008 and April 2009, many of the unemployed left the labor force, reducing the labor force participation rate.  If the labor force participation rate had not fallen in the last year, would the unemployment rate in April 2009 be more than, less than, or equal to 8.9 percent?  Explain.  Be sure to define all terms.

Part III.  Comprehensive Essay

    Congratulations!  You’ve landed a summer internship with Senator Barbara Boxer’s office.  She was impressed by your Cal education and your knowledge of economics.  Your first assignment is to prepare a briefing paper on government subsidies for business and consumer investment in green technology.  Senator Boxer will rely on your analysis to decide whether or not to publicly support the subsidies.

    Her chief of staff gave you the following memo which lays out the points you should address for the Senator.  Remember that the Senator is a well-educated woman, bright, but not an economist.  So you want to explain things in clear language.  Graphs will be helpful only if they enhance your presentation and are clear to someone who hasn’t taken an economics class in over 40 years.  Here’s the memo:

Part I.    Last Third of Course

1.
a.    For each program below, describe the program, state who the beneficiaries are (who receives its benefits), note what conditions the beneficiaries must meet in order to qualify for the program, and describe the general pattern of spending 1970-2010  (when describing the pattern of spending, combine Medicare & Medicaid).
            •    Social Security
            •    Medicare
            •    Medicaid
b.    Drawing on article #24 (“Will Aging Boomers Lose Benefits?  Medicare and Social Security Need Serious Financial Help,” by Sue Kirchhoff) and/or article #25 (“Medicare Meltdown,” by Thomas R. Saving), discuss one possible solution to the Medicare funding crisis.  (If you didn’t read the articles, save yourself and your GSI time – and earn 1 point – by just saying so and going to the next question.)

2.  Suppose the economy can be described by the following equations (all values are billions of dollars per quarter)

        C = 100 + 0.70Yd        EX = 340
        I = 400 + 0.05Y        IM = 100 + 0.25Y
        G = 400            TR = 300            TA = 500

a.    What is the equilibrium level of output and income, Y*?  Show all your work or you will receive zero (0) points on this question.  If you cannot solve this problem without a calculator, set it up and go as far as you can (cost of not fully solving = loss of 3 .  No calculators allowed during the exam.
b.    If government spending in this economy increases by $100 billion per quarter, equilibrium output and income will rise by $200 billion per quarter.  Why is the increase in equilibrium income greater than the increase in government spending?  Be clear & complete.
c.    Why is fiscal policy less effective in this economy than it would be in an economy that did not import any goods and services?  Be clear & complete.

3.
a.    Define “exports, EX” and “imports, IM.”
b.    The word “capital” is used differently by most economists than it is by economists who study international trade & finance.  What do most economists mean by the word “capital”?  What do those who study international trade & finance mean by the word “capital”?

4.  There is a floating exchange rate system between the United States dollar and Europe’s currency, the euro.  Rates of return on foreign financial assets have increased relative to rates of return on U.S. financial assets.  As a result, many U.S. workers have moved some of their retirement fund savings into European stocks. 

What is the effect of the increase in foreign rates of return on the value of the dollar relative to the euro?  Supplement this answer with a graph.  What is the effect on the U.S. trade deficit?  Explain your answers.


Part II    The whole course

5.  For each of the following activities, is it counted in GDP?  If so, where is it counted on the expenditure side of GDP accounting, and why?  If it is not counted in GDP, why not?
a.    A bank in Italy buys a U.S. government bond.
b.    The California state government pays to have state highway 99 repaved.
c.    Prof. Olney buys a 6-ounce cup of raspberry-flavored frozen yogurt.  (She doesn’t like chocolate!)
d.    The U.S. federal government uses borrowed money to pay President Bush’s salary.

6.  Currently there is no law in California preventing you from using your cell phone while you drive.  Two new laws go into effect in California on July 1, 2008.  The first prohibits all drivers from using a handheld cell phone while operating a motor vehicle, (Vehicle Code (VC) §23123). Drivers 18 and over may use a “hands-free device.” Drivers under the age of 18 may not use a cell phone or hands-free device while operating a motor vehicle (VC §23124).  The base fine for the first offense is $20 and $50 for subsequent convictions.  (This is not a made-up example.)
a.    Under what circumstances will the first law described above result in the socially optimal use of handheld cell phones by drivers 18 and over in California?  Explain, supplementing your answer with a graph.
b.    What three conditions must be satisfied for the Coase Theorem to apply?  Which of those conditions are satisfied here?

7.  Restaurants are a good example of a monopolistically competitive market.  Celia’s Restaurant is one restaurant in a town with many restaurants.
a.      Suppose the restaurants in a town are initially in long-run equilibrium.  Draw a graph for Celia’s Restaurant that shows the equilibrium price, quantity, and profit.
b.    Are restaurant meals normal or inferior goods?  Do you think demand for restaurant meals is income elastic or income inelastic?  Briefly defend your answers.
c.    Income and expected income in this town are declining, as is wealth.  What effect will this have on the equilibrium price, quantity and profit for restaurants such as Celia’s?  Explain.
d.    In the long-run, as a result of the declines in income, expected income, and wealth, what will happen to the number of restaurants in this town?  For those restaurants still in business when the new long-run equilibrium is reached, compare their initial (part a) and final equilibrium price, equilibrium quantity, and profit.  What factor(s) will determine which restaurants survive and which ones shut down?

8.  Like most central banks around the world, the Federal Open Market Committee (FOMC) of the Federal Reserve conducts monetary policy by changing interest rates in an attempt to achieve an inflation rate target.
a.    Explain why the increased use of corn for producing biofuel is increasing the inflation rate.
b.    When the inflation rate rises, what does the FOMC do? 
c.    Is the FOMC’s action in part (b) different if the FOMC is dominated by hawks rather than by doves?  Explain.
d.    Explain why an increase in the unemployment rate is supposed to lower the inflation rate.

9.  Explain why an increase in the expected cost of energy leads to a decrease in investment spending.

10.  The market for baked goods is a perfectly competitive market.
a.    The City Council imposes a price ceiling on the price of baked goods, and the price ceiling is binding.  Draw a graph at the right that shows the market equilibrium price (p*) and quantity (q*) of baked goods, the price ceiling (pC) and quantity sold (qC) when the ceiling is binding.  Is there a market shortage or a market surplus when the price ceiling is put into place?
b.    On your graph, show the consumer surplus, producer surplus and deadweight loss when the price is set at the price ceiling.  In what sense is the deadweight loss a “loss” – what exactly are we losing?

Part III.  Comprehensive Essay
    Congratulations!  You landed a job teaching high school through the Teach for America program!  You need to prepare notes for your AP Econ class.  You’re still nervous when you teach so you like to write out what you plan to say. 

    Your plan for tomorrow’s class is to pull together a lot of what you’ve covered all term by talking about the U.S. economy’s current problems, how we got into this mess, and what will pull the economy out of recession.  Your students are smart but young.  It’s important to you to leave them with words of hope.  You feel as if you’ve overemphasized the “dismal” part of economics and it’s time for something uplifting.  They need to be reminded that recessions come and – importantly – go.  You’ve put together the following outline.  Now your job is to write out what you’ll say.  Graphs may help your students understand.  They know the basic terminology (or at least most of them do!), so you don’t have to define basic terms.

•    Introduction
        – What we’re going to talk about today
        – The “bottom line” message(s) of the day

•    Background on how we got into an apparent recession
        – Subprime crisis in brief
        – Why investment spending began to fall
        – Why consumption spending began to fall
        – Why state government policy may make things worse

•    Some of the micro effects
        – Housing prices
        – Labor costs in construction industry
        – Why stores like Linens ‘n’ Things are closing but sales of Kraft’s Mac & Cheese are rising

•    Policy efforts by the Fed
        – What the Fed has done with interest rates and why
        – How their policy is supposed to affect the economy
        – 1 or 2 reasons why Fed policy isn’t working the way it’s supposed to
            (Note to self: Keep eye on the clock – don’t get carried away here!)

•    Policy efforts by the U.S. federal government
        – What they’ve done
        – How their policy is supposed to affect the economy
        – 1 or 2 reasons why their policy might not work the way it’s supposed to

•    The Hopeful Part
            (Note to self: Allow enough time here so you end with hope!)
        – Historical context: 20th & 21st century pattern of recession and recovery
        – How bad are things now
        – What part(s) of aggregate demand can lead the U.S. into recovery
        – 1 or 2 policy ideas that could increase aggregate demand

•    Conclusion
        – Restate the “bottom line” message(s) of the day
        – Remember to end class with “Go Bears!”
            (Note to self: So glad I teach at a school that has a bear as its mascot.  How would I end class each day if I had to say something like “Go Tree”?)

PART I.  Questions covering the material since Midterm #2

1.    What is included in M1 in the United States?  Who creates money in the United States?  Briefly, how?

2.    In the U.S. in the 1950s and 1960s, imports were a constant 4 percent of GDP.  Today, imports as a share of U.S. GDP is about 17 percent, and that share is rising.  Explain why, all else constant, fiscal policy had a larger effect on GDP in 1960 than it does today.

3.    Inflation in China reached 3.3 percent in March, the highest rate in more than two years and above the target of three percent set by China’s central bank, the People's Bank of China.  China’s GDP grew in early 2007 at an annual rate of 11 percent.   Analysts recommend that China’s central bank raise interest rates. 

China pegs its exchange rate of the yuan (China’s currency) to the U.S. dollar.  If the Chinese yuan was instead allowed to freely (cleanly) float against the U.S. dollar, what effect would China’s increase in interest rates have on the exchange rate between the yuan and the dollar (that is, on the price in dollars of 1 yuan)? Would the yuan appreciate or depreciate relative to the U.S. dollar?   Explain.  Supplement your answer with a graph.

4.    Robert Samuelson (article #25) entitled his article “How Baby Boomers are Robbing Our Grandchildren.”  He says that baby boomers (those born between 1946 and 1964) are in a “state of denial about the true cost of” Social Security and Medicare and that “their blindness could put the country’s future at risk.”  Explain why future Social Security and Medicare spending is potentially a problem.

5.    Federal Reserve Board Vice Chairman Roger Ferguson ended his speech (article #29, “The Importance of Education”) by saying “the economy of the United States depends greatly on an educated workforce – one with the skills to tackle new ideas and new technologies, one in which morals and ethics are deeply instilled, and one with a love of learning, exploring, and questioning that lasts a lifetime.”
A.    What effect does the education of the workforce have on living standards (that is, on output per person)?
B.    What was the focus of Ferguson’s speech?  Provide enough illustrations from his speech to indicate that you read it.  (If you didn’t read the article, save yourself and your GSI time by just saying so and going to the next question.)

PART II.  Questions covering the entire course

6.    The price of gas increased to a nationwide average of $3.07 per gallon last week.  Analysts blamed the increase on temporary decreases in supply of gas by refineries. 
A.    Using supply and demand analysis, explain and show how the temporary decreases in supply of gas by refineries could affect the price of gas.  Supplement your answer with a graph.
B.    By late May, refineries will increase how much gas they produce. But in late May, the “summer driving season” begins, when many people take long vacations by car.  Do you think the nationwide average price of gas in early June will be more than $3.07, less than $3.07, or equal to $3.07 per gallon?  Explain.  Supplement your answer with a graph.

7.    Your sister and brother-in-law have been doing well.  They are very happy with their dance club, RROYB (Rock-and-Roll On You Bears).  Several other clubs have opened near by.  They lost some business to some of those clubs.  But generally, things have been going well.  They are doing just as well running the dance club as they could working anywhere else. 

    There is just one problem: they received a letter in the mail this morning notifying them that the cost of insurance for the club has jumped from $6,000 to $24,000 per year.  The cost of the insurance doesn’t depend upon how many nights a week they are open nor how many customers they serve.  Your cell phone rings.  It’s your sister.  She wants to know what you think they should do.  “Should we raise our prices? Should we close the club?  If we close, should we do so now?  Or later?”  What do you tell your sister?  Why?

8.    The day after a tanker fire closed two key overpasses at the MacArthur Maze, BART dropped their price to zero and offered free rides.  The number of people riding BART increased about 25 percent.  Does the increase in riders indicate that demand for BART rides is price elastic?  Explain.

9.    Because of the freeway ramp closure at the MacArthur Maze, the number of cars driving through city streets in West Oakland has increased from 5,000 to 30,000 per day.  The residents of West Oakland are suffering from increased noise, traffic, congestion, and pollution. 
A.   What is the socially optimal quantity of traffic in West Oakland?  What strategies might local government take to generate this socially optimal amount of traffic in West Oakland?  Explain.  Supplement your answer with a graph.
B.    Is this a situation in which the Coase Theorem applies?  Explain.

10.    On CNN.money, readers were asked what they would do if they unexpectedly received $5,000.  The results were:  25 percent would spend the money, 30 percent would use it to pay off credit card debt, and 40 percent would save the money.  An advisor to President Bush points to these results and says “See, the government can cut taxes even when the economy is booming, and our tax cut won’t have much effect on the inflation rate.”  Explain how the advisor draws this conclusion from the CNN.money results. 

Part III.  Comprehensive Essay

    Congratulations!  You landed an internship with Dr. Janet Yellen, President of the S.F. Fed. Your first task: write a background paper she can use to decide whether to advocate for Fed intervention in the U.S. housing market.  In your analysis, you want to explain the economics carefully.  Clearly indicate where you have invoked assumptions and what those assumptions are.  Supplementing your written analysis with clear and well-explained graphs is acceptable.   Including information from articles you have read is appropriate. Here is Dr. Yellen’s memo to you:

    Welcome to the San Francisco Federal Reserve Bank!  I’m very happy to have you here with us for the summer.  I know what a fine education in economics you are receiving.  I am looking forward to both teaching and learning from you.  And as a member of the Cal faculty (on leave), I must add:  Go Bears!
    The housing market is an ongoing concern of the Fed.  At the regional Federal Reserve Banks, we are concerned about the impact of the housing market on our local economies.  At a national level, we are considering whether intervention in the home mortgage market is called for.  I need some background information and analysis to guide my public statements in the months to come.
    There are two interrelated issues, as I’m sure you know.  One is the housing market itself.  The other is the subprime mortgage market.  The housing market issues are largely regional.  To the extent there is or was a housing bubble, it is (or was) regionally-specific.  The subprime mortgage market issue, however, is national in scope.  These lenders all operate in the national marketplace.  Few are specific to one region.
    There is pressure on the Fed to intervene in the housing market and in the subprime mortgage market.  Before I decide my position, I need to analyze the causes and effects of the problems.  I need your help.  Please prepare a position paper for me on the questions: Should the Fed intervene in the housing market?  Should it intervene in the subprime mortgage market?  I think the following issues are probably relevant.

•    Many pundits are talking about a “housing bubble.”  Certainly we’ve seen housing prices rise in the West in recent years, although in the last year prices have been steady or in some cases have fallen.  What forces could account for the rise in prices?  What is the evidence that this was a “bubble”?
•    The West and Southwest have been magnets for undocumented workers, many of whom get day work in construction.  Some politicians blame border enforcement for the large numbers of undocumented workers.  But does the housing market have anything to do with this?  For instance, is there any connection between the housing market and wages paid to construction workers?
•    Then there is the whole subprime mortgage market.  Perhaps you could start by explaining what a subprime mortgage is, and who is involved in this market.  Is there a connection between the pattern of prices in the housing market and the subprime mortgage market?
•    More and more of these mortgages are going into foreclosure due to default.  Several subprime lenders have gone out of business recently because they lost so much money on mortgage defaults.   The Fed controls the federal funds rate, as you know, and leaves determination of long-term interest rates to the market. How might all of this affect long-term interest rates?  Is this a cause for Fed intervention?
•    As we think about foreclosures, we probably want to think about both the housing market too.  What’s the impact of foreclosures on the housing market? 
•    The Fed has been successfully managing the macroeconomy for some time now.  But now there are apparently signs that the problems in the housing and subprime mortgage markets could push the economy into a recession.  How might that happen?  That is, how do we logically go from the problems in the housing and subprime mortgage markets to a macroeconomic recession?
•    At the same time, there seem to be signs that inflation is rising.  Is the inflation at all part of this story, or are its causes separate?  How does all this impact the Fed’s decisions about the federal funds rate?
•    Finally, your opinion!  Should I support Fed intervention in the housing market?  In the subprime mortgage market?  I’m interested particularly in the reasons for your opinion.