Answers: Chapter 9 - Government Information & Actions that Affect the Market


9.1: Which of the following can best describe the meaning of inflation:

  1. The increase in the price of stock

  2. The extent to which your money today can buy less in the future

  3. The extent to which a company can increase its profit

The correct answer is #2
Inflation measures the year-to-year rise in price for all goods/services, and thus can be interpreted as the extent to which your money today can buy less in the future. 

 

9.2: Which one of the following is most likely not to cause temporary of long-lasting inflation in prices of goods:

  1. When more people want a particular product such as red roses for Valentines Day
  2. When companies raise prices due to the increase in prices of the materials they use to make their products
  3. When a lot of stores close due to lack of customers because of a bad economy
  4. When there are shortages of particular goods such as gasoline for your car in the aftermath of a devastating hurricane

The correct answer is #3
A bad economy which results in store closures is unlikely to cause inflation -- it may actually cause the inflation rate to go down since this indicates less demand for products.

 

9.3: What is the most prominent index in the United States used to gauge inflation?

  1. The Consumer Price Index for All Urban Consumers (CPI-U)
  2. The Dow Jones Industrial Average
  3. The S&P 500

The correct answer is #1
The U.S. Labor Department produces the monthly CPI-U, which measures the increase in the price of a given “basket” of goods and services purchased by typical consumers. It covers a large number of items, including food, housing, apparel, transportation, medical care, and entertainment.

 

9.4: Give a reason why very low inflation is not a good thing for the economy.

A very low inflation rate can signal that the economy is stagnating. As described in the Boston Globe article that as referenced in Chapter 9 (p. 119): "some inflation — the Fed says about 2 percent a year — is the sign of a healthy economy, translating into rising wages, appreciating assets, and stronger growth, as well as higher prices. But inflation at the consumer level has been nonexistent in recent months; in July it rose at annual rate of just 0.2 percent, according to the Labor Department. Other economic conditions, including a weakening global economy and falling crude oil prices, suggest inflation will remain low for a while."

 

9.5: Give a reason why very high inflation is not a good thing for the economy.

While it is difficult to understand why very low inflation is a bad thing, understanding why very high inflation is a bad thing is much easier. Remember that inflation is the extent to which your money today can buy less in the future. Very high inflation means that your money today will buy mush less in the future, which is not  a good thing for the economy (or for you).

 

9.6: Which of the items below best describes Gross Domestic Product(GDP)

  1. The rate of increase in the S&P 500 stock index 
  2. The dollar value of what the national economy produced during a certain period of time
  3. The amount of money spent by the government on defense

The correct answer is #2

 

9.7: Which of the items below contributes more to Gross Domestic Product than all the others?

  1. How much you, your family, and other citizens spend on food, clothing, services, and other items.
  2. The money businesses spend to buy equipment for their factories, the money families spend to buy homes, and the change in certain items on the balance sheets of companies.
  3. The money spent by the government for defense, roads, schools, and other items.
  4. The amount of goods and services the United States sells to other countries.

The correct answer is #1
The amount that everyone spends on goods and services - sometimes referred to as "consumption" - is the largest contributor to GDP.

 

9.8: Explain why a very fast growing GDP can be bad for the economy. Hint: Inflation

A fast-growing GDP can lead to inflation, because this probably means that too many consumers are buying goods and services. When you have more people with more money trying to buy goods and services, prices tend to go up.

 

9.9: The Labor Force or Workforce is described most accurately by which of the following:

  1. The number of people employed
  2. The number of people unemployed who are actively seeking work
  3. The number of people employed and unemployed who are actively seeking work
  4. The number of people unemployed who are actively seeking work

The correct answer is #3

The Labor Force (aka Workforce) is composed of:

1) people who have jobs (known as the employed) and

2) people who do not have jobs who are actively seeking jobs (known as the unemployed).

It does NOT include people who do not have jobs and are not actively seeking work.

 

9.10: The unemployment rate can best be described as:

  1. The percentage of the labor force that is out of work
  2. The percentage of the labor force that is working
  3. The percentage of the US population out of work who are not actively seeking employment

The correct answer is #1
The unemployment rate is the percentage of the labor force that is out of work. The percentage of the US population out of work who are not actively seeking employment is not considered part of the labor force, so #3 cannot be the answer. 

 

9.11: Which of the following items is the tool the Federal Reserve Bank uses to stop the economy from overheating or encourage the economy to grow:

  1. By changing the discount rate
  2. By engaging in more advertising to affect consumer behavior
  3. By printing more or less money

The correct answer is #1
To stop consumers and others who contribute to the GDP from spending too much money too fast, the government (specifically, the Federal Reserve Bank, often just referred to as the Fed makes it harder for people to borrow money by increasing the discount rate. This increase, which is known as “tightening monetary policy,” eventually makes it more expensive for consumers and others to borrow money from banks. With less money being borrowed, there is less spending. This eventually reduces consumer spending, reduces the possibility of inflation, and causes the GDP to go down.

If the GDP is not growing at all, it probably means that consumers are not spending much money at all. To encourage people to spend more, the Federal Reserve can decrease the discount rate, which eventually makes it easier for consumers to borrow. This action is known as “loosening monetary policy.”