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Describe Microeconomics vs. Macroeconomics

Microeconomics is the study of how individuals and companies make decisions to allocate scarce resources, which helps in understanding how individuals and companies prioritize their wants.

Macroeconomics is the study of an economy as a whole. For example, macroeconomics examines factors that affect a country’s economic growth.


What is price elasticity?

What goods are said to be inelastic vs elastic?

Price elasticity is the responsiveness of the quantity of a good demanded to changes in price, all other economic forces remaining constant.

Demand for necessities, such as food or gasoline, responds relatively little to price changes; therefore, those types of goods are said to be inelastic.

Demand for luxuries, such as a new motorboat, responds relatively more to price changes; therefore, those types of goods are said to be elastic or demonstrate a great deal of price elasticity.


What is GDP and how is it measured?

The U.S. gross domestic product (GDP) is the total monetary value of all goods and services produced within the domestic United States over the course of a given year, including income generated domestically by a foreign firm

GDP = C + I + G + NE

C = consumption (generally spending by individuals on durable and nondurable goods and services)
I = investment (generally business spending on inventory, plants, and equipment, but including new housing purchases by consumers)
G = government spending, including federal, state, and local
NE = net exports (total exports less total imports)


Identify the inelastic good(s).

I. Stereo equipment
II. Prescription medication
III. Fine art
IV. Electricity

The answer is II and IV.

Prescription medication and electricity would be most likely considered necessities and would demonstrate price inelasticity. The others are not necessities and represent demand that is heavily influenced by the item’s price (elasticity).


Who is responsible for fiscal policy and what tools do they have to implement changes?

Congress and the president

■ Makes changes in tax laws
■ Increases and decreases government spending


Who is responsible for monetary policy and what tools do they have to implement changes?

Federal Reserve Board (Fed)

■ Changes reserves required for banks
■ Changes the discount rate that banks pay for short-term loans from the Fed
■ Conducts open-market operations


What would expansionary fiscal policy look like vs contractionary policy?

An expansionary fiscal policy often involves increasing government spending or by reducing taxes for individuals and/or businesses.
A contractionary fiscal policy commonly incorporates decreases to government spending and/or increases to individual and/or business taxes.


What actions would the fed take to expand economic activity vs. contract economic activity?

If the Fed wants to expand economic activity, it will buy government securities in exchange for money, thereby increasing the money supply and driving down overall interest rates. The Fed can lower the discount rate when it wants to increase the money supply. When banks are able to borrow funds at lower rates and lend more money, they increase the supply of money in circulation and this stimulates demand. The fed can also lower reserve requirements.
If the Fed wants to contract economic activity, it will sell government securities from its existing inventory, thereby decreasing the money supply, driving up overall interest rates, and reducing prices. The Fed can also raise the discount rate, increasing the cost of borrowing and discourages member banks from borrowing funds, resulting in a contraction of the money supply. The fed can also raise reserve requirements.


Which rate is the only one the fed directly controls?

The Fed only directly controls the discount rate (the rate at which banks can borrow from any of the Federal Reserve Banks).


What two rates does the fed greatly influence without directly controlling?

The federal funds rate - The interest rate charged on short-term borrowing (often overnight to fulfill reserve requirements) between banks; the Fed targets, but does not directly control, this rate in all of its interest rate decisions.

The prime rate - The rate of interest charged by commercial banks to their best business and personal customers. This rate is set directly by commercial banks; however, it normally is about 3% higher than the federal funds rate.


The federal funds rate will tend to move upward under which of the following conditions? (Note: This is a previously released CFP® Certification Exam question.)

A. The Federal Reserve is buying government securities.
B. The Federal Reserve lowers the discount rate.
C. A few banks have excess reserve deficiencies, and the rest have ample excess reserves.
D. A few banks have excess reserves, and the rest have significant reserve deficiencies.


The answer is a few banks have excess reserves, and the rest have significant reserve deficiencies. If most banks have reserve deficiencies (that is, they need money) and only a few banks have excess reserves (that is, they have an ample supply of money), supply and demand factors will cause the federal funds rate to rise. This is because, from the standpoint of the overall economy, there is a low supply of money and a large demand for money, meaning that interest rates will rise.


Select the strategy the Fed would implement if it wanted to contract the overall economy.

A. Buy U.S. government securities in the open market.
B. Lower the discount rate.
C. Target the federal funds rate in a lower range than previously.
D. Increase the reserve requirements for member banks.


The answer is increase the reserve requirements for member banks. If the reserve requirement is increased for member banks, less money will be available for loans to existing or potential customers, thereby restricting the overall money supply.


The economy is approaching full employment and inflation is rising rapidly. What would be the prudent fiscal policy to enact under this scenario?

A. Raise taxes and raise the discount rate.
B. Raise taxes and decrease government spending.
C. Lower taxes and increase government spending.
D. Lower taxes and lower the discount rate.


The answer is raise taxes and decrease government spending. Under this scenario, the economy is overheating and should be slowed down. Possible fiscal actions include raising taxes, decreasing government spending, or increasing government borrowing (which then increases interest rates). Lowering or raising the discount rate is a monetary (not fiscal) tool available to the Federal Reserve.


What constitutes a recession vs a depression?

A recession occurs when the GDP has experienced a decrease in real terms for two consecutive quarters or a minimum of six months from a baseline of zero.

Alternatively, a depression is when the GDP has experienced a decrease in real terms for six consecutive quarters or a minimum of 18 months from a baseline of zero.


What do the following general economic factors do during expansion vs. contraction?

Consumer Credit
Retail Sales
Auto Sales
Mortgage Debt
Housing Starts
Consumer Price Index


Income - Rise
Demand - Rise
Sentiment - Rise
Consumer Credit - Rise
Retail Sales - Rise
Auto Sales - Rise
Mortgage Debt - Rise
Housing Starts - Rise
Inflation - Fall
Unemployment - Fall
Consumer Price Index - Fall

Contraction: Opposite of above


Where are the following general economic factors at during peak vs. trough?

Producer Price
Index Inflation
Industrial Production
Capacity Utilization
Labor Productivity


GDP - Up
Producer Price - Up
Index Inflation - Up
Output - Up
Industrial Production - Up
Capacity Utilization - Up
Labor Productivity - Down
Efficiency - Down

Trough: Opposite of above


Define leading indicators for the economy and name all 6.

Leading indicators are those that tend to precede actual economic change. Examples of leading indicators are:

– housing starts,
– new claims for unemployment,
– bond yields (spread between 10-year Treasury bonds and federal funds),
– indexes of stock prices,
– orders for durable goods, and
– changes in investor sentiment.


Define coincident indicators for the economy and name all 3.

Coincident indicators are those that occur simultaneously during the business cycle and confirm the stage that the economy is currently experiencing. Examples of coincident indicators are:

– industrial production,
– level of personal income, and
– amount of corporate profits.


Define lagging or confirming indicators indicators for the economy and name all 4.

Lagging or confirming indicators are those that usually change after the economy has passed through one business cycle and allow confirmation of a previous economic environment. Examples of lagging indicators are:

– prime interest rates,
– changes in CPI, particularly for services,
– amount of business and consumer loans outstanding, and
– average duration of unemployment.


The economy is experiencing an increase in housing starts and a decline in the unemployment rate. Based on this economic activity, identify the phase of the business cycle.

A. Peak
B. Trough
C. Expansion
D. Contraction


The answer is expansion. An increase in housing starts and a decline in the unemployment rate are reflections of an economy that is expanding. If a peak had been reached, housing start numbers would be at a relative high and would then start to decline.


Identify the economic indicators that can best be described as preceding or leading to a change in the business cycle.

A. Unemployment rate and bond yields
B. Prime rate of interest and industrial production
C. Amount of corporate profits and level of personal income
D. Level of housing starts and orders for durable goods


The answer is level of housing starts and orders for durable goods. The level of housing starts precedes economic change and may, thus, be termed as a leading economic indicator. Durable goods are long-lasting, characterized by a usable life span over three years. Examples include automobiles, computers, household goods, and medical equipment. When an order for durable goods is placed with a manufacturer, production to fill the order is initiated in the future which creates employment opportunities across a variety of related industries. Since new orders for durable goods preempt future economic production, they are considered a leading indicator. All of the other choices are incorrect because they represent coincident or lagging indicators or are paired with one.


Define inflation and the two common ways to measure it.

Inflation is defined as a rise in the average level of prices of goods and services.

The two most common measures of inflation are the Consumer Price Index (CPI) and the Producer Price Index (PPI).

The CPI program produces monthly data on changes in the prices paid by urban consumers for a representative basket of goods and services. The PPI program measures the average change over time in the selling prices received by domestic producers for their output.


What is deflation?

When prices are falling in absolute terms, deflation exists

Not since the depression of the 1930s has the United States experienced pronounced deflation. In general, a deflationary period is one where preservation of capital should be of primary concern; investments should center on very high-quality debt instruments.


What is disinflation?

Disinflation exists when prices are still rising, but at a declining rate


What is stagflation?

The term stagflation comes from a combination of “stagnation” and “inflation.”

Stagflation is the worst of both worlds, combining high unemployment and high inflation. Due to the reduction in productive output within a stagflation economy, there are few monetary or fiscal policies that can be implemented to quickly counter its effects.


Match the description with the appropriate term. Use each letter once.

___ Deflation
___ Stagflation
___ Inflation
___ Disinflation

a. An increase in the general level of prices.
b. A decline in the general price level and is often caused by a reduction in the money supply and consumer demand.
c. Characterized by high inflation and increasing unemployment. The general growth of the economy slows as business output falls.
d. A decline in the rate of inflation.

__B__ Deflation is a decline in the general price level and is often caused by a reduction in the money supply and consumer demand.

__C__ Stagflation occurs when inflation and unemployment rise and the general growth of the economy is slow as business output falls.

__A__ Inflation denotes an increase in the general level of prices

__D__ Disinflation indicates a decline in the rate of inflation.


What characterizes Chapter 7 bankruptcy?

Under Chapter 7 bankruptcy, the individual is permitted to keep certain assets, but all others are relinquished to satisfy the costs of bankruptcy and the claims of creditors. It should be noted that if any of these protected assets have been pledged to secure a specific debt, they may be seized legally by the creditor.

Upon completion of Chapter 7 bankruptcy proceedings, most debts are discharged completely—the debtor is no longer responsible for their repayment. However, certain debts cannot be discharged. Student loans and unpaid taxes can only be discharged in extremely rare situations.

Child support, alimony debts, and 401(k) loans are not dischargeable through bankruptcy. When a person borrows against their 401(k), they are the borrower and lienholder, and a person cannot discharge a debt to themselves.


What characterizes Chapter 13 bankruptcy?

Under Chapter 13 bankruptcy, a plan is created under which the debtor will repay outstanding debts within a specified time period—normally three to five years. Frequently, the amount owed is reduced so that payments will be manageable. Generally, Chapter 13 bankruptcy is more favorable for creditors because they receive at least some portion of what is owed them.

Chapter 13 bankruptcy is available for those whose debts total less than certain amounts and who have regular income. For this reason, Chapter 13 bankruptcy is sometimes called the wage-earner plan.


EXAMPLE: Limitations of Personal Bankruptcy John and Mary are considering filing for personal bankruptcy to discharge their major debts and have a fresh start. They have asked their financial advisor for her advice and have provided the following overview of their current financial situation: „

Combined after-tax income of $58,000 „
$1,500 monthly rent payment „
Monthly expenses (after rent) of $3,500 „
Negative net worth „
$65,000 in outstanding student loans „
$22,000 balance in revolving credit debt „
$500 monthly alimony payment to John’s former spouse „
$4,000 outstanding loan balance from Mary’s 401(k), which has a current balance of $2,000

Their financial advisor counseled them to carefully consider the ramifications of bankruptcy before filing. She pointed out that the potential pitfalls of filing for bankruptcy include the following:

There would be a negative impact on their credit rating, impacting their ability to borrow. They would also be unable to obtain a home mortgage for a considerable period of time should they decide to file. Filing for bankruptcy would also impact their relationship with other institutions that rely on credit scores, such as auto insurers who use it to help establish insurance premiums. Their bankruptcy would remain on their credit report for 10 years.
Chapter 7 bankruptcy is not possible because the Bankruptcy Abuse Prevention and Consumer Act of 2005 eliminated this possibility for individuals with the ability to pay at least $100 a month to creditors.
Chapter 13 bankruptcy would potentially eliminate some of the credit card debt; however, it is more likely some sort of repayment plan will be worked out. The alimony John pays to his former spouse would not be discharged and student loans are extremely difficult to get discharged. John and Mary would also be required to submit to credit counseling before filing for Chapter 13.

The outstanding 401(k) loan will remain. It is a loan Mary owes to herself since it is from her retirement account. State law typically exempts balances held in ERISA-covered retirement plans, such as 401(k) plans, from the claims of creditors.
There are court costs and fees associated with bankruptcy, as well as other adverse effects that may impact other family members and businesses.

Rather than filing for bankruptcy, their advisor recommended that John and Mary cut their monthly expenses and come up with a repayment plan for their debts. They have adequate income to avoid bankruptcy, and bankruptcy would not enable them to discharge their large debts and have a fresh start as they thought. Avoiding bankruptcy would enable them to start improving their credit rating over time as they get their spending under control and finances in order.


Select the item that is NOT generally dischargeable by a debtor in a bankruptcy filing.

A. Veterans’ benefits
B. Past-due alimony obligations
C. Equity in a personal residence
D. A specified amount in a personal automobile


The answer is past-due alimony obligations. Read the question carefully: it is asking about the obligations of the debtor and which of these is not dischargeable, not which assets are protected. Past-due alimony obligations are not generally dischargeable in bankruptcy. The remaining items are either state or federally exempt assets.