Testing my economic knowledge

Not PC has a quiz up on economics stuff – I thought it would be fun to do.  So here goes.

1)  Gross Domestic Product (GDP) measures a country’s total economic activity.

Answer:  False.  As it excludes activities where the market isn’t explicit.

2)  Consumer spending represents around two-thirds of the economy.

Answer:  Depends how you define “economy”.  It is around 2/3 of the expenditure measure of GDP sure, but that doesn’t really tell us much.  When we say “economy” my guess is we are thinking along the lines of all activity, and in a production sense, so I’d probably guess the answer would be false.

3)  If prices are stable, that means there is no inflation.

Answer:  Depends how we define inflation, and depends how we define prices.  If the price of a quality adjusted unit of all good or services were unchanged, then inflation as defined by an economist would be zero.  Given that we can observe no change in a price index and still have inflation (depending on changes in quality, or shifts in relative prices) I would say the answer here is false.

4)  Money is a creation of government.

Answer:  Currently money is created by the sovereign state – but this doesn’t mean that money would only exist if we had a centrally organised authority guiding it.  As a result this could be true or false.

Given that the question says “is” I am assuming it is talking about money that is currently in circulation – and yes that money is created by the state, and individuals use it when trading with each other in order to lower the search cost associated with trade (relative to a barter economy).  So I would say true.

5) A period of gently falling prices is a bad thing.

False:  We just need a single counterfactual here.  So if prices are gradually declining, and economic agents expect them to, then there is no problem.  Furthermore, if this drop is the result of productivity improvements that is a nice thing.

6)  Before the Reserve Bank/Fed/Bank of England was created, the world was wracked with inflations, booms and busts.

True:  Back in the day there was indeed lots of volatility in prices and in output.  Sure the price level was on “average” stable – but hell did it move around!!!  Now we have booms and busts nowadays, and there are likely issues with the way monetary policy is put in place – sure.  But I take the fact that prices have risen gently over time during the last 30 years as an indication that central bank policy has increased certainty for economic agents – which is a good thing.

7)  Economics is a “value-free” science

False:  No science is “value-free” in the most extreme definition of the word.  However, economics does attempt to make its premises and the link to conclusions obvious such that any debatable value judgments are clear.

When economists describe a situation they are relatively close to value-free, when they make a conclusion they are far from it.  However, I think that the economic method is very good – I appreciate the transparency associated with it.  But I realise that a truly “value-free” science is a myth.

8)  Saving takes money out of the economy

False:  This doesn’t need explanation does it. In fact, to be honest I’d need a good definition of “money” and “economy” before I could answer this clearly.

9)  Interest rates are set by the Central Bank.

Yes and no.

Central banks set the “opportunity cost” of lending/borrowing for banks.  As a result, they tend to control marginal funding and therefore price.  They can “control” long-rates through peoples expectations of their future actions as well.

However, interest rates depend on a whole range of other factors – such as risk, and interest rates globally.  That is why we see interest rates move around a lot even when the central authority isn’t doing anything.

If all the other factors are constant then, yes it is TRUE central banks do set the opportunity cost of lending and borrowing and thereby control the interest rate.

10)  A good war is good for the economy

False:  Unless people value war I guess …

11)  Government spending pumps up an economy in depression

Depends how we define a depression.

If we define a depression as a sharp drop in economic activity, where the relative price of labour isn’t able to decline, and where monetary authorities are unwilling to print money to help this adjust, then there is a potential role for government.

Given the behaviour of economic agents, and given the very real labour market issues in the face of a rare “depression” then yes, it is TRUE government spending can increase activity by getting otherwise unemployed labour doing something.

Note:  A depression is an effective supply side failure – we have a market failure in the labour market that implies there is “money on the ground”.  This is a very rare situation.

12)  Banks are inherently bankrupt.

False:  I am not sure what this question means.  Literally they aren’t bankrupt as they have money (and a claim on loans).  Figuratively they aren’t morally bankrupt as they are just providing a service to help lenders and borrowers meet – and to pool risk.