Archive for the ‘Economics’ Category

Real World Graduation: Question 11

RealWorldGraduation_Question_11   <– PDF

Some in Congress in 2006 proposed an income-tax modification bill that would have provided a 5% across-the board reduction in federal income tax rates. The bill mandated that the highest marginal income tax rate would have been reduced from 38% to 33%; the next rate from 25% to 20%, and the lowest from 10% to 5%.  Capital gains rates would remain unchanged.  Critics have claimed that only the very rich would benefit from this measure. They were joined by Mr. Ralph Thompson, estimated to be the nations fourth-richest person, who came out in opposition to the tax cut, saying, “Neither I nor any other wealthy people need an income tax cut.”  But people who favor the tax cut claim that the working people will benefit because they will have more money in their pocket.  For example, the single person working a full-time job (40 hours per week) at $6.50 per hour (just over minimum wage of $5.75 per hour) would have their marginal rate reduced to 5%, so they would have received a tax cut of approximately $4.57 per week after the combined standard deduction of $8,750.  Does this income tax proposal unfairly benefit the wealthy or unfairly penalize the working poor with regard to income tax rates?

a) It unfairly benefits the rich because they will pay less in income taxes.

b) It unfairly benefits the rich because they don’t need the extra money, as Mr. Thompson said.

c) It unfairly penalizes the poor because it left the minimum wage unchanged.

d) It unfairly penalizes the poor because the proponents of the tax cut are lying: the extra $4.57 won’t buy much and isn’t necessary.

e) All of the above are true to some extent.

(The answer is on p. 2 of the PDF.)

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Real World Graduation: Question 10

RealWorldGraduation_Question_10   <– PDF

A Savings-and-Loan bank crisis in the 1980’s and 1990’s required a government bailout. Major automobile companies (Chrysler and General Motors) have sometimes required government bailouts.  In the most recent bailout (2007-2009), many banks (Washington Mutual, Indy Mac), mortgage companies (Fannie Mae, Freddie Mac), and financial institutions (Bear Stearns, American International Group) required government bailouts.

“Fannie Mae” and “Freddie Mac” are nicknames for two government-sponsored entities (GSE) that buy residential mortgages; the goal being to stimulate home-buying. In the latest bailout, the losses to the taxpayers for bailing out these two organizations will range between $221 billion and $363 billion [1].

Bear Stearns, a long-standing investment bank specializing in mortgage securitization, was sold to JP Morgan Chase in an emergency sale to avoid a formal bankruptcy that would negatively affect the rest of the economy. The New York Federal Reserve bought $30 billion of Baer Stearns’ “assets” to get them off the balance sheet, then lent $29 billion to JP Morgan to finance the purchase of Stearns [2].

American International Group, an insurer of mortgage contracts, borrowed $182 billion in bailouts from the Federal Reserve, with the taxpayers liable if they fail to pay it back [3].

Morgan Stanley and Goldman Sachs converted to bank holding companies in order to obtain access to emergency funding from the Federal Reserve to stay afloat and avoid collapse [4]. Goldman Sachs required loans totaling $67 billion, while Morgan Stanley required loans of $96 billion.

How can one predict in advance which segment of the economy will require a bailout?

a) The ones with the highest CEO pay will require the bailout, because the CEO takes all the money out of the company.

b) All companies who operate in accordance with for-profit capitalism.

c) Only foreign companies require bailouts, because they borrow too much American money and fail to pay it back on time.

d) They are not really bailouts because the government pays for it.

e) All of the above.

(See answer on p. 2 of PDF.)

[1] Phil Angelides, Chairman, The Financial Crisis Inquiry Report, New York: Public Affairs, 2001, p. 322

[2] ibid., pp. 290, 291

[3] ibid., p. 350

[4] ibid., p. 362, 363

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Real World Graduation: Question 7

RealWorldGraduation_Question_7   < PDF

A reputable economic research organization conducted a survey of prices in 2004. They found that median prices of the following items increased as follows:

  1. Unleaded gasoline, from $1.59 per gallon to $1.88 per gallon; an increase of 18.23% [1]
  2. Single-family homes, from $243,756 to $264,540; an increase of 8.52% [2]
  3. Soybeans, from $6.08 per bushel to $7.56 per bushel; an increase of 24.34% [3]
  4. Flour, 5-lb bag, from $1.55 to $1.65; an increase of 6.45% [4]

From these statistics, what is the approximate inflation rate from 2003 to 2004:

a) The inflation rate should include only the data for gasoline, soybeans, and flour, since those are common products that people use directly or indirectly every day; the inflation rate is approximately 16.3% = ((18.23 + 24.34 + 6.45)/3)

b) Only the data for single-family homes should be used, since homes are purchased on long-term mortgages (usually 30 years), and are therefore a better predictor of long-term inflation. The long-term inflation rate is the most important metric.  Therefore the inflation rate for 2003-2004 is approximately 8.5%.

c) Only the data for unleaded gasoline should be used because it is the only one of these that most people have to buy directly. Most people do not buy homes every year, and the prices of soybeans and flour are not useful because they are only components in items purchased by most people (i.e., flour is used in making bread, but there are other costs besides flour that contribute to the increase price of bread, such as sugar, butter, and fuel).  Therefore, the inflation rate for 2003 – 2004 is approximately 18.23%.

d) All of the data should be used, but not equally weighted, since some of these are purchased frequently, and some infrequently, and some are used more than others. For example, gasoline is purchased frequently, and homes infrequently.  No data was provided on the pro-rated amount of usage, so the most that can be inferred about inflation during this period is that was somewhere between 6.45% and 24.34%.

e) Only the data for soybeans and sugar should be used, since they are basic commodities that are used in a large number of products, and represent structural trends in the economy. Therefore, the inflation rate was approximately 15.39% (the average of 24.34 and 6.45)

[1]        Energy Information Administration

[2]        Federal Housing Finance Board; see Government info (The New York Times Company)

[3]        farmdoc Project, College of Agricultural, Consumer and Environmental Sciences, University of Illinois at Urbana-Champaign

[4]        Wisconsin Farm Bureau Federation

(See answer on p. 2 of the PDF.)

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Real World Graduation, Question 5

RealWorldGraduation_Question_5   <– PDF

A study by the U. S. Department of Education in 2006 [1] reported that college tuition, fees, and room and board are continuing to rise. The data in Figure 5-1 shows the costs of tuition, fees, books, and room and board for in-state students attending public four-year universities, living on-campus.  A separate study [2] concluded that a college graduate with a 4-year degree in 2005 will earn 63% more than a person with only a high school diploma (approximately $57,000 per year vs. $35,000 per year).  This means, on average, that a college graduate earns approximately 75% more over their working lifetimes ($2.1 M vs. $1.2 M) as compared to a person with only a high-school diploma.  Given the costs of a college education shown in Figure 5-1, and the earnings benefits of a college education, what is a good federal policy regarding college costs?

  1. a) The federal government should ensure all tuition, fees, and room-and-board is free.
  2. b) Congress should enact price controls on tuition, fees, and room and board to keep the annual rate of increase at or below the rate of inflation.
  3. c) Congress should pass a law requiring that tuition costs be frozen at the rates that prevailed during the freshman year.
  4. d) Attendance at college should be mandatory so that everyone’s income will rise.
  5. e) Some combination of a), b), and c) should be adopted to improve the current system.

School Year    Tuition & Fees ($)    % Increase in Tuition & Fees     Room & Board ($)     % Increase in Room & Board

1998-1999          3640                                –                                             4985                                           –

1999-2000          3768                            3.52                                          5144                                         3.19

2000-2001              3979                        5.60                                         5342                                         3.85

2001-2002              4273                         7.39                                         5675                                         6.23

2002-2003             4686                         9.67                                         5918                                         4.28

2003-2004             5363                        14.45                                        6316                                          6.73

2004-2005             5939                         10.74                                        6649                                         5.27

2005-2006             6399                           7.75                                        7025                                         5.65

Figure 5-1

(Answer on p. 2 of the PDF)

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