ECON 102 Exam 2 Study Guide

What item from McDonald's does the weekly magazine, The Economist, use to test purchasing-power parity? A. Big Mac B. Double cheeseburger C. Large fries D. Quarter pounder

A. Big Mac

In open economy, what is the effect of a government budget deficit? A. increase real interest rates B. increase real exchange rates C. decrease net exports D. all of the above

D. all of the above

In 2012, for each $1 you could get 2 Brazilian Reais. Today, for each $1 you can get 4 Brazilian Reais. Everything else constant, the Brazilian Reais has A. appreciated and can buy more US goods and services. B. appreciated and can buy fewer US goods and services. C. depreciated and can buy more US goods and services. D. depreciated and can buy fewer US goods and services

D. depreciated and can buy fewer US goods and services

The purchase and sale of government bonds by the central bank refers to A. closed-market operations B. discount lending C. lender of last resort D. open-market operations

D. open-market operations

True or False: As banks create money with new loans, they do create wealth.

False

True or False: Cryptocurrencies serve none of the functions of money.

False

True or False: For a country with a trade deficit, domestic saving is greater than domestic investment.

False

True or False: If the Fed reserve requirements, the money supply will increase.

False

True or False: If the government budget deficit decreases, then the foreign-exchange price of the dollar will rise.

False

True or False: Inflation makes it harder for people to pay off their debts.

False

True or False: Over the long run, there is a weak relationship between a country's inflation rate and nominal exchange rate to the dollar.

False

True or False: The leverage ratio describes how many dollars of bank capital for each dollar of assets.

False

True or False: When there is a trade surplus, there are capital inflows.

False

FOMC

Federal Open Market Committee

Quantity Theory of Money Equation

Money Supply (M) x Velocity (V) = Price (P) x Real output (Y)

Saving and investment in an open economy

S = I + NCO (If +NCO saving in foreign economy)

What is the Foreign Price Level?

The exchange rate between two counties' currencies equals the ratio of the counties' price levels.

True or False: Abhijit Banerjee, Esther Duflo, and Michael Kremer won the 2019 Sveriges Riksbank in Economic Sciences in Memory of Alfred Nobel.

True

True or False: According to the Fisher effect, a decrease in the inflation rate would decrease nominal interest rates.

True

True or False: An example of capital outflow for the US would be a US bank buying a German government bond.

True

True or False: For a closed economy, national savings always equals domestic investment

True

True or False: Money velocity has been stable with the introduction of new forms of electronic payment.

True

True or False: The "twin" deficits that the US economy has experienced in recent history are the federal budget deficit and trade deficit.

True

law of one price

in competitive markets free of transportation costs and barriers to trade, identical products sold in different countries must sell for the same price when their price is expressed in the same currency

price floor

interest rate on reserves

Monetary Policy

reserve requirement, open market operations, federal funds rate - central banks don't do this anymore

What gives money its value?

taxes, April 15th we pay gov taxes in money. Government only accepts money in dollars so that's how it gets its value

Shoe leather costs

the resources wasted when inflation encourages people to reduce their money holdings

classical dichotomy

the theoretical separation of nominal and real variables

Balance Sheet

- T account

Big Mac Index

- a measure created by the Economist magazine that compares the value of currencies by comparing the cost of a Big Mac hamburger in different countries. The United States is used as the baseline cost for the index - Tool for calculating purchasing power parity that compares prices of a Big Mac throughout the world.

Purchasing Power Parity

- a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries - a measure of how many units of currency are needed in one country to buy the amount of goods and services that one unit of currency will buy in another country

reserve ratio and money multiplier

- banks may hold onto reserves more than required -since financial crisis, banks have been holding on to more reserves - with reserve ratio we understand how far that money can go

Twin Deficits

- deficits that occur when a country is running both a trade and a budget deficit - going from a budget surplus to deficit thats more negative public saving decreasing supply of loanable funds - more capital inflow, less capital outflow - new higher equilibrium real interest rate, higher real interest rates, less NCO, less supply Federal Exchange Rate, less capital supply

The Classical dichotomy and money neutrality

- nominal variables interact with each other but have no affect on real variables -if classical dichotomy holds, changes in money supply have no affect in the long run - in short run, it doesn't hold, which means money is not neutral but only in the short run

closed vs open economy

- open economies interact freely with other economies around the world whereas closed economies do not interact with them at all.

Net Capital Outflow (NCO)

- purchase of foreign assets by domestic residents - purchase of domestic assets by foreigners - describes trade of financial assets across economies

Response to Financial Crisis

- raised discount rate to 4% - raised interest rate on reserves to 3.75% - so Fed Funds rate would fall somewhere between

The Fed Monetary Policy

- special Fed Loanable Funds Market - Banks who need more reserves can borrow at low ratio - Banks who have extra reserves give at high interest rates - Any bank can borrow from central rate with discount rate - lowers/cuts off part of demand curve

Hyperinflation

- very high and rising inflation rate - ~50% per month or ~500% per year - government gets in trouble and starts issuing money to finance their expenditures, printing money rapidly, inflation increases, value of dollar plummets

Structure of the Fed (FOMC)

-central bank formation/creation -created as decentralized w/ regional Feds (was seen as bad throughout the Great Depression) - 7 governors -5 presidents 1 is president of NY fed because of NY being central location

Inflation Tax

-printing money causes inflation, which is like a tax on everyone who holds money -paid by people who hold currency who see value loss in currency holding as government prints more money

Costs of inflation

-shoe leather costs, menu costs, unit of account costs -hold wealth in as little liquid forms as possible -managing stock and bond portfolio redistribution of wealth across economy -people who lent out money are being paid back in less -what price to charge and in comparison to competitors

Fractional Reserve Banking System

-some amount of reserves banks need to have -deposits not used as reserves = loans for mortgages/businesses/people -when banks make a loan with deposits, they're creating money but NOT wealth. Debts owed, liabilities added

what are the functions of money?

1.Medium of exchange 2.unit of account 3. store of value

money multiplier

1/reserve ratio

There is currently political unrest in Chile, we would expect A. Chilean net capital outflow to rise so Chilean interest rates rise. B. Chilean net capital outflow to rise so Chilean interest rates fall. C. Chilean net capital outflow to fall so Chilean interest rates rise. D. Chilean net capital outflow to fall so Chilean interest rates fall.

A. Chilean net capital outflow to rise so Chilean interest rates rise.

Which of the following would cause both the equilibrium interest rate and quantity of loanable funds increase? A. Net capital outflows increase B. Net capital outflows decrease C. Government budget deficit grows D. Trade surplus decreases

A. Net capital outflows increase

What is the primary difference between the M2 and M1 measures of the money supply? A. assets in M1 are more liquid than M2 B. assets in M2 are more liquid than M1 C. all assets in M2 are included in M1 D. not all assets in M1 are included in M2

A. assets in M1 are more liquid than M2

Which of the following is true about a country with a trade surplus? A. capital outflows are greater than capital inflows B. capital outflows are equal to capital inflows C. capital outflows are less than capital inflows D. not enough information

A. capital outflows are greater than capital inflows

Holding all else constant, an increase in US real interest rates will A. increase the real exchange rate. B. decrease the real exchange rate. C. not affect the real exchange rate. D. have an undetermined effect on the real exchange rate

A. increase the real exchange rate.

T account

An accounting device used to analyze transactions

An investment bank before the financial crisis had $100 billion in assets and $90 billion in debt. What would be the value of bank capital if the value of assets falls to $95 billion? A. $10 billion B. $5 billion C. -$5 billion D. -$10 billion

B. $5 billion

When more American students choose to go on spring break in Mexico instead of Florida: A. US net exports fall and the US trade deficit becomes closer to balanced trade B. US net exports fall and the US trade deficit becomes further from balanced trade C. US net exports rise and the US trade deficit becomes closer to balanced trade D. US net exports rise and the US trade deficit becomes further from balanced trade

B. US net exports fall and the US trade deficit becomes further from balanced trade

Using the quantity theory of money, if the rate of real GDP growth is greater than the rate of money growth, then there would be A. disinflation B. deflation C. inflation D. hyperinflation

B. deflation

Most economists believe that the classical dichotomy and money neutrality holds A. in the long-run and the short-run. B. in the long-run but not the short-run. C. in the short-run but not the long-run. D. not in the long-run and not in the short-run.

B. in the long-run but not the short-run.

If the Fed purchases government bonds, which of the following has only actions that would each counter the effect of government bond purchases on the money supply? A. increase reserve requirements, decrease the discount rate B. increase reserve requirements, increase the discount rate C. decrease reserve requirements, decrease the discount rate D. decrease reserve requirements, increase the discount rate

B. increase reserve requirements, increase the discount rate

Sometimes economists label "medium of deferred payment" as a fourth function of money, but it is really just a combination of which two functions: A. medium of exchange, unit of account B. medium of exchange, store of value C. unit of account, store of value D. none of the above

B. medium of exchange, store of value

Inflation causes tax distortions because A. taxes are set in nominal terms, leading to different nominal returns based on tax rates. B. taxes are set in nominal terms, leading to different real returns based on tax rates. C. taxes are set in real terms, leading to different nominal returns based on tax rates. D. taxes are set in real terms, leading to different real returns based on tax rates.

B. taxes are set in nominal terms, leading to different real returns based on tax rates.

All else constant, as more international students from China choose to go to universities in Europe instead of the United States, what would happen? A. the Chinese currency would appreciate against the dollar and the euro B. the Chinese currency would appreciate against the dollar and depreciate against the euro C. the Chinese currency would depreciate against the dollar and appreciate against the euro D. the Chinese currency would depreciate against the dollar and the euro

B. the Chinese currency would appreciate against the dollar and depreciate against the euro

Suppose the reserve requirement in a fractional reserve banking system is 20%. If you took $100 of currency and deposited it in the bank, how much additional money could be created? A. $0 B. $100 C. $400 D. $500

C. $400

For which reason(s) might purchasing-power parity not hold? A. some goods and services are not easily traded across countries B. some goods and services are not perfect substitutes across countries C. both of the above D. neither of the above

C. both of the above

Assume the economy produces only oranges. There is a money supply of $6000. The economy produces 6000 oranges that sell for $3 each. What is nominal GDP and money velocity? A. nominal GDP = $6000, velocity = 3 B. nominal GDP = $6000, velocity = 9 C. nominal GDP = $18000, velocity = 3 D. nominal GDP = $18000, velocity = 9

C. nominal GDP = $18000, velocity = 3

Trade policies, like import tariffs and export quotas, affect A. the trade balance. B. net capital outflows. C. specific firms and industries. D. none of the above.

C. specific firms and industries.

The inflation tax refers to A. the increase in the price of a product as a result of an increase in taxes B. the fact that income tax rates rise with inflation C. the revenue the government creates by printing money D. the inflationary effect of a decrease in taxes

C. the revenue the government creates by printing money

As the Fed increases the money supply, A. the value of money increases and the price level increases B. the value of money increases and the price level decreases C. value of money decreases and the price level increases D. the value of money decreases and the price level decreases

C. value of money decreases and the price level increases

Commodity vs. Fiat Money

Commodity: has value other than as money (ex. gold and silver coins, intrinsic value, seashells in west African war trade.) Fiat money: given value by government decree. Most money is fiat money

variables that influence net exports

e= PC/$, P, P*, tastes and preferences

A US mutual fund sells Canadian stocks and buys American stocks. Holding all else constant, in the market for foreign-currency exchange A. demand for dollars rises B. demand for dollars falls C. supply of dollars rises D. supply of dollars falls

D. supply of dollars falls

If the exchange rate is 8 Moroccan dirhams per US $, a crate of oranges costs 400 dirhams in Morocco, and a crate of oranges costs $45 in Florida, then A. the real exchange rate is greater than one and there is an arbitrage opportunity to buy oranges in Morocco and sell in Florida B. the real exchange rate is greater than one and there is an arbitrage opportunity to buy oranges in Florida and sell in Morocco C. the real exchange rate is less than one and there is an arbitrage opportunity to buy oranges in Morocco and sell in Florida D. the real exchange rate is less than one and there is an arbitrage opportunity to buy oranges in Florida and sell in Morocco

D. the real exchange rate is less than one and there is an arbitrage opportunity to buy oranges in Florida and sell in Morocco

Value Assets - Value of Liabilities

Equity

reserve ratio formula

bank reserves/total deposits

Fisher Effect

created by economist Irving Fisher that describes the relationship between inflation and both real and nominal interest rates. The Fisher Effect states that the real interest rate equals the nominal interest rate minus the expected inflation rate.

price ceiling

discount rate