Econ Exam #3
6. The phase of the business cycle that refers to the point in time at which overall economic activity reaches its maximum is the
Peak.
8. The U.S. economy grew for an uninterrupted 10 year period from
September 1979 through September 1989.
2. The ______________ refers to government policies with the primary aim of minimizing fluctuations in overall macroeconomic activity.
Stabilization Function of Government
expansion
a period of time during which an economy is growing or recovering (i.e., economic activity is increasing, often reflected by a positive GDP growth rate)
starting at a point where Q is below its maximum, increasing the money supply can lead to
a real increase in economic activity (i.e., in Q)
market failure
a situation in which the "free market outcome" is inefficient, in that there is a positive Deadweight-Loss at the resulting "free market level of trade."
fractional reserve banking system
a system in which at any point in time a commercial bank is only required to retain a portion of the money it has accepted as deposits
overall price level
the "average" of all the prices of goods/services traded (denoted P )
25. Monetary Policy in the United States is determined by
the Federal Reserve.
statements related to monetary policy and fiscal policy with which there is general agreement among economists:
"Fiscal Policy has a significant stimulative impact on a less than fully employed economy." [88.6% agreement] "Inflation is caused primarily by too much growth in the money supply." [75.0% agreement] "Management of the business cycle should be left to the Federal Reserve; activist fiscal policy should be avoided." [70.4% agreement]
Milton Friedman:
"Inflation is always and everywhere a monetary phenomenon."
four common sources of market failure:
(1) profit maximization by a firm with market power, (2) market provision of public goods, (3) market provision of goods generating externalities, and (4) lack of information by market participants
So, why not always increase the money supply in order to stimulate economic activity? Monetarist's answer:
-In the long run, changes in the money supply have no impact on the overall level of real economic activity, but rather only have an impact on price -in the long run, an efficient market economy will tend toward a situation in which all resources are being used and society is producing close to its maximum level of output (i.e., Q is at its maximum value) -recalling MVPQ, the only possible consequence of an increase in M is ultimately a corresponding increase in P => an increase in the money supply will not alter total output in the long run but will only increase prices in the long run
central bank
-entity which has the ability to alter the money supply of an economy -Primary task is to control the nation's money supply.
Milton Friedman
1912-2006; Nobel Prize in 1976
17. Peru experienced an inflation rate of ___________ in 1990.
512%
However, if instead productive resources are not fully employed, then government spending will use otherwise idle resources and thus will generate new economic activity
=> could lead to a significant short term increase in overall economic activity as desired
19. ____________________ refers to the time it takes a policymaker to decide upon the specific stabilization policies which should be enacted.
A Decision Lag
market power
A firm has market power if they have some "control over the price of their output," in that they: (i) can increase price without losing all customers and (ii) must decrease price in order to increase sales
UK Central Bank
Bank of England (created in 1694)
5. ___________________ can potentially be used by the government in order to stabilize the performance of the macroeconomy (i.e., to minimize fluctuations in the rate of economic growth) over time.
Both Fiscal Policy and Monetary Policy
3. The ______________ refers to the periodic but irregular fluctuation in overall macroeconomic activity which occurs over time.
Business Cycle
12. ___________________ refers to decreases in private spending that occur following increases in government spending.
Crowding Out
24. President Trump is concerned that the U.S. economy is not experiencing a sufficiently strong economic recovery. In light of this view, he argues that we should drastically decrease tax rates in 2017 for all income earners, in an attempt to further stimulate overall macroeconomic activity. This proposal could be described as
Expansionary Fiscal Policy.
11. The _________________ is the Central Bank of the United States.
Federal Reserve
US Central Bank
Federal Reserve, created in 1913, is an independent central bank, in that its actions are not directly dictated by the legislative or executive branch
low output equilibria caused by too little spending (Key Implication)
Fiscal Policy can indirectly stabilize macroeconomic activity ("spending against the wind")
Fiscal Policy
Government policies related to spending and revenue generation.
Monetary Policy
Government policies which determine a nation's Money Supply.
Timing Difficulties of Stabilization (both Fiscal Policy and Monetary Policy):
Information and Recognition Lags Decision Lag Implementation Lag
7. "The General Theory of Employment, Interest and Money" was written by
John Maynard Keynes
4. Which of the following is NOT one of the primary policy tools used by a central bank?
Loaning money to low income home buyers at below market interest rates (in order to make housing "affordable for all").
18. The Equation of Exchange is
MV=PQ
13. ________________ said that "Inflation is always and everywhere a monetary phenomenon.
Milton Friedman
In the decades following WW-II "Monetarism" emerged as an alternative to "Keynesianism" =>
Monetarism argued that economic fluctuations depended more on Monetary Policy than on Fiscal Policy
20. The Fed can increase the Money Supply in the U.S. by A. selling U.S. Treasury debt securities to the public. B. increasing the reserve requirement. C. decreasing the discount rate.
More than one (perhaps all) of the above answers is correct.
recession
a period of time during which an economy is contracting, commonly defined as six or more consecutive months of declining real GDP
"The General Theory of Employment, Interest and Money" (1936) by John Maynard Keynes
a book, written against the backdrop of the Great Depression, which was in many ways an assault on "traditional macroeconomic thought" (previous argument was for direct control of the macroeconomy)
27. Suppose that the government of county X has revenues of $247 billion and spends $233 billion. As a result, the government of country X realizes
a budget surplus of $480 billion.
if G is increased, does C remain constant or decrease?
a decrease in C reveals "crowding out"
contractionary monetary policy
a decrease in the money supply which dampens overall economic activity, resulting in lower levels of output, employment, and incomes in the short term (but greater stability in the long term)
rival good
a good for which consumption by one person does diminish the quantity or quality of consumption by others
non-rival good
a good for which consumption by one person does not diminish the quantity or quality of consumption by others
non-excludable good
a good for which it is difficult (or very costly) to prevent consumption by those who do not pay
excludable good
a good for which it is easy to prevent consumption by those who do not pay e.g., Big Mac from McDonald's; market provision is typically efficient
club good
a good that is excludable and non-rival in consumption e.g., satellite radio or television broadcast
public good
a good that is non-excludable and non-rival in consumption e.g., national defense
common good
a good that is non-excludable and rival in consumption e.g., stock of fish in the ocean
aggregate level of output
a measure of the real quantity of goods/services produced (denoted Q)
21. Consider the following two statements: (1) "Fiscal Policy can never have any stimulative impact on the macroeconomy" and (2) "Inflation is caused primarily by too much growth in the money supply." Most economist would
agree with Statement (2) but not Statement (1).
Three primary functions of government in the economy
allocation function, distribution function, and stabilization function
Equation of Exchange
an identity which relates the money supply, velocity of money, overall price level, and aggregate level of output to each other: MV=PQ
expansionary monetary policy
an increase in the money supply which provides a short term stimulus to the macro-economy, resulting in higher levels of output, employment, and incomes
experience suggests that independent central banks are better at promoting stable economic growth and maintaining the value of a country's currency =>
an independent central bank is less vulnerable to short term political pressures
Inflation and Money Supply in Peru (1979-1991)
annual inflation rates of 3,398% in 1989 and 7,482% in 1990
stabilization function
attempts by government to minimize fluctuations in overall macroeconomic activity.
when loanable funds are more readily available, interest rates decrease =>
businesses are more inclined to build factories, expand production, and hire workers, while households are more inclined to make major purchases
open market operations
buying and selling of U.S. Treasury debt securities to and from the public o buying bonds puts more money in circulation (increases money supply); selling bonds takes money out of circulation (decreases money supply)
14. During the most recent recession in the U.S. (which officially lasted from December 2007 through June 2009) Real GDP _____________.
decreased by 4.1%
Contractionary Fiscal Policy
decreases in government spending or increases in taxes with the aim of dampening overall economic activity
Crowding Out
decreases in private spending that occur following increases in government spending
distribution function
government policies aimed at changing the final distribution of goods/services across consumers, usually with the intention of realizing a "fairer" apportionment of consumption/income/wealth.
allocation function
government production of goods or regulation of business, aimed at improving the allocative efficiency of the economy (i.e., getting the "right mix" of products produced, each in the "ideal quantity" and at the "ideal quality").
budget surplus occurs when
government revenues exceed spending
low output equilibria caused by too little spending (Corollary)
government should cut back spending and run a surplus during an expansion (this has often been overlooked) [a budget surplus occurs when government revenues exceed spending]
budget deficit occurs when
government spending exceeds revenues
free rider problem
if a public good were supplied in a free market, the amount traded would be less than the efficient quantity, since many people would attempt to enjoy the benefits of units purchased by others, while not purchasing any units themselves
23. Monetarists believe that increasing the money supply can potentially increase real output
in the short run but not the long run.
Expansionary Fiscal Policy
increases in government spending or decreases in taxes with the aim of stimulating overall economic activity
22. The central bank of the United Kingdom
is the Bank of England, which was founded in 1694.
monopoly
market structure in which there is one single seller of a unique good with no close substitutes. -The "polar opposite" of "perfect competition." -The demand curve facing a monopolist is the market demand curve. -They can choose any price/quantity combination along the market demand curve. profit - the difference between revenues and costs of production
central argument of "The General Theory..."
markets are volatile and might not result in "full employment"
setting of reserve requirements
minimum restrictions on the amount of money that a bank must keep on hand at any point in time, in the form of either cash in its vault or deposits with the central bank o lowering the reserve requirement increases the money supply; raising the reserve requirement decreases the money supply
Three policy tools of the Fed to alter the money supply:
open market operations setting of reserve requirements setting of discount rate
15. According to the views held by Monetarists, if the money supply is drastically increased, then in the long run
prices will increase but the level of real output will not increase.
"A Monetary History of the United States, 1867-1960" (1963) written by Friedman and Anna Schwartz
provided strong evidence to support a claim that the money supply has a direct impact on short run levels of income, employment, and inflation
10. If the federal government of Keynesland (a small island nation off the western coast of Portugal, with an economy highly dependent upon bowling ball production) had revenues of €950,000,000 and expenditures of €800,000,000 in 2012, then in 2012 this government
realized a budget surplus of €150,000,000.
low output equilibria caused by too little spending
recall, from our discussion of GDP that: Y =C+I+G+NX => a low value of C can bring down Y
1. "Fiscal Policy" can be described as government policy
related to spending and revenue generation.
low output equilibria caused by too little spending (solution)
replace missing private spending with government spending (i.e., offset the low value of C with a higher value of G ) => deficit spending as an economic stimulus during downturns [a budget deficit occurs when government spending exceeds revenues]
9. The arguments made by John Maynard Keynes suggest that during an economic downturn, the government should
run a budgetary deficit, in order to stimulate the economy by replacing missing private spending with government spending.
setting of discount rate
setting the interest rate that the Fed charges banks on short-term loans o lowering the discount rate increases the money supply; raising the discount rate decreases the money supply
marginal costs of production
the amount by which production costs change as the firm's quantity of output is increased by a unit
marginal revenue
the amount by which revenue changes as the firm's quantity of output is increased by a unit
money supply
the amount of money in circulation in an economy (denoted M )
loanable funds market
the collection of all markets in which lenders and borrowers interact (e.g., mortgage markets, auto loan markets, consumer credit markets, business loan markets)
profit
the difference between revenues and costs of production
velocity of money
the number of times that a typical dollar is used in market transactions in a single year (denoted V )
business cycle
the periodic but irregular fluctuation in overall macroeconomic activity which occurs over time, measured by changes in Real GDP (and other measures of macroeconomic activity)
trough
the point in time at which an economy stops contracting at the end of a recession (i.e., economic activity reaches a minimum)
peak
the point in time at which an economy stops growing at the end of an expansion (i.e., economic activity reaches a maximum)
Decision Lag
the time that it takes a policymaker to decide upon the specific stabilization policies to enact (it may take Congress several months to pass a "stimulus bill")
Implementation Lag
the time that it takes for the enacted policy to have an impact on macroeconomic outcomes (it often takes about 12 to 18 months for an enacted policy to have an actual impact on the economy)
Information and Recognition Lags
the time that policymakers must wait in order to collect and process economic data and confirm that a stabilization policy is needed -data on macroeconomic outcomes is not available immediately (most measures are available three months after the fact) -policymakers must wait for economic data to be collected, processed, and reported -further, a small change in an economic outcome (e.g., a slight decline in GDP or slight increase in unemployment) might be the start of a recession...or might not -we are often several months into a downturn before we even know it
26. The number of times that a typical dollar is used in market transactions in a single year is referred to as
the velocity of money.
If a significant amount of crowding out occurs,
then the effectiveness of stimulative Fiscal Policy will be reduced, since the government spending does not create any new economic activity, but rather replaces private economic activity with government economic activity (in a likely inefficient way)
16. The ________________ refers to the number of times that a typical dollar is used in a transaction in a given year.
velocity of money
observed outcomes during Great Depression:
• people don't have jobs/incomes • without income people don't buy output from firms • firms can't make profits, so they shutdown and layoff workers • stable state with low resource use and low output