Macro Economics Test 3

Suppose that the opportunity-cost ratio for watches and cheese is 1C ≡ 1W in Switzerland but 1C ≡ 4W in Japan. At which of the following international exchange ratios (terms of trade) will Switzerland and Japan be willing to specialize and engage in trade with each other? (choose 2) 1C ≡ 3W 1C ≡ ½W 1C ≡ 5W ½C ≡ 1W 2C ≡ 1W

1C ≡ 3W ½C ≡ 1W

The Taylor Rule

A policy rule proposed by economist John Taylor. • Suggests how the Fed will adjust the nominal interest rate as it pursues the Dual Mandate. • Based on the idea that if forced to make a choice between inflation being too high and unemployment being too high, central bankers will err on the side of inflation being too high. • More specifically, the Taylor Rule assumes that the Fed cares twice as much about hitting its full-employment target as it does about hitting its inflation target.

Suppose that the opportunity-cost ratio for fish and lumber is 1F ≡ 1L in Canada but 2F ≡ 1L in Iceland. Then ____________ should specialize in producing fish while ___________ should specialize in producing lumber. A) Iceland; Canada B) Canada; Iceland

A) Iceland; Canada Iceland should specialize in producing fish while Canada should specialize in producing lumber. This is true because Iceland has a comparative advantage in producing fish while Canada has a comparative advantage in producing lumber. Those comparative advantages imply that if each country specializes in the production of the product for which it has a comparative advantage, total output between the two countries can rise. It is for that reason—increasing the total amount of output that can be produced—that the two countries should specialize and trade. To see that Iceland has a comparative advantage in producing fish, divide both sides of its opportunity-cost ratio by 2. Doing so yields 1F ≡ ½L. That version of Iceland's opportunity-cost ratio demonstrates that in order to produce one ton of fish, Iceland has to give up only ½ ton of lumber. By contrast, Canada's opportunity-cost ratio of 1F ≡ 1L indicates that in order to produce one ton of fish, Canada must give up one ton of lumber. Thus, Iceland has the comparative advantage in producing fish because it can produce fish at a lower opportunity cost in terms of lumber forgone. A similar analysis demonstrates that Canada has the comparative advantage in producing lumber because it has the lower opportunity cost in terms of fish forgone. You can see this by comparing Canada's opportunity-cost ratio of 1F ≡ 1L with Iceland's opportunity-cost ratio of 2F ≡ 1L. Canada only has to give up one ton of fish to produce a ton of lumber whereas Iceland has to give up 2 tons of fish to produce a ton of lumber.

The total demand for money curve will shift to the right as a result of A) an increase in nominal GDP. B) an increase in the interest rate. C) a decline in the interest rate. D) a decline in nominal GDP.

A) an increase in nominal GDP.

Assume the legal reserve ratio is 25 percent and the Fourth National Bank borrows $10,000 from the Federal Reserve Bank in its district. As a result, A) commercial bank reserves are increased by $10,000. B) the supply of money automatically declines by $7,500. C) commercial bank reserves are increased by $7,500. D) the supply of money is automatically increased by $10,000.

A) commercial bank reserves are increased by $10,000.

When bond prices go up, interest rates go __________. A) down B) up C) nowhere

A) down When bond prices go up, interest rates go down. This happens because bond prices and interest rates are inversely related. To see why they are inversely related, recall that bonds are promises to repay particular amounts of money at particular points in the future. For instance, suppose that a bond promises to pay exactly $100 in one year. Also suppose that the current price of the bond is $50. Then the bond will yield an interest rate of 100 percent because $50 spent purchasing the bond today will yield a payment of $100 in one year, thereby doubling the owner's money. Next, suppose that the current price is instead $90. Then purchasing the bond today and holding it for a year would yield an interest rate of a little more than 11 percent (because $90 today would become $100 in one year, thereby generating a $10 gain—or a little more than 11 percent of the current purchase price of $90). Because the bond's future payout is fixed at $100, a higher current price implies a lower interest rate while a lower current price implies a higher interest rate.

If there is an increase in the nation's money supply, the interest rate will A) fall, investment spending will rise, aggregate demand will shift right, and real GDP and the price level will rise. B) rise, investment spending will fall, aggregate demand will shift right, real GDP will fall, and the price level will rise. C) fall, investment spending will rise, aggregate demand will shift right, real GDP will rise, and the price level will fall. D) rise, investment spending will fall, aggregate demand will shift right, real GDP will rise, and the price level will fall.

A) fall, investment spending will rise, aggregate demand will shift right, and real GDP and the price level will rise. A change in the nation's money supply (achieved by changing reserves in the banking system) will cause an opposite change in the interest rate. An increase in the money supply will make funds increasingly available and drive down their price (interest rate). The interest rate and investment spending are also inversely related. A falling interest rate will make some investments (capital spending projects) more profitable, so spending on those will increase. Investment spending is part of aggregate demand, so they will move together, as will real GDP. An increase in spending (AD) will increase inflationary pressure (and will increase prices).

Tariffs and import quotas can reduce unemployment in a U.S. import industry, but A) foreign countries could impose nontariff barriers on U.S. goods, reducing jobs in an export industry. B) the U.S. economy could falter, and jobs would decrease anyway. C) foreign countries could impose nontariff barriers on U.S. goods, increasing jobs in an export industry. D) if foreign countries experience growth, export jobs may grow.

A) foreign countries could impose nontariff barriers on U.S. goods, reducing jobs in an export industry.

The Federal Reserve Banks buy government securities from commercial banks. As a result, the checkable deposits A) of commercial banks are unchanged, but their reserves increase. B) and reserves of commercial banks both decrease. C) of commercial banks are unchanged, but their reserves decrease. D) and reserves of commercial banks are both unchanged.

A) of commercial banks are unchanged, but their reserves increase.

Protective tariffs might reduce both the imports and the exports of the nation that levies tariffs because A) other countries may follow with their own import tariffs. B) protective tariffs can be designed to either reduce imports or exports. C) exports and imports must be equal. D) other countries may follow with their own export tariffs.

A) other countries may follow with their own import tariffs. If a country imposes import tariffs, other countries may follow with their own import tariffs. These foreign import tariffs will reduce the exports of the nation that originally imposed the import tariffs.

Distinctive products... A) provide an export niche for a country. B) decrease production costs for a country. C) increase production costs for a country. D) are the basis for international trade and specialization.

A) provide an export niche for a country. Distinctive products—those associated with a particular country (perhaps because of a reputation for quality)—can provide an export niche for a country. Even though the country may have no cost advantage in producing the good, the "label" on the good is enough to attract buyers willing to pay more than for potentially comparable substitutes.

Consider the following statement: "The United States can make certain toys with greater productive efficiency than can China. Yet we import those toys from China." We import these toys from China because A) the United States has an absolute advantage in producing toys, but China has a comparative advantage in producing toys. B) the United States has a higher cost per unit of producing the toys. C) China produces better toys. D) China has an absolute advantage in producing toys, but the United States has a comparative advantage in producing toys.

A) the United States has an absolute advantage in producing toys, but China has a comparative advantage in producing toys. A country is said to have an absolute advantage over other producers of a product if it is the most efficient producer of that product (by which we mean that it can produce more output of that product from any given amount of resource inputs than can any other producer.) A country is said to have a comparative advantage over other producers of a product if it can produce the product at a lower opportunity cost (by which we mean that it must forego less output of alternative products when allocating productive resources to producing the product in question).

Complete the following statement: If there is an increase in the total demand for money, A) the equilibrium interest rate will rise. B) the equilibrium interest rate will fall. C) the money supply will fall. D) the money supply will rise.

A) the equilibrium interest rate will rise. An increase in the total demand for money will shift money demand to the right, raising the equilibrium interest rate. The money supply is changed by the Fed; it does not change with money demand.

Which of the following will increase commercial bank reserves? A) the purchase of government bonds in the open market by the Federal Reserve Banks B) a decrease in the reserve ratio C) an increase in the discount rate D) the sale of government bonds in the open market by the Federal Reserve Banks

A) the purchase of government bonds in the open market by the Federal Reserve Banks

The basic objective of monetary policy is A) to assist the economy in achieving a full-employment, noninflationary level of total output. B) to eliminate inflation and lower interest rates. C) to maintain steady exchange rates and lower inflation. D) to increase employment and stabilize exchange rates.

A) to assist the economy in achieving a full-employment, noninflationary level of total output.

Evaluation and Issues

Advantages over fiscal policy: • Speed and flexibility. • Isolation from political pressure. • Monetary policy is more subtle than fiscal policy.

NAFTA

Agreement between United States, Canada, and Mexico Established a free trade zone between the countries Trade has increased in all countries Enhanced standard of living

Federal Reserve Balance Sheet

Assets: • Securities • Loans to commercial banks Liabilities: • Reserves of commercial banks • Treasury deposits • Federal Reserve Notes outstanding

Assumptions and Opportunity Cost Ratio

Assumptions: • Two nations • Same size labor force • Constant costs in each country • Different costs between countries • United States has absolute advantage in both Opportunity cost ratio: • Slope of the curve • Vegetables sacrificed per ton of beef

Suppose that the opportunity-cost ratio for sugar and almonds is 4S ≡ 1A in Hawaii but 1S ≡ 2A in California. Which state has the comparative advantage in producing almonds? A) Hawaii B) California C) Neither

B) California California has the comparative advantage in producing almonds. This is true because California has to give up less sugar in order to produce a ton of almonds. The easiest way to see this is to begin by dividing both sides of California's opportunity-cost ratio by 2. That will give you ½S ≡ 1A. That version of California's opportunity-cost ratio makes it clear that for every ton of almonds that California produces, it must forgo ½ ton of sugar. By contrast, Hawaii's opportunity-cost ratio of 4S ≡ 1A indicates that for every ton of almonds that Hawaii produces, it must forgo 4 tons of sugar. As a result, California has a comparative advantage in producing almonds because it can produce them at a lower opportunity cost as measured by the amount of sugar that must be forgone in order to free up enough resources to produce one ton of almonds.

In Country A, a worker can make 5 bicycles per hour. In Country B, a worker can make 7 bicycles per hour. Which country has an absolute advantage in making bicycles? A) Country A B) Country B

B) Country B Country B has an absolute advantage in making bicycles because Country B is more efficient in the sense of being able to convert the same amount of input into a larger amount of output. Please note that the definition of absolute advantage focuses on the efficiency with which countries can turn input into output. It says nothing at all about the opportunity costs of producing a particular type of output or how much of other products must be forgone in order to produce a unit of that particular type of output. The concept of comparative advantage deals with those opportunity-cost issues.

Suppose that the current international price of wheat is $6 per bushel and that the United States is currently exporting 30 million bushels per year. If the United States suddenly became a closed economy with respect to wheat, would the domestic price of wheat in the United States end up higher or lower than $6? A) Higher B) Lower C) The same

B) Lower If the United States suddenly became a closed economy, the domestic price of wheat would end up being lower than the current international price of wheat. That is because from the perspective of U.S. farmers, closing the U.S. economy to international trade in wheat would mean drastically lowering the overall demand for their product. That is, the total demand for U.S. wheat would fall sharply because U.S. wheat farmers would now be cut off from all of the foreign consumers who had previously been consuming all of the wheat that the United States had been exporting. That reduction of the total demand for U.S. wheat would result in a lower equilibrium domestic price of wheat if the United States were to become a closed economy with respect to wheat.

The eurozone is A) a group that oversees trade agreements reached by member nations and arbitrates trade disputes among them. B) a common currency zone in which members have adopted the euro as their common currency. C) a trading bloc of 28 European countries who have agreed to abolish tariffs and import quotas on most products and have liberalized the movement of labor and capital. D) a trade bloc made up of the United States, Canada, and Mexico whose purpose is to reduce tariffs and other trade barriers among the three countries.

B) a common currency zone in which members have adopted the euro as their common currency.

The World Trade Organization (WTO) is A) a trading bloc of 28 European countries who have agreed to abolish tariffs and import quotas on most products and have liberalized the movement of labor and capital. B) a group that oversees trade agreements reached by member nations and arbitrates trade disputes among them. C) a trade bloc made up of the United States, Canada, and Mexico whose purpose is to reduce tariffs and other trade barriers among the three countries. D) a common currency zone in which members have adopted the euro as their common currency.

B) a group that oversees trade agreements reached by member nations and arbitrates trade disputes among them.

The equilibrium interest rate in the money market is determined A) at the intersection of the aggregate demand and aggregate supply curves. B) at the intersection of the total demand for money curve and the supply of money curve. C) by how much the interest rate fluctuates over time. D) by the Fed.

B) at the intersection of the total demand for money curve and the supply of money curve.

Import competition can lead to A) job losses worldwide. B) quality improvements and cost reductions by American firms. C) fewer high-quality products. D) job gains worldwide.

B) quality improvements and cost reductions by American firms. If domestic firms need to compete with imports, this may lead to quality improvements in domestic goods as domestic firms try to differentiate themselves from the imports. It may also result in cost reductions in the United States as firms try to compete on the cost side of the ledger (allows the firm to lower the price).

The purchase of government securities from the public by the Fed will cause A) commercial bank reserves to decrease. B) the money supply to increase. C) demand deposits to decrease. D) the interest rate to increase.

B) the money supply to increase.

Suppose Big Country can produce 80 units of X by using all its resources to produce X or 60 units of Y by devoting all its resources to Y. Comparable figures for Small Nation are 60 units of X and 60 units of Y. Assuming constant costs, Big Country needs to give up A) 1 unit of Y for 1 unit of X and should produce good X. Small Nation needs to give up 3/4 of a unit of X for 1 unit of Y and should produce good Y. B) 1 unit of Y for 1 unit of X and should produce good Y. Small Nation needs to give up 3/4 of a unit of X for 1 unit of Y and should produce good X. C) 3/4 of a unit of Y for 1 unit of X and should produce good X. Small Nation needs to give up 1 unit of X for 1 unit of Y and should produce good Y. D) 3/4 of a unit of Y for 1 unit of X and should produce good Y. Small Nation needs to give up 1 unit of X for 1 unit of Y and should produce good X.

C) 3/4 of a unit of Y for 1 unit of X and should produce good X. Small Nation needs to give up 1 unit of X for 1 unit of Y and should produce good Y. To answer this question, we find the opportunity cost of the two goods.The opportunity cost of good Y (in terms of good X) in Big Country is 3/4 (= 60/80) unit of Y for each unit of X. That is, Big Country needs to give up 3/4 of a unit of Y to produce 1 more unit of X. Note that this is the slope of Big Country's production possibilities curve with Y on the vertical axis. The opportunity cost of good Y (in terms of good X) in Small Nation is 1 (= 60/60) unit of Y for each unit of X. That is, Small Nation needs to give up 1 unit of Y to produce 1 more unit of X. Note that this is the slope of Small Nation's production possibilities curve with Y on the vertical axis. Given these opportunity costs, Big Country should produce good X (only needs to give up 3/4 of a unit of Y for 1 X) and Small Nation should produce good Y (needs to give up 1 unit of X for 1 unit of Y). That is, Big Country has a comparative advantage in producing good X because it has to give up less good Y to produce X per unit.

Which of the following represents land-, labor-, and capital-intensive commodities, respectively? A) Automobiles, corn, and transistor radios B) Clothing, aircraft, and automobiles C) Corn, clothing, and aircraft D) Wheat, automobiles, and transistor radios

C) Corn, clothing, and aircraft Land-intensive commodities include agricultural products such as corn and wheat. Labor-intensive commodities require much labor in production, such as transistor radios and clothing. Capital-intensive products are produced with a large amount of capital equipment and include manufactured items such as aircraft and automobiles.

The European Union (EU) is A) a group that oversees trade agreements reached by member nations and arbitrates trade disputes among them. B) a common currency zone in which members have adopted the euro as their common currency. C) a trading bloc of 28 European countries who have agreed to abolish tariffs and import quotas on most products and have liberalized the movement of labor and capital. D) a trade bloc made up of the United States, Canada, and Mexico whose purpose is to reduce tariffs and other trade barriers among the three countries.

C) a trading bloc of 28 European countries who have agreed to abolish tariffs and import quotas on most products and have liberalized the movement of labor and capital.

Distinctions between land-, labor-, and capital-intensive commodities are important because A) when a country has an abundance of one type of resource, it usually does not have much of other resources. B) for every one unit of capital-intensive commodities, two of land and labor must be present. C) an abundant supply of one type of resource gives a country a comparative cost advantage in products using that resource. D) these commodities must be present for growth to occur.

C) an abundant supply of one type of resource gives a country a comparative cost advantage in products using that resource.

The use of artificial trade barriers, such as tariffs and import quotas, A) cannot increase domestic output and employment in the short run, but can in the long run. B) can increase domestic output and employment in the short run and in the long run. C) can increase domestic output and employment in the short run, but that is not likely to last in the long run. D) cannot increase domestic output and employment in the short run or in the long run.

C) can increase domestic output and employment in the short run, but that is not likely to last in the long run.

A commercial bank sells a Treasury bond to the Federal Reserve for $100,000. The potential money supply: A) decreases. B) is unaffected by the transaction. C) increases.

C) increases. The potential money supply will increase. This is true because when the commercial bank sells the Treasury bond to the Fed for $100,000, the Fed creates $100,000 of new money to pay for the bond. That $100,000 will increase the bank's excess reserves and thereby enable the bank to lend more. An increase in lending would push additional money into the economy.

The basic determinant of the transactions demand for money is the A) reserve ratio. B) price level. C) level of nominal GDP. D) interest rate.

C) level of nominal GDP. The basic determinant of the transactions demand for money is the level of nominal GDP. The higher this level, the greater the amount of money demanded for transactions.

The net outcome of either tariffs or quotas for the world economy is A) indeterminate, since neither the costs to consumers nor the gains to producers and government are consistent. B) zero, since the costs to consumers equal the gains to producers and government. C) negative, since the costs to consumers substantially exceed the gains to producers and government. D) positive, since the costs to consumers do not exceed the gains to producers and government.

C) negative, since the costs to consumers substantially exceed the gains to producers and government.

In which of the following situations is it certain that the quantity of money demanded by the public will decrease? A) nominal GDP decreases and the interest rate decreases B) nominal GDP increases and the interest rate decreases C) nominal GDP decreases and the interest rate increases D) nominal GDP increases and the interest rate increases

C) nominal GDP decreases and the interest rate increases

Consider the following statement: "The United States can make certain toys with greater productive efficiency than can China. Yet we import those toys from China." We import these toys from China because A) China has an absolute advantage in producing toys, but the United States has a comparative advantage in producing toys. B) the United States has a higher cost per unit of producing the toys. C) the United States has an absolute advantage in producing toys, but China has a comparative advantage in producing toys. D) China produces better toys.

C) the United States has an absolute advantage in producing toys, but China has a comparative advantage in producing toys. In 1776, Adam Smith used the concept of absolute advantage to argue for international specialization and trade. His point was that nations would be better off if they each specialized in the production of those products in which they had an absolute advantage and were therefore the most efficient producers. In the early 1800s, David Ricardo extended, and modified, Smith's idea by demonstrating that it is advantageous for a country to specialize and trade even if it is more productive in all economic activities than some trading partner. A nation does not need Smith's absolute advantage—total superiority in producing some good—to benefit from specialization and trade. It needs only a comparative advantage. In summary, it is the relative cost of producing the good—not the absolute cost—that drives trade.

When a commercial bank borrows from a Federal Reserve Bank, A) the supply of money automatically increases. B) it indicates that the commercial bank is unsound financially. C) the commercial bank's lending ability is increased. D) the commercial bank's reserves are reduced.

C) the commercial bank's lending ability is increased.

The four main tools of monetary policy are A) tax-rate changes, the discount rate, open-market operations, and the federal funds rate. B) tax-rate changes, changes in government expenditures, open-market operations, and interest on excess reserves. C) the discount rate, the reserve ratio, interest on excess reserves, and open-market operations. D) changes in government expenditures, the reserve ratio, the federal funds rate, and the discount rate.

C) the discount rate, the reserve ratio, interest on excess reserves, and open-market operations.

The opportunity cost of holding money A) is zero because money is not an economic resource. B) varies inversely with the interest rate. C) varies directly with the interest rate. D) varies inversely with the level of economic activity.

C) varies directly with the interest rate.

Assume that the comparative-cost ratios of two products—baby formula and tuna fish—are as follows in the nations of Canswicki and Tunata: Canswicki: 1 can baby formula ≡ 2 cans tuna fish Tunata: 1 can baby formula ≡ 4 cans tuna fish a. In what product should each nation specialize? Canswicki should produce_____ ,and Tunata should produce _______

Canswicki should produce baby formula, and Tunata should produce tuna fish.

The Reserve Ratio

Changes the money multiplier. The discount rate: • The Fed as lender of last resort. • Short-term loans. Term auction facility: • Introduced December 2007. • Banks bid for the right to borrow reserves.

The Fed's Dual Mandate

Congress ordered the Fed to pursue two objectives: 1. Full employment in the labor force 2. Stable prices

Consider the following statement: "The United States can make certain toys with greater productive efficiency than can China. Yet we import those toys from China." Which ideas of Adam Smith and David Ricardo are represented? A) China does not need Smith's expected advantage to specialize in toys, rather it needs Ricardo's actual advantage. B) China does not need Smith's comparative advantage to specialize in toys, rather it needs Ricardo's absolute advantage. C) China needs Smith's customer advantage to specialize in toys rather than Ricardo's producer advantage. D) China does not need Smith's absolute advantage to specialize in toys, rather it needs Ricardo's comparative advantage.

D) China does not need Smith's absolute advantage to specialize in toys, rather it needs Ricardo's comparative advantage.

NAFTA is A) a group that oversees trade agreements reached by member nations and arbitrates trade disputes among them. B) a common currency zone in which members have adopted the euro as their common currency. C) a trading bloc of 28 European countries who have agreed to abolish tariffs and import quotas on most products and have liberalized the movement of labor and capital. D) a trade bloc made up of the United States, Canada, and Mexico whose purpose is to reduce tariffs and other trade barriers among the three countries.

D) a trade bloc made up of the United States, Canada, and Mexico whose purpose is to reduce tariffs and other trade barriers among the three countries.

Suppose Big Country can produce 80 units of X by using all its resources to produce X or 60 units of Y by devoting all its resources to Y. Comparable figures for Small Nation are 60 units of X and 60 units of Y. The limits of the terms of trade between these two countries will be A) 4/3 units of Y and 3/4 of a unit of X. B) 3/4 of a unit of Y and 4/3 units of X. C) 1 unit of Y and 1 unit of X. D) between 1 unit of good X for a unit of good Y and 4/3 units of good X for a unit of good Y.

D) between 1 unit of good X for a unit of good Y and 4/3 units of good X for a unit of good Y.

A major strength of monetary policy is A) its long-term consequences. B)the rule that it uses to manage the economy. C) the relatively short appointments of members of the Fed's Board of Governors. D) its speed and flexibility.

D) its speed and flexibility. The major strengths of monetary policy are: there is speed and flexibility compared to fiscal policy, the Board of Governors is somewhat removed from political pressure, and it has a successful record in preventing inflation and keeping prices stable. The Fed is given some credit for prosperity in the 1990s and early 2000s.

A quota that results in the same level of imports as a tariff is more detrimental to an economy because A) exports fall more with a quota. B) a quota is permanent, but a tariff is temporary. C) the government collects more in tax revenue. D) the government loses tax revenue.

D) the government loses tax revenue.

Monetary policy is easier to conduct than fiscal policy because A) monetary policy is easier to understand. B) the economy responds better to monetary policy than to fiscal policy. C) the Fed has more control of the economy. D)monetary policy has a much shorter administrative lag than fiscal policy.

D)monetary policy has a much shorter administrative lag than fiscal policy. Monetary policy is formed by the seven members of the Board of Governors. Fiscal policy requires the consent of both houses in Congress and the president. One of the implications is that monetary policy has a much shorter administrative lag than fiscal policy.

Economic Impact of Quotas

Decline in consumption. Increase in domestic production. Decline in imports. Quotas do not provide any government revenue but instead transfer it to foreign producers.

Economic Impact of Tariffs

Direct effects: • Decline in consumption • Increase in domestic production • Decline in imports • Tariff revenue Indirect effects

Expansionary Monetary Policy

Economy faces a recession. Lower target for federal funds rate. Fed buys securities. Expanded money supply. Downward pressure on other interest rates.

Monetary Policy, Real GDP, Price Level

Effect on real GDP and price level. Cause-effect chain: • Market for money • Investment and the interest rate • Investment and aggregate demand • Real GDP and prices Expansionary monetary policy. Restrictive monetary policy.

World Trade Organization

Established by Uruguay Round of GATT. 164 member nations in 2018. Oversees trade agreements and rules on disputes. Critics argue that it may allow nations to circumvent environmental and worker-protection laws.

True or False: If a country is open to international trade, the domestic price of a product can differ from the international price of that product.

False: If a country is open to international trade, the domestic price for a particular product will always be equal to the international price. That is because anyone in the country who wants to buy or sell will be participating in the international market and paying the international price that equates the quantities demanded and supplied globally. By contrast, if a country is closed to international trade, the domestic price can differ substantially from the international price because the domestic price will be affected only by domestic demand and domestic supply.

True or False: If Country B has an absolute advantage over Country A in producing bicycles, it will also have a comparative advantage over Country A in producing bicycles.

False: The possession of an absolute advantage does not necessarily imply that a country will also have a comparative advantage. A country can have an absolute advantage but not a comparative advantage because the definitions of absolute advantage and comparative advantage focus on different things.

The Taylor Rule Equation

Fed target interest rate = real risk-free interest rate + current actual inflation rate + 0.5*(Inflation Gap) - 1.0*(Unemployment Gap)

Benefits of international trade

Gains from specialization Deterring monopoly A more efficient allocation of resources A higher level of material well-being Reducing the threat of war Promoting competition

European Union

Initiated in 1958 as Common Market Abolished tariffs and import quotas between member nations Established common tariff with nations outside the EU Created Euro Zone with one currency

Problems and Complications

Lags: • Recognition and operational • Cyclical asymmetry • Liquidity trap

The Case for Protection

Military self-sufficiency Diversification for stability Infant industry Protection against dumping Increased domestic employment Cheap foreign labor

Open-Market Operations

Open-market operations: • Buying and selling of government securities (or bonds). • Commercial banks and the general public. • Used to influence the money supply. When the Fed sells securities, commercial bank reserves are reduced.

Restrictive Monetary Policy

Periods of rising inflation Increases federal funds rate Decreases money supply Increases other interest rates

Principal U.S. Exports

Principal U.S. exports include: • Chemicals • Agricultural products • Consumer durables • Computer software and services • Aircraft The United States provides about 8.5 percent of the world's exports.

Principal U.S. Imports

Principal U.S. imports include: • Petroleum • Automobiles • Metals • Household appliances • Computers

The Federal Funds Rate

Rate charged by banks on overnight loans. Targeted by the Federal Reserve. FOMC conducts open-market operations to achieve the target. Demand curve for federal funds. Supply curve for federal funds.

Comparative Advantage

Self-sufficiency output mix Specialization and trade Produce the good with the lowest domestic opportunity cost Opportunity cost of 1 ton of beef: • 1 pound of vegetables in United States • 2 pounds of vegetables in Mexico

The Fed's Dual-Mandate Policy Targets

The Fed has developed two specific target numbers to help it fulfill the Dual Mandate: • A 4.3 percent target unemployment rate (= Fed's current best estimate of the full-employment rate of unemployment) • A 2-percent target inflation rate

GATT

Three principles: 1. Equal, nondiscriminatory trade between member nations 2. Reduction in tariffs 3. Elimination of import quotas

Taylor Rule Definitions

To express the Taylor Rule mathematically, we must define: • Inflation Gap = the current actual rate of inflation minus the Fed's 2.0 percent target rate for inflation • Unemployment Gap = the current actual unemployment rate minus the Fed's 4.3 percent target rate for the unemployment rate • Real risk free interest rate = 2 percent

Helping Those Hurt by Free Trade

Trade Adjustment Assistance Act: Designed to help individuals hurt by international trade. Offshoring of jobs: Shifting of work previously done by American workers to workers abroad.

Trade: Increasing Costs

Trade with increasing costs: • Concave production curve • Resources not perfectly substitutable • Incomplete specialization Case for free trade: • Promote efficiency • Promote competition

Some Key Trade Facts

U.S. trade deficit in goods: $891 billion in 2018 U.S. trade surplus in services: $270 billion in 2018 Canada largest U.S. trade partner Trade deficit with China: $419 billion in 2018 Exports are 12 percent U.S. output

Supply and Demand Analysis

World price Domestic price with no trade World price > domestic price: • Export surplus • Export supply curve World price < domestic price: • Import shortage • Import supply curve

Suppose the Federal Reserve sets the reserve requirement at 10 percent, banks hold no excess reserves, and no additional currency is held. a. What is the money multiplier? b. By how much will the total potential money supply change if the Federal Reserve changes the amount of reserves by −$50 million? c. Suppose the Federal Reserve wants to decrease the total money supply by $600 million. By how much should the Federal Reserve change reserves to achieve this goal?

a. Depending on the data that you have, the money multiplier can be found by taking 1/r, where r is the reserve requirement in decimal form, or by taking the total change in the money supply divided by the change in reserves. In this case, we are given a reserve requirement of 10 percent. Therefore, we can find the money multiplier by taking 1/r, which is equal to 1/0.1 = 10. b. When we know the money multiplier, we can find the total potential change in the money supply by taking the money multiplier times the change in reserves. If the money multiplier is 10 and reserves decrease by $50 million, then the total potential change in the money supply can be found by taking 10 × −$50 million = −$500 million. Therefore, the money supply changes by a total of −$500 million. c. Because the total change in the potential money supply equals the money multiplier times the change in reserves, we can use this relationship to find the needed change in reserves given the total potential change in the money supply and the money multiplier. This uses the same relationship only with different information. The total change in the money supply desired is a $600 million decrease, and with the reserve requirement at 10 percent, we know the money multiplier is 10. Thus, putting in the information, we have −$600 million = 10 × change in reserves. Using algebra to find the change in reserves, we take the −$600 million and divide it by 10 such that −$600 million/10 = −$60 million. Therefore, the Federal Reserve would need to change reserves by −$60 million to achieve its goal.

New Zealand's Production Possibilities Table (Millions of Bushels) Product Production Alternatives A B C D Apples 0 20 40 60 Plums 15 10 5 0 Spain's Production Possibilities Table (Millions of Bushels) Product Production Alternatives R S T U Apples 0 20 40 60 Plums 60 40 20 0 a. New Zealand's cost of producing 1 plum is _______ b. Spain's cost of producing 1 plum is ______ c. Which nation should specialize in which product?

a.4 apples b. 1 apple c. New Zealand should produce apples and Spain should produce plums.