OSU Econ 2002.03H Final

Extensive Growth

- Adding more factors of production ex) increase population

Shifts in the Money Demand Curve

- An increase in GDP will shift money demand to the right (and vice-versa) - An increase in price level will shift money demand to the right (and vice-versa)

Why is the short-run aggregate supply curve upward sloping?

- Because it reflects the marginal cost of the company. - There will be supply only when the marginal cost is greater than the average cost.

Why Some Monetary Policies Might Fail

- Changing the discount rate only impacts short-term borrowing, so long-term rates may stay high - Banks may choose not to loan out excess reserves or may have trouble finding willing borrowers - The Fed may not have enough information to know the true state of the economy, or may act too slowly

M1 Money

- Checking Accounts (demand deposits) in banks

Combining Expansionary Fiscal and Monetary Policy

- Crowding out can be avoided if money supply is allowed to expand to accommodate increased demand - Can move the economy more quickly toward long-run equilibrium, but will cause more rapid increases in prices and wages - This may be difficult for the government to control, especially considering policy lags

Fiscal Policy

- Deliberate attempts to increase output/income by changing government spending or taxation - Government makes fiscal policy

Calculating max amount in additional loans a bank can make

- Equal to excess reserves Deposits x RR= Required Reserve Reserves - Required Reserves = Excess Reserves

If monetary policy works...

- Federal Reserve can quickly move economy back to long-run equilibrium - Recessions can be made shorter through expansionary policy - Inflationary bursts can be suppressed through contractionary policy

What things fund the majority of the governmet

- Personal Income Tax - 40-48% - Payroll Taxes (Social Security, Medicare) - 32-40%

Contractionary Monetary Policy

- Policies made by the Federal Reserve to decrease money supply and reduce economic activity, usually by raising interest rates. - Is put in place when the economy is over-inflated Graphically: aggregate demand shifts left, making equilibrium on the LRAS Note: short-run equilibrium would be initially above output level and not on LRAS

Expansionary Monetary Policy & Graphically

- Policies made by the Federal Reserve to increase money supply and boost economic activity Graphically: (x-axis: Real GDP; y-axis: Price Level) aggregate demand shifts right, making equilibrium on the LRAS Note: short-run equilibrium would be initially below output level and not on LRAS

What usually happens to the productivity of labor in the early stages of an economic recovery? Why is this the case?

- Productivity rises because firms increase output quickly but delay hiring until they are certain the recovery will last - Firms will pay overtime to existing workers at first

Banks' Role in Creating Money

- Suppose a bank wants to put some of its excess reserves to work, and decides to make a $1 million loan. - The borrower deposits the loan proceeds from bank #1 into its bank (bank #2), which now has $1 million, most of which is available for lending

The Quantity Theory of Money

- The amount of money in an economy is directly related to the level of goods and services sold - If the amount of money in economy doubles, so does price level

Money Market & Graph Set-Up

- affects households' and firms' decision between holding cash and holding financial assets (deposits and/or securities) Graphically: x-axis: quantity of money y-axis: short-term nominal rate of interest

Loanable Funds Market & Graph Set-Up

- affects households' decision between consumption and investment - affects firms' decisions on making new investments Graphically: x-axis: quantity of loanable funds y-axis: long-term real rate of interest

What shifts the demand curve to the left?

- decrease in income - decrease in the price of a substitute/increase in the price of a complement. - decrease in population

What shifts the supply curve to the right?

- decrease of input cost(s) - technological advancements - decrease in taxes - good expectations - entry of more firms into the market

Effects of Increasing Discount Rate

- encourages banks to borrow from the Fed and use the proceeds to make more loans - discourages private lending

How can someone raise his/her likelihood of being able to buy something? (multiple ways)

- get there before everyone else - scalper market (secondary market) - bribery

What shifts the supply curve to the left?

- increase of input cost(s) - increase in taxes - bad expectations - exit of firms from the market

What shifts the demand curve to the right?

- rise in income - rise in the price of a substitute/fall in the price of a complement. - increase in population

Commodity money A) has value independent of its use as money. B) has little to no value independent of its use as money. C) is backed by a valuable commodity such as gold. D) can be used to purchase commodities, but not services.

A) has value independent of its use as money.

The more excess reserves banks choose to keep, A) the smaller is the deposit multiplier. B) the larger is the deposit multiplier. C) the higher is the required reserve ratio. D) the lower is the required reserve ratio.

A) the smaller is the deposit multiplier.

Ashley buys a new television for $795. She receives consumer surplus of $355 from the purchase. How much does Ashley value her television? A) $355 B) $440 C) $795 D) $1,150

D) $1,150

12. The phrase "demand has increased" means that A) a demand curve has shifted to the left. B) there has been an upward movement along a demand curve. C) there has been a downward movement along a demand curve. D) a demand curve has shifted to the right.

D) a demand curve has shifted to the right.

The quantity theory of money predicts that, in the long run, inflation results from the A) velocity of money growing at a faster rate than real GDP. B) velocity of money growing at a lower rate than real GDP. C) money supply growing at a lower rate than real GDP. D) money supply growing at a faster rate than real GDP

D) money supply growing at a faster rate than real GDP

M2 Money

M1 + savings account balances + small-denomination time deposits + non-institutional money market fund shares.

Demand/Supply Curve Shift vs. Moving Along the Curve

Moving Along The Curve - when all factors affecting demand/ supply are constant and ONLY the PRICE changes. Demand/Supply Curve Shift - when any one of the factors affecting demand/supply changes.

Which component of our economy's GDP is typically negative? Why is this the case?

Net exports is typically negative because we import many more goods and services than we export

Positive economic statement

Objective and Fact-Based ex.) Increasing the interest rate will encourage people to save

Normative economic statement

Opinionated & "what we should do" ex.) The price of milk should be $6 a gallon to give dairy farmers a higher living standard and to save the family farm

Why is the production possibilities frontier bowed outward?

Opportunity cost increases as more and more of one good is produced

Purpose of Lowering and Purpose of Raising Fed Reserve Required Ratio

Overall Purpose: Changing the reserve required ratio to raise of lower the money supply Lowering - allows banks to make more loans, thus increasing the money supply over time Raising - Banks must make fewer loans or increase their reserves to cover the required ratio, thus reducing the money supply

Intensive Growth

Growth through entering a new market, introducing a new product, technology, or market research

Fiscal Policy Issue #2 - Crowding Out

In order for the gov't to spend, they must get the money from somewhere... If gov't raises taxes to pay for the spending: - tax increases will counter-act the spending stimulus If government borrows money from households: - they will have to increase savings, causing consumption to fall If gov't borrow money from firms: - they will have to reduce investment, which counteracts the stimulus If government borrows from overseas investors: - the increase in debt may destabilize the country Graphically: Money Market Model: (x-axis: quantity of money; y-axis: interest rate) As real GDP and income rise, Money Demand shifts right, causing the equilibrium interest rate to rise. AD/AS Model: (x-axis: real GDP; y-axis: price level) AD shifts right to meet LRAS, but crowding out shifts AD to the left slightly, ending up being lower than LRAS In the long run: - economy will return to LRAS regardless of the gov'ts fiscal policy - higher gov't spending will completely displace consumption and investment - Result: a larger gov't, relative to the size of the entire economy

Required vs. Excess Reserves

Required reserves - minimum amount of cash a bank is required to keep on hand ○ Expressed as a ratio of reserves to deposits - reserve ratio (RR) Excess reserves - amount of cash bank holds in addition to the required reserves - an indication that businesses do not want to borrow OR that banks are unwilling to lend; both hinder economic growth

Monetary Base (MB)

Reserves held at banks

Rule of 72

Tells you how many years it will take you to double your money. - Yeas required to double investment = 72 ÷compound annual interest rate

Discount Rate

The minimum interest rate set by the Federal Reserve for lending to other banks.

Economics

The study of the allocation and use of scarce resources to satisfy unlimited human wants

Macroeconomics

The study of the economy as a whole, including topics such as inflation, unemployment, and economic growth

As a result of the recent recession in the U.S., many foreign workers returned to their home countries to look for work. Describe the impact on AD/AS in the U.S. and in their home country.

UNITED STATES - The SR AS curve in the US will shift to the left, putting upward pressure on wages, causing the price level in the US to increase. If the departure becomes permanent, GDP will fall in the US (but not necessarily GDP per capita) - since the workers have left, there may be no increase in US unemployment HOME COUNTRY - in the home country, SR AS will shift to the right; producing downward pressure on wages; the price level will fall in the home country and GDP will rise although not necessarily on a per capita basis

Automatic Stabilizers Used to Eliminate Fiscal Policy Delays

Used to 'pre-program' the economy to respond with expansionary policy during recessions - The tax system: what employment, wages, and profits fall, less tax is collected - this serves as a tax cut - Unemployment benefits: increase government spending when workers lose their jobs - Nutrition assistance (WIC, SNAP): increase government spending as households fall into poverty

Impact of an Increase in the Money Supply

When money supply increases, banks have excess reserves; if they can't make more leans, they lower deposit interest rates; some depositors remove money from the bank & hold it as cash Graphically: Money Supply (vertical line) shifts right, causing interest rate to fall

When is an economically efficient level of output produced?

When the marginal benefit equals the marginal cost of the last unit sold in a competitive market

Comparative Advantage

You have this if you have the lowest opportunity cost (in terms of the other item you can produce) compared to other countries

Absolute Advantage

You have this if you produce something the most efficiently compared to others

Holding everything else constant, an increase in the price of raisins will result in: a. an decrease in the quantity of raisins demanded. b. an increase in the demand for raisins. c. a decrease in the supply of raisins. d. an increase in the quantity of raisins demanded.

a. an decrease in the quantity of raisins demanded.

Electric car manufacturers want to sell more electric cars at a higher price. Which of the following events would have this effect? a. an increase in the price of gasoline. b. technological advancement in the production of electric car batteries. c. an increase in the number of manufacturers of electric cars. d. a decrease in the price of lithium, which is used in the electric car batteries.

a. an increase in the price of gasoline.

Which of the following is not one of the most important services provided by the firms in the financial system? a. decreasing taxes b. risk sharing c. liquidity d. generating information

a. decreasing taxes

The substitution effect of a(n): a. price increase works to reduce the quantity of the good demanded. b. price increase works to increase the quantity of the good demanded. c. price decrease works to reduce the quantity of the good demanded. d. income increase works to shift the supply curve to the right.

a. price increase works to reduce the quantity of the good demanded.

How economic decisions are made

at the margin (marginal benefit= marginal cost)

Consumers are willing to purchase a product up to the point where: a. they spends all of their income. b. the marginal benefit is equal to the price of the product. c. the quantity demanded is equal to the quantity supplied. d. they are indifferent between consuming and saving.

b. the marginal benefit is equal to the price of the product.

Which of the follow is a result of imposing a rent ceiling? a. Some consumer surplus is converted to producer surplus. b. There is an increase in the quantity of apartments supplied. c. There is an increase in the quantity of apartments demanded. d. The marginal benefit of the last apartment rented is less than the marginal cost of supplying it.

c. There is an increase in the quantity of apartments demanded.

If the price of coffee falls, the substitution effect due to the price change will cause: a. an increase in the demand for coffee. b. an increase in the demand for tea, a substitute for coffee. c. an increase in the quantity of coffee demanded. d. a decrease in the quantity of coffee demanded.

c. an increase in the quantity of coffee demanded.

Which of the following will increase investment spending in the economy, holding everything else constant? a. an increase in the federal government surplus b. an increase in the budget deficit c. an increase in consumer dissavings d. an increase in transfer payments

d. an increase in transfer payments

Consumer surplus in a market for a product would be equal to the area under the demand curve if: a. producer surplus was equal to zero. b. marginal cost was equal to the market price. c. the product was produced in a perfectly competitive market. d. the market price was zero.

d. the market price was zero.

Long-lasting consumption items are called _______________ whereas consumption items that are used up quickly are called _______________ .

durable goods; common goods

1) One government tool historically used to encourage business expansion is the Investment Tax Credit (ITC), in which businesses can earn a tax deduction for a portion of the dollars they spend on new investments. Draw a diagram to show the impact of a new 10% ITC on the loanable funds market. 2) Describe the likely short-run impacts on C, I, and G, assuming the government doesn't raise taxes on consumers to make up for the lost tax revenue. 3) Can you tell from this analysis whether overall GDP (represented by Y) will rise or fall in the short run? Will Y rise or fall in the long run?

1) Demand shifts right 2) - I rises as firms' expected returns on projects increases - C falls as consumers save more of their income - G probably will not change 3) - The impacts of C and I work in opposite directions - the overall impact on Y is not certain in the short run - in the long run, Y should increase as the investments lead to higher production

Four Primary Goals of the Federal Reserve

1) Lower Inflation 2) Lower Unemployment 3) Maintain Stability of the Financial Markets 4) Economic Growth

Monetary Price Levers (for Federal Reserve)

1) Open Market Operations - buying and selling treasury debt 2) Discount Policy - making emergency/routine loans to banks 3) Reserve Requirements - setting required reserve ratios

What are the uses of money? (3)

1) Store of Value a. If income > consumption, I may have money left over b. I may choose to hold some of my savings as money 2) Unit of Account a. Most of all transactions are denominated in money terms b. Most account values are measured in money terms 3) Medium of Exchange a. One side of every transaction in the circular flow b. This function is key to bank operations, monetary policy

1) Cyclical Unemployment 2) Frictional Unemployment 3) Structural Unemployment

1) caused by economic downturns or recessions; caused by business cycle 2) normal and unavoidable; Firings, seasonal firms closing down, firms grow and shrink 3) Surplus of labor; long-term mismatch between workers and job requirements; Happens when a person's specialized skill's market shuts down ex) car industry, etc

What is the current target for inflation rate and what is it based on?

2% per year - based on the 'core PCE'

Milton Friedman advocated this monetary growth rule (instead of Fed targeting interest rates)

Allow the money supply to grow at the same rate as long-run GDP and prices will be stable

Describe the affects of decreasing the interest rate in terms of opportunity cost, and how is the demand for money changed

As interest rates decrease, the opportunity cost for holding money decreases, so the quantity of money demanded increases. Graphically: (y-axis: interest rate; x-axis: Quantity of money) a downward movement along the demand curve, so the supply curve will also shift right

Describe the affects of increasing the interest rate in terms of opportunity cost, and how is the demand for money changed

As interest rates rise, the opportunity cost for holding money increases, so the quantity of money demanded falls. Graphically: (y-axis: interest rate; x-axis: Quantity of money) an upward movement along the demand curve, so the supply curve will also shift up

Why is the short-run aggregate demand curve downward sloping?

As the price level drops, the quantity of output demanded increases

The economic growth model predicts that A) GDP per capita of rich countries will grow more rapidly than in poor countries. B) GDP per capita of poor countries will grow more rapidly than in rich countries. C) Governments must centrally direct the economy for growth to occur. D) GDP per capita of poor countries will never change.

B) GDP per capita of poor countries will grow more rapidly than in rich countries.

Fiat money has A) little to no intrinsic value but is backed by gold held by the central bank. B) little to no intrinsic value and is authorized by the central bank or governmental body. C) value, because it can be redeemed for gold by the central bank. D) a great intrinsic value that is independent of its use as money.

B) little to no intrinsic value and is authorized by the central bank or governmental body.

If the Fed can act as a lender of last resort during a banking panic, banks can A) call in their loans to their customers and eventually restore the public's faith in the banking system. B) satisfy customer withdrawal needs and eventually restore the public's faith in the banking system. C) borrow more and more money from the central bank, and this will lower its reserves and decrease the public's faith in the banking system. D) encourage the public to borrow directly from the central bank, and this will worsen the banking panic.

B) satisfy customer withdrawal needs and eventually restore the public's faith in the banking system.

If a tax is levied on the buyers of a good: A) the price received by sellers will increase. B) the price paid by buyers will increase. C) consumer surplus will increase. D) producer surplus will increase.

B) the price paid by buyers will increase.

Without technological advancement, how can a nation achieve economic growth? A) by producing more high-value goods and fewer low-value goods B) through an increase in supplies of factors of production C) by producing more low-value goods and fewer high-value goods D) by decreasing the size of the labor force

B) through an increase in supplies of factors of production

Which of the following best describes an assumption economists make about human behavior? a. They assume that individuals act rationally all the time in all circumstances. b. They assume that rational behavior is useful in explaining choices people make even though people may not behave rationally all the time. c. They assume that people consider questions of fairness in all decisions they make. d. They assume that individuals act randomly.

B. They assume that rational behavior is useful in explaining choices people make even though people may not behave rationally all the time.

Who are the buyers and sellers in the Factors Market Model (simple circular flow model)?

Buyers - Firms Sellers - Households

Who are the buyers and sellers in the Goods and Services Market Model (simple circular flow model)?

Buyers - Households Sellers - Firms

What is Quantitative Easing?

Buying treasury and private debt to free up bank reserves for more lending; forcing down interest rates

Discount Rate & How it Works

By lowering the rate at which it loans money to banks, the Fed increases the money supply a. Banks can borrow more easily, so they can lend out more b. Since their cost of funds has decreased, they can lower the interest rates they charge for loans c. Result: lowering the discount drives down interest rate for all short term loans in the economy d. If the Fed increases the discount rate, the cost of funds increases, banks reduce the number of loans they make

If the required reserve ratio is 10 percent, an increase in bank reserves of $1,000 can support an increase in checking account deposits in the banking system of up to A) $100. B) $1,000. C) $10,000. D) $100,000.

C) $10,000.

The term "market" in economics refers to A) a place where money changes hands. B) a legal institution where exchange can take place. C) a group of buyers and sellers who come together to trade. D) an organization which sells goods and services.

C) a group of buyers and sellers who come together to trade.

If households in the economy decide to take money out of checking account deposits and hold it as currency, this will initially A) not change M1 and increase M2. B) decrease M1 and decrease M2. C) decrease M1 and not change M2. D) not change M1 and not change M2.

C) decrease M1 and not change M2.

Which of the following is not a function of the Federal Reserve System, or the "Fed"? A) acting as a lender of last resort B) acting as a banker's bank C) insuring deposits in the banking system D) taking actions to control the money supply

C) insuring deposits in the banking system

The major assets on a bank's balance sheet are its A) checking and savings account deposits. B) loans, and checking and savings account deposits. C) reserves, loans, and holdings of securities. D) reserves, checking and savings account deposits.

C) reserves, loans, and holdings of securities.

Increasing opportunity cost as one moves down a bowed-out production possibilities frontier occurs because: a. of inefficient production. b. of ineffective management by entrepreneurs. c. some factors of production are not equally suited to producing both goods or services. d. of the scarcity of factors of production.

C. some factors of production are not equally suited to producing both goods or services

Textbook examples of trade between two nations are simplified in order to show how two nations both benefit from trade. These examples may be misleading because: a. in the real world, rich countries can take advantage of poor countries. b. they do not account for the reduction in wages that occurs in both countries as a result of trade. c. some individuals in both countries may be made worse off because of trade. d. trade restrictions are likely to be imposed as trade grows over time.

C. some individuals in both countries may be made worse off because of trade.

If the production possibilities frontier is linear, then: a. opportunity costs are decreasing as more of one good is produced. b. it is easy to efficiently produce output. c. opportunity costs are increasing as more of one good is produced. d. opportunity costs are constant as more of one good is produced.

D. opportunity costs are constant as more of one good is produced.

Calculating total amount of loans a bank can support at a new RR ratio

Deposits x RR= Required Reserve Reserves - Required Reserves = Excess Reserves Loans + Excess Reserves = ANSWER

Federal Spending - Mandatory vs. Discretionary

Discretionary: - Money where the gov't has the choice to spend or not, and where to spend - Often a target for reductions ex.) Veteran's Benefits, Education & Training, Transportation, Justice Dep'ts Mandatory: Required spending ex.) Social Security, Defense Spending, Medicare & Medicaid

Expansionary Fiscal Policy

Either a tax cut or an increase in gov't spending; Used in attempt to shorten recessions - AD shifts to the right in short-run

Contractionary Fiscal Policy

Either a tax increase or a decrease in gov't spending; cools down economy - AD shifts to the left in short-run

Fiscal Policy Issue #1 - Policy Delay

Since the average recession is less than 1 year, fiscal policy must work quickly - Recognition Lag: time the government agency takes to realize a problem exists & formulate a plan - Decision Lag: time it takes to submit the bill, get it passed by Congress, and sign the bill into law - Implementation Lag: time required for government to change the system, write detailed rules, communicate - Outside Lag: time it takes for the economy to adjust to the new policy (and shift AD curve left or right)