Econ Exam 3
what happens when Price level decreases?
-fed lowers interest rates -real exchange rate depreciates and increases net exports
The members of the Federal Open Market Committee (FOMC) who can actually vote on policy decisions are:
fed governors, new york fed president, and four other district bank presidents
formula for natural rate of unemployment
fictional + structural unemployment
what are examples of automatic stabilizers?
-corporate and personal income taxes -transfer systems such as unemployment insurance -welfare
what is full employment?
(potential GDP) the maximum quantity that an economy can produce given full employment of its existing levels of labor, physical capital, technology, and institutions
tax multiplier formula
-MPC/(1-MPC)
what does contractionary fiscal policy do and why implement it?
-decreases aggregate demand -decreases output -decreases the price level used to combat high inflation
what does the Board of Governors do?
-guides the operations of the Federal Reserve -ensures that interest rate ceilings are maintained -oversees all the Federal Reserve district banksFf
which things are provided by state government?
-most spending on unemployed/poor and retired state workers -Medicaid -unemployment insurance -employment services -pensions for state employees -education
which things are provided by federal government?
-most spending to military and social insurance -pell grants -education -student loans -food support programs -highway/transportation -housing -science -energy -environment -international affairs -foreign aid
which things are provided by local government?
-most to education -bus services -water -sewer lines -local parks/playgrounds -trash/recycling -firefighters/police -emergency services
reasons to worry about government debt
-slower economic growth -future fiscal choices are constrained as higher gov. debt makes it harder to borrow more when they need funds -risk of crisis of confidence -debt crisis becomes more likely
okun's rule of thumb
1% increase in unemployment will lead to a 2% fall in real GDP
In your current job, you earn $55,000. You take the standard deduction of $12,200. You have an offer of a new job working for a different employer. Your salary would go up by $5,000. Given your current taxable income, what is your marginal tax rate? how much do you owe in income taxes if have no other income and additional deductions?
1. I fall into the 22% range because 55,000-12,200=$42800 taxable income 2. pay 10% on first $9700= $970 3. pay 12% on next $29,775 (39475-9700) = .12 x 29775 = $3,573 4. pay 22% on next $44,725(84200-39475) = .22 x $44,725 = $9,839.5
Which of the following is a fiscal policy action that would be the best choice to return the economy to full employment output?
1. There is a $20 million output gap caused by the positive aggregate demand shock. The government would need to use contractionary fiscal policy to close this, either increasing taxes or decreasing government spending 2. spending needed = size of gap/spending multiplier 3. -20/10 = $-2 million (decrease spending by $2)
tax incentives
1. mortgage 2. health insurance purchased through employers 3. rental value on owner-occupied housing 4. contributions toward your retirement account
reasons not to worry about government debt
1. most of gov. debt is owed by americans to other americans 2. debt can spread over future generations 3. it doesn't take much to repay the debt b/c your current "share" of the debt is relatively small compared to how much the government spends per person 4. government doesn't ever really need to repay the debt, they just have to have the means of making the required payments 5. the government can easily reprint money or raise revenue
Suppose the economy is operating at an output of $4,000 billion. Assume furthermore that potential output is $5,000 billion and the marginal propensity to consume is 0.75. _____ would close this recessionary gap.
1. multiplier = 1/(1-MPC) = 4 2. required change in spending = gap/multiplioer = 1000/4 3. 1000/4 = $250 increase in gov. spending
spending multiplier formula
1/(1-MPC)
define decision lag
A decision lag is time spent as policymakers try to figure out the best course of action
define tariff
A tariff is a tax imposed by one country on the goods and services imported from another country.
expansionary policy causes what to shift and where?
AD curve shifts to right
in long-run equilibrium, what curves intersect?
AD intersects LRAS and SRAS at the same point
what best describes the interest rate effect?
An increase in the price level will lead to an increase in interest rates
what are automatic stabilizers?
Automatic stabilizers are features of the tax and transfer systems that temper the economy when it overheats and stimulate the economy when it slumps, without direct intervention by policymakers. Automatic stabilizers offset fluctuations in economic activity without direct intervention by policymakers
How will a decrease in the price level impact the money market and nominal interest rates?
Demand for money decreases; nominal interest rates decrease because when the price level decreases, the demand for money will decrease. As a result, the nominal interest rate will decrease
define discretionary fiscal policy
Discretionary fiscal policy is the change in government spending or taxes
formula for NOMINAL federal funds rate
FFR - inflation = neutral rate + 0.5(inflation-neutral) +/- output gap
Which of the following best describes why an increase in government spending increases aggregate demand directly but decreases in taxes affect aggregate demand indirectly?
Government spending is included as a component of aggregate demand, but it also affects consumption. Taxes only affect consumption.
Which of the following best describes an automatic stabilizer that will help Lincolnland recover from a recession?
Government transfer programs, such as unemployment benefits because during a recession, government transfer programs will increase the disposable income available to households and increase consumption spending
short-run vs. long-run
In the short run, wages and other prices are fixed, while in the long run, they're flexible.
monetary vs. fiscal policy
Monetary Policy: Federal Reserve decisions that shape the economy by influencing interest rates and the supply of money Fiscal Policy: government efforts to influence the economy through taxation and spending
What happens to the nominal interest rate and the quantity of money in the money supply if the demand for money increases?
Nominal interest rate increases; no change in the quantity of money
why is SRAS upward sloping?
Prices and nominal wages are slow to adjust to changes in the price level (real wage = nominal wage - inflation)
Under which circumstance is crowding out most likely to be a concern?
When an economy is operating near full employment b/c there's more private investment spending and interest sensitive consumption. any borrowing by government would increase competition for savings, and therefore a higher potential for crowding out
define fedspeak and its purpose
a term what Alan Blinder called "a turgid dialect of English" used by Federal Reserve Board chairmen in making wordy, vague, and ambiguous statements it's used to minimize market reactions from federal reserve statements
what is a consequence of sticky wages?
The amount of aggregate output supplied increases in response to inflation (upward-sloping AS curve)
if nature rate is equal to current rate of unemployment, the economy produces at:
at full potential output
Which of the following best describes an equilibrium in the money market?
The nominal interest rate adjusted until people are holding the money they want to hold (the price of money is the nominal interest rate because that is the opportunity cost of holding money)
If the reserve requirement in a banking system is lowered, what is the most likely consequence?
The nominal interest rate decreases because a lower RR means banks will lend more and when they lend more, that increases money supply, and this lowers the nominal interest rate
wealth effect
The tendency for people to increase their consumption spending when the value of their financial and real assets rises and to decrease their consumption spending when the value of those assets falls.
How can "crowding out" be a negative side effect of fiscal policy?
When there's crowding out, borrowing is more expensive, which causes AD to decline. Companies are less likely to invest because costs to borrow are higher. This causes investment projects to be less profitable.
output gap formula
[(Actual output - Potential output) / Potential output] x 100
gdp deflator
a measure of the price level, calculated by dividing nominal GDP by real GDP and multiplying by 100
what best describes what is occurring when an economy's actual output is above its full employment level of output?
a positive output gap
the government's debt is:
accumulation of all the deficits or all the money it owes
If a bank's reserves are low, it can increase reserves by:
borrowing from other banks in the overnight loan market
If the supply of money shifts from S1 to S2, the Federal Reserve must have _____ Treasury bills in the open market.
bought
change in GDP formula
change in spending x multiplier
Monetary policy affects GDP and the price level by:
changing aggregate demand
what occurs during stagflation? what can lead to stagflation?
decreased output and increased inflation a negative SRAS shock can lead to stagflation b/c decrease in SRAS leads to higher price and lower output
If the Turkish Central Bank forecasts a negative output gap, you can reasonably expect _____ on the horizon.
deflation
if a bank forecasts a negative output gap, you can assume there will be ___ on the horizon.
deflation
Which of the following stages of the business cycle is most preferable when you graduate from college and begin looking for a job?
expansion
Suppose a high-income person, a middle-income person, and a low-income person purchase identical houses that are financed by similar mortgages. Who gets the largest tax benefit?
higher-income person
If the interest rate on CDs rises from 5% to 10%, the opportunity cost of holding money will _____ and the quantity demanded of money will _____.
increase;decrease
when demand for money increases, nominal interest rates:
increases
In the short run, a positive demand shock _____ aggregate output and _____ the aggregate price level.
increases; increases
what occurs with a decrease in SRAS?
inflation occurs
the wealth effect has a ___ relationship between ___ and ___ due to changes in wealth.
inverse; prices; consumption
define leading indicators and give examples
leading indicators are variables that tend to predict the future path of the economy examples: -business confidence -consumer confidence -stock market
AD-AS model
model in which the aggregate supply curve and the aggregate demand curve are used together to analyze economic fluctuations with price level on y-axis and real GDP on x-axis
federal funds rate (fed's rule of thumb) formula
neutral rate + 0.5 x (inflation - neutral rate) + output gap (negative if output is below potential output)
positive demand shock vs. negative demand shock
positive: a sudden increase in demand (examples: tax cuts, interest rate cuts) negative: a sudden decrease in demand (examples: natural disaster, stock market crash)
the short-run aggregate supply curve has a ___ relationship between the ___ and the ___ in the economy and ___ and ___ in the economy.
positive; aggregate price level; quantity of aggregate output; inflation; unemployment
The long-run level of output is known as _____ output.
potential output
Which of the following best describes the purpose of the expenditure multiplier?
quantify the size of the change in aggregate demand (AD) that occurs as a result of a change in a component of AD
In the long run, the aggregate supply curve is vertical because the:
quantity of output returns to potential GDP as market prices adjust and resource markets return to equilibrium.
The lower bound for the federal funds rate is set by the:
repurchase agreements and interest on excess reserves
Ceteris paribus, a decrease in imports leads to a:
right shift of the AD curve
What is the likely impact of government borrowing on spending on capital goods and economic growth
spending on capital goods decreases because more government borrowing increases interest rates; less spending causes decrease in economic growth
In the AD-AS framework, price and quantity are represented by _____, respectively.
the GDP deflator and the real GDP
what is Lender of Last Resort and what are its factors?
the fed is the lender that financial institutions turn to when they need cash right away, but having trouble getting a loan elsewhere -can prevent financial crisis -can lose money if lends to failing financial institutions -can lead banks to take on large risks
define floor framework
the fed's approach of setting other interest rates to put a lower bound on how low the federal funds rate will go
define quantitative easing and its effects
the fed's strategy of purchasing large quantities of longer-term government bonds and other securities to put downward pressure on long-term interest rates By buying long-term bonds, the Fed is increasing the supply of long-term loans. This increase in supply pushes down interest rates on other long-term loans, allowing businesses to borrow at lower rates
Dual Mandate of the Fed
the fed's two goals of low and stable prices and maximum sustainable employment to reach their inflation target
market for loanable funds
the interaction of borrowers and lenders that determines the market interest rate and the quantity of loanable funds exchanged
A change in _____ does NOT shift the money demand curve.
the interest rate
what happens when a bank sells bonds?
the money supply decreases which increases the nominal interest rate.
define forward guidance and why does fed implement it?
the strategy of providing information about future course of monetary policy in order to influence market expectation of future interest rates the fed. uses this to: -promising to keep rates low in future and for longer
what is the relationship between the interest rate and the money supply when a country's monetary base is determined by a central bank?
the supply of money doesn't change in response to an interest rate. This results in a money supply curve that is vertical. The monetary base is chosen by the central bank to achieve a nominal interest rate, rather than in response to one
define marginal tax rate
the tax rate you pay if you earn an additional dollar (as you earn more, your marginal tax rate increases... higher incomes get taxed more)
if tariff is implemented on imports, what occurs in the importing country?
their aggregate supply decreases (shifts to left)
what is the exchange rate effect
this describes how changes in the price level alter the prices of goods in one country relative to another country, leading to changes in the quantity of aggregate demand
what is the liquidity preference theory
this describes people's preferences to hold money versus some other form of asset that earns interest, such as bonds. When people want to hold more money instead of bonds, the demand for money increases and when people want to hold more bonds and less money, the demand for money decreases
Which of the following best describes the four phases of the business cycle in the correct order?
trough, expansion, peak, recession
True or False: The size of the multiplier increases as the size of the marginal propensity to consume increases.
true
when real GDP is higher than full employment output, what happens to unemployment?
unemployment is lower than the natural rate of unemployment
the long run aggregate supply curve shows how the aggregate output supplies is:
unrelated to aggregate price level
define lagging indicators and give examples
variable that tend to follow business cycle movements with a bit of delay examples: -unemployment
approximate change in wage formula
wage x (%raise - %inflation rate)
inflationary gap
what occurs when the equilibrium quantity of output is above potential output
recessionary gap
what occurs when the equilibrium quantity of output is below potential output
what are overnight reverse repurchase agreements?
when the desk sells a government bond to a financial institution, with an agreement to buy it back the next day at a higher price
how do you determine the current rate of unemployment, given the natural rate of unemployment?
when the economy produces more than potential output, current unemployment rate is less than natural rate of unemployment... VICE VERSA
