Econ Midterm 3 Review

Supply Shock

An event that directly alters firms' costs and prices, shifting the economy's aggregate-supply curve and thus the Phillips Curve.

Which of the following shifts both the short-run and long-run aggregate supply right?

An increase in the capital stock.

Which of the following would not lead to a decrease in aggregate demand and a leftward shift in the AD curve? - A decrease in housing prices - An increase in interest rate - An increase in the domestic price level - An appreciation in the domestic currency.

An increase in the domestic price level.

In the long-run...

An increase in the price level has no effect on the aggregate quantity of GDP supplied.

Inflation Formula

CPI2 - CPI1 / CPI1

Automatic Stabilizers

Changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession without policymakers having to take any deliberate action.

Which of the following would lead to a decrease in the multiplier effect of fiscal policy?

Households save a higher fraction of income.

What does a greater money supply do?

Increase demand for goods and services; prices will rise and the value of money will fall.

What causes a rise in Aggregate Demand?

Increased Wealth, Expected Rate of Return on Investment, and Incomes in Other Countries; Decrease in Taxes.

Suppose the Federal Reserve announces an expansion in the money supply. Households and firms act rationally by revising expectations to anticipate an increase in the inflation rate. As a result...

Inflation rises and the unemployment rate does not change very much.

Theory of Liquidity Prefrence

Keynes's Theory that the interest rate adjusts to bring money supply and money demand into balance.

Which graph best describes the short-run effect of a decrease in the quantity of discount loans made by the Federal Reserve?

Left-ward shift in the money supply.

The notion that an increase in the quantity of money will impact the price level but not the output level is known as ____

Monetary Neutrality

The federal reserve controls ____ and influences ___ with the intention of influencing ____.

Money supply/ interest rates/ investment

Quantity of Output Supplied Formula

Natural Level of Output + a x (actual price level - expected price level)

Actual Inflation Rate Formula

Nominal interest Rate - Actual Interest Rate

New Nominal Interest Rate Formula (Fisher Effect)

Old Nominal Interest Rate + Change in Inflation Rate

Where, in the short-run aggregate supply curve, is the expected price level?

On the point intersecting the LRAS

Sticky Price Theory

Output prices of some goods and services adjust slowly to changes in the price level

The vertical axis of the aggregate demand curve represents the...

Price Level

Relationship Between Price Level and Value of Money

Price Level = P; Value of Money = 1/P

The horizontal axis of the aggregate demand curve represents the...

Quantity of Output

The short-run economic outcome resulting from the increase in production costs is known as...

Stagflation

Multiplier Effect

The additional shifts in aggregate demand that results when expansionary fiscal policy increases income and thereby increases consumer spending.

Shoeleather Costs

The resources wasted when inflation encourages people to reduce their money holdings.

Inflation Tax

The revenue the government raises by creating money.

Fiscal Policy

The setting of the level of government spending and taxation by government policy makers.

Compared with lower inflation rates, a higher inflation rate will ___ the after-tax real interest rate when the government taxes nominal interest this tends to ___ saving, there by ___ the quantity of investment in the economy and ___ the economy's long-run growth rate.

decrease; discourage; decreasing; decreasing

The unanticipated change in inflation arbitrarily harms...

depositors.

A reduction in the rate of inflation is known as...

disinflation

As the price level rises, the impact on domestic interest rate will case the real value of the dollar to ___ in foreign markets; exports ___; imports ____; net exports ___; quantity of domestic output demanded to ___; known as the ___.

rise; fall; rise; fal; fall; exchange rate effect

Increase in minimum wage will cause the natural rate of unemployment to ___, which will ___.

rise; shift the long-run aggregate supply curve to the left.

Relative price variability...

rises with inflation, leading to a misallocation of resources.

Increase in foreign spending on domestic goods associated with expansion abroad causes the price level to ___ the price level expected and the quantity of output to ___ the natural level of output. Economic prosperity abroad will cause the unemployment rate to ___ the natural rate of unemployment in the short run.

rise above; rise above; fall below

As the price level rises, the cost of borrowing money will ___, causing the quantity of output demanded to ___. This phenomenon is known as...

rise; fall; interest rate effect

A favorable supply shock, like a decrease in the price of oil, would cause...

the short-run Phillips curve to shift to the left and a more favorable trade-off between unemployment and inflation.

Which of the following policy actions shifts the aggregate-demand curve?

- An increase in government spending - An increase in taxes - An increase in the money supply

The inflation tax...

- is an alternative to income taxes and government borrowing - is like a tax on everyone who holds money - is the revenue created when the government prints money

Aggregate Supply Curve

A curve that shows the quantity of goods and services that firms choose to produce and sell at each price level.

Aggregate Demand Curve

A curve that shows the quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level.

Phillips Curve

A curve that shows the short-run trade-off between inflation and unemployment.

Which of the following accounts for about two-thirds of the decline in output during a recession?

A decline in investment spending

Which of the following would lead to a shift in the short-run aggregate supply curve but no change in the long-run aggregate supply curve?

A decrease in the expected price level.

Deflation

A decrease in the overall level of prices.

Which of the following would cause leftward shift in aggregate demand?

A fall in housing prices.

The short-run consequence of an increase in the personal income tax levied on households is best described by...

A leftward shift in the aggregate demand curve (lower demand)

What is the short-run result of an open market purchase of securities by the Federal Reserve?

A leftward shift in the aggregate demand curve.

An earthquake destroys the capital stock in an economy. The result is...

A leftward shift in the long-run aggregate supply curve.

Which graph best describes the effect of a decrease in price level, all else held constant.

A leftward shift in the quantity of money.

Recesssion

A period of declining real incomes and rising unemployment.

Accommodative Policy

A policy of increasing aggregate demand in response to a decrease in short-run aggregate supply.

Depression

A severe recession.

Quantity Theory of Money

A theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate.

In ordered to increase aggregate supply (right-shift)...

Decrease input prices, decrease tax rates, and decrease burdensome regulations.

Hyperinflation

Extraordinarily High Inflation

Natural-Rate Hypothesis

The claim that unemployment eventually returns to its normal, or natural, rate regardless of the rate of inflation.

Menu Costs

The costs of changing prices.

Quantity Equation

The equation M x V = P x Y, which relates the quantity of money, the velocity of money, and the dollar value of the economy's output of goods and services

Which of the following would be classified as fiscal policy?

The federal government cuts taxes to stimulate the economy.

Inflation

The increase in the overall level of prices.

Increase in money growth will change...

The inflation rate and the price level.

Model of Aggregate Demand and Aggregate Supply

The model that most economists use to explain short-run fluctuations in economic activity around its long-run trend.

Suppose the expected inflation rate increases from 5% to 8%. According to the Fisher effect...

The nominal interest rate increases by 3 percentage points.

Crowding-Out Effect

The offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending.

Fisher Effect

The one-for-one adjustment of the nominal interest rate to the inflation rate.

Natural Level of Output

The production of goods and services that an economy achieves in the long run when unemployment is at its normal rate.

Monetary Neutrality

The proposition that changes in the money supply do not affect real variables.

Velocity of Moeny

The rate at which money changes hands.

Classical Dichotomy

The theoretical separation of nominal and real values.

Rational Expectations

The theory that people optimally use all the information they have, including information about government policies, when forecasting the future.

The Phillips curve suggests that in the short run...

Unemployment and inflation are negatively/inversely related/

Which of the following occurred as the U.S. economy experienced declining real GDP in 1953?

Unemployment rate increased, retail sales declined, and consumer spending declined.

Velocity of Money Formula

V = (P x Y) / M

Nominal Variables

Variables measured in monetary units (dollar prices)

What demonstrates an adjustment back to the natural level of output?

Wages and input prices fall and the new equilibrium is at Point D.

In the short-run, an increase in aggregate supply leads to ___ price level and ___ in unemployment.

a decrease; a decrease

In the short run, an unexpected decrease in the money supply results in ___ in the inflation rate and ___ in the unemployment rate.

a decrease; an increase.

In the long run, the decrease in the money supply results in ___ in the inflation rate and ___ in the unemployment rate.

a decrease; no change.

Suppose the central bank decreases the money supply; the on run effect of the central bank's policy is a ___ in the inflation rate, ___ in the unemployment rate, and ___ in real GDP.

a decrease; no change; no change.

The short-run Phillips curve is a ___ line representing ____.

a downward-sloping; the tradeoff between unemployment and inflation.

The long-run Phillips Curve (LRPC) is a ___ line at the ___.

a vertical; at the natural rate of unemployment

During the transition form the short run to the long run, price-level expectations will ___ and the ___ curve will shift to the ___.

adjust upward; short-run aggregate supply; left

Money neutrality suggests that an increase in the money supply leads to ____ in price level and inflation and ___ in real GDP.

an increase / no change

Suppose the relevant Phillips curve is curve II and the natural rate of unemployment is 4.5%. If the Federal Reserve decides to decrease the money supply and the effects are perfectly anticipated, then the economy most likely moves to point....

at 4.5% on the standard curve.

In order to increase the money supply, the Fed can use open market operations to...

buy bonds from the public

If inflation is higher than what was expected...

creditors receive a lower real interest rate than they had anticipated.

If the economy is producing below the natural rate of output in the short-run, wages and input prices will eventually ___ and ___ will increase, returning the economy to long-run equilibrium.

fall / short-run aggregate supply

Other things the same, when the price level falls, interest rates...

fall, so firms decrease investment.

The short-run quantity of output supplied by firms will fall below the natural level of output when the actual price level ___ the price level that people expected.

falls below

Examples of automatic stabilizers include government expenditures that ___ when national income decreases and help explain why deficits are ___ during recessions.

increase / larger

Suppose an economy is experiencing a period of high inflation. The government and central bank announce a contractionary policy to reduce the rate of inflation. The Philip's curve predicts a(n) ___ in unemployment. If households and firms believe the policy to be credible and revise their expectations to expect lower inflation, the change in unemployment would be ____ than if households and firms maintain their previous expectations.

increase/less

In the long run, as a result of economic prosperity abroad, the price level ___, the quantity of output ____ the natural level of output, and the unemployment rate ___ the natural rate of employment

increases; returns to; returns to

Suppose the economy begins in long-run equilibrium. The Federal Reserve has decided the inflation rate is too high and implements a contraction in the money supply. What best describes the path the economy takes as a result of the contraction in the money supply and the subsequent adjustment to a new long-run equilibrium?

left-shift in aggregate demand and then right shift in aggregate supply

The lower the price level, the ____ money the typical transaction requires, and the ____ money people will wish to hold in the form of currency or demand deposits.

less; less

If the Federal Reserve implements a policy to decrease the money supply and the effects are not anticipated, the economy most likely...

lowers inflation, increases unemployment in the same Phillips curve.

Suppose that the government is considering enacting an expansionary policy. This would cause a ___ the short-run Phillips curve, resulting in an ___ in the inflation rate and a ___ in the unemployment rate.

movement along; an increase; a decrease

Expected Real Interest Rate Formula

nominal interest rate - expected inflation rate

The sticky wage-theory of the short-run aggregate supply curve says that when the price level rises more than expected...

production is more profitable and employment rises.

In order to understand how the economy works in the short run, we need to...

study a model in which real and nominal variables interact

Real Variables

variables measured in physical units (relative prices, real wages, real interest rate)