Marco Exam 2 Chapter 5-8

Relative price

is the P of one good relative to (divided by) another

NRU

is the normal rate of U around which the actual U-rate fluctuates. The NRU consists of frictional U & structural U

According to the quantity theory of money, what is the effect of an increase in the quantity of money?

According to the quantity theory of money, an increase in the quantity of money causes a proportional increase in the price level.

Assets

Includes loans & reserves

Unemployment Insurance

A gov't program that partially protects workers' incomes when they become unemployed UI increases frictional U. Benefits of UI: 1) reduces uncertainty over incomes, 2) gives the unemployed more time to search, resulting in better job matches and thus higher productivity

Purchasing-Power Parity (PPP)

A theory of exchange rates whereby a unit of any currency should be able to buy the same quantity of goods in all countries - based on the law of one price (arbitrage).

According to the Fisher effect, how does an increase in the inflation rate affect the real interest rate and the nominal interest rate?

According to the Fisher effect, an increase in the inflation rate raises the nominal interest rate by the same amount that the inflation rate increases, with no effect on the real interest rate.

What claims do advocates of unions make to argue that unions are good for the economy?

Advocates of unions claim that unions are good for the economy because they are an antidote to the market power of the firms that hire workers and they are important for helping firms respond efficiently to workers' concerns.

Explain how an increase in the price level affects the real value of money.

An increase in the price level reduces the real value of money because each dollar in your wallet now buys a smaller quantity of goods and services.

Bank A has a leverage ratio of 10, while Bank B has a leverage ratio of 20. Similar losses on bank loans at the two banks cause the value of their assets to fall by 7 percent. Which bank shows a larger change in bank capital? Does either bank remain solvent? Explain.

Bank B will show a larger change in bank capital. The drop in assets will render Bank B insolvent because its assets will fall below its liabilities. Bank A will suffer a large decline in bank capital (70%) but will remain solvent

Why don't banks hold 100 percent reserves? How is the amount of reserves banks hold related to the amount of money the banking system creates?

Banks do not hold 100% reserves because it is more profitable to use the reserves to make loans, which earn interest, instead of leaving the money as reserves, which earn no interest. The amount of reserves banks hold is related to the amount of money the banking system creates through the money multiplier. The smaller the fraction of reserves banks hold, the larger the money multiplier, because each dollar of reserves is used to create more money.

What is commodity money? What is fiat money? Which kind do we use?

Commodity money is money with intrinsic value, like gold, which can be used for purposes other than as a medium of exchange. Fiat money is money without intrinsic value; it has no value other than its use as a medium of exchange. Our economy today uses fiat money.

What are demand deposits and why should they be included in the stock of money?

Demand deposits are balances in bank accounts that depositors can access on demand simply by writing a check or using a debit card. They should be included in the supply of money because they can be used as a medium of exchange.

Using a diagram of the labor market, show the effect of an increase in the minimum wage on the wage paid to workers, the number of workers supplied, the number of workers demanded, and the amount of unemployment.

Figure 2 shows a diagram of the labor market with a binding minimum wage. At the initial minimum wage (m1), the quantity of labor supplied L1S is greater than the quantity of labor demanded L1D, and unemployment is equal to L1S - L1D. An increase in the minimum wage to m2 leads to an increase in the quantity of labor supplied to L2S and a decrease in the quantity of labor demanded to L2D. As a result, unemployment increases as the minimum wage rises

Explain four ways in which a firm might increase its profits by raising the wages it pays.

Four reasons why a firm's profits might increase when it raises wages are: (1) better paid workers are healthier and more productive; (2) worker turnover is reduced; (3) the firm can attract higher quality workers; and (4) worker effort is increased.

Why is frictional unemployment inevitable? How might the government reduce the amount of frictional unemployment?

Frictional unemployment is inevitable because the economy is always changing. Some firms are shrinking while others are expanding. Some regions are experiencing faster growth than other regions. Transitions of workers between firms and between regions are accompanied by temporary unemployment. The government could help to reduce the amount of frictional unemployment through public policies that provide information about job vacancies in order to match workers and jobs more quickly, and through public training programs that help ease the transition of workers from declining to expanding industries and help disadvantaged groups escape poverty.

If inflation is less than expected, who benefits—debtors or creditors? Explain.

If inflation is less than expected, creditors benefit and debtors lose. Creditors receive dollar payments from debtors that have a higher real value than was expected.

A can of soda costs $0.75 in the United States and 12 pesos in Mexico. What would the peso-dollar exchange rate be if purchasing-power parity holds? If a monetary expansion caused all prices in Mexico to double, so that soda rose to 24 pesos, what would happen to the peso-dollar exchange rate?

If purchasing-power parity holds, then 12 pesos per soda divided by $0.75 per soda equals the exchange rate of 16 pesos per dollar. If prices in Mexico doubled, the exchange rate will double to 32 pesos per dollar.

If the Fed wants to increase the money supply with open-market operations, what does it do?

If the Fed wants to increase the supply of money with open-market operations, it purchases U.S. government bonds from the public on the open market. The purchase increases the number of dollars in the hands of the public, thus raising the money supply.

You take $100 you had kept under your mattress and deposit it in your bank account. If this $100 stays in the banking system as reserves and if banks hold reserves equal to 10 percent of deposits, by how much does the total amount of deposits in the banking system increase? By how much does the money supply increase?

If you take $100 that you held as currency and put it into the banking system, then the total amount of deposits in the banking system increases by $1,000, because a reserve ratio of 10% means the money multiplier is 1/0.10 = 10. Thus, the money supply increases by $900, because deposits increase by $1,000 but currency declines by $100.

Liabilities

Include deposits

In what sense is inflation like a tax? How does thinking about inflation as a tax help explain hyperinflation?

Inflation is like a tax because everyone who holds money loses purchasing power. In a hyperinflation, the government increases the money supply rapidly, which leads to a high rate of inflation. Thus the government uses the inflation tax, instead of taxes, to finance its spending

Three Functions of Money

Medium of exchange, Unit of account & Store of value

Are minimum-wage laws a better explanation for structural unemployment among teenagers or among college graduates? Why?

Minimum-wage laws are a better explanation for unemployment among teenagers than among college graduates. Teenagers have fewer job-related skills than college graduates do, so their wages are low enough to be affected by the minimum wage. College graduates' wages generally exceed the minimum wage.

What distinguishes money from other assets in the economy?

Money is different from other assets in the economy because it is the most liquid asset available. Other assets vary widely in their liquidity.

Trade deficit

NX < 0

Balanced trade

NX = 0

Explain the difference between nominal and real variables and give two examples of each. According to the principle of monetary neutrality, which variables are affected by changes in the quantity of money?

Nominal variables are those measured in monetary units, while real variables are those measured in physical units. Examples of nominal variables include the prices of goods, wages, and nominal GDP. Examples of real variables include relative prices (the price of one good in terms of another), real wages, and real GDP. According to the principle of monetary neutrality, only nominal variables are affected by changes in the quantity of money.

What are reserve requirements? What happens to the money supply when the Fed raises reserve requirements?

Reserve requirements are regulations on the minimum amount of reserves that banks must hold against deposits. An increase in reserve requirements raises the reserve ratio, lowers the money multiplier, and decreases the money supply.

What are the three categories into which the Bureau of Labor Statistics divides everyone?

The BLS categorizes each adult (16 years of age and older) as either employed, unemployed, or not in the labor force.

Why can't the Fed control the money supply perfectly?

The Fed cannot control the money supply perfectly because: (1) the Fed does not control the amount of money that households choose to hold as deposits in banks; and (2) the Fed does not control the amount that bankers choose to lend. The actions of households and banks affect the money supply in ways the Fed cannot perfectly control or predict.

Who is responsible for setting monetary policy in the United States? How is this group chosen?

The Federal Open Market Committee (FOMC) is responsible for setting monetary policy in the United States. The FOMC consists of the 7 members of the Federal Reserve Board of Governors and 5 of the 12 presidents of Federal Reserve Banks. Members of the Board of Governors are appointed by the president of the United States and confirmed by the U.S. Senate. The presidents of the Federal Reserve Banks are chosen by each bank's board of directors.

What are the costs of inflation? Which of these costs do you think are most important for the U.S. economy?

The costs of inflation include shoeleather costs associated with reduced money holdings, menu costs associated with more frequent adjustment of prices, increased variability of relative prices, unintended changes in tax liabilities due to nonindexation of the tax code, confusion and inconvenience resulting from a changing unit of account, and arbitrary redistributions of wealth between debtors and creditors. With a low and stable rate of inflation like that in the United States, none of these costs are very high. Perhaps the most important one is the interaction between inflation and the tax code, which may reduce saving and investment even though the inflation rate is low.

What is the discount rate? What happens to the money supply when the Fed raises the discount rate?

The discount rate is the interest rate on loans that the Federal Reserve makes to banks. If the Fed raises the discount rate, fewer banks will borrow from the Fed, so both banks' reserves and the money supply will be lower.

How does the BLS compute the labor force, the unemployment rate, and the labor-force participation rate?

The labor force consists of the sum of the employed and the unemployed. The unemployment rate is the percentage of the labor force that is unemployed. The labor-force participation rate is the percentage of the total adult population that is in the labor force.

Velocity of Money

The rate at which money changes hands P x Y = nominal GDP = (price level) x (real GDP) M = MS V = velocity V=PxY/M

The Nominal Exchange Rate (e)

The rate at which one country's currency trades for another (example) - Appreciation & Depreciation

Three reasons for structural u?

Three reasons: Minimum wage, Union (insiders vs. outsiders), and the efficiency wage.

Is unemployment typically short term or long term? Explain.

Unemployment is typically short term. Most people who become unemployed are able to find new jobs fairly quickly. But some unemployment is attributable to the relatively few workers who are jobless for long periods of time.

How do unions affect the natural rate of unemployment?

Unions may affect the natural rate of unemployment via the effect on insiders and outsiders. Because unions raise the wage above the equilibrium level, the quantity of labor demanded declines while the quantity supplied of labor rises, so there is unemployment. Insiders are those who keep their jobs. Outsiders, workers who become unemployed, have two choices: either get a job in a firm that is not unionized, or remain unemployed and wait for a job to open up in the union sector. As a result, the natural rate of unemployment is higher than it would be without unions.

Suppose the banking system currently has $400 billion in reserves, the reserve requirement is 10 percent, and excess reserves are $3 billion. What is the level of loans?

a. $3,603 billion b. $3,600 billion c. $3,573 billion d. $3,570 billion *** The level of deposit is (400-3) / 0.1 = 3,970. Since R = 0.1, 90% of deposits are held as loans. 3,970 x 0.9 = 3,573 Since excess reserve is 3, the actual loan amount is 3,573 - 3 = 3,570

If the reserve ratio is 5 percent, then $2,500 of additional reserves can create up to

a. $62,500 of new money. b. $50,000 of new money. *** c. $45,600 of new money. d. $37,500 of new money.

If the price level increased from 120 to 126, then what was the inflation rate?

a. 3 percent b. 5 percent ** c. 6 percent d. None of the above is correct.

The U-rate is not a perfect indicator of joblessness or the health of the labor market because:

a. It excludes discouraged workers. b. It does not distinguish between FT and PT work, or people working PT because FT jobs not available. c. Some misreport their work status in the BLS survey. d. all of the above**

You put money in the bank. The increase in the dollar value of your savings

a. and the change in the number of goods you can buy with your savings are both nominal variables. b. and the change in the number of goods you can buy with your savings are both real variables. c. is a nominal variable, but the change in the number of goods you can buy with your savings is a real variable. * d. is a real variable, but the change in the number of goods you buy with your savings is a nominal variable.

The natural unemployment rate includes

a. both frictional and structural unemployment. **** b. neither frictional nor structural unemployment. c. structural, but not frictional unemployment. d. frictional, but not structural unemployment.

Over time both real GDP and the price level have trended upward. Which of these trends would the classical dichotomy say could be explained by an upward trend in the money supply?

a. both the upward trend in real GDP and the upward trend in the price level b. the upward trend in real GDP but not the upward trend in the price level c. the upward trend in the price level but not the upward trend in real GDP * d. neither the upward trend in the price level nor the upward trend in real GDP

The price level falls. This might be because the Federal Reserve

a. bought bonds which raised the money supply. b. bought bonds which reduced the money supply. c. sold bonds which raised the money supply. d. sold bonds which reduced the money supply. ***

When conducting an open-market purchase, the Fed

a. buys government bonds, and in so doing increases the money supply. **** b. buys government bonds, and in so doing decreases the money supply. c. sells government bonds, and in so doing increases the money supply. d. sells government bonds, and in so doing decreases the money supply.

Which of the following is not included in M1?

a. currency b. demand deposits c. traveler's checks d. credit cards ****

Which list ranks assets from most to least liquid?

a. currency, demand deposits, money market mutual funds ***** b. currency, money market mutual funds, demand deposits c. money market mutual funds, demand deposits, currency d. demand deposits, money market mutual funds, currency

If the natural rate of unemployment is 5.2 percent and the actual rate of unemployment is 5.7 percent, then by definition there is

a. cyclical unemployment amounting to 0.5 percent of the labor force. *** b. frictional unemployment amounting to 0.5 percent of the labor force. c. structural unemployment amounting to 0.5 percent of the labor force. d. search unemployment amounting to 0.5 percent of the labor force.

Economic variables whose values are measured in monetary units are called

a. dichotomous variables. b. nominal variables. * c. classical variables. d. real variables.

According to the quantity equation, the price level would change less than proportionately with a rise in the money supply if there were also

a. either a rise in output or a rise in velocity. b. either a rise in output or a fall in velocity. * c. either a fall in output or a rise in velocity. d. either a fall in output or a fall in velocity.

Which of the following does not help reduce frictional unemployment?

a. government-run employment agencies b. public training programs c. unemployment insurance **** d. All of the above help reduce frictional unemployment.

If the United States imposes an import quota on clothing, then U.S. exports

a. increase, U.S. imports increase, and U.S. net exports will not change. b. increase, U.S. imports decrease, and U.S. net exports increase. c. decrease, U.S. imports increase, and U.S. net exports decrease. d. decrease, U.S. imports decrease, and U.S. net exports will not change. *

Open-market purchases by the Fed make the money supply

a. increase, which makes the value of money increase. b. increase, which makes the value of money decrease. *** c. decrease, which makes the value of money decrease. d. decrease, which makes the value of money increase.

From 2001 to 2004 the U.S. budget went from surplus to deficit. According to the open economy macroeconomic model, this change should have

a. increased U.S. interest rates and increased the real exchange rate of the dollar.* b. increased U.S. interest rates and decreased the real exchange rate of the dollar. c. decreased U.S. interest rates and increased the real exchange rate of the dollar. d. decreased U.S. interest rates and decreased the real exchange rate of the dollar.

Money is the most liquid asset available because

a. it is a store of value. b. it is a medium of exchange. ** c. it is a unit of account. d. it has intrinsic value.

If the real exchange rate is less than 1, then the

a. nominal exchange rate x U.S. price > foreign price. The dollars required to purchase a good in the U.S. would buy more then enough foreign currency to buy the same good overseas. b. nominal exchange rate x U.S. price > foreign price. The dollars required to purchase a good in the U.S. would not buy enough foregoing currency to buy the same good overseas. c. nominal exchange rate x U.S. price < foreign price. The dollars required to purchase a good in the U.S. would buy more then enough foreign currency to buy the same good overseas. d. nominal exchange rate x U.S. price < foreign price. The dollars required to purchase a good in the U.S. would not buy enough foreign currency to buy the same good overseas. *

A rise in the budget deficit

a. shifts both the supply of loanable funds in the market for loanable funds and the supply of dollars in the market for foreign-currency exchange right. b. shifts both the supply of loanable funds in the market for loanable funds and the supply of dollars in the market for foreign-currency exchange left. * c. shifts both the demand for loanable funds in the market for loanable funds and the demand for dollars in the market for foreign-currency exchange right. d. shifts both the demand for loanable funds in the market for loanable funds and the demand for dollars in the market for foreign-currency exchange left.

When a minimum-wage law forces the wage to remain above the level that balances supply and demand, the result is a

a. shortage of labor and a shortage of jobs. b. shortage of labor and a surplus of jobs. c. surplus of labor and a shortage of jobs. *** d. surplus of labor and a surplus of jobs.

Which of the following is not a cause of frictional unemployment?

a. the destruction of manufacturing jobs b. a worker leaving a job to find one with better benefits c. minimum-wage laws **** d. unemployment insurance

Other things the same, which of the following would both make Americans more willing to buy Italian goods?

a. the nominal exchange rate falls, the price of goods in Italy falls b. the nominal exchange rate falls, the price of goods in Italy rises c. the nominal exchange rate rises, the price of goods in Italy falls * d. the nominal exchange rate rises, the price of goods in Italy rises

Suppose there are a large number of men who used to work or seek work who now no longer do either. Other things the same, this makes

a. the number of people unemployed rise but does not change the labor force. b. the number of people unemployed rise but makes the labor force fall. c. both the number of people unemployed and the labor force fall. ***** d. the number of people unemployed fall but does not change the labor force.

The Fed (monetary policy) can influence unemployment in

a. the short run and in the long run. b. the short run, but not in the long run. **** c. the long run, but not in the short run. d. neither the short nor the long run.

If the U.S. has a trade deficit and the nominal exchange rate depreciates, then other things the same

a. the trade deficit rises and net capital outflow rises. b. the trade deficit rises and net capital outflow falls. c. the trade deficit falls and net capital outflows rise. * d. the trade deficit falls and net capital outflows fall.

Your boss gives you an increase in the number of dollars you earn per hour. This increase in pay makes

a. your nominal wage increase. If your nominal wage rose by a greater percentage than the price level, then your real wage also increased. *** b. your nominal wage increase. If your nominal wage rose by a greater percentage than the price level, then your real wage decreased. c. your real wage increase. If your real wage rose by a greater percentage than the price level, then your nominal wage also increased. d. your real wage decrease. If your real wage rose by a greater percentage than the price level, then your nominal wage decreased.

Nominal variables

are measured in monetary units. Ex: nominal GDP, i, nominal w

Real variables

are measured in physical units. Ex: real GDP, r & real w

Demand deposits

balances in bank accounts that depositors can access on demand by writing a check

The Real Exchange Rate (E)=

e X P/p* The rate at which the g&s of one country trade for the g&s of another:

Structural U

occurs when there are fewer jobs than workers. Usually longer-term. Due to min. wages, labor unions, efficiency wages

Frictional U

occurs when workers spend time searching for the jobs that best suit their skills and tastes.

Cyclical U

the deviation of U from its natural rate, associated with business cycles

Currency

the paper bills and coins in the hands of the (non-bank) public

Monetary neutrality

the proposition that changes in the MS do not affect real variables