ECN211 Final Exam
expected inflation
Expected inflation measures how much people expect the overall price level to change
the third reason the aggregate-demand curve slopes downward:
When a fall in the U.S. price level causes U.S. interest rates to fall, the real value of the dollar declines in foreign exchange markets. This depreciation stimulates U.S. net exports and thereby increases the quantity of goods and services demanded. Conversely, when the U.S. price level rises and causes U.S. interest rates to rise, the real value of the dollar increases, and this appreciation reduces U.S. net exports and the quantity of goods and services demanded.
interest rate effect
When a lower price level reduces the interest rate, investors move some of their funds overseas in search of higher returns. This movement of funds causes the real value of the domestic currency to fall in the market for foreign-currency exchange. Domestic goods become less expensive relative to foreign goods. This change in the real exchange rate stimulates spending on net exports and thus increases the quantity of goods and services demanded.
The same three effects work in reverse:
When the price level rises, decreased wealth depresses consumer spending, higher interest rates depress investment spending, and a currency appreciation depresses net exports.
supply shock
an event that directly alters firms' costs and prices, shifting the economy's aggregate-supply curve and thus the Phillips curve
For the U.S. economy, the most important reason for the downward slope of the aggregate-demand curve is the ________________
interest rate effect
One reason the short-run aggregate-supply curve slopes upward is that a higher price level
reduces real wages if nominal wages are sticky.
property rights
refer to the ability of people to exercise authority over the resources they own
recession
relatively mild rising unemployment and falling incomes
sacrifice ratio
the number of percentage points of annual output lost in the process of reducing inflation by percentage point
crowding-out effect
the offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending
A sudden increase in business pessimism shifts the aggregate-________ curve, leading to ________ output.
. demand; lower
stagflation
a period of falling output and rising prices
Reducing inflation will tend to be costly if
expectations of inflation are slow to adjust
Monetary policy affects the economy with a lag mainly because it takes a long time
for a change in interest rates to affect investment spending.
multiplier effect
the additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending
productivity
the amount of goods and services produced for each hour of work.
reserve requirements
the amount of reserves banks must hold against deposits
natural-rate hypothesis
the claim that unemployment eventually returns to its normal, or natural, rate, regardless of the rate of inflation
externality
the effect of one person's actions on the well-being of a bystander
brain drain
the emigration of many of the most highly educated workers to rich countries, where these workers can enjoy a higher standard of living
A change in which of the following would shift the short-run aggregate-supply curve but not the long-run aggregate-supply curve?
the expected price level
Marginal Propensity to Consume (MPC)
the fraction of extra income that a household consumes rather than saves
factors of production
the inputs used to produce goods and services—labor, capital, and so on
discount rate
the interest rate at which banks can borrow reserves from the Fed
The aggregate-demand curve slopes downward because a fall in the price level causes
the interest rate to decline.
Human Capital
the knowledge and skills that workers acquire through education, training, and experience.
the aggregate-supply curve is vertical only in _____________________.
the long run
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
The natural rate of unemployment is
the normal level of joblessness, regardless of inflation.
analysis of the interest-rate effect
- A higher price level raises money demand. - Higher money demand leads to a higher interest rate. - A higher interest rate reduces the quantity of goods and services demanded.
There are three distinct but related reasons a fall in the price level increases the quantity of goods and services demanded:
- Consumers become wealthier, stimulating the demand for consumption goods. - Interest rates fall, stimulating the demand for investment goods. - The currency depreciates, stimulating the demand for net exports.
Why Might the Aggregate-Demand Curve Shift?
- Shifts Arising from Changes in Consumption: An event that causes consumers to spend more at a given price level (a tax cut, a stock market boom) shifts the aggregate-demand curve to the right. An event that causes consumers to spend less at a given price level (a tax hike, a stock market decline) shifts the aggregate-demand curve to the left. - Shifts Arising from Changes in Investment: An event that causes firms to invest more at a given price level (optimism about the future, a fall in interest rates due to an increase in the money supply) shifts the aggregate-demand curve to the right. An event that causes firms to invest less at a given price level (pessimism about the future, a rise in interest rates due to a decrease in the money supply) shifts the aggregate-demand curve to the left. - Shifts Arising from Changes in Government Purchases: An increase in government purchases of goods and services (greater spending on defense or highway construction) shifts the aggregate-demand curve to the right. A decrease in government purchases on goods and services (a cutback in defense or highway spending) shifts the aggregate-demand curve to the left. - Shifts Arising from Changes in Net Exports: An event that raises spending on net exports at a given price level (a boom overseas, speculation that causes a currency depreciation) shifts the aggregate-demand curve to the right. An event that reduces spending on net exports at a given price level (a recession overseas, speculation that causes a currency appreciation) shifts the aggregate-demand curve to the left.
Why Does the Aggregate-Demand Curve Slope Downward?
- The Wealth Effect: A lower price level increases real wealth, stimulating spending on consumption. - The Interest-Rate Effect: A lower price level reduces the interest rate, stimulating spending on investment. - The Exchange-Rate Effect: A lower price level causes the real exchange rate to depreciate, stimulating spending on net exports.
Which of the following would shift the aggregate-demand curve to the left?
A decline in the stock market b. An increase in taxes c. A decrease in government spending
wealth effect
A lower price level raises the real value of households' money holdings, which are part of their wealth. Higher real wealth stimulates consumer spending and thus increases the quantity of goods and services demanded.
exchange rate effect
A lower price level reduces the amount of money people want to hold. As people try to lend out their excess money holdings, the interest rate falls. The lower interest rate stimulates investment spending and thus increases the quantity of goods and services demanded.
second reason the aggregate-demand curve slopes downward:
A lower price level reduces the interest rate, encourages greater spending on investment goods, and thereby increases the quantity of goods and services demanded. Conversely, a higher price level raises the interest rate, discourages investment spending, and decreases the quantity of goods and services demanded.
quantitative easing
A second option is to have the central bank conduct expansionary open-market operations using a larger variety of financial instruments
The Misperceptions Theory
An unexpectedly low price level leads some suppliers to think their relative prices have fallen, inducing a fall in production.
sticky-price theory
An unexpectedly low price level leaves some firms with higher-than-desired prices, depressing their sales and leading them to cut back production.
sticky-wage theory
An unexpectedly low price level raises the real wage, causing firms to hire fewer workers and produce a smaller quantity of goods and services.
..
Any event or policy that raises consumption, investment, government purchases, or net exports at any given price level increases aggregate demand. Any event or policy that reduces consumption, investment, government purchases, or net exports at any given price level decreases aggregate demand.
diminishing returns
As the stock of capital rises, the extra output produced from an additional unit of capital falls.
theory of liquidity preference
Keynes's theory that the interest rate adjusts to bring money supply and money demand into balance
supply siders
Economists who stress the importance of tax policy for aggregate supply rather than aggregate demand
the business cycle
Fluctuations in the economy
From one year to the next, inflation falls from 5 to 4 percent, while unemployment falls from 7 to 6 percent. Which of the following events could be responsible for this change?
Newly discovered oil reserves cause world oil prices to plummet.
model of aggregate demand and aggregate supply
On the vertical axis is the overall price level in the economy. On the horizontal axis is the overall quantity of goods and services produced in the economy.
forward guidance
One option is to have the central bank commit itself to keeping interest rates low for an extended period of time
catch-up effect
Other things being equal, it is easier for a country to grow fast if it starts out relatively poor. This effect of initial conditions on subsequent growth
An upward-sloping short-run aggregate-supply curve is represented by which of the following equations?
Quantity of output supplied = Natural level of output + a(Actual price level - Expected price level)
Why Might the Short-Run Aggregate-Supply Curve Shift?
Shifts Arising from Changes in Labor: An increase in the quantity of labor available (perhaps due to a fall in the natural rate of unemployment) shifts the aggregate-supply curve to the right. A decrease in the quantity of labor available (perhaps due to a rise in the natural rate of unemployment) shifts the aggregate-supply curve to the left. Shifts Arising from Changes in Capital: An increase in physical or human capital shifts the aggregate-supply curve to the right. A decrease in physical or human capital shifts the aggregate-supply curve to the left. Shifts Arising from Changes in Natural Resources: An increase in the availability of natural resources shifts the aggregate-supply curve to the right. A decrease in the availability of natural resources shifts the aggregate-supply curve to the left. Shifts Arising from Changes in Technology: An advance in technological knowledge shifts the aggregate-supply curve to the right. A decrease in the available technology (perhaps due to government regulation) shifts the aggregate-supply curve to the left. Shifts Arising from Changes in the Expected Price Level: A decrease in the expected price level shifts the short-run aggregate-supply curve to the right. An increase in the expected price level shifts the short-run aggregate-supply curve to the left.
Most economists believe that classical theory describes the world in the long run but not in the short run.
TRUE
From one year to the next, inflation falls from 5 to 4 percent, while unemployment rises from 6 to 7 percent. Which of the following events could be responsible for this change?
The government cuts spending and raises taxes to reduce the budget deficit.
physical capital
The stock of equipment and structures used to produce goods and services
Phillips curve
a curve that shows the short-run trade-off between inflation and unemployment
inward-oriented policies
aim to increase productivity and living standards within the country by avoiding interaction with the rest of the world.
subprime borrowers
borrowers with a higher risk of default based on their income and credit history—to get loans to buy homes.
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
exchange rate effect begins with ________
change in interest rate
wealth effect begins with______________
change in price level
When the Federal Reserve increases the money supply and expands aggregate demand, it moves the economy along the Phillips curve to a point with ________ inflation and ________ unemployment.
higher; lower
Suppose a wave of negative "animal spirits" overruns the economy, and people become pessimistic about the future. To stabilize aggregate demand, the Fed could ________ its target for the federal funds rate or Congress could ________ taxes.
decrease; decrease
If the Federal Reserve reduces the rate of money growth and maintains it at the new lower rate, eventually expected inflation will ________ and the short-run Phillips curve will shift ________.
decrease; downward
An increase in the aggregate demand for goods and services has a larger impact on output ________ and a larger impact on the price level ________.
in the short run; in the long run
If the government wants to expand aggregate demand, it can ________ government purchases or ________ taxes.
increase; decrease
Natural Resources
inputs into production that are provided by nature, such as land, rivers, and mineral deposits
natural level of output
it shows what the economy produces when unemployment is at its natural, or normal, rate. The natural level of output is the rate of production toward which the economy gravitates in the long run.
Stagflation is caused by a
leftward shift in the aggregate-supply curve.
credit crunch
many financial institutions did not have funds to loan out, and the ability of the financial system to channel resources to those who could best use them was impaired. Even creditworthy customers found themselves unable to borrow to finance investment spending
Which of the following is an example of an automatic stabilizer? When the economy goes into a recession,
more people become eligible for unemployment insurance benefits.
Unemployment rate = ?
natural rate of unemployment - a(actual inflation - expected inflation)
The Phillips curve started as an observed ________ correlation between the inflation rate and the ________.
negative; unemployment rate
outward-oriented policies
ntegrate these countries into the world economy. International trade in goods and services can improve the economic well-being of a country's citizens.
In the model of aggregate demand and aggregate supply, the quantity of ________ is on the horizontal axis, and the ________ is on the vertical axis.
output; price level
wage-price spiral.
phenomenon of higher prices leading to higher wages, in turn leading to even higher prices
determinants of productivity
physical capital, human capital, natural resources, and technological knowledge
depression
severe rising unemployment and falling incomes
When an adverse supply shock shifts the short-run aggregate supply curve to the left, it also
shifts the short-run Phillips curve to the right.
aggregate-supply curve
shows the quantity of goods and services that firms produce and sell at each price level.
aggregate-demand curve
shows the quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level.
securitization
the process by which a financial institution (specifically, a mortgage originator) makes loans and then (with the help of an investment bank) bundles them together into financial instruments called mortgage-backed securities
Advocates of the theory of rational expectations believe that
the sacrifice ratio can be much smaller if policymakers make a credible commitment to low inflation.
Fiscal policy
the setting of the level of government spending and taxation by government policymakers
rational expectations
the theory that people optimally use all the information they have, including information about government policies, when forecasting the future
technological knowledge
the understanding of the best ways to produce goods and services.
Real GDP measures ___________
the value of all final goods and services produced within a given period of time. It also measures the total income (adjusted for inflation) of everyone in the economy.
"underwater"
they owed more on their mortgages than their homes were worth