Econ test 4
Which of the following is always correct in an open economy?
S = I + NCO
If a country has Y > C + I + G, then it has
S > I and it has a trade surplus.
Y=C+I+G+NX
S=Y-C-G Y-C-G=I+NX S=I+NX pg 379 S=I+NCO
exchange 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.
Refer to Figure 33-3. The natural rate of output occurs at
Y2
Policymakers who control monetary and fiscal policy and want to offset the effects on output of an economic contraction caused by a shift in aggregate supply could use policy to shift
aggregate demand to the right.
Which of the following would cause stagflation?
aggregate supply shifts left
closed economy
an economy that does not interact with other economies in the world
open economies
an economy that interacts freely with other economies in the world
supply shock
an event that directly alters firms' costs and prices, shifting the economy's aggregate supply curve and thus the Phillips curve
trade surplus
an excess of exports over imports
trade deficit
an excess of imports over exports
If the budget deficit increases, then
an increase in the interest rate decreases net capital outflow.
appreciation
an increase in the value of a currency as measured by the amount of foreign currency it can buy
Automatic stabilizers
are changes in taxes or government spending that increase aggregate demand without requiring policy makers to act when the economy goes into recession.
During a recession the economy experiences
falling employment and income.
If the demand for dollars in the market for foreign-currency exchange shifts left, then the exchange rate
falls and the quantity of dollars exchanged does not change.
In the open-economy macroeconomic model, if a country's interest rate rises, its net capital outflow
falls and the real exchange rate rises.
When aggregate demand shifts right along the short-run aggregate supply curve, unemployment
falls, so there are upward pressures on wages and prices.
in the short run, shifts in aggregate demand cause
fluctuations in the economy's output of goods and services
imports
goods and services that are produced abroad and sold domestically
exports
goods and services that are produced domestically and sold abroad
definitions
here
In the long run, the aggregate supply curve is vertical, whereas
in the short run, the aggregate supply curve slopes upward
Suppose there is a tax increase. To stabilize output, the Federal Reserve will
increase the money supply.
When aggregate demand shifts rightward along the short-run aggregate-supply curve, inflation
increases and unemployment decreases.
If expected inflation is constant, then when the nominal interest rate increases, the real interest rate
increases by the change in the nominal interest rate.
Other things the same, a decrease in the real interest rate
increases the quantity of loanable funds demand
Changes in monetary policy aimed at expanding aggregate demand can be described either as
increasing the money supply or as lowering the interest rate
Policymakers who can influence aggregate demand can potentially mitigate the adverse impact on output but only at the cost of exacerbating the problem of
inflation
In the long run,
inflation depends primarily upon the money supply growth rate.
In the long run, if the Fed decreases the growth rate of the money supply,
inflation will be lower.
A government budget deficit reduces the supply of loanable funds, drives up the interest rate, and crowds out
investment
According to Friedman and Phelps, the unemployment rate is above the natural rate when actual inflation
is less than expected inflation.
if a nation wants to reduce inflation
it must endure a period of high unemployment and low output
If a country raises its budget deficit then
its supply of but not its demand for loanable funds shifts.
One year a country has negative net exports. The next year it still has negative net exports and imports have risen more than exports.
its trade deficit rose
In a closed economy, a budget deficit represents negative public saving, so it reduces national saving and shifts the supply curve for loanable funds to the
left
If the exchange rate falls, U.S. residents pay
more dollars for foreign bonds and get more dollars from interest payments.
A depreciation of the U.S. real exchange rate induces U.S. consumers to buy
more domestic goods and fewer foreign goods.
Suppose that real interest rates in the U.S. rise relative to real interest rates in other countries. This increase would make foreigners
more willing to purchase U.S. bonds, so U.S. net capital outflow would fall.
Historically, the change in real GDP during recessions has been
mostly a change in investment spending.
In the open-economy macroeconomic model, the supply of loanable funds comes from
national saving. Demand comes from domestic investment and net capital outflow.
Because a government budget deficit represents
negative public saving, it decreases national saving.
According to purchasing-power parity, if prices in the United States increase by a larger percentage than prices in the United Kingdom, then the
nominal exchange rate falls.
Most recessions and depressions
occur with little advance warning.
If it took as many dollars to buy goods in the United States as it did to buy enough currency to buy the same goods in India, the real exchange rate would be computed as how many Indian goods per U.S. goods?
one
If it were not for the automatic stabilizers in the U.S. economy,
output and employment would probably be more volatile than they are now.
Monetary policy and fiscal policy influence
output in the short run only.
Why the Short-Run Aggregate-Supply Curve Might Shift
page 439
the effects of a shift in aggregate supply
page 448 can cause stagflation
chapter 20 conclusion
page 453`
Chapter 22 conclusion
page 501
conclusion of chapter 18
pg 391
How Policies and Events Affect an Open Economy
pg 404
trade policy / tariff effects
pg 406 figure 6
Chapter 19 Conclusion
pg 413
conclusion for chapter 21
pg 477
quantity of output supplied
quantity of output supplied= natural level of output + a(actual price level - expected price level) a is a number that determines how much output responds to unexpected changes in the price level
The model of aggregate demand and aggregate supply explains the relationship between
real GDP and the price level.
Which of the following is most commonly used to monitor short-run changes in economic activity?
real GDP.
If purchasing-power parity holds, then the value of the
real exchange rate is equal to one.
A favorable supply shock
reduces unemployment and the inflation rate.
favorable supply shock
reduces unemployment and the inflation rate. reduces costs and prices
deflation
reduction in the price level
disinflation
reduction in the rate of inflation
An adverse supply shock causes inflation to
rise and the short-run Phillips curve to shift right.
A favorable supply shock causes output to
rise. To counter this a central bank would decrease the money supply.
Other things the same, people in the U.S. would want to save more if the real interest rate in the U.S.
rose. The increased saving would increase the quantity of loanable funds supplied.
Suppose that a small economy that produces mostly agricultural goods experiences a year with exceptionally good conditions for growing crops. The good weather would
shift the short-run aggregate supply curve to the right, and the short-run Phillips curve to the left.
When the fed increases the money supply, it lowers the interest rate and increases the quantity of goods and services demanded for any given price level,
shifting the aggregate demand curve to the right
The phillips curve shows the combinations of inflation and unemployment that arise in the short run as
shifts in the aggregate demand curve move the economy along the short run aggregate supply curve
Most economists believe that classical theory describes the world in the long run but not in the
short run
Long run trends are the background on which
short run fluctuations are superimposed
Refer to Figure 32-1. If the real interest rate is 2 percent, there will be a
shortage of $40 billion.
Why the aggregate supply curve slopes upward in the short run following theories differ in their details but they share a common theme: The quantity of output supplied deviates from its long run, or natural, level when the actual price level in the economy deviates from the price level that people expected to prevail.
sticky wage theory, sticky price theory, misperceptions theory pg 437
purchasing power parity states
that a unit of a currency must have the same real value in every country
A trade policy is a government policy
that directly influences the quantity of goods and services that a country imports or exports.
Capital flight from Mexico increases Mexican interest rates and decreases the value of
the Mexican peso in the market for foreign-currency exchange Figure 7
Which of the following will not change the U.S. real interest rate?
the U.S. imposes import quotas
Which of the following will not change the U.S. real interest rate? a. None of the above is correct. b. the government budget deficit increases c. capital flight from the United States d. the U.S. imposes import quotas
the U.S. imposes import quotas
When the Mexican peso gets "stronger" relative to the dollar,
the U.S. trade deficit with Mexico falls.
multiplier effect
the additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending Figure 4 pg 468 important because it shows how the economy can amplify the impact of changes in spending
natural rate hypothesis
the claim that unemployment eventually returns to its normal, or natural, rate, regardless of the rate of inflation
The imposition of an import quota shifts
the demand for currency right, so the exchange rate rises.
According to the theory of liquidity preference,
the demand for money is represented by a downward-sloping line on a supply-and-demand graph.
If the U.S. government imposes a quota on imports of jet planes, then
the exchange rate rises.
marginal propensity to consume (MPC)
the fraction of extra income that a household consumes rather than saves example. MPC is 3/4. for every extra dollar that a household earns, the household spends 3/4 or $0.75 and saves the rest.
Suppose the Fed increased the growth rate of the money supply. Which of the following would be higher in the long run?
the inflation rate, but not the natural rate of unemployment
If the Fed increases the money supply,
the interest rate decreases, which tends to raise stock prices.
If the price level rises, then
the interest rate rises and spending on goods and services falls.
Shifts in the aggregate-demand curve can cause fluctuations in
the level of output and in the level of prices.
If efficiency wages became more common,
the long-run Phillips curve would shift right, and the long-run aggregate supply curve would shift left.
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 illustrated in Figure 2
the effect from changes in taxes is affected by
the multiplier effect, crowding out effect, AND households' perception about whether the tax change is permanent or temporary if tax cut is expected to be permanent, spending will be increased by a large amount
natural rate of unemployment
the normal rate of unemployment around which the unemployment rate fluctuates
sacrifice ratio
the number of percentage points of annual output lost in the process of reducing inflation by 1 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 and thus puts downward pressure on aggregate demand
in the long run, shifts in aggregate demand affect
the overall price level but do not affect output
According to classical macroeconomic theory, changes in the money supply affect
the price level, but not real GDP.
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
net capital outflow (NCO)
the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners For an economy as a whole, NCO must always equal net exports NCO=NX
nominal exchange rate
the rate at which a person can trade the currency of one country for the currency of another
real exchange rate
the rate at which a person can trade the goods and services of one country for the goods and services of another pg 384 Real exchange rate=(nominal exchange rate x domestic price) / foreign price
variables that influence net capital outflow
the real interest rates paid on foreign assets the real interest rates paid on domestic assets perceived economic and political risks of holding assets abroad the government policies that affect foreign ownership of domestic assets
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
trade balance
the value of a nation's exports minus the value of its imports; also called net exports
net exports
the value of a nation's exports minus the value of its imports; also called the trade balance
purchasing power refers to
the value of money in terms of the quantity of goods it can buy
How Monetary Policy Influences Aggregate Demand
the wealth effect, interest-rate effect, exchange-rate effect these effects work together to explain downward slope of aggregate demand curve For the US economy, the most important reason for the downward slope of the aggregate demand curve is the interest rate
subprime borrowers
those borrowers with a higher risk of default based on their income and credit history
Refer to Figure 33-4. If the economy starts at A, a decrease in the money supply moves the economy
to C in the long run.
Increases in the money supply, increases in government spending, or cuts in taxes expand aggregate demand and move the economy
to a point on the phillips curve with lower unemployment and higher inflation, opposite actions will do the opposite, higher unemployment and lower inflation
Conversely, when the Fed contracts the money supply, it raises the interest rate and reduces the quantity of goods and services demanded for any given price level, shifting the aggregate demand curve
to the left
Similarly, a tax increase depresses consumer spending and shifts the aggregate demand curve
to the left
Because it increases consumer spending, a tax cut shifts the aggregate demand curve
to the right
unemployment rate formula analysis of friedman and phelps
unemployment rate= natural rate of unemployment - a (actual inflation - expected inflation) variable a is a parameter that measures how much unemployment responds to unexpected inflation
why the aggregate demand curve slopes downward
wealth effect, interest rate effect, exchange rate effect pg 427
Which of the following will both make people buy more?
wealth rises and interest rates fall.
Changes in Government Purchases
when the government alters it own purchases of goods and services, it shifts the aggregate demand curve directly
Three Key Facts about Economic Fluctuations
1. Economic fluctuations are irregular and unpredictable 2. Most macroeconomic quantities fluctuate together 3. As output falls, unemployment rises
phillips curve long run
A vertical line at the natural rate of unemployment that illustrates the view that there is no trade-off between the inflation rate and the unemployment rate or the price level and the level of unemployment
Refer to figure 35-5. In this order, which curve is a long-run Phillips curve and which is a short-run Phillips curve?
A,D
A country has national saving of $50 billion, government expenditures of $30 billion, domestic investment of $10 billion, and net capital outflow of $40 billion. What is its supply of loanable funds?
$50 billion
Short Run Aggregate Supply Curve summary
!!!!!!!!!!!!!!!! Table 2 pg 440
money demand curve
"Slopes downward because an increase in the interest rate increases the opportunity cost of holding money" "an INCREASE IN PRICE LEVEL would shift the money demand curve to the right" " the variable on the vertical axis is the interest rate on SHORT TERM FINAnCIAL ASSETS, SUCH AS TREASURY BILLS OR MONEY MARKET MUTUAL FUNDS"
A tall latte in China costs 30 yuan. The same latte in the U.S. costs 4 dollars. If the exchange rate is 6.5 yuan per dollar then, the real exchange rate is
.867 so the good is more expensive in China.
If a Starbucks tall latte cost $3.20 in the United States and 3 euros in the Euro area, then purchasing-power parity implies the nominal exchange rate is how many euros per dollar?
.938 If the exchange rate is less than this, it costs more dollars to buy a tall latte in the U.S. than in the Euro area.
If a country has net exports of $8 billion and sold $40 billion of goods and services abroad, then it has
$40 billion of exports and $32 billion of imports.
A country has I = $200 billion, S = $400 billion, and purchased $600 billion of foreign assets, how many of its assets did foreigners purchase?
$400 billion
According to purchasing-power parity, if the same basket of goods costs $100 in the U.S. and 50 pounds in Britain, then what is the nominal exchange rate?
1/2 pound per dollar
If the exchange rate is 5 Egyptian pounds per U.S. dollar, a watch that costs $25 US dollars costs
125 Egyptian pounds
If a U.S. dollar purchases 4 Argentinean pesos, and a gallon of milk costs $3 in the U.S. and 6 pesos in Argentina what is the real exchange rate?
2
If the Fed wants to reverse the effects of a favorable supply shock on the inflation rate, it should a. increase the money supply growth rate, but this moves unemployment further from its natural rate. b. decrease the money supply growth rate which also moves unemployment closer to its natural rate. c. increase the money supply growth rate which also moves unemployment closer to its natural rate. d. decrease the money supply growth rate, but this moves unemployment further from its natural rate.
??????? NOT "increase the money supply growth rate which also moves unemployment closer to its natural rate." NOT "decrease the money supply growth rate which also moves unemployment closer to its natural rate."
the 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.
the interest-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.
Any policy change that reduced the natural rate of unemployment would a. shift the long-run Phillips curve to the left. b. shift the long-run aggregate-supply curve to the right. c. improve the functioning of the labor market. d. All of the above are correct.
ALL of the above pg 487
When the price level changes, which of the following variables will change and thereby cause a change in the aggregate quantity of goods and services demanded? a. the real value of wealth b. the interest rate c. the value of currency in the market for foreign exchange d. All of the above are correct.
All of the above are correct
Which of the following shifts aggregate supply to the right? a. a decline in the price of imported natural resources b. a technological advance c. an older labor force that leaves jobs less frequently d. All of the above are correct.
All of the above are correct
The long-run aggregate supply curve a. is vertical. b. is a graphical representation of the classical dichotomy. c. indicates monetary neutrality in the long run. d. All of the above are correct
All of the above are correct.
Purchasing-power parity theory does not hold at all times because
Both a and b are correct
How Fiscal Policy Influences Aggregate Demand
Changes in Government Policy, multiplier effect, a formula for the spending multiplier, the crowding out effect, changes in taxes
Volcker Disinflation
Fed Chairman Paul Volcker Appointed in late 1979 under high inflation & unemployment Changed Fed policy to disinflation 1981-1984: Fiscal policy was expansionary, so Fed policy had to be very contractionary to reduce inflation. Success: Inflation fell from 10% to 4%, but at the cost of high unemployment...
Implications of Purchasing-Power Parity
It tells us that nominal exchange rate between the currencies of two countries depends on the price levels in those countries **For the purchasing power of a dollar to be the same in two countries this must be the case ***1/P=e/P* with rearrangement it becomes ***1=eP/P* left side is constant and the right side is the real exchange rate so **** IF the purchasing power of the dollar is always the same at home and abroad, then real exchange rate-the relative price of domestic and foreign goods-cannot change -nominal exchange rates change when price level changes ***When the central bank prints large quantities of money, that money loses value both in terms of the goods and services it can buy and in terms of the amount of other currencies it can buy pg 387
theory of liquidity preference
Keynes's theory that the interest rate adjects to bring money supply and money demand into balance
Limitations of Purchasing Power Parity
Many goods are not easily traded or shipped from one country to another/ first reason-many goods are not easily traded(haircut more expensive in Paris then New York) 2.Even tradable goods are not always perfect substitutes when they are produced in different countries. (German vs. US cars) -Thus, both because some goods are not tradable and because some tradable goods are not perfect substitutes with foreign counterparts, purchasing power parity is not a perfect theory of exchange rate determination.
The Role of Interest Rate Targets in Fed Policy
Monetary policy can be described either in terms of the money supply or in terms of the interest rate. Changes in monetary policy can be viewed either in terms of a changing target for the interest rate or in terms of a change in the money supply. A target for the federal funds rate affects the money market equilibrium, which influences aggregate demand.
Formula for the Spending Multiplier
Multiplier=1 / (1 - MPC)
Which of the following does purchasing-power parity imply?
The nominal exchange rate is the ratio of foreign prices to U.S. prices.
When the dollar depreciates, U.S.
exports increase, while imports decrease.
A policy that results in slow and steady growth of the money supply is an example of
a "passive" monetary policy.
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
depreciation
a decrease in the value of a currency as measured by the amount of foreign currency it can buy
Which of the following would cause the price level to fall and output to rise in the short run?
a favorable supply shock
trade policy
a government policy that directly influences the quantity of goods and services that a country imports or exports do not affect the trade balance pg 408
Capital flight refers to
a large and sudden movement of funds out of a country.
capital flight
a large and sudden reduction in the demand for assets located in a country
phillips curve short run
a model that demonstrates the inverse relationship between unemployment (horizontal) and inflation (vertical axis) A downward-sloping curve showing the short-run inverse relationship between the level of inflation and the level of unemployment.
recession
a period of declining real incomes and rising unemployment
stagflation
a period of falling output and rising prices
depression
a severe recession
balanced trade
a situation in which exports equal imports
purchasing power parity (PPP)
a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries
why the aggregate supply curve is vertical in the long run
because the price level does not affect the long run determinants of real GDP, the long run aggregate supply curve is vertical as in Figure 4
Carl and Carly are American residents. Carl buys stock of a corporation in Austria. Carly opens a coffee shop in Austria. Whose purchase, by itself, decreases Austria's net capital outflow?
both Carl's and Carly's
Matt and Melinda are American residents. Matt buys stock issued by a German corporation. Melinda opens a shoe factory in Panama. Whose purchase, by itself, increases the U.S.'s net capital outflow?
both Matt's and Melinda's
An Italian company exchanges euros for dollars from U.S. residents and then uses the dollars to buy U.S. products to sell in its stores in Rome. U.S. residents who exchanged their dollars for euros use the euros to buy bonds issued by French corporations. At this point
both U.S. net exports and U.S. net capital outflows have risen.
A policy change that changes the natural rate of unemployment changes
both the long-run Phillips curve and the long-run aggregate supply curve.
When Congress reduces spending in order to balance the government's budget, it needs to consider
both the short-run effects on aggregate demand and aggregate supply, and the long-run effects on saving and growth.
If the U.S. has exports of $1.5 trillion and imports of $2.2 trillion, then the U.S.
buys more from overseas then it sells overseas; it has a trade deficit.
The Downward Slope of the Aggregate Demand Curve
caused by the Real Wealth Effect, the Interest-Rate Effect, and the International Trade Effect. The price level is one determinant of the quantity of money demanded. A higher price level increases the quantity of money demanded for any given interest rate. Higher money demand leads to a higher interest rate. The quantity of goods and services demanded falls. The end result of this analysis is a negative relationship between the price level and the quantity of goods and services demanded.
Why the Aggregate-Demand Curve Might Shift
changes in consumption, changes in investment, changes in government purchases, changes in net exports TABLE 1: Aggregate Demand Curve Summary pg 431 !!!!!!!!!!!!!
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 -most important one is the tax system -government spending also acts as an automatic stabilizer pg 476
Why the Long-Run Aggregate-Supply Curve Might Shift
changes in labor, capital, natural resources, technological knowledge !!!!!!! page 433
menu costs
costs to adjusting prices include cost of printing and distributing catalogs and the time required to change price tags
The large increase in oil prices in the 1970s was caused primarily by a(n)
decrease in the supply of oil.
If expected inflation is constant and the nominal interest rate decreases by 2 percentage points, then the real interest rate
decreases by 2 percentage points.
When the interest rate decreases, the opportunity cost of holding money
decreases, so the quantity of money demanded increases.
Changes in monetary policy aimed at contracting aggregate demand can be described either as
decreasing the monetary supply or as raising the interest rate
In an open economy, national saving equals
domestic investment plus net capital outflow.
because policymakers influence aggregate demand, they can potentially mitigate the severity of
economic fluctuations
Which of the following increases inflation and reduces unemployment in the short run?
either an increase in government expenditures by itself or an increase in the money supply growth rate by itself
If purchasing-power parity holds, a dollar will buy
enough foreign currency to buy as many goods as it does in the United States.
parity
equality