Exam 2

Potential GDP or Full Employment GDP

the amount of real GDP an economy can produce by fully employing its existing levels of labor, physical capital, and technology

Aggregate Demand (AD)

the amount of total spending on domestic goods and services in an economy

coins and currency in circulation

the coins and bills that circulate in an economy that are not held by the U.S Treasury, at the Federal Reserve Bank, or in bank vaults

Transaction costs

the costs associated with finding a lender or a borrower for money

Money Market Fund

the deposits of many investors are pooled together and invested in a safe way like short-term government bonds

Net Worth

the excess of the asset value over and above the amount of the liability; total assets minus total liabilities

neoclassical perspective

the philosophy that, in the long run, the business cycle will fluctuate around the potential, or full-employment, level of output

rational expectations

the theory that people form the most accurate possible expectations about the future that they can, using all information available to them

adaptive expectations

the theory that people look at past experience and gradually adapt their beliefs and behavior as circumstances change

Aggregate Supply (AS)

the total quantity of output (i.e. real GDP) firms will produce and sell

physical capital per person

the amount and kind of machinery and equipment available to help a person produce a good or service

Keynes' Law

"demand creates its own supply"

Say's Law

"supply creates its own demand"

Complete the sentences with the correct function of money. 1. Norah walks into her favorite department store, Bullseye, to pick out a new dress. She checks out the price tag and is excited to see that the dress is on sale and is now relatively cheaper than another dress she was considering. Here, money is serving as a... 2. She is especially excited because she has been saving money each week in her piggy bank at home so that she can afford a trip to Florida next summer. Here, money is serving as a... 3. She quickly walks to the checkout line where she pays the cashier for her new dress. Here, money is serving as a... a.unit of account b.store of value c.medium of exchange d. purchase agent.

1.a Money provides a standard and widely accepted method for reporting the price of goods and services. Price tags are an example of money serving as a unit of account; by pricing items in U.S. dollars in the United States, consumers have a clear and universal method for determining the cost of a variety of goods and services. 2.b People use money as savings to buy goods and services in the future. 3.c Money is widely accepted in transactions in the economy.

Suppose that the required reserve ratio is 7.00 %. What is the simple money (deposit) multiplier? Round to two decimal places. money multiplier: Increasing the reserve ratio will ........ the money multiplier.

14.29 Increase

Multiplier formula

=1/Reserve Requirement total money in the economy divided by the original quantity of money, or change in the total money divided by a change in the original quantity of money

One benefit of using money to facilitate economic activity is that it does not require a double coincidence of wants. Which of the examples describes a double coincidence of wants? -A baker, who is interested in acquiring meat, meets a butcher interested in acquiring bread. -A baker, who is interested in acquiring vegetables, meets a butcher who is also interested in acquiring vegetables. -Two couples both try to purchase the same house. -Two people, who do not know one another, both order an extra-value meal #1 from McDonald's at the exact same moment.

A baker, who is interested in acquiring meat, meets a butcher interested in acquiring bread. Explanation: A baker interested in acquiring meat meeting a butcher interested in acquiring bread describes a double coincidence of wants because both people want something that the other can provide. Because it allows people to avoid the extra search time needed to find a double coincidence of wants, using money is a more efficient way of making exchanges.

Table 1 shows the financial position of Bank Uno once $3485.003485.00 has been deposited. Assume that the required reserve ratio is 7.007.00%, that banks do not keep excess reserves, and that all the money loaned out from Bank Uno is deposited into Bank Duo (whose loans go to other banks not shown here). Once the lending and depositing process is complete, what will the accounts look like in Tables 2 and 3? Specify all answers to two decimal places. Table 1. Bank Uno's Initial T-Account Assets: Reserves: $3485.00 Liabilities: Deposits: $3485.00 Table 2. Bank Uno's T-Account After Loans Assets: Reserves: ? Loans: ? Liabilities: Deposits: ? Table 3. Bank Duo's T-Account After Deposits and Loans Assets: Reserves: ? Loans: ? Liabilities: Deposits: ? What are Bank Uno's deposits in Table 2? $ A What are Bank Uno's reserves in Table 2? $ B What are Bank Duo's loans in Table 3? $ C What are Bank Uno's loans in Table 2? $ D

A. 3485.00 B. 243.95 C. 3014.18 D. 3241.05 Loans made by a bank do not affect the money that the bank owes to its depositors (the liabilities side of the T‑account), so its deposits in Table 2 remains $3485.00. Assuming that banks do not keep any excess reserves, Bank Uno will only keep 7.00% of its deposits and loan out 93.00%. This means it keeps reserves of $243.95 and makes loans of the remaining $3241.05 . When the $3241.05 gets deposited into Bank Duo, the bank similarly keeps 7.00 % and loans the remaining $3014.18 . Note that each of these series of deposits and loans increases the money supply by a smaller and smaller amount. Eventually, when this process completes, the money supply will be increased by a factor of 14.29 (assuming that all loans get redeposited and no bank keeps more than the minimum reserves; otherwise, it will increase by a smaller factor). How is this money multiplier calculated? money multiplier=(1/required reserve ratio)=(1/7.00%)=14.29

If Kelly transfers $500 from her savings account to her checking account, M1 will "A" and M2 will "B" Increase, decrease, or remain the same.

A. Increase B. Remain the same M1 includes currency and coins held by the non‑banking public, checkable deposits, and traveler's checks. When Kelly transfers $500 from savings to checking, M1 will increase by $500. M2 includes M1 plus savings accounts, money market mutual funds, and small denominated time deposits. It follows that when the transfer occurs, M2 does not change because it is just a movement of funds from one component in M2 to another.

Suppose that the graph represents the aggretergate demand (AD) and aggregate supply (AS) of Latvia. What will happen to Latvia's economy in the long run, according to the neoclassical view? -Latvia's aggregate supply will shift to the left. -Latvia's potential GDP line will shift to the right. -Latvia's aggregate demand will shift to the left. -Latvia's aggregate supply will shift to the right.

A. Latvia's aggregate supply will shift to the left. Because Latvia's real GDP is above potential GDP, the economy is above full employment. In the short run, aggregate supply responds to higher demand by bringing more inputs into the production process. Consequently, the economy will experience a shortage of labor, which will drive up wages in the long run. As a result, the AS curve will shift to the left, returning real GDP to its potential level.

commodity money

An item that is used as money, but which also has value from its use as something other than money. Example: People have used gold, silver, cowrie shells cigarettes, and even cocoa beans as money.

Determine if the items listed should be classified in a bank's T‑chart as an asset, a liability, or neither. reserves loans bonds deposits income from ATM fees operating expenses of a bank

Asset: reserves, loans, bonds Liability: Deposits Neither: income from ATM fees and operating expenses of a bank Items of value that a firm owns are classified as assets. Here, reserves (funds the bank keeps on hand), loans (a stream of payments that will occur in the future) and bonds (also a stream of payments that will occur in the future) are assets. Items that describe debts or amounts owed are classified as liabilities. Here, deposits (funds the bank owes back to its customers) are liabilities. Income from ATM fees and operating expenses are revenue and costs, respectively, and are therefore not classified as assets or liabilities.

Demands Deposits

Checkable deposit in banks that is available by making a cash withdrawal or writing a check

Rank the different types of bank accounts according to their liquidity. Highest liquidity to Lowest liquidity savings account certificate of deposit (CD) Lowest liquidity

Checking account Savings account Certificate of deposit (CD) Explanation: Savings accounts come with limited restrictions on the frequency and amount of withdrawals. Converting a CD to cash before its maturity date typically entails substantial fees.

Suppose you win on a scratch‑off lottery ticket and you decide to put all of your $3,500 winnings in the bank. The reserve requirement is 10%. What is the maximum possible increase in the money supply as a result of your bank deposit? maximum increase: $ Which events could cause the increase in the money supply to be less than its potential? -Some loan recipients choose to hold some cash instead of depositing all of it in banks. -Banks decide to keep some excess reserves on hand. -Banks choose to loan out all excess reserves. -All money loaned out is deposited back into the banking system.

Consider the formula for the money multiplier. money multiplier=1/reserve requirement Here, the reserve requirement is 10%, so the money multiplier is 10. The bank has to hold 10% of your $3,500 deposit, or $350. To find the maximum possible increase in the money supply, multiply the excess reserves of $3,500−$350=$3,150 by the multiplier to get the answer of $31,500. Note that this is the maximum possible increase, but it assumes all available money is deposited into the banking system and that banks loan as much as they possibly can. If some cash "leaks out," then the actual impact on the money supply will be smaller. This may occur if some loan recipients hold onto cash instead of depositing the loan entirely back into the banking system. Similarly, if banks choose to hold onto some excess reserves instead of loaning them all out, the money supply will not be increased as much as the multiplier indicates.

Components that comprise Aggregate Demand

Consumption Spending (C) Investment Spending (I) Government Spending (G) Spending on Exports (X) minus Imports (M) AD=C+I+G+X-M

Match the given statements to the appropriate type of plastic money card. Debit card Credit card Smart money needs to be reloaded functions like a check functions as a preapproved loan

Debit card- functions like a check Credit card- functions as a preapproved loan Smart money- needs to be reloaded

Real GDP

GDP adjusted for inflation

Money as a standard of deferred payment

If money is usable to today to make purchases, it must also be acceptable to make purchases today that the purchaser will pay in the future. Example: Loans

foreign price effect

If prices rise in the US and stay the same elsewhere then X goes down and M goes up

Consider the table presenting information about an economy's money supply. Currency in circulation $982 billion Checkable deposits $1,334.7 billion Savings accounts $6,312.2 billion Money market mutual funds $695.3 billion Time deposits less than $100,000 $797.3 billion Traveler's checks $4.7 billion Gold coins $1.4 billion Calculate the values of M1 and M2

M1 = $2,321.4 billion M2= $10,126.2 billion

M1 and M2 are two definitions of money supply. Determine if the items listed are included in the money supply under each of these definitions and place them in the appropriate category. M1 only M2 only M1 and M2 Neither M1 nor M2

M2 only: balances in saving accounts, certificates of deposit, and money market account balances, M1 and M2: Currency, traveler's checks, and balances in checking accounts. Neither M1 nor M2: Credit Cards, Gold, and Common Stock.

Money as a medium of exchange

Money acts as an intermediary between the buyer and the seller. Examples: Exchanging accounting services for money. Buying shoes.

Which of the phrases is not a stated function of money? -Money is used as a means of preserving economic value for the future. -Money is used to adjust an individual's income for inflation. -Money serves as a medium of exchange. -Money is used to measure material value in the economy.

Money is used to adjust an individual's income for inflation. Money is used for several purposes. As a medium of exchange, money can be traded from one person to another as a way to pay debts or bills. It can be used to measure material value in the economy, known as a unit of account, and also as a way to keep economic value for use in the future. However, money is not used to compensate for inflation. Rather, inflation is a general rise in overall prices, and when prices rise, the same amount of money now buys less than before. Increasing amounts of money are involved in compensating for the effect inflation has on an individual, but it is not the purpose of money to help resolve inflation.

Assume that the T‑chart shows the financial position of a small local bank. What is the bank's net worth? Assets Loans: $15.00 Bonds: $11.00 Reserves: $41.00 Liabilities Deposits: $40.00

Network= 15+11+41-40 =$27

Select the statement that best describes money's function as a standard of deferred payment. -A currency is widely accepted in exchange for goods and services and therefore makes economic transactions easier. -People are willing to accept a currency in the future as compensation for debts accrued earlier -The purchasing power of a currency is relatively stable over time -A currency can be used to express the value goods and services that are both relatively expensive and goods and services that are relatively cheap.

People are willing to accept a currency in the future as compensation for debts accrued earlier

Money as a store of value

Something that serves as as way of preserving economic value that one can spend or consume in the future.

Does the aggregate demand curve slope up or down?

The AD curve slopes down, which means that increases in the price level of outputs lead to a lower quantity of total spending. (As price level decreases, Real GDP increases)

Liquidity

The ease of converting an asset into money (either checking accounts or currency) in a timely fashion with little or no loss in value.

Table 1 shows the financial position of the Smithville Bank once $2195.00 has been deposited. Assume that the required reserve ratio is 5.00%. The bank manager decides to lend Billy Bob Smith all of the bank's excess reserves. Billy Bob takes the funds to Eula Mae's Used Machines and buys a pickup truck. Eula Mae then deposits the money in her account back at the Smithville Bank. Table 2 should show the bank's accounts after the loan is made and the funds again deposited. Round all answers to the nearest cent. Table 1. Original Assets and Liabilities Assets- reserves: $2195.00 Liabilities-deposits: $2195.00 Table 2. Assets and Liabilities After Bank Makes a Loan Assets- reserves: ? loans: ? Liabilities- deposits: ? What are the bank's loans in Table 2? $ A What are the bank's reserves in Table 2? $ B What are the bank's deposits in Table 2? $ C

The problem assumes that the bank does not keep excess reserves, meaning that the bank will only keep 5.00% of any deposit and loan out the remaining 95.00%. The loan to Billy Bob is therefore: A=$2195.00×(100%−5.00%)=$2085.25 The problem also assumes that loaned funds are deposited back into the Smithville Bank. Hence, the $2085.25 that was loaned out to Billy Bob is redeposited back into the bank by Eula Mae. This amount is added to its existing reserves, and can be represented by: B=($2195.00×5.00%)+$2085.25=$2195.00 The bank's deposits are now the sum of the initial $2195.00$2195.00 deposit and the $2085.25 that Eula Mae redeposited, or $4280.25. This loan increases the money supply. C= $4280.25 Note that Eula Mae's deposit puts Smithville Bank over the required reserve ratio again, so it will make additional loans. This ongoing sequence of smaller and smaller loans and redeposits will eventually have a multiplier effect on the money supply.

Gross Domestic Product (GDP)

The total output of all economic activity in the nation, including goods and services.

Barter

Trading one good for another in an economy without money

Bank capital

a bank's net worth

money as a unit of account

a common way in which we measure market values in an economy

Aggregate Demand (AD) curve

a curve that shows the total spending on domestic goods and services at each price level

M2 Money Supply

a definition of the money supply that includes everything in M1, but also adds savings deposits, money market funds, and certificates of deposit

expected inflation

a future rate of inflation that consumers and firms build into current decision making

M1 Money Supply

a narrow definition of the money supply that includes currency and checking accounts in banks, and to a lesser degree, traveler's checks.

Savings deposits

bank account where you cannot withdraw money by writing a check, but can withdraw the money at a bank—or can transfer it easily to a checking account

Does the aggregate supply curve slope up for down?

the Aggregate Supply (AS) curve slopes down. As the price level for output rises (input remaining fixed) firms have an incentive to produce more to earn higher profits

Suppose the equilibrium level of the gross domestic product (GDP) is beyond potential output due to an increase in aggregate demand (AD). Using neoclassical economics, rank the statements, beginning with the increase in AD and ending with the neoclassical explanation of how the economy returns to potential output. Recall that AS stands for the aggregate supply curve. a.There are more jobs available than unemployed people b.the short-run AS curve shifts to the left c. the shortage of workers drives wages up d. the intersection of the AD and short-run AS curves is at full employment

a>c>b>d Explanation: Due to an increase in the AD curve, the actual equilibrium of the economy is beyond potential output. According to Keynesian economics, the economy will stay at this equilibrium until something moves the economy to a new equilibrium. Using neoclassical economics, it is possible to explain how the economy can return to potential output by understanding the effects of wages on the short‑run AS curve. Since the actual equilibrium of the economy is beyond potential output, this indicates that the unemployment rate is below the unemployment rate when the economy is at full employment. When the economy is at full employment, there is no cyclical unemployment, but there is frictional and structural unemployment present. So, the labor market is tight, meaning that there are more unfilled jobs than there are unemployed people to fill them. A tight labor market puts upward pressure on wages to increase. Employers need to pay workers more in order to keep their workers; otherwise, their workers can easily quit and find higher-paying jobs. This increase in wages makes the production process more expensive, which decreases the short‑run AS curve. So, the short‑run AS curve shifts to the left. This decrease in the short‑run AS curve helps the economy to return to potential output. The new intersection of the short‑run AS and the AD curve intersects potential output but the economy is now also at a higher price level, which indicates that the economy is experiencing inflation.

Time deposits

account that the depositor has committed to leaving in the bank for a certain period of time, in exchange for a higher rate of interest; also called certificate of deposit.

Balance Sheet

an accounting tool that lists assets and liabilities

Financial Intermediary

an institution that operates between a saver with financial assets to invest and an entity who will borrow those assets and pay a rate of return

Assets

an item of value that a firm or an individual owns

Liability

any amount or debt that a firm or an individual owes

commodity-backed currencies

are dollar bills or other currencies with values backed up by gold or another commodity

interest rate effect

as price for outputs rise, the same purchases will take more money or credit to accomplish; additional demand for money will push interest rates higher, reducing borrowing

wealth effect

as the price level increases, the real value of household wealth declines, reducing consumption.

Asset-liability time mismatch

customers can withdraw a bank's liabilities in the short term while customers repay its assets in the long term

Neoclassical economists

economists who generally emphasize the importance of aggregate supply in determining the size of the macroeconomy over the long run

Reserves

funds that a bank keeps on hand and that are not loaned out or invested in bonds

Payment System

helps an economy exchange goods and services for money or other financial assets

Depository Institutions

institution that accepts money deposits and then uses these to make loans

debit card

like a check, is an instruction to the other user's bank to transfer money directly and immediately from your bank account to the seller

Diversify

making loans or investments with a variety of firms, to reduce the risk of being adversely affected by events at one or a few firms

Fiat money

money that has no intrinsic value, but it is declared by a government to be the country's legal tender

double coincidence of wants

occurs when each party in an exchange transaction happens to have what the other party desires.

Neoclassical zone

portion of the SRAS curve where GDP is at or near potential output where the SRAS curve is steep

Intermediate zone

portion of the SRAS curve where GDP is below potential but not so far below as in the Keynesian zone; the SRAS curve is upward-sloping, but not vertical in the intermediate zone

Keynesian zone

portion of the SRAS curve where GDP is far below potential and the SRAS curve is flat

aggregate supply curve

shows the total quantity of output (i.e. real GDP) that firms will produce and sell at each price level

Match the given terms to the appropriate statement relating to the various functions of money. Each term is used only once. Money provides a way of measuring a good for value in standardized terms. Money permits us to make purchases today and enables us to pay off the purchases at some future point in time. Money keeps its overall purchasing power. Money is used to complete the transaction between the buyer and seller.

unit of account standard of deferred payment medium of exchange store of value

Long Run Aggregate Supply (LRAS) Curve

vertical line at potential GDP showing no relationship between the price level for output and real GDP in the long run