ECON MIDTERM 2
Inflation in the short run confuses who
Consumers, workers, firms, and entrepreneurs
Economic bubbles are created because of inflated (and in the short-run self-fulfilling) expectations of
Future asset prices
What causes a change in growth rate of velocity of money
Government spending Net exports Rate of consumption
What leads to hyperinflation ?
Governments trying to pay their debts by increasing money supply
What would prevent asset bubbles from forming?
Greater transparency in assessing the value of companies and assets
Risk return take off
Higher returns come at the price of higher risk
When a company sells stock for the first time to raise money for a business expansion this is called
IPO = (Initial Public Offering)
Unexpected inflation always:
Turns into expected inflation
managerial fee
a MUTUAL FUND pools money from many customers and invests that money in many firms
The benefit of a high leverage ratio to a firm is that a
a small increase in prices leads to large profits
importance of past events in predicting future events
adaptive expectations
a rapid and unexpected shift in the AD curve (spending)
aggregate demand shock
negative shocks = LRAS curve moves left because of
bad weather higher price in oil technology slump higher taxes disruption bc of war, earthquake, pandemic
Why is solow growth curve vertical ?
Money in neutral in the long run In the long run, real GDP growth will be the same regardless of inflation
in the long run, money is ...?
NEUTRAL
What may lead to failures in efficient financial intermediation?
Politicized lending Bank panics Insecure property rights
higher returns comes at the price of higher risk
Risk return trade off
If the rate of spending growth decreases, what happens to the aggregate demand curve?
Shifts down and to the left
Factors that shift AD Negative shocks
Slower money growth rate Fear Reduced wealth Higher taxes Lower growth of gov spending Decreased export growth Increased import growth
Why does SRAS shift up?
So the actual inflation rate equals the expected inflation rate
occurs when asset prices rise far higher and more rapidly than can be accounted for by the fundamental prospects of the company ... can hurt the economy
Speculative bubbles
The decrease in private consumption and investment that occurs when government borrows more is called
crowding out
unemployment correlated with the business cycle
cyclical unemployment
How does faster growth in real GDP affect unemployment?
decrease in unemployment
an employee may quit and an employer may fire an employee at any time and for any reason
employment at will doctrine
the tendency of nominal interest rates to rise with expected inflation rates
fisher effect
short term unemployment caused by the ordinary difficulties of matching employee to employer
frictional unemployment
positive shocks = LRAS curve moves right because of
good weather lower oil price technology boom lower taxes smooth production
what country has the longest long term unemployment
greece
What is the long run effect of a permanent aggregate demand shock?
higher inflation
unexpected inflation hurts and benefits who
hurts lenders, benefits borrowers
inflation that is 3,000% for example Price increases so much the dollar bill you are holding just does not make sense Price increases are so out of control that the concept of inflation is meaningless
hyperinflation
when will AD curve shift
if our spending growth rate (M+v) changes
an increase in AD in the short run results in
inflation and growth rate increase
How would economic sanctions reduce a country's productivity but not consumers spending habits be represented in the AS-AD model? What is the long run and short run of this situation?
inward shift in LRAS to the left Higher inflation and lower output growth
Technical analysis is a field of study that:
looks for patterns in stock and asset prices
Which of the following is a potential explanation for the stickiness of prices and wages in the short run?
menu costs
the costs of changing prices
menu costs
Which event would NOT cause a change in the growth rate of the velocity of money?
money supply
shifts the solow growth curve to the left → lower real growth
negative real shock
when workers respond to the wage number on their paychecks rather than to what their wage can buy in goods and services (the wage after correcting for inflation)
nominal wage confusion
Stock markets provide a way of __
of transferring company control
an increase in AD in the long run results in
only higher inflation
if government is borrowing money, then demand shifts
outward
Money growth can be set
permanently at any rate
shifts the solow growth curve to the right → higher real growth
positive real shock
amount you get every month or year
price coupon
any shock that increases or decreases the potential growth rate
real shock
An increase in the expectations of inflation will
shift the SRAS curve upward, to the left
shows the positive relationship between the inflation rate and real growth during the period when prices and wages are sticky
short run aggregate demand curve
an economy's potential growth rate the rate of economic growth that would occur given the flexible prices and existing real factors of production
solow growth rate
If you own stocks in a nuclear power company what would be the best way to diversify your portfolio?
stocks in fossil fuels
Changes in velocity growth tend to be
temporary
A positive AD shock will increase the real growth rate in:
the short run only
Most economists believe that the aggregate supply curve is
upward sloping in the short run, but vertical in the long run
The long run aggregate supply curve is what kind of line
vertical
possible shocks include
wars, weather, tax rate changes
HOW TO PICK STOCKS - advice
Diversify Avoid high fees Buy and hold — best trading strategy There is no return without risk
the prices of traded assets reflect all publicly available information
Efficient market hypothesis
the ratio of nominal to real GDP multiplied by 100, covers finished goods and services. Measures the average price of all final goods and services
GDP deflator
The more capital an economy can invest, the greater the
GDP per capita
Benefits of stock markets
Have uses beyond investment New stock and bond issues are an important means of raising capital for capital investment Source of capital for businesses (MAIN SOURCE OF CAPITAL)
quantity of money formula growth rate
M + V=P + Yr M = money supply growth v = velocity growth P = inflation Yr = growth in output
Quantity of money equation
M x V = P x Y
GDP deflator formula
Nominal GDP/Real GDP x 100
the purchase of new capital goods
investment
a decrease in spending growth shifts the AD curve ...?
inward
Unemployment increases dramatically during a recession for 2 reasons
laid off and cannot create jobs
he market where savers of funds trade with borrowers of funds is called the
market for loanable funds
when the government pays off its debts by printing money
monetizing the debt
when people mistake changes in nominal prices for changes in real prices
money illusion
the rate of structural plus frictional unemployment
natural unemployment rate
the rate of return that does not account for inflation
nominal rate of return
choosing a group of stocks that mimic a broad market index
passive investing
a price that has been corrected for inflation
real price
certificate of ownership in a corporation. Also called a share
stock
persistent, long term unemployment caused by long lasting shocks or permanent features of an economy that make it more difficult for some workers to find jobs
structural unemployment
an approach that looks for patterns in stock and asset prices
technical analysis
If the government offers an investment tax credit during a recession in order to stimulate investment demand, it will probably make the tax credit
temporary, to encourage firms to invest quickly.
If no inflation occurs, who benefits?
the bank
owner equity equation
the value of the asset minus the debt or E = V - D
part time workers who would rather have a full time position
underemployment rate
labor force participation rate formula
unemployed + employed / adult population x 100
the percentage of the labor force without a job
unemployment rate
an association of workers that bargains collectively with employers over wages, benefits, and working conditions
union
refers to how many times a given dollar is spent on finished goods and services in a year on average
velocity of money
In the long run, real GDP is determined by
capital, labor, and technology, none of which is affected by the money supply.
What does the quantity theory of money assume about the relationship between M and YR?
changes in M cannot change YR.
workers who have given up looking for work but who would still like a job
discouraged workers
who does not count in labor force
discouraged workers, people in army, jail, or school
bridge the gap between savers and borrowers
financial intermediaries
higher returns are accompanied by...
higher risk
Monetary policy is more effective when
in the short run than long run
income that is not spent on consumption goods
saving
allow individuals, firms, and governments to smooth their consumption over time
saving and borrowing
save during working years, spend during retirement years
smooth consumption
adults who do not have a job but who are looking for work
unemployed workers
unemployment rate formula
unemployed/unemployed+employed x 100
measure average price for a basket of goods and services bought by a typical consumer
CPI consumer price index
Cost of stock markets
Can encourage speculative bubbles If others buy you want to buy, then everyone crashes
Employment protection laws have the following effects
Create valuable insurance for workers with full time jobs Make labor markets less flexible and dynamic Increase the duration of unemployment Increase unemployment rates among young, minority, or otherwise riskier workers
4 FACTORS THAT DETERMINE SUPPLY OF SAVINGS
smoothing consumption impatience marketing and psychological factors interest rates
The rate of return for a zero-coupon bond can be expressed by:
[(FV − price) ÷ price] × 100
Financial intermediation may fail if something causes
an increase in the politicization of lending
bank-like activities (mainly lending) that take place outside the traditional banking sector includes investment banks, hedge funds, money market funds, and others
shadow banking
banks that are funded by investors and are not insured by the FDIC
shadow banks
companies giving up ownership of their company
the stock market
All else equal, if consumers decide to borrow less, the
Demand for funds will go to the left
Inflation Rate Formula
P2-P1 / P1 x 100 P2 = index value in year 2 P1 = index value in year 1
measure average price received by producers, includes intermediate and finished goods and services
PPI producer price index
QUANTITY OF MONEY DEPENDS ON 2 ASSUMPTIONS
Real GDP is stable compared to the money supply The velocity of money, v, is stable compared to the money supply
Equilibrium in the market for loanable funds determines the
The price of loanable funds is the interest rate
To Be Counted As Unemployed
16 years or older Not in prison A civilian Looking for work
QUANTITY OF MONEY DOES 2 THINGS
Defines relationship between money, velocity, real output, prices Explains role of money supply in determining inflation rate
unexpected disinflation hurts and benefits who
benefits lenders, harms borrowers
fluctuations in the growth rate of real GDP around its trend growth rate
business fluctuations
the % change in a price index from one year to the next
inflation rate
first time a corporation sells stock to the public in an effort to raise capital
initial public offering (ipo)
when a firm has liabilities that exceed its assets
insolvent
those in jail
institutionalized
tells us how many dollars the lender can get in the future by giving the borrower $1 today
interest rate
the nominal rate of return minus the inflation rate
real rate of return
why can bubbles be harmful to the economy
resources get misallocated and workers lose job
leverage ratio equation
the ratio of debt to equity or D / E
Factors that shift AD Positive shocks
A faster money growth rate Confidence Increased wealth Lower taxes Greater growth of gov spending Increased export growth Decreased import growth
shows how unexpected economic disturbances or shocks can temporarily increase or decrease the rate of growth
AD - AS aggregate demand and aggregate supply
solow growth rate is determined by?
Increases in the stocks of labor and capital; Increases in productivity
The life cycle theory of savings says that:
Individuals will borrow when they are young, save during their working years, and dissave when they retire.
Why does the bridge between savers and borrowers break?
Insecure property rights Interest rate Bank failures and panics Politicized lending Inflation Gov banks
can all contribute to the breakdown of financial intermediation
Insecure property rights, inflation, politicized lending, and bank failures and panics
4 problems with inflation
1. price confusion and money illusion 2. inflation redistributes wealth 3. inflation interacts with other taxes 4. inflation is painful to stop
*Bond face value of 1000, matures in one year and has an interest rate of 5.26%* bond price is...
1000 / (1+5.26)
picking individual stocks. Done by money mutual funds
active investing
policies such as work tests, job search assistance, and job retraining programs that focus on getting unemployed people back to work
active labor market polices
Expected inflation =
actual inflation
shows all the combinations of inflation and real growth that are consistent with a specified rate of spending growth
aggregate demand curve
3 curves
aggregate demand curve, long run aggregate supply curve, short run aggregate supply curve
how much a lender has to give a borrower today to receive $1
bond price
think of as loans
bonds
___ is essential for investment to occur
borrowing
a decrease in the average level of prices (negative inflation rate)
deflation
a reduction in the inflation rate
disinflation
a number that compares the price level in one period relative to the prices in some base year
index
an increase in the average level of prices
inflation
the percentage of adults in the labor force. also students and retirees
Labor force participation rate
