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