EC102 Exam 3 Ch. 18-21

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In examples of capital flight, what happens to NCO?

The entire NCO curve (on the NCO + r graph) SHIFTS!! + increases in FCEM

Under PPP, Nominal exchange rate =

foreign price level/domestic price level

Stagflation

high inflation + high unemployment and stagnant (low GDP/Y/output) in a country's economy.

9. Trade allows a country to consume outside its production possibilities frontier. a. True b. False

—> TRUE

How/does E effect S or I (the supply of dollars in the LF's --> NCO)?

• An increase in E has no effect on S or I, so it does not affect NCO or the supply of dollars.

• Both I and NCO depend (positively/negatively on r, so the D curve is (upward/downward) sloping.

• Both I and NCO depend negatively on r, so the D curve is downward-sloping. • r adjusts to balance supply and demand in the LF market.

LRAS Shifters

• Changes in L or natural rate of unemployment -Immigration -Baby-boomers retire -Government policies reduce natural u-rate • Changes in K or H -Investment in factories, equipment -More people get college degrees -Factories destroyed by a hurricane •Changes in natural resources -Discovery of new mineral deposits -Reduction in supply of imported oil Changing weather patterns that affect •Changes in technology -Productivity improvements from technological progress

Expansionary Monetary Policy: Contractionary Monetary Policy:

• Expansionary Monetary Policy: When GDP falls below its natural rate, use expansionary monetary or fiscal policy to prevent or reduce a recession. •Contractionary Monetary Policy: When GDP rises above its natural rate, use contractionary policy to prevent or reduce an inflationary boom

Market for LF's supply + demand? • In an open economy, S = ???

• In an open economy, S = I + NCO - This determines the equilibrium where S=D: -Supply = national saving (S) -Demand = domestic investment (I) + net capital outflow (NCO)

Monetary vs Fiscal Policy

• Monetary policy - The supply of money set by the central bank • Fiscal policy -The levels of government spending and taxation set by the president and Congress

In open economy, because NX = NCO, Saving =

• S = I + NCO • Saving = Domestic investment + Net capital outflow

A decrease in P increases the quantity of goods and services demanded because:

• the wealth effect (C increases) • the interest-rate effect (I increases) • the exchange-rate effect (NX increases)

0 Bound + Liquidity trap

- If interest rates have already fallen to around zero: - Monetary policy may no longer be effective, since nominal interest rates cannot be reduced further - Aggregate demand, production, and employment may be "trapped" at low levels

What is the effect of an increase in immigration on the LRAS curve?

- Immigration increases the economy's stock of labor, L, causing YN to rise. -Any event that changes any of the determinants of YN (labor, capital, technology, natural resources) will shift LRAS.

Suppose the government provides new tax incentives to encourage investment. • Determine how this policy would affect: A.the real interest rate, r B.net capital outflow, NCO C.the real exchange rate, E D.net exports, NX

- Investment—and the demand for LF—increase at each value of r. - r rises, causing NCO to fall. - The fall in NCO reduces the supply of dollars in the FCEM - The real exchange rate appreciates, reducing net exports.

- If the interest rate is "too high" - If the interest rate is "too low"

- MD<MS --> people will sell more bonds which drives IR up - MS<MD people will buy more bonds which drives IR down

Sticky Price Theory

- Many prices are sticky in the short run (due to menu costs, the costs of adjusting prices) + -Firms set sticky prices in advance based on PE - If Fed increases the money supply unexpectedly -In the long run, P will rise -In the short run: •Firms without menu costs can raise their prices immediately •Firms with menu costs wait to raise prices. With relatively low prices: increase demand for their products: increase output and employment Hence, higher P is associated with higher Y.

32. Java Hut, a U.S. coffee retailer, buys $10 million worth of coffee beans from Colombia. It also pays $5 million for paper cups and utilities, all produced in the U.S. It sells the coffee it produces using the above inputs to U.S. consumers for $50 million. Overall how do these expenditure affect net exports? How do these expenditures effect U.S. consumption?

- Net exports are $10 million less than otherwise.- $50 million of expenditures are included in U.S. consumption.

•Net outflow of capita when NCO > 0 •Net inflow of capital when NCO < 0

- Net purchase of capital overseas adds to the demand for domestically generated loanable funds - Capital resources coming from abroad reduce the demand for domestically generated loanable funds

Structural unemployment occurs when:

- Occurs when the number of jobs available in some labor markets is insufficient to provide a job for everyone who wants one -Usually longer-term - Occurs when wage is kept above equilibrium 3 Causes: Min wage, union, efficiency wages

Frictional Unemployment occures when

- Occurs when workers spend time searching for the jobs that best suit their skills and tastes - Short-term for most workers Frictional = temporary, workers spend time searching for the jobs that best suit their skills + tastes

The Exchange-Rate Effect (P and ___ )

- P and NX - Suppose the U.S. price level P declines -Decrease in the U.S. interest rateàincrease in NCO (the supply of the dollar in foreign exchange market) -U.S. dollar depreciates (decline in the real value of the dollar in foreign-exchange markets) -This makes imports more expensive and exports cheaper -We import less and export more, NX increases -Increase in quantity demanded of goods and services

The Crowding-Out Effect

- Results when expansionary fiscal policy raises the interest rate -The higher interest rate reduces investment spending - This reduces the net increase in aggregate demand (i.e. offsets the increase in aggregate demand caused by increase in G) - So, the size of the AD shift may be smaller than the initial fiscal expansion.

Variables that Influence NCO

-Real interest rates paid on foreign assets -Real interest rates paid on domestic assets -Perceived economic and political risks of holding foreign assets -Government policies affecting foreign ownership of domestic assets

Money demand, MD reflects...

-Reflects how much wealth people want to hold in liquid form -Assume household wealth includes only two assets: •Money - liquid but pays no interest •Bonds - pay interest but not as liquid -A household's "money demand" reflects its preference for liquidity relative to holding interest-bearing assets

Cyclical Unemployment Cyclical Unemployment is 0% when...(+) when...(-) when...

-The deviation of unemployment from its natural rate - 0% when unemployment rate = natural rate of unemployment - (+) when UR > Natural Rate - (-) when UR < Natural Rate

The most important of these effects for the U.S. economy:

-The interest-rate effect (1 reason the AD curve slopes downward)

NCO if US residents purchase $8 mil in German bonds and German residents purchase $10 mil in US bonds

-US NCO: $8 mil - $10 mil = -$2 mil -Negative Net Capital Outflow implies an Inflow -Note: German NCO: $10 mil - $8 mil = +$2 mil -German had a net capital outflow (i.e. capital flowed out of Germany on net)

• A tax incentive for investment has similar effects as a budget deficit b/c: • EXCEPT one important difference:

-r rises, NCO falls -E rises, NX falls -Investment tax incentive INCREASES investment, which increases productivity growth and living standards in the long run. - Budget deficit REDUCES investment, which reduces productivity growth and living standards

After Tax Real interest rate

1) Find the nominal IR = real - inflation rate OR ($'s now - $'s was)/$'s was *100 2) After tax nominal return = (1- .tax rate) x nominal interest rate 3) After Tax Real interest rate = After tax nominal interest rate - inflation rate

3 Facts about economic fluctuations:

1) irregular and unpredictable 2) Most macroeconomic quantities fluctuate together.

Use the AD-AS diagram to show the effect of a stock market crash.

1. Affects C, AD curve 2. C falls, so AD shifts left 3. SR equilibrium at B. P and Y lower, unemployment higher 4. Over time, PE falls, SRAS shifts right, until LR equilibrium at C. Y and unemployment back at initial levels.

Fisher Effect

An increase in the rate of money growth raises inflation but won't affect REAL VALUES's

diminshing returns

As k (capital) rises, extra output from additional K unit falls

4. You are planning a graduation trip to Mexico. Other things the same, if the dollar appreciates relative to the peso, then the dollar buys a. fewer pesos. Your hotel room in Mexico will require fewer dollars. b. fewer pesos. Your hotel room in Mexico will require more dollars. c. more pesos. Your hotel room in Mexico will require fewer dollars. d. more pesos. Your hotel room in Mexico will require more dollars.

5. Suppose a Starbucks tall latte costs $4.00 in the United States and 2.50 euros in the Euro area. Also, suppose a McDonald's Big Mac costs $4.50 in the United States and 3.60 euros in the Euro area. If the nominal exchange rate is 0.80 euros per dollar, which goods have prices that are consistent with purchasing-power parity? a. Both the tall latte and the Big Mac b. The tall latte but not the Big Mac c. The Big Mac but not the tall latte d. Neither the Big Mac nor the tall latte

Rule of 70

Doubling time (in years) = 70/(percentage growth rate). 70/x = number of years for income to double X = interest rate as %

Real Exchange rate =

E = ( e x P ) / P* (nominal exchange rate x domestic price)/foreign price - measured in goods •P = domestic price •P* = foreign price (in foreign currency) •e = nominal exchange rate (foreign currency per unit of domestic currency) - Rate at which g/s of one country trade for the goods and services of another

Draw the AD-AS diagram for the U.S. economy starting in a long-run equilibrium (point A). • A boom occurs in Canada. Use your diagram to determine the SR and LR effects on U.S. GDP, the price level, and unemployment.

Event: Boom in Canada 1.Affects NX, AD curve 2.Shifts AD right 3.SR equilibrium at point B. P and Y higher, unemployment lower 4.Over time, PE rises due to the higher price level, SRAS shifts left, until LR equilibrium at C. Y and unemployment back at initial levels.

expansionary vs. contractionary fiscal policy

Exp: Fiscal policies, like higher spending and tax cuts, that encourage economic growth Con: Fiscal policies, like lower spending and higher taxes, that reduce economic growth

In Trade deficit: Exports ___ imports S___ I NCO __ 0

Exports < imports S < I NCO < 0

In a trade surplus, Exports ___ imports S___ I NCO __ 0

Exports > imports S > I NCO > 0

If you currently make $25,000 a year and the CPI rises from 110 today to 150 in five years, then you need to be making $43,333.33 in five years to have kept pace with consumer price inflation. (T/F)

FALSE b/c...

T/F: A statement needs to be true to be positive.

False

Net capital outflow (net foreign investment)

Foreign Assets - Domestic Assets Purchase of foreign assets by domestic residents - Minus the purchase of domestic assets by foreigners

An increase in the budget deficit reduces net capital outflow and domestic investment. True/False

True

From 1980 to 1987, U.S. net capital outflows decreased. According to the open-economy macroeconomic model, a decrease in the supply of loanable funds could have caused this. True/False

True

When a country experiences capital flight, the interest rate rises because the demand for loanable funds shifts right. True False

True

Import quotas do not alter the trade balance because they cannot alter the national saving or domestic investment of the country that implements them. True/False

True If the U.S. implements import quotas imports will be reduced. Because net exports equal exports minus imports, net exports increases initially. Because net exports are the source of demand for dollars in the market for foreign -currency exchange, the demand for dollars increases (represented by a rightward shift in the demand curve in the market for loanable funds), causing an increase in the exchange rate. When the dollar appreciates in value in the market for foreign-currency exchange, domestic goods become more expensive relative to foreign goods. This appreciation encourages imports and discourages exports, and both of these changes work to offset the direct increase in net exports due to the import quota. In the end, an import quota reduces both imports and exports, but net exports (exports minus imports) are unchanged.

U-Rate

UR = (# unemployed/Labor Force) *100

Shorthand Summary: (be able to explain in words)

Wealth effect (P + C): - P decreases, (Wealth/P) increases, C increases, AD increases Interest Rate Effect (P + I): - P decreases, r decreases, I increases, AD increases Exchange Rate Effect (P + NX) - P decreases, r decreases, NCO increases (FA-DA), E decreases, NC increases, AD increases

Production Function

Y = A x F(L, K, H, N) a = tech knowledge L = workers K = physical capital H = human capital N = natural resources

Closed economy GDP (Y) = Private Savings = Public Savings = National Savings =

Y = C + I + G + NC Private Savings = (Y-T-C) Public Savings = (T-G) National Savings = private + public savings

• In all 3 theories, Y deviates from YN when P deviates from PE so we get the following equation:

Y = Yn + a * (P - PE) a > 0, measures how much Y responds to unexpected changes in P Pe = Expected price level

Increase MS Fed must - What happens to Value of money - Price level?

buy bonds, decreases $ value, increases price level

19. If U.S. speculators gained greater confidence in foreign economies so that they wanted to move more of their wealth into foreign countries, the dollar would a. appreciate which would cause aggregate demand to shift right. b. appreciate which would cause aggregate demand to shift left. c. depreciate which would cause aggregate demand to shift right. d. depreciate which would cause aggregate demand to shift left.

A change in r will

cause a movement ALONG the MD curve, not a shift (holding Y and P constant!)

The change in nominal GDP reflects...

changes in quantities + prices.

In an economy where net exports are zero, if saving rises in some period, then in that period consumption _______ and investment ______

consumption falls and investment rises

10. At the equilibrium real interest rate in the open-economy macroeconomic model, a. saving = domestic investment.b. saving = net capital outflow. c. net capital outflow = domestic investment. d. net capital outflow + domestic investment = saving.

Required reserves =

required reserve ratio x total deposits

basket cost =

sum of given prices + quantities (PQ1) + (PQ2) + (PQ3) ... in year X

comparative advantage Ex) Country can produce only soybeans (5,000 tons) Only airplanes (100 airplanes), or a combination of both - Opportunity cost of 1 airplane = ______ - Opportunity cost of 1 ton of soybeans = _______

the ability to produce a good at a lower opportunity cost than another producer - If a country produces plans and soybeans, what's the OC of 1 plain? 1 soybean/plane = OPPOSITE / What Q's asking - Opportunity cost of 1 airplane = Loss/gain = soybeans/plane= 5,000/100= 50 soybeansOpportunity cost of 1 soybean = plane/soybeans= 100/5000= .02 airplanes

Absolute Advantage

the ability to produce more of a given product using a given amount of resources

GDP is + includes + excludes:

total market value of all final goods & services produced within a country in a given period of time(annually) in an economy Includes: - legally sold goods - ONLY final goods- tangible goods + intangible services (hair cuts, concerts..) - currently produced goods, not goods produced in the past. - usually a year Excludes: - illegal - intermediate goods/inputs - goods produced in the past

% Change =

(IS-WAS)/WAS

•Variables that influence money demand:

-Y, r, and P.

LFPR

= (labor force/Adult Population) *100

MS curve is _______ b/c

MS curve is vertical: Changes in r do not affect MS, which is fixed by the Fed.

GDP Deflator

(Nominal GDP/Real GDP) x 100 -Measures the current level of prices relative to the level of prices in the base year

Wealth Effect (P and ___)

(P and C ) • If price level, P, declines -Increase in the real value of money (each dollar of wealth is worth more) -When consumers are wealthier, they spend more -Increase in C -Increase in quantity demanded of goods and services

Interest-Rate Effect (P and ___)

(P and I) • If price level, P, declines -Increase in the real value of money (each dollar of wealth is worth more) -When consumers are wealthier, they spend more -Increase in consumer spending, C -Increase in quantity demanded of goods and services -Buying g/s requires fewer dollars: people buy bonds and other assets with the "savings" -This decreases the interest rate (details: next chapter) - A lower interest rate increases spending on investment goods, I • Remember the interest rate is the cost of borrowing for investment goods, so lower interest rates --> more investments -Increase in quantity demanded of g/s

CPI

(consumer price index) a measure of the overall cost of g/s bought by a typical consumer... USE BASE YR QUANTITIES!! CPI = (Basket cost current year/basket cost BASE year) * 100

Real GDP

- (BASE YR PRICE x QA) + (BASE YR PRICE x QB) + ... - adjusted for inflation - Also: (Nominal GDP/GDP Deflator) x 100 - Base yr real gdp = nominal gdp

Inflation Rate (3 Equations)

- (GDP Deflator Yr 2 - GDP Deflator Yr 1)/GDP Deflator Yr 2 *100 - (CP1 yr 2 - CPI yr 1) / CPI yr 1 *100 Inflation Rate = Nominal Interest Rate - Real Interest Rate

How the interest-rate effect works

- A fall in P reduces money demand, which lowers r. - A fall in r increases I and the quantity of g&s demanded, Y.

Ex) What is the effect of a stock market boom on the AD curve?

- A stock market boom makes households feel wealthier, C rises, the AD curve shifts right. - Any event that changes C, I, G, or NX (except a change in P) will shift the AD curve.

The connection between r and E

- Anything that increases r will reduce NCO + the supply of dollars in the foreign exchange market. - Result: The real exchange rate appreciates. - Keep in mind: The LF market (not shown) determines r. - This r determines NCO (shown in upper graph). - This NCO determines supply of dollars in foreign exchange market (in lower graph).

In reality, in the SHORT RUN... - Changes in nominal variables can/cannot affect real variables (like Y or the u-rate).

- Changes in nominal variables (like the money supply or P ) CAN affect real variables (like Y or the u-rate). - reflected in ADAS graph

Monetary Neutrality

- Changes in the money supply affect nominal but not real variables - An increase in the quantity of $ will impact the price (nom) but not the output level (real) - changes in the MS have don't affect REAL variables, but do affect NOM variables

Suppose that real interest rates decrease across Europe. This development will (INC/DEC) U.S. net capital outflow at all U.S. real interest rates, which in turn will cause the (supply/demand) for loanable funds to (INC/DEC) because net capital outflow is a component of the relevant curve in the loanable funds market

- Decrease, demand for, decrease Lower real interest rates in Europe lead to decreased U.S. net capital outflow, since lower European real interest rates discourage Americans from buying European assets and encourage Europeans to buy U.S. assets. The purchase of a capital asset adds to the demand for loanable funds, regardless of whether that asset is located at home (as domestic investment) or abroad (as net capital outflow). Therefore, the demand for loanable funds decreases as a result of the decreased real interest rates across Europe.

Ex) Political instability in Mexico made world financial markets nervous. use graphs

- Demand for LF = I + NCO. The increase in NCO increases demand for LF. The equilibrium values of r and NCO both increase. - The increase in NCO causes an increase in the supply of pesos in the foreign exchange market. - The real exchange rate value of the peso falls

In response to "0 Bound / Liquidity trap" A central bank continues to have tools to expand the economy:

- Forward guidance: raise inflation expectations by committing to keep interest rates low - Quantitative easing: buy a larger variety of financial instruments (mortgages, corporate debt, and longer-term government bonds)

The change in real GDP is the amount that ...

- GDP would change if prices were constant (i.e., if zero inflation) .• Hence, real GDP is corrected for inflation.

Trade policy:

- Government policy that directly influences the quantity of goods and services a country imports or exports -Tariff: a tax on imported goods -Import quota: limit on the quantity of imports •Some arguments for restricting trade: -Save jobs in domestic industry -Reduce the trade deficit

Suppose real income (Y) rises: What happens to money demand in the following two scenarios?

- Households want to buy more goods and services, so they need more money -To get this money, they attempt to sell some of their bonds. - An increase in Y causes an increase in money demand, other things equal. MD shifts right

Note: Everything that shifts LRAS shifts SRAS, too + also, PE shifts SRAS because:

- If PE rises, workers & firms set higher wages. - At each P, production is less profitable, Y falls, SRAS shifts left.

Budget Deficit Effects on: - National savings (S) - Real interest rate (r) - domestic investment (I) - NCO - Real exchange rate (E) - Net exports (NX) - Trade deficit

- S decreases (shifts left) - r rises - I decreases (shifts AD left) - NCO decreases - E rises/appreciates - Net exports (NX) fall - Trade deficit increases

Budget Surplus Effects on: - National savings (S) - Real interest rate (r) - domestic investment (I) - NCO - Real exchange rate (E) - Net exports (NX) - Trade deficit

- S increases (shifts right) - r falls - I increases (shifts AD right) - NCO increases - E falls/depreciates - Net exports (NX) rise - Trade deficit decreases

An increase in costs of production economy-wide causes...

- SRAS to shift left - SR equilibrium at point B. P higher, Y lower, unemployment higher - From A to B, stagflation, a period of falling output and rising prices. - If policymakers do nothing, Low employment causes wages to fall, SRAS shifts right, until LR equilibrium at A. - Or, policymakers could use fiscal or monetary policy to increase AD and accommodate the AS shift: Y back to YN, but permanently higher.

How Fiscal Policy Influences AD

- Setting the level of government purchase (G) and taxation (T) by government policymakers -An increase in G shifts AD right + decrease in G shifts AD left -A decrease in T shifts AD right (more money in people's pockets for spending) + increase in T shifts AD left

CIRCLUAR FLOW DIAGRAM - Decision makers: - Interacting in __ markets

- Shows how dollars flow through markets among households and firms - Decision makers: firms + households - Market for: g/s + for factors of production (inputs/resources) - Households sell resources + buy g/d - Firms sell g/s + buy resources

SRAS is upward sloping b/c

- Sticky Wage Theory - Sticky Price Theory - Misperceptions Theory

Market for LF's - what is supply + why is it upward sloping - what is demand + why is it upward sloping?

- Supply = national savings - As r rises, higher return means more supply of loans (more lenders want higher returns) - Demand = I + NCO (domestic + foreign investment) - As r rises, cost of borrowing increases so borrowers' demand decreases

AD curve

- The AD curve shows the quantity of all g&s demanded in the economy at any given price level - AD = Y = Y = C + I + G + NX -

AS Curve

- The AS curve shows the total quantity of goods and services firms produce and sell at any given price level. - AS is: upward-sloping in short run (SRAS) + vertical in long run (LRAS)

How r is determined

- The interest rate adjusts to ensure that the quantity of (liquid) money demanded is equal to the quantity supplied by the Fed- - If the interest rate is "too high", MD<MS --> people will sell more bonds which drives IR up - If the interest rate is "too low", MS<MD --> people will buy more bonds which drives IR down

required reserve ratio

- The minimum fraction of deposits banks are required by law to keep as reserves - Given as % - Multiply by DEPOSITS to get required reserves

Natural rate of unemployment? What does it include

- The normal rate of unemployment around which the unemployment rate fluctuates - Includes structural + frictional unemployment

Describe the money supply chart w/ Value of $ + Price level

- Value of $ on Y axis (= 1/P) - Price on second Y axis (bottom = high price level, top = low price level --> negatively related to value)

Equality of NX = NCO means that: - When a U.S. citizen buys foreign goods... - When a foreigner purchases a good from the U.S...

- When a U.S. citizen buys foreign goods, imports increase, NX decreases + US buyer pays w/ USD's or assets so other country acquires US assets (DA) --> so NCO decreases - When a foreigner purchases a good from the U.S, exports + NX increase + foreigners pay with foreign currency/assets so US acquires FA --> so US NCO increases

Purchasing Power Parity

- a unit of any given currency should be able to buy the same quantity of goods in all countries - Based on the law of one price (a good should sell for the same price in all locations, otherwise there would be: arbitrage) - If purchasing power of the dollar is always the same at home and abroad, the REAL exchange rate can't change so: 1 = (e x P)/P* Rearrange e = P*/P

Crowding out effect

- budget defecit shifts savings (LF's supple left, causing interest rates to rise so investment falls) - When govt borrowing increases interest rates + crowds out investment/consumption so less buying of loans - The tendency for an increase in government purchases to increase interest rates and reduce investment is known as the crowding-out effect

The Misperceptions Theory

- changes in the overall price level can temporarily mislead suppliers about what is happening in the individual markets in which they sell their output - Firms may confuse changes in P with changes in the relative price of the products they sell. •If P rises above PE -A firm sees its price rise before realizing all prices are rising. •The firm may believe its relative price is rising, and may increase output and employment. - So, an increase in P can cause an increase in Y, making the SRAS curve upward-sloping.

18. When the government increases its borrowing, the budget _____ increases and government debt _____. The resulting change in investment due to this increased government borrowing is called _____.

- deficit - increases - crowding out

Over time Sticky wages + prices become _____ Misperceptions are _______

- flexible + Misperceptions are corrected

You can tell from year to year if price levels did/did not change from:

- if GDP deflator is the same, price levels didn't change (if it changes, price levels changed)

- Recessions - Depressions

-Periods of falling real incomes and rising unemployment - depressions = Severe recessions (very rare)

The Fed uses monetary policy to shift the AD curve

-Policy instrument: the money supply (MS) -Targets the interest rate: the federal funds rate •This is the rate banks charge each other on short-term loans (remember from chapter 16) -Conducts "open market operations" to change MS - Monetary policy can be described either in terms of the money supply or in terms of the interest rate.

Suppose the government uses import quotas on cars imported from Japan, in order to protect jobs in the domestic auto industry. • Use the appropriate diagrams to determine how this policy would affect: A.the real interest rate, r B.net capital outflow, NCO C.the real exchange rate, E D.net exports, NX E.Does the policy saves U.S. jobs?

- import quota does not affect saving or investment, so it does not affect NCO. - Since NCO is unchanged, S curve does not shift. - D curve shifts: At each E, imports of cars fall, so net exports rise, D shifts to the right. (initial excess demand in the foreign exchange market + E rises to restore equilibrium) - NX DOES NOT CHANGE!! - If E could remain at E1, NX would rise, and the quantity of dollars demanded would rise. - But the import quota does not affect NCO, so the quantity of dollars supplied is fixed. - Since NX must equal NCO, E must rise enough to keep NX at its original level. - Hence, the policy of restricting imports does not reduce the trade deficit. - The quota reduces imports of Japanese autos --> -So the policy saves jobs in the U.S. auto industry. - But E rises, reducing foreign demand for U.S. exports. -Export industries contract, exporting firms lay off workers. *nothing happens on any graph except for rightward shift of NC in FCEM

• An increase in E makes U.S. goods ________ to foreigners, and _______ the quantity of dollars demanded to buy those goods.

- more expensive - increases QD

While the nominal ER is expressed in ____ E is expressed in _____

- nom: express all exchange rates as foreign currency per unit of domestic currency. - real: measured in goods

Over the long run, tech. progress shifts LRAS to the right and ultimately results in.

- ongoing inflation and growth in output (b/c growth in the money supply shifts AD to the right)

How NCO depends on the real interest rate

- r = real return on DA (govt bonds, stock, etc.) - A fall in r makes domestic assets less attractive relative to FA - People in the U.S. purchase more FA -People abroad purchase fewer U.S. assets. -NCO rises.

•The theory of liquidity preference

- r adjusts to bring money supply and money demand into balance (both the nominal and real interest rates) - Money supply, MS -Assumed fixed by central bank, does not depend on interest rate

Review: Suppose the government runs a budget deficit. What happens to r + NCO? How does the budget deficit affect the U.S. real exchange rate? The balance of trade?

- r rises + NCO falls (In FCEM) - The budget deficit reduces NCO and the supply of dollars. • The real exchange rate appreciates, reducing net exports. Since NX = 0 initially, the budget deficit causes a trade deficit (NX < 0).

Money (is neutral/ has real effects) in the short run but (is neutral/ has real effects) in the long run. While output initially rises because of the (inc/dec) in aggregate demand, it will fall once short-run aggregate supply declines.

- real effect in SR - neutral in LR - increase in AD While output initially rises because of the increase in aggregate demand, it will fall once short-run aggregate supply declines. Thus, there is no long-run effect of the increase in the money supply on real output.

The natural rate of output (YN) is .... and is determined by...

- the amount of output the economy produces when unemployment is at its "natural rate" - YN determined by the economy's stocks of labor, capital, and natural resources, and on the level of technology. - An increase in P does not affect any of these, so it does not affect YN (Classical dichotomy), hence why LRAS is vertical

Nominal GDP

- the production of goods and services valued at current prices - NOT adjusted for inflation - Also: (GDP deflator x Real GDP) /100 - (price A x QA) + (price B x QB) + ...

Real GDP in SR fluctuates around... - GDP in the short run

- the upward LR GDP trend -Fluctuates around its trend

Pro Active Stabilization Policy

- waves of pessimism + optimism among households and firms, leading to shifts in aggregate demand and fluctuations in output and employment. • other factors cause fluctuations: -Booms and recessions abroad -Stock market booms and crashes •If policymakers do nothing- -These fluctuations are destabilizing to businesses, workers, consumers. - Government should use policy to reduce these fluctuations-

Why does the AD curve slope downward?

- wealth effect, interest rate effect, exchange rate effect - changes in P affects C, I, + NX (which = AD)

Trade Deficit and NCO

-Buying more goods and services from foreigners than it is selling to them. -The economy is financing the net purchase of these goods and services in world markets by selling assets abroad. -Capital is flowing into the country to acquire our assets, so NCO < 0

Factors that might influence a country's exports, imports, + NX:

-Consumers' tastes for foreign and domestic goods -Prices of goods at home and abroad -Exchange rates at which foreign currency trades for domestic currency -Incomes of consumers at home and abroad -Transportation costs -Government policies

The Classical theory describes the world in the ______ run, but not the ______ run

-Describes the world in the long run, but not the short run

Foreign-Currency Exchange Market demand + supply

-NX is the demand for dollars: foreigners need dollars to buy U.S. net exports. -NCO is the supply of dollars: U.S. residents sell dollars to obtain the foreign currency they need to buy foreign assets.

PPP implications

-Nominal exchange rates change when price levels change -When a central bank in any country increases the money supply •And causes the price level to rise •It also causes that country's currency to depreciate relative to other currencies in the world

Sticky wage theory: What is it + If P>Pe...

-Nominal wages are sticky in the short run,they adjust sluggishly (due to labor contracts, social norms, etc. - Firms and workers set the nominal wage in advance based on PE, the price level they expect to prevail. - If P>Pe - Revenue is higher, but labor costs are not. - Production is more profitable, so firms increase output and employment. Hence, higher P causes higher Y, so the SRAS curve slopes upward.

- In the LR, -PE = -AS curve is ______

-PE = P (price level expectations will match the actual price level) - AS is vertical

nominal exchange rate is the

-Rate at which one country's currency trades for another

4 steps to analyzing economic fluctuations:

1.Determine whether the event shifts AD or AS. 2.Determine whether curve shifts left or right. 3.Use AD-AS diagram to see how the shift changes Y and P in the short run. 4.Use AD-AS diagram to see how economy moves from new SR equilibrium to new LR equilibrium.

Ex) Alexandra, a French business owner, buys wine made in U.S. for her French restaurants.

1.The supply of dollars falls. The transaction reduces NCO, which we think of as the supply of dollars.

In 2011 a country had a real GDP of $13.89 trillion and GDP deflator of 110. In 2012 it had a nominal GDP of $17.8 trillion and real GDP of 14.24 trillion. What is the rate of inflation in 2012?

2012 Inflation Rate = (125 - 110)/110 *100 = 13.63%

55. Suppose the rate of inflation rate is two percent and the nominal interest rate is five percent. According to the Fisher Effect, an increase in the inflation rate to six percent should cause the nominal interest rate to increase from five percent to _____ in the long run.

Multiplier effect: the additional shifts in AD that result when fiscal policy increases income and thereby increases consumer spending.

: the additional shifts in AD that result when fiscal policy increases income and thereby increases consumer spending.

PV (in N years)

= FV / (1+r)^n

MS =

= Money Multiplier (1/R) x Bank Reserves MS = Currency + Deposits

Future Value (in N years)

= PV x (1+r)^n r in decimal form

Reserves =

= Required reserves + excess reserves = (reserve ratio x Deposits) + excess reserves

Reserve Ratio

= Reserves / Deposits the fraction of deposits that banks hold as reserves

Excess Reserves

= reserves - required reserves

Labor Force:

= total # of (employed + unemployed) workers - Employed = paid - Unemployed = ppl not working willingly looking for work in past 4 weeks

1. If a country has positive net capital outflows, then its net exports are a. positive, and its saving is larger than its domestic investment. b. positive, and its saving is smaller than its domestic investment. c. negative, and its saving is larger than its domestic investment. d. negative, and its saving is smaller than its domestic investment.

2. Suppose that the real return from operating factories in Spain falls relative to the real rate of return in the United States. Other things the same, this will a. decrease U.S. net capital outflow and increase Spanish net capital outflow. b. decrease U.S. net capital outflow and decrease Spanish net capital outflow. c. only decrease U.S. net capital outflow. d. only decrease Spanish net capital outflow.

What happens to money demand in the following two scenarios? A.Suppose r rises, but Y and P are unchanged. B.Suppose P rises, but Y and r are unchanged.

A. - r is OC of holding $ so increase in r reduces quantity of $ demanded (households try to buy bonds bc of higher return so less liquid $ needed) - an increase in r causes a decrease in the quantity of money demanded, other things equal. - This is represented by a movement along the MD curve, NOT a shift!!! B. People will want to buy same amount of g/s (since Y is the same) - since P increases, they need more $ to do so - so increase in P causes an increase in MS (shifts right) --> this is the interest rate effect b/c increase in P increases MD which increases r

• Determine the short-run effects on output • Determine how the Fed should adjust the money supply and interest rates to stabilize output A.Congress tries to balance the budget by cutting government spending. B.A stock market boom increases household wealth. C.War breaks out in the Middle East, causing oil prices to soar.

A. -reduces aggregate demand and output. -To stabilize output, the Fed should increase MS to reduce r, which would increase aggregate demand. B. -This event would increase aggregate demand, raising output above its natural rate. -To stabilize output, the Fed should reduce MS to increase r, which would reduce aggregate demand (and inflationary pressures on the price level). C. -This event would reduce aggregate supply, causing output to fall. -To stabilize output, the Fed should increase MS to reduce r, which would increase aggregate demand to get the economy back to full employment (albeit at a higher price level)

A. Which of the following statements about a country with a trade deficit is not true? a)Exports < imports b)Net capital outflow < 0 c)Investment < saving d)Y < C + I + G B. A Ford Escape SUV sells for $24,000 in the U.S. and 720,000 rubles in Russia. If purchasing-power parity holds, what is the nominal exchange rate (rubles per dollar)?

A. C •A trade deficit means: NX < 0; exports < imports; •Y < domestic spending (C + I + G); •and NCO < 0. •Since NX = S - I, a trade deficit implies I > S. B. •P* = 720,000 rubles •P = $24,000 •e = P*/P = 720000/24000 = 30 rubles per dollar

Pos/Norm: A. "Minimum-wage laws cause unemployment." B. "The government should raise the minimum wage." C. Prices rise when the government increases the quantity of money. D. The government should print less money E. A tax cut is needed to stimulate the economy. F. An increase in the price of burritos will cause an increase in consumer demand for movie streaming.

A. Pos B. Norm C. Pos D. Norm E. Normative (needed is a value - subjective) F. Pos

Ex A) Shemar, a U.S. resident and business owner, buys cars made in Germany. How is this transaction affecting supply or demand in the foreign exchange market? Ex B) Alexandra, a French business owner, buys wine made in U.S. for her French restaurants.

A. The demand for dollars decreases. The increase in imports reduces NX, which we think of as the demand for dollars. (So, NX is really the net demand for dollars.) B) The supply of dollars falls. The transaction reduces NCO, which we think of as the supply of dollars.

Which of the following statements is true about the effect of a reduction in restrictions of imports? Check all that apply. A. The equilibrium level of net exports will remain unchanged. b. The real exchange rate will remain unchanged. c. Imports will increase. d. Exports will increase. e. Net exports at any given real exchange rate will increase. f. The demand curve for dollars will shift to the left.

A. The equilibrium level of net exports will remain unchanged. b. The real exchange rate will remain unchanged. c. Imports will increase. d. Exports will increase. e. Net exports at any given real exchange rate will increase. A reduction in the restrictions of imports reduces net exports at any given real exchange rate because of an increase in imports, shifting the demand curve for dollars to the left: The shift of the demand curve for dollars leads to a decline in the real exchange rate, which increases net exports because of an increase in exports. Because net capital outflow is unchanged, and net exports equals net capital outflow, there is no change in equilibrium in net exports or the trade balance. Thus, both imports and exports rise by the same amount, and export industries benefit from the reduction in restrictions on imports.

What happens to U.S. net exports if: A.Canada experiences a recession (falling incomes, rising unemployment) B.U.S. consumers decide to be patriotic and buy more products "Made in the U.S.A." C.Prices of goods produced in Mexico rise faster than prices of goods produced in the U.S.

A. U.S. net exports would fall due to a fall in Canadian consumers' purchases of U.S. exports B. U.S. net exports would rise due to a fall in imports C. This makes U.S. goods more attractive relative to Mexico's goods. Exports to Mexico increase, imports from Mexico decrease, so U.S. net exports increase.

Likely to increase/reduce structural/frictional unemployment? A. The government eliminates the minimum wage. B. The government increases unemployment insurance benefits. C. A new law bans labor unions. D. More workers post their resumes at LinkedIn.com, and more employers use LinkedIn.com to find suitable workers to hire. E. Sectoral shifts become more frequent.

A. reduce Structural b. increase frictional c. reduce structural d. reduce frictional e. increase frictional

In each of the following, what happens to the u-rate? Does the u-rate give an accurate impression of what's happening in the labor market? A.Hailey lost her job and begins looking for a new one. B.Josiah, a steelworker who has been out of work since his mill closed last year, becomes discouraged and gives up looking for work. C.Karim, sole earner in his family of 5, just lost his $80,000 job as a research scientist. Immediately, he takes a part-time job at McDonald's until he can find another job in his field.

A. u-rate risesNumber of unemployed increases, labor force stays the same. A rising u-rate gives the impression that the labor market is worsening, and it is. b. Discouraged workers would like to work but have given up looking for jobs. Classified as "not in the labor force" rather than "unemployed"U-rate falls because Josiah is no longer counted as unemployed.A falling u-rate gives the impression that the labor market is improving, but it is not. c. U-rate unchanged because a person is "employed" whether they work full or part time.Number of unemployed and labor force stay the same.Things are worse, but the u-rate fails to show it.

A.A ten-year-old investment tax credit expires. B.The U.S. exchange rate falls for reasons other than changes in the price level. C.A fall in prices increases the real value of consumers' wealth. D.State governments replace their sales taxes with new taxes on interest, dividends, and capital gains.

A.A ten-year-old investment tax credit expires. - I falls, AD curve shifts left. B.The U.S. exchange rate falls for reasons other than changes in the price level. -NX rises, AD curve shifts right. C.A fall in prices increases the real value of consumers' wealth. -Move down along AD curve (wealth-effect). D.State governments replace their sales taxes with new taxes on interest, dividends, and capital gains. -C rises, AD may shift right (but new taxes may reduce I so effect could be ambiguous).

CPI --> dollar value in different times Formula

Amount in Todays $'s = Amount in year T Dollars * (Price level Today / Price Level in yr T)

2 Measures of inflation

CPI and GDP deflator

CHANGE IN MS =

Change in MS x Money Multiplier = Total change in MS

3. Other things the same, if the exchange rate changes from 40 Thai bhat per dollar to 51 Thai bhat per dollar, then the dollar has a. depreciated and so buys fewer Thai goods. b. depreciated and so buys more Thai goods. c. appreciated and so buys fewer Thai goods. d. appreciated and so buys more Thai goods.

budget deficit

Government spends more than it takes in taxes (T-G<0 or T<0)

M1 vs M2

M1 = currency, travelers checks, demand deposits, + other checkable deposits M2 = M1 + money market mutual funds, savings deposits, small time deposits, etc.

MD is _____ sloping b/c a fall in r _____

MD curve is downward sloping: A fall in r reduces the return to holding interest-bearing assets (here, bonds), and therefore increases the quantity of money demanded.

money multiplier

MM = 1/Reserve Required (ratio) the amount of money the banking system generates with each dollar of reserves

Quantity Theory of $ = - When govt increases M...

MV = PY - M =MS - V = velocity of $ - P = price level - Y = gdp/output - or increase in M means P must increase, Y must increase, or V must decrease M = PY/V - When govt increases M, one of the other 3 variables (PVY) must increase equivalently

Monetary policy can be described either in terms of the ________ or in terms of the _______

Monetary policy can be described either in terms of the money supply or in terms of the interest rate.

What model helps explain the interest-rate effect and how monetary policy affects aggregate demand.

Money demand, MD + MS Graph

NX (>,<,=) NCO

NCO = NX -Every transaction that affects NX also affects NCO by the same amount (and vice versa)

MS Relationship to - Reserve IR - Reserve Requirement - FFR Target - Discount Rate

NEGATIVE/OPPOSITE FOR ALL - If Fed LOWERS FFR target, fed must INCREASE MS

Do people pay taxes on real or nominal gain?

NOMINAL not real

If the interest rate is below the FFR target, the fed should ____ bonds to ____ the MS

SELL, DECREASE

In a closed economy, S ____ I

Savings = Investment

Decrease MS fed must

Sell bonds, increases value of $, decreases price level

Classical Dichotomy

Separation b/w real + nominal variables Real = physical units/output Real = monetary unites

If the interest rate is below where MS + MD meet in Money Demand graph, there is a (surplus/shortage) so ppl will (buy/sell) bonds to (inc/dec) interest rates.

Shortage, sell, to increase r's

Positive vs. Normative Statements

Statements of fact (positive) as opposed to value judgements or subjective opinions (normative) Pos: - Descriptive- Attempt to describe the world as it is- Confirm or refute by examining evidence- I am POSITIVE that's right! Norm: -Attempt to prescribe how the world should be:- Describes the NORM (opinion)

Money is a:

Store of value, median of exchange, unit of account

Straight PPF vs Curved PPF

Straight PPF - constant OC Curved PPF -

31. If the Federal Reserve increases the money supply, and the price level does not change, a. there will be an increase in the equilibrium quantity of goods and services demanded. b. there will be a decrease in the equilibrium quantity of goods and services demanded. c. there will be an increase in the equilibrium interest rate. d. fewer firms will choose to borrow to build new factories and buy new equipment

34. If the interest rate is above the Fed's target, the Fed should a. buy bonds to increase the money supply. b. buy bonds to decrease the money supply. c. sell bonds to increase the money supply. d. sell bonds to decrease the money supply

35. In the short run, open-market purchases a. increase investment and real GDP, and decrease interest rates. b. increase real GDP and interest rates, and decrease investment. c. increase investment and interest rates, and decrease real GDP. d. decrease investment, interest rates, and real GDP

37. Other things the same, which of the following responses would we expect from an increase in U.S. interest rates? a. Your aunt puts more money in her savings account. b. Foreign citizens decide to buy fewer U.S. bonds. c. You decide to purchase a new oven for your cookie factory. d. More people decide to purchase a home using a mortgage loan.

42. Using the liquidity-preference model, when the Federal Reserve decreases the money supply, a. the equilibrium interest rate increases. b. the aggregate-demand curve shifts to the right. c. the quantity of goods and services demanded is unchanged for a given price level. d. the short-run aggregate-supply curve shifts to the left.

46. If a country places tariffs on imported goods, then its a. currency appreciates which reduces exports leaving the trade balance unchanged. b. currency appreciates which increases exports improving the trade balance. c. currency depreciates which reduces exports leaving the trade balance unchanged. d. currency depreciates which increases exports improving the trade balance.

Suppose that political instability in other countries makes people fear for the value of their assets in these countries so that they desire to purchase more U.S assets. 22. What would happen to the dollar? a. It would appreciate in foreign exchange markets making U.S. goods more expensive compared to foreign goods. b. It would appreciate in foreign exchange markets making U.S. goods less expensive compared to foreign goods. c. It would depreciate in foreign exchange markets making U.S. goods more expensive compared to foreign goods. d. It would depreciate in foreign exchange markets making U.S. goods less expensive compared to foreign goods.

Why are budget deficits and trade deficits called twin deficits?

a government budget deficit often lead to trade deficits.

capital flight

a large and sudden reduction in the demand for assets located in a country due to political instability - ppl sell assets, pulling capital OUT of foreign country

46. If the Fed's reserve requirement is 5 percent, then what quantity of excess reserves does the Bank of Smileville now hold? Assets: Reserves ($4,000) + Loans ($46,000) Liabilities: Deposits ($50,000) a. $1,500 b. $750 c. $1,800 d. $2,500

a. $1,500

(Midterm 2) If Country A produces 7,000 units of goods and services using 700 hours of labor, and if Country B produces 5,500 units of goods and services using 500 units of labor, then a. Country B's productivity is higher than Country A's. b. Country A's productivity is the same as Country B's. c. Country A's productivity is higher than Country B's.d. There is not enough information to answer this question.

a. Country B's productivity is higher than Country A's.

38. The banking system currently has $10 billion of reserves, none of which are excess. People hold only deposits and no currency, and the reserve requirement is 10 percent. If the Fed raises the reserve requirement to 12.5 percent and at the same time buys $1 billion worth of bonds, then by how much does the money supply change? a. It falls by $12 billion. b. It falls by $19 billion. c. It falls by $21 billion. d. It rises by $19 billion.

a. It falls by $12 billion.

Identify the immediate effect of each of the following events on U.S. GDP and its components. a.James receives a Social Security check. b.John buys an Italian sports car. c.Henry buys domestically produced tools for his construction company.

a. No change (transfer payment) b. C + imports rise and cancel each other out so no change in GDP c. C + GDP increase

13. Other things the same, if reserve requirements are decreased, the reserve ratio a. decreases, the money multiplier increases, and the money supply increases. b. increases, the money multiplier increases, and the money supply increases. c. decreases, the money multiplier decreases, and the money supply increases. d. increases, the money multiplier decreases, and the money supply decreases.

a. decreases, the money multiplier increases, and the money supply increases.

Assets: Reserves = $30,000 +Loans = $170,000 Liabilities: Deposits = $200,000 If the bank faces a reserve requirement of 6 percent, then the bank a. is in a position to make new loans equal to a maximum of $18,000. b. has excess reserves of $12,000. c. has excess reserves of $30,000. d. is in a position to make new loans equal to a maximum of $12,000.

a. is in a position to make new loans equal to a maximum of $18,000.

Deposits = 200K Reserves = 30K Loans = 170K If the bank faces a reserve requirement of 6 percent, then the bank a. is in a position to make new loans equal to a maximum of $18,000. b. has excess reserves of $12,000. c. has excess reserves of $30,000. d. is in a position to make new loans equal to a maximum of $12,000.

a. is in a position to make new loans equal to a maximum of $18,000.

Changes in real GDP reflect a. only changes in the amounts being produced. b. both changes in prices and changes in the amounts being produced. c. only changes in prices. d. neither changes in prices nor changes in the amounts being produced

a. only changes in the amounts being produced.

1. The key determinant of the standard of living in a country is a. the amount of goods and services produced from each hour of a worker's time. b. the total amount of goods and services produced within the country. c. the total amount of its physical capital. d. its growth rate of real GDP.

a. the amount of goods and services produced from each hour of a worker's time. Productivity = output / (# of hours x # of workers)

31. A company sells steel to a scooter company for $150. The scooter company uses the steel to produce a scooter, which it sells for $290. Taken together, these two transactions contribute a.$290 to GDP. b. between $290 and $440 to GDP, depending on the profit earned by the bicycle company when it sold the bicycle. c.$140 to GDP. d. $150 to GDP.

a.$290 to GDP.

In the United States, real incomes have increased about 2 percent per year. At this growth rate, average income doubles every a.35 years. b.45 years. c.25 years. d.15 years

a.35 years. 70/2 = 35

If the fictional country of Joplait experienced capital flight 10 years ago, what should have happened to Joplait's net capital outflow? a.It should have increased. b.It should have decreased. c.It should have decreased, and then increased. d.It should have stayed the same

a.It should have increased.

Real GDP is most commonly used to monitor short-run changes in a.economic activity. b.the price index from the preceding period. c.the income distribution over time. d.the rate at which a person can trade the currency of one country for the currency of another.

a.economic activity. Real GDP is the variable most commonly used to monitor short-run changes in the economy because it is the most comprehensive measure of economic activity.

budget surplus

an excess of tax revenue over government spending (T-G>0 or T>G)

When real interest rates decrease across Europe, this causes U.S. net capital outflow to decrease, the U.S. real exchange rate (appreciates/depreciates)

appreciates (market for loanable funds + net capital outflow graphs) The supply of dollars in the market for foreign-currency exchange comes from net capital outflow, which equals net exports in an open economy. As you can see from the previous graph, the equilibrium level of net capital outflow decreases as a result of a lower real interest rate, so the supply of dollars must decrease as well.

leverage ratio

assets/capital capital = Assets (reserves, loans, securities) - liabilites (deposits, debt)

12. If the real exchange rate for the dollar is above the equilibrium level, the quantity of dollars supplied in the market for foreign-currency exchange is a. greater than the quantity demanded and the dollar will appreciate. b. greater than the quantity demanded and the dollar will depreciate. c. less than the quantity demanded and the dollar will appreciate. d. less than the quantity demanded and the dollar will depreciate.

13. Refer to Figure 32-3. Suppose that U.S. firms desire to purchase more equipment and build more factories and stores in the United States. The effects of this are illustrated by a. shifting the demand curve in panel a to the right and the demand curve in graph (c) to the left. b. shifting the demand curve in panel a to the right and the supply curve in graph (c) to the left. c. shifting the supply curve in panel a to the right and the demand curve in graph (c) to the left. d. shifting the supply curve in panel a to the right and the supply curve in graph (c) to the right.

15. If the U.S. government went from a budget deficit to a budget surplus then the real interest rate a. and the real exchange rate would increase. b. and the real exchange rate would decrease. c. would increase and the real exchange rate would decrease. d. would decrease and the real exchange rate would increase.

16. Which of the following accurately describes of the effect of the government budget deficit on the open economy? a. Real interest rates fall, which encourages domestic investment; the currency appreciates pushing the trade balance toward deficit. b. Real interest rates rise, which causes crowding out of domestic investment; the currency appreciates pushing the trade balance toward deficit. c. Real interest rates fall, which encourages domestic investment; the currency depreciates pushing the trade balance toward surplus. d. Real interest rates rise, which causes crowding out of domestic investment; the currency depreciates pushing the trade balance toward surplus.

28. The price level rises in the short run if a. aggregate demand or aggregate supply shifts left. b. aggregate demand shifts right or aggregate supply shifts left. c. aggregate demand shifts left or aggregate supply shifts right. d. aggregate demand or aggregate supply shifts right.

36. Which of the following correctly explains the crowding-out effect? a. An increase in government expenditures decreases the interest rate and so increases investment spending. b. An increase in government expenditures increases the interest rate and so reduces investment spending. c. A decrease in government expenditures increases the interest rate and so increases investment spending. d. A decrease in government expenditures decreases the interest rate and so reduces investment spending

38. Shortage + Surplus explanation a. there is an shortage of money. b. people will buy more bonds, which drives interest rates down. c. as the money market moves to equilibrium, people will sell more goods. d. the quantity of money supplied is less than the quantity of money demanded.

8. If real interest rates rose less in New Zealand than in the United States, then other things the same a. U.S. citizens would buy fewer New Zealand bonds and New Zealands would buy fewer U.S. bonds. b. U.S. citizens would buy fewer New Zealand bonds and New Zealands would buy more U.S. bonds. c. U.S. citizens would buy more New Zealand bonds and New Zealands would buy more U.S. bonds. d. U.S. citizens would buy more New Zealand bonds and New Zealands would buy fewer U.S. bonds.

11. In 2002 it looked like the Argentinean government might default on its debt (which eventually it did). The open- economy macroeconomic model predicts that this should have a. raised Argentinean real interest rates and caused the Argentinean currency to appreciate. b. raised Argentinean real interest rates and caused the Argentinean currency to depreciate. c. lowered Argentinean real interest rates and caused the Argentinean currency to appreciate. d. lowered Argentinean real interest rates and caused the Argentinean currency to depreciate.

b The default risk in Argentina would make Argentinean assets much less attractive, and so, both Argentinean and foreign investors wouldn't want to purchase Argentinean assets. Thus, Argentinean NCO would rise. Then, in the loanable funds market in Argentina, the demand curve would shift to the right, and the real interest rate in Argentina would rise. Also, because Argentinean NCO rises, the supply curve in the foreign exchange market in Argentina would shift rightward, and so, the equilibrium exchange rate would fall.

Which of the following accurately describes the effect of an investment tax credit? Check all that apply. a. Exchange rate decreases b. Net capital outflow decreases c. National saving increases d. Domestic investment decreases e. Trade balance increases f. Real interest rate increases

b. Net capital outflow decreases c. National saving increases f. Real interest rate increases

5. If your firm's production function has constant returns to scale, then if you double all your inputs, your firm's output will a. double and productivity will rise. b. double but productivity will not change. c. more than double and productivity will rise. d. more than double but productivity will not change

b. double but productivity will not change.

13. Suppose a country has only a sales tax. Now suppose it replaces the sales tax with an income tax that includes a tax on interest income. This would make equilibrium a. interest rates and the equilibrium quantity of loanable funds rise. b. interest rates rise and the equilibrium quantity of loanable funds fall. c. interest rates fall and the equilibrium quantity of loanable funds rise. d. interest rates and the equilibrium quantity of loanable funds fall.

b. interest rates rise and the equilibrium quantity of loanable funds fall.

45. Money is a. the most liquid asset and a perfect store of value. b. the most liquid asset but an imperfect store of value. c. not the most liquid asset but a perfect store of value. d. neither the most liquid asset and nor a perfect store of value.

b. the most liquid asset but an imperfect store of value.

20. 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 a. aggregate supply to the right. b. aggregate supply to the left. c. aggregate demand to the right. d. aggregate demand to the left.

32. Changes in the interest rate a. shift aggregate demand whether they are caused by changes in the price level or by changes in fiscal or monetary policy. b. shift aggregate demand if they are caused by changes in the price level, but not if they are caused by changes in fiscal or monetary policy. c. shift aggregate demand if they are caused by fiscal or monetary policy, but not if they are caused by changes in the price level. d. do not shift aggregate demand.

39. Which of the following events shifts aggregate demand leftward? a. A decrease in government expenditures or a decrease in the price level b. An increase in government expenditures or an increase in the price level c. A decrease in government expenditures, but not a change in the price level d. An increase in the price level, but not a change in government expenditures

7. Other things the same, a decrease in the U.S. real interest rate induces a. Americans to buy fewer foreign assets, which increases U.S.'s net capital outflow. b. Americans to buy more foreign assets, which reduces U.S.'s net capital outflow. c. foreigners to buy fewer U.S. assets, which increases U.S.'s net capital outflow. d. foreigners to buy more U.S. assets, which reduces U.S.'s net capital outflow

Imagine that in the current year the economy is in long-run equilibrium. Then stock prices fall more than expected and stay low for some time. 29 How is the new long-run equilibrium different from the original one? a. The price level and real GDP are lower. b. The price level and real GDP are higher. c. The price level is lower and real GDP is the same. d. The price level is the same and real GDP is lower.

22. You bought some shares of stock and, over the next year, the price per share increased by 5 percent, as did the price level. Before taxes, you experienced a. both a nominal gain and a real gain, and you paid taxes on the nominal gain. b. a nominal gain, but no real gain, and you paid no taxes on the transaction. c. a nominal gain, but no real gain, and you paid taxes on the nominal gain. d. both a nominal gain and a real gain, and you paid taxes only on the real gain

c. a nominal gain, but no real gain, and you paid taxes on the nominal gain. - nominal return = 5% - price also increases by 5% so 5-5 = 0 - no real gain

The fictional country of Joplait experienced capital flight 10 years ago, what should have happened to Joplait's real interest rate? a. it fell and the Joplaitian dollar appreciated. b. it fell and the Joplaitian dollar depreciated. c. it rose and the peso depreciated. d. it rose and the peso appreciated.

c. it rose and the peso depreciated. When investors around the world observe political problems in a country, they usually decide to sell some of their assets from that region and use the proceeds to buy assets from safer environment. This act increases net capital outflow. When net capital outflow increases, there is greater quantity of loanable funds demanded to finance these purchases of capital assets abroad. Both the net capital outflow curve and the supply of the Joplaitian dollar shift to the right, leading to a depreciation of the currency. This rightward shift in the NCO curve increases the demand curve for loanable funds as well, which leads to a higher real interest rate in Joplait.

Which of the following would not be caused by the imposition of an import quota? a.imports decrease. b.the demand for currency shifts right c.the demand for currency shifts left. d.the exchange rate rises.

c. the demand for currency (in FCEM) shifts left. If the U.S. implements import quotas, imports will be reduced. Because net exports equal exports minus imports, net exports increases initially. Because net exports are the source of demand for dollars in the market for foreign-currency exchange, the demand for dollars increases (represented by a rightward shift in the demand curve in the market for loanable funds). This leads to a higher equilibrium exchange rate.

A U.S. manufacturing company borrows money to buy a forklift from a U.S. company and a conveyor belt from a company in Japan. Which of the following is true regarding the money borrowed for these capital asset purchases? a.only borrowing the conveyor belt purchase is included in the demand for loanable funds in the U.S. b.borrowing for neither capital asset purchase is included in the demand for loanable funds in the U.S. c.borrowing both capital asset purchases are included in the demand for loanable funds in the U.S. d.only borrowing the forklift purchase is included in the demand for loanable funds in the U.S.

c.borrowing both capital asset purchases are included in the demand for loanable funds in the U.S. Loanable funds should be interpreted as the domestically generated flow of resources available for capital accumulation. The purchase of a capital asset adds to the demand for loanable funds, regardless of whether that asset is located at home (I) or abroad (NCO). Therefore the borrowing for both the forklift and the conveyor belt is included in the demand for loanable funds in the U.S.

Suppose the U.S. exchange rate increases relative to foreign currencies. This means that U.S. citizens pay a.more dollars for foreign bonds and get more dollars from interest payments. b.fewer dollars for foreign bonds but get more dollars from interest payments. c.fewer dollars for foreign bonds and also get fewer dollars from interest payments. d.more dollars for foreign bonds but get fewer dollars from interest payments.

c.fewer dollars for foreign bonds and also get fewer dollars from interest payments. When the exchange rate for the U.S. dollar increases, it's expensive for an American to buy foreign assets, and when these foreign assets pay dividends (in the case of stock) or other such returns, those will be in foreign currency as well. As the foreign currency is exchanged for dollars, the high value of the dollar means that the dividend or return will buy fewer dollars.

A change in weather could ____ a.cause a left to right movement along the long-run aggregate-supply curve. b.cause a right to left movement along the long-run aggregate-supply curve. c.shift the long-run aggregate-supply curve. d.not change the long-run aggregate-supply curve.

c.shift the long-run aggregate-supply curve. A change in weather can create more or less favorable growing conditions, impacting total output for all price levels.

What could cause U.S. goods to become less attractive to consumers in the U.S. and abroad? a.when the U.S. real exchange rate stays the same. b.nothing. c.when the U.S. real exchange rate increases. d.when the U.S. real exchange rate decreases.

c.when the U.S. real exchange rate increases.

14. If for some reason Americans desired to increase their purchases of foreign assets, then other things the same a. both the real exchange rate and the quantity of dollars exchanged in the market for foreign currency would fall. b. both the real exchange rate and the quantity of dollars exchanged in the market for foreign currency would rise. c. the real exchange rate would rise and the quantity of dollars exchanged in the market for foreign currency would fall. d. the real exchange rate would fall and the quantity of dollars exchanged in the market for foreign currency would rise.

33. In which of the following cases would the quantity of money demanded be smallest? a. r = 0.06, P = 1.2 b. r = 0.05, P = 1.0 c. r = 0.04, P = 1.2 d. r = 0.06, P = 1.0

43. The nominal exchange rate is about 3 Aruban florin per dollar. If a basket of goods in the United States costs $40, how many florins must a basket of goods in Aruba cost for purchasing-power parity to hold? a. 43 florin b. 13.3333333333 florin c. 37 florin d. 120 florin

44. If there is a surplus in the U.S. loanable funds market, then a. NCO > I. b. NCO < I. c. NCO + I > S. d. NCO + I < S.

47. Which of the following shifts aggregate demand to the left? a. An increase in the price level b. An increase in the money supply c. A decrease in the price level d. A decrease in the money supply

6. If U.S. net exports are negative, then net capital outflow is a. positive, so foreign assets bought by Americans are greater than American assets bought by foreigners. b. positive, so American assets bought by foreigners are greater than foreign assets bought by Americans. c. negative, so foreign assets bought by Americans are greater than American assets bought by foreigners. d. negative, so American assets bought by foreigners are greater than foreign assets bought by Americans.

9. In the open-economy macroeconomic model, the key determinant of net capital outflow is the a. real exchange rate. When the real exchange rate rises, net capital outflow rises. b. real exchange rate. When the real exchange rate rises, net capital outflow falls.c. real interest rate. When the real interest rate rises, net capital outflow rises. d. real interest rate. When the real interest rate rises, net capital outflow falls.

Imagine that in the current year the economy is in long-run equilibrium. Then stock prices fall more than expected and stay low for some time. 30. Suppose the economy is in long-run equilibrium. If there is a sharp increase in the minimum wage as well as an increase in taxes, then in the short run, real GDP will a. rise and the price level might rise, fall, or stay the same. In the long run, the price level might rise, fall, or stay the same but real GDP will be unaffected. b. fall and the price level might rise, fall, or stay the same. In the long run, the price level might rise, fall, or stay the same but real GDP will be unaffected. c. rise and the price level might rise, fall, or stay the same. In the long run, the price level might rise, fall, or stay the same but real GDP will be lower. d. fall and the price level might rise, fall, or stay the same. In the long run, the price level might rise, fall, or stay the same but real GDP will be lower.

Suppose that political instability in other countries makes people fear for the value of their assets in these countries so that they desire to purchase more U.S assets. 21. What would the change in the exchange rate make happen to U.S. net exports and U.S. aggregate demand? a. Net exports would rise which by itself would increase U.S. aggregate demand. b. Net exports would rise which by itself would decrease U.S. aggregate demand. c. Net exports would fall which by itself would increase U.S. aggregate demand. d. Net exports would fall which by itself would decrease U.S. aggregate demand.

Suppose that political instability in other countries makes people fear for the value of their assets in these countries so that they desire to purchase more U.S assets. 23. What would the change in the interest rate created by foreigners wanting to buy more U.S. assets do to investment spending in the United States? a. Make it rise which by itself would increase U.S. aggregate demand. b. Make it rise which by itself would decrease U.S. aggregate demand. c. Make it fall which by itself would increase U.S. aggregate demand. d. Make it fall which by itself would decrease U.S. aggregate demand.

d As foreigners purchase more US assets, US NCO would fall. Remember that US NCO is the purchase of foreign assets by US residents (US capital outflow) minus the purchase of US assets by foreigners (US capital inflow). Then, in the loanable funds market in the US, the demand curve would shift to the left, and the equilibrium interest rate would fall. When the interest rate falls, investment would rise, and the aggregate demand would also rise. *The answer key typo (says D, but it's A)

45. A country produces two goods, soda and chips. It currently exports soda and imports chips. If it were to impose a tariff on chips, a. both imports of chips and exports of sodas would rise. b. imports of chips would rise, but exports of sodas would fall. c. imports of chips would fall, but exports of sodas would rise. d. both imports of chips and exports of sodas would fall

d If the country imposes tariff on chips, imports of chips would fall because importing chips becomes more expensive. Then, net exports would rise, because net exports are exports minus imports. Then, in the foreign exchange market, the demand curve would shift to the right because the demand curve represents net exports at each real exchange rate. Then, you can see that the equilibrium real exchange rate would rise. A higher real exchange rate means that the domestic good becomes more expensive relative to the foreign good. Because of the increase in the real exchange rate, the country's exports would also fall because their good becomes more expensive for foreigners. Overall, both imports of chips and exports of sodas would fall.

36. Assets: Reserves ($4,000) + Loans ($46,000) Liabilities: Deposits ($50,000) Assume the Fed's reserve requirement is 5 percent and all banks besides the Bank of Smileville are exactly in compliance with the 5 percent requirement. Further assume that people hold only deposits and no currency. Starting from the situation as depicted by the T-account, if the Bank of Smileville decides to make new loans so as to end up with no excess reserves, then by how much does the money supply eventually increase? a. $18,750.00 b. $30,811.93 c. $32,034.39 d. $30,000.00

d. $30,000.00

1. Consider the production function Y=2F(L,K,H,N). Suppose F(12, 10, 9, 7) = 100 and that this production function has the property of constant returns to scale. Then F(24, 20, 18, 14) = a. 400 b. 100 c. 50 d. 200

d. 200 (12+10+9+7) = 38 --> 100/38 = 2.6.. 2.6 x (24 + 20 +18 + 14) = 200

Assume that U.S. products did decline in relative quality during the 1980s. According to this model, which of the following statements are true as a result of the quality change? Check all that apply. a. The trade balance decreases. b. Net capital outflow decreases. c. There is no change in the real interest rate. d. The real exchange rate declines. True or False: The change in the real exchange rate that resulted from the decline in the quality of U.S. products may increase our standard of living.

d. The real exchange rate declines. The shift to the left of the demand curve for dollars leads to a decline in the real exchange rate. Because net capital outflow is unchanged and net exports equal net capital outflow, there is no change in the equilibrium quantity of net exports or the trade balance. Moreover, the market for loanable funds remains unchanged, so there is also no change in the real interest rate: False: The decline in the real exchange rate means that we get fewer foreign goods in exchange for our goods, so our standard of living may, in fact, decline.

If the fictional country of Joplait experienced capital flight 10 years ago, what should have happened to Joplait's net exports? a.They should have decreased. b.They did not change. c.They should have decreased until the Joplaitian dollar appreciated, then increased. d.They should have increased.

d.They should have increased.

If businesses in general decide that they have underbuilt and so now have too little capital, their response to this would initially shift a.aggregate-supply curve to the right. b.aggregate-demand curve to the left. c.aggregate-supply curve to the left. d.aggregate-demand curve to the right.

d.aggregate-demand curve to the right. If firms become optimistic about future business conditions, they will increase investment spending, shifting the aggregate-demand curve to the right.

Which of the following would cause U.S assets to become more attractive thereby decreasing U.S. net capital outflow? a.a decrease in the U.S. real interest rate. b.net capital outflows can only decrease. c.no change in the U.S. real interest rate. d.an increase in the U.S real interest rate

d.an increase in the U.S real interest rate When the U.S. real interest rate rises, U.S. capital assets become more attractive to foreign countries as well as domestic investors. Thus, an increase in the U.S. real interest rate discourages Americans from buying foreign assets and encourages foreigners to buy U.S. assets. For both reasons, a high U.S. real interest rate reduces U.S. net capital outflow. ***An increase in the US real interest rate discourages Americans from buying forgeign assets + encourages Foreigners to buy US assets (bc higher return) —> SO NCO DECREASE

Other things the same, people in the U.S. would want to save less if the real interest rate in the U.S. a.rose. The decreased saving would decrease the quantity of loanable funds demanded. b.rose. The decreased saving would decrease the quantity of loanable funds supplied. c.fell. The decreased saving would decrease the quantity of loanable funds demanded. d.fell. The decreased saving would decrease the quantity of loanable funds supplied.

d.fell. The decreased saving would decrease the quantity of loanable funds supplied.

If the U.S. nominal exchange rate declines and prices are unchanged in the United States and abroad, the real exchange rate ______

decreases

Under PPP, the nominal exchange rate (e) should be able to be computed by....

e = P*/P Derived from: 1=(e x P)/P*

20. If consumers reduced their spending, what would happen to the interest rate and investment?

interest rate falls so investment rises

When the U.S. real interest rate rises, U.S. capital assets become more/less attractive to foreign countries as well as domestic investors. Thus, an increase in the U.S. real interest rate encourages/discourages Americans from buying foreign assets and encourages/discourages foreigners to buy U.S. assets. For both reasons, a high U.S. real interest rate reduces U.S. net capital outflow.

more attractive, discourages Americans, encourages foreigners

Real Interest Rate = Therefore nominal interest rate =

nominal interest rate - inflation rate - nominal interest rate = Real interest rate + inflation rate

59. Jackie saves $100 and receives $106 the next year. During the same year, the price of the basket of goods that she purchases increases from $100 to $104. What is nominal interest rate on Jackie's saving? What is the real interest rate on Jackie's saving? What was the inflation rate?

nominal interest rate = 6%, real interest rate = 2%, inflation rate = 4%

An increase in P reduces the quantity of goods and services demanded because:

• the wealth effect (people are less wealthy, C falls) • the interest-rate effect (interest rate rises, I falls) • the exchange-rate effect (the dollar appreciates, imports increase, exports decrease à NX falls)

AD Curve Shifters

•Changes in C -Stock market boom/crash -Preferences re: consumption/saving tradeoff -Tax hikes/cuts •Changes in I -Firms buy new computers, equipment, factories -Expectations, optimism/pessimism -Interest rates -Monetary policy -Investment Tax Credit or other tax incentives •Changes in G -Federal spending, e.g., defense -State & local spending, e.g., roads, schools •Changes in NX -Booms/recessions in countries that buy our exports -Appreciation/depreciation resulting from international speculation in foreign exchange market

Assets incldue

•Foreign direct investment •Foreign portfolio investment Stocks + bonds

The Classical Dichotomy + The neutrality of money:

•The Classical Dichotomy -Separation of variables into two groups: •Real - quantities, relative prices •Nominal - measured in terms of money •The neutrality of money: -Changes in the money supply affect nominal but not real variables

- Trade Surplus - Trade Deficit - Balanced Trade

•Trade surplus, NX > 0, Exports are greater than imports, The country sells more goods and services abroad than it buys from other countries • Trade deficit, NX < 0, Imports are greater than exports, the country sells fewer goods and services abroad than it buys from other countries • Balanced trade: Exports = Imports

- When NCO (>,<,=) 0, "capital outflow" - When NCO (>,<,=) 0, "capital outflow"

•When NCO > 0, "capital outflow" -Domestic purchases of foreign assets exceed foreign purchases of domestic assets •When NCO < 0, "capital inflow" -Foreign purchases of domestic assets exceed domestic purchases of foreign assets

Trade Surplus and NCO

•When a country has a trade surplus: NX > 0 -Selling more g/s to foreigners than buying -The economy uses the foreign currency it receives from the net sale of g/s abroad to buy foreign assets. -Capital is flowing out of the country to acquire the foreign assets, so NCO > 0

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