ECO 201 Final Exam Study Guide

If there is a shortage of loanable funds, then the quantity of loanable funds

demanded is greater than the quantity of loanable funds supplied and the interest rate will rise.

A bank loans Danuta's Ice Cream $190,000 to remodel a building near campus to use as a new store. On their respective balance sheets, this loan is

an asset for the bank and a liability for Danuta's Ice Cream. The loan increases the money supply.

When the market for money is drawn with the value of money on the vertical axis and the quantity of money on the horizontal axis, the price level increases if money demand shifts

left and decreases if money supply shifts left.

While a television news reporter might state that "Today the Fed raised the federal funds rate from 1 percent to 1.25 percent, " a more precise account of the Fed's action would be as follows:

"Today the Fed told its bond traders to conduct open-market operations in such a way that the equilibrium federal funds rate would increase to 1.25 percent. "

Suppose a burrito costs $6. Clara holds $120. What is the real value of the money she holds?

20 burritos. If the price of burritos rises, to maintain the real value of her money holdings she needs to hold more dollars.

Which of the following both increase the money supply?

A decrease in the discount rate and a decrease in the interest rate on reserves

Which of the following is an example of menu costs?

Advertising new prices

Which of the following properly describes the interest-rate effect that helps explain the slope of the aggregate-demand curve?

As the price level increases, the interest rate rises, so spending falls.

Which of the following lists is included in what economists call "money"?

Cash

Hideo and Hannah decide to go on a vacation. As a result, they withdraw $5,000 from their savings account to purchase $5,000 worth of traveler's checks. As a result of these changes,

M1 increases by $5,000 and M2 stays the same.

Which of the following increases when the Fed makes open-market sales?

Neither currency nor reserves

If the economy starts at point O, a short-run fall in output would be consistent with a movement to point

R.

Which of the following is included in M2 but not in M1?

Small time deposits.

A change in which of the following would shift the short-run aggregate-supply curve but not the long-run aggregate-supply curve?

The expected price level.

Which of the following would shift the aggregate-demand curve to the left?

a. A decline in the stock market b. An increase in taxes c. A decrease in government spending D. ALL THE ABOVE* Correct Answer

If the money multiplier is 3 and the Fed wants to increase the money supply by $900,000, it could

buy $300,000 worth of bonds.

If taxes decreases, then

consumption increases, and aggregate demand shifts rightward.

An increase in taxes will

decrease aggregate demand.

Suppose there was a large increase in net exports. If the Fed wanted to stabilize output, it could

decrease the money supply, which will increase interest rates.

An increase in household saving causes consumption to

fall and aggregate demand to decrease.

If households view a tax cut as temporary, then the tax cut

has less of an effect on aggregate demand than if households view it as permanent.

An increase in the aggregate demand for goods and services has a larger impact on output ________ and a larger impact on the price level ________.

in the short run; in the long run

Stagflation is caused by a

leftward shift in the aggregate-supply curve.

In the model of aggregate demand and aggregate supply, the quantity of ________ is on the horizontal axis, and the ________ is on the vertical axis.

output; price level

Suppose the economy is in long-run equilibrium. If the government increases its expenditures, eventually the increase in aggregate demand causes price expectations to

rise. This rise in price expectations shifts the short-run aggregate supply curve to the left.

At the broadest level, the financial system moves the economy's scarce resources from

savers to borrowers.

Imagine that in the current year the economy is in long-run equilibrium. Then the federal government reduces its purchases of goods by 50%. In the long run, the change in price expectations created by the reduction of federal government purchases causes the

short-run aggregate supply to shift to the right.

If the quantity of loanable funds demanded exceeds the quantity of loanable funds supplied, there is a

shortage and the interest rate is below the equilibrium level.

As the interest rate falls to equilibrium in the market for money,

the quantity of money demanded rises, which would reduce a surplus of money.

The wealth effect, interest-rate effect, and exchange-rate effect are all explanations for

the slope of aggregate-demand curve.

If the reserve ratio is 5 percent, then $500 of additional reserves would ultimately generate

$10,000 of money.

If the MPC is 0.50 and there are no crowding-out or accelerator effects, then an initial increase in aggregate demand of $95 billion will eventually shift the aggregate demand curve to the right by

$190 billion. Because 1 - 0.50 = 0.5 THEN 1 / 0.5 = 2 AND 95 x 2 = $190

In the special case of the 100-percent-reserve banking, the money multiplier is

1 and banks do not create money.

There are three distinct but related reasons a fall in the price level increases the quantity of goods and services demanded:

1) Consumers become wealthier, stimulating the demand for consumption goods. 2) Interest rates fall, stimulating the demand for investment goods. 3) The currency depreciates, stimulating the demand for net exports.

Four Steps for Analyzing Macroeconomic Fluctuations

1) Decide whether the event shifts the aggregate-demand curve or the aggregate-supply curve (or perhaps both). 2) Decide the direction in which the curve shifts. 3) Use the diagram of aggregate demand and aggregate supply to determine the impact on output and the price level in the short run. 4) Use the diagram of aggregate demand and aggregate supply to analyze how the economy moves from its new short-run equilibrium to its new long-run equilibrium.

Why Does the Aggregate-Demand Curve Slope Downward?

1) The Wealth Effect: A lower price level increases real wealth, stimulating spending on consumption. 2) The Interest-Rate Effect: A lower price level reduces the interest rate, stimulating spending on investment. 3) The Exchange-Rate Effect: A lower price level causes the real exchange rate to depreciate, stimulating spending on net exports.

A bank's reserve ratio is 7 percent and the bank has $1,000 in deposits. Its reserves amount to

1,000 x 0.07 = 70 THEREFORE, the answer is $70.

If the reserve ratio is 4 percent, then the money multiplier is

1/4 = 0.25 THEREFORE, the answer is 25.

The nominal interest rate is 6 percent and the real interest rate is 4 percent. What is the inflation rate?

2%

If the MPC is 3/5 then the multiplier is

2.5, so a $100 increase in government spending increases aggregate demand by $250.

If the multiplier is 3, then the MPC is

2/3

Which of the following sequences (numbered arrows) shows the logic of the interest-rate effect on the slope of aggregate demand?

3, 2, 1, 4 Price Level Money Demand Shift Interest Rate Quantity of Output

If the nominal interest rate is 8 percent and the inflation rate is 3 percent, then the real interest rate is

5%.

Which of the following shifts aggregate demand to the left?

A decrease in the money supply.

Which of the following events could explain an increase in the equilibrium interest rate from r1 to r3?

A increase in the price level

Imagine that in the current year the economy is in long-run equilibrium. Then the federal government reduces its purchases of goods by 50%. Which curve shifts and in which direction?

Aggregate demand shifts left.

A decrease in Y from Y1 to Y2 is explained as follows:

An increase in P from P1 to P2 causes the money-demand curve to shift from MD1 to MD2; this shift of MD causes r to increase from r1 to r2; and this increase in r causes Y to decrease from Y1 to Y2.

Which of the following correctly explains the crowding-out effect?

An increase in government expenditures increases the interest rate and so reduces investment spending.

Which of the following events shifts aggregate demand rightward?

An increase in government expenditures, but not a change in the price level

Which of the following is an example of crowding out?

An increase in government spending increases interest rates, causing investment to fall.

Which of the following shifts the long-run aggregate supply curve to the left?

An increase in the price of imported natural resources and an increase in trade restrictions.

People had been expecting the price level to be 120 but it turns out to be 122. In response Robinson Tire Company increases the number of workers it employs. What could explain this?

Both sticky price theory and sticky wage theory

Imagine that in the current year the economy is in long-run equilibrium. Then the federal government reduces its purchases of goods by 50%. In the short run what happens to the price level and real GDP?

Both the price level and real GDP fall.

Which of the following would not be directly included in aggregate demand?

Governments tax collections.

The figure depicts a demand-for-loanable-funds curve and two supply-of-loanable-funds curves. Which of the following events would shift the supply curve from S1 to S2?

In response to tax reform, households are encouraged to save more than they previously saved.

In a closed economy, what does the difference between the tax revenue and government purchases, (T − G), represent?

Public saving.

The nominal interest rate is 6 percent and the inflation rate is 3 percent. What is the real interest rate?

Real Interest Rate = Nominal Interest Rate - Inflation THEREFORE, 6 - 3 = 3 The answer is 3.

Which of the following policies can the Fed follow to increase the money supply?

Reduce the interest rates on reserves.

A decrease in taxes would move the economy from U to

T in the short run and S in the long run.

If the reserve requirement is 10 percent, which of the following pairs of changes would both allow a bank to lend out an additional $10,000?

The Fed buys a $10,000 bond from the bank or the Fed lends the bank $10,000.

Which of the following is not an example of monetary policy?

The Federal Reserve facilitates bank transactions by clearing checks.

Which of the following is not a determinant of the long-run level of real GDP?

The price level.

The figure shows two demand-for-loanable-funds curves and two supply-of-loanable-funds curves. A shift of the demand curve from D2 to D1 is called

a decrease in the demand for loanable funds.

When you list prices for necklaces sold on your website, www.sparklingjewels.com, in dollars, this best illustrates money's function as

a unit of account.

If the stock market crashes, then

aggregate demand decreases, which the Fed could offset by purchasing bonds.

The price level rises in the short run if

aggregate demand shifts right or aggregate supply shifts left.

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.

If the Federal Open Market Committee decides to increase the money supply, it

creates dollars and uses them to purchase government bonds from the public.

If the reserve ratio is 5 percent, banks do not hold excess reserves, and people do not hold currency, then when the Fed sells $20 million worth of government bonds, bank reserves

decrease by $20 million and the money supply eventually decreases by $400 million.

If taxes

decrease, then consumption increases, and aggregate demand shifts rightward.

If expected inflation is constant and the nominal interest rate decreases by 4 percentage points, then the real interest rate

decreases by 4 percentage points.

The wealth effect along an aggregate-demand curve stems from the idea that a higher price level

decreases the real value of households' money holdings.

Other things the same, if reserve requirements are decreased, the reserve ratio

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

Crowding out occurs when investment declines because a budget

deficit makes interest rates rise.

From 2001 to 2005 there was a dramatic rise in the value of houses. If this rise made homeowners feel wealthier, then it would have shifted aggregate

demand to the right.

A sudden increase in business pessimism shifts the aggregate-________ curve, leading to ________ output.

demand, lower

Suppose banks decide to hold more excess reserves relative to deposits. Other things the same, this action will cause the money supply to

fall. To reduce the impact of this the Fed could buy Treasury bonds.

When the economy goes into a recession, real GDP ________ and unemployment ________.

falls; rises

Institutions that help to match one person's saving with another person's investment are collectively called the

financial system.

In the short run, open-market purchases

increase investment and real GDP, and decrease interest rates.

If the Fed raised the reserve requirement, the demand for reserves would

increase, so the federal funds rate would rise.

When the Fed buys government bonds, the reserves of the banking system

increase, so the money supply increases

When the Fed buys government bonds, the reserves of the banking system

increase, so the money supply increases.

The federal funds rate is the

interest rate at which banks lend reserves to each other overnight.

When the Fed increases the money supply, we expect

interest rates to fall and stock prices to rise.

Recessions or depressions occur

irregularly

Most economists believe that classical macroeconomic theory

is valid only in the long run.

Katleen is considering expanding her dress shop. If interest rates rise she is

less likely to expand. This illustrates why the demand for loanable funds slopes downward.

When the Consumer Price Index decreases from 140 to 125

less money is needed to buy the same amount of goods, so the value of money rises.

If the Federal Reserve increases the interest rate on bank deposits at the Fed, banks will want to hold

more reserves, so the reserve ratio will rise.

Other things the same, when the interest rate rises, people would want to lend

more, making the quantity of loanable funds supplied increase.

If the economy is at S and there is a reduction in aggregate demand, in the short run the economy

moves to V.

Suppose private saving in a closed economy is $21b and investment is $8b. The government budget deficit

must equal $13b.

If the reserve requirement is 7 percent, a bank desires to hold no excess reserves, and it receives a new deposit of $200, it

must increase required reserves by $14.

If the current interest rate is 2%

people will sell more bonds, which drives interest rates up.

If the economy is in long-run equilibrium, a favorable shift in short-run aggregate supply curve would move the economy from

point S to T.

Suppose the economy starts at Point Y. If aggregate demand increases from AD2 to AD3, then in the short run the economy moves to

point V.

If the economy starts at Point Y, then a recession occurs at

point W.

Suppose the economy starts at Point Y. If there is a reduction in aggregate demand, then in the long run the economy moves to

point Z.

An increase in the government's budget surplus means public saving is

positive and increasing.

The slope of the supply of loanable funds curve represents the

positive relation between the interest rate and saving.

In a closed economy, national saving equals

private saving plus public saving.

When the Federal Reserve decreases the federal funds target rate, the lower rate is achieved through

purchases of government bonds, which reduces interest rates and causes people to hold more money.

Other things the same, automatic stabilizers tend to

raise expenditures during recessions and lower expenditures during expansions.

If the interest rate is below the Fed's target, the Fed should

sell bonds to decrease the money supply.

When conducting an open-market sale, the Fed

sells government bonds, and in so doing decreases the money supply.

You saved $500 in currency in your piggy bank to purchase a new laptop. The $500 you kept in your piggy bank illustrates money's function as a _______. The laptop's price is posted as $500. The $500 price illustrates money's function as a _____. You use the $500 to purchase the laptop. This transaction illustrates money's function as a ______.

store of value, unit of account, medium of exchange

Cash, fine art, and silver are all

stores of value.

If the money supply is MS2 and the value of money is 5, then there is an excess

supply of money that is represented by the distance between points D and A.

According to classical macroeconomic theory and monetary neutrality, changes in the money supply affect

the GDP deflator.

A tax cut shifts the aggregate demand curve the farthest if

the MPC is large and if the tax cut is permanent.

In a closed economy, private saving is

the amount of income that households have left after paying for their taxes and consumption.

When the money supply curve shifts from MS1 to MS2,

the equilibrium value of money decreases.

The aggregate-demand curve slopes downward because a fall in the price level causes

the interest rate to decline.

Aggregate demand includes:

the quantity of goods and services the government, households, firms, and customers abroad want to buy.

In the long run, the aggregate-supply curve is ____________, whereas in the short run, the aggregate-supply curve slopes ____________.

vertical, upward

The Federal Open Market Committee is ​

​the group at the Federal Reserve that sets monetary policy.

One reason the short-run aggregate-supply curve slopes upward is that a higher price level

reduces real wages if nominal wages are sticky.

Why Might the Short-Run Aggregate-Supply Curve Shift?

1) Shifts Arising from Changes in Labor: An increase in the quantity of labor available (perhaps due to a fall in the natural rate of unemployment) shifts the aggregate-supply curve to the right. A decrease in the quantity of labor available (perhaps due to a rise in the natural rate of unemployment) shifts the aggregate-supply curve to the left. 2) Shifts Arising from Changes in Capital: An increase in physical or human capital shifts the aggregate-supply curve to the right. A decrease in physical or human capital shifts the aggregate-supply curve to the left. 3) Shifts Arising from Changes in Natural Resources: An increase in the availability of natural resources shifts the aggregate-supply curve to the right. A decrease in the availability of natural resources shifts the aggregate-supply curve to the left. 4) Shifts Arising from Changes in Technology: An advance in technological knowledge shifts the aggregate-supply curve to the right. A decrease in the available technology (perhaps due to government regulation) shifts the aggregate-supply curve to the left. 5) Shifts Arising from Changes in the Expected Price Level: A decrease in the expected price level shifts the short-run aggregate-supply curve to the right. An increase in the expected price level shifts the short-run aggregate-supply curve to the left.

There are three alternative explanations for the upward slope of the short-run aggregate-supply curve:

1) sticky wages: An unexpectedly low price level raises the real wage, causing firms to hire fewer workers and produce a smaller quantity of goods and services. 2) sticky prices: An unexpectedly low price level leaves some firms with higher-than-desired prices, depressing their sales and leading them to cut back production. 3) misperceptions about relative prices: An unexpectedly low price level leads some suppliers to think their relative prices have fallen, inducing a fall in production.

Why might the aggregate demand curve shift?

Shifts Arising from Changes in Consumption: An event that causes consumers to spend more at a given price level (a tax cut, a stock market boom) shifts the aggregate-demand curve to the right. An event that causes consumers to spend less at a given price level (a tax hike, a stock market decline) shifts the aggregate-demand curve to the left. Shifts Arising from Changes in Investment: An event that causes firms to invest more at a given price level (optimism about the future, a fall in interest rates due to an increase in the money supply) shifts the aggregate-demand curve to the right. An event that causes firms to invest less at a given price level (pessimism about the future, a rise in interest rates due to a decrease in the money supply) shifts the aggregate-demand curve to the left. Shifts Arising from Changes in Government Purchases: An increase in government purchases of goods and services (greater spending on defense or highway construction) shifts the aggregate-demand curve to the right. A decrease in government purchases on goods and services (a cutback in defense or highway spending) shifts the aggregate-demand curve to the left. Shifts Arising from Changes in Net Exports: An event that raises spending on net exports at a given price level (a boom overseas, speculation that causes a currency depreciation) shifts the aggregate-demand curve to the right. An event that reduces spending on net exports at a given price level (a recession overseas, speculation that causes a currency appreciation) shifts the aggregate-demand curve to the left.