ECON 202 Exam 3

Real exchange rate=

(Nominal exchange rate x Domestic Price)/Foreign Price

Real Exchange rate=

(e x P)P*

Net capital outflow

=Purchase of foreign assets by domestic residents-Purchase of domestic assets by foreigners

Purchasing Power Parity

A unit of any given currency should be able to buy the same quantity of goods in all countries

Nominal exchange rate=

FC/$

In the long run the natural rate of unemployment is primarily determined by labor market factors including government policy concerning minimum wages and unemployment benefits. In the long run inflation is primarily determined by money supply growth. These determinants are consistent with the classical dichotomy which states that real and nominal variables are determined independently

Illustrate the classical analysis of growth and inflation with aggregate demand and long-run aggregate supply curves.

In the long run the natural rate of unemployment is primarily determined by labor market factors including government policy concerning minimum wages and unemployment benefits. In the long run inflation is primarily determined by money supply growth. These determinants are consistent with the classical dichotomy which states that real and nominal variables are determined independently

In the long run what primarily determines the natural rate of unemployment? In the long run what primarily determines the inflation rate? How does this relate to the classical dichotomy?

Y=Yfe

LRAS equation

U%=NRU

LRPC equation

Vertical

LRPC shape

Consumer tastes and preferences, price of goods at home and abroad, Exchange rates, income of consumers home and abroad, Cost of transporting goods at home and abroad, Governmental policies toward international trade

List the factors that might influence a country's exports, imports, and trade balance.

stock market boom that increases consumption spending, a tax cut that increases consumption, improvements in capital goods such as computers that increase investment, increased optimism about the future of the economy induces increased investment, an investment tax credit, an increase in the money supply, an increase in government defense expenditures, and economic expansions overseas that create increases in net exports

Make a list of things that would shift the aggregate demand curve to the right

Y=Yfe+a(P-Po)

SRAS equation

U%=NRU-a(actual inflation-expected inflation)

SRPC equation

Negative slope

SRPC shape

1 euro per dollar

Suppose a bottle of wine costs 20 euros in France and 25 dollars in the United States. If the exchange rate is .80 euros per dollar, what is the real exchange rate?

Supply shifts right, interest rate falls, exchange rate depreciates

Suppose that U.S. citizens start saving more. What does this imply about the supply of loanable funds and the equilibrium real interest rate? What happens to the real exchange rate?

Net capital outflow decreases, *U.S. real interest rate decreases

Suppose that U.S. savers decide that holding Brazilian assets has become riskier. What happens to U.S. net capital outflow? What happens to the U.S. real interest rate?

This is possible for an open economy. The remaining $40 billion is for net capital outflow in the form of purchases of foreign-owned assets by this country's residents. Domestic residents can save by buying U.S. assets or by buying foreign assets

Suppose that a country has $120 billion of national saving, and $80 billion of domestic investment. Is this possible? Where did the other $40 billion of national savings go?

The nominal exchange rate will increase and the real exchange rate will stay the same

Suppose that money supply growth continues to be higher in Turkey than it is in the United States. What does purchasing-power parity imply will happen to the real and to the nominal exchange rate?

In the short run, unemployment will rise, because, contractionary policy reduces actual inflation and so moves the economy down along the Phillips curve. In the long run, the economy will return to its natural rate of unemployment as a reduction in expected inflation shifts the short-run Philip curve left

Suppose that the Fed unexpectedly pursues contractionary monetary policy. What will happen to unemployment in the short run? What will happen to unemployment in the long run? Justify your answer using the Phillips curves.

The supply of loanable funds curve shifts right because a reduction in the deficit raises national saving which is the source of the supply of loanable funds. As the supply of loanable funds shifts right, the interest rate falls. This decrease in the interest rate causes the quantity of net capital outflow to rise, which means that U.S. residents will supply more dollars in order to purchase more foreign assets. So the supply of dollars in the foreign-currency exchange market shifts right.

Suppose that the U.S. government budget deficit decreases. What curves in the open-economy macroeconomic model shift? Explain why each curve shifts the direction it does.

If unemployment is above its natural rate, then actual inflation is less than expected inflation. According to sticky-wage theory, when inflation is less than expected, prices will have risen less than nominal wages which are based on expected inflation. Because prices have risen less than nominal wages, firms will choose to reduce production and lay off or fire workers. Eventually workers and firms will have lower inflation expectations and the nominal wage will adjust to a level consistent with lower inflation expectations which will encourage firms to raise production. This increase in production causes unemployment to fall and shifts the short-run Philips curve to the left and the unemployment rate will return to it natural rate.

Suppose that the economy is at an inflation rate such that unemployment is above the natural rate. How does the economy return to the natural rate of unemployment if this lower inflation rate persists? Use sticky-wage theory to explain your answer.

Nominal exchange rate

The rate at which a person can trade the currency of one country for the currency of another

Real exchange rate

The rate at which a person can trade the goods and services of one country for the goods and services of another

Friedman and Phelps predicted that, over time, people would come to expect higher inflation, so the short-run Phillips curve would shift right. When this happened, unemployment would go back to its natural rate, but inflation would be higher. The behavior of the economy in the late 1960s and the 1970's was consistent with their theory. Inflation rose but unemployment did not remain low.

What did Friedman and Phelps predict would happen if policymakers tried to move the economy upward along the Phillips curve? Did the behavior of the economy in the late 1960s and the 1970s prove them wrong?

Shifts supply of loanable funds to the left

What does a budget deficit do to the graphs from chapter 14

Shifts demand of loanable funds to the right

What does capital flight do to the graphs from chapter 14

Shifts demand for dollars to the right

What does imposing a quota do to the graphs from chapter 14

That it is equal to one. The number of dollars it takes to buy goods in the U.S.buys enough foreign currency to buy the same amount of goods in a foreign country.

What does purchasing-power parity imply about the real exchange rate? Explain what this means

Demand shifts right for consumption goods

What happens to demand when consumers are wealthier

Demand shifts right for investment goods

What happens to demand when interest rates fall

Demand shifts right for net exports

What happens when currency depreciates

demand shifts right

What happens, if anything, to supply or demand of loanable funds when domestic investment increases at each interest rate

Demand shifts right

What happens, if anything, to supply or demand of loanable funds when net capital outflow increases at each interest rate

Supply shifts right

What happens, if anything, to supply or demand of loanable funds when private saving increases

Supply shifts left

What happens, if anything, to supply or demand of loanable funds when the government deficit increases

Higher domestic interest rates make domestic assets more desirable. So, domestic purchases of foreign assets decline while foreign purchases of domestic assets increase, both of which reduce net capital outflow.

Why do higher real interest rates lead to lower net capital outflow?

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

Sticky-price theory

the prices of some goods and services also adjust sluggishly in response to changing economic conditions

Sticky-wage theory

the short-run aggregate-supply curve slopes upward because nominal wages are slow to adjust to changing economic conditions

The Phillips Curve

the short-run relationship between inflation and unemployment

depreciate

what would happen to the U.S. dollar real exchange rate if Prices in the rest of the world rise

Depreciate

what would happen to the U.S. dollar real exchange rate if The U.S. nominal exchange rate depreciates

appreciate

what would happen to the U.S. dollar real exchange rate if U.S. domestic prices increase.