ECON 202 - Midterm #2
The commercial banks on Sunny Island have checking deposits of $4 million, reserves of $600,000, and loans of $2.4 million. The desired reserve ration is 10 percent. The banks have _____ of desired reserves and _____ of excess reserves.
$400,000; $200,000
When disposable income increases from $6 trillion to $6.5 trillion, consumption expenditure increase from from $5.5 trillion to $5.9 trillion. The MPC equals
0.8.
Role of depository institutions in the US
1. Commercial Banks 2. Thrift Institutions 3. Money market mutual funds. The goal of any bank is to maximize the wealth of its owners. The interest rate at which it lends exceeds the interest rate it pays on deposits. Loans generate profit; Depositors must be able to obtain their funds when they want them (reserves, liquid assets, securities and loans).
What is money?
1. Medium of Exchange (eliminates double coincidence of wants) 2. Unit of Account 3. Store of Value
Basic elements of Keynesian model
1. Prices are fixed (households and firms) 2. Aggregate demand determine real GDP (firms supply all that is demanded)
Multiplier =
1/1-Slope of AE
Money Multiplier =
1/Desired Reserve Ratio
If investment increases by $300 and, in response, equilibrium aggregate expenditure increases by $600, the multiplier is
2.
If there are no taxes or imports and MPC = 0.5, the multiplier equals
2.0.
Board of Governors
7 members appointed by president of US and confirmed by Senate; 14-year staggered term; appoints one member a renewable 4-year term as chairman; each Fed Reserve Bank has a nine-person board and president.
There are several reasons why the aggregate demand curve is downward sloping. Which of the following correctly describes one of these explanations?
A fall in the price level, holding foreign prices and the exchange rate constant, increases net exports.
The initial impact of the Fed's open market sale of government securities to banks is
a decrease of the banking system's reserve deposits at the Fed.
Saving equals
disposable income minus consumption expenditure.
The AD curve slopes
downward due to the wealth and substitution effects.
Classical macroeconomics
economy is self regulating and always at full-employment
Keynesian macroeconomics
expectations the most important factor for aggregate demand; nominal wages downwardly sticky -- therefore they do not fall quickly to increase SAS
The marginal propensity to consume is the
fraction of a change in disposable income spent on consumption expenditure.
If firms' inventories are less than they planned, aggregate planned expenditure is ____ real GDP and firms ____ their production.
greater than; increase
price level
higher prices induce people to hold more nominal money; real money (M/P, or the amount of money measured in terms of what it can buy) is not changed by prices
nominal interest rate
higher rates means the opportunity cost of holding money is higher, so hold less
Members of the Federal Reserve System's Board of Governors
hold 14-year staggered terms.
quantity of theory of money
in the long run, an increase in the quantity of money brings an equal percentage increase in the price level; based on velocity of circulation and equation of exchange (MV=P(GDP))
Increases in capital, technology, and full employment labor
increase LRAS (rightward shift -- SRAS shifts by same amount).
The multiplier is 2.5 and the SAS curve is upward sloping. Investment increases by $20 billion. In the short run, equilibrium real GDP will
increase by less than $50 billion.
When price levels rise, the quantity of nominal money demanded will ____ and the quantity of real money demanded will ____.
increase; stay the same
When autonomous expenditure increases, equilibrium aggregate expenditure
increases by a greater amount due to the multiplier.
velocity of circulation
average number of times in a year a dollar is used to purchase goods and services in GDP; V = P(GDP)/M
In the short run, when the Fed increases the quantity of money
bond prices rise and the interest rate falls.
In a change to immigration policy, during 2012, "people younger than 30 who came to the US before the age of 16, pose no criminal or security threat, and were successful students or served in the military can get a two-year deferral from deportation, Homeland Security Janet Napolitano said," according to CNN, 06/16/2012. If many of these immigrates had previously been afraid to work, now as a result of being able to work legally,
both the short-run and long-run aggregate supply curves shift rightward.
In the short run,
capital and technology are fixed, but labor is not.
What is the multiplier?
change in total output caused by a change in autonomous expenditure (spending); Multiplier = change in output/change in spending = 1/(1-MPC)
loans
commitments of fixed amounts of money for agreed-upon periods of time
actual reserves
consists of notes and coins in its vault and its deposit at the Fed
Depository institutions provide 4 benefits:
create liquidity, pool risk, lower the cost of borrowing, and lower the cost of monitoring borrowers.
Money in the US
currency -- notes and coins held outside the banks; deposits at depository institutions.
In the short run, the intersection of the aggregate demand and the short-run aggregate supply curves,
determines equilibrium price level, is a point where there is neither a surplus nor a shortage of goods, and determines the equilibrium level of real GDP.
Which of the following is true?
MPS + MPC = 1
In the money market, if the interest rate exceeds the equilibrium interest, there is a surplus of money. How is the surplus eliminated?
People buy bonds to rid themselves of the surplus money, bidding up their price and pushing interest rates down.
Structure of Federal Reserve
The Board of Governors, the regional Federal Reserve banks, and the the Federal Open Market Committee.
In the short run, an increase in government expenditure on goods and services _____ real GDP and _____ the price level.
increases; rises
The multiplier effect exists because a change in autonomous expenditure
leads to changes in income, which generate further spending.
currency drain
leakage of reserves into currency; people hold some fraction of their money as currency
In the Keynesian model of aggregate expenditure, real GDP is determined by the
level of aggregate demand.
The quantity theory of money predicts that in the ____, a 10 percent increase in the quantity of money leads to a 10 percent increase in ____.
long run; price level
securities
longer-term US government bonds and other bonds such as mortgage-backed securities
Federal Open Market Committee
main policy-making group in the Fed Reserve System; Board of Governors, president of Fed Reserve Bank of NY, 11 presidents of other regional Fed Reserve banks of whom, on a rotating basis, 4 are voting members; meets every 6 weeks to formulate monetary policy.
MPS
marginal propensity to save
The most direct way in which money replaces barter is through its use as a
medium of exchange.
Controlling the quantity of money and interest rates to influence aggregate economic activity is called
monetary policy.
inflation rate
money growth rate - real GDP growth
Because of changes in the ____, the long-run effect of a $10 increase in investment on real GDP equals ____.
money wage rate and price level; zero
real GDP
more activity induces more holding of money
The opportunity cost of holding money is the
nominal interest rate on assets other than money.
reserves
notes and coins in its vault or its deposit at the Federal Reserve
When the economy is at full employment (equivalently, when unemployment is at the natural rate),
quantity of real GDP supplied is equal to potential output.
Monetarist macroeconomics
quantity theory of money is most important influence on aggregate demand; if money keeps growing at stead pace, aggregate demand fluctuation will be minimized
currency drain ratio
ratio of currency to deposits
desired reserve ratio
ratio of the bank's reserves to total deposits that a bank plans to hold
At long-run macroeconomic equilibrium, _____.
real GDP equals potential GDP
We distinguish between the long-run aggregate supply curve and the short-run aggregate supply curve. In the long run
real GDP equals potential GDP.
When the labor market is at full employment,
real GDP equals potential GDP.
During periods of inflation, which function of money is most severely affected?
store of value.
open market operation
the purchase or sale of government securities by the Fed from or to a commercial bank or the public
The money multiplier determines how much
the quantity of money will be expanded given a change in the monetary base.
money multiplier
the ratio of the change in the quantity of money to the change in the monetary base; depends on the desired reserve ratio and the currency drain ratio
demand for money
the relationship between the quantity of real money demanded and the nominal interest rate when all other influences on the amount of money that people wish to hold remain the same
monetary base
the sum of the Fed Reserve notes, coins and depository institutions' deposits at the Fed; desired holdings depends on the quantity of money
Which of the following directly shifts the short-run aggregate supply curve?
a change in resource prices
An increase in currency held outside the banks is _____.
a currency drain
What is the marginal propensity to consume?
C = C1 + MPC(GDP) MPC is the change in output for a given change of disposable income; in-between 0 and 1.
Change in real GDP =
Change in AE * Multiplier
Slope of AE =
Change in AE/Change in Real GDP or MPC
MPC =
Change in Consumption/Change in Disposable Income
Change in Money Supply =
Change in Monetary Base * MM
Desired Reserves =
Desired Reserve Ratio * Deposits
Changes in demand
Expectations (of future incomes, inflation and profits); Fiscal and Monetary Policy (Government spending and taxes (fiscal policy), changing money supply/interest rates (monetary policy)); World Economy (higher output in rest of world means more exports from US)
liabilities
Fed Reserve notes in circulation + banks' deposits at the Federal Reserve
An open market operation occurs when the _____ buys or sells securities _____.
Federal Reserve System; in the open market
Autonomous Expenditure =
G + I + X
Inventory adjustment mechanism
If planned spending is lower than output, firms will find they have excess inventories. In response, they cut production and employment until output falls to the level of planned spending
Required Reserves =
Required Reserve Ratio * Deposits
Changes in short-run aggregate supply
SRAS will shift in response to a resource price change, traditionally a change in nominal wages; if nominal wages rise, holding the price level constant, firms will supply less output
Which of the following best describes the chain of events in the money creation process?
The monetary base increases. Banks acquire excess reserves which they loan out, increasing deposits and also the quantity of money. The new deposits that create additional excess reserves.
Excess Reserves =
Total reserves - Desired reserves
liquid assets
US government Treasury bills and commercial bills
assets
US government securities + loans to depository institutions
Substitution effect
When prices increase but other things remains the same, interest rates rise because the real money supply in the economy falls; domestic prices are not higher relative to international prices
Wealth effect
When prices increase but other things remains the same, the real value of people's wealth decreases; when real wealth falls, consumption falls
Feds balance sheet and tools
When the Fed BUYS securities, it ays for them with newly created reserves held by the banks; when they SELL securities, they are paid for with reserves held by banks
Aggregate demand
Y = C + I + G + X - M
Suppose consumers decrease their consumption expenditure because they worry about their income will be in the future. There is
a leftward shift of the aggregate demand curve.
In the long run,
actual output is equal to potential GDP at all prices
excess reserves
actual reserves -desired reserves
The consumption function shows how much
all households plan to consume at each level of real disposable income.
Nominal wages are fixed
along any SRAS curve.
Long-Run Aggregate Supply (LRAS)
amount of GDP supplied at full employment given a mixed level of capital and technology; not affected by price level -- real wage rate remains at unchanged at its full employment level
Your real wealth is measured as the
amount of goods and serves your wealth will buy.
below full-employment equilibrium (Business Cycle)
an equilibrium in which potential GDP exceeds real GDP
full-employment equilibrium (Business Cycle)
an equilibrium in which real GDP equals potential GDP
above full-employment equilibrium (Business Cycle)
an equilibrium in which real GDP exceeds potential GDP
In a simple economy in which prices are constant and with no income taxes or imports, the marginal propensity to consumer is 0.8. In order to increase real GDP by $500 billion, then
an increase in autonomous expenditure of $100 billion will lead to the increase of $500 billion.
Potential GDP (LRAS) will increase if
an increase in the full-employment quantity of labor, an increase in the quantity of capital, and advance in technology; SRAS increases along with LRAS
The short-run multiplier is equal to 3, real GDP equals potential GDP of $8,000, and the price level is equal to 100. Suppose that government expenditure decreases by $200. The long-run effect of the decrease in government expenditure changes real GDP by
nothing; that is, in the long run real GDP equals $8,000.
Long-run macroeconomic equilibrium
occurs when real GDP equals potential GDP -- when the economy is on its LAS curve; intersection of AD and LAS curves
Short-run macroeconomic equilibrium
occurs when the quantity of real GDP demanded equals the quantity of real GDP supplied at the point of intersection of the AD curve and the SAS curve
A decrease in the money wage rate increases ____ and an increase in the full employment quantity of labor increases ____.
only the SAS; the SAS and the LAS
Fed's Policy Tools
open market operations, last resort loans, required reserve ratios
When the nominal interest rate rises, the quantity of money demanded decreases because
people shift funds from money holdings to interest-bearing assets.
In the very short term, in the Keynesian model, which of the following is fixed and does not change when GDP changes?
planned investment
The short-run aggregate supply curve is upward sloping because in the short run the
price level changes but the money wage rate does not.
The SRAS curve is upward sloping; as prices rise,
profit rises and firms have an incentive to increase quantity supplied of real GDP.
Determinants of quantity supplied of
real GDP.
Short-Run Aggregate Supply (SRAS)
relationship between real GDP supplied and the price level holding constant wages and other resource prices; if prices increase, real wages fall; profits rise, so firm have an incentive to increase production; opposite if prices fall
If taxes are increased, the AD curve
shifts leftward and aggregate demand decreases.
In a short-run macroeconomic equilibrium, real GDP exceeds potential GDP. If aggregate demand does not change, then the
short-run aggregate supply curve will shift leftward as the money wage rate rises.
The relationship between the multiplier and the MPC is
that as the MPC increases, so does the value of the multiplier.
last resort loans
the Fed stands ready to lend reserves to depository institutions that are short of reserves
The velocity of circulation is
the average number of times a dollar bill is used in a year to buy the goods and services in GDP.
financial innovation
the development of new financial products; lower the cost of deposits or to increase the return from lending; more innovation generally reduce the need to hold money
required reserve ratio
the minimum percentage of deposits that a depository institution must hold as reserves ; ratio of bank's reserves to total deposits that a bank is required to hold (rarely changes)