Macro test 3

The Sticky-Wage Theory​

-Imperfection: ​Nominal wages are sticky in the short run,​ they adjust sluggishly. ​ -If P > PE, ​ Revenue is higher, but labor cost is not. ​ Production is more profitable, so firms increase output and employment.

When NCO < 0,

"capital inflow"​ Foreign purchases of domestic assets exceed domestic purchases of foreign assets​

When NCO > 0,

"capital outflow"​ Domestic purchases of foreign assets exceed foreign purchases of domestic assets​

The theory of liquidity preference​

-A simple theory of the interest rate (r)​ -r adjusts to balance supply and demand ​ for money​ -Nominal interest rate, real interest rate​ -Assumption: expected rate of inflation is constant​

The Misperceptions Theory​

-Imperfection: ​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. ​

The Sticky-Price Theory​

-Imperfection: ​Many prices are sticky in the short run. Firms set sticky prices in advance based ​ on PE​

Net capital outflow, NCO (net foreign investment)​

-Purchase of foreign assets by domestic residents​ -Foreign direct investment​ -Foreign portfolio investment​ -Minus the purchase of domestic assets by foreigners​

Supply shock: ​

An event that directly alters firms' costs and prices​ Shifting the AS and PC curves ​ Example: large increase in oil prices ​

-Expansionary fiscal policy​:

An increase in G and/or decrease in T, ​ shifts AD right​

Common reasons for policies that restrict imports:​

Save jobs in a domestic industry that has difficulty competing with imports​ Reduce the trade deficit​

Fiscal policy: ​

Setting the level of government spending and taxation by government policymakers​

Depressions​

Severe recessions (very rare)​

Phillips curve, PC: ​

Short-run trade-off between inflation and unemployment ​

Theories that explain why the AS curve slopes upward in short-run:​

Sticky-wage theory​ Sticky-price theory​ Misperceptions theory​

Why the AD Curve Might Shift​: Changes in C​ ​

Stock market boom/crash ​ Preferences re: consumption/saving tradeoff​ Tax hikes/cuts ​

Arbitrage​

Take advantage of price differences for the same item in different markets​

Classical economics:​

The Classical Dichotomy, the separation of variables into two groups: ​ Real - quantities, relative prices​ Nominal - measured in terms of money​

Natural-rate hypothesis: ​

The claim that unemployment eventually returns to its normal or "natural" rate, regardless of the inflation rate​

If purchasing power of the dollar is always the same at home and abroad​

Then the real exchange rate cannot change​

Rational expectations: ​

Theory according to which people optimally use all the information they have​

Purchasing-power parity​ ​

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

When a foreigner purchases a good ​ from the U.S., ​

U.S. exports and NX increase​ The foreigner pays with currency or assets, ​ so the U.S. acquires some foreign assets, ​ causing NCO to rise. ​

When a U.S. citizen buys foreign goods, ​

U.S. imports rise, NX falls​ The U.S. buyer pays with U.S. dollars or ​ assets, so the other country acquires ​ U.S. assets, causing U.S. NCO to fall. ​

The Fed​

Use monetary policy to shift the AD curve​ Policy instrument: the money supply (MS) ​ Targets the interest rate: the federal funds rate​ Banks charge each other on short-term loans ​ Conducts open market operations to change MS ​ ​

Variables that influence money demand: ​

Y, r, and P.​

Import quota -

a limit on the quantity of imports​

Tariff -

a tax on imports​

A tax cut shifts the aggregate demand curve the farthest if a. the MPC is large and if the tax cut is permanent. b. the MPC is large and if the tax cut is temporary. c. the MPC is small and if the tax cut is permanent. d. the MPC is small and if the tax cut is temporary

a.

An increase in U.S. sales of movies to other countries raises U.S. a. exports and so raises the U.S. trade balance. b. exports and so reduces the U.S. trade balance. c. imports and so raises the U.S. trade balance. d. imports and so reduces the U.S. trade balance

a.

If government spending decreases the AD shifts

left

Nominal exchange rates change when

price levels change

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.

A tax incentive for investment has similar effects as a budget deficit: ​

r rises, NCO falls​ E rises, NX falls​

. When the Federal Reserve increases the Federal Funds target rate, it achieves this target by a. purchasing government bonds. This action will reduce investment and shift aggregate demand to the right. b. purchasing government bonds. This action will increase investment and shift aggregate demand to the right. c. selling government bonds. This action will reduce investment and shift aggregate demand to the left. d. selling government bonds. This action will increase investment and shift aggregate demand to the left

c.

A vertical long-run Phillips curve is consistent with a. the conclusion of Friedman and Phelps, but it is not consistent with the classical idea of monetary neutrality. b. the classical idea of monetary neutrality, but it is not consistent with the conclusion of Friedman and Phelps. c. both the conclusion of Friedman and Phelps and the classical idea of monetary neutrality. d. neither the conclusion of Friedman and Phelps nor the classical idea of monetary neutrality.

c.

If a country's budget deficit increases, then in the market for foreign-currency exchange, a. the supply of its currency shifts right, so the exchange rate falls. b. the demand for its currency shifts right, so the exchange rate rises. c. the supply of its currency shifts left, so the exchange rate rises. d. the demand for its currency shifts left.so the exchange rate falls.

c.

If for some reason Americans desired to decrease 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 exchange 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

c.

If the U.S. has a trade deficit and the nominal exchange rate depreciates, then other things the same a. the trade deficit rises and net capital outflow rises. b. the trade deficit rises and net capital outflow falls. c. the trade deficit falls and net capital outflows rise. d. the trade deficit falls and net capital outflows fall

c.

Suppose expected inflation and actual inflation are both low, and unemployment is at its natural rate. If the Fed then pursues an expansionary monetary policy, which of the following results would be expected in the short run? a. The short-run Phillips curve would shift to the left. b. The short-run Phillips curve would shift to the right. c. The economy would move up and to the left along a given short-run Phillips curve. d. The economy would move down and to the right along a given short-run Phillips curve.

c.

The long-run Phillips curve would shift left if a. the money supply increased or if the minimum wage was reduced. b. the money supply increased but not if the minimum wage was reduced. c. the minimum wage was reduced but not if the money supply increased. d. None of the above is correct

c.

Which of the following shifts both the short-run and long-run aggregate supply right? a. an increase in the actual price level b. an increase in the expected price level c. an increase in the capital stock d. None of the above is correct.

c.

If stock prices rise then AD shifts

right

national saving

S = I + NX

Net exports (Trade balance)​

= Value of exports - value of imports​

Contractionary fiscal policy​

A decrease in G and/or increase in T, ​ shifts AD left​

Law of one price: ​

A good should sell for the same price in all markets​

Disinflation: ​

A reduction in the inflation rate

Basic logic of purchasing-power parity​

Based on the law of one price​ A good must sell for the same price in all locations

Why the AD Curve Might Shift​: Changes in NX​ ​

Booms/recessions in countries that buy our exports​ Appreciation/depreciation resulting from international speculation in foreign exchange market

Fiscal policy also works with a long lag:​

Changes in G and T require acts of Congress.​ Legislative process can take months or years​

Automatic stabilizers: ​

Changes in fiscal policy that stimulate ​ aggregate demand when economy goes into recession​ Without policymakers having to take any deliberate action​

In the short run​

Changes in nominal variables (like the money supply or P ) can affect real variables (like Y or the u-rate).

The neutrality of money:

Changes in the money supply affect nominal but not real variables​

Depreciation (or "weakening")​

Decrease in the value of a currency​ As measured by the amount of foreign currency it can buy​ Example: dollar depreciation ​ Exchange rate (old) = 80 yen per dollar​ Exchange rate (new) = 70 yen per dollar​ (Yen appreciation)​ ​

Why the LRAS Curve Might Shift​: Changes in natural resources​

Discovery of new mineral deposits​ Reduction in supply of imported oil​ Changing weather patterns that affect agricultural production​

Saving =

Domestic investment + Net capital outflow​

Closed economy​

Economy that does not interact with other economies in the world​

Open economy​

Economy that interacts freely with other economies around the world​ It buys and sells goods and services in world product markets​ It buys and sells capital assets such as stocks and bonds in world financial markets​

An accounting identity: NCO = NX ​

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

Trade deficit:

Exports < Imports​ Net exports < 0​ Y < Domestic spending (C+I+G)​ S < I​ NCO < 0​

Trade surplus:

Exports > Imports​ Net exports > 0​ Y > Domestic spending (C+I+G)​ S > I​ NCO > 0​

Trade surplus (Positive net exports)​

Exports are greater than imports​ The country sells more goods and services abroad than it buys from other countries​

Balanced trade:

Exports equal imports​

Why the AD Curve Might Shift​: ​Changes in G​ ​

Federal spending, e.g., defense ​ State & local spending, e.g., roads, schools​

Why the AD Curve Might Shift​: Changes in I​

Firms buy new computers, equipment, factories​ Expectations, optimism/pessimism​ Interest rates, ​ Monetary policy,​ Investment Tax Credit or other tax incentives​

Monetary policy affects economy with a long lag:​

Firms make investment plans in advance, ​ so I takes time to respond to changes in r​ Most economists believe it takes at least ​ 6 months for mon policy to affect output and employment​

Demand for loanable funds​

From domestic investment (I) ​ And net capital outflow (NCO)​

Supply of loanable funds​

From national saving (S)​

Imports​

Goods and services that are produced abroad and sold domestically​

Exports​

Goods and services that are produced domestically and sold abroad​

Trade policy: ​

Government policy that directly influences the quantity of goods and services a country imports or exports​

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​

Why the LRAS Curve Might Shift​: Changes in L or natural rate of unemployment​ ​

Immigration ​ Baby-boomers retire​ Government policies reduce natural u-rate ​

Trade deficit (Negative net exports)​

Imports are greater than exports​ The country sells fewer goods and services abroad than it buys from other countries ​

Appreciation (or "strengthening")​

Increase in the value of a currency as measured by the amount of foreign currency it can buy​ -EXAMPLE Exchange rate (old) = 80 yen per dollar​ Exchange rate (new) = 90 yen per dollar​ (Yen depreciation)​

A tax cut ​

Increases households' take-home pay​ Households respond by spending a portion of this extra income, shifting AD to the right​ The size of the shift is affected by the multiplier and crowding-out effects ​

Why the LRAS Curve Might Shift​: Changes in K or H​

Investment in factories, equipment​ More people get college degrees​ Factories destroyed by a hurricane​

If stock prices fall then AD shifts

LEFT

Capital flight: ​

Large and sudden reduction in the demand for assets located in a country

Theory of purchasing-power parity​

Nominal exchange rate between the currencies of two countries​ Must reflect the price levels in those countries​

The crowding-out effect​

Offset in aggregate demand​ Results when expansionary fiscal policy raises the interest rate​ Thereby reduces investment spending​ Which reduces the net increase in aggregate demand.

Sacrifice ratio: ​

Percentage points of annual output lost ​ per 1 percentage point reduction in inflation​

Recessions​

Periods of falling real incomes and rising unemployment​

Why the LRAS Curve Might Shift​: Changes in technology​

Productivity improvements from technological progress ​

Nominal exchange rate: ​

Rate at which one country's currency trades for another​ We express all exchange rates as foreign currency per unit of domestic currency. ​

Real exchange rate:​

Rate at which the goods and services of one country trade for the goods and services of another​

Money demand ​

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 ​

In an open economy,

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

If the Fed wants to reverse the effects of an adverse supply shock on unemployment, it should a. increase the money supply growth rate which raises the inflation rate. b. increase the money supply growth rate which reduces the inflation rate. c. decrease the money supply growth rate which raises the inflation rate. d. decrease the money supply growth rate which reduces the inflation rate.

a.

If there is an adverse supply shock, then a. unemployment rises and the short-run Phillips curve shifts right. b. unemployment rises and the short-run Phillips curve shifts left. c. unemployment falls and the short-run Phillips curve shifts right. d. unemployment falls and the short-run Phillips curve shifts left

a.

Other things the same, as the price level decreases it induces greater spending on a. both net exports and investment. b. net exports but not investment. c. investment but not net exports. d. neither net exports nor investment.

a.

Other things the same, if the real interest rate in a country falls, domestic residents will desire to purchase a. more capital goods and more foreign bonds. b. more capital goods but fewer foreign bonds. c. more foreign bonds but fewer capital goods. d. fewer capital goods and fewer foreign bonds.

a.

The Federal Funds rate is the interest rate a. banks charge each other for short-term loans. b. the Fed charges depository institutions for short-term loans. c. the Fed pays on deposits. d. interest rate on 3 month Treasury bills.

a.

Which of the following can explain a decrease in the U.S. real exchange rate? a. the U.S. government budget deficit falls b. the U.S. impose import quotas c. the default risk of U.S. assets falls d. All of the above are correct.

a.

Which of the following decrease if the U.S. imposes an import quota on computer components? a. U.S. exports and U.S. imports b. U.S. exports but not U.S. imports c. U.S. imports but not U.S. exports d. neither U.S. exports nor U.S. imports

a.

3. Net capital outflow measures the imbalance between the amount of a. foreign assets held by domestic residents and domestic assets held by foreign residents. b. foreign assets bought by domestic residents and the amount of domestic assets bought by foreigners. c. foreign assets bought by domestic residents and the amount of domestic goods and services sold to foreigners. d. None of the above is correct

b.

According to Friedman and Phelps, policymakers face a tradeoff between inflation and unemployment a. only in the long run. b. only in the short run. c. in neither the long run nor short run. d. in both the short run and long run.

b.

According to the long-run Phillips curve, in the long run monetary policy influences a. both the inflation rate and the unemployment rate. b. the inflation rate but not the unemployment rate. c. the unemployment rate but not the inflation rate. d. neither the unemployment rate nor the inflation rate.

b.

Aggregate demand shifts right if a. government purchases increase and shifts left if stock prices rise. b. government purchases increase and shifts left if stock prices fall. c. government purchases decrease and shifts left if stock prices rise. d. government purchases decrease and shifts left is stock prices fall.

b.

If the real exchange rate between the U.S. and Argentina is 1, then a. purchasing-power parity holds, and 1 U.S. dollar buys 1 Argentinean bolivar. b. purchasing-power parity holds, and the amount of dollars needed to buy goods in the U.S. is the same as the amount needed to buy enough Argentinean bolivars to buy the same goods in Argentina. c. purchasing-power parity does not hold, but 1 U.S. dollar buys 1 Argentinean bolivar. d. purchasing-power parity does not hold, but the amount of dollars needed to buy goods in the U.S. is the same as the amount needed to buy enough Argentinean bolivars to buy the same goods in Argentina.

b.

One year a country has positive net exports. The next year it still has positive but larger net exports a. its trade surplus fell. b. its trade surplus rose. c. its trade deficit fell. d. its trade deficit rose

b.

The country of Solidia is politically very stable and has a long tradition of respecting property rights. If several other countries suddenly became politically unstable, we would expect Solidia's a. real interest rate to rise. b. real exchange rate to rise. c. net exports to rise. d. None of the above is likely.

b.

When the dollar depreciates, U.S. a. exports and imports increase. b. exports increase, while imports decrease. c. exports decrease, while imports increase. d. exports and imports decrease.

b.

Which of the following is an example of U.S. foreign portfolio investment? a. Disney builds a new amusement park near Barcelona, Spain. b. A U.S. citizen buys bonds issued by the British government. c. A Dutch hotel chain opens a new hotel in the United States. d. A citizen of Singapore buys a bond issued by a U.S. corporation

b.

An increase in the expected price level shifts short-run aggregate supply to the a. right, and an increase in the actual price level shifts short-run aggregate supply to the right. b. right, and an increase in the actual price level does not shift short-run aggregate supply. c. left, and an increase in the actual price level shifts short-run aggregate supply to the left. d. left, and an increase in the actual price level does not shift short-run aggregate supply.

d.

If the demand for dollars in the market for foreign-currency exchange shifts left, then the exchange rate a. rises and the quantity of dollars exchanged rises. b. rises and the quantity of dollars exchanged does not change. c. falls and the quantity of dollars exchanged falls. d. falls and the quantity of dollars exchanged does not change

d.

Other things the same, an increase in the U.S. interest rate causes a. demand in the market for foreign-currency exchange to increase so the exchange rate increases. b. demand in the market for foreign-currency exchange to decrease so the exchange rate decreases. c. supply in the market for foreign-currency exchange to increase so the exchange rate decreases. d. supply in the market for foreign-currency exchange to decrease so the exchange rate increases.

d.

Suppose there are both multiplier and crowding out effects but without any accelerator effects. An increase in government expenditures would a. shift aggregate demand right by a larger amount than the increase in government expenditures. b. shift aggregate demand right by the same amount as the increase in government expenditures. c. shift aggregate demand right by a smaller amount than the increase in government expenditures. d. Any of the above outcomes are possible

d.

Suppose there is an increase in government spending. To stabilize output, the Federal Reserve would a. increase government spending. b. increase the money supply. c. decrease government spending. d. decrease the money supply.

d.

When taxes decrease, consumption a. decreases as shown by a movement to the left along a given aggregate-demand curve. b. decreases as shown by a shift of the aggregate demand curve to the left. c. increases as shown by a movement to the right along a given aggregate-demand curve. d. increases as shown by a shift of the aggregate demand curve to the right.

d.

Which of the following is always correct in an open economy? a. S = I b. S = NX + NCO c. S = NCO d. S = I + NCO

d.

Real exchange rate =

e x P / P*​ Where​ P = domestic price​ P* = foreign price (in foreign currency)​ e = nominal exchange rate (foreign currency per unit of domestic currency)​

"Voluntary export restrictions" -

the government pressures another country to restrict its exports (essentially the same as an import quota)​