Macro Econ

If a cup of coffee costs 2 euros in Paris and $6 in New York and purchasing-power parity holds, what is the exchange rate?

1/3 euro per dollar

Nominal Exchange Rate = Price of a Basket of Goods AbroadPrice of a Basket of Goods Domestically = 50 pesos$1.25 = 40 pesos per dollar

A can of soda costs $1.25 in the United States and 25 pesos in Mexico. Assume purchasing-power parity holds.

A sudden crash in the stock market shifts

A stock market crash, or any event that causes consumers to cut back on spending and firms to cut back on their investment, reduces aggregate demand at any given price level (that is, causes a leftward shift of the aggregate-demand curve). See Section: Why the Aggregate-Demand Curve Might Shift.

misperceptions theory

According to the misperceptions theory, the economy falls into recession when the price level falls below the expected price level, so that individual firms temporarily misperceive the fall in the price of their own product as a fall in the relative price of their product, motivating them to cut back on production. Over time, as people observe that the lower price is part of a fall in the general price level, with relative prices remaining constant, their expectations adjust, and the economy returns to the natural rate of output. See Section: Why the Aggregate-Supply Curve Slopes Upward in the Short Run.

sticky price theory

According to the sticky-price theory, the economy goes into recession because not all prices adjust quickly. Over time, firms are able to adjust their prices more fully, and the economy returns to the natural rate of output.

sticky wage theory

According to the sticky-wage theory, the economy falls into recession when the price level declines so that real wages are too high, causing labor demand to be too low. Over time, as nominal wages adjust so that real wages decline, the economy returns to full employment.

Change Needed to Increase AD Consumer expectations about future profitability

Consumer spending is influenced, in part, by consumer expectations. If households expect strong economic growth and higher earnings, they will spend more today. The increase in current consumption causes an increase in aggregate demand at each price level.

For each country, select the predicted exchange rate of the local currency per U.S. dollar. (Hint: Recall that the U.S. price of a Big Mac was $4.93.) Chile 2,100 pesos

For example, the predicted exchange rate in Chile is 426 pesos/$: Predicted Exchange Rate = Units of Foreign Currency per Big Mac$4.93 per Big Mac = 2,100 pesos per Big Mac$4.93 per Big Mac = 426 pesos/$

Change Needed to Decrease AS Human capital

Human capital, the knowledge and skills embodied in the workforce, is an important determinant of productivity. Reductions in human capital reduce productivity (output per hour of labor), causing firms to supply a lower quantity of aggregate output at each price level. Declining human capital shifts the AS curve to the left.

Indicate what is happening to the U.S. real exchange rate in each of the following situations. The U.S. nominal exchange rate is unchanged, but prices rise faster in the United States than abroad.

If the U.S. nominal exchange rate is unchanged, but prices rise faster in the United States than abroad, the real exchange rate increases.

Change Needed to Decrease AS Inflation expectations

If workers, landlords, and firms expect higher rates of inflation in the future, they will negotiate existing wage and rent contracts in order to compensate for rising prices. The increase in wages and rents represents an increase in input costs for firms, reducing the quantity of aggregate output supplied at each price level. Higher inflation expectations shift the AS curve to the left.

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

Short run, in the long run increase in aggregate demand affects output in the short run. In the long run, however, an increase in aggregate demand has no impact on output and affects only the price level, as wages and prices adjust to bring output back to the natural rate of output. See Section: The Effects of a Shift in Aggregate Demand.

Indicate whether each of the following groups would be happy or unhappy if the U.S. dollar appreciated. U.S. manufacturing industries

U.S. manufacturing industries would be unhappy if the U.S. dollar appreciated because their prices would be higher in terms of foreign currencies, which will reduce their sales.

If a country is experiencing a trade surplus, then the value of exports exceeds the value of imports. Because net exports is defined as exports minus imports, this implies that net exports must be greater than zero. Since you know that income ( Y ) is equal to C+I+G+NX , if net exports is positive, this means that income is greater than domestic spending ( C+I+G ). As you saw in the previous question, saving is what is left over from income after consumption and government purchases ( S=Y−C−G ). Therefore:

Y > C+I+G Y−C+G > I S > I Because the country is saving more than it is investing, some of its saving must be going abroad. Therefore, net capital outflow must be positive.

Stagflation is caused by

a leftward shift in the aggregate-supply curve.

If a nation's currency doubles in value on foreign exchange markets, the currency is said to ________, reflecting a change in the ________ exchange rate.

appreciate, nominal

Comparing the U.S. economy today to that of 1950, one finds that today, as a percentage of GDP,

exports and imports are both higher.

A change in the expected price level shifts

short-run aggregate supply curve

The idea that economic downturns result from an inadequate aggregate demand for goods and services is derived from the work of which economist?

Economist John Maynard Keynes believed that recessions and depressions can occur because of inadequate aggregate demand for goods and services. Because of this, he advocated policies to increase aggregate demand during times of recession. This is in contrast to the classical approach of allowing the economy to correct itself in the long run. See Section: The Origins of the Model of Aggregate Demand and Aggregate Supply.

Dutch pension funds holding U.S. government bonds Indicate whether each of the following groups would be happy or unhappy if the U.S. dollar appreciated.

Dutch pension funds holding U.S. government bonds would be happy if the U.S. dollar appreciated. They would then get more euros for each dollar they earned on their U.S. investment. In general, if you have an investment in a foreign country, you are better off if that country's currency appreciates.

The theory of purchasing-power parity says that higher inflation in a nation causes the nation's currency to ________, leaving the ________ exchange rate unchanged.

depreciate, real

Change Needed to Increase AD Government spending

Because government purchases are one component of aggregate demand, an increase in government spending causes aggregate demand to increase at each price level.

Indicate what is happening to the U.S. real exchange rate in each of the following situations. The U.S. nominal exchange rate declines, and prices are unchanged in the United States and abroad.

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

Indicate what is happening to the U.S. real exchange rate in each of the following situations. The U.S. nominal exchange rate declines, and prices rise faster abroad than in the United States.

If the U.S. nominal exchange rate declines and prices rise faster abroad than in the United States, the real exchange rate decreases. See Sections: Nominal Exchange Rates; and Real Exchange Rates.

Indicate what is happening to the U.S. real exchange rate in each of the following situations. The U.S. nominal exchange rate is unchanged, but prices rise faster abroad than in the United States.

If the U.S. nominal exchange rate is unchanged, but prices rise faster abroad than in the United States, the real exchange rate decreases.

Change Needed to Increase AD The value of the domestic currency relative to the foreign currency

When the value of the domestic currency depreciates against foreign currencies, foreigners will find domestic products less expensive and citizens of the domestic country will find foreign goods more expensive. The depreciation of the domestic currency causes exports to rise and imports to fall. Because net exports are one component of aggregate demand, this increase in net exports (exports minus imports) causes an increase in aggregate demand at each price level.

Change Needed to Decrease AS Technology

Loss of technology reduces productivity (output per hour of labor), causing firms to supply a lower quantity of aggregate output at each price level. Declines in technology shift the AS curve to the left.

In an open economy, national saving equals domestic investment

National saving is the nation's income that is left after paying for current consumption and government purchases, that is: S=Y−C−G . Substituting the term for GDP ( Y=C+I+G+NX ) into the national saving identity, national saving can be rewritten as S=I+NX . Since the value of net exports must equal the value of net capital outflow, national saving can be further rewritten as S=I+NCO . Thus, national saving equals domestic investment plus the net outflow of capital abroad. See Section: Saving, Investment, and Their Relationship to the International Flows.

Nominal Exchange Rate = Price of a Basket of Goods AbroadPrice of a Basket of Goods Domestically = 25 pesos$1.25 = 20 pesos per dollar

Suppose a monetary expansion caused all prices in Mexico to double so that soda rose to 50 pesos.

Change Needed to Increase AD Interest rates

The real interest rate is a key determinant of investment. Lower interest rates reduce the cost of borrowing and encourage business investment. The increase in investment causes aggregate demand to increase at each price level.

If the value of a nation's imports exceeds the value of its exports, which of the following is NOT true?

When the value of a nation's imports exceeds the value of its exports, its net exports are negative—that is, the nation is buying more goods and services from foreigners than it is selling to them. To finance the excess of the nation's purchases from abroad over its receipts, it must sell assets abroad—that is, capital must flow into the country, so that the nation is experiencing a net inflow (not an outflow) of capital. Recall that GDP equals the sum of consumption, investment, government purchases, and net exports ( Y=C+I+G+NX ). If NX is negative, GDP must be less than the sum of consumption, investment, and government purchases. Since Y<C+I+G , you can see that Y−C−G<I . Thus, domestic investment is greater than national saving ( Y−C−G ). See Section: Summing Up.

Because of how net capital outflow and net exports are defined and measured, a change in one term must result in a change in the other for the identity to remain true. In this case, the increase in U.S. net exports is matched by an increase in U.S. net capital outflow. Net capital outflow is defined as the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreigners. In order for net capital outflow to increase, either the purchase of foreign assets by domestic residents must increase, or the purchase of domestic assets by foreigners must decrease

Your investment abroad in Thai assets, such as bonds, stocks, or even the local currency, increases the purchase of foreign assets by U.S. residents, which causes an increase in the net capital outflow. Alternatively, if you choose to exchange the THB 90,000 at your local bank, the subsequent purchase of Thai stock by the bank is also considered an increase in the purchase of foreign assets by domestic residents and has the same effect as your personally purchasing Thai bonds or stocks.