Macroeconomics Final

Changes in NX

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

Changes in G

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

Changes in I

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

The Interest Rate Effect (P and I)

- Suppose P decreases o Buying g&s requires less dollars o People try to reduce their holding of money by lending dome of them out or deposit the excess money in an interest bearing savings account o This drives sown interest rates - Results: I increases (recall I depends negatively on interest rates)

Wealth Effect (P and C)

- Suppose P decreases o The dollars people hold buy more g&s, so the real value of money increases o People feel wealthier - Results: C increases

The Exchange Rate Effect (P and NX)

- Suppose P decreases o US interest rates decrease (the interest rate effect) o Foreign investor desire less US bonds o Higher supply of $ in foreign exchange market o US exchange rate depreciates - Result: NX falls

Stock Market Crash:

1. Affects C, AD curve 2. C falls, so AD shifts left 3. SR eq'm at B. P and Y lower, unemp higher 4. Over time, PE falls, SRAS shifts right, until LR eq'm at C. Y and unemp back at initial levels.

Four steps to analyzing economic fluctuations:

1. Determine whether the event shifts AD or AS. 2. Determine whether curve shifts left or right. 3. Use AD-AS diagram to see how the shift changes Y and P in the short run. 4. Use AD-AS diagram to see how economy moves from new SR eq'm to new LR eq'm.

Suppose the current equilibrium interest rate is r1. Which of the following events would cause the equilibrium interest rate to increase? A. Money demand increases. B. The price level decreases. C. The Federal Reserve increases the money supply. D. All of the above are correct.

A. Money demand increases.

When the money supply increases A. interest rates rise and so aggregate demand shifts right. B. interest rates fall and so aggregate demand shifts right. C. interest rates rise and so aggregate demand shifts left. D. interest rates fall and so aggregate demand shifts left.

B. interest rates fall and so aggregate demand shifts right.

What the three have in common:

o In all 3 theories, Y deviates from YN when P deviates from PE. Y = YN + a(P - PE ) Output, Natural rate of output (long-run), a > 0 measures how much Y responds to unexpected changes in P, Actual price level, Expected price level

Changes in C

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

When the price level falls the quantity of A. consumption goods demanded and the quantity of net exports demanded both rise. B. consumption goods demanded falls, while the quantity of net exports demand rises. C. consumption goods demanded and the quantity of net exports demanded both fall. D. consumption goods demanded rises, while the quantity of net exports demanded falls.

A. consumption goods demanded and the quantity of net exports demanded both rise.

The sticky-wage theory of the short-run aggregate supply curve says that when the price level is lower than expected, A. production is less profitable and employment falls. B. production is less profitable and employment rises. C. production is more profitable and employment rises. D. production is more profitable and employment falls.

A. production is less profitable and employment falls.

In the short run, open-market purchases A. decrease investment, nominal interest rates, and real GDP. B. increase investment and real GDP, and decrease nominal interest rates. C. increase investment and nominal interest rates, and decrease real GDP. D. increase real GDP and nominal interest rates, and decrease investment.

B. increase investment and real GDP, and decrease nominal interest rates.

Other things the same, a decrease in the price level motivates people to hold A. more money, so they lend more, and the interest rate rises. B. more money, so they lend less, and the interest rate falls. C. less money, so they lend more, and the interest rate falls. D. less money, so they lend less, and the interest rate rises.

C. less money, so they lend more, and the interest rate falls.

Refer to Stock Market Boom 2015. What happens to the expected price level and what impact does this have on wage bargaining? A. The expected price level falls. Bargains are struck for lower wages. B. The expected price level rises. Bargains are struck for higher wages. C. The expected price level rises. Bargains are struck for lower wages. D. The expected price level falls. Bargains are struck for higher wages.

B. The expected price level rises. Bargains are struck for higher wages.

According to the aggregate demand and aggregate supply model, in the long run a decrease in the money supply leads to A. an increase in real GDP and an increase in the price level. B. a decrease in the price level but does not change real GDP. C. decreases in both the price level and real GDP. D. an increase in the price level but does not change real GDP.

B. a decrease in the price level but does not change real GDP.

If speculators gained greater confidence in foreign economies so that they wanted to buy more assets of foreign countries and fewer U.S. bonds, A. the dollar would depreciate which would cause aggregate demand to shift right. B. the dollar would appreciate which would cause aggregate demand to shift right. C. the dollar would depreciate which would cause aggregate demand to shift left. D. the dollar would appreciate which would cause aggregate demand to shift left.

A. the dollar would depreciate which would cause aggregate demand to shift right.

The Stock Market Boom of 2015 Imagine that in 2015 the economy is in long-run equilibrium. Then stock prices rise more than expected and stay high for some time. Refer to Stock Market Boom 2015. In the short run what happens to the price level and real GDP? A. the price level rises and real GDP falls. B. both the price level and real GDP rise. C. the price level falls and real GDP rises. D. both the price level and real GDP fall.

B. both the price level and real GDP rise.

In the context of aggregate demand and aggregate supply, the wealth effect refers to the idea that, when the price level decreases, the real wealth of households A. decreases and as a result consumption spending increases. This effect contributes to the upward slope of the aggregate-supply curve. B. increases and as a result consumption spending increases. This effect contributes to the downward slope of the aggregate-demand curve. C. decreases and as a result households increase their money holdings; in turn, interest rates increase and investment spending decreases. This effect contributes to the upward slope of the aggregate-supply curve. D. increases and as a result households increase their money holdings; in turn, interest rates increase and investment spending decreases. This effect contributes to the downward slope of the aggregate-demand curve.

B. increases and as a result consumption spending increases. This effect contributes to the downward slope of the aggregate-demand curve.

The sticky-price theory of the short-run aggregate supply curve says that when the price level is higher than expected, some firms will have A. higher than desired prices, which leads to an increase in the aggregate quantity of goods and services supplied. B. lower than desired prices, which leads to an increase in the aggregate quantity of goods and services supplied. C. lower than desired prices, which leads to a decrease in the aggregate quantity of goods and services supplied D. higher than desired prices, which leads to a decrease in the aggregate quantity of goods and service supplied.

B. lower than desired prices, which leads to an increase in the aggregate quantity of goods and services supplied.

A decrease in the expected price level shifts short-run aggregate supply to the A. left, and an increase in the actual price level shifts short-run aggregate supply to the left. 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 does not shift short-run aggregate supply. D. 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

Refer to Stock Market Boom 2015. In the long run, the change in price expectations created by the stock market boom shifts A. long-run aggregate supply left. B. short-run aggregate supply left. C. long-run aggregate supply right. D. short-run aggregate supply right.

B. short-run aggregate supply left.

The primary argument against active monetary and fiscal policy is that A. history demonstrates that interest rates respond unpredictably to active policies, leading to unpredictable effects on income. B. these policies affect the economy with a long lag. C. these policies affect the economy too quickly and with too much impact. D. attempts to stabilize the economy do not constitute a proper role for government in a democratic society.

B. these policies affect the economy with a long lag.

Take the following information as given for a small, imaginary economy: • When income is $10,000, consumption spending is $6,500. • When income is $11,000, consumption spending is $7,250. Refer to Scenario 34-1. For this economy, an initial increase of $200 in net exports translates into a(n) A. $1,400 increase in aggregate demand in the absence of the crowding-out effect. B. $800 increase in aggregate demand when the crowding-out effect is taken into account. C. $800 increase in aggregate demand in the absence of the crowding-out effect. D. $570 increase in aggregate demand when the crowding-out effect is taken into account.

C. $800 increase in aggregate demand in the absence of the crowding-out effect.

Which of the following shifts long-run aggregate supply right? A. an increase in technology, but not the human capital stock. B. an increase in human capital but not technology. C. an increase in either technology or the human capital stock. D. neither an increase in technology nor the human capital stock.

C. an increase in either technology or the human capital stock.

According to the misperceptions theory of the short-run aggregate supply curve, if a firm thought that inflation was going to be 4 percent and actual inflation was 2 percent, then the firm would believe that the relative price of what it produces had A. increased, so it would increase production. B. increased, so it would decrease production. C. decreased, so it would decrease production. D. decreased, so it would increase production.

C. decreased, so it would decrease production.

The price of imported oil rises. If the government wanted to stabilize output, which of the following could it do? A. decrease government expenditures or increase the money supply B. decrease government expenditures or decrease the money supply C. increase government expenditures or increase the money supply D. increase government expenditures or decrease the money supply

C. increase government expenditures or increase the money supply

According to the liquidity preference theory, an increase in the overall price level of 10 percent A. decreases the quantity of money demanded by 10 percent, leaving the interest rate and the quantity of goods and services demanded unchanged. B. increases the quantity of money supplied by 10 percent, leaving the interest rate and the quantity of goods and services demanded unchanged. C. increases the equilibrium interest rate, which in turn decreases the quantity of goods and services demanded. D. decreases the equilibrium interest rate, which in turn increases the quantity of goods and services demanded.

C. increases the equilibrium interest rate, which in turn decreases the quantity of goods and services demanded.

Take the following information as given for a small, imaginary economy: • When income is $10,000, consumption spending is $6,500. • When income is $11,000, consumption spending is $7,250. Refer to Scenario 34-1. The multiplier for this economy is A. 1.53. B. 2.85. C. 7.00. D. 4.00.

D. 4.00.

Which of the following would help explain why the aggregate demand curve slopes downward? A. A lower price level causes domestic interest rates to rise and the real exchange rate to appreciate, which stimulates spending on net exports. B. A higher price level increases real wealth, which stimulates spending on consumption. C. An unexpectedly low price level raises the real wage, which causes firms to hire fewer workers and produce a smaller quantity of goods and services. D. A lower price level reduces the interest rate, which encourages greater spending on investment goods.

D. A lower price level reduces the interest rate, which encourages greater spending on investment goods.

If the money-supply curve MS on the left-hand graph were to shift to the left, this would A. create, until the interest rate adjusted, an excess demand for money at the interest rate that equilibrated the money market before the shift. B. shift the AD curve to the left. C. represent an action taken by the Federal Reserve. D. All of the above are correct.

D. All of the above are correct.

If the stock market booms, then A. aggregate demand increases, which the Fed could offset by purchasing bonds. B. aggregate supply increases, which the Fed could offset by purchasing the money supply. C. aggregate supply increases, which the Fed could offset by selling bonds. D. aggregate demand increases, which the Fed could offset by selling bonds.

D. aggregate demand increases, which the Fed could offset by selling bonds.

The initial impact of an increase in an investment tax credit is to shift A. aggregate demand left. B. aggregate supply left. C. aggregate supply right. D. aggregate demand right.

D. aggregate demand right.

Other things the same, if the price level falls, people A. decrease foreign bond purchases, so the supply of dollars in the market for foreign-currency exchange decreases. B. increase foreign bond purchases, so the supply of dollars in the market for foreign-currency exchange decreases. C. decrease foreign bond purchases, so the supply of dollars in market for foreign-currency exchange increases. D. increase foreign bond purchases, so the supply of dollars in the market for foreign-currency exchange increases.

D. increase foreign bond purchases, so the supply of dollars in the market for foreign-currency exchange increases.

In order to understand how the economy works in the short run, we need to A. understand that money is neutral in the short run. B. understand that "money is a veil." C. study the classical model. D. study a model in which real and nominal variables interact.

D. study a model in which real and nominal variables interact.

How is the new long-run equilibrium different from the original one? A. the price level and real GDP are lower. B. the price level and real GDP are higher C. the price level is the same and real GDP is higher. D. the price level is higher and real GDP is the same.

D. the price level is higher and real GDP is the same.

Misperceptions Theory

o Imperfection: Firms may confuse changes in P with changes in the relative price of the products they sell. o 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. o So, an increase in P can cause an increase in Y, making the SRAS curve upward-sloping.

The Sticky-Price Theory

o Imperfection: Many prices are sticky in the short run. Due to menu costs, the costs of adjusting prices. Examples: cost of printing new menus, the time required to change price tags o Firms set sticky prices in advance based on PE. o Suppose the Fed increases the money supply unexpectedly. In the long run, P will rise. o In the short run, firms without menu costs can raise their prices immediately. o Firms with menu costs wait to raise prices. Meanwhile, their prices are relatively low, which increases demand for their products, so they increase output and employment. o Hence, higher P is associated with higher Y, so the SRAS curve slopes upward.

The Sticky-Wage Theory

o Imperfection: Nominal wages are sticky in the short run, they adjust sluggishly. Due to labor contracts, social norms o Firms and workers set the nominal wage in advance based on PE, the price level they expected to prevail. o If P > PE , revenue is higher, but labor cost is not. Production is more profitable, so firms increase output and employment. o Hence, higher P causes higher Y, so the SRAS curve slopes upward.