WGU Macroeconomics C719
What is the 'PCE Price Index'? (or Personal Consumption Expenditures price index) How does it differ from CPI? (less biased than CPI...disguises inflation trend a little less than GDP price index)
"An average of the current prices of the goods and services included in the consumption expenditure component of GDP expressed as a percentage of base-year prices." ~ has the same advantages as the GDP price index— uses current information on quantities and to some degree overcomes the sources of bias in the CPI. ~ also has an advantage shared by the CPI of focusing on consumption expenditure and therefore being a possible measure of the cost of living. ~ A WEAKNESS of the PCE price index is that it is based on data that become known AFTER the lapse of several months - so the CPI is more current
change in quantity demanded" X "demand" X Change in Demand
"Change in Quantity Demanded" - The amount of any good, service, or resource that people are willing and able to buy during a specified period at a specified price. "Demand" - The relationship between the quantity demanded and the price of a good when all other influences on buying plans remain the same. "Change in Demand" - A change in the quantity that people plan to buy when any influence on buying plans OTHER THAN the price of the good changes.
What does choosing an activity at the Margin mean, in terms of giving it up?
"How much" of the activity you must give up - adjusted at the edge
How can you describe the relationship between price level and the quantity of real GDP demanded?
"Other things remaining the same, the higher the price level, the smaller is the quantity of real GDP demanded; and the lower the price level, the greater is the quantity of real GDP demanded."
If aggregate demand increases and the aggregate supply curve is upward sloping and unchanged,
"P" rises (When the aggregate demand shifts to the right, the new equilibrium will be at a higher price level) and "Y" rises (When the aggregate demand shifts to the right, the new equilibrium will be at a higher real output)
If the economy needs to increase by $800,000 to be at full employment and the marginal propensity to consume is .75, how big an increase in investment would be needed to reach the full-employment output?
$200,000 An increase in investment of $800,000 would be needed to reach the full-employment output. With an MPC of .75, the multiplier is 4, so 4 x $200,000 = $800,000
In Figure 8.2, if current equilibrium income is $3,300, but the target level of income is $3,500, the recessionary gap is
$50, so the expenditure multiplier is 4 The recessionary gap, distance DE, measures how much aggregate expenditure must rise to bring national income up to the desired level. The ratio of the change in equilibrium income ($200) divided by the recessionary gap ($50) is the expenditure multiplier
Dannon purchased plastic containers for $20,000 and fruit for $30,000, and then added $40,000 in value by producing individual yogurts. Based on this data, Dannon's activities caused GDP to increase by how much?
$90,000 GDP includes the value of the final good, which includes the value added at each stage of production, or $20,000 + $30,000 + $40,000.
What do we call the distribution of income among the factors of production (and what are the individual 'income' names for each factor?)
'The Functional Distribution of Income' Rent (for Land) Wages (for Labor) Interest (for Capital) Profit or Loss (for Entrepreneurship)
What is the main purpose of "Operation Twist"?
(When the Fed buys long-term gov't securities and sells short-term gov't securities, the action is called Operation Twist): The idea is to lower long-term interest rates and stimulate long-term borrowing and investment expenditure.
**Aggregate Demand**
**Aggregate Demand**
**Aggregate Supply**
**Aggregate Supply**
When price changes, one should expect a change in
*quantity* supplied
MPC + MPS + MPT + MPM = MPC - Marginal Propensity to Consumer MPS - Marginal Propensity to Save MRT - Marginal Rate of Taxation MPM - Marginal Propensity to Import MRL - Marginal Rate of Leakages
1
What is the Cost of Living Index and why does the CPI not perfectly measure it?
1. B/C the CPI only measures PRICE changes for fixed quantities in the market basket - NOT quantity changes (like more natural gas use in wintertime) 2. Even those components of the cost of living that are measured by the CPI are not always measured accurately. The result is that the CPI is possibly a biased measure of changes in the cost of living.
What are the 4 types of expenditures these 4 groups spend $ on?
1. Consumption Expenditure 2. Investment 3. Gov't expenditure on goods/svcs 4. Net export of goods/svcs
What three components of aggregate expenditure INCREASE when the long-term real interest rate is low? (as a result of lowering federal funds rate, and with other things remaining the same)
1. Consumption expenditure 2. Investment 3. Net exports
What are the 4 groups of goods and services?
1. Consumption goods 2. Capital 3. Government 4. Export
What are major issues in both political and economic discussions?
1. Deficit spending 2. Debt by the government
What are the sources for expansion of human capital?
1. Education and training 2. Job experience 3. Health and diet
Federal government expendure
1. Good and services (legal system, nat'l defense, homeland security) 2. Social Security and welfare payments (and medicare / medicaid) 3. Transfers to state and local governments (to provide more equality across states and regions)
What are the Federal Govt's major expenditures? How does the it get $ for it's expenses?
1. Good and services (soc sec, medicare/medicair, nat'l defense and HLS) 2. Social Security and welfare payments 3. Transfers to state and local governments 1. Personal income taxes 2. Corporate (business) income taxes 3. Social Security taxes
State and local government expenditure
1. Goods and services 2. Welfare benefits
What are State Gov't expenditures? How does it get $ for it's expenses?
1. Goods and services (police, firefighters, education is biggest, etc) 2. Welfare benefits 1. Sales taxes 2. Property taxes 3. State income taxes
What four groups buy the final goods and svcs produced?
1. Households 2. Firms 3. Governments 4. The rest of the world
Give some reasons why costs tend to increase with output?
1. If firms are using machines and tools more, they wear out faster and break down more often 2. When more entrepreneurs are trying to start or expand businesses, there is greater competition for loans, so interest rates rise 3.In order to raise production with given resources, some labor has to work overtime at higher pay
What are the 4 factors of production?
1. Land 2. Labor 3. Capital 4. Entrepreneurship
What types of workers does the unemployment rate NOT take into account?
1. Marginally attached workers - unemployed and available for work (have looked for work in the recent past, but not in the last 4 weeks - maybe because too busy or whatnot) 2. Discouraged Workers - unemployed and available for work (have looked for work in the recent past but because of rejection, have not been actively looked in the last 4 weeks)
What are the Fed's extraordinary crisis measures?
1. Quantitative Easing 2. Credit Easing 3. Operation Twist
The Theory of Price Formation is based on 2 propositions
1. Quantity demanded is negatively related to price 2. Quantity supplied is positively related to price
The Federal Reserve has three functions
1. Sets monetary policy through decisions that affect the flow of money and credit 2. Contribute to the safety and soundness of the financial system by supervising and regulating banks 3. Bank for depository institutions and the government and makes sure the payment system works efficiently
Briefly describe the four tools that governments use to restrict international trade
1. TARIFFS: A tax imposed on a good when it is imported 2. IMPORT QUOTA: A quantitative restriction on the import of a good that limits the maximum quantity of a good that may be imported in a given period. 3. HEALTH, SAFETY & REGULATION BARRIERS: Thousands of detailed health, safety, and other regulations restrict international trade even though they weren't originally designed to have that effect. 4. VOLUNTARY EXPORT RESTRAINTS: A voluntary export restraint is like a quota allocated to a foreign exporter of the good- it decreases imports just like an import quota does, but the foreign exporter gets the profit from the gap between the domestic price and the world price.
What two approaches does the US Gov't use to measure GDP?
1. The EXPENDITURE approach 2. The INCOME approach
What are the three broad types of economies?
1. Traditional economy 2. Command (or planned) economy 3. Market economy
Final Goods (only) are counted as part of GDP - not Intermediate Goods. What are ALSO not counted in GDP?
1. Used goods (only new goods are considered, in the year they were made) 2. Financial svcs (when households buy stocks and bonds, they're making loans - not buying goods & svcs)
What are the 2 main ways that households and firms interact with the global economy?
1. international finance 2. international trade
A change in one of the ceteris paribus conditions will cause the entire supply curve to shift. The most important of these are:
1. the state of technology 2. the prices of the productive resources 3. the number of suppliers 4. expectations about the future, and 5. the prices of related goods
The nonprice determinants of demand are:
1. the tastes of the group demanding the good or service 2. the size of the group demanding the good or service 3. the income and wealth of the group demanding the good or service 4. the prices of other goods and services 5. expectations about future prices or income
The World Bank has established the threshold for absolute poverty at $1.25 per day in 2005 U.S. dollars. At this level, approximately how many people are living below the extreme poverty line?
1.3 billion people Although all regions have reduced the level of poverty, a large percentage of the world's population still faces extreme poverty
multiplier
1/(1-MPC) = 1/(MPS+MPT+MPM)
Since WWII the highest unemployment rate during a downturn was
10.8% (occurred in October 1982)
The Fed was established in
1913
In a certain year, 143,060 of a country's residents were employed and 11,844 were unemployed. Under the formal definition for being unemployed, what is the unemployment rate for that year?
7.64% Unemployment rate = (unemployed worker/labor force/)*100 = {11,844 ÷ (143,060 + 11,844)}*100 = 7.64%.
According to the rule of 70, the number of years it takes for the population to double is equal to
70 divided by the growth rate
If the labor force is 250,000 and the working-age population is 350,000, what is the labor force participation rate?
71.43% Labor force participation rate = (labor force/working age population) * 100 = (250000/350000) * 100 = 71.43%
If the unemployment rate is 3.5% and the labor force is 25,0000, what is the number of unemployed workers?
8750 Unemployment rate = (unemployed worker/labor force/)*100. This means, 3.5 = (unemployed worker/250000)*100 = 8750
What is a visual picture of the relationships between the resource market, in which income is earned, and the product market, in which income is used to purchase goods and services?
A Circular Flow Model (describes a mixed economy)
Which of the following activities is counted as part of GDP?
A baker purchasing flour to use an an ingredient for cookies to be sold to the baker's customers The value of the final product (cookies) includes the value of intermediate products like flour (nothing illegal or "under the table")
What are Excess Reserves?
A bank's actual reserves minus its desired reserves.
What are Bank Reserves and how are they calculated?
A bank's reserves consist of currency in its vaults plus the balance on its reserve account at a Federal Reserve Bank. [The currency in a bank's vaults is a reserve to meet its depositors' withdrawals]
How does a change in quantity supplied differ from a change in supply?
A change in the price affects quantity supplied, not supply.
What is a Change in Demand? What happens with a Change in Demand? (to the curve?)
A change in the quantity that people plan to buy when any influence on buying plans OTHER THAN the price of the good changes. The Demand Curve actually SHIFTS
What is Change in Supply?
A change in the quantity that suppliers plan to sell when any influence on selling plans other than the price of the good changes.
Name the largest asset and largest liability for commercial banks
A commercial bank's largest ASSET is LOANS Their largest liability is the DEPOSITS in M2 (checking/savings deposits, small time deposits, money market funds, and other deposits)
What is Economic Freedom?
A condition in which people are able to make personal choices, their private property is protected by the rule of law, and they are free to buy and sell in markets. The rule of law, an efficient legal system, and the ability to enforce contracts are essential foundations for creating economic freedom. Impediments to economic freedom are corruption in the courts and government bureaucracy; barriers to trade, such as import bans; high tax rates; stringent regulations on business, such as health, safety, and environmental regulation; restrictions on banks; labor market regulations that limit a firm's ability to hire and lay off workers; and illegal markets, such as those that violate intellectual property rights.
What is the Short-Run Phillip's Curve?
A curve that shows the relationship between the inflation rate and the unemployment rate when the natural unemployment rate and the expected inflation rate remain constant.
What happens to ALL the components of aggregate expenditure with a decrease or increase in the Federal Funds Rate?
A cut in the federal funds rate increases all the components of aggregate expenditure; a rise in the federal funds rate decreases all the components of aggregate expenditure. These changes in aggregate expenditure plans change aggregate demand, which in turn changes real GDP and the inflation rate.
What is the Real Business Cycle?
A cycle that results from fluctuations in the pace of growth of labor productivity and potential GDP.
What is the "targeting rule" for monetary policy decisions?
A decision rule for monetary policy that sets the policy instrument at a level that makes the central bank's forecast of the ultimate policy goals equal to their targets. The Fed uses the targeting rule to set the Federal Funds rate To hit the federal funds rate target, the New York Fed conducts open market operations until the supply of reserves is at just the right quantity to hit the target federal funds rate.
In setting monetary policy, what is the Instrument Rule?
A decision rule for monetary policy that sets the policy instrument by a formula based on the current state of the economy.
Which of the following decreases aggregate supply?
A decrease in labor supply If there is less input of production, aggregate supply will decrease
Which of the following will not cause a leftward shift in the aggregate demand curve?
A decrease in taxes A decrease in taxes generally does not cause a leftward shift of the aggregate demand curve
What is one of the costs of economic growth?
A deficit on the current account Increased economic growth tends to cause an increase in spending on imports, causing a deficit on the current account
Which of the following is an example of consumption expenditure, which is one of the components of aggregate demand (AD)?
A family's purchase of a durable good, such as a new refrigerator Consumption expenditure includes spending on consumer durables as well as services and nondurables
What is Discretionary Fiscal Policy?
A fiscal policy action that is initiated by an act of Congress is called a discretionary fiscal policy. A discretionary fiscal policy action requires a change in a spending program or in a tax law. Increases in defense spending or cuts in the income tax rates are examples of discretionary fiscal policy.
What is Automatic Fiscal Policy?
A fiscal policy action that is triggered by the state of the economy. For example, an increase in unemployment induces an increase in transfer payments, and a fall in incomes induces a decrease in tax revenues.
What is a Recessionary Gap?
A gap that exists when potential GDP exceeds real GDP and that brings a falling price level.
What is an Inflationary Gap?
A gap that exists when real GDP exceeds potential GDP and that brings a rising price level.
What is a FINAL good or service?
A good or service that is produced for its final user and not as a component of another good or service. Final Good: DOES count toward GDP
What is an INTERMEDIATE good or service?
A good or service that is used as a component of a final good or service. (a TIRE can be an intermediate good if used in making a car - the final good - or the tire can be considered the final good, if someone is buying a tire to replace a flat) Intermediate Good: does NOT count toward GDP
Define Consumer Price Index. What is a major purpose of the CPI?
A measure of the average of the prices paid by urban consumers for a fixed market basket of consumption goods and services. A major purpose of the CPI is to measure changes in the cost of living and in the value of money
What is 'Means of Payment'?
A method of settling a debt (like a loan)
What is the Circular Flow model?
A model of the economy that shows the circular flow of expenditures and incomes that result from decision makers' choices and the way those choices interact to determine what, how, and for whom goods and services are produced.
What is nominal GDP targeting?
A monetary policy rule that adjusts the interest rate to achieve a target growth rate for nominal GDP.
What is the k-percent rule?
A monetary policy rule that makes the quantity of money grow at k percent per year, where k equals the growth rate of potential GDP.
What is a discretionary monetary policy?
A monetary policy that is based on an expert assessment of the current economic situation.
What is Standard of Living?
A nation's standard of living is measured by the value of goods and services that its people enjoy, on average.
What is the CPI's 'Reference Base Period'?
A period for which the CPI is defined to equal 100. Currently, the reference base period is 1982-1984.
What is a Business Cycle?
A periodic but irregular up-and-down movement of total production and other measures of economic activity such as employment and income. The business cycle isn't a regular, predictable, and repeating cycle like the phases of the moon. The timing and the intensity of the business cycle vary a lot, but every cycle has two phases: 1. Expansion 2. Recession and two turning points: 1. Peak 2. Trough
What is 'Comparative Advantage'?
A person has a comparative advantage in an activity if that person can perform the activity at a lower opportunity cost than anyone else.
What happens to demand with a rise or fall in income?
A rise in income brings an increase in demand and a fall in income brings a decrease in demand for a normal good. A rise in income brings a decrease in demand and a fall in income brings an increase in demand for an inferior good
What happens to demand for a good regarding Expected Future Prices?
A rise in the expected future price of a good increases the current demand for that good and a fall in the expected future price decreases current demand
What happens to the Aggregate Supply curve with fluctuations in price level?
A rise in the price level brings an increase in the quantity of real GDP supplied and a movement up along the aggregate supply curve; a fall in the price level brings a decrease in the quantity of real GDP supplied and a movement down along the aggregate supply curve
How does price influence the aggregate demand curve and expenditure plans? (being that the price level is the only influence on expenditure plans, along the aggregate demand curve)
A rise in the price level decreases the quantity of real GDP demanded and brings a movement UP along the aggregate demand curve; a fall in the price level increases the quantity of real GDP demanded and brings a movement DOWN along the aggregate demand curve
What is Financial Stability?
A situation in which financial markets and institutions function normally to allocate capital resources and risk. It is a PREREQUISITE for achieving the goals of stable prices and maximum employment
Define 'Deflation'
A situation in which the price level is falling and the inflation rate is negative.
What is the 'PCE Price Index excluding Food and Energy'? (disguises inflation trend the least)
A smaller component of the PCE price index: The annual percentage change in the PCE price index is the Core Inflation Rate: the inflation rate, but excluding the prices of food and energy (because those fluctuate much more than other things so they need to be isolated out to get a clearer pic of inflation)
Define Economic Growth
A sustained expansion of production possibilities - Economic growth is different from the rise in incomes that occurs during the recovery from a recession. Economic growth is a sustained trend, not a temporary cyclical expansion.
'Discouraged Worker'?
A type of unemployed person, a marginally attached worker - NOT accounted for in the unemployment rate; unemployed and available for work (have looked for work in the recent past but because of rejection, have not been actively looked in the last 4 weeks)
Which of the following is not a motive for holding money?
Accumulation demand Accumulation demand is not a motive for holding money
Who was the original theorist of economic development?
Adam Smith Adam Smith was the original theorist of economic development. He was also the person who is regarded as the founder of market economics
What happens to Aggregate Supply if Potential GDP changes (shifts)?
Aggregate Supply changes also - so, with an increase in Potential GDP (vertical line shifts rightward), the Aggregate Supply curve will shift rightward (increase) Potential GDP ANCHORS Agg. Supply, so if Pot. GDP shifts, the Aggr. Supply curve shifts along with it
In 1987, Federal Reserve chair Paul Volcker was succeeded by whom?
Alan Greenspan Greenspan served as Fed chair for the remainder of Volcker's term and was then appointed to his own 14-year term
How does M1 differ from M2?
All the items in M1 are used for transaction purposes, whereas all the items in M2 a are not All the items in M1 are used for transactions purposes, whereas all the items in M2 are not
What is the 'GDP Price Index'? How does it differ from CPI? (less biased than CPI...disguises inflation trend a lot)
Also known as the GDP Deflator: An average of the current prices of ALL the goods and services included in GDP expressed as a percentage of base-year prices. 1. GDP uses the prices of ALL the goods/svcs in GDP (consumption, capital goods, gov't, export) whereas the CPI only considers consumption goods/svcs 2. The GDP price index weights each item using information about CURRENT QUANTITIES (as opposed to CPI using a past survey w/ fixed quantities) ***But GDP measures too many items to be used as a measure of cost of living
GDP Price Index X CPI?
Also known as the GDP Deflator: An average of the current prices of all the goods and services included in GDP expressed as a percentage of base-year prices. 1. GDP uses the prices of ALL the goods/svcs in GDP (consumption, capital goods, gov't, export) whereas the CPI only considers consumption goods/svcs 2. The GDP price index weights each item using information about current QUANTITIES (as opposed to CPI using a past survey of quantities, that are now always fixed from that point on until next survey is done) ~ But GDP Price Index measures too many items to be used as a measure of cost of living
What is a 'Unit of Account'?
An agreed-upon measure for stating the prices of goods and services. (same price in terms of dollars and cents, or in whatever currency in whichever country you're paying)
What is the Federal Budget?
An annual statement of the tax revenues, outlays, and surplus or deficit of the government of the United States.
What is the Equation of Exchange?
An equation that states that the quantity of money multiplied by the velocity of circulation equals the price level multiplied by real GDP.
When does an expansion end and a recession begin?
An expansion ends and a recession begins at a business cycle peak. A peak is the highest level of real GDP that has been attained up to that time. A recession ends at a trough when real GDP reaches a low point and from which a new expansion begins.
Define EXPANSION and RECESSION
An expansion is a period during which REAL GDP INCREASES. In the early stage of an expansion, real GDP remains below potential GDP and as the expansion progresses, real GDP eventually exceeds potential GDP. A period during which REAL GDP DECREASES for at least two successive quarters; or defined by the NBER as "a period of significant decline in total output, income, employment, and trade, usually lasting from six months to a year, and marked by contractions in many sectors of the economy."
What is Fiscal Stimulus, according to Keynesian Theory?
An increase in government outlays or a decrease in tax revenue designed to boost real GDP and create or save jobs (by increasing aggregate demand)
What happens to supply when there's a change in Productivity (output per unit of input)?
An increase in productivity increases supply, and vice versa
What is Cost-Push Inflation?
An inflation that BEGINS with an increase in cost (but is MAINTAINED by the growth in the quantity of money) The two main sources of cost are: increases in the money wage rate and increases in the money prices of raw materials
What is a 'Medium of Exchange'?
An object that is generally accepted in return for goods and services. (Money is a medium of exchange)
What is an example of a non-economic condition that would increase GDP but not the standard of living?
An outbreak of the SARS virus leading to large increase in the production of health care products to prevent SARS The production of preventive health care products would increase GDP. Citizens would be better off if there was no virus and the resources used to produce these healthcare products could be used to produce something else
What is a 'Store of Value'?
Any commodity or token that can be held and exchanged later for goods and services.
What is the definition of 'Money'?
Any commodity or token that is generally accepted as a means of payment.
What are Automatic Stabilizers?
Automatic fiscal policy is a consequence of tax revenues and outlays that fluctuate with real GDP. These features of fiscal policy are called automatic stabilizers because they work to stabilize real GDP without explicit action by the government.
Why would a country EXPORT something to the rest of the world?
B/c that country has a comparative advantage in producing that item and providing it to others
Which is an example of foreign direct investment (FDI) in the United States?
BMW building a car factory in Spartanburg, South Carolina States in the United States often welcome foreign direct investment and give tax credits and subsidies to foreign companies that create jobs in their cities
WHY does the price level influence the quantity of real GDP demanded?
Because a change in the price level brings a change in: • The buying power of money (a rise in price level causes people to slash spending = real GDP demanded decreases - a lower price has opposite effect) • The real interest rate (when the price rises, demand for money rises = nominal interest rate rises = people cut back on spending = real GDP decreases) • The real prices of exports and imports (the exchange rate; if your country's prices are better than other countries' prices then you buy domestic - if the reverse is true, you buy foreign goods - this can neutralize price level effects in your own economy, in the short run)
Why does a change in the money wage rate change the Aggregate Supply curve?
Because it changes the firm's costs; an increase in the real wage rate increases the firm's costs which in turn causes supply to decrease
Why does a change in the money price of other resources change Aggregate Supply?
Because it changes the firms' costs; at each price level, firms' real costs change and the quantity that firms are willing to supply changes so aggregate supply changes.
How is the "dumping" argument used as a case against international trade?
Because people suspect that countries which may be "dumping" goods on other countries in the form of exports, where they sell it for less than it costs to produce, may be either: 1. Predatory pricing (trying to drive everyone out of business, then hike up prices), or 2. Getting subsidies from their government to make up the price difference, and flooding other countries with the good
Why is avoiding bias important for the CPI?
Bias leads to: • Distortion of private contracts (the CPI may not adjust at the same rate as written into private contracts which can cause losses to the economy) • Increases in government outlays and decreases in taxes (Social Security and other benefits are directly tied to CPI and are to adjust w/ cost of living, so an overestimated bias in CPI costs taxpayers more money to compensate for increases in cost of living that are false...also, taxes are adjusted as prices rise according to CPI so if CPI is biased upward, less taxes are paid than need to be)
Bowed" PPF represent, vs a straight-line PPF?
Bowed represents increasing opportunity cost and trade-off RATE as opposed to straight-line PPF which is constant rate of opp cost increase
Generally, when firms increase output using existing resources, higher costs lead to higher prices, resulting in an upward-sloping supply curve. Which explanation does not help to explain why costs tend to increase with output?
Businesses purchasing more raw materials may be given volume discounts Volume discounts result in a lower cost of materials, so this does not help explain why costs increase with output
How does the Fed maintain full employment and keep the price level stable?
By keeping the growth rate of the quantity of money in line with the growth rate of potential GDP
Market eliminate shortages?
By raising the price of the good
In a two-sector economy, planned expenditures equal
C + I In a two-sector economy, planned expenditures equal Consumption + Investment
GDP
C + I + G + ( X - M ) C - equal to all private consumption, or consumer spending, in a nation's economy G - the sum of government spending I - the sum of all the country's investment, including businesses capital expenditures NX - the nation's total net exports, calculated as total exports minus total imports (NX = Exports - Imports)
What is 'Total Expenditure' the addition of?
C + I + G + NX = Total Expenditure C = Consumption goods expend I = Investment goods expend G = Gov't expenditure on goods/svcs NX = Net Exports of goods and svcs the total amount received by the producers of final goods and services
Who conducts fiscal policy?
CONGRESS (The President and Congress develop the budget and fiscal policy but Congress has to make the tough decisions on spending and taxes)
How do you calculate Inflation rate?
CPI in Current Year - CPI in previous year divided by CPI in previous year x 100 (to get % change)
Which would be counted in GDP, but not in GNP?
Cars produced at a Japanese-owned factory located in Detroit GDP includes the value of output produced by a foreign-owned plant located within the U.S
What is Change in Quantity Supplied versus Change in Supply?
Change in Quantity Supplied is when there is a PRICE change, and movement up or down along the supply curve. Change in Supply is when a force OTHER than price acts on supply, and the supply curve shifts
What is the MAIN source of the business cycle?
Changes in Aggregate Demand; The key reason is that the swings in aggregate demand occur more quickly than changes in the money wage rate that change aggregate supply. The result is that the economy swings from inflationary gap to full employment to recessionary gap and back again.
Which of the following is not one of the Federal Reserve's tools for changing the money supply and interest rates?
Changing the prime rate The prime rate is determined by market forces, so the Fed can try to shift supply and demand to move this interest rate, but the Fed does not set this rate directly
What is the largest liability for most banks?
Checkable deposit accounts A bank's biggest liability are checkable deposit accounts
Since 2010, the most significant demand for natural resources has come from
China China has the most significant demand for natural resources. With nearly 20% of the world's population, China is demanding more and more natural resources, such as energy, oil, and gas
Who is the largest holder of the U.S. debt?
China China holds $1.3 trillion of U.S. debt
What is a graph that shows the various combinations of choices an individual can make with the resources available?
Choice curve
The composite aggregate supply is vertical in the
Classical region
What is the fundamental concept that drives international trade?
Comparative advantage: We can define national comparative advantage as the ability of a nation to perform an activity or produce a good or service at a lower opportunity cost than any other nation
What are goods that are jointly consumed?
Complementary goods (cereal and milk, lamps and light bulbs)
Automatic stabilizers DO NOT require further action by
Congress
In the Keynesian view, several things could go wrong in translating changes in the money supply into changes in output. Which of the following is not one of these things?
Consumers may not respond to lower taxes This is a potential problem with fiscal policy rather than with monetary policy
What is "contractionary" monetary policy and why is it used?
Contractionary monetary policy ("contracting" or restricting the amount of money in the economy) is what the Fed practices when it wants to counteract over-inflation
What is "contractionary" fiscal policy and why is it used?
Contractionary, or Restrictive, fiscal policy is a TYPE (along w/ Expansionary Fiscal Policy) of Discretionary Fiscal Policy that the gov't uses to combat inflation or gain control when the economy is growing too fast (which typically would lead to inflation)
What action(s) would be taken if inflationary pressures were present in the economy? Why?
Contractionary/Restrictive Fiscal Policy would be taken: 1. Decrease in spending or raise taxes 2. Aggregate Expenditure DECREASES 3. Investment/Consumption/Net Exports DECREASE 4. Aggregate Demand DECREASES 5. AD curve shifts to the LEFT 6. Real GDP and Price Level FALL (multiplier effect does the trick) - Gov't can use fiscal policy to change price level & GDP to stabilize the economy
An unexpected reduction in inflation would tend to benefit which of the following?
Creditors When inflation decreases, the value of the dollar increases, making the loan more profitable.
What is M1?
Currency held by individuals and businesses, traveler's checks, and checkable deposits owned by individuals and businesses. All the components of M1 are a means of payment
Which of the following will prevent expansion of the money supply from reaching its potential maximum?
Currency withdrawals by the public Currency withdrawals by the public will prevent the expansion of the money supply from reaching its potential maximum
This occurs during periods of slow economic growth or during periods of economic contraction
Cyclical unemployment (an auto worker being laid off during a recession)
As the price level rises, the purchasing power of financial assets owned by households
Declines If the prices increase, purchasing power is reduced
Which of the following will cause an increase in aggregate supply?
Decreased input prices A decrease in input prices makes it cheaper to produce goods and increases aggregate supply
What is the difference between Deficit and Debt?
Deficit is what the federal budget runs in a year if it's spending increases revenue. Debt (in this context, National Debt) is the sum total of all the outstanding deficits from years past to current.
How are deficits financed?
Deficits are financed through borrowing and our gov't does plenty of this and has to pay INTEREST annually on the amounts it borrows. Sometimes if the gov't cuts taxes, it gets less revenue to pay down the deficit and thus borrows more of the loanable funds available - which "crowds out" private investors, decreases quantity of money available and drives up interest rates
What is the most basic function of the government in a market economy?
Defining and Enforcing property rights
What determines the long-term real interest rate?
Demand and supply in the market for loanable funds
What determines the nominal interest rate?
Demand and supply of money
The relationship between the quantity demanded at the price applied is the
Demand curve
What happens to demand with a greater number of buyers in the market?
Demand increases (curve shifts right)
What is the decrease in the capital stock that results from wear and tear and obsolescence?
Depreciation
Which is not one of the major differences between NI (national income) and PI (personal income)?
Depreciation of capital equipment Correct. Depreciation is the difference between GNP and NNP
What is Discretionary Spending?
Discretionary Spending is government spending implemented through an appropriations bill. This spending is an optional part of fiscal policy
Explain the gains and losses because of imports
Domestic consumers GAIN from imports, and domestic producers LOSE from imports. In the case of imports, consumers gain what producers lose and then gain even more from the cheaper imports. So international trade provides a net gain for a country.
Who loses, and who gains, from Importing?
Domestic consumers gain Domestic producers lose
Who loses, and who gains, from Exporting?
Domestic consumers lose Domestic producers gain
What are the goals of monetary policy?
Dual Mandate: To achieve stable prices (keeping inflation low and predictable, and ensuring moderate long-term interest rates) And achieve maximum employment (attaining the maximum sustainable growth rate of potential GDP, keeping real GDP close to potential GDP, and keeping the unemployment rate close to the natural unemployment rate) [price stability is the key goal b/c it causes everything else to fall in place - full employment and thus economic growth)
Which of the following characteristics of money is important for considering how well it will stand up under continued use?
Durability Durability is important for the continued use of money
What is an electronic version of paper cash?
E-cash, or electronic cash (like Bitcoin) - portable, untraceable and anonymous, using a smart card
How do we measure economic growth?
Economic growth is measured by the Economic Growth RATE, which is calculated by: Subtracting Real GDP in Previous Year from Real GDP in Current Year...dividing by GDP Previous...multiply by 100 (to get percentage)
Goods that nonpayers, or free riders, *CAN* be kept from consuming
Excludables
What action(s) would be taken if the economy was in a recession? Why?
Expansionary Fiscal policy would be used: Problem: unemployment / recession 1. Increase in Gov't Spending or CUT in taxes 2. Aggregate Expenditure INCREASES 3. Investments, Consumption, Net exports INCREASE 4. SHIFTS Aggregate Demand Curve to the RIGHT 5. Real GDP and Price Level RISE multiplier effect happens
True or false. Full employment means that everyone in the population is employed.
False
True or false. When quantity supplied equals quantity demanded, there is an excess of quantity supplied
False
True or false. A negative value for net exports causes GDP to increase
False GDP=C+I+G+(X-M), so GDP falls if the last term is negative
True or false. If the quantity demanded for pizza is 100 and the quantity supplied is 120, and the pizza is sold at a fair price, the market for pizza is in equilibrium.
False (Quantity supplied is more than quantity demanded, so the market is not in equilibrium)
True or false. A market demand curve is the same as an aggregate demand curve
False A market demand curve relates to a particular good or service, while aggregate demand relates to all goods and services combined
True or false. A tariff quota means that a tariff is applied to imports up to the amount of the quota, but then the tariff is removed on additional imports
False A tariff quota means that a certain amount of a good from one country is allowed to enter another country without a tariff. For amounts in excess of that limit, a tariff is applied
True or false. All industrialized countries are in tropical climates
False All industrialized countries are in temperate climates
True or false. In the United States, national-level political elections are infrequent and campaigns are brief
False All members of the House of Representatives and one third of the Senate are elected every 2 years, and presidents are elected every 4 years, so the next election is never very far from the mind of anyone in Congress or the White House
True or false. Bank reserves may increase when the Fed buys bonds directly from a bank, but not when the Fed buys bonds from the public
False Bank reserves increase either way
True or false. According to the quantity theory, individuals and private banks find that they are holding smaller money balances than they want when the central bank increases the money supply
False Because individuals and private banks are holding larger money balances than they want, they will react by spending and making more loans
True or false. The unemployment rate is defined as the percentage of the labor force that is actively looking for a job.
False Besides actively looking for a job, a person must also not currently have a job.
True or false. Changes in the discount rate bring about large changes in bank reserves, lending, the money supply, and spending, so the discount rate is the Fed's preferred monetary tool
False Changes in the discount rate are used more as a signal of the direction of upcoming policy
True or false. Because changing the required reserve ratio is such a powerful tool, the Fed uses this option most often to bring about desired changes in the money supply
False Changing the required reserve ratio is too powerful and uncertain
True or false. The Federal Reserve System was established in the U.S. Constitution, so Congress cannot take away the powers assigned to it
False Congress passed the Federal Reserve Act in 1913 and created the Fed. The Federal Reserve is aware that Congress has the power to change the laws concerning it and is prepared to lobby for its position on any proposed legislation
True or false. Consumption expenditure refers to spending on goods, but not services.
False Consumption expenditure includes expenditures on consumer durables, nondurables, and services
True or false. Trading allows people, businesses, and countries to consume inside their production possibility curve
False Consumption is inside the production possibilities curve if there is inefficiency or high unemployment
True or false. Actual deficit reduction may be larger than planned because the economy may suffer from slow growth and high unemployment
False Cutting the deficit is a form of contractionary fiscal policy. Out of a lower level of output, tax revenues will fall and transfer payments will rise as the automatic stabilizers kick in
True or false. If government follows a laissez-faire approach, it must not define and protect property rights or discourage monopoly
False Defining and protecting property rights, and discouraging monopoly are important functions for government to perform and are consistent with a reduced role for government, according to the Classical tradition
True or false. The monetary base is equal to deposits made by the public in their bank accounts
False Deposits are larger than the monetary base in a fractional reserve system because of bank loans
True or false. Development economists in the field are more interested in broad theories than in workable strategies
False Development economists in the field are less interested in broad theories than in workable strategies
True or false. Developing countries' development efforts are hampered by foreign direct investment by private firms and individuals
False Direct foreign investment supplies scarce financial capital and aids the development process for many countries
True or false. Discretionary fiscal policy makes an economy more stable when there are lengthy policy lags
False Discretionary fiscal policy combined with lags could actually make an economy less stable
True or false. Disposable income is the income households earned before income taxes are deducted
False Disposable income is the income the household sector has left after taxes. DI can be spent on consumption or saved
True or false. GDP and price indexes are computed the same way in all countries
False Each country develops its own methods for computing national statistics, although the methods are very similar
True or false. Expanding aggregate demand is a way to stabilize the economy when recession threatens, but it is not a strategy for achieving economic growth
False Expanding aggregate demand can be a growth strategy as well as a stabilization strategy
True or false. When the economy is doing well and income and output are rising at a healthy rate, transfer payments for food stamps, unemployment compensation, and social security are likely to rise
False Fewer people will be eligible for these programs when the economy is healthy, so these payments are likely to fall
True or false. Firms often do not purchase inputs at prices that stay fixed for considerable periods of time
False Firms decide how much to produce by comparing their selling prices with their costs of production, and production costs depend, among other things, on input prices
True or false. An equal increase in government spending and taxes will have no effect on equilibrium income
False For example, if government spending and taxes are both increased by $20 billion, equilibrium income will increase by $20 billion
True or false. If actual output is equal to potential output, the cyclical deficit is larger than the structural deficit
False If actual output is equal to potential output, the cyclical deficit is zero
True or false. If people doubt money's acceptability, then they will still using it as a medium of exchange
False If people doubt money's acceptability, they will not use it as a medium of exchange
True or false. If required to choose between imposing a tariff or an import quota with equivalent consequences, most economists prefer quotas over tariffs
False If they have to choose, economists usually consider a tariff less harmful in terms of efficiency than an equivalent quota
True or false. In 2011, $1.5 billion in aid flowed from the developed countries to the 48 developing countries
False In 2011, $133.5 billion in aid flowed from the developed countries to the 48 developing countries
True or false. Currently, loans from the World Bank must be used for such developmental projects as roads, dams, electric power plants, and water systems
False In the 1980s, the World Bank concluded that infrastructure projects for a poorly functioning economy were not getting at the root of the problem
True or false. In the long run, an increase in aggregate demand raises the equilibrium price level and the equilibrium level of real GDP
False In the long run, an increase in aggregate demand only raises the equilibrium price level
True or false. Environmental cost is a benefit of economic growth
False Increased economic growth will lead to increased output and, therefore, increased pollution and congestion. This will cause health problems such as asthma, reducing the quality of life
True or false. The standard of living is lowered when a country has more workers to feed
False Increases in both the size and the quality of the labor force can contribute to economic growth
True or false. Innovations resulting from research and development and investment spending tend to occur at a steady pace
False Innovations do not occur at a steady pace, which leads to some instability. This is the source of real business cycles
True or false. If John uses his savings to purchase stock in Coca-Cola, he is making an investment expenditure as defined in the national income accounts.
False Investment expenditure refers to the purchase of plant and equipment, residential construction, and changes in inventory.
True or false. Policies that encourage investment have a negative impact on the economy's future rate of growth
False Investment makes workers more productive and leads to increased output, so the economy's future rate of growth is enhanced
True or false. Keynesian economists advocate using fiscal policy to offset any shift in aggregate demand that will cause equilibrium income to deviate from full-employment income
False Keynesian economists advocate using policy to offset shifts that have substantial and prolonged effects on output, employment, and prices
True or false. Economists disagree on why aggregate supply shifts
False Many economists tend to agree on the reasons for aggregate supply shifts
True or false. The national security argument is used to prevent having specialized military hardware made in a different country, but is never applied to non-military output
False Many industries use this argument when it is not necessary
True or false. The Federal Open Market Committee (FOMC) consists of the 12 Federal Reserve Bank presidents, one from each district
False Membership of the FOMC reflects a compromise between centralized and decentralized power
True or false. Since 1982, the Fed has been committed to a money supply target and has allowed the money supply to grow at a fixed rate each year
False Money supply growth has not been stable during this time period
True or false. Most U.S. output is produced by the government sector, including federal, state, and local government entities.
False Most output is from the business sector, the government produces roughly 20% of GDP in the United States
True or false. Full employment means that everyone in the population is employed or even that 100% of those who are able are willing to take a job.
False One way of defining full employment is to identify some level of unemployment as normal (acceptable or desirable) and only be concerned about unemployment in excess of that amount.
True or false. The amount of income households receive is equal to the amount of income households earn
False PI is the amount of income households receive and NI is the amount of income households earn
True or false. In the Keynesian view, financial markets are linked to aggregate supply and aggregate demand primarily through changes in planned investment. Additionally, planned investment is the most stable component of aggregate demand
False Planned investment changes when interest rates change, along with other factors
True or false. Say's law explains how long-run real Gross Domestic Product (GDP) stability is achieved in the Keynesian model
False Say's law only states that supply creates its own demand
True or false. In developing countries, foreign direct investment can bring needed expertise and technology, but it creates too much reliance on foreign governments
False Since foreign direct investment is done privately, it is a way for countries to grow without having to deal with other governments
True or false. A shift of the aggregate demand curve to the right will have the greatest impact on the price level if the aggregate supply curve is horizontal
False Since the aggregate supply curve is horizontal, there will be no impact on the price level that remains constant
True or false. To stabilize the economy, fiscal policy should be used to reduce spending during recessions and increase spending during inflationary periods
False Stabilizing the economy means using expansionary policy when spending is too low and using contractionary policy when spending is too strong
True or false. If a worker's job providing technical support in a call center is outsourced to another country, that worker is frictionally unemployed
False Structural unemployment occurs when jobs are lost due to structural changes in the economy, like outsourcing
True or false. Labor force participation has increased recently in the United States, while in other countries, such as Germany and Spain, the rate is declining
False Table 16.1 shows a slight decline for the United States and increases for both Germany and Spain since the year 2000
True or false. Economic growth is not associated with technological changes
False Technological change increases productivity and is associated with economic growth
True or false. An interest rate target requires the Fed to decrease the monetary base when the actual interest rate is higher than the target rate
False The Fed would need to increase the monetary base to cause the actual interest rate to fall in the direction of the target rate
True or false. The Keynesian horizontal short-run aggregate supply curve assumes that there is full employment in the economy
False The Keynesian horizontal SRAS assumes that there is unemployed and underutilized resources
True or false. If a deficit exists, the government must be pursuing an expansionary fiscal policy
False The deficit may simply be the result of automatic stabilizers and recessionary conditions
True or false. The deficits of the 1970s and 1980s were largely due to attempts by the federal government to implement Keynesian policies to combat recessions
False The deficits of the 1970s and 1980s were incurred even during years when the economy was booming
True or false. When the Fed lowered the interest rate to near zero in 2008 through mid-2015, investment spending responding sharply and equilibrium output quickly returned to the full-employment level
False The economy recovered very slowly because reducing interest rates did not have a significant effect on borrowing and spending
True or false. The fact that most countries have become members of WTO provides strong support for the claim that free trade has more costs than benefits
False The fact that the majority of countries have become members of WTO is a reflection of the vast good that comes from free trade and the harm that trade barriers impose
True or false. Economists agree that the short-run aggregate supply curve is vertical
False The long-run aggregate supply is vertical at full-employment output
True or false. Due to the uncertainty created by widespread bank failure, the public began holding more cash relative to bank deposits in the early 1930s, causing the monetary base to contract, but not the money supply
False The money supply fell 25% between 1929 and 1933
True or false. The national debt is the amount by which the federal government's expenditures exceed its revenues in a given year
False The national debt is the cumulative total of all past budget deficits minus all past surpluses. It is the amount owed to lenders by the federal government
True or false. If interest rates are low, the opportunity cost of holding money instead of interest-bearing assets is higher
False The opportunity cost of holding money is lower when interest rates are low
True or false. The presence of discouraged workers may cause the unemployment rate to be overstated.
False The presence of discouraged workers may cause the unemployment rate to be understated. This is because discouraged workers are those who were seeking employment, but have given up and stopped looking, so they are not included in unemployment calculations.
True or false. During a period of inflation, the real value of the debt increases
False The real deficit measures the federal budget deficit as the change in the real (inflation-adjusted) value of the national debt from one year to the next
True or false. If something causes the short-run aggregate supply curve to shift, it will also cause the long-run aggregate supply curve to shift
False The short-run aggregate supply curve can shift without shifting the long-run aggregate supply curve
True or false. If consumers fail to respond to a temporary increase in disposable income by spending a large fraction of it, then fiscal policy will have more of an effect on output
False The size of the multiplier effect depends on the amount of new spending caused by policy. Failure to respond means consumers are not spending in response to the policy, so it will have little or no effect
True or false. The system of income distribution in a market economy is not dependent on employment.
False The system of income distribution in a market economy is very dependent on employment. If people do not have jobs, they do not earn income.
True or false. If the economy achieves full employment at an income level of $15 trillion, and equilibrium income is currently $14.9 trillion, Keynesian economists recommend using fiscal policy to reduce equilibrium income
False The target income level is $15 trillion, where the economy reaches full employment
True or false. According to the theory of diminishing marginal productivity, additional resources add more and more to total output as an economy grows
False The theory of diminishing marginal productivity suggested that as an economy grew, additional resources would add less and less to total output
True or false. If China's economy is growing at a faster rate than Canada's economy, people living in China are better off than people living in Canada
False There are many reasons why GDP growth may not exactly coincide with individual well-being, including income distribution and economic bads
True or false. Because economic conditions can influence political outcomes, economists are certain that politicians are able to create a political business cycle for their own benefit
False Thus far, no economist has been able to show that politicians are actually able to create a political business cycle for their own benefit
True or false. Total labor supply does not affect the unemployment rate over longer periods.
False Total labor supply *does* affect the unemployment rate over longer periods
True or false. If the price of a washing machine increases because of an improvement in durability, GDP should not reflect this change
False Unless a specific feature can be separated out and assigned a price tag, GDP accountants have no good way of correcting for quality improvements
True or false. Politically, it is much easier to raise taxes than it is to lower them
False Voters are generally supportive of tax cuts
True or false. At lower interest rates, people will not be willing to hold larger cash balances
False When interest rates are lower, people will hold more cash balances
True or false. If there is a shortage of coffee in the market, the price of coffee will drop.
False (If there is a shortage of coffee in the market, the price will rise because the sellers will raise the price to make more profit since it's hard to get)
True or false. If there is a surplus of coffee in the market, the price of coffee will rise.
False (If there is surplus of coffee in the market, the price will drop because the sellers will drop the price to get rid of their coffee because it's taking up space)
How to calc REAL GDP between years?
Find out the real (base year) GDP rate/value of goods - then multiply current (nominal) year QUANTITY of goods by the real/base year values - this will give you the straight up increase or decrease in REAL GDP subtract smaller number from larger number - then divide the difference you just found by the smaller number, to get the % change
What is Okun's Law?
For each percentage point that the unemployment rate is above the natural unemployment rate, real GDP is 2 percentage points below potential GDP. (one over, two under)
What did goldsmiths develop?
Fractional reserve banking Goldsmiths developed fractional reserve banking
The Keynesian consumption function was first modified by
Franco Modigliani Modigliani hypothesized that spending behavior is different for young families getting started, middle-aged families with higher earnings, and older families who have retired
Unemployment: 'Frictional', 'Structural', and 'Cyclical'
Frictional Unemployment: The unemployment that arises from people entering and leaving the labor force, from quitting jobs to find better ones, and from the ongoing creation and destruction of jobs—from normal labor turnover. Structural Unemployment: The unemployment that arises when changes in technology or international competition change the skills needed to perform jobs or change the locations of jobs. Cyclical Unemployment:The fluctuating unemployment over the business cycle that increases during a recession and decreases during an expansion. At a business cycle trough, cyclical unemployment is positive and at a business cycle peak, cyclical unemployment is negative.
Short-term unemployment is called
Frictional unemployment (approx. 3-4% of the labor force) Frictional unemployment is chosen by the workers. Frictional unemployment would generally be classed as voluntary unemployment because workers are choosing to remain unemployed rather than get the first job that comes along.
Why does "Value of Production = Income = Expenditure"?
From the viewpoint of firms, the value of production is the cost of production, which equals income. From the viewpoint of purchasers of goods and services, the value of production is the cost of buying it, which equals expenditure.
This embodies the highest amount of skilled and unskilled labor that could be employed within an economy at any given time
Full employment
The total market value of all final products produced within a country during a given time period is
GDP (gross domestic product) GDP is output produced on U.S. soil and includes production by foreign-owned businesses and foreign workers
GNI GNI - Gross National Income
GDP + (income from abroad - income sent abroad)
GDP and GNP difference
GDP just counts what a country produces IN itself, not what it's companies may produce in other countries GNP is the GDP + Net Factor Income from abroad or paid to other countries
If rising GDP comes at the expense of leisure time,
GDP may be overstating the increase in well-being Although there is more output, the reduction in leisure time causes the quality of life to fall
Which is the correct formula for GDP?
GDP= C + I + G + (X - M)
Which is a criticism often made against the role of multinational corporations in developing countries?
Good jobs are often filled by foreign nationals, but not local workers Host countries are concerned that the opportunities for local workers are limited
What are the two primary markets we discuss in economics?
Goods markets (goods & svcs bought and sold) Factors markets (factors of production bought and sold)
What is Government Expenditure on Goods/Svcs?
Government expenditure on goods and services is expenditure by all levels of government on goods and services. For example, the U.S. Defense Department buys missiles and other weapons systems, the State Department buys travel services, the White House buys Internet services, and state and local governments buy cruisers for law enforcement officers.
Which of the following is not a component of aggregate supply?
Government spending Government spending is a part of aggregate demand
What do both sides of the Federal budget do to influence potential GDP?
Government spending/the provision of public goods and services increases potential GDP Taxes reduce incentives, drive a wedge between wage and what workers actually receive, and drive down potential GDP/reduce productivity The income tax wedge effectively lowers the wage a worker gets b/c it reduces the amount of goods/svcs a wage can buy
What is GDP?
Gross Domestic PRODUCT- The MARKET VALUE of all the final goods and services produced within a country in a given time period.
Which of the following are benefits of economic growth?
Higher income This enables consumers to enjoy more goods and services, as well as better standards of living
How does the Government fit into the Circular Flow?
Households and Firms pays taxes to the Gov't... The Gov't buys goods and services from firms... The Gov't makes transfer payments to households and firms (redistribution)
In the Circular Flow, who chooses what to produce or do (in terms of households and firms)?
Households choose the quantities of the factors of production to provide to firms, and firms choose the quantities of the services of the factors of production to hire.
What are some differences in capital between Advanced and Emerging economies?
Human Capital (Advanced economies have greater numbers of skilled and/or educated workers) Physical Capital (Advanced economies tend to have a higher percentage of technologically advanced factories, machinery, etc and better infrastructure, like highways and roads, etc)
Explain Hyperinflation and Stagflation
Hyperinflation: Inflation at a rate that exceeds 50 percent a month (which translates to 12,875 percent per year)...occurs when the quantity of money grows at a rapid paces and outgrows real GDP... Stagflation is persistent high inflation combined with high unemployment and stagnant demand in a country's economy. Stagflation is the worst of both worlds, as unemployment and the cost of living both increase. The combination of recession (decreasing real GDP) and inflation (rising price level).
What happens to supply when Expected Future Prices change?
If a frost wipes out an orange crop, it won't affect supply today but it will affect future prices - OJ will be more expensive b/c less oranges - so suppliers will want to stock up NOW (increase inventory of frozen OJ) in order to have enough OJ to sell in the future at the higher prices
Price increases, what happens to its quantity demanded? What happens to demand?
If a price of a book increases, the QUANTITY DEMANDED decreases and there is movement UP the demand curve (demand decreases)
What happens to supply when the prices of Resources and other Inputs change?
If input cost goes UP, supply goes DOWN
What action(s) would be taken if the economy was in a recession? Why?
If the economy was in a recession, the Fed would practice Expansionary monetary policy by conducting an Open Market PURCHASE (where it buys securities from banks, releasing more $ into economy which decreases the interest rate, stimulates consumption, investment and net export expenditures and overall, stimulates aggregate demand, which increases Real GDP and encourages full employment)
What happens to the Short and Long-run Phillip's curves if there is a change in unemployment?
If the natural unemployment rate changes, both the long-run Phillips curve and the short-run Phillips curve shift. When the natural unemployment rate increases, both the long-run Phillips curve and the short-run Phillips curve shift rightward; and when the natural unemployment rate decreases, both the long-run Phillips curve and the short-run Phillips curve shift leftward.
What is the distinction between DEMAND and QUANTITY DEMANDED?
If there is a change in QUANTITY DEMANDED, that means there's been a change in PRICE only and movement along the curve If there is a change in DEMAND, that means a change in something OTHER THAN price, and the curve will shift left or right
Define Imports and Exports
Imports: The goods and services that firms in one country buy from people and firms in other countries. Exports: The goods and services that people and firms in one country sell to firms in other countries.
What happens with unemployment and inflation during an expansion and during a recession?
In an expansion, unemployment decreases and inflation increases. In a recession, unemployment increases and inflation increases (STAGFLATION is where unemployment increases AND inflation increases, the worst of all worlds)
How are Net Gains from exporting or importing created?
In the case of imports, consumers gain what producers lose and then gain even more from the cheaper imports. In the case of exports, producers gain what consumers lose and then gain even more from the items exported. So international trade provides a net gain for a country.
What is a key proposition about the quantity of money and the price level?
In the long run and other things remaining the same, a given percentage change in the quantity of money brings an equal percentage change in the price level.
What do choices respond to?
Incentives - "carrot and stick" (positive or negative incentives)
What is Real GDP Per Person?
Income per person determines what people can afford to buy and real GDP is a measure of real income. So real GDP per person—real GDP divided by the population—is a commonly used measure for comparing the standard of living OVER TIME (using Real GDP to remove influence of rising prices/cost of living)
What is Disposable Personal Income?
Income received by households minus personal income taxes paid.
The market demand curve is found by adding up the
Individual demand curves
What are "Automatic Stabilizers" and why are they used?
Induced Taxes: taxes adjust w/ real GDP flux and Needs-Based Spending: gov't makes transfer payments to those who need them, depending on whether they qualify and the current state of the economy
What is a good for which demand falls when income rises?
Inferior good (ramen noodles)
The policy of stealing employees away from jobs by offering them higher salaries doesn't lead to more production for the economy. Instead, this policy just rearranges what is produced and leads to
Inflation Workers who take higher-paying jobs have more money, but more goods and services aren't being produced, which leads to inflation.
What does the Short-Run Phillip's Curve represent a trade-off between?
Inflation and unemployment; in order to avoid inflation, you pay the cost in increasing unemployment...and in higher employment rates, you pay the price with higher inflation
What does Inflation result from?
Inflation results from a growing quantity of money that outpaces the growth of potential GDP
Outside of the Fed's primary monetary policy strategy (Targeting rule), which alternative strategy would the Fed most likely adopt?
Inflation targeting: A monetary policy strategy in which the central bank makes a public commitment to achieving an explicit inflation target and to explaining how its policy actions will achieve that target.
What is Demand-Pull Inflation?
Inflation that STARTS because aggregate demand increases (but is MAINTAINED by the growth in the quantity of money) Demand-pull inflation can be kicked off by any of the factors that change aggregate demand
What is Investment Expenditure?
Investment is the purchase of new capital goods (tools, instruments, machines, and buildings) and additions to inventories. Capital goods are durable goods produced by one firm and bought by another. Examples are PCs produced by Dell and bought by Ford Motor Company, and airplanes produced by Boeing and bought by United Airlines. Investment also includes the purchase of new homes by households. ~ When a firm adds unsold output to inventory, we count those items as part of investment. ~ Important to note that investment does not include the purchase of stocks and bonds. In macroeconomics, we reserve the term "investment" for the purchase of new capital goods and the additions to inventories.
Explain how the Fed can achieve a federal funds rate target of 1.5% if the federal funds rate is currently at 2%
It can conduct an Open Market Purchase, which releases more money into the monetary base to banks in the form of reserves...this increase in available money DECREASES the Federal Funds rate
What two effects does a tax cut have?
It increases aggregate demand by boosting consumption expenditure and it increases potential GDP.
An increase in interest rates, ceteris paribus, will cause the money demand curve to do which of the following?
It only causes a movement along the demand for money curve A change in interest rates, ceteris paribus, will only cause a movement along the money demand curve
Which of the follow accurately describes the types of production not included in GDP and how the non-included production affects GDP and the economy
It probably does not make a big difference in year-to-year comparisons within a country Changes from one year to the next are not likely to be significant
PPF if it SHIFTS outward?
It represents economic growth
Macroland's crime rate has dropped significantly and is expected to stay low for the foreseeable future. What effect will this have on the economy?
It will lead to a higher living standards Even if the reduced crime rate had no effect on GDP, people prefer living safely
Which government spending programs are easy to cut?
It's very difficult to find a specific type of government spending program that is easy to cut Every program, every subsidy, every agency has a constituency—the employees, customers, and suppliers that depend on its survival for their economic futures
Import substitution, or self-sufficiency, has been a productive development strategy in a few countries, notably
Japan
Which of the following is not one of the benefits of free trade?
Job gains in both export- and import-competing industries As a country transitions to a free trade equilibrium, export industries are likely to expand, resulting in job creation, but import-competing industries will shrink as consumers are offered cheaper, imported goods
The composite aggregate supply is horizontal in the
Keynesian region
The horizontal portion of the short-run aggregate supply curve in which there is excessive unemployment and unused capacity in the economy is the
Keynesian short-run aggregate supply curve The horizontal portion of the SRAS is from the Keynesian model
The quantity of money demanded is very sensitive to interest rates in the
Keynesian view
Production resources categories
Land - paid with rent Labor - paid with wages Capital - paid with interest Entrepreneurship - paid with profit or loss
What are the interest-earning assets of a bank?
Loans Loans are the interest-earning assets of a bank
A decrease in Demand or an increase in Supply LOWERS the equilibrium price, so combined, these changes lower the price - but what happens to QUANTITY when these happen together?
Look at the MAGNITUDES of the changes: If demand decreases by more than supply increases, the quantity decreases. But if supply increases by more than demand decreases, the quantity increases.
An increase in Demand or a decrease in Supply RAISES the equilibrium price (so combined they lower the price) - but what happens to QUANTITY when these happen together?
Look at the MAGNITUDES of the changes: If demand increases by more than supply decreases, the quantity increases. But if supply decreases by more than demand increases, the quantity decreases.
What is one benefit of economic growth?
Lower government borrowing Economic growth creates higher tax revenues and there is less need to spend money on benefits, such as unemployment
Define M1 and M2. If you transfer $100 cash to the checking account with your bank, what is the change in M1?
M1 (Currency held by individuals and businesses, traveler's checks, and checkable deposits owned by individuals and businesses) and M2 (M1 + savings deposits and small time deposits, money market funds, and other deposits.) are the two official measures of money M1 doesn't change b/c it includes currency (cash) you have and checking deposits etc.h- the TOTAL of all you have
What is M2?
M1 + savings deposits and small time deposits, money market funds, and other deposits. [the savings deposit component IS convertible to a means of payyment]
What is the monetary policy instrument currently used by the Fed?
Manipulating the Federal Funds Rate (raising or lowering it) - aka, Open Market operations
What are Marginal Cost and Marginal Benefit?
Marginal Cost: The opportunity cost that arises from a one-unit increase in an activity. The marginal cost of something is what you must give up to get one additional unit of it Marginal Benefit: The benefit that arises from a one-unit increase in an activity. The marginal benefit of something is measured by what you are willing to give up to get one additional unit of it... a fundamental feature of marginal benefit: it diminishes
What is most likely to happen if the supply of coffee shifts to the right, and the price has not yet changed to a new price?
Market forces will drive the price down (When the supply curve shifts to the right, the new equilibrium has greater quantity and lower prices)
Which of the following is the most successful method to allocate sweaters in Macroland?
Market prices
What is the sum of all of the individual supply curves?
Market supply curve
Give an example of an unfunded liability of the U.S. federal government?
Medicare payments for those who are retiring this year Government has been using past contributions to Medicare to fund medical expenses for past retirees. The medical expenses of those who are retiring now must be funded out of money that has not yet been collected
A main function of money is to avoid the need for double coincidence of wants. What is the name of this function?
Medium of exchange function As a medium of exchange, money avoids the need for double coincidence of wants
Who said, "It is possible to have economic freedom without political freedom, but it is not possible to have political freedom without economic freedom?"
Milton Friedman Milton Friedman said that famous quote. Friedman wrote such books; some of which were made into a series on PBS
Franco Modigliani's ideas were further developed by
Milton Friedman, who hypothesized that current consumption depends on past income and expected future income and not current income alone The permanent income hypothesis is the view that consumption does not depend on current income alone, but on past income and expected future income as well
What determines the VALUE of money, in the long run?
Money market equilibrium - If quantity of $ supplied exceeds quantity demanded, people spend it; the fixed quantity of goods may run low, so prices go higher and the value of money drops If quantity of $ supplied is less than quantity demanded, people hold on to it; there is a surplus of goods/svcs, so prices drop and the value of money increases
What happens to supply when the Number of Sellers changes?
More sellers = more supply, and vice versa
The income earned by resources is called
NI (national income) Several adjustments have been made to convert GDP to NI and measure only income payments to resources
GNP minus depreciation is
NNP (net domestic product) GNP includes gross private domestic investment, but NNP includes net private domestic investment. The difference between gross and net private domestic investment is depreciation, or the value of capital that has been used up, worn out, or become obsolete
Are checks, credit cards, debit cards and e-checks considered MONEY?
NO - they are instructions to banks to make payment for you (checks, and debit cards are like plastic checks) or types of ID to get you an instant loan (credit card)
What are 'Net Taxes' and 'Saving'?
Net Taxes = Taxes paid minus cash benefits received from governments. Saving = The amount of income that is not paid in net taxes or spent on consumption goods and services. Total Income = Consumption + Net Txs + Saving
What does GDP equal?
Net domestic product at factor cost PLUS indirect taxes LESS subsidies PLUS depreciation (capital consumption)
Is Currency INSIDE the banks considered money?
No - it's not available as a means of payment while it's in there (the notes and coins and stuff...it's called 'reserves')
GDP Nominal / Real
Nominal GDP is the value of final goods and services produced in a given year expressed in terms of the prices of that same year. Real GDP is the value of the final goods and services produced in a given year expressed in terms of the prices in a base year.
What is NOMINAL wage rate vs. REAL wage rate?
Nominal Wage Rate: The average hourly wage rate measured in current dollars Real Wage Rate: The average hourly wage rate measured in the dollars of a given reference base year.
What is a good for which demand increases as income increases, ceteris paribus?
Normal good (meat, you might eat hamburger when you have less money, but you'll still eat steak if you earn a little more money)
Contrast Normative X Positive analyses
Normative Statements are statements about what OUGHT to be - cannot be tested (about values) Positive Statements are statements about what IS - right or wrong, and CAN be tested - assert facts
What is Currency?
Notes (dollar bills) and coins. Currency INSIDE the banks is NOT money - b/c while it's in there, it's not available as a means for payment (it's "on deposit")
What is Fiat Money?
Objects that are money because the law decrees or orders them to be money.
What is a Budget Deficit?
Obligations/outlays exceed tax revenues
What explains the vertical "Supply of Money" curve?
On any given day, the quantity of money supplied is fixed and the only thing that can fluctuate on it is the nominal interest rate (that is, the supply is fixed regardless of the nominal interest rate) - therefore, the vertical line of 'Supply of Money' is fixed on a specific quantity for any given day
The value of the best alternative that is sacrificed to obtain something you want is a/an
Opportunity cost
Law of Demand?
Other things remaining the same, if the price of a good rises, the quantity demanded of that good decreases; and if the price of a good falls, the quantity demanded of that good increases.
What is 'The Law of Demand'?
Other things remaining the same, if the price of a good rises, the quantity demanded of that good decreases; and if the price of a good falls, the quantity demanded of that good increases. The downward slope of the demand curve illustrates the law of demand...when the price falls, demand increases along the x-axis
What is the Law of Supply?
Other things remaining the same, if the price of a good rises, the quantity supplied of that good increases; and if the price of a good falls, the quantity supplied of that good decreases. The upward slope of the supply curve illustrates the law of supply. Along the supply curve, when the price of the good rises, the quantity supplied increases.
Describe the relationship between the quantity of real GDP supplied and the price level:
Other things remaining the same, the higher the price level, the greater is the quantity of real GDP supplied, and the lower the price level, the smaller is the quantity of real GDP supplied.
Which types of workers might cause unemployment to be understated?
Part-time workers who are working fewer hours than they would like and discouraged workers
In sequence, what are the four phases of the business cycle?
Peak, recession, trough, expansion
Who is most likely to be a winner during times of inflation?
People who hold real assets and the government. When inflation increases, the value of real assets increases, making it more profitable to hold them. The government also is a winner because tax revenue increases.
All else being equal (ceteris paribus), as the price of a good or service increases,
People will buy less of it
What is one of the criticisms of the CPI?
People's taste and consumption habits change with the introduction of new goods or trends or changes in prices and the basket should be revised more often
The 1964 and 1981 income tax cuts, which were enacted as permanent changes, appear to have had more effect on income and consumption than the 1968 temporary surcharge or the 1975 one-time tax rebate. What is the most probable explanation for this?
Permanent tax cuts increase permanent income, which in turn increases current consumption The permanent income hypothesis is supported by historical experience
Which proposed tax cut is likely to have the largest effect on output, according to the permanent income hypothesis?
Permanently reducing tax rates at all income levels A permanent change in tax rates creates an increase in currency and expected future disposable income
Explain any 3 actions that governments can take to achieve faster economic growth
Pick three from: • Create incentive mechanisms. • Encourage saving. • Encourage research and development. • Encourage international trade. • Improve the quality of education.
PPF pints: ON/inside/beyond
Points INSIDE are attainable but inefficient Points ON are attainable and efficient Points OUTSIDE unattainable completely
What is an example of a negative externality?
Pollution. It's a negative externality because it has spillover costs to third parties.
Spillover benefits to third parties are called
Positive Externalities (Public Education)
The vertical axis of the aggregate demand curve represents the
Price level The aggregate demand curve represents the total quantity of all goods and services demanded by the economy at different price levels
What did Classical economists assume?
Prices and wages are flexible According to Classical economists, both prices and wages are flexible
The relationship between the inputs employed by a firm and the maximum output that it can produce with those inputs is the firmʹs
Production function A production functions shows how much a firm can produce with the inputs available
What are negative effects that have an impact on everyone to some degree?
Public Bads (Pollution, Global Warming, Animal Extinction)
A good that is nonrival in consumption and not subject to exclusion is called a(n)
Public Goods (Sunsets & Lighthouses)
How is Quantitative Easing different from a regular Open Market Purchase?
Quantitative Easing is different because the Fed charges very low or 0% to banks, to lend money to them, in order to create bank reserves; an Open Market Purchase is where the Fed BUYS securities from a bank, in order to put more money in the monetary base
When price changes, there is an opposite change in what?
Quantity demanded
Which of the following is not one of the reasons why the aggregate supply curve slopes upward in the short run?
Quick responses to information The aggregate supply curve's upward slope results from market imperfections, such as delayed responses to information, not quick responses
REVIEW: What is the definition of 'the Quantity of Real GDP Demanded'?
REVIEW: The total amount of final goods and services produced in the United States that people, businesses, governments, and foreigners plan to buy. This quantity is the sum of the real consumption expenditure (C), investment (I), government expenditure on goods and services (G), and exports (X) minus imports (M). That is, Y = C + I + G + X − M.
What is Real GDP, and what is Nominal GDP?
Real GDP - The value of the final goods and services produced in a given year expressed in terms of the prices in a base year. (like, 2005 is the base year price value that our gov't uses to this day) Nominal GDP - The value of final goods and services produced in a given year expressed in terms of the prices of that SAME year (like a more precise name for GDP)
What is the relationship between real and potential GDP when the economy is in a recessionary phase? What is happening to cyclical unemployment in such times?
Real GDP is LESS than Potential GDP. Cyclical unemployment is POSITIVE (growing or high) during a recession, or business cycle trough
What is the Output Gap?
Real GDP minus potential GDP expressed as a percentage of potential GDP. When the unemployment rate is above the natural unemployment rate, in part (a), the output gap is negative (real GDP is below potential GDP), in part (b); when the unemployment rate is below the natural unemployment rate, the output gap is positive (real GDP is above potential GDP); and when the unemployment rate equals the natural unemployment rate, the output gap is zero (real GDP equals potential GDP).
Real GDP per capita for the year for a population of 50,000 and the real GDP of 5,000,000 is
Real GDP per capita for the year for a population of 50,000 and the real GDP of 5,000,000 is 100. Real GDP/capita = Real GDP/Population = 5,000,000/50,000 = 100
Real Interest Rate formula
Real Interest Rate = Nominal Interest Rate - Inflation Rate
What do we mean by a "recessionary gap" or "inflationary gap"? Where do the AD-AS curves intersect for each with respect to the Potential GDP curve?
Recessionary Gap: A gap that exists when potential GDP exceeds real GDP and that brings a falling price level (In a recessionary gap, there is a surplus of labor and firms can hire new workers at a lower wage rate. As the money wage rate falls, the AS curve shifts from AS1 RIGHT, toward AS* and the price level falls and real GDP rises. The money wage continues to fall until real GDP equals potential GDP—full-employment equilibrium - AS and AD previously intersecting to the LEFT of potential GDP before equil is reached) Inflationary Gap: A gap that exists when potential GDP exceeds real GDP and that brings a falling price level (In an inflationary gap, there is a shortage of labor and firms must offer a higher wage rate to hire the labor they demand. As the money wage rate rises, the AS curve shifts from AS2 toward AS* and the price level rises and real GDP falls. The money wage rate continues to rise until real GDP equals potential GDP - the AS and AD previously intersected to the RIGHT of potential GDP)
Which of the following is not one of the original functions of the Federal Reserve System?
Regulating the supply of money and the availability of credit in the United States The Federal Reserve System was intended to regulate banks and serve as a lender of last resort. It would also serve as a banker to the treasury, clear checks, and issue currency. Only later did monetary policy become its major function
If the Fed conducts an Open market Purchase, how does this action affect reserves in the banking system? State one reason why Fed would want to conduct an Open market Purchase
Reserves will INCREASE The Fed may want to decrease interest rates
In which case would the capital gains tax apply?
Rob purchased stock for $10,000 and later sold it for $15,000 Rob would be taxed on the $5,000 profit he made after selling the stock
Describe the three types of thrift institutions
SAVINGS AND LOAN ASSOC: (S&L) a financial institution that accepts checkable deposits and savings deposits and that makes personal, commercial, and home-purchase loans. A SAVINGS BANK is a financial institution that accepts savings deposits and makes mostly consumer and home-purchase loans. The depositors own some savings banks (called mutual savings banks). A CREDIT UNION is a financial institution owned by a social or economic group, such as a firm's employees, that accepts savings deposits and makes mostly consumer loans.
How do you calculate Deflation?
Same as inflation, and the 'previous year' CPI will be higher than the current year so the resulting percentage change will be negative (have minus sign in front of it)
Which of the following is included in M2, but not in M1?
Savings deposits Savings deposits are included in M2, but not in M1
The idea that supply creates its own demand is known as
Say's law Say's law states that supply creates its own demand
scarcity influence choices
Scarcity forces us to CHOOSE the things we want most A choice is a trade-off...A choice that uses the available resources to best achieve the objective of the person making the choice is a RATIONAL choice
Who does the Federal Reserve Board of Governors include?
Seven members appointed by the U.S. president for 14-year staggered terms These governors do not always complete the entire 14-year term. Also, no more than one governor from any of the 12 districts can serve on the board
n 2011, the per capita gross national income was $850 in
Sierra Leone
How do we convert factor cost value of goods to market price value?
Since sales taxes make market prices exceed factor cost, and subsidies make factor cost exceed market prices, to convert the value at factor cost to the value at market prices we must add indirect taxes and subtract subsidies.
How do you calculate the CPI?
Since the CPI avgs price increases by comparing cost of market baskets (instead of prices of individual products in baskets): 1. Multiply quantities of products by their prices in the BASE year market basket - add them up for the basket price 2. Multiply quantities of products by their prices in the CURRENT year market basket - add them up for the basket price 3. Divide Cost of CPI basket at current period prices by Cost of CPI basket at base period prices, then multiply by 100
What happens if comparing both Expenditure and Income results and there is a discrepancy?
Since the expenditure is considered more reliable of the two, the discrepancy is usually added to or subtracted from the income total
What does a tax on interest (earned by lenders) slow the growth of?
Slows the growth rate of Real GDP - lowers saving and investment. Even small amount of inflation lowers the "real" interest you earn and the resulting tax on THAT remainder whittles real interest down way below what you want to keep (as opposed to income tax on labor wages, which lowers quantity of labor employed = lowers potential GDP)
Which category of transfer programs is least likely to change in response to changing economic conditions?
Social Security Survivor's benefits A family is eligible for a survivor's benefits when a covered employee (parent or spouse) dies; this is not an event that depends on the state of the economy. Other transfer programs that can change are Medicaid, Food Stamps and Unemployment Benefits
What is Undistributed profit?
Some part of total income, called undistributed profit, is a combination of interest and profit that firms retain and do not pay to households. But from an economic viewpoint, undistributed profit is income paid to households and then loaned to firms.
What is Needs-Tested Spending?
Spending on programs that entitle suitably qualified people and businesses to receive transfer payments that vary with need and with the state of the economy.
What function of the government promotes price stability and full employment?
Stabilization (The Government cutting taxes to end a recession)
Which of the following is a function performed by a modern society's money?
Store of wealth Store of wealth is a function of money
Suppose you store part of your income in the form of money to be used 1 year from now. Which function of money are those dollars performing?
Store of wealth The dollars are acting as a store of wealth
A mismatch of workers and jobs is commonly known as
Structural unemployment (available workers do not match the jobs in terms of skills or location)
What are goods that replace each other?
Substitute goods (orange juice & apple juice, Coke & Pepsi, Reebok & Adidas)
How does the Income approach work? (to measure GDP)
Sum the incomes of the factors of production into 2 groups: wages, and then rent/interest/profit or loss
With ceteris paribus conditions remaining constant, suppose the price of cement goes up in the United States. What happens in the market for new homes?
Supply shifts upward and to the left
What are two names for monetary policy strategy?
Targeting Rule and Instrument Rule
What is 'Quantity Supplied'?
Tastes or preferences, as economists call them, influence demand
What happens to demand for a good when preferences (tastes) for that good change?
Tastes or preferences, as economists call them, influence demand - if people don't want the good because it's not popular, for example, demand curve shifts left b/c demand decreases
What is a Budget Surplus?
Tax revenues exceed outlays/obligations
What effect would taxation have on real consumption spending when government spending is autonomous?
Taxation reduces real consumption spending Taxation reduces real consumption spending by reducing consumers' income
What are Induced Taxes?
Taxes that vary with real GDP. This happens because tax laws dictate what tax RATES will be, not what actual amounts of tax dollars will be paid. When real GDP increases in an expansion, wages and profits rise, so the taxes paid on these incomes—induced taxes—rise. When real GDP decreases in a recession, wages and profits fall, so the induced taxes on these incomes fall.
Which event will cause a country's production possibilities curve to shift outward?
Technological advances that improve productivity Technological advances that improve productivity enable a country to produce more output with available resources
Supply curve shifts right?
That there was a change in supply OTHER THAN price, that caused supply to increase
If the interest rate is determined by real forces in the long run, what is the variable that adjusts to make the quantity of money that people plan to hold equal the quantity of money supplied?
The "price" of money (or, the VALUE of money)
What determines the Quantity of Money Demanded? (the amount of money that people want to 'hold' and not invest)
The "price" of money, which is described in two ways: 1. The value of money - what you can buy with a given amount, which is related to the PRICE LEVEL 2. The opportunity cost of holding money; if the interest rates are HIGH, people would rather not hold and instead invest; if the interest rates are LOW, people want to have more money in their wallet, not investing
CPI measurement.
The CPI is measured by taking about 80,000 fixed quantities of goods and measuring their exact prices (for exact items) each month - these items have been the same since 2011 HOUSING comprises the largest share - 41.5%
Who conducts monetary policy?
The Fed (The Board of Governors of the Federal Reserve System and the Federal Open Market Committee)
What are two policy actions that the Fed can take to lower inflation?
The Fed can lower inflation expectations (either by Surprise Inflation reduction - hiking up the interest rate, but that can lead to a recession - or by a Credible Announced Reduction where they credibly state and support that they are going to get inflation down to a certain level)
What is the Required Reserve Ratio? Why do banks not lend out all of their reserves?
The Fed requires the banks and thrifts to hold a minimum % of deposits as reserves, known as a required reserve ratio. The Fed determines a required reserve ratio for each type of deposit. Currently, required reserve ratios range from zero to 3 percent on checkable deposits below a specified level to 10 percent on deposits in excess of the specified level. The banks NEED their reserves for depositors' withdrawals! They need to have cash on hand. The bank uses its reserve account at the Fed to receive and make payments to other banks and to obtain currency.
What should the FED NOT do in order to combat inflation?
The Fed should NOT target unemployment, because it is difficult to lower the inflation rate in this way without bringing on a recession. Keeping inflation low and stable is the best that monetary policy can do to keep unemployment low.
What is the Federal Reserve System's (the Fed's) primary Responsibility?
The Fed's main task is to regulate the interest rate and quantity of money to achieve low and predictable inflation and sustained economic expansion.
How do the Fed's policy tools work?
The Fed's normal policy tools work by changing either the demand for or the supply of the monetary base, which in turn changes the interest rate By increasing the required reserve ratio, the Fed can force the banks to hold a larger quantity of monetary base. By raising the discount rate, the Fed can make it more costly for the banks to borrow reserves—borrow monetary base. And by selling securities in the open market, the Fed can decrease the monetary base. All of these actions lead to a rise in the interest rate.
How does the Federal Funds Rate differ from the Discount Rate?
The Federal Funds Rate is for Interbank lending (banks buying/selling between themselves); the Discount Rate is what the FED charges banks to lend to them
Explain the composition of the Federal Open Market Committee (FOMC). How frequently does FOMC meet?
The Federal Open Market Committee (FOMC) is the Fed's main policy-making committee, consists of 12 members: • The Chairman and the other six members of the Board of Governors • The president of the Federal Reserve Bank of New York • Four presidents of the other regional Federal Reserve Banks (on a yearly rotating basis) They meet approx every six weeks to ruminate on the state of the economy/make decisions
What is the Banking System?
The Federal Reserve and the banks and other institutions that accept deposits and provide the services that enable people and businesses to make and receive payments.
The longest contractionary period in the U.S. was
The Great Depression (1929-1939)
On average, over the long run, what is a remarkably accurate predictor of inflation?
The Quantity Theory of Money
The U.S. government must pay interest on the outstanding debt. Which group is ultimately responsible for paying this expense?
The U.S. taxpayers The debt imposes a net interest burden on the U.S. government and, by extension, the U.S. taxpayers
What is National Debt?
The accumulated balance of all past budget deficits. If one year, the country has a budget SURPLUS (more tax revenue than obligations), it goes to pay down the nat'l debt
What is the Aggregate Demand Multiplier?
The aggregate demand multiplier is an effect that magnifies changes in expenditure plans and brings potentially large fluctuations in aggregate demand.
When investment spending increases, the aggregate expenditure line
The aggregate expenditure line increases. AE = C + I + G + (X - M)
What is 'Quantity Demanded'? What happens with a CHANGE in Quantity Demanded?
The amount of any good, service, or resource that people are willing and able to buy during a specified period at a specified PRICE [one quantity at one price] There will be movement up or down ALONG the curve
What is the 'Quantity of Money Demanded'?
The amount of money that households and firms choose to hold.
What is the Economic Growth Rate?
The annual percentage change of real GDP. To Calculate: Subtract Real GDP in Previous Year from Real GDP in Current Year - then divide by Real GDP in Previous Year - multiply by 100 This growth rate tells us how rapidly the total economy is expanding
What is the Velocity of Circulation?
The average number of times in a year that each dollar of money gets used to buy final goods and services.
What is a Cyclical surplus or deficit?
The budget balance that arises because tax revenues and outlays are not at their full-employment levels.
What is a Structural Surplus or Deficit?
The budget balance that would occur if the economy were at full employment.
What is the consumer price index (CPI)?
The current CPI is a measure of the average of the prices paid by consumers for a fixed market basket of consumer goods and services. The market basket is based on the consumption of the typical urban family of four.
What happens to demand for a good with a change in the price of a substitute or complement?
The demand for a good and the price of one of its substitutes move in the same direction. The demand for a good and the price of one of its complements move in opposite directions.
Explain why the "Demand of Money" curve is downward sloping
The demand for money curve is MD. When the interest rate rises (y axis), everything else remaining the same, the opportunity cost of holding money rises and the quantity of money demanded decreases (x axis)
What is Statistical Discrepancy?
The discrepancy between the expenditure approach and the income approach estimates of GDP, calculated as the GDP expenditure total minus the GDP income total. (not all income is reported but the discrepancy usually gets caught when all money gets spent - this is why the expenditure approach is more reliable than the income approach, as a measurement - although income gets reported on tax returns whereas not all expenditures are recorded so there can be a reversal sometimes)
What is a Nominal Interest Rate?
The dollar amount of interest expressed as a percentage of the amount loaned.
Of all the relevant data and economic science are used to forecast inflation, what ingredient is the major one that is used to determine Rational Expectation (forecast) of what will happen with inflation?
The dominant factor is the Fed's monetary policy
What is a Government Expenditure Multiplier?
The effect of a change in government expenditure on goods and services on aggregate demand. [Gov't Expenditure is a COMPONENT of aggregate expenditure...money gets spent, goes out into the economy, is rec'd by consumers who then increase consumption expenditure and all this increases aggregate demand]
What is the Balanced Budget Multiplier?
The effect on aggregate demand of a simultaneous change in government expenditure and taxes that leaves the budget balance unchanged - the gov't spending injects $1 into aggregate demand while a $1 tax hike takes LESS than $1 out of aggregate demand, so the net result is increase in aggregate demand
What are Supply-side Effects?
The effects of fiscal policy on potential GDP and the economic growth rate. In the long run, supply-side effects of fiscal policy are what dominate and determine potential GDP.
The following are justifications for the allocation function of the government
The existence of public bads The presence of external effects The existence of public goods (NOT the basic instability of the economy)
How do the Expenditure and Income approaches differ, regarding valuation of goods?
The expenditure approach values goods and services at market prices The income approach values them at factor cost—the cost of the factors of production used to produce them. Indirect taxes (such as sales taxes) and subsidies (payments by government to firms) make these two values differ.
What is Consumption Expenditure?
The expenditure by households on consumption goods and services - It includes expenditures on non-durable goods such as orange juice and pizza, durable goods such as televisions and DVD players, and services such as rock concerts and haircuts. Consumption expenditure also includes house and apartment rents, including the rental value of owner-occupied housing.
What is Cyclical Unemployment?
The fluctuating unemployment over the business cycle that increases during a recession and decreases during an expansion. At a business cycle trough, cyclical unemployment is positive and at a business cycle peak, cyclical unemployment is negative.
What is the GOAL of calculating REAL GDP?
The goal of calculating real GDP is to measure the EXTENT TO WHICH TOTAL PRODUCTION HAS INCREASED and remove from the nominal ("same year") GDP numbers the influence of price changes.
What is a Real Interest Rate?
The goods and services forgone in interest expressed as a percentage of the amount loaned and calculated as the nominal interest rate minus the inflation rate. (basically, you need $1030 to buy what $1000 previously would've, so the $50 interest you earned on your $1000 is now essentially reduced to $20 in real interest, or the REAL value of the $50 interest is $20)
Which of the following is not included when public debt is reported?
The government debt held in the Social Security Trust Fund Debt owned by non-government groups (the public) is called public debt
Which of the following would cause aggregate demand to decrease?
The government increases personal income taxes When the government increases personal income taxes, consumers' spending plans will decrease as they have less disposable income
What happens to loanable funds when a tax cut reduces paying down the deficit?
The government will still need money to pay it's debts, so when it cuts taxes it cuts revenue - which means the gov't now has to go borrowing money from lenders in order to pay down the deficit - this "crowds out" private investors, makes loanable funds more scarce, and drives up interest rates
This is an indicator of strength or weakness in the national labor markets. It provides information on how many positions need to be filled.
The help wanted index
What are short-term affects of the quantity of money?
The immediate effects are on the short-term nominal interest rate. If the Fed increases (or decreases) the quantity of money, the short-term nominal interest rate falls (or rises).
What do the Income and Expenditure approaches measure, in regard to product?
The income approach measures NET product the expenditure approach measures GROSS product The difference is depreciation, which is the decrease in the value of capital that results from its use and from obsolescence.
What is the Expected Inflation Rate?
The inflation rate that people forecast and use to set the money wage rate and other money prices.
What is the Discount Rate?
The interest rate at which the Fed stands ready to lend reserves to commercial banks.
What is the Federal Funds Rate?
The interest rate on interbank loans (loans made in the federal funds market) - part of banks' liquid assets
What is the Federal Funds Rate?
The interest rate on interbank loans (loans made in the federal funds market).
What is the labor force participation rate?
The labor force participation rate measures the fraction of the adult population that is employed or actively seeking work. The labor force participation formula is Labor Force/Working age population X100
What is the Law of Market Forces?
The law of market forces states: When there is a surplus, the price falls; and when there is a shortage, the price rises.
What is the Long-Run Phillip's Curve?
The long-run Phillips curve shows the relationship between inflation and unemployment when the economy is at full employment. At full employment, the unemployment rate is the natural unemployment rate, so on the long-run Phillips curve, there is only one possible unemployment rate: the natural unemployment rate. At this point, any inflation rate is possible. The vertical line that shows the relationship between inflation and unemployment when the economy is at full employment.
What are the long-run affects of the quantity of money?
The long-run effects of the Fed's actions are on the price level and the inflation rate. In the long run, the loanable funds market determines the real interest rate and the Fed's actions determine only the price level and the inflation rate. If the Fed increases (or decreases) the quantity of money, the price level rises (or falls). And if the Fed speeds up (or slows down) the rate at which the quantity of money grows, the inflation rate increases (or decreases).
What is Gross NATIONAL product? (GNP)
The market value of ALL the final goods and services produced anywhere in the world in a given time period by the factors of production supplied by the residents of the country. GNP equals GDP plus net factor income received from or paid to other countries.
GDP?
The market value of all the final goods and services produced within a country in a given time period.
Why does the quantity of real GDP supplied increase when the price level rises and decrease when the price level falls?
The money wage rate and money prices of other resources are constant along the AS curve: a movement along the AS curve brings a change in the real wage RATE (what the wage is worth in terms of what producer sells) - (and changes in the real cost of other resources whose money prices are fixed). If the price level rises, the real wage rate falls, and if the price level falls, the real wage rate rises. When the real wage rate changes, firms change the quantity of labor employed and the level of production.
Define the Money Multiplier. What does it indicate?
The number by which a change in the monetary base (due to say, an increase from an open market purchase) is multiplied to find the resulting change in the quantity of money, from loans/money getting passed from one bank account to another... The larger the currency drain and desired reserve ratio, the SMALLER is the money multiplier (aka, the less money is going to end up in the monetary base) and vice versa
What is the Money Multiplier?
The number by which a change in the monetary base is multiplied to find the resulting change in the quantity of money. The magnitude of the money multiplier depends on the desired reserve ratio and the currency drain ratio. The smaller are these two ratios, the larger is the money multiplier.
What is the rule of 70?
The number of years it takes for the level of any variable to double is approximately 70 divided by the annual percentage growth rate of the variable.
Define 'Inflation Rate'
The percentage change in the price level from one year to the next. INFLATION is positive change from one yr to next - "going up" When the price level rises rapidly, the inflation rate is high; when the price level rises slowly, the inflation rate is low; and when the price level is falling, the inflation rate is negative (or deflation)
Unemployment Rate
The percentage of the people in the labor force who are unemployed.
What is the Unemployment Rate and what does it tell us?
The percentage of the people in the labor force who are unemployed. It tells us the amount of unemployment is an indicator of the extent to which people who want jobs can't find them - the amount of slack in the labor market.
What is the Labor Force participation rate?
The percentage of the working-age population who are members of the labor force.
What are potential sources of bias in the CPI?
The potential sources of bias in the CPI are • New goods bias (new goods change the market basket composition, for which adequate comparisons can't be made w/ past years and this skews the CPI bias) • Quality change bias (does quality warrant price increases? are price increases proportional to quality increase, or not? these inconsistencies create CPI bias) • Commodity substitution bias (CPI basket has fixed quantities so if a price rises for a carrot and a person decides to switch to more lower-priced broccoli and spends the same as previous month, the CPI doesn't take this into account - the carrots still make the market basket rise in price even if consumers AREN'T spending more b/c of substitution) • Outlet substitution bias (people get goods CHEAPER at outlets but the CPI doesn't account for this and so the basket may increase in price)
If the aggregate supply curve shifts to the right and the aggregate demand curve shifts to the left, what happens to the price level and real output?
The price level falls, but the effect on real output cannot be determined If both curves shift in opposite directions, in general, we cannot determine the real output without knowing the extent of the shifts
If the quantity demanded for strawberries is more than the quantity supplied, what will happen to the price of strawberries?
The price will rise ( If there is more demand than supply of strawberries, this provides an incentive to the sellers to raise the price of strawberries. Thus, the price of strawberries will rise)
What is the Quantity Theory of Money?
The proposition that when real GDP equals potential GDP, an increase in the quantity of money brings an equal percentage increase in the price level.
What is the Natural Rate Hypothesis?
The proposition that when the inflation rate changes, the unemployment rate changes temporarily and eventually returns to the natural unemployment rate.
What is an Open Market Operation?
The purchase or sale of government securities—U.S. Treasury bills and bonds—by the New York Fed in the open market. A transaction between the Fed and some other bank or business. This is the Fed's main tool in manipulating the interest rate
What is the purpose of the CPI?
The purpose of the CPI is to measure the cost of living or what amounts to the same thing, the value of money. 'Cost of Living Index' is another name for CPI
What varies (in regard to banks) with the variation of the Federal Funds rate?
The quantity of money banks want to HOLD in reserves; if the FFR is HIGH, they want to hold little (because they would rather lend and get a higher interest rate from the other banks) - and vice versa
What is Labor Productivity?
The quantity of real GDP produced by one hour of labor. When Labor Productivity grows, Real GDP per person grows (and thus, the Standard of Living grows!)
In the United States, the redistributive function of the government is carried out mainly by
The redistribution function is financed at the federal level and implemented at the state and local levels.
Where do a nation's monetary policy and framework for those objectives stem from?
The relationship between the nation's central bank and the gov't
What is 'Demand'?
The relationship between the quantity demanded and the price of a good when all other influences on buying plans remain the same.
What is Aggregate Demand?
The relationship between the quantity of real GDP demanded and the PRICE LEVEL when all other influences on expenditure plans remain the same.
What is Aggregate Supply?
The relationship between the quantity of real GDP supplied and the price level when all other influences on production plans remain the same.
What is 'Supply'?
The relationship between the quantity supplied and the price of a good when all other influences on selling plans remain the same.
What is MacroEconomics?
The study of the choices that individuals and businesses make and the way these choices interact and are influenced by governments.
What is the Monetary Base?
The sum of coins, Federal Reserve notes, and banks' reserves at the Fed.
What is 'Market Demand'?
The sum of the demands of all the buyers in the market.
What is 'Market Supply'?
The sum of the supplies of all the sellers in the market.
What is Net Domestic Product at Factor Cost?
The sum of the wages, interest, rent, and profit. (NOT the same thing as GDP!)
How do prices of related goods (Substitute in Production or Complement in Production) change Supply?
The supply of a good decreases if the price of one of its substitutes in production rises; and the supply of a good increases if the price of one of its substitutes in production falls. That is, the supply of a good and the price of one of its substitutes in production move in opposite directions. The supply of a good increases if the price of one of its complements in production rises; and the supply of a good decreases if the price of one of its complements in production falls. That is, the supply of a good and the price of one of its complements in production move in the same direction.
What is 'Economic Growth'?
The sustained expansion of production possibilities. To make it happen, consumption must decrease and the resources put toward producing more capital (so consumption must be kept UNDER maximum) Economic growth SHIFTS the PPF outward
What is the Tax Multiplier?
The tax multiplier is the magnification effect of a change in taxes on aggregate demand. A decrease in taxes increases disposable income, which increases consumption expenditure. A decrease in taxes works like an increase in government expenditure. But the magnitude of the tax multiplier is smaller than the government expenditure multiplier because a $1 tax cut generates less than $1 of additional expenditure.
What is New Growth Theory?
The theory that our unlimited wants will lead us to ever greater productivity and perpetual economic growth.
What is Classical Growth Theory? (also called the Malthusian Theory)
The theory that the clash between an exploding population and limited resources will eventually bring economic growth to an end.
Opportunity Cost
The thing you have to give up to get something else - the best alternative of that thing you want most, foregone
What are the "tools" of fiscal policy?
The tools of fiscal policy are essentially government spending or taxes (how they are used - cut or increased) Automatic Fiscal Policy - triggered by the state of the economy: where an increase in unemployment induces an increase in transfer payments, and a fall in incomes induces a decrease in tax revenues Discretionary Fiscal Policy - initiated by an act of Congress: requires a change in a spending program or in a tax law; like increases in defense spending or cuts in the income tax rates
What is the Transfer Payments Multiplier?
The transfer payments multiplier is the effect of a change in transfer payments on aggregate demand. This multiplier works like the tax multiplier but in the opposite direction. An increase in transfer payments increases disposable income, which increases consumption expenditure. But like the Tax Multiplier it acts as $1 generating less than $1, and how much aggregate demand it generates depends on the marginal propensity to consume.
Natural Unemployment Rate
The unemployment rate when the economy is at full employment - it arises solely from Frictional and Structural unemployment fluctuations and NOT due to recession or expansion fluctuations (aka the absence of cyclical unemployment)
What is Natural Unemployment?
The unemployment rate when the economy is at full employment - it arises solely from Frictional and Structural unemployment fluctuations and NOT due to recession or expansion fluctuations (aka the absence of cyclical unemployment)
What is Frictional Unemployment?
The unemployment that arises from people entering and leaving the labor force, from quitting jobs to find better ones, and from the ongoing creation and destruction of jobs—from normal labor turnover.
What is Structural Unemployment?
The unemployment that arises when changes in technology or international competition change the skills needed to perform jobs or change the locations of jobs.
What is Net Export of Goods and Svcs?
The value of exports of goods and services MINUS the value of imports of goods and services. If exports exceed imports, net exports are positive and expenditure on U.S.-produced goods and services increases. If imports exceed exports, net exports are negative and expenditure on U.S.-produced goods and services decreases.
What is Potential GDP?
The value of real GDP when the economy is at full employment—all the economy's factors of production (labor, capital, land, and entrepreneurial ability) are employed. Real GDP equals potential GDP when the economy is at full employment.
What is the outcome if AD curve shifts to the right?
There has been a change (increase) in Aggregate Demand
What is happening when the Potential GDP line/curve (the vertical line) shifts ever rightward?
There is economic growth
What do firms do if the real wage rate rises?
They change the quantity of labor employed and the level of production If the price goes UP in relation to real wage rate, profits could be increased/production goes up If the price goes DOWN in relation to real wage rate, profits will decrease and some businesses temporarily shut down or go out of biz altogether
What does the Fed do, to change the interest rate?
They change the quantity of money; if they decrease the supply, the interest rate RISES; if they increase the supply, the interest rate FALLS
What happens to real GDP and potential GDP in the long run?
They equal each other - that is they equal each other, on average, in the long run
What happens to the amount of money people hold if the VALUE of it is high?
They hold smaller amounts - and if the value of money is low, they hold larger amounts
What happens to interest rate in regard to bond price?
They move in opposite directions - so if you want to earn $100 on a bond, and it costs $1,000, then the interest rate will be 10%; if it costs $500, then the interest rate will be 20% so you still get $100
What happens when foreign investors lose confidence in a nation's ability to repay the loans?
They will no longer want to hold that country's debt When a country's debt is too large, foreign investors find it too risky to hold the debt
In the first year, the real GDP for a population of 200 people is $50,000 and in the second year, the real GDP for a population of 202 people is $51400. The growth rate of the real GDP from year 1 to year 2 is
This is calculated as follows: (real GDP for year 2 − real GDP for year 1) divided by (real GDP for the year 1) ✕ 100 = 2.8%
What is the equation used to define Aggregate Demand (AD)?
This quantity is the sum of the real consumption expenditure (C), investment (I), government expenditure on goods and services (G), and exports (X) minus imports (M). That is, Y = C + I + G + X − M
GDP calculation (income)
To calc GDP using INCOME approach, add: Wages + Rent + Interest + Profits
What are the Fed's goals, as far as inflation rate and output gap (difference between real and potential GDP)?
To keep inflation at about 2% a year and to keep the output gap as close to zero as possible
What is currently the main function of the Federal Reserve?
To manage the money supply to promote economic growth, high employment, and a stable price level This is now the Fed's most important function, but it was not part of the original design of the system
PPF (Production Possibilities Frontier) tradeoff
To move up or down along the PPF, it involves the need to give up one thing in order to gain more of another thing - this is a trade-off
Why did Congress create the Federal Reserve (the U.S. Central Bank)?
To regulate lending practices and act as a "lender of last resort" The Fed seeks to keep banks from making risky loans that threaten the safety of deposits. A second purpose is to rescue sound banks threatened with failure because of temporary economic conditions
In the United States, GDP is about twice as large now as it was 20 years ago. What does this indicate?
Total spending has doubled, but part of this increase reflects higher prices Increases in GDP reflect both higher output and higher prices
True or false. Although GDP is used as a proxy for living standards or economic well-being, there are reasons why GDP is not a perfect proxy
True
True or false. As a percentage of GDP, the U.S. national debt has been increasing for the past several decades
True
True or false. Each period of unemployment is a lost opportunity to develop skills and experience that may make a worker more valuable to an employer.
True
True or false. When there is full employment, the number of job seekers is approximately equal to the number of job vacancies.
True
True or false. Unplanned changes in inventories play a very important role in moving an economy toward equilibrium. Sudden increases or decreases in inventories may signal to producers that they need to change their level of output
True Unplanned changes in inventories will cause producers to change their level of output, and this will affect the equilibrium
True or false. A change in the price level will not shift the aggregate supply curve
True A change in the price level does not cause a shift of the aggregate supply curve
True or false. Infant industries may need protection from foreign competition initially, but if they have this protection, there may be little incentive for them to "grow up."
True A company that gets protection or a subsidy has a strong incentive to never "grow up"
True or false. If the government must cut spending programs in order to use tax revenues to repay the debt, the people who would benefit from those spending programs will essentially be "taxed" to pay back the debt
True A cut in government spending could involve a cut in welfare spending programs
True or false. As countries have developed, death rates fell first, as better health care, better nutrition, and higher standards of living lengthened life spans. Then, birth rates fell later
True A nation that has bridged the developmental gap from falling death rates to falling birth rates, thus slowing population growth and reducing the dependency ratio, has made the demographic transition
True or false. The Keynesian short-run aggregate supply curve is horizontal when there are unused resources and prices do not increase when aggregate demand increases
True According to Keynes, when there are unused resources, the SRAS tends to be horizontal, so prices do not increase when aggregate demand increases
True or false. According to Say's law, if a company produces output with a value of $500, then the company also creates incomes for the resources equal to $500
True According to Say's law, the production of goods and services generates an amount of income equal to the value of the products produced
True or false. Aggregate income could be measured to calculate economic growth
True Aggregate income is the component of GDP, which is the measure of a country's economic growth
True or false. Aggregate supply is defined as the total amount of goods and services (real output) produced and supplied by an economy's firms over a period of time
True Aggregate supply represents the ability of an economy to deliver goods and services to meet demand
True or false. Economist Simon Kuznets noted many differences between conditions in developing countries and the pre-industrial phase of developed countries
True Although the stages might describe the development process of the present industrialized nations, critics point out that the present developing countries will not necessarily follow the same sequence
True or false. If taxes increase and the aggregate supply curve is upward sloping, then output falls and the price level increases
True An increase in taxes causes a decrease in aggregate demand. The new equilibrium will show a fall in output and increase in the price level
True or false. Suppose the Federal Reserve increases the money supply. In a Keynesian model, the increase in the money supply will cause an inflationary gap, a demand-pull inflation, and a movement along the short-run aggregate supply curve
True An increase in the money supply will cause an inflationary gap, a demand-pull inflation and a movement along the short-run aggregate supply curve
True or false. Events that shift the aggregate supply curve to the right lead to economic growth
True Anything that shifts the aggregate supply curve to the right is a source of economic growth because it will produce a rise in real output and income
True or false. As the domestic price level rises, the demand for imports increases
True As the domestic price level rises, foreign‐made goods become relatively cheaper, so that the demand for imports increases
True or false. The Fed changes the discount rate to signal the direction of monetary policy rather than as a direct tool for changing the money supply
True Banks have many other options for obtaining reserves, so they will not necessarily alter the amount of reserves they borrow when this rate changes
True or false. Aggregate supply and demand combined with the aggregate production function determine not only the price level and real output, but also the level of employment and, by extension, the level of unemployment
True By extending the AD/AS equilibrium to the production function, you can determine the level of employment and unemployment at every level of real output
True or false. The aggregate supply and demand curves, taken together, determine the price level and the level of real output. Adding an aggregate production function also indicates the level of employment
True By extending the equilibrium line from the AD/AS graph to the production function graph, you can identify the level of employment
True or false. A situation in which all available labor resources are being used in the most economically efficient way is full employment.
True By this definition, an economy is at full employment when 93%-94% of those who want to work are employed.
True or false. An increase in capital or an improvement in technology will shift the aggregate production function
True Capital and technology are the ceteris paribus factors that will cause a shift of the production function when they change
True or false. Changes in price expectations influence the demand for money because changes in the price level affect the purchasing power of money
True Changes in price expectations influence the demand for money because changes in the price level affect the purchasing power of money
True or false. Checking accounts have many advantages over banknotes. For example, checking accounts are easier to protect from theft than cash, because you can stop payment on checks if your checkbook or checking account number is stolen
True Checking accounts have many advantages over banknotes. One benefit is that they make it easier to protect cash from theft through the use of a stop payment on checks, when your checkbook or checking account number is stolen
True or false. The Classical theory claims that most government economic policies are ineffective, ill timed, or downright harmful, and that the market system works best in macroeconomics, as well as microeconomics, when left alone
True Classical economists assumed that the market is self-regulating and that no government intervention is necessary
True or false. The percentage of the labor force that is 16 to 24 years of age has been declining since 1990
True Correct. The percentage of workers that are 16 to 24 years of age has fallen from about 18% in 1990 to 13.5% in 2010, and is projected to fall further by 2020
True or false. Countries with high levels of economic freedom have longer life expectancy, higher average incomes, lower child mortality, cleaner environments, and less governmental corruption
True Countries with high levels of economic freedom have longer life expectancy, higher average incomes, lower child mortality, cleaner environments, and less governmental corruption. For these reasons, economic freedom is closely associated with economic growth
True or false. The urban population in a dual economy is too small to provide a market for manufacturing and services, or to generate enough saving and investment in human and physical capital
True Dualism can be a major handicap to development
True or false. An annually balanced budget would force Congress to collect taxes to pay for spending programs and, thus, restrict the growth of government
True During the recession phase, when tax revenue automatically falls and transfer programs are more expensive, there is a deficit, which would have to be reduced through higher taxes or lower spending under an annually balanced budget rule
True or false. During the Great Depression, there was support for spending more on social projects during economic downturns and cutting back when the economy returned to full employment
True Economic downturns are often the result of weak spending, so spending more on social projects is a way to prevent a downturn from becoming more severe
True or false. Hotel chains and professionals in need of household help are likely to see immigrants as a major benefit if they are willing to work for lower wages
True Employers benefit when wages are lower
True or false. When all the excess reserves in the banking system have been used up, the money supply stops expanding
True Expansion of the money supply cannot continue when there are no more excess reserves in the banking system
True or false. In the short run, when aggregate supply slopes upward, expansionary policies can stimulate production and job creation
True Expansionary policies cause aggregate demand to shift to the right
True or false. According to Keynesian theory, fiscal policy works by shifting the aggregate demand curve to either increase output and employment or reduce the price level
True Fiscal policy can be either expansionary, shifting AD to the right to increase output and employment, or contractionary, shifting AD to the left to reduce the equilibrium price level
True or false. According to the Keynesian model, there is sometimes a conflict between actions that are in the social interest and actions that are in a person's self-interest
True For example, in a recession, social interest calls for increased spending, but self-interest might best be served by saving more money due to concerns about future job loss
True or false. For most of its history, the United States has had high tariffs and other trade restrictions
True For example, the Smoot-Hawley Tariff Act of 1930 imposed an average tariff charge of 53%
True or false. Fractional reserve banking is the practice of holding a fraction of money deposited as reserves and lending the rest
True Fractional reserve means that not all the money is lent out since a portion is reserved
True or false. By definition, an economy is at full employment when 93%-94% of those who want to work are employed.
True Full employment does not mean that everyone in the population is employed or even that 100% of those who are able are willing to take a job.
True or false. Government takes funds out of the stream by taxing households and by borrowing in the credit market
True Government taxes and borrowing are leakages from the income flow
True or false. The basic elements of the development process are the same as those for economic growth in developed countries
True Growth and development go hand in hand
True or false. An increase in energy prices causes aggregate supply to shift to the left
True Higher input prices make production more expensive and cause aggregate supply to shift to the left. When aggregate supply shifts to the left, the equilibrium price level increases, demonstrating that higher costs lead to higher product prices
True or false. Unemployment allows for growth in the economy.
True If a business wants to expand, but there are no workers available to hire, the only way the expanding business can get a new employee is to "steal" the employee away from the existing employer, which can be done by offering higher pay or benefits.
True or false. According to the Keynesian model, the economy varies from the goal of full employment when aggregate expenditure is too weak
True If aggregate expenditure is too weak, equilibrium income will be less than full-employment income
True or false. The omission of barter, or "under-the-table," transactions understates GDP
True If an accountant trades services with a dentist, production has increased for both of these individuals, yet this would not be reflected in GDP because GDP excludes barter transactions
True or false. If wages do not change, improvements in productivity stemming from improved technology will decrease business costs, improve profitability, and encourage more production
True If the wage of a labor remains the same, the improvement in technology will decrease business costs and improve profitability because the output per hour of work is increased
True or false. In the Keynesian view, the monetary process is longer and more complicated than in the Classical view
True In the Keynesian model, monetary policy may be ineffective if interest rates do not fall or if investment spending does not increase
True or false. A hurricane that destroys businesses can have a positive effect on GDP
True In the short run, destruction can increase GDP because of the rebuilding that occurs. In the long run, it does not create economic growth because of the broken window fallacy, which you learned about in module 1
True or false. Demand-based growth strategy is more effective if the short run is actually a long period of time
True Increasing output by increasing aggregate demand in the short run is possible, so this strategy has more impact if the short run is a significant period of time
True or false. In 2015, the majority of foreign investors are not worried about the United States defaulting. This has allowed the U.S. government to issue government bonds with very low interest rates
True Interest rates in the United States are still very low, thanks also to the confidence of investors
True or false. When budget deficits are not controlled, there is no constraint on the size of the public sector
True It is much easier for everyone to support government spending when they do not have to face the burden of higher taxes
True or false. It is estimated that it takes about 18 to 24 months for the full effect of monetary policy to be felt due to inside and outside lags
True It takes this much time to recognize a problem, implement policy, and wait for policy to have effect
True or false. Keynes challenged the classical school during the Great Depression. He advocated government intervention in the form of fiscal policy to shift aggregate demand
True Keynes advocated government intervention to bring the economy back to equilibrium by shifting aggregate demand while Classical theorists believed the market self-regulated
True or false. One of Keynes' criticism of Classical macroeconomic is based on the belief that neither labor markets nor product markets can be counted on to be self-regulating
True Keynes did not believe that the markets could be self-regulating
True or false. The three fiscal policy lags are the recognition lag, the implementation lag, and the impact lag
True Lags in making policy decisions provide a limitation on discretionary fiscal policy
True or false. Lowering the interest rate to try and get businesses to invest more and people to borrow more money is a common way governments try to stimulate economic growth
True Lowering the interest rates will encourage people and businesses to invest more
True or false. M1, which is often referred to as the money supply, consists of coins, currency in non-bank hands, checkable deposits, and traveler's checks
True M1 is the monetary aggregate with the greatest liquidity
True or false. Comparing current GDP with last year's GDP provides more accuracy than comparing current GDP with GDP 20 years ago
True Many changes have occurred over the past 20 years, such as the introduction of new products. These changes are not always reflected in GDP estimates
True or false. According to the Monetarist view, the Fed should use monetary policy to stabilize money growth and keep the economy on a stable growth path
True Monetarists place less emphasis on interest rates and more on the direct effects of changes in the money supply on spending
True or false. The Fed did not cause the Depression, but perhaps a more aggressive expansionary monetary policy would have made it shorter and milder
True Monetarists, led by Milton Friedman, have demonstrated that the Fed's lack of action may have caused such a prolonged and severe downturn
True or false. Experience suggests that a good candidate for serving as money should be somewhat scarce, portable, durable, divisible, and generally acceptable
True Money should possess all of those characteristics
True or false. A family spending on electricity is a consumer's expenditure
True Money that is spent on maintaining a household is considered a consumer's expenditure. Examples could include food, gas, and clothing
True or false. In the process of producing GDP, income is generated
True National income consists of wages, rent, interest, profit, and proprietors' net income; business owners deduct wages and other expenses from revenue and the amount that is left becomes profit or income to the proprietor (owner) of the business
True or false. A decrease in net export spending caused by an appreciation of the U.S. dollar would cause the aggregate demand curve to shift to the left
True Net exports are one of the components of aggregate demand. If they decrease, aggregate demand will shift left
True or false. Non-Economic conditions can affect the economy both positively and negatively
True Non-economic conditions in the country can have both negative and positive effects on GDP
True or false. The actual deficit is not known until after the fiscal year is over
True One of the problems with taming the deficit is that its size is difficult to predict and control
True or false. In 2014, the target range for the federal funds rate was between 0 and 0.25%
True Rates were kept very low after the financial crisis of 2007
True or false. Remittances sent from workers employed in foreign countries back to their home countries are considered a massive poverty-alleviation program; although not one that leads to economic development
True Remittances sent from workers employed in foreign countries back to their home countries are considered a massive poverty-alleviation program; although not one that leads to economic development
True or false. The first two attempts at central banks were also private banks, but concerns about corruption led Congress to seek a different structure for the U.S. central bank
True The Bank of the United States, established in 1791, was privately owned but chartered by the federal government. Its charter expired in 1811. In 1816, the Second Bank of the United States was created, but its charter was not renewed in 1835
True or false. The Bush and Clinton tax increases in 1990 and 1993 were both intended primarily to control the deficit rather than to influence the level of output
True The Bush and Clinton tax increases in 1990 and 1993 were both intended primarily to control the deficit rather than to influence the level of output
True or false. The Fed's most frequently used monetary tool is buying and selling government bonds in the open market
True The Fed's preferred tool is open market operations
True or false. The United States is divided into 12 Federal Reserve districts, each with its own Reserve Bank
True The Federal Reserve System was designed to allay fears about concentrating financial power at the federal level
True or false. When the Federal Reserve buys federal debt, it is monetizing the debt
True The Federal Reserve is able to pay for government bonds using newly created money, which increases the money supply
True or false. As a result of the Great Depression and World War II, the national debt increased significantly
True The Great Depression caused a sharp drop in output, leading to lower tax revenues and an increase in government borrowing. World War II brought a large increase in output, but an even larger increase in government borrowing
True or false. The benefit of inflation targeting is to reduce uncertainty and reassure the public regarding how the Fed intends to respond when inflation threatens to escalate
True The Taylor Rule is one example of inflation targeting
True or false. In 2011, the United States fell out of the top ten countries ranked according to economic freedom, and for the first time Canada surpassed the United States with a ranking of sixth place
True The United States had been in the top ten for a long time prior to 2011
True or false. The World Bank was created when representatives of the major nations met in Bretton Woods, New Hampshire in 1944 to make plans for international economic coordination in the postwar period
True The World Bank's first charge was to assist Europe in recovering from World War II. The International Monetary Fund was also created at this time
True or false. The points on an aggregate demand curve are equal to the various equilibrium points on the aggregate expenditure graph when the price level changes, but all other components remain the same
True The aggregate demand curve shows the relationship between demand and price levels. Each aggregate expenditure line has a given price level
True or false. There is an inverse relationship between the price level and the quantity demanded of real GDP
True The aggregate demand curve, like the demand curves for individual goods, is downward sloping
True or false. The aggregate production function shows how much total real output can be produced by various amounts of labor, given the amount of capital and available technology
True The aggregate production function shows the relationship between the total real output and the inputs available
True or false. Evidence suggests that some recessions or expansions may be triggered by aggregate supply shifts, but fluctuations also result from aggregate demand shifts
True The behavior of the price level over the course of the business cycle provides evidence regarding whether the change in output was caused by a supply shift or a demand shift
True or false. When net exports are negative, imports exceed exports
True The calculation for GDP adds exports and subtracts imports; these two operations are often combined and the difference between them (net exports) is reported
True or false. Reducing the deficit requires raising taxes and/or lowering government spending and both of these have political difficulties
True The deficit can only be reduced if the government raises taxes, cuts spending, or some of each
True or false. Equilibrium values of the price level, and real output is determined by the intersection of aggregate supply and aggregate demand
True The intersection of aggregate demand and aggregate supply determines the equilibrium values for price level and real output
True or false. The ease with which an asset can be converted into the medium of exchange is called liquidity
True The more an asset can be used as a medium of exchange, the more liquid it is considered
True or false. If a country is poor in skilled labor, it has two possible remedies: it can import the goods that require skilled labor to produce, or it can make the effort to raise the level of skilled labor through immigration or education
True The movement of inputs between countries can substitute for free movement of goods
True or false. According to Friedman's permanent income hypothesis, a 22-year-old who is about to graduate from college will likely spend more than a 22-year-old with very little education or job experience
True The permanent income hypothesis is the view that current consumption depends on expected income and the soon-to-be graduate will likely spend more based on higher expected income
True or false. The interest rate is determined where the money market is in equilibrium
True The price of money is the interest rate and that is determined where the money demand curve intersects the money supply curve
True or false. A major shortcoming of the quantity theory of money is that it cannot explain short-run fluctuations in the level of output and employment
True The quantity theory of money cannot explain short-run fluctuations in the level of output and employment
True or false. The most successful form of import substitution for many developing countries has been improving domestic agriculture to reduce dependence on imported food
True The result of this successful strategy has been hard times for farmers in countries like the United States that formerly exported food to developing countries
True or false. Monetary policy is affected by the same kinds of lags as fiscal policy: recognition, implementation, and impact
True These are often called inside and outside lags, but they are essentially the same
True or false. If output falls far below full employment, progressive income taxes and transfer programs will create a deficit, as tax revenues fall and transfer payments rise, but these changes will help increase spending and output
True These automatic stabilizers help to smooth out the ups and downs of the business cycle
True or false. More fuel-efficient cars, alternative energy sources, insulation, modified production methods, and other responses minimized the long-run effect of high energy costs on the economy after 1980
True These changes prevented higher energy prices from having such a negative impact on the economy
True or false. If leakages are greater than injections, the size of the income flow will shrink
True Think of a bathtub; if a lot of water is being drained, but only a little is being added, the water level falls
True or false. The Fed's dual mandate is to maintain both full employment and price stability
True This dual mandate was formalized with legislation passed in the 1970s
True or false. The Keynesian belief that banks are more likely to hold larger amounts of excess reserves during a recession was supported when excess reserves rose from $1.5 billion in September 2008 to above $900 billion in January 2009
True This increase happened when the economy entered recession
True or false. After 40 years of economic growth, average weekly earnings, adjusted for inflation, have only risen about 11.7%
True This is a dismal picture of real gains for U.S. workers
True or false. Congressional legislation over the years, much of it enacted during the Great Depression, has created a system of tax collections and transfer payments that change automatically in response to changes in national income
True This legislation has primarily included changes in income tax collections, Social Security and welfare benefits, and unemployment compensation claims
True or false. Goods and services for export, such as chemicals, entertainment, and financial services, are also a key component of aggregate supply
True Traded goods are the components of aggregate supply
True or false. The value of government expenditure included in GDP is smaller than the true amount spent by government, because it does not include transfer payments.
True Transfer payments are income payments to individuals who provide no goods or services in exchange, such as Social Security or welfare
True or false. The distribution of income in developing countries shows great inequality, making it difficult to save and invest because the wealthy group is so small and most of the rest of the population is at a subsistence level of income
True Typically there are greater extremes of wealth and poverty, with a small wealthy elite, a large mass of people who are poor in both urban and rural areas, and a very small middle class
True or false. If firms' unplanned inventories are increasing, then in a closed, private economy consumers are saving more than businesses anticipated
True When consumers are saving more than anticipated, businesses are left with unplanned inventory
True or false. The slope of the aggregate supply curve depends on how costs change when firms change the level of production or quantity of output supplied
True When costs go up as firms attempt to increase output, the aggregate supply (AS) curve is upward-sloping
True or false. A declining labor force participation rate means fewer workers are supporting an increasing number of non-workers.
True When people leave the labor force, they still consume goods and services, and it is up to the remaining workers to create these goods and services
True or false. A higher price level causes an increase in nominal GDP, but not an increase in real GDP
True When real GDP is calculated, the increase in the price level is removed
True or false. The Fed cannot pursue both an interest rate target and a money supply target at the same time
True When the Fed chooses one target, it loses control of the other
True or false. A recessionary gap occurs when aggregate expenditures intersects the 45-degree line to the left of the full-employment level of output
True When the aggregate expenditure intersects the 45-degree line that is the equilibrium output. Since it is less than full-employment it would be to the left
True or false. If the price level increases net exports, assets, government spending and household wealth all decrease
True When the price level increases the economy will move up and to the left on the aggregate demand curve
True or false. As women entered the labor force, male participation declined partially due to the increased safety net for married men.
True When their wives work more men have the option of leaving the workforce and still having their families provided for
True or false. In a closed economy, equilibrium output occurs where the C + I + G line crosses the 45-degree line
True Where aggregate expenditure crosses the 45 degree line determines the equilibrium output
True or false. The two government groups that own federal debt are the Social Security Trust Fund and the Federal Reserve
True While the Social Security Trust fund owns the majority of the non-public debt, the Federal Reserve owns some of the debt
True or false. Lower unemployment is a benefit of economic growth
True With higher output firms tend to employ more workers creating more employment
True or false. A number of studies have concluded that workers are more productive when offered incentives like profit-sharing or bonuses
True Workers are motivated to work harder or acquire more skills when offered financial incentives
True or false. If Emily puts her son into the local daycare, GDP increases. If she stays home and cares for her son, GDP does not increase
True If Emily pays a childcare provider, this is considered a market transaction and is counted in GDP. If Emily cares for her son herself, this is a non-market transaction and is not counted in GDP
True or false. In the United States, gross domestic produce (GDP) is currently the most widely used measure of total output.
True (we stopped using GNP in 1991)
Which statement about the U.S. political system is false?
U.S. Senators are all elected every 4 years Senators serve 6-year terms and one-third of the Senate is up for election every 2 years
A Federal Reserve note is accepted as money by most Americans because
U.S. law establishes it as legal tender Money is accepted because the U.S. law established it as legal tender
Unit 3
Unit 3
Unit 4: Economic Theory and Fiscal Policy
Unit 4: Economic Theory and Fiscal Policy
In 2011, the per capita gross national income was $48,890 in the
United States
Two types of workers that cause unemployment to be overstated are
Unreported legal workers and reported illegal workers (These problems result from the inability of the BLS (Bureau of Labor Statistics) to verify the truthfulness of the information provided by respondents.)
The difference between GDP and GNP is likely to be what?
Very large, if many foreign citizens are employed within a country Output produced by foreign citizens working within a country is counted in GDP, but is not counted in GNP
Which of the following is an example of a transfer payment?
Veterans' benefits. They are transfer payments because they are income and they are disbursed without work being done.
As of April of 2015, 161 countries are members of the
WTO (World Trade Organization)
Which two presidential candidates lost their elections due to the public's dislike of tax increases?
Walter Mondale and George H.W. Bush In 1984, Democratic presidential candidate Walter Mondale admitted that, if elected, he would raise taxes. He carried two states and the District of Columbia. In 1988, George H. W. Bush promised no new taxes. He was elected, agreed to raise taxes, and lost the election in 1992
What happens to PRICE when Demand and Supply Increase together? (think about the different effects they each have on price...we already know the quantity will increase)
We can't say what happens to the price unless we know the MAGNITUDES of the changes. If demand increases by more than supply increases, the price rises. But if supply increases by more than demand increases, the price falls.
Describe how the Equation of Exchange explains the Quantity Theory of Money
Well, the Quantity Theory of Money states: The proposition that when real GDP equals potential GDP, an increase in the quantity of money brings an equal percentage increase in the price level. The Equation of Exchange says this: When the economy is at full employment (real GDP equals potential GDP) and the velocity of circulation is stable, the price level and the quantity of money increase by the same 20 percent. BECAUSE potential GDP is not influenced by nominal factors like quantity of money (but rather, real things like physical capital or labor productivity) and velocity of circulation (how many times money gets spent in an economy during a set time period) is ALSO not influenced by quantity of money, then % change in quantity of money leads directly to % change in price level alone
The fifth stage, high mass consumption, describes the present level of development in the United States and
Western Europe
What is Potential GDP?
What the GDP would be if ALL factors of production were fully employed. When this is not the case, the Real GDP is BELOW Potential GDP The growth rate of potential GDP fluctuates less than real GDP (and if there is growth slowdown, potential GDP can go down as the years go by, which essentially means that a nation's potential GDP is getting less and therefore worse)
What are the three basic economic questions?
What to produce? How to produce? For whom to produce?
When does Aggregate Supply change?
When any influence on production plans other than the price level changes. In particular, aggregate supply changes when: • Potential GDP changes. • The money wage rate changes • The money prices of other resources change
What happens to PRICE when Demand and Supply both DECREASE? (think about the different effects they each have on price...we already know the quantity will decrease)
When demand and supply decrease together, we can't say what happens to the price unless we know the magnitudes of the changes. If demand decreases by more than supply decreases, the price falls. But if supply decreases by more than demand decreases, the price rises.
What happens to demand regarding Expected Future Income or Credit?
When income is expected to increase in the future, or when credit is easy to get and the cost of borrowing is low, the demand for some goods increases. And when income is expected to decrease in the future, or when credit is hard to get and the cost of borrowing is high, the demand for some goods decreases
What is 'Absolute Advantage'?
When one person (or nation) is more productive than another—needs fewer inputs or takes less time to produce a good or perform a production task, we say that person (or nation) has an absolute advantage.
When can running a deficit cause a problem for future generations?
When resources may be diverted away from productive investment If the government increases spending when the economy is at full employment, resources may be diverted away from productive investment
What do we mean by "Balanced Budget"?
When tax revenues equal outlays (obligations)
What is Operation Twist?
When the Fed buys long-term government securities and sells short-term government securities; the idea is to lower long-term interest rates and stimulate long-term borrowing and investment expenditure.
What is Credit Easing?
When the Fed buys private securities or makes loans to financial institutions to stimulate their lending
What is Quantitative Easing?
When the Fed creates bank reserves by conducting a large-scale open market PURCHASE at a low or possibly zero federal funds rate
Explain how an Open Market Purchase changes Reserves and Monetary Base
When the Fed makes an Open Market Purchase, currency and reserves both go UP by the amount of the purchase - it increases the monetary base
What is 'Market Equilibrium'?
When the quantity demanded equals the quantity supplied—buyers' and sellers' plans are in balance. Where the curves intersect.
When are price level and value of money at equilibrium levels?
When the quantity of money supplied equals the long-run quantity demanded, the price level and the value of money are at their equilibrium levels.
What is Macroeconomic Equilibrium?
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 AS curve.
What is Full Employment?
When there is no cyclical unemployment or, equivalently, when all the unemployment is frictional or structural.
How do you know when you've made a 'rational choice'?
When your MARGINAL BENEFIT from that choice equals or exceeds it's MARGINAL COST
What does the GDP count the value of?
With one exception, it includes only those items that are traded in markets and does not include the value of goods and services that people produce for their own use. For example, if you buy a car wash, the value produced is included in GDP. But if you wash your own car, your production is not counted as part of GDP. The EXCEPTION is the market value of homes that people own. GDP puts a rental value on these homes and pretends that the owners rent their homes to themselves.
Multilateral organizations involved in assisting developing countries include the
World Bank, United Nations, and the World Trade Organization These organizations are involved in assisting developing countries
The Fed's first challenge was helping the treasury finance the budget deficit during and after
World War I
Does WHEN a good is produced matter to GDP?
YES - GDP measures the time period it's produced in; either GDP quarter or year (quarter-year, to track short-term evolution, and annual GDP tracks long-term) GDP measures value of total production AND total income and total expenditure
Does WHERE a good is produced matter to GDP?
YES - it only considers production WITHIN a country, as part of a country's DOMESTIC GDP, NOT goods produced outside of the its country (even if it's a US company - if it produces in Vietnam, it's not part of US GDP but rather, Vietnam's GDP)
Are Deposits money?
Yes, because you can use your check or debit card to tell your bank to move money and pay someone
According to Franco Modigliani, which groups are most likely to engage in dissaving?
Young families and retired individuals Modigliani hypothesized that young families would dissave to acquire their start-up capital of houses and cars while their current earnings were low, but their potential future earnings were high. During retirement years, households would again become dissavers, drawing on their pool of accumulated savings, as their consumption needs exceeded their income
Mixed economy
a blend of tradition, command, and market economies (Most modern industrial countries have this)
The main cost of active fiscal policy is
a budget deficit The negative effect of using active fiscal policy to combat recession is a budget deficit. Since it is politically difficult to cut spending or raise taxes, there is a bias in favor of deficits
Because the demand for agricultural output is not very responsive to price changes,
a bumper crop will lead to a big price drop A bumper crop means an increase in supply, which causes a large decrease in price if demand is inelastic
NAFTA is
a free trade agreement between Canada, the United States, and Mexico Canada, the United States, and Mexico formed NAFTA in 1993 when Bill Clinton was president
Aggregate supply is vertical in the long run, so a rightward shift of aggregate demand leads to
a higher equilibrium price level
Smith's Classical principles of economic development rested on
a laissez-faire governmental policy of nonintervention toward private industry and commerce Smith is regarded as the founder of market economics
The big push strategy calls for
a major thrust on all fronts in the economy by government or by private enterprise with the government's support Development in all sectors helps create new markets to aid in continued development
When quantity supplied equals quantity demanded, there is
a market-clearing price (equilibrium price)
The standard of value function of money refers to money as
a method of measurement or comparison The standard of value makes money a method of measurement and comparison
Economists generally believe that the aggregate demand curve has
a negative slope
A banknote is
a promise entitling the bearer to an amount of gold on demand at the bank A banknote is a promise entitling the bearer to an amount of gold on demand at the bank
Getting a mandated vaccination that protects you, but also protects others, would be considered
a pure public good
One of the main differences between tariffs and quotas is that
a tariff raises tax revenue, whereas a quota does not A tariff is a tax, so it generates tax revenue as each imported unit is subject to the tax
Fiscal policy is most effective when
a tax cut has a large effect on consumer spending A large change in spending helps the policy have greater impact
For the United States, the average rate of growth from 1950 to 2011 has been
about 3.3% The overall (compounded) rate of growth from 1950 to 2011 has been about 3.3% per year
The recognition lag is
about the same for monetary and fiscal policy The time it takes for policymakers to recognize a problem with the economy is independent of the type of policy chosen to combat the problem
The fact that money is legal tender increases its
acceptability
output gap
actual GDP - potential GDP
When banks are holding excess reserves,
actual reserves exceed required reserves, and they are not maximizing loans and profit potential Banks are allowed to continue making loans until excess reserves equal zero, when actual reserves are equal to required reserves
GDP calculation (expenditure)
add: Consumption + Investment + Gov't Spending + Net Export
Resources flow to certain sectors of the economy, such as real estate, that enjoy tax
advantages
The total of all planned expenditures in the entire economy is
aggregate demand The aggregate demand curve is the total planned expenditures in an economy
In the Classical tradition, an increase in the money supply creates excess money balances. As these balances are spent,
aggregate demand shifts to the right, increasing equilibrium prices and output With higher spending, aggregate demand shifts right and equilibrium price and output both increase
The amount of real output that can be produced by various amounts of labor can be represented by a(n)
aggregate production function The relationship between real output and labor is represented by the aggregate production function
The total amount of goods and services that firms are willing to sell at a given price level during a specific time period in an economy is called the
aggregate supply
According to real business cycle theory, economic fluctuations result from changes in
aggregate supply Economic fluctuations result from changes in aggregate supply, according to real business cycle theory
the relationship between the quantity of total real output supplied and the price level when all other factors influencing production plans are held constant is called the
aggregate supply curve
If aggregate demand and nominal GDP increase while the price level is constant, one would conclude that the
aggregate supply curve is horizontal Graphically, if aggregate supply is horizontal, shifts in aggregate demand can only affect the output level
A curved production possibilities curve (PPC) changes the assumption that resources are
alike
GNP (gross national product) is the total market value of
all final products produced by a nation's citizens during a given time period GNP is output produced by U.S. resources, whether production happens in the United States or in a foreign country
The Classical model uses the assumption that
all wages and prices are flexible Classical economists assume that prices and wages are flexible
The Classical model uses the assumption that
all wages and prices are flexible In the Classical model, all wages and prices are flexible
If the Fed is committed to a money supply target and interest rates increase because of a housing boom, the Fed would need to
allow interest rates to increase, even though investment spending could suffer as a result High interest rates have a negative impact on investment spending
Reduced tax rates give people more disposable income, resulting in
an increase in spending
Increased demand for natural resources causes
an increase in the price of natural resources, which causes aggregate supply to shift to the left Higher input prices cause aggregate supply to shift to the left
Keynesians emphasize the impact of changes in interest rates on investment spending, aggregate demand,
and equilibrium output and employment
Prices play a central role in a market system in allocating scarce resources and
answering the basic economic questions (The primary functions of prices are to inform, direct, and motivate consumers and firms)
Traditional economy
answers the basic economic questions by tradition, or custom (Haiti banana farmers)
Command (or planned) economy
answers the basic economic questions through central command and control (Soviet Union, China, North Korea and Cuba)
An aggregate supply curve shifts to the left when
any non-price-level factor decreases the total cost of production
With all else held constant, suppliers usually will supply less of a good or service
at lower prices
total spending
autonomous + induced
The big push strategy calls for
balanced growth The big push strategy calls for a major thrust on all fronts
If the Fed sells bonds,
bank reserves decrease
If the Fed buys bonds,
bank reserves increase
Monetary policy refers to the Fed's control over
bank reserves, credit, and interest rates
Additional deposits create additional reserves for the
banking system
A document that entitles the bearer to an amount of gold on demand at the bank is a
banknote A banknote is a document that entitles the bearer to an amount of gold on demand at the bank
The federal funds rate is the interest rate
banks charge each other on reserve loans If a bank is not meeting the reserve requirement, it can borrow reserves from another bank in the federal funds market
According to the Keynesian model, contractionary monetary policy is more likely to be effective than expansionary monetary policy because
banks have no choice but to reduce loans when reserves fall, but they can maintain positive excess reserves If the Fed acts to reduce bank reserves, banks may borrow reserves from the Fed on a temporary basis, but will have to contract their loan portfolios to avoid negative excess reserves
In the Keynesian model, monetary policy is effective when
banks lower interest rates and increase lending
When the Fed uses the monetary tools to increase bank reserves,
banks may not increase lending, so the policy is not always effective Banks may choose to hold positive excess reserves if they are not confident that borrowers will repay loans
Import substitution is a strategy of
becoming less dependent on other countries by developing domestic industries to produce goods that had previously been imported Import substitution is a strategy of becoming more self-sufficient
After classifying 115 economies on the basis of political rights, individual rights, and use of a free market, Gerald Scully found that those that most strongly emphasized political and individual rights and the use of markets had
been growing at a rate 2.7 times as fast as those that did not Scully found that countries that emphasized political and individual rights and the use of markets had been growing at a rate 2.7 times as fast as those that did not. Adkins and Savvides confirmed these findings more recently, using data for 73 developed and developing countries
Capitalism is based on the
benefits of competition
In general, when unskilled workers migrate to the United States, business firms and skilled workers are
better off
The composite aggregate supply is upward-sloping in
between the Classical & Keynesian regions
If the interest rate in this market drops below the target rate set by the Fed, the Fed will sell
bonds to adjust reserves and cause the rate to rise Bank reserves are reduced when the Fed sells bonds, so the supply of federal funds decreases, causing the equilibrium price in this market to go up
Aggregate demand shifts to the right when businesses and consumers are able to
borrow and spend more
When government spends more than the revenue it takes in, it must
borrow funds in the credit market to cover the deficit
The transactions demand for money depends on
both the price level and real income The transactions demand for money does depends on both the price level and real income
When money demand is highly sensitive to interest rates, a given expansion of the money supply will
bring about a smaller decline in interest rates
If the Fed is seeking to expand the availability of credit in order to increase aggregate demand, it will most likely
buy bonds in the open market Bank reserves increase when the Fed buys bonds
Bank reserves increase when the Fed
buys bonds in the open market, and decrease when the Fed sells bonds in the open market The Fed creates new money to pay for bonds, causing bank reserves to expand. When the Fed sells bonds, bank reserves are taken out of the system
How do we measure gains and losses from imports and exports?
by examining their effect on the price paid and quantity bought by domestic consumers and their effect on the price received and quantity sold by domestic producers
When a bank lends out a portion of its customers' deposits, it is
called fractional reserve banking Lending a portion of the deposits is called fractional reserve banking
When the economy is in a recession, running a budget deficit
can help end the recession by increasing spending Higher government spending and higher private spending resulting from lower taxes creates a budget deficit, but also helps end the recession
Plants, equipment, and machinery are examples of
capital resources
The initial effect of expansionary policy was a decrease in the interest rate, but inflationary expectations offset this change and
cause interest rates to move in the other direction
Leakages in the circular flow model are
caused by people saving instead of spending When people save, not all the income produced is used to purchase the goods produced
What is the most important assumption in economic models?
ceteris paribus assumption "all else being equal."
Keynesian multiplier
change in real GDP/initial change in expenditure
The measure of inflation is the
change in the price index. The percentage change in the CPI from one year to the next is the inflation rate.
Real GDP is a more accurate measure of output than nominal GDP because
changes in nominal GDP reflect changes in both output and product prices Nominal GDP is adjusted for changes in the price level to arrive at real GDP
Real GDP is a measure of the value of economic output adjusted for
changes in the price level Nominal GDP is adjusted for changes in the price level to arrive at real GDP
The quantity theory of money states that The quantity theory of money states that
changes in the price level are proportional to changes in the money supply
The M1 money supply includes
checkable deposit accounts The M1 money supply does includes checkable deposit accounts
These two groups will experience higher returns to their past investment in physical and human capital, because unskilled labor is a
complement to these other productive resources
Research has shown that public and private investments can be
complementary
A total fertility rate of 2 keeps the population
constant
Consumption expenditures are divided into
consumer durables, nondurables, and services
A war in the Middle East that affects the U.S. stable economy could cause a
contraction. This means that the economic activity has slowed down.
Cutting the government's budget deficit is a form of
contractionary fiscal policy Contractionary fiscal policy involves reducing government spending and/or raising taxes, both of which lead to a leftward shift of aggregate demand
Based on the Keynesian model, policymakers are able to use
contractionary fiscal policy to reduce inflation
If the Fed attempts to maintain a target interest rate and a recession causes interest rates to fall, the Fed would need to pursue
contractionary monetary policy to raise interest rates, but this would likely worsen the recession This is an argument against using an interest rate target
In the short run, an increase in aggregate demand
creates an opportunity for firms to increase profit if they sell more units of output Assuming there is no change in input prices, an increase in product price creates a larger profit margin on each unit sold. A firm that sells more units of output will earn more profit on each unit as well as more profit in total
The Fed acts as the government's bank to prevent
cronyism
The United States does not export a lot of rice to Japan based on the
cultural heritage argument Japan views rice and rice farming as part of its heritage, and has many programs protecting rice farming from foreign competition
An increase in the interest rate is the correct policy to
cure inflation
The monetary base consists of
currency in the hands of the public plus reserves held by banks The Fed determines the size of the monetary base, the public determines the division between cash and bank deposits
The first stage is the traditional society, in which economic decisions are made on the basis of
custom and obligation
When the economy is in a downturn, automatic fiscal policy creates a deficit. Since this deficit is the result of business cycle activity, it is called a
cyclical deficit
EPA regulations that prevent irrigation of farms in order to protect the smelt fish cause the GDP and standard of living to
decrease Fewer fruits and vegetables are produced, which decreases GDP. This increases the price, leading households to buy less and puts farm workers out of work. Both effects decrease the standard of living
If U.S. spending for foreign-made autos increases while foreign spending for autos made in the United States decreases, ceteris paribus, then U.S. net exports will
decrease If U.S. spending for foreign-made autos increases while foreign spending for autos made in the United States, ceteris paribus, then U.S. net exports will decrease
If two goods are complements, a rise in the price of one will
decrease the demand of the other (if the price of cream cheese goes up, people will eat less bagels)
Used correctly, active fiscal policy should
decrease the ups and downs of the business cycle
A rightward shift of the short-run aggregate supply causes the equilibrium price level to
decrease, and the equilibrium output level to increase Prices fall and output increase when aggregate supply shifts right
The best example of a contractionary fiscal policy, designed to decrease aggregate spending, is
decreased spending on national defense and elimination of tax loopholes Both of these actions result in lower spending
The fracking of oil that occurred after 2010
decreased the price of oil and shifted short-run aggregate supply rightward A decrease in the price of oil will shift the short-run aggregate supply to the right
When interest rates rise, the transactions demand for money usually
decreases When interest rates rise, the transactions demand for money decreases
Active fiscal policy results in budget
deficits when used to combat recession and in budget surpluses when used to combat inflation
According to the M1 definition, the money supply consists of currency held by the public, plus
demand deposits and traveler's checks Demand deposits and traveler's checks are part of M1 monetary aggregate
Economists in the Keynesian tradition argue that the short run is a long period of time. This is the reason Keynesian economists support active
demand-management policies
Economists of the Classical tradition claim that the short run is a short period of time. This is the reason Classical economists do not support active
demand-management policies
Export promotion is a strategy of
developing export industries in order to earn foreign exchange to purchase consumer goods, capital equipment, raw material, and food from abroad This explanation is what is meant by export promotion. Promoting exports is a way to foster growth and development
The leading sectors strategy calls for
developing successful sectors that will then influence other sectors in the chain of production through backward and forward linkages If there is a successful sardine fishing industry, for example, it could be linked forward to a canning operation, which in turn could be linked forward to a packing and shipping industry
The existence of transactions costs means that
different people may pay different prices for the same good or service
In the Classical view, the link between money and spending is
direct
The money supply contracts when the Fed raises the
discount rate
It is important for the Fed to pay attention to interest rates, because letting interest rates rise too high will likely
discourage investment and cause a recession High interest rates cause investment spending to fall and lower spending shifts aggregate demand left, which causes output, income, and employment to fall
People who have looked for work in the past 6 months, but NOT in the past 4 weeks, are called
discouraged workers (not calculated in labor force #'s)
In response to a free trade treaty, a country increases its exports of computer software and begins to import kitchen appliances. As a result of free trade,
domestic jobs are lost in the kitchen appliance manufacturing industry, but jobs are created in the computer software industry Because domestic consumers are importing kitchen appliances from abroad, the number of domestic jobs manufacturing appliances will fall. Jobs in the export sector will increase
Suppose there is a surplus of goods, and firms collectively cut their output. A Classical economist would predict that competition among workers for fewer jobs will drive wages
down A Classical economist would predict that competition among workers will drive wages down
The aggregate demand curve is
downward sloping
Selling a good at a lower price in a foreign country than in the firm's home country is known as
dumping Firms may dump abroad to get rid of surpluses, to take advantage of differences in elasticity of demand (price discrimination), or to establish a foothold in a competitive market
Chile is an example of a country that used export promotion to achieve
economic development
If the economy is experiencing both high unemployment and high inflation, the Fed can use monetary policy to solve
either high unemployment or high inflation, but cannot solve both at once If the Fed pursues expansionary monetary policy, it can reduce unemployment; if it pursues contractionary monetary policy, it can reduce inflation
The second stage develops the preconditions for takeoff. In this stage, an entrepreneurial class of risk takers begins to
emerge
Classical economists thought that the economy tended naturally toward full
employment Classical economists assumed that the economy always tended back to a full employment equilibrium
What are the two major characteristics that governments look at when determining the health of their economies?
employment and inflation
According to the Classical model, the income generated by production is
enough to purchase all the goods and services produced According to Classical economists, production is the source of demand
According to the Classical model, the income generated by production is
enough to purchase all the goods and services produced According to the Classical model, the income generated by production is enough to purchase all the goods and services produced
If a bank sells a bond and uses the proceeds to make a loan, it has
exchanged one asset for another Bonds and loans are both assets
In the Classical view, monetary policy works directly to change the economy because when the Federal Reserve buys bonds in the open market, the money supply
expands and spending increases as well When the Fed increases the money supply, then at the current level of money income, money supply will exceed money demand. People attempt to spend their excess cash balances
According to the political business cycle theory, when inflation is not a problem, a politician seeking reelection is likely to pursue
expansionary fiscal policy prior to the election, so voters will be satisfied with the state of the economy Political business cycle theory suggests that incumbents are more likely to win when economic conditions are favorable immediately before an election
Based on the Keynesian model, policymakers are able to use
expansionary fiscal policy to reduce unemployment
The Fed buys bonds in the open market to pursue
expansionary monetary policy
Goods and services sold to foreign buyers are
exports Exports are injections into the income stream
If an attempt is made to use aggregate supply to increase output, prices should
fall When aggregate supply shifts to the right, real output will increase, but the price level will decrease
When the supply of a product increases, but the demand for the product remains unchanged, the equilibrium price of the product will
fall, and the equilibrium quantity will increase
When the economy is booming, income is rising
faster than normal, so tax revenues are likely to be higher than anticipated Since the federal government's main source of tax revenue is the federal income tax, higher income results in higher tax revenue
One way for banks to correct a shortage of required reserves is to borrow reserves from each other as well as from the Fed. Loans between banks are made in the
federal funds market Banks borrow reserves from each other in the federal funds market and the interest rate in this market is called the federal funds rate
In the United States, 2% of the labor force produces enough agricultural output to
feed the entire nation
Between August of 1929 and March of 1933, the U.S. money supply
fell by 25%, and there were widespread bank failures The money supply fell by 25% from August 1929 to March 1933, in part because of widespread bank failures
During the Great Depression, the velocity of money
fell significantly During the Great Depression, the velocity of money fell significantly
Microfinancing is when
financial services are offered to small business owners who lack access to traditional banking avenues Microfinancing loans are very small and are most often made to women
Multinational corporations are
firms with headquarters in one country and one or more branch plants in other countries There has been a foreign corporate presence in most developing countries at least since World War II, and in many cases going back to the beginning of the century
Gross private domestic expenditures include
fixed investment (plants and equipment), residential construction, and changes in inventory Investment occurs when someone starts a new business or grows an existing business. Investment activities include building factories or stores, purchasing equipment, and adding inventory. Residential construction is also counted as an investment.
The annual budget deficit is a
flow concept The annual budget deficit is the amount added to the national debt each year
If the Fed follows a money supply target, interest rates will
fluctuate with the ups and downs of the business cycle, causing more volatile investment spending Interest rates are sensitive to the business cycle because the demand for investment funds is stronger when the economy is stronger, and vice versa
Economists use the phrase "business cycle" when discussing
fluctuations in aggregate measures of economic output or income.
Indirect crowding out occurs when
government competes for funds in the credit market, causing interest rates to rise for all borrowers Private sector borrowers, such as a corporation seeking to finance a new factory, are less able to borrow when government borrows available funds and causes higher interest rates
Fiscal policy is
government spending or tax policy passed specifically to affect the economy when it is not at full-employment equilibrium. Fiscal policy is influenced by both Classical and Keynesian economic theory
The U.S. currency that was first issued during the Civil War and not redeemable in gold was called
greenbacks The U.S. currency issued during the Civil War was called greenbacks
Julian Simon, in his book The Ultimate Resource 2e (1998), argues that a
growing population due to high birth rates can have positive consequences Simon argues that an additional person is a productive resource who will ultimately add more to production than society had to invest in his or her care, feeding, and education up to maturity
A rightward shift of supply increases output and causes
growth
Real GDP has been adjusted for inflation and nominal GDP
has not been adjusted for inflation
Discretionary fiscal policy
has primarily supply side effects, but can affect aggregate demand as well through the structure of tax changes or the composition of spending changes Discretionary fiscal policy has primarily supply side effects, but can also affect aggregate demand through the structure of tax changes or the composition of spending changes
The aggregate supply curve
has various shapes, based on the differing economic theories
According to economist Douglas A. Hibbs, Jr., economic conditions at the time of an election
have a definite effect on the success or failure of the incumbent party Evidence reported in 1989 found that incumbents were more likely to win reelection when the economy was doing well
According to James Gwartney, a public choice economist, the characteristics necessary for economic freedom include all of these, except
heavy environmental regulations One of the characteristics identified by Gwartney was a low level of government regulation, not heavy environmental regulations
Decreasing money growth leads to
higher interest rates
Higher price levels are associated with
higher interest rates Borrowing usually falls when interest rates go up, so the quantity demanded is reduced
If a tax cut is successful in raising incentives and causing aggregate supply to shift to the right, this supply-side policy will lead to
higher output, income, and employment, but a lower price level Equilibrium output increases and the equilibrium price level falls
If aggregate demand increases, the likely effect in the short run is
higher product prices and increased output In the short run, aggregate supply is upward-sloping, so the equilibrium price level and output level increases when aggregate demand shifts to the right
If a shift in aggregate demand only affects real Gross Domestic Product (GDP), then the short-run aggregate supply (SRAS) curve must be
horizontal A shift in aggregate demand that only affects the real GDP means that SRAS is horizontal
The Keynesian short-run aggregate supply (SRAS) curve is
horizontal For Keynes, SRAS is horizontal in the short run
Keynes challenged the classical school during the Great Depression. He suggested that the aggregate supply curve could be
horizontal Keynes assumed that aggregate supply was horizontal in the short run, or at least very flat in the short run Keynes assumed that AS is horizontal only on the short run because prices are "sticky"
For Keynes, the short-run aggregate supply (SRAS) curve is
horizontal The Keynesian SRAS is horizontal
Everything that is produced in a year must be purchased by
households, business, firms, the government, or foreign entities The sum of spending by the four buying sectors is GDP
An outward shift of the production possibilities curve (PPC) increases the economy's capacity to respond to
human wants
Mexico complained that the United States was unfairly banning its tuna after the United States put a requirement on imported tuna that it had to be caught with dolphin-safe nets. The WTO found that the United States had put a
illegal trade barrier up, and the regulation was repealed
The time that elapses between the implementation of a fiscal policy and its full effect on economic activity is called the
impact lag The third lag is waiting for the policy to have an impact
The time it takes after a problem is recognized to choose and enact a fiscal policy in response is the
implementation lag The second lag is implementing the policy
Purchases from foreign firms are
imports Purchases of imports are flows out of the stream (leakages)
Banks are more likely to hold a larger amount of excess reserves when the economy is
in recession and the risk of borrowers defaulting is higher Individuals are more likely to become unemployed and businesses are more likely to fail when the economy is in recession, so this increases the risk of default and motivates banks to extend fewer loans
As prices rise, the quantity supplied will
increase (because it's more profitable to produce and sell the good when you're charging more)
Suppose there is a surplus of goods, and firms collectively cut their output. A Classical economist would predict that unemployment will
increase When there is a surplus, a Classical economist would predict that unemployment will increase
When money supply increases, interest rates are kept low. The direct effect of an increase in the money supply is to
increase aggregate demand, as people try to spend their excess money balances An increase in money supply increases aggregate demand, as people try to spend their excess money balances
When the interest rate is low, a household might decide to borrow to buy a new car. This will
increase consumption, which increases aggregate demand, which leads to an increase in output
If a politician is seeking to reduce unemployment and increase economic growth prior to an election, the fiscal policies that would most likely achieve these goals would be to
increase government spending and decrease taxes Increased government spending increases aggregate demand, leading to higher equilibrium output and employment Decreased taxes raise disposable income, causing aggregate demand to shift rightward. Stronger spending causes higher equilibrium output and employment
If two goods are substitutes, a rise in the price of one will
increase the demand for the other (if the price of mountain dew goes up, people will buy mellow yellow to replace it)
The Fed can buy bonds in the open market to
increase the money supply and lower interest rates
The Taylor rule stipulates that for each 1% increase in inflation, the Fed should
increase the nominal interest rate by more than 1% The benefit of such a rule is to reduce uncertainty about how the Fed would choose to respond to inflation, thereby promoting price stability
With increased prices for cars, producers
increase their supplies, and consumers decrease their demands
During the expansionary phase of the business cycle, it is likely that real income will
increase, the price level will increase, and the unemployment rate will decrease. During an expansionary phase, price level and real income will increase while unemployment will decrease.
One of the biggest benefits of free trade is
increased consumption Numerical examples in the previous section illustrate the potential gains from trade in terms of additional output
One of the main benefits of active fiscal policy is
increased employment Active fiscal policy means raising government spending and/or lowering taxes to combat recession. If successful, this policy increases output and employment
In the 1970s, the labor force changed significantly because of the
increased labor force participation by women and the entrance of baby boomers The labor force grew significantly during the 1970s because of more women joining the labor force and the entrance of baby boomers. However, productivity did not improve because so many new entrants had low skills and experience
The best example of an expansionary fiscal policy, designed to increase aggregate spending, is
increased public spending on infrastructure and a reduction in the income tax Both of these actions result in higher spending
When consumption increases, aggregate demand also
increases
When households buy new goods, consumption
increases
If investment increases in the aggregate expenditure equation, aggregate demand
increases An increase in aggregate expenditure will lead to an increase in aggregate demand
When aggregate expenditures increases the equilibrium output
increases When aggregate expenditures increases the equilibrium output increases. The new AE line intersects the 45-degree at a higher point, leading to a higher equilibrium output
The demand curve for cars will shift upward when income
increases and when the price of gasoline decreases
Adding the foreign sector to the Keynesian model,
increases income and output only if net exports are positive The foreign sector increases income and output only if the net exports are positive
Falling prices worsens the position of debtors because it
increases the real value of money
An aggregate demand curve shifts to the right when any non-price-level factor
increases total planned real spending An increase in aggregate demand means the curve has shifted to the right
The quantity theory of money held that, in the long run, the level of output was
independent of the stock of money and the price level The quantity theory of money held that, in the long run, the level of output was independent of the stock of money and the price level
If interest rates fall to a very low level, then
individuals will hold less money If interest rates fall, individuals will tend to hold less money
During the Great Recession (2007 to 2009), the United States experienced increasing unemployment and a low rate of
inflation
The Federal Reserve is able to monetize debt by creating new money. If the Federal Reserve creates too much money, the result is
inflation If too much new money is created, the value of the currency decreases and leads to inflation
In the 1970s, when oil prices increased tenfold, the economy experienced
inflation combined with high unemployment, because aggregate supply shifted to the left Higher input prices cause aggregate supply to shift to the left, increasing the equilibrium price level, reducing output and employment, and increasing unemployment
Most of the problems caused by inflation are caused by the fact that
inflation is often unanticipated, and therefore comes as a surprise to individuals in the economy
Fully anticipated inflation occurs when
inflation rises the same as the forecast expected, then inflation is fully anticipated.
The goal of fiscal policy is to
influence employment, inflation, and economic growth Only when changing government spending or taxes is an attempt to change economic conditions are they considered fiscal policy
An event that causes the aggregate demand curve to shift inward or outward is one that
influences spending plans When consumers change their spending plans, aggregate demand will shift
change in real GDP
initial change * multiplier
The supply curve for an individual good is drawn under the assumption that
input prices remain constant As the price of good X rises, sellers' per unit costs of providing good X do not change
Keynes found many failings in Classical theory. He criticized the quantity theory because it neglects the role of
interest rates and fails to explain short-run changes in velocity
Investment spending rises when
interest rates fall
In the Classical model, aggregate demand and aggregate supply will
intersect at the point of full employment Classical economists assume that AD/AS intersect at full employment
The Fed is able to create money to pay for the bonds, thus putting new money
into the economy
An example of an injection into the income stream is
investment spending by business firms Injections are additions to the circular flow that represent spending not paid for out of resource income
The chair of the Federal Reserve Board of Governors
is chosen by the president from among the sitting governors for a 4-year, renewable term The current chair is Janet Yellen, formerly the vice-chair and the first woman to serve in this capacity
In the Keynesian model, employment
is determined by output In the Keynesian model, employment is determined by output
The relationship between price level and aggregate supply
is positive At higher price levels across the economy, firms expect that they can sell their final products at higher prices
Transaction demand for money
is positively related to real income Demand for money is positively related to real income
It is more difficult to measure output in services like banking or health care. For example, with widespread use of automatic teller machines and electronic banking, the number of checks is significantly down, yet productivity
is up
One reason why governments try to restrain inflation is because
it causes an unintended and often undesirable redistribution of income and wealth
The CPI tends to overstate the true inflation rate because
it fails to consider the effects of new products in the marketplace The CPI does not adjust the basket when new products are introduced that will shift consumption from one good to another
If GDP is growing at a faster rate in country A than in country B,
it is likely that living standards are improving more in country A, but this may not be the case It is possible that living standards are improving more in country B, yet GDP is not reflecting this because of omitted transactions, changes in leisure, or inaccurate data
The Keynesian short-run aggregate supply curve is horizontal because
it reflects wage and price inflexibility The Keynesian SRAS is horizontal because it reflects wages and price inflexibility
For monetary policy, the outside lag may be long because
it takes time for banks to increase or decrease their lending or for individuals to adjust their spending The outside lag refers to the time from action to impact. Once monetary policymakers take action, they must wait for banks to extend loans and borrowers to take out loans, then they must wait for borrowers to spend and for the additional spending to work it's way through the economy
Given the existence of automatic stabilizers, if the budget is balanced when the economy is at full employment,
it will be in deficit when the economy is in recession and in surplus when the economy is booming Government will automatically take in less tax revenue when recessions lower income and more tax revenue during upturns. Likewise, transfer programs like unemployment compensation are more expensive during recession
The argument against fair trade that is most used and most often makes the news is the
jobs argument People losing their jobs at a factory is bigger news than people gaining jobs from trade
When U.S. workers and voters express concern about outsourcing, they are generally worried that
jobs will be sent overseas because there is cheaper labor to be found there Workers in other countries are often paid substantially less than U.S. workers because their economic and legal environment is different
An indicator that is helpful in sorting out the relative importance of changes in total demand for labor and total labor supply is the
labor force participation rate The labor force participation rate measures the fraction of the adult population that is employed or actively seeking work
The four factors of production are
land, labor, capital and entrepreneurship
According to real business cycle theory, unemployment is
largely voluntary, caused by the decision to work less during times when wages are low Workers work extra hard when wages are high and then catch up on leisure time when wages are low, according to the real business cycle theory
Dirigiste means "directing" and represents the belief that government should play a
larger role
Because of the multiplier process, if a tax cut causes consumption spending to initially rise by $100, the resulting change in income is likely to be
larger than $100, as spending by one person creates additional income for another person The multiplier process magnifies the initial change in spending into a much larger change because each time someone receives additional income, their spending rises by the added income multiplied by the marginal propensity to consume
Takeoff is the third stage, during which there is a large increase in the rate of saving and increased saving finances capital investment in the
leading sectors
At higher rates of interest, businesses invest
less When interest rates are higher, business investments are more costly and businesses will invest less
During the depression, consumer spending fell because there were fewer jobs and
less income
The federal government is
less likely to declare bankruptcy than a city government, since it has a broader tax base The federal government has the power to tax over 300 million people and has access to other revenue sources as well
A quota is a
limit on the amount of a good or service that can be imported during a given time period A limit on the quantity to be imported is called a quota
The big push strategy is based on the Classical notion that growth in the output of an industry is
limited by the extent of the market At low levels of economic development, it is futile for any one industry to expand its output to a larger scale because it would be unable to sell its added product
Money is organized into monetary aggregates based on its
liquidity
The vicious circle of poverty occurs because
little is invested in human capital due to a low level of income, and a low level of income due to little being invested One reason why low-income countries invest little in human capital is that they have little to invest
Classical theory takes a
long-run view of the economy and believes that the economy will self heal if given time. It also believes that supply is the driving force of the economy.
Unanticipated positive inflation will create
losses for creditors and gains for debtors. When inflation is unanticipated interest rates are not adjusted for inflation and loans have lower interest rates.
The World Bank considers any country with a gross national income (GNI) of less than $1,006 per capita (in 2012 U.S. dollars) as a
low-income country
Aggregate demand is downward-sloping because a higher price level leads to
lower exports Higher domestic prices mean that a country's exports become more expensive to foreigners, so the quantity demanded falls
The results of airline deregulation over the past 30 years has been
lower fares, but increases in bankruptcy filings, union disputes, and customer complaints Although the average fare per passenger mile did fall from 33.3 cents in 1974 to 13 cents in 2010 (in real terms), deregulation also brought about a wave of bankruptcy filings, union disputes, and a sky-high number of passenger complaints
Successful deficit reduction is likely to result in
lower interest rates and a reduction in the international value of the dollar Lower interest rates will reduce the price of the dollar and stimulate export sales while curtailing import purchases
In the Keynesian view, an increase in the money supply causes aggregate demand to shift to the right. That means that if there is an increase in bank reserves, this leads to
lower interest rates, which causes investment spending to increase An increase in the money supply reduces interest rates because more funds will be available for banks to lend. The lower interest rates will stimulate investment demand
The indirect effect of an increase in the money supply is to
lower interest rates, which stimulates both investment and consumption spending, thereby increasing aggregate demand An increase in the money supply will lower interest rates and ultimately increase aggregate demand
Over time, there is a tendency for
major macroeconomic variables to move together in a predictable way In theory, major macroeconomic variables move together in a predictable way
A capital inflow means an increase in the demand for dollars and an increase in the price of a dollar,
measured in foreign currency
At higher rates of interest, households save
more When interest rates are higher, households will save more
Banks lower interest rates to encourage
more borrowing
Market transactions are
more important in developed countries than in less developed countries In developed countries, families are more likely to purchase services like cleaning, child care, and repairs
Effective monetary policy increases bank reserves, which results in
more lending and more investment spending If banks are willing to lend and businesses are willing to borrow, monetary policy has a significant impact on aggregate demand
If banks have more reserves, they are able to finance
more loans
The interest rate increases when prices are expected to increase because lenders
must charge an inflation premium
Import substitution and export promotion strategies are
mutually exclusive, since one concentrates on developing production for domestic buyers, while the other focuses on products to be sold abroad in order to earn the foreign exchange with which to import goods for domestic consumers.Correct. The two strategies are alternative trade strategies from which countries must choose The two strategies are alternative trade strategies from which countries must choose
The World Trade Organization (WTO) deals with the global rules of trade between
nations
In the Classical view, economic freedom is
necessary for a country to experience growth Many Classical economists see a need for economic freedom in order to have economic growth
In a four-sector model, the addition of a government with a balanced budget and
net exports that are positive has increased the equilibrium level of income compared to the two-sector model (Correct. Net exports are the fourth sector added to the model) (Correct. The four-sector model includes government expenditure)
real GDP
nominal GDP/price deflator * 100
GDP deflator
nominal GDP/real GDP * 100
The Fed is able to create money to pay for the bonds, which the public is
now holding
unemployment rate
number of unemployed/labor force * 100
Most economists in the Classical tradition consider fiscal policy to be
of limited benefit, sometimes even harmful
Most economists in the classical tradition consider fiscal policy to be
of limited benefit, sometimes even harmful
According to the Classical model, in the short run, the money supply affects
only the general price level In the short run, the money supply affects only the general price level
The money supply contracts when the Fed sells bonds in the
open market
An increase in aggregate demand leads to an increase in
output
The second stage develops the preconditions for takeoff. In this stage, cultural barriers to development are
overcome
The implication of Say's law is that
overproduction in a market economy is not possible In the case of overproduction, supply will adjust and produce only what can be purchased
The turning points of the business cycle are called
peaks and troughs
labor force
people employed + unemployed people of working age
Capital increases only when
physical or human capital increases
In 1983, the Social Security system was reformed because
policymakers noted that there would have to be increased outlays in the period after the year 2000, as the baby boomers began to reach retirement age Baby boomers were born between 1940-1960, so they began to retire in 2005. The Social Security Trust Fund was built up to cover the extra payments needed for a larger group of retirees
The relationship between the number of workers and output, with a fixed amount of capital, is
positive and decreasing Every additional worker will produce less output than the previous one with the resources avail
Ceteris paribus, as applied in demand theory, means holding constant all factors that affect demand except one
price
The two variables on a supply curve are
price and quantity
A supply curve has a positive relation between
price and quantity supplied
When the quantity demanded equals the quantity supplied,
price is at equilibrium
Demand is the relationship between quantities demanded and
price levels at a certain time period
A key component of the Keynesian model is that
prices are sticky Keynes assumed that prices were sticky
A decrease in aggregate demand will cause
prices to fall, according to classical economists, and unemployment to increase, according to Keynes For Classical economists, the SRAS is upward sloping and a decrease in aggregate demand will cause a fall in prices. For Keynes, a decrease in aggregate demand will only cause an increase in unemployment, since SRAS is assumed to be horizontal and the shift will have no impact on prices
When the quantity demanded is less than the quantity supplied,
prices will fall
When the quantity demanded exceeds the quantity supplied,
prices will rise
When the Federal Reserve pays with newly created money, some people call this
printing money
Private investment is undertaken by business firms operating in the
private sector
Equilibrium output increases when aggregate demand shifts rightward, and firms employ more workers in order to
produce more output
A function of the early goldsmith was to
provide a storehouse for gold and other metals A goldsmith used to provide a storehouse for gold and other metals
Public investment is undertaken by the government operating in the
public sector
The Fed can increase bank reserves by
purchasing bonds
A key assumption in the Classical model is that
pure competition exists In the Classical model, pure competition exists
Automatic stabilizers are
put into place and left to respond automatically to changes in the level of economic activity Automatic stabilizers respond to changes in economic activity without any need for direct action by policymakers
When price changes, there is an opposite change in
quantity demanded and demand, when the whole set of price and quantity change
Equilibrium occurs at a price for which the
quantity supplied and the quantity demanded are equal
Market equilibrium occurs at that price for which quantity demanded by consumers is equal to
quantity supplied by producers (This equilibrium price is also called the market-clearing price)
The Fed can sell bonds in the open market to decrease the money supply and
raise interest rates
Monopolies restrict output in order to
raise the product price
Economists assume people are
rational
In 1993, Federal Reserve Board of Governors chair Alan Greenspan announced that the policy of the Fed would emphasize
real (inflation-adjusted) interest rates as a policy target Greenspan's goal was to slow the growth of bank reserves and put the brakes on bank lending so that the expansion would continue, but not at a pace that would result in accelerating inflation
The tax advantages increase after-tax returns in the
real estate sector
Productivity is the measure of
real output per worker hour Productivity is defined to measure how much output is produced per worker hour
If real gross domestic product increases 10% and, at the same time, the population and the labor force both increase 10%,
real per capita gross domestic product remains the same Real per capita GDP is equal to GDP divided by population; if the numerator and denominator increase at the same rate, the ratio is unchanged
Lower output and employment is the defining characteristic of
recession
One possible result of a fall in aggregate demand coupled with a stable short-run aggregate supply is a(n)
recession
If the impact of expansionary fiscal policy is delayed until the economy has already recovered by itself, it is possible that policy intended to combat
recession may simply fuel inflation If the economy has already recovered, additional spending can lead to demand-pull inflation
Organized labor has generally opposed raising or eliminating immigration quotas because it wants to protect jobs for U.S. citizens, especially during and after a
recession, like that of 2007-2009 Organized labor is concerned with restricting the supply of labor in order to keep wages high
In discussions of monetary policy, the inside lag is the
recognition and implementation lags combined Both of these lags are called the inside lag, and the outside lag refers to the time from action to impact
The length of time needed to become aware of an economic problem is called the
recognition lag The first lag is in identifying the problem
Supply-siders believe higher taxes and transfers
reduce incentives to work, save, invest, and innovate High taxes reduce the rewards to these activities and high transfers increase the rewards associated with being poor or unemployed
When the Fed sells bonds to a bank, the bank's reserves are
reduced, so bank loans must fall Sales of government bonds by the Fed reduce bank reserves
When both demand and supply shift to the right, equilibrium output definitely increases, although the effect on equilibrium price level depends on the
relative size of the two shifts
Developing countries are similar in that they all have
relatively low per capita income Although developing countries are diverse, they all have some important similarities. The most obvious characteristic of a developing economy is low per capita income
Market economy
relies on incentives and the self-interested behavior of individuals to direct production and consumption through market exchanges (America)
According to Classical theory, the best strategy for economic development is to
rely on the power of market forces The Classical tradition, following Adam Smith, favors a laissez-faire approach
A multilateral approach to free trade is one where two or more countries
remove their trade barriers
A unilateral approach to free trade is one where a country, acting alone,
removes its barriers to trade
The money supply contracts when the Fed raises the
required reserve ratio
Encouragement of production through reduced taxes or regulations that lower costs to firms will shift the aggregate supply curve to the
right
Equilibrium output increases when aggregate demand shifts to the
right
An increase in the quantity or quality of resources leads to a
rightward shift of long-run aggregate supply
According to the Keynesian view of the monetary process, higher investment spending causes output and national income to
rise and employment rise Increased spending causes aggregate demand to increase, so equilibrium output increases, resulting in more employment
When aggregate demand shifts to the right, output and the price level
rise in the short run, but only prices rise in the long run Aggregate supply is upward-sloping in the short run, but is vertical in the long run
When the Fed bought government bonds during World War II to help finance the war effort, the money supply
rose, creating inflationary pressures The Fed was buying bonds, causing the money supply to increase and creating inflationary pressures
This behavior consists of people trying to get the most of something they want (to maximize some goal) out of available resources
self-interested behavior
The Classical school advocated a laissez-faire approach. That means no government intervention, as the market will
self-regulate Classical economists believed that the market self-regulated and tended back to full employment
In the Classical model, the economy will tend toward full employment because of
self-regulating markets In the Classical model, the economy will tend to full employment because of self-regulating markets
When the price of the dollar rises, exporters find it harder to
sell their goods abroad
The share of services in total output has been rising for at least 2 decades. The United States has become a
service economy
A higher level of investment would
shift both the aggregate demand curve and the aggregate supply curve to the right Investment affects both demand (spending) and supply. Investment is a type of spending, so aggregate demand increases, but it also affects the ability of business firms to produce by providing additional resources (investment in human capital and physical capital) and technology (investment in research and development)
Increased investment spending causes aggregate demand to
shift to the right
Investment spending is expected to increase when interest rates fall, causing aggregate demand to
shift to the right
Fiscal policy is most effective when policy lags are
short Short policy lags mean that policymakers quickly recognize the problem and implement a solution, and that the policy works quickly to improve the economy's performance
Keynesian theory takes a
short-run view of the economy and does not argue that the economy will self-heal. Keynesian theory views aggregate supply as horizontal so it does not worry a great deal about changes in the price level or inflation. It also believes that demand is the driving force of the economy.
The implementation lag is
shorter for monetary policy The FOMC is able to make faster decisions than Congress
Laissez-faire means "let it be" and represents the belief that government should play a
smaller role
Monetary policy is less effective in a global economy, because if policymakers expand the money supply and cause spending to increase,
some of the increased spending is used to purchase foreign-produced goods and services Some of the extra money is, in effect, exported, increasing demand in the rest of the world as well as at home
According to Keynes, the government should use its power to
spend (According to Keynes, through spending and taxing the government can affect the aggregate demand curve) and tax people in order to shift aggregate demand to the right, increasing output and employment. (According to Keynes, the government should increase aggregate demand to increase output and employment)
Deflation is bad for the economy because when people start anticipating falling prices, they are less willing to
spend or borrow money
In order to eliminate a budget deficit, the government must decrease
spending and/or increase taxes However, it is politically very difficult to do either of these during the expansionary phase of the business cycle Bringing in more tax revenue will reduce the size of the deficit. Spending less will reduce the size of the deficit
Because a given expansion of the money supply has little effect on the interest rate, it has a smaller impact on
spending, output, and employment
Keynesian economists consider fiscal policy to be an important
stabilization tool
One of the Fed's functions is to supervise and regulate banks to ensure the monetary system of the United States is
stable
If supply and demand both shift to the right by the same amount, the equilibrium price level
stays the same
A key component of the Keynesian model is that prices are
sticky
The national debt is a
stock concept The national debt is the total amount owed at a particular time
During the depression, business firms reduced output because they could not sell their products. They also
stopped investing because they had little confidence in the future
The assumption that all resources are alike will produce a
straight line curve
This is the part of a deficit that would persist even if the economy were at the full-employment level
structural deficit
There is a positive relationship between price and quantity
supplied, and there is a negative relationship between quantity demanded
Say's law says that
supply creates its own demand Say's law states that supply creates its own demand
Prices rise during a
supply-induced recession
Classical economists tend to
support Say's law Classical economists support Say's law
With a cyclically balanced budget,
surpluses during the expansion phase of the business cycle offset deficits incurred in the recession phase The surpluses and deficits occur automatically and cancel each other out over the course of the business cycle
Protection of domestic industries is accomplished with two main tools, including
tariffs and quotas Tariffs are taxes imposed on imports and quotas are quantity limits
A tariff is a
tax on imported goods or services The tariff can be specific (based on weight, volume, or number of units) or ad valorem (figured as a percentage of the price)
Fiscal policy is most effective when policymakers are motivated to pursue actions
that improve the economy's performance The Keynesian argument in favor of active fiscal policy assumes that policymakers are motivated to do what is in the best interest of the economy, both in the short run and in the long run
The United State is in a recession if
the GDP (real output) declines for two successive quarters
The main competing views in economics today are
the New Keynesian and the various new Classical theories (Classical theories came first, before Keynesian)
What is entrepreneurship?
the activity of combining the other productive resources to produce goods and services, taking risks, and introducing new methods and new products (innovation.)
Deflation is the situation in which
the average of all prices is declining
Comparing the size of the debt to the size of the economy by using the percentage of GDP is more meaningful than just looking at the absolute value of the debt because
the capacity to repay the debt grows as the economy grows Incomes are rising when the economy is growing, so anticipated tax revenues are up. Similarly, a household can afford to take on more debt when income is higher
Economic growth can not be measured by
the credit market The credit market is the broad market for companies looking to raise funds through debt issuance. The credit market encompasses both investment-grade bonds and junk bonds, as well as short-term commercial paper. Economic growth cannot be measured by the credit market
If the market for money is in equilibrium, then
the demand for money must be equal to the supply of money If the market is in equilibrium the demand for money will be equal to the supply of money
Automatic stabilizers partially offset changes in private spending and tend to reduce fluctuations in output and employment and are triggered by changes in
the economy
If aggregate demand and aggregate supply both shift to the right by approximately the same distance,
the equilibrium level of output will increase with little or no change in the price level A higher level of investment would shift both the aggregate demand curve and the aggregate supply curve to the right, resulting in increased output and employment without inflation
The more sensitive money demand is to the interest rate,
the flatter the money demand curve
Keynes developed his theory at a time when
the government was a drastically smaller part of the economy than it is today and therefore had much less impact on it. This smaller size influenced his theory
For most people, the problems of inflation are caused by the fact that
the inflation is unanticipated
Ignoring the government and foreign sectors, equilibrium output is determined by
the intersection of planned saving and planned investment In a closed economy, equilibrium output is determined by the intersection of planned saving and planned investment
What explains how the production of larger amounts of one good leads to an increase in the sacrifice of the alternative good?
the law of increasing opportunity costs
The Fed has the most direct control over
the monetary base The Fed controls the monetary base, which consists of currency in the hands of the public plus reserves held by banks
It is not possible for the Fed to target both
the money supply and interest rates
When the Federal Reserve buys government bonds,
the money supply increases The Federal Reserve is able to create new money to pay for bonds, and purchasing bonds puts new money into circulation, so the money supply increases
If most government bondholders are rich, repaying the debt will redistribute income from
the poor to the rich
According to Simon Kuznets, developing countries will not necessarily follow the stages of growth identified by W. W. Rostow, because
the population is growing more rapidly in developing countries than in today's developed countries at a similar stage in their development This is one of many reasons identified by Kuznets that developing countries will not necessarily follow the stages of growth identified by W. W. Rostow
On a policy level, quantity theorists argue that in the long run, ceteris paribus, increases in the money stock cause
the price level to rise Increases in the money stock do cause the price level to rise in the long run
The two primary markets in the circular flow diagram are
the product market (upper flow) and the resource market (lower flow) The labor market is the largest part of the resource market
An example of a leakage from the income stream is
the purchase of imported goods, like wine from countries like Italy, France, or Spain Leakages occur when income is received, but not spent directly on purchases from domestic firms
What does the short-run Phillips curve indicate?
the relationship between the inflation rate and the unemployment rate when the natural unemployment rate and the expected inflation rate remain constant
What is profit?
the reward for innovation, risk taking, and organization
One tenet of Classical economics that Keynes criticized is that
the role of the government should be limited, since the market will always be self-correcting Keynes did not believe that the role of the government should be limited
The Classical model assumes that the general price level is determined by
the supply of money The general price level is determined by the supply of money
What are the 2 components of opportunity cost ("the best thing you must give up to get it")?
the things you can't afford to buy and the things you can't do with your time
When the price of the dollar rises, import-competing firms find that their foreign competitors can more easily undersell them because
their goods are cheaper in dollar terms
Monopolies have less incentive to expand output, innovate, or take risks because
there are no competitors nipping at their heels
The Keynesian short-run aggregate supply curve is horizontal if
there are unutilized resources in the economy When resources are underutilized, SRAS is horizontal
Politicians tend to prefer bilateral aid rather than multilateral aid, because
they can exercise more control Politicians can attach conditions to bilateral aid
Unskilled workers in the United States are worse off because
they face increased competition for jobs and from people who are often willing to work for less
The labor force consists of
those who are working and those who are actively seeking work.
What are the goals of fiscal policy?
to achieve the macroeconomic objectives of high and sustained economic growth and full employment
In the Keynesian model, government spending is considered
to be autonomous (acting independently or having the freedom to do so)
Coins with a value less than the monetary value are
token money Coins with a value that is less than the monetary value are token money
In the absence of government intervention, there will be both
too many public bads and too few public goods.
Redistribution is more likely to occur when inflation is
unanticipated
The leading sectors strategy calls for
unbalanced growth The leading sectors strategy, sometimes referred to as "unbalanced growth," argues that a country should concentrate on developing successful sectors that will then influence other sectors in the chain of production through backward and forward linkages
According to Keynes, increased planned spending would reduce
unemployment
According to Keynes, too little spending was the cause of
unemployment
The Fed typically lowers the target rate if the economy is experiencing higher than normal
unemployment The Fed lowers this rate by pumping reserves into the system, which leads to more borrowing and spending and can potentially help to reduce unemployment
Keynesian economics recommends the use of active fiscal policy. Specifically, policymakers should increase spending to reduce
unemployment and decrease spending to reduce inflation
If the economy is in equilibrium at a point on the long-run aggregate supply,
unemployment is equal to the natural rate The long-run aggregate supply curve is vertical at the real output level corresponding to the natural rate of unemployment
A period of 18 months of job searching is considered an
unemployment period
What is the formula to calculate the unemployment rate?
unemployment rate=Unemployed workersLabor force×100
Suppose that there is no government and no international trade. When C + I is less than the level of output
unplanned inventories increase When C + I is less than the level of output, unplanned inventories increase
Foreign competition is
unpopular with the owners of productive resources, whether the competition is in product markets or in resource markets The owners of productive resources experience reduced income as a result of foreign competition, whether it is in product markets or in resource markets
Seventy countries made the list of high-income countries, including both industrial market economies and high-income oil exporters. Among this prosperous group, per capita incomes ranged from $12,275 and
up
Dualism refers to the coexistence of
urban, market-oriented societies and rural societies with little market activity Almost all developing countries are really two societies in the same country, and this coexistence is called dualism
Keynesians regard active fiscal policy as a
valuable tool for stabilizing economic activity
If changes in the price level have no effect on real output, aggregate supply is
vertical A fixed real output level and a variable price level imply a vertical aggregate supply curve
The Classical aggregate supply curve was
vertical Classical economists assumed that the aggregate supply curve is vertical because prices will adjust so that output is always at full employment
In the long run, aggregate supply is
vertical, because input prices are flexible in the long run Firms might earn higher profit per unit in the short run, because product prices are rising while input prices remain the same. However, in the long run, input prices will rise as well, and per unit profit returns to normal
If the demand for food is highly price-inelastic and there is an increase in the supply, the equilibrium quantity will increase
very little, while the equilibrium price will fall substantially A rightward shift of supply causes a small increase in quantity and a large drop in price when demand is inelastic
In recent years, the link between the money supply and GDP has
weakened, leading the Fed to focus more on interest rate targets This link has weakened, leading the Fed to focus more on interest rate targets
When does Inflation occur?
when the quantity of money grows more rapidly than real GDP (as in Germany, where the gov't prints tons of money to pay its debts)
The goal of an economy is for the goods and services to go to the people
who will value them the most
In the Classical model, an increase in the unemployment rate
will likely be temporary In the Classical model, an increase in the unemployment rate is likely to be temporary
What are the 6 ideas that define The Economic Way of Thinking?
• A choice is a tradeoff • People make rational choices by comparing benefits and costs. • Benefit is what you gain from something. • Cost is what you must give up to get something. • Most choices are "how much" choices made at the margin. • Choices respond to incentives.
Name the three types of financial institutions accept the deposits that are part of the nation's money:
• Commercial banks (chartered by the comptroller of the currency in the U.S. Treasury to accept deposits/make loans) • Thrift institutions ( • Money market funds
What does today's Fiat Money consist of?
• Currency • Deposits at banks and other financial institutions
What are the two sources of inflation?
• Demand-pull inflation • Cost-push inflation
What are the factors that change Aggregate Demand? (causing it to SHIFT right or left)
• Expectations about the future (if income is expected to increase, people spend money now = aggregate demand increases/shifts right...expected increase in future inflation has the same effect: get it while you can afford it!...increase in expected future profit increases demand now by investing now) • Fiscal policy and monetary policy (a tax cut or an increase in either transfer payments or government expenditure on goods and services increases aggregate demand. A cut in the interest rate or an increase in the quantity of money increases aggregate demand) • The state of the world economy (the foreign exchange rate - the amount of foreign income you can buy w/ the US dollar and whether it's worth more or less than a foreign currency and thus determines what you can buy, their products vs. ours - and foreign income: if foreigners are making more, they will buy more US exports and thus increase aggregate demand for US goods and svcs)
GDP limitation measure
• Household production • Underground production • Leisure time • Environment quality
What does the GDP EXCLUDE?
• Household production (cooking, mowing lawn - b/c people don't buy these in the mrkts, the GDP undervalues these productions - but now you can buy some of these svcs, so real GDP grows FASTER than GDP + Home production) • Underground production (wages/tips "not on the books") • Leisure time (an economic good valued almost as much as a hourly wage production hour but not counted in GDP) • Environment quality (lowers the standard of living but not measured by GDP) It also emits health and longevity, and political freedom and social justice - all of which contribute to or detract from the standard of living
What are the two big questions that summarize the scope of economics?
• How do choices end up determining what, how, and for whom goods and services get produced? • When do choices made in the pursuit of self-interest also promote the social interest?
What are the 4 things that hamper Discretionary Fiscal Policy?
• Law-making time lag (the amount of time it takes Congress to pass necessary laws - long debates, committee meetings) • Shrinking area of law-maker discretion (about 80% of the federal budget is off-limits for congress to change and the remaining 20% very difficult to cut) • Estimating potential GDP (hard to 'guess' where potential GDP is and may end up moving real GDP further away than toward it, accidentally...too much stimulus = inflation, and too little = recession) • Economic forecasting (inexact/subject to error - may move real GDP AWAY from potential GDP)
What are the three vital functions that money is expected to perform?
• MEDIUM of EXCHANGE (money guarantees that there is a double coincidence of wants because people with something to sell will always accept money in exchange for it. Money acts as a lubricant that smoothes the mechanism of exchange. ) •UNIT OF ACCOUNT (An agreed-upon measure for stating the prices of goods and services - everything priced in the same terms, like dollars and cents - helps you know what your opportunity cost for other things is) • STORE OF VALUE (can be held and exchanged later for goods and services)
CPI bias source
• New goods bias (new goods • Quality change bias • Commodity substitution bias • Outlet substitution bias
What are the factors that determine shift of the AS curve?
• Potential GDP changes [Anything that changes potential GDP changes aggregate supply and shifts the aggregate supply curve - AS is anchored to potential GDP vertical curve and if potential GDP moves, AS moves w/ it] • The money wage rate changes [b/c it changes the firm's costs: an increase in the real wage rate increases the firm's costs which in turn causes supply to decrease] • The money prices of other resources change [Because it changes the firms' costs: at each price level, firms' real costs change and the quantity that firms are willing to supply changes so aggregate supply changes]
What are the main influences on a Change in Demand? (shift)
• Prices of related goods • Expected future prices • Income • Expected future income and credit • Number of buyers • Preferences
What are the main influences on selling plans that change Supply?
• Prices of related goods • Prices of resources and other inputs • Expected future prices • Number of sellers • Productivity
What are the factors that determine growth of labor productivity?
• Saving and investment in physical capital (increases the amount of capital per worker and increases labor productivity) • Expansion of human capital and discovery of new technologies
What are the "four costs of Inflation"?
• Tax costs • Shoe-leather costs • Confusion costs • Uncertainty costs
What are the most important factors that influence the Natural Unemployment Rate?
• The age distribution of the population (younger population = more job seekers/frictional unempl...old population=less frictional unempl, few new job seekrs) •The pace of structural change (technological upheaval is sometimes high and sometimes low for awhile) • The real wage rate (Anything that raises the real wage rate above the market equilibrium level creates a surplus of labor and increases the natural unemployment rate: a minimum wage or an efficiency wage) • Unemployment benefits (lowers the opportunity cost of job search, increases the natural unemployment rate)
What are the 3 main influences on the demand for money?
• The price level • Real GDP • Financial technology A rise in the price level, an increase in real GDP, or an advance in financial technology that lowers the opportunity cost of holding money or makes money more useful increases the demand for money. A fall in the price level, a decrease in real GDP, or a technological advance that creates a substitute for money decreases the demand for money.
What are the two main labor market indicators?
• The unemployment rate • The labor force participation rate
GDP measure use
• To compare the standard of living over time • To track the course of the business cycle • To compare the standard of living among countries
Who gains and who loses from tariffs?
• U.S. consumers of the good lose • U.S. producers of the good gain • U.S. consumers lose MORE than U.S. producers gain: Society loses (net loss)
Who gains and who loses from import quotas?
• U.S. consumers of the good lose. • U.S. producers of the good gain. • Importers of the good gain. • Society loses b/c the loss to consumers is GREATER than the gains to producers and importers