question
Scarcity
answer
Society has unlimited wants & limited resources
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What are the 4 fundamental economic questions?
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(1)What goods and services should be produced? (2)How should these goods and services be produced? (3)Who consumes these goods and services? (4)Who produces these goods and services
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Traditional economy
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An economic system in which the 4 economical questions are answered for you
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Command economy
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An economic system in which the government makes all production & consumption decisions.
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Market economy
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Production & consumption decisions are made by individuals or the open market.
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Trade-off
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An exchange of one thing in return for another (you don get the one you give up)
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Opportunity cost
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What one must give up after making a certain choice
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Macroeconomics
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Focuses on the behavior of the market as a whole
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Microeconomics
answer
Focuses on the choices of individuals and firms
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Examples of renewable resources
answer
Forests, sea & land animals, water, grasses & forage on rangelands
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Examples of nonrenewable resources
answer
Metals & ores, oil & natural gas
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What are the 4 factors of production
answer
Land, labor, capital, & entrepeneurship
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Land
answer
Resources which come from nature
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Labor
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Resource which is the effort of workers
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Entrepeneurship
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Resource which is the efforts made by entrepreneurs for production
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Capital
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Resource which is the manufactured good are used to make products/services
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Production possibilities curve
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Model that shows alternative ways that an economy can use its scarce resources
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Points inside the frontier line are
answer
obtainable, but not efficient
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Points on the frontier line are
answer
Obtainable & efficient
question
Points outside of the frontier line are
answer
Unobtainable due to the lack of resources
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What causes the PPC to shift?
answer
Change in resource quantity/quality, technology, or trade
question
Increasing opportunity cost
answer
the skills and knowledge gained by a worker through education and experience
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Constant opportunity cost
answer
money used to buy the tools and equipment used in production
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Human capital
answer
Goods and services are produced in better quality, quantity and speed when people focus on producing a few things instead of making everything they want by themselves.
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Financial capital
answer
The ability of a country to produce a good at a lower cost than another country can.
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Specialization
answer
the ability to produce a good using fewer inputs than another producer
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Comparative advantage
answer
Comparative advantage
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Absolute advantage
answer
There is an inverse relationship between price and quantity demanded, as price goes up demand goes down
question
Specialization is based on which advantage?
answer
There is a direct relationship between price and quantity supplied, as price goes up supply goes up
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Law of demand
answer
Change in price
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Law of supply
answer
(1)Change in income (2)Change in consumer tastes & preferences (3)Change in the price of supstitute & complimentary goods (4)Change in the expected future price of a good (5)Change in the number of consumer
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What causes a movement along the supply or demand curve?
answer
a good that consumers demand less of when their incomes increase
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What are the factors of demand?
answer
a good that consumers demand more of when their incomes increase
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Inferior good
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Curve shifts right
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Normal good
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Curve shifts left
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Increase in demand/supply
answer
a special type of supply curve/situation where quantity is fixed (ex: concert tickets)
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Decrease in demand/supply
answer
(1)Change in costs of production (2)Change in technology (3)Change in numbers of producers (4)Change in taxes (5)Change in the producers expectations
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Market day supply
answer
Quantity demanded equals quantity supplied
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What are the factors of supply?
answer
Quantity demanded is greater than quantity supplied (prices will increase)
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Market equilibrium
answer
Quantity demanded is less than quantity supplies (prices will decrease)
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Shortage
answer
a minimum price for a good or service (ex. minimum wage) causes a surplus
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Surplus
answer
a maximum price for a good or service (rentals) causes a shortage
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Price floor
answer
Demonstrates the way that money and goods and services flow between households and firms
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Price ceiling
answer
the market in which households purchase the goods and services that firms produce
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The circular flow model
answer
The market in which firms purchase the goods and services that households produce
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Product market
answer
the branch of economic analysis that describes the way the economy actually works. Facts, right or wrong
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Resource market
answer
the study of what the goals of the economy should be. Opinion
question
positive economics
answer
the ability of an individual, a firm, or a country to produce a good or service at a lower opportunity cost than competitors
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normative economics
answer
the ability of an individual, a firm, or a country to produce more of a good or service than competitors, using the same amount of resources
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comparative advantage
answer
the claim that, other things being equal, the quantity demanded of a good falls when the price of the good rises. Inverse relationship
question
absolute advantage
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The principle that as a consumer increases the consumption of a good or service, the marginal utility obtained from each additional unit of the good or service decreases. Marginal= additional Utillity=satisfaction. So the additional satisfaction one recieves from a good or service goes down the more it is consumed.
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Law of demand
answer
a table that shows the relationship between the price of a good and the quantity demanded
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law of diminishing marginal utility
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the change in the quantity demanded of a good that results from the effect of a change in the good's price on consumers' purchasing power. More income means more purchasing power and feeling richer.
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demand schedule
answer
when consumers react to an increase in a good's price by consuming less of that good and more of other goods. When butter is too expensive one will turn to margarine to buy.
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Income effect
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non-price related
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substitution effect
answer
I-income(rise in income=rise in demand)
T-tastes(trends, seasonal, popularity, new)
S-substitutes
N-number of consumers(more consumers more demand and curve shifts to the right)
C-complements(use of one increases the use of another like phone and phone charger)
E-expectations
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Change in demand
answer
change in price
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6 Factor affecting demand
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measure of responsiveness relating change in quantity demanded to a change in price
question
change in quantity demanded
answer
1.)portion of income- large=elastic, small=inelastic
2.)luxury vs. necessity- luxurious=elastic, necessity=inelastic
3.)delayabillity of purchase- yes=elastic no=inelastic
4.)avalilbillity of substitutes- yes=elastic no=inelastic
2.)luxury vs. necessity- luxurious=elastic, necessity=inelastic
3.)delayabillity of purchase- yes=elastic no=inelastic
4.)avalilbillity of substitutes- yes=elastic no=inelastic
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demand elasticity
answer
the claim that, other things equal, the quantity supplied of a good rises when the price of the good rises. Direct relationship
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4 factors of demand elasticity
answer
Technology-advancement means more supply being made(price remain constant but curve shifts to the right)
Weather/catastrophic events- storms that cuts supplies means supply curve shifts to the left
Input costs/expectations- a cost business gets when producing something. supply goes down when it costs more to make.
Governments regulation- costs money to meet requirements by law
Suppliers in a market-more suppliers means more supply and vice versa
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Law of Supply
answer
a situation in which quantity demanded equals quantity supplied. Qd=Qs meet on the graph
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Factors that shift supply
answer
Increase in supply due to lower input costs
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market equilibrium
answer
Increase in supply due to advancement in technology
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Auto Workers' Union Agrees to Wage Cuts
answer
Decrease in supply due to catastrophic event
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New Robot Technology Increases Efficiency
answer
decrease in supply due to government regulations
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Nationwide Auto Strike Began at Midnight
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decrease in supply due to higher input price
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New auto import quotas reduce foreign cars
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decrease in supply due to less suppliers
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costs of steel rises
answer
no change
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Auto producer goes bankrupt, closes operation
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Qd goes down due to price increasing
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Buyers reject new models
answer
demand decreases because income decreased
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The price of peaches is 2.29 per pound on monday. On thursday, the price of peaches goes to 2.79 per pound. What changes?
answer
Demand goes up due to either expectations or taste
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The income of the city Downville have decreased by 20%. What happens to the peach market in the local grocery store?
answer
Qd goes up
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suppose the american heart association declares that peaches promote good heart health. What happens to the peach market?
answer
Demand increases for peaches because of substitution effect.
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price of popcorn decreases
answer
demand increases due to the expectations that the price will increase in a month
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Peaches and apples are substitutes. Apple prices increase. What happens to peaches?
answer
Supply will decrease due to the input price rising.
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Downloads are free until next month. What happens now?
answer
Supply of hot chocolate increases due to the advancement of technology
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Cost of milk and eggs used to make a cake increases. What happens to the supply of cakes?
answer
Supply increases beacause more suppliers=more supply
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An invention makes hot chocolate being made faster. What happens to the supply?
answer
Input costs will increase in the future, due to that expectation supply will increase today
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A new producer of cookies enters the industry. What happens in the market for cookies?
answer
Price increases so Qs increases
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Brownie producers expect the cost of their raw materials to increase in 4 months. What happens in the market for the supplier today?
answer
Inelastic-a necessity
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Price of ice cream cones go up. What happens in this market from the supplier pov
answer
elastic-a luxury
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funeral services
answer
elastic-many substitutes
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Airline tickets for vacation
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inelastic-a necessity
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Butter
answer
elastic-many substitutions
question
medical care
answer
inelastic-a necessity
question
potatoes
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elastic-many substituions
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gasoline
answer
inelastic-a necessity
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milk
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demand increases due to expectation
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insulin
answer
demand for beef decreases due to the substitution effect
question
price of beef to rise in june-how does this effect demand for beef in may?
answer
demand for beef decreases due to the income effect
question
pork prices drop-how does this effect demand for beef in may?
answer
a market in which there are many buyers and many sellers of the same good or service so that none can influence the price of which a good or service is sold at.
question
income drops-how does this effect demand for beef in may?
answer
a model of how a competitive market works
question
competitive market
answer
the amount of a good or service that a consumer is willing and able to purchase at a given price
question
supply and demand model
answer
a curve that shows the relationship between the price of a product and the quantity of the product demanded. graphical representation of the demand schedule
question
Quantity Demanded (Qd)
answer
a shift of the demand curve, which changes the quantity demanded at any given price
question
demand curve
answer
a change in the quantity demanded of a good that is the result of a change in that good's price
question
change in demand
answer
rise in the price of one leads to a increase in demand for the other
question
movement along the demand curve
answer
a rise in the price of one leads to the decrease in demand in the other since they go together
question
two substitutes of eachother...
answer
a good that consumers demand more of when their incomes increase
question
two complements of eachother...
answer
a good that consumers demand less of when their incomes increase
question
normal good
answer
the amount of a good that sellers are willing and able to sell at a specific price
question
inferior good
answer
a chart that lists how much of a good a supplier will supply at different prices
question
quantity supplied
answer
a graph of the relationship between the price of a good and the quantity supplied
question
supply schedule
answer
a shift of the supply curve, which changes the quantity supplied at any given price
question
supply curve
answer
changes in the quantity supplied arising from a change in price
question
change in supply
answer
illustrates the relationship between quantity supplied and price for an individual producer
question
movements along the supply curve
answer
due to change in price
question
individual supply curve
answer
due to a factor other than price
question
movement along curve
answer
no individual would be better off doing something different
question
shift of curve
answer
the price that matches the quantity supplied and the quantity demanded.
question
Equilibrium
answer
the quantity bought and sold at the equilibrium price
question
equilibrium price/market clearing price
answer
when the price has moved to a level at which the quantity demanded of a good equals the quantity supplied of that good. The price at which this takes place at is the equilibrium price, the quantity of the good bought and sold at this price is the equilibrium quantity. When two curves cross
question
equilibrium quantity
answer
all sellers recieve and all buyers pay the same price
question
When is a competitive market in equilibrium?
answer
when the quantity supplied exceeds the quantity demanded. When the price is above its equilibrium level. The price of a good will fall because surpluses incentivives sellers to lower their prices, causing the price to fall down to the equilibrium price
question
market price
answer
quantity demanded is greater than quantity supplied. Shortages occur when the price is below its equilibrium level. When there is a shortage, buyers can't find willing sellers at the current price so they either are willing to buy at a higher cost, or sellers realize they can charge higher prices. Market price will always rise if it is below the equililbrium level.
question
surplus
answer
the surplus leads buyers and sellers to take actions that lower the price
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shortage
answer
the ensuing shortage leads buyers and sellers to take actions that raise the price
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If market price is above the equilibrium level:
answer
equilibrium price(the price at which there is neither surplus or shortage
question
If the market price is below the equilibrium level:
answer
falls
question
market price always moves towards the
answer
rise
question
When the demand for a good or service decreases, its equilibrium price ________ and equilibrium quantity ________.
answer
maximum legal price that can be charged for a product. Protects consumers. Makes price lower. Below equilibrium on graph. causes shortages
question
When the demand for a good or service increase, its equilibrium price ________ and equilibrium quantity ________.
answer
a minimum price for a good or service. Price floor makes price higher on graph. Above equilibrium. causes surplus
question
price ceiling
answer
equilibrium price falls and equilibrium quantity rises
question
price floor
answer
Equilibrium price rises and equilibrium quantity falls
question
When supply of a good or service increases
answer
the equilibrium price rises but the change in the equilibrium quantity is ambiguous
question
when supply of a good or service decreases
answer
the equilibrium price falls but the change in the equilibrium quantity is ambiguous
question
When demand increases and supply decreases
answer
the equilibrium quantity increases but the change in equilibrium price is ambiguous
question
when demand decreases and supply increases
answer
the equilibrium quantity falls but the change in equilibrium price is ambiguous
question
When both demand and supply increase
answer
keep track of the flows of money between different sectors of the economy. in general the more reliable the accounts, the more economically advanced the country is
question
when both demand and supply decrease
answer
simplified representation of the macroeconomy. shows the flow of money, goods and services, and factors of production through the economy. the flow of money into each market or sector is equal to the flow of money coming out of that market or sector.
question
national income and product accounts
answer
consists of either an individual or a group of people who share their income
question
circular flow diagram
answer
an organization that produces goods and services for sale-and that employs members of households
question
household
answer
where goods and services are bought and sold. households buy the goods and services they want from firms. this produces a flow of goods and services to the households and a return flow of money to the firms,
question
firm
answer
where resources, especially capital and labor are bought and sold. firms buy the resources they need to produce goods and services. The best known factor market is the labor markets where workers are paid for their time.
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product markets
answer
households own the factors of production, households buy all the goods and services that firms produce, land, labor, and capital flow from households to firms. There is a products market and a labor market
question
factor markets
answer
...
question
In the simple circular-flow diagram,
answer
household spending on goods and services
question
Expanded Circular Flow Diagram
answer
a share in the ownership of a company held by a shareholder
question
consumer spending
answer
a loan in the form of an IOU that pays interest
question
stock
answer
profit distributed to company shareholders and the interest payments on any bonds that they hold. Also, rent they receive from firms in exchange for the use of land or structures they use. Wages, inerest, rent.
question
bond
answer
payments that the government makes to individuals without expecting a good or service in return. not counted in GDP
question
whats the income households receive from the factor markets?
answer
taxes, and private savings
question
government transfers
answer
Income remaining for a person to spend or save after all taxes have been paid and recieving government transfers. Income-taxes+government transfers=income available to spend on consumption and save.
question
why doesn't the market for goods and services absorb all of a household's income?
answer
disposable income not spent on consumption. Goes into financial markets
question
disposable income
answer
where individuals, banks, and other institutions buy and sell stocks and bonds as well as make loans. receive funds from the rest of the world and provide funds to the government, to firms, and to the rest of the world.
question
private savings
answer
the total amount of funds borrowed by federal, state, and local governments in the financial markets
question
financial markets
answer
total purchases by federal, state, and local governments on goods and services
question
government borrowing
answer
Goods and Services sold to other countries. Leads to a flow of funds from the rest of the world into the US to pay for them
question
government purchases of goods and services
answer
goods and services purchased from other countries. Leads to a flow of funds out of the US to pay for them
question
exports
answer
lending by foreigners to borrowers in the US and purchases by foreigners of shares of stock in American companies. generates a flow of funds into the US from the rest of the world
question
imports
answer
stocks of goods and raw materials held to facilitate business operations
question
foreign lending
answer
spending on new productive physical capital, such as machinery and structures(including houses), and on changes in inventories. goes toward total spending on goods and services.
question
inventories
answer
they change the abillity of a firm to make future sales
question
investment spending
answer
goods and services sold to the final, or end, user. Ex. buying a new car from the dealer
question
why are changes in inventory included in investment spending?
answer
goods and services bought from one firm by another firm to be used as inputs into the production of final goods and services. purchaser is not the final user. Like buying steel from a steel maker
question
final goods and services
answer
the total value of all final goods and services produced in the economy during a given period. 3 approaches to the calculation of GDP
question
intermediate goods and services
answer
calculating GDP is to survey firms and add up their contributions to the value of final goods and services
question
GDP
answer
to add up aggregate spending on domestically produced final goods and services in the economy —the sum of consumer spending, investment spending, government purchases of goods and services, and exports minus imports
question
value added approach
answer
the total spending on domestically produced final goods and services in the economy-is the sum of consumer spending, investment spending, government purchases of goods and services, and exports minus imports
question
Expenditure Approach
answer
add up the total factor income earned by households from firms in the economy, including rent, wages, interest, and profit
question
aggregate spending
answer
value of its sales minus the value of its purchases of inputs(intermediate goods)
question
Income Approach
answer
value of exports - value imports
question
value added
answer
would be double counting, an input like steel is used up in production. A metal stamping machine would not be used up
question
Net Exports (NX)
answer
don't represent production or the sale of the final product
question
why isn't isn't spending on inputs counted in GDP?
answer
the total quantity of goods and services produced in an economy in a given period
question
why aren't financial assets included in GDP?
answer
the total value of all final goods and services produced in the economy during a given year, calculated using the prices of a selected base year in order to remove the effects of price changes
question
aggregate output
answer
the total value of all final goods and services produced in the economy during a given year, calculated with the prices current in the year in which the output is produced
question
real gdp
answer
the method of calculating changes in real GDP using the average between the growth rate calculated using an early base year and the growth rate calculated using a late base year
question
Nominal GDP
answer
GDP divided by population. avergae gdp per person used because a country with a higher population will have higher GDP, simply because there is more people working
question
chain linking
answer
can't determine standard of living or policy goals. doesn't measure how income is distributed, so whether or not its used to better quality of life we don't know. it just measures that a country with gdp will be able to afford higher expenditures on health, education, etc. not that they use it on that
question
GDP per capita
answer
paid employees, self-employed, and unpaid workers in a family business. either part time or full time
question
what are the limitations of real GDP per capita
answer
people who are jobless, looking for jobs for the past 4 weeks, and availble for work
question
employed
answer
employed + unemployed
question
unemployed
answer
the percentage of the population aged 16 or older that is in the labor force. LFPR=(LF)/civillian pop. 16 and older x 100. same as employment rate
question
labor force
answer
the portion of people in the labor force who are unemployed. UR=(#unemployed/#labor force) x100
question
labor force participation rate
answer
It is a good indicator of how easy or difficult it is to find a job given the current state of the economy.
question
unemployment rate
answer
a worker who is confident of finding a job, but has not yet accepted a position, is considered unemployed. unemployment rate never falls to 0
question
Significance of the Unemployment Rate
answer
an individual who has given up looking for a job for the time being, because there are no jobs available is not counted as unemployed because they have not been looking for a job in the previous four weeks. discouraged workers, marginally attached workers, and underemployed people
question
how the unemployment rate can overstate the true level of unemployment
answer
nonworking people who are capable of working but have given up looking for a job due to the state of the job market. doesn't count toward unemployment.
question
how the unemployment rate can understate the true level of unemployment
answer
would like to be employed and have looked for a job in the recent past but are not currently looking for work. doesn't count toward unemployment. unlike discouraged workers, they ended their job search for a reason other than a beleif that there was no job avaiable for them.
question
discouraged workers
answer
workers are overqualified for their jobs or work fewer hours than they would prefer. frustrated with their work, but not counted as unemployed.
question
marginally attached workers
answer
The BLS is the government agency responsible for tracking income expense and labor statistics in the USA
question
Underemployment
answer
unemployment goes down
question
BLS (Bureau of Labor Statistics)
answer
A business owned by one person, gets all profits
question
GDP goes up
answer
a business owned and operated by two or more people on the daily, both are responsible for eachother
question
Sole Proprietorship
answer
form of partnership where one or more partners are not active in the daily running of the business, and whose liability for the partnership's debt is restricted to the amount invested in the business
question
Partnership
answer
a company or group of people authorized to act as a single entity (legally a person) and recognized as such in law. owners not responsible but do have to pay taxes
question
limited partnership
answer
C-private consumption(consumer spending)
G-government spending(ex.paying a company to build a bride. does not include government transfers)
I-business spending(capital, anything used to produce a good or service)
Xn-next exports(exports-imports)
G-government spending(ex.paying a company to build a bride. does not include government transfers)
I-business spending(capital, anything used to produce a good or service)
Xn-next exports(exports-imports)
question
corporations
answer
C-consumer spending
question
4-5 components of GDP
answer
1.) doesn't account for underground economy(illegal, non-official transactions)
2.)imperfect measure-doesn't take into account that some profits are made by companies overseas-so that money goes to foreign investors, GDP is overstated
3.) measures output not wellbeing like affects on the environment
2.)imperfect measure-doesn't take into account that some profits are made by companies overseas-so that money goes to foreign investors, GDP is overstated
3.) measures output not wellbeing like affects on the environment
question
What is the biggest component of the American economy?
answer
second hand sales, black market, government transfers(reparations, stimulus, welfare), and financial investments/transaction, non market activities
question
3 criticisms of using GDP to measure economic output
answer
not counted because its a financial transaction
question
What's not counted in GDP
answer
counted because of consumer spending
question
you buy 100 shares of amazon
answer
Yes, consumer spending
question
you spend 87 dollars on a new pair of shoes
answer
not counted, second hand sale
question
your parents buy you a new condo built this year to live in while you are at college
answer
not counted, non market activity
question
you buy your cousin's car
answer
counted, consumer spending
question
your mother bakes cupcakes for your sisters bday party
answer
not counted, its a financial investment
question
you pay tuition to attend college
answer
counted-business spending because it counts towards their profits and production of goods and services
question
you cash in savings bond to pay your college tuition
answer
counted, consumer spending because you are paying the realtor
question
at the end of the year, a shoe store find its shoe inventory is 2000 more than it was at the beginning of the year
answer
counted, government spending
question
realtor earned 5000 commision of the sale of your newly built condo
answer
not counted, government transfers
question
government increases spending on health care
answer
not counted, second hand sale
question
grandma collects 1200 each month in social security
answer
Yes/no-Nx
question
american arilines buys a plane from southwest
answer
not counted, second hand sale
question
you buy a television for your dorm room that was made in china
answer
net exports. value of exports-value of imports
question
parents buy a 5-year old house so that family has more room
answer
workers who spend time looking for employment
question
Nx
answer
unemployment that occurs when people take time to find a job. exists exists when # of people looking for jobs is equal to # of jobs being offered
question
job search
answer
the constant process of job creation and job destruction. new workers are always entering the labor market. always exist in the economy
question
frictional unemployment
answer
frictional unemployment because it reduces incentive to find a job quickly
question
two reasons for why frictional unemployment is inevitable
answer
unemployment that occurs when workers' skills do not match the jobs that are available or there are more people seeking jobs in a labor market there there are jobs available at the current wage.
question
what does public policy designed to help workers who lose their jobs lead to?
answer
when price of labor-wage rate- increases, employers demand less labor. more workers are willing to supply labor at the prevailing wage rate. where they meet is where there is an equilibrium wage rate for any given type of labor in a particular location
question
structural unemployment
answer
W(e). no structural unemployment here, only when wage rate is above the equilibrium causing a surplus of labor
question
what does the labor demand and supply curve indicate?
answer
is binding and can lead to structural unemployment. countries with higher minimum wage, affects more people as being binding
question
Equilibrium wage rate
answer
alters both the quantity demanded and quantity supplied of labor. if its above W(e) then it causes a labor surplus because more people want to work than is available. Qs(labor) is more than Qd leading to a structural unemployment
question
minimum wage
answer
An organization of workers that tries to improve working conditions, wages, and benefits for its members. leads to structural unemployment because they bargain for higher wages, pushing it above W(e) and causing a surplus of labor(more people willing to work) than is desired
question
A binding minimum wage
answer
above-equilibrium wages paid by firms to increase worker productivity(incentive). leads to structural unemployment because leads to a pool of people who want jobs that can't find them
question
labor union
answer
the unemployment rate that rises from the effects of frictional plus structural unemployment
question
efficiency wages
answer
the deviation of unemployment from its natural rate. arises from the business cycle. actual-natural rates of unemployment
question
The natural rate of unemployment:
answer
natural unemployment + cyclical unemployment
question
cyclical unemployment
answer
changes in labor force, labor market institutions, changes in government policies
question
actual unemployment
answer
decrease in labor unions, temp employment agencies(reduce frictional), job websites(reduce frictional). technological changes(higher demand for people tech savvy, leading to wages increasing for skilled and decreasing for non skilled, but cus of binding minimum wage it just leads to structural unemployment and a higher natural rate of unemployment will result.
question
What causes the natural rate of unemployment to change?
answer
high minimum wage-causes structural unemployment
generous unemployment benefits- cause frictional unemployment
job training(teaches unemployed people new skills for jobs)-lower natural rate
employment subsides-provide a financial incentive to offer or accept jobs-lowers natural rate
generous unemployment benefits- cause frictional unemployment
job training(teaches unemployed people new skills for jobs)-lower natural rate
employment subsides-provide a financial incentive to offer or accept jobs-lowers natural rate
question
examples of labor market intsitutions changing affecting natural rate of unemployment
answer
the wage rate divided by the price level to adjust for the effects of inflation or deflation
question
examples of changes in government policies affecting natural rate of unemployment
answer
income divided by the price level to adjust for the effects of inflation or deflation
question
real wage
answer
the percentage increase in the price level from one year to the next. Price level in year 2- price level in year 1/price level in year 1 x 100
question
real income
answer
the resources wasted when inflation encourages people to reduce their money holdings. increased cost of transactions. occcurs in economies with high inflation rates
question
inflation rate
answer
The real cost of changing a listed price. Businesses have to change prices constantly with high inflation economies. higher prices for economy as a whole
question
shoe leather costs
answer
costs arising from the way inflation makes money a less reliable unit of measurement. impacts tax system
question
menu cost
answer
the role of the dollar as a basis for contracts and calculations
question
unit-of-account costs
answer
shoe leather costs, menu costs, unit of account costs
question
unit of account role of money
answer
the interest rate actually paid for a loan, not adjusted for inflation
question
high rates of inflation impose costs like...
answer
the nominal interest rate adjusted for inflation, nominal interest rate - inflation rate
question
nominal interest rate
answer
The lenders will gain at the expense of borrowers: borrowers must repay their loans with funds that have a higher real value than had been expected.
question
real interest rate
answer
borrowers gain at the expense of lenders. borrowers will repay their loans with funds that have a lower real value that had been expected-purchase fewer goods and services with the money
question
if inflation rate is lower than expected
answer
helps borrowers hurts the lenders
question
is inflation rate is higher than expected
answer
people signing long term contracts
question
higher inflation does what
answer
the process of bringing the inflation rate down. harder and more costly to do the higher the inflation is in an economy
question
high inflation discourages
answer
a measure of the overall level of prices in the economy
question
Disinflation
answer
a hypothetical set of consumer purchases of goods and services
question
aggregate price level
answer
a number that compares prices in one year with some earlier base year. cost of market basket in given year/cost of market in base year x100
question
market basket
answer
measures the cost of the market basket of a typical urban American family
question
price index
answer
product improvements, you aren't really paying for the same product from years ago, maybe more expensive but a better product, so its balanced. Innovation, more products are created widening the range of consumer choice, innovation created benefits similar to a fall in consumer prices
question
Consumer Price Index (CPI)
answer
measures the prices of goods and services purchased by producers
question
why might inflation be miscalculated?
answer
a measure of the price level calculated as the ratio of nominal GDP to real GDP times 100
question
Producer Price Index (PPI)
answer
Hurt:inflation makes his fixed income worth less
question
GDP deflator
answer
helped: Jill's raise is more than inflation, gains money
question
Jack retired five years ago and now lives on a fixed-income annuity and a small savings account that pays him 1% interest on the balance. The current inflation rate is 1.7%.
answer
hurt:price increased but his savings didn't, lost interest
question
Jill has worked at her current position without a raise for 4 years. Because inflation has risen 5% over the course of the 4 years, she has struggled to pay day-to-day living expenses and her house payment. She asked her employer for a raise and he gave her a 6% raise because she is such a good worker.
answer
hurt: bank will be paid back with money that has a lower real value than the money they loaned out.
question
Peter has has been saving money for a ring. He gives his money to his mom to save. During this time the price of ring increased 10%
answer
helped: cost of living adjusts to any inflation
question
Wendy manages a bank in the local area. The previous manager made several fixed-rate loans to customers at low interest rates to bring in new depositors. Inflation is now rising at 3% per year.
answer
hurt: revenue collected from year five will be equivalent to year one revenue
question
luke is part of the ironworkers union. the contractor is currently building 5 skyscrapers, union negotiated a 5 year contract that includes small annual raises and cost of living adjustment
answer
helped: his lease payment wont go up no matter what
question
han works at the local tax agency. The county commissioners just voted to sell license tags at the same rate for the next 5 years
answer
the increase in consumer spending when disposable income rises by $1. MPC=change in consumer spending/change in disposable income. Will be a number between 0 and 1
question
Lando signed a 4-year fixed rate lease for the condo he is going to live in while he attends college.
answer
The fraction of any change in disposable income that households save; 1-MPC
question
Marginal Propensity to Consume (MPC)
answer
((1+MPC+MPC2(second round of increase in consumer spending) and on)) x100 billion(the increase in spending)
question
Marginal Propensity to Save (MPS)
answer
an initial rise or fall in aggregate spending that is the cause, not the result, of a series of income and spending changes
question
Total increase in real GDP
answer
the ratio of the total change in real GDP caused by an autonomous change in aggregate spending to the size of that autonomous change; it indicates the total rise in real GDP that results from each $1 of an initial rise in spending. M=1/mps or M=1/(1-mpc)
question
autonomous change in aggregate spending
answer
disposable income
question
Spending Multiplier
answer
shows how a household's consumer spending varies with the household's current disposable income. The rise is the increase in consumer spending and the run is the increase in current disposable income. For each 1$ run in income, the rise is the MPC, so the slope is MPC/1=MPC
question
most important factor affecting a familys consumer spending
answer
the amount of money a household would spend if it had no disposable income. vertical intercept on a consumption function. always greater than zero, because even with no disposable income one can still borrow or use its savings.
question
consumption function
answer
the relationship for the economy as a whole between aggregate current disposable income and aggregate consumer spending. C=A+MPCxYd. C is aggregrate consumer spending. Yd is aggregrate current disposable income, and A is aggregrate autonomous consumer spending, the amount of consumer spending when disposable income is 0
question
autonomous consumer spending
answer
changes in expected future disposable income and changes in aggregate wealth
question
aggregate consumption function
answer
consumer spending ultimately depends mainly on the income people expect to have over the long term rather than on their current income.
question
two principal causes of shifts of the aggregate consumption function:
answer
If two people make the same amount of money, but one has more wealth, that person will likely spend more and save less for retirement. When aggregate wealth increases, consumption function shifts up. Example of increase in wealth: booming stock market. Example of decrease in wealth: drop in house prices. Changes in wealth across the economy can shift aggregate consumption function
question
Permanent Income Hypothesis
answer
the investment spending that businesses intend to undertake during a given period. Depends on three factors: interest rate, the expected future level of real GDP, and the current level of production capacity.
question
changes in aggregate wealth
answer
The higher the rate the lower level of planned investment spending
question
planned investment spending
answer
firms will undertake more investment spending when they expect their sales to grow, since capacity of production needs will grow. The higher the current production capacity, the lower the investment spending. So, if higher sales means needs or more production, it also means a higher real GDP, since gdp is an indicator of growth in sales, which means higher investment spending. So expected growth of future real GDP is directly related to investment spending.
question
how does interest rate affect investment spending?
answer
the value of the change in total inventories held in the economy during a given period. Only form of investment spending that could be negative.
question
How does expectations of future real GDP affect investment spending?
answer
occurs when actual sales are lower than businesses expected, leading to unplanned increases in inventories; sales in excess of expectations result in negative unplanned inventory investment.
question
inventory investment
answer
the sum of planned investment spending and unplanned inventory investment
question
unplanned inventory investment
answer
shows the relationship between the aggregate price level and the quantity of aggregate output demanded by households, businesses, the government, and the rest of the world
question
actual investment spending
answer
a simultaneous change in the prices of all final goods and services
question
aggregate demand curve
answer
wealth effect and interest rate effect of a change in aggregate price level.
question
when we consider movements up or down the AD curve, were considering...
answer
reduces the purchasing power of a given amount of many assets. Ex. if the aggregate price level rose by 25%, someoneś 5,000 dollars would buy as much as 4,000 would have. leading to less consumption
question
why does a rise in aggregate price level lead to a fall in the quantity of all domestically produced good and services demanded?
answer
increases the purchasing power of a consumers assets, leading to more consumer demand.
question
an increase in the aggregate price level...
answer
is the change in consumer spending caused by the altered purchasing power of consumers´ assets. Consumer spending, C, falls when the aggregate price level rises, leading to a downward-sloping aggregate demand curve
question
A fall in the aggregate price level
answer
depresses investment spending, I, and consumer spending, C, leading to a downward sloping AD curve.
question
wealth effect of a change in the aggregate price level
answer
is the change in investment and consumer spending caused by altered interest rates that resulted from changes in the demand for money. Since when prices increase people want to hold on to their money which means less to lend or borrow which drives up interest rates, negatively affecting RGDP
question
rise in aggregate price level
answer
E-expectations of economy, optimistic=AD increases pessimistic=AD decreases
W-changes in wealth. when wealth increases so does AD and vice versa
C-capital(stock of). when the existing stock of physical capital is relatively small, AD increases and vice versa
fiscal policy-taxes, subsidiaries(govt payments), controlled by congress. when gov increases spending or cuts taxes, AD increases. when gov reduces spending or increases taxes, AD decreases
monetary policy-done by fed reserve board,how much money is in circulation. When the central bank increases the quantity of money, AD increases, and vice versa
W-changes in wealth. when wealth increases so does AD and vice versa
C-capital(stock of). when the existing stock of physical capital is relatively small, AD increases and vice versa
fiscal policy-taxes, subsidiaries(govt payments), controlled by congress. when gov increases spending or cuts taxes, AD increases. when gov reduces spending or increases taxes, AD decreases
monetary policy-done by fed reserve board,how much money is in circulation. When the central bank increases the quantity of money, AD increases, and vice versa
question
interest rate effect of a change in the aggregate price level
answer
The effect of government purchases of final goods and services, G, is direct, since the purchases are themselves a component of aggregate demand. Changes in tax rates or govt transfers influence the economy indirectly through disposable income. Lower taxes means more disposable income, which means more consumer spending and a shift of the AD curve to the right
question
Factors affecting a shift of an AD curve
answer
managing the economy by altering the supply of money and interest rates
question
How does fiscal policy impact AD both directly and indirectly?
answer
shows the relationship between the aggregate price level and the quantity of aggregate output supplied in the economy
question
monetary policy
answer
shows the relationship between the aggregate price level and the quantity of aggregate output supplied that exists in the short run, the time period when many production costs can be taken as fixed, like nominal wages
question
aggregate supply curve
answer
a rise in the quantity of aggregate output supplied.
question
short-run aggregate supply curve
answer
a fall in the quantity of aggregate output supplied
question
A rise in the aggregate price level is associated with
answer
price per unit - production cost per unit
question
A fall in the aggregate output supplied causes...
answer
nominal wages that are slow to fall even in the face of high unemployment and slow to rise even in the face of labor shortages. Won´t last forever as contracts are renegotiated to take into account the changing economic circumstances. How long it takes for sticky wages to become normal is an integral part of what differentiates short run from long run.
question
profit per unit
answer
a market in which all market participants are price-takers
question
sticky wages
answer
producers have some ability to choose the prices they charge
question
perfectly competitive market
answer
the positive relationship between the aggregate price level and aggregate output
question
imperfectly competitive market
answer
P-changes in productivity
E-Expectations about inflation
A-actions of govt(taxes+subsidiaries)
R-Resources(input cots), like wages and commodities.
E-Expectations about inflation
A-actions of govt(taxes+subsidiaries)
R-Resources(input cots), like wages and commodities.
question
Why does the short-run aggregate supply curve slope upward?
answer
a standardized input bought and sold in bulk quantities. Not a final good so they are not counted in aggregate price level
question
What causes shifts in the short run aggregate supply curve?
answer
A raise in price of a commodity, raises production costs across the economy and reduces the quantity of aggregate output supplied at any given aggregate price level, shifting the curve to the left.
question
commodity
answer
A rise in nominal wages increases production costs, shifts SRAS to the left. and vice versa
question
How does a change in commodities or input costs shift the SRAS?
answer
Increase in productivity means a worker can produce more units of output with the same quantity of inputs. The cost to a store of producing one dollar of sales fell and profits rose. So the quantity supplied increased. Shifts to the right. And vice versa
question
how does nominal wages affect SRAS?
answer
If inflation is expected to be higher than previously thought, workers will seek higher nominal wages to keep pace with the higher prices. Then nominal wages rise, and curve shifts to the left. When inflation is expected to be lower, lower nominal wages are accepted SRAS shifts to the right.
question
How does productivity affect SRAS?
answer
short run aggregate supply increases
question
How does inflation affect SRAS?
answer
short run aggregate supply decreases
question
When commodity prices fall
answer
short run aggregate supply increases
question
when commodity prices rise
answer
short run aggregate supply decreases
question
When nominal wages fall
answer
short run aggregate supply increases
question
when nominal wages rise
answer
short run aggregate supply decreases
question
When workers become more productive
answer
short run aggregate supply increases
question
When workers become less productive
answer
short run aggregate supply decreases
question
if inflation is expected to be lower
answer
shows the relationship between the aggregate price level and the quantity of aggregate output supplied that would exist if all prices, including nominal wages, were fully flexible
question
if inflation is expected to be higher
answer
nominal wages that are sticky in the short run
question
long-run aggregate supply curve
answer
contracts and informal agreements are negotiated in the long run, so nominal wages-like the aggregate price level-are flexible not sticky. Wage flexibillity greatly alter the long run relationship between aggregate price level and aggregate supply. In fact, in the long run the aggregate price level has no effect on the quantity of aggregate output supplied.
question
why, in the short run, does a fall in aggregate price level lead to a decline in the quantity of aggregate output supplied?
answer
changes in aggregate price level are accomponied by equal changes in all input prices, including nominal wages. This is why graph is vertical
question
Why in the long run, are nominal wages not sticky?
answer
the level of real GDP the economy would produce if all prices, including nominal wages, were fully flexible. Shown as Yp on long run supply graph
question
Why do changes in the aggregate price level not change the quantity of aggregate output supplied in the long run?
answer
- Available land and raw materials
- Quantity and productivity of labour
- Quantity and productivity of capital
- Technological improvements which affect productivity and output
- The level of entrepreneurship in the economy
- Increase in capital investment
- Quantity and productivity of labour
- Quantity and productivity of capital
- Technological improvements which affect productivity and output
- The level of entrepreneurship in the economy
- Increase in capital investment
question
potential output
answer
The economy is always in one of these two states. It can be on both simultenously by being at a point where the two cross. If the economy is on the short run but not the long run supply curve the short run curve will shift over time until the economy is at a point where both curves cross- a point where actual aggregate output is equal to the potential output
question
What causes a shift of the LRAS curve
answer
the aggregate supply curve and the aggregate demand curve are used together to analyze economic fluctuations
question
Rules of LRAS and SRAS
answer
when the quantity of aggregate output supplied is equal to the quantity demanded. Where AD and SRAS curve intersect at Esr.
question
AD-AS model
answer
the aggregate price level in the short-run macroeconomic equilibrium. the aggregate price level at Es, Pe,
question
short-run macroeconomic equilibrium
answer
the quantity of aggregate output produced in the short-run macroeconomic equilibrium. The level of aggregate output at Esr, Ye.
question
short-run equilibrium aggregate price level
answer
the quantity of aggregate output supplied exceeds the quantity of aggregate output demanded. This leads to a fall in aggregate price level, pushing it towards equilibrium.
question
short-run equilibrium aggregate output
answer
the quantity of aggregate output supplied is less than the quantity of aggregate output demanded. This leads to a rise in aggregate price level, pushing it towards equilibrium.
question
If the aggregate price level is above its equilibrium level...
answer
shifts of either the AD curve or the SRAS curve
question
If the aggregate price level is below its equilibrium level..
answer
an event that shifts the aggregate demand curve. causes aggregate output and aggregate price level to move in the same directionsup
question
The short run equilibrium aggregate output and the short-run equilibrium aggregate price level can change because of...
answer
Shifts AD curve to the left, from AD1 to AD2. Economy moves down the SRAS curve from E1 to E2. Leading to a lower short run equilibrium aggregate output and lower short run equilibrium aggregate price level.
question
demand shock
answer
Shifts AD curve to the right, from AD1 to AD2. Economy moves up the SRAS curve from E1 to E2. Leading to a higher short run equilibrium aggregate output and higher short run equilibrium aggregate price level.
question
negative demand shock
answer
An unexpected event that causes the short-run aggregate supply curve to shift.
question
positive demand shock
answer
AS curve shifts left, from AS1 to AS2, price increases from P1 to P2, and output decreases from Y1 to Y2
question
supply shock
answer
AS shifts right from AS1 to AS2, price decreases from P1 to P2, output increases from Y1 to Y2.
question
negative supply shock
answer
is the combination of inflation and stagnating(or falling) aggregate output. basically stagnation plus inflation.
question
positive supply shock
answer
when the point of short-run macroeconomic equilibrium is on the long-run aggregate supply curve.
question
Stagflation
answer
Negative demand shock decreases aggregate price and output. This decrease in output will cause nominal wages to fall. This will cause the short run AS to increase, so now the economy(E1) is back to potential output(Y1). Recessionary gap occurs
question
long-run macroeconomic equilibrium
answer
when aggregate output(E2) is below potential output. Corresponds to high unemployment. But this high unemployment leads to a fall in nominal wages, leading produces to increase output, causing the SRAS to gradually shift right, until (E3) is at potential output again and all curves intersect.
question
Effects of negative demand shock on Long-run vs short run.
answer
Positive demand shock increases the aggregate price level and output. This decreases unemployment in the short run, until the eventual rise in nominal wagesin the long run reduces short-run aggregate supply, moving the economy(E3) back to potential output. Inflationary gap occurs.
question
recessionary gap
answer
when aggregate output is above potential output
question
Effects of positive demand shock on Long-run vs short run.
answer
the percentage difference between actual aggregate output and potential output. (actual aggregate output-Potential output)/potential output x 100. always tends toward 0
question
inflationary gap
answer
in the long run, shocks to aggregate demand affect aggregate output in the short run, but not the long run
question
output gap
answer
AD curve shifts less due to future expectations. This affects investment spending
question
self-correcting
answer
AD curve shifts left due to less wealth, affects consumer spending and government spending negatively
question
business owners are less optimistic about the health of the economy.
answer
AD shifts left due to monetary policy(interest is higher), consumer spending is affected negatively
question
the government decreases welfare and veterans benefits
answer
Movement down the AD curve as consumer purchasing erodes
question
the federal reserve increases interest rates
answer
AD shifts right, lower tax implies more disposable income, so consumer spending rises.
question
A rising price level decreases the value of money held for purchases
answer
AD shifts right due to positive future expectations for employment, increases investment and consumer spending
question
the government lowers personal income taxes
answer
AD shifts right due to wealth increasing, positively affects consumer spending
question
consumers expect the job market to be much stronger in the next few months
answer
AD shifts right, investment increases to replace failing stock of capital
question
Stock market has reached new record high levels of value
answer
A.D., consumer spending, shifts right, PL increases, RGDP increases
question
The stock of physical capital has been falling for nearly a year
answer
A.D., consumer spending and investment spending, left, negative negative
question
Consumer wealth increases
answer
C+G+I+Nx. When AD increases so does price level an output, when it decreases so does the price level and output.
question
interest rate increases
answer
fiscal policy that increases aggregate demand. speeds up economy by cutting taxes, increasing gov't spending, creates a deficit in the budget, increases employment and inflation
question
Aggregate Demand
answer
fiscal policy that reduces aggregate demand, by slowing down the economy. Gov't reduces spending, increases taxes, creates a larger surplus in the budget. Reduces inflation and unemployment
question
expansionary fiscal policy
answer
the price, calculated as a percentage of the amount borrowed, charged by lenders to borrowers for the use of their savings for one year
question
contractionary fiscal policy
answer
savings and investment spending are always equal for the economy as a whole
question
interest rate
answer
the difference between tax revenue and government spending when tax revenue exceeds government spending
question
savings-investment spending identity
answer
the difference between tax revenue and government spending when government spending exceeds tax revenue
question
budget surplus
answer
the difference between tax revenue and government spending, refers to budget deficit/surplus
question
budget deficit
answer
the sum of private savings and the budget balance, is the total amount of savings generated within the economy
question
budget balance
answer
foreign savings that finance investment spending in the country
question
National Savings
answer
domestic savings that finance investment spending in another country
question
inflows of funds
answer
the total inflow of foreign funds minus the total outflow of domestic funds to other countries. can be negative or positive
question
outflows of funds
answer
comes at a higher national cost than if it was financed by national savings
question
Capital inflow
answer
investment spending is equal to spending, where spending is equal to national savings PLUS capital inflow. So in an economy with a positive capital inflow, some investment spending is funded by the
savings of foreigners. And, in an economy with a negative capital inflow (a net outflow), some portion of national savings is funding investment spending in other countries.
savings of foreigners. And, in an economy with a negative capital inflow (a net outflow), some portion of national savings is funding investment spending in other countries.
question
a dollar of investment spending financed by a capital inflow...
answer
where households invest their current savings and their accumulated savings, or wealth, by purchasing financial assets
question
savings-investment spending identity for an economy with inflows and outflows of capital
answer
a paper claim that entitles the buyer to future income from the seller, like a loan, bond, stocks, and bank deposits
question
financial markets
answer
claim on a tangible object, such as a preexisting house or a preexisting piece of equipment. It gives the owner the right to dispose of the object as he or she wishes (for example, rent it or sell it).
question
financial asset
answer
a requirement to pay money in the future. loan is a financial asset from the bank's point of view, but a liability borrower point of view: a requirement that you
repay the loan, including any interest.
repay the loan, including any interest.
question
physical asset
answer
1. Transaction costs (what's involved in loaning)
2. Financial Risk (this dictates amount of interest and length)
3. Desire for liquidity (ease with which a physical asset can be turned to cash)
2. Financial Risk (this dictates amount of interest and length)
3. Desire for liquidity (ease with which a physical asset can be turned to cash)
question
liabillity
answer
the expenses of negotiating and executing a deal. Solution:when large businesses want to borrow money, they either get a loan from a bank or sell bonds in the bond market. Obtaining a loan from a bank avoids large transaction costs because it involves only a single borrower and a single lender
question
3 problems facing borrowers and lenders
answer
financial risk is uncertainty about future outcomes that involve financial losses or gains. Financial risk (which from now on we'll simply call "risk") is a problem because the future is uncertain; it holds the potential for losses as well as gains. Solution: diversification-investing in several assets with unrelated, or independent. This is why we have stocks and stock market
question
reducing transaction costs
answer
the reluctance to invest heavily in illiquid assets deters business growth and many major purchases the
initial sale of stocks and bonds can resolve some liquidity problems by raising money for new and expanding projects. And, by taking deposits and lending them out, banks allow individuals to own liquid assets (their deposits) while financing investments in
illiquid assets such as businesses and homes.
initial sale of stocks and bonds can resolve some liquidity problems by raising money for new and expanding projects. And, by taking deposits and lending them out, banks allow individuals to own liquid assets (their deposits) while financing investments in
illiquid assets such as businesses and homes.
question
Reducing Risk
answer
as with money deposited in a bank, it can be quickly converted to cash without much loss of value
question
providing liquidity
answer
as with a business, car, home, cannot be easily converted to cash
question
liquid
answer
loans, bonds, stocks, and bank deposits
question
illiquid
answer
a lending agreement between an individual lender and an individual borrower. Most people encounter loans in the form of bank loans or finance the purchase of a car or a house. And small businesses usually use bank loans to buy new equipment.
question
four major types of financial assets
answer
a given loan is usually tailored to the needs of the borrower. Before a small business can get a loan, it usually has to discuss its business plans, its profits, and so on with the lender. This results in a loan that meets the borrower's needs and ability to repay.
question
loans
answer
making a loan to an individual person or a business typically involves a lot of transaction costs, such as the cost of negotiating the terms of the loan, investigating the borrower's credit history and ability to repay, and so on. To minimize these costs, large borrowers such as major corporations and governments often take a
more streamlined approach: they sell (or issue) bonds.
more streamlined approach: they sell (or issue) bonds.
question
good aspect of loans
answer
an IOU issued by the borrower
question
bad aspect of a loan
answer
currency + coin + traveler's checks + checking deposits
question
bond
answer
money that takes the form of a commodity with intrinsic value
question
M1
answer
a medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods, like gold
question
commodity money
answer
money that has value because the government has ordered that it is an acceptable means to pay debts
question
commodity-backed money
answer
M1 + savings accounts + short-term CDs + money market accounts
question
fiat money
answer
Value today of a future cash flow. PV = FV/(1+r)t. Interest paid on savings and interest charged on borrowing is designed to equate the value of
dollars today with the value of future dollars.
dollars today with the value of future dollars.
question
m2
answer
the amount of money in the future that an amount of money today will yield, given prevailing interest rates. FV= PV(1+r)t
question
Present Value (PV)
answer
the less value is placed upon future dollars (they're more heavily discounted)
and more emphasis is placed upon current dollars.
A higher interest rate makes an alternative (like a simple savings account) more attractive.
and more emphasis is placed upon current dollars.
A higher interest rate makes an alternative (like a simple savings account) more attractive.
question
Future Value
answer
Banks are financial intermediaries in business to earn profit, but in the process they do make more money.
Banks offer a safe place for depositors to put money and they offer lending services to borrowers who
need money.banks take liquid assets (savings) to finance the investment of illiquid assets (homes and capital equipment).
Banks offer a safe place for depositors to put money and they offer lending services to borrowers who
need money.banks take liquid assets (savings) to finance the investment of illiquid assets (homes and capital equipment).
question
The higher the interest rate
answer
there is now more money in circulation, and the money supply increases.
question
What do banks do
answer
the percentage of deposits that banking institutions must hold in reserve. 10%di
question
Once loans are made...
answer
A business's T-account summarizes its financial position by showing, in a single table, the
business's assets and liabilities, with assets on the left and liabilities on the right.
business's assets and liabilities, with assets on the left and liabilities on the right.
question
reserve requirement
answer
The Federal deposit insurance corporation, provides deposit insurance, a guarantee that depositors will be paid even if the bank can't come up with the funds, up to a
maximum amount per account.
maximum amount per account.
question
t-account
answer
To reduce the incentive for excessive risk-taking, regulators require that the owners of banks hold
substantially more assets than the value of bank deposits. That way, the bank will still have assets larger
than its deposits even if some of its loans go bad, and losses will accrue against the bank owners' assets,
not the government.
Bank's capital = assets - liabilities
substantially more assets than the value of bank deposits. That way, the bank will still have assets larger
than its deposits even if some of its loans go bad, and losses will accrue against the bank owners' assets,
not the government.
Bank's capital = assets - liabilities
question
What does the FDIC do
answer
an arrangement in which the Federal Reserve stands ready to lend money to banks in trouble
question
capital requirement
answer
1. deposit insurance
2. capital requirements
3. reserve requirements
4. discount window
2. capital requirements
3. reserve requirements
4. discount window
question
discount window
answer
When you make a deposit into your checking account, the bank can make a loan to a borrower and he/she
has part of your money in his/her checking account. So by making a loan, the checking deposits have
increased, thus increasing M1; the money supply.
has part of your money in his/her checking account. So by making a loan, the checking deposits have
increased, thus increasing M1; the money supply.
question
bank regulations
answer
money multiplier used to find how much money can be created from loans. MM = 1/rr
Where rr is the reserve ratio.
MM tells us how much money will be created if a bank has $1 of excess reserves.
MM = 1/.10 = 10 so the initial $4500 of excess reserves would theoretically multiply by a factor of 10 to
$45,000 of newly created M1. Deposits do not count toward more money
Where rr is the reserve ratio.
MM tells us how much money will be created if a bank has $1 of excess reserves.
MM = 1/.10 = 10 so the initial $4500 of excess reserves would theoretically multiply by a factor of 10 to
$45,000 of newly created M1. Deposits do not count toward more money
question
How does a bank create money?
answer
is a central bank—an institution that oversees and regulates the banking system, and
controls the monetary base. created in 1913 as a result of the panic of 1907
controls the monetary base. created in 1913 as a result of the panic of 1907
question
MM
answer
- Board of Governors
- 12 regional Fed banks,
- Federal Open Market
Committee (FOMC),
includes the Bd of Govs and
presidents of some of the regional Fed banks
The FOMC decides monetary policy.
- 12 regional Fed banks,
- Federal Open Market
Committee (FOMC),
includes the Bd of Govs and
presidents of some of the regional Fed banks
The FOMC decides monetary policy.
question
Federal Reserve System
answer
7 members appointed by the President, confirmed by the senate and serve 14 years. Chairman is every 4 years. Create and implement monetary policy, decides on amount of money to loan member banks and to set the rate of interest on loans, over sees bank mergers and acquisitions of American banks and any international member banks. Reports to congress.
question
structure of the fed
answer
serve a region of the country, providing various banking and supervisory services.
Each regional bank is run by a board of directors
The Federal Reserve Bank of New York plays a special role: it carries out open -market operations,
usually the main tool of monetary policy.
Each regional bank is run by a board of directors
The Federal Reserve Bank of New York plays a special role: it carries out open -market operations,
usually the main tool of monetary policy.
question
Board of Governors
answer
monetary policy, consists of the
Board of Governors plus five of the regional bank presidents. The president of the Federal Reserve Bank
of New York is always on the committee, and the other four seats rotate among the 11 other regional bank
presidents. The chairman of the Board of Governors also serves as the chairman of the Open
Market Committee.
Board of Governors plus five of the regional bank presidents. The president of the Federal Reserve Bank
of New York is always on the committee, and the other four seats rotate among the 11 other regional bank
presidents. The chairman of the Board of Governors also serves as the chairman of the Open
Market Committee.
question
12 regional banks
answer
Provide financial services, supervise and regulate banking, maintaining financial stability, and conducting monetary policy.
question
Federal Open Market Committee (FOMC)
answer
holds reserves, clears checks, provides cash, and transfers funds for commercial banks
The Federal Reserve also acts as the banker and fiscal agent for the federal government.
The U.S. Treasury has its checking account with the Federal Reserve, so when the federal government
writes a check, it is written on an account at the Fed.
The Federal Reserve also acts as the banker and fiscal agent for the federal government.
The U.S. Treasury has its checking account with the Federal Reserve, so when the federal government
writes a check, it is written on an account at the Fed.
question
functions of fed
answer
The regional Federal Reserve banks examine and regulate commercial banks in
their district. The Board of Governors also engages in regulation and supervision of financial institutions.
their district. The Board of Governors also engages in regulation and supervision of financial institutions.
question
financial services
answer
As part of this function,
Federal Reserve banks provide liquidity to financial institutions to ensure their safety and soundness.
Federal Reserve banks provide liquidity to financial institutions to ensure their safety and soundness.
question
Supervise and Regulate Banking Institutions
answer
One of the Federal Reserve's most important functions is the conduct of monetary policy through their tools of reserve requirement, discount rate, and open market operations
question
maintain stability of financial system
answer
The amount of excess reserves decreases.
The money multiplier decreases.
The available lending capacity shrinks.
contractionary monetary policy
The money multiplier decreases.
The available lending capacity shrinks.
contractionary monetary policy
question
conducting monetary policy
answer
The amount of excess reserves increases.
The money multiplier increases.
The available lending capacity expands.
expansionary monetary policy
The money multiplier increases.
The available lending capacity expands.
expansionary monetary policy
question
increase reserve requirement
answer
allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves
question
decrease reserve requirement
answer
Interest rate banks charge each other for loans to each other
question
federal funds market
answer
The interest rate on the loans that the Fed makes to banks. rare to change
question
federal funds rate
answer
decrease the money supply, contractionary. the cost to
banks of being short of reserves rises; banks respond by decreasing their lending, and the money
supply decreases via the money multiplier.
banks of being short of reserves rises; banks respond by decreasing their lending, and the money
supply decreases via the money multiplier.
question
discount rate
answer
increase the money supply, expansionary. the cost to
banks of being short of reserves falls; banks respond by increasing their lending, and the money
supply increases via the money multiplier.
banks of being short of reserves falls; banks respond by increasing their lending, and the money
supply increases via the money multiplier.
question
increase discount rate
answer
principal tool of monetary policy.
fed buys government debt from banks=injecting money into system, giving money to banks to loan out by buying debt
fed sells government debt=reduces reserves that banks have to loan out, contractionary
fed buys government debt from banks=injecting money into system, giving money to banks to loan out by buying debt
fed sells government debt=reduces reserves that banks have to loan out, contractionary
question
decrease discount rate
answer
holding cash means no interest paid to them
question
open market operations
answer
shows the relationship between the interest rate and the quantity of money demanded.
question
oppurtunity cost of holding money
answer
changes in aggregate price level(proportional so PL increases so does MD)
changes in Rgdp(gdp increases so does MD)
changes in technology
changes in institutions
changes in Rgdp(gdp increases so does MD)
changes in technology
changes in institutions
question
money demand curve
answer
the difference between tax revenue and government spending. S(savings by government)=T(tax revenues)-G(government purchases of goods and services)-TR(government transfers)
question
factors that shift MD curve
answer
positive budget balance
question
budget balance
answer
negative budget balance
question
Budget surplus
answer
expansionary policy: cut taxes, increase government spending, increase government transfer payments. This will cause AD to increase, reverse the recession, but will decrease the budget balance
question
budget deficit
answer
contractionary policy: increase taxes, decrease government spending, decrease government transfers. Will cause AD to decrease, inflation to reverse, increase the budget balance
question
recessionary gap
answer
1.) Two different changes in fiscal policy that have equal-size effects on the budget balance may have
quite unequal effects on the economy.
Example: If government spending increases by $1000, it will have a larger impact on real GDP than a tax
decrease of $1000. The budget balance would change by $1000 in each case, but the impacts would be
different.
2.) Often, changes in the budget balance are themselves the result, not the cause, of fluctuations in the economy.
quite unequal effects on the economy.
Example: If government spending increases by $1000, it will have a larger impact on real GDP than a tax
decrease of $1000. The budget balance would change by $1000 in each case, but the impacts would be
different.
2.) Often, changes in the budget balance are themselves the result, not the cause, of fluctuations in the economy.
question
inflationary gap
answer
rises, falls
question
why doesn't the budget balance always reflect changes in fiscal policy?
answer
1.)Tax revenues decline because incomes and profits are declining.
2.) Transfer payments, like welfare assistance, begin to rise as more people find themselves
unemployed and struggling.
budget balance to declines without deliberate fiscal policy changes
2.) Transfer payments, like welfare assistance, begin to rise as more people find themselves
unemployed and struggling.
budget balance to declines without deliberate fiscal policy changes
question
The budget deficit almost always ____ when the unemployment rate rises and ____ when the unemployment rate falls.
answer
1.)Tax revenues rise because incomes and profits are rising
.2.) Transfer payments, like welfare assistance, begin to fall as fewer people find themselves
unemployed and struggling.
budget balance rises without deliberate fiscal policy changes
.2.) Transfer payments, like welfare assistance, begin to fall as fewer people find themselves
unemployed and struggling.
budget balance rises without deliberate fiscal policy changes
question
what happens to the budget balance when the economy heads toward a recession?
answer
an estimate of what the budget balance would be if real GDP were exactly equal to potential output
It takes into account the extra tax revenue the government would collect and the transfers it would save if a recessionary gap were eliminated—or the revenue the government would lose and the extra transfers it would make if an inflationary gap were eliminated.
If we adjust for the effects of the business cycle, and the government is still running a deficit, then
we might come to the conclusion that their fiscal policy decisions are not sustainable over the long run
It takes into account the extra tax revenue the government would collect and the transfers it would save if a recessionary gap were eliminated—or the revenue the government would lose and the extra transfers it would make if an inflationary gap were eliminated.
If we adjust for the effects of the business cycle, and the government is still running a deficit, then
we might come to the conclusion that their fiscal policy decisions are not sustainable over the long run
question
What happens to the budget balance when the economy heads toward inflationary gap
answer
all past deficits-minus all past surpluses
question
Cyclical adjusted budget balance
answer
government debt held by individuals and institutions outside the government
question
national debt
answer
1.) crowding out happens.
2.)Today's deficits, by increasing the government's debt, place financial pressure on future
budgets. Interest must be paid in the future, and this can take dollars away from other future
obligations like education, the military, space exploration, etc. also inflation
2.)Today's deficits, by increasing the government's debt, place financial pressure on future
budgets. Interest must be paid in the future, and this can take dollars away from other future
obligations like education, the military, space exploration, etc. also inflation
question
public debt
answer
a decrease in investment that results from government borrowing. government borrows funds in the financial markets, competing with firms that
plan to borrow funds for investment spending. As a result, the government's borrowing may
"crowd out" private investment spending, increasing interest rates and reducing the economy's
long-run rate of growth.
plan to borrow funds for investment spending. As a result, the government's borrowing may
"crowd out" private investment spending, increasing interest rates and reducing the economy's
long-run rate of growth.
question
problems with a rising government debt
answer
the government's debt as a percentage of GDP
question
crowding out
answer
spending promises made by governments that are effectively a debt despite the fact that they are not included in the usual debt statistics
question
debt-GDP ratio
answer
buys treasury bills, money supply increases, interest rates fall
question
implicit liabilities
answer
sells treasury bills, money supply decreases, interest rates rise
question
Fed takes steps to increase the money supply
answer
Interest rate banks charge each other for loans
question
Fed takes steps to decrease the money supply
answer
the fed will increase the money supply so that the rates will fall to the target
question
federal funds rate
answer
the fed will decrease the money supply so that the rates will rise to the target
question
if the federal funds rate is higher than the target...
answer
AD will rise, because consumption and investment spending increases
question
if the federal funds rate is lower than the target...
answer
The Fed observes that the economy is in a recessionary gap.
The Fed increases the money supply.
The interest rate falls.
Investment and consumption increase.
AD shifts to the right.
Real GDP increases, unemployment rate decreases, the aggregate price level rises.
The Fed increases the money supply.
The interest rate falls.
Investment and consumption increase.
AD shifts to the right.
Real GDP increases, unemployment rate decreases, the aggregate price level rises.
question
when interest rate falls
answer
The Fed observes that the economy is in an inflationary gap.
The Fed decreases the money supply.
The interest rate rises.
Investment and consumption decrease.
AD shifts to the left.
Real GDP decreases, unemployment rate increases, the aggregate price level falls.
The Fed decreases the money supply.
The interest rate rises.
Investment and consumption decrease.
AD shifts to the left.
Real GDP decreases, unemployment rate increases, the aggregate price level falls.
question
expansionary monetary policy chain of events
answer
a rule for setting the federal funds rate that takes into account both the inflation rate and the output gap.
Federal funds rate = 1 + (1.5 x inflation rate) + (0.5 x output gap)
Federal funds rate = 1 + (1.5 x inflation rate) + (0.5 x output gap)
question
contractionary monetary policy chain of events
answer
a policy of keeping interest rates at a level that creates a specific level of price
inflation, or at least attempts to keep inflation rates within an acceptable range.
inflation targeting is forward-looking rather than backward-looking. Taylor rule adjusts monetary policy in response to past inflation, but inflation targeting is based on a forecast of future inflation.
two key advantages:
Transparency: Economic uncertainty is reduced because the public knows the objective of an
inflation-targeting central bank.
Accountability: The central bank's success can be judged by seeing how closely actual inflation
rates have matched the inflation target, making central bankers accountable.
inflation, or at least attempts to keep inflation rates within an acceptable range.
inflation targeting is forward-looking rather than backward-looking. Taylor rule adjusts monetary policy in response to past inflation, but inflation targeting is based on a forecast of future inflation.
two key advantages:
Transparency: Economic uncertainty is reduced because the public knows the objective of an
inflation-targeting central bank.
Accountability: The central bank's success can be judged by seeing how closely actual inflation
rates have matched the inflation target, making central bankers accountable.
question
the taylor rule
answer
shows the relationship between the quantity of money supplied and the interest rate. Increase in money supply, interest rate decreases, Fed purchases bonds in this scenario. Decrease in money supply, interest rates increase, fed selling bonds
question
inflation targeting
answer
inverse, when money supply rises, interest rate falls and vice versa
question
money supply curve
answer
If the Fed were to conduct expansionary monetary policy, the interest rate would fall.
x A lower interest rate would shift AD to the right.
x In the short run, real GDP would increase, but so would the aggregate price level.
x Eventually nominal wages would rise in labor markets, shifting SRAS to the left.
x Long-run equilibrium would be established back at potential GDP and a higher price level.
x So in the long run, expansionary monetary policy doesn't increase real GDP, it only causes
inflation.
x A lower interest rate would shift AD to the right.
x In the short run, real GDP would increase, but so would the aggregate price level.
x Eventually nominal wages would rise in labor markets, shifting SRAS to the left.
x Long-run equilibrium would be established back at potential GDP and a higher price level.
x So in the long run, expansionary monetary policy doesn't increase real GDP, it only causes
inflation.
question
relationship between money supply and interest rate
answer
changes in the money supply have no real effects on the economy. In the long run,
the only effect of an increase in the money supply is to raise the aggregate price level by an equal
percentage.
the only effect of an increase in the money supply is to raise the aggregate price level by an equal
percentage.
question
Suppose the economy is currently in LR equilibrium.
answer
the money supply increases by any given percentage, in the long run, the aggregate price level will rise by the same percentage. no affect on the real value of the money supply or GDP. interest rate won't change after a change in the money supply.
question
Money Nuetrality
answer
public debt,treasury bills, notes, and bonds owned by U.S. investors, the Federal Reserve, and foreign governments.
question
how does money neutrality work
answer
social security and medicare
question
whats counted in debt
answer
monetary policy
question
an example of an implicit liabillity
answer
self-correcting
question
tool of choice to help stabilize the economy in the short run
answer
SRAS decreases due to an increase in resource prices
question
in the long run the economy is
answer
caused by an increase in AD that increases the price level
This is likely to be caused by economic growth that is coupled with either expansionary fiscal or
monetary policy.
This is likely to be caused by economic growth that is coupled with either expansionary fiscal or
monetary policy.
question
cost-push inflation
answer
(inflationary gap) the unemployment rate is below the natural rate
question
demand-pull inflation
answer
(recessionary gap) the unemployment rate is above the natural rate
question
When the output gap is positive
answer
the negative short-run relationship between the unemployment rate and the inflation rate
question
when the output gap is negative
answer
inflation rate is high
question
Short-Run Phillips Curve (SRPC)
answer
inflation rate is low
question
when employment rate is low
answer
rate of inflation that employers and workers expect in the near future. changes in the expected rate of inflation affect the short-run trade-off between unemployment and inflation and shift the short-run Phillips curve.
question
when employment rate is high
answer
shifts the short-run Phillips curve upward
question
expected rate of inflation
answer
shifts the short-run Phillips curve downward
question
An increase in expected inflation
answer
A relationship between the tax rates and tax revenues that illustrates that high tax rates could lead to lower tax revenues if economic activity is severely discouraged.
question
A decrease in expected inflation
answer
- Adam Smith
- free market
- let the economy self adjust
- free market
- let the economy self adjust
question
Laffer Curve
answer
john maynard keyes, fiscal and monetary policy is needed
question
classical economics
answer
Milton Friedman, use the monetary rule(MV=PY), wages are sticky
question
Keynesian economics
answer
ronald lucas, use the monetary rule(MV=PY), wages and prices are fully flexible
question
Monetarism
answer
expectations
wealth
stock of capital
fiscal policies-taxation, gov spending
monetary policy-money supply, done by fed reserve board
wealth
stock of capital
fiscal policies-taxation, gov spending
monetary policy-money supply, done by fed reserve board
question
rational expectations
answer
productivity-shifts right when it increases
expectations about inflations- if you think its going down, it shifts right
actions by gov't-taxes, payments
resources(input costs)-if prices go down, AS shifts right
expectations about inflations- if you think its going down, it shifts right
actions by gov't-taxes, payments
resources(input costs)-if prices go down, AS shifts right
question
factors of AD
answer
A flow variable measuring the amount by which federal government outlays exceed federal government revenues in a particular period, usually a year
question
factors of AS
answer
a fiscal policy used to reduce economic growth, often through decreased spending or higher taxes. RGDP and price level decreases. Fed sells bonds
question
federal budget deficit
answer
a fiscal policy used to encourage economic growth, often through increased spending or tax cuts. Price level and RGDP increases. Fed buys debt, interest rate falls
question
contractionary policy
answer
lower interest rate increases consumer spending, investment and RGDP, AD would shift right, AS shifts left
question
expansionary policy
answer
AD increases, inflation increases, unemployment decreases, so move up the phillips curve from A to B
question
How would change in interest rate affect AD/AS model
answer
AS increases, inflation and unemployment decrease, phillips curve shifts left
question
government spending increases
answer
AS decreases, inflation and unemployment rise, phillips curve shifts right
question
The price of oil decreases
answer
AD decreases, inflation decreases, unemployment rises, move down the phillips curve from A to C
question
inflation expectations rise
answer
central bank should be independent, monetary policy should play main role in the stabilization policy, discretionary fiscal policy should be used sparingly
question
The Fed increases interest rates.
answer
undefined
question
Modern Macroeconomics
answer
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