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Principle of economics > CH 16+18 > Flashcards

CH 16+18 Flashcards

1
Q

classical model of the price level (definition)

A

a simplified model in which the real quantity of money is always at its LR equilibrium level
- assumes that economy moves directly from one LR equilibrium to another
- assumes aggregate output (aka real GDP) never changes in response to a change in money supply
- analyses the effects of money supply changes as if the SR as well as the LR aggregate supply curves were vertical

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2
Q

when is the classical model of price level a good approximation of reality of economy?

A

when economy is facing persistently high inflation
–> short run stickiness of nominal wages+prices tends to vanish–> because used to inflation–> respond to changes in price level quicker–> so SRAS curve shifts quicker than if not used to adjusting quickly–> therefore more rapid return to potential output, only now with higher inflation

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3
Q

seigniorage (definition)

A

the difference between the value of currency/money and the cost of producing it
–> aka amount of money government actually captures by printing (more) money

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4
Q

inflation tax (definition)

A

the reduction in the value of money held by the public as a result of inflation
–> because inflation erodes the purchasing power of people’s money holdings
–> 5% inflation rate–> results in 5% inflation tax rate on value of all money held by the public

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5
Q

seigniorage (equation)

A

the change in money supply over the same period of time that the seigniorage is collected

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6
Q

real seigniorage (equation)

A

rate of rgowth of money supply X real money supply

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7
Q

how does hyper inflation happen?

A
  • in face of high inflation–> public reduces real amount of money it holds
  • this reduces the real money supply
  • government needs to print more money to pay for G+S and its debt
  • but because people hold less real money–> government has to respond by accelerating rate of growth of money supply because money worth less so need more to pay for things–> even higher levels of inflation
  • people respond to this higher inflation by again reducing their money holdings
  • this reinforces this process–> can spiral out of control
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8
Q

output gap (definition)

A

the percentage difference between actual level of real GDP (aggregate output) and potential output

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9
Q

unemployment rate=

A

cyclical+natural unemployment

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10
Q

the 2 rules that define the relationship betweenunemployment rate and output gap:

A
  1. when the actual aggregate output is equal to the potential output–> the actual unemployment rate is equal to the natural rate of unemployment
    • when output gap is positive (inflationary gap) –> economy temporarily using resources higher than normal amounts–> unemployment rate below natural rate
    • when output gap negative (recessionary gap) –> not full use of productive resources–> unemployment rate above natural unemployment rate
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11
Q

short-run philips curve (SRPC) (definition)

A

the negative SR relationship between unemployment rate and inflation rate
- when unemployment is low–> inflation high
- when inflation low–> unemployment high

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12
Q

a negative supply shock shifts SRPC…

A

upwards–> because inflation rate increases for every level of unemployment

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13
Q

a positive supply shock shifts SRPC…

A

downwards–> because inflation falls for every level of unemployment

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14
Q

expected rate of inflation (definition)

A

the inflation rate that businesses and workers are expecting in the near future
–> changes in expected rate of inflation affects SR trade-off between unemployment and inflation & shift the SRPC

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15
Q

stagflation (definition)

A

the combination of high inflation and high unemployment

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16
Q

how to avoid accelerating inflation over time:

A

unemployment must be high enough that the actual rate of inflation matches the expected rate of inflation
–> aka at the Nairu

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17
Q

non accelerating inflation rate of unemployment (NAIRU)

A

the unemployment rate at which inflation doesn’t change over time

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18
Q

Long-Run Philips Curve (LRPC) (definition)

A

shows the relationship between unemployment and inflation after expectations of inflationhave had time to adjust to experience
–> vertical line–> because no LR trade off between unemployment and inflation

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19
Q

natural rate of unemployment (definition)

A

portion of unemployment unaffected by swings of business cycle

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20
Q

deflation (definition)

A

fall in aggregate price level

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21
Q

deflation repercussions lenders+borrowers:

A
  • lenders–> are owed money–> gain under deflation–> because real value of borrower’s payments increases
  • borrowers–> owe the money–> lose–> burden of their debt rises
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22
Q

debt deflation (definition)

A

the reduction in aggregate demand arising from increase in real burden of outstanding debt caused by deflation
–> because borrowers are usually ones that spend that money, lenders are not–> therefore decrease in disposable income borrowers leads to less aggregate demand

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23
Q

liquidity trap (definition)

A

when in economy conventional monetary policy is ineffective because the nominal interest rate is up against the zero lower bound
–> can occur when there’s a sharp reduction in demand for loanable funds–> like during the Great Depression

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24
Q

international macroeconomics (definition)

A

branch of macroeconomics that deals with the relationship between national economies

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25
Q

balance of payments accounts (definition)

A

a summary of the country’s transaction with other countries over a year

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26
Q

factor income (definition)

A

the income that foreigners pay to US residents for the use of US owned factor sof production & income paid by US to foreigners for use of foreign owned factors of production

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27
Q

international transfers (definition)

A

funds send by US residents to residents of other countries and vice versa

28
Q

(balance of Payments on) Current Account (definition)

A

country’s balance of payments on G+S+net international transfer payments+factor income

29
Q

balance of payments on goods and services (definition)

A

the difference between country’s exports and imports during given period of time

30
Q

(merchandise) trade balance (definition)

A

the difference between country’s exports and imports EXCLUDING services
–> economists sometimes focus on this 9even though not complete measure) because data on international trade in service isn’t as accurate as that of trade of goods

31
Q

(balance of payments on) financial account (definition)

A

the difference between country’s sales of assets to foreigners and its purchases of assets from foreigners for given period

32
Q

current account deficit (definition)

A

amount paid to foreigners for G+S+Factors+Transfers–> more than amount received

33
Q

financial account account surplus (definition)

A

value of assets it sold to foreigners was more valuable than assets bought from foreigners

34
Q

what is the basic rule of balance of payment accounting?

A

current account and financial account must sum up to zero!!!!

aka: CA+FA=0

35
Q

by what is the financial account determined?

A

by the supply and demand market for loanable funds
–> capital moves from places where would be cheap in absence of international capital flows to where it would be expensive in absence of such flows

36
Q

how does capital tends to flow?

A

from slowly growing economies to rapidly growing economies
–> because faster growing economies offer higher interest rates

37
Q

reasons for 2-way capital flows:

A
  • investors seeking to diversify against risk by investing in different countries
  • corporations often engage in international investment as part of their business strategy–> eg: auto company might be better off to compete overseas if assemble cars overseas etc
  • some countries are international banking centres–> people form all over world put money in US financial institutions–> which then fund those funds overseas
38
Q

result of 2-way flows of capital:

A

moderne conomies are typically both debtors and creditors

39
Q

foreign exchange market (definition)

A

market where currencies can be traded for one another

40
Q

exchange rate (definition)

A

the price at which currencies trade
–> set by foreign exchange market

41
Q

appreciates (definition)

A

when currency becomes more valuable in terms of other currencies

42
Q

depreciates (definition)

A

when currency becomes less valuable in terms of other currencies

43
Q

how is the exchange rate determined?

A

by the supply and demand in the foreign exchange market

44
Q

equilibrium exchange rate (definition)

A

the exchange rate at which the quantity of a currency demanded in foreign exchange market is equal to the quantity supplied

45
Q

real exchange rate (definition)

A

exchange rate adjusted for international difference in aggregate price level (inflation)

46
Q

equation real exchange rate

A

real exchange rate= Mexican pesos per US dollar X PUS : PMex
PUS/PMex= indexes of aggregate price levels in US and mexico

47
Q

purchasing power parity (definition)

A

the purchasing power parity between two currencies is the nominal exchange rate at which a given basket of G+S would cost the same amount in each country

48
Q

effective exchange rate (definition)

A

measure of average value of dollar against other currencies

49
Q

real net exports (definition)

A

exports-imports

50
Q

exchange rate regime (definition)

A

a rule governing policy toward the exchange rate

51
Q

2 main types of exchange rate regimes (definition):

A
  • fixed exchange rate
  • floating exchange rate
52
Q

fixed exchange rate (definition)

A

when country’s government keeps exchange rate against some other currency at or near particular target

53
Q

floating exchange rate (definition)

A

when country’s government lets market forces determine the exchange rate

54
Q

3 ways government can keep value of EXR higher than equilibrium EXR:

A
  1. exchange market intervention–> use foreign currency to buy own currency
  2. try shift S+D curves for currency in foreign exchange market–> by raisinginterest rates–> more capital inflow+less capital outflow–> increased demand+reduced supply–> worth more because scarce
  3. government can support their currency by reducing supply of genos to foreign exchange market–> using foreign exchange control–> limiting its residents yo buy foreign currency
55
Q

foreign exchange reserves (definition)

A

stocks of foreign currency that governments maintain to buy their own currency on foreign exchange market

56
Q

foreign exchange controls (definition)

A

licensing systems that limit right of individuals to buy foreign currency

57
Q

3 things government can do to keep EXR lower than equilibrium price (shortage):

A
  1. intervene foreign exchange market–> selling their currency+buying foreign currency
  2. reduce interest rates–> increased supply of their cureency and reduced demand
  3. impose foreign exchange controls–> limit ability of foreigners to buy their currency
58
Q

2 benefits o fixed exchange rate:

A
  • certainty about future value of currency–> beneficial to know for international trade, amount of money agreed on stays the same worth
  • by committing itself to a fixed rate–> country also committing itself not to engage in inflationary policies
59
Q

4 costs of fixing the exchange rate:

A
  • to stabilise EXR through intervention–> country must keep large quantities of foreign currencies on hand–> (usually low return of investment)
  • even largest reserves can be quickly exhausted when large amount capital flows out of country
  • if country chooses to stabilise EXR by adjusting monetary policy instead of intervention–> must divert monetary policy from other goals–> like stabilising economy+managing inflation rate
  • foreign exchange controls–> like import quota’s+tariffs–> distort incentives for importing+exporting G+s
60
Q

3 policy issues raised by international aspects of macroeconomics (definition):

A
  1. devaluation and revaluation of fixed exchange rates
  2. monetary policy under floating exchange rates
  3. international business cycle
61
Q

devaluation (definition)

A

a reduction in the value of a currency that is set under fixed exchange rate regime
–> makes domestic goods cheaper compared to foreign goods–> increase in exports and reduces imports–> this effect increases the balance of payments on the current account

62
Q

revaluation (definition)

A

an increase in value of a currency that set under fixed exchange rate regime
–> makes domestic goods more expensive–> reduced exports+increase imports–> this effect reduces the balance of payments on the current account

63
Q

2 purposes of devalutions+revaluations under fixed exchange rates:

A
  1. can be used to eliminate shortages/surpluses in foreign exchange market
  2. can be used as tools of macroeconomic policy:
  • devaluation–> increases exports+reduces imports–> can be used to reduce/eliminate recessionary gap
  • revaluation–> reduces aggregate demand by increasing imports–> can be used to reduce/eliminate inflationary gap
64
Q

monetary policy under floating exchange rates (explanation)

A

even though floating exchange rate regime–> country’s monetary policy can still affect the EXR:

  • lower interest rate–> higher investment+consumer spending–> but also causes less incentives foreigners to move their funds to that country–> so decline in demand for that currency–> at same time increased supply because residents want to get rid of their currency–> leads to depreciation in their currency exchange rate
    –> this leads to increased aggregate demand because imports too expensive

–> so this monetary policy is working double: not only results the reduction in interest rate to increased spending, but also leads to increase in aggregate demand

65
Q

international business cycle (explanation)

A

changes in aggregate demand affect demand G+S produced abroad as well as domestically

66
Q

recession+imports relation:

A

recession leads to fall in imports

67
Q

expansion+imports relationship:

A

expansion leads to rise in imports

Principle of economics (7 decks)

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