E Flashcards
(254 cards)
1
Q
the amount of unemployment is a determinant of the standard of living. I all workers are employed, what will happen to the GDP?
A
It will increase
2
Q
What is the natural rate of unemployment?
A
It is the type of unemployment that does not go away on its own even in the long run.
3
Q
What is the type of unemployment that the economy usually experiences?
A
Natural rate of unemployment
4
Q
What is cyclical unemployment?
A
It refers to the year to year fluctuations in unemployment around its natural rate. It is associated with short term ups and downs in the business cycle
5
Q
How is the unemployment rate measured?
A
by statistics NZ who do a regular survey of 30 000 individuals, called the household labor force survey
6
Q
What are the 3 categories that adults can be placed in the survey?
A
- employed
- unemployed
- not in the labor force
7
Q
What is the labor force?
A
the total number of workers including both employed and unemployed
8
Q
What is the equation for working out the unemployment rate?
A
number of unemployed/labor force x 100
9
Q
What is the equation for the labor force participation rate?
A
Labor force / adult population x 100
10
Q
Who has lower rates on labor participation but once in the labor force they have similar rates?
A
Women
11
Q
What are the reasons for women’s labor force participation rates rising since 1960?
A
- Technology e.g vacuum cleaner
- Social attitudes
- People living longer
- House husbands
12
Q
What are the 3 reasons as to why the unemployment rate is not a perfect measure?
A
- It is difficult to distinguish between a person who is not in the labor force and someone who is unemployed.
- There are discouraged workers - people who would like to work but have given up in looking for a job, do not show up in unemployment statistics
- other people may claim to be unemployed to receive financial assistance, even though they are not looking for work.
13
Q
What is the unemployment problem mostly due to?
A
The few people who are unemployed for long periods of time
14
Q
Why are there always people who are unemployed?
A
In an ideal labour market, wages would adjust to balance out the supply and demand for labour, ensuring that all workers are fully employed - frictional unemployment
15
Q
What is frictional unemployment?
A
the type of unemployment that results from the time it takes to match workers with jobs. It takes time for workers to find jobs that match their tastes and skills. It is not caused by a wage rate higher than the equilibrium. it is caused by the time spent looking for the right job.
16
Q
What is structural unemployment?
A
the type of unemployment that results because the number of jobs available in some labour markets are insufficient to provide a job for everyone who wants one
17
Q
Why is search unemployment inevitable?
A
because the economy is always changing
18
Q
What are sectoral shifts?
A
changes in the composition of demand among industries or regions
19
Q
What are the 3 government programs to help unemployment?
A
- Government-run unemployment agencies
- Public training programs
- Unemployment insurance
20
Q
What are Government-run unemployment agencies?
A
they give out information about job vacancies in order to match workers and jobs more quickly. It increases job finding rate
21
Q
What are Public training programs?
A
they aim to ease the transition of workers from declining to growing industries and help disadvantaged groups escape poverty
22
Q
What is unemployment benefit?
A
a government program that ensures a minimum standard of living for workers when they become unemployed. While reducing the hardship of unemployment, the unemployment benefit may actually increase the level of unemployment.
23
Q
Why is there structural unemployment?
A
- minimum wage laws
- unions
- efficiency wages
24
Q
How do minimum wage laws affect unemployment?
A
When the minimum wage is set above the level that balances supply and demand it creates unemployment
25
What is a union?
A worker association that bargains with employers over wages and working conditions. It is a type of cartel attempting to exert its market power
26
What is collective bargaining?
The process by which unions and firms agree on the terms of employment
27
What is a strike?
It will be organised if the union and the firm cannot reach an agreement. It is a withdrawal of labor from the firm by the union. It will make some workers better off and some worse off.
28
What did the ECA (employment contracts act) do for strikes?
Workers in unions (insiders) used to reap the benefits of collective bargaining, while workers not in the union (outsiders) bear some of the costs. After the ECA, insiders also include other employees who are not union members and outsiders represent unemployed workers only.
29
Why do critics say that unions are a drag on productivity?
Because unions obstruct competition in the labor market
30
What did the employment relations act (ERA) of 2000 do?
It amended the ECA with a clause "Personal Grievance" based on which an employee can take an employer to court
31
What are efficiency wages?
They are above equilibrium wages paid by firms in order to increase worker productivity. The theory is that firms will operate more efficiently if wages are above the equilibrium level
32
Why would firms want to pay higher than equilibrium wages?
1. Worker health: Better paid workers eat a better diet and thus are more productive
2. Worker turnover: A higher paid worker is less likely to look for another job
3. Worker quality: Higher wages attract a better pool of workers to apply for jobs
4. Worker effort: Higher wages motivate workers to put forward their best effort
33
Define money:
It is the set of assets in an economy that people regularly use to buy goods and services from other people
34
What are the 3 functions of money?
1. Medium of exchange
2. Unit of account
3. Store of value
35
How is money a medium of exchange?
It is an item that buyers give to sellers when they want to purchase goods and services. A medium of exchange is anything that is readily acceptable as payment. It helps society to escape the complications of barter and gain the benefits of specialisation.
36
To be a medium of exchange what 6 things must money be?
1. Acceptable to all
2. limited in supply (scarce)
3. readily portable
4. divisible
5. durable and not perishable
6. stable in value
37
How is money a unit of account?
It acts as a yardstick people use to post prices and record debts. It s used as a measuring rod to measure the relative worth of goods and services without having to measure in terms of other products.
38
How is money a store of value?
A store of value is an item that people can use to transfer purchasing power from the present to the future. Money is a store of value because it helps a person to store his wealth in the form of money.
39
How is money a standard of deferred payment?
Money measures the value of outstanding debt - buy now pay later system
40
What is the most liquid asset?
money
41
What is liquidity?
It is the ease with which an asset can be converted into the economy's medium of exchange (goods and services)
42
What is commodity money?
It is a form of money with intrinsic value - i.e chairs and gold
43
What is fiat money?
It has no intrinsic value - i.e a $100 note is worth no more than the paper it is printed on.
44
Why is fiat money used as money?
Because of government decree
45
What is the nations central bank?
the Reserve Bank of New Zealand RBNZ
46
What are the functions of the RBNZ?
1. Oversee the banking system
2. Regulates the quantity of money in the economy
3. Ensure price stability
4. Implementing the monetary policy objectives set out by the policy target agreement
5. issuing notes and coins and providing banking services to registered banks and the government
6. conducting prudential supervision to maintain a healthy financial system. It requires banks to maintain a minimum capital adequacy ratio (CAR)
47
What is the range of inflation rates that the reserve bank aims for?
1-3%
48
What do commercial/registered banks aim to make?
a profit
49
What are settlement accounts?
These accounts are held by the reserve bank and other financial institutions (e.g BNZ, ANZ) with the reserve bank and are used to settle debts between themselves and the government.
50
Describe the primary expansion of money supply:
This takes place when a new deposit is made at a registered bank by a member of the public.
51
Describe the secondary expansion of money supply:
This takes place when banks starts giving loans to the public against the deposits made. This is called the credit creation process. This is illustrated in the flow chart of the chain of multiple deposit creation. In this process the banking system creates more money than the cash they hold with them.
52
What are the 4 main functions of the reserve bank?
1. Bank to government
2. Bankers bank
3. Implementation of government monetary bank
4. Issue of currency and coins
53
What is the official cash rate?
The interest rate set by the Governor of the RBNZ every 6 weeks. It determines the interest that banks earn on their deposit with the RBNZ as well as the interest that banks pay to borrow overnight cash from RBNZ
54
What is the settlement cash balance?
the deposit that banks keep with the RBNZ as cash reserves for settling their end of day net transaction
55
What is the liquidity ratio?
the ratio of settlement cash to banks assets that can be used as collateral
56
What is monetary policy?
measures taken by the RBNZ to manipulate money supply
57
What are reserves?
deposits that banks have received but have not loaned out.
58
What is a fractional-reserve banking system?
Banks hold a fraction of money deposited as reserves and lend out the rest
59
Why do banks have to keep a proportion of the deposits in the vault?
Because depositors can ask for some of their money back at any time
60
What is the reserve ratio?
the fraction of deposits that banks hold as reserves
61
What happens when there are no banks in an economy and currency is the only form of money?
the supply of money will be equal to the quantity of currency
62
When a bank makes a loan from its reserve, money supply ______ ?
increases
63
What is the money supply affected by?
the amount of money deposited in banks and the amount banks lend
64
deposits into a bank are recorded as both...
assets (reserves $10 and loans $90) and liabilities (deposits $100)
65
What is the money multiplier?
the amount of money the banking system generates with each dollar of reserves
MM = 1 ÷ RR (reserve ratio)
66
What are the 3 tools that the central bank RBNZ has in its toolbox?
1. open market operations
2. changing the reserve requirement
3. changing the discount rate
67
Describe how the reserve bank conducts open market operations:
It does this by buying government bonds (increase money supply) and selling government bonds (decrease money supply)
68
Describe how the reserve bank changes the reserve requirement:
the reserve requirement is the amount (%) of a banks total reserves that may not be loaned out. Increasing the reserve requirement decreases money supply and decreasing the reserve requirement increases money supply
69
Describe how the reserve bank changes the discount rate:
the discount rate is the interest rate that the central bank charges banks for loans. Increasing the discount rate decreases the money supply. Decreasing the discount rate increases the money supply.
70
Over the last 2 decades, many central banks have changed their ways of implementing monetary policy, why?
- for short-run control of reserves
| - to influence short-term interest rates
71
What happens if a bank ends up with a positive net transaction?
It could lend the surplus amount to other banks with a net demand for cash or it could make a deposit at RBNZ.
72
What happens if a bank ends up with a negative net transaction?
the bank would require more cash to settle the deficit
73
Describe how the RBNZ uses the OCR?
1. Trading banks can borrow at a margin of 0.25% above the OCR
2. Trading banks can receive interest rates on their surplus reserves with the RBNZ at a margin 0.25% lower than the OCR.
3. In addition, RBNZ sets no limit on the amount of overnight cash demanded or supplied at the rate of 0.25% above or below the OCR
74
Is it likely or unlikely that a bank would want to offer a short term loan at a rate above the upper bound and why?
unlikely because no one would want to accept this loan since cash is always available at the reserve bank at 0.25% in addition to the OCR.
75
Is it likely or unlikely that a bank would want to lend at a rate below the lower bound and why?
unlikely
76
What is the optimal reserve ratio (ORR)?
The ratio of the SCB to demand deposits (DD) can be compared with the reserve ratio (RR) that the commercial banks are required to hold in a fractional reserve system. The trading banks optimally adjust the ratio of SCB to DD in response to changes in the market interest rate and OCR
77
What happens when the RBNZ raises the OCR?
trading banks with surplus settlement balance earn higher interests. Those with negative settlement balances pay higher
78
What are the negative effects of the RBNZ raising the OCR?
The trading banks increase their reserve ratio, or they decrease the fraction of deposits they put back into the economy as new loans. so they money supply decreases
79
What is SCB?
settlement cash balance
80
an increase in OCR .....
decreases money supply and increases interest rate
81
a decrease in OCR ....
increases money supply and decreases interest rate
82
How does the OCR affect the interest rate?
The money demanded remains unchanged, the reduced money supply due to OCR increases the market interest rate (nominal)
83
What is monetary injection?
When RBNZ puts more money in i.e increases money supply
84
What is the quantity theory of money?
How the price level is determined and why it might change over time.
85
What determines the value of money?
The quantity of money available in the economy
86
What is the primary cause of inflation?
the growth in quantity of money
87
Describe the adjustment process after an injection of money into the economy i.e inflation:
An increase of money supply to an economy in equilibrium means that the quantity of money supplied is larger than the quantity demanded. Individuals no hold more money than they desire. This will increase consumption to compensate. The economy's ability to produce goods and services has not been altered by the increase in money supply. The excess demand for goods and services means prices must rise. People then demand more money as they require more to consume at the new level. Eventually money demand will equal money supply and the economy will be in equilibrium. The price level acts to bring the supply and demand for money into equilibrium.
88
What are nominal variables?
Variables measured in monetary units
89
What are real variables?
variables measured in physical units
90
Out of the 2 types of variables, which are affected by changes in the money supply?
nominal
91
What is classical dichotomy?
the separation of real and nominal variables
92
What is money neutrality?
The irrelevance of monetary changes for real variables
93
What is the velocity of money?
The speed at which the typical dollar coin travels around the economy from wallet to wallet
94
What is the quantity equation?
```
V = (P x Y)IM
V is velocity
P is price level
Y is quantity of output
M is the quantity money
```
MV=PY
95
What does the quantity equation show us?
If you increase money supply then either:
- the velocity of money must decrease (not possible)
- the price level must rise
- the quantity of output must rise (output not affected by money supply because need more land labour etc)
therefore prices rise due to inflation
96
What is the formula for inflation rate?
inflation rate = growth of money supply - growth of real GDP
so inflation results when the money supply grows faster than the real GDP
97
What is hyperinflation and why does it occur?
It is inflation that exceeds 50% per month. It occurs in some countries because the government prints too much money to pay for its spending.
98
Describe an inflation tax:
When the government raises revenue by printing money it is said to levy an inflation tax. An inflation tax is like a tax on everyone who holds money. The inflation ends when the government institutes fiscal reforms such as cuts in government spending.
99
What is the fisher effect?
A one-to-one adjustment of the nominal interest rate to the inflation rate. When the rate of inflation rises, the nominal rate rises by the same amount and real interest rate stays the same.
100
What are the 7 costs of inflation?
1. purchasing power
2. shoe leather costs
3. menu costs
4. relative price variability
5. tax distortions
6. confusion and inconvenience
7. arbitrary redistribution of wealth
101
Describe the cost of inflation: purchasing power
Inflation itself does not reduce peoples real purchasing power but the fallacy is due to a lack of understanding about the neutrality of money.
102
Describe the cost of inflation: shoe leather costs
these are the wasted resources when inflation encourages people to reduce their money holdings. Inflation reduces the real value of money so people have incentive to minimise other cash holdings. Less cash requires more frequent trips to the bank to withdraw money from interest bearing accounts. The actual cost of reducing your money holdings is the time and convenience you must sacrifice to keep less money on hand. Extra trips to the bank take time away from productive activities.
103
Describe the cost of inflation: menu costs
they are the costs of adjusting prices. During inflationary times it is necessary to update price lists and other posted prices. This is a resource-consuming process that takes time away from other productive activities.
104
Describe the cost of inflation: relative price variability and the misallocation of resources
inflation distorts relative prices. Consumer decisions are distorted and markets are less able to allocate resources to their best uses.
105
Describe the cost of inflation: inflation induced tax distortions
Inflation exaggerates the size of capital gains and increases the tax burden on this type of income. With progressive taxation, capital gains are taxed more heavily.
106
What is bracket creep?
When there is inflation, wages are adjusted to the same level, however this means that sometimes you are moved to a higher tax bracket meaning you must pay more tax.
107
Describe the cost of inflation: confusion and inconvenience
When the RBNZ increases money supply and creates inflation, it erodes the real value of the unit of account. Inflation causes dollars at different times to have different real values. therefore with rising prices, it is more difficult to compare real revenues, costs and profits over time.
108
Describe the cost of inflation: arbitrary redistribution of wealth
unexpected inflation redistributes wealth among the population where savers lose and borrowers gain
109
What does specialisation result in?
comparative advantage
110
What is a closed economy?
one that does not interact with other economies in the world. there are no exports, no imports and no capital flows
111
What is an open economy?
one that interact freely with other economies around the world.
112
What are the 2 ways that open economies interact with other countries?
1. it buys and sells goods and services in world product markets
2. it buys and sells assets in world financial markets
113
trade is like....
a type of technology
114
what are imports?
goods and services that are produced overseas and sold domestically
115
what are exports?
goods and services that are produced domestically and sold overseas
116
what are net exports (NX) ?
they are the value of a nations exports - value of imports. They are also called the trade balance
117
what is a trade deficit?
when net exports are negative so imports>exports
118
what is a trade surplus?
when net exports are positive so exports>imports
119
what is a balanced trade?
when net exports are 0 so imports=exports
120
What are the factors that affect net exports?
1. the tastes of consumers for domestic and foreign goods
2. the prices of goods at home and overseas
3. the exchange rates at which people can use domestic currency to buy foreign currency
4. the income of consumers at home and overseas
5. the costs of transporting goods from country to country
6. the polices of the government towards international trade (protection, tariffs etc)
121
What are the reasons for international trade increasing?
1. better and faster transport e.g ships and airplanes
2. improved telecommunications
3. government trade polices are for free trade e.g GATT, WTO NAFTA, EU, CER i.e let the poor countries export for free to richer countries
122
What are the balance of payments?
they measure all international transactions. recorded at time of change of ownership or when service performed.
123
What is in the current account in the balance of payments?
1. merchandise trade (export and import of goods. Net exports, exports increase CA and imports decrease CA)
2. services trade (imports and exports)
3. international investment income
4. current transfers - money taken in/out by immigrants
124
the current account combines an imbalance between what 3 things?
1. a countries exports and imports
2. a countries receipts of income and transfers from abroad
3. its payments of income and transfers overseas i.e its net foreign income
125
describe the capital account:
it is separated into capital and financial accounts and records changes in financial liabilities and assets and sales and purchases of fixed assets
126
In the current account how do receipts affect assets and liabilities?
increase assets, decrease liabilities
127
In the current account how do payments affect assets and liabilities?
they increase liabilities and decrease assets
128
In the capital account, how do surpluses affect assets and liabilities?
They increase liabilities and decrease assets due to the deficit of the current account
129
In the capital account, how do deficits affect assets and liabilities?
They increase assets and decrease liabilities due to the surplus of the current account
130
The current account and capital account must sum to?
0
131
If there is a surplus of the current account, how is this matched by the capital account?
By a deficit
132
If there is a deficit of the current account, how is this matched by the capital account?
By a surplus
133
What does a surplus in the capital account indicate?
That NZ's current account is being financed from the savings of foreigners which is bad because they will take the profit back to their own country, not NZ. It comprises foreign direct investments and foreign portfolio investments.
134
What makes up the visible (trade balance) part of the current account?
merchandise trade balance and services trade balance
135
What makes up the invisible trade balance?
services trade balance, balance on international investment income and balance on current transfers
136
Why is overseas borrowing not sustainable?
as long as other countries have confidence in NZ it is fine
137
What is the international investment income made up of?
dividends and interest from direct and portfolio investments, loans and trade credits. Also direct investors share of retained earnings
138
When would there be outflows to foreign investments in NZ?
They tend to rise/fall when the NZ economy is buoyant/depressed
139
When would there be inflows relating to NZ investment overseas rise/fall?
When overseas economic conditions are buoyant/depressed
140
Describe NZ's biggest problem - persistent large deficit in the current account is a major factor in the large invisible deficit:
reflects NZ's heavy independence over long periods on foreign investment and overseas borrowing to finance current account deficits
141
What are the 2 main causes of the external debt in NZ - the deficit in the current account?
1. rising overseas claims (including external debt) caused by persistent current account deficits
2. ready availability of overseas capital has encouraged national "overspending" i.e living beyond our means
142
What does the capital account measure?
the imbalance between the amount of foreign assets bought by domestic residents and the amount of domestic assets bought by foreigners
143
What causes a financial capital inflow?
when foreigners buy domestic assets
144
What causes a financial capital outflow?
when domestic residents buy foreign assets
145
What are the 3 benefits of foreign direct investments?
1. provides an additional source of capital for economic development
2. access to markets through integration in international production networks - complements liberalisation of trade
3. access to technology
146
How can we limit foreign investment when it gets excessive?
1. Bring national expenditure more in line with national earnings (accept a lower standard of living)
2. increase the proportion of domestic investment financed from domestic saving.
147
What is net capital outflow?
the purchase of foreign assets by domestic residents (total capital outflow) - the purchase of domestic assets by foreigners (total capital inflow).
148
What are the 4 variables that affect net capital outflow?
1. the real interest rates being paid on foreign assets
2. the real interest rate being paid on domestic assets
3. The perceived economic and political risks of holding assets overseas
4. the government polices that affect foreign ownership of domestic assets
149
describe the relationship between savings investments and the NCO in and eqn:
```
S = I + NCO
savings = domestic investments + net capital outflow
```
150
What are exchange rates?
the price at which one currency exchanges for another
151
What is the trade weighted index?
it is an alternative to quoting the price of NZ$ in terms of individual foreign currencies. It measures the value of the NZ$ in terms of weighted average of currencies of major trading partners. The weightings are loosely based on importance in overseas trade transactions. It provides a more balanced measure of value of NZ$ over time.
152
Describe the demand curve for NZ$:
- slopes down to the right
| - demand for NZ$ = supply of foreign currency
153
Describe the supply curve for NZ$:
- slopes up to left
| - supply of NZ$ = demand for foreign currency
154
What are the 2 types of exchange rates?
fixed and floating/free
155
Describe a freely floating exchange rate:
- rate free to settle at equilibrium level
- adjusts continuously to maintain equilibrium as demand and supply changes
- clean float means that no government or central bank intervention
156
Describe the fixed exchange rate:
- rate at pre-announced level
- generally above or below equilibrium
- may be pegged to one currency or to a currency basket
- intervention or policy action needed to hold rate at pre-determined level
157
Fall in price of NZ$ (rise in price of foreign currency)
depreciation
158
Rise in price of NZ$ (fall in price of foreign currency)
appreciation
159
What are the factors affecting equilibrium exchange rates?
1. trade
2. relative rates of interest
3. Terms of trade shock
4. relative inflation rates
5. relative prosperity of our trading partners
160
Describe relative rates of interest:
Demand for NZ$ rises, so supply falls and equilibrium price rises. equilibrium NZ$ price will fall if NZ interest rates fall relative to foreign rates. we can raise interest rates to stop exchange rate falling or lower interest rates to encourage the exchange rate to fall.
161
Describe terms of trade shock:
- sudden rise in import prices - supply of NZ$ rises and equilibrium exchange rate falls
- sudden collapse of export prices - demand for NZ$ falls and equilibrium exchange rate falls
162
What are the 2 most important international prices?
the nominal exchange rate and the real exchange rate
163
What is the nominal exchange rate?
the rate at which a person can trade the currency of one country to the currency of another. it can be expressed in 2 ways:
1. in units of foreign currency per one NZ dollar
2. in NZ dollars per one unit of the foreign currency
164
What is the real exchange rate?
A measure of international competitiveness and of relative purchasing power. Adjusts the nominal exchange rate for any inflation differential between trading partners. The real exchange rate is the rate at which a country trades its goods and services with another country. It compares the prices of domestic goods and foreign goods in the domestic economy.
165
What units is the real exchange rate measured in?
Units of the foreign item per unit of the domestic item
166
What is the real exchange rate equation?
= (nominal exchange rate x domestic price - in domestic currency) ÷ foreign price (in foreign currency)
167
If there is inflation, how does it affect the competitiveness of NZ and the real exchange rate?
NZ competitiveness falls and he real exchange rate rises. It can be fixed with the depreciation of NZ$
168
When does the real exchange rate rise i.e NZ loses competitiveness?
NZ inflation exceeds trading partners inflation and nominal exchange rate rises (NZ$ appreciates)
169
When does the real exchange rate fall i.e NZ gains competitiveness?
NZ inflation is lower than trading partners inflation and nominal exchange rate falls (NZ$ depreciates)
170
What is the key determinant of how much a country imports/exports?
the real exchange rate
171
What is the PPP (purchasing power parity) theory?
a unit of any given currency should be able to buy the same quantity of goods in all countries
172
What is the law of one price?
a good must sell for the same price in all locations
173
What is arbitrage?
the process of taking advantage of differences in prices in different markets. eventually prices that differed in two markets would necessarily converge
174
If the purchasing power is always the same at home and overseas, what would happen to the nominal exchange rates?
the nominal exchange rate can't change and it will be 1
175
What are the limitations of purchasing power parity?
- many goods are not easily traded or shipped from one country to another
- tradable goods are not always perfect substitutes when they are produced in different countries
176
in a large open economy, describe government budget deficits:
- reduce national saving and hence the supply of loanable funds
- drive up interest rate
- crowd out domestic investments
- cause net capital outflow to fall (i.e NZ investment overseas decreases and foreign investment in NZ increases)
177
What is the effect of budget deficits on loanable funds?
decreases the supply i.e shifts to the left which raises interest rate
178
how do government deficits affect net capital outflow?
higher interest rates reduce capital outflow so NZ investors cut back their purchase of foreign capital and foreign investors buy the NZ$ denominated bonds and other assets which yield a higher interest rate
179
How do government deficits affect foreign currency exchange rates?
a decrease in net capital outflow reduces the supply of NZ dollars in the international market. This causes the real exchange rate to appreciate and the CAB (current account) to deteriorate
180
What are the twin deficits?
Higher rate of interest will result in overseas people buying NZ bonds which increases the demand for NZ$ so the NZ$ appreciates. exports are reduced and imports increase so net exports are down which leads to a trade deficit (twin deficits)
181
describe the effect of government deficits on a small open economy e.g NZ:
they reduce national savings however its effect on supply of loanable funds is negligible since reduction of savings is almost always offset by an increased inflow of funds from overseas, hence the interest rate does not change. there is also no crowd out of domestic investments
S (decreases) = I + NCO (decreases)
182
What is a trade policy and what are 3 examples?
Trade policies are government policy hat directly influences the quantity of goods and services that a country imports or exports
1. Tariff - a tax on an imported good
2. Import quota - a limit on the quantity of a good produced overseas and sold domestically
3. Export subsidy - cash payments to exporters per unit of export
183
describe how trade policies affect the NCO or CAB:
they don't because they don't change national savings or domestic investments. For a given level of national savings and domestic investments, the real exchange rate adjusts to keep the trade balance the same. more affects microeconomic rather than macroeconomic - only helps 1 industry
184
What are the effects of promoting trade?
1. no change in interest rate because nothing happens in the loanable funds market
2. no change in NE and the CAB
185
What is capital flight?
a large and sudden reduction in the demand for assets located in a country
186
What is the affect of capital flight?
interest rate increases and domestic currency depreciates
187
What is a recession?
a period of declining real incomes and rising unemployment - insufficient demand
188
What is a depression?
A severe recession
189
Describe the economic fact - most macroeconomic variable fluctuate together
Most macroeconomic variables that measure some type of income or production fluctuates closely together. Although they fluctuate together, they fluctuate by different amounts
190
changes in GDP are ______ related to changes in the unemployment rate
inversely
191
In the eqn involving G, what does G depend on?
it is a fixed policy variable of government fiscal policy whereas the other 3 variables depend on economic conditions i.e the price level
192
describe the economic fact: net exports and output tend to move in the opposite direction
output has a weak negative correlation with changes in net exports. when GDP declines net exports increase. the relationship depends on what caused the GDP change
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What are the 4 key facts about economic fluctuations?
1. Economic fluctuations are irregular and unpredictable
2. Most macroeconomic variables fluctuate together
3. As output falls, unemployment rises
4. Net exports and output tend to move in the opposite direction
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We cannot use the classical theory of economics to describe economics in the short run, therefor what doe we use instead?
the model of aggregate demand and aggregate supply.
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What is the eqn for aggregate demand?
AD = C + I + G + NX
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What are the 2 variables that make up the model of aggregate demand and supply?
1. the economy's output of goods and services measured by the real GDP. The overall price level measured by the CPI or GDP deflator
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What does the aggregate demand curve show?
the quantity of goods and services that households, firms, and the government want to buy at each level
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What does the aggregate supply curve show?
the quantity of goods and services that households, firms, and the government choose to produce and sell at each price level
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Why does the demand curve slope downwards i.e what are the 3 theories?
1. the price level and consumption - the wealth affect
2. the price level and investment - the interest rate effect
3. the price level and net exports - the exchange rat effect
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describe the price level and consumption - the wealth affect
a decrease in the price level makes the consumer feel more wealthy which in turn encourages them to spend more. This increase in consumer spending means that larger quantities of goods and services are demanded (affect C) - the pigou effect
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describe the price level and investment - the interest rate effect
a lower price level decreases the interest rate which encourages greater spending on investment goods. this increase in investment spending means a larger quantity of goods and services demanded (affects I) - the keynes effect
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describe the price level and net exports - the exchange rat effect
when a fall in the NZ price level (less inflation) causes NZ interest rates to fall, the real exchange rate depreciates which stimulates NZ net exports. the increase in NE spending means a larger quantity of goods and services demanded (NX) - the mundell-flemming effect
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What are the 4 things that cause a shift in the AD curve?
changes in:
- consumption
- investment
- government purchases
- net exports
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Describe the shifts of the AD curve arising from consumption:
1. If NZ become more concerned with saving for retirement and reduce current consumption, aggregate demand will decline
2. If the government cuts taxes, it encourages people to spend more resulting in an increase in aggregate demand
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Describe the shifts of the AD curve arising from investment:
1. If firms become pessimistic about future business conditions, they may cut back on investment spending shifting aggregate demand to the left
2. An investment tax credit increases the quantity of investment goods that firms demand which results in an increase in aggregate demand
3. An increase in the supply of money lowers the interest rate in the short run. This leads to more investment spending which causes an increase in aggregate demand
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Describe the shifts of the AD curve arising from government purchases
If the NZ government decides to reduce purchases of construction materials for building new roads, aggregate demand will fall
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Describe the shifts of the AD curve arising from net exports
1. When east Asia experiences a recession, it buys fewer goods and services from NZ which lowers net exports. Aggregate demand will shift to the left
2. If the value of the NZ dollar increases, NZ goods will become more expensive to foreigners. Net exports fall and aggregate demand shifts to the left
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In the long run, the aggregate supply curve is _____
| in the short run, the aggregate supply curve is ______
vertical
| upward sloping
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Why is the long run supply curve vertical?
In the long run, an economy's production of and services depends on its supplies of labour, capital and natural resources and on the available technology used to turn these factors of production into goods and services. The price level does not affect variables in the long run
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In the vertical supply curve, the level of production is often called?
the natural rate of output or potential output (Yp) or full-employment output (Yfe) - when the economy is working at full capacity
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Is the vertical aggregate supply curve an application of the classical theory of economics?
Yes, it is an application of the classical dichotomy and monetary neutrality
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describe the effect of price level on aggregate supply of one product - i.e ice cream (microeconomics)
The upward sloping curve as more resources can be diverted to increase supply, but overall production in economy cannot increase when all prices increase
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What are the 5 variables that cause shifts in the aggregate supply curve?
1. labour
2. capital
3. natural resources
4. technological knowledge
5. government polices
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Describe the shifts of the AS curve arising from labour:
Increases in skilled worker immigrants increases the number of workers available. The ling-run aggregate supply curve would shift to the right.
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Describe the shifts of the AS curve arising from capital:
An increase in the economy's capital stock raises productivity and thus shifts the long run AS curve to the right. this is true for both human and physical capital
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If the natural rate of unemployment goes down, how does this affect the LRAS curve?
It will shift to the right
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If minimum wage is raised, how does this affect the LRAS curve
it will shift to the left because unemployment levels have risen
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Describe the shifts of the AS curve arising from changes in natural resources
- a discovery of a new mineral deposit increases LRAS
- a change in weather patterns that makes farming more difficult shifts the LRAS curve to the left
- a change in the availability of imported resources can also affect long-run aggregate supply
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Describe the shifts of the AS curve arising from technological knowledge:
- the invention of the computer has allowed the production of goods and services from any given level of resource. it shifted the AS curve to the right
- opening up international trade has also shifts the curve to the right
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Describe the shifts of the AS curve arising from government polices
- economic reforms introduced in NZ in the 1980's and the 1990's reduced the cost of resource allocation and that led to an economy wide gain in efficiency which in turn lead to an increase in productivity and an increase in real wages followed by unprecedented growth in innovative activities by self-employed people
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What are the 3 theories as to why the short term AS curve slopes upwards?
1. the sticky wage theory
2. the sticky price theory
3. the misperceptions theory
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Describe why the short term AS curve slopes upwards: the sticky wage theory
nominal wages at slow to adjust. wages do not adjust immediately to a fall in the price level. A lower price level makes employment and production less profitable. This induces firms to reduce the quantity of goods and services supplied. wages are fixed on long term contracts and when prices fall, wages are stuck, the costs of firms go up and firms will hire less labour and supply less goods and services
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Describe why the short term AS curve slopes upwards: the sticky price theory
prices of some goods and services adjust slowly in response to changing economic conditions due to menu costs. An unexpected fall in the price level leaves some firms with higher than desired prices. This depresses sales which induces firms to reduce the quantity of goods and services they produce
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Describe why the short term AS curve slopes upwards: misperception theory
changes in the overall price level temporarily mislead suppliers about what is happening in the markets in which they sell their output. A lower price level causes misperceptions about relative prices which induce suppliers to decrease the quantity of goods and services supplied
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What are the 5 variables that cause a shift in the short term AS curve?
1. labour
2. capital
3. natural resources
4. technology
5. expected price level
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Why might the short term AS curve shift in response to changes in the expected price levels?
1. an increase in expected price level reduces the quantity of goods and services supplied and shifts the short term aggregate supply curve to the left
2. A decrease in the expected price level raises the quantity of goods and services supplied and shift the short run aggregate supply curve to the right
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in the short run, shifts in the aggregate demand cause?
fluctuations in the economy's output of goods and services
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in the long run, shifts in the aggregate demand cause?
affect the overall price level but not the output
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What are the 3 causes of the supply curve shifting to the left - not impacting on demand?
1. output falls below the natural rate of employment
2. unemployment rises
3. the price level rises
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What is the result of an adverse shift in aggregate supply?
It causes stagflation - a period of recession and inflation. Output falls and prices rise. Policy makers who can influence aggregate demand cannot offset both these adverse effects simultaneously
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How can we fix the effects of an adverse shift in aggregate supply i.e stagflation?
Policy makers can respond to these changes i one of 2 ways
1. do nothing and wait for prices and wages to adjust
2. take action to increase aggregate demand by using monetary and fiscal policy
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Describe the money supply curve:
It is a variable of the central bank and does not depend on other variables or the ROI. The fixed money supply in the USA is represented by a vertical supply curve
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For the NZ economy, what are the 2 most important reasons for the downward slope of the aggregate demand curve?
interest rate effect and the exchange rate effect
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Describe the theory of liquid preference:
It is theory by Keynes that explains what factors determine the economy's interest rate. According to the theory, interest rate adjusts to balance the supply and demand for money
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What are the 3 ways that the money supply is controlled by the central bank?
- open-market operations (buying and selling bonds)
- changing the reserve requirements
- changing the OCR
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What are the 2 things that determine money demand?
1. According to the theory of liquidity preference one of the most important factors is the interest rate.
2. people choose to hold money instead of other assets that offer higher rates of return because money can be used to buy goods and services
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What is the opportunity cost of holding money?
It is the interest that could be earned on interest earning assets. An increase in the interest rate raises the opportunity cost of holding money. As a result, the quantity of money demanded is reduced
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How can the central bank shift the demand curve by changing monetary policy?
An increase in money supply shifts the money supply curve to the right
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What happens when the central bank increases the money supply?
It lower the interest rate and increases the quantity of goods and services demanded at any given price level, shifting the aggregate demand curve to the right
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What happens when the central bank contracts the money supply?
It raises the interest rate and reduces the quantity of goods and services demanded at any given price level, shifting the aggregate demand curve to the right
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What is fiscal policy?
The governments choices regarding the overall level of government purchases or taxes (G + T)
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What does fiscal policy affect in the short run?
Aggregate demand
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What does fiscal policy affect in the long run?
Saving, investments and growth
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How do monetary policy and fiscal policy differ on the way they affect the aggregate demand curve?
Monetary policy (money supply) and fiscal policy (taxes) is indirect because it affects the aggregate demand curve through the decisions of firms or households (C + I). When the government alters its own purchases of goods and services it shifts the aggregate demand curve directly
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What are the 2 macroeconomic effects from the change in government purchases?
1. The multiplier effect
| 2. The crowding out effect
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Describe the multiplier effect:
Each dollar spent by the government can raise the aggregate demand for goods and services by more than one dollar. Expansionary fiscal policy increases income and therefore consumer spending.
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What is the eqn for the multiplier effect?
Multiplier = 1/(1 - MPC)
MPC = marginal propensity to consume which is the fraction of extra income that a household consumes rather than saves
MPS = marginal propensity to save
MPC + MPC = 1
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What is the crowding out effect?
Fiscal policy may not affect the market as strongly as the multiplier. An increase in government purchases causes the interest rate to rise. A higher interest rate causes reduction in investment spending. The reduction in demand that occurs when a fiscal expansion raises the interest rate is called crowding out. It dampens the effects of fiscal policy on aggregate demand
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How does the crowding out effect affect the AD curve?
When the government increases its purchases by 20 million, the aggregate demand for goods and services could rise by more or less than 20 million depending on the relative strength of the multiplier effect and crowding out effect
250
Describe what happens to the aggregate demand curve when the government cuts personal income taxes:
It increases the households take home pay. Households save some of this additional income and also spend some of it on consumer goods. It shifts to the right
251
What determines the size of the shift in aggregate demand resulting from a tax change?
The multiplier and crowding out effect and also the households perceptions about the permanency of the tax change
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What are the 2 implications of the employment act?
1. The government should avoid being the cause of economic fluctuations
2. The government should respond to changes in the private economy in order to stabilise aggregate demand
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What are the implications of the RBA and FRA?
1. Monetary policies would keep AD = LRAS
| 2. Fiscal policies would not be used to manage AD
254
What are automatic stabilisers?
They are changes in fiscal policy that stimulate aggregate demand when economy goes into a recession without policymakers having to take any deliberate actions. It includes the tax system and some forms of government spending
