Exam 2 part 2

Question 1

nominal vs. real

with examples.

Answer 1

The first variable is the economy’s output of goods and services, as measured by real GDP.
The second is the average level of prices, as measured by the CPI or the GDP deflator. Notice that output is a real variable, whereas the price level is a nominal variable.
The nominal value of this money is fixed: One dollar is always worth one dollar.
Yet the real value of a dollar is not fixed. If a candy bar costs one dollar, then a dollar is worth one candy bar. If the price of a candy bar falls to , then one dollar is worth two candy bars.

Question 2

Define aggregate demand and aggregate supply. Also model with Price =Price Level (CPI) on y-axis, Quantity= (Y)GDP - all goods and services on x-axis.

Answer 2

model of aggregate demand and aggregate supply: the model that most economists use to explain short-run fluctuations in economic activity around its long-run trend.

The aggregate-demand curve shows the quantity of goods and services that households, firms, the government, and customers abroad want to buy at each price level.
The aggregate-supply curve shows the quantity of goods and services that firms produce and sell at each price level.
According to this model, the price level and the quantity of output adjust to bring aggregate demand and aggregate supply into balance.

Question 3

Explain what is meant by a business cycle. (Recession versus expansion).

Answer 3

Fluctuations in the economy are often called the business cycle. they are irregular and not predictable.
These are economic fluctuations correspond to changes in business conditions.
Expansion is when real GDP grows rapidly, business is good. During such periods of economic expansion, most firms find that customers are plentiful and that profits are growing.
When real GDP falls during recessions, businesses have trouble. During such periods of economic contraction, most firms experience declining sales and dwindling profits. recessions don’t come at regular intervals.

Question 4

Give three reasons why the aggregate demand curve slopes downward.

Answer 4

The fall in the price level leads to an increase in the quantity of goods and services demanded. This is what the downward slope of the aggregate-demand curve represents.
- Consumers are wealthier, which stimulates the demand for consumption goods.
(lower price level higher the real value of money = wealthy consumers = spend more = more quantity of goods and services demanded.).
Interest rates fall, which stimulates the demand for investment goods.
(lower price level = lower the interest rate = more spending on investment goods =more the quantity of goods and services demanded)
The currency depreciates, which stimulates the demand for net exports.
(U.S. price level falls = U.S. interest rates to fall = the real value of the dollar falls in foreign exchange markets = higher exports = increases the quantity of goods and services demanded).
Changes in investment, consumption, government expenditures, and exports all shift the demand curve.

Question 5

Explain the shape of the long-run aggregate supply curve. (ideas of natural rate of output (full employment)

Answer 5

Because the price level does not affect the long-run determinants of real GDP, the long-run aggregate-supply curve is vertical
In other words, in the long run, the economy’s labor, capital, natural resources, and technology determine the total quantity of goods and services supplied, and this quantity supplied is the same regardless of what the price level happens to be.
The natural level of output of the production of goods and services that an economy achieves in the long run when unemployment is at its normal rate.

Question 6

What shifts the long run aggregate supply curve?

Answer 6

If more people migrate to the country, then the line would shift to the right. An increase in the economy’s capital stock increases productivity shifting the line to the right. Similarly, it would happen with natural resources and technological advances. (Shifts arising from changes in labor, in capital, in natural resources, and in technological advances).

Question 7

Why is the short run supply curve upward and what shits it?

Answer 7

The short-run supply curve is upward because price levels do affect the economy. It causes this because of the sticky wage theory (nominal wages are slow to adjust to changing economic conditions meaning if prices go up they enjoy for the short run or vice versa), the sticky price theory (the prices of some goods and services also adjust sluggishly in response to changing economic conditions – menu costs), and the misperceptions theory (changes in the overall price level can temporarily mislead suppliers because other prices haven’t risen or fallen).

Question 8

Describe the functions of Money and the difference between commodity money and fiat.

Answer 8

Money has three functions in the economy: It is a medium of exchange (writing a check), a unit of account (determining the price of civic to the price of accord), and a store of value (savings in your checking account).

• commodity = intrinsic value =having value even if it were not used as money like gold.
• Fiat =Money without intrinsic value = money is established as money by government decree.(compare monopoly money to us. dollar)

Question 9

The ideas of the coincidence of wants/ barter.

Answer 9

barter—the exchange of one good or service for another—to obtain the things they need. Immediately
In such an economy, trade is said to require the double coincidence of wants—the unlikely occurrence that two people each have a good or service that the other wants.

Question 10

Compute a bank’s required and excess reserves when you are given its balance sheet figures.

Answer 10

Reserve requirements, the regulations that set the minimum amount of reserves that banks must hold against their deposits.
Reserves = demand deposits – loans = required reserves + excess reserves
Required reserves = demand deposits * required reserve ratio.
Because the required reserve ratio is 20%, First Main Street Bank is required to hold 20% of its fresh reserves (that is, the initial deposit). Since 20% of $1,500,000 is $300,000, this means that First Main Street Bank’s required reserve has increased by $300,000.
The remaining 80% of the fresh reserves, or $1,200,000, is excess reserve and can be used to make loans.

Question 11

Fractional reserve banking system….Explain why a commercial bank is required to maintain a reserve and why it isn’t sufficient to cover deposits.

Answer 11

Fractional-reserve banking: a banking system in which banks hold only a fraction of deposits as reserves.

Question 12

Compute the size of the monetary multiplier and the money creating potential of the banking system when provided with appropriate data.

Answer 12

The money multiplier is the reciprocal of the reserve ratio. Under the assumption that banks do not hold excess reserves, the reserve ratio will be equal to the reserve requirement set by the Federal Reserve. For a reserve requirement of 15%, the reserve ratio is 1/6.67, and the multiplier is, therefore, 6.67. When the multiplier is 6.67, a banking system with $100 in reserves can support in demand deposits.If the reserve requirement falls from 15% to 10%, the reserve ratio falls from 1/6.67 to 1/10, and the multiplier rises from 6.67 to 10. At the lower reserve requirement, the banking system’s $100 in reserves supports in demand deposits.

Question 13

Explain the make up of the FED Reserve

Answer 13

The FOMC is made up of the seven members of the board of governors and five of the twelve regional bank presidents. All twelve regional presidents attend each FOMC meeting, but only five get to vote. The five with voting rights rotate among the twelve regional presidents over time.
Through the decisions of the FOMC, the Fed has the power to increase or decrease the number of dollars in the economy.
The Fed’s primary tool is the open-market operation—the purchase and sale of U.S. government bonds. (to increase money supply they sell bonds and vice versa to decrease the supply).
Fed also lends to the banks by charging them the discount rate.

Question 14

what are demand deposits?

Answer 14

balances in bank accounts that depositors can access on demand simply by writing a check or swiping a debit card at a store.

Question 15

what is the Fed and what is it composed of?

Answer 15

Whenever an economy uses a system of fiat money, as the U.S. economy does, some agency must be responsible for regulating the system. In the United States, that agency is the Federal Reserve (Fed).
The Fed is run by its board of governors, which has seven members appointed by the president and confirmed by the Senate. The governors have 14-year terms.
The Fed has two related jobs. to regulate banks done by the regional Federal Reserve Banks and second is the money supply

Question 16

Explain money supply and monetary policy and reserves.

Answer 16

-money supply = the quantity of money that is made available in the economy
-Decisions by policymakers concerning the money supply constitute monetary policy.
-Deposits that banks have received but have not loaned out are called reserves.
Reserves, securities, and loans are assets and deposits, debt, and capital are liabilities.

Question 17

What is the reserve ratio, money multiplier and the leverage ratio?

Answer 17

The fraction of total deposits that a bank holds as reserves is called the reserve ratio.
The Fed sets a minimum amount of reserves that banks must hold, called a reserve requirement.
The amount of money the banking system generates with each dollar of reserves is called the money multiplier. The money multiplier is the reciprocal of the reserve ratio. If R is the reserve ratio for all banks in the economy, then each dollar of reserves generates 1/R dollars of money. In our example, R=1/10 , so the money multiplier is 10. Thus, the higher the reserve ratio, the less of each deposit banks loan out, and the smaller the money multiplier. In the special case of -100 percent reserve banking, the reserve ratio is 1, the money multiplier is 1, and banks do not make loans or create money.
Leverage ratio = total assets/bank’s capital.

Question 18

Define financial intermediaries.

Answer 18

Financial intermediaries are financial institutions through which savers can indirectly provide funds to borrowers. The term intermediary reflects the role of these institutions in standing between savers and borrowers. Here we consider two of the most important financial intermediaries: banks and mutual funds.

Question 19

The identity where the turn the Closed Economy GDP into I=S. Private Saving and Public Savings = national savings which is equal to investment.

Answer 19

•	closed economy an economy that does not interact with other economies in the world
y=C+I+G
national saving (saving)the total income in the economy that remains after paying for consumption and government purchases
S=I
 Private saving is the amount of income that households have left after paying their taxes and paying for their consumption =Y-T-C
 Public saving is the amount of tax revenue that the government has left after paying for its spending =T-G. if it is positive then there is a surplus and negative means there is a deficit.