exam review topics Flashcards
how does an increase in the money supply affect the ad/as model?
it first increases consumer spending causing the aggregate demand curve to shift up/right (in the short run). in the long run, the aggregate output (suppy) is only affected by the capital–labor and technology. the supply side adjusts to the price level and the economy return to the same output as before
the long-run output (real variable) is not affected by changes in nominal variables (money supply), but the price level (nominal variable) is affected
difference between real and nominal variables
real goods, nominal money
real variables give prices in terms of goods and not money, and reflects the actual purchasing power of money adjusted for inflation
nominal variables are expressed in monetary terms, without adjusting for inflation, representing its face value
what does it mean when net exports are positive?
because NX = NCO, net capital outflow is also positive, so foreign assets bought by Americans are greater than American assets bought by foreigners
NCO = domestic residents’ purchases of foreign assets minus foreigners’ purchases of domestic assets
why is it better when NCO is positive?
positive NCO means domestic residents are not putting all their eggs in one basket, which offers stability and less dependence on one economy
who controls the money supply?
the federal reserve (central bank) controls the money supply by buying and selling government bonds
what do the axes represent on an ad/as graph?
Y - axis = price level
X - axis = real output
what are the axes in a money demand (MD) and money supply (MS) model?
Y-axis = real interest rates
X-axis = quantity of money
what are the effects of an increase in price level?
an increase in price level increases the money demand, which increases the interest rate, then decreases investment and the demand of g&s, so real output decreases
what does a move along the money demand curve indicate?
the price level is helf fixed; the graph displays the relationship between the real interest rate and the quantity of money, all else equal, including price level. the interest rate is represented on the y-axis so a change in interest rate (an axis variable) is a movement along the curve, not a shift.
what does the classical dichotomy suggest about changes in the money supply?
the money supply (nominal variable) affects only nominal variable, not real variables such as output, employmetn and the long-run real interest rate
what happened to the U.S. real interest rate when Mexico suffered from capital flight in 1994?
using the loanable funds, NCO, exchange rate diagram (LNE)
Mexico’s capital flight > more U.S. investors sold their Mexican assets and Mexican investors bought U.S. assets > NCO decreases > demand for loanable funds decreases and demand curve shifts left > interest rate falls
NCO decreases also > reduces amount of U.S. dollars in the foreign exchange market > supply curve in the foreign exchange market shifts left > real exchange rate increases
according to the theory of liquidity preference, the money supply..
the money supply is independent of the interest rate as it is set by the central bank, while money demand is negatively related to the interest rate (Law of Demand - money demand decreases as the price of money increases)
how can you find the money multiplier given the reserve ratio? if the ratio is 4%?
money multiplier is the inverse of the reserve ratio; if the reserve ratio is 4%, the multiplier is 25 (because the inverse of 4/100 is 100/4 = 25)
what policies could offset a change in ouput caused by an increase in exports?
when exports increase,aggregate demand increases. to offset this, policies such as decreasing the money supply and increasing tax hikes will decrease aggregate demand
less money in circulation and more taxes causes consumers to spend less
are reserves of financial institutions assets or liabilities?
assets that financial institution’s try to keep at the legal limit; they do not earn a return so banks do not want to hold them. because reserves are safer than other assets, banks are legally required to hold a minimum amount relative to their liabilities, the minimum reserve ratio. thus, banks try to keep their holdings of reserves at this minimum.