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Macroeconomics > Final Macro Test > Flashcards

Final Macro Test Flashcards

1
Q

If banks choose to increase their R/D, the DM and MM will…

A

fall because banks are lending less, so borrowing, spending and depositing have decreased.

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2
Q

If banks choose to decrease their R/D, the DM and MM will…

A

rise because banks are lending more, so borrowing, spending and depositing increase.

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3
Q

If depositors choose to increase their C/D, the MM will…

A

fall because people aren’t depositing money in the bank as they are holding more cash.

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4
Q

If depositors choose to decrease their C/D, the MM will…

A

rise because people hold less cash, and are depositing more.

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5
Q

What functions must any item fulfill in order to be used as money?

A
  1. medium of exchange: acceptable as payment
  2. unit of account: agreed measure for stating prices
  3. store of value: must be able to hold it and use it later
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6
Q

What is a commodity money system?

A

when any object is attributed a value and is being used as money… most often used coins of gold, silver, and copper.

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7
Q

What are some problems associated with the commodity money system?

A

clipping: shaving off the edges of the coin and using the scrapings to make newer and thinner coins.
debasement: when a monarch recalls existing coins, takes them out of circulation, and replaces them with newer smaller coins. this often triggers inflations.
opportunity cost: loss of personal security from carrying actual gold or silver with you.

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8
Q

What is the convertible paper money system? Its problems?

A

It is paper money that is fully/partly represented by either gold or silver.
problem: cost of storage and protection from theft.

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9
Q

What is the fiat money system?

A

it is a naturally worthless comidity that serves the purpose of money. it would be considered money because the government declares it as “legal tender”.

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10
Q

What does the money supply consist of?

A

Ms = Currency + Deposits
- Currency: notes and coins NOT in banks (are in circulation)
- Deposits (aka demand deposits): checking and savings accounts

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11
Q

What are the measures the Bank of Canada uses to keep track of the money supply?

A

M1: currency + checking accounts
M2: M1 + savings accounts

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12
Q

Are cheques, debit cards and credit cards considered money?

A

NO. they transfer money from one mean to another.

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13
Q

What are financial intermediaries?

A

they are businesses that have a federal licence to take in deposits and extend loans. this includes chartered banks (commercial banks), caisse populaires, and trust companies.

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14
Q

What are the assets and the liabilities of chartered banks?

A

assets: reserves and loans
liabilities: deposits

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15
Q

what is the R/D ratio?

A

Reserve/Deposit Ratio. it’s the proportion of deposits that banks wish to keep on reserve to cover withdrawals. so if R/D = 0.2, then for each 1$, the bank keep 0.20$.

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16
Q

What is the C/D ratio?

A

Currency/Deposit Ratio. it’s the proportion of cash available for deposit that people instead keep on them in the form of cash. so if C/D = 0.2, then for each 1$, the person will keep 0.20$ in cash form.

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17
Q

Where do banks keep a portion of the money deposited?

A

In reserves, in ATM machines, the vault or on deposit at the Bank of Canada.

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18
Q

What is the formula for deposit multiplier (DM)?

A

DM = 1/(R/D)

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19
Q

What is the formula for money multiplier (MM)?

A

MM = (1 + C/D) / (R/D + C/D)

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20
Q

If there is a large purchase of bonds, would bond prices rise or fall? Would interest rates on bonds rise or fall?

A

prices would rise, interest rates would fall

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21
Q

If there is a large volume of sales of bonds, would bond prices rise or fall? Would interest rates on bonds rise or fall?

A

prices would fall, interest rates would rise

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22
Q

What can the bank do instead of borrowing from a bank when they are in debt?

A

They can sell bonds or treasury bills (T bills).

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23
Q

What is a bond?

A

it is a promise to pay back they money borrowed (called the face value) with interest over a period LONGER than 1 year. The interest paid is FIXED and is paid every year or every 6 months.

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24
Q

What is the yield and how to calculate it?

A

The yield is the amount you will receive when the bond reaches maturity.
yield (r) = coupon (fixed amount) / bond price x 100

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25
Q

Let’s suppose you bought a bond at a 10% interest rate. Then it goes up to 12.5% while you’re in the life of the bond. Is it a good idea to sell the bond?

A

No, because it only yields 10%, so your bond would be unattractive. You would have to sell for less than you paid for it.

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26
Q

Let’s suppose you bought a bond at 10% interest rate, and before its 4-year maturity date, the interest goes down to 8%. Is it a good idea to sell the bond?

A

Yes, because the bond would be attractive since it pays higher than everything else on the market. You would sell for more than you paid for it.

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27
Q

What are Treasury Bills (T-Bills)?

A

They are SHORT-TERM debt instruments issued by the government. They would have the same face value, but no coupons since they mature in 1 year or less.

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28
Q

What is the objective of the Bank of Canada (B of C)?

A

to keep inflation between 1% and 3%. its more about controlling inflation than unemployment.

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29
Q

What are the functions of the Bank of Canada?

A
  1. Manage monetary policy of Canada: decide on expansionary or contractionary policy
  2. Control Canada’s money supply: if Ms increases too rapidly, interest rates fall and inflation can occur. If Ms increases too slowly. interest rates can rise and recession can occur.
  3. Bank of the chartered banks
  4. Support the financial system: to reduce uncertainty about the direction of interest rates by making only gradual changes to interest rates, making regular policy statements and keeping inflation low
  5. Fiscal agent and financial advisor to the government
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30
Q

What does the Bank of Canada do to increase money supply?

A

they will lower interest rates to increase money supply, which will also grow investment. this is expansionary monetary policy (AD shifts right)

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31
Q

What does the Bank of Canada do to decrease the money supply?

A

they will increase interest rate to decrease money supply, which will also make investment fall. this is contractionary monetary policy (AD shifts left)

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32
Q

What is OMO?

A

open market operation. requires buying or selling of bonds and t-bills by the Bank of Canada

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33
Q

What is the Bank Rate? Who is the lender and the borrower? Why would banks borrow from the B of C?

A

The bank rate is the interest rate charged by the bank of canada for loans and reserves to chartered banks.
the lender is the bank of canada and the borrower is the chartered bank.
to not have to borrow from other banks at higher interest rates than the bank rate.

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34
Q

What is the target overnight rate? When does the B of C refer to it and why?

A

The target overnight rate is the mid-point between the bank rate and the bankers deposit rate.
to reduce uncertainty, the B of c announces its interest rate policy intentions in 8 policy statements per year by referring to the target overnight rate.

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35
Q

If the B of C lowers the Bank Rate, will AD shift to the right or left?
If the B of C increases the Bank rate, will AD shift to the right of left?

A

if bank rate increases, it means its more expensive for banks to borrow reserves if they run short. chartered banks will eventually hold more reserves, extend fewer loans, and raise interest rates. this is contractionary monetary policy, so AD will shift left.
the reverse would happen if the bank rate is lowered.

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36
Q

What is the Prime Rate?

A

the prime rate is the interest rate charged by the chartered banks on loans to their best corporate customers.

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37
Q

What are redeposits, and do they make the Ms rise or fall? Will interest rates rise or fall? Do redeposits make AD shift to the right or left?

A

redeposits are when the BofC shifts the government deposits from the BofC to chartered banks. banks deposits and cash reserves rise, interest rates on loans will fall, lending will increase and the money supply grows. AD shifts right (expansionary)

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38
Q

What are drawdowns, and do they make the money supply rise or fall? Will interest rates rise or fall? Do redeposits make AD shift to the right or left?

A

drawdowns are when the BofC shifts government deposits from the chartered banks to BofC. bank deposits and cash reserves fall, interest rates on loans rise, lending decreases and the Ms falls. AD shifts left (contractionary)

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39
Q

What are the three ways the government can use to finance the deficits?

A
  1. Money financing
  2. Internal debt financing
  3. External debt financing
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40
Q

Discuss the “money financing” technique.

A
  • The government borrows from the Bank of Canada
  • This is expansionary for Y
  • No effects on interest rates
  • Compound interest payments a concern for the government? NO gov owns BofC
  • Problems: very strong risk of hyperinflation if the amount borrowed from the BofC is large
  • Advantage: necessary for open market operations
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41
Q

Discuss the “internal debt financing” technique.

A
  • The government borrows from the bondholders IN Canada
  • No effects on Y since investment falls but G rises
  • interest rates rise
  • Compound interest payments a concern for the government? YES
  • Problems: Crowding out and uneven redistribution of income
  • Advantage: investors like government bonds are considered secure
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42
Q

What are the problems related to internal debt financing?

A

-Crowding out G rises but at the expense of investment falling
-uneven redistribution of income

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43
Q

What is crowding out?

A

when government debt causes government spending to increase as a % of GDP while investment falls as a % of GDP

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44
Q

What do we mean by “redistribution of income” in the context of the budget deficit?

A

when middle to upper-class investors are benefiting from investments generated by government debt, but those in the lower income levels pay a disproportionate amount of income in taxes

45
Q

Under which financing technique(s) do we experience high domestic interest rates?

A

Internal debt financing

46
Q

Should external debt financing be discouraged?

A

Yes, because it is contractionary for the economy. it can cause possible currency depreciation and balance of payments problems

47
Q

What are the four things that must be done for the budget deficit and debt to be reduced or eliminated?

A
  1. real GDP must increase
  2. Interest rates (r) must be held as low as possible to contain the growth of interest payments on the debt
  3. a primary surplus must exist and must grow each year, preferably by reducing excess government spending
  4. surpluses have to be used to pay down the debt
48
Q

What is the difference between deficit and debt?

A

Deficit: difference between tax revenue and government spending for a single year.
Debt: total accumulated unpaid deficit including interest.

49
Q

What are automatic stabilizers? How do they work during recessions and recoveries?

A

automatic stabilizers are fiscal policy tools that work to increase the stability of the business cycle without the need for government action.
Recessions: income falls, so the amount of income tax collected falls and the amount of transfer payments paid out rises. Recession is not at deep as it would be without the existence of stabilizers.
Recovery: income rises, so the amount of income tax collected increases and the amount of transfer payments paid out decreases. Recovery is not as fast as it would otherwise be.

50
Q

How do recoveries and recessions affect the budget deficit?

A

Recovery: income rises so amount of income tax collected increases, meanwhile transfer system payouts decrease. so, recoveries tend to improve government budgets.
Recession: income falls so amount of income tax collected decrease meanwhile transfer system payouts increase. so, recessions tend to worsen government budgets.

51
Q

What are the factors of production?

A

Labour: number and skills of workers
Land: natural attributes, resources, fisheries, weather
Capital: technology, machinery, buildings, equipment

52
Q

What is the tradition economic system?

A

economic decisions made by custom, tradition, and habit
pro: social stability – everyone knows their role
con: resistant to change

53
Q

What is the command economic system?

A

economic decisions made by central authority
pro: effective for creating change at will of leadership
con: more industrialized country becomes, more difficult for government to make sound economic decisions

54
Q

What is the market economic system?

A

economic decisions made by individual firms and consumers – works because of property rights
pro: better for complex industrialized societies
con: business cycle problems (inflation, unemployment, deficits…)

55
Q

What do people use as a signal for every-day economic decisions? And for long-term?

A

short-term: observe price changes
long-term: understanding of how market and macro economy works

56
Q

What are the goals of firms and households? Do they make economic choices by cooperating with each other?

A

firms’ goal: maximise profit by keeping costs low
households’ goal: maximise leisure and income
make choices by COMPETING with each other.

57
Q

What is a forecast?

A

a forecast is a detailed probability estimate of future events to assess risk based on currently known facts.

58
Q

Is variation in forecast good?

A

yes, because when economists have different views on normative matters, it provides a more detailed assessment of risk factors

59
Q

What are the 3 factors to be considered unemployed?

A
  1. 15 + years old
  2. actively seeking work
  3. available for work
60
Q

What is the unemployment equation?

A

UR = U / LF x 100

61
Q

What the natural rate equation?

A

NR = Fr + St / LF x 100
OR
NR = U - Cy / LF x 100

62
Q

What are the 3 main measurement problems for the unemployment data?

A
  1. unrealistic wage expectations causes the UR to overstate the problem
  2. discouraged workers causes the UR to understate the problem
  3. involuntary part-time workers causes the UR to understate the problem
63
Q

What are the types of unemployment?

A

Frictional (Fr): lost job due to normal business conditions (fired, bankruptcy)
Structural (St): lost job due to permanent declines in available jobs in chosen field of work
Cyclical: lost job temporarily due to recession

64
Q

What is the natural rate of unemployment?

A

it tells us what the UR would be if there was no cyclical unemployment. when an economy is operating at full employment, it is because there is no cyclical unemployment

65
Q

What is the loss of potential output (Yfe) ? Okun’s law? How to calculate it?

A

Okun’s Law: for every 1% drop in the UR, Real GDP increases by 3%
To calculate:
1. UR-NR = x%
2. (x% * 3)/100 = z
3. Y (1+z) = Yfe

66
Q

When does inflation and deflation occur in terms of price index?

A

inflation is occurring when the price index increases
deflation is occurring when the price index decreases

67
Q

What is the CPI?

A

Consumer Price Index: change in the general level of prices (prices) of goods and services that consumers buy

68
Q

What are the degrees of severity of inflation?

A

Creeping inflation: below 10%/year
Double-digit inflation: over 10%/year
Galloping inflation: between 20 and 60%/year
Hyperinflation: 50%+/month OR 600%+/year
Deflation: inflation rate is negative

69
Q

What are the 3 causes of inflation?

A
  1. excess demand: interest rates rise, spending accelerates, business investment tends to fall
  2. supply shock inflation: prices of key items increase due to shortages… spending slows down, production will decrease which will result in recession
  3. Hyperinflation: government take from central bank, causing big government debt
70
Q

What is the macro effect of excess demand inflation?

A

decrease in savings, which increases interest rates, which will decrease investment

71
Q

What are the micro effects of excess demand inflation?

A

WINNERS:
1. owners of real assets: buy a house in year 1 for 100,000$ … 20% inflation - house rises to 120,000$
2. Debtors (borrowers): if interest rate on loan is fixed, inflation cannot affect interest you pay
3. Producers: firms have time to absorb higher prices of inputs so they can set prices for their products high enough to cover the increased costs

LOSERS:
1. owners of financial assets: interest of savings is 10% but prices rise by 20%. savings buys fewer goods than before inflation
2. Creditors (lenders): if interest rate on loan is fixed, loaner is not making enough money to cover increase in prices from inflation
3. fixed income recipients: people with fixed income probably wont be able to cover increased prices

72
Q

What is the GDP?

A

Gross Domestic Product: dollar value of the FINAL goods and services produced within the geographic borders of a country

73
Q

What does GDP NOT include?

A

value of previously produced goods
purely financial transactions (savings, purchase of stocks and bonds, transfer payments, …)
non-recorded transactions (things with no paper trail like criminal activity)

74
Q

Why does GDP tend to trend upwards overtime?

A

population growth
spread of technology
advancement in quality of technology

75
Q

What are the 4 parts of a business cycle?

A

Recession, Trough (low point), Recovery, and Peak

76
Q

What is a recession? What is a recovery?

A

Recession: negative % change in Real GDP compared to the previous year. so country is producing fewer goods and services than before.
Recovery: when % change becomes positive again. real GDP is higher than previous year, so producing more goods and services than before.

77
Q

What is the relationship between business cycle, inflation, and unemployment?

A

Changes in GDP cause changes in the UR and inflation.

78
Q

What is the equation for the rate of growth (inflation rate)?

A

rate of growth / inflation rate = (present - past) / past x 100

79
Q

What is the equation for Real GDP?

A

Real GDP = nominal GDP / Prince Index (P) current year x 100

80
Q

What is the equation for Price Index?

A

Price Index (P) = Nominal GDP / Real GDP x 100

81
Q

What is the nominal GDP?

A

The nominal GDP is the value of the current year’s output calculated at the current year’s prices (not the base year’s). It is unadjusted raw data.

82
Q

What is the expenditure approach to calculating Real GDP?

A

Y = C + I + G + X - M
NOTE: when calculating the AE equation = C + I + G - T + X - M

83
Q

What are withdrawals? Injections?

A

Injections into the circular flow are additions to investment, government spending or exports which boosts the circular flow of income so that there is an expansion: I + G + X
Withdrawals are increases in savings, taxes, or imports which reduces the circular flow of income and leads to a contraction or recession: S + T + M

84
Q

What is the equation for real interest rate?

A

nominal interest rate - inflation rate = real interest rate

85
Q

What is the multiplier (K) effect?

A

If there is an increase in one of the constants, equilibrium Y will rise by more than the increase in the constant. If there is a decrease in one of the constants, equilibrium Y will decrease by more than the decrease in the constant.
EXCEPTION: if T rises, then Y will DECREASE

86
Q

What is the trade balance equation?

A

first must find the total value of imports (by finding Y)
Trade balance = X - M

87
Q

What is the government budget equation?

A

government budget balance = tY + T - G

88
Q

What goes in AD? SAS? SAS & LAS?

A

AD: changes in C, I, G, T, X, M + anything involving policies
AS: change in input prices like wages and energy costs
SAS & LAS: shock to resources or technology

89
Q

What is expansionary fiscal policy?

A

increase G or decrease T

90
Q

What is contractionary fiscal policy?

A

decrease G or increase T

91
Q

What expansionary monetary policy?

A

decrease r to increase investment

92
Q

What is contractionary monetary policy?

A

increase r to decrease investment

93
Q

What is the inflationary gap?

A

AE > Y, so spending unexpectedly accelerated, and inventories fell. Firms need to increase production to keep up with spending.
Need contractionary policy due to recovery:
contractionary fiscal policy: decrease G or increase T
contractionary monetary policy: increase interest rate (r) so investment can decrease.

94
Q

What is the recessionary gap?

A

AE < Y, so spending unexpectedly fell, and inventories rise.
Firms need to reduce production.
Need expansionary policies due to recession:
expansionary fiscal policy: increase G or decrease T (or both)
expansionary monetary policy: decrease interest rate (r) so the investment can increase.

95
Q

Equation for:
1. Total of all taxes collected by the government
2. Total income tax collected
3. Equilibrium Y
4. Multiplier

A
  1. Total of all taxes collected by the government = tY+T
  2. total income tax collected = tY
  3. Equilibrium Y = K x A
  4. K = 1 / (1 - B)
96
Q

What is in the current account?

A

All transactions involving “current” spending.
It includes trade in goods, trade in services, investment income like interest payments and dividend payment
– mainly merchandise trade

97
Q

What is the capital account?

A

Involves all other types of financial transactions.
It includes direct investment (Canadian companies establish branches in foreign countries (-) or foreign companies establish branches in Canada (+)). Also includes portfolio investment (transactions involving stocks and bonds)
– mainly stocks and bonds purchases

98
Q

Discuss the “external debt financing” technique.

A
  • The government borrows form bondholders OUTSIDE Canada
  • Contractionary because T rises to pay foreign bondholders
  • No effects on interest rates
  • Compound interest payments a concern for government? YES
  • Problems: contractionary, possible currency depreciation, and balance of payments problems
  • Makes it easy for government to overspend… not really an advantage
99
Q

Discuss deficits or surpluses in current and capital account.
(Balance of Payments = Current + Capital)

A

(Current - Capital – to calculate deficits/surpluses)
A surplus in the balance of payments means there has been more selling than buying of Canadian dollars, so the Canadian dollar should appreciate.
A deficit in the balance of payments means there has been more selling than buying of Canadian dollars, so the Canadian dollar should depreciate.

100
Q

Why is it better for a country to have a surplus in its current account than in its capital account?

A

because a current account surplus means we can afford a capital account deficit without impacting our currency, so the BofC can lower interest rates. this is expansionary for the economy

101
Q

What does it mean when the current account is in deficit?

A

It means to cover current spending on goods and services and pay the interest we owe, we have to borrow from other countries, which means raising interest rates (contractionary).
NOTE: current account deficits are usually triggered by government deficits

102
Q

How to calculate the exchange rate?

A

Foreign / CAD
this would, for instance be:
0.76 USD / 1 CAD = 0.76
so, 1 Canadian dollar will buy 0.76 worth of goods in USA
OR
CAD / Foreign
this would, for instance be:
1 CAD / 0.76 USD = 1.3158
so, 1 USD buys 1.3158 CAD worth of Canadian goods

103
Q

What is the difference between appreciation and revaluation of currency.

A

Revaluation means a rise of CAD in relation to foreign currency in a fixed exchange rate. –> change in exchange rate made by the central bank
Appreciation implies an increase in the external value of a currency. –> change in exchange rate depending on supply and demand of the Canadian dollar

104
Q

What causes the Canadian dollar to appreciate? Depreciate?

A

Appreciation: an increase in foreign purchases of Canadian exports will cause an increase in demand for Canadian dollars.
Depreciation: a decrease in foreign purchases of Canadian bonds, say because of lower Canadian interest rates, will cause a decrease in demand for Canadian dollars.

105
Q

What is revaluation and devaluation of currency?

A

Its when the central bank “plays around” with the value of its currency. to increase the value, they revalue it, to decrease value, they devalue it.

106
Q

What is the floating exchange rate system?

A

It is when the exchange rate is flexible. The central bank will intervene to prevent short-term fluctuations by buying or selling official forex reserves vs their own domestic currency.

107
Q

What is the fixed exchange rate system?

A

The exchange rate is maintained by the central bank of the country who will buy or sell its own currency against a foreign one.

108
Q

What is accounting cost, sunk cost, opportunity cost, economic cost?

A

Accounting cost: out-of pocket expense
Sunk cost: irrelevant cost to decision making
Opportunity cost: cost of what you’re missing out on if you choose the alternative
economic cost: accounting + opportunity cost

109
Q

Positive vs Normative statement?

A

Positive: backed up by facts
Normative: Opinion

Macroeconomics (2 decks)

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