Macro Economics Final Exam Flashcards
autonomous consumption
Consumption that is independent of the level of disposable income.
aggregate expenditures function (AE)
The function that represents total spending in an economy at a given level of real disposable income.
autonomous expenditure
Spending that does not vary with the current level of disposable income.
classical economists
A group of economists whose theory dominated economic thinking from the 1770s to the Great Depression. They believed recessions would naturally cure themselves because the price system would automatically restore full employment.
consumption function
The graph or table that shows the amount households spend for goods and services at different levels of disposable income.
dissaving
The amount by which personal consumption expenditures exceed disposable income.
investment demand curve
The curve that shows the amount businesses spend for investment goods at different possible rates of interest.
John Maynard Keynes
British economist (1883–1946) whose influential work offered an explanation of the Great Depression and suggested, as a cure, that the government should play an active role in the economy.
marginal propensity to consume (MPC)
The change in consumption resulting from a given change in real disposable income.
marginal propensity to save (MPS)
The change in saving resulting from a given change in real disposable income.
saving
The part of disposable income households do not spend for consumer goods and services.
Say’s Law
The theory that supply creates its own demand.
Who was John Maynard Keynes?
British economist (1883-1946) who offered an explanation of the Great Depression of the 1930’s
When were the ideas of the classical economists widely accepted?
Prior to the 1930’s
What did the classical economists believe?
The economy is always tending toward a full employment equilibrium
What does Say’s Law say?
Supply creates its own demand.
Why is Say’s Law a full employment theory?
Producers produce goods consumers want and consumers have the money to buy because of the wages they were paid
Under Say’s Law, is unemployment possible?
Yes, but it is a short-lived adjustment period in which wages and prices decline or people voluntarily choose not to work
What is the name of the book Keynes had published in 1936?
The General Theory of Employment, Interest, and Money.
Why did Keynes believe that “supply did not create its own demand”?
Demand can be forever inadequate for an economy to achieve full employment.
What changed people’s mind about Say’s Law?
The Great Depression and the advent of Keynesian economics
What is the essence of Keynesian Economics?
The economy could tend toward a less than full employment equilibrium.
What determines demand for goods and services?
Disposable income
What is the consumption function?
A graph that shows the amount households spend for goods and services at different levels of disposable income
What is savings?
Money earned but not spent.
What is dissaving?
The amount by which personal spending exceeds disposable income.
How do people dissave?
By taking money from personal savings
What is autonomous consumption?
Consumption that is independent of the level of disposable income.
What happens when disposable income is zero?
Spending will equal autonomous consumption because households will dissave for basic needs.
What is the marginal propensity to consume (MPC)?
The change in consumption resulting from a change in real disposable income
Why does MPC plus MPS always equal 1?
Because savings is defined as money earned but not spent.
What does Marginal Propensity to Spend plus Marginal Propensity to Consume equal?
MPS + MPC = 1
If MPC changes from .50 to .75 then?
Consumption function shifts from C1 to C2 and People spend more at all levels of real disposable income.
What happens when real disposable income changes?
There is a direct relationship between changes in real disposable income and changes in consumption.
What happens if factors other than income change?
There is a shift in the consumption schedule.
Consumption shifts because of a change in?(Five reasons)
- Expectations
- Wealth
- Price levels
- Interest rates
- Stock of durable goods
How do expectations affect the consumption function?
Consumers expectations of things to happen in the future will affect their spending decisions today.
Does wealth affect consumption?
There is a direct relationship between a change in wealth and a change in consumption.
Is there a direct or indirect relationship with the price level affect the consumption function?
There is an indirect relationship between a change in prices and a change in consumption..
Is there an direct or indirect relationship with the interest rate affect the consumption function?
There is an indirect relationship between a change in interest rates and a change in consumption.
How does the stock of durable goods affect the consumption function?
When durable goods are suppressed, like during WWII, afterwards there is an increase in the demand for goods not previously made available.
How does consumption compare with investment?
Consumption is more stable than investment.
According to the classical economists, what determined the level of investment?
The interest rate.
According to Keynes, what determines the level of investment?
Expectations of future profits is the primary factor, along with the level of interest rates.
What is the investment demand curve?
The curve that shows the amount businesses invest at different possible rates of interest.
Why is investment demand unstable?(Five reasons)
- Expectations
- Technological change
- Capacity utilization
- Business taxes
- Autonomous reasons
How do expectations affect investment?
Investors are susceptible to moods of optimism and pessimism.
How does technological change affect investment?
New products and new ways of doing things have a big impact on investment decisions.
What happens when capacity utilization is low?
Firms can meet an increase in demand without expanding.
What happens when capacity utilization is high?
Firms must increase investment to meet an increase in demand.
How do business taxes affect investment?
Business decisions depend on the expected after-tax rate of profit.
What is autonomous expenditure?
Spending that does not vary with the current level of disposable income.
What is the aggregate expenditure function?
The function that relates aggregate desired expenditure to national income.
According to Say’s law, there cannot be overproduction of goods and services because:
A: planned aggregate expenditures sometimes fall short of total output.
B:prices and wages are “sticky” or inflexible in the downward direction.
C: demand creates its own supply.
D: supply creates its own demand.
D
The school of thought that emphasizes the natural tendency for an economy to move toward equilibrium full employment is known as the: A: Keynesian school. B: supply-side school. C: rational expectations school. D: classical school.
D
John Maynard Keynes and his followers argued that the Great Depression was primarily the result of:
A: excessive government spending.
B: large budget deficits.
C: the perverse monetary policies of the Fed.
D: insufficient aggregate spending on goods and services.
D
The consumption function shows the relationship between:
A: planned consumption expenditures and disposable income.
B: permanent income and savings.
C: business inventory and real GDP.
D: aggregate demand and aggregate consumption.
A
A movement along the consumption function is caused by a change in: A: consumption. B: expectations. C: aggregate supply. D: disposable income.
D
If people’s real assets increase, then the:
A: economy will move to the right along the existing consumption function.
B: economy will move to the left along the existing consumption function.
C: consumption function will shift down.
D: consumption function will shift up.
E: investment demand curve will shift up.
D
That part of disposable income not spent on consumption is defined as: A: transitory disposable income. B: permanent disposable income. C: disposable income. D: autonomous consumption.E: saving.
E
The marginal propensity to consume is:
A: the change in disposable income divided by the change in consumption.
B: consumption spending divided by disposable income.
C: disposable income divided by consumption spending.
D: the change in consumption divided by the change in disposable income.
E: the change in consumption divided by disposable income.
D
If the marginal propensity to consume = 0.75, then: A: the marginal propensity to save = 0.75.
B: the marginal propensity to save = 1.33.
C: the marginal propensity to save = 0.20.
D: the marginal propensity to save = 0.25.
E: since the marginal propensity to save and the marginal propensity to consume are unrelated, we cannot determine the marginal propensity to save from the information given.
D
The demand curve for investment in the economy as a function of interest rates is: A: vertical. B: horizontal. C: upward sloping. D: downward sloping. E: elliptical.
D
aggregate expenditures-output model
The model that determines the equilibrium level of real GDP by the intersection of the aggregate expenditures and aggregate output (and income) curves.
inflationary gap
The amount by which the aggregate expenditures curve must be decreased to achieve full-employment equilibrium.
recessionary gap
The amount by which the aggregate expenditures curve must be increas ed to achieve full-employment equilibrium.
spending multiplier (SM)
The ratio of the change in real GDP to an initial change in any component of aggregate expenditures, including consumption, investment, government spending, and net exports. As a formula, the spending multiplier equals 1/(1 - MPC) or 1/MPS.
tax multiplier
The change in aggregate expenditures (total spending) resulting from an initial change in taxes. As a formula, the tax multiplier equals 1 - spending multiplier.
Why is government spending an autonomous expenditure?
Government spending can be the result of political decisions regardless of national output.
Why is net exports assumed to be negative?
Spending for imports usually exceeds the value of exports.
What does the term equilibrium mean?
Equilibrium is the point toward which the economy tends.
In the Keynesian model, where is the equilibrium level of GDP?
It is where the value of goods and services produced is equal to the spending for these goods and services.
What is the aggregate expenditures formula?
Aggregate expenditures = C + I + G + (X-M)
How do aggregate expenditures affect the economy?
They pull aggregate output either higher or lower toward equilibrium.
What causes a decrease in real GDP and employment?
Excessive inventories.
Why do excessive inventories cause unemployment?
Firms will cut back production and lay off workers in order not to add to inventories excessively.
What causes an increase in GDP and employment?
Inventory depletion.
What happens when inventories decline too much?
Firms will increase production and hire more workers to meet the demand for their product.
What is the aggregate expenditures-output model?
It determines the equilibrium level of real GDP by the intersection of aggregate expenditures and aggregate output.
How can full employment be reached with aggregate expenditure?
The aggregate expenditure curve must be shifted upward until the full-capacity output is reached.
What is the spending multiplier?
Any initial increase in spending will lead to a multiple increase in GDP.
How does the multiplier work?
Any initial change in spending causes a chain reaction of more spending.
What is the Marginal Propensity to Consume?
MPC is the change in consumption spending resulting from a given change in income.
What is the Marginal Propensity to Save?
MPS is the fraction of any change in real disposable income that households save.
What is the relationship between MPC and MPS?
MPC + MPS = 1
What is the formula for the multiplier?
1 / (1 – MPC)(or)1 / MPS
If the MPS is 1/2, what is the multiplier?
1 / MPS = 1 / 1/2 = 2
What is the GDP gap?
The difference between full employment real GDP and actual real GDP
What is a recessionary gap?
The amount by which aggregate expenditures fall short of the amount required to achieve full employment equilibrium.
What is the Keynesian remedy for a recessionary gap?
Increase autonomous spending by the amount of the recessionary gap.
What can the government do to close a recessionary gap?
•Increase government spending•Lower taxes•Raise transfer payments
What is an inflationary gap?
The amount by which aggregate expenditures exceed the amount required to achieve full employment equilibrium.
What is the Keynesian remedy for an inflationary gap?
Reduce spending by the amount of the inflationary gap.
How can the government close an inflationary gap?
•Cut government spending•Increase taxes•Reduce transfer payments
In the aggregate expenditures-output model, if aggregate expenditures (AE) are greater than GDP, then: A: inventory is accumulated. B: inventory is unchanged. C: employment decreases. D: employment increases.
D
In the aggregate expenditures-output model, if an economy operates above equilibrium GDP, there will be: A: unplanned inventory accumulation. B: unplanned inventory depletion. C: an increase in GDP. D: an increase in employment.
B
In the Keynesian model, investment, government spending, and net exports are treated as autonomous expenditures, which means they are independent of: A: expectations. B: the price level. C: political processes. D: real GDP.
D
At the equilibrium level of real GDP, total production equals total: A: saving. B: investment. C: net exports. D: spending.
D
The formula to compute the spending multiplier is: A: 1/(MPC + MPS).
B: 1/(1 - MPC).
C: 1/(1 - MPS).
D: 1/(C + I).
B
If the marginal propensity to consume (MPC) is 0.80, the value of the spending multiplier is: A: 2. B; 5. C: 8. D: 10.
B
If an economy spends 90 percent of any increase in real GDP, then an increase in investment of $1 billion would result ultimately in an increase in real GDP of: A: $0. B: $0.9 billion. C: $1.0 billion. D: $10 billion.
D
If MPC = 0.80, how much should government spending change to correct a recessionary gap of $500? A; -100. B: +80. C: -80. D: +500. E: +100.
E
If the economy experiences a recessionary gap then:
A: aggregate expenditures exceed the level of spending necessary to provide for full employment.
B: Keynesian economics would recommend a reduction in government spending or an increase in taxes.
C: Keynesian economics would recommend an increase in government spending or a decrease in taxes.
D: the equilibrium level of output and income is above full employment.
C
Assume that an inflationary gap must be closed by reducing aggregate expenditures. If consumers refuse to cut spending on consumption and producers won’t cut demand for investment goods, the President:
A: can do nothing.
B: must build more roads.
C: must borrow from Wall Street.
D: must increase Social Security expenditures.
E: must cut government spending.
E
aggregate demand curve (AD)
The curve that shows the level of real GDP purchased by households, businesses, government, and foreigners (net exports) at different possible price levels during a time period, ceteris paribus.
aggregate supply curve (AS)
The curve that shows the level of real GDP produced at different possible price levels during a time period, ceteris paribus.
classical range
The vertical segment of the aggregate supply curve, which represents an economy at full-employment output.
cost-push inflation
An increase in the general price level resulting from an increase in the cost of production that causes the aggregate supply curve to shift leftward.
demand-pull inflation
A rise in the general price level resulting from an excess of total spending (demand) caused by a rightward shift in the aggregate demand curve.
interest-rate effect
The impact on total spending (real GDP) caused by the direct relationship between the price level and the interest rate.
intermediate range
The rising segment of the aggregate supply curve, which represents an economy as it approaches full-employment output.
keynesian range
The horizontal segment of the aggregate supply curve, which represents an economy in a severe recession.
long-run aggregate supply curve (LRAS)
The curve that shows the level of real GDP produced at different possible price levels during a time period in which nominal incomes change by the same percentage as the price level changes.
net exports effect
The impact on total spending (real GDP) caused by the inverse relationship between the price level and the net exports of an economy.
real balances
The impact on total spending (real GDP) caused by the inverse relationship between the price level and the real value of financial assets with fixed nominal value.
short-run aggregate supply curve (SRAS)
The curve that shows the level of real GDP produced at different possible price levels during a time period in which nominal incomes do not change in response to changes in the price level.
stagflation
The condition that occurs when an economy experiences the twin maladies of high unemployment and rapid inflation simultaneously.
What is the difference between market and aggregate models?
The market model measures physical units whereas the aggregate model measures value.
What is the aggregate demand curve?
The curve shows the level of real GDP purchased by everyone at different price levels during a time period, ceteris paribus.
What does the horizontal axis measure?
The value of final goods and services included in real GDP measured in base year dollars.
What does the vertical axis measure?
It is an index of the overall price level, such as the GDP deflator or the CPI.
Why does the aggregate demand curve slope downward to the right?
•Real balances effect•Interest-rate effect•Net exports effect
What is the real balances effect?
Consumers spend more on goods and services because lower prices make their dollars more valuable.
What is the interest-rate effect?
Assuming fixed credit, an increase in the price level translates through higher interest rates into a lower real GDP.
What is the net exports effect?
A higher domestic price level makes U.S. goods more expensive compared to foreign goods, exports decrease, imports increase, decreasing real GDP.
Decrease in the price level equals?
Increase in the real GDP demanded.
What can cause a shift in the aggregate demand curve?
Consumption, investments, government spending and net exports can change.
Increase in C,I, G, (X-M) equals?
Increase in the aggregate demand curve
What is the aggregate supply curve?
Shows the level of real GDP produced at different price levels during a time period, ceteris paribus.
Why did Keynes assume fixed product prices and wages?
During a deep recession or depression, there are many idle resources in the economy.
Why do idle resources mean fixed prices?
Producers are willing to sell additional output at current prices because there are plenty of resources to go around for everyone who wants them.
Why do idle resources mean fixed wages?
Unemployed workers willing to work for the prevailing wage diminish the power of workers to increase their wages.
What kind of supply curve would explain fixed prices and wages?
A horizontal supply curve
Government spending (G) increases and has what effect?
Aggregate demand increases and the economy moves from E1 to E2. Price level remains constant, while real GDP and employment rise.
According to Keynes, what will a shift in aggregate demand do?
It will restore a depressed economy to full employment.
What is the classical view of the aggregate supply curve?
It is a vertical line at the full employment output.
According to the classical economists, where does the economy normally operate?
The economy normally operates at its full employment level.
How do the classical economists view prices and costs?
The price level of products and production costs change by the same percentage in order to maintain full employment.
Aggregate demand decreases at _____ _______?Unemployment causes a decrease in ________? The economy moves to a level of ____ _____?
full employment
prices
full employment
What are the two types of inflation?
•Cost push•Demand pull
What is cost push inflation?
A rise in the general price level resulting from an increase in the cost of production.
What is stagflation?
High unemployment and rapid inflation exist simultaneously.
What is demand pull inflation?
A rise in the general price level resulting from an excess of total spending.
What determines the business cycle?
Shifts in the aggregate demand and aggregate supply curves.
What happens when both curves increase?
That depends on how much each increases.
Increase in aggregate demand and supply leads to an Increase in ______ _____ and an increase in _______ ________.
real GDP
price level
The aggregate demand curve:
A: shows the level of real GDP purchased in the economy at different possible price levels during a period of time.
B: Shows the level of real GDP produced in the economy at different possible price levels during a period of time.
C: shifts to the left whenever there is an increase in aggregate expenditures.
D: slopes upward.
A
When price level in the United States rises,
A: there is a increased demand for borrowed money.
B: producers’ demand for new machinery increases, contributing to an increase in aggregate demand.
C: Americans tend to buy more foreign goods and services.
D: the French, Canadians, and Japanese would find our exports more attractive.
E: to replenish the value of your real wealth, you would save less and consume more.
C
When the price level falls, the total quantities of goods and services demanded: A: decreases. B: stays the same. C: increases. D: increases and then decreases. E: decreases and then increases.
C
The real balances effect occurs because a higher price level will reduce the real value of people's: A: financial assets. B: wages. C: unpaid debt. D: physical investments.
A
Which of the following would shift the aggregate demand curve to the left? A: An increase in exports. B: An increase in investment. C: An increase in government spending. D: A decrease in government spending.
D
If every household in the United States won a lottery which gave it an extra $50,000 to spend, the:
A: aggregate supply curve would shift to the right. B: aggregate supply curve would shift to the left.
C: general price level would rise causing a movement up the aggregate demand curve.
D: aggregate demand curve would shift to the left. E: aggregate demand curve would shift to the right.
E
Gradual adjustment of prices and wages to an increase in the aggregate demand curve implies that the aggregate supply curve is: A: horizontal. B: Vertical. C: upward sloping but not vertical. D: downward sloping.
C
In the upward-sloping segment of the aggregate supply curve,
A: increases in output are linked to decreases in the price level.
B: increasing prices drag down resource costs.
C: producers can hire more workers without having to raise the wage rate.
D: the economy can increase aggregate supply without prices going up.
E: firms are willing to pay higher wages to get more labor.
E
At low levels of employment, the Keynesian aggregate supply curve: A: tilts downward to the right. B: tilts upward to the right. C: is vertical. D: shows a constant price level. E: shows a rising price level.
D
automatic stabilizers
Federal expenditures and tax revenues that automatically change levels in order to stabilize an economic expansion or contraction; sometimes referred to as nondiscretionary fiscal policy.
balanced budget multiplier
An equal change in government spending and taxes, which changes aggregate demand by the amount of the change in government spending.
budget deficit
A budget in which government expenditures exceed government revenues in a given time period.
budget surplus
A budget in which government revenues exceed government expenditures in a given time period.
discretionary fiscal policy
The deliberate use of changes in government spending or taxes to alter aggregate demand and stabilize the economy.
fiscal policy
The use of government spending and taxes to influence the nation’s spending, employment, and price level.
laffer curve
A graph depicting the relationship between tax rates and total tax revenues.
marginal propensity to consume (MPC)
The change in consumption spending resulting from a given change in income.
marginal propensity to save (MPS)
The change in saving resulting from a given change in income.
spending multiplier (SM)
The ratio of the change in real GDP to an initial change in any component of aggregate expenditures, including consumption, investment, government spending, and net exports. As a formula, spending multiplier equals 1/(1 - MPC) or 1/MPS.
supply-side fiscal policy
A fiscal policy that emphasizes government policies that increase aggregate supply in order to achieve long-run growth in real output, full employment, and a lower price level.
tax multiplier
The change in aggregate demand (total spending) resulting from an initial change in taxes. As a formula, tax multiplier equals 1 - spending multiplier.
What is a discretionary fiscal policy?
The deliberate use of changes in government spending or taxes to alter aggregate demand
What are examples of expansionary fiscal policy?
•Increase government spending•Decrease taxes•Increase government spending and taxes equally
An Increase in government spending leads to an Increase in the __________ _________ curve. Than an increase in the ________ _______ and the _____ ____.
aggregate demand
price level
real GDP
What is the spending multiplier?
Any initial change in spending leads to a chain reaction of more spending which causes a greater change in demand.
How is the spending multiplier calculated?
The ratio of the change in real GDP to an initial change in aggregate expenditure.
What is marginal propensity to consume?
MPC is the change in consumption resulting from a change in income.
What is marginal propensity to save?
MPS is the change in saving resulting from a change in income.
If MPC is 0.75, what is MPS?
0.25
With an MPC of 0.75, what is the spending multiplier?
1/MPS = 1/1/4 = 4
How much will real GDP increase with an increase in government spending of $50 billion?
4 x $50B = $200B
What is the tax multiplier?
The change in aggregate demand (total spending) resulting from an initial change in taxes.
What happens when government cuts taxes by $50 billion?
The multiplier process is less because initial spending increases only by $38B instead of $50B
What is the formula for the tax multiplier?
1 – spending multiplier
With a spending multiplier of 4 what is the tax multiplier?
1 – spending multiplier = – 3
How much does real GDP increase by with a cut in taxes of $50B?
3 x $50B = $150B
Can we assume that the MPC will remain fixed?
No, it can change from one time period to another
Can fiscal policy be used to combat inflation?
Yes, this would happen when the economy is operating in the intermediate range of the aggregate supply curve.
What will happen to AD with a cut in G spending of $25B? (Spending Multiplier of 4)
−$25B x 4 = −$100B
What will happen to AD with a cut in taxes of $33.3B? (Spending Multiplier of 4)
$33.3B x −3 = −$100B
What is the balanced budget multiplier?
An equal change in government spending and taxes will change aggregate demand by the amount of the change in government spending.
What is an automatic stabilizer?
Federal expenditures and tax revenues that automatically change levels in order to stabilize an economic expansion or contraction.
What are examples of automatic stabilizers?
•Transfer payments•Unemployment compensation•Welfare
What is a budget surplus?
A budget in which government revenues exceed government expenditures in a given time period.
What is a budget deficit?
A budget in which government expenditures exceed government revenues in a given time period.
What is supply-side fiscal policy?
A fiscal policy that emphasizes government policies that increase aggregate supply.
What is the purpose of supply-side fiscal policies?
To achieve long-run growth in real output, full employment, and a lower price level.
A decrease in resource prices; technological advances; subsidies; decrease in regulations, leads to an Increase in the _________ _______ _________.
aggregate supply curve
What is the Laffer Curve?
Puts forth the idea that increasing taxes from zero will increase tax revenues up to a certain point.
Will an increase in taxes lead to higher government revenues?
That depends on where the economy is on the Laffer Curve.
What happens if taxes increase beyond a certain point?
Tax revenues begin to decline as the economic pie begins to shrink.
Why does the economic pie begin to shrink?
Workers have less incentive to work and investors have less of an incentive to invest as their taxes increase beyond a certain level.
crowding-in effect
An increase in private-sector spending as a result of federal budget deficits financed by U.S. Treasury borrowing. At less than full employment, consumers hold more Treasury securities, and this additional wealth causes them to spend more. Businesses investment spending increases because of optimistic profit expectations.
crowding-out effect
A reduction in private-sector spending as a result of federal budget deficits financed by U.S. Treasury borrowing. When federal government borrowing increases interest rates, the result is lower consumption by households and lower investment spending by businesses.
debt ceiling
A legislated legal limit on the national debt.
external national debt
The portion of the national debt owed to foreign citizens.
internal national debt
The portion of the national debt owed to a nation’s own citizens.
national debt
The total amount owed by the federal government to owners of government securities.
net public debt
National debt minus all government interagency borrowing.
What are the four stages of the budget process?
•Agency budget proposals•President submits budget•Budget resolution•Budget passed
What is the federal fiscal year?
October 1 through September 30
What is the federal deficit?
How much money the government borrows in any given fiscal year.
What is the national debt?
Amount owed by the federal government to owners of government securities.
How does the U.S. Treasury borrow money?
By selling securities promising to make interest payments and to repay on a given date.
What is the net public debt?
National debt minus all government interagency borrowing.
What has been done to curb the national debt?
•Tax increase•Spending caps•Debt ceiling
What happened to taxes in 1993?
Raised the highest marginal tax rate from 31% to 36%•Increased tax on gasoline by 4.3 cents per gallon.
What happened to spending in 1993?
Reduced military spending and cut some entitlements, including Medicare, Medicaid, and food stamps.
What was the result through the late 1990s?
Four years of federal surpluses from 1998 to 2001
What happened in 2001?
Recession, tax cuts, and increased spending on the war on terrorism meant a return to deficits.
What is a debt ceiling?
The legislated legal limit on the national debt.
What usually happens when the debt pushes against the ceiling?
Congress raises the ceiling to accommodate the budget deficit.
Can the government go bankrupt? Does the national debt need to be paid off?
•Yes, it’s possible•No, the debt need never be paid off
Are we passing the debt burden to our children?
•Yes, especially if it continues to increase•No, not as long as the debt is internally owned
What is the internal national debt?
The portion of the national debt owed to a nation’s own citizens.
What is the external national debt?
The portion of the national debt owed to foreign citizens.
What is the crowding-out effect?
When federal government borrowing increases interest rates, the result is lower consumption and investments.
Does government borrowing crowd out private-sector spending?
• Yes, the more the government borrows the less loanable funds for everyone else• No, especially if it occurs during economic downturns
When Govt. spends and borrows:Govt. competes with _________ __________, Interest rates _____, Consumers and business spending _________, AD and real GDP _______ _________.
private borrowers- rise- decrease- increase dampened
Fiscal policy is government action to influence aggregate demand and in turn to influence the level of real GDP and the price level, through:
A: expanding and contracting the money supply.
B: regulation of net exports.
C: changes in government spending and/or tax revenues.
D: encouraging businesses to invest.
C
If the marginal propensity to consume (MPC) is 0.80, and if policy makers wish to increase real GDP $200 billion, then by how much would they have to change taxes? A: -$240 million. B: -$200 million. C: -$180 million. D: -$50 million.
D
It is inflationary for government to increase spending if:
A: it also cuts taxes.
B: the aggregate supply curve is flat.
C: the economy is at full employment.
D: equilibrium real GDP is well below full employment.
C
If the economy is experiencing demand-pull inflation, then the appropriate government policy would be to shift the:
A: aggregate demand curve by using a tax increase coupled with spending cuts.
B: aggregate demand curve by using a tax increase coupled with more spending.
C: aggregate demand curve by using a tax cut coupled with spending cuts.
D: aggregate demand curve by using a tax cut coupled with more spending.
E: aggregate supply curve by using a tax cut coupled with spending cuts.
A
Equal increases in government expenditures and taxes will:
A: Cancel each other out so that the equilibrium level of output will remain unchanged.
B: lead to an equal decrease in the equilibrium level of output.
C: lead to an equal increase in the equilibrium level of output.
D: lead to an increase in the equilibrium level of real GDP output that is larger than the initial change in government expenditures and taxes.
E: lead to an increase in the equilibrium level of output that is smaller than the initial change in government expenditures and taxes.
C
Which of the following is the best example of an automatic stabilizer? A: Welfare payments. B: Foreign aid C: Defense spending. D: Highway construction.
A
According to supply-side fiscal policy, reducing tax rates on wages and profits will:
A: create demand-pull inflation.
B: lower the price level but may trigger a recession.
C: result in stagflation.
D: reduce both unemployment and inflation.
D
The national debt is unlikely to cause national bankruptcy because the federal government can: A: raise taxes.
B: print money.
C: refinance its debt.
D: all of the above.
D
One concern over external national debt is that interest and principal payments transfer wealth overseas. The percentage of the national debt held in recent years by foreigners is approximately: A: 5 percent. B: 10 percent. C: 12 percent. D: 17 percent. E: 50 percent.
E
Crowding out occurs when the federal government: A: raises taxes to finance a budget deficit.
B: refinances maturing U.S. Treasury bonds.
C: borrows by selling bonds to finance a deficit.
D: uses a budget surplus to pay off part of the national debt.
C
barter
The direct exchange of one good or service for another good or service, rather than for money.
Board of Governors of the Federal Reserve System
The seven members appointed by the president and confirmed by the U.S. Senate who serve for one nonrenewable 14–year term. Their responsibility is to supervise and control the money supply and the banking system of the United States.
checkable deposits
The total of checking account balances in financial institutions convertible to currency “on demand” when a check is written without advance notice.
commodity money
Anything that serves as money while having market value in other uses.
currency
Money, including coins and paper money.
Federal Deposit Insurance Corporation (FDIC)
A government agency established in 1933 to insure commercial bank deposits up to a specified limit.
Federal Open Market Committee (FOMC)
The Federal Reserve’s committee that directs the buying and selling of U.S. government securities, which are major instruments for controlling the money supply. The FOMC consists of the seven members of the Federal Reserve’s Board of Governors, the president of the New York Federal Reserve Bank, and the presidents of four other Federal Reserve district banks.
Federal Reserve System
The 12 central banks that service banks and other financial institutions within each of the Federal Reserve districts; popularly called the Fed.
fiat money
Money accepted by law and not because of its redeemability or intrinsic value.
M1
The narrowest definition of the money supply. It includes currency, traveler’s checks, and checkable deposits.
M2
The definition of the money supply that equals M1 plus near monies, such as savings deposits and small time deposits of less than $100,000.
medium of exchange
The primary function of money to be widely accepted in exchange for goods and services.
Monetary Control Act
A law, formally titled the Depository Institutions Deregulation and Monetary Control Act of 1980, that gave the Federal Reserve System greater control over nonmember banks and made all financial institutions more competitive.
money
Anything that serves as a medium of exchange, unit of account, and store of value.
store of value
The ability of money to hold value over time.
unit of account
The function of money to provide a common measurement of the relative value of goods and services.
What is barter?
The direct exchange of one good for another good, rather than for money.
What is the problem with barter?
It requires a coincidence of wants.
What is money?
Anything that serves as a medium of exchange, unit of account, and store of value.
What is the advantage of money?
The use of money simplifies and therefore increases market transactions.
What are the functions of money?
•Medium of exchange•Unit of account•Store of value
What is a medium of exchange?
The primary function of money to be widely accepted in exchange for goods and services.
What is a unit of account?
The function of money to provide a common measurement of the relative value of goods and services.
What is a store of value?
The ability of money to hold value over time.
What does it mean that money is liquid?
It is available to spend in exchange for goods and services without any additional expense.
Are credit cards money?
No, credit cards fail to meet the store-of-value criterion and are therefore not money.
What is the best level of scarcity for money?
The supply of money must be great enough to meet ordinary transactions needs, but not be so plentiful that it becomes worthless.
What are other properties of money?Money must be …
•portable•divisible•uniform•acceptable
What is commodity money?
Anything that serves as money while having market value in other uses.
Is our money backed up by gold or silver?
No, our paper money was exchangeable for gold until 1934, and in 1963 Congress removed the right to exchange $1 bills for silver.
What is fiat money?
Money accepted by law and not because of redeemability or intrinsic value.
What makes our dollar bills fiat money?
All our bills claim that “This note is legal tender for all debts public and private”
What does legal tender mean?
Legally dollar bills cannot be refused as payment for a debt.
What is M1?
The narrowest definition of the money supply. It includes currency, traveler’s checks, and checkable deposits.
What is currency?
Money, including coins and paper money.
What are checkable deposits?
The total of checking account balances in financial institutions convertible to currency “on demand” by writing a check without advance notice.
What is M2?
The definition of the money supply that equals M1 plus near monies, such as savings deposits and small time deposits of less than $100,000.
What distinguishes M1 from M2?
M1 is more liquid than M2.
What is the Federal Reserve System?
The 12 Federal Reserve district banks that service banks and other financial institutions within each of the Federal Reserve districts.
What is the Board of Governors of the Fed?
The seven members appointed by the President and confirmed by the U.S. Senate.
How long do board members serve?
They serve for a non-renewable fourteen-year term.
What is the responsibility of the board?
To supervise and control the money supply and the banking system of the U.S.
What is the chairman of the Board of Governors?
The President designates one member of the Board to serve as chair for a renewable four-year term.
Who is Ben Bernanke?
Chairman of the Board of Governors of the Fed.
What is the Federal Open Market Committee (FOMC)?
The FOMC is the Fed’s committee that directs the buying and selling of U.S. government securities.
What is the purpose of the FOMC?
To increase the money supply if we have unemployment and decrease it if we have inflation.
What is the Federal Advisory Council?
12 prominent commercial bankers who advise board members, but who do not have voting rights.
What percent of all deposits reside in member banks?
About 70%
What does a Federal Reserve Bank do?(6 actions)
•Controls the money supply•Clears checks•Supervises and regulates banks•Maintains and circulates currency•Protects consumers•Maintains federal government checking accounts and gold
What is the Federal Deposit Insurance Corporation (FDIC)?
The FDIC is a government agency established in 1933 to insure commercial bank deposits up to a specified limit.
What is the Monetary Control Act?
A 1980 law that gave the Fed greater control of nonmember banks and makes all financial institutions more competitive.
What is the Financial Services Modernization Act?
A 1999 law that allows banks, securities firms, and insurance companies to merge.
Barter requires: A: that the exchange medium be divisible. B: an effective middleman. C: that the exchanged goods be durable. D: that the exchanged goods be portable. E: a coincidence of wants.
E
The use of a dollar bill to buy a concert ticket represents the function of money as a: A; All of the above. B: store of value. C: medium of exchange. D: unit of account.
C
Anything can be money if it acts as a: A: medium of exchange. B:store of value. C: unit of account. D: All of the above.
D
Credit cards are: A: M1 money. B: M2 and M3 money. C: M3 money. D: near money. E: not money.
E
Which of the following is not counted as part of M1?
A: Federal Reserve notes or & paper money.
B: Coins.
C: Passbook savings deposits.
D: travelers’ checks.
E: Checkable deposits.
C
Members of the Federal Reserve Board of Governors serve one nonrenewable term of: A: 14 years. B: life. C: 4 years. D: 7 years.
A
Which of the following types of financial institutions is required to belong to the Federal Reserve System? A: National banks. B: Credit unions. C: Savings and loan institutions. D: State-chartered banks.
A
The Federal Reserve System:
A: pursues independent fiscal policy at the behest of Congress.
B: never acts to control inflation.
C: pursues an independent monetary policy which can conflict with the government’s economic policy.
D: was created by and is owned by the government.
E: only acts to lower taxes and increase spending when there are recessionary tendencies in the economy.
C
Which of the following is not one of the functions of the Federal Reserve? A: Controlling the money supply. B: Clearing checks. C: Printing currency. D: Supervising and regulating banks.
C
Which of the following is the most important protection against fears of bank collapse?
A: The gold and silver that backs Federal Reserve notes.
B: The Federal Deposit Insurance Corporation.
C: The Federal Reserve Open Market Committee.
D: The Federal Reserve.
B
discount rate
The interest rate the Fed charges on loans of reserves to banks.
excess reserves
Potential loan balances held in vault cash or on deposit with the Fed in excess of required reserves.
federal funds market
A private market in which banks lend reserves to each other for less than 24 hours.
federal funds rate
The interest rate banks charge for overnight loans of reserves to other banks.
fractional reserve Banking
A system in which banks keep only a percentage of their deposits on reserve as vault cash and deposits at the Fed.
monetary policy
The Federal Reserve’s use of open market operations, changes in the discount rate, and changes in the required reserve ratio to change the money supply (M1).
money multiplier
The maximum change in the money supply (checkable deposits) due to an initial change in the excess reserves banks hold. The money multiplier is equal to 1 divided by the required reserve ratio.
open market operations
The buying and selling of government securities by the Federal Reserve System.
required reserve ratio
The percentage of deposits that the Fed requires a bank to hold in vault cash or on deposit with the Fed.
required reserves
The minimum balance that the Fed requires a bank to hold in vault cash or on deposit with the Fed.
term auction facility (TAF)
A monetary policy tool created in 2007 during the financial crisis to encourage banks to borrow reserves and thereby extend new loans. Under this program, banks in sound financial condition are allowed to make interest rate bids for short term collateralized Federal Reserve loans.
The Federal Reserve (the Fed) and banks work together to influence?
the supply of money
In the Middle Ages, what was used for money?
Gold was the money of choice in most European nations.
Who were the founders of our modern-day banking?
Goldsmiths, people who would keep other people’s gold safe for a service charge.
What was the first currency?
People would use the receipts they received from goldsmiths as paper money.
How did the early goldsmiths act as the first banks?
Some goldsmiths made loans and received interest
Where do banks get their money to lend?
From depositors
What is fractional reserve banking?
A system in which banks keep only a small percentage of their deposits in reserve.
What are required reserves?
The minimum balance that the Fed requires a bank to hold in vault cash or on deposit with the Fed.
What is a required reserve ratio?
The percentage of deposits that the Fed requires a bank to hold in vault cash or on deposit with the Fed
What is the Required Reserve Ratio of the Fed?
7.8 million through 48.3 million = 3%Over 48.3 million = 10%
What are excess reserves?
Potential loan balances held in vault cash or on deposit with the Fed in excess of required reserves.
What money do banks use to lend out?
Banks are allowed to loan money taken from their excess reserves.
What are total reserves?
Total reserves equal required reserves plus excess reserves.
What are three steps in the multiplication of money?
•accepting a new deposit•making a loan•clearing the loan check
When will the money supply increase?
The money supply increases when banks lend money to borrowers.
What is the money multiplier?
Because money is passed from person to person, there is a multiple effect on any initial money banks lend to borrowers.
What is the money multiplier equal to?
1 / required reserve ratio
If the reserve ratio is one tenth, what is the multiplier?
1 / 1/10 = 10
If the reserve ratio is one twentieth, what is the multiplier?
1 / 1/20 = 20
What conclusion can we make?
There is an inverse relationship between the size of the required reserve ratio and the money multiplier
Actual money supply change
Initial change in excess reservesMoney multiplier.
Can the multiplier be smaller than indicated?
Yes, because of cash leakages and the chance that banks will not use all of their excess reserves to make loans.
What is an example of a leakage?
When people receive money but decide to save the entire amount instead of spending most of it.
What is monetary policy?
The Fed’s use of policy tools to change the money supply.
What would the Fed do when we have unemployment?
Increase the money supply.
What would the Fed do when we have inflation?
Decrease the money supply.
How does the Fed effect a change in the money supply?
It will use its monetary tools to influence banks.
How does the Fed influence a bank?
•open market operations•change in the discount rate•change in the required reserve ratio.
What are open market operations?
The buying and selling of government securities
What would the Fed do if we have unemployment?
Buy securities; this will increase the money supply.
What is the discount rate?
The interest rate the Fed charges on loans to banks.
What would the Fed do with unemployment?
Decrease the discount rate
What would the Fed do if we have inflation?
Increase the discount rate
What is the federal funds market?
A private market in which banks lend reserves to each other for less than 24 hours.
What is the federal funds rate?
The interest rate banks charge for overnight loans of reserves to other banks.
What would the Fed do with unemployment?
Decrease the federal funds rate
What would the Fed if we have inflation?
Increase the federal funds rate
What is the reserve ratio?
The Fed determines how much a financial institution must keep in reserve as a percentage of its total assets.
What would the Fed do if we had unemployment?
Decrease the reserve ratio
What would the Fed do if we had inflation?
Increase the reserve ratio
Is changing the reserve ratio a popular monetary tool?
No, changing the reserve ratio generates some instability and is thus infrequently used.
What are shortcomings of monetary policy?
•multiplier inaccuracy•competition of nonbanks•definition of money•lag effects
The required reserves of a bank are: A: held as deposits with the Federal Reserve System. B: equal to its loans. C: equal to its checkable deposits. D: none of the above.
A
Banks normally hold few excess reserves because this practice is: A: subject to an excess-reserves tax. B: not profitable. C: against Fed policy. D: illegal.
B
Which of the following would be classified as a liability for a bank? A: Required reserves. B: Excess reserves. C: Loans. D: Checkable deposits.
D
The quantity of reserves held by a bank in addition to the legally required amounts is known as: A: actual reserves. B: excess reserves. C: the required reserve ratio. D: the money multiplier. E: the monetary base.
B
When new checkable deposits are created through loans, A: the money supply contracts. B: excess reserves are destroyed. C: the money supply remains the same. D: the money supply expands. E: the required reserve ratio declines
D
Best National Bank operates with a 20 percent required-reserve ratio. One day a depositor withdraws $500 from his or her checking account at this bank. As a result, the bank's excess reserves: A: fall by $500. B: fall by $400. C: rise by $100. D: rise by $500.
A
If a bank keeps some of its excess reserves, the money multiplier: A: increases. B: stays the same. C: goes to zero. D: decreases. E: increases, then decreases.
D
Which of the following directs the buying and selling of U.S. government securities? A: Board of Governors. B: Federal Reserve Banks. C: Federal Open Market Committee. D: Federal Advisory Council. E: Member banks.
C
Which of the following is an appropriate monetary policy if the Fed wants to increase the money supply?
A: An increase in the required reserve ratio.
B: An increase in the discount rate.
C: Purchases of bonds in open market operations. D: Higher taxes on interest income.
C
The discount rate is the interest rate charged by:
A: major banks to their best customers.
B: banks for overnight loans to other banks.
C: the Fed on loans of reserves to banks.
D: banks for loans of less than 24 hours.
C
demand for money curve
A curve representing the quantity of money that people hold at different possible interest rates, ceteris paribus.
equation of exchange
An accounting identity that states the money supply times the velocity of money equals total spending.
monetarism
The theory that changes in the money supply directly determine changes in prices, real GDP, and employment.
precautionary demand for money
The stock of money people hold to pay unpredictable expenses.
quantity theory of money
The theory that changes in the money supply are directly related to changes in the price level.
speculative demand for money
The stock of money people hold to take advantage of expected future changes in the price of bonds, stocks, or other nonmoney financial assets.
transactions demand for money
The stock of money people hold to pay everyday predictable expenses.
velocity of money
The average number of times per year a dollar of the money supply is spent on final goods and services.
What is the transactions demand for money?
The stock of money people hold to pay everyday predictable expenses.
What is the precautionary demand for money?
The stock of money people hold to pay unpredictable expenses.
What is the speculative demand for money?
The stock of money people hold to take advantage of expected future changes in the price of bonds, stocks, or other nonmonies.
How does a change in interest rates affect speculative demand?
As the interest rate falls, the opportunity cost of holding money falls, and people increase their speculative balances.
What is the demand for money curve?
A curve representing the quantity of money that people hold at different interest rates, ceteris paribus.
How do interest rates affect the demand for money?
There is an inverse relationship between the quantity of money demanded and the interest rate.
What gives the demand for money a downward slope?
The speculative demand for money at possible interest rates.
What determines interest rates in the market?
The demand and supply of money in the market.
Decrease in the interest rate leads increase in the quantity of _________ ___________.
money demanded
Why do bond prices fall as interest rates rise?
Bond sellers have to offer higher returns (lower price) to attract potential bond buyers, or else they will go elsewhere to get higher interest returns.
Why do bond prices rise as interest rates fall?
Bond sellers are put in a better bargaining position as interest rates fall (higher price); potential buyers cannot go elsewhere to get higher interest returns so easily.
How can the Fed influence the equilibrium interest rate?
It can increase or decrease the supply of money.
In the Keynesian model, what do changes in the money supply affect?
Interest rates, which in turn affect investment spending, aggregate demand, and real GDP, employment, and prices.
When will businesses make an investment?
When the investment projects for which the expected rate of profit equals or exceeds the interest rate.
What is the classical economic view?
The economy is stable in the long run at full employment.
How did the classical economists view the role of money?
They believed in the equation of exchange.
What is the equation of exchange?
An accounting identity that states the money supply times the velocity of money equals total spending.
What is the velocity of money?
The average number of times per year a dollar of the money supply is spent on final goods and services.
MV = PQ is worded how?
Money X Velocity = Price X Quantity
What is monetarism?
The theory that changes in the money supply directly determine changes in prices, real GDP, and employment.
What is the quantity theory of money?
The theory that changes in the money supply are directly related to changes in the price level.
What is the conclusion of the quantity theory of money?
Any change in the money supply must lead to a proportional change in the price level.
Who are the modern monetarists?
Monetarists argue that velocity is not unchanging, but is nevertheless predictable.
According to monetarists, how do we avoid inflation and unemployment?
We must be sure that the money supply is at the proper level.
Who was Milton Friedman?
In the 1950’s and 1960’s, he was a leader in putting forth the ideas of the modern-day monetarists.
What did Milton Friedman advocate?
The Federal Reserve should increase the money supply by a constant percentage each year to enhance full employment and stable prices.
How do the Keynesians view the velocity of money?
Over long periods of time, it can be unstable and unpredictable.
What is the conclusion of the Keynesians?
A change in the money supply can lead to a much larger or smaller change in GDP than the monetarists would predict.
What is the crux of the Keynesian argument?
Because velocity is unpredictable, a constant money supply may not support full employment and stable prices.
What is the conclusion of the Keynesian argument?
The Federal Reserve must be free to change the money supply to offset unexpected changes in the velocity of money.
What are the main points of classical economics?
•The economy tends toward a full employment equilibrium•Prices & wages are flexible•Velocity of money is stable•Excess money causes inflation•Short-run price & wage adjustments cause unemployment•Monetary policy can change aggregate demand & prices•Fiscal policies are not necessary
What are the main points of Keynesian economics?
•The economy is unstable at less than full employment•Prices & wages are inflexible•Velocity of money is unstable•Excess demand causes inflation•Inadequate demand causes unemployment•Monetary policy can change interest rates and level of GDP•Fiscal policy is effective through spending multiplier changes in aggregate demand
What are the main points of the monetarists?
•The economy tends toward a full employment equilibrium•Prices & wages are flexible•Velocity of money is predictable•Excess money causes inflation•Short-run price & wage adjustments cause unemployment•Monetary policy can change aggregate demand & prices•Fiscal policies are not necessary
What is the crowding-out effect?
Too much government borrowing can crowd out consumers and investors from the loanable funds market.
What is the Keynesian view of the crowding-out effect?
The investment demand curve is rather steep or vertical, so the crowding-out effect is insignificant.
What is the monetarist view of the crowding-out effect?
The investment demand curve is flatter or horizontal, so the crowding-out effect is significant.
The precautionary demand for money:
A: varies inversely with the price level.
B: is a classical concept in monetary theory.
C: is used as an insurance agent against unexpected needs.
D: varies inversely with the income level.
E: states that nominal income must exceed real income.
C
Other things being equal, an increase in the rate of interest causes a (an):
A: upward movement along the demand for money curve.
B: leftward shift of the demand for money curve.
C: downward movement along the demand for money curve.
D: rightward shift of the demand for money curve.
A
If people attempt to sell bonds because of excess money demand, then the interest rate will: A: rise. B: react unpredictably. C: remain unchanged D: fall.
A
Using the aggregate supply and demand model, assume the economy is operating along the intermediate portion of the aggregate supply curve. An increase in the money supply will increase the price level and:
A: raise the interest rate and lower real GDP.
B: lower the interest rate and raise GDP.
C: raise both the interest rate and real GDP.
D: lower both the interest rate and real GDP.
B
If there is a recession, the Fed would most likely:
A: restrict bank lending by lowering the federal funds rate.
B: encourage banks to provide loans by lowering the discount rate.
C: restrict bank lending by raising the discount rate. D: restrict bank lending by lowering the discount rate.
E: encourage banks to provide loans by raising the discount rate.
B
Keynesians believe that an increase in the money supply will lead to: A: an decrease in nominal GDP. B: an increase in the price level. C: an increase in real GDP. D: both c and d. E: all of the following.
C
According to Keynesians, an increase in the money supply will have its greatest impact on GDP when the aggregate demand curve intersects:
A: the horizontal portion of the aggregate supply curve.
B: either the upward sloping or the vertical portions of the aggregate supply curve.
C: the vertical portion of the aggregate supply curve.
D: either the horizontal or vertical portions of the aggregate supply curve.
E: the upward sloping portion of the aggregate supply curve.
A
If M stands for the money supply, V for the velocity of money, P for the average selling price, and Q for the output of goods and services, the equation of exchange is: A: MV = PQ. B: MP = VQ. C: MQ = VP. D: MP = PQ.
A
The belief that the velocity of money is not constant but highly predictable is associated with the:
A: monetarist school
B: Keynesian school.
C: supply-side school.
D: rational expectations school E: classical school.
A
