Macro Unit Five

Question 1

The Phillips curve

Answer 1

Shows the short run trade off between inflation and unemployment
A shift in AD causes a shift along the Phillips curve
Inflation is y axis, unemployment is x axis, downward sloping
Shifts in AS cause shifts of Phillips curve, shifts in AD cause travel along Phillips curve to different point

Question 2

Negative supply shock

Answer 2

Occurs when a reduction in short run AS causes stagflation
Shifts SRPC (positive supply shock shifts SRPC other way)
On AS/AD graph, AS shifts left
On Phillips curve graph, Phillips curve shifts right/up/out

Question 3

Long run Phillips curve

Answer 3

There is no trade off between inflation and unemployment in the long run
LRPC is vertical, no matter how much inflation unemployment remains constant
Similar to LRAS curve, no matter what price level RGDP remains constant

Question 4

Rational expectations theory

Answer 4

Short run economic policies can be negated by people’s expectations and perceptions

• people change behavior based on what they foresee in the future
• Monetary and fiscal policy are not effective in changing real variables as AD shifts are immediately negated by AS shifts

Question 5

Closed economy

Answer 5

Economy that does not trade

Question 6

Open economy

Answer 6

Economy that does trade

Question 7

Savings

Answer 7

Unspent income
-(= Y - C - G in a closed economy)
Savings (aka national savings) =
-public savings + private savings
•public savings = income that remains after governments spend
•private savings = income that remains after people consume

Question 8

Market for loanable funds

Answer 8

Sets the real interest rate where savings = investment
Supply comes from public and private savings
-higher interest rate = higher quantity savings
Demand comes from demand for money to invest (buy capital stock)
-includes government demand for loans
-lower real interest rate = cheaper loans
Real interest rate on y axis, quantity of loanable funds on x axis
Supply of LF = savings
Demand for LF = investment

Question 9

Long-run economic growth

Answer 9

Savings = investment
-investment, and therefore savings, is needed for economic growth
Real interest rate falls —> more investment —> more capital —> increase in economic growth
Real interest rate rises —> less investment —> less replacement of capital —> decrease in economic growth

Question 10

Things that shift the demand for loanable funds

Answer 10

Government incentives and private investors
GI: subsidies/tax credits for investments shift demand right, taxes on investments shift demand left
PI: investors expect good times shifts demand right, investors expect bad times shifts demand left

Question 11

Things that shift the supply of loanable funds

Answer 11

Private savings and public savings
Private: people have an incentive to save (ex. tax benefits) shifts supply right, people consume more shifts supply left
Public: government runs a surplus shifts supply right, government runs a deficit shifts supply left

Question 12

International trade

Answer 12

Regarded by most economists as a good thing
-there are winners and losers, but the overall economy is more efficient because of trade
-trade shifts the US PPF rightward
Market inefficiencies are created by:
-tariffs —> set the price of imports
-import quotas —> fix the quantity of imports

Question 13

Balance payments: current account vs financial/capital account

Answer 13

Current account = measures flow of physical goods and services
-includes trade balance: exports vs imports
Financial/capital account: measures flow of money
-capital balance = inflow - outflow

Question 14

Capital account vs current account (cont)

Answer 14

Current account + capital account = 0
Net capital outflow = net exports
-NCO is outflow of money in capital account - inflow of money in capital account
•OPP (???) of capital account balance

Question 15

Sale of bonds

Answer 15

Deficit spending in the US is financed by the sale of US treasury bonds
The US has a current account deficit and a budget deficit
-both require the US to borrow/sell bonds

Question 16

Market for loanable funds: open economy

Answer 16

The supply of loanable funds can also come from foreigners

In an open economy the demand for loanable funds includes the demand for NCO or investments in foreign countries

Question 17

Simple foreign exchange model: US

Answer 17

Supply: US buying foreign goods/services/assets
Demand: foreigners buying US goods/services/assets (NX)
X per $ on y axis, quantity of US dollars in foreign exchange market on x axis
Intersection on y axis is equilibrium exchange rate

Question 18

Simple foreign exchange model: foreign country (Mexico)

Answer 18

Supply: Mexico buying foreign goods/services/assets
Demand: foreigners buying Mexican goods/services/assets
$ per peso on y axis, quantity of pesos in foreign exchange market on x axis

Question 19

A change in supply or demand causes

Answer 19

Appreciation of depreciation

• appreciation = a relative rise in the value of a currency
• depreciation = a relative fall in the value of a currency

Question 20

Things that will shift demand/supply for a foreign currency

Answer 20

Changes in flows based on changes in interest rates
Changes in the rate of inflation
Business cycle of a foreign economy

Question 21

The effect on exports/imports

Answer 21

Appreciation of the US dollar will cause:
-exports to fall
-imports to rise
Depreciation of the US dollar will cause:
-exports to rise
-imports to fall

Question 22

Relationship between value and y axis

Answer 22

If pesos per dollar and equilibrium exchange rate goes up, pesos have depreciated and dollars have appreciated

Question 23

Key components of the capital account

Answer 23

Portfolio investment: includes the transfer of stocks and bonds
Foreign direct investment: the purchase of machinery, buildings, and manufacturing plants by foreigners
Reserve of foreign countries