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ECON 102 > Midterm 2 (Chapters 23-27, no 25) > Flashcards

Midterm 2 (Chapters 23-27, no 25) Flashcards

1
Q

Aggregate Demand (AD) curve

A

combinations of real GDP and the price level that make desired aggregate expenditure equal to actual national income; a set of stable equilibriums

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2
Q

Negative slope of AD curve

A

Inverse relationship between P and Ye

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3
Q

Relationship between price and wealth held in money

A

When price increases, purchasing power of money decreases, so wealth decreases

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4
Q

Relationship between price and wealth held in bonds

A

When price increases, value of the loan repayment decreases, so the wealth of the lender decreases while the wealth of the borrower increases

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5
Q

Relationship between wealth and consumption

A

Direct relationship

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6
Q

Trade effect

A

When domestic price increases, X decreases and M increases, NX decreases, and AE decreases

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7
Q

Relationship between P and AE

A

Inverse relationship: economy doesn’t have to make as much to satisfy lower desired spending

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8
Q

Fallacy of Composition

A

Individual micro demand curves cannot be added to get the aggregate demand curve

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9
Q

Movement along AD curve

A

A change in the price level causes a shift of the AE curve and a movement along the AD curve

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10
Q

Aggregate Demand Shock

A

Increase in autonomous AE shifts AE curve upward and AD curve to the right, vice versa

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11
Q

Simple multiplier of AD curve

A

Measures the horizontal shift in AD curve in response to a change in autonomous desired expenditure

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12
Q

Size of the horizontal shift of AD curve

A

simple multiplier x increase in autonomous expenditure

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13
Q

Aggregate supply (AS) curve

A

relationship between the price level and the quantity of aggregate output supplied for given technology and factor prices

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14
Q

Aggregate Supply Shock

A

Due to exogenous changes in costs: factors prices (increase, leftward) or technology/productivity (increase, rightward)

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15
Q

Macro equilibrium

A

AD=AS; Ya (points on SRAS)=Ye=Y (points on AD)

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16
Q

Keynesian SRAS

A

constant unit costs, P is constant while Y increases, k=simple multiplier

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17
Q

Intermediate SRAS

A

increasing unit costs, P and Y increase, k= multiplier

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18
Q

Classical SRAS

A

escalating unit costs, P increases while Y is constant, k=0 (very inflationary)

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19
Q

Key assumptions in the short run

A

factor prices are exogenous, technology and factor supplies are constant, thus Y* is constant, means that Real GDP is determine by AD=AS

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20
Q

Key assumptions in the adjustment process

A

factor prices are flexible/endogenous and adjust in response to output gaps, technology and factor supplies are constant, thus Y* is constant, real GDP=Y*

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21
Q

Key assumptions in the long run

A

factor prices are fully adjusted/endogenous, technology and factor supplies are changing, thus Y* is changing, meaning economic growth

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22
Q

Adjustment asymmetry

A

Booms cause wages to rise quickly, Recessions cause wages to fall slowly

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23
Q

3 ways to eliminate an output gap

A

(1) Do nothing, inventory adjustment forces Y back to Y* (2) Demand shock through fiscal policy (3) Supply side economics

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24
Q

Phillip’s curve

A

rate of change of wages are inversely related to unemployment rate

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25
Q

Potential output as “anchor” and SRAS as “chain”

A

SRAS reacts to AD/AS shocks using wage adjustments to pull Y back to Y* automatically

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26
Q

Long run equilibrium

A

Y is no longer adjusting to output gaps, AD intersects SRAS at Y*

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27
Q

LRAS or Classical AS

A

relationship between P and Y after all input costs have adjusted; a vertical line at Y* (Y*=LRAS)

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28
Q

What causes economic growth (changes in long run EQ)?

A

Only changes in Y* create economic growth due to increase in technology and factor supplies. Increase in AD only causes inflation in the long run (unless expenditure is on technology).

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29
Q

Paradox of thrift

A

In a recession, there’s a natural tendency for individuals to increase savings but this decreases C, AE, AD, Ye for the group and exacerbates a recessionary gap

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30
Q

Automatic fiscal stabilizers

A

built-in tax-and-transfer system that automatically stabilizes business cycle

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31
Q

Automatic stabilization vs. discretionary stabilization

A

If GDP is relatively low, the government automatically runs a deficit, and vice versa; Shift of budget function due to intentional change in budget

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32
Q

Limitations of discretionary fiscal policy

A

(1) Decision and Execution lags (2) Temporary v. Permanent changes - H may not trust change, long-run expectations (3) Fine v. Coarse tuning - fiscal may be too broad for fine-tuning but useful for gross-tuning

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33
Q

Real sector

A

allocation of resources among alternative uses depends on relative prices (Px/Py) i.e. shape of P distribution

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34
Q

Money sector

A

change in the money supply would change the absolute price level (Px in terms of dollars or the common denominator) i.e. mean of P distribution

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35
Q

Classical dichotomy

A

divide the economy (fictitiously) into real and monetary sectors

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36
Q

Exchange identity

A

amount of money/value that you give up = what you get; MV=Py

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37
Q

Neutrality of Money

A

Change in M leads to a change in P if you assume velocity (V) is constant since technology is constant and Y is constant since it’s at/near Y*

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38
Q

Modern view of money

A

In the SR, change in M can lead to a change in P or Y. In the LR, change in M leads to a change in P.

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39
Q

What is money?

A

Medium of exchange, store of wealth, unit of account

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40
Q

Medium of exchange

A

facilitates trade, “double coincidence of wants” i.e. A wants what B has, vice versa

41
Q

Characteristics of medium of exchange

A

generally acceptable, high value relative to its weight, divisible and durable, cannot counterfeit

42
Q

Store of wealth or store of purchasing power

A

earning and spending are not synchronized so it must have a stable value e.g. deferred payments

43
Q

Unit of account

A

a means for comparing values of G&S (relative or absolute)

44
Q

Commodity money

A

high intrinsic value that’s recognizable, durable, divisible, and stable e.g. precious metals and gold

45
Q

Paper money

A

token money that had value because it was generally accepted, not intrinsic, by custom or mandated/legislated by the state, fully convertible to gold on demand (goldsmith receipt)

46
Q

Fractionally backed paper money

A

Banks issue more notes convertible to gold (loans) than gold in their vaults as reserves and charge interest; banks have discovered there are less withdrawals than deposits

47
Q

Fiat money

A

declared by law as legal tender i.e. if you pay off debt, you’ve discharged your debt, not convertible to gold

48
Q

The gold standard

A

Domestically, the economic unit of account is fully convertible to gold at a fixed rate

49
Q

Chequing account or demand deposits

A

interest rates are relatively low, withdrawn on demand with no prior notice needed

50
Q

Savings accounts

A

needs a notice prior to withdrawal, higher interest rates

51
Q

Term deposits

A

Makes higher interests for a specific period of time but penalized if withdrawn early (interest reduced)

52
Q

Central bank

A

government Crown corporation (solely owned by the government) whose primary function is to implement monetary policy

53
Q

Financial intermediaries or “the banks”

A

privately owned profit-maximizing corporations that transform assets (deposits) to liabilities (loans)

54
Q

Functions of BOC

A

(1) Banker’s bank- holds reserves, lender of last resort at bank rate, settles accounts (bank transfer funds), (2) Government’s bank- short-term T-bills or long-term G bonds (3) Regulates money supply (4) Regulates financial markets- prevents panic and bank failures

55
Q

Functions of commercial banks

A

(1) To provide credit (lend) and accept deposits (borrow) (2) Interbank activity- pooled loans to large companies (3) Clearing cheques by chartered banks through “clearing house”

56
Q

Main asset and liability of commercial banks

A

Asset: securities and loans; Liability: deposits

57
Q

Reserves

A

Profit that isn’t loaned out to meet demands on deposits and avoid a run on the banks (withdrawals>reserves)

58
Q

Methods to avoid run on banks

A

(1) BOC can induce an increase in reserves by loaning money directly to banks on overnight market or through open market operations- banks buy securities (2) Canada Deposit Insurance Corporation- govt. can insure deposits (3) Narrow banking- banks restricted to make safe loans

59
Q

Reserve ratio

A

% of deposits that are not loaned out either in cash or BOC deposits; RR= Reserves/total deposits

60
Q

Target reserves

A

what banks wish to hold

61
Q

Actual reserves

A

what banks actually hold

62
Q

Excess reserves

A

amount of reserves held above target

63
Q

Secondary reserves

A

liquid assets convertible to cash e.g. T-bills and govt. bonds

64
Q

Fractional reserve system

A

BOC can bail the banks out if reserves are low by changing the bank rate (cost of borrowing from BOC), which is inextricably linked to the overnight market and determines level of reserves

65
Q

What happens when BOC changes the bank rate?

A

If BOC increases the bank rate, banks are induced to hold more reserves. If BOC decreases the bank rate, banks are induced to decrease level of reserves and loan out more.

66
Q

Simplifying assumptions for the creation of money

A

(1) Fixed reserve ratio- money creation only works if banks loan excess reserves or grant credit (2) No leakage in the banking system=no cash drain; money creation is not automatic but depends on both public and bank behavior (trust)

67
Q

Money Supply

A

currency in circulation (cash) + deposits (many types)

68
Q

Multiple expansion of money supply

A

A portion of a new deposit into a bank (RR) is kept as reserves while the rest are loaned out, which is deposited into other banks etc. Total change in M= Change in new deposit/RR

69
Q

M1

A

Cash + demand deposits in banks (not used anymore0

70
Q

M2

A

M1 + savings deposits (used by BOC)

71
Q

M2+

A

M2 + deposits at other financial intermediaries

72
Q

M2++

A

M2+ plus all other mutual funds

73
Q

M3

A

M2 + all other deposits (foreign currency deposits)

74
Q

Near money

A

not a very good medium of exchange, but a good store of wealth e.g. T-bills and trust company deposits

75
Q

Money substitutes

A

good medium of exchange but not a very good store of wealth e.g. credit and debit card

76
Q

Division of wealth in financial portfolio

A

Money are non-interest bearing assets (no risk, no return) and bonds are interest-bearing assets

77
Q

Bond

A

financial contract to pay fixed payment (interest) at future specified date(s) and repay the principal at the end of maturity

78
Q

Debtor vs. Creditor

A

Debtor=borrower=sells bond and creditor=lender=buys bond

79
Q

Clipping

A

shaving the edges of coins, collecting the shavings, then minting new coins

80
Q

Milling

A

placing rough edges on coins to prevent clipping and counterfeits

81
Q

Debasement

A

adding cheap metal when reminting coins, thus lowering their intrinsic value; causes inflation (classical theory of inflation: more money chasing the same goods)

82
Q

Gresham’s law

A

“bad money drives out good” people hoard money with high intrinsic value (i.e. keep them out of circulation) while using ones made of cheaper metal for payment

83
Q

4 pillars of the financial system

A

commercial banks, insurance companies, security companies, trust companies

84
Q

Wealth in a financial portfolio

A

accumulated purchasing power divided into non-interest bearing assets or money and interest-bearing assets or bonds

85
Q

Face value of a bond

A

initial price of the bond or the original loan value

86
Q

Coupon

A

dollar value of future return; constant

87
Q

Coupon yield

A

coupon/face value; constant; market yield when the bond was originally sold in the primary market

88
Q

Price of the bond (Pb)

A

originally the face value but its present value (PV) can change once it’s sold in the secondary bond market

89
Q

Bond yield or rate

A

the yield to maturity or effective yield, which is determined by coupon + capital gain, and moves in tandem with the market yield

90
Q

Market yield (i-rate)

A

the average interest rate on all interest-bearing assets currently in the market or the minimum you would accept in order to loan money

91
Q

Primary market and secondary market of bonds

A

primary market is where you buy new bonds (Pb=face value) and secondary market is where you buy used bonds (Pb=Pv, can go up or down)

92
Q

Present value approach

A

varies inversely with the i-rate or market yield; the discounted value of all expected future returns using the market yield

93
Q

What happens when market yield increases and decreases?

A

When the market yield increases, the demand for existing bonds (in the primary market) decreases, the Pb or PV of those old bonds decreases (in the secondary market) and the bond yield increases to match the current higher market yield i.e. the bond gets sold “at a discount” (PVFV).

94
Q

Liquidity preference function (L)

A

the demand for money or the willingness to hold money (real cash balances) instead of bonds

95
Q

Bond rate (nominal)

A

directly related with OC of holding money and inversely related with Ls (speculative demand for money)

96
Q

Why do households and firms hold money?

A

Transactions demand (Lt), precautionary demand (Lp), speculative demand (Ls)

97
Q

Marginal Efficiency Investment (MEI) curve

A

real interest rate in the nominal sector and willingness to invest in the real sector (PEI’R) are inversely related; decreasing i-rate = decreasing OC of borrowing for investment

98
Q

What are hysteresis effects?

A

Argues that a change in M can affect Y*

ECON 102 (3 decks)

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