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Economics 151 > Topic 11 - Money, Aggregate Demand and Supply, Monetary and Fiscal Policy > Flashcards

Topic 11 - Money, Aggregate Demand and Supply, Monetary and Fiscal Policy Flashcards

1
Q

True/False: Money has multiple meanings.

A

True. The term “money” has several different meanings depending on its use.

  • Your paycheck is income.
  • The income you don’t spend is saving.
  • The increase in the value of your stock is a capital gain.
  • When your house appreciates, your wealth increases.
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2
Q

What is the definition of money?

A

Money is the set of assets in an economy that people regularly use to buy goods and services from other people.

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3
Q

What are the three principal uses of money?

A
  1. Medium of exchange.
  2. Unit of account.
  3. Store of value.
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4
Q

What would people use if money did not exist?

A

Without money people would have to rely on a barter system.

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5
Q

Why does barter not work?

A

Because of what is known as Double Coincidence of Needs. Both people on each side of an exchange must have items of the same value, that the other side wants.

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6
Q

What is meant by a unit of account?

A

Money provides a system by which to evaluate the value of many different goods and services.

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7
Q

What are the benefits of a medium of exchange?

A

Mediums of exchange help society to escape the complications of barter and gain the benefits of specialisation.

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8
Q

In order for money to function as a medium of exchange what attributes must it have?

A
  1. Acceptable to all
  2. Limited in supply (scarce)
  3. Readily portable
  4. Divisible
  5. Durable and non-perishable
  6. Stable in value
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9
Q

Why must money be acceptable to all?

A

Because if it isn’t accepted then it cannot be used as a medium of exchange?

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10
Q

Why must money be limited in supply?

A

Because if there is an infinite supply of money then it has no value.

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11
Q

Why must money be readily portable?

A

So that it can be easily carried and used.

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12
Q

Why must money be divisible?

A

So that it can be easily used to buy goods and services of different values.

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13
Q

Why must money be durable and non-perishable?

A

So that the money does not expire.

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14
Q

Why must money be stable in value?

A

So that the purchasing power is maintained.

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15
Q

True/False: Money is the most liquid asset.

A

True. It can easily be converted into goods and services, unlike other less liquid assets such as a house, or shares in a company.

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16
Q

What is commodity money?

A

Commodity money has intrinsic value. Salt would be an example of commodity money, so would shares in a business.

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17
Q

How is the liquidity of different kinds of money categorised?

A

M1 and M2.

M1 is the most liquid.

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18
Q

What does M1 money consist of?

A
  1. Currency.
  2. Demand deposits.
  3. Other checkable deposits.
  4. Travelers’ checks.
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19
Q

What does M2 money consist of?

A
  1. M1 money.
  2. Savings Deposits.
  3. Small-denomination time deposits.
  4. Money market mutual funds.
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20
Q

Is money deposited in a bank considered a liability for the bank or an asset?

A

It is both. The money itself is an asset and can be used for loans etc to make money. But the deposit is a liability because at anytime the owner of the money can come back and claim it.

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21
Q

What is 100% reserve banking?

A

A banking system in which the assets and liabilities of a bank are equal. I.e. the bank keeps all money that is deposited and do not lend anything out. No bank does this.

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22
Q

Why don’t banks keep 100% reserve?

A

Because when they lend the money that is deposited out they are able to make money on the interest of those loans. Also it is extremely unlikely that everyone will suddenly request all their money from the bank at once, so they only need to keep enough of a reserve that they are able to satisfy peoples transactions.

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23
Q

What is it called when a bank does not keep 100% of the deposits as a reserve?

A

Fractional Reserve Banking.

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24
Q

Why is the money supply so much larger than the currency supply?

A

Because when a loan is taken out, that money is given to the seller, and then deposited by the seller back in a bank. This money can then be loaned out again. This increases the money supply.

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25
Q

True/False: The money supply can grow infinitely.

A

False. The money supply will only grow up to the reserve limit of the bank. If a bank has 10% reserves, then they will only have deposits up to 10x the banks reserves. They will not loan out money beyond this.

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26
Q

What is a money multiplier?

A

The money multiplier is 1 divided by the reserve ratio.

1/10% would be 10x.

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27
Q

What is the Reserve Bank of New Zealand?

A

The Reserve Bank of NZ is New Zealand’s central bank, it is responsible for monetary policy and the oversight and regulation of financial markets.

28
Q

What is monetary policy?

A

Monetary policy is deciding and managing the size of the nation’s money supply. This is influenced via the official cash rate (OCR).

29
Q

What are open market operations?

A

Open market operations refers to the sale and purchase of government bonds in the open market.

30
Q

What happens when the central bank purchases a bond from the public?

A

The central bank pays the bond holder with new money. This money is then deposited and leads to multiple expansion of the money supply.

31
Q

What happens when the central bank sells a bond to the public?

A

The bondholder pays with checking funds. The banking reserves therefore decrease and lead to multiple contraction of the money supply.

32
Q

What are short-run economic fluctuations?

A

Economic activity fluctuates from year to year. In most years the production of goods and services rises. In some years normal growth does not occur causing a recession.

33
Q

What is a recession?

A

A recession is a period of declining real GDP, falling incomes, and rising unemployment.

34
Q

What is a depression?

A

A depression is a severe recession.

35
Q

What is a recession as defined by Keynes?

A

Keynes defined a recession as a situation with insufficient demand. Low demand, leads to low supply, leads to unemployment.

36
Q

True/False: Economic fluctuations are predictable.

A

False. Economic fluctuations are irregular and unpredictable.

37
Q

What are fluctuations in the economy often called?

A

The business cycle.

38
Q

True/False: Most macroeconomic variables fluctuate together.

A

True.

39
Q

What are the two important variables that are used to analyse the short-run fluctuations?

A
  1. Real GDP.

2. CPI or GDP deflator.

40
Q

What is the aggregate demand curve?

A

The aggregate demand curve shows the quantity of goods and services that households, firms and the government want to buy at each price level.

41
Q

What is the aggregate supply curve?

A

The aggregate supply curve shows the quantity of goods and services that firms want to produce and sell at each price level.

42
Q

What is the equation for aggregate demand?

A 
AD = C + I + G + NX
AD = Aggregate Demand.
C = Consumer Demand
I = Investment Demand
G = Government Demand
NX = Export Demand

This is the same as the GDP equation.

43
Q

Why is aggregate demand curve downward sloping?

A
  1. The wealth effect.
  2. The interest rate effect.
  3. The exchange rate effect.
44
Q

What is the wealth effect?

A

A decrease in price levels makes consumers feel more wealthy, which in turn encourages them to spend more, this increase in consumer spending means larger quantities of goods and services are demanded.

45
Q

What is the interest rate effect?

A

A lower price level, means consumers need to hold less liquid cash. Can put more money in interest bearing assets. More loanable funds, more investment demand.

46
Q

What is each of the three effects that cause the downward slope of the aggregate associated with?

A
  1. The wealth effect -> Consumer demand (C).
  2. The Interest rate effect -> Investment demand (I).
  3. The exchange rate effect -> Net Export Demand (NX).
47
Q

What is the Mundell-Fleming theory to explain NX?

A

A lower price level in a country will lead to lower rate of interest, and investors will seek higher returns by investing overseas. Thus they will sell domestic bonds to buy foreign bonds, thus increasing the supply of domestic money to the foreign exchange market. This depreciates the domestic dollar, increasing exports and decreasing imports.

48
Q

True/False: Exports change as a result of a change in GDP.

A

False. Exports do not change because of a change in GDP. Exports depend on the rest of the world’s expenditure. Consequently net exports increase as imports fall due to a fall in GDP.

49
Q

How will the aggregate demand curve shift if firms become pessimistic about future business conditions?

A

It will shift to the left, as they may cut back on investment spending.

50
Q

What effect does an investment tax credit have on the aggregate demand curve?

A

It will increase the quantity of investment goods demanded by firms resulting in an increase in aggregate demand.

51
Q

How would a change in the government’s plans to spend money on infrastructure affect the aggregate demand?

A

A reduction in purchases of infrastructure, will result in a reduction in aggregate demand.

52
Q

In the long run the aggregate supply curve is ____?

A

Vertical, because it has nothing to do with the price level, and is instead a result of the country’s productive capacity.

53
Q

In the short run the aggregate supply curve is ____?

A

Upward sloping.

54
Q

What are the other terms for the natural rate of output?

A

Full-employment output, and potential output.

55
Q

What may cause a change in the long run aggregate supply curve?

A
  1. Labour.
  2. Capital.
  3. Natural Resources.
  4. Technology.
56
Q

Why does the aggregate supply curve slope upwards in the short-run?

A
  1. The Misperceptions Theory.
  2. The Sticky-Wage Theory.
  3. The Sticky-Price Theory.
57
Q

What is the Misperceptions Theory?

A

Increases in the overall price level temporarily mislead suppliers about what is happening in the markets in which they sell their output. They believe it is only their price that is going up and respond by increasing supply.

58
Q

What is the Sticky-Wage Theory?

A

Nominal wages are slow to adjust or are “sticky” in the short run (wages are negotiated once a year). This induces firms to reduce the goods and services supplied to try and save money when prices reduce.

59
Q

What is the Sticky-Price Theory?

A

Prices of goods and services adjust sluggishly in response to changing economic conditions. This affects their sales, causing them to change the quantity of goods and services they produce. Prices cannot change quickly without angering customers.

60
Q

What is stagflation?

A

Stagflation is a situation in which the price level rises, but output falls.

61
Q

What is a supply shock?

A

A situation where there is a sudden shift in the price and/or supply of a good.

62
Q

What can a government do to correct stagflation?

A
  1. Expansionary fiscal policy, increase government spending, reduce taxes (increase inflation, increase GDP).
  2. Contractionary fiscal policy, reduce government spending, (reduce inflation, reduce GDP).
63
Q

What is the issue with government intervention in stagflation?

A

Because any intervention from the government will solve one side at the cost of the other. The government cannot fix both problems at the same time (stagnation & inflation).

64
Q

What is the expansionary gap?

A

A situation where an increase in aggregate demand beyond the potential output, causes an increase in inflation.

65
Q

True/False: In the long run the economy tends to be self-correcting.

A

True.

66
Q

What are the two ways the government can use monetary and fiscal policy to combat a recession?

A
  1. Indirectly stimulate aggregate demand via increases in aggregate consumption via tax cuts, subsidies benefits etc…
  2. Directly affect aggregate demand by increasing government spending.

Economics 151 (10 decks)

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