Unit 2 Test Flashcards
A measure of the overall cost of the goods and services bought by a typical consumer.
Consumer Price Index (CPI)
What are the 5 steps to calculate the CPI?
- Fix the basket
- Find the prices
- Compute the basket’s price
- Choose a base year and compute the CPI
- Compute the inflation rate
[Price of basket of goods and services in current year/Price of basket in base year] * 100
Equation for Consumer Price Index (CPI)
The percentage change in the price index from the preceding period.
Inflation Rate
A measure of the overall cost of consumer goods and services excluding food and energy.
Core CPI
([CPI in Year 2 - CPI in Year 1] \ CPI in Year 1) * 100
Inflation Rate in Year 2
A measure of the cost of a basket of goods and services bought by firms.
Producer Price Index (PPI)
What are 3 problems with how the CPI is calculated?
- Substitution bias
- Introduction of new goods
- Unmeasured quality change
The CPI computation assumes a fixed basket of goods, but because not all prices change proportionately, consumers substitute towards goods that have become relatively less expensive. These changes in the basket of goods and services is not accounted for in the computation of CPI.
Substitution Bias
As new goods are introduced, consumers have more choices, and each dollar is worth more. But because the CPI is based on a fixed basket of goods and services, it does not reflect the increase in the value of the dollar that results from the introduction of new goods.
Introduction of New Goods
When the quality of a good in the basket changes, the Bureau adjusts the price of the good to account for the quality change, but quality is hard to measure.
Unmeasured Quality Change
What are 2 differences between the GDP Deflator and the Consumer Price Index?
- GDP Deflator: reflects the prices of all goods and services produced domestically; CPI: reflects the prices of all goods and services bought by consumers.
- GDP Deflator: compares the price of currently
produced goods and services to the price of the same goods and services in the base year; CPI: compares price of a fixed basket of goods and services to the price of the basket in the base year
Amount in year T dollars * [Price level today/Price level in year T]
The formula for turning dollar figures from year T into today’s dollars.
The automatic correction by law or contract of a dollar amount for the effects of inflation.
Indexation
Nominal interest rate - Inflation rate
Real Interest Rate
Interest rate corrected for the effects of inflation.
Real Interest Rate
The group of institutions in the economy that help match one person’s saving with another person’s investment
Financial System
What are the 2 categories into which financial institutions are grouped?
Financial Markets
Financial Intermediaries
Financial institutions through which savers can directly provide funds to borrowers
Financial Markets
What are the 2 most important financial markets in the economy?
Stock Market
Bond Market
A certificate of indebtedness
Bond
What are 4 significant characteristics of bonds?
Term
Credit Risk
Tax Treatment
Inflation Protection
The length of time until a bond matures.
Bond Term
The probability that the borrower will fail to pay some of the interest or principal.
Credit Risk
The way the tax laws treat the interest earned on a bond.
Tax Treatment
Whether a bond is written in nominal terms or if payments are indexed to inflation.
Inflation Protection
A claim to partial ownership in a firm.
Stock
Financial institutions through which savers can indirectly provide funds to borrowers.
Financial Intermediaries
What are 2 of the most important financial intermediaries?
Banks
Mutual Funds
An institution that sells shares to the public and uses the proceeds to buy a portfolio of stocks and bonds.
Mutual Fund
S = Y - C - G
Identity for National Saving (national saving = investment in a closed economy)
S = (Y - T - C) + (T - G)
Identity for National Saving (including taxes)
Y - T - C
Identity for Private Saving
T - G
Identity for Public Saving
Income that households have left after paying for taxes and consumption.
Private Saving (Y - T - C)
Tax revenue that the government has left
after paying for its spending.
Public Saving (T - G)
T - G > 0
Budget Surplus
Excess of tax revenue over government
spending.
Budget Surplus
T - G < 0
Budget Deficit
Shortfall of tax revenue from government
spending.
Budget Deficit
The purchase of new capital.
Investment
The market in which those who want to save supply funds and those who want to borrow to invest demand funds.
Market for Loanable Funds
The source of the supply of loanable funds.
Saving
The source of the demand for loanable funds.
Investment
The Y axis on the supply-demand graph for loanable funds shows __________ .
Interest Rate
What are 3 ways government policies can affect the market for loanable funds?
Saving Incentives
Investment Incentives
Government Budget Surpluses/Deficits
What is an example of a policy that would provide a saving incentive?
A policy that would allow people to shelter some of their saving from taxation.
Does a saving incentive policy affect the supply or demand in the market for loanable funds? Does it increase or decrease?
Supply
Increase
How are the equilibrium interest rate and equilibrium quantity affected by saving incentive policies?
Lower Interest Rate
Higher Quantity of Loanable Funds
What is an example of a policy that would provide an investment incentive?
An investment tax credit.
Does an investment incentive policy affect the supply or demand in the market for loanable funds? Does it increase or decrease?
Demand
Increase
How are the equilibrium interest rate and equilibrium quantity affected by investment incentive policies?
Higher Interest Rate
Higher Quantity of Loanable Funds
Does a government deficit affect the supply or demand in the market for loanable funds? Does it increase or decrease?
Supply
Decrease
How are the equilibrium interest rate and equilibrium quantity affected by a government deficit?
Higher Interest Rate
Lower Quantity of Loanable Funds
Does a government surplus affect the supply or demand in the market for loanable funds? Does it increase or decrease?
Supply
Increase
How are the equilibrium interest rate and equilibrium quantity affected by a government surplus?
Lower Interest Rate
Higher Quantity of Loanable Funds
A decrease in private investment that results from government borrowing.
Crowding Out
The unlikely occurrence that two people each have a good or service that the other wants.
Double Coincidence of Wants
The set of assets in an economy that people regularly use to buy goods and services from other people.
Money
What are the 3 functions of money?
- Medium of Exchange
- Unit of Account
- Store of Value
An item that buyers give to sellers when they want to purchase goods and services.
Medium of Exchange
The yardstick people use to post prices and record debts.
Unit of Account
An item that people can use to transfer purchasing power from the present to the future.
Store of Value
The ease with which an asset can be converted into the economy’s medium of exchange.
Liquidity
Money that takes the form of a commodity with intrinsic value.
Commodity Money
Money without intrinsic value that is used as money by government decree.
Fiat Money
The paper bills and coins in the hands of the public.
Currency
Balances in bank accounts that depositors can access on demand by writing a check.
Demand Deposits
An institution designed to oversee the banking system and regulate the quantity of money in the economy.
Central Bank (Federal Reserve)
The setting of the money supply by policymakers in the central bank.
Monetary Policy (made by the Federal Open Market Committee - FOMC)
What are the 2 jobs of the Federal Reserve?
- Regulate banks and ensure the health of the banking system.
- Control the quantity of money available in the economy (money supply).
Deposits that banks have received but have not loaned out.
Reserves
A banking system in which banks hold only a fraction of deposits as reserves.
Fractional-reserve Banking
The fraction of deposits that banks hold as reserves.
Reserve Ratio
The amount of money the banking system generates with each dollar of reserves.
Money Multiplier
1/R, the reciprocal of the reserve ratio.
Money Multiplier
Interest rate at which banks make overnight loans to one another.
Federal Funds Rate
The purchase and sale of U.S. government bonds by the Fed.
Open Market Operations
Increase in the overall level of prices.
Inflation
Decrease in the overall level of prices.
Deflation
Extraordinarily high rate of inflation.
Hyperinflation
A theory asserting that the quantity of money available determines the price level and that the growth rate in the quantity of money available determines the inflation rate.
Quantity Theory of Money
In the diagram for the supply and demand of money, what is shown on the left vertical axis?
Value of Money
In the diagram for the supply and demand of money, what is shown on the right vertical axis?
Price Level
How are the value of money and the price level related?
The value of money (1/P) is the reciprocal of the price level (P).
In the diagram for the supply and demand of money, the price level on the right vertical axis increases / decreases from bottom to top.
Decreases
In the diagram for the supply and demand of money, the value of money on the left vertical axis increases / decreases from bottom to top.
Increases
In the diagram for the supply and demand of money, the money supply curve is vertical because…
The quantity of money is fixed by the Fed.
Variables measured in monetary units.
Nominal Variables
Variables measured in physical units.
Real Variables
The theoretical separation of nominal variables and real variables.
Classical Dichotomy
The proposition that changes in the money supply do not affect real variables.
Monetary Neutrality
The rate at which money changes hands.
Velocity of Money
V = [P * Y]/M
Formula for the velocity of money
In the formula for the velocity of money, the P equals…
Price Level
In the formula for the velocity of money, the Y equals…
Real GDP
In the formula for the velocity of money, the M equals…
Money Supply
In the formula for the velocity of money, P * Y equals…
Nominal GDP
M * V = P * Y
Quantity Equation
The revenue the government raises by creating money.
Inflation Tax
The resources wasted when inflation encourages people to reduce their money holdings.
Shoeleather Costs
The costs of changing prices .
Menu Costs
