Econ 201 Study Guide O'Dea

Econ 201 Final study
Exam: Ch.12 – 16
[ ] test file
[ ] print flash cards of multiple choice and equations
[ ] homework (practice) online
[ ] review practice in quiz sections (highlighted)
[ ] draw all graphs, label scenarios / practice
[ ] practice sets
[ ] organize notes, finalize to memorize morning of

Chapter 12: “Aggregate Demand and Aggregate Supply”
Lecture notes:
Aggregate Demand: Shows the relationship between the aggregate price level and the quantity of aggregate output demanded by households, businesses, government, and the rest of the world.
-A movement down the AD curve leads to a lower aggregate price level and higher aggregate output. * Y = C + I +G + NX
(before adding G and NX back into the Keynesian Cross to discuss fiscal policy and trade.)
Now- price level.
The Aggregate Demand Curve: Shows the relationship between the aggregate price level and the quantity of aggregate output demanded. *Not the same as micro.
*if all prices change
Wealth Effect of a change in the aggregate price level: the effect on consumer spending caused by the effect of a change in the aggregate price level on the purchasing power of consumers’ assets.
Interest Rate Effect of a change in the aggregate price level: the effect on consumer spending and investment spending caused by the effect of a change in the aggregate price level on the purchasing power of consumers’ and firms’ money holdings.

Downward sloping for two reasons: 1. Wealth effect of a change in the aggregate price level. This reduces purchasing power in households, reducing consumer spending. a. A fall in the price level is an increase in purchase power.
-Shift up of planned AE aggregate expenditure curve.
-Shift along the aggregate demand curve. 2. Interest rate effect of a change in aggregate price level.
Aggregate Definition: A collection of items that are gathered together to form a total quantity.

Outcomes:
-If you lower the price level… * There is a movement along the aggregate demand curve. * This increases output and consumption, shifting Planned aggregate spending upward, resulting in a new Y2 along the 45degree line. * Resulting in more GDP
Therefore, Lower price level = higher consumption, AE curve goes up.
**A shift in the price level causes: * Shift of the AE curve * Movement along the AD curve * Anything that changes firm production or consumption = a shift.
AD curve shifts when: * Changes in expectations * Changes in wealth * Changes in stock of physical capital * If existing stock of physical capital is relatively small, AD increases * Change in government spending * Fiscal and monetary policy
Factors that Shift Aggregate Demand:
-Aggregate demand Increases when: * Changes in expectations: * when consumers and firms become more optimistic. * Changes in Wealth: * When the real value of household assets rise. * Size of the existing stock of physical capital: * When the existing stock of physical capital is relatively small. * Fiscal Policy: * When the government increases spending or cut taxes. * Monetary Policy: * When the central bank increases the quantity of money.

Increase in output = increase in consumption or investment - increase in AD. * An inward shift would be caused by a rise in interest rates due to worse business conditions.
Multiplier effect: upward move in the $ market.
Monetary Policy: If bank increases quantity of money, AD increases.

Aggregate Supply Curve: the relationship between the aggregate price level and the quantity of aggregate output supplied in the economy.
*In the LR total possible production doesn’t depend on prices. only on physical capital, human capital, and technology.
*In the SR prices may affect how much production is possible. wages are different than other prices.
=Sticky Wages.

SR aggregate Supply Curve: Upward sloping because nominal wages are sticky in the SR.
-Higher aggregate price level leads to higher profits and increased aggregate output in SR.
-revenue rises, but wages don’t.
Nominal wage: dollar amount of the wage paid.
Sticky wages: nominal wages that are slow to fall even in the face of unemployment, also slow to rise in the face of labor shortages.
Short-run Aggregate Supply Curve: Shows the relationship between the aggregate price level and the quantity of aggregate output supplied that exists in the short run, the time period when many production costs can be taken as fixed.
*SRAS shifts include anything that affects firm profitability.
Increase when: * Commodity prices Fall * Nominal wages Fall * Productivity Rises.
Long-run aggregate supply: Relationship between aggregate price level and quantity of aggregate output supplied. As long as all prices, including nominal wages, were fully flexible.
Ex: a fall in the aggregate price level leaves output supplied unchanged in the long run due to the economy returning to potential output.
LRAS curve = vertical. * In SR wages don’t follow rest of prices, however… * Actual and potential output * Quantity of LRAS is constant * Economic growth shifts the LRAS curve rightward.
Actual and Potential Output: * In a recession actual output is below potential output.
Potential Output: Level of real GDP the economy would produce if all prices, including nominal wages, were flexible.
* a rise in nominal wages shifts SRAS leftward. (opposite applies)
*long run changes in aggregate price level change no effect on aggregate output.
*if actual aggregate output exceeds potential output, nominal wages eventually rise and the short-run aggregate supply curve shifts leftward.
The economy is in Short-run macroeconomic equilibrium when the quantity of aggregate output supplies is equal to the quantity demanded.
Negative demand shock = recession. * Aggregate expenditure at every level falls. * Inward shift of the aggregate demand. Lower price, lower output.
Positive demand shock * Outward shift of the aggregate demand * Increase in aggregate expenditure. * Higher price, higher output. Inflation?
Supply shocks * Negative: inward shift of supply curve. Higher price level, lower output. Inflation + recession. * Positive: opposite. * Ex: improvements to technology.
The economy is in a Long-run macroeconomic equilibrium when the point of short-run macroeconomic equilibrium is on the long-run aggregate supply curve. *A rise in the wages shifts SRAS outward.
Long-run
-growth takes place over decades.
In long run, actual aggregate output fluctuates around potential output.
Rate of growth = close to potential.
Recessionary gap: aggregate output is below potential. 1. An initial negative demand shock reduces the aggregate price level and aggregate output and leads to higher unemployment in the short run until an eventual fall in nominal wages in the Long run increases SRAS and moves back to potential output.
Inflationary gap: aggregate output is above potential output.
Output gap: the percentage difference between actual and potential output. (Actual aggregate output – potential output) / potential output x100 Self-correcting shocks to aggregate demand affect aggregate output in short term but not long run.
Stabilization policy: the use of government policy to reduce the severity of recessions and rein in excessive strong expansions.
(offset demand shocks) * May lead to a long-term rise in the budget deficit and lower long-run growth because of crowding out. * Due to incorrect predictions, a misguided policy can increase economic instability.
Negative supply shock dilemma-
-Fighting the slump in aggregate output worsens inflation and fighting inflation worsens the slump.
Supply shock not a lot of policies to deal with this.
Policy dilemma: one that counteracts the fall in aggregate output by increasing aggregate demand.
--- Keynesian corss with Govt and trade ---
In equilibrium
Y = C + IPlanned
Full income accounting identity: Y = C + I + G + NX
Equilibrium: Y = a + MPC * (Y-T) + IPlanned + G + NX
Government can affect AE through G and T
AEplanned = C (Y-T) + Iplanned + G +NX
*cutting taxes will increase consumption, shifting AE up.
-This increases spending which shifts AE up. Fiscal policy!
* if the economy is in SR equilibrium, and the government increases G, this will increase both prices and output in the SR.

Chapter 13: “Fiscal Policy”
Social Insurance: Government programs that are intended to protect families against economic hardship.
Expansionary Fiscal Policy: Increases aggregate demand by closing the inflationary gap.
-an increase in government pruchases of goods and services
-a cut in taxes
-an increase in government transfers
Contractionary Fiscal Policy: Fiscal Policy that reduces aggregate demand.
-reduction in government purchases of goods and services
-an increase in taxes
-reduction in government transfers Arguments against the use of expansionary fiscal policy: * Government spending always crowds out private spending * Government borrowing always crowds out private investment spending * Government budget deficits lead to reduced private spending.
*most government transfers in the US are social insurance programs.
Government influences C and I through taxes and transfers time lags can reduce the effectiveness of fiscal policy.
The amount by which changes in government purchases raise real GDP is determined by the multiplier.
*in the market equilibrium if Y* is too small, (less than potential) then they can increase G.
-- this leads to the multiplier process. They spend 25, get 100. Change in Y = Change in G times the spending multiplier **keep in mind that when government saves, people do not spend all the money. They only spend what the spending multiplier is. Tax multiplier = -MPC / 1-MPC . (negative because an increase in taxes decreases spending. Spending increases Y but raising taxes reduces Y. Balanced Budget multiplier: Spending multiplier + Tax multiplier. *hard to fight a recession and balance a budget at the same time. Budget balance: Sgovernment = T – G – TR *the budget deficit tends to rise during recessions and fall during expansions. This reflects the effect of the business cycle on the budget balance. Automatic Stabilizers: Spending that occurs automatically when there is a recession. Government spending and taxation rules that cause fiscal policy to be automatically expansionary when the economy contracts and automatically contracting when the economy expands. -unemployment insurance -Progressive taxation -income redistribution * a recessionary gap leads to a rise in unemployment claims and therefore a rise in spending. (govt) - US government budget accounting is calculated on the basis of fiscal years.
Lump taxes: taxes that don’t depend on the tax payer’s income.
Taxes
Lump-Sum: A tax scheme that is levied as a fixed amount. Proportional Tax: levied as a percentage of income. The change in RGDP = Change in Net Taxes * Tax Multiplier - taxes reduce the size of the multiplier unless they are lump-sum taxes. Discretionary fiscal policy: The result of deliberate actions by policy makers, rather than rules. More controversial than automatic stabilizers. Cyclically adjusted budget balance: An estimate of what the budget balance would be if Real GDP were exactly equal to potential output. Fiscal year: Oct 1 – Sept 30th, labeled in the year in which it ends. Deficit: difference between the amount of money a government spends and the amount it receives in taxes over a given period. Public debt may Crowd out investment spending, which reduces long run economic growth. –market for loanable funds. In an extreme case, rising debt may lead to government default, resulting in economic and financial turmoil. Mostly long-run problems Public Debt: government debt held by individuals and institutions outside the government. *budget deficit as a percentage of GDP moved closely in tandem with unemployment rate. Debt- GDP Ratio: can remain stable or even fall in the face of moderate budget deficits because of GDP over time. -indicator of fiscal health Impact liabilities: Spending promises made by government that are effectively a debt despite the fact that they are not included in the usual debt statistics. -social securities, Medicare and Medicaid. *persistent budget deficits lead to increases in public debt. --Rising public debt can lead to government default.

Chapter 14: “Money, Banking, and the Federal Reserve System”
Federal reserve undertakes monetary policy. Their actions affect the banking and loan process.
Monetary policy shifts AD by manipulating money supply. Used to close recessionary gap.
Central bank: is an institution that oversees and regulates the banking system and controls the monetary base.
-the federal reserve is our central bank. * Consists of board of governors, plus 12 regional Federal Reserve banks. * Makes policy decisions through the “Federal Open Market Committee” – FOMC
-The board of governors plus 5 regional presidents, the 5 rotate. Chairman – Ben Bernake
The Fed has 3 major policy tools:
-the Reserve Requirement
-The Discount Rate
-Open Market Operations
Monetary Base: the Sum of currency in circulation and bank reserves.
Money Multiplier: The ratio of the money supply to the monetary base.
Money supply/ monetary base
OR 1/RR (reserve ratio)
Federal Funds Market: allows banks that fall short of the reserve requirement to borrow funds from banks with excess reserves.
-allowing them to meet their overnight reserve requirements.
Federal Funds Rate: the interest rate determined by the federal funds market
-lowering the Federal Funds Rate, increases the money supply.
Discount Rate: the interest rate on loans that federal reserve makes to banks
-The discount rate is for borrowing directly from the Fed. -Bad sign for abank to need the feds money.
Open market operations: The Fed buying and selling assets in the open market, like any other trader.
* an open market purchase of treasury bills increases the monetary base and therefore the money supply.
-the fed can increase or reduce the monetary base by buying government debt from banks or selling government debt to banks.
Typical trade – Fed buys US treasury bills, pays with cash.
When the Fed buys something, they pay with brand new money that didn’t exist before.
=putting cash into the economy.
Money: anything that can be used to purchase goods and services. (assets)

The most liquid asset turning into cash without loss of value.
Ex: checking account: liquid
Home: illiquid
Currency in circulation: cash held by the public.
Checkable bank deposits: bank accounts on which people can write checks.
Money Supply: total value of financial assets in the economy. * Sales when defining GDP
Medium of exchange: an asset that individuals acquire for the purpose of trading rather than for their own consumption.
Store of Value: Holding purchasing power over time.
Unit of account: A measure used to set prices and make economic calculations.
Commodity money: A good used as a medium of exchange that has intrinsic value in other uses.
Commodity-backed money: A medium of exchange with no intrinsic value whose ultimate value is guaranteed by a promise that it can be converted into valuable goods.
Fiat money: a medium of exchange whose value derives entirely from it’s official status as a means of payment.
Measuring the Money Supply:
Monetary aggregate: An overall measure of the money supply. (M1 and M2)
Near-Moneys: Financial assets that can’t be directly used as a medium of change but can be readily converted into cash or checkable bank deposits.

Assets and Loans example: * Assets: * Loan 900$ * Reserve 100$ * Liabilities: 1000$
Excess reserves: Bank reserves over and above the bank’s required reserves.
Categories of new money:
-M1: Closer to money: traveler’s checks, checkable bank deposits
-M2: less close, more of it: savings deposits

Financial intermediary: Uses liquid assets in form of bank deposits to finance the illiquid investment of borrowers.
T-Account: a tool for analyzing a business financial position. Table: assets – left. Liabilities – right.
Bank Reserves: Currency held + deposits at Federal Reserve.
Reserve Ratio: Fraction of bank deposits that a bank holds as reserve.
Bank Run: many depositors try to withdraw their funds.
--Bank regulation-- 1. Deposit insurance: Guarantees that a bank’s depositors will be paid even if the bank can’t come up with the money. 2. Capital Requirements 3. Reserve requirements: Rules set by Federal Reserve that determines the minimum ratio for a bank. a. If the federal reserve raised the reserve requirement, the supply of money lowers and raises the interest rate. 4. Discount window: An arrangement in which the Federal Reserve lends money to banks when in trouble.
Commercial bank: accepts deposits and is covered by deposit insurance.
Investment bank: Trades financial assets and is not covered by deposit insurance.
Savings and Loan: another type of deposit-taking bank, usually specialized in issuing home loans.
Leverage: A financial institution finances its investment with borrowed funds.
Balance sheet effect: The reduction in a firms’ net worth due to failing asset prices.
Vicious cycle of deleveraging: Takes place when asset sales to cover losses produce negative balance sheet effects on other firms and force creditors to call in their loans, forcing sales of more assets and causing further declines in asset policies.
Subprime Lending: lending to home-buyers who don’t meet the usual criteria for being able to afford their payments.
Securitization: a pool of loans is assembled and shares of that pool are sold to investors. “Shadow banking” – institutions reciprocating bank jobs but without regulations, taking bigger risks.
Short-term interest rates: interest rates on financial assets that mature
-treasury bills pay lower interest rates – safest asset
Money Demand Curve: shows the relationship between the quantity of money demanded and the interest rate.
Shifts of the Money Demand Curve: * Changes in the aggregate price level * Changes in Real GDP * Changes in Technology * Interest rates always stay the same during a shift of the money demand curve, but the quantity of money changes.
M1: money you can use for purchases.
Money Supply curve is chosen by the fed.
*holding money provides liquidity but incurs an opportunity cost that rises with the interst rate, leading to a downward slope of the money demanded curve.
Chapter 15: “Monetary Policy”
*Money supply is chosen by the Fed
Typical exercise of monetary policy- * The Fed buys T-Bills, pays with new money. * Money leads to lending * Money supply curve shifts outward.
Target federal funds rate- * If the Fed wants it higher, they can make an open-market sale, which drives the interest rate up.
Liquidity preference model of the interest rate: according to this, the interest rate is determined by the supply and demand for money.
Money Supply curve: shows how the quantity of money supplied varies with the interest rate.
*if the quantity of money exceeds the money supply curve chosen by the fed, (verticle line) then it is below equilibrium interest rate, and investors will raise the interest rate, lowering the Q of money to equilibrium.
Expansionary Monetary Policy: Increase money supply, lower interest rate, higher investment spending raises income, higher consumer spending (via multiplier) = increase in aggregate demand and AD curve shifts to the right.
Contractionary Monetary Policy: opposite ^
*As interest rates fall, the Market for Loanable funds raises
IPlanned depends on firm’s decisions about investment opportunities. * The lower the interest rate, the more projects are profitable. * Lower interest rate – Higher planned investment * Higher interest rate – Lower planned investment. * A reduction in the interest rate leads to a rise in planned investment, shifting AE up, RGDP rises.
If there is equilibrium at an output above potential, the fed could close the gap by selling T-bills, lowering money supply and raising interest rates.
Scenario:
1) Increase in the money supply reduces the interest rate and increases AD 2) But the eventual rise in nominal wages leads to a fall in short run aggregate supply and aggregate output falls back to potential. 3) This creates a new Equilibrium at a point with less interest rate.
In the LR, expansionary monetary policy will lead to higher prices.
Taylor Rule for Monetary Policy: a rule that sets the federal funds rate according to the level of the inflation rate and either the output gap or the unemployment rate.
Inflation targeting: occurs when the central bank sets an explicit target for the inflation rate and sets monetary policy in order to hit that target.
Zero Lower bound for interest rates: Interest rates cannot fall below zero. – limits the power of monetary policy.
Taylor rule = forward looking price rule. * Target funds rate rises when there is high inflation and either a positive output gap or very low unemployment; it falls when there is a low or negative inflation and either a negative output gap or high unemployment.
*monetary policy is the main tool for macroeconomic stabilization because it is subject to fewer lags than fiscal policy.
Monetary Neutrality: Changes in the money supply have no real effect on the economy.
(example in quiz section notes). In the Long Run, changes in the money supply affect the aggregate price level but not real GDP or interest rate.
*Money in the LR*
-- If there were no wage stickiness, SRAS would adjust immediately after the Fed shifted AD.
(no room for monetary policy)
“real money supply” = M/P
*an increase in the money supply reduces the interest rate and increases aggregate demand. But the eventual rise in nominal wages leads to a fall in short-run aggregate supply and aggregate output falls back to potential output.
Interest rate in the SR * In the short run, and increase in the money supply reduces the interest rate. * This leads to a short-run increase in RGDP and an increase in the Supply of Loanable Funds
Interest rate in the LR 1) In the LR the rise in the price level shifts the money demanded curve to the right 2) Raising the interest rate back to its original level 3) Reducing the RGDP and the supply of loanable funds until aggregate output equals potential output.
Chapter 16: “Inflation, Disinflation, and Deflation”
-Expanding the money supply can lower interest rates and shift AD outward.
This can lead to more inflation and speed up how quickly SRAS shifts inwards, as wages rise. * Even larger increase in money supply needed to do the same. * Leads to hyperinflation.
Seignorage: government gains money from printing money. Deflation facts: Transactions of money, quantity X velocity drives the level of prices. Confidence in the market can determine a cause of deflation even if there is an increase in money supply.
*Deflation hurts borrowers – the dollar now represents more $
Classical Model of the Price Level: The real quantity of money is always at its long-run equilibrium level. * An increase in money supply shifts the aggregate demand curve rightward. * Then, in the LR, nominal wages adjust upward and push the SRAS curve leftward.
*The total percent increase in the price level is equal to the percent increase in the money supply. – works for high inflation economics.
-The classical model ignores trasition period in SR and assumes LR result.
Inflation Tax: The reduction in the value of money held by the public cause by inflation.
-caused by government printing money to cover a budget deficit.
Real inflation tax = seignorage
=viscous circle of shrinking real money supply and a risin rate of inflation. – hyperinflation, financial crisis.
*in the SR policies that produce a booming economy also tend to lend to higher inflation, and policies that reduce inflation tend to depress the economy.
*high inflation rate causes people to reduce their real money holdings, leadiging to the printing of more money and higher inflation in order to collect the inflation tax.
-can cause hyperinflation
Okun’s Law: The negative relationship between the output gap and cyclical unemployment.
-Output gap raises 2x as much as inflation rate.
Short-run Phillips Curve: The negative short-run relationship between the unemployment rate and the inflation rate.
-The SRPC slopes downward because the relationship between the unemployment rate and the inflation rate is negative.
*increase in aggregate demand leads to both inflation and a fall in the unemployment rate. negative supply shock shifts SRPC up & vice versa. * An increase in the expected rate of inflation pushes the SRPC upward.
Nonaccelerating inflation rate of unemployment (NAIRU): The unemployment rate at which inflation does not change over time. =to rate of unemployment.
Long-Run Phillips curve: shows the relationship between unemployment and inflation after expectations of inflation have had time to adjust to experience.
Disinflation: the process of bringing down inflation that is embedded in expectations.
The LRPC is vertical and shows that an unemployment rate below the NAIRU cannot be maintained in the LR. – limits expansionary policies.
*disinflation imposes high costs – unemployment and lost output – on an economy. Governments do it to avoid costs of persistently high inflation.
Debt inflation: the reduction in aggregate demand arising from the increase in the real burden of outstanding debt caused by deflation.
-There is a Zero Bound on the nominal interest rate: it cannot go below zero.
Liquidity Trap: When the economy’s conventional monetary policy is ineffective because nominal interest rates are up against the zero bound.
*unexpected deflation helps lenders and hurts borrowers. This leads to a debt deflation: a negative shock to AD lowers prices, leads to further falls in spending shifting AD more, further fall in prices.
-vicious cycle:
-contractionary effect on AD.

Why the AD curve is downward sloping:

Wealth Effect: Refers to an increase (decrease) in spending that accompanies an increase (decrease) in perceived wealth. It explains the downward sloping aggregate demand curve.
-Essentially, if the price level of items lowers, and everything else is held constant, people will seem wealthier because they are able to purchase more things and a lower cost.

Savings/Interest Rate Effect: If the prices go down, the consumer will buy less items and save more. The supply of money to lend goes up, price of borrowing goes down = interest rates lower. This means it is cheaper to borrow and make investments. This stimulates investment, causing the economy to expand. More goods and services being produced.

Foreign Exchange Effect: If prices go down, this lowers interest rates. People want to convert their money into the type that has a
-us dollars weaken
-exports increase

Y = C + I + G + NX

Shifts of Aggregate Demand Curve
-Components of Y = C + I + G + NX

Tax cut: (c) (consumption) more money, more demand, more consumption. AD goes up. Shift to the right.
Investment: (I) increase = rightward shift
Government spending: (G) increase = rightward shift
Net exports: (NX) increase = rightward shift.

**when buying a bond, you are lending to the federal government.

Monetary and Fiscal Policy:
Monetary Policy: * Prints money * Central bank * Federal reserve * Buys debt by lending money * By increasing the supply of money, interest rates fall.
Fiscal Policy: * Government sells Treasury bills and bonds, shifts AD to the right. Raises spending.

Interest rates = price of renting money.

Practice questions: If the Reserve requirement is .10 and the fed sells $900 worth of treasury bills, the money supply falls by 9,000.
Disinflation vs deflation:?
Disinflation is a lowering in the inflation rate, deflation is a negative inflation rate.
Formulas:
Reserve ratio = Reserves / deposits
Tax multiplier: -MPC/1-MPC
Assets – loans, reserves, securities (t-bills)
Liabilities – Deposits
Money multiplier = Money supply/ monetary base
Spending multiplier = 1/1-MPC

Concepts:
Expansionary Fiscal Policy: Increase in AD by closing inflationairy gap. * Increase in govt purchases * Cut in taxes * Increase in govt transfers

Questions:
What is the relationship between the discount rate and the Federal funds rate?
-to reduce the federal funds rate, the federal reserve uses open market operations to buy T-bills from the public. The federal reserve’s treasury bills purchase injects reserves into the banking system. With additional reserves, banks are no longer as close to their reserve ratio. So the demand from banks for borrowed reserves declines, pushing the federal funds rate downward
-the Federal Reserve sells treasury bills in order to raise the federal funds rate. The sale of treasury bills reduces the quantity of reserves in the banking system, causing banks’ demand for borrowed reserves to rise. The increase in demand for borrowed reserves causes the Federal funds rate to rise.
Practice
Change in checkable deposits (the money creation process #6 question)
=change in excess reserves x 1 / rr + initial deposit
Money multiplier = 1/RR (reserve ratio)
-Banning payment of interest rates on checking accounts: shifts Money Demand curve left. The economy’s demdiand for money decreases, its equilibrium interest rate decreases, and its equilibrium quantity of money remains unchanged.
-In an economic expansion, the Money demand curve shifts right, increasing the economy’s demand for money and equilibrium interest rate. The equilibrium quantity of money also remains unchanged.

Increase in price level from increase in money demand: People want to increase their money holdings by selling bonds – bond issuers have to offer higher interest rates until the money market reaches a higher equilibrium interest rate.

Econ 201 Final Exam Test Version B 1) Automatic stabilizers act like a. Automatic expansionary fiscal policy when the economy has a recessionary gap. 2) When the output gap is positive, the unemployment rate is b. Below the natural rate 3) If the Federal Reserve wants to increase the money supply, it might c. Engage in an open market purchase of treasury bills 4) Aggregate demand will decrease d. if the government raises taxes 5) RGDP is $4,000 Billion. Assume that potential output is $5,000 billion and the MPC is .75. what would close the recessionary gap? e. A $250 billion increase in government spending 6) Consider the economy: MPC = .75, no taxes, no government, no foreign trade. If the level of potential output is 500 billion, the government spending multiplier is f. 4 7) The tax multiplier is g. Less than the government spending multiplier 8) If a negative demand shock occurs, shifting AD down it causes a h. Recessionary gap, which can be closed by expansionary fiscal policy. 9) If there is an expansionary monetary policy from the Fed shifting AD upward, the economy is producing more output, Y^ P ^ then without any actions in the LR i. Nominal wages will increase, shifting SRAS to the Left, decreasing real output. P goes up to match LRAS. 10) -If there is a recessionary gap, j. Expansionary policy and nominal wages falling can both close the recessionary gap. 11) If a bank has 10% required reserve ratio which is $100, and they are fully loaned out, the amount of deposits are k. $1,000 12) Money is l. Any asset that can be easily used to purchase goods and services 13) Currency held in bank vaults and reserves held at the federal reserve are m. Not part of the money supply 14) If the natural rate of unemployment is 5% and the actual rate of unemployment is 4% then n. Inflation will increase 15) If any economy’s short-run Phillips curve shifts up, this is most likely due to o. A Negative supply shock 16) If the reserve ratio is 5% and the system does not want to hold any excess reserves, how much more money can ultimately be added to the money supply? Reserves = 200,000, deposits =1,000,000 p. Take 5% of 1,000,000 = 50,000 q. Subtract 50,000 from 200,000 that’s how much more you can add in r. Divide 150,000 by .05 (5% rr) to get $3,000,000 17) If the rr is 10% then s. 100,000 divided by .1 = $1,000,000 18) Suppose banks decide to end fees for the use of ATMs and debit cards. If the Federal Reserve wants to maintain the same Federal Funds Rate it should t. Sell treasury bills 19) Suppose the fall in commodity prices causes a supply shock. The short-run Phillips curve will u. Shift down 20) Some argue that budget deficits reduce private spending because v. Consumers, anticipating higher taxes in the future, reducing their current consumption to save to pay these taxes. 21) Over time, contractionary monetary policy lowers nominal wages and causes short rune aggregate supply to shift left. 22) If the government decides to print money to finance a deficit, w. People who hold money will be harmed, as inflation increases. 23) The long run Phillips curve is x. Verticle at the non-accelerating inflation rate of unemployment 24) A movement rightward of point A to point C on the aggregate demand curve could have resulted from y. A lower real interest rate, y^, P no change. 25) A shift in the AD curve to the right could have been caused by z. An increase in government spending 26) The decision to build a bridge to nowhere to keep unemployment high is an example of {. Expansionary Fiscal Policy 27) In the Long run, an increase in the money supply |. Won’t affect the real interest rate. 28) Which of the following has the most direct impact on aggregate demand? }. Changes in government spending 29) The Aggregate Demand curve is negatively sloped due to ~. The rise in consumer’s wealth, and thus consumption, as the price level falls 30) Monetary Policy affects aggregate demand through changes in . Consumer and investment spending 31) If the interest rate on CDs rises from 5% to 10%, the opportunity cost of holding money will increase, and the quantity of money demand will decrease. 32) Suppose you are told there has been an upward movement along the fixed short-run Phillips curve, what happened? . AD shifted to the right 33) Expansionary monetary policy will lower interest rates and increase consumer savings in the short run. 34) If Unemployment is currently high, then in the short run . Nominal wages will be inflexible downwards