Term
| When we ask why the AD curve slopes down, we are really asking what? |
|
Definition
| Why does a lower price level result in more spending? |
|
|
Term
| Explain the Wealth (Real Balance) Effect |
|
Definition
| Everything else the same, when the price level drops, the purchasing power of dollar-denominated assets is more/ increased. In effect, you are wealthier- and wealthier people spend more money. |
|
|
Term
| Explain the Interest Rate Effect. The nominal money supply is fixed along the AD curve |
|
Definition
When the price level drops, the real interest money supply increases. That interest rate decreases which increases spending.
Price level down => real money supply up => interest rates down => spending up |
|
|
Term
| Explain the International Trade Effect |
|
Definition
| As the price level drops, our exports become cheaper to foreigners and so our exports increase. Also, as the price level drops, U.S. made goods become relatively a better deal to U.S. customer so purchases of imports increases and purchases of U.S. made goods increases. Net Exports (NX) equals Exports minus Imports and NX increase. Y = C + I + G + NX and the conclusion then is that a lower price level increases spending in part because it increases NX. |
|
|
Term
| When we ask what shifts the AD curve to the right we are really asking what question? |
|
Definition
| What would increase the level of spending holding the price level constant? |
|
|
Term
| How could monetary policy be used to shift the AD curve to the right? |
|
Definition
FED could __increase _ the money supply which would lower interest rates which would increase spending.
Real money supply goes up=> interest goes down=> spending goes up |
|
|
Term
| How could fiscal policy be used to shift the AD curve to the right? |
|
Definition
| Congress could decrease taxes and/or increase government spending. |
|
|
Term
| How could a change in expectations shift the AD curve to the right? |
|
Definition
| Households and firms could become more optimistic about future economic conditions and this could cause them (everything else the same) to increase their level of spending at any current price level. |
|
|
Term
| How could an increase in foreign income shift the AD curve to the right? |
|
Definition
An increase in foreign income would increase the spending
by foreigners on everything including imports. When foreigners buy more imports this means that U.S. exports increase. As a result, at any given price level, spending in the U.S economy is greater because NX is greater and therefore the AD curve has shifted to the right. |
|
|
Term
What does it mean when we say the dollar has depreciated relative to
a foreign currency? |
|
Definition
| It means that in takes foreigners less of their own currency to buy the dollars which will be used to buy our exports. In effect, our exports have become _cheaper_ to them. |
|
|
Term
| How could a depreciation of the U.S. dollar shift the AD curve to the right? |
|
Definition
| As the dollar depreciates, U.S. exports increase and so Net Exports (NX) increase. Y = C + I + G + NX and so at any given price level, spending is _increased__ and the AD curve has shifted to the right. |
|
|
Term
|
Definition
Exchange Rates: Demand and Supply in the foreign exchange markets.
How many euros does it take to buy a dollar?
When we buy from abroad, dollar is depreciating (because it shifts to the right)—if dollar depreciates, foreign currencies have relatively appreciated.
If Germans decide to buy more from us, dollar appreciates |
|
|
Term
| What are four reasons which explain the upward sloping Short Run Aggregate Supply Curve? |
|
Definition
1. Contracts make some wages and prices “sticky” (slow/difficult to adjust)
2. Firms are often slow to adjust wages.
3. Menu costs make some prices _sticky.
4. __Shortages_ and ____bottlenecks_ can develop as the economy approaches the level of full employment YFE |
|
|
Term
| Explain the Profit Effect |
|
Definition
As the price level increases, revenues
increase faster_ than do costs.
Profit is equal to Total Revenue minus
Total Costs.
As profit margins expand, existing and new
suppliers increase the amount of output
supplied
Price goes up => (revenue Up >cost up) => profit up=> output up |
|
|
Term
| What is the difference between a shortage and a bottleneck? |
|
Definition
| With regard to a shortage, at the existing price, the quantity demanded exceeds the quantity produced and which is for sale. With regard to bottlenecks, the quantity produced and the quantity demanded may be equal at the existing price but _transportation_ difficulties have prevented the quantity produced from getting to market so in reality quantity demanded is exceeding quantity actually available for purchase and that is putting upward pressure on prices. |
|
|
Term
|
Definition
| As the economy approaches the full employment level of output, ___shortages________ and ___bottlenecks_________ occur, and this makes the slope of the short run AS curve become increasingly STEEP |
|
|
Term
| How do the Profit Effect and the Cost Effect affect the slope of the Short Run Aggregate Supply Curve? |
|
Definition
The PROFIT EFFECT explains why the short run AS curve slopes up and
The COST EFFECT explains why the AS curve gets ______steepers_____ as the economy approaches full employment Y. |
|
|
Term
| What is the relationship between time since 1979 and real consumption? |
|
Definition
|
|
Term
| What has caused investment spending since 1979 to occasionally decrease? |
|
Definition
|
|
Term
| . What has been the trend in real government purchases since 1979? |
|
Definition
|
|
Term
| What happened to net exports between 1994 and 2004? |
|
Definition
| They dropped like a rock. |
|
|
Term
| What are three determinants of net exports? |
|
Definition
1. The price level in the U.S. relative to the price levels in other countries.
2. The growth rate of GDP in the U.S. relative to the growth rates of GDP in other countries.
3. The exchange rate between the dollar and other currencies. |
|
|
Term
| Define Marginal Propensity to Consume (MPC) and the Average Propensity to Consume (APC). |
|
Definition
c = The Marginal Propensity to Consume
= MPC
= C / Y
= The slope of the Total Consumption Curve
Hint: Marginal is ALWAYS the slope of a
Total Curve
The Average Propensity to Consume
= C / Y |
|
|
Term
| 26. Define the Marginal Propensity to Save and the Average Propensity to Save. |
|
Definition
s = The Marginal Propensity to Save
= MPS
= S / Y
= The slope of the Total Savings Curve
The Average Propensity to Save
= S / Y |
|
|
Term
| What is the relationship between the MPC and equilibrium Y? |
|
Definition
Y = C + I = AD
Y = A + cY
Y – cY = A
Y (1 – c ) = A
Y = 1 * A
1 - c |
|
|
Term
| The multiplier is defined as |
|
Definition
| the amount by which equilibrium Y changes when Autonomous Aggregate Demand increases by one unit |
|
|
Term
| What is the formula for the simple multiplier in the Keynesian model? |
|
Definition
1 = 1 = 1 / (1-MPC) = 1 / MPS
1- c s |
|
|
Term
| Given an initial change in spending, what will be the ultimate change in the level of Y? |
|
Definition
| Delta Y = multiplier * delta Spending |
|
|
Term
| If the MPC equals .9 and the marginal tax rate t = .1, by approximately how much does the introduction of an endogenous income tax reduce the multiplier compared to the simple Keynesian multiplier without taxes? |
|
Definition
| By approximately one half. |
|
|
Term
| Other than taxes, what are three other reasons the economy has become more stable since WWII? |
|
Definition
1. Services have become _more _ important and goods have become less important.
2. Automatic stabilizers such as unemployment insurance.
3. Better macro economic policy. |
|
|
Term
| What is the difference between an “inside lag” and an “outside lag”? |
|
Definition
An inside lag refers to how long it takes to put a policy in place so that it is ready to start affecting the economy.
An outside lag refers to how long it takes a policy once it is in place to
have its effect on the economy |
|
|
Term
| What are five problems with Fiscal Policy and multipliers? |
|
Definition
1. The “Inside Lag” is very long for fiscal policy
2. Where is YFE? If economy is at full employment
3. Where does the money come from? Did it reduce other spending?
Delta y/ delta spending is the multiplier—except that other things are happening at the same time that would have affected the change in y, which warrants the question “how well did you control the things that may affect y”
4. How steep is the AS? (Determines the size of the multiplier)
When you get on the steeper part of the AS curve, much more is needed to reach Y(fe) because part of spending just raises price level, rather than raising output. Multiplier would be becoming smaller as we get closer to Y(fe)
5. How will the multiplier be affected by changing expectations? Expectations affect both the Aggregate Demand and Supply curves |
|
|
Term
Answer the following problem:
Y = C + I y is total spending
C = 100 + .8Y
I = 50 |
|
Definition
Y = C + I y is total spending
C = 100 + .8Y
I = 50
1. What is equilibrium Y?
Y= 100+.8y+50
.2y=150
Y=750
2. What is the level of saving at equilibrium? Y-C
Savings = 50
3. If Y = 800, what is the level of involuntary inventory investment? What would total spending be if y=800? Subtract the total spending from 800
y-c=
800-[100+.8(800)-50]
=10
4. If I increases to 100, what is the new equilibrium level of Y?
Y=100+.8y+100
.2y=200
Y=1000
5. What is the value of the multiplier?
1/(1-.MPC)
1/(1-.8)
1/(.2)
=5
deltaY=Multiplier(Abar) |
|
|
Term
| The consumption function: does it have a positive intercept? |
|
Definition
|
|
Term
| Life Cycle Theory of Consumption |
|
Definition
Franco Modigliani
C=cbar+littlecY
The difficulty is that if you take consumption vs income, you don’t get an intercept that’s statistically different from zero
Question of the APC- average propensity to consume- what happens to it between two points? Apc is C/Y |
|
|
Term
| Explain the “Consumption Puzzle”. What is the significance of a positive versus a zero intercept for the consumption function? |
|
Definition
Read Consumption Puzzle Essay Handout
If the total consumption curve has a positive intercept then the __APC____ declines as Income increases.
If the total consumption curve has a zero intercept then the APC is constant regardless of the level of Income.
The puzzle is that when the consumption curve is estimated over short periods of time it has a positive intercept but when estimated over long periods of time such as decades the intercept appears to be zero. In other words, the puzzle becomes is the APCconstant or does it decrease with income? |
|
|
Term
| Draw and explain the graph for the Life Cycle Theory of Consumption |
|
Definition
| See Life Cycle Theory of Consumption handout |
|
|
Term
| What is the answer of the Life Cycle Theory of Consumption to the “Consumption Puzzle”? |
|
Definition
The ratio of wealth to disposable income varies greatly
in the short run but not in the longrun. This fact
generates an APC that appears to decrease with increases in income when short run data is used but which is constant when long run data is used. |
|
|
Term
| What are three extensions of the simple Life Cycle Hypothesis? |
|
Definition
1. Money earns ____interest___________.
2. People have wealth from sources other than labor income.
3. People want to leave bequests (estates) |
|
|
Term
| What are five forecasting difficulties that complicate averaging consumption over your lifetime as proposed by the Life Cycle Theory of Consumption? |
|
Definition
1. How will your personal income change over time?
2. When will you retire?
3. When will you _die?
4. What rate of return will you earn on savings?
5. What will happen to Social Security and Government provided healthcare? |
|
|
Term
| Has most of the expansion in average life spans come from increasing the maximum age or from people not dying as frequently at younger ages? |
|
Definition
| Not dying as frequently at younger ages. |
|
|
Term
| What appears to happen to people’s ability to spend money as they get older? |
|
Definition
|
|
Term
| Three implications of the Life Cycle Hypothesis are that aggregate consumption is affected by: |
|
Definition
1. The age_ distribution of the population.
2. Retirement age.
3. Social Security. |
|
|
Term
| With reference to the Permanent Income Theory of Consumption graph and using the simple Keynesian multiplier, explain why the change in Y will be greater for a permanent tax cut compared to a temporary tax cut. |
|
Definition
| The MPC out of _permanent__ income is greater than the MPC out of transitory income. Therefore the multiplier for permanent income is larger and changes to income that are perceived as permanent will have a greater impact on the economy than changes perceived as transitory. |
|
|
Term
| What is a “Ponzi Scheme”? |
|
Definition
| In a Ponzi scheme, there are no real investments. Earnings paid out to new customers are coming solely from money paid in by new customers. |
|
|
Term
| The Social Security Trust funds has net assets equal to what amount? |
|
Definition
| Zero. Net Assets equal _zero__. Assets owned by the Social Security Trust Fund are ___liabilities_ to the U.S. Treasury. Both agencies are parts of the same U.S. Government. |
|
|
Term
Asset- people owe you money
Liability- you owe people money
Deposits in a bank are, to them, liabilities; to us they are assets |
|
Definition
|
|
Term
|
Definition
Workers pay 6.2% or earnings and employers “pay” 6.2% of earnings. Only on first $102,000 of earnings
Eligible if you have 40 hours of work under social security and are 62 or older
Annuity is based on highest 35 earnings years
The annuity is less generous for higher income people compared to lower income people
If you are married, you can claim as your benefit one-half of your spouse’s benefit if that is more than your benefit.
If your spouse dies, you can claim his/her benefits
Benefits reduced one dollar for every two dollars earned over $14,160. Applies to recipients ages 62-64. |
|
|
Term
| What are four criticisms of Social Security? |
|
Definition
1. Has benefited older generations at the expense of
younger generations.
2. Social Security discriminates against ____higher_____ income recipients.
3. Social Security discriminates against single women or men in the work force, against men, against married couples when both work
4. Political dependency results from the system.
“The third rail of American politics”- don’t touch, or you’ll die
By some estimates, SS keeps 60% of elderly out of poverty |
|
|
Term
| How does Social Security discriminate against married women or men? |
|
Definition
| You can receive either the Social Security benefits you qualify for based on your own work or ____one half___ _________ of the benefit earned by your spouse. |
|
|
Term
|
Definition
40% of pre-retirement income for average person
60% for low income
20% for high income |
|
|
Term
|
Definition
Private sectors are too expensive due to adverse selection
The diminished role of “Defined Benefit Pension Plans”
Give yourself an annuity so that you don’t outlive your money
Consumption smoothing
If social security has just replaced private savings, then it has not solved a consumption smoothing problem. |
|
|
Term
You qualify for social security- should you start collecting or work one more year?
If you work one more year you will: |
|
Definition
If you work one more year you will:
1- pay an extra year of payroll taxes on your earnings
2- Receive one less year of benefits
3- Get a higher benefit level
Social security payouts and labor participation are inversely related
It is potentially very costly to ahev systems that penalize addtl work beyond the retirement age |
|
|
Term
| What are four options for solving the Social Security funding problem? |
|
Definition
a. ____Means__ Testing
b. Raise retirement Age- effectively reduced benefit- but lower income people may not live long enough
c. Change AIME formula or index with the CPI minus 1%
d. For higher income groups
e. Could index wages using price level instead of wage growth changes |
|
|
Term
| What is the obstacle in allowing people to own their own Social Security contributions within private accounts? |
|
Definition
Social Security redistributes income from ___high________ income
earners to ____low___ income earners. Where would the money
for this transfer come from if it all goes into private accounts? |
|
|
Term
40% of trust fund invested in mkt might solve half of defecit
Congress could use money for other things
US govet becomes a substantial owner of US business
Is it possible to design ironclad safeguards? |
|
Definition
|
|
Term
| What is the definition of money? |
|
Definition
| Whatever is accepted in exchange for goods or services, or to pay debts |
|
|
Term
| What is the definition of commodity money? |
|
Definition
| Money that has a value independent of its role as money |
|
|
Term
|
Definition
| No intrinsic value- only money because the government says that it is |
|
|
Term
| What are five desirable characteristics about items that serve as money? |
|
Definition
1) It must be acceptable by most traders
2) It should be of standardized quality
3) It should be durable
4) It should be valuable relative to its weight
5) It should be divisible |
|
|
Term
| What are the four roles that money plays? |
|
Definition
1) Medium of exchange
2) Unit of account- how we measure
3) Store of Value- should allow for long-term savings
4) Standard of deferred payment- contracts written in the form of money |
|
|
Term
| What macroeconomic experiment did Pol Pot attempt? |
|
Definition
| What happens to an economy if it attempts to function without money? |
|
|
Term
|
Definition
| No. Credit cards are a short-term loan |
|
|
Term
| What is the definition of liquidity? |
|
Definition
| How quickly and easily can a financial asset be converted into a form that would allow you to buy groceries. In other words, converted into cash or checking account deposits |
|
|
Term
| What are the main components of M1? |
|
Definition
| Checking account deposits and checks/currency |
|
|
Term
| What are the main components of M2? |
|
Definition
| Besides M1, savings deposits, small denomination (time) deposits and money market mutual fund shares |
|
|
Term
| What has happened to the proportion of M2 made up of checkable deposits since 1960? |
|
Definition
|
|
Term
| What is the difference between a "Money Market Instrument" and a "Capital Market Instrument"? |
|
Definition
| A money market instrument has a maturity of less than a year and a capital market instrument has a maturity of longer than a year |
|
|
Term
| What is a "Euro Dollar" and what percent of financial assets are held by depository institutions? |
|
Definition
| A dollar that is held in an account controlled by a foreign bank and which under the banking regulations of a foreign government. 42% |
|
|
Term
|
Definition
| Money is created when loans are made. |
|
|
Term
| What is the definition of an asset? |
|
Definition
|
|
Term
|
Definition
| You owe other people money |
|
|
Term
| Are deposits- from a banker's perspective- assets or liabilities? |
|
Definition
|
|
Term
| Are loans- from a banker's perspective- assets or liabilities? |
|
Definition
|
|
Term
| What is the definition of the Reserve Ratio? |
|
Definition
| Bank reserves divided by bank deposits (total) |
|
|
Term
| What is the definition of excess reserves? |
|
Definition
| The difference between total reserves and required reserves |
|
|
Term
| What is the maximum size of the money multiplier? |
|
Definition
| 1 divided by the required reserve ratio |
|
|
Term
| What is included in the monetary base? |
|
Definition
| Reserves held by the Fed+ currency |
|
|
Term
| What is high-powered money? |
|
Definition
| High-powered money is another name for the monetary base |
|
|
Term
| What level of control does the Fed have over the monetary base and the money supply? |
|
Definition
| Complete (direct) control over the monetary base and indirect control over the money supply |
|
|
Term
| Which is larger, the M1 multiplier or the M2 multiplier? |
|
Definition
| M2 is larger than M1 so m2 is larger because we divide by the monetary base |
|
|
Term
| What are three constraints on deposit creation? |
|
Definition
1) Willingness of the public to deposit funds in banks
2) Willingness of the public to borrow money from banks
3) Regulatory constraints on lending |
|
|
Term
| How much did the Savings and Loan Crisis cost? |
|
Definition
|
|
Term
| What was the Glass-Steagall Act and what did it try to limit? |
|
Definition
| A Depression-era law that tried to limit competition and speculation |
|
|
Term
|
Definition
| A section of the Glass-Steagall Act which set limits on the interest rates which could be paid on deposits |
|
|
Term
| What role was envisioned for Savings and Loans? |
|
Definition
| Savings and Loans were created so that people could pay for houses over time instead of having to make huge down payments. |
|
|
Term
| What is disintermediation? |
|
Definition
| Savings and Loan would accept deposits and use that money to make small loans(?) |
|
|
Term
| Why did Savings and Loans start to suffer disintermediation in the 1960s? |
|
Definition
| Because of Regulation Q- people could get a higher interest rate by taking their money out of savings and loan and putting it into money market funds |
|
|
Term
| Explain the role of deposit insurance and moral hazard in causing the Savings and Loan crisis? |
|
Definition
| Because the US govt guaranteed deposits, depositors did not care if Savings and Loans were being run by crazy people or crooks. Moral Hazard- would do something with someone else's money that you wouldn't do with your own |
|
|
Term
| With regard to the First (1791-1811) and Second(1816-1826) Banks of the United States, what was the source of tension regarding the need for a national bank? |
|
Definition
| There was a fear that a National Bank would serve special interests and limit the power of individual states |
|
|
Term
| During the 19th century, who was the lender of last resort in case of a bank panic? |
|
Definition
|
|
Term
| Why was the Federal Reserve created in 1913? |
|
Definition
| To be a lender of last resort in order to stop bank panics. Also, to make sure that farmers could get necessary loans |
|
|
Term
| What three Federal Reserve Banks have more than half of all the Federal Reserve deposits? |
|
Definition
| New York, Chicago, and San Francisco |
|
|
Term
| Who belongs to the Board of Governors? |
|
Definition
| 7 members appointed by the President. Chairman and Vice Chairman are confirmed by the Senate. They serve staggered 14-year terms |
|
|
Term
| Who belongs to the Federal Open Market Committee? |
|
Definition
| The seven members of the Board of Directors, plus 5 Federal Reserve Bank Presidents (one of whom MUST be the NY president) |
|
|
Term
| What part of the Federal Reserve most actively conducts monetary policy? |
|
Definition
|
|
Term
| What are the four goals of monetary policy? |
|
Definition
Price stability
High Employment
Economic Growth
Stability of financial markets and institutions |
|
|
