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Figure 14.5 Suppose the economy is in short-run equilibrium above potential GDP, the unemployment rate is very low, and wages and prices are rising. Using the static AD-AS model, the correct Fed policy for this situation would be depicted as a movement from
C to B
Table 14-1 The hypothetical information in the table shows what the values for real GDP and price level will be in 2015 if the Fed does not use monetary policy. Which of the following policies makes sense if the Fed wants to keep real GDP at its potential level in 2015?
The Fed should lower the target for the federal funds rate
Which of the following would be classified as fiscal policy?
------ The federal government cuts taxes to stimulate the economy
The increase in the amount that the government collects in taxes when the economy expands and the decrease in the amount that the government collects in taxes when the economy goes into a recession is an example of
Automatic stablizer
The largest and fastest-growing category of federal government expenditures is
transfer payment
An increase in government purchases will increase aggregate demand because
government expenditures are a component of aggregate demand
Expansionary fiscal policy involves
increasing government purchases or decreasing taxes
Figure 15-1 An increase in taxes would be depicted as a movement from
using the static AD-AS model ------ B to A
Figure 15-1 Suppose the economy is in short-run equilibrium below potential GDP and Congress and the president lower taxes to move the economy back to long-run equilibrium. Using the static AD-AS , this would be depicted as movement from
------ A to B
Figure 15-1 Suppose the economy is in short-run equilibrium below potential GDP and no fiscal or monetary policy is pursued. Using the static AD-AS model, this would be depicted as a movement from
A to E
If real GDP exceeded potential real GDP and inflation was increasing, which of the following would be an appropriate fiscal policy?
An increase in taxes
Figure 15-3 In the dynamic model of AD-AS, if the economy is at point A in year 1 and it is expected to go to point B in year 2, Congress and the president would most likely
Increase taxes
The multiplier effect refers to the series of
induced increases in consumption spending that result from an initial increase in autonomous expenditures
A change in consumption spending caused by income changes is ______ change in spending, and a change in government spending that occurs to improve roads and bridges is _____ change in spending.
an induced; an autonomous
Which of the following would increase the size of the government purchases multiplier?
a decrease in the amount saved by households from an increase in income
If the tax multiplier is -1.5 and a $200 billion tax increase is implemented, what is the change in GDP, holding everything else constant? (Assume the price level stays constant.)
------ a $300 billion decrease in GDP
Suppose the government spending multiplier is 2. The federal government cuts spending by $40 billion. What is the change in GDP if the price level is not held constant?
------ a decrease of less than $80 billion
Suppose Congress increased spending by $100 billion and raised taxes by $100 billion to keep the budget balanced. What will happen to real equilibrium GDP?
Real equilibrium GDP will rise
An economic expansion tends to cause the federal budget deficit to _____ because tax revenues _______ and government spending on transfer payments ________.
------ decrease; rise; falls
Which of the following is a reason why we should consider the federal national debt a problem?
------ If the debt drives up interest rates, crowding will occur.
What is the fundamental macro equation?
Y= C + I + G + NX
Which of the following best describes supply-side economics
Tax rates, particularly marginal tax rates, affect the incentive to work, save, and invest, and therefore, aggregate supply
Which of the following is considered a weakness of the flat tax?
------ The distribution of income would be more unequal under the tax
According to the short-run Phillips curve, the unemployment rate and the inflation rate are
------ negatively related
Figure 16-1 What should the Federal Reserve do if it wants to move from point A to point B in the short-run Phillips curve depicted in the figure above?
sell treasury bills
Figure 16-1 Suppose that the economy is currently at point A. If the Federal Reserve engaged in contradictory monetary policy, where would the economy end up in the short run?
point B
16-1 Suppose that the economy is currently at point A, and the unemployment rate at A is the natural rate. What policy would the Federal Reserve pursue if it wanted the economy to move to point B in the long run?
No policy will move the economy to point B in the long run
According to the short-run Phillips curve, if unemployment is 3.2% and inflation is 1.3% an increase in the inflation rate might result in which of the following?
------ a decrease in the unemployment rate to 3.0%
Figure 15-3 In the dynamic model of AD-AS, if the economy is at point A in year 1 and is expected to go to point B in year 2, and no fiscal or monetary policy is pursued, then at point B
The unemployment rate is very low
Figure 15-1 Suppose the economy is in short-run equilibrium above potential GDP and automatic stabilizers move the economy back to long-run equilibrium. Using the static AD-AS, this would be depicted as a movement from
C to B
What is the natural rate of unemployment?
the unemployment rate that exists when the economy is at potential GDP
Matt's real wage in 2010 is $26.80. If the price level is 104, what is Matt's nominal wage?
------ $27.87
Figure 16-2 Suppose the economy is at point B in the figure above. Which of the following is true?
The expected rate of inflation is 3%
Figure 16-2 Suppose the economy is at point C. If the Fed decreases the money supply so that inflation falls, the economy will ________ in the long run, holding all else constant.
eventually move to point A
If actual inflation is greater than expected inflation, what is the relationship between the actual real wage and the expected real wage?
The actual real wage will be lower than the expected real wage.
If firms and workers have rational expectations, including knowledge of the policy being used by the Federal Reserve
expansionary monetary policy is ineffective
If wages and prices adjust slowly, we would expect expansionary monetary policy to be -
more likely to affect the unemployment rate
Models that focus on factors such as technology shocks rather than "monetary" explanations of
real business cycle modes
Which of the following would be the source of a "real" business cycle?
changes in technology
Some economists argue that the short-run Phillips curve is not vertical, and that the monetary policy can be effective in the short run. Which one of the following is not one of the reasons for this skepticism?
Empirical evidence shows workers and firms have rational expectations
Figure 16-2 Suppose the economy is at point A. The Fed uses expansionary monetary policy to lower the unemployment rate permanently below the level associated with A. Which of the following will occur?
------ Inflation will accelerate in the long run
Figure 16-2 At which point is the unemployment rate equal to the natural rate of unemployment?
A
Figure 16-2 Suppose the economy is at point A in the figure above. Which of the following is true?
------ The current unemployment rate is equal to the natural rate of unemployment
16-2 Suppose the economy is at point C. If workers adjust their expectations of inflation, which of the following will be true?
------ The short-run Phillips curve will shift to the left
Figure 16-2 Suppose the economy is at point A in the figure above. Which of the following is true?
Actual inflation and expected inflation are the same
What is transfer payment?
social security, it's not included in GDP
What are the 3 types of investment?
1. Business fixed investment (building)
2. Residential (housing)
3. Business inventories
Stocks or rare coins
What happen in the long run when there's an increase in saving?
saving can help the economy grow b/c there's more $ to borrow
What is GDP?
Goods + services produced within a country in a year.
Include market value of final goods
Only includes current production
Financial assets are not GDP b/c they don't produce anything
What GDP won't include?
1. Household production
2. Underground econ
What are the shortcomings of GDP as a measure of well-being?
1. Value of leisure not included in gdp
2. Not adjusted for population
3. Not adjust for changes in crimes
4. Good/services not equally distributed
What is real GDP?
Value of goods + services calculated @ base year prices or at constant price level
Takes inflation into account
real GDP may be a better measure b/c it holds prices constant
Nominal GDP
Value of final goods & services evaluated @ current year price level
How to calculate Real GDP
P of 1 (2009) x Q1(2009) + P of 2(2009) x Q of 2 (2009)
What is the equation for Nominal GDP
Real GDP x Price level
GDP deflator
Nominal GDP/Real GDP x 100
Calculating inflation b/w 2 years using GDP deflator
GDP deflator in later yr- GDP deflator in earlier yr/ GDP earlier x 100
What is potential GDP
Level of real GDP attained when all firms are producing at capacity --> what would have been if all factors of production (labor & capital) had been used at their normal rates
What is inflation
Percent increase in price level from one year to the next
Difference b/w CPI & GDP deflator
CPI includes only goods bought by consumers + imported goods

GDP deflator--> includes ALL goods
Only domestic goods
CPI formula
Expenditures in current year/ Expenditures in base year x 100
Inflation rate formula. In other words, to show how much CPI changes over the year
CPI current - CPI previous/CPI base x 100
Name reasons why CPI may overstate inflation
1. Substitution bias--> doesn't reflect that consumers can substitute the goods
2. Increase in quality bias--> over time product quality increase --> price increase not just b/c of pure inflation
3. New product bias --> CPI doesn't include new product
4. Outlet bias--> consumers buy products online --> discount and cheaper
What is Nominal interest rate? State the formula
Stated interest loan
i = r + pi (inflation)
If forecasting using expected inflation rate
bank wants r= 5%, but expected inflation is 3%, so it will set at 8%
Price level goes up, interest rates goes up
Real interest rate
adjust for inflation
Inflation rate goes up, expected inflation rate will go up
Growth rate of real GDP or real GDP/capita
GDP current yr- GDP previous yr/ GDP pre yr x100
Calculation of growth rate & rule of 70
# of year to double = 70/growth rate
What determines the rate of long run growth? (GDP/per capita)
1. Labor productivity--> quantity of goods + services that can be produced by one worker or by one hr of work
What causes labor productivity to increase?
1. Quantity of capital/hr worked
2. Level of tech
Increase in capital/hr worked
Capital--> goods + equipment used to produce other goods + services
Human capital--> accumulated knowledge & skills
Tech change
Is an increase in quantity of outputs firms can produce using a given quantity of inputs
What determines how fast econ grow?
1. Better machines & equipment
2. Increase in human capital
3. Better means of organizing & managing production
Calculate unemployment rate
# unemployed/labor force (unemployed + employed) x100
Labor force participating rate
labor force/ working-age population
What is the effect of min, wage law on unemployment?
Fairly small
But only cause higher unemployment rate b/c if set above the market rate determined by demand + supply of labor --> quantity of labor supplied will be greater than demand
Efficiency wages
Quantity of labor supplied > dmeand
leads to unemployment, just like min. wage laws + unions
Diminish return to capital
Increase in the quantity of capital/hr worked will result in diminishing output/hr worked
Fundamental concept of per worker function
each additional increase in captal/hr worked will result in smaller increase in output/hr worked
So at very high lvl of capital/hr worked, further increase will not result in any increase in real GDP/hr work
Tech change
In the long run, a country will experience an increasing standard of living only if it experiences continuing tech change
What is the fundamental macro equation?
GDP = Aggregate expenditure
Consumption
Is a component of GDP, spending by household on goods + services with the exception of purchases of new housings (which is investment)
Government purchases
Does not include transfer payments
Net exports
Exports - Imports
What is the aggregate demand curve?
Relates Price level to Aggregate Expenditures on economy
s goods + services
For every possible price level, it shows the total level of aggregate expenditure in the economy
Price level
a measure of the overall price level (GDP deflator or CPI)
Aggregate expenditure
is a POINT ON an aggregate demand curve
So the AD Curve shows what AE will be at EVERY price level
Increase in AE
is a movement ALONG the AD Curve
It moves down the AD curve at a lower P, which makes sense b/c decrease in price will increase in expenditures (or spending)
P goes up, Y goes down
A decrease in AE
Is a movement (up) along the AD curve
P goes up, Y goes down
It is an inverse r/s
Why does AD slope down? Why is it when P goes up, AE goes down? and when P goes down AE goes up?
1. Wealth effect (Consumption function)
2. Interest rate effect
3. International trade effect
What is consumption function?
C= f((Y-T), (Y-T)^e, r, Wealth, Price level)
Consumption function component: wealth effect
The wealth effect
When P increase, the Purchasing power of household wealth decreases, which leads to a decrease in consumption (people buy less stuff when price goes up) and ultimately leads to decrease in AE
Consumption function: Why does an increase in P cause an increase in the interest rate (r)?
When r goes up, people have more incentive to save money (b/c it's costly to buy cars + it's more profitable to put their $ in the bank and get the extra interest) and it costs more to borrow. This will lead to a decrease in consumption
Investment function (component of GDP)
I = f(r, Y, Ye, tax policy)
NPV of Investment
= (PDV of Project Revenues) - (PDV of Project Costs)
What is the effect of an increase in interest rate on Investment?
When interest rate goes up, there are fewer investement projects w/ NPV > 0
It also costs more to borrow to finance investment
So Investment goes down
What is the Interest Rate Effect?
When Price goes up, Interet rate goes up, leads to decrease in both Consumption & ,Investment,
Net Exports. Ultimately leads to decrease in AE
Real Exchange Rate
Real exchange rate = e = P^domestic x E (nominal exchange rate) /P foreign
Therefore, e will change if Pdom changes
Pdom increase (relative to Pfor) will lead to increase of e, which will leads to a decrease of exports & increase of imports
Since NX = X-IM
the overall NX will decrease
International trade effect
Increase in P, leads to increase in e, which leads to decrease in NX and this will leads to decrease in AE
Increase in AD
Increase in AD --> AD curve will move rightward or upward
Decrease in AD--> AD curve move leftward or inward
What could shift the AD curve?
1. Gov policies
2. Changes in Expectations of Households & Firms
3. Changes in foreign variables
Gov policies & AD Curve
Monetary policies
--are policies that affect r, this is done by the FED
When FED increase r--> C decrease, I decrease, NX decrease-->AD shifts left (AD decreases)
On the other hand, when FED decreases r, C + I + NX (all is function of AD)--> AD will shift right
What is monetary policy?
actions which increases $ supply
i.e when FED buys bonds
Change in Total Deposits Function
1/(R+E) x Initial Change in Reserves
Money supply
Change in Total Deposits + Change in Cash Held By the Public
What is the Interest Rate Effect?
When Price goes up, Interet rate goes up, leads to decrease in both Consumption & ,Investment,
Net Exports. Ultimately leads to decrease in AE
What is the effect of an increase in Interest Rates on Net Exports?
edit later
Real Exchange Rate
Real exchange rate = e = P^domestic x E (nominal exchange rate) /P foreign
Therefore, e will change if Pdom changes
Pdom increase (relative to Pfor) will lead to increase of e, which will leads to a decrease of exports & increase of imports
Since NX = X-IM
the overall NX will decrease
International trade effect
Increase in P, leads to increase in e, which leads to decrease in NX and this will leads to decrease in AE
Increase in AD
Increase in AD --> AD curve will move rightward or upward
Decrease in AD--> AD curve move leftward or inward
What could shift the AD curve?
1. Gov policies
2. Changes in Expectations of Households & Firms
3. Changes in foreign variables
Gov policies & AD Curve
Monetary policies
--are policies that affect r, this is done by the FED
When FED increase r--> C decrease, I decrease, NX decrease-->AD shifts left (AD decreases)
On the other hand, when FED decreases r, C + I + NX (all is function of AD)--> AD will shift right
What is monetary policy?
actions which increases $ supply
i.e when FED buys bonds
Change in Total Deposits Function
1/(R+E) x Initial Change in Reserves
Money supply
Change in Total Deposits + Change in Cash Held By the Public
Describe in a graph, equlibrium in the Money Market. What if the FED buys bonds?
Draw it
Contractionary Monetary Policy
Give example & graph
actions which decreases the $ supply
i.e when FED sells bonds
What is the economic consequences of FED actions? When FED buys bonds
When FED buys bonds, i goes down, r goes down --> C + I + NX goes up
--> AD goes up and so the AD Curve shifts up or right
What are fiscal policies
policies which affect G and/or T done by Congress/White Hosue/Treasury Dept
G goes up, AD shifts right
G goes down, AD shifts left
So when Congress raises T --> C goes down, I goes down and AD shifts to the left
When T decreases, I goes up, C up--> AD shifts right
What could shift the AD curve? Changes in expectation of household & firms
(Y-T)^e from C function
(Y-T)^e (expectation) goes up--> people will spend more--> increase in C--> AD shifts right
But when expectation decreases--> C goes down and AD shifts left

In the I function (Y^e)
If Y^e increase, I will increase --> AD shifts right
Changes in Foreign Variables
the NX in Y function

NY= f(e, Yfor, Ydom, Tastes, Trade policies)
E goes up, e goes up, NX goes down---> AD will shift left
Ydom goes up, IM goes up -->NX goes down and AD shift left
But when Yfor goes up--->X goes up--->NX goes up --> AD shifts right
Draw a graph describing an increase in AD
when r goes down --> C goes up, I up, NX up ---> AD shifts right
G goes up & T goes down---> AD shifts right
Government Spending Multiplier
1/(1-Cy)
Tax multiplier
is the negative of Gov Multi
-Cy/(1Cy)
Expansionary Fiscal Policy
is when G increase, Taxes decrease, and/or Transfer Payment increase
Federal Funds rate
is the interest rate banks charge each other for short-term loans of reserves
What determines the slope of the SRAS Curve?
When SRAS Curve is steep --> most prices are flexible. Flat is sticky
So the ans is the degree of how sticky/flex prices are in an economy
What might cause the SRAS Curve to shift?
1. Negative Supply Shock will cause SRAS to shift left (lower)
2. Positive Supply Shock will cause SRAS curve to shift right
Calculating the current price of a past price
Value in time t + n dollars = (Values in time t dollars) (P t+n (current)/Pt (past))
Quantity Equation
Velocity (of M1) = Nominal GDP/M1 Money Stock
V= P x Y/M
MV = PY
Growth rates form:
%changeM + %changeV = %changeP + %changeY
What are the 2 assumptions that turn the Quantity Equation into the Quantity Theory?
1) In the long run, %changeV = 0
2) In the long run, %changeM does NOT affect %changeY
Quantity Theory of Money
From the 2 assumptions
%changeP = %changeM - %changeY
Why would we expect convergence?
1) Tech transfer
2) Poorer countries can attract more capital
To raise K/L --> productivty,wages, living standard, what else can gov also encourage?
1) Foreign direct investment: capital investment, owned & operated by foreign entity
2) Foreign portfolio investment: capital investment financied w/ foreign $ but operated by domestic residents
What are the 3 major approaches to Development?
1) Environmental approach (geography, climate, disease,inaccessibility to trade routes, lack of natural resources)
2) International Trade Approach
2 dimensions of integration into worlkd economy (a. trade in goods & services, b. capital inflows)
3. Institutional Approach
legal & political system, corruption
If $ growth does not affect real GDP, V is stable, an increase in money supply creates proportional increase in
both price level & nominal GDP
What is budget balance?
T (gov revenue) - (G + TR) which are gov expendatures
When T > (G + TR) ---> Budget surplus
T < (G + TR) ---> budget deficits
T = (G + TR) --> a balanced budget
Federal debt
total of accumulated deficits
= total amount owned by govt
Describe economy is in LR E when expansionary fiscal policy is undertaken
move from E1 (AD0) to E2 at SRAS on AD2 (rightward shift). There is an inflationary gap as P1 moves to P2
Describe economy is in recession when expansionary fiscal policy is undertaken
E1(on LR) on AD0 moves to AD1 (a rightward shift) until it intersects LRAS at E2. As P1-->P2, there is a recessionary gap
Explain how a change in i causes a change in the q of $ demanded
With an increase in i, there is a smaller quantity of money demanded
How money demanded also depends on nominal gdp (p x y)
an increase in nominal gdp shifts Md to the right
SR Effects of Expansionary Fiscal Policy
higher i leads to crowding out of investment
i up --> r up ---> C, I, NX down, AD curve ends up left of where it would have been after expan fiscal policy if there were no crowding out
Supply & demand in loanable funds market
Private saving + Public saving = Investment + NFI

S + T-(G+TR) = I + NFI at E
Decrease in supply of loanable funds due to expan policy
the supply curve shifts left and a decrease in supply --> increase in in equil r + decrease in equil Q
Automatic stabilizers
programs which tend to stabilize demand by expanding or shrinking w/ the econ w/o any additional legis action
ex: progressive income tax
unemployment compen
welfare payment
food stamps
Money multiplier
1/ R + E, R= reserve requirement
long run phillips curve
According to Friedman and Phelps, there is no trade-off between inflation and unemployment in the long run. Growth in the money supply determines the inflation rate. Regardless of the inflation rate, the unemployment rate gravitates toward its natural rate. As a result, the long-run Phillips curve is vertical.
How Does a Vertical Long-Run Phillips Curve Affect Monetary Policy?
The inflation rate is stable only if the unemployment rate equals the natural rate of unemployment (point C).
If the unemployment rate is below the natural rate (point A), the inflation rate increases, and, eventually, the short-run Phillips curve shifts up.
If the unemployment rate is above the natural rate (point B), the inflation rate decreases, and, eventually, the short-run Phillips curve shifts down.
LR Effects of Monetary Policy
In the Long Run, Monetary Policy only affects the price level
Functions of Money
Medium of Exchange
Store of Value
Unit of Account
M1
Currency and Traveler’s Checks
Cash in the hands of the public
Checking Deposits
Held at commercial banks, S & Ls, Savings Banks, and Credit Unions
M2
M1
Savings deposits
Time deposits
Money market mutual funds and other deposits
Recessionary Gap
YActual < YPotential
Price Level Goes Down
Unemployment > Natural Rate
Inflationary Gap
YActual > YPotential
Price Level Goes Up
Unemployment < Natural Rate
sr pc
Monetary policy can reduce u-rate below the natural u-rate by making inflation greater than expected
lr pc
Expectations catch up to reality, the unemployment rate goes back to natural rate, whether inflation is high or low
nairu
The unemployment rate at which the inflation rate has no tendency to increase or decrease.
Balance of Payments
The record of a country’s trade with other countries in goods, services, and assets.
Current Account
Financial Account
Current Account
trade in goods and services
≈ X – IM
≈ Net Exports (NX)
Financila Account
= trade in assets
= Capital coming in – capital leaving
= Net Capital Flows
Relationship Between Current Account and Financial Account
Current Account = − Financial Account
Net Foreign Investment is another measure of the imbalance in a country’s trade in assets:
When Net Foreign Investment > 0, domestic purchases of foreign assets exceed foreign purchases of domestic assets.
When Net Foreign Investment < 0, foreign purchases of domestic assets exceed domestic purchases of foreign assets.
Variables that Influence Net Foreign Investment
Real interest rates paid on foreign assets
Real interest rates paid on domestic assets
Perceived risks of holding foreign assets
Govt policies affecting foreign ownership of domestic assets
The Equality of NX and Net Foreign Investment (NFI)
An accounting identity: NFI = NX
arises because every transaction that affects NX also affects NFI by the same amount (and vice versa)
When a foreigner purchases a good from the U.S.,
U.S. exports and NX increase
the foreigner pays with currency or assets, so the U.S. acquires some foreign assets, causing NFI to rise.
When a U.S. citizen buys foreign goods,
U.S. imports rise, NX falls
the U.S. buyer pays with U.S. dollars or assets, so the other country acquires U.S. assets, causing U.S. NFI to fall.
SavingPrivate
Y + TR - (C +T)
SavingPublic
T-G-TR
National Saving
S = Y − C − G
What does export depend on
Real exchange rate (e)
GDP of our trading partners (YFor)
Tastes and preferences of people abroad for our goods and services
Trade policies
= f (e, YFor, Tastes, Trade Policies)

e↑  X↓ e↓  X↑
YFor↑  X↑ YFor↓  X↓
What do imports depend on?
Real exchange rate (e)
Domestic GDP (YDom)
Domestic tastes and preferences for foreign goods
Trade policies

IM = f (e, YDom, Tastes, Trade Policies)

e goes up, IM goes up; e goes down IM down
Nx
e↑  X↓, IM↑  (X – IM)↓  NX↓
e↓  X↑, IM↓  (X – IM)↑  NX↑

YFor↑  X↑  (X – IM)↑  NX↑
YFor↓  X↓  (X – IM)↓  NX↓
Nominal Exchange Rate
– price of one currency in terms of another currency
= number of units of foreign currency per unit of
domestic currency
Real Exchange Rate
the price of goods in one country in terms of the price of goods in some other country
Purchasing Power Parity
E should be such that e = 1

e =

e = 1  E = Pfor/Pdomest

If e > 1, then E is too high, i.e., the foreign
currency is undervalued relative to the
domestic currency
If E is at the PPP level, e = 1
If e < 1, then E is too low, i.e., the foreign
currency is overvalued relative to the
domestic currency
Determinants of I
Expectations of future profitability
Optimism or pessimism
Taxes
Corporate income tax
Investment tax incentives
Cash flow
Real interest rate
Marginal propensity to save (MPS)
The change in saving divided by
the change in disposable income.