Econ 190 18-22

Front 1

financial system

Back 1

consists of the group of institutions in the economy that help to match one person's saving with another person's investment

it moves the economy's scarce resources from savers to borrowers

Front 2

financial markets

Back 2

the institutions through which savers cand irectly provide funds to borrowers (stock market & bond market)

Front 3

financial intermediaries

Back 3

financial institutuions through which savers can indirectly provide funds to borrowers (banks & mutual funds)

Front 4

Bond - define

Back 4

a certificate of indebtedness that specifies obligations of the borrower to the holder of the bond.

Front 5

Bond - characteristics

Back 5

Characteristics of a Bond
Term: The length of time until the bond matures.
Credit Risk: The probability that the borrower will fail to pay some of the interest or principal.
Tax Treatment: The way in which the tax laws treat the interest on the bond.
Municipal bonds are federal tax exempt.

Front 6

What does a stock represent?

Back 6

represents a claim to partial ownership in a firm and is therefore, a claim to the profits that the firm makes.

Front 7

equity financing

Back 7

The sale of stock to raise money is called equity financing.
Compared to bonds, stocks offer both higher risk and potentially higher returns.

Front 8

Important stock echanges in the US

Back 8

the New York Stock Exchange, the American Stock Exchange, and NASDAQ.

Front 9

Newspaper stock table info

Back 9

Price (of a share)
Volume (number of shares sold)
Dividend (profits paid to stockholders)
Price-earnings ratio

Front 10

Bank - functions

Back 10

take deposits from people who want to save and use the deposits to make loans to people who want to borrow.
pay depositors interest on their deposits and charge borrowers slightly higher interest on their loans.

Front 11

Mutual Fund

Back 11

A mutual fund is an institution that sells shares to the public and uses the proceeds to buy a portfolio, of various types of stocks, bonds, or both.
Mutual funds allow people with small amounts of money to easily diversify.

Front 12

List other financial institutions

Back 12

Credit unions
Pension funds
Insurance companies
Loan sharks

Front 13

GDP

Back 13

both total income in an economy and total expenditure on the economy’s output of goods and services:
Y = C + I + G + NX

Front 14

National Saving

Back 14

National saving is the total income in the economy that remains after paying for consumption and government purchases.

Front 15

Private Saving

Back 15

Private saving is the amount of income that households have left after paying their taxes and paying for their consumption.
Private saving = (Y – T – C)

Front 16

Public Saving

Back 16

Public saving is the amount of tax revenue that the government has left after paying for its spending.
Public saving = (T – G)

Front 17

Budget Surplus

Back 17

If T > G, the government runs a budget surplus because it receives more money than it spends.
The surplus of T - G represents public saving.

Front 18

Budget Deficit

Back 18

If G > T, the government runs a budget deficit because it spends more money than it receives in tax revenue.

Front 19

For the economy as a whole, saving must be equal to ______.

Back 19

Investment

S=I

Front 20

market for loanable funds

Back 20

Financial markets coordinate the economy’s saving and investment in the market for loanable funds.
The market for loanable funds is the market in which those who want to save supply funds and those who want to borrow to invest demand funds.

Front 21

T/F Loanable funds refers to all income that people have chosen to use for their own consumption

Back 21

False - Loanable funds refers to all income that people have chosen to save and lend out

Front 22

Where does the supply of loanable funds come from?

Back 22

people who have extra income they want to save and lend out

Front 23

Where does the demand of loanable funds come from?

Back 23

households & firms that wish to borrow to make investments

Front 24

T/F. If a change in tax law encourages greater saving, the result will be increase interest rates and greater investment.

Back 24

False. If a change in tax law encourages greater saving, the result will be lower interest rates and greater investment.

Front 25

T/F. An investment tax credit increases the incentive to borrow and the demand for loanable.

Back 25

True. It also raises the interest rate, and a greater quantity saved.

Front 26

crowding out

Back 26

Government borrowing to finance its budget deficit reduces the supply of loanable funds available to finance investment by households and firms.
This fall in investment is referred to as crowding out.
The deficit borrowing crowds out private borrowers who are trying to finance investments.

Front 27

Which bond would you expect to pay a higher interest rate?

a bond of the U.S. government or a bond of an East European government.

Back 27

The bond of an eastern European government would pay a higher interest rate than the bond of the U.S. government because there would be a greater risk of default.

Front 28

a bond that repays the principal in year 2005 or a bond that repays the principal in year 2025

Back 28

A bond that repays the principal in 2025 would pay a higher interest rate than a bond that repays the principal in 2005 b/c it has a longer term to maturity, so there is more risk to the principal.

Front 29

a bond from Coca-Cola or a bond from software company you run in your garage.

Back 29

A bond from a software company you run in your garage would pay a higher interest rate than a bond from Coca-Cola because your software company has more credit risk.

Front 30

a bond issued by the federal government o r a bond issued by New York state.

Back 30

A bond issued by the federal government would pay a higher interest rate than a bond issued by New York State b/c an investor does not have to pay federal income tax on the bond from New York State.

Front 31

Why is it important for people who own stocks and bonds to diversify their holdings? What type of financial institution makes diversification easier?

Back 31

It is important for people who own stocks and bonds to diversify their holdings because then they will have only a small stake in each asset, which reduces risk. Mutual funds make such diversification easy by allowing a small investor to purchase parts of hundreds of different stocks and bonds.

Front 32

Use the saving and investment identities from the national income accounts to answer the following questions. Suppose the following values are from the national income accounts for a country with a closed economy (all values are in billions).
Y= $6,000
T= $1,000
C = $4,000
G =$1,200
a. What is the value of saving and investment in this country?

b. What is the value of private savings?

c. What is the value of public savings?

d. Is the government’s budget policy contributing to growth in this country or harming it? Why?

Back 32

a. (Y-T-C)+(T-G)=($6,000 - $1,000 - $4,000) + ($1,000 - $1,200) = $800 billion
b. (Y-T-C)=($6,000 - $1,000 - $4,000) = $1,000 billion
c. (T-G)=$1,000 - $1,200 = -200 billion
d. It is harming growth because public saving is negative so less is available for investment.

Front 33

If GDP = 1,000, consumption = $600, taxes = $100, and government purchase = $200, how much is saving and investment?

a.savings=$200,investment=$200
b.savings=$300,investment=$300
c.savings=$100,investment=$200
d.savings=$200,investment=$100
e.savings=$0,investment=$0

Back 33

A.savings=200,investments=200

Y-C-G=S=I

Front 34

8. If the public consumers $100 billion less and the government purchases $100 billion more (other things unchanging), which of the following statements is true?
a. There is an increase in saving, and the economy should grow more quickly.
b. There is a decrease in saving, and the economy should grow more slowly.
c. Saving is unchanged.
d. There is not enough information to determine what will happen to saving.

Back 34

Saving is unchanged.

Front 35

11. If Americans become more thrifty, we would expect
a. the supply of loanable funds to shift to the right and the real interest rate to rise.
b. the supply of loanable funds to shift to the right and the real interest rate to fall.
c. the demand of loanable funds to shift to the right and the real interest rate to rise.
d. the demand of loanable funds to shift to the right and the real interest rate to fall.

Back 35

the supply of loanable funds to shift to the right and the real interest rate to fall.

Front 36

Finance

Back 36

the field that studies how people make decisions regarding the allocation of resources over time and the handling of risk.

Front 37

Present Value

Back 37

refers to the amount of money today that would be needed to produce, using prevailing interest rates, a given future amount of money.

Front 38

T/F. Receiving a given sum of money in the present is not as valuable to receiving the same sum in the future.

Back 38

False. Receiving a given sum of money in the present is preferred to receiving the same sun in the future.

Front 39

T/F. In order to compare values at different points in time, compare their present values.

Back 39

True. In order to compare values at different points in time, compare their present values.

Front 40

T/F. Firms undertake investment projects if the present value of the project exceeds the cost.

Back 40

True. Firms undertake investment projects if the present value of the project exceeds the cost.

Front 41

Discounting

Back 41

Because the possibility of earning interest reduces the present value below the amount X, the process of finding a present value of a future some of money is called discounting.

Front 42

Future value

Back 42

The amount of money in the future that an amount of money today will yield, given prevailing interest rates, is called the future value.

Front 43

Rule of 70

Back 43

if some variable grows at a rate of x percent per year, then that variable doubles in approximately 70/x years.

Front 44

risk averse

Back 44

a person is said to be rick averse if he or she exhibits a dislike of uncertainty

Front 45

How individuals can reduce risk

Back 45

buy insurance
diversify
accept a lower return on their investments

Front 46

Diversification

Back 46

refers to the reduction of risk achieved by replacing a single risk with a large number of smaller unrelated risks.

Front 47

T/F. Diversification can remove market risk

Back 47

False. Diverisifcation can only remove firm-specific risk, or risk that affects only a single company. Market risk is risk that affects all companies in the stock market

Front 48

Fundamental analysis

Back 48

is the study of a company’s accounting statements and future prospects to determine its value.
People can employ fundamental analysis to try to determine if a stock is undervalued, overvalued, or fairly valued.
The goal is to buy undervalued stock.

Front 49

efficient markets hypothesis

Back 49

the theory that asset prices reflect all publicly available info about the value of an asset

Front 50

informationally efficiency

Back 50

when the market reflects all available info about the value of an asset in a rational way

Front 51

T/F. If markets are inefficient, the only thing an investor can do is buy a diversified portfolio.

Back 51

FALSE. If markets are efficient, the only thing an investor can do is buy a diversified portfolio.

Front 52

Random walk

Back 52

Random walk refers to the path of a variable whose changes are impossible to predict.
If markets are efficient, all stocks are fairly valued and no stock is more likely to appreciate than another. Thus stock prices follow a random walk.

Front 53

According to an old myth, Native Americans sold the island of Manhattan about 400 years ago for $24. If they had invested this amount at an interest rate of 7% per year, how much would they have today?

Back 53

The future value of $24 invested for 400 years at an interest rate of 7% is (1.07)^400 *($24) = $13,600,000,000,000 = $13.6 trillion.

Front 54

Imagine that you intend to buy a portfolio of 10 stocks with some of your savings. Should the stocks be of companies in the same industry? Should the stock be of companies located in the same country? Explain.

Back 54

To reduce the risk associated w/the portfolio, it is better to diversify. This means that the stocks should be of companies from different industries as well as located in different countries.

Front 55

A company faces 2 kinds of risk. A firm specific risk is that a competitor might enter is market and take some of its customers. A market risk is that the economy might enter a recession, reducing sales. Which of these 2 risks would more likely cause the company’s shareholders to demand a higher return? Why?

Back 55

Shareholders will likely demand a higher return due to the stock’s firm-specific risk. Firm-specific is risk that affects only that particular stock. All stocks in the economy are subject to market risk.

Front 56

Whitewater Raft Tour Company can purchase rafts today for $100,000. They will earn a $40,000 return on the rafts at the end of each of the next 3 years.

a. If the interest rate were 12%, what is the present value of each of the future returns that Whitewater Raft expects to receive?

b. If the interest rate were 12%, should Whitewater Raft invest in the rafts? Explain.


c. If the interest rate were 7%, should Whitewater Raft invest in the rafts? Explain.

d. Compare your answer to parts b and c above. What general principal about the relationship between investment and the interest rate is demonstrated?

Back 56

a. $40,000/1.12 = $35,714.29; $40,000/(1.12)^2 = $31,887.76; $40,000/(1.12)^3 = $28,471.21
b. No, the cost is $100,000 but the present value of the return is only $96,073.26.
c. Yes. Although the cost is still $100,000 the present value of the return is now the sum of ($40,000/1.07 ) + ($40,000/(1.07)2) + ($40,000/(1.07)3 ). = $104,972.65.
d. Investment is inversely related to the interest rate---lower interest rates stimulate investment.

Front 57

For each of the following, determine the type of problem from which the insurance market suffers (adverse selection or moral hazard) and explain.

a. Susan buys health insurance at the nonsmoker rate. After she obtain the insurance, she begins smoking again.

b. Bryce discovers that he has a liver condition that will shorten his life. He seeks life insurance to help pay for his children’s college expenses.

c. Fred gets a new job and will have to commute to Chicago. Fearing that he will get into an auto accident in the heavy traffic, he increases his auto coverage.

e. After Lisa gets fire insurance on her house, she burns fire in the fireplace without closing the fireplace doors.

Back 57

a. Moral hazard, because after she obtains the insurance, she is less careful with her health.
b. Adverse selection because after he knows that his probability of death is higher than average, he seeks life insurance.
c. Adverse selection b/c after he knows that his probability of an accident is higher than average, he seeks more auto insurance.
d. Moral Hazard b/c after she obtains the insurance, she becomes less careful with fire.

Front 58

According to the rule of 70, how long will it take for your income to double if you get a 5% raise every year? If you start work at the age of 23 earning $40,000 per year and get a 5% raise every year, how much will you be earning if you retire at 65?

Back 58

70/5 = 14 years. Your income would double three times in the 42 year period or $40,000(2)3 = $320,000 per year.

Front 59

What property of an individual’s utility function is necessary for that individual to be risk averse? Explain.

Back 59

Diminishing marginal utility of wealth. Therefore, the increase in utility from a $1 gain is less than the decrease in utility from a $1 loss.

Front 60

Using the rule of 70, if your income grows at 10% per year, your income will double in approximately
a. 700 years
b. 70 years
c. 10 years
d. 7 years
e. There is not enough information to answer this question.

Back 60

D. 7 years

Front 61

Which of the following does not help reduce the risk that people face?
a. buying insurance
b. diversifying their portfolio
c. increasing the rate of return within their portfolio
d. All of the above help reduce risk.

Back 61

C. increasing the rate of return within their portfolio

Front 62

Speculative bubbles may occur in the stock market
a. when stocks are fairly valued
b. only when people are irrational
c. because rational people may buy an overvalued stock if they think they can sell it someone for even more at a later date.
d. during periods of extreme pessimism because so many stocks become undervalued.

Back 62

C. because rational people may buy an overvalued stock if they think they can sell it someone for even more at a later date.

Front 63

How is Unemployment measured?

Back 63

Categories of Unemployment
-the problem of unemployment is usually divided into two categories, the long-run problem and the short-run problem.
-The natural rate of unemployment
-The cyclical rate of unemployment

Front 64

Cyclical unemployment

Back 64

refers to the year-to-year fluctuations in unemployment around its natural rate.
It is associated with with short-term ups and downs of the business cycle.

Front 65

Unemployment measurement

Back 65

Unemployment is measured by the Bureau of Labor Statistics (BLS).
It surveys 60,000 randomly selected households every month.
The survey is called the Current Population Survey.

Front 66

3 categories of employment

Back 66

Employed
Unemployed
Not in the labor force

Front 67

Unemployed person

Back 67

he or she is on temporary layoff, is looking for a job, or is waiting for the start date of a new job.

Front 68

Employed person

Back 68

A person is considered employed if he or she has spent some of the previous week working at a paid job.

Front 69

Labor force

Back 69

The labor force is the total number of workers, including both the employed and the unemployed.
The BLS defines the labor force as the sum of the employed and the unemployed.

Front 70

Unemployment Rate

Back 70

The unemployment rate is calculated as the percentage of the labor force that is unemployed.

#unemployed/laborforce * 100

Front 71

Labor-force participation rate

Back 71

The labor-force participation rate is the percentage of the adult population that is in the labor force.

laborforce/adultpop. * 100

Front 72

discouraged workers

Back 72

people who would like to work but have given up looking for jobs after an unsuccessful search, don’t show up in unemployment statistics.

Front 73

Fricional unemployment

Back 73

refers to the unemployment that results from the time that it takes to match workers with jobs
-in other words, it takes time for workers to search for the jobs that are best suit their tastes and skills

Front 74

Structural unemployment

Back 74

the unemployment that results because the number of jobs available in some labor markets is unsufficient to provide a job for everyone who wants one

Front 75

Job search

Back 75

the process by which workers find appopriate jobs given their tastes and skills
-results from the fact that it takes time for qualified individuals to be matched with appropriate jobs

Front 76

T/F. Government programs can affect the time it takes unemployed workers to find new jobs.

Back 76

True. These programs include Government-run employment agencies, public training programs and unemployment insurance

Front 77

Unemployment insurance

Back 77

a government program that partially protects workers' incomes when they ebcome unemployed.
-offers workers partial protection against job losses
-offers partial payment of ofrmer wages for a limited time to those who are laid off

Front 78

T/F. Unemployment insurance decreases the amount of search unemployment.

Back 78

False. Unemployment insurance increases the amount of search unemployment.

It also:
reduces the search efforts of the unemployed & may improve the chances of wrkers being matched with the right jobs

Front 79

When does structural unemployment occur?

Back 79

when the quantity of labor supplied exceeds the quantity demanded

Front 80

T/F. Structural unemployment is often thought to explain longer spells of unemployment.

Back 80

True, Structural Unemployment exists becasue of Minimum-wage laws, Unions, and Efficiency Wages.

Front 81

T/F. When the minimum wage is set above the level that balances supply and demand, it decreases unemployment.

Back 81

False. When the minimum wage is set above the level that balances supply and demand, it creates unemployment.

Front 82

Union

Back 82

a worker association that bargains with employers over wages, benefits and working conditions.
In the 1940s and 1950s, when unions were at their peak, about a third of the U.S. labor force was unionized.
A union is a type of cartel attempting to exert its market power.

Front 83

Collective Bargaining

Back 83

The process by which unions and firms agree on the terms of employment

Front 84

Strike

Back 84

A strike will be organized if the union and the firm cannot reach an agreement.
A strike occurs when the union organizes a withdrawal of labor from the firm

Front 85

Effects of Strikes

Back 85

A strike makes some workers better off and other workers worse off.
Workers in unions (insiders) reap the benefits of collective bargaining, while workers not in the union (outsiders) bear some of the costs.

Front 86

T/F. Union workers earn 10 to 20 percent more than nonunion workers.

Back 86

True. By acting as a cartel with ability to strike or otherwise impose high costs on employers, unions usually achieve above-equilibrium wages for their members.

Front 87

Unione, good or bad for the economy?

Back 87

Critics argue that unions cause the allocation of labor to be inefficient and inequitable.
Wages above the competitive level reduce the quantity of labor demanded and cause unemployment.
Some workers benefit at the expense of other workers.

Advocates of unions contend that unions are a necessary antidote to the market power of firms that hire workers.
They claim that unions are important for helping firms respond efficiently to workers’ concerns.

Front 88

Efficiency Wages

Back 88

Efficiency wages are above-equilibrium wages paid by firms in order to increase worker productivity.
The theory of efficiency wages states that firms operate more efficiently if wages are above the equilibrium level.

Front 89

Reasons firms may perfer higher than equilibrium wages

Back 89

Worker health: Better paid workers eat a better diet and thus are more productive.
Worker turnover: A higher paid worker is less likely to look for another job.
Worker quality: Higher wages attract a better pool of workers to apply for jobs.
Worker effort: Higher wages motivate workers to put forward their best effort.

Front 90

Are minimum wage laws a better explanation for structural unemployment among teenagers or among college graduates? Why?

Back 90

Minimum wage laws are a better explanation for unemployment among teens than among college graduates. Teenagers have fewer job-related skills than college graduates do, so their wages are low enough to be affected by the minimum wage. College graduates’ wages generally exceed the minimum wage.

Front 91

1. The Bureau of Labor Statistics announced that in July 2005, of all adult Americans, 142,076,000 were employed, 7,497,000 were unemployed, and 76,580,000 were not in the labor force. Use this information to calculate:
a. The adult population
b. the labor force
c. the labor-force participation rate
d. the unemployment rate

Back 91

The labor force consists of the number of employed (142,076,000) + the # of unemployed (7,497,000) = 149, 573,000.
To find the labor-force participation rate, we need to know the size of the adult population. Adding the labor force (149,573,000) to the number of people not in the labor force (76,580,000) gives the adult population of 226,153,000.

The labor-force participation rate is the labor force (149,573,000) divided by the adult population (226,153,000) times 100%, which equals 66%.

The unemployment rate is the # of unemployed (7,497,000) divided by the labor force (149,573,000) times 100%, which equals 5 %.

Front 92

Are the following workers more likely to experience short-term or long-term unemployment? Explain.
a. A construction worker laid off because of bad weather.
b. A manufacturing worker who loses her job at a plant in an isolated area.
c. A stagecoach-industry worker laid off because of competition from railroads.
d. A short-order cook who loses his job when a new restaurant opens across the street.
e. An expert welder with little formal education who loses her job when the company installs automatic welding machinery.

Back 92

a. Short-term unemployment b/c the worker will be back to work as soon as the weather clears up.
b. Long-term unemployment b/c there are probably fewer other employment opportunities in the area. She may need to move elsewhere to find a suitable job, which means she will be out of work for some time.
c. Long-term unemployment b/c his entire industry is shrinking. He will probably need to gain additional training or skills to get a job in a different industry.
d. Short-term unemployment b/c he can find a new job at a new restaurant,.
e. Long-term unemployment b/c she lacks technical skills to keep up w/the latest equipment. To remain in the welding industry, she may need to go back to school and learn the newest techniques.

Front 93

Does the minimum wage cause much unemployment in the market for accountants? Why?

Back 93

No b/c the competitive equilibrium wage for accountants exceeds the minimum wage, and hence, the minimum wage is not a binding constraint for accountants.

Front 94

A minimum wage law tends to
a. create more unemployment in high-skill job markets than in low-skill job markets.
b. create more unemployment in low-skill job markets than in high-skill job markets.
c. have no impact on unemployment as long as it is set above the competitive equilibrium wage.
d. help all teenagers because they receive a higher wage than they would otherwise.

Back 94

B. create more unemployment in low-skill job markets than in high-skill job markets.

Front 95

If unemployment insurance were so generous that it paid laid-off workers 95% of their regular salary,
a. the official unemployment rate would probably understate true unemployment.
b. the official unemployment rate would probably overstate true unemployment.
c. there would be no impact on the official unemployment rate.
d. frictional unemployment would fall.
e. none of the above is true.

Back 95

B. the official unemployment rate would probably overstate true unemployment.

Front 96

Which of the following government policies would fail to lower the unemployment rate?
a. reduce unemployment benefits
b. establish employment agencies
c. establish worker training programs
d. raise the minimum wage
e. establish right-to-work laws

Back 96

D. raise the minimum wage

Front 97

If for any reason, the wage is held above the competitive equilibrium wage,
a. unions will likely strike and the wage will fall to equilibrium.
b. the quality of workers in the applicant pool will tend to fall.
c. the quantity of labor supplied will exceed the quantity of labor demanded and there will be unemployment.
d. the quantity of labor demanded will exceed the quantity of labor supplied and there will be a labor shortage.

Back 97

C. the quantity of labor supplied will exceed the quantity of labor demanded and there will be unemployment.

Front 98

Money

Back 98

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

Front 99

Functions of Money in the Economy

Back 99

Medium of exchange
Unit of account
Store of value

Front 100

Medium of exchange

Back 100

an item, that buyers give to sellers when they want to purchase goods and services
-anything that is readily acceptable as payment

Front 101

Unit of account

Back 101

the yardstick people use to post prices and record debts

Front 102

store of value

Back 102

an item that people can use to transfer purchasing power from the present to the future

Front 103

Liquidity

Back 103

the ease with which an asset can be converted into the economy's medium of exchange

Front 104

Commodity money

Back 104

takes the form of a commodity with intrinsic value
ex: gold, silver, cigarettes

Front 105

fiat money

Back 105

used as money becuase of government decree
-does not have intrinsic value
ex: coins, currency, check deposits

Front 106

currency

Back 106

the paper bills and coins in the hands of the public

Front 107

demand deposits

Back 107

balances in bank accounts that depositors can access on demand by writing a check

Front 108

federal reserve

Back 108

serves as the nation's central bank
-is designed to oversee the banking system
-regulates the quantity of money in the economy

Front 109

why was the FED created

Back 109

was created in 1913 after a series of bank failures convinced congress that the united states needed a central bank to ensure the health of the nation's banking system

Front 110

primary elements of the FED

Back 110

board of governors
regional federal reserve banks
federal open market comittee

Front 111

primary functions of the FED

Back 111

regulates banks to ensure they follow federal laws intended to promote safe and sound banking practicies
acts as a banker's bank, making loans to banks and as a lender of last resort
conducts monetary policy by controlling the money supply

Front 112

FOMC- federal open market committee

Back 112

conducts monetary policy

Front 113

money supply

Back 113

refers to the quantity of money available in the economy

Front 114

monetary policy

Back 114

the setting of the money supply by policy makers in the central bank

Front 115

open-market operations

Back 115

primary way in which the FED changes the money supply is through open-market operations
-purchases & sells US government bonds

Front 116

Increasing/Decreasing the money supply

Back 116

increase - FED buys government bonds from the public
decrease - FED sells government bonds to the public

Front 117

reserves

Back 117

deposits that banks have received but have not loaned out

Front 118

fractional-reserve banking system

Back 118

banks hold a fraction of the money deposited as reserves and lend out the rest

Front 119

reserve ratio

Back 119

the fraction of deposits that banks hold as reserves

Front 120

T/F. When a bank makes a loan from its reserves, the money supply decreases.

Back 120

False. The money supply is affected by the amount deposited in banks and the amount that banks loan.
-deposits into a bank are recorded as both assets and liabilities
-the fraction of total deposits that a bank has to keep as reserves is called the reserve ratio
-loans become an asset to the bank

Front 121

T/F. When a bank makes a loan from its reserves, the money supply decreases.

Back 121

False. When a bank makes a loan from its reserves, the money supply increases.
-When one bank loans money, that money is generally deposited into another bank.
-This creates moer deposits and more reserves to be lent out.

Front 122

Money multiplier

Back 122

the amount of money the banking system generates with each dollar of reserves
-reciprocal of the reserve ratio: M=1/R
EX: with a reserve requirement, R=20%, or .2, the money multiplier is 1/.2=5

Front 123

FED's 3 tools in its monetary toolbox

Back 123

Open-market operations
Changing the reserve requirement
Changing the discount rate

Front 124

Reserve requirements

Back 124

regulations on the minimum amount of reserves that banks must hold against deposits.

Front 125

T/F. Decreasing the reserve requirement increases the money supply.

Back 125

True. The reserve requirement is the amount (%) of a bank's total reserves that may not be loaned out.
Just as decreasing the reserve requirement increases the money supply, increasing the reserve requirement decreases the money supply.

Front 126

1.Suppose the Federal Reserve purchases a U.S. government bond from you for $10,000.
a. What is the name of the Fed’s action?

Back 126

Open Market Operations

Front 127

Which of the following policy combinations would consistently work to increase the money supply?
a. sell govt. bonds, decrease reserve requirements, decrease discount rate
b. sell govt. bonds, increase reserve requirements, increase discount rate
c. buy govt. bonds, increase reserve requirements, decrease discount rate
d. buy govt. bonds, decrease reserve requirements, decrease discount rate
e. None of the above

Back 127

D. buy govt. bonds, decrease reserve requirements, decrease discount rate

Front 128

Suppose all banks maintain a 100% reserve ratio. If an individual deposits $1,000 of currency in a bank, then:
a. the money supply is unaffected
b. the money supply increases by more than $1,000
c. the money supply increases by less than $1,000
d. the money supply decreases by more than $1,000
e. the money supply decreases by less than $1,000

Back 128

A. the money supply is unaffected

Front 129

If the Fed engages in an open-market purchase, and at the same time, it raises reserve requirements:
a. the money supply should rise
b. the money supply should fall
c. the money supply should remain unchanged
d. we cannot be certain what will happen to the money supply

Back 129

D. we cannot be certain what will happen to the money supply

Front 130

Inflation

Back 130

we cannot be certain what will happen to the money supply

Front 131

Quantity theory of money

Back 131

The quantity theory of money is used to explain the long-run determinants of the price level and the inflation rate.

Front 132

T/F. When the overal price level rises, the value of money rises.

Back 132

False. When the overall price level rises, the value of money falls. Inflation is an economy-wide phenomenon that concerns the value of an economy's medium of exchange.

Front 133

Nominal variables

Back 133

variables measured in monetary units

Front 134

Real variables

Back 134

monetary values measured in physical units

Front 135

T/F. Changes in the money supply affect real variables, but nor nominal variables.

Back 135

False. Nominal variabels are measured in monetary units, so therefore are affected by changes in the money supply.

Front 136

Velocity of money

Back 136

The velocity of money refers to the speed at which the typical dollar bill travels around the economy from wallet to wallet.

V=(P*Y)/M
V-velocity
P-price level
Y-quantity of output
M-quantity of money

Front 137

Rewriting the velocity of money equation gives you the quantity equation

Back 137

M*V=P*Y
relates the quantity of money (M) to the nominal value of output (P*Y)
-shows that an increase in the quantity of money in an economy must be reflected in one of three other variables:
1)price level must rise
2)quantity of output must rise
3)velocity of money must fall

Front 138

Hyperinflation

Back 138

inflation that exceeds 50% per month
-occurs sometimes if a country's government prints too much money to pay for its spending

Front 139

inflation tax

Back 139

a tax on anyone who holds money
-when the government raises revenue by printing money, it is said to levy an inflation tax
-inflation ends when the government institutes fiscal reforms such as cuts in gov. spending

Front 140

fisher effect

Back 140

one-to-one adjustment of the nominal interest rate to the inflation rate
-when the rate of inflation rises, the nominal interest rate rises by the same amount
-the real interest rate stays the same

Front 141

Shoeleather cost

Back 141

the resources wasted when inflation encourages people to reduce their money holdings
-actual cost of reducing your money holdings is the time and convenience you must sacrifice to keep less money on hand; also trips to the bank take away from productive activities

Front 142

Menu costs

Back 142

costs of adjusting prices
-during inflationary times, it is necessary to update price lists and other posted prices
-resource-consuming process that tkes away from other productive activities

Front 143

T/F. With rising prices, it is more difficult to compare real revenues, costs, and profits over time.

Back 143

True. When the Fed increases the money supply and creates inflation, it erodes the real value of the unit of account. Inflation causes dollars at different times, to have different real values.

Front 144

1. Use the quantity equation for this problem. Suppose the money supply is $200, real output is 1,000 units, and the price per unit is $1.
a. What is the value of velocity?

b. If velocity is fixed at the value you solved for in part a, what does the quantity theory of money suggest will happen if the money supply is increased to $400?


c. Is your answer in part b consistent with the classical dichotomy? Explain.

d. Suppose that when the money supply is doubled from $200 to $400, real output grows a small amount (say 2%). Now what will happen to prices? Do prices more than double, less than double, or exactly double? Why?


e. When inflation gets very high, people do not like to hold money because it is losing value quickly. Therefore, they spend it faster. If when the money supply is doubled, people spend money more quickly, what happens to prices? Do prices more than double, less than double, or exactly double? Why?

Back 144

a. (1,000*$1)/ $200 = 5
b. $400*5 = $2*1000, prices will double from $1 to $2.
c. Yes. The classical dichotomy divides economic variables into real and nominal. Money affects nominal variables proportionately and has no impact on real variables. In part b, prices double, but real output remains constant.
d. The quantity equation says that nominal output must change in proportion to money. Prices will still rise, but since real output is larger, prices will less than double.
e. Money has a proportional impact on nominal output if V is constant. If V grows, a doubling of M will cause P to more than double.

Front 145

6. What are the 3 sources of revenue a government can use to support is expenditures? Which method causes inflation, and who bears the burden of the method of raising revenue?

Back 145

Taxes, borrowing, and printing money. Printing money. Those that hold money because its value decreases.

Front 146

9. If the Money supply grows 5% and real output grows 2%, prices should rise by :
a.5%
b. Less than 5%
c. more than 5%
d. none of the above

Back 146

B. Less than 5%

Front 147

15. If actual inflation turns out to be greater than people had expected, then
a. wealth was redistributed to lenders from borrowers
b. wealth was redistributed to borrowers from lenders.
c. no redistribution occurred.
d. the real interest rate is unaffected.

Back 147

B. Wealth was redistributed to borrowers from lenders

Front 148

17. Suppose that because of inflation, a business in Russia must calculate, print, and mail a new price list to its customers each month. This is an example of
a. menucosts
b. shoeleather costs
c. costs due to inflation-induced tax distortions
d. arbitrary redistribution of wealth
e. costs due to confusion and inconvenience

Back 148

A. Menu Costs

Front 149

1.Other things the same, as the maturity of a bond becomes longer, the bond will pay,
a. less interest because it has less risk
b. less interest because it has more risk.
c. more interest because it has more risk
d. There is no relation between term to maturity and risk.

Back 149

C. More interest becasue it has more risk

Front 150

2. Suppose that in a closed economy GDP is equal to 11,000, Taxes are equal to 1,500, Consumption equals 7,500, and Government purchases equal 2,000. What is national savings?
a. -500
b. 0
c. 1500
d. None of the above is correct.

Back 150

C. Y-C-G=11000-7500-2000=1500

Front 151

3. Fred is considering expanding his dress shop. If interest rates rise he is
a. less likely to expand. This illustrates why the supply of loanable funds slopes downward.
b. more likely to expand. This illustrates why the supply of loanable funds slopes downward.
c. less likely to expand. This illustrates why the demand of loanable funds slopes downward.
d. more likely to expand. This illustrates why the demand of loanable funds slopes downward.

Back 151

C. less likely to expand. This illustrates why the demand of loanable funds slopes downward.

Front 152

4. An increase in the budget deficit would cause a
a. shortage of loanable funds at the original interest rate, which would lead to falling interest rates.
b. surplus of loanable funds at the original interest rate, which would lead to rising interest rates.
c. shortage of loanable funds at the original interest rate, which would lead to rising interest rates.
d. surplus of loanable funds at the original interest rate, which would lead to falling interest rates.

Back 152

C. shortage of loanable funds at the original interest rate, which would lead to rising interest rates.

Front 153

5. Which of the 2 bonds in each example would you expect to generally pay the higher interest rate? Explain why.
a. a U.S. government bond or a Brazilian government bond
b. a 6-month Treasury bill or a 20 year Treasury bond
c. a Microsoft bond or a bond issued by a new recording company.

Back 153

a. The Brazilian government bond would likely pay a higher interest rate b/c the market perceives a higher level of risk for the Brazilian bond relative to the U.S. bond.
b. The 20-year bond would likely pay a higher interest rate than would the 6-month bill. The future is uncertain and therefore more risky for a year 20 year bond than for a 6 month bill.
c. Since the Microsoft is less likely to default than a new and unknown company, the interest on bond of the new company is likely to be higher.

Front 154

1. Which of the following changes would increase the present value of a future payment?
a. an increase in the size of the payment
b. an increase in the time until the payment is made
c. an increase in the interest rate
d. All of the above are correct.

Back 154

A. an increase in the size of the payment

Front 155

2. According to the rule of 70, if the interest rate is 5%, how long will it take for the value of a savings account to double?
a. 6.3 years
b. 3.5 years
c. 12 years
d. 14 years

Back 155

D. 14 years

Front 156

3. When you rent a car, you might treat it with less care than you would if it were your own car. This is an example of
a. market risk
b. Moral hazard
c. adverse selection
d. risk aversion

Back 156

B. Moral hazard

Front 157

4. Other things the same, as the stocks of a greater number of corporations are held in a portfolio,
a. risk increases at an increasing rate
b. risk increases at an decreasing rate
c. risk decreases at an increasing rate
d. risk decreases at a decreasing rate

Back 157

D. risk decreases at a decreasing rate

Front 158

5. Give an example of adverse selection and an example of moral hazard using homeowners insurance.

Back 158

Ex of adverse selection: someone whose home is in a location prone to theft is more likely to apply for homeowner insurance.
Ex of moral hazard: once someone has insurance, he might keep fewer fire extinguishers at home.

Front 159

1. The natural rate of unemployment is the
a. unemployment rate that would prevail with zero inflation
b. rate associated with the highest possible level of GDP.
c. difference between the long-run and short-run unemployment rates.
d. amount of unemployment that the economy normally experiences.

Back 159

D. amount of unemployment that economy normally experiences

Front 160

2. Which of the following would be counted as unemployed according to official statistics?
a. George, a full-time student who is not looking for work
b. Jenna, who is on temporary layoff
c. Larry, who has retired and is not looking for work
d. All of the above would be counted as unemployed

Back 160

B. Jenna, who is on temporary layoff

Front 161

3. Anna has just finished high school and started looking for her first job, but has not yet found one. As a result, the unemployment rate
a. increases, and the labor-force participation rate is unaffected.
b. increases, and the labor-force participation rate increases.
c. is unaffected, and the labor-force participation rate increases.
d. increases, and the labor-force participation rate decreases.

Back 161

B. increases, and the labor-force participation rate increases.

Front 162

4. An increase in the minimum wage would
a. increase both the quantity demanded and the quantity supplied of labor.
b. decrease both the quantity demanded and the quantity supplied of labor.
c. increase both the quantity demanded, while decreasing the quantity supplied/
d. decrease the quantity of labor demanded, while increasing the quantity supplied.

Back 162

D. decrease the quantity of labor demanded, while increasing the quantity supplied.

Front 163

5. Teenage unemployment is higher than unemployment of people ages 20 and over. Explain why economists would attribute at least part of this difference to minimum-wage laws.

Back 163

People w/experience and education tend to find jobs where the eqm. Wage is above the minimum wage. In these labor markets, there is less unemployment.

Front 164

Which of the following is included in M2 but not M1?
a. currency
b. demand deposits
c. savings deposits
d. All of the above are included in both M1 and M2.

Back 164

C. Savings deposits

Front 165

2. The Federal Reserve does all except which of the following?
a. control the supply of money
b. control the value of money
c. make loans to individuals
d. regulate the banking system

Back 165

C. make loands to individuals

Front 166

3. Suppose that the reserve ratio is 10%, and that a bank has deposits of $2,000. Its reserves are
a. $20
b. $200
c. $1880
d. $1800

Back 166

B. $200

Front 167

4. If the reserve ratio is 5%, the money multiplier is
a. 25
b. 20
c. 2.5
d. 1.25

Back 167

A. 25

Front 168

4. If the reserve ratio is 5%, the money multiplier is
a. 25
b. 20
c. 2.5
d. 1.25

Back 168

a. If it buys bonds, it pays for them w/reserves so banks will have more reserves, and can lend more which will create more deposits and more money.
b. Banks will borrow less, so less to loan out, decreases the money supply.
c. Banks have to hold more onto their reserves, thus less deposits, and the money supply decreases.

Front 169

1.Economic variables whose values are measured in monetary units are called
a. dichotomous variables
b. nominal variables
c. classical variables
d. real variables

Back 169

B. nominal variables

Front 170

2. Based on the quantity equation, if M = 100, V = 3, and Y = 200, then P =
a. 1
b. 1.5
c. 2
d. None of the above is correct.

Back 170

B. MV=PY, (100)(3)=200P, P=1.5

Front 171

3. Printing money to finance government expenditures
a. causes the value of money to rise.
b. imposes a tax on everyone who holds money.
c. is the principal method by which the U.S. government finances its expenditures.
d. None of the above is correct.

Back 171

B. imposes a tax on everyone who holds money.

Front 172

4. The nominal interest rate is 6% and the real interest rate is 2%. What is the inflation rate?
a. 3%
b. 4%
c. 8%
d. 12%

Back 172

B. 4% (Use nominal interest rate = inflation + real interest rate)