Macro Exam 4

Front 1

Classical economic theory states what?

Back 1

Nominal variables such as the money supply and price level do not influence real variable such as output and unemployment.

Front 2

When is the classical economic theory accurate?

Back 2

In the long run, not the short run.

Front 3

What is used to analyze short run economic fluctuations?

Back 3

The model of aggregate demand and aggregate supply.

Front 4

According to the model of aggregate demand and aggregate supply...

Back 4

the output of goods and services and the overall level of prices adjust to balance aggregate demand and aggregate supply.

Front 5

What are the three reasons the aggregate demand curve slopes downward?

Back 5

1. The wealth effect
2. The interest-rate effect
3. The exchange-rate effect

Front 6

What is the wealth effect?

Back 6

A lower price level raises the real value of households' money holdings, which stimulates consumer spending.

Front 7

What is the interest-rate effect?

Back 7

-A lower price level reduces the quantity of money households demand.
-As households try to convert money into interest-bearing assets, interest rates fall.
-This stimulates investment spending.

Front 8

What is the exchange-rate effect?

Back 8

-A lower price level reduces interest rates
-The dollar depreciates in the market for foreign-currency exchange
-Thus stimulating net exports

Front 9

What events or policies increase aggregate demand?

Back 9

Ones that raise:
-consumption
-investment
-government purchases
-net exports
-(GDP)

Front 10

How is the long run aggregate supply curve shaped? Why?

Back 10

-vertical
-long run quantity of supply does not depend on overall price levels

Front 11

What affects long run aggregate supply?

Back 11

the economy's:
-labor
-capital
-natural resources
-technology

Front 12

What shape is the aggregate demand curve?

Back 12

downward sloping

Front 13

What three theories attempt to explain the upward sloping short-run aggregate supply curve?

Back 13

1. Sticky-wage theory
2. Sticky-price theory
3. Misperceptions theory

Front 14

What is the sticky-wage theory?
What does it attempt to explain?

Back 14

1. -An unexpected fall in the price level temporarily raises real wages
-this induces firms to reduce employment and production
2. The upward slope of the short-run aggregate supply curve.

Front 15

What is the sticky-price theory?

Back 15

1. -An unexpected fall in the price level leaves some firms with prices that are temporarily too high
-This reduces their sales and causes them to cut back production.

Front 16

What is the misperceptions theory?

Back 16

-An unexplained fall in the price level leads suppliers to mistakenly believe their relative prices have fallen
-This induces them to reduce production.

Front 17

What do all three theories on the upward slope of aggregate supply imply?

Back 17

Output deviates from its natural rate when the actual price level deviates from the price level that people expected.

Front 18

What events alter an economy's ability to produce output?

Back 18

-labor
-capital
-resources
-technology

Front 19

What two things shift the short-run aggregate supply curve?

Back 19

1. Events that alter the economy's ability to produce output
2. The expected price level

Front 20

What are two possible cause of economic fluctuations?

Back 20

-A shift in aggregate demand.
-A shift in aggregate supply.

Front 21

What happens when the aggregate demand curve shifts to the left? How does this affect the aggregate supply curve in the short run? Why?

Back 21

-output and prices fall in the short-run.
-The aggregate supply curve shifts to the right
-a change in the expected price level causes wages, prices, and perceptions to adjust.

Front 22

What effect has the short-run aggregate supply curve shifting to the left? What is this called?

Back 22

-Falling output and rising prices.
-Stagflation

Front 23

Who developed the theory of liquidity preference?

Back 23

Keynes

Front 24

What is the theory of liquidity preference?

Back 24

The interest rate adjusts to balance the supply and demand for money.

Front 25

How does an increase in the overall price level affect the money demand and interest rates?

Back 25

it raises money demand and increases the interest rate that brings the money market into equilibrium.

Front 26

What does the interest rate represent?

Back 26

The cost of borrowing

Front 27

What does a rising interest rate cause?

Back 27

A reduction in investment and the quantity of goods and services demanded

Front 28

What does the downward sloping aggregate demand curve express?

Back 28

The negative relationship between the price level and the quantity of output.

Front 29

What are two ways that policy makers can influence aggregate demand?

Back 29

Fiscal and Monetary policy

Front 30

What is the effect of an increase in the money supply on the interest rate, investment spending, and aggregate demand?

Back 30

-Reduction of the equilibrium interest rate for any given price level.
-Lower interest rate stimulates investment spending.
-Aggregate demand curve shifts to the right.

Front 31

What is the cause of a lower interest rate?

Back 31

an increase in investment spending

Front 32

What is the effect of a decrease in the money supply on interest rates and demand?

Back 32

-Increase in the equilibrium interest rate for any given price level
-Shifts aggregate demand curve to the left.

Front 33

What are two ways the government can use fiscal policy?

Back 33

-Government spending
-Taxes

Front 34

What is the effect of an increase in government purchases on aggregate demand?

Back 34

Aggregate demand curve shifts to the right

Front 35

What is the effect of an increase in taxes on aggregate demand?

Back 35

Aggregate demand curve shifts to the left

Front 36

What is the effect of a decrease in government purchases on aggregate demand?

Back 36

Aggregate demand curve shifts to the left

Front 37

What is the effect of a decrease in taxes on aggregate demand?

Back 37

Aggregate demand curve shifts to the right

Front 38

What amplifies the effects of fiscal policy on aggregate demand?

Back 38

The multiplier effect

Front 39

What dampens the effects of fiscal policy on aggregate demand?

Back 39

The crowding-out effect

Front 40

What two things cause fiscal policy to not have an exact impact on aggregate demand?

Back 40

1. The multiplier effect
2. The crowding-out effect

Front 41

What are the beliefs of advocates of active stabilization policy?

Back 41

-changes in attitudes of households and firms shift aggregate demand
-if the gov't does not respond the result is undesirable and unnecessary fluctuations in output and employment

Front 42

WHat are the beliefs of critics of active stabilization policy?

Back 42

Monetary and fiscal policy work with such long lags that attempts to stabilize the economy often end up in destabilization.

Front 43

What is the multiplier effect?

Back 43

The additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending

Front 44

What is the crowding out effect?

Back 44

The offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending

Front 45

What is an automatic stabilizer?

Back 45

a change in fiscal policy that stimulates aggregate demand when the economy goes into a recession without policy makers having to take deliberate action

Front 46

What is the most important automatic stabilizer? Why?

Back 46

-The tax system
-Taxes collected in a recession fall because they are almost all tied to economic activity

Front 47

What does the Phillips curve describe?

Back 47

A negative relationship between inflation and unemployment.

Front 48

What does an expansion of aggregate demand by policy makers cause in regards to the Phillips curve?

Back 48

Higher inflation and lower unemployment.

Front 49

When does the trade-off between inflation and unemployment in the Phillips curve hold true?

Back 49

Only in the short-run

Front 50

What does the Phillips curve look like in the long run and at what rate? Why?

Back 50

-It is vertical at the natural rate of unemployment.
-In the long run expected inflation adjusts to actual inflation causing the short-run Phillips curve to shift.

Front 51

What are three causes of shifts in the short-run Phillips curve?

Back 51

1. Expected inflation adjusting to actual inflation
2. Shocks in aggregate supply
3. Policies that cause changes in aggregate demand.

Front 52

What does an adverse supply shock cause in regards to the Phillips curve? Which way does it shift?

Back 52

-A less favorable trade-off between inflation and unemployment.
-It shifts to the right.

Front 53

What happens when the fed contracts growth in the money supply in regards to the short-run Phillips curve?

Back 53

Lower inflation and higher unemployment.

Front 54

What effect does an increase in aggregate demand have on the Phillips curve?

Back 54

Higher inflation rate and lower unemployment.

Front 55

What effect does a decrease in aggregate demand have on the Phillips curve?

Back 55

Lower inflation and higher unemployment

Front 56

What are the labels for the X and Y axes of aggregate demand and aggregate supply?

Back 56

X - Quantity of Output
Y - Price Level

Front 57

What are the labels for the X and Y axes of the Phillips curve?

Back 57

X - Unemployment rate
Y - Inflation rate

Front 58

Why is it called the "natural" rate of unemployment?

Back 58

It is beyond the influence of monetary policy

Front 59

What is the natural rate of unemployment?

Back 59

The rate of unemployment at which the economy gravitates to in the long run

Front 60

What is the equation for the Phillips curve?

Back 60

Unemployment rate = Natural rate of unemployment - (actual inflation - expected inflation)

Front 61

How does a higher expected inflation rate shift the Phillips curve?

Back 61

It shifts to the right.

Front 62

What is the sacrifice ratio?

Back 62

the number of percentage points of annual output lost in the process of reducing inflation by 1 percentage point

Front 63

What is the theory of rational expectations?

Back 63

the theory that people optimally use all the information they have, including information about government policies, when forecasting the future.

Front 64

How do advocates of active monetary and fiscal policy view the economy?

Back 64

Inherently unstable