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148 Cards in this Set

  • Front
  • Back
The U.S. economy has experienced a long run ______ trend in Real GDP
upward
The long run upward trend in Real GDP in the U.S. has resulted in...?
A much higher standard of living than we had 50 years ago
In the short-run, real GDP does what? why?
It fluctuates around the long-run upward trend because of the business cycle.
Fluctuations in real GDP lead to fluctuations in...?
employment
Which fluctuations are the two most dramatic in the business cycle?
Real GDP and Employment
In addition to changes in output and employment, the business cycle causes changes in what two other areas?
Wages and Prices
The aggregate demand and aggregate supply model helps analyze the effects of _____ and _____, on ______, ______, and _____.
1. Recessions and Expansions
2. Production, employment, and prices.
Fluctuations in the unemployment rate are mainly caused by fluctuations in...?
Real GDP
What is the Aggregate demand and aggregate supply model?
A model that explains short-run fluctuations in real GDP and the price level.
Real GDP and the Price Level in the ADAS Model are determined in the short-run by what?
The intersection of the aggregate demand curve and the aggregate supply curve.
Fluctuations in Real GDP and the Price Level are caused by what?
Shifts in the AD curve or in the AS curve.
The Aggregate Demand (AD) Curve is what?
A curve that shows the relationship between the price level and the quantity of real GDP demanded by households, firms, and the government.
The Short-Run Aggregate Supply (SRAS) Curve is what?
A curve that shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms.
The AD Curve is _____ sloping, and the SRAS Curve is ______ sloping.
1. downward
2. upward
What are the 4 components of GDP?
Consumption + Investment + Government Purchases + Net Exports
Why is the AD Curve downward sloping?
Because a fall in the price level increases the quantity of real GDP demanded.
Which 3 components of GDP are affected by the Price Level? Which one is not?
Affected: Consumption, Investment, Net Exports

Not Affected: Government Purchases
How does a change in Price Level affect Consumption?
When the price level rises, the real value of household wealth declines, and so will consumption.
Household wealth is...?
The difference between the value of its assets and the value of its debits.
How does a change in Price Level affect Investment?
When the price level rises, so does the interest rate usually, so firms borrow less money for investments.
How does a change in Price Level affect Net Exports?
When prices rise in the U.S., other countries buy less of our goods. The U.S. also buy more goods from other countries that sell it cheaper.
If the price level changes but other variables that affect the willingness of households, firms, and the government to spend are unchanged, the economy will...?
move up or down a stationary AD Curve.
If any variable other than the price level changes, the AD Curve...?
will shift
The variables that cause the AD Curve to shift fall into what 3 categories?
1. Changes in Government Policies

2. Changes in the expectations of households and firms

3. Changes in foreign variables
The government uses monetary policy and fiscal policy to...?
Shift the AD Curve
What is Monetary Policy?
The actions the Federal Reserve takes to manage the money supply and interest rates to pursue macroeconomic policy objectives, and to ensure the flow of funds from lenders to borrowers.
What is Fiscal Policy?
Changes in federal taxes and purchases that are intended to achieve macroeconomic policy objectives.
If households/firms become more optimistic about their future incomes, they are likely to...?
increase their current consumption.
If Real GDP increases in the U.S. faster than it does in other countries, what happens?
U.S. Imports will increase faster than U.S. exports and net exports will fall.
If the exchange rate rises, what happens to net exports?
Net exports will fall
A change in net exports that results from a change in the price level in the U.S. will result in a...?
movement along the aggregate demand curve, NOT a shift of the AD Curve (because price level caused it).
Why do we use 2 different Aggregate Supply Curves?
Because the effect of changes in the price level on aggregate supply is very different in the short run from what it is in the long run.
In the long run, the level of real GDP is affected by what? (3 things)
1. The number of workers

2. Capital Stock (including factories, office buildings, and machinery and equipment.

3. The available technology
In the long run, how do changes in the price level affect the level of real GDP?
It does NOT affect it
What does the Long-Run Aggregate Supply (LRAS) Curve show?
It is a curve that shows the relationship in the long run between the price level and the quantity of real GDP supplied.
What type of line is the LRAS curve?
Vertical
What type of line is the SRAS curve?
Upward Sloping
Why is the SRAS curve upward sloping?
Because, over the short run, as the price level increases, the quantity of goods and services firms are willing to supply will increase.
The main reason firms are willing to increase their supply when price levels increase is because...?
As prices of final goods and services rise, prices of inputs - such as the wages of workers or the price of natural resources - rise more slowly.
Profits rise when...?
The prices of goods and services firms sell rise more rapidly than the prices they pay for inputs.
A higher price level leads to...?
higher profits and increases the willingness of firms to supply more goods and services.
What is a secondary reason the SRAS curve is upward sloping?
As the price level rises or falls, some firms are slow to adjust their prices. A firm that is slow to raise its prices when the price level is increasing may find its sales increasing and, therefore, will increase production.
If firms and workers could predict the future price level exactly, the SRAS curve would...?
be the same as the LRAS curve.
Prices or wages are said to be "sticky" when they...?
do not respond quickly to changes in demand or supply.
What are Menu Costs?
The costs to firms of changing prices. As in, if a catalog for a company has prices they wanted to change, they would have to print all new catalogs, which could be costly.
What are the 5 most important variables that cause the SRAS curve to shift?
1. Increases in the Labor Force and in the Capital Stock.

2.Technological Change

3. Expected changes in the future price level.

4. Adjustments of workers and firms to errors in past expectations about the price level.

5. Unexpected changes in the price of an important natural resource.
As the labor force and the capital stock grow, firms will...?
supply more output at every price level, and the SRAS curve will shift to the right. A decrease would result in a shift to the left.
As positive technological change takes place, what happens?
The productivity of workers and machinery increases, which means firms can produce more goods and services with the same amount of labor and machinery. This increase in productivity reduces the firms' costs of production and, therefore, allows them to produce more output at every price level. As a result the SRAS curve shifts to the right.
In general, if workers and firms expect the price level to increase by a certain percentage, the SRAS curve will...?
shift by an equivalent amount, holding constant all other variables that affect the SRAS curve.
If workers and firms across the economy are adjusting to the price level behind higher than expected, the SRAS curve will...? What about lower than expected?
Higher than expected: The SRAS curve will shift to the left.

Lower: Shifts to the right.
What is a Supply Shock?
An unexpected event that causes the SRAS curve to shift.
Supply shocks are often caused by...?
unexpected increases or decreases in the prices of important natural resources that can cause firms' costs to be different from what they had expected.
Because firms face rising costs, they will...?
supply the same level of output only if they receive higher prices, and the SRAS curve will shift to the left.
Holding everything else constant, expectations of a higher price level will cause the SRAS curve to...?
shift to the left. (But everything else is usually not constant, and those variables cause the SRAS curve to shift to the right. The shift to the left or right in any particular year depends on how big of an impact those other variables have.)
When long-run macroeconomic equilibrium occurs at a point along the LRAS model, we know the economy is at...?
potential real GDP
A decline in aggregate demand causes what in the short run? How about the long run?
Short run: Recession

Long run: Only a decline in the price level
What is Automatic Mechanism?
The adjustments back to potential GDP from a recession. (Firms will sell goods for less, and workers will take lower wages, etc).
How is the workforce affected when real GDP is above potential GDP?
Firms are operating beyond their normal level of capacity and some workers who would ordinarily be structurally or frictionally unemployed or who would not be in the labor force are now employed.
What is stagflation?
A combination of inflation and recession, usually resulting from a supply shock.
Potential Real GDP ______ continually, shifting the LRAS curve to the _____.
increases; right
During most years, the AD curve shifts to the _____.
right
The SRAS curve shifts to the right except when?
Except during periods when workers and firms expect high rates of inflation.
There is no inflation when AD and AS shift by exactly as much as...?
LRAS
Changes in the price level and in real GDP in the short run are determined by...?
shifts in the SRAS and AD curves.
What results if the AD curve shifts to the right by more than the LRAS curve?
Inflation will result because equilibrium occurs at a higher price level.
Inflation usually results from what?
Total spending growing faster than total production
What else can cause inflation?
A shift to the left of the SRAS curve
What were the 3 main factors that combined to bring on the recession of 2007-2009?
1. The end of the housing bubble

2. The financial crisis

3. The rapid increase in oil prices during 2008
What is the Keynesian Revolution?
The name given to the widespread acceptance during the 1930's and 40's of John Maynard Keynes's macroeconomic model.
What are the 3 major alternative model's to the keynes's model?
1. The monetarist model
2. The new classical model
3. The real business cycle model
What is the Monetary Growth Rule?
A plan for increasing the quantity of money at a fixed rate that does not respond to changes in economic conditions.
What is the main point of each of the 3 alternative models?
Monetarist model: Quantity of money should be increased at constant rate.

New Classical Model: The idea that workers and firms have rational expectations.

Real Business Cycle Model: Focuses on real, rather than monetary, causes of the business cycle.
What did Karl Marx predict?
That a final economic crisis would lead to the collapse of the market system.
Chapter 15
Chapter 15
What are the Federal Reserve's (the Fed) 4 main monetary policy goals?
1. Price Stability
2. High Employment
3. Stability of financial markets and institutions
4. Economic growth
What two goals are mentioned in the Employment Act, leading to sometimes saying that the Fed has a dual mandate to attain there two goals?
1. Price Stability
2. High Employment
The Fed promotes the stability of financial markets and institutions so that...?
an efficient flow of funds from savers to borrowers will occur.
Investment banks can be prone to what kind of problems?
Liquidity problems
Who do investment banks borrow primarily from?
Primarily they borrow from other financial firms, such as other investment banks, mutual funds, or hedge funds.
Commercial banks go into crisis if what happens?

Investment banks go into crisis if what happens?
Commercial: If depositors begin to withdraw their funds.

Investment: If other financial firms stop offering them short-term loans.
Policymakers aim to encourage stable economic growth because...?
It allows households and firms to plan accurately and encourages the long-run investment that is needed to sustain growth.
Policy can spur economic growth by...?
providing incentives for saving to ensure a large pool of investment funds, as well as by providing direct incentives for business investment.
How can the President and Congress be better able to increase saving and investment than the Fed?
They can change the tax laws to increase the return to saving and investing.
What are the Fed's 3 policy tools?
1. Open market operations
2. Discount policy
3. Reserve requirements
The Fed tries to do what with unemployment and inflation rates? What is the Fed's main setback here?
The Fed tries to keep both the rates low but it can not affect either of the economic variables directly.
How does the Fed go about affecting their monetary policy goals?
The Fed uses variables, called Monetary Policy Targets, that it can affect directly and that, in turn, affect variables, such as real GDP, employment, and the price level, that are closely related to the Fed's policy goals.
What are the 2 main monetary policy targets? Which one does the Fed typically use as its policy target?
1. The money supply
2. The interest rate

The Fed typically uses the Interest Rate as its policy target.
What is the M1 definition of money?
Currency in circulation + Checking account deposits
The demand curve for money is _______ sloping.
downward
What is the most desirable characteristic of money and what is its major flaw?
Pro: Can be used to buy goods, services, or financial assets.

Con: It earns either no interest (the money in your wallet) or very little interest (the money in your checking account).
What are U.S. Treasury Bills?
They pay interest but have to be sold if you want to use the funds to buy something.
When the interest rates rise on financial instruments like U.S. Treasury bills, the amount of interest that households and firms lose by holding money ______.
Increases, and vice versa if the interest rates fall.
What is Opportunity Cost? What is the opportunity cost of holding money?
What you have to forgo to engage in an activity. The interest rate is the opp cost of holding money.
When interest rates are high/low, what is the demand for money?
High: Low demand for money because the opp cost of holding onto the money is high.

Low: The demand for money increases because the opp cost of holding onto the money is low.
The demand curve for money is drawn...?
holding constant all variables, other than the interest rate, that affect the willingness of households and firms to hold money.
Changes in variables other than the interest rate cause the demand curve for money to...?
shift
What are the 2 most important variables that cause the demand curve for money to shift?
1. Real GDP
2. Price Level
An increase in Real GDP means that the amount of buying and selling of goods and services will ______.
Increase
An increase in Real GDP _______ the quantity of money demanded at each interest rate, and will shift the money demand curve to the _____.
Increase; right
An decrease in Real GDP _______ the quantity of money demanded at each interest rate, and will shift the money demand curve to the _____.
Decrease; left
An increase in the price level _______ the quantity of money demanded at each interest rate, and will shift the money demand curve to the _____.
Increase; right
An decrease in the price level _______ the quantity of money demanded at each interest rate, and will shift the money demand curve to the _____.
Decrease; left
What is the FOMC?
Federal Open Market Committee
If the FOMC decides to increase the money supply, it orders the trading desk at the Federal Reserve Bank of New York to...?
purchase U.S. Treasury Secruities
The sellers of these Treasury securities do what with the money which does what?
the sellers deposit the funds they receive from the Fed in banks, which increases the banks' reserves.
If the FOMC decides to decrease money supply, it orders the trading desk to....?
sell Treasury securities, which decreases banks' reserves and contracts the money supply.
Equilibrium in the money market occurs where...
the money demand curve crosses the money supply curve.
If the Fed increases the money supply, the money supply curve will...
shift to the right and the equilibrium interest rate will fall.
When the Fed increases the money supply, the short-term interest rate must...?
fall until it reaches a level at which households and firms are willing to hold the additional money.
The loanable funds model is concerned with the...?
long-term real rate of interest.
The money market model is concerned with the...?
short-term nominal rate of interest.
The long-term real rate of interest is...?
most relevant to firms that are borrowing to finance long-term investment projects, or to households that are taking out mortgage loans to buy new homes.
When conducting monetary policy, however, the short-term nominal rate of interest is...?
the most relevant interest rate because it is the interest rate most affected by increases and decreases in the money supply.
Is there ever any close connection between the short-term nominal rate of interest and the long-term real rate of interest?
There is often, but not always, a close connection between the movements of the two.
For purposes of monetary policy, the Fed has targeted the interest rate known as the...?
federal funds rate.
What is the federal funds rate?
The interest rate banks charge each other for overnight loans.
Does the Fed set the federal funds rate?
No, it is determined by the supply of the reserves relative to the demand for them.
Only who can borrow or lend in the federal funds market?
Banks
A change in the federal funds rate has a greater effect on what compared to what?
It has a greater effect on short-term interest rates than on long-term interest rates, and its effect on long-term interest rates may occur only after a lag in time.
What does the Fed use the federal funds rate as? Why?
The Fed uses the federal funds rate as a monetary policy target because it has good control of the federal funds rate through open market operations and because it believes that changes in the federal funds rate will ultimately affect economic variables that are related to its monetary policy goals.
How do you calculate the Real interest rate?
Nominal interest rate - Inflation rate
Ultimately, the ability of the Fed to use monetary policy to affect real economic variables like real GDP depends on...?
its ability to affect real interest rates, such as the real interest rates on mortgages and corporate bonds.
What is aggregate demand?
The total level of spending in the economy.
Do changes in interest rate affect aggregate demand?
Yes
What are the 4 components of aggregate demand?
Consumption, Investment, Government Purchases, and Net Exports.
Changes in interest rates dont affect which component of AD?
Government Purchases
Lower interest rates...
Lead households to save less and spend more.
If interest rates in the U.S. decline relative to other countries, the value of the dollar will...?
fall, and net exports will rise.
What is an expansionary monetary policy?
The Fed's decreasing interest rates to increase real GDP.
What is a contractionary monetary policy?
The Fed's increasing interest rates to reduce inflation.
Keeping real GDP above potential GDP will result in...?
rising inflation.
The Fed can use monetary policy to affect...
the price level and, in the short run, the level of real GDP, allowing it to attain its policy goals of high employment and price stability.
What is a liquidity trap?
It is in which short-term interests rates are pushed to zero, leaving the central bank unable to lower them further.
What is a policy of quantitative easing?
It involves buying securities beyond the short-term Treasury securities that are usually involved in open market operations.
What is a procyclical policy?
It increases the severity of the business cycle.
What is a countercyclical policy?
It is meant to reduce the severity of the business cycle.
Does a contradictionary monetary policy cause the price level to fall?
No, rather it causes the price level to rise by less than it would have risen without the policy.
Why doesn't the Fed target both the interest rate and the money supply, making both groups happy?
Because the Fed cant target both at the same time.
Does the Fed control money supply and money demand?
No, it controls money supply but money demand is determined by decisions of households and firms between money at a low interest rate or other financial assets.
Only combinations of what two things that represent equilibrium are possible in the money market?
Interest rate and Money supply.
What is the Taylor Rule?
A rule developed by John Taylor that links the Fed's target for the federal funds rate to economic variables.
What is the formula for the federal funds target rate according to the Taylor rule?
Current inflation rate + Real equilibrium federal funds rate + ((1/2) x Inflation gap) + ((1/2) x Output gap)
What is the Inflation gap?
Current inflation rate - Target rate
What is the Output gap?
Real GDP% - Potential Real GDP%
What two things does the Taylor Rule not account for?
Changes in the target inflation rate and the equilibrium interest rate.
What is Inflation Targeting?
Conducting monetary policy so as to commit the central bank to achieving a publicly announced level of inflation.
What is the moral hazard program?
Worried that the managers of financial firms would make riskier investments if they believe that the federal government will save them from bankruptcy.
What is the troubled asset relief program?
The Treasury attempted to stabilize the commercial banking system by providing funds to banks in exchange for stock.