Economics

Front 1

Brieflydiscuss the difference between microeconomics and macroeconomics.

Back 1

Microeconomics: is the study of how households and firms make choices, how theyinteract in markets, and how the gov’t attempts to influence their choices.

Macroeconomics:is the study of the economy as a whole, including topics suchas inflation, unemployment, and economic growth.

Front 2

What is acircular-flow diagram, and what does it demonstrate?

Back 2

Acircular-flow diagram illustrates how participants in markets are linked. Itshows that in factor markets, households supply labour and other factors ofproduction in exchange for wages and other payments from firms. In productmarkets, households use the payments they earn in factor markets to purchasethe goods and services produced by firms.

Front 3

If , over time, the demandcurve for a product shifts to the right (out) more than the supply curve does,what will happen to the equilibrium price? What will happen to the the equilibrium price if the supply curve shiftsout more than the demand curve?

Back 3

If thedemand crve shifts to the right more than the supply curve does, theequilibrium price will rise. (Figure 1) If the supply curve shifts to the rightmore than the demand curve, the equilibrium price will fall. (Figure 2)

Front 4

Describe the four major categories of expenditures of GDP andwrite the equation used to represent the relationship between GDP and the fourexpenditure categories.

Back 4

GDP= C + I + G + NX. Consumption© is spending by households on goods and services, and investment (I) is spendingby forms on new plant, equipment, buildings, and changes in inventories, and byhouseholds and firms on newsingle-family and multi-unit houses. Government purchases (G) are made by thefederal, provincial, local, and municipal governments for goods and services,and net exports (NX) equal exports minus imports. Exports are goods andservices produced in Canada that are purchased by foreign firms, households,and governments, and imports are goods and services produced in foreigncountries, but purchased by Canadian firms, households, and governments.

Front 5

What is the “natural rate of unemployment”? What is the relationship between the naturalrate of unemployment and full employment? Would it be better for economies to define full employment as being anunemployment rate equal to zero?

Back 5

Thenatural rate of unemployment is the normal rate of unemployment consisting offrictional unemployment plus structural unemployment. The natural rate ofunemployment is also called the full-employment rate of unemployment.Economists do not define full employment as being an unemployment rate equal tozero because the creating and destroying of jobs that leads to frictionalunemployment and the structural changes in the economy from factors such asinnovation that lead to structural unemployment are ongoing features of agrowing, dynamic economy. No economy attains an unemployment rate of zero, evenduring wartime.

Front 6

What is potential rGDP (real GDP)? Does potential rGDP remain constant overtime?

Back 6

Potentialreal GDP is the level of real GDP attained when all firms are producing atcapacity. Historically, potential real GDP has substantially increased overtime.

Front 7

Briefly describe three government policies that can increaseeconomic growth.

Back 7

Governmentscan aid economic growth through policies that enhance property rights and therule of law, improve health and education, subsidize research and development,and provide incentives for saving and investment.ation"

Front 8

What is the relationship among the AD, SRAS and LRAS curveswhen the economy is in the long-run macroeconomic equilibrium?

Back 8

When theeconomy is in a long-run equilibrium, the short-run aggregate supply curve andthe aggregate demand curve intersect at a point on the long-run aggregatesupply curve.

Front 9

What are the four functions ofmoney? Can something be considered moneyif it doesn’t fulfill all four functions?

Back 9

Thefour functions are medium of exchange, unit of account, store of value, andstandard of deferred payment. In the long run, something will not serve asmoney if it does not fulfill all four functions.

Front 10

Why does the Bank of Canada use six definitions of the moneysupply rather than one?

Back 10

The Bank of Canada uses 6 definitions of the money supply to bettercapture the relationship between money and the level of economic activity. Forexample, the Bank believes that the M1+ definition is closest to money as amedium of exchange, while M2++ includes some assets that first have to be soldbefore being used to purchase goods and services. Because households often sellassets in M2+ in order to make purchases of goods and services, movements inM2++ can potentially have an important effect on the economy.

Front 11

Give the formula for the simple deposit multiplier. If the desired reserve ration is 20%, what isthe maximum increase in chequing account deposits that will result from anincrease in the bank reserves of $20,000.

Back 11

The simple deposit multiplier is 1/rd. The maximum increase in chequingaccount deposits would be $20,000 x 5 = $100,000.

Front 12

What policy tools does the Bank of Canada use to control themoney supply? Which tool is the mostimportant?

Back 12

The threepolicy tools are open market buyback, lending to banks, and settlement balancesmanagement, with open market operations being the most important.

Front 13

What is the quantity theory of money (or the equation ofexchange). What explanation does thequantity theory provide for inflation?

Back 13

Thequantity theory of money starts from the quantity equation: M x V=P x Y; where M is the moneysupply, V is the velocity of money, P is the price level, and Y is real output.Because velocity is defined to equal (P x Y)/M, the quantity equation mustalways hold true. Irving Fisher turned the quantity equation into the quanititytheory of money by asserting that velocity was constant. With velocityconstant, inflation occurs whenever the growth rate of the quanity of moneyexceeds the growth rate of real output.

Front 14

What is the Bank of Canada’s four monetary policy goals?

Back 14

The Bank of Canada’s four monetary policy goals are price stability,high employment, economic growth, and stability of financial markets andinstitutions. However price stability is the Bank’s main policy objective.

Front 15

What do economists mean by the demand for money? What is the advantage of holding money? What is the disadvantage?

Back 15

The demandfor money refers to the amount of money, as measured by M1+ or M1++, thathouseholds and firms desire to hold at different nominal interest rates. Theadvantage of holding money (the medium of exchange) is that it can be used tobuy goods, serices, and financial assets. The disadvantage of holding money isthat money earns little to no interest.

Front 16

How does an increase in interest rates affect agggregatedemand? Briefly discuss how eachcomponent of aggregate demand is affected.

Back 16

Anincrease in interest rates decrease aggregate demand. Higer interest ratesdecrease investment spending, including spending on new homes, and consumptionspending, particularly spending on durable goods. Net exports also decline as higher interest rates increase theexchange rate between the dollar and foreign currencies. Government purchasesare not affected by increases in the interest rate.

Front 17

If the Bank of Canada believes the economy is about to fallinto recession, what actions should it take? If the Bank of Canada believes the inflation rate is about in increase,what actions should it take?

Back 17

If theBank of Canada believes the economy is about to fall into recession, it shouldconduct expansionary monetary policy, increasing the money supply and reducinginterest rates. If the Bank of Canada believes that the inflation rate is aboutto increase, it should conduct contractionary monetary policy, adjusting themoney supply so as to increase interest rates.

Front 18

For more than 20 years the Bank of Canada has used theovernight interest rate as its monetary policy target. Why doesn’t the Bank of Canada target themoney supply at the same time?

Back 18

Becausethe Bank of Canada does not control money demand, it cannot target both theovernight funds rate and the money supply at the same time.

Front 19

What is the difference between fiscal policy and monetarypolicy?

Back 19

Fiscalpolicy involves changes in government purchases and taxes. Monetary policyinvolves changes in the money supply and interest rates. Both are intended toachieve macroeconomic policy objectives.

Front 20

What is expansionary fiscal policy? What is a contractionary fiscal policy?

Back 20

Anexpansionary fiscal policy is a decrease in taxes or an increase in governmentpurchases intended to increase aggregate demand. A contractionary fiscal policyis an increase in taxes or a decrease in government purchases intended todecrease aggregate demand.

Front 21

Why does$1 increase in government purchases lead to more than $1 increase in income andspending?

Back 21

A $1 increase in government purchases inititallyincreases real GDP and national income by $1. The $1 increase in nationalincome increases consumption spending by, say, $0.50. The $0.50 increase inconsumption spending increases income, which increases consumption spendingagain. The process continues as increases in income lead to increases inconsumption spending, which lead to increases in insome, which lead toincreases in consumption spending, and on and on. This process is referred toas the multiplier effect.

Front 22

Which can be changed more quickly;monetary policy or fiscal policy? Briefly explain.

Back 22

Monetary policy can be changed more quickly than fiscalpolicy. The Federal Open Market Committee can change monetary policy at any ofits meetings, which are scheduled to occur 8 times per year-or more frequently,if need be. Fiscal policy has to go through the legislative process of thePrime Minister, cabinet, and legislature approving a fiscal policy action. Evenonce approved, it takes time to implement the fiscal policy change.

Front 23

Why do feweconomists argue that it would not be a good idea to balance the federal budgetevery year?

Back 23

Balancingthe government’s budget during a recession would require raising taxes orreducing government purchases. These actions would reduce aggregate demand andmake the recession worse.

Front 24

Why did Milton Friedman argue that the Phillips curve did notrepresent a permanent trade-off between unemployment and inflation? In your answer, be sure to explain whatFriedman meant by the “natural rate of unemployment”.

Back 24

Friedman argued that in the long run the unemployment rate would equalthe natural rate of unemployment, which is the unemployment rate that existswhen the economy is at potential GDP. Just as the price level does not affectreal GDP in the long run because real GDP will be at potential GDP, theinflation rate does not affect the unemployment rate in the long run becausethe unemployment rate will be at the natural rate of unemployment.

Front 25

What are the three main sets of factors that cause the supplyand demand curves in the foreign market to shift?

Back 25

The threemain sets of factors that cause the supply and demand curves in the foreignmarkets to shift are; 1) Changes in the demand for Canadian-produced goods andservices, 2) Changes in the desire to invest in Canada and changes in the desireto invest in foreign countries, and 3) Changes in the expectations of currencytraders-particularly speculators-concerningthe likely future value of the dollar and the likely future value of foreigncurrencies.