Econ Quiz 2

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GDP Multiplier

The ratio of the change in RGDP divided by the initial change in aggregate expenditures that causes the change in RGDP.
𝑆𝑖𝑚𝑝𝑙𝑒 𝐺𝐷𝑃 𝑚𝑢𝑙𝑡𝑖𝑝𝑙𝑖𝑒𝑟 = 1/1−𝑀𝑃𝐶

The AD curve and its four components

Plots the relationship between the price level and RGDP demanded (that is, the total value of all domestically produced final goods and services that all spending actors in the economy plan to buy), assuming that aggregate supply follows passively along with aggregate demand and holding all other determinants of aggregate demand other than the price level and RGDP constant. The major components are:
Consumption (C)
Investment (I)
Government Spending (G)
Net Exports (NX) = Exports - Imports

The SRAS curve

A curve that shows the relationship in the short run between the price level and the quantity of real GDP supplied by firms, holding all other factors constant.

The LRAS curve

A curve that shows the relationship in the long run between price level and the quantity of real GDP supplied.

The Expenditure Function

Plots the relationship between aggregate real expenditures (AE) in the economy and the value of aggregate real output (RGDP), holding all the factors that influence aggregate real expenditures other than RGDP constant

Production Function

The relationship between real GDP per hour worked and capital per hour worked, holding the level of technology constant.

Principle of diminishing returns

As we add more of one input to a fixed quantity of other inputs, output increases by smaller additional amounts.

The MPC

The change in aggregate real consumption spending divided by the change in aggregate real disposable income that produces the changes in real consumption. It tells you how much more or less consumers will spend if their income increases or decreases by $1. It is also the slope of the consumption function.

Disposable Income

Income - taxes + payment transfer

Money

Anything that is generally accepted in society as a medium of exchange

M1, M2

The sum of currency in circulation and the value of all funds in normal checking deposits. M1 plus all money market mutual funds and all savings accounts

Open Market Operation (OMO)

Refer to the Fed's purchases or sales of Government securities, normally Treasury bills, through transactions in the open market.

Simple Money Multiplier

1/𝑅𝑅 𝑟𝑎𝑡𝑖𝑜

Required Reserves Ratio

The minimum fraction of deposits banks are required by law to keep as reserves.

Asset

Something owned that has monetary value (i.e., it is either money or can be sold in an organized market for money)

Liability

Something owed that has monetary value (i.e., it is either money or can be sold in an organized market for money)

Explain why the Aggregate Demand curve is normally downward sloping

The real wealth effect: Price level increases --> real wealth decreases --> Consumption decreases -->AD decreases.

Explain why at the equilibrium, real aggregate expenditure must equal total real output

If real aggregate expenditure is above total real output, firms' inventories falls below the optimal level --> firms will react by increasing their production until total output is equal to aggregate expenditure --> the economy is at the equilibrium.
If real aggregate expenditure is below total real output, firms are producing too much --> inventories increase above the optimal level --> firms will produce less until total output is equal to aggregate expenditure --> the economy is at the equilibrium

Explain why the Short-Run Aggregate Supply curve is normally upward sloping

The SRAS curve is normally upward slopping because firms want to maximize their profit and
when price level increases, firms have more profit opportunities --> supply more.

Explain why the actual money multiplier is much smaller than the simple money
multiplier.

The actual money multiplier is much smaller than the simple money multiplier (1/rr ratio) because in the real world, banks are keeping excess reserves and people/firms are holding cash. If we assume that banks loan out all excess reserves and people/firms deposits all their money in their checking accounts with the banks, we will have the simple money multiplier.

What should the Fed do if they want to conduct expansionary monetary policy? Contractionary monetary policy?

Expansionary Monetary Policy:
- Lower Required Reserves Ratio
- Lower the Discount Rate
- OMO buying T-bill
- Quantitative Easing buying Government securities (other than T-bill)
Contractionary Monetary Policy:
- Increase Required Reserves Ratio
- Increase the Discount Rate
- OMO selling T-bill
- Quantitative Easing selling Government securities (other than T-bill)

Explain the impacts of monetary policy on real output (RGDP)? There are two ways to explain the impacts of monetary policy on real output. Assuming that the Fed implements contractionary monetary policy.

- Contractionary monetary policy --> Money supply decreases --> Banks having less reserves --> Banks lending out less --> Consumers and Firms borrowing less --> Consumption (C) and Investment spending (I) decrease --> AD decreases and shifts to the left --> lower RGDP and lower price level
- Contractionary monetary policy --> Money supply decreases --> higher interest rate --> Lower investment spending --> AD decreases and shifts to the left --> Lower RGDP and lower price level.

Three pillars of long run economic growth?

The growth rate of: 1.Capital Stock
2.Labor Force 3.Technology

Explain how the production function changes if we have advanced technology

The production function will shift upward (production function 1 to production function 2). At the same level of capital per hour worked (K/L) the economy can produce more output per hour worked (Y/L) (Move from point A to point C)

Suppose that in 2011 real GDP grew in Estonia by 3% and that the population increased by 5%. Therefore in 2011, Estonia experienced

An economic growth, but not an increase in living standards.

f real GDP in the United States is growing at an annual rate of 3.2% per capita and Bolivia's real GDP per capita is growing at a rate of 1.3%, which of the following would we expect in the long run? Assume real GDP per capita in the United States begins at a level above that of real GDP per capita in Bolivia.

The difference between the level of real GDP per capita in the United States and real GDP per capita in Bolivia will increase over time.

If real GDP per capita in the United States is $8,000, what will real GDP per capita in the United States be after 5 years if real GDP per capita grows at an annual rate of 3.2%?

$9,365



pg714/340

If real GDP per capita in the United States is $8,000 in 2011, and if real GDP per capita is $12,000 in 2021, what is the average annual percent change in the growth rate of GDP per capita between 2011 and 2021?

5%



pg715/341

If real GDP per capita in the United States is $8,000 in 2011, and if real GDP per capita is $12,000 in 2021, what is the total percent change in the growth rate of GDP per capita between 2011 and 2021?

50%


pg715/341

Which of the following would you expect to result in faster economic growth?
A) the invention of new computers that increase labor productivity
B) a decrease in the average level of education in the economy
C) a decrease in the stock of capital per worker
D) a decrease in research and development

A

When an economy faces diminishing returns...

The slope of the per-worker production function becomes flatter as capital per hour worked increases.

When additions of input to a fixed quantity of another input lead to progressively smaller increases in output, we say we are facing...

diminishing returns.

Refer to Figure 11-1. Diminishing marginal returns is illustrated in the per-worker production function in the figure above by a movement from

A to C.

Refer to Figure 11-1. Technological change is illustrated in the per-worker production function in the figure above by a movement from

B to C.

The aggregate expenditure model focuses on the relationship between ________ and ________ in the short run, assuming ________ is constant.

total spending; real GDP; the price level

All of the following are one of the four main categories of spending identified by John Maynard Keynes except

taxes

Consumption is $5 million, planned investment spending is $8 million, government purchases are $10 million, and net exports are equal to $2 million. If GDP during that same time period is equal to $27 million, what unplanned changes in inventories occurred?

There was an unplanned increase in inventories equal to $2 million.

If aggregate expenditure is less than GDP, how will the economy reach macroeconomic equilibrium?

Inventories will rise, and GDP and employment will decline.

Which of the following will cause a direct increase in consumption spending?
A) an increase in planned investment
B) an increase in government spending
C) an increase in disposable income
D) a decrease in net export spending

C

________ in taxes will decrease consumption spending, and ________ in transfer payments will increase consumption spending.

A decrease; an increase

If disposable income increases by $100 million, and consumption increases by $90 million, then the marginal propensity to consume is

0.9


pg757/383

If disposable income falls by $50 billion and consumption falls by $40 billion, then the slope of the consumption function is

0.80


pg757/383

If the MPC is 0.5, then a $10 million increase in disposable income will increase consumption by...

$5 million.


pg758/384

If firms are more optimistic that future profits will rise and remain strong for the next few years, then...

Investment spending will rise.

On the 45-degree line diagram, the 45-degree line shows points where...

Real aggregate expenditure equals real GDP.

Refer to Figure 12-1. According to the figure above, at what point is aggregate expenditure greater than GDP?

J

Refer to Figure 12-2. If the U.S. economy is currently at point N, which of the following could cause it to move to point K?
A) Households expect future income to decline.
B) Household wealth rises.
C) The firm's cash flow rises as profits rise. D) Government expenditures increase.

A) Households expect future income to decline.

Refer to Figure 12-3. Suppose that investment spending increases by $10 million, shifting up the aggregate expenditure line and GDP increases from GDP1 to GDP2. If the MPC is 0.9,
then what is the change in GDP?

$100 million


pg773-774/399-400

Refer to Figure 12-4. Potential GDP equals $100 billion. The economy is currently producing GDP1 which is equal to $90 billion. If the MPC is 0.8, then how much must autonomous spending change for the economy to move to potential GDP?

$2 billion


pg 773-774/399-400

John Maynard Keynes argued that if many households decide at the same time to increase saving and reduce spending,
A) this may benefit the economy in the short run, but not in the long run.
B) the economy will benefit in the short run and benefit by an even greater amount in the long run.
C) this will have a major negative impact on the economy in both the short run and in the long run.
D) this may benefit the economy in the long run, but could be counterproductive in the short run.

D

An increase in the price level results in a(n) ________ in the quantity of real GDP demanded because _______

decrease; a higher price level reduces consumption, investment, and net exports.

Which of the following is one explanation as to why the aggregate demand curve slopes downward?
A) Decreases in the price level raise the interest rate and increase consumption spending. B) Decreases in the price level raise the interest rate and increase investment spending.
C) Decreases in the U.S. price level relative to the price level in other countries lower net exports.
D) Decreases in the price level raise real wealth and increase consumption spending.

D

Spending on the war in Afghanistan is essentially categorized as government purchases. How do increases in spending on the war in Afghanistan affect the aggregate demand curve?

They will shift the aggregate demand curve to the right.

The recession of 2007-2009 made many consumers pessimistic about their future incomes. How does this increased pessimism affect the aggregate demand curve?

This will shift the aggregate demand curve to the left.

Last week, six Swedish kronor could purchase one U.S. dollar. This week, it takes eight Swedish kronor to purchase one U.S. dollar. This change in the value of the dollar will ________ exports from the United States to Sweden and ________ U.S. aggregate demand.

decrease; decrease

Refer to Figure 13-1. Ceteris paribus, an increase in the price level would be represented by a movement from...

point B to point A.

Refer to Figure 13-1. Ceteris paribus, an increase in interest rates would be represented by a movement from..

AD2 to AD1.

If stricter immigration laws are imposed and many foreign workers in the United States are forced to go back to their home countries..
A) the long-run aggregate supply curve will shift to the right.
B) the long-run aggregate supply curve will shift to the left.
C) we will move up along the long-run aggregate supply curve. D) we will move down along the long-run aggregate supply curve.

B

Full-employment GDP is also known as

potential GDP

Hurricane Katrina destroyed oil and natural gas refining capacity in the Gulf of Mexico which subsequently drove up natural gas, gasoline, and heating oil prices. Three years later, once the refining capacity was restored, these prices came back down. The restoration of refining capacity should
A) shift the short-run aggregate supply curve to the left.
B) shift the short-run aggregate supply curve to the right.
C) move the economy up along a stationary short-run aggregate supply curve.
D) move the economy down along a stationary short-run aggregate supply curve.

B

Workers expect inflation to rise from 3% to 5% next year. As a result, this should A) shift the short-run aggregate supply curve to the left.
B) shift the short-run aggregate supply curve to the right.
C) move the economy up along a stationary short-run aggregate supply curve.
D) move the economy down along a stationary short-run aggregate supply curve.

A

What would cause the short-run aggregate supply curve to shift to the right?

a technological advance

Refer to Figure 13-2. Ceteris paribus, an increase in the labor force would be represented by a movement from

SRAS1 to SRAS2.

Refer to Figure 13-2. Ceteris paribus, a decrease in the capital stock would be represented by a movement from

SRAS2 to SRAS1.

Interest rates in the economy have fallen. How will this affect aggregate demand and equilibrium in the short run?

Aggregate demand will rise, the equilibrium price level will rise, and the equilibrium level of GDP will rise.

Suppose the economy is at full employment and firms become more optimistic about the
future profitability of new investment. Which of the following will happen in the short run?

Unemployment will decline.

Refer to Figure 13-3. Which of the points in the above graph are possible short-run equilibria but not long-run equilibria? Assume that Y1 represents potential GDP.

B and D

A negative supply shock in the short run causes...

The aggregate supply curve to shift to the left.

Stagflation usually results from

a supply shock.

Refer to Figure 13-4. In the figure above, LRAS1 and SRAS1 denote LRAS and SRAS in year 1, while LRAS2 and SRAS2 denote LRAS and SRAS in year 2. Given the economy is at point A in
year 1, what is the growth rate in potential GDP in year 2?

10%


pg 813-814/439-440

Refer to Figure 13-4. Given the economy is at point A in year 1, what is the inflation rate between year 1 and year 2?

1.8%


pg813-814/439-440

In economics, money is defined as

Any asset people generally accept in exchange for goods and services.

Which of the following functions of money would be violated if inflation were high?
A) unit of account
B) store of value
C) certificate of gold
D) medium of exchange

B) Store of value

The M1 measure of the money supply equals...

Currency plus checking account balances plus traveler's checks.

If a person withdraws $500 from his/her savings account and puts it in his/her checking account, then M1 will ________ and M2 will ________.

increase; not change

Refer to Scenario 14-1. M2 in this simple economy equals

$21,000.


pg 836/462

A bank will consider a car loan to a customer ________ and a customer's checking account to be ________.

an asset; a liability

The required reserves of a bank equal its ________ the required reserve ratio.

deposits multiplied by

Refer to Scenario 14-2. As a result of Kristy's deposit, checking account deposits in the banking system as a whole (including the original deposit) could eventually increase up to a maximum of...

$50,000.


pg838-840/464-466

Suppose Warren Buffet withdraws $1 million from his checking account at Chase Manhattan
Bank. If the required reserve ratio is 20 percent, what is the maximum change in deposits in the banking system?

-$5 million


pg 842-844/468-470

Monetary policy refers to the actions the...

Federal Reserve takes to manage the money supply and interest rates to pursue its macroeconomic policy objectives.

Using the money demand and money supply model, an increase in money demand would cause the equilibrium interest rate to...

increase

In response to already low interest rates doing little to stimulate the economy, the Fed began buying 10-year Treasury notes and certain mortgage-backed securities to keep interest rates low. This policy is known as...

quantitative easing.

Expansionary monetary policy refers to the ________ to increase real GDP.

Federal Reserve's increasing the money supply and decreasing interest rates

Refer to Figure 15-5. Suppose the economy is in a recession and the Fed pursues an expansionary monetary policy. Using the static AD-AS model in the figure above, this would be depicted as a movement from...

A to B.

Your roommate is having trouble grasping how monetary policy works. Which of the following explanations could you use to correctly describe the mechanism by which the Fed can affect the economy through monetary policy? Increasing the money supply...

Lowers the interest rate, and firms increase investment spending.

If the Fed orders a contractionary monetary policy, describe what will happen to the following variables relative to what would have happened without the policy:
a. The money supply
b. Interest rates
c. Investment
d. Consumption
e. The aggregate demand curve
f. Real GDP
g. The price level

Answer:
a. The money supply decreases
b. Interest rates rise
c. Investment decreases
d. Consumption decreases
e. The aggregate demand curve shifts to the left
f. Real GDP falls
g. The price level falls

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