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Economics Chapter 17-18 Final Exam

the assets that economy regularly uses to buy G and S
Money Supply (Ms)
the amount of money available to households and firms
Money Demand (Md)
the amount of money households and firms want to hold to buy G and S
Price Level (P)
measure of the prices in the economy
*GDP Deflator
a general increase in the overall price level
a general decrease in the overall price levels
Quantity Theory of Money
used to explain the long run determinants of the price level and the inflation rate
monetary injection
the fed uses its tools to put money into the economy ( increase the money supply)
*causes inflation--> price level rises
* value of money falls
Quantity Theory of Money
the quantity of money available determines the value of money
nominal variables
measured in monetary units
real variables
measured in physical units
classical dichotomy
different factors affect nominal variables and real variables.
*changes in money supply ONLY affect nominal variables
Monetary Neutrality
money supply does not affect real variables ==> Y bar
Quantity Equation
M V= P Y
V ( velocity)
how many times money changes hands within a given period of time
Fisher Effect
the one to one adjustment of the nominal interest rate to the inflation rate
Cost of Inflation
inflation does not reduce people's real purchasing power
6 reasons
Shoe leather costs
cost and time needed to go to the bank
Menu costs
costs to firms of changing prices
comes from losing customers
Relative Price Variability
some prices increase faster than other prices
Inflation- Induced Tax Distortion
income tax on nominal savings so after tax real interest rate falls
Confusion and Inconvenience
developing countries
causes hoarding
lose customers
Arbitrary Redistribution of Wealth
lender of a loan can lose money when inflation rate causes value of the loan to decrease
*borrower wins
Closed Economy
no imports or exports
Net Exports
Exports (x)- Imports (M)
Country interacts economically with other country
1. imports and exports of goods and services
2. buying and selling capital assests
Factors that affect Net Exports
1. Tastes of consumers for foreign and domestic goods
2. Prices in domestic and foreign countries
3. Exchange rates at which people use domestic currency to buy foreign currency
4. Income of consumers home and abroad
5. Cost of transporting goods between countries
6. Policies of the government toward international trade
Net Capital Outflow NCO
purchase of foreign assets by domestic residents - purchase of domestic assets by foreign residents
Factors that Affect NCO
1. Interest rate paid on domestic assets
2. Interest rate paid on foreign assets
3. Perceived economic and political risk of holding assets abroad
4. Government policies that affect foreign ownership of domestic assets
Economy as a whole
nominal exchange rate
the rate at which a person can trade the currency of one country for the currency of another country

foreign/ domestic
increase in the value of a currency as measured by the amount of another currency it can buy
decrease in the value of a currency as measured by the amount of another currency it can buy
real exchange rate
the rate at which a person can trade the Goods and services of one country for the goods and services of another country

nominal exchange rate * US price/ foreign price
If our currency value goes up
makes domestic goods more expensive
lowers exports
raises imports
law of one price
a good must sell for the same price in all locations (internationally) If not same price, arbitrage
taking advantage of differences in prices to make a profit
Purchasing power parity
a theory of exchange rates where by a unit of any given currency should be able to buy the same amount of good in all countries
- law of one price assumed
- arbitrage assumed
-exchange rates move
Limitations to Purchasing Power Parity
1. many goods are not easily traded or shipped between countries
2. Trade-able goods are not always perfect subtitute