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Ivy Software MBA Prepworks Fundamentals of Economics

Terms in this set (286)

The main concept demonstrated in the production possibilities frontier is
Opportunity cost
When country A has a lower opportunity cost of producing sugar relative to country B, then country A is said to have
Comparative Advantage
A graph that shows the combinations of two goods that the economy can produce given the available scarce resources and available technology is called a
Production Possibilities Frontier
Assume a production possibilities frontier for pickup trucks and big Mac hamburgers. The economy is producing 20 big Mac hamburgers and 65 pickup trucks (point 20, 65). What is the opportunity cost of producing an additional 20 Big Mac hamburgers (point 40, 60)?
Five Pickup Trucks
The opportunity cost of an item is
whatever must be given up to obtain the item.
Consider market for pork, suppose that price of beef, a substitute for pork, increases. Because of the change in price of beef, the equilibrium price of pork...?
Increases
Consider the market for pork, suppose that the price of beef, a substitute for pork, increases. Because of this change in the price of beef, the equilibrium quantity of pork will...?
Increase because increase in price of beef causes demand curve for pork to shift North East. B/c of this shift, the equilibrium quantity of pork will increase.
Consider the market for pork. Suppose that the price of hog feed, an input to the production of pork, increases. Because of that change in the price of hog feed, the equilibrium quantity of pork ...?
Decreases because the increase in price of hog feed causes the supply curve for pork to shift NW. B/c of this shift, the quantity of pork decreases.
Consider the market for pork. Suppose that disposable income increases and pork is an inferior good. Because of that change in income, the equilibrium price of pork...?
Decreases because the increase in disposable income causes the demand curve for pork to shift south west, because pork is an inferior good. because of this shift, the equilibrium price of pork decreases.
Consider the market for pork. Suppose that 1) disposable income increases and pork is a normal good, And 2) the price of hog feed decreases. Because of these changes, the equilibrium price of pork is...
Indeterminate because the increase in disposable income causes the demand curve for pork to shift north east because pork is a normal good. The decrease in price of hog feed causes the supply curve to shift to the south east. The net effect of these shifts leaves us unable to say waht will happen to the equilibrium price of pork.
Consider the market for pork. Suppose that disposable income increases and pork is a normal good and the price of hog feed decreases. The equilibrium quantity of pork...?
Increases.
Suppose the price elasticity for demand for retail phone service in the US is 0.95. If the # of retail substitutes for retail telephone service increases, will the price elasticity of demand become more elastic or more inelastic?
Elastic. When the number of substitute products increases, the price elasticity of demand will become more elastic. consumers become more sensitive to price when they have more options to chose among.
True or False: the law of demand states that if the price of a good increases, CP, then the quantity demanded of that good will increase.
False. quantity demanded of that good will decrease.
Suppose the cross-price elasticity of demand for home heating oil with respect to the price of natural gas is +0.6. This number tells us that home heating oil and natural gas are substitute or compliment goods?
Substitute goods. When the cross price elasticity is positive then they are substitutes.
Consider the market for mustard which is a complement to hot dogs. Suppose the price of hot dogs increase. What happens to the equilibrium price and equilibrium quantity of the mustard market?
Equilibrium price decreases and equilibrium quantity decreases. The price of hot dogs is an independent variable in the demand function for mustard. This is because hot dogs and mustard are complementary goods. Therefore, if the price of hot dogs increases, then the demand curve for mustard shifts to the south-west. People demand less mustard at every price when hot dogs are more expensive. In the mustard market, the equilibrium price decreases and equilibrium quantity decreases.
profit maximizing rule
a business maximizes profits when it produces where the marginal revenue from selling another unit equals the marginal cost of producing another unit.

Marginal Revenue=Marginal Cost
Marginal cost
is equal to the change in the total cost that arises from an extra unit of production. It is calculated by taking the change in total cost and dividing it by the change in the quantity produced
=change in TC/change in Q
Marginal revenue
is the change in total revenue generated from an additional unit sold. It is calculated by taking the change in total revenue divided by the change in quantity sold
Short Run
a time horizon where some fixed costs exist.
is a time horizon within which a business is unable to adjust at least one input because there is a fixed cost of some kind.
we think in terms of the short run not the long run
Long Run
a situation where the fixed costs (the inputs) become variable. a time horizon long enough for the seller to adjust all inputs. If you observe a business with no fixed costs, then it is in a long run state.
\when prices remain low for a very long period of time, then the business moves into a long run decision mode. In the long run there are no fixed costs.
fixed costs
costs that do not vary with changes in the quantity produced. what expenses must be paid even if production equals zero?
variable costs
costs that do vary with changes in the quantity produced
total cost
equals the sum of the fixed costs and variable costs
TC=VC+FC
average fixed cost
equals fixed cost divided by quantity produced
AFC= TC/Q
average variable cost
equals variable cost divided by the quantity produced
average total cost
equals the total cost divided by the quantity produced, or it is the sum of average fixed cost plus average variable cost
sunk cost
a cost that has already been committed and cannot be recovered
joint costs
costs that do not change with changes in the scope of production. economies of scope arise when there are joint costs. (ie: comcast purchasing NBC universal).
perfect competition
occurs in an industry in which
- there are many buyers and many sellers
- an industry in which the good is homogeneous
- and an industry in which all who want to enter the industry are free to do so and any business may exit at a time of their choosing
monopoly
an industry that is controlled by a monopolist firm who is the only seller of a good. the good the monopolist sells is heterogeneous because they are the only one that sells the good and the market that the monopolist sells its product in has barriers to entry
short run shut-down rule
a business could shut down if production at the profit maximizing quantity (where MR=MC) generates total revenues that are less than variable costs. In all other cases the business should stay open

a business should shut down when the losses from operating are greater than the total fixed costs.
Economies of scale
occur over a range of production in which average total costs decline as output increases (ie: creation of software, a pharmaceutical pill) they have large fixed costs and relatively low marginal costs.
diseconomies of scale
occur over a range of output in which average total costs increase as output increases
constant economies of scale
occur over a range of production where constant average total cost as output increases
economies of scope
occur when an organization can produce several products together at less cost than could a group of single product firms operating independently
whenever marginal cost is higher than average variable cost or average total cost, the average variable cost or average total cost must
increase
decrease
stay the same
increase
whenever marginal cost is lower than average variable cost or average total cost, then the average variable cost or the average total cost must
increase
decrease
stay the same
decrease
whenever the marginal cost curve crosses the average variable or total cost curve then the values are
higher
lower
equal
equal
price takers
businesses operating in a perfectly competitive industry
in a perfectly competitive industry, market prices are determined by
the interaction of the market demand and market supply curves
total revenue
calculated by multiplying price and quantity or Marginal Revenue and quantity
market price
change in total revenue resulting from a on-unit increase in the quantity sold equals the market price.
in the pursuit of maximizing profits, business owners are constrained in two fundamental ways:
1) the competency of its employees and the market prices of inputs into the production process dictate the costs of producing output
2) the price that a perfectly competitive business can charge is determined by the market, and not the business owner
long run decision
states that a business should exit the industry if production at the profit maximizing quantity where (MR=MC) generates total revenues that are less than total cost. Otherwise they stay open.
three characteristics of a monopolistic industry include:
1) there are many buyers and only one seller
2) the good is heterogeneous, and
3) barriers to entering the market exist (ie: patents are barriers that make it illegal for someone to produce a product without permission from the patent owner)
price setter
in a monopolistic industry, because there is only one seller of a product the business owner actually goes through a process of setting the price of its product, a task that competitive firms are unable to do. Thus monopolistic firms are called price setters.
constraints of a monopoly
1) ....?
2) the market demand
three decisions faced by a monopoly
1) determine the profit maximizing quantity to produce
2) decide what price to charge
3) because this is the short run, decide whether to produce or shut down the business for a short period of time.
profit maximizing quantity
marginal revenue equals marginal cost
Marginal cost is the increase in total cost that arises from an extra unit of production (T/F)
True.
A production process has economies of scale if average total cost decreases as production increases (true or false)
True
A production process has diseconomies of scale if average total costs increase as output increases (T/F)
True.
The production of a product has either economies of scale, constant economies of scale, or diseconomies of scale (t/F)
True
If a company's average total costs remain constant as output increases, then the company has constant economies of scale. (t/F)
TRUE
A sunk cost is a cost that has already been committed and can be recovered.
false. can never be recovered. in contrast, any product that can be re-sold for a positive dollar amount would not be considered a sunk cost.
A business always maximizes profits when it produces where total revenue equals total cost (t/f)
False. the profit maximizing rule states that a business maximizes profits when it produces a quantity where the MR from selling another unit equals the MC of producing an additional unit.
A business should shut down if production at the profit maximizing quantity generates total revenues that are less than total fixed costs. (t/f)
false. a business should shut down when the losses from operating are greater than the total fixed costs.
short run shutdown rule.
a business should shut down if production at the profit maximizing quantity
The accountants hired by Costa law firm have calculated that at the profit maximizing quantity, total fixed costs equal $56,791, total variable costs equal $113,555 and total revenue equals $112,000. Because of this info, Costa Law firm decides:
A) to exit the industry
B) to shut down
C) decides to stay open because shutting down would be more expensive
D) decides to stay open because they are making an economic profit
B. to shut down. the shutdown rule states that a business should shut down in the short run only if total revenue is less than total variable costs. In this case, total revenue is $112,000 and total variable cost is $113,555. Because total variable cost exceeds total revenue, CLF should shut down.
How can you tell if a business is operating in a perfectly competitive market?
the marginal revenue from selling an additional unit does not change as output increases. They are also known as a price taker. You will notice the Marginal revenue column stays constant as output increases.
What is the per unit price in a perfectly competitive market? The market equilibrium price is equal to
marginal revenue
total cost equals
total revenue minus profit
if marginal revenues and marginal costs do not equal in a chart choose the closest option to determine marginal cost (t/f)
true
In the WSJ article it was reported that Mitsubishi is seeking a buyer for its U.S> operations, a move that may well signal the company's intent to exit the world's largest car market. The potential move by Mitsubishi is a matter of economies of scale or economies of scope?
Economies of scale. it is trying to sell its U.S> operations because they have been losing money for some time in the U.S. market. By contracting its scale of operation, Mitsubishi believes that it can turn its financial situation around.
Consider the following decision made by Old Century Power Company. In electricity production, once electricity has been generated at a power plant, distribution networks are needed to bring electricity to the customer. Suppose Old Century Power Company has decided to build its own electricity generating plants and its own electricity distribution network. In making this decision, OCPC has calculated that economies of scale or economies of scope exist when electricity generation and electricity distribution are integrated under unified ownership?
economies of scope. OCPC must observe an advantage to having unified ownership of electricity generation and electricity distribution. If two activities in the production of a good are integrated under unified ownership for a cost advantage, then economies of scope are present.
Consider the following decision made by New Century Power Company. In electricity production, once electricity has been generated at a power plant, distribution networks are needed to bring the electricity to the customer. Suppose NCPC has decided to build its own electricity distribution network, but it has also decided to purchase electricity from many different independent electric power producers. In making this decision, NCPC has calculated that diseconomies of scale or diseconomies of scope exist when electricity generation and electricity distribution are integrated under unified ownership?
diseconomies of scope. NCPC must observe an advantage to NOT having unified ownership of electricity generation and electricity distribution. If two activities in the production of a good are integrated under unified ownership and there is a cost DISadvantage, then diseconomies of scope exist. By purchasing electricity generation from the market, then it must be less costly. Otherwise, we would observe unified ownership of the distribution network and the generation of electricity.
The profit maximizing rule states that a business maximizes profits when it produces where total revenue equals total cost (t/f)
False.
The accountants hired BBB law firm have calculated that at the profit maximizing quantity total fixed costs equal $56,272,000 total variable costs equal $213,235,000 and total revenue equals $213,236,000. Because of this information BBB law firm decides
A. to exit the industry
B. to shut down
C. decides to stay open because shutting down would be more expensive
D. decides to stay open because they are making an economic profit
C. decides to stay open because shutting down would be more expensive. Because total variable cost is less than total revenue, BBB Law Firm should stay open.
The accountants hired by Truscott and Associates have calculated that at the company's current production level, total fixed costs to equal $21,000, total variable costs to equal $42,000 and total revenue to equal $45,000. Because of this information Truscott & Associates decide
A) to exit the industry
B) to shut down
C) to stay open because shutting down would be more expensive
D) to stay open because they are making an economic profit
C. to stay open because shutting down would be more expensive
The profit maximizing rule states that a business maximizes profits when it produces where marginal revenue equals average variable cost. T/F
False
Real Gross Domestic Product (GDP)
a measure of the market value of the production of the final goods and services after an adjustment has been made for changes in the price level
= Nominal GDP / Price level index * 100
The National Income Identity
the accounting concept which states that, in a time period, aggregate expenditure on wages, interest, rents, and profits is equal to nominal GDP is equal to consumption spending, investment spending, government spending, and net exports. The cycle depicted in a circular flow diagram graphically depicts the national income identity.

Aggregate expenditure is a measure of nominal GDP and it is also known as the national income identity
The Consumer Price Index (CPI)
measures changes over time in the cost of buying a "market basket" of goods and services purchased by a typical family
calculated and reported by the Bureau of Labor Statistics (BLS)
it is reported monthly as a % change in consumer prices over the previous month. (aka inflation rate)
The Producer Price Index (PPI)
measures the change over time in the cost of buying a "market basket" of inputs purchased by producers
Inflation Rate
a percentage change in a price index between two periods
Unemployment Rate
defined as the percent of people who do not want a job right now, have been looking for work, but have not found a job that they would take divided by the labor force
macroeconomics
offers a set of tools and concepts that both economists and policy makers use to try to figure out the overall pulse of the economy
The term "gross" in GDP means that
the data are not adjusted for depreciation- a term that represents the reduction in market value of economic capital as it slowly wears out and approaches the end of its useful life.
Net domestic product
the calculation of GDP which adjusts for depreciation
Product in GDP equals
the market value of final goods and services produced over the course of a year in the domestic economy
nominal GDP
equals the market value of final goods and services produced at current year prices.
-almost always useless at telling us the true value of final goods and services because it confuses changes in the inflation or deflation with changes in total production.
= C + I + G + NX
-economies reject nominal GDP and use real GDP
per capita
means that total GDP is divided by the U.S. population. This is done to control for changes, positive or negative, in the U.S. population
Intermediate goods and services
used in the production of final goods and services. not included in GDP. ie: Starbucks purchasing coffee beans is an intermediate good.
business cycles
irregular changes in the level of total output measured by real GDP
economic contraction
the negative movement from peak to trough in a business cycle because real GDP is smaller than the previous period
recession
if a contraction moves below the trend line for two or more quarters of a year then it is called a recession
economic expansion (or recovery)
the positive movement from trough to peak because real GDP is larger than the previous period
who measures GDP in the U.S.?
the U.S. Department of Commerce's Bureau of Economic Analysis (BEA)
Aggregate Expenditure
BEA sum of GDP from four main components: consumption expenditures, investment expenditures, government expenditures, and net exports
is a measure of nominal GDP and is also known as the national income identity.
Consumption spending (C)
is made up of all the final goods and services that are ultimately bought and used by households, except for newly constructed buildings
Investment spending (I)
is made up of all the final goods and servicesthat become part of the business or residential capital stock, including newly constructed buildings
Government spending (G)
is made up of all the final goods and services bought by the government like lumber and raw materials purchased and deployed to Iraq for the reconstruction effort
transfer payments like welfare benefit or unemployment insurance are not included in G
Net Exports (NX)
is made up of the difference between exports (E) and imports (I)
Exports
final goods and services produced in the U.S. and purchased by foreigners living outside the U.S.
Imports
include all final goods and services produced by foreigners outside the U.S. and purchased by a member of the domestic population.
domestic entry bookkeeping
ensures that the expenditure on final goods and services in the domestic economy equals the total incomes paid for the scare factors of production used to produce those final goods and services (ie wages, rent, interest and profit earned from production).
Aggregate income
equald the sum of income paid for the scarce factors of production used to produce total final output in the domestic economy.

Aggregate expenditure = GDP = Aggregate income
price level
is a composite measure reflecting the pricews of all goods and services in the economy relative to prices in a base year
Nominal GDP measures the economic value of all goods and services produced inside the boundaries of a country, not adjusted for the changes in the price level (T/F)
True
The circular flow diagram demonstrates that the expenditures on final goods and services in the domestic economy is equal to the total income paid for the scarce factors of production used to produce those final goods and services. (T/F)
True. double entry bookkeeping insures that the expenditures on final goods and services in the domestic economy is equal to the total income paid for these scare factors of production used to produce those final goods and services.
The labor force is defined as all those who are employed and all those who have been looking for work. T/F
True. LF= employed + have been looking for work
Frictional unemployment occurs because it takes time for workers to search for new jobs that best suit their tastes and job skills (t/f)
True
Cyclical unemployment occurs because the number of jobs available in a labor market is insufficient to provide jobs for all those who want one. (t/f)
False
The following is called the national income identity: C + I + G + NX = Aggregate Expenditure = Real GDP (true or false)
False = Nominal GDP
The unemployment rate is defined as all those who are employed divided by those looking for work (T/F)
False. = have been looking for work divided by labor force (employed + have been looking for work)
The largest component of the U.S. real GDP is
consumption
Trade deficit
if the country's imports are greater than its exports
trade surplus
when a country exports more than it imports
the measure of the economic value of all final goods and services sold inside the boundaries of the country, adjusted for changes in the price level is called
Real GDP
the measure of the economic value of all final goods and services sold inside the boundaries of the country, not adjusted for changes in the price level is called
nominal GDP
Money
is any asset that may be used to carry out a transaction between a buyer and a seller.
solves the transaction cost problem in a barter economy
Three basic functions of money
1) a medium of exchange
2) a store of value
3) a unit-of-account
medium of exchange
money is a medium of exchange because it makes exchange easier.
barter economy
an economy with no money
store of value
money is a store of value because people will hold money only if they believe it will continue to have some value, so money can operate as a medium of exchange only if it serves as a store of value.
unit of account
money is a convenient and widely recognized measure for accounting and transactions; it is a yardstick for measuring the value of all goods and services.
fiat money
is paper money that derives its status as money from the power of the state or by fiat. it is money because the government says it is money, otherwise it has no real value.
commodity money
exists when some intrinsically valuable good also serves as money. Gold is an example of commodity money because it has value even if it were not used as money
money supply
quantity of money. currency is not the only asset that you can use to purchase goods and services. The Federal Reserve system, the central bank of the U.S., classifies several alternative definitions of money. One of the FR's definitions of money supply is called M1 and the other is M2
consists of more than the value of the currency. the determination of the actual money supply depends on the behavior of the commercial banks and their depositors.
since bank reserves are not circulated among the public they are not counted as part of the money supply
measured as the sum of checkable deposits and currency in circulation
M1
the most narrowly defined money supply which includes currency, traveler's checks, demand deposits, and other checkable deposits
the most common definition of money is M1
M2
includes everything in M1 plus savings deposits, small time deposits, money market mutual funds, and a few other minor categories.
currency
the paper bills and coins in the hands of the public
demand deposits
a depositor with such an account can write a check to demand those deposits at any time
other checkable deposits
other deposits against which checks may be written
savings deposits
deposits that earn interest but have no specific maturity date
small time deposits (certificate of deposits or CD)
deposits that earn a fixed rate of interest if held for the specified period, which can range anywhere from several months to several years, commonly referred to as certificates of deposit or CDs.
money market funds
an open-end mutual fund which invests only in money markets. These funds invest in short term, one day to one year debt obligations such as Treasury bills, certificates of deposit, and commercial paper
assets of the commercial banking system equal
the value of the currency sitting in the banks' vaults, the value of the government bonds held by the bank, and the value of loans issued by the bank
the liabilities of the commercial banking system equal
the deposits of the banks' customers, since checking account balances represent money owed by the banks to the depositors.
bank reserves equal
the currency that is held by banks
100 percent reserve banking
when 100% of bank's currency is being held in reserves
fractional-reserve banking system
a banking system in which banks have checkable deposits that exceed annual reserves
checkable deposit balances are counted as money and therefore are part of the money supply because they may be used in making transactions throughout the economy. (t/F)
True
the sum of checkable deposits and currency in circulation is
money supply
reserve-deposit ratio
bank reserves divided by checkable deposits
What is the Federal Reserve's most important tool that it uses to increase the money supply?
buying and selling government securities
desired reserve deposit ration equals
bank reserves divided by checkable deposits
checkable deposits equals
bank reserves divided by desired reserve deposit ratio
The banking system's ability to create money depends on the amount of bank reserves and
the desired reserve deposit ratio
monetary policy
any action that changes the supply of money and alters the interest rate. In the U.S. it is implemented by the Federal Reserve System.
Three tools that the Federal Reserve can use to alter the money supply:
1) open market operations
2) reserve requirement changes
3) changes to the Federal Reserve's discount rate
open market operations
purchases and sales of government securities by the Federal Reserve in an effort to influence the money supply.
when the Federal Reserve decides to purchase government securities (ie: Treasury bills) it is choosing to _______ the money supply
increase
decrease
increase
when the Federal Reserve desides to sell government securities (ie: treasury bills) it is choosing to ________ the money supply
increase decrease
decrease
An increase in the required reserve deposit ration will lead to a _________ in the money supply
increase/decrease
decrease
a decrease in the required reserve deposit ratio will lead to a _____ in the money supply
increase/decrease
increase
A bank borrows from the Federal Reserve when
it has too few reserves to meet reserve requirements
an increase in the discount rate____________ the quantity of reserves in the banking system which in turn ______________ the money supply
reduces/reduces
A decrease in the discount rate, encourages borrowing reserves from the Federal Reserve, which in turn _______ the money supply
increases
As the overall level of prices increases, the value of a unit of money
decreases
money creation process
a process that describes the amount of money the banking system creates with each dollar held in reserve (ie: dollars that have not been loaned out by a bank). The banking system's ability to create money depends on the amount of currency held in bank reserves and the required reserve deposit ratio, which is the ratio of bank reserves divided by the checkable deposits
Currency is defined as paper bills, traveler's checks, and coins in the hand of the public. (T/F)
False. currency is just the paper bills and coins in the hands of the public.
Small time deposits are deposits against which checks may be written. (T/F)
False.
The basic functions of money are: a medium of exchange, a store of value, and a unit of account. (T/F)
True
Fiat Money is paper money with intrinsic value (T/F)
False. fiat money has no intrinsic value
Federal Reserve notes are printed by a division of the Treasury Department. (T/F)
True. All federal reserve notes are printed at the Bureau of Engraving and Printing at the Department of Treasury, but they are issued by the regional Federal Reserve banks.
The Federal Reserve Bank has three monetary policy tools: open market operations, reserve requirement changes, and changes to the Federal Reserve's discount rate (T/F)
True
The Federal Open Market Committee decides on changes to the fiscal policy. (T/F)
False. The Banking Acts of 1933 and 1935 centralized power of the Federal Reserve Bank in Washington DC and established the FOMC. The FOMC meets about every 6 weeks in DC in order to discuss the condition of the economy and consider changes to monetary policy- most important of which is open market operations.
Federal Reserve discount rate
is the interest rate on loans the Federal Reserve charges to other banks.
If the price level increases, the value of money decreases (T/F)
True. the price level and the value of money are directly related. As the overall level of prices increases, the value of a unit of money decreases. For example: if a bottle of soda increases in price from 5 cents to $1.25 over 80 years, it is likely that the satisfaction level has stayed the same and the money used to purchase the soda has decreased in value because of an increase in the price level.
Supposed the price level equals 5 (P=5). The value of one unit of money is
1/5 or .2. 1/P
The value of one unit of money is calculated by
dividing 1 by the price level (1/P)
Suppose the price level equals 5 (P=5). Now suppose the Federal Reserve Bank conducts open market operations and auctions off government bonds. Assume nothing else in the economy changes. Because of the sale of bonds, the price level will _________
increase
decrease
not change
decrease
Suppose the price level equals 5 (P=5). Now suppose the Federal Reserve Bank conducts open market operations and auctions off government bonds. Assume nothing else in the economy changes. Because of the sale of bonds, the value of one unit of money will __________
increase
decrease
not change
increase. When the Fed auctions off government bonds, currency is taken out of circulation and the money supply is decreased. A decrease in the money supply is graphically demonstrated by shifting the money supply curve to the left.
Suppose the price level equals 5 (P=5). Now suppose the Federal Reserve Bank conducts open market operations and purchases government bonds. Assume nothing else in the economy changes. Because of the purchase of bonds, the price level will __________
increase
decrease
not change
increase
Suppose the price level equals 5 (P=5). Now suppose the Federal Reserve Bank conducts open market operations and purchases government bonds. Assume nothing else in the economy changes. Because of the purchase of bonds, the value of one unit of money will __________
increase
decrease
not change
decrease. when the Fed purchases government bonds, the money supply increases, an increase in the money supply is graphically demonstrated by shifting the money supply curve to the right.
SUppose the price level equals 8 (P=8) Now suppose the Fed decreases the required reserve deposit ratio, ceteris paribus. In the money market, this monetary policy change will cause the money ________ (supply/demand) curve to shift ________ (left, right, north-east, south-west)
supply, southwest.
When the Federal Reserve Bank decreases the required reserve deposit ratio, currency is taken out of bank reserves and placed into circulation. As a result, the money supply is increased. An increase of money supply is graphically demonstrated by shifting the money supply curve to the right.
SUppose the price level equals 8 (P=8) Now suppose the Fed decreases the required reserve deposit ratio, ceteris paribus. Because of the change to the required reserve deposit ratio, the price level will_______ (increase, decrease, not change)
increase. WHen the Fed decreases the required reserve deposit ratio, currency is taken OUT of bank reserves and placed into circulation. As a result the money supply is increased. An increase of money supply is graphically demonstrated by shifting the money supply curve to the right. An increase in the money supply causes the price level to increase
SUppose the price level equals 8 (P=8) Now suppose the Fed decreases the required reserve deposit ratio, ceteris paribus. Because of the change to the required reserve deposit ratio, the value of one unit of money will _______ (increase, decrease, not change)
decrease. An increase in the money supply causes the price level to increase and the value of each unit of money to decrease.
Suppose the price level equals 9 (P=9). Now suppose the Fed increases the discount rate, ceteris paribus. In the money market, this monetary policy change will cause the money ________ (supply/demand) curve to shift _______ (L/R/NE/SW)
supply/left. When the Fed increases the discount rate, the money supply is decreased. A decrease of money supply is graphically demonstrated by shifting the money supply curve to the left.
Suppose the price level equals 9 (P=9). Now suppose the Fed increases the discount rate, ceteris paribus. Because of the increase in the discount rate, the price level will______ (increase/decrease/not change)
decrease
Suppose the price level equals 9 (P=9). Now suppose the Fed increases the discount rate, ceteris paribus. Because of the increase in the discount rate, the value of one unit of money will ______ (increase/decrease/not change)
Increase. A decrease in the money supply causes the price level to decrease and the value of each unit of money to increase
A money market fund is an open-end mutual fund which invests only in stocks and bonds. (T/F)
False. A money market fund is an open-end mutual fund which invests only in money markets. Money market funds invest in short term, one day to one year obligations such as treasury bills, certificates of deposit, and commercial paper.
The M1 definition of the money supply includes currency, traveler's checks, savings deposits, demand deposits, and other checkable deposits. (True or False)
False. Not Savings deposits- those are in M2
Federal Reserve notes are printed by the Federal Reserve Bank. (True or False)
False. All Federal Reserve notes are printed at the Bureau of Engraving and Printing at the Department of Treasury, but they are issued by the regional Reserve banks.
An increase in the required reserve deposit ratio causes the money supply to increase (true or false)
False. An increase in the required reserve deposit ratio will lead to a decrease in the money supply.
Open market operations are purchases and sales of government securities by the Federal Reserve Bank in an effort to change the money supply. (True or False)
True
The money supply decreases when the Federal Reserve Bank increases the Federal Reserve discount rate. (T/F)
True
inflation
an increase in the price level from one period to the next
an increase in the value of money from one period to the next is called inflation (T/F)
false
deflation
a decrease in the price level from one period to the next aka an increase in the value of money from one period to the next
Equilibrium exists where the price level is 9 and the money supply equals 25 billion. What is a new possible equilibrium when the Federal Reserve Bank sells some government bonds?
P= 4 and MS = 21
when the federal reserve bank sells government bonds, ceteris paribus, it decreases the supply of money circulating in the economy. In this example, the money supply would shift left from MS2 to MS1.
Money's basic function is:
a medium of exchange
a store of value
a unit of account
all of the above
all of the above
An item that buyers give sellers when they want to purchase goods and services is called:
a medium of exchange
a unit of account
liquidity
a medium of exchange
A decrease in the value of money from one period to the next is called:
deflation
inflation
an expansion
unemployment
inflation
An increase in the required reserve deposit ratio causes the money supply to:
increase
decrease
not change
not enough info
decrease
The money supply increases when the Federal Reserve Bank decreases the Federal Reserve discount rate (T/F)
True
Open market operations are purchases and sales of government securities by the Federal Reserve Bank in an effort to change the money demand (T/F)
False
long-run aggregate supply curve
is vertical and the location of the curve depends on the economy's supply of land, capital, labor, and entrepreneurial ability and the productivity of these resources. LRAS located at the economy's potential real GDP, which is defined as the economy's maximum sustainable output level given the supply of factors of production, the state of technology, and formal and informal institutions supporting the economy and NOT the price level.
Inflationary gap
the amount by which the equilibrium level of real GDP exceeds the potential real GDP
deflationary gap
the amount by which the equilibrium level of real GDP falls short of potential real GDP. an economy that is in a deflationary gap experiences an unemployment rate that is higher than the natural rate of unemployment because cyclical unemployment is now added to the natural rate of unemployment.
fiscal policy
the government's plan for managing aggregate demand through government's power to tax individuals and businesses and its power to spend and transfer tax revenues that it collects. Can be used to:
1) stimulate aggregate demand when the economy is in a deflationary gap
2) slow the economy down when it is in an unsustainable inflationary gap
automatic stabilizers
automatically stimulate the economy when it enters a deflationary gap and automatically cools the economy down when it enters an inflationary gap. They are a just-in-time fiscal policy, because they operate without policymakers having to take any deliberate action. Examples include unemployment insurance, welfare benefits, and income taxes.
short run aggregate supply curve
reflects the total quantity of goods and services that producers in the economy are willing and able to produce at any given price level. the short run aggregate supply curve is upward sloping because of the profit effect, the misperception effect, and the menu costs effect.
profit effect
a concept that, ceteris paribus, sticky wages in the short run
1) induce firms to increase the production of goods and services when the price level increases
2) induce firms to decrease their production of goods and services when the price level decreases because it lead to an increase in real profits
misperception effect
argues that in the short run, producers are temporarily fooled about what is really causing price changes in the markets in which they sell their products. Because of these misperceptions, producers respond to changes in the price level despite no change in a product's real price, and this response leads to an upward sloping supply curve
The menu costs effect
argues that because it can be expensive to change menus and pricing boards and because the business owners don't want to constantly tell their customers that they have changed their prices, they don't do it often. This implies that when there is a change in the price level because of a contraction in the economy, for example, producers keep their prices unchanged.
Aggregate demand curve
reflects the real GDP demanded by all groups in the economy at any given price level. The aggregate demand curve is negatively sloped because of the interest rate effect, the wealth effect, and the open economy effect. May shift to the NE and to the SW
The interest rate effect
a reduction in the price level causes people to convert cash to interest bearing assets (ie: bonds and certificates of deposit)- aka Loanable funds. An increase in the supply of loanable funds causes a south-east shift of the supply of loanable funds, which leads to a lower interest rate. Since the interest rate is equal to the price of investment goods, a decrease in the interest rate causes an increase in spending on investment goods (I) which by definition increases real GDP
wealth effect
a decrease in the price level makes consumers feel wealthier because each nominal dollar can purchase more goods and services, relative to before the price level decrease. This causes an increase in real GDP demanded at every price level
open economy effect
a factor in the negative slope of the aggregate demand curve. When the price level falls, it causes the real exchange rate to depreciate. The real exchange rate is the rate at which foreign made goods can be bought or sold for domestic made goods. The depreciation of the real exchange rate increases the quantity of exports and decreases the quantity of imports and therefore it increases the net exports (NX) or exports minus imports. Because of the increase in net exports, the quantity demanded of real GDP increases.
classical dichotomy
theoretical separation of real and nominal variables
monetary neutrality
the idea that the money supply does not affect real economic variables
Three general explanations for the negative slope of the aggregate demand curve are:
1) the interest rate effect
2) real wealth effect
3) open economy effect
interest bearing assets are also called
loanable funds which is a catch-all term that includes all resources available to finance investment spending and capital accumulation.
real exchange rate
the rate at which foreign made goods can be bought or sold for domestic made goods. The depreciation of the real exchange rate increases the quantity of exports and decreases the quantity of imports and therefore it increases the net exports (NX) or exports minus imports.
Increases in aggregate demand (NE Shift)
Consumption (lower personal taxes, a rise in consumer confidence, greater stock market wealth)
Investment (lower real interest rates, optimistic business forecasts, lower business taxes)
Government purchases (an increase in government purchases, an increase in transfer payments)
New Exports (income increases abroad, which will likely increase exports)
Decreases in aggregate demand (SW shift)
Consumption (higher personal taxes, a fall in consumer confidence, reduced stock market wealth)
Investment (higher real interest rates, pessimistic business forecasts, higher business taxes)
Government purchases (a decrease in Government purchases, decrease in transfer payments)
New Exports (income decreases abroad, which will likely decrease exports)
Aggregate supply curve
reflects the total quantity of goods and services that producers in the economy are willing and able to produce at any given price level. In the short run, the ASC is upward sloping and in the long run it is a vertical line located at the economy's potential real GDP.
Sticky wages
nominal wage (w) contracts do not automatically adjust to the ebb and flow of real-time labor market prices, so they are considered sticky. In an environment with a lot of long term labor contracts, if the price level (P) increases, employment and production become more profitable because real wage expenditures (nominal wage/the price level - w/P) which are adjusted for changes in the price level, actually decrease.
Real Wage Expenditures
equal nominal wage divided by the price level (w/P)
long-run aggregate supply curve
in the long run everything in the economy is variable. the long run provides enough of a time horizon for producers to figure out whether a market price fluctuation is due to a change in consumer valuation or change in the price level.
natural rate of unemployment
the unemployment rate that exists when the economy is operating at potential real GDP. Unemployment exists when the real GDP is equal to potential real GDP. This level of unemployment includes structural and frictional unemployment but excludes cyclical unemployment. The natural rate of unemployment moves slowly but is currently estimated to be between 4 and 5%
the short run and long run aggregate supply curves shift when
there is a change in any one of the factors of production.
Increase in Aggregate Supply
(SRAS: SE shift)
(LRAS: rightward shift)
Lower Costs
-lower wages
-other input prices fall
Government Policy
- tax cuts
-deregulation
-lower trade barriers
Economic growth
- improvements in technology
- productivity advances
- an increase in labor
Favorable weather
Decrease in Aggregate Supply
(SRAS: NW shift)
(LRAS: Leftward shift)
Higher costs
- higher wages
- other input prices rise
- higher oil prices
Government policy
- tax increases
- overregulation
- higher trade barriers
- a decline in labor productivity
Terrorist Attacks
Natural Disasters
Unfavorable weather
The idea that there is a separation of real and nominal variables in the long run is called the classical dichotomy (T/F)
True.
the aggregate demand curve reflects the nominal GDP demanded by all groups in the economy at any given price level (T/F)
False. reflects the REAL GDP not nominal
The open economy effect is observed when a decrease in the price level causes the real exchange rate to depreciate, which subsequently causes an increase in net exports. (T/F)
True
The short run aggregate supply curve is upward sloping because of a combination of the profit effect, the misperception effect, and the menu cost effect. (T/F)
True
Sticky wages induce firms to increase their production of goods and services when the price level decreases (T/F)
False.
The menu cost effect tells us that when there is a real price level decrease in the economy, businesses do not quickly change the price of their products. This behavior generates a real price increase for their products, thereby decreasing the quantity that they sell. (T/F)
True.
The location of the long run aggregate supply curve depends on the economy's supply of land, capital, labor, entrepreneurial ability, and productivity of its scarce resources. The location of the long run aggregate supply curve does not depend on the price level. (T/F)
True.
The long aggregate supply curve shifts to the right when the government permanently lowers trade barriers (T/F)
True.
Determine how the aggregate demand curve is affected because of the following:
There is a decrease in government purchases
shifts to the south-west
Determine how the aggregate demand curve is affected because of the following:
The President and Congress implement lower marginal federal income tax rates.
shifts to north-east
Determine how the aggregate demand curve is affected because of the following:
Price level decreases
the statement causes a movement along the aggregate demand curve. A decrease in the price level causes an increase in the real GDP demanded by all groups in the economy. This is a movement along the aggregate demand curve because of a change in some exogenous factor. The aggregate demand curve does not shift in this case.
Determine how the aggregate demand curve is affected because of the following:
The Federal Reserve Bank increases the required deposit-reserve ratio.
shifts to the south-west
Determine how the aggregate demand curve is affected because of the following:
The United States and China are major trading partners. Suppose that the Chinese evonomy goes into a recessionary period, causing their national income to decrease.
shifts to the south-west
Determine how the long run aggregate supply curve is affected because of the following:
A permanent technological change occurs
LRAS shifts to the right. Since there is a permanent increase in a technology, then the LRAS shifts to the right.
Determine how the long run aggregate supply curve is affected because of the following:
The labor force decreases
LRAS shifts to the left
Determine how the long run aggregate supply curve is affected because of the following:
The President and Congress permanently repeal all inter-state trade restrictions on the sale of wine.
LRAS shifts to the right
Determine how the long run aggregate supply curve is affected because of the following:
The price level decreases
The statement does not affect the location of the LRAS
Determine how the long run aggregate supply curve is affected because of the following:
The price of crude oil (an input into many production processes) temporarily decreases
The statement does not affect the location of the LRAS since it is a price change.
Determine how the short run aggregate supply curve is affected because of the following:
The price level increases
The SRAS does not shift because of a change in the price level. There is movement along the upward sloping SRAS
Determine how the short run aggregate supply curve is affected because of the following:
There is a decrease in the labor force
SRAS shifts to the north-west. A decrease in the labor force causes a decrease in the supply of labor, which causes the price of labor to increase, ceteris paribus. Higher labor prices (ie: wages) cause the SRAS to shift NW
Determine how the short run aggregate supply curve is affected because of the following:
The President and Congress lower corporate tax rates.
SRAS shifts to the south-east
Determine how the short run aggregate supply curve is affected because of the following:
The price of crude oil (an input to many production processes) decreases.
SRAS shifts to the south-east
Determine how the short run aggregate supply curve is affected because of the following:
The Federal Reserve increases the money supply
THe SRAS does not shift when the Fed increases the money supply. The aggregate demand curve shifts to the north-east because of an increase in the money supply. The shifting aggregate demand curve moves along the SRAS.
If corporate taxes are temporarily lowered, ceteris paribus, the policy change will cause the economy to move into a(n) ______ gap and will cause the price level to _______
inflationary/decrease
If consumers' expectations about the state of the economy improve, ceteris paribus, the change will cause the economy to move into a(n)______ gap and will cause the price level to _______
inflationary/increase
If the Federal Reserve Bank sells government bonds, ceteris paribus, the change will cause the economy to move into a(n)______ gap and will cause the price level to _______
deflationary/decrease X
Policy Instrument: the required reserve-deposit ratio.
The Federal Reserve bank should ________ the required reserve deposit ratio if the economy is in a deflationary gap.
decrease.
Policy instrument: the Federal Reserve Bank discount rate.
The Federal Reserve bank should ______ the discount rate if the economy is in a deflationary gap.
decrease
Policy instrument: federal marginal income tax rates.
The President and Congress should _______ federal marginal income tax rates if the economy is in a deflationary gap.
decrease
Policy instrument: government spending:
The President and Congress should ________ government spending if the economy is in a deflationary gap.
Increase
THe idea that the money supply affects only nominal variables and not real variables is formally known as the classical dichotomy. (True or False)
False. In the long run, the money supply affects only nominal variables and not real variables. This means that when there is a change in the money supply by the Federal Reserve Bank, then the only effect is a change in the price level (ie: causing inflation or deflation). In the long run, a change in the money supply has absolutely no effect on the real value people place on goods and services. This second idea is formally called monetary neutrality
The idea that the money supply affects only nominal variables and not real variables is formally known as monetary neutrality. (T/F)
True.
The aggregate demand curve reflects the real GDP demanded by all groups in the economy at any given price level (T/F)
True.
The aggregate demand curve is negatively sloped because of a combination of the interest rate effect, the menu costs effect, and the wealth effect. (T/F)
False. the three general explanations for the negative slope of the aggregate demand curve are: the interest rate effect, real wealth effect, and the open economy effect. On the other hand, the SRAS is upward sloping because of the profit effect, the misperception effect, and the menu costs effect.
The interest rate effect tells us that a reduction in the price level causes people to convert cash into interest bearing assets. This behavior causes a decrease in the interest rate, which subsequently causes an increase in real GDP demanded.
True.
sticky wages induce firms to decrease their production of goods and services when the price level increases. (T/F)
False
Assume that the economy is currently at potential real GDP. Which of the following would put the economy in an inflationary gap?
A) Temporary increase in wages
B) greater stock market wealth
C) higher business taxes
D) decrease in income abroad
greater stock market wealth
If an economy is producing below its potential real GDP, then it is in a(n)
deflationary gap
Which curve reflects the real GDP demanded by all groups in the economy at any given price level?
Aggregate demand curve
Suppose the economy is in an inflationary gap. Which of the following public policies could help the economy get back to potential real GDP?
A) increase unemployment insurance benefits
B) decrease the required reserve deposit ratio
C) Increase the discount rate
D) have the Federal Reserve buy back government bonds
C. increase the discount rate
A permanent decrease in productivity in the economy causes:
A) the long run aggregate supply curve to shift to the left
B) the aggregate demand curve to shift to the south-west
C) the aggregate demand curve to shift to the north-east
D) the long-run aggregate supply curve to shift to the right
A. the long run aggregate supply curve to shift to the left
If an economy is producing below its potential real GDP then:
A) it is in an inflationary gap
B) it is in a deflationary gap
C) there is no unemployment
D) the economy is operating at the natural rate of unemployment
B. it is in a deflationary gap
Suppose that the economy is in a deflationary gap. Which of the following public policies would help the economy get back to potential real GDP?
A) decrease the required reserve deposit ratio
B) have the Federal Reserve buy back government bonds
C) have the President and Congress cut marginal tax rates
D) all of the above are correct
D. all of the above are correct
One explanation for a positively sloped short run aggregate supply curve is that businesses sometimes mistake changes in the price level for a change in the value that consumers have for their product. (T/F)
True
When there is a decrease in the price level, consumers feel wealthier because each nominal dollar can purchase more goods and services relative to before the price level decrease. This is called the wealth effect of a price level change. (T/F)
True
The location of which curve depends on the economy's supply of land, capital, labor, entrepreneurial ability, and productivity of its scare resources; it does not depend on the price level?
long-run aggregate supply curve
factors of production
encompass all the possible resources used to produce goods and services. Labor, capital, land, and entrepreneurial ability are the four categories of factors of production and encompass all the possible productive resources used to produce goods and services.
production possibilities frontier
is a model of a two-good economy that shows how much the economy can produce using all of its factors of production efficiently
increasing opportunity cost
as more and more of an economy's factors of production are employed in the production of a good, the economy must sacrifice the production of other goods at an increasing rate.
Absolute advantage
means that one has the lowest absolute production cost relative to those with whom they are compared
comparative advantage
one has the lowest opportunity cost relative to those with whom they are compared
Law of increasing opportunity cost
once all factors of production are at maximum output and efficiency, producing more will cost more than average. As production increases, the opportunity cost does as well.
as more and more of an economy's factors of production are employed in the production of a good, the economy must sacrifice the production of other goods at an increasing rate.
demand schedule
A table showing the relationship between price and the quantity of a good that buyers are willing to buy
demand curve
a picture of the way an individual responds to changing prices of a good
demand function
a relationship between independent demand variables such as the price of good X and the price of a substitute good Y, and the dependent variable, the quantity demanded of good X.
law of demand
as the price of a good increases, ceteris paribus, the quantity demanded of the good decreases
market demand curve
the horizontal summation of individual demand curves yields the market demand curve
market demand schedule
the market demand schedule is a table that is calculated by summing up how many units of a good buyers are willing to purchase at every market price
price elasticity of demand
a measure of the relationship between a percentage change in the market price of product and a consequential percentage change in the quantity demanded of a product.
cross price elasticity of demand
a measure of the relationship between a percentage change in the market price of product X and a consequential percentage change in the quantity demanded of product Y.
income elasticity of demand
a measure of the relationship between a percentage change in income and a consequential percentage change in the quantity demanded of a product
supply schedule
a table showing the relationship between price and the quantity of a good that sellers are willing to produce.
supply curve
a picture of the way in which a producer responds to changing market prices of a good
supply function
a relationship between independent supply variables, such as the price of inputs and technology, and the dependent variable, the quantity supplied of a good.
law of supply
as the price of a good increases, ceteris paribus, the quantity supplied of the good increases
market supply curve
the horizontal summation of individual supply curves yields the market supply curve
market supply schedule
is calculated by summing up how many units of a good sellers are willing to produce at every market price
elasticity of supply
a measure of the relationship between a percentage change in the market price of a product and a consequential percentage change in the quantity supplied of a product.
market equilibrium
an economic balance in which no individual would be better off doing something different; an equality of supply and demand
comparative-static analysis
the process of comparing two market equilibrium (static) points, one equilibrium point before and the other after a change in an independent variable
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