Study sets, textbooks, questions
Upgrade to remove ads
Macro Final Exam
Terms in this set (34)
What is the opportunity cost of money?
The nominal interest rate
Know the definition of money demand and the money demand curve.
The demand for money is the amount of wealth people wish to hold in the form of money; the money demand curve shows us the amount of money people wish to hold at different possible nominal interest rates
What are three macroeconomic factors that affect the demand for money?
Nominal interest rates (movement along a given curve), the price level (shift factor), and real income (shift factor)
How does the money supply curve look? Why is it shaped this way?
The money supply curve is a vertical line at the amount of money the Fed wants in circulation
When the Fed makes an open market purchase, what happens to the money supply and the nominal interest rate? What about an open market sale?
Open-market purchase: money supply increases and nominal interest rates fall
Open-market sale: money supply decreases and nominal interest rates increase
What is the definition of the federal funds rate?
The interest rate that commercial banks charge one another for very short-term lending of reserves (usually overnight)
Why might banks hold excess reserves during times of economic uncertainty?
Banks might not be able to find a lot of lending opportunities that are sufficiently safe
What does the term "zero lower bound" mean?
A level below which the Fed cannot reduce short-term interest rates any further
How does quantitative easing differ from traditional open market operations?
Quantitative easing focuses on different asset types with different terms/maturities.
What is forward guidance?
When the Fed provides information to financial markets regarding its future expected monetary policy path; helps market participants form expectations
Suppose potential output is $800 billion and actual output is $720 billion. What type of output gap exists? In which direction should the Fed move the interest rate to close this gap?
There's a recessionary output gap of $80 billion. Ultimately the Fed needs to boost aggregate spending to close this gap. It should decrease the interest rate (by increasing the money supply) to increase spending
According to the Taylor rule, the Fed sets interest rates in response to what two measures?
The inflation rate and the current output gap
Know what Bitcoin is. What do people do with Bitcoin?
Bitcoin is a virtual currency controlled by decentralized network of users. People use Bitcoin to buy and hold (most common), day trade, transfer money, and make purchases.
Know the key advantages and disadvantages of Bitcoin.
Key advantages: increasing acceptance, easier to make international transactions, lower transaction fees, not controlled by central bank, and built-in scarcity. Key disadvantages: black market activity, high price volatility, no refunds, can be replaced by a superior cryptocurrency, and environmental impact
What is the Fed's dual mandate? What is the Fed's long-term target inflation rate?
The dual mandate is to achieve a stable price level and maximum sustainable employment. The Fed's long-term target inflation rate is 2%.
What is the Phillips curve? What are possible reasons for the breakdown in the relationship between inflation and unemployment since the 1990s?
The Phillips curve shows the inverse relationship between inflation and unemployment. Possible reasons for the apparent breakdown in the relationship between inflation and unemployment are: inflation expectations matter more, labor markets have changed, international trade forces producers to keep prices low, and traditional inflation measures may not be as accurate.
Know the shape of the aggregate demand (AD) curve and the reasons why it's shaped that way.
The AD curve shows the relationship between short-run equilibrium output Y and the rate of inflation. The AD curve slopes downwards since lower inflation increases aggregate spending and, therefore, short-run output.
What factors shift the aggregate demand curve and in which direction?
Changes in exogenous spending (spending not related to output or the real interest rate) and changes in the Fed's policy reaction function will shift AD. If exogenous spending increases (if government spends more on defense, if consumer or businesses are more confident), AD will increase or shift to the right (and vice versa). If the Fed tightens monetary policy, it raises the real interest rate which will decrease spending, shifting AD to the left (a decrease).
What is inflation inertia? Know the two reasons given for why inflation exhibits inertia.
Inflation inertia is the tendency for inflation to change relatively slowly from year to year. If people expect low inflation, they will be slow to demand raises, suppliers will be slow to raise prices, etc. which will cause actual inflation to be low. Expectations are one reason for inflation to exhibit inertia; long-term wage and price contracts are another.
What does the term "self-correcting economy" mean?
The self-correcting economy is the notion that output gaps are eventually eliminated by increasing or decreasing inflation.
What is the short-run aggregate supply (SRAS) line and what factors will shift it?
SRAS is a horizontal line showing the current rate of inflation, as determined by past expectations and pricing decisions. SRAS shifts due to changing inflation expectations and due to inflation shocks.
How are short-run and long-run equilibria represented on a graph?
Short-run equilibrium occurs at the intersection of the AD curve and the SRAS line (either to the right or the left of potential output). Long-run equilibrium occurs when the AD curve, the SRAS line, and the LRAS line all intersect at a single point.
Know how output and inflation will change in the context of the self-correcting economy.
First start from long-run equilibrium. Now if businesses become less confident, they will decrease their investment spending. This decrease in exogenous spending shifts the aggregate demand curve to the left (decrease). We're now in a recession where short-run equilibrium output (at the current rate of inflation) is below potential output. As a result, production costs will be slow to increase (and may even decline) and workers will be slow to request wages (and may even see layoffs or pay cuts). Inflation will gradually decline. As inflation declines, we move along the AD curve and short-run equilibrium output will increase until we've returned to potential output at a lower rate of inflation.
What are the three main sources of inflation? What is stagflation?
The three main sources of inflation are excessive spending, shocks to inflation, and shocks to potential output. Stagflation is a combination of a recession with high inflation.
What is a nominal exchange rate? What does it mean for a currency to appreciate or depreciate? Be able to identify.
The nominal exchange rate is the rate at which two currencies can be traded for each other. Appreciation is an increase in the value of a currency relative to other currencies, while depreciation is a decrease in the value of a currency relative to other currencies. If the exchange rate between the U.S. dollar and the Canadian dollar changes from $1 = 1.4 CAD to $1 = 1.35 CAD, the U.S. dollar has depreciated and the Canadian dollar has appreciated.
What is the law of one price?
The law of one price says that if transportation costs are relatively small, the price of an internationally traded commodity must be the same in all locations
What is purchasing power parity (PPP)? Know how inflation factors into the long-run value of a currency.
Purchasing power parity is the theory that nominal exchange rates are determined as necessary for the law of one price to hold. In the long run, the currencies of countries that experience significant inflation will tend to depreciate.
Why isn't PPP good at explaining short-run nominal exchange rates?
Because not all goods and services are traded internationally and not all internationally traded goods and services are perfectly standardized commodities
Know the factors that shift the demand and supply for a currency. Know how the equilibrium exchange rate will change if demand or supply changes.
Demand for dollar by holders of a foreign currency is affected by the preference for U.S.-made goods, real GDP (income) in the foreign country, and real interest rate on foreign assets relative to real interest rate on U.S. assets. The supply of dollars in exchange for the foreign currency is affected by the preference for foreign-made goods, real GDP (income) in the U.S., and real interest rate on foreign assets relative to real interest rate on U.S. assets. When demand for the dollar increases, the equilibrium exchange rate increases (meaning the dollar appreciates). The reverse is true if demand decreases. If the supply of dollars increases, the equilibrium exchange rate decreases (meaning the dollar depreciates). The reverse is true if supply decreases.
How does monetary policy affect an economy's exchange rate and, in turn, its net exports?
Monetary policy affects the interest rate in the U.S. If the Fed tightens monetary policy, meaning it pursues higher interest rates, U.S. assets looks comparatively better than foreign assets. That will increase the demand for dollar, causing the dollar to appreciate. This has the effect of decreasing U.S. net exports since a strong dollar means foreign currency can be exchanged for fewer dollars, diminishing foreign buyers' ability to purchase our goods. At the same time, foreign-made goods appear cheaper from our perspective.
Know the difference between a flexible (or floating) exchange rate and a fixed exchange rate.
A flexible exchange rate is when the value of a currency is determined by the supply and demand for the currency in the foreign exchange market. A fixed exchange rate is an exchange rate set by official government policy.
How can a country maintain a fixed exchange rate?
To maintain a fixed exchange rate, a country can impose trade barriers. It can also use its international reserves to buy its own currency in the case of an overvalued exchange rate. To maintain an undervalued exchange rate, the country would buy up foreign currency using its own. Alternatively, the country could use monetary policy to bring the fundamental exchange rate more in line with the official, fixed exchange rate the country wants to maintain.
What problem do policymakers face if they use monetary policy to stabilize their currency's value? Know how the effectiveness of monetary policy is impacted depending on whether a country's currency is flexible or fixed.
If monetary policy is used to set the fundamental value of the exchange rate equal to the official value, it is no longer available for stabilizing the domestic economy.
Know the difference between absolute advantage and comparative advantage.
An absolute advantage is when a person can perform a task in fewer hours than the other person. A comparative advantage is when a person can perform a task at a lower opportunity cost than another person.
Recommended textbook explanations
Principles of Microeconomics
N. Gregory Mankiw
Principles of Microeconomics
N. Gregory Mankiw
Essentials of Investments
Alan J. Marcus, Alex Kane, Zvi Bodie
Bundle: Principles of Microeconomics, 6th + Study Guide + Tomlinson Learning Path Videos Economics Printed Access Card + Aplia Printed Access Card + Aplia Edition Sticker
N. Gregory Mankiw
Other sets by this creator
Accounting Exam 3
MacroEconomics Exam 3
Macroeconomics Exam 2
Macro Economics Exam 1
Other Quizlet sets
Day 4: Chapter 18 (Heart )
SCM 406 Exam 2
Final Exam 3 study guide
My Life in Pink and Green