ECO 201:Study Guide
197 Cards in this Set
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Adam Smith's Invisible Hand
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Phrase coined by Adam Smith - describe the process that turns self-directed gain into social and economic benefits for all.
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We Need Govnmn't
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Enforce rules and maintain institutions
Enforce property rights (police & courts)
Promote efficiency
Avoid market failure
Promote equality
Avoid disparities in economic wellbeing
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Property rights
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Ability of an individual to own and exercise control over scarce resources
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Market failure
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Situation in which the market on its own fails to produce an efficient allocation of resources.
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Causes for market failure
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Externality
Impact of one person's actions on the well-being of a bystander (ex. Pollution)
Market power
Ability of a single economic actor (or small group of actors) to have a substantial influences on a market prices (Ex. Monopoly)
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Externality
Impact of one person's actions on the well-being of a bystander (ex. Pollution)
Market power
Ability of a single economic actor (or small group of actors) to have a substantial influences on a market prices (Ex. Monopoly)
Disparities in economic wellbeing
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Market economy rewards people
according to their ability to produce things that other people are willing to pay for.
Government intervention: Public policies
May diminish inequality
Process far from perfect
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A country's standard of living depends on...
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its ability to produce goods and services
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Large differences in living standards
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Among countries
Over time
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Explanation of differences of differences in living standards?
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Differences in productivity.
Productivity depends on the equipment, skill sand technology available to workers but other factors (e.g., labor unions, competition from abroad) have far less impact on living standards.
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Prices rise when
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Government prints too much money (inflation)
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Inflation
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an increase in prices or decline in purchasing power caused by an increase in the supply of money
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Society faces a short-run trade off between
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unemployment and inflation
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short run effects of monetary injections
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-simulates the overall level of spending because of the higher demands for goods and services
-firms (over time) raise prices, hire more workers, and produce more goods and services
-lower unemployment (from more hiring)
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Short run trade-off between unemployment and inflation
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key role in the anaylsis of business cycle
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Business cycle
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–Fluctuations in economic activity
•Employment
•Production
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In Figure 1, equilibrium price equals ____ while equilibrium quantity equals ____.
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P2 ; Q2
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What is true at a price of P1 dollars?
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A disequilibrium because D (Demand) is greater than S (Supply)
B quantity demanded (Qd) equals Q3 units
C quantity supplied (Qs) equals Q1 units
D shortage of Q1 minus Q3 un…
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What is true at a price of P3 dollars?
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A equilibrium because D=S
B quantity demanded equals Q3 units
C quantity supplied equals Q1 units
D there is a disequilibrium surplus (S>D) equal to Q3 minus Q1 units *
E in a free market price will increase to resolve the disequilibrium shortage
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If price equals P1, what if any adjustments place in a free market with no government interference?
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A price decreases until S = D
B price increases up to P2, eliminating the shortage as Qd decreases and Qsincreases *
C price increases to P3 to solve the shortage
D Demand will decrease (shift Left) while the Supply curve increases (shift Right)
E the government will “…
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At P3
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A quantity demanded equals Q1 units and quantity supplied equals Q3 units
B to restore equilibrium in a free market, price will decrease to P2 until D=S and the surplus is eliminated
C if government controlled price at a minimum of P3 it would be a price ceiling
D the hig…
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What happens if Demand increases, ceteris paribus?
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A equilibrium price and quantity both increase *
B equilibrium price and quantity both decrease
C equilibrium price increases but equilibrium quantity decreases
D equilibrium price decreases but equilibrium quantity increases
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What happens to the market if Demand decreases, ceteris paribus?
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A equilibrium price and quantity both increase *
B equilibrium price and quantity both decrease
C equilibrium price increases but equilibrium quantity decreases
D equilibrium price decreases but equilibrium quantity increases
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What happens when Supply increases (shift Right), ceteris paribus Demand?
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A equilibrium price and quantity both increase
B equilibrium price and quantity both decrease
C equilibrium price increases but equilibrium quantity decreases
D equilibrium price decreases but equilibrium quantity increases *
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What happens when Supply decreases (shift Left), ceteris paribus Supply?
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A equilibrium price and quantity both increase
B equilibrium price and quantity both decrease
C equilibrium price increases and equilibrium quantity decreases (depending on Demand elasticity) *
D equilibrium price decreases and equilibrium quantity increases
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Which of the following shifts Demand?
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A Price
B Cost of Production
C Technology
D Numbers of Sellers
E Tastes and Preferences of Buyers *
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Which of the following shifts Supply?
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Costs of production and technology
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What happens when Tastes and Income increase?
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Demands Increase
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What happens when Technology increases and business taxes decrease (CTEGNP)?
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Supply increases
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If consumer tastes increase (T in TINEAR)
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Equilibrium Price Increases, Demand Increases
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As the price level rises,ceteris paribus, people holding some of their wealth in monetary form become
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less wealthy and they buy less.
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Suppose consumption decreases at each price level. As a result, aggregate demand ________, and the AD curve shifts _________.
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decreases; leftward
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________ will cause a movement from one point on an AD curve to another point on the same AD curve.
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A change in the price level
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The real balance effect is one of the
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reasons why an AD curve is downward-sloping.
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real balance effect
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change in the purchasing power of dollar assets that result from a change in the price level
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Which factors can shift the AD curve?
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net exports, government purchases, and the money supply
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If consumption changes because of a change in a factor other than the price level, then the
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AD curve shifts.
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Suppose a drop in stock prices makes people feel less wealthy. This would cause __________ the economy's AD curve.
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a leftward shift of
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Expectation of lower future prices is a
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leftward shift of AD.
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Expectation of lower future prices is a
An economic policy initiative results in the AD curve shifting to the right. As a result
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the price level will rise.
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An increase in the interest rate ______ purchases of consumer _______.
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reduces; durables.
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As the interest rate rises, the cost of a given investment project ______ and business invest _______.
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rises; less
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As income taxes rise, disposable income _____, causing _____ the AD curve.
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decrease; a leftward shift of
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Business optimism about future sales tends to ______ investment expenditures, shifting the AD curve to the _______.
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increase; right
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A decrease in business taxes, by ________ the expected profitability of investment projects, shifts the AD curve to the ________.
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raising; right
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A rise in foreign real national income tends to raise U.S. _______, shifting the U.S. AD curve to the ________.
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exports; right
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An increase in the MI money supply may _____ total expenditures, leading to a _______ shift of the AD curve.
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increase; rightward
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A short-run aggregate supply curve shows the
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real output (Real GDP) producers are willing and able to sell at different price levels, ceteris paribus.
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A rise in wage rates
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causes the SRAS curve to shift leftward.
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An increase in the price of nonlabor inputs
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shifts the SRAS curve leftward.
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An increase in labor's productivity will cause the AS curve to shift _______ and the price level to _______.
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rightward; decrease.
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A rise in aggregate demand and a fall in short-run aggregate supply will definitely
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raise the price level, but there is not enough information to know how Real GDP will change.
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If consumption increases,
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the AD curve will shift rightward, which will push the price level up.
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Short-run equilibrium exists
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where the AD curve intersects the short-run aggregate supply (SRAS) curve.
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An increase in investment at a given price level
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shifts the AD curve to the right.
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Generally, an increase in aggregate supply is
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represented by a rightward shift in the AS curve.
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What would cause a rightward shift in the AD cure?
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an increase in government purchases of goods and services
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Ceteris paribus, Real GDP and the unemployment rate are
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inversely related.
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The Great Depression can be analyzed using the simple aggregate supply and aggregate demand model. A series of events caused ______ to decline which resulted in _______ and __________.
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aggregate demand; deflation; high unemployment.
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Starting from short-run equilibrium, wage rates rise. What is the effect on the price level, Real GDP, and the unemployment rate in the short run?
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The price level rises, Real GDP falls, and the unemployment rate rises.
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If the nominal wage is $40 and the price level (as measure by a price index) is 2.5 if follows that the real wage is
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(nominal wage/price level = real wage)
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A change in Real GDP in the short run can be brought about by a change in
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the exchange rate, labor productivity, expectations of future sales, and wealth.
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The economy suffers an adverse supply shock. As a result, in the short run Real GDP will ______ and the price level will _______.
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fall; rise
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When the economy is at its full employment Real GDP, the unemployment rate is equal to
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the natural unemployment rate.
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An economy is producing its Natural Real GDP when the rate of unemployment is the _________ unemployment rate.
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sum of the frictional unemployment rate and the structural
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Natural Real GDP is equal to
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full-employment Real GDP.
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If Real GDP is less than Natural Real GDP, the economy is in
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a recessionary gap.
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If Real GDP is less than Natural Real GDP, then the (actual) unemployment rate is
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greater than the natural unemployment rate.
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If Real GDP is greater than Natural Real GDP, the economy is in a(n)
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inflationary gap.
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The long-run aggregate supply (LRAS) curve is
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vertical.
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Long run aggregate supply (LRAS) curve
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vertical at the natural real GDP level
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In a self-regulating economy, inflationary and recessionary gaps produce shifts of the
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SRAS curve that move the economy to a long-run equilibrium point.
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A laissez-faire macroeconomic policy, based on a _____ in self regulating properties of the economy, implies ______ by the government.
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belief; noninterference
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Self-regulating
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the economy can remove itself from recessionary and inflationary gaps and produce at Natural Real GDP.
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A necessary condition for the economy to be self-regulating is that
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wages must be flexible in both an upward and downward direction.
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Say's law says
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supply creates its own demand.
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The classical economists argued that saving is matched by an equal amount of investment because of
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interest rate inflexibility.
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Consumption and disposable income are
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directly related.
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The classical economists believed ______ determined savings, while Keynes said it was ______.
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interest rates; income
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The efficiency wage model is an explanation of wage ______ and thus a support for ______ macroeconomics.
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inflexibility; Keynesian
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Keynes believed that
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wages and prices are often inflexible in the downward direction.
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Keynes believed that
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monopolistic elements in the economy prevent immediate and sharp price declines in response to falling demand.
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The marginal propensity to consume plus the marginal propensity to save is
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equal to one.
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Between 1929 and 1933, a series of shocks caused ______ to ______ repeatedly in the United States.
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aggregate demand; decline
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According to Keynes, the private sector (by itself)
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cannot always move the economy out of a recessionary gap.
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Fiscal Policy
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changes in government expenditures and/or taxes to achieve economic goals, such as low unemployment, stable prices, and economic growth
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fiscal policy
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changes in gov expenditures/taxes to achieve economic goals
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Discretionary Fiscal Policy
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deliberate changes of government expenditures and/or taxes to achieve economic goals.
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Automatic Fiscal Policy
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changes in government expenditures and/or taxes that occur automatically without (additional) congressional action
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Full Employment Act of 1946
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lays the responsibility of economic stability of inflation and unemployment onto the federal government
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Expansionary Fiscal Policy
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increases in government expenditures and/or decreases in taxes to achieve particular economic goals
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Contractionary Fiscal Policy
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decreases in government expenditures and/or increases in taxes to achieve economic goals
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Crowding Out
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the decrease in private expenditures that occurs as a consequence of increased government spending or the financing needs of a budget deficit
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crowding out
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decrease in private expenditures that occurs as a consequence of increased gov spending
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Laffer Curve
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the curve, named after Arthur Laffer, that shows the relationship between tax rates and tax revenues. According to the Laffer curve, as tax rates rise from zero, tax revenues rise, reach a maximum at some point, and then fall within further increases in tax rates.
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Budget Deficit
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government expenditures greater than tax revenues
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Public Debt
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the total amount that the federal government owes its creditors
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public debt
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total amount the federal gov owes its creditors
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Consumption Function
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C=Co+(MPC)(Yd)
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Marginal Propensity to Consume (MPC)
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MPC=^C(consumption)/^Yd(disposable income)
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Multiplier
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M=1/(1-MPC)
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If some of a person's wealth is in money form, it follows that
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this person's wealth will change as the price level changes.
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Computing Savings
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Saving = Disposible Income - Consumption
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Computing Marginal Propensity
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MPC = change in consumption / change in disposable income
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Computing Average Propensity
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APS = consumption / disposable income
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Money
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any good that is widely accepted for purposes of exchange and the repayment of debt
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Barter
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exchanging goods and services for other goods and services without the use of money
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Medium of Exchange
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anything that is generally acceptable in exchange for goods and services; a function of money
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Unit of Account
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a common measure in which relative values are expressed; a function of money
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Store of Value
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the ability of an item to hold value over time; a function of money
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Double Coincidence of Wants
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in a barter economy, a requirement, which must be met before a trade can be made. It specifies that a trader must find another trader who at the same time is willing to trade what the first trader wants and wants what the first trader has
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M1
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currency held outside banks plus checkable deposits plus traveler's checks
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Currency
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coins and paper money
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Federal Reserve Notes
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paper money issued by the Federal Reserve
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Checkable Deposits
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deposits on which checks can be written
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M2
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M1 plus savings deposits (including money market deposits accounts) plus small-denomination time deposits plus money market mutual funds (retail)
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Savings Deposit
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an interest-earning account at a commercial bank or thrift institution. Normally, checks cannot be written on savings deposits, and the funds in a savings deposit can be withdrawn at any time without a penalty payment
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Time Deposit
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an interest-earning deposit with a specified maturity date. Time deposits are subject to penalties for early withdrawal, that is, withdrawal before the maturity date. Small-denomination time deposits are less than $100,000
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Money Market Deposit Account (MMDA)
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an interest-earning account at a bank or thrift institution, for which a minimum balance is usually required and most of which offer limited check-writing privileges
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Money Market Mutual Fund (MMMF)
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an interest-earning account at a mutual fund company, for which a minimum balance is usually required and most of which offer limited check-writing privileges. Only retail MMMFs are part of M2
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Fractional Reserve Banking
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a banking arrangement that allows banks to hold reserves equal to only a fraction of their deposits liablilities
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Federal Reserve System (the Fed)
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the central bank of the United States
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Reserves
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the sum of bank deposits at the Fed and vault cash; reserves = bank deposits at the Fed + vault cash
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Required Reserve Ration (r)
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a percentage of each dollar deposited that must be held in reserve form (specifically, as bank deposits at the Fed or vault cash)
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Required Reserves
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the minimum dollar amount of reserves a bank must hold against its checkable deposits, as mandated by the Fed; required reserves = r(required reserve ratio) • checkable deposits
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Reserve Requirement
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the Fed rule that specifies the amount of reserves a bank must hold to back up deposits
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Excess Reserves
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any reserves held beyond the required amount; the difference between (total) reserves and required reserves; excess reserves = reserves - required reserves
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Direct Finance
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borrows and lenders come together in a market setting, such as in the bond market
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Indirect Finance
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funds are loaned and borrowed through a financial intermediary
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Financial Intermediary
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a financial intermediary transfers funds from those who want to lend funds to those who want to borrow them
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Asymmetric Information
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relates to an economic agent on one side of a transaction having information that an economic agent on the other side of the transaction does not have
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Adverse Selection
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a phenomenon that occurs when the parties on one side of the market, who have information not known to others, self-select in way that adversely affects the parties on the other side of the market
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Moral Hazzard
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a condition that exists when one party to a transaction changes his or her behavior in a way that is hidden from and costly to the other party
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Balance Sheet
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a record of the assets and liabilities of a bank
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Asset
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anything of value that is owned or that one has claim to
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Liability
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anything that is owned to someone else
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Insolvency
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a condition in which one's liabilities are greater than one's assets
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Serves as a medium of exchange, a unit of account, and a store of value
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Money
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Money evolved out of a barter economy as traders attempted to make exchange easier. What are the goods that have been used as money?
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gold, silver, copper, cattle, rocks, and shells
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Includes currency held outside banks, checkable deposits, and traveler's checks
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M1
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Includes M1, savings deposits (including money market deposit accounts), small-denomination time deposits, and money market mutual funds (retail)
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M2
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Credit cards are not money. When a credit card is used to make a purchase, a ______ is incurred. This is not the case when money is used to make a purchase.
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liability
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A financial system is a means of getting people with ______ surplus funds (with funds to lends) together with people who have a ______ of funds (who want to borrow funds).
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surplus; shortage
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Board of Governors
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the governing body of the Federal Reserve System
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Federal Open Market Committee (FOMC)
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the 12-member policy-making group in the Fed. The committee has the authority to conduct open market operations.
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Open Market Operations
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the buying and selling of government securities by the Fed
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Monetary Policy
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changes in the money supply or in the rate of change of the money supply, intended to achieve stated macroeconomic goals
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U.S. Treasury Securities
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bonds and bond-like securities issued by the U.S. Treasury when it borrows
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Open Market Purchase
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the buying of government securities by the Fed
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Cash Leakage
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occurs when funds are held as currency instead of deposited into a checking account
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Simple Deposit Multiplier
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the reciprocal of the required reserve ration, 1/r
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Open Market Sale
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the selling of government securities by the Fed
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Equation of Exchange
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an identity stating that the money supply (M) times velocity (V) must be equal to the price level (P) times Real GDP (Q): MV=PQ
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Equation of Exchange
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MV = PQ
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Velocity
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the average number of times a dollar is spent to buy final goods and services in a year
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Velocity (V)
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V = GDP / M
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Money Multipler (K)
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K = change in money / change in base
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Actual K
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Actual K = 1 / r + cash leakage
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Base
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Base = Reserves + Currency
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Money Supply (M)
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M = K • B
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Monetary Base (B)
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B = M / K
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Change required reserve ratio (EASY)
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decrease in required reserve ratio, increase in excess reserves, increase in money supply
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Change in required reserve ratio (TIGHT)
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increase in required reserve ratio, decrease in excess reserves, decrease in money supply
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Change in discount rate (EASY)
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decrease in DR, increase in excess reserves, increase in money supply
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Change in discount rate (TIGHT)
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increase in DR, decrease in excess reserves, decrease in money supply
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Open Market Operations ( Buy Sec.)(EASY)
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increase in excess reserves, increase in money supply
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Open Market Operations (Sell Sec.) (TIGHT)
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decrease in excess reserves, decrease in money supply
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Recession (EASY)
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increase in money supply, decrease in interest rate, increase in Aggregate Demand
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Recession (Buy Sec.)
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decrease in required reserve ratio, decrease in DR
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Inflation (TIGHT)
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decrease in money supply, increase in interest rate, decrease in Aggregate Demand
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Inflation (Sell Sec.)
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increase in required reserve ratio, increase in DR
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Stagflation
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SRAS problem; Phillips Tradeoff
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Real Interest Rate
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Nominal interest rate - Expected inflation rate
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Nominal interest rate
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Real interest rate + Expected inflation rate
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Aggregate demand
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quantity demanded of all goods and services at different price levels, ceteris paribus
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The aggregate demand curve slopes downward because of:
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real balance, interest rate, and international trade effects
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Rise in price level causes:
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purchasing power to fall and less goods to be bought
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Aggregate supply
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quantity supplied of all goods and services at different price levels
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Short run aggregate supply (SRAS) curve
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upward sloping relationship between price level and quantity supplied
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3 states of an economy
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short-run equilibrium, long-run equilibrium, or disequilibrium
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interest rate effect
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changes in household/business buying as the interest rate changes
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international trade effect
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change in foreign spending as the price level changes
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4 major spending components:
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Consumption (c), investment (i), government purchases (g), net exports (NX)
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To calculate the 'total expenditures on US goods/services':
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add up c, i, g, and NX
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appreciation
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increase in onc currency value
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depreciation
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decrease i value of one currency
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recessionary gap
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Real GDP is less than the natural real GDP, and unemployment rate is greater than the natural unemployment rate
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inflationary gap
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real GDP is greater than natural real GDP, and unemployment is less than natural unemployment rate
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laissez-faire
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public policy of no interference in economy market activities
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progressive income tax
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system in which ones tax rates rise as taxable income rises
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proportional income tax
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system in which a persons tax rate is the same regardless of taxable income
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regressive income tax
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system in which tax rate declines as taxable income rises
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budget surplus
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tax revenues greater than government expenditures
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balanced budget
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government expenditures equal to tax revenues
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cyclical deficit
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part of the budget deficit that is a result of a downturn in economic activity
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structural deficit
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part of the budget deficit that exists even if the economy were operating at full employment
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marginal (Income) tax rate
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tax payment / taxable income
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tax base
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tax revenue= tax base X average tax rate
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ECO 201:Study Guide