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Question: Explain why monetary and fiscal policies work

Explain why monetary and fiscal policies work with a lag. Why do these lags matter in the choice between active and passive policy?

> Draw the short-run Phillips curve and the long-run Phillips curve. Explain why they are different.

> Draw the long-run trade-off between inflation and unemployment. Explain how the short-run and long-run trade-offs are related.

> Illustrate the effects of the following developments on both the short-run and long-run Phillips curves. Give the economic reasoning underlying your answers. a. a rise in the natural rate of unemployment b. a decline in the price of imported oil c. a ris

> If the Federal Reserve increases the rate of money growth and maintains it at the new higher rate, eventually expected inflation will ________ and the short-run Phillips curve will shift ________. a. decrease, downward b. decrease, upward c. increase, do

> Suppose that the government reduces spending on highway construction by $10 billion. Which way does the aggregate-demand curve shift? Explain why the shift might be larger or smaller than $10 billion.

> Use the theory of liquidity preference to explain how a decrease in the money supply affects the aggregate- demand curve.

> List and describe the three functions of money.

> The Federal Reserve expands the money supply by 5 percent. a. Use the theory of liquidity preference to illustrate in a graph the impact of this policy on the interest rate. b. Use the model of aggregate demand and aggregate supply to illustrate the impa

> If the government wants to contract aggregate demand, it can ________ government purchases or ________ taxes. a. increase, increase b. increase, decrease c. decrease, increase d. decrease, decrease

> How does the economy’s behavior in the short run differ from its behavior in the long run? Draw the model of aggregate demand and aggregate supply. What variables are on the two axes?

> If the Fed wanted to use all of its policy tools to decrease the money supply, what would it do?

> Draw a diagram with aggregate demand, short-run aggregate supply, and long-run aggregate supply. Be careful to label the axes correctly.

> Explain whether each of the following events will increase, decrease, or have no effect on long-run aggregate supply. a. The United States experiences a wave of immigration. b. Congress raises the minimum wage to $15 per hour. c. Intel invents a new and

> A sudden crash in the stock market shifts a. the aggregate-demand curve. b. the short-run aggregate-supply curve, but not the long-run aggregate-supply curve. c. the long-run aggregate-supply curve, but not the short-run aggregate-supply curve. d. both t

> In the model of the open economy just developed, two markets determine two relative prices. What are the markets? What are the two relative prices?

> Why are budget deficits and trade deficits sometimes called the twin deficits?

> Suppose that Congress is considering an investment tax credit, which subsidizes domestic investment. a. How does this policy affect national saving, domestic investment, net capital outflow, the interest rate, the exchange rate, and the trade balance? b.

> Holding other things constant, an appreciation of a nation’s currency causes a. exports to rise and imports to fall. b. exports to fall and imports to rise. c. both exports and imports to rise. d. both exports and imports to fall.

> What distinguishes money from other assets in the economy?

> Define nominal exchange rate and real exchange rate, and explain how they are related. If the nominal exchange rate goes from 100 to 120 yen per dollar, has the dollar appreciated or depreciated?

> Explain the relationship among saving, investment, and net capital outflow.

> Who is responsible for setting monetary policy in the United States? How is this group chosen?

> Would each of the following transactions be included in net exports or net capital outflow? Be sure to say whether it would represent an increase or a decrease in that variable. a. An American buys a Sony TV. b. An American buys a share of Sony stock. c.

> In an open economy, national saving equals domestic investment a. plus the net outflow of capital abroad. b. minus the net exports of goods and services. c. plus the government’s budget deficit. d. minus foreign portfolio investment.

> List and describe six costs of inflation.

> According to the quantity theory of money, what is the effect of an increase in the quantity of money?

> Suppose that changes in bank regulations expand the availability of credit cards so that people need to hold less cash. a. How does this event affect the demand for money? b. If the Fed does not respond to this event, what will happen to the price level?

> If nominal GDP is $400, real GDP is $200, and the money supply is $100, then a. the price level is ½, and velocity is 2. b. the price level is ½, and velocity is 4. c. the price level is 2, and velocity is 2. d. the price level is 2, and velocity is 4.

> What are the primary responsibilities of the Federal Reserve? If the Fed wants to increase the supply of money, how does it usually do so?

> What is commodity money? What is fiat money? Which kind do we use?

> Which of the following are considered money in the U.S. economy? Which are not? Explain your answers by discussing each of the three functions of money. a. a U.S. penny b. a Mexican peso c. a Picasso painting d. a plastic credit card

> Explain whether each of the following events increases or decreases the money supply. a. The Fed buys bonds in open-market operations. b. The Fed reduces the reserve requirement. c. The Fed increases the interest rate it pays on reserves. d. Citibank rep

> Beleaguered State Bank (BSB) holds $250 million in deposits and maintains a reserve ratio of 10 percent. a. Show a T-account for BSB. b. Now suppose that BSB’s largest depositor withdraws $10 million in cash from her account. If BSB decides to restore it

> Chloe takes $100 of currency from her wallet and deposits it into her checking account. If the bank adds the entire $100 to reserves, the money supply ________, but if the bank lends out some of the $100, the money supply ________. a. increases, increase

> How would an increase in the world price of oil affect the amount of frictional unemployment? Is this unemployment undesirable? What public policies might affect the amount of unemployment caused by this price change?

> Is unemployment typically short-term or long-term? Explain.

> Explain whether each of the following events increases, decreases, or has no effect on the unemployment rate and the labor-force participation rate. a. After a long search, Jon finds a job. b. Tyrion, a full-time college student, graduates and is immedi

> Using the numbers in the preceding question, what is the size of Ectenia’s labor force? a. 50 b. 60 c. 70 d. 80

> Describe three ways that a risk-averse person might reduce the risk she faces.

> What benefit do people get from the market for insurance? What two problems impede the insurance market from working perfectly?

> A company has an investment project that would cost $10 million today and yield a payoff of $15 million in 4 years. a. Should the firm undertake the project if the interest rate is 11 percent? 10 percent? 9 percent? 8 percent? b. Can you figure out the e

> If the interest rate is 10 percent, then the future value in 2 years of $100 today is a. $80. b. $83. c. $120. d. $121.

> The money supply includes all of the following EXCEPT a. metal coins. b. paper currency. c. lines of credit accessible with credit cards. d. bank balances accessible with debit cards.

> A bank has capital of $200 and a leverage ratio of 5. If the value of the bank’s assets declines by 10 percent, then its capital will be reduced to a. $100. b. $150. c. $180. d. $185.

> What is “natural” about the natural rate of unemployment? Why might the natural rate of unemployment differ across countries?

> Define private saving, public saving, national saving, and investment. How are they related?

> Why is it important for people who own stocks and bonds to diversify their holdings? What type of financial institution makes diversification easier?

> Many workers hold large amounts of stock issued by the firms at which they work. Why do you suppose companies encourage this behavior? Why might a person not want to hold stock in the company where he works?

> Elaine wants to buy and operate an ice-cream truck but doesn’t have the financial resources to start the business. She borrows $10,000 from her friend George, to whom she promises an interest rate of 7 percent, and gets another $20,000 from her friend Je

> What causes the lags in the effect of monetary and fiscal policies on aggregate demand? What are the implications of these lags for the debate over active versus passive policy?

> The chapter suggests that the economy, like the human body, has “natural restorative powers.” a. Illustrate the short-run effect of a fall in aggregate demand using an aggregate-demand/aggregate- supply diagram. What happens to total output, income, and

> Approximately how long does it take a change in monetary policy to influence aggregate demand? a. 1 month b. 6 months c. 2 years d. 5 years

> Draw the Phillips curve. Use the model of aggregate demand and aggregate supply to show how policy can move the economy from a point on this curve with high inflation to a point with low inflation.

> Draw the short-run trade-off between inflation and unemployment. How might the Fed move the economy from one point on this curve to another?

> How does a union in the auto industry affect wages and employment at General Motors and Ford? How does it affect wages and employment in other industries?

> How is the unemployment rate measured? How might the unemployment rate overstate the amount of joblessness? How might it understate the amount of joblessness?

> Suppose the natural rate of unemployment is 6 percent. On one graph, draw two Phillips curves that describe the four situations listed here. Label the point that shows the position of the economy in each case. a. Actual inflation is 5 percent, and expect

> The population of Ectenia is 100 people: 40 work full-time, 20 work half-time but would prefer to work full-time, 10 are looking for a job, 10 would like to work but are so discouraged they have given up look- ing, 10 are not interested in working becaus

> The interest rate is 7 percent. What is the present value of $150 to be received in 10 years?

> The interest rate is 7 percent. Use the concept of present value to compare $200 to be received in 10 years and $300 to be received in 20 years.

> According to an old myth, Native Americans sold the island of Manhattan about 400 years ago for $24. If they had invested this amount at an interest rate of 7 percent per year, how much, approximately, would they have today?

> When the Federal Reserve increases the money supply and expands aggregate demand, it moves the economy along the Phillips curve to a point with ________ inflation and ________ unemployment. a. higher, higher b. higher, lower c. lower, higher d. lower, lo

> If the interest rate is zero, then $100 to be paid in 10 years has a present value that is a. less than $100. b. exactly $100. c. more than $100. d. indeterminate.

> What is a share of stock? What is a bond? Explain their differences and similarities.

> What is the role of the financial system? Name and describe two markets that are part of the financial system in the U.S. economy. Name and describe two financial intermediaries.

> Are minimum-wage laws a better explanation for structural unemployment among teenagers or among college graduates? Why?

> For each of the following pairs, which bond would you expect to pay a higher interest rate? Explain. a. a bond of the U.S. government or a bond of an Eastern European government b. a bond that repays the principal in year 2020 or a bond that repays the p

> The economy of Elmendyn contains 2,000 $1 bills. a. If people hold all money as currency, what is the quantity of money? b. If people hold all money as demand deposits and banks maintain 100 percent reserves, what is the quantity of money? c. If people h

> Assume that the reserve requirement is 20 percent. Also assume that banks do not hold excess reserves and there is no cash held by the public. The Fed decides that it wants to expand the money supply by $40 million. a. If the Fed is using open-market ope

> Consider an economy described by the following equations: Y = C + YY I + II G C = 100 + 0.75(Y – T) I = 500 - 50r G = 125 T = 100 TT where Y is GDP, C is consumption, I is investment, G is government purchases, T is taxes, and r is the interest rate.

> Suppose that Congress passes a law requiring employers to provide employees some benefit (such as healthcare) that raises the cost of an employee by $4 per hour. a. What effect does this employer mandate have on the demand for labor? (In answering this

> What adverse effect might be caused by tax incentives to increase saving?

> In which of the following circumstances is expansionary fiscal policy more likely to lead to a short-run increase in investment? Explain. a. When the investment accelerator is large or when it is small? b. When the interest sensitivity of investment is l

> Use the theory of liquidity preference to explain how a decrease in the money supply affects the equilibrium interest rate. How does this change in monetary policy affect the aggregate-demand curve?

> Suppose firms become very optimistic about future business conditions and invest heavily in new capital equipment. a. Draw an aggregate-demand/aggregate-supply diagram to show the short-run effect of this optimism on the economy. Label the new levels of

> Why can’t the Fed control the money supply perfectly?

> How would the following transactions affect U.S. exports, imports, and net exports? a. An American art professor spends the summer touring museums in Europe. b. Students in Paris flock to see the latest movie from Hollywood. c. Your uncle buys a new Volv

> Assume that the banking system has total reserves of $100 billion. Assume also that required reserves are 10 percent of checking deposits and that banks hold no excess reserves and households hold no currency. a. What is the money multiplier? What is the

> This chapter explains that investment can be increased both by reducing taxes on private saving and by reducing the government budget deficit. a. Why is it difficult to implement both of these policies at the same time? b. What would you need to know abo

> Some income from capital is taxed twice. Explain.

> Suppose government spending increases. Would the effect on aggregate demand be larger if the Federal Reserve held the money supply constant in response or if the Fed were committed to maintaining a fixed interest rate? Explain.

> For each of the following events, explain the short-run and long-run effects on output and the price level, assuming policymakers take no action. a. The stock market declines sharply, reducing consumers’ wealth. b. The federal government increases spendi

> Suppose that Americans decide to increase their saving. a. If the elasticity of U.S. net capital outflow with respect to the real interest rate is very high, will this increase in private saving have a large or small effect on U.S. domestic investment? b

> Purchasing-power parity holds between the nations of Ectenia and Wiknam, where the only commodity is Spam. a. In 2015, a can of Spam costs 4 dollars in Ectenia and 24 pesos in Wiknam. What is the exchange rate between Ectenian dollars and Wiknamian pesos

> Explain whether the following statements are true, false, or uncertain a. “Inflation hurts borrowers and helps lenders, because borrowers must pay a higher rate of interest.” b. “If prices change in a way that leaves the overall price level unchanged, th

> What is the theory of liquidity preference? How does it help explain the downward slope of the aggregate-demand curve?

> What are reserve requirements? What happens to the money supply when the Fed raises reserve requirements?

> Between January 2010 and January 2016, U.S. employment increased by 12.1 million workers, but the number of unemployed workers declined by only 7.3 million. How are these numbers consistent with each other? Why might one expect a reduction in the number

> Suppose that the reserve requirement for checking deposits is 10 percent and that banks do not hold any excess reserves. a. If the Fed sells $1 million of government bonds, what is the effect on the economy’s reserves and money supply? b. Now suppose the

> Structural unemployment is sometimes said to result from a mismatch between the job skills that employers want and the job skills that workers have. To explore this idea, consider an economy with two industries: auto manufacturing and aircraft manufactur

> Jamal has a utility function U = W 1/2, where W is his wealth in millions of dollars and U is the utility he obtains from that wealth. In the final stage of a game show, the host offers Jamal a choice between (A) $4 million for sure, or (B) a gamble that

> Suppose the government borrows $20 billion more next year than this year. a. Use a supply-and-demand diagram to analyze this policy. Does the interest rate rise or fall? b. What happens to investment? To private saving? To public saving? To national savi

> Some economists say that the government can continue running a budget deficit forever. How is that possible?

> What is the fundamental trade-off that society faces if it chooses to save more? How might the government increase national saving?

> As described in the chapter, the Federal Reserve in 2008 faced a decrease in aggregate demand caused by the housing and financial crises and a decrease in short-run aggregate supply caused by rising commodity prices. a. Starting from a long-run equilibri

> An economy is operating with output that is $400 billion below its natural level, and fiscal policymakers want to close this recessionary gap. The central bank agrees to adjust the money supply to hold the interest rate constant, so there is no crowding

> Explain whether each of the following events shifts the short-run aggregate-supply curve, the aggregate- demand curve, both, or neither. For each event that does shift a curve, draw a diagram to illustrate the effect on the economy. a. Households decide

> Explain how each of the following developments would affect the supply of money, the demand for money, and the interest rate. Illustrate your answers with diagrams. a. The Fed’s bond traders buy bonds in open-market operations. b. An increase in credit-c

> In a competitive labor market, when the government increases the minimum wage, the result is a(n) __________ in the quantity of labor supplied and a(n) __________ in the quantity of labor demanded. a. increase, increase b. increase, decrease c. decrease,

> Suppose that real interest rates increase across Europe. Explain how this development will affect U.S. net capital outflow. Then explain how it will affect U.S. net exports by using a formula from the chapter and by drawing a diagram. What will happen to


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