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 impact of this change in the interest rate on output and the price level in the short run. c. When the economy makes the transition from its short-run equilibrium to its new long-run equilibrium, what will happen to the price level? d. How will this change in the price level affect the demand for money and the equilibrium interest rate? e. Is this analysis consistent with the proposition that money has real effects in the short run but is neutral in the long run?
> What is capital flight? When a country experiences capital flight, what is the effect on its interest rate and exchange rate?
> An economist discussing trade policy in The New Republic wrote: “One of the benefits of the United States removing its trade restrictions [is] the gain to U.S. industries that produce goods for export. Export industries would find it easier to sell their
> The nation of Ectenia has long banned the export of its highly prized puka shells. A newly elected president, however, removes the export ban. This change in policy will cause the nation’s currency to ________, making the goods Ectenia imports ________ e
> Describe the economic logic behind the theory of purchasing-power parity.
> Give an example of a favorable shock to aggregate supply. Use the model of aggregate demand and aggregate supply to explain the effects of such a shock. How does it affect the Phillips curve?
> How would the following transactions affect U.S. net capital outflow? Also, state whether each involves direct investment or portfolio investment. a. An American cellular phone company establishes an office in the Czech Republic. b. Harrods of London sel
> Define net exports and net capital outflow. Explain how and why they are related.
> When an adverse supply shock shifts the short-run aggregate-supply curve to the left, it also a. moves the economy along the short-run Phillips curve to a point with higher inflation and lower unemployment. b. moves the economy along the short-run Philli
> If a nation’s currency doubles in value on foreign exchange markets, the currency is said to ________, reflecting a change in the ________ exchange rate. a. appreciate, nominal b. appreciate, real c. depreciate, nominal d. depreciate, real
> Suppose a wave of negative “animal spirits” overruns the economy, and people become pessimistic about the future. What happens to aggregate demand? If the Fed wants to stabilize aggregate demand, how should it alter the money supply? If it does this, wha
> The government spends $3 billion to buy police cars. Explain why aggregate demand might increase by more or less than $3 billion.
> Suppose a computer virus disables the nation’s automatic teller machines, making withdrawals from bank accounts less convenient. As a result, people want to keep more cash on hand, increasing the demand for money. a. Assume the Fed does not change the mo
> The Federal Reserve’s target rate for the federal funds rate a. is an extra policy tool for the central bank, in addition to and independent of the money supply. b. commits the Fed to set a particular money supply so that it hits the announced target. c.
> Describe the difference between foreign direct investment and foreign portfolio investment. Who is more likely to engage in foreign direct investment—a corporation or an individual investor? Who is more likely to engage in foreign portfolio investment?
> If the value of a nation’s imports exceeds the value of its exports, which of the following is NOT true? a. Net exports are negative. b. GDP is less than the sum of consumption, investment, and government purchases. c. Domestic investment is greater than
> Explain the difference between nominal and real variables and give two examples of each. According to the principle of monetary neutrality, which variables are affected by changes in the quantity of money?
> It is sometimes suggested that the Federal Reserve should try to achieve zero inflation. If we assume that velocity is constant, does this zero-inflation goal require that the rate of money growth equal zero? If yes, explain why. If no, explain what the
> According to the quantity theory of money, which variable in the quantity equation is most stable over long periods of time? a. money b. velocity c. price level d. output
> Describe how banks create money.
> In what sense is inflation like a tax? How does thinking about inflation as a tax help explain hyperinflation?
> What are demand deposits and why should they be included in the stock of money?
> Your uncle repays a $100 loan from Tenth National Bank (TNB) by writing a $100 check from his TNB checking account. Use T accounts to show the effect of this transaction on your uncle and on TNB. Has your uncle’s wealth changed? Explain.
> If the reserve ratio is ¼ and the central bank increases the quantity of reserves in the banking system by $120, the money supply increases by a. $90. b. $150. c. $160. d. $480.
> Draw the supply curve and the demand curve for a labor market in which the wage is fixed above the equilibrium level. Show the quantity of labor supplied, the quantity demanded, and the amount of unemployment.
> Suppose that this year’s money supply is $500 billion, nominal GDP is $10 trillion, and real GDP is $5 trillion. a. What is the price level? What is the velocity of money? b. Suppose that velocity is constant and the economy’s output of goods and service
> Why is frictional unemployment inevitable? How might the government reduce the amount of frictional unemployment?
> The main policy goal of the unemployment insurance system is to reduce the a. search effort of the unemployed. b. income uncertainty that workers face. c. role of unions in wage setting. d. amount of frictional unemployment.
> Fortune magazine regularly publishes a list of the “most respected” companies. According to the efficient markets hypothesis, if you restrict your stock portfolio to these companies, will you earn a better-than-average return? Explain.
> What is diversification? Does a stockholder get a greater benefit from diversification when going from 1 to 10 stocks or when going from 100 to 120 stocks?
> Bond A pays $8,000 in 20 years. Bond B pays $8,000 in 40 years. (To keep things simple, assume these are zero-coupon bonds, which means the $8,000 is the only payment the bondholder receives.) a. If the interest rate is 3.5 percent, what is the value of
> Suppose that a country’s inflation rate increases sharply. What happens to the inflation tax on the holders of money? Why is wealth that is held in savings accounts not subject to a change in the inflation tax? Can you think of any way holders of savings
> If the interest rate is 10 percent, then the present value of $100 to be paid in 2 years is a. $80 b. $83. c. $120. d. $121.
> If more Americans adopted a “live for today” approach to life, how would this affect saving, investment, and the interest rate?
> What is national saving? What is private saving? What is public saving? How are these three variables related?
> Explain the difference between saving and investment as defined by a macroeconomist. Which of the following situations represent investment and which represent saving? Explain. a. Your family takes out a mortgage and buys a new house. b. You use your $20
> If the government collects more in tax revenue than it spends, and households consume more than they get in after-tax income, then a. private and public saving are both positive. b. private and public saving are both negative. c. private saving is positi
> The classical principle of monetary neutrality states that changes in the money supply do not influence ________ variables and is thought most applicable in the ________ run. a. nominal, short b. nominal, long c. real, short d. real, long
> According to traditional Keynesian analysis, which has a larger impact on GDP—a dollar of tax cuts or a dollar of additional government spending? Why?
> According to traditional Keynesian analysis, why does a tax cut have a smaller effect on GDP than a similarly sized increase in government spending? Why might the opposite be the case?
> Policymakers who want to stabilize the economy must decide how much to change the money supply, government spending, or taxes. Why is it difficult for policymakers to choose the appropriate strength of their actions?
> According to traditional Keynesian analysis, which of the following will increase aggregate demand the most? a. $100 billion increase in taxation b. $100 billion decrease in taxation c. $100 billion increase in government spending d. $100 billion decreas
> Hyperinflations occur when the government runs a large budget ________, which the central bank finances with a substantial monetary ________. a. deficit, contraction b. deficit, expansion c. surplus, contraction d. surplus, expansion
> 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.
> 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
> Explain why monetary and fiscal policies work with a lag. Why do these lags matter in the choice between active and passive policy?
> 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