Free Response Quiz 2

Free Response Quiz 2

1.       What 2 factors of the economy does the Phillips curve correlate?

2.       What would be the real interest rate if the nominal interest is 12% and the expected Inflation is 7% and the unemployment rate is 6%?

3.       What would be the real interest rate if unemployment is 8% the nominal interest is 6% and the expected Inflation is 4%?

4.       What is the difference between Nominal Interest and Real Interest?

5.       If the inflation rate were 2% what are the actions that the Federal Reserve can take to target 3% inflation.

a.       Why would they want to do that?

6.       If the inflation rate is 5% what actions can Congress take to target 4% inflation?

a.       Why would they want to do that?

7.       If the inflation rate were 1% what Fiscal Policy actions can be taken to target 3% inflation?

a.       Why would they want to do that?

8.       If the inflation rate were 9% what Monetary Policy actions can be taken to target 5% inflation?

a.       Why would they want to do that?

9.        How would Expansionary Fiscal Policy affect Aggregate Demand?

10.   How would Contractionary Monetary Policy affect Short Run Aggregate Supply?

11.   How would Expansionary Monetary Policy affect real GDP?

12.   What are the effects of a Depreciating currency to a country’s GDP?

13.   What are the Effects of an Appreciating Currency to a country’s Exports?

14.   If the US demands products from France where the Euro is traded, what will happen to value of the US Dollar?

15.   If the US demands products from Germany where the Euro is traded, what will happen to value of the Euro?

16.   What will happen to the value of the Canadian Dollar if Mexican National s start vacationing in Calgary, Toronto, and Vancouver?

a.       How does this increase in tourism in Canada affect Canadian exports?

b.      How does this increase in tourism in Canada affect US Currency?

c.       How does this increase in tourism affect Mexico’s GDP?

Top10 AP Macroeconomics Exam Concepts

https://www.youtube.com/watch?v=v4dmUrUqvWs

Topics AP Macroeconomics

What AP says should be covered in Unit 1:

Scarcity

Opportunity Cost

Production Possibilities Curve

Demand,

Supply,

Market Equilibrium

Supply and Demand:  “used to analyze the workings of the free market system”

Absolute Advantage, Comparative Advantage, Mutually Advantageous Trade

Business Cycles

Economic Growth

Graphs students need to draw or identify for multiple choice questions:

Production Frontiers (especially for use in Comparative Advantage questions)

Supply and Demand

Supply and Demand with Ceilings and Floors

Currencies (as examples of Supply and Demand) (US dollars, other currencies: real or made up)

Cycles

What AP says should be covered in Unit II:

Circular Flow, Households, Businesses, Government, International

Gross Domestic Product, Expenditure Approach Components

Unemployment, Types, Measures, Causes, Unemployment Rate, Natural Rate

Inflation Measures, Changes in Dollar Values over Time, Costs of Inflation

Nominal GDP, Real GDP

Consumer Price Index

GDP Deflator

Graphs students need to draw or identify for multiple choice questions:

The basic Circular Flow model

Investment Demand

What AP says should be covered in Unit III:

Aggregate Supply and Aggregate Demand

Equilibrium National Output, Full Employment Output

General Price Level

Effects of Public Policy

AD and AS Curves

AD Factors (C + Ig + G + Xn) 

AS Factors

Short Run AS

Long Run AS

Spending Multiplier (applied to Aggregate Models)

Crowding Out (save for Unit V)

Sticky Price, Sticky Wages

Flexible Price and Flexible Wage

Graphs students need to draw or identify for multiple choice questions:

Aggregate Model

What AP says should be covered in Unit IV:

Money Supply and Factors

Money Demand and Factors

Definition of Money

Measures of Money Supply

Time Value of Money

Stocks and Bonds (Definitions)

Fractional Reserve Banking

The Federal Reserve System

Multiple Deposit Expansion

T-Account Money Creation

Money Multiplier (via Loans)

Monetary Policy

Equilibrium Interest Rates

Interest Rates and Aggregate Demand

Aggregate Demand and Real Output and Price Level

Financial Markets

Loanable Funds Market (Private Savings Market)

Real Interest Rate

Money Market (as different from Loanable Funds)

Tools of Central Bank Policy

Quantity Theory of Money

Graphs students need to draw or identify for multiple choice questions:

Money Market

Loanable Funds (Private Savings Market)

What AP says should be covered in Unit V:

Public Policy and Output, Price Level, Employment in the SR and LR

Fiscal Policy

Monetary Policy

Short Run Shocks

Long Run Equilibrium

Budget Deficits and Crowding Out

The Burden of the National Debt

Phillips Curves:  Short Run and Long Run

Inflation and Unemployment Trade Off

Inflation Expectations

Graphs students need to draw or identify for multiple choice questions:

Crowding Out (Shown in? -- Investment Demand Graph, Money Market Graph, Loanable Funds Graph, Aggregate Model)

Phillips Curves

The Phillips and Aggregate Model Link (Coming to future tests?)

What AP says should be covered in Unit VI:

Long Run Economic Growth

Productivity Measures

Standard of Living

Role of Investment

Physical Capital Accumulation

Research and Development

Graphs students need to draw or identify for multiple choice questions:

(No new graphs)

What AP says should be covered in Unit VII:

Balance of Payments Accounts

Trade Balance

Current Account

Capital (Financial) Account

Foreign Exchange Markets

Equilibrium Exchange Rates

Currency Demand and Supply

Currency Appreciation and Depreciation

Net Exports

Trade Restrictions

Graphs students need to draw or identify for multiple choice questions:

(No new graphs)

Phillips Curve Notes

The Phillips Curve and Its Modern Uses

William Phillips: 1958

Paul Samuelson and Robert Solow: 1960

Edmund Phelps:  2006 Nobel Prize

The Original Short Run Phillips Curve

Basic Assumptions:

·        There is an inverse relationship between inflation and unemployment.  When one increases, the other decreases.

·        If an economy has inflation, usually due to demand pull growth, then more workers are being hired to produce the greater number of goods being produced.

·        If an economy is in a recession, more resources are being left idle, therefore fewer workers are needed and less pressure is put on the resource base.  This results in less inflation.

·        Movement along the Phillips Curve represents year to year changes in the business cycle.

The original data collected in the 1940’s and 1950’s showed this general connection with the business cycle. This also held during the 1960’s in the US (see most texts).  

Why the Phillips Curve?  

Original SR Phillips Curve
Inflation and Unemployment =	There is an assumed inverse relationship
Inflation =	Increases as the economy expands
Recession =	Unemployment increases as the economy slow down, contracts
Along the Curve =	Cyclical changes in the GDP
Stagflation
Late 1970’s to 1981	Increasing inflation and unemployment during the same year
Data?	1974, 1980, 1981….
A New Phillips Approach
New Range?	The SRPC can move outward and inward as well as illustrate the business cycle
Cost Push Inflation	More stress on resources, wages, input costs
Supply Shocks	Rapid loss of resources or rapid increase in resource costs
SRPC Curve moves	Outward during these Shocks
SRPC moves back	Inward as the society increases productivity or regains resources
Long Run Phillips Curve
Inflation?	Society adjusts for cost/wage increases with new prices.  “Real” balances
LRPC is?	The efficient Production Possibilities Frontier
Natural Rate of Unemployment	Becomes the equivalent of the Full Employment Unemployment Rate
Phillips and AD/AS Curves
Change points on SRPC =	If AD changes, move points on the SRPC
Move the SRPC =	If SRAS changes, move the SRPC

The Problem of Stagflation

Phillips Curves under attack:

·        Starting in the mid-1970’s the economy started to suffer from increasing amounts of inflation and unemployment (see the Business Cycles Data chart).

·        The data points on the Phillips Curve no longer fit into any immediately recognizable pattern.

·        Did the model seem to present the relationship between inflation and unemployment too simplistically?

A New “Phillips” Approach

Stagflation, and its removal, explained:

·        If the fundamental efficiencies and demographics of an economy change, then the relationship between inflation and unemployment is still valid, just in a new range.

·        One key change is the type of inflation.  If inflation now becomes “cost push” inflation, the resource base has now changed.  The aggregate supply is reduced due to resources being used up or lost, disasters, boycotts, etc.  More costs and job losses occur.

·        The result of cost push inflation will be higher prices due to fewer and more expensive resources, plus more unemployment due to business production cuts.  This is also known as a supply shock.

·        The Short Run Phillips Curve still has a relationship between the two factors, but the curve moves outward.  Year to year business cycles still occur, just at higher levels than before.

·        When the economy is able to adjust with improved technologies, or the resource supply is re-established, the inflation pressures level off and businesses are able to lower costs and produce more.  The SRPC moves back inward (to the left). 

·        This approach appears to answer the late 1970’s changes.  As energy resources were cut and significant demographic changes like women moving into the workforce changed, the economy suffered from stagflation.  This was “cured” by the restoration of cheaper energy and new technologies in the 1980’s and 1990’s.

·        The logic of the Phillips Curve was intact, just in new ranges.

The Long Run Phillips Curve

Inflation has less importance in the Long Run.

·        Two new factors emerge in Long Run analysis.  The first is that the economy can adjust for inflation in the long run through wage and real-wage changes.  The second is based on Rational Expectations School theories that expected inflation rates are controllable and predictable by the market, therefore no longer a random factor. 

·        The Long Run Phillips Curve is therefore vertical at some natural rate of unemployment. This is now presumed to be around 4 to 5 % for the US and 6% for Canada.  This vertical LRPC is also known as the NAIRU line, or “non accelerating inflation rate of unemployment”. 

·        The analysis of the LRPC is now based on arguments of how a country can change the natural rate of unemployment.  Usually this is connected to long run productivity of the workforce and the willingness of a country to help those who are unemployed.   The theory is that financial assistance given to those who lose jobs will lengthen their “willingness” to wait, or settle, for new jobs.   This will increase the natural rate of unemployment (move it to greater levels of unemployment). 

The Phillips Curve and the AD/AS Model

Phillips Curves and AD/AS Graphs:  Mirror Images

·        When you move points along the SRPC you are showing changes in the year to year business cycle.  This is exactly what you are illustrating when you move the AD line on the AD/AS model.

·        When you move the entire SRPC outward to show supply shocks or cost push inflation problems, it is exactly the same at moving the SRAS curve inward. The AD/AS model will also show the simultaneous creation of greater inflation and more unemployment. This will also be true of movements in the opposite directions, like the SRPC moving back inward is the same as the SRAS curve moving outward to better levels of inflation and production.

Current Thinking About the Phillips Curve

Recent and growing critiques of the Phillips Curve use:

·        I quote a brief article from Dr. D. Hamermesh of the University of Texas at Austin, “By the mid-1980’s the Phillips Curve was no longer taught as offering a trade-off between inflation and unemployment and was hardly mentioned in economics courses anymore.”  “…Nobel Prize winners Milton Friedman and Edmund Phelps suggested that there was no good theoretical basis for the relationship…”  These words are typical of university critiques of the curve.

• Data from the 1990’s forward also seems to show that economies like the US can sustain long periods of growth, with falling inflation and low, steady levels of unemployment.

Crowding out Quiz

What is “Crowding Out”? Quiz

Bonds in Monetary Policy:

1.       If the economy is suffering from a recession, the __1___ will ____2______ bonds.  This will move money from the government to the public.

2.      On the Money Market Graph, show the change by moving the _____3_______ line.

3.      This will create a ________4_____________ interest rate, therefore helping ____5____.

4.      This will improve __6__ on the Aggregate Model Graph.

Bonds in Fiscal Policy:

5.       If the economy is suffering from a recession, _____7_____ will ____8_____ taxes or ____9_______ government spending, or do both.

6.      This policy will increase __10____ and ___11____ as parts of AD.

7.      However, it is assumed that this policy will affect the federal budget.  If the government income ___12_______ due to tax ___13____, and expenditures ____14_______, then a budget ____15_______ will occur.

8.      Government will now have to __16_____ bonds.

Money Market Graph:

9.       If Monetary Policy actions move the __17____ line, then Fiscal Policy actions will move the __18_____ line.

10.  When Congress causes this line to move, it will move _____19________.

11.  As a result, the interest rate will ____20_______.

Loanable Funds Graph (Private Savings Graph):

12.   Deficit spending will cause the ____21_______ line to move outward.

13.   Deficit spending will cause the _____22______ line to move inward.

14.  Either way, the interest rate will _____23_________.

Investment Demand Graph:

15.   Higher interest rates will cause the quantity of investment demand funds to ___24______.

16.  This will _____25_____ Ig, as a component of AD.

17.  If a Private Savings (Supply) line is shown on this graph, then deficit spending will move this line ____26________.

Aggregate Model Graph:

18.   The initial fiscal policy increases in _27____ and _28____ will cause AD to move ___29_____.

19.  However, the reduction of _30___ will cause AD to move ____31_____, but not all the way back to the original, recessionary position.

20.  Keynesians believe this because the ___32_____ is more important than the ____33______.

Semester Topics (1-17)

Topic 1:  Introductory Materials and Production Possibilities

·         For an economist, ­­­­­­­­­­__________ is scarce.

·         All decisions require an _____________ ______.

·         Most problems of predicting changes will require c_______   p________ assumptions.

·         The most common labels on the PPC are Y Axis = _________, X Axis = _________

·         Students must know the significance of points inside the Frontier, on the Frontier, and outside the Frontier.  They are equal to:  _______________, ___________, _________.

·         Students must understand that moving the Frontier requires more _______ __ _______.  Big Chart Graph:  Production Possibilities Curves/Frontiers (#1)

Topic 2:  Supply and Demand Basics and Currency Exchanges

·         When product prices are changed first, move points on the ______.      This is known as a __________ Change and this will create a surplus or a shortage.

·         When government steps in with artificial price floors and ceilings, they are trying to help suppliers with _________ and consumers with __________. 

·         Artificial floors always create greater ______________.

·         Artificial ceilings always create greater ______________.

·         When any other product factor changes first, move either the __ or __ _______.  This is known as a “Supply or Demand” Change.

·         This will create a new ___ and ___ for that market.

·         When the price of a good increases, a substitute’s demand will __________.

·         When the price of a good increases, a complement’s demand will _________.

·         Perfectly inelastic supply lines are __________________. (Elaticity)

·         For the rest of a macro course, skip discussions or lessons on elasticity.

·         Currencies are supply and demand products.

·         Demand for currencies will flow to the __________ economy.

·         If D changes for one currency, __ must change for the other currency.

·         The two currency graphs will move in ___ ________ direction.

·         One currency will always appreciate, the other will _________.

·         Appreciation of a currency hurts _________, depreciation helps make them cheaper.

·         Big Chart Graphs:  Dollar Graph, Other Currency Graph (#2, #3)

Topic 3: Goods and Government

·         Durable goods and non-durable goods are based on length of ________ _____.

·         Transfer payments are from government to _________.

·         Subsidies are payments from government to _________.

Topic 4:  GDP Accounting

·         The expenditure approach of __ + __ + __ + __ must be memorized.

·         The expenditure approach is equal to ____.

·         The expenditure approach is also equal to _______________.

·         __ is the most significant in the US, __ has no savings leak, __ is affected by interest rates (in an inverse way for the domestic market).

·         For GDP accounting, intermediate goods are ___ ________.

·         Unsold inventory is counted as __ at year’s end.

·         Used goods do ___ count in the year they re-sell.

·         Goods and  _________ both count as Consumption.

·         GDP to NDP accounts for Depreciation of Capital or Consumption of Fixed Capital (CFC).   This gives the _____ measure of growth.

·         Nominal minus Inflation = ____.

Topic 5:  Business Cycles

·         The up-sloping Secular Trend is a Classical Theory of gradual improvement of lifestyles over time.  It can be connected to_____ Law.

·         The minimum time span for a change in the cycle is ______________________.

·         The cycle is measured from ________ to _________.

·         _______ and _______ can only be recognized after they have occurred.

·         Expansions and Contractions/Recessions can be recognized as they occur.

·         The average cycle for the US has been about ________ (200 years of data).

·         Recessions have historically lasted about ___ months (20 century and beyond).

·         It will be assumed that Recession will have excess ______________.

·         It will be assumed that Expansions will have some excess _____________.

·         Big Chart Graph:  Business Cycles (#4)

Topic 6: Employment and Unemployment

·         Part time workers are ___________ as “employed”.

·         Discouraged workers are ____ ___________ as unemployed.

·         “Full Employment Unemployment” (FE) is the ________ ____ __ __________ for a country.

·         The differences between frictional and structural unemployment are important.

Topic 7:  CPI, GDP Deflators, Inflation

·         An Index Year is always made equal to _______.

·         Real change of values over time can always be calculated with the formula:  Later Year – Earlier Year/Earlier Year.  This = the Rate of Change.  The Rate x 100 = Inflation %. 

·         CPI measures monthly purchases by _______, the GDP deflator looks at the _____ ___________.

·         G spending changes are assumed to be more important that private C changes because C changes always have a __________ leak.

·         Demand Pull inflation is caused by excessive ____________________.  It can be manipulated by governmental policies.

·         Cost Push inflation is a _______ ___ _____________ and often can’t be corrected.

·         Stagflation is the presence of rising unemployment and rising inflation, and can be created by ___________ ______________.

Topic 8:  Spending Multipliers

·         Marginal Propensity to Consume or Marginal Propensity to Save are results of new money being given to citizens, or being taken away from citizens.

·         The MPC + MPS must always = ___.

·         The Spending Multiplier Formula is therefore a guess on how many times new income will be spent by a series of consumers.  The formula will be: 1/1-MPC or 1/MPS. 

·         Big Chart Graphs:  Consumption Function, Savings Function, Consumption and Savings Link (#5, #6, #7)

Topic 9:  Investment Demand

·         On the domestic market, interest rates (i) are a ____ of borrowing and have an inverse effect on the willingness to create Ig.

·         Big Chart Graph:  Investment Demand Graph (#8)

Topic 10:  Aggregate Analysis (AD and SRAS) (AD/AS)

·         Any change that can be connected to C + Ig + G + Xn will be a change in ____ first.  Students often miss the Ig part.

·         Any change that can be connected to input costs, resource availability, wage rates, or worker productivity will change the ________________

·         The LRAS is approximately equal to the PPF and Full Employment GDP.

·         Changes in basic factors of production can move the _____________.

·         Big Chart Graphs:  AD/AS (3 Versions while using McConnell 15^th) (#9, #10, #11)

Topic 11:  Schools of Economics

·         Classical economists believe that competition is ______ and the invisible hand will create better goods, cheaper goods, and more competition.

·         Classical economists believe in ________ prices and wages, long run balance near Full Employment GDP (Say’s Law).

·         Classical economists want government to promote competition, stop monopolies and cheating, stop actions that limit _____________ prices and wages.

·         Neo-classical economists like the idea of tax______ for trickle down growth.

·         Neo-classical economists also like the idea of tax ______ to starve government’s ability to interfere with competition.

·         Keynesians believe that competition is ________ and must be corrected in the Short Run. 

·         Keynesians believe that Fiscal Policies will focus on ______ and _________.

·         Keynesians believe that wages are sticky and prices are stuck by the ________ effect.

·         Monetary policy advocates don’t think Keynesians can _______ policy correctly.

·         Monetary policy advocates don’t think Keynesians can fight ___________.

·         Monetary policy advocates support fine tuning with ____________ rates.

Topic 12:  Countercyclical Policies:  Fiscal and Monetary

·         Always connect ______ Policies to Keynes and ______________.

·         Congress can change taxes and government spending and target ___ and ___ of AD.  Use the terms “expansionary and contractionary” policies

·         When in a recession, assume that tax _____ and spending __________will create ________ and that crowding out can occur.

·         Always connect Fiscal Policies to automatic stabilizers like Social Security and Unemployment Compensation.

·         Always connect Monetary Policies to the ______________________________

·         The Fed can control Bonds, target the Fed Fund Rate, change the Discount Rate, and change the Reserve Requirement.

·         When the Fed buys bonds it is “______ Money” policy (expansionary).  Remember BB = BB (Buy Bonds = Big Bucks).

·         When the Fed sells bonds it is “______ Money” policy (contractionary).

Remember SB = SB (Sell Bonds = Small Bucks).

·         The OMC (FOMC) is always connected to the bond markets.

·         Bond “prices” and interest rates are____________ in values.

·         All Fed policies target the Money Supply, interest rates, Ig, ______.

·         Big Chart Graphs:  Money Market, Loanable Funds/Private Savings Market, Versions of Crowding Out (#12, #13, #14).

Topic 13:  Banks Creating Money

·         The Money Multiplier formula is _____________________.

·         Demand Deposits (DD) are a bank __________ and must equal bank assets

·         Required Reserves (RR) are a bank ________ and are set by the rr.

·         Excess Reserves (ER) are the monies banks can lend from each DD.

·         RR and ER must _______ DD.

·         ER x the Loan Multiplier will equal to new loans for the economy which are assumed to be new ___________  ____________.

·         If someone is using cash to create a new DD, then the ER x Loan Multiplier will equal New Money Supply.

·         If the Fed is buying bonds that become DDs, then the ER x Loan Multiplier plus the original bond amount will equal New Money Supply.

Topic 14:  Phillips Curves

·         The relationship between inflation and unemployment is assumed to be _________.

·         Combining the inflation % and the unemployment % is known as the ________ Index.

·         The changes in the business cycle due to changes in AD will move points _____ the Short Run Phillips Curve (SRPC).

·         Changes in SRAS will move the _______ SRPC.  The two curves will move in ________ directions.

·         When the SRPC moves outward, it will usually be connected to __________.

·         The Long Run Phillips Curve (LRPC) is equated to the _________ _______ __ ______________ for a country. 

·         It is assumed by Classical Economists that the NRU is greater for countries that give the unemployed more help, or time to find a new job.

·         Big Chart Graphs:  Phillips Curve, Phillips-AD/AS Connection (#15, 16)

Topic 15:  Monetarism (Not the Same as Monetary Policy by the Fed!)

·         The Equation of Exchange is ____ = ____.

·         Monetarists assume that velocity is ___________.

·         The general assumption of this thinking is that most inflation can be controlled by limiting the growth of the ___________ ______________.

Topic 16:  International Comparative Advantages

·         If two countries have similar resources, the country that can produce the most has the _______________ Advantage.

·         The country with the lowest opportunity cost has ______________ Advantage.

·         Countries will trade to gain beyond their own domestic opportunity cost.

·         Both countries must gain for trade to occur, but both will _______ if they trade their own comparative advantage products.

Topic 17:  International Balance of Payments Accounting

·         BOP Assets (Credits) are ____________ for a country’s money and are “inflows”.

·         BOP Liabilities (Debits) are _____________ of a country’s money and are “outflows”.

·         ______________ Accounts are the transfer of money/wealth that is immediate.

·         ________________ Accounts are the transfer of money/wealth that occur between countries, but hope to create future revenue.

·         Reserves are used by countries if Current Accounts do not __________ Capital/Financial Accounts.