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Economic System
A set of institutional arrangements to determine how to distribute scarce resources to satisfy peoples wants.
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4 Characteristics of the Market system
- Extensive Private Property rights
- Freedom of enterprise and choice
- Self interest as the primary motivating force
- competition
- existence of market and prices
- Active, but limited government
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Economic Growth
An increase in RGDP per Capita
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Natural Rate Hypothesis
The claim that unemployment eventually returns to its normal, or natural, rate, regardless of the rate of inflation
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What is the central bank of USA called
Federal Reserve Bank
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Fractional Reserve Banking
Banking system in which banks are required to keep a percentage (fraction) of checkable deposits in cash or with the central bank.
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What is Crowding out and how is it caused by expansionary fiscal policy?
the decrease in investment that results from decrease in public savings/ expansionary fiscal policy. With expansionary fiscal policy, the public savings decreases, therefor the supply of loanable funds decreases. This results in a higher interest rate and lower demand for loans in the new equilibrium in the loanable funds market.
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Three tools of monetary Policy
Reserve Ratio (RR): Regulations on the minimum amount of reserves that banks must hold against deposits; Open-Market Operations: The purchase and sale of US government bonds by the Fed Discount Rate: The interest rate on the loans that the Fed makes to the banks
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Four components of Aggregate Supply
Consumption, Investment, Government purchases, Net Export
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4 different groups that have a theory for fluctuations in the economy
- -New Keynesians: unexpected shocks to either aggregate demand or supply interacting with sticky prices
- -Monetarists: Inappropriate Gov Policy
- -Real Business Cycle: Shocks to Real factors
- -Coordination Failure: People lack ta way to coordinate their actions, and therefor we have events that result from people's expectations, rather than anything fundamental to the economy.
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Balanced government budget: Good or bad?
- -Pro: Places a burden on future taxpayer, Lower national savings
- -Con: Tax burden is not large compared to a person's lifetime income, budget deficit has to be seen in the picture.
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Fixed Exchange rate
Gov determine exchange rates and make necessary adjustments in their economies to maintain those rates
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Flexible Exchange Rate
Demand and supple determine exchange rates and no gov. intervention occurs
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3 disadvantages of a flexible exchange rate system
Uncertainty and diminished trade; terms of trade changes; instability
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Most common exchange rate system?
Managed exchange rate float
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4 ways the government can control the exchange rate
- 1: trade policies
- 2: Exchange Rate controls and rationing
- 3: Domestic Macroeconomic Adjustment
- 4: Currency Intervention
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Scarcity
The observation that people have unlimited wants but limited resources
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Frictional unemployment
type of unemployment caused by workers taking their time searching for a job that matches their skill tastes
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The Wealth effect
If the money supply is fixed, increases in the price level tend to decrease the real value of financial assets, which lowers consumer spending.
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Aggregate Demand Shifters
- 1: Change in consumer Wealth
- 2: household borrowing
- 3: Taxes
- 4: interest rates
- 5: expected returns
- 6: government spending
- 7: income or wealth in foreign countries
- 8: exchange rates
- 9: tarrifs
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List the two roles of a Government in a market economy
Regulator and equalizer
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Assumptions economists make about consumers
People are rational, people have unlimited wants, people have limited income.
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GDP
Gross Domestic Product- The market value of final goods and services produced within the borders of a given country within a given period of time.
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Reasons economists use RGDP per capita to study cross county welfare
- - Strong correlation between GDP and other quality of life factors
- - GDP data is available for many countries
- - Countries have a good incentive to collect accurate GDP data (tax purposes)
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3 assumptions economists make about firms?
- -Firms act to maximize profits
- -Firms produce goods with a technology that requires resources
- -Resources are limited
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Business Cycles?
What is meant by an expansion in the context of business cycles?
- The recurring increases and decreases in the level of economic activity over periods of years.
- An expansion is the phase in a business cycle in which the RGDP, income and employment increase.
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expansionary Monetary policy
Monetary policy that increases money supply, lowers interest rates and increases aggregate demand.
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Discount Rates
The rate that the federal reserve bank charges on the loans it makes to commercial banks and thrift institutions
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Consumer Price index
A measure of the overall cost of the goods and services used by a typical consumer
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Automatic stabilizer
Changes in fiscal policy that stimulate AD when the economy goes into a recession (or slows AD when economy goes into a boom) without policy makers having to take any deliberate action.
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Economic investment
Payments for new additions to the nations capital stock, whether public (new roads and bridges) or private (new factories, homes, and equipment)
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What is money?
- Medium of exchange: an item that buyers give sellers when they want o purchase goods and services.
- Unit of Account: The measure people use to post prices and record debts.
- Store of Value: An item that people can use to transfer purchasing power from present to the future.
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functions performed by the federal goverment
- lending money to banks
- set the reserve ratio
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Fisher Effect
The one-for-one adjustment of the nominal interest rate to the inflation rate.
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Costs of inflation
shoeleather costs, menu costs, relative price-variability and the misallocation of resources, confusion and inconvenience, inflation-induced tax distortions, unexpected inflation causes redistributions of wealth
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cons of commodity money
- limited amount of money that can be printed
- resources could be put to better use
- value of resources need not be stable
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A Bond is?
A loan from the saver to the borrower
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fiscal policy
Changes in government purchases and/or tax collections designed to achieve full-employment and noninflationary domestic output.
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Official name for the paper currency used in the USA?
Is it a commodity of fiat currency?
- Federal Reserve notes
- It is an example of fiat currency, because it is not backed up by the value of an underlying asset.
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What differentiates short run and long run aggregate supply?
- Short run input or output prices are sticky-
- They do not immediate respond to changes in economic conditions. In the long run all prices are fully flexible and accurate reflect the value of inputs and outputs.
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Financial investment
Buying or building an asset in expectation of earning financial gain (new factories and homes, but also old buildings, plus stocks, bonds, and other financial assets)
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Monetary Neutrality
The proposition that changes in the money supply do not affect real variables
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Market Basket
The goods a typical consumer buys
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Why might CPI do a bad job of measuring "cost of living"
- Substitution bias
- quality change
- intro of new goods
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Small Country assumtions
- -Country is small enough so that whatever amount they demand can be supplied
- -Country's demand does not affect prices
- -Supply first comes from domestic firms and the remainder is met by foreign firms
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Tariff:
Revenue Tariff:
Protective Tariff:
A tax imposed by a nation on an imported good.
designed to produce income for the federal government
designed to shield domestic producers from the competition with foreign producers.
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Import Quota
A limit imposed by a nation on the quantity of good that may be imported during some period of time.
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Nominal Exchange Rate
The rate at which the currency of onenation can be exchanged for the currency of another nation.
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Depreciation
A decrease in the value of a currency as measured bythe amount of foreign currency it can buy.
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Appreciation
An increase in the value of a currency as measured by the amount of foreign currency it can buy.
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Real Exchange Rate
The rate at which a person can trade the goods and services of one country for the goods and services of another country.
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Purchasing Power Parity
A theory of nominal exchange rates whereby a unit of any given currency should be able to buy the same quantity of the same goods in all countries.
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Two forms of capital outflow
- 1 Foreign direct investment: e.g. McDonald's opens up a fast-food restaurant in Russia. They actively manage the investment.
- 2 Foreign portfolio investment: e.g. an American buys stock in a Russian corporation. The American owner has a more passive role.
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Net Capital Outflows (NCO)
Purchase of foreign assets by domestic residents - purchase of domestic assets by foreigners.
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