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A Swiss watchmaker opens a factory in the US. This in an example of Swiss
foreign direct investment
If Germany purchased more abroad than it sold abroad last year, then it had
negative net exports which is a trade deficit
An open economy’s GDP is always given by
Y = C + I + G + NX
If a country changes its corporate tax laws so that foreign businesses build and manage more business in that country, then that net capital outflow of that country
falls and the net capital outflow of other countries rise
Which of the following is always correct?
NCO = NX
If the exchange rate is 125 yen = $1, a bottle of rice wine that costs 2500 yen costs
If the exchange rate changes from 135 Kazakhstan tenge per dollar to 150 per dollar, the dollar has
appreciated. Other things the same, it now takes fewer dollars to buys Kazakhstani goods
If purchasing power parity holds, the price level in the US is 120, and the price level in Canada is 140, which of the following is true?
the nominal exchange rate is 140/120
Nominal exchange rate is about 2 Aruban florin per dollar. If a basket of goods in the US costs $40, how many florins must a basket of goods in Aruba cost for purchasing power parity to hold?
Which of the following does purchasing power parity imply?
The purchasing power of the dollar is the same in the US as in foreign countries
Which part of real GDP fluctuate most over the course of the business cycle?
Which of the following explains why productions rises in most years
Aggregate demand shifts left when the government
cuts military expenditures (when G goes down)
The aggregate quantity of goods and services demanded changes as the price level falls because
real wealth rises, interest rates fall, and the dollar depreciates
Which of the following is not a determinant of the long-run level of GDP?
the price level
The long run aggregate supply curve shifts right if
All of the above
The variables on the vertical and horizontal axes of the AD and AS graph are
the price level (P) and real output (Y)
AS curve is upward sloping in
the short run, not the long run
refer to graph 33-1) If the economy starts at C, an increase in the money supply moves the economy
to A in the long run (up the vertical line)
(grap 33-1) If the economy is at A and there is a fall in AD curve, in the short run the economy
moves to D
According to liquidity preference theory, the money-supply curve would shift rightward
if the Federal Reserve chose to increase money supply
When the interest rate increases, the opportunity cost of holding money
increases, so the quantity of money demanded decreases
Which of the following events would shift the money demand to the right?
an increase in the price level, but not an increase in the interest rate
(figure 34-4) A shift of the money demand curve from MD2 to MD1 (shift down) is consistent with which of the following events?
The government reduces government spending, resulting in a decrease in people’s incomes
Assume MPC is .75. The multiplier is
If Congress cuts spending to balance the federal budget, the Fed can act to prevent unemployment and recession by
buying bonds to increase the money supply
What actions could be taken to stabilize output in response to a large decrease in US net exports?
increase government expenditure or increase money supply
Fiscal policy refers to the idea that AD is affected by changes in
government spending and taxes
The government buys new weapons systems. The manufacturers of weapons pay their employees. The employees spend this money on goods and services, the firm from which the employees ut the g and s pay their empliyees. this sequence of events illustrates
the multiplier effect
a decrease in government spending initialy and primarily shifts
AD to the left
According to the Phillips Curve, unemployment and inflation are inversely related in
the short run, but not the long run
Which of the following is correct concerning the long run Phillips curve
Its position depends on the natural rate of unemployment
(figure 35-4). If the economy starts at C and the money supply growth rate increases, then in the short run the economy moves to
An adverse supply sock causes inflation to
rise and the short run Phillips curve to shift right
Variables that Influence Net Exports
- preferences for foreign and domestic goods
- of goods at home and abroad
- of consumers at home and abroad
- exchange rates at which foreign currency trades for domestic currency
an excess of imports over exports
an excess of exports over imports
Net capital outflow (NCO):
- residents’ purchases of foreign assets
- foreigners’ purchases of domestic assets
NCO is also called net foreign investment
Foreign direct investment
- residents actively manage the foreign investment, e.g.,
- McDonalds opens a fast-food outlet in Moscow.
Foreign portfolio investment
- residents purchase foreign stocks or bonds, supplying “loanable funds” to a
- foreign firm.
- NCO = NX
- Y = C + I + G + NX accounting identity
- Y – C – G = I + NX rearranging
S = I + NX since S = Y – C – G
S = I + NCO
Real exchange rate
- (e x P)/P*
- P = domestic
- P* = foreign
- price (in foreign currency)
- e = nominal exchange rate, i.e.,
- currency per unit of domestic currency
- theory of exchange rates whereby a unit of
- any currency should be able to buy the same quantity of goods in all countries
of the following statements about a country with a trade deficit is not true?
A. Exports < imports
B. Net capital outflow < 0
C. Investment < saving
D. Y < C + I + G
- separation of variables into two groups:
- – quantities, relative prices
- – measured in terms of money
increase in P reduces the quantity of g&s
event that changes C, I, G, or NX—except
a change in P—will shift the AD
- A stock market boom makes households feel wealthier, C rises,
- the AD
- curve shifts right.
Why the AD Curve Might Shift
- re: consumption/saving tradeoff
- buy new computers, equipment, factories
- rates, monetary policy
- Tax Credit or other tax incentives
- in G
- spending, e.g.,
- & local spending, e.g.,
- roads, schools
- in countries that buy our exports
- resulting from international speculation in foreign exchange market
Why the LRAS
Curve Might Shift
- in L or natural rate of unemployment
- policies reduce natural u-rate
- in factories, equipment
- people get college degrees
- destroyed by a hurricane
- in natural resources
- of new mineral deposits
- in supply of imported oil
- weather patterns that affect agricultural production
- improvements from technological progress
Event: Stock market crash
- 2. C
- falls, so AD
- shifts left
- 3. SR eq’m at
- P and Y lower,
- 4. Over time, PE falls,
- shifts right,
- until LR eq’m at
- and unemp back
at initial levels.
Event: Oil prices rise
- 1. Increases costs,
- shifts SRAS
- LRAS constant)
- 3. SR eq’m at
- point B.
- P higher, Y
- From A to B, stagflation,
- a period of
- falling output
- and rising prices.
The variables that influence money demand
Y, r, and P
A. Suppose r rises, but Y and P are
unchanged. What happens to money demand?
B. Suppose P rises, but Y and r are
unchanged. What happens to money demand?
curve is vertical: Changes in r do not affect MS,
which is fixed by the Fed.
A fall in r increases money demand.
How the Interest-Rate Effect Works
- A fall in P reduces money demand, which lowers r.
- A fall in r increases I and
- the quantity of g&s demanded
federal funds rate
- which banks charge each other on
- short-term loans
change the interest rate and
shift the AD
the Fed conducts open market operations
to change MS.
The Effects of Reducing the Money Supply
- Fed can raise r by reducing the money supplyAn
- increase in r reduces the quantity of g&s
- policy stimulates aggregate demand by reducing the interest rate.
- §Liquidity trap:
- when the interest rate is zero
- §In a
- liquidity trap, mon. policy may not work, since nominal
- interest rates cannot be reduced further.
- central bank can make real interest rates negative by raising inflation
§Expansionary fiscal policy
increase in G and/or decrease in T
§Contractionary fiscal policy
- decrease in G and/or increase in T
the additional shifts in AD
- that result when fiscal policy increases income and thereby increases consumer
The Crowding-Out Effect
- policy has another effect on AD
that works in the opposite direction.
- fiscal expansion raises r,
which reduces investment,
which reduces the net increase in agg demand
Changes in Taxes
- §A tax
- cut increases households’ take-home pay.
- respond by spending a portion of this extra income, shifting AD to
- the right.
- size of the shift is affected by the multiplier and crowding-out effects.
- factor: whether households perceive the
- tax cut to be temporary or permanent.
- permanent tax cut causes a bigger increase in C—and
- a bigger shift in the AD
- curve—than a temporary tax cut.
- claim that unemployment eventually returns to its normal or “natural” rate,
- regardless of the inflation rate
natural rate of unemp-(a(actual inflation -expected inflation))
How an Adverse Supply Shock Shifts the PC
- SRAS shifts left, prices rise, output &
- employment fall.Inflation
- & u-rate both increase as the PC shifts upward.
- reduction in the inflation rate
- reduce inflation,
- Fed must slow the rate of money growth,
- which reduces agg demand.
- Output falls and unemployment rises.
- Output & unemployment return to their natural rates.