Basic Economic Concepts

Question 1

Monetary Policy

Answer 1

The financial policy of managing the money supply to achieve specific goals (reducing inflation, or achieving full employment). Bank of Canada is responsible for monetary policy

Question 2

Tools to carry out monetary policy

Answer 2

1) Raise/lower interest rates
2) Raise/lower reserve rates
3) Buy/sell government bonds and T-Bills.

Question 3

Expansionary Monetary Policy

Answer 3

Increase money supply and stimulate the economy.
(Lower interest rate, lower reserve rate or buying government bonds and T-Bills).

**Increase money supply results in lower interest rates and increase business investing leading to increase in GDP

Question 4

Restrictive Monetary Policy

Answer 4

Decrease money supply and slow down the economy.
(Raise interest rate, raise reserve rate or sell government bonds and T-Bills)

**Decrease money supply results in higher interest rates and decrease business investing leading to decrease in GDP

Question 5

Business Cycle

Answer 5

Periodic swings in an economy’s pace of demand and production activity

Question 6

Economic Expansion

Answer 6

Period in which GDP is rising steadily.

Question 7

Economic Recession

Answer 7

Period in which GDP is falling steadily.

Question 8

Economic Recovery

Answer 8

The early stage of an expansion, following a recession

Question 9

Recession

Answer 9

A significant decline in activity spread across the economy, lasting more than a few months.

Begins after an economy has reached its peak.

Ends as the economy reaches its trough

Question 10

Expansion

Answer 10

When the economy is in between a trough and a peak

Question 11

Leading Indicators

Answer 11

Change prior to changes in economic activity

Used to judge what is going to happen in the near future

Ex. Housing starts, changes in profits, stock prices etc.

Question 12

Coincident Indicators

Answer 12

Change at the same time as changes in economic activity

A broad-based measurement of current economic conditions

Ex. GDP, personal income, retails sales etc.

Question 13

Lagging Indicators

Answer 13

Follow economic changes

Used as an after-the-fact way to help confirm economists’ assessment of current economic conditions

Ex. Business investment, unemployment rate, inflation etc.

Question 14

Deflation

Answer 14

Tendency, over an extended period of time, for prices and incomes to decline, creating pessimism, and the economy could fall into a recession

Question 15

Inflation

Answer 15

A rise over time in the average price of goods and services (cost of living)

Affects purchasing power

Question 16

Consumer Price Index (CPI)

Answer 16

Measure of inflation

Reflects changes in the price of a representative “basket” of goods and services sold in Canada (food, housing, transportation, other)

When CPI rises, the purchasing power of the average consumer’s dollar falls

CPP and OAS use CPI to calculate changes in government payments

Question 17

High Inflation

Answer 17

Prices increase as the demand for goods and services exceed the normal capacity of producers to supply goods and services.

Excess supply of goods and services puts downward pressure on prices.

Creates uncertainty for consumers and investors.

It erodes the value of incomes and savings

Question 18

Cost of High Inflation

Answer 18

1) Erodes the value of money. Future prices are less predictable.

2) Encourages speculative investing that take advantage inflation rather than production.

3) Businesses and investors respond to signs of inflation by pushing up prices, wages and interest rates to protect themselves

4) Individuals on fixed incomes may fall into hardship as their incomes won’t keep up with rising level of prices.

Question 19

Benefits of Low Inflation

Answer 19

1) Consumers and businesses can make longer-plan since they know that their money is not losing its purchasing power

2) Encourages investment to improve productivity and businesses can prosper without raising prices.

3) Self-reinforcing since businesses and individuals do not react so quickly to short-term price pressures by seeking to raise prices and wages

Question 20

Interest Rate

Answer 20

The percentage fee received or paid by individuals are organizations when they lend or borrow money.

Overnight target rate is set by Bank Of Canada. A change in this rate will lead to changes in other interest rates.

Question 21

Yield Curve

Answer 21

A graph that plots the yields of similar quality bonds against maturities.

Shows the various yields that are currently being offered on bonds of different maturities

Question 22

Normal Yield Curve

Answer 22

Short term yields are lower than long term yields (sloping upwards)

Question 23

Inverted Yield Curve

Answer 23

Short term yields are higher than long term yields (sloping downwards)