unit 15

Question 1

when unemployment is low what happens to inflation

Answer 1

inflation tends to increase

Question 2

inflation targeting

Answer 2

Monetary policy regime where the central bank changes interest rates to influence aggregate demand in order to keep the economy close to an inflation target, which is normally specified by the government.

Question 3

disinflation

Answer 3

A decrease in the rate of inflation

Question 4

0 inflation

Answer 4

constant price level from year to year

Question 5

who benefits from inflation?

Answer 5

borrowers with nominal debt will benefit:because the debt stays the same in nominal terms, and so becomes smaller in real terms.

Question 6

nominal interest rate

Answer 6

The interest rate uncorrected for inflation. It is the interest rate quoted by high-street banks.

Question 7

who loses from inflation

Answer 7

pensioners who receive fixed income in nominal terms so an increase in price level means they can buy fewer goods and services than previously
lenders with nominal assets as the sum repaid will be worth less in terms of goods and services it can buy

Question 8

real interest rate

Answer 8

The interest rate corrected for inflation (that is, the nominal interest rate minus the rate of inflation). It represents how many goods in the future one gets for the goods not consumed now

Question 9

fisher equation

Answer 9

The relation that gives the real interest rate as the difference between the nominal interest rate and expected inflation: real interest rate = nominal interest rate – expected inflation.

Question 10

menu costs

Answer 10

the resources used in setting and changing prices.

Question 11

protectionist policy

Answer 11

Measures taken by a government to limit trade; in particular, to reduce the amount of imports in the economy. These are designed to protect local industries from external competition. They can take different forms, such as taxes on imported goods or import quotas.

Question 12

what happens to inflation if gov implements protectionist policies?

Answer 12

this limits international trade so firms in home economy face less competition so they can charge a higher markup on its costs which will increase the price level in the economy if all firms do so. this means real wages have fallen so workers are less motivated to work thus HR increase nominal wage. this increase in nominal wages increases firms costs of production so they increase their markup which increases prices and wages as a result. so we have inflation. this keeps happening as long as firms are powerful enough to charge a higher markup and workers at given U rate have enough bargaining power to require the initial real wage to motivate them to work

Question 13

what happens to inflation if employment increases

Answer 13

competition stays the same an employment level rises so at new lower level of U firms want to pay workers a higher real wage to keep them working. the marketing department thus increases prices to maintain the markup that competitive conditions allow and so price level has risen and inflationary process begins

Question 14

wage inflation

Answer 14

increase in nominal wage measured usually over a year

Question 15

phillips curve

Answer 15

inverse relationship between the rate of inflation and rate of unemployment so as unemployment decreases, inflation increases

Question 16

wage price spiral

Answer 16

this occurs if an initial increase in wages in the economy is followed by an increase in the price level, which is followed by an increase in wages and so on. It can also begin with an initial increase in the price level.

Question 17

bargaining gap

Answer 17

The difference between the real wage that firms wish to offer in order to provide workers with incentives to work, and the real wage that allows firms the markup that maximizes profits given the degree of competition.
So it is the difference between the wage given by the w.s curve and that given by the price-setting curve.

Question 18

When the bargaining gap is positive

Answer 18

the real wage on the wage-setting curve is above the price-setting curve, and the claims of employers and owners to output per worker are inconsistent.

Question 19

The percentage bargaining gap is equal to

Answer 19

The percentage bargaining gap is equal to the wage on the wage-setting curve, minus the wage on the price-setting curve, divided by the wage on the price-setting curve.

Question 20

At a higher level of aggregate demand (a boom)

Answer 20

inflation is positive: Unemployment is lower, which means there is a positive bargaining gap, so wages and prices are rising continuously.

Question 21

At a lower level of aggregate demand (a recession)

Answer 21

there is deflation: Unemployment is higher, which means there is a negative bargaining gap

Question 22

why is the policy makers indifference curves the shape they are?

Answer 22

because we assume that there are diminishing marginal returns to the 2 targets of high employment and low inflation which implies when the outcome is further from the inflation target but closer to full employment, the indifference curve is flatter because the policy maker places more value on getting closer to the inflation target. when the outcome is further from full employment and closer to the inflation target, the IC is steeper because the policy maker puts more value on getting close to full employment

Question 23

when is the phillips curve not a feasible set and why?

Answer 23

when the trade-off between inflation and unemployment is not stable because when a government tries to keep unemployment too low, the result is that there will be higher inflation and also rising inflation and so the phillips curve would keep shifting up.

Question 24

when is there only one U rate at which the inflation rate is stable?

Answer 24

at the labour market nash equilibrium

Question 25

what is the fundamental reason for rising prices?

Answer 25

the battle for the pie between workers and the owners of firms

Question 26

expected inflation

Answer 26

The opinion that wage- and price-setters form about the level of inflation in the next period.

Question 27

when inflation is not zero what how can expected inflation effect inflation?

Answer 27

last period’s inflation = expected inflation so then expected inflation + BG increases wages by this amount so that workers receive an expected real wage rise which increases unit costs so firms increase prices which is inflation

Question 28

when does the phillips curve shift up?

Answer 28

when expected inflation increases

Question 29

inflation-stabilizing rate

Answer 29

the unemployment rate (at labour market equilibrium) at which inflation is constant. Originally known as the ‘natural rate’ of unemployment

Question 30

why does inflation rise in every period

Answer 30

because the previous period’s inflation feeds into expected inflation and therefore into wage and price inflation

Question 31

for how long does the phillips curve shift up for

Answer 31

as long as there is a positive bargaining gap, caused by the low unemployment rate.

Question 32

effect of a supply shock such as an increase in oil prices

Answer 32

initially the economy is at the labour market eqauilibrium. An increase in oil prices increases a firm’s costs of production and so the firm increases prices to protect their profit margins. if all firms do this, this will lower the real wage and so the price-setting curve shifts down. If AD is maintained to keep the economy at equilibrium there is a positive bargaining gap which will increase inflation year on year as wages will rise by expected inflation + bargaining gap so workers still work thus unit costs increase and prices rise again and so the rise in oil prices triggers a wage-price spiral. by bidding for higher nominal wages the result will be there is a new labour market equilibrium with higher unemployment where post-shock price-setting curve intersects the wage-setting curve. The phillips curve has shifted up year by year.

Question 33

markup

Answer 33

the share of the price that represents profits to the firm

Question 34

output per worker including imports=

Answer 34

wage+ profit per worker+imported materials costs per worker

Question 35

firms costs include

Answer 35

wages and cost of purchasing imported materials

Question 36

markup =

Answer 36

P-umc-ulc/P

Question 37

zero lower bound

Answer 37

this refers to the fact that the nominal interest rate cannot be negative, thus setting a floor on the nominal interest rate that can be set by the central bank at zero.

Question 38

quantitative easing

Answer 38

Central bank purchases of financial assets aimed at reducing interest rates on those assets when conventional monetary policy is ineffective because the policy interest rate is at the zero lower bound. thus by reducing interest rates on other financial assets This boosts spending: Particularly on housing and consumer durables, because both the cost of borrowing and return to holding financial assets has gone down.

Question 39

common currency area

Answer 39

A group of countries that use the same currency. This means there is just one monetary policy for the group. e.g. the Eurozone - members use the euro

Question 40

what does the interest rate tell you being the borrower and the lender?

Answer 40

how many dollars (or euros, pounds, or the currency you use) you will have to pay in the future in exchange for borrowing $1 today. If you are a lender, it tells you how many dollars you will receive in the future by giving up the use of $1 today.

Question 41

how does a higher inflation rate affect the real interest rate?

Answer 41

since real interest rate=nominal i - inflation rate then for a given nominal i, a higher inflation rate will decrease the real i and so reduce the real cost of borrowing

Question 42

exchange rate

Answer 42

The number of units of home currency that can be exchanged for one unit of foreign currency.

Question 43

what happens to a country’s currency when the central bank lowers its interest rate?

Answer 43

international investors who buy bonds and financial assets in this country want to earn a higher return so when i falls, the demand for these assets declines. in turn this decreases the demand for the currency to buy these bonds and hence this leads to a depreciation of the currency

Question 44

depreciation

Answer 44

fall in value of exchange rate. so the home country has to spend more of its currency in order to buy the same quantity of foreign currency as before.

Question 45

what does a depreciation do to exports

Answer 45

it makes them cheaper and thus more competitive

Question 46

foreign exchange markets

Answer 46

market in which currencies are traded against each other

Question 47

effect of a negative demand shock

Answer 47

decreases real GDP, fall in inflation and increase in U