Adjustment Mechanisms Flashcards
(32 cards)
The auto adj mechanism (versus the classical adj mechanism) assumes which of the following (select all that apply): (a) prices are not constant (b) national income remains constant (c) relies on induced changes in level of nat’l income (d) deficits/surpluses arise in the current account of the BoP (e) adj brought on by auto price changes (f) adj brought on by auto income changes.
Only (c) and (f).
(c) because the auto adj mechanism does in fact rely on induced changes in the level of nat’l income; (f) because the auto adj mechanism does in fact rely on auto income changes to improve Bop
Not (a) because auto adj does assume constant prices (i.e. auto adj assumes constant prices); not (b) because constant nat’l income is the classical assumption [versus auto]; not (d) because only the classical model assumes deficits/surpluses arise in the current account exclusively; not (e) because auto price changes were the adj mechanism of the classical model
In a closed economy without a gov’t sector, the equilibrium level of nat’l income and production is equal to what?
Y = C(Y) + I
Where I is planned investment and C(Y) is equal to desired consumption expenditures; C(Y) is a function of the level of nat’l income
The multiplier is (a) 1/(1+MPC) (b) 1/(1+MPS) (b) 1/(1-MPC) or (c) 1/(1-MPS)?
(c) 1/(1-MPS)
An E(r) depreciation (a) redistributes income to the general public (b) shifts income to wage earners (c) shifts income to profit earners (d) causes the overall MPS to increase (e) shifts income to wage earners more than profit earners (f) reduces absorption (g) increases absorption? (Select all that apply).
Only (c) (d) and (f) An E(r) depreciation redistributes income to profit-earners, who save more than consume (i.e. Profit-Earner MPS > Wage-Earner MPS). This reduces absorption.
If the income/price level places the public in a higher tax bracket this reduces or increases domestic absorption?
Reduces domestic absorption
Under the absorption approach, an E(r) depreciation will result in: (a) greater exports (b) greater imports (c) more domestic expansion (d) an increase in income (e) all of the above (d) none of the above
(e) all of the above. If the E(r) depreciates, exports will appear cheaper and the nation will export more. Increased exports means increased domestic production and the level of national income will increase. If income goes up, imports also tend go up since people can afford more imports.
Domestic absorption is equal to what?
Y = C + I + (m-x)
C + I is domestic absorption
(m-x) is the trade balance
So domestic absorption is consumption plus investment.
Does desired/planned investment I change with the level of nat’l income?
No
Do consumption expenditures C(Y) change with the level of nat’l income?
Yes
The MPC is the change (delta) in ____ associated with the change in ____.
Consumption, income
As income (Y) rises, consumption rises (a) by the same amount (b) by more than the rise in income (c) by less than the rise in income (c) by the multiplier (d) only b and c
(c) as income rises, consumption rises by less than the rise in income. This ratio is the MPC (C/Y). This is because as Y rises, consumption rises BUT SO DOES SAVING. And the rise in saving is equal to the investment constant. So if Y rises by 600, C(Y) rises by 450. Where is the missing 150? -> That represents adt’l increase in savings (which also happens to equal the investment constant). Leakages must equal injections. Here: Leakages are 150 [savings], Injections are 450 [consumption] + 150 [investment]. We have equilibrium.
If investment is constant at 1.5, income (Y) rises by 6 and consumption rises by 4.5, then there is (a) net leakage (b) less saving (c) unplanned reduction of inventories (d) desired expenditures fall short production (e) only a and d.
(e) a net leakage and desired expenditures falling short of output. Since consumption is less than income/Y/output, firms have unplanned ACCUMULATION of inventories. This unplanned accumulation leads to cutting production. This cut in production restores equilibrium back to where Y=C(Y)+I. In other words, if Y rises by 6 and consumption only rises by 4.5, there is 1.5 unaccounted for. This unaccounted sum represents SAVINGS (remember that as Y rises, savings also rises). Therefore, when consumption rose by 4.5, savings rose by 1.5. Savings is a net leakage from the system, therefore we have a 4.5 injection [consumption] and a 1.5 leakage [savings]. Thus, leakages do not equal injections. One must correct the other to restore equilibrium. In this case, firms cut production, leading to lower Y, leading to lower C(Y), leading to lower S, and ultimately to equilibrium where Y = C(Y) + I
True or False: The gold standard has an automatic adjustment system, and flexible exchange rates to a degree.
True; Exchange rates under the gold standard can fluctuate (slightly), within mint parity ‘bands,’ representing the cost of shipping gold from one country to the other. Automatic adj does not occur through E(r) fluctuations, but does occur through auto changes in price levels.
Describe the difference between internal and external balance. Under the gold standard, which is more important.
External balance is maintaining equilibrium in the BoP. Internal balance is maintaining full employment w/o inflation. Under the gold standard, ext balance was more important.
A 10% multiplier will turn an initial injection of $100 into a final output of a) $1,100 b) $10,000 c) $110 d) $1,000 e) none of the above
d) $1,000
A multi-national would engage in horizontally integrated investment in a foreign nation to a) avoid the tariffs in the home country b) secure an uninterrupted supply of lower-cost input resources c) buy out a foreign firm to neutralize potential future competition d) produce a differentiated product adapted to better serve the foreign market e) both b and c e) all of the above
Only d); horizontal integration is the foreign production of a differentiated product that is also produced at home tailored to better serve the foreign market
A multi-national would engage in vertically integrated investment in a foreign nation to a) avoid the tarrifs in the home country b) take advantage of foreign gov’t subsidies/incentives c) enter an ogiopolistic market to share profits d) to take advantage of higher returns abroad e) none of the above
e) none of the above; vertical integration is FDI to obtain an uninterrupted supply of raw material at the lowest possible cost (e.g. mineral rich countries, mining, etc…)
The relative PPP theory will tend to a) over-predict b) under-predict or c) depreciate the E(r) for developed nations relative to under-developed nations because the general price levels includes both traded and non-traded goods.
a) over-predict. p. 466
A deficit in the BoP may result from a) an excess in the stock of money supplied b) an increase in the demand for money satisfied by an inflow of funds c) an outflow of reserves d) an excess in the stock of money demanded e) both a and c f) both c and d
e) Both a and c; A BoP deficit results from an excess in the stock of money supplied that leads to an outflow of reserves (BoP deficit) sufficient to eliminate the excess supply of money in the nation, or the excess in the stock of money supplied that is not eliminated or corrected by the nation’s monetary authorities. 473
A nation experiences an increase in GDP of 100 million. The demand for money a) ________ (increases/decreases), and if the central bank keeps the domestic component of the nation’s monetary base constant, then the foreign component must b) _________ (increase/decrease) to keep the nation’s money supply equal, prompting a c) _________ (surplus/deficit) in the BoP.
a) increases; b) increase; c) surplus 472
The actual exchange value of a nation’s currency in terms of other currencies is determined by the a) change in domestic prices that accompanies the change in the exchange rate b) the supply and demand forces resulting from the in/outflow of international reserves c) the rate of growth of the money supply and real income relative to other nations’ d) the resulting effect from monetary authorities’ intervention in the Forex markets to increase/decrease the domestic/foreign component of a nation’s monetary base
c) the rate of growth of the money supply and real income relative to other nations’; don’t confuse ‘actual exchange value’ with the ‘exchange rate,’ the actual exchange value is determined by the rate of growth of the nation’s money supply and real income in the nation relative to the growth of the money supply and real income in the other nations. E.g. assume zero growth worldwide. A nation’s growth in excess of that leads to an increase in prices and in the exchange rate (depreciation of the currency) 473
A BoP deficit is corrected by a) accumulating int’l reserves b) loosening int’l reserves c) take action to depreciate the exchange rate d) impose dividend repatriation controls against foreign firms in the country e) only b and c f) only a and c
f) only a and c; accumulating int’l reserves and depreciating the exchange rate
The interest rate has risen to 5 from 3. The quantity of money demanded for speculative/liquidity purposes (a) increases proportional to the rise in the interest rate (b) decreases but by less than the rise in the interest rate (c) is autonomous and therefore remains constant (d) decreases proportional to the rise in the interest rate
d) decreases proportional to the rise in the interest rate; this would be the LM curve. At a higher interest rate, there is less incentive to seek higher returns in speculative assets, and there is more incentive to retain funds in inactive money balances. Thus demand for speculative assets/funds/money falls.
The exchange rate E(r) has risen by 3. To maintain external balance, domestic absorption must (a) decrease by an equal amount (b) increase by an equal amount (c) increase by more than the rise in the E(r) to correct the surplus by inducing a deficit (d) increase by less than the rise in the E(r) to correct the deficit by inducing a surplus
(b) increase by an equal amount; If absorption increases by more, you will overshoot and now incur a BoP deficit, a small increase in domestic absorption will lead to a BoP surplus.
