ch.35 Flashcards
(37 cards)
What is the interest-rate effect?
The interest-rate effect helps explain the slope of the aggregate-demand curve by showing how changes in the interest rate affect the quantity of goods and services demanded.
How can the central bank shift the aggregate-demand curve?
The central bank can use monetary policy to shift the aggregate-demand curve by changing the money supply.
What are the primary effects of fiscal policy on aggregate demand?
Fiscal policy affects aggregate demand primarily through changes in government spending and taxation.
What is the theory of liquidity preference?
John Maynard Keynes’ theory that the interest rate adjusts to bring money supply and money demand into balance.
What happens to money demand if income (Y) rises?
An increase in income causes an increase in money demand because households want to buy more goods and services.
What happens to money demand if the interest rate (r) rises?
An increase in the interest rate reduces money demand since households attempt to buy bonds to take advantage of the higher interest.
What occurs to money demand if the price level (P) rises?
An increase in the price level increases money demand, as people need more money to buy the same amount of goods and services.
What is the role of the central bank in monetary policy?
The central bank uses monetary policy to target the interest rate, which affects the money supply and aggregate demand.
What is expansionary fiscal policy?
Expansionary fiscal policy involves an increase in government spending (G) and/or a decrease in taxes (T), shifting aggregate demand to the right.
What is contractionary fiscal policy?
Contractionary fiscal policy involves a decrease in government spending (G) and/or an increase in taxes (T), shifting aggregate demand to the left.
What is the multiplier effect?
The multiplier effect is the additional shifts in aggregate demand that result from expansionary fiscal policy increasing income and consumer spending.
What is the formula for the multiplier?
Multiplier = 1 / (1 - MPC), where MPC is the marginal propensity to consume.
What is the crowding-out effect?
The crowding-out effect is the offset in aggregate demand that results when expansionary fiscal policy raises interest rates and reduces investment spending.
How does a tax cut influence aggregate demand?
A tax cut increases households’ take-home pay, leading to increased consumer spending and shifting aggregate demand to the right.
What should the government do to end a recession if MPC = 0.8 and the AD curve needs to shift right by $200 billion?
The government should increase G by $40 billion.
If there is crowding out, will the government need to increase G more or less than the calculated amount?
The government will need to increase G by a larger amount.
How might fiscal policy affect aggregate supply (AS)?
A cut in the tax rate may incentivize workers to work more, potentially increasing the quantity of goods and services supplied and shifting AS to the right.
What is the case for active stabilization policy?
The case for active stabilization policy is to reduce economic fluctuations caused by irrational waves of optimism and pessimism, using expansionary or contractionary policies as needed.
True or False: Monetary policy can be described in terms of the money supply or the interest rate.
True.
Fill in the blank: The __________ trap occurs when the interest rate is zero.
liquidity
What are the two effects of fiscal policy on aggregate demand?
- The multiplier effect
- The crowding-out effect
What is the main argument for active stabilization policy?
Government should use policy to reduce economic fluctuations caused by irrational waves of pessimism and optimism, booms and recessions abroad, and stock market booms and crashes.
What should be done when GDP falls below its natural rate?
Use expansionary monetary or fiscal policy to prevent or reduce a recession.
What should be done when GDP rises above its natural rate?
Use contractionary policy to prevent or reduce an inflationary boom.
