Exam 3

Question 1

information asymmetry problems

Answer 1

• adverse selection problems

- moral hazard

Question 2

adverse selection problems (information asymmetry)

Answer 2

• increases the probability that a potential borrower is a bad credit risk
• lenders may refuse loans even when good credit risks exist in financial markets

Question 3

differentiating bad from good credit risks

Answer 3

difficult and costly

Question 4

moral hazard (information asymmetry)

Answer 4

• when a borrower engages in activities that are undesirable from the perspective of the lender

Question 5

moral hazard can also be called

Answer 5

agent problems or agency problems

Question 6

agents and principals

Answer 6

• stock brokers for their clients
• investment bankers for firms whose stock offerings they underwrite
• CEOs for a corporations shareholders

Question 7

when do adverse selection problems occur

Answer 7

• before transactions occur

Question 8

when do moral hazard problems occur

Answer 8

• they exist because there is a problem monitoring behavior after a transaction is already under way

Question 9

adverse selection can lead to

Answer 9

credit rationing

Question 10

how do bad credit risks effect interest rate

Answer 10

bad credit risks are interest rate inelastic

Question 11

financial intermediarys

Answer 11

are important for solving information asymmetry problems and bringing savers and investors together

ex. commercial and investment banks
ex. stock and bond exchanges

Question 12

% GDP relative to financial markets: Highest

Answer 12

switzerland

Question 13

% GDP relative to financial markets: Lowest

Answer 13

ecuador

Question 14

business cycle expansions

Answer 14

GDP grows faster than average

Question 15

business cycle recessions

Answer 15

GDP growth becomes negative

Question 16

what are business cycles

Answer 16

1. variation in actual output relative to potential output
2. short run changes in potential output

• which one depends on if we believe Say’s law is true or not

Question 17

Say’s Law

Answer 17

• supply creates its own demand

Question 18

John Maynard Keynes

Answer 18

• in the long run we are all dead
• Say’s Law: products always exchange for products
• money is an important intermediary but can create problems
• produce a good -> get money -> buy goods

Question 19

why may prices or their growth rates be sticky

Answer 19

1. there are physical costs associated with changing prices
2. there are costs associated with informing customers about price changes (advertising)
3. coordination problems can exist across competitors (pepsi & coke)
4. nominal price increases upset customers (gas prices)
5. unions can build nominal wage stickiness into wage contracts

Question 20

aggregate demand

Answer 20

• combinations of inflation and real growth that are consistant with a specific rate of spending growth

Question 21

equation

Answer 21

%∆M + %∆V = %∆P + %∆Y

money supply, velocity, price level, real growth

spending growth = inflation + real growth

Question 22

%∆M + %∆V

Answer 22

spending growth

Question 23

%∆P + %∆Y

Answer 23

inflation + real growth

Question 24

higher inflation rates yield

Answer 24

lower real growth rates

Question 25

lower inflation rates yield

Answer 25

higher real growth rates

Question 26

menu costs

Answer 26

if you want to change the menu then you have to buy all new menus. its not as simple as saying you have lower prices

Question 27

aggregate demand graph

Answer 27

relates peoples spending behavior to possible rates of inflation and real growth

Question 28

spending in the aggregate

Answer 28

must be consistent with how many good firms can and are willing to produce

Question 29

long run aggregate supply (LRAS)

Answer 29

- solou growth curve | - represents the growth rate of potential output (what firms can sustainably produce)

Question 30

short run aggregate supply (SRAS)

Answer 30

- represents what firms are willing to produce

Question 31

determine the sustainable long run growth for the economy

Answer 31

- institutional quality - technology change - investments

Question 32

real "productivity" shocks

Answer 32

an unexpected change in the solou growth rate

Question 33

aggregate demand "nominal" shocks

Answer 33

unexpected changes in the spending growth rate

Question 34

π

Answer 34

inflation y axis

Question 35

g

Answer 35

real growth rate x axis

Question 36

every nominal spending growth rate has some inflation rate that is consistant with

Answer 36

the solou growth rate

Question 37

what if that particular inflation rate doesnt occur

Answer 37

- then spending growth will be greater or less than the real potential growth rate - firms will want to produce consistent with actual spending growth

Question 38

if prices are sticky

Answer 38

then short run aggregate supply (SRAS) will be different than long run aggregate supply (LRAS)

Question 39

sluggish adjust

Answer 39

the short run is separated from the long run by the extent to which prices are sticky

Question 40

what determines the real potential growth rate

Answer 40

- institutions - technological progress - increase in capital per worker

Question 41

changes in spending growth in the short run

Answer 41

lead to changes in both %∆P and the real growth

Question 42

Keynes on recessions

Answer 42

recessions correspond to increases in money demanded

Question 43

3 things people do with income

Answer 43

1. spend it on goods 2. make loans to others who spend it on goods 3. hold onto it as money

Question 44

if prices do not adjust

Answer 44

spending growth can fall short of potential real growth

Question 45

if prices adjust fully

Answer 45

the economy can get back to potential growth and eventually will

Question 46

Keynesian type recession story

Answer 46

assume that consumers and firms become pessimistic about the future (their animal spirits become negative) %∆V decreases people hold on to more money %∆C and %∆I decreases

Question 47

long run of Keynesian type recession

Answer 47

in the long run prices will adjust to this negative nominal shock In the long run we are all dead

Question 48

why would prices remain sticky for so long while unemployment is high

Answer 48

policies that point to long run stickiness - minimum wage laws - union wage contracts

Question 49

can animal spirits and sticky prices account for the great depression

Answer 49

1. sticky prices during 4 years of falling incomes and peak unemployment of 25% 2. federal reserve decreased the money supply 3. Smoot - Hawley Tariff put in place june 1930 which raised tariffs on 20,000 types of imported goods