Final Exam

Question 1

Which of the following is a generally accepted medium of exchange?
A. a plane ticket
B. federal government bonds
C. fine art
D. currency

Answer 1

D. currency

Question 2

What do economists use the word “money” to refer to?
A. income generated by the production of goods and services
B. those assets regularly used to buy goods and services
C. the value of a person’s assets
D. the value of stocks and bonds

Answer 2

B. those assets regularly used to buy goods and services

Question 3

Which of the following is current Canadian currency?
A. fiat money with intrinsic value
B. fiat money with no intrinsic value
C. commodity money with intrinsic value
D. commodity money with no intrinsic value

Answer 3

B. fiat money with no intrinsic value

Question 4

Which of the following is included in M1?
A. government bonds
B. demand deposits
C. savings deposits
D. travellers’ cheques

Answer 4

B. demand deposits

Question 5

How are credit card balances treated in M1 as compared to M2?
A. They are included in M1 but not M2.
B. They are included in M2 but not M1.
C. They are included in M1 and M2.
D. They are included in neither M1 nor M2.

Answer 5

D. They are included in neither M1 nor M2.

Question 6

Which of the following is the fundamental function of credit cards?
A. Credit cards are used for deferring payments.
B. Credit cards are used as store of value.
C. Credit cards are used for increasing the money supply.
D. Credit cards are used as investment assets.

Answer 6

A. Credit cards are used for deferring payments.

Question 7

Given the size of the Canadian money stock, is the amount of currency per person reasonable?
A. Yes, the amount of currency per person is about right.
B. There is no way of determining the amount of currency in circulation.
C. No, there is too little currency per person.
D. No, there is too much currency per person.

Answer 7

D. No, there is too much currency per person.

Question 8

Which of the following agencies is responsible for regulating the money supply in Canada?
A. the Comptroller of the Currency
B. the Bank of Canada
C. the TD Bank
D. the Canadian Payments Association

Answer 8

B. the Bank of Canada

Question 9

For how long is the governor of the Bank of Canada appointed?
A. life
B. a seven-year term
C. a five-year term
D. a two-year term

Answer 9

B. a seven-year term

Question 10

What is the role of the Minister of Finance with respect to the Bank of Canada or the banking system?
A. to control all activities of the Bank of Canada
B. to issue the Governor of Bank of Canada a written directive to resign
C. to issue currency
D. to maintain the stability of the banking system

Answer 10

B. to issue the Governor of Bank of Canada a written directive to resign

Question 11

How do deposits and reserves appear on a bank’s T-account?
A. Both deposits and reserves are assets.
B. Both deposits and reserves are liabilities.
C. Deposits are assets and reserves are liabilities.
D. Reserves are assets and deposits are liabilities.

Answer 11

D. Reserves are assets and deposits are liabilities.

Question 12

Suppose a bank has $200 000 in deposits and $180 000 in loans. What is its reserve ratio?
A. 1 percent
B. 5 percent
C. 10 percent
D. 18 percent

Answer 12

C. 10 percent

Question 13

When a bank loans out $1000, what happens to the money supply?
A. It does not change.
B. It decreases.
C. It increases.
D. It has an indeterminate effect on the money supply.

Answer 13

C. It increases.

Question 14

If the reserve ratio is 7 percent and a bank receives a new deposit of $300, which of the following will this bank most likely do?
A. It will increase required reserves by $2100.
B. It will initially see reserves increase by $279.
C. It will be able to make new loans up to a maximum of $279.
D. It will be able to increase its required reserves by $30.

Answer 14

C. It will be able to make new loans up to a maximum of $279.

Question 15

A central bank raised the reserve requirement ratio from 10 percent to 12 percent. Other things the same, how does the money multiplier change?
A. It increases by 1.67.
B. It decreases by 1.67.
C. It increases by about 2.
D. It decreases by 2.

Answer 15

B. It decreases by 1.67.

Question 16

Assets:
Reserves=$100
Loans=$900
Liabilities: 
Deposits=$1000

If the Bank of Edmonton has loaned out all the money it wants, given its deposits, what is its reserve ratio?
A. 1 percent
B. 5 percent
C. 10 percent
D. 15 percent

Answer 16

C. 10 percent

Question 17

Assets:
Reserves=$100
Loans=$900
Liabilities: 
Deposits=$1000

Assume that the Bank of Edmonton is holding the required percent of deposits as reserves. Also, assume all other banks hold only the required percent of deposits as reserves, and that people hold only deposits and no currency. What is the money multiplier?
A. 1
B. 5
C. 10
D. 15

Answer 17

C. 10

Question 18

Assets:
Reserves=$100
Loans=$900
Liabilities: 
Deposits=$1000

Assume that all other banks hold only the required 5 percent of deposits as reserves and people hold only deposits and no currency. If the Bank of Edmonton decides to hold exactly 5 percent reserves, by how much would the economy’s money supply increase?
A. $500
B. $1000
C. $1500
D. $2000

Answer 18

B. $1000

Question 19

If a bank uses $80 of excess reserves to make a new loan when the reserve ratio is 25 percent, what happens to the money supply?
A. The money supply initially decreases by $80.
B. The money supply initially increases by $20.
C. The money supply will eventually increase by more than $20 but less than $80.
D. The money supply will eventually increase by $320.

Answer 19

D. The money supply will eventually increase by $320.

Question 20

In Wellville, the money supply is $80 000 and reserves are $18 000. Assuming that people hold only deposits and no currency, and that banks hold only required reserves, what is the required reserve ratio?
A. 29 percent
B. 22.5 percent
C. 16 percent
D. 4.44 percent

Answer 20

B. 22.5 percent

Question 21

At one time, the country of Freedonia had no banks, but had currency of $40 million. Then a banking system was established with a reserve requirement of one-third. The people of Freedonia now keep half their money in the form of currency and half in the form of bank deposits. If banks do not hold excess reserves, how much currency do the people of Freedonia now hold?
A. $13.33 million
B. $20 million
C. $30 million
D. $36.36 million

Answer 21

C. $30 million

Question 22

Suppose the banking system has $10 million in reserves, the reserve requirement is 20 percent, and there are no excess reserves. The public holds $10 million in cash. Then bankers decide that it is prudent to hold some excess reserves, and so begin to hold 25 percent of deposits in the form of reserves. Other things the same, what will this action cause the money supply to do?
A. to change forms, but not size
B. to fall by $10 million
C. to fall by $5 million
D. to fall by $0.5 million

Answer 22

B. to fall by $10 million

Question 23

Which of the following lists contains only actions that increase the money supply?
A. make open market purchases; raise the reserve requirement ratio
B. make open market purchases; lower the reserve requirement ratio
C. make open market sales; raise the reserve requirement ratio
D. make open market sales; lower the reserve requirement ratio

Answer 23

B. make open market purchases; lower the reserve requirement ratio

Question 24

Which of the following lists ranks the Bank of Canada’s monetary policy tools from most to least frequently used?
A. bank rate changes; reserve requirement changes; open market transactions
B. reserve requirement changes; open market transactions; bank rate changes
C. open market transactions; bank rate changes; reserve requirement changes
D. open market transactions; reserve requirement changes; bank rate changes

Answer 24

C. open market transactions; bank rate changes; reserve requirement changes

Question 25

``` Which of the following is not a tool of monetary policy? A. open market operations B. reserve requirements C. changing the bank rate D. increasing the deficit ```

Answer 25

D. increasing the deficit

Question 26

How may the Bank of Canada influence the price level? A. by conducting open market sales and raising the bank rate B. by conducting open market sales and lowering the bank rate C. by conducting open market purchases and raising the bank rate D. by conducting open market purchases and lowering the bank rate

Answer 26

D. by conducting open market purchases and lowering the bank rate

Question 27

``` When and where did hyperinflation occur? A. during 1880–1896 in the United States B. in post–World War I Germany C. during the 1970s in Canada D. during 1930–1933 in the United States ```

Answer 27

B. in post–World War I Germany

Question 28

Which of the following does the classical theory of inflation try to explain? A. changes in relative prices in the economy determined by factors other than inflation B. the effect of inflation on economic growth C. the short-run determinants of the price level and the inflation rate D. the long-run determinants of the price level and the inflation rate

Answer 28

D. the long-run determinants of the price level and the inflation rate

Question 29

When the value of money rises, what happens to the number of dollars needed to buy a representative basket of goods? A. It increases, and so the price level rises. B. It increases, and so the price level falls. C. It decreases, and so the price level rises. D. It decreases, and so the price level falls.

Answer 29

D. It decreases, and so the price level falls.

Question 30

Why is the money supply curve vertical? A. because the quantity of money supplied increases when the value of money increases B. because the quantity of money supplied increases when the value of money decreases C. because the quantity of money supplied increases only if people desire to hold more money D. because the quantity of money supplied increases only if the central bank increases the money supply

Answer 30

D. because the quantity of money supplied increases only if the central bank increases the money supply

Question 31

``` How is the supply of money determined? A. by the price level B. by the Ministry of Finance C. by the Bank of Canada D. by the demand for money ```

Answer 31

C. by the Bank of Canada

Question 32

When the money market is depicted in a graph with the value of money on the vertical axis, as the price level increases, which of the following happens to the value of money? A. It increases, so the quantity of money demanded increases. B. It increases, so the quantity of money demanded decreases. C. It decreases, so the quantity of money demanded decreases. D. It decreases, so the quantity of money demanded increases.

Answer 32

D. It decreases, so the quantity of money demanded increases.

Question 33

Which of the following best describes the effects of an open market operation undertaken by the Bank of Canada? A. If the Bank of Canada purchases bonds in the open market, then the money supply shifts right and the price level increases. B. If the Bank of Canada sells bonds in the open market, then money supply shifts right and the price level decreases. C. If the Bank of Canada purchases bonds, then the money supply shifts left and the price level decreases. D. If the Bank of Canada sells bonds, then the money supply shifts right and the price level decreases.

Answer 33

A. If the Bank of Canada purchases bonds in the open market, then the money supply shifts right and the price level increases.

Question 34

When the money market is depicted in a diagram with the value of money on the vertical axis, in which of the following situations does the value of money increase? A. if either money demand or money supply shifts right B. if either money demand or money supply shifts left C. if money demand shifts right or money supply shifts left D. if money demand shifts left or money supply shifts right

Answer 34

C. if money demand shifts right or money supply shifts left

Question 35

In the 14th century, the Western African Emperor Kankan Musa travelled to Cairo where he gave away much gold, which was in use as a medium of exchange. Which of the following would we predict this increase in gold would do to the price level and value of gold in Cairo? A. raise both the price level and the value of gold in Cairo B. raise the price level, but decrease the value of gold in Cairo C. lower the price level, but increase the value of gold in Cairo D. lower both the price level and the value of gold in Cairo

Answer 35

B. raise the price level, but decrease the value of gold in Cairo

Question 36

In the 1970s in response to recessions caused by an increase in the price of oil, the central banks in many countries increased the money supply. How might the central banks have done this? A. by selling bonds on the open market, which would have raised the value of money B. by purchasing bonds on the open market, which would have raised the value of money C. by selling bonds on the open market, which would have raised the value of money D. by purchasing bonds on the open market, which would have lowered the value of money

Answer 36

D. by purchasing bonds on the open market, which would have lowered the value of money

Question 37

When the money market is depicted in a diagram with the value of money on the vertical axis, which of the following happens if the price level is above the equilibrium level? A. There is a shortage, so the price level will rise. B. There is a shortage, so the price level will fall. C. There is a surplus, so the price level will rise. D. There is a surplus, so the price level will fall.

Answer 37

B. There is a shortage, so the price level will fall.

Question 38

In a graph, on the vertical axis is the Value of Money and horizontal axis is the Quantity of Money. MS1 shifts to the right to become MS2. The equilibrium value of money went fro 2 to 1. If the money supply is MS2 and the value of money is 2, which of the following relationships holds? A. The value of money is less than its equilibrium level. B. The price level is higher than its equilibrium level. C. Money demand is greater than the money supply. D. The money supply is greater than money demand.

Answer 38

D. The money supply is greater than money demand.

Question 39

In a graph, on the vertical axis is the Value of Money and horizontal axis is the Quantity of Money. MS1 shifts to the right to become MS2. The equilibrium value of money went fro 2 to 1. What happens when the money supply curve shifts from MS1 to MS2? A. The demand for goods and services decreases. B. The economy's ability to produce goods and services increases. C. The equilibrium price level increases. D. The equilibrium value of money increases.

Answer 39

C. The equilibrium price level increases.

Question 40

``` Which of the following terms refers to economic variables whose values are measured in monetary units? A. dichotomous variables B. nominal variables C. classical variables D. real variables ```

Answer 40

B. nominal variables

Question 41

Which of the following does nominal GDP measure? A. the total quantity of final goods and services produced B. the dollar value of the economy's output of final goods and services C. the total income received from producing final goods and services in constant dollars D. the price level

Answer 41

B. the dollar value of the economy's output of final goods and services

Question 42

Which of the following does real GDP measure? A. the total quantity of final goods and services produced B. the dollar value of the economy's output of final goods and services C. the total income received from producing final goods and services at current prices D. the change in prices from the base year to current year

Answer 42

A. the total quantity of final goods and services produced

Question 43

``` What type of variable is the price level? A. a relative variable B. an actual variable C. a real variable D. a nominal variable ```

Answer 43

D. a nominal variable

Question 44

``` What is the price of a Honda Accord divided by the price of a Honda Civic called? A. a classical variable B. a dichotomous variable C. a nominal variable D. a real variable ```

Answer 44

D. a real variable

Question 45

An assistant professor of economics gets a $100-a-month raise, but then she figures that with her current monthly salary she can't buy as many goods as she could last year. Which of the following has happened to her real and nominal wage? A. Her real and nominal wages have risen. B. Her real and nominal wages have fallen. C. Her real wage has risen and her nominal wage has fallen. D. Her real wage has fallen and her nominal wage has risen.

Answer 45

D. Her real wage has fallen and her nominal wage has risen.

Question 46

``` Which of the following kinds of variables are interest rates adjusted for the effects of inflation? A. nominal variables B. real variables C. classical variables D. dichotomous variables ```

Answer 46

B. real variables

Question 47

``` According to the classical dichotomy, which of the following increases when the money supply increases? A. the real interest rate B. real GDP C. the real wage D. the price level ```

Answer 47

D. the price level

Question 48

According to the classical dichotomy, which of the following is NOT influenced by monetary factors? A. nominal GDP and nominal interest rates B. real wages and real GDP C. the price level and nominal GDP D. the price level and nominal GDP

Answer 48

B. real wages and real GDP

Question 49

``` How is velocity computed? A. (PY)/M B. (PM)/Y C. (YM)/P D. (YM)/V ```

Answer 49

A. (PY)/M

Question 50

``` Based on the quantity equation, if M = 125, V = 4, and Y = 200, what is P? A. 0.5 B. 1 C. 1.5 D. 2.5 ```

Answer 50

D. 2.5

Question 51

According to the quantity equation, if Y and M are constant, and V doubles, which of the following will happen to the price level? A. It will less than double. B. It will double. C. It will more than double. D. It might double, more than double, or less than double; more information is needed.

Answer 51

B. It will double.

Question 52

Assuming that velocity is stable, if real GDP grows by 10 percent this year, and if the money supply does not change this year, how does the price level or nominal GDP change? A. The price level will not change. B. Nominal GDP will grow by 10 percent. C. Nominal GDP will stay the same. D. The price level will increase by 10 percent.

Answer 52

C. Nominal GDP will stay the same.

Question 53

Velocity in the country of Shem is always stable. In 2009, the money supply was $200 billion and the GDP price deflator was four times as high as it was in the base year. In 2010, the money supply increased to $240 billion, the price level increased by 15 percent, and nominal GDP equalled $1200 billion. By how much did real GDP increase between 2009 and 2010? A. 20 percent B. 4.35 percent C. 2.17 percent D. There is not enough information to answer the question.

Answer 53

B. 4.35 percent

Question 54

Which of the following best explains why governments may prefer an inflation tax to some other kind of tax? A. The inflation tax is easier to impose. B. The inflation tax reduces inflation. C. The inflation tax falls mainly on high-income individuals. D. The inflation tax reduces the real cost of government expenditure.

Answer 54

A. The inflation tax is easier to impose.

Question 55

``` What is the name of the one-for-one adjustment of the nominal interest rate to the inflation rate? A. the Friedman Effect B. the Hume Effect C. the Fisher Effect D. the Ricardian equivalence effect ```

Answer 55

C. the Fisher Effect

Question 56

Greta puts money in a savings account at her bank earning 6.5 percent. One year later she takes her money out and notes that while her money was earning interest, prices rose 3.5 percent. Which of the following does Greta now have? A. 3.5 percent more money with which she can purchase 6.5 percent more goods B. 6.5 percent more money with which she can purchase 3 percent more goods C. 6.5 percent more money with which she can purchase 6.5 percent more goods D. 10 percent more money with which she can purchase 3 percent more goods

Answer 56

B. 6.5 percent more money with which she can purchase 3 percent more goods

Question 57

Which of the following does the shoeleather cost of inflation refer to? A. the fall in real income associated with inflation B. the time spent searching for low prices when inflation rises C. the waste of resources used to maintain lower money holdings D. the increased cost to the government of printing more money

Answer 57

C. the waste of resources used to maintain lower money holdings

Question 58

``` Which of the following terms refers to the cost of changing price tags and price listings? A. inflation-induced tax distortions B. relative-price variability costs C. shoeleather costs D. menu costs ```

Answer 58

D. menu costs

Question 59

Given a nominal interest rate of 7 percent, in which of the following cases would you earn the lowest after-tax real rate of interest? A. Inflation is 4 percent, and the tax rate is 25 percent. B. Inflation is 3 percent, and the tax rate is 20 percent. C. Inflation is 2 percent, and the tax rate is 15 percent. D. Inflation is 1 percent, and the tax rate is 10 percent.

Answer 59

A. Inflation is 4 percent, and the tax rate is 25 percent.

Question 60

``` Under which of the following conditions is wealth distributed from debtors to creditors? A. When inflation is high, but expected. B. When inflation is low, but expected. C. When inflation is unexpectedly high. D. When inflation is unexpectedly low. ```

Answer 60

D. When inflation is unexpectedly low.

Question 61

Inflation vs Deflation vs Hyperinflation

Answer 61

Inflation: The increase in the overall level of prices. Deflation: The decrease in the overall level of prices. Hyperinflation: An extraordinarily high rate of inflation.

Question 62

Why do economists use the “Classical Theory of Inflation” today?

Answer 62

To explain the long-run determinants of the price level and the inflation rate.

Question 63

Name the determinants of price level and inflation rate in the “Classical Theory of Inflation.”

Answer 63

A) The level of prices and the value of money B) Money supply, money demand and monetary equilibrium C) Effects of a monetary injection D) Classical dichotomy and monetary neutrality E) Velocity and quantity equation F) Inflation tax G) Fisher Effect

Question 64

“Classical Theory of Inflation” - Determinant: The Level of Prices and the Value of Money (Theory of Inflation)

Answer 64

- inflation is more about the value of money than the value of goods - key point: Inflation is an economy-wide phenomenon that concerns the value of the economy’s medium of exchange. - a rise in the price level means a lower value of money because each dollar in your wallet buys a smaller quantity of goods and services * **price level rises = value of money falls (Value of money = 1/P (price of goods)

Question 65

What happens to the value of money when price levels rise?

Answer 65

***price level rises = value of money falls | Value of money = 1/P (price of goods)

Question 66

“Classical Theory of Inflation” - Determinant: Money supply, money demand, and monetary equilibrium (Quantity theory of money)

Answer 66

- value of money is determined by supply and demand for money - supply of money determined by Bank of Canada - demand determined by how much wealth people want to hold in liquid form - in the long run, the overall level of prices adjusts to the level at which the demand for money equals the supply

Question 67

How can the Bank of Canada reduce the money supply?

Answer 67

- increasing overnight rate discourages banks from borrowing from Bank of Canada = reduction in quantity of reserves in banking system = reduces money supply - Bank of Canada sells bonds in open-market and receives dollars = money supply contracts

Question 68

Which factors influence the quantity of money demanded or the preference for holding wealth in liquid form?

Answer 68

- how much people rely on credit cards - whether an automated teller machine is easy to find - depends on the interest rate a person could earn by using the money to buy an interest-bearing bond instead of leaving it in the wallet or a low-interest chequing account - average level of prices in the economy (money is a medium of exchange to buy goods and services, so the prices of these goods and services is also a factor)

Question 69

What happens to the quantity of money demanded when price levels increase?

Answer 69

- the higher the prices are, the more money the typical transaction requires and the more money people will choose to hold in their wallets and chequing accounts - the higher the price level, the lower the value of money, the quantity of money demanded increases

Question 70

How is monetary equilibrium maintained if the price level is above equilibrium?

Answer 70

-people will want to hold more money than the Bank of Canada has created, so the price level must fall to balance supply and demand

Question 71

If the value of money (1/P) is on the left vertical axis, the price level (P) is on the right vertical axis (increases from top to bottom) and the quantity of money is on the horizontal axis. How are money supply and money demand shown on the graph?

Answer 71

- money supply curve is vertical because the quantity of money supplied is fixed by the Bank of Canada - money demand curve is downward sloping because people want to hold a larger quantity of money when each dollar buys less

Question 72

“Classical Theory of Inflation” - Determinant: The Effects of Monetary Injection (Quantity theory of money)

Answer 72

- change in monetary policy - economy is in equilibrium and then Bank of Canada doubles the supply of money by printing more bills = monetary injection - supply curve moves from MS1 to MS2 and equilibrium moves from point A to B - value of money decreases and equilibrium price level increases (increase in money supply makes dollars more plentiful, increases price level and makes each dollar less valuable)

Question 73

Def: Quantity theory of money

Answer 73

A theory asserting that the quantity of money available determines the price level and the growth rate in the quantity of money available determines the inflation rate

Question 74

What happens to an economy who was at equilibrium, but then the Bank of Canada decides to do a monetary injection by increasing the supply of money?

Answer 74

An increase in the supply of money: - people now have more money in their wallets than they want (money supplied exceeds money demanded) so try to get rid of it by buying goods and services or make loans to others by depositing in the bank - increases the demand for goods and services, but the economy’s ability to supply goods and services has not changed - increases the price level (prices of goods and services increases due to increase in demand for them) which increases the quantity of money demanded because people are using more dollars for every transaction - decreases the value of money

Question 75

“Classical Theory of Inflation” - Determinant: Classical dichotomy and monetary neutrality

Answer 75

- classical dichotomy: the theoretical separation of nominal and real variables - monetary neutrality: the proposition that changes in the money supply affect nominal variables, but do not affect real variables - when central bank doubles money supply, all prices double and value of unit of account falls by half ; government reduces length of metre from 100 to 50 cm, all measured distances would double, but the actual distances (real variables) would remain the same - monetary neutrality does apply in the long run, but maybe not in the short run

Question 76

Nominal vs Real variables in Classical dichotomy

Answer 76

Nominal variable: variables measured in monetary units (Nominal GDP, prices) Real variable: variables measured in physical units (Real GDP, relative prices, real wage, real interest rate), not influenced by prices, some adjusted for inflation

Question 77

Nominal vs Real GDP

Answer 77

Nominal GDP: measures the dollar value of the economy’s output of goods and services (nominal variable in classical dichotomy) Real GDP: measures the total quantity of goods and services produced and is not influenced by the current prices of those goods and services (real variable in classical dichotomy)

Question 78

Def: Relative prices

Answer 78

The price of one thing compared to another where the dollar signs cancel out ($/$), making it a real variable since it is now measured in physical units.

Question 79

Def: Real wage

Answer 79

- dollar wage adjusted for inflation - real variable - measures the rate at which the economy exchanges goods and services for each unit of labour

Question 80

Def: Real interest rate

Answer 80

- the nominal interest rate adjusted for inflation - real variable - measures the rate at which the economy exchanges goods and services produced today for goods and services produced in the future

Question 81

“Classical Theory of Inflation” - Determinant: Velocity and the Quantity Equation

Answer 81

-Velocity of money: the rate at which money changes hands -V=(P*Y)/M V=velocity of money P=price level (GDP deflator) Y=quantity of output (real GDP) M=quantity of money -Quantity Equation: M*V=P*Y which relates the quantity of money, the velocity of money, and the dollar value of the economy’s output of goods and services -velocity of money is relatively stable (so assume constant velocity)

Question 82

According to the quantity equation (M*V=P*Y), what happens to the three variables if the quantity of money increases in the economy?

Answer 82

- the price level (P) must rise - quantity of output (Y) must rise - velocity of money (V) must fall

Question 83

Name the 5 steps and key points of the quantity theory of money.

Answer 83

1) The velocity of money is relatively stable over time. 2) Because velocity is stable, when the central bank changes the quantity of money (M), it causes proportionate changes in the nominal value of output (P*Y) 3) The economy’s output of goods and services (Y) is primarily determined by factor supplies (labour, physical capital, human capital, and natural resources) and the available production technology. In particular, because money is neutral, money does not affect output. 4) With output (Y) determined by factor supplies and technology, when the central bank alters the money supply (M) and induces proportional changes in the nominal value of output (P*Y), these changes are reflected in changes in the price level (P). 5) Therefore, when the central bank increases the money supply rapidly, the result is a high rate of inflation.

Question 84

How is hyperinflation defined and how can it be used in the economy?

Answer 84

- defined as inflation that exceeds 50% per month, so price level increases more than 100-fold over the course of a year - changes in money supply and price level are so large, but move together - used to study the effects of money on the economy - prices rise when the government prints too much money

Question 85

Why do central banks of countries who experienced hyperinflation choose to print so much money that its value is certain to fall rapidly over time?

Answer 85

-governments of these countries use money creation as a way to pay for their spending (build roads, pay salaries, give transfer payments to the poor or elderly)

Question 86

“Classical Theory of Inflation” - Determinant: Inflation Tax

Answer 86

- The revenue the government raises by creating money. - not like other taxes since no one receives a bill from the government, it’s more subtle - when the government prints money, the price level rises, and the dollars in your pocket are less valuable - inflation tax is like a tax on everyone who holds money - leads to hyperinflation

Question 87

How can hyperinflation end?

Answer 87

-when the government institutes fiscal reforms like cuts in government spending and to eliminate the need for the inflation tax

Question 88

How do you calculate the real interest rate?

Answer 88

Real interest rate = Nominal interest rate - Inflation rate Nominal interest rate: tells you how fast the dollars in your account will rise over time Real interest rate: corrects the nominal interest rate for the effect of inflation to tell you how fast the purchasing power of your savings account will rise over time

Question 89

“Classical Theory of Inflation” - Determinant: The Fischer Effect

Answer 89

- when the Bank of Canada increases the rate of money growth, the result is both a higher inflation rate and a higher nominal interest rate - Fischer effect=one-for-one adjustment of nominal interest rate to inflation rate - does not hold in the short run (only long run)

Question 90

What is the inflation fallacy?

Answer 90

- what people think: when prices rise, each dollar buys fewer goods and services, so inflation directly lowers living standards - FALSE! - inflation does NOT reduce people’s real purchasing power, because when prices rise, buyers pay more but those selling get a bigger income (inflation in income goes hand in hand with inflation in prices = monetary neutrality) * inflation=tax on holders of money

Question 91

Costs of inflation: Shoeleather costs

Answer 91

- the resources wasted when inflation encourages people to reduce their money holdings - inflation=tax on holders of money - taxes are an incentive for people to alter their behaviour to avoid paying it so causes deadweight losses for society as a whole and people waste scarce resources trying to avoid it - inflation erodes the real value of money in your wallet so to avoid the inflation tax, you hold less money (go to bank more often) - cost of reducing money holdings=shoeleather cost, where cost of time and convenience is sacrificed - really affects countries experiencing hyperinflation

Question 92

Costs of inflation: Menu costs

Answer 92

- the costs of changing prices - typical Canadian firms change prices once a year, but for countries in hyperinflation, prices need to be changed daily to keep up with all other prices in the economy - menu costs include cost of deciding on prices, cost of printing new catalogues, cost of advertising, cost of dealing with annoyed customers

Question 93

Costs of inflation: Relative price variability and misallocation of resources

Answer 93

- no inflation means constant relative prices - increase in inflation rate means relative prices start off high, then will be low (higher the inflation=greater the automatic variability) - colonies rely on relative prices to allocate scarce resources - consumers decide what to buy by comparing quality and prices of goods and services, but if inflation distorts relative prices, consumer decisions are distorted and markets are less able to allocate resources

Question 94

Costs of inflation: Inflation-induced tax distortions

Answer 94

- lawmakers often fail to take inflation into account in tax laws - inflation tends to raise the tax burden on income earned from savings - inflation discourages saving (ex-tax treatment on capital gains, the profits made by selling an asset for more than its purchase price; ex-tax treatment of interest income) - solution: index the tax system (rewrite tax laws to take into account inflation)

Question 95

Costs of inflation: Confusion and Inconvenience

Answer 95

- Bank of Canada ensures the reliability of a commonly used unit of measurement (dollar), so when it increases the money supply and creates inflation, it erodes the real value of the unit of account - accountants incorrectly measure firm’s earnings when prices are rising over time (inflation) - inflation makes investors less able to sort out successful from unsuccessful firms which then impedes financial markets that allocate the economy’s saving to investment

Question 96

Costs of inflation: Arbitrary redistributions of wealth

Answer 96

- unexpected inflation redistributes wealth in a way that has nothing to do with merit or need - ex) unexpected changes in prices redistribute wealth among debtors and creditors; hyperinflation would enrich the debtors (it diminishes the real value of the debt) but a deflation would enrich the creditor (it increases the real value of the debt) - since inflation is hard to predict, it puts both creditors and debtors at risk they would both like to avoid - inflation is volatile and uncertain when the average rate of inflation is high

Question 97

Costs of inflation: inflation is bad, but deflation may be worse

Answer 97

- the Friedman rule: a small and predictable amount of deflation may be desirable since it would lower the nominal interest rate and reduce the cost of holding money, so would require deflation equal to real interest rate - falling price levels (menu costs) - deflation comes as a surprise so causes the redistribution of wealth toward creditors and away from debtors (debtors usually poorer so harmful) - fall in aggregate demand=falling incomes and rising unemployment - symptom of deeper economic problems

Question 98

What is the viewpoint “monetarism” and why it was not successful?

Answer 98

- central banks should keep the supply of money growing at a slow constant rate = monetary gradualism - this policy was adopted due to the problem of inflation in order to try and make it fall - results: at first, inflation stayed high despite the slowdown in money growth, then inflation fell much more quickly than money growth, so this policy was given up

Question 99

The policy of inflation targeting is now being used by many of the world’s central banks. How does this policy work?

Answer 99

- central bank sets a target rate of inflation of 2% - Bank of Canada adjusts monetary policy by changing the overnight rate of interest to stay at this 2% inflation target - if there is danger of going over 2% inflation, it raises the overnight rate which reduces the growth rate of money supply and reduces future inflation - other things equal, an increase in money growth will cause an increase in inflation

Question 100

How does international trade affect the standard of living? A. It raises the standard of living in all trading countries. B. It lowers the standard of living in all trading countries. C. It leaves the standard of living unchanged. D. It raises the standard of living for importing countries and lowers it for exporting countries.

Answer 100

A. It raises the standard of living in all trading countries.

Question 101

``` Country A buys $150 of wine from country B, and B buys $30 of wool from A. Which of the following correctly indicates the two countries’ net exports (in the order A, B)? A. $180 and $0 B. $150 and $30 C. –$120 and $120 D. $120 and –$120 ```

Answer 101

C. –$120 and $120

Question 102

Sonya, a citizen of Denmark, sells Danish boots and shoes in Canada. Which of the following correctly identifies the effects of these sales on net exports? A. They increase Canadian net exports and have no effect on Danish net exports. B. They decrease Canadian net exports and have no effect on Danish net exports. C. They increase Canadian net exports and decrease Danish net exports. D. They decrease Canadian net exports and increase Danish net exports.

Answer 102

D. They decrease Canadian net exports and increase Danish net exports.

Question 103

Which of the following best defines net capital outflow? A. It is the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreign residents. B. It is the purchase of foreign assets by domestic residents minus the purchase of foreign goods and services by domestic residents. C. It is the purchase of domestic assets by foreign residents minus the purchase of domestic goods and services by foreign residents. D. It is the purchase of domestic assets by foreign residents minus the purchase of foreign assets by domestic residents.

Answer 103

A. It is the purchase of foreign assets by domestic residents minus the purchase of domestic assets by foreign residents.

Question 104

Which of the following would be Canadian foreign direct investment? A. A Swedish car manufacturer opens a plant in Sherbrooke, Quebec. B. A Dutch citizen buys shares of stock in a Canadian company. C. Tim Hortons, a Canadian company, opens a restaurant in Jamaica. D. A Canadian citizen buys stock in companies located in Japan.

Answer 104

C. Tim Hortons, a Canadian company, opens a restaurant in Jamaica.

Question 105

Which of the following would be a Canadian foreign portfolio investment? A. Nortel, a Canadian company, builds a new factory near Rome, Italy. B. Your economics professor, a Canadian citizen, buys stock in companies located in Eastern European countries. C. A Dutch hotel chain opens a new hotel in Canada. D. A citizen of Singapore buys a bond issued by a Canadian corporation.

Answer 105

B. Your economics professor, a Canadian citizen, buys stock in companies located in Eastern European countries.

Question 106

Suppose Connie, a Canadian citizen, buys bonds issued by an automobile manufacturer in Sweden. Which of the following would her expenditure be? A. Canadian foreign direct investment that would increase Canadian net capital outflow B. Canadian foreign direct investment that would decrease Canadian net capital outflow C. Canadian foreign portfolio investment that would increase Canadian net capital outflow D. Canadian foreign portfolio investment that would decrease Canadian net capital outflow

Answer 106

C. Canadian foreign portfolio investment that would increase Canadian net capital outflow

Question 107

``` Which of the following shows that any trade transaction must have a financial counterpart? A. NCO = NX B. NCO + I = NX C. NX + NCO = Y D. Y = NCO – I ```

Answer 107

A. NCO = NX

Question 108

Suppose Canada sells chocolate to the United States. Which of the following correctly identifies the effects of this transaction? A. U.S. net exports increase, and U.S. net capital outflow increases. B. U.S. net exports increase, and U.S. net capital outflow decreases. C. U.S. net exports decrease, and U.S. net capital outflow increases. D. U.S. net exports decrease, and U.S. net capital outflow decreases.

Answer 108

D. U.S. net exports decrease, and U.S. net capital outflow decreases.

Question 109

A Canadian firm opens a factory that produces camping equipment in Albania. Which of the following correctly identifies the effects of this transaction? A. Canadian net capital outflow increases, and Albanian net capital outflow decreases. B. Canadian net capital outflow decreases, and Albanian net capital outflow increases. C. Only Canadian net capital outflow increases. D. Only Albanian net capital outflow increases.

Answer 109

A. Canadian net capital outflow increases, and Albanian net capital outflow decreases.

Question 110

A British pharmacy buys drugs from a Canadian company and pays for them with British pounds. Which of the following correctly identifies the effects of this transaction? A. It increases British net exports and increases Canadian capital outflow. B. It increases British net exports and decreases Canadian capital outflow. C. It decreases British net exports and increases Canadian capital outflow. D. It decreases British net exports and decreases Canadian capital outflow.

Answer 110

C. It decreases British net exports and increases Canadian capital outflow.

Question 111

``` Which of the following is the formula for an open economy's GDP? A. Y = C + I + G B. Y = C + I + G + T C. Y = C + I + G + S D. Y = C + I + G + NX ```

Answer 111

D. Y = C + I + G + NX

Question 112

``` Which of the following is the formula for investment in an open economy? A. I = Y – C B. I = S C. I = S – NCO D. I = S + NX ```

Answer 112

C. I = S – NCO

Question 113

``` A country has $80 million of saving and domestic investment of $30 million. What are net exports? A. –$50 million B. $50 million C. $80 million D. $110 million ```

Answer 113

B. $50 million

Question 114

The country of Freedonia has a GDP of $4000, consumption of $1800, and government purchases of $500. Which of the following does this situation imply? A. Investment is equal to –$1700. B. Investment plus net capital outflow is equal to $1700. C. Investment plus net exports is equal to $2300. D. Saving is equal to $2200.

Answer 114

B. Investment plus net capital outflow is equal to $1700.

Question 115

Which of the following does a trade deficit imply? A. saving is greater than domestic investment and Y > C + I + G B. saving is greater than domestic investment and Y < C + I + G C. saving is less than domestic investment and Y > C + I + G D. saving is less than domestic investment and Y < C + I + G

Answer 115

D. saving is less than domestic investment and Y < C + I + G

Question 116

If a country has business opportunities that become relatively attractive to other countries, which of the following best predicts the effects of this change? A. Both net exports and net capital outflow increase. B. Both net exports and net capital outflow decrease. C. Net exports increase, but net capital outflow decreases. D. Net exports decrease, but net capital outflow increases.

Answer 116

B. Both net exports and net capital outflow decrease.

Question 117

``` If the exchange rate is 175 yen = $1, what is the cost of a bottle of rice wine that costs 5250 yen? A. $28 B. $30 C. $32 D. $34 ```

Answer 117

B. $30

Question 118

``` Suppose the exchange rate is 5 units of Peruvian currency per dollar, and a hotel room in Lima, Peru, costs 350 units of Peruvian currency. How many dollars do you need to get a room in Lima? A. $1750 B. $355 C. $70 D. $35 ```

Answer 118

C. $70

Question 119

``` Exchange rates are 0.98 U.S. dollars per Canadian dollar, 150 yen per Canadian dollar, 0.8 euro per Canadian dollar, and 20 pesos per Canadian dollar. A bottle of beer in New York costs 6 U.S. dollars, 1200 yen in Tokyo, 7 euros in Munich, and 100 pesos in Cancun. Which of the following indicates the most expensive beer? A. Cancun B. New York C. Tokyo D. Munich ```

Answer 119

D. Munich

Question 120

``` The nominal exchange rate is about 2 Aruban florin per dollar. If a basket of goods in Canada costs $40, how many florins must a basket of goods in Aruba cost for purchasing-power parity to hold? A. 20 florins B. 40 florins C. 80 florins D. 100 florins ```

Answer 120

C. 80 florins

Question 121

According to the theory of purchasing-power parity, what must the nominal exchange rate between two countries reflect? A. the different price levels in those countries B. the different resource endowments in those countries C. the different income levels in those countries D. the different standards of living between those countries

Answer 121

A. the different price levels in those countries

Question 122

When a country's central bank decreases the money supply, which of the following best predicts the consequences? A. Its price level rises, and its currency appreciates relative to other currencies in the world. B. Its price level falls, and its currency appreciates relative to other currencies in the world. C. Its price level rises, and its currency depreciates relative to other currencies in the world. D. Its price level falls, and its currency depreciates relative to other currencies in the world.

Answer 122

B. Its price level falls, and its currency appreciates relative to other currencies in the world.

Question 123

According to purchasing-power parity, if prices in Canada increase by a smaller percentage than prices in Algeria, how does the exchange rate change? A. The real exchange rate, defined as Algerian goods per unit of Canadian goods, rises. B. The real exchange rate, defined as Algerian goods per unit of Canadian goods, falls. C. The nominal exchange rate, defined as Algerian currency per dollar, rises. D. The nominal exchange rate, defined as Algerian currency per dollar, falls.

Answer 123

C. The nominal exchange rate, defined as Algerian currency per dollar, rises.

Question 124

On behalf of your firm, you make frequent trips to Hong Kong. You notice that you always have to pay more dollars to get enough local currency to get your hair styled than you have to pay to get your hair styled in Canada. Is this consistent with purchasing power parity? A. No, but it might be explained by limited opportunities for arbitrage across international borders. B. Yes, if prices in Hong Kong are rising more rapidly than prices in Canada. C. Yes, if prices in Hong Kong are rising less rapidly than prices in Canada. D. No, but it can be explained by arbitrage across international borders.

Answer 124

A. No, but it might be explained by limited opportunities for arbitrage across international borders.

Question 125

In the open-economy macroeconomic model, where does the demand for loanable funds come from? A. domestic investment B. net exports C. net capital outflow D. the sum of net capital outflow and domestic investment

Answer 125

A. domestic investment

Question 126

``` What does a higher real interest rate lowers the quantity of? A. national saving B. net capital outflow C. loanable funds demanded D. loanable funds supplied ```

Answer 126

C. loanable funds demanded

Question 127

What effect does a fall in the real interest rate have on the quantity of loanable funds? A. It increases the quantity of loanable funds demanded. B. It decreases the quantity of loanable funds demanded. C. It increases the quantity of loanable funds supplied. D. It does not affect the quantity of loanable funds supplied.

Answer 127

A. It increases the quantity of loanable funds demanded.

Question 128

``` In an open economy, what does net capital outflow equal? A. imports B. net exports C. exports D. net imports ```

Answer 128

B. net exports

Question 129

``` If the world real interest rate exceeds the interest rate that would occur if the Canadian economy were closed, then the Canadian net capital outflow will be which of the following? A. positive B. negative C. decreasing D. increasing ```

Answer 129

A. positive

Question 130

``` Which of the following is consistent with positive net exports? A. Exports are greater than imports. B. Net capital outflow is negative. C. Exports are less than imports. D. Net capital outflow is zero. ```

Answer 130

A. Exports are greater than imports.

Question 131

In the market for foreign currency exchange in the open economy macroeconomic model, which of the following does the amount of net capital outflow represent? A. the quantity of dollars supplied for the purpose of selling assets domestically B. the quantity of dollars supplied for the purpose of buying assets abroad C. the quantity of dollars demanded for the purpose of buying Canadian net exports of goods and services D. the quantity of dollars demanded for the purpose of importing foreign goods and services

Answer 131

B. the quantity of dollars supplied for the purpose of buying assets abroad

Question 132

Which of the following is included in the supply of dollars in the market for foreign-currency exchange in the open-economy macroeconomic model? A. A retail outlet in Afghanistan wants to buy watches from a Canadian manufacturer. B. A Canadian bank loans dollars to Blair, a Canadian resident, who wants to purchase a new car made in Canada. C. A Canadian-based mutual fund wants to purchase stock issued by a Polish company. D. A Canadian resident imports a car made in Japan.

Answer 132

C. A Canadian-based mutual fund wants to purchase stock issued by a Polish company.

Question 133

What is the real exchange rate equal to? A. the relative price of domestic and foreign currency B. the relative price of domestic and foreign goods C. the ratio between the domestic and foreign interest rates D. the nominal exchange rate minus the inflation rate

Answer 133

B. the relative price of domestic and foreign goods

Question 134

What does the identity “net capital outflow = net exports” imply? A. The supply of dollars equals the demand for dollars in the foreign-currency exchange market. B. National saving equals domestic investment. C. The volume of exports equals the volume of imports. D. National saving is greater than domestic investment.

Answer 134

A. The supply of dollars equals the demand for dollars in the foreign-currency exchange market.

Question 135

Which of the following is consistent with a depreciation of the dollar? A. Canadian goods become less expensive relative to foreign goods, which makes exports rise and imports fall. B. Canadian goods become less expensive relative to foreign goods, which makes exports fall and imports rise. C. Canadian goods become more expensive relative to foreign goods, which makes exports rise and imports fall. D. Canadian goods become more expensive relative to foreign goods, which makes exports fall and imports rise.

Answer 135

A. Canadian goods become less expensive relative to foreign goods, which makes exports rise and imports fall.

Question 136

``` In the open-economy macroeconomic model, which of the following is the key determinant of net capital outflow? A. the nominal exchange rate B. the nominal interest rate C. the real exchange rate D. the real interest rate ```

Answer 136

D. the real interest rate

Question 137

If Canadian firms decide to invest more domestically at each interest rate, which of the following best describes the results? A. The real interest rate decreases, the real exchange rate of the dollar depreciates, and Canadian net capital outflow decreases. B. The real interest rate decreases, the real exchange rate of the dollar appreciates, and Canadian net capital outflow increases. C. The real interest rate increases, the real exchange rate of the dollar appreciates, and Canadian net capital outflow decreases. D. The real interest rate increases, the real exchange rate of the dollar depreciates, and Canadian net capital outflow increases.

Answer 137

C. The real interest rate increases, the real exchange rate of the dollar appreciates, and Canadian net capital outflow decreases.

Question 138

How does a change in government budget affect national saving? A. An increase in budget deficit increases national saving. B. An increase in budget surplus increases national saving. C. A decrease in budget surplus increases national saving. D. A decrease in budget deficit does not affect national saving.

Answer 138

B. An increase in budget surplus increases national saving.

Question 139

The People's Republic of China has had a large trade surplus in recent years. Which of the following is the most likely explanation of this surplus? A. China has a high rate of inflation, which reduces the value of its currency. B. China has a large supply of labour, so low wages give it a competitive edge. C. China has many trade barriers, which restrict the ability of other countries to sell their products in China. D. China has a large amount of saving relative to domestic investment.

Answer 139

D. China has a large amount of saving relative to domestic investment.

Question 140

Since the mid 1990s, Canadian governments have tried to eliminate budget deficits. Which of the following was expected to happen? A. This would decrease national savings, appreciate the real exchange rate, and decrease net exports. B. This would increase national savings, depreciate the real exchange rate, and increase net exports. C. This would increase national savings, depreciate the real exchange rate, and increase net exports. D. This would decrease national savings, depreciate the real exchange rate, and decrease net exports.

Answer 140

C. This would increase national savings, depreciate the real exchange rate, and increase net exports.

Question 141

Suppose that Canada imposes an import quota on automobiles. Which of the following describes the most likely effects of this quota? A. The quota would cause the real exchange rate of Canadian dollars to appreciate, but it would not change the real interest rate in Canada. B. The quota would cause the real exchange rate of Canadian dollars to appreciate and the real interest rate in Canada to increase. C. The quota would cause the real exchange rate of Canadian dollars to depreciate and the real interest rate in Canada to decrease. D. The quota would cause the real exchange rate of Canadian dollars to depreciate, but it would not change the real interest rate in Canada.

Answer 141

A. The quota would cause the real exchange rate of Canadian dollars to appreciate, but it would not change the real interest rate in Canada.

Question 142

``` What happens to sales and profit during recessions? A. sales and profits fall B. sales and profits rise C. sales rise and profits fall D. profits fall and sales rise ```

Answer 142

A. sales and profits fall

Question 143

How does the size of investment as a fraction of GDP compare to its importance in creating economic fluctuations? A. Investment is a small part of real GDP and it accounts for a small share of the fluctuation in real GDP. B. Investment is a small part of real GDP, yet it accounts for a large share of the fluctuation in real GDP. C. Investment is a large part of real GDP and it accounts for a large share of the fluctuation in real GDP. D. Investment is a large part of real GDP, yet it accounts for a small share of the fluctuation in real GDP.

Answer 143

B. Investment is a small part of real GDP, yet it accounts for a large share of the fluctuation in real GDP.

Question 144

``` In addition to the price level, which of the following does the aggregate demand and aggregate supply model focus on? A. real GDP B. nominal GDP C. the neutrality of money D. stock prices ```

Answer 144

A. real GDP

Question 145

Which of the following best explains the slope of the aggregate demand curve? A. The aggregate demand curve slopes downward for the same reasons that market demand curves slope downward. B. The aggregate demand curve is vertical in the long run because people can only consume a certain maximum quantity. C. The aggregate demand curve is downward sloping because it shows an inverse relation between the price level and the quantity of all goods and services demanded. D. The aggregate demand curve is downward sloping because the more people wish to consume, the lower is the price.

Answer 145

C. The aggregate demand curve is downward sloping because it shows an inverse relation between the price level and the quantity of all goods and services demanded.

Question 146

Which of the following is NOT included in aggregate demand? A. purchases of stock and bonds B. purchases of services such as visits to the doctor C. purchases of capital goods such as equipment in a factory D. purchases by foreigners of consumer goods produced in Canada

Answer 146

A. purchases of stock and bonds

Question 147

Which of the following best describes the effects of a fall in the price level? A. Dollars become more valuable, and interest rates rise. B. Dollars become more valuable, and interest rates fall. C. Dollars become less valuable, and interest rates rise. D. Dollars become less valuable, and interest rates fall.

Answer 147

B. Dollars become more valuable, and interest rates fall.

Question 148

``` In the aggregate demand and aggregate supply model, when does the aggregate quantity of goods demanded decrease? A. when real wealth increases B. when the interest rate falls C. when the dollar depreciates D. when stock prices fall ```

Answer 148

D. when stock prices fall

Question 149

How does the aggregate demand and supply model reflect a decrease in taxes? A. Consumption increases, so aggregate demand shifts right. B. Consumption increases, so aggregate supply shifts right. C. Consumption decreases, so aggregate demand shifts left. D. Consumption decreases, so aggregate supply shifts left.

Answer 149

A. Consumption increases, so aggregate demand shifts right.

Question 150

``` Which of the following shifts aggregate demand to the left? A. an increase in the price level B. a decrease in the money supply C. an increase in net exports D. an investment tax credit ```

Answer 150

B. a decrease in the money supply

Question 151

When is the aggregate supply curve upward sloping rather than vertical? A. in the short and the long run B. in neither the short run nor long run C. in the long run, but not in the short run D. in the short run, but not in the long run

Answer 151

D. in the short run, but not in the long run

Question 152

``` In which of the following situations would the long-run aggregate supply curve shift right? A. if immigration from abroad decreases B. if the capital stock decreases C. if the money supply increases D. if technology advances ```

Answer 152

D. if technology advances

Question 153

According to misperceptions theory, if a firm thought that inflation was going to be 5 percent and actual inflation was 6 percent, how the firm may be affected? A. It may believe that the relative price has increased, so it would increase production. B. It may believe that the relative price has increased, so it would decrease production. C. It may believe that the relative price has decreased, so it would increase production. D. It may believe that the relative price has increased, so it would decrease production.

Answer 153

A. It may believe that the relative price has increased, so it would increase production.

Question 154

According to the sticky wage theory, which of the following is consistent with an unexpected fall in the price level? A. The real wage rises and employment rises. B. The real wage rises and employment falls. C. The real wage falls and employment rises. D. The real wage falls and employment falls.

Answer 154

B. The real wage rises and employment falls.

Question 155

Which of the following shifts the short-run aggregate supply left? A. an increase in the price level B. an increase in the expected price level C. an increase in the capital stock D. a decrease in taxes

Answer 155

B. an increase in the expected price level

Question 156

Which of the following could create an increase in the price level and a decrease in real GDP in the short run? A. an increase in the money supply B. an increase in government expenditures C. a fall in stock prices D. bad weather in farm provinces

Answer 156

D. bad weather in farm provinces

Question 157

``` Which of the following would cause stagflation? A. aggregate demand shifts right B. aggregate demand shifts left C. aggregate supply shifts right D. aggregate supply shifts left ```

Answer 157

D. aggregate supply shifts left

Question 158

Suppose the economy is in long-run equilibrium. Concerns about pollution cause the government to significantly restrict the production of electricity. At the same time, the value of the dollar falls. What would we expect to happen in the short run? A. Real GDP will rise, and the price level might rise, fall, or stay the same. B. Real GDP will fall, and the price level might rise, fall, or stay the same. C. The price level will rise, and real GDP might rise, fall, or stay the same. D. The price level will fall, and real GDP might rise, fall, or stay the same.

Answer 158

C. The price level will rise, and real GDP might rise, fall, or stay the same.

Question 159

Suppose the economy is in long-run equilibrium. If there is a sharp decline in the stock market combined with a significant increase in immigration of skilled workers, what would we expect to happen? A. In the short run, real GDP will rise, and the price level might rise, fall, or stay the same. In the long-run, real GDP will rise, and the price level might rise, fall, or stay the same. B. In the short run, the price level will fall, and real GDP might rise, fall, or stay the same. In the long-run, real GDP and the price level will be unaffected. C. In the short run, the price level will rise, and real GDP might rise, fall, or stay the same. In the long run, real GDP will rise, and the price level will fall. D. In the short run, the price level will fall, and real GDP might rise, fall, or stay the same. In the long run, real GDP will rise, and the price level will fall.

Answer 159

D. In the short run, the price level will fall, and real GDP might rise, fall, or stay the same. In the long run, real GDP will rise, and the price level will fall.

Question 160

What are the benefits of international trade?

Answer 160

- raise living standards in all countries (make everyone better off) - each county can specialize in producing goods and services in which it has comparative advantage - allows consumption of a great variety of goods and services produced around the world

Question 161

Closed vs Open Ecocomy

Answer 161

Closed economy: an economy that does not interact with other economies in the world Open economy: an economy that interacts freely with other economies around the world (it buys and sells goods and services in world product markets and it buys and sells capital assets like stocks and bonds in world financial markets)

Question 162

Exports vs Imports

Answer 162

Exports: goods and services produced domestically and sold abroad Imports: goods and services produced abroad and sold domestically

Question 163

Formula of net exports

Answer 163

Net exports = value of country’s exports - value of country’s imports *also called trade balance

Question 164

Trade surplus vs trade deficit vs balanced trade

Answer 164

Trade surplus: if net exports are positive, so exports are greater than imports Trade deficit: if net exports are negative, so imports are greater than exports Balanced trade: if net exports is 0, so exports and imports are equal

Question 165

Name the factors that might influence a country’s exports, imports and net exports.

Answer 165

- tastes of consumers for domestic and foreign goods - prices of goods at home and abroad - exchange rates at which people can use domestic currency to buy foreign currencies - incomes of consumers at home and abroad - cost of transporting goods from country to country - government policies toward international trade

Question 166

Why has international trade increased throughout the years?

Answer 166

- New improvements to transportation of goods around the world (For example, boats can now carry more cargo and planes allow for better air transport) - Advances in telecommunications allows businesses to reach overseas customers more easily - Changes in the kinds of goods produced (modern technology allows for lighter products that are less costly and easier to transport) - Government trade polices (ex-crossing items over US and Canada border without paying import duties, elimination of tariffs, North American Free Trade Agreement, import quotas)

Question 167

Give the formula for net capital outflow.

Answer 167

The purchase of foreign assets by domestic residents - purchase of domestic assets by foreigners

Question 168

What happens to Canadian net capital outflow when: A) a Canadian buys tock in Telmex, the Mexican phone company B) a Japanese resident buys a bond issued by the Canadian government

Answer 168

A) raises Canadian net capital outflow | B) reduces Canadian net capital outflow

Question 169

Foreign direct investment vs Foreign portfolio investment

Answer 169

Foreign direct investment: Tim Hortons opens a fast food outlet in Russia (Canadian owner is actively managing the investment) Foreign portfolio investment: Canadian buys stock in a Russian corporation (Canadian owner has a more passive role)

Question 170

How do foreign direct investment and foreign portfolio investment affect Canadian net capital outflow?

Answer 170

- in both cases, Canadian residents are buying assets located in another country, so both purchases increase Canadian net capital outflow - net capital outflow is sometimes called net foreign investment

Question 171

When is net capital outflow positive or negative?

Answer 171

Positive: domestic residents are buying more foreign assets than foreigners are buying domestic assets; capital flows out of the country Negative: domestic residents are buying less foreign assets than foreigners are buying domestic assets; capital flows into the country (capital inflow)

Question 172

Name some variables that influence net capital outflow.

Answer 172

- real interest rates being paid on foreign assets - real interest rates being paid on domestic assets - perceived economic and political risks on holding assets abroad (default: not pay interest or principal of the bond when it’s due) - government policies that affect foreign ownership of domestic assets * the higher a bond’s real interest rate, the more attractive it is

Question 173

Def: Identity

Answer 173

An equation that must hold because of the way the variables in the equation are defined and measured

Question 174

What is the accounting equation or identity when it comes to net capital outflow and net exports? And why does it hold true?

Answer 174

NCO=NX * every international transaction is an exchange - when a seller country transfers a good or service to a buyer country, the buyer country gives up some asset to pay for this good or service - the value of that asset equals the value of the good or service sold

Question 175

When a country is running a trade surplus, it is selling more goods and services to foreigners than it is buying from them. What happens to NX and NCO? What is it doing with the foreign currency it receives from the net sale of goods and services abroad?

Answer 175

NX>0 and NCO>0 (since NX=NCO) - with the foreign currency it receives from the net sale of goods and services abroad, it uses it to buy foreign assets - capital is flowing out of the country

Question 176

When a country is running a trade deficit, it is buying more goods and services from foreigners than it is selling to them. What happens to NX and NCO? How is it financing the net purchase of these goods and services in world markets?

Answer 176

NX<0 and NCO<0 (since NX=NCO) - to finance the net purchase of these goods and services in world markets, it must be selling assets abroad - capital is flowing into the country

Question 177

What is the accounting identity for the economy’s domestic gross product (Y)? What about national saving (S)and how it can be applied to this equation?

Answer 177

``` Y=C+I+G+NX (Total expenditure on the economy’s output of goods and services is the sum of expenditure on consumption, investment, government purchases and net exports) S=Y-C-G Y-C-G=I+NX S=I+NX S=I+NCO ```

Question 178

What does the equation S=I+NCO represent?

Answer 178

Saving=Domestic investment+Net capital investment outflow - when a Canadian citizen saves a dollar of their income for the future, that dollar can be used to finance accumulation of domestic capital or be used to finance the purchase of capital abroad - in a closed economy, S=I, but in an economy S=I+NCO (two opportunities for investment)

Question 179

A) When a nation’s saving exceeds its domestic investment, what is net capital outflow? B) When a nation’s domestic investment exceeds its saving, what is net capital outflow?

Answer 179

A) positive (nation is using some of its saving to buy assets abroad) B) negative (foreigners are financing some of this investment by purchasing domestic assets)

Question 180

There are three possible outcomes for an open economy when it comes to international flows of goods and capital: trade deficit, balanced trade and trade surplus. Give a summary for each of their effects.

Answer 180

A) Trade Deficit | Exports

Question 181

Def: Nominal exchange rate

Answer 181

-the rate at which a person can trade the currency of one country for the currency of another

Question 182

Appreciation vs Depreciation of the dollar

Answer 182

Appreciation: an increase in the value of a currency as measured by the amount of foreign currency it can buy (if the exchange rate changes so that a dollar buys more foreign currency) Depreciation: a decrease in the value of a currency as measured by the amount of foreign currency it can buy (if the exchange rate changes so that a dollar buys less foreign currency)

Question 183

What is the exchange rate index and what does it take into account?

Answer 183

- turns the many exchanges rates into a single measure of the international value of the currency - so appreciation and depreciation refers to an exchange rate index that takes into account many individual exchange rates

Question 184

Def: Real Exchange Rate

Answer 184

- the rate at which a person can trade the goods and services of one country for the goods and services of another - ex) a case of German beer is twice as expensive as a case of Canadian beer, so the real exchange rate is half of a case of German beer per case of Canadian beer - expressed as units of foreign item per unit of domestic item (good, not currency)

Question 185

What is the equation to calculate the real exchange rate when calculating for individual items?

Answer 185

Real exchange rate = (Nominal exchange rate*Domestic price)/Foreign price

Question 186

The real exchange rate is a key determinant of what?

Answer 186

Of how much a country exports or imports

Question 187

What is the equation to calculate the overall real exchange rate when calculating for the overall prices (the economy as a whole)? What does it measure?

Answer 187

Real exchange rate = (e*P)/P* Where, e=nominal exchange rate between the Canadian dollar and foreign currencies, P=price index for a Canadian basket, P*=price index for a foreign basket -measures the price of a basket of goods and services available domestically relative to a basket of goods and services available abroad

Question 188

A depreciation in Canada’s real exchange rate means what? An appreciation in Canada’s real exchange rate means what?

Answer 188

- A depreciation in Canada’s real exchange rate means that Canadian goods have become cheaper relative to foreign goods, encourages both consumers at home and abroad to buy more Canadian goods and fewer foreign goods, so Canada’s exports rise and Canada’s imports fall, so Canada’s net exports rise. - An appreciation in Canada’s real exchange rate means that Canadian goods have become more expensive compared to foreign goods, no Canada’s net exports fall.

Question 189

What are the benefits and costs of adopting a common currency (what happened in Europe with the euro)?

Answer 189

Benefits: makes trade easier, each time you wanted to go cross a border you needed to change your money with the exchange rate making it inconvenient and deter you from buying goods and services outside your country Costs: only one monetary policy so each nation must come to a common agreement on a single policy

Question 190

Def: Purchasing-power parity

Answer 190

-a theory of exchange rate determination (in the long-run) whereby a unit of any given currency should be able to buy the same quantity of goods in all countries

Question 191

What does the “law of one price” explain and how is it a principle that the theory of purchasing-power parity is based on?

Answer 191

- asserts that a good must sell for the same price in all locations, otherwise, opportunities for profit would be left unexploited - a currency must have the same purchasing power in all countries (purchasing-power parity) - a Canadian dollar must buy the same quantity of goods in Canada and Japan, and a Japanese yen must buy the same quantity of goods in Japan and Canada

Question 192

Def: arbitrage

Answer 192

The process of taking advantage of differences in prices in different markets.

Question 193

What are the equations that represent the purchasing power of a dollar to be the same in two countries?

Answer 193

1/P =e/P* (1/P is the purchasing power of 1$ at home and e/P* is the purchasing power for the exchange of the dollar for the foreign currency) 1=eP/P* (real exchange rate)

Question 194

What does the theory of purchasing-power parity imply about the nominal exchange rate between the currencies of two countries?

Answer 194

- The nominal exchange rate between the currencies of two countries must reflect the different price levels in those countries. - nominal exchange rates change when price levels change, so also depends on money supply and money demand

Question 195

Does currency appreciate or depreciate relative to other currencies in the world when a central bank decides to increase the money supply?

Answer 195

- causes the price level to rise - country’s currency depreciates relative to other currencies in the world - money loses value - can buy less goods and services - can buy less of an amount of other currencies

Question 196

Why did the Canadian dollar lose value compared to the German mark and gain value compared to the Italian lira?

Answer 196

Germany pursued a less inflationary monetary policy than Canada (Canadian prices rose and value of the dollar fell) and Italy pursued a more inflationary monetary policy than Canada (Canadian prices fell and value of the dollar rose).

Question 197

Explain what happens (the pattern) during hyperinflation to the price level, money supply and the exchange rate.

Answer 197

- price level increases dramatically - money supply increases dramatically at the same rate - exchange rate depreciates dramatically at the same rate - when things stabilize, everything stabilizes

Question 198

Name two reasons why the theory of purchasing-power parity does not always hold in practice.

Answer 198

1) many goods are not easily tradable 2) even tradable goods are not always perfect substitutes when they are produced in different countries - for these reasons, real exchange rates fluctuate over time

Question 199

How do economists describe the Canadian economy?

Answer 199

A small open economy with perfect capital mobility

Question 200

Def: Small open economy

Answer 200

-an economy that trades goods and services with other economies and, by itself, has a negligible effect on world prices and interest rates

Question 201

Def: Perfect capital mobility

Answer 201

Full access to world financial markets

Question 202

What is the relationship between the Canadian real interest rate and the world real interest rate with perfect capital mobility?

Answer 202

For a small open economy, r=r^w ( r=Canadian real interest rate and r^w=world real interest rate) -As long as the Canadian and foreign assets are close substitutes, the difference in interest rates provides an arbitrage opportunity for either borrowers or savers

Question 203

Def: Interest rate parity

Answer 203

A theory of interest rate determination whereby the real interest rate on comparable financial assets should be the same in all economies with full access to world financial markets

Question 204

Name the two reasons why the interest rate parity does not always hold in practice.

Answer 204

1) financial assets carry with them the possibility of default (seller may not repay the buyer), where buyers incur a default risk; the higher the default risk, the higher the interest rate; interest rate differences may persist if the seller of one asset is perceived likely to default more than another 2) financial assets offered for sale in different countries are not necessarily perfect substitutes for one another (tax treatments)

Question 205

Is Canadian net capital outflow positive or negative today?

Answer 205

negative NCO, foreigners purchased more Canadian assets than Canadians purchased foreign assets, so many firms in Canada are owned by foreigners

Question 206

What are the components of the market for loanable funds?

Answer 206

- demand for loanable funds comes from domestic investment (I) - supply of loanable funds comes from national saving (S)

Question 207

Explain what happens when SI.

Answer 207

S=I+NCO | -SI: Canadian savings have been used to purchase foreign assets and NCO is positive

Question 208

Suppose that the Canadian interest rate is 5% and the world interest rate is 8%. Why can’t this situation persist?

Answer 208

- because of full access to world financial markets, Canadian savers would prefer to buy foreign assets that pay the higher interest rate - savers sell their holdings of Canadian assets and buy foreign assets instead - Canadian borrowers would have to offer to pay the more attractive world interest rate of 8%

Question 209

In the diagram for the market of loanable funds, why does the demand curve slope downward?

Answer 209

- a higher real interest rate makes borrowing to finance capital projects more costly - discourages investment - reduces the quantity of loanable funds demanded

Question 210

In the diagram for the market of loanable funds, why does the supply curve slope upward?

Answer 210

- a high real interest rate encourages people to save - raises the quantity of loanable funds made available by national saving - unlike the closed economy where you only take into account the savings of Canadians (real interest rate determined by the intersection of the demand and supply curves for loanable funds), but in a small open economy with perfect capital mobility, the interest rate is equal to the world interest rate and now savings of foreigners are taken into account

Question 211

How is net capital outflow and net exports determined in the market for loanable funds?

Answer 211

- net capital outflow is determined by the difference between the supply of loanable funds due to national saving (S) and demand for loanable funds (I) at the world interest rate - net exports are determined by the difference between the supply of loanable funds due to national saving (S) and the demand for loanable funds (I) at the world interest rate - due to NCO=NX

Question 212

Why does the market for foreign currency exchange exist?

Answer 212

- because people want to trade goods, services, and financial assets with people in other countries, but they want to be paid for these things in their own currency - for a Canadian to purchase a good, service or financial asset from someone in another country, the Canadian must purchase the other country’s currency as well

Question 213

Which identity is useful for describing the market for foreign-currency exchange?

Answer 213

S-I=NX - states that the imbalance between domestic supply of loanable funds due to national saving (S) and the demand for loanable funds for domestic investment (I) must equal the imbalance between exports and imports - the difference between S and I (=NCO) represents the quantity of dollars supplied in the market for foreign-currency exchange for the purpose of buying foreign assets - Japanese want to buy airplane but need Canadian dollars so must demand dollars in the market for foreign-currency exchange

Question 214

What price balances the supply and demand in the market for foreign-currency exchange?

Answer 214

- real exchange rate, is the relative price of domestic and foreign goods - a key determinant of net exports

Question 215

When Canada’s real exchange rate appreciates, what happens to net exports and to the market for foreign-currency exchange?

Answer 215

- Canadian goods become more expensive relative to foreign goods, making Canadian goods less attractive to consumers both at home and abroad - exports from Canada fall and imports into Canada rise - net exports fall - reduces the quantity of dollars demanded in the market for foreign-currency exchange

Question 216

Why does the demand curve slope downward in the market for foreign-currency exchange?

Answer 216

- a higher real exchange rate makes Canadian goods more expensive - reduces the quantity of dollars demanded to buy those goods - demand for dollars comes from net exports

Question 217

Why is the supply curve vertical in the market for foreign-currency exchange?

Answer 217

- quantity of dollars supplied for net capital outflow does not depend on the real exchange rate - this is due to changes in the exchange rate influence both the cost of buying foreign assets and the benefit of owning them, and these two effects offset each other

Question 218

A) What happens in the market for foreign-currency exchange if the real exchange rate was below the equilibrium level? B) If the real exchange rate was above the equilibrium level?

Answer 218

A) the quantity of dollars supplies would be less than the demanded, the resulting shortage of dollars would push the value of the dollar upward B) the quantity of dollars supplied would exceed the quantity demanded, the surplus of dollars would drive the value of the dollar downward

Question 219

The market for foreign-currency exchange’s at the equilibrium real exchange rate means what?

Answer 219

-the number of dollars people supply to buy foreign assets exactly balances the number of dollars people demand to buy net exports

Question 220

A) When a Canadian resident imports a car made in Japan, this transaction does what to the quantity of dollars demanded or supplied? B) When a Japanese citizen buys a Canadian Government bond, this transaction does what to the quantity of dollars demanded or supplied?

Answer 220

A) decrease in quantity of dollars demanded (because net exports fall) rather than an increase in the quantity of dollars supplied B) decrease in the quantity of dollars supplied (because net capital outflow falls) rather than an increase in the quantity of dollars demanded

Question 221

Which variable links the market for loanable funds and the market for foreign-currency exchange? What is the key determinant for this variable?

Answer 221

A) Net capital outflow | B) world interest rate

Question 222

Is net capital outflow positive or negative when: A) the world interest rate is higher than the interest rate that equates the demand for loanable funds to the supply of loanable funds coming form savings B) the world interest rate is lower than the interest rate that equates the demand for loanable funds to the supply of loanable funds coming form savings

Answer 222

A) net capital outflow is positive and is equal to the difference between national saving and the domestic demand for loanable funds B) net capital outflow is negative and is equal to the difference between national saving and the domestic demand for loanable funds

Question 223

Because national saving in the market for loanable funds is more than sufficient to provide loanable funds for domestic investment, the excess is used to ______.

Answer 223

Buy foreign assets, this is net capital outflow. | NCO=S-I

Question 224

What does the net capital outflow in the Market for Loanable Funds represent in the Market for Foreign-Currency Exchange?

Answer 224

It represents the supply of dollars (S-I); the vertical line

Question 225

Name what each market allows us to determine. A) The Market for Loanable Funds B) The Market for Foreign-Currency Exchange

Answer 225

A) national saving, domestic investment, net capital outflow (NCO=S-I) B) real exchange rate (price of domestic goods and services relative to foreign goods and services)

Question 226

Why is the Canadian economy affected by the changes in interest rates in the United States?

Answer 226

Because the United States is the largest economy in the world, so movements in the US interest rates are responsible in large part for movements in the world interest rate.

Question 227

An increase in the world interest rate would affect the Market for Loanable Funds and the Market for Foreign-Currency Exchange how?

Answer 227

Market for Loanable Funds: causes net capital outflow to increase Market for Foreign-Currency Exchange: increase in supply of dollars to be exchanged into foreign currency and causes the real exchange rate to depreciate (so there’s a shift to the right in the supply of dollars) *a depreciation in the real exchange rate makes Canadian goods less expensive so people switch to this less expensive product, meaning Canada’s exports rise and imports fall = net exports rise *Conclusion: In a small open economy with perfect capital mobility, an increase in the world interest rate crowds out domestic investment, causes the dollar to depreciate, and causes net exports to rise

Question 228

An increase in the government budget deficit would affect the Market for Loanable Funds and the Market for Foreign-Currency Exchange how?

Answer 228

Loanable Funds: reduces national saving (shifts supply of loanable funds from national saving curve to the left), reduces net capital outflow Foreign-Currency Exchange: reduces supply of dollars (shifts supply of dollars curve to the left), causes real exchange rate to appreciate *dollar becomes more valuable relative to foreign currencies, so Canadian goods become more expensive and people buy foreign goods instead, exports fall and imports rise, net exports fall *Conclusion: In a small open economy with perfect capital mobility, an increase in government budget deficits causes the dollar to appreciate and causes net exports to fall

Question 229

A decrease in the government budget deficit would affect the Market for Loanable Funds and the Market for Foreign-Currency Exchange how?

Answer 229

In a small open economy with perfect capital mobility, a decrease in budget deficit causes the dollar to depreciate and causes net exports to rise.

Question 230

Def: Trade policy

Answer 230

A government policy that directly influences the quantity of goods and services that a country imports or exports. Ex) tariff or import quota

Question 231

Def: Tariff

Answer 231

A tax on goods produced abroad and sold domestically (tax on imported goods)

Question 232

Def: Import quota

Answer 232

A limit on the quantity of a good that is produced abroad and sold domestically

Question 233

What are the effects of an import quota on the Market for Loanable Funds and the Market for Foreign-Currency Exchange?

Answer 233

Market for Foreign-Currency Exchange: increases demand for dollars (shifts supply of dollars curve to the right), causes the real exchange rate to appreciate Market for Loanable Funds: net capital outflow and net exports remain the same *the appreciation in the real exchange rate encourages imports and discourages exports which offset the direct increase in net exports due to quota *Conclusion: Trade policies do not affect the trade balance

Question 234

Why do most economists oppose trade policies?

Answer 234

- free trade allows economies to specialize doing what they do best, making residents of all countries better off - trade restrictions interfere with these gains from trade and reduce the overall economic well-being

Question 235

Def: Capital flight

Answer 235

A large and sudden reduction in the demand for assets located in a country *tends to increase interest rates and cause the currency to depreciate

Question 236

Explain what is the open economy trilemma?

Answer 236

- in most nations, economic policy makers would like to achieve these three goals: 1) make the country’s economy open to international flows of capital 2) use monetary policy as a tool to help stabilize the economy 3) maintain stability in the currency exchange rate - BUT you can’t get all three! Can only choose two of the three!

Question 237

Def: Recession

Answer 237

A period of declining real incomes and rising unemployment (real GDP falls) -recessions are two or more quarters of negative real GDP growth

Question 238

Def: Depression

Answer 238

A severe recession

Question 239

Name three facts about economic short-run fluctuations.

Answer 239

1) are irregular and unpredictable 2) most macroeconomic quantities fluctuate together 3) as output falls, unemployment rises

Question 240

Def: Business cycle

Answer 240

- another name for short-run fluctuations in the economy - economic fluctuations correspond to changes in business conditions - misleading because it suggests that economic fluctuations follow a regular, predictable pattern which it is NOT predictable - when real GDP grows rapidly, business is good, customers are plentiful and profits are growing = economic expansion - when real GDP falls during recession, businesses have trouble, firms experience declining sales and dwindling profits= economic contraction

Question 241

What does real GDP measure?

Answer 241

- the value of all final goods and services produced within a given period of time - measures the total income (adjusted for inflation) of everyone in the economy

Question 242

Which macroeconomic quantities fluctuate together in the economy, especially evident during recessions?

Answer 242

(recessions are two or more quarters of negative real GDP growth) - real GDP declines - investment spending declines - unemployment rises

Question 243

Which variable causes the biggest decline in GDP during recessions but only accounts for a small portion of GDP?

Answer 243

- investment spending accounts for only 1/5 of GDP but it represented 80% of the declines in GDP during Canada’s last three recessions - much of the decline is attributable to reductions in spending on new factories, housing and inventories

Question 244

What is the natural unemployment rate in Canada?

Answer 244

6-7% | -it never approaches zero, instead it fluctuates around its natural rate

Question 245

How is unemployment affected by recessions?

Answer 245

-when real GDP declines, firms choose to produce a smaller quantity of goods and services so they lay off workers, increasing the rate of unemployment

Question 246

What do most economists say about the classical theory in the short-run and the long-run?

Answer 246

Most economists believe that classical theory describes the world in the long-run, but not in the short-run. In the short-run, real and nominal variables are highly intertwined, and changes in the money supply can temporarily push real GDP away from its long-run trend.

Question 247

What do we mean by a “social recession”?

Answer 247

The daily lives of individuals, their families and whole communities are torn by financial loss, unemployment, fear and declining physical and mental health during economic recessions.

Question 248

Def: Model of Aggregate Demand and Aggregate Supply

Answer 248

The model that most economists use to explain short-run fluctuations in economic activity around its long-run trend

Question 249

The Model of Aggregate Demand and Aggregate Supply focuses on the behaviour of which two variables?

Answer 249

- real GDP, a real variable | - overall price level (measured by the CPI or GDP deflator), a nominal variable

Question 250

Def: Aggregate demand curve

Answer 250

A curve that shows the quantity of goods and services that households, firms, and the government want to buy at each price level

Question 251

Def: Aggregate Supply Curve

Answer 251

A curve that shows the quantity of goods and services that firms choose to produce and sell at each price level

Question 252

Why is the Aggregate Demand Curve downward sloping (Summary)?

Answer 252

- a fall in the price level increases the quantity of goods and services demanded 1) consumers are wealthier, which stimulates the demand for consumption goods 2) interest rates fall, which stimulates the demand for investment goods 3) the exchange rate depreciates, which stimulates the demand for net exports * assume “other things equal” which means money supply is fixed (amount of money in economy is fixed)

Question 253

Why the Aggregate Demand Curve slopes downward: The Wealth Effect

Answer 253

- nominal value of the dollar is fixed (always 1$) but real value of money is not fixed - when the price level falls, the value of money rises, which increases your real wealth and your ability to buy goods and services so want to spend more, which also means a larger quantity of goods and services demanded

Question 254

Why the Aggregate Demand Curve slopes downward: The Interest Rate Effect

Answer 254

-a lower price level means less money people need to hold to buy goods and services so try to reduce their holdings of money by lending some out, which reduces interest rates on bonds and loans, encourages greater spending on investment goods and finally increases the quantity of goods and services demanded

Question 255

Why the Aggregate Demand Curve slopes downward: The Real Exchange Rate Effect

Answer 255

-for a given nominal exchange rate, a lower price level causes the real exchange rate to depreciate, making Canadian produced goods and services cheaper relative to foreign produced goods and services, which stimulates Canadian net exports and increases the quantity of goods and services demanded

Question 256

Why might the aggregate-demand curve shift: Changes in consumption

Answer 256

- an event that makes consumers spend more at a given price level (tax cut, stock market boom) shifts the aggregate demand curve to the right - an event that makes consumers spend less at a given price level (tax hike, stock market decline) shifts the aggregate demand curve to the left

Question 257

Why might the aggregate-demand curve shift: Changes in investment

Answer 257

- an event that makes firms invest more at a given price level (optimism about the future, fall in interest rates due to an increase in money supply) shifts the aggregate demand curve to the right - an event that makes firms invest less at a given price level (pessimism about the future, a rise in interest rates due to a decrease in the money supply) shifts the aggregate demand curve to the left

Question 258

Why might the aggregate-demand curve shift: Government purchases

Answer 258

- an increase in government purchases of goods and services (greater spending on defence or highway construction) shifts the aggregate demand curve to the right - a decrease in government purchases of goods and services (a cutback in defence or highway spending) shifts the aggregate demand curve to the left

Question 259

Why might the aggregate-demand curve shift: Net exports

Answer 259

- an event that raises spending on net exports at a given price level (a boom experienced by a major trading partner, an exchange rate depreciation) shifts the aggregate demand curve to the right - an event that reduces spending on net exports at a given price level (a recession experienced by a major trading partner, an exchange rate appreciation) shifts the aggregate demand curve to the left

Question 260

What is the difference between the aggregate supply curve in the long-run and the short-run?

Answer 260

In the long run, the aggregate supply curve is vertical, whereas in the short run, the aggregate supply curve is upward sloping.

Question 261

Why is the aggregate supply curve vertical in the long run?

Answer 261

- in the long run, an economy’s production of goods and services (its real GDP) depends on its supplies of labour, capital, and natural resources and on the available technology used to turn these factors of production into goods and services - because price level does not affect these long run determinants, the supply curve is vertical - a graphical representation of the classical dichotomy and monetary neutrality - implies that the quantity of output (real variable) does not depend on level of prices (nominal variable)

Question 262

How does a change in price level affect the long-run aggregate supply curve?

Answer 262

Does not affect the quantity of goods and services supplied in the long run.

Question 263

Natural level of output / potential output / full-employment output

Answer 263

The production of goods and services that an economy achieves in the long run when unemployment is at its normal rate.

Question 264

Why might the aggregate supply curve shift: Changes in labour

Answer 264

- an increase in the quantity of labour available (perhaps due to a fall in natural rate of unemployment) shifts the aggregate-supply curve to the right - a decrease in the quantity of labour available (perhaps due to a rise in the natural rate of unemployment) shifts the aggregate-supply curve to the left

Question 265

Why might the aggregate supply curve shift: Changes in capital

Answer 265

- an increase in physical or human capital shifts the aggregate supply curve to the right - a decrease in physical or human capital shifts the aggregate supply curve to the left

Question 266

Why might the aggregate supply curve shift: Changes in natural resources

Answer 266

- an increase in the availability of natural resources shifts the aggregate supply curve to the right - a decrease in the availability of natural resources shifts the aggregate supply curve to the left

Question 267

Why might the aggregate supply curve shift: Changes in technology

Answer 267

- an advance in technological knowledge shifts the aggregate supply curve to the right - a decrease in available technology (perhaps due to government regulation) shifts the aggregate supply curve to the left

Question 268

What do short-run fluctuations represent?

Answer 268

Short-run fluctuations in output and the price level should be viewed as deviations from the continuing long-run trends.

Question 269

Explain what happens when the long-run growth and inflation in the model of aggregate demand and aggregate supply?

Answer 269

- in the long run, technological progress shifts the long-run aggregate supply to the right - growth in money supply (done by the Central Bank) shifts the aggregate demand to the right - this leads to growth in output - an ongoing inflation of price levels

Question 270

Why is the aggregate supply curve sloping upward in the short run?

Answer 270

- an increase in the overall price level tends to raise the quantity of goods and services supplied - a decrease in the price level tends to reduce the quantity of goods and services supplied * the quantity of output supplied deviates from its long run or “natural” level when the actual price level deviates from the price level that people expected to prevail (when price level rises above the expected level, output rises above its natural level and when the price level falls below the expected level, output falls below its natural level) * the three theories will not persist forever!

Question 271

Theories for upward slope of the short-run aggregate supply curve: The Sticky Wage Theory

Answer 271

- because nominal wages are slow to adjust to changing economic conditions (wages are sticky in the short run) - nominal wages are based on expected prices and do not respond immediately when the actual price level turns out to be different from what was expected - firms have an incentive to produce less than the natural level of output when the price level turns out to be lower than expected and to produce more when the price level turns out to be higher than expected

Question 272

Theories for upward slope of the short-run aggregate supply curve: The Sticky-Price Theory

Answer 272

- emphasizes that the prices of some goods and services also adjust sluggishly in response to changing economic conditions - slow adjustment of prices occurs in part due to costs to adjusting prices (menu costs) - an unexpected fall in price level leaves some firms with higher than desired prices which depress sales and induce firms to reduce the quantity of goods and services they produce

Question 273

Theories for upward slope of the short-run aggregate supply curve: The Misperceptions Theory

Answer 273

- changes in the overall price level can temporarily mislead suppliers about what is happening in the individual markets in which they sell their output - a lower price level causes misperceptions about relative prices and these misperceptions induce suppliers to respond to the lower price level by decreasing the quantity of goods and services supplied

Question 274

What is the formula for the quantity of output supplied?

Answer 274

Quantity of output supplied = natural level of output + a (actual price level-expected price level) SHORT RUN Where a is a number that determines how much output responds to unexpected changes in the price level Quantity of output supplied = Natural level of output LONG RUN

Question 275

Why the Short-Run Aggregate-Supply Curve Might shift: Changes in the Expected Price Level

Answer 275

* *all the same reasons in the long-run except for an additional reason: - a decrease in the expected price level shifts the short-run aggregate-supply curve to the right - an increase in the expected price level shifts the short-run aggregate-supply curve to the left (wages are higher, costs increase and firms supply a smaller quantity of goods and services at any given price level)

Question 276

How does a wave of pessimism affect the economy?

Answer 276

- affects spending plans so affects the aggregate-demand curve - households and firms want to buy a smaller quantity of goods and services for any given price level, reduces aggregate demand so shifts to the left - causes output to fall in the short-run and price level to fall = recession - firms respond to lower sales and production by reducing employment (rising unemployment) and falling incomes - expected price level falls which alters wages, prices and perceptions - firms begin to bargain for lower nominal wages, which encourages firms to hire more workers an expand production - over time, the short-run aggregate supply curve shifts to the right - now in the long run, price level falls and output returns to its natural level * the long-run effect of a shift in aggregate demand is a nominal change (price level is lower) but not a real change (output is the same)

Question 277

What are the three important lessons of shifts in aggregate demand?

Answer 277

1) in the short-run, shifts in aggregate demand cause fluctuations in the economy’s output of goods and services 2) in the long-run, shifts in aggregate demand affect the overall price level but do not affect output 3) policymakers who influence aggregate demand can potentially mitigate the severity of economic fluctuations

Question 278

How does an increase in production costs affect the economy?

Answer 278

- production costs affect the firms that supply goods and services so does changes to the aggregate-supply curve - higher production costs make selling goods and services less profitable, firms now supply a smaller quantity of output for any given price level - short-run aggregate supply curve shifts to the left - causes output to fall - price level rises * economy experiences both stagnation (falling output) and inflation (rising prices) =stagflation - firms raise their expectations of the price level and set higher nominal wages, so costs rise again and short-run aggregate supply curve shift further to the left (stagflation even worse) =wage-price spiral - low level of output and employment will put downward pressure on worker’s wages due to less bargaining power when unemployment is high - nominal wages fall, producing goods and services become more profitable and the short-run aggregate supply curve shifts to the right - price level falls and quantity of output approaches its natural level (in the long run)

Question 279

Def: stagflation

Answer 279

A period of falling output and rising prices

Question 280

What does it mean when policymakers accommodate the shift in aggregate supply curve?

Answer 280

-accepts a permanently higher level of prices to maintain a higher level of output and employment

Question 281

What are the two important lessons about the shifts in aggregate supply?

Answer 281

1) shifts in aggregate supply can cause stagflation-a combination of recession (falling output) and inflation (rising prices) 2) Policymakers who can influence aggregate demand can potentially mitigate the adverse impact on output, but only at the cost of exacerbating the problem of inflation

Question 282

Def: Cartel

Answer 282

A group of sellers that attempts to thwart competition and reduce production in order to raise prices