ECN211 Midterm #3 Terminology

quantity theory of money

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

nominal variable

variables measured in monetary units

real variables

variables measured in physical units

classical dichotomy

the theoretical separation of nominal variables and real variables

monetary neutrality

the proposition that changes in the money supply do not affect real variables

velocity of money

the rate at which money changes hands

quantity equation (+what it is)

the equation M x V = P x Y, which relates the quantity of money, the velocity of money, and the dollar value of the economy’s output of goods and services

inflation tax

the revenue the government raises by creating money

fisher effect

the one-for-one adjustment of the nominal interest rate to the inflation rate

shoeleather cost

the resources wasted when inflation encourages people to reduce their money holdings

menu costs

the costs of changing prices

recession

a period of declining real incomes and rising unemployment

depression

a severe recession

model of aggregate demand and aggregate supply

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

aggregate demand curve

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

aggregate supply curve

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

natural level of output

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

stagflation

a period of falling output and rising prices

theory of liquidity preference

keyne’s theory that the interest rate adjusts to bring money supply and money demand into balance

fiscal policy

the setting of the levels of government spending and taxation by government policymakers

multiplier effect

the additional shifts in aggregate demand that result when expansionary fiscal policy increases income and thereby increases consumer spending

crowding out effect

the offset in aggregate demand that results when expansionary fiscal policy raises the interest rate and thereby reduces investment spending

automatic stabilizers

changes in fiscal policy that stimulate aggregate demand when the economy goes into a recession but that occur without policymakers having to take any deliberate action

phillips curve

a curve that shows the short run tradeoff between inflation and unemployment

natural rate hypothesis

the claim that unemployment eventually returns to its normal, or natural, rate, regardless of the rate of inflation.

supply shock

an event that directly alters firms’ costs and prices, shifting the economy’s aggregate supply curve and thus the phillips curve

sacrifice ratio

the number of percentage points of annual output lost in the process of reducing inflation by 1 percentage point

rational expectations

the theory that people optimally use all the information they have, including information about government policies, when forecasting the future