AP Macroeconomics Chapter 4 - TEST REVIEW

ADDING TIPS FROM THE STUDY GUIDES SOON

Why do assets hold value? Are loans critical in any way?

Assets hold value because they allow the holder to get more wealth over time, allows for asset growth due to interest. Loans are critical because they help grow the aggregate economy.

Are loans an asset?

No, its both an asset and liability.

Nominal interest rates:

Real Interest rates:

Nominal: Are the rates you see when doing business with a financial institution. Charged by banks on loans!

Real: Real rate of return earned on financial assets or paid back loans. Adjusted for inflation.

What equation helps us calculate the real rate of return?

The Fischer equation.

How to calculate nominal and real interest rate?

Nominal interest rates = real interest rate + inflation rate

Real interest rates = nominal interest rate - inflation rate

What happens when expected turns out to not be realized, and there’s unexpected inflation?

• Real rate of return on financial asset falls.

• Real value of the financial asset falls.

If the question asked “fixed interest” does nominal interest chnage?

No.

What happens in scenarios with higher unexpected inflation?

• Borrowers are better off as they pay back their loans with the dollar holding less value.

• Lenders lose, they expected higher rates of return.

What is a:

Unit of account:

Medium of exchange:

Store of value:

Unit of account: Something that people commonly accept as money and as a way to set prices. (Ex: dollars, yen, euros).

Medium of exchange: Money holds purchasing power over time. (Ex: Inflation)

Store of value: It is a way to exchange goods and services. (holding money into a retirement account over time).

Highlight the money Supply:

M0: Monetary Base, currency and bank reserves.

M1: Currency in circulation, demand deposits, and savings accounts.

M2: M1 + small denomination time deposits + retail money market funds.

What is the RR?

Central bank sets a % on how much a consumer bank needs to have to remain open.

What do changes in demand deposits impact?

Bank’s reserves and the amount of new loans it can make.

Money multiplier formula:

1/rr

Max possible change to ms:

(OMO amount) x MM

Who controls the supply in the money market?

Central Bank.

What does the supply curve look like of the quantity of money supplied?

Horizontal.

At higher interest rates on the MM graph, what happens?

Surplus will drive down interest rate.

At lower interest rates on the MM graph, what happens?

Shortage will drive up interest rate.

What’s true about quantity of money demanded?

Falls when IR rise, opportunity cost of holding money increases.

What happens if more money is demanded than supplied?

Interest rates increase.

When price level increases, what happens to the demand for money?

Increase.

What can banks do when they don’t meet the RR?

• Call in loans

• Sell Assets

• Borrow from the central bank (discount rate)

• Borrow from other commercial banks (policy rate)

How does expansionary monetary policy work?

When the central bank decreases nominal interest rates in the short run to get the economy out of a recessionary gap.

How does contractionary monetary policy work?

When the central bank increases nominal interest rates in the short run to get the economy out of an inflationary gap.

What would lead to an increase in nominal interest rates?

Contractionary monetary policy accompanied by an increase in the demand for money.

How would a FED increase on the RR effect MS and interest rates?

Decrease MS, increase Interest rates.

How would a FED decrease on the RR effect MS and interest rates?

Increase MS, decrease Interest rates.

If the FED sells bonds the money supply does what? What happens to interest rates and investment?

Decrease; Increase; Decrease.

If the FED decreases the discount rate, the MS will ____ and interest rates will ____ .

Increase; Decrease.

If the FED buys bonds the money supply does what? What happens to interest rates and investment?

Increase; Decrease; Increase.

What’s the FFR (Federal Funds Rate)?

Interest rate banks charge each other for taking out loans.