Honors Economics Macro Test (#1): Study Guide

Classical Dichotomy

A theory that suggests changes in the money supply only affect nominal variables, like prices, but do not impact real variables, like output or employment

Demand for Money

The amount of money that households, businesses, and the government wish to hold in liquid form, such as cash or in transaction accounts

Financial Intermediary

An institution, like a bank, that acts as a middleman between savers who provide funds and borrowers who use them

Financial Intermediation

The process through which financial intermediaries channel funds from savers to borrowers by lending out deposited funds

Hyperinflation

An extremely high and rapidly accelerating rate of inflation that causes a drastic loss in the value of a currency

Loanable Funds

The total amount of money available in the economy for lending and borrowing, typically determined by savings and investment

Monetary Neutrality

The idea that changes in the money supply only affect nominal variables, like the price level, and have no long

Nominal Interest Rate

The interest rate that is stated on a loan or deposit, not adjusted for inflation

Nominal Variables

Economic variables that are measured in monetary terms and are influenced by changes in the price level or inflation

Real Interest Rate

The interest rate that has been adjusted to remove the effects of inflation, reflecting the true cost of borrowing

Real Variables

Economic variables that are adjusted for changes in the price level or inflation, such as real GDP or real wages

Velocity of Money

The rate at which money circulates in the economy, measured by the number of times a unit of currency is used to purchase goods and services in a year

Equation of Exchange

An equation expressing the relationship between the money supply, velocity of money, price level, and real output

M × V = P × Y, where M is the money supply, V is the velocity of money, P is the price level, and Y is real GDP

Nominal Interest Rate Formula

The nominal interest rate is the sum of the real interest rate and the expected inflation rate

Crowding Out Effect

The reduction in private investment that occurs when the government increases borrowing, leading to higher interest rates

Expansionary Fiscal Policy

A policy that involves increasing government spending or decreasing taxes to stimulate economic activity, often used to combat a recession

Contractionary Fiscal Policy

A policy aimed at reducing government spending or increasing taxes to slow down an overheated economy and control inflation

Loanable Funds Market

A model that shows the interaction of borrowers and lenders in the economy, determining the equilibrium interest rate and the quantity of loanable funds

Real vs. Nominal GDP

Nominal GDP is the total value of goods and services produced in an economy without adjusting for inflation, while real GDP accounts for inflation, reflecting the actual output

Monetary Policy Tools

Tools used by the central bank, such as open market operations, the discount rate, and reserve requirements, to influence the money supply and interest rates

Automatic Stabilizers

Economic policies and programs, such as unemployment benefits and tax systems, that automatically adjust to stabilize an economy without the need for new government action

Budget Deficit

A situation where government spending exceeds tax revenues in a given period, leading to borrowing to cover the gap

Budget Surplus

A situation where government revenues exceed spending in a given period, resulting in savings or debt reduction

Economic Investment

Spending on physical capital goods, like machinery, factories, or infrastructure, to increase future productive capacity

Financial Investment

The purchase of assets like stocks, bonds, or real estate for the purpose of earning a return

Phillips Curve

A concept that shows an inverse relationship between inflation and unemployment, suggesting that higher inflation is associated with lower unemployment in the short run

State Government Spending

Spending by state governments, which are required to balance their budgets and cannot run deficits like the federal government

Federal Government Spending

Spending by the federal government, which has more flexibility to run deficits and borrow money to finance spendin