ECO 202

CH 15-18 Study Guide

What are macroeconomic policies and their goals?

They include fiscal and monetary policy, aiming to influence GDP, unemployment, and inflation.

What is Keynesian economics?

Theory that government intervention can stabilize the economy through fiscal policy.

What is Classical economics?

Belief that markets are self-correcting and government should stay out of economic affairs.

What are government outlays?

Government spending that includes transfer payments, purchases, and interest on debt.

What are the main categories of government outlays?

1. Mandatory (e.g., Social Security, Medicare)

2. Discretionary (e.g., defense, education)

3. Interest on debt.

What are transfer payments?

Payments made without exchange for goods or services (e.g., Social Security, unemployment benefits).

What is Social Security?

A federal insurance program for retirees, disabled persons, and survivors.

What is Medicare?

A federal health insurance program for people 65 and older.

What is the source of government revenue?

Mainly taxes (income, payroll, corporate, excise, etc.).

What is a progressive tax?

A tax where the rate increases as income increases.

What is a budget deficit, surplus, and balanced budget?

Deficit: spending > revenue; Surplus: revenue > spending; Balanced: revenue = spending.

What is the difference between deficit and debt?

Deficit is the yearly shortfall; debt is the total accumulation of past deficits.

What is fiscal policy and who conducts it?

Government changes in spending and taxes, conducted by Congress and the President.

What happens with expansionary fiscal policy?

Government increases spending or cuts taxes → GDP ↑, unemployment ↓, inflation ↑.

What happens with contractionary fiscal policy?

Government cuts spending or raises taxes → GDP ↓, unemployment ↑, inflation ↓.

What would a Keynesian economist do?

Use fiscal policy to manage demand and stabilize the economy.

What would a Classical economist do?

Avoid government intervention; trust the market to self-correct.

What is countercyclical fiscal policy?

Policy that moves against the business cycle—stimulative in recessions, restrictive in booms.

What is MPC (marginal propensity to consume)?

The portion of extra income that consumers spend (not save).

What is the spending multiplier?

1 / (1 - MPC); shows how initial spending leads to larger total impact.

How does MPC affect the multiplier?

Higher MPC → larger multiplier.

What are the shortcomings of fiscal policy?

Time lags, crowding out, savings shifts, and imperfect information.

What are automatic stabilizers?

Policies that automatically change with the economy (e.g., unemployment insurance, progressive taxes).

Examples of automatic stabilizers?

Unemployment benefits, income tax system, welfare.

What is supply-side fiscal policy?

Policy focused on long-run growth by increasing productivity and incentives (e.g., tax cuts, deregulation).

What is the definition of money?

Anything widely accepted in exchange for goods/services.

What are the three functions of money?

Medium of exchange, unit of account, store of value.

What is fiat money?

Money with no intrinsic value, backed by government decree.

What is commodity money?

Money that has intrinsic value (e.g., gold, silver).

What is M1?

Currency, checking deposits, and traveler’s checks.

What is M2?

M1 + savings deposits, small time deposits, and money market mutual funds.

What isn’t included in M1/M2?

Stocks, bonds, credit cards, large time deposits.

What is fractional reserve banking?

Banks hold only a fraction of deposits as reserves.

What is the required reserve ratio?

The percentage of deposits a bank must hold in reserve.

What are required vs. excess reserves?

Required = what must be held; Excess = what can be loaned out.

What is a bank run?

When many depositors withdraw funds due to fear of insolvency.

What is the FDIC?

Insures deposits up to $250,000 to prevent bank runs.

What is a balance sheet?

A financial statement listing assets, liabilities, and equity.

What is the simple money multiplier formula?

1 / reserve ratio.

What is the Federal Reserve (the Fed)?

The U.S. central bank, responsible for monetary policy.

What are the functions of the Fed?

Conduct monetary policy, supervise banks, stabilize financial system.

What is a central bank?

An institution managing the nation’s currency and monetary policy.

What are federal funds? Federal funds rate?

Overnight loans between banks; the interest rate on those loans.

What is a discount loan? Discount rate?

Loan from Fed to bank; interest rate charged is the discount rate.

Tools of the Fed?

Open market operations, discount rate, reserve requirements.

What are open market operations (OMO)?

Buying/selling government bonds to affect money supply.

What is quantitative easing (QE)?

Large-scale bond buying to stimulate the economy.

What happens when the Fed buys bonds?

Increases money supply, lowers interest rates.

What happens when the Fed sells bonds?

Decreases money supply, raises interest rates.

What is the short run vs. long run in economics?

Short run: some prices are sticky; Long run: all prices adjust.

Which prices are sticky?

Wages and some input costs.

What happens during expansionary monetary policy?

Fed increases money supply → interest rates ↓, investment ↑, GDP ↑, price level ↑, unemployment ↓.

When is expansionary policy used?

During recessions or high unemployment.

What are real vs. nominal effects?

Real: affect output and employment; Nominal: affect prices and money values.

What happens during contractionary monetary policy?

Fed decreases money supply → interest rates ↑, investment ↓, GDP ↓, price level ↓, unemployment ↑.

When is contractionary policy used?

During periods of high inflation.

What graphs are used to show monetary policy?

AD-AS model and Money Market graph.

Why doesn’t monetary policy always work?

Long lags, expectations, liquidity traps, and global influences.

What is long-run adjustment?

Economy returns to full employment as prices/wages adjust.

What is the Phillips Curve?

Shows inverse relationship between inflation and unemployment in the short run.

What is the short-run Phillips Curve?

Downward-sloping; tradeoff between inflation and unemployment.

What is the long-run Phillips Curve?

Vertical; no tradeoff—economy returns to natural rate of unemployment.

How do expectations affect the Phillips Curve?

If inflation is expected, workers adjust wage demands, shifting the short-run curve