Unit 5 Test Review

Define the crowding-out effect

Government takes massive loans out for public projects (expansionary fiscal). Long term results of increased government borrowing, since G takes up so many bank loans the average ^^interest rate goes up, private investments decrease.^^

Explain the effects of crowding-out within the short-run aggregate demand and aggregate supply model

In the short run crowding out can increase AD and/or AS, however in the longer run or eventually both will decline as a result of increased interest rates (decreased Investment spending)

Demonstrate the use of monetary policy to lessen or reinforce the crowding-out effect

Since the crowding out effect eventually leads to higher interest rates, the Fed can use monetary policy to “add” money (increase money supply) to bring interest rates back down

Analyze the effects of combined monetary and fiscal policies on the loanable funs market

Fiscal Policy: expansionary (increase AD) higher demand for money for C and I

Monetary Policy: Expansionary leads to more supply of money since more is in circulation, interest rates come down allowing for more investment again

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Fiscal policy is the steroid, and monetary is the acne medication (steroid analogy)

Define the Phillips Curve

showing the direct relationship between inflation and unemployment in an economy

Show how monetary and fiscal policy can help economy move along the short-run Phillips Curve

Tools of Fiscal Policy (changes in taxation/ Government spending)

Tools of Monetary Policy (changes to the money supply through G bond sales primarily)

Aiming at either fixing inflation (contractionary) or fixing unemployment (expansionary)

Describe long-term growth trends in the U.S.

Slightly raising levels of inflation (2-3% per year) with overall increases in GDP output, includes business cycle. Upward growth despite occasional dips and peaks of business cycle.

How can economic growth be measured

Through the economy’s GDP, more accurate if adjusted for inflation, even more accurate if “per capita”

Relate economic growth to the long-run aggregate supply curve and the production possibilities curve

The shifters of the PPC will also shirt the LRAS curve (natural resources, technology, techniques, quantity and quality of population)

Explain the reason why prices and wages do not adjust instantaneously

Prices take time to adjust to market values, wages are even more “sticky” as those hiring will try to resist paying more and will try to become more efficient.

Policy lags before the changes and after the changes can take weeks, months, years to feel the effects

What is fiscal policy? Who controls it and what are the tools?

Actions taken by the Government (congress + president) to adjust taxes and government spending to increase or decrease AD (aggregate demand)

What is monetary policy? Who controls it and what are the tools?

Actions taken by the Federal Reserve System to adjust the money supply and therefore interest rates for borrowing money. Controlled by the Fed. Tools: Adjusting reserve requirements, discount rate, open market operations.

What is classical theory? What did Keynes change about this theory?

Classical theory is the lack of government intervention in the economy, let the market sort itself out over time. John Maynard Keynes suggested slight and calculated adjustment could lights the dips of the business cycle with government intervention, we now call our modern understanding of economics “Keynesian Theory”

How does expansionary fiscal policy impact interest rates?

Expansionary Fiscal Policy looks to increase AD in the economy by lowering taxes and increasing government spending to create new government funded jobs, but this money has to be borrowed from banks to fund the jobs, therefore interest rates will go up.

How can expansionary monetary policy be used to compliment expansionary fiscal policy and continue encouraging economic growth

Expansionary policy will inadvertently raised interest rates (crowding out from government borrowing). Expansionary monetary policy can increase the supply of money and bring interest rates back down (steroid side effects being treated)

What are the main components for encouraging economic growth

Improving physical captial, improving human capital, improving technology. the government can also have a factor in all three of these

What is the spending multiplier and how do you find the spending multiplier when you have MPC/MPS? Create and example problem and solve it. How does this apply to a change in government spending?

Spending multiplier is the expected amount that money will be re-spent within an economy after there is a change in spending habits or the supply of money in the economy. If MPC = .75 and MPS = .25, the formula is 1/MPS which in 4x. A $100million change in government spending would result in $400 million change in GDP output.

With high unemployment (recession) what policy do you take?

Expansionary

With high prices (inflation) which policy do you take?

Contractionary

Recessionary AD/AS graph

Inflationary AD/AS graph

What fiscal policy responses correct recession

\-Cut taxes

\-Increase gov spending

What fiscal policy responses correct inflation

* Increase taxes
* Cut government spending

What monetary policy response to correct recession.

decrease reserve requirement

decrease discount rate

decrease federal funds rate

Fed buys bonds

What monetary policy response to correct inflation.

increase reserve requirement

increase discount rate

increase federal funds rate

Fed sell bonds