Macro Final M/C and T/F practice

4 Functions of Money

1. A medium of exchange

• Facilitates trade by reducing the transaction costs

2. A unit of account

• comparison of value of different goods and services

3. A store of value

• Easy to store and allows for the accumulation of wealth 

• standard of deferred payment

• allows debts to be expressed and paid back with items similar in quality to what was borrowed.

Money

 any asset that is generally acceptable in exchange for goods and services or as payment for debt 

liquidity

The idea of acceptability of money

M1

Cash, checking accounts, and saving accounts

M2

M1 + Non-Transaction Accounts

M3

M2 + Institutional Accounts

Automatic Stabilizers

• government policies or programs that moderate fluctuations in income in the economy

• reduce the unpredictability of the business cycle

Discretionary fiscal policy

• government decides to change government spending or taxes through changes in legislation or regulation to influence the macroeconomy (increase spending or tax cuts)

Recessionary Gap

the increase in aggregate expenditure required to bring the economy to full employment when actual real GDP is less than potential real GDP.

Inflationary Gap

the decrease in aggregate expenditure necessary to return the economy to full employment when actual real GDP is less than potential GDP.

GDP Gap

the difference between potential real GDP and actual real GDP

ΔG

• ΔY / [1 / (1 - MPC + MPIM)]

• ΔY / SM

Paradox of Thrift

Increase in Saving = Decline in real GDP (in fixed-price keynesian model)

Cost-Push Inflation

Cost-push inflation results from decreases (leftward shifts) in the aggregate
supply curve due to higher resource prices.

Demand-pull inflation

Demand-pull inflation results from increases
in AD due to increases in spending in the economy.

equation of exchang

MV = PY

Gresham’s Law

• A british coin in circulation while the people practiced “Clipping”: taking the silver off the coins 

• They wanted new coins. 

• “Bad Money Drives out Good Money”

The bank balance sheet

 Assets = Liabilities + Net Worth

Assets and Liabilities

• Assets: What you own. Property or financial instruments that are subject to ownership.

• Liabilities: What you owe. The financial claims on an institution. 

• Bank capital: A bank’s net worth or equity, Bank Capital = Assets – Liabilities

The Monetarist Model of Monetary Policy

the most important economic variable in understanding United States economic history is the rate of growth of the money supply

Spending Multiplier

• ΔG = ΔY / [1 / (1 - MPC + MPIM)]

• ΔY = 1/1-b+d times ΔG

Tax multipler

• -b+d/1-b+d

• ΔY= -b+d/1-b+d times ΔT

What happens if the government buys more bonds

Increases the money supply

What happens if the federal funds rate increases

Decrease in the money supply, excess demand for money, excess supply of bonds. (price of bonds decline) so interest rates increase

Neo-classical model in a recession

The neo-classical model assumes both short-run and long-run aggregate supply
curves. If the economy starts in a recession, then the intersection of AD and SRAS will
be at a level of GDP that is less than full employment. The economy is in a recession since Y* < YF

Classical (supply-side) response to Neo-classical model in a recession

First, the supply-side response would be to let the economy correct itself. If the
economy is in a recession, then resources are idle. We should see declines in real wages, prices and interest rates as a result of the idle resources. As resource prices fall the SRAS will increase until the economy returns to full employment. In the supply-side response, the economy can correct itself

Keynesian (demand-side response) to Neo-classical model in recession

Keynes, on the other hand, felt that the long run adjustment process may take too long, and in the meantime we have to suffer with high rates of unemployment. “In the long run we’re all dead.” Keynes believed that the government should use active fiscal and monetary policies to increase the aggregate demand curve in the economy (a demand-side response). If the economy starts in a recession, then the increase in aggregate demand leads to an increase in both the price level and real GDP until the economy returns to full employment at a higher price level.