I. Define and Explain

What does the Pigou effect explain about inflation?

When prices rise, our wealth decreases, resulting in a fall in aggregated demand.

What results from prices dropping according to the Pigou effect?

Our wealth increases, leading to rising aggregated demand.

What is a demand-induced recession?

A situation where aggregated demand falls, bringing down output, employment, and prices.

What are animal spirits of capitalists?

The degree of optimism and confidence the business community has in their long run profitability.

What happens if capitalists believe profits on capital investment will be high?

It results in an investment boom, shifting aggregated demand outward.

What is overheating in an economy?

When actual output exceeds potential output, resulting in labor shortages, capital shortages, and inflation problems.

What is stagflation?

An economic condition of the 1970s characterized by rising prices alongside declining output and employment.

What is an adverse supply shock?

A situation where the aggregated demand curve shifts to the left, causing decreases in output, employment, and increases in price inflation.

What is commodity money?

Money from the 19th century with two values: as money for transactions and as a commodity like gold or silver.

What is the difference between M1 and M2 in terms of money supply?

M1 is a narrow measure including currency and checkable deposits, while M2 is broader and includes near money like liquid savings.

What is the basic function of money as a medium of exchange?

Money serves as an intermediary in transactions, allowing trade between parties.

How does money function as a store of value?

It maintains purchasing power over time and space, allowing consumers to use it later for transactions.

How does money serve as a unit of account?

It helps to denominate prices in dollars and write contracts for trade.

What are required reserves and excess reserves?

Required reserves are the minimum reserves a bank must hold, while excess reserves are the additional funds available for lending.

What is a liquidity problem in banking?

It occurs when there's a large outflow of funds that exceeds a bank's reserves, potentially leading to the bank's failure.

What causes an insolvency problem in banking?

It happens when a bank suffers a large loss due to bad loans or trades, exceeding its capital.

What is the role of the lender of last resort?

The Federal Reserve provides emergency loans to failing financial institutions to prevent economic panic.

What is the Fed's Dual Mandate?

1. Price stability, aiming for a low and stable inflation rate. 2. High employment, targeting a 95%-96% employment rate.

What are open market operations?

The buying and selling of bonds on the open market by the Federal Reserve to conduct monetary policy.

What is the difference between open market purchase and open market sale?

Open market purchase increases deposits and reserves by buying bonds, while open market sale decreases them by selling bonds.

What is the Federal Open Market Committee (FOMC)?

A committee made up of 7 board members and 12 regional reserve presidents that meets to discuss and vote on monetary policy.

What is the Federal funds rate?

The interest rate set by the Federal Reserve when conducting monetary policy, influenced by open market operations.