ECON 3334 Intermediate Macroeconomics Chapters 7–12 Practice Questions

Vocabulary practice flashcards covering labor markets, inflation, short-run economic fluctuations, the Great Recession, the IS curve, and monetary policy with the Phillips curve from ECON 3334 Chapters 7 through 12.

Unemployed Status

The labor market condition of a civilian who is not currently employed, wants a job, and has actively searched for work within the last four weeks; individuals who do not have a job and have not searched within that window are classified as not in the labor force.

Unemployment Rate

The percentage of the labor force without a job, computed as the number of unemployed individuals divided by the total labor force (employed plus unemployed); for example, with $25\text{ million}$ unemployed and $225\text{ million}$ employed, the rate is $\frac{25}{250} = 0.100$ (or $10\%$).

Labor Demand Curve Slope

The downward slope of the labor demand curve reflecting that the marginal product of labor diminishes as additional units of labor are employed by firms.

Oil Price Shock in the Labor Market

A negative macroeconomic supply shock caused by an increase in energy input costs that shifts labor demand inward, resulting in lower equilibrium wages and lower employment.

Labor Supply Tax with Wage Rigidity

A policy shock where a tax is placed on labor supply while wages remain stuck at their pre-shock level; because the wage fails to adjust upward to clear the market, both the wage and the employment-population ratio fall below new market-clearing levels.

Cyclical Unemployment

Short-run deviations of unemployment from its natural rate associated with business cycle fluctuations, such as a worker losing her job because the economy begins to enter a recession.

Bathtub Model of Unemployment

A steady-state labor market model where a permanent policy increase in only the job finding rate leads directly to a decline in the natural rate of unemployment.

Natural Rate of Unemployment Formula

The steady-state rate defined in the bathtub model as $u^* = \frac{s}{s + f}$, which equals approximately $4.1\%$ when the job separation rate $s$ is $0.9\%$ ($0.009$) and the job finding rate $f$ is $21\%$ ($0.21$).

European Unemployment Disparity

The structural phenomenon of higher unemployment rates in Europe relative to the United States over recent decades, driven by the combined effect of an inefficiently designed unemployment insurance system, the 1970s productivity slowdown, and high oil prices.

Efficiency Wage Hypothesis

The economic theory showing that paying wages above the reservation wage required to retain workers does not necessarily decrease firm profits, because higher pay can enhance worker effort, reduce turnover, and boost productivity.

Future Value ($FV$)

The compounding value of a current asset at a future date; depositing $\$100$ at a $5\%$ annual interest rate yields a future value of \100 \times (1 + 0.05)^2 = \$110.25$ in two years.

Present Discounted Value ($PDV$) Interest Rate Sensitivity

The present valuation of a stream of future cash flows, which decreases when the market interest rate increases because future income is discounted more heavily.

Perpetuity Due Present Value

The present discounted value of an infinite series of fixed payments where the first payment arrives immediately; evaluated as $PDV = C + \frac{C}{R}$, which equals \50 + \frac{\50}{0.05} = \$1{,}050 at a $5\%$ interest rate.

Compounding Equivalence

The indifference between two savings structures with equal two-year returns; depositing $\$625$ into Bank A yielding $\$756.25$ in two years is mathematically identical to Bank C paying $10\%$ compounded annually (\625 \times 1.10^2 = \$756.25$).

College Wage Premium

The wage ratio of college-educated workers relative to high school graduates; the required increase in demand for college graduates needed to explain its rise depends fundamentally on supply shifts and developments in the high school labor market.

Hyperinflation

An extreme, uncontrolled inflationary episode characterized by rapidly rising prices; exemplified when a country's price level surges tenfold from $100$ to $1{,}000$ in a single period.

Real versus Raw Price Comparison

The analytical practice of converting historical nominal prices into constant purchasing power dollars, demonstrating that raw dollar differences over time do not represent true comparative costs because inflation erodes currency value.

CPI Deflating Formula

The method of converting historical prices using the formula $\text{Price}_{2015} = \text{Price}_{1900} \times \frac{\text{CPI}_{2015}}{\text{CPI}_{1900}}$; coffee costing $8.25\text{ cents}$ in 1900 ($\text{CPI} = 3.43$) equals $\$2.41$ in 2015 dollars ($\text{CPI} = 100$), making coffee at $\$1.50$ less expensive in 2015.

Classical Dichotomy

The long-run theoretical separation of nominal variables from real economic variables, stating that real GDP is determined by inputs, technology, and ideas, and not by the aggregate price level.

Quantity Theory Money Supply Calculation

The quantity equation identity $M \times V = P \times Y$; if nominal GDP ($PY$) is $\$5{,}000$ and the velocity of money ($V$) is $5$, the money supply in circulation is $M = \frac{\$5{,}000}{5} = \$1{,}000$.

Quantity Theory Inflation Relationship

The principle stating that inflation is determined by money growth minus real output growth ($\pi = g_M - g_Y$); increases in the money supply raise inflation, whereas increases in real GDP reduce inflation by expanding transaction demand.

Price Stability Growth Rule

The central bank policy guideline derived from the quantity theory requiring money supply growth to exactly equal real GDP growth (e.g., $g_M = 2\%$ when $g_Y = 2\%$) in order to keep price levels constant.

Long-Run Neutrality of Money Growth

The quantity theory prediction that doubling the growth rate of the money supply leads in the long run to a doubling of the inflation rate without having any permanent effect on real GDP growth.

Monetary Renomination Neutrality

The macroeconomic rule that purely nominal currency changes, such as reissuing bills with new designs or doubling all nominal currency units in circulation, have zero real impact on long-run output.

Short-Run Non-Neutrality of Money

The empirical finding that changes in monetary policy have real effects on output and employment in the short run due to price and wage stickiness, despite money being neutral in the long run.

Fisher Equation Deflation Condition

The nominal interest rate identity $i = R + \pi$; when the real interest rate is $R = 3\%$ and the nominal interest rate is $i = 1\%$, inflation is $\pi = i - R = -2\%$, indicating that the economy is in deflation.

Surprise Inflation Redistribution

The arbitrary wealth transfer caused by unanticipated inflation, which benefits borrowers repaying fixed nominal debt obligations at lower real values, while hurting fixed-rate lenders and pensioners.

Seigniorage

The real revenue a government raises by printing money to finance expenditures; when a $\$500\text{ million}$ project is funded with $\$200\text{ million}$ in debt and $\$200\text{ million}$ in taxes, the remaining $\$100\text{ million}$ is seigniorage.

Inflation Tax Incidence

The erosion of purchasing power incurred by holders of unindexed currency and liquid money; it does not fall on individuals who hold all their wealth in physical capital or artwork.

Government Reliance on Inflation Taxation

The fiscal conditions prompting monetary financing of debts, triggered when governments run large budget deficits, lenders doubt sovereign solvency, and politicians cannot politically raise direct taxes.

Hyperinflation Dynamics

The characteristics of an extreme monetary collapse, which include skyrocketing nominal interest rates, severe fiscal deficits, and a high probability of recurrence if structural reforms fail.

Short-Run Model Focus

The macroeconomic framework primarily focused on determining the simultaneous equilibrium of current output (deviations from potential) and current inflation over business cycle frequencies.

Short-Run Output (Output Gap, $\tilde{Y}_t$)

The percentage deviation of actual output ($Y_t$) from potential output ($Y^*_t$), defined as $\tilde{Y}_t = \frac{Y_t - Y^*_t}{Y^*_t}$; with actual output at $\$110$ and potential at $\$100$, short-run output is $10\%$.

Recession Dating Rule

The formal business cycle convention where a recession is declared over as soon as economic contraction ends and growth resumes, rather than when short-run output fully recovers to potential.

Boom-Induced Price Adjustments

The behavior of firms raising prices during economic expansions both to exploit elevated consumer demand and to cover higher marginal wage costs incurred when expanding output.

Phillips Curve Deflation Implication

The macroeconomic relationship dictating that when an economy experiences deflation or declining inflation, actual output must be operating below potential output ($\tilde{Y}_t < 0$).

Okun's Law Short-Run Output

The empirical relationship linking output deviations to labor slack via $\tilde{Y}_t = -2(u - u^*)$; when the natural rate is $u^* = 5\%$ and cyclical unemployment is $u - u^* = 2\%$, short-run output equals $-4\%$.

Phillips-Okun Transmission

The empirical macroeconomic link between price changes and unemployment; an inflation increase from $0\%$ to $1\%$ typically implies positive short-run output and a cyclical unemployment drop of approximately $-1.5\%$ to $-2\%$.

2000s Housing Price Boom

The rapid expansion of residential real estate prices during the early 2000s driven primarily by low interest rates, global excess savings, and a substantial deterioration in mortgage underwriting standards.

Aggregate Risk in Mortgage-Backed Securities

The systemic threat confronting holders of securitized debt when broad economic downturns cause widespread simultaneous mortgage defaults across the entire financial system.

Federal Reserve Balance Sheet Expansion

The unprecedented increase in the size and composition of the U.S. central bank's assets and liabilities during the 2008 financial crisis via emergency lending facilities and asset purchases.

Consumption Volatility in the Great Recession

The sharp and historically atypical decline in private household consumption during the 2007–2009 recession, which historically remained steady during standard post-war downturns.

Bank Capital Requirement Calculation

The minimum equity buffer mandated by regulators as a share of total assets; for a bank with $\$1{,}000$ in assets ($\$500$ loans, $\$400$ investments, $\$100$ cash/reserves), a $20\%$ capital requirement equals $\$200$.

Bank Leverage Ratio Calculation

The ratio of total assets to equity capital; with $\$1{,}000$ in assets and $\$750$ in liabilities ($\$500$ deposits + $\$250$ debt), equity is $\$250$, yielding a leverage ratio of $\frac{1000}{250} = 4$.

IS Curve Interest Rate Mechanism

The channel where an increase in the real interest rate lowers short-run output primarily by raising borrowing costs and depressing business investment.

Consumption Smoothing in the IS Model

The microeconomic behavior where forward-looking households stabilize spending across time based on permanent income, explaining why consumption is modeled as a fraction of potential output.

Marginal Product of Capital Investment Condition

The firm optimization rule dictating that borrowing to purchase capital is profitable only if the marginal product of capital ($\bar{r}$) exceeds the real interest rate ($R_t$); if $\bar{r} = 4\%$ and $R_t = 7\%$, the firm does not invest because it would lose $3\text{ units}$.

Exogenous Variable in the IS Model

A variable determined outside the model; in the standard short-run IS curve framework, the real interest rate $R_t$ is set exogenously by monetary policy, while output, consumption, and investment are endogenous.

IS Curve Output Calculation

The short-run output formula $\tilde{Y}_t = \bar{a} - \bar{b}(R_t - \bar{r})$; when $\bar{a} = 0$, $\bar{b} = 1/2$, $\bar{r} = 2\%$, and $R_t = 6\%$, short-run output is $\tilde{Y}_t = 0 - \frac{1}{2}(6 - 2) = -2\%$.

Investment-Saving Identity

The macroeconomic accounting relationship between national investment and national saving from which the IS curve derives its name.

Movement Along the IS Curve

The adjustment in short-run output resulting strictly from an exogenous shift in the real interest rate $R_t$, which does not shift the underlying IS curve.

Investment Demand Shock ($\bar{a}_i$)

A positive innovation in technology or business confidence that increases the investment demand parameter, shifting the IS curve rightward.

Interest Rate Contraction Channels

The combined macroeconomic transmission mechanisms whereby higher interest rates reduce output by increasing borrowing costs for firms, increasing borrowing costs for households, and depressing business investment.

Import Aggregate Demand Parameter ($\bar{a}_{im}$)

The parameter measuring the share of income spent on foreign goods; because imports enter aggregate demand negatively, an increase in $\bar{a}_{im}$ shifts the IS curve to the left, opposing consumption demand increases.

Marginal Product of Capital IS Shift

A change in the underlying productivity of capital; a decrease in $\bar{r}$ lowers baseline investment at every interest rate, shifting the IS curve inward to the left.

Physical Capital Destruction Shock

A localized supply shock, such as hurricane damage to productive capital, which decreases both short-run output and potential output.

Life-Cycle / Permanent-Income Hypothesis (LC/PI)

The consumer theory stating that households smooth lifetime consumption based on permanent earnings; therefore, a college student with low current income should borrow and consume more than her current income.

IS Multiplier

The amplification parameter measuring how strongly short-run output reacts to demand shocks; an economy with a higher IS multiplier will experience a larger change in output for a given $3\%$ aggregate demand shock.

Moral Hazard

The behavioral tendency of individuals to take greater risks when insulated from negative consequences, such as a motorist driving faster because they are wearing a seatbelt.

Ricardian Equivalence

The theoretical proposition that the timing of government tax increases does not alter household lifetime wealth or consumption because forward-looking agents anticipate the present value of future tax liabilities.

Overnight Rate Arbitrage

The market discipline ensuring interbank alignment: if a bank lends overnight below the central bank rate, other banks borrow from it and deposit at the central bank for riskless profit until the lending bank exhausts its resources.

Sticky Inflation Monetary Transmission

The mechanism enabling nominal policy actions to alter real variables: because inflation is sticky in the short run, raising the nominal interest rate directly increases the real interest rate, depressing investment and output.

Monetary Stabilization Policy

The central bank response required to stabilize output at potential following a positive demand shock (increase in $\bar{a}$), achieved by raising the nominal interest rate.

Phillips Curve Output Inference

The deduction of short-run output using $\Delta \pi_t = 0.5\tilde{Y}_t$; when inflation drops steadily by $2\%$ annually (from $6\%$ to $4\%$ to $2\%$), short-run output has been negative, around $-4\%$.

Phillips Curve Supply Shock Calculation

The determination of current inflation via $\pi_t = \pi_{t-1} + \bar{\nu}\tilde{Y}_t + \bar{o}$; with prior inflation of $3\%$, $\bar{\nu} = 1/2$, output gap $\tilde{Y}_t = -2\%$, and cost shock $\bar{o} = 2\%$, inflation equals $3 - 1 + 2 = 4\%$.

Price-Setting Sensitivity

The degree to which price-setters adjust to output slack; when pricing becomes more sensitive to demand conditions, the Phillips curve becomes steeper, requiring a smaller recession to achieve a target disinflation.

Disinflation

A intentional reduction in the rate of inflation, requiring the central bank to raise nominal interest rates to create economic slack rather than lowering them.

Adaptive Expectations Sacrifice

The policy cost associated with backward-looking expectations and sticky inflation, requiring the central bank to drive short-run output below potential to push down inflation.

Productivity Slowdown Misperception

A central bank error where a structural decline in potential output is misdiagnosed as an economic recession, causing policymakers to over-stimulate and fuel higher inflation.

2020–21 Covid-19 Recession Profile

The macroeconomic trajectory observed during the 2020–21 pandemic downturn, characterized empirically as an unusually deep recession followed by a rapid, fast recovery.

Flexible Price Monetary Neutrality

The theoretical state in which all goods prices adjust instantly without sticky inflation, causing monetary policy changes to exert only nominal effects and zero real output effects.

Horizontal Money Supply Curve

The graphical representation of monetary policy when the central bank fixes a target interest rate and supplies whatever quantity of reserves the financial system demands at that rate.