INTRODUCTION OF MACROECONOMICS MODULE
INTRODUCTION OF
MACROECONOMICS MODULE
TEACHING ASSISTANTS OF MICROECONOMICS AND
MACROECONOMICS
ECONOMICS AND DEVELOPMENT STUDIES
FACULTY OF ECONOMICS AND BUSINESS
UNIVERSITAS PADJADJARAN
In the name of Allah, The Most Gracious, The Most Merciful
Alhamdulillah, all praises to Allah SWT, The Almighty, forgiving belief, health, confidence and blessing for the writers to
accomplish this Module of Introduction to Macroeconomics. Shalawat
and Salam be upon our Prophet Muhammad SAW, who has brought
us from the darkness into the brightness and guided us into the right
way of life.In this opportunity, we also like to express our deep thanks
to Head Department of Economics, Coordinator of Undergraduate Program
of Department of Economics, lecturers, and those who contributed and
helped in the process of making this module. All of your kindness and help
means a lot to us. Thank you very much We realise that the contents in this module is not that perfect.Therefore, we are willing to receive and consider feedback, suggestions and
constructive criticisms, and eager to implement improvements.Hopefully this module can be the short guide for the
students in order to deepen their understanding and analysis of
Macroeconmics theory. Thank you.
List of the Module Writers:
1. Azka Nasir Nugraha 120210130110
2. Fierera Devi Febiosa 120210120012
3. Gita Permatasari 120210120092
4. Harumi Nimas 120210120148
5. Meinari Claudia M 120210110032
6. Ridha Subagja 120210110049
7. Silvia Adhiarahmawati 120210110058 Acknowledge and Agree, Coordinator of Undergraduate Program of Department of Economics Dr.Adiatma Yudistira Manogar Siregar, S.E., ME. conSt.
NIP. 19801205 200812 1 001
CHAPTER 6 MONEY GROWTH AND INFLATION Classical Theory
Relationship between the price level and the value of money is negative. When a price level is high so the value money is low. The goal of monetary injection is to stimulate the production by increased the money supply. Money injection which is not balanced with an increase in output causes the price level rises and the value of money falls.
Classical dichotomy is the separation of the determinants of real and nominal variables. Monetary neutrality is the idea the change in money supply will not affect real variable. Velocity of money tells us the number of times a dollar bill changes hands in a given period of time. According to the quantity theory, the formula is:
=
( ) .
Hyperinflation is defined as inflation that exceeds 50 percent per month, which is just over 1 percent a day. The fisher equation expresses the relationship between nominal and real interest rate. With formula = + , where I si nominal interest rate; r is real interest rate; π is inflation.
Cost of Expected Inflation
The cost of expected inflation includes shoe leather , menu costs, confusion and inconvenience,
costs relative price variability, and tax distortions .
Unexpected inflation has an additional cost that is arbitrary redistribution of wealth .
CHAPTER 6
MONEY GROWTH AND INFLATION FILL IN THE BLANK1. __________ is the proposition that changes in the money supply do not affect real variables.
2. A decrease in the overall level of prices is called __________. 3. ______________ is the separation theoretically between nominal variables and real variables.
4. __________ measured by physical unit and __________ measured by monetary unit.
5. The rate at which money changes hands is called
____________ .
6. The practice of a government raising revenue by printing money is called __________.
7. When prices rise at an extraordinarily fast rate that exceeds 50 percent per month, it is called __________.
8. Monetary injection will ______ the money supply curve to
______ .
9. __________ is the one-for-one adjustment of the nominal interest rate to the inflation rate. 10. ____________ refers to the actual cost of holding less cash which includes wasted time and inconvenience.
TRUE OR FALSE
1. If money is neutral, a change in the money supply does not affect either prices or real output.
2. The impacts of monetary injection are lower price level and higher value of money.
3. The Fisher effect suggest that, in the long run, if the rate of inflation rises from 2% to 5%, the nominal interest rate should increase by 4% and the real interest rate should increase.
half.
5. If the money supply is $500, real output is $2.500 units, and the price is $2/unit, the velocity of money is 2,5.
6. The quantity theory of money concludes that an increase in the money supply causes a proportional increase in real output.
7. An inflation tax is a tax borne only by people who hold interest bearing savings accounts.
8. When inflation rises, people desire to hold more money and firms make less frequent price changes.
9. If actual inflation turns out to be greater than people had expected, then wealth was redistributed to lenders from borrowers.
10. Arbitrary redistributions of wealth do not occur when inflation is constant and predictable.
MULTIPLE CHOICE
a. the price of soda
b. the ratio of the value of wage to the price of soda
1. An example of a real variable is?
d. none of the above
2. Which statement is true according to the quantity theory of money? a. V and M are constant.
b. Y are not affected by the quantity of money.
c. P are not affected by the quantity of money.
d. V are not affected by changes in the price level.
3. According to the quantity theory of money, money growth and inflation are a. positively correlated
b. negatively correlated
c. independent, that is, not correlated
c. the wage rate in rupiah negatively correlated if the inflation rate is negative.
4. Suppose initially the real interest rate is 4 percent, the nominal interest rate is 6 percent and the inflation rate is 2 percent. If the inflation is increased to 4 percent, according to Fisher effect, the nominal interest rate should be… a. 8 percent
b. 6 percent
c. 4 percent
d. 2 percent
5. Suppose that, because of inflation, a business in Mozambik must calculate, print and mail a new price list to its customers each month. This is an example of …
a. menu cost
b. shoeleather cost
c. arbitrary redistribution of wealth
d. inflation-induced tax distortions
6. In which of the following cases was the inflation rate 10 percent over the last year? a. One year ago, the price index had a value of 132, and now it has a value of 120.
b. One year ago, the price index had a value of 121, and now it has a value of 110.
c. One year ago, the price index had a value of 110, and now it has a value of 121.
d. One year ago, the price index had a value of 100, and now it has a value of 121.
7. If M = 10,000, P = 2, and Y = 20,000, then velocity is …..
a. Velocity will rise if money changes hands more frequently.
b. Velocity will rise if money changes hands less frequently. frequently.
d. Velocity will fall if money changes hands more frequently.
8. When the price level falls, the number of dollars needed to buy a representative basket of goods….
a. increases, so the value of money rises.
b. increases, so the value of money falls.
c. decreases, so the value of money rises.
d. remains constant to offset the fall in the value of money.
9. In 2016, Fathan gets €500 a month raise. With his new monthly salary, he can buy more goods and services than he could buy last year. Hence …..
a. his real salary has fallen and his nominal salary has rise b. his real salary has risen and his nominal salary has fallen.
c. his real and nominal salary has fallen.
d. his real and nominal salary has risen.
10. For whom can inflation be beneficial?
a. long-term creditors
b. long-term debtors
c. both debtors and creditors
d. neither debtors nor creditors
1. Identify each of the following as nominal or real variables.
a. the physical output of goods and services
b. the dollar price of apples
c. the price of apples relative to the price of oranges
d. the amount that shows up on your paycheck after taxes
e. the amount of goods you can purchase with the wage you get each hour f. the taxes that you pay the government
2. What happen to the value of money and the money market when Bank Indonesia injects more money in circulation? Draw and explain.
3. Explain the relationship between velocity of money, the money supply, and the nominal GDP. How must an increase in the money supply be reflected in velocity of money and nominal GDP?
4. How does the nominal interest rate differ from the real interest rate? Write down the equation that represents the real interest rate and explain what this equation shows.
5. Hyperinflation occurs in Zimbabwe because the government prints too much money. Why do they keep printing money if they know it causes inflation?
6. Suppose that a hypothetical single-economy produce 600 tons of potatoes and sells by $15 per kilogram while the money supply is $1.200.000.
a. Calculate the nominal GDP
b. Calculate the velocity of money
c. If the money supply increases by $400.000 while the velocity of money and real GDP remain unchanged, what is the new price level of potatoes? people spend a total of Rp. 50.000.000 per year for that commodity.
a. If the cocoa production is 2 tons and the quantity of money is Rp 6.000.000, what is the price level of cocoa (per 1 kg)?
b. What is the velocity of money?
c. If the cocoa production decreased by 50 percent due to El Nino, the quantity of money change to Rp. 4.000.000 and the price level increased by 20 percent, what is the velocity of money?
8. If the tax rate is 20 percent, compute the before-tax real interest rate and the after-tax real interest rate in each of the following cases:
a. The nominal interest rate is 10 percent and the inflation rate is 5 percent.
b. The nominal interest rate is 6 percent and the inflation rate is 3 percent.
c. The nominal interest rate is 4 percent and the inflation rate is 2 percent.
9. Unexpected inflation has an additional cost to the economy, because it arbitrarily redistributes wealth. Explain how the redistribution among borrower and lender can occur. In which condition redistribution most likely to take place, high inflation or low inflation?
10. Suppose that Nanda, Jo, and Amadea expect inflation to equal 3 percent, but in fact prices rise by 6 percent. Describe how this unexpectedly high inflation rate would help or hurt them if their conditions are as follow: a. Nanda has invested some of his endowment in government bonds b. Jo is a worker in the second year of a labor contract.
c. Amadea owns a house with a fixed-rate mortgage.
OPEN ECONOMY MACROECONOMICS: BASIC
CONCEPT
Open economy is an economy that interacts freely with other economies around the world. Net export is the value of a nation’s exports minus the value of its imports, also called trade balance.
The situation when export exceeds the value of import, the trade balance is surplus. In contrast, when the value of exports is less than the value of imports, the trade balance is deficit. If exports equal imports it called balanced trade.
Net capital outflow (NCO) is the acquisition of foreign assets by domestic resident minus the acquisition of domestic asset by foreigners. Due to every international transaction involves an exchange rate of an asset for a good or service, an economy’s net foreign investment always equal its net export.
Nominal exchange rate is the relative price of the currency of two countries. The situation when the nominal exchange rate changes which each dollar buys more foreign currency, the dollar is said
appreciate or strengthen. In contrast, when nominal exchange
rate changes and lead dollar buys less foreign currency, the dollar is said depreciate or weaken. Real exchange rate is the relative price of the goods and service of two countries.
ℎ
= If arbitrage occurs, eventually prices that differed in two markets would necessarily converge.
Purchasing power parity (PPP) is a theory of exchange rates whereby a unit of any given currency should be able to buy the same quality of goods in all countries. This theory implies that the nominal exchange rate between the currencies of two countries should reflect levels in those countries. As a result, countries with relatively low inflation should have appreciating currencies.
OPEN ECONOMY MACROECONOMICS: BASIC
CONCEPT
FILL IN THE BLANK1. _______________ refers to condition when net exports are zero; exports and imports are exactly equal.
2. Decrease in the value of a currency as measured by the amount of foreign currency it can buy, called as________ 3. ______________ is a theory of exchange rates whereby a unit of any given currency should be able to buy the same quantity of goods in all countries. 4. _____________ is the rate at which a person can trade the currency of one country to the another currency. 5. ____________ is purchasing of foreign assets by domestic residents minus the purchasing of domestic assets by foreigners.
6. If the yen price of the dollar increases, the dollar has _______against the yen. 7. ________ is the rate at which a person can trade the goods and services of one country for the goods and services of another.
8. Good and services that are produced abroad and sold domestically is _______.
9. If a case of German beer is twice as expensive as American beer, the real exchange rate is _____case of German beer per case of American beer.
10. An appreciation in the U.S. real exchange rate means that U.S. goods have become more _______compared to foreign goods
TRUE OR FALSE
1. It is possible to have a real exchange rate appreciation and a nominal exchange rate depreciation at the same time
buys more foreign currency, the dollar is said depreciate.
3. A country with negative net exports has a trade surplus 4.
If a country’s import exceed its exports it has a trade deficit
5. If a country sells more goods and services abroad than it purchases abroad, it has positive net exports and a trade surplus
6. If a case of German beer is twice as expensive as American beer, the real exchange rate is 1/2 case of German beer per case of American beer.
7. Net Capital Outflow is the purchase of domestic asset by foreign residents minus the purchase of foreign assets by domestic residents.
8. The process of taking advantage of differences in prices in different markets is called arbitrage.
9. A decrease in government spending and a real depreciation is the right policy mix to improve the trade balance without changing the level of domestic output
10. If a dollar buys more foreign currency, there is an appreciation of the dollar.
MULTIPLE CHOICE
1. Bob, a Greek citizen, opens a restaurant in Chicago. His expenditures a. Increase U.S. net capital outflow and have no impact on Greek net capital outflow.
b. Increase U.S. net capital outflow and increase Greek net capital outflow.
c. Increase U.S. net capital outflow, but decrease Greek net capital outflow.
d. Decrease U.S. net capital outflow, but increase Greek net capital outflow.
2. What is the primary determinant of long-run movements in nominal exchange rates?
a.
Domestic and foreign inflation rates. c.
Domestic inflation rate and foreign interest rate d. Domestic interest rate and foreign inflation rate
5. Country A is a small country. Country B is a large country. If Country A's currency is pegged to Country B's currency,
b. Exports
6. Which of the following refers to net saving or investment abroad and is approximately equal to the value of net exports? a. Imports
d. None of the above.
c. Country B's monetary will have no effect on Country A.
b. Country A's interest rates will be determined by Country B's monetary policy.
a. Country B's interest rates will be determined by Country A's monetary policy.
d. net exports
3. If you go to the bank and notice that a dollar buys more Mexican pesos than it used to, then the dollar has
c. net foreign investment
b. exports
4. Which of the following refers to goods and services produced abroad and consumed in domestic? a. imports
d. Depreciated. Other things the same, the depreciation would make Americans more likely to travel to Mexico.
c. Depreciated. Other things the same, the depreciation would make Americans less likely to travel to Mexico.
b. Appreciated. Other things the same, the appreciation would make Americans more likely to travel to Mexico.
a. Appreciated. Other things the same, the appreciation would make Americans less likely to travel to Mexico.
c. net foreign investment d. none of the above.
7. We would expect that an increase in investment demand would result in a(n) _______ in the exchange rates and a(n) _______ in net exports.
a. increase; increase
b. increase; decrease
c. decrease; increase
d. decrease; decrease
8. You are staying in London over the summer and you have a number of dollars with you. If the dollar depreciates relative to the British pound, then other things the same,
a. The dollar would buy more pounds. The depreciation would discourage you from buying as many British goods and services.
b. The dollar would buy more pounds. The depreciation would encourage you to buy more British goods and services.
c. The dollar would buy fewer pounds. The depreciation would discourage you from buying as many British goods and services.
d. The dollar would buy fewer pounds. The depreciation would encourage you to buy more British goods and services.
9. We would expect that an increase in government spending would result in a(n) _______ in the exchange rates and a(n) _______ in net exports.
a. increase; increase
b. increase; decrease
c. decrease; increase
d. decrease; decrease
- – 10. Suppose saving is $1000 billion and net capital outflow is
$200 billion. Domestic investment is a. $800 billion.
b. $1200 billion d. $5 billion
ESSAY 1.
Suppose that UK consumers’ taste for Japanese cars increases. Answer this question using the open economy model from the Japanese perspective.
a. What happens to the demand for yen in the foreign currency exchange market b. What happens to the value of yen in the foreign currency exchange market c. What happens to Japanese net exports? Why?
d. If the Japanese are selling more cars, what must be true about Japanese imports and exports of other items?
2. Suppose the United Kingdom is perceived to be politically unstable, which induces capital flight to the United States.
a. Describe what happens in the foreign currency exchange market from the perspective of the United Kingdom b. Describe what happens in the foreign currency exchange market from the perspective of the United States.
c. Are your answers to part (a) and (b) above consistent with one another? Why? d. If the economy of United Kingdom is small when compared to the economy of the United States, what should this event do to each country's balance of trade?
3. What do you think would happen to U.S. net exports if:
a. Canada experiences a recession (falling incomes, rising unemployment) b. U.S. consumers decide to be patriotic and buy more products “Made in the U.S.A.” c. Prices of goods produced in Mexico rise faster than prices of goods produced in the U.S. 4. a. Suppose private saving increased at each real interest rate.
What would happen to the important macroeconomic variables in our model of an open economy? answer you would write if the government had reduced its deficit? Why? c. Suppose the government were to introduce an investment subsidy that increases domestic investment at each real interest rate. How would this change the important economic variables in the model?
5. Explain variables that Influence Net Exports and Net Capital Outflow.
6. Suppose a Big Mac costs $2.50 in U.S., 400 yen in Japan, nominal exchange rate is 120 yen per $. Calculate the real exchange rate.
7. Explain briefly about purchasing power parity theory and what is it limitations.
8. Would each of the following groups be happy or unhappy if the U.S. dollar appreciated? Explain.
a. Dutch pension funds holding U.S. government bonds
b. U.S. manufacturing industries
c. Australian tourists planning a trip to the United States
a. an American firm trying to purchase property overseas
9. A can of soda costs $0.75 in the United States and 12 pesos in Mexico. What would the peso-dollar exchange rate be if purchasing-power parity holds? If a monetary expansion caused all prices in Mexico to double, so that soda rose to 24 pesos, what would happen to the peso dollar exchange rate?
10. A case study in the chapter analyzed purchasing-power parity for several countries using the price of Big Macs. Here are for a few more countries:
Country Price of Predicted Actual a Big Exchange Exchange Rate Mac Rate
Indonesia 15,900 9,015 rupiah rupiah/$
Hungary 600 forints 180 forints/$
Czech Republic
52.9 korunas 21.1 korunas/$
Brazil
6.90 real 1.91 real/$
Canada
3.88 C$
1.05 C$/$
a. For each country, compute the predicted exchange rate of the local currency per U.S. Dollar. (Recall that the U.S. price of a Big Mac was $3.41.)
b. According to purchasing-power parity, what is the predicted exchange rate between the Hungarian forint and the Canadian dollar? What is the actual exchange rate? c. How well does the theory of purchasing-power parity explain exchange rates?
A MACROECONOMIC THEORY OF THE OPEN
ECONOMY
There are two basic assumption of macroeconomic model of open economy: the first is the model takes the economy’s GDP as given
the second is the model takes the economy’s price level as
given. To understand about open economy we need to focus on supply and demand in two markets. The market for loanable funds, coordinates the economy’s saving, investment, and flow of loanable funds abroad (called the net capital outflow). At the equilibrium interest rate, the amount that people want to save exactly balances the desired quantities of investment and net capital outflows.
S = I + NCO
The market for foreign-currency exchange, coordinates people who want to exchange the domestic currency for the currency of other countries. In this section, we discuss supply and demand in each of these markets.
NCO = NX
Government budget deficit occurs when the revenue applied by the government is lower than the expenditure. Trade policy is a government policy that influence the quantity of goods and services that a country import or export. in an open economy, government budget deficits raise real interest rates, crowd out domestic investment, cause the currency to appreciate, and push the trade balance toward deficit.
A MACROECONOMIC THEORY OF THE OPEN ECONOMY FILL IN THE BLANK
1. The supply of loanable funds comes from ; the demand for loanable funds comes from _____________and .
2. The supply of dollars in the market for foreign exchange comes from ; the demand for dollars in the market for foreign exchange comes from . The link between the two markets is .
3. The two markets in the model of the open economy are and the . .
4. If Net Capital Outflow increases, the ________ of loans will increase, causing the real domestic interest rate to ________.
5. If the Net Capital Outflow increases, the ________ of dollars in the Foreign Currency Exchange Market will increase, causing the real exchange rate to ________.
6. If American goods became more popular abroad, the ________ of dollars in the Foreign Currency Exchange Market will increase, causing the real exchange rate to ________.
7. If American goods become more popular abroad, the real exchange rate will ________, and Net Exports will ________.
8. Other things remaining equal, if the Federal government budget deficit increases, the real interest rate will ________, causing Net Capital Outflow and Net Exports to ________.
9. If the government imposes hefty taxes on imports (tariffs), imports will decrease, causing the real exchange rate to ________ exports, so that overall, Net Exports ________.
10. If an economic crisis were to occur in the U.S., domestic interest rates would ________, the real exchange rate would ________, and Net Exports would ________.
1. The government budget deficit leads to reduced national saving, causing the interest rate to decrease, thus reducing net capital outflow, which in turn reduces net exports.
2. If a union of textile workers encourages people to buy only American-made clothes, imports would be reduced, so net exports would increase for any given real exchange rate.
3. Japan generally runs a trade surplus because the Japanese saving rate is high relative to Japanese domestic investment.
The result is low net capital outflow, which is matched by high net exports, resulting in a trade surplus.
4. A reduction in the U.S. government budget deficit would increase national saving, shifting the supply curve of loanable funds to the right. This would increase the real interest rate in the United States, thus increasing net capital outflow, and reducing the real exchange rate.
5. Capital flight is a large and sudden movement of funds out of a country.
6. Capital flight causes the interest rate to increase and the exchange rate to appreciate
7. The market for loanable funds determines the real interest rate
8. The market for foreign-currency exchange determines the real exchange rate.
9. When domestic conditions are uncertain, capital leaves a country increasing the supply of its currency to foreign exchange markets and rising the exchange rate.
10. At the equilibrium real exchange rate, the demand for dollars to buy net exports exactly balances the supply of dollars to be exchanged into foreign currency to by assets abroad Figure 1
1. Refer to Figure 1 ---- Which of the following is consistent with capital flight from Mexico? a. The real exchange rate of the peso appreciates from E0 to E1.
b. The real exchange rate of the peso depreciates from E0 to E1.
c. The real exchange rate of the peso appreciates from E1 to E0.
d. The real exchange rate of the peso depreciates from E1 to E0.
2. Other things the same, people in the United States would want to save more if the real interest rate in the United States…
a. fell. The increased saving would increase the quantity of loanable funds supplied.
b. rose. The increased saving would increase the quantity of loanable funds demanded.
c. rose. The increased saving would increase the quantity of loanable funds supplied.
d. rose. The increased saving would increase the quantity of loanable funds supplied and would increase the quantity of loanable funds demanded.
3. You see on the Internet that the U.S. exchange rate has fallen. This might have been caused by a. a decrease in the demand for or a decrease in the supply of dollars in the market for foreign-currency exchange. dollars in the market for foreign-currency exchange.
c. an increase in the demand for or a decrease in the supply of dollars in the market for foreign-currency exchange.
d. an increase in the demand for or a increase in the supply of dollars in the market for foreign-currency exchange.
4. Suppose that the United States imposes an import quota on automobiles. In the open-economy macroeconomic model this quota shifts the a. U.S. supply of loanable funds left.
b. U.S. demand for loanable funds left.
c. demand for U.S. dollars in the market for foreign-currency exchange right.
d. supply of U.S. dollars in the market for foreign-currency exchange left. Figure 2
5. Refer to Figure 2--- Which curve shows the relation between the exchange rate and net exports? a. the demand curve in panel a.
b. the demand curve in panel c.
c. the supply curve in panel a.
d. the supply curve in panel c.
6. If U.S. citizens decide to save a larger fraction of their incomes, the real interest rate
U.S. net capital outflow increases.
b. decreases, the real exchange rate of the dollar appreciates, and U.S. net capital outflow decreases.
c. increases, the real exchange rate of the dollar appreciates, and U.S. net capital outflow decreases.
d. increases, the real exchange rate of the dollar depreciates, and U.S. net capital outflow increases.
7. Which of the following contains a list only of things that decrease when the budget deficit of the U.S. increases? a. U.S. net exports, U.S. domestic investment, U.S. net capital outflow b. U.S. supply of loanable funds, U.S. interest rates, U.S. domestic investment
c. U.S. imports, U.S. interest rates, the real exchange rate of the dollar d. None of the above is correct.
8. In the open-economy macroeconomic model, if a country's interest rate increases, its net capital outflow a. and the real exchange rate increase.
b. and the real exchange rate decrease.
c. increases and the real exchange rate decreases.
d. decreases and the real exchange rate increases.
9. In an open economy, the source of supply of loans in the loanable funds market is ________, and the source of demand is ________.
a. Investment and Net Capital Outflow, National Saving
b. Investment, National Saving and Net Capital Outflow
c. National Saving and Net Capital Outflow, Investment
d. National Saving, Investment and Net Capital Outflow
10. In the Foreign Currency Exchange Market, the supply of dollars comes from ________, and the demand for dollars comes from ________.
a. National Saving and Net Capital Outflow, Investment c. Net Exports, Investment
d. Net Capital Outflow, Net Exports
ESSAY
1. Explain the differences of open economy and close economy!
2. Explain with graph the market for loan-able funds and the effect raising real interest rate in demand site!
3. Explain and graph the market for foreign currency exchange!
4. How are the market for loan-able funds and the market for foreign currency exchange linked?
5. Why the supply curve in foreign currency exchange is vertical?
6. What is purchasing power parity?
7. Explain the effect of capital flight in a country! (use graph)
8. Explain about import quota into foreign- currency exchange market! (use graph)
9. Why Net Capital Outflow depends on the Interest Rate?
10. Why budget deficit and trade deficit called the twin deficit?
AGGREGATE DEMAND AND AGGREGATE SUPPLY
Three key of facts about economic fluctuations:
1. Economic fluctuations are irregular and unpredictable
2. Most macroeconomic quantities fluctuate together
3. As output falls, unemployment rises Economists use the model of aggregate demand and aggregate supply to analyse economic fluctuations.
Aggregate Demand Curve Aggregarte demand curve shows the quantity of goods and services that households, firms, and the government want to buy at each price level.
The curve slopes downward for three reasons:
1. Wealth effect
2. Interest-rate effect
3. Exchange-rate effect A change in consumption, investment, government purchases, and net export might shift the aggregrate demand curve.
Aggregate Supply Curve Aggregate suppy curve shows the quantity of goods and services that firms choose to produce and sell at each price level.
In the long run, the aggregate supply curve is vertical because the quantity of output does not depend on the level of prices. In the short run, the curve slopes upward for three reasons:
1. Sticky-wage theory
2. Sticky-price theory
3. Misperception theory A change in labour, capital, natural resources, technology, and expected price level might shift the short-run aggregate supply curve.
AGGREGATE DEMAND AND AGGREGATE SUPPLY
FILL IN THE BLANK1. __________ and __________ is the model economists use to analyze short run fluctuations in economic activity around its long-run trend.
2. A period of falling incomes and rising unemployment is called __________ if it is relatively mild and __________ if it is more severe. 3. __________ is based on classical dichotomy and monetary neutrality that are true in long run but not in short run. 4. __________ is short run economic fluctuations.
5. The aggregate supply curve is ________ sloping in the short run and ________ in the long run.
6. Shifts in aggregate demand might arise from __________, __________ , __________, and __________.
7. An increase in government purchase will ______ the aggregate demand curve to the ______.
8. A ________ in the expected price level raises the quantity of goods and services supplied and shifts the short-run aggregate supply curve to the ______.
9. When output falls below the natural rate of employment the ____________ shifts to the ______.
10. A period of falling output and rising prices is called ________.
TRUE OR FALSE 1. Economic fluctuations are regular and predictable.
2. Most macroeconomic variables that measure some type of income or production fluctuate separately by exactly same amount.
3. Changes in real GDP are inversely related to changes in the unemployment rate.
makes consumers feel more wealthy, which in turn encourages them to spend less.
5. According to the exchange rate effect, a rise in the Canadian price level causes Canadian interest rates to fall, the real exchange rate depreciates, which stimulates Canadian net exports.
6. The level of production in long run aggregate supply curve is also referred to as potential output or full-employment output.
7. The discovery of a new mineral deposit shifts the long-run aggregate-supply curve to the left.
8. The rises of unemployment shifts aggregate supply curve to the right.
9. In the long run, shifts in aggregate demand affect both the overall price level and output.
10. When short-run aggregate supply falls, policymakers can accommodate the shift by contracting aggregate demand to keep output at its natural rate.
MULTIPLE CHOICE 1.
An aggregate supply curve depicts the relationship between…
a. the price level and nominal GDP
b. household expenditures and household income
c. the price level and the aggregate quantity demanded
d. the price level and the aggregate quantity supplied
2. Which of the following is true about the long-run aggregate supply curve? a. It is vertical at the level of potential GDP
b. It shows the relationship between the price level and real GDP when the economy is at full employment
c. It shifts due to changes in labor, capital, natural resources, and technology d. All of the above are true price level rises significantly. Hence….
a. the individual ’s real wealth and consumption expenditure decrease b. the individual
’s real wealth decreases but real national wealth increases c. there is no change in the individual
’s real wealth
d. the individual ’s wealth increases 4.
Other things constant, the economy’s aggregate demand curve shows that… a. as the price level falls, real GDP decreases
b. any change in the price level shifts the aggregate demand curve c. the quantity of real GDP demanded decreases when the price level rises d. the quantity of real GDP demanded and the price level are not related
5. An aggregate supply curve has positive slope, because not all prices adjust instantly to changing condition so the sales will depresses and leads the firm to cut back production. This theory is called ….
a. Misperception theory
b. Classical theory
c. Sticky-wage theory
d. Sticky-price theory 6. According to ….. effect, if price rises, goods and services require more dollars, and to get these dollars, people sell bonds or other assets; this dri ves ….. interest rates and therefore the investment ….. so does the aggregate demand.
a. interest-rate; up; falls
b. exchange-rate; down; falls
c. interest-rate; up; rise
d. interest-rate; down; falls increased. Such an outcome might have occurred because sort- run aggregate supply ….. and aggregate demand …...
a. decreased; decreased
b. decreased; increased
c. increased; decreased
d. did not changed; increased
8. In the short run, a supply shock that shifts the short-run aggregate supply curve leftward ….. real GDP and …... the price level.
a. increases; raises
b. decreases; raises
c. increases; lowers
d. decreases; lowers
9. Below are some examples of changes in natural resources that shift aggregate supply curve, except …..
a. discovery of new mineral deposits
b. reduction in supply of imported oil
c. changing weather patterns that affect agricultural production d. factories destroyed by a hurricane 10. An adverse shifts in short-run aggregate supply will cause .....
a. stagflation
b. deflation
c. contraction
d. expansion
ESSAY
1. Why the aggregate supply curve in the long run is vertical? Draw and explain.
2. What is the relationship between long-run growth and inflation? Draw and explain. shock and an adverse supply shock!
4. Explain the chain of events that leads from an increase in the price level to an increase in output in the sticky-wage model!
5. Explain the chain of events that cause aggregate demand to be downward sloping according to the wealth effect?
6. What are the short-run and long-run effects of a decrease in aggregate demand! Draw and explain.
7. Suppose suppliers suddenly believe that inflation will be quite high over the coming year. Suppose also that the economy begins in long-run equilibrium, and the aggregate demand curve does not shift. What will happen to the supplier’s willingness to sell in the current time, output level and price level?
8. Draw and explain each of the following events. What will happen to the short run and long run equilibrium? a. The government cuts the tax rate on goods and services
b. The government announce a reduction in fuel prices
9. The recent flare- up of tension following Israel’s attack on Lebanon has increased the risk that other Middle-East countries could get drawn into a widening war. As a result, Iran has made it clear it is prepared to use oil as a weapon by cutting off export. In your opinion, what will happen to the equilibrium across the world? Use graph and explain how this event affect the economy?
10. Policymakers can accommodate an adverse shift in aggregate supply through monetary or fiscal policy. Explain the mechanism using graph.
THE INFLUENCE OF MONETARY AND FISCAL
POLICYON AGGREGATE DEMAND
How Monetary policy influences aggregate demand Theory of liquidity preference tells Keynes’s theory that the
interest rate adjust to bring money supply and money demand into balance. The aggregate demand curve slopes downward is caused of three reason : the wealth effect, the interest rate effect, the exchange rate effect. Equilibrium interest rate the rate at which quantity of money demanded exactly balances the quantity of money supplied. Changes in money supply > changes in interest rate > changes in total ouput at a given price. If money supply increase, it will lowers interest rate and increase total output for any given price, so the aggregate demand curve will shift to the right. If money supply decrease, it will rises interest rate and decrease total output for any given price, so the aggregate demand curve will shift to the left. How fiscal policy influences aggregate demand
Fiscal policy influences aggregate demand in two ways :