ECON 3430 Lecture Notes - Lecture 18: Real Interest Rate, Deflation, Aggregate Supply

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mag0sea

14 Apr 2017

School

York University

Department

Economics

Course

ECON 3430

Professor

Brenda Spotton- Visano

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ECON 3430 Full Course Notes

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Monetary policy should try to minimize the difference between inflation and the inflation target. In case of both demand shocks and permanent supply shocks. Policy makers can simultaneously pursue price stability and stability in economic activity. Policy makers can achieve either price stability or economic activity stability, but not both. This tradeoff poses a dilemma for central banks with dual mandates. Policy makers can respond in two possible ways: no policy response, policy stabilizes economic activity and inflation in the short run. No tradeoff between the pursuit of price stability and economic activity stability. Aggregate demand shock: policy stabilizes output and inflation in the short run. Two policy responses to a permanent supply shock: no policy response, policy stabilizes inflation. There is no trade off between the dual objectives of stabilizing inflation and stabilizing economic activity. When a supply shock is temporary, policymakers face a short-run tradeoff between stabilizing inflation and economic activity.

Related Questions

What is the main difference between a demand shock stemming from monetary policy and a demand shock that comes from a change in spending?

A) In the short-run, an autonomous monetary policy easing lowers real interest rates and raises aggregate output whereas a positive spending shock has the opposite effect on both variables.

B) An autonomous monetary policy easing raises inflation permanently whereas a positive spending shock only raises inflation temporarily.

C) An autonomous monetary policy easing has a temporary effect on the real interest rate whereas a positive spending shock has a permanent effect on the real interest rate.

D) all of the above

E) none of the above

redcattle972

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You are responsible for economic policymaking in your country. Your desire is to eliminate inflation, keeping prices absolutely stable at P = 100, no matter what happens to output. Currently, the economy is in equilibrium at Q = 3200 (where Q = potential GDP) and P = 100. You can use monetary and fiscal policies to affect aggregate demand but you cannot affect aggregate supply in the short run. How would you respond to the following scenarios?

Explain and illustrate how each of these events would affect aggregate demand, aggregate supply, and prices, then explain how you would respond with economic policies.

1. A surprise increase in investment spending

In the short run, when investment spending increases, it results in an increase in Aggregate Demand (AD), which in turn pushes up both GPD and the price index.

To counterbalance this development, government might pursue contractionary fiscal policy by increasing taxes (to reduce consumption) or decreasing its own investment and spending so that the AD curve shifts back to its original position. Alternatively, the government can pursue contractionary monetary policy by reducing money supply and increasing interest rate to discourage economic activity.

2. Catastrophic floods that cause a sharp food price increase

In this case, sharp food shortages and consequent price increases cause a shock-type adjustment of the aggregate supply curve (it shift up and to the left). The result is a lower GDP and a higher price level.

The government cannot do anything to adjust AS in the short run. However, if the goal is to maintain the price level constant, the government can decide to do something to decrease the aggregate demand to force prices to come down, though it will be accompanies by another contraction in GDP and so it would not be a smart thing to do.

To cause AD to decrease, the government, similar to example above, can pursue fiscal policy (increase taxes, decrease spending) or monetary policy (reduce supply of money to the economy and thus increase interest rates).

3. A productivity decline that reduces potential output

In this case, AS shifts to the left, as was the case in example 2. As a result, price levels go up, as the same amount of money is chasing the reduced amount of goods and services, and GDP declines.

Government remedies here would be centered about causing AD to decrease through contractionary fiscal (higher taxes, lower spending) or monetary (reduce money supply and increase interest rates) policy. Again, this decision reduces inflation but at expense of GDP, as real output shrinks further.

4. A deep depression in East Asia that causes a sharp decrease in net exports to the United States

A decrease in exports of goods to from the United States to Asia will mean that the aggregate demand (which includes net exports

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Which of the following statements has been proposed as a benefit of passive policy making?

		Passive policy making utilizes the rational expectations hypothesis.
		Passive policy making allows for making immediate changes in response to an anticipated change in economic performance.
		When using passive policy making there is no tradeoff between price stability and unemployment.
		Passive policy making does not wait for the time lag between recognition of a problem and policy action before engaging in economic policies to stabilize the economy.

1.47 points

QUESTION 6

The idea of policy making taking place in response to a predetermined set of rules is referred to as

		discretionary policy making.
		passive policy making.
		Keynesianism.
		active policy making.

1.47 points

QUESTION 7

What types of unemployment will still exist when the economy is at the natural rate of unemployment?

		frictional and cyclical unemployment only
		frictional, structural, and cyclical unemployment
		frictional and structural unemployment only
		structural and cyclical unemployment only

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QUESTION 8

The natural rate of unemployment is

		the unemployment rate that exists in long-run equilibrium, after adjustments to all changes have occurred.
		the unemployment rate when there is no structural unemployment.
		the unemployment rate when there is no structural or cyclical unemployment.
		zero.

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QUESTION 9

According to the text, minimum-wage laws cause increases in

		employment possibilities.
		structural unemployment.
		poverty.
		productivity.

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QUESTION 10

During a recession, the overall unemployment rate

		exceeds the natural rate of unemployment.
		falls below the natural rate of unemployment.
		falls rapidly.
		equals the inflation rate.

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QUESTION 11

Cyclical unemployment is

		the unemployment due to the unemployment benefits and welfare programs of the government.
		the unemployment due to union activities and government-imposed restrictions to entry into specific occupations.
		the difference between the actual unemployment rate and the natural rate of unemployment.
		the difference between the unemployment rate when the economy is in a recession and the unemployment rate when the economy is at the peak of an expansion.

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QUESTION 12

Which of the following unemployment rates can be negative?

		the natural unemployment rate
		the seasonal unemployment rate
		the official unemployment rate reported by the Bureau of Labor Statistics
		the cyclical unemployment rate

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QUESTION 13

An unexpected increase in aggregate demand typically causes

		the price level to increase but has no effect on the unemployment rate.
		frictional unemployment to increase but structural unemployment to decrease.
		the price level to increase and the unemployment rate to fall.
		the price level to increase and the unemployment rate to increase.

1.47 points

QUESTION 14

The rate of unemployment below which the rate of inflation tends to rise and above which the rate of inflation tends to fall is known as the

		non-accelerating-inflation rate of unemployment (NAIRU).
		contrary rate of unemployment.
		Phillips rate of unemployment.
		menu cost rate of unemployment.

1.47 points

QUESTION 15

Based on the work of economist A.W. Phillips, economists concluded that

		high inflation rates are associated with low unemployment rates.
		higher rates of inflation are associated with higher rates of unemployment.
		there is no trade-off between inflation and unemployment.
		unemployment can be effectively combated by raising wages.

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QUESTION 16

What happens to the Phillips curve when the expected rate of inflation rises?

		The curve shifts to the right
		The curve shifts to the left
		The Phillips curve is unaffected
		The curve becomes horizontal

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QUESTION 17

The short-run Phillips curve suggests what policy making implications?

		Passive policy making is more effective than active policy making.
		Active policy making does not yield any predictable results.
		Maintaining both the inflation and unemployment rates at low levels is possible if policy makers will rely solely on nondiscretionary policy making.
		Using discretionary policies, it may be possible to achieve just the right unemployment and inflation mix.

1.47 points

QUESTION 18

We observe the duration of unemployment falling and wage rates rising. It is likely that

		aggregate supply has increased.
		aggregate demand has increased.
		summer has arrived.
		the government has initiated expansionary fiscal policy but the policies haven't taken effect yet.

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QUESTION 19

Policymakers' attempts to use the Phillips curve to reduce the unemployment rate below the natural rate

		will be successful since the Phillips curve shows the relationship between the inflation rate and the unemployment rate.
		will be unsuccessful if monetary policy is used since monetary policy leads to higher prices.
		will be successful if monetary policy is used.
		will be unsuccessful since workers' expectations adjust to attempts to reduce unemployment below the natural rate.

1.47 points

QUESTION 20

Which one of the following would likely reduce the level of structural unemployment?

		strengthening restrictions on who can be licensed to enter certain professions
		increasing the minimum wage to encourage more people to work
		increasing the level of union bargaining power
		limiting unemployment insurance benefits

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QUESTION 21

An unexpected decrease in aggregate demand

		will decrease real GDP, but will not affect the rate and duration of unemployment.
		will decrease the price level.
		will decrease long-run aggregate supply.
		will decrease the average duration of unemployment.

1.47 points

QUESTION 22

When a person bases her future expectations for the economy on all available current data and her own judgment about future policy effects, this is known as

		rational expectations.
		irrational expectations.
		the policy irrelevance proposition.
		the new classical theory.

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QUESTION 23

According to the rational expectations hypothesis, monetary policy can have real effects on such variables as real Gross Domestic Product (GDP) in the short run

		when the Federal Reserve's open market committee operates as expected in either buying or selling bonds.
		regardless of whether the policy is anticipated or unanticipated.
		only when the policy is unsystematic and unanticipated.
		only when the policy is anticipated.

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QUESTION 24

Rational expectations theory suggests that short-run stabilization policy

		should not be attempted.
		is best achieved with fiscal policy.
		is best achieved with monetary policy.
		is equally easy to achieve with monetary or fiscal policy.

1.47 points

QUESTION 25

Proponents of the policy irrelevance proposition believe that, under the assumption of rational expectations, the unemployment rate will

		go down whenever the Fed announces an anticipated fiscal policy change.
		equal the natural rate of unemployment in the long run, regardless of any monetary policy actions.
		always be higher in the long run than the natural rate of employment.
		go up whenever the Fed announces an anticipated monetary policy change.

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QUESTION 26

For the policy irrelevance theorem to hold, people must

		not persistently make the same mistakes in forecasting the future.
		know exactly what the Fed is planning to do.
		know the future perfectly.
		never make mistakes in their forecasts, even when they do not know the future perfectly.

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QUESTION 27

According to the policy irrelevance proposition, the impact of an anticipated expansionary monetary policy will be to

		increase the price level in the long run.
		increase the real Gross Domestic Product (GDP) in the long run.
		decrease the natural rate of unemployment.
		decrease the price level and the unemployment rate.

1.47 points

QUESTION 28

One key assumption lying behind the policy irrelevance proposition is that

		prices are "sticky" upward.
		wages are "sticky" downward.
		markets are not purely competitive.
		the rational expectations hypothesis is correct.

1.47 points

QUESTION 29

According to the real business cycle theory, an increase in an input price, such as oil, will

		increase both real Gross Domestic Product (GDP) and the price level.
		increase real Gross Domestic Product (GDP) but not change the price level.
		decrease both real Gross Domestic Product (GDP) and the price level.
		decrease real Gross Domestic Product (GDP) but increase the price level.

1.47 points

QUESTION 30

When "stagflation" occurs,

		the economy experiences higher inflation rates and higher unemployment rates at the same time.
		the economy experiences lower inflation rates and higher unemployment rates at the same time.
		the economy experiences higher inflation rates and lower unemployment rates at the same time.
		the economy experiences lower inflation rates and lower unemployment rates at the same time.

1.47 points

QUESTION 31

When a supply shock is permanent

		only the short-run aggregate supply curve shifts leftward.
		only the long-run aggregate supply curve shifts leftward.
		there are no shifts in either the long-run or short-run aggregate supply curve.
		both the long-run and short-run aggregate supply curves shift leftward.

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QUESTION 32

According to economists who promote sticky-price theories,

		only monetary policy is an effective stabilization policy.
		only fiscal policy is an effective stabilization policy.
		both fiscal and monetary policy can be effective stabilization policies.
		neither fiscal nor monetary policy is an effective stabilization policy.

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QUESTION 33

Some economists suggest that because of the costs of negotiating contracts, printing price lists, etc., it is costly for firms to change prices in response to demand changes. This hypothesis is known as the

		menu cost theory.
		Phillips theory.
		Freidman theory.
		sticky wage theory.

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QUESTION 34

The menu cost theory suggests that

		wages and prices move freely and quickly.
		there will be no unemployment.
		firms find frequent price changes to be costly.
		the economy is characterized only by perfect competition.

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QUESTION 35

In new Keynesian theory, the pattern of inflation exhibited by an economy with growing aggregate demand known as inflation dynamics is

		initially speedy upward adjustment of the price level and inflation in response to higher aggregate demand followed by lower inflation in the future.
		initially sluggish downward adjustment of the price level and inflation in response to higher aggregate demand followed by lower inflation in the future.
		initially sluggish upward adjustment of the price level and inflation in response to higher aggregate demand followed by higher inflation in the future.
		initially speedy upward adjustment of the price level and inflation in response to higher aggregate demand followed by higher inflation in the future.

1.47 points

QUESTION 36

Menu costs are a possible reason for

		swings in the labor force participation rate.
		sticky product prices.
		aggregate supply shocks.
		low levels of consumer confidence in response to aggregate supply shocks.

1.47 points

QUESTION 37

New Keynesians hypothesize that

		the relationship between inflation and unemployment is exploitable in the short run.
		fluctuations in output are largely caused by supply shocks.
		the relationship between inflation and unemployment is exploitable in the long run.
		there is no relationship between inflation and unemployment.

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QUESTION 38

Economists Milton Friedman and E.S. Phelps suggested that the apparent trade-off suggested by the Phillips curve could not be exploited by policy makers, because

		unemployment levels and the inflation rate have a negative (inverse) relationship.
		unemployment levels and the inflation rate have a clear, positive relationship.
		economic participants routinely incorporate changes in the inflation rate into their expectations.
		economic participants are not rational, and therefore act unpredictably to any policy change.

1.47 points

QUESTION 39

When it comes to active policy making most economists agree that

		it is unlikely that active policy making will have any long term effects on the economy.
		it will lead to long term shocks in the system.
		it is likely that active policy making will have long term effects on the economy.
		active policy making should be used over passive policy making.

1.47 points

QUESTION 40

If population growth occurs while jobs are difficult to obtain or labor force participation does not increase,

		economic growth will be robust because any population gain is a plus.
		per capita GDP is likely to increase sharply.
		there may be little or no increase in a nation's labor resources.
		a nation's labor resources will still continue to increase in both quality and quantity.

1.47 points

QUESTION 41

If the level of aggregate real Gross Domestic Product (GDP) remains constant, a reduction in the population

		indirectly reduces per capita real GDP.
		directly reduces per capita real GDP.
		directly increases per capita real GDP.
		has no effect on real per capita real GDP.

1.47 points

QUESTION 42

Suppose a nation's real Gross Domestic Product (GDP) grows at a constant rate of 5 percent per year while its population grows 2 percent annually. Given this information, this nation's annual rate of per capita real GDP growth is approximately equal to

		2 percent
		1 percent
		5 percent
		3 percent

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QUESTION 43

In the determination of economic growth, political freedom

		is equally as important as economic freedom.
		appears to be less important than economic freedom.
		contributes little to job growth.
		is more important than economic freedom.

1.47 points

QUESTION 44

Political freedom can sometimes moderately reduce economic growth because

		special interest groups may gain at the expense of the overall economy.
		campaign contributions rob the economy of investment.
		most jobs are in unions that are politically connected.
		none of the above.

1.47 points

QUESTION 45

Economic freedom is

		the right to own private property and to exchange goods with minimal government interference.
		present as long as private individuals own businesses.
		the amount of control that the government has in a market.
		the right to vote in an election for a political leader.

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QUESTION 46

The right to openly support and democratically select national leaders is

		population freedom.
		political freedom.
		economic freedom.
		capital freedom.

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QUESTION 47

Economic growth is measured by

		the annual percentage change in nominal GDP.
		the annual percentage change in per capita real GDP.
		the annual percentage change in per capita nominal GDP.
		the annual percentage change in the unemployment rate.

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QUESTION 48

Laws that make it difficult to start a new business lead to a

		laissez-faire.
		low rate of economic growth.
		high rate of economic growth.
		more political freedom.

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QUESTION 49

Dead capital is

		any capital resource that lacks clear title of ownership.
		machinery that requires constant maintenance.
		machinery that fails to operate properly.
		a capital resource that depreciates rapidly.

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QUESTION 50

The significance of dead capital is that

		it is being removed from its most efficient use.
		it is difficult to allocate to its most efficient use.
		its fixed cost is too high.
		it replaces too many workers.

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QUESTION 51

Developing countries are damaged by dead capital because

		it replaces too many workers, creating unemployment.
		resulting inefficiencies greatly reduce the rate of return on investment.
		it must be sold as scrap.
		none of the above.

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QUESTION 52

The role that dead capital plays in a country's economic growth is that

		growth neither increases nor is impaired by dead capital.
		growth increases because the dead capital is replaced with more technologically efficient capital.
		growth increases since the firms using the dead capital are using it for free.
		growth is impaired since the capital cannot be allocated to its most efficient use.

1.47 points

QUESTION 53

When government inefficiencies exist,

		a country tends to grow at a faster rate.
		economic growth is not influenced.
		dead capital is usually not a problem.
		a country tends to grow at a slower rate.

1.47 points

QUESTION 54

The acquisition of more than 10 percent of the shares of ownership in a company in another nation is called

		gross private international investment.
		majority investment.
		foreign direct investment.
		portfolio investment.

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QUESTION 55

Most international investment finance today comes from

		portfolio and foreign direct investment.
		the sale of antiques.
		government financing.
		tax collections.

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QUESTION 56

Portfolio investment means buying

		livestock.
		less than 10 percent ownership in a foreign company.
		a life insurance policy when traveling abroad.
		more than 50 percent ownership in a foreign company.

1.47 points

QUESTION 57

The primary motivation for private foreign investment in developing nations is

		to eradicate poverty.
		to improve the standard of living for workers.
		the potential for high rates of return.
		to do research in countries with fewer social regulations.

1.47 points

QUESTION 58

An international financial crisis is most often caused by

		a nation's central bank lowering domestic interest rates.
		a drop in the value of the U.S. dollar.
		foreign investments and loans being withdrawn from a nation.
		a government refusing to pay its dues to the United Nations.

1.47 points

QUESTION 59

Adverse selection is a barrier to financing global growth because

		there is the possibility that the funds are used for riskier behavior than the lender agreed to.
		firms sometimes have trouble determining whether they need funds or not.
		if investors have trouble identifying high-risk firms they may be unwilling to lend funds to creditworthy firms.
		of the differences between financing using loans, portfolio investment and foreign direct investment.

1.47 points

QUESTION 60

Moral hazard is a barrier to financing global growth because

		there is the possibility that the funds are used for riskier behavior than the lender agreed to.
		if investors have trouble identifying high-risk firms they may be unwilling to give money to creditworthy firms.
		firms sometimes have trouble determining whether they need funds or not.
		of the differences between financing using loans, portfolio investment and foreign direct investment.

1.47 points

QUESTION 61

Two types of asymmetric information that create problems for international investment are

		adverse hazard and moral selection.
		adverse hazard and moral hazard.
		adverse selection and moral selection.
		adverse selection and moral hazard.

1.47 points

QUESTION 62

The multinational agency that specializes in making loans to developing nations in an effort to promote long-term development and growth is the

		International Monetary Fund.
		United Nations Development Program.
		World Trade Organization.
		World Bank.

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QUESTION 63

The multinational organization that aims to promote world economic growth by fostering financial stability is the

		World Bank.
		United Nations.
		International Monetary Fund.
		World Trade Organization.

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QUESTION 64

A nation's account with the IMF is called its

		deposit surplus.
		capital account.
		current account.
		quota subscription.

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QUESTION 65

The international unit of accounting used by the International Monetary Fund (IMF) is called

		the Eurodollar.
		the IMF dollar.
		the quota subscription.
		special drawing rights.

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QUESTION 66

The International Monetary Fund (IMF) was created to achieve each of the following goals EXCEPT

		to supervise exchange-rate practices of member countries.
		to help finance economic development in poor countries.
		to encourage convertibility of member countries' currencies.
		to lend funds to countries having difficulties meeting their international payment obligations.

1.47 points

QUESTION 67

The World Bank specializes in making loans to promote

		short-term assistance when a nation experiences a financial crisis.
		financial stability.
		so-called stand-by arrangements and credits.
		long-term development and growth.

1.47 points

QUESTION 68

The International Monetary Fund

		is the bank that causes international financial crisis when the reserves are too high.
		is a central bank like the Federal Reserve System.
		is a multinational organization that aims to promote world economic growth through more financial stability.
		is a multinational agency that specializes in making loans to promote long-term development and growth in developing countries.

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ECON 3430 Lecture Notes - Lecture 18: Real Interest Rate, Deflation, Aggregate Supply

ECON 3430 Full Course Notes

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