Questions and Answers
Which of the statements best describes why the aggregate demand curve is downward sloping? (Select all that apply)
What is the interest rate effect?
The change in consumer and investment spending due to changes in interest rates resulting from changes in the aggregate price level.
How do nominal wage changes affect the economy's output at the long-run equilibrium?
Nominal wages have no impact on output in the long run.
In the long run, the aggregate price level______ and real GDP (aggregate output)______.
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Match each of the characteristics to the situation with which they are most associated.
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What happens to the price level and GDP when a snowstorm destroys a large number of corn crops?
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What is the eventual effect on real GDP if the government increases its purchases of goods and services by $60,000?
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What is the eventual effect on real GDP if the government increases transfers by $60,000?
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What is an essential characteristic of money that fresh fish lacks?
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What is an essential characteristic of money that cattle lacks?
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Which of the statements is NOT true about a bank run?
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What is the simple money (deposit) multiplier if the required reserve ratio is 6.0%?
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Increasing the reserve ratio will _____ the money multiplier.
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If the central bank has $151709 in excess reserves and the reserve ratio is 12 percent, what is the maximum increase in money supply?
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What are open market operations?
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What is deposit switching?
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What is the bank rate?
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How much will a deposit of $4,000 increase the total value of checkable bank deposits if the reserve requirement is 18%?
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How much will a deposit of $4,000 increase the total value of checkable bank deposits if the reserve requirement is 7%?
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Decreasing the reserve requirement ____ the money supply.
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Match each scenario to whether it causes an increase or decrease in money supply:
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The Bank of Canada (BOC) is a corporation.
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Which of the statements about subprime lending is false?
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What is the term for when a change in the output gap occurs with a change in the rate of unemployment that is smaller in magnitude and in the opposite direction?
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What does the term 'money neutrality' mean?
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A decrease in real GDP causes a ____ the money demand curve.
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An increase in technology which makes it easier to pay for goods and services without carrying lots of cash causes a ____ the money demand curve.
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An increase in the aggregate price level causes a ____ the money demand curve.
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Study Notes
Aggregate Demand and Supply
- The aggregate demand curve slopes downward due to the inverse relationship between price levels and quantity demanded; as price rises, purchasing power decreases, reducing consumer spending.
- The interest rate effect indicates that changes in aggregate price levels can lead to shifts in consumer and investment spending through interest rate adjustments.
Aggregate Demand Changes
- A federal tax increase by the government leads to a decrease in aggregate demand.
- Rising consumer confidence can increase aggregate demand.
- An oversupply in a key commodity may decrease aggregate demand.
- Increasing the money supply by the Federal Reserve stimulates aggregate demand.
Short-run Aggregate Supply (SRAS)
- Higher costs in healthcare increase the burden on employers, leading to a decrease in SRAS.
- Rising commodity prices (e.g., lumber) due to weather conditions cause a decrease in SRAS.
- New productivity-enhancing technology can increase SRAS, reflecting improved efficiency.
Long-run and Short-run Equilibrium
- An increase in contracted nominal wages shifts SRAS left, but nominal wages do not impact long-run output.
- Technological advancements shift both LRAS and SRAS to the right, decreasing price levels and increasing real GDP.
Demand and Supply Shocks
- Positive demand shocks shift the AD curve right, leading to higher prices; negative shocks shift it left, lowering prices.
- Positive supply shocks reduce prices, shifting SRAS right; negative shocks raise prices, shifting SRAS left, often producing stagflation.
Economic Policy and Fiscal Measures
- Cutting taxes can counteract economic contractions and boost aggregate demand.
- Government spending increases employment rates; however, funding mechanisms affect overall economic stability.
- Automatic stabilizers, like unemployment benefits, respond to economic changes without additional legislative action.
Government Spending and Depression
- Keynes described the long-term inadequacy of waiting for market corrections, highlighting the need for immediate intervention during downturns.
- Economic stimulus through government spending can lead to significant increases in real GDP, measured by multipliers based on the marginal propensity to consume (MPC).
Money Supply Definitions
- M1+ refers to the most liquid forms of money, including currency and chequable deposits.
- M2 includes M1+ and certain types of deposits, providing a broader measure of the money supply.
- M3 expands further to include non-personal deposits and foreign currency deposits at banks.
Banking and Money Regulation
- The capital requirement ensures banks maintain a minimum capital to meet withdrawal demands and financial stability.
- The Canadian Deposit Insurance Corporation (CDIC) protects depositors in federally regulated institutions.
- A higher reserve ratio results in a lower money multiplier, while lower ratios foster more money supply expansion.
Money Supply Changes
- Central bank operations, such as buying bonds, increase the money supply; selling bonds decreases it.
- Changes in reserve requirements significantly influence the total value of checkable bank deposits, impacting the overall money supply and economic activity.### Bank of Canada (BOC) Structure and Functions
- The BOC is a corporation with the federal government appointing its governor.
- Key tasks of the BOC include managing the Canadian money supply, engaging in monetary policy, and printing money.
- Fiscal policy, managing Europe’s money supply, and creating a federal budget are not tasks of the BOC.
Subprime Lending
- Subprime lending involves issuing loans to individuals less likely to repay.
- A false statement about subprime lending is the assumption that homeowners can always sell their homes to pay off mortgages if unable to afford payments.
Open-Market Operations
- Open-market operations are central bank activities like purchasing or selling government securities to influence money supply.
- Increasing money supply occurs through buying securities, while selling them reduces it.
Money Demand Curve
- The money demand curve illustrates how saving and interest rates motivate people's liquidity preferences regarding deposits.
- Events that cause shifts include decreases in real GDP and advancements in payment technology, influencing how much money people wish to hold.
Effects of Monetary Policy
- Decreasing the money supply leads to a leftward shift in the money supply curve, resulting in increased interest rates.
- Conversely, increasing the money supply shifts the curve rightward and potentially lowers interest rates.
Inflation and Deflation
- Inflation is characterized by an overall rise in prices and can cause price fluctuations, while deflation involves a drop in prices.
- Both situations can lead to liquidity traps and have become common challenges in modern economies.
Monetary Policy Actions
- Expansionary monetary policies, such as purchasing bonds or lowering interest rates, stimulate the economy, shifting the aggregate demand curve to the right.
- Contractionary policies, like selling bonds, aim to slow economic growth and shift aggregate demand left.
Long-Run Economic Impacts
- Money neutrality suggests that changes in money supply have no real long-term effects on the economy.
- In the long run, an increase in money supply results in increased prices but does not affect real GDP.
Phillips Curve and Expected Inflation
- The Short-Run Phillips Curve (SRPC) shows the relationship between inflation and unemployment, representing how inflation expectations can shift the curve.
- A decrease in expected inflation shifts the curve downwards, leading to lower unemployment rates.
Liquidity Trap
- A liquidity trap occurs when nominal interest rates are at their lowest point and cannot be decreased further, hindering monetary policy effectiveness.
Okun's Law
- Okun's Law illustrates that changes in the output gap correlate with unemployment rates, with changes in output being smaller and opposite in direction to unemployment changes.
Summary of Graphical Relationships
- The aggregate demand and supply curves demonstrate how monetary policy influences economic variables such as interest rates, inflation, and real GDP both in the short run and long run.
- Adjustments to these curves based on expected inflation changes reflect the dynamic interactions within the economy.
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