Economics Chapter: Asymmetric Information & IS Curve
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Questions and Answers

What is the primary source of sustained real increases in household incomes?

  • Economic growth (correct)
  • High unemployment
  • Stable financial markets
  • Low interest rates

    • What does the money multiplier depend on?

  • The amount of currency printed by the treasury
  • Actions of the central bank, banking system, and nonbanking public (correct)
  • Government spending
  • Interest rates set by financial institutions

    • Which type of unemployment does monetary policy aim to lower?

  • Cyclical unemployment (correct)
  • Seasonal unemployment
  • Structural unemployment
  • Frictional unemployment

    • What effect does high unemployment have on businesses?

    <p>Decreases investment likelihood</p> Signup and view all the answers

    How does an increase in the required reserve ratio (RR) affect the money multiplier?

    <p>It decreases the money multiplier</p> Signup and view all the answers

    In the realistic deposit multiplier formula, what does '(C + D)' represent?

    <p>Total currency and demand deposits</p> Signup and view all the answers

    What is one of the goals of maintaining interest rate stability?

    <p>To avoid financial market distortions</p> Signup and view all the answers

    Which monetary policy goal relates to stabilizing the currency's foreign-exchange value?

    <p>Foreign-exchange market stability</p> Signup and view all the answers

    What components are included in the M2 money supply?

    <p>Currency, demand deposits, savings, and money market accounts</p> Signup and view all the answers

    How does frictional and structural unemployment affect monetary policy efforts?

    <p>They do not need to be addressed by monetary policy.</p> Signup and view all the answers

    Which of the following is NOT considered a goal of monetary policy?

    <p>Income redistribution</p> Signup and view all the answers

    What is a consequence of inflation on economic decision-making?

    <p>It diminishes the effectiveness of prices as signals</p> Signup and view all the answers

    What is the Fed’s Dual Mandate concerned with?

    <p>Price stability and maximum employment</p> Signup and view all the answers

    How does a rise in currency to demand deposit ratio (C/D) impact the money supply?

    <p>It decreases the money supply</p> Signup and view all the answers

    What can result from sharp fluctuations in interest rates?

    <p>Problems for financial institutions</p> Signup and view all the answers

    What is the first priority of the six monetary policy goals?

    <p>Price stability</p> Signup and view all the answers

    What does Adverse Selection primarily involve in the context of asymmetric information?

    <p>The process through which sellers have information that buyers do not regarding product risk.</p> Signup and view all the answers

    How does a rightward shift in the IS curve generally affect the economy?

    <p>It signals a lower real interest rate and increased overall demand.</p> Signup and view all the answers

    According to Okun's Law, what happens when the output exceeds potential output?

    <p>The unemployment rate is one-half of a percentage point below the natural rate.</p> Signup and view all the answers

    What is the primary focus of the Phillips Curve?

    <p>The trade-off between unemployment and inflation in the short run.</p> Signup and view all the answers

    What is the general outcome of applying monetary policy aimed at controlling inflation?

    <p>It can lead to higher unemployment in the short run.</p> Signup and view all the answers

    Which of the following is NOT a component of Aggregate Demand?

    <p>Wage Levels</p> Signup and view all the answers

    What is indicated by a tight labor market according to the Phillips Curve?

    <p>Increased inflation rates.</p> Signup and view all the answers

    What does 'r' represent in the context of real interest rates?

    <p>Nominal interest rate adjusted for inflation.</p> Signup and view all the answers

    What does an expected appreciation of the domestic currency imply for the interest rate on domestic bonds?

    <p>It will decrease the interest rate on domestic bonds</p> Signup and view all the answers

    In the context of foreign exchange intervention, what is the primary goal of a central bank when it increases the supply of its own currency?

    <p>To decrease the foreign exchange value of the dollar</p> Signup and view all the answers

    What is an effect of unsterilised intervention by a central bank?

    <p>It increases the monetary base</p> Signup and view all the answers

    If the expected returns on assets in terms of foreign currency are higher than domestic assets, what is likely to happen?

    <p>There will be an increased demand for foreign assets</p> Signup and view all the answers

    What is the role of international reserves for a central bank?

    <p>They are assets denominated in foreign currencies used in transactions</p> Signup and view all the answers

    How does the equilibrium state relate the returns on domestic and foreign assets?

    <p>Returns on domestic and foreign assets must equal each other</p> Signup and view all the answers

    What happens to the demand for domestic assets when expected returns in dollars are greater than in foreign currencies?

    <p>Demand for domestic assets increases</p> Signup and view all the answers

    What is the effect of 'expected depreciation' of the domestic currency on foreign bond interest rates?

    <p>It increases foreign bond interest rates</p> Signup and view all the answers

    What is the effect of sterilised intervention on the monetary base?

    <p>The monetary base remains unchanged.</p> Signup and view all the answers

    Which of the following best describes the impact on the exchange rate when the central bank conducts an open market purchase of Treasury Bonds?

    <p>The exchange rate will stabilize and not change.</p> Signup and view all the answers

    In a fixed exchange rate regime, a currency is typically:

    <p>Fixed to a certain price with another currency.</p> Signup and view all the answers

    What components are included in the IS curve?

    <p>Interest rates and GDP or aggregate demand.</p> Signup and view all the answers

    When firms with excess funds decide to invest, which factor primarily influences their decision?

    <p>The rate of return on investments relative to the opportunity cost.</p> Signup and view all the answers

    What does the monetary policy aim to correct during fluctuations?

    <p>Fluctuations in aggregate demand.</p> Signup and view all the answers

    Which type of investment is considered 'planned' investment?

    <p>Fixed investment.</p> Signup and view all the answers

    The equation B = R + Currency in Circulation illustrates the relationship between which factors?

    <p>Monetary base and currency circulation.</p> Signup and view all the answers

    Study Notes

    Asymmetric Information

    • Adverse selection occurs when one party to a transaction has better information than another party.
    • Moral hazard occurs when one party to a transaction takes actions that are detrimental to the other party, but which are not fully apparent to the party they are acting against.

    Net Exports

    • The responsiveness of net exports to changes in the real interest rate is denoted by 'X'.

    Government

    • The government uses a number of tools to control spending and taxation, including consumption, investment, government purchases, and net exports.
    • Goods market equilibrium is represented by the equation: Y = C + I + G + NX.

    IS Curve

    • The IS curve is a negative relationship between the interest rate and the level of GDP.
    • An increase in the real interest rate, represented by 'r', shifts the IS curve to the left.
    • An increase in government spending, represented by 'G', shifts the IS curve to the right.

    Monetary Policy

    • Monetary policy is the control of the money supply and credit conditions.
    • Monetary policy can affect both inflation and GDP.

    Aggregate Demand (AD)

    • The aggregate demand curve shows the relationship between the price level and the quantity of goods and services demanded.
    • The AD curve is downward sloping due to the real balance effect, interest rate effect, and exchange rate effect.

    Aggregate Supply (AS)

    • The aggregate supply curve shows the relationship between the price level and the quantity of goods and services supplied.
    • The AS curve can be short-run or long-run, and shifts due to factors such as changes in resources, technology, and expectations.

    Phillips Curve

    • The Phillips curve shows the negative relationship between unemployment and inflation.
    • In the short-run, there is a trade-off between unemployment and inflation.
    • In the long-run, there is no trade-off, as the economy will naturally gravitate to a natural rate of unemployment.

    Okun's Law

    • Okun's Law explains the relationship between the output gap and the unemployment gap.
    • It states that for every percentage point that output is above potential, the unemployment rate is half a percentage point below the natural rate of unemployment.

    The Money Multiplier

    • The money multiplier is the ratio of the change in the money supply to the initial change in reserves.
    • The money multiplier is affected by the required reserve ratio, excess reserves, and the nonbank public's desire to hold checkable deposits.

    Monetary Policy Goals

    • The primary goal of monetary policy is to promote price stability.
    • Other important goals include high employment, economic growth, and stability of financial markets and institutions.

    Monetary Policy Tools

    • The three main monetary policy tools used by the central bank are open market operations, the discount rate, and reserve requirements.

    Exchange Rates

    • The exchange rate is determined by the relative supply and demand for currencies.
    • The exchange rate affects international trade and investment.

    Foreign Exchange Intervention

    • Foreign exchange intervention is the deliberate action by a central bank to influence the exchange rate.
    • International reserves are central bank assets that are denominated in a foreign currency and used in international business transactions.
    • The central bank can increase the supply of dollars by buying foreign assets, which injects more dollars into the international financial system.

    Sterilised Intervention

    • Sterilised intervention is used by a central bank that wants to influence exchange rates without impacting the money supply.

    Exchange Rate Regimes

    • There are three main types of exchange rate regimes: fixed, floating, and managed float.
    • A fixed exchange rate regime is when a currency is pegged to another currency.
    • A floating exchange rate regime is when a currency is allowed to fluctuate against other currencies.
    • A managed float regime is when a central bank attempts to influence exchange rates by buying and selling currencies.

    Expenditure Concepts

    • Household, business, foreign and government spending are all factors that influence the demand for domestically produced goods and services.

    Consumption Expenditures

    • Household consumption, represented by 'C', is influenced by disposable income and the marginal propensity to consume.

    Investment Expenditures

    • Investment expenditures, represented by 'I', include fixed investment and inventory investment, and are affected by interest rates, expected returns on investment and business expectations.

    IS Curve

    • The IS curve is a graphic representation of the relationship between interest rates and the level of GDP.
    • It shows how changes in investment, consumption, or government spending can impact GDP.
    • The IS curve is downward sloping, because as interest rates rise, investment spending tends to decline, leading to a decrease in GDP.
    • The IS curve shifts because of changes in factors that affect investment, consumption, or government spending.

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    Description

    Test your understanding of key economic concepts including asymmetric information, net exports, government spending, and the IS curve. This quiz covers crucial relationships like adverse selection, moral hazard, and the impacts of monetary policy. Explore how these factors interact to shape economic outcomes.

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