Macroeconomics Unit 5 Study Notes
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Questions and Answers

If an economy is in long-run equilibrium, which of the following combinations of policy actions will necessarily result in inflation in the short run?

  • Increasing administered interest rates and increasing government spending
  • Increasing administered interest rates and decreasing government spending
  • Decreasing administered interest rates and increasing government spending (correct)
  • Decreasing administered interest rates and decreasing government spending

Given the situation illustrated in the graph and holding all other influences constant, which of the following policies will restore the macroeconomic equilibrium to full employment?

  • An expansionary fiscal policy and an expansionary monetary policy
  • A contractionary fiscal policy and an expansionary monetary policy
  • An expansionary fiscal policy and a contractionary monetary policy
  • A contractionary fiscal policy and a contractionary monetary policy (correct)

If the actual inflation rate is less than the expected inflation rate, which of the following must be true? Potential real output exceeds equilibrium real output.

True (A)

Assume members of the Organization of the Petroleum Exporting Countries (OPEC) agree to a coordinated increase in oil production. If the economy is at equilibrium at point B, what effect will this have on the Phillips curve model in the long run?

<p>The SRPC will shift to the left. (A)</p> Signup and view all the answers

According to the quantity theory of money, if the money supply is $40 billion, real output is $100 billion, and the price level is 1.2, what is the velocity of money?

<p>3.0</p> Signup and view all the answers

Country X's economy is currently at full employment. Assume Country X's central bank increases the money supply by 2 percent over a prolonged period. According to the quantity theory of money, which of the following will happen in the long run for a given velocity of money?

<p>Nominal output will increase by 2%. (D)</p> Signup and view all the answers

Which of the following is true about the national debt of the United States?

<p>It is the accumulation of past and current budget deficits and surpluses. (A)</p> Signup and view all the answers

Which of the following will most likely occur if a government adopts an annually balanced budget rule that requires the government to eliminate any deficits or surpluses?

<p>The automatic stabilizing effect of fiscal policy will be eliminated. (A)</p> Signup and view all the answers

If the total of government spending plus government transfer payments is less than tax revenues, which of the following must be true? The government budget is in surplus.

<p>True (A)</p> Signup and view all the answers

The United States national debt is

<p>the amount of money owed to holders of United States government securities (D)</p> Signup and view all the answers

Assume a country's government has a balanced budget. If the economy goes into a recession, what will happen to the government's budget in the short run?

<p>It will be in deficit, because there will be an automatic decrease in tax receipts. (C)</p> Signup and view all the answers

Assume a country's banking system has limited reserves. If the government has increased the budget deficit and interest rates have remained constant, which of the following is true?

<p>Government spending is greater than tax revenue, and the central bank increases the money supply. (C)</p> Signup and view all the answers

Crowding out occurs when

<p>government borrowing to finance its spending decreases private sector spending (B)</p> Signup and view all the answers

An increase in government spending financed by increased borrowing will most likely change the real interest rate and the gross private domestic investment in which of the following ways?

<p>Real Interest RateGross Private Domestic InvestmentIncreaseDecrease (A)</p> Signup and view all the answers

If investment demand becomes less responsive to changes in interest rates, which of the following is true?

<p>An expansionary fiscal policy results in less crowding out. (B)</p> Signup and view all the answers

Which of the following describes the effect of an increase in a government's budget deficit on the real interest rate and private investment?

<p>Increase, Decrease (C)</p> Signup and view all the answers

Increases in human capital can be achieved by which of the following?

<p>Improving the quality of job-training programs (C)</p> Signup and view all the answers

Economic growth is best defined as

<p>a sustained increase in real gross domestic product per capita (C)</p> Signup and view all the answers

Country A's growth rate in per capita real gross domestic product (GDP) has been consistently higher than that of Country B. Which of the following factors can account for these differences in the per capita GDP growth rates?

<p>The labor force of Country A is becoming more skilled than the labor force of Country B. (D)</p> Signup and view all the answers

Economic growth refers to an increase in which of the following?

<p>Potential real gross domestic product (B)</p> Signup and view all the answers

If an economy experiences an improvement in technology, what will happen to its production possibilities curve (PPC) and its long-run aggregate supply (LRAS) curve?

<p>Both curves shift outward. (A)</p> Signup and view all the answers

If the government offers a tax credit to businesses, what will be the most likely effects of this action?

<p>An increase in investment spending, an increase in the capital stock, and an increase in real output (D)</p> Signup and view all the answers

An increase in which of the following would be most likely to increase long-run growth?

<p>Subsidies to businesses for purchases of capital goods (B)</p> Signup and view all the answers

Policymakers concerned about fostering long-run growth in an economy that is currently in a recession would most likely recommend which of the following combinations of monetary and fiscal policy actions?

<p>Monetary PolicyFiscal PolicyDecrease administered interest ratesNo change (A)</p> Signup and view all the answers

If marginal business tax rates are decreased, how will aggregate supply and employment change in the long run?

<p>Aggregate SupplyEmploymentIncreaseIncrease (A)</p> Signup and view all the answers

Flashcards

Inflationary Policy Actions

A combination of decreasing administered interest rates (loosening monetary policy) and increasing government spending (expansionary fiscal policy) that will inevitably result in inflation in the short run, when an economy is in long-run equilibrium.

Restoring Full Employment

A combination of contractionary fiscal policy (reducing government spending or increasing taxes) and contractionary monetary policy (raising interest rates) can restore macroeconomic equilibrium to full employment, assuming all other factors remain constant.

Expected vs. Actual Inflation

If the actual inflation rate is lower than what was anticipated, it signifies that potential real output exceeds equilibrium real output. This suggests that the economy has spare capacity and is operating below its potential.

OPEC and Phillips Curve

If OPEC coordinates an increase in oil production, this would generally reduce input costs for businesses, leading to a shift in the short-run Phillips curve (SRPC) to the left, indicating lower inflation for a given level of unemployment in the long run.

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Velocity of Money

The velocity of money measures the average number of times a unit of money changes hands in a given period. In this case, with a money supply of $40 billion, real output of $100 billion, and a price level of 1.2, the velocity of money would be 3.0 (calculated as (price level * real output) / money supply).

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Money Supply & Nominal Output

According to the quantity theory of money, if the money supply increases by 2% over an extended period and velocity remains constant, nominal output will increase by 2% in the long run. This implies that inflation will offset the increase in real output.

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National Debt

The national debt of the United States represents the cumulative sum of past and present budget deficits and surpluses. It indicates the total amount owed by the government to holders of U.S. government securities.

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Balanced Budget Rule

A rule that requires the government to eliminate any budget deficits or surpluses each year would eliminate the automatic stabilizing effect of fiscal policy. This means that government spending and tax revenue would not fluctuate with changes in economic activity, potentially exacerbating business cycles.

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Budget Surplus

If government spending and transfer payments combined are lower than tax revenue, it indicates a government budget surplus, meaning the government takes in more revenue than it spends.

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Recession and the Budget

If a country's government has a balanced budget and the economy enters a recession, the budget will shift into a deficit in the short run. This is because tax revenue declines as economic activity slows.

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Limited Reserves & Budget Deficit

If a country's banking system has limited reserves and the government increases its budget deficit, the central bank will likely increase the money supply to accommodate this. The government spending exceeding tax revenue will lead to increased borrowing, which the central bank will then finance through monetary expansion.

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Crowding Out

Crowding out occurs when government borrowing to fund its spending displaces private sector investment in the economy. This happens because government borrowing increases demand for loanable funds, pushing up interest rates, making it less attractive for businesses to invest.

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Government Borrowing & Investment

Increasing government spending financed through increased borrowing (higher deficits) usually leads to a rise in the real interest rate and a decrease in gross private domestic investment. The increased borrowing to fund government spending increases demand for loanable funds, pushing up interest rates.

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Investment Sensitivity

If investment demand becomes less sensitive to changes in interest rates, an expansionary fiscal policy will result in less crowding out. This is because even if the government increases borrowing, the impact on interest rates and thus investment will be smaller if investors are less responsive to interest rate changes.

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Budget Deficit & Investment

An increase in a government's budget deficit typically leads to a higher real interest rate and a decrease in private investment. The increased government borrowing to finance the deficit increases demand for loanable funds, driving up interest rates.

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Human Capital Growth

Improving the quality of job-training programs (along with initiatives like education reform and access to healthcare) can contribute to increases in human capital, which refers to the knowledge, skills, and abilities of a workforce.

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Economic Growth

Economic growth is most accurately defined as a sustained increase in real gross domestic product (GDP) per capita over a period of time. This means an increase in the output of goods and services per person.

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Growth Rate Differences

A difference in per capita real GDP growth rates between two countries may be explained by various factors, including differences in labor force skills, technological advancements, and capital investment. If one country's labor force has become more skilled than another's, it can result in higher productivity and growth.

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Economic Growth Definition

Economic growth refers to an increase in the potential real gross domestic product of an economy. It indicates that the economy's capacity to produce goods and services has expanded.

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Technology & Growth

An improvement in technology would cause both the production possibilities curve (PPC) and the long-run aggregate supply (LRAS) curve to shift outward. Technological advancements increase productivity and allow the economy to produce more output with the same resources.

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Tax Credits & Businesses

Offering tax credits to businesses would likely lead to an increase in investment spending, an increase in the capital stock (more machinery and equipment), and an increase in real output in the long run. Tax credits incentivize firms to invest.

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Long-Run Growth Driver

An increase in subsidies to businesses for the purchase of capital goods would be most likely to increase long-run growth. These subsidies encourage firms to invest in new capital, which increases productivity and potential output.

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Recession Policy

Policymakers concerned about fostering long-run growth in an economy currently experiencing a recession would likely recommend decreasing administered interest rates (monetary policy) to stimulate demand and support economic recovery. They would likely not call for a change in fiscal policy during a recession, as the automatic stabilizers (like unemployment benefits) would help counteract the downturn.

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Tax Rate & Growth

Decreasing marginal business tax rates can increase aggregate supply and employment in the long run. Lower taxes give businesses more incentives to invest, expand, and hire more workers, leading to increased production capacity and higher employment.

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Study Notes

Unit 5 Macroeconomics Study Notes

  • Short-Run Inflationary Policies: Decreasing administered interest rates and increasing government spending can lead to inflation in the short run.

  • Restoring Macroeconomic Equilibrium: A contractionary fiscal policy paired with a contractionary monetary policy can restore equilibrium to full employment.

  • Actual vs. Expected Inflation: If actual inflation is lower than expected inflation, potential real output exceeds equilibrium real output.

  • OPEC Production Increase (Long-Run): A coordinated increase in OPEC oil production will shift the short-run Phillips Curve (SRPC) to the left in the long run.

  • Velocity of Money: Given a money supply of $40 billion, real output of $100 billion, and a price level of 1.2, the velocity of money is 3.0.

  • Long-Run Money Supply Increase: A 2% increase in the money supply over time will increase nominal output by 2% (given constant velocity) in the long run.

  • National Debt: The national debt is the accumulation of past and current budget deficits and surpluses.

  • Balanced Budget Rule: An annually balanced budget rule eliminates the automatic stabilizing effect of fiscal policy.

  • Government Budget Surplus/Deficit: If government spending plus transfers are less than tax revenues, the budget is in surplus.

  • National Debt Definition: The national debt represents the total amount owed by the government to its creditors.

  • Recessionary Budget Impact: A recessionary period results in an automatic budget deficit due to decreased tax revenue.

  • Limited Reserves and Budget Deficit: Limited banking system reserves, an increased budget deficit, and constant interest rates suggest that the central bank increases the money supply to support the deficit spending.

  • Crowding Out: Government borrowing to fund its spending can decrease private sector investment and lead to crowding out.

  • Government Spending & Real Interest Rates: Increased government spending financed by borrowing will most likely increase real interest rates and decrease private investment.

  • Investment Demand Responsiveness: If investment demand is less responsive to interest rate changes, an expansionary fiscal policy will lead to less crowding out.

  • Budget Deficit Impact on Interest Rates and Investment: An increase in the government's budget deficit will cause an increase in the real interest rate and a decrease in private investment.

  • Improving Human Capital: Improvements in job-training programs can increase human capital.

  • Economic Growth Definition: Economic growth is a persistent increase in per capita real GDP.

  • Per Capita GDP Growth Differences: Differences in per capita GDP growth rates may originate from differences in labor force skills between countries.

  • Economic Growth & Potential GDP: Economic growth refers to an increase in potential real GDP.

  • Technological Advancement and PPC/LRAS: Technological improvements shift both the production possibilities curve (PPC) and the long-run aggregate supply (LRAS) curve outward.

  • Tax Credit and Business Effects: Government tax credits increase investment spending, capital stock, and potentially real output.

  • Long-Run Growth Increase: Subsidies for business capital purchases are likely to increase long-run growth.

  • Policy Recommendations for Recession: Policymakers facing a recession would recommend decreasing administered interest rates but maintain current fiscal policy levels to boost the economy.

  • Marginal Business Tax Decrease Impact: Decreasing marginal business tax rates increase aggregate supply and employment in the long run.

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Explore key concepts in Macroeconomics Unit 5 including short-run inflationary policies, restoring macroeconomic equilibrium, and the effects of OPEC production increases. This quiz will test your understanding of theories such as the velocity of money and long-run money supply implications.

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