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Econ 110 FinalReview
Review Qs
| Question | Answer |
|---|---|
| Suppose the federal government cuts spending to the Supplemental Nutrition Assistance Program (SNAP). How does this affect AD or AS, and what happens to output and production? | This shifts the aggregate demand (AD) curve back (left) because government spending is a component of AD. As a result, output and production decrease, unemployment rises, and there is downward pressure on the price level. |
| A massive tornado destroys key infrastructure in Kansas. How does this affect AD or AS, and what happens to output and production? | This shifts the short-run aggregate supply (SRAS) curve back (left) due to higher production costs and reduced productive capacity. As a result, output and production fall while the price level rises, creating stagflation-like conditions. |
| Suppose the reserve requirement (rr) is 12% and the initial deposit is $20,000. How much money is created? | Money multiplier (mm) = 1/rr = 1/0.12 = 8.33 Total deposits = 8.33 × $20,000 = $166,666.67 Money created = $166,666.67 − $20,000 = $146,666.67 |
| List and explain the four functions of money. | Means of Exchange – used to buy goods and services • Store of Value – holds purchasing power over time • Unit of Account – provides a common measure of value • Standard of Deferred Payment – used to settle future payments and debts |
| What happens in the AD/AS model if the Fed increases the interest on reserve balances (IORB)? | An increase in IORB encourages banks to hold reserves rather than lend, reducing investment. This shifts aggregate demand (AD) back (left). As a result, output and production decrease, unemployment rises, and the price level falls. |
| According to the Quantity Theory of Money, what happens if the money supply decreases and velocity is constant? | Using V × M = P × Y, a decrease in the money supply leads to a decrease in the price level (P) and real GDP (Y). Investment falls, causing aggregate demand to decrease. |
| Explain the basic structure of the individual income tax system in the U.S. | Individuals pay taxes on all income earned during the year. Income is divided into tax brackets, higher brackets taxed at higher rates. |
| Why is the basic structure of the individual income tax system progressive? | PROGRESSIVE to promote equity, AUTOMATIC STABILZER by collecting more taxes during expansions and less during recessions. |
| What is crowding out, and how does government borrowing affect the economy? | Government borrows in the loanable funds market to finance deficits, increasing demand for funds. Raises interest rates, making private investment more expensive and reducing investment. Can slow long-run economic growth by limiting capital accumulation. |
| Identify and explain one practical difficulty of discretionary fiscal policy related to politics. | Political bias makes expansionary policy more attractive than contractionary policy. More willing to cut taxes/increase spending during recessions but reluctant to raise taxes or cut spending during booms, persistent deficits and inflationary pressure. |
| Identify and explain a second practical difficulty of discretionary fiscal policy. | long legislative lag. Fiscal policy requires approval from both Congress and the President, which can take time w/ debate and amendments. Takes time to enact, economic conditions can change, making the policy ineffective or counterproductive. |
| What is real GDP? | Real GDP measures total output of goods and services in the economy, adjusted for changes in the price level. |
| Aggregate Supply Definition | Total quantity of OUTPUT (real GDP) firms produce and sell at each price level, UPWARD Sloping |
| Aggregate Demand Definition | Total amount of SPENDING on goods and services in an economy, DOWNWARD sloping |
| AD components | C, I, G, Nx |
| What shifts AD outward | tax cuts, confidence, low interest rates, optimism, gov spending, favorable exchange rates |
| What shifts AD inward | low confidence, high interest rates, strong dollar, trade restrictions |
| What shifts SRAS outward | lower input costs, productivity, favorable supply shocks |
| What shifts SRAS inward | higher input costs, negative supply shocks |
| what shifts LRAS | productivity growth, technology, capital, labor, human capital |
| Real Wealth Effect (AD Movement) | Changes in real value or purchasing power of household assets (stocks, home) make people feel richer or poorer, affecting their spending and economic demand |
| Money Market Effect (AD Movement) | How shifts in the supply and demand for short-term funds influence INTEREST RATES, liquidity, and overall lending/borrowing conditions in the economy. |
| International Substitution Effect (AD Movement) | Changes in relative prices b/n countries make domestic goods seem more or less expensive than foreign goods, causing consumers and firms to shift spending towards the cheaper option, altering demand for imports/exports |
| LRAS Definition | Vertical Line of full employment/potential real GDP |
| The flatter SRAS is... | price level changes affect larger changes in output |
| High Unemployment on LRAS | equilibrium is left of LRAS |
| Inflation on AD/AS | higher equilibrium price level, AD shifts right or AS shifts left |
| Economic growth in AD/AS | LRAS shifts right (economic capacity increases) |
| When costs increase, SRAS shifts ___ | back |
| What zone of SRAS shows high unemployment and low inflation? | Keynesian zone (flat SRAS) |
| What zone shows trade-off between unemployment and inflation? (inverse relationship) | Intermediate zone |
| What zone shows low unemployment and strong inflation pressure? | Neoclassical zone (steep SRAS) |
| 2 Causes of inflation | 1. AD shifts out past potential GDP, increases PL, fully employed; 2. Shift back in SRAS due to changed in input prices |
| What is stagflation? | Inflation + falling output, typically from SRAS shifting left |
| What are the four functions of money? | Medium of exchange, store of value, unit of account, standard of deferred payment |
| What characteristics must money have? | Durable, valuable, standardized, divisible, generally accepted |
| What is commodity money? | Money with intrinsic value (gold, silver) |
| What is commodity-backed money? | Paper money redeemable for a commodity |
| What is flat money? | Money with no intrinsic value; value comes from government declaration |
| What is the double coincidence of wants? | In barter, both parties must want each other’s goods—money solves this |
| What is M1? | Currency, demand deposits, checkable deposits |
| What is M2? | M1 + money market funds + time deposits (savings) |
| When did we leave the gold-standard | under Nixon in 1972 |
| Debit cards ____ counted but credit cards ___ counted | are, aren't |
| How do banks make profit? | Paying low interest on deposits and earning higher interest on loans |
| Banks want to maximize what to maximize profit? | giving out loans |
| What is fractional reserve banking? | Banks keep only a fraction of deposits as reserves and loan out the rest |
| Formula for money multiplier? | mm = 1 / rr |
| Total deposits formula? | mm × initial deposit |
| Money Created formula? | Total Deposit - Initial Deposit |
| What year was the Federal Reserve created? | 1913 |
| Why was the Fed created? | Prevent bank failures, stabilize financial system |
| What is the Fed’s structure? | Board of Governors (7 members) + 12 Regional Banks |
| What is the Fed’s key role during crises? (prevent bank runs) | Lender of last resort |
| What is deposit insurance? | FDIC insures deposits up to $250,000 |
| What is the federal funds rate? | Rate banks charge each other for overnight loans of reserves |
| What are open market operations? | Fed buys/sells treasury securities to change reserves and interest rates |
| What happens when Fed buys bonds? | Reserves ↑, interest rates ↓, money supply ↑, AD shifts outward |
| What is the discount rate? | Rate banks pay when borrowing directly from the Fed. |
| What is IORB? | Interest On Reserve Balances—rate paid on reserves in ample reserves framework. |
| What is ONRRP? | Overnight Reverse Repo Facility—sets rate floor for non-banks |
| What is ample reserves framework | Banks hold abundant reserves so the Fed controls interest rates directly instead of the money supply |
| In ample reserves framework, how does Fed influence rates? | Using administered rates (IORB, ONRRP) instead of changing money supply |
| What is a pitfall of monetary policy? | Long lags, excess reserves reduce effectiveness, unpredictable velocity of money |
| Velocity of Money is | How fast money circulates in the economy, V=Nominal GDP/Money Supply |
| Quantity Theory of Money | more money = higher prices if output is constant |
| Quantity theory of money equation? | Money Supply × V = PL × Real GDP |
| Non-Ample Reserves | Fed controls interest rates by adjusting scarce bank reserves rather than targeting abundant reserves |
| Difference between deficit and debt? | Deficit = yearly shortfall; debt = accumulation of past deficits |
| What is entitlement spending? | Mandatory spending (Social Security, Medicare, Medicaid) |
| What is discretionary spending? | Spending Congress decides annually (defense is largest) |
| What is a progressive tax system? | Higher income → higher tax rate |
| Expansionary Monetary Policy | stimulate borrowing AD OUTWARD |
| Contractionary Monetary Policy | reduce borrowing AD INWARD |
| What is crowding out? | Government borrowing raises interest rates, reducing private investment |
| What are automatic stabilizers? | Policies that automatically change with the business cycle (UI, SNAP, progressive taxes) |
| Problems with fiscal policy? | Recognition lag, legislative lag, implementation lag, political incentives, inflation risk |
| What is the debt-to-GDP ratio? | Government debt divided by GDP, measure of solvency (ability to pay debt) |
| Deficit | spending > revenue |
| Budget Surplus | spending < revenue |
| Non-ample reserves framework | Changes in the money supply will change federal funds rate |
| State and Local taxes | property, income, and sales |
Created by:
lexi.welte
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